Thread by @AtifRMian

1/ On Pakistan's #IndependenceDay2018 , why is the country still far from economic independence? (e.g. seeking its largest bail out ever this year)

I'll focus on last 5 years as an example ... it will get a bit technical but i'll try to be clear.

2/ Economic growth is almost entirely a function of *domestic* productivity growth. What matters is investment in building your institutions and people.

Instead pak govts have increasingly looked *outside* in what i'd call an attempt at "import-led" growth ... it doesn't work

3/ The idea is to borrow from outside, and task another country with building your infrastructure or institutions, and hope some magic others .

The latest example starts in 2013, when PML-N comes to power and decides to outsource growth to China. I'd explain why it doesn't work

4/ Gov funds large infrastructure projects through China's Belt and Road Initiative (CPEC in pakistan), external debt rises from 62 to 90 billion $. The borrowing raises domestic demand "artificially", making Pakistan more expensive and less competitive globally.

5/ This is a variant of the famous "dutch disease" and Pak suffered an extreme version of it. Poof?

Real effective exchange rate (pak prices relative to trading partners) increased by 20+ % and total exports DID NOT INCREASE over past 5 years.

6/ To make matters worse, Pakistan's "in-law" finance minister strips away independence of the central bank and sets the terrible policy of keeping the exchange rate appreciated. Now Pakistan has the dutch disease, on steroids.

7/ Meanwhile there is a blanket ban on any objective assessment of CPEC. Ask a question, and you'd be accused of conspiring against national interest.

Media feeds the frenzy that its a "game changer" & a big bubble develops in the port city (currently largely sand) of Gawadar.

8/ Real estate bubbles further artificially raise domestic demand, & given the senseless exchange rate policy, it makes the dutch disease sclerotic

Notice we haven't even gotten into whether the $$ borrowing is "sustainable", the damage is being done before any repayment is due

9/ So lets talk about debt sustainability now.

The first thing to remember is, you are borrowing in dollars, while most revenue from the projects are in rupees (think domestic transportation use and local energy consumption)

This is a big problem for two reasons.

10/ First, the whole enterprise is exposed to exchange rate (ER) risk. A future depreciation of the currency, which is almost certain to happen given the inane ER policy, will jeopardize profitability.

11/ Second, the country must generate sufficient additional exports to pay back, or else it will be forced to become poorer in order to generate an export surplus to pay back.

This, again, makes things more difficult given the dutch disease in the first place.

12/ Another big ? on sustainability is that the borrowing and spending deals are highly opaque. No one really knows what's going on.

For example, what is the cost of capital in CPEC? A loan contract may report a "concessional" rate of 2%. But is it really 2%? Consider this ...

13/ There is no open bidding and Chinese companies decide everything. They charge 100$ for equipment, but put in place lower quality equipment worth only $80.

Guess what, the "true" cost of capital just went up to (2+20)/80=27.5%!

14/ There is a lot China and Pakistan can gain from each other. But deals have to be structured properly, with proper macro-prudential framework. Unfortunately, none of that was done.

The govt wanted a shiny new road real bad before the next election, which they lost anyways.

15/ Let's hope for better economic sense this time.

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