Countries in Asia Prepare for European Debt Crisis Fallout

Sources:

Agence France-Presse: Asian Countries Cut Rates amid Global Economic Woe

FT: Indonesia Slashes Interest Rates by 50 Basis Points

WSJ: Asia—Pacific Economies Gird for Turbulence

WSJ: Some Asian Economies Reflect Strains

Countries throughout Asia and the South Pacific have responded to the European debt crisis and waning global demand by lowering their benchmark interest rates. Australia, China, Indonesia, Pakistan, and Thailand have all decreased benchmark interest rates in recent months, and Malaysia, New Zealand, Singapore, and South Korea are considering other policies to inject more money into their economies.

The use of monetary policy to spur spending and economic growth represents a shift in policy for many of these countries. In recent years, these countries have experienced robust economic growth and have been primarily concerned with curbing high inflation. This concern has led them to maintain high interest rates to decrease the money supply—and thereby inflation—by making saving more attractive and borrowing more expensive. However, the once-rising inflation rate is now falling in many of these countries and economic growth has also decreased. It is this reversal in growth that has convinced many of the countries to change course.

The benchmark interest rate is the rate of return on new government-issued bonds. In theory, lowering the benchmark interest rate can decrease the value of a country’s currency and spur its export industries, which is an effective way to generate economic growth. For example, if Indonesia lowers its benchmark interest rate, demand for Indonesian bonds will fall because they are not as profitable as before. Since investors use the Indonesian currency (rupiah) to buy government bonds, when demand for the bonds falls so does demand for the currency, which lowers its value in accordance with supply and demand principles. If the rupiah costs less on the foreign exchange market, it will be cheaper for businesses in the United States, for example, to buy the rupiah required to pay Indonesian manufacturers for their goods. The lower currency value will, therefore, jumpstart Indonesian export industries and generate economic growth.

A lower benchmark interest rate also has an effect domestically. When interest rates are lower, saving is less attractive and borrowing is cheaper, which encourages people to spend their money rather than save it. The additional spending increases overall demand and economic growth.

Some analysts question whether policies aimed at increasing economic growth at the risk of increased inflation are necessary. Although economic growth rates have fallen of late, a recent Asian Development Bank report indicated that Asian countries are still on pace for 7.5% growth in 2011. These analysts believe that this level of growth is appropriate given the global economic downturn, and think that preventing the potentially destabilizing effects of inflation on food and commodity prices should be the countries’ priority.

Whether this policy shift represents a temporary response to worsening conditions in Europe or a more prolonged transformation of Asian monetary policy remains to be seen. There is no doubt, however, that Asia’s path forward will be closely observed and scrutinized by the global community.

Three Multilateral Financial Institutions Will Collaborate to Loan Money to Help Fund the First Private Wind Farm in Pakistan

Sources:
Associated Press of Pakistan: IFC Supports Landmark Wind Power Project in Pakistan
Bloomerg: Zorul Gets $111 Million Loan for Pakistan Wind-Power Project
Business Recorder: ADB Boosts Pakistan's Wind Power Capacity

The International Finance Corp (IFC), the Asian Development Bank (ADB), and the ECO Trade and Development Bank (ECO) are providing loans of $38.1 million, $36.8 million, and $20 million, respectively, to a company named Zorlu Enerji Electrik Uretim (Zorlu) to expand its wind power generation plant in the Sindh province of Pakistan, near the border with India. Zorlu will use the funding to install additional wind turbines and increase the facility’s electricity capacity from 6 megawatts (MW) to 56.4 MW. The Zorlu project will be the first internationally financed wind power facility in Pakistan and one of the first two wind power projects to operate commercially in Pakistan.

Zorlu’s total cost for the wind expansion project is $147 million. In addition to the amounts supplies by the ADB, ITC, and ECO, Zorlu will supply $35.9 million and Pakistani bank Habib will loan the remaining $16.2 million.

Increased wind power generation is important in Pakistan because the country’s demand for electricity has increased by 40% over the last five years while production has been unable to keep up. Pakistan’s lack of electricity has resulted in brownouts (the partial loss of electricity) in all major urban centers, electricity rationing, and early closing times for businesses, all of which undermine the country’s economy. To combat these problems, the Pakistani government is pushing to expand its energy resources, which includes increasing wind power generation.

