Domestic monetary systems Essay Example for Free

Domestic monetary systems Essay With a population of 170 million, the Islamic Republic of Pakistan is strategically located in South Asia, sharing borders with India to the East, China to the North East, Afghanistan to the North West and Iran to the West. To the south lies the Arabian Sea, this provides close proximity to the Gulf Cooperation Council (GCC) countries. The country is predominantly Muslim with a major portion of the population (65%) residing in the rural areas. Although significant progress has been made in recent years, the country still lags behind as far as social infrastructure and human development are concerned. (Bajwa, 1999) Structure of Government and Politics: The constitution of the country, promulgated in 1973, holds out the country as a parliamentary democracy with all powers vested in the parliament. However, for much of the past decade, Pakistan was run along the lines of a military dictatorship, with Parliament subservient to the President and vast powers vested in his self. After the gradual transfer of power to democratic forces following an election on the 18th of February, the resignation of General (Retd) Pervaiz Musharraf, and the election of Asif Ali Zardari as the new President, parliament is reviewing the balance of power between the Presidential Palace and the Parliament House and it is expected that, soon, the country would revert back to the old format of the President being a ceremonial Head of State and the Prime Minister running the country independently with Parliament backing. (Malik, 2001) At present, there is a coalition government in place that comprises the Pakistan Peoples Party (PPP). It is led by the President of the country, Asif Ali Zardari, who happens to be the widower of famed democratic leader Benazir Bhutto, assassinated by terrorist elements during an election rally in the city of Rawalpindi last year. Other coalition partners include the MQM (Muthaida Quami Movement translated as United National Movement) and the ANP (Awami National Party). The Opposition is deeply divided and primarily consists of the Pakistan Muslim League (Q) and the Pakistan Muslim League (N). The main political issues on the domestic front are, as mentioned above, the repealing of anti democratic laws enacted as part of the constitution by the outgoing military regime and the issue of the deposed judges of the supreme court that were sacked by the former military regime when they refused to remain puppets. Apart from this, there is the dire issue of reconciliation between neglected provinces. However, the inability of the new coalition government to actively address issues of popular appeal and an over indulgence in issues of power sharing and power consolidation lend it ever decreasing credibility in the eyes of the general public. Although the new government has been in power for almost an year, its performance has been dismal. The popular mandate of democracy that has shot the PPP and its coalition partners into power has not been implemented. The Prime Minister, Yousuf Reza Gillani, remains a puppet and the Presidential Palace remains the main power fort. Despite the fact that the opposition is ready to support the government on national issues, such as the reinstatement of deposed judges and the repealing of undemocratic laws, the government has so far shown quiet restraint to address these issues. Foreign Policy: â€Å"Pakistans foreign policy has been marked by a complex balancing processthe result of its history, religious heritage, and geographic position. The primary objective of that policy has been to preserve Pakistans territorial integrity and security, which have been in jeopardy since the states inception. † (US Library of Congress) The aforementioned paragraph adequately describes Pakistan’s foreign policy ever since it came on the map of the world in 1947. Being predominantly Muslim, the country finds itself sentimentally attached to the Islamic World, in particular the Middle East. A developing country, lacking skilled manpower and capital to exploit the wealth of natural resources that its lands have been bestowed with, the country’s foreign policy has had to take in account the economic impact that relations with other countries can have. Moreover, traditional enmity with the giant neighbor on its eastern borders (India) has forced it to make balancing measures with staying in the good books of China and supporting pro Pakistan elements in Afghanistan. (Bajwa, 1999) Pakistans foreign policy is deeply aligned with the United States goal of War on terror. After the September 11 attacks, Pakistan renounced terrorism and became a frontline state in the war against terrorism. The country is the main supply route to NATO forces stationed in Afghanistan and is a major non NATO US ally. Despite this close alignment with the United States, the country often finds itself in a tricky situation when it comes to its tribal belt bordering Afghanistan. These areas are largely unregulated since independence from the British in 1947, operate with full autonomy while pledging allegiance to Islamabad. Pakistan is blamed for â€Å"not doing enough† to quell terrorist incursions from these tribal areas. Tribes here are said to be providing safe havens to terrorist and Taliban elements with the theory that the top brass of Al Qaeda and the Taliban is hiding here. NATO led forces have made several air strikes in the area which Pakistan declares as encroachment on its sovereignty but takes little steps to discipline these tribal belts. Part of this inaction is based on the fact that a stable Afghanistan, aligned with India is not in the best interests of Pakistan. Traditional enmity with India over the Jammu Kashmir disputed territory has led the two countries to fight three full scale wars in 1948, 1965 1971 and one limited war in 1999. Pakistan perceives a pro Pakistan Afghan government or an unstable Afghanistan as a hedge against encirclement by India. It is this threat to its security that leads it to, introvert