Speech by Mr. Yaseen Anwar, Governor State Bank of Pakistan at Pakistan Navy War College, Lahore

Speech by Mr. Yaseen Anwar, Governor
State Bank of Pakistan
at Pakistan Navy War College,
Lahore, March 5, 2013

Respected guests, esteemed servicemen, and students at this fine

establishment, Assalam-o-Alaikum!

I’m glad that you could join us today and thank you for inviting me

to introduce you, very briefly, to a strategy for the revitalization of

the Pakistani economy.

Our roles at the State Bank, and your roles in the armed forces, are

not very different from each other. We are both tasked with

guarding national interests and we both seek to actively mitigate

threats – both from within our boundaries, and from the outside

world. Today, I hope to be able to share with you, how we, at the

central bank, guard and guide this economy towards a path of

sustainable growth and stable prices.

But before I go down that path, I would like to put some things in

perspective here. For instance, I’d like to point out that we are not in

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the middle of an economic meltdown. In fact, we are not even close

to being in an economic meltdown. That is why the topic of this

lecture “A strategy to improve economic meltdown” may just have

been a tad misleading. So yes, we certainly face challenges, but I

assure you that they can hardly be categorized as a meltdown.

Since we’re on the subject of economic catastrophes, I think it would

be enlightening if we talk about a few countries that have seen their

economies collapse in the past few years. Let’s start with Greece.

Their latest unemployment rate is roughly 27 percent. That means

that more than one in four people remain jobless. Let me

reemphasize that: one out of every four individuals does not have a

job! Can such a high unemployment rate be socially acceptable or

sustainable? Of course not. That’s why the country was beset with

riots, massive protests, political bickering and a very uncertain and

bleak outlook.

Youth unemployment in Greece is more than 50 percent. That

means that more than half of the youth – the most productive part

of any labor force – remains jobless. Can you imagine how

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demoralizing that is for new entrants into the workforce? If you

throw this into the mix, you will have some very strong incentives

for social unrest, with sharp rises in crime, hooliganism, and general

despondency. It’s no surprise then that the suicide rate in the

country has doubled in the past five years. 2013 will mark the sixth

year of the Greek Depression. For six consecutive years, the

economy has shrunk. The light at the end of the tunnel is a very,

very long way off for Greece. That… ladies and gentlemen… is an

economic meltdown.

In fact, southern Europe has been teetering on the edge of an

economic disaster for a while now. Their governments borrowed

incredible sums of money when times were good in the first few

years of the 21st century, and are now struggling to repay their

debts. In some instances, their debts reached 200 percent of their

GDP – twice the size of their entire economy’s output. It was fiscal

irresponsibility at its worst. Pakistan’s national debt is 60 percent of

its GDP – and that is an uncomfortable level for us. 200 percent, on

the other hand, is a completely different ballgame. Now they have to

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balance their books once more and live within their means. And

they’re discovering just how painful the process of deleveraging, or

paying off their debts, can be. Their economies are facing serious

difficulties, unemployment is very high, and the prospect of default

looms large. Since their economies are so interconnected with the

rest of Europe and indeed, with the rest of the world, they are

threatening to plunge the entire world into a recession if their

economic conditions deteriorate further. And if that happens, ladies

and gentlemen, I will be inclined to believe that we are living in the

middle of a global economic meltdown.

At this point, let me walk you through a meltdown that happened

quite recently in the largest economy in the world: the financial

meltdown of 2008-2009 in the US. It started off with irresponsible

lending by the banks, which was backed implicitly by the

government, to individuals who wanted to buy property – and not

just one. Investment banks then bought these loans from the banks

that had originated them, and proceeded to create complex financial

products anchored to these loans, which were then peddled to other

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investors. Some of those investors were pension funds, and state

governments – funds that basically came from hardworking

families’ taxes and savings. Such funds are only allowed to invest in

riskless assets, ones which are considered as safe as possible.

But most investors did not truly understand the nature of these

products, and instead turned to rating agencies for assurance.

Rating agencies, such as S&P and Moody’s, evaluate financial assets

and rate them in terms of their riskiness. For reasons that should

not be mentioned, these agencies decided that the toxic assets were

of the highest quality, and least riskiness – equal to sovereign debt.

All this while, the regulators had, more or less, gone to sleep.

Eventually, they woke up to a very rude shock. Since the financial

system was so interconnected, one ripple is all it needed to create a

tidal wave in such an unstable scenario. Banks’ irresponsible

lending meant that eventually, individuals defaulted on their

mortgages. Once this cycle of defaults started, it spilled over from

mortgage companies to investment banks. Of the five large

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investment banks in the US, one defaulted, two got sold, and two

others had to be rescued by the government.

The fear and panic that gripped the financial markets meant that

banks were reluctant to lend to each other – markets froze

completely. The regulators had to no choice but to step in, but a lot

of the damage had already been done. The economy went into

recession, and the next four years brought a flickering flame of

economic growth – vulnerable to the next gust of wind that

threatens to blow it out altogether.

