PULLING FOOT OFF THE BRAKE PEDAL
Oct 17 - 23, 2011
In the wake of late seventies' US economic crisis, Clyde Prestowitz wrote in his book The Betrayal of American Prosperity: "The extreme fiscal measures required to break the back of the runaway inflation obviated the benefits of the decoupling of the dollar from the value of gold. Federal Reserve Chairman Paul Volcker pushed short-term interest rates up to 20 percent, with those for home mortgages running up to 17 percent. Inflation was finally tamed, but the high interest rates also made investing in the United States extremely attractive; the high returns they would bring led to a rush of foreign investment into the U.S. economy. That, in turn, dramatically strengthened the dollar, more than offsetting the devaluation that followed decoupling from gold. The resurgence of the dollar made the United States a very costly place to produce goods and services for trade, and many more U.S. companies moved production to offshore locations such as Singapore, Hong Kong, and Malaysia."
Seen in this background, the policies of Pakistan's monetary bosses, after the removal of previous regime, would appear highly misconceived and counterproductive. These policies, besides failing to control inflation, triggered swift outflow of foreign investment and freefall of Pak rupee. The high interest rates coupled with the inefficient government's unprecedentedly high borrowings, both from the State bank and the banking system, made it difficult for the commodity and service sectors to produce goods and services for the economy.
High interest rate and government's growing demand for credit encouraged banks to invest in risk-free government papers and securities thereby crowding out the private sector. The private sector retaliated by moving investment to offshore operations.
The monetary policy bosses, sticking to one-point agenda-inflation control-refused to change their stance causing severe economic growth problems. It was during this period that phony issue like energy sector inter-corporate debt was created and full utilization of existing power generation capacity was blocked to hamstring the industry on one hand and cause misery to the people on the other.
INTEREST RATES IN SELECTED COUNTRIES
COUNTRY INTEREST RATE % COUNTRY INTEREST RATE % COUNTRY INTEREST RATE % Australia 4.75 Hong Kong 0.50 Pakistan 12.00 Brazil 12.00 Hungary 6.50 Poland 4.50 Canada 1.00 Iceland 4.50 Switzerland 0.00 China 6.56 India 8.25 South Africa 5.50 Czech Republic 0.75 Japan 0.10 Sweden 2.00 Denmark 1.25 Korea Republic 3.25 Turkey 6.25 Egypt 8.25 New Zealand 2.50 U.K 0.50 European Union 1.50 Norway 2.25 U.S 0.25
The recent change in SBP outlook augurs well for the economy. The 200 basis points cut in the policy rate in two phases is a puff of fresh air. The long vitiated economic environment needs a constant flow of fresh, revitalizing air. This can be achieved by unfettering the economy and let it grow at its natural pace.
Our economy has great potential with unmistakable competitive edge our many other regional economies. With the focus of growth having shifted from the developed industrialized economies to the emerging Asian economies, it will be a folly, rather crime, if the economy is not timely unshackled to resume its onward run. This scribe wrote a few months back: "Besides stifling the economy, a high interest rate puts immense pressure on domestic currency. High cost of borrowing increases the cost of input which in turn makes our exports uncompetitive in the international markets. With this, the dollar inflow is restricted and external account imbalances are created which are corrected either through lesser imports, leading to low capital formation, or by exporting our bread and butter ñ wheat, rice, meat, fish, fruits and vegetables ñ leaving our poor masses to starve. The recent current account respite is short lived as international oil price hikes in the wake of Middle East political crises coupled with the higher debt maturities that lie ahead threaten this temporary external account relief.
The recent improvement in the foreign portfolio investment is also not to be counted on as this short term dollar inflow can go as fast as it comes. Services sector and foreign remittances are holding the economic fort since quite some time while the real sector economy has been systematically destroyed. Will someone ask the state bank to remove its foot from the brake pedal?"
Finally, the foot has been removed from the brake pedal. So long as the driving mechanism is sound, the prudent use of gas and brake pedals can steer the economy past the recessionary zones. Skepticism about the recent policy rate cut is being shown by some conservative circles.
A recent Dawn editorial says: "Meanwhile, at the helm of the State Bank is an acting governor, a position in which one has incentive to try to secure a permanent nomination. Under these circumstances, a normal rate cut of 50 basis points would not have raised eyebrows."
We should bear in mind that central bank governors coming through political rout cannot be trusted to carry out economic programs of national interest. The autonomy of an autonomous body has to be respected. Politically appointed governors may come and go. It is the below-governor tier of experts and economists that has to carry the blame if things go wrong. A certain governor may quit if things are not to his liking, but the central bank has to keep operating in line with its mandate. We are not sure about the ambitions of the acting governor, but we are sure that the things have started to move in the right direction.
Our policy rate is still the highest amongst the surrounding economies. We still need more policy rate cuts to settle around single-digit rate of 8-9 percent. With the current interest rate at 14 percent (expected to go up to 15 percent by the next week), Vietnam is the only exception in the region to have surpassed our policy rate. It had an interest rate of 7 percent in December 2010. Since then, half a dozen interest rate hikes have befallen this economy which is under severe inflationary stress for the time being. But Vietnam is altogether a different story. With almost self sufficient in oil and gas and its state-owned enterprises contributing 40 percent of GDP, the economy is well set to hold to its reputation of being one of the next-eleven booming economies after BRIC countries. We are also one of the next-eleven nominees. Despite the current bleak scenario, we still have the potential to vindicate Goldman Sachs who nominated us in 2005 as one of the next-eleven. What we need is good governance and the right kind of monetary and fiscal policies.