An increase in prices of commodities in the international market brings significant challenges for Pakistan and its economic managers.

Since the year 2000, the world has seen two major commodity supercycles, and in both instances, Pakistan’s economy was trapped in a low growth-high inflation cycle. The first one was in FY08 and the latest in FY23.

Although the reasons for the rapid rise in commodity prices in both cases were different, the response of central banks across the world was initially similar — monetary tightening in order to tame down inflationary pressures.

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The 2008 crisis:

The oil price more than doubled between December 2006 and mid-July 2008 and food prices rose by more than 50 percent during this period in the international market. These surges came on top of large price increases during 2003-06.

A significant reason was growth acceleration in emerging and developing economies including India and China, driven by industrialisation takeoff and strong per-capita income increases from a low base.

In the events leading up to 2008, developing and emerging countries were attractive investment destinations and foreign currency was flowing into these economies.

Advanced economies including the United States were running a big trade deficit while China was reporting trade surplus, causing the value of USD to decline against major currencies and a weaker dollar was causing inflation.

The central bank of the United States started to raise interest rates in 2004 and continued doing so until 2006.

The response of the central bank in Pakistan was also not very different initially. It started raising policy rates in 2005 from a low of 7.5% and continued monetary tightening alongside global economies in order to fight inflation.

As interest rates were rising, prices in the housing sector in the United States and advanced economies started to fall, and credit defaults began increasing, developing into the sub-prime mortgage crisis in 2007 and a financial crisis in 2008.

Although there was no sub-prime mortgage loan crisis in Pakistan, due to tighter regulations in consumer lending, the financial crisis still managed to enter Pakistan.

2008 was an election year, as the national assembly was to complete its term on Nov 15, 2007, and the elections were due on Feb 18, 2008. This is the same year when the prices of commodities in the international markets skyrocketed.

The increasing prices of commodities, including wheat and oil, became a challenge for the outgoing government as it was politically difficult for them to pass it on to the public in the election year.

At the start of FY 2008 the government had a stockpile of resources. USD reserves with the State Bank of Pakistan (SBP) of $13.3 billion were sufficient for 31 weeks of imports.

Along with this, the government was free to borrow from the State Bank of Pakistan (SBP).

The availability of financing tempted the government to absorb increases in the prices of imported commodities in order to gain political advantage.

As a result it began subsidising oil, electricity, and wheat among other commodities. The subsidy was being financed by borrowing from the SBP.

The lower prices induced demand and the consumption of imported commodities continued to increase, putting pressure on precious foreign currency reserves of the country on the external side.

The caretaker government, during its tenure, between Nov 15, 2007 to March 17 2008 allowed the financial situation to aggravate for the new government which was formed in coalition with other parties in Mar 2008.

While SBP was raising interest rates in FY08 to control demand, it was also looking towards these governments to stop the subsidies. Neither the caretaker setup nor the newly formed government took corrective actions to eliminate the subsidies despite reiteration by the SBP in the monetary policy notes of January and May 2008 and despite a continuous increase in commodity prices.

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Karachi Stock Exchange:

During the first few months of CY2008, the stock exchange was rallying, and it touched its high of 15,739 points in April 2008. The foreign portfolio investment continued to build up until April 2008, reaching a high of $5 billion or 7.2% of market capitalization.

The market, however, started tumbling in May 2008 on withdrawals by foreign investors with declining confidence in the domestic economy and risk assets across the world. Local investors also started selling in the market and the market dropped by 20% in the month of May 2008. With some stability in June 2008 the fall continued in July and August 2008.

To curtail the fall, the management of KSE decided to put a floor under prices so that shares could not be sold at rates below the level existing at the close of market on August 26, 2008 (KSE-100: 9,140).

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Money market and the banking sector

As the government had the facility to borrow from the SBP, it was reluctant in borrowing from commercial banks which were demanding higher rates for Treasury bills (T-bills) auctions.

Gradually, due to maturities and lack of participation by Banks, their T-bill stock began to decline, which limited banks’ ability to access the discount window and to participate in the open market operation.

The alternative source of funds for the banks was borrowing from the call inter-bank market.

Consequently, the activity in the call market increased relative to the repo market and the overnight call rates rose to as high as 45 percent during the period from 4th-11th October 2008.

The extraordinary increases in the interest rate caused panic among depositors, who started withdrawing funds from their bank accounts.

At the peak of the crisis, the foreign currency reserves with SBP dropped to just over $5 billion and the government was left with no option but to approach IMF for bailout and begin a program to fix the imbalances.

Finally in November 2008, the government managed to negotiate a bailout package from the IMF and implemented measures to attain stabilization in the economy.

