Two years ago the federal government decided to offer long-term Pakistan Investment Bonds (PIB) on floating rates. It took the decision because banks had started redeeming in bulk fixed-rate PIBs as rising interest rates in the country had made them less attractive.

The offering of PIBs on floating rates turned the tables. Banks and non-bank institutions both started purchasing the bonds in large volumes. Greater sales of these long-term, floating-rate bonds helped the government keep the stock of its short-term domestic debt low and enabled banks to park surplus funds with peace of mind. Interest rates on these bonds were tied to short-term treasury bills rates and banks could decide with greater accuracy whether they should invest in the bonds during a particular time of the year.

At the end of June 2018, the stock of investment in fixed-rate PIBs had fallen to Rs3.4 trillion from about Rs4.4tr at the end of June 2017. Floating-rate PIBs launched in May 2018 became so popular among banks and non-bank financial institutions that the stock of investment in PIBs surged to Rs10.933tr in June and then to Rs12.886tr by the end of June 2020. The latest stats released by the State Bank of Pakistan (SBP) show that at the end of February 2021, the stock of investment in PIBs reached a new height of Rs14.272tr.

Within the NSS regime, inflation-protected certificates of investment can initially be introduced for certain segments of prospective investors

This dramatic rise in investment in long-term bonds (of three-year to 30-year maturity) after offering floating interest rates on them clearly shows that floating rates can work wonders in the development of the bonds market. That is because when yields on long-term debt instruments are tied up with the most recent yields of short-term instruments the investors class — banks, non-bank financial institutions or even the corporate sector and individuals — all have less to worry about locking funds for three, five or ten years — or even for longer periods.

Why then the government does not consider floating interest rates on national saving schemes that it uses to generate non-bank debts from ordinary Pakistanis, including senior citizens and widows? To make these floating rates more relevant to people the government can consider linking them with the headline consumer inflation or food inflation. It is easy to create awareness about and acceptability for inflation-protected saving products for hundreds of millions of Pakistanis who experience inflation first-hand.

Within the entire regime of National Saving Schemes (NSS), inflation-protected certificates of investment can initially be introduced for certain segments of prospective investors like farmers or factory workers.

It is true that NSS products not being tradeable contribute less to the deepening of the bonds market in the country in the manner that PIBs or treasury bills do. But since banks remain major holders of PIBs and market treasury

At the end of December 2020, banks held 78.5 per cent of the entire stock of the government’s marketable debt securities

bills, the debt raised through them constitutes the government’s borrowing from banks. This means overexposure of banks in them crowds out the private sector. And that, in turn, affects the private sector’s efficiency — and overall economic growth.

At the end of December 2020, banks held 78.5 per cent of the entire stock of the government’s marketable debt securities including PIBs, T-bills, Ijara Sukuk or Islamic bonds, the latest available SBP stats reveal.

Pakistan’s central bank is about to begin inflation-targeting. It has already stopped the government from making fresh borrowing from it, compelling it to borrow either from banks or expand the scope of non-bank borrowing. The government is, therefore, in the need of diversifying its sources of non-bank borrowing — and start the process as soon as possible. Because the government’s bank borrowing keeps growing thus crowding out the private sector and affecting economic growth.

In 2019-20, when the economy experienced a 0.4pc recession, the federal government borrowed about Rs2.47tr from banks. Obviously, such huge borrowing played little or no role in economic growth; it rather enabled it to meet domestic and foreign debt servicing requirements and meet a large gap between revenue generation and huge expenses of defence and the day-to-day running of the government. On the other hand, the private sector got just Rs196 billion from banks — partly because the economic recession had depressed credit demand to some extent but largely because banks were busy lending massively to the government.

In more than nine months of this fiscal year (between July 1 and April 9), banks have already lent Rs1.821tr to the government by continued net fresh investment in debt securities. In contrast, they have lent only about Rs400bn to the private sector — the main engine of economic growth in Pakistan. This clearly indicates that banks in Pakistan badly need to boost private-sector lending and limit investment in debt securities.

The government, on the other hand, needs to roll out new and innovative schemes to borrow from non-bank sources including individuals and companies. That is where inflation-protected saving products, whether short-term certificates of investment or long-term bonds, emerge as a possible option. And, that is where the scope of generating non-bank borrowing from targeted groups lies.

Offering PIBs on floating rates was a smart move. And, its results are good. But the results could have been far better, in terms of diversifying the sources of borrowing or making a gradual shift from bank borrowing to non-bank borrowing had SBP ensured accelerated sales of PIBs to non-bank entities.

In regular auctions of PIBs, non-competitive bids are invited from the corporate sector and even individuals but their share in total bids remains frustratingly low. Why? Banks do not want to create mass awareness about this fact — not even after oft-repeated reminders by the central bank. Insurance companies and other non-bank financial institutions mostly purchase PIBs from the secondary market i.e. when banks start trading them. It is time for the government to come up with more debt securities exclusively designed for non-bank entities. But does the government have the grit required to do this? Can the government afford to annoy banks?

Published in Dawn, The Business and Finance Weekly, April 26th, 2021