In this article we will discuss about the sources of foreign savings.
Since most LDCs have low per capita incomes, they are unable to save enough to be able to investment in capital stock such as plant, equipment, machines, structures, etc. So, they are constrained to rely on the savings of other countries to bridge the domestic saving-investment gap and thus achieve faster growth (and rapid development) of their economies. Foreign savings may come from both private and official sources.
Private foreign saving (capital) may take four different forms: direct investment, portfolio investment, commercial bank loans and trade credit. Many LDCs are aided by direct foreign investment, which supplies scarce capital.
Both private land and multinational corporations transfer capital to these countries. Foreign direct investment is made by multinational corporations that purchase of long-term financial assets like stocks and bonds.
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Thus, while foreign direct investment takes the form of ‘real’ capital formation, ‘portfolio’ investment is just the purchase of securities or acquisition of financial assets. In case of direct investment, the supplier of foreign capital such as a multinational corporation actually operates the business.
But, portfolio investment just helps finance a business, and host-country (i.e., the capital-receiving country) managers run the enterprise. Foreign investors act as sleeping partners. They simply hold pieces of paper (i.e., ownership certificates) that represent a share of the ownership or the debt of the firms or governments of foreign countries. These loans are usually made by a bank syndicate, a group of several banks, for risk-sharing, i.e., to share the risk associated with lending to a single country.
Finally, trade credit is offered by exporting firms and commercial banks. Such credit allows importers a period of time before payment is due on the goods and services purchased. Usually, such credit involves payment in 30 days (or some other term) after the goods are received.
In the last two decades there has occurred a considerable change in the pattern (composition) of foreign capital in LDCs. While in the 1970s direct investment in LDCs far exceeded bank loans, in the 1980s bank loans were much greater than direct investment.
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While bank lending gives the borrowing nation greater flexibility in deciding how to use funds, direct investment carries with it an element of foreign control over domestic resources. Nationalist sentiments as also the fear of exploitation by foreign investment. (In India the Foreign Exchange Regulation Act has been passed in 1974 for the same purpose).
Official foreign savings are usually made available to LDCs in the form of foreign aid which may be either outright gift or low-interest loan. When an aid is given to an LDC, some concessional element is involved (such as low-interest and/or long repayment period).
Some aid need not be repaid. Such aid is known as outright grant. Foreign aid may take various forms such as commodities like food, technical assistance or even military equipment (as in the case of Pakistan).