ECONOMY OF PAKISTAN

In this shrinking global village internet chats, cable TV, talk shows and
transmissions through satellite dishes have made perceptions more
powerful than realities in influencing public opinion. There is a widely
held perception in Pakistan – right or wrong - that the popular American
view of the U.S.S.R. as an evil empire and communism as a threat to
economic and social stability of the world is beginning to resonate itself
with Islam replacing communism and Pakistan and other Muslim
countries, standing in for the USSR.
Those who hold this perception point out, as an example, to the recent
Council of Foreign Relations – Asia Society Task Force Report which
aptly sums up the popular American view about Pakistan in the
following sentence: “Pakistan presents one of the most complex and
difficult challenges facing US diplomacy. Its political instability,
entrenched Islamist extremism, economic and social weaknesses and
dangerous hostility towards India have cast dark shadows over this
nuclear-armed nation”.
I have chosen to focus my remarks today on the one aspect of Pakistan
and Islam that is, in my view, hardly discussed, least known but creates
a lot of jitters in the U.S. This issue has received increased importance
since the elections of October 2002 when an alliance of religious parties
won power in the province of NWFP. I propose to walk you through the
past and current trends of Pakistani economy, sketch the future direction
and offer my own assessment of how the adoption of an Islamic
economy, if it indeed happens, will affect Pakistan’s future.
This paper is divided into six sections.
The first section deals with the past achievements and failures of
Pakistan’s economy. The second section presents a synopsis of
economic performance during 1999-2003 – a period of intensive
restructuring and reforms of the economy.
Section III distils the policy lessons learnt from the historical and most
recent experience of Pakistan’s economic management. Section IV
attempts to lay down the contours of the future direction of Pakistan’s
economy based on the lessons learnt and development experience gained
from in-country and crosscountry record.
Section V assesses as to how the attempts to introduce Islamic economic
model in the country, if successful, will impact upon this future
direction. The final section provides insights into the economic
prospects of Pakistan in the medium term.
PAST ACHIEVEMENTS AND FAILURES:
Pakistan was one of the few developing countries that had achieved an
average growth rate of over 5 percent over a four-decade period ending
1988-89. Consequently, the incidence of poverty had declined from 40
percent to 18 percent by the end of the 1980s. Table I lays down the
main economic and social indicators in 1947 and compare them with
2003. The overall picture that emerges from a dispassionate examination
of these indicators is that of a country having made significant economic
achievements but a disappointing record of social development. The
salient features of Pakistan’s economic history are:
• A Country with 30 million people in 1947 couldn’t feed itself and had
to import all its food requirements from abroad. In 2002, the farmers of
Pakistan were not only able to fulfill the domestic needs of wheat, rice,
sugar, milk of 145 million people at a much higher per capita
consumption level, but also exported wheat and rice to the rest of the
world.
• An average Pakistani earns about $500 in 2003 compared to less than
$100 in 1947. In US current Dollar terms, the per capita income has
expanded more than fivefold and in constant terms three times.
• Agriculture production has risen five times with cotton attaining a level
of more than 10 million bales compared to 1 million bales in 1947.
Pakistan has emerged as one of the leading world exporters of textiles.
• Pakistan hardly had any manufacturing industries in 1947. Five
decades later, the manufacturing production index is 12,000 with the
base of 100 in 1947. Steel, cement, automobiles, sugar, fertilizer, cloth
and vegetable ghee, industrial chemicals, refined petroleum, and a
variety of other industries manufacture products not only for the
domestic market but in many cases for the world market too.
• Per capita electricity generation in 2003 was 10,160kwh compared to
100 in 1947. Pakistan’s vast irrigation network of large storage
reservoirs and dams, barrages, link canals constructed during the last
five decades has 5 enabled the country to double the area under
cultivation to 22 million hectares. Tube well irrigation provides almost
one third of additional water to supplement canal irrigation.
• The road and highway network in Pakistan spans 250,000 km – more
than five times the length inherited in 1947. Modern motorways and
superhighways and four lane national highways link the entire country
along with secondary and tertiary roads.
• Natural gas was discovered in the country in the 1950s and has been
augmented over time. As of now, almost 26 billion cubic meters of
natural gas is generated, transmitted, and distributed for industrial,
commercial, and domestic consumption.
• Private consumption standards have kept pace with the rise in income.
