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Students Corner - A Decade of Economic
Reforms in India - A Review

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The process of economic growth hinges critically on the generation of greater saving and its channelisation into productive investment. The overall improvement in GDP growth during the reform period seems to have been facilitated by the improvement in the rate of aggregate domestic saving as corroborated by an empirical exercise discussed subsequently. During the period of reforms as a whole, the rate of Gross Domestic Saving (GDS) increased to 23.1 per cent from 19.8 per cent in the preceding decade, with both periods witnessing some variability on a year-to-year basis

The behaviour of the saving rate and economic growth in India during the reform period seems to suggest that the high growth phase is associated with higher order of increase in domestic saving. Within the first phase, the second sub-period, which was also a period of high GDP growth, witnessed an increase of 2.2 percentage points in the domestic saving rate over the first sub-period. During the second phase of reforms, which was marked by a distinct deceleration of growth, the saving rate declined by 1.3 percentage points to reach 23.1 per cent. Empirical relationship between the changes in GDP and incremental saving provides the evidence of a bidirectional causality - highlighting the role of the feedback effects emanating from saving to economic growth and vice versa

A salient feature of the 1990s was the rising trend in the household sector saving. Within the household sector saving, the rate of saving held in financial assets steadily increased during this period. Financial liberalisation has an important bearing on financial saving as it involves the creation of newer instruments and avenues of saving, and also reduces intermediation costs (McKinnon, 1973). In India, the phenomenon of improvement in financial saving could be attributed to more efficient financial intermediation, greater opportunities for diversification across financial assets and emergence of market related returns

Notwithstanding financial innovations, bank deposits continued to be the most important instrument of financial saving among the households during the period of reforms. An empirical exercise conducted to estimate the effect of real interest rate on saving held in bank deposits indicates that interest rate plays an insignificant role. Personal disposable income, however, is found to be an important determinant of this saving.

Another important feature of household saving during the reform period has been the increasing importance of saving held in insurance funds, and provident and pension funds (together described as contractual saving). The growing share of this saving is a positive development, given that such saving is long-term in nature and can be an important instrument for channelising funds towards certain productive sectors of the economy, such as infrastructure, which require lumpy investments and involve long gestation lags (Government of India, 1996). Apart from ensuring assured rates of return with tax exemptions, contractual saving also provides old age security. As disposable income rises and life expectancy continues to increase, concerns regarding old age security can be expected to result in increasing share of financial saving held in contractual instruments

‘Shares and debentures’ is another instrument of financial saving that was expected to get a boost from the reforms. Measures undertaken for developing the capital market were expected to divert saving from the traditional financial instruments to the capital market instruments. Reflecting this, the proportion of household saving in ‘shares and debentures’ (inclusive of investment in mutual funds) rose steeply to over 20 per cent of total financial saving in the initial years of the 1990s from 9.4 per cent in the 1980s. This was due to a shift away from the relatively safer modes of saving, such as small saving instruments (included under ‘claims on Government’). Following the irregularities in stock market in 1992 and the associated price uncertainty that prevailed in the subsequent period, the proportion of household financial saving held in ‘shares and debentures’, however, witnessed a decline to reach a low of 3.2 per cent by 2000-01. On the whole, the proportion of financial saving in ‘shares and debentures’ rose by little less than two percentage points between 1981-91 and 1991-2001. The pattern of financial saving that emerges during the decade of reforms, thus, indicates a continued preference of households for relatively safer instruments with assured returns.

The improved performance of the private corporate sector saving during the second sub-period of Phase I can be attributed to high industrial growth and rising profitability of corporate entities. On the other hand, the distinct slowdown in corporate sector saving witnessed since 1996-97 can be attributed to declining profitability of these entities engendered by industrial slowdown.

The public sector witnessed a noticeable decline in its saving during the reform period. The deteriorating fiscal position during the 1980s had resulted in worsening of contribution of this sector to aggregate saving. During the period of reforms, despite the increased emphasis on fiscal discipline, at least in the initial years, the rising expenditure burden on account of factors such as higher interest payments and salaries coupled with a fall in the tax-GDP ratio, placed considerable strain on the saving from this sector. During the 1990s, gross tax-GDP ratio for the Central Government fell by about 2.0 percentage points whereas interest payment as a proportion of GDP rose from 3.8 per cent to 4.6 per cent during the same period. Similarly, falling trend in salaries as a proportion of GDP witnessed in the early 1990s also got reversed after the implementation of the award of Fifth Pay Commission in the latter part of the 1990s. This contributed to the public sector saving rate turning negative (-1.1 per cent) during 1997-98 to 2001-02 from 1.8 per cent of GDP during 1994-95 to 1996-97 – a reduction of 2.9 percentage points. The high levels of public sector deficit imply a draft on the private saving in the economy. More worrisome aspect is that predominant part of Government draft on private saving is utilised for consumption purposes and to that extent productive capacity of the economy gets impaired.