State of the economy

WHILE acknowledging that “growth momentum remains strong” the State Bank, in its third quarterly 2005-2006 report, has reiterated that it is “more narrowly based.” The trend witnessed over the past two years has been “a point of unease” despite the exceptional growth of 8.6 per cent during 2004-2005. The narrow base, coupled with growth declining by two per cent to 6.6 per cent last year, indicates a longer-term petering out. The government has so far focused on growth from the existing manufacturing base and private sector funds have been diverted to buying state units rather than creating new capacities. Burdened with an idle industrial capacity, the private sector has responded to the rising domestic demand, fuelled by an annual inflow of Rs240 billion in remittances and consumer financing, with a policy of industrial consolidation rather than expansion. The declining rates of savings are not enough to finance a high level of investment. Policymakers have also encouraged massive imports which make no contribution to the GDP and often tend to discourage domestic production. With growth in exports and imports sliding in the second half of last year (but for the surging high-priced oil bill), it seems that the domestic demand that fuelled growth is slackening.

With the current level of spending on education and health, though increasing slowly, the economic growth rate is also not socially sustainable. With so many constraints affecting the quality of growth, the government has chosen to substantially increase public sector development spending to Rs415 billion, notwithstanding the rising fiscal deficit. The tax revenue needed to meet government expenditure is not keeping pace with the high growth rate as important sectors are either not taxed or are under-taxed. A policy shift to enlarge development spending has come at a time when, according to the State Bank, it involves grave risks for “the hard-won macro-economic stability”. The SBP report warns that “risks to long-term growth prospects are mounting with emerging macro-economic imbalances.” These include an increase in inflationary pressures, weakening of the fiscal indicators and widening of the current account deficits. The average seven per cent economic growth for the past three years has not strengthened the fundamentals of the economy and has, in fact, weakened them. The best opportunity to set things right, during the current phase of rapid economic growth, is apparently being missed.

The data for July-March 2006 shows that the deceleration of industrial growth is quite broad-based compared to the previous year. Large-scale manufacturing has fallen from 15.6 to nine per cent. The only sectors showing higher growth include food, leather, pharmaceuticals, and paper and board. The share of machinery in import growth has dropped from 29 per cent in July-January 2006 to seven per cent in February-May 2006. The poor performance of key cash crops like cotton and sugarcane pulled agricultural growth down to “2.5 per cent from the previous year’s 6.7 per cent.” In the absence of modernisation of agriculture, farm output has fluctuated from year to year. Surprisingly, however, the State Bank report attributes “a substantial portion of losses in agriculture” to a medieval concept of “bad luck”. Instead of recounting the causes of failures, the decision-makers need to review their policy while the going is still good.

Britain’s BLA ban

MONDAY’S move by the UK home office to add the Balochistan Liberation Army (BLA) to its growing list of proscribed terrorist organisations represents a symbolic victory for Islamabad in its efforts to muster international support for its counter-insurgency operations. Intriguingly, the announcement came close on the heels of a high-ranking Pakistani military official’s arrival in the UK to discuss possible cooperation with British troops deployed in Afghanistan. The draft proscription order was issued under the Terrorism Act 2000 which allows the British government to ban any organisation which commits, promotes or encourages acts of terrorism either in the UK or abroad. To come into force, however, the home office decision must be ratified by both houses of parliament. The democratic process was less visible in the imposition of a similar ban by the Pakistan government in April 2006. Then, the BLA was summarily outlawed as a terrorist organisation through an interior ministry notification. The British government’s proposed ban has, understandably, been welcomed by the foreign office in Islamabad. At the same time, it is believed that the finance ministry has been directed to freeze the accounts of some 45 suspected BLA members, further tightening the screw on the shadowy militant organisation.

These latest moves are clearly aimed at squeezing the BLA’s funding network which, it is believed, may include overseas sources. The danger, however, lies in the potential for political victimisation. The BLA is at best a nebulous umbrella organisation of small militant groups with no clear command structure and an even less distinct membership. In this murky scenario, it is not inconceivable that any Baloch leader who falls foul of the authorities in the current stand-off with the federal government may be branded a BLA member and effectively silenced. The BLA tag could also be used to settle personal scores. Intimidation, including massive military assaults, has so far failed to control the situation and it is imperative that a process of dialogue be initiated at the earliest possible opportunity. Now is as good a time as any. The stability and future well-being of Pakistan is not so precariously dependent on what a handful of BLA militants may or may not do.

