Precautionary savings

Households tend to save more during the time of economic turmoil and income uncertainties. Since this can affect aggregate demand in the economy, governments are expected to run larger deficits. The current economic chaos is very different from the usual business cycle slowdown. The contraction is the result of a deliberate shutdown of economic activity to contain the spread of Covid-19, which has resulted in significant hardship for a large number of households. India was anyway witnessing a sharp economic slowdown even before the spread of the virus and its impact was visible in household finances. As the outlook has now become even more uncertain, the impact on household finances is expected to play out for a long period of time. If the recovery is seen to be slow, households would get more risk-averse and cut consumption further.

For the first time, the quarterly data on household finances has been published by the Reserve Bank of India (RBI). This is a welcome development because it will help improve the general understanding of the sector. For instance, the data shows that household deposits with banks tend to contract in the first quarter, while currency holding peaks during this period. The mobilisation of deposits and disbursement of credit tend to get a boost in the last quarter of the financial year. The overall data showed net financial savings went up to 7.7 per cent of gross domestic product (GDP) in 2019-20, compared with 7.2 per cent in the previous year. However, this was not a result of an overall increase in financial savings. Net savings went up because of lower borrowing by Indian households. In fact, borrowing by households from the banking system contracted in the first quarter of the last fiscal year. In absolute terms it came down in 2019-20 over the previous year. Gross financial savings also declined to 10.6 per cent of GDP in 2019-20, compared with 11.1 per cent in the previous year. Thus, a reduction in liabilities resulted in higher net financial assets. It appears that households were reducing debt accumulation because of slowing economic growth. Financial liabilities came down from a high of 4.2 per cent of GDP in 2017-18 to 2.9 per cent in 2019-20.

It’s also likely that banks were reluctant to extend credit because of the economic environment. However, the RBI noted that borrowing picked up in the January-March quarter, partly because of the Covid-related hardship. If this is correct, banks have reasons to worry. Like the corporate sector, households are also trying to deleverage, which would reduce lending opportunities for the banking system. Further, if part of the lending in the last quarter was on account of Covid-related uncertainties, it is possible that recovery will become difficult for the banking system. While the impact would depend on the nature of the economic recovery, assuming the trend continues, higher financial savings in the household sector — with lower overall credit demand in the private sector — will help finance the fiscal deficit. The general government Budget deficit is likely to expand significantly in the current year. A reversal would depend on how quickly India is able to contain the virus.

 



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