Despite massive obstacles, government seems headed in the right direction
Economic revival was the top priority of PML-N government when they took power after May 11 elections. However, they had given an impression that they have already done their homework, were just waiting to take control of power and would fix the troubling economy sooner than later. But soon the government realized its limitations.
To be fair, the government inherited an economy in a shambles. Inflation is on the rise; circular debt has reached Rs. 950 billion, budget deficit is at its peak. There wasn’t any fiscal cliff for the government, money printing, T-Bills auctions, external debt, government borrowing from schedule banks and other public loans have already been taken to their limit to finance budget deficit. Too many un-targeted subsidies, including Rs. 1.4 trillion subsidies to energy sector, huge energy shortfall, gigantic public debt with more pinching payments of debt servicing, low growth of GDP, and fall in foreign exchange reserves, the government inherited a plethora of bad indicators.
IT is difficult to explicitly spell out the performance of any government in the first 100 days because most of the indicators have minimum of 3-6 months lag effect. However, we can examine the policy actions taken by the government and their possible impact on the overall economy.
Budget document, which was the first outcome of the current government, was expected to give some relief to the middle class, lower middle class and the poor. However, it has apparently pushed them towards more misery by imposing one extra percent GST on them and not subsidizing wheat flour and other necessities, which increases the price of goods in their basket. Moreover, increase in utility, petrol and CNG prices by 12 percent has already damaged the expectations formed by the people from the current government. Most of the subsidies were reduced or removed in the Budget. However, Rs. 503 billion were sanctioned for the payment of circular debt. Other negative points which have affected the expectations of the current government are : 5 percent extra witholding-tax imposed on cellphone users, exchange rate is depreciating (8.4 percent), and overall inflation is going up (more than 3.2 percent), which pressurizes the financial market thus result in increase in interest rate by 50 basis points.
In the rest of the article, we will try to explore the possibilities of curbing the above mentioned increase in taxes and prices, depreciation in exchange rate and reduction in subsidies.
As far as overall inflation is concerned, it increased due to three reasons during 100 days of PML-N government: (1) Ramzan effect (2) persistence in inflation and (3) lagging effect of previous policies taken by the last government. Artificial control of prices is not a good idea at any time. Finance Minister Ishaq Dar wanted to intervene in the market and activate district-level price control committees for fixing, monitoring and enforcing controls on prices of essential items. But it would not have worked. Therefore, it would be illogical to blame current government for increase in inflation in its first 100 days.
Exchange rate is the second most talked variable after inflation in the society. No doubt the depreciation in exchange rate was too much after the current government took charge. Though, real effective exchange rate is still overvalued by 5-6 percent, therefore one should not be surprised if it depreciates more in the next few weeks. Although we cannot rule out IMF conditions but most of the times these rumors. Exchange rate cannot be controlled unless: (i) we remove the differences between our inflation and world inflation (currently our inflation is more than world inflation) (ii) our current account balance becomes surplus or becomes zero and (iii) we attract foreign direct investment and foreign portfolio investment, which is possible by removing the barriers and constraints to investment such as terrorism and energy shortages.
Foreign exchange we earn from foreign investment will then be used to artificially control the exchange rate, as we used to do in 2006-07 and 2007-08. Therefore I will not blame the current government for depreciation in exchange rate.
Petrol prices are adjusted according to change in international oil prices or if there is a change in exchange rate. Since June 2013, the overall trend shows increase in oil prices, which is the main reasons for increase in petrol prices. Moreover, exchange rate in the last 100 days depreciated as well and thus, in Rupee terms, domestic petrol prices have also increased. Therefore I would not blame the current government on increase in petrol prices.
Other than above mentioned problems, the public complains that government has not done sufficient work to eradicate problem of State Owned Enterprises, which costs us Rs. 500 billion a year. The amount can be used to finance the circular debt but due to its presence, the government needs to borrow required amount from either State Bank of Pakistan or schedule banks, which pressurizes inflation and crowd out investment.
However, recently announced privatization policy by the government to sell 26 percent of PIA shares may reduce some loss of PIA but they are committed not to lay off any employee. It would be interesting to see that how 26 percent PIA privatization would help mitigate the problem of Rs.500 billion loss. Moreover, Railways is also among the loss making, SOEs which is in revamping stage. It seems government does not either want Railways to be privatized or it will make it profitable and then sell it. In concise manner SOEs are hurting Rs. 1.37 billion daily, which is a lot and if we calculate it on 100 days then we have already lost Rs. 137 billion on these SOEs if the ultimate loss remained at Rs. 500 billion.
Heavy debt burden is one of the biggest problems current government is facing, with depreciation in exchange rate and increase in overall inflation. Moreover, increase in the net domestic assets will further increase pressure on the government if non-performing loans will increase. Thus, government, and especially State Bank of Pakistan, need to seriously follow non-performing loans, which needs to stay as low as possible. Otherwise, increase in net domestic assets will results in increase in inflation without having any impact on real sector.
Terrorism and energy crisis are among the major constraints of investment in Pakistan. Both the problems need to be addressed for economic revival. The government has been successful in mitigating energy shortages and came to an agreement in All Parties Conference to tackle terrorism although the negotiations with terrorists have not yet been started. Nevertheless, problem of energy shortage has lessened but not completely fixed. Strong energy policy by the government ensures continuous electricity supply for the next 10-13 years. If both the obstacles are removed by the government in the next two to three years, it would be an astounding work for Pakistan for next many years.
Different projects have been signed with Chinese and Turkish investors and government, and private as well, are investing a lot in the infrastructure projects but investment in soft infrastructure is also needed. Soft infrastructure implies reforms process, which is essential for removal of barriers and constraints prohibiting investors from investing in Pakistan. For Example, inefficiency in customs, custom formalities needs to be removed. Clearance of consignments is among the major problems due to weaknesses in custom administration and cumbersome regulatory processes. Excessive procedural requirements and too much reliance on the custom inspectors, who have extra discretionary powers, create more complex situations including corrupt practices. Regulations either related to tax, health, labor laws or environment need to be transparent. Moreover, environment of lesser regulations are required to give free business environment with lesser anomalies.
