PERSPECTIVES

Growth and Crisis in Pakistans Economy

Sushil Khanna

This essay looks at the political economy of Pakistan during the last two decades. Why has Pakistan faced recurrent balance of payments difficulties? Are the structure of production and exports the culprits? The essay first seeks to throw light on the current crisis facing Pakistan, and then goes on to examine the crisis of 1998 and the stabilisation strategy pursued. This is followed by a look at the long-term evolution of Pakistans economic policies from the days of Z A Bhutto, touching upon the structural weaknesses that have plagued the economy.

I am grateful to the Centre for Development Studies, Thiruvananthapuram for providing me with an opportunity to spend a few months at their campus, where the first draft of this paper was completed. Thanks are also due to Mritiunjoy Mohanty, Nirmal Chandra and an anonymous referee for their comments and suggestions. However, I am solely responsible for all errors and omissions. Sushil Khanna (sushil@iimcal.ac.in) is with the Indian Institute of Management, Kolkata.
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akistan has been in the grip of a serious economic crisis for the last one year. High inflation, deteriorating balance of payments, fast depleting foreign exchange reserves and declining value of the currency have been its hallmark. The new government led by Prime Minister Yousuf Raza Gilani and President Asif Ali Zardari had to grapple with this even before they had settled on their chairs. And, as the latest Economic Review published in June this year shows, despite the large-scale aid from the International Monetary Fund (IMF) and the World Bank, and bilateral aid from allies, the crisis is far from over. Though much has been written in the Indian press and journals on the political and social tensions in Pakistan, the serious economic situation in the country has been almost entirely ignored. Similarly, though the close political relationship between the western countries (especially the United States) and the Pakistani elites and establishment (to borrow a popular phrase in Pakistan to describe the military, intelligence and its allied politicians and businessmen) is often analysed by the so-called strategy and policy experts, the way economic policy in Pakistan is shaped is obscure to most observers. After the demise of Zia-ul-Haq in 1988 and the beginning of an era of alternating civilian and military governments, the Pakistani elite and state have found it difficult to forge a cohesive and stable economic regime. The country has lurched from one economic crisis to another. Pakistan has the dubious distinction of having approached the IMF more than 11 times (15 times if the multiple arrangements sanctioned simultaneously are counted). If the World Banks numerous crisis-related bailouts are added, then Pakistan received assistance from the Bretton Woods twins in 24 different arrangements in the two decades since Zias death in 1988 (Easterly 2001). Some
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of these arrangements were negotiated and launched even before the earlier programmes had been completed (Table 1, p 40). Pakistans development during the last two decades is in stark contrast to other Asian economies. With low growth in income and exports, Pakistans efforts at liberalisation and deregulation have accentuated the crisis. Poverty has shown a significant increase (in the headcount ratio as well as the poverty gap). Pakistan stands out as an economy that has failed to ride the wave of globalisation sweeping the region. Till September 2001, the US had been a marginal player in economic policymaking in Pakistan (except as an enthusiastic proponent of large-scale denationalisation and privatisation carried out by the military and the civilian regimes). Since then, American aid for the economic and social sectors, as well as military aid and payments for mercenary services provided by the Pakistani army, have become significant. Pakistan has sought and obtained special concessions, like preferential access for its exports, though the impact has been marginal, given the phasing out of the multi-fibre agreement (MFA). The IMF has been the most important player in shaping economic policy in Pakistan since 1988. Almost every major domestic policy shift like the denationalisation of banks and manufacturing units, tax reforms, policies governing foreign currency deposits or even commercial disputes between foreign firms and public utilities has borne the stamp of the IMF. Pakistan thus provides another example of the limitations and negative consequences of the IMFs policy prescriptions, where repeated adjustments and praise from the IMF are soon followed by another crisis and bailout. The last serious crisis that besieged Pakistan was after Nawaz Sharifs decision to explode a nuclear device in 1998. However, it was only one in a series that hit Pakistan in the decade preceding the explosion. As Japan and western donors imposed economic sanctions, the country faced another serious balance of payments crisis. His economic teams botched attempt to check capital flight (after the sanctions) worsened the situation, with the drying up of foreign currency account (FCA) deposits

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Table 1: Pakistan History of Arrangements with the IMF since 1988
IMF Programme To Run For (Coverage) Total Amount $ Million Sanctioned Drawn Completed/Delayed/Suspended

1 2 3 4 5 6 7

Structural Adjustment Facility (SAF) Stand-by Arrangement (SBA) Contingency and Compensatory Financing Facility (CCFF) Emergency Assistance Stand-by Arrangement Enhanced Structural Adjustment Facility (ESAF) Extended Fund Facility (EFF)

