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FOREIGN AID AND PAKISTAN ECONOMY

PREPARED BY:

SADIQ ABBAS MALIK ALI HADI HASSAN MUKHI

FOREIGN AID AND PAKISTAN ECONOMY PREPARED BY: SADIQ ABBAS MALIK ALI HADI HASSAN MUKHI

The Role of Foreign Aid in the Pakistan Economy

INTRODUCTION

The misery of Under Developed Countries like Pakistan, which have the resources to become a prosperous country, however, have not fully achieved their potential, is mainly associated with the problem of poverty. Because of low incomes, the saving ratios also remain low, resulting in low investment levels. At the same time, due to low income the taxable capacity remains lower, i.e. government earnings also remain low. Due to low levels of investment along with the low income on the part of the government the country faces saving-investment deficit as well as the deficit in balance of payments.

The theory of Two Gap Model suggests that the economic development policy focuses on two constraints: the need for savings to finance investment, and the need for foreign exchange to finance imports. The Two-Gap Model suggests that developing countries have to rely on the Foreign Inflows to fill these two gaps. The Foreign Inflows are available in various manifestations to a country, which includes the grants, loans, foreign direct investment (FDI), export credit, project/non-project assistance, technical assistance and emergency relief etc.

Moreover, the nature of the FI available to a country also depends upon various factors however mainly on the size of the country its economic circumstances. African nations rely mainly on the foreign aid however countries in East Asia enjoy the benefit of foreign direct investments owing to their investor friendly policies and the availability of infrastructure in the form of land and human resource. In case of Pakistan the foreign aid is mainly in the form of foreign aid because it lacks physical, financial & human capital as well as political & macroeconomic stability, which are the main attraction for foreign direct investments.

The Role of Foreign Aid in the Pakistan Economy

PURPOSE OF THE STUDY

As mentioned in the captioned subject, our purpose of the study is to assess the role of foreign aid in the economy of Pakistan. In this regard we would explore

  • a) Sources of the Foreign Inflows available,

  • b) The Role of Donor Agencies ,

  • c) Assessing the impact of Foreign Aid,

  • d) Trends and Composition of Aid; and

  • e) Conclusion

The Role of Foreign Aid in the Pakistan Economy

SOURCES OF FOREIGN INFLOWS

There are many forms of the FCIs, which includes the grants, loans, foreign direct investment (FDI), export credit, project/non-project assistance, technical assistance and emergency relief etc. The objectives behind these inflows vary from political to humanitarian grounds however, following objectives could be broadly categorized:

  • a) As a signal of diplomatic approval, or to strengthen a military ally, to reward a government for behavior desired by the donor, to extend the donor's cultural influence, to provide infrastructure needed by the donor for resource extraction from the recipient country, or to gain other kinds of commercial access.

  • b) Humanitarianism and altruism are, nevertheless, significant motivations for the giving of aid.

  • c) Aid may be given by individuals, private organizations, or governments. Standards delimiting exactly the kinds of transfers that count as aid vary. For example, aid figures may or may not include transfers for military use: to cite one instance, the United States included military assistance in its aid figure until 1957 but no longer does.

We can categorize foreign inflows under following main categories, namely:

  • Grants

  • Foreign Direct Investments

  • Loans and credits

Foreign Grants:

Grants, otherwise known as international aid, overseas aid, or foreign aid, are a voluntary transfer of resources from one country to another. These grants could be in the form of project assistance, commodity assistance, technical assistance or other assistance such as relief aid and foreign aid.

The Role of Foreign Aid in the Pakistan Economy

Foreign Direct Investment:

Foreign direct investment (FDI) refers to long term participation by country into another country. It usually involves participation in management, joint-venture, transfer of technology and expertise. There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow (positive or negative).

Loans and Credits:

External loan (or foreign debt) is that part of the total debt in a country that is owed to creditors outside the country. We can categorize the sources of these loans as official creditors such as World Bank, Asian Development Bank and Industrial Development Bank and bilateral loans by governments and their agencies.

The Role of Foreign Aid in the Pakistan Economy

ROLES OF MALOR DONOR AGENCIES

There are three leading multilateral agencies viz. IMF, World Bank and the ADB that provide loans and credit on soft and hard terms. The core function of IMF is to provide support to countries facing acute imbalances between their external payments and receipts. The World Bank or the ADB, unlike the IMF, are development banks dedicated purely for poverty reduction and improving the living standards of people. Nevertheless, all the three institutions pursue a common objective of promoting economic growth and reduce unemployment.

