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An attempt at explaining Pakistan's Economic Woes By Ali G

Feb 22, 2014
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Let's start the discussion by looking at the exchange rate . We always hear people saying that Ishaq Dar kept the rupee at an over valued rate which created difficulties for the incoming PTI Govt in 2018.


let's look at the REER (real effective exchange rate). Let me first explain REER. In simple words, REER shows the buying power of a currency at home vs abroad compared to a base year. In the graph below 2010 is set as the base year.

Now if the index goes above 100 that means PKR's buying power abroad is more than buying power at home, in other words, the currency is overvalued, and it's cheaper to import products rather than buying locally made products. The opposite is true if the index goes below 100.

Now looking at the REER graph for Pakistan it is quite visible that the currency was indeed overvalued during Ishaq Dar's term.

This was also confirmed by Miftah Ismail in 2018 while giving an interview to Bloomberg.


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As a result of an overvalued currency Pakistan's import rose sharply from $44.6B in 2013 to $60.1B in 2018 & at the same time our exports fell from $25B in 2013 to a low of $20.3B in 2016 and slowly rising again to $23.3B in 2018 after devaluation by Miftah Ismail

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Owing to lower exports and a sharp increase in imports Pakistan's trade deficit worsened from $15.7B in 2013 to $34.9B in 2018. The current account Deficit went from $2.5B in 2013 to $19.9B in 2018.
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When PTI assumed power in 2018, Pakistan's Net Foreign Reserves held by the SBP had fallen to $7.2B after reaching a high of $18.1B in 2015. As the graph's above show, a sharp increase in imports and REER around 2015 and a decline in exports



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Pakistan's Current Account deficit was at $19.9B in 2018, which means the country had less than 6 months of $ to meet its external payments and was at the verge of bankruptcy. We needed a bail out and we needed it quick.
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Pakistan looked towards IMF once again for a bail out but IMF doesn't just hand out money, they ask you to correct the mistakes that brought you in the position where you had to seek a bail out.


Pakistan's biggest mistake was maintaining an over valued rupee and IMF asked Pakistan to adopt a flexible exchange rate instead of a fixed one. This meant that rupee was to be devalued to bring the REER down.


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An expensive USD meant that all our imports cost a lot more now and since we import a lot of necessities like lentils (daal) this created a very bad effect on all of Pakistan's population and reduced the buying power of a consumer in Pakistan.

It created a sharp increase in inflation and wages could not keep up with the increase hence reducing real wages. To curb inflation SBP had to increase interest rate which also increased the cost of doing business.

To explain why SBP had to increase interest rate we need to understand that banks lend based on real interest rates not on nominal interest rates. Real interest rate is nominal interest rate - inflation. The next tweet gives an example of why that is.

Lets say bread costs Rs.100 & u come to me asking for a Rs.100 loan and promise to pay me Rs.105 next year (5% interest). A year later when you pay me back, inflation turns out to be 10% and bread is now 110. Even though you gave me more money than you borrowed...

...my buying power has gone down. I could buy bread a year ago but I can not buy bread now. This is why real interest rates need to be positive other wise banks would not lend money to anyone.

High interest rates also slow down business activity which contributes to bringing down inflation. In other words we had to shut our whole economy down, fix the factors that were pushing us towards bankruptcy and start again.

This is a very painful process but lets not forget that we wouldn't have had to go through all this if we hadn't over valued the rupee to begin with. If anyone tries to tell you otherwise just ask them how else could Pakistan have been saved from bankruptcy?

Now moving to the advantage of keeping the currency at its actual value. First of all it decreases unnecessary imports while at the same time making Pakistani products more competitive in the global market, hence increasing exports.

A boost in the export sector creates more employment as more labour is needed to manufacture rather than importing goods. So not only does it result in wealth creation it also does a better job of wealth distribution.

This also increases our FX reserves and puts us in a better condition to honor our FX payments. Creating more stability and increasing the confidence of a foreigner to invest in Pakistan.

There are a lot more things which are too long to discuss in a thread. I will be making a more detailed video soon in Urdu. For now I am going to be writing another thread soon on how despite doing everything wrong PMLN managed to keep GDP growth high.



How PMLN govt managed to keep the GDP growth rate high Every time I debate economy with a PMLN supporter I get 2 arguments: 1. $ 100 ka tha 2. GDP growth 5.8% thi



To begin the discussion we first need to understand the multiplier effect. Multiplier effect basically says that if money is injected in to an economy from a source (govt in this case) that money is multiplied in the economy.

Lets look at an example of how that money is multiplied. Lets say that the govt starts a mega project that temporarily employs thousands of workers and when all those workers get paid, they all decide to go buy cars.

The demand for cars increases and the manufacturer now needs to employ more people to increase production to keep up with the demand. Now when all these new workers at the car factory get paid, they all go buy furniture and demand for furniture increases.

This chain reaction keeps going on and more and more demand is created in the economy and consumption goes up and businesses start making money and the whole economy starts running.

This is what PMLN did and at first it sounds like a good way to keep things going but there a few issues with this. First of all consumption driven growth strategy is used when we see that we have unused production capacity and we need to give the economy a push

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Second is that since PKR was overvalued, the demand created was for imported goods and not for local goods, since it was cheaper to import rather than buy local goods. Below is an example from Bloomberg that shows that local industry was not benefiting from this strategy.


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Third reason also explains what I said in the first reason. We were spending borrowed money on projects that needed more money to run and at some point we had to stop spending money we don't have.