1988-91 (3-years) 1988-91 (3-years) 1991-92 (one time) 1992-93 (one time) 1993-94 (1-1 years) 1993-96 (3-years) 1993-96 (3-years) 1995-97 (1-1 years) 1997-2000 (3-years) 1997-2000 (3-years) 1998-2001 (3-years) 1998-2001 (3-years) January 1999 (one time) December 2001 November 2008

516 259 171.6 262 377 849 531 600 216 935 623 637 557 495 1,300 7,500

516 259 171.6 262 125.5 290 177 277 150 310 77 53 77.6 495 na 3,950

Completed after delay of one year. Completed after delay of one year. One time facility in one tranche. One time drawn in one tranche. Suspended in 1993. Suspended after about a year plus. Suspended after about a year plus. 1 Programme suspended in March 1996. 2 Programme reactivated in December 1996. 3 Again suspended in 1997 Suspended in October 1997. Suspended in October 1997. Suspended after nuclear test in May 1998 and reactivated in January 1999. Again suspended in September 1999. Suspended after nuclear test in May 1998 and reactivated in January 1999. Again suspended in September 1999. Completed in one tranche drawl. Withdrawn in 2004 at Pak request First instalment of $3.1 bn released in 8 November, and second of $890 million in April 2009

8 Stand-by Arrangement 9 Enhanced Structural Adjustment Facility 10 Extended Fund Facility 11 Enhanced Structural Adjustment Facility (Reactivation of 1997 programme) 12 Extended Fund Facility (Reactivation of 1997 programme) 13 Contingency and Compensatory Financing Facility 14 Poverty Reduction and Growth Facility (PRGF) 15 Stand-by-Arrangement

Source: State Bank of Pakistan (2000): Chapter VIII-External Sector, Annual Report 1999-2000, Karachi, and IMF website for later arrangements.

from non-resident and resident Pakistanis. It was this crisis General Pervez Musharraf pointed to before the Supreme Court to justify his coup. After the coup, a team led by Shaukat Aziz, his finance minister (later prime minister) made efforts to stabilise the macroeconomic situation by deflating the economy, which brought down the annual growth rate in 1999 to a new low of 2%. But, after 2001, the situation improved. Transfer payments went up four times, and exports began to rise after a decade of stagnation. For two-three years Pakistan enjoyed a current account surplus. Aziz was hailed as the economic wizard who had converted an adverse situation into an advantage. Yet, the era of stability and balanced growth was painfully short. By 2005, the situation had begun to deteriorate, and substantially worsened by 2006. Once again the old manifestations of a looming crisis were on the horizon rising inflation, widening trade and current account deficits along with rising confrontation between Musharraf and the political parties. It is true that some of the problems were the result of a poor agricultural harvest and rising global prices of foodgrains, petroleum and other commodities, and Pakistan was not the only country facing this situation. Yet, the government seemed to lack a clear strategy to tackle it. With political legitimacy of the regime fast eroding, Shaukat Aziz was forced to step down from the position

of prime minister in November 2007 and the lame duck administration that followed was unable to face the economic challenges. This points to the fact that the so-called turnaround under Aziz had failed to address the long-term structural weaknesses and issues. It also exposed the boast that Musharraf and Shaukat Aziz made of having rescued Pakistans economy from endemic crisis was premature. If we keep in mind the fact that the current crisis in Pakistan pre-dates the global financial crisis, we can see that the stability provided to Pakistan by the Musharraf regime was ephemeral and that structural weaknesses had made growth and recovery unsustainable. This essay looks at the political economy of Pakistan during the last two decades. Why has Pakistan faced recurrent balance of payments difficulties? Is the structure of production and exports the culprit? What has been the nature of growth in the periods of interlude that failed to address these structural weaknesses? The first section looks at the current crisis facing Pakistan, while the next looks at the crisis of 1998 and stabilisation strategy pursued by Aziz and his team. The last section looks at the long-term evolution of Pakistans economic policies from the days of Z A Bhutto, touching upon the structural weaknesses that have plagued the economy. It is our hypothesis that the crisis faced by Pakistans economy in the 1990s has its

roots in the nature of dependent development that has long characterised Pakistans economic strategy. The structural weaknesses are linked to the structure of production, the level of human development and nature of Pakistans economic integration with the global economy. The close links forged with the western powers, especially the US, and the rewards of this special relationship undermined the potential for a self-reliant and sustainable growth strategy.

