ISLAMABAD, June 26: The government is currently evaluating various proposals, including the one offered by the World Bank, to lower the real interest rate from 6 per cent to 4 per cent by 2006-07.

An official concerned told Dawn here on Saturday that cutting further interest rates was one of the important undertakings of the government. He said since the budget for 2004-05 has been finally approved by the National Assembly, the government would now be taking into accounts various important issues including further lowering the real interest rate.

"The other two important issues which will get due importance is the strict monitoring of development programme by the federal government, and to create a better business environment for the private sector," he said. He said lowering of interest rate was one of the major demands of the private sector.

According to the World Bank, lowering of real interest from 6 per cent to 4 per cent would save interest payments equivalent to 1 per cent of the GDP.

The most immediate problem is the high real interest rate on domestic debt. The average interest rate peaked in 1999-2000 at 10.8 per cent and declined to 5.6 per cent in 2002-03. In the past, the high level of domestic interest rates reflected upward pressure placed on the country's narrow financial markets by the considerable borrowing needs of the government. Now that the net government borrowings are projected to be modest, it has much greater degrees of freedom in the management of its domestic debt.

A central problem, according to the World Bank, is still high cost of borrowing under the National Saving Schemes (NSS), notwithstanding recent rate reductions. Interest rates on NSS instruments such as ten-year Defence Savings Certificates (DSCs), the five-year Regular Income Certificates (RICs), and the three-year Special Savings Certificates (SSCs) are fixed administratively. Holders of NSS instruments can redeem them at any time, encashing both the face value of the bond and the accumulated interest savings. On the initial assumption that NSS serves a population of small, relatively unsophisticated (such as widows, orphans and pensioners) who are unlikely to place their funds with banks or other financial institutions, rates of return on these instruments tended to be generous and tax-free.

The World Bank, however, appreciates that government has taken several strong measures in recent years to address some of the weaknesses of NSS instruments. It eliminated the access of institutional investors to the schemes in early 2000. Recently it took commercial banks out because of abuses of the system. It has made a number of successive reductions in the administratively set interest rates in new issues since May 1999 and has linked the NSS rates to the market benchmark Pakistan Investment Bonds (PIBs), which have been revived as an important instrument of debt management.

However, the Bank is of the view that fundamental problem remains. First despite the action taken in recent years, NSS is still a source of high cost borrowing for the government. This is because the sharp drop in the rate of inflation has greatly offset the impact of normal interest rate reductions for NSS on the real rates. Second, the on-tap nature of schemes limits the government's options to explore optimal mix of borrowing. Also the way NSS are administered makes it difficult for the government to accurately plan the interest payments in the coming budget years.