May 12, 2003	Monday	Rabi-ul-Awwal 9, 1424

From a lay man’s point of view, savings by individuals represent the difference between income and expenditure. In the corporate sector, the difference between the post-tax earnings less the dividends distributed to shareholders i.e. the retained earnings transferred to the “reserves” are the savings. Individuals’ (household) and corporate savings taken together are the private sector savings.

When public sector corporations’ savings are added to the private savings, the aggregate is “domestic savings”. Pakistanis working abroad remit a part of their earnings to their relatives in the country. There are other inflows from abroad also. These inflows are taken as ‘foreign savings”. The domestic and foreign savings taken together constitute “ national savings”.

As it is almost impossible to gather data about the savings from individuals and corporate sector entity, government has devised a mechanism for estimating the data about the savings mostly based on the budgetary data under which :national savings are the sum total of foreign savings and domestic savings are computed on ‘residual” basis as under:

(a) total investment: foreign savings equals to national savings;

(b) national savings: public savings (taken from budgetary accounts) equals to private savings;

(c) private savings: corporate savings (estimated independently) equals to household savings;

In estimating foreign savings, capital inflows are taken into account which include the amounts of disbursements under foreign loans/credits made either for payments for purchase of goods and services for the projects direct cash receipts for balance of payments support. In either case, these inflows constitute liabilities of the federal government and in no case the foreign savings. This is the distortion of the highest order crept in the government calculations since many decades in the past and needs be removed.

At individual level, savings are essential to ensure on the one hand that these generate adequate income during the post-retirement life when regular earnings are non-existent while on the other hand these savings are channelised by the financial sector and the government on the “investment” activities.

It is generally said that to generate 6 per cent growth in the gross domestic product (GDP), it is necessary to make investment of the order of 20 per cent of the GDP. (Therefore, the ideal situation would be that the quantum of savings equals to or exceeds the funds required for investment). However, a paradoxical situation may arise where,say, domestic savings alone are sufficient to cover the full investment requirements but foreign exchange accruals, including foreign exchange savings, are not adequate to permit the purchase of the required amount of foreign exchange for the purchase of machinery, technical know-how and payment of royalties etc.

In such an event, borrowings in foreign exchange or inviting foreign direct investment (FDI) becomes essential as has been in our case. The savings rate in Pakistan is the lowest in the region and also depicts the declining trend. The figures of savings since the fiscal year 1998-99 (FY-99) to the fiscal year 2001-02 (FY-02) as a percentage of GNP (gross national product) are given in Table A.

The reasons for substantial difference between the savings: GNP ratio for FY01 in the SBP’s two annual reports remain unexplained. It is said that to sustain the poverty level at a given level and to bring reduction in it, the annual investment should be at least to the level of 20 per cent of the GDP so as to achieve the growth target of 6 per cent or should exceed that.

China has achieved the annual growth level of over 8 per cent. In Pakistan the details of the GDP growth during the last 3 fiscal years is: 3.9 per cent (FY-OO), 2.6 per cent (FY-OI) and 3.6 per cent (FY-02). The low growth rates seem to be on account of low investments. The investment: GNP ratio for the last few years is: FY-99 15.7 per cent, FY-OO 16.25 per cent, FY-O1 16.8 per cent and FY-02 13.79 per cent It is also depicting the declining trend.

The GDP growth during the current fiscal 2002-03 (FY-03) is expected to touch 4.5 per cent and may exceed 6 per cent during the next fiscal FY-04. Given the current declining investment scenario, expectation of the GDP growth reaching (or exceeding) 6 per cent during the fiscal FY-04 do not seem to be very bright.

Consequently, the chances of poverty reduction also seem far-fetched. It will be a great success if the economic managers are successful in containing the poverty at the current level (35-40 per cent of the population), rhetorics notwithstanding. lt would not be out of place to mention here that the government has withheld the post-l999 data about the poverty level- obviously because the situation has turned worse.

