Spearhead Analysis-30.01.2020

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

Pakistan is grappling with a difficult economic situation, which has severely burdened the people with a high cost of living with rising interest rates in an inflationary environment. On top of that the Government has all but lost its control over the Financial and Economic team. The country has a Central Bank Governor and a Finance Minister, who are both firmly indoctrinated and entrenched in the IMF and World Bank way of thinking. As a result, while the Government continues to emphasize the anti-corruption drive for recovery of ‘looted’ wealth, the Finance team is busy trying to implement the IMF agenda at a very high cost for the people of Pakistan. Amidst all this, reliance yet again continues to be placed upon the economic stalwarts from the past, who have served under successive governments without any meaningful improvement in the economic or financial condition of Pakistan.

If the past is anything to go by, then there was apparent economic progress when funds from the USA were freely flowing into the country and there were hardly any laws to circumvent infusion of money through the parallel economy. Now when the screws have been tightened in the aftermath of the FATF actions and a crack-down launched on the parallel economy, we suddenly find a very different Pakistan. There is severe demand constraint due to reduced spendable income and opportunities for investment and employment continue to decline. At the same time with a flawed governance structure and continued experimentation by the Government, the confidence levels have fallen and there are limited opportunities for growth or employment. The multi-lateral institutions have accepted that the growth rates would be significantly lower in this and the next year.

The Supreme Court of Pakistan is pursuing the case against the Railways Minister and has even indicated that he should have resigned in the aftermath of the recent tragedy. This is a task that should have been performed by the Executive office of the country. The Court has also severely reprimanded the National Accountability Bureau (NAB) for ‘crossing’ its limits. Most of the political opponents, chastised for corruption, are out on bail while some have left the country. Cases continue to be pursued, and media headlines keep coming out about the corrupt practices of the past, but nothing meaningful has come out of these to date. There appears to be growing disenchantment amidst some factions of the PTI, which is impairing the ability to govern effectively. In a word, nothing has really changed as the saga of political bickering, infighting, and flawed decision making continues to plague the system. All this comes at a high cost for the people of Pakistan.

The economy is the crucial link in the revival chain and one that has failed to perform as per the promises made by the Government. At this crucial juncture the eminent Economist Dr. Atif Mian has come out with his opinion on the manner in which the Central Bank is managing the fiscal situation. The State Bank in its recent statement has kept the key policy rate at 13.25%, which has led to an influx of ‘Hot’ money in search of higher returns, with some US$2.25 Billion in T-Bills (short-term), which has helped elevate the reserves to a level of US$18 Billion plus. The problem with Hot money is that it can disappear just as quickly as it came in with a decline in the interest rate. As a result, if the Central Bank had made a downward revision in the rates it could have drained a substantial portion of these funds and placed Pakistan in a difficult position to manage the outflow. For now the Central Bank is constrained to maintain a high interest rate environment. Perhaps, the thinking was that the high interest rates would attract instant Hot money to bolster the reserves, but then higher exports and Foreign Direct Investment (FDI) would start to reduce the risk created by the Hot money. The latter scenario has not played out as the Government has been unable to create the environment of confidence and growth required for building up traction in FDI.  

The mistakes of the past are being repeated according to Dr. Mian. The reliance has continued to be on external borrowings, with IMF support and maintenance of an over-valued Rupee which severely hampered exports. Today Pakistan’s debt has the lowest maturity among peer countries. As a result, inflows continue to be short-term with maturities in the 3 -12 month range. Of the foreign investment of US$2.25 Billion only US$24 Million went towards the longer term Pakistan Investment Bonds (PIBs). If the short term inflows are not rolled over the Government faces massive repayment risk. According to him this dependence has led the country to losing its sovereignty due to the ‘external fragility’, which in turn translates into a dependent foreign policy as shown by the recent actions of the Government, such as the decision not to attend the Malaysia Summit. The borrowing from Saudi Arabia has come at a high cost for the country.

To resolve the quagmire Dr. Mian proposes a four-pronged strategy:

  1. Flexible Exchange rate management to deliver accumulation of real net reserves, essentially modest current account surplus, for a while. This would also send a strong signal of support to the export sector.
  2. Discourage short-term debt and portfolio flows. Promote long-term capital formation via FDI, but with proper valuation protocols and technology transfer.
  3. Strong safeguards against money-laundering and capital flight.
  4. Capital account convertibility should be prioritized for tradable and high-spillover sectors, and for long-term capital. Convertibility should be discouraged for non-tradable sectors such as real estate.

The crux is that there should be reduced focus on short-term foreign investment in Government Money Market instruments at high rates. FDI has to be based on the fundamental strength of the economy and should build the technology base within the country – it should not be on speculative basis. Convertibility has to be restricted to asset classes such as shares, rather than assets such as real estate and gold. 

Unfortunately, Dr. Mian summarizes that. “we have not seen a coherent framework that takes these principles into account. In fact, on the worrying side, the government has gone out of the way to encourage short-term foreign investment in government T-Bills. There is little benefit of such inflows…and much potential risk….they can constrain monetary policy and generate external vulnerability.”

The State Bank has been following a market-based exchange rate mechanism, but for the other recommendations to fall in place there has to be a paradigm shift in the structural framework of the economy. For that the Government needs to get its act together and engage people who understand the dynamics instead of relying on tried, tested and failed professionals, who have brought us to this level. Perhaps it is time to be objective about the whole situation and to rise above self and petty differences to work towards the real building up of the Pakistan economy.