High ambitions, low savings

POLICYMAKERS in Islamabad have high ambitions for the economy’s rate of growth. Some senior leaders have repeatedly proclaimed that by adopting the right set of policies in the recent past they have managed to place the economy on a trajectory of high growth. A rate of increase of eight per cent in GDP is often mentioned as within the country’s grasp.

It has been difficult to understand the growth accounting behind these claims. I have yet to see a well-developed financial strategy that would provide the resources required for a sharp acceleration in the rate of economic expansion and its sustainability over a period of a decade or two. Has Pakistan reached the position from which it could launch such an ambitious growth strategy? Does the government know what to do to move the economy forward at such a pace?

The answers to both questions are “no” but that does not mean that Pakistan cannot achieve the kind of economic expansion we have seen across the borders in China and India or further afield in East Asia. Pakistan’s economy has the wherewithal to achieve these goals and to climb the economic heights ascended by many other Asian countries that, in fact, were relatively less well-endowed.

What is missing in Pakistan — and, unfortunately, missing by a long shot — is a strategy that would result in the design and implementation of public policy to achieve these lofty and commendable ambitions. There are many problems in the way the economy is being managed at the macro and micro level. Today I will focus on the question of the availability of resources for accelerating economic development and the use of the capital market for this purpose.

A sustainable and high level of growth can only be achieved if the economy has an adequate amount of resources available to invest; a well developed human resource base that could be put to work in the processes of production; access to technologies that would increase the productivity of the workforce; and access to markets, both inside and outside the country, to which the producers could sell their products.

None of these things are available in the needed quantity and right quality. Instead of going over the entire gamut of issues, I will focus today on what the government needs to do — but, thus far, has failed to do — in the area of mobilising domestic savings for development.

Commercial banking is one part of the financial system where the Musharraf government has made some progress. The banks, with 80 per cent of the assets controlled by the private sector, are aggressively mobilising resources and developing new product lines for putting them to use. The banking system is being reasonably well supervised by the central bank, and the regulatory system is keeping pace with developments in the world’s more developed financial centres. That notwithstanding, there are some problems with the sector.

The margins — the difference between the borrowing and lending rates — are still very high. This usually implies systemic inefficiencies or collusion among the operators. Experience from other parts of the developing world suggests that when foreign banks enter the system, efficiency improves and margins decline. Foreign banks are coming back to Pakistan.

Most of them were absent from the country; some of them are either expanding their operations or are entering the Pakistani market. This will have a positive effect on the development of the financial markets. It is, however, the development of the capital markets that is currently stalled thus creating pressure on the commercial banks to provide finance for industry and commerce. What is particularly underdeveloped is the bond market.

Many Asian countries have made impressive strides in developing the bond markets which barely existed a few years ago when what came to be called the “Asian financial crisis” swept the region. Bond markets are generally seen as stabilisers in the financial markets. If they had a significant presence in 1997 and beyond, they would have helped the countries cushion the shock produced by sudden withdrawals by foreigners from the banking systems.

Realising the role fixed income assets can play in bringing market stability, several Asian countries took measures to liberalise bond markets by opening them to foreign investors and by allowing international borrowers to issue domestically. Several governments also began to issue longer-dated debt maturing in 20 to 30 years.

Accordingly, aggregate local currency bonds outstanding in Asia, not counting Japan, grew 32 per cent in 2006, reaching $2.9 trillion in 2006. The combined value of these bonds was only $356 billion in 1997, the first year of the financial crisis. The surge towards long-term, fixed-interest borrowing is not limited to government issuers.

Corporate bond markets showed an even stronger growth at about 36 per cent. While these numbers are impressive in light of the history of the region, they are not very large given the resource needs of the Asian markets.

As countries develop, they seem to go through four stages, some of which overlap. As enterprises need to expand, they first tend to use “retained earnings.” Profits are ploughed back as investment. This was the case in the early phase of development for Pakistan’s industry where even large entities used internally generated further. This is till the case for small enterprises. The Asian Development Bank has estimated that there are some quarter of a million small enterprises in Punjab alone.

