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A SHORT history lesson might help put Pakistan’s dilemma regarding whether or not to join the Saudi military operation in Yemen in a little perspective. The story begins at an unusual point, but has tremendous relevance.
In 1973, Pakistan introduced a foreign currency account scheme for overseas nationals so they could save their money in deposits held in Pakistani banks. In part, the purpose was to funnel the earnings of overseas Pakistanis into the country’s reserves. In 1991, as the country’s foreign exchange reserves were hitting dangerous lows, the scheme was broadened to include resident Pakistanis and firms.
Over the years, the amount of money held in these accounts grew enormously. In 1984, they exceeded official foreign exchange reserves of the country, and by 1990, they were triple the official reserves. In 1991, the floodgates opened, and by 1996, foreign currency deposits had reached $6 billion, more than six times our total reserves. This was a staggering rate of growth, and for most people in government, it was something to be celebrated since the funds helped in financing the country’s current account deficit.
Short-term thinking had led us into one of the most serious balance of payments crises we have ever faced.
Not so for the State Bank. More specifically, not so for Dr Muhammad Yaqub, who was the governor of the bank at the time. In a paper he wrote in 1996, he laid out in detail the growing risks that the use of these deposits to finance the country’s external deficit was posing to the economy. The paper was submitted to the government in August 1996, and again in November 1996, and yet again in December 1997. But the warnings were not heeded.
Here are his words from that paper: “The accumulation of foreign currency deposits to finance large external current account deficits in the context of a low level of reserves is much more threatening to the soundness of the economy than even the accumulation of large domestic debt to finance the budget deficits.” He listed the damaging effects of these deposits, from spurring “a very rapid dollarisation of the economy” to erosion of the tax base due to the whitening implied in the no-questions-asked protections given to funds in these accounts, to creating a conflicted environment for the interest rate, exchange rate and fiscal policies.
In short, the paper listed the massive damage that resort to this mode of arranging foreign exchange was doing to the wider economy, and how various tools of economic policy were being rendered ineffectual because of them. “The short-term considerations of maintaining incentives for the continuation of foreign currency deposits conflict with the objectives of long-term sound economic management”.
Funds in these accounts needed to be recognised as debt, he warned, adding that “the average interest rate on foreign currency deposits is more than twice that on Pakistan’s medium- and long-term external debt”, and the ever-present fear of rapid withdrawals from these accounts “creates foreign exchange market pressure” and can lead to sudden depletion of the country’s reserves.
But even he could not anticipate that the dangers he was warning about were in fact lurking around the corner. In May 1998, following the nuclear detonations and imposition of sanctions, large withdrawals indeed occurred from these deposits, leading ultimately to the decision to freeze the accounts. The foreign exchange crisis created as a result lingered till 9/11, when massive inflows of aid once again bailed the country out.
In December of that year, seeing his worst fears materialise before his eyes, Dr Yaqub made the decision to include this paper in the State Bank’s annual report, thereby making it public. It appeared as an appendix to chapter seven, and is one of the most crucial documents in the economic history of our country.
I’m reminded of this document these days, and the story it tells of the desperation and folly with which Pakistan pursued its foreign exchange requirements throughout the 1990s, when the country was drifting deeper and deeper into isolation. The short-term thinking led us into one of the most serious balance of payments crises we have ever faced, and one thing that saved us from being engulfed by the consequences was the Saudi oil facility.
Years later, I was reminded of our dependence on this sort of largesse, while observing a meeting of the Pakistan Development Forum, convened by the government to ask the international community for assistance in dealing with the floods of 2010. One by one the delegates of all the countries made their speeches, lecturing the finance minister about the importance of reform but promising no funds. Then the Saudi delegate spoke, and promised $300 million from his country. I never saw Hafeez Shaikh, then finance minister, smile so broadly ever again during his tenure.
And again last year, as the rupee was sinking and reserves depleting once again, a mysterious deposit of $1.5bn showed up in our foreign exchange reserves from a friend who did not want to be named. We were promised repeatedly by the government that there is no quid pro quo attached to that money. Maybe they even believed it.
For too long we have been using short-term means to arrange for our foreign exchange reserves. And for too long now, we’ve been looking for ways to serve the geopolitical interests of outsiders as a way to attract foreign exchange. Today, it is time to pay the piper, as the government struggles to find the words with which to respond to the ‘request’ for military assistance for a Saudi military campaign in Yemen.
Today, our thirst for foreign exchange, and the short-term expedient means by which we have sought to quench it throughout our past, is reaching out for its due. And now more than ever, the government of Nawaz Sharif must find a way to say ‘no’ to the Saudis in what is for them, their hour of need.
The writer is a member of staff.
Twitter: @khurramhusain
Published in Dawn, April 2nd, 2015
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