Keeping the fiscal deficit at a low level is must for ensuring that the economy continues to grow, development agenda is pursued and jobs are created. The fiscal deficit cannot be reduced effectively unless the parking of untaxed money in undocumented avenues of savings and investment is discouraged.

Policymakers had this basic principle in mind when they decided in February 2019 to discontinue the sales of bearer prize bonds of Rs40,000. The government initially asked people to get all such bonds registered by March 2020 but then extended the deadline to December 2020. Now, as the deadline for the conversion of Rs40,000 bonds from bearer to “registered” is about to expire, the government has announced that sales of bearer bonds of Rs25,000 will be stopped after May 2021. Through a notification issued on Dec 9, the government has offered people to get such bonds “registered” or replace them with Special Savings Certificates (SSCs) or Defence Savings Certificates (DSCs). The budget wing of the Finance Division has said that the bonds can be registered or replaced with SSCs or DSCs through 16 field offices of the State Bank of Pakistan (SBP) Banking Services Corporation.

To incentivise people to get bearer bonds “registered,” the government has said that these bonds will attract two first prizes of Rs30 million each, five second prizes of Rs10m each and 700 third prizes of Rs0.3m each.

A sustainable model of borrowing needs to be designed with a greater focus on the NSS and registered prize bonds

The conversion of bearer bonds of high denominations into registered bonds or their replacement with SSCs or DSCs should enable the government to trace the actual wealth of the bondholders more effectively and tax them accordingly. That, in turn, should expand the tax base and yield the much-needed extra tax revenue.

The move should also help the authorities remove a key concern of the Financial Action Task Force (FATF) relating to the circulation of undocumented funds in the economy which, during untraceable change of hands, could potentially be misused for money laundering or, in the worst scenario, terror financing.

This is a serious concern. And to address it effectively, the government has promised to the FATF — and also to the International Monetary Fund (IMF) that is concerned about the circulation of bearer bonds for economic reasons — to convert other high-value bonds of Rs15,000 and Rs7,000 into “registered” bonds or replace them with well-documented instruments of national savings like SSCs or DSCs in the next few years.

Pakistan is just a few steps short of coming out of the grey list of the FATF. The recent decision to discontinue bearer bonds of Rs25,000 and convert them into “registered” bonds or replace them with SSCs or DSCs by May 2021 is one of those steps. Earlier, the country succeeded in cracking down on illegal transfers of foreign funds to and from Pakistan that not only satisfied the FATF but also helped in attracting larger volumes of home remittances.

But from a purely economic point of view, bearer bonds are intrinsically injurious to the economy’s health because they promote a parallel economy and affect revenue generation negatively. As a matter of principle, bearer bonds, particularly those of high denominations, should not have been introduced in the first place. When bearer prize bonds of high value were launched, banks had conveyed their concerns to the SBP regarding how these bonds would affect their deposit mobilisation. And the SBP had also conveyed its reservations to the Ministry of Finance citing peculiar economic ills associated with such bonds but to no avail.

To incentivise people to get bearer bonds ‘registered,’ the government has said that these bonds will attract two first prizes of Rs 30 million each, five second prizes of Rs10m each and 700 third prizes of Rs0.3m each

In fact, it was the PML-N government that had initially started facilitating the conversion of Rs40,000 bearer bonds into “registered” bonds — and had even introduced a “premium” or registered version of the same bonds. But the sales of bearer bonds were not discontinued at that time. Stopping fresh sales of high-value bearer bonds and converting those already in circulation into “registered” bonds are necessary also because the stock of prize bonds makes up a significant percentage of the stock of all National Saving Schemes (NSS). At the end of October 2020, the total stock of all prize bonds was about Rs760 billion or equal to 21.6 per cent of the total stock of NSS (net of prize bonds), SBP statistics reveal.

After gradually increasing the share of registered bonds in the overall stock of prize bonds, the government will be able in a few years to make greater non-bank borrowing through such bonds without compromising on its documentation drive. Since the Zardari era, banks in Pakistan have been lending heavily to the government, crowding out the private sector. This practice has to be altered to unleash the potential of the private sector and to compel the government of the day to exercise greater fiscal discipline. But that cannot happen in the medium term i.e. within three to five years if the government does not raise more domestic debts via well-documented instruments of non-bank borrowing, including the NSS of different tenors and “registered” prize bonds.

Generating larger volumes of non-bank debts will become all the more important once the economic recovery gains strength and demand for private-sector credit starts growing. On the insistence of the IMF, the government has already stopped inflation-fuelling fresh borrowings from the SBP and currently relies too heavily on commercial bank borrowing to meet fiscal gaps. In 2019-20 that ended in June, the federal government borrowed about Rs2.47tr from commercial banks whereas banks’ net lending to the private sector remained below Rs200bn or less than 8pc of the federal government’s borrowings. Meanwhile, net government non-bank borrowing through the NSS and prize bonds stood at Rs371bn or just 15pc of its commercial bank borrowing.

This pattern of domestic debt borrowing is not sustainable for economic growth. A sustainable model of domestic borrowing needs to be designed with greater focus on the NSS and registered prize bonds and reduced reliance on commercial bank borrowing.

Published in Dawn, The Business and Finance Weekly, December 21st, 2020