Pakistan: Pegging to the Dollar: A tailspin to disaster.

 When Mr. Ishaq Dar was brought back to head the finance ministry, political supporters of PMLN were certain the guru was back. Mr. Dar talked down the dollar, and for a couple of days it seemed the mighty dollar quivered and retreated. But then the reality of economic performance surfaced and endemic economic problems need bold, yet sensible, solutions, The Dar response was two fold, shifting attention to the trend in the economy rather than the emphasis on the quarterly numbers and more importantly to silently peg the Pak Rupee to the US dollar at a notional rate of Rs221 to the dollar. 

During his last stint as the finance minister the idea of a managed float of the Rupee was used as a policy. Indeed this would normally help in making the exports from Pakistan competitive. In the previous years, when Mr Dar was the FM, the managed float worked because of dollar inflows from borrowings rather than trade surplus. during the period 2014 to 2018 Pakistan's total debt went from $77 billion to $110 billion largely to prop up the rupee. 

Pegging the domestic currency works when two conditions are met; 1) the country had a large surplus of dollar inflows from investments and/or exports and 2) when exports are substantial and a pegged currency is needed to make them internationally competitive. 

Clearly the exports were always under performing in the period 2014 to now and this is shown by the trade deficit has grown from $2 billion monthly in 2014 to over $5 billion a month now. So one cannot see that benefit the pegged rupee brings to a country where exports have declined to abysmal levels. Countries like China have developed to hold the pegged policy, like 66 other countries linked to the dollar, because they have a balance in their trade and their exports remain stable and robust. These countries use the surplus dollars to buy US treasuries and when their domestic currency needs support the US treasuries are sold and the proceeds used to buy the domestic currency. 

One fails to understand why a pegged rupee policy is still being followed by Mr Dar other than to give a false perception of the economy doing well because the 'rupee' is stable. The lesson of finance is that window dressing only works so far you have the means to keep putting up the decorations and when you run out of dollars the house cards comes crashing down. Therefore it is vital that this managed float policy should be put aside and while there will be a collapse of the rupee it will at least be dictated by the market conditions and eventually will normalise. 

The effort must be a broad tackling of the economy to bring back a direction to economic performance. One would like to see the following happen;

• Measures to increase exports.
• Encourage capital formation for industries in the export sector;
• Broaden the tax base and try and achieve a 3 % of population in 2023 and raise that to 4% of the population paying taxes;
• Manage the current account effectively and debt burden to be reduced.
• Effective measures to solve the circular debt issue that comes from the energy sector.
• Increase the national savings rate, which is miserably low. 

There is no doubt that the economy is walking a tight rope and needs some critical measures to be taken now. It is not time to play politics with the economy and all stakeholders need to understand that clarity is needed. The current economic situation is the cumulative effect of decades of mismanagement and lack of progressive economic policies. 

Brexit and its impact.

In a close vote the Britons have spoken; they want out of the EU, want to take charge of their own country and its destiny and in the process have created a scenario where the possibilities are endless and the outcomes less than certain. The outcome of leaving the European Union while now inevitable has shown that Britain is a very divided country, surprising many who knew it would be a close vote but the outcome was not entirely expected. So what happens next.

Britain has two years to negotiate an exit deal from the EU, and if there is extension granted to this process then leaving without a deal would spell its own set of problems. This is much like a possible lengthy divorce proceeding, trade agreements to be unwound, new agreements to be made with partners like the US and Japan without the EU umbrella and the key aspects of preparing the financial disengagement costs between Britain and the rest of the EU. Most likely two years is not enough to hammer out the divorce agreement after a 43 year marriage and some EU members might well simply say that you elected to leave the marriage then do so without a favourable exit deal or an extension.

The effect of Brexit is wide ranging, one the one hand there is a strong possibility of a Nexit (Netherlands seeking an exit), and the right wing in France will push for a similar referendum with other members testing the mood for their electorate. In a sense politically the EU will feel stronger as a partner who was not entirely on board with the long term vision of the EU is now out. The flip side is that Germany may remain the only strong EU member wanting a stronger united Europe, while France, Netherlands and Denmark leading the charge for a looser Union arrangement. In essence the main problem for Britain was immigration law and they had wished a more Australia type point system on immigration rather than the current policy. EU leaderships stubborn stance on revising the policy then opened the pandoras box to a plethora of other issues resulting in Brexit.

