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DECODING THE SAVINGS RATE MIRACLE

One of the real macroeconomic successes of this phase of India’s reform process has been the increase in our savings rate. This has also resulted in a higher investment rate, which, indeed, is now leading to a higher level of GDP growth. For example, in the three years to FY 2004, the savings rate hovered around 25% of GDP; but in the recent three years, it has averaged 34%.

If we look at the three components of the savings rate — household, corporate and public sector savings — we find that the corporate sector and, to a lesser extent, the public sector have caused this remarkable rise, the household rate having risen from 15% to 22% in the seven years to FY 2004 and stood flat since then. Corporate savings have increased from about 4% to 10% while the public sector has actually gone from a negative number to positive 4% — together the two accounting for the positive swing of 10%.

Let’s examine what has caused this corporate and public sector savings spurt. During this same time period from 2003 to 2009, the overall corporate profitability — measured in the PAT to sales ratio — more than doubled from 3.6% to 8%. At the same time, companies reduced the dividend rate from half of profits down to a quarter — in other words, companies were not only growing their top lines faster on account of faster economic growth in general, their profitability rate also almost doubled during this time, and they distributed less of their profits. This increased growth in the top line, higher profitability along with higher retention is what led to the doubling of the corporate and public sector savings rates.

The other consequential impact of this has been the increase in corporate tax collections. Interestingly, since 2004, the overall tax to GDP ratio has gone up by almost 20% — from 8.9% of GDP to 10.7%. Most of the increase was driven by increased direct tax collections — again from the corporate sector — an increase from 1.9% of GDP to 3.6%. This better tax performance, along with spending controls under the Fiscal Responsibility and Budget Management Act, is what led to a consistent decline in India’s fiscal deficit down to 4% of GDP in FY 2008 before it ballooned up again in the last two years under the weight of profligate spending schemes leading up to the elections.

It is apparent that a number of the big macroeconomic improvements over the last five to six years can be traced back to improvements in corporate performance. This in itself is an interesting fact — that the liberalisation of the Indian economy has led to the corporate sector becoming a much more significant engine of the improving India story. One must naturally examine why corporate performance has improved so dramatically.

This is largely because of micro reforms. Take the case of telecom. In fiscal 2000, this sector hardly existed and the predominant player was BSNL. Today, the turnover in this sector is in excess of $50 billion — a compounded growth rate of 50% per annum. This one sector itself has contributed approximately 5% to India’s total GDP growth over the last 10 years. This growth has been largely possible on account of the new telecom policy in 1999 and the high volume , low-cost competition it engendered.

Similarly, take the case of power. In 2003, the New Electricity Act further incentivised the participation of the private sector in power. This is now finally yielded significantly higher contributions of private sector players in the incremental capacity additions and will hopefully address India’s power shortages at some point. Take the case of better roads and ports infrastructure — it is making more efficient and faster transportation possible as well as reducing waiting time for both domestic market as well as for exports. The creation of consumer demand through lower interest rates has fuelled the growth of consumer durables and housing industries.

THERE is, however, another typical Indian school of thought which believes that the only reason we have seen such rapid growth in corporate top lines and profitability is the growing importance of the stock markets in promoters’ thought process. Since the markets reward earnings so handsomely — by multiplying the earnings with the P/E multiple — leading to upfront value creation, which can then be diluted or sold. Promoters are, therefore , now incentivised to fully report their full business earnings. Earlier, as promoters took cash out of the business, this leakage resulted in lower profitability. Now the cash is kept in the business as it leads to better upfront value creation. The reason this explanation does not work is that this might have led to profitability increases over one, two or three years, but not over such an extended period of time.

We can safely say that there have been actual performance improvements caused by an improvement in the overall operating environment in various sectors. Such micro reforms on a sector-bysector basis need to go on to ensure that our macroeconomic position continues to stay healthy to support India’s growth aspirations — these reforms are needed in the areas of further and faster infrastructure build out, lower inflation and interest rates, improvements in agriculture to broadbase drivers of growth to encompass rural areas, education, health, vocational training, labour reforms, water management, debt markets reforms, fiscal policy, etc.

Unfortunately, the government has not cottoned on sufficiently to the fact that it is these micro reforms that are so critical to drive our continued macroeconomic growth. How else does one explain the almost complete absence of real structural reforms over the last few years? It is no longer enough to bask in the reflected glory of India’s individual entrepreneurs and the many decades of repressed consumer demand that has been released by the reforms to date. Unless we continuously keep improving the macro and micro operating environment and reducing friction losses whether brought on by poor infrastructure or a poor regulatory environment , the recent wave of corporate growth which has driven such a large part of our macroeconomic story will begin to peter out and along with it, our growth engine will begin to sputter just when it needs to be recharged and further broadened to include as many sectors as possible , including and particularly, rural India.

Source: Economic Times