The world has come a full circle. Yesterday’s frenetic economic growth has come to be replaced by rather tepid forecasts, as analysts scour the earth for any bright spots. Even in the US, which was thought to be the fastest to recover, growth prospects remain uncertain at best.
Whilst the world economy changed dramatically in 2015, not many commentators have taken sufficient notice of how this impacts Pakistan. A popular view holds that unlike some of the other large emerging economies – a la Brazil and countries closer to home like Turkey, Indonesia, and Malaysia – our economy depends for only 11% of its GDP on exports. It is therefore effectively delinked from the unfolding turmoil in global commodity prices and demand. It is also in better shape, having surmounted its immediate macro-economic challenges, and does not have quite as acute a dollar debt problem. Quite the contrary, being an oil importer, Pakistan stands to benefit greatly from lower prices for oil and cheaper fuels like coal and LNG in future. At the same time, Pakistan looks to the longer term with great optimism as its relishes the prospects emanating from its reenergized economic partnership with China – a country that has a central role in the global economy.
There is some merit in the argument, but there is also a very perverse logic attached to it. The irony is that having largely failed at growth in comparison in the last few years, we present the disconnect with global markets as a virtue. A fast changing world scenario could expose many vulnerabilities, and hence this rose tinted view could only be of short-term relevance. Ultimately, it may not redound to the country’s benefit, unless we are far more adaptable and opportunistic than in the past. This is the thesis of this article. But in order to form a view of the prospects and pitfalls going forward, it may help to understand what ails the world today and how we got here.
Going back some 15 years, almost all commodities experienced real double-digit year-over-year growth – a process that came to be dubbed as the commodity super cycle. This resulted essentially from years of low prices and underinvestment in commodities that had to contend with a burgeoning of demand as emerging markets began to grow more rapidly. Between December of 1998 and June 2008, oil rose by a staggering 1062%, copper by 487% and corn by 240% (Bloomberg). After 2008, a huge financial stimulus was launched to deal with the global financial crisis. What is perhaps less well realized is that quite apart from the repeated rounds of quantitative easing in the West and latterly Japan (and consequentially extremely low or negative real interest rates), the largest domestic debt bubble was in fact created in China by a general loosening of credit. This lead to a boom in property, infrastructure and manufacturing investments in China on a scale that is difficult to imagine, and which economists characterize as a once-in-a-lifetime event. To have some idea, lending in China ballooned from $2.1 trillion in 2000 to $28 trillion in 2014 – equivalent to 282% of its GDP, according to McKinsey. This was perhaps the fastest credit expansion the world has ever seen. This led to an investment-based and resource-intensive growth not only in China, but also in most commodity producing countries, aided by cheap dollar-based debt. Concurrently, high growth in many countries helped to stabilize economies the world over. It also created demand for durables and capital goods and led to an unprecedented expansion of global trade. Positive trade balances enabled a lot of central banks, including that of China and the oil producing countries, to accumulate massive foreign currency reserves. That swelled sovereign wealth fund investments in the developed world, bringing stable exchange rates. As reported by the Economist, central bank reserves grew from $1.8 trillion in 2001 to $12 trillion by mid-2014. The commodity boom eventually faded in 2013, and with it a rare confluence of multiple factors – themed centrally around China – that had underpinned growth and optimism in the world economy after 2008. In 2015, China’s investment based growth has slowed by as much as 40% to around 6% (estimates vary as statistics on China’s are not considered fully reliable by Western researchers), as China attempts to regain control of its debt mountain – almost 50% of which is in real estate and infrastructure development. Further investment is stymied by businesses preoccupied with repaying their loans, as previously growth-led demand is not being replaced fast enough by consumption. The point to be noted is that the events of the last 7 years are unlikely to be repeated any time soon, and the world is indeed an altogether new place. Anxiety about the world economy is rising, and this is the biggest worry for most countries. As yet, there is nothing on the horizon to stimulate growth.