We saw that in 2019 and all the economic activity was killed at its source since it was unsustainable to keep spending at the same rate, all the temporary jobs that were created were lost and all the unsustainable economic activity was killed.


This is also one of the points raised by IMF in Pakistan's review in 2018 where they reffered to this "high growth" as "weak and unbalanced"


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This thread presents one of the reasons y we call the high growth in PMLN time "unsustainable" I might add more to this thread as I do more research and get input from others




 

Norwegian

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Now looking at the REER graph for Pakistan it is quite visible that the currency was indeed overvalued during Ishaq Dar's term.
We have discussed this to death here:

@Patriot forever @ziaulislam @Indus Pakistan @Del @Dual Wielder
 

Indus Pakistan

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We have discussed this to death here
While all this is true but the real issue with Pakistan's economy is structural. The groups and businessmen who dominate the economy are political favourites who carve out a racket within the Pakistani political economy. Which is not one of them is able to fish abroad but are sharks at home.

Unless this culture is not broken not much will change.
 

Indus Pakistan

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@Norweigian The auto sector is perfect exampe of this. Essentially this is not a industry. It's just a bolting together of imported parts. Even us PDF'es could set up a PDF-Toyota Corporation. If any of you had reach within the government to give you the preferance to get a licence. Then just order a knocked down kits of a Toyota Corolla. Then as they land at Karachi just bolt them together. Then place a 25% markup and sell the products. Get rich.

Example of this racket - sorry auto industry.

Under the 2016-21 policy, new entrants are allowed import of parts at concessionary custom duty of just 10 per cent, while old manufacturers are importing these parts at 30pc custom duty.

Chairman of the Pakistan Association of Automotive Parts and Accessories Manufacturers (Paapam) Abdul Rehman Aizaz said the assembly of SUVs is an easy option for new entrants. “They have been allowed to import most of its parts at concessionary rate of duty due to a thin ‘A max part list’ of this segment, assemble the vehicle and sell these in the market easily which is already booming because of low interest rates and a high demand from consumers,” the Paapam chairman explaine



 

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Bro @Kabira you mentioned in your post the other day that previous governments before plmn were artificially manipulation currency, this will clear if you have any doubt that this was the doing of plmn.
They destroyed the economy before aswell if you recall the condition in 1998 before his ouster.


THE THING I GET FROM THE FIGURES IN THE ARTICLE IS PPP WAS A THOUSAND TIMES BETTER THAN PLMN.
SECOND NO OTHER GOVERNMENT INHERITED A CRISIS AS PTI IN OUR 70 YEAR HISTORY. PLMN GOT A VERY BALANCED ECONOMY TO BEGIN THEIR TENURE AND THEY DESTROYED IT.
 

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Bro @Kabira you mentioned in your post the other day that previous governments before plmn were artificially manipulation currency, this will clear if you have any doubt that this was the doing of plmn.
They destroyed the economy before aswell if you recall the condition in 1998 before his ouster.


THE THING I GET FROM THE FIGURES IN THE ARTICLE IS PPP WAS A THOUSAND TIMES BETTER THAN PLMN.
SECOND NO OTHER GOVERNMENT INHERITED A CRISIS AS PTI IN OUR 70 YEAR HISTORY. PLMN GOT A VERY BALANCED ECONOMY TO BEGIN THEIR TENURE AND THEY DESTROYED IT.
Musharraf fixed rate at rs60. Anyway majority of our population is dumb economically thanks to education system. They have no idea why inflation is sky high every few years. Rent seeking elite have destroyed Pakistan economy and army generals are part of this crime against Pakistani public. PTI too is part of the same rot. Look at new finance minister, Tarin is again going to print notes for GDP growth instead of doing reforms that will hurt rent seeking bastards.
 

Indus Pakistan

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THE THING I GET FROM THE FIGURES IN THE ARTICLE IS PPP WAS
Yes, interesting you say this. From my reading it appears that PPP performed better then PMLN on the economic front. People like Sheikh Hafiz and Tarin are from the PPP economic stable.
Rent seeking elite have destroyed Pakistan economy and army generals are part of this crime against Pakistani public. PTI too is part of the same rot. Look at new finance minister, Tarin is again going to print notes for GDP growth instead of doing reforms that will hurt rent seeking bastards.
I agree with you but do you really think a weak coalition government could hurt these "rent seeking bastards" as you put it nicely? They deeply entrenched and have tentacles in media, military, politics. PMIK has even struggled to go after just the sugar mafia leave alone taking on the rest. Elections are coming fast. Unless some goodies are not thrown around it will be back to the Sharif/Bhutto game of music chairs.
 

Patriot forever

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Musharraf fixed rate at rs60. Anyway majority of our population is dumb economically thanks to education system. They have no idea why inflation is sky high every few years. Rent seeking elite have destroyed Pakistan economy and army generals are part of this crime against Pakistani public. PTI too is part of the same rot. Look at new finance minister, Tarin is again going to print notes for GDP growth instead of doing reforms that will hurt rent seeking bastards.
Nope Tareen is not going to do that. SBP has been autonomous since pti took over. There is not a single sign of that happening. See for your self governemnt borrowing data after tareen took over.

The data is from 2003 onwards, we can see minimum deviation of REER, the actual value of rupee was around 60.

The reason why currency depreciated is because of the stress it was under due to manipulation in plmn term, the growing demand vs supply gap.
Now the currency is in equilibrium. Its a cycle when the REER goes up to extremes due to manipulation the actual value of currency starts depreciating.
 

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