Inflation or recession?

THERE is nothing to write home about with regard to the recent appointment of the new governor of the State Bank, except that it has been made in time.

It need not detract us from the conclusion of the IRI (International Republican Institute) survey last month that inflation is the main problem being faced by a majority of Pakistanis. Is it time for inflation targeting? That is not to say there is no target for inflation now. There is one, but it is not set by the State Bank.

Let me explain. While the State Bank Act assigns the function of price stability to the State Bank, the target for inflation is fixed by the government in its annual plan. Like other macroeconomic targets, it is an indicative target. The role of the State Bank through its monetary policy is to broadly achieve the government’s target. It expands or contracts monetary assets, the so-called M2, by varying the interest rate. This is the case of relative autonomy.

However, inflation targeting is a different approach. Under this the bank would have the independence to set a strict target for inflation and undertake measures for its single-minded pursuit. Beginning with New Zealand, and now in a host of countries, the approach has been employed with some success to achieve a stable rate of inflation and a predictable environment for investment. The most important condition for this is a highly independent central bank, which is fully responsible and therefore accountable for its monetary policy.

Research carried out at GC University, Lahore, shows that conditions in Pakistan are ripe for adopting inflation targeting. The sticking point may the autonomy of the State Bank. Governments are not interested and the governors take it seriously only towards the end of their tenure.

Nothing is known about an inter-agency committee that was to be set up under the IMF programme to review the “legal provisions relating to the operational independence of the SBP”. What is known is that the previous governor has left a whole new draft of the State Bank Act, with the bizarre recommendation to appoint governors for two five-year renewable terms.

Right now the target for inflation has been set out in the agreement with the IMF and to which both the finance ministry and the State Bank are signatories. The resolution of the main issue raised in a special report in this paper on the IMF programme — whether or not to raise the policy rate further — hinges on the achievement of this target. Benchmarked at the 12-month headline inflation rate of 25 per cent in October 2008 and a core inflation (non-food and non-energy) of 18.3 per cent, the target is to bring it down to 20 per cent in June 2009 and six per cent in June 2010.

This inflation trajectory is to be achieved mainly through a tight monetary policy.

On Nov 12, 2008, the State Bank had raised the discount rate by 200 bases points to 15 per cent. This was only the first step on this path. There is a commitment “to increasing the discount rate further at the time of the Monetary Policy Statement at end-January 2009, or earlier, as needed, if the SBP’s actual net foreign assets fall short of monthly benchmarks”. According to the IMF, Pakistan’s crisis is located in the balance of payments not recession, originating in lax financial policies. So a higher discount rate with continuing interest rate flexibility is required to safeguard the reserve position and ensure government financing through the market, not the State Bank. Minimal intervention in the exchange rate market, elimination of any vestiges of multiple exchange rates and the discontinuation of the provision of foreign exchange for energy imports are steps in this direction.

Last November, the 12-month food inflation declined but non-food inflation did not, due mainly to energy items. The impact on headline inflation was marginal; it declined to 24.7 per cent. Core inflation actually increased slightly to 18.4 per cent.

While the monetary overhang of the past persists, the State Bank continues to accommodate government budgetary requirements. Data in December will reflect lower energy prices. Yet the headline inflation is likely to remain at a higher level.

A combined tightening of as much as 550 bases points in the past 18 months, according to the First Quarterly Report of the State Bank, has actually led to a year-on-year decline of 0.2 per cent in money supply in July-November, 2008. But this is more because of a high negative level of net foreign assets rather than a shrinkage of domestic demand. There is thus the IMF case for further monetary tightening in January.

In the absence of quarterly GDP data, large-scale manufacturing serves as a proxy for the real sector which experienced a negative growth of 6.2 per cent in July-September, reflecting in part the impact of the July tightening. The October-December data will show the impact of the November hike of 200 bases points. We know that exports in November declined by 0.76 per cent. We do not have an official definition of recession.

