ANALYZING THE DETERMINANTS OF PRIVATE SAVINGS IN SRI

LANKA
N.P. Ravindra Deyshappriya1
ravipdn@yahoo.com
ravindra@uwu.ac.lk

ABSTRACT

The relationship between financial sector development and economic growth has commonly
been discussed in the recent literature and most of research studies have revealed that saving is
the engine of financial sector development. Especially developing countries like Sri Lanka,
savings play a major role in the development process by enhancing the investment. Even if the
empirical research studies analyzing the determinant of savings have not been widely raised in
the recent research works. Therefore this study was conducted with the aim of narrowing this
gap. The present study investigates the determinant of private savings in Sri Lanka during the
period of 1990- 2009. Ordinary least squared method has been employed econometrically to
estimate the multi variable saving function for the sample time period.

Present study has identified several crucial factors affecting to the private savings in Sri Lanka.
After analyzing the relationship between explanatory variables and the growth rate of private
savings it has been observed that there is a highly significant positive relationship between
growth rate of private savings and bank density ratio as well as the growth rate of M2 money
supply which has been employed as a proxy for the wealth of the public. In addition to that
growth rates of real GDP and population also positively related with saving while inflation and
real interest rate have negatively affected to the growth rate of private savings. In the era of
developing and booming all the field of economy, a rapid hike of private savings is highly
emphasized by spreading the stable banking system in Sri Lanka and policy instruments lead to
decrease the inflation which is also recommended as a strategy of motivating higher saving rate.

Keywords: Multivariable Saving Functions, Real GDP, Inflation, M2 Money Supply

1. INTRODUCTION

1 Lecturer in Economics, Uva Wellassa University, Sri Lanka

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01.1 Background of the study

Economists always try to enhance the standard of living of people by working

out various empirical research works which can provide sound policy
implications. In this regards economic growth is among the most important
factors affecting the quality of life that a people lead in a country. If
economies want to maintain steady economic growth overtime, there should
be a sufficient saving rate in order to full fill the required investment. The
capital stock in the economy is depreciating with time and population also
increasing continuously, therefore capital stock needs to be replaced
according to the depreciation rate and population growth.(Solow - 1956) In
this sense savings of an economy have been contributing immensely to the
process of economic growth by enhancing the investment to maintain a
steady growth level. Moreover private savings account for considerable
amount of total savings of an economy and specially developing countries
like Sri Lanka is currently targeting higher level of economic growth to
accomplish the objective of being a developed country by encouraging
private savings. Therefore empirical studies on private savings is timely
important and highly recommended.

In recent literature, there has been a flood of empirical work on saving both in developed and
developing countries and those have mainly been concerned on the relationships such as growth
and savings, financial sector development and saving and savings behavior of different regions.
According to the empirical works on growth and savings, it has been observed that the
conventional perception is that savings contribute to higher investment and
hence higher GDP growth in the short run (Bacha, 1990; DeGregorio, 1992;
Jappelli and Pagano, 1994). The central idea of Lewis’s (1955) traditional
development theory was that increasing savings would accelerate growth.
Kaldor (1956) and Samuelson and Modigliani (1966) studied how different
savings behaviors induced growth. On the other hand, many recent studies
have concluded that economic growth contributes to savings (Sinha and

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Sinha, 1998; Salz, 1999; Anoruo and Ahmad, 2001). Caroll, Overland, and
Weil (2000) demonstrated that “if utility depends partly on how consumption
compares to a habit stock determined by past consumption, an otherwise-
standard growth model can imply that increases in growth can cause
increased saving.” According to the empirical study of (Kelly and Movrotas
-2003) they have found that significant positive relationship between
financial sector development and saving and an inverse relationship between the
relaxations of credit constraints and private savings was also found.

Studies were used to identify the private savings is not much common in the literature, but
(Agrawal et al – 2008) have analyzed the behavior of savings in South Asia and observed
positive relationship between the main factors affecting the total savings rate in
these countries are income per capita or its growth rate and access to
banking facilities. They also observed that dependency ratio and availability
of foreign savings have a statistically significant negative effect on savings.
Thus the recent increase in savings rates in South Asia is largely explained
by the increasing per capita income or growth, declining dependency rates
and improved availability of banking facilities. Furthermore the real interest
rate affects the savings rate positively but negligibly in Bangladesh and
Nepal but negatively in India, Pakistan and Sri Lanka. The above mentioned
study also concern on total saving instead of having private saving.
An econometric analysis on determinants of private savings in India (Athukorala and Sen -2001)
found that real interest rate, growth and the level of per capita income, spread of banking
facilities, and the rate of inflation as statistically significant positive influences on domestic
saving while terms of trade changes and inward remittances by expatriate Indians seem to have a
negative impact on the saving rate. After reviewing the literature it is obvious that Most of the
empirical studies are based on total national or domestic saving. However, some studies have
examined private sector saving, but only a few have explicitly focused on household saving.
Moreover, most of the studies have used cross-country data for estimation. Cross-country
regression analysis is based on assumptions of homogeneity about the nature and quality of data;
these are very restrictive assumptions so the validity of the results becomes doubtful. There is a

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need to use individual country time-series data for undertaking econometric analysis of private
savings behavior to provide a sound foundation for a policy debate.

