Pakistan’s Economy under Musharraf

The second popular perception is that Pakistan’s debt re-profiling was made possible by the U.S. because of September 11, 2001 events. As a matter of record, the broad contours of this arrangement were agreed with the IMF and Paris Club long before September 11 as Pakistan had successfully implemented the standby agreement with the Fund establishing its credibility and becoming eligible for their medium term facility. It is true that the formal agreement was signed in December 2001 but the lead time because of extensive preparation, negotiations and building consensus of 20 members of Paris Club had taken almost a year.

Third, there are those who argue vociferously that Musharraf did not take advantage of debt relief and did not focus on any structural reforms, oversaw Pakistan spending beyond its means and the growth was fuelled by consumption .What does the evidence show? Investment/GDP ratio touched 23 percent which was the highest in Pakistan’s economic history and has since then revolved around 15 percent. The structural reforms consisted of fiscal consolidation by raising tax revenues, reducing expenditures, cutting down subsidies and containing the losses of public enterprises. Tax reforms were undertaken to widen tax base, remove direct contact between tax payers and tax collectors, introduce value-added tax as the major source of revenue, simplify tax administration and strengthen the capacity of the Central Board of Revenue. The adoption of universal self-assessment followed by random audit of selected tax returns, automation and reorganization of the tax machinery helped tax collection to double in five years.

Third, there are those who argue vociferously that Musharraf did not take advantage of debt relief and did not focus on any structural reforms, oversaw Pakistan spending beyond its means and the growth was fuelled by consumption .What does the evidence show? Investment/GDP ratio touched 23 percent which was the highest in Pakistan’s economic history and has since then revolved around 15 percent. The structural reforms consisted of fiscal consolidation by raising tax revenues, reducing expenditures, cutting down subsidies and containing the losses of public enterprises. Tax reforms were undertaken to widen tax base, remove direct contact between tax payers and tax collectors, introduce value-added tax as the major source of revenue, simplify tax administration and strengthen the capacity of the Central Board of Revenue. The adoption of universal self-assessment followed by random audit of selected tax returns, automation and reorganization of the tax machinery helped tax collection to double in five years.
To tackle external account weaknesses, trade policy reforms and liberalization helped the country in earning foreign exchange through non-debt creating flows. Exports of goods almost tripled from $7.8 billion to $21.2 billion and along with a six-fold increase in the workers’ remittances ($1billion to $6.5 billion), the foreign exchange earnings almost tripled from $16.8 billion to $46.0 billion. Tariffs on imports were rationalized and brought down to average 7.6 percent. FDI inflows touched $5 billion in each of the last two years and foreign exchange reserves rose from 991 million dollars to US $14 billion covering six months’ imports.
An aggressive privatization plan of state-owned enterprises in oil and gas, banking, telecommunications and energy yielded $3 billion. The privatization of Habib Bank, United Bank, and Allied Bank - three large nationalized commercial banks of the country - transformed the banking sector into an efficient, privately owned and managed sector. Private sector credit grew at an average rate of 25% annually. At the same the Central Bank was granted autonomy and its capacity strengthened. Banks became profitable, non-performing loans were reduced substantially and interest rates fell significantly. Capital market capitalization rose eight times and 60 new IPOs were listed and 48 corporate debt bonds issued.

Oil and gas, telecommunication, media and civil aviation sectors were deregulated. New gas fields operated by private sector companies added new capacity to meet the growing energy needs of the country. Power generation exceeded the demand and relied predominantly on domestic fuel, i.e. the natural gas, thus saving foreign exchange. Telecommunication witnessed a boom since the private sector companies were allowed licenses to operate cellular phones. Telephone penetration rate reached 50 percent with about 70 million subscribers.

The cornerstone of the governance agenda was the devolution plan which transferred powers, responsibilities and financial resources from the federal and provincial governments to local governments headed by elected representatives. A new Police Order replacing the 19th century law was passed to modernize the force. The National Accountability Bureau (NAB) was established under a new legal framework as the main anti-corruption agency.

Fourth, some economists are of the view that the loose monetary policy stance of the State Bank of Pakistan (SBP) resulted in overheating of the economy and led to inflationary pressures. It is true that the monetary policy in initial years was managed to kick-start the economy when it was trapped in low growth-low inflation equilibrium. Until FY 2005 inflation remained subdued (the average rate for first five years was slightly below 4 percent) but subsequently the inflation target slipped due to the uptrend in the global commodity prices as well as inefficiencies of wholesale and retail markets. As soon as there were signs of upsurge in inflationary pressures, interest rates were raised and monetary policy tightened. Other macroeconomic indicators also did not provide any signs of overheating as fiscal deficit was contained between 3 to 4 percent and current account was in surplus for consecutive three years and in negligible deficit in the next two years. Domestic productive capacity in agriculture and manufacturing had been expanding and thus supply shocks were not imminent. Excess demand, therefore, did not spill over into higher imports, which were in any case financed mainly by non-debt creating flows. How can in the weight of this overwhelming evidence one read overheating of the economy?

Finally, it has been surmised by some economists that Exchange Rate was artificially fixed for over six years. The data on Real Effective Exchange rate for this entire period does not show any such indication as it hovered around 100 deviating from the mean by 5 percentage points. Exchange rate can be defended by the SBP only if it is burning its reserves. In this period the situation was quite the opposite. Foreign exchange reserves were accumulating at a rapid pace because of huge inflows of export earnings, remittances and FDI, official grants and relief on account of debt servicing rising from $0.9 billion to $14 billion. The SBP had the difficult task of avoiding appreciation of exchange rate and thus hurting exporters and had to sterilize these foreign inflows.

It is, however, true that the policies pursued in 2007/08 did leave the economy in a parlous state. The momentum of growth slowed down due to derailment from the past track. Fiscal and current account deficits did widen leading to excessive borrowing resulting in expansion in money supply, foreign capital inflows shrank, inflationary pressures intensified reaching double digits, exchange rate came under pressure as foreign reserves depleted. Both agriculture and large scale manufacturing performed poorly. International prices of food and fuel were not passed on to the consumers because of political considerations in an election year. This expediency cost the country another round of IMF programme which the new government had to enter in 2008. The lesson is that delayed and postponed decisions bring with them avoidable grief to the economy.