There are 30 road vehicles for 1000 persons in 2001 relative to only one
vehicle for the same number of populations in 1947. Phone connections
per 1,000 persons have risen to 28.6 from 0.4. TV sets which were
nonexistent adorn 26.3 out of every 1,000 houses.
These achievements in income, consumption, agriculture, and industrial
production are extremely impressive and have lifted millions of people
out of poverty levels. But these do pale into insignificance when looked
against the missed opportunities. The largest setback to the country has
been the neglect of 6 human development. Had adult literacy rate been
close to 100 instead of close to 50 today, it is my estimate that the per
capita income would have reached at least $1000 instead of $500.
Pakistan’s manufactured exports in the 1960s were higher than those of
Malaysia, Thailand, Philippines, and Indonesia. Had investment in
educating the population and upgrading the training, skills and health of
the labor force been up to the level of East Asian Countries and a policy
of openness to world market would have been maintained without any
break, Pakistan’s exports would have been at least $100 billion instead
of paltry $12 billion. Had the population growth rate been reduced from
3 percent to 2 percent, the problems of congestion and shortages in the
level of infrastructure and social services would have been avoided, the
poor would have obtained better access to education and health and the
incidence of poverty would have been much lower than what it is today.
But as if this neglect of human development was not enough, the country
slacked in the 1990s and began to slip in growth, exports, revenues, and
development spending and got entrapped into deep morass of external
and domestic indebtedness. As a result, the incidence of poverty rose
from 18 percent in 1988-89 to 33 percent by the end of the 1990s. This
was due to both fundamental structural and institutional problems as
well as to poor governance and frequent changes in political regimes.
With short life spans, succeeding governments were hesitant, if not
outright unwilling, to reform the rent-seeking activities of the ruling
elite- consisting of a small class of politicians, bureaucrats 7
businessmen, feudal landlords and other vested interests and desisted
from taking tough unpopular economic decisions to set the economy
right. Understandably, they were more preoccupied with the imperatives
of retaining political power and making such decisions could have
further exposed them to the risk of removal from office. Moreover, the
average lifespan of two to three years was clearly inadequate for
meaningful policy or institutional change. The external environment was
also unfavorable as the inability of successive governments to meet their
commitments with international financial institutions led to a serious
credibility gap among the donors and intermittent withdrawal of
assistance. The event of May 1998, when Pakistan conducted its first
nuclear test, and its aftermath led to further economic isolation of
Pakistan and a considerable erosion of confidence by domestic and non-
resident Pakistanis. Economic sanctions were imposed against Pakistan
by the western governments. By the late 1990s Pakistan had entered
almost a critical state of paralysis and stagnation in its economy
particularly in its external sector. The freezing of foreign currency
accounts had resulted in a significant drop in workers’ remittances,
export growth was negative, IMF programmed, and World Bank
assistance were suspended, bilateral donors had terminated their aid
while debt payments due were in far excess of the liquid foreign
exchange resources the country possessed. Pakistan was almost at the
brink of default on its external payments.
ECONOMIC PERFORMANCE 1999 - 2003:
It was at this stage that the military government under General Pervez
Musharraf assumed power in October 1999. The initial period was
devoted by the economic team of the new government in managing the
crisis and making sure that the country avoided default. A
comprehensive programmed of reform was designed and implemented
with vigor and pursued in earnest, to put the economy on the path of
recovery and revival. The military government did not face the same
constraints and compulsions as the politically elected governments. It
was therefore better suited to take unpopular decisions such as imposing
general sales tax, raising prices of petroleum, utilities and removing
subsidies so badly needed to bring about fiscal discipline and reduce the
debt burden. The IMF and the World Bank were invited to enter
negotiations on new stand-by and structural adjustment programmers.
Although the canvas of reform in Pakistan was vast and corrective action
required on a few fronts, there was a conscious effort to focus on
achieving macroeconomic stability, on certain key priority structural
reforms and improving economic governance. The structural reforms
included privatization, financial sector restructuring, trade liberalization,
picking up pace towards deregulation of the economy and generally
moving towards a market-led economic regime. A stand-by IMF
programmed was put in place in November 2000, which was
successfully implemented followed by a three-year Poverty Reduction
and Growth Facility (PRGP), which will expire in November 2004. 9
What have been the outcomes of the economic reforms undertaken
during the past four years?
