The Hindu Business Line : On `money trail' and savings rate

Little attention has been paid to the reported high saving/investment rate and the proposed tax on cash withdrawals in excess of Rs 10,000 from banks. Both are quirks, the first of statistics and the second of the political economy, says A. Vasude van, looking closely at the two issues of significant import.

TWO ISSUES of import — one concerning the reported high saving/investment rate and the other relating to the Finance Minister's announcement of tax on withdrawal of cash by residents of their deposits from scheduled commercial banks of or beyond Rs 10,000 — have not received the requisite attention in spite of their crucial macroeconomic implications. The Minister has emphasised that the announced tax measure is not for raising revenue but is essentially meant to find out the trail that such withdrawals leave behind. Such a trail, he hopes, would help the Government unearth unaccounted money.

Saving-investment rates

The latest estimates place the saving rate at 28.1 per cent in 2003-04 against 26.1 per cent in 2002-03, and 23.4 per cent in 2001-02. The rate has thus gone up in two years by almost 500 basis points and in the last reported year by 200 basis points. The investment rate in the last two years is estimated to have to gone up by about 400 basis points. In 2003-04, the investment rate is placed lower than the saving rate. This is conventionally interpreted as India exporting savings by creating external current account surplus.

Very rarely do developing economies have external current account surpluses though such a surplus had happened in the Indian economic history once in the 1970s. But such outcomes could be more frequent since `invisibles' have become vibrant owing to the dynamism of the services sector. There is a need to examine the theoretical construct that treats the surpluses on current account as flow of saving to the rest of the world even when there are large surpluses on capital account.

In the Indian case, the sharp increase in the saving and investment rates and the excess of the saving over the investment rate seem to arise due to infirmities in collection of data and analysis.

The problem has arisen first on account of the estimation of saving of the household sector in the form of physical assets (machinery and equipment and construction) and second in regard to the estimation of the saving of the household sector in terms of currency and deposits. The public sector hardly saves. The problem cannot be sourced to the organised private corporate sector which, going by the released data, has registered saving in line with the past trends.

The household sector's holdings of physical assets have been notoriously volatile partly because of the estimation of the data on capital formation that contains considerable chunk of `errors and omissions'. The expert group on saving and capital formation under the chairmanship of Raja Chelliah in 1996 (of which I was a member) was assured of the replacement of `errors and omissions' by statistical discrepancy or difference.

In relation to nominal GDP, the household's physical asset holdings moved in a broader range (7.4 to 13.0 per cent) than the household's holdings of financial assets (8.7 to 11.9 per cent) since the early 1990s. Again, the share of the physical asset holdings in the total net financial saving of the households has been in excess of 100 per cent since 2000-01. There are no good explanations for these two phenomena. Whether this is because of valuation of physical assets and/or whether the shift in household sector's preference was because of possible long-term capital gains rather than by current interest income are issues that need to be researched into against the background of the downward drift in the overall public and private corporate sector investment rates. Besides the implications of the phenomena for fostering market financing as against bank financing need to be studied.

The estimation of saving in the form of currency and deposits is also an area where further research is needed. In years of high liquidity, saving in the form of currency tends to be high. This is because the public sector and the organised private corporate sector economise on their cash balances given the fact that cash on hand or in vaults would not attract any rate of return and the residual (more than 90 per cent of the cash held in the economy) is therefore considered as being held by the households. In regard to deposits, one needs to see whether the capital inflows that are purely temporary and are in the nature of `floats' have been included in the estimation.

It is more than two months since the data were released. Silence on the issue could lead to an inference that the relatively high growth rates in recent years were not facilitated by productivity gains — a point that would not be taken kindly by many observers particularly those who are impressed by the strides made in the area of information technology.

One could argue that the increase in the stock of knowledge has not given rise to improvements in what economists call total factor productivity. This would imply that there has been considerable wastage of capital use, a point that was so effectively echoed by Prof Paul Krugman in his analysis of the high saving and investment rates in East Asia some years ago. From the point of view of the Reserve Bank of India, it would be of relevance to know the impact on the economy that the soft interest rate policy has had during the last 4-5 years.

Tax on cash withdrawals

Suggestions have been made to the effect that the limit of Rs 10,000 could be raised or that it be made applicable only to current accounts and not to saving accounts. The Finance Minister, averse to `roll back' of proposals, can be expected to restructure his proposal. But the fundamental logic behind the proposal needs to be more elaborately explained. The explanation in terms of trails does not seem to convince any one. For, income-tax payers submit returns along with their bank statements wherein explanations are provided about the credits and debits into the bank accounts. This institutional mechanism could be strengthened for money trail if necessary.

Taxation is not the alternative. For, a tax penalises those who save or hold money balances for liquidity or business uncertainty reasons, even though they are not compensated fully in real terms, given the high inflation rates or given the higher rates of return available on alternative instruments. In addition, the depositors would have to incur shoe leather and transaction costs in respect of submission of returns for such withdrawals. Whether the tax would lead to deceleration of deposits is difficult to say but one should not discount that possibility.

There are also costs for the system as a whole since the income tax department would have to ensure submission of such returns and scrutinise them.

Some one has to explain that the costs cited above are still lower than the costs that the system incurs for want of information about the trails of cash flows arising, in this case, only from withdrawals from banks, before going ahead with the said tax proposal. It is also surprising how the Rs 10,000 limit was arrived at for I know from personal experience that at least one public sector bank branch refuses saving account withdrawal of more than Rs 7,000 across the teller-counter. If one were to draw more than this limit, the depositor would have to approach the manager and explain the need for drawing more than the limit. Very few individuals maintain current accounts and the traders/business entities tend to economise on their current account balances. But who cares for economic logic? Obviously, it is the `political economy' that matters.

(The author, a former Executive Director of the Reserve Bank of India, can be accessed on asurivasudevan@hotmail.com)

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