So what are the curve balls that could come Pakistan’s way and what is its readiness to bat them off? An uncertain environment requires quick adaptability to change – not our strong point judging from recent history. For example, the upsurge in trade that grew at twice the rate of world growth beginning at the turn of the century virtually bypassed Pakistan, whilst peer economies leapfrogged ahead in size and prosperity. The inability to diversify its economy and move up the value chain has also crimped Pakistan’s ability to increase its share of exports, as it continues to compete with exports from poorer countries. It is thought that unless these structural weaknesses are addressed, a 6-7% growth rate is unsustainable. Periods of growth have invariably led to a balance-of-payment crisis, as imports outpaced exports and debt repayments came to a head.
This is where the greatest vulnerability lurks for Pakistani economy. Whilst Pakistan stands to benefit by default from lower oil prices, a prolonged period of low oil prices will weaken regional oil producer economies very significantly. This has negative implications for Pakistan, because its fortunes are closely linked to the GCC region’s prosperity, and more particularly to foreign remittances emanating from there. This year, Saudi Arabia is expected to run a budget deficit equivalent to 20% of its GDP after costs associated with the Yemen conflict are counted. Whilst it has large reserves of more than $660 billion and its ability to manage short term imbalances has not been tested. Some fiscal adjustment will have to be made and some investment curtailed, whilst oil prices remain below $50 per barrel. Any significant reduction in remittances, which are nowadays $20 billion and equal the country’s exports, cannot be made up for quickly, given our perennially weak export performance. With as-yet relatively small foreign currency reserves, the outlook to withstand such externalities is weak, and could enforce a quick reversal of exchange and monitory policy – a factor also noted by the IMF.
There could be more complications. Drastically reduced oil and commodity incomes have also put extreme downward pressure on emerging market currencies. The Economist estimates that China, Saudi Arabia and Russia have collectively burnt through at least $500 billion of their accumulated reserves within 2015. Commentators including the Bank of America have pointed to a heightened possibility of a discontinuation of the Saudi Riyal/Dollar peg, leading to a devaluation of the Saudi Riyal. Some derivative effects are already apparent – the spectacular rise of the US dollar versus Emerging Markets currencies has depressed the leveraged speculative Dubai property market as well as tourist arrivals from countries such as Russia, South Africa, Turkey and Malaysia. And all regional bourses have plunged since mid-2014, to reflect lower growth, or even recession. As liquidity shrinks, a tightening credit market could sound the death knell of many projects in the GCC. Finally, whilst the security situation is on an improving trend line in Pakistan, it is actually worsening in the Gulf countries as a consequence of geo-political developments, increased polarization between Shia/Sunni factions, and the latest ISIS inspired attacks to destabilize the region. There are credible reports that the enhanced threat levels are increasing economic risk perception in GCC countries. Quite apart from the inflow of worker’s remittances, Pakistanis have large investments in the Gulf. Dawn reported in its February 2015 editorial that Rs 445 billion were invested in Dubai real estate in 2013 and 2014 alone. Pakistan’s large undocumented economy has a nexus with that of the Gulf States, and any disruption there will inevitably resound very loudly in Pakistan.
So should we consign our future to doom and gloom? No, that is not the point of this article. All things considered, the country is on an uptrend, and despite criticism – some of which is unwarranted – the government must be credited for achieving a measure of security and macro-economic stability. There can be no disagreement that this was a necessary first step towards instilling confidence and luring both domestic and foreign investment. Pakistan is looking to attract as much as $46 billion CPEC funding from China over the next many years. Since a substantial part of this is in the form of Chinese investment by the very large state enterprises in commercially well-founded projects at attractive rates of return, it should be a win for both countries. Along the way, some mistakes have been and will be made, but given the circumstances that country found itself three years ago, CPEC should be recognized more widely as the turning point in the developmental history of Pakistan. To be sure, the Chinese are canny investors and despite the rhetoric of the relationship, there is no free lunch on offer. Whilst Pakistan desperately needs the infrastructure investment for growth in the future, China will benefit as it gains strategic leverage and opens up development in its areas bordering Pakistan, whilst also creating demand for its capital goods and services industries. As part of an ongoing strategic relationship, we can be optimistic that these investments will not be rolled back regardless. Unlike risk-driven private capital flows, they have a game changing strategic potential by adding to the stock of Foreign Direct Investment in the country. This last factor needs to be appreciated more profoundly, especially in the context of the investment down cycle elsewhere in the world.
