The Economist 07Dec2019

74 Finance & economics The EconomistDecember 7th 2019

2 against that condition. Silvia Merler of Al-

gebris Policy & Research Forum, an adviso-

ry group, says that previous steps to make

restructuring easier made Italy’s bonds

look less risky to investors, not more.

By describing the reform as a danger to

Italy, Mr Salvini may spy a chance to score

political points. For its part, m5smight

want to shore up its ebbing support. But by

doing so it has created a rift with its current

partner in government, the eu-friendly

Democratic Party.

The populists want either to reopen

talks on the esmor to gain something in re-

turn for acquiescence. But meaningful

concessions look unlikely. Reopening talks

at such a late stage might even provoke the

northerners to walk away.

Nor has much progress been made on

the second and third pillars. Politicians

have only just agreed to begin talking about

deposit insurance. Germany had long

dragged its feet, but in November Olaf

Scholz, its finance minister, said he would

be amenable—if a host of other fixes, some

unappealing to other members, were

made. The euro-zone budget is a stripped-

down version of that first envisioned by

Emmanuel Macron, France’s president, in

2017. Fiscally hawkish northerners insisted
      that it must not be used to support econo-
      mies in downturns, and that it should be
      funded using the European Union’s seven-
      year budget, not new spending.
      The eubudget has itself been the sub-
      ject of tortuous negotiations for nearly two
      years. The latest proposal allocates €13bn
      ($14.4bn) to the euro-zone fund—a paltry
      €98m per country per year. Once in place,
      say optimists, it can be beefed up. Yet an-
      other fix to be done in a frantic hurry when
      the next crisis hits. 7

Buttonwood More in Lahore

A

recent editionof “The Joe Rogan

Experience”, a popular podcast,

features the comedian Artie Lange. Mr

Lange is an engaging personality who, as

he candidly admits, has battled with

drugs and gambling. Not long out of his

umpteenth period in rehab, he is work-

ing in stand-up again. “This business

keeps taking me back,” he says with

something like amazement.

Forgiveness for recidivists is found

outside show business, too. In July the

imf approved a $6bn bail-out for Paki-

stan. As the fund acknowledged at the

time, with something like weariness,

Pakistan is back in rehab less than three

years after completing its previous pro-

gramme. But the fund has not abandoned

it. And nor have investors. Pakistan is

enjoying a flood of foreign capital on the

promise of reform. The Karachi stock

index is up 25% since the start of October.

This may seem hard to fathom. The

imfregards the chance that its pro-

gramme will fail as “particularly high”.

Yet a band of investors are prepared to

bet on success. A rehab economy such as

Pakistan offers a rare opportunity. It is

one of the few places where investors can

find high interest rates, a devalued cur-

rency and cheap-looking stocks. True,

things could go very wrong. Look at

Argentina, which was embraced by in-

vestors after Mauricio Macri was elected

in 2015 on a platform of orthodox eco-

nomics, only to be abandoned when his

reforms failed. But if things go right, the

returns can be substantial.

Rehab economies follow a familiar

pattern. The cycle begins when the econ-

omy bumps up against a budgetary or

balance-of-payments constraint. The

trigger may be external: an oil-price

shock, say, or a shift in policy by the

Federal Reserve. Funding dries up. Then

comes capital flight. Foreign-exchange

reserves are run down so that the govern-

ment can sustain the illusion that the local

currency is worth more than it really is.

Hard currency is then rationed. That leads

to shortages of essential imports, which

further hamper the economy.

With luck, at this point the authorities

recognise the hole they are in. To get out of

it, they must embrace more orthodox

economics. In practice, this means letting

the currency fall, getting rid of subsidies in

order to cut the budget deficit, and starting

to use monetary policy as a way to tame

inflation rather than finance the govern-

ment. Sometimes (but not always) the imf

is brought in to lend hard currency and

give policy advice.

This, more or less, describes events in

Pakistan leading up to mid-2019. It also

describes the cycle in Egypt up to the start

of 2016 when it entered its (successful) imf

programme. And, for that matter, it is the

same pattern seen in Pakistan in 2012-13.

At this stage of the rehab cycle, if things

are to go well, the fund’s money needs to

act as a catalyst for other sources of capital.

This is needed as a kind of bridge fi-

nance—to pay for essential imports and

allow the rebuilding of foreign-exchange

reserves, until exports pick up in re-

sponse to a cheaper currency. That might

seem a big task. Economies in rehab are

typically unstable places (Ireland in 2010

was a rare exception). Pakistan is unlike-

ly to threaten Denmark’s place at the top

of global rankings of security, gover-

nance and development. But investors

are not betting that a rehab economy will

become a paragon, only that it will im-

prove, at least a bit.

A first task is to lure back capital

shifted offshore by rich locals when they

saw the crisis coming. The twin attrac-

tions are the high interest rates needed to

curb inflation and a cheaper currency,

which acts as reassurance against a

further devaluation. Once the locals

come back, yield-hungry foreigners will

follow. And before long, so will stock-

market investors. Like Egypt, Pakistan

has a wide range of listed companies for

investors to buy—from industrial firms

to banks to consumer stocks, says An-

drew Brudenell of Ashmore, a fund man-

ager. It may take a while for firms to see

the benefits of improved economic

stability. But investors are tempted to

buy when stocks are trading at attractive

price-to-earnings multiples.

Such bets can pay off handsomely.

Reforms to improve macroeconomic

stability have led to bountiful invest-

ment returns in surprising places. An

obvious danger is that hardship and

social unrest derail the reform process.

Another is that reformed characters have

a tendency to fall from grace again. But

progress is never in a straight line. When

the potential is great and the price is

right, there will always be people willing

to bet that next time will be different.

The perils and rewards of investing in economies in rehab