Savings, for Domestic Capital Formation and Investment

Anyone who has held a job and a bank account understands the potential benefit of postponing consumption today in order to enjoy greater consumption in the future. This activity is called saving. What is it? Saving is basically income earned today but which is not spent today/a deferred consumption/a reduced expenditure – this include putting money aside in, for example, a deposit account with a bank, or a pension scheme, or an investment fund, etc. On this basis, one may rightly say, saving takes place when people abstain from consumption, or when they consume less than their income.  The motive for saving is one of deferring current consumption to a later day. We save when we consume only part of our income now and save for a better future, i.e. retirement, putting children through college, etc. People save so that they can consume in the future.  A decision to spend now or save is really a choice of when to spend – now or in the future.  The decision depends on wealth, disposable income, tastes or preferences for spending now versus waiting for the future, etc.

The concept of saving is closely related to investment, in that the former provides a source of funds for the latter i.e. by not using income to buy consumer goods and services, it is possible for such resources to instead be invested (directly or indirectly — this is to say, investment should not be understood in the context of bank deposits, or of buying stocks or bonds) by being used to produce fixed capital goods such as factories, plant, machinery, etc which makes workers and businesses more productive in the future. Saving can therefore be vital to increase the amount of fixed capital in the economy, which then contributes to economic growth and development. As you will see in a moment, you can think of saving as a supply of funds for investment and investment as a demand for funds.

Thus, investment takes place when we purchase new capital equipment or other assets that make for future productivity.  The motive for investment is to produce more money in the future based on what is produced by the investments make (emanating from savings). The key to this is that the investments can be made in productive enterprise. It is generally more better when savings in banks, pension schemes, etc are invested in productive enterprises than in consumer loans because lending to productive enterprises means that savings are channeled into expanding production (rather than financing consumption), and when this is done then total economic output grows over time, eventually, in principle allowing every member of society to enjoy larger incomes.

Some of us, in some instances, confuse the concepts of saving and investment. Even though ultimately saving and investment are equal (subject to a couple of complications that makes nice for academic intellectual conversations).  However, we may wish to also note that, there are fundamental differences– for example, increased saving does not always correspond to increased investment, i.e. if savings are stashed in or under a mattress, or otherwise not deposited into a financial intermediary such as a bank, there is no chance for those savings to be recycled as investment by business. This means that saving may increase without increasing investment, possibly causing a short-fall of demand (a pile-up of inventories, a cut-back of production, employment, and income, and thus a reduction in economic growth and development) rather than an increase in economic growth. If saving falls below investment it eventually reduces investment and detracts from future growth. Future growth is made possible by foregoing present consumption to increase investment, however, if such savings are kept in a mattress instead of being lent to the government (via central bank) or the corporate world (via banks), for recycling and intermediation, then there is a problem in a society.

At any moment, despite the complications, a society has a choice on how it could divide its GDP between consumption and investment, i.e. by dividing resources between production of goods that would be consumed immediately and goods that would yield future benefits.

Now, having spent time on the theoretical context of what I mean to say – let me extend the argument from the personal analogues to a nation as I submit a case for more domestic savings, for our indigenous capital formation towards financing our future development.

In order to succeed in our economic transformation, in whatever form of strategy, it must be underpinned by transformative changes in the country’s financial institutions whereby the creation of domestic systems of capital formation goes hand in hand with efforts to transform. Creating a set of institutional factors and policy tools that encourages and enable the culture of savings and capital formation is equally fundamental.

According to the recent data by the Bank of Tanzania, the National Bureau of Statistics and the CIA World Factbook, Tanzania’s economic and financial indicators in the context of national savings and investment had a following snapshot: Stock of domestic credit (21% of GDP); Banking sector size (27% of GDP); Credit to private (sector by banks) (16% of GDP); Pension funds’ assets size (8% of GDP); Domestic stock market capitalization (7.5% of GDP); Bonds market size (5.5% of GDP); Annual national gross savings rate (23% of GDP); Annual national investments rate (35% of GDP); while Consumption rate is (62% of GDP).

According to these data, total country’s gross savings as a proportion of our GDP is about 23% per annum while our investment rate per year is about 35% of GDP — meaning, the inflows of foreign capital (FDIs, grant and loans) offsets the difference between national investment and national savings. In the long run, and because a country’s savings rate is, predetermined by households’ attitudes toward savings, by the fiscal incentives for private savings, and by the public attitude toward savings and investments – we need to somehow institute instruments that will encourage more savings that to be directed towards productive investments.

