Economic managers of our country, in particular, the governor of the State Bank of Pakistan and the finance minister have drawn big credit out of a rapid increase in our exchange reserves that now have climbed to $8 billions level.
But, those who do not see present regime in favourable colours attribute this rise to a bagfull of fortuitous circumstances. Some even view it to be a kind of legerdemain of one-track dollarization process orchestrated on the pattern of previous regimes. More pedantic thinkers attribute it to current artificial pegging of the Rupee against slippery and often sliding, dollar and their irrational interest rate differentials. While some substance exists in claims of both sides, but, in deed, the SBP exchange reserves are now at a comfortable level of$ 6 billions and can meet our import bills for almost six months period.
There is no doubt that a durable exchange rate regime is an essential requirement of a long-term sustainable economic growth. Its vibrant execution is needed, particularly, in the domain of balance of payments, trade and aid and flow of capital within a dynamic and wise decision-making framework for future success. Hence, some reflections on this subject of vital national importance are in order.
A global economic upturn was already in making in 1945 when hostilities of the World War II ceased. Despite a trauma of bloody partition of 1947 and ensuing economic dislocations, Pakistan on its independence, was well poised to draw substantial economic dividends from post-War economic resurgence. Its further spurt came in 1949 from the Korean conflict that engaged all major powers of the world in a ferocious war. It triggered fresh bouts of demand for our raw materials, particularly, for our cotton, hides and skin, wool and jute fibres (Bangladesh was then part of Pakistan). Therefore, its timing could not be more opportune.
But then, besides, an on going military conflict in Kashmir, Pakistan was confronted with an insidious commercial strife with India on the issue of parity of its Rupee. In September 1949, Britain devalued its Pound Sterling in terms of US dollar and India quickly followed its lead. Against its ardent desire, however, Pakistan did not follow this course. Henceforth, Indian reaction was perfidious and resulted in an instantaneous dissolution of erstwhile Customs’ Union that was the linchpin of our commerce with India and with the rest of the world. Its telling impact was a huge accumulation of unsold stockpiles of fibres and other raw materials in our godowns and in our fields. At this juncture, to assert our independent course we had no reserves of our own. These were either with the Bank of England in a restricted account or were under snail pace transfer from India.
The Korean War came to our assistance in time and we were able to market our materials and fibres at speed and on prices of our own liking in alternative global markets. We were also able to add new customers into our foray. Indian resistance to our Rupee parity soon caved in and we resumed our normal trade with India on our own terms. Our achievements, unfortunately, proved short lived and exchange reserves, thus, acquired were swiftly squandered away on imports of goods and services that we could do well without. Hence, at the close of our first decade in 1957, we were nearly out of our exchange reserves and, thus, were forced to put up with a draconian exchange-rate regime.
We, thus, failed to capitalise on an invaluable opportunity for promotion of our industrial base on “addition” of value and, instead, were lumbered with an assortment of extractive industries of fibres and raw materials with “low” output value addition in processing sector. But, sever exchange shortages of almost a decade resulted in an irrational allocation of scarce economic resources along with lopsided development of the economy.
Second opportunity in this respect emerged out of the Arab oil embargo of the 70’s in the last millennium. Under its impact, oil prices rocketed to a $30 a barrel level from their low uneconomic base of $3 a barrel in a few years time. This tilted the world financial scales in favour of oil producers. A gusher style petrodollar cycle erupted under which a large-scale transfer of assets commenced from rich industrialised countries to relatively underdeveloped oil producing nations.
Pakistan was fortunate enough to be in the neighbourhood of most of them. It had a plenty of semi-skilled manpower that then found its gainful employment with them. Its labour was deployed in building up of their infrastructure and other construction works. Economy of the country experienced a sharp expansion under the inflow of workers’ remittances. Its domino impact was quite visible in our cities and in our countryside. Demand for domestic goods and services shot up working its way into higher investment and employment levels because of its ripple effects.
