Fiscal policies challenged in SC: Govt economic team has clash of interest

February 19, 2020

ISLAMABAD: Former caretaker federal minister for finance Muhammad Zubair Khan has challenged the fiscal policies of the government and appointment of Advisor to the Prime Minister on Finance Dr....

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ISLAMABAD: Former caretaker federal minister for finance Muhammad Zubair Khan has challenged the fiscal policies of the government and appointment of Advisor to the Prime Minister on Finance Dr. Abdul Hafeez Sheikh, Governor State Bank Dr. Reza Baqir, and Deputy Governor Murtaza Sayed under plea of clash of interest and steps taken by the government in the fiscal fields through a constitutional petition filed with the Supreme Court.

The petitioner has made Prime Minister Imran Khan, federal ministries concerned, banks and others respondents in his petition.

Terming increase in interest rates highly inflated returns on foreign investments in treasury bills, and resultant increase in inflation etc unconstitutional and unjustified, the petitioner has contended that the petition has been filed against the illegal, malafide, unconstitutional and acts in conflict of interest done by the respondents in general and in particular that of Dr. Abdul Hafeez Sheikh, Dr. Reza Baqir and Murtaza Sayed in respect of the arbitrary unlawful and unjustifiable increase in the interest-rates, increasing in Federal Fiscal Deficit in comparison of its Gross Domestic Product (GDP) etc in blatant violation of the Fiscal Responsibility and Debt Limitation Act, 2005.

He has taken the plea that the government will spend the largest amount ever on any budget item in the history of Pakistan i.e. on interest payments, as a result of self-imposed decision, which could have been avoided, which is not in the economic interest of the country, and which exposes the financial system and the foreign exchange market to high risk of severe instability by encouraging the inflow of “hot money” into the country.

This avoidable waste of scarce public fund is at a cost of rising public debt leading to an unsustainable fiscal situation. Specifically, the government will spend Rs3,125 billion on interest payments, which is more than half of all the tax revenues by government, twice the defence budget just when India is threatening Pakistan’s existence, four times the development budget, and many a time the expenditures on social welfare.

The petition has maintained that the unjustified interest rate policy is shutting down industry, trade and commerce, transport and construction. Instead it is encouraging foreigners and Pakistanis to invest in interest-bearing instrument, contrary to the Constitutional and Islamic injunctions to avoid and refrain from the business of usury and interest-rates.

The petitioner/public at large suffers constitutional violations of Articles 4, 5, 6, 9, 14, 15, 25, 29, 35, 73, 74, 77, 79, 88 and 90 of the Constitution and other finance laws including the Fiscal Responsibility and Debt Limitation.

