Behold the ‘beauty’ of democracy: death by a thousand debts

[Grevion]

A lot of Pakistan's problems arise out of lack of awareness. Not many voices speak out against government policies that are NOT going to benefit them in the long term. As you rightly said, the security environment in Pakistan is such that foreign investors are not willing to lock into the country through FDI. Seems the Pakistani government's solution to it is - never mind, we will borrow our way through. Money from abroad is no good if it can be withdrawn the next day in the face of a crisis. Mexico, as @Nilgiri mentioned, suffered from such devastating capital flight that the economy didn't recover for over a decade - some say it still hasn't. Malaysia, Thailand and South Korea suffered similarly in the 90s.

They learned their lessons; today, these countries neither welcome loans nor portfolio investment. They want FDI and technology transfer. Unless you make other countries stakeholders in your own well-being, they will withdraw capital at the first sign of trouble and that is the end of that. And yes, for that, you need security. Unless FATA, KPK, Balochistan and Karachi are safe places to do business, all Pakistan can look forward to are loans at 18% sovereign guarantee and selling bonds at 8.5% interest. The cost of servicing the finance they are raising is unsustainable in the medium term.

Rightly said. Pakistan pay back its borrowing by borrowing more. The problem for them is that they face huge debt(internal+external) which they have to pay back or else declare themselves bankrupt, they are draining their financial resources in the payment of interest+principle. Apart from that they face a security crises with many of their regions under militancy/extremism which causes high instability in their country they have to control that by military operations which again requires resources to spend, in such a security environment nobody invests in an unstable country. Then there is an energy crises 'Pakistani' metro cities like Karachi has been affected by frequent power cuts. Local business cannot flourish if you don't have an adequate supply to the power demand. It can only be solved by long term investments in energy sector which will take time and investment and result will only come three year after the investment. Its really a mess. For Pakistan now its all about priority.
The best Pakistan can do now is to invite more local+foreign partnerships which will help them with tech inflow and some FDI but again given the security and energy crises it may not be easy.

Hi,

Million dollar question, isn't it? Well, this is a very long debate to have. @Nilgiri has already responded to your question by way of a contrasting study of two countries. I would like to present some other dimensions:

In an ideal world, there would be nothing wrong in governments functioning like corporations. However, we don't live in an ideal world. The essence of fiscal management as prescribed by the IMF is to cut down on government spending to reduce the fiscal deficit and eventually eliminate it altogether. That may sound good in theory, but what actually happens is that when it comes to identifying "wasteful" government spending, those sections of the economy that do not wield influence in decision-making loose out. In country after country, fiscal tightening has meant reducing budget allocation for education, healthcare, and other critical sectors.

Now at this point, you might ask - so what is wrong in government privatizing these areas like many countries have? Firstly, primary services such as education and healthcare for the poor cannot, and will not, be provided by the private sector in poor countries. The government has to cover the cost, period. Secondly, the squeeze on public expenditure does not arise in a vacuum. It is almost invariably matched by taxation policy that disproportionately benefits the richest people in the country by lowering their taxes. The IMF is very clear that the government must be frugal. It has never suggested that any government increase taxes on the rich, as it believes that it will be counter-productive. Similarly, the IMF advocated increase in consumption-based indirect taxes rather than income tax, as it disproportionately benefits the 1% at the expense of the rest.

Look, one way to look at it would be to simply agree with what the IMF prescribes, as those who oppose Keynesian and/or development economics would do. Those who support Milton Friedman's free-market economics have wielded too much influence in Bretton Woods institutions. Some of what they support - deregulation, ease of doing business, rationalized taxation, free movement of capital etc are all desirable goals. But unfortunately, all too often, they become a trojan horse for vested interests to promote crony-capitalism, reverse transfer of wealth from the poor to the rich, and dismantling of the social sector and replace it with for-profit services for a few.

Of course, what I stated above would be merely the opening remarks in the broader discussion. The questions you need to ask are:

1. Do you believe that the government should spend more on incentivizing the rich or ensuring that vital services reach everyone?

2. Do you believe in Milton Friedman's free market, supply-side policies or John Meynard Keynes' demand-driven model where the government intervenes to ensure equitable outcomes?

3. Do you believe that in no circumstances can the government be allowed to run up deficits for sustained periods, or do you think that deficits are fine, as long as one is sure that the cause is a necessary one?

We can discuss these issues. Some of it may be outside the purview of this thread but nonetheless I think it is an interesting discussion to have.

