June 14, 2002	Friday	Rabi-us-Sani 2, 1423

ISLAMABAD, June 13: Following is the text of overview of the Economic Survey 2001-02, released here on Thursday:

The outgoing fiscal year (2001-02) has been the most difficult and challenging year for the world economy in general and Pakistan’s economy in particular. This year has witnessed the world undergoing cataclysmic changes. Many epoch-making events unfolded on the international and national scene which impacted economies around the world, including Pakistan. In particular, the events of September 11 and December 13 and their aftermath, and continuation of catastrophic drought conditions adversely affected the pace of economic recovery in Pakistan.

The world economy was witnessing synchronized slow down along with deceleration in trade growth and falling commodity prices since late 2000. To a considerable extent, this synchronicity was the result of common shocks, including the rise in oil prices; bursting of dot.com bubble and the rise in interest rates in the United States. They precipitated a sharp slow down in the US economy and with the reversal of an incipient recovery in Japan, the growth momentum in Europe also faltered. For the first time since 1974-75, the world’s major economies were decelerating in tandem.

The tragic events of September 11 and their aftermath further exacerbated the already difficult emerging situation on the global economic scene. By the end of the year 2001 the major growth poles of the world economy slipped into recession, causing serious damage to the economies of the developing countries. The latter have seen their economic growth rates plunge with export growth undergoing one of the severest deceleration in modern times. Lower growth in the developing countries would prevent millions of poor emerging from poverty in 2002. Instead, million of people will be added to the list of poor living below the poverty line.

The easing of macroeconomic policies in advanced countries, notably in the United States and in a number of emerging market economies, particularly in Asia, to combat downturn are paying dividends. Recent information suggests that the global slow down may be bottoming out and that the recovery would come sooner than later. The growth outlook for 2002 appears brighter and the developing countries, including Pakistan would benefit from the pickup of external demand.

Notwithstanding the recent “soft take off”, the events of September 11 have caused serious difficulties for Pakistan as it has witnessed its exports, imports, industrial production, tax revenue, foreign investment and privatization program badly affected. Its efforts at consolidating the gains of the last two years and taking the economy to a higher growth path have been interrupted.

Yet another epoch-making development of the outgoing fiscal year relates to the events of December 13 leading to the unprecedented massing of troops by India on Pakistan’s borders. Pakistan had to deploy troops in self defense resulting in an over-run in defense spending. This has seriously undermined Pakistan’s efforts towards further fiscal consolidation. Heightened tensions with India have also dampened investors’ sentiment and have adversely affected the pace of economic turnaround.

The continuation of catastrophic drought conditions during the year has been yet another exogenous shock, causing serious damage to agriculture for second year in a row. The acute shortage of irrigation water and substantially lower than normal rainfall have adversely affected the performance of major crops, preventing agriculture to contribute its due share in overall economic growth. The impact of drought has also been felt in electricity and gas distribution compounding the shock to the economy from the energy sector. Lower reservoir levels in both Mangla and Tarbela and lower releases of water from these reservoirs resulted in a shortfall of hydel generation, forcing WAPDA to purchase expensive thermal electricity from IPPs and thus, generating negative value addition in this sector for three years in a row.

Notwithstanding the exogenous shocks of extraordinary nature discussed above, Pakistan’s economy has demonstrated greater resilience, thanks to the wide-ranging structural reform program which was put in place for over two and a half years. These reforms have enhanced the capacity of the economy to withstand the adverse impact of exogenous shocks. When compared with the performance of major economies in different parts of the world, Pakistan’s overall economic performance has been reasonably good during the outgoing fiscal year. Pakistan’s key economic fundamentals have improved but at the same time some weak areas continued to be a source of concern. These developments are summarized in the ensuing pages.

A modest pickup of growth in the midst of serious multifaceted challenges is one of the major achievements of the outgoing fiscal year. The real GDP grew by 3.6 per cent in fiscal year 2001-02. It may be noted that the real GDP was originally targeted to grow by 4.0 per cent with agriculture and manufacturing growing by 2.0 per cent and 6.2 per cent, respectively. The continuation of drought and the events of September 11 and their subsequent developments compelled the government to revise the growth target to 3.3 per cent with agriculture and manufacturing growing by 1.9 per cent and 3.8 per cent, respectively.

