Professor Baqer delivered an Econ 101 lecture to journalists is his maiden moot where he explained the role of exchange rate, interest rates and updated on the IMF programme. The explanation was bookish, true for a developed market. He was clear in thoughts and gave a direction, which a few think, is a path to fiscal debt trap.
The clarity is on the definition of market based exchange rate - demand supply to determine rate whilst SBP measured intervention to curb excessive volatility. It is neither fixed exchange rate nor free float; and the movement would be on both sides. That is a good strategy, and given high gaps, further adjustment in rupee cannot be ruled out. And to curb inflationary pressures due to currency adjustment, interest rates would go up, as he said that the chief mandate of MPC is to curb inflation.
A few economists strongly disagree on Governor's position on interest rates determination where the singular focus is to curb (core) inflation. He needs to explain how steep hike in interest rates can curb cost push inflation. How in an economy where only 4 percent of banking credit is consumer finance, excessive higher rates can curb demand? How in an economy where majority of private credit is for working capital, too much tightening is fruitful?
How would businesses afford to invest in expansion and Greenfield projects for import substitution and exporting sectors given rising imported cost of fixed capital due to currency adjustment and too high financing cost due to spike in rates? He needs to explain how 11-13 percent average inflation is forecasted in FY20. The worry is on the fiscal side where only primary deficit is the target while the high rates will balloon debt servicing.
Beyond econ 101, strategy is hidden in his response on current account targeting. What he meant that any level of current account is sustainable as long as it is financed by portfolio and direct investment. A deficit to be financed by inflows, and surplus to net off outflows.
Between the lines, the bet is to increase interest rates to a level where undervalued currency would become attractive. The strategy is to lure domestically held foreign currency and high local currency in circulation to come back in system by investing in mouthwatering fixed income instruments. The idea is to attract foreign portfolio investment, both from expat and foreign funds to invest in T-Bills and PIBs, and stocks - never really happened at required scale.
The gross financing need is to the tune of $50 billion, including current account and short term debt repayments, in the next 3 years and the IMF is giving a mere $6 billion. The game is to finance it by market based flows. That could be a great plan in a developed market, but it could be dicey in Pakistan.
Some reasons for money not flowing in, or laundered out, are beyond macroeconomics. Yesterday, NAB arrested CEO and CFO of a listed company. Mian Mansha and Shehzad Saleem are aspiring businessmen in Punjab, and people follow them, and people may think twice before taking the money out in open. The fear of FATF and geopolitical factors in Pakistan may hinder investment flows, or too much risk premium would be required. And for that, the fiscal cost could be exuberant.
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