CAPITAL FLIGHT - FADING VALUE OF CURRENCY
FOZIA AROOJ, Fozia.firstname.lastname@example.org
Oct 13 - 19, 2008
Capital flight is going on from across the country. The highest amount of money is being transferred illegally from the NWFP due to serious law and order situation which has not only stopped investment in the province but caused flight of foreign investment. The NWFP in terms of individual riches is the richest province as undocumented wealth is much larger than the disclosed wealth. This is the reason that highest capital flight is taking place from the province. Most of the money is sent to Dubai.
The remittances by overseas Pakistanis have increased by 24% in the last two months, but still the open market is receiving dollars from individuals in much bigger number.
It is believed that many currency dealers indulge in illegal currency business and are sending millions of dollars daily out of the country. Transferring dollars without informing the State Bank of Pakistan is illegal, but the money changers help anyone who wants to send dollars abroad. The illegal currency trading has been in practice for years however it was restricted to some extent after the 9/11 when the US authorities made it difficult to transfer money without documentation.
It is difficult to give exact amount which is being transferred through this illegal channel, but some currency experts guess that it could range $2 to $5 million a day. It is not difficult to find people who help to send the dollars abroad. They charge at a certain rate and even bargaining is possible. The State Bank has tough laws but is not vigilant enough to stop this illegal transfer of money.
The terrorist attack has done incalculable damage to the economy that was struggling to recover from a deep crisis. The country is in great deal of economic stress and the government almost paralyzed into inaction. There is anecdotal evidence of capital flight which always results when there is loss of confidence in the future. People are buying properties not only in the Middle East - in particular in such booming cities as Dubai, Abu Dhabi, Bahrain and Doha - but also in Malaysia.
The Islamabad bombing probably exacerbated and, most probably, caused additional capital to flee the country. The flight of capital put simultaneous pressure on the value of the rupee which continued to slide. It also put additional burden on the stock market which also continued its downward spiral. The most obvious reason for outflow of money is that the investors have lost confidence in the future of the Pakistani economy because of political uncertainty and terrorism.
Stock markets, after all, reflect how investors view the future of the economy. It is not easy to be confident that the country's economy will achieve much if some of the political issues that continue to draw so much of the attention of the policy makers away from economic management don't get resolved quickly.
From the experience of many countries across the globe it is evident that nothing troubles markets more than uncertainty. That has been established by the empirical work done at many development and financial institutions. There are good reasons why that is the case. Investors make assumptions about the environment in which they are operating. Sudden changes alter the calculations they have made. When a great deal of capital moved into Pakistan's stock markets, there was an assumption that the policies adopted by the state over half a dozen years would continue even if there was a change of personnel among the ranks of senior policymakers. That has not happened.
There are very large countries in the group (China and India) and very small ones (Ireland and Portugal). There are those that have managed their economies extremely well (Ireland, China and India) and those that have not done so well in terms of economic management (Pakistan).
Pakistan is the only country in this group that has had to deal with extreme domestic political difficulties. For other countries other than political factors were responsible. Two of these also apply to Pakistan. China and India were regarded as the new growth centers of the global economy. It seemed a good idea to invest in their capital markets. Portugal was regarded as a catch-up economy somewhat like Spain that has overtaken some of the more established European economies. In Pakistan's case, speculative behavior had multiple causes including a fiscal system that did not punish speculation (Pakistan is one of the few large economies that does not tax capital gains), it is physically close to a number of countries with large amounts of investing capital, there was an impression that the country may have finally found a way of climbing on to the trajectory of growth taken by a number of large Asian economies. It also seemed like a good investment bet.
To the political pressures playing on the market we should also add factors such as the perceptions about the country's medium-term economic prospects, fiscal and other policies that allow speculation, and the increase in the price of oil that has severely affected the state of the economy. Given that, what is that policymakers can do?
Ultimately it is the level of confidence in the country's economic future that will stabilize the economy. This can only happen once the operators in the markets are persuaded that policymaking positions in Islamabad are occupied by those who have the competence as well as the authority to take actions that will revive the economy. If that were to happen, capital will flow back into the markets. As shown in the table, the yield, at seven per cent, available in the Pakistani market is the highest among those countries that are experiencing falls in equity prices. This level of yield will bring capital back once confidence returns.
How would the increase in terrorism and continued conflict in the tribal areas affect the economy? For this question to be answered, the policy makers must have access to better information about the state of the economy. However, that is not the case. Most developing countries update their national income accounts every quarter; in the case of Pakistan this is done on an yearly basis which means that if the policymakers wish to take remedial action to correct some aspect of the economy they have to operate blindfolded.
The rate of growth of GDP is expected to decline to 4.2%, more than one and half percentage points lower that of last year's increase of 5.8% and much lower than the average for the last six years of about 7%. The worrying part of this anticipated loss in growth momentum is a significant increase in unemployment. The economy will create far fewer jobs than the growth in the workforce. The sectors that provide jobs to the poorer and less educated and trained workforce are expected to do less well. Their poor performance will not be because of the terrorist attacks. It will be because of the havoc caused by interruptions in the supply of electric power during the summer months.
The most important impact of terrorist activity will be to reduce the flow of private finance into the country. This will happen at the time when Pakistan is running very high trade and balance of payments deficits. These have to be financed. Even after taking into account a significant increase in workers' remittances to about $ 7 billion in 2008-09, there will still be a financing gap of some $5 billion. At this point there is no indication by the government as to how it proposes to finance this deficit.