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PRIVATE SAVING IN INDIA1

Norman Loayza (World Bank) and Rashmi Shankar (U. C. Santa Cruz)

September 1998

1 We are grateful to LuRs ServJn for very valuable comments. The opinions expressed inthis paper are not necessarily those of the World Bank, its Executive Directors, or thecountries they represent.

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I. Introduction

There are many reasons for studying private saving in India. On the one hand, India’sperformance has surpassed that of other developing countries with comparable per capitaincomes. However, given the Indian Government’s ambitious growth targets, and the need inthe present global environment to continue to generate investible resources largely internally,the design of policies aimed at enhancing saving acquire great significance. In this context, wewould like to assess the extent to which an increase in public saving is offset by a reduction inprivate saving (effectively testing for Ricardian equivalence), whether an increase in rates ofreturn in financial markets leads to a rise in private saving rates (which would have implicationsregarding the effectiveness of tax incentives on saving instruments), and to what extent anincrease in average private disposable income brings about a rise in private saving rates (whichhas implications concerning the wide range of policies that induce growth in private income).

Besides studying the policy determinants of private saving, it is also important to take intoaccount the remarkable demographic transition in India in the last 30 years and its impact oncurrent and future saving rates. In India there has been a dramatic change in the age structureof population. The number of persons over 65 years of age as a proportion of total adults (thatis, between 16 and 65 years of age), has risen from 6% to 8%. On the other hand, thecorresponding figure for children below the age of 16 has declined from 72% in 1965 to 58%in 1994. We are interested in finding the impact of this change on saving since “demographicinertia” is likely to manifest in the next few years in a continuing rise in the share of the workingadults in population.

The major difference between this study and other macroeconomic saving studies applied toIndia is the use of private saving and income figures adjusted for capital gain/losses due toinflation. When inflation occurs, the value of government debt held by the private sectordecreases (unless the interest rate on government paper is indexed to inflation); this implies awealth loss to the private sector and a concomitant gain to the government that must be takeninto account in computing income and saving figures. Clearly, this correction becomes moreimportant as the level of government debt held by the private sector and/or inflation rises. Aswe will see in Section II, in India the “adjusted” figures are significantly different from theunadjusted ones, particularly since the 1980s. We find significant differences between ourfindings and those emphasized in the received historiography and believe this to be largely dueto our working with “adjusted figures.”

Another important change in this paper is the use of three different measures of saving. Wehave referred above to inflation adjusted saving. We also have a measure of saving in which weinclude in household saving, and hence private and national saving, private expenditure onconsumer durables2, including personal transportation. This is not only because householdsperceive expenditures on durables as an investment in their quality of life, but also because inIndia most consumer durables and motor vehicles have an extremely high resale value. In the

2 Following Jorgneson-Fraumeni (1989).

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absence of data on gold imports over the long period 1960-94, since durables includesjewellery, we hope also to use this definition of saving to correct to some extent for theunderstatement of household physical saving.

The third measure of saving involves both private and public saving. We add to privateadjusted saving, not only expenditure on consumer durables, but also on education and health.Correspondingly, we augment public adjusted saving with the Government’s final consumptionexpenditure on health and education. These adjustments are made as a proxy to accumulationof human wealth.

The layout of the paper is as follows. Section II describes the major trends in Indian saving. First, we compare India’s saving rates, national and private, with that of other countries andcountry groups. Second, we contrast the trends in saving with those of other macroaggregates over the period 1960-94 in India. And third, we look at how the components ofnational and private saving have changed over time. Section III is a brief of survey of majorwork done in this area. Section IV addresses the issue of the corporate veil. Section Vpresents our empirical results on the determinants of private saving rates. Lastly, Section VIconcludes and offers suggestions for future research.

II. Major Trends in Indian Saving Rates

A. Indian Saving in the International Context. The trend of the saving rate (defined asgross national saving including net current transfers) in India compares favorably to that ofboth developing (excluding the 11 fastest growing economies) and OECD countries. TableI indicates that it falls short of the trend for the 11 “take-off” countries.3 In 1965 thesaving rate in India was similar to the average of all developing countries. It hashenceforth followed a rising trend that allowed it to surpass the average saving rate ofOECD countries by the late 1980s and gain about 8 percentage points on the average ofnon-take-off developing countries by 1995. Although strong, the rising trend of the savingrate in India has fallen short of that of the take-off countries, which by 1995 was about 9percentage points higher than that of India. The strong saving performance of the take-offcountries has been accompanied by high and rising investment rates, no doubt a significantcontributing factor to the impressive per capita GDP growth rate, which averaged almost8% in the period 1960-94 (see Table III).

3 The take-off countries include Botswana, Chile, Hong Kong, Indonesia, Korea,Malaysia, Singapore, Taiwan, China and Thailand.

