Tuesday, 15 August 2017

Finance and a donor-distracted SBP Nadeem Ul Haque

In 2008 financial overzealousness led the global economy over a precipice but it did not kill the romance of finance. In particular donors love finance and love to offer financial inclusion as a panacea for all societal ills.

DFID and the IFC have made the State Bank of Pakistan (SBP) run programs for financial inclusion in exchange for loans for more than a decade. SBP mission expanded into development and it opened up departments on housing, small and medium business and microfinance. Meanwhile, the IMF was pushing for independence for SBP with a sharp focus on monetary policy. 

The country’s development body, The Planning commission has been rendered a mere project office because donors have full freedom to do policy everywhere.

SBP engaged in mission creep could not even design its own financial inclusionprogram; it needed Oxford Policy Management, a UK based consulting firm, to do the design.

Many million dollars later, SBP is pushing financial programs for these SMEs, housing and microfinance with some form of subsidy or guarantee. Received wisdom in this area is that the supervisor of the banking system should not be involved in any way in either directing credit or offering subsidies or guarantees. Monetary-Policy making can be conflicted if the SBP gets involved in development policy. 

Has the SBP done a sterling job in its primary mission—managing inflation and the exchange rate? I think the consensus would be “NO!” SBP presided on the at least 2 crises in recent memory and managed them badly. In 1998, they had let the foreign exchange deposits grow to about 10 times reserves and could only exit with a default.

In the early 2000s they had held on to a policy of exchange rate over- valuation for about 7 years with widening inflation differentials.  Eventually the bubble burst with an exchange rate crisis when the rate depreciated by about 40% in a matter of weeks. In other words, policy created room for an ‘exchange rate attack.”

Perhaps focused on development, SBP has always been wrong on exchange rate. SBP has always erred on the side of keeping the exchange rate over valued i.e., the dollar is cheaper that it should be. 

Much research and evidence shows that a developing country must keep the exchange rate undervalued i.e., make the dollar more expensive than the fundamentals would suggest. Most glaring example of that recently has been China.

(But before people think I am advocating a devaluation. No! it is a question of managing a policy that will allow the correct exchange rate to emerge just like the temperature and the RPM of a finely balanced machine. Fixing the rate is not a good policy. This requires skill and research.)

Quite possibly, SBP focused on its primary task might have managed exchange rate and monetary policy better. But now more than half the bank is doing development policy in probably a turf battle with the Planning commission. Remember, this has happened through the candy of money offered by donors. 

But now our distracted SBP has once again over-valued our exchange rate to decimate our export sector.

Many studies (World Bank Doing business) have shown that investment is largely constrained by factors such as weak property rights and contract enforcement and poor governance (registration processes, taxation and corruption) and knowledge and space constraints. A course in elementary finance suggests the pricing of such risks will preclude most investment possibilities. Still expends real resources trying to solve the problem through improving loan terms. Offering cheaper and better loans to propositions that have huge structural hurdles is unlikely to make them grow and achieve solvency.

How does this make sense and has this helped or hurt SMEs? Could DFID and IFC evaluate their little experiment and tell us how the costs of a distracted SBP square off against the non-existent benefits of this decade-long activity. Are the 100 million + USD spend here justified? Could we not have dedicated that money better to importing a few professors for our professor-less universities?

Could they also tell us if all real problems can be solved merely with clever finance? Is there no need to fix domestic institutions and governance first?

Surprisingly this project was initiated at the time of the global crisis. It seems neither the donors nor SBP learned anything from the global crisis. 

And let us not ask does EAD know anything of this? Should they have?

Friday, 11 August 2017

You can’t finance away bad policy and thinking

Reagan deregulation created a romance with finance. My generation of educated Pakistanis benefited from it greatly—even gave us a Prime Minister. The romance with finance still plays strongly in Pakistani political/administrative and intellectual class. We look to finance our way out of things. It is the easy way out and we love shortcuts.

Every government runs after money. Bureaucrats are trained to look for aid and financing above all other issues. We sing siren songs to foreign investors luring them into our quagmire unaware that they like Ulysses might come prepared.

We love clever financing schemes: diaspora bonds as if immigrants can be conned into ‘cheaper than the market’ lending. Policy circles continuously chatter about securitizing remittances, floating convertible bonds or issuing more Sakooks expecting financial magic to deliver effortless development.   

Why do we think that we can con the world with financial instruments? Do we now know that financial firms are 1000s of times better at it than our policymakers? Would our politicians and bureaucrats be able to con the conmen who conned the world in 2008?

Did IPPs not come back to haunt us? Did we not learn from the Rek o Diq fiasco that the foreign investor is no friend but a shark who will take his pound of flesh?  

The romance with finance is also fed by donors after all they have to push money. We are always told how much we need their money for infrastructure, schooling, food security, sanitation, water, environment and much more. They do have an army of analysts who have nothing better to do than write reports and blogs and preach “you need money” to our governments.

All officials know that their post retirement jobs depend on donors and their children’s careers lie with donors. So, they are captured audience to the donor mantra of “you need more finance.”

Can finance solve all problems? Let us look the use simple economics to study the example of housing.

Donors have pitched for long that the shortage of housing is because of the lack of mortgages and SBP keenly engaged in mission creep for the last 10 years to develop a mortgage market. Yet the housing stock expands through the DHAs, the bureaucratic plot development (DMG), or cooperative housing societies. The first 2 are schemes for self-dealing 101, and the last is Pakistan’s contribution to the scam literature given the number of uninvestigated scams in coops.

So, the housing stock expands in expensive sprawl-based single-family homes. Cheap flats in dense spaces where the middle class can live are severely limited because the self-dealing paradigm of land development (inherent in the DHA/DMG model) seeks to restrict density and flats.

By now our demographic situation is well known. Our labor force is increasing about 2-3 million a year and our housing needs will also grow by about a 0.5- million a year. Yet the stock seems to grow in the 1000s given the myriad planning issues. Given the huge shortage, prices are escalating rapidly. 

In most cities, the cheapest house runs over a 100,000 USD forcing most people to seek informal housing or join up in some form of informal extended family arrangement. Neither of the informal arrangements are bankable given unclear property rights and contractual arrangements.

Let us examine the proposition of getting a mortgage on a house of a 100,000 USD which is about the minimum for a house in Pakistan. Even though interest rates have come down, mortgages will still be priced at 12-15%. At 12% the payment will be about 12000 USD a year. Add a little for insurance and maintenance and not including principle we will be looking at a minimum of a 15000 USD a year all included. 

Generally, it is regarded that housing should be no more than 30% of your income. This means that the income of the family buying such a house should be about 45000 USD a year. 

Just review the state of salaries. 45000 USD or 4.8 million rupees (about 400,000 rupees a month) is a seriously high salary in Pakistan even if both spouses are working.

So even if we develop a mortgage market, are we doing it only for the rich? Why then is SBP expending so much effort and why are donors funding this effort so huge? Just bad analysis?

Another approach could be to adopt reform and increase the supply of flats as dwelling units not just single family homes. This would mean break the DHA/DMG hold on the housing market to allow more density through high-rise flat construction. Supply if it goes up sharply will bring the price of dwelling unit down.

A virtuous cycle would happen as more real estate construction invigorates the economy as well as the labor market. More jobs and more bankable properties will lead to a mortgage market. 

So, donors and SBP have it the wrong way around. Rather than increase supply they are pushing expensive mortgages on a poor population. 

Moral of the story: countries and societies grow with good policy analysis rather than fanciful finance and begging for money.