AFTER three years of a well focused reform effort, Pakistan now seems poised to move forward in an area in which it has lagged behind other countries of South and Southeast Asia. Over the last two to three years the country has undertaken a number of reforms in the sector of finance which should help deepen and widen the country’s relatively under-developed financial system. What are the areas that need more attention and what could be done to close the gap that has emerged between Pakistan and the countries in its neighbourhood?

In this space today I will first provide a brief overview of the state of the financial system in Pakistan at this time and then suggest what are the additional reforms that need to be implemented to move it forward so that the country can begin to partner with the rest of the world.

Pakistan’s financial sector is small and highly concentrated in the banking system. Banks account for 86 per cent of the total financial assets in the country, a proportion much higher than for other countries at the same stage of development as Pakistan. Much of the banking system is under government control. This is the case even after the successful privatization of the United Bank Limited (UBL). State-dominated banking systems do poorly in mobilizing savings and this has happened in Pakistan as well.

Bank deposits amount to only 56 per cent of GDP in Pakistan compared to 150 per cent in India and 125 per cent in Malaysia. The money (M2) to GDP ratio — which is an indicator for the depth of the financial sector — is only 44 per cent in Pakistan compared to 58 per cent in India and 106 per cent in Malaysia. This suggests that a major part of our economy is not monetized. Unless that happens the economy’s modernization will remain seriously constrained.

Privatization of the remaining parts of the state-owned banking sector will certainly help in bringing the money-to-GDP ratio closer to that of other rapidly modernizing countries. This will also be helped by the development of the non-bank financial sector (NBF). This sector is critical for the widening and deepening of the financial system. The NBF sector is continuously evolving as institutions and new product lines are developed to meet the need of an expanding economy. Non-bank financial institutions (NBFIs) the world over have played an important role in bringing about the financial sector’s development. I will return to the subject of NBFs in a moment. Financial intermediation in Pakistan is dominated by the banking system which accounts for 61 per cent of deposits by savers of all classes — households, the corporate sector, and the government. About 34 per cent of deposits are with the National Savings System (NSS) while the NBF sector accounts for only five per cent of the deposit base. It is estimated that there is currently approximately $11 billion in NSS, of which an estimated 20 per cent is held by institutions.

The growth of the NSS has been a major distorting element in the Pakistani financial system. It was developed to meet the government’s demand for resources which should have been met by the fiscal system. Failing to mobilize resources through taxation, a succession of governments in Pakistan resorted to paying handsome dividends to the people to garner their savings. The khas deposits scheme was the most generous of the various NSS lines of products developed to obtain funds from the people. At one point, the government was paying a return of 18 per cent on these deposits. At that time this translated into a real return of 10 per cent — a return discounted for inflation.

Why was the NSS distorting for the financial system and why did it prove to be a long-term burden for the economy? This was so for at least three reasons. By offering such high returns to savers, the government crowded out the private sector which naturally had to pay a much larger amount to get people’s savings for investment. Second, by allowing financial institutions to invest in the NSS, the government gave them an easy way out to make profit on people’s deposits. The banks did not spend much time or effort on cultivating customers who wished to invest in the economy. Third, it added enormously to the burden of internal debt.

The banks play a useful role in intermediating between savers and investors. However, they are not expected to take risks that could hurt their depositors. That is better left to a group of institutions that are now generally lumped together as NBFIs. Pakistan has several of these. According to one count, there are 13 investment banks, 16 development finance institutions (DFIs), 33 leasing companies, 45 modarbas, 41 investment companies and mutual funds, 420 brokers, three discount houses, and 55 insurance companies. Despite this institutional proliferation, this sector accounts for a paltry five per cent of total financial assets in the country. The development of this important part of the economy’s infrastructure was inhibited in part by the dominant presence of the banks and in part by its own internal dynamics. The NBFIs were motivated by short-term returns and by what economists call “regulatory arbitrage.” This fancy term simply means that when institutions can take advantage of regulations such as severe constraints on new entrants into the sector, that is where they will concentrate most of their energies. That is precisely what the NBFI sector did in Pakistan.

Licences to operate in various areas of the financial sector were not given out easily; those who were lucky enough (or, more to the point, influential enough) to be granted the permission to work in the sector simply took advantage of their presence in the field. They did not innovate or aggressively seek new businesses which is what financial institutions are supposed to do and which is why they are so important to the economy at large.