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Table I: Median National Saving Rates**Period India China Low-Income South Asia* East Asia OECD1960-73 .15 .26 .11 .12 .20 .251974-82 .21 .33 .13 .15 .29 .231983-91 .21 .36 .11 .17 .33 .211992-94 .22 .41 .12 .18 .34 .19*South Asia excluding India**For country groups, the median is of the individual country averages while for India and China theaverages across time are reported.

Therefore, as can be seen in Figure I, although India’s saving rates were not as high as those inKorea, Malaysia or Indonesia, India has done well in comparison to other low-incomecountries and also in comparison to the OECD, especially since the late 1980s.

Table II comparesadjusted median private saving rates across country groups. We see that the adjusted private

Figure INational Saving Rates(Medians By Region)

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

1960 1965 1970 1975 1980 1985 1990

OECD

Low IncomeCountriesE Asia

India

China

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saving rate appears to be consistently lower in India than in East Asia or the OECD, though ithas been growing faster in comparison to both. It must be noted that while in most othercountries, private savings exclude savings of public enterprises, this is not true of the OECDcountries. This overstates OECD’s private saving rate relative to that of India’s.

Table II: Median Private Saving Rates (adjusted)Period India Low-Income South Asia* East Asia OECD1960-73 .12 .09 NA .20 .231974-82 .16 .10 .10 .27 .231983-91 .17 .09 .10 .29 .221992-94 .18 .10 NA .29 .23*South Asia excluding India

We next look at the relationship between saving, investment and growth as suggested bycross-country comparison. Table III compares saving, investment and growth across thecountry groups. Each country relies to a varying extent on national saving to finance theinvestment necessary to fuel growth. Comparing performance on all these fronts yieldssome inferences about the best use of resources garnered through saving.

The saving rate in China for example, was, on average, 70% higher than in India, saving wasapproximately 50% higher and growth was 100% greater. East Asia achieved a growth ratethat was twice as large as India’s with an investment rate that was 34% higher, and a savingrate that was about 45% higher. On the other hand, regarding the relationship between saving,investment and growth, Table III shows that India’s long-run averages are quite similar tothose of OECD countries. From Table III, we also observe, from the direction of the saving-investment gap, that India had to rely on foreign saving more than the East Asian countries butnotably less than other low-income countries.

Table III: -Median Saving, Investment and GDP (1960-94)India China Low-Income South Asia East Asia OECD

National SavingRate

.20 .34 .11 .16 .29 .22

GDI/NDI .21 .32 .17 .17 .27 .21GDP Growth .04 .08 .03 .04 .08 .04

B. Saving rates and other Macroeconomic Aggregates in India. As shown in Table IV, wehave divided the long period 1960-95 into four sub-periods. The first two, 1960-1973 and1974-82 are separated by an oil crisis, as are the second and third sub-periods. The third andfourth sub-periods (1983-91 and 1992-95) are distinguished by the 1991 structural adjustmentprogram instituted by the Indian Government.

Table IV: -Basic Macro IndicatorsInflation(GDP deflator)

GDPgrowth

GDI/GNDI National SavingRate (GNS/GNDI)

CAD/GNDI

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1960-73 .07 .033 .17 .15 .021974-82 .077 .039 .21 .21 0.001983-91 .085 .052 .23 .21 .021992-95 .09 .049 .23 .22 .01

Inflation has been increasing fairly smoothly across these broad sub-periods as have real GDPgrowth and the rate of investment (given by gross domestic investment over gross nationaldisposable income), both of which dipped slightly in the last period.

The peak saving rate in the 1960-82 period was achieved in 1978 when the national savingrate rose to 22%. There was a sharp increase in private saving in the second period i.e.,1974-82, of about 5 percentage points. A number of factors operated in the late seventies- notably, the end of a decade of vigorous bank expansion, and foreign remittances fromIndians working in the Gulf area. This is also indicated by the fall in the average CAdeficit in this period. Real GDP growth did not exhibit any marked trend over theprevious period.

The national saving rate remained at about 21% in the last three periods despite the sharpincrease in the GDP growth rate between the second and third periods and its subsequent slightdecline in the fourth one. The investment rate stayed closely linked to the saving rate, resultingin a small current account deficit all throughout the 1960-95 period.

C. Changing Composition of National Saving in India. We study the composition ofnational saving by first, describing the trends in public and private saving, paying specialattention to the comparison between adjusted and unadjusted figures, and second describingthe behavior of the components of private saving.

As mentioned in the introduction, private income and saving figures must be adjusted totake into account the redistribution of wealth from the public to the private sector due tothe erosion by inflation in the value of public debt held by the private sector. Thiscorrection is sizable -- adjusted public saving as a ratio of gross national disposableincome increased by 3 points while the corresponding unadjusted figure rose by about halfas much over the long period 1960-94.

