Understanding the Factors Behind Low Saving Rates in Pakistan: Insights and Policy Recommendations

ABSTRACT

Savings play an essential role in economic growth and development as it provides resources for investment and financial stability. Pakistan, like many developing economies, faces challenges in promoting a robust savings culture. This study examines key determinants of savings behaviour, including macroeconomic factors, fiscal policies, interest rates, inflation, remittances, and religious beliefs. Findings suggest that enhancing financial literacy, offering tax incentives, and ensuring economic stability can boost savings. Policies to manage inflation and improve real interest rates are vital for encouraging household savings. The study also highlights theoretical insights, such as the Harrod-Domar model and the Permanent Income Hypothesis, underscoring the link between savings, investment, and long-term growth. To enhance savings, the government should adopt both short- and long-term initiatives, such as expanding financial literacy programs and promoting investment-oriented savings schemes. Tax and duty reductions for productive industries for encouragement may lead to higher savings. Ensuring financial stability, controlling inflation, and strengthening institutions are important for building saver’s confidence. Similarly, higher real interest rates encourage savings while inflation erodes their value emphasising effective inflation management essential for to build saving culture in Pakistan. As controlling inflation remains a key policy objective of URAAN project, this study indicates that higher savings are possible with decline in inflation in Pakistan. Consequently, an increase in savings is expected as inflation decreases. Moreover, higher savings can support the government in achieving its economic growth targets.

1. INTRODUCTION

Savings are essential components of economic growth and development as they provide resources for investment, bring financial stability, and enable individuals and households to deal with financial shocks. Pakistan, like many developing economies, faces challenges in promoting a robust savings culture. Pakistan is currently observing a low savings rate and sluggish economic growth. The saving to GDP ratio is recorded at 13.0 percent in FY2024 compared to 13.2 percent in FY2023 (Pakistan Economic Survey, 2023-24). Within Pakistan, there exist a noticeable disparity in savings rates across different provinces. The country’s inadequate savings levels pose a significant challenge in financing its current account deficit, which floats around 5-6 percent of GDP. The current account deficit as a percentage of GDP, as mentioned by (Mukhtar & Khan, 2016) ranged from 0.83 percent to 5.8 percent between the fiscal years 2004-05 and 2008-09. However, it declined to 2.13 percent in 2009-10. The current account turned into a surplus in 2010-11 but returned to a deficit in the subsequent years. For sustainable economic development, Pakistan requires a savings rate of 22-25 percent, a target that seems far away given the current economic conditions. In contrast, countries like China, India, and Bangladesh have shown higher savings rates of 45 percent, 32 percent , and 37 percent of GDP, respectively. In 2022, Pakistan’s gross savings rate was around 10.6 percent while India and Bangladesh were 30 percent and 34 percent, respectively (Business Recorder, 2024). Observing the world and South Asian average for the saving rate remained 28 percent and 26.3 percent, respectively Business Recorder, (2024).

1.1. Significant Theories on Savings

A large body of literature exists to address savings, Investment, capital accumulation which is important for capital accumulation and economic growth. This section discusses theoretical literature, models and growth theories with respect to their importance for savings.

The basic and important model of Harrod-Domar Model (1946) addresses the importance of savings, investment in economic growth by creating links in the level of savings to the capital-output ratio. According to this theory, higher savings lead to greater capital accumulation, which in turn causes economic growth. The model emphasises the key role of savings in financing investment, which is very essential for sustainable economic growth and development.

Solow Growth Model (1956) was another important famous breakthrough after Harrod-Domar model. Solow addressed significant impact of savings on economic growth through increased capital formation. A higher savings rate leads to a higher steady-state level of capital and output per worker and contributes in economic growth. The model also emphasised on technological progress that drives sustained growth, and explains how savings are crucial for accumulating capital and higher growth rates.

As the higher savings are necessary for economic growth so after the popularity of Solow model, there was time of emergence of New Growth Theories which were addressed by Romer (1986, 1990) Barro (1990); and Lucas (1988). These new theories captured a lot of attention as they incorporated the role of human capital, innovation, and knowledge spillovers, while emphasising that savings contribute to physical capital accumulation and also to investments specially in education and technology. Lucas (1988) specifically posits that increased savings and capital formation can lead to a permanent increase in economic growth rates by adopting continuous advancements in production and innovation.

The importance of Keynesian Consumption Theory cannot be unaddressed in context of savings as savings are a residual of income after consumption. With a rise in income of a person, his savings also tend to rise because they do not spend all of their additional income. The theory highlights the relationship between income levels and savings, suggesting that higher income leads to higher savings, which are invested and become a source of economic growth. The hypothesis of Absolute Income (1936) was also given by Keynes where savings are a positive function of current income. This hypothesis stresses the idea of correlation between income levels and the propensity to save. Another advancement was Relative Income Hypothesis (1949) by James Duesenberry which suggests that individual’s consumption and savings decisions are persuaded by their income relative to others and their own past income levels. The social context of saving behaviour is specially highlighted where individuals aim to maintain their standard of living in comparison to others.

The theoretical development didn’t stop here, and Life Cycle Hypothesis was formulated by Franco Modigliani, which states that individuals plan their savings and consumption over their lifetime, considering their anticipated future income and life expectancy. People usually save during their working years to fund consumption during retirement. During different stages of life the saving pattern varies (Ahmad & Ahmad, 2020). After this Milton Friedman took the lead and his Permanent Income Hypothesis suggests that individuals base their consumption and saving decisions on their expected long-term average income not on their current income. People do save if their current income is higher than their permanent income and dis-save when their current income is lower. In this way he nicely expressed the idea of smoothing consumption over time. Precautionary Saving Hypothesis explains the concept of uncertainty is associated with income as individuals save to protect finances against unexpected downturns. Individuals prefer to accumulate savings as a precautionary measure to fulfill sudden financial liabilities.

The importance of saving is also clear from Paradox of thrift and Buffer Stock. Paradox of Thrift was introduced by Keynes suggests individuals to save more to secure their financial future, if everyone increases their savings simultaneously, it can lead to reduced economic activity and lower overall income, thus negating the benefits of higher individual savings. On the other hand, Buffer Stock theory explains the individuals maintain a buffer stock of savings to smooth consumption in response to income fluctuations.

Summarising the above discussion, these theories offer different perspectives on why and how individuals save, considering various factors such as lifetime income planning, income stability, and uncertainty. Understanding the theoretical foundations is necessary for formulating policies that encourage savings and economic growth.