THIS July, the rate of return on the National Savings Schemes (NSS) was reduced a third time since January 2001 by 2.5 per cent. In the year 2001, it was reduced by 2 per cent and 1.5 per cent in January and July respectively. Such a drastic reduction has had a telling effect on the incomes of those who relied on NSS profits. It is argued that the above reduction is driven by some “sound” economic logic that actually requires a closer examination.

The first argument given in defence of a cut is that the rate of inflation has been brought down significantly from a double- to a single-digit. So, the real rate of return is not affected so severely. The argument would have been sound if the officially determined rate of inflation was not disputed. As assessed by the independents and the buyers in the marketplace, there has been no let up on the price pressures. The price line appears to be rising steeply in the wake of the GST levies or exemption withdrawals, increases in the administered prices of utilities and in the price of oil claimed to be hooked to international oil prices. Increase in prices of these basic items sets off a spiral difficult to control.

Also, privatization of education is increasing the price of education tremendously. With significant upfront price pressures on education, health care (GST levies), transportation, and utilities with all their spill-over effects; common person wonders as to how the rate of inflation has been brought down to the levels as low as those claimed by the finance ministry. If people keep groaning under price pressures, then the technical argument of nominal versus real return on NSS does not carry weight.

A second argument that was popular with the policy-makers earlier was that of capital market development. The idea was to encourage people to invest alternatively in the capital markets even before capital market reform had run its full course. NSS profit rate cut was viewed as a measure to facilitate capital market development. This was highly impractical given the treatment that has thus far been meted out to small investors in both the stock and the bond markets. It is not in the near future that the capital markets will begin to instil confidence in the small savers who are more interested in risk-free returns. They would much rather purchase fixed assets likely to appreciate than transfer their money to avenues where it is likely to sink. This reason given for lowering the NSS returns will, therefore, remain unsound until the SECP has accomplished its mission of corporate and market reform that many are currently skeptical about. Skepticism notwithstanding, these are rare steps that require relentless pursuit until the goals are achieved. Only then will the finance minister be justified in exhorting the small savers to channelize their money in the above direction. Otherwise, he will sound like a neo-liberal enthusiast out of touch with the third world ground reality that makes NSS rate cut an inviable means towards the end of capital market development. The latter route does not offer a safe alternative to individual financial investments in the NSS.

As for institutional investments in NSS, while a ceiling would be in order in the light of institutional cash and funds management requirements, viewing the ceiling and NSS rate cut as means to induce fixed investment from the private sector is to take another simplistic view of the investment climate in the country. If the investment climate is not conducive as has been the case in Pakistan for several years, then private capital will tend to fly out from a country which is also closing various options for, at least, secure financial investment. Capital flight has been a problem for many underdeveloped countries even during relatively stable periods conducive for investment.

So, while a development encouraging environment should be inducing private investment, domestic capital may tend to flow out still if returns from fixed investment at home are below expectations, other things held constant. So, even in those times when the non-economic variables are not discouraging, capital may flow out in search of higher returns thus creating pressure on the capital account. Private sector investment is, therefore, inter alia a function of high ROI expectations that may never be realized even in a smoothly functioning economy. This is one of the factors that may also inflate the underground economy thus creating further pressure on the fiscal deficit. Both of the above tendencies would increase demand for government borrowing thus making us sink deeper into the quagmire from which we are trying to emerge. So, to believe that NSS rate cut will alternatively encourage more private sector investment is to again ignore other crucial factors that discourage it. Unrealistically high ROI expectations are a major deterrent to fixed investment in the formal sector. Hitting it big overnight is a part of our culture which puts a premium on rapid acquisition of wealth even if it is ill-gotten.