1.2. Savings trend in South Asia and Sri Lanka

Before starting a formal empirical works, it is essential to identify behavior of savings in the Sri
Lanka in the past and present and also it is worth to analyze the domestic situation in an Asian
perspective. Especially developed countries such as Singapore, Malaysia, Hong Kong and South
Korea in the region have shown remarkable improvement savings from history also. The
following table summarizes achievements of savings and investment of each country in three
different time periods in the past.

Table -01; Savings and Investment of Asian region

Gross Domestic Saving Gross Domestic Investment

1960 1980 1995 1960 1980 1995
Sri Lanka 9 14 14 14 36 25
India 14 20 22 17 23 25
Pakistan 5 6 16 12 18 19
Indonesia 8 30 36 8 22 38
Thailand 14 22 36 16 27 43
Malaysia 27 32 37 14 29 41
Hong Kong 6 24 33 18 29 35
South Korea 1 23 36 11 31 37
Singapore -3 30 … 11 43 33

Source: Explaining Growth Performance in Sri Lanka: Fifty Years in Retrospect 1950-2000

According to the above table, changes in gross domestic savings and investment have been
presented as a percentage of GDP among selected Asian countries. During the period of 1960s,
Sri Lanka has maintained considerable position among many Asian countries although saving
rate was quite low. In fact, Sri Lanka’s 9% of savings ratio and 14% of investment ratio in 1960
were greater than those of South Korea and Singapore, but lower than those of India and
Thailand. The striking fact is the performance in savings and investment of the country over the
subsequent decades, when compared to the other countries in Asia. The savings ratio has
increased up to 14% of GDP by 1980 therefore investment ratio had increased up to 36% of GDP
by 1980, and was the second largest among those of the countries listed in the Table. However
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saving ratio remained the same at 14% in 1995 also, as a result of that investment ratio, which
declined to 25% of GDP by 1995, because the saving ratio was not sufficient to maintain even
previous level of investment. Therefore maintaining a adequate savings rate is very essential to
hold a constant level of investment or to increase the level of investment in order achieve a
higher level of growth rate.

Considering about the domestic savings of a country, it can be clearly identified that private
savings is playing a vital role in domestic savings. Even if domestic savings are jointly explained
by both private and government savings, in the context of Sri Lanka private savings are the most
crucial part of domestic saving. Following graph clearly illustrates the behavior of private,
government and domestic savings in Sri Lanka.

Figure – 01; Private, Government and Domestic Savings in Sri Lanka

Source: Annual Reports of Central Bank of Sri Lanka

According to the above graph, it is apparent that government savings have been recording a
negative value over the time and moreover it shows that this negative trend also increases
continuously. Although private saving was increasing considerably from 2002 to 2009, currently
there is a decline trend in private savings after reducing the interest rate by the banks according
to the request of government and central bank in early 2010. If this trend continues for a long
time, it will directly affect to the level of domestic and total savings as well. Therefore it is worth
to identify the other determinants of private savings in order to avoid the decline trend or
increase the private savings through expanding other determinants.

02' OBJECTIVE OF THE STUDY

The current study mainly focuses on the behavior of private savings in Sri Lanka during the
period of 1990-2009. As literature implies there is a huge gap of analyzing the determinants of
private savings in locally and globally. Therefore this study more specifically concentrates on
identifying the key determinants of private saving in Sri Lanka.

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3. METHODOLOGY

3.1 Identification of determinants of private savings

Even if the literature is very limited on discussing title, it is worth to take the determinants of
private savings in to account which have been considered by the previous researches. In this
regards empirical models are estimated by them play an important role in this section. Previous
study in the context of India (Athukoral and Sen -2001) has been econometrically estimated
following model.