The figures in Table V suggest that there was a steady increase in adjusted private savingin the entire period except between 1974-82 and 1983-91 when it remained stable at about14%. The unadjusted figures for private saving shows a sharper increase, from 12% to21%, as opposed to the adjusted figures which show an increase from 11% to 16%. Theunadjusted public saving rate declined from 3% to 1% over the long period, reaching alow of .94% in 1984. However adjusted public saving increased from 4% to 7% between1960 and 1994.

What is striking about Table V is the increasingly larger difference between the adjustedand unadjusted figures in each period. In the period 1960-73, the differences are marginal.

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However in the next sub-period, there is a 3% difference between the adjusted andunadjusted figures. This difference increases to 5% in later years. This increasingly largerdifference is due to the gradual rise of inflation and, most importantly, the increase inpublic debt held by the private sector.

Table V: Private and Public Saving Rate in India - Adjusted4 and Unadjusted FiguresAdj. PrivateSaving Rate

Adj. PublicSaving Rate

Unadj. PrivateSaving Rate

Unadj. PublicSaving Rate

1960-73 .11 .04 .12 .031974-82 .14 .07 .17 .041983-91 .14 .07 .19 .021992-94 .16 .07 .21 .01

Both adjusted and unadjusted private and public saving declined. The difference between thechange in unadjusted and adjusted public saving remained stable at around 1.5 % of grossnational disposable income.

Table VI decomposes aggregate private saving into household physical, householdfinancial and corporate saving. These figures are not adjusted since there was no soundbasis on which to apportion the total adjustment between the household financial, physicaland corporate sectors.

Table VI: -The Composition of Private Saving in India (% of unadjusted privatedisposable income):Period Household Physical

SavingHouseholdFinancial Saving

Household Saving CorporateSaving

1960-73 7.61 3.62 11.23 2.461974-82 9.83 6.40 16.23 3.031983-91 9.82 8.81 18.63 2.641992-95 8.67 11.16 19.83 3.46

The entire period (1960-94) was marked by an increase in the share of household saving as aproportion of unadjusted private disposable income, while the analogous measure of corporatesaving remained mostly stagnant. This is seen clearly in Figure II.

4 Here adjusted refers to inflation adjusted.

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It can be argued that the sharp rise in national saving following the bank nationalization andvigorous branch expansion beginning 1969 was spurred by a rapid growth in financial saving inthe 1970s. The 1970’s were also characterized by a jump in remittances from abroad – mostlythe Middle east, which could have partially contributed to the increase in household savingbetween the first and second periods.

The rate of household physical saving also increased in the first three periods; however, in thelast period, 1992-95, it decreased somewhat, reflecting in part a portfolio shift from physical tofinancial saving. The slight decline in household physical saving has generated some debate inIndia, specially by 1994, when the decline appeared to be more substantial. There is aviewpoint that this decline is a statistical illusion (Athukorala, 1995). The Central StatisticalOrganization (CSO) sets household physical saving exactly equal to household investment,which in turn is determined residually. In national accounts, domestic investment is adjusted toequal the sum of domestic and foreign saving. Then only investment is adjusted for errors andomissions. This asymmetric adjustment is advocated on the argument that public and corporatesaving is more reliable than investment data. This might be true in the case of public saving;however, the estimate of corporate saving (and investment) is based on small, not necessarilyrepresentative samples, and rely on voluntary responses from enterprises. At any rate, althoughthere are reasons to believe that the private saving figures, particularly those of householdphysical saving, are erroneous, it is not at all obvious that measurement error is behind the

Figure II

Components of Private Saving

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994

HH Physical HH financial Corporate

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recent trends.5

Table VII looks at the adjusted and unadjusted private and public saving, with the formeraugmented by expenditure on consumer durables.

Table VII: Private and Public Saving Rate in India - Adjusted6 and Unadjusted Figures

Adj. PrivateSaving Rate

Adj. PublicSaving Rate

Unadj. PrivateSaving Rate

Unadj. PublicSaving Rate

1960-73 .13 .04 .15 .031974-82 .18 .07 .21 .041983-91 .19 .07 .24 .021992-94 .20 .07 .25 .01

In Table VIII we present augmented saving measures inclusive of expenditure on both healthand education.

Table VIII: Private and Public Saving Rate in India - Adjusted7 and UnadjustedFigures

Adj. PrivateSaving Rate

Adj. PublicSaving Rate

Unadj. PrivateSaving Rate

Unadj. PublicSaving Rate

1960-73 .16 .06 .18 .041974-82 .22 .10 .24 .071983-91 .23 .11 .27 .061992-94 .23 .11 .28 .05

5 It is worth noting that some physical assets, traditionally preferred as saving tools inIndia, such as jewelry and gold, are not covered in the CSO estimates. This furtherincreases the likelihood of measurement error in this category of saving.6 Here adjusted refers to inflation adjusted and augmented with household consumptionexpenditure on durables.7 Here adjusted refers to inflation adjusted and augmented with household consumptionexpenditure on durables and with public and private expenditure on health and education.

