Indian Economy for Dummies - II
S Gurumurthy, Chairman, VIF

In the second of a three-part series on the Indian economy ahead of the presentation of the Union Budget, well-known commentator on political and economic affairs, S Gurumurthy argues that the Indian family’s instinct to save in banks rather than spend at stores, which is similar to that of Japanese families, has insulated the economy from global crises. However, this cultural aspect has not been given due consideration when it comes to policy and budget-making efforts in the country. This, he explains, is due to the Western bias of Indian economists.

Domestic Impulses

Recall the economic discourse in the 1990s when, threatened by a forex crisis and nearly defaulting on its external debts, India liberalised its economy to allow free foreign investment and foreign trade. The nation was told then that as Indians did not save enough, the economy did not generate adequate capital, and therefore foreign investment was needed for growth. Emphasis was also laid on exports and foreign trade as the main drivers of growth. Looking back from the vantage point of 25 years of liberalisation, it is self-evident now that foreign investment has played but only a secondary role in the Indian growth story. The Indian economy grew primarily through domestic savings, which rose from 21 per cent of GDP in 1991-92 to as high as 37 per cent of GDP in 2009 and now hovers around 31 per cent. Domestic capital formation rose from 22 per cent in 1991-92 to a high of over 38 per cent in 2011-12.

Besides, it is not export but household consumption, close to 60 per cent, which was the mainstay of the nation’s growth. (In contrast, household consumption in China is around 36 per cent, which implies the disproportionately high external dependence of China.) Net foreign investment in India during two decades of liberalisation averaged around 3 per cent of national investment. Foreign investment mainly funded external deficit more than development within. Domestic impulses — in terms of both investment and demand — were therefore the core factors in the Indian growth story, the external forces being additives, though not unimportant. The world began taking notice of India as a domestically driven economy.

Additionally, the Global Entrepreneur Monitor Study (2002) found that India (18 per cent) was ahead of China (12 per cent) and US (11 per cent) in entrepreneurship. This helped brand India as entrepreneur-led. But the Indian-establishment economists would still underplay the domestic impulses and speak and celebrate only the role of the external drivers in the Indian growth story.

Stable Families

What is often, if not totally, missed in the Indian discourse, and in the budget making, is the undeniable fact that the household sector is the strongest and stablest component of the Indian economy. Family savings rose from 16 per cent of GDP in 1991-92 to a high of 25 per cent in 2009-10. This is because of the relation-based cultural life that marks India out from the contract-based individualist West. Except for a fraction of ultra-westernised Indians, family is not a contract to live together, terminable at will. It is an integrated cultural institution of mutually dependent persons bound by relationships of caring and sharing. It takes care of the elderly and the infirm, the ill and the jobless, which constitutes its propensity to save. In most of the West, family functions have been taken over by the State through social and health security, which, in substance, means nationalising families.

The families being rid of their relational responsibilities, their propensity to save weakened and consequently the household savings in US which was 80 per cent of US national savings in 1960 nosedived to minus 20 per cent in the third quarter of 2006. Savings turned just a subject of personal choice of the atomised individual and ceased to be a cultural, filial responsibility. The sense of duty to the near and dear, more than one’s own rights, which is inherent in Indian family culture acts as the bulwark against the unbridled individualism of the modern West. It needs no seer to say that culturally India belongs to Asia, not Europe or America. As Barry Bosworth of the Brookings Institution wrote, in Asia savings are dynastic, not personal. The idea of a rational economic man, who acts only in his self-interest, does not apply to Asia or India where filial relations undermine self-interest.

As families in the West were nationalised, traditional government functions like water supply, road building and public utilities, began to be privatised. Significantly, in the US, nationalisation of families and privatisation of government went hand in hand from around the late 1970s. Liberal economic policies, largely imported from the US, have not been able to change the cultural behaviour of Indian families. This was brought out in the Economic Survey 2007-8 (see page 3 Table 1.2/para 1.4). The income-consumption-saving for the period 1981-2 to 2007-8, which covered 10 years of command economy and 16 years of liberal economy demonstrated that the ratio of spending to savings declined from 64 per cent in 1991-2 to 58 per cent in 2007-8 — implying that Indian families have defied consumerist trends encouraged by new economic policies. Noting this fact, the Survey says, “The average growth of consumption is slower than that average growth of income primarily because of rising savings rates.” It concludes: “Year to year changes in consumption also suggest that the rise in consumption is more gradual and steady process, as any sharp changes in income tend to get adjusted in savings rate.”

