SOUTHERN DENMARK UNIVERSITY (DEPARTMENT OF ECONOMICS)

MOBILISATION OF SAVINGS FOR ECONOMIC GROWTH AND DEVELOPMENT IN GHANA

A SEMINAR PAPER IN PARTIAL FULFILMENT OF REQUIREMENT FOR MASTER OF SCIENCE IN ECONOMICS DEGREE

Submitted by

EMMANUEL KWAME OCLOO CPR: 210672-4701

OCTOBER 2OO5

MOBILISATION OF SAVINGS FOR ECONOMIC GROWTH AND DEVELOPMENT IN GHANA

Foreword This study arrays strategies and mechanisms to assist decision makers in the private and public sectors to address the important issue of savings mobilisation for economic growth and development in Ghana. These issues are why savings is low, the impact of financial reforms, theoretical underpinnings of the relationship between savings, investment and growth as well as financial mechanisms to achieve long term savings mobilisation in Ghana. The course supervisor reviewed the initial draft of the work and suggested a more theoretical analysis. This considerably improved the scope and objective of the study. Acknowledgement I would like to thank Professor Ulrich Kaiser for valuable comments. The paper has also benefited comments indirectly from participants at the 14th Annual Africa/Diaspora Conference at California State University, Sacramento (USA) in April 2005 in a preliminary paper I presented on Micro financing educational development in Ghana which became a backbone of this present paper. Special thanks are also due to Ghana Statistical Service for their assistance in obtaining data. I also acknowledge the fact that the paper might not achieve its full objective to many audience as both academic and action research material and therefore I accept any omission and error to be mine.

EMMANUEL KWAME OCLOO Author

ULRICH KAISER Supervisor

MOBILIZATION OF DOMESTIC SAVINGS FOR ECONOMIC GROWTH AND DEVELOPMENT IN GHANA

CHAPTER ONE

1.0 Abstract .

Ghana like other Sub-Saharan African countries faces binding lending constraints in international capital markets or concessional development finance, therefore mobilizing national saving will drive aggregate investment and hence saving will influence the sustainability of growth. Savings mobilization refers to any set of policy actions that aim to raise the savings rate above its present level and make it available for investment. Saving means foregoing consumption and is the principal source of domestic capital accumulation, which in turn, when combined with healthy economic and investment policies, allows a country to ensure sustained growth and improvements in the standard of living of its citizens. The importance of savings in the developing economies can be discussed from two main perspectives. The first relates to the resource gap which needs to be bridged through enhanced savings culture amongst the population. The second is that as a result of low per capita income, most developing countries have low savings rates relative to their counterparts in the advanced economies and this has affected the level of capital formation in those countries. The purpose of this study is to assess the nature and structure of savings in Ghana and to examine how these savings could be mobilized into domestic investment capital for economic growth and development. The study reveals that the contractual savings which consist of pension fund contributions and life insurance premiums are part of the structure of savings in Ghana and constitute about two thirds of the total private domestic savings. This is followed by commercial banks savings, which account for about a third of the total private domestic savings.
The premise on which this paper is built is that the current low level of savings in Ghana coupled with structural current fiscal deficit of Government cannot support the Ghana development agenda. The saving

performance is below the Sub Saharan benchmark. Obviously, a national economy can only invest to

the same extent as it also saves. 1.1 Study objective The objective of this paper is to produce a scholarly work that fits into long term development plans of Ghana as outlined in the Vision 2015 Development Document. This focuses on effective mobilisation of domestic saving as means of promoting economic growth through capital formation and investment.

1.3 Statement of the Problem The inability to mobilise adequate domestic resources to finance development has continued to restrain the rate of growth in Ghana. This is an important reason why the actual rate of development has been below the potential rate of development. It has also been responsible for increasing our dependence on external savings in the form of loans, investments and grants to an extent that it now impinges on our economic sovereignty.

1.4 Background The Ghanaian economy is characterised by a robust and diversified financial sector that can make it possible to mobilise savings from a large number of clients, largely in urban areas and in some rural communities. But, since its independence 48 years ago, the financing of economic development programmes are largely determined by the amount of foreign capital available to the national budget. This obviously suggests that, there is a poor link between the financial sector and the savings that is needed in Ghanas economic development process. The lack of clearly defined national savings policy appears to be a disincentive to both corporate and personal savers who can keep part of their wealth in form of savings capital for investment in future production activities. This is evidenced by the fact that expatriate businesses for instance,

repatriate almost about 90 per cent of their profit when this should actually be re -invested in the economy. Various studies on Ghanas capacity to generate savings towards its economic development reveal that a large part of active domestic savings is considered to be linked to employment in certain sectors and is mobilised through life assurance policies and pension fund contributions. The key sectors include government, financial, real estate and business services, mining, and fishing. It appears, contrary to theory, there is no strong link between savings and investment in Ghana as most savers only save for consumption purposes and therefore prefer to keep current accounts instead of savings or fixed deposit accounts. In this regard, a proper understanding of the saving-investment link is seen as the first step in grasping the knowledge about how effective mobilisation of savings will stimulate economic growth and development and it is important for at least two reasons: first, it may hold the key to the positive correlation between saving and growth. It is also further recognized that if savings is to be mobilised on sustainable basis then there should be need to protect the interest of savers . 1.5 Introduction The first question at the heart of this study is why savings mobilisation so important to Ghanas economic development? The simple answer is that the vicious circle of poverty" that runs from low-income to low-savings to low-investment to low-productivity and then back to low real income can be broken by an increase in the ratio of savings and investment to national income. Ghana is a country faced by four main development objectives namely to revive and sustain economic growth, to create employment, to reduce inequalities in income distribution, and to reduce poverty .

From the classical days, saving has been considered as one of the determinants of growth and
this has been important since the time of the industrial revolution because much of the domestic investment that propelled this growth was financed through domestically generated savings. Economic theory suggests that a higher savings rate leads to a higher growth rate. The hypothesis is supported by the evidence from market economies, especially, that from fast growing economies in East Asia (World Bank, 1993, p.41). There can be exceptions, if capital is invested inefficiently, as what happened in Poland and other socialist countries under the planning system (Chang and Xu, 1996). Since the mid-1980s, development economists have strongly advocated that increasing national saving is central to improving economic performance and long-term living standards. Moreso, saving by resident households is thought to reduce the economys reliance on foreign saving and allow greater capital accumulation and hence greater aggregate production and income. Domestic savings are vital to the reduction of dependence on external savings, increasing the level of financial savings and thereby the level of investment in the domestic sphere, achieving macroeconomic equilibrium and stable economic growth. The importance of savings is also beyond capital formation (Rose (1986). It is a major determinant of the cost of credits based on the law of scarcity, which holds that when the former is low and scarce, it becomes more costly to obtain As a good example domestic savings in most high growth countries in East Asia generally make a large contribution to gross national capital and thus to productivity. In Malaysia and South Korea before the Asian crises in 1999, national savings rates were above 48 % of their GDP. According to Rodrik (1997) roughly a third of the countries in Sub-Saharan Africa (16 countries in all including Ghana) had higher savings per capita GDP in the early 1960s than they do three and a half decades later.

According to Hans-Gert (2003) national savings rates in Ghana were between just -5% and 24%
between 1990 and 2000. As a rule of thumb, there will only be economic development if the savings

rate is over 20%; above 25% it is classed as good and above 30% as very good.

Savings and investments naturally play an important role in the long run economic growth and development process. Savings determine the national capacity to invest and thus to produce, which in turn affect the economic growth potential. Sustained growth rate over long periods are possible if saving and investments are high enough. The growth of output of any economy depends on capital accumulation, and capital accumulation requires investment and an equivalent amount of saving to match it. Following from Lewiss growth model savings rate associated with same level of investment turns out to be the most robust correlation of growth. As a matter of fact, an economy investing more than 30 per cent of its GDP relying on foreign savings will imply running a persistent budget deficit in excess of 6 per cent. This appears to be an economic disaster and the usual trend in most developing countries such as Ghana. In the next section and the rest, I have attempted to discuss the fundamental issues involved in savings mobilisation in the context of the developmental aspirations of Ghana. Following these lines of debate, the paper argues that there can be no growth without investment and no investment without savings and savings can only have positive impact on growth and development if it is effectively mobilized. The paper borrows from the idea of Neoclassical Solow model (1956) which suggests that an increase in the saving rate generates higher growth at least in the short run. This assumes that in Ghana, there is a strong presence of rationally behaved economic individuals who value both consumption and wealth. The paper is structured into four chapters. The importance of savings mobilisation in economic development is highlighted in chapter one. Chapter two discusses the theoretical developments

underlying the role of savings in economic growth. Chapter three reviews the strategies and mechanisms to encourage savings. Chapter four concludes the paper.