Current Crisis
The current economic crisis has little to do with the global financial crisis and meltdown; indeed, it preceded the more severe manifestation of global crisis in SeptemberOctober 2008. Pakistans economic situation was deteriorating even before Shaukat Aziz was forced to step down as prime minister due to the imposition of the emergency and dismissal of the judges in November 2007. Yet, global conditions have made the task of alleviating the crisis that much more difficult. According to one version (of the crisis), after the resignation of Prime Minister Aziz, the subsequent interim administration abandoned any effort to manage the looming economic crisis triggered by the unprecedented increase in oil prices and widening trade deficit, along with a widening current account deficit. The trade deficit widened to $15 billion in 2007-08,
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(up from $10 billion a year ago) and the current account deficit doubled to $14 billion (Table 3). Similarly, the interim administration failed to exercise fiscal restraint and the budget deficit that had been brought down to about 1.5% of GDP, widened to 4.5% of GDP. The value of the Pakistani rupee began to plunge and the foreign exchange reserves erosion accelerated. By June 2008, the foreign exchange reserves had declined to $8.5 billion (down from $13.5 billion a year ago). Simultaneously, with rising cost of imported commodities, inflation (as measured by the Consumer Price Index) touched a new high of 22% in 2008-09.

instability hit Pakistan. Shaukat Aziz and his team were ensconced in office when the macro imbalances were deteriorating. So fast has been the deterioration that some observers even cast doubt on the numbers put out by the Musharraf team. There is little doubt that like many developing countries, rising food and commodity prices across the globe hit Pakistan during 2005-07. A poor agricultural crop and the need to import food exacerbated the inflationary situation, as global prices of food too reached new highs. Simultaneously, oil and gas prices were rising, though, like in India, all the increase in prices was not being passed on to the Table 2: Pakistan Balance of Payments under Civilian Governments (1994-99, $ million) consumers. Rising inflaItems 1994-95 1995-96 1996-97 1997-98 1998-99 tion was also adding to Exports (fob) 7,759 8,311 8,096 8,434 7,528 alienation of the popuImports (cif) -10,296 -12,015 -11,241 -10,301 -9,613 lace from the Musharraf 1 Trade Balance -2,537 -3,704 -3,145 -1,867 -2,085 2 Services (Net) -2,384 -3,249 -3,659 -3,264 -2,618 regime, while instability 3 Private Unrequited Transfers (net) 2,437 2,378 2,958 3,210 2,274 was undermining the (Workers Remittances) (1,866) (1,461) (1,409) (1,490) (1,060) confidence of foreign 4 Current Account -2,484 -4,575 -3,846 -1,921 -2,429 investors. Annual inSource: Pakistan, Economic Survey, various years. flows of foreign direct
Table 3: Pakistan Balance of Payments under the Musharraf Government (1999-2007, $ million)
Items 1999-2000 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

international club of friendly western countries. President Zardari flew to Tokyo to meet the club of bilateral donors (Friends of Pakistan)1 and pleaded for another $10 billion. He was promised bilateral aid to the tune of $5 billion from major donors, with more to follow if needed. The financial crisis and global slowdown has lowered exports during the last two years. But thanks to the decline in oil prices and buoyant remittances from workers abroad, the current account deficit is substantially lower in the first nine months (July 2009-March 2010) of the current year. Large disbursements by the IMF have restored the foreign exchange reserves. However, FDI is at a low level and the new government is yet to proceed with more selloffs of state assets. Commercial borrowings remain frozen and it will be sometime before the external balance is restored.

The Economy under Musharraf

As mentioned above, the balance of payments crisis that preceded the coup by general Musharraf against the government of Nawaz Sharif in 1999 was triggered by the decision to explode the nuclear device in 1998. The subsequent Kargil conflict and the tightened economic sanctions only worsened the situation. But even before Pakistan exploded the bomb in the summer of 1998, its trade and balance of payments were already in disarray. Exports were stagnant at around $8 billion during the second half of 1990s, and with the onset of the Asian crisis in 1997, marginally declined. Workers remittances too were stagnant at around $1 billion mark per annum (Table 3). The current account deficit had widened over the decade and was in the region of $3.8 billion by 1997, equivalent to 6% of GDP. Over the decade of the 1990s, the State Bank of Pakistan (the central bank), had managed this deficit by encouraging both resident and non-resident Pakistanis to deposit funds in FCA. This had become a major source of capital inflows in the overall balance of payments situation. Thus the current account deficit was met by rising FCA deposits at attractive rates, while the value of rupee was controlled to rule out any depreciation that may jeopardise the inflow of deposits (Mirakhor and Zaidi 2004).

