Hot Money route to No Money!

Hassnain Javed

JANUARY 21, 2020

 

 

Paul Krugman, Nobel Memorial Prize in Economic Sciences and Distinguished Professor of Economics at City University of New York, wrote: “….foundation for crisis was laid by a rush of foreign investors into a country, followed by a sudden rush out.”

Professor Krugman further add: “Since 1980, however, the roster has been impressive: Mexico, Brazil, Argentina and Chile in 1982. Sweden and Finland in 1991. Mexico again in 1995. Thailand, Malaysia, Indonesia and Korea in 1998. Argentina again in 2002. And, of course, the more recent run of disasters: Iceland, Ireland, Greece, Portugal, Spain, Italy, Cyprus.”

Keeping above in view throughout the years, consistently low investment rates are a promising sign for Pakistan, and it has become difficult to deal with the growing and developing economies, which are increasing at a much steady pace, rendering it a daunting challenge for the country. Structural flaws, legal and constitutional restrictions, enhanced tax compliance, policy instability and unexpectedness are major challenges to securing substantial conventional capital inflows into the country.

In order to have access to debt trapping, Pakistan has also been locked in a perpetual cycle of low-investment-low-saving generally results in private sector dragging out, which has constrained the country’s growth prospects. Regarding the regional economies, the investment rate in Pakistan is weakening both in absolute terms and as a percentage of GDP, which has adversely affected economic productive sectors like human capital, infrastructure, electricity, industrial sector, transport, agriculture, etc.

Resurrecting the economy is essential to government but securing foreign investors to invest in the country is equally valuable. The government’s economic team recently visited the US and Europe, and went out of their way to persuade and attract and retain investors to invest in government bills and bonds as lending rates are reportedly very high in Pakistan. Therefore, interest rates in Europe and the US are not so high, foreign investors will earn better returns by lending money to Pakistan due to high interest rates, while Pakistan can receive foreign currency, that will further help build its foreign reserves.

This is technically called Carry Trade and is also known as Hot Money. Hot Money means is an investment strategy concerning low interest rate borrowing and investing in an asset that delivers a higher rate of return. Pakistan has already been naturally drawn by international investors to some USD 400 million as Hot Money. SBP authorities believe that in the months ahead Pakistan will be able to raise up to USD 2 billion as hot money, while the Ministry of Finance will also finalize the recapitalization of Euro Bonds with a very attractive return rate.

Pakistan initiated foreign currency accounts (FCAs) in the early 1970s by providing the necessary and saving mechanisms to employees working overseas to draw capital flows to fund rising deficits. This scheme proved costly as accounts covered against the exchange risk, banks were granted a’ cushion’ advance cover on their foreign exchange liabilities towards the forefront by State Bank of Pakistan (SBP).

Hot Money means is an investment strategy concerning low interest rate borrowing and investing in an asset that delivers a higher rate of return. Pakistan has already been naturally drawn by international investors to some USD 400 million as Hot Money

In early 1990s, Pakistan opened up its economy, embraced liberal and market-oriented policies, and boosted private sector by introducing incentive packages eying capital flows. FCAs evolved into tax havens for international investors to park capital as a result of some legal measures to entertain tax evaders, which raised the country’s external debt and additional expense to the economy.

The trade liberalization regime’s adherents believe that financial capital markets and flexible exchange rates chase away free inflows of capital from one country to another to manipulate short-term gains that make the economies more susceptible. Due to the sheer trend of globalization, various global hedge funds began approaching Pakistani stock market and started pouring hot money for their narrow-term gains.

In order to complement the critical necessity of opening capital accounts during the first half of the 2000 era / decade, the liberalization process persisted and culminated in more openness and control, allowing foreign exchange companies promote structured inward remittance networks rather than hawala and hundi ones. With both the liberalizing procedures of foreign banks, industry-determined exchange rates, and financial reforms, in 2007 country garnered $8 billion in private foreign investment.

These foreign capital inflows exacerbated stock market and real estate speculations, which made them resilient contribution to degenerating competition in the country. If the prominence of Pakistan’s economy to the global economy is not as large as that of emerging economies, but in the past, it persisted highly susceptible and consistently felt the ‘ heat ‘ from economic shocks originating from international oil prices that chucked Pakistan into regular payment balance shocks. Successive governments have not followed any serious legislation on foreign investment policies to entice capital flows in human capital, superior technology, infrastructure, industry or business ecosystem.

Homeland has in the earlier days raised loans from foreign commercial banks or international cooperation agencies to build foreign exchange reserves at floating rates with short-term investment boundaries. All these previous activities of capitalizing hot money create major debt sustainability challenges, and destabilize the country’s external account.

In order to conclude, the current designated economic team needs to understand rather than living in fool’s paradise and assuring everything will get in align the short term benefits should be weigh against the tsunami of losses and economic disaster. As expressed in “Why nations fail” experiences should be taken as precedent. Pakistan economyhad experienced the severe backlashes of hot money due to its volatile nature. Such evidences are also found in the case of Mexico (peso crisis, 1994), Thailand (Baht crises, 1997), Russia (1998), Argentina (2001) which led to massive disruptions, fluctuations in foreign exchange market and at domestic front as well. In brief, IMF is also of belief the short-term debt is route to channelize higher financial crises. I will end my discussion with an urge to country Prime Minister and his economic team to religiously adhere to Chinese philosophy “it is better to teach a man to fish than give him fish”.

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