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Home > Business > Columnists > Guest Column > Haseeb A Drabu

How household savings are changing shape

September 18, 2003

While there has been a lot of debate on the highs and lows of the savings rate in the economy, not much attention has been paid to the changing composition of savings and the role that the structure of savings plays in determining the kinds of investments that will be financed by incremental savings.

This is especially important at a time when an economy is undergoing structural reforms because the composition of savings goes through considerable change during this period as inter-asset substitutability options open up.

The latest annual report of the Reserve Bank of India gives the data on household savings which forms the largest component of aggregate savings in India.

The savings of households, which includes non- corporate enterprises, are broken up into savings in physical assets and financial assets.

The latter consists of currency holdings of households, deposit holdings of banks and non-bank companies, life insurance fund, provident and pension funds, the Unit Trust of India and other financial institutions, claims on government consisting of net purchases of bonds and small savings assets by households, and the net purchases of shares and debentures by households.

This data can be usefully mined to understand the preference structure -- the microeconomic foundations for savings behaviour -- of households as they choose among various financial assets.

The rate of financial savings at 6 per cent was low in the 1970s, but with a secular rise in the interest rates and yields during the eighties and through the nineties, this registered a rise, peaking at 15 per cent by 1994-95, the highest figure reached by the financial savings ratio post-Independence.

Thereafter, with interest rates moving southwards, the ratio has been on the decline and is now estimated to be around 11 per cent.

Normally one would expect that prior to financial sector reforms, household savings will primarily be in the form of physical assets and as the financial system matures, financial intermediation will channelise more savings into the financial side and finance more productive investments.

However, the obverse seems to be happening. Till the mid-nineties, household savings in financial assets were more than household savings in the form of physical savings.

Now as per the latest estimates available, it is the physical savings that are more then those in financial assets. More than 52 per cent of the total household savings are in the form of physical assets compared to 44 per cent in the early nineties.

There seems to be a basic preference shift underlying this change.

A look at what has changed within the financial savings shows an interesting pattern.

In 1993-94, shares and debentures accounted for 13.5 per cent of the total household financial savings which has now dropped to a bare 2 per cent.

As a percentage of GDP, it is down from 2 per cent to 0.3 per cent.

This drop is largely because the savings in shares and debentures of the private corporate sector is down from 7.5 per cent  to just 1per cent.

The financial savings in deposits has also dropped from 42 per cent to 37 per cent.

The claims on government have shot up from 6 per cent to 17 per cent. The rise is evenly distributed across savings in government securities and the small savings.

Savings in government securities which was a mere 0.4 per cent in 1993-94, is now accounting for 6 per cent of the total financial savings and small savings has almost doubled from 6 per cent to 12 per cent.

The contractual savings (insurance and provident funds) have grown and now account for one third of the overall financial savings compared to a quarter in 1993-94.

To some extent, it is true that household savings in the form of financial assets were higher because of the stock market boom in the early nineties.

But what it also points to is a much stronger impact that the policy of downward drift in interest and yield rates in the last couple of years has had on the financial savings ratio.

Be that as it may, what the shift in saving towards physical assets shows is that, at present household savings in the system are being driven not by current incomes, but on expected future cash flows.

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