Exports (fob) Imports (cif) 1 Trade Balance 2 Services (Net) (Workers Remittances) 4 Current Account

8,190 -1,412 -2,794

8,933 -1,269 -3,142 3,898 -513

9,140 10,889 -294 -2,617 4,249 1,338 -444 -2,128 5,737 3,165

12,396 14,401 16,388 -1,208 -3,594 6,116 1,314 -4,352 -5,841 8,440 -1,753 -8,259 -7,304 9,914 -5,649

17,119 -9,495 -7,968 10,102 -7,361

-9,602 -10,202

-9,434 -11,333 -13,604 -18,753 -24,647 -26,614

3 Private Unrequited Transfers (net) 3,063 -1,143

(983) (1,087) (2,389) (4,237) (3,871) (4,168) (4,600) (5,494)

Source: Pakistan, Economic Survey, various years.

According to another version, the Musharraf government came under pressure from lawyers and other civil society organisations from the beginning of 2007 and abandoned any attempt to manage the crisis. Afraid of raising prices of petroleum products, and abandoning tax reforms, the country was left with a widening budget deficit. Even the current account balance had begun to deteriorate in the last year of the Aziz regime. From a current account surplus of $1.8 billion in the year ending June 2004 (when Pakistan informed the IMF that it was discontinuing its assistance), the current account showed a deficit of $4.7 billion in 2005-06 and rose by 45% the very next year to touch $6.8 billion; again doubling in 2007-08. Similarly, the trade deficit had doubled during 2004-05 and 2005-06 (Table 3). Inflation has been rising since 2004-05 and touched 12% in 2007-08. All this was long before the political crisis and
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investment (FDI), which had been in the range of $2 to 5 billion per annum from 2000, plunged during the period. Fortunately there was little impact on workers remittances and other transfer payments, but they were not adequate to pay for the widening trade deficit (Table 3). The new civilian government headed by President Zardari and Prime Minister Gilani approached the IMF in October 2008 for assistance under the Stand-By Arrangement (SBA) to the tune of $15 billion. The IMF has already sanctioned the SBA with assistance of $7.1 billion and has promised to support the plan to restore macroeconomic balance with more tranches. Amounts equivalent to $3.1 billion were disbursed in the first few months, and have continued since early 2009. The World Bank also disbursed a $500 million interest free loan. Simultaneously, the Pakistan government has asked for additional support from the
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But once the western countries imposed sanctions on Pakistan after its nuclear explosion, and the IMF and bilateral donors cut off their assistance, the crises in the balance of payments suddenly acquired a more serious dimension. As the IMF withdrew disbursal of the already sanctioned Extended Fund Facility and Structural Adjustment Facility in 1998, the situation became worse, leading to capital flight and premature withdrawal of FCA deposits. The Pakistani rupee began to depreciate and curb rates of foreign currency surged. The civilian government under Nawaz Sharif faced difficult choices. As depositors withdrew funds and reserves were depleted, the government hit the panic button. The State Bank of Pakistan imposed restrictions on withdrawal and remittances from the FCA. This freezing of the FCA accounts was seen by investors as a serious breach of its solemn promise to allow free remittances. This single act of the central bank undermined its credibility and accentuated capital flight from Pakistan. The new Musharraf regime that seized power in October 1999 started on a shaky footing. Musharraf appointed Shaukat Aziz, a senior manager with Citibank, as his finance minister, with the explicit mandate to tackle the balance of payments crisis. He even cited this crisis and this appointment as a justification for the coup to the Supreme Court in the case challenging his seizure of power. Aziz became his most important minister, with clear freedom and mandate to tackle the financial situation, often bypassing the prime minister. Later, when the general ran out of puppet prime ministers, he promoted Aziz as his new prime minister in 2004. Aziz put together a team of international bankers and former or current employees of the World Bank and IMF as his economic team. It included Ishrat Husain, former director for central Asia at the World Bank, who was appointed the governor of State Bank of Pakistan. However, the external situation faced many challenges. International sanctions were in place, bilateral aid had been cut off and the IMF/World Bank disbursement of sanctioned facilities was tardy. Without the IMF assistance, the first two years of the Musharraf regime were difficult. However, Aziz put in place policies that would meet the IMFs approval, as he

pleaded for resumption of assistance. He imposed a severe squeeze on demand, raising interest rates and cutting back on public spending. The so-called development expenditure was pushed down to a new low of 2% of GDP. He also eased restrictions on FCA, though this did not immediately reverse the flight from foreign currency deposits. Thanks to the severe demand compression and accompanied deflation, and import compression, economic activity slowed down as the external situation stabilised. GDP growth declined to below 1.9% in 2000-01, with a decline in per capita income.

