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Indian households faced a massive income shock in the worst months of the pandemic. How did they respond? And will their reaction have an impact on the trajectory of India’s economic recovery in the years ahead?

The government recently released revised estimates on national income, consumption expenditure, savings and capital formation for the fiscal year that began soon after the pandemic hit India and ended on 31 March 2021. The new data can be used to get vignettes of how households managed through the crisis, especially their finances. Here are some salient facts.

First, consumer spending in the first year of the pandemic fell compared to the previous fiscal year, more sharply in real terms than in nominal terms. Real personal final consumption expenditure, or consumer spending, came down by ₹5 trillion, or nearly 6%. It fell by a more modest ₹2 trillion (1.7%) in terms of current rather than constant prices.

Second, nominal spending on some items such as food, utilities, health and communications went up, despite the overall decline in consumer spending. The money spent on education remained more or less steady. The data on output suggests that households cut back on items such as clothing, footwear, restaurants and transport, partly because of the restrictions imposed on mobility during various lockdowns.

Third, even as the gross savings of Indian households went up by ₹4.61 trillion in nominal terms, the distribution of these savings between financial and physical savings tells an important story. Gross financial savings increased by ₹7.09 trillion while savings in physical assets declined by ₹2.25 trillion. The money spent on precious metals such as gold and silver was more or less the same. (Note: Households include unincorporated enterprises in the informal sector.)

The sharp increase in gross financial savings by households in 2020-21 was partly forced by the harsh lockdown in the early months of the pandemic. The Reserve Bank of India had estimated that household financial savings had shot up to 21% of gross domestic product in the first quarter of 2020-21, but then came back to their normal level of around 8% once mobility restrictions were eased. The unusually high household savings in the first quarter have undoubtedly bloated the annual numbers, though this also means that the excess savings between April and June 2020 were not spent down.

Why would this be so? The answer is rooted in psychology. Economists generally believe that people respond to severely negative income shocks in two ways. They either borrow to maintain previous levels of consumption or cut their spending to protect savings. A lot depends on whether people expect the income shock to be temporary or permanent. The usual response to a temporary income shock is to smoothen consumption through borrowing, while in the case of a permanent income shock, the household cuts back on spending to protect savings over the long term.

The fact that household debt has not increased significantly in 2020-21, compared to the sharp increase in the two years after demonetization, suggests that Indian households have gradually begun to see income shocks as more permanent than transitory. This is just a guess from reading the macro numbers, but this is an issue that needs more detailed household surveys to understand the underlying behaviour.

It is likely that the gross financial savings rate of households—as a percentage of disposable income—will normalize as the economic recovery deepens. Yet, it is worth pointing out that Indian households seem to have made a decisive switch from physical to financial savings, compared to what they did in the initial years of the previous decade, when physical savings were higher than financial savings as a result of high inflation as well as negative real interest rates.

On the other hand, the savings of private sector companies—or private non-financial corporations, in the precise lingo of government statisticians— actually came down in nominal terms in 2020-21, by ₹1.19 trillion. This fact sits uncomfortably with the overall trend of higher corporate profits plus weak capital spending by companies. Is it possible that the strengthening balance sheets of large companies hides the damage to the balance sheets of smaller companies?

The data cited in this column is on flows rather than stocks. It is quite likely that more savings in 2020-21 has increased the stock of household savings as well, though as this column had earlier argued in another context, a large increase in the stock of household financial savings is not immediately evident in banking data.

In countries such as the US, massive income support for households led to a stock of excess savings that is now being spent down, so an increase in household savings was a mirror image of a higher fiscal deficit. The Indian fiscal response to the pandemic shock was quite different, so the link between a higher fiscal deficit and household finances is less clear.

The Indian economy has recovered from its massive drop in output in the worst months of 2020. It is likely that the difficulties faced by households then could have lingering effects, especially in the choices made between spending, saving and borrowing.

This article was originally published in Mint on Feb 9, 2022

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The opinions expressed in this essay are those of the authors. They do not purport to reflect the opinions or views of CCS.