KARACHI, Jan 28: A major challenge as well as opportunity facing policy makers is how to employ the growing foreign exchange reserves/surplus money to spur economic growth. The key issue is how and where to invest?
The economy is now experiencing an increasing imbalance, with growing supply of foreign exchange far exceeding the sluggish market demand, creating excess liquidity.
And the formidable challenge is to make the domestic market prosperous, initially through employment-generating investments.
A frustrated president of a small private bank, awash with liquid cash, encountering lack of investment avenues, complains: “ There is no market demand for money, no business and no economic growth. If there is economic growth, there will be demand for money.”
Apart from home remittances, the exporters are remitting 100 per cent of their earnings or even liquidating funds accumulated abroad. These funds are being invested in running businesses, in stock trading and in buying real estate. These remittances have reduced the demand for bank credit.
Trading in shares has made stock exchanges buoyant but is not creating new assets, enhancing productive capacities or creating employment. Money is easier to make from currency and stock trading than investment in manufacturing or agriculture, for which, the government needs to improve enabling environment, say investors. For lack of business opportunities, the banks are also investing in equities.
And to quote a financial analyst “The tidal flow of liquidity is likely to continue” and” a momentum investment mindset should propel domestic equity market.”
Currently, the capital inflows are robust, principally, due to soaring remittances, stimulated by 9/11 incident and the Bush doctrine. The remittances have swelled from under one billion dollars per year prior to 9/11 to $2 billion during July-December 2002. The figure may go up to $4 billion for current fiscal.
And to quote the SBP governor Dr Ishrat Husain, these massive inflows of remittances are creating the country’s” capacity to stand on its own feet.”
As the foreign exchange reserves have soared to an unprecedented level of $9.5 billion, policy makers want to retire expensive multilateral debts. The IMF would be consulted on the issue and the numbers would be worked out. This could reduce the budget deficit and create more space for spending on badly needed infrastructure.
Similarly, the fiscal deficit target has been revised, with IMF approval, from four per cent to 4.7 per cent. Public sector projects will be provided bank credit in foreign exchange. The limit for these loans will be set by the State Bank. An official reckons that these borrowings could range between $100-200 million.
The State Bank is buying the foreign exchange in excess of the demand in the inter-bank market and is sterilizing the rupee sale proceeds by transferring its own stock of T-bills to the commercial banks. The SBP intervention in a declining exchange market involves costs, which, according to one estimate, would mount to Rs23 billion during current fiscal. SBP’s budgeted revenue was projected at Rs 26 billion.
While not opposing the central bank’s policy, currency experts feel that exchange rate adjustments should have been faster and the SBP costs, thus saved, could have gone for anti-poverty programmes instead of subsidizing exporters who have already been compensated by lower interest rates for the loss suffered due to appreciation of the rupee.
Financial analysts think that gradually the rupee will be allowed to gain further strength and the short-term exchange rate will stabilize at Rs55 per dollar.
Pakistan, for the first time, has surplus foreign exchange reserves that require to be gainfully employed. About ten per cent of the reserves are proposed to be invested in Triple A securities, that are almost risk free but yield very low returns.
The State Bank is not looking at options in the Asian region, where many governments have floated bonds, now being traded in the market, with much higher yields, four per cent above the rate on US government securities.
As money invested in the USA by individuals and business houses in the Middle East started flowing back to its place of origin, some countries like Iran have floated euro-denominated bonds. The Islamic Development Bank raises money from the markets for financing projects and imports of commodities by Muslim nations. Though the Asian markets do not have an appetite for massive investments like USA or Europe, yet small investments in a wide range of securities launched by different governments, could spread the risk and improve the yield. As in many of these states, IMF and World Bank have huge stakes, sovereign defaults are unlikely. Besides, the global trend of flight of capital from the world financial centres to the periphery, is reducing risks.
Presently, the entire forex reserves are held in dollars, though some countries like China, diversified their holdings in euro with the initial signs of a economic downturn. Today, the euro is quoted around Rs 62 against approximately Rs58 for a dollar. Of course, the euro has not become strong, owing to it’s purchasing power parity (PPP) but because the dollar is becoming weaker. Pakistan needs to look at the option for diversifying its forex holdings.
The dollar reserves have to be seen in the context of the US economy struggling for economic recovery. If historical record is any guide, the US may face a cyclic depression, repeated every sixty years. It means a bleak future for the dollar, specially when the US fiscal deficit is growing.
The American trade deficit is financed by trillions of dollars. To quote an Indian report “The USA has taken $5 trillion from the world” and so” the world saves for the USA and the Americans spend freely.” The question arises how long will Washington sustain the growing deficits and service these debts specially in difficult times? Merely, by printing more dollars to keep the process going ? Would not the foreign investors in US securities, like Japan, India and China, at some point of time, get wiser?
The turn around in Pakistan’s external sector is explained primarily by “reverse flight of capital” and remittances which currency experts believe could continue at an accelerated pace for the next three to five years. The flight of capital has stopped due to increased scrutiny of international fund flows. Now. the “reverse flight of capital”, according to one official estimate, accounts for $500-600 million.
Overseas Pakistani investors’ first preference is to make investments in stock market and buy plots to build houses. They buy durable for their families. It has ripple effect on the economy.
Yet the major banks are not ready for house financing. Their traditional business is opening of letters of credits and corporate financing. They have yet to acquire professional expertise for house-financing. The enterprising ones among bankers are inclined to fund commercial housing projects but find already invested money stuck up and avenues of funding choked because of irregular construction of plazas and shops have not been legalized despite many policy pronouncements. Officials have identified no less than 38 industries which could get a boost from housing and construction industry. A top banker says to begin with, HBFC should be activated. Other snags have to removed promptly.
In rich countries, individuals own $23 trillion worth of equity and have invested nearly twice the amount, an estimated $40 trillion, in real estate.
Whereas, there is focus on the problem of risky bank lending and rightly so, not much attention is paid to cost of the loans to small or retail borrowers. Corporates can get loans at as low as 7 per cent. For consumer banking, the rate is 13 per cent. With fees and other charges, the cost goes up to at least 15-16 per cent. Can even all middle class consumers afford such expensive loans ?
The government is trying to create employment through development of small and medium sized industries. In India, funds are flowing into a network of small and cottage industries in the countryside. In Pakistan, there is no rural industrialization and no rural infrastructure. And the bank loans are expensive.
There are improvements in the economy that send positive signals to the investors. To quote Taurus Securities “the exchange rate is stable, foreign exchange reserves are high, inflation and interest rates are low, there is a slight improvement in public sector governance and corporate earnings are up.”
The government’s growth strategy rests largely on the provision of cheap capital (low interest rate) to business, coupled with friendly policies.
However, the security house reckons that “ a monetary policy driven growth will take time to work its way through the economy and till that time the banks will be flushed with excess
liquidity.”