For Pakistan all the three agencies have contributed significantly in providing assistance and almost 50 percent of our external debt is owed to these to these institutions.

International Monetary Fund (IMF):

The IMF was established in 1945 to promote international monetary co-operation, facilitate the expansion and balanced growth in international trade, promote exchange rate stability and orderly exchange arrangements among members, assist in the establishment of a multilateral system of payments in respect of current transactions, give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, etc. The Fund provides financial resources to its members to overcome temporary balance of payments difficulties through a variety of facilities and policies, which differ mainly in the type of BOP need they address and in the degree of conditionality attached to them.

IMF Loans to Pakistan

IMF loans have been an important source to manage the financial problems of Pakistan such as balance of payment deficits, stabilization of currency, rebuilding international reserves, managing liquidity problems along with enabling the respective countries to meet their short term needs by providing various types of loans which IMF calls as its lending „facility‟. In the last few months, there was a lot of speculation and discussion on the government decision to call for IMF loan to meet its liquidity and financial problems. In spite of effective policy actions taken by State Bank of Pakistan, issues such as sharp

The Role of Foreign Aid in the Pakistan Economy

depreciation of exchange rate, depletion of foreign exchange reserves of $5 billion till November 2008, inflation rate of more than 25%, and increase in import bill by 35.2% created immense challenges for the government and State Bank of Pakistan. Finally, the IMF loan of $7.6 billion was approved to help Pakistan come out of the liquidity and financial crisis albeit with certain IMF conditions. The IMF facility is still an important topic of discussion until the real gains from IMF loans are realized.

To determine the effects of IMF loans on Pakistani economy, it is important to analyze the history of IMF loans to Pakistan briefly. Since 1988 when Pakistan became member of IMF, almost eleven loan arrangements (including the recent IMF loan of $7.6 billion in 2008) have taken place under various IMF facilities/programs. Almost six loan arrangements were made during the regime of Benazir Bhutto including standby arrangement, Structural Adjustment Programs (SAP), Poverty reduction and Growth Facility (PRGF) and Extended SAP. Two IMF loan arrangements were made during Nawaz Sharif regime and two standby agreement and PRGF under Musharraf regime to stabilize the economy. It is important to note that in the tenure of last two decades, on average almost 44% of the total lending amount has been drawn from the original 100% agreed upon lending amount because of the failure of the government to act upon the strict measures determined by IMF. For the first time in the year 2000, this tradition was broken in Musharraf regime when Musharraf‟s government successfully implemented the conditions proposed by IMF and successfully drew the whole lending amount of $1.3 billion. It is also very interesting to note that only two loan arrangements were made during the military regime whereas nine IMF agreements (including the recent IMF loan) were made during the civilian regime.

The conditions posed by IMF mostly include the close monitoring, reduction of government spending, revision in tax collection policies, change in policy/discount rate etc. to make sure that funds granted to the borrower country are utilized in optimal manner. The IMF loans greatly impact the economic indicators and bring change in the regulatory framework which

has both positive and negative impacts on the country. Pakistan saw a decline in GDP growth rate and other economic indicators right after infusion of IMF funds in the economy

except in the second last lending arrangement in Musharraf‟s regime when full amount of

loan was drawn from IMF. The economic indicators after IMF loans in the last two decades

followed a typical cycle. Usually the trend after IMF loans show immediate decline in GDP growth rate, increased tax revenues to GDP ratio, increased CPI, increased debt on the

The Role of Foreign Aid in the Pakistan Economy

country and then restoration of the conditions back to their previous states because of the cancellation of loans in the later years. The cancellation of IMF loan agreements in the previous regimes along with the initial IMF loan effects created quite negative impacts on the economy as a whole which shows that there were very few times when IMF loans were fully optimized.

The current IMF loan is expected to have both positive and negative impacts. The immediate benefits include quick influx of liquidity, improvement in credit rating by reducing

the country‟s default risk, enhancement of foreign exchange reserves, stabilization of rupee (which faced 25% depreciation against U.S. dollar till November), increased investor‟s

confidence in both money and capital markets and increased financial assistance from the friends of Pakistan. However the negative impacts associated with the increase in policy rate include increased costs for the banks, increase in unemployment (because many banks and organizations will go for restructuring and downsizing to reduce their operating costs) and increase in poverty rate.

