October Issue 2003
Interview: Ishrat Hussain
“There have been no political loans given in Pakistan for the last five years” –
Dr Ishrat Hussain, Governor, State Bank of Pakistan
A: This is part of the strategy to get Pakistan back on its original path of a 6 per cent growth rate and above, with poverty being reduced to 20-25 per cent. For that there has to be a sequence of events: firstly to get a handle on our external debt problem, and that we have managed to do, by re-profiling our bilateral stock of debt over a longer period of time. Second, by substituting soft-term loans from the multilateral institutions and by paying them back their non-concessional loans. The third part was to get rid of all the expensive commercial loans, short-term debts and the foreign currency liabilities. So from 1999, our stock of debt and external liabilities has declined from 38 billion to 35 billion, which for the first time, even in absolute terms, is a decline in the external debt situation. What it has done in terms of our capacity to surface is that in 1999, we paid close to 6.5 billion for debt servicing. Now debt servicing has come down to 4 billion and this accounts for only 25 per cent of our foreign exchange earnings. In 1999, 66 per cent of our foreign exchange earnings were going for external debt servicing, so this is a significant decline in our external sector cash flow management. The result is that we have a current account surplus which is equal to 7 per cent of GDP.
Q:Is this the first time we have achieved such a large surplus ?
A: Yes. People keep saying that we have received a lot of grand assistance and reimbursements from the US after 9/11 — even if you exclude that, we have a current account surplus of almost 3.6 billion dollars, which is almost 5 per cent of our GDP. Our dependence on borrowing has declined in a fundamental way. The second part of our strategy was to provide fiscal space for development expenditure. So monetary policy and the fiscal policy had to be coordinated. The government fiscal deficit has been reduced from 7 per cent of GDP to 4.3 per cent of GDP. By reducing fiscal deficit and allocating less resources towards debt servicing, those sources can be used for development expenditure. So the monetary policy has to be synchronised with the fiscal policy, and the weighted average rate of the six-month table, which is what the government is borrowing. That has now come down to 2 per cent, saving the government a lot of money which went towards both external and domestic debt servicing. Instead of 66 per cent of the revenues being allocated for debt servicing, we were able to spend only 36 per cent this year. Consequently public sector development expenditure has risen from 100 billion rupees to 130 billion rupees. This year we are going to have 160 billion rupees so in two years time there is an increase of almost 60 per cent for public sector development.
Q: But this macro-economic improvement has been marred by unemployment, while most of the investment has come in real estate and the stock market.
A:I think we have to get the facts right. It is true that the investment ratio has remained stagnant, and there has been no job creation in the formal organised sector of the economy. But don’t forget that jobs were being created in the past in public sector organisations. For instance, though the Steel Mill needed only 10, 000 people there were 25,000 employed; if the banks needed 50,000 people there were 100,000. So this massive over-staffing was resulting in operational losses and the government was footing a bill of almost 100 billion rupees. The poor need education, health, a clean water supply and sewage. They need farms to market roads and irrigation channels. If you are spending 100 billion rupees to offset the losses of your public sector corporations because you have created jobs, this hardly helps poverty reduction. So, while it is true that this government has not created any jobs in the public sector, it is also a fact that jobs are generated through larger economic activity — in the agriculture, SME, services and the construction sector. Therefore, policies have to stimulate activity in those sectors. In agriculture you have to upgrade growth rates. Unfortunately, for three years we have had a drought, so activity is down. In construction and housing, we have given a lot of incentives. Budget, mortgage financing, consumer financing etc, have been given prime importance as far as credit policies are concerned, but it will take some time to get off the ground. The linkages between the construction industry and housing and other industries in Pakistan is very strong: 37 other industries are dependent on housing and construction. This also helps the middle class because the banking sector in Pakistan so far has concentrated only on the corporate sector and trade financing. They have done nothing as far as the middle class is concerned. We have created a low interest environment in which a young couple instead of renting an apartment can now afford to pay a mortgage instalment at about the same rental amount. If the demand for this picks up, it will help both the middle class as well as the construction industry. The problem in the SME sector is that we have some regulations, which are not suitable for SME financing. The central bank is trying to make a new set of potential SME regulations whereby relaxation will be given to the banks to provide financing to the SME sector. These are the building blocks through which we hope to stimulate financing and economic activity and that will create jobs in the economy. Our IT industry was about to take off before 9/11 and we had started getting orders from US companies for subcontracting and outsourcing, but after 9/11 those companies cancelled their orders because they felt that Pakistan was a frontline state and therefore the services might have been affected. So that was a big setback.
Q: Would you agree that the flow of US aid and the debt — scheduling has been quite helpful?
