April 7, 2003	Monday	Safar 4, 1424

For a long time, the rationale given by commercial banks in defence of their failure to lower lending rates was the high tax-free returns available on deposits in government National Savings Schemes (NSS).

In order to attract funds from the public under these conditions of unfair competition, argued commercial bankers, they were forced to offer depositors high rates of return - though not as high as those of the NSS - thus driving up their cost of funds. In order to meet this higher cost, they pleaded, there was no alternative other than to charge high rates from borrowers.

Since the induction in late 1999 of a banker as a finance minister who was more amenable to prodding by the IMF than his predecessors, the country has witnessed a sharp and regular decline in the rates of return on NSS, a trend that is expected to continue. A 10 per cent withholding tax has also been imposed on returns accruing on NSS deposits maintained above a certain limit: one more step in removing incentives from NSS deposits to bring them further into line with commercial bank deposits. The threshold for such tax exemption is also lowered periodically.

Justifying its policy of a planned and consistent reduction in NSS rates of return, the government points to the falling rate of inflation. Official sources insist that despite the reductions in rates of return on NSS, there has in effect been an increase in real rates of return i.e. the nominal rates payable on NSS deposits less the rate of inflation. This is debatable.

While official figures do in fact point to a lowering of inflation the reality on the ground is quite different, as witness for example the prices of petroleum products. These are revised every 15 days, mostly upwards. Since December 1, 2002, the prices of petroleum products have risen by 30 per cent. This has a ripple effect since it results in an increase in the prices of all goods and services including gas and electricity. Paradoxically, prices of imported goods such as cars have continued to rise despite the almost 15 per cent appreciation of the rupee against the US dollar since late 2001, and a consistent lowering in the rates of import duties. Someone is obviously profiteering at the expense of hapless consumers.

In response to nation-wide protests the government did offer a sop in the form of higher returns on a specified deposit limit, but only to government/armed forces pensioners. Why discriminate against so many others who also depend on the income from their NSS deposits for meeting their living expenses? Is this still a government of, by and for the babus and faujis?

It is interesting to note that the biggest beneficiary of the lower rates is the government itself since it is the largest borrower. By one stroke of its pen every six months the government reduces dramatically its debt servicing liability. The government’s gain has to be someone else’s loss. Who are these losers? One group as mentioned above is that of those NSS depositors who are not government/armed forces pensioners. The other group is surprisingly that of the bankers.

In the days of high interest rates the banks would invest predominantly in government securities. The periodic auctions of public debt by the State Bank of Pakistan (SBP) were heavily oversubscribed. Banks would invest far greater sums than required under their statutory liquidity requirement (SLR). The reason was obvious: government debt offered fairly high return and more importantly was risk-free.

Banks started bringing in foreign currency deposits, surrendering them to the SBP and buying government debt with the rupee proceeds. After paying the return on the foreign currency deposits and the associated exchange risk premium, the banks were still netting about 6 per cent on such transactions. The government with its voracious appetite not only crowded out the genuine demands of private borrowers but also contributed directly to the improved profitability of banks.

The SBP has over the last year drastically reduced its discount rate i.e. the rate at which it lends funds overnight to banks. Consequently the return available on government debt is now a fraction of its pre-2001 levels. Demand for credit from business and industry is stagnant. Thus banks are discouraging depositors by offering very low rates of return. Many of the foreign banks are paying zero returns on deposits below a certain limit. They are also desperately seeking viable lending opportunities.

With industrial credit requirements continuing to remain moribund, consumer financing has moved to occupy the top position on the agenda of all banks. Lease financing for motor cars that was offered not so long ago at annual rates of 22 per cent and above is now available at less than half that, with additional incentives such as free insurance and registration thrown in. Conspicuous consumption can also now be financed by mortgaging your future income. Finance is available for the cost of performing Umra and going abroad on vacation.

Clearly this is the American model, spending your way out of a recession. But by encouraging consumption we are only sucking in imports. Local industry does not benefit. Do we really want to squander our much-trumpeted foreign exchange reserves in this irresponsible manner? A low interest rate is a truly laudable objective of any sound economic policy if, as a consequence there is a spurt in investment in industrial assets leading to a higher GDP and a reduction in unemployment.

But is it all that desirable when it results instead in an increase in consumer spending on imported goods and foreign tourism? Especially when the reduction in interest rates is achieved at the cost of retired persons and their dependents, whose sole or major source of income is their NSS investment. A spendthrift government has now been joined by a sizable number of equally spendthrift citizens to indulge in their favourite pastime of spending as if there is no tomorrow, and in the process impoverishing pensioners, widows, orphans and other underprivileged members of society.

These unfortunate people will again become prey to scheming finance companies that promise impossibly high returns (but nevertheless in line with inflation), and then decamp with their hard-earned savings. Are we engineering a repeat of this? Why are we promoting a policy that encourages consumption when we have one of the lowest savings rates in the world?