Effect of decline in financial savings on interest rates and investment

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- Companies will not make big new investments as global demand is also expected to remain weak

The domestic financial savings data released by the Reserve Bank of India has surprised economists. This data could have a profound impact on medium-term growth. The data shows that net domestic fiscal savings are limited to 5.1 percent of gross domestic product (GDP) in 2022-23, the lowest level in decades. Last year it was 7.2 percent. There could be several reasons for such decline in financial savings. As there is an overall decline in savings, it is possible that the incomes of households whose incomes were affected during Corona may not have fully recovered. Therefore, it is possible that the improvement in the economy is due to corporate profits, which have been growing well for the last several quarters.

There is also a possibility that households will not be able to save due to the ever-increasing inflation. The rate of inflation based on the retail price index has remained high since the pandemic. The Reserve Bank has also failed to meet the inflation target set for 2022. The rate of inflation is once again above the range set by the central bank. Household financial liabilities also increased to 5.8 per cent of GDP in 2022-23 from just 3.8 per cent in 2021-22.

It is possible that people borrowed for consumption because their income was not enough. It is also possible that people may have spent and borrowed money to buy immovable property like houses etc. Domestic debt increased from 36.9 percent in 2021-22 to 37.6 percent of GDP in 2022-23. If consumption demand is also being supported by credit, which appears to be the case to some extent.

Weak demand will mean weaker economic growth in the near term. Improvement in private investment is expected to support growth. But in the absence of sustained growth in private consumption, firms may also be reluctant to expand capacity. As global demand is also expected to remain weak, companies will not want to make big new investments. In such a scenario, if private consumption, investment and exports are weak from a macroeconomic perspective, the government has to compensate. The government has been doing the same through high capital expenditure for some time now. But given all the financial constraints, the government will not be able to do this for long.

A reduction in household financial savings may also affect interest rates and investment. Notably, government debt exceeds the supply of financial savings from the domestic sector. If the corporate sector starts borrowing more for investment, the interest rate will increase. An increase in investment with less domestic savings would mean that India would have to import capital.

If this has to be done then various kinds of problems will arise. In such a situation, it seems that the overall production has recovered from the corona shock. Then the recovery is unstable and it will take time to rebalance. Therefore, how to achieve economic growth at a time when growth in the global economy is expected to slow and financial constraints may increase is a major policy challenge.

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