By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
I had forecast a collapse in the Pakistani rupee to a 160 – 180 range against the US dollar and a plunge in the Karachi stock market index to 32000 after PMLN Prime Minister Nawaz Sharif was sacked by the Supreme Court at the behest of the Rawalpindi GHQ/deep state in July 2017. At the time, the rupee was grossly inflated in a dirty peg at 105 and the Karachi 100 index even made all-time highs at 52000. I immediately sold my entire Pakistani equities exposure and narrowly avoided getting skinned alive in a US dollar adjusted 70% ghastly currency/stock market collapse, unlike so many of my “long and wrong” compatriots in Dubai, led by prominent bankers, property spin masters and hawala kings.
The Pakistani rupee plunged again last week to 157 in a spasm of panic selling in local foreign exchange markets. The sudden arrest of billionaire-politician Asif Zardari, a former President of Pakistan and Nawaz Sharif’s nephew Hamza Shahbaz Sharif has spread panic among the Pakistani elite. Imran Khan’s PTI government has launched a draconian anti-corruption campaign that has already ensnared member of the Sharif and Bhutto-Zardari clans, Pakistan’s two political dynastic families. The Jinnah clan had no chance to make serious money in Pakistan other than the members who stayed put on the other side of the Radcliffe Award. I know – he was my ancestral kinsman.
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Even though Islamabad insists that the free fall of the rupee had nothing to do with current negotiations to obtain a $6 billion IMF loan to defuse Pakistan’s balance of payments time bomb, the capital markets are convinced that State Bank of Pakistan (SBP) governor Dr. Reza Baqir, a former IMF resident economist in Cairo who engineered the epic November 2016 devaluation of the Egyptian pound, has capitulated to the diktat of the Bretton Woods twins in Washington and accelerated the devaluation path of the rupee. Ironically, the IMF was not satisfied with the 35% fall in the Pakistani rupee’s exchange rate in the past year, making it Asia’s worst performing currency.
After all, Pakistan is now entering its thirteenth IMF program since the 1980’s, a track record of economic failure notorious even by the modest standards of the emerging markets. Prime Minister Imran Khan, who had sworn to avoid an IMF bailout, failed to generate Chinese, Saudi Arabian and UAE financial commitments on a scale sufficient to avert recourse to a structural adjustment program. In fact, Imran Khan was forced to sack his bombastic self-styled “opening batsman” Finance Minister Asad Umar and replace him with Dr. Abdul Hafeez Shaikh, a former World Bank technocrat and PPP member who had served as Minister of Privatization in General Musharraf’s Cabinet.
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The IMF’s insistence on the abandonment of the SBP’s managed float regime in favour of a “free market” regime has led to a de facto “dollarization of the Pakistani currency market. Investors and traders have lost confidence in the ability of the central bank to smoothen the rupee’s fall, making a currency crisis an inevitable, self-fulfilling prophecy. A free-float exchange regime in the shallow, volatile, easily manipulated local money market is a classic formula for a rupee meltdown.
Not even the slight rise in Pakistan’s total foreign exchange holdings to $14.8 billion can negate the sheer drag of a $20 billion current account deficit, lower remittances from the Gulf and an external debt above $100 billion. The orthodox macroeconomic model of a J-curve in the post-devaluation balance of payments is inapplicable to Pakistan since its low value-added exports have not benefited even from the massive devaluation of the rupee while the Pakistani elite’s insatiable demand for luxury goods means a price inelastic import demand curve. It is tough to survive in cutthroat global market by exporting just textiles, leather, fruits and footballs.
The tragedy of Pakistan’s public finance (and governance) black hole is that, seventy-two years after Partition, a mere 2 million out of a population of 213 million even file, let alone pay, income tax. Tax collection to GDP ratio trails even Bangladesh and Sri Lanka. As in ancien regime of Bourbon France, feudal land owners, some with make believe titles like Jam, Pir, Malik and Nawab pay no taxes. Again, I know – I studied and partied with some of their sons in my Karachi boyhood.
Imran Khan has announced an austerity budget to raise taxes and slash public spending at a time when the inflation rate has spiked above 8% while GDP growth is a dismal 3.2% way below the Finance Ministry’s 5% plus projections. The central bank has no choice but to raise the policy borrowing rate to at least 12% to combat the surge in petrol, food and basic commodities prices.
There is a geopolitical dimension to Pakistan’s IMF bailout loan. The Pentagon wants Islamabad to pressure the Taliban as it exits its 18-year-old military quagmire in Afghanistan while the US Treasury does not want IMF rescue funds to be used to pay off Pakistan’s opaque CPEC debt burden to China. It is no coincidence that the Chinese CPEC inspired construction boom has ended and the top cement manufacturers in Pakistan have lost 50 – 60% of their value in the stock market. Washington’s tariff threats against China are a disaster for Pakistan, the showcase for President Xi Jinping’s Belt and Road Initiative. The Chinese built port of Gwadar on the Arabian Sea is unacceptable to US naval strategists in Central Command. This is a perfect geopolitical storm for the viscerally anti-American Imran Khan.
Pakistan faces a grave consumer recession risk. Auto sales, 50% financed by consumer loans, have plunged 25% since last year as higher interest rates bite. A spike in youth unemployment is inevitable, a metric correlated with crime and ethnic/sectarian political violence. Imran Khan’s campaign promise of an Islamic welfare state is unattainable amid this fiscal Black Death.
External debt servicing imperatives mean the State Bank of Pakistan (SBP) reserves have fallen to $7.6 billion, a dangerously low level for an economy under an IMF free float mandate. Sadly, I see no reason to amend my view that the Pakistani rupee could depreciate to 180 by year 2019 even as “IMF bread riots” breakout across Pakistan and destabilize an increasingly unpopular and incompetent Imran Khan government. This is a tragedy for a nation whose powerless masses have always been defined in the image of its powerful captains and kings. This is not the Pakistan my ancestor the Quaid-e-Asam envisaged or changed the course of South Asian history for – what a pity, what a world!