BY end 2004, it became obvious that the monetary policy had remained unfairly slanted in favour of the borrowers. In spite of claims of the Federal Bureau of Statistics, inflation never really dropped to 3.5 per cent anytime during the past two years. Therefore discount rate cuts in large doses in 03 (3 per cent in twelve weeks) effectively forced a price on the money market belying claims of freeing the market.

But the policy did achieve two objectives: it helped the government cut its fiscal deficit and the industry to reap huge profits, all at the cost of the savers.

The result of the policy (pursued in tandem by the SBP and the ministry of finance) facilitated sustained reduction in profit rates on savings of all kinds, the biggest being in the rates on gilt-edged securities meant for small savers.

Profit rate payable on Special Saving Certificates (SSCs) was nearly halved from 12 to 6.8 per cent per annum while on Defence Saving Certificates it was cut from 15 to 8.15 per cent per annum. Made in less than two years, the reductions proved crippling for widows and old age pensioners.

Such cuts in profit rates on savings hurt because they yield negative real returns on savings. The cuts weaken the sentiment for saving. Since 1993, PLS accountholders (contributing over 60 per cent of bank deposits) received negative real return because inflation consistently remained higher than the average rates of profit paid on deposits. This injustice was sustained on the back of official inflation estimates that suited the governments in power.

Small savers therefore quite rightly stopped trusting the banking system. Even now while profit rates on deposits remain questionably low, banks as a whole have registered a rise of over one per cent in the spread between the average cost of deposits and average loan rates.

The only savings instruments that used to pay savers positive real rates of return were National Saving Scheme(NSS) securities. Reduction in the rates of profit payable on NSS securities dealt a severe blow to saver confidence in the system as a whole.

The policy favouring rapid lowering of interest rates was resorted to as a quick fix without bothering about its future impact. The desire to put too things right (e.g. fiscal deficit and public sector debt servicing) is commendable, but these can’t be put right overnight; steps to speed up reform must be taken with care to avoid backlashes.

The monetary policy, it seems, was either short-sighted or driven by expediency. Had that not been the case inflation would not have surged up as rapidly (from 4.8 to 9.37 per cent) as it did in the past twelve months.

Rapid rise in inflation suggests that corrective action was delayed for a bit too long. Most observers believe that firstly, increase in the yield on gilt-edged securities should have commenced around June 2004. Secondly, fresh public sector debt funded by SBP since July 2004 should have been monetized much earlier instead of coercing banks (by rejecting their bids at successive security auctions) into demanding lower yields on these securities.

All that has been achieved in the process are artificially low yields that continue to distort the money market. An indication thereof is the fact that 6-month T-Bill yield is still below the going rate of inflation although most central banks keep its yield slightly higher than the going rate of inflation to keep inflation in check. This distortion is magnified further by the fact that even 3, 5 and 10-year PIB yields are below the current rate of inflation.

The government’s own estimates indicate that, at present, inflation is over 9.3 per cent. Yet, the 10-year PIB continues to yield no more than 9.1 per cent per annum and shorter term PIBs carry even lower yields. In this scenario, aligning returns on SSCs and DSCs with 3-year and 5-year PIBs will be unjust because investors will once again be forced to accept negative real returns. Similar market distortions in the past, allowed borrowing at unrealistically low rates.

That this strategy is flawed has been proved beyond doubt. As feared by most observers, the forced lowering of profit rates pushed savings out of banks and government securities into speculative activities that jacked up inflation.

In rural areas the convenient speculative activity was hoarding commodities, especially essential food items. In the cities the speculation-fuelled on-going rise in property prices continues to baffle everyone but the crowning event has been the meteoric rise and crash of the KSE-100 index.

The scenario was not unexpected and observers had warned about it. Ballooning of KSE index without a commensurate rise in real investment activity was indicative of share trading at inflated prices. Yet, the small, little-informed savers in the cities staked their savings at Pakistan’s inadequately regulated stock market.

Being uninitiated for undertaking such risky investments, they suffered from bad broker advice and lost out to a handful of clever manipulators of this market. How the small shareholders were taken for a ride by the brokerage houses, remains shrouded the inquiry committee report which, in spite of SECP promise, has not been made public yet.

Pakistan is, and will remain, an under developed country as long as we manage our monetary system the way we did in the past. It would be criminal to force small savers to undertake investments about the down side of which they know nothing. Disasters of this kind are not lacking in Pakistan’s history. Losses the small shareholders suffered at the hands of sharp stockbrokers in the 1990s, finance and investment company fiascos, and the cooperative bank scam offer unforgettable lessons.

The hallmark of good regulation is that it doesn’t place small savers at the mercy of the speculators. Given the present profile of banking ethics (reflected in the deceptive designs of deposit products that offer minimum or no returns to small depositors), it is imperative that small savings be channelled into the economy through government securities.

Therefore, to revive sagging saver confidence, the grandiose plan to turn the Directorate of National Savings into a body corporate should be shelved until corporate ethics take a turn for the better.

A widely shared view is that current yields on 3, 5 and 10 -year PIBs are artificially low. Therefore, aligning the NSS security profit rates with current 3 and 5-year PIB yields would be wrong because, effectively, it will continue to burden investors in NSS securities with a negative real rate of return. What is more important is the fact that these negative real returns will increase as inflation rises further in the coming months. Definite signs thereof are already there

Given the impending snow-balling effect of high oil prices on the economy as a whole, inflation is unlikely to fall in the next two years. At the very best, it could be contained between 10 to 11 per cent revision of profit rates on NSS securities (promised in the federal budget 05-06) must not overlook this reality. That being so, a profit rate below 11 per cent per annum on SSCs and 12.5 per annum on DSCs, would be wholly unjust.

The government must not overlook the impact of high oil price. In all probability, it will force the government to exceed its borrowing target as it did in 04-05. In fact, government will overshoot the target by a wider margin in 05-06 unless far more than 10 per cent of the privatization proceeds are spent on subsidizing this cost. The government must mend fences with the investor market by acting fairly.

It is time small savers’ confidence is restored by offering them positive returns on their savings. The government must encourage saving rather than consumption or bad investment.