Institutional investment in NSS

It is now more than clear that the government is resorting to desperate measures to finance the bulging budget deficit. Apprehending that the fiscal deficit would be very high and anticipated sources of financing were drying up, the State Bank on 2nd April announced the auction of government securities, envisaging borrowings of over Rs one trillion from the banking sector during the current quarter of FY12. As if this was not enough, the Economic Co-ordination Committee (ECC) of the Cabinet has gone a step further to allow institutional investment in National Saving Schemes (NSS) in order to meet the growing requirements of the government.
It may be mentioned that when the government's financial position was relatively better, special funds like pensions, gratuity, superannuation, provident funds and trust funds were barred from investment in NSS, resulting in withdrawal of approximately Rs 150 billion from the NSS. The idea was, that since the NSS offered a higher rate of return, it was primarily meant for ordinary and disadvantaged groups of society like pensioners, widows and old people and institutional deposits such as the funds should flow to the banks. With the lifting of restrictions on institutional investment in the NSS, the government obviously hopes to raise a substantial amount from non-bank domestic sources and reduce its increasing dependence on the banking system, which had come under a lot of criticism in recent months. Another argument for such a step could be that bank borrowings by the government, especially from the State Bank, to finance the budget deficit are more inflationary than other forms of borrowings, and as such, should be curtailed to the possible extent.
However, seen closely, the ECC decision to allow institutional investment in NSS is a clear indicator that the government is not inclined or able to restrict its borrowing needs through prudent measures like lowering the budget deficit by mobilising higher revenues or curtailing expenditures or seeking the targeted level of budgetary resources from abroad. A glimpse of such an attitude could be seen from the proceedings at the ECC meeting on the same day (6th April) where, instead of some belt tightening measures in view of the dismal budgetary situation, fiscal concessions were offered to certain business enterprises. To make matters worse, the Federal Government had to agree to provide sovereign guarantees for raising Rs 210 billion for wheat procurement because the provincial representatives argued that it was not the provincial governments but the Prime Minister who had unilaterally increased the support price of wheat from Rs 950 to Rs 1050 per maund. Such a non-serious attitude of the government is fraught with risks which could be very damaging for the economy. The inflation rate, in particular, could rise at an alarming rate. The precise impact in terms of higher inflation could, nonetheless, only be estimated when we know the response of the financial system towards this measure. For instance, the measure could be highly inflationary if withdrawal of institutional investment from the banks is compensated by the State Bank by pumping in more money into the system. Since the State Bank has been resorting to this practice on the pretext of keeping the financial system liquid in the past, the implications in terms of inflation, exchange rate, poverty levels etc are quite obvious. The situation could further worsen because of lower availability of credit to the private sector due to the diversion of loanable funds to the public sector.
The measure could have been somewhat justified if domestic savings as a percentage of GDP were quite substantial and enough to meet both the government and private sector requirements. Since the rate of savings in the country is already dismal and there are no prospects of raising this rate in the foreseeable future in view of stagnant growth and the declining power and will of the households to save, the increasing pre-emption of available domestic resources by the government through any mode could only result in accentuating inflationary pressures further in the economy with all its ugly consequences. We are certain that the Finance Minister and his team is well aware of the ill-effects of the present strategy of the government and would try to do their best to follow a more prudent fiscal policy so that the task of the incoming government is less challenging.