Here we are, once again at a loss, as to what the present governmental dispensation really wants to achieve with the economy in theoretically about 18 months that it has at its disposal. We were not even finished moaning about a lack of holistic policy making by the previous government, and now even with these new economic managers in the hot seat the much-needed clarity on the way forward eludes the investors and the private sector! We all know by now that a resumption of the IMF programme is imperative (since it serves as an auditor to allow other IFIs to release promised funds) to open doors for renewed borrowing, but then what? What one would like to understand is that once the pain of the fund programme is endured, how exactly do we start restoring the confidence in the markets over the medium and long term to take the economy back to a sustainable path—it appears to be in a free fall for now. With debt servicing taking almost 30 percent of annual national revenues, have we reached a threshold where the present debt burden is essentially unserviceable? Pakistan’s borrowing portfolio in essence is expensive (Pak bond is presently discounting at almost 40 percent, a level that is not only un-sustainable but renders the instrument itself to a status of junk) and economic history tells us that countries with softer borrowing terms tend to face difficulties in debt servicing once they go beyond the 15 percent mark—Sri Lanka at the time of default was around the 30 percent mark of its total revenues being taken up by debt servicing. Some South American economies of late have had to move towards restructuring of debt at levels of under 20 percent. While this is something that the government needs to start quickly exploring vis-à-vis its international commitments, the overall reality is that any turnaround is invariably achieved through domestic fortunes, which eventually transform into enhanced fiscal space for the government over the longer-term and allows it to manage its debt burden successfully, provided of course it steers a prudent course on the very nature cum purpose of its fresh borrowings.
With a few good names in the current team who at some stage or the other of their careers have been associated with the private sector and have therefore actually walked the talk, perhaps the time has come for them to start addressing some key issues that continue to plague Pakistan’s economy. Though—given the consistent poor policy making over almost two decades—the list is quite an extensive one by now, still it would serve them well by focusing on mainly three areas, which if addressed quickly can serve as a possible platform for economic resurrection. First is to ring policy changes that address the external account on an emergency basis. It is no secret that our growth in recent history has mainly been driven through imports and it is time that we change this behaviour permanently, because every time we grow at more than 3 percent our foreign exchange outflows become unsustainable leading us to cycles of significant currency devaluations and exorbitantly high interest rates, in-turn killing any type of productive investment in the country. The underlying necessity is to provide jobs for the new job-entrants (a large number coming in every year) and to alleviate growing poverty in the country.
For this to meaningfully happen, Pakistan’s GDP must grow at 7 percent or more annually, but then this growth has to be from our own resources and not on imported reliance. India today grows at around 7 percent with an exchange rate double that of ours and an interest rate at 4 percent, Bangladesh again at around 7 percent with an exchange rate almost double that of ours and an interest rate of 6.50 percent; and even Afghanistan last month announced a surplus development budget with its currency almost double that of ours. So, what have India and Bangladesh done to achieve this? Primarily they have resorted to import substitution followed by a surge in exports and in doing so have allowed a role to the private sector far greater than even some of the western or developed economies. This in the process has not only allowed the government to save on valuable capital outlays in some development sectors, but at the same time also given it the luxury to invest it in areas that are much more important for sustainable growth, for example in human capital and investment/spending in deep poverty pockets and areas otherwise not in reach. The mindset for this manufacturing push has been quite deliberate with a clear eye on building reserves, because remember import substitution is largely a one-time exercise and unless cemented by exports through shoring up national competitiveness it can often become counterproductive through resultant inflation, a depleted value for money and rent seeking. As a result not only has their manufacturing grown per se, but more importantly in a way that bases itself on global competitiveness. Foreign Direct Investment or industry that erodes foreign exchange surpluses have been kept at bay. Only recently India put an overall cap on its automobile industrial sector by correlating exchange outflows to the net exchange earnings, something that not restricts sectoral external account imbalance, but also ensures implementation on deletion targets and in the process adding local jobs. Little wonder then that their reserves match or exceed their respective annual export earnings; India today has in excess of $600 billion as foreign exchange reserves, whereas Bangladesh is at around the $50 billion mark.
Secondly, the entire national financial dispensation needs to be looked at in a new light. The privatising of nationalised banks is yet another story of conflict-of-interest and rent seeking that the writer will touch upon some other time, however, the problem that we face today is that the current banking structure in Pakistan is hurting an equitable and priority based growth and investment in the country. The very element of the state stepping in to the ambit of private sector borrowings from privatised cum commercial sector banks is not only crowding out the private sector, but also allowing the luxury to these banks of being able to selectively decline some key or important lending portfolios in order to maximise their own profits or simply because they do not anymore require to take any operational lending risks to make money. The mantra being to primarily undertake sovereign lending positions thereby guaranteeing healthy returns at minimal risk. This in-turn has grave overall ramifications on the preferred (in national interest) sectors, areas and the very types of growth and investment that the country requires. The dwindling fortunes and a declining output in national agriculture and a general phenomenon of de-industrialisation can be largely attributed to this. Also, such an environment creates undesirable barriers to entry and stokes concentration of wealth in a few hands. In fact even the government, being the largest domestic borrower, suffers heavily since as interest rates go up, so do the government’s debt servicing.
