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The state of the Pakistani Economy – part ii

(This post follows on the comments made in my previous post “The rise and fall of the Pakistani Rupee“)

Entrepreneurs are the most irrational of all creatures. We see hope and optimism, when the rest of the world sees doom and gloom. While our internal outlook at times may turn to despair (we never have enough cash), our external outlook is always positive (you can’t short optimism and work for yourself). In the long run we always expect to make money; in the short run, every now and then, we lose our shirts.

Having now qualified my opinion, here is my outlook on the Pakistani Economy. In the long run, if we stick to it, we will all make money; more than enough to compensate us for the minor inconveniences we face for working in a country whose official motto is “we are in the news again.” In the short run, there is going to be pain and suffering.

Let’s take a closer look on this anticipated pain and suffering.

The political outlook is uncertain. The political outlook has been uncertain now for more than 18 months. Technically speaking it has been uncertain all the way from 1948 when Mr. Jinnah died inconveniently for all of us. Since that day in September, things have never been really clear on this front. Let’s not expect that our national character which has held true now for more than six decades will suddenly change for the better. But then this is just one more variable that we have all learnt to live with. Once we accept that it become easier to manage. Don’t get me wrong; it is inconvenient; it is irritating and it is really bad for business. But if there is not much that you can do to control it, you shouldn’t let it nitro your blood pressure.

The primary impact of an uncertain political outlook is an uncertain economic outlook. The uncertainty doesn’t short circuit the economy but it certainly makes everyone rethink their investment preferences. Cash gets pulled out and converted into more liquid and portable instruments. Investment decisions get deferred and delayed and that big colossal purchase order you were counting on to make your yearend numbers doesn’t close. Capital inflows reverse and turn into capital flight. If it was capital you were counting on you can wave it goodbye.

But the core economy still chugs on. 160 million souls have to eat, drink, work, commute and consume. Somebody has to feed and clothe them. If you are part of the core economy, you survive. You are stretched but you make enough to put food on the table. Exotic vacations are out; austerity is in and if you can still quote a stable price in rupees for something that everyone needs, you are hot.

Inflation is at a 10 year high. Have you ever really thought about where does inflation come from and who does it really hurt? Inflation is an indirect, misunderstood government tax that the government uses to depreciate its liabilities. And the biggest chunk of government liabilities is the money it borrows in the form of long term bonds and savings certificates. So if the government borrowed a 100 rupees from you and inflation is running at 25% a year, effectively the government needs to only pay back 75% of the amount borrowed not the full 100. Of the many sources of inflation the most common in our economy is liquidity and excess cash generated by printing of notes by the government. This happens when we don’t bear our fair share of taxes and there literally isn’t enough money in the coffers in Islamabad to cover expenses.

How and where do you hide undocumented gains? Amongst other tools, you buy bearer bonds (a no questions asked money whitening/cleansing instrument), national savings certificates, you keep liquid cash under your mattress and stay away from asset classes that document your invisible wealth or lock you down for good. And where does inflation hits the hardest? That is right, liquid and portable instruments in the local currency. If you bought real estate, gold or diamonds you are safe from inflation but create a security or liquidity (true for real estate) nightmare. Historically speaking if you bought foreign currency you could save part of the pain, but with the entire globe suffering from an economic meltdown and rising prices, it is no longer such a sure bet. To this add the woes of a depreciating dollar and you have a double whammy.

If you had been sleeping over mattresses full of currency notes (any denomination) the government just stole a full 25% with a tool called inflationary adjustment.

To be fair, there are other buyers of long term bonds and liquid instruments (widows, trust funds, pensioners, employee benefit plans and insurance companies) who suffer side by side with the first category. But inflation steals equally from the poor and the needy as well as from the crooked. It is the only universal tax from which you cannot run or hide or cheat. It works. This is why it is so popular in developing countries and emerging markets.

The only way to fight inflation is to invest and build businesses that create real assets and inflation adjusted capital.

