July 02, 2007	Monday	Jamadi-us-Sani 16, 1428

Dr Abdul Karim

The long awaited increase in the rate of return on NSS has been announced. The rate has been raised on Defence Savings Certificates from 10 per cent to 10.15 per cent or by 0.15 per cent, on Special Saving Certificates from 9.17 per cent to 9.25 per cent or by 0.08 per cent, on Regular Income Certificates from 9.24 per cent to 9.54 per cent or by 0.30 per cent, on Pensioners’ Benefit Account and Behbood Savings Account from 11.52 per cent to 11.64 per cent or by 0.12 per cent.

The range of increase is thus 0.08 –0.30 per cent but is even less on those schemes which are subject to 10 per cent withholding tax. For instance, the actual increase, after the tax, on Special Savings Scheme is 0.07 per cent. If allowance is made for the capital loss the holders have to suffer on account of continuous inflation, rate of which during July-May FY 07, according to questionable official figures, was 7.84 per cent, the measly increase becomes a cruel joke with small savers.

The explanation offered by NSS Director General is, “The rates of return on NSS are revised biannually keeping in view the returns on products of similar maturities offered by the financial sector. The revision of rates on NSS has been bench-marked to the yield on Pakistan Investment Bonds (PIBs) to ensure cost effectiveness fundraising for bridging the government’s budgetary deficit. The latest increase is in line with government ‘s overall macroeconomic policy of containing the debt to GDP ratio and simultaneously ensuring level playing field for the players of the financial market. Thus diligence has also been exercised while carrying out the revision to ensure that no distortion are caused in the financial market by keeping in view the returns offered on competing products, including PIBs, besides ensuring reasonable lending rates.”

The DG has identified with basic elements of public debt management policy and these can be summed up as (a) link the rate of return to the yield on PIBs, (b) keep the rates low so as to reduce the cost of debt servicing and (c) to interfere with the market forces in the name of distortions in the financial markets. These need to be examined more closely.

First the link between the yield on PIBs and return on NSS. This could be justified only if the yield on PIBs was genuinely market determined. The hard fact is that there is no market determined interest rate worth the name.The State Bank has been injection money into the economy on massive scale regardless of the excess liquidity created by other factors. The State Bank accounted for no less than 23 per cent of total outstanding money supply and 74 per cent of reserve money as of end-March, 07. The Bank accounted for 32 per cent of the increase in money supply and 78 per cent of reserve money since the onset of the so- called tight monetary policy.

The yield on PIBs reflects the administrative decision seeking to keep the cost of borrowing low. The history of PIBs is very interesting. The first issue was 10-years PIBs on June18, 02 with cut-off yield of 10.90 per cent. This was followed by 3- and 5-year PIBs on July 20,02 with cut-off yields of 8.06 per cent and 8.96 per cent respectively. New 20-year PIBs were issued on Jan 20, 04 with cut-off yield of 8.80 per cent followed by 30-year PIBs on Dec. 21, 06 with cut off yield of 11.70 per cent. With the beginning of FY 03, cut-off yields tended to decline and reached their nadir on April 29, 04 when the cut-off yield for 3-year PIBs was 3.77 per cent for 3-year and 4.90 per cent for 5-year and 6.49 per cent for 10-year PIBs. There was no issue of 20-year PIBs in April and May, 04. Thereafter, the yields tended to increase in line with the tight monetary policy. They touched the highest level for 3-year PIBs on Oct 30, 06 when the cut-off yield was 9.85 per cent. On 21 Dec 06 this came down to 9.74 per cent, while other bonds reached 10.0 per cent, 10.53 per cent and 11.42 per cent respectively. New 30-year PIBs were issued on that date with cut-off yield of 11.70 per cent. The yields again tended to fall, in spite of tight monetary policy in FY 07 and were down to 9.32 per cent for 3-year, 95.5 per cent for 5-year, 10.12 per cent for 10-year, 11.20 per cent for 20-year and 11.59 per cent for 30-year PIBs as on June 5, 07.

The issuance of PIBs is just a formality as not much is raised through them. The issues are infrequent and auctions are even scrapped when authorities do not like the terms sought by the investors. Two issues were scraped in August-Nov, 04 and one on Nov. 06. Total outstanding amount of PIBs was Rs332.5 billion as of end-May 07 as compared with Treasury Bills worth Rs1,086.5 billion on that day.