Internationally, negative growth in two successive quarters signals the onset of recession. Except for sugarcane, the agriculture sector is likely to perform better. The overall growth may be positive. But the relevant number in a developing economy is growth per capita, which may be minimal, if not negative.

May we hope that the new governor learned at rival Oxford or the ailing Citibank what impoverishes more — inflation or recession Being from Cambridge myself, I don’t think much of Oxford anyway.

The writer, a former chief economist of the Planning Commission, is presently Mahbub ul Haq Chair at GC University, Lahore.

Unconstitutional rule

GEN Ziaul Haq hanged Zulfiqar Ali Bhutto, but could not destroy Bhutto’s 1973 Constitution — the only constitution unanimously adopted by the directly elected representatives of the people of Pakistan.

The constitutional bill tabled by the PPP was endorsed by every shade of public opinion, including Bhutto’s powerful detractors Wali Kan and Mufti Mahmood. But those who inherited the business of politics from their family members appear committed to destroying the constitution that binds Pakistan; each step designed to attain absolute power and remove all checks and balances.

Usurpers, Zia and Musharraf, after the holding of general elections and upon the restoration of the democratic order, sought to have their actions validated by parliament otherwise they may have faced the hangman’s rope for dismembering the constitution. Accordingly, Mohammad Khan Junejo’s government secured the requisite two-thirds majority from parliament and enacted the Eighth Amendment, and Zafrullah Jamali’s government the Seventeenth Amendment to the Constitution. These amendments respectively inserted Articles 270A and 270AA and provided constitutional cover to the aberrations.

No effort, however, has been made by this PPP government to govern constitutionally. They accept Musharraf’s Nov 3, 2007 imposition of one-man rule, the abrogation of the constitution, the devastation of the superior judiciary, the enactment of anti-media laws and the removal of conscientious judges.

Whilst the PPP was not the perpetrator of the crime committed against the institutions of the state on that bleak day in November, it has acted as an accomplice and co-conspirator ever since. It reaps the benefit of Musharraf’s unconstitutional and illegal actions, without obtaining the required validation from parliament. It governs, like Musharraf did after his Nov 3 action, on the strength of a non-existent amendment to the constitution, the infamous ‘Article 270AAA’, which Musharraf sought to write into the constitution without tabling a constitution-amending bill.

Musharraf realised his untenable constitutional position after his Nov 3 actions and sought to have the same ‘assailed’ before the remnant of the Supreme Court. On Nov 2, 2007 the Supreme Court comprised 18 judges, the following day it was left with only five. The 13 Supreme Court judges who refused to violate their oath to preserve, defend and protect the constitution were immediately placed under house arrest and remained incarcerated, whilst those who had been appointed to fill the ‘vacancies’ only a few days earlier determined the fate of the nation. The petitions challenging the Nov 3 actions were dismissed in a record 13 days.

One petition was filed by Tikka Mohammad Iqbal, who was well known to NAB, and the other by his lawyer, chairman of the unknown Watan Party. The reconstituted Supreme Court announced its order on Nov 23, 2007. This judgment followed a long line of controversial judgments that justified the overthrow of civilian power by the force of arms. However, these judgments protect the usurper only until the new parliament convenes whereafter parliament’s validation is required.

The court’s verdict of Nov 23, 2007 did not refer to ‘Article 270AAA’, promulgated only two days earlier. However, when the reasons were given, several months later, ‘Article 270AAA’ was mentioned in the penultimate paragraph, in passing and for the very first time. However, these reasons did not state that Musharraf could himself validate his actions of Nov 3 or that this could be achieved by ‘Article 270AAA’. The PPP government, however, acts as if this was the decision of the court. Let us assume that PPP is correct to consider the effect of this judgment.

Jurisprudential principles and well-settled precedents of the Supreme Court dictate that only a dispute before a court can be adjudicated. ‘Article 270AAA’ had not been enacted when the petitions were filed and the petitions were not amended subsequently to cover this matter. The court therefore neither had the mandate nor the jurisdiction to determine the validity of ‘Article 270AAA’.