The speech by Prime Minister Nawaz Sharif on Sept. 21 was very interesting. He announced six projects for youth including Micro Interest Free Loans Scheme, Small Business Loans Scheme, Youth Training Scheme, Youth Skill Development Scheme, Fee Assistance Scheme and PM’s Scheme for Laptops Provision. Although they have allocated Rs. 20 billion for the six major projects, which is not too much, but I am hoping that they will increase the amount by next year. Moreover, to keep transparency in these small projects, strict monitoring and evaluation of these programs is needed. Apart from the first five initiatives, I have my own reservations on the laptop scheme. It is more of a political gimmick than a youth development policy. Instead of distributing laptops to the individuals, they should setup IT/computer labs in schools so that more than one user can take benefit from it.
The chances of economic revival are very bleak in the first year of the government in the presence of high fiscal deficit as well as circular debt, debt servicing, Rs. 636 billion loans from schedule banks and rise in inflation etc. However, based on reputation and then the policies were adopted by the government, the stock market is giving us positive sign. It has gone up by 3,000 points since the government has taken control. Thus as far as economic revival is concerned and it seems that government is going in the right direction.
The article appeared in the Money Matters on December 16, 2013
In the last three decades, successive governments have emphasised the importance of export promotion. But, the country’ export performance still remains dismal. Although Pakistan’s exports have increased from 10.5 percent in 1980 to 16.8 percent in 1990 and currently stand at 21.3 percent, the share of manufacturing exports and the terms of trade have declined in the last ten years.
The Ministry of Planning and Development is in process of developing Vision 2025 and the Five-Year Plan. Similar to its previous plans, more emphasis is being placed on increasing exports through value addition, which can take place through industrial development.
To achieve the aforesaid goal various strategies including technical upgradation; improvement in business environment; restructuring of industries; internalisation of innovation; tariff escalation and tariff rationalisation; export-oriented industrial policies; research and development; human resource development and enhancement of workers’ skills and the establishment of industrial clusters, estates and zones are being discussed by the economic policymakers. However, all these strategies have been discussed and partially implemented before but the issue of branding has not been taken into consideration as yet.
A brand name is the name of a distinctive product or service, which people can associate themselves with. It is an idea or image of a specific product or service that consumers can connect with, by identifying the name, logo, slogan, or design of the company who owns the idea or image. In today’s age of globalisation and e-commerce, foreign buyers can ask for any product or service by looking at the brand name.
Building a brand name is none other than building trust with one’s employees, customers and stakeholders. In terms of marketing, a brand name represents the value of a company. The assumption that only big companies have better brands is incorrect. Strong brands help consumers know what to expect, regardless of the company size. In addition, a brand name helps develop a unique product or service that develops customer loyalty overtime. For instance, even though Cola is a brown, sweetened beverage, a loyal Coca Cola customer will always prefer Coca Cola over other brands.
Similarly, a significant component of branding is how much a certain brand is valued or its reputation in the market. Unique selling proposition is another factor that makes a product or service different from and better than that of competitors. Reputable brands deliver their message clearly; maintain their product or service credibility; form emotional connections with their prospective consumers; motivate buyers and solidify customer loyalty.
A brand name represents the quality of a product or service, which determines its price. It also makes it easier for local and foreign buyers to decide what to purchase and in what quantity. In other words, a brand name gives potential clients a better idea of what they are buying, thus making the purchasing decision easier.
Consequently, consumers are ready to pay a higher price if they see that the product quality is better than what is available in the market. Foreign buyers are also willing to buy a high quality product, which leads to more foreign exchange earnings for the country. For example, a few products that have a competitive advantage over their competitors include: Coca Cola and Pepsi Cola as compared to other Colas that may have almost the same taste; various smartphones against other ordinary phones and among them, iPhone is the most reliable and expensive brand both globally and domestically; Bareeze as compared to other similar clothing outlets and Shan Masala has its own significance as compared to other spices available in markets.
On the other hand, when it comes to the services sector, for instance the construction sector, most of the materials used are similar in nature for building buildings, commercial centers and homes. However, if the products being used are branded then a reliable brand name has more demand in the market. Branding in the construction industry is more profitable in terms of value addition that pays more when exported to the other countries. Nevertheless, the construction services sector should have certain features such as creativity, durability and integrity, which add to its branding value.
The above discussion leads us to the conclusion that branding is critical to increase a country’s export earnings through value addition. However, producers want to protect their rights to produce and sell products, thereby making it necessary to enforce patent laws in the country.
Intellectual property rights help promote branding and invention as they protect the name, product, logo, design, image and slogan of a product. The issue of intellectual property rights has neither been discussed at length nor strictly implemented in Pakistan. This needs to be addressed on an urgent basis. Similarly, the country’s justice system should be quick and transparent to ensure that any violation of intellectual property rights would not be tolerated. In terms of law-making, clear legal ownership and copyrights should be defined as well as further licencing and conditions for franchises should be clearly laid out .
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What are the Problems of high government borrowing?
There are many theoretical problems of high levels of government borrowing. But, usually these problems don’t materialise under normal circumstances. However, as government borrowing as a % of GDP increases, the problems of government borrowing are exacerbated. With UK facing an annual budget deficit of over 11% of GDP, there are many potential problems.
Higher Debt Interest Payments. As borrowing increases, the government have to pay higher interest rate payments to those who hold bonds (lend government money). In some circumstances, higher borrowing can push up interest rates because markets are nervous about governments ability to repay. This means they have to pay even higher interest rate costs. Currently, the UK pays approximately £43bn in interest payments.
Inflationary Pressure. It is rare for government borrowing to cause inflation. But, the combination of quantitative easing and very high levels of borrowing make inflation more likely.
