Saving and Investment in Developing Countries: Sources and Uses of Funds, 1975—96
Kenneth S. Warwick
Research Department, IMF
One of the most important requirements for an improvement in the medium-term growth performance of the indebted developing countries is a recovery in domestic saving and investment rates from current levels. The charts show how saving and investment behavior has changed since 1975, along with projections for the next five years prepared by the IMF staff as part of the May 1991 World Economic Outlook exercise. In most cases, a significant increase in saving and investment is envisaged, but only if countries adhere to recently adopted stabilization plans and adjustment measures.
Following the debt crisis, saving and investment rates fell sharply in many developing countries. The financing of investment also changed markedly, with much greater reliance on domestic sources of finance after 1982. Some countries have subsequently managed to increase domestic saving and investment, but in other cases, rates of capital accumulation continue to be very low. For the medium term, the flow of external saving to the indebted developing countries is projected to rise in absolute terms but to continue to decline relative to GDP. Although some debtor countries will continue to rely heavily on external finance, it seems likely that an increasing proportion of domestic investment in the developing countries will be financed by domestic savings.
The charts show saving and investment in a flow of funds framework—described more fully in the box—for six different groups of developing countries. Perhaps the most significant contrast is between countries that experienced debt-servicing difficulties—such as the accumulation of external payments arrears or debt rescheduling—in the second half of the 1980s and those that avoided such difficulties (Charts 1 and 2). Countries in the first group relied more heavily on external finance than the others in the 1970s and suffered a sharper reduction in gross external saving in relation to GDP after 1982. The accumulation of debt in the 1970s also increased the vulnerability of this group to the higher real interest rates that prevailed in the 1980s, leading to a sharp increase in net factor payments. Investment abroad fell in both groups of countries, but the decline was sharper in the countries that encountered debt-servicing problems, largely reflecting their use of foreign exchange reserves. Investment in external assets also became more volatile, partly as a result of movements in flight capital.
Chart 1.Countries without debt-servicing difficulties Chart 2.Countries with debt-servicing difficulties
Source: World Economic Outlook, May 1991.
Note: Figures for 1991–96 are IMF staff projections
The response of domestic saving to the external shocks of the 1980s was very different in the two groups of countries. Between 1975-S2 and 1983-90, domestic saving rates fell by 2½ percentage points in the countries that experienced debt-servicing difficulties, whereas other indebted developing countries were able to increase their domestic saving rates by 2 percentage points. Reflecting this, investment rates remained depressed in the countries with debt-servicing difficulties for most of the 1980s, whereas other countries managed to sustain, or even increase, investment rates. The IMF staffs medium-term projections envisage that domestic saving might recover in countries with debt-servicing difficulties to levels comparable to those elsewhere. Investment and growth would also increase substantially compared with recent performance, but would still fall short of rates achieved in other parts of the developing world.
The differential impact of the shocks of the 1980s can also be seen by comparing the experience of countries that depended on commercial sources of finance with the experience of those that obtained external credit mainly from official sources (Charts 3 and 4). The market borrowers (a diverse group of 27 countries) sharply reduced their use of external saving after 1982, whereas the official borrowers (including most of the African countries and other low-income countries) continued to receive substantial inflows from official sources. Although the commercial borrowers were more vulnerable to changes in market conditions, domestic saving in this group, on average, held up more strongly in the 1980s and domestic investment has been on an upward trend since 1983. For the medium term, increases in saving and investment are projected for both groups of countries, with external saving and transfers from abroad continuing to play an important role in the financing of investment for the official borrowers.
Chart 3.Market borrowers
Source: World Economic Outlook, May 1991. Note: Figures for 1991–96 are IMF staff projections
Chart 4.Official borrowers
Sources: Gross external saving
Uses: Net factor payments
The third set of charts provides a comparison of developments in two regions, Asia and the Western Hemisphere (Charts 5 and 6). In Asia, there has been fairly steady growth in domestic saving and investment since 1980 and a slight decline in the use of external saving. Hardly any change in investment and saving rates is projected over the next five years and growth rates are expected to continue to be among the highest in the world. In the Western Hemisphere, saving and investment rates have been consistently lower than those recorded in Asia. Furthermore, the decline in gross external saving was particularly pronounced in this region, and the rise in interest payments after 1979 was not offset by a rise in domestic saving. Domestic investment fell sharply after 1981 and remained low for much of the 1980s, while movements of flight capital and changes in foreign exchange reserves led to a high degree of volatility in investment abroad. The medium-term projections for the Western Hemisphere involve a significant rise in saving and investment, but this will require substantial progress in macroeconomic stabilization and structural reform in many Latin American countries.
Chart 5.Asia Chart 6.Western Hemisphere
Transfers from abroad
The flow of funds framework used in the charts distinguishes between three main sources and three main uses of funds. The sources of funds are domestic saving, gross external saving, and transfers from abroad:
Domestic saving is the part of domestic output (GDP) that is not used for consumption. It differs from national saving in that it excludes transfers and net factor income from abroad.
Gross external saving is defined as the inflow of external resources corresponding to a balance of payments deficit on current account plus any investment abroad (defined below).
Transfers from abroad include workers’ remittances, other private transfers, official aid, and other official transfers.
The uses of funds include domestic investment, net factor payments to foreign residents, and investment in external assets:
Domestic investment comprises investment in fixed assets and inventories.
Net factor payments consist mainly of interest obligations falling due to external creditors.
Investment abroadis measured as the sum of asset transactions and errors and omissions (on the assumption that these two categories include any capital flight) and the acquisition of official foreign exchange reserves.
The empirical evidence suggests a strong relationship between saving, investment, and growth in developing countries. These interactions need to be taken into account in addressing the problem of how to restore adequate rates of growth in the indebted developing countries. While an increase in the availability of financing, either domestic or external, is important, there is no guarantee that it will lead to a rise in the rate of capital formation or an improvement in the efficiency of resource use. Policies must therefore be designed as a package to address the underlying causes of low saving, low investment, and low productivity simultaneously.