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Saving, growth and the current account
ERSA / SASI Savings workshop August 2009
Daan Steenkamp
Agenda
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Link between saving, investment and the current account
Theoretical relationship between saving and growth
The case of a small open economy
Macro implications of low saving
Sustainability of the current account deficit
Implications for macro policy
Accounting identities
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In an open economy, domestic spending is the absorption of locally produced goods
and services plus goods and services from overseas:
GNP = C + I Pr iv + G + X - M + NCE + IB
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Gross national product can also be expressed as the sum of expenditures by residents
from national income
GNP = C + S Pr iv + T + TFR
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Setting the above equal, the current account balance is the difference between
domestic saving and investment (private and public):
CA = ( X - M ) + NCE - TRF + IB = (S priv - I priv ) + (T - G)
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Current account balance is linked to net international capital flows:
Re-arranging:
S priv = I priv + (G - T ) + ΔNFA
ΔNFA = (S priv - I priv ) + (G - T ) = CA
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Current account balance = Domestic investment - domestic saving
Foreign financing of domestic investment generate claims on domestic assets.
Saving & Growth Theory
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Exogenous growth models:
– Saving supports higher investment and therefore a higher capital stock
– Higher saving raises growth per worker only temporarily
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Endogenous growth models:
- Higher saving raises per capita output and growth of per capita output
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Do savings alone drive growth?
– Positive impact of saving has, however, been shown to be contingent on
complementary macroeconomic conditions and government policies that help
channel savings into productive investment.
– E.g. financial sector development, macroeconomic stability, openness to trade,
prudent fiscal policies, investment in education, microeconomic reforms that
support efficient resource allocation.
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Can growth drive saving?
– Life cycle models with liquidity constraints or endogenous models with habit
formation suggest that growth could impact saving.
Open economy setting
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If the economy is open and capital is mobile, foreign saving can be used to finance
higher investment rate than domestic saving would allow.
If the return on foreign capital after depreciation > cost of foreign borrowing
- Foreign borrowing will raise the level of national income
Availability of foreign capital can also lower domestic interest rates
Impact of inflows of foreign saving on domestic saving is ambiguous
- Lower interest rates reduce opportunity cost of current consumption, lower
saving (substitution effect)
- Lower interest payments (borrowers) or income (lenders), can increase or
decrease saving (income effect)
- Interest rate sensitivity of domestic saving an empirical question
High levels of domestic saving and investment are associated with
high levels of economic growth
GDP (RHS)
Domestic Investment % GDP
Domestic Savings %GDP
45
40
35
9
8
7
30
6
25
5
20
4
3
15
2
il
az
Br
ric
a
Af
d
So
uth
Po
lan
Pe
ru
Tu
rke
y
t
Eg
yp
Ind
on
an
ail
Th
Ko
re
So
uth
es
ia
0
d
5
a
1
ina
10
Ch
6
10
Saving shortfalls raises growth volatility
1.4
1.2
GDP volatility
4
Balance on current account %
GDP (RHS)
3
2
1.0
1
0.8
Ch
Eg
yp
Ko
a
So
uth
ric
Af
So
uth
ail
Th
Ind
on
Br
ina
-4
t
0.0
re
a
-3
Po
lan
d
0.2
an
d
-2
es
ia
0.4
az
il
-1
Pe
ru
0.6
Tu
rke
y
7
0
Impact of increased savings on the economy
Decrease in level of consumption
•
-1
3
2
Ma
r
-1
Se
p
-1
2
1
-1
Ma
r
Ma
r
Se
p
-1
1
0
-1
Se
p
-1
0
9
Ma
r
-0
Se
p
Ma
r
-0
9
-0
8
increase, thereby increasing medium and
Se
p
Ma
r
By substituting current consumption with
future consumption, investment can
long run productivity
Leads to investment increasing significantly
•
Investment
20
The 5% level decrease in consumption
15
initially results in total saving increasing
10
by 20% which then allows investment to
5
increase by 15%
-1
3
Ma
r
2
-1
Se
p
-1
2
Ma
r
1
-1
Se
p
-1
1
Ma
r
0
-1
Se
p
-1
0
Ma
r
9
-0
Se
p
-0
9
Ma
r
8
-0
Se
p
Ma
r
-0
8
0
8
To increase domestic savings, domestic
consumption will have to decrease
25
per cent
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Consumption
Total saving
-0
8
per cent
40
35
30
25
20
15
10
5
0
-5
-10
Increased investment increases exports and GDP
Increase in competitiveness
3
•
Exports
Imports
2.5
exports, improving our
2
Per cent
The increase in productivity promotes
1.5
competitiveness, while imports are
1
driven by the increase in investment.