If markets fail to buy enough gilts to finance the deficit, the deficit can always be financed through ‘monetisation’. i.e. creating money. This creation of money creates inflation, reduces the value of exchange rate and makes foreign investors unwilling to hold UK debt. So far quantitative easing has not caused inflation because of the falling velocity of circulation. But, if the economy was close to full capacity, printing money to ‘monetize the debt’ would lead to inflation. In the case of Zimbabwe this could lead to hyperinflation.
Higher Interest rates.
To finance a budget deficit, the government need to sell bonds. If markets fear there is a chance of default, they will demand higher interest rates to give return for greater risk. Countries in the Eurozone experienced rapidly rising interest rates because of markets fears over their ability to repay. (see: bond yields on EU debt)
Higher interest rates on government bonds tends to push up other interest rates in the economy and reduces spending and investment. (This impact of higher interest rates in reducing private sector spending is known as financial crowding out)
These higher interest rates increase the cost of paying interest payments.
Crowing Out. A classical monetarist argument is that high levels of government borrowing cause ‘crowding out’. What they mean is that the government borrow from the private sector by selling bonds. Therefore, the private sector have less money to spend and invest. Therefore although government spending increases, private sector spending falls and there is no boost to the economy.
However, this is unlikely to apply in a recession because in a recession private sector saving is rising. The government are spending to offset the rise in private sector saving.
Higher taxes in the future. The government will need to reduce borrowing as a % of GDP. It means future budgets will need to increase taxes and / or limit spending. The danger is that if taxes are increased too early too quickly it could snuff out the recovery and cause a further downturn. If they don’t raise taxes markets may be alarmed at size of borrowing. There will be difficult choices for the future chancellors; it is a difficult situation to be in.
The article is published in the Money Matters on 25 Nov 2013
Every political party emphasises the need to reduce inflation, create employment and alleviate poverty before elections. Inflation and unemployment are among the major concerns for policymakers as well with both variables of core importance while making macroeconomic policies.
Inflation is currently on the rise and it is expected that it will reach double digits in the current fiscal year against the target of 9.5 percent. The State Bank of Pakistan (SBP) has recently increased the discount rate by 50 basis points to reduce inflation. The PML-N government has been under attack since it came into power by other political parties as well as its critics due to the increase in inflation. The policies of the current government are being held responsible for higher than expected inflation. The agreement with the IMF is also severely criticised for playing a role in increasing inflation while some critics associate the programme with excessive borrowing by the government, buying foreign exchange from the market and depreciation in the exchange rate.
Economists, in general, associate inflation to the money supply in the long run, especially the excessive money supply. However, researchers have also tried to link inflation with the political economy, fiscal and structural variables. Without any doubt these variables have some effect on inflation in the short run but in the long run the sole determinant of inflation is money supply.
Contrary to these popular beliefs, an excessive increase in current inflation can be linked to four political factors which are strongly associated to the 2013 elections. However, in the end we’ll see that political factors are subjective and in reality it is the money supply which contributed to inflation only.
The federal government as well as the provincial governments increases their spending on the development projects before the elections to show their determination and commitment to development of Pakistan. The increase in development expenditures from 3.6 percent of GDP in 2011-12 to 4.4 percent of GDP in 2012-13 strengthens our claim that excessive money is spent on development projects before the election year. Thus money/funds which were hoarded are spent before the election to gain support of nation to vote for them.
Subsidies are among the most important variables which negatively affect inflation in the short run but in the long run they may affect the inflation rate positively depending on the financing process of subsidies. However, subsidies given to the farmers in the name of support price lead to an increase in inflation. Therefore, the nature of subsidies is also important. It can be in the form of cash transfers such as income support programmes, support price to specific a sector, interest free loans or loans provided at a lower rate than the market prevailing interest rate such as an export finance scheme, tax holidays and rebates to different sectors such as duty drawback to the export sector. Before the elections subsidies are also used to control the prices if they are expected to go up. The best example in our context would be subsidies given to the energy sector. Circular debt was the outcome of several subsidies given by the government not to increase the price of electricity.
An excessive increase in the money supply to mitigate the gap between potential and actual employment is a major socio-political economic policy. This policy leads to trade-off between inflation and employment since increase in money supply may increase employment in the short run but eventually contributes to inflation. However, excessive monetary borrowing was carried out to finance the budget deficit before the elections and continuous purchase of domestic assets to increase foreign exchange injections into the market to control the exchange rate may not give us a clear illustration of our claim.
Moreover, money spent on election campaigns including public meetings, poster printing etc increases domestic commerce activity. Politicians and political parties spend billions of rupees on their election campaigns every five years. The money hoarded by either politicians, political parties or their financers is given to the people who are involved in their election campaigns.
Furthermore, black money is also involved in elections, which is either used to gain the support of leaders in the villages or given to their workers, mostly belonging to lower middle class who will do various chores for them related to election campaigns. Nevertheless, money circulation will increase in the economy which increases the purchasing power of the people to spend on various items, particularly food. Therefore, expectations of an increase in the purchasing power lead to increase in food prices. This is also evident in the first three months of the current fiscal year with food inflation more than non-food inflation, opposite to the trend in 2011-12.
The above discussion on a possible increase in inflation is based on politics. However, each case presented in this article is related to circulation of money in the economy which leads to inflation. Research tells us that the impact of money supply affects inflation with a nine to ten month lag. The effect of money supply on inflation may take more time if it is hoarded by people or institutions for a longer period. Therefore, we can conclude that current rise in inflation is the lag effect of previous year’s policies of the last government which are strongly associated with the 2013 elections and the money spent on elections by politicians and political parties. Moreover, as economists suggests it is the money supply which is the sole determinant of inflation.
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While teaching course of Statistics at PIDE I realized that students are in general confused between mutually exclusive events and independent events. Since I taught this concept recently thus i thought that i should upload the explanation. There are good chances that some other websites have explained this as well.