The unemployment level shall also rise further because of the exodus of the staff from the public sector including banking institutions and non-availability of the jobs in the private sector due to stagnancy in the economy as would be evident from the failure of the government in salvaging the sick units which are believed to number over 4000 ( and continue to increase) while no new industrial undertaking has been established during over three years of the governance of the present economic managers. The probable return of expatriate Pakistanis working in the Middle East, the USA and other foreign countries is likely to further worsen the conditions.

The only correlation between the budget and the savings seems to be that whenever government needs to borrow for meeting the fiscal deficit which arises on many accounts including the public sector development programme expenditure, sufficient savings be available for the purpose failing which the government will be left with no option except to resort to the deficit financing in the shape of printing of new currency notes.

Interest rate policies: The incentive for savings demand (i) adequate return to the savers, (ii) investment opportunities and (iii) appetite of the government in absorbing the savings made. Until early 1997, “demand management policies” were followed which envisaged tight monetary policy under which interest rates continued to be raised so much so that the maximum lending rates of the banks shot up to 20-22 per cent p.a.This provided large margins to the banks which permitted them to pay higher rates on deposits.

One of the reasons for increasing the interest rates was that demand side economists believed that high interest rates were necessary to contain (or reduce) inflation.

The other reason for keeping the interest rates high was unquenching thirst of the Government for the borrowing to cover the dual deficits i.e. fiscal deficit(domestic) and the current account deficit ( external sector). During 1990s government’s borrowing appetite was so great that the financial institutions were left with very inadequate resources to meet the private sector demands.

The government’s compulsion for borrowing in the external sector grew from bad to worse and the then SBP Governor raised the interest rates on bank deposits with it/ Treasury Bills to 17 per cent p.a. in 1996-98. The foreign banks were asked to bring foreign currencies and place the rupee counterparts in SOP or in the Treasury Bills at the said rate. Under the foreign banks’ pressure, they were also exempted from capital adequacy requirement (CAR) “hereunder these banks were required to place with SBP,interest-free, 7.5 per cent of the amounts of their total deposits.

The high interest rates policy enabled the banks to invest in government papers upto 40-45 per cent of their deposits as against the statutory liquidity requirement (SLR) of 25 per cent. This further squeezed the banking sector’s capacity to extend funding to the private sector.

Shift: After Nawaz Sharif took over as Prime Minister in February,1997, emphasis shifted from “demand management” to “supply side” policies and as a consequence thinking for reduction in the interest rates commenced. The then SBP governor held the view that banks should lend at 11 per cent p.a. and pay interest to the depositors at 9 per cent p.a. ( on one year fixed deposits). This required the banks to manage to work at 2 per cent intermediation cost. The SBP did not succeed in it.

Although there has been a slight reduction in the intermediation cost but it is much below the desired level. The position as of February,2003 is that the weighted average lending/ deposit rates of the banks are 9.36 per cent and 3.04 per cent which puts the intermediation cost at 6.32 per cent. Thus banks are retaining for themselves more than double of what they are paying to the depositors.

Economists believe that the deposit rates should be linked to the prevailing inflation rate and depositors should get 2-3 per cent above the inflation rate. As per government’s own calculations, the current inflation rate is slightly over 3 per cent. Thus depositors should get a return of at least 6-6.5 per cent p.a. The current weighted average deposit rate of the banks, after deduction of 10 per cent withholding tax-comes further down to 2.74 per cent p.a.

In other words, depositors are now getting a negative return. Payment of zakat is a religious obligation and after payment of zakat, the depositor is left with a return of quarter per cent p.a. Is it a reasonable return? The above analysis is based on the weighted average interest rate of the banks. On savings accounts, the banks are paying 2.5 per cent p.a. which after adjustment of withholding tax,stands reduced to 2.25 per cent p.a. which means that for payment of zakat, the depositors will be required to deplete their savings.

Rationale: The rationale behind the current interest policy seems to be to (i) provide cheap credit to the entrepreneurs to enable them to establish new industrial undertakings with a view to increasing the GDP and providing fresh employment opportunities and (b) to reduce debt-servicing cost for the government. Despite substantial reduction in the interest rate, no new investment is forthcoming. Only the second objective appears to have been successfully achieved.

