Financially, these are difficult times for Pakistan and if we do not take the right measures urgently, the country could be on the brink of default; we have seen this happen in the neighbourhood in Sri Lanka. In addition to a new government, we also have a new acting governor of the central bank and whatever tenure he is handed out (till confirmed or otherwise) one is hoping that collectively, they re-think the policy measures of their predecessors.
With almost 3 million job entrants every year and an unemployment level that is already quite high, the highest interest rates and tax slabs in the region are just not going to wash—the rate in India is around 4 percent and approximately 6.50 percent in Bangladesh, whereas, 12.50 percent in Pakistan. By now we know that this time, the exceptionally high interest is neither taming inflation (again, the highest in the region with the exception of Sri Lanka, which is in a state of wilful default) nor stabilising the currency by attracting parachute money, and not even curtailing imports. In fact, it is shutting down small businesses and hurting the category of masses that is most vulnerable. So, obviously, to counter the current market anomalies, the traditional monetary tools are not working and therefore some out-of-the-box, innovative solutions are needed. More on this later in another piece.
The rather precarious economic situation in Pakistan is exacerbated by the fact that after covid and with the advent of the Ukraine war, the entire global financial lending scenario stands changed, whereby the world is today witnessing unprecedented international liquidity constraints, making it increasingly difficult for the majority of developing countries to secure budgetary support funds amidst some significant shortfalls to meet their debt servicing requirements; something our economic managers and the new governor will have to be mindful of.
Little surprise then that both Pakistan and Sri Lanka are still struggling to bring on board the lender of the last resort, the International Monetary Fund (IMF). Further, for developing countries an additional challenge is always the very thinking at the IMF quarters: It invariably supports an unyielding view of how global finance should work—capital must flow freely across borders, no matter the consequences. This volatility in capital flows, especially in small and emerging economies, have always created problems of its own, ones that are mainly pertinent to vulnerable economies, the type that ironically need the IMF support in the first place!
For example, at present, having barely weathered the Covid crisis, in part with the help of emergency lending and debt-service relief from their wealthier counterparts, the world’s low- and middle-income countries face another challenge: The cost of servicing their external debt—which amounted to about $9 trillion in 2020—is set to increase sharply as central banks such as the US Federal Reserve raise interest rates to combat inflation. In 2022 alone, public and private borrowers will have to pay almost $1 trillion, according to the World Bank. The danger is that global speculative investors, spooked by the daunting debt payments, will further undermine developing nations’ finances by pulling out en-masse. Such reversals can be swift and punishing, as private credit vanishes and exchange-rate swings boost foreign-currency debt burdens. During the last central-bank tightening cycle in 2013, more than $20 billion in capital fled emerging markets in just 45 days. During the Covid crisis, the outflows reached $100 billion. Meaning, one can see why easy money can no longer be easily lured by simply increasing the interest rates.
Also, one can imagine or it comes as no surprise the kind of competition Pakistan faces today in securing its funding requirements from international financial institutions that already stand over-stretched in their lending portfolios. More importantly, this very kind of threat primarily illustrates where perhaps our previous central banker went wrong, because in effect such a phenomenon becomes a quandary for the emerging markets (say Pakistan): Where on one hand foreign capital is critical for development, on the other it becomes extremely hard to manage. In good times, inflows of hot money expand credit and fuel inflation. And as long as capital flows freely, there’s not much developing-nation central banks can do to cool things down: Higher interest rates only attract even more foreign money, further overheating the economy until some event triggers an exodus (as it happened here in Pakistan).
It is a dynamic that has played out time and again not just with us, but from Mexico in 1994 to Asia in the late 1990s. However, while this foreign capital volatility can be extremely tricky, it is not that it cannot be managed at all. Unlike us, some prudent economic managers in developing nations are not always helpless to control fickle and temperamental capital flows. On the contrary, they’ve developed tools to slow inflows when credit expansion starts to look like a bubble, and to mitigate outflows when the bubble bursts. Some, such as Malaysia, limit foreign ownership or foreign sales of property to constrain excessive real-estate investment. Others, such as Indonesia, require banks to maintain a higher percentage of foreign investment in the form of liquid reserves. In all cases, the broader aim is to encourage the kind of longer-term investment that contributes to sustainable export growth.
