05 January 2004	Monday	12 Ziqa'ad 1424

The condition of the small man is the center of attention these days through the rubric of poverty alleviation. International financial institutions are lending their support.

Pakistan, being a beneficiary of the programmes, particularly of the currently operative PRGF of the IMF, is bound to take measures towards that end and thus improve the lot of the small man.

According to the Economic Survey, 2002-03, "Key reasons for poverty identified were lack of education and skills, high incidence of health problems, rise in population, lack of access to justice and empowerment, inaccessibility of capital, increase in unemployment, and weak service delivery." The Government of Pakistan adopted a comprehensive strategy in November 2001 to reduce poverty, articulated in the Interim Poverty Reduction Strategy Paper (IPRSP). The final version of PRSP is still awaited.

The basic strategy to address the problem consists of targeted policy interventions to provide quick relief through short-term employment opportunities, social safety net and financial assistance.

The specific measures taken to augment targeted interventions include small & medium enterprises, micro finance, Public Works Programme (Tameer-e-Pakistan Program, Khushal Pakistan, Drought Emergency Relief Fund, and Rural Development). Social safety nets have been expanded to embrace Zakat Program, Food Support Program, Employees Old Age Benefit Institution, Private Sector Pension Fund, indigenous philanthropy and the State land distribution.

The Prime Minister has recently set up a Task Force on Poverty Alleviation and Employment Generation, which would review the current poverty and employment status, public sector contribution, government policies, suggest improvements and submit its report within a month.

According to the Pakistan Human Condition Report, 2003, the official measure of poverty line of Rs748.56 per capita per month based upon the minimum calorie requirement of 2,350 calories per day at the 2002-01 prices, reveals that the ratio in 2001 was 32 percent rising from 30 percent in 1997, and 31 percent in 1998. The Report, using the Human Poverty Index (HPI), puts the ratio at 39 percent in 2001. In any case, poverty in Pakistan is increasing at a rapid pace and this is an alarming situation, to say the least.

The State Bank Annual Report for 2002-03 observes: "Given the carry over of the past legacy, current geopolitical and security situation, non-supportive external economic environment, and weak institutional capacity, it will be a pipe dream to expect an accelerated fall in the incidence of poverty in Pakistan in the short-run." (p.5)

For an effective approach, the problem must be seen in two dimensions, namely, (a) deeply entrenched long term factors governing distribution of income and wealth in the country and (b) the short-term forces which exacerbate that pattern. The last may be taken up for its immediate importance. There is a strong inherent bias against the small man in both fiscal and monetary policies that can be corrected in the short-term, given the will.

In the realm of fiscal policy, the villains are indirect taxes and the withholding tax (WHT). It is well known that the incidence of indirect taxes is ultimately on the consumer, which in Pakistan is the small man. There is increasing reliance on this tax with the result that it has become the main source of tax revenue.

Total tax revenue of federal and provincial governments has risen from Rs391 billion in FY 99 to Rs442 billion in FY 03. The federal tax revenue has improved from Rs347 billion to Rs460 billion. Receipts from indirect taxes had gone up from Rs234 billion in FY 99 to Rs309 billion in FY 03, when direct taxes yielded Rs151 billion. The ratios of indirect and direct taxes to GDP during FY 03 were 8 percent and 4 percent respectively. No less than 67 percent of the aggregate direct taxes came through WHT during FY 03 (July-May). The share of WHT on interest was Rs5 billion during this period.

The WHT is charged in a manner that defies common sense and makes a mockery of the perceived concept of equity and justice. This is charged at the rate of 10 percent, regardless of the amount involved, which throws over-board the threshold for income tax purposes, so far as the small man is concerned. For instance, a person earning Rs10 as a return on his deposit with banks has to suffer a cut of Rs1.

Currently the taxable income is Rs80 thousand per annum and the rate in the first slab up to Rs150 thousand is 7.5 percent. Thus a person liable to income tax can get rate relief in WHT in his annual assessment but no such relief is available to the small man, being too poor to be assessable for income tax.

Government introduced small saving schemes to encourage small savers and special rates of interest\profit were offered to them and this income was free from income tax. Initially, there was a ceiling on investment in these schemes but this was later done away with. The package is now known as National Saving Scheme (NSS). In compliance with the conditionalities of the recent borrowing from IMF, the concessional rate of return and tax benefits are being gradually eliminated with a view to reduce the burden of domestic debt servicing on government.