if not extrovertly, refrain from taking any drastic steps to quell those destabilizing elements in Afghanistan that originally emanate from its terrotiry. (Bajwa, 1999) On the economic front, Pakistan is primarily an exporter of textiles accounting to about 57% of the country’s exports. Prime markets are North America and Europe. Good relations are important with these two blocks of nations as they provide trade facilitation and, at the same time, help with soft loans and aid to help in social and economic development. Remittances also play an important part in the country’s balance of payments and a large amount of Pakistani’s work in the Middle East, Europe and America. The country’s foreign policy also has to take account of these factors. (Malik, 2001) Thus, to sum up, as implied earlier, the country’s foreign policy is driven by its perceived security threat, religious affiliation with the Islamic fraternity of nations and the dependence upon economic aid and facilitation by friendly countries. While the policy has been largely successful in maintaining the country’s territorial (if we exclude the secession of East Pakistan in 1971 due to Indian intervention) integrity and safeguarding its economic interests, continuing on such lines indefinitely is not an option and it is important that the country makes a strategic review of its policy and seek alternative ways of addressing outstanding issues. Domestic Monetary Systems: Speaking In purely political economic terms, the government of technocrats that took power in October 1999 was faced with a huge crisis. Business confidence was low, investors were hesitant and the economy seemed to be heading for a deeper depression. Political legitimacy for the regime was another issue. Quite smartly, the policy makers then decided to lower interest rates. The idea was that low interest rates would encourage private sector borrowing, push up aggregate demand, increase corporate sector profitability, help in the generation of employment and quite importantly provide legitimacy to the regime. The concept to create this artificial boom was not a bad idea at all, but the fact that this approach only stocks problem for the future are alarming. While banking is referred to as â€Å"the refined management of money†, during the last 9 years, the country bore witness to the greatest mismanagement of scarce resources in the history of the country. The rise of consumer banking in an undocumented economy meant that people borrowed cheap and spent it on unproductive activities like buying consumables, investing on a volatile stock market vacationing in Europe. New investment in capital was made, but the bulk of the corporate sector used the low interest rates to either replace existing machinery or reschedule existing loans at cheaper rates. Thus, the economy was inflated by the use of an expansionary monetary policy that increased the dependence on oil and fuel. Worse, the effect is more severe as a high proportion of petroleum consumption is used by private car owners. Had the government tried to balance total economic and social benefit with total economic and social costs, by for example, encouraging public transport as opposed to private car ownership, the economy would have been less affected by the oil price hikes. Switching to Compressed Natural Gas was instead provided as a viable alternative but the result was lower gas supply for domestic and industrial use. Today, the Pakistani economy is representative of an over inflated balloon and attempts to deflate it are having serious repercussions. The state bank of Pakistan has raised interest rates to 15. 5% in attempt to curb inflation running as high as 20%. Measures have been introduced to reduce the money supply. This would help ease inflationary pressures on the demand side. However the argument goes that high interest rates would discourage investment, lead to low business confidence result in excessive saving as people would consume less and save more. This would mean that a â€Å"general glut† would appear in the economy with high inventories and unused capacity. Unless there is adequate demand outside the economy, employment levels may fall and output would decrease, leading to further slow growth, possibly complete stagnation. Given the current world economic scenario, with recession in the US, the sub prime mortgage crisis, competition from low cost producers such as China and India and the overall geo political scenario, monetary contraction is only making matters worse. Another important problem is the fact that unethical business practices like cartelization and hoarding are ever prevalent in this country. Moreover, the country is highly dependent upon imports of fuel and other items to aid its industries. Thus, a major portion of the inflation that the country faces is cost push in nature. However, the aim remains to target aggregate demand. (Janjua, 2008) This policy of the government makes some sense as the economy is artificially inflated. However, by not targeting the cost push factors and solely targeting the demand factors by reducing money supply, the government is not helping consumer and business confidence. The government’s inaction can be explained by two reasons. First, the country has recently obtained a hefty loan of USD 7. 6 billion from the IMF. A condition of this loan is to restrict money supply further. This is typical of many IMF financings which focus on monetary betterment as opposed to the level of unemployment and GDP growth. Secondly, many of the cartels have representation in the government and due to the absence of a strict legal system; any action against them is made impossible. Foreign Trade: A very interesting scenario is presented in the Economic survey of Pakistan 2007-8, which states that exports â€Å"suffer from serious structural issues which need to be addressed primarily by the industry itself, with government playing its role of a facilitator. † It then goes on to tell how textiles are the most important contributor to exports (56. 