As it is, the ratio of savings relative to GDP in Tanzania is far too low; the ratio is far lesser relative to other poor countries (outside SSA) such as Vietnam where a savings rate is 33% proportionate to its GDP. For us, through proper policies we have the opportunity to enhance the national capacity to mobilize financial resources because raising the level of a nation’s savings and capital formation is one of the fundamental ways out of underdevelopment.

For sustainable growth, we need to gradually reduce this rate of reliance on foreign capital. This requires policy makers, the people and as a nation to make a cultural reorientation, from a cycle of low savings and high consumption to high savings and high investment. East Asian countries have done that very well during their industrialization journey – China reached a savings to GDP ratio of 50% and used its savings to fund industrial investments.

The target, in my estimate, should be to achieve a savings/GDP ratio of at least 30% per annum in the next 5 years. At the current GDP of about Tsh. 100 trillion and at the anticipated compounded GDP growth rate of 7%, this will translate into a movement from an annual savings quantum of Tsh. 23 trillion (23% of the current GDP) to about Tsh. 42 trillion per annum or (30% of the projected GDP in 2021) where GDP is projected to be Tsh. 140 trillion in current shillings.

How does one increase national savings? The process of encouraging savings in formal ways and capital formation requires us to consider key reforms and transformations in the government’s borrowing attitude and the mechanisms of pricing such borrowings, also reforms in banking sector and capital markets are necessary. For instance, today, Tanzania has over 50 banks and non-banking financial institutions with combined balance sheets size of about 27% of GDP, however, the majority of these are commercial banks mainly focusing on providing short to medium term working capital. Lending activities are highly geared towards supporting trading activities and consumer loans. In such a situation, a mix of banks including banks that will provide long term financing to industries and infrastructure development is urgently required. The same applies to the capital markets space where enhancement of the current regulatory framework is urgently needed as is for the mix of products and services.

The government and private sector should champion introduction of financial instruments that will be used as investment platforms and vehicles for mobilization of investable funds i.e., common stock (for common ownership), micro savings bonds such as M-Akiba (currently rolled-out in Kenya), specialist instruments and institutions (e.g. real estate investment schemes [REITs] for real estates; industrial development banks for industries; infrastructure bonds for infrastructure projects; municipal revenue bonds for local government projects; etc.). Such financial instruments should be linked to practical industrialization projects and entities that will be in need of such funding. This will require a strong coordination among various ministries, agencies and private sector and other supporting institutions.

An Idea of the FYDP-II Bonds, Why Not?

In the recent past, the government is seem to pursue efforts that are meant to encouraging business transparency, economic empowerment, a vibrant capital markets and some form of wealth redistribution. This has been demonstrated in various actions, ranging from political decisions, policy announcements and legislative actions (or enhancement thereof). The finance Act of 2016, Finance bill of 2017 and regulations meant to enforce the Mining Act of 2010 are clear measures as to these ideals. Upon full implementation, some of the legislative actions will result into a significant positive impact in our capital market and in achieving one of its core objectives (namely economic empowerment and financial inclusion) to my estimate – probably significant than what was achieved during the peak of privatization in late 1990s and early 2000s where about seven companies got listed in the stock market, in the process empowering more than 150,000 Tanzanians who participated during the IPOs and further in the secondary market activities.

Similarly – in these past two years, there has been more issuance and listing of government bonds where annual issuance and listings of such bonds is unparalleled, albeit these are all still general-purpose bonds issued by the government to finance various development projects and/or retire some of the government maturing obligations. What has been missed though are specific bonds issued for specific development plans, programs and projects – i.e. Industrialization bonds? Infrastructure development bonds? Municipal bonds? – and what about a potential for a bonds programme by the name of Five Years Development Plan (FYDP)-II Bonds? Such a bond can be as ambitious as the FYDP-II itself targeting to raise, say about one third of the funds needed for the FYDP-II – i.e. Tsh. 30 trillion out of the Tshs. 107 trillion planned. The bond can be issued to various forms of investors – local, diaspora, foreign, retail, institutions, etc and whose period to maturity can be as ambitiously long.