1.6 The nature and problems of savings mobilisation in Ghana The first question on the mind of every researcher interested in this study is to ask the question Why is domestic savings so low in Ghana? The simple answer to this question is that in the past few years both domestic and external debt has created a scenario in the Ghanaian economy such that the country has accumulated virtually no wealth on its own to invest in capital and investment development. This is coupled with the fact that Ghanas per capaita income at present around $400 dollars (World Bank), is still one of the lowest in the world. A study done by Quartey and Blankson (2004) seem to reveal some stylized facts about domestic savings in Ghana. First, it is observed that there are three main categories of domestic savings in Ghana which includes personal savings, corporate savings and national savings. Secondly, Private savings in Ghana especially household level savings are usually not covered in official data and therefore seem to be underestimated. Savers hesitate to keep their assets in financial form. Instead they prefer to hold them in less risky forms that provide a very low (and perhaps even negative) rate of return. Thirdly and also most importantly, the apparent low savings in Ghana has been due to a combination of
micro and macroeconomic and political factors.

Also a survey by Bank of Ghana on household level spending in 2001 revealed extravagance in status oriented demonstrative consumption and mistrust of financial institutions, which led to the purchase of real estate by way of transfer payments and avoided investment in financial assets.

Other factors that have been identified as accounting for the low level of savings in Ghana include not only low income, but also the high dependency ratio, the underdeveloped financial system and macroeconomic instability. Recent surveys conducted in Ghana show that private savings are probably higher than the official data suggest. The survey also shows that savers hesitate to keep their assets in financial form. Instead they prefer to hold them in less risky forms that provide a very low (and perhaps even negative) rate of return. Also due to limited operation of formal commercial banking activities particularly in the rural areas of Ghana, savings at the household level are done through micro finance institutions such as credit associations or Susu and mutual fund agencies. Thirdly, most people in Ghana keep their saving and wealth in both physical forms such as estate building or houses, cattle, land, gold and in cash which are deposited at banks or kept at home. Since the early 1990s the Bank of Ghana has adopted a strict credit ceiling for Bank lending activities in line with real GDP growth rates and inflation targets stipulated in the monetary survey.
According to monetary theory credit ceilings could achieve the desirable objective of stabilization if adopted for a short period of time (Dordunoo and Donkor, 1998). However, because the ceilings were imposed for a long period of time, they created serious distortions. First, they made redundant the use of reserve ratio as an instrument of monetary and credit management, leading to excess reserve holdings. Second, lending interest rates of commercial banks were increased and deposit rates were kept low, resulting in a widening of the spread. Third, they led to an increase in currency with the non-bank public and discouraged deposit mobilization. Fourth, they reduced the M2-GDP ratio or the degree of financial intermediation. Additionally, credit ceilings discourage competition among banks since the banks have little or no incentive to compete for new deposits if they are up against their ceiling. Further, they have strong incentives to compete for favours (in the form of higher ceilings) from the monetary authorities. In analyzing the implication of this to economic activity, Dordunoo (1998) observed that because of the draconian credit

ceilings the banks were unable to lend all the resources mobilized nor could the resources be invested in other lucrative investment opportunities. The lack of active mobilization of resources by the deposit money banks (DMBs), coupled with very low deposit rates, and resulted in the build up of liquidity outside the banks. This was reflected in a high proportion of currency with the non-bank public, i.e., M0, which remained above 50% of M1. The follow-up effect of inability of the DMBs to mobilize deposits further not only results in a shift out of deposits to cash but also reduces the overall supply of money leading to financial squeeze. This may reduce inflation in the short run. In the medium term, however, the financial squeeze leads to contraction of economic activity.

The direct impact on the deposit money banks was to dampen their resources mobilization efforts. It has been alleged that some banks were turning away potential savers, a practice that was extremely unhealthy for savings in the economy. This should not be surprising based on the reserves position of the deposit money banks due to the credit ceiling. Because of the credit constraint on the DMBs, banks had loaded their lending rates to cover operational costs and maintain profitability, thereby increasing the effective cost of credit. The higher lending rates vis-vis low deposit rates drastically discouraged financial intermediation. Additionally, the DMBs revealed stronger preference for demand deposits as against saving and time deposits. Thus while time deposits amounted to about 16.3 billion by end December 1988, by March 1990 this had fallen to less than 9.91 billion. For the same period, despite the fact that lending rates had been around 34.4%, time deposit rates ranged between 9.0% and 15.0%. There was evidence adduced to the fact that some banks were paying as low as 6.0% per annum. All this vividly illustrates the lack of competition among the DMBs due mainly to the credit ceilings imposed. With reserve requirements as high as 57%, the wide spreads also resulted in an indirect control system and therefore impair the credit creation potential of the deposit money banks.

In recent years the Ghanaian Government has been uneasy or impatient with policies to increase private savings. As a consequence, she has attempted to follow an explicit public savings strategy: to draw resources into the public sector by fiscal means and to undertake public investment with 10

these resources. Usually, such efforts demand a substantial increase in taxes. And in fact much of the emphasis on increasing taxes in Ghana had as a rationale the need to increase public savings. The results have not been much gratifying at least as concerns resources mobilization. In analyzing low savings rates in Ghana, Gockel (2005) argued that low savings interest rate was a disincentive to the public to save at the banks. The structure of the real interest rate for savings from December 2003 to December 2004 for instance showed a considerable nosedive indicating a negative rate. The real interest rate based on 2005 budget estimations stood at -2.06 per cent. In Ghana, inflationary pressures are unlikely to abate over the next fe w months. Over the past three years, as interest rates fell to record lows, bank borrowers benefited immensely. Savers, especially those belonging to vulnerable sections of society, have not been in a position to influence policymaking. At the end of the current interest rate cycle, when all market signals point to a hardening of interest rates, some major banks will have actually reduced their short-term deposit rates. This seemingly illogical action is a rude reminder to depositors that they have nowhere else to park their savings. 1.7 Financial reforms in Ghana Financial liberalization has long been thought to encourage aggregate saving. According to Honohan (1999) analysis of eight financial liberalization episodes in Chile, Ghana, Indonesia, the Republic of Korea, Malaysia, Mexico, Turkey and Zimbabwe however, failed to find a systematic direct effect on saving. The effect was negative in Korea and Mexico, positive in Ghana and Turkey, and negligible in Chile, Indonesia, Malaysia, and Zimbabwe. Levine (1996) suggests that financial liberalization that includes interest rates usually results in a rise in real interest rates on deposits. This means that each unit of resources saved yields more interest income, reducing the need to save. But the price of current consumption rises with interest rates: households might save more because a unit of income saved now would yield greater interest income in the future.

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Liberalizing interest rates will increase saving only if this intertemporal substitution effect overcomes the income effect. There is no consistent evidence supporting a positive net effect of liberalization on saving. If liberalization expands the supply of credit to agents that had been creditconstrained, this can reduce saving, because easier access to credit reduces the need to set aside resources in anticipation of adverse income changes.

Ghana took a very systematic approach to reforming its financial sector in the early 90s. In the first phase of those reforms, the government placed ceilings on net bank credit to the government to avoid crowding out the private sector. While administrative controls on interest rates remained in place, they were gradually relaxed. The second phase of reform focused on liberalizing controls on interest rates and bank credit. In the third phase, there was a gradual shift from a direct system of monetary controls to an indirect system that utilized market-based policy instruments. As part of the process, the Bank of Ghana rationalized the minimum reserve requirements for banks, introduced new financial instruments, and absorbed excess liquidity from open market operations. These policies were complemented by improving the soundness of the banking system by improving the regulatory framework, strengthening bank supervision, and improving the efficiency and profitability of banks, including the replacement of their non-performing assets. In the final stage of this process, Ghana has embarked on the privatization of the major publicly owned banks. But the slow response of the Banks to devising attractive products for their customers which can encourage savings deposit accounts undermined the reforms largely. The Banks were highly profit oriented and only deal with customers especially expatriate businesses who transact huge money into their accounts for payments. Besides, most banks especially the foreign owned ones such as Standard Chartered and B arclays Banks demand high minimum deposits from customers in order to operate a bank account. These high minimum deposits were unaffordable to low income earners which constitute over 60 percent of potential customers of these banks. In most developed countries such as Denmark, Germany