The petitioner has raised the points that i. Whether the fundamental rights of the public at large are not infringed when they are forced to pay more due to high interest rates; and whether the same would not amount to a burden affecting the economic life in other words right to life of public at large in violation of Articles 4, 9, 14 and 25 of the Constitution? ii. Whether the Advisor to the Prime Minister on Finance and the Governor State Bank of Pakistan have severe conflict of interest and are beneficiaries of present economic policy-making; and whether they have ignored Pakistan’s national interest in order to keep their own relations with the IMF on favorable terms? iii. Whether the present economic policy of high interest rates is violative of principles of sound fiscal and debt management policy as given in the Fiscal Responsibility and Debt Limitation Act, 2005? iv. Whether the total public debt for the financial year 2019, which is more than 83.5% of the Gross Domestic Product, is violative of Clause (b) of subsection 3 of Section 3 of the Financial Responsibility and Debt Limitation Act, 2005? v. Whether the appointments of Dr. Abdul Hafeez Sheikh, Dr. Reza Baqir and Murtaza Sayed are in clear violation of transparency, impartibility and against the interest of the Country and Public at large? vi. Whether the policy of high interest rates on returns on short-term investment in treasury bills is based on some objective criteria or aimed at benefiting commercial banks, some individuals including foreign portfolio investors maliciously and at the cost of the country and public at large? vii. Whether the handover of the entire economic policy of the country to questionable foreign/dual nationals is against the very principle of natural justice, fair play, and openness; and whether there is not a clear conflict of interest on the part of the respondents, since they are the very beneficiary of any outcome of the high interest rates? viii. Whether generally the conduct of the aforesaid respondents did not amount to misrepresentation, malicious and discreet; and which is designed to deceive and defraud the public at large by controlling or artificially affecting and manipulating the interest rates? ix. Whether in the very circumstances of this case, increase in interest rates is not the result of an illegal exercise of power by private individuals who happened to be the beneficiaries of such increase; and whether such a practice is not illegal? x. Whether or not Respondent (No. 4 to 7) are required to make full and complete disclosure of the names of all the individual entities who have invested in Treasury Bills issued by the Federal Government; and whether if the same are found to be in any way related, directly or indirectly, to the Respondents would it then be a conflict of interest and whether the income/profit generated from the same should not be forfeited in favour of the public at large? xi. Whether the economic policy of high interest rate is aimed at giving windfall profits to Banks at the costs of public; and whether the huge difference between the borrowing and lending rate is violative of Banking Companies Act, 1963? The petitioner has taken the plea that the PTI government procrastinated at first; instead of adjusting policies to address the root causes of the hemorrhage of official reserves, it also began borrowing from ‘friends of Pakistan’ to bolster the country’s official reserves, (US$3.0 billion) from China and (US$2.0 billion) from KSA. Since the causes of the decline in reserves had not been addressed, these loans also dissipated from the reserves at the rate of $1.0 billion per month. By January 2019 Pakistan’s official reserve stood at $7.0 billion, down from $18.5 billion in September 2016 despite borrowing $20.0 billion by the two governments, hence a total decline of $31.5 billion in official reserves. And since SBP reserves accumulated during the IMF program had also been accumulated with borrowed resources not earned, Pakistan will now have to pay back the dissipated $31.5 billion and the interest on it. Total public debt increased from 71.6% of GDP at end FY2018 to 83.5% of GDP at end FY2019. There is broad consensus that the root causes of Pakistan’s macroeconomic imbalances were: · the over-valued rupee, · excess domestic demand driven by the persistent and high government fiscal deficit · and continuing loss of competitiveness of the economy. On July 3, 2019, the Executive Board of the International Monetary Fund (IMF) approved a 39month extended arrangement under the Extended Fund Facility (EFF) for Pakistan for about US$6 billion to support the authorities’ economic reform program 4. Among other measures the rupee was devalued to find its market-based exchange rate, but the fundamental problem of excess domestic demand was not addressed. Referring to various reports the petitioner has contended that addressing the very high fiscal deficit (deficit projected to rise to 7.6% of GDP in FY20 from budgeted 7.0% of GDP in FY19) which was the major contributor to the external current account deficit and the resultant decline in reserves, the government and SBP raised interest rates to record levels and raised import duties and charges on imports. The increase in interest rates was neither justified because private sector borrowing was not driving excess domestic demand nor effective in curtailing inflation historically and presently. As a consequence of the incorrect and misdirected policy actions of this government, colossal damages of trillions of rupees are being inflicted on the public exchequer and the national economy has been inflicted a severe blow, slowing down economic activity with GDP growth expected to decline to 2%, closing down businesses and industry, causing unemployment and loss of incomes of the people of Pakistan. As the economy slows down millions of additional people will be pushed into poverty reducing their incomes below the poverty line. ii. Conflict