The second reach for yield

Low global interest rates provide a fantastic opportunity for Pakistan's economy.

Over the last few weeks, I have been thinking about what happens with all this free money going around in the global economy. This questions has two components: the first focuses on the sovereign, i.e. the nation-state, and what it can do to take advantage of this opportunity; and the second relates to the individual investor and how he / she can improve their financial security during a period where asset prices are inflated.

Today’s blogpost focuses on the first component of the question and tries to figure out whether this liquidity present any sort of opportunity for countries like Pakistan, which need significant human capital and economic development investments?

The first reach for yield

The global economy experienced its first reach for yield after the financial crisis of 2007-08, following which global central banks opened the floodgates to rescue the world economy. Bond yields fell around the world, asset prices rallied, and emerging markets including Pakistan found that they could borrow a whole lot of money at relatively lower interest rates.

This reach for yield benefited Pakistan in particular, which took advantage of this moment to tap into both the international bond market as well as Chinese funding sources — the latter was flush with trillions in reserves and excess industrial spare capacity, which was redirected to countries like Pakistan under the broader Belt and Road Initiative.

Following the coronavirus pandemic, global central banks have opened up the floodgates once again and governments from the United States to India are spending enormous sums of money to shore up their economies. Given that the global economy is still in poor shape due to the pandemic, it is likely that the world will be awash in liquidity for a long time to come. This is what a recent article in Bloomberg said:

Investors looking for euro exposure, but put off by the continent’s negative yields, may find emerging-market bonds capable of reducing their pain when inflation returns. Such a trade is also supported by expectations of a global growth recovery fueled by U.S. President Joe Biden’s stimulus plan.

From 2013-18, the PML-N government took advantage of the first reach for yield to direct investments into Pakistan’s electricity sector. The reach for yield also allowed the country to run higher current account deficits and fund them through higher external borrowing. While this allowed the country to deal with its chronic power shortages and generated higher levels of economic growth, the investments were at times directed towards projects that led to the production of expensive, dirty power that undermined the country’s economic security (coal power projects requiring imported coal are a case in point).

Additionally, a flawed policy of overvaluing the currency meant that the situation became unsustainable, leading to a sharp devaluation of the currency and a twin-deficit crisis that sent the country back into yet another IMF program.

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The second reach for yield presents another unique opportunity for Pakistan to invest in its economy and boost its long-term economic prospects.

Doing this, however, requires that policy makers have a cohesive understanding of where Pakistan’s economic shortcomings are and where investment is needed. For example, if the government is going to float $500 million worth of “green bonds” and use the proceeds to finance its budget and / or current account deficit (the latter driving in part by growing food imports), then it would be a waste.

If on the other hand the funds are used to develop / upgrade public infrastructure, such as the country’s electricity grid, expanding broadband internet access, and promoting off-grid renewable energy connectivity, then the loans would be transformative.

But just borrowing money to fund these projects will not be enough. Just like a new Mac requires updated software to take advantage of the new hardware built into the machine, the software running Pakistan’s political economy needs a major update as well.

This software update, however, requires a government to focus on mundane and boring issues such as reforming the bureaucracy, imparting basic literacy skills to millions of individuals on an emergency basis, and building political consensus on major economic issues, such as the country’s energy security policy.

Why is consensus important?

Because upgrading the software and debugging it will require years, meaning that successive governments will have to build upon the work conducted by their predecessors.

While this may sound like a pipe dream given all the polarization in the system, there are some areas that lead to some optimism. The biggest case in point is the ongoing Ehsaas Program, which has been built on the Benazir Income Support Program. The fact that a program initiated by the PPP, given more funding by the PML-N, and expanded by the PTI is positively impacting millions of lives across the country means that political parties can and do build on top of the good work conducted by their predecessors.

This sense of cooperation, however, has been missing on big picture economic policymaking. And one hopes that political elites come together and realize that the the second reach for yield is an opportunity that can transform Pakistan’s economy, provided that they cooperate and build a consensus on the economy.