For instance, the return on SSC (registered) has been gradually reduced from 14 percent for the first 5 half years and 16 percent in the last half year in 99 to 7.50 percent and 8.50 percent for these periods. The rate on DSC, 10 years (compound) has been reduced from 15 percent to 8.5 percent over this period. The NSS was subjected to WHT and the threshold has been gradually reduced to Rs0.15 million. A further reduction in the return and the threshold for WHT, with effect from January 1, 2004, is on the cards.

In response to the hue and cry among the investors due to the drastic reduction in returns on NSS, the government has introduced two special schemes. The first was Pensioners' Benefit Accounts for public servants, which is for 10 years, carried a return of 11.04 percent effective from January I, 2003 but reduced to 10.08 percent with effect from July 1, 2003.This is subject to WHT and a penalty of 2 percent for premature encashment before 4 years. The ceiling for investment is Rs1 million.

The second scheme, called Behbood Saving Certificates, is for widows and has the same terms and conditions as for the pensioners. Ultimately the returns on NSS are to be aligned with that of Pakistan Investment Bonds, which, in turn, are supposed to be market determined. How far the return on PIBs is market determined will be discussed later.

Easy monetary policy pursued by the State Bank, along with the massive excess liquidity primarily generated by workers' remittances from abroad, has led to a marked reduction in interest rate structure of banks. The weighted average lending rate dropped from 14.6 percent in June 99 to 7.6 percent in June 03. At the same time, the weighted deposit rate fell from 6.5 percent to 1.9 percent. Allowing for Zakat, WHT and inflation, the real rate of return on deposits has been substantially negative.

Weighted averages conceal the wide dispersal of rates. In order to know the rate actually charged from the most favoured and least favoured clients, it is necessary to look into distribution by various rates.

The table gives return on Islamic modes of financing, which accounted for 72 percent of total bank advances, the rest being interest based. One must look at the effective rates of return. The most important rate has been 14 percent at which Rs106 billion were lent, or 20 percent of the total advances, to private business in 99. This was followed by 18 percent with Rs73 billion or 14 percent of the advances. In terms of band, in 99, 14-15 percent rate accounted for 27 percent and 18-19 percent with 26 percent of the advances.

There has been a general downward shift, reflecting easy money policy. The rate for export refinance, which was raised from 6 percent in 99 to 11.5 percent in 01, has since been reduced to 1.5 percent. However, 14 percent remained the most important rate. By 02, the amount had increased to Rs167 billion and the relative share to 25 percent of the advances. Next were 16.25 percent and 16.75 with 7 percent each of the advances.

The main band was 14-15 percent with Rs 207 billion or 30 percent of the advances. It was followed by 16-17 percent with Rs113 billion of 17 percent of the advances. The top rate bracket of 20 percent and above had Rs16 billion or 2.4 percent of the advances in 02 as against Rs36 billion or 7 percent of the advances in 99. The most significant change has been in the advances made at zero rate of return. This increased from Rs3.5 billion or 0.7 percent of the advances in 99 to Rs27.2 billion or 4 percent of the advances in 02. This is quite intriguing.

The pattern of interest-based advances to the sector, at Rs48 billion in 99 and Rs61 billion in 02, has been more or less similar. In that case, the maximum rate is 16 percent and above and the advances at that rate were Rs15 billion or 32 percent of the advances in 99 and Rs21 billion or 34.31 percent of the advances in 02.

This is the picture of the prevailing banking culture, which favours the elite and disregards the small man. In this regard, the observations made by the State Bank Governor are very poignant and pertinent. He says, "The industry (banking) is short of high calibre bankers and I have to pick up chief executive from foreign banks as most of local bankers are politicized having affiliation with one or the other political party to secure personal gains." "I personally feel pained when I see senior bankers in corridors of the parliament for their posting and promotions. As a result, the bankers have to give undue favour to their patrons."

There is a general impression that the small man has little capacity to save. This is true at the individual level but their modest savings, if garnered properly, can add up to a tidy sum. This is fully borne out by the Pakistan experience. Deposits up to Rs25 thousand, an amount close to per capita income in the country, may be taken to represent the small man. They were Rs276 billion, or 17 percent of total bank deposits as of end June 03. If the size is doubled to Rs50 thousand, they were Rs466 billion, or 28 percent of the total deposits. In the category of personal deposits the ratio of the first bracket was 21 percent and in the second bracket 31 percent in 03.

