THE governor of the State Bank of Pakistan, Dr Ishrat Husain, who had earlier acknowledged the limits of tighter monetary control to fight the irrepressible inflation is back talking of tightening monetary control to bring down inflation.

He had then said that strengthening the supply side was far more important in our context.

Tighter monetary control essentially means reducing the money supply by raising interest rates and sucking up a part of the money afloat by selling treasury bills and government bonds like the Pakistan Investment Bonds. But that can effect economic growth which the government wants to sustain at 7—8 per cent, after achieving 8.4 per cent growth last year.

But improving the supply side as through importing sugar or cement duty-free or vegetables and meat from India duty-free has not helped much. The prices instead of coming down are creeping up.

When it came to meat, the meat merchants said frozen meat was not popular with Pakistanis, and retailers had no refrigeration arrangements, but the meat of live animals will be popular here. The first consignment of 334 sheep and goats has arrived in Lahore via Wagha. Let us see whether, as more supplies arrive, meat prices come down in Pakistan or at least in the principal cities.

Meanwhile, the price of pulses on which withholding tax has been reduced has instead of going down, has gone up.

If such supplies, too, are not very effective in bringing down prices, tighter monetary control has to be added to the remedial measures.

Dr Ishrat says the such imports, to add to the available supplies at home, will bring down the prices, then the inflation will drop and thereafter the interest rates.

The government wants positive results in this area as Ramzan is coming within a month. And that is the period of soaring prices and shrill consumer protest, which the opposition MMA can now exploit for political purposes.

The State Bank of Pakistan wants to tighten monetary control by resuming the sale of the Pakistan Investment Bonds after the lapse of a year and through higher interest rates initially.

The State Bank has already raised the export refinance rate to 7.5 per cent from three per cent. The exporters get the money from commercial banks at nine per cent. Exporters find the rate too high as many of their competitors around the world get their export refinancing at a far lower rate.

The Karachi inter-bank offered rate (KIBOR) has been steady for the last two months after it had risen from 2.90 per cent to 8.71 per cent in 2004. By August, it had risen to 8.87 per cent. But if interest rates in the country rise, KIBOR too will rise.

While the rise in the lending rate has been inconveniencing the borrowers, the depositors are not the gainers. It is a one-way street here with the banks gaining all the time.

The European Central Bank met last week and decided to retain the bank rate at two per cent, the rate for lending by commercial banks at three per cent and the deposit rate at one per cent. The ratio of lending rate to deposit rate is 3 to 1. Will the banks accept such a ratio with a narrow gap between the lending and deposit rates? In Pakistan the ratio is one to 5-6 with the depositor losing heavily all the time. And the banks as the supreme gainer.

Dr Ishrat hence ask the banks: “If the depositors will not get handsome returns on their investments, why should they bring their savings to the banks. They will naturally look to other avenues, like real estate, dollarization, and speculation.

“Don’t cut the hand that feeds you otherwise the depositors will direct their funds to other sectors for better returns,” he warned the banks.

But the efficacy of tighter monetary control to lower inflation is reduced by the fact there is too much money afloat outside the banking system. Hence the banks can be choosy in accepting the deposits. And the bank managers know for sure small savers have small options and cannot go into the real state or even the stock exchange now. And the dollar has been too shaky for too long for the small investor to opt for hoarding it. Hence the banks can ask for Rs5,000 to Rs50,000 to open a savings account and penalize the clients whose deposits go below that watermark.

Pakistanis in the last financial year, for example, got $4 billion dollars or Rs240 billion as home remittances. A good part of that money is afloat in the market after land prices sky rocketed and the stock market crash.

Then there is the tax-evaded income of about Rs300—Rs400 billion in a year of which only a part goes into the banks. The bulk of that tends to circulate outside the banking system. And there is the money made by the officials through corruption or crimes which do not go into the banks. In fact, a large part of that income is kept outside the country as the corrupt have their relatives abroad to oversee the use of that wealth and multiply that through the right investment. When that money is needed at home that can come as home remittances and enjoy collateral benefits as well.

All these makes tightening the monetary control ineffective as a means to fight inflation, unlike in the West or where there is developed economy. When the returns on bank deposits are too small, many persons tend to keep their savings outside the banking system.

Dr Ishrat says that when the banks were owned by the government or under rigid control of the State Bank they were serving under one million people, but now they are catering to the needs of over four million people. And the banks are now reaching out to lower income groups in the rural areas and will provide loans for house building in the rural areas as well.

But the efficacy of such loans has been neutralized by the high price of land and the stiff prices of the construction materials.

Circulation of money in the rural areas has increased following the steady rise of the support prices of agricultural products. Prime Minister Shaukat Aziz says that about Rs100 billion had been pumped into the rural areas in the last two years through enhanced support prices for agricultural products.

But the banks are not satisfied with the doubling of the profits in the first half of this calender year as many have done, the latest being Habib Bank. They are setting up their own insurance companies as well. After Pak-Saudi Commercial Bank and PICIC Commercial Bank the Bank of Punjab and Bank Al-Falah are setting up their own insurance companies.

In addition, insurance companies — under the Islamic system are to come up and the government has formulated the Takaful rules for that.

More Islamic banks are to come up, while the commercial banks are setting up their own Islamic banking sections. And the Bank of Dubai is to acquire 18.75 per cent stake in the new Bank Islami.

In the past, every major business house had its own insurance company as a part of a kind of vertical monopoly, but now the banks are setting up their own insurance companies and borrowers of money from such banks for commercial or industrial purposes have to get their assets insured by their insurance companies.

Bank loans to the small and medium enterprise have been too small and increased a little recently. They were earlier expected to pay an interest rate of 18 per cent on the loans which has come down to some extent now. Far more has to be done in this sector, if the SMEs are to flourish and strengthen the economy.

The State Bank does not want to intervene to increase the return on deposits and instead prefers to leave that to competition between banks to enhance the rates. But there is very little competition between banks in this area. Instead there is a collusion, to keep the leading rates up and the deposit rates down and rejoice over their one hundred per cent profits.

The small saver is helpless in the face of such collusion between bankers. If the State Bank does not want to compel the banks to raise the deposit rates, it should use its persuasive powers to make the bankers meet to the social obligation of banking system. It is not enough if the Dr Ishrat tells the bankers not to cut to hand that feeds them; he should also take positive steps to make that advice effective and truly beneficial to the small depositor.

After all, more savings mean less money in circulation and less inflation. Hence everything possible has to be done to promote larger savings, higher investment and far more production which too is anti-inflationary.