SPRV = f[GY, GPOP, RID, W, PCY, BOR, INF, TOT, SPB,BDN, TRN, AGS] (1)

Dependent variable SPRV is Private saving rate, defined as the ratio of household plus corporate
saving to Gross National Disposable Income (GNDI), which is GNP at factor cost plus
unrequited current transfers from abroad. The independent variables were used in above stated
model and their expected signs as follows. GY (+ or -) Rate of growth of real per capita GNDI,
GPOP (+ or -) Rate of growth of the population, RID (+ or -) Equals i - INF , where i is the
nominal interest rate on bank deposits and INF is the inflation rate, W (-) Real wealth, proxied by
the ratio of money stock (M3) to GNDI, PCY (+) Real per capita GNDI, BOR (-) Total lending to
household sector by domestic financial institutions as a ratio of GNDI, INF (+) The rate of
inflation, TOT (+ or -) Equals PX/PM, where PX and PM are the price of exports and imports,
respectively (both in domestic currency), SPB (+ or -) Public saving as a ratio of GNDI, BDN (+
or -) Population per bank branch (“bank density”). TRN (+ or -) Remittances by Indian
expatriates relative to GNDI, AGS (+ or -) Share of agriculture in total GDP. Apart from the
model of (Athukoral and Sen -2001), another empirical work on household savings in Pakistan
(Hasnain et el -2006) has suggested following model including several determinants of
household savings.

HS = α0 + α1GR + α2PC + α3YD + α4OD + α5IR + α6IF + α7PS + U E(1) (2)

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This model consists of eight variables, growth rate per capita income (GR), per capita income
(PC), young dependency ratio (YD), old dependency ratio (OD), real interest rate (IR), inflation
rate (IF) and public saving (PS).

03.2 The empirical model

After analyzing the determinants of private savings and models of previous researchers, an
empirical model was developed to analyze the data of considered time period in order to
accomplish the objective of the study. After taking the most important determinants of private
savings in to account, following empirical saving function was illustrated in the context of Sri
Lanka and it is going to be estimated econometrically by employing OLS method.

(3)
GRPSAV = β0 + β1GRRGDP + β2 GRPOP + β3 INFLATION + β4 RINTEREST + β5 BD + β6GRM 2 + U

GRPSAV – Growth rate of private saving

GRRGDP – Growth rate of real GDP
GRPOP – Growth rate of population
INFLATION – Inflation rate
RINTEREST – Real Interest rate
BD – Bank density
GRM2 – Growth rate of M2 money supply
U – Random error term

Above mentioned multiple regression equation was estimated by using STATA 8.0 for the period
of 1990 – 2009.In the above function growth rate of M 2 money supply was used as a proxy for
the wealth of public.
4. DATA ANALYSIS AND RESULTS

As mentioned in the methodology section the empirical model has been shown in equation 3 was
estimated and the results of this multiple regression can be interpreted as follows.

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 GRPSAV = −17.45 + 0.22GRRGDP+ 13.5GRPOP − 1.49** INFLATION− 2.1** RINTEREST

+ 1.66** BD + 0.834** GRM 2 + U

R2= 0.7740
Prob > F = 0.0045

** - 5% Significance level

According to the estimated saving function, inflation rate has related negatively with the growth
rate of savings in Sri Lanka during the considered time period and also the coefficient of
inflation rate is significant at 5% significance level by confirming this relationship. However an
empirical study in the context of India (Athukorala and Sen -2001) has found that there was a
positive relationship between inflation and private saving. However, when inflation rate is
increasing the real value of private savings decreases, therefore people are not willing to save
more. Although, if the interest rate is higher than that of inflation rate, then they can avoid from
this risk up to some extent. It obvious that one unit change in real interest rate causes to change
growth rate of private saving averagely by -2.1 units and this relationship can be considered 95%
confidence level. Furthermore according to the previous studies (Agrawal et al – 2008) there was
a positive relationship between above variables in Bangladesh and Nepal which was not
statistically significant. However at the same time they have revealed the positive and significant
relationship between same variables in the context of India was found. Moreover bank density
and growth rate of M2 money supply have linked positively with the growth rate of private
savings and those coefficients also significant at 5% level saying the strength of the relationship.
With process of development, financial market of Sri Lanka has been expanding and it is obvious
that specially banking sector is flourishing rapidly expanding their branches network.
Consequently banks are highly accessible to the public and ultimately it leads to increase the
private saving through increasing the saving habit of people.

In this model growth rate of M2 money supply has been included as a proxy for the wealth of the
public. As we know, when the wealth increasing people tend to save more and more, therefore it
will result to increase the growth rate of private savings. According to the multivariable saving
function growth rate of real GDP and growth rate of population are not statistically significant
even if they had shown positive relationship with private savings. However after taking value of
R2 in to account, it can be concluded that all the determinants of private saving explains
approximately 77% of the total variation of growth rate of private savings. It reveals that model
has a higher level of goodness of fit and not only that but probability F also expresses that overall
model is significant at 1% level.