As an example, the recent hike of interest rates to 13.75 percent correspondingly swells the state’s debt servicing to over 1 trillion rupees every year, leaving nothing in return to spend on the people. Ironically, even for the commercial banks, if one scratches the surface to get to the real profits they earn, one determines that they may not reflect ideal pickings for the banks either. Most are book entries, since a cash strapped government invariably borrows more to service previous debts with very little excess cash or liquidity finding its way into the hands of the lending institution; something that is quite reflective in the percentage of earnings that the banks pay as dividends to their shareholders. Also, with the government’s declining ability to pay its debt the very argument of sovereign debt risk becomes questionable and may on the contrary reflect some hidden toxic assets that may never materialise! As if this was already not enough of an impediment to contend with for the real movers and shakers of the economy (the private sector), the whole way of working of the FBR puts a complete dampener on the confidence of the investor. The much-anticipated reforms never really took place and the draconian laws and high-handed tactics simply make the investor shy away from investing in the country. Frivolous notices, attaching accounts, refusing sales tax refunds on flimsy grounds, arbitrary tax notices and assessments, etc have led to a disinterest of the investor in the documented sector. DFI and domestic investment in manufacturing has all but been eroded. In contrast, Bangladesh grows both its LSM and SME in double digits, no wonder it has over the years amassed the capability of converting $2 billion of annual cotton imports into a (ten times) value added corresponding export of $20 billion (its total annual export is now almost $50 billion). It seems that successive governments in Pakistan have consciously been anti-investment in manufacturing, because their interest can be gauged from the fact that today there is not a single dedicated industrial development financing institution in the country whereas, we had almost 10 such state-run financial institutions back in the 80s!
Finally, third, one sees that investment in human capital and a focus on enhancing productivity in general has been missing. Pakistan today has 7 million young unemployed or underemployed degree holders under the age of 35 and nearly 3 million enter the job market every year out of which again around 15 percent hold some sort of an education qualification on paper. It just goes down to show that not only the quality of education being imparted in the country is rather dismal, but also irrelevant. Additionally, polytechnics are all but non-existent and the ones that do still function lack the updated knowledge and tools necessary for an individual to excel in the modern industrial environment. Productivity is something that is defined as the value of goods and services produced per hour of work. Pakistan since the last 7 years have had a negative growth in productivity. Since productivity is more aptly measured on an international scale, the incentive to be productive in Pakistan has mostly suffered just by the dint of repeated currency devaluation. For example, for a similar productivity gain to take place in the UK and Pakistan simultaneously the yielded gains in the UK would tend to be almost 5 times more rewarding than in Pakistan. More pertinently, productivity is one area where seemingly small percentage gains can make a big difference in a country’s wealth and living standards over time. For example, according to a McKinsey and Company report published last year, in the US, just an additional 1 percent annual increase in productivity over a few years, to 2024, would generate an extra $3,500 in per-capita income for Americans. The sooner we also start grappling with such realities the better chance we will stand to at least stabilise the economy over the next 18 months, even if a turnaround dream could be a long way away at this stage!
With a few good names in the current team who at some stage or the other of their careers have been associated with the private sector and have therefore actually walked the talk, perhaps the time has come for them to start addressing some key issues that continue to plague Pakistan’s economy. Though—given the consistent poor policy making over almost two decades—the list is quite an extensive one by now, still it would serve them well by focusing on mainly three areas, which if addressed quickly can serve as a possible platform for economic resurrection. First is to ring policy changes that address the external account on an emergency basis. It is no secret that our growth in recent history has mainly been driven through imports and it is time that we change this behaviour permanently, because every time we grow at more than 3 percent our foreign exchange outflows become unsustainable leading us to cycles of significant currency devaluations and exorbitantly high interest rates, in-turn killing any type of productive investment in the country. The underlying necessity is to provide jobs for the new job-entrants (a large number coming in every year) and to alleviate growing poverty in the country.
For this to meaningfully happen, Pakistan’s GDP must grow at 7 percent or more annually, but then this growth has to be from our own resources and not on imported reliance. India today grows at around 7 percent with an exchange rate double that of ours and an interest rate at 4 percent, Bangladesh again at around 7 percent with an exchange rate almost double that of ours and an interest rate of 6.50 percent; and even Afghanistan last month announced a surplus development budget with its currency almost double that of ours. So, what have India and Bangladesh done to achieve this? Primarily they have resorted to import substitution followed by a surge in exports and in doing so have allowed a role to the private sector far greater than even some of the western or developed economies. This in the process has not only allowed the government to save on valuable capital outlays in some development sectors, but at the same time also given it the luxury to invest it in areas that are much more important for sustainable growth, for example in human capital and investment/spending in deep poverty pockets and areas otherwise not in reach. The mindset for this manufacturing push has been quite deliberate with a clear eye on building reserves, because remember import substitution is largely a one-time exercise and unless cemented by exports through shoring up national competitiveness it can often become counterproductive through resultant inflation, a depleted value for money and rent seeking. As a result not only has their manufacturing grown per se, but more importantly in a way that bases itself on global competitiveness. Foreign Direct Investment or industry that erodes foreign exchange surpluses have been kept at bay. Only recently India put an overall cap on its automobile industrial sector by correlating exchange outflows to the net exchange earnings, something that not restricts sectoral external account imbalance, but also ensures implementation on deletion targets and in the process adding local jobs. Little wonder then that their reserves match or exceed their respective annual export earnings; India today has in excess of $600 billion as foreign exchange reserves, whereas Bangladesh is at around the $50 billion mark.
