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Mexico 1994, Pakistan 1996?

A confidential informal note being circulated in the World Bank seeks to compare the economic situation in Pakistan today with that availing in Mexico prior to the economy crash in 1994. To quote “Over the last three years, Pakistan’s macroeconomic performance has been disappointing. Real income per capita has hardly grown, while inflation and urban unemployment have risen. Although the country’s long-term growth potential remains favourable, prospects for sustained non-inflationary growth of per capita income are fraught with serious downside risks. The economy remains overly dependent on the cotton sector and highly vulnerable to external shocks and financial instability. Because of the unfavourable economic performance, there has been a noticeable rise in social and political pressures and loss of popularity for the current government. Concerned about potential short-term adverse impact of economic adjustment or key interest groups, the government decided in June 1995 to slow down the pace of reforms. However, this decision led to loss of credibility of government’s macroeconomic policies, emergence of serious fiscal and financial imbalances and eventually financial turbulence. Although the authorities are now trying to steer the economy back on track, and thanks to cotton’s bumper crop economic growth is forecast to accelerate, nevertheless, Pakistan’s macroeconomic/financial problem is much more serious than assumed by the authorities.” unquote. All in all, this is rather a damning indictment of Ms Benazir regime’s economic policies.

As a participant in the North American Free Trade Agreement (NAFTA) — Europe Meeting of the World Economic Forum in Washington DC in May 1994, one developed an inferiority complex at the scornful arrogance of the senior Mexican bureaucrats and technocrats present. Aware that NAFTA’s emergence had ensured the commercial world’s intense excitement at Mexico’s availability as an industrial staging post just south of the US border, these government functionaries made no bones about their utter contempt for the low-life we were representative of the Third World. “Miracle-worker” US educated economist President Jorge Carlos Salinas was eulogized in God-like esteem. Pride cometh before a fall and by the end of 1994 a series of political assassinations and a sharp rise in US interest rates led to a substantial reduction of capital inflows (and subsequent outflows) requiring a sharp reduction in the Mexican current account deficit (8% of GDP).

Continuing outflows brought massive pressure on the currency to devalue. With steep decline in official reserves and heavy selling pressures in domestic financial markets, the Mexican “peso” was allowed to float, thus rapidly increasing the dollar-linked debt. The domestic interest rates were then raised to stem the outflow of capital but this significantly increased the amount of non-performing loans of the banking system, most of which in any case had been given to favourites of the ruling clique, thus threatening complete collapse of the banking system. To contain the possible resultant anarchy from eventually spilling over its borders into the American heartland, the US President circumvented US Congress in organizing a massive rescue package of almost US$ 30 billion in loans and guarantees from the IMF and the US (another US$ 10-12 billion was arranged by the Mexican Government separately), a total of about US$ 40 billion. It may be noted that the political assassinations carried out were of political reformers who had upset hard-line members of their own party for campaigning against corruption among the ruling coterie draining the country of foreign exchange and commensurately raising the domestic debt. Today Raul Salinas, (then) President Salinas’ brother, is accused of maintaining at least 700 secret accounts in different banks in many countries. Former President Salinas himself lives in absolute luxury in the US in self-imposed exile since he apprehends detention on various criminal counts. This was “the right stuff” of the Mexican “miracle”.

Our current situation can be compared to that of Mexico in 1994 i.e. large short-term foreign currency dominated debt is in excess of official foreign exchange reserves (foreign exchange reserves US$ 1.3 billion while foreign currency deposits are US$ 7.4 billion) but there are critical differences that protects us from Mexico’s fate despite the best efforts of V.A. Jafarey and Qazi Alimullah to scuttle the economic equilibrium by following a virtually insane economic policy of adding to taxation when relief across the board is necessary. Pakistan is vulnerable to major downside risks resulting in slow growth or even economic collapse, viz (1) sudden outflow of capital collapse of exchange rate and serious banking crisis causing financial instability, scenarios termed by the World Bank Report as one of “high” likelihood and of almost “immediate” nature, induced by wrong macro policies and inadequate response as well as adverse political developments (2) external shocks such as substantial deterioration in Pakistan terms of trade  i.e. falling cotton prices and rising oil prices, increase in international interest rates, reduction in workers remittances, worsening law and order situation, scenarios termed as of “moderate” likelihood in the “short and medium term” induced by external events (3) unsustainable fiscal deficit along with rapid build-up of domestic and internal debt, rapid domestic expansion, accelerating inflation and exchange rate depreciation, scenarios termed as of “moderate” likelihood in the “medium term” induced by loose fiscal and accommodating monetary policies and (4) slowdown and reversal of structural reforms in areas of trade, taxation and privatization leading to fiscal and balance of payments problems and slowdown of growth, scenarios termed “moderate to high” in the “medium term” induced by yielding to pressures from interest groups.