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and Sweden, banks can allow customers to open accounts even without initial first time deposits. This makes it easier for people to transact business with the banks. Technically, it is a confidence building measure which can encourage people to cultivate the culture of saving. 1.7 The general impact on savings In many respects the outcome of the reform in Ghana reflected the pace of its implementation. The nominal deposit and lending rates increased gradually from 1984 in consonance with the scope of liberalization. After five years, the average nominal lending rate increased by just 3.7% over its level at the start of the program (Table 14.4). Immediately the reform started, interest rate spread dropped considerably but later rose (Seini 1992). Improvement in the real deposit rate has been very significant. In the first year of the reforms , that is, stabilization cum interest rate liberalization, real deposit rate increased by 86.7% points from 111.5% to 24.8%. Further into the reform positive real deposit rates were achieved. Between the pre-reform and the reform periods real deposit rate increased by 52.2% although it remained negative (Table 14.4). This resulted mainly from the stabilization measures which led to lower rates of inflation. The contribution of nominal interest rate growth was marginal. The rise in real deposit rates did not however lead to higher rate o f savings. The ratio of savings-toGDP decreased slightly by 0.6% over the reform. This poor performance of savings is believed to have resulted from the public loss of confidence in the banking system as a result of government intervention in 1982 (Aryeetey et al. 1991). The mobilization of savings gradually improved with the continued implementation of the reform program especially in the 1990s, when real deposit rate became positive. Ghanas success story attracted Development Assistance from both bilateral and multilateral development partners, which by 1989 was as high as 103% of the countrys Gross Do mestic Investment. This increasing foreign aid however had negative effects on some aspects of the economy. The side effects were a downward trend in domestic savings, and increasing aid dependence. Gross Domestic Savings as a percentage of GDP declined from 4.9% in 1980 to

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1.3% in 1992 and -2.2% by 1993. Further to this, Ghanas GDP growth shrunk from the average of 5.7% in the late 1980s to an average of 3.6% over the past five years.

By 2004, gross investment is projected to reach 21.2 percent of GDP while national savings is projected to reach 18.1 percent of GDP, substantially narrowing the investment-savings gap. As with gross investment, gross national savings also maintained an upward trend up to 1991, doubling from a low of 4.0 percent of GDP in 1982-84 to 8.0 percent in 1989-91.8 during this same period, private savings increased from 4.6 percent of GDP to 5.6 percent while public savings increased from -0.6 percent of GDP to 2.4 percent. But the fiscal shock sent gross national savings into a tailspin, averaging only 3.8 percent of GDP in 1992-94. The decline in national savings took place in 1992 and 1993, concomitantly with the fiscal shock. From 9.3 percent of GDP in 1991, gross national savings fell to 4.2 percent in 1992 and to 1.4 percent in, 1993 (Figure 1). Private savings also fell during the same period from 6.1 percent of GDP in 1991 to 2.3 percent of GDP in 1993. In 1994, national savings saw some recovery, rising to 7.3 percent of GDP. This increase was fueled from public sources, primarily the receipts from the divestiture of SOEs. Private savings rose only marginally to 2.6 percent of GDP which suggests that even the recent increase in gross national savings, though still very small, may not be sustainable. Table 1: Savings and Investment in Ghana Savings\ Investment (% of GDP) Gross Investment (S\Y) Public Investment Private 8.1 4.3 4.9 3.2 3.0 4.1 7.7 8.5 9.9 113 2.0 2.3 13.6 15.8 12.8 14.8 15.9 4.0 1993 1994 1995 1996 1997 1998

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Investment National Savings Public Savings Private Savings 6.1 6.4 2.3 2.6 2.0 4.0 3.2 -2.2 -0.9 4.7 1.0 4.0 7.3 9.3 4.2 1.4 4.0 7.3

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Projected figures in the period 1996-2000. Source: Ghana vision-2020: The first medium ter m development plan (1997-2000

As with private investment, the cost to Ghana of the decline in private savings over 1992-94 has been high. Assuming that private savings had stayed at their 1991 levels, then the cumulative additional flows of private savings over 1992-94 would have amounted to $620 million in current values. If private savings had maintained its pre-1992 trend (see Figure 1.2), the gains would have been much greater and private savings in 1994 would have been almost 10 percent of GDP.

More than 50 percent of this decline was accounted for by the fall in public savings (the fiscal current account) which fell from a surplus of 3.2 percent of the GDP in 1991 to a deficit of 0.9. World Bank estimates of gross national savings are lower than the Gross Domestic Savings because they do not include net official transfers from abroad. Table 2 Deposit Share of Four Largest Commercial Banks: 1988 and 1994 (%) 1988 GCB SSB BARCLAYS STANDARD TOTAL 36 18 12 12 76 1989 29 14 14 13 70

Source: Bhatt (1993, p11) and Ghana Commercial Bank Share Offer, mini prospectus, 1996, p3. 1.8 Savings and Interest Rate in Ghana In the Table 2 above a look at the structure of the financial intermediation in Ghana between the period of 1979 to 1992 show that the interest rate spread was too large thus reducing the capacity

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of the financial system to mobilize loanable funds from savers to borrowers to be channeled into effective investment. The spread or margin between lending and deposit interest rates is a key variable in the financial system. It reflects the additional cost of borrowing related to intermediation activities performed by banks in linking borrowers with the ultimate fund lenders. When it is too large, it can contribute to financial disintermediation as it discourages potential savers with too low returns on deposits and limits financing for potential borrowers, thus reducing feasible investment opportunities and therefore the growth potential of the economy. In general, a minus real deposit rate means that growth in the prices of goods and service is higher than returns savers get from deposit rates. This implies that ultimately savers' money parked in deposit accounts could have less value because of higher prices (Srisukkasem, 2004). This is exactly the case for the entire period covered in the data. It may explain the basic reason for the low savings rate in Ghana. The role of interest rate in the determination of investment and, hence economic growth, has been a matter of controversy over a long period of time. Yet, what constitutes an appropriate interest rate policy still remains to be a puzzling question. Until the early 1970s, the main line of argument was that because the interest rate represents the cost of capital, low interest rates will encourage the acquisition of physical capital (investment) and promotes economic growth. Thus, during that era, the policy of low real interest rate was adopted by many countries including the developing countries of Africa. This position was, however, challenged by what is now known as the orthodox financial liberalization theory. The orthodox approach to financial liberalization (McKinnon-Kapur and the broader McKinnon-Shaw hypothesis) suggests that high positive real interest rates will encourage saving. This will lead, in turn, to more investment and economic growth, on the classical assumption that prior saving is necessary for investment. The orthodox approaches brought into focus not only the relationship between investment and real interest rate, but also the relationship between the real interest rate and saving. It is argued that financial repression which is often associated with negative real deposit rates leads to the withdrawal of funds from the banking sector. The reduction in credit availability, it is argued, would reduce actual investment and hinders growth.

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Because of this complementarity between saving and investment, the basic teaching of the orthodox approach is to free deposit rates. Positive real interest rates will encourage saving; and the increased liabilities of the banking system will oblige financial institutions to lend more resources for productive investment in a more efficient way. Higher loan rates, which follow higher deposits rates, will also discourage investment in low-yielding projects and raise the productivity of investment. This orthodox view became highly influential in the design of IMF World Bank financial liberalization programmes which were implemented by many African countries under the umbrella of structural adjustment programs.

CHAPTER TWO 2.0 SELECTIVE REVIEW OF LITERATURE

2.1. Introduction
In this chapter I review the issue of domestic savings mobilisation which is directed to economic growth and development. The chapter will discuss work covered in the literature about domestic savings particularly in developing countries and how it can be effectively utilized towards growth and development of an economy that wants to free itself from dependence on foreign capital for investment. In part, the chapter will also briefly examine savings-growth relationship and the impact of financial liberalization on domestic savings. However, due to the short nature of the study it will not be possible to investigate their causality.

As this study is only meant to explain the measures and strategies that are available for mobiliz ing savings in Ghana, the literature review will focus on how financial mechanisms operate to facilitate savings mobilisation. It needs to be stated that the absence of consistent and reliable data complicates the study of Ghanas domestic saving mobilisation, resulting in a dearth of literature on the subject.