Secondly, the entire national financial dispensation needs to be looked at in a new light. The privatising of nationalised banks is yet another story of conflict-of-interest and rent seeking that the writer will touch upon some other time, however, the problem that we face today is that the current banking structure in Pakistan is hurting an equitable and priority based growth and investment in the country. The very element of the state stepping in to the ambit of private sector borrowings from privatised cum commercial sector banks is not only crowding out the private sector, but also allowing the luxury to these banks of being able to selectively decline some key or important lending portfolios in order to maximise their own profits or simply because they do not anymore require to take any operational lending risks to make money. The mantra being to primarily undertake sovereign lending positions thereby guaranteeing healthy returns at minimal risk. This in-turn has grave overall ramifications on the preferred (in national interest) sectors, areas and the very types of growth and investment that the country requires. The dwindling fortunes and a declining output in national agriculture and a general phenomenon of de-industrialisation can be largely attributed to this. Also, such an environment creates undesirable barriers to entry and stokes concentration of wealth in a few hands. In fact even the government, being the largest domestic borrower, suffers heavily since as interest rates go up, so do the government’s debt servicing.
As an example, the recent hike of interest rates to 13.75 percent correspondingly swells the state’s debt servicing to over 1 trillion rupees every year, leaving nothing in return to spend on the people. Ironically, even for the commercial banks, if one scratches the surface to get to the real profits they earn, one determines that they may not reflect ideal pickings for the banks either. Most are book entries, since a cash strapped government invariably borrows more to service previous debts with very little excess cash or liquidity finding its way into the hands of the lending institution; something that is quite reflective in the percentage of earnings that the banks pay as dividends to their shareholders. Also, with the government’s declining ability to pay its debt the very argument of sovereign debt risk becomes questionable and may on the contrary reflect some hidden toxic assets that may never materialise! As if this was already not enough of an impediment to contend with for the real movers and shakers of the economy (the private sector), the whole way of working of the FBR puts a complete dampener on the confidence of the investor. The much-anticipated reforms never really took place and the draconian laws and high-handed tactics simply make the investor shy away from investing in the country. Frivolous notices, attaching accounts, refusing sales tax refunds on flimsy grounds, arbitrary tax notices and assessments, etc have led to a disinterest of the investor in the documented sector. DFI and domestic investment in manufacturing has all but been eroded. In contrast, Bangladesh grows both its LSM and SME in double digits, no wonder it has over the years amassed the capability of converting $2 billion of annual cotton imports into a (ten times) value added corresponding export of $20 billion (its total annual export is now almost $50 billion). It seems that successive governments in Pakistan have consciously been anti-investment in manufacturing, because their interest can be gauged from the fact that today there is not a single dedicated industrial development financing institution in the country whereas, we had almost 10 such state-run financial institutions back in the 80s!
Finally, third, one sees that investment in human capital and a focus on enhancing productivity in general has been missing. Pakistan today has 7 million young unemployed or underemployed degree holders under the age of 35 and nearly 3 million enter the job market every year out of which again around 15 percent hold some sort of an education qualification on paper. It just goes down to show that not only the quality of education being imparted in the country is rather dismal, but also irrelevant. Additionally, polytechnics are all but non-existent and the ones that do still function lack the updated knowledge and tools necessary for an individual to excel in the modern industrial environment. Productivity is something that is defined as the value of goods and services produced per hour of work. Pakistan since the last 7 years have had a negative growth in productivity. Since productivity is more aptly measured on an international scale, the incentive to be productive in Pakistan has mostly suffered just by the dint of repeated currency devaluation. For example, for a similar productivity gain to take place in the UK and Pakistan simultaneously the yielded gains in the UK would tend to be almost 5 times more rewarding than in Pakistan. More pertinently, productivity is one area where seemingly small percentage gains can make a big difference in a country’s wealth and living standards over time. For example, according to a McKinsey and Company report published last year, in the US, just an additional 1 percent annual increase in productivity over a few years, to 2024, would generate an extra $3,500 in per-capita income for Americans. The sooner we also start grappling with such realities the better chance we will stand to at least stabilise the economy over the next 18 months, even if a turnaround dream could be a long way away at this stage!
