V. V. Bhatt
In a large number of developing countries, the only reliable data presently available for analyzing trends in the economy and for formulating policy relate to the monetary sector and the balance of payments. These data thus assume critical significance as flow-of-funds data and are commonly not available in most developing countries. But whatever the development objectives of a country may be, it is essential to aim at financial balance. This balance indicates that the demand for investment resources by the deficit sectors is met by the supply of required resources from the surplus sectors. In most of the developing countries—just as in developed countries—the surplus sector is the household sector which provides resources directly, or indirectly through financial intermediaries, to the government and the corporate sector. The other sector providing necessary resources in the developing countries is the external sector through official external assistance and private foreign investment. For the viability of a development program, it is essential that these resource-flows are consistent with the projected volume and pattern of investment. Furthermore, various policy instruments can be rationally used for attaining financial balance only when the degree and nature of imbalances are clearly known through flow-of-funds analysis.
Although flow-of-funds data are not often being compiled, they would not be difficult to collect in most developing countries. The data relating to corporate enterprises and financial intermediaries are available and could, given some extra effort, be consolidated in the required form along with data relating to the government sector and the balance of payments. The data for the government sector, corporate enterprises, and financial intermediaries can in turn provide the necessary information relating to transactions of these sectors with the household sector—an omnibus term for the sector comprising all unincorporated enterprises and households. Thus, provided the usefulness of the flow-of-funds analysis is recognized, it may not be difficult to collect and process data in the necessary form.
Characteristic features of saving and flow of funds
Table 1 on sectoral surpluses and deficits during 1950-59 in 14 developed and 10 developing countries shows clearly the distribution of financial surpluses and deficits in various economies. In the developing countries, both the government and business sectors had deficits—that is, their capital expenditures exceeded their own saving, while the household sector showed a surplus and, along with the external sector, financed the deficits of the government and business sectors. In the developed countries, the government sector showed a surplus. However, in the data as presented, government enterprises are included in the business sector; if they had been shown in the government sector, it is likely that the government sector, too, would have been in deficit.
|Per cent of gross domestic product|
|Rest of the world||−0.1||2.1||1.0|
Includes government enterprises.
Includes government enterprises.
Household saving pattern
Total household sector saving is partly in the form of physical assets—residential housing, equipment, and inventories of goods—and partly in the form of financial assets. Saving in the form of physical assets represents household sector investment, which is financed partly by direct saving of the sector and partly by borrowing from the financial institutions. Thus, the second significant fact shown by saving and flow-of-funds analysis is that the household sector can only transfer to the other two sectors that part of its savings held in the form of financial assets. Of course, a part of this surplus returns to the household sector via its borrowing from the financial institutions.
Table 2 shows the household sector saving pattern for India (1963–64) and for the United States (1909–14 and 1960–64). It appears from this table that about 50 per cent of the saving was in the form of net financial assets (net of financial liabilities) in India (1963–64) and the United States (1909–14). Thus the household sector transferred half of its saving to the other two sectors. But the U.S. data for 1960–64 reveal a picture that is somewhat different and possibly indicates the nature of evolution of the household sector saving pattern for the developing countries. These data show that a dominant part of the saving was in the form of financial assets. Own saving used for direct investment was negligible so that household sector investment was financed completely by borrowing from the financial institutions. There was in fact excess borrowing (that is, borrowing exceeded investment in physical assets) which financed the acquisition of consumer durables, which are not themselves included in the data on saving.
|Form of saving||1963-64||1909-14||1960-64|
|percentage share of|
|household saving in|
Desirable pattern of household sector saving
It is quite likely that as poorer countries develop, saving in the form of financial assets and borrowing from financial institutions will also come to dominate the saving pattern. However, it should be the aim of financial policies to quicken this process. It seems that the full potential saving of the household sector is not mobilized due to inadequate development of financial institutions and instruments which suit savers’ preferences. In the developing countries, the capital market in the rural and semiurban areas is highly fragmented so that potential saving in one area or sector cannot easily be transferred to others that are in deficit. Further, due to inadequate facilities for borrowing on reasonable terms, the potential saving may be inadequate to finance investment required by these units. This potential saving may then simply be devoted to consumption.
Financial institutions generally finance a very small part of household sector investment—in India, for example, the proportion so financed is 15–20 per cent. A major part of investment is, thus, financed by own saving and borrowing from the surplus units and from private money lenders and indigenous bankers who constitute the so-called unorganized market for capital funds. Annual interest rates in this market are very high and commonly range from 20 per cent to 35 per cent a year. In consequence, worthwhile productive projects cannot be implemented and such high rates induce speculative investment in land, real estate, scarce commodities, gold, and the like.
Because of the existence of this unorganized market, government economic policies—credit as well as fiscal—are not very effective in influencing the magnitude as well as the pattern of investment in the household sector.
Most planning in the developing countries is directed toward rapid growth of investment in both the government sector and private corporate sector. This is not possible without an adequate transfer of household saving—a transfer that can be facilitated only if a major part of household sector saving is in the form of financial assets. In such a case, government economic policies can be effective in attaining an efficient allocation of saving among the various sectors of the economy.