Meanwhile, in neighbouring Afghanistan important events surprised Pakistan and the world at large. Its strategic location in world power politics and serious civil disorder in early Seventies encouraged its invasion and occupation by the Soviet troops. This led to a fiery tenacious Afghan resistance. An alliance was quickly formed under US leadership in support of the resistance movement. This was followed with generous global flow of aid, arms and ammunitions and volunteers into Afghanistan. Pakistan was an obvious choice as a staging ground of this movement. Thus, it emerged as a front-line hub of its overall operations. In mid-Eighties, once Soviet forces were thoroughly routed and, in consequence its “evil” empire was fully dismembered, the US and the world at large consigned both Afghanistan and Pakistan to history.
Unfortunately, we drew no long-term benefits from the above mentioned opportunities. Our workers’ remittances via banking channels peaked at $3 billion level in 1982-83 (more than our exports of $2.7 billion the same year) and, thereafter, took a steep downward decline to $1.5 billion level in 1993-94. Our manpower export fared no better than our erstwhile exports of fibres and materials. Government agencies assigned with this task and their hand picked ‘fly-by-night’ recruitment agents spoiled the game. Oblivious of the dynamic skill requirements of foreign employers and equally ignorant of emerging challenge from other sources, Pakistan was quickly overwhelmed by cheaper and better skilled manpower from Far Eastern countries. Soon, nations such as the Philippines and Korea edged out our labour into poor pay and lesser quality of work.
In case of the Afghan war itself, our gains were sordid as well. Only intelligence sources, internal as well as external, would know the true extent of cash flows and quantum of goods and services, arms and ammunitions routed through our soil. More difficult guess, though, would be about how much of it found its way into our social and economic stream. Nevertheless, no one now doubts that bulk of it went to a few Afghan warlords and their counterparts in Pakistan whose hands were always in the tills. Nonetheless, it criminalized our society with ubiquitous presence of guns and drugs. Pakistan was left alone to bear the brunt of its tragic legacy of social strife, communal violence and widespread drug-abuse.
History then revisited the United States, Pakistan and the rest of the world on September 11,2001 in a grand finale. In the mayhem that followed the war of liberation, an arch-conservative regime of Taliban took over Afghanistan. the US in its flawed perception had forgotten the country and had assumed that Taliban posed no tangible threat to its way of life. Instead, Americans reckoned Pakistan to be a risky business with nukes in its arsenal. However, subsequent events proved both paradigms to be grave errors of judgment. To its utter horror, US discovered that primitive forces from a far off land could deliver a terrible blow to its far-flung targets with disastrous consequences for its security as well as for its economy. Once again, Pakistan was placed into a front-line state in a fresh conflict and was in earnest demand as an ally in the US-sponsored global “war” against terror.
This then, perhaps, is another unique opportunity for us to seek a fair deal with the US and international institutions under its tutelage such as, the IMF, the World Bank and the WTO. In this context, we should review carefully our options and opportunities.
At the conclusion of the Great War, the supremacy of US dollar was overwhelmingly established as a global reserve currency. The British Pound was fashioned out under the ravages of the war. This was then formalised in a US resort town of Bretton Woods in 1945 when its European allies and the US hammered out financial restructuring of the world and formed the IMF and the World Bank to this end. Under a well-defined role model, the first one was set up as the global central bank while, the latter one was established as global development bank. The management and policy decisions of both institutions were firmly placed with its European allies and US in particular. Their governments were to monitor, nominate and select senior level management of both institutions. Furthermore, the world in this conference was reclassified from “victor” and “vanquished” nations to “developed” and “underdeveloped” lands. Under a well-regulated “quota” system each country was measured on its wealth scale and, thus, was enfranchised in both institutions.
In all fairness, the above institutions, did provide some lucrative employment and training opportunities to a large number of nationals from poor countries so long as they met their watertight “orientation” and discipline requirements and adapted and exhibited an “Uncle Tom” kind subservience in resonance with their guidance mentors at the top. Though, policy-making decisions remained with the elite of these institutions, who by and large were from former world colonial powers.