Institutions that restore liquidity to the banking system are an increasingly important component part of the NBFI segment of the financial sector. These institutions are simply not present in Pakistan. The best way to explain this point is to look at the rapidly developing field of housing finance in the country. Until very recently, most people built houses from their savings; they borrowed little to construct their dwellings. In other words, a very large amount of people’s accumulated savings are locked in the housing sector. If commercial banks are prepared to lend for housing, including lending for the existing stock, a very large amount of savings would become available to the people to invest in other parts of the economy.

However, housing finance is provided for long periods of time; for terms that range between 15 and 30 years. No commercial bank can afford to have its assets committed for such a long period of time. They need to sell the mortgages they hold to the institutions that can afford to have long-term assets on their books. These institutions operate in what the people in finance call “secondary markets.” They buy mortgage paper from the banks, providing liquidity the banks need. Such institutions don’t exist in Pakistan. They need to be developed as more money flows into the sector of housing finance.

Pakistan’s capital markets are also weak and shallow. In spite of the sharp run-up in share prices in 2002, market capitalization is still about 14 per cent of GDP compared to 41 per cent in India and 154 per cent in Malaysia. The issue and investor base is very narrow. A handful of companies — Pakistan Telecom, Pakistan State Oil, and the Hub River Project — account for a major share of the market’s total capital and for the bulk of daily turnover. These three companies account for 27 per cent of market capitalization. Ten large companies, of which two are still held by the Pakistani state, account for 42 per cent of market capitalization.

And there have been very few new issues. Only four new companies raised capital on the stock market in 1997, only one in 1998, none in 1999, three in 2000 and only one each in 2001 and 2002. And only one new company has been listed thus far in 2003. These numbers don’t reflect a very vibrant capital market — they don’t indicate that there were a significant number of entrepreneurs willing to seek funds for investment from the stock market. Very few were able to meet the regulatory requirements for new entrants. Players in the stock market were also not interested in trusting their capital to new entrants. They were much more comfortable in confining their play to the existing and well known stocks, which is why they dominated the daily turnover.

There are a number of ways of getting capital markets to expand. Some of these measures were adopted several decades ago during the period of President Ayub Khan, which saw many innovations in the field of finance. The National Investment Trust was set up in that period and, with assets in 2002 valued at $270 million, became a large player in the market. NIT holds shares in over 600 companies with a significant presence in several large state-owned companies. For example, it has 20 per cent of the stock of Pakistan State Oil Company.

In 1966 the Ayub Khan government set up the Investment Corporation of Pakistan (ICP) to float and manage close end funds that turned tens of thousands of people into investors in the capital market. ICP launched 26 close end mutual funds with a total listed capital of $100 million as of September 30, 2002. Recently the management of three tranches of ICP mutual funds were sold in privatization auctions. The NIT is also likely to be privatized in 2003.

These are all very positive developments but the area that needs the attention of policy makers in Islamabad is the legal system, particularly the part that interacts with the economy. Much of the economic life in a mature economy is centred around formal contracts that must be enforced by the legal system. This is as necessary for the contract between a house-builder and the bank from which he borrows as is the agreement between a corporation and its shareholders.

Any violation of these contracts must be remedied quickly and that can only be done by courts. A good legal system creates an environment in which the parties to a contract take it seriously since they know that a heavy penalty will have to be paid if it is violated. Pakistan has as yet to get to that position.

SELDOM before had so much happened on the India-Pakistan front in so few days as it did in the last three weeks. Mr Vajpayee during a visit to Srinagar on April 18 offered to hold dialogue with Pakistan on all bilateral issues including Kashmir. The offer constituted a major departure from his aggressive no-talks stance since Kargil episode of 1999.

Prime Minister Jamali immediately reacted positively, “we welcome it, we appreciate”. And on April 22, Jamali, while reversing the government’s hard stance on the Legal Framework Order, formally invited the combined opposition for talks on the contentious constitutional amendments — a move seemingly dictated also by the compulsions of new realities emerging in the region.

Two days later on April 24 General Musharraf also broke his silence and welcomed Vajpayee’s initiative expressing the hope that it was a genuine gesture. On April 26 Prime Minister Jamali and General Musharraf attended a meeting in the GHQ, the nation’s undeclared but real centre for foreign policy formulation according to a former foreign minister. Then, on April 28 Jamali unexpectedly picked up the phone and in a 15-minute ‘most cordial and useful’ conversation invited Vajpayee to Pakistan.

