In our contemporary landscape, a ground-breaking financial innovation has emerged - the realm of cryptocurrency. This digital alternative to conventional currency possesses the potential to reshape the global economic panorama. While sceptics often label it speculative or akin to gambling due to its notorious volatility, this judgment is predominantly a consequence of its current lack of regulation and low acceptance compared to fiat currencies. However, with proper regulation and universal acceptance, it could achieve stability at par with traditional currencies.

The cryptocurrency phenomenon is intricately linked to the rise of decentralized finance and is far more than just a financial fad. Its transformative potential lies in its ability to disrupt and reshape the economic system on a global scale. From limiting money supply to crowdsourcing computing power, improving e-governance, and enabling digital contracts, cryptocurrencies offer unique solutions to age-old challenges.

Bitcoin, the pioneering cryptocurrency introduced in 2009 by the pseudonymous Satoshi Nakamoto, has been followed by numerous cryptocurrencies, each offering unique features and serving various purposes. While central banks worldwide are presently attempting to introduce their own Central Bank Digital Currencies (CBDCs), it must be noted that these CBDCs lack the fundamental features inherent to cryptocurrencies such as decentralization and democratization. In essence, they constitute only a slightly enhanced manifestation of conventional digital banking.

Decentralized finance marks a paradigm shift and revolutionizes finance by eliminating traditional intermediaries, enabling direct transactions, lending, borrowing, and trading among individuals through smart contracts and decentralized applications, without centralized institutions like banks. It offers the potential to address chronic economic challenges, especially in developing nations like Pakistan. Many economic upheavals witnessed worldwide over the past century has been precipitated by unwarranted governmental actions stemming from centralized control. Instances of misguided priorities, political agendas, short-sightedness, and miscalculations have served as triggers for economic debacles and rampant inflation.

The unrestrained printing of money represents a significant challenge for numerous economies today. This approach fosters uncertainty and a lack of fiscal restraint. In contrast, decentralized currencies eliminate this risk by being programmed with a fixed supply, predetermined quantity, and annual supply increase that cannot be altered. Adherence to a transparent issuance protocol makes decentralized currencies a bulwark against excessive government printing, potentially curbing inflation and promoting financial stability. This implementation alone can significantly reduce the threat of rampant inflation and provide clear guidance to economic managers and businesses.

At the core of the cryptocurrency realm lies blockchain technology, dependent on a decentralized network of computers for transaction validation, a process known as mining. Miners use computational power to solve complex puzzles, ensuring blockchain integrity through Proof of Work (PoW). Cryptocurrency efficiency thrives on crowdsourced computing power. Unlike centralized systems, cryptocurrencies use a distributed network of miners, enabling anyone with access to computing power to participate in securing and validating transactions. This inclusivity defines cryptocurrency networks, democratizing the system and rewarding contributors from all backgrounds.

Furthermore, incentivizing computing power opens intriguing possibilities for economic growth, especially in remote areas. People can profit from harnessing cheap and small power sources in such regions, potentially transforming connectivity without costly infrastructure investments. Small-scale, affordable, and abundant power generation can seamlessly integrate into the national system, reducing the need for substantial transmission line investments.

An equally, or perhaps even more important benefit of this technology, is the implementation of smart contracts, especially in Pakistan, where commercial dispute resolution processes are slow and inefficient, hindering market-oriented enterprises and discouraging domestic and foreign investment. The judicial system is overwhelmed with over two million cases, with a third related to commercial disputes, highlighting the government's inability to enforce contractual obligations effectively.

On the other hand, cryptocurrencies can streamline the use of smart contracts. These contracts are automated and self-executing, with terms written in code, eliminating the need for intermediaries, reducing costs, and ensuring contract enforcement. This innovative approach has profound implications in Pakistan, where legal disputes often last five to ten years. This transformative shift offers individuals and businesses a more efficient and reliable framework for conducting commercial affairs.

Few studies have identified the presence of a Pareto distribution within cryptocurrencies realm, akin to traditional fiat currencies, where a minority holds a substantial share of the wealth. Critics argue that this concentration of wealth contradicts the principles of egalitarianism and decentralization. It is imperative to clarify, however, that decentralization does not inherently advocate for absolute wealth equality among all participants; rather, it promotes the distribution of power and control. Those who exhibit greater resource productivity will inevitably see their wealth grow, a universal truth regardless of the specific currency system at play.