Dramatic Change
But after 11 September 2001 attack on the World Trade Centre, Pakistans fortunes changed dramatically. Thanks to the American war on Afghanistan, Pakistan once again became an important front line state for US. Aid was resumed and within months the IMF approved a new Poverty Reduction and Growth Facility (PRGF) of $1.3 billion. Simultaneously the other western donors rescheduled Pakistans burgeoning debt. Pakistan also demanded and received some increase in its textile export quota and soon exports began to increase. What is more fortuitous, American efforts to check financing to terrorists by actions to plug the illegal flow of cross-border funds (hawala) and closer supervision of banking transactions, led to Pakistani workers substantially enhancing their remittances through legal banking channels. Workers remittances doubled from about $1 billion in 1999-2000 to $2.3 billion the next year and again doubled to $4.2 billion in 2002-03 (Table 3). The year 2004 saw an end to successive years of draught and poor rains. With excellent monsoon precipitation, agricultural output surged by 7%. The growth of GDP gradually rose to 3 and 4% in the next two years, rising to 8.4% in 2004-05. Given the new geopolitical position and changing international situation, Pakistans economic challenge became manageable. Thanks to the earlier demand compression, average inflation during the five years (1999-2004) was only 4% (though it touched 9% in 2004-05). By 2004-05, industrial growth too rose. Manufacturing grew by over 15% per annum. The Aziz regime claimed to have carried out radical fiscal reforms, and through overhaul of the sales

tax system, enhanced tax collection, which rose by 14% per year. With a tight leash on spending, it lowered the fiscal deficit to a new low of 3.3% of GDP. Exports doubled in six years to touch $14.5 billion in 2004-05. The current account was in surplus during the three years 2001-02 to 2003-04 (Husain 2005). With increasing remittances through official channels, the national savings (domestic savings remained constant at 15-18% range) began to rise. National savings rose from 17.6% of GDP in 1998 to an all-time high of 28% in 2003. Simultaneously, due to large-scale privatisation and sale of public sector companies to foreigners, FDI inflows too surged. However, FDI was limited to the telecom and financial sector. Thanks to these trends, foreign exchange reserves rose, touching a high of $13 billion in 2004 and $17 billion in 2007. Shaukat Aziz and his team of economists claimed unparallel success in stabilising the economy and in restoring macroeconomic balances, pushing up investment and rebuilding foreign exchange reserves and returning to a high growth path (Husain 2005). In 2004, the Pakistan government informed the IMF that it did not need any further assistance and was not going to extend the so-called PRGF beyond December 2004. The architects of the turnaround, namely, Shaukat Aziz and Ishrat Husain were joined by the IMF in this bout of selfcongratulations and adulation. Musharraf rewarded Aziz by making him the prime minister in the summer of 2004. With macrostability and substantial foreign inflows, his economic managers began to expand demand and substantially increased development outlays, especially on education and irrigation. However, this stability was shortlived. As Pakistan abandoned the IMF programme in 2004, inflation began to increase. The next two years saw further increases in prices accompanied by decline in GDP growth that fell from a high of 9% in 200405 to 6-6.5%. But by 2007, the political situation began to change rapidly. As Musharraf faced an increasingly united opposition and challenge to his regime from the judiciary and other sections, these economic gains were further whittled way. As he became more determined to cling to power, his favourite prime minister and his team of technocrats departed. The international
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situation too was changing rapidly, with rising prices of food, oil and other commodities. The trade deficit began to grow and the balance of payments was in crisis. Domestic prices of food and other commodities rose, fuelling disenchantment with the military regime. When he departed in late 2008, Musharraf left the country in a bigger mess than the one he inherited in 1999.