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Nevertheless, the present paper identifies a number of key factors affecting savings mobilization in Ghana which include the poor state of the economy, the early 1990s banking irregularities increased investment in property for private and commercial purposes, foreign exchange liberalization, and the absence of well managed rural financial savings institutions as well as low capitalization of the existing rural banks. The method used to discuss domestic savings mobilisation is based on both qualitative and quantitative analysis. The prior-saving approach which takes its root in Lewis (1954) classical theory show that savings is equal to investment. As well the McKinnon-Shaw framework has explicitly sought to relate long-term economic growth in developing countries to capital-market developments (McKinnon 1973; Shaw 1973); these will form important parts of the study. The quantitative method employs secondary data to illustrate how the various monetary tools for instance interest rate affect saving in the deposit banking sector. In the context of this paper, some of the discussion will be informed by the wave of financial liberalization that swept through Africa especially within the last two decade s, citing the case of Ghana. Notwithstanding, the critical research question that borders on this study and seems to attract a lot of interest in the literature is that although financial reforms in Ghana resulted in the emergence of new forms and types of financial institutions, it did not largely boost savings mobilization. The scope of the study also attempts to cover savings mobilisation efforts in the past within both the institutional banking sector and development finance institutions. Aggregate savings behaviour which essentially considers the role of different layers of savings mobilisation including government finance and private finance are discussed. 2.2 Theories of Saving As an accounting concept, saving can be defined as the residual that is left from income after the consumption choice has been made as part of the household's utility maximization process. Substantially, saving is future consumption, and it is an important example of an intertemporal

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decision. The division of income between consumption and saving is driven by preferences between present and future consumption (and the utility derived from consumption). The main determinants of the consumption-saving trade-off are the interest rate and the individuals rate of time preference, reflecting the intertemporal substitution from one period to a future period. Income that is not used for consumption purposes can be saved and consumed one period later, earning an interest payment and hence allowing for more consumption in the future. This increase in the absolute amount available for consumption, as reflected in the interest rate, has then to be compared with the individuals rate of time preference (the latter expressing her patience with respect to later consumption, or, more generally, to delayed utility derived from consumption. In the optimum, the interest rate and the rate of time preference have to be equal. This is one of the fundamentals of intertemporal choice (as a special form of rational behavior. This intertemporal trade-off is the central building block of the life-cycle model of saving. This model is firmly grounded in expected utility theory and assumes rational behavior. In recent years, there is much research on psychological aspects of savings. Wrneryd (1999) contains a good introduction to that literature. There is a large but inconclusive body of work on saving theory and research (Beverly, 1997; Carney & Gale, 2001). Neoclassical theories represent the core of the discussion. The two most well known are the life cycle hypothesis (Modigliani & Blumberg, 1954) and the permanent income hypothesis (Friedman, 1957). These theories assume that individuals and households are focused on expected future income and long -term consumption patterns. In recent years, some economists have proposed additions to the life cycle hypothesis and the permanent income hypothesis, the so-called buffer-stock models of saving (e.g., Carroll, 1997; Carroll & Sam wick, 1997; Deaton, 1991; Ziliak, 1999). These models emphasize a precautio nary motive for saving, particularly for younger households and for households facing greater income uncertainty. Overall, economic theories suppose that people are forward looking and concerned about consumption patterns, that preferences are fixed, and that people are all-knowing and rational. Variations on the standard economic theories include a wide range of behavioral, psychological and sociological theories. Behavioral theories emphasize financial management strategies and self-imposed incentives and constraints.

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Individuals may save in different ways and accumulate different types of assets. For example, they may store tangible goods, they may invest in human capital, or they may loan money or in kind resources to social network members. Economic theory predicts that the absolute amount of savings will increase with income. This is because people with more income have more resources available to save. Theory also predicts that savings relative to income, the savings rate, will increase with income (Deaton, 1992b). This occurs because people with more income also tend to consume more. As they consume more, the marginal benefit from additional consumption decreases. The current cost of saving, in terms of foregone benefits from consumption, is lower for people who consume more, and this increases savings. Empirical evidence clearly indicates that higher-income households save a larger portion of their incomes, and accumulate greater wealth, than lower-income households. In fact, most low-income households have very low or negative saving rates and very limited or negative asset accumulation (Bernheim & Scholz). Each of the theories described above calls attention to institutional characteristics that are expected to affect saving and asset accumulation. Neoclassical economic theories emphasize the role of institutions that affect the economic costs and benefits of saving (e.g., markets and public policies). Psychological and sociological theories consider institutions that affect an individuals understanding or perceptions of economic costs and benefits that change non-economic costs and benefits, and/or that shape preferences (e.g., peers and family members). Behavioral theories highlight the role of institutions that allow individuals to modify the costs and benefits of saving by creating their own incentives and constraints (e.g., payroll deduction, saving clubs, and the option to over-withhold income taxes). By integrating these theoretical perspectives, while emphasizing the role of institutions , it may be possible to develop a theory that more accurately explains saving and asset accumulation in the general population and in the low income population. An institutional perspective suggests that external factors other than income and preferences may influence saving behavior and that low

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savings and asset accumulation by poor people might be explained in part by limited institutional saving opportunities. From this perspective, asset accumulations are primarily the result of institutionalized mec hanisms involving explicit & Sherraden, 1999). The first three are commonly discussed, and we have offered the fourth term facilitation to describe institutional arrangements where depositing is actually done for the participant, as in automatic payroll deduction. Facilitation is a key feature of most contractual saving systems. The exact mechanism by which savings contributes to economic growth is subject to debate. It is indeed difficult to pinpoint savings as a key determinant of economic growth, inde pendently of other factors such as technology, institutions, resources, etc. Moreover, theory suggests that causality runs in both directions: savings contributes to growth and economic growth increases savings. This theoretical ambiguity has not been solved empirically and results are contradictory. However, if developing economies are to promote savings for the financing of investment, its determinants must be clearly identified. At the aggregate level studies have shown that factors such as fiscal policy, pension reform, external borrowing and foreign aid influence national savings rates (Loayza, et al., 2000). Nevertheless, the literature on the determinants of savings mobilisation at the institutional level is still extremely scarce and this study contributes to building up some evidence on the importance of innovative policies to ensure the participation of poor people in the financial sector.

2.3 Types and determinants of domestic savings

Savings, which is defined as the part of incomes not immediately, consumed, but reserved for future consumption, investment or for unforeseen contingencies is considered as an indispensable weapon for economic growth and development. Its role is reflected in capital formation through

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increased capital stock and the impact it makes on the capacity for an economy to generate more and higher incomes. Domestic savings may be subdivided into private domestic savings and government domestic savings. Private domestic savings are from two sources- (a) corporate savings or the retained earnings of corporate enterprises and (b) household savings which represent that part of household income that is not consumed. The saving behaviour of households and corporations are
related, because private corporations are largely owned by domestic households. Therefore, they have indirect ownership of corporate retained earnings, which would be a factor in their spending and saving decisions. Also, changes in corporate savings may be offset by changes in household savings. For example, if there is rapid wages growth in excess of productivity increases, household income and therefore savings will increase but corporate profits and savings will fall. As previously observed by Aryeetey (1999) the early 1990s in Ghana saw a trend toward incorporation of previously unincorporated enterprises which shifted some savings, previously classified as household savings, into the measure of corporate savings.

Government savings are primarily the excess of government revenues over government consumption, defined as all current government expenditures plus capital outlays for military equipment. Important examples of government consumption include salaries of government employees, government procurement, maintenance expenditures and interest on the national debt. Where they exist, profits from state-owned enterprises can also contribute to government savings. For any economy that wants to increase its real capital formation, the objective must be to provide a climate receptive to the encouragement of domestic savings. Miracle and Cohen (1980:13) showed that in developing countries foreign capital alone cannot create any permanent basis for higher standard of living in future and that greater dependence on domestic sources of finance facilitates the successful implementation of any planned economic development. Analyzing the determinants of private savings, Dooley and Mathieson (1987) suggested that the main theoretical explanation of individual saving behaviour in the economic literature is based on 23

the notion of the intertemporal allocation of resources: individual agents (households) decide what portion of their current income they should allocate for present consumption and what portion should be set aside for future consumption (saving). According to Keynes (1936) the behaviour of saving is related to the nations marginal propensity to consume which in turn depends upon the level of income of the economy. A number of theoretical models have been proposed in the economic literature to study the saving behaviour of individuals including those based on the optimization of an individual utility function over a life cycle (Dennizer and Ying, 2000). During the life cycle, the patterns of individual saving behaviour may change (switching from saving to dis-saving), depending on the present level of income. In the economic sense, the savings behaviour is the obverse of a nations consumption behaviour. Secondly, savings may be influenced also by the investment opportunities or investment demand which in turn depends upon the growth prospects and the potential return available. Thirdly, the level of savings will also depend upon the avenues available in the economy for mobilizing such savings particularly from the household sector in the form of well-developed financial system with a variety of institutions and markets for different instruments. If savings from the national economy are mobilised by the financial sector and then used for investments one speaks of intermediation.

