Fiscal discipline is necessary to not just rebuild public savings, but also to redirect government spending towards productive purposes.
The country’s high savings rate, which underpinned much of its growth and investment boom of the past decade, is increasingly becoming history. The Government’s latest national income data shows a significant fall in gross domestic savings in the Indian economy from 34 to 30.8 per cent of GDP between 2010-11 and 2011-12. This is bad enough. But indications are that the savings rate could drop even further. The Japanese brokerage firm, Nomura, basing its calculations on more current trends in investments, reckons that it might touch 27 per cent this fiscal. The implication of it for investments in the economy is straight forward. During the period from 2001-02 to 2007-08, for instance, gross domestic capital formation – investment rate, in common parlance – soared from 24.3 to 38.1 per cent of GDP. Much of it was facilitated by the increase in the savings rate, from 24.9 to 36.8 per cent, that took place correspondingly. A decline in savings to 30 per cent or below means that much less of internal resources available to finance investments.
A plunge in domestic savings may not necessarily bring down investment though, to the extent of there being compensating foreign capital inflows. These inflows can keep the investment engine going for sometime. But there is a limit to how much such external capital can neutralise the erosion in the domestic resource base, which a rising cost of imports relative to exports (evident in the higher levels of current account deficits or CAD) causes. Thus, the economy may have survived a more than trebling of the CAD, from under 1.3 to 4.2 per cent of GDP during 2007-08 to 2011-12, and a sharp reduction in domestic savings as a consequence, with only a modest decline in the investment rate during this period (38.1 per cent to 35 per cent of GDP). However, the present CADs are not sustainable. In the event, either the investment rate will have to drop substantially – not a desirable outcome – or the domestic savings rate should go up to be able to finance the desired levels of investment. The latter is the only sustainable and desirable solution for restoring macroeconomic balance.
Key to this process, of course, is the Government. Fiscal discipline is necessary to not just rebuild public savings, but also to redirect government spending towards productive purposes that can stimulate the economy, thereby generating more jobs and incomes. These will, then, translate into higher savings with households and firms, besides bringing in more tax revenues for the Government. We actually saw all this happen during the last decade, and need to make it happen again.