The wind project will also help reduce Pakistan’s reliance on imported fossil fuel for the majority of its energy needs, which is very costly and leaves the country vulnerable to changes in global price. The ADB believes that Zorlu’s additional wind output will provide Pakistan with much needed electricity while also increasing the country’s energy security and lowering its reliance on fossil fuels. The IFC hopes that its investment in the Zorlu project will stimulate other international investors to invest in wind power within Pakistan which will stimulate and strengthen the Pakistani economy.

Pakistan and India Plan to Increase Trade

Sources:
The Diplomat: Most Favoured India?
FT: Islamabad Looks to India to Aid Economy
FT: Pakistan and India in Historic Trade Push
FT: Pakistan Takes Giant Step with Trade Move
Livemint: PM-Level Talks between India, Pakistan Likely in November
Reuters India: India-Pakistan Trade Deal is but a First Step
WTO: Principles of the Trading System

Representatives from India and Pakistan met earlier this month and agreed in principle to the most extensive measures to promote trade between the countries since they were granted their independence from Britain in 1947. The countries aim to increase their bilateral trade to $6 billion annually within three years from the current $2.7 billion annually. The countries’ commerce secretaries plan to meet in India in November to finalize the trade agreement.

Pakistani political and military officials have previously insisted that trade agreements be conditioned on the resolution of a territorial dispute over Kashmir (a Muslim-majority region divided among India, Pakistan, and China), but they have backed away from this stance. The countries discussed a trade agreement in November 2008, but India halted negotiations after a Pakistan-based terrorist group killed 166 people in Mumbai. The two countries’ prime ministers did not meet again until March 2011, when Indian Prime Minister Manmohan Singh engaged Pakistani Prime Minister Yousuf Raza Gilani in “extremely positive and encouraging” talks while the latter was in India to watch the India-Pakistan semi-final match of the cricket World Cup.

The proposed trade deal includes an agreement by Pakistan to ease visa restrictions for business leaders in India and Pakistan and to allow goods and services to travel more freely between the two countries. Pakistan’s decision to consider easing trade restrictions with India was spurred primarily by the relatively poor performance of its economy. Pakistan’s 3% growth rate lags behind China’s and India’s 8% growth rates, and increased budget deficits and debt threaten Pakistan’s long-term economic viability. Pakistan anticipates that increased trade with India will promote its export industries, which is an effective way to generate jobs and boost the local economy. A better economic outlook may slow the “brain drain” (a phenomenon in which the best and brightest citizens seek work abroad) and convince its citizens to remain in Pakistan and contribute to its economic development. Another reason for Pakistan’s policy shift is due to improved relations with India following India’s acquiescence in allowing Pakistan to have preferential European Union (EU) market access following last year’s floods in Pakistan. Furthermore, Pakistan may fear being left behind, both politically and economically, after India signed a similar free trade agreement with Afghanistan last week.

Business leaders in Pakistan anticipate that the easing of restrictions will benefit the Pakistani cement, textiles, agriculture, and engineering industries (industries that produce products India desires, and Pakistanis cannot wholly afford), but others fear that opening up Pakistan to India’s generic drug industry and Bollywood (India’s entertainment industry)will destroy Pakistan’s pharmaceutical and entertainment industries. Nevertheless, officials in both countries believe the deal will benefit both economies.

Although Pakistani and Indian officials are optimistic that they will reach a deal, a degree of doubt is warranted. Pakistani-based militant attacks often accompany diplomacy between the two countries, and a Kashmiri group, the United Jihad Council, has threatened “grave consequences” if Pakistan cooperates with India. If an attack resembling the Mumbai attack of November 2008 or a violent uprising in Kashmir occurs, trade negotiations may fall apart and the prospect of economic development could be put on hold. Regardless, the renewed effort to set aside political differences is encouraging.