The real GDP, growing by 3.6 per cent has surpassed the revised target. This growth was supported by a 1.4 per cent growth in agriculture, 4.4 per cent growth in manufacturing and 5.2 per cent growth in services. Two points need to be noted as far as Pakistan’s growth performance is concerned. First, Pakistan’s growth performance was better than many developed and emerging market economies. For example, as against the growth performance of Korea (3.0%), Singapore (-2.1%), Indonesia (3.3%), Hong Kong (0.1%), Malaysia (0.4%), Thailand (1.8%), Philippines (3.4%), Sri Lanka (0.4%), US (1.4%), Canada (1.5%) and Germany (0.6%); Pakistan’s growth performance stands out clearly. Second, when growth decelerated all around, it staged a modest recovery in Pakistan with little or no contribution coming from the single largest sector of the economy, agriculture.

The persistence of drought has prevented Pakistan achieving even higher economic growth. This fact becomes clear once we examine the performance of non-agricultural GDP. Pakistan’s non-agricultural GDP grew by 4.3 per cent in 2001-02 as against 4.2 per cent of last year. Drought has not only impacted agriculture but its impact has also been felt in electricity and gas distribution sector. Once we adjust the impact of drought, that is, excluding agriculture and value added in electricity and gas distribution, the real GDP grew by 4.7 per cent in 2001-02 as against 5.2 per cent of last year. What is important to note is that, the slower growth in real GDP over the last two years has been caused by catastrophic drought. Had there been no drought, Pakistan’s economic growth would have been around 5 per cent.

Another major achievement of outgoing fiscal year has been the sharp increase in the growth of real GNP. The real GNP grew by 5.4 per cent in 2001-02 as against 2.2 per cent last year, mainly on account of extraordinary increase in net factor income from abroad, which, in turn, is the result of a sharp increase in the inflow of workers’ remittances. With population growing by 2.2 per cent, the real per capita income grew by 3.2 per cent in 2001-02 as against almost zero growth of last year.

The sharp deceleration in inflation has been another major achievement of the year. Inflation, as measured by the changes in the consumer price index, stood at 2.6 per cent during the first ten months (July-April) of the current fiscal year as against the target of 5.0 per cent and last year’s achievement of 4.7 per cent in the same period. Food and non-food inflation stood at 1.4 per cent and 5.0 per cent, respectively as against 4.1 per cent and 5.3 per cent, respectively of last year in the same period. Inflation at 2.6 per cent is the lowest in three decades. Efficient monetary management, prudent fiscal operation, the better availability of food and essential consumer items, and moderate increase in international prices of key importables, such as sugar, edible oil, pulses and crude oil have been mainly responsible for keeping inflow low. Since inflation is a regressive and arbitrary tax and hurts the poor most, keeping inflation, and most importantly food inflation low, must be seen as a necessary part of an effective poverty alleviation strategy.

The overall developments in the monetary and credit sector have been satisfactory during the outgoing fiscal year. Money supply grew by 9.3 per cent during the first nine months (July-March) as against the annual target of 9.5 per cent. Almost 78 per cent contribution to monetary expansion has come from the strong build up in net foreign assets. Credit expansion to private sector appears low but the same is not true for the following reasons. First, the figures of monetary expansion or credit to private sector are on net basis (gross disbursement minus retirement). Higher credit expansion last year means more retirement in the current year. Since credit expansion was much higher last year, therefore, there was larger retirement this year. Second, there was accelerated retirement of export finance this year because of their declining rates. Thus, excluding export refinance, private sector credit expansion was higher than what is reported. Third, as a result of low prices of raw and lint cotton, credit requirements for cotton-related activities were low. Fourth, higher tax refund by the CBR improved the liquidity position of the businesses and as such their credit need were reduced to that extent. Fifth, private sector raised their funds by issuing TFCs and through the stock market. Thus, their dependence on banking sector for credit is declining. Once adjustments are made on these factors it would appear that credit to the private sector has been higher or at best, remained at last year’s level.