Coupled with political uncertainty, the investment issue becomes a more complex which even a lowering of the rates of interest has not been able to address thus far. So, another stated reason for cutting the rates of NSS profits is to divert savings to the banking channels instead. It is again believed that a decrease in the lending rates of interest would encourage private investment. Even though the above relationship holds good in elementary theory, it assumes other things constant which are not so in turbulent third world countries as briefly outlined above. So, relationship between the lending rates of interest and fixed investment is not as direct as posited in theory. Last year, the private sector lending targets were not achieved as neither was the demand for loanable funds adequate nor were the lenders confident about lending liberally. In the wake of wilful defaults in collaboration with banks’ staff and ensuing accountability, the lenders remained shy too, finance ministry’s calculations to explain this shortfall notwithstanding. So, in addition to non-economic variables and investors’ ROI expectations, organizational governance and management at both the ends of borrowers and lenders will assume salience in determining private fixed investment. Therefore, to believe that diversion of savings from NSS to banks and lowering of interest rates would be themselves spur private investment is indeed simplistic.

Further, lowering of the rates of return on savings would adversely affect individual savings in a country where government savings are non-existent and corporate savings lower than the potential due to either poor corporate performance or incomplete disclosures. Individual savings are low not only due to low per capita income but also due to iniquitous income distribution skewed in favour of the wealthy whose savings potential is low and that of conspicuous consumption high. With rising unemployment and stagnancy in the job market, individual savings are likely to be further depressed. This tendency will be aggravated by a downward pressure on the rate of return on savings, both nominal and real. Real rate will decline too in view of rising pressure on the price line, finance ministry’s claims to the contrary notwithstanding. With a dismal outlook for savings, the lending rates of interest are least likely to look up too unless repressed.

With the reasons given for cutting NSS profit rates not very convincing, one can only conclude that the cut is made prematurely before the right institutional, attitudinal, cultural, and politico-economic conditions could come to prevail in the country for the much desired investment so difficult to mobilize yet for the reasons above. The NSS depositors are then expected to wait for the “trickle” not likely to come unless we grow out of the current impasse. It is unfortunate that we are again being told to wait for the “trickle-down” effect by none other than the finance minister, Mr Shaukat Aziz, when such promises never worked in the past anywhere in the developing world. The “trickle-down” model, therefore, stood debunked in theory and in practice. Resurrection of such obsolete concepts certainly does not augur well for the future. A disappointed people will only find amidst them greater dissidence, frustration, violence, and a law & order situation which we unfortunately try to treat in isolation of the econo-political factors that feed into them. One such factor is the withdrawal of a bit of a trickle from people’s savings that they accumulate by foregoing current consumption or over a life time in the form of pensions or lump-sum payments from premature severance. Snatching away this fraction of a trickle is indeed harsh especially when it is not backed by sound economic logic.

Another reason usually given is the reduction in the domestic debt-servicing burden. This is where more information needs to be made public. That is, the precise impact of NSS rate cut on domestic debt-servicing needs to be communicated. The nominal interest rate on the stock of domestic debt showed a declining trend between 1996 and 2000, according to a Debt Reduction and Management Committee Report of 2001. The real interest rate will remain disputed in the absence of a credible rate of inflation. While Pakistan’s domestic debt burden is comparable to India’s as a percentage of GDP and is lower than India’s as a percentage of revenue, it is the net present value of Pakistan’s external debt as a percentage of GDP which is more than twice as high as India’s.

And, while more than 80 per cent of India’s total debt is domestic, Pakistan’s domestic debt is almost 50% of the total debt. So, if Pakistan is attacking its domestic debt as a part of a debt management strategy, then this strategy by itself will not make Pakistan’s economy turn the corner unless it is a part of an effectively comprehensive overall economic development strategy. As for the overall approach, we either get to hear about the “trickle” two to three years down the road or we see a belief rooted in the neo-classical tradition inappropriate for a developing economy like Pakistan’s. Or, worse still, we see issues being dealt with in isolation like that of debt or investment or terrorism mentioned above when actually all of these are intricately intertwined.

As a part of these piece-meal approaches, it is the good NSS saver who stands crucified for a goal least likely to be achieved with a neo-classical mindset. It is hoped that before calling for more sacrifices, a credible development strategy will be hammered out with consensus and the neo-classical autocracy will be overthrown soon!