of Interest and Incompetence in Policy Making Policies detrimental to the economic interests of Pakistan were brazenly undertaken by an economic team appointed by the Prime Minister on the eve of signing an agreement with the IMF. During protracted negotiations with the IMF over the design of the stabilisation program stretching over many months, the Prime Minister abruptly changed the economic team. The PM appointed Dr. Hafeez Sheikh as Advisor for Finance on April 18, 2019. Dr. Hafeez Sheikh was at the time Partner in the New Silk Route (NSR) Growth Fund led by CEO and Founder Parag Saxena together with two other ‘Hindu’ Indian partners. NSR is focused on India and the sub-continent. The present Governor of the State Bank of Pakistan, Dr. Reza Baqir, took office on May 5, 2019, who was at the time a career staff member of the IMF serving as the IMF’s Senior Resident Representative in Egypt. The petitioner recalled that the economic team reached understanding with the IMF on May 10, 2019 within a short time of being appointed to their posts on a set of policies including the interest rate policy which was both irrelevant and detrimental to Pakistan’s economic conditions. The interest rate policy to maintain high ‘real interest rates’ (i.e. interest rates above the inflation rate) prescribed to Pakistan is in contrast to the policy of ‘financial repression’ (keeping interest rates below the inflation rate) adopted across western countries especially post 2008 Financial Crises to deal with high debt 5 . The controversial interest rate policy is a dogmatic IMF prescription which will adversely affect Pakistan’s economy and keep the country dependent on western creditors and vulnerable to pressures on foreign and strategic policy matters. It is understandable that the IMF was able to obtain such an agreement from Pakistan’s team because Dr Baqir and Dr Sheikh had a potential conflict of interest and the latter seemingly ignored Pakistan’s national interest in order to keep their own relations with the IMF on favorable terms or due to lack of competence. The negotiations were marred in the concluding days by the abrupt unceremonious removal of the Secretary Finance from office because of his persistence on a matter under negotiations, which reflected the haste on the part of Pakistan’s economic managers to reach agreement with the IMF team. It is doubtful if the interest of Pakistan could be strongly defended as Dr Baqir is quite likely to return to the IMF after his term as Governor SBP at a higher position in the IMF. And the primary residence of both members of the economic team are abroad and their career and business interests are abroad. One of the conditionalities of the IMF program is to grant policy independence to the SBP with which Pakistan is complying. With an IMF man as Governor, the IMF’s influence on the choice of policies has become stronger and further strengthened by the FATF regulations. In a startling move, Governor Dr Baqir has recently appointed another “Financial Repression Has Come Back to Stay” by Carmen M. Reinhart, Peterson Institute for International Economics, serving IMF staff member, Murtaza Syed, as Deputy Governor of the SBP in a not so transparent manner. iii. Colossal Loss to the Public Exchequer As a result of the self-imposed high interest rates by the government and the rapid build-up of public debt 6 , interest payments in the current budget (FY20) will use up Rs.3,125 billion from the public exchequer, compared to Rs.1,500 billion in FY18. By far the single largest expenditure item in the budget this year, interest payments will consume the bulk of scarce public funds constitutionally mandated for the welfare of the people of Pakistan, using more than half of all tax revenues (51.7%) collected by the government (despite an increase of 35% in tax revenues in the same year) 7 . To highlight the scale of this misuse and wastage of public funds, interest payments will be more than 211% of development spending (PSDP), and 233.6% of defense spending and 306.7% of subsidies and grants for the poor and under-privileged in FY20. Clearly, the constitutional right of the government to allocate public funds to expenditure heads in accordance with its priorities has been misused to the detriment of the welfare of the people of Pakistan. The main recipients of Rs. 3,125 billion interest payments from the budget will be the commercial banks, which have deviated from their legally mandated role of financial intermediation to finance private sector economic expansion, instead relying on fat profits from sovereign guaranteed T-bills. The other recipients include foreign portfolio investors who have invested over $3 billion 8 of hot money in T-bills. iv. Adverse Consequences of High Interest Rates for the Private Sector Adverse consequences of the unnecessary and inappropriate interest rate policy are not restricted to losses to the public exchequer. High and rising interest rates have caused partly due to extravagant spending by the government in FY2019 reflected in a budget deficit of 8.9% of GDP (one of the highest in the economic history of the country). It would cause huge losses to private sector businesses and industry. In recent years the private sector has utilized commercial bank credit mostly for working capital with little fixed investment. High interest rates (the highest in the region and among emerging markets) have raised the cost of doing business contrary to government claims, making Pakistani businesses less competitive against imports and unable to export. As a result, working capital and fixed investment in agriculture, manufacturing, construction, wholesale and retail trade, and transport have all declined during 2019. There is growing evidence that businesses and industry are shutting down causing unemployment and loss of incomes across the economy. Large Scale Manufacturing has recorded negative growth in two successive quarters for the first time in over a decade.