Hitherto, Pakistani entrepreneurs and larger investors have been very risk averse. They either look for short-term gains or safe high yielding long-term investments (read rent seeking). This is not altogether surprising. An indifferent government, bad infrastructure and poor security have distinct consequences. They concurrently increase the cost of doing business whilst raising the risk premium for capital investment, and in some instances, the motivation to hedge against a complete breakdown of the economy – a scenario that is never too distant in the minds of those who have capital in Pakistan. Pakistanis need to make sure that this opportunity is not squandered because of political infighting and vested interests, and that all those who can make a difference, whether in or out of government, the press, the security apparatus, the bureaucracy and last but not least, entrepreneurs and investors, work in synergy towards a common purpose to ensure that the infrastructure investments lead to sustained growth and long term fiscal stability. Underlying this is the necessity for all Pakistanis to have faith that the state of Pakistan will abide and become stronger.
Credit expansion to the private sector and domestic investment rates continue to lag despite the low interest rate environment. Pakistani entrepreneurs need to exhibit the risk taking “animal spirits” that are so characteristic of countries which make use of circumstances to their own advantage, such as Vietnam, Philippines and even Cambodia. At the same time, large established investment houses need to lower their return expectations – I was recently told by an international development finance institution representative that investments at or below an internal rate of return of 10% in dollar terms were common in India, even though the risk profile other than for security was not that different to Pakistan’s. If Pakistanis do not invest, how can we expect foreigners to do so?
From the point of view of foreign direct investment, as other Emerging Markets countries contract or slow down, the differential of attraction between Pakistan and others will be reduced. As the security situation improves, the narrative about Pakistan is bound to change. As a country we are long on potential but have tended to fall short in realizing it. This must change. Potent global growth will eventually emerge – the question is, will Pakistan be ready to take full advantage this time around?
The author is a former CEO of Dawood Hercules Corporation Ltd
Whilst the world economy changed dramatically in 2015, not many commentators have taken sufficient notice of how this impacts Pakistan. A popular view holds that unlike some of the other large emerging economies – a la Brazil and countries closer to home like Turkey, Indonesia, and Malaysia – our economy depends for only 11% of its GDP on exports. It is therefore effectively delinked from the unfolding turmoil in global commodity prices and demand. It is also in better shape, having surmounted its immediate macro-economic challenges, and does not have quite as acute a dollar debt problem. Quite the contrary, being an oil importer, Pakistan stands to benefit greatly from lower prices for oil and cheaper fuels like coal and LNG in future. At the same time, Pakistan looks to the longer term with great optimism as its relishes the prospects emanating from its reenergized economic partnership with China – a country that has a central role in the global economy.
There is some merit in the argument, but there is also a very perverse logic attached to it. The irony is that having largely failed at growth in comparison in the last few years, we present the disconnect with global markets as a virtue. A fast changing world scenario could expose many vulnerabilities, and hence this rose tinted view could only be of short-term relevance. Ultimately, it may not redound to the country’s benefit, unless we are far more adaptable and opportunistic than in the past. This is the thesis of this article. But in order to form a view of the prospects and pitfalls going forward, it may help to understand what ails the world today and how we got here.
