‘Geopolitics’ and the IMF: Is Pakistan delusional or myopic?

Uzair M Younus in The Dawn


Despite the pronouncements coming out of Islamabad that the 9th review of the ongoing International Monetary Fund (IMF) programme is still a possibility, the fact of the matter is that successful completion of the review is a distant possibility.

This view is reinforced by the fact that the IMF’s own executive board calendar, which shows planned meetings through June 29, does not mention Pakistan. While these calendars can and do shift, recent developments would lead one to believe that if the Staff Level Agreement (SLA) has not happened yet, it is not happening in the next ten days or so.

The root cause of this failure, of course, is the hard-headedness of Pakistan’s finance minister who has refused to pay heed to common sense ever since returning to Pakistan and taking over the economy.

Whether it be the infamous Dar Peg – which angered the IMF and distorted the entire economy – or the strategy of negotiating through a staring contest, Dar has been lost at sea. As a result, Pakistan’s rock-bottom credibility in front of international creditors, key among them being the IMF, has further collapsed.

This view was summed up to me during the IMF’s 2023 spring meetings by a couple of bondholders who had gathered to listen to Pakistan’s central bank governor talk about the country’s economy. Following the discussion, these bondholders noted that the best way for Pakistan to gain its credibility and bring the IMF programme back on track was to do just one thing: get rid of Dar.

Alas, this has not happened and the prospects of the prime minister firing his family member are even slimmer than the resumption of the IMF programme.

As if keeping Dar in place was not enough, the government has also started to blame everyone but itself and its finance minister: Dar has been once again hinting at the fact that the programme is not moving forward due to geopolitics.

The truth of the matter is that everyone involved, including the United States and China, want Pakistan to remain economically stable.

But let’s assume that Dar is being truthful. This logic then leads one to question whether China and Saudi Arabia, two of Pakistan’s strategic partners, are in on the conspiracy.

After all, both these countries have made disbursement of their financial commitments to Pakistan contingent on successful completion of the 9th review.

So, if these countries were opposed to the geopolitics being played to punish Pakistan, as it has been alleged by the finance minister, then why is it that they have not yet released the additional funds they have promised to Islamabad?

This is why Islamabad’s apparent Plan B, to get additional deposits from friendly countries (like China and Saudi Arabia), also seems to be wishful thinking.

How and why these same countries would give additional funds to Pakistan when it fails to remain in the IMF programme is a question that Islamabad seems unwilling or unable to answer.

And while Dar and company continue to insist that all will be well, it is time for Pakistanis to recognise and accept that digging the economy out of this hole will be a Herculean task even in the best of circumstances. The challenge becomes that much more daunting if one were to look at the cast of characters across party lines that are potential contenders to be finance czars.

The recovery will first and foremost require rebuilding the country’s credibility, which can only be achieved by pushing through extremely painful short-term measures that help balance the books.

This would require major cuts to government spending, drastic measures to truly broaden the tax net – existing taxpayers are basically tapped out – and a structural reform agenda that is viewed positively by creditors. If this were to happen, then the recent budget put forth by the government would have to be tossed into the dustbin.

These would only be the easiest steps in a long journey.

According to data released by the IMF in September 2022, Pakistan has gross external financing needs in excess of $35 billion a year for the next three years. These needs would have to be fulfilled at a time when economic growth is down sharply, supply-chains have been distorted, investor confidence has been shattered, and the era where cheap capital was available in global markets has come to an end.

How ruling elites manage to meet these financing needs in the near future is a big question mark, and the next government will have its work cut out for it.

An alternative solution that is being discussed is debt restructuring. But this will be an even more painful process, especially for a sovereign that already has limited capacity to deal with the fallout of the IMF’s existing demands. In addition, external debt restructuring may also open the door for a conversation on domestic debt restructuring. This would stoke chaos in the country’s fragile banking sector which has binged on government debt over the last few years.

The prolonged process of debt restructuring would essentially mean that Pakistan has declared default. As a result, import of critical inputs would stall, leading to shortages of everything from fuel to imported pulses and palm oil.

