Mobilisation of savings for self-reliance

source: http://jang.com.pk/thenews/apr2008-weekly/busrev-21-04-2008/p2.htm

By Aftab Ahmad Khan

The inability to mobilise adequate domestic resources to finance development has continued to restrain the rate of growth in Pakistan. This is an important reason why the actual rate of development has been below the potential rate of development. It has been responsible for increasing our dependence on external savings in the form of loans, investments and grants to an extent that it now impinges on our economic sovereignty. According to Prof. Ragnar Nurkse “the vicious circle of poverty” that runs from low income to low investment to low productivity and then back to low real income can be broken by an increase in the ratio of savings and investment to national income.

Pakistan’s national savings to GDP ratio in FY07 was 18.0 per cent as compared with 17.2 per cent in FY06 and 17.5 per cent in FY05. Savings –Investment gap in FY07 was 5 per cent of GDP as compared with 4.6 per cent of GDP in FY06.

Savings to GDP ratio in Pakistan is quite low as compared with the regional economies. According to Asian Development Bank (key indicators 2007), gross domestic savings as a percentage of GDP in 2006 were 32.4 India, 20.3 in Bangladesh, 50.5 in Singapore, 43 in Malaysia, 47.3 China and 13.7 in Pakistan.

The State Bank of Pakistan has quite appropriately pointed out that a large savings-investment gap is not desirable for the country in the long run because of its negative impact on macro-economic stability. It results in accumulation of external debt and puts additional burden on the country’s balance of payments in terms of mounting debt servicing.

Despite low rates of national savings, Pakistan has somehow managed to sustain a respectable growth rate of domestic output. This apparent contradiction is resolved if one accepts the view that estimates of savings and investments are considerably under-stated as they do not take into account saving and investment activity in the parallel on black economy. A more likely explanation might be that Pakistan over the last decades has been depleting its existing stock of capital and neglecting maintenance and replacement, thus attaining high income growth with low investment at the expense of future growth. This is visible in the public infrastructure facilities under-maintained roads, railways and irrigation networks, and by the low level of investment in social sectors. Whatever the reason, it is prudent to assume that the Incremental Capital Output Ratios (ICORs) will be higher in the future. The composition of future investment with heavy infra-structure requirements for every, irrigation, transport and urban renewal as well as new emphasis on social sectors will entail more capital per unit of output and therefore higher rates of investment.

The prevailing rates of investment and savings are not adequate to support future economic growth at the socially necessary rate of 8 per cent per annum. Pakistan therefore has no alternative but to make determined and sustained efforts to raise significantly its national savings and investment rates.

Various reasons have been advanced to explain Pakistan’s lacklustre savings performance. These include the existence of a large unorganised black economy whose savings are not captured by official statistics, a feudal outlook characterised by wasteful expenditure, a development strategy which has emphasised the production of consumer goods, conspicuous consumption and ostentatious living by the elite, rates of inflation higher than the rates of return on financial savings, lack of adequate attention to the efficiency dimension of investment, a high population growth rate with a concomitant high dependency ratio and low level of per capita income.

The most frequently cited reason, however, is a culturally induced bias in favour of consumption. But while such a bias would affect the propensity to save, it cannot by itself satisfactorily explain all aspects of Pakistan’s savings performance and by constantly citing this cultural factor as a principal reason for Pakistan’s low savings rates, the importance of other determinants tends to be either disregarded or discounted. In our case, it is quite clear that inadequate returns on financial savings and unequal and inefficient distribution of credit have exercised inhibiting impact on the process of savings and investment. Admittedly, the rate of return is not the only determinant of savings, but the evidence suggests that it is far more important than bankers and policy makers have acknowledged for a long time.

Savings, like other economic variables are related to a large number of factors, such as income expectations, investment opportunities, import regulation, pattern of industrialisation, inter-sectoral transfer of income and distribution of income etc. The rate of savings can be influenced by many of these variables.

Growth and savings feed back into each others in the virtuous circle of savings-investment-growth-savings.

The feed back mechanisms depend on the efficiency with which savings are channelled into productive investments. Hence, financial infrastructure, such as banking systems, stock and bond markets, insurance and the degree of monetisation play a key role in packaging risk for savers, transmitting information and lowering the cost of equity for firms.

The main imbalance between savings and investment in Pakistan arises in the public sector. Budget deficit i.e. the gap between consolidation revenues and expenditures has been one of the most serious problems facing the economy and is an important cause of the low level of domestic savings. During the 1980s and 1990s it annually averaged 7.1 per cent and 6.9 per cent of GDP respectively.

The budgetary deficit was, however, brought down to 4.3 per cent of GDP in FY06 and FY07. In the current fiscal year FY08, unfortunately on present indications it is likely to substantially exceed 4.0 per cent GDP target.

It is heartening to note that the present government has realised the importance of a significant fiscal adjustment involving major public resources mobilisation effort and expenditure control / rationalisation measures accompanied by steps aimed at improving tax administration.

The present tax structure of Pakistan unfortunately falls short in all major functions of a modern tax system. The system is characterised by the dominance of indirect taxes (around 63 per cent of total tax receipts). At the same time the system has many exemptions and concessions. Furthermore, those subject to taxation, with the exception of wage and salary earners are known to pay only a fraction of their share. In order to maintain the present low tax-GDP ration (10.2 per cent), the tax system needs to be supplemented with frequent ad-hoc measures.

Moreover, tax evasion has encouraged the growth of a parallel economy which in turn results in cumulative loss to the public exchequer.

In the context of stepping up the rate of national savings, the necessity of avoiding ostentation and waste in public and private expenditures cannot be over-emphasised. In our bi-polar society wherein a small island of opulence and privilege is vulnerable to an ominously rising tide of poverty and despair, conspicuous consumption and waste (manifesting itself in palatial houses and costly furnishings, high priced conveyances, expensive banquets and marriage ceremonies, vulgar display of jewellery and frequent trips to foreign countries) rub salt as it were on the wounds of large number of poor. In the case of a poor country like Pakistan, extravagant living is highly immoral insofar as it involves the unproductive use of limited resources; moreover, (this is of much greater significance), the frustration and discontent generated by it impede the process of social cohesion and stability.

The very high incomes, which accrue to businessmen, industrialists, landowners and speculators, have their justification only, if these lead to increased savings and high productive investments.