Going back some 15 years, almost all commodities experienced real double-digit year-over-year growth – a process that came to be dubbed as the commodity super cycle. This resulted essentially from years of low prices and underinvestment in commodities that had to contend with a burgeoning of demand as emerging markets began to grow more rapidly. Between December of 1998 and June 2008, oil rose by a staggering 1062%, copper by 487% and corn by 240% (Bloomberg). After 2008, a huge financial stimulus was launched to deal with the global financial crisis. What is perhaps less well realized is that quite apart from the repeated rounds of quantitative easing in the West and latterly Japan (and consequentially extremely low or negative real interest rates), the largest domestic debt bubble was in fact created in China by a general loosening of credit. This lead to a boom in property, infrastructure and manufacturing investments in China on a scale that is difficult to imagine, and which economists characterize as a once-in-a-lifetime event. To have some idea, lending in China ballooned from $2.1 trillion in 2000 to $28 trillion in 2014 – equivalent to 282% of its GDP, according to McKinsey. This was perhaps the fastest credit expansion the world has ever seen. This led to an investment-based and resource-intensive growth not only in China, but also in most commodity producing countries, aided by cheap dollar-based debt. Concurrently, high growth in many countries helped to stabilize economies the world over. It also created demand for durables and capital goods and led to an unprecedented expansion of global trade. Positive trade balances enabled a lot of central banks, including that of China and the oil producing countries, to accumulate massive foreign currency reserves. That swelled sovereign wealth fund investments in the developed world, bringing stable exchange rates. As reported by the Economist, central bank reserves grew from $1.8 trillion in 2001 to $12 trillion by mid-2014. The commodity boom eventually faded in 2013, and with it a rare confluence of multiple factors – themed centrally around China – that had underpinned growth and optimism in the world economy after 2008. In 2015, China’s investment based growth has slowed by as much as 40% to around 6% (estimates vary as statistics on China’s are not considered fully reliable by Western researchers), as China attempts to regain control of its debt mountain – almost 50% of which is in real estate and infrastructure development. Further investment is stymied by businesses preoccupied with repaying their loans, as previously growth-led demand is not being replaced fast enough by consumption. The point to be noted is that the events of the last 7 years are unlikely to be repeated any time soon, and the world is indeed an altogether new place. Anxiety about the world economy is rising, and this is the biggest worry for most countries. As yet, there is nothing on the horizon to stimulate growth.
There is nothing on the horizon to stimulate growth
So what are the curve balls that could come Pakistan’s way and what is its readiness to bat them off? An uncertain environment requires quick adaptability to change – not our strong point judging from recent history. For example, the upsurge in trade that grew at twice the rate of world growth beginning at the turn of the century virtually bypassed Pakistan, whilst peer economies leapfrogged ahead in size and prosperity. The inability to diversify its economy and move up the value chain has also crimped Pakistan’s ability to increase its share of exports, as it continues to compete with exports from poorer countries. It is thought that unless these structural weaknesses are addressed, a 6-7% growth rate is unsustainable. Periods of growth have invariably led to a balance-of-payment crisis, as imports outpaced exports and debt repayments came to a head.
This is where the greatest vulnerability lurks for Pakistani economy. Whilst Pakistan stands to benefit by default from lower oil prices, a prolonged period of low oil prices will weaken regional oil producer economies very significantly. This has negative implications for Pakistan, because its fortunes are closely linked to the GCC region’s prosperity, and more particularly to foreign remittances emanating from there. This year, Saudi Arabia is expected to run a budget deficit equivalent to 20% of its GDP after costs associated with the Yemen conflict are counted. Whilst it has large reserves of more than $660 billion and its ability to manage short term imbalances has not been tested. Some fiscal adjustment will have to be made and some investment curtailed, whilst oil prices remain below $50 per barrel. Any significant reduction in remittances, which are nowadays $20 billion and equal the country’s exports, cannot be made up for quickly, given our perennially weak export performance. With as-yet relatively small foreign currency reserves, the outlook to withstand such externalities is weak, and could enforce a quick reversal of exchange and monitory policy – a factor also noted by the IMF.
