How To Get More Of It

Savings-investment missing link

Asadul Islam

The effect of savings on the economy is relatively straightforward - higher savings enhances investment. High rate of investment improves productive capacity of the economy and thereby increases GDP growth rate, which in turn helps generate more employment and better living standards. Thus, high savings and investment rates appear very desirable for improving national welfare.

Savings-investment performance
Bangladesh's domestic saving rate has generally experienced a steady and substantial rise over the past quarter of the century- it rose from a low of 2.93 percent of GDP at constant market prices in 198081 to a high of 20.2 percent in 2004-05. The rate of investment in 1980-81 was 10.6 percent, which has increased to 24.4 percent in 2004-05. Data on individual years have shown vast fluctuation in the rate of savings and investment. This is also reflected in the fluctuation in the growth rate of GDP.

However, domestic savings of the Bangladesh economy have entered a phase of relatively slow growth during the 1990s. It rose from 12.9 percent in 1990-01 to 17.9 percent in 1999-00. The investment in the 1990s shows a relatively better trend than domestic savings. It increased from 17 percent in 1990-01 to 23 percent in 1999-00. The period of 1990s coincides with the period of economic reform and financial sector liberalisation. The performance of the domestic savings in the 1990s does not appear to be satisfactory as compared to that of many other developing countries. Bangladesh's failure to raise the base of domestic savings in 1990s is inextricably linked to the poor performance of the public sector in that respect. The private sector has shown an improvement in the rate of savings with corresponding dissavings in the public sector. The increase in the private sector savings rate in the 1990s can be linked with the liberalisation of the economy (through the corporate sector's profitability due to perhaps competitiveness and efficiency), combined with easing interest rate burden, low incidence in the corporate sector taxation.

In the last five years the savings and investment rate of Bangladesh have increased at a very slow rate. The domestic savings have increased from 18 percent in 2000-01 to 20.20 percent in 2004-05 - less than 0.5 percent increase per year. The corresponding national savings show a relatively better sign- it has increased from 22.40 percent to 26.50 percent an increase of 4.1 percent of GDP. The investment-GDP ratio was 23 percent in 2000-01 while it stood up to 24.40 percent in 2004-05. The investment in public sector is now at historically low level of 5.9 percent. The private investment has been increasing while the public investment is declining gradually.

Bangladesh's savings-investment ratio compares favourably with countries such as South Africa and Chile with ratios of 21 per cent and 25 percent respectively but lags behind Botswana and Malaysia with 30 per cent and 36 percent respectively. One important aspect of the savings-investment scenario is that even with low rate of savings, Bangladesh has not been able to translate the savings into investment. The savings-investment gap has been persistent from the early-1990s- except in the year 2000-01 when there was excess investment over savings. This excess liquidity- excess of savings over investment- in the recent years has been almost 2 percent of GDP.

Small savings add up

If we look at the GDP growth rate, we see that this has been volatile in the past five years. The growth rate was 5.3 percent in 2000-01, it went down to 4.4 percent in the following year, then it increased in the successive two years and stood at 6.3 percent in 2003-04, but again fell down to 5.4 percent in the last fiscal year. The capital-output ratio (Investment ratio divided by GDP growth rate) also shows a variable trend. If we compare with the developing countries that have been successful in accelerating their GDP growth rate, we can say that Bangladesh has been operating at a low level of investment. The country can achieve a growth rate of about 5 percent with such a low level of investment! The country needs to boost its investment-GDP ratio and improve the capital output ratio to achieve a much higher rate of economic growth.

Savings, investment and macroeconomic policy
In the 1980s and the early 1990s, the discourse on macroeconomic issues was dominated by concern with short-term stabilisation and adjustment. The focus has shifted now on to savings and the corresponding investment performance of the economy.