If Vajpayee’s offer of talks was significant the invitation to him to visit Pakistan was no less significant either. For the first time there was no insistence to first address the core issue before other issues were taken up. On April 30 the Pakistan government declared to ban all those extremist and jihadi groups, which had earlier been banned but had later resumed activities and regrouped themselves under different names.

On May 2, Prime Minister Vajpayee declared before the Parliament to restore full diplomatic relations and re-establish air links with Pakistan. The announcement was promptly welcomed by Islamabad. The Foreign Office stated that Prime Minister Jamali would ‘respond in concrete form’ in due course. A two-hour meeting with General Musharraf of Prime Minister Jamali, Foreign Minister Kasuri and Foreign Secretary Riaz Khokhar preceded this announcement.

On May 3 Prime Minister Jamali formally invited Vajpayee to Pakistan saying ‘a warm welcome awaits you’. Within hours the Indian Prime Minister responded promptly though cautiously. “Careful preparations need to be made on the ground so that a meaningful engagement can be made at the highest level”, his letter said.

The next day on May 4 Prime Minister Jamali invited the country’s opposition parties for a dialogue on the peace process.

Earlier Mr Vajpayee had won crucial support from his BJP as the BJP President Venkaiah Naidu backed the talks offer as ‘a bold gesture’.

The world hailed these moves. Colin Powell telephoned Jamali to express his deep appreciation for his initiative to ring the Indian Prime Minister. It would be unrealistic to discount the US and international community’s behind-the-scenes moves that made it possible. “The whole of the subcontinent’s problems” Colin Powell had said a month earlier were part of the United States ‘broad agenda’ followed by a warning last week by his deputy Armitage that the situation in the region was truly ‘frightening’.

As these moves between India and Pakistan were taking place publicly some other moves were also taking place simultaneously in Washington. As Vajpayee offered talks in Srinagar, his security advisor Birjesh Misra was already in Washington, perhaps to fine-tune the peace move.

The rabidly anti-Pakistan US ambassador in New Delhi was quietly withdrawn from India in what was seen in Pakistan as a message that the US was keen to balance off both sides.

The United States banned the Hizbul Mujahideen, the Kashmir based dominant militant group, as a foreign terrorist organization, clearly indicating the keen American interest in restoring peace to the region.

Banning Hizb was a signal to Pakistan that the US would not permit Islamabad to employ force multipliers to augment the Kashmiris struggle.

The message was not lost on Pakistan.

The Hizb chief retracting from past rhetoric saw ‘a ray of hope’ in Vajpayee’s overtures, a far cry from the Hizb Chief Salahuddin’s hitherto hard stance and declarations that jihad was the only option. ‘A ray of hope’ declaration together with the fact that in the recent elections in Indian held Kashmir the local Hizb commanders actually supported candidates of Mufti Sayeed’s party in several constituencies are significant developments. Could it be taken as a paradigm shift in stance of the most militant Kashmir based jihadi outfit which was now willing to look at the issue politically rather than militarily?

The ISI chief Lt General Ehsanul Haq was, earlier, scheduled to arrive in Washington on a three-day official visit to meet the CIA chief Tenet and also possibly the National Security Advisor Condoleeza Rice. Neither Rice nor Tenet would be talking about weather. There was to be some tough talking.

In the meantime Pakistan dutifully kept arresting and handing over to the US the Al Qaeda suspects found in Pakistan. Vajpayee certainly has incentives to improve relations with Pakistan. Whether we like it or not, the recently held election in Indian Kashmir was a watershed mark indicating that the people were too eager to see return of peace and were weary of militancy and wars.

For Vajpayee to capitalize on the elections it is imperative that the Kashmiris are not driven to exasperation on the one hand and that there should be more US pressure on Pakistan to stop aiding the violence in the valley on the other.

For Pakistan’s civil society the dividends of peace are too well known and need no recapitulation. If one goes by these indicators a breakthrough should be possible. But will there be?

An answer to this question lies in the fact whether Jamali is prepared to act according to his own judgment and refuse to be a frontman of the security apparatus which has thus far been the sole arbiter and determinant of security agenda in the region.