Throughout history, governments have been issuing bonds for specific purposes and for financing of some of the flagship development programs i.e. it can be financing a war — war bonds, which are debt securities issued by a government to finance military operations and other expenditure in times of war; or infrastructure bonds, issued when a government need to build new infrastructure with significant impact or perform major repairs to the existing infrastructure (roads, railways, ports, airports, water, sewage system, etc); and so it applies for industrial bonds for financing construction, purchase of machinery and equipment, build the industrial estate and its embed infrastructure,  etc. whether infrastructure or industrial development bonds, or war bonds or any form of bonds , they can be either retail bonds marketed direct to the public (where they tend to have a yield which is below that offered by the market and are often made available in a wide range of denominations to make them affordable for all citizens) or wholesale bonds issued to institutional investors such as pensions funds, banks, insurance companies, private fund managers, etc and traded on a stock market. As it is for the financing of a major national development plans such as industrialization, infrastructure, agriculture, etc so is for war bonds — where in some cases retail and institutions are exhorted to buy bonds often accompanied by appeals to patriotism and conscience — supplementing the commercial and economic interests.

Let us go back to the basics — what are bonds, why are they relevant? A bond is a long-term contract in which the bondholder lends money to a company, government or some other organisation. In return the company, government, etc promises to make predetermined payments (usually regular) in the future which may consist of interest and a capital (principal) sum at the end of the bond’s life. The period to maturity for bonds is generally 2 to 30 years. In our case, maturities range from 2 years to 15 years. In other economies bonds period to maturity have longer maturities beyond the 30 years i.e. IBM and Reliance of India have issued 100 years bonds as have been for Coca-Cola and Walt Disney. There are even some 1,000-years bonds in existence; Canadian Pacific Corporation is paying a dividend of 4 per cent per annum on a 1,000-year bonds issued in 1883!

Why are bonds relevant for the financing of economic development activities and for a vibrant financial market? I will explain below – but first, bonds especially those issued by governments are basically used as benchmarks for valuation and pricing of other financial products in an economy. Therefore, any right or wrong doings in the government bonds impacts directly the cost of funding in an economy. Share issuance and trading prices depends on what happens in the bond markets, banks’ lending on the private sector largely depends on what happens in the bonds markets, housing and real estate pricing depends on what happens in the bonds markets, private sector issuance of corporate bonds depends on what happens in the government bonds markets, etc – the so-called yield curve on bonds plays a significant role in pricing of financial assets in the economy.

Governments and companies around the world have learned of the enormous power of the bonds markets. For example, government leaders, in many occasions try to increase the gap between what the government spends and what it raises as taxes and then fill in the gap by borrowing in the bond markets. As it is, many governments around the world are desperately dependent on the availability of money in the bond markets to allow them to spend on development projects.

The above, is a short explain the value of developing an understanding of bond markets and appreciate of the significant power of the collective will of bond markets participants.

Using bond markets to finance major development plans and programmes is a smart, right and good thing to pursue – however, the ugly part kicks in when investors gets a hint of government not being able to repay because it has over borrowed or that inflation is about to take off, in such cases investors refuse to continue supplying new bond finance or push up yield they require as returns for their investments. This has been the sobering experience on the politicians from developed and emerging economies Ireland, the US, Greece, the UK, to most recently South Africa.

The bond markets had a major role to play in the run up to recent financial crisis (in the South-East Asia during 1997-1999 and then in the famous financial crisis of 2008), with securitised bonds and derivatives of securitised bonds at the heart of the matter. Then, in the recovery, companies queued up to sell new bonds to raise cash as they fought to survive the economic downturn. Without the bond markets being willing to supply those funds some governments and global leading companies would have met their demise, after all in such crisis situations, banks are normally not willing/able to lend and equity (share) investors are sacred – the same was in the above-mentioned crisis. So as banks and equity investors fly out, the bonds markets remain.

Currently, bonds worth only Tsh. 6.5 trillion are listed in the Exchange, annual issuance (despite the increment in recent past as I indicated above) but it is still less than 10 percent of our annual budget and less than 15 percent of the annual tax revenues. We also have largely the general-purpose bonds issued by the central government. The potential for infrastructure, industrial, diaspora, municipal, corporate bonds is there – the exploitation of which could facilitate our domestic financing of the FYDP-II in a manner that encourages local participation and a sense of patriotism.