Pakistan Shinning II - Propoganda or Reality

In the part I of this series I set out to expose the hollow slogans of this Government, especially its tall claims of the great strides in economic development that have occurred over the past 6 years. Using officially published data, I had demonstrated how the story of our phenomenal GDP growth was nothing more than number juggling.

The present dispensation remains as clueless as its predecessors when it comes to analysing the primary drivers of economic growth in our country. In this writeup, I intend to focus on the single most important driver of economic development for any country and suggest a possible course of action that can truly set us on the path of sustained development.

For those who may have missed my last article, its main thrust was that, in the entire history of human endeavour, there is no precedent of any nation having developed economically without consistently saving and reinvesting a substantial portion of its annual GDP. The stellar growth of the Asian Tigers (Hong Kong, Singapore, South Korea, Taiwan, and Malaysia) and Mainland China during the past 25-30 years is witness to this phenomenon.

All these countries displayed rates of saving and investment in the region of 25-35 per cent per annum...which, using standard Capital Input-Output ratio of 3:1 translated into annual GDP growths of 8-10.5%. It is no wonder then that their GDPs grew from 500% to 1000% over this timeframe. Even India, a relative newcomer on the scene, has been able to achieve similar success over the past 10-12 years.

For Pakistan, despite the Government’s attempts at obfuscation, utter failure is confirmed by our recent official data encapsulated below:

Fiscal Years (amounts in PKR billion)2002-032003-042004-052005-06

GDP at current factor cost4,8235,5326,5487,450

GFCF (Gross Fixed Capital Formation)7368451,0871,420

Less: Consumed in the year (depreciation)391428480580

NFCF (Net Fixed Capital Formation)345417607840

Maximum possible incremental GDP (1/3)115139202280

As percentage of GDP2.38%2.51%3.09%3.76%


So, all that talk of our economy having grown at 7% p.a. over the recent past is nothing but hogwash.

For the last fiscal year on record, ie 2005-06, the components of the Gross Fixed Capital Formation reported at PKR 1420 billion have roughly been the following:

1. Domestic Savings @ 9.6% p.a. 715
2. Inward remittances (USD 5.25 billion) 315
3. Foreign Direct Investment (USD 3 billion) 180
4. Foreign borrowing and Official Direct Assistance (USD 3.2 billion) 210
------------------------------------------------------- ----------------------
Grand Total 1,420
As percent of GDP 19.06%


If we are ever to achieve sustained GDP growth in excess of 7% per annum (which ensures a doubling of GDP every 10 years), then we need to target a GFCF ratio of 35-40% per annum. Obviously, of the resource heads mentioned above, the only one that any Government can directly influence, and one that should be the mainstay of any economy over the long run, is the first one, ie domestic savings.

Our performance on this measure, at under 10% per annum is one of the lowest rates in the world. There is absolutely no precedent in history where a country with such low rate of savings has shown high rates of GDP growth. It is a mathematical impossibility. We simply need to double this number, and in quick time too.

What keeps us from achieving a sustained annual domestic savings rate of 20% plus? The simple answer is "an anti-savings Government policy". First let us examine the various saving options available to ordinary citizens.

1. Hoard it as cash...because it is derived from undocumented trade or from illegal sources;

2. Keep it in a saving account in a bank or in some National Savings Scheme;

3. Invest it in real estate; or

4. Use it for punting on the Karachi Stock Exchange.

For most of the 80’s and 90’s, people preferred to buy high yielding (14-16% p.a.) National Savings Certificates. During the same period, national inflation ran around 10-12% p.a. This gave savers a real return of 2-4% per annum. In fact, thousands of middle-class retirees and savers simply lived off their savings which successive Governments were glad to soak up to finance budgetary deficits. The rate of domestic savings, accordingly, fluctuated between 12-15% p.a.

However, when this elitist Government took over in 1999, its priorities were quite different. It sought to lower its borrowing costs by forcing small savers to foot the bill...first by drastically slashing returns on National Saving Schemes, and secondly by allowing scheduled banks to lower returns on savings accounts to practically zero. As the then SBP Governor maintained, "my mandate is to recapitalize and revive domestic banking". What he left unsaid was, "by robbing poor and middle-class households".