[Governor’s comments on the future of the US and the Euro, and their

efforts to rekindle their economies after the financial meltdown…]

Let me get back now to the Pakistani economy. The word that’s

been used to describe our economy quite a few times has been

“resilient”. I think it’s worth talking about how that word describes

this economy. In 65 years, Pakistan has never gone through an

episode of hyperinflation; Pakistan has never defaulted on its

international and domestic debts; in fact, our economy has grown

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consistently, but not spectacularly, over the past six decades. Not

many countries in the developing world can claim to have achieved

all of that. This has been despite periods of international alienation

and sanctions, three expensive wars, two hostile fronts, regular

political upheaval, social unrest, sharp increases in the price of oil,

and much, much more.

However, it would be dishonest to say that the economy’s resilience

is completely by design. Yes, regulation and strict oversight has had

a part to play in it. And I’d like to briefly touch upon that here. The

State Bank has always ensured that the financial system of the

country remains safe and stable. We may not have always gotten

things completely correct, but we have made sure that banks remain

healthy and depositors’ money remains safe. We have managed to

do this despite privatizing the banking system almost entirely. This

means that capital is now allocated more efficiently, and private

sector businesses can borrow freely for their requirements. I must

add though that we are a little disappointed with the current risk

aversion of the banks.

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The reforms process was initiated in the early 90s and focused on

more private sector participation as financial intermediaries;

developing a more robust regulatory framework; restructuring

banks; and developing non-bank financial institutions (also known

has NBFIs), as well as equity and bond markets, as alternatives to

the banking system for both savers and borrowers. The financial

sector was essentially given a completely new look during the course

of that decade. The purpose of all these changes was to enhance

competition and efficiency in the financial sector. That would mean

that capital gets allocated into productive investment, which can

drive future growth. Simultaneously, as banks became more

efficient, savers could receive a better return on their deposits and

borrowers could finance themselves at lower rates.

The robustness of our financial system, is a direct consequence of

the reforms process and the State Bank’s constant vigilance. There’s

a lot that can be improved in our financial system – for instance, I

would love to see the development of efficient debt markets, even

better regulatory and reporting practices, and the broadening of the

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financial sector’s scope to include largely unbanked, such as

agriculture, small and medium enterprises, and housing. Despite

this wish-list, the fact remains that our financial system is, by

design, secure and does not pose any threat to the economy as a

whole.

Now let’s turn to the features of this economy that have, helped the

country become and remain resilient in the face of adversity. I

believe that our social system in Pakistan influences why the

economy remains resilient. Our family structure is a huge blessing

in economic terms. Children take care of their parents, and that

spares the state from the responsibility of taking care of the elderly

and sick. Governments in developed economies are currently

struggling to meet their social commitments, with healthcare costs

surging for an aging population. Our social fabric also ensures that

informal employment is always readily available in some shape or

the other – relatives and family friends usually help out in providing

the unemployed with some form of work, and the immediate family

supports unemployed individuals financially. That spares the state

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from paying out unemployment benefits to such individuals. I

believe that the nature of our society and the close relationships of a

family-oriented society, is one of the primary reasons for Pakistan’s

relatively low rate of unemployment and overall resilience to

adverse conditions.

I would like to clarify here that this resilience has come with a cost:

the size of the informal sector. The size of Pakistan’s undocumented

economy is, by some estimates, as large as the formal economy. The

informal economy does not file taxes and, while it does absorb a

significant chunk of the labor force, it also evades corporate and

labor laws. Therefore, although close informal relationships do

make the economy more resilient, they do so at a cost to the overall

economy, by eroding the ambit of the regulators. Ideally, we, at the

State Bank, would like to see a smaller informal economy, while

society retains the structure that has made it so resilient.

The second factor that has unintentionally helped the country’s

resilience is the limited interconnectedness between the Pakistani

and the global financial and economic system. Although the absence

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of such integration is by no means desirable, it has happened due to

non-economic factors, and has insulated our domestic economy. It’s

also the reason that our financial system and financial markets

remain relatively sheltered from global events.

Let me re-emphasize here, that greater integration with global

markets is something that we should aspire towards. But that does

not mean we should not have proper controls and mechanisms in

place to safeguard our own interests. For instance, greater

integration with financial markets will mean that capital will flow

more quickly through our borders. It’s definitely something that

will boost the national economy, but, as most East Asian countries

learned in the 90s, it can be a double-edged sword. Therefore,

having some capital controls in place, which reduce the volatility of

capital flows, is a necessary regulation in this day and age.

Personally, I believe the role of effective regulation only increases as

the economy becomes more integrated and more market-oriented.

Markets in themselves have no moral character. Inherently, they are

neither good, nor evil. But they remain very powerful tools that

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distribute goods and services across the economy. Regulation is

necessary because it gives markets a direction, and can govern them

with a set of values, which markets do not possess innately.

Less, but more effective regulation is the need of the hour for our

own economy too. It’s an essential part of what is needed today to

get the economy on a track for steady and sustainable growth. The

government’s footprint in some sectors of the economy is very large,

and quite negligible in other sectors. Such divergence is unhealthy.

