The level, extent, nature and composition of ‘cash economy’ of the country constitute a subject which is not researched and identified on scientific basis in Pakistan so far. All calculations are only estimates based on extrapolations. In my experience of over 40 years as an accountant as a chairman of the Federal Board of Revenue (FBR) and continued interaction with business and business families I think I have developed an informed perspective on that subject. That too, however, is only an estimate.
‘Cash economy’, however, is not limited only to transactions that are undertaken for transfer of physical cash. There are a substantial number of economic transactions that go through the banking system and remain outside the documented sector. There is, therefore, a need to fully understand the size and nature of ‘cash economy’ in Pakistan where ‘cash economy’ is composed of two elements. One is represented by transactions that are conducted through the banking system. However, the bank accounts through which such transactions are made are not reflected in tax and other records as part of the documented economy. This is obvious from the fact that there are more than 45 million bank accounts in the country whereas only around 15 million or less appear or are directly or indirectly reflected in the documented sector. This means that deposits in around seventy five percent of bank accounts remain outside the documented system. As per a KPMG Taseer Hadi report on banking sector in Pakistan, the size of bank deposits is around PKR 18,500 billion. If these numbers are correct then a very substantial amount of deposits is directly or indirectly used for undocumented economic activities.
The second kind of cash economy is represented by transactions made in cash. The size of this economy can be estimated by the amount of currency in circulation (M2) which was 1,501 billion rupees in 2011 and has now increased to 6,142 billion rupees, as per State Bank of Pakistan website. This phenomenal increase in currency in circulation reflects the frequent use of cash for undertaking transactions. Now a new medium of using US dollars has also entered the field.
As per the KPMG Taseer Hadi report on banking sector, total bank advances as at December 2020 are of around Rs 8,897 billion. On the basis of my experience I can safely say that there is a direct relationship between customers’ advances and deposits as stated above. It is quite common in Pakistan that ‘black’ or ‘grey’ money is kept as deposits (undeclared) whereas the same person borrows from the bank on the security of such deposits to reflect a charge against documented taxed income. These types of transactions are phenomenal and frequent in Pakistan.
On the basis of my experience as Chairman FBR I can safely say that there is substantial, (around 40 to 50 percent in some cases) underreportings of production in some industrial sectors. The common culprits are tobacco, sugar, textiles, motorcycles, tyres, paints, car batteries and other FMCG goods. The whole chain of economic activity from procurement of raw material to final sales remains out of books. Even salaries are paid under the commonly used term ‘Lifafa’ in cash.
All these statistics and information have been cited to emphasise that Pakistan’s economy and decisions relating to it are to be taken after taking into account these hard, undesirable facts on ground.
The classical theory of monetary policy states as under:
Because money is used in virtually all economic transactions, it has a powerful effect on economic activity. An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending. Business firms respond to increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labour and raises the demand for capital goods. In a buoyant economy, stock market prices rise and firms issue equity and debt. If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits. As the public begins to expect inflation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans.
Opposite effects occur when the supply of money falls or when its rate of growth declines. Economic activity declines. Moreover, either disinflation (reduced inflation) or deflation (falling prices) results.
That increase in money supply leads to inflation is a valid theory. However, the fundamental point with reference to Pakistan’s case is whether or not the increase or decrease in the interest rates by the State Bank of Pakistan has the same effect on inflation as is prescribed in the textbooks. I am confident that due to aberrations that we have created in our system, there is no such linear relationship. For example, it is an established fact that the increase or decrease in the interest rate has no relation with food inflation in Pakistan especially for the commodities which are produced in Pakistan. The producers, distributors, hoarders, the retailers are all using funds outside the (bank) credit system for their activities. Increase in the interest rates does not reduce their buying power; it, in fact, provides them an unnecessary excuse to increase prices. This is a double jeopardy. I am of the firm opinion that if anyone considers that food inflation in Pakistan has some relationship with interest rates then that person should undertake a case study of procurement of any commodity in Pakistan from growers to customers. There is a need to understand the economics of Akbari Mandi of Lahore and Jodia Bazaar of Karachi to gauge the impact of discount rates. On the basis of my direct access to Jodia Bazaar, I can assure you that most of the people in this trade do not even understand the meaning of discount rate. A lot of them, being religious conservatives, reject bank lendings.
In this respect I would like to narrate a personal incident about people educated and trained in western universities whilst dealing with the ground realities of Pakistan’s economy. I was the Board Member of a university which sought to hire highly qualified persons in the field of economics. In that process we hired around 10 highly qualified people (PhDs) from the West and paid them salaries commensurate with the wages in the US. One of them produced a study on a commodity trade in Pakistan. He presented the draft to me. I asked him whether he had studied the manner in which that commodity is traded in wholesale markets in Pakistan, such Jodia Bazaar and Akbari Mandi. He replied that he does not know anything about Jodia Bazaar. His knowledge was limited to information available in books and that too on the social media. I asked him to study the Jodia Bazaar. Which he did obligingly. Subsequently, he decided not to publish the study. This is more than sufficient to understand and appreciate the chasm in theoretical knowledge and market practices in Pakistan.
The recent increase in the discount rate is totally unjustified if it has been made on the basis that there is abnormal inflation in food and essential commodities. It is therefore earnestly suggested that a downward revision be made. Many people, especially some economists, will totally disagree with what has been said; however, in the interest of the country it is essential that decisions are made on the basis of facts on the ground after a comprehensive study of the market mechanism. The excuse of IMF (International Monetary Fund) pressure for such decisions is also not justifiable as people within the IMF are competent enough to understand the ground realities. They are our well-wishers, not enemies.
The other excuse for increase in the interest rate is providing an effective saving rate to persons deriving income from national savings. This argument has weight, however, the question is to settle the ‘balance’ between an expected economic growth with low interest rate and the return under the national savings schemes. Pakistan at this stage with continuously increasing unemployment and social unrest cannot place the industries on a reverse cycle. The only people who are really affected by the increase in the interest rates are organised industries, mainly those in the large-scale sector. These industries have made plans for expansion with a stable rate below double digit. The increase in policy rate in recent weeks has totally destroyed their projections. This is neither fair nor it is in the interest of Pakistan.
There can be more discussion and debate on the subject, however, the first message is that the recent increase in the interest rate is unjustified and if there is another increase in the interest rate then there will be questions on the objectives of actions undertaken by a few against the interest of masses.
Copyright Business Recorder, 2021