67%) and the issues that the industry faces as a result of its inability to innovate, become efficient and embrace fashion trends in its primary foreign markets. A new surprise is found in the face of food items (the country is running out of water, by the way) accounting for 13% of total exports, petroleum products (meager resources at best) accounting for 6% of total exports, manufactured leather products 3. 7% and chemicals and pharma products almost 3. 27% of total exports. Aggregate these and you find that the top five exports make up 83% of total exports. (Ministry of Finance, 2008) The point of doing this analysis is to show that as an economy; Pakistan is heavily exposed to, what is called in financial management terminology, unsystematic risk. Its lack of diversity makes it more prone to microeconomic shocks in the prime exports that it makes. Another worrying problem is the terms of trade, (a monetary measure of the price of exports upon the price of imports). Sadly, whereas the terms of trade were highly in favor of Pakistan until 1998-99 (115. 7), they have since then nose dived to stand at 58. 35 (2007-8). What this implies is that although the country has been exporting a lot more in volume, in value terms, international trade is becoming increasingly disadvantageous for Pakistan. Even if you take the effect of rising oil prices out of this analysis, the terms of trade had, never the less had fallen to 73. 6 by 2004-5. This lack of value addition makes us it more suspect to microeconomic level industry shocks that could further damage its standing in the export market. (Ministry of Finance, 2008) The previously mentioned most accurately describes the Pakistani government’s policy towards foreign trade. Although it has been working tirelessly to gain access to markets in Asia, Europe and North America for its export industries, the emphasis has remained towards increasing textile exports. This support of textiles and agricultural items to a certain extent has not fared well for other industries and sectors. Export diversity is low and so is value addition. Moreover, the country has not been able to reposition itself with regard to reliance on imports. So in so, that even though the country is an agricultural country by definition, due to poor harvests and lack of support, in certain years, we see that staple food items are imported by this agricultural country. Although natural consequences favor that Pakistan produces and exports textiles and food items, unfortunately, but both these industries have certainly lost their efficiency at doing the job that is intended of them. The textile industrys inability to change coupled with power shortages and political nightmares and our lack of water resources for agriculture coupled with reluctance from commercial banks to serve this sector means that there should be a policy change at the federal level. The high level of competition that these industries face means that the government has to take steps not only to help these industries blossom and at least maintain their market share, but to ensure that comparative advantage is exploited in other fields as well. The Pakistani government has been providing support to the traditional industries for some time now with mixed results. Therefore, instead of a status quo â€Å"wait and see† policy, a change is warranted. Thus, a policy shift should be made towards growth of value adding, job and export oriented activities. Exchange Rate Policy: Interest rate parity and purchasing power parity holds that changes in exchange rates between currencies can be explained by differences in interest rates and inflation rates respectively between countries. Building on this premise, the Rupee Dollar (PKR:USD) exchange rate remained range bound between PKR 59/USD to PKR 62/ USD for almost 8 years, starting 2000. The reason was that the country followed a managed float, with the central bank intervening in the market whenever the exchange rate would go out of range. This was happening against the backdrop of the fact that interest rates and inflation rates were considerably high in Pakistan and the currency was expected to depreciate. (State Bank of Pakistan) This managed float policy changed in early 2008 when the new government took power and the country reverted to a floating system. The rupee has since lost 33% of its value against the US dollar and currently stands at PKR 80/USD. (State Bank of Pakistan) The current policy is more realistic in its economic nature as the country, lacking substantial foreign currency reserves and a permanent balance of payment deficit could not continue to support an artificially strong exchange rate. Furthermore, this new policy of floating exchange rate systems will benefit the country with regard to its exports becoming cheaper when priced in USD. However, whether demand for the country’s exports picks up is another issue. More over, the effect of the rise in the prices of imports also has to be considered as many inputs in the production process are imported. Conclusion: The analysis of Pakistan’s monetary, foreign trade, exchange rate and foreign policy reveals the tendency in many developing countries to take decisions regarding economy based on politics. The short term benefits include lending credibility to the person in power, but the long term effects are almost always devastating. References: Bajwa Naseem, F. (1999) Pakistan : A Historical and Contemporary Look. Karachi : Oxford University Press. Asif Malik, M. (2001). Ideology and Dynamics of Pakistan. Karachi: Publishers emporium. Lipsey G. , H. Harbury, C. (1992) First Principles of Economics. London: Oxford University Press. Library Of Congress. For Researchers. Retrieved from http://www. loc. gov/rr/ State Bank Of Pakistan. Publications : Financial Stability Review. [Data File] Retrieved from http://www. sbp. org. pk/fsr/2006/index. htm Janjua Ashraf, M. (2008).. Government Borrowing and State Bank’s Authority. The Daily Dawn Economic and Business review Retrieved 12th december 2008 from http://www. dawn. com/2008/11/24/ebr14. htm