Though Pakistan has seen an average growth of 6 percent for the last four years, the Bank has questioned how, with low domestic saving rate and low foreign direct investment, Pakistan would be able finance its rapidly growing economy in the medium term.
The World Bank report titled 'Determinants of saving in Pakistan' argues that if Pakistan wants to sustain its growth and increase its investment without paying increasing shares of income in interest or dividends, it has to finance this investment by raising its domestic saving rate.
It says that countries frequently rely on inflow of foreign savings ie capital or international borrowing, to meet investment needs. However, international borrowing can rise, or decline, depending on cyclical movements, exchange rates, external shocks, and a host of other factors. In the long run, reliance on foreign capital is also unsustainable as international liabilities erode the national income base, the report said.
Very few countries go without any international borrowing or lending in a particular year, and Pakistan is no exception. The difference between Pakistan and other fast growing economies like the ones in East Asia is that while inflow of foreign saving gave an initial boost to growth in these countries, domestic saving has been key in sustaining rapidly increasing domestic investment.
The report says: "The recent decline in household and public saving rates in Pakistan juxtaposed to increasing domestic investment needs in a fast growing economy suggest that unless saving goes up, economic growth will suffer.
To sustain its current growth momentum, without incurring the expenses of heavy international borrowing, Pakistan will need to reverse the current low (and declining) trend of domestic saving and resolve its geopolitical challenges in order to attract FDI.
Foreign direct investment could not fill the domestic resource gap even if it is doubled; hence, domestic saving is the only feasible source of extra funding unless Pakistan goes on an international borrowing spree with all of its consequences."
It says: "Saving rates have declined since 2003, despite strong economic growth in the country. Moreover, from a brief domestic resource surplus in the early 2000s, Pakistan is currently facing a domestic resource gap of around 3.5 percent of output. With a gross domestic investment rate of only 18 percent of GDP in recent years and a widening domestic resource gap, targeted growth by the government of 6 percent or higher is unlikely to be achieved."
Historical data for Pakistan place the national saving rate at around 14 percent of GDP, on average, for the period 1973-2005, and the domestic saving at 11 percent of output, on average, for the same period. While the national saving rate has been at comparable levels to the one in some of the fast growing East Asian economies, the domestic saving rate for Pakistan has been significantly lower. This suggests that net income and current transfers from abroad comprise a rather larger component in Pakistan's national saving than in the counterpart countries.
Moreover, the responsiveness of Pakistan's domestic saving rate to changes in the GDP per capita growth is lower than in the comparator countries. For example, a one percent increase in the income levels (measured by the GDP per capita in constant 2000 US$) increases Pakistan's domestic saving rate by 0.06 percentage points.
The estimated coefficient for Pakistan (5.52) is lower than the estimated ones for China (12.42), Indonesia (7.97), and Malaysia (7.55). This suggests that the elasticity of saving rate to changes in the level of income in Pakistan is smaller than in other fast growing economies.
The domestic saving rate in Pakistan has been around less than 12 percent on average for the last four decades, or almost three times smaller to the one in East Asia, for the same period. Second, despite strong economic performance, foreign direct investment (FDI), although improving, is low in Pakistan by regional and world standards.
The report says that East Asia has sustained high growth rates in the last decades, with a different magnitude of foreign capital flows in their domestic investment than the one in Pakistan. While the share of FDI in total investment has more than doubled since 1990 in Pakistan, it is still only at less than 7 percent of gross capital formation at present. This reflects low confidence of foreign investors in Pakistan, it added.
The report analyses that first, Pakistan's domestic saving rate is historically lower than the one of the fast growing Asian economies in absolute terms and when controlling for the level of economic development. Second, the domestic saving rate has considerably different structure in Pakistan from the one in the comparator East Asian countries, with corporate and public saving at significantly lower levels in Pakistan. Third, informal channels of saving are popular in Pakistan, and their economic significance (albeit difficult to quantify) could be as large as 2 to 4 percent of output.
Fourth, based on regression analysis, it has been found that demographic, financial development, fiscal, and economic growth variables are statistically significant determinants of Pakistan's domestic and private saving rates; hence, policy recommendations focus on these four factors.
Saving trends in Pakistan reveal cyclical patterns much like saving trends in the rest of the world. The domestic saving trend of Pakistan is marked by a notable increase in the early 1990s, from an average rate of 8 percent of GDP in the 1980s to 17.5 percent of GDP in 1991. High returns on the National Saving Scheme (NSS) instruments, especially over 1993-99, attracted individual and institutional deposits and explain the boost in saving.
Sectoral breakdown of Pakistan saving shows that private saving accounts for over 90 percent of national saving and preliminary data for 2005 place private saving at 12.5 percent of GDP. In comparative perspective, the private saving rate of China is three times the one of Pakistan, and the private saving rate of India is twice the one of Pakistan.
Household saving is the largest component of private (and domestic) saving in Pakistan and has accounted for about 11 percent of GDP on average for the period 1981-2005. Since its peak in 2003, which may well be due to official recording of flows that already existed, household saving has declined in both nominal and real terms.
Pakistan households save in conventional financial instruments such as various types of deposits, NSS instruments, mutual funds, GP fund, and cash. However, even if all forms of financial saving are accounted for, the financial saving rate of Pakistan is below 10 percent of GDP; and considerably lower than the one in East Asia (and especially China) and even India.
Although deposits of scheduled banks (stock) have been growing steadily in the last several years in Pakistan, their penetration is still low at around 40 percent of GDP, compared with 190 percent of GDP in China. There are 192 bank deposit accounts per 1000 people in Pakistan, compared to 1250 in Malaysia.
Corporate saving in Pakistan accounts for about 10 percent of private saving and 1.3 percent of GDP on average for the period 1981-2005. Compared to the fast growing economies of East Asia, and especially to China, the level of corporate saving in Pakistan is negligible. Observers attribute the rise of overall saving in East Asia precisely to a surge of corporate profits, which became a significant source of investment in several of the countries in East Asia.
Public saving accounts for around 10 percent of national saving in Pakistan, or 1.5 percent of output, on average, for the period between 1970 and 2005. Government saving witnessed an increase in 2004, which could be attributed to some improvement in financial management of government resources (expenditure management) and somewhat tightened fiscal discipline. Albeit positive since 1976, public saving is still in the neighbourhood of 3 percent of GDP, which is low when compared to the rate of public saving in East Asia.
Overall, in comparative perspective, saving rates in Pakistan are lower across the board than those in countries with similar per capita income. While the rate of household saving has been moderate for the last three decades (although still lower than the one in East Asia), corporate and public saving rates have been considerably lower in Pakistan than in the fast growing Asian economies.