Exchange rate and the Pakistani economy

Why is it that while we Indians love India, Pakistanis don’t seem to like Pakistan? — L K Advani


I visit Pakistan two to three times a year and am always struck by the negative views held by the people I come across in both Lahore and Islamabad. In listening to some of what is being said, I am reminded of the conversation I had a few years ago with L K Advani, a senior BJP leader, who had served as India’s deputy prime minister under Atal Bihari Vajpayee. The Advani meeting was arranged by Arun Shouri who had worked with me at the World Bank and is now a senior BJP leader. Advani greeted me very warmly and said that he was widely misunderstood in Pakistan. He was neither against Pakistan nor against Islam. He was just pro-India. He then asked me a question that I was unable to answer. “Why is it that while we Indians love India, Pakistanis don’t seem to like Pakistan?”

This has been one of my longer stays in Pakistan and during it I have heard a great deal of negative talk about the country. There are two themes in these talks. It is widely believed that Pakistan is being torn apart by politics and that the country’s economy is moving towards a hard-to-tackle disaster. Neither assertion is correct.

The latter is based on the recently released report by the International Monetary Fund (IMF) following the institution’s ‘Article IV’ consultations. The IMF, while accepting that the Pakistani economy is on the road to recovery, believes the country faces serious headwinds. These are coming in in the form of growing fiscal and balance-of-payments deficits. The two taken together are resulting in a growing debt burden. This view has led to a great deal of commentary in the media, much of it not based on a good understanding of what is happening.

It is hard to reconcile the ‘headwinds’ approach to economic forecasting. While I was looking after the Latin American region at the World Bank, I dealt with a number of countries that were dealing with situations similar to those Pakistan faces today. They were leaving behind years of slow growth and getting on high growth trajectories. In doing so, they borrowed from both domestic and foreign sources of capital. This meant increasing the burden of debt. The IMF was invariably opposed to this approach. It is deeply embedded in the institution’s culture to focus only on the short term, showing little concern for the long term. It sacrifices growth and development to stability. My advice to the Latin American governments always was to take one of the development banks along with them when they went to discuss their situation with the IMF staff so that development momentum is not lost.

Why am I sanguine about deficits incurred to finance growth? The reason is simple. The size of our economy, estimated on the basis of the current exchange rate, is about $400 billion. Adding two percentage points to the expected rate of growth means increasing the national income by $2 billion a year. This gives us the cushion to service the debt incurred now to pay for growth a bit later. Also, in most of the commentary on the debt burden the country carries, there is the belief that the debt burden is unbearable. This is wrong. Once again, most analysts don’t do serious work before offering comments for public consumption. According to the CIA, Pakistan’s public debt is estimated at 59 per cent of the country’s gross domestic product (GDP), it ranks 77^th in the list of 207 countries for which it published data in its World Factbook for the year 2017. Japan tops the list with its debt at 223.8 per cent of the GDP, followed by Greece at 180 per cent. Singapore comes at 11^th with the debt burden of 114.6 per cent. There are 16 countries whose debt is higher than their GDPs. The United States with debt at 77.14 per cent ranks 43^rd. Pakistan, in other words, is situated in the comfort zone.

What really matters is the purpose for which the government borrows. No body would accuse Japan of poorly managing its economy. It borrowed heavily and invested wisely in climbing out of the low growth trap into which it had been caught for decades. Greece, on the other hand, has the second-highest debt burden. Much of its burden was incurred in the construction activity related to the Olympics that the country hosted in 2004 on which it spent lavishly. Pakistan need not be worried as long as its borrowings are being spent on programmes and projects that would have worthy results. Much of the expenditure related to the China-Pakistan Economic Corridor falls in this category.

Where the government needs to be concerned is the country’s continuing decline in exports as proportion of the GDP. Much of this is the result of poor management of the exchange rate that has made Pakistan not competitive in the global markets. For seven years I managed the World Bank’s programme in the Latin America and the Caribbean region. At that time, a number of countries were pursuing strong currency policies.

I once told Domingo Cavallo, the Harvard University trained economist, who was then finance minister of Argentina, that he was making a big mistake by following the parity exchange rate formula. He had pegged the Argentinian peso at one-one to the American dollar. “When a finance minister begins to equate the exchange rate with manhood, there is inevitably a problem.” I advised him to de-peg the Argentinian peso to the American dollar and let the domestic currency float. He didn’t take my advice; the country’s exports collapsed and it eventually removed the peg and the peso plunged in value. If I were asked, I would give the same advice to the authorities in Pakistan. They should allow the currency to depreciate, a process that seems to have begun.

Published in The Express Tribune, March 26^th, 2018.

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