Do you believe that having a revenue budget is good/beneficial for developing countries.

 

[Jacob Martin]

Rightly said. Pakistan pay back its borrowing by borrowing more. The problem for them is that they face huge debt(internal+external) which they have to pay back or else declare themselves bankrupt, they are draining their financial resources in the payment of interest+principle.

The tragedy is that it does not need to be that way though. China has shown the world how one can build as much as one wishes without borrowing anything from another country. If you have a strong domestic industrial framework, external debt will never be an issue. This is because you can run up as much of internal debt as you wish and write it down gradually. The ideal developing economy should have China's manufacturing prowess and our service sector. Such an economy would not need to care about foreign borrowings. China has a huge debt mountain, but do you see the Chinese worried? That is because they owe the debt internally, to themselves. Which means that if they handle things well, it will not result in a catastrophe, although it will still impact them no doubt.

 

[Grevion]

The tragedy is that it does not need to be that way though. China has shown the world how one can build as much as one wishes without borrowing anything from another country. If you have a strong domestic industrial framework, external debt will never be an issue. This is because you can run up as much of internal debt as you wish and write it down gradually. The ideal developing economy should have China's manufacturing prowess and our service sector. Such an economy would not need to care about foreign borrowings. China has a huge debt mountain, but do you see the Chinese worried? That is because they owe the debt internally, to themselves. Which means that if they handle things well, it will not result in a catastrophe, although it will still impact them no doubt.

What china did in the past 30-35 years is absolutely amazing but that requires a strong political mindset, in context to Pakistan political conditions in China are much different then Pakistan and also China started their economic miracle in the 90's improvised by Deng which would not have been easy in a democracy.
You didn't ans. my previous question.

 

[Jacob Martin]

Rightly said. Pakistan pay back its borrowing by borrowing more. The problem for them is that they face huge debt(internal+external) which they have to pay back or else declare themselves bankrupt, they are draining their financial resources in the payment of interest+principle. Apart from that they face a security crises with many of their regions under militancy/extremism which causes high instability in their country they have to control that by military operations which again requires resources to spend, in such a security environment nobody invests in an unstable country. Then there is an energy crises 'Pakistani' metro cities like Karachi has been affected by frequent power cuts. Local business cannot flourish if you don't have an adequate supply to the power demand. It can only be solved by long term investments in energy sector which will take time and investment and result will only come three year after the investment. Its really a mess. For Pakistan now its all about priority.
The best Pakistan can do now is to invite more local+foreign partnerships which will help them with tech inflow and some FDI but again given the security and energy crises it may not be easy.


Do you believe that having a revenue budget is good/beneficial for developing countries.

I am assuming you mean a balanced budget with less/no deficit? Yes, that would be nice, isn't it?

Let's assume that as a developing country, we would like to fund our social sector expenditure generously, as well as run up large bills for shoring up the economy every now and then. When the US Financial Institutions were in trouble in 2008, the US government initiated the TARP relief package to help these banks, worth about $431 billion. Where did the money come from? Some of it was provided by the US treasury from existing funds. But most of it was just an accounting entry - money created from thin air. The same happened in the case of hundreds of billions spent by the American government to stimulate demand in the economy around the same time.

If a government is not able to balance the budget, what happens? The deficit is covered by the Treasury/Central Bank and shows as debt. Over time, this debt keeps piling up. What can be done with the debt depends on who you owe it to. If the debt is owed to foreign governments and institutions, then we better pay it back ASAP. If the debt is owed to foreign bond-holders, the same applies. But debt which the government owes within the country can be dealt with differently. It gives you flexibility in how you wish to deal with it, so it is better to owe within the country than borrow from outside.

The problem with developing countries is that we find it very difficult to raise debt internally. Our revenue expenditure consists of things that we simply cannot produce locally. So we end up with foreign debt. Once we owe other countries or IMF/World Bank enough, and there are doubts about our ability to service that debt, they will start dictating to us about reducing the deficit. A country that either has a hard currency or strong domestic industry is free from that compulsion. Foreign debt can be avoided by simply printing money, as in the case of the US, or producing within the country and importing less, as in the case of China.

Without ending dependence on foreign debt, a country cannot be free to pursue its independent economic policies. Running up deficits is fine, but so long as you don't owe it to the outside world, for they will want their pound of flesh.