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In figure III below, we compare the trends in our three measures of private saving. Since wedid not want to arbitrarily allocate private expenditures on health and education between thehousehold and corporate sectors, we restrict ourselves to a comparison of aggregate adjustedprivate saving.

We see from the graph that saving by any definition rose sharply in the early and mid 1970s,and then again in the early 1980s. The plateauing of saving in the early 90s is less pronouncedfor the augmented measures, which continue to rise, albeit by less than in the 1986-88 period.

Figure IITrends in Aggregate Private Saving

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992

PSRA

PSRCON

PSR

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Figure IVAugmented and Unaugmented Measures of Public Saving

0

0.05

0.1

0.15

0.2

0.25

0.3

1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993

GSRA

GSR_PA

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In Figure IV, we compare the two measures of public saving, both inflation adjusted, withGSRA representing augmented public saving, and GSR_PA representing the conventionalmeasure.

As in figure III, we can see that spending on health and education increased sharply post-1965and then continued to rise, though more smoothly.

III. Saving Issues in the Indian Context

Much of the literature on saving in India distinguishes between private and public savingfor analytical purposes, and treats public saving as exogenous. Public saving has beenconspicuous by the lack of attention it has received. According to Pandit (1991) publicsaving in India has been largely residual and driven, to a large extent, by expansionaryfiscal policy and public sector pricing policy. Most of the literature focuses, as we do, onaggregate private saving. In this context, the following issues have been raised:

Dependence on public saving: The issue here is the extent to which the private sectorinternalizes the government’s budget constraint and hence the extent to which an increase inpublic saving is offset by an increase in private saving. Muhleisen (1997) presents evidence thatRicardian equivalence is of minor importance in India. According to him, long run aggregateprivate saving decreases by 0.25% in response to a 1% increase in public saving. He comparesthis to other estimates for developing countries that range from 0% (Haque and Montiel, 1989)to 50% (Corbo and Schmidt-Hebbel, 1991).

Growth in income/appropriate scale variable: Lahiri (1989) bases his empirical findings onindividual time-series analyses of various Asian countries including India. According to him,this has the advantage over a panel-based analysis that the marginal response of the saving rateto various factors need not be assumed uniform across countries. Private saving were found byhim to be significantly determined by the rate of growth of personal disposable income in all thecountries in him sample, including India. Muhleisen (1997) uses a VAR process in logarithmsto jointly model the relationships between the private saving rate and growth, and betweenprivate and public saving (i.e. Ricardian equivalence). Using Granger-causality tests,Muhleisen shows that growth leads to both higher public and private saving.

A related line of research studies the relation between permanent and transitory incomeand the saving rate. Porter-Hudak (1992) attempts to test the permanent incomehypothesis (PIH) for India. She computes data on non-human wealth of India for 26 years(1949-50 to 1975-76) and uses varying-parameter regressions to calculate values ofpermanent income, permanent consumption, transitory income and transitory consumptiondirectly from the wealth data. She finds the results broadly consistent with the PIH. Fora definition of wealth that includes the value of land, reproducible tangible assets, and M2,she finds that the marginal propensity to consume out of transitory income is notsignificantly different from zero.

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Demography: Lahiri (1989) found the age dependency ratio (fraction of the population underthe age of 16 and over the age of 64) to be a significant determinant of private saving. UnderLahiri’s specification, a 1 percentage point increase in the dependency ratio lowered the long-run average propensity to save by 1.6 percentage points in India, Korea, Malaysia, Singapore,and Sri Lanka. Muhleisen (1997) obtains that the age dependency ratio is the most significantdeterminant of private saving, with the usual negative relationship between the two variables.

Level of Financial Development: According to Muhleisen (1997), public policy could play arole in providing credible and stable financial intermediation, and thereby, by encouragingsaving in financial assets, also encourage the further development of financial markets. Hehighlights the need for reform in insurance, pension schemes and mutual funds. He calls forpolicies that would mobilize greater financial saving and favor long-term saving instruments,such as reducing the government’s recourse to captive saving by allowing greater flexibility inportfolio allocation to pension funds and the LIC. Muhleisen bases his call for greater financialdevelopment on his empirical results, in particular those that find that the ratio of M2/GDP, asa proxy for financial depth, has a positive long-run relationship with private saving. Hismethodological tool is the analysis of cointegration of time series, following the maximumlikelihood method of Johansen (1989, 1991).

Urban vs. Rural Propensities to Save: Pandit (1991) tests single equation cross-sectionalmodels for aggregate household saving with the purpose of, among others, contrasting thepropensities to save in rural and urban areas. He compares cross-sectional data for the twoyears 1967-68 and 1975-76. He does not find convincing or consistent evidence to supportthat both the average propensity to save and the marginal propensity to save are higher in urbanareas, and thus that a worsening of agricultural terms of trade could lead to higher saving. Pandit does not attempt a more disaggregated analysis, that is, one that would study thepropensities to save in urban and rural areas at the level of the physical and financialcomponents of household saving. This distinction might be important given that urban andrural households have different access to financial saving instruments.