Another entrenched principle mandates that all interested parties must be provided an opportunity to be heard before deciding a case. The power to amend the constitution vests in parliament therefore the proposition that one man could validate amendments, made by himself, to the constitution would be a matter that impinged on the powers of parliament, making each parliamentarian an interested and necessary party in the determination of the dispute. However, not a single parliamentarian was made a party to the petition, either directly or through his/her political party or even through the chairman or speaker, respectively of the Senate or National Assembly.

Yet, another legal principle prescribes that the core and binding part of a decision is its ratio decidendi, meaning reasons for deciding. It is the decision on the issue raised by the facts. As no discussion took place in the judgment on ‘Article 270AAA’, reference to it can at best be regarded as obiter dictum and not binding.

Why then is the party founded by the maker of the 1973 Constitution enamoured of Musharraf’s unconstitutional ‘Article 270AAA’? The machinery that preserves Bhutto’s 1973 Constitution and protects against tyranny has been bartered away. Judas’s betrayal of Christ was for 30 pieces of silver, what is the price of this betrayal?

Systematically, the co-chairman of the PPP has gathered all power in his hands. His is the prime minister, his is the speaker and his friends occupy all important cabinet, advisory and nearly all constitutional positions. He himself is the president, an office acquired by climbing over a heap of broken agreements. He also retains the position of the chairperson of the PPP against all propriety and decorum. Either he trusts no one in the PPP or he wants to be all powerful or perhaps both.

The court uprooted by Gen Musharraf also suits his successor just fine. The federal law secretary of the PPP government, who attended school at Petaro with the president, has issued a seniority list of judges wherein he has placed himself at the very top. With respect, the question arises whether one can be a judge in one’s own cause? The PPP government’s seniority list rebukes the seniority list of the judges list issued by the high court.

The bayonet plunged deep into the constitutional belly on Nov 3, 2007 still lies embedded and the gangrene spreads. The constitutional garment clings to the body politic like a soiled pamper and our lives are turning into a putrid nightmare. Zia deposed and hanged an elected prime minister, but failed to destroy Bhutto’s legacy. Will the present leadership of the PPP succeed where Zia failed?

A million dollars in his head

WHEN Bernard Madoff was arrested last December on accusations of a $50bn swindle, every-one started talking of a Ponzi scheme.

Ponzi frauds are defined in financial lingo as scams through which a handful of people are initially paid mind-boggling profits on their investments.

This attracts more capital and you repeat the trick, as many times as you want, of paying off earlier investors at unheard of interest rates. At a given moment you find yourself with a mountain of cash and, to quote the great American philosopher P. T. Barnum, a new sucker being born every minute!

The inventor of the fraud originally was a Scotsman named John Law as far back as 1719 who had made a killing out of selling stocks (with an astounding 40 per cent interest rate!) in a French company trading up the Mississippi River in the United States. Today, however, this type of cozening is incontrovertibly linked with the name of Charles Ponzi who had lived closer to our times.

After all, you cannot call a harebrained swindle a Law scheme!

Charles Ponzi, a diminutive, Chaplinesque Italian, had immigrated to the United States in 1893, “with $2.50 in my pocket and a million bucks in my head”, to repeat his own words.

Following a succession of petty con operations that either floundered hopelessly or landed him in jail for short periods, Ponzi found a $16-a-week clerical job in 1915 with a Boston-based import-export firm. For the next four years he sat at his desk, playing with various ideas and abandoning them just as quickly as unworkable.

Then, one fine morning in 1919, he learned about the international postal union coupons. His brain exploded!

These coupons could be bought in Italy, and other war-depressed European countries, for a penny apiece and could be redeemed in the United States for many times that price. Ponzi immediately set down to work on raising an initial capital on the promise of paying back his investors with a high interest rate. He used his relatives in Italy to buy the coupons and was soon enough able to disburse profits worth $750 on an initial investment of $1,250. Incredible! said the investors.