Mutually Exclusive events are those events which cannot occur together/simultaneously. Moreover in simpler words if certain events cannot happen together at the same time then those events are known as mutually exclusive events.
For Example: (1) Its raining outside and it's not raining outside (2) he had tea in office and he did not have tea in office (3) arrow hitting a dart and not hitting a dart (4) cyclone happen and not happen (5) sick and not sick. All the examples are very clear that these events can occur at the same time. Independent Events are those event which can occur together but there is no association between them. For instance (1) it will rain today as well as we will have too much work in office (2)Teacher will take a class and painter paint a portrait (3) purchase a computer and eating eggs in breakfast (4) elections in India and tree plantation in England. All the examples show that the events can occur at the same time but there is not correlation between the two variables.
Published in Money Matters, November 4, 2013 entitled "Energy:
Tackling the Crisis"
Pakistan has been facing a severe energy crisis since 2007, which has badly affected its industrial sector. The main reason for the crisis is that in the past, efforts were not taken to enhance the power generation capacity by installing new plants or building new dams.
The CNG policy has proved to be another nail in the coffin. But the new government has been contemplating to abolish its supply to vehicles, especially in the coming winter in order to provide continuous supply to households as well as to the industrial sector.
Addressing energy shortages has been one of the main priorities of the PML-N government. In fact, Prime Minister Nawaz Sharif’s first public speech (right after winning the elections) focused on addressing electricity shortages. And his political party started working on mitigating the crisis in the quickest time possible by signing international and national contracts for electricity generation as well as paying off a part of circular debt.
According to studies conducted by Pakistan Institute of Development Economics (PIDE), governance, capacity issues and circular debt are the major factors behind the crisis. The crisis can be mitigated by resolving any one of these three issues and can be completely abolished by simultaneously addressing all the three issues.
Apart from that, a USAID and Planning Commission’s Framework for Economic Growth (FEG) report emphasised on governance issues to eradicate the issue of circular debt as well as making circular debt part of debt financing.
The severity of the energy crisis has been increasing since 2007. Undoubtedly, the new government is adamant to eradicate the crisis but it would take three to four years to overcome energy shortfall. Governance, as stated in the Planning Commission’s FEG report, is among the quickest ways to lessen the crisis. Another equally important step, which has been deliberated for weeks by Federal Minister for Water and Power Khawaja Asif, is of energy conservation.
Several energy conservation strategies have been implemented in the country, such as use of energy savers, implementation of daylight saving time (DST) plan and early closure of markets. However, these strategies have failed to achieve the desired result. Let’s take a look at the three strategies:
Daylight saving time (DST) helps conserve electricity by reducing the gap of excess demand, especially in summers. This enables individuals to use an extra hour of daylight in evenings by making use of less artificial lights.
Daylight saving time has been implemented thrice in the country since its inception. As energy demand increased in summer, daylight saving time was implemented for the first time in 2002 from April-October. Thereafter, it was executed again in 2008 from June to October and April to October in 2009.
The daylight saving plan has mostly failed in the country due to non-acceptability. Generally, people used to change their work hours with the plan, which subsided the impact of advancing clocks by an hour. At the commercial level, a minimum of one hour of electricity was saved by the end of the day.
By spreading awareness and executing proper research, the government can implement the daylight saving plan more effectively.
The use of energy savers helps save electricity but it doesn’t reduce consumption. Hence, it is an energy efficiency strategy. Despite the fact that the use of energy efficient appliances have been on the rise since the last one decade, it is difficult to ascertain if the overall consumption has decreased.
Early closure of markets is a vital policy that can save electricity. But either the authorities are fearful of retailers/wholesalers or there is a lack of will as it has not been implemented effectively. In Europe, more than 95 percent of markets shut down by 6 pm or 8 pm and if the same policy is implemented in Pakistan, customers will adjust to timings and thereby save significant amounts of electricity.
Although not a popular measure, increasing electricity prices will compel the consumers to reduce its usage. We recently experienced the reaction of the people, political parties and even the Supreme Court when the government announced rise in electricity prices. Rationalisation of electricity prices is important – be it producer or consumer price rationing.
Similarly, there are certain measures that can be taken at the individual level to conserve energy. These include: building energy-efficient buildings, less use of high electricity consuming appliances and creating awareness campaigns.
The abovementioned conservation strategies can be easily implemented without increasing government’s expenses. Thus, the government needs to pursue different conservation policies by coordinating with households and industrialists.
Most importantly, implementation is the key to get the desired results. Remember, a megawatt saved is better than a megawatt produced
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Article is published on 30 September 2013 in Money Matters
A long way to go
Before the govt of PML-N took charge of the office I wrote an article on economic revival based on the manifestos of four major parties including PML-N, PTI, PPP and PML-Q. One of the major points was that the economy desperately needs stronger actions, which will fix things in the short to medium run. Meanwhile, in the long run certain reforms are needed for the stabilisation of the growth process.
Investment, which is crucial for growth, is being constrained by terrorism and energy shortages. Other constraints include lack of skilled labour and the high cost of doing business. For the removal of the constraints and dealing with other obstacles it is necessary to facilitate investment.
From the manifesto of each political party, all of them seek economic revival, and the PML-N suggested a good strategy for curbing of energy shortage, which is a topmost constraint in investment. The manifestos advocate formal and technical education, but the policies suggested were directionless. The cost of doing business can be reduced through provision of incentives. But this is not good for the economy because incentives in the form of tax holidays and tax exemptions can be abused by seekers of rent and revenue. Loopholes in the system are used by these elements because of weaknesses in our tax system, tax administration and excessive discretionary powers given to tax officials. Without any doubt, we need reforms in all departments concerned, including the ministry of commerce and industry, the FBR, and Smeda.
Before the elections, all parties, especially the PML-N, pledged that the energy crisis would be eradicated within two years. But they soon realised that the solution is not that simple. But those parties which came to power or share power are in the process of trying to make a strong energy policy. Meanwhile, the shortage of electricity has been mitigated and some other projects will ensure continuous electricity supply for the next 10-13 years.