The IMF Warns Pakistan on Economic Reforms

Sources:

Int’l Herald Tribune: Ailing economy: IMF censures Pakistan over ‘retarding reforms’

Reuters: Pakistan's forex reserves sustainability a cause for concern

The Economist: The Decline of Pakistan: Five Years On

Bloomberg Businessweek: Pakistan Keeps Rates on Hold, as Forecast, on Easing Inflation

This week the IMF released a report strongly criticizing Pakistan for backtracking on economic reforms it agreed to as a condition loans. In 2008, the IMF and Pakistan began an $11.3 billion loan program on the condition that the government would increase tax revenue and give its central bank more autonomy to set monetary policy. The IMF says that in the early months of the program, Pakistan followed through on its commitments. However, in May of 2010 the IMF stopped payments to Pakistan after reforms stalled. In December of 2010, the IMF granted Pakistan a nine month extension of the program with the expectation that Pakistan's government would institute a new sales tax program. Pakistan is now attempting to negotiate a second round of loans from the IMF, in part to help pay back loans from the first round.

Pakistan has one of the lowest tax-to-GDP ratios in the world, yet is consistently in danger of defaulting on loans by the IMF and foreign lenders. Pakistan's government has a total public debt of roughly $138 billion and a debt-to-GDP ratio of more than 60%, higher than most quickly developing countries. The IMF has been pushing Pakistan to increase its tax revenues by improving collections, specifically by instituting a sales tax. Pakistan has instituted a sales tax, but some traders have shutdown their businesses in protest over the measures. As a result, the government has been slow to implement the tax. The IMF is pushing for the tax in the hopes that it would allow Pakistan's government to fund more development and poverty reduction projects, especially in areas with poor security conditions.

Beyond tax reform, the IMF plan for Pakistan includes several other measures. The IMF wants Pakistan's government to pay down its debts to boost economic confidence that will lead to higher savings rates and investments. The IMF also believes that Pakistan's monetary policy should be dictated by the central bank and insulated from political pressures. Finally, the IMF is pressuring Pakistan to decrease its subsidies for petroleum, however this is politically unpopular at a time when global fuel prices continue to rise.

Pakistan's GDP is projected to grow at 2.5% this year as it struggles to manage its debt obligations and pay for the cleanup of the 2010 floods that affected more than 20 million people. Pakistan's economy also suffers from internal fighting that frequently lead to displacements of large numbers of people in the areas that provide much of the country's food and mining resources.

Pakistan and the IMF

Sources:
Guardian: Pakistan Takes $5bn IMF Bail-Out After Allies Refuse Funds
WSJ: IMF Chides Pakistan on Budget Gap
Daily News & Analysis: IMF Warns About Pakistan's Deteriorating Economy
The Telegraph: Pakistan Wins Reprieve from Financial Crisis

In an official letter to the President of Pakistan, Asif Ali Zardari, the IMF warned that Pakistan’s economy is in danger of crisis and urged immediate fiscal tightening. Implementing IMF reforms will be difficult as the government is unstable after ministers from Zardare’s coalition partners left this week. Also, many politicians are resisting austerity measures while Pakistan is still suffering from the devastating flood that occurred earlier this year.

The IMF, and the World Bank, in conjunction with influential members – the U.S., Japan, and European countries− worry that Pakistan’s economy will unravel through escalating inflation caused by poor tax revenue. Pakistan is financing the budget deficit by borrowing from the central bank, so Pakistan is printing money. If done on a large scale and continuously, borrowing from the central bank will lead to inflation as the money supply disproportionately expands.

The IMF became involved in Pakistan in 2008 with a balance of payments crisis. The IMF gave Pakistan $5 billion so it could make payments on foreign debts. Pakistan’s foreign exchange reserves were nearly depleted, making Pakistan unable to repay debts and functionally bankrupt. The IMF then gave Pakistan access to £7.5 billion from 2008-9, more than it had ever received since 1947.

In 2010 the IMF withheld $3.5 billion from its total $11.3 billion loan package to Pakistan to induce fiscal responsibility. The IMF has not disbursed any loans to Pakistan since May; the exception was the $450 million in IMF relief aid for the flood. The IMF wants to decrease the budget deficit of 6% of GDP, above the 4% target, as the government failed to decrease expenses and enact a general sales tax , both of which Pakistan promised in exchange from IMF financing.

