04 October 2004	Monday	18 Shaban 1425

The State Bank of Pakistan's official foreign exchange reserves for the FY 1998-99 stood at $2,279 million. Then came the coup d'etat. Our foreign exchange reserves went down to $1,967 million, a loss of 13.7 per cent. Then came September 11 followed by Bush's USA Patriot Act (the US Senate passed the USA Patriot Act on 11 October 2001).

For the FY 2001-02, SBP's official foreign exchange reserves stood at $3,219 million. The following year, our reserves went up by 100 per cent. For FY 2002-03, the reserves were up again crossing the $10 billion mark, an increase of 67 per cent. For FY 2003-04, the reserves rose but by a meagre 15 per cent.

To be certain, the SBP's foreign exchange growth is not 'export led. In 1998-99, our exports totalled $7,779 million. By 2003-04, exports had gone up to $12,313 million, or an average increase of 9.7 per cent a year.

Imports, over the same period jumped from $9,431,million in 1998-99 to $15,591 million in 2003-04. or an average annual increase of 10.5 per cent. In effect, imports have risen faster than have exports.

What we have been through has been an extraordinary accumulation of foreign exchange reserves. Japan, Thailand, Hong Kong, Taiwan, Singapore and China have all been through periods of rapid accumulation of foreign exchange reserves.

Almost every country that accumulated foreign exchange at a very rapid pace has experienced 'asset inflation' or a brisk increase in the monetary value of assets (primarily, property and stocks).

Almost universally, extraordinarily high bank liquidity and access to cheap credit have been the two main precursors to asset price bubbles. In Pakistan, for the past three years, money supply (the sum of cash, ordinary deposits, time deposits and readily convertible deposits) has grown much faster than nominal GDP.

We experienced high bank liquidity and went through the resultant asset price bubbles (read: high property and stock prices). To be sure, the SBP's raw data on foreign exchange reserves is forming a definite pattern.

Starting from 1998-99 up until 2001-02, our reserves were increasing at an increasing rate. Post 2001-02, our reserves were still increasing but at a decreasing rate.

During 2002-03 and 2003-04 the reserves did go up but the rate of increase had sharply slowed down to under 15 per cent.The raw data on remittances is also forming a pattern.

Starting from 2000-01, remittances went up by a hefty 120 per cent. During the years 2001-02 and 2002-03, remittances again went up but at a slower pace of 77 per cent. Post 2002-03, remittances have actually fallen by 8.6 per cent.

The rapid accumulation of foreign exchange reserves by Japan, Thailand, Hong Kong, Taiwan, Singapore and China was 'export driven'. In the case of economies that accumulated foreign exchange reserves through exports-Japan in the 80s and Thailand in the 90s, for example-the bubble lasted for a decade or so.

Production capacity, based on higher exports, expanded and that in return further stimulated export earnings. The cycle fed on itself but the bubble finally did bust leaving behind excess production capacity, severe asset deflation (read: falling prices) and bankrupt banks.

All bubbles eventually bust. Pakistan's accumulation of foreign exchange reserves, as a sharp contrast, has been 'fear driven' (as opposed to 'export driven). The life cycle of our bubble, as a consequence, is bound to be shorter than the bubbles that are 'export driven'.

On 19 April 2004, the KSE-100 Index of the Karachi Stock Exchange (KSE) reached a peak of 5,620 points with market capitalisation at Rs1.5 trillion. By September 22, market capitalisation had lost a colossal Rs132 billion or some $2 billion.

On September 14, Dawn reported that "flight of capital to lucrative real estate investment opportunities in the United Arab Emirates (UAE) in the recent months has emerged as a real threat to Pakistan's over $12 billion foreign exchange reserves." On I January 2004, one US dollar was worth 57.35 rupees. On September 23, the same was quoted at Rs59.75.

Gazing into the crystal ball, our rate of inflation is going to pick up steam, interest rates are on a rise, property and stock market bubbles are loosing air and a currency adjustment (read: rupee devaluation) is written large on the wall.