PAKISTAN seems to be stuck in a low-saving low-investment trap, which has seriously hampered its growth potential: a low savings rate reduces the volume of investible funds; low investments make growth spurts unsustainable; and low growth generates fewer domestic savings.
It is not surprising therefore, that nearly all of Pakistan’s high growth periods have coincided with abundant inflows of foreign savings (in the form of external loans, grants and remittances).
Accordingly, whenever such inflows dried up, economic growth slid back, as domestic saving and investment were never sufficient to keep up the growth momentum.
While foreign savings are important in financing the saving-investment gap, the most reliable source of funds for investment in a country is its own saving — Pakistan’s record in this aspect is also not encouraging. National savings as per cent of GDP were around 10pc during 1960s, which increased to above 15pc in 2000s, but declined afterwards. Pakistan’s saving rate also compares unfavourably with that in neighbouring countries: last five years average saving rate in India was 31.9pc, Bangladesh 29.7pc, and Sri Lanka 24.5pc.
Similarly, domestic savings (measured as national savings less net factor income from abroad) also declined from about 15pc of GDP in 2000s, to less than 9pc in recent years.
Domestic savings are imperative for sustainable growth, because inflow of income from abroad (remittances and other factor income) is uncertain due to cyclical movements in world economies, exchange rates, and external shocks.
Low level of saving is one aspect of the problem; other equally important issue is channelising of saving through financial sector for their efficient allocation to investment. It is found that less than 50pc of the national savings find its way in to financial sector. The rest is used in real estate or other form of capital formation by informal ways. Interestingly, financial savings (i.e. savings kept in the form of financial instruments) declined sharply to 22pc of the total national savings during 2000-05 — a period of real estate boom. Incidentally, the interest rates were also very low during this period.
Saving behaviour of economic agents is a complex phenomenon which is the outcome of interaction of a large number of social and economic factors. However, key determinants of saving rates are the following three macroeconomic variables:
(i) Income level: Savings are positively associated with income. There is a general consensus in economic literature that people with low level of income have lower propensity to save and vice versa. One reason for collapse of saving rates in Pakistan in recent years is persistently low real GDP growth.
Role of income in determining savings rate is also clear from micro data of Household Integrated Economic Survey (HIES). An analysis of this makes several revelations: (a) overall saving rate of urban household is higher than rural household, as per capita income is higher in urban areas; (b) in both urban and rural areas, rich class has the highest saving rate; and (c) interestingly, saving rate in rural areas increased during recent years as rural income increased significantly due to increase in agricultural commodity price (going forward this trend may reverse due to the recent fall in commodity prices).
Although remittances (which are savings of Pakistanis working abroad, and are part of National Savings) have been showing robust growth for the past several years, their contribution to sustainable growth is less clear.
(ii) Inflation: A continuous five years of double digit inflation between FY08-FY12 has also contributed to decline in saving rates during this period.
(iii) Rate of return: Rate of return on saving is the most important factor affecting saving rate. The national saving rates have followed the trend on real interest rate in general. Particularly, private sector savings have strong association with the real interest rate — having a correlation coefficient of 0.62. However, public savings are not interest sensitive (with a correlation coefficient of 0.12).
While the past trend in saving rate as well as its recent fall can fairly be explained by real GDP growth, inflation and real interest rate, there is still a need to understand the structural factors that have kept savings rate historically low in Pakistan. Empirical literature on determinants of saving behaviour finds education, financial deepening, culture, religion, and demographic factors (like labour force participation rate, dependency ratio, etc.) as major factors affecting private sector saving rate; and political stability as a key determinant of public saving rate. While some of these factors may be quantifiable, many are qualitative in nature.
With improved security situation and business sentiments in the country, we expect investment to pick up going forward. Encouragingly, the environment of low inflation, low global oil prices, and relatively safer external macro balances has provided a room for government to address structural problems.
An important task is to ensure continuity of an environment conducive for businesses (eg consistent policies, smooth energy availability, improved governance, etc). Next, the government should design a coherent industrial policy and provide adequate incentives so that manufacturers can move up in the value chain, and invest in technology that will allow shift from producing low value added products to high value products. At the same, the regulatory institutions should be strengthened so that private intellectual rights are suitably enforced and protected.
The direct role of the government includes public investment in infrastructure (primarily in electricity and gas distribution, construction, transport and human capital), which crowds in private investment. Given the strong spillover of education on productivity growth, the public investment on R&D and better skill set is critical. A focus on expanding network of technical and vocational education institutions, and establishing industry-academia linkages can yield fruitful results.
In terms of domestic resource mobilisation, the role of the financial sector is critical. Commercial banks in particular should focus on unlocking household savings placed in real estate and precious metals (eg gold), and then channelise them into productive investments. Similarly, more schemes are needed to attract contractual saving schemes in private sector like pension, provident fund, gratuity, old-age benefit schemes, as well as small savings (like committee/bisi system) into the formal financial system.
— Edited extracts from a paper on ‘Savings and Investment in Pakistan’, by Mr Amjad Ali, an analyst in Economic Policy Review Department at the SBP.
Published in Dawn, Business & Finance weekly, February 1st, 2016