Econ666: Liquidity Crisis in Pakistan

If the possibility of default is not enough to give jitters to Pakistanis, now they also have to worry about liquidity in inter-bank market so that banks might not collapse.

Due to the limits imposed on foreign investments for commercial banks, Pakistani banks are not exposed to subprime crisis in US. However, we have our very own subprime crisis lurking in the shadows due to runaway consumerism such as car loans, credit cards, personal loans and mortgage finance at a scale never seen before. More on consumer debt in later articles.

Its amazing how the current economic managers (Shamshad Akhtar – SBP governor, Shaukat Tareen – Advisor to Finance Minister) are actually ending up screwing the economy. Though SBP by reducing CRR by 100bps has managed to alleviate the situation and proven me wrong, what remains to be seen is what actually caused the crisis. What is amazing is that everyone is to blamed for this crisis as the players range from housewives to finance supremo.

One, It has been claimed by SBP that the liquidity shortage was because of Eid withdrawals. If that is the case then I am really amazed at naivete of the banks  and SBP. Its not like Eid is once in a decade event. Its an annual event. If the banks have not learnt to manage their liquidity during Eid and that is the real reason, then the bank management or at least their treasury should be fired.

Two, rumor mongering and a possibility of default which might lead to free fall in rupee had housewives withdrawing their rupee deposits from banks and converting them to US dollars. The matters were not help by shortage of cash at some branches as no branch is ready for huge withdrawals However, the problem was exacerbated when rumors started flying that certain banks are about to default such as Bank Al Falah etc.

Three, we all know that government is borrowing hugely from SBP and SBP has been raising a flag on the budget deficit for sometime. So what does our advisor Shaukat Tareen decide to do. Rather than cut spending to reduce deficit, he asks Public Sector Enterprises (PSEs) to withdraw deposits and uses those for spending. SBP actually agreed to this proposal. Worst kind of window dressing (voodoo economics) that is possible. Banking system was suddenly hit with huge withdrawals adding to the shortage of liquidity.

Four, its known that inflation is high and controlling inflation is on the agenda of SBP. The monetary policy measures taken by SBP can affect demand pull inflation but they hardly go anywhere in controlling cost push inflation. Nevertheless SBP had been conducting treasury auctions regularly to drain liquidity from the market. If it had any effect on inflation, remains to be seen. What is most shocking was that SBP had also conducted a treasury auction on October 8th, 2008 when the liquidity problem was most acute.

Thankfully, SBP came to its senses and reduced CRR by 100bps which brought in much needed liquidity into the banking system. However, the way the above events have played out, it does not give people much confidence in the financial sector or the economic managers of the country.

Econ666: How not to manage the emerging market economy?

I don’t know why we Pakistanis think of the locally educated or locally trained professionals as inferior and are so smitten with foreign bankers. Whenever we have imported anyone, he had no idea of ground realities, experimented with the economy and left without investing his single penny in the country. If we have to resort to hiring bankers only, I am sure we can find some expert local banker or are we implying that this land is incapable of training and honing talent.

Shaukat Aziz we have already covered in earlier post. At the receiving end of my wrath now is another legacy of Musharraf era, Governor of State Bank of Pakistan (SBP) Shamshad Akhtar, someone who was unqualified to hold the top post which called for a trained economist whereas she built her career in Operations. Her only qualification was that she worked for a multilateral organization namely Asian Development Bank (ADB).

She seems focused on implementing textbook policies that might have worked in developed economies but are not relevant or effective in Pakistan recent example of which is her instruction to increase the minimum capital requirement (MCR) of banks.

Her latest fiasco is handling of liquidity crisis in banking sector of Pakistan. Banks are running out of cash faster can they can replete their reserves. Two reasons:

  1. Depositors had withdrawing a lot of cash during the Eid season
  2. With declining value of rupee, whoever can withdraw money has done it and is converting it to foreign currency.

Though as per official statements, the exhange rate is Rs.81/$1 i.e., you can buy 1 dollar for 81 rupees. However, no one will give you dollars at that rate. The actual rate in the kerb market is Rs.83/$1. To think that SBP was actually thinking recently of pegging rupee to the dollar requires wild imagination. Somebody please tell SBP governor that people have started losing faith in SBP. Fixing the exchange rate might solve the problem in economic textbooks but when panic strikes, nobody is going to sell you $ at Rs. 81 whether fixed, managed floating or floating. She might as well peg it at Rs. 75/$1.