Return on NSS is supposed to be revised bi-annually in line with the yield on PIBs. Strangely enough, when the yields increased during the second half of 06 in the range of 0.17-0.65 per cent, the government preferred to remain silent. In the following first half of 07, when the yields declined in the range of 0.11-0.45 the government came up with the insignificant revision.

It is not fair to link the return on NSS with the yield on PIBs because of the marked fundamental difference in the character and nature of assets in the two categories. Mostly individuals hold NSS with a view to earning income, which may serve as a means of sustenance and the rate of return is thus their primary interest. In contrast, PIBs are mainly held by financial institutions in compliance with the statutory requirements of minimum liquidity ratio and that become more important than the return. For want of eligible private sector instruments, these institutions have to rely mainly on government securities.

Withholding tax on return from some NSS makes a mockery of equity and is a patent anti-poor act. For income tax for individuals, there is the condition of annual income of Rs150 thousand and the rate in the first slab is five per cent. In sharp contrast, for return on some NSS there is no threshold and rate of tax is 10 per cent or twice the rate in the first income tax slab. For instance, in case of Special Saving Certificates, a person investing the minimum amount of Rs1 thousand will get Rs92.5 per annum, at the new enhanced rate, but the withholding tax will reduce it to Rs83.25.

Affluent holders of NSS, who are otherwise liable for income tax, can get half relief when they club it with other income, as the rate in the first slab is only five per cent. No such relief is available to those who are poor enough not to make Rs150 thousand a year. To ask them to go and get refund from income tax authorities will, be, with the present ground realities, an unbearable punishment involving time, money and inconvenience

As regards the need to avoid distortion in the financial sector, the State Bank has identified institutional investment in NSS as a possible element and repeatedly stressed this in its publications. This is certainly a valid concern. It may be recalled that government had banned institutional investment in NSS some years back. However, when confronted with net withdrawals from NSS which was as much as Rs44 billion in FY 05 as against an increase of Rs3 billion in the preceding year and Rs36 billion a year earlier, the government again allowed institutions to make investment in NSS.

The government does not release information giving the break up of outstanding NSS by holders and as such it not possible to comment on the role of institutional investment in NSS. In any case, there is a strong case in banning institutional investment in NSS restricting it to individuals.

The crucial, rather unique, role of NSS in financing fiscal deficit is unfortunately not appreciated, especially by the country’s economic managers. It is the only non-inflationary financing as public saving is transferred to government. In order of inflationary impact of other sources of meeting fiscal deficit, the next is financing by banks who have to have some public saving with them to enable them to undertake multiple expansion under a proportional cash reserve base system.

The central bank financing of fiscal deficit is most inflationary as money can be artificially created out of thin air with practically no limit except prudence. The State Bank has been publicly warning government in this regard. The professional economists serving in government would do a great national service it they could bring home to the economic managers of the country the simple choice of saving cost of debt serving by borrowing cheap from inflationary sources of finance and then ultimately pay a higher hidden cost by paying more for purchasing domestic goods and services due to the resultant inflation or to pay a higher nominal return to the providers of non-inflationary financing of fiscal deficit but save the large ultimate cost entailed by inflation. This interesting and significant cost-benefit exercise can only be attempted by those who have access to unpublished detailed information on government expenditure. Prime facie, the course of higher nominal return for financing by non-inflationary means, giving savings in government expenditure, will win by a big margin. The trade off is quite clear for those who care to see.

In conclusion, it may be observed that government can raise lot of non-inflationary financing by giving a realistic real return to the holders of NSS. The additional nominal financial cost is well worth the ultimate saving in real expenditure by government. Return on NSS should not be linked to PIBs but to the rate of inflation.

Government should, as a matter policy, decide how much real return is to be given and this should reflect the existing scarcity cost of capital in a very low saving economy. In this case, the need for measures to encourage domestic saving cannot be over emphasized. Small investors of NSS should be spared the withholding tax by taking a declaration from all investors of NSS whether they are otherwise liable for income tax. Those whose answer is in the affirmative should be subjected to the withholding tax, which they can adjust in their returns. Others should be freed from this unjust burden.