To permit an efficient and sustainable mobilisation of savings in general a number of factors must be fulfilled. These, according to (Hussein & Thirlwall, 1999) are classified into the capacity to save and the willingness to save. Whereas the capacity to save is influenced by the level of per capita income, growth of these incomes, population age structure and income distribution; the willingness to save on the other hand depends more on the countrys financial system through variables such as the level of financial deepening, and inflation.

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They however concludes that the number, proximity and diversity of financial institutions (willingness to save factor) serving the various needs of savers play a dominant influence over the primeval factor of the capacity to save. But there appear to be a strong link between the rates of growth of financial circuits and how develop and efficient a countrys financial system can sustainably mobilise domestic savings. Klaus (1999) also suggested that the dependence on domestic sources of capital requires a wide range of independent well-organized and adapted financial institutions, which have to mobilize internal resources for the purpose of capital formation and allow the capital to be invested conveniently and freely into desired development ventures. Furthermore, the general thriftiness of the public as a part of nations culture could also influence the saving behaviour in an economy. Zeldes (1989) suggested Social security expenditure (as a percentage of GDP) as determinant of savings. This factor is a proxy for the generosity of the social security system. In principle, theory would suggest individuals would tend to save less if they expect more generous social security benefits.

Another important factor that could influence the level of financial saving is the political and economic stability. People will fear about the loss of their wealth when such stability does not exist. In a highly inflationary economy, people may abstain from investing in financial assets due to fear of erosion in the value and in turn could look for inflation hedges like property and gold. It is extremely important, therefore, that financial stability, in particular, a low level of inflation is maintained if an economy wants to sustain the level of savings flow for purposes of capital formation. Using the same line of argument, Adjasi and Coleman (2004) observe that savings depends on a host of variables including income levels, population growth and age composition, as well as the return on assets.

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One of the necessary conditions for financial savings is the development of domestic capital markets. Capital markets provide an accessible and economical variety of financial instruments to encourage savers, largely households, to shift from real assets into financial assets. Odife (2000) observe that there are widespread benefits from capital market development as regards mobilisation of domestic savings. Capital markets direct savings into the most profitable investments available in the economy. By doing so they improve the overall efficiency of the economy and this also permits corporations to expand beyond the limits imposed by self-financing from retained earnings. Edwards (2000) analyzed the impact of absolute level of income on saving behaviour during the period 1995-1998 in Eastern Europe and observed that the higher the level of per capita income the greater the share of income that was allocated to savings. The level of monetization (the share of broad money in GDP) and the level of real interest rate s are also thought to have a significant influence in domestic savings but their effect are empirical issue (Dennizer and Wolf, 2000). Modigliani (1966) made mentioned of how higher interest rates, for instance, encourage savings in his neo classical growth theory. The table 1 in the appendix provides a breakdown of both nominal lending and real lending interest rates in Ghana from 1970-2000. These data illustrates the evolution of interest rates since the development of the money market in the early 1970s to the period when interest rate was liberalized.

The age dependency ratio (defined as the proportion of the non-working age population to the working age population) is another important determinant of domestic savings. The models of

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saving behaviour based on the life-time cycle imply that individuals save more during their productive age and save less during their old age. Studies about the relationship between public savings and private savings indicate a degree of substitutability. So changes in government savings are partly offset by opposite changes in private savings. 2.4 The link between saving, growth and development What is economic development? Economic development is growth in GDP accompanied by relevant social and institutional changes by which that growth can be sustained. These changes include reduction in absolute poverty, a better quality of life, high literacy level, improved productivity of labour and other factors of production, sophisticated techniques of production, development of physical and commercial infrastructure, higher savings, increase in employment opportunities, a positive attitude towards life and work, and a stable political system. Having defined economic development let me discuss the factors underlying it. The foremost factor lying at the bottom of development is economic growth. Economic development is possible only if the real GDP grows at a fast pace over a long period. The engine of GDP growth is investment or capital formation. The less developed countries (LDCs) such as Ghana are characterized by deficiency of capital due to low level of investment. Many authors have proposed different growth theories to examine the role of savings in economic growth. Obviously there are two strands of economic growth the ory-the neo classical and the Keynesian. Keynes work also discussed three basic types of domestic savings which include voluntary, involuntary and forced savings. Voluntary saving relates to the voluntary abstinence from consumption by private individuals out of personal disposable income and by companies out of profits. The classical as well as modern growth models hold that savings constitute the principal parameter, and determinant of economic growth. This idea is upheld by (World Bank, 1989) which

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showed that on the average, third world countries with higher growth rates incidentally are those with higher saving rates. Capital mobilized from domestic sources is very fundamental for a countrys development not only because it has a low cost, but also due to the fact that it is durable and permanent.

Traditional growth and saving analysis for example focuses on the effect of higher savings on the long-run growth and the impact of an increase in domestic savings on investment. The neoclassical model suggests that during the transition between steady states, an increase in saving ratios generate higher growth only in the short run (Solow 1956). Endogenous growth theories developed by Romer (1986) and Lucas (1988) suggest that permanent increases in growth rates can be determined by increased capital accumulation and achieved higher savings.

The Lewis model is a type of classical theory that equates S = I. According to this model investment (I) and development are led by saving (S). Therefore investments are constrained by the prior level of savings. Earlier (pre-neo-classical) growth models such as the Harrod-Dommar growth model implied a direct link between the (short-run) rate of economic growth and the level of current investment A series of recent theoretical and empirical works found the causality between savings and growth should also work from the other direction. The studies indicate incomes often have risen before savings rates rather than after, suggesting that growth drives savings rather than the other way around (World Bank, 1993). In an empirical testing for 64 large market economies, Carroll and Weil (1994) presented strong evidence that growth causes savings.

The reasons for the causality are as follows. First, a higher growth rate leads to higher return from capital investment thus higher interest rate, which encourages savings. Second, it takes time for

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households to adjust their consumption level or pattern they are used to, which is known as habit formation behavior. As an economy is growing quickly, consumption lags behind, hence savings increase. The bi-directional causalities between savings and growth provide a nice explanation for the crucial role of savings in sustained growth. From higher savings, to higher growth, then to even higher savings, then to even higher growth, a virtuous cycle is thus formed. An examination of the growth and savings patterns in fast growing economies in Asia in general agrees with this hypothesis. If high growth does not cause high savings, the virtuous circle cannot be completed, and then the growth in the long run will suffer.

A long-standing view of the macroeconomic dynamics of the development process was that a poor country had to raise its savings rate (that is to say, to change from a 12 per cent saver to a 20 per cent saver) and transform the increased savings into productive investment in order to achieve an economic take-off (Lewis, 1954).

Investment has both supply and demand sides. On supply side, investment requires savings . Investment is not constrained by prior saving; but ultimately saving must match planned investment for real capital accumulation to take place. There is clearly a link between saving and growth according to neoclassical growth theory. Growth and savings feed back into each other in the virtuous circle of savings investment growth savings. The feedback mechanisms depend on the efficiency with which savings are channelled into productive investment. Hence financial infrastructure, such as banking systems , stock and bond markets, insurance and the degree of monetisation play a key role in packaging risk for savers, transmitting information and lowering the cost of equity for firms . Despite the indisputable fact of the existence of links between saving, investment and growth, there is an ongoing debate as to how precisely savings and investment affect economic

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performance and vice versa: different theoretical models provide different interpretations of the causal relations and transmission mechanisms, and many of the results in this area are quite ambiguous (UNECE paper, 2001). Investment is clearly a function of saving that can also be linked to output growth of the economy. Mathematically, the growth of output (Y/Y) can be expressed as the product of the ratio of investment to national output (I/Y) and the productivity of investment (Y/I), i.e.

Y 1 Y ...........................(1) Y Y I
This is definitionally true, and identical to Harrods famous growth formula for the actual rate of growth (Harrod, 1939) of:
g S , where g is the growth rate (Y/Y); s is the savings ratio (S/Y), and c is the incremental C

capital-output ratio (I/Y) i.e. the amount of investment or increase in the capital stock required to increase the flow of output by one unit (which is the reciprocal of the productivity of investment, Y/I). The Harrod formula for the actual rate of growth is definitionally true since in the national accounts (ex-post) saving (S) and investment (I) are always equal. The simple Harrod growth formula has proved to be remarkably useful for the purposes of planning and forecasting, and the development plans of many developing countries invariably make reference to it. It is clear, for example, that given the capital output ratio for a country, the ratio of saving and investment to national income can be calculated for any target rate of growth stipulated. Suppose a country wishes to grow at 5 percent per annum, and the capital-output ratio is 3, it can be seen from equation (2) that it must save and invest 15 percent of its national income. If it saves less, growth will be slower, unless the country can somehow reduce the incremental capital -output ratio or raise the productivity of investment.

