Our external borrowing binge and its repercussions

Growth is not well-planned and the country may slip into balance of payments crisis

LAHORE: The current democratic dispensation has just completed an Extended Fund Facility of the IMF which remained a soft programme under fortuitous global circumstances.

After coming out of the programme, the government realised that it has to have a large cushion of foreign exchange reserves to run the economy for the next 20 months since it is embarking on large China-Pakistan Economic Corridor-related projects with imports rising despite declining exports and impending fall in remittances.



This urgency has put the country on the course of an external borrowing binge; specifically short-term commercial loans, Eurobonds and Sukuks.

This is a new experiment in the economic and development history of Pakistan since the government is looking for private capital inflows to provide a growth spurt to the economy.

The military governments used to get geostrategic rents from the multilateral and bilateral sources in the past, which helped in bringing bouts of economic growth with small amounts of private capital inflows. Whenever geostrategic rents were exhausted, the growth rate plummeted and the country had to fall back on the IMF to negotiate the balance of payments (BOP) crisis. The economic development of a country requires imports of capital goods, used in the production of finished goods.

Such imports are indispensable and quite expensive compared to the exports of developing countries which are relatively cheap and result in a current account deficit. Hence, the current account deficit increases when a country grows.

This growth has to be well-planned and orderly in order to avoid financial and currency crisis. However, the economic growth is not well-planned as far as the case of Pakistan is concerned and the country may slip into BOP crisis any time in future.

There are certain negative repercussions associated with private capital inflows.



Loss of control over exchange rate

First, the exchange rate in a developing economy is highly affected by capital inflows and outflows. When trade balance is persistently in deficit, the exchange rate is manipulated by the private capital flows.

If capital inflows are larger than outflows, an exchange rate appreciation will take place, though there is a role of trade deficit in the exchange rate determination.

By attracting large capital inflows, a country loses control over its exchange rate which may become detrimental for industrial development of the country.

Loss of control over monetary policy

Second, the exchange rate and monetary policy are interdependent on each other. When there is a loss of control over the exchange rate, a developing economy cannot run an independent monetary policy.

Here, independent means that actions of the central bank become hostage to the external and/or international influences. These external influences are often in conflict with the domestic demand of entrepreneurs in an economy.

When economy is on a downhill, the entrepreneurs clamour for big cuts in policy rates in a brisk manner, while the central bank tries to manage the external influences and cannot pay attention to entrepreneurial demands.

Hence, the loss of control over exchange rate leads to loss of control over monetary policy.

Loss of control over domestic production

Third, the loss of control over monetary policy leads to a loss of control over domestic production, which is instrumental in economic development.



When domestic production requires bouts of credit, the central bank is not in a position to provide the desired credit. This lack of provision could lead to economic downturn at a time when the economy is well poised for growth.

In a nutshell, external borrowing through private capital inflows for development is a new experiment in Pakistan.

Latin American developing countries have tried, tested and tasted the negative repercussion of this novel experiment during the 1980s and 1990s in the form of sovereign debt, financial and currency crisis.

This crisis proves the lesson that we learn nothing from the history.

The writer is an assistant professor of
economics at LUMS

Published in The Express Tribune, October 17^th, 2016.

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