BR Research: Among other factors, over-valued local currency is encouraging imports. Government is using duty and tariff barriers to taper this flow. What is your view on this approach? Dr Ishrat Husain: Protectionism does not benefit consumers and it is not in the interest of the country. Firms should be allowed to compete on a level playing field.
If there is any dumping of goods into Pakistan; the recourse available for that is the National Tariff Commission. Affected party has to go to the Commission and prove that there is material injury to the industry. However no position can be taken just because one lobby makes unsubstantiated allegations to protect their interests.
Import substitution hits the poor the most. Let me give you a personal anecdote. When I was an economist for Ghana; a young flight lieutenant came to power through a military coup. The first thing he did was to ban all the second hand clothing so that the local textile mills could become profitable. The next day he went to the Ashanti region of the country where one million cocoa farmers were highly agitated because they had been deprived of the clothing that was one-tenth of the cost charged by local textiles.
They argued that the government should support the one million small farmers who are collectively a major foreign exchange earner for that economy, instead of supporting three multi-millionaires and a few hundred of their employees. The government reversed its ban on import of second hand clothing, soon after.
There are no lobbies for consumers in this country. In economic terms, you have to maximise consumer welfare because they constitute the majority. You don't have to maximize either the government's welfare beyond the normal taxation or producers' welfare beyond their normal return on capital. Protecting inefficient, non-competitive industry is a disservice to the country as it will retard economic growth.
BRR: Many other countries use tariffs and NTBs to protect domestic industry. In your opinion, how should the domestic businesses be supported?
IH: The infant industry argument, that there are some new industries that require some support for a certain amount of time during which they can mature, remains valid. So for instance, you can give them a five-year tax holiday or impose regulatory duty on comparable imports. But you have to tell them that over next five years, all these concessions will be removed gradually. Either they should be ready to compete or ready to pack up.
Government Support has to be targeted. During my tenure at the SBP, we provided long-term financing for exports as textile industry wanted to import new machinery to compete in the post MFA period (i.e. after the removal of quotas). As a result, machinery worth $5 billion was imported into the country and Pakistan's textile industry was able to increase its exports.
BRR: Should government intervene in the value of the Pakistani Rupee against other currencies?
IH: It should be a managed float. We must stay competitive, vis-à-vis our partners who should be able to find our exports cheaper than others. We have to position ourselves vis-à-vis our competitors in third country markets. We have to look at the impact on our external debt stock, outflows of debt servicing and remittances. We have to evaluate the attractiveness of foreign investors towards Pakistan. The empirical evidence about devaluation and surge in exports in case of Pakistan is weak and ambiguous. In global value chains, imported components and parts form a significant element of the final price. However, if exporters' costs of inputs are reduced, ease of doing business without hassles are ensured and reliable supplies of energy are restored, the net benefits to the economy would surpass those from straight devaluation.
BRR: Banking sector is still shy to lend to the private sector. What will it take to spur private sector lending?
IH: Banks are profit maximising institutions. They are not here for social service. If the banks lend to the sovereign, they don't have to earmark any capital for that. So as far as the capital adequacy ratio is concerned, they are better off lending to the government. The market is assured because the government has a huge appetite for borrowing and they give you a very good return. The quality of the asset is superior as there is no danger of non-performing loans. This is just rational thinking on the part of the banks that is driving their business decisions these days.
The government has to reduce borrowing from the banking system and approach non-banking sector i.e. individuals, pensions, widows and trusts.
The other reason for banks' ascendency is that our capital markets are shallow. Only 250,000 people take part in it. These markets have to be developed to give a run to the banks in the financing space.
BRR: Business confidence surveys report improved sentiments regarding the domestic economy. Pakistan has received some notably positive mentions from international media, in recent times. Why have the investments into the country not taken off yet?
IH: It takes time. There is always a lag. The turnaround in Karachi's situation is very recent. Now the people need to believe that this new found stability is not aberrant; it is here to stay. Then investments will follow. If I know that a compromise is being made and things will return to square one; I would not invest here.
If you lay down seeds to feed some pigeons; they come down one by one. After a while, many of them gather to feed themselves. But when one is scared away; the whole flock flies off together. Then they only return gradually. That is how investments are. Having said that, the domestic investors must be first to invest that convinces international investors to also enter the economy.
In the five years between 2008 and 2013, there was nobody minding the store seriously as far as the economy was concerned. There were five finance ministers and five governors of the central bank, who came and went. At least now you have a strong Finance Minister who is calling the shots. Yes, he has his critics and you could differ with his policies but there is somebody to whom the problems can be pitched. The Governor of the State Bank of Pakistan has been in place since last year. This continuity of economic managers in itself lends some semblance of stability to the macroeconomic environment.
The country has done well recently in terms of economic stabilisation. The global economy has helped us. As oil prices have gone down, our imports have eased. But remittances have not suffered. The flip side of declining oil prices is that expatriate workers become unemployed and remittances fall. We are in the best of both worlds right now. We have $4 billion in savings annually, thanks to lower oil prices and our remittances are still on the rise. This is a very unusual situation.
