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The portfolio investment in government papers – the hot money, is getting traction. To date this fiscal, $724 million came and with an outflow of $13 million, the net amount is $711 million. The major chunk of net inflows ($708 mn) is in T-Bills. The amount is too small relative to marketable securities of around Rs9 trillion ($58 bn), and total central government debt stock of Rs17.8 trillion ($115 bn) of T-Bills and PIBs.

If we try to compare this foreign portfolio investment in debt with equity market- where on free float basis, foreign investment is around 28-30 percent and 9-10 percent of total market capitalization, the foreign portfolio investment in debt is 1.2 percent of marketable securities (free float) and 0.6 percent of debt stock (market capitalization).

The inflows to date are peanuts, and to reach free float of equity market, the foreign portfolio investment in debt could reach around $16-17 billion, or based on total market cap ratio, the potential is $10-11 billion. The gap is huge, and there is no fear from the perspective of market absorption of such flows – the heat is yet to come.  The foreign portfolio investors are right now just testing the market. If things go right on the IMF and FATF fronts, along with proposed taxation changes, expect the sum to reach around $3-5 billion within 12-18 months. And these estimates are conservative.

Rs bn  Total T-Bills  participation Foreign portfolio investment  % of total
Jul-19                            3,162                                            2 0.08%
Aug-19                            1,887                                          12 0.65%
Sep-19                               897                                          38 4.29%
Oct-19                            1,238                                          18 1.46%
Nov'19 TD                               783                                          42 5.31%
Total                            7,967                                        113 1.41%
Source: SBP

The question is why the market is fearful. The first point is the element of uncertainty – anything which is unprecedented is taken with a pinch of salt by conventional thinkers. Fears will subside with more flows– there is always a first time, and progression is not possible without risk.

The second point is that interest rates are kept artificially high to attract this money, and once rates are down, the money will evaporate. That premise might not be true as with falling market rates in T-Bills in November, the flows have only increased. The critics may argue that the carry trade is still attractive as Fed has cut its rate lately. Well, if that is the case, the flows might stop in a few months, as the interest rates will come down further in Pakistan, while in the US the signal of no easing going forward. The carry trade spread is going to shrink, and that may stop more flows.

Another fear is stemming in anticipation of higher inflows- what if things go south for Pakistan, and sudden outflows create a crisis. Before delving into the explanation – if this risk is valid, then the argument of keeping high rates to attract hot money is uncalled for.

Someone said what plans do we have in case of a Black Swan event. One of the mistake mentioned by Naseem Talib, is predicting it - you cannot predict it. Anyhow, balance of payment crisis is not a Black Swan for Pakistan, as it has a pattern.

Fast forward in 2024, if history is any guide, we will have a balance of payment crisis by then. Assuming that around $7-10 billion hot money would be parked by then. And one day, there is a bank run – like it happened in East Asian economies in 90s and more recently in Turkey, Brazil and Malaysia or at a lesser degree in India. With flexible exchange rate market, the currency can nosedive and could create a crisis which is unprecedented in Pakistan.

Even the thought of it is scary. But it is encouraging to compare Pakistan with economies like East Asia, Turkey or Brazil. There are risks an economy has to take to move up the ladder – just like an entrepreneur has to take risk to grow.  Of course, it goes without saying, that without doing much needed structural reforms in next 2-3 years, thinking big would just be day dreaming.