Structural Crisis: A Long View

The Pakistani economy had experienced exceptionally high rates of growth in the 1960s and again in the 1980s, when India was stuck with its Hindu rate of growth. Under Ayub Khan, it was a successful exporting country, with exports in 1965 higher than the combined exports of South Korea, Turkey and Indonesia. However, the break-up of the country in 1972 was a traumatic experience for the economy and polity of the country. The secession of the eastern wing robbed the western wing of a large internal market. Since intra-wing exports were about 50% of western wings total exports and 20% of imports, there was an urgent need for Pakistan to find new markets for these products. The economy also faced large external shocks due to the fourfold increase in petroleum prices by the Organisation of Petroleum Exporting Countries. Pakistan succeeded in overcoming the twin shocks. Thanks to the commodity boom that followed the oil price increase, the country was able to increase its exports in a few years and reduce its external deficit. Zulfikar Ali Bhutto, who came to power after the end of the military regime responsible for the break-up of the country, represented the populist policies of an elected leader who aspired to develop a strong and resurgent Pakistan. His emphasis was on large-scale manufacturing and industrialisation in the public sector and later, a programme to develop the atomic bomb. This was to neutralise Indian hegemony on the subcontinent and avenge the defeat in the 1971 conflict where Bangladesh was carved out of Pakistan. Bhuttos emphasis on a strong public sector and socialism was to lead the political economy of Pakistan onto hitherto uncharted territory. He also tried to accelerate the pace of investment and modernisation and laid the foundation of heavy industry, like steel in public sector, along with nationalisation
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and greater control over the private sector. Public investment rose sharply from Rs 58 million in 1971 to Rs 1,085 million by 1977, while private investment declined from Rs 700 million in 1971 to Rs 183 million by 1975. Under the Bhutto regime, two-thirds of the industrial investment was now concentrated in the public sector, a significant proportion diverted to the capital goods sector. Thus, the setting up of the Pakistan Steel Mill Corporation and a nuclear reprocessing facility became symbols of the regimes strategy to diversify the industrial base. Though the export boom after the first oil shock of 1973 helped find an outlet for the intra-wing exports, it could not meet the import requirements of the economy. The modernisation drive and setting up of basic industries like steel further intensified the demand for imports. While exports doubled from $591 million in 1971 to $1,141 million in 1977, imports increased fourfold from $638 million in 1971 to an astounding $2,325 by 1977. This laid the foundation of a perennial balance of payments crisis that continues to this day. In contrast, Zia-ul-Haq, who replaced Bhutto after the coup dtat, relied on Islam and private enterprise to consolidate his power. This would take Pakistan along a path that would shape the politics and economics for more than a decade, and perhaps, lay the basis of a social and economic crisis that plagues the country even today. Both the legacies ignored the tensions in the social and economic spheres. As a result, they missed the opportunity to lay the basis of an independent, sustainable growth strategy that had the potential of modernising Pakistani society and economy. While the Bhutto era is associated with efforts to build a socialist Pakistan with a strong public sector and nationalisations of many private units, the rates of growth remained low. In contrast, the Zia regime was associated with denationalisation, rising remittances from workers, along with liberal American aid thanks to the war against the Soviet presence in Afghanistan. This resulted in very high annual growth rates (6-7% over 1979-88 period) and declining poverty. During the Zia era, the Pakistani economy benefited from a number of special factors, both domestic and external. While investment in large public sector projects did not lead to high growth in the Bhutto
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era, as they were yet under construction, Zia reaped the reward. It was under the Zia regime that the steel mills and several large public sector projects were completed and industrial output expanded. Similarly, completion of the long gestation period Indus Basin Tarbela Dam helped unleash unprecedented agricultural growth (Hasan 1998). Being favoured by the US had other advantages. Garment and textile exports boomed as the US enhanced the quota under MFA. Pakistan soon emerged as a major exporter of cotton yarn, with 1989-90 yarn exports exceeding the export of cloth by more than 50%. The share of cotton and cotton goods export in the total exports of Pakistan increased sharply from 40% in 1979-80 to 60% in 1989-90 (Table 7, p 45). Pakistans per capita income in the early 1990s was about 25% higher than India (close to $500 per head compared to Indias $390). The average Pakistani was better fed and clothed than the average Indian. While 52% of Indias population in 1992 had an income below $1 a day, only 11% of Pakistanis were below this poverty line. Pakistan has around two million migrant workers, roughly equal to the Indians working in west Asia, with large remittances that helped finance the trade deficit. What then is the cause of the recurrent crisis, which has forced Pakistan to crawl before the IMF, not once, but more than a dozen times during the last two decades?

Long-Term Structural Constraints

To make sense of these recurrent macroeconomic imbalances and the constraints they impose on economic policy in Pakistan, it is necessary for us to appreciate the structure and capability of the economy. Tables 4 to 6 (p 44) provide an overview of the structure of the economy and its relationship to the global economy, as compared with that of India and a few other south Asian countries. On first impression, the structure of the Pakistani economy looks disarmingly like the Indian economy. The structure of output is similar, with the industrial sector in both the countries being about 27% of GDP, and the service sector in both above 50%. In both countries, the agricultural sectors share in output has fallen to about 20-22%. Yet this similarity hides several fundamental differences in the underlying structure

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Table 4: Output Structure Selected SAARC Countries (% of GDP at current factor cost)
1990 2000 2007

Table 6: Balance of Payments Structure Selected SAARC Countries (% of GDP at current market prices)
1990 2000 2007

Pakistan Agriculture Industry Services India Agriculture Industry Services Sri Lanka Agriculture Industry Services Bangladesh Agriculture Industry Services

26.0 25.2 48.8 29.3 26.9 43.8 24.2 28.9 46.9 30.2 21.5 48.3

25.9 23.3 50.7 23.4 26.2 50.5 15.6 27.8 56.6 25.5 25.3 49.2

19.6 26.8 53.7 17.6 29.4 52.9 11.7 29.9 58.4 18.9 28.5 52.6

Pakistan Exports Imports Balance on goods Current account balance Overall balance India Exports Imports Balance on goods Current account balance Overall balance Sri Lanka Exports Imports Balance on goods Current account balance Overall balance Bangladesh Exports Imports Balance on goods Current account balance Overall balance

12.5 -18.8 -6.3 -3.4 1.0 5.7 -8.6 -2.9 -3.0 -0.8 25.0 -33.9 -8.9 -4.7 1.5 5.1 -11.6 -6.5 -1.5 ...

