HERE come the politics. The first devaluation undertaken by this government sent a jolt through the economy, briefly restored some confidence, before it waned once again (more on that in a moment).
The second devaluation, which was considerably more disorderly in the wild swings its generated, and accompanied by one of the sharpest interest rate hikes in many years (frankly I can’t recall the last time we saw a 150 basis point hike in a single stroke since 2008), has jolted the economy and the government alike.
Take a look: Was the rupee depreciation avoidable?
The weekend wasn’t over and we saw the prime minister distancing himself from the step, saying he had no knowledge of the event, learned about it on the news, and expressing the wish to be informed so he can “provide his input” in the decision, for the next time.
All through Monday, rumours circulated of the finance minister resigning, or threatening to resign. Finally, on Wednesday, at least one channel began running that Asad Umar had been asked to step aside; it went so far as to name a replacement. Minister of State for Finance Hammad Azhar tweeted later in the evening that Asad is staying put, adding that “[v]ested interests that thrive on the status quo arrangements will resort to different tactics. Simply ignore!”
What is happening to Asad Umar now is similar to what happened to Hafeez Shaikh a year or so into his term.
Somebody needs to tell Hammad Azhar that the “vested interests” in this case are most likely within his own party.
The politics of adjustment have kicked in. What is happening to Asad now is similar to what happened to Hafeez Shaikh a year or so into his term. The adjustment he was undertaking at that time was one of the most intense the country has seen — this at a time when the first impact of the NFC award was making itself felt, the floods of 2010 had wreaked havoc on the fiscal framework, the war in the tribal areas was picking up in earnest, and relations with America were in disarray, eventually going towards total rupture after the Salala incident and the Abbottabad raid.
What Asad is looking at today is a cakewalk by comparison. Nevertheless, Shaikh’s predicament provides a comparison. He was isolated among his own cabinet colleagues, and not only had to own the failures of his water and power minister, for example, but found little to no help among his own party when it came to passing the so-called Reformed General Sales Tax legislation, which was an essential condition in the IMF programme signed in 2008.
Something similar is happening to Asad because he has the unfortunate job of administering the economic adjustment that is necessary to stabilise the economy. We are only two devaluations and two interest rate hikes into the adjustment, and already something has come unhinged within the government. What will happen once the fiscal adjustment has to kick in, when the deficit has to be reduced by two to three percentage points of GDP before the end of the fiscal year? And, of course, more devaluations and interest rate hikes are a virtual certainty at this point in time.
Consider what the markets are saying. As of the beginning of 2018, successive auctions of government debt have shown a consistent pattern: nobody is willing to go longer than six months. Most bids are placed in three-month tenors, a few in six-month tenors. This is mostly in anticipation of a rising interest rate environment. Nobody wants to lock in present day yields for longer than six months because they expect rates to rise in the intervening period.
Since July, that pattern has not changed, except on two short-lived occasions. One was on July 18, when there was a jump in participation. The previous two auctions had brought in measly amounts (by comparison to what the government was seeking). The July 18 auction suddenly raised Rs3.1 trillion, a massive jump from the Rs56 billion in the preceding one. In subsequent auctions, this amount again fell to Rs933bn, then to Rs48bn, and continued falling.
Then came another jump on Oct 10, when the auction brought in another Rs2.7tr, only to see the amounts fall again in subsequent auctions to Rs587bn, then to Rs11bn and then to Rs7bn. Mind you, the government is seeking to lift hundreds of billions of rupees in these auctions, so the low participation was particularly troublesome, because it meant nobody was lending to the government out of expectation of a rate hike.
So what happened on July 18 and Oct 10? Both those auctions were conducted immediately after a rate hike of 100bps, which caused a short-lived surge of interest that waned quickly. And the latest rate shows a similar pattern.
Where the last auction brought in a miserly Rs7bn, with no bid received in 12-month tenors and bids in six-month tenors rejected outright (because the banks were asking for too high a yield), the latest auction held on Dec 5 (Wednesday) raked in Rs2tr, almost entirely in three-month tenors.
So once again, the first auction immediately after a rate hike sees a spike in participation, but most of it is clustered around three months, showing even now there is an expectation that further rate hikes lie ahead and the government will be raising rates further in the next quarter. That’s the Rs2tr bet the markets just placed on Wednesday, the day the government shook with ramifications of the adjustment undertaken thus far.
So yes, the worst is yet to come. What we have seen thus far is a trailer. If the government is already turning on its own finance minister, and if he himself is turning to happy talk to make the ill winds go away, then it only means these guys have neither the stomach nor the brains for the job ahead.
Published in Dawn, December 6th, 2018