In the blind pursuit of hot money, Pakistan’s economic managers are foolhardily focused on generate dollar inflows by from abroad by selling short-term Treasury Bills (T-bills) and Pakistan Investment Bonds (PIBs) at higher rates.
Exactly, the incumbent regime is following “Egyptian model” for building up foreign currency reserves despite knowing that Cairo was facing catch-22 situation at the moment for doing the same under the guidelines of the International Monetary Fund (IMF) programme. When Egypt had entered the programme by end of 2016, its foreign currency reserves were in the range of $15 billion and under a three-year program of $12 billion they rose to $45 billion. The foreign currency reserves of northeastern African nation increased $30 billion out of which $20 billion were raised through hot money.
Now Egypt is on the horns of a dilemma because its policy makers are facing a difficult situation to keep this hot money worth $20 billion in the system. Recently, Egypt’s central bank decreased policy rate by 100 basis points that resulted in the exclusion of $1 billion. If their policy rate further reduces then it is feared the accumulated hot money will find any other destination, where the lenders could maximise their profits through short-term investments. Egypt was pursuing this flawed policy when Dr Reza Baqir was working there as IMF’s resident chief before deciding to quit that position to join as Governor State Bank of Pakistan (SBP).
Pakistan is now following the same policy and in the first few months the country has attracted over $1.5 billion as investment in short-term its debt market.
Pakistan’s debt market has, so far, fetched around $1.5 billion and $10 million from abroad through the short-term T-bills and PIBs respectively at markup rates that are on the higher side.
This foreign funding landed in short-term T-bills at a time when the policy rates are persisting at 13.25 percent for a while. It is feared that when policy rates will be slashed down, this money will fly out of Pakistan in search of more favourable destination in any other part of the world. So we will be witnessing quite a peculiar situation when this hot money dries out in case policy rates go down.
This will incentivise the central bank to keep the policy rates on higher side. It can lead to the creation of a ‘conflict of interest’ for the policymakers, who might prefer to keep the monetary stance tighter in order to keep foreign investments within the system.
The independent economists’ hue and cry that this blind pursuit for luring hot money at higher rates will harm domestic investment and economic activities is only falling on the deaf ears of the policy-smiths.
Pakistan’s former economic advisor and renowned economist Dr Ashfaque Hassan Khan said, “There is no rationale behind attracting this kind of hot money”. “There can be a substitute to this highly unpredictable short-term money. The government can launch international bonds such as Eurobond and sukuk bond for a period of five to ten years with single-digit markup rate.” When apprised that federal cabinet deferred Ministry of Finance-tabled summaries for launching international bonds, mainly because certain ministers opposed the proposal following mortgaging motorways, highways, and airport terminals, Khan said it could only be termed as ‘economic illiteracy’ and nothing else. The economist also said the sukuk was an asset-backed bond and many Islamic countries used this instrument to generate dollar inflows.
There is another element that should also be kept in mind. The government had projected generating $3 billion through international bonds, so if this plan was dropped then the government would have to rely on domestic borrowing for raising around Rs500 billion for financing its budget deficit that would have grown even larger keeping existing higher interest rates in view.
Out of $1.5 billion inflows into short-term debt market, the bulk of foreign money into T-bills has come from the UK and the USA amounting $746 million and $663 million, respectively.
Dr Hafeez A Pasha, another top economist of the country, said there was no justification for drawing in hot money at the expense of discouraging private sector investment. “The higher policy rate was also playing havoc with budgetary estimates and increasing debt servicing requirements,” Pasha added.
Inflationary expectations have been cited as a major cause for keeping the policy rate high. However, the inflation rate clocked in at 12.63 percent but the core inflation has started receding, coming down from 8 percent to 7.5 percent for December 2019.
When core inflation (non food and non energy) stands at 7.5 percent, there is no justification for freezing the overall policy rate at 13.25 percent other than a means for attracting hot money from abroad.
The SBP officials do not agree to certain assumptions and argued that the foreign portfolio was a friction to overall investment so the central bank could not be held responsible for protecting friction part of over $1 billion as the sole reason for maintaining a hawkish monetary regime. Now the question arises that: are there any guarantees this friction will remain lower over the next two and half year period? It is feared that it might cross $10 billion to $15 billion -to meet Net International Reserves (NIR) target- under the IMF programme.
On other hand, the Federal Board of Revenue (FBR) also promulgated Tax Laws (second amendment) Ordinance, 2019. The FBR states that the existing foreign exchange framework of the country allows non-residents to invest in debt securities and government securities through Special Convertible Rupee Accounts (SCRAs) maintained with banks in Pakistan.
There is no restriction on repatriation of funds from SCRAs, which incentivises investment in the debt market by non-resident investors. Several amendments for encouraging investment in the domestic debt market and simplifying the tax regime for non-resident companies have been introduced.
This hot money poses risks for Pakistan’s economy and even Humayun Akhtar Khan, chairman Institute of Policy Reforms, who is also a member of the ruling party, has recently cautioned the policymakers against attracting hot money, thus this policy needs to be reversed.
The writer is a staff member