Determinants of household savings in lam dong province

VIETNAMESE-NETHERLANDS PROJECT ON DEVELOPMENT ECONOMICS DETERMINANTS OF HOUSEHOLD SAVINGS A Thesis Submitted In Partial Fulfillment of the Requirement for the Degree of MASTER OF ART IN ECONOMICS O f li TRU()I;G L , ;''*~m ':1 I SUPERVISOR: DR NGUYEN B¢ GIAO DUC VA f)~O T~O TRIJ0NG [)11 KINH TE TP.HCM j- TI-ITJ VI:E:~o hi Minh City, Dec CERTIFICATION I certify that this thesis has not already been submitted for any degree and is not being submitted for any other degree I certify that to the best of my know ledge any help received in this thesis and all sources used have been acknoledged in this thesis ?( NGUYENTHJNAMPHUONG Date ABSTRACT The current empirical study is to examine the detenninants of household savings in Lam Dong province The methodology of the paper is the estimating the saving function of households in Lam Dong province by employing Integrated Model with special focus on the influence of financial development on household savings The econometric analysis in this empirical study is based on the data from household survey in Lam Dong province From the total sample size of 203 observations, the regression results show that among variables considered, financial development proxied by the distance to the nearest financial institution, has no significant effect on the volume of household savings However, six social economic variables, which are educational level, occupation, gender of household head, family size, land size, household income, are found to be strong detenninants of household savings in Lam Dong province 11 CONTENTS ACKNOWLEDGMENT ABSTRACT CONTENT LIST OF TABLES LIST OF FIGURES CHAPTER 1: INTRODUCTION 1.Problem State 2.Objectives of 3.Research Met 4.The Structure CHAPTER 2: THEORETICAL FRAMEWORK I IMPORTANT CONCEPTS II THEORETICAL REVIEW Household Financial Development and Household Savin III FINANCIAL DEVELOPMENT AND SAVINGS CHAPTER 3: FINANCIAL DEVELOPMENT AND HOUSEHOLD SAVINGS IN VIETNAM I FINANCIAL SYSTEM BEFORE FINANCIAL R Impact on the Incentive to Save 2.Impact on the II FINANCIAL SYSTEM AFTER REFORM 1.The First Rou 2.The Second R 2.1 Impact on iii CHAPTER 4: EMPIRICAL ANALYSIS I MODEL SPECIFICATION AND SAMPLING METH 1.5 Me II DATAANALYSIS 1.Findings fro 1.1 The 1.4 Th Househ Model 2.1 Re CHAPTER 5: EMPIRICAL FINDINGS AND POLICY RECOMMENDATIONS I SUMMARY OF MAIN EMPIRICAL FINDINGS II POLICY RECOMMENDATIONS Reduci Access Other P REFERENCE LIST APPENDIX IV LIST OF TABLES AND APPENDICES: Table 1: Financial Indicators and Domestic Saving in Vietnam before 1988 22 Table 2: Financial Development in Vietnam, 1988-1999 29 Table 3: Change in Composition of Household Savings, 1993-1998 30 Table 4: Saving ratios ofhouseholds in Vietnam, 1993-1998 33 Table 5: Distribution of Household Sample,(% households) 42 Table 6: Changes in the Use of Financial Institutions by households, 1993-2002 45 Table 7: The Use of Financial Institutions and Some Selected Indicators of Household Savings 46 Table 8: Distribution of the Most Preferred Savings Forms(% of survey Sample) 48 Table 9: Structure of Households' Financial Savings 50 Table 10: Results of Least Square Model 52 Table 11: Results after Dropping Insignificant Variables 52 Appendix 1: The Increase in Mechanization in Vietnam 64 Appendix 2: Diagnostic testing of the Models 65 v LIST OF FIGURES: Figure 1: Real Three-month Deposit annual Interest Rate, (1986-1999) 25 Figure 2: Interest Rate Spread, Credit to Private Sector and the Broad Money Ratio, 1993-1997.28 Figure 3: Poverty Profile in Lam Dong Province 41 Figure 4: Structure of Household Savings(% of the sample) .43 Figure 5: Using Financial Institutions(% ofhouseholds) 44 Figure 6: Savings and Loans in Lam Dong province .47 VI ACRONYMS GDP: Gross Domestic Products GSO: General Static Office OLS: Ordinary Least Square USD: United States Dollar VBARD: Vietnam Bank for Agriculture and Rural Development VBP: Vietnam Bank for the Poor VLSS: Vietnam Living Standard Survey VND: Vietnam Dong WB: World Bank IMF: International Monetary Fund vii ACKNOWLEDGEMENTS To complete this MDE program as well as this thesis I have been indebted to so many people that I could not mention them all here Hereinafter, I would like to express my thanks to those who have helped me in some important ways First of all, I would like to thank all the staff of Vietnamese-Dutch project for Master in Economic Development for their help during my study time and the Ho Chi Minh Political Academy, where I have worked, for its support and providing the opportunity for me to take this course I would like to express my gratitude to Pr Dr Karen Jansen who is the course leader of Banking and Finance During his course, not only I can achieve the knowledge about the Finance and banking but also I have the opportunity to discuss household saving behavior with him I would like to thank Dr Nguyen Trong Hoai, my supervisor, for his helpful comments Especially, during the time of supervising my thesis, he has also given me useful documents, which are hard to find in Vietnam Without these documents, the thesis would have taken a longer time to finish I am much in debt to Dr Gabrielle Berman and Dr Youdhi Schipper who corrected my thesis and guided me into the right way of doing the thesis The fulfillment of this thesis perhaps is an end of my study in this program, but the image of Dr Youdhi Schipper going with us into every single household in Hoi An to guide us on how to conduct a household survey as well as to show us how to analyze the collected data is definitely everlasting in my memory I am much in debt to Dr Haroon Akram Lodhi, the Project Leader During the M.A study course, he has taught