Atif Mian's recent tweets on debt financing in Pakistan.
The Perfect Doom Loop
Accounting vs economics: When it comes to balance of payment crises, there's a temptation to look at financing or current account deficits and say, "we are short X billion dollars, let's bridge that gap through administrative actions by curtailing imports"
Tempting as this might be, it's a foolish policy that results in even greater disaster
When you try to cut imports through administrative restrictions, you essentially open multiple auction markets where some bureaucrat decides what is "essential" and what is not. It is a recipe for corruption and for gatekeepers to get rich quick
But let's leave that aside, the greater cost is economic
A restriction on imports, even with the most pious of bureaucrats, will inevitably strike at the heart of "production networks". For example, if an exporter cannot import raw material, or an intermediate input for production - the entire export chain will break down
Economists have carefully looked at the multiplier effects of disruptions in these production networks, and found them to be quite large. So now you have a situation where your attempt at closing the X bil $ gap has, (a) reduced economic output, and (b) further pressured balance of payment as exports will start drifting down
But this is not all, there's more pain to come!
Recall that the original problem was deficits, deficits in balance of payment, but also deficits on fiscal side - and very large deficits
What happens when growth slows down due to (a) above? A well-known fiscal math fact is that tax revenue is quite elastic to growth, but fiscal expenditure is not
In plain english, when growth slows, your tax receipts go down, but you still have to pay the salaries and service the debt. So when supply (growth) shrinks and deficits rise, you will see, (c) stronger inflation
Where are we then? (a) falling growth/output, (b) continued balance of payment pressures, and (c) stronger inflation
But, there is yet more pain to come ...
The import-curtailing administrative actions were deemed "necessary", because government was afraid to devalue the currency
So now you have (a), (b) and (c), while having a large black market exchange rate premium. Every investor knows gov cannot sustain the unsustainable, and eventually ER will snap.
So in anticipation, FDI dries up, domestic investment dries up, there is capital flight, there is hoarding of dollars, domestic liquidity dries up ...
This gives you, (d) a perfect doom loop.
So a policy that started with "plugging an accounting hole", ends up doing very serious - and totally avoidable - damage to the economy.
The Perfect Doom Loop
Accounting vs economics: When it comes to balance of payment crises, there's a temptation to look at financing or current account deficits and say, "we are short X billion dollars, let's bridge that gap through administrative actions by curtailing imports"
Tempting as this might be, it's a foolish policy that results in even greater disaster
When you try to cut imports through administrative restrictions, you essentially open multiple auction markets where some bureaucrat decides what is "essential" and what is not. It is a recipe for corruption and for gatekeepers to get rich quick
But let's leave that aside, the greater cost is economic
A restriction on imports, even with the most pious of bureaucrats, will inevitably strike at the heart of "production networks". For example, if an exporter cannot import raw material, or an intermediate input for production - the entire export chain will break down
Economists have carefully looked at the multiplier effects of disruptions in these production networks, and found them to be quite large. So now you have a situation where your attempt at closing the X bil $ gap has, (a) reduced economic output, and (b) further pressured balance of payment as exports will start drifting down
But this is not all, there's more pain to come!
Recall that the original problem was deficits, deficits in balance of payment, but also deficits on fiscal side - and very large deficits
What happens when growth slows down due to (a) above? A well-known fiscal math fact is that tax revenue is quite elastic to growth, but fiscal expenditure is not
In plain english, when growth slows, your tax receipts go down, but you still have to pay the salaries and service the debt. So when supply (growth) shrinks and deficits rise, you will see, (c) stronger inflation
Where are we then? (a) falling growth/output, (b) continued balance of payment pressures, and (c) stronger inflation
But, there is yet more pain to come ...
The import-curtailing administrative actions were deemed "necessary", because government was afraid to devalue the currency
So now you have (a), (b) and (c), while having a large black market exchange rate premium. Every investor knows gov cannot sustain the unsustainable, and eventually ER will snap.
So in anticipation, FDI dries up, domestic investment dries up, there is capital flight, there is hoarding of dollars, domestic liquidity dries up ...
This gives you, (d) a perfect doom loop.
So a policy that started with "plugging an accounting hole", ends up doing very serious - and totally avoidable - damage to the economy.
