Bonded Labour Through Interest Rate Arbitrage

Bonded Labour Through Interest Rate Arbitrage
In the 21st century, it is expected that slavery has been abolished but in reality, it is still very much there. It has only changed its form. Bonded labor is one of the most common forms of slavery that is practiced in rural areas in many countries where society is weak.

In this practice, a family borrows money from a loan shark at an exorbitant interest rate to meet an urgent need like paying for the hospital bills to deal with a critical illness, etc.

The family signs a loan agreement that bounds them to perform labor work at a compensation rate that ensures they remain enslaved for many years. The system is so cruel that sometimes many generations are bonded to repay the original loan and earn freedom. 

At the international level, this bonded labor works through financial institutions like IMF, international mining and petroleum companies, hedge funds, and aid packages. Nigeria, Sudan, Libya, Venezuela, and Brazil are rich in resources but the citizens of these countries are not benefiting from these resources.

The agreements signed with foreign corporations only benefit a handful of elites and their foreign masters. One of the international instruments of slavery is interest rate arbitrage. In this practice, the fund managers borrow money from a bank at an interest rate of 3.5% (which is the prime rate these days in the USA for investment-grade borrowers) and invest these in government securities at 13.5% (which is the interest rate in Pakistan these days).

Government treasuries are considered one of the safest investments in any country although it does carry a sovereign risk which is rewarded through a higher return on investment. Pakistan has attracted an estimated $2.2 billion with an average maturity of 3 months. This is a highly alarming situation and has practically enslaved Pakistan in bonded labor.

If you recall when SBP Governor Baqir Reza was appointed, I held the position that although his appointment process is questionable we should give the man the benefit of doubt. Now it is quite clear that he is working more for international fund managers than people of Pakistan. There are many high risks with attracting large portfolio investment in the country which I will highlight here.

First, the portfolio investment is for a very short duration of three months. This means that if tomorrow there is a no-confidence motion against the government, this money will run away in rush causing a banking and exchange rate crisis.

Second, the rate of return is much higher than if a bond was floated of longer maturity. Recently, 500 million dollars worth of Euro bond was reportedly paid off. This was paid through these high rate borrowing rather than replace it with another bond of similar maturity. So we reduced the maturity which is bad for the country as well as increases our cost of borrowing. Third, this portfolio investment comprises almost 20% of our foreign reserve which is a very high percentage and its departure can cause a crisis.

Fourth, this portfolio investment is done in the rupee which is the main reason the rupee appreciated by 5% in the last few months reducing from Rs 162/dollar to Rs. 154/dollar. This has been presented as a good thing for the country but could turn out to be a disaster when the portfolio investor decides to get out in a rush. This means that rupee can depreciate fast as we experienced last year when this portfolio investment leaves which will cause another wave of inflation. Fifth, this portfolio investment is presented as a precursor to foreign direct investment (FDI) in the country.

There is no evidence this is the case because most of these fund managers are classified as vultures investors that scout for best returns around the world. For these funds, Pakistan is a small portion of the whole portfolio and a high-risk country. Sixth, the money raised is consumed to fill the fiscal gap rather than invest in creating capital that can result in the generation of employment. 

After watching the performance of Finance Minister Hafeez Sheikh and SBP Governor Baqir Reza for the last 18 months, I have concluded that they have seriously damaged Pakistan’s economic condition. The issues they have created will haunt us in the future. I support the efforts of Shabbat Zaidi to develop revenue base and believe that there may be efforts to remove him.

He is blamed for revenue shortfall but it is not his fault rather unusually high commitment was made by Hafeez Sheikh and Baqir Reza just like the bonded labor loan sharks subjugate the borrowers. These people have to be replaced by economists who have been working in Pakistan for many decades and we do not have a shortage of talent.

I blame the current republic for the enslavement of the country and during the tenure of Imran Khan, the problem has worsened.