Pakistan’s stock market remained buoyant during the outgoing fiscal year. The KSE-100 index increased by almost 40 per cent during the first ten months (July-April). In fact, the Karachi Stock Exchange has been the best performing market during December 31, 2001 to May 14, 2002 among the 14 leading markets in Asia with rate of return of 41 per cent. The most important achievement of the year has been the significant improvement in Pakistan’s external account. Improvement in trade balance, sharp increase in the inflow of workers’ remittances and substantial increase in official transfers are mainly responsible for strengthening of external account. The current account balance (excluding official transfers) turned surplus to the extent of $ 913 million or 1.5 per cent of GDP during July-March 2001-02 as against a deficit of $ 746 million in the same period last year. However, including official transfers, the size of the current account surplus increased to $ 2095 million or 3.4 per cent of GDP as against a deficit of $ 82 million in the same period last year. Can Pakistan maintain a surplus in current account on a sustained basis? The answer depends on whether the flow of external resources including workers’ remittances can be sustained. This seems to be a difficult proposition at the moment.

The improvement in trade balance has been the result of relatively sharper decline in imports than exports. Exports in value terms registered a decline of 1.8 per cent and stood at $ 7.32 billion during the first ten months of the current fiscal year. Being a frontline state in the war against terrorism, Pakistan witnessed its trading activities disrupted as a result of the events of September 11 leading to war in Afghanistan. Pakistan’s export orders were cancelled, clearance of export consignments at various ports were delayed, obtaining new orders became even more difficult, shipment of exports postponed and cost of trading increased substantially because of the rise in freight and insurance charges. The depressed international commodity prices caused unit values of Pakistan’s major exports to decline in the range of 1 to 27 per cent. All these factors have impacted Pakistan’s export performance in value term.

Pakistan’s exports have nevertheless, expanded substantially in volume term. Exports of basmati rice in quantity terms were up by 7 per cent; cotton cloth, towel, bed wear, and readymade garments were up in the range of 12 to 26 per cent; and leather gloves and footwear were up by 12 to 39 per cent. Exports of petroleum products in quantity terms were up by 70 per cent. With firming of prices in international market as a result of recovery in global economy, Pakistan’s exports may rise substantially next year.

Pakistan’s imports also suffered because of the disruption in shipping and cargo services, and substantial increase in freight charges. These factors along with the decline in prices of POL products in international market and lesser import requirements of sugar and soyabean oil have led to a decline in imports by almost 7 per cent during the first ten months of the current fiscal year and stood at $ 8.2 billion. As a result of the developments in export and import, the trade balance improved by 34 per cent during the first ten months of the current fiscal year.

One of the key elements in improving current account balance has been the sharp increase in the inflow of workers’ remittances. Workers’ remittances were targeted at $ 1.3 billion for the fiscal year 2001-02 almost 20 per cent higher than last year. During the first ten months (July-April) remittances amounted to $ 1.865 billion as against $ 0.922 billion in the same period last year. Remittances not only doubled over last year but have crossed the annual target by $ 0.565 billion. If current trend continues, workers’ remittances may cross $ 2.2 billion by the end of the current fiscal year.

Despite difficult external environment the overall foreign investment, though falling short of the target ($ 600 million), increased substantially over last year. During the first ten months of the fiscal year foreign investment stood at $ 306 million as against $ 129 million last year - registering an increase of more than 100 per cent. Foreign direct investment stood at $ 308 million as against $ 259 million last year, thus registering an increase of 19 per cent. Portfolio investment has witnessed sharp inflow in recent months resulting in neutralizing almost all outflow of last year. With significant improvements in economic fundamentals on the one hand, and consistency and transparency in policies on the other, along with privatization program being more or less back on track, Pakistan may receive higher inflow of foreign investment in coming years.

Yet another most important achievement of the year has been the sharp build up in foreign exchange reserves. As on June 01, 2002, Pakistan’s total foreign exchange reserves stood at $ 5566 million, of which $ 3663 million was held by the State Bank of Pakistan and $ 1903 million was held by banks (other than SBP). More than $ 2.4 billion reserves were accumulated during the fiscal year 2001-02 of which, $ 2.0 billion were added to the SBP reserves and the remaining $ 400 million to banks reserves. The build-up in foreign exchange reserves is the direct outcome of the government’s macroeconomic policies that have been pursued over the last two-and-a-half years. Improvements in the trade and current account balances, substantial increase in private flows, availability of grant assistance and inflow of assistance from donor agencies are responsible for the reserves build up. The contribution of outright purchases in building reserves has been, at best, minimal. If Pakistan would not have taken enough measures to build up foreign exchange reserves it would have faced serious balance of payment crisis of its history after the events of September 11 and December 13. As a result of the strong build up of reserves, the vulnerability to external shocks has been reduced to a larger extent.

