Consumption, savings and investment

1.32 The increasing trend in gross domestic savings as a proportion of GDP observed since 2001-02 has continued with the savings ratio rising from 26.4 per cent in 2002-03 to 29.7 per cent in 2003-04, 31.1 per cent in 2004-05 and 32.4 per cent in 2005-06 (Table 1.3). The rise in the savings rate in 2005-06 was contributed by two of its three components: private corporate and the household sector, which as proportion of GDP, increased by 1.0 percentage point and 0.7 percentage point, respectively. The third component, namely public savings, declined by 0.4 percentage points, and made a negative contribution to the overall savings rate. However, a redeeming feature of recent years is that the savings of the public sector, which had been negative until 2002-03, was positive for the third successive year in 2005-06. The positive saving of Rs. 71,262 crore in 2005-06 (QE) is largely attributable to the higher savings of non-departmental as well as departmental enterprises.

1.33 A dramatic element in the savings profile of the Indian economy has been the sharp rise in the savings rate of the private corporate sector for four years in a row. For 2004-05, the earlier quick estimate of private corporate savings of 4.8 per cent of GDP has been substantially scaled up to 7.1 per cent in the provisional estimates released by the CSO. The savings rate for 2005-06, as per the quick estimates, has been placed at 8.1 per cent. The private corporate sector has financed a large part of its investment in the on-going long capex cycle from such retained earnings or savings.

1.34 As much as 0.7 percentage point of the 1.3 percentage points increase in gross domestic savings rate between 2004-05 and 2005-06 has come from the household sector. Two forces have been acting simultaneously on the portfolio behaviour of Indian households: a construction boom with residential buildings financed from housing loans from banks and the progressive maturing of the domestic financial markets. While the former has tended to increase household savings in physical form and depress financial savings, the latter has provided incentives for higher financial savings. There was a perceptible shift in the household portfolio in the three years ending in 2005-06. Physical savings as a proportion of GDP has declined steadily from a high of 12.4 per cent in 2003-04 to 10.7 per cent in 2005-06. Financial savings, on the other hand, after declining from 11.3 per cent to 10.2 per cent between 2003-04 and 2004-05, more than recovered to 11.7 per cent in 2005-06.

1.35 The increase in savings rate is what is to be expected with higher growth rate of the economy and a declining dependency ratio. With the proportion of population in the working age group of 15-64 years increasing steadily from 62.9 per cent in 2006 to 68.4 per cent in 2026, the demographic dividend in the form of high savings rate is likely to continue. As the savings rate has gone up, private final consumption expenditure (PFCE), at current prices as a proportion of GDP, has shown a declining trend particularly from 2001-02. PFCE as a proportion of GDP declined from 63.1 per cent in 2002-03 to 62.1 per cent in 2003-04, 60.0 per cent in 2004-05, and further to 58.7 per cent in 2005-06. This decline has also been accompanied by substantial changes in the consumption basket in terms of the shares of different commodity groups. In PFCE, the share of food, beverages and tobacco came down from 43.3 per cent in 2002-03 to 39.4 per cent in 2005-06. The other major item of importance, namely, transport and communication, as a proportion of PFCE, rose from 15.8 per cent in 2002-03 to 19.1 per cent in 2004-05.

1.36 As a proportion of GDP at current prices, Government final consumption expenditure (GFCE), after declining from 11.9 per cent in 2002-03 to 11.0 per cent in 2004-05, increased to 11.5 per cent of GDP in 2005-06.

1.37 In tandem with the rise in the rate of gross domestic savings between 2003-04 and 2004-05, there was a step up in the rate of gross domestic capital formation (GDCF) or investment from 28 per cent of GDP to 31.5 per cent of GDP leading to a savings investment gap or a current account deficit of 0.4 percent of GDP in 2004-05 (Table 1.3). GDCF rose further to 33.8 per cent of GDP in 2005-06 as per the quick estimates, widening the saving–investment gap to 1.4 per cent of GDP, with its implications for the current account of the balance of payments.

1.38 GDCF at constant prices (base: 1999-2000) as a proportion of GDP (Table 1.4) is consistently lower than the corresponding proportion at current prices (Table 1.3). This differential may reflect the greater increase in the prices of capital goods relative to the general price level, with growing technological sophistication of the production processes in the economy in general and manufacturing in particular. But, irrespective of the choice of constant or current prices as the weights, the direction of change from year to year remains unaltered.

1.39 Of the two components of GDCF, namely gross fixed capital formation (GFCF) and changes in stocks, the contribution of GFCF (consisting of items such as plant and machinery) to growth of GDFC was lower than the corresponding contribution of changes in stocks between 2003-04 and 2004-05. While GFCF continued to lag behind changes in stocks in terms of contribution, the difference between the two contributions narrowed. This may indicate a recent pick up in fresh investment for creating additional capacity through fixed capital formation, particularly in the private sector.

1.40 From the demand-side perspective, unlike countries of East Asia during their high-growth phase or China in more recent times, GDP growth in India in the post-reform period was driven mostly by private final consumption expenditure or PFCE growth. PFCE contributed more than one half of the growth every year until 2001-02. After falling below one half in 2002-03, it had again dominated GDP growth in 2003-04. But this pattern appears to have undergone a virtuous transformation with investment rather than private consumption being the main source of GDP growth in the latest two years of 2004-05 and 2005-06 (Figure 1.2 and Table 1.5). Data on consumption and investment in the national accounts available until 2004-05 show that the 6.8 percentage point contribution of investment to 13.1 per cent growth in GDP at current market prices in 2004-05 exceeded the corresponding contribution of private final consumption expenditure at 6.1 percentage point for the first time in recent years. In terms of contribution to growth of GDP at current market prices, from the demand side, investment continued to provide the lead during 2004-05 and 2005-06. The percentage point contribution of investment in the growth of GDP at current market prices of 13.1 per cent and 14.1 per cent in 2004-05 and 2005-06, respectively, were 7.6 per cent and 7.0 per cent, respectively. With imports growing faster than exports, the external balance continued to have a negative contribution to GDP growth in recent years.