Challenging the CW

Updated 30 Aug 2019


The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.
The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

THE PTI government marked its first anniversary on Aug 18. The past year has witnessed an incessant as well as intense debate on the performance or non-performance of the new government with regards to the economy.

Unfortunately, much of this discussion has been grounded neither in fact nor in economic precepts, and has thus not only been very non-illuminating — generating more heat than light — but has also caused confusion and deepened the prevailing uncertainty.

For some among the ‘commentariat’ engaged in this shrill national debate, this is partly deliberate and agenda-driven, deflecting criticism from PML-N’s poor management of the economy or scoring political points. For many others, the arguments are either misinformed, lacking context or downright alarmist. The ‘punditocracy’ is most off the mark in assessing or discussing critical parameters of the economic situation: the fall in the rupee, the knock-on impact on the stock market as well as on growth and inflation, and the sharp increase in the country’s debt stock. We will examine the first three of these.

‘Devaluation’: The exchange rate is a ‘price’ determined, like in any other non-restricted market, by the interaction of supply and demand. Viewed from this perspective, examining the demand and supply of dollars will put the movement of the rupee over the last year in context.

Conventional wisdom on the economy is wide off the mark.

In July 2018, at the beginning of fiscal year 2018-19, the situation with regards to the country’s external payments for the year ahead (the demand for dollars) was as follows:

Read: PM forms body to control rupee devaluation

The gross external financing requirement was around $27 billion. Predetermined short-term outflows (foreign exchange swaps, central bank liabilities) not included in the above total amounted to a further $7bn. Hence, the total demand for dollars for 2018-19 was circa $34bn. (It is important to realise this estimation of demand did not include the need to build foreign exchange reserves by at least a further $6bn to $8bn at the time.)

On the supply side, the foreign exchange reserves held by the SBP on July 1, 2018, amounted to $9.8bn. During the course of the year, this would likely be augmented by foreign exchange inflows from FDI and external loans, but the timing as well as magnitude of these remained highly uncertain without the IMF. Hence, as things stood for all practical purposes, there was an excess demand of over $24bn in the country’s exchange market.

Given the unprecedented size of the gap between the supply and demand of dollars, there should be no mystery why the rupee crashed when the SBP withdrew its support (because its foreign exchange reserves were depleting untenably). This is a repeat, albeit on a much smaller scale, of what happened in Thailand and Indonesia during the East Asian crisis in 1997. And yet senior commentators, including eminent economists, practitioners, and opinion influencers, have continued to rail against the government’s decision to ‘devalue’ the rupee, as if there was a choice.

A final point on the rupee to address the deliberate confusion being spread by those elements wishing to deflect criticism from the atrocious economic management of the PML-N, which was directly responsible for this crisis. The country’s foreign exchange reserves had already fallen from $16.1bn to $9.8bn in 2017-18 — before the PTI government took over. In fact, in July 2018, one month before the formation of the PTI government, there was a near-consensus in the financial markets that the rupee would fall to at least Rs180 to Rs200 per dollar. This is as clear an indication as any that the mess had already been created before the PTI government took over.

While policy missteps by the government have compounded the situation in many ways, the sharp adjustment of the exchange rate is at the root cause of the evaporation of confidence, the spike in inflation as well as policy interest rates, and the consequent slowdown in the economy.

Growth: Another pervasive criticism of the government is that economic growth has stalled. With the country undergoing its severest economic crisis on record, this expectation is completely misplaced when viewed in the context of multiple crisis episodes, whether across a range of countries or Pakistan’s own experience.

As I wrote in a previous column in Dawn, ‘Anatomy of a crisis’ (July 19): “Declining confidence of economic agents, sharply curtailed access to credit, a steep contraction of purchasing power induced by the falling value of the currency and the associated inflation, are amplified by the defensive policy measures that authorities need to take (higher interest rates, taxation measures, expenditure reduction). The result is that the contagion effects are soon transmitted from the financial markets to the real sector. Large output losses are experienced, with resulting unemployment.

To put this in perspective, Greece’s economy shrank over 29 per cent between 2008 and 2016, while Ireland faced an economic contraction of almost 10pc in 2008-09 in the aftermath of the global financial crisis. Spain’s economy shrunk by over 9pc between 2009-13. Pakistan’s own experience of the 2008 crisis is of economic growth slowing down sharply to only 0.4pc in 2009, with large-scale manufacturing contracting 4.2pc.”

Stock market: A similar disconnect appears between the experience of multiple countries facing economic crises, and the expectation of local market participants, that somehow the stock market should defy a historical pattern. Facing large currency devaluations, Indonesia’s JCI index plummeted more than 50pc in 1997, while Argentina’s stock market has fallen 31pc since January 2018, just to highlight two examples.

None of this is intended to suggest that the government has handled the situation without reproach, or that there is little it can do other than to ‘wait it out’. The economic team has done poorly on some fronts, and is choosing not to rectify some egregious policy missteps. However, much of the criticism the government has faced in the past year with regards to the economy is misplaced and not based on facts, or is out of context.

The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

Published in Dawn, August 30th, 2019