As supply-chains would get distorted, prices of essential commodities would skyrocket. The value of the rupee would also collapse, leading to further inflation. Hospitals would run out of essential medicines, farmers would run out of essential inputs for the next harvest, and the entire economy would come to a grinding halt.

In short, this process would lead to near-term economic and political fallout that may be untenable for any government, let alone a coalition of status quo parties that is already deeply unpopular.

What the ruling elites in Pakistan have continuously failed to do is take a bit of a long-term view of the situation. After all, given where the politics of Pakistan is at this point in time, members of the existing coalition are likely to come back to power after general elections. This means that they will have to ultimately take charge of the situation and take measures that they are unwilling to take today.

Perhaps their rationale is that elections will provide them with a fresh mandate, but that logic is also flawed – after all, an election that leads some or all of the government’s existing members to form government in Islamabad will be seen as a continuation of the existing setup. This means that a new government will not be able to magically gain some new political capital that it can then utilise to push through painful reforms.

It appears the PML-N’s thinking is that since it will not be the senior member of a government come October, this will be someone else’s problem. There is some merit to this logic, but perhaps Pakistan’s ruling classes ought to do some deeper thinking.

After all, a country on the verge of default, where the ruling elites have run out of ideas and capacity to rescue the situation, is a problem for everyone that is part of the status quo elites.

The India US Ties

 

Luck and Politics

Bagehot in The Economist

Monday june 19th was a typical day in British politics insofar as it involved a series of humiliations for the Conservative Party. mps approved a report on Boris Johnson condemning the former prime minister for lying to Parliament over lockdown-busting parties. Rishi Sunak skipped proceedings for a fortunately timed meeting with Sweden’s prime minister. On the same day, the invite emerged for an illegal “Jingle and Mingle” event at the party’s headquarters during the Christmas lockdown of 2020. A video of the event had already circulated, with one staffer overheard saying it was fine “as long as we don’t stream that we’re, like, bending the rules”. Labour, through no efforts of their own, had their reputation comparatively enhanced.

Luck is an overlooked part of politics. It is in the interests of both politicians and those who write about them to pretend it plays little role. Yet, as much as strategy or skill, luck determines success. “Fortune is the mistress of one half of our actions, and yet leaves the control of the other half, or a little less, to ourselves,” wrote Machiavelli in “The Prince” in the 16th century. Some polls give Labour a 20-point lead. Partly this is because, under Sir Keir Starmer, they have jettisoned the baggage of the Jeremy Corbyn-era and painted a picture of unthreatening economic diligence. Mainly it is because they are damned lucky.

If Sir Keir does have a magic lamp, it has been buffed to a blinding sheen. After all, it is not just the behaviour of Mr Johnson that helps Labour. Britain is suffering from a bout of economic pain in a way that particularly hurts middle-class mortgage holders, who are crucial marginal voters. Even the timing helps. Rather than a single hit, the pain will be spread out until 2024, when the general election comes due. Each quarter next year, about 350,000 households will re-mortgage and become, on average, almost £3,000 ($3,830) per year worse off, according to the Resolution Foundation. Labour strategists could barely dream of a more helpful backdrop.

Political problems that once looked intractable for Labour have solved themselves. Scotland was supposed to be a Gordian knot. How could a unionist party such as Labour tempt left-wing voters of the nationalist Scottish National Party (snp)? The police have fixed that. Nicola Sturgeon, the most talented Scottish politician of her generation, found herself arrested and quizzed over an illicit £100,000 camper van and other matters to do with party funds. The snp’s poll rating has collapsed and another 25 seats are set to fall into the Labour leader’s lap thanks to pc McPlod and (at best) erratic book-keeping by the snp.

It is not the first time police have come to Sir Keir’s aid. He promised to quit in 2022 if police fined him for having a curry and beer with campaigners during lockdown-affected local elections in 2021. Labour’s advisers were adamant no rules were broken. But police forces were erratic in dishing out penalties, veering between lax and draconian. It was a risk. Sir Keir gambled and won.