In answer to exclamations of wonder, and often disbelief, on the part of his future victims, Ponzi smiled a smile of the one who knows all and quietly advised everyone to reinvest, not forgetting to spread the word around!

Only a few days later thousands of people were scrambling over each others’ shoulders, waving fistfuls of dollars, their lifetime savings, to get through the door to the maestro’s desk. By the end of that year Ponzi was paying back his investors up to 50 per cent in interest; the investments had amounted to a dizzying $200,000 a day — cash!

When a Boston daily got suspicious of his operations and published a somewhat incomplete and hesitant report, Charles Ponzi sued the newspaper for defamation and claimed half a million dollars in damages. That set the sceptics at rest.

With dollar notes now literally spilling out of his desk drawers, filing cabinets and suitcases, it was time for Charles Ponzi to take care of his own little self. He bought a 20-room mansion in the countryside and a chauffeur-driven limousine, not to speak of hundreds of suits, silk shirts, silk ties, diamond stickpins, gold-handled canes and hundreds of pairs of shoes. By way of prudence he also bought controlling shares in a number of successful companies, paying in cash of course.

By now enjoying the solid reputation of a stock market genius, Charles Ponzi was in heavy demand for interviews and talks at important economic conferences. Unable to cope, he hired a public relations expert named William McMasters — a fatal mistake that initialled Ponzi’s downfall.

McMasters was soon to find out his boss was, in his own words “more of a financial idiot that a financial wizard, with cash stuffed into every conceivable place in his office, feet on the desk and talking unstoppable but complete gibberish about postal coupons.”

The PR man also discovered that Ponzi’s ledgers contained entries of enormous sums without the names of investors and investors’ names without mentioning the money. Everything was in Ponzi’s head; every one of his clerks was an illiterate Italian relative, hardly able to speak English and with the sole duty of receiving or paying out stacks of dollar notes. McMasters reported everything to the authorities.When Charles Ponzi was arrested his admirers were incredulous.

“You are the greatest Italian that ever lived”, shouted one man as Ponzi was being handcuffed. The greatest of Italians was characteristically unruffled.

“No, Columbus and Marconi come before me!” he modestly reminded the man.

Investments in Charles Ponzi’s scam by the time of his arrest had amounted to a total of $20m. Out of this he had paid back $15m. His own take of $5m was a good match in 1920 to Bernard Madoff’s $50bn swindle today.

But that was hardly the end of Charles Ponzi’s brilliant financial career. After a series of jail terms in a number of American states, he was deported in 1934 back to Italy.

Not all his countrymen were convinced that Ponzi had done anything wrong. One of these was Benito Mussolini who gave the returning prodigal son of Italy a high-ranking job in the ministry of finance. Il Duce was soon to suspect however that little Charlie was up to something. But, before a probe could be ordered and formal charges brought in, Ponzi took a ship to South America, not forgetting to help himself to a considerable sum from the Italian treasury, all in cash of course.

The last Charles Ponzi was heard of was when he died of heart attack in Rio de Janeiro in 1949. But his name will forever remain synonymous with the phenomenon of a financial fraud involving a pyramid of investments and reinvestments.

The writer is a journalist based in Paris.

Search for supply routes

A SERIES of recent attacks by militants on US and Nato supplies traversing Pakistan en route to landlocked Afghanistan illuminates an important fact: the United States cannot prosecute the war in Afghanistan without Pakistan’s cooperation.

Between 70 and 80 per cent of US supplies destined for Afghanistan pass through Pakistan. Militants have struck shipments at least eight times since Dec 7, destroying nearly 300 vehicles and containers in the process. With about 300 trucks supplying Afghanistan daily before the ongoing spate of attacks, the material losses have not crippled Washington’s ability to wage war — for now.

