Savings and Investment Trends in India : Impact of external finance (savings) on Indian investment and its implication for India?s macro-economic fundamentals

By Akhil Raj Gupta

This paper attempts to highlight the growing impact of external savings on India’s investment and thereafter analyze the positive and negative consequences of this financing arrangement. This analysis becomes extremely pertinent in the backdrop of the 2008 financial crisis, following which loose monetary policy and loss of business confidence abroad led to a flurry of Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) in emerging-market economies such as Brazil, Indonesia, and most importantly India. This is measured largely by the widening current account deficits of these nations, which also captures a ‘stock’ representation of the savings-investment gap, necessitating the inflow of foreign capital towards this lacuna. However, a closer look might also reveal that ‘hot money’ from abroad can have a debilitating effect on the economic stability of a nation, as measured by the veritable  ‘free-fall’ of the nominal value of the Indian rupee upon announcements of the quantitative easing taper by the United States Federal Reserve. This section also encompasses the notion of allocative efficiency for this external capital and whether it is higher investment or overconsumption that is continuously driving the current account chasm wider. Accordingly, I have divided the analysis into the following subsections –

 

1. 1.     Trends in external investment in India (Post 1991 under the framework of the New Economic Policy)
2. 2.     Favorable impact of external investment in India
3. 3.     Negative impact of external finance in India

1.     Trends in external investment in India – Equity flows

Year	A. Direct Investment		B. Portfolio Investment
	Rs. crore	US $ million	Rs. crore	US $ million
1990-91	174	97	11	6
1991-92	316	129	10	4
1992-93	965	315	748	244
1993-94	1,838	586	11,188	3,567
1994-95	4,126	1,314	12,007	3,824
1995-96	7,172	2,144	9,192	2,748
1996-97	10,015	2,821	11,758	3,312
1997-98	13,220	3,557	6,794	1,828
1998-99	10,358	2,462	(257)	(61)
1999-00	9,338	2,155	13,112	3,026
2000-01	18,406	4,029	12,609	2,760
2001-02	29,235	6,130	9,639	2,021
2002-03	24,367	5,035	4,738	979
2003-04	19,860	4,322	52,279	11,377
2004-05	27,188	6,051	41,854	9,315
2005-06	39,674	8,961	55,307	12,492
2006-07	103,367	22,826	31,713	7,003
2007-08	140,180	34,835	109,741	27,271
2008-09	173,741	37,838	(63,618)	(13,855)
2009-10	179,059	37,763	153,516	32,376
2010-11	138,462	30,380	143,435	31,471
2011-12	NA	32,957	NA	17,171
2012-13	NA	26,953	NA	26,891

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

2.   Trends in external investment in India – Debt flows

Year	Gross External Debt (USD million)	Short Term Debt (%) of Total Debt
1995-96	99,008	4.3
1996-97	93,730	5.4
1997-98	93,470	7.2
1998-99	93,531	5.4
1999-00	96,886	4.4
2000-01	98,263	4.0
2001-02	101,326	3.6
2002-03	98,843	2.8
2003-04	104,914	4.5
2004-05	112,653	3.9
2005-06	134,002	13.2
2006-07	139,114	14.0
2007-08	172,360	16.3
2008-09	224,407	20.4
2009-10	224,498	19.3
2010-11	260,935	20.1
2011-12	305,861	21.2
2012-13	345,498	22.6
2013-14	390,048	24.8

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

3.     Indices of International Finance

3.a Current account Deficit / Savings- Investment Gap

 To prove that the current account deficit is identically equivalent to the savings-investment gap, we start with the basic macroeconomic identity of national income-

Y = C + I + G + (EX – IM)

 YD = C + I + G + TR – T + CA                                                (CA = EX – IM by definition)

 YD – C = I + (G – T) + CA                                                       (TR = 0 by assumption)

S_pvt = I + ( – S_govt) + CA

CA ?  S_national – I

 Accordingly, if current account is in deficit, it implies a savings-investment gap and necessitates a requirement of international borrowing.

