Savings have been recognized as crucial determinant of economic growth because it finances investment – higher investment is associated with higher growth. Given the fact that economic growth plays a pivotal role in improving well-being of people and reducing poverty, the analysis of saving behavior becomes a very crucial policy issue for developing countries.
Two main theories in explaining saving behaviour are: “Permanent income hypothesis” [Friedman (1957)], and “life-cycle hypothesis” [Ando and Modigliani (1963)]. In permanent income hypothesis, transitory and permanent components of income are differently analyzed in determining savings.
Permanent income is defined as long-time income expectation over a period, while transitory income is the difference between permanent and actual income. The hypothesis suggests that transitory changes in income do not have any significant impact on savings and savings are determined only by permanent income. According to the life-cycle hypothesis, lifetime consumption of an individual is spread over his lifetime. Saving is accumulated in working years and is used to maintain consumption level after the retirement period. It suggests the importance of demographic factors in determining savings. Despite the large existing empirical work, there exist mixed results regarding effects of interest rate on savings. Mikesell and Zinser (1973), McKinnon (1973), Fry [(1988), (1995)], Gylfason (1993) and Munir, et al. (2010) found that interest rate has a positive impact on savings, while Giovaninni (1985), Gupta (1987), Jongwanich (2010) and many others found it as insignificant. The role of interest rate in Muslim countries is rather a complex issue. Assuming that majority of Muslims follows Islam in its true spirit, interest rate (Riba) has a very limited role in attracting savings of Muslims because interest is forbidden in Islam. The first explicit prohibition of interest came in 2 AH. The directive is found in Surah Al-Imran, verse 130 where Allah says; “O those who believe do not consume up Riba, doubled and redoubled”. Latter, after the conquest of Makkah in 8 AH, the most comprehensive condemnation of Riba was in Surah Baqarah verse 275-280, where Allah says;”Those who take usury will not stand on the day of Judgment except as he who has been driven mad by the touch of the Demon. . . . . . . . .Oh you who believe give up what remains of Riba if you are believers. But if you do not then listen to the declaration of War from Allah and his messenger (SAW). If you repent, yours’ is your principal and nothing more’
In 10 AH, the Prophet (P.B.U.H.), in his famous last sermon at Mount Arafat said; “All interest obligation shall henceforth be waived. Your capital however is yours to keep. You neither wrong nor be wronged. Allah has judged that there be no Riba and that all interest due to Abbas ibn Abd Al-Muttalib shall henceforth be waived”.
It is to be noted that during the period 1980 to 2013, saving rates varied considerably all over the world. Latin America and the Caribbean countries save around 20 per cent of their GDP and the East Asian countries save more than 30 per cent. Similarly, Arab countries (limited data is available) save approximately 30 per cent per cent, South Asian countries around 25 per cent; and in complete contrast the Sub-Saharan African countries save only 15 per cent of the GDP [WDI (2014)]. The situation raises an important research question, as to: why do the savings rates fluctuate between various regions. It also leads toward another related question, about the forbidden status of interest rate affects savings behaviour of Muslim countries?
The layout of the paper is as follows: the review of relevant literature is presented in Section II. Section III discusses the data sources and methodology. Empirical analysis and estimation of results, based on the data are summarised in Section IV. Finally, conclusions and policy implications are given in Section V.