Macroeconomic Stability:
There has been considerable progress in achieving macroeconomic
stability. Strong fiscal adjustment has led to primary budgetary surplus
and significant reduction of the fiscal deficits. Current account has
turned around from chronic deficit to a surplus of more than 5 percent of
GDP, mainly due to renewed export growth and resurgence of workers’
remittances. Monetary aggregates have been contained and inflation rate
is below 4 percent. External debt burden has been reduced in absolute
terms from $38 to $35 billion and as a proportion of GDP from 62.5% to
46%. The risk of default on external debt, which loomed large on the
horizon in 1999 and 2000, was mitigated and the country's capacity to
service its restructured debt has considerably improved. Exchange rate
has not only stabilized but appreciated during the last two years. Table II
shows the changes in the key economic indicators between October
1999 and September 2003.
Structural Reforms - Privatization, Deregulation, Liberalization:
 The Musharraf Government actively pursued an aggressive and
transparent privatization plan whose thrust was sale of assets in the oil
and gas industry as well as in the banking, telecommunications, and
energy sectors, to strategic investors, with foreign investors encouraged
to participate in the 10-privatization process. This plan is being followed
by the newly elected government under Prime Minister Jamali.
To demonstrate the seriousness of the government in encouraging
foreign investment flows in Pakistan; there has been a major, and
perceptible liberalization of the foreign exchange regime. Foreign
investors can now bring in and take back their capital, remit profits,
dividends, and fees etc., without any restrictions. Foreign Portfolio
Investors (FPI) can also enter and exit the market without any
restrictions or prior approvals. In the Karachi Stock Exchange with a
market capitalization of $15 billion, over 700 listed companies showed
average returns of 15 per cent that were higher than those in most
emerging countries. This makes Pakistan an attractive place to invest for
foreign portfolio investors. As part of this liberalization, non-residents
and residents are allowed to maintain and operate foreign currency
deposit accounts, and a market-based exchange rate in the inter-bank
market is at work. Allied to this effort, the trade regime has been opened
and the maximum tariff rate has been cut down to 25 per cent with only
four slabs and the average tariff rate is down to 14 percent. The financial
sector too, has been restructured and opened up to competition. Foreign
and domestic private banks currently operating in Pakistan have been
able to increase their market share to more than 60 percent of assets and
deposits. The interest rate structure has been deregulated and monetary
11 policy uses indirect tools such as open market operations, discount
rates etc. Domestic interest rates on lending have dropped to as low as 5
percent from 20 percent substantially reducing financial costs of
businesses. Central to the economic reforms process has been a clear
progression towards deregulation of the economy. Prices of petroleum
products, gas, energy, agricultural commodities, and other key inputs are
determined by market. Imports and domestic marketing of petroleum
products have been deregulated and opened to the private sector. The
markets do not always function effectively. Independent regulatory
agencies have been set up to protect the interests of consumers and end-
users of utilities and public services. Despite this movement towards a
liberalized and deregulated regime, old habits die-hard. Bureaucratic
hassles at lower levels continue to be irritants for the business
community.
Tax Reforms:
Taxation reform has figured prominently on the government's agenda,
as this is another area where the business community has innumerable
grievances and dissatisfaction with the arbitrary nature of tax
administration. Tax reforms are aimed at broadening the tax base,
bringing in tax evaders under the tax net, minimizing personal
interaction between taxpayer and tax collector, eliminating the
multiplicity of taxes and ultimately reducing the tax rate over time. A
massive survey and documentation drive was undertaken to widen the
tax base, extend incidence to all sectors of the economy and develop the
data for purposes of 12 assessment. Despite these reforms, the business
community remains dissatisfied with the performance and attitude of tax
officials particularly at the lower level. Complaints of delays in refunds
of sales tax persisted throughout the three-year period. The Central
Board of Revenue (CBR) is being restructured to improve tax
administration including taxpayer facilitation.
Economic Governance:
The most dramatic shift introduced by the military government is in
promoting good economic governance. Transparency, consistency,
predictability, and rule-based decision-making have begun to take roots.
Discretionary powers have been significantly curtailed. Freedom of
press and access to information has had a salutary effect on the behavior
of decision makers. The other pillars of good governance are, (a)
devolution of power to the local governments who will have the
administrative and financial authority to deliver public services to all
citizens, and (b) an accountability process which will take to task those
indulging in corruption through a rigorous process of detection,
investigation, and prosecution. Despite these positive outcomes and their
impact on the business community and other stakeholders, within the
country as well as abroad, the incidence of poverty is still quite high and
unemployment rates are worrisome. The challenge therefore for the next
phase of the reform process is to accelerate growth rate and reduce
poverty and unemployment.