A:Debt-scheduling was taking place because of our compliance agreement with the IMF. Even if there was pressure from the US after 9/11, we would never have received the debt scheduling, because that was a condition of the Paris Bank and this was happening even before 9/11. The case for debt profiling was prepared before 9/11 because we had completed, without any interruption, the ten-month standby program and we qualified for the PRGF facility of the IMF, which is the precursor for debt re-profiling. Many people confused debt reprofiling with 9/11, but actually it took place in December 2001 and the spade work had been done way before 9/11. The US has provided us a billion dollars in cash and it has written off one billion dollars of debt, but if you look at the loss of one billion dollars in exports and the loss in the IT industry, I think we have come out quite well.
Q:What about the increase in remittances? .
A: That is also based on a lot of misunderstandings. When the Nawaz Sharif government liberalised the economy in 1991, there were two channels through which remittances would come in: one was remittances for consumption purposes which were coming from banks, and one was the foreign currency deposits. So 3 to 3.5 billion dollars were coming into Pakistan through the foreign currency deposits and through remittances. On May 28, 1998, when the foreign currency deposits were frozen, this channel dried up, and all this money started coming in through the kerb market through money changers. The central bank, because it was short of foreign exchange, started purchasing from the kerb market. So we collectedtwo billion dollars every year. We got a billion from official channels and two billion from the money changers. Come 9/11, this money started flowing back through banking channels instead of coming through the kerb market, because there was action taken against the money changers in Dubai and in the US. Yes, we got 500 million dollars more than what we were expecting. So there is some increase, but this year our budget for remmittances is back to 3.6 billion dollars. We got a windfall gain of almost 700 million dollars after 9/11. But this was a one-off thing.
Q: Despite the government’s claim of improving the economic fundamentals, foreign investment has not picked up yet and domestic investors are also hesitant. The only major investment has come in the textile sector. Why are investors still shy?
A:I think there are two reasons for this: the textile industry has balanced, modernised and replaced its old machinery. In some cases the machines are so modern that they are displacing labour . We have 3-4 billion dollars of investment in textiles but it has had only marginal repercussions on employment. The other part of foreign investment is going into the oil and gas sector, which is also very capital intensive, but does not create employment. Cement, sugar, the automobile industry — all of them have excess capacity. When you have excess capacity it does not make sense to go in for new investments. The only sectors where jobs can be created are agriculture, small and medium enterprises and housing and construction. Hubco, which is a 1.5 billion dollar project, only employs 200 people. Parco, an 800 million dollar project, employs less than 400 people. Jobs will not come through these big projects. The issue is always confused, you can have a lot refineries and power stations worth billions of dollars, but that is not going to solve the employment problem. For example tourism in this country, has completely dried up after 9/11. Tourism is a highly employment-intensive industry — people need transportation, hotels, restaurants, entertainment, etc. However, the Northern Areas for example, which were dependent on tourism and earned a fair amount of foreign exchange, have suffered. These are the shortfalls of being a frontline state. The chief executives of some companies have told me that they can’t get insurances to visit Pakistan. Many airlines have cancelled their flights to Pakistan. These are some of the difficulties that are preventing us from reaping full dividends from the improvement in the economic fundamentals.
Q: Why do you think the investment climate has improved now?
A: Domestic investment is picking up in bits and pieces. The automobile industry has increased tremendously during the last three years. Car production has gone up from 30,000 to 60,000. The auto parts industry has now invested a billion rupees in expanding its capacity and for the first time they are exporting their products. Credit and monetary policy will push aggregate demand through consumer goods, housing and the auto industry. This will have backward linkages with production. The interest rate environment today is extremely favourable: the average rate has come down from 14-15 per cent to 7 per cent. Never before in the history of Pakistan can you find such low interest rates. There is liquidity with the banks who are competing with each other. All the regulatory hurdles have been removed for new products and new means of financing. We are doing things which will stimulate domestic investment.
Q:Can the growth rate be sustained?
A: Yes, provided you have political stability, no problems on the geo-political side and no natural calamities. Between 1999 and 2002 we had four major external shocks: global recession, a three-year drought, 9/11 when we became a front line state and the mobilisation of troops with India which translated into further expenditure on defence. Then there was the Iraq war. Despite all this, however, we have achieved a 20 per cent growth in exports, built up our current account surplus and achieved a 5.1 per cent growth rate. If the effects of these shocks can be nullified, there is no reason why we cannot reach a six per cent growth rate in two years time
Q: What are the problems in the way?
A:Three problems. One is political stability. We have to demonstrate that the democratic form of government and good governance are compatible. The Jamali government has continued with the same policy as General Musharraf and if it continues for five years, I can assure you there will be a paradigm shift in the thinking of both Pakistani and foreign investors. Second is that for poverty reduction, we have to depend on local governance to articulate the needs of the people and deliver at the lowest cost. If we are not able to nurture and sustain the capacity of the local government and provide them with the requisite financial and administrative powers, it will not result in poverty reduction. The third is the geo-political situation: if we have peace in the region and our borders are secure, I think that will give a big boost to the economy.
