Rising foreign investment in government securities

In order to allay the fears regarding rising foreign investment in government securities, the State Bank of Pakistan (SBP) in a press release on 16th December argued that risks posed by such transfers are limited at current levels and higher investment is a manifestation of growing confidence of international investors in the positive outlook of Pakistan's economy. Also, market-based exchange rate system now in vogue has addressed the previous concerns of these investors about the sustainability of the exchange rate regime. International investors have been investing in Pakistan's equity market for a long time and such investments are considered portfolio investments, just like investments in government debt instruments, and the same framework of Special Convertible Rupee Account (SCRA) is used for the purpose. The investors in these securities have always been able to move capital in and out of Pakistan's financial markets without any problems. Together with continued reforms and improvement in our balance of payments and reserve buffers, the comfort level of international investors in the local currency denominated financial assets has increased.

Regarding the benefits of higher foreign investment in government securities, the SBP has highlighted that such investments help deepen the capital market by increasing the pool of funds available in the local market and allow banks to deploy available funds for lending to the private sector. The interest by international investors also raises the demand for government securities and reduces the cost of borrowing for the government. Besides, the growing role of international investors in the local debt market may serve as a positive feedback mechanism for further improving domestic practices, policies, systems and institutions in line with international best practices. The risks posed by such investment are, however, limited on account of lower share in outstanding external debt. The current level of international investment in debt securities is only dollar 1.2 billion and accounts for less than 2 percent of the total outstanding marketable government securities and less than 0.5 percent of GDP. Besides, the tenor of such investment has been increasing with more investments in longer dated debt instruments. The SBP has also assured the stakeholders that it continues to monitor developments in the financial sector carefully and stands ready to take action against any risk.

It is of course true that there were certain apprehensions in some quarters about the rising level of international investment in government securities (T-bills and PIBs) and these apprehensions were growing especially after these investments had exceeded the one billion dollar mark. It was argued that such investments are just like portfolio investment and will leave the country immediately when there are certain indications of uncertainty in the market or the economy is expected to perform poorly. The risk of default by the country or the expectations of better returns in other countries could also result in the outflow of foreign exchange when it is most needed by the country, destabilise the market and have an adverse impact on the financial system of the country. While there could hardly be any argument about these risks, the SBP has tried to mollify these concerns by elaborating that interest rates in Pakistan were higher in the past (for example, interest rates were around 13.75 percent on average in FY11) but our debt market had failed to attract interest from the international investors. This observation of the SBP may be true but we fail to understand the logic behind this argument. Foreign investors, it may be stressed, are profit maximisers like other business entities and have obviously invested in Pakistan due to much higher returns in the country on T-bills and PIBs than investment in other countries which could at best yield a return of 2 percent or so. Previously, say in 2011, there was a risk of wide fluctuations in the exchange rate of the rupee which did not suit the foreign investors. Such a risk has diminished greatly after Pakistan agreed to the market-driven exchange rate of the rupee under a programme with the IMF which has further strengthened the confidence of foreign investors. To strengthen the argument for the present level of foreign investment in gilt-edged securities, the SBP has also said that this level of investment in government securities at about dollar 1.2 billion is too small to destabilise the local market and is also insignificant when compared to overall debt level or the GDP of the country. The central bank could be right in saying so but, given the present level of reserves, the sudden outflow of this investment in a short period of time could have a very negative impact on the exchange rate of the rupee and increase the cost of production which could fuel inflationary pressures in the economy.