Page 104 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 5: Consumption Function

The issue with Indian savings is not the trade-off with consumption, but rather the Notes
composition and total level of Indian national savings. National savings are made up of
three sources: households, businesses, and government. Indian households are among the
most frugal in the world, saving even more than their Chinese counterparts. The slight
decline in their savings rate that we predict would merely bring them closer to levels seen
in other fast-growing economies.
But India's businesses and government save far less than they should and this leaves the
country's national savings skewed and heavily dependent on households. While India's
services-driven economy has not been as capital-hungry as China's manufacturing-based
one, and household savings have been sufficient for the required investments so far,
rectifying this imbalance offers the key to accelerating India's growth rate in the future.

There are three issues that need to be addressed in order to rebalance the composition of
Indian savings. First, as other MGI work has shown, reforming India's financial system
will be critical to making the allocation of capital in India more efficient, increasing the
depth of its capital markets, and raising real returns in the economy, thus encouraging
capital formation. Poor capital allocation coupled with India's heavy regulation of many
industries continues to discourage the formation of medium and large-size enterprises.
This leaves much of India's capital inefficiently tied up in small-scale, informal businesses
and classified as household savings. Both the financial system and regulations on industry
need to be reformed over time. Second, the Indian government needs to play its part in
maintaining fiscal responsibility and growing its own contribution to net national savings.
Finally, it will be important to acknowledge that Foreign Direct Investment (FDI) can also
play a growing role in supplying India with investment capital and should be encouraged.
While FDI is still modest relative to the size of India's economy (and dwarfed by the flows
of FDI going to China and other parts of Asia), it has increased almost 18-fold from $315
million in 1992 to about $15 billion in 2006. We expect FDI to continue to increase
significantly, especially if the regulatory and business environment continues to evolve
in directions that welcome it.
Growth in Indian incomes and consumption will deliver substantial societal benefits,
with further declines in poverty and the growth of a large middle class. The good news for
the long-term health of the economy is that India's growth as a consumer superpower
doesn't depend on Indians saving less, but rather on high overall growth continuing to
translate into rising incomes. However, this positive outcome does depend on Indian
businesses making their contribution by saving more, and the government being fiscally
responsible while continuing to reform the economy to ensure that India has sufficient
capital to invest in its future growth.

Question:
Compare savings vis-à-vis consumption scene in India.

Source: Subbu Narayanswamy & Adil Zainulbhai, May 7, 2007, Business Standard (India)
Self Assessment

Fill in the blanks:
5. Negative savings are also called ......................
6. Difference between income and consumption is represented by ......................
7. ...................... consumption represents the basic minimum need of a household.

8. In equation, C= a + b.Y, b.Y represents ...................... consumption.

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