True, there are risks in it. The last time a civilian prime minister challenged the so-called ‘strategic depth’ theory and went ahead with signing the Geneva accords, he was sacked even though he had the backing of the nation’s political parties. That was in 1988. Almost fifteen years later, another civilian prime minister is on the cross-roads to challenge another pet theory of the security apparatus, namely ‘calibrated response’ and a ‘low intensity conflict’.

Prime Minister Jamali seems to be playing his cards carefully. Despite the ‘boss’ being around and calling the shots he has done well to take the initiative and invite the political parties. What is there for Jamali to aim at in the short term under the circumstances? Armed with the support of the political parties and the Parliament, the prime minister should make a policy statement of his government declaring to cease permanently the export of terrorism as was done by the ‘boss’ in January 2002.

In return he should demand and get a guaranteed composite dialogue with India that promises a resolution of the Kashmir dispute within a stipulated time-frame in accordance with the wishes of the people of Kashmir.

In a newspaper interview Foreign Minister Khursheed Kasuri has said that since General Musharraf was also the army chief and the president, therefore the army was fully on board with the government as far as the present drive to normalize relations with India was concerned. Why Mr Kasuri felt the need to assure the nation that the military was on board? In the unsolicited assurance of his foreign minister lies the prime minister’s dilemma.

It is a manifestation of this dilemma that when a former ISI chief Hameed Gul was asked as to ‘why can’t the establishment develop a working relationship with any civilian government?’ his blunt reply was ‘Why don’t the civilian governments on national objectives go along with the will of the defence establishment?’. And it is this dilemma, which exasperated Benazir Bhutto to remark ‘the security apparatus has run amok’.

To overcome this dilemma Prime Minister Jamali has no alternative but to rely on the will of the people expressed through the Parliament rather than ‘the will of the defence establishment.’There are no alternatives to that.

ONE wonders whether the government and the opposition realize that when they discuss the LFO, they are in fact talking about the future form of government. The extent of power exercised by one or the other organ of state determines whether the system is nearer the parliamentary or the presidential form of government. The printing of an article entitled “Presidential system is the remedy” by Kunwar Idrees in Dawn of April 27 was thus appropriately timed. The old debate, it would seem, has re-started.

Many intellectuals in this country would immediately condemn the idea of re-opening the issue, with the oft-repeated phrase, “please stop experimenting with the country.” The sad truth is that stopping experiments is not a remedy. Experiments must go on until goals are realized. Fine-tuning must continue until the arrival of near-perfection. The very fact that the LFO crisis (which is nothing but a fight over the division of powers between the state organs), is jolting the present set-up, is a proof that in our search for a system that suits our society we are still miles away from the destination.

Most people shy away from supporting the presidential form of government because of a misconceived notion that it has already been tried with unhappy results. They equate the Ayub era with the presidential form of government. Nothing could be farther from the truth. The 1962 constitution was a thinly masked dictatorship imposed by a military man. It was an insult to the presidential form of democracy, which is one of the most stable and successful forms of government best suited for Third World countries. The single most important lesson that can objectively be drawn from Pakistan’s five turbulent decades is that the presidential system is probably nearest to the societal and political needs of this country. Here is why:

The parliamentary form of democracy has failed in this country. People would say, with justification, that it was not given a fair chance. However, the very existence of factors that have denied it a fair chance for fifty years underline the point. What is the guarantee that they will allow it to work in the next fifty years? Is not the present hold-up enough proof? It is time we acknowledged the death of the parliamentary form of government in this country. Rather than keep on trying to resurrect the corpse, it might be a good idea to try the presidential form of government. It happens to be a bit stronger, and just might withstand the usual attempts on its life.

At this stage, it is necessary to take care of another myth, which many otherwise well-informed opinion holders in Pakistan believe to be the gospel truth: they think that parliamentary government is synonymous with “pure” democracy while the presidential system is either dictatorial or somehow an impure version of democracy. This kind of thinking is the result of long eras of “presidents” like Ayub and Ziaul Haq. Their iron-fisted rule has impacted on the psyche of the Pakistanis, subconsciously identifying the “president” with autocratic rule. This is not so in reality. One can cite countries like the US, France, Germany, Russia and South Africa as examples of the success of presidential democracy.