Proof of the foregoing can easily be gleaned from the data on scheduled banks presented below:

Calendar Years (amounts in PKR billion)2003200420052006

Bank’s Networth (Capital plus reserves)129151194336

Compound annual growth of Bank’s Network17.1%28.5%73.2%

Customer Deposits1793216126623,000

Customer Loans & Advances1170158920442,409

Net Interest Spreads (per annum)7.50%5.28%6.56%7.51%

Global average Net Interest Spreads3.00% ---

Excess spread earnings of Pakistani banks4.50%2.28%3.56%4.51%

Post-tax earnings at Savers’ expense37244667173

In a nutshell, over the past 4 years, PKR 142 billion or 42% of banking industry’s current networth of PKR 336 billion is derived from ripping off their hapless savers. Is it any wonder that today our banking industry is the darling of Karachi Stock Exchange? The situation is so scandalous that even the new SBP Governor has taken note and made threatening remarks in an effort to induce banks to give their depositors a fair return on their savings.

However, as mattes now stand, with inflation around 9-10% per annum, and average deposit rates still stuck at 3-4%, bank savers are losing upto 6% of their yearly savings. Under these circumstances, do you suppose our national savings rate is likely to increase or decrease?

The recent profile of the other pillar of domestic savings, ie National Savings Schemes, is no better. In the decades of the 80’s and 90’s, domestic savings under this head were growing at a fast clip in excess of 10% per annum. Recent data of this source of national savings is given below:


Fiscal Years (amounts in PKR billion)2002-032003-042004-052005-06

In current Rupees982984940934

In inflation adjusted 2001-02 Rupees893856783718

Could one imagine a more pathetic snapshot of retrogression? And, yes, this is the consequence of the Government’s conscious elitist policy to enrich the well-off at the expense of the poor and middle class. The added bonus is that it also lowers the Government’s borrowing cost on its PKR 2.5 trillion worth of domestic debt in which NSS figures shown above are reflected as "Unfunded Debt".

Since I often receive emailed feedback from my readers complaining that I only pen critiques without offering viable solutions to issues, let us now focus on the latter in as much as our abysmally low rate of national savings is concerned. And because the two major repositories of our national savings are the banking industry on the one hand, and National Savings Schemes on the other, my suggested solutions are also in two parts.

THE BANKING INDUSTRY: As regards the banking industry, the SBP Governor’s veiled threats of disciplinary action notwithstanding, I tend to agree with the industry’s view that apart from jaw-boning the Governor can legally do precious little to rein in the industry’s rapacious practices.

However, I am sure that the Governor is aware of the fact that a similar situation had arisen in UK some years ago. There, on recommendations of the FSA, the British Government had imposed a special one-off tax on the industry’s super-profits. I suggest that the Governor request the Government to pass special legislation to do the same and to impose super taxes on banking incomes covering the period described above. This will in one fell swoop bring banks to their senses, while contributing billions of Rupees to Government coffers.

NATIONAL SAVINGS SCHEMES (NSS): The other day, while visiting a friend of mine, who happens to be a senior bureaucrat in the know of things, I learnt some interesting facts. We all know that the bulk of funds in NSS are locked up in term deposits such as Defence Saving Certificates and Mahana Income Certificates.

With coupon rates on these schemes still in the region of 10-12% p.a., the Government is of the impression that they are expensive sources of funding its budgetary deficits. In actual fact, because a vast majority of these term funds are encashed before maturity, their holders suffer penalties for premature encashment.

I was told that taking premature encashment into account, the real cost of NSS averages around 6-7% p.a. Now, with inflation running 50% over this rate, the Government’s public debt is in fact shrinking in real terms. This is confirmed by the snapshot of inflation-adjusted NSS balances noted above.

If one accepts Government data and takes account of the 35% cumulative real GDP growth over the past 6 years, NSS balances should today have been 35% higher, ie at least of the order of PKR 1.3 trillion instead of being a shade under 1 trillion. The easiest and simplest solution for the Government is to immediately raise the yield on standard NSS offerings described above in a manner that ensures savers a positive, inflation adjusted, return.