The concept of decentralization should not be misconstrued or dismissed as undermining the myriad benefits it offers. Despite the challenges associated with embracing decentralized currencies, their adoption is inevitable. As the evolution of Web 3.0 continues, characterized by greater decentralization and personalization, the use of microtransactions is set to increase significantly. Leading social media platforms such as Facebook are actively pursuing the development of their unique digital currencies, aligning with the ongoing technological shift towards a more decentralized web. As a result, the adoption of cryptocurrencies is anticipated to experience substantial growth.

In the face of these dynamic developments, the establishment of a regulatory framework poses a formidable challenge. Nevertheless, it remains of utmost importance for governments to take proactive steps in crafting a policy framework that not only serves as a regulatory mechanism but also positions them as frontrunners in embracing this emerging phenomenon. Such a strategic approach will not only expedite the development of essential ecosystem but also foster the growth of IT human resources necessary for assuming leadership roles on the global stage. This will enable them to become centers of competence and service excellence within this evolving paradigm.

In a recent interview, the former Finance Minister, Miftah Ismail,advanced a notion that Pakistan's economic woes could be resolved by increasing exports by $20 billion. This proposition prompts a crucial inquiry: would this remedy indeed alleviate our economic challenges if it led to a corresponding rise in imports of equal or greater magnitude? One cannot dismiss the potential resurgence of a current account deficit as imports escalate, possibly by $40 billion or more. The question thus arises: did our substantial curtailment of imports in the last few years genuinely yield any substantial improvement?

Miftah Ismail's stance isn't an isolated perspective. Over the recent years, a clamor around the current account deficit has echoed amongst financial managers and economic pundits alike. The prevailing consensus among these opinion leaders suggests the pursuit of a nationalistic policy involving import tariffs, export subsidies, and protectionist measures. A common observer of television broadcasts might conclude that only exports hold the key to a nation's prosperity while imports stand as a threat to its very way of life. Trade deficits are portrayed as the road to economic destruction.

This line of thinking corresponds to a school of thought known as mercantilism. This doctrine strives to avert potential current account deficits or to achieve a current account surplus, employing tactics aimed at accumulating monetary reserves via a positive balance of trade. While comprehensible, it's no wonder that many individuals are swayed by this perspective, perceiving trade as a competition centered on exports and harboring suspicions that other countries inflict harm by providing us with quality goods at a reasonable cost. This palpable misunderstanding fuels the fervor around import substitution, irrespective of production quality and opportunity cost considerations.

To delve deeper into this perspective, consider a hypothetical yet illustrative trade example. Imagine a scenario where we discover intelligent life on Mars, prompting us to export wheat, rice, and vegetables to this celestial sphere due to their inability to cultivate these crops. One might wonder: what's our gain in this trade when the exported crops effectively mean they can't be consumed by us? Would we truly benefit from such trade? After all, it represents the ultimate dream of a trade surplus. The answer is no. Our actual gain from this trade scenario hinges on receiving something in return that we value more than the goods exported — perhaps precious minerals. In the realm of trade, the true advantage stems from imports, making exports nothing more than a cost required to obtain those imports. The same principle resonates within international trade among nations: exports facilitate the acquisition of imports, which is the ultimate objective. It allows us to import items that are either difficult for us to produce or at least challenging to produce at a low cost. The emphasis invariably rests on maximizing the value of imports.

Then, why is a trade deficit often perceived as problematic? In truth, a trade deficit poses no inherent issues, as trade is primarily about imports, not exports. Managing the current account deficit lies beyond the purview of the government; it’s a solution trying to find a problem. Trade occurs between private individuals and enterprises, and the government should refrain from financing consumer preferences, much like it refrains from financing the foreign debt obligations of private businesses.

In instances where imports surpass exports, equilibrium is restored through adjustments in the exchange rate. Regrettably, governments are consistently preoccupied with either controlling or exerting influence over the exchange rate, much like they do with various other essential commodities. Ironically, many of those who endorse price controls on commodities passionately advocate for a free-market approach concerning exchange rates, perhaps persuaded by the clearly evident outcomes in this particular situation. However, market includes two components: demand and supply. So, restricting imports is still a market manipulation and does more harm than good.

