Making of bubbles

OVER the past two years, the Government of Pakistan's burden of foreign debt has assumed a new dimension. The repayment of installments of principal amount and interest exceeds the disbursement of new loans and grants. On this count, the net capital inflow is negative. The key issue is why and how did it happen? The IMF credit helps fire-fighting in times of severe fiscal distress. Multilateral assistance from donors like the World Bank and the Asian Development Bank finances development projects. Bilateral official support comes both in the form of balance of payments support and project assistance that includes grants and debt forgiveness. And in the past decade or more, there has been a huge inflow of foreign investment, loans and grants. It is not the volume of loans and grants but how prudently, economically and productively the money is employed so that it generates earning capacity of the funded projects and in the economy to repay debts. In the absence of cost- benefit analysis, one can only point out numerous anecdotal evidence of how foreign aided projects prove to be much more costlier than similar cash funded projects, particularly those sponsored by local community e.g. school buildings in Sindh. There is a huge leakage of funds due to poor governance. Delays, normally apply to most, if not all, of the projects and escalate costs. Donors are trying to make up for the lost opportunities by providing funds to NGOs and through professional bodies. Money provided to governments operating inefficiently, is badly spent. Yet the spending—an input —is accounted for determining the GDP growth rate. Governments do not measure the output that is needed to arrive at their contribution to GDP while the spending may go up but its contribution may be correspondingly much lower, if the money has not been spent productively. Recent studies in the US have thrown up a controversy about the contribution of aid to economic growth For a variety of reasons, some eminent American economists find no link between aid and economic growth while others still hold the conventional wisdom that aid does spur growth. Those who do not find any link between aid and growth maintain that foreign aid is given to reward allies or enlist their support for donors' foreign policy objectives.. Enhancing economic growth is not the primary or sole motivation of aid. Foreign aid can jump-start economies of recipient countries but cannot sustain growth. These economists insist that just spending more money is not going to build the long-term functional economies that would create wealth and employment. For this to happen, the right policy and institutional environment is absolutely necessary. To the extent, the governments can stimulate investment particularly through tax incentives and to the extent they can encourage more domestic savings ( enlarge pool of funds to finance investment at lower cost), they can enhance the long-term prospects for economic growth. Unwanted capital: Similarly, unwanted global capital inflows , another set of economists say, can do more harm than good. The policy of quantitative easing and close-to-zero interest rates in developed economies, notably the US, are generating a surge in the speculative capital flows to developing countries in search of yield and creating bubbles in foreign exchange, asset, credit and commodity markets, says Chief Economist of Geneva-based South Centre, an inter-governmental body of developing states, Yilmaz Akyuz. In his research paper, he points out that this latest surge constitutes the fourth post- war I(WWII) boom in capital flow to developing countries. All previous ones ended with busts, causing serious damages to the recipient countries. He warns "The boom in capital flows and commodity markets are most vulnerable to a possible reversal which needs to managed more effectively by developing countries. The developing countries are receiving strong impulses through capital flows by self-centred responses to the crisis in developed countries, particularly the US. Bubbles are forming in credit, equity and property markets, currencies are appreciating and deficits widening in several major emerging economies. To contain these damages that could be inflicted by unwanted capital flows, they need to take much more determined action and introduce a comprehensive and effective system of controls. Collectively, the developing countries have been running a current account surplus and do not need capital from the advanced economies. There is a need to establish both at the regional and global level, reliable and stable mechanism for South-South recycling from surplus to deficit countries without going through the Wall Street or the City. The current difficulties created by the unstable capital flows and commodity prices show once again that the international monetary and financial system should be so reformed that the global financial and monetary stability is not left to the whims of self-seeking policies of a single country enjoying an 'exorbitant' privilege. The question of regulation of commodity speculation should be placed on the table in order to put an end to gambling with the livelihood of the poorest segment of the world population and promote food and energy security."