An expensive lunch for Pakistan's Youth

A letter to Maryam Nawaz Sharif (http://youth.pmo.gov.pk)

Dear Maryam Nawaz Sharif and team,

Firstly, I want to appreciate the efforts you and your team have undertaken for the youth and the simple majority of the motherland. The prime minister's youth loan scheme is for the age group 21-45, with CNICs and are well connected to a high net worth individual or a govt employee. The govt has lots of issues which need to be tackled at priority. There are several risks which can cost our govt and our coming generations such as: indebted youth in an indebted nation funded by an indebted govt hence creating a vicious cycle. Refinancing the debt can become a huge task for the future govt and generation as it will be repaid after 8 years when possibly a different govt might be in power. Moreover, such usury driven funding will not be welcomed by many in our society and the cost of monitoring funds to the tune of billions of rupees will be an expensive task for the govt.

I do not restrict my argument to criticizing your plan but I want to add a suggestion which could be a win-win stunt for all.

1 - The govt must establish a SME fund which must be overlooked by the Finance Ministry and the judiciary or any other independent agency which will ensure transparency for the investors

2 - A board must be set up which comprises of individuals from different circles and backgrounds.

3 - Any individual/team interested in a venture must present a business plan with a 5 years projection before the board

4 - Post review the board/jury must acknowledge the review and within 30 days it must come up with the result, whether the fund is willing to provide seed funding or not. If not, then why.

5 - If yes, then certain covenants must be placed and the amount (ranging from 50% to 70%) must be put in the form of equity.

6 - A (put/call) option must be included in the covenant which will allow the fund to liquidate its stake in the venture (post 5 years at a premium)

7 - Don't benchmark your plan with what has been done in the US, but compare it what has been done in the UAE (Khalifa Fund) and many other countries in Africa (Rwanda, Tanzania & etc) are doing it too to create self-employment. Let’s be realistic we cannot print money like US.

8 - After 5 years, the govt must allow these businesses (based on their financial performance and business scalability) to get listed on a secondary listing (like AIM in the UK) and let the locals become multinationals for tomorrow.

Sister - kindly read, reflect and act!

US default 'extremely unlikely'

Before we go deep into the mess, it is important to highlight the difference between a shutdown and debt crisis. In simple terms, in a shutdown, the government lacks the legal authority to spend money on non-essential services. In a debt crisis, the government is mandated to spend money — but doesn't have the legal authority to borrow the money to spend it.

What happens if the debt crisis occur (post 17th October) ? - A Default!

U.S. will certainly default if it does not pay its bills on time or the debt ceiling is not raised. Ahan - then the debt ceiling should be our discussion as it is the only temporary, please note, -TEMPORARY life line. If the US does not raise its USD 16.7 trillion debt ceiling "temporarily" by October 17, the country will default on its debt.

What US could potentially do:

The most extraordinary measure the government could take and that is to exhaust its cash. It is expected that the U.S. will have about $30 billion in cash, which will be short of expenditures that can reach as high as $60 billion in subsequent days. This is dangerously low level of cash in the bag.

The US government could use all their tax revenues to meet their interest payments on debt and roll-over the existing debt. They will have to take extreme measures such as cuts in public spending (healthcare programs) and defense spending. This will attract a lot of repercussion from the public, but it has to happen one day, then why not today!

President Obama is left with no option but to kill the fly

Even if the Congress decides to raise the debt limit, the republicans will be looking  for some very critical areas, prior to the approval, such as cuts in government spending, reducing the impact of Obamacare and no new taxes. They will keep their focus limited to the spending. An ice-break could prevent:

- Sliding US Dollar

- China catching the cold; biggest buyer of US debt

- America gets downgraded again!

- Banking industry getting banged
- Army pull-out

You are broke because you have overspent, and a correction is required not delay. Again, in simple words - Open the government and pay your bills.

Forgive me for using the word "Temporary" temporarily and wish not to use this again in near future.