POLICY LESSONS LEARNT:
I now turn to the policy lessons learnt from the experience of last 50
years and the success achieved in reforming and restructuring Pakistan’s
economy during the last four years. With experiments running from state
controls, liberalization, socialism, reversal to market mechanism,
deregulation and privatization, there is today almost a consensus on the
broad contours of economic policy in the country although the
modalities, policy instruments and nuances differ as they ought to. My
reading of the last 15 years suggests that the general thrust of Pakistan’s
economic policies broadly reflects the following lessons learnt from the
past:
(a) Central planning has been a failure as it leads to low productivity,
lack of innovation, lack of incentives, poor quality goods and services
and low investment in human resources. Bureaucratic judgment is a poor
substitute for market’s judgment on allocation of scarce resources.
(b) Licensing to open, operate, expand, close business by the
government functionaries is a sure way to promote rent-seeking in the
economy for the benefits of a few whiles keeping the majority poor. The
basic business decisions should not be made for the businessmen by the
bureaucrats. 14
(c) Public sector ownership and management of business, production,
distribution, and trade do not capture the commanding heights but lead
to a fall into the deep morass of inefficiency, waste, and corruption.
(d) Import substitution behind high tariffs not only protects a few
thousand inefficient producers but also penalizes the millions of
consumers with shoddy and expensive goods, which they do not
particularly want. Profits at world prices are negative in these protected
industries thus leading to inefficient utilization of capital and labor.
(e) Over regulation, controls, and inspection of all kinds on the private
sector not only hike up the cost of doing businesses, subdues
entrepreneurship but also make a few wily politicians and bureaucrats
rich at the expense of the prosperity of the country. Private monopolies
and oligopolies were nurtured under the cover of these controls.
(f) High tax rates on individuals and corporates are counterproductive as
they raise costs, discourage effort and initiatives and lead to widespread
tax evasion, and have unintended consequences of lowering overall
revenue collection.
(g) Banks and financial institutions owned and managed in public sector
offering cheaper credit and/or directed credit have a pernicious effect 15
on economic growth as credit decisions are made based on political
connections rather than on the merit of the proposal. Value subtracting
enterprises are set up while real opportunities for businesses that
contribute to output and employment are missed.
(h) Administered prices of key commodities and utilities are the worst
possible means of insulating the poor segment of the population from the
onslaught of market forces. Instead, these prices create shortages in the
economy and hit the poor hardest by denying them access to essential
commodities or services.
(i) Subsidies on inputs such as fertilizers, seeds, electricity, water, gas,
petroleum, etc. incur heavy budgetary costs but benefit the well-to-do
classes and highly influential individuals rather than those for whom the
subsidies are intended.
(j) Foreign investment and multinational corporations are not evils that
should be shunned but are the most important conduits for transfer of
technology, managerial skills, organizational innovation in addition to
much needed capital and foreign exchange. They should be welcomed
and made to feel comfortable in their operations.

TABLE – II CHANGES IN KEY MACRONOMIC INDICATORS October 1999 September 2003

Change in the Indicator GDP growth rate 4.2% 5.3% Positive Inflation 5.7% 3.3% Positive Fiscal
deficit/GDP -6.1% -4.0% Positive Current account/GDP -3.2% +5.0% Positive Domestic Debt/GDP
52.0% 43.4% Positive External Debt $ 38 billion $ 35 billion Positive Remittances $ 88 million per
month $ 300 million per month Positive Exports $ 7.8 billion $ 12 billion Positive Tax Revenues Rs. 391
billion Rs. 510 billion Positive Rupee-Dollar Parity Depreciating Appreciating Positive Foreign Direct
Investment $ 472 million $ 500 million Positive Foreign Exchange Reserves $ 1.6 billion $ 12.0 billion
Positive Poverty Incidence 33% Data not available but perhaps rising Negative Poverty related
expenditure Rs. 133 billion Rs. 161 billion Positive Unemployment 6% 8% Negative Note: All indicators
in Column 1 pertain to 1998-99 or October 1999. All indicators in Column 2 pertain to 2003-04 or end
September 2003.