Rate of Interest: The presence of imperfect, segmented capital markets with administeredrates of interest in India suggest that estimating the interest elasticity of private saving may beproblematic in the Indian context. The available empirical evidence (see, for example,Muhleisen 1997) does not provide support for the hypothesis that aggregate private saving isincreasing in the real rate of interest. Muhleisen argues that, to the extent that the measuredinterest rate reflects only the rate of return on controlled financial instruments and not the rateof return on investment, changes in measured interest rates mostly generate a substitution effectbetween physical and financial assets, and between different kinds of financial assets.

Decomposition of Private Saving: Pandit (1991) further decomposes private saving intohousehold and corporate saving, mostly in an attempt to explain the household’s portfoliodecision:Household Physical and Household Financial Saving: Pandit finds that household investment

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(identical to household physical saving) declines when household financial saving increases,suggesting substitutability between the two components of household saving, and, therefore,the need to treat them jointly. Nevertheless, Pandit further decomposes financial saving intothe real demand for money, saving in time deposits, saving in insurance premia and in providentfunds. He finds that the composition of household financial saving is, as expected, driven bythe rates of return on each type of financial saving and, to some extent, by bank expansion.Household vs. Corporate Saving: Corporate saving is defined as excess of profits overdividends. Pandit estimates a two-equation model by OLS: one each for corporate profits aftertax and corporate dividends. He finds that after tax profits are positively related to sales and tonon-agricultural terms of trade, and negatively correlated with per unit wage costs. Dividendsare explained by profits after tax and availability to the firm of external financing. Panditanalyzes the components of private saving without giving clear evidence that a disaggregativeapproach is needed.

IV. Do households in India “pierce the corporate veil”?

The household sector, which includes unincorporated enterprises, is the ultimate owner ofincorporated business. The question is to what extent the household sector takes intoaccount the saving decisions of corporations in formulating its own saving decisions. Inorder for households to treat corporate saving as its own, they must both understandcorporate actions and have a marginal propensity to save out of wealth equal to that out ofdisposable income. As Poterba’s (1987) seminal paper explains, if households “pierce thecorporate veil,” aggregate private saving becomes the variable of interest, with littleinformational gain from further breaking it down into household and corporate saving.8 On the other hand, if household and corporate saving decisions are independentlyobtained, then they must be studied separately, for its likely that they have differentdeterminants.9 We argue in this section that household saving react sufficiently tocorporate saving so as to allow focusing on private saving as a whole as the relevantdependent variable.

We study the relationship between household and corporate saving in the framework oftime-series cointegration. Below, we provide evidence that all series involved areintegrated of order 1 and, therefore, that cointegration analysis can be relevant. If savingin the form of household saving is equivalent to that of corporate saving, the two variablesshould be cointegrated, possibly including other variables in the long-run relationship, withcointegrating vector (1, 1). We follow Johansen’s maximum likelihood method to test forcointegration and estimate the cointegrating vector. We additionally include in the long-run relationship unadjusted private income and the ratio of agricultural income to GDP; 8 See also Smith 1990.9 As an illustration, consider the following example of corporate saving not being neutralwith respect to private saving. If corporate dividends increase at the expense ofundistributed profits, generating an increase in private disposable income, and a decreasein share prices, total private saving will fall if the marginal propensity to consume out ofdisposable income exceeds that from wealth.

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other variables, such as public saving rate and dependency ratios could be excluded fromthe long-run relationship. We find a unique cointegrating vector and the estimatedcoefficients are as follows, with asymptotic standard errors in parantheses.

HHCON = -.88 CORPSR + .05 LRPDI_PU -.18 DEP + .111 INFL + .255RR70_EX

(.047) (.0025) (.014) (.030) (.021)

LRPDI_PU is the natural log of real unadjusted private disposable income, HHCON ishousehold saving as a proportion of private disposable income augmented by privateexpenditure on consumer durables and CORPSR is the analogous figure for corporatesaving. The saving rates and income figures are unadjusted given our inability to apportionthe adjustment on private sector saving between the household and corporate sectors.HHSR would refer to unadjusted household saving.

The negative coefficient on corporate saving is consistent with the hypothesis thathouseholds allocate their portfolio between corporate and household financial saving, andthat there is a strong substitution between the two. Moreover the estimated coefficient isclose to -1, indicating that household saving increases more than proportionally given adecline in corporate saving. We conducted a likelihood ratio test10 and could not rejectthe hypothesis that the coefficient on corporate saving is –1 at 5%. The relevant 5%critical value is 3.84 (χ2(1) = 3.84) while our test statistic for the null that the coefficienton corporate saving rate is –1, is 11.39.