Once having exhausted the possibility of using internally generated funds, enterprises enter the informal markets for the financing they need. This preference for tapping the informal market is for different reasons. The enterprise owners and operators don’t have the assets the formal financial sector will need as collateral, or they don’t have the expertise to deal with the banks, or they don’t feel comfortable in pledging their assets.

The use of the informal sector for resource generation is a serious constraint on both expansion as well as new entrepreneurial activity. It is only when owners have gained financial and operational maturity that they are prepared to take the next step: go to the banking sector in search of finance. In many cultures and economies, traditional and regulatory systems allowed the close association of banks and industry.

In continental Europe and Japan, it was not unusual for banks and industries to have cross-cutting relationships. This was also the norm in Pakistan for a quarter of a century after independence. The Habib family, with extensive trading and later industrial interests, was invited by Mohammad Ali Jinnah to establish a commercial bank.

The success of the Habib Bank led other industrial and business families to take the same route, most notably the Saigol family that founded the United Bank and the Adamjee family that established an insurance business. It was the close relationship between the banks and the industrial houses that created the impression that there was a progressive concentration of wealth in the country. That impression resulted in their nationalisation in 1972-74.

Industrialists find it more comfortable to establish a relationship with the banks than to tap the equity markets to raise finance. In the latter cases there is some loss of control since raising capital through equity means, by definition, the dilution of control.

Traditionally, family-owned companies have found it difficult to issue shares in the capital markets since that exposes their working to outside examination and also allows outsiders, by entering the boards some say, in management matters. That said, equity as a source of finance has become an attractive proposition. This is particularly the case for the entrepreneurs setting up new enterprises.

By issuing “initial public offerings,” or IPOs, new entrants can raise money which does not carry any obligation, just a promise of a share in profits whenever they get to be made. While bank financing has to be serviced on a regular basis, return on equity is contingent upon the firm being set up making a distributable return.

This is where Islamic bonds — or ‘sukuks’ — enter the picture. Sukuk is a relatively new instrument of finance which has to meet certain conditions, the most important of which is that it must be “Shariah compliant.” There are no fixed “compliance” rules available and no single global — not even national — authority in existence thus far that can issue the compliance certificate to an issuer.

What the interested issuers have done is to set up their own Shariah boards made up of people who are recognised as authorities in the subject of Islamic finance. Their formal nod is needed before a company or a government can tap the rapidly growing Islamic finance markets.

What do the Shariah boards look for by way of finance? They investigate the products that will be produced by the company looking for finance (no alcohol in the line of production, for instance). If it is a mutual fund looking for capital, a Shariah board would exclude the companies that charge or pay interests for their operations. If an airline is looking for Islamic money, it cannot serve alcohol to its passengers.

Bonds become active instruments for the saving public, only if they are reasonably liquid. This means that the holders of the paper should be able to sell them in the market. The price the market will charge or pay for a bond depends upon a number of factors that include a return on investment, which is fixed for the duration of the instruments, the viability of the company which depends in turn on its ability to sell its products and services, and the fundamentals of the economy in which the company is located. The riskier the investment, the higher will be the rate of return.

A new instrument called junk bonds was developed when the investors were prepared to make risky investments and were willing to pay very high rates of return to those ready to buy their bonds. To help ordinary investors make choices in the fixed income markets, credit rating agencies give rankings to the issuer. An AAA bond carries very little risk. The bonds issued by the US treasury fall in this category. As we go down the alphabet list, the quality of investment deteriorates.

Pakistan has lagged behind in developing the bond market for financing the private sector. The few enterprises that have entered the market have done it modestly. The government needs to develop a well thought-out plan to develop this important instrument of finance.

This would need creating an environment within which the bond market can grow. Ultimately, the government should also look at the possibility of allowing local governments — in particular the municipalities in large cities — to tap the bond markets for the generating resources that they need for improving public services. Fixed markets have an important role to play but their development will need the government’s support.