As for policies on eradication of terrorism set out in the parties’ manifestoes, in each case they were only vaguely discussed, with none of the document clearly indicating the root cause of terrorism, or suggesting a viable solution to the problem. Therefore, despite the fact that terrorism is under the government’s consideration since the formation of the new governments, no workable policy is in place yet. The APC discussed the issue and came up with the unanimous decision of talking to the Taliban. We avoided doing any kind of analysis before the talks started. Karachi, Pakistan’s business hub, has witness a large number of targeted killings for many months. The Rangers are deployed and their charge has been given to the Chief Minister of Sindh, but whether this will benefit the economic situation in Karachi is a big question mark.
The budget was the first major policy of the government after they took charge. Could we leave budget-making to the bureaucracy and its team of accountants? Budget-making is not an exercise in accountancy. The first budget was brutally criticised by analysts since everyone was expecting some relief resulting from it. The budget is supportive of economic revival since the government gave some exemptions to the industries. The budget deficit is huge and we need more revenues to overcome problems of piling public debt. More taxes on the salaried class and the one percent increase in GST created havoc for the government, and afterwards the increase in taxes on prepaid cards had a devastating effect, especially on the social media, even though the tax on prepaid cards is a progressive tax.
I put some question to people belonging to the educated working class. Almost everyone said he or she believed that the PML-N has not clearly spelled out the direction the party intends to take. The government is in the process of making “Vision 2025,” which has some new points that were absent in “Vision 2030.” The think tanks and the Planning Commission are working on “Vision 2025.” which will elucidate the main points of the policies and plan of action for achievement of the vision.
Due to the circular debt payment and other measures taken by the government, the duration of load-shedding has come by a significant number of hours. On the performance of the current government the respondents were clueless about what the government actually wanted to do. They said that the policies of the government are directionless. This is because the Prime Minister did not mention the policies his government will adopt during the next five years. He should have taken the nation into confidence on the current situation and the policies the government is going to implement. In the first three months of the government, most people have faith that the policies of economic revival, the energy policy and development of better relations with India will have positive long-term outcomes on the economy.
In order to get an idea of how people perceive the performance of the current government everyone was asked to rank the performance on a scale of 0 to 10, with zero implying the worst and 10 implying the best. The average score is 4.3, which is below average. This implies that even though load-shedding has mitigated and some other policy measures are taken, the performance is not satisfactory.
From their speeches made at rallies before the elections, people were expecting that things will change overnight and some of the old ministers will be imprisoned by the new government, but these did not happen. This kind of expectations are too emotional. Moreover, expectation of a pro-poor budget wasn’t unconventional but the budget was definitely not pro-poor. Corruption eradication, police reforms, judiciary reforms, civil bureaucracy reforms and tax reforms were among the top priorities of the educated class which are not addressed by the current government and there is a hunch that they might take some measures to eradicate corruption. However, they are not in a mood to work on reforms to make the overall system better so that it facilitates the common man.
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World is pro free trade but it is not beneficial for everyone. Some will be gainers and
some will be losers. The gainers will compensate the losers. But How...? Under WTO safety
nets program is designed to distribute resources among losers after getting from gainers. Who will do it...? Are we looking towards the
government who is very inefficient due to high transaction cost including
corruption and high maintained status quo and hierarchy? In the corruption
index we are among the list of corrupt countries, though improved in the last few years.
This is one problem which we might face under free trade. Another
problem is that the losers will lose the job as well as money. If they get do
not get required amount of money to live their standard life they’ll be
deprived off what they were having without free trade. Moreover, we are
ignoring the component of satisfaction here. A person who was previously
working is either unemployed or working at some place where he does not want to
work. In other words his job satisfaction is zero compare to his/her previous
job, hence the overall satisfaction. If the person remains unemployed for a
longer period of time he thinks of many different thing including shake hands
with the extremist element, become a thief or a dacoit. Thus unemployment is
definitely a social evil which is very high right now in our country.
From the above can we conclude that unemployment or dissatisfaction
from employment could be a big cause of terrorism? After all this do we need
blind eye free trade or we need to see pros and cons of free trade for our own
country, first solve those issues and then pursue for free trade.
P.S. During the last one decade of low growth and higher unemployment, inequality has increased. Moreover, unfortunately frustration has increased which leads to intolerance. Unemployment and several other factors has increased the possibilities of terrorits activities
This article in published in the "money matters" on 16 Sep 2013...
The analysis of an event requires the use of logical facts that are based on observational features. That is the art of conducting an effective analysis. Meanwhile, it can also be based on data. Data helps reveal accurate and logical results. Hence, it plays a crucial role in analysis. Different data sets are available for different countries in the world that have their own definitions and adjustment factors. For instance, the GDP data obtained from Pakistani sources will differ from that obtained from World Bank and IMF publications or the CIA Factbook. Although international sources obtain data from Pakistani sources, it is then changed based on their own definitions.
Besides data obtained from local sources, international organisations are also involved in collecting primary data. Transparency International and Global Competitiveness Index draw data from an opinion survey that is designed by them. On the other hand, some international sources obtain data from various local sources, including national accounts, Pakistan Bureau of Statistics and non-governmental organisations such as Gallup. Subsequently, an index is compiled using the country data, which also helps to compare that particular indicator with other countries.
Due to the nature of different data sets, definitions of variables and dissimilarities in the classification of fiscal year for each country, the indices could be misleading and thus the reliability of data sets comes under question. The problem lies with all those data sets (human development index, failed state index, etc.) that use macro variables, such as per capita income. Similarly, Transparency International’s corruption data is a perception survey but is generally considered as actual data on corruption. Further, the International Country Risk Guide’s quality of governance data represents points assigned to different variables by respondents in different countries.
