Today, Pakistan presents a picture of striking contrasts. On the one hand, there is a consumption boom and asset price escalation never seen before. There are more cars on the road than ever before; more refrigerators, more TVs and more air conditioners are being sold.
Urban land prices have skyrocketed. The government claims that it has raised GDP growth rates, doubled per capita income to $847, increased employment and reduced poverty through a trickle down of benefits.
While admitting inflation of near 8-9 per cent, the government believes people are better off nevertheless. It claims FDI may cross the $3 billion mark, indicating confidence. Quite a rosy picture.
On the other hand and in contrast, most of the people especially in rural areas feel excluded from the economic boom. They continue to suffer in congested mass transport, limited access to safe water and sanitation, and are barely able to pay electricity bills for one bulb and a fan, leave alone purchase of expensive appliances.
For them, the high real estate prices means owning an urban home is impossible, and many of them have lost their life-time savings in manipulated and volatile stock market.
Inflation has seriously eroded the purchasing power of fixed and lower income people. There is not a single government school or hospital of an acceptable standard of service.
Poverty is pervasive and may have increased. Macroeconomic indicators point to serious imbalances in the fiscal and external accounts. Institutions are in decay; law and order and the justice system unsatisfactory. The military is at war in two regions against its own people. This picture is quite bleak.
It is obvious that both the pictures take a partial view. Viewed together- while there has been a revival of economic activity, and some have benefited, it looks like a shining veneer on a rusty body. What is more conspicuous is the great disparities across social and income groups, across the urban/rural divide, and across provinces.
Most importantly, the institutional weaknesses and security issues could well jeopardise the economic revival altogether. How did we get there and what are the risks and challenges looking ahead?
To understand what triggered the growth revival, we need to recall some past developments. During the 1990’s, the successive governments undertook extensive structural reforms which included public debt management, reforms of tariffs and trade, tax reforms, liberalisation of interest rates, external current and capital accounts, utilities tariff rates and administered prices, reforms in the financial sector, etc. The list is long.
Despite the reforms, the growth rate averaged about 4.5 in the 1990s, compared to 6.5 per cent in the 1980s. And because each government grappled unsuccessfully with macroeconomic stabilisation, foreign exchange reserves remained low.
When the present government took power in 1999, it continued with the same structural reforms but pursued demand management more effectively. As a result, during its first two years, the growth rate declined to 2.5 per cent, but foreign exchange reserves rose. What was common throughout this period was the lack of resources, public and private, to kick start the economy.
Then 9/11 happened in 2001. It triggered two events which changed the economic fortunes. One: Pakistan received a favourable rescheduling of its external debt, lifting the burden of a large debt service from the government. And two: Workers abroad started remitting home large sums of their earnings. Remittances reached $4 billion in 2002-03 and have remained at that level ever since.
When converted, annual remittances worth Rs240 billion became the driving force behind the escalation of urban land prices and stocks prices, provided liquidity and created a wealth effect.
Consumption expenditures shot up, causing a surge in GDP in the following years, further buoyed by low interest rates and rapid growth in consumer credit. Two years later, investment started to pick up reflecting both higher public and private investment in some industries as existing capacity was utilised.
The economic revival following 9/11, rooted in the structural reforms of the previous decade, provided the policy-makers with the best opportunity to set the stage for sustainable growth and reduce poverty permanently.
The challenge was to utilise remittances to finance investment, maintain competitiveness of exports and domestic productive sectors and sustain fiscal and external balances, allocate finances to provinces to reduce poverty and keep prices stable.
Unfortunately in the costliest policy mistakes of recent years, the SBP and the ministry of finance failed to grab the opportunity. Today macroeconomic imbalances, the institutional decay and disparities threaten the sustainability and expansion of the economic revival while poverty persists.
Headline statistics of $847 per capita income, 25 per cent poverty and $3 billon of FDI are more for public relations than indicators of real change.
Yet there is a hope that if appropriate measures are taken, the underlying fundamentals of the economy are likely to remain strong. In fact stronger than what the present regime would like us to believe, because our economic strength is rooted in 15 years of structural reforms and not in the continuity of the regime. The fundamentals will remain strong even after this regime is gone.