Saarc: challenges ahead

ALL eyes are focused on the two-day 14th summit of the South Asian Association for Regional Cooperation opening in New Delhi today. Saarc is the largest regional organisation in the world in terms of population and covers approximately 1.5 billion people.

It is an economic and political organisation of eight countries — Pakistan, India, Bangladesh, Bhutan, the Maldives, Nepal, Sri Lanka and Afghanistan. It is estimated that out of the region’s total population at least 500 million people possess adequate purchasing power.

This, by any standards, constitutes one of the largest markets in the world. Besides this, major markets like China, Japan and the Asean countries are in the Saarc neighbourhood. Some emerging markets, like Russia and the oil-rich Central Asian states are also located in its vicinity.

Unfortunately, Saarc has not achieved much progress in its declared objectives of increasing regional economic cooperation to help South Asia’s teeming millions conquer poverty. However, its slow progress ought not to prematurely turn off interest in this very promising regional cooperative. Analysts say that the European Union, the most successful example of regional cooperation today, took around 50 years to achieve its present stature.

Saarc’s first two decades may be considered as its teething stages where it faced “traditional mindsets, fears, deep-seated prejudices and acrimonious bilateral relations” that underlined the history of some member countries. While bilateral issues of conflict still exist, it would only be fair to point out that the concerned countries have moderated their conflicting positions.

Indeed, this realisation is the most promising aspect of Saarc and could accelerate positive developments in the near future. Apart from economic cooperation as the main goal, Saarc leaders also realise how the organisation can be of use to them in giving mutual security and hastening positive developments in other areas.The world is now seized by the concept of finding bigger and bigger markets. The traditional view of the national market is too narrow to permit the unrestricted expansion of enterprise and economic growth. Only frameworks for regional organisations like Saarc can facilitate increased cross-border transactions of goods and, in the process, substantially increase the mobilisation of capital, entrepreneurship and production and distribution activities in individual countries. This, in turn, will increase employment and boost income-generation.

In recent times, President George W. Bush has made extensive visits to South American countries to sell his idea of free trade of the Americans. The move ultimately aims at carving out a common trading bloc of the North and South American countries to make the region a formidable economic giant.

Saarc is already the world’s biggest bloc (in terms of population) for trading but needs practical steps to move ahead. The region’s aggregate GDP stands at over 932 billion dollars, which is less than two per cent of the world’s GDP. The region’s per capita average is $2,777, which is more than 12-fold below the EU’s per capita income.

In view of the trend towards regionalism, as exemplited by successful trading blocs like the European Union, Nafta, the G-8, Asean etc, it becomes all the more essential for Saarc to safeguard its economic interests through an urgent coordinated course.Apparently in recognition of this fact, Saarc leaders decided to execute the South Asian Preferential Trade Agreement (Sapta) in April 1993, with the objective of facilitating trade among Saarc countries. This was followed by the signing of the South Asia Free Trade Agreement (Safta) in January 2004 in Islamabad.

Under this agreement, the relatively developed states in the region namely India and Pakistan are required to bring down their custom duties to zero to five per cent within five years. Sri Lanka would implement this plan in a span of six years while other member states would achieve this target within a period of 10 years.

Some estimates suggest that at present more than 60 per cent of world trade is being generated through regional trading arrangements. However, intra-regional trade among the Saarc countries constitutes only five per cent of the region’s total international trade. This compares quite adversely with other regional blocs. Nafta has succeeded in increasing trade amongst the member countries to 37 per cent, the EU to 63 per cent while Asean members conduct 38 per cent of their total international trade amongst themselves.

Geographically, the region is endowed with abundant diversity. A multitude of rivers spread throughout the subcontinent give buoyancy to agriculture in the plains and enhance the potential for hydroelectric power. Also, in an era when energy security has become an important issue, our proximity to regions which possess the bulk of the world’s energy resources augurs well for future economic development.

Given these inherent strengths, a smooth implementation of Safta can prove to be the harbinger of sustainable growth although this would mean overcoming all impediments through political will.

