November Issue 2008

By | Business | News & Politics | Published 11 years ago

The devastating suicide blast at the Marriott Hotel in Islamabad, apart from its heavy death toll, also had severe economic ramifications. The first economic casualty of the blast was the hotel industry, when a majority of foreigners cancelled their advance bookings at hotels in the capital and other cities. Similarly, many meetings and conferences in the hotels have either been cancelled or postponed.

But this was only the start of the capital and human flight that is a direct consequence of the Marriott blast and other terrorist attacks in urban areas. An IMF team, which was holding technical consultations with Pakistani officials on a plan for macro-economic stabilisation, cut short its visit after the blast. British Airways suspended all its flights into and out of Pakistan, while the US and UK embassies shut down their visa services for a few days.

The unkindest cut is that the woman is based in Amritsar, the holy city of the Sikhs, located in the eastern part of Indian Punjab.

These incidents are part of a broader pattern which has seen a marked increase in the flight of capital — both foreign and domestic— out of Pakistan since terrorism became an everyday concern. Many Pakistanis are expediting the shift of their capital to Dubai and other investor-friendly countries, while Pakistan’s stock exchange, which was already at its lowest point in a decade, has devalued even further. The Pakistani rupee has also gone down to a new low of about Rs.84 to the dollar.

Brokers have pointed to the worsening law and order situation in the country, including terrorism in the tribal areas, as the main reason for this capital flight. The increasing prices of essential commodities and the withdrawal of foreign investors’ portfolios has further intensified the sluggish trend of the market. Further problems include the judicial crisis and the American attacks within Pakistan’s borders.

In such an economic scenario, the small investor is usually the hardest hit. Of particular concern has been the declining rate of return on mutual funds. There are over 300,000 unit holders of various mutual funds in the country, mostly in the private sector. Most of these units are based on trading on the stock exchange, and so have suffered greatly.

According to official data, the cumulative withdrawal of foreign money from the capital market from January 1, 2008 to July 18, 2008 was $288.351 million. Data compiled by the National Clearing Company of Pakistan indicates that another $111.032 million was withdrawn by foreign investors from the country’s equity market in only the last month. Companies with foreign direct investment repatriated $735 million of the profits and dividends from Pakistan during the first 10 months of the last fiscal year, which was 12.2% more than the $654.9 million repatriated in the corresponding period the previous year, according to figures released by the State Bank of Pakistan. In an attempt to contain the flight of currency, the central bank restricted exchange companies to sending out of the country only 78% of the home remittances it had received.

The economic effects of the capital flight are already being felt in Pakistan, as inflation has increased and the central bank has been forced to increase the interest rates from 10-12% in an attempt to contain it. The country’s economic indicators were already dismal, and the flight of capital has further aggravated them. The GDP during the financial year 2007-08 was 5.8%, below the projected figure of 7.1%.

Majyd Aziz, a leading industrialist and former president of the Karachi Chamber of Commerce, says, “Investors have no confidence in Pakistan’s economy.” He claims that after earning huge profits, the foreign investors have repatriated their profits and capital and that now, even Pakistanis are investing in real estate in Dubai and other Middle Eastern and African countries, rather than investing their money at home. “There is the fear of Talibanisation and attacks by American forces inside Pakistan. So how can one invest?” asks Aziz.

Experts have some advice for the government to try and overcome this crisis. Dr Shahid Hasan Siddiqui, a senior economist and chairman of the Research Institute of Islamic Banking and Finance says, “Instead of relying on liquid portfolio investment in stocks, which often creates liabilities, the government should encourage overseas Pakistanis to invest in Pakistani banks with a fixed mark-up for a short period of time.” He said this would help contain the depreciation of currency and improve the foreign exchange reserves. He also says, “We have witnessed investment in the telecom, banking and services sector, which was not actually helping exports.” Instead of creating import substitution, this investment has created liabilities for the country because most of the profits earned from these services have been repatriated.

“The only area of concern for us is the depreciating currency,” says Dr Asad Saeed, an independent economist and director of the Collective for Social Science Research. He maintains that investment in real estate and capital market is actually speculative liquid capital and its withdrawal will not harm the economy much.

However, he agrees that this flight of capital from stocks and real estate has created volatility in the exchange rate, because huge amounts have been transferred through the non-banking system of hundi. The devaluation of currency would be reflected in an increase in imports and repayment of foreign debts and services, thus depleting the foreign exchange reserves. The currency fluctuation also has inflationary impacts.

In such a situation, when the exports are not rising in proportion to the imports, Pakistan would have to look again at the international donors like the IMF by the end of this year, Dr Saeed says.

The country’s foreign exchange reserves have been depleting rapidly due to a growing gap between imports and exports and the present government has not been able to plug this drain. No major measures have been taken to attract new foreign direct investment. The present government has still not chalked out its privatisation programme. Foreign exchange reserves have reached at an alarming level of below $9 billion. Pakistan’s forex reserves fell to $8.8 billion in the week ended on September 20, from $8.91 billion a week earlier, the State Bank of Pakistan statistics reveal.

According to economists, out of these reserves, the State Bank holds only $5.4 billion, which are equal to two months of imports. A halt to privatisation programmes has further added to the dryness of the reserves.

The rising prices of petroleum products in the international market and costly imports of food items has further swelled the import bill of the country, which, according to Federal Bureau of Statistics (FBS) data, touched a record level of $39.968 billion during the fiscal year 2007-08 against $30.539 billion last year, thus increasing by 30.87%.

Although the country has achieved the $19.2 billion export target in the fiscal year 2007-08 amid depreciating currency, the trade imbalance is still growing rapidly. It rose to an all time high of $20.745 billion by June 2008 from $13.563 billion in the previous year showing a 52.95% increase, which has further worsened the trade imbalance.

Local businessmen and traders are not happy with the state of affairs of the economy and say that only political stability and incentives to local export-oriented industries can save the economy and halt the flight of capital.

According to Majyd Aziz, former president of KCCI, only exports can save the economy and the local export-oriented industry needs a pull in the form of incentives and a reduction in the input costs. The recent increase in electricity and gas prices has escalated the cost of doing business. The transport charges have increased due to a hike in petroleum prices and the cost of raw material has doubled due to the withdrawal of subsidies.

In such a situation, economists and traders are not so hopeful as they think the economy can only be stabilised if the government shows political will. After a supply of oil by Saudi Arabia on a one-year deferred payment and increasing remittances, there would be some stabilisation to the foreign exchange reserves. The World Bank has also assured Pakistan that it will provide a $1.377 billion package to help Pakistan overcome its economic problems. All these measures may give some respite to the dwindling economy, but until the economic indicators show a marked improvement, Pakistan’s economy will remain under pressure.