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?