The sharp build up in foreign exchange reserves not only have provided much needed stability in the exchange market but have strengthened Pakistani rupee viz US dollar. Pakistani rupee appreciated by 7 per cent in inter-bank and almost 11 per cent in open market since the beginning of the current fiscal year.

While discussing the series of positive developments during the year, mention must be made of the significant reduction in Pakistan’s outstanding stock of domestic as well as external debt. Pakistan’s external debt and foreign exchange liabilities stood at $ 36 billion by end-March 2002 as against $ 37 billion by the end of last fiscal year. This shows a reduction of $ 1 billion of external debt and foreign exchange liabilities in nine months. As per centage of GDP, it has been reduced from 63.5 per cent to 58 per cent - a reduction of 5.5 per centage point in less than a year.

The Paris Club debt rescheduling/ re-profiling has been yet another milestone towards achieving debt sustainability. Unlike the standard ‘flow’ treatment, Pakistan received ‘stock’ treatment to its Paris Club bilateral debt. Pakistan has been the fourth non-HIPC country to get ‘stock’ treatment of its debt beside Egypt, Poland and Yugoslavia. The Paris Club debt rescheduling has provided substantial debt relief to Pakistan. As far as domestic debt is concerned, it has declined from almost Rs 1.8 trillion last year to Rs. 1.65 trillion this year - a decline of Rs 147 billion. As per centage of GDP, domestic debt has declined from 52.7 per cent to 44.3 per cent - a decline of 8.4 per centage points in one year.

The government has brought the issue of poverty alleviation to the centre-stage of economic policy-making, to which end a strategy to reduce poverty and improve income distribution has already been put in place. This strategy is based on the premise that sustained economic growth accompanied by macroeconomic stability is the most powerful mean of reducing poverty in the medium-term. Although growth is absolutely essential, focus on this alone is not sufficient to achieve poverty alleviation, for which direct programs have been launched. Despite difficulties in budget caused by the shortfall in revenue, the poverty-related expenditure continued to rise. As against Rs. 119 billion or 3.4 per cent of GDP last year, poverty-related expenditure increased to Rs 136 billion or 3.7 per cent of GDP - an increase of 17 per cent in a relatively difficult budgetary environment speaks of the government commitment to reducing poverty. Next year this expenditure is likely to increase by more than 18 per cent and may reach 4 per cent of GDP.

Pakistan has made considerable progress in many areas in a difficult environment during the year. While key economic fundamentals have improved, some weak areas continued to be source of concern. One of the weaker areas has been the growth in the economy. Although the economic growth has remained hostage to unprecedented drought for over two years, low levels of investment have nevertheless been responsible for keeping economic growth at a lower level. There is now considerable evidence that investment is one of the most important determinants of long-term economic growth. Both investment and growth decelerated in the 1990s which was a mirror image of the prevalent macroeconomic environment in the country. Investment declined from 19 per cent of GDP in early 1990s to 16 per cent on average, over the last two years - a loss of 3 per centage points. Growth has also lost ground by one-half during the same period.

How to raise investment level is a major challenge for the government over the medium-term. Although investor confidence has improved over the last two years much more will, however, be required to improve investment climate. There are three broad and interrelated elements that shape good investment climate: the overall macroeconomic situation, governance, and infrastructure. As regards the first element, a stable macroeconomic environment characterized by low inflation, low budget and current account deficits, and comfortable foreign exchange reserves, accompanied by wide-ranging structural reform program, make up one crucial set of ingredient for spurring investment and productivity growth. It has been commonly observed in developing countries that they start with macro reform but fail to move ahead with institutional and infrastructure improvements. As a result, the growth generated by macro reform peters out. Thus, what is required is that improvement in macroeconomic environment must be accompanied by concerted efforts in improving governance and infrastructure.