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The link between saving, capital and output can be illustrated with the Solow diagram. Figure 1 plots the production function, y , the saving function, sy , and savings needed to maintain any given level of capital, ((1 Time subscripts are dropped as the diagram describes the long run. The savings function and savings needed to maintain a given level of capital intersect at the longrun equilibrium, steady state, where capital accumulation is zero, point (k*, y*). The Solow diagram can be used to investigate how changing the saving rate affects the economy. For example, consider the effect of an increase in the saving rate from s to s. The steady state capital per efficiency worker increases from k* to k** and income per efficiency labour rises from y* to y**. However, once the economy adjusts to its new level of capital, it resumes its former growth rate. The relationships among savings, investment and growth have been found to be more complex than initially imagined, but it remains generally accepted that increasing savings and ensuring that they are directed to productive investment are central to accelerating economic growth. As recognized by one of its authors, this model was not meant to be a long run growth model; it was envisaged as a tool to analyze economic performance in the short run, particularly during the course of a business cycle. In the growth model developed by R. Solow, a rise in the saving rate only causes a one-time increase in the level of per capita income and does not affect the equilibrium rate of growth; it is only during the transition from one steady state to another that the rate of growth changes in response to a change in the saving rate Figure 1: The Solow-Swan model efficiency worker, k .

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Savings mobilisation involves the agglomeration of capital from disparate savers for investment (Levine 1996:20). Without access to multiple investors, many production processes will be constrained to economically inefficient scales. Furthermore, mobilisation involves the creation of small denomination instruments, which provide opportunities for households to hold diversified portfolios, invest in efficient scale firms, and to increase asset liquidity. Mobilisation, therefore, improves resource allocation. Mobilisation also means capital formation that has been emphasized as the major factor governing the rate of development. Whether it is financed from internal or external sources, the accumulatio n of capital in any economy requires the mobilisation of economic surplus. There are varying opinions as to whether a mere increase in savings can lead to higher growth rate or what matters in this regard is how to bring together the various savings resources that are at disposal of a countrys economy.

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In this regard, Lewis suggested that policies need to focus on raising the level of savings either voluntarily or involuntarily. Since involuntary savings has aversion towards inflation, there is need for non-inflationary monetary policies.

Secondly, policies need to promote voluntary saving especially in the private sector. Lewis views this to include the monetization of the economy, develop and extend the banking and credit system (financial intermediation) including fractional reserve system, credit mechanism, and range of financial assets, as well as expand bank branches.

Senbet and Otchere (2005) have examined the role of financial sector development to economic development and noted the significance of domestic savings mobilisation to growth performance. In several countries, savings banks have proven to be instrumental in setting a vigorous savings mobilisation policy. A combination of factors like proximity, accessibility, attractive products and services and safety has proven a key to their success in mobilizing saving deposit. The basic institutional foundations for enhanced financial intermediation are already present in Ghana (Boehmer and Wetzel, 1994). Its bank financial institutions include the Central bank-the Bank of Ghana- 9 commercial banks, 3 merchant banks, and over 100 rural unit banks. Non-bank financial institutions include a stock exchange, 21 insurance companies, the Social Security and National Insurance Trust, 2 discount houses, the Home Finance Company, numerous building societies, a venture capital company, a unit trust, and a leasing company. Informal financial arrangements include "susu" collectors, who engage in mobilizing short-term savings, rotating credit groups, and traders and money lenders.

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Table 3: Domestic Savings Mobilisation Institutions in Ghana Commercial Banks Ghana commercial Bank Ltd Social Security Bank of Ghana Ltd Barclays Bank of Ghana Standard Chartered Bank Ltd The Trust bank Ltd International Commercial Bank Stanbic Bank Ghana Ltd Unibank Merchant Bank Merchant Bank Ghana Ltd Ecobank Ghana Ltd CAL Merchant Bank First Atlantic Bank Amalgamated Bank Development Banks Agricultural Development Bank National Investment Bank Prudential Bank Rural Banks Non Bank-financial institutions Insurance companies Discount Houses 24 8 39 11 5 123 5 4 34 2 1 No of Branches 133 38 24 23 6 3 1 1

Source: Authors own compilation from Bank of Ghana Records-2000 Traditionally, the models that look at the interface between saving and development are based around the life-cycle or permanent income theory of consumption. The life cycle hypothesis 34

assumes that people save in order to smooth their consumption over their life time. This is positive for young households and negative for the retired, so that wealth should be hump -shaped (Modigliani-Ando, 1986). In its basic formulation, the LCH posits that saving behavior is forward looking and driven by the desire to prepare for future expenditures above later income throughout life. Clearly the linkage between savings mobilisation and economic development is the function of a well designed financial system. Developing countries in general have always attributed the intrinsic problem of economic development to inadequate savings capacity of the populace. It is also argued that the problems of promotion and mobilization of savings are caused; by inadequacies in the structure of financial markets and the density of financial intermediaries. Indeed, Lewis (1970) observed that there is a whole range of saving institution that can be developed and that experience shows that the amount of savings depends partly on how widespread these facilities are. Support for this argument has come from some empirical evidence that has shown savings to be responsive to the number, availability and efficiency of financial market (Wai, 1972).

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CHAPTER THREE

3.1 STRATEGIES OF SAVINGS MOBILIZATION IN GHANA Savings mobilization is at the core of financial intermediation. This includes formal banking activities which began in 1894 with the establishment of a branch of a foreign bank in Ghana. The financial sector of Ghana is composed of a variety of formal and informal institutions. 1. The central bank 'Bank of Ghana', which issues the currency and supervises other financial organizations. 2. Money transfer intermediaries such as Commercial Banks and Merchant Banks. 3. Organizations which work closer to the public primarily by accepting deposits such as postal saving services, private finance corporations such as insurance companies, discount houses and finance houses 4. Specialized banks which directly serve the public primarily by issuing loans in the agricultural sector, i.e., the 'Agricultural Development Bank of Ghana and, 5. Informal self-administered saving groups such as 'Rotatory Saving Organizations' (ROSCAs).

The manner in which the financial sector creates, collects and processes money is broadly referred as financial technology. There are two fundamental processes of savings mobilization - either through fiscal policy by budgetary surpluses at macro level, or through accumulation and concentration of private savings through saving organizations at micro level. The function of financial institutions is to link potential savers and investors.

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The efficiency of financial institutions lies in two interrelated features: their ability to attract and mobilize domestic savings and their adequacy in channelling funds towards productive use. In the capital deficient economy of Ghana, meagre savings cannot be channelled in a productive manner until a sound financial system exists. Saving organizations offer attractive and lucrative incentives such as security of capital and a handsome rate of return as a reward to the public for postponing consumption expenditure. Access to formal savings instruments is commonly assumed in the economics literature. Nevertheless, in developing countries such as Ghana, availability of these instruments especially for low-income people is not universal. As characteristic of most developing countries, opening a bank account in Ghana has relatively high transaction costs and relatively high fees and commissions for this sector of the population. These impediments to save or savings constraints must have some impact on the individuals behavior. In spite of that, little is known about this issue. According to conventional models of savings behavior, if people are constrained to save in certain instruments, they should be saving using alternative ways. Access to new and better instruments should imply a crowd out of the less attractive into the more desirable ones. The new level of total savings would depend on the relative weights of the substitution and income effects. This situation is a reflection of the formal banking system in Ghana where individuals cannot access saving products more easily. For instance, most banks require individuals which wants to open accounts to have a minimum deposit amount that scare away potential savers to le sser known savings forms. In reality, the great bulk of the Ghanaian population makes little or no use of formal savings and lending institutions. Because they offer relatively low returns, savers are reluctant to use formal institutions (Miracle, Miracle and Cohen, 1980). On the other hand however, traditional savings generally in form of microfinance has proved very effective in mobilization local savings for community level development.

