Tough times need tough decisions

THE ghost of BCCI must be justifiably apoplectic at the recklessness that has brought the international financial system to this precipice.

Banking legends Bear Stearns, Merrill Lynch and Lehman Brothers were the first to go to the wall but the contamination, now out of control, crippled behemoths Lloyds TSB, RBS and HBOS amongst others.

The virus was not, as presumed, in the sub-prime sector, neither in toxic assets nor mortgage losses, which comprised some $550bn out of an outstanding credit in excess of $11,000bn. It was, ironically, spread by the might of the marketplace. Once corporate treasurers and bank chanceries joined Joe Public in withdrawing deposits, the impending run on the banks was warded off only by bailouts organised by free-enterprise, market-driven, capitalist governments one after the other.

The action that began with nationalisation-lite, as in the case of Northern Rock and Freddie Mac/Fannie Mae, turned to ‘part-nationalisation’ with the UK plan and was followed briskly by ‘quasi-nationalisation’ in the US. Other than a suggestion by one wag commenting on the crisis in Iceland — to wit, the proposal that since the number of depositors was greater than the entire population of Iceland, depositors should take to the boats and take over that country — the alternative was laissez-faire and putting at risk the entire financial system.

There was an inevitability, however unpalatable, in the coordinated action of the developed world in order to restore confidence, culminating in the $250bn purchase of equity stakes announced last Tuesday by Secretary Paulson.

This intervention was original only in its enormity and its unequivocal commitment to end the mayhem. Ten years earlier the US Federal Reserve had bailed out Long-Term Capital Management and reduced interest rates, leading to the greatest surge in consumer debt, inflated asset prices and in effect fathering the sub-prime crisis. Free market ideology subordinated to the dictates of pragmatism. Defenders of the free market will claim that since the origin of the problem was government intervention, governments must provide the solution. Detractors will see it as the evils of capitalism.

Pakistan’s issues are in the main home-grown, isolated from events abroad. Certainly some strains of the virus creep through but without a secondary market, derivatives and hedge funds, NBFIs and banks were not busy slicing up assets into instruments for downstream distribution. Interdependence of global financial systems notwithstanding, our issues of liquidity and falling asset values are a function not of a lack of confidence in the banking system but of widespread uncertainty over our future.

The regulatory regime over the formal sector as exercised by the central bank, government agencies and independent accountancy bodies has been up to date, efficient and effective. Our dilemma stems from the rapaciousness of governments — uncontrolled even by an independent central bank — who over the past years focused on consumption-driven growth and were impotent when it came to galvanising agricultural or industrial production. Whatever benefits that accrue in the early years of dictatorship evaporate at speed, leaving the fundamental problems unresolved. The corollary of such policies has been the ballooning of consumer debt and inflated asset values. Unfortunately debts are real whereas asset values are nominal and variable.

So where should we go from here? Certainly policymakers should heed Ben Bernanke’s warning that “failure of government to act in a timely manner was a major factor in past crises”, but today we need a clear committed vision of the achievable. We must avoid micro-management and focus rather than tinker at all levels. A tough policy is needed that targets a limited number of declared objectives — agriculture, education and SMEs. We must dig ditches, dredge canals, train teachers, promote industrial zones — do whatever it takes till these sectors are secure and sustainable, independent of the vagaries of the weather or political expediency.

But if intervention at the micro level is to be made even though support to the financial system may undermine the balance sheet of the government, then let it be wholehearted. The proposed Pakistan State Enterprise Fund (PSEF) of Rs20bn is a palliative not a solution. A more realistic solution, as proposed by London-based economist Iqbal Latif, is to buy back undervalued assets — NBP, petrochemicals, cement — in a form of reverse privatisation that would provide a strong signal for a return of confidence and good use of taxpayer money, especially when the economy improves and the government can offload the same assets at a profit.

Crisis provides opportunity to show the real quality of governance and to allow the State Bank independent room to manoeuvre and formulate sound decisions on the critical questions of liquidity, interest rates and banking regulation. This was done last week with a Rs270bn injection in the banking sector and easing of cash ratios. Irrespective of the immediate benefits provided by SBP intervention in the money market, the more lasting and useful benefit is the perception that there is independence of operations, there is a thought-out plan, there is someone’s hand on the tiller and that good governance is not just a mantra but a real policy.

But SBP intervention should come with the precaution that once a policy is formulated there will be consistency and no further tinkering until policy prescriptions are allowed time to work. This would also apply to the call from the West to alter accounting rules and permit corporations to adjust asset values to reflect their ‘true’, rather than marked-to-market, values. There is a danger that this would make valuations vulnerable to creative accounting measures and place an intolerable burden on external auditors.