An evening with Paul Donovan, Global Economist

I recently had the privilege to meet Mr. Paul Donovan, Global Economist, Managing Director UBS Investment Bank on September 23, 2013 in Dubai. Paul co-authors the Global Economic Perspectives publication with other members of the Global Economic team. Paul regularly appears on CNN, Bloomberg TV, and CNBC.
Paul, very comprehensively, covered various developments in the global economy ranging from the selection of US FED chair to the Japanese issuing bonds, devaluation of currencies and region-wise economic outlook.
There was a Q/A session which allowed me to put forward questions/opinions to Paul and I am glad he answered those questions to my satisfaction. The following were the communications exchanged

1 - Creation of Fake Capital

“I own apples and Paul owns oranges and we both agree to exchange each fruit worth millions. Paul sells me the oranges and I sell Paul apples. Next morning, we are no more fruit vendors but banks with assets worth millions. How this creation of fake capital is preventing organizations and economies to bounce back?" I related this to what happened in Iceland (shift from fish to investment banking) and other European economies.

Paul’s response: As this was the very first question to Paul that evening, he smiled to me and said that this is quite unfortunate and many bankers in the hall will not like us for discussing this. He added that banks have realized this and regulations are being brainstormed and developed to overcome these issues. Banks are becoming more systematic than before. He added that a bad situation in Euro will result in good outcomes. Many banks have recently either ceased or limited their operations in the Middle East and other regions. Banks like BNP Paribas have ceased operations in most of the gulf countries and Barclays has limited its operations too. These banks have been influenced by their respective countries’ governments to return and invest in their local economies. The increase in lending within the Euro bloc will improve the economic conditions over the medium term.

2 - Volatile Commodity Prices

“Theoretically prices decline when demand falls. Prices of coal, gold and several other commodities have either declined or remained volatile amid increasing demand trends year over year. What is to be blamed for low commodity prices? Am I right in saying that high capex is to be blamed for low commodity prices ?”

Paul’s response: “Yes, it is true that excessive capex in certain regions has resulted in volatile commodity prices. Expanding upon your statement mis-allocation of capex and resources is to be blamed for volatile commodity prices.”

3 - Asset Nationalization

“Asset rationalization, by Jan 2014, in countries like Indonesia can create serious issues in the global economy as China imports more than 80% of its bauxite requirements from Indonesia. What implications will this carry for the Global economy ?”

Paul’s response: “As a global economist I am more concerned whether the world’s global resource requirements will be fulfilled. China has invested in countries in Africa and has acquired mines, which it cannot fully rely upon because in the past sudden shifts in the governments in Africa has also caused disruptions in the mining activities and complicated ownership structure. As a global economist Indonesia must continue to supply raw material to China as China processes resources primarily for its local economy. Indonesia’s move is politically correct but not on economic terms because it has energy crisis and processing industries need adequate and cheap energy supplies. This move will worry the Chinese and will have a global impact.” 

And, the intellectual evening came to an end.

Denying developing countries access to coal is like restricting food aid to the poor

Coal mining plays a significant role in many national economies. Developing countries rank highly among the world's major coal producing countries. In cases of China, India and South Africa coal is utilized for domestic electricity generation. Moreover, these countries have export markets generating export revenue. Colombia and Indonesia earn considerable export revenues from the coal production industry which is highly export-oriented. Coal currently provides 30% of the global energy needs, 41% of its electricity and 68% of its steel.

Coal in Electricity Generation

Pakistan is the sixth most populous country in the world with an estimated population of 184.35 million in 2012 - 2013. With a growth rate of 2.0 percent in 2012/2013, it is estimated that Pakistan will move to the fifth position by 2050. With rapid urbanization and population boom in major cities of Pakistan, the demand for electricity continues to exceed the supply. As per the Power and Water Ministry the supply of electricity stands at only 12,150 MW while demand is 16,400 MW creating a shortfall of 4,250 MW. Opportunity lies in the crisis, they say.