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For instance, City and Loan Savings Company in Ghana is on record of mobilizing substantial savings from over thousand customers since its establishment over 15 years ago to provide investment capital to small and medium scale enterprises in various sectors of the economy . The unorganized financial sector which forms part of Ghanas financial system consists of individuals and intermediaries such as moneylenders, traders, friends, landlords, pawnbrokers, fixed fund associations, mobile bankers, rotating savings and credit organizations, and co operative thrift and credit societies. Contrary to popular belief, the Ghanaian informal sector is extremely rich and dynamic in terms of savings mobilization. The savings options that exist are not only used to meet family and/or social obligations; the informal sector also satisfies the financial needs linked to the development of economic activities. Informal finance is highly revealing of the real demand for savings services, the embeddedness of economic activities (investments, credit, insurance) within social processes (trust, solidarity, proximity), and the specificity of savings mobilization strategies. The informal sector is able to reach a large public and satisfy its wide variety of needs because it is diverse and highly adaptable. That said, it faces a limited supply of resources, high transaction costs, and serious risks. Added to this are several rural banks widely distributed throughout the country. The post office savings outlets that were inherited from the colonial era are also partly considered as semi-financial institutions but unfortunately they could not be efficiently operated to meet the aspirations of the population. The institutional arrangement for the mobilization of savings in Ghana is discussed under two main broad headings: the formal sector and the informal arrangement.

3.2 Formal Financial Institutions

Formal institutions that have been established to encourage financial savings include the deposit money banks, insurance companies, pension funds and the capital market, as well as innovative

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institutions like the Rural Banks and the Community Banks. The ratio of institutional savings relative to Gross Domestic Product (GDP) was 9.0 per cent in 2001. 3.2.1 Deposit Money Banks The deposit money banks constitute the main formal channels through which financial savings are mobilized in Ghana. Currently, there are 17 commercial banks with 330 branches located all over the country as well as 123 rural banks with 123 branches mostly in the rural areas of Ghana. The banks provide services and offer various types of products which give some returns to savers. Of the total amount of institutional savings in Ghana less than 50 per cent was accounted for by banks. Attempts were made in the past through the rural banking scheme to encourage banks to locate in the rural areas. However, with progress made in financial sector reform other innovative institutions have been promoted to encourage rural savings

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3.2.2 Insurance Companies and Pension Funds

Insurance companies and pension funds have contributed to savings mobilization. There are 24 insurance companies currently in operation. Life insurance premium constituted the main channel through which resources are pooled by insurance companies to finance economic development. Pension funds represent money set aside to provide for employees when they retire from service. The funds which are largely contributory provide an avenue for making resources available to enhance economic development. Currently, the Social Security and National Insurance Trust (SSNIT) which serves as a national social security fund allows individuals employed in both public and private sectors to compulsorily contribute 17 per cent of their monthly earnings into the fund and at the end of the employees retirement they receive a cumulative payment which is equivalent of at least 240 months of individuals working period. The fund from SSNIT is invested in various economic activities such as housing, venture capital to businesses and as loans to students studying in various institutions i n Ghana.

3.3 The Capital Market Ghana Stock Exchange (the Exchange) was incorporated in July 1989 with trading on its floor commencing in November, 1990. Since then, the Exchange has been progressively strengthening its facilities for businesses and the Government to raise long term capital as well as for investors to obtain liquidity, reasonable capital safety and diversity of investments. GSE is the prime operational institution in the Ghanaian capital market. With its current market capitalization of some US$2 billion, the Ghana Stock Exchange, in terms of market capitalization, has become one of the largest sub-Saharan Stock Exchange . As a capital market institution, the Stock Exchange plays an important role in the process of economic development. It helps mobilize domestic savings thereby bringing about the reallocation of financial resources from dormant to active agents.

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The very fact that institutions exist where savers can safely invest their money and in addition earn a return, is an incentive to people to consume less and save more. Secondly, the stock exchange assists in the transfer of savings to investment in productive enterprises as an alternative to keeping the savings idle. It should be appreciated that in as much as an economy can have savings, the lack of established mechanisms for channeling those savings into activities that create wealth would lead to misallocation or waste of those savings. Therefore, even if a culture of saving were to be encouraged, the lack of developed financial markets may lead to economic stagnation. Currently the exchange has a number of listed companies including Anglo-Gold Ashanti, Fan Milk Ghana, Unilever and Ghana Breweries Limited.

3.4 Innovative Financial Institutions Following financial reforms since 1994 and the need to expand the scope of financial intermediation to meet the developmental aspirations of the Ghanaian economy, community banks and the Rural Bank were established to operate at the community level in the urban and rural areas. A community bank is a unit bank, which is established through the efforts of the various groups in the community.

The performance of the community banks, however, suffered a setback following the distress in the financial sector in the recent past. At the end of 2001, there were 123 rural banks in operation. With the current involvement of the BOG and Apex Bank in the regulation and supervision of rural banks, the institutions are being strengthened to perform their expected functions of financial intermediation in the rural economy. The commercial banking system in Ghana, is dominated by a few major banks (among the total of 17), reaches only about 5 percent of households, most of which are excluded by high minimum deposit requirements. With 60 percent of the money supply outside the commercial banking system, the rural banks, savings and loans companies, and the semi-formal and informal financial systems play a particularly important role in Ghanas private sector development and poverty

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reduction strategies. The assets of RCBs are nearly 4 percent of those of the commercial banking systems, with Susu and Loan companies and Credit Unions adding another 2 percent. In Ghana the informal financial system covers a range of activities known as Susu, including individual savings collectors, rotating savings and credit associations, and savings and credit clubs run by an operator. It also includes moneylenders, trade creditors, self accepted deposits from clients who were mainly self-employed, artisans and traders who did not have access to conventional banking facilities. It also extended credit to its clients and provided advisory services that could help in the development and expansion of such trades. These informal financial institutions broadly operate in the microfinance sector (MFI) in Ghana.

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3.5 Informal Institutions in Savings Mobilization There are still various institutional arrangements in the informal credit market in spite of the progress that has been made in the liberalization of the financial sec tor. These include the Cooperative Societies, the Rotating Savings and Credit Associations (ROSCAS), otherwise called Susu, Credit Unions, which serve as a vehicle for pooling small savings. Ghana's informal financial sector is large. It is estimated that 45 percent of all private sector financial savings are initially mobilized through informal channels. Still, its capacity to intermediate between savers and investors is limited, in part by people's savings behavior, and in part by the absence of strong links with the formal sector. The shortcomings of these arrangements notwithstanding, they provide veritable sources of investible funds for their members. For example, savings generated by Susu collectors can be deposited at formal institutions, and traders may gain access to formal credit through the simplified use of collateral. The informal sector's capability to mobilize savings and its information base for lending are assets .There may be considerable opportunity for profitable contacts between the informal and the formal sectors. The challenges facing the monetary authorities are not only that of integrating these institutions into the formal financial system, but largely that of ensuring adequate monitoring of their activities in order to plug the leakages, which their operations constitute to the monetary policy framework .

Given the relatively small share of total savings that now passes through the financial system, the scope for enhanced intermediation and faster economic growth is large. Conserv atively estimated by the World Bank, if 16 percent of existing non-financial savings were brought into the system, the increase in real GDP growth would be in the order of 1 percentage point. With a faster uptake, even larger gains could be achieved. CHAPTER FOUR

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4. 0 CONCLUSION AND RECOMMENDATION The mobilisation of savings in Ghana is crucially important for the financing of credit, making possible investment in micro- enterprises, SMEs, and other similar entities, with knock-on effects on overall economic growth through the creation of local employment and the reduction of poverty. Savings and investment are closely related, with financial institutions playing the intermediation role of mobilizing and allocating financial resources from savers to investors. From the study, it is becoming clearer that two of the most important issues in development economics, and for developing countries such as Ghana, are how to stimulate investment, and how to bring about an increase in the level of saving to fund increased investment. In order to sustain high levels of economic growth, Ghana needs increasing levels of investments which will improve and expand the countrys productive capacity, help create more jobs and increase the overall income of the population. Increasing investments, in turn, require higher levels of capital to finance and sustain them. Domestic saving, composed of saving by households, businesses/corporations and government, provides the pool of resources to finance these investments. The economy has to grow in order to allow for savings mobilisation. It can therefore be argued that devising strategies and policies that aim at promoting and supporting domestic savings will be necessary for higher and sustained growth while at the same time ensuring a smooth transition to less aid dependence. It is thus all the more important for Ghana to
mobilize domestic savings that can be channeled towards development. . To achieve this demands an

effort to reorient the savings philosophy of our economic system is needed. The mobilization of savings starts with a strong and diversified financial sector and efficient capital markets. It is the fact that in Ghana, the financial system is still far from developed and the market

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is fragmented, with a large and vibrant informal sector at the periphery and a formal (largely banking) system at the core. While some long term savings instruments are issued in the formal financial sector, there is little effective intermediation and not much access by borrowers to the large pool of funds in the form of another constraint to the mobilization of domestic savings is the lack of a diversified range of long term savings instruments on the market. And this clearly is an area that demands attention. The domestic bond market is undeveloped with virtually no secondary market trading. The current efforts at ensuring a sound and stable financial system, through sanitization and strengthening of the supervisory framework are expected to provide financial environment that does not endanger greater competition. This is expected to facilitate the introduction of new savings products that could enhance the mobilization of resources for development. Reforming social security systems is an important route for mobilizing savings in less developed countries. Private savings are affected by the extent and coverage of government-run social security systems, in the sense that, if individuals perceive that when they retire they are going to receive high benefits from the government, they will tend to reduce the amount saved during their active days. It is also important that savers are adequately protected and the real question is what manner of fixing the return on savings will protect savers interest? Until recently, real interest rates on deposits have been negative, giving individuals little incentive to hold savings in bank accounts. Economists generally argue that savers should get effective real return of say at least 2 to 3 per cent to sustain their interest in savings and also if their wealth is to remain intact. Broadly speaking, economists relate the maximum realizable real rate of return for an economy to the real return on capital, or putting in the other way, real rate of growth in the economy.

