Analytical Lethargy

Even for the little that it has to cheer about, it doesnt do so. The most important data in this years Survey is on the central governments primary consumption account. It is now a surplus. As the graph shows, even though the primary fiscal account is still in deficit, the primary consumption account has a surplus of 0.5 per cent of GDP. A small but significant surplus. This is perhaps the first time since 1974-75 that this account is not in the red. True, some shine has gone out of the quality of fiscal adjustment by the fact that primary investment deficit has been cut by reducing capital expenditure. Nevertheless, primary consumption expenditure being less than revenue receipts is a significant development.

 

What this fundamentally means is that every rupee now spent on current expenditure the incremental revenue expenditure is not adding to the governments debt. This is the first sign of the economy getting over the fiscal hump. It is the profligacy of the past that is now creating a problem. But if prudence at the margins continues, the backlog effect should also wear off. It is now almost certain that on Friday, Mr Chidambaram will announce a primary fiscal surplus.

This small ray of hope isnt noticeable in the Survey. It is too preoccupied with contending that the recent spurt in growth is sustainable. The sustainability of this 7 per cent plus growth, the Survey points out, is due to the rise in the savings and investment rates.

It has been recognised for a while now that the rates of savings and investment have staged a dramatic statistical recovery. The savings rate gross savings as a percentage of GDP reached a historic high of 24.9 per cent in 1994-95 to move up to 25.6 per cent in 1995-96. Such a quantum jump has never taken place in the past. The rate of investment is even higher at 27.4 per cent in 1996-97.

The Survey doesnt deem it fit to explain this sustained and unprecedented rise except for stating that this seems to vindicate the reform strategy of encouraging savings by expanding saving and investment opportunities rather than giving special incentives.

Explanations are tailored to suit the situation! Commenting on the drop in the savings rate (the figure was later revised upwards), the Survey of 1994-95 shot off that: Since this decline (in the rate of savings) is observed for a year in which the GDP growth from agriculture shows a sharp turnaround from minus 2.5 per cent to plus 5.3 per cent, there appear to be grounds for reviewing the methodology for estimating savings and capital formation in the economy.

Now that the savings rate has peaked in a year of low agricultural growth, there is no mention of methodological quirks and inadequacies. Instead, the rise is seen to be the fructification of reforms.

There is one common element between the two explanations : analytical lethargy. One doesnt expect the Survey to explain the change in savings and investment rates in relation to income, interest rates, inflation, taxation, changing terms of trade between agriculture and the rest of the economy, inter-sectoral and inter-personal distribution of national income, and the spread of financial institutions. That is for the academicians to sort out. But it must draw out the full implications of its observations.

It recognises that the source of the increase in savings is the household sectors physical assets. And that the savings in financial assets has actually declined. Financial savings are the excess of current income over current expenditure.

So far, the main source of domestic savings has been the household sector. This is an indication of the financial deepening of the economy as it has allowed domestic savings to go up in a monetised form. It is these savings which pass through the financial sector in the form of savings in financial instruments currency, deposits, shares and debentures, government debt (mainly small savings) and insurance and pension funds.

As such, the decline in financial savings from 11.5 to 8.8 per cent of GDP is an extremely important trend. Yet the Survey stops short of working out the implications of this shift for their central concern sustainability. The fact that the savings which flow into the financial system are declining is surely a cause for concern.

It is obvious from the composition of the rise in savings, which is in physical assets, that well known macroeconomic growth implications will only be statistical. In doing so, sustainability of the growth argument will stand questioned.

What makes this rise significant is that household savings in the form of physical assets is a common element used by the CSO to measure savings and investment. The age-old problem of translating savings into investment has been resolved with estimational finesse!

Why have financial savings declined? Given the fact that households which account for two-thirds of the savings rate include unincorporated enterprise, it can be argued that reforms have led to this shift by adversely affecting these enterprises. Apart from other secondary affects, the decline in fixed capital formation in these enterprises is closely related to the decline in public investment.

Not much is known about the inter-relationship between different macroeconomic variables. An increase in government savings achieved through higher taxation (or even elimination of some subsidies) may result in a corresponding or even larger decline in household savings. Indeed, a part of the rise in corporate savings during the last few years is related to the reduced incidence of corporate taxation.

It may be pointed out that with such a high rate of investment, the growth rate of output has not improved to a corresponding extent. This can be taken to indicate that there has been no improvement in the efficiency of resource use in general, and that of investment in particular. This goes against conventional wisdom about gains from reforms. Domestic competition has been heightened by the deregulation process and removal of entry barriers. And import liberalisation and tariff reduction have brought in external competition. Yet, there are no indications of an increase in resource use efficiency. If anything, preliminary evidence on the lagged incremental capital output ratios show a rise.

In this context, the explanation in the Survey that private investment appears to have responded vigorously to the policy of promoting competition, removing policy distortions and hurdles, and improving access to the factors of production is not only wishful thinking but also pre-determined reasoning.