Politicians often highlight export figures as a yardstick of success, acting as if these numbers must be attained at any cost. The notion of using subsidies is thus put forth as a mechanism to bolster competitiveness. However, international trade is not a competition for exports, it’s a cooperation. Just as trade with our local grocery store is not a competition. When governments extend subsidies, they essentially prioritize the interests of specific groups, usually consumers, which enhances their welfare at the expense of broader societal economic welfare. Subsidizing exports takes this a step further, amplifying the welfare of foreign consumers at the expense of domestic welfare. Such a situation is inherently lose-lose and ultimately favors export-oriented companies that are inclined towards seeking special privileges, a trend that has been unfolding.

Furthermore, there's a growing obsession on import substitution, yet a pertinent question remains: at what cost? One must first probe why certain products are not domestically manufactured or grown. Often, the reason is their elevated cost or inferior quality. Would anyone willingly purchase an inferior product at a premium price and feel content? The goal should not involve rejecting cost-effective imports to manufacture everything domestically. Pursuing self-sufficiency leads down the path to impoverishment. If China offers us superior products below cost, the sensible response is to welcome these imports with gratitude. There is no good reason why we should object to the foreign aid that we can receive through the imports subsidized by the Chinese government.

This brings us to the crux of the matter: the actual predicament. As previously explained, a current account deficit is not a problem at all. The true challenge lies in the government's incapacity to honor foreign debt obligations due to its fiscal imprudence and its inability to broaden the tax base. Undoubtedly, it presents a significant concern of utmost national consequence, requiring a host of governmental actions to ensure the sustainability of debt payments. However, addressing the current account deficit is not among these necessary measures.

Before making any decisions, it's imperative to embrace and acknowledge the hard-hitting economic realities at play. The gradual adoption of free trade and a market-driven exchange rate holds the potential to strategically harness our comparative advantage. This, in turn, would allow us to manufacture a specific product or service at a significantly reduced opportunity cost compared to our trade partners. Rather than being fixated on the production of costly goods for local consumption or camouflaging the costs of exported items through subsidies, the focus should pivot to reducing business costs by removing unnecessary obstacles, facilitating the unimpeded flow of capital and resources into sectors where our comparative advantage thrives.

Consequently, such a stance would set the stage for market dynamics to organically shape the economic landscape, liberating resources from wasteful rent-seeking and inefficient high-cost production. Ultimately, consumers would reap the rewards by gaining access to the best bargains from every corner of the world, while exporters could reap sustainable profits and heightened productivity without depending on subsidies or hampering national economic welfare.

As a transaction of otherwise legal goods, smuggling is no different than trade, except that there is no government involved in this, at least in its formal and institutional meaning.

If smuggling of any product is on the rise, it implies that tariff rates in the case of imported goods and excise duties in the case of locally manufactured items have been set too high compared to prices of similar goods available in bordering countries.

It is well acknowledged that Pakistan’s import taxation (customs duties, additional duties, advance income taxes, advance sales tax, etc) results in probably the world’s highest ratio of import taxes as a percentage of total taxes collected in the country.

This poses a significant barrier against competitive products, which depend on competitive prices. Effectively, this import taxation system is a tax on exports.

Another way to look at smuggling is the impact of increase in excise duties on products made in Pakistan. A notable rise in excise duty usually leads to increase in the flow of illicit goods – cigarettes are the case in point. Last year, a significant rise in excise duty led to increase in prices and hence the inflow of illicit and counterfeit products.

Pakistan has already seen results of a complete ban on imports, which proved to be disastrous for productive and export sectors of the economy, while bringing short-term advantage in terms of reduction in trade deficit.

While large and formal firms were badly hit by these general restrictions on imports, the small and medium-scale enterprises increased their reliance on imports through informal means, ie smuggling. This led to a decrease in collection of customs revenues as well. Smugglers came to the rescue of SMEs.

Recently, a significant increase in smuggling has been observed in the case of petrol. If we allow Iranian refineries to sell petrol directly to Pakistan, the smuggling of petrol will vanish in one day.

