Imran Khan inherits bankrupt Pakistan

Pakistan is grappling with a big economic crisis. The State Bank of Pakistan has only about $10 billion of foreign exchange reserves, enough to fund two months imports. Pakistan runs a serious risk of defaulting on its payments. The situation poses a challenge to Pakistan’s prime minister-elect Imran Khan who will be sworn in today, August 18, 2018. 

• Pakistan's current account deficit has grown four times in just two years. It touched $18 billion in FY18, up 42.5% over the previous fiscal year. Two years ago, it was at $4.876 billion, rising to $12.621 billion the following year. 
• The import bill ballooned mainly due to higher oil prices and imports from China which is building several infrastructure projects in Pakistan under the China-Pakistan Economic Corridor programme. 
• There was a marginal increase in exports which are mainly textiles. Pakistan has devalued its rupee four times since December with an aim to make its exports cheaper. 
• The previous Nawaz Sharif government failed to take advantage of low oil prices to build foreign reserves. Corrupt regimes, faulty economic policies and low tax revenues have brought Pakistani economy to the brink. 
• But the only option visible to Pakistan is to go for IMF loan. Pakistan has borrowed from IMF several times since 1980. Though the total financing gap for the current fiscal is at around $12 billion, Pakistan may not get more than $9 billion from IMF according to its maximum quota. For the IMF bailout, it needs support of several countries, including the US which has warned the IMF against helping Pakistan as the country could use the IMF money to repay its China debt.
• Even if IMF extends help to Pakistan, it will come with conditions like devaluation of the currency, disinvestment in loss-making PSUs, hiking electricity rates and cutting agricultural subsidies which will jeopardise Imran Khan's new government as well as hit economic growth. 
• Imran Khan has announced that he would run an "Islamic welfare state" hinting at higher public spending. So far, IMF has not made any promise to bail out Pakistan, nor has Pakistan asked for a bailout.
• Pakistan can also seek Saudi Arabia's help, which can only defer oil payments. 
• Pakistan can borrow from its all-weather friend China which would mean a higher debt burden. Chinese debt is already a worry for Pakistan. China has lent Pakistan $1 billion in June and total lending to Pakistan in this fiscal year exceeded $5 billion. 

The new Imran Khan government faces a tough task of turning around the economy. Khan needs to bring in economic reforms, restrict government spending and imports, try to increase tax revenues and increase exports. 

Read the source article

In April 2018, India's foreign exchange reserves had hit a life-time high of $425 billion. Things have changed since then. The forex reserves have been falling by about $2 billion a week for seven weeks and present balance is under $400 billion. But government maintain that there's no reason to panic. Falling reserves are a result of RBI's intervention to arrest the slide of the rupee, which has depreciated around 8% in this year (16% in the past 2 years). Rupee slide against USD is the worst among the Asian currencies. No amount of reserves is ever adequate. China's reserves also fell by $14 billion in one month to $3,111 billion. Rupee is expected to remain under pressure in the near future due to rising oil prices, global trade wars, tightening of global liquidity and a strong dollar. On Aug 17, 2018 USD/INR touched 70-mark and likely to touch the 72-mark soon. 

Rupee falling is disastrous

The recent sharp depreciation of rupee is a cause for concern. The depreciation was largely against the dollar, by more than 7.5% in this year 2018. The rupee’s decline is likely to continue due to rise in the current account deficit on India’s balance of payments, intensified by the recent sharp rise in the price of crude oil. The current account deficit rose from $41.6 billion in 2016 to $73.3 billion in 2017. A depreciating rupee affects the local economy in several ways.

• Periodical rupee depreciation is a symptom that India is a bubble economy. 
• The success of India's liberalizing reforms is not because it has transformed into a manufacture & export driven economy, but indicates its emergence as a favored destination for international financial investors resulting in large capital inflows. The large capital inflows resulted in stock market values, but the valuations are not warranted by its potential earnings.
• Large inflows of foreign capital, enhances the liquidity in the system, triggers a credit boom that spurs demand and drives domestic market growth. 
• The debt-financed consumption and investment results in excess liquidity that drives banks to increase lending. This increases the defaults which can lead to systemic fragility that can intensify the capital flight and exchange rate volatility.
• The import liberalization fuels the demand funded by debt and in the absence of matching enhance in exports, the import-intensive consumption and investment results in widening current account deficit.
• The net foreign exchange outflow is due to mismatch between imports and exports and remittances and the deficit gets financed by capital inflows. A country that cannot earn the foreign exchange to finance its current needs is vulnerable to balance of payments difficulties and cannot sustain the value of its currency. 
• The low oil prices, between 2014-17, had depressed the outflows on account of excess import of goods. Now as oil prices have risen to $80 a barrel, the reality is that India is a country that is vulnerable on the balance of payments front.
• Liberalized trade and liberalized capital flows have enhanced India’s vulnerability, of which periodical currency depreciation is a symptom which got concealed so far by the large capital inflows and by the benefits of low oil prices. Both those advantages are now under threat.
• Trade liberalization has increased dependence on imports for consumption and investment and now the depreciating rupee increases cost of imports that aggravates inflation. Increase in the price of crude oil has the potential for much higher inflation. Inflation forces RBI to raise interest rates. 
• Many companies have outstanding foreign currency loans, either as working capital or acquisition-related debt, will be seriously affected.
• The liberalizations results in surge in capital flows that in turn increases private foreign debt. Since large capital inflows make the domestic currency appear strong, much of this borrowing in foreign currency is not hedged for possible losses stemming from any currency depreciation.
• Any plunge in the rupee effectively accentuates foreign institutional investors' losses on their equity portfolios and triggers stop-losses, which forces further sales, dragging markets even further down. 
• A falling rupee, in theory, should help exporters. But due to other factors export gains due to a depreciating currency may be limited.
• A falling rupee impacts tourist & business foreign travelers and students joining foreign universities. 
• FIIs have been supporting the rupee in the last three years, their inflows have dried up. So far in 2018, FIIs have pulled out Rs 46,197 crore from the Indian markets. 
• The Indian currency's vulnerability is particularly heightened by the fact that among its emerging market peers, India runs a high current account deficit.
• Large number of expatriates returning from Saudi Arabia and modified H1B visa rules by USA will hit remittances in coming years and impact current account deficit.

