June issue 2002
The Maths of Mayhem
The continued economic stability of the subcontinent hinges on developments in the political and security environment in the months ahead, a fact well established during the ongoing war posturing in the region.
Pakistani stocks fell by 15 per cent and Indian stocks by nine per cent, soon after Atal Behari Vajpayee declared it “time for a decisive fight.” Both Karachi and Bombay stock markets bounced back within 24 hours as the Indian Prime Minister took a U-turn, stating the absence of war clouds on the horizon, but adding the disclaimer that lightning might still strike.
In the process, the Indian rupee hit an all-time low at IRS 49.08 to the dollar, before the Reserve Bank of India pulled it back up to IRS 48.98 per dollar. For the first time in the last 36 weeks, Indian reserves posted a decline of 135 million dollars, resting at 55.5 billion dollars, worth approximately six months of imports. But warning signs were present as Standard and Poors indicated a possible downgrading of Indian sovereign ratings, which were already below the investment grade at BBB. As a result, some foreign fund managers have liquidated their positions, and an overall capital flight amounting to 73 million dollars has been registered in just a few weeks.
India has received over 12 billion dollars in capital flows last year, against just over 600 million dollars foreign direct investment (FDI). A change in investor perceptions, or fear in overseas workers can prove damaging in the long run. However, India’s external debt burden, at approximately 100 billion dollars, does not pose any immediate threat given the reserve position.
Pakistan’s interbank rupee-dollar parity remained firmly in place at a little over 60 rupees to the dollar, but the kerb market experienced wild swings between 60.30 to 61.30 rupees to a dollar. The forex reserve position marginally improved to 5.38 billion dollars on the back of large inflows. However, FDI flows were still not very attractive at 300 million dollars. Portfolio investment till end-April was negative, at two million dollars.
On the basis of large inflows and falling import requirements, Pakistan’s current account balance at end-March 2002, stands at an unprecedented surplus of 2.1 billion dollars.
According to the official State Bank of Pakistan (SBP) data, this remarkable recovery is based on a quantum jump in remittances, a contraction in the trade deficit, outright purchases, grants, US payments under ACSA, the Saudi Oil Facility (SOF) and higher profits from Pak telecom. During 2000-01, the current account surplus was 331 million dollars.
Recovery on the external account was particularly strong after the events of September 11, which provided new challenges as well as opportunities to the Pakistani economy. Pakistan’s support to the international coalition against terror, the drive against the hawala system, the rising strength of the rupee against the dollar and a slowdown in international trade and debt rescheduling have all contributed to the stabilisation of the external account.
Exports from Pakistan were a major casualty of this situation, with the momentum achieved in the last two years disrupted as a result of leading American buyers cancelling and suspending orders for Pakistani products. The additional quotas, mainly provided by the European Union in January of this year, helped to some extent, as trends were positive during the month of April. However, as a whole, the contraction in trade narrowed down the deficit from 1,177 million dollars in July-March 2000-01 to 286 million dollars in the corresponding period of the current fiscal year.
The Acquisition and Cross Servicing Agreement (ACSA) between Pakistan and the United States, to facilitate reciprocal logistics support has also helped. Items permitted under ACSA include food, water, transportation, POL, communications and medical services. It also covers the use of facilities, training services, repairs and maintenance. In addition to normal billing of fuel, water and communication charges, the government also charges for facilities like air bases and storage offered to US forces in the region. The first payment due till end-December is 300 million dollars. Official sources indicate that an amount of 60-70 million dollars will be charged per month on this account from the United States.
Central Bank data has not provided particular details, but under the category of ‘other goods, services and income,’ an amount of 431 million dollars has been shown, against a negative 43 million dollars of the corresponding period last year. This could be the result of ACSA payments, and higher profits of Pak telecom, due to the heightened international activity in the country.
During this period, the Central Bank bought 1,068 million dollars from the kerb market to shore up its reserves and absorb excess liquidity from the market. The Bank also purchased 1.6 billion dollars from the official interbank market. However, purchases from the interbank market were not explicitly shown under ‘current transfers,’ as the Central Bank maintains that this only involves a change in accounting heads, from authorised dealers to official reserves.