In August 1947 when Pakistan was born, a die was already cast on our lot with practically disenfranchised poor of the world. We inherited a financial system that was carved out for us by our erstwhile masters. Our conditions, in fact, were worse than other colonies that had gained independence with us. For instance, paucity of skills and lack of wherewithal prevented us from setting up a central bank of our own. We were still passing through the mayhem of the Partition and, thus, had to leave our vital central banking functions to the Reserve Bank of India (RBI) for almost a year, prior to formation in July 1948 of the State Bank of Pakistan (SBP).
The independent journey of our Rupee, however, commenced even later in 1949, when Pakistan chose a course other than Indian devaluation of its Rupee as stated earlier. It had to start afresh then with nominal exchange resources under a brave new world kind of scenario. But, braves are often lucky too. At the peak of Korean War in 1951-52 Pakistan survived with a healthy surplus in its trade and, thus, a modest level of exchange reserves emerged with it. Unfortunately, it was quickly converted into a huge deficit of $185 million in 1957-58 on a small export base of $91 million; a steep fall from its $406 million peak of 1950-51.
Despite deterioration in terms of trade and its mounting trade deficit, Pakistan stoically maintained its Rupee at 4.76 to a dollar up to April 1972, while its open market value gravitated around Rs.8 to a dollar. Rupee was not a freely convertible currency under the IMF grading and, thus, Pakistan was free to choose its value as well as its ambit of transactions while its market value could fluctuate widely if not wildly. Rupee did win some stability and even limited convertibility with the induction in 1959 of Export Bonus Scheme under the first military regime of Pakistan. Stagnation of our exports and growing imbalances in our trade and payments dictated a comprehensive review of exchange rate policy. This scheme allowed an exporter of good and services from a selected list of items (mostly of non-traditional type) to retain a portion of his earnings for auctioning at the KSE (only stock exchange in the country then). Its buyer on the other hand, was free to utilise foreign exchange, thus, acquired to import goods and services of his choice.
The Export Bonus Scheme introduced multi-tier exchange rates and was a first step towards market-oriented value of the Rupee. Its initial success was phenomenal. Export of non-traditional goods, particularly, from fabrication sector with higher value output, thus, got a shot in the arm. Our dependence on exchange earnings from fibres and raw materials (most out of the ambit of this scheme), to some extent, was minimised. Domestic supplies of non-essential goods also improved somewhat and dented their rampant smuggling in the country. Nonetheless, this scheme was not a substitute for market-based exchange rate.
It was meant to be a short-term solution to a long-term problem. Its continuation for thirteen years and its deviation into multiple exchange rates spurred the bigwigs into minting money from speculation as well exploitation, while poor rural subsidised their capital imports resulting in massive transfer of their resources into “islands of prosperity” within an ocean of adversity type urban centres. The scheme had been cited as one of the major causes of social discord and civil unrest that erupted into complete breakdown of law and order in 1971-72 and resulted into the emergence of Bangladesh.
In May 1972, soon after the collapse of the second military regime, a socialist leaning Government was elected into office in Islamabad that scrapped the Bonus Voucher Scheme and revised the long-standing official parity of Rupee to 11 to a dollar; a whopping 131 percent devaluation. Though, the devaluation of the Rupee was a foregone conclusion, its extent was surprisingly excessive. Its impact on essential imports of energy, consumer goods, equipment and machinery was hyper-inflationary and debt-servicing costs soared both in public and private accounts. Soon inflation was raging in neighbourhood of 30 percent (1973-74) and 27 percent (1974-75) in the country. Hence, potential medium-term benefits of devaluation were limited. Its contribution into export promotion and towards reserves build up was short lived. Pakistan experienced only a modest trade surplus of $20 million in 1973-74 but continued to run expansive trade deficits in the following years.
President Nixon in February 1973 devalued US dollar by 10 percent against its price in gold and closed its “gold window” for good. Pakistan again did not follow US action and, thus, new parity of its Rupee was revised up to 9.90 to a dollar. This remained unchanged till January 1982, when the third military regime in saddle placed Rupee on a limited “float” on the basis of a formula whose real contents are not known to date. Hence, a process of “creeping” devaluation was followed that saw Rupee decline to levels as low as Rs.70 before it got stabilised around Rs.60 under the fourth military regime now in charge in Islamabad.