The experience of other regional trade agreements has revealed that harmonising standards and customs procedures and reducing transaction costs of trading by addressing non-tariff barriers play a larger role in effectively enhancing trade amongst member countries than the lowering of tariffs.

A study instituted by the Australian department of foreign affairs and trade has estimated that reducing international transaction costs by five per cent would increase the aggregate GDP of Asia Pacific Economic Cooperation Forum (Apec) countries by 0.9 per cent. Safta also envisages the initiation of such steps. It is essential that a liberal approach be adopted towards opening up respective economies. The larger economies, of course, are expected to be more flexible in this regard.

India is the largest country in the region. Its economy constitutes approximately 70 per cent of the region’s aggregate GDP. Thus though the trading regimes adopted by all the member countries will have an impact in their own right, the trading policies followed by India will have the most discernible impact.

The Saarc summit is expected to make progress towards the formation of a South Asian Development Fund. Also, Saarc has evolved various platforms over the years to tackle regional necessities.

Many developed countries have expressed an interest in being included in Saarc. So far observer status has been extended to China, Japan, South Korea, the EU and the US.

Iran has expressed its desire to become a member. In February 2005, Iran indicated its interest in joining Saarc as an observer, saying it could provide the region with “East-West connectivity. However, because of the current row over its nuclear facilities, it seems unlikely that it will be accepted as a member although its request for observer status could be taken up during the summit.

What triggered the judicial crisis

AT a time when one feared that the value of truth and what is right may not have survived the crush of expediency, sycophancy and habitual sacrifice of all that is holy and worth cherishing for the attainment of narrow self-interests, the 'black coats’ have risen to defend the honour and sanctity of the institution they are associated with.

The question now arises whether they can sustain their movement till they achieve their ends. This will be very difficult to do since their own livelihood is being affected.

After all, it is not the affluent, elite echelons of the black coat community that are bearing the brunt but those belonging to the middle and lower classes whose families break no bread if they do not earn on a daily basis.

The government has also realised that the momentum of the lawyers’ protest needs to be broken.

It is for this reason that future hearings of the reference against the ‘non-functional’ Chief Justice before the Supreme Judicial Council are likely to take place at longer intervals.

The issue is bigger than the fate of just one judge. It pertains to the independence and sanctity of the judiciary and is, as such, a political issue. In addition to this, democracy, the Constitution, parliament, good governance and the will of the people have all been reduced to a sad burlesque.

The need of the hour is for the mainstream political parties which have gained the most, politically and materially, from the system that now lies in shards and splinters at their feet, to rise to the occasion in support of the black coats.

They claim to have the people’s card in their pocket but have miserably failed to flex any muscle in recent years. Events have given them another opportunity to redeem themselves.

But with the exception of the MMA, which does not command nationwide support, the leaders of the big parties fled the country several years ago to escape legal action on corruption and criminal charges. The people are not going to follow lightweight second-tier politicians who carry no weight into the streets to face tear-gas, lathi charge and imprisonment.

The common man has lost all interest in politics. He may come out into the streets only on issues directly related to his interests but not on some arcane points of principles which do nothing to fire his imagination anymore.

Besides, this government gauged the depths of the so-called leaders and their parties some time ago and feels no threat from them. They know how to deal with them.

Action against the Chief Justice was precipitated by Naeem Bokhari’s open letter, which was widely circulated on the internet. The reference too was based on material contained in this letter. Apart from allegations regarding the Chief Justice’s son, Mr Bokhari’s gripe against the Chief Justice is that he used excessive protocol, insisted on a guard of honour in Peshawar, acquired a Mercedes, used government helicopters, airplanes and houses and refurbished his chambers at considerable cost.

If The Chief Justice abused his office, then he should be held accountable. But so should those who acceded to his demands in providing such perks, including the appointing authority which gave his son a job.

In any case, who doesn’t avail himself of such perks and benefits when in public office to as great an extent as they can get away with, especially with regard to nepotism and protocol? The prime minister’s motorcade on Shahrah-i-Faisal in Karachi on March 21, which I witnessed first hand, is a perfect example.