The Role of Foreign Aid in the Pakistan Economy

International Bank for Reconstruction & Development (IBRD):

The International Bank for Reconstruction and Development (IBRD), better known as the World Bank, was established in 1944 to help Europe recover from the devastation of World War II. The success of that enterprise led the Bank, within a few years, to turn its attention to the developing countries. By the 1950s, it became clear that the poorest developing countries needed softer terms than those that could be offered by the Bank, so they could afford to borrow the capital they needed to grow.

With the United States taking the initiative, a group of the Bank‟s member countries decided

to set up an agency that could lend to the poorest countries on the most favorable terms possible. They called the agency the "International Development Association." Its founders saw IDA as a way for the "haves" of the world to help the "have-nots." But they also wanted

IDA to be run with the discipline of a bank. For this reason, US President Dwight D. Eisenhower proposed, and other countries agreed, that IDA should be part of the World Bank

The World Bank’s Role in Pakistan:

The World Bank has played an important and essential role in the development process of Pakistan particularly in modifying the structure of the economy to restore growth through the structural adjustment-lending program introduced in 1980. The Bank Group‟s assistance strategy focuses intently on supporting the government‟s development strategy and is organized around three mutually reinforcing pillars which are:

Strengthening Macroeconomic Stability and Government Effectiveness, Strengthening and Enabling the Investment Climate and Supporting Pro-poor and Pro-gender Equity Policies. The Bank has contributed to alleviate poverty, mitigate the social effects of economic adjustment programs, and provides the poor greater access to health care, education and physical infrastructure, environmentally sustainable development and to improve conditions of women in Pakistan. The government of Pakistan has shown a strong commitment to reducing poverty and is receiving support from the World Bank through around US$ 1.2 billion in financing for 18

active projects and, over the past five years, an additional US$ 1.5 billion in adjustment lending to strengthen the government's broader reform programs.

The Role of Foreign Aid in the Pakistan Economy

The Country Assistance Strategy (CAS), endorsed by the Bank in 2002, was designed to

support Pakistan‟s reform program, which aimed at engendering growth, reforming

governance, creating income-generating opportunities, and improving human development. The World Bank is the main financer of Pakistan‟s Poverty Alleviation Fund, which provides assistance to poor communities throughout the country. The Fund has been working with nearly 40 local organizations and has extended micro-credit loans to more than 275 thousand borrowers, of which 45 percent are women. Recently, Pakistan has sought additional soft-term loan facility from the World Bank for its infrastructure development and poverty alleviation efforts through a long-term development partnership to transform the country and facilitate second generation reforms.

The Role of Foreign Aid in the Pakistan Economy

Asian Development Bank (ADB):

The ADB, functioning since December, 1966, has been engaged in promoting the economic and social progress of its developing member countries in the Asia-Pacific region. The Bank‟s principal functions are: (i) to make loans and equity investments for the economic and social advancement of developing member countries, (ii) provide technical assistance for the preparation and execution of development projects and advisory services, (iii) promote investment of public and private capital for development purposes, and (iv) respond to requests for assistance in coordinating development policies and plans of member countries. The Bank‟s operations cover the entire spectrum of economic development, with particular emphasis on agriculture, energy, capital market development, transport & communications and social infrastructure.

ADBs Role in Pakistan:

Pakistan has received more than $20 billion in loans since joining ADB in 1966, with more than $15 billion disbursed as of 31 December 2009. A total of 288 loans were provided through the highly concessional Asian Development Fund window and the Ordinary Capital Resources window, with $188 million provided in grants for more than 300 technical

assistance (TA) projects.

ADB continued with its large lending program to Pakistan in 2009 with $1.10 billion disbursement and $942.7 million in newly approved assistance. As of 31 December 2009, the portfolio contained 42 active loans amounting to $4.36 billion, 37 ongoing loans of $3.97 billion, and 3 grants totaling $180 million, with bulk of these supporting development initiatives in energy, social sectors, governance, and transport in the four provinces and at the national level.

ADB is working with the government and the private sector to improve the country‟s infrastructure, energy security, and basic public services. Aligned with national development objectives, ADB‟s partnership priorities aim to attract investment, create industries and jobs, and improve the quality of life of citizens.

The Role of Foreign Aid in the Pakistan Economy

A new Country Partnership Strategy (CPS) for Pakistan, approved by ADB‟s Board of Directors in March 2009, aims to support Pakistan‟s strategic objectives of prosperity and poverty reduction.

