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Disappointing monetary management

09 October, 2013

By Dr Kamal Monnoo


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With the national investment climate already at a low, the recent signals coming from the State Bank of Pakistan have not only been unclear but also quite confusing. 'Uncertainty' as any management or economic guru will tell you tends to be one of the principal impediments to investment, both domestic and foreign. The monetary announcements of late tend to be neither here nor there; meaning if you ask a potential investor whether the Pakistani Central Bank is focusing on inflation or growth, his answer would be: 'Not Sure'. This confusion in itself can be quite damaging, because if investment has to be rekindled in the country any potential investor needs to be clear on what the government is looking for and likely to support going forward. In addition, to make matters worse, the recent saga of the rapid currency devaluation (post IMF package) does not only border on the bizarre, but is also likely to have extremely negative implications on Pakistan's long term economic prospects, and especially on our financial stability in the period to follow.

Again, the policymakers' explanations put forward on the Pak Rupee's slide point towards a government that is either unsure of itself to tackle confronting economic challenges or has simply caved in to donor driven recipes on how to manage the Pak economy. Initially, we were told that the devaluation will help Pakistan enhance its export competitiveness, but on being pointed out about the pitfalls in such an argument due to: a relatively inelastic import demand, a history in Pakistan that does not support volume growth in exports via currency devaluation, a negative impact on manufacturing related investment due to higher capital costs, a wave of inflation that will be hard to arrest, and last but not least, an external debt situation that will only get worse with a devalued Pak Rupee, we saw a complete summersault by the Governor of the State Bank of Pakistan (SBP) by instead shifting the blame on a phenomenon often referred to (in developing economies) as the 'personal baggage flight' of dollars. What the governor SBP failed to admit was that if a modern day economy has to remain linked with the global world its currency needs to be supported by the confidence its government policies yield and not by blaming individuals. He must realise that it is in this sphere (building investors' confidence) that the policymakers have failed during their first 100 days in office – "Capital knows no boundaries and flows to the most efficient markets." ~ Schumpeter.

As the foreign reserves dwindle and IMF support assumes an even more critical role, we are now being told that Pakistan perhaps ought to also revisit its currency swap arrangements, whatever little they have in place at the moment. These swap arrangements (as one is being made to understand), according to the IMF experts, are a form of liability/debt that tends to put pressure on the country's currency value. Nothing could be further than the truth. In fact swap arrangement, on the contrary, is one of the tools available with Central Banks to provide currency stability. Now one understands that while swaps can take care of immediate needs, they do have certain costs attached, but then the role of a good central banker is to precisely factor in any signaling impacts and market perceptions on utilizing a given swap! As a good regional example of a stable swap agreement one can study the US$ 3 billion arrangement between India and Japan from 2008 to 2011, which was used so successfully that they now enjoy a much higher renewed swap agreement. Further, until recently most currency swaps were denominated in the US Dollar, but this is now changing along with the change in the local trade patterns. Asian countries amongst themselves are using more and more local currencies in their respective currency swap arrangements (especially when working with China, Japan and Turkey) to reduce dependence on the US Dollar.

Currency swaps in essence provide an additional pool of resources, which is stabilizing in its effect for the currencies of both the countries involved. According to a research paper released in 2012 by the People's Bank of China, for all countries enjoying a sizeable trade relation with China and aspiring to significantly build-up on this bilateral trade relationship (Pakistan certainly being the case), it will be very important going forward that these countries also maintain RMB (Rinminbi, Chinese internationally trade able currency) based liquidity just as they keep US Dollar based liquidity in order to keep up with the desired increase in trade with China. As we know, China initiated its first bilateral 'local' currency swap with the Republic of Korea (ROK) back in 2008 and has never looked back since. The move was a win-win for both countries, especially for the junior partner ROK, as the arrangement provided ROK much support during the global financial crisis in 2008. Ironically, ROK never practically utilized this facility, but it provided ROK with a sense of liquidity and confidence amidst some very testing times. In 2009, China signed similar agreements with Malaysia, Indonesia and Hong Kong. To date China has signed about 18 bilateral swap agreements for a total amount exceeding RMB 1.6 trillion by June 2012.

The point is that solving an economy's financial problems should not (especially in Pakistan's case) be left to central banks alone. The private sector and the civil society should work cum partner with central banks in finding pathways for solving financial problems in an evolving economy. As a current example of this model, an out of box solution on these lines is at present being worked out between China and India. Indo-China trade, which was virtually zero about 10 years back has today increased to nearly US$ 100 billion. However, the pattern of this trade is asymmetric, since India in this relationship undergoes an annual $ 30-40 billion trade deficit putting a heavy burden on its already large current account deficit.

At the same time India has large infrastructure requirements and against this backdrop, it has been signing several agreements with China on high speed rail, power and other infrastructure needs. In such a scenario it is only logical that China should be investing in Indian infrastructure in local currency. Keeping to this an agreement is being put in place where China will initiate a long-term debt fund that will invest in India and hence for India local currency lost through the current account can be invested back in India through the capital account transactions. Such a bond will carry a pre-negotiated interest rate, hence also benefiting China, as it will ensure steady returns, whereas, India would get access to long-term infrastructure funds that are not denominated in US Dollars.

Even our Governor SBP would be well advised to come up with similar kind of proactive and innovative solutions with the help cum involvement of the private sector and 'national savers', instead of indulging in an unhealthy blame game. At the end of the day, only rebuilding confidence in the domestic markets can arrest the on-going slide of our Rupee!



The writer is an entrepreneur and economic analyst.

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