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“The Risks Faced by Pakistan’s Economy”

November 17, 2014

By: ASAD RIZVI   Published on November 14, 2014
State Bank of Pakistan will be announcing its Monetary Policy Statement (MPS) for the next two months on Saturday. The purpose of MPS is to provide direction to the economy, promote sustainable economic output and create jobs. More importantly, the central bank is required to make future projections by using its monetary tool effectively.

Central banks all over the world normally keep a close watch on the global economic and financial events. In recent months the Federal Reserve, the US central bank, remained in the limelight, as it decided to do away with quantitative easing (QE) that helped to avoid global financial collapse as well as create jobs in America. The impact of Fed exit on Pakistan’s economy has been almost nothing, as Pakistan was never a beneficiary of QE inflows. Unlike other emerging economies that were badly hit, our economy did not feel the pinch after the “Fed Tapering Talk” that began in May 2013.

Unfortunately, however, during all these years no extraordinary fiscal or monetary measure to improve the micro and macroeconomic conditions has been noticed. Rather focus remained tilted towards borrowing from overseas lenders and printing of money at home to fill the gaps that may have given some temporary breathing space. The fact is that a minor upward adjustment of economic numbers does not tell the truth about the growth story.

To support my argument, history suggests that since Independence, we have approached the IMF over dozen times to meet our funding requirements and to maintain foreign exchange reserves at a desirable level or else the coutnry would have defaulted. The sad part is that till date we have not been able to fix our ongoing challenges.

Our economic problem is that we rely heavily on foreign money that has inflated the size of our financial problems to an unimaginable level. The factors are obviously known, but remain unattended. They are low tax-to-GDP ratio in terms of percentage. Debt-to-GDP is extremely threatening; it is caused by low growth, low revenue collection. A high discount rate further makes debt financing very costly pushing it to a dangerous point, which requires serious attention and strategy to arrest its climb. There is surely lack of planning/vision to manage debt without any realisation that how much damage it is causing to the economy.

Business activity will never flourish and job conditions will never improve if we continue to target fiscal deficit aggressively, as it requires more balanced approach to maintain economic stability. Low business activities always have adverse impact on tax collection and depress new job opportunities.

Unfavourable economic environment also causes excessive pressure on exchange rate and exerts pressure on inflation, especially in our condition that suffers from deficit. Yet another big benchmark or indicator is the per capita income of Pakistanis, which is now falling behind its neighbours.

Furthermore, if we take a look at some of the monetary statistics of last 8-10 years ie, rising government borrowing from banks and the outstanding balance amount are no more in proportion. Currency in circulation that has hit a new high point of Rs 2.328 trillion or nearly 28 percent. It is extremely inflationary and is being ignored by authorities due to a lack of awareness about its impact on economy. Even SBP avoids discussing it at length in its monetary policy probably to avoid criticism.

The real factor of sharp rise of cash money in circulation is caused by rising asset prices. Real estate remains undocumented and actual amount is a black hole setting by the day. This type of inflation always has an effect on the stability of the system, as it is hazardous for the financial system. Interestingly, the size is in 5-7 folds of the actual documented amount and large part is not taxed. Hence, it is not the part of credit expansion in SBP’s balance sheet.

Lending ratio of the banking sector against deposits is down to an alarming level, which is almost half of the total deposits. Whereas, investment portfolio of government securities held by banks and financial institutions is whisker away from touching the highs of 70 percent, which must be some sort of bank portfolio world record. Technically such a high percentage of investment in government paper comfortably breaches the global rating agencies red line.

Such a high percentage of investments in government portfolio faces risk of downgrading by the international rating agencies. Because on demand, even 20 to 25 percent of the amount cannot be liquidated to meet requirement due to a liquidity squeeze. Economies faced with large deficits always have liquidity issues. Therefore, our growth story suffers from a complete mismatch. The nation should not be misled by the stock market boom, since it does not represent economic recovery in true sense. The national savings rate is too low and public debt is rising at an alarmingly high pace and gap between saving and investment increasing by the day. This is reflective of the fact that there is no economic healing.

The real cause of all the mess is that our economic model has become obsolete. Hence, a change in the model has become necessary. Pakistan’s economy suffers from a weak taxation system, a lack of economic foresight and weak legislations. Sate Bank of Pakistan needs to boldly write its Monetary Policy Statement and tell the truth about the undocumented and hidden asset bubble. SBP should highlight the factors causing unrest in the domestic market and the suffering of common man caused by incorrect food support price and food security policy. SBP needs to mention that the benefit of a fall in global commodity prices, in last four years by nearly 25-30 percent was not passed on to the common man, nor is it helping the economy.

Inflation is already down. LSM growth of 2.4 percent, agriculture growth of 2.2 percent or minor upward push in private sector is not commendable by any means. It does not justify a 10 pct discount rate, as the economy has to pay a heavy price due to higher discount rate.

This is one of the major causes of a sharp surge in debt (foreign and domestic). Annual debt financing of nearly Rs 1.6 trillion, which is 64 percent of the annual tax collection is a sin. Of the total Rs 18 trillion debt nearly 45 percent rise in this decade is caused due to a high discount rate policy.

Our annual debt financing cost is five times of our annual foreign borrowings. Our Central Bank should cut coupon rate and discount rate simultaneously by 300 basis points. It will reduce cost of financing by nearly Rs 170 billion annually. It is important to understand that with 12 pct coupon rate on 10-year bond, the cost at the time of maturity is 13. Such an action would also give a much-needed boost to a collapsing economy. Otherwise, at current pace another Rs 4-5 trillion will be added to the national debt in the next three years.

The views expressed in this article are not necessarily those of the newspaper.

Copyright Business Recorder, 2014

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