Boosted by rising incomes, households will likely build back their financial assets: RBI Dy Guv Patra

While the net financial savings of households have almost halved from their level in 2020-21, going forward, boosted by rising incomes, they will likely build back their financial assets, said RBI Deputy Governor MD Patra, even as he assessed that the required investment over a decade of high growth would be in the range of 33-38 per cent of GDP per annum.

Net financial savings of households refer to the net financial assets, which are measured as the difference of financial asset and liabilities flows. In 2020-21, households had annual net financial savings of ₹2280608.2 crore, per RBI data.

Behavioural changes

“In India, the household sector typically generates surplus savings relative to its investment which it lends to other sectors. Recently, the net financial savings of households have almost halved from their level in 2020-21 due to behavioural changes underway in the form of unwinding of prudential savings accumulated during the pandemic as well as shifts from financial assets to physical assets such as housing,“ Patra said at CII’s Financing 3.0 Summit.

He opined that going forward, boosted by rising incomes, households will likely build back their financial assets – 15 per cent of GDP was observed during the early 2000s up to the global financial crisis.

“This process has already begun – households’ financial assets have increased from 10.6 per cent of GDP during 2011-17 to 11.5 per cent during 2017-23 (excluding the pandemic year).

“Their physical savings have also risen in the post-pandemic years to over 12 per cent of GDP and could rise further – they had reached 16 per cent of GDP in 2010-11. Accordingly, households will remain the top net lenders to the rest of the economy in the coming decades,” the Deputy Governor said.

Patra noted that the private corporate sector has drastically reduced its net borrowings from the rest of the economy (from close to 9 per cent of GDP in 2007-08 to under 1 per cent more recently), reflecting a combination of rising internal accruals and subdued capacity creation.

“Looking ahead, its net borrowing requirement is likely to rise on the back of a revival in the capex cycle. These financing requirements will largely be met by households and external resources.

“Net dissaving of the public sector has been moderating albeit unevenly; this sector will remain a net borrower in the economy in view of the critical role envisaged for fiscal policy in shaping India’s future,” Patra said.

The Deputy Governor observed that India will need a transformation in its institutional architecture for intermediating the needs of finance of its aspirational trajectory.

He observed that if the nation as a whole has a deficit, it borrows from the rest of the world and the inflow of foreign savings helps finance its investment needs.

“For India, domestic savings have largely financed the overall investment requirements of growth, with external financing playing a supplemental role as reflected in largely modest current account deficits.

“As the productive capacity of the economy rises and its ability to absorb foreign resources expands, the volume of external financing and its composition may undergo fundamental shifts, but in the light of past experiences, external debt sustainability will remain a policy priority,” the Deputy Governor said.

Incremental capital output ratio

Patra noted that historically, phases of growth accelerations in India have been accompanied by higher gross domestic investment rates. A key determinant of the desired investment rate, apart from the overall rate of growth, is the efficiency of capital use in terms of the number of units of capital required to produce one unit of GDP.

“The lower this incremental capital output ratio (ICOR), the higher the productivity of capital or the marginal efficiency of capital. In most developed countries the ICOR is in the neighbourhood of 3.

“Over the period 2012-19, the ICOR in India averaged 5.0, but in the last three years, it eased to 4.0. As these efficiency gains rise, the workforce gathers skills and the economic structure acquires sophistication and technological progress, it is possible to envisage the ICOR in the range of 3.5 to 4,” the Deputy Governor said.

Accordingly, the required investment over a decade of high growth would be in the range of 33-38 per cent of GDP per annum.

He underscored that this is by no means infeasible if the peak of about 39 per cent achieved in 2010-11 can be reckoned as the potential.

“It is possible to finance this desired investment rate with saving rates in the range of 32-36 per cent of GDP, again achievable considering the peak of 37.8 per cent achieved in 2007-08.

“Looking ahead, this aspiration is premised on an improvement in saving potential among all major constituents – households on the back of a growing skilled workforce; businesses benefiting from the thrust on manufacturing and exports; and governments maintaining the consolidation that is underway. The contribution of external financing can change in magnitude and composition, as stated earlier,” he said.

Referring to estimates that infrastructure investment will need to rise to US$ 1.7 trillion (₹143 lakh crore), with about US$ 0.4 trillion in green investments, over the period 2024-30, Patra said going forward, the private sector will move into centre-stage for infrastructure spending, especially in energy and transportation.

The sources of financing will be diverse, ranging from debt and equity issuances in the domestic capital markets to external commercial borrowings and foreign direct investment (FDI).

Of the overall finance demand of India’s MSMEs is around US$ 1,955 billion, the demand for debt-based finance is pegged at US$ 1,544 billion, with half coming from those that prefer financing from informal sources or financially unviable enterprises.

“This leaves a debt demand of US$ 819 billion, of which US$ 289 billion demand is currently fulfilled by formal credit lenders like banks. The remaining unfulfilled demand of US$ 530 billion makes up a huge addressable market for banks, FinTechs and NBFCs,” he said.