The key question is will Britain benefit from this decision. There cannot be a serious sensible answer to this because a great deal will depend on the moving parts of the business environment. Yes emotionally the idea of 'winning back the country' has its own charm; but does this put bread on the table and create a strong economy? Personally, I believe till the exit deal is not worked out and new partnership agreements worked out over the next two years the British economy will remain depressed and the economic environment uncertain. A strong British economy will fundamentally rest upon two things:

1. Will the private sector in Britain take advantage of the lesser legislation (from EU) to invest heavily into the economy?

2. How successful will Britain be in negotiating new agreements with the US, Japan and the EU that cover trade, taxes and investments.

The best bet for Britain is that private sector investment will offset the effect of big business moving out of Britain as Brexit takes away the advantage for these manufacturers, like Nissan, to produce cars in Britain. Job losses from these closures will not be the only negative as such measures will effect the secondary and tertiary manufacturing sectors that support the factors supply chain. Can the private sector be strong enough to negate some of this effect is still questionable.

The question of negotiating new trade deals and investment and tax agreements is a more tricky matter. Britain, while the worlds fifth largest economy, now will negotiate from a weaker platform. These agreements are tedious and in some cases require multi level approvals, like in the US, and therefore a three to five year period is not unreasonable before this is sorted out. Britain might want to have a loose partnership agreement with the EU so as to not upset the existing relationship with EU too much, but I suspect that the European leadership may not be that accommodating on accepting such a partnership on terms too favourable to Britain.

If and only if, Britain can over come these two challenges that I have mentioned than perhaps in a period of five years from now Britain may well emerge from the this decision more stable and perhaps stronger. However, one must speculate that stronger does not mean stronger than the EU, but stronger from the position the country has been thrown into now.

In the interim what this means for business and the common man in Britain is that there will be a period of three to five years of uncertainty, higher consumer prices, more unemployment, lower investment into new businesses and the financial markets being in turmoil. While Britain will over haul their own immigration law and perhaps reduce the impact on the large number of EU citizens currently working in UK, there will be shrinking of the financial sector with job losses, manufacturing industry slow down. Yes a weaker pound will mean competitive exports but will this be substantial remains to be seen.

To me at a very personal level it is surprising that the issue of introducing a point system immigration system has been blown up to the extent that Brexit became a reality. In a sense this is a failure of intellect to emotion, a stubborn EU leaderships success over the voice of reason and this lack of flexibility will be the test for the EU in how it handle discontent in its own camp.

The Recession: A year on.

A year back, Lehman Brothers, the icon of Wall Street and all that it stood for, came crumbling down, in almost prophetic fashion ushered in the worst economic recession that the world has ever seen. The event was not the crash of Wall Streets premier bank, but it was perhaps the proverbial straw that broke the camels back. Economies around the world felt the economic tsunami that ensued, wave after tidal wave of what was bad news. The GGC economies, who had on the back of their liquidity, weathered previous recessions of global proportions without more than a sneeze, suddenly realized the interlinking of economies was perhaps more closely knotted than one would have imagined in the past.

The issue is what does it feel for a recession to be one year old? Well in large measure some people would say 'miserable' while others, who are prone to seeing the forest rather than count the trees, would say well 'value was created'. Indeed, its all about perspectives and its not like the world came to a standstill, even though belts were tightened and a difference emerged between those who hope it will all go away, and those who did something about it. China and India shrugged off the recession with remarkable ease, Germany and France has shown more grit than was expected. The United States has been a bit of a struggle but the stock markets are off their bottom levels, the impending collapse of some banks has been averted and in a sense there is evidence that things do have the thinest of hopes for a better recovery.

As bizarre as this may sound my guess is that the slide in the market will be arrested now and we may begin to see signs of a gradual recovery. It is more likely that this recovery will be slow with some stops and starts. In the context of the GGC and specifically the UAE I feel a little more optimistic given that liquidity levels have improved and the banks are beginning to see they have a more positive role to play and this will translate into a better economic performance. The recovery will not be euphoric but more cautious and this will be good for the overall health of the economy.