Stabilising external finances

June 03, 2019

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PAKISTAN is sailing into a perfect storm of economic problems — urgent, important, short-term and long-term — that threaten political stability, social cohesion and even national security. While the list of what needs to be done is long and interrelated, this article is confined to outlining a complete checklist of policies to solve our most urgent short-term problem: the imbalance (‘disequilibrium’) in our balance of payments, reflected in our falling foreign exchange reserves.

At the highest level, policymakers can pursue any two of three desirable goals: (1) fixed exchange rates; (2) independent monetary policy; and (3) free capital inflows and outflows (the ‘Fleming-Mundell Trilemma’). The government seems to have chosen the last two, while allowing the rupee to depreciate. The correct choice would be to choose the first two, and design an appropriate prudential system of capital controls, as permitted by the IMF’s Articles of Agreement (VI, s.3) and included in some programmes (Argentina 2002, Iceland 2008).

Although capital outflows are controlled, Pakistan allows residents to hold foreign currency deposits, and buy and sell foreign banknotes. This must end immediately. “What is needed is to gradually dismantle the [Protection of Economic Reforms Act, 1992] regime, bring the foreign exchange market within the banking system, [and] do away with licensed money changers.…” (‘Bad amnesty’, The News, April 22, 2018). Equally, to avoid adverse effects (dubbed ‘Dutch disease’) when exceptional capital inflows cease (as they did post-9/11 and recently, with CPEC), capital inflows should also be better regulated.

It is high time that better planning and sensible regulation of markets by the government was restored.

To stem the rupee’s free fall, we should adopt managed (not freely) floating exchange rates. This is because expectations are driving the dollar/rupee rate down and there is, strictly speaking, no equilibrium market rate for the rupee. Moreover, given the low real return on fixed capital investment, amnesty schemes add to the pool of capital eligible for remittance abroad, which is not sensitive to exchange rates.

We should also pursue an independent monetary policy directed at domestic goals. Although not a medium of exchange, dollars serve as stores of value and hence as quasi-money in our dual-currency system (like bimetallism). This should render the demand for money even more unstable than it usually is, defeating an essential requirement of effective policymaking. We should consider expanding the monetary policy toolkit to include less-fashionable instruments: like credit planning, aimed at directing credit to priority exports and investment.

The monetary approach to the balance of payments, which underlies IMF programmes, views changes in foreign exchange reserves as a phenomenon related to changes in assets and liabilities of the banking system (not to trade, or the real economy). Consequently, apart from currency depreciation, it solves balance-of-payments difficulties primarily by regulating money and credit. Thus, in the IMF’s approach the Ministry of Commerce has no role in stabilising external finances.

But exports and imports aren’t determined by exchange rates alone: on a year-on-year basis, while the rupee has depreciated by some 30 per cent in the last 10 months, exports have fallen by 1.9pc (and imports, by 4.9pc). There is a need therefore to promote exports by non-price administrative measures as well, as successful East Asian economies have done for long. To do this, the Export Promotion Bureau — and the Trade Development Authority of Pakistan — must be resuscitated immediately. Equally, imports should be compressed, and much-needed government revenues enhanced, by tariffs on non-essential imports.

One of the few advantages of IMF programmes is that they make borrowers eligible for debt rescheduling. Although interest payments on foreign debt are negligible in the budget, they aren’t insignificant in the balance of payments. Consequently, weighing pros and cons, the government should consider working with the IMF to restore debt sustainability by restructuring our multilateral, bilateral and commercial debt, with substantial write-offs.

Separately, the government should establish a high-level Debt Audit Committee, following Ecuador’s (2008-2009) example, to look into the possibility of repudiating or renegotiating our ‘odious’ debts, among other initiatives. In international law, a debt is ‘odious’ (or ‘illegitimate’) if (1) it is contracted against the interests of the population of a state, (2) without its consent, and (3) with the creditor’s full awareness. If all three conditions are met, then the debt is unenforceable under international law.

Although creditor-friendly courts resist using the term, prosecution of those involved in such debts is gaining traction. In January 2019, three Swiss bankers were arrested in London over $2 billion of odious loans in Mozambique in 2013, secured by $200 million in bribes and kickbacks. Others arrested include the former finance minister, a UAE firm, and several individuals. There are precedents, therefore, to argue that obligations incurred under the WB-sponsored energy sector contracts (involving WB-staff corruption) and debts incurred under the Musharraf regime (an odious regime, meeting all three criteria) may qualify as odious debts.

In many ways, the economic crisis is a crisis of management. After three decades, it is clear that the private sector and that mythical creature ‘the market’ have failed to a far greater extent than the government failure they were expected to correct. It is high time that better planning and sensible regulation of markets by the government was restored.

There is finally a political limitation. Where governments work with IMF staff, their joint efforts can lead to successful programme outcomes. Where they don’t — in IMF lingo: where programmes lack ownership — they frequently fail. The government must somehow empower its economic team so that it can engage the IMF substantively, rather than just adopting a ‘10pc less, six months later’ negotiating strategy.

The economic crisis, of course, is much wider than that of the balance of payments or the government budget. Durable solutions lie in studying and addressing how grand corruption has rendered the cost structure of most domestic industry uncompetitive, how the bias towards foreign expenditures in the current and capital spending of the elite has depressed the demand for local goods, and how the misguided naïve neoliberalism of government has allowed these problems to grow over the last three decades. But space precludes a discussion of these big issues.

The writer is a retired economist.

Published in Dawn, June 3rd, 2019