What we have to do is take advantage of this situation to bring about structural reforms in four areas. Get the energy sector in shape. The DISCOs are not able to plug in the leakages. Unaccounted for gas losses have surged from 3-4 percent to about 12 percent. Utility bills are not being recovered.
Second is the taxation. Let us get out of all the games; rate adjustments, withholding tax, presumptive taxes. We know that there are 3.5 million people who should be paying taxes. We only have about a million taxpayers of whom 750,000 pay not out of choice, but because they are employed with the organised sector. Bring in another million into the tax net and these games can end. There is very high incidence of collusion between taxpayers and tax collectors. This corruption needs to be quelled. Tax officials are reluctant to proceed for training courses as they fear they would lose their lucrative posts.
Third, don't privatise public enterprises that are already doing well, improve their governance structure and processes. But get rid of those who are chronically a drain on the exchequer.
Fourth, is the administrative reform. Underpinning most of our difficulties and problems is the weak implementation capacity. We have to reform our Civil Service structure and make it compatible with the requirements of a modern functioning sovereign state.
The reviews by the International Monetary Fund (IMF) in next year should focus more on government's ability to implement these structural reforms.
BRR: How do you view the progress on devolution thus far?
IH: I am an ardent believer of devolving authority, powers and funds to the local governments. The provincial governments can devise policy framework, hold the local governments accountable for results and take action against corrupt elements. The federal government should run the economic, foreign, and defence policies, communications, the national human development strategies, national infrastructure and inter-provincial coordination, harmonisation and standard setting.
Unfortunately, the provincial governments in both Punjab and Sindh under the new laws have hijacked the powers of the local government. The prevalent model in place in Khyber Pakhtunkhwa is very much an improvement over the 2001 local government ordinance. In our report to the National Commission on Government Reforms, we had stated that police, revenues and land records along with disaster management should not be given to the Nazim. These functions should be in the hands of a neutral public servant. But agriculture, education, health, water, sewerage and sanitation, public health engineering, public transportation, rural infrastructure; all these departments should be devolved to the District Governments. KPK has done it and my argument is that Punjab and Sindh should follow the KPK example and hold elections on basis of the amended law.
Look at the piles of garbage infesting the whole of Karachi. These did not exist when the City District Government was active.
BRR: You have set the wheels in motion for the establishment of a company to assist small and medium enterprises gain access to funds, markets and expertise. Please share the vision for this endeavour.
IH: We are in early stages. The objective is to bring in private equity and credit lines to the small and medium enterprises (SMEs). This is a part of the financial inclusion strategy. When I was at the State Bank of Pakistan, we introduced mortgage financing, micro financing, agriculture credit for small farmers and also, SME financing. Out of the total private sector credit, almost 25 percent of the money lent by banks was going into these areas which serve the lower middle and lower income groups of the country. Traditionally, Pakistan's banking sector has been catering either to the big names or to the large corporate sector, the multinationals, and the government and public sector organisations. The majority of the small-scale businesses, small and medium-sized farmers, consumers trying to buy their own homes, or motorcycles and cars or start-ups; have not been provided credit to the extent they need.
If you look at the record, most of the non-performing loans in the past were attributable to the big names who were politically influential and who got the loans from the nationalised commercial banks at the behest of the leadership. In micro finance which is tailor made for poor communities and individuals, the repayment rate is 99 percent.
Why is this happening? It requires a lot of effort and cost on the part of a commercial bank to give thousands of loans of Rs 10,000 each. It is easier for them to give a loan for Rs 1 billion. That is why we have seen that in the last ten years, credit to SMEs, agriculture for small farmers, low-cost housing and micro finance has gone down substantially.
So we decided to bring in a dedicated private equity fund in which we will use the existing financial institutions and give them a line of credit which they shall leverage with their own money. We will teach them how to reach out to the small and medium businesses and farmers.
You cannot use the same credit appraisal methods for the SMEs as you would for the corporate sector. Here, you should go for program lending; cash flow lending because they don't have collateral. We are trying to revive inclusive financing so that a larger segment of the population in this country can benefit from the banking system.
BRR: Is there a timeline for it?
IH: We have recently signed an agreement with Meezan Bank which will work with the corporate sector and provide term financing to their vendors and distributors. We will evaluate the progress of this project. This is a very slow, deliberative process, we don't want to do things which have instantaneous success but fade away subsequently. We want a sustainable model that has been tested, tried and can be replicated over time. When you do things to get instant results; either for your own ego or to project yourself; then things fall apart.
I am not interested in that. I want something that can be seen, 25 years from now, as a successful model which has reached out to the poor and lower income groups of this country. I don't want to disburse Rs 500 billion in my lifetime; that would be easy. We have a very different approach to this project i.e. reach out the underserved sectors and neglected market segments in a financially viable mode.
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