While the stock market collapse of 2005 was triggered by the manipulations of a few brokers and bankers, the current stock market surge seems to be caused more by the inflow of portfolio capital particularly from neighbouring Gulf states flushed with current account surpluses following the boost in oil prices.
It has continued to feed on snowballing expectations about the future based on the assumption that General Musharraf¹s regime will continue well-beyond its current ³mandate², with the continued US support and substantial progress in its relations with India. Some of these assumptions are already being undermined by developing events, both at home and abroad. The public protests over the removal of the Chief Justice continue to gather momentum and could possibly take a sudden turn for the worse if an amicable solution of the crisis does not emerge soon.
Similarly, the pressure from the US Congress to tie future US financial assistance to Pakistan to the restoration of democracy, combating religious extremism and ensuring nuclear non-proliferation could result in a serious setback to the inflow of capital and overall economic performance, notwithstanding the best efforts of a former state bank governor and a world bank mandarin to allay these fears.
The lack of any significant progress on economic and trade issues in our negotiations with India could also serve to send negative vibes about the long-run prospects of development in the South Asian region. All these factors, individually and together, could put a brake on the current surge in investment inflows.
The economic prospects for this fiscal year are already indicating a deceleration in the rate of GDP growth, which had spurted to over eight per cent blip two years ago, is forecast to grow by 6.8 per cent this year, slower than an earlier estimate of seven per cent. That compares with an 8.4 per cent pace for Asia's developing nations and well below that of China and India, the leading dynamos of the Asian region. Thus, Pakistan¹s growth sustainability can’t be ensured by mere reforms in macroeconomic management but also structural changes in the economy, which are much more difficult to undertake.
At a time when the economy is experiencing the worst trade, current account and rising budgetary deficits, such long-term issues need to be addressed less cavalierly than by the present regime.
The forthcoming budget is likely to focus more on short-term palliative measures to attract votes from its favourite constituencies than to address the need for investment in physical and social sector for sustaining these high growth rates.
Much is being made of the large increase in the amount of foreign direct investments (FDI)s in the last two years, just as the euphoria often spun around remittances, portfolio capital and foreign exchange reserves. However, a close look at the sources, magnitude and composition of these flows do not necessarily indicate the health of the economy or the sanguineness of their impact on the sustainability of growth. Although the FDI flows have recently taken a large jump, it is not yet certain whether this is indicative of a stable trend.
Rising from a modest $1 billion in fiscal 2001, they are expected to have reached over $3 billion in fiscal year 2005-2006. The 2006-2007 estimates are likely to increase to over $5 billion as FDI flows from Qatar and Kuwait in the power, hotel, insurance and oil refinery sectors.
The factors that have propelled the growth of FDI flows in the last two years have both domestic and external origins. On the domestic side, the main attraction of FDI has been the privatisation of a large array of public enterprises.
The major foreign factor contributing to the growth of FDIs has been the sharp rise in oil prices since 2003, which caused an unprecedented rise in the current account surpluses of the neighbouring Middle Eastern oil producing countries, especially UAE, Kuwait and Qatar, who are looking for investment opportunities in the region, primarily in the real estate sector. The oil price increase has also attracted FDIs from large oil exploration companies in the United States and Europe.
In terms of sectoral composition, the FDIs are mainly concentrated in the oil and gas exploration, financial services (including the acquisition of a domestic private bank) and communication (including telecommunications). Very little identifiable industrial investment, which is the main source of technology transfer, seems to have taken place through the FDIs.
Much of the FDIs are in the nature of addition to old capacity (³brownfield) FDI to privatised or acquisitioned enterprises, rather than investment in new enterprises (greenfield FDI) which have a greater developmental impact through technology transfer. The FDI inflows primarily target the domestic rather than the export market (e.g. telecommunications and real estate) and thus have a low potential for improving the balance of payments.
