The Elusive Task of Matching Saving and Investment Rates

Ethiopia is among developing countries that have achieved fast and sustainable economic growth in the last decade, mostly through massive public led investment. Despite this, the domestic saving rate remains low, relative to the investment rate. As a result, the country is forced to depend on debt to fill the gap. Currently, the gross domestic saving to GDP ratio in Ethiopia is 22.3Pct, with the gross capital formation to GDP ratio at 37Pct. In fact, the gap between saving and investment is now wider than it was 15 years ago. As the government envisions increasing the saving ratio to 30Pct of GDP in the next 10 years, EBR’s Ashenafi Endale explores the reasons for the low domestic saving rate and offers solutions.

Over the last decade, Ethiopia has emerged as the fastest growing non-oil producing country in the world. Considered by many as admirable, this rapid growth is one of the great growth stories of the 21st century. Yet, the economic growth comes at a huge cost. Ethiopia has had to invest immense resources equivalent to 37Pct of its annual GDP in the past decade. This is 12Pct higher than what South Korea invested to grow at the same rate.
However, unlike South Korea, the massive public sector led investment in Ethiopia was not only financed by domestic saving. Since the saving rate is much lower than the investment rate, Ethiopia had to rely on debt to bridge the gap.

Economists stress the scale of economic growth in a given country is reliant upon the level of investment. The rate of investment, on the other hand, is highly dependent upon the level of gross domestic savings.

Of course, during the initial stages of growth, there will not be enough domestic savings to finance the necessary investment. So, alternative sources such as borrowing are vital to launch the economy from the ground. For instance, when the Ethiopian economy started to take off 15 years ago, the gross domestic saving as a percentage of GDP was 15.7 while gross capital formation (investment) accounted 27Pct of GDP, according to the annual report of the National Bank of Ethiopia (NBE). To fill the gap created between savings and investment, the government borrowed primarily from external sources.

But as time moves on, the initial investment is expected to translate into economic growth that would increase personal income and savings. Yet this did not occur in Ethiopia. In fact, the gap between savings and investment is now wider compared to 15 years ago. Currently, the gross domestic saving to GDP ratio is 22.3Pct, while gross capital formation to GDP ratio is 37Pct.

This contradicts with the experiences of most Asian countries that achieved remarkable growth in recent years. In these countries, investment during the initial years of development facilitated economic growth that contributed to growths in personal income and ultimately raised the gross domestic saving to GDP ratio. Contrary to this trend, the saving rate in Ethiopia still remains the lowest amongst other countries in the region.

In its annual report, the World Bank concludes that investment financing in Ethiopia is gradually shifting away from domestic savings towards net income transfers, foreign direct investment, and external borrowing. The remarkable recent growth performance was supported by robust investment, but not matched by similarly high saving rates, according to the World Bank.

In theory, sustainable growth can be achieved when the rate of domestic saving is equivalent to rate of investment. In reality, however, there is no single recipe regarding the correct saving and investment rate an economy must have. Therefore, a country must find its own recipe.

Fekadu Digafe, Vice Governor and Chief Economist at NBE, stated that the saving-investment balance ratio depends on a country’s economic model. For instance, in some fast-growing Asian countries, the saving rate is 40Pct of GDP. But there is no threshold for Ethiopia, thus far.”

“It is tolerable if saving is lower than the investment ratio, by up to five percentage points,” says Yohannes Ayalew (PhD), President of Development Bank of Ethiopia. “In Ethiopia’s case, the saving-investment gap is large. The gap has been bridged by external and domestic loans. Saving needs to be 30Pct, at least, and investment below 36Pct of GDP for Ethiopia to have a balanced saving-investment ratio.”

Domestic saving is the portion of the current national income that is not spent on current consumption. It includes savings in banks, export earnings, all residual incomes, and other non-remitted revenues as well as resources and production.

Income is one of the important factors that determine the level of domestic saving in a given country. When the aggregate income of active workers rises, domestic saving increases. The massive public led investment endeavors that took place in Ethiopia within the past 15 years have increased the per capita income to USD985. But the saving rate only showed a marginal improvement.

Experts stress that the notion that domestic savings increase when aggregate income rises, only works if price levels remain stable. But in Ethiopia, the average annual inflation rate in the past decade and a half was 16Pct. Since the prices of food and non-food items continuously and rapidly increase, the additional income gains will be offset by inflation.

“Due to high inflation, it is better in Ethiopia to invest in lucrative sectors like housing than to save,” Fikru Woldetinsae, a bank expert with decades of experience told EBR. “Since the purchasing power of the local currency depreciates quickly, people prefer to spend the money today, instead of saving it for future use.”
Frezer Ayalew, Director of bank supervision at NBE conformingly says “people prefer to spend or invest their money because the local currency depreciates fast.”

Even worse in Ethiopia, saving is not responsive to interest rates, another important factor determining the level of domestic savings. “People save mainly for security reasons, and not to collect interest,” explains Fekadu.
Although the government has increased the minimum interest rate financial institutions pay on savings and time deposits by two percentage points to 7Pct as of October 2017, it is still not favorable in relation to inflation rate changes. On the other hand, average lending interest rates stand around 13.5Pct. Because real interest rates are negative due to the high inflation rate, saving is discouraged.

Expansion of bank branches and access to banking services are also determinant to the level of domestic savings. In recent years, commercial banks operating in Ethiopia embarked on massive branch expansions. Within in a few years, their networks expanded and currently around 6,000 bank branches operate nationwide. Partly as a result, total deposits mobilized by the banking system reached ETB917.2 billion, while 38 micro-finance institutions operating in Ethiopia collected ETB41.2 billion in deposits as of the end of September 2019. Although these improvements are encouraging, Ethiopia still lags behind many Sub-Saharan African countries. Only 35Pct of adults are bank account holders who save at formal financial institutions, while only 260,000 people borrow from banks.

In its economic plan crafted for the next 10 years, the government envisions increasing the savings ratio to 30Pct of GDP from the current level while maintaining the investment to GDP ratio at 37Pct. However, experts say it is unlikely under current circumstances. “It is difficult to close the saving-investment gap in 10 years,” argues Fekadu.

Abie Sano, President of the Ethiopian Bankers Association and Commercial Bank of Ethiopia, stressed that the role of saving is still given too little attention in Ethiopia. “First, the majority of the population should earn enough income. Since a significant portion of the population is engaged in agriculture, the lives of the rural population should improve in order to change Ethiopia’s saving landscape,” he remarked. “Banks can also play their role in boosting saving by introducing incentive packages.”

Yinager Dessie, Governor of NBE, also echoed the same message during a recent discussion. “Talking about saving and financial literacy is not enough. Providing convenient saving mechanisms and options for farmers and pastoralists is necessary.”

Yohannes, on the other hand, argues keeping interest rates and inflation in balance is critical to boost saving. “People save only after making sure their money in the bank will not be eaten by high inflation. If their money loses value due to inflation, they would rather invest in assets, than keeping their money in banks.”

Experts also indicate that the majority of resources and assets in Ethiopia remain in kind. “So, monetization of these resources is critical for Ethiopia to increase saving and expand financial inclusion,” stated Yohannes. EBR

9th Year • Oct 16 – Nov 15 2020 • No. 91