Allied policies: Banks are awash with liquidity and are not finding borrowers and the government’s appetite for borrowing has also reduced to a certain extent. The influx in the deposits seems to be on account of heavy foreign currency inflows in the post 9/11 scenario. The SBP has, therefore, allowed lending for consumer durables like cars, fridges, electronic items, etc. Banks have also been allowed to lend for purchase/building of the housing units.

The reports indicate that lending for consumer durables is picking up but the lending for housing units remains stagnant. Who is benefiting from this policy? The foreign suppliers and the smugglers as the loans are mainly being used for purchase of foreign goods. Have we framed the policies for generating employment in foreign countries? The immediate need, therefore, is to restrict such loans to the domestically manufactured goods which will help increasing our GDP and will create new employment opportunities in the country.

The only sector which qualifies for low-priced loans is the housing sector because the houses/flats etc. do not lose their value with the passage of time but their value appreciates which benefits the borrowers in the medium/long term. Apart from that, picking up of housing loans will immediately result in increasing employment opportunities, utilization of the idle capacities of the industries more particularly the cement industry and conserving the savings of the borrowers in the shape of tangible assets.

The another aspect of the policy will be felt in the medium/long term. The savings rate in Pakistan is already too low. If the individual Pakistanis use up their future savings in buying consumer goods which will be turned into trash in the medium term, the saving rate will further plunge in future and we shall be left with no money for industrial sector investment if the investment picks up later.

Causes of lack of investment: A question is generally asked why industrial sector investment is not picking up. A few reasons are enumerated below:

(i) Since the creation of Pakistan, private sector investment in industrial sector was shy. The government had, therefore, established the Pakistan Industrial Development Corporation (PIDC) which set up industrial units and sold them to the private sector after the same came into operation. During General Ayub Khan’s regime, some industrial development took place but it was in small industries and the emphasis was on import substitution. After that in Zulfikar Ali Bhutto’s regime, the industries were taken over in government’s control. In that era, capital intensive industries like steel mills, Heavy Mechanical Complex, Heavy Electrical Complex, etc, were set up in the public sector but the bureaucracy’s / politicians’ loot and plunder ruined them. Z.A.Bhutto’s take-over of private industries and banks made the already shy private capital more shy and moved into trade.

The result is that the trade sector has since turned into powerful mafia of the tax evaders. The Central Board of Revenue’s efforts two years back to get the trade sector documented with a view to bringing additional revenues to the extent of Rs 100 billion utterly failed. There has been some industrial development in 1980s/ 1990s but without entrepreneurs’ own resources as the facility of debt: equity ratio of 80:20 was permitted by the government. Under the scheme a major part of equity brought by the entrepreneurs was recovered by them instantly through overinvoicing of the imported capital goods and consultancy while bank loans were taken at the highest interest rates as the intention largely was not to repay these loans. The textile sector was the largest beneficiary of the scheme. (ii) The law and order situation seems to be the top reason for the current situation. About a dozen vehicles including cars/motor cycles are snatched daily in Karachi. The situation in other cities may also be similar. It is believed that influential personalities are involved in this business.(iii) There is rampant extortion drive in Karachi and other cities.(iv) Rampant smuggling continues. The law enforcing agencies have utterly failed to check the same. The Afghan Transit Trade (ATT) is one mode of smuggling. Afghanistan makes import of such items like tyres, electronic items etc. for which there is no demand in that country. These goods are meant for smuggling into Pakistan.(v)Smuggling has resulted in the closure of electronic industry in Pakistan as the smuggled goods are cheaper than the locally manufactured ones.

(vi) One of the inputs in the industrial sector is electricity the cost of which goes on inflating. Entrepreneurs are crying for reduction in the price but the utilities, Wapda and the KESC, are always for the increase. The high electricity cost makes the domestically manufactured goods uncompetitive, both in the domestic as well as export markets.

Will the authorities make serious efforts to address the above and other relevent issues before expecting large scale investment?