Chances of the respondents being biased in attributing scores for various indicators in different countries are significantly high.
Recently, the Walt Disney Company decided to cancel textile import orders worth $150 million with Pakistan due to the country’s inability to improve its position in the worldwide governance index (WGI).
The cancellation of import orders based on specific data that has nothing to do with the quality of products is a non-tariff barrier on the textile sector by Walt Disney. It is anticipated that other firms will soon follow suit, which could cost the country more than $1 billion exports.
The WGI compiles aggregate and individual governance indicators for 215 countries using six dimensions of governance (voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law and control of corruption) over the period 1996-2011. The index value for each of the six governance indicators varies between -2.5 and 2.5 (from worst to the best). Various data sources, including the Economic Intelligence Unit, Afrobarometer, etc., are used to develop these indices. More than 20 sources are used to construct each variable index and then the six variables are combined to construct the WGI.
While the data provides an insight into the overall performance for the last many years, it also portrays an astonishing economic picture. For example, the variables ‘political stability’ and ‘absence of violence’ have only two dimensions, i.e. political stability and absence of violence. In the last era of democratic government we had political stability but violence in terms of drone attacks and suicide attacks had increased. Thus respondents could give biased opinion if both the questions are asked together.
The data on political stability and absence of violence reveals that there was more political stability and lack of violence over the period of 1996-2000. Further, political instability and violence had risen from 2008 to 2011 as compared to the Musharraf/PML-Q era. Undoubtedly, drone attacks and acts of terrorism were more frequent during 2008-2011 but that era was the most politically stable. Nevertheless, the data tells us a different story, which raises questions about its authenticity.
Apart from voice and accountability, all the variables have shown deterioration in the last era of the PPP government. The WGI data might be misleading but it can be used effectively for the country.
All the six indicators show that the country’s position has remained below zero, which implies weak governance and the need to undertake strong measures to fix these issues. We need to stop seeking donors’ assistance and instead undertake soft reforms in different sectors, particularly civil service. Undertaking these reforms does not require heavy investment funds, rather strong will of the government and bureaucracy.
The cancellation of import orders by Walt Disney is a wake up call for the government. There is a possibility that Pakistan’s products could lose a substantial chunk of exports in future if companies look toward the WGI or any other indicator before entering into a trade agreement with the country. As the data represents the scenario till 2011, the question is how a well-established company could cancel a $150 million deal in 2013.
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The article was published in the "Money Matters" on August 26, 2013
There are some possible solutions to stabilise exchange rate. First and foremost is the exchange rate forecast. Different fundamentals are considered to forecast it in the short, medium and long run. The demand and supply of foreign exchange reserves in Pakistan is the most vital determinant, which determines the value of exchange rate in the short run. Another key variable is the interest rate that helps to forecast exchange rate through two channels: impact through change in money supply in the long run and impact through change in capital inflows or outflows.
The possibility of the former channel is more likely to affect the country’s exchange rate in the long run. As there are capital controls in Pakistan; the latter channel may not be feasible in studying movements in the exchange rate. However, if expectations of price changes are included due to changes in money supply then interest rate might be a suitable determinant of exchange rate in the short run.
The relative price (difference between price in home and foreign country) is another important determinant of exchange rate. Technically, it is known as Purchasing Power Parity (PPP). If the exchange rate is adjusted according to changes in relative prices, the PPP holds.
However, due to State Bank of Pakistan (SBP) interventions, delayed response of price increase and speculators creating excess demand and supply of foreign exchange in the market to manipulate movements in the exchange rate, it is not receptive to price changes in the short run. But change in relative prices is an effective determinant of exchange rate in the long run.
In the wake of a balance of payments deficit, it is difficult to control exchange rate depreciation. Nevertheless, the country can do away with the need to borrow if it liberalises its capital account and the current account is financed by foreign direct investment and foreign portfolio investment, along with remittances (part of current account balance). Consequently, external debt will decline.
Due to increase in forex reserves, the exchange rate will be artificially controlled by foreign exchange injections in the market. Can this policy be supported? Judging from the Indian and South East Asian experience, it is a definite yes but with several reforms. A rule-based policy is needed to avoid time inconsistency. Further, the fiscal deficit should be reduced to decline the overall public debt as well as debt servicing.
Operational independence of the SBP is a key prerequisite to stabilise the exchange rate. The government should refrain from any policy intervention. For instance, the SBP should ask to maintain exchange rate within a certain band with specific interventions in the market. Similarly, targets should be set according to expected changes in prices in a particular year, expected trade balance and expected changes in forex reserves position. This would help boost the confidence of domestic as well as foreign investors. This policy would not favour rent seekers.
Monetary stability is necessary to reduce inflation and maintain exchange rate stability. However, this is not possible in the presence of a huge fiscal deficit as the government seeks funds from the central bank or scheduled banks with regular intervals. This causes inflation in the economy, thus contributing to exchange rate depreciation in the long run. In the short run, it overvalues the real exchange rate and makes exports expensive globally. Ultimately, this causes a decline in exports and trade balance, which has a directly impact on exchange rate.
Despite mitigating the current account deficit, remittances are still not among the most favoured policies to curb the deficit. Exports and imports are the two main components of current account. A cut down in imports resolves the problem but what kind of imports and how is the main question of concern? Reducing imports of capital and intermediate goods is not beneficial for the production sector. On the other hand, the end consumer is worse off if imports of consumerable items are reduced.
Another option is to increase exports by increasing production, discovering new potential markets and signing preferential and/or free trade agreements. Is this possible? For the last many years, several export-oriented policies have been adopted. Have those policies, by any means, had a positive impact on the trade balance. The answer to this is a no, as is evident from the situation of trade balance.
In conclusion, there is a fundamental solution to all the problems and that is the growth of the economy. For growth, exchange rate stability is not required. Slight volatility may help the economy to grow faster but higher volatility may dampen growth. Volatility is not the major issue in Pakistan.
