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Pakistan’s currency crisis

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Meekal Aziz Ahmed

Once again, the State Bank, the guardian of our financial system and watch dog over currency dealers, has been caught napping on the job. Asleep and blissfully unaware at the helm, an estimated $10 billion, most certainly much more than that, has left the country through capital flight, right under its nose. If the State Bank could not do anything about it, it should have, at least, known about it. I doubt it did.

In any event, I don’t understand why everyone should be wringing their hands in anguish at this news as though it is a novel phenomenon. Capital flight is nothing new and any serious observer of the economy knew it was happening and happening in mind-boggling amounts.

This is because capital flight is the outcome of bad economic policies. Such policies unnerve “market participants” and cause an erosion of confidence. Indeed, Pakistan has presented a propitious environment for capital flight. The new government has taken some measures, but not enough strong measures, to stem the economy’s drift towards a crisis. Many had predicted such a crisis was coming six months ago as the first, classic signs of economic stress emerged. In response, the government should have put together an economic program, any program, and announced it. Such a program would have demonstrated that the government was in charge, was focused, had a clear strategy, and knew what needed to be done. It would have had many benefits, including slowing the pace of capital outflows.

To be fair, the government appointed a panel of economists under the able leadership of Dr Hafeez Pasha, one of Pakistan’s pre-eminent economists to develop an adjustment program. The panel has since come up with their recommendations, some of which have been reported in the press. The panel’s recommendations are hardly surprising because Dr. Hafeez Pasha and his colleagues on the panel are not dreamers, know the economic situation well, and have spoken with a clear mind. Now it is too late because the IMF die is cast and the report of one more panel in Pakistan will turn to dust.

Instead of putting a program together, the government has spent its energies pursuing a naive and deeply flawed strategy based on the premise that our “Friends” will bail us out and we don’t have to do anything in return. Yet, even as it became increasingly clear that this strategy was going nowhere, precious time was being wasted and confidence in government’s handling of the economic situation ebbed with each passing day.

Worse still, contradictory, and ill-informed statements were and continue to be issued by all and sundry, including the media, none of whom know much about economics and even less about the topic on which they speak with such authority, the IMF. Every time we come up with another Plan X, an additional $100 million leaves the economy for safer havens abroad. Every time we come up with the brilliant idea that all we need to do is get all the “big fish” to return the money they have spirited abroad and there is no need for the IMF, another $200 million leaves the country because markets think no one is serious.

The sight of us kicking and screaming as we are dragged into an IMF program because no one else will help us does not inspire confidence. It simply contributes to more capital flight as doubts grow into the fear that the government is not committed to undertaking any economic reforms at all, IMF or no IMF.

Capital flight has been a long-standing phenomenon in Pakistan. It is nothing new. It accelerates in times of economic stress and reverses when the economy is perceived to be strong and growing. The fact that Pakistan enjoys de facto convertibility of the rupee facilitates capital flight. Indeed, as far as this writer is aware, private capital outflows are not illegal. Pakistan has had an “open” capital account for some time.

Whatever the basis for the estimate of $10 billion of private capital outflows, and it certainly is an under-estimate, the government, in a panic, has responded with a typically clumsy overreaction. It has picked up a few people and has promised to punish all those responsible, including the “big fish”. This is the usual empty threat and bluster that we hear each time there is a scandal, which ends with a whimper. No one is fooled. No one, and certainly not the rich and powerful, or any snappy commercial banker in our country, all long-time participants in, and enablers of, capital flight, will be “punished”. This must be some sort of cruel joke. An additional adverse reaction to all this drama of parading persons accused of capital flight is that it will give capital flight additional momentum as people fear a future crackdown and take their money out pre-emptively. They may not do this through “normal” channels, but will surely find a way, creating a new, back-door underground economy, until things calm down and the government is distracted elsewhere. Then it will be business as usual.

I believe very little can be done in the immediate to short-term. Confidence once lost is painfully difficult to regain. Capital flight will only diminish and start to reverse itself when we adopt sensible policies, “market participants” see this, feel reassured, and confidence returns. Whether this will happen with the impending IMF program is not clear but experience suggests that a program should help. In the past, an IMF program has been associated with enhanced confidence and a quick turn-around of the external position which is typically boosted by capital inflows.

However, it is possible that this time, such a turn-around may prove to be more elusive and could be more drawn out in time because of the on-going global financial meltdown and the looming risk of a synchronized, global recession. Nevertheless, one remains hopeful that an IMF program will turn the tide, albeit slowly. This places a high premium on steadfast implementation of the program and a willingness to resist the temptation of a premature relaxation of macroeconomic polices, just as the economy is beginning to respond to policy action and is poised to grow.

Avoiding the temptation to ease the stance of polices too soon will represent a significant departure from the past. In every case, the first signs of economic recovery have been accompanied by the abandonment of an IMF program amid much cheering that we have regained our “economic sovereignty”, a halt and rollback of anything good we may have done, and a resumption of economic decision-making with no constraints. One can only hope that this time our history will not repeat itself.

The writer has a doctorate from Oxford University and has worked at the Planning Commission and the IMF. Email:


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