This paper’s conclusion last week that “a global recession is the final nail in the coffin” is a dire prediction but a scenario that can be averted. Pakistan’s room to manoeuvre gets progressively restricted. Shahid Javed Burki referred to the developed world’s falling appetite for bailing out the poorer nations whilst their own economies wrestle with impending recession.

Government must focus on stabilising finances through all available means — finding donors for balance-of-payments support and securing trade credits — but the time for lateral thinking is now. Let government focus on clear achievable goals such as the expansion of the tax base, a task made easier in this technological age, so all sectors contribute equitably to the reconstruction and revival of the economy.

The poor abandoned?

WHILE the fight against terrorists continues to cause nightmares Pakistan has run into another menace — the threat of an economic implosion. And the hardest hit by this affliction too are likely to be the poor across the country.

Grey-haired economists are warning of hyperinflation, some of them hinting at three-digit inflation and not discounting four-digit figures. They foresee an industrial slowdown and a serious fall in employment. It is not possible to dismiss this assessment because reports of job cuts and lay-offs are already coming in from Karachi, Faisalabad and other industrial centres. As prices soar and the value of the rupee in the exchange market continues to tumble, it is said, all those hovering around the line of absolute poverty will find themselves increasingly unable to secure the bare essentials of existence.

It is possible that these pessimistic findings are somewhat exaggerated but prudence demands preparing for the worst even when the visible tip of an iceberg offers no indication of a deluge.

The repercussions of the global financial crisis have hit Pakistan’s poor at a time when their energies have been sapped and their reserves exhausted by the rising prices of atta and shrinking supplies of electricity and gas.

The price of wheat flour has been continually rising for quite some time. At some places the increase over two years has been estimated at 100 per cent. The entire population has seen images of people scrambling for a bag of flour offered at a discount. Many of them have been buying flour that is not fit for human consumption. No account is being kept of the time consumed in the search for the most essential food item at rates the poorest families can afford, nor of their humiliation.

At the same time the energy crisis is causing distress to a much larger section of the population, as its victims include beside the poor the lower rungs of the affluent who can have their bread and cake both. But the disruption of production again hits the poor the most. Many are forced to work longer to earn their meagre wages and a larger number are pushed into forced idleness and obliged to dip into their savings, if they have any.

Increases in street crime, the suicide rate and cases of mental disorder are all being attributed to the people’s growing inability to make the two ends meet.

A greater cause for anxiety than the misery of the country’s overwhelming majority is the state’s attitude to the multi-dimensional economic crisis. A senior economist’s observation that the plight of the underprivileged does not bother the elite because it is busy garnering its gains on dollar accounts may be an indulgence in cynicism but it is impossible to deny the fact that official initiatives over the past 20 months or so have failed to inspire public confidence.

When the present spell of the people’s misfortune began, the official experts parroted the line that the economy was enjoying robust health and only prices of food items had been rising, as if an increase in the cost of foodstuffs did not matter so long as sales of cosmetics and cellphones were going up. Then came ad hoc measures to subsidise the cost of food and some other consumer items at utility stores.

More recently much noise has been made about ensuring the sale of roti for two rupees (involving the loss of a rupee on each roti, according to one estimate).

The responses to the energy crisis have been far more outlandish and their benefit hard to fathom — from better use of daylight hours and regulation of loadshedding spells to hefty increases in tariff.

All these are devices favoured by desperate accountants and do not indicate the working of sober and mature minds the nation needs at the moment. In the same category falls the State Bank plan to extend succour to reckless bankers and ruthless manipulators of stocks. A lot of money is being pumped into the system that has flourished by oppressing the masses, by making the poor poorer without always making the rich richer.

These steps offer little to ordinary citizens who are quite incensed at every new sign of extravagance (such as proliferation of ministers and sinecures carrying ministerial perks) on the part of the opulent guardians of a callously impoverished flock.

According to gossip in Islamabad the government is confident of weathering the crisis because the rich and advanced powers will not abandon Pakistan, because this country is indispensable for saving the world order. Nothing can be more dangerous than the delusion that the world has the resources and patience to go on rescuing a country that shows no sign of helping itself. Even if assumptions of external help are proved correct, Pakistan’s ability to benefit fully will depend on the sincerity and efficiency of its economic managers.

Unfortunately the government has shown greater interest in blaming its poor inheritance for the economic difficulties than in trying to solve them. True, most of Pakistan’s problems can be traced to the autocratic regimes of generals Zia and Musharraf. Indeed the people’s current tribulations should cement their resolve to ensure that the democratic process will never again be derailed. Still, no government can opt out of its primary responsibilities to overcome a crisis with the plea that someone else had created it. No time should be lost in finding long-term solutions to the people’s suffering.

