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KARACHI, Sept 4: Consider this. You invest Rs10,000 in one-year bond carrying three per cent annual profit. After a year, you get back Rs10,300 the additional Rs300 being the profit. But during the year consumer inflation was at five per cent. So, the actual worth of your principal amount i.e. Rs10,000 fell to Rs9,500. Add to this Rs300 profit and you end up getting Rs9,800. You actually lose Rs200.
Now consider this. You invest Rs10,000 in one-year bond carrying three per cent annual return. Inflation during a year remains at five per cent. At the end of the year, your principal amount rises to Rs10,500 and you also get a profit of Rs300. That is you end up getting Rs10,800. You actually get real return of Rs300.
The difference between the two bonds is that the second one is inflation-protected bond and the first one is not. Which one would you prefer? "Certainly, the second one," says Mr. Muhammad Minhaj, a multinational corporate executive. "We do need such bonds that can protect the value of our money from inflation."
This view is widely shared among people from all walks of life, businessmen and stockbrokers included.
Says Karachi Stock Exchange (KSE) Chairman Arif Habib: "I do believe there is a need for inflation-protected bonds. Savers would like any instrument of saving that protects the value of their investment from inflation."
Federation of Pakistan Chambers of Commerce & Industry President Riaz Tata also thinks Pakistan needs to introduce inflation-protected bonds to expand investment base.
Former KSE chairman Yasin Lakhani and Head of Economics Department of Karachi University Prof Dr Shafiqur Rehman are also among those who believe there is a need for such bonds.
Inflation in July 2004 shot up by 9.3 per cent over July 2003, far higher than the annualized return of 8.15 per cent on 10-year Defence Saving Certificates!
THE ISSUER: But who should issue these bonds, the government or the private sector, or both? Opinions differ. Arif Habib, whose company Arif Habib Investments manages mutual funds, says "Such bonds should be issued by the government - the private sector can manage them like they manage other bonds and securities through mutual funds." His predecessor Yasin Lakhani also says that "only the government should issue these bonds." But Riaz Tata believes that the private sector is more suited to do this job. His argument is that the government almost always pay a higher-than-inflation return on saving schemes because it needs to raise funds more from non-banking sector than from the banking sector.
GOVT VIEW: "That actually is the case," says Dr Ashfaque Hasan Khan, director general debt management and adviser in the ministry of finance. "The government has already been paying handsome returns on its bonds and saving schemes. So we do not think there is a need to issue inflation-protected bonds."
"We need to develop our bonds market first (before toying with the idea of issuing inflation-protected bonds)," he says.
Dr Khan laments that primary dealers or banks tasked by the State Bank to sell the government securities have so far not developed a sizable secondary market for long-term Pakistan Investment Bonds or PIBs. "They are sitting on Rs270 billion worth of PIBs and are not doing much to market these bonds in the corporate sector." He also says that mega corporates like PTCL, PSO, OGDCL, State Life Insurance Corporation and others have a combined surplus of Rs150 billion but they are shy to invest this amount in government bonds.
Is this because these corporates have taken a view that the yields on these bonds are being kept unrealistically low and that these should be raised immediately in view of soaring inflation?
"No, I think the real reason is that corporates have not developed the expertise (needed for making realistic projections of interest rate movements)," says Dr Khan. "The corporates should come forward and invest more money in PIBs. That is going to help the government in the manner that it would shift part of the government's bank borrowing to non-bank borrowing." When the government's borrowing from banking sector rises beyond a certain level, it does not only burst the target set for this purpose but also leads to crowding out of private sector credit with all its negative fallouts on the economy.
He fears that if the government issues another bond, say inflation-protected one, the same thing will happen with it. Banks responsible for marketing them will over-invest in the same and a secondary market will never develop, thereby defeating the very idea of insulating households and corporates from inflation.
While talking to Dawn by telephone from Islamabad, Dr Khan discussed in detail how the capital market should be developed and bonds market deepened but he apparently dismissed the idea of introducing an inflation-protected bond. One of the arguments he offered for why he felt such bonds are not needed was this: Once the government knows it has offset the impact of inflation on the incomes of a large section of population through issuing inflation-protected bonds it may not remain as pro-active in containing inflation as it is now. On the other hand, if senior government officials including those responsible for economic management have an inflation-protected bond for investment, they too may slack in making efforts to keep inflation in check.
REAL NEED: Regardless of whether the government plans to introduce inflation-protected bonds or not, there seems to be a real growing need for such bonds for the simple reason that rising inflation is fast eroding the real value of people's saving with banks and investment in National Saving Schemes. The stock market currently witnessing a boom does offer better prospects but the majority of people lack the expertise needed for making investment in stocks. Mutual funds seem to be the natural future choice for small savers but even these funds cannot guarantee that the real value of one's principal investment would not erode with rising inflation.
Even in the most developed capital market of the USA where investors have far better resources needed for making an informed decision than in Pakistan, there is an instrument called TIPS i.e. Treasury Inflation-Protected Securities. These securities adjust the value of the principal amount of investment according to inflation and do offer a floating rate of return.
And traditionally inflation-protected securities are "issued by governments themselves and not by the corporate sector," said Basir Shamsie, head of fixed income, at Jahangir Siddiqui & Co. Ltd.