Q: The poverty level has increased substantially in the past decade. What is the government doing to deal with this?
A: What is required is a focus on agriculture. If we do not provide infrastructure , social services and the right prices to our farmers,then we will never be able to achieve meaningful poverty reduction. You also need some social safety nets for those who have no assets, land or skill. We need Bait-ul-Maal, Zakat, Khushali programmes and Khushali banks which give micro credit. If we do not provide safety nets for the poorest of the poor, or do not concentrate on the agricultural sector, and if we do not have a high growth rate, we will never be able to reduce poverty. We have to get back on the path which we have drifted away from.
Q: Pakistan says it has done a lot to eliminate the hawala system. But the recent increase in the gap between the kerb and the interbank rates indicates a resurgence in hawala.
A: By June 2004, we want all the money changers to organise themselves either in the form of an exchange company which the central bank will be regulating, or become the franchisees of those exchange companies for which we originally issue licenses. They are trying to create problems for these exchange companies and that is the reason why in July and August, you saw an increase in the spread between the interbank. Today, it has come down to almost the same levels. The message is very clear: we are quite determined to eliminate money changers because it’s not possible for us to regulate 480 money changers all over Pakistan. It is easy for us to regulate 15 to 20 exchange companies and these exchange companies can have branches and money changers as their franchisees. There are elements within the money changers community who want to defeat our endeavours but we have made it very clear that we’ll go ahead by June. We have taken steps on the freezing of accounts. Pakistan is the largest contributor to frozen accounts and we have reported this all over the world. Second is money-laundering. We are going to put in a stringent law, but even now there are regulations for knowing your customers, opening new accounts and reporting of suspicious transactions. Regulations have become very tough and we are training our bankers in money laundering activities. So we are way ahead of many other countries. It’s one thing to have a law and another thing to implement it, and you can implement it only if you have trained manpower.
Q: How effectively have we utilised the foreign aid which came in post-September 11 and the debt scheduling?
A: I think we have utilised it to completely waive off our debt to the US and we will continue to press for the remaining 1.8 or 1.9 billion to be completely waived in the next appropriation, which Pakistan will get after Camp David. Our debt situation will improve, and debt stock will go down. We are taking care of the fundamental structural problem. It is not something that will come back and this is the best use for the assistance we have received.
Q: Pakistan has large foreign exchange reserves. Does the State Bank have any plans to invest it?
A: We were always borrowing in order to build our reserves so we didn’t have the in-house capacity in the central bank to manage this large amount. The first thing that we have done is to engage an international consultant who is helping us build our own capacity. We will allocate these funds with international fund managers, who will be given a benchmark of what we expect them to earn for us. We have selected the international consultant firm and they have started working on the business plan. Once our board approves it, we will go for the placement of these funds with the international fund managers.
Q: One of the major tasks the government had undertaken was to reform the banking system. How successful has that been?
A: I think if you read the international financial institutions reports, they’re all unanimous that the major success story of Pakistan have been the banking sector reforms. This has been a long continuous process which was started some time ago. The idea is to have a managed banking sector with a healthy competitive environment, but regulated very strongly by the central bank. We have a two track approach. We were successful in privatising Habib Bank which is just around the corner. Eighty per cent of the banking assets in Pakistan will be in the hands of the private sector. There are very few developing countries that can boast of this particular achievement. Ten years ago 90 per cent of banking assets were in the hands of the public sector in Pakistan, so within a decade we have been able to transform the banking sector from a public sector monopoly to a healthy, competitive private sector industry. Secondly, we have an autonomous central bank which has developed the competence, expertise, technology and the know-how to regulate the banks so that they are performing according to the rules of the game. We had to change the ownership of two commercial banks,suspend the board of directors, de-bar some bankers from lifetime banking and merge a major financial institution with another bank. Today a family, even with 100 per cent ownership, can have only 25 per cent membership on the board of directors. Seventy-five per cent of membership will be made up of independent professionals. We have a proper criteria for the board members and for the chief executive. For example, if you are a stock market broker, a money changer, or you are doing any other business, then you cannot become a board director, because there is a conflict of interest. We are forcing owners to give up their ownership of the banks and hand over to professionals who fulfill those criteria. Then there are the risk management guidelines. There have been no political loans given in Pakistan for the last five years. Every loan has been given on merit and that’s why the performance of the banking sector has improved to the extent that only five per cent of loans are non-performing and 95 per cent recovery has taken place.
Q: When did this begin?
A: From 1997 onwards, almost all new loans are being paid on time. So the NPL ratio, which used to be 25-30 per cent is down to five per cent. The international norm is five per cent and above. So this is a big change. If you look at all the banks, today they are being managed by professionals of the highest integrity. They have not been inducted on the basis of sifarish. And this is a huge change in the banking culture in Pakistan. Recruitment is taking place on merit alone.
The writer is a senior journalist and author. He has been associated to the Newsline as senior editor at.