The Economic Coordination Committee of the Cabinet (ECC), the highest economic decision-making body in the country, has under the chairmanship of Adviser to the Prime Minister on Finance Dr Hafeez Sheikh approved proposals submitted by the Ministry of Finance to simplify the tax regime for non-resident companies investing in the local debt market (read government paper) with the objective of deepening the country’s capital markets (an objective of previous administrations as well that remains unachieved to this date). The ECC summary concluded that this decision would reduce the cost of debt for the government and increase foreign exchange reserves of the country.
The Ministry of Finance during the PML-N administration led by Ishaq Dar for four years and later by Miftah Ismail, was proactively engaged in deepening the capital debt market through issuance of sukuk/Eurobonds and other government paper. While foreign exchange reserves were visibly strengthened as a consequence yet the country was acquiring debt equity to shore up reserves, a disastrous policy that the PTI administration is grappling with today.
Financial deepening is an economic concept that refers to increasing the instruments of available financial services through developing financial institutions. Economic theory dictates that the desired way to increase such investment is initially from local as opposed to the external market (hot money) because reliance on the latter can plunge an economy into a crash overnight. An example is the 1997 Asian financial crisis that plunged the currencies of some of the countries in the region by as much as 38 percent.
What is therefore critical prior to implementing this ECC decision is to first strengthen market capitalization (calculated as the number of shares traded on the stock exchange times their prices) to Gross Domestic Product (GDP) ratio which as per the World Bank was 32.97 percent in 2016. In marked contrast, India’s was calculated at 76.4 percent in 2018. Economists are agreed that any market capitalization ratio to GDP ratio less than 50 percent requires strengthening and, to reiterate the point, the key is to support growth in the local as opposed to relying on the external market.
Pakistan’s investment to GDP ratio is also extremely low – at 15 percent of GDP. There is therefore a need for the economic team to focus attention on raising domestic investment. And to add to these relevant concerns is the fact that the budget for fiscal year 2019-20 envisages a growth rate of no more than 2.4 percent (Hafeez Sheikh expects the actual rate to increase to 3.5 percent) – a rate backed by the contractionary fiscal and monetary policy supported by the Ministry of Finance and the State Bank of Pakistan under the ongoing International Monetary Fund programme.
To conclude, one would hope that the present economic team would carefully review the incentives it has extended to non-resident companies to attract hot money to ensure that Pakistan is not plunged into yet another crisis as a consequence.
(This news/article originally appeared in Business Recorder on September 6th, 2019)