There is now consensus among the development economists that better living standards and elimination of poverty must be based on sustained expansion of output, which requires accumulation of capital and its corresponding financing. The endogenous growth theorists have recently focused on the links between savings, investment and growth. The insufficiency of savings can itself be a binding constraint on investment and growth in the absence of foreign capital. So it is important to design appropriate macroeconomic policies that would promote the expansion of public and private savings and help the transmission of these savings into productive investment and improving the overall efficiency. In Bangladesh a large number of households have a tendency to resort to holding unproductive assets or even to generate unearned or unproductive incomes and spend them on conspicuous consumption. So, macroeconomic policies have to be designed to discourage such tendency and help surpluses into productive forms of saving and investment. Furthermore, policies that promote domestic savings must go hand in hand with policies designed to step up productive investment.

What do we need to do
Bangladesh economy has entered the phase of relative stagnation in domestic savings and investment in the recent years. At the same time, the economy also experiences a recession of industrial growth. In this phase of rapid technological progress, the investible funds required for normal replacement of machinery and equipment are much higher than the existing trend. In order to promote the pace of industrial growth, Bangladesh needs substantial quality investment in the industrial sector and investment in those activities where we can produce more efficiently. This should be supported by improvement in the efficiency of capital use and the reduction in capital output ratio.

Despite low level of savings, Bangladesh has not been able to absorb all the savings into investment. This implies that the economic growth rate in Bangladesh is not necessarily constrained by insufficient savings; rather it is due to poor level of investment and lack of efficient use of capital. Bangladesh has a high capital-output ratio making the investment less productive. In such a labour surplus economy this seems to be wastage of resources, as the scarce capital is not being used efficiently.

So, Bangladesh needs both increase in investment and productive use of the new capital, which is going to be injected every year. There is also need to strategise the policy and appropriate intervention in the economy to encourage households to save more. However, the balance between domestic savings and investment reflects the foreign saving position of the country, and so the extra savings will fly abroad if national savings are not translated into investment. The inadequate investment as compared to savings in Bangladesh raises the question as to why we are not been able to inject the savings into productive investment despite our most liberal investment policies in South Asia and incentive schemes provided by the government to the existing and potential investors. The institutional weaknesses, the lack of entrepreneurial skills in the public sector enterprises, socio-political climate are major factors hindering both accumulation and efficient use of capital and improving the business climate for investment.

Investment and foreign capital
An economy needs to generate sufficient savings to finance investment required for economic growth. Otherwise, the economy can borrow from abroad to do so. However, borrowing from abroad may have adverse effects on the balance of payments as these loans will have to be serviced in the future. It also carries a foreign exchange risk. This is also reflected in the country's current account position. Therefore, sufficient domestic saving is necessary for economic growth because it provides the domestic resources needed to fund the investment effort of a country.

In the recent months there has been a growing expectation about the rapid increase in the flow of foreign capital in view of the growing interest shown by some reputed foreign multinational companies like Tata to invest in Bangladesh. Foreign investment is important for an economy to grow but its role should be complementary, and should usually be subsequent to domestic efforts. Absorption of foreign investment beyond a certain point can entail substantial structural and institutional constraints. This has been proved in case of India which can not absorb more than 10 percent of domestic investment as foreign saving, or 2 to 2.5 percent of GDP as current account deficit.

So, foreign capital can be a substitute for domestic savings only to a limited extent. On the other hand, not all foreign savings are complementary to domestic savings. Evidence also suggests that foreign aid, commercial borrowing and portfolio investment can limit the expansion of savings by augmenting consumption. The economy can fall into the debt trap and the subsequent decline in the growth rate would be unavoidable.

Conclusion
Savings and investment are necessary but not panacea for development and economic growth. They can perform a better role and be driving forces for economic growth and poverty reduction efforts in a sound macro-economic situation that promotes coherent and consistent long-term government policy. So government must follow an appropriate policy scheme to boost the existing levels of domestic savings and investment. An appropriate policy intervention is also essential so that foreign investment does not crowd out domestic investment as has happened in some transitional economies.

The experiences from South East Asia and China can give us some lessons of how to follow a sustained increase in the rate of investment. We might not be able to replicate their model totally in Bangladesh due to historical, social and political dissimilarities that exist with those countries. But the lessons provided by those economies through spectacular economic growth over a long period of time have been supported by phenomenally high rates of domestic savings and investment.

.......................................................
The writer is Research Associate, BIDS.