Recent events in Europe have been extremely instructive. Greece accounts for a very small proportion of the main European economy. It comprises but a couple of percentage points of continental GDP. Yet its debt debacle has had the entire continent strung in an awkward position for a good two years now. Germany and France, the two biggest EU economies, have thrown in all but the kitchen sink to keep the debt ridden country from defaulting.
What is more, the bailout package just agreed has all but turned the bond market on its head. Ironically, the ECB is saved from the painful haircut all other ‘old’ bondholders have been made to take. Why such desperation? Why must Greece be kept from defaulting, which is what ordinarily happens when a country is unable to meet debt obligations?
The reasoning is pretty simple. The minute Greece defaults, exits the EU and abandons the single currency, an untold number of big international financial organisations will immediately go belly up, their position compromised by overwhelming exposure to Greece and other, bigger economies, sometimes in much worse position. And when big money collapses, the financial and political elites on both sides of the Atlantic will be ruined, even though Greece will revert to the drachma, devalue considerably and export and grow out of the subsequent depression.
While this partially explains the rush to rescue Greece, it does not nearly save the European project. Portugal, Spain, Italy and even France are hemorrhaging, and not very far from needing substantial help in doses, which will inevitably tilt towards the bailout precedent that the Greece example has set. Counting on Germany to keep filling budget deficits of other, less resilient economies would, of course, border on insanity.
Interestingly, financial markets initially greeted the deal with optimism. The euro advanced, crude oil rallied and, coupled with signs of growth returning to the American economy, the European package introduced much welcome risk appetite in global currency and commodity markets. However, it was only a matter of quick time before long term concerns returned to pundits. When that happened, the euro collapsed, reintroducing long-term shorts.
The message for other economies, especially Asia’s emerging markets, is obvious. In the post recession era, when capital market solvency is in serious question, sovereign debt is a very serious issue. Once capitals start running serious deficits, financial institutions with the slightest exposure are put at serious risk. And when that happens, the life and blood that oils the international globalised market – credit – dries up, compromising whatever efforts are made to return to growth.
For an economy like Pakistan the message is even more serious. Unlike regional economies, our state of stagnancy is acute. Growth is nowhere on the horizon, there is still no value addition in exports, and the rupee is in freefall. While February’s impressive stock market performance deserves credit, it does not reflect critical structural deficiencies in the macro economy that cannot be sustained without serious overhaul of policy.
Our deficits are in serious red. With substantial components of international aid also petering out, there will be yet more unforeseen upward revision of the current account deficit, while the development budget, year-end revenue and final GDP are all revised downward. We must immediately introduce policies that check unnecessary leakages and stimulate growth. At present, both fiscal and monetary policies are counter productive, while relevant authorities doing little of intrinsic value. The election is near. Learning from examples of countries destroyed by debt will not only heal the state of the economy, but also facilitate the government’s long term survival in Islamabad.
The writer is Chief Manager, SME Bank, with more than 30 years’ experience in the banking industry.