**Policy Research**

## **Debt and International Finance**

# WPS 861

TI'his paper - a joint product of the Debt **an(i** Intemational Finanice<sup>Division, International Economics</sup> Department, and Country Operations Division,<sup>Country Deparlmenit 1, Latin America and the Caribbean</sup> -- i:. part of a largcr effort in **thc** Bank to identify<sup>extenial and</sup><sup>**internal**factors that affect savings and</sup> investmt;nt in developing countries. Copies of'the<sup>paper are available free from the World Bank, 1818 H</sup> Stretc NW, Washington, DC 20433. Please<sup>conltact Sheilah King- Watson, room S8-040, extension 31047.</sup> (February 1992, 47 pages).

Between 1987 and 1990, Mexico's current account and Lrade balance deteriorated by more than US$10 billion. Higher investment accounts only partly for this deterioration, nor can it be attributed to the public sector. By conventional (unadjusted) measures of private saving -- the total investment not financed by public or - fo`-cig-n savings private saving did decline sharply betweeni 1987 and 1990.

cause for concern than if it stems from noninterest income.

The followinig are among the conclusions of Arrau and Oks:

* Whcni conventional mcasures of private saving **ailC** cot-rected, the recent declinc in private saving appears less importanit tllhzn it did before.

But that diagnosis does not hold true when **Dnivate,** public, and foreign savings are corrected (as they are here) to account for shifts in portfolio composition from loreign to domestic assets, for the effects of inflation on foreign and domestic interest income (the inflation tax), for fluctuations in the real exchange rate, and for other faciors.

Arrau and Oks providc morc informaztion about thc components of private saving than most sludies do, addrcssing such questions<sup>as thc</sup> tollowing: Is consumplion1 more important than disposable income in explaining changes in private saving? What components of consumplion and disposable income matter the most?<sup>If,</sup> for example, the bulk of consumption growth is accounted for by durable consumption in the wake of trade liberalization, the mcasured decline in private saving need not be cause foi concern as it would be for a once-and-for-all stock adjustment in durable goods. On thlc other hand, if the main factor behind **thc** recent declinc in private saving is disposable incomc (rather than conIsumption), it is useIul to identify whlichI component of'disposable income accounits for the dcclinc. If', for example, the declinc in disposable income stcms from a rcduction in **the** domestic public debt service, there may he Icss

* Most variations in private saving between 1980 and 1990 arc ascribable to fluctuations in disposable income. Disposable income fluctu- **aed** consi(dcratblv morc than did private consurn,l-on.

* The sharp drop in private saving in 1990 was prompted primarily by a decline in disposable income and, less so, by f'ast-growing consumptionl.

* Only a quarter of the increase in consumplion in 1988-90 was attributable to increased - consumption of durables which grew almost thrce times faster than consumption of other items but represents only a small share (about<sup>11</sup> percent) of' total consumption.

* Fluctuations in the real exchange rate played an important role in the evolution of public savinig because that exchange ratc influences the real intercst scrvice on foreign debt. Real peso devaluations in 1982 and 1985-86 hurt public finiances anld rcal peso app)reciation later<sup>helped</sup> thcm. StronIg rCial PCSo appreciation in 1988<sup>and,</sup> to a lesser cxtent, in 199(0 reduced real income f'rom private foreign assets, reducing private saving in those years.

Thc Pticy R~ccrch WorTking P;per Ser ies<sup>di~s</sup> nats the' I indinigs ofsx o k uiidV. rva! in ittic Bank. An ohjcetix'c of the scries is to get th 'se findings **0UI** quickh, even if<sup>presentationsireless</sup> **Ihaii** fUlly **1f** polishid Thie linditip, interpretations, and conclusion:. in these papers (lo not necescaril\ repreM.nt<sup>oicsiC Bankpolic\.</sup> Produced by the Policy R.scaTch Diseniination Center