The behavioural model of Indian households has a lesson for policy makers — that is, shopping is not, and cannot become, central to Indian families. But, in the US, as the famous American anthropologist Marshall Sahlins says shopping is the culmination of modernity. When an Indian household gets extra income it does not go straightaway to the shops. It saves rather than spends it. If the Pay Commission report is implemented, it will not cause instant inflation as the RBI governor seems to fear. This cultural differential is missed in the economic discourse and therefore in policy-making in India.

Similar to Japan, not US

Indian families, generally like Asian ones and particularly like the Japanese, are hooked to banks as the preferred savings vehicle. The bank deposits to GDP ratio in India was 34 per cent in 1992, and is over 70 per cent now — doubling as a proportion of GDP. The Indian stock market yielded a compounded annual return of 14 per cent between 1991 and 2015. Despite that the people have queued up before banks to deposit their savings. The share of equities in the total savings stood at less than 2 per cent in seven out of the 11 years (2004 to 2014). It exceeded 3 per cent only in three years (2007 to 2008) when there was an unprecedented boom in the stock markets. In the four years ending fiscal 2014, the share of stocks in national savings has been less than 2 per cent.

Elite economic thinkers often fault Indian families, which seek safe investment models, as backward and unenlightened. Some even fault them for saving too much. In early 1990s, Dr Jagdish Bhagwati, the India-born US economist, advised the Indian government to make policies to cut family savings by half so their consumption spend would rise. Fortunately, Indian families defied his advice. Actually, as their incomes expanded, Indian families ramped up their savings but maintained their moderate consumption. They lived within their incomes and hardly borrowed to spend. This alone insulated India from the contagion effect of the global crisis in 2008. Had Indian families followed the prescription of experts, they would not have saved as much as they did, which dramatically increased the national investment and GDP. Nor would they have avoided debts that would have risked and even bankrupted them. Indian families compare favourably with Japanese households which too are habituated to save and, like Indians, are also addicted to keeping their savings in banks, not in risky stocks. The economists of the West used to deride the Japanese financial system as inefficient for this reason. But when the monetary crisis hit the West, the Bank of Japan had the last laugh and proudly claimed that the Japanese financial system was safe and sound unlike the Western.

In a paper published in the Bank of International Settlements Site (BIS paper no 46, May 2009) two officials of the Bank of Japan (Shinobu Nakagawa and Yosuke Yasui) wrote: “The average Japanese household has a financial balance sheet that is far more conservative” than that of households in West, with “cash and deposits” representing “half of total financial assets”. In contrast, the ratio for US households is only 16 per cent and in Europe, about one-fourth to one-third. The authors asked, “Why do Japanese households prefer deposits so much over more risky financial assets” when other financial instruments are well-developed and heavily traded in Japan, unlike in some other Asian markets? They answered, “the elderly Japanese were educated to believe that saving through bank deposits was a virtue”. They went on to assert “that the Japanese household sector, far from being a shock originator, is rather a shock absorber” even as they admitted that the risk is therefore “concentrated in the Japanese banking system”, which “continues to be a matter to resolve.”

This is precisely the Indian situation. The risk of financing business is on the Indian banks like it is on the banks in Japan. The Japanese banks, like the Indian ones, also have the same issue of Non-Performing Assets. How they handle the NPA problem will be relevant to India. But the RBI, prone to looking at the West, ignores the Japanese parallel, which is nearer to the Indian filial and financial system. With the result that the RBI is strangulating the Indian economy by applying Western standards when the nation is struggling to come out of almost a decade of economic destruction by the UPA, particularly UPA II. This is a topic by itself.

Read More:
Indian Economy for Dummies - II

Is Selling PSBs to Foreigners Rajan's Agenda?

The author is a well-known commentator on economic and political affairs.

Published in The New India Express on 19th February 2016. Image Source:
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the Vivekananda International Foundation)

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