The process must begin by removing the perception that the state has abandoned the poor. Instead of seeking the survival of the poor through a dole system their interest must be at the centre of economic planning and management. The state should spend scarce resources less on itself and more on the people, especially the poor. These people are capable of doing great deeds provided that their potential is recognised and practically utilised. In any case they form the largest chunk of our human capital.

This is not the time to merely pretend allegiance to the poor; this is the time to recognise their inviolable right to gainful employment, upward social mobility and their due role in managing the state. There is a near consensus that Pakistan will not be able to turn the corner unless defence expenditure is reduced (without, of course, weakening defence), wasteful and non-productive expenditure on administration is radically slashed, a new land utilisation policy is adopted, and the born-again robber barons are reined in. Time to get cracking, as they say.

The US-Iraq deal

IT has been a short hundred years. That’s how Republican presidential candidate John McCain said that American troops might have to stay in Iraq at the beginning of his campaign, but the deal that Washington concluded with the Iraqi government last week said that they must all be gone by 2011. And they must be off the streets of Iraqi cities by the middle of next year.

That’s not enough for a lot of Iraqis. Fifty thousand supporters of Moqtada al-Sadr, the Shia leader who embodies the resentment of the poor against the Shia establishment, came out onto the streets of Baghdad on Saturday to protest against the deal signed by Prime Minister Nouri al-Maliki. They want the Americans to leave now, which is also Sadr’s position, and it may win him a commanding position in parliament when Iraq votes again next year.

Maliki stood up for Iraqi sovereignty partly because he would pay for it in next year’s election if he did not, but he was never just an American puppet. He opposed the US invasion of Iraq in 2003, and he also opposed the decision of his own party, al-Dawa, to join the first Iraqi “governing council” set up by occupation pro-consul Paul Bremer six months later.

So the negotiations for a “status of forces agreement” to provide legal cover for the US military presence in Iraq after the United Nations mandate expires in December were not just window-dressing. The Bush administration had to abandon its quest for permanent military bases in Iraq, although there is a clause in the deal that allows for a change of mind in Baghdad.

As Iraqi government spokesman Ali Dabbagh put it, “in 2011 the government at that time will determine whether it needs a new pact or not, and what type of pact will depend on the challenges it faces.” But the shoe is definitely on the other foot now, with the American right to keep troops in Iraq lapsing automatically at the end of 2011 unless the Iraqi government wishes otherwise.

Iraq was less successful in trying to make American troops responsible to Iraqi courts for their actions. The deal contains a clause which says that Iraqi law will apply “if they commit a serious and deliberate felony outside their bases and when off duty,” but in practice no American soldiers leave their bases when off duty, and while on duty they can still kill any Iraqi who seems threatening with no questions asked. However, foreign civilian contractors will be subject to Iraqi law in future.

It’s not all that bad a deal, given the extent to which Maliki’s government depends on American troops for survival. But even within the alliance of Shia parties that dominates the government it faces severe criticism, and may not get through parliament. Outside, in the real world, it still feels like a fantasy.

It is now an undisputed factoid in the American political debate that Iraq has been stabilised by last year’s “surge” of US troops, but the reality on the ground is rather different. There is less sectarian killing, but that is mainly because the ethnic cleansing of mixed neighbourhoods where Sunni and Shia Arabs used to live side by side is almost complete. Other major outbreaks of violence remain possible.

The “Awakening” movement, in which tens of thousands of Sunni Arabs who had been fighting the American occupation went on the US government payroll in order to fight the take-over of their community by Al Qaeda extremists, is at a crossroads. Starting this month, the “Awakening” fighters are being paid by the Iraqi government, not by the Americans, and it has announced that only 20 per cent of them will be absorbed into the Iraqi army.

The other 60-odd thousand fighters of the “Awakening” will only be paid until they find civilian jobs — but there are almost no well-paying jobs available in Iraq apart from government work, which usually requires a recommendation from one of the big Shia parties. So what do the rest of the Sunni fighters do? Go back to fighting the Americans? It’s not unimaginable.

And the possibility of war between Arab Iraq and Kurdish Iraq over the border between the two regions is ever present: the promised referendum on the future of the city of Kirkuk and its surrounding oilfields is the sword of Damocles hanging over the whole of Iraqi politics. The relative calm that Iraq is experiencing at the moment may just be the eye of the hurricane.

— Copyright Gwynne Dyer