Luck will always play a large role in a first-past-the-post system that generates big changes in electoral outcomes from small shifts in voting. Margins are often tiny. Mr Corbyn came, according to one very optimistic analysis, within 2,227 votes of scraping a majority in the 2017 general election, if they had fallen in the right places. Likewise, in 2021, Labour faced a by-election in Batley and Spen, in Yorkshire. A defeat would almost certainly have triggered a leadership challenge; Labour clung on, narrowly, and so did Sir Keir. If he enters Downing Street in 2024, he will have 323 voters just outside Leeds to thank.

Sir Keir is hardly the first leader to benefit from fortune’s favour. Good ones have always needed it. Sir Tony Blair reshaped Labour and won three general elections. But he only had the job because John Smith, his predecessor, dropped dead at 55. (“He’s fat, he’s 53, he’s had a heart attack and he’s taking on a stress-loaded job” the Sun had previously written, with unkind foresight.) Without the Falklands War in 1982, Margaret Thatcher would have asked for re-election soon afterwards based on a few years of a faltering experiment with monetarism. Formidable political talent is nothing without a dash of luck.

Often the most consequential politicians are the luckiest. Nigel Farage has a good claim to be the most influential politician of the past 20 years. He should also be dead. The former leader of the uk Independence Party was run over in 1985. Then, in 1987, testicular cancer nearly killed him. In 2010, he survived a plane crash after a banner—“Vote for your country—Vote ukip”—became tangled around the plane. Smaller factors also played in Mr Farage’s favour: when he was a member of the European Parliament he was randomly allocated a seat next to the European Commission president, providing a perfect backdrop for viral speeches. (“They handed me the internet on a plate!” chortles Mr Farage.) Britain left the eu, in part, because Mr Farage is lucky.

Stop polishing that lamp, you’ll go blind

Too much good luck can be a bad thing. David Cameron gambled three times on referendums (on the country’s voting system, on Scottish independence and on Brexit). He won two heavily and lost one narrowly. Two out of three ain’t bad, but it is enough to condemn him as one of the worst prime ministers on record. “A Prince who rests wholly on fortune is ruined when she changes,” wrote Machivelli. It was right in 1516; it was right in 2016. Labour would do well to heed the lesson. It sometimes comes across as a party that expects the Conservatives to lose, rather than one thinking how best to win.

Fortune has left Labour in a commanding position. Arguments against a Labour majority rely on hope (perhaps inflation will come down sharply) not expectation. Good luck may power Labour to victory in 2024, but it will not help them govern. The last time Labour replaced the Conservatives, in 1997, the economy was flying. Now, debt is over 100% of gdp. Growth prospects are lacking, while public services are failing. It will be a horrible time to run the country. Bad luck.

Economics Essay 105: Government Oversight of Financial Markets

Evaluate the view that strict rules and regulations on financial markets are essential to help create a more stable economy.

The view that strict rules and regulations on financial markets are essential to create a more stable economy is supported by several arguments. Here is an evaluation of this view:

1. Preventing Market Failures: Strict rules and regulations help prevent market failures that can lead to economic instability. Regulations such as capital requirements, leverage limits, and risk management practices aim to ensure that financial institutions operate in a prudent manner, reducing the likelihood of systemic risks and the potential for financial crises.

2. Safeguarding Investor Protection: Regulations help protect the interests of investors and consumers. Measures such as disclosure requirements, investor education, and consumer protection laws ensure that individuals have access to accurate information, can make informed decisions, and are not subject to fraudulent or predatory practices. This fosters trust in the financial system and contributes to its stability.

3. Controlling Excessive Risk-Taking: Regulations can limit excessive risk-taking behavior by financial institutions. For example, restrictions on certain speculative activities, such as proprietary trading, and the implementation of stress tests and capital adequacy standards can help prevent excessive risk accumulation. By promoting responsible risk management, regulations contribute to a more stable financial sector.

4. Mitigating Externalities: Financial markets have spillover effects on the broader economy. Regulations can help mitigate negative externalities by imposing safeguards against contagion and systemic risks. For instance, regulations that require financial institutions to hold sufficient capital buffers or contribute to a deposit insurance scheme help protect against the adverse effects of potential failures or crises.