The government and the multilateral donors all agree that the GDP growth rate will decline sharply this year. The high interest rate policy of the government is also intended to attract short-term highly liquid capital inflows 10 to bolster foreign exchange reserves.

With exchange rate stability having been assured by our economic managers, foreign portfolio investors have invested over $3 billion in the government 3-month T-bills reaping over 13% interest whereas the cost of borrowing abroad for portfolio investors in US$ is about 2%, thus making huge profits. The portfolio inflows have added to the official reserves, the SBP proudly claims, at the cost a severe economic slow-down at home and stagnant exports.

Thus, instead of earning foreign exchange through export expansion, the SBP is attracting short term temporary inflows offering huge profits to overseas investors. As yet there is no information shared with the public about the identity of these lucky investors. With an open capital account regime as in Pakistan, these inflows (known as hot money) are extremely volatile and can flow out digitally in a matter of hours or minutes if perceptions about Pakistan’s economic and financial stability are changed by credit rating.

Agencies abroad for any arbitrary reason, triggering automatic sell commands on the computers of hedge funds and portfolio funds managers. Sudden outflows cause immense instability on foreign exchange and stock markets draining official foreign exchange reserves with very serious and adverse consequences for the host country.

The East Asian Financial crisis of the late 1990s was triggered by the outflow of ‘hot money’ and countries like Malaysia have taken pains to discourage attracting hot money or imposed some controls on sudden capital outflows.

The build-up of portfolio inflows has already seriously compromised the independence of policymakers in Pakistan in making interest rate policy. If, and when the government realizes its mistake and decides to decrease interest rates, this portfolio investment of $3 billion will flow out overnight causing the rupee exchange rate to go through the roof.

To avoid exchange rate instability Pakistan is now trapped to continue with high interest rates to the detriment of the national economy.

The high cost of this short-term volatile hot money is in contrast to the lower interest rate that Pakistan would pay on longer-term bonds if the government had chosen to float in the international market. vi. High Interest Rates are Bad Economics Too It is widely agreed that following a large devaluation of the currency as experienced in Pakistan recently, the SBP must pursue a tight monetary and fiscal policy to control the resultant inflationary pressures.

Contrary to what the State Bank of Pakistan and government claims, interest rates are not an effective instrument of monetary policy in Pakistan because private sector spending is not driven by credit and because deposit interest rates do not reflect the policy rate.

The recent sharp rise in interest rates has not been able to curtail inflation which continues to grow because the SBP has failed to focus and control total banking sector lending which is accelerating due the growing budget deficit and budget financing from the banking sector.

The petitioner has submitted that the rise in the policy rate of the SBP has led to an increase in banks’ lending rates (as high as 18% to most businesses) but a lesser increase in deposit rates, thus increasing “the spread” between the average deposit and lending rates, further boosting profits of the banking sector. High interest rates are also further immersing Pakistan in a debt trap.

With real interest rates (interest rates adjusted for core inflation) above the GDP growth rate, the Debt/GDP ratio will continue to increase even as the primary deficit (budget deficit minus interest payments declines). vii. Inherent flaws in Policy and harm to the country Raised with Government.

The petitioner is seeking the honorable court’s indulgence after raising the issues raised above with the government at the highest level and in the media over a protracted period but to no avail while irreparable loss is being inflicted on the public exchequer and the national economy to the detriment of the people of Pakistan.

Before the policy choices had been made and while negotiations were going on with the IMF over the design of the stabilisation program, the petitioner, in response to the PM’s instructions, sent the framework of a complete stabilisation program to the PM and presented the details to the then Finance Minister and his economic team on January 15, 2019.

It highlighted the dangers of following the IMF demand for higher interest rates.

In the event the government chose the IMF route after changing the economic team. As the adverse effects of the policy decisions started to emerge in the data released by the SBP and the Ministry of Finance, the petitioner appeared in a succession of talk shows on some of the major talk shows starting on September 8 2019, pointing out the adverse effects of the policies adopted and warning the government and Prime Minister Imran Khan of the inherent dangers for the country.

The economic team, Dr. Hafeez Sheikh and Dr Reza Baqir, responded by defending their wrong policies by statements which essentially were attempts to hoodwink the people and their own government. In view of receiving no serious attempt by the government to rectify the wrong direction of policies, the petitioner feels compelled to seek the indulgence of this honorable court.

The petitioner has prayed that the Hounorable Court may kindly be pleased to order the federal government to lower the policy interest rate to 6-7% 11 , which will reduce the allocation of public funds for interest payments by about Rs.1,000 billion 12 , and to utilize the resultant fiscal space to primarily lower the budget deficit.

The reduction in deficit will have a number of positive effects: it will contribute to the reduction of the external current account deficit and contain the depletion of foreign exchange reserves, and the lower deficit will reduce inflationary pressures, and control the accumulation of debt.

Some of the fiscal space created by lower interest payments should be used to eliminate custom duties on machinery, raw materials and inputs to stimulate the economy, increase exports and create employment and raise incomes.

Order instructing the State Bank of Pakistan to immediately introduce appropriate capital controls to ensure the orderly withdrawal of hot money from Pakistan, to avoid the risk of instability in the foreign exchange market due to the flight of hot money following the acceptance of this petition by this Honourable court.

Dr. Zubair submitted the court that the petitioner is a PhD from John Hopkins University (1978) and has nearly 40 years of experience in macroeconomic and trade policy-making. Since returning from the IMF in 1992 where he worked on major economies over 12 years, the petitioner has had extensive economic policy-making experience both as an international consultant to the multilateral IFIs and bilateral donors, and serving the federal government first as a federal minister of commerce (1996 - 1997) and then on federal policy making bodies like the National Finance Commission (2001 - 2008), responsible for fiscal devolution between the federation and provinces, and the Securities Exchange Commission of Pakistan.

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