11.6 -13.6 -2.0 -0.3 -5.5 9.7 -12.4 -2.7 -0.6 1.3 33.0 -43.8 -10.8 -6.4 -3.1 12.5 -16.6 -4.1 -0.9 0.4

12.1 -18.8 -6.8 -4.8 2.6 14.0 -21.9 -7.9 -1.5 8.1 23.9 -34.9 -11.0 -4.2 1.6 17.8 -22.9 -5.1 1.4 2.2

Source: Asian Development Bank: Key Indicators, 2008.

Table 5: Savings and Investment Selected SAARC Countries (% of GDP at current market prices)
1990 2000 2007

Pakistan Gross domestic saving Gross national saving India Gross domestic saving Gross national saving Sri Lanka Gross domestic saving Gross national saving Bangladesh Gross domestic saving Gross national saving

13.5 24.7 22.8 22.2 12.0 14.3 12.9 17.1

16.0 14.7 20.1 24.0 17.2 23.0 23.7 34.8 25.5 37.1 24.3 38.4 15.2 16.9 19.1 22.7 25.4 27.2 17.9 20.5 23.1 29.1 23.0 24.3

Gross domestic capital formation 18.9

Source: Asian Development Bank: Key Indicators, 2008.

Gross domestic capital formation 26.0

Gross domestic capital formation 20.7

Gross domestic capital formation 17.1

Source: Asian Development Bank: Key Indicators, 2008.

and the relationship of the two economies to the world economy. While India has grown largely on domestic savings and investment, Pakistan has long financed its investment from foreign savings loans from non-residents and bilateral and multilateral aid. It is characterised by low domestic savings (about 15% of GDP) and rather low levels of investment, even compared to a poorer economy like Bangladesh. Its gross domestic capital formation (GDCF) has actually declined marginally from the mid-1980s level of 18%. There are also several other notable differences. The narrow export basket, a very small capital goods sector and absence of basic industries are also noteworthy. The episodes of recurrent balance of payments problems and IMF bailouts have to be analysed by looking at Pakistans engagement with the global economy.

Pakistans external sector also shows a divergence from other South Asian Association for Regional Cooperation countries. Its external sector has been characterised by large current account deficits, and an export sector that has not expanded relative to the economy. Pakistans merchandise exports as a percentage of GDP have been stagnant at around 12 for more than two decades. Indeed they have declined marginally from about 14% in 1988 (end of the Zia regime). On the other hand, all other south Asian economies have succeeded in substantially raising the ratio of exports to GDP (Table 6). It is most dramatic in the case of Bangladesh, where the share of exports since 1990 has risen by more than three times to touch the 18% mark. India too has increased its share from about 5.8% in 1990 to 14% in 2007 for merchandise exports. If services are added, the ratio would be close to 20%. In contrast, Pakistan has also failed to penetrate the growing trade in services, and has a persistent and large deficit in services trade. Given Pakistans small and declining share, the export sector has a marginal impact on GDP growth. Trade deficits have been large and till the hawala crackdown in 2002, the current account deficits too were large. The large