Increased investment in the technological development and higher labor productivity through improvement in education, health and training facilities are the main modes of increasing productivity of human resources. But how is this all possible without an investment in the energy sector, primarily coal.

Apart from being the sixth most populous state, the country is the sixth richest nation in respect of coal reserves, amounting to more than 200 billion tons. For further clarity, these coal reserves account for 2% of the reserves in the Asia-Pacific region and 0.2% of the world. Of this 200 billion tons, 185.5 billion tons (93%) of the coal reserves are in Thar in the province of Sindh which is 8 hours drive from the coastal city of Karachi. All coal is sub-bituminous and lignite in grade and is optimum for the energy sector. With the Chinese assistance Pakistan has 3 X 50 MW power plants in Lakhra, Balochistan and only 15 MW is being produced which is only 0.1% of the actual energy mix as displayed above. Majority of the electrification is via Oil which has traded above the $ 100 mark for quite some time in the international market and Pakistan nearly imports all its oil requirements. The other primary source is Gas. Gas is currently being increasingly consumed by the industries, households and the transportation sector in Pakistan. This has caused bottlenecks in timely supply of gas resulting in shortages and power cuts. The other source is hydroelectric where Pakistan faces an issue of water shortages in rivers and banks which have sources in Indian controlled Kashmir. There have been several rounds of dialogues between the two neighbors India and Pakistan to abide by the Indus Water Treaty and Pakistan has voiced its concern on international conventions and forums regarding India building dams in Kashmir. 

The current energy mix is quite expensive which is causing unrest in public and pushing businesses out of the country. The Pakistani economy can save around $26 billion in fuel costs over the next 15 years if thermal plants of only 420MW are shifted to coal.

Many of the countries with significant coal reserves also have significant coal production. However, Pakistan is counted amongst those nations whose coal reserves are yet to be utilized at a large scale. This provides economic opportunity to further develop the coal extraction industry and poses a great potential for a secure and affordable domestic energy supply using the indigenous coal reserves.

Pakistan currently imports more than 6 million tons of coal annually to meet the requirement of its thriving cement and ailing steel industry resulting in loss of foreign reserves and lost employment opportunities at home.

The current prime minister of Pakistan, Mr. Nawaz Sharif and his government, have several times shown interest in setting up greenfield power projects in Gadani and converting diesel and furnace oil based thermal power plants to coal. There has been no constructive talks on how could Pakistan mobilize its internal resource to attract capital inflow.

Earlier governments had policies directing towards exploiting the local Thar coal reserves to produce energy, but due to Asian Development Bank’s withdrawal of USD 1.4 billion in finance, Pakistan will resort to coal imports, atleast in the short run, to provide cheap electricity to the consumers and breathe life into industries, textile in particular. It appears that multilateral banks listen only to their donors, not their customers. And donor governments, like the US and the EU, are more interested in being politically correct on climate control than actually addressing poverty. It is interesting to note that US is the largest producer of coal, accounting for 13.4% of the global coal production and consumes 88% of the coal produced domestically and half of the electricity produced in the country is generated through coal.

For critics: Coal has a bad reputation due to the widely held view that it causes global warming and is responsible for death of many miners. What people don't tend to realize that coal has changed the living conditions of many in the developing countries such as India and China. For example, China, a model country for the developing world, has witnessed 536% growth in GDP since 1990 and more than 660 million people have been lifted out of poverty. Today more than 99% of the Chinese population has access to electricity. Coal has proven to be a "critical enabler" for successful economies. This has helped countries to further invest in cleaner technology and renewable energy resources. Coal is potentially the "fuel" towards any successful economy.

A great mind: Ibn Khaldun

One article on this great personality will be considered as a disservice and I  shall try my best, within my capacity, to read and research more and write about the great works of the historian Ibn Khaldun who was born in 1332 in Tunis. He was educated in the religious studies of Qur'an, Hadith, jurisprudence, and law, as well as sciences such as physics, mathematics, philosophy and logic. His strong base in a wide variety of disciplines helped him to analyze the worldly affairs, specially governments, in greater depth.

