There is a global economic crisis at play here. More than a decade of cheap money is coming to an end, and global economies are now playing catch-up. The punch bowl is now being taken away, and chaos is ensuing.
The Great Britain Pound (GBP) hit its lowest point against the US$ only last week following a disastrous mini budget. Only a few weeks back, the EUR also hit its lowest point against the US$ as it comes to terms with an era in which there is no cheap Russian energy available. The US FED, which is responsible for maintaining oversight of monetary policy, has adopted a hawkish stance and has started increasing interest rates.
As interest rates in US$ start to increase, there has been a flight to quality of capital, whether it be from more stable currencies like GBP and EUR, or from other emerging market currencies. The US$ has gained more than 16 per cent in value against major currencies during the last nine months, and as the US FED grapples to fight inflation, this may not be the end of it all.
An increase in interest rates has an adverse effect on consumption, as households have less of an incentive to consume, or are forced to make increasing payments on higher household debt, which further squeezes disposable income. To avoid erosion of the value of currencies, monetary policies around the world are adopting a more conservative and hawkish stance to rein in inflation. It is pertinent to note here that inflation in Germany hit double digits the first time after the Second World War, and as inflation hits double digits, it takes years to bring it back down, as the second round effects of inflation start kicking in.
If a contractionary monetary policy wasn't enough, a complete breakdown of the global energy chain following the Russian invasion of Ukraine has also led to spiraling cost-push inflation. Households in Europe have seen their energy bills increase by more than five times; these are being partially funded by subsidies being given by respective governments, which are being funded by more debt. On the industrial side, production of key inputs such as fertilizer has ceased, which can potentially lead to a food shortage globally that can also trigger spiraling food inflation.
As US$ based interest rates increase, so do interest payments on external debt denominated in US$ of emerging markets. An increase in interest rates will further increase the cost of servicing debt for emerging and frontier economies that are already grappling with weak currencies, and high energy, and commodity prices. This may lead to a scenario where an increasing number of emerging economies are not able to service their debt, and opt for restructuring of their debt, effectively invoking a default. A blanket rescheduling of multilateral and bilateral debt may also be on the cards if such emerging economies are given any chance to survive and avoid a complete breakdown of society due to civil unrest.
In the local context, all of the factors discussed above affect our economic sustainability. The great floods of 2022 have had a massive human and financial cost, from which it will take a few years before we fully recover. There is a possibility that multilateral and bilateral debt can be reprofiled to give the country more fiscal space in view of a climate disaster. Such a fiscal space ideally should be used to rehabilitate, reconstruct, and build back better. However, the signals that are being sent out from policy circles is that of assuming an economic stance which spurs growth for a few months, till we have elections, only to completely crash following elections. In such a model, the massive economic cost that will emerge may (or may not be) someone else's problem.
The policymakers at the helm have already been flexing options to keep the PKR-USD parity at a fixed level, even though currencies globally are readjusting. A fixed (or pegged) parity can only work if we have a treasure trove of US$ in foreign reserves that we can burn, or literally throw money at the problem. The word on the street is that we are actively seeking more bilateral debt, not to fix any structural issues, but to enable maintenance of the PKR-USD parity. A parity which keeps the PKR overvalued against a basket of its key trade partners would essentially encourage imports-driven consumption growth, in a macroeconomic environment where the rest of the world is reining in consumption.
The global economy is on the cusp of a recession, which would have an adverse impact on our ability to export, as key markets cut down on consumption. In such a scenario, there would be additional pressure on the PKR as export receipts dry up. In the presence of high-risk premium associated with the country, largely due to a dysfunctional legal system, and an ever-volatile political environment, attracting any sizable foreign direct investment will remain a distant dream.
The world is going through a structural change. The time of cheap capital is over. It's time that our policymakers wake up and smell the coffee and adjust strategies accordingly. An inability to do this will further push the country into a debt, and a liquidity trap, inadvertently pushing millions down the poverty line. But for a brief moment in time, we would have maintained a favoured price against the PKR, as many policymakers and their cronies wish.
The writer is an independent macroeconomist.