Turning to the governance component of the investment climate, bureaucratic hurdles, cumbersome labour laws, interaction with tax authorities, and other irritants have been the major problems in doing business in Pakistan. Although the government is making effort to address these issues, there are rooms for further improvement. There are two other dimensions that are linked with governance. First, the existing regulations and procedures, their effectiveness and transparency, and corruption associated with them. Second, the rule of law and enhancing transparency and accessibility of the legal system. The government is taking keen interest in streamlining regulations and procedures as part of its exercise in removing irritants. The government has also undertaken judicial reform aimed at strengthening the rule of law and enhancing the transparency and accessibility of the legal system by modernizing the court system at all levels. These efforts need to be expedited to improve investment climate.

Infrastructure is the third element of the investment climate issue. Uninterrupted power supply at competitive rates, good condition roads, rail and telecommunications network, efficient port operations, and quick custom clearance from the port are important ingredients of any country’s infrastructure. These areas require serious consideration of the government.

Investment climate plays a critical role in poverty reduction. A conducive investment climate benefits both the formal and informal sectors, and it is the latter where the poor often have the best chance of finding employment. Whereas conducive investment climate helps the formal sector to grow and create jobs, it also generates new demand for an expansion of the informal sector which benefits the poor.

Fiscal balance is another weak area that continues to be a source of concern. A general deterioration in public finances in Pakistan during the 1990s has caused serious macroeconomic imbalances and subsequent rise in public debt. Failures in enhancing tax revenues consistent with the growing expenditure requirements exacerbated fiscal imbalances over the period. Considerable progress has been made over the last two years to bring the fiscal deficit to a sustainable path. Fiscal deficit as per centage of GDP which used to average 7.0 per cent of GDP in the 1990s was brought down to 5.3 per cent last year. During the outgoing fiscal year it was targeted at 4.9 per cent. The events of September 11 and December 13 and their subsequent developments seriously undermined government’s effort to further reduce fiscal deficit. While the former is responsible for revenue slippages, the latter, leading to the military stand-off caused slippages on the expenditure side. Accordingly, the fiscal deficit for the outgoing fiscal year is provisionally estimated at 5.7 per cent of GDP. The underlying deficit for the fiscal year, however, still remains at 4.9 per cent because these slippages on revenue and expenditure sides are one-off element. For fixing fiscal deficit target for 2002-03, 4.9 per cent instead of 5.7 per cent, would be treated as base.

Notwithstanding the extraordinary events that undermined government’s efforts to further consolidate fiscal gains during the year, more durable improvements in fiscal performance must lie at the heart of structural reform program. Durable improvements require reforming the tax and tariff systems and their administration.

Tax administration plays a vital role in the success or failure of any attempt to reform taxation. It is in this view that a serious attempt has now been made to redesign tax administration on modern lines. Experts from the private sector have been inducted in the CBR at the top management level. A time-bound reform agenda of the CBR is likely to be announced shortly. The monitoring of the tax administration reform should be high on the agenda of the government over the medium-term.

A critical ingredient to successful adjustment is prolonged commitment to fiscal discipline. There is a general consensus that commitment to fiscal discipline can only come from a rule-based fiscal policy. A rule-based fiscal policy is considered essential for achieving long-run fiscal sustainability, maintaining fiscal discipline, and preventing potential future increases in public indebtedness. Given the difficult past that Pakistan’s macroeconomic environment had reached by the end of the last decade a rule-based fiscal policy would be highly desirable for restoring macroeconomic stability and promoting growth on a sustainable basis.

The wide-ranging structural reform programs which were put in place for over two and a half years are paying dividends. Pakistan has witnessed a modest rebound in growth, its vulnerability to external shocks has reduced, and its key economic fundamentals have improved. To ensure sustained high economic growth and resilience against external shocks, Pakistan needs to work towards achieving not only sound macroeconomic fundamentals but also sound structural fundamentals. Key to attaining these objectives is expeditious completion of the structural reform agenda.

Pakistan has witnessed a long and harsh winter in the 1990s. Through two-and-a half years of concerted efforts spring is now descending on Pakistan’s economic scene. The future of Pakistan is seen with optimism and hope. But at the same time, Pakistan is fully conscious that, in the past many opportunities were lost. The same should not be repeated.