Current Account Deficit in India – Historical Trends

Year	Current account deficit  (% of GDP)
1995-96	NA
1996-97	NA
1997-98	NA
1998-99	NA
1999-00	0.9
2000-01	0.6
2001-02	-0.7
2002-03	-1.2
2003-04	-2.3
2004-05	-0.3
2005-06	1.2
2006-07	1.0
2007-08	1.3
2008-09	2.3
2009-10	2.8
2010-11	3.51
2011-12	4.2
2012-13	4.61

 

Source – Planning Commission Data, dated 10/03/2014

(-ve sign indicates surplus)

3.b NER (Nominal Exchange Rate of Rupee v/s SDR, Dollar)

Year	SDR		US Dollar
	Average	End-year	Average	End-year
2012-13	83.0262	81.4764	54.4091	54.3893
2011-12	75.3132	79.2512	47.9229	51.1600
2010-11	69.7228	70.7930	45.5768	44.6450
2009-10	73.7333	68.5335	47.4166	45.1350
2008-09	71.2770	76.1742	45.9170	50.9450
2007-08	62.6506	65.7307	40.2410	39.9850
2006-07	67.2538	65.8289	45.2849	43.5950
2005-06	64.4898	64.2566	44.2735	44.6050
2004-05	66.9282	66.0987	44.9315	43.7550
2003-04	65.6876	64.2393	45.9516	43.4450
2002-03	64.1257	65.2550	48.3953	47.5050
2001-02	60.2150	60.8446	47.6919	48.8000
2000-01	59.5459	58.7969	45.6844	46.6400
1999-00	58.9335	58.7505	43.3327	43.6050
1998-99	57.5129	57.6132	42.0706	42.4350
1997-98	50.6735	52.7677	37.1648	39.4950
1996-97	50.8858	49.8032	35.4999	35.9150
1995-96	50.4768	50.1633	33.4498	34.3500
1994-95	45.7908	49.1558	31.3986	31.4950
1993-94	43.8863	44.3133	31.3655	31.3725
1992-93	37.1415	43.6511	30.6488	31.2354
1991-92	33.4325	35.5143	24.4737	31.2256
1990-91	24.8431	26.4140	17.9428	19.6429

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

3. Inflow of foreign reserves

Year	Accumulation of reserves (US$ million)
1995-96	21,687
1996-97	26,423
1997-98	29,367
1998-99	32,490
1999-00	38,036
2000-01	42,281
2001-02	54,106
2002-03	76,100
2003-04	112,959
2004-05	141,514
2005-06	151,622
2006-07	199,179
2007-08	309,723
2008-09	251,985
2009-10	279,057
2010-11	304,818
2011-12	294,398
2012-13	292, 046

Source – Handbook of Statistics on Indian Economy, Reserve Bank of India (www.rbi.org)

 Conclusion

The data in the preceding tables unequivocally suggests an increasing AND accelerating trend of international capital as a mechanism of investment finance in India.  This has coincided with a generic rise in gross-domestic capital formation (GDCF) in India with very high rates of economic growth, implying a strong causal link between the two. However, quantitative numbers do not present the whole picture. One has to undertake a detailed qualitative assessment to determine whether productive capacity has been increased through an increase in investment. Some evidence points to the contrary. For instance, price of gold has surged recently due to increased imports. If household financial savings are being channelized towards such ‘unproductive assets’ due to inflation-hedging tactics, it reduces the pool of funds available for private corporate investment who are then forced to seek assistance from international capital markets.

The next section of the report deals with beneficial and negative impacts of external finance in India.

Appendix I – Analysis of the above data

1. The years 2006-07 and onwards (highlighted) represent an inflexion point across all categories. There is a sharp difference in CAGR that has been analyzed and presented below

Category	Pre-2006 CAGR	Post-2006 CAGR	Difference
Equity flows	13.66%	35.44%	21.78
Debt flows	1.30%	12.5%	11.2

1. In the years post 2005-06, all economic indices seem to move in the direction corresponding to an increase in foreign investment, as predicted by economic theory. The specific trends are listed below –
2. Current account deficit increased from -0.3 to 1.2 percent and stood at 4.8 percent in the last fiscal to represent savings-investment gap.
3. Rupee appreciated significantly in 2006-07 against the dollar, registering an increase of approximately 10%. This can be attributed primarily due to the increase in supply of dollars on account of positive capital flows.
4. A slightly worrying signal is the increase of debt-financing, especially short-term debt that has risen proportional to concessional debt. This increases the probability of a bankruptcy in case of a sudden loss of business confidence prompting a situation similar to a bank run.
5. RBI has slowly but steadily accumulated foreign exchange reserves upto 294 billion dollars, with the greatest upswing being generated predictably in 2006-07 when reserves grew at 51% y-o-y.

Akhil is currently in his second year at college, pursuing a Bachelor of Arts degree in Economics (Hons) at Sri Ram College of Commerce, University of Delhi. He has been passionate about writing since an early age and is currently involved with the official College magazine and Economics Department magazine at SRCC. His areas of interest include behavioural economics / finance, econometric analysis, macroeconomic policy, and political theory. He spends his free time reading extensively, watching interesting videos on YouTube, and trying to convince everybody around him that he really does know a thing or two about economics in the midst of all the pontification!