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Falling savings ratios -- Why not a small policy u-turn?

P. R. Brahmananda

MONETARY policy in Indian conditions should properly have a number of non-conflicting objectives. These consist of: a) attainment of price stability; b) prevention of unpredictable fluctuations in exchange rates; c) the achievement of a high and rising s avings/investment to income ratios; d) consequent to (c), the obtaining of a high growth rate. These four objectives do affect positively the wellbeing of the people in a community.

As most of the labour force has no access to inflation indexing provisions in their incomes, price stability is a most desired goal from the angle of the stability of their real incomes. Autonomous fluctuations in exchange rates disturb trade and lead to socially hurtful speculations. These have to be avoided, and some measure of intervention in exchange markets, assuming a measure of freedom in their normal functioning, becomes necessary.

In a developing economy, such as India, high and upward drifts in savings-investment ratios are welcome, as the growth rate is increased by higher savings and investment ratios. Care has to be taken to see that the incremental capital-output ratio does n ot go up proportionately to increases in savings ratios.

The two instruments for attaining all the four objectives are control over growth rate of money magnitudes and appropriate interest rates and changes therein.

Monetary policy has to be a mix of the money supply and interest rate changes. Appropriate money supply changes lead to price stability given the real output factor.

Appropriate interest rate changes lead to a desirable savings-investment ratio, especially in financial savings ratios.

Open market operations in sale and purchase of securities and foreign exchange help regulate the course of money supply; at the same time, suitable variations in the cash deposit ratio also help the process.

The instrument of changes in the bank rate, repo rate, etc., also helps both to regulate the course of money supply and to reach suitable yield and interest rates in the market.

Keeping down or bringing down the cash ratio increases the money multiplier. But keeping down and moving down interest rates increases the ratio of money balances held to the flow of money or nominal income. Thus, it often happens that one instrument can move up the money multiplier, while another may move down velocity.

Policies moving down the cash deposits ratio going along with a reduction in the bank rate, the repo rate etc., tend to cancel out in their effects on nominal income flows. This is what is actually happening now. The money multiplier has been going up si nce Mr Sinha took charge and at the same time, since he is pressing for a lower and lower interest rates, the income velocity is also going down.

People are holding a higher ratio of money balances with respect to their incomes. A higher money multiplier may imply an increasing drift in RBI and bank credit to government. But such increases in credit do not automatically and proportionately lead to increases in expenditures such as to keep velocity constant. Seemingly, the action by one hand of the monetary and fiscal authorities is cancelling that by the other hand of the same authorities.

One of the important promised policies by which the new government came to power was that it would move up radically the savings ratios in the economy and consequently would generate a higher growth rate. Actually, conspicuous increases in savings ratios were included prominently in the national agenda.

One would have supposed that policies would be initiated to bring about upward drifts in the savings ratios. Let us see what is happening. The net domestic savings ratio in the economy was close to 17 per cent of income in 1994-95 and 1995-96. Thereafter , it moved down to 15 per cent in 1997-98, to 13.8 per cent in 1998-99 and to 14.3 per cent in 1999-2000. Probably, during the current year, as the growth rate would be just 5 per cent less than the 6.6 per cent of 1999-2000, in all probabilities the net domestic savings ratio would have gone down.

When the present Government came to power, it promised it would push up the savings ratios and consequently generate a higher growth rate. But the net domestic savings ratio has been falling since 1995-96.

Anyway, there is no reason to expect it to be higher than 14 per cent. Since the chief instrument which the Authorities have been deploying is the increase in money supply each year, it would be interesting to express the domestic savings of each year as a multiple of the increase in money supply in that year.

The net savings to increment in broad money supply is a crucial ratio pointing to the savings-investment effect of the policy of increase in M3.

The second ratio is that of financial savings to increases in M3 during a given year. These are the two crucial ratios that are important in appraising the effect of overall fiscal and monetary policy on the growth objective.

We have worked out the two ratios for the period 1980-81 to 1999-2000. The net domestic savings to increment in M3 ratio was about 1.9 in the early 1980s. Thereafter, it came down to 1.5 in 1986-87. However, in 1990-91, it moved up to 2.19.

In the crisis year of 1991-92, it fell to 1.85. However, the policies of Dr Manmohan Singh and Dr Rangarajan enabled the ratio to go up to 2.4 in 1995-96, the highest in recent years in India. In 1996-97, it slipped to 2.0 and has been moving down therea fter.

It may be noticed that the latter is the period when the interest rates have been continuously brought down.

In 1999-2000, it was 1.66, well below the average of about 1.9, obtained during 1991-92 to 1995-96.

These were years when the growth rate goal started becoming more and more successful. The ratio of financial savings to increment in M3 was about 1.2 in 1980-81. It moved up to 1.46 in 1982-83 and thereafter started coming down.

However, during the Manmohan Singh-Rangarajan period in 1993-94, it reached a high of 1.73. Increases in M3 were being reflected in a high measure in increases in savings/investment. Thereafter, it started moving down slightly and had reached 1.57 in 199 6-97.

The aggressive policy of removal of tax exemptions on savings and of reduced interest rates brought the ratio down to 1.34 in 1999-2000. If an objective appraisal is made, the fiscal policy and the powerful pressure put by the Finance Minister for lower and lower interest rates has been the primary factor reducing the savings ratios in the economy and, consequently, reducing the growth rate of the economy.

Had the RBI been independent and this is a reasoned hunch; probably, only history can tell if I am right the growth rate would have been higher as the savings ratios would also have been higher. I do not want to blame only the Finance Minister who, unf ortunately, is not a trained economist.

But the powerful lobby in New Delhi surrounding the Finance Minister has been continuously for lower and lower interest rates and any non- independent central bank would have been probably helpless in this respect. It is not too late for the fiscal autho rities to change the policies.

A powerful Finance Minister, knowledgeable in economic matters, could surely have withstood the pressures for lower and lower interest rates. There is nothing wrong in going back to the type of policies introduced by Dr Manmohan Singh.

He moved up the growth rates and made India the talk of the world in economics. There is no great advantage in being different just for its own sake. If the economy goes on moving down in growth rates and this is due to lower than desirable drifts in sav ings ratios, why not take a small u-turn in policies?

The graph indicates clearly the three declining drifts in the most recent period in the Indian economy: One, the falling drift in the interest rate; two, the falling drift in the ratio of net savings to increase in M3; and three, the falling drift the ra tio of financial savings to increase in M3.