If that is not the case, the desired savings and investment trends will translate into higher world interest rates rather than large external imbalances.

Although a neoclassical approach predicts that these countries could run much larger current account deficits, there is substantial disagreement about these predictions. Critics would argue that the neoclassical predictions do not take into account several factors unique to China and India and do not explain the recent past and distinctive nature. More specifically, several studies have suggested that savings rates are likely to remain high in China and India. For instance, Fehr, Jokish, and Kotlikoff (2005) interpret China’s recent savings behavior as indicative of a low rate of time preference, they and suggest that China will remain a large net saver. Based on household survey data, Chamon and Prasad (2005) make demographic projections and predict higher household saving rates over the next couple of decades. Finally, Kuijs (2006) argues that structural factors mean that savings and investment rates in China will decline only mildly in the decades ahead. With respect to India, Mishra (2006) argues that the upward trend of Indian saving rates will continue. For instance, India’s working-age population as a percentage of total population is expected to peak in 2035, much later than in other Asian economies.

Although demographic considerations may mean that savings rates are unlikely to plummet, it is plausible that further domestic financial development and capital account liberalization will induce a downward adjustment in the savings rate. For instance, Chamon and Prasad (2005) point out that the savings rate (especially for younger households) could decline if the growing demand for consumer durables were to be financed through the development of consumer credit. This would be reinforced by the liberalization of controls on capital flows that would provide greater competition in the domestic financial sector and improved opportunities for risk diversification, leading to more lending and less savings. In addition, there are recent indications that China plans a range of policy initiatives to raise the domestic level of consumption.<sup>33</sup> Furthermore, over time, improvements in social insurance systems and provision of public services in both countries would reduce over time the self-insurance motivation of high savings rates.

To project the net position, it is important also to consider the prospects for the level of investment. In China and India, a combination of an improvement in domestic financial intermediation and capital account liberalization would raise the attractiveness of these countries as a destination for external capital and would enhance the ability of domestic private firms to pursue expansion plans.<sup>34</sup> In the Indian case, a primary driver of larger current account deficits could be a higher rate of public investment, in view of the deficiencies in the current state of its public infrastructure.

> 33 See the media coverage of the March 2006 Party Congress.

> 34 In view of the high level of inefficient investment in China, it is plausible that corporate governance reforms and higher dividend payouts (together with domestic financial deepening and external liberalization) could lead to a reduction in the absolute level of investment in tandem with a decline in the level of enterprise savings. With an increase in market-driven investment and a decline in savings, the prediction of an increased current account deficit still would hold.

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