The outflows of profit repatriation have steadily increased over time and reduced the net flow by more than half a billion dollars. The euphoria about the increased FDI inflows needs to be tempered by these basic characteristics. Besides, continued large FDI inflows, such as those from China and other East and Southeast Asian countries are crucially dependent on three factors: an improvement in the domestic political and law and order situation, an improvement in the political and economic relations with India and, last but not least, the human development base.
A major downside of the current spurt in FDI inflows has been the complacency that seems to have crept into policy circles about the trade balance which has deteriorated sharply in the last few years. Despite its much more permissive trade and regulatory policies and a more open economy, Pakistan¹s export/GDP ratio lags behind those of the much larger and previously much less open economies of India and China, because of its inability to diversify its exports in the last decade or so.
While exports doubled from a little over $4 billion in 1989 to over $8 billion in 1999, they are currently hovering a little over $16 billion. Despite various cosmetic measures and grandiose plans, economic managers have been unable to make any significant breakthroughs in diversifying exports, which remains heavily dominated by cotton and cotton-based manufactures.
The textiles continue to receive ever-increasing fiscal and monetary concessions while the share of higher and medium technology products in all exports of manufactures remains well below those of most dynamic economies of our region. These are symptoms of the Dutch disease which economic managers have been unable to combat, preferring the increasing dependence on capital inflows to greater competitiveness and diversification of exports.
The external economic imbalances, in the pursuit of high growth rates which are now under threat from a likely reduction or withdrawal of large inflows of US aid are the focal point of current economic concerns. However, the central problem of the economy are the increased domestic imbalances being created by the non-inclusive growth pattern. While poverty alleviation has been the pet theme of most donor agencies and government plans in recent years, without having made much dent into poverty incidence, the real problem facing the economy is the increasing economic inequality and polarisation in the society.
Although it is a cliché to say that growth is a necessary condition for alleviating poverty, the high rates of growth being attempted to achieve, is creating conditions for widening the chasm between those privileged with the fruits of growth and those being crushed with poverty.
While data on economic growth, poverty incidence and income inequality are often doctored by the official agencies in an effort to show high growth rates and low levels of poverty and inequality, this attempt to achieve better economic performance and reduce poverty by edict is seldom successful and continues to be exposed by analytical studies.
A recent study by Dr Talat Anwar, analysing the data from household surveys held in fiscal 2001-2002 and 2004-04 shows that inequality worsened during the period.
While the richest 20 per cent of the population gained their share in total income, the poorest 70 per cent lost their share during the period. An interesting conclusion of the study on the long-term relationship of growth and inequality is that the degree of inequality has increased, regardless of the changes in economic growth.
The increasing income inequality in recent years reflects that one of its major sources is the enormous capital gains due to rising property values. The stock market has quadrupled in less than half a decade and a small number of investors have benefited from the often manipulated gyrations of the stock market.
There is a need to tap the windfall gains from both the real estate and stock market sectors, which are lightly taxed. Taxation of agricultural incomes, along with land reforms, have been put on hold, because of their assumed infeasibility on political grounds. Apart from raising questions of equity, it has also frozen the power structure in the rural areas.
An urgent need for effective reduction in poverty is of the initiation of employment guarantee schemes in rural areas. The main hindrance to the adoption of such a programme is the political capture of development funds by those allied to incumbent regimes. The basic prerequisites for the success of such a scheme are the existence of local level participatory institutions and the right to information legislation for ensuring the transparency and equity of the employment guarantee scheme
Another serious issue is the provision of public goods, especially education and health, without discrimination and differentiation relating to their economic or social situation or location. There has been a steady incursion of the private sector in the field of social services which has largely benefited the middle classes and has marginalised the poor, who have access only to the degraded public sector facilities.
Pakistan¹s record in meeting most of the MDGs and especially in meeting the goal of primary education for all has been one of the worst among developing countries. The MDGs do not include the goal of reducing economic equality and ensuring a common public educational system, with equal access to all, although in Pakistan¹s context they are among the most urgent social needs and should receive high priority.
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