Due to the shortage of liquidity overnight interbank call rates (the rate at which banks lend to each other to meet SBP requirements) had shot up. Though SBP had conducted Open Market Operations this week to ease liquidity, whats amazing is that SBP actually went ahead with a Treasury auction (which was rejected due to sufficient bids not received). I mean at one end we are trying to inject liquidity through OMO and on the other hand we try to suck away that liquidity by auctioning treasuries. Mind boggling…

Desperate times call for desperate actions. You don’t try to resolve crisis in piece meal reducing cash reserve requirement (CRR) by 1% this month and another 1% after one month. If the 1% is not effective in solving it right now, you cannot wait one month to reduce it further. You will do it right away and that will reduce the credibility of SBP that it doesn’t know hot manage the economy (which will not be far from truth).

For those of us who had to taken Econ102 (Macroeconomics) there are two types of inflation. Demand pull and cost push. Monetary policy like increasing interest rates, CRR or draining liquidity from the market through OMOs etc can have some impact on reducing demand pull inflation but it has negligible impact on cost push inflation. Pakistan is facing cost push inflation due to rising fuel and commodity prices and under such circumstances, the only efforts SBP had taken (prior to current crisis) are to increase CRR/SLR and increase interest rates which are totally useless under such circumstances.

Another volteface according to Business Recorder,

Governor said that banks have been advised to launch more aggressive efforts to mobilise deposits including extension of their outreach in rural areas. Offering adequate real returns on deposits would help banks alleviate any bank specific liquidity shortages.

This goes against SBP policy of encouraging consolidation among banks by raising the MCR because then banks will not have any incentive to increase deposit or extend outreach as it becomes marginally unprofitable for large banks to engage in such activities. Does SBP have any idea of its myriad actions/instructions?

Shortcut’s Short Legacy

I am still amazed at so many people still holding Musharraf-Shaukat team in high esteem for building a house of cards that came crashing down within seven months of Shaukat Aziz disappearing. I will not use some twisted economic logic to justify my contrarian point of view rather present data and information from other so-called credible sources to highlight the havoc played by the earlier regime. (However, this does not mean that I support the current regime or their management or lack thereof of the economy)

Some people had pinned high hopes on Shaukat Aziz since he was from Citibank. Those of you who don’t know, and I don’t want to engage in unnecessary character assassination here, he was a Private Banker helping corrupt dictators, rulers, etc in managing and hiding their looted wealth. He was also under investigation in US Senate as Asif Zardari had laundered away his millions under his watch.

Now since we have so much faith in western financial institutions and their employees regardless of the fact that these very employees have recently brought these institutions to the ground, I will here only refer to Citibank research report on Pakistan dated September 8, 2008 written by Citibank resident economist in London Mushtaq Khan.

Rupee weakness is a legacy of flawed policies
Although the trigger for recent weakness can be traced to adverse political development, we believe sentiment reflects economic fundamentals. The underlying problem in Pakistan is simple: the current account deficit inherited from the previous government has become unsustainable.

The consumption-led growth engineered by the policies of Shaukat Aziz was easy to initiate using cheap and plentiful credit, and self-serving – high growth, strong FDI and the stock market boom were used as trophies of success – but would invariably end in tears (rising inflation, the power shortage, a growing income divide and, more recently, the FX crisis and the stock market collapse). With little policy focus on exports, Pakistan’s ability to generate FX was quickly eclipsed by its demand for FX, as the  consumption-led growth provided a tremendous boost to imports.

As per State Bank of Pakistan data


Now look at the last two lines of the table. It shows in what sectors was all the FDI coming. Almost negligible in export oriented sectors and heavily weighted towards consumer sectors. Without any increase in export revenues, you can’t go on increasing imports forever.

The previous government did not focus on the export sector, but we feel this will have to change. ….. textile export growth has been unimpressive, while non-traditional exports like carpets & rugs, sports goods, leather items, and surgical instruments have not fared well during the previous regime. In the 1990s, non-traditional sectors were actively encouraged to reduce Pakistan’s dependency on textiles.

