Where is the money going?

Ever since the new government announced its budget, there is growing noise that foreign exchange is going out of the country. The central bank took a strong notice of this perception and asked the Federal Investigation Agency to take adequate measures to arrest this informal capital flight.
And there is probably some truth in the notion that money is indeed going out of the system since the start of this fiscal year amid a weakening currency. This assertion is based on the fact that banking deposits are falling whereas the monies routed to the Nation Savings Schemes are not much.
Whether dollarization is happening or not; the money precipitating out the system is a point of concern for the central bank as well as the commercial banks. It is financial disintermediation and that practice ought to be stopped.
According to SBP’s data, scheduled banks deposits stocks are down by 2.6 percent or Rs192 billion in the first four months of this fiscal year. Then the weekly monetary assets sheet published at SBP reveals that demand and time liabilities of commercial banks are down by Rs138 billion from 1st July to 25th October.
Another worrisome fact is that biggest non-banking saving avenue is dry as well. Average monthly savings mobilized by NSS is meagre Rs15 billion in the first quarter of this fiscal year vis-à-vis a healthy average monthly inflow of Rs32 billion last year.
One plausible reason of lackluster performance of NSS is lower interest rates. But, that only partially explains this steep fall. During the first half of last fiscal year when the discount rate was in double digits average monthly inflows of NSS were as high as Rs42 billion while in the second half with single digit rates money flowing to NSS dropped to Rs22 billion per month. Therefore, something else has to explain the multiyear low inflows in NSS in the first quarter of this year.
There may be a case of people saving less; as disposable income (in purchasing power terms) decreases, marginal propensity to consume increases. Although historically Pakistan’s economic growth is consumption led, in FY13 the consumption expenditure has marginally reduced to 87.66 percent of GDP. This implied that savings were relatively high last year and the data of NSS supports that argument. So skeptics are susceptible about the root cause of low savings this year.
The announcement of levy of 0.5 percent tax on non-movable assets and access of FBR to banking deposits in this budget was initially cited by policy experts as a reason why people were shying away from financial instruments. Nonetheless, FBR is no more levying this tax, so the monies diverted from domestic financial system might revert back.
Still, the policymakers have to do more to entice people to save in domestic instruments. One instrument the SBP can deploy is to raise interest rates to discourage capital flight as well as make NSS lucrative. Then pegging banking deposits’ saving rates (demand liabilities) to discount rate is a step in the right direction. The rest is rightly left to government agencies including FIA to curb illegal capital flight.