5. Enhancing Market Confidence: Strict rules and regulations provide a clear framework and set of standards for market participants. This transparency and predictability enhance market confidence, attract investment, and facilitate economic growth. When market participants trust that regulations are effectively enforced, they are more likely to engage in economic activities, which contributes to stability.

However, it is important to consider potential counterarguments against strict regulations:

1. Excessive Burden on Financial Institutions: Excessive or poorly designed regulations can impose unnecessary burdens on financial institutions, hindering their ability to operate efficiently and stifling innovation. Overly complex or stringent regulations may divert resources away from productive activities, potentially reducing economic growth.

2. Regulatory Capture and Moral Hazard: Strict regulations may inadvertently lead to regulatory capture, where regulated entities influence or control the regulatory process for their own benefit. This can create moral hazard, as institutions may become complacent or take undue risks, assuming that they will be bailed out or protected by the government.

3. Regulatory Arbitrage: Stringent regulations in one jurisdiction may lead to regulatory arbitrage, where institutions move their operations to jurisdictions with less stringent regulations. This can undermine the effectiveness of regulations and create regulatory gaps that increase systemic risks.

In evaluating the view, it is important to strike a balance between effective regulation and the need to foster innovation and competitiveness. Well-designed and properly enforced regulations can promote stability, protect investors, and prevent excessive risk-taking. However, excessive or poorly implemented regulations can hinder economic growth and lead to unintended consequences. Therefore, finding the right balance and regularly reviewing and adjusting regulations is crucial to creating a more stable economy.

Economics Essay 104: Monetary Policy Transmission Mechanism

 Explain how the monetary policy transmission mechanism works when the Monetary Policy Committee (MPC) raises Bank Rate.

When the Monetary Policy Committee (MPC) decides to raise the Bank Rate, it aims to tighten monetary policy and control inflation. The transmission mechanism explains how this policy action affects the broader economy. Here's an overview of the monetary policy transmission mechanism when the MPC raises the Bank Rate:

1. Commercial Banks: The change in the Bank Rate directly affects the interest rates commercial banks charge on loans and pay on deposits. When the Bank Rate increases, commercial banks are likely to raise their lending rates, making borrowing more expensive for businesses and individuals. This reduces the demand for loans and can slow down investment and consumption.

2. Borrowing Costs: Higher lending rates have an impact on various forms of borrowing, including mortgages, personal loans, and corporate borrowing. As interest rates rise, the cost of servicing existing debt increases, which can put financial strain on borrowers and reduce their spending capacity.

3. Consumption and Investment: Higher borrowing costs and reduced access to credit can discourage consumer spending and business investment. Individuals may cut back on discretionary purchases, leading to lower retail sales. Similarly, businesses may delay or reduce their investment plans, which can have a negative impact on economic growth.

4. Aggregate Demand: The decline in consumer spending and business investment, resulting from higher borrowing costs, can lead to a decrease in aggregate demand. This reduction in demand can contribute to a slowdown in economic activity and potentially dampen inflationary pressures.

5. Price Levels: The tightening of monetary policy through an increase in the Bank Rate aims to control inflation. Higher borrowing costs can reduce consumer spending, which may moderate price increases and help keep inflation in check. By curbing demand, the policy action can alleviate inflationary pressures in the economy.

6. Exchange Rates: A change in interest rates can also affect exchange rates. If the Bank Rate increases, it can make the currency more attractive to investors seeking higher returns. This increased demand for the currency can lead to an appreciation, making exports relatively more expensive and imports cheaper. This, in turn, can impact the trade balance and competitiveness of domestic industries.

It's important to note that the transmission mechanism is not instantaneous, and the full effects of a change in the Bank Rate take time to filter through the economy. The responsiveness of the transmission mechanism can vary depending on factors such as the financial system's health, the level of household and corporate debt, and the overall economic conditions.

In summary, when the MPC raises the Bank Rate, it influences borrowing costs, which can affect consumption, investment, aggregate demand, price levels, and exchange rates. The overall impact on the economy depends on how businesses, households, and financial markets respond to the change in interest rates.

Economics Essay 103: Currency Depreciation and Macroeconomic Effects

Assess the view that a depreciation of the pound against other currencies is likely to improve the UK’s macroeconomic performance.