Impact of Assistance by ADB

ADB‟s support to Pakistan in recent years has helped the government implement its development programs, while contributing to macroeconomic stability and revived economic growth, as well as reduced poverty levels. This support was premised on the three cornerstones of ADB‟s strategy: sustainable economic growth, inclusive social delivery, and pro-poor governance policies. ADB support in various sectors is evident in the number of people whose lives have been improved. For instance, between 2004 and 2008, ADB-supported projects helped build or upgrade more than 80,000 classrooms and trained more than 145,000 teachers, benefiting nearly 4 million students in the country. ADB assistance resulted in an increase of 1,500 megawatts of power generation capacity and the installation or upgrading of 450 kilometers (km) of transmission lines, which brought electricity to about 1.6 million households. ADB assistance to strengthen the power transmission network is helping to improve the efficiency of the system and will lead to reduced line losses and improve availability of electricity.

The Role of Foreign Aid in the Pakistan Economy

U.S Assistance to Pakistan

1 The history of U.S. assistance to Pakistan follows a predictable script: aid is tied to security imperatives that come and go, while the country‟s political and economic well-being is effectively ignored. As an early ally in the cold war, Pakistan received nearly $2 billion from 1953 to 1961, a quarter of which was military assistance. The United States then suspended assistance during the Indo-Pakistan wars and following Pakistan‟s construction of a uranium enrichment facility in 1979. Pakistan remerged as an ally in the 1980s during the Soviet

Union‟s occupation of Afghanistan and was again the recipient of aid. But following the

withdrawal of Soviet troops in the late 1980s, assistance to Pakistan took another nosedive. Following 9/11, Pakistan became a U.S. ally once more, and unsurprisingly, almost all of the aid provided since has gone to military operations.

Unfortunately, all the aid after the post 9/11 was either in the form of military equipment or aid genuinely given for fighting against terrorism. This is evident form the below statistics

$7.89 billion: The amount of U.S. military assistance to Pakistan since 9/11, the majority of which has been from “coalition support funds” intended as reimbursement for Pakistani

assistance in the war on terror.

$3.1 billion: The amount allocated to economic and development assistance, including food aid, during the same period.

1 http://www.americanprogress.org/issues/2008/08/pakistan_aid_numbers.html

The Role of Foreign Aid in the Pakistan Economy

Below is the history of US Assistance to Pakistan over previous 5 years

(Thousands of US $)

Account

FY2005

FY2006

FY2007

FY2008

FY2009

CSH

21,000

22,757

22,385

29,816

27,855

DA

29,000

26,990

95,327

29,757

ESF

297,600

296,595

283,673

347,165

603,200

FMF

298,800

297,000

297,000

297,570

300,000

IMET

1,885

2,037

1,992

2,103

1,950

INCLE

32,150

34,970

24,000

21,822

32,000

NADR

7,951

8,585

9,977

9,725

11,250

Total

688,386

688,934

734,354

737,958

976,255

2 Child Survivor and Health (CSH) Development Assistance (DA) Economic Support Funds (ESF) Foreign Military Financing (FMF) International Military Education and Training (IMET) Counter-narcotics and law enforcement assistance (INCLE) Non-proliferation, Anti-terrorism, Demining and Related Programs (NADR)

2 CRS Report for Congress “U.S Foreign Aid to East and South Asia: Selected Recipients”

The Role of Foreign Aid in the Pakistan Economy

ASSESSING THE IMPACT OF FOREIGN AID

THE AID AND GROWTH OF GDP

Different types of studies were under taken in order to understand the impacts of foreign capital inflows (FCIs) on the economic development and the different methods and variables were used to analyze the role of foreign aid in economic development. None of the studies has shown with certainty that whether FCIs are favorable or unfavorable for an economy. However, results of FCIs in the perspective of the Pakistan Economy can be deduced by looking at the Table 1.1 (Trend of ODA) and Table 1.2 (Trend of GDP).

The result depicts the positive effect of aid on the GDP in Pakistan from the year 2000-2009. It is seen that the GDP increases as the ODA increases but at the decreasing rate.

AID AND DEBT BURDEN

The burden of excessive dependence on the foreign aid has been caused by the: firstly, the shift in the composition of foreign aid from grants to hard loans has, over the time, taken up a relatively large share of the gross aid for debt servicing thereby reducing the amount of net aid available for financing the imports and investments. Secondly, the terms and conditions

attached to the credits have imposed both economic as well as political costs on the country. 3

The increased debt burden in Pakistan can be depicted by the Table 1.3 (External Debt) and Table 1.4 (Trend of Debt). It shows that the amount of external debt rises over the period of the 1970-2002 in Pakistan. It is clear that the overall debt burden also rises as the flow of foreign capital also increased over the same period.