The results are we believe consistent with the hypothesis that households pierce thecorporate veil (or at least, see through it) to a sufficient extent for us to focus on thebehavior of aggregate private saving. Additionally, we do not undertake the disaggregatedanalysis given that data problems would render less than credible focusing on thedeterminants of corporate saving, in particular. Data on dividends and undistributedprofits, while available from the Reserve Bank Of India’s Reports on Currency andFinance, are based on voluntary response surveys of incorporated enterprises. The samplesize is not consistent and neither is the population from which it is drawn.

VI. Private Saving DeterminantsAs a first shot, we present below two sets of cross-correlations. Table IX presentscorrelations among various saving rates, while Table VIII presents correlations betweensaving rates and potential explanatory variables (abbreviations are defined in Table IX).

10 Refer to Hamilton(1994) for likelihood ratio tests about the cointegrating vector.

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Table IX: Correlations between Various Saving Rates

CORPSR GSR_PA HHSR NSR_PA PSR_PACORPSR 1.00 0.00 -0.11 0.26 0.42GSR_PA 0.00 1.00 0.68 0.80 0.27HHSR -0.11 0.68 1.00 0.86 0.69NSR_PA 0.26 0.80 0.86 1.00 0.80PSR_PA 0.42 0.27 0.69 0.80 1.00

Table X: Correlations between Saving Rates and Potential Saving Determinants

INFL M2R RR70_EX SHAGRI LRPDI_PA DEP OLDR YNGRGSR_PA 0.51 0.58 -0.14 -0.55 0.35 -0.48 0.56 -0.49HHSR 0.21 0.88 0.32 -0.88 0.85 -0.87 0.90 -0.87NSR_PA 0.19 0.81 0.35 -0.78 0.69 -0.74 0.82 -0.75PSR_PA -0.22 0.71 0.71 -0.68 0.75 -0.70 0.74 -0.71

While these simple correlations are only indicative, we used them to help us establish thevariables to be included in the regressions. Surprisingly enough the share of agriculturalincome is negatively correlated with private saving though our cointegration results yield apositive coefficient that is robust to changes in specification. The strongly negativerelationship with the dependency ratio (DEP) indicated here is likewise not a robust result.Apart from these two variables, further empirics generate results consistent with the abovecorrelations.

Tables XI-XVII summarize the results of the empirical exercises conducted. Weperformed Augmented Dicky-Fuller Unit Root Tests on the key variables. As suggestedby Table IX, the variables are non-stationary and with the exception of URB (proportionof population in urban areas) are integrated of order 1.

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Table XI: - Unit Root Test Results

DEP I(1)**(dependency ratio) 4 lags;interceptGSR_PA I(1)**(adjusted public saving rate) 4 lags;interceptM2R I(1)*(M2 / GDP) 2 lags;interceptOLDR I(1)*(over 65 as a proportion of 15-65) 2 lags;interceptPSR_PA I(1)**(adjusted private saving) 2 lags;interceptRR_EX I(1)**(real ex-post rate of interest) 2 lags;interceptSHAGRI I(1)**(share in GDP of agricultural income) 2 lags;interceptURB I(2)(share of population in urban areas) 4 lags;interceptYNGR I(1)*(under 15 as a proportion of 15-65) 2 lags;interceptLRPDI_PA I(1)*(natural log of real private disposable income) 2 lags;interceptINFL I(1)**(inflation in GNP deflator) 2 lags;no intercept, no trend*significant at 5%

**significant at 1%

In using Johansen’s method, we faced the problem of finding multiple cointegratingrelationships among a given set of variables (See Cheung and Lai, 1993). The problemincreases with the number of variables included in the system. Clearly, having multiplelong-run relationships makes considerably difficult the economic interpretation of theestimated coefficients. We cannot reject the null of there being at most one cointegratingrelationship once we adjust the confidence intervals for the small sample size.

In Table XII we report our results on the income and public sector effects on privatesaving rates. There is a single cointegrating relationship linking private saving adjusted forinflation, public saving rate, log of real private adjusted disposable income, thedependency ratio, the real ex-poste rate of interest, and inflation. Surprisingly enough, thecoefficient on the income variable, though correctly signed is not significant. This could bepartially due to the dependent variable being expressed as a proportion of private

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disposable income, and partly due to the high correlation between money supply(M2R)and income. The coefficient on public saving rate, is statistically significant, and suggests alower degree of Ricardian equivalence (offset coefficient equal to 0.14), than reported inprevious work11. DEP appears to positively influence private saving rate, possibly becauseof the negative correlation between OLDR and PSR_PA, and the dramatic decline inOLDR as a share of DEP. We find that inflation, the real interest rate and money supplyare all significantly positive in their effect on PSRCON (the private saving rate augmentedwith consumption expenditure on durables). These results are reported in Table XIII.Table IV presents the results with private and public saving rates having been adjusted forexpenditures on health and education, and denoted by PSR and GSR respectively.