In addition to budgetary concerns, Pakistan’s external debt is also a growing problem. The external debt is currently £35.5 billion, and will increase to over £47 billion in 2015. This has led the interior minister, Rehman Malick, to ask for Pakistan’s external debt to be written off. Financial analysts, and even some financing ministry officials in Pakistan, greeted his request with derision and warned it would frighten investors and thus slow economic growth.

The IMF projects that Pakistan’s economy will grow by 2.5% in the fiscal year through June 2011, lower than the 9.1% projected for India, and half the growth rate of Bangladesh. The IMF is also concerned the Pakistan’s central bank will be forced to raise interest rates to combat inflation at the same time the economy is suffering, which would make the economic situation more dire. There are also political implications of slow growth. Pakistan’s economy must grow between 8% and 10% a year to absorb the two million new entrants to the labor force and reduce poverty. However, the many unemployed are recruits for the Taliban, which use Pakistan as a base for the fight in Afghanistan.

Discussion:
1. Pakistan’s military is still producing nuclear weapons at the highest rate in the world. How could that money be appropriated to help the economy?
2. How do concerns about corruption in Pakistan and neighboring nations affect the fight against terror in those nations?
3. Agricultural elites generate a fifth of Pakistan’s GDP and pay less than 1% of taxes. Is there a legitimate economic reason for this, or, if not, how should Pakistan redistribute the tax burden?

International Funds Slow to Trickle into Pakistan After Massive Flooding

Sources:
AP: Official: Int’l Aid for Pakistan for Pakistan Floods Over $800M
CSMonitor.com: Pakistan Flood Waters Recede but Country’s Debt Rises
IMF.org: IMF to Provide US$450 Million in Immediate Emergency Assistance to Pakistan and Work Toward Completion of Stand-By Arrangement Program Review
NYTimes.com: U.N. Flood Relief Official Says She Will Seek More Money
Reuters.com: World Bank Boosts Pakistan Flood Support to $1 Bln
UPI.com: Pakistan Flood Emergency Far From Over

Pakistan is currently enduring possibly its worst natural disaster in history. The UN estimates that so far 1,750 people have died, 1.8 million homes are either destroyed or damaged, 6 million people are homeless, and 21 million people have been affected in some way due to massive flooding affecting one-fifth of the country’s entire territory.

The world’s financial institutions have pledged millions to support the country. The World Bank increased its pledge last week to $1 billion. The money is meant to help finance both the immediate recovery needs and long-term reconstruction projects. It comes from International Development Association (part of the WB) funds already earmarked for Pakistan. These loans carry a longer term for repayment and are interest-free. The IMF agreed to make $450 million available within the next month as immediate emergency relief. This money is on top of the $7.3 billion already available as part of the Stand-By Arrangement in place since November 2008 whose terms also might be renegotiated as a result of the flooding.

The UN originally called for $460 million in global relief for the country, but has asked for more money in recent days. So far pledges have amounted to only 64% of the original request. The U.S. alone has pledged $150 million. Pakistan itself is requesting countries cancel some of its outstanding debts (which will reach $74 billion by 2014) as an additional form of relief. It argues that the flooding justifies this action under the UN Human Rights Commission “State of Necessity” resolution. Pakistan has also mentioned that 70% of its international debt was accrued by dictatorial governments as further justification for its request for debt repudiation.

All of these institutions have raised fears that Pakistan is not receiving enough money to properly cope with the crisis, citing possible donor exhaustion following large fundraising campaigns after major earthquakes in Haiti and Chile. Some also blame the relatively low death toll for creating the international perception that the situation is not as bad as it is.

Discussion:
1) In light of the fear of “donor exhaustion,” do you think it is the world’s responsibility to come to the aid of other countries when natural disaster strikes? If yes, do you think this responsibility should extend to providing assistance to countries that are in dire straits no matter the cause?
2) Would it be moral for countries to limit their assistance to those countries with which it has some kind of political tie (for example, the U.S. giving aid to Pakistan because it sees it as an important ally in the war in Afghanistan)?
3) Should the UN be able to require countries to donate to disaster-stricken countries?
4) Does the fact that a dictator accrued a country’s foreign debt provide sufficient justification for international debt repudiation?