These purchases have mainly been made from export receipts and workers’ remittances and services, which belong to the state. These purchases were necessitated as large inflows and weak import requirements were appreciating the rupee value of the dollar, adversely affecting exports from Pakistan. The rupee-dollar parity had narrowed from 64 to 60.07 rupees to a dollar in the previous seven months, showing an appreciation of about seven per cent.
Remittances of overseas Pakistanis have also increased in the changed international security scenario, with the FBI launching investigations in the US against the hawala system in order to detect terror-related flows. At end-April, remittances totalled 1.87 billion dollars.
The current account was also supported by a change in the accounting of the Saudi Oil Facility (SOF), from non-food aid to official transfers. Pakistan received this facility from Saudi Arabia after the 1998 nuclear tests. This year, the SOF, a free oil facility, is expected to total over 600 million dollars.
These positive trends have helped the Central Bank to build reserves and liquidate some of the expensive commercial debts and rupee-dollar swaps.
As a result, Pakistan’s total external debt, also reflecting the impact of rupee appreciation on the rupee-denominated external debt, declined from 38.43 billion dollars on June 30, 2001, to 35.93 billion dollars at end-March 2002. Military debt also fell from 825 million to 778 million dollars in the period under review. New arrangements with international creditors also facilitated a fall in domestic debt as there was less demand for budgetary financing. Domestic debt also declined by over 100 billion rupees in this period.
Pakistan’s total official foreign exchange reserves, including money held by the commercial banks, is likely to be in the range of 6-6.5 billion dollars by end-June 2002, as the Bank intends to continue its purchases. Large payments are due from the multilaterals, including 500 million dollars from the World Bank, and other factors such as remittances and payments under the ACSA and SOF will continue in the given period.
Despite these positive factors, the economies of both the countries are facing a threat of destabilisation due to growing tensions on the border. Almost half of the world’s poor live in the South Asia region. A so-called limited war or any other sort of adventurism could lead to a great catastrophe, in which ordinary people would suffer.
Independent analysts reckon that the Indian military build-up serves three purposes in this scenario: forcing Pakistan to end its 20-year old Kashmir policy, keeping Pakistan under pressure to squeeze out more concessions on the western borders, and scaring away any prospective foreign investors that could have come in on the back of new found relations with the developed world, particularly in the privatisation process.
All these objectives have apparently been achieved. A report leaked by the Hindustan Times, claiming that India had agreed to give Pakistan two months time for clamping down on infiltrators, and the official reiteration condemning cross-border terrorism, is seen as part of the game plan. The Pakistani government has, for the first time, pledged that nobody will be allowed to use Pakistani territory, or the territory whose defence was its responsibility, as a staging ground for cross-border terrorism anywhere in the world.
In this game of give and take, both countries could suffer political setbacks, at home and abroad, but Pakistan is obviously more vulnerable. Despite Pakistan’s support in the strikes aginst the Taliban, it is the Indians who clearly have the backing of the West, as evidenced by EU External Affairs Commissioner Chris Patten’s linking of current events with UN Resolution 1373 on terrorism.
Going forward,this could remain a crucial issue. Pakistan’s foreign policy and economic interests are so closely interlinked that one mistake in the former could adversely affect the latter.
At a time when the budget for the fiscal 2002-03 is just around the corner, the government has to assure all its international creditors that it will stick to its announced policy objectives, both in the field of the economy and in terms of its regional security arrangements.
While the political trade-offs are clear, their success will determine the fate of Pakistan’s economic goals. The government has indicated a growth rate target of 4.2-4.5 per cent next year, depending upon the final GDP estimates for the current fiscal year, which includes higher development spending of around144-150 billion rupees to dent poverty, foster growth and create more job opportunities. All this will have to be achieved while maintaining a low budget deficit of 4.2 per cent, down from 5.7 per cent of the current fiscal year, by reining in spending on defence.
For the current fiscal year, large tax revenue slippages and additional defence spending of at least 15 billion rupees will be compensated by an almost 30 billion rupee shortfall in the programmed Public Sector Development Programme (PSDP) and savings on the account of debt servicing. Latest growth estimates indicate a 3.2 per cent growth for the current fiscal year, with a low inflation rate of three per cent.
For the next fiscal year, the continuation of the economic reform agenda and implementation of painful measures, particularly on the taxation structure, will need political stability and the support of the international community, which should allow generous funding and the necessary breathing space to ‘do more’ — a demand which the United States and other allies of the anti-terror coalition have voiced repeatedly.