Monday March 04, 2024

Economy: myths and failures (Part – I)

March 17, 2023

This piece, the first of two parts, is not about the current economic crisis the country faces. Opinions about that are legion and are being expressed everywhere. And as is quite clear, whatever immediate palliatives are sought for today’s crisis will only lead to another and then another and still another.

The prime task of our national leadership is to recognize the realities that have sucked the country into this recurrent spiral and take the long path of extricating ourselves from it. The challenges facing any Pakistani leadership are enormous. We have many under-tapped opportunities and resources but any leadership taking on the necessary restructuring of the economic engine has a formidable task.

This is a country with chronic trade and fiscal deficits, weighed down by enormous debt, an exploding population to feed and employ, misconceived religious interference, self-seeking short-term attitudes, and a hungry and disenfranchised people. Our various leaderships have to date lacked the confidence, courage, or honesty, to explain the truth or have the patience to cope with the necessary, interim hardships. But the arduous journey to recovery must begin or Pakistan will continue down the abyss of a failing state.

The points I wish to make here may not be comfortable and may even cut against the commonly held wisdom nor am I seeking to commend or indict any particular government. There are certain fundamental flaws in our thinking that I wish to highlight. No doubt many innovative strategies will surface. The aim of highlighting eight erroneous beliefs is the recognition of boundaries which should be used to screen out those initiatives which breach the framework defined by these boundaries.

The first of these flaws I wish to highlight is this current trope: ‘If IMF fails, money won’t come in and Pakistan is doomed’. This is false. The money that ‘comes in’ from the IMF and friendly nations if and when an IMF agreement is reached is not income. These are loans, the servicing of which cannibalizes the nation’s future. It is logically obvious that if our export revenues are not adequate to meet our current imports and existing debt servicing needs, new loans will only cause the country’s future debt to spiral and erode further our consumption space. Until such time as our exports increase, we should cut our coat according to our cloth by curbing imports rather than seeking more loans.

Another long-standing trope has been: ‘Import substitution is the solution as it reduces our need for foreign exchange and creates local employment. This too is false. This is the belief that has driven the structure of our industrialization for the past 70 years. And what do we see? Shoddy product quality that fails to match international standards, on the one hand, and on the other, a growing foreign currency debt mountain. Clearly, this belief has not served us well. After all, most items we produce also have imported content, be it plant and machinery or raw material or royalty payments etc. The mushrooming population and consequent demand for imported substitution products has caused imports of these components to outstrip the foreign exchange saved by not importing the finished product.

Given that competitive advantage means that we cannot will ourselves out of import dependency, the way forward is to ensure that: first, manufacturing units are of a scale that matches international scale and consequent economies of scale. Second, that all manufacture meets international quality standards; and, third, that a significant part of the output is earmarked as a priority for international exports to at least offset the foreign currency needs and only the remaining production should be available for domestic consumption

The third belief that bears questioning is: ‘The government is to blame, as the business community holds, for foreign currency insufficiency for their import substitution needs.’ This too is false. Business owners have traditionally measured their competence in terms of successfully selling their products to domestic consumers and the resulting profits they make. They thus have the local currency capacity to pay for their inputs, whether domestic or imported. They do not see it as their own responsibility to generate the foreign income to fund their own import needs. They simply assume to be available on the market or from the government.

But the government is not an exporter and not a recipient of foreign incomes. Like an indulgent parent, it resorts to borrowing from external sources to supply the importer with foreign currency. The result is the outcome we see: a growing foreign debt burden. It is high time the government came out transparently to state that it cannot afford to remain a provider of last resort of the foreign currency. The business community must recognize its own responsibility to earn or arrange the foreign currency for its own import needs.

Particularly prevalent is this fourth belief: ‘We must seek to indiscriminately attract Foreign Direct Investment (FDI) as this will revitalize the economy and cushion the foreign currency deficit. It is also beneficial to sell loss-making state-owned enterprises to foreign investors’. False. Foreign investors rightfully expect to repatriate their earnings in foreign currency and their rate of return expectation is far higher (above 20 per cent per annum) than interest rates payable to foreign lenders (say, 5.0 per cent per annum). If the underlying project largely serves the domestic market, its earnings will be in Pakistani rupees. The more successful the project, the greater the rupee profit, and the greater the size of profit repatriation in foreign currency. The same is the consequence of privatizing state-owned enterprises to foreign owners.

FDI, unless predominantly channeled into export-oriented businesses, is costly and destructive. Only a very small share of equity should be permitted to foreigners in the case of SOEs and import substitution businesses and that too if the foreign investor brings a unique contribution in terms of technology or access to export markets.

The four points made above relate primarily to transforming Pakistan’s economy, from being import-based, debt-accumulating, and perpetually crisis-ridden, to an export-driven, solvent, and growing economy. There are four further points, relating primarily to government actions, that I will discuss in the second of these two articles.

To be continued…

The writer is a senior international banker exposed to markets in the Middle East, Far East, Africa, and Europe. He was invited to Pakistan in 2020 to restructure, commercialize and successfully privatize UBL.