Investment – private domestic investment or foreign investment – is required for growth. Reforms are needed to attract investors to the country. The framework of economic growth (FEG) is among the better policy options for the government to move on to the path of growth.
However, researchers have criticised the FEG as no timeframe has been provided in the document. Further, it will probably take 30 to 50 years to implement the FEG’s policies.
Hence, there is a need for short term policy measures to overcome the anomalies in the path of long run growth.
Finally, a few research questions that will further increase the understanding of exchange rate economics of Pakistan: do we need to control exchange rate? What if we have free float exchange rate systems with limited SBP interventions or no interventions at all? As volatility is not a problem for the economy, can we handle the trivial volatility patches in exchange rate? The writer is a research economist at PIDE
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The Article was Published in the "Money Matters" on August 19, 2013
Much has been written recently about the exchange rate movement and the rupee downfall. Interestingly, the exchange rate is forecast based on random market research without using fundamentals in several of these writings. In the presence of balance of payments deficit and its financing through capital account (mainly by taking loans), it is reasonable to believe that the currency will not be appreciating for a long time.
Contrary to popular opinion, the layman also takes a keen interest in the exchange rate movement. It is one of the most talked about economic or financial variables. However, people have several misconceptions about the subject that have nothing to do with economics.
Recently, a newspaper article claimed that the IMF has asked the country to devalue its currency and a few economists believe that imports will rise due to depreciation. While not a single economics text book has explained this relationship, it is likely that these economists have included some aspect of the political economy. Typically, the term depreciation and not devaluation is used in a free float or managed float exchange rate.
Quite simply, exchange rate is the price of domestic goods in the international market. Depreciation implies that the exchange rate in terms of rupee against other foreign currencies increases. Hence, the prices of domestic products increase relative to those of foreign products. If the rise in domestic prices is consistently more than the increase in the prices of foreign countries then the exchange rate keeps depreciating at regular intervals.
On the other hand, if the depreciation rate is more than the increase in the rate of relative prices between two countries then the country’s goods become cheaper internationally. Consequently, the country’s exports will rise and imports will decline.
In the last one month, the exchange rate had depreciated between 99 and 105 against US dollar and then it appreciated to 102.5 in the open market. Either the relative price of the country’s goods has escalated by this margin or exports are getting cheaper in the world market and so is the possibility of increase in exports.
What are the other factors that influence exchange rate? The most significant of these that determines the exchange rate on a daily basis is the demand and supply of foreign exchange (forex) reserves. The increase in exchange rate is due to the excess demand for foreign currency in the market. Market forces push up the price of dollar - known as depreciation in exchange rate - until demand equals supply.
The problem starts when it is not known as to how high the price of foreign exchange (dollar) will go. When the price of foreign exchange exceeds a certain limit, the State Bank of Pakistan (SBP) intervenes in the market to inject foreign currency and close the gap between demand and supply of foreign exchange.
A significant factor that has led to the current rise in exchange rate from 99 to 105 against the greenback is the central bank’s decision not to intervene in the foreign exchange market. However, this has also led to currency speculation and investors opting for more dollarisation.
In the ‘90s, Pakistan’s foreign exchange reserves stood close to $1 billion. A thesis conducted by the Quaid-i-Azam University at that time concluded that whenever the forex reserves dropped below $1 billion, the gap between the open market and official exchange rate started widening. Nonetheless, it created more options for speculators and investors to gain from exchange rate fluctuations, mostly in the form of depreciation.
After 9/11, the situation has changed completely and the forex reserves’ position has started to improve. More foreign exchange is available for international transactions. Consequently, the trade gap has started to expand as more consumer-oriented goods are imported. The inflow of remittances has increased to narrow down the rapid increase in trade deficit. Further, it has also led to surplus balance of payments in the last decade.
Although remittances have increased multifold today as compared to the ‘80s and ‘90s, we have still been witnessing balance of payments deficit for several years due to increase in oil prices in the last five to six years and increase in import of consumer goods. The balance of payments deficit is financed by forex reserves and IMF loans. Until 2007, the exchange rate was controlled artificially by foreign exchange injections in the market. But as soon as the new government came into power, it let the exchange rate move freely and as a result, the exchange rate depreciated from 62 to 78 against the greenback in a few months.
Besides forex reserves and relative prices, there are other determinants of exchange rate, such as interest rate differentials between the home and foreign country. Higher interest rate invites capital inflows and increases foreign exchanges, which leads to exchange rate appreciation or vice versa.
The terms of trade, political and economic stability as well as public debt are the perceptual determinants of exchange rate, which can directly or indirectly affect it through changes in forex reserves, balance of payments or prices.
With regard to exchange rate, there are several issues that need to be addressed by researchers. The first and foremost is whether depreciating exchange rate is a real problem when there is a balance of payments deficit. Other issues include: the problems in artificially controlling exchange rate; if free floating is the answer to all problems; the intervention of SBP in the market; the monetary policy’s role in determining exchange rate; stabilising exchange rate; the benefits and problems of liberalising capital account and whether its liberalisation is a remedy for exchange rate stability.
The article was published in the "Money Matters" on 22 July 2013 entitled "External DebtA blessing for an ailing economy"
The International Monetary Fund (IMF)’s bailout programme remains a hot topic in the country. And while the caretaker government refused to go back to the IMF, it only took the new government a few weeks to acquiesce to an ‘inevitable’ IMF deal.
Economists in the country are divided over the controversial programme and its pros and cons, while some seem to enjoy the empty rhetoric when it comes to the controversial loan programmes.
Some are even scared that Pakistan will be colonised if we take loans from the IMF, a sense of trepidation that partly arises from the mystification created by the media and politicians, who readily attack the IMF to improve their own standing with the people.
Dr Meekal Ahmed and Dr Ashfaque Hasan Khan are among those who have been vocal about the country’s immediate need for the loans since it will raise our forex reserves, which have been declining for the last two years. Capital inflow will stabilise the exchange rate and country will not face the risk of default, they argue.