The rupee is at historic lows. There are a number of reasons why we are in such deep dodo right now on the currency front. To begin with we have had a terrible year. Imagine if immediately after the 2000 elections the tiff between George W. Bush and Al Gore over Florida had run all the way into September 2001. Besides the fact that we would have been sitting in a completely different world today, it wouldn’t have done wonders for the US economy. A much smaller tiff between President Clinton and the US Congress caused delays in the approval of the federal budget and effectively shut the US government down.

We have had more than our fair share of these tiffs. First our new Finance minister within a few weeks of his arrival went off and settled his score with the previous government by announcing to the world that the Pakistani economy had been a smoke and mirror show (effectively the US Treasury secretary standing up and proclaiming that you should sell the US dollar). There went a decade of stability and any impression of growth and future prosperity. By the time he left and the powers that be woke up the rupee had already breached the magic number of 70 to a dollar. Once you remove currency stability and create doubts about your intentions to defend your currency you open up flood gates of capital flight and lockdown capital inflow. When the central bank tried to defend the rupee, it was second guessed and resisted at every step. Policy debates and conflicts were not uncommon in the last ten years but they were never as counterproductive as they were in the last three months. We then fell to our traditional diplomatic resort of asking everyone in sight to come and help us with our balance of payment issues.

To be fair the one thing the gentleman in question did get right was the issue of removing fuel and grain subsidies. This is the brightest thing any government in Pakistan has ever done, including the one run by our ex premier, Mr. Shaukat Aziz.

Today the rupee stands at 75 and there is not much that we can do about it as individuals, other than not converting everything we own into a foreign currency account. If you are concerned about the falling rupee or inflation do yourself and us a favor and invest in a real asset in Pakistan that adds to national productivity and contributes to the overall GDP. You are a smart individual; I will leave what you buy up to your imagination.

Now that the Rupee has fallen what does that mean for you?

Well, despite my love affair with a stable currency the classical defense to a Balance of Payment problem is a sharp revaluation of domestic currency. Theoretically this is supposed to curtail imports and give a boost to exports.

The export numbers for June 08 and July 08 both indicate that as far as exports are concerned we have seen a sharp pickup. Exports in these two months came in at nearly two billion dollars each; implying that if all bodes well we may see a year-end export number of 24 billion dollars. We also saw a decline in the total import bill (from over 4 billion a month to 3.5 billion) reducing the monthly trade gap from 2 billion dollars a month to 1.6 billion dollars a month. Remittances for July 08 clocked in at 627 million dollars (7.5 billion dollar annualized rate) growing at 26 plus percent year on year. The best news however has been the sharp decline in oil prices from the peak of 147 to 113 dollars per barrel. Combine these two factors with the Pakistani Saudi oil facility and the overall outlook for the rupee is not all that bleak. Of the projected 19 billion dollars of trade deficit, 7.5 will be offset by worker’s remittances, 6 by the Saudi oil facility, and another 2 or 2.5 by the allied total of capital inflows, privatization proceeds and balance of payment support from aid agencies. At best we will be left with a gap of 3 billion US dollars, at worst a number hovering around 6.

It could be better if exports and workers’ remittances grow at a faster clip and worse if the slowdown in imports and the decline in oil prices turn out to be temporary.

Does that mean that the rupee will stay at 75 to a dollar, lose or gain value? I will take you back to my original post on this subject. Not much has changed in the last four months for me to revise that opinion.

Last words. My objective is to not deny or make light of what has happened or what will happen. It is to just restore perspective. We are in a bad way, so is everyone else. This is temporary, not permanent. This has happened before, it will happen again. Remember that at heart you are a nation of commodity producers (grains, cereals, fruits, milk, ore, coal, cement and cotton) in a rising commodity prices world. If you think a dollar deposit will save you from an inflationary bite, think again.

As Jamshaid Khan of OPEN said the other day, a recession is the best opportunity for you to expand since you are the only game in town. Go forth and expand.

 

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