The Savings Multiplier : The Efficiency of Savings



I have made this point before:

GDP= Consumption + Investment + Govt (Spending) + Exports – Imports

In India, Consumption is roughly 60%, Investment 30%, Govt Spending is about 20% (of which the Fiscal Deficit is -8%), while the Current Account Deficit is about the same -5%.

Now, we have a Tax: GDP ratio of 12%.

So, private Savings is GDP- Consumption  – Taxes = 100%-60%-12%= 28%

While Public/ Govt Savings is Taxes- Govt Spending= 12%-20%= – 8%

And of course, the Current Account Deficit, a.k.a. Foreign Savings imported into India,  is Exports- Imports= (5%)

Declaimer: This article written was originally in May 2013, and some of the data points may be outdated.

The  Meaning Of Fiscal Deficit

Let us now look at where this Savings is going, to see whether there is any possibility of any dramatic improvement in India’s macro-fundamentals. Most of the Govt’s Fiscal Deficit is going into Food/ Fertiliser and Fuel subsidies, food-for-work programmes and such. For example, Food subsidies take away Rs.60,000 cr (about 0.7% of GDP), fertiliser about Rs.20,000 cr and fuel about 85,000 cr (i.e. 1% of GDP). That is about 2% of GDP, actually 2.2% if you include NREGA.

India’s sustainable CAD is often touted to be 2.2%, at least that is the number the RBI is supposed to be comfortable with. Gold imports are $66 bn in a $2 trn economy, roughly 3% of GDP. If we could bring down gold imports to zero, and use it to fund the Fiscal Deficit, everybody (except the savers) would be happy. That is the laudable target of Govt policy, how credible is another matter?

If you draw a Fund Flow, you will find that this undependable Foreign Savings (a.k.a. CAD) is going mostly to fund Govt profligacy of 2.2% of GDP. So the same objective could be (theoretically) achieved if, with one stroke of the e-pen, we do away with these misdirected fuel-type subsidies. How probable is that, except in a European-type Currency Crisis?

Govt Savings vs Private Savings – which is better?

If Taxes could go up to a more reasonable 15% of GDP, then private Savings would fall proportionately. Given that the GDP multiplier of private Savings is (intuitively) much better than that of Govt Savings, that would reduce the Fiscal Multiplier. Not, because most of that money is being salted away in gold, which is a dead investment for Gross Fixed Asset (GFA) formation anyway.

So now look at the locked-in behaviours of each set of participants. Foreign Savings comes from FDI/ FII flows and NRI debt and capital flows, more of the latter. They now expect the Rupee to depreciate (given the heightened inflationary expectations embedded in investor psychology now). Hence they increase the expected return from their stock investments. This pushes up the cost of capital for long-term fixed investments into India (FDI) and increases volatility in the Indian stock markets, as the FIIs take an increasingly shorter-term approach, given that they have to keep an eye on the door….the Rupee could depreciate if you are not looking!!!

What do we do with this Foreign Saving

What do we do with this Foreign Savings (~5% of GDP)? The Govt uses precious tax money to burn it up as fuel and other subsidies (~2% of GDP), while the rest of it is sent back as payments for gold (~3% of GDP). Most gold investments are an attempt to explicitly save taxes (including the backdoor taxation, a.k.a. inflation). Hence this entire conundrum is because of two locked-in behaviours: a Govt that tries to steal from its citizens (through inflation and the misuse of tax receipts), resulting in a citizenry that is bent upon stealing it right back from the Govt (by diverting their savings into gold). How soon is this likely to change?

In other words, given the locked-in behaviour of the major participants, the Rupee is set to depreciate by at least 5% per annum, exactly the amount of money that is systematically going out of the savings system every year. Given that inflation is running at an average of 10%, what is the probability that the RBI will EVER see its target of 5% on a sustainable basis?

What do the markets think? Why are Interest rate differentials in the Bond markets (India vs US) at 5%, yet the Forward Premium in the NSE $: Re market being discovered at nearly 10%? Last month I got 49p in the near month, annualised 12%.

The Sustainable GDP Rate

 I can’t believe that our esteemed Prime Minister (Dr Manmohan Singh) does not know this; I thought he was an eminent economist. If you have a 31% Savings Rate, with 3% going into gold, it leaves 28% net Savings. Given the GDP:: Investment ratio of 0.25, that translates into a sustainable GDP growth rate of 6.5%, exactly where we are just now. To get it up to the claimed 8%, we would need an extra 10% of GDP as savings. That can only come from plugging the Fiscal Deficit (which would free up another 5%) and reducing consumption (or saving most of the GDP growth). That would set off a virtuous cycle of higher savings, higher investment and still higher GDP. India is supposed to be at that stage of development, but it has fettered itself with its economic governance.

Another way would be to change the GDP multiplier of investment, which is very low for a country at India’s stage of development. If the Govt were to focus its expenditure on basic infrastructure and regulation, it would push up private savings and bring in foreign savings, pushing up the sustainable GDP growth rate.

Lastly, there is a ‘hierarchy’ of Savings/ Investment as far as the sustainable GDP growth rate is concerned. At the top is Govt investment in basic infrastructure. This triggers further investment from the private and foreign sectors, setting off a virtuous cycle of further GDP growth referred to above. A good local example is Gujarat, where most of the big initiatives were taken in Narendra Modi’s first term. He is just fortunate enough to reap the political benefits of his good economics.

‘Fertile’ soil for foreign and private investment

That may not be true of the Congress Govt, which has taken a few good initiatives, the Aadhar project being a big one. If this is now inherited by a 3rd Front Govt, with their motley crowd of ‘harvesters’ looking to get their (economic) payback from public works, then the Aadhar project will die a quiet death. In a country where the basic infrastructure is already in place, the soil is ‘fertile’ for foreign and private investment to pick up the baton thereafter, with highly productive investments into employment-and-GDP generating projects.

Chandigarh is a very good example, where the Govt handled regulation and focused on urban development, leaving industrial development in private hands. The result has been sustainable investment, which has come without any sops, creating an ecosystem that sustains itself on economic logic, rather than Govt support.

The Right Mix of Investments

The ‘hierarchy of productivity’ of investments then puts private and foreign investments on a higher rung than Govt investment, EXCEPT when the Govt investment is into basic infrastructure or greenfield/ white space investments like the Delhi-Mumbai Industrial Corridor (DMIC). If the Govt ‘investment’ is going into NREGA (a backdoor dole, which produces a few check dams and some rural roads, doing little for agricultural productivity) or fuel subsidies, it is not going to achieve much. In this situation, an ‘Investment Allowance’ of the kind announced in the recent Budget will do far more for growth than any directed Govt ‘investment’. That is because it gives up a little Govt revenue to promote a lot of private investment…just the right mix of increased Investment that has the highest impact on GDP growth.

In all this, where are we headed? On the one hand, an Aadhar project will reduce Govt wastage and corruption, while some of the drops in fuel subsidies will go into the right hands. Funding ‘viability gaps’ in PPP projects in basic infrastructure, (especially in energy projects in Renewable Energy) will achieve much. But deep and effective re-purposing of Govt spending still has to wait for a better Govt, perhaps…however, given the overall drop in Interest Rates in most places in the world, the creation of such an enabling environment would attract enough overseas savings to get the sustainable GDP growth rate back to 8%, if only till the next wave of complacency sets in.



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