For instance, the government has a very large presence in our

agriculture and energy markets. Those sectors are, in some ways,

over-regulated. Too much regulation and red tape can breed

incentives for the abuse of power, mismanagement and corruption.

It also acts as a disincentive for the private sector. And we must

remember here that it is always the private sector that functions as

the engine of the economy.

However, effective regulation is sorely lacking in other sectors. The

tax machinery can be tightened considerably. One of the country’s

most challenging problems today is the size of the fiscal deficit – and

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a large part of the solution lies in increasing our tax base by

enacting regulation that encourages tax compliance, and punishes

tax evasion.

The link between better tax collection and faster economic growth

deserves to be flushed out here. Better tax collection means that the

government has to depend less on foreign support for its budgetary

needs, and can decrease its fiscal deficit. More importantly, the

government will not have to borrow as much from the domestic

banking system to finance itself. Less borrowing from commercial

banks will encourage market rates to fall and banks will lend more

to the private sector. As investment picks up, the growth potential of

the economy increases. Similarly, the government will need to

borrow less money from the central bank as well. Borrowing from

the central bank is popularly known as printing money. This is

inflationary, and I don’t think I need to introduce you to the

problems associated with high levels of inflation. If government

borrowing from the central bank falls, inflation will follow suit.

Therefore, better tax collection is a necessary condition for faster

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economic growth. And for that we need to have more effective tax

regulation.

Another problem that we desperately need to fix is our energy

problem. It’s something that has been affecting every citizen of the

state, and I don’t think that I need to highlight the scope of the

problem here. Similarly, I think the effect on the economy of an

energy shortage should be fairly straightforward: energy is one of

the key inputs in any value-added production process. Less energy

availability will translate into lower output. The solutions to the

energy problem will take time – unfortunately, there is no magic pill

here. We will need to invest in infrastructure for hydro-electricity,

natural gas transportation and transmission, and more efficient

power plants. Moreover, we will need to move to greater private

sector participation in the energy sector. That means there will, once

again, be a need for less, but more effective regulation – one that

safeguards the rights of both producers and consumers, while

ensuring adequate incentives for the exploitation of our natural

resources.

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The most important incentive here will be prices. Unfortunately, a

large part of our energy problems today can be traced to a

mispricing of fuels. Under-pricing any commodity will always lead

to a shortage – that’s one of the fundamental axioms of economics.

Letting the market decide the price is one way of ensuring that

future shortages are averted. But remember that markets do not

have morals – and that’s why we will need regulation to make sure

that those markets serve and protect the interests of all

stakeholders.

At this point, I would also like to touch very briefly upon the State

Bank’s efforts to accelerate economic growth. As you may know,

any central bank’s primary policy tool is the discount rate – the

basic interest rate which acts as an anchor for all other rates in the

economy. Unlike most central banks, and similar to the US Federal

Reserve, the State Bank has a dual mandate: it must tackle the issue

of maintaining price stability, i.e. inflation, while also keeping an eye

on economic growth. The preamble to the SBP Act of 1956 defines

that the institution has “to regulate the monetary and credit system

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of Pakistan and to foster its growth in the best national interest with

a view to securing monetary stability and fuller utilization of the

country’s productive resources”. So at the State Bank, we need to

pay close attention to both monetary stability and fuller utilization

of the country’s resources.

That is a tough balance to strike in the best of times. The Bank’s

policy is to use any room available to cut interest rates in order to

promote economic growth. After being in double-digits almost

consistently for two years, inflation has come down substantially in

the past few months to single digit, because of this, the Bank decided

to reduce its interest rate into single-digits. The benchmark rate now

stands at 9.5 percent. We also expect that average inflation for the

year will remain in the 8.50-9.50 percent range. Interest rates are

reviewed, and may be revised, every two months, which allows our

policy responses to be nimble and respond quickly to any changes in

the economic environment. The Bank also ensures that the money

market is never short of funds, which means that monetary policy

signals are transmitted efficiently.

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Our primary constraints to faster growth, however, remain the

large size of the fiscal deficit and the energy shortfall. As with most

economic problems, there is no immediate solution. Both problems

require systemic changes that will take time to achieve, through the

implementation of effective regulation and a move towards greater

private sector participation. Meanwhile, rest assured that while our

current economic situation is less than optimal, it is also very far

from what may be described as an economic calamity. In fact, over

the years, this economy has shown an inherent resilience, and I’ve

shared my thoughts about why I think our economy has the ability

to navigate through choppy waters. Nevertheless, this economy

remains quite far below its potential – however, the solutions to our

problems regarding faster growth are an open secret. It’s only a

question of implementing them.

I’d like to end my talk here on that relatively optimistic note. Unlike

the problems of the US and the Euro, our problems have very

attainable solutions. Those economies are still trying to work out

what would work best for them. We already know what we need to

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do. It’s only a matter of execution now. I’m excited by the economic

potential that this country holds, and I encourage you all to become

a part of the country’s future, by becoming a part of the solution.

Thank you!

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