 

[Nilgiri]

Lianchao Han's assessment from 22 minute mark to 38 minute approx:

1. This is a pet project of Xi Jinping and its somewhat of a rush of blood to his Head
2. The projects are not well researched and the route is difficult to maintain
3. For a solar project in Karachi... Pakistan is paying 33% interest!!!
4. High interest rates will ultimately and eventually cause resentment in the Pakistani public
5. This is ultimately a road to no-where (for Pakistan)
6. Ultimately China wants a captive market to spend its overcapacity margins and earn good profits through interest payments from Pakistan.

@Syed.Ali.Haider , reminds me of what you were discussing in other threads

 

[Jacob Martin]

Lianchao Han's assessment from 22 minute mark to 38 minute approx:

1. This is a pet project of Xi Jinping and its somewhat of a rush of blood to his Head
2. The projects are not well researched and the route is difficult to maintain
3. For a solar project in Karachi... Pakistan is paying 33% interest!!!
4. High interest rates will ultimately and eventually cause resentment in the Pakistani public
5. This is ultimately a road to no-where (for Pakistan)
6. Ultimately China wants a captive market to spend its overcapacity margins and earn good profits through interest payments from Pakistan.

@Syed.Ali.Haider , reminds me of what you were discussing in other threads

Yes, I wanted to discuss this as well, along with all that we know about CPEC and potential benefits/pitfalls. Can you shed some light on the CPEC project overall? All I know is that a bunch of coal-fired power plants are going to come up around a road and a railway line, with China provding funds agaisnt 18% sovereign guarantee. So it seems the Pakistanis will get some excellent infrastructure and legacy energy production capacity, but with a hefty bill to foot for it. Am I missing something here?

 

[Nilgiri]

All I know is that a bunch of coal-fired power plants are going to come up around a road and a railway line, with China provding funds agaisnt 18% sovereign guarantee. So it seems the Pakistanis will get some excellent infrastructure and legacy energy production capacity, but with a hefty bill to foot for it. Am I missing something here?

Its big, its white and its elephant-like imho.

Everyone has a differing opinion and bias....but essentially its supposed to be some industrial+transport corridor that kickstarts everything....thats the official narrative. Problem is the details, especially that this could all just be a massive ponzi scheme for the Chinese to dump their overcapacity in a neo-colonialist sort of way (thats the other extreme view).

I incline towards more of the latter ( one of the talkers brings up a very good point that the proper way for development is to genuinely reform the economic bottlenecks that exist in Pakistan.....rather than rely on a grand ticket project). But I guess its one of those things where one has to wait and see.

 

[Jacob Martin]

Its big, its white and its elephant-like imho.

Everyone has a differing opinion and bias....but essentially its supposed to be some industrial+transport corridor that kickstarts everything....thats the official narrative. Problem is the details, especially that this could all just be a massive ponzi scheme for the Chinese to dump their overcapacity in a neo-colonialist sort of way (thats the other extreme view).

I incline towards more of the latter ( one of the talkers brings up a very good point that the proper way for development is to genuinely reform the economic bottlenecks that exist in Pakistan.....rather than rely on a grand ticket project). But I guess its one of those things where one has to wait and see.

Hmm...giving loans for development projects is one thing. Japan has given India massive loans for infrastructure projects. But these are project-specific, and not part of a grand narrative such as CPEC. Let me try and dig up what I can about Japanese funding of projects in India and we could compare the two.

 

[somebozo]

There are countries in much worst position..the fact is that Pakistan has high potential of growth and a highly productive nation...and together we can make it happen!

 

[Jacob Martin]

Problem is the details, especially that this could all just be a massive ponzi scheme for the Chinese to dump their overcapacity in a neo-colonialist sort of way (thats the other extreme view).

You know what. I have been thinking about this for a while. On paper, the Chinese approach of partnering infrastructure projects in developing countries sounds great. They are efficient, plus they do not interfere politically. That sounds like music to the ears of countries tired of Bretton Woods interference in their economy by way of unsolicited periodic prescriptions. But the bulk of Chinese investment so far has been in African countries, many of them plagued with dictatorial regimes who would love to be propped up by anyone as long as their own power remains intact.

I think the Chinese have figured out that (quoting you) "dumping their overcapacity" in infrastructure and legacy industries is a smart move. They are peddling coal-powered power plants to Pakistan for Chrissakes! Something which China itself has committed to phasing out shortly.

 

[Nilgiri]

I think the Chinese have figured out that (quoting you) "dumping their overcapacity" in infrastructure and legacy industries is a smart move.