3 Khan, Omar Asghar (1993). “The Impact of Foreign Aid on Economic Development”. in Viqar Ahmad and Rashid Amjad. The Management of Pakistan’s Economy (1947-82)”. Karachi: Oxford University Press.

The Role of Foreign Aid in the Pakistan Economy

CONCLUSION

The current study shows positive effects of foreign aid on the economic development. Foreign aid, on positive side, has helped in boosting the GDP Growth through structural transformation of the economy, laid foundations of the industrial and agricultural sectors, provided technical assistance, policy advice and modern technology, assisted in overcoming the budget deficits and the BOP deficits and has also funded the projects for the social sector development projects. GDP increases at the decreasing rate, as the flow of foreign capital increases. Thus, the overall impact of the aid on the economic development is positive.

The Role of Foreign Aid in the Pakistan Economy

TRENDS AND COMPOSITION OF AID

Table 1.1 OFFICIAL DEVELOPMENT ASSISTANCE 4 Trend of ODA from 1960 to 2008

The Role of Foreign Aid in the Pakistan Economy TRENDS AND COMPOSITION OF AID Table 1.1

Table 1.2 GROSS DOMESTIC PRODUCT

The Role of Foreign Aid in the Pakistan Economy TRENDS AND COMPOSITION OF AID Table 1.1

4 http://www.google.com/publicdata?ds=wb- wdi&met=dt_oda_alld_cd&idim=country:PAK&dl=en&hl=en&q=trend+of+oda+in+pakistan

The Role of Foreign Aid in the Pakistan Economy

Table 1.3 EXTERNAL DEBT

Profile of Total Debt and Liabilities

billion Rupees

 

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

Total debt & liabilities (TDL)

3856.1

3863.8

3998.4

4263.7

4549.2

5036.5

6418.1

8151.4

Growth rate

-4.2

0.2

3.5

6.6

6.7

10.7

27.4

27

                 

Total debt (TD)

3723.5

3781.4

3917

4181.6

4468.6

4956.9

6302.3

7982.6

Growth rate

-1.8

1.6

3.6

6.8

6.9

10.9

27.1

26.7

                 

Domestic debt

1717.9

1853.7

1979.5

2149.9

2321.7

2600.6

3266.1

3852.6

Growth rate

-0.8

7.9

6.8

8.6

8

12

25.6

18

                 

Share in TD

46.1

49

50.5

51.4

52

52.5

51.8

48.3

External debt

2005.6

1927.7

1937.5

2031.7

2146.9

2356.3

3036.2

4131.3

                 

Growth rate

-2.7

-3.9

0.5

4.9

5.7

9.8

28.9

36.1

Share in TD

53.9

51

49.5

48.6

48

47.5

48.2

51.8

                 

Explicit liabilities *

132.6

82.4

81.4

82.1

80.6

79.6

115.8

168.8

Growth rate

-43.2

-37.8

-1.3

0.9

-1.8

-1.3

45.5

45.8

                 

Total debt servicing

592.4

440.4

492.1

358.9

424.7

538.5

679.9

938.2

Total interest payment

276.8

243.2

241.8

236.3

293.9

425.5

548.4

662.1

                 

Domestic

212.5

189

185.3

181.9

237.1

358.6

473

570.2

Foreign

51.3

48.1

51.2

49.1

50.5

61.1

70.7

87.4

                 

Explicit liabilities

12.9

6.1

5.3

5.2

6.4

5.8

4.7

4.5

Repayment of principal (foreign)

315.7

197.2

250.3

122.6

130.7

112.9

131.5

276.2

                 

Debt as percent of GDP

-6.4

-6.1

-8.1

-5.1

-5.7

-1.8

3.3

0.8

Total debt

83.6

77.6

 
  • 69.4 58.6

64.3

 

57.2

61.3

61

                 

Domestic debt

38.6

38

 
  • 35.1 30.5

33.1

 

30

31.8

29.4

External debt

45

39.5

 
  • 34.3 28.2

31.3

 

27.2

29.5

31.5

                 

Explicit liabilities

3

1.7

1.4

1.3

1.1

0.9

1.1

1.3

Note: Rupee value of external debt for each year computed by applying the corresponding average annual exchange to the end-June stock.

Sources: i) SBP, ii) DM section, Finance division

The Role of Foreign Aid in the Pakistan Economy

Table 1.4 (TREND OF DEBT)

The Role of Foreign Aid in the Pakistan Economy Table 1.4 (TREND OF DEBT) EMBA-BFS-2 BATCH