Recent lowering of rates of return on the National Saving Schemes (NSS) - the 10th six-monthly downward revision since July 1999 - will force small savers to explore new areas of investment. This, in the long run, should benefit both the saver and the economy. But in short term, majority of small savers would continue to suffer.

Small savers hit hard: From January 1, the government has reduced the rates of return from 8.50 per cent to 7.96 per cent on the 10-year Defence Saving Certificates (DSCs) and from 7.68 per cent to 7.08 per cent on the five-year Regular Income Certificates (RICs). It has also lowered the return on three-year Special Saving Certificates from 7.67 to 7.27 per cent.

This is 10th successive cut in the interest rates on the NSS in three and a half years. In July 1999 the government had announced sharp cuts in the NSS rates in the first ever six-monthly revision of these rates.

Till June 1999, people were getting a return of 18.04 per cent on the DSCs, 18 per cent on the RICs, and 16.33 per cent on the SSCs. Thus, in three and a half years, the rates of return have fallen by 10.08 percentage points on the DSCs; 10.92 percentage points on the RICs and 9.06 percentage points on the SSCs. This huge rate-cut has hit the small savers hard whose chief source of income is return on the NSS.

They have been hit hard for they could not withdraw savings from the NSS in the past to reemploy it somewhere else and earn higher returns because premature encashment would have meant still lower returns. Besides, they lacked the required expertize to reinvest their life-long savings in relatively risky areas and in most cases, their savings were too small in volumes to take such risks.

Harder times ahead: The recent cuts in the NSS rates have made it further difficult for small savers to explore new areas of investment for the same reasons. But as the rates of return have fallen to unmanageable lows and further downward revision is due in July, majority of small savers can hardly retain their investment in the NSS.

And, they would surely not make new investment in the same. So, what they should do with the money already invested in the NSS, or the money they have in their hands or in their bank accounts?Retaining investment in the NSS does not seem to be a good option as their rates of return would fall further - maybe by wide margins. One of the IMF's conditions tagged with its $1.5 billion three-year Poverty Reduction and Growth Facility is that the rates of return on the NSS should be brought at par with the yields on Pakistan Investment Bonds of similar maturity.

Pakistan is supposed to introduce a formula for this purpose, in consultation with the IMF staff, by the end of March this year. The NSS rates will have to be revised again in July according to that formula.

Currently there is a wide gap between the NSS rates and the yields on PIBs of similar maturity. The government has six months to improve the PIB yields before it can bring down the NSS rates at par with them. But it can allow only a modest increase in the PIBs' yield, because a big increase would mean reversal of the current policy of lifting the economy with low interest rates. This means another round of significant cuts in the NSS rates is inevitable in next six months. Hence the difficulty in retaining investment in the NSS or making fresh investment in the same.

Bank deposit rates too, have fallen to humiliating lows. Weighted average return on the deposits of all banks combined was negative at 1.45 per cent in October 2003 against annualized CPI inflation of 2.2 per cent in July-October that year.

There are no indications of an immediate major improvement in this rate, which reflects largely, though not fully, the actual low rates of return people are getting from individual banks. Economists believe that the interest rates have bottomed out in Pakistan and would now take a spike, but bankers say that the returns on bank deposits would improve slowly over a long period.

Savers turn panicky: This situation had made small savers panicky, compelling them to explore riskier areas of investment in the short term before getting a longer term view of investment scenario. A significant number of small savers have already entered into the most troubled waters of currency speculation. The rise of euro and pound sterling on the back of a weaker US dollar and emergence of Iraqi dinar after the recent capture of Saddam Hussain by the US forces are attracting them.

Others are testing their investment skills in the glamorous, yet the mysterious world of gold, and some are waiting for the right time to enter the stock market. Investment in real estate and speculation in automobiles do not normally suit small savers but some of them are so panicky they are exploring these areas as well- at an absolutely wrong time. The real estate boom seems to be over and speculating on the premiums on car deliveries has become too risky, because the auto industry is facing tough competition from foreign brands.

Future outlook: Small savers may not have to suffer long if they learn a lesson from the past and position themselves accordingly. Some government policies also offer a silver lining for them. The downward revision of the NSS rates in the past three and a half years is a part of the policy of eliminating interest rate subsidies and making interest rates market-driven. The country could not have allowed distortions in interest rate structure for long. It had to make it market-based.

Initially profit rates on the NSS were kept deliberately high for vulnerable groups - the old and the weak, pensioners, widows and the likes. But then, huge investments started pouring in from the rich and the powerful. That increased the government's cost of borrowing and made deposit mobilization expensive for banks. The banks, in turn, started making still more expensive loans: the trade and the industry suffered and so did the economy.

So, whereas it is necessary to support the old and the poor through high yielding saving schemes, it is equally important to make interest rates responsive to market forces for long term gains. The latest government decision of lowering the NSS rates but allowing all citizens of 60 years and more to invest in a tailor-made high yielding scheme should be seen in this light. This scheme was initially meant for the public sector pensioners only.

It is indeed heartening, that while lowering the NSS rates from January 1, it has left the rates of return unchanged on this scheme and another scheme meant for widows. These two schemes, both of 10-year maturity, offer 10.08 per cent annual return - substantially higher than 7.96 per cent on the 10-year DSCs.

As for the ordinary investors of the NSS, they must now recognize the ground realities. The NSS rates would continue to fall till they come at par with the yields on the PIBs. It is time for them to look for other avenues. Stocks could be a good option. But they should not enter the market in a hurry - ambitious yet unprepared to make millions overnight. Instead, they should seek qualified advice and also try to get maximum insight into the stock market.