The presidential form of government is much more suited to the Pakistani conditions than the parliamentary form. Pakistanis believe in authority. They learn to be obedient to the authoritative father from their early days. A president elected through universal franchise would be respected a lot more than a prime minister, who is not directly elected by the people. He is a lot more likely to be “owned” by the common man in the street. He will surely be nearer to the people. The strength that he draws from this mass support just might deter those who wish to remove him by intrigue or force. Of course, there are no guarantees in this respect, except that removing a president might be far more difficult than in the case of a prime minister. A strong president, not vulnerable to the blackmail of parliamentarians, would be able to deliver more, more assuredly.

However much we may hate the guts of the Americans these days, the fact is that they are the most powerful country in the world. Ask them the single most important reason for their success and they will almost unanimously say that it is their political system. And they are right. Their constitution, one of the briefest in the world, has never been changed for 250 years, except for minor amendments. Their presidential system has stood the test of time, winning two world wars and the world’s worst depression, during which several established parliamentary democracies of Europe crumbled and crashed. It is worthwhile looking at their system and adopting some of its features.

Somehow, several traits of character of Pakistanis resemble those of American society, especially the less decent ones, like love of money and power, a desire for luxury and extravagance, selfishness and a certain amount of heartlessness. Like the Americans, we are more likely to obey the law when the law enforcer is vested with sufficient authority. As in America, we too have a federation rather than a single unitary polity. A federation of states or provinces in very successfully governed through a presidential system while a single polity is more amenable to the parliamentary form of government. The parliamentary system is even a little too sophisticated for us just as it would be for the Americans. It depends too much on voluntary consultation between the chief executive and his junior colleagues. The prime minister must be good enough to consult on all issues with his cabinet and the parliament. Most Pakistani prime ministers have not been so good, as we all found sooner than later. In the parliamentary system, prime ministers are not free to appoint ministers of their choice; they are restricted to choose from among a few hundred elected persons whereas there are hundreds of thousands of able (and more amenable) persons outside the parliament. On top of that, they are required to consult them before taking decisions.

Most Pakistani prime ministers, therefore, formed informal ‘kitchen cabinets’ and/or appointed “advisers” whom they used as ministers. They also wanted to have more powers, including those usually enjoyed by presidents or even dictators, since there was no shortage of role models for the latter category. Scratch any former prime minister and you will find an overwhelming desire in him to be as powerful as the president of the US. If the desire is so strong and the national psyche so similar, why not try adopting the American system?

Imagine if both of our former prime ministers had actually been presidents (as in the US system), they would no longer be eligible to stand for the post, eliminating the need for going through so much hard work just to keep them out. This is actually the biggest benefit of the presidential system, and one that is most useful for Third World countries.

The major reason the political parties have not been able to mature in Pakistan is the parliamentary system, which gives permanent life to the head of a party by allowing him or her to be leader of the parliament until the day he or she drops dead. This gives these leaders the power to own political parties. If every one knew that a person could lead the country only once (as in the Philippines) or at the most twice, there would be little possibility of dictatorial control of a party by a single individual or his/her coterie.

In countries like Pakistan, the opposition knows that the governing party will never give them a fair chance even at the end of its term, as evidenced by large-scale rigging. As such, they try every means to make life difficult for the government from the very start. If they knew the incumbent leader would be relinquishing the charge within a given number of years, coupled with the provision of a care-taker government every time to hold general elections as in Bangladesh, they would probably agree to wait it out with patience.

Checks and balances in the presidential system are much more practical and formal than in the parliamentary system. The separation of the executive from the legislature is as important in a democracy as the separation of the judiciary. In a developing country like Pakistan the executive needs to be free from political haggling and the necessity to appease legislators so that he can devote all his energies to development. When he is directly answerable to the parliament he can never rise above the pettiness of politics.

In the presidential system, he is indirectly dependent on the legislature because whatever law he needs to be enacted or amended is to be okayed by the parliament. The parliament is as supreme and sovereign as it is in the parliamentary system, except that the sovereignty is exercised more openly and clearly in the passing of laws rather than in leg-pulling.

In the parliamentary system the executive and the legislature are combined in the parliament, with the result that, at least in this country, the parliament has virtually become a branch of the executive, leading individual parliamentarians indulging in the exercise of authority even in day-to-day matters. This has legitimized corruption.

This is not to say that the presidential system is free of all evils. A system will be only as good or bad as the people make it. However, assuming other factors remaining the same, a presidential system would be better suited to our society. At any rate, let there be an open, honest debate on the subject.