How to avert economic collapse

The worst kept secret about the present economic crisis is that it has resulted from our rulers having saddled the people with a huge debt while harvesting its proceeds to acquire properties, businesses, and citizenships abroad.

As a result, ordinary citizens as ultimate debtors can no longer pay even the interest payments on this debt (which are growing explosively), without unbearable hardship. The rulers, who contracted this debt on their behalf, would rather emigrate than share the burden. The creditors will not lend more without committing the government to the very policies that got us here.

In this standoff, the creditors’ cartel has captured government and prevailed. Since 1988, we have secured thirteen IMF loans (eight, with policy conditions), each tied to the same generic solutions, each leaving Pakistan in deeper crisis. Even a rat in a maze learns from experience to avoid dead ends and find its way out. Not us. We keep trying the same policies, expecting different results.

This article examines why we do this and outlines alternative solutions to our economic problems.

Given a lock to unlock, instead of trying to unlock the lock ourselves, our knee-jerk reaction is to turn to foreigners (actual, and those who live or have lived among them) to seek advice on what other countries have done.

This is why we are perpetually beating our breasts at our failures and are perennially perplexed at why what works in Xanadu (substitute your country of choice) doesn’t work in Pakistan. It doesn’t work because the Xanadu key doesn’t fit the Pakistan lock.

But this is impossible for our decision-makers to grasp, for four main reasons. One, most lack the capacity to judge arguments on merits and with colonised minds their reflexive tendency is to privilege foreign over domestic advice.

Two, consequently, the policy agenda gets confined to selecting foreign solutions to mimic, rather than working out problem-focused solutions to try. Three, because foreign advisors, usually on a short visit, can offer only generic solutions, they fail in Pakistan. Finally, with the short shelf-life of governments, generic solutions—sweetened by loans—usually win the day. This is the disastrous path all governments have followed and are still following.

To avoid economic collapse, now imminent, we must abandon this solutions-based approach to problems, for a problem-based approach to solutions, with all options on the table. Accordingly, this article outlines, summarily, solutions to the urgent foreign exchange crisis; and, at greater length, to the more intractable problem of restoring fiscal and debt viability.

While space precludes justifications, the foreign exchange crisis can be ameliorated by three obvious if unfashionable steps. One, to stem the rupee’s fall, change the exchange regime and fix the rate at Rs.220 or so to the dollar (or an equivalent basket of currencies), and defend it.

Two, design an appropriate prudential system of capital controls, permitted by the IMF’s Articles of Agreement (VI, s.3) and included in some programmes (Argentina 2002, Iceland 2008). Finally, change official debt policy, to permit only necessary foreign debt; declare a two-year moratorium on additional foreign borrowing; and close deadweight projects with large undisbursed balances of foreign loans.

On the fiscal and debt front, the government should do four things. One, unilaterally reduce its future interest obligations, by restructuring domestic-law debt (following the detailed four-month, six-step, IMF-supported procedure outlined in: How to solve the debt crisis, BR, 22 Apr 2022). Two, reduce policy-determined interest rates on new debt. Three, restore the right of government to monetary financing of the deficit. Finally, undertake comprehensive financial sector reforms.

First, interest due in FY23, in trillions of nominal rupees, would perhaps be around Rs 4 trillion (domestic Rs 3.4 trillion, foreign Rs 0.6 trillion). Immediate action on restructuring domestic debt should lower currently projected interest obligations by some Rs 0.75 trillion in FY23, and around Rs 1.5 trillion in each successive year.

Second, another Rs 1.5 trillion can be reduced by gradually lowering average interest rates by 600 basis points. If it is feared that this will lead to misallocation of credit, then the credit planning system (1972-2006), abandoned at the behest of the IMF, can be revived. Any other negative consequences should be anticipated and addressed in the light of experience, not religious dogma.

Since this flies in the face of well-entrenched IMF dogma, supported by domestic bankers, we are forced to digress to explain why IMF’s convictions don’t hold in Pakistan. From the 1990s, a consensus emerged in industrial countries that monetary policy should target inflation, and actual and expected interest rates determine inflation. But in Pakistan inflation is neither the main policy target nor, empirically, is it determined by interest rates.

So, by its impact on public debt, misguided doubling of interest rates over the last two or three years caused the present fiscal and debt crisis. And by forcing government to mobilise public revenues to pay interest to banks, it enriched the super-rich at the expense of ordinary citizens, contributing to political instability.

It is preposterous that defence expenditures during the last two years were 11 percent less than the Rs 1.4 trillion per year paid in interest to just the top ten banks. Not only should interest rates be reduced, but the entire framework of monetary policy based on inflation targeting by an alienated central bank, mimicking industrial countries, needs to be rethought.

Third, for reasons elaborated at length in an earlier article (‘New’ State Bank of Pakistan, BR, 2 Feb 2022), the government must untie its hands and restore, in principle, its right to borrow from the central bank, if necessary.

This will provide for emergency deficit financing and restore competition in the sovereign debt market. Without competition from the central bank, the banks — a close cartel, with the six biggest banks (two foreign-owned) accounting for 80 percent of assets of all banks — have jacked up interest rates (6-month T-bill from 7.5 percent in Aug-21 to 14.7 percent today) and are quietly making massive windfall profits.

Both steps, however, of lowering interest rates and restructuring domestic debt, must be entrusted to capable hands. This is because the co-dependence of banks and government on each other can create a downward spiral in which a public debt crisis triggers a banking crisis, and vice versa, with one aggravating the other. (In the jargon: the sovereign-bank ‘nexus’ creates a ‘doom-loop’.) Consequently, preparation and sequencing are essential to successful implementation.

Finally, dysfunctional fiscal policies have transformed the banks from being financial intermediaries to becoming sovereign debt brokers. Thus, in 2018-20, sovereign debt constituted the bulk of bank assets in Pakistan (38 percent, up from 20 percent in 2008-10), by far the highest anywhere in the world. In second place, Brazil, this ratio was 25 percent, up from 21 percent. With few exceptions, in most countries it hovers around the 5-10 percent band.

There is a need, therefore, for adapting the logic of the US Glass-Steagall Act (1933, repealed 1999), to separate normal commercial banking from dealing in sovereign debt. In addition, both commercial banks and primary dealers should be discouraged from holding government debt beyond a specified level, by a heavy tax on excess holdings.

There is in fact a consensus, endorsed by prominent central bankers, that the financial sector is long overdue for root-to-branch reforms. While exceptionally profitable in commercial terms, former central bank governor, Yaqub, points out, the banking system in Pakistan is among the weakest in the world, if judged by global standards of sound banking. Banks pay less attention to mobilising private savings for investment, than to channelling tax-evaded surpluses of the rich and advances from the central bank, to government as debt.

The directions of reform can be guided by proposals of former central bank governor, Salim Raza, who calls for a comprehensive restructuring of credit flows to better balance the predominance of large-scale manufacturers and exporters, often the same, with the needs of mid-size high-productivity farming and import substitution industries, especially of intermediate goods. This can be done, among others, through a specialised development finance institution, as he proposes, and/or by reviving credit planning, as suggested earlier.

Naturally, these summary solutions must be supplemented by many details and supportive measures. What this article demonstrates, hopefully, is that there are alternatives to the self-defeating policies that come bundled with IMF money. Policies that we have tried repeatedly, for thirty years, with repeated failures and disastrous results.

“Insanity,” Einstein is reported to have said, “is doing the same thing over and over and expecting different results.” This article, quite simply, is a plea for sanity.

Copyright Business Recorder, 2022