There are four major weaknesses in existing policies that threaten sustainability of economic growth. These are in policies addressing poverty, regional disparities, investment, and macroeconomic management.
Poverty: It is a multi-dimensional phenomenon. It takes more than a trickle to reduce poverty when 32 per cent of 150 million people live below the poverty line. It requires large budgetary allocations and improvements in service delivery to accelerate human development through education and better health, and raise the quality of life with decent housing, safe water and sanitation.
The Constitutional and legislative responsibility to provide these services to the people lies with the provincial and local governments. By refusing to increase financial allocations to the provinces in the NFC framework, the federal government cut off the possibility of reaching out to the poor.
If benefits have not trickled down in seven years, the regime may not have the time to see this through. What started as a revival in mainly two sectors, large-scale manufacturing and commerce, could not be extended to the labour intensive sectors like agriculture, small scale manufacturing, construction and transport.
These are the sectors where the poor reside and remain excluded from the economic revival. Yet surprisingly, the government quotes a recent survey showing reduction in poverty from 32 to 25 per cent in the last five years as a result of trickle down. This report is questionable, both because the treatment of raw survey data is not transparent, and because it flies in the face of a priori expectations based on policy actions and sector data.
The government’s claim that per capita income is at $847 also sounds hollow for two reasons. First, because per capita income is an average and it conceals growing disparities in income and the plight of the poor. And second, the arithmetic implies that per capita income grew by nearly eight per cent annually from $526 in year 2000, contradicting official population growth figures.
Regional disparities: Pakistan is a federation of four provinces with unequal levels of economic and social development. The ethnic distinction of provinces makes horizontal equity in development vital to political stability and national cohesion.
The adoption of the 1973 Constitution with unanimous support of all remaining provinces, by addressing many of the contentious economic issues, provided the country another opportunity to address regional economic disparities and strengthen the federation.
Unfortunately, violations of the Constitutional mandate as well as partisan interpretation of various Articles of the Constitution over the last 33 years have aggravated economic disparities between the provinces and rekindled perceptions of economic injustice among provinces. As we speak, there is a war going on in Balochistan triggered by perceptions of inequity, while NWFP has decided to rectify its grievances through an arbitration tribunal.
The failure of the National Finance Commission (NFC) to reach consensus on the division of resources between the federal and four provincial governments was a serious deadlock that potentially destabilises the federal structure. Disagreements remained unresolved over almost all issues before the NFC mainly because constitutional obligations and economic arguments were over-ruled by political compulsions.
Lack of consensus at the NFC was further complicated by the continuing dispute between the provinces and the federation over the determination of royalties and surcharges on gas and over calculation of hydro profits.
Despite having potential persuasive powers, the federal government failed to display leadership and a commitment to any constitutional obligations in resolving disputes at the NFC.
Instead, when the deadlock at NFC persisted, the federal government asked all the provincial chief ministers and NFC members to sign off their constitutional responsibilities as members of NFC in favour of the president on letters drafted for them, giving the president unquestioned authority to decide whatever he deemed fit.
Unfortunately, the three provinces signed off their responsibilities. NWFP held out on grounds that it would violate the Constitution and further erode the remaining provincial autonomy, while setting a precedent that would weaken the federation.
In response, the government announced an interim-award anyway, calling it an amendment in the 1996 award, a route available in the Constitution without requiring the consensus of all provinces. Not surprisingly, the changes announced in the 1996 Award do not reflect any principles or equity considerations.
The share of the federation has been reduced by an amount which is a mockery of the needs of the provinces to address poverty, and the additional cost of running the huge local government machinery. To rub salt in the wound, the federal government has subsequently withdrawn federal support for provincial investment programmes, thus taking away more than what little they had initially given.
Investment climate: Two pre-requisites for private investment in any economy are peace and political stability and the rule of law, before they look at anything else. Unfortunately, Pakistan remains afflicted by the absence of all three. The government has not been able to capitalise on the peace dividend after tensions with India were reduced for good.
