Just as 'hot money' is attracted by interest rate parity differentials across borders, so does the 'domestic' hot money keeps circulating among few sectors/activities within an economy, in search of higher, quicker and dirty expected rates of returns in the immediate to short run above the prevailing real/nominal rates of interest. Interestingly, the definition of casino economy is still evolving but its driver is profit. As per Collins Dictionary, casino economy is "an economic environment which encourages large risks, especially to public funds in the quest for large profits". Many readers may still find the above definition puny and incomplete. For the stakeholders in casino economy, large risks justify large returns, so ethically there is nothing wrong with it. At the outset it is appropriate to flag that casino economy should not be equated with informal/underground economy. Although there may be some overlap, the financial flows under domestic hot money (the sole metric of casino economy) are 'expectations' oriented then the latter which is mainly production, consumption and services oriented. Moreover casino economy exists in varying degrees in all economies and under all political setups. Regarding the source of domestic hot money, it is common knowledge that documented/un-documented profits fuel the casino economy. Since casino economy is an 'economic environment' one needs answers to many questions to fully delineate it. Few important ones are: What constitutes 'casino' economy? What is the likely size of casino economy as measured by the 'domestic' hot money in relation to national GDP? Does it drive/or jump-start the real economy or is it vice a versa? An attempt will be made to answer some of these questions with reference to Pakistan.
In case of Pakistan, one fundamental question is the quantification of 'large' risks and profits. Is lower bound of profits measured relative to the policy rate environment or is it a weighted composite of policy rate and expected risk premium? Most likely it is the latter benchmark. As witnessed in the last few months, as soon as policy rate was fixed below 10 percent, 'quasi' casino economy picked up. Thus it is safe to state that the lower bound of 'large' profits in casino economy in Pakistan is higher than 10 percent plus the casual empirically observed risk premium. One conjectural rule of thumb is that average of 'large' profits in Pakistan's quasi casino economy lies between 15-30 percent in the immediate to short run. This rate of return is not comparable with the theoretical concept of 'large' profits in a casino, therefore one can describe it in Pakistan as a 'quasi' casino economy rather than a casino economy.
One can include the following as major components of the 'quasi' casino economy in Pakistan: Just as there is poker, roulette and slot machines in a casino, there are similar activities in an economy, including in Pakistan such as domestic hot money flowing in the stock market (including mutual funds/derivatives), foreign currencies, prize bonds, Ponzi schemes, gold/jewelry, real estate, automobiles, imported durable and consumer goods and in times of demand/supply imbalances, hoarding in cereals. However, unlike the winnings/losses generated in a casino whose forward linkages are few but far stronger than backward linkages, the forward and backward linkages to real economy of some of the above activities in a 'quasi' casino economy may be balanced. Given the varying substitution and retention rates (technically speaking velocity) of domestic hot money among the above activities, lack of high frequency statistical data and role of 'fungible' subsidized credit, measuring the size of casino economy is a challenge in developing countries including Pakistan. However, it is safe to hypothesize that its overall size (as measured by the domestic hot money flows) and inter-activity size and substitution rates is a function of extent of documentation of the economy, regulatory environment including tax regime, formal/informal conduits for 'domestic' hot money flows and where the economy is/or expected to be positioned on its short-run business cycle. Moreover, inter-activity substitution rates that fluctuate even within a span of months are sensitive to economic/political uncertainties, vulnerabilities and expectations. Whether the casino economy is a sustained driver of real economy or vice a versa is dependent on how accurately the 'financial/money' trail of domestic hot money can be captured, but with current state of weak knowledge it remains a conjecture in Pakistan as in other countries. The remaining article will present stylized dynamics supported by anecdotal evidence of inter-activity flow of domestic hot money in Pakistan.
Stock and derivatives market: All over the world, there is casual empiricism that performance of stock markets has only a limited connection with the real economy more so since the dawn of the new millennium. This is also true in Pakistan. Apart from the fact that it is loosely linked with interest rates, 'fungible' private bank credit, insider information and political temperatures, funds flow in/out in line with foreign investors' mood. Once stock market builds in a rationally expected level of corporate profits due to expected policy rate profile, it begins to move sideways as being currently observed. The governments are habitual of mis-interpreting short booms in stock markets as a signal of approaching GDP growth and profit bonanza, although they are nothing more than in/out flows of domestic hot money. In times of depressed stock markets, the government in power remains silent, while opposition keeps shouting needlessly.
Foreign currency: Other activity that has remained a close substitute for stock market in/outflows, is selling/buying of foreign currency, specifically USD. It has remained a favorite driver of the 'quasi' casino economy, since capital account was liberalized in late 80s as it is an active source of in/out cash flows in the immediate to short run and store of value investment in the medium to long run. However, since the hanging of the FATF sword and various regulations to control and document its unofficial movement within the economy along with incentives through banking channels, it has begun to lose its short-term shine. The last fiscal quarter's current account surplus and depressed import demand officially exhibit 'irrational exuberance' of sustainable rise in exports and remittances. Consequently, stakeholders of casino economy, along with exporters and those holding USD under the pillow have queued up to cash USD to cut loses (also due to slide in USD value) or earn below expected profits. Thus we also observe an outflow of hot domestic money at least temporarily from this activity. Where it may be going is discussed in the second part of this article.
(to be continued)
Copyright Business Recorder, 2020