Clearly this kind of a resolve was overlooked in our case. The real problem with us being that since our economic managers over the last few years had a mindset akin to that of IMF’s official policy, we kept on following a course without properly ascertaining whether it was in our interest or not. Unfortunately, the IMF has long been reluctant to approve capital flow measures—and in those rare cases where it does, it typically encourages their swift retraction. This position has created tension with even developed-nation members such as Australia, Canada, Korea and New Zealand. For emerging economies, it can be devastating, as they’re more likely to depend on IMF support and their foreign investors are more sensitive to the fund’s recommendations.
Fortunately, this hard-line position of the IMF seems to be changing. It recently took an important step away from that orthodoxy—and not a moment too soon for some developing nations. In a 2020 report, the IMF recognised that its position was “at odds with country experience and recent research.” Consider the case of India, which in 2013 faced a sudden capital reversal triggered by the Fed’s plans to remove monetary accommodation in the US. The Reserve Bank of India moved quickly to restrict outflows, attract inflows, support the market for currency swaps and limit outward foreign direct investment. The IMF later concluded that the measures “helped to restore confidence,” but it never endorsed them at the time—a failure that interfered with their efficacy. Still, when it mattered India unilaterally took some bold financial policy decisions, which (now officially recognised) paid off for them. Sadly, no such assertiveness has ever been displayed by us even as late as 2020-21 when our foreign exchange reserves started to deplete.
Anyway, back to 2022 and the question being, so what now as after all we are still desperately vying to re-commence—albeit with a higher outlay—the stalled Fund’s program? Well, fortunately the good news now is that the IMF finally has officially revised its institutional view to be more accepting of capital controls that are also known as macroprudential measures—that is, those put in place to pre-empt crises or to mitigate systemic risk—and those that are meant to ensure “national or international security.” This is a crucial step toward rebalancing power, towards giving emerging economies more autonomy in managing their capital accounts and monetary policy.
That said, the IMF can and should do more—for example, by also allowing for targeted capital controls (both inflows and outflows) aimed at specific domestic goals. Still for now, even this new shown flexibility is a good omen and a good start. Now surely, we all know that capital controls alone can’t address the deeper issues of international finance, such as why investment doesn’t flow the way it should to higher-growth countries, or how emerging economies can achieve the safety and stability that command such a large premium during crises. However, the measures can at least mitigate the volatility that so often does so much damage—which is why this well overdue IMF’s policy shift is truly welcome. One only hopes though that the new acting State bank Governor will take cognisance of these developments and hopefully unleash some fresh thinking in Pakistan’s monetary policy framework that focuses on domestic aspirations and needs rather than merely policing the Fund’s discipline imposed from faraway.
With almost 3 million job entrants every year and an unemployment level that is already quite high, the highest interest rates and tax slabs in the region are just not going to wash—the rate in India is around 4 percent and approximately 6.50 percent in Bangladesh, whereas, 12.50 percent in Pakistan. By now we know that this time, the exceptionally high interest is neither taming inflation (again, the highest in the region with the exception of Sri Lanka, which is in a state of wilful default) nor stabilising the currency by attracting parachute money, and not even curtailing imports. In fact, it is shutting down small businesses and hurting the category of masses that is most vulnerable. So, obviously, to counter the current market anomalies, the traditional monetary tools are not working and therefore some out-of-the-box, innovative solutions are needed. More on this later in another piece.
The rather precarious economic situation in Pakistan is exacerbated by the fact that after covid and with the advent of the Ukraine war, the entire global financial lending scenario stands changed, whereby the world is today witnessing unprecedented international liquidity constraints, making it increasingly difficult for the majority of developing countries to secure budgetary support funds amidst some significant shortfalls to meet their debt servicing requirements; something our economic managers and the new governor will have to be mindful of.
Little surprise then that both Pakistan and Sri Lanka are still struggling to bring on board the lender of the last resort, the International Monetary Fund (IMF). Further, for developing countries an additional challenge is always the very thinking at the IMF quarters: It invariably supports an unyielding view of how global finance should work—capital must flow freely across borders, no matter the consequences. This volatility in capital flows, especially in small and emerging economies, have always created problems of its own, ones that are mainly pertinent to vulnerable economies, the type that ironically need the IMF support in the first place!
For example, at present, having barely weathered the Covid crisis, in part with the help of emergency lending and debt-service relief from their wealthier counterparts, the world’s low- and middle-income countries face another challenge: The cost of servicing their external debt—which amounted to about $9 trillion in 2020—is set to increase sharply as central banks such as the US Federal Reserve raise interest rates to combat inflation. In 2022 alone, public and private borrowers will have to pay almost $1 trillion, according to the World Bank. The danger is that global speculative investors, spooked by the daunting debt payments, will further undermine developing nations’ finances by pulling out en-masse. Such reversals can be swift and punishing, as private credit vanishes and exchange-rate swings boost foreign-currency debt burdens. During the last central-bank tightening cycle in 2013, more than $20 billion in capital fled emerging markets in just 45 days. During the Covid crisis, the outflows reached $100 billion. Meaning, one can see why easy money can no longer be easily lured by simply increasing the interest rates.