On the credit side, advances of the first bracket have tended to decline in absolute amount and were only Rs5 billion on that date, down from Rs5.46 billion in 99. Their ratio to total advances was hardly 0.5 percent in 03. In the second bracket the ratio was slightly better but only 3.4 percent. The average size of advance in the first group was Rs14,937 and in the second group it was Rs24,167. The ratio of advances to deposits in the same size bracket is quite revealing. It was only 2 percent in the first bracket and 8 percent in the second bracket. In other words, the small man got back in advances only a fraction of his own deposits.

It is obvious that the banking system has systematically and ruthlessly exploited the small man. The cheap credit and its pre-emption by the elite means a massive transfer of income, directly through their own borrowing and indirectly by enhanced corporate profits, to that small select group at the expense of the small man. It is difficult to work out precisely the net quantitative impact of all this for want of all necessary details. However, a rough estimate can be ventured.

The small man has lost through the difference in reduction of return on his deposits minus the gain on his borrowing from reduced interest. Taking the overall weighted average of return of 1.9 percent as of end-June 03 and their deposits, as defined above, and comparing it with 99, small depositors up to Rs25 thousand each lost Rs7 billion in the half year ending June 03 or the annualized Rs14 billion. For the depositors up to Rs50 thousand, the annual loss comes to Rs18 billion. This is in sharp contrast with debt write off of Rs25 billion since 99.

The loss of income suffered by the holders of NSS is colossal. In the similar manner, taking the first year rate, the annual loss on DSC was Rs18 billion, on SCA\C (R) Rs19 billion and MIC Rs15 billion, adding up to Rs52 billion during 03.How retired persons, widows, orphans and other senior citizens who mostly depended on this income would have adjusted to the sudden drastic reduction can easily be imagined.

All this loss suffered by the small man more than offsets whatever little is being done by government otherwise for poverty alleviation. This leads to the question of interest rate determination in the economy as such, justification for any consideration for the vulnerable groups and the manner of dealing with them.

Market mechanism to decide resource allocation is the philosophy these days. Interest rate would be genuinely market determined if there is no official interference with the market forces. What is being touted by the economic managers as the market determined rate is nothing but a myth. It will remain so as long as the State Bank, in departure from its traditional central banking functions as the lender of the resort, continues to inject purchasing power on its own, serving as a prime source of investable funds and that too at very low rates.

Giving priority to its developmental role, which was justified in the early fifties but not any more after half a century of economic development, the State Bank has injected a huge amount in the financial system, currently standing at 16 percent of total money supply in the country. In the past, it used to be much more.

It is not difficult to imagine the interest rate that would emerge, if the State Bank cleans the system of this money, which favours government in debt servicing and the other borrowers at the expense of the small man by holding down the market interest rates, including that on PIBs, which are serving as the bench mark for NSS.

There is a stock excuse of IMF conditionality for every hardship caused to the public. It is more so in case of NSS. What is the truth? First, the return on PIBs is to be genuinely market determined without the central bank money but this is not so. The image of IMF as a callous institution notwithstanding, it shows concern for the small man, provided it is properly argued with them. Here is an instance relating to Pakistan.

Para 39 of Standby Agreement with IMF in 1999 read, "As the availability of commercial banking facilities is limited and capital market instruments to the savours is limited, the absence of secure vehicles for saving could result in the re-emergence of unregistered pyramid saving schemes. Thus NSS instruments are likely to continue to have a useful role in mobilizing their savings, similar to government-run saving schemes in operation in many countries, including industrial economies." (Italics supplied)

It is time to rectify the tilt against the small man to restore balance. It would go a long way towards poverty alleviation, if a threshold, commensurate with that for taxable income, is established for WHT for all kinds of return on saving, including NSS. It is true that interest rate policy cannot be tailored to serve as a welfare measure and this applies as much to the elite as to the poor.

In the absence of a social safety net something has to be done to protect the most vulnerable sections of the society. Pakistan is one of those few countries where senior citizens receive no consideration. In the given circumstances, NSS has much to commend itself. To ensure its proper use, a ceiling may be fixed, as was envisaged in the original NSS.

Authorities in Islamic Republic of Pakistan should remember the Islamic teachings about the poor. The Holy Prophet (PBUH) has said, "You are not helped and provided for but for the poor amongst you." (Bukhari) "If you want my pleasure, look after the poor. You will deserve Allah's help and His provision, if you look after the poor." (Abu Daud) "A town in which a person spends a night on empty stomach forfeits Allah's protection. (Ahmad bin Hambal)