Poor state of zoos

KARACHI zoo suffered a loss on Monday with the passing of Anarkali, the 65-year-old elephant which, in the 1950s, crossed into then East Pakistan from Burma before being brought to the Karachi zoo. Before the zoo authorities rush to find her replacement, it would be better if they took time to consider the poor state of the zoo as well as the pitiable condition of its inmates. Although authorities claim that the zoo attracts 3.5 million visitors a year, it is hard to imagine how that becomes possible given the wretched condition of the zoo premises. The less said about the animals and birds in cages the better. The zoo has been severely short-staffed for some time, on account of a ban on fresh recruits, with no signs of a reversal in the foreseeable future. That the helpless staff stood by and watched as a Bengal tiger attacked and killed its female mate in February this year proves just how poorly equipped they are. The same is true of Safari Park which is said to house 450 animals and 350 birds but lacks much of the necessary equipment, resources and staff to ensure the inhabitants’ well-being. Such problems are not confined to Karachi alone. There is just one vet at Lahore’s zoo to deal with the 1,200 animals residing there. This explains why as many as 16 animals have died in the last few months.

Despite being allocated Rs70 million to buy new animals, neither the Karachi Zoo, Safari Park nor Landhi-Korangi zoo have been able to do so because of bureaucratic delays that stood in the way of timely approval of tenders. This is how little attention is given to recreational facilities, to say nothing of animal welfare. Undoubtedly, the condition of zoos across the country is one of utter neglect. This must be rectified before new animals are brought in and made to suffer a terrible fate.

Time to open up the political system: Is Pakistan in a mess? — II

IF General Pervez Musharraf were to fail in his enterprise — to create a moderate system of values that accommodates different points of view, not just religious but also ethnic linguistic and regional — it will not be so much because of the inability and unwillingness to lay the foundations for a durable political structure. Paradoxically, the reason for the failure would be on the economic front.

This would be paradoxical for the reason that it is in the economic field that President Musharraf and his associates feel that his regime has scored the most notable success. In terms of the growth in gross domestic product the economy has done well. The GDP has increased by close to seven per cent a year and income per capita by 4.5 per cent per annum. This is a better record than that achieved by the government of President Ayub Khan some four decades ago. What were the reasons for this burst in growth and why do I believe that this record points to a failure rather than a success?

The Economist’s survey is wrong once again in identifying the reason for the economy’s seeming impressive performance. “The Pakistani most responsible for the economy’s brilliant turnaround, it might be argued, is not General Pervez Musharraf or his technocratic prime minister Shaukat Aziz. It was an ethnic Pakistani currently in American custody, Khaled Sheikh Mohammed, the architect of the attacks on September 11, 2001.”

KSM, as he is known in the western intelligence community, was picked up from a house in Rawalpindi’s housing community, Westridge. His arrest was the result of months of a joint effort by the Americans and Pakistan’s ISI. The American support of Pakistan after the latter’s willingness to help Washington in its “war on terror” had begun to yield results. KSM was one of the several fruits the US was able to pluck in Pakistan. Islamabad was helpful since it had been generously rewarded.

Says The Economist: “America wanted Pakistan as an ally and was prepared to pay. It gave $600 million straight up, promised to forgive $2 billion of debt and persuaded other creditors to go easy. Some of Pakistan’s debt was already due to be rescheduled; America ensured that the terms were generous. In December 2001, the IMF agreed on a $1.3 billion facility. Meanwhile, remittances rocketed, especially from Pakistanis in America, reflecting fears that Christian countries might freeze Muslim assets.”

There is some — but only some — truth in this description. The easing of foreign exchange constraints on a resource-strapped country certainly helped to reignite growth. But there were other reasons; among them, good weather that produced a 7.5 per cent increase in agricultural output. Also helpful was the pick-up in domestic demand — the Pakistani consumers were reacting to the relative political calm that prevailed during the first five years of General Musharraf’s tenure. There was also enough unutilised capacity in the manufacturing sector that could be put to use to satisfy growing domestic demand. The economy, in other words, was ready for a bounce and it bounced.

The mistake The Economist has made in identifying the reasons for the interest of Pakistanis abroad in the development of the homeland was to attribute it to Washington’s close scrutiny of financial flows to countries such as Pakistan where external capital helped to finance Islamic extremists. The full details of the programme of financial surveillance launched by the United States soon after 9/11 have come to light as a result of the recent investigative reporting of The New York Times. However, much more important is the confidence the well-to-do community of Pakistani Americans developed in the economic prospects of their homeland.

