The new budget and after

Finally the state minister for revenue – whatever that title means let slip what everybody in the government had been denying all this time. It turns out that, all things considered, the unique approach of side-stepping – or at least trying to side step a structural adjustment program with the IMF in favour of bailouts from friendly countries hasn’t quite panned out the way PTI would have hoped.

Inflation is already above seven percent, growth is supposed to trickle down to less than four percent by the end of the fiscal, and foreign exchange reserves, give or take a few hundred million dollars, are not far from where the PML-N government left them. That means that after having taken the begging bowl across the Middle East and then to China, our reserves stand at just above eight billion dollars now, as opposed to just under eight when PTI took over.

So much for what has happened in the half-year or so of the present dispensation so far. Now let’s see what’s likely to follow. Wasn’t the budget a sweetener for almost everybody? SMEs, banks, exporters, brokers; all got their share of stimuli. How different from PTI’s first budget, which slapped an additional Rs200b or so in taxes. Now all that needs to be done is cash in on all the incentives, ramp up manufacturing and production, and before you know it your exports will be fetching top dollar in the international market.

But wait just a minute. Wasn’t the deficit the number-1 problem? After all, what good will all the incentives do if we just default before any of the production, manufacturing and earnings kick in? And didn’t we just miss the six month revenue target by a good Rs170-180b? How much sense do these incentives make considering how far in red the reserves are presently?

There’s more. With the latest advance in the interest rate and the life being squeesed out of the rupee for a good year, it is safe to say that monetary policy is text book contractionary. Plus, look at the subsidy slashing and tax piling, till the second budget at least, and you’d agree that fiscal policy is pretty tight as well. Then how much sense do incentives to raise exports and add revenue make at this time?

Uncertainty caused by a fickle currency delivers the kiss of death to any potential foreign investment, direct or portfolio, because any likely interest rate gains are washed away by snap depreciations

The government, by its own admission, is borrowing to the tune of Rs15b a day. And, in the absence of solid monetary inflows, it doesn’t exactly take an Asad Omar to figure out what that does to the overall deficit. There can be only one reason, realistically, for such an unrealistic, populist budget/finance bill. They have, despite denying it all along, agreed to sign a program with the Fund. Hence the feel good speech, littered with incentives, which will counter the bad press for a while besides pushing up the equity market a notch or two. But don’t count of the Fund to tolerate too many of these concessions once it starts dolling out more billions. And that will most likely be when the government blames PML-N and IMF all over again for everything that is wrong.

Perhaps they’ll offset all the bad news with the diaspora bonds. Minimum $5,000 investment with a three- and five-year maturity and a 6.25pc and 6.75 return, in dollar terms no less. But doesn’t that put the cart before the horse, especially in the present environment? Now they will have to come up with more dollars; both at the time of issuing the bonds and at maturity. How’ll they do that without printing more money? Instead of strengthening the rupee, they are strengthening the greenback.

The right approach, considering how high the interest rate is, would have been inviting investment in rupee terms. It’s text book theory, after all, that higher interest rates fetch hot money inflows in the local currency. That’s precisely how Sultan Erdogan attracted investments in and around the Istanbul Exchange and made his country an economic powerhouse that did better than mainland Europe in weathering the Great Recession storm a decade ago.

The State Bank must immediately restore confidence in the rupee. Uncertainty caused by a fickle currency delivers the kiss of death to any potential foreign investment, direct or portfolio, because any likely interest rate gains are washed away by snap depreciations. Therefore the Bank should, at the risk of a dirty float, announce supporting the rupee between, say, a 140-145 band to the dollar. It might cause a dip in the graph initially, but it will guarantee a quantifiable forex inflow that is far more reliable than taking the begging bowl for an outing, which only means more loans to be paid back eventually.

Such steps, in tandem with initiatives like stock market fine-tuning – more on that later – will also sit better with the IMF than ad hoc, uncertain measures like friendly bailouts. So far, statistics have only proved what was till now a very compelling hypothesis; that the government has singularly failed to knit together a clear and comprehensive economic/financial plan and continues to grope in the dark.