December issue 2010
Interview: Ishrat Husain, Director of IBA and Former Governor of the SBP
“This country has always come out of economic crises —
ours continues to be a very resilient economy”
– Dr Ishrat Husain, Director of IBA and
Former Governor of the SBP
Q: Is raising the interest rate the right tool to control inflation?
A: Yes. We don’t have any other option. If prices of commodities go up beyond a certain level then people start to hoard products, and that could be devastating.
Q: According to the State Bank of Pakistan (SBP), one of the main reasons for raising the discount rate is inflationary government borrowing. What do you have to say about that?
A: There are reasons for high government borrowing. Firstly, policymakers set unrealistic targets in the budget (2010/11). Also, high expectations were attached to foreign aid and grants, which didn’t come. Then the war expenditure exceeded the amount set aside for defence in the budget. Thirdly, the flood and its aftermath increased government spending. Lastly, under the new NFC (National Finance Commission) award, the federal government’s share in revenue has reduced. So it has lesser room to manoeuvre.
Q: Till mid-November, the government had borrowed Rs 266 billion from the central bank. Is there any way of stopping this inflationary borrowing?
A: Not until there is a law prohibiting it. A bill is pending approval in the National Assembly that will allow the State Bank’s board of directors to set limits on government borrowing.
Q: So this means the central bank is not independent?
A: Not exactly. There is little that the central bank can do at the moment if the government needs the money. It can issue market treasury bills and the mechanism works automatically. So the SBP can’t stop it.
Q: Do you think the tenure of the governor SBP should be extended, just like in the case of the US Federal Reserves’ chairman?
A: Definitely not. I completed two terms and was offered another extension of three years. But six years are more than enough. You have to realise that this is Pakistan and not the US. Here there could be too much political interference if one man stays in the office for a longer duration. Nepotism will set in and officials will start appointing their relatives.
Q: You are credited with bringing about reforms in the central bank and the finance industry. Can you tell us a little bit about it?
A: The first major step we took was the privatisation of state-run banks. Some of the banks were incurring heavy losses, but now they are profitable; they pay dividends to shareholders and taxes to the government.
Then, we invested a lot in human resources and technology at the State Bank. There was a time when international financial institutions used to come and audit us for the work we did. Now, the World Bank and the Asian Development Bank take our assessments of the economy as authentic, without asking any questions.
Most importantly, we set the tradition of publicly speaking out against the government. That was something truly new and revolutionary.
Q: But if the financial structure which you helped build was so strong, then what is happening to all the smaller banks? Some of them can’t even meet the minimum capital requirement?
A: That was the whole idea. The philosophy behind the reforms was to “end” the smaller banks and create larger and stronger institutions. There is no need for so many banks. We need only 20 large banks in a market like ours. The smaller ones should merge with the larger ones.
Q: Then what went wrong with consumer banking?
A: First you need to help dispel a misconception about consumer banking in Pakistan. The general perception is that cheap money made things harder for the people. That is not true. Imagine a man who wanted to a buy a bike but didn’t have the capital. Well, consumer banking helped him buy that on easy instalments. Is it easy for a salaried person to buy property? No. He lives on rent, which does not help build assets. The banks helped him buy an apartment, paid for in easy instalments.
Consumer banking actually helped create wealth.
Q: But banks really went too far with consumer banking. They ignored the moral hazards and the problem of asymmetric information associated with lending.
A: That’s not correct. When we started out in 1999, the banking industry had non-performing loans (NPLs) of 25%. Today, the gross NPLs stand at 10%. You have to realise that a private bank would never lend if it fears default. That was the problem associated with nationalised banks in the 1990s. We had to write off all that bad debt to give them a push.
As far as the performance of the banks is concerned, when the economy takes a downturn, the banks take the losses.
Q: Coming to the economy now, where do you think the country is heading with the recent bomb blasts, the political crisis, the imposition of new taxes and the government running from pillar-to-post with a begging bowl?
A: This country has always come out of economic crises — ours continues to be a very resilient economy. There are not many countries which have had 5% GDP growth, on an average, over a span of 50 years. Ups and downs come in any economy. The economy went down in the ’70s and then up again in the ’80s. It has been like that ever since. But the problem is that we as a nation forget our past very quickly. That is why there is so much talk about gloom and doom. I believe, the more challenges an economy faces, the more resilient it becomes.
Q: Do you really think we have become more resilient?
A: I will tell you what the situation was in 1999. We did not have money to pay for the oil which was loaded on a ship and anchored at Keamari, Karachi. There were military and nuclear sanctions imposed on the country. There was negative economic growth in 2001. When we went to the IMF, there were 39 conditionalities that we had to fulfill. In the latest arrangement, there are just three conditions.
Q: What are those three conditions attached with the IMF loan?
A: They want you to bring the Reformed General Sales Tax (RGST) regime, reduce fiscal deficit and government borrowing from the central bank. That’s all.
Q: Isn’t the RGST going to flare up inflation?
A: That is not true. As a matter of fact, it will bring all those businesses which are not paying the sales tax under the tax net.
Q: Do you think taxes should be increased — especially that one-time flood tax on the salaried class?
A: We have to raise taxes. But the burden should only fall on people who hold assets. The principle I advocate is that of burden-sharing, irrespective of one’s profession.
If someone feels like he is paying all the taxes while the other is not, then this leads to tax evasion. More people should be brought under the tax net.
In recent years, there has been a major shift in the economy. The urban fixed-income people, who represent the middle class, have reduced in number. On the other hand, the rural population is becoming more prosperous, especially when you look at the rise in prices of rice, sugar and wheat. This gives us another reason for taxing the agriculturist.
Q: Why should the citizens of Pakistan not be sceptical about the IMF when it is calling for an increase in power tariff and taxes?
A: Okay, let’s assume for a moment that there is no IMF. Don’t you owe it to your country to pay for the cost of electricity being consumed? There is a wide gap between the cost of power being produced and what is being paid for it. Someone has to foot the bill.
When you pay for that gap from the national exchequer, you sacrifice the necessary expenditure on health and education. Surely, there is an urgent need to fix power distribution companies, which have high line losses. But as a good economic manager, I have to balance my books!
Q: The World Bank has backed off from financing coal-fired power plants in Pakistan. Energy is the most important thing we need.
A: They have just changed their priorities. The focus has shifted towards cleaner fuels and green technology. The World Bank and ADB are paying millions for dredging at Karachi coast where a deep water container port is being built. That will help increase trade and bring ships here from across the region.
Q: Should we always look up to the United States for financial assistance?
A: There is no need to. Seventy per cent of what the US gives to us is taken back by their own consultants appointed to work on the projects.
Q: Don’t you think that the IMF should push for austerity measures in Pakistan just like it is doing in Greece and Ireland?
A: We don’t have a government that spends a lot on the social sector like pensions and retirement benefits. So it really doesn’t matter.
Q: What steps need to be taken to improve the economy?
A: The development programme of the federal government is spread all over the place. Money is going to many different projects without anyone giving any thought to the need of the hour. All the projects should be completed as per priority. Electricity and water projects should be completed urgently. Then the schemes which are near completion must be given funds. Most importantly, the loss-making public sector enterprises have to be privatised.
Q: Where do you see the economic growth in coming years?
A: I am looking at a GDP growth of 4-5% in the next five years. But the potential for economic growth remains at 6%.