INTERVIEW WITH CEO AKD INVESTMENT MANAGEMENT LTD.
"IF OUR FOREIGN EXCHANGE RESERVES START TO CONTRACT SHARPLY FOR ANY REASON, THEN INTEREST MAY END UP GOING HIGHER."
Mar 14 - 20, 2011
Nadeem Naqvi is the CEO of AKD Investment Management Ltd. He has over twenty-eight years experience in the international financial services industry and has worked in New York, London, Bahrain, Karachi, and Toronto. Mr. Naqvi was the CEO of AKD Securities Limited from 2005-08, where the firm twice received the prestigious CFA Association of Pakistan award for 'Best Domestic Brokerage House' for 2006 and for 2007. Between 2002-05, he was a Principal and Director of Investology Inc., a U.S. based independent research firm ranked 3rd out of 300 U.S. independent research firms by Business Week Magazine in July 2004. He headed the advisory team of Morgan Stanley's Pakistan Investment Fund for four years from 1996 to 2000 and was an Executive Director at Khadim Ali Shah Bokhari (KASB) and Head of Merrill Lynch Pakistan Research team. Mr. Naqvi has an MBA in Finance from the City University Business School, London, England and is a member of the CFA Association, Toronto Society.
PAGE: WHAT IS YOUR OPINION ABOUT MONETARY POLICY IN PAKISTAN?
NADEEM NAQVI: Monetary policy in Pakistan over the last several years has followed an orthodox approach of the monetarist school of thought. This holds that inflation is essentially a monetary phenomenon. If money supply increases faster than commensurate growth in real output, prices will rise. In its simplest formulation, the 'Quantity Theory of Money' linking money supply and real output is depicted by the equation MV=PQ, where M is money supply, V is velocity of money (or how many times it circulates in a given period), P is price, and Q is quantity of goods & services produced (real output). V is usually assumed by monetarists to be reasonably stable (which is a questionable assumption). Q is limited by the capacity of plant & machinery in the economy. Thus, according to monetarists, if M increases, after a time lag P will inevitably increase.
How does M increase? One way is when the government borrows money from the central bank, the central bank credits Ministry of Finance (MoF) account at National Bank of Pakistan. MoF writes checks in favour of other ministries who then withdraw this money as expenditure. This is like printing of notes. Now, when ministries spend money they create public sector demand for Q (goods & services). If public sector demand increases while private sector demand is also high then total (aggregate) demand for Q in the economy will increase and the effect will be rise in P - or inflation. In order to counter this excess demand from public sector and keep aggregate (total) demand stable, the central bank has to try and reduce private sector demand. This is done by raising interest rates so that (a) consumers have an incentive to save more and spend less and (b) businesses find loans becoming expensive so they borrow less and invest less. In this way, pressure on P reduces and inflation slows down.
PAGE: IS THE PRESENT MONETARY POLICY APPROPRIATE FOR THE PAKISTAN'S ECONOMY?
NADEEM NAQVI: The problem in Pakistan is that Q (output) is below its potential in many industries. Secondly, inflation over the last 12 months at least, is being driven by supply side shortages and international commodity price hike, not simply a huge jump in aggregate demand. This is evident by the fact that real GDP growth is in the 2.5 - 3 per cent range verses historic average of 4.5 - 5 per cent, implying that the economy is operating below its potential output (Q) level. In my view, while the central bank may have been correct about interest rates early on, it is now causing enormous stress on businesses in terms of very high financing cost, at a time when energy and raw material costs are rising rapidly and unavailability of energy (oil & gas) is creating disruption in production. This is especially hurting small and medium sized business & industries, which tend to pay higher borrowing costs as it is. Given that small and medium enterprises are the engine of employment generation and income growth for majority of people, focusing on interest rate as the single tool of controlling inflation is inappropriate, in my opinion.
PAGE: WHAT ALTERNATIVE APPROACH WOULD BE MORE APPROPRIATE IN YOUR VIEW?
NADEEM NAQVI: In my view, parliament should grant the central bank the power to say 'no' to federal and provincial government borrowing beyond agreed targets. This is the only way to curb the fiscal excess of the public sector translating into printing money and causing high inflation. The recently reported view of the Senate Committee declaring monetary policy as illegal is incorrect, in my opinion. The politicians have to focus on the cause of inflation which is excessive federal expenditure on the one hand and poor revenue generation on the other. Blaming the central bank for their failures to enact RGST law and avoiding agri'tax legislation will not solve the problem.
Second, I believe that the leasing sector should be'brought under the umbrella of the State Bank or; at the very least, under a joint platform of the SBP and SECP. It should be provided a certain quantum of long-term financing/credit lines at attractive rates (as for example, is done with export financing) for asset-backed financing of up to 5 years for medium and small enterprises.
At the same time, our business people brethren are no saints. There is enough anecdotal evidence of over invoicing purchased assets and abuse of financing facilities by a goodly proportion of borrowers. Hence, a special vigilance cell should be formed in the State' Bank which conducts large sample inspections to identify misuse and hand out strong financial penalties in cases where misuse/ corruption is evidently present.
Third, sector/segment specific lending limits (e.g. consumer finance, home-equity loans, import of luxury items) can be imposed by the central bank to curb "non-essential" excess demand from a small segment of the well-to-do population.
Finally, the State Bank always has the tools of cash and reserves requirements for banks, limits on advance to deposit ratio and capital adequacy ratio to curb excessive credit growth and thus aggregate demand in the broader economy.
In my view, if the above comprehensive approach is taken, the need to keep interests so high will not be there. As interest rates come down by 200-300 basis points over the next twelve months, while the government is prohibited from further borrowing from the central bank, the economy will get a breather. Moreover, our political parties have to accept the reality of global commodity price spike and agree on subsidy reduction. This will itself lead to demand reduction due to higher cost of imported materials - most important being petroleum products and industrial raw materials and inputs.
PAGE: HOW WOULD YOU COMPARE REGIONAL COUNTRIES WITH PAKISTAN IN TERMS OF INTEREST RATES?
NADEEM NAQVI: Global interest rates are inevitably rising, led by large emerging markets such as China, Brazil, and India. Their situation is different from Pakistan. These are other emerging economies that have been growing rapidly (5 per cent - 10 per cent real GDP growth rates), so they need to curb aggregate domestic demand in order to counter commodity price inflation. I expect Asian interest rates to rise significantly over the next 12 months. I also sense that by 4Q2011, the U.S. Federal reserve may be forced to reverse its easy monetary policy due to growing inflationary pressure in the United States. On the other hand, Pakistan has likely reached the peak interest rate level in this economic cycle. If some of the actions mentioned above are taken, it will be possible to see interest rates in Pakistan coming down by 4Q2011. The only significant risk that I sense is that if our foreign exchange reserves start to contract sharply for any reason, then interest may end up going higher.