me not only the methodology but also the honest intellectual ways of doing a thesis Without his contribution, the thesis could not have been successful Finally, I would like to thank to my mother, late father, sisters and brothers for their love, support and encouragement viii CHAPTER I INTRODUCTION Problem Statement Interest in the study of household savings is increasing, especially in developing countries where thousands of people live in poverty and the problem of capital shortage is severe According to Waheed (1996), a low level of household income reflecting low productivity caused by the lack of capital investment, will result in low saving rates Low saving rates, as a culprit of scarce investment capital, in turn will lead to a low level of income and therefore poverty and low savings again That is how the cycle of household poverty works For Vietnam, the study about determinants of household savings is important for following reasons: First, from the perspective of savings-investment gap, with the objective to tum the Vietnamese economy to industrialized and modernized country by the year 2020, Vietnam needs a huge amount of capital for investment However, most of the rural enterprises in Vietnam have long been facing a serious capital shortage: only 12-15 percent of rural enterprises can access capital from formal financial institutions Three quarters of enterprises claim that they desire to bonow capital to expand and maintain their business More than half of Vietnam's population has not been served by the financial system (World Bank, 1998) There are two ways that Vietnam can solve the problem of lack investment capital, either by increasing domestic savings or by increasing foreign savings However, there is general agreement thaTin the early stages of economic development, developing countries can rely on foreign savings to reduce their savings-investment gap in order to develop their economies The purpose of using foreign savings to increase domestic income (and therefore to increase domestic savings) after all is to achieve sustainable development and to reduce the dependence on foreign countries Therefore, to achieve sustainable development, domestic savings sources play a decisive role The important role of domestic savings in achieving stable economic growth is obvious for the case of Vietnam The practical experience from previous years showed that a sharp reduction of foreign direct investment as a consequence of the Asian crises caused the problem of capital shortage in Vietnam to be more severe, widened budget deficit and resulted in slowing the Vietnamese economic growth rate (World Bank, 1997; O'Connor, 2000; Akram-Lodhi and Sepehri, 2002) Financing investment by borrowing foreign capital is also not easy for Vietnam because Vietnam is considered as one of the severely indebted low-income countries with limited debt service capacity (World Bank, 1997) Accessing foreign aid is not easy too because in order to receive aid, Vietnam should meet many conditions set by its donors the high transaction cost prevents households from allocating their savings into the financial institutions because the high transaction cost also means the low return on household savings On the demand side, the high operating cost reduces the profit of financial institutions, which prevent the sustainable development of financial system Third, the insignificant relationship between the volume of household savings and the distance to the nearest financial institution indicates that financial products are badly designed to suit the characteristic of rural households That is due to agricultural characteristics, the excesses in rural household income are usually small and irregular However, according to McCarty (2001) rural financial institutions react to the high operating cost by unwilling to accept small volumes of household savings This prevents rural households, especially poor rural households from using financial services even in the case that financial institutions are very near their houses Turning to three possibilities posed in chapter that during the 1990s that an increase in the volume of household savings may come from an increase in household income, from financial development or from both The regression results from regression model confirm the frrst possibility that the increase in the volume of household savings comes mostly from increase in household income rather than from financial development The coefficient of family size variable is negative significant at one percent level in the saving model This means that the larger household is the less household saves This suggests interdependence of Asian traditional large family culture rather than the economies of scale in family consumption Specifically, family size has two opposite effects on household savings The positive effect on household savings is that the larger family is the lower in expenditure per capital family has For example, ten people living in the same house, they have to buy one freezer Only two people live in the same house they also have to buy one freezer Thus, the average expenditure of ten people living in the same house is smaller than that of two people living in the same house This is called the economies of scale of family consumption The negative effect of family size on household savings is that, each member in households can rely on other members in households in case his or her income is decreased and therefore, savings for precautionary motive will be reduced The negative sign of family size in the current empirical study indicates that the effect of reduction of savings for precautionary purpose is much greater than the effect