When depreciation actually occurs, the rupee costs of servicing foreign debt rise sharply. When the stagflation afflicts the economy hurts corporate profits and makes the burden of servicing foreign debt too much to bear. The distress sale of assets that follows bankruptcies results in asset price deflation, which worsens the problem. Depending on the intensity of these effects, the bubble can burst and the game of speculation can unravel. It is for this reason the bubble economy becomes unsustainable.

India escaped the last two global financial crises, but it may not be as lucky this time. Rising oil prices & increasing inflation and combined with the bad loans & capital flights already occurring, there is trouble looming. Turkey and Argentina, two of the world's biggest emerging markets, have been plunged into economic turmoil. Both the Turkey's lira and the Argentina's pesos have gone into free fall in recent months due to panic-selling by investors. Emerging markets were under performing by 2.5% so far this year. The strong US dollar is putting pressure on other currencies. Turkey's inflation rate exceeded 10%. The Argentine peso has plummeted by more than 10% against the US dollar. In May 2018, Argentina's central bank hiked interest rates from 27.5%  to 40% to avoid further capital outflows. While Argentina had already requested IMF help to rescue its economy, it is only a matter of time for Turkey to request IMF to help rescue its economy. Other emerging markets may be able to adapt to rising US interest rates without facing such turbulence. The strong $ 400+ billion reserves are sufficient for meeting contingencies but uncontrolled current account deficit will compel FII's to withdraw their exposures in India that will spell doom for our economy. Hence reducing current account deficit and inflation control are paramount.

Implications of Moody's ratings upgrade for India

• Moody's upgrading India's ratings from 'Baa3' to 'Baa2' two days ago - even though a notch up but still remains in 'Investment grade-Moderate credit risk' band only. The rating outlook was only changed to 'positive' from 'stable'.
• However, Moody’s have put out a caveat that they will watch out for any deterioration of the fiscal situation or banking system. 
• S&P has stated that it will continue to keep India's rating unchanged.
• The only jubilation for BJP is that Manmohan Singh tried but couldn't get it. And Modi tried and failed in 2016, but could get it citing demonetisation and GST roll out as reforms now in 2017.
• India’s last upgrade by Moody’s was 13 years ago in 2004 to 'Baa3' from 'Ba1'. 
• From Jan, 1988 India had a credit rating of A-2, the highest investment grade rating it ever got. But on Oct, 1990, it was downgraded to Baa1 in the wake of India’s twin crisis of worsening balance of payments and fiscal indiscipline. On Mar, 1991, it was further downgraded two notches to Baa3, which was the last category of investment grade rating. On Jun, 1991, India plunged into the non-investment category at Ba2, a downgrade of two notches. From Jun, 1998 (in the aftermath of India’s nuclear tests in Pokhran) India remained classified in the non-investment or ‘junk’ category 'Ba2'. 

• In the last 13 years, investment flows from abroad have seen a steady rise and Indian companies have been borrowing more from overseas markets, though the terms of these loans could have been better with a higher rating from Moody’s. Nevertheless, a rating of Baa3 has really not come in the way of either more foreign investment or higher foreign borrowing. 
• On the back drop of botched demonetisation and badly implemented GST, Moody’s upgrade found it reassuring that the economic outlook is better now, thus puncturing the domestic narrative. But ground reality remains same that economy is in shambles and much needed to be done for its revival.
• Economic decisions should be analysed only from an economic point of view only. Seen through the colour of political ideologies, all kinds of biases creep in.
• For corporates, who are leveraged and have overseas borrowing, it will lower cost of borrowings. 
• The increased flow of foreign exchange into the country is likely to see appreciation of INR, which is already overvalued and impacts already stressed exports and surge in imports that might not augur well for current account deficit that has already widened to over 2% GDP.
• The combined fiscal deficit of states and the Centre is still in control at 6.4% of GDP in 2016-17 that gave the Moody’s some confidence in India’s ability to stay on the path of fiscal consolidation.
• If the health of the banking system does not improve in the next year or two, the risks of a downgrade may lurk once again.
• If oil prices rise and the government is not able to manage their consequences in the domestic economy properly, then the newly acquired rating could be subjected to a review.
• Moody’s has noted that the combined debt of the governments has risen to 68% of GDP, which is significantly higher than the median rate of 44% for all countries classified under the Baa group. While there are many other positive countervailing factors in India’s case, but further growth in debt can be a cause for concern.
• If elections could be won with the help of good economic news from international agencies, leaders of the BJP should consider themselves fortunate but elections are hardly won on external certifications.

Moody's upgrading India rating with a caveat and S&P maintaining status quo clearly indicates that Moody's had succumbed to intense lobbying by Modi & Co and hence this upgrading speaks out nothing and reaffirms domestic narrative that Indian economy is in shambles following botched demonetisation and badly rolled out GST. Now we can see Modi & BJP bombarding nation with high pitch campaigns that our economy is booming and targeting Congress with choicest abuses. Moody's decision of politics hurts its integrity and its ratings will be of no use going forward.