Table XII: Johansen Cointegration ResultsLikelihood Ratio 5 % critical value

(corrected)Hypothesized No. of

Cointegrating Equations148.1043 165.32 None

97.889 114.21 At most 167.574 92.73 At most 239.397 62.38 At most 3

• LR test indicates 1 cointegrating relationship at 5% level of significance, under theassumption of a linear deterministic trend in data.

• Normalized Cointegrating Coefficients: PSR_PA = - .14 GSR_PA + .0479 LRPDI_PA - 1.08 DEP - .0097 INFL+.1508RR70_EX (.09996)* (.042)* (.22730)* (.067) (.0654)* +1.0007 SHAGRI (.17756)* The importance of the financial variables is manifest. Inflation is included as a proxy foruncertainty in financial markets. It also represents in some sense the real rate of return onhousehold physical saving. The share of agricultural income in GDP serves as theoccupation structural variable, and the real interest rate is a proxy, albeit imperfect, for therate of return on investment projects in the economy. The positive coefficients on thesevariables suggests that saving increases in response to greater uncertainty in financialmarkets (precautionary motive), deeper (and more diversified) financial intermediaries,and larger rates of return (which implies that the substitution effect outweighs the incomeeffect of an interest rate rise). We must note that although our results regardingdependency ratio and public saving are consistent (in the direction of the impliedrelationship) with the received literature on Indian saving, the finding regarding thepositive saving impact of the real rate of interest is new and, admittedly, controversial. The positive coefficient on SHAGRI though surprising in the Indian context is consistentwith the cross-country results obtained by Loayza et al (1998). It is also robust to changes 11 For example, Muhleisen (1997).

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in specification and in variables included in the cointegration test, as well as to changes inthe definition of private saving. The importance of the variable cannot be denied in alargely agricultural economy. The dominance of agriculture also implies that a large shareof the population that is dependent on it faces an uncertain income. It is therefore possiblethat Indian farmers save to diversify monsoon risk. We next look at the results with private saving augmented by household expenditure onconsumer durables. Table XIII: Johansen Cointegration Results

Likelihood Ratio 5 % critical value (corrected)

Hypothesized No. of Cointegrating Equations

164.2982 172.05 None 114.3506 134.21 At most 1 73.04176 101.09 At most 2 49.65748 71.16 At most 3

• LR test indicates 1 cointegrating relationship at 5% level of significance, under theassumption of a linear deterministic trend in data.

• Normalized Cointegrating Coefficients: PSRCON= - .23GSR_PA - .013806LRPDI_PA - .78 DEP + .037 INFL+.15 RR70_EX

(.14355)* (.06263) (.26630)* (.0844) (.0973)* +.524072 SHAGRI (.20722)* The financial variables are proxied by the real rate of interest whose coefficient and signremains robust to the change in the definition of saving. The off-set between public andprivate saving increases significantly. The income variable is no longer significant, possiblybecause private saving is a ratio to the level of private disposable income. DEP andRR70_EX remain the dominant determinants of saving while the positive and significantcoefficient on SHAGRI is unchanged. Table XIII: Johansen Cointegration Results

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Likelihood Ratio 5 % critical value (corrected)

Hypothesized No. of Cointegrating Equations

145.3862 164.32 None 99.37578 126.09 At most one 61.97763 92.68 At most 2

38.864 63.28 At most 3• LR test indicates 1 cointegrating relationship at 5% level of significance, under the

assumption of a linear deterministic trend in data.• Normalized Cointegrating Coefficients:PSR= - .29 GSR - .099720 LRPDI_PA - .77 DEP + .0147 INFL+.190103 RR70_EX

(.13986)* (.055) (.2579)* (.0758) (.0751)*

+.266 SHAGRI (.18244)*

We can see that the relationships of interest are robust to changing the definition ofsaving. The increase in the off-set between public and private saving once we adjust forexpenditures on health and education are to be expected. Health and education servicesare provided in India largely by the Central and State governments with minimum, indeednegligible cost recovery. Saving for the purposes of investing in education, or as aprecaution against ill-health could be a significant motivation to save at the level of thehousehold. Since the government removes the need for such saving, we expect privatesaving to decline in response to increased public investment in these areas.

For the sake of completeness, Table XV-VII present the vector error correction model foreach group of variables. Except for the structural factors group, the coefficient on theerror correction term is correctly signed and there is indication of quick reversion to thelong-run equilibrium relationship.