Let’s now consider smuggling of currency. Our former finance minister believed that dollars are being smuggled in huge quantities, causing its appreciation. It is correct that there were a couple of successful raids in which dollars were forfeited, however, it should not be generalised. But for a moment, let’s assume he was right.

A sudden rise in dollar smuggling, if it happened, also signalled that the policy created arbitrage opportunity, which then increases the physical flight of dollars. Thus, once again, smugglers provided a signal to policymakers.

We now know clearly that the difference between open market and inter-bank rates was a signal of policy gap itself.

In a country where incomes are not rising whereas prices are on an upward spiral, smuggled goods, often less costly than “taxed goods”, offer an alternative to low-income households as well as street vendors. We see this in many large-scale markets.

Let’s take the recent seizure of NLC trucks where sugar was being “exported” in the name of other goods.

This also occurred because the government refused on-time permission to industrialists to export sugar, which was trading at a much higher rate before the world market crashed. Thus, the traders who were using those trucks also signalled a policy correction.

Whenever we hear about smuggling, the recommendation is to always take strict enforcement measures on borders, by increasing surveillance and security check posts in border areas.

In a system, where such security arrangements can be breached or rather purchased easily, these policies only increase the cost of goods but do not reduce the quantum of smuggled goods.

In Pakistan’s social system, it is often observed that smugglers become very religious and perform pilgrimages. Smugglers should indeed be rewarded for their service to economic and policy systems.

This Article was originally published in The Express Tribune on September 11, 2023.

Last week, I had the opportunity to visit two large factories, both operating within special economic zones, supplying goods for the international market while creating job opportunities and fostering technological advancements for the domestic market. These firms operate in competitive global markets and serve as prime examples of the untapped potential that lies within Pakistan, encouraging investors to kickstart businesses. In this article, I will delve into the factors hindering our ability to generate sustained economic growth in the country, while drawing insights from these successful examples. This discussion is imperative given the concerted efforts by the country’s leadership, both civil and military, to encourage foreign investments as a means to bolster our foreign exchange reserves.

First and foremost, let’s take a look at the bigger picture. Pakistan was on the verge of default not too long ago, until a high-level discussion between Pakistani, US, and International Monetary Fund (IMF) leadership culminated in another IMF assistance package, the Stand-By Arrangement, providing a short-term financial boost of $3 billion. While the IMF diplomatically states that this programme “builds on” efforts under the Extended Fund Facility (EFF), it is evident that the EFF fell short—a failure that both IMF and Pakistan must acknowledge and shoulder.

A more accurate summary would attribute this shortfall to “policy missteps.” The major blunders were the restrictions imposed on imports and interventions in the forex market—measures that did more harm than good. While Pakistan may have saved $10 billion through these actions, it ended up losing even more through reduced exports and remittances. Importantly, these actions eroded the confidence of Pakistan’s existing private sector.

There’s a consensus that Pakistan lacks the necessary foreign exchange reserves to meet its external obligations. Our sources of foreign exchange—exports, remittances, and foreign investment—consistently fall short of requirements, leading to a perpetual balance of payment crisis, compelling successive governments to seek assistance or loans. The objective has always been to maintain foreign exchange reserves equivalent to at least three months’ worth of imports. While external inflows such as debts, rollovers, and aid provide temporary relief, the underlying issue remains unresolved, and we continue to kick the can down the road. However, the roadblock we encounter each time seems to get larger, as seen in the recent accumulation of reserves through roll-overs, loans, and aid.

Enter “Plan B,” recently unveiled as an alternative strategy. This plan aims to attract foreign exchange through inter-governmental transactions, wherein the Government of Pakistan (GoP) can sell, lease, or outsource its assets to international players to raise capital. The Pakistan Sovereign Wealth Fund is a key component of this strategy, encompassing at least seven state-owned enterprises (SOEs) with assets totalling Rs2.3 trillion or $8 billion. Once enacted, these SOEs will be exempt from the Privatisation Commission, SOE Act, and Procurement Act. The Fund’s shares and management will be presented as investment opportunities to “friendly countries.” The potential costs and benefits of these inter-governmental deals remain shrouded in official secrecy.