of the economies of scale of family consumption The coefficient of occupation of household head, which has expected sign and significant at one percent level, indicates that income fluctuations force households to save more for precautionary 54 purpose Specifically, households engaging in farming activities, who suffer more from income fluctuations than households engaging in other sectors, save more than other households The coefficients of other variables such as the household income, educational level of household head and land size have expected signs and they are strong significant positive effect on the volume of household savings at one and five percent level respectively As regards to affect of the gender of household heads on the volume of household savings, the coefficient of gender variable is statistical significant at five percent level The negative sign of this variable in saving function suggests that male household heads are more wasteful than female household heads The intercept term is negative and significant at one-percent level The traditional explanation for the negative intercept term in saving model in any textbooks is that when the income of households is zero, households have to borrow to finance for their consumption Therefore, the saving function always has negative intercept term However, it is worth mentioning that the coefficient of the intercept term does not have much economic meaning, therefore it is usually ignored (Gujarati, 1995) The regression results of the Integrated model confirm the main hypothesis that "household savings is determined by not only one factor but by a set of socioeconomic factors" Particularly, a set of socioeconomic factors is occupation of household heads, family size, gender, household il1come, land size, educational level These six variables appear to be ilnportant determinants of household savings in Lam Dong province Conclusion In summary, by using prilnary data from household survey in Lam Dong province, the regression results from il1tegrated model reject the hypothesis that "there is a negative relationship between the volume of household savings and the distance from the household to the nearest financial institution" Six socioeconomic variables, which are occupation of household heads, family size, gender, household income, land size, educational level are found to be ilnportant detenninants of household savings in Lam Dong province Therefore, the main hypothesis that "household savings is determined not by only one factor but by a set of socioeconomic factors" is confirmed Given the results from the regression, the next chapter will present some policy recommendations 55 CHAPTERS EMPIRICAL FINDINGS AND POLICY RECOMMENDATIONS I SUMMARY OF MAIN EMPIRICAL FINDINGS The empirical study aims at figuring out determinants of household savings in Lam Dong province with the focus on financial development to see how financial development influences the saving behavior of households The study at descriptive statistics shows that during the process of financial development, the Vietnam's financial system has achieved successes in both providing saving incentive and t savings opportunities for households The changing from negative real interest rates to positive real interest rates and an increase in the number of financial institutions together with increasing diversification of saving products, have together influenced the savings behavior of households By employing data at the macro level and micro level from household surveys VLSS 1993, VLSS 1998, and household survey in 2002 in Lam Dong province, both the change in volume and the change in composition of household savings have been traced The examination of these figures shows that during process of financial development there was an increase in the proportion of financial savings However, the shift into financial savings happened slowly, especially in rural areas By analyzing the primary data from household surveys, the explanations for this slow shift into financial assets and the holding of physical assets among rural households are as follows: Firstly, by setting a minimum accepted amount of savings deposit, financial institutions have prevented poor rural households from using financial services This has contributed to the slow shift into holding financial savings of rural households Secondly, in comparison with households in urban areas, households in rural areas have more slowly shifted their savings into financial forms than in urban areas, because during the process of financial development there has also been a process of increasing mechanization in Vietnam The holding of modem agricultural machinery can help rural households increase their income Therefore, rural households shift their savings into financial form only when the marginal return on financial savings is at least equal or greater than the marginal return on holding modern agricultural machines By undertaking econometric analysis based on the primary data from the household survey in Lam Dong province, the regression results reject the second hypothesis "there is a negative 56 relationship between the volume of household savings and the distance from the household to the nearest financial institution" Six socioeconomic variables, which are occupation of household heads, family size, gender, household income, land size, educational level appear to be important determinants of household savings in Lam Dong province Therefore, the hypothesis that "household savings is determined by not one factor but by a set of socioeconomic factors" is confirmed by the regression results of Integrated model Given what have been found in empirical study, the