There could be more complications. Drastically reduced oil and commodity incomes have also put extreme downward pressure on emerging market currencies. The Economist estimates that China, Saudi Arabia and Russia have collectively burnt through at least $500 billion of their accumulated reserves within 2015. Commentators including the Bank of America have pointed to a heightened possibility of a discontinuation of the Saudi Riyal/Dollar peg, leading to a devaluation of the Saudi Riyal. Some derivative effects are already apparent – the spectacular rise of the US dollar versus Emerging Markets currencies has depressed the leveraged speculative Dubai property market as well as tourist arrivals from countries such as Russia, South Africa, Turkey and Malaysia. And all regional bourses have plunged since mid-2014, to reflect lower growth, or even recession. As liquidity shrinks, a tightening credit market could sound the death knell of many projects in the GCC. Finally, whilst the security situation is on an improving trend line in Pakistan, it is actually worsening in the Gulf countries as a consequence of geo-political developments, increased polarization between Shia/Sunni factions, and the latest ISIS inspired attacks to destabilize the region. There are credible reports that the enhanced threat levels are increasing economic risk perception in GCC countries. Quite apart from the inflow of worker’s remittances, Pakistanis have large investments in the Gulf. Dawn reported in its February 2015 editorial that Rs 445 billion were invested in Dubai real estate in 2013 and 2014 alone. Pakistan’s large undocumented economy has a nexus with that of the Gulf States, and any disruption there will inevitably resound very loudly in Pakistan.
So should we consign our future to doom and gloom? No, that is not the point of this article. All things considered, the country is on an uptrend, and despite criticism – some of which is unwarranted – the government must be credited for achieving a measure of security and macro-economic stability. There can be no disagreement that this was a necessary first step towards instilling confidence and luring both domestic and foreign investment. Pakistan is looking to attract as much as $46 billion CPEC funding from China over the next many years. Since a substantial part of this is in the form of Chinese investment by the very large state enterprises in commercially well-founded projects at attractive rates of return, it should be a win for both countries. Along the way, some mistakes have been and will be made, but given the circumstances that country found itself three years ago, CPEC should be recognized more widely as the turning point in the developmental history of Pakistan. To be sure, the Chinese are canny investors and despite the rhetoric of the relationship, there is no free lunch on offer. Whilst Pakistan desperately needs the infrastructure investment for growth in the future, China will benefit as it gains strategic leverage and opens up development in its areas bordering Pakistan, whilst also creating demand for its capital goods and services industries. As part of an ongoing strategic relationship, we can be optimistic that these investments will not be rolled back regardless. Unlike risk-driven private capital flows, they have a game changing strategic potential by adding to the stock of Foreign Direct Investment in the country. This last factor needs to be appreciated more profoundly, especially in the context of the investment down cycle elsewhere in the world.
Pakistani entrepreneurs and investors are risk averse
Hitherto, Pakistani entrepreneurs and larger investors have been very risk averse. They either look for short-term gains or safe high yielding long-term investments (read rent seeking). This is not altogether surprising. An indifferent government, bad infrastructure and poor security have distinct consequences. They concurrently increase the cost of doing business whilst raising the risk premium for capital investment, and in some instances, the motivation to hedge against a complete breakdown of the economy – a scenario that is never too distant in the minds of those who have capital in Pakistan. Pakistanis need to make sure that this opportunity is not squandered because of political infighting and vested interests, and that all those who can make a difference, whether in or out of government, the press, the security apparatus, the bureaucracy and last but not least, entrepreneurs and investors, work in synergy towards a common purpose to ensure that the infrastructure investments lead to sustained growth and long term fiscal stability. Underlying this is the necessity for all Pakistanis to have faith that the state of Pakistan will abide and become stronger.
Credit expansion to the private sector and domestic investment rates continue to lag despite the low interest rate environment. Pakistani entrepreneurs need to exhibit the risk taking “animal spirits” that are so characteristic of countries which make use of circumstances to their own advantage, such as Vietnam, Philippines and even Cambodia. At the same time, large established investment houses need to lower their return expectations – I was recently told by an international development finance institution representative that investments at or below an internal rate of return of 10% in dollar terms were common in India, even though the risk profile other than for security was not that different to Pakistan’s. If Pakistanis do not invest, how can we expect foreigners to do so?
From the point of view of foreign direct investment, as other Emerging Markets countries contract or slow down, the differential of attraction between Pakistan and others will be reduced. As the security situation improves, the narrative about Pakistan is bound to change. As a country we are long on potential but have tended to fall short in realizing it. This must change. Potent global growth will eventually emerge – the question is, will Pakistan be ready to take full advantage this time around?
The author is a former CEO of Dawood Hercules Corporation Ltd