Well this is what the Chinese analyst was saying in the video I posted....though I would agree with him.

 

[Jacob Martin]

High interest rates will ultimately and eventually cause resentment in the Pakistani public

As if on cue.

China's infra loans far more expensive than that of Japan: Arvind Panagariya - The Economic Times

"High speed rail is an expensive proposition. What kind of finance Chinese are willing to bring to the table is important. Japanese are bringing incredibly attractive finance to the table. They are offering 40-year loan where there is no payments for 10 years and after that only 0.3 per cent a year. So it is a highly concessional loan. Chinese are not offering anything close to that. So there is big difference what Chinese offer and that of Japanese"

 

[somebozo]

As if on cue.

China's infra loans far more expensive than that of Japan: Arvind Panagariya - The Economic Times

"High speed rail is an expensive proposition. What kind of finance Chinese are willing to bring to the table is important. Japanese are bringing incredibly attractive finance to the table. They are offering 40-year loan where there is no payments for 10 years and after that only 0.3 per cent a year. So it is a highly concessional loan. Chinese are not offering anything close to that. So there is big difference what Chinese offer and that of Japanese"

I have experience working with these ultra low interest rate loans from Japanese banks (namely Sumitomo bank) and I even know everyone well in their Dubai branch.

While Japanese loans have ultra low interests they come with so many exclusive conditions that you will end up paying close to 18%.

 

[Jacob Martin]

I have experience working with these ultra low interest rate loans from Japanese banks (namely Sumitomo bank) and I even know everyone well in their Dubai branch.

While Japanese loans have ultra low interests they come with so many exclusive conditions that you will end up paying close to 18%.

I am in the process of looking into this, so I will not negate the possibility of hidden costs in Japanese project finance. However, off-hand I can tell you a few things:

These are infrastructure projects. Finance in these cases are structured very differently than consumer, real estate or business loans. Unlike the standard form contracts that are pushed across when we approach a bank for these kinds of loans, long-term infrastructure finance is procured through a competitive process. Unless all competing financiers are colluding with one another, one can always secure the best deal possible.

For example, China and Japan were recently competing for a high speed rail project in Indonesia. The competition was so intense that China finally agreed to lend $5 billion without any sovereign guarantee from the Indonesian government. Now they are bidding for further projects and sovereign guarantee is completely off the table.

http://www.ft.com/intl/cms/s/0/f20f9fec-90f4-11e5-bd82-c1fb87bef7af.html#axzz3sux8p9D0

Japanese lending for Indian infra projects is nothing new. JICA, the Japanese government's lending agency, has been funding projects in India since 1958. Currently over 70 projects, including the Delhi metro, are underway. JICA has already lent over $6 billion for Delhi Metro, and financing has been on-going for 18 years now. If any major complications regarding hidden costs were involved, I am sure these would have been highlighted and addressed by now. There has been a small issue with "step loans" (purchasing part of the project from Japanese companies), and a similar issue has cropped up in the case of the High Speed Rail project as well, for which both China and Japan are bidding.

Charting the rise and spread of Japanese funding in India | Business Standard News

OTOH, Chinese project finance is under review in at least one country that I know of. Sri Lanka had signed several agreements with China as part of One-Belt-One-Road.

I quote:

....They also argue that the hidden costs of Chinese proposals will come to haunt many of the projects being launched under the Obor initiative. Analysts in Tokyo point to the debate in Sri Lanka, where the new government in Colombo has sought to review the terms and conditions of the various mega projects that the Rajapaksa regime had signed with Chinese companies. Addressing this weakness, Abe is highlighting the importance of "sustainable infrastructure development".

Analysis

Also, see:

The Trouble With China’s ‘One Belt One Road’ Strategy | The Diplomat

Suspended Sri Lankan Port Project Complicates Sirisena’s Trip to China | The Diplomat

Quoting from: China’s continuing woes in Sri Lanka | South Asia Analysis Group

President Sirisena the new incumbent froze all China-aided mega projects notably the $1.4 billion Colombo Port City Project signed up during Rajapaksa-rule, pending their review for procedural lapses and corruption investigation. However, since then both the countries have tried to understand, if not redress, each other’s concerns also on the twin issues of high cost of Chinese loans and financial viability of the mega projects.

The more I research, the more it seems that Pakistan is getting a raw deal qua CPEC financing. But I will do some further research before I can conclusively say so.