Rumours of default and role of public | By Dr Atiq-ur-Rehman

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Rumours of default and role of public

RUN on bank is a popular term in economics. It refers to a situation when the rumors about insolvency of a bank becomes popular i.e.it becomes popular that the bank is unable to pay to its depositors.

In such a case, all depositors will want to withdraw their funds before the situation worsens, whereas the bank would not have kept all these funds in the bank.

Banks cannot earn profit on the money kept in their lockers, they can earn profits only when they invest or lend to third parties.

Banks keep only a few percent of deposits in their lockers for their daily transactions. If a large number of people demand the return of their deposits, the bank will have to withdraw the loans or to withdraw the money from investments, both of which cannot be done in hurry without causing losses to the bank.

In this case, refunds will not be possible to all the account holders and the bank will actually default.

In the 19th Century, many banks suffered from such a situation, while in the early 20th century, this was also the case with many banks.

This situation led to the evolution of modern central banking. Today’s commercial banks keep some deposits with the central bank, and in exchange, the central bank provides them a bail-out facility.

That is, if a bank faces a solvency problem, the central bank will give money to that bank to avoid a situation like run-on bank.

After the introduction of bailouts, many banks needed bailouts in parts of the world. In particular, in the financial crisis of 2007-08, the banks in the United States and other developed countries faced such a situation and to deal with it, a total bailout package of more than 2500 billion dollars was provided.

The description of this phenomenon shows that general perception of the people play a very important role in the economic and financial system, and that such news reports themselves are the cause of their validity.

For example, if someone spreads a rumour today that sugar will become expensive in the next ten days due to exports, then everyone will want to buy sugar for their needs today.

This sudden increase in sugar demand will increase the price of sugar in two days instead of ten days.

This phenomenon works in the same way in international financial relations. If news becomes public that a country is about to default, the overseas partners of local traders will take a more cautious approach.

Lenders will want lending to be delayed, investors will want to hold off on their investment until conditions improve, profiteers and speculators will want to hoard commodities and foreign currencies to exploit the possibility of price increase.

All these factors together will actually pave the way for insolvency. But unfortunately, there is no bailout system in financial matters among the nations.

There is no international organization which guarantees to bailout a country in case of insolvency.

Therefore, the default of a country is more sense-making than that of a normal commercial bank.

When such a situation occurs with a country, rivals will want to take full advantage of the situation.

In such a situation, if popular voices from within the country participate consciously or unconsciously, then only a miracle can save them from default.

Same is the situation with Pakistan today. Real or fake, news reports about the country’s economy are not good and obviously our rivals are involved in promoting such news.

Some local popular leaders have joined them, both consciously and unconsciously, and a large number of people are unconsciously participating in intensifying this desperation.

Conscious effort refers to the efforts in which a former Finance Minister of the country was advising the provincial ministers to try to derail the negotiations with the IMF, while unconscious efforts are those when we try to undermine our political rival by spreading confirmed and unconfirmed negative news.

The news that we propagate actually presents the image of our country to the world, and the world feels the country is actually in a very pathetic situation.

All this discussion does not mean that there is no real threat to Pakistan’s economy. Even if there is no real threat, the prediction of default is in fact a self-fulfilling prophecy, which is capable of making itself a truth.

The more important thing in this whole situation is to examine our role at this stage. Was our role helpful in saving the country’s economy or was it to increase its chances of default?

If the country is heading towards insolvency, we should play our role in reducing the chances of this situation.

If we are using imported goods worth $10 per day, we should try to reduce it to $2. In fact, after the installation of the incumbent government, the import of certain items was banned but the government had to lift the ban due to international pressure.

But individually, we are not bound to the dictations of the IMF and World Trade Organization. If we decide to use local products instead of imported ones, no one can stop us.

So, if we intend to buy any imported product, in the wake of the current situation, we should find some local alternative for it.

If we prefer imported goods over local products in the name of status symbol or quality, then we are actually participating in taking the country towards default.

—The writer is Director, Kashmir Institute of Economics, Azad Jammu and Kashmir University.