Yet, an alternative roadmap exists—a “Plan C” or rather “C2,” where C signifies a “Capitalist Charter.” This roadmap has three main pillars: low taxes, open trade, and a level playing field. Businesses operate to earn profits, and in a country where corporate taxes consume over 50% of income, genuine investments are hard to attract. We need to significantly lower income tax rates for businesses and salaried individuals while streamlining exemptions and raising thresholds. An effective tax policy could serve as a powerful investment policy if it guarantees a low rate for a 10-year span. Alongside reduced taxes, the country must rationalise and decrease tariffs, encompassing all forms of import taxation. No other country relies on tariffs to the extent that we do for revenue. A regime of predictable, low tariffs aids businesses in planning production and inventories. Import restrictions should never again be employed as a tool. Lastly, fostering a business-friendly environment entails eliminating unnecessary hurdles and roadblocks, ensuring a level playing field for all enterprises. The state and its institutions should collaborate with, rather than compete against, the private sector.

This “Plan C” holds more promise than both “Plan A” (IMF) and “Plan B” (Sovereign Wealth Fund or Special Investment Facilitation Council (SIFC)). “Plan A” has faltered, and “Plan B” is unlikely to deliver sustained and inclusive economic growth. We must work alongside Pakistan’s homegrown entrepreneurs and capitalists. To create a credible alternative to the state-linked elite, we need to cultivate a counter capitalist elite that isn’t reliant on state largesse. This transformation begins with reducing the state’s scope and preventing its expansion into the private sector. 

This Article was originally published in The Express Tribune on August 07, 2023.

ISLAMABAD: It seems that the caretaker cabinet is setting its eyes on the future instead of just steering the country through next general elections.

There are two statements made by caretaker Minister of Commerce and Industries Gohar Ejaz, which make me think this way.

He has recently called for establishing new business parks “to consolidate Pakistan’s global trade connections. These parks or facilitation centres for traders would be designed to serve as hubs for foreign traders, enhancing trade relationships and driving economic growth.” He believes these business parks are good for trade connectivity.

Ejaz has also announced an export target of $80 billion and a “new” strategy of targeting specific countries and by devising a new trade policy framework.

This is wrong on a number of grounds. First of all, the caretaker cabinet should not be allowed to make any pronouncements with long-term consequences for economic policies.

Setting up new business parks or devising new trade policy frameworks are ambitious undertakings.

Similarly, following an export target of $80 billion from the current level of $40 billion is a very ambitious plan. It is unrealistic to achieve it within the period for which the cabinet has sworn in.

The appointment of an industrialist on a public position is also a serious conflict of interest. Public position holders, even if they are financially honest, become privy to critical information much ahead of time that they can easily use to gain private benefits, even if these gains are to materialise in the future.

A caretaker government for three months or six months cannot be taken seriously by investors and diplomats who are looking for a long-term and stable political outlook. In fact, one wonders if this should be taken too seriously by members of the cabinet themselves.

A best caretaker government is no caretaker government. There is hardly any country in the world which practices this arrangement. The sitting government continues till the holding of elections and transfer of power whereas the Election Commission is much more empowered.

If the caretaker government continues for an extended time period, as it is generally believed, till March 2024, then their main mandate is to ensure that Pakistan is not worse off than it is today in terms of economic stability.

That means, primarily, stabilisation of exchange rate, which demands keeping the forex market free from any kind of intervention. This, in turn, is the function of central bank, and not of the federal government, which should continue to exercise its constitutional mandate.

There is another news recently that electricity distribution companies will be handed over to provincial governments. While the caretaker government does not have a mandate to take such a decision, the transfer to provincial governments is hardly going to be a solution.

The solution lies in creating competition in the electricity distribution market and not in “provincialisation” of DISCOs. However, it will help in reducing the federal government’s budget deficit as a significant chunk of subsidies is allocated for the power sector.

Expectations have been built that the caretaker government will take some “tough” economic decisions which elected governments usually hesitate to undertake.

While political governments may be happy to pass on the buck to an interim setup, this does not solve fundamental issues that require consensus on restructuring and reforms.

One of the long-term challenges that Pakistan will have to face is its debt management. As the IMF standby arrangement continues to hold, there should be public discussion on various options for Pakistan’s next government including that of debt restructuring coupled with economic reforms.

The debate can help guide political parties in formulating their manifestos as they prepare for next general elections.

This Article was originally published in The Express Tribune on August 28th, 2023.