Nonetheless, 1982-99 is the most wanton period of our exchange and reserves policy. Though, 63 per cent depreciation of Rupee in 1982-83 to 1985-86 period had some element of overdue adjustment in its value, its present precipitous index fall to 500 level; with its real value of 8 paisa to its original worth is nothing but a national disgrace. This may not sound much when compared to Argentina, Brazil or Turkey or pre-War Germany. However, in comparison with erstwhile cheaper currencies of India and Bangladesh, its decline against them of as much as 50 per cent is reflective of a serious decline of our economic fortunes.
Hence, a major cause of massive flight of capital from our country is the slipshod manner in which our currency has been debased over a period of thirty years. After all, no one likes to hold on to a depreciating asset. In early years, its decline was in a slow drain mostly emanating from over-invoicing of imported capital goods or under-invoicing of exports in general. Even then, a great deal of it found its way back into the economy either in the form of working capital or as an equity contribution in another investment. Hence, its economic damage was minimal. Its impact on capital formation, output and employment level was somewhat benign. Nonetheless, it did contribute to a general drain on our reserves and evasion of taxes, besides inflating our international borrowings. It also produced an occasional swing in the free market value of the Rupee.
In mid-Eighties, however, upon cessation of the Afghan war, flight of capital galloped into an avalanche. In its aftermath of drugs and guns, an obscene flow of US dollars found its way into private accounts of a large number of individuals who directly or indirectly, were its major players. New players in this process were added in, when semi-civilian governments took over and spurred heavy weight public sector financial institutions into bankrolling of some of their half-baked and ill-conceived schemes for economic jumpstart. Large doses of cheap and insufficiently collateralised loans for locally fabricated machinery, export finance, yellow cab and other such projects were administered for promotion of investment and employment in the country. Bulk of this loaning eventually proved unviable. It lumbered financial institutions with huge non-performing portfolio. A large number of unscrupulous borrowers sharked out huge sums out of these schemes and joined the fast expanding elite club of robber barons in Pakistan.
Then to top it of, in early nineties, the government with common wizardry of the IMF nudged the SBP into a bona fide permission of foreign currency account facility to resident citizens also. This was apparently to tap huge volumes of foreign currencies floating in the open markets of the country. But, this measure, in fact, immensely facilitated those who were hunting for safe havens for their unscrupulously acquired untaxed funds. Thus, funds siphoned out by way of kickbacks from public and private contracts and myriad kinds of dirty money accumulated over several decades found its legal refuge into newly formed safe haven in the country. A widely publicised “no questions asked” policy was aggressively promoted both by the SBP and the CBR to this end. The governments, of course, were at the forefront to assure owners of such funds of “full protection” from any inquisition either on taxes or on the origin of funds with complete cover of secrecy. Thus, Pakistan finally had acquired an edge over the traditional gnomes of Zurich.
This then opened the floodgates of a dollarization process that was earlier in place at low key for quite some time. But, soon we experienced Latin American style frenzy for mighty dollar. With rising tides of domestic inflation and consequent depreciation of the Rupee with wild speculation on its future, ordinary savers and pensioners too joined in this race to protect the value of their meagre savings. However, despite a large build up of such deposits in the neighbourhood of $11 billions at peak, several times larger than our exchange reserves at that time, their nature remained tenuous. Their flow took wild swings with major internal or external events and so did the value of the Rupee against dollar.
On an agreed value basis, the SBP foolishly absorbed foreign currency deposits received from banking channels and suffered horrendous losses in this process. It made no plans or provisions of reserves for any possible run on its tills. Despite its practical stance of US dollar as a semi-legal tender, it did not endeavour for evolution of reserves nor it encouraged banks in this direction. This turned out to be a fatal flaw. Hence, when a crunch came eventually on the eve of our nuclear explosion in May 1998, both the government and the SBP tragically failed to meet their fiduciary obligations. An immediate conversion freeze was placed on foreign currency deposits in violation to all earlier legal or moral commitments. Even to date no one knows where all the funds have gone.
