Daily Times

By now, the mountain of gratis economic advice provided to the new PTI government probably runs a few miles high. Predictably, much of the advice revolves around those deep-rooted issues that are all too familiar: fixing the energy sector, broadening the tax base, increasing the transparency of CPEC, implementing institutional reform, to IMF or not, etc. But among this cacophony of ideas, some fundamental truths are glossed-over, and false dichotomies are imposed. The emotive issue of foreign financing strikes a particularly raw nerve.

An inescapable truth is that investment needs financing. If a country does not have sufficient domestic savings to finance its investment needs, then there is simply no alternative but to attract foreign capital to fill the gap, irrespective of one’s economic ideology. And, regardless of rhetoric, it follows the new government will need to raise a significant amount of foreign financing if there is to be investment in the country.

That Pakistan needs investment is without doubt: in education, healthcare, agriculture and public infrastructure to name a few areas. Even with CPEC already underway, Pakistan still only invests around 17% of GDP. By contrast, India, Bangladesh and Sri Lanka invest over 30% of GDP. The only way to ensure prosperity tomorrow is to invest today, and unless the current pitifully low rates of investment pick-up significantly, Pakistan is guaranteed to slide further behind.

But Pakistan’s domestic savings rate, at around 12% of GDP (close to a thirty-year low) is woefully inadequate to finance the required ramp-up in investment. (The other South Asian countries’ savings rate are in the high-20s/low-30s as a percent of GDP.) The new government will almost certainly have to resort to some belt-tightening via monetary and fiscal policies in the near term to put the economy on a stable footing. This should raise the domestic savings rate to some degree. But it is difficult to imagine that savings will rise to levels required to fully finance even a modestly ambitious investment agenda in coming years. For example, the peak in Pakistan’s domestic savings rate over the past 40-years is around 21% in 2003.

Therefore, it is clear, at least for the foreseeable future, that access to foreign capital will be required to plug the gap between domestic savings and investment. Badly-designed policies aimed at import substitution for example, are unlikely to meaningfully reduce the need for foreign capital unless they fundamentally alter the savings-investment gap, which they usually don’t (or do in the wrong way, by constraining investment or reducing real incomes). Barring a miracle, there must be recognition that attracting foreign capital (both debt and equity) is a necessary part of any medium-term program for growth, at least in the government’s first term.

While there is apprehension in accumulating even more foreign liabilities, Pakistan’s external debt ratio is not extreme. At around 30%, Pakistan’s external debt/GDP ratio is higher than India’s (20%) or Bangladesh’s (13%) but it is still much lower than Sri Lanka’s at 59% or Malaysia’s at 65%. In the long run, the right type of supply-side policies (like those which have been discussed ad-infinitum) should reduce the need for foreign capital. But such policies take time to bear fruit, certainly beyond the five-year term of this government. What’s more important for now is that any foreign capital inflow is channelled efficiently.

Meanwhile, the government needs to ensure that the cost, terms and sources of foreign financing are viable and sustainable. It can do this in the following three ways:

First, eschew the false dichotomy between the IMF v. Beijing and Riyadh. The knee-jerk reaction to oppose an IMF program (“it has never worked”) is understandable. Yet the “bad old” IMF of the past is not the same as the IMF of today, and other countries (India and South-East Asia in the 1990s) have managed to utilise IMF programs as a launchpad for longer-term success. Engagement with the IMF, for better or worse, signals to the world that a country is willing to adopt prudent economic policies. This opens the door to additional, diversified pools of private capital if done properly. Relying solely on makeshift arrangements with Riyadh and Beijing, however, send no such signal to the world and make it difficult to reset the country’s narrative. A balance therefore must be reached. Engagement with the IMF has been complicated by the US administration’s hawkishness. But some engagement with the IMF, even if on a precautionary basis, is still warranted for the signal it sends.

Second, borrowing in local currency and tapping institutional capital pools. The new government should focus on institutional investors as opposed to overseas Pakistanis. Diaspora bonds have not had much success internationally, are likely to be a one-off, and will probably cannibalise remittances. A better strategy would be to make a concerted push for rupee-denominated bonds to be included in global bond indices. This would directly target a captive institutional investor base. Many emerging market countries have substituted away from borrowing in USD to their own currencies in the past decade as a way of raising foreign exchange without increasing their USD debt burden. A precondition for this strategy is an empowered and credible State Bank (SBP) as well as high-quality engagement with institutional investors, both of which have sadly been lacking.

Third, paving the way, eventually, for foreign direct investment (FDI) inflows. Balancing the IMF against Beijing and Riyadh or changing the currency profile of debt are not long-term solutions, however. Ultimately, for the country to reduce its reliance on debt and the conditions of foreign creditors, it must attract private and diversified FDI to plug the savings-investment gap. It is abundantly clear that firms and corporations in the West are keen on the opportunities arising from the belt and road initiative (BRI). Pakistan is well placed, thanks to CPEC, to channel these desires into inward FDI and turn CPEC into the “game changer” PTI aspires to. Yet any program to attract private FDI must be carefully designed to avoid the pitfalls that have plagued CPEC, placing transparency and inclusivity at its core.

A well-designed strategy to manage and access foreign capital is a crucial pillar of any long-term economic plan. It will determine the fate of the rupee, macroeconomic stability, and ultimately provide the bedrock on which to implement serious economic reform. Given the circumstances, the government will only get one chance to get it right; getting it wrong is a sure shot way to take naya Pakistan back to the future.

The writer is an economist. The views expressed here are personal. He can be reached at mssid40@gmail.com

Published in Daily Times, August 22^nd 2018.