0.5
0
fully flow through to GDP
GDP
Saving as % of GDP
5
4
per cent
increased savings and investment to
Impact of increased savings on GDP
6
•
The rebalancing of growth from
3
consumption to investment has a
2
1
lasting positive impact on GDP
-1
3
M
ar
2
-1
Se
p
-1
2
M
ar
1
-1
Se
p
-1
1
M
ar
0
-1
Se
p
-1
0
M
ar
9
-0
Se
p
8
-0
9
M
ar
-0
Se
p
M
ar
-0
8
0
9
It takes about 1 year for the impact of
3
M
ar
-1
-1
2
Se
p
M
ar
-1
2
-1
1
1
Se
p
M
ar
-1
-1
0
0
Se
p
M
ar
-1
-0
9
Se
p
M
ar
-0
9
-0
8
Se
p
M
ar
-0
8
•
Inflows of foreign saving have helped raise domestic investment
45
40
per cent of GDP
35
Gross saving
GFCF
30
25
20
15
10
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20
Source: SARB
10
Domestic investment requires sustained foreign financing which is
dependent on macroeconomic stability
Proportion of gross capital formation financed by foreign capital
40
30
20
10
%
0
-10
-20
-30
-40
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
-50
Source: SARB
Low domestic saving relative to investment manifests as a current
account deficit
3
2
1
0
per cent of GDP
-1
-2
-3
-4
-5
-6
-7
-8
-9
Saving-investment gap
Source: SARB
Current account balance
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
-10
The current account deficit has been comfortably financed
Unrecorded transactions
Net other investment flows
Net foreign direct investment flows
Net portfolio investment flows
Total current account
18
15
12
% of GDP
9
6
3
0
-3
-6
-9
04
20
*Quarter 1 annualised
Source: SARB
05
20
06
20
07
20
08
20
*
09
20
Capital inflows adding to stock of foreign liabilities
350000
300000
Net equity liabilities
250000
Net FDI liabilities
200000
Debt liabillities
100000
50000
0
-50000
-100000
-150000
Source: SARB
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
-200000
1994
R million
150000
Relying on foreign savings implies growing claims on the income
of domestic assets
14
4.5
12
Dividend payments as % of GDP (RHS) lagged two quarters
10
4.0
3.5
8
3.0
6
2.5
2.0
4
1.5
2
1.0
0
0.5
15
08
20
07
20
06
20
05
20
04
20
03
0.0
20
20
02
-2
per cent of GDP
per cent of GDP
5.0
Net capital flows as % of GDP
An increasing proportion of foreign liabilities are equity liabilities
Foreign Portfolio Liabilities: Equity and Debt
100
90
80
60
Equity
50
Debt
40
30
20
10
Source: SARB
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
0
1994
%
70
Volatility is a greater problem if majority share of capital is short
term capital
50
direct investment (long term capital)
portfolio investment (short term capital)
other investment
45
40
% total investment
35
30
25
20
15
10
5
0
2000
17
2001
2002
2003
2004
2005
2006
2007
Cost of capital
Declining costs of domestic borrowing
27
Nominal prime*
24
21
Real prime (CPI)**
Real prime (CPIX)***
15
12
9
6
3
0
Source: SARB, NT calculations
* End of period
** Metropolitan areas, 2000=100
*** Metropolitan and other urban areas, 2000=100
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
-3
1990
per cent
18
Cost of capital
Declining costs of foreign borrowing (before crisis)
18
700
R157 yield
600
15
SA sovereign spread (EMBI) (RHS)
500
12
per cent
400
9
300
6
200
2009
2008
2008
2007
2007
2006
2006
2005
2005
2004
2004
2003
2003
2002
2002
2001
0
2001
0
2000
100
2000
3
Sustainability of the current account
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In the short term, the availability of foreign capital will depend on maintaining investor
confidence.
This underscores the importance of sound macro management and political stability.
In the longer run, the efficiency with which saving is converted into investment is
particularly important for the sustainability of the current account deficit and ensuring we
benefit from drawing on foreign saving.
Servicing our foreign debt requires an increase in future exports or sufficiently high
future real returns to domestic capital to service.
Microeconomic reforms that address constraints to growth and enhance the economy’s
international competitiveness and flexibility are crucial.
Conclusion
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By investing in resources, rather than consuming them, economies make a trade-off
between present and future standards of living.
Investment is funded through savings (both domestic and foreign).
Fixed investment allows for more sustainable economic growth and improves
international competitiveness.
In spite of low domestic saving, availability of foreign savings has supported higher
domestic investment in South Africa.
This has, however, seen the current account deficit widen and foreign liabilities rise.
Foreign saving must be used to expand our ability to export and save in future.
A higher rate of domestic saving would reduce our vulnerability to the vagaries of
investor sentiment.
It would help us develop a deeper and more liquid capital market, helping our
companies expand.
Higher saving would also give South Africans a greater stake in the gains from domestic
growth.