Also, one can imagine or it comes as no surprise the kind of competition Pakistan faces today in securing its funding requirements from international financial institutions that already stand over-stretched in their lending portfolios. More importantly, this very kind of threat primarily illustrates where perhaps our previous central banker went wrong, because in effect such a phenomenon becomes a quandary for the emerging markets (say Pakistan): Where on one hand foreign capital is critical for development, on the other it becomes extremely hard to manage. In good times, inflows of hot money expand credit and fuel inflation. And as long as capital flows freely, there’s not much developing-nation central banks can do to cool things down: Higher interest rates only attract even more foreign money, further overheating the economy until some event triggers an exodus (as it happened here in Pakistan).
It is a dynamic that has played out time and again not just with us, but from Mexico in 1994 to Asia in the late 1990s. However, while this foreign capital volatility can be extremely tricky, it is not that it cannot be managed at all. Unlike us, some prudent economic managers in developing nations are not always helpless to control fickle and temperamental capital flows. On the contrary, they’ve developed tools to slow inflows when credit expansion starts to look like a bubble, and to mitigate outflows when the bubble bursts. Some, such as Malaysia, limit foreign ownership or foreign sales of property to constrain excessive real-estate investment. Others, such as Indonesia, require banks to maintain a higher percentage of foreign investment in the form of liquid reserves. In all cases, the broader aim is to encourage the kind of longer-term investment that contributes to sustainable export growth.
Clearly this kind of a resolve was overlooked in our case. The real problem with us being that since our economic managers over the last few years had a mindset akin to that of IMF’s official policy, we kept on following a course without properly ascertaining whether it was in our interest or not. Unfortunately, the IMF has long been reluctant to approve capital flow measures—and in those rare cases where it does, it typically encourages their swift retraction. This position has created tension with even developed-nation members such as Australia, Canada, Korea and New Zealand. For emerging economies, it can be devastating, as they’re more likely to depend on IMF support and their foreign investors are more sensitive to the fund’s recommendations.
Fortunately, this hard-line position of the IMF seems to be changing. It recently took an important step away from that orthodoxy—and not a moment too soon for some developing nations. In a 2020 report, the IMF recognised that its position was “at odds with country experience and recent research.” Consider the case of India, which in 2013 faced a sudden capital reversal triggered by the Fed’s plans to remove monetary accommodation in the US. The Reserve Bank of India moved quickly to restrict outflows, attract inflows, support the market for currency swaps and limit outward foreign direct investment. The IMF later concluded that the measures “helped to restore confidence,” but it never endorsed them at the time—a failure that interfered with their efficacy. Still, when it mattered India unilaterally took some bold financial policy decisions, which (now officially recognised) paid off for them. Sadly, no such assertiveness has ever been displayed by us even as late as 2020-21 when our foreign exchange reserves started to deplete.
Anyway, back to 2022 and the question being, so what now as after all we are still desperately vying to re-commence—albeit with a higher outlay—the stalled Fund’s program? Well, fortunately the good news now is that the IMF finally has officially revised its institutional view to be more accepting of capital controls that are also known as macroprudential measures—that is, those put in place to pre-empt crises or to mitigate systemic risk—and those that are meant to ensure “national or international security.” This is a crucial step toward rebalancing power, towards giving emerging economies more autonomy in managing their capital accounts and monetary policy.
That said, the IMF can and should do more—for example, by also allowing for targeted capital controls (both inflows and outflows) aimed at specific domestic goals. Still for now, even this new shown flexibility is a good omen and a good start. Now surely, we all know that capital controls alone can’t address the deeper issues of international finance, such as why investment doesn’t flow the way it should to higher-growth countries, or how emerging economies can achieve the safety and stability that command such a large premium during crises. However, the measures can at least mitigate the volatility that so often does so much damage—which is why this well overdue IMF’s policy shift is truly welcome. One only hopes though that the new acting State bank Governor will take cognisance of these developments and hopefully unleash some fresh thinking in Pakistan’s monetary policy framework that focuses on domestic aspirations and needs rather than merely policing the Fund’s discipline imposed from faraway.
