Households have been putting less money in financial savings recently. Two recent reports on the macro economy have drawn attention to this development, which has deep implications for the economy.

The Economic Outlook, a publication of the Economic Advisory Council of the Prime Minister (PMEAC), headed by C. Rangarajan, and the Reserve Bank of India’s statutory publication, the Annual Report (2011-12), were released in quick succession.

According to the Economic Outlook, gross financial savings (measured as increase in gross financial assets), which was at 15.4 per cent of gross domestic product (GDP) in 2007-08, fell to 13.6 per cent in 2010-11, and could have possibly fallen to below 12 per cent in the next year (2011-12). Even more relevantly, net financial savings of households available for use by the rest of the economy fell below 11.6 per cent of GDP in 2007-08, to 10 per cent in 2010-11 and likely to go below 9 per cent in 2011-12.

Net financial savings are calculated by deducting financial liabilities such as mortgage and personal loans from gross financial savings.

The RBI’s estimate is even less upbeat: household financial savings fell to 7.8 per cent (of GDP) in 2011-12, the lowest since 1989-90. During the preceding three years, it averaged 11 per cent.

When the economy is faring well, households tend to put more money in financial savings instruments. In a buoyant economic environment, it is very likely that the stock markets will be bullish and mutual funds will also look attractive.

However, when the cycle turns and the environment is less optimistic, households tend to do the reverse. They usually withdraw from organised financial savings that include bank deposits, shares and mutual funds.

If inflation is high, people will have less money to invest. That is because household expenses will eat into the savings potential of households. If the aggregate household savings are less, the economy suffers.

The stock of savings available for industrial and modern sectors gets reduced.

The unmistakable lure of gold

In India recently households have withdrawn from financial savings to put more money into gold. This parallel development is not new to India.

The world-over, gold has become a reserve currency at a time of uncertainty. Gold prices have recently been soaring to new highs day after day.

What has contributed to the surge in demand for gold in India is the fact that it is more easily available than ever before. More importantly, there is an awareness of the investment potential of gold. Even ordinary investors buy gold, hoping it would protect them from inflation.

It is very likely that the craving for physical gold can never be suppressed through measures such as import curbs, higher tariffs and so on.

The only way forward is to integrate the physical market for gold with the financial market.

Already this is happening. The oldest example is a gold loan. Traditionally, jewellery items were kept with banks as security.

Gold loans have taken off in a big way recently with some non-banking finance companies (NBFCs), especially in Kerala, specialising in the business. So rapidly have some of them grown that the RBI has thought it fit to impose some restraints on the NBFCs. Exchange Traded Funds (ETFS) are mutual funds listed on a stock exchange.

A number of gold ETFs have been launched, and most of them are flourishing. It is, however, doubtful whether these are patronised by common folks.

A truer integration will happen if banks start offering gold-backed deposit schemes. Widely popular in places such as Singapore, these, in effect, offer a two-way quote for the precious metal.

Ordinary individuals can open “gold-backed” deposit schemes with banks. Here conventional deposit schemes, savings bank accounts and recurring deposit are in local currency but at any time the balances are redeemable in gold at the prevailing price.

This is an idea whose time might have come. Nevertheless, it cannot be implemented straightaway without some accompanying policy measures. For instance, banks need to manage gold supply with them much the same way as they are managing cash now. A high degree of standardisation is a pre-requisite. Besides, physical gold must be traded freely - not subject to policy curbs.

No competition to bank deposits

The recent dip in households’ financial savings is reflected in the fall in the quantum of the small savings schemes, shares and debentures, including mutual funds.

The fall in small savings collection is attributed to lower interest rates as well as the withdrawal of certain favourable conditions (such as a bonus on maturity). It is also likely that when even the most stodgy public sector banks are adopting the latest technology and offering their customers services such as anywhere banking, the post office should lag behind in certain aspects of customer service. Bank deposits have held their own accounting for more than 50 per cent of the savings. Along with NBFCs, deposit mobilisation by banks has been one bright spot.

High interest rates offered by these two categories have been one major factor. Assurance of a safe, steady return from banks and top-rated NBFCs has been a big draw. One, however, wonders whether banks, especially the bigger public sector ones, look at deposit mobilisation from the point of view of their depositors.

More often than not, it is their lenders’ requirements, and the banks’ own asset-liability positions that guide their deposit rates. The fact that inflation has already eroded the return on bank deposits and a further cut would only worsen their depositors’ plight seems to have escaped the attention of banks. That most depositors have really no alternative makes it worse.