Pakistan must improve its domestic savings rate for sustainable economic growth

Over the last two decades, Pakistan has not only experienced a chronically low gross domestic savings rate but has also seen the savings rate decline until recently. According to data from the World Bank, the gross domestic saving rates fell from 16.4 percent in 2000 to just 5.4 percent in 2019. Pakistan’s savings rate compares unfavorably with East Asian countries and South Asian peers. Bangladesh and India have seen their savings rates increase over the same period, which in 2019 stood at 25 percent and 28.2 percent respectively.

Several studies show the relationship between the savings rate and economic growth, especially in developing countries. Economist Robert Solow first argued that larger savings result in higher investments and increased production (Quarterly Journal of Economics, 1956). Other economists such as McKinnon (Money and capital in economic development, 1973) and Shaw (Financial deepening in economic development, 1973) further emphasized the causative relationship between savings and economic development. Empirical evidence shows that as income increases with higher economic growth, it tends to also boost capital accumulation. Such favorable conditions help create a virtuous cycle of further investment and accelerating economic growth.

However, it is not always easy to identify the determinants of a society’s savings propensity. The collective spending behavior of households and public and private entities is subject to several interdependent social and economic factors. Literature suggests that a major factor of savings rates is the level of financial deepening in a society, that is, inter alia, the percentage of the population holding bank accounts, the development of financial markets and the diversity in financial instruments available.

Other factors influencing the savings propensity include culture, religion, and demographic factors such as the labour force participation rate and dependency ratio. Pakistan’s high fertility rate and burgeoning dependent youth population does not encourage household savings. The interplay of disparate factors is not always obvious, and yet often converge to affect the direction of the national savings rate.  There is a consensus that people with high levels of income have a greater propensity to save and vice versa. However, for this to be sustainable, the growth should be through productivity gains and not consumption driven that is fuelled by external borrowings. If higher incomes do not result in investments in productive capacity, then the long-term savings rate is unlikely to improve and may even decline.

That has been the case with Pakistan where the economy expanded despite relatively low and declining domestic savings rates between 2000 and 2019. Such a growth model was unsustainable because the savings-investment gap was filled by foreign funding, primarily in the form of borrowings. More perversely, the economic growth was largely consumption-driven and masked the structural issue of low savings rate. It has led the country closer than ever to a foreign debt trap where the bulk of new external funding is not deployed in productive capacity but rather to service old foreign debts. With foreign borrowing now over $115 billion, Pakistan is having to spend over 50 percent of its goods exports earnings on foreign debt servicing. The high dependency on external borrowing just to service old debt makes the economy susceptible to external shocks.

A major factor of savings rates is the level of financial deepening in a society, that is, inter alia, the percentage of the population holding bank accounts

Javed Hassan

In order to reduce external dependency, Pakistan has to improve its domestic savings rate. The financial sector, especially the banks, has to play an important role in doing so. According to the State Bank of Pakistan (SBP), in 2019 “out of the total adult population of Pakistan, the financially excluded population make up 53%. One of the major reasons for why a large portion of the population is unbanked is the lack of awareness of financial products and their usage…”.

Policymakers must promote financial inclusion initiatives such as educational campaigns that inform the public about available financial banking products and services, and ease the process of opening accounts. The provision of licenses by SBP to mobile banking and digital banking platforms such as EasyPaisa and TAG Innovation Pvt. will also help boost the level of financial inclusion, especially in rural areas. These new channels can eliminate lengthy documentation processes and multiple branch visits that are associated with opening accounts with traditional brick-and-mortar banks.

At the macro level, Pakistan has persistently suffered from high fiscal deficits which effectively serves as national dissaving. Controlling the fiscal deficit and thus reducing the crowding out effect will allow banks to allocate a greater portion of the national savings to building productive capacity.

It is encouraging to note that over the last three years the savings rate has improved from a low of 5.4 percent to 19.9 percent in 2020 and 2021. This has been helped by robust growth in remittances as well as the various measures being taken to deepen the financial system. These efforts must be expanded so that Pakistan is less reliant on foreign sources for sustainable economic growth.

- Javed Hassan is an investment banker who has worked in London, Hong Kong, and Karachi. He tweets as @javedhassan.