In the 1990s: Is Citibank implying that previous democratic governments were actually trying to improve Pakistan’s export base but all those efforts were wasted during Musharraf-Shaukat Aziz regime? I guess so. But isn’t that blasphemy to actually praise the earlier democratic governments and fault the Musharraf-Shaukat regime?

After taking Econ101 you can justify that consumer credit was the engine of growth etc. but what the numbers say is that the engine had actually been moonwalking _ giving the illusion of going forward but actually going backwards. We are actually in this crisis because of those consumer oriented policies.

In Yesterday’s DAWN, Shahid Javed Burki (a highly respected economist) had this to say

This is what the country did in 1999 and gave up growth in favour of stabilisation. It was in an effort to pick up growth that the Musharraf administration loosened fiscal and monetary controls over the economy, laying the ground for the current crisis.

The [Planning] Commission was overshadowed by the Ministry of Finance during the Musharraf period for the reason that the man who headed the ministry for the entire period did not have the self-confidence to ask for advice.

During his tenure economic policy making became ad hoc, subject to personal whims and pressures exerted by powerful groups of lobbyists.

I rest my case.

Declining currency – a crisis?

According to FT

Pakistan’s economic crisis deepened on Monday after the rupee sank to an all-time low and Standard & Poor’s, the global rating agency, downgraded the rating on the country’s sovereign debt to CCC-plus – a few notches above default level.

But should we use depreciating currency value as a barometer of economic crisis. Rupee has declined more than 20% against USD over the period of a year


But the Rupee is not the only currency declining. Here is a graph of GBP against USD for the same period


A decline of more than 15%. If we plot USD against JPY, USD has declined by more than 20%. But do you see anybody mentioning the same in the current crisis.


Though I am not denying that we are in crisis. Only we should be aware of the statistics and ratings thrown up by the press to sensationalize the news.


ADB has approved a package of US$ 500 million for Pakistan to accelerate economic transformation. Reminds of an incident in 1979 when Zia ul Haq rebuffed an offer of $325 million by Jimmy Carter as “peanuts”. We should do the same with ADB aid package.

The foreign exchange reserves of Pakistan stand around $8 billion. With monthly foreign exchange burn rate (difference between monthly import bill and export proceeds a.k.a trade deficit) of $800 million to $1 billion. At this rate, and no other sources of major inflows expected, we will go bankrupt by first quarter next year. The only impact of ADB package will be to delay the inevitable by another 15-20 days.

But I got a good laugh from reading the purpose of this loan on ADB’s website

The fiscal space created by reforms [from this package] will cut financing gaps, generate conditions for a better deal in the sectors down the road, and provide much-needed cash flow to pay for safety net programs that protect the most vulnerable. ADB’s support balances the need for addressing the needs of Pakistan’s people while reassuring markets that the government is on the right track with its ongoing economic stabilization program.

What stabilization program? I have yet to heard of a program. About ‘Safety net program’ the only news I recall was its removal where government is removing subsidies from gas, electricity and most recently wheat.

Will somebody please share with me any solid steps taken by the current government to stabilize the situation. The only thing that is keeping the country afloat is the credit crisis in the world. With everybody worried about western economies crashing, nobody has time to really step back and worry about Pakistan except for Moody’s, Standard & Poor’s and Pakistani press. We all know how credible they are.

Now the question that arises is what is needed? Frankly, a lot of money. $10 Billion per year for 3 to 4 years. Yeah Right!! Who is going to give us this money? At the way we are operating at the moment _ no one. We don’t have a plan or strategy or even an inkling of an idea to get ourselves out of this mess.

We need the first $10 Billion just to stabilize the currency. And other billions to put in place sustainable growth program. Programs which unlike the ones implemented by former banker-turned-prime minister do not result in windfall profits to just banks but the effects trickle down to common man as well.

It is not impossible. But requires honesty and hard-work two things that never come to mind when you think about the current government. Rather than use the advices of imported consultants/ ministers/ governors from Citibank, IMF or ADB where they only end up benefiting their former employers or elite segments of society, we need to use our local economist and we do have some very good ones to chalk out a strategy to take us out of this mess.

Fingers crossed.