Ronald Reagan, 40th president of the United States, commented on Ibn Khaldun by saying: 

“May I offer you the advice of the 14th century Arab historian Ibn Khaldun, who said: “At the beginning of the empire, the tax rates were low and the revenues were high. At the end of the empire, the tax rates were high and the revenues were low.”

And, no, I did not personally know Ibn Khaldun, although we may have had some friends in common!”[1]

His economic ideas which he analyzed during the 14th century became part of the governments’ fiscal policies around the globe. Very correctly, a co-relation has been established between the tenor of the governments and the tax rates. As per the guidelines of Islam, the Zakat (philanthropy/charity tax) is 2.5% of accumulated wealth. Other taxes like land tax, inheritance tax and tax on spending have not been popular in the Muslim World. It is quite comprehensible from the above that if the tax rates are low, the public is encouraged to pay tax and the governments end up collecting greater tax revenues. Furthermore, Ibn Khaldun stated:

“The reason for this is that when the dynasty follows the ways (sunan) of the religion, it imposes only such taxes as are stipulated by the religious law, such as charity taxes, the land tax, and the poll tax. They mean small assessments, because, as everyone knows, the charity tax on property is low.”[2]

And then he added:

“At the beginning of the dynasty, the revenues are distributed among the tribe and the people who share in the ruler’s group feeling, in accordance with their usefulness and group feeling and because they are needed to establish the dynasty, as we have stated before. Under these circumstances, their leader refrains in their favor from (claiming) the revenues which they would like to have.”

Ibn Khaldun studied government’s behavior in great depth and it seems the same behavioral trends exist till date.  Governments prefer using public finances for the welfare of the tribes and societies and to establish a strong liking or aptitude towards their rule. In contrast, when governments sway from the path and corruption becomes the culture, the tax revenues are siphoned off to non-productive areas bearing nil or negative results.

Accountability, Self-checks and balances

Umar Bin Al Khattab, the second caliph of Islam, was known to have two lamps that he would use to light his house. One lamp was funded by the tax payer’s money and he would use that only during his work, in his official capacity, as the leader of the vast empire. The second lamp was personally funded by the caliph and he would use that when engaged in personal affairs, and not of the government. It was Umar bin Al Khattab’s accountability which contributed to the strong foundations of a successfully run and contolled empire.

Ibn Khaldun opposed high levels of taxation

“The result [of high taxation] is that the interest of the subjects in cultural enterprises disappears, since when they compare expenditures and taxes with their income and gain and see the little profit they make, they lose all hope. Therefore, many of them refrain from all cultural activity. The result is that the total tax revenue goes down, as (the number of) the individual assessments go down.”

Governments tend to increase taxes excessively to finance public debt and extravagant ventures within the boundary and overseas. This negatively impacts the willingness of the public to contribute or participate in the economics of the country. Excessive taxes have discouraged investments and consumerism and this has had further effects on poverty, employment and crime rates. The words of Ibn Khaldun can be very rightly analyzed in the form of the Laffer curve as below.

The Laffer Curve, named after the American economist  Arthur Laffer, credited his work to the great Ibn Khaldun

Ibn Khaldun’s ideas have actually been known to us in the form of the Laffer curve (advocates supply-side economics). The Laffer Curve helps the economists to ascertain the optimum tax rates which maximizes the tax revenue, without the need of increasing the tax rates in proportion. The basis of setting an optimum tax rate is to encourage businesses to re-invest their profits in expanding their businesses which creates opportunities. As purchasing power increases, businesses earn more, and more jobs are created a greater number of individuals and corporations tend to fall in the tax bracket. 

I prefer to refer to the graph above as Khaldun's curve and his immense contribution to the economics of the world is extraordinarily remarkable.

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[1] Ronald, Reagan. “There They Go Again.” New York Times February 18 1993, n. pag. Web. 1 Dec. 2012

[2] Ibn Khaldūn. The Muqaddimah, An Introduction To History.