Instead we started boasting of being a frontline state in another war, the war on terror. Before long, policy failures led to launching two wars within the country against different segments of our society for different reasons.
Today the newspapers report as many stories from the domestic front as from Iraq and Afghanistan. In such an environment, investors are unlikely to choose long-term investment in a manufacturing plant over trading and speculation. To encourage industrial investment, we really need to put our guns away and start talking and find political solutions to our differences.
Political stability is essential for investor confidence to assure continuity in policies. By governing outside the constitutional framework, the regime has failed to create predictability in the political future.
Yes, we have had seven years of the same regime, but this is not stability, it is continuing instability. The sooner we return to the Constitutional process, the better it is for investor confidence.
Apart from these fundamental issues, the lack of development of the capital market is the most serious impediment to generating investment resources. The risks are rooted mainly in the structure of the market where concentration of financial power and the unholy nexus between lender and investor gives brokers an unfair edge over other investors. The risks arise because the role of the front line regulators is compromised by the continuing conflict of interest on the boards of the stock exchanges.
Risks also lie in the opaque domain of the exchanges where manipulations are designed behind the veil of group accounts, benami accounts and dhobi brokers. The repeated crises have shown that presently this is not a place where small savers can invest their life-long savings on the strength of fundamentals.
A taskforce appointed by the government to investigate the crash of the stock market in March 2005 had many recommendations to reform the stock exchanges. Unfortunately when the previous SECP chairman started to pursue the investigation of wrongdoing and took steps to remove the conflict of interest on the boards, the government removed him immediately on Eid day sending a clear signal: ‘Don’t mess with the market bosses’. A message that is unlikely to attract genuine investors.
The concentration of financial power in the hands of some who wear several hats simultaneously, of broker, of ‘badla/COT’ provider, of mutual fund and investment bank owner, has not only created an unfair advantage for them and created opportunities for market abuse, these few are also using that power to expand into large-scale manufacturing and acquiring major privatisation assets. This is reminiscent of the days of the 22 families, except that the concentration of financial power now is much greater.
The concentration of financial power has a parallel in industry as well. Consumers suffer at the hands of cartels in the sugar, cement and automobile industries. The blatant manipulation of prices by industrialists in these sectors, which is contributing to inflation, is supported by vested interests in the government. Apparently the government cares more about the interests of a few in big business than the interests of the people.
Macroeconomic management: Just three years ago, the economy was enjoying one of the lowest rates of inflation, a low fiscal deficit, a surplus on the external current account and growing foreign exchange reserves.
In the period since then, the fiscal deficit has doubled annually in terms of GDP, inflation reached double digits, the trade account deficit has exploded offsetting the large inflows of remittances, and the current account has shifted from surplus to a significant deficit.
The rapid emergence of macroeconomic imbalances is the result of initially adopting an inappropriate monetary policy response to the continuing inflow of foreign exchange, and later to a rash policy of monetary expansion during 2003-2005, together with a naïve approach to public debt management that financed budget deficits with direct borrowing from the SBP.
The outcome was that money supply expanded much too rapidly, resulting in inflation and excessive domestic demand, eventually causing a deficit in the external current account. And the exchange rate appreciated in real terms eroding the competitiveness of exports and domestic import substituting sectors.
The problem is graver than the government believes because the $3 billion FDI which it hopes will finance the external imbalance and fill the investment gap, actually includes proceeds of PTCL privatisation, which is not new investment, and FDI in services typically tend to be a net drain on the balance of payments rather than help finance current account deficits. The sustainability of the economic revival is threatened by the urgent need to address inflation including by raising interest rates, but that will hamper investment which is already too low.
While adequate investment, which if successfully generated, will add to domestic demand and increase the saving-investment gap and increase the current account deficit unless domestic savings can be increased significantly. Ways out of this macroeconomic mess are available, but these involve conflicting choices between growth and inflation. Both choices diminish the prospects that benefits will ever trickle down to the poor.
The author is a former federal minister of commerce