The author is a Director at the World Bank. The views expressed in this article are personal and should not be attributed to the World Bank, its management or Executive Directors. 

 The recent turmoil in the equity and currency markets of Thailand, Indonesia and Korea has given rise to two diametrically opposite reactions. One school of thought believes that trade liberalization, financial market integration,currency convertibility and foreign capital flows have brought about this havoc and should be shunned. It is argued by the proponents of this school that controls, interventions and protectionism would have insulated the markets from these undesirable shocks. The other school is of the view that in a globalized economy the penalties for lax or delayed policy response are quite severe and the contagion effect is highly pronounced. Under this scenario,Thailand stuck too long to fixed exchange rate pegged to the US dollar when the dollar was getting overvalued,Thailand’s export growth was slowing down and current account deficit was widening. In all these countries the politically favored financed companies and the pressures on the banks to lend for real estate and property to influentials and well connected further aggravated the problem and put the financial sector to unbearable risks.

 What are then the lessons we in Pakistan can learn from this episode? Not that our economic structure is much similar to the East Asian economies or the intertwining between the two is strong . Although the spill over effects may be insignificant we should not lull ourselves into complacency.In neighboring India,a country more akin to us,it was the political crisis that plunged the markets last week. The nervousness of the market players can be triggered by entirely innocuous factors. The imperatives of prudence dictate that we should examine our situation objectively and take appropriate measures to avoid the recurrence of the pattern witnessed elesewhere. The point is that we should be prepared and not taken off-guard.

 In my judgment, there are at least ten lessons which are relevant in case of Pakistan and merit serious consideration. First, the structure of our external liabilities should be transformed--from short end of maturity to medium and long term. The duration of foreign currency deposits and short term commercial obligations imposes severe rigidities in the management of foreign exchange liabilities. Efforts should be made through relative pricing mechanisms to attract assets of medium and longer duration.

 Second, related to the first is the need to build up extra cushion in the foreign exchange reserves. The strategy should be to substitute high cost commercial borrowing that is used to boost the reserve build up by concessional official balance of payments financing and bond placements of 5-7 years in different markets. The choice of markets and currency  should be made to  match the inflows with the currency profile of payments due. Currency and interest rate swaps can also prove useful if they are done right.
 

  Third, devaluation ranging from 20-30% has been achieved by many of our competitors in East Asia during the last few months. This will make their exports relatively more attractive in the third country markets where we are selling identical products. It is essential that we do not follow the competitive devaluation route but at the same time make sure that our exchange rate is pegged to the right basket of currencies,does not deviate too long from its real effective exchange rate and remains flexible. Instead of large discrete devaluations the rate should be allowed to fluctuate within a given band to maintain its real value. Supply elasticities of non-traditional exports should be computed to determine the incentive effect of exchange rate flexibility.Pressure on the exchange rate may also be generated --in the opposite direction-- if the fund managers try to divert some of their holdings from East to South Asia.

  Fourth, the financial sector in the broadest sense of the terms--the commercial banks, investment banks, modarabas, leasing companies,DFIs, private finance companies, cooperatives,and other non-banking financial institutions should be kept under strict vigilance. Norms of capital adequacy, income recognition, loan classification, loans loss reserves, insider lending, sectoral concentration of assets, exposure limits ,off balance sheet liabilities and inter- locking relationships  should be examined in a comprehensive manner by a single strong regulatory agency free from any political interference. Delinquents should be punished under the law as and when the infarction takes place rather than allowed to linger on.

  Fifth, the choices of public investment projects particularly those which involve large capital outlays, and domestic or external debt financing including contingency liabilities such as BOT or BOOT should be put to rigorous economic cost-benefit analysis.Unless the risk-adjusted rate of return under the most probable outcome scenario is acceptable and the cash flow stream can support the project independent of any subsidy or budgetary assistance it is always advisable to drop the project. Unfortunately, in the short term, the defense and debt servicing obligations do not permit any room for maneuverability in the recurrent budget and thus the ax has to fall on public sector investment program to contain the fiscal deficit--not an altogether a happy outcome.

  Sixth, the financial health of WAPDA needs to be restored to a satisfactory level. The large exposure of the banking system, the accumulating arrears of payments to suppliers of goods and services, the growing inter-enterprise debt,the prospective payments to independent power producers under the internationally established contractual arrangements and the cost overruns due to delays in major projects under execution have created an enormous financial and economic burden on the national economy. It is neither fair nor realistic to expect the WAPDA to resolve its financial crisis on its own or  to move in a piecemeal and adhoc fashion fixing band aid where major surgery is required. Yes, WAPDA must improve its performance, shed off extra labour and put its own house in order but a comprehensive solution is required if we wish to avoid a financial shock to the economy emanating from the financial collapse of this huge giant.
 
  Seventh, the speed of privatization of major state owned enterprises and ,immediate measures to drastically improve the financial conditions of Pakistan Steel Mill, Pakistan Railways, PIA etc. should be accelerated. The repayment of debt by using the sale proceeds of privatization would have a salutary effect on the inflexible budgetary situation of the Federal Government by a reduction in  the burden of external and internal debt. But the Provincial Governments should  also be persuaded to auction very expensive property and land held by the various government agencies and departments such as the GOR colonies in the prime locations of the big urban cities . The easing of financial situation of the public enterprises  and the Provincial Governments will create a multiplier effect  through which the small and medium enterprises providing goods and services to these organizations would also benefit.
 

      Eighth, a high domestic interest rate structure relative to foreign denominated assets induces large inflows of speculative capital flows in search of high returns. These short term flows that do not finance real assets in the economy create most head aches for the policy makers.It is therefore necessary to pursue a monetary policy that does not create a large wedge between the domestic interest rate adjusted for currency depreciation and foreign interest rate. This has proved to be quite difficult in actual practice but other complementary measures described earlier should help narrow the country risk premium and thus this gap.
 
   Ninth, the present  Government has set a healthy precedent by allowing the nationalized banks and the DFIs to allocate credit to the private parties on the basis of profitability and potential repayment capacity of the borrowers rather than considerations of political affiliations and favors. This tradition should be strongly upheld but also genuinely promoted throughout the financial system. Those found guilty of violating these standards should be punished and instances of illegal gratification publicized openly and publicly.

   Finally, it is fortuitous that a group of highly competent and capable individuals currently occupy key managerial positions---Minister and Secretary Finance; Minister of Commerce; Deputy Chairman, Planning Commission; Governor, State Bank of Pakistan and Chairman,CLA. This group should coalesce itself into an economic team that meets regularly and frequently, examines a comprehensive set of indicators and takes timely decisions. This team should be given full political support and authority but also held accountable for results. In this fast moving world, the traditional method of noting on the files and preparing summaries which move up and down and across will not work. This team should draw upon the  best professional expertise within the country for high quality rigorous analysis on the basis of which various options and trade offs should be debated and discussed  and finally  judgment calls are made by this team.We should not be misled by the poor quality of our economic journalism or by the caliber of the so called economic experts  who write regularly in our newspapers.There are many individuals on the staff of the foreign banks, brokerage houses, LUMS and IBA and other assorted places in the country who have the capacity to provide excellent professional analysis and advice to this team.

  Despite  all the above precautions and pursuing sensible and prudent economic policies it is hard to predict when a country is likely to be the target of speculative attack. Even when the economic fundamentals are strong such as in case of Hong Kong the markets have witnessed serious disruptions. But its better to have good policies and bad luck rather than bad policies and bad luck.