THIS is with reference to, and basically in continuation of, the letter ‘Miscal-culated FDI may make it worse’ (Aug 5) which talked about the current economic woes of the country, and the arguably flawed policy of seeking foreign direct investment (FDI) without due diligence.

As inflation goes vertical, one of the most common arguments put forth by governments in Pakistan is that the happenings at home are nothing but a consequence of rising international prices of commodities and a devaluing rupee that cannot be controlled. This is erroneous, false and dangerous. Such explanations provide a shield to the State Bank of Pakistan (SBP) against its incompetence to control runaway rupee devaluation and inflation.

Both inflation and currency devaluation are results of growth in domestic money supply in the absence of a similar growth in the supply of goods and foreign exchange. The money supply grows if the government borrows directly from the central or commercial banks to finance its rupee-denominated deficit. While direct borrowing from the central bank has been curbed, that from the commercial banks has been allowed to grow unabated by the SBP.

This has caused a spiralling growth in money supply, which, in turn, is reflected in the growth of private savings that has fuelled the demand. The prices of consumer goods and services, therefore, have gone up, and so has been the case with real estate and durables, like vehicles.

That also explains financial investments in the shape of purchasing gold and foreign currency, especially the United States dollar. By not working to restrict government borrowing from the banks, the SBP is allowing money supply growth, resulting in inflation and depreciation of the rupee.

The step forward, naturally, should be restriction on government borrowings, and a progressive decline in the asset allocation ratio of the commercial banks. Lending by the banks should be directed towards private savers and non-bank financial institutions.

This would mop up the surplus money supply. However, the banks should ensure that private investors do not invest their borrowings in government schemes as this would negate the whole objective of the plan.

Besides, the government malpractice of buying foreign exchange to fund rupee expenditure and periodically selling the reserves in the domestic market needs to come to a complete and immediate halt.

In the short term, this strengthens the rupee artificially, but in the medium term it only adds to foreign exchange liabilities, depreciates the rupee and creates future deficits.

Clearly, the ideal discipline is that the government deficit itself is curbed. Beyond that, the central bank needs to step forward as the nation’s guardian of domestic money supply.

Amar Z. Khan
Kuala Lumpur, Malaysia

Published in Dawn, August 10th, 2023