The Savings Multiplier | Value Research If we could bring down gold imports to zero, and use it to fund fiscal deficit, everybody would be happy
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The Savings Multiplier

If we could bring down gold imports to zero, and use it to fund fiscal deficit, everybody would be happy

I have made this point before:
GDP= Consumption + Investment + Govt (Spending) + Exports – Imports In India, consumption is roughly 60 per cent, investment 30 per cent, government spending is about 20 per cent (of which the fiscal deficit is -8 per cent), while the Current Account Deficit (CAD) is about the same: 5 per cent. Now, we have a Tax: GDP ratio of 12 per cent.

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 (CAD) a.k.a. foreign savings imported into India, is Exports- Imports= (5%)

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 government’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 crore (about 0.7 per cent of GDP), fertiliser about Rs 20,000 crore and fuel about 85,000 crore (i.e. 1 per cent of GDP). That is about 2 per cent of GDP, actually 2.2 per cent if you include MNREGA.

India’s sustainable CAD is often touted to be 2.2 per cent, at least that is the number the RBI is supposed to be comfortable with. Gold imports are $66 billion in a $2 trillion economy, roughly 3 per cent 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 government policy, how credible is another matter.

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

If taxes could go up to a more reasonable 15 per cent of GDP, then private savings would fall proportionately. Given that the GDP multiplier of private Savings is (intuitively) much better than that of government savings, that would reduce the Fiscal Multiplier. Actually 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 come 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 savings (5 per cent of GDP)? The government uses precious tax money to burn it up as fuel and other subsidies (2 per cent of GDP), while the rest of it is sent back as payments for gold (3 per cent of GDP). Most gold investments are basically 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 government 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 government (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 cent 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 per cent, what is the probability that the RBI will ever see its target 5 per cent on a sustainable basis?

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

The sustainable GDP rate
I can’t believe that our esteemed Prime Minister does not know this; I thought he was the eminent economist. If you have a 31 per cent savings rate, with 3 per cent going into gold, it leaves 28 per cent net savings. Given the GDP:Investment ratio of 0.25, that translates into a sustainable GDP growth rate of 6.5 per cent, exactly where we are just now. To get it upto the claimed 8 per cent, we would need an extra 10 per cent of GDP as savings. That can only come from plugging the fiscal deficit (which would free up another 5 per cent) 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 government 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 government investment into 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.

That may not be true of the Congress government, which has taken a few good initiatives, the Aadhar project being a big one. If this is now inherited by a Third Front government, 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 government 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 government support.

The ‘hierarchy of productivity’ of investments then puts private and foreign investments on a higher rung than government investment, except when the government investment is into basic infrastructure or greenfield/ white space investments like the Delhi Mumbai Industrial Corridor (DMIC). If the government ‘investment’ is going into MNREGA (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 government ‘investment’. That is because it gives up a little government 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 really headed? On the one hand, an Aadhar project will reduce government wastage and corruption, while some of the drop 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 government spending still has to wait for a better government, 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 per cent, if only till the next wave of complacency sets in.

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