Around the same time the world was entering into recession and prices of commodities had begun to drop. The SBP began lowering interest rates, after keeping it at a high of 15% for just a few months between November 12, 2008 to April 21, 2009.

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The 2023 crisis

The current crisis in Pakistan has many similarities with 2008, in how it was developed and managed.

The recent economic problems in Pakistan also started with the commodity super cycle. The prices began increasing in 2021 as governments across the world were stimulating economies by driving fiscal support along with implementing accommodative monetary policies in response to Covid-19.

Despite the resulting inflation, growth took priority over price stability as the latter was considered transitory by the central banks until the month of February 2022 when the war in Ukraine began a fresh wave of increases in commodity prices from their elevated levels of 2021.

In March 2022, the United States began raising interest rates in an effort to control demand amidst continuation of supply disruption and spiraling inflation. The continued monetary tightening in advanced economies increased the cost of borrowing for developing and emerging economies.

Like 2008, in Pakistan, price increases in international commodities were politically difficult for the government to pass on to the public due to political instability.

As the government was surviving under the threat of a vote of no-confidence (VoNC), it decided to absorb the increase in prices by utilising local and foreign resource envelopes. This was the same policy mistake that trapped Pakistan in a high inflation and low growth environment in 2008.

As a result, the primary account reported a deficit of Rs528 billion in 3rd quarter FY22 alone.

The government changed as a result of VoNC and the new government took over on Apr 11, 2022. The new government continued the subsidy announced by the previous government despite its unsustainable cost. The Q4 2022 primary deficit was reported at Rs1,630 billion. Cumulatively during FY22, the country incurred an all-time high primary deficit of Rs2,077 billion.

In Feb 2022 the country had foreign currency reserves of over $16 billion. The subsidy on prices of petrol and electricity facilitated their high demand and made monetary policy tightening ineffective. By June 2022, foreign currency reserves with SBP fell to less than $10 billion.

Like 2008, after consuming the foreign and local resource envelopes, the government decided to take corrective actions. It was left with no option but to seek help from the IMF.

The collapse in Pakistan economy in 2008 was coincidentally simultaneous with the global crisis when multilateral lenders were already helping countries on softer conditions. This time, however, the crisis was less global, and the policy errors that led to the crisis were visible to the lenders.

The revival of program was therefore difficult, as Pakistan had to demonstrate its willingness to take corrective actions to turn the high primary deficit into primary surplus in FY23.

Mapping current situation in equity and money markets with 2008

Considering the similarities of the events in 2008, we have mapped them to the present situation in the equity and money markets.

The primary events behind the crisis in 2008 as well as in 2023 in Pakistan had many similarities. However, the economic situation is very different. In the three years prior to the crisis, during 2005-07, the GDP growth was 5.7% annually, the currency was stable and KSE 100 index was growing at 37% per annum. It was a high base from where adjustments had to begin.

Comparatively, in the three years prior to the crisis between 2020-2022, the GDP growth was substantially lower at CAGR of 3.7%, the currency was unstable and KSE 100 index was range bound with CAGR of 7% per annum.

The investors had been cautious in the equity market in the years before the development of the current crisis.

On the banking and money market side, during the 2008 crisis, the government was mostly borrowing from the SBP and therefore it was not competing with the private sector.

The absence of the government in borrowing from the commercial banks kept the KIBOR lower than the policy discount rate on the false impression of liquidity in the banking sector.

Comparatively, this time, on-tap borrowing from SBP is not an option for the government and it is fulfilling its demands by borrowing from the market. The interest rates in the money market reflect the complete demand situation of the government as well as private sector and there is no hidden borrowing.

This is also a money-making time for the commercial banks and they are reporting strong earnings on account of high spreads earned from the government and the private sector.

The international economic situation has so far not indicated any crisis-like situation in development. Initially when a few banks reported default, there was a fear that these could result in failure of more banks.

However, the consensus is that these events are specific to certain banks due to their specific decisions / circumstances. For example, the Silicon Valley Bank was heavily concentrated in a single sector — venture capital-backed startups in tech and healthcare, and a single region: North California.

The international and domestic economic events in 2008 took investors by surprise in an optimistic environment. Until April 2008, investors believed that economic problems will be resolved which ended up in a full-blown economic crisis, from a high base.

The domestic economic events of 2023 have not taken investors by surprise and they have already been cautious on the economic developments since the high achieved by the market in May 2017. The optimism and pessimism by the investors, as a result, is range bound.

The international economy in 2023 is so far stable, the problems in their banking sector are limited and the central bankers are staying put in their fight against inflation. Any negative development on that front could pose new challenges in Pakistan economy, which is otherwise stabilising.

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