Still, Washington must anticipate that today’s inconvenience could escalate and threaten Nato’s mission in Afghanistan. Warning signs abound. Pakistan can close the border at a moment’s notice, as the London Times reported it did for nine days in early December after the first two of the recent attacks and as it did again on Dec 30 after launching a military operation in the area.

Some 3,500 Pakistani truckers recently went on strike, further endangering Washington’s ability to transport supplies through Pakistan. With at least 20,000 more US troops slated to arrive in Afghanistan in 2009, the demands on Nato’s tenuous transport route through Pakistan will only increase.

The recent disruption to the Afghan supply chain has exposed Washington’s increasingly urgent search for viable alternatives. Unfortunately, the options are grim. An airlift would be exceedingly expensive and limited by the number of runways in Afghanistan that can accommodate cargo aircraft. Nor do alternate ground routes elicit optimism. To the west of Afghanistan lies Iran, with which the United States does not have diplomatic relations. To the north are the Central Asian republics of Turkmenistan, Uzbekistan and Tajikistan, all of which are governed autocratically and remain in Russia’s sphere of influence.

One potential route from Europe to Afghanistan crosses Russia, Kazakhstan, and Uzbekistan. To avoid Russia, which has a vested interest in a stable and moderate Afghanistan but has also clashed with the United States recently on Georgia and the US plan to build a missile defence shield in Eastern Europe, supplies would need to navigate a torturous path across the Black Sea, Georgia, Azerbaijan, the Caspian Sea, and Turkmenistan before reaching Afghanistan.

Though Washington asserts it is in advanced negotiations with potential Central Asian partners, shipment length, expense and the requisite diplomatic concessions to fickle non-allies are all serious hurdles to overcome. There is a reason Pakistan remains the primary supply conduit to Afghanistan despite the security challenges posed.

Pakistan recognises its leverage. After helicopter-borne US commandos raided Pakistan’s tribal areas on Sept 3, Islamabad shut down the Torkham border crossing into Afghanistan for several days. Many interpreted this reaction as a none-too-subtle warning that Islamabad would not hesitate to play this card in response to heavy-handed US actions.

As a means to reduce Pakistan’s monopoly on US supply of its forces in Afghanistan, Washington is right to explore the feasibility of Central Asian supply routes. Ideally, the United States would negotiate the right to transport provisions via both Central Asian routes, to guard against the security contingencies that could limit Pakistan’s viability as a conduit. Moreover, only by reducing its logistical dependence on Pakistan can Washington persuade Islamabad, using the US State Department’s full array of carrots and sticks, to undertake actions that it would not otherwise contemplate — like fully dismantling the militant infrastructure that has been implicated in the Mumbai attacks.

Nonetheless, since a long-term partnership with a stable Pakistan remains in US interests, Washington cannot present Islamabad with an ultimatum that could result in the severance of US-Pakistan relations. Rather, the United States must work with Islamabad to address the recent security lapses along the supply route to Afghanistan, in concert with developing alternative passages.

The United States should impress upon Pakistan the importance of protecting these shipments with well-armed and motivated forces, for its own sake as well as Washington’s. Militants garner confidence and publicity from these attacks, which fuel their cause. The strikes also cut into the revenue of Pakistan’s trucking industry, which is a major income source for, and employer of, the ethnic Pakhtuns who inhabit Pakistan’s tribal belt.

The reports of Pakistan’s ongoing clearing operation along the supply route are promising, but still only a temporary fix to a protracted problem. As a longer-term carrot, Washington should offer to bolster its training and equipping of Pakistan’s outmanned and outgunned provincial police force and paramilitary Frontier Corps, which is tasked with protecting the supply route through the dangerous tribal frontier.

By cultivating new transport routes through Central Asia and working with Pakistan to improve security along the existing route, the United States will ensure that its troops are properly equipped to tackle a daunting enough challenge: stabilising Afghanistan.

The writer is a research associate at the Washington-based Council on Foreign Relations.