Of the foreign currency deposits (FCDs) amounting to US$ 7.4 billion US$ 6 billion belong to individuals and the remainder (US$ 1.4 billion) to foreign banks. Our total foreign exchange reserves at the moment is US$ 1.3 billion while FCD deposits of residents is around US$ 3.9 billion. We have 2.15 million ounces of gold in State Bank of Pakistan’s (SBP’s) vault worth US$ 900 million and of the Resident accounts 60-70% is pledged to cover domestic loans and thus cannot take wings easily. Our economic gravediggers do not seem to take into account encashment of export bills, worth US$ 1.5 billion at any given time. Unlike Mexico 90% of our debt still remains medium to long-term. God forbid that there is a large cash outflow (US$ 1-2 billion) or should individual depositors try pulling their funds out (like it almost happened in November 1995), Pakistan’s economy will not crash as the World Bank pessimists seem to be implying, in a worst-case scenario it will SLIDE. Mexico’s debt was (and is) much larger, its structure was far weaker than ours and its economy very vulnerable to the rise and fall of US interest rates. Pakistan’s liquidity requirement in a doomsday scenario would be less than US$ 3 billion (i.e. one-tenth of Mexico’s). Some worried but patriotic technocrats not so enamoured of the World Bank and IMF as the likes of Ms Jafarey, Alimullah, etc had unofficially (and independently) lined up the required liquidity in November 1995, just in case.

The price of the Pakistan Rupee against the US dollar is likely to slide but not plummet, going down to Rs 50 to the US dollar in controlled fashion by end December 1996. In 1991, the Russian Rouble was 5-6 against the US dollar, today it is 2000 Roubles plus. If the Pakistan Rupee slides as expected, an average refrigerator that would normally cost Rs.15,000 would end up costing Rs.40,000 and even more. Taking into account inflation and depletion of purchasing power, a person who today earns Rs.5,000 has to spend more than Rs.5,900 to maintain the same lifestyle in comparison to January 1995 while his purchasing power of Rs.5,000 has eroded down to Rs.4,100. After a sustained slide and taking into account the proposed taxation that purchasing power may well be a fraction of that amount. Without an increase amounting to 36% of his take-home, the annual equivalent of four months salary, the individual has either to acquire debts (or sell off assets) to meet his obligations or be forced to severely cramp the family lifestyle. The other alternative is to become corrupt as is generally the norm prevalent in society. Nothing was more devastating to Mexico’s economy than the corruption among the ruling family that permeated through the ruling clique, in effect corruption was institutionalised through the bureaucracy and the party. Every salaried person’s tax burden has just gone up by more than 100% while the new born child’s debt burden has become Rs.13500. A person who earns Rs.5,000 per month will now require a total Rs.25,600 to meet his obligations while a person who earns Rs.20,000 would have to come up with about Rs.100,000 EXTRA somehow, falling in line with the corrupt becomes an only option. All this is still good news, if the economy even partly collapses, these figures will jump 5-10 times. One does not even want to speculate what will happen if the economy completely crashes. Even in the “partly collapse” scenario, one will hardly be able to have one meal a day i.e. if we do NOT send our children to school.

The effect of even a partial collapse will be a vast social upheaval on the lines of the French or Iranian revolution. The Law Enforcement Agencies (LEAs) will themselves be effected, their discipline will be subjected to a severe test. Anarchy is not a distinct possibility, it will become reality on the pattern of Rwanda and Liberia. Marie Antoinette’s naive plaint to let the people “eat cakes if they cannot get bread” will not remain a funny story anymore.

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