Irrational Exuberance – Dr Ashfaque H Khan

The last two weeks have witnessed a massive turmoil in the country’s exchange market. A sudden inflow of $1.5 billion in two instalments under the hitherto unknown Pakistan Development Fund (PDF) caused a rampage in the exchange market. The rupee-dollar parity, which stood at Rs104.96 per US dollar on March 3, appreciated to Rs98.19 per US dollar by March 13 – an appreciation of seven percent in ten days.

The sudden injection of $1.5 billion cannot lead to the appreciation of the rupee by seven percent in such a short period of time without massive intervention by the State Bank of Pakistan (SBP). It appears that the first instalment of $750 million increased the reserves of the SBP.

The government may have asked the SBP to intervene aggressively in the market. Such an intervention changed the market sentiment and those who were holding dollars panicked and started offloading in fear of further appreciation. Supply of dollar further improved and the inflow of the second instalment of $750 million added fuel to the fire, appreciating Pakistani rupee by seven percent in ten days.

What did we gain through this jhatka (shock)? Within 24 hours, the rupee lost Rs1.28 per dollar and stood at Rs99.47 per dollar on March 14. As a student of economics, I fail to understand why the finance ninister has asked people to celebrate the appreciation of the rupee. We were also told that Pakistan’s public debt has been reduced by Rs800 billion. Such statements are far below the status of a finance minister.

The dollar component of Pakistan’s public debt stood at $50 billion as of December 2013. With an exchange rate of Rs105 per dollar on March 3, the dollar component when converted to rupee, stood at Rs5250 billion. On March 13, when the rupee appreciated to Rs98.19 per dollar, the same dollar component of public debt stood at Rs4910 billion – a decline of Rs340 billion.

Within 24 hours, the rupee lost its ground by Rs1.28 per dollar and with the new exchange rate the gain in reduction in debt was wiped out by Rs64 billion to Rs276 billion. Such numbers are notional in nature as they keep on changing with the change in exchange rate.

The recent appreciation of the rupee will have serious budgetary as well as balance of payments implications. Since almost 40 percent of the FBR revenue is import related (customs duty, sales tax and withholding tax at import stage), the appreciation of exchange rate will reduce the rupee value of import and, given the tax rates, the FBR’s revenue will decline. Furthermore, the appreciation of the rupee has also eroded Pakistan’s export competitiveness. The seven percent appreciation of the rupee may have neutralised the gain that Pakistan received in terms of the GSP Plus status. Appreciation may also adversely affect the flow of remittances going forward.

Based on the above, my suggestion to the government is to avoid shock therapy and pursue sound macroeconomic policies. The cost of short-term gains through shock is high as it destabilises the market. The government should steadfastly pursue its sound fiscal and monetary policy; make efforts to bring peace and stability (particularly in the major growth poles of the country) and improve electricity generation to minimise loadshedding. I am confident that with support from the private sector, Pakistan’s economy will improve.

It takes time for the economy to deteriorate; it also takes time for it to improve. What is required is patience, perseverance and dedication to bring change for the better. It took more than two decades of hard work to take the Japanese economy out of its prolonged recession. It has taken almost five years for the US economy to come out of the woods. The eurozone is still reeling under the European debt crisis despite massive support from Germany, France and the IMF since 2009-10.

Why should we expect Pakistan’s economy to start booming in the midst of serious security challenges and energy bottlenecks within a span of eight/nine months? In the desire to show massive improvements all around in a short period of time there is a danger that we may manipulate statistics. (I have been writing on data issues for quite some time).

On March 4, (‘Living on illusion’), I highlighted issues concerning quarterly GDP, large-scale manufacturing statistics and budgetary numbers. The government responded to my article on March 10. Without responding in detail, I would simply say that the defence by the government was absolutely indefensible.

Ever since the revelation of ‘strong economic recovery’ (real GDP has grown by 5.1 percent in the first quarter). I wrote four articles in these pages questioning the authenticity of these numbers. Instead of looking into these statistics, the government continued to adopt an aggressive posture (“to hell with critiques”). Initially the government neither owned these statistics nor disowned them. With the passage of time it not only ‘owned’ these numbers but forced others to adopt the same. Going by the trend, the Bureau of Statistics will ‘manufacture’ a growth of five percent for 2013-14.

Large-scale manufacturing numbers are fictitious; no sensible economist would accept such idiosyncratic growth numbers. Large-scale manufacturing number is quantum index; the fictitious growth numbers will have a devastating impact on real GDP growth.

As if growth, unemployment, poverty and inflation were not enough, we have now added budgetary numbers in the list of controversial statistics. In response to the government’s claim in its response to my March 4 article, I would like to make few observations to prove that the government’s defence was indefensible.

First, on the universal support fund, the government’s position is that since this amount was lying in a bank account, the government amended the rules and transferred Rs68 billion to the federal consolidated fund. Isn’t this surprising? Where should the money be kept? In the PTA building or in a cupboard or in some personal account? Naturally the money would be lying in the bank. There are billions of rupees of different government institutions lying in bank accounts. Should the government transfer all these monies to the federal consolidated fund by amending rules?

Second, on treating foreign grants as non-tax revenue, the government’s position is that it is an acceptable international practice. My question is: why was this practice not adopted in the last 65 years? Is the budget deficit number of this year comparable to the previous ones? Changing goal posts that suit us is bad economic policy.

Third, on the issue of receipts from PSEs, SBP profits and gas development surcharge, these amounts were left by the previous governments. The present government has taken these monies, which were lying under different accounts. Should we call this fiscal effort? If we accept the government’s position then should we say that we inherited an ‘empty treasury’? The fact is that the government took over Rs200 billion lying in different accounts and treated it as non tax revenue.

My humble request to all those who matter is to not destroy statistics. The economy will improve through sound policies and not through jhatkas (shocks) or by manipulating statistics.