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5. CONCLUSION

It has been clearly indicated the determinants of growth rate of private savings in Sri Lanka and
the relationship among them in previous section. According to the data analysis, there is a higher
possibility of increasing growth rate of private savings by expanding branches network of banks.
Especially after finishing the civil war situation in North and East provinces, those provinces are
being developed rapidly. Therefore there should be an appropriate policy changes to expand the
branches network of these areas and promotion campaign to motivate people to save more. Apart
from increasing the bank density, there should be a proper plan to increase the wealth and
income of the people. In fact increase of disposable income is highly recommended by reducing
unnecessary tax rates in order to achieve a higher growth rate of private savings. Although
increment of growth rate of real GDP is not directly affecting to the growth rate of private
saving, disposable income can be lifted up by increasing real GDP. Therefore the production of
the economy should be increased continuously to achieve both targets of savings and real GDP.
At the same time it is very essential to maintain a low level of inflation rate in the economy,
because it results to increase the real value of saving and avoid people from the inflationary risk.
Ultimately I conclude that variable such as disposable income, dependency ration and
unemployment level also affect to the private savings. Therefore If researches can take these
variable in to account, the results will be very much appropriate and realistic.

6. REFERENCES

Abeyrathne, and S.,Rodrigo C., 2000, Explaining Growth Performance in Sri Lanka: Fifty
Years in Retrospect 1950-2000, South Asian Network of Economic Research Institutes (SANEI),
New Delhi.

Agrawal, P., 2008,The Relation between Saving and Growth: Cointegration

and Causality Evidence from Asia, Applied Economics, 33, pp 499-513.

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Anoruo E., and Ahmad, Y., 2001, Causal Relationship between Domestic
Savings and Economic
Growth: Evidence from Seven African Countries, African Development Bank,
Blackwell Publishers, Oxford.

Bacha, E.L., 1990, A Three-Gap Model of Foreign Transfers and the GDP
Growth Rate in
Developing Countries, Journal of Development Economics, Vol. 32, 279-96.

Caroll, C.D., and Weil, D.N., 1994, Saving and Growth: A Reinterpretation,
Carnegie-Rochester
Conference Series on Public Policy, 40:133-92.

Overland, J., Weil, D.N., 2000, Saving and Growth with Habit Formation,
American Economic Review, Vol. 90, 3:351-55.

DeGregorio, J., 1992, Economic Growth in Latin America, Journal of

Development Economics,
Vol. 39: 59-84.

Japelli, T., and Pagano, M. 1994, Savings, Growth and Liquidity Constraints,
Quarterly Journal
of Economics, 109: 83-109.

Kaldor, N., 1956, Alternative Theories of Distribution, Review of Economic

Studies, 23(2): 83-
100.

Lewis, W.A., 1955, The Theory of Economic Growth. Homewood, III: Irwin.

Kelly, R. and G. Mavrotas. 2003. On the Determinants of Saving in India. Mimeo.University of

Manchester.

Sinha, D., and Sinha, T., 1998, Cart Before Horse? The Saving-Growth Nexus
in Mexico, Economics Letter, 61: 43-47.

Saltz, I. S., An Examination of the Causal Relationship between Savings and

Growth in the
Third World, Journal of Economics and Finance, Vol. 23 (1), 1999, pp. 90-98.

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Solow, R., 1956, A Contribution to the Theory of Economic Growth, Quarterly
Journal of
Economics, Vol. 70, pp. 65-94.

APPENDICES

Stata output for multiple regression function

reg grpsav grrgdp pop inflation rinterest bd grm2

Source | SS df MS Number of obs = 18

-------------+------------------------------ F( 6, 11) = 6.28

Model | 789.428176 6 131.571363 Prob > F = 0.0045

Residual | 230.536986 11 20.9579078 R-squared = 0.7740

-------------+------------------------------ Adj R-squared = 0.6507

Total | 1019.96516 17 59.9979507 Root MSE = 4.578

------------------------------------------------------------------------------

grpsav | Coef. Std. Err. t P>|t| [95% Conf. Interval]

-------------+----------------------------------------------------------------

grrgdp | .2126929 .5407506 0.39 0.702 -.9774911 1.402877

pop | 13.50038 10.15071 1.33 0.210 -8.841173 35.84194

inflation | -1.488283 .6129726 -2.43 0.034 -2.837427 -.1391397

rinterest | -2.101736 .7971319 -2.64 0.023 -3.856212 -.3472608

bd | 1.661674 .7353756 2.26 0.045 .0431235 3.280225

grm2 | .8340345 .3371125 2.47 0.031 .0920549 1.576014

_cons | -17.44562 20.86939 -0.84 0.421 -63.37884 28.48761

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