The strategy is to accumulate foreign currency from the local market at lucrative rates. The interest rates are rising, and the currency is undervalued now (REER is roughly around 97-98) at every level. A few may opt to sell in the market. And those who may not, element of fear is going to be applied. A carrot and stick approach!
The plan is a 180 degree shift from Dar's philosophy, to keep currency levels intact and sell dollars in the market to meet the rising demand. Those days were of overvalued currency and low rates, exporters were keen to keep their liquidity in foreign currency and the domestic accumulation of foreign currency was making sense. Besides, the black economy operators preferred hard cash in any currency. He used a carrot and stick approach, but beneficiaries of that time could be punished now, and vice versa.
Asad Umar tried to revert to real equilibrium, but his pace was slow. Pressures from within party, and for his own political stake, he was hanging in the middle. That brewed uncertainty, and in panic, dollarization and currency in circulation paced up. He merely used carrots, and that was not enough.
Now cold-hearted surgeons are in actions. The SBP's game plan is to buy dollars from the market. NFA, NDA and NIR targets are going to be stiff. The resolve seems to be serious on ending government borrowing from the SBP, as well. This will put further pressure on the banking liquidity and will jack up the interest rates - another 100-150 bps hike is on cards. The opportunity cost of keeping cash will increase and undervalued currency would make foreign currency holdings more expensive.
The problem would be on the mechanism to entice people to document cash holdings. Some Rs 1 trillion cash has been accumulated, in excess from its historic average, in the past 4 years. Can adjusting the macroeconomic variables be enough? The micro-level structural reforms are ought to be implemented sector-wise in parallel.
Even within the macro frame, the fiscal deficit is likely to slip further. According to Dr Pasha and Mr. Kardar, the fiscal deficit is expected to slide by 2.4 percent from target to 9.5 percent of GDP in FY20 – highest in decades, if not ever. More interest rate adjustments are to take place to create financing requirement from domestic liquidity.
The retail investment through NSS or new instruments (which should be offered) in government papers has to be designed in a way so that it can tap undocumented cash money, and in turn document it. High rates and the stick of taxmen have to be complemented with the carrot of continued allowance for declaration.
The asset declaration scheme has so far not yielded anything. It is failing, and the government has to establish its writ. The FBR or other agencies have to crack down on non-tax paying individuals and firms. At the same time, investor confidence has to be restored. It is a tough call as both are hard to go hand in hand.
The foreign money has to be flown in. The portfolio investment in T-Bills may not come without attaining stability. The budgetary support money ($3-5bn) is expected from multilaterals, including the IMF, in two years. But for this, the IMF programme is to continue, which may test Imran politically.
The government should get $3-5 billion from the international capital market right after signing off the IMF programme. The other element is to initiate privatization. That will be a complete shift from Asad’s philosophy of governance that was aimed at reforming SOEs and then privatizing them. Hafeez wants to cut the losses, and move on.
The policy direction is right and bold decisions are being made. The catch is in building tax and other institutions’ capacity to document the economy. Next three to nine months are critical.
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