This does not mean that it should simply raise its rates on longer term deposits to 12% p.a...which is where they are already...but to a target rate that accounts for the fact that premature encashment habit of the average saver usually shaves 3-4% per annum from the coupon yield of these schemes. In other words, the Government needs to enhance these rates back up to their levels of 2001-02. That is the price one has to pay if the goal is to raise the level of annual national savings back to at least 14-15% immediately.

NOVEL NEW SCHEME: However, the foregoing initiatives may not be enough, and for a very good reason too. If one looks at the profile of deposits in the banking industry, it becomes apparent that over 70% of banking deposits are either current accounts (that pay no return at all) or savings deposits (with average yield under 3.5% p.a.).

In the absence of any competitive threat for these core deposits, banks have no reason to change their predatory pricing. For the average household that perforce maintains savings accounts at banks to draw funds as and when needed there is really no viable alternative. What I am about to suggest is one such alternative.

Readers, especially those who happened to have travelled to USA in the early 80’s will recall a seminal development in the financial markets spearheaded by the famous brokerage firm Merrill Lynch. It was called the Cash Management Account, or CMA. It was simply one’s brokerage account at Merrill Lynch on which Merrill Lynch credited daily interest income at the going money market rate (the rate at which banks borrow overnight money from each other).

In a very short time, everyone and his uncle too had a CMA account earning income at the going market rate. This put the entire banking industry under the gun. It could not ignore Merrill Lynch’s challenge, and had to follow suit or risk losing its customer base.

I suggest that the Government use its NSS franchise for a similar initiative. The mechanism is simplicity itself. All that NSS needs to do is to authorise a bank (or banks) of its choice to accept deposits into so-called CMA accounts and to issue depositing customers checkbooks with the NSS logo and to credit these accounts daily with a return equal to the going money market rate.

Of course, all inflows to these accounts would be immediately credited to the Government’s consolidated fund, which would be periodically debited for amounts equivalent to normal customer withdrawals and the contractual credit of daily mark-up. For its services, the partner-bank of NSS can be reimbursed a negotiated fee, say a quarter of one percent on balances handled.

Since savers would no longer need to maintain idle cash balances for daily kitchen expenses, I believe that through this device, the average rate of national savings will jump by at least 2-4% per annum.

DOING AWAY WITH TAX ON SAVINGS: Finally, we come to the issue of taxing savings. Nothing could be more detrimental to inculcating a national savings habit. The Government taxes savers’ mark-up earnings at a rate of 10% per annum (in fact 10.4% p.a. if one accounts for the factor of quarterly compounding).

Since savings accounts in the banking industry hold around PKR 1.2 trillion worth of customer deposits that on average earn 3.5% p.a., mark-up credited is of the order of PKR 42 billion of which Government takes away PKR 4.2 billion. Surely, the Government can do without this piddly amount if withdrawal of such a tax can boost the level of national savings by several percentage points.

And if the Government chooses not to do so, it should at the very least exempt all NSS accounts including the suggested CMA accounts from such a levy.

And as long as we are borrowing one American idea (CMA accounts), we might as well borrow another one of their successful models. To promote rapid infrastructural development, US lawmakers authorised city and town governments to issue tax-exempt bonds to individual (non-corporate) savers.

These instruments, known in financial market jargon as "Muni’s" (short for Municipal Debt), remain the mainstay of urban development. For Provincial Governments that are forever cribbing about the paucity of Federal transfers from the common revenue pool, this would immediately create a low cost of investible resources. The added bonus would be a significant rise in national rate of savings.

To conclude, in the humble opinion of this scribe, our economy has no hope of catching up with economic growth rates currently enjoyed by China, India, and the Asian Tigers as long as our national rate of savings remains in the pits. And, it is not enough to force the banking industry to give a fair shake to its depositors.

Proactive policies and initiatives need to be taken to ensure a positive outcome in quick time through a thorough revamp of NSS with introduction of savings boosting schemes like the CMA account and tax exempt Municipal Bonds. With a PM who has spent the better part of his life in the service of Citibank, these suggestions should not pose any conceptual difficulties.