Nature of Relationship Between Inflation and Savings: Evidence from India


Madhunika Iyer, under the Guidance of Dr. Shreya Biswas


This paper investigates the importance of inflation in explaining the recent slowdown in savings in India using time series data for the period 1971-2015. Using Autoregressive Distributed Lag Co-integration technique, it was estimated that in the long-run, inflation has a negative impact on savings. The impact of inflation on financial and physical savings is considered separately. It was found that the threshold value of inflation that minimises the residual sum of squares for both financial and physical savings is 6.5%. For inflation below this value, it increases financial savings while it has the opposite impact beyond the threshold. For inflation below the threshold, it negatively impacts physical savings and inflation above the threshold works to increase physical savings. This confirms the feature of Indian savings wherein physical savings instruments like gold and real estate are used as an inflation hedge. This has important policy implications given the importance of savings for growth in India.


According to Planning Commission data, India’s gross domestic savings rate fell to 30.35% of GDP in 2014-15 from 36.82% in 2007-08. During the same period, GDP growth rate increased from 4% in 2008 to a peak of 10% in 2010 and has since sustained at 8% per annum. While growth has picked up since 2008, savings has not shown the same trend. Domestic savings is essential for investment, which must otherwise be financed by borrowing or foreign capital.

A DBS Report (2016) points out that the slowdown in savings could be a function of cyclical factors or structural factors. Cyclical factors listed are low incomes, tough economic conditions and high inflation. On the other hand, the structural factor affecting savings is rising dependency ratio, which is a consequence of the changing age structure of the population and fall in working age population. However, dependency ratio in India has been steadily falling since the 1990s with a consequent rise in working age population over the same period. Hence, cyclical factors are causing a drag on savings.

Savings has been pegged back by frequent episodes of inflation. During the period of relatively high inflation between 2011 and 2013, nominal interest rates were high; however, real interest rates were negative/very low. Since savings (financial) depends on interest rates, it was negatively impacted. Further, during episodes of high inflation in India, households turn to physical savings instruments such as gold, which serves as an inflation hedge. This is counter-productive because not only are domestic resources diverted towards the purchase of gold, but also depreciation of currency due to deteriorating current account balance further leads to inflation.

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