For rational and efficient mobilization of saving as well as for attaining an investment pattern consistent with development objectives, it seems to be essential: (a) to widen the geographical and functional scope of financial institutions; (b) to develop financial instruments and to provide a yield pattern consistent with the preferences of savers; and (c) to evolve such economic policies as would induce not only a higher rate of saving but also a much higher rate of saving held in the form of financial assets.
For evolving an integrated and efficient capital market, it is thus essential to induce the household sector to have a dominant part of its saving in the form of financial assets. The next logical problem is to find out the type of financial instruments that are consistent with the saving preferences of the household sector.
The structure of the household sector’s financial saving for some developed as well as developing countries is shown in Table 3. This structure reveals that with the evolution of financial institutions, the household sector prefers to hold more than 50 per cent of its financial saving in the form of money and deposits. The second most preferred asset is claims on social security institutions—life insurance, pension and provident funds, and the like. In other words, the major part of financial saving seems to be in the form of claims on financial institutions. Except in a few countries like Belgium and Malaysia, saving in the form of direct claims on the nonfinancial sectors is usually less than 25 per cent of the total financial saving—in the United States and the United Kingdom, it is negligible.
Thus the trend is toward a financial structure in which indirect financial saving (that is, saving in the form of claims on financial institutions) is gaining at the expense of direct saving (in the form of direct claims on the government and corporate sectors) and in which borrowing is increasing in importance. It seems desirable for developing countries to encourage this trend and to concentrate their efforts on bringing about those changes in their financial structure that will ensure, or at least make more likely, that a predominantly indirect and institutional—and largely contractual and compulsory—flow of personal saving contributes as much as possible to economic growth. For this purpose, several important changes will be called for in government and business policies in many developing countries. To give just one example, governments will have to abandon the policy of attempting to bring back, or to create, a broad market for government and corporate securities among individual buyers. It does not seem to be essential for developing countries to replicate that phase of the evolution of financial structure which the developed countries experienced several decades back.
To stimulate indirect financial saving, several institutional and policy measures seem to be essential. Since thrift deposits—saving and fixed deposits— seem to be a preferred asset, the institutional development that should have first priority should be the widening and deepening of the geographical and functional scope of the commercial banking system. This system has already evolved in the developing countries but its scope is largely restricted to urban areas and to the financing of modern enterprises in industry and trade. Rather than create new institutions, it seems to be more rational and economical to expand the scope of this system through creating a nation-wide network of bank branches, and enlarging their functional scope. Such a system need not restrict its role to that of purveying credit and deposit mobilization; it can also provide entrepreneurial and managerial guidance to agriculture and small industry.
Savers are likely to prefer a financial instrument that is simple, convenient, and easily intelligible, that does not involve transaction costs and that can be easily, and without loss, converted into money. Saving and fixed deposits provide such a financial asset. However, to make them attractive to savers, it is essential to design deposit schemes in the light of basic motives to save. Apart from the link of deposits with saving motives, some deposit schemes should also be linked with certain services desired by savers. The essential point is to make the real return on deposits sufficiently attractive to induce savers to prefer this form of financial asset to private lending or to holding physical assets like gold, real estate, and commodity inventories.
Apart from this, the monetary yield on various types of deposits should be comparable to the yield, exclusive of risk premium, on private lending. The yield on private lending is, of course, high but it does involve a higher degree of risk. If the banks enter that field of lending so far monopolized by private lenders, the interest rate is likely to decline. Taking into account this possible decline in yield on private lending and the risk premium attached to such lending, the deposit rates should be fixed so as to compare to these adjusted rates on private lending. Interest rates as such may or may not have much impact on total saving but it has certainly a substantial impact on the pattern of saving. Interest rate structure, then, should be such as to induce savers to keep their saving in the form of bank deposits rather than in the form of private lending/gold, real estate, or inventories of commodities.
Compulsory provident fund schemes— which have proved attractive in such countries as Malaysia and India—should be introduced to cover wage and salary earners in as many sectors as possible in developing countries. As we have discussed earlier, social security deposits have been a preferred asset in both developed and developing countries and their full potential should be exploited as should that of life insurance policies which have also proved attractive to savers. In the agricultural sector, life insurance may not be as attractive as crop insurance but it may be possible to introduce compulsory crop insurance schemes that are attractive to farmers. For these purposes, banks’ branches could function as agents of insurance companies so as to minimize administrative expenses. Some bank deposit schemes could be linked with life insurance as well as crop insurance.
To encourage a higher rate of overall saving held in the form of specified financial assets, such saving should be made deductible for income tax purposes. In a number of countries, provident fund subscriptions and insurance premiums are already deductible and the scope of such deduction should be widened by including all financial saving other than that in the form of currency and gold.
These policy measures are likely to modify the pattern of household sector saving in favor of financial assets and thus making the saving-investment process more efficient. The allocative efficiency of the integrated capital market would be much greater than that of the isolated markets existing at present. Thus, these measures would not only raise the rate of financial saving, but also improve the productivity of investment. Further, it would then be possible to regulate the magnitude and allocation of investment by means of available policy instruments.