The twin policies of rupee devaluation and raising discount rate to curb inflation have cost Pakistan PKR 6,353 billion in about three years, according to Dr Ashfaque H. Khan. This works out to approximately USD 40 billion for a USD 6 billion IMF Program.
“The nation has paid a heavy price of these misconstrued policies”, says the current Principal and Dean of the School of Social Sciences & Humanities (S3H), NUST, Islamabad. “People who landed by helicopter had little or no idea about the statistics of Pakistan. They have never studied Pakistan’s economy.”
“They brought the knowledge of Western economies and policies and brutally implemented the same in a developing country like Pakistan. Such policies have severely damaged the economy, dented the popularity of the Prime Minister and put the government on the back foot, trying to hide behind inheritance.”
In a powerful op-ed piece published by the SOUTHASIA magazine, the veteran economist cites hard data to demolish two key precepts of the policy prescribed by International Monetary Fund (IMF) for Pakistan: market-based exchange rate (read rupee devaluation) and a tight monetary policy (read policy rate hikes to curb inflation).
Khan says the IMF policy prescriptions call for tightening of monetary policy, that is, raising the discount rate as fast as possible. “Since the discount rate serves as a bench- mark for all the lending rates, private sector investment declines, which, in turn, reduces import demand,” said Dr Khan.
“Since developing countries’ economic activity depends principally on imported raw materials, imported capital goods, imported machinery and equipment and imported energy, any decline in imports slows down the economic activity. In other words, demand destruction is achieved by chocking the economic activities of the country.”
Another intervention the IMF advocates to reduce current account imbalance is currency devaluation. “Devaluation increases the landed cost of all the imported items, including inputs for the production process. Higher cost of imported items not only discourages its consumption but also increases the cost of production.”
“Hence, lower import slows economic growth. Since devaluation is also inflationary by definition, the Central Bank justifies tightening of monetary policy (i.e., raising discount rate) to contain inflationary pressures.”
He pointedly notes the paradox of creating inflation through devaluation and then trying to control inflation by raising discount rate. “Higher interest rate, on the other hand, increases cost of borrowing of the government to finance fiscal deficit and therefore, increases interest payment.”
“In the absence of commensurate rise in revenue, the overall fiscal deficit increases. Hence, an irrelevant tax target is given under the IMF program to achieve targeted fiscal deficit.
“The government is also being asked to raise utility prices, supposedly to improve the financial health of the utility companies, but actually it also increases the cost of production.”
The Program thus increases the cost of production, making the industry non-competitive in the international market as well as raising public debt. “A higher interest rate increases cost of capital; devaluation increases cost of imported inputs; higher utility prices (gas, electricity) and irrelevant revenue targets further burden the industry with tax incidence.
“Devaluation accompanied by higher interest rate drowns the country into debt.”
Khan shows that the SBP assumption that there is an inverse relationship between discount rate and inflation is patently wrong as there is a strong positive relationship between the two.
“[Whenever] discount rate is raised, CPI-based inflation rises accordingly… When [interest] is raised, the cost of borrowing goes up and, accordingly, it is passed on to the consumers.” “Recent empirical evidence in the case of Pakistan suggests that a one percent increase in discount (policy) rate causes CPI-based inflation to rise by 1.3 percent. In other words, there is a strong positive relationship in Pakistan between the discount (policy) rate and CPI-based inflation.”
“The Governor of SBP had stated several times during the release of monetary policy statements that inflation in Pakistan is a supply side phenomenon followed by the rise of government administered prices (prices of gas, electricity, etc.) and yet he continued to use the demand side instrument (discount rate) to contain inflation.”
“He failed to see the composition of the CPI-basket where almost 35 percent contribution comes from food items followed by the prices of gas, electricity, fuel, water and house rent (24%).” “Thus, almost three-fourths of the CPI basket is not affected by discount rate at all and yet our Central Bank continues to use this instrument to control inflation.”
“This misconstrued policy alone added Rs. 1687 billion to interest payment from July 2018 till March 2020. It has simply eroded fiscal space and contributed immensely in widening fiscal deficit and raising public debt.”
“The high interest rate policy on the other hand attracted ‘Hot Money’, or in the short term ‘Treasury Bills’, which benefited foreigners immensely by damaging the local economy. The high interest policy attracted ‘Hot Money’ by putting the domestic economy in cold storage.” “High interest rate policy certainly did not reduce inflation but it contributed to a rise in interest payment, deterioration in fiscal balance, addition to public debt, reducing investment, slowing economic growth, raising unemployment and poverty, reducting tax collection and so on. Who is responsible for this damage to the economy?”
Moving on to the policy of market-based exchange rate, Khan says, “We have been told by the SBP and its Governor that devaluation would improve the competitive- ness of our industry abroad and hence would help increase exports.”
He again uses empirical data show that our exports have remained invariant to the adjustment of the exchange rate. “Based on over 100 months of exports and exchange rate numbers, it is clear that our exports have moved in a narrow monthly range of $1.7 billion to $2.3 billion, irrespective of exchange rate, whether it is Rs. 60 per dollar or Rs. 160 per dollar.”
“I have been arguing time and again that by adjusting its exchange rate, Pakistan cannot increase its exports. Devaluation raises input cost of export-oriented industries and makes them non-competitive.”
“According to Dr. Ishrat Hussain, close to 60 percent of the inputs to export-oriented industries are imported, hence devaluation raises their costs and makes them non-competitive.”
“While devaluation failed to increase exports, it certainly added Rs. 4666 billion to public debt without borrowing a single dollar during July 2018 to March 2020…”
“Devaluation simply caused public debt to rise without increasing a single dollar in exports… Who has paid the price of this misconstrued policy? Naturally, this government and the people of Pakistan.”
Says Dr Khan, “One of the helicopter persons has left the government and the remaining one should have the moral courage to leave, particularly after the statement of the current Finance Minister when he said (of course, before taking charge of the ministry) that the two and a half years of economic policies have grossly damaged the economy of Pakistan.”
In conclusion, he reiterates that the neo-liberal economic order as implemented vigorously by the IMF has never worked in the past and will not work in the future. “A home-grown reform agenda and policies are the solution to address the balance of payments crisis…”
