Tough times need tough decisions-By Khurshid Hadi

THE ghost of BCCI must be justifiably apoplectic at the recklessness that has brought the international financial system to this precipice.

Banking legends Bear Stearns, Merrill Lynch and Lehman Brothers were the first to go to the wall but the contamination, now out of control, crippled behemoths Lloyds TSB, RBS and HBOS amongst others.

The virus was not, as presumed, in the sub-prime sector, neither in toxic assets nor mortgage losses, which comprised some $550bn out of an outstanding credit in excess of $11,000bn. It was, ironically, spread by the might of the marketplace. Once corporate treasurers and bank chanceries joined Joe Public in withdrawing deposits, the impending run on the banks was warded off only by bailouts organised by free-enterprise, market-driven, capitalist governments one after the other.

The action that began with nationalisation-lite, as in the case of Northern Rock and Freddie Mac/Fannie Mae, turned to ‘part-nationalisation’ with the UK plan and was followed briskly by ‘quasi-nationalisation’ in the US. Other than a suggestion by one wag commenting on the crisis in Iceland — to wit, the proposal that since the number of depositors was greater than the entire population of Iceland, depositors should take to the boats and take over that country — the alternative was laissez-faire and putting at risk the entire financial system.

There was an inevitability, however unpalatable, in the coordinated action of the developed world in order to restore confidence, culminating in the $250bn purchase of equity stakes announced last Tuesday by Secretary Paulson.

This intervention was original only in its enormity and its unequivocal commitment to end the mayhem. Ten years earlier the US Federal Reserve had bailed out Long-Term Capital Management and reduced interest rates, leading to the greatest surge in consumer debt, inflated asset prices and in effect fathering the sub-prime crisis. Free market ideology subordinated to the dictates of pragmatism. Defenders of the free market will claim that since the origin of the problem was government intervention, governments must provide the solution. Detractors will see it as the evils of capitalism.

Pakistan’s issues are in the main home-grown, isolated from events abroad. Certainly some strains of the virus creep through but without a secondary market, derivatives and hedge funds, NBFIs and banks were not busy slicing up assets into instruments for downstream distribution. Interdependence of global financial systems notwithstanding, our issues of liquidity and falling asset values are a function not of a lack of confidence in the banking system but of widespread uncertainty over our future.

The regulatory regime over the formal sector as exercised by the central bank, government agencies and independent accountancy bodies has been up to date, efficient and effective. Our dilemma stems from the rapaciousness of governments — uncontrolled even by an independent central bank — who over the past years focused on consumption-driven growth and were impotent when it came to galvanising agricultural or industrial production. Whatever benefits that accrue in the early years of dictatorship evaporate at speed, leaving the fundamental problems unresolved. The corollary of such policies has been the ballooning of consumer debt and inflated asset values. Unfortunately debts are real whereas asset values are nominal and variable.

So where should we go from here? Certainly policymakers should heed Ben Bernanke’s warning that “failure of government to act in a timely manner was a major factor in past crises”, but today we need a clear committed vision of the achievable. We must avoid micro-management and focus rather than tinker at all levels. A tough policy is needed that targets a limited number of declared objectives — agriculture, education and SMEs. We must dig ditches, dredge canals, train teachers, promote industrial zones — do whatever it takes till these sectors are secure and sustainable, independent of the vagaries of the weather or political expediency.

But if intervention at the micro level is to be made even though support to the financial system may undermine the balance sheet of the government, then let it be wholehearted. The proposed Pakistan State Enterprise Fund (PSEF) of Rs20bn is a palliative not a solution. A more realistic solution, as proposed by London-based economist Iqbal Latif, is to buy back undervalued assets — NBP, petrochemicals, cement — in a form of reverse privatisation that would provide a strong signal for a return of confidence and good use of taxpayer money, especially when the economy improves and the government can offload the same assets at a profit.

Crisis provides opportunity to show the real quality of governance and to allow the State Bank independent room to manoeuvre and formulate sound decisions on the critical questions of liquidity, interest rates and banking regulation. This was done last week with a Rs270bn injection in the banking sector and easing of cash ratios. Irrespective of the immediate benefits provided by SBP intervention in the money market, the more lasting and useful benefit is the perception that there is independence of operations, there is a thought-out plan, there is someone’s hand on the tiller and that good governance is not just a mantra but a real policy.

But SBP intervention should come with the precaution that once a policy is formulated there will be consistency and no further tinkering until policy prescriptions are allowed time to work. This would also apply to the call from the West to alter accounting rules and permit corporations to adjust asset values to reflect their ‘true’, rather than marked-to-market, values. There is a danger that this would make valuations vulnerable to creative accounting measures and place an intolerable burden on external auditors.

This paper’s conclusion last week that “a global recession is the final nail in the coffin” is a dire prediction but a scenario that can be averted. Pakistan’s room to manoeuvre gets progressively restricted. Shahid Javed Burki referred to the developed world’s falling appetite for bailing out the poorer nations whilst their own economies wrestle with impending recession.

Government must focus on stabilising finances through all available means — finding donors for balance-of-payments support and securing trade credits — but the time for lateral thinking is now. Let government focus on clear achievable goals such as the expansion of the tax base, a task made easier in this technological age, so all sectors contribute equitably to the reconstruction and revival of the economy.

Source: Daily Dawn, 23/10/2008

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