On the other hand, some have slammed, ridiculed and maligned the government for going back to the IMF despite campaigning against the “begging bowl”. However, most such commentators or analysts totally ignore the worrying balance of payments and other issues facing the country.
The word “IMF” in our society is dreaded and unpleasant to say the least. It is considered a sort of a phantom, which will steal our belongings while we sleep. Most believe that the IMF, which works like a bank and provides loans to countries with ailing economies, often, ends up maintaining a debt crisis in the country it aims to assist.
The IMF first carries out research on any given country and then suggests different options to help the country move towards development and eventually a successful repayment of their loan with interest. However, it is generally believed that the conditional loans are only repaid by requesting more assistance and without much improvement in the economy. It’s tough to totally disagree with this statement, nevertheless, there are number of misconceptions attached to it.
A survey using purposive sampling, one that is selected based on the knowledge of a population and the purpose of the study, to verify the public’s knowledge about the IMF and objectives associated with its loan programmes reveals that 90 percent of the respondents are simply clueless when it comes to the IMF and its functions.
Further, around 70 percent of the respondents are unaware about the role these loans play when it comes to exchange rate stability, increase in the debt repayment capacity, reducing the speed of forex depletion etc. Most significantly, more than 80 percent are not aware of the share of IMF loans in total debt.
The recent $5.3 billion bailout package signed between Pakistan and the IMF is a three-year programme under an Extended Fund Facility. Pakistan has requested an additional $2 billion, which will be considered by the IMF Executive Board on September 4, as the country has to repay $4.6 billion in the next three years and it does not posses significant investment in foreign exchange reserves. The only way to pay the amount is to borrow more or post a current account surplus by reducing imports and increasing remittances in the short run.
Before proceeding further it is important to understand what the Extended Fund Facility (EFF) entails. Among various IMF programmes, EFF was launched in 1974 to provide assistance to countries which were experiencing long-term payments imbalances because of structural impediments. It can also be used for an economy which has low growth and inherently weak balance of payments position. This programme’s duration is usually longer than other IMF programmes, such as Stand-By Arrangements between 3.25 and 5 years. Usually, the countries enrolled in this programme can repay the loans between 4.5 and 10 years. Another important characteristic of this programme is that IMF works with the country to design and implement adjustment policies to ensure that the particular country overcomes its structural weaknesses. Moreover, EFF is also available if country is facing serious medium-term balance of payments issues.
The IMF programme comes with conditionalities, which may or may not be optimal in the short-term but is certainly better in the long-term. But as Keynes pointed out “this long run is a misleading guide to current affairs. In the long run we are all dead,” the country’s future depends on our negotiators, who must protect the lives of their people and accept conditions which remove the obstacles to growth in the long-run without hurting people in the short run.
For the past two decades, IMF’s major focus has been on structural adjustment. It could be through the privatisation of state-owned enterprises or through fiscal austerity by raising share of direct taxes, removal or reduction in import duties and cutting down expenditures especially subsidies.
Pakistan has requested the IMF management to increase the present level of access of 348 per cent of quota ($5.3bn) to 500pc of quota ($7.3bn) with appropriate front loading of disbursements to match Pakistan’s repayment obligations under the previous IMF program-me to ensure that net outflows don’t exceed fresh disbursements.
The country can borrow up to 200 percent annually of their allocated quota under the EFF, which is equal to 600 percent over the three years. It seems the IMF delegation, which is due to come back in September to discuss the additional $2 billion request, is likely to approve Pakistan’s request as the government is simply accepting IMF advice and asking for less than the designated quota of 600 percent.
The real question is what impact the IMF bailout package will have on our economy? After the agreement was singed between Pakistan and the IMF, the Karachi Stock Exchange (KSE)’s benchmark index rose by 211 points, a sign that the deal has boosted investors’ confidence. However, uncertainty surrounds whether the move will boost investors’ confidence across the board. With comparatively lower interest rates and policies geared towards reforming the economy towards macroeconomic stability, many are questioning whether private credit will increase and whether the government will continue borrowing from schedule banks.
Depleting reserves have put immense pressure on the exchange rate with the rupee already crossing the Rs100/$ mark. To prevent further depreciation, the State Bank of Pakistan (SBP) will inject foreign exchange into the market. However, this exercise may stabilise the exchange rate but the country will slowly but surely lose all of its forex reserves.
A more practical solution is to let the exchange rate move freely and invite capital to inflow into the country. Several options can be exercised such as reduction in the oil import which is one third of total transactions in the current account. Moreover, the country can invite more remittances into the country.
But in reality, it’s either wait for any of the abovementioned solutions or take loans from the IMF to correct the balance of payments issue. The inflow of forex reserves due to the IMF loan will stabilise the exchange rate to a certain limit. The stabilisation of the exchange rate will be short-lived with the pressure mounting soon after the payments to IMF are made. Moreover, if balance of payments problem persists which is normally the case in Pakistan then currency will depreciate further.
Overall the EFF arrangement will help stabilise the economy if everything goes well. Since forex inflow stabilise the currency in the short run, the State Bank of Pakistan will not need to intervene in the market.
Although the IMF loan has various conditions, including reduction in fiscal deficit, if the country manages to reduce the fiscal deficit there will be greater control on government borrowing, especially borrowing through SBP and commercial banks. As a result, transitory component of money supply will be lessened. Hence there will be no surprise inflation. Therefore, monetary stability will be achieved along with stable growth, lower fiscal deficit and lower inflation. However, this does not mean that the growth rate will be higher.
And while certain members of the educated class continue to spew venom against the IMF, an organisation whose functionalities they don’t even understand, the current IMF bailout package is nothing short of essential for the country in many ways with repayment of previous loans amongst the most important component at present. The loan will stabilise the exchange rate in the short run, improve the position of portfolio investment and if everything goes the country will be on a stable path of economic growth in the next 4-5 years.
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