An Empirical Analysis of Savings and Investment Determinants in Pakistan: A Simultaneous Equation Modeling Approach

Abstract

This study investigates the determinants of savings and investment in Pakistan from 1999 to 2023 using a simultaneous equation modeling approach. Using Two-Stage Least Squares (2SLS), the analysis identifies significant factors influencing both savings and investment. For investment, foreign direct investment (FDI) emerges as the most significant determinant, exhibiting a strong positive effect, followed by GDP growth, which fosters a conducive environment for capital formation. In contrast, interest costs of borrowing are a negative driver for investment; hence borrowing cost needs to be regulated. Public debt has an almost insignificant positive effect and savings have a nil direct impact on investment. Remittances have a strong influence on the saving level as savings have a strongly positive impact; however investment and inflation negatively impact GDP growth has an insignificant relationship with savings. The models achieve quite strong explanatory power, with the R-squared values obtained for investment being 58.8% and 75.97% for savings, and pass key diagnostic tests for homoscedasticity and absence of serial correlation. Findings underscore the critical role of FDI in inducing investment and remittances in saving. Policymakers are advised to focus more on attracting FDI; maintaining economic growth; and mitigating the inflationary pressures to bolster Pakistan's savings and investment landscape.