policy recommendations will be presented in the next section II POLICY RECOMMENDATIONS As noted earlier, the necessary and sufficient condition for Vietnam to achieve sustainable economic growth is to increase not only the volume of savings but also to channel savings into investment Therefore, the policies aiming at increasing the volume of household saving, reducing the volume of holding unproductive assets and channeling savings into investment is important not only for households themselves but also important for the country as a whole Reducing Transaction Cost and Creating More Chance for Households to Access to Financial Services The insignificant relationship between the distance to the nearest financial institution and the volume of household savings indicates the high operating cost of Vietnam's financial system The high operating cost makes the return on household savings to be less attractive to rural ~ ···· ·~ -· -·········-····· ··- -~ -· -······ · -··· · households to save in financial 'hi~titutions In addition, the Vietnam's financial institutions react to high operating cost by unwilling to accept the small volume of household savings, which make impossible for poor rural households to allocates their small excess in income into fmancial institutions As a result, widespread of financial network in condition of high operating cost does not yield good impact on the volume of household savings as expected Therefore, in order the financial system to be an engine of economic growth by intermediating savings resources from the savers to investors, policies aiming at increasing density of financial network should go hand in hand with reducing transaction cost, increasing public confidence in financial system and providing appropriate financial products Policies, which aim at reducing transaction cost are extremely important for Vietnam's financial system This is because not only can the reduction of transaction cost allow households to access 57 financial services but it is also a necessary and sufficient condition for Vietnam's financial system to earn profit therefore to achieve sustainable financial development From the perspective of savings-investment gap, providing appropriate saving products to collect small savings of the large population of Vietnam can result in a large fund that could supply a considerable investment resource for the country This is because nearly eighty percent of Vietnamese population lives in rural areas and almost 70 percent of labor force engages in agricultural sector (Hung, 1999) Therefore, the collection of many small savings from this large population can result in lump sum large enough for Vietnam to reduce the investment-saving gap Furthermore, the collection of small savings can help rural households turn small saving amounts into large lump sums that can be useful for them to engage in income generating activities Therefore, policies to mobilize household savings should aim at not only big savers but also aim at small savers To design good saving products, financial institutions should understand the nature of rural household savings Due to the agricultural cycle, the saving of rural households is small, temporary and seasonal Therefore, saving products suited to the rural households' capacity to save should accept any volume of saving that is available In addition, there is general agreement that a well designed saving products should be secure, convenient, confidential, and varied with regard to the rate of returns on savings and the ratio of liquidity From the perspectives of poverty alleviation and the savings-investment gap, fmancial institutions should aim at increasingly providing financial services for rural households to help households reduce the savings in unproductive physical assets Other Policies Aim at Increasing Savings The regression results show that there is significant positive relationship between household income and the volume of household savings Policies, which aim at increase household income, have long been central concerns of all countries all over the world For an agricultural province like Lam Dong, where the agricultural conditions are not favorable and where most households live on growing coffee, tea and rice, the falling prices of coffee and rice in the world market have had inverse impact on the volume of household income and savings in recent years Therefore, policies to increase household income should aim at diversifying agricultural products to reduce risk for farmers, increasing investment in agriculture to increase farm productivity Besides, government policies should aim at creating more opportunities for households to engage in income generating activities As the relationship between the educational level and the volume of household savings is positive, 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THE INCREASE IN MECHANIZATION IN RURAL VIETNAM Sorn e indices of machine energy for agri production 300000 250000 200000 I.'iOOOO 100000 50000 1980 1981 I 1982 Source: Statistical data of Vietnam Agriculture, Forestry and Fishery 1975-2000, Hanoi: Statistical Publishing House, 2000 N u m ber of pum p for agri p rod u c ti on I00000 4000 0 1980 ll !911 19SS 1917 1990 1991 1992 199J 1994 t99S 1996 1997 BIBpum p Source: Statistical data of Vietnam Agriculture, Forestry and Fishery 1975-2000, Hanoi: Statistical Publishing House, 2000 64 t99S 1999 APPENDIX 2: DIAGNOSTIC TESTING OF THE MODEL Test for Functional Form, Heteroscedasticity and Autocorrelation: Dependent variable is SAVING, 203 observations used for estimation from to 203 Regressor Intercept DIS (in natural logarithm) GEN EDU ace F SIZE Y(in square root) DEP AGE1(age