The difference between the real return on investment and the real return for savers will depend upon the efficiency of the financial system in minimizing its transactions or intermediation costs. If the long-term growth rate of the economy, let us say is about 6 per cent, the

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transactional/intermediation cost would be around 3 per cent, then the real return to savers may have to be around 3 per cent. There are two ways of protecting the real return on savings. First, the real return could be fixed and the nominal returns could be indexed to a measure of inflation. On the other hand, such funds can be invested in inflation indexed bonds issued by the government which will in turn ensure real return to savers funds. The recent introduction of GGILB by Government as an alternative saving instrument provides a safe insurance to savers against increasing cost of inflation. Ghana's formal banking system is still dominated by state-owned banks that have a monopoly in banking services and only concentrated in large urban communities. Rural areas are particularly underserved by financial institutions. Ghana's informal financial sector is large, mobilizing an estimated 45 percent of all private sector financial savings, but its capacity to intermediate between savers and investors is limited.

The economy of Ghana will require a sustained GDP growth rate of about 7-8 per cent for poverty to be halved by the year 2020. To achieve such performance in the present environment of the Ghanaian economy requires high levels of investment of 25-30 per cent of GDP.

For that purpose Ghana should target a savings rate of 20 per cent as minimum and mobilize external savings as a supplement. This is different from direct foreign aid that distorts the economy structure when its flow is discontinued. This would suggest that the resources to finance productive investments may already exist not only in Ghana but in the Diaspora population.
Finally, four issues emerge in this study which will be useful for further research activity and policy formulation.

First, the evidence in support of promoting domestic savings is well researched and documented. Secondly, mobilizing domestic savings is essential for capital formation and capacity expansion without which a countrys growth cannot be sustained. Moreover, given that there are limitations on the level of access to the international capital market by developing countries like Ghana, domestic

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savings will be a key factor in promoting aggregate investment in the domestic economy. Thirdly, the experience of some South American and Asian countries suggest that domestic savings is key to avoiding financial crises and a total collapse of the growth process. Ghana has the potential to generate saving especially from the private sector to finance its growth. These savings are mostly untapped in the informal sector and are linked to indigenous businesses. Savings in Ghanas informal sector provide a strong link between investment and production. Though there is optimism in this regard there is no guarantee that the most productive investments are undertaken. Banks can play a vital role in encouraging and communicating savings resources to investors. Two issues emerge from this. It explains how important it is to understand why individuals are reluctant to participate in formal financial markets. It is equally important to understand the cost that low intermediation poses to the economy in terms of lost economic growth. There is a tremendous capacity for improving growth prospects by encouraging individuals to hold their savings in financial forms. It is also important that both the public and private sector should combine efforts to tap into available savings resources already mobilised in the banks for investment in both research and infrastructure development. This is because despite the increasing savings in Ghana in recent years, domestic capital resources have funded a declining proportion of fixed asset investment. The decline was partly attributed to the increased utilization of foreign funds. But more importantly, it was a result of the under-utilization of Ghana's domestic savings, which has not only put a drag on the expansion of productive investment, but also impeded the growth potential of the economy. Finally there is critical need for a channel of communication between potential savings and potential real investment in Ghana.

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References 1. Ernest Aryeetey and Fritz Gockel (1998) Mobilizing Domestic Resources for Capital Formation in Ghana: The Role of Informal Financial Markets, Research Paper 3. CGAP Working Group on Savings Mobilization, "Savings Mobilization Strategies Lessons from Four Experiences", CGAP Working Group, Eschborn Germany 2.Vogel, R.C., "Savings Mobilization: The Forgotten Half of Rural Finance", in Undermining Rural Development with Cheap Credit, edited by D.W. Adams, D. Graham and J.D. Von Pischke, Westview Press, Boulder (1984 3. Loaya, N.H. Lopez, K. Schmidt-Hebbel and L. Serven (1982): Saving in the World: Stylized Facts (November 1988) 4. Modigliani, F. (1966) the Life Cycle Hypothesis of Savings, the Developed for Health and the Supply of Capital (Social Research, 33 pp. 160-217, Summer 1966) 5. Giovanini A. (1985): Saving and the Real Interest Rate in LDCs. (Journal of Developme nt Economics 18, pp. 197-218, August 1985). 6. Bandiera, O., C. Caprio, Jr., P. Honohan and F. Schiantelli (1999): Does Financial Reform Raise or Reduce Saving? Available at http: || www.worldbank.org\research\projects\savings\policies\\html, 1999) 7.Ross Levine, Stock Markets: A Spur to Economic Growth, Finance and Development 33, no. 1 (March 1996) 8.World bank (1989). Sub-Sahara Africa. From crisis to sustainable Growth. A Long-term perspective study. Washington D.C 9. Aryeetey, E; E Asante; A Kyei and F Gockel (1990), Mobilizing Domestic Savings for African Development and Diversification: A Ghanaian Case-Study , Research Report presented at a Workshop on Domestic Resource Mobilization at the International Development Centre, Queen Elizabeth House, University of Oxford, 16-20/7/90. 10. Bernheim, B.D., & Scholz, J.K. (1993). Private saving and public policy. Tax Policy and the Economy, 7, 73-110. 11. M. Sherraden, M. Schreiner& S. Beverly (2002). Income, Institutions, and Saving Performance in Individual Development Accounts, Center for Social Development, St Louis (USA)
12. Demirg-Kunt A.,

and R. Levine, 2001, Financial Structure and Economic Growth. (Cambridge, Mass.: MIT Press)

13. Bank of Ghana, Quarterly Economic Reports

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14. C. Diop C. Dorsner D. M. Gros (2000) Understanding Savings Mobilisation by Mutual Savings and Loan Institutions in WAEMU Countries, London School of Economics, London

Appendix Table 4: Financial Intermediation in Ghana, 1979-1992

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Source: Computed from (i) IMF, International Financial Statistics, (various issues) (ii) ADB, African Development Repor t, 1995.

Table 5: Financial ratios of Ghana from 1975-1995 12 MONTH DEPOSIT 8 8 8 13 13 13 19 9 12.5 16 17 20 20-22 17-22 12-20 14.22 16-24 15.5-22.5 17-32 17.32 14.31 18.34

YEAR

SAVINGS DEPOSIT 7.5 7.5 7.5 12 12 12 18 8 11 14.5 15.5 18.5 21.5 17-21.5 15-19 14-18 10.6-19.5 11-16 15-22.5 13.5-22.5 21.5-31 22.5-32

LENDING AGRIC 6 8.5 13 13 13 20 8 12.5 16 18 22.5 22.8-30 22.5-29.5 19.5-31.5 19.8-26.5 19.8-26.5 23-30 24-39 22.5-35.5 23.-36.5 27-38.5

LENDING OTHER 12.5 11.5-12.5 11.5-12.5 18.5 17.5-18.5 25.5 14 19 22.5 22.5 23 26 23-30.3 22.5-30.5 23-31.5 24-29 26-29 26-29 29-37.5 32-40.5 33.5-40.6 34.5-42.5

TREASUR- INFLATION Y BILLS 7.8 7.8 7.8 12 12 12 18.5 9.5 13.0 16.8 16.8 19.6 19.8 18.0 19.9 27.5 18.0 25.4 32 29.5 32.5 33.0 18.8 55.4 116.5 73.1 54.5 50.2 116.5 22.3 122.8 39.7 10.4 24.6 39.8 31.4 25.2 37.2 18.0 10.0 24.9 24.9 38.5 39.9

1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Source: Computed from: (i) IMF, International Financial Statistics, (various issues) (ii) ADB, African Development Repor t, 1995. Source: Computed from: (i) IMF, International Financial Statistics, (various issues) (ii) ADB, African Development Repor t, 1995

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