Table XV: -Vector Error Correction Results for PSR_PAD(PSR_PA) Coefficient t-statistics R2I. CR -.233860 -.53 .40 D(PSR_PA(-1)) -.15 -.44 D(INFL(-1)) .36 1.89* D(RR70_EX(-1)) .407 1.77* D(SHAGRI(-1)) .72 1.6* D(GSR_PA(-1)) -.36 -1.51* D(LRPDI_PA(-1)) -.29 -1.7* D(DEP(-1)) -2.11 -.67

Table XVI: -Vector Error Correction Results for PSRCON

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D(PSRCON) Coefficient t-statistics R2I. CR -.56 -1.15 .31 D(PSRCON(-1)) .22 .54 D(INFL(-1)) .221 .9085 D(RR70_EX(-1)) .122 .43 D(SHAGRI(-1)) .31 .65 D(GSR_PA(-1)) -.11 -.39 D(LRPDI_PA(-1)) -.16 -.79 D(DEP(-1)) -3.568 -1.05

Table XVII: -Vector Error Correction Results for PSRD(PSR) Coefficient t-statistics R2I. CR -.4171 -.92576 .29 D(PSR(-1)) .139 .35 D(INFL(-1)) .198 .82 D(RR70_EX(-1)) .09 .30 D(SHAGRI(-1)) .31 .62 D(GSR (-1)) -.19 -.69 D(LRPDI_PA(-1)) -.194 -.97 D(DEP(-1)) -3.123 -.83

Here CR refers to the cointegrating relationship. The coefficient on CR is thus expected tobe negative, as CR is the long-run equilibrium to which the system returns afterexperiencing a shock. The absolute value of the coefficient indicates the speed ofreversion. This suggests that shocks are persistent to a degree.

The slight negative relationship between an acceleration in income and in saving rate isunsurprising if we account for short-run growth leading to some increase in consumption.This is consistent both with the absolute income hypothesis and with the consumptionsmoothening hypothesis if these short run changes are perceived as transitory. The stronglagged negative effects in the short-run of money supply reflect the positive relationshipbetween money supply and inflation, and between money supply and income.

VII. Conclusion: What is Special about Saving in India?

As we noted earlier, India’s saving rate has been consistently higher than that of othercountries with comparable per capita income. Regarding aggregate national saving as aratio of GNDI, India has performed as well as the OECD.

India has also traditionally relied largely on national saving to fuel her investment needs,

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with relatively less reliance on foreign saving compared with less developed countries.Even the 1991 liberalization that led to an increase in foreign capital inflows has notsignificantly changed this scenario. Given the ambitious growth targets of the government,and the current global environment, it is likely that policies oriented towards raisingaggregate national savings will play a key role in future Indian economic development.

Our results on the determinants of private saving rate in Indian highlight five issues thatwe note here.

Firstly, a large share of India’s GDP originates in agriculture, and a large proportion of thepopulation lives in rural areas. This suggests that the income of a large number ofhouseholds is characterized by the uncertainty associated with agriculture in India. Thisintroduces a precautionary motive to save. This should manifest in a positive relationshipbetween aggregate private saving and SHAGRI (the share of agricultural income in GDP)and is borne out by our empirical exercises.

This should manifest in a positive relationship between aggregate private saving andinflation, given also the limited range of financial instruments available to thesehouseholds. We note here that while we have corrected for expenditure on consumerdurables including jewellery, the bulk of household saving in gold, traditionally a favoriteinvestment in India, is unrecorded. Limited data is available post-1992 when gold importswere liberalized. We find that inflation is not a statistically significant determinant ofsaving, possibly because the real interest rate is largely driven by inflation, and is stronglypositively significant.

Thirdly, in contradiction to much of the literature on saving, the real ex-post rate of returnis a positive and strongly significant determinant of long run aggregate private saving. Thisis a highly robust result. Together with the positive saving impact of financial depth, theresult on the interest rate gives support to financial liberalization as a means to increasesaving rates. A rather controversial implication of this result is that tax incentives thatincrease the net rate of return on saving instruments could bring about an increase inprivate saving rates. We are, however, hesitant to recommend tax incentives given theirdistortionary effect on resource allocation and the associated fiscal impact. In the future,an interesting area of research is the design of tax policy that is generative of highersaving.

Fourthly, we would like to extend the present study by adjusting both private and publicsaving with expenditure on health and education. This would be a proxy for accumulationof human wealth. We would expect that this would, given the large and increasing share ofpublic expenditure in education in total public expenditure, reduce the offset coefficientbetween private and public saving.

Fifthly, private saving rate are unresponsive to increase in private income. However, levelof saving is highly positively correlated with both the log level of private disposable

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income, and the growth rate of private disposable income. The implication is that anypolicy that encourages income growth in the long run will have an indirect impact onprivate saving rate. Considering the historical close link between saving and investmentrate, an increase in growth rates will result in a virtuous circle of higher income and savingrates.

Lastly, we note that, although significant, demographic variables do not appear to be thesole or most important determinants of private saving, as previous studies had indicated. We contend that the differences between our study’s findings and previous ones may bedue to our use of inflation-corrected income and saving figures, and our inclusion insaving of private consumption expenditure on consumer durables.

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