This unwise dollarization policy orphaned the Rupee in the end and encouraged an unprecedented flight of capital from our country. Its principal beneficiaries were foreign banks and their elite customers. Hitherto, their operations were focussed on trade and aid flows. But, with deteriorating business environments of the country, quantum of both had diminished. Many of them then were contemplating of winding up their operations in Pakistan. But, out of the blue emerged a bonanza of renewed fury of dollarization process. With this surge of dollar deposits, few shiny and tidy branches of foreign banks emerged feasible that, hitherto, were dogged with high costs of operations. More than that their global network of affiliates and investment subsidiaries ultimately received fresh massive transfusion of liquidity from a poor land.
Foreign banks since the birth of Pakistan are well entrenched with the upper crust of our society that harbour deep affiliations with the rich West. It has its control and command over the bulk of old as well as new moneys. Most of the local management of foreign banks comprises of carefully groomed siblings of well-placed civil-military ruling elite of the country that is the key constituent of this class. They are well versed in the craft of movement and placement of emigre capital through their vast conduit of international network of specialised institutions. Hence, during above stated era, financially engineered capital flight reached to its dizzy heights that according to some estimates were in the region of $ 50 billions.
Nonetheless, only a few of robber barons were hit by May 1998 freeze. Most of them had seen impending crisis coming and, thus, had already moved out their moneys unscathed overseas. Many had access to insiders’ knowledge of forthcoming freeze and, hence were bailed out in time by their banks. In fact, most hapless victims of above freeze were ordinary savers who were left in the lurch. Their efforts in seeking refuge in the US dollar from continuous slide in the value of the Rupee had gone in vain. However, finally like death, events of September 11 turned out to be a leveller when, hitherto, so-called safe havens quickly turned into inhospitable terrains with tighter regulations that ipso facto clamped down money laundering from poor lands like Pakistan.
Prior to September 11,2001, rich countries, particularly, the US paid only a lip service to the money laundering phenomenon and, therefore, took only cosmetic measures towards its the interception. Their enforcement drive was constrained to moneys drawn out of production and marketing of narcotic drugs. Other than that, both public and private institutions amongst these countries were facilitating flight of capital with sham inquisitions of “investors” antecedents.
Furthermore, September 11 had its countervailing economic effects also: First, the US in particular and the rich nations in general, went into an economic tailspin that now hovers around depression. Investors from rich as well as poor nations experienced sharp losses in stock markets, in currency speculations and in their investments in general. Second, terrorist fears have instilled in the minds of erstwhile recipients of dirty money with deep suspicions about such funds and, thus, laundered money tap is inoperative for the time being due to lack of access channels.
In this global scenario, an opportunity for us exists for recovery of a substantial chunk of dirty money under a pragmatic reconciliation and accommodation policy. However, taping of funds outside the domain of dirty money is quickly possible with improvement in investment climate. Its speedy flow could be sustained with effective placement channels within the country. A realistic exchange rate regime is the first sound step in this direction. It is vital for growth of our exchange reserves in the long run. Our current trade deficit is somewhat benign but is likely to shoot up once economic indicators show a rise in our capital formation, industrial and agricultural production and family incomes. Our cost of funds, energy and even industrial raw materials are higher than our main competitors in exports. Therefore, earnest attention should be paid to reductions in the present high level of input costs.
Pakistan now has won a substantial debt-rescheduling package with some improvements in terms of old and new aid. Hopes are high for major debt writes-off. However, more than anything else, home remittances of overseas Pakistanis are likely to touch $3 billions mark once again. This time our compatriots from the UK and the US are in the lead. Movement of funds from developed world is likely to expand into transfer of technology and into investments in “new” technology in the long run. However, this is possible provided our institutions are up to the task. Overseas Chinese have changed the shape of the present day China for good, why Pakistanis living and working abroad cannot do the same for their country?