Traffic was blocked at all intersections along the route and at least a two-mile buffer was enforced ahead and behind the motorcade.

Pedestrians were not allowed to stand on the sidewalks and were herded into the nearest shops and side streets (where have the days gone when people would throng their leaders and shower rose petals on them as they passed by? Where have those leaders gone?). The motorcade itself consisted of at least a hundred vehicles of all sorts, with sirens blaring.

The intimidating scene was reminiscent of a full-scale armed invasion, drawing much comment in newspapers the next day. Is all this in strict conformity with the rules? I have seen British Prime Minister Tony Blaire’s motorcade in London. It comprised of two police motorcycles driving ahead of the prime minister’s car, which was followed by just two other vehicles carrying officials and security personnel. Even high-ranking police officers get more protocol than that in Pakistan.

As for the refurbishment of chambers, Benazir Bhutto and Nawaz Sharif both refurbished the Prime Minister’s House during their tenures. They also built a massive, vulgar new Prime Minister’s Secretariat that is a monstrous eyesore. Does anyone know how much all that cost? Who in power doesn’t use government helicopters, airplanes, vehicles and houses, even for private use? Recently, the chief minister of Sindh sent an Indian lady on a tour of Sindh in a government helicopter.

If all this, which has hitherto been condoned common practice, has suddenly become a crime, then why just target one culprit in an ocean of offenders?

Mr Bokhari’s other complaint against the Chief Justice is that he was harsh with police officers and often treated them to verbal threats and onslaughts. What was he supposed with do when the police overstepped their legal bounds or his orders were disobeyed? And since when have police officers become heroic standard bearers of all that is good and sacrosanct, deserving deferential treatment? They are an even greater nuisance for the poor common man than criminals.

But the government understandably has a soft corner for the police because they do their dirty work, particularly victimising political opponents. After I was elected MPA in 1997, the newly elected chief minister, Sindh, took me aside one day and complained that a judge of the Sindh High Court, who had been appointed during my father’s caretaker period, was creating problems by being harsh with police officers. I tried to explain, in vain, that he was doing no more than applying the law and giving legal relief to people who had been victimised by the police.

When his tenure as an ad hoc judge expired, he was not confirmed and returned to private practice. Our rulers forge greater affinity with state instruments of coercion that prop them up in power than the people whom they purport to represent.

Mr Bokhari further alleges that the Chief Justice would announce one decision in court but would produce a different written one. He also accuses the Chief Justice of mistreating lawyers, displaying an arrogant attitude towards them, not allowing them to present their cases and leaving no room for advocacy. Even if all this is true, the Chief Justice is not the only one guilty of such conduct.

The entire judiciary is in an advanced state of decay. Discrepancies in the announced and written orders have become a common occurrence.

The judiciary causes bottlenecks instead of providing remedies. Cases linger on in courts for decades without resolution, leaving no other course of action open for the parties but to take the law into their own hands, exacerbating the law and order situation.

Litigation has become a punishment for the complainant who exhausts himself in the pursuit of justice, while the defendant remains untouched and ignores the proceedings.

There is much evil under the sun, such as sifarish, favouritism, incompetence and worse that ails the entire judicial system that does not bear elaboration here. But it is an open secret. The cure lies in long overdue effective reform of the judiciary rather than a selective witch hunt.

Interestingly, Mr Bokhari writes “The Chief Justice would rise in the eyes of everybody if he walked from his residence to the court and hooters, police escorts, flags is just fluff not the substance of office.” Well, the Chief Justice tried to walk to court from his residence on March 13 to attend the first hearing of the Supreme Judicial Council and the world watched in horror the treatment meted out to him. A live illustration of enlightened moderation worth saving on a tapestry.

The fate of the non-functional Chief Justice and the outcome of the reference against him will go a long way in defining the future of the judiciary in Pakistan. If equity and justice do not prevail, then the blood on the black coats may eventually dry up and be washed away, but it will leave behind a stigmatic, indicting stain that no amount of whitewash will be able to conceal.