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August 15, 2019

Flawed economic policies curse for masses


August 15, 2019

LAHORE: Pakistan is trapped in a situation where any move by the central bank to restore balance is wrought with numerous risks. Economy does not have strength to bear bust and boom in interest rates, while the financial markets are hostage to central bank policies.

In the last two decades, we saw alternative phases of low and high interest rates. During 2003/08 period, the interest rates were very low. In fact, the bank mark-up reached low for the first time in decades, encouraging the business to go for rapid expansion from low-cost loans.

The following period of 2008/13 saw an abrupt increase in interest rates that made it extremely difficult for the entrepreneurs to serve their loans taken at a time when interest rates were very low. That resulted in numerous bank defaults and shattered the confidence of the businesses.

From 2013 to 2017, we saw lowering of bank mark-up even to lower levels than 2008/13, but this time around, the investment remained elusive, as investors learnt their lesson.

Moreover, the federal government was the main borrower of bank loans crowding out private sector credit. In the last two years, the interest rates started climbing up again more so in the last one year.

Investment at the current interest rate is extremely risky for the manufacturing sector. Grasping the consequences of interplay between monetary inflation and deflation is crucial for prudent investors.

It has now been established that the long-term consequences of low interest rates are disastrous. These rates result in creating real estate and stock market bubbles. We have seen stock market reaching new heights during the low interest regimes of Shaukat Aziz and Nawaz Sharif eras.

The real estate prices also shot up more during these periods. The stocks plunged miserably during PPP’s 2008 regime and during the PTI’s one-year rule high interest rates took their toll. The bankruptcies or the ratio of nonperforming loans also increased during these periods.

The planners are well aware that normalising interest rates from very low regime risk a credit collapse. This happened during PPP regime and we are experiencing similar situation now. Credit is available, but there are a few takers.

Agriculture has proved to be a saving grace for the commercial banks where credit uptake reached Rs1.2 trillion. Our private sector loan shark system helped the banks as even at high current mark-up the rate at which they provide loan to farmers is much lower than the markup charged by loan sharks.

Last two regimes, one led by Nawaz Sharif and the present headed by Imran Khan, boast of massive spending cuts. But these cuts are more illusionary than real reduction in spending.

True reforms have not yet been introduced. Prudent reforms make it impossible to increase the expenditure after approval of the budget. In the past several years, we have seen every government presenting supplementary budgets to cover over expenditure of the fiscal year. Massive increase in tax rates by this government has proved counterproductive, resulting in economic plunge.

Bringing tax evaders in the tax net is a good approach, but penalising tax compliant sectors with more taxes is irrational. After increase in tax rates the government needs more growth to service this debt and risk price inflation.

Successive governments have merely postponed or looked the other way on the problems afflicting the economy. Look at how all governments in the last three decades ignored the massive hemorrhage of public sector companies. None was ever reformed and losses in all of them continue to increase with the passage of time.

What turned out to be unprofitable hasn’t been liquidated, but has been kept on artificial life support. These public sector entities are the main cause of current monetary deflation.

It, as expected, has triggered a chain reaction with highly adverse domino effects; that lead to downgrades, and to rising financial costs and ultimate defaults, as well as falling asset prices.

The accompanying inflation as a result of flawed policies is a curse for the masses. It is an implicit tax on the poor, but it is also a blessing for a few providing them a golden chance to get rich by speculation and windfall instead of hard work.

It conceals and encourages waste and inefficiency in production. It goes without saying that inflation finally tends to demoralise the entire community.

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