This is where the question of failure arises. Having carefully watched the performance of the Musharraf government I have come to the conclusion that it has operated without a well thought-out economic strategy. When I raised this concern with some of the regime’s senior leaders not long ago, I was told to read a document titled Medium-term Development Framework, 2005-15. I have done that — and done it very carefully — and my conclusion is that it is a conceptually flawed piece of analysis.

If the government’s growth strategy is based on the assumptions factored in the document’s scenario, it would be safe to suggest that uneasy times lie ahead. One of the critical assumptions made in the document pertains to the incremental capital output ratio (ICOR) for the next decade or so. It is said that the ICOR for Pakistan will be less than two, meaning that it would take investment equivalent to only two per cent of GDP to produce one per cent increase in gross domestic product. For a seven per cent GDP increase, the country will need to invest only 14 per cent of national income.

This is, of course, a grossly underestimated number, and if this is the basis of public policy in the future and if the government believes that it does not need to work hard to increase the rate of domestic savings, then it is condemning the country to a slow rate of GDP growth. With the policies currently in place, the sustainable rate of growth is not seven but only four per cent a year. At four per cent, the pool of poverty will not shrink while income disparities — both interpersonal and interregional — will continue to increase. This is a recipe for social and political instability. It is the failure of the economy to attain a rate of growth that could be sustained over a long period of time — say over a decade — at a pace fast enough to ensure a significant reduction in the pool of poverty that would save Pakistan from what The Economist calls a “bearded future.”

It takes many years to increase domestic savings. Given that, the government must rely on external flows — not from friendly governments since there are not many of those, but from the investors who may be prepared to come to the country. This is where the increasingly affluent Pakistani expatriate communities enter the picture. They are in the Middle East, Britain and North America. The members of these communities have shown interest in investing in the homeland which is why the flow of “remittances” acquired considerable importance in the last few years. These have increased not entirely because of the financial surveillance referred to in The Economist’s survey, but as a result of investors’ interest in Pakistan. The members of the diasporas are prominent among this nascent group of investors.

This is where public policy is failing in three respects but is on the right line in one way. Public policy’s failure is in the areas of capital market development, energy development and easing of other infrastructure constraints, and development of a dynamic export sector. Where public policy appears to be headed in the right direction is in the promotion of higher education, albeit from a very low base.

Islamabad’s difficulties in creating a regulatory framework within which capital markets can function has come to light in recent days as a result of the open quarrel between the former head of the Security and Exchange Commission (SECP) and the ministry of finance. This dispute cannot create confidence for those who are prepared to put their money into the capital markets. The development of the stock market will not happen for as long as the ministry of finance is not prepared to grant operational autonomy to the various regulatory bodies, including the SECP and the State Bank.

General Musharraf has been in power for almost seven years but this period there was no significant investment in physical infrastructure. This neglect is nowhere more visible than in the sector of energy where the capacity to generate electricity increased by only 10 per cent while the demand for it has grown steadily at the rate of eight per cent a year. This has created a wide gap between demand and supply.

This year, the gap between the expenditure on imports and earning from exports is large enough to consume the entire foreign exchange reserve. Pakistan will not be able to sustain this trade gap for long; it has been financed by remittances and by foreign direct investment. Much of the remittances are the result of the confidence of the expatriate communities in the homeland’s economic future. This confidence is now being shaken. Much of the foreign investment was directed towards the assets that were being privatised. The recent Supreme Court judgment concerning the privatisation of the Steel Mill in Karachi may also inhibit privatisation plans. In sum, it is the way the regime has handled the economy that may prove to be its Achilles’ heel.

Pakistan is a country in transition; the choices it faces are similar to those a number of other non-democratic nations have had to deal with over the last couple of decades. The Economist’s advice has been consistent in this respect: open the political system to broad representation and the rest will take care of itself.

In the short time available to the Musharraf government before it calls another election in the closing months of 2007, it must do what it has not done up until now. It must develop a strategy for economic growth, poverty alleviation, and reduction of interpersonal and interregional income disparities. It must allow the development of institutions that would work independently of those who control politics.

The judiciary and the Election Commission are the two most important institutional devices that need to be free of political influence. But institutions such as the SECP and the State Bank also need to be set free.

Concluded