The impact of a depreciation of the pound against other currencies on the UK's macroeconomic performance is a topic of debate among economists. Assessing the view that such a depreciation is likely to improve the UK's macroeconomic performance involves considering both the potential benefits and drawbacks:

1. Export Competitiveness: A depreciation of the pound can make UK exports more competitive in international markets. As the value of the pound decreases, UK goods and services become relatively cheaper for foreign buyers. This can lead to an increase in export demand, boosting exports and potentially improving the trade balance.

2. Tourism and Foreign Investment: A weaker pound can also make the UK a more attractive destination for foreign tourists and investors. With a lower exchange rate, travel and investment in the UK may become more affordable, stimulating tourism and attracting foreign capital inflows.

3. Domestic Industries: A depreciation of the pound can benefit certain domestic industries that rely heavily on imported inputs. As the cost of imports rises due to the weaker currency, domestic producers may find it more cost-effective to source inputs domestically, leading to increased production and investment in domestic industries.

4. Inflationary Pressure: A depreciation of the pound can have inflationary implications. It makes imports more expensive, which can lead to higher prices for imported goods and raw materials. This can contribute to inflationary pressure in the economy, potentially eroding consumers' purchasing power.

5. Imported Inflation: A weaker pound can also lead to higher costs for imported goods and services, which can affect businesses and consumers. Industries that rely heavily on imported inputs, such as manufacturing or energy, may experience higher production costs, potentially leading to lower profitability or increased prices for consumers.

6. Imported Inputs and Supply Chains: A depreciation of the pound can disrupt supply chains that rely on imported inputs, as the cost of those inputs increases. This can negatively impact businesses that rely on imported components or materials, potentially leading to reduced output and profitability.

7. Consumer Spending: A weaker pound can affect consumers' purchasing power, as imported goods become more expensive. This can lead to reduced consumer spending, which is a significant driver of economic growth.

Overall, the impact of a depreciation of the pound on the UK's macroeconomic performance is complex and depends on various factors. While it can provide some advantages, such as improving export competitiveness and attracting foreign investment, it also poses challenges such as inflationary pressure, increased costs for imported inputs, and potential disruptions to supply chains. The net effect on the UK's macroeconomic performance will depend on how these factors interact and the overall state of the economy.

Economics Essay 102: Floating Exchange System

 Explain why the value of a currency may fall in a floating exchange rate system.

In a floating exchange rate system, the value of a currency is determined by market forces of supply and demand in the foreign exchange market. Several factors can lead to a fall in the value of a currency:

1. Changes in Relative Interest Rates: If a country's interest rates decrease relative to those of other countries, it can reduce the attractiveness of holding that currency and lead to a decrease in its value. Investors may seek higher returns in other countries with relatively higher interest rates.

2. Economic Performance and Outlook: Market participants closely monitor a country's economic performance and future prospects. Factors such as low economic growth, high inflation, political instability, or fiscal imbalances can negatively impact the value of the currency. Investors may sell the currency, leading to its depreciation.

3. Trade Balance and Current Account: A country with a persistent trade deficit or a deteriorating current account balance may experience a decline in its currency's value. A trade deficit means that more goods and services are being imported than exported, resulting in a net outflow of the currency.

4. Market Speculation: Speculative activities in the foreign exchange market can also contribute to currency depreciation. If traders anticipate a fall in the value of a currency based on economic indicators or market sentiment, they may sell the currency in the expectation of buying it back later at a lower price.

5. Market Intervention: In some cases, central banks or governments may actively intervene in the foreign exchange market to influence the value of their currency. Intervention to sell or buy the currency can impact its value in the short term.

It is important to note that currency depreciation can have both positive and negative effects on an economy. On one hand, it can make a country's exports more competitive, stimulating economic activity and potentially improving the trade balance. On the other hand, it can increase the cost of imports, leading to higher inflation and potentially reducing consumers' purchasing power.

The value of a currency in a floating exchange rate system is determined by a complex interplay of economic factors, market forces, and investor sentiment. The relative strength or weakness of a currency reflects the market's assessment of a country's economic fundamentals and its position in the global economy.