Tightening of the belt, at last

24 May, 2008

What the Governor SBP presented before the nation at her press conference on May 22 was a shocking picture of Pakistan's finances. Given the huge size of the external imbalances, the SBP action plan seems appropriate though, perhaps, late by at least two quarters and not making requisite concessions for the export and pharmaceutical sectors.
Chiefs of the Korangi, Federal B Area, and North Karachi associations of trade and industry were quick to fault the SBP for raising its discount rate and minimum profit payable on saving and PLS deposits because they all believe that industrial borrowers will bear the impact of these changes jacking up their cost of doing business, and paying 35 percent LC margin up-front will aggravate their liquidity problems.
That's all true. But who should pay these costs? Is the industry only to benefit all the time at the expense of the rest, or it too should carry its fair share of the burden? In the past forty years, with some notable exceptions, members of the industry have perpetually been asking for crutches. Doesn't this reflect managerial weaknesses within the industry that have become its culture of living beyond means?
Facing up to the circumstances Pakistan is confronted with, there is no room, at least for a couple of years, for anyone to have all that he or she may want. It is time to tighten our belts, use our abilities to drastically cut waste of all kinds, economise on resource use, and give up wasteful consumption. More importantly, look into our own shirt before blaming others for our ills. But that isn't happening yet. The same evening, in a late night TV talk show, Chairman APTMA went as far as predicting the closure of the textile industry by early FY09.
This industry - our biggest - has never been happy with monetary and fiscal policies, and has always complained of booking losses but generation after generation, factory owners stay in the same business. Interesting, isn't it? Yet, the seasoned compere conducting the show didn't raise this issue.
In the same talk show Dr Salman Shah opined that SBP measures will spur stagflation forgetting very conveniently that, besides the uncertainties caused by post-election discord between coalition members, in its reasons for downgrading Pakistan's sovereign risk Moody pointed to fiscal loosening and poor tax collection in the run up to the general elections, and resultant escalation of the of external imbalances.
This was the period when Dr Shah was the most trusted macro economic advisor of Shaukat Aziz, the erstwhile PM, and then served as the caretaker Finance Minister. The huge external imbalances that the SBP is now trying to contain are the legacy left behind by the regime he served. More disappointing was the fact that he offered nothing in terms of an alternate strategy for clearing this mess. In fact, there is none.
Public sector borrowing, that has beaten all past records in terms of its size as proportion of the GDP, and proportion of the debt in short-term paper, owes a lot to the way public debt was raised and spent by the last regime, and the fact that earlier increases in SBP Discount rate did not lead to the desired cut in monetary expansion and inflation has principally to do with the forced magnetisation of the public debt.
It is this aspect of financial mismanagement that brought real interest rates down drastically. On the one hand it seriously undermined the incentive for saving, and on the other forced businesses to seek enormously high nominal returns to end up with reasonable real returns on investment. The ruthlessly pursued policy of liberalisation, deregulation and privatisation seriously undermined rationality and ethics in business dealings, and a sense of social responsibility.
In the recent past, how many businesses showed, or even now show, their concern over the record trade and current account deficits? On the contrary, they reject the measures to contain these dangerously high deficits simply because they can't, even for a while, live with lower returns to allow these imbalances to come down to levels that reflect the collective rationality of Pakistan's businesses. Let us not forget that it is imperative for encouraging investment, sustaining economic growth, and containing poverty.
In the current scenario, import of non-essentials has to be contained, though, besides food grain and oil, SBP could have exempted imports of raw materials for the export and pharmaceutical sectors, and plant and equipment for BMR as well as for power generation, from the condition of importers providing 35 percent up-front LC margin. Undoubtedly, it will compound the liquidity problems of the export sector that has to sell on credit in overly competitive foreign markets.
Surely, Pakistan needs to implement measures that cut its external imbalances but those that may hamper sustaining exports at their current level, will make it tougher to achieve this objective, given the fact that uncertainties on the political front are slowing down FDI flows that Shaukat Aziz got us into believing as the remedy for containing external imbalances caused by imports with peripheral economic value.
There are doubts also about the efficacy of the large (150 basis points) hike in the SBP Discount Rate. While it will certainly push banks into safer lending to avoid queuing up frequently at the SBP Discount window, the added cost would hurt even those borrowers that run safe businesses and repay on time. This could hurt them for no fault of theirs.
SBP could have raised the reserve requirements even higher on the saving deposits. It would have served three purposes: encourage savings and induce banks into market for deposits with longer life spans, cut marginally safe lending, and accumulate higher liquidity for investment in public debt to minimise the need for printing more money to fund fiscal slippages.
In the absence of these frills, the measures announced by SBP could become the target of criticism for more trade associations and chambers of commerce in spite of the fact that, in essence, SBP has taken the right approach to containing external imbalances. Was it hurry or was it incomplete assessment of impact that led to overlooking these areas, is a question that policymakers need to ask themselves.

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