current account deficits have led to persistent dependence on foreign savings. The success of the Shaukat Aziz-Irshat Husain strategy to tackle the balance of payments crisis rested on attracting FDI to Pakistan. This was achieved through large-scale privatisation of state-owned enterprises like telecom, power, energy, banks, etc. This strategy has obvious limitations, as the stock of public enterprises is limited and soon gets exhausted. Felipe et al (2009) look at the constraints and their implications for the long-term growth of Pakistan. In the face of its inability to raise its savings ratio, balance of payments seems to be a binding constraint in Pakistans economy. This arises from the countrys inability to change the structure of its industrial output and its exports. Despite once being Asias most successful exporter, Pakistan has been left behind by most countries as the integration of the global economy and world trade has accelerated during the last two decades. As mentioned above, Pakistans exports as a share of GDP have been stagnant or declining during the last 20 years. The World Bank (2006) attributes poor performance to an anti-export bias due to high protection and declining competitiveness. A World Bank study using Integrated Value Chain Analyses for selected products finds that domestic cost are higher due to poor infrastructure and acute scarcity of skilled workers and engineers. But a more important reason seems to be the structure of exports. As Table 7 shows, the structure of Pakistans exports has not changed for more than two (or three) decades. Textiles constitute two-thirds of exports. If other traditional commodities like leather, sports goods, etc, are included, then 80% of Pakistans exports constitute low technology and low value added commodities. The phasing out of the MFA from 2005 has already begun to threaten Pakistans textile exports from competitors in China and India. The fact that this is so is shown by the structure of industrial production. Textiles still constitute about 34% of industrial value added (Pakistan 2001). The traditional industries, like food products (sugar, dairy, etc) and others like sports goods, nonmetallic products (cement), and handicrafts
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stabilise the macroeconomic imbalances. Repeated deflations Cotton 61 58.7 61 57.4 61.5 have the consequence of underLeather 9.1 8 6.3 5.8 4.5 mining investment. Hence it is Rice 5.6 5.6 6.3 6.5 6.6 not surprising that every time Synthetic textiles 5.7 7.1 5.3 2.1 3 Pakistan experiences an episode Sports goods 2.2 3.2 3.3 2.1 1.6 of increase in growth and investSub-total 83.6 82.6 82.2 73.9 77.2 Others 10.7 12.9 17.8 26.1 22.8 ments, it also runs up an unsusTotal 100 100 100 100 100 tainable current account deficit Total exports ($ million) 6,131 7,759 8,190 14,482 20,122 and therefore growth is quickly Source: Pakistan, Economic Surveys, various years. aborted by a policy of credit constitute another 24%. The weight of squeezes, increase in interest rates and reeven medium technology sectors like duction in import of capital goods due to chemicals, engineering and transport currency devaluations. equipment has remained relatively low, The austerity measures also result in with fertiliser and petroleum refining ac- sharp cuts in social sector spending and a counting for half the chemical production. decline in social indicators such as health Machinery constitutes only 5% of total and education and increase in poverty value added. rates. Though IMF often clothes its condiThe states ability to raise resources has tions as poverty reduction strategy, there been limited. The total tax revenue to GDP is little doubt that these policies are likely which was in the range of 12-13% in the to worsen the condition of the poor and 1990s has hovered around 10-11% of GDP. undermine growth and employment in What is even more striking, military ex- the name of macroeconomic stability. penditure has exceeded development exThe fact Pakistan has found it difficult penditure in most years. Debt repayment to raise its domestic savings and investand defence have absorbed 55-60% of the ments can be directly attributed to the total outlay (Table 8). long shadow of the IMF and its mandated policies. Thus the latest IMF supported Pakistan under the IMF programme which began in 2008 has Pakistan has been under the shadow of resulted in a sharp decline in capital IMF-mandated structural adjustment pro- formation. Gross fixed capital formation grammes from the early 1990s. It is well (GFCF) has declined by 0.6% for the econknown that these programmes result in omy as a whole in 2009-10 compared to deflation and a squeeze on demand to the earlier year while the GFCF in the private sector has declined by Table 8: Pakistans Fiscal Indicators Revenue Expenditure Overall 3.5% and by 5% in private manuYear Total Rev Tax Non-Tax Total Current Development Fiscal facturing and as much as 13% Deficit FY92 19.2 13.7 5.5 26.5 19 7.5 8.7 in large-scale manufacturing. FY93 18.1 13.4 4.7 26.2 20.5 5.7 8.1 Simultaneously, foreign investFY94 17.5 13.4 4.1 23.4 18.8 4.6 5.9 ment also declined by 32% FY95 17.3 13.8 3.5 22.9 18.5 4.4 5.6 (Pakistans Economic Survey 2010). FY96 17.9 14.4 3.5 24.4 20 4.4 6.5 Overall, fixed investment in the FY97 15.8 13.4 2.4 22.3 18.8 3.5 6.4 economy during 2009 contractFY98 16 13.2 2.8 23.7 19.8 3.9 7.7 ed by as much as 2.3% of GDP. FY99 15.9 13.3 2.7 22 18.6 3.3 5 An Asian Development Bank FY00 13.4 10.6 2.8 18.9 16.4 2.5 5.4 FY01 13.1 10.5 2.6 17.4 15.3 2.1 4.3 working paper on Pakistan FY02 14 10.7 3.3 18.5 15.7 2.8 4.3 (Felipe and Lim 2008) warns FY03 14.8 11.4 3.4 18.8 16.2 2.6 3.7 that raising interest rates to FY04 14.2 11 3.2 16.5 13.7 2.8 2.3 check inflation dampens investFY05 13.8 10.1 3.7 16.8 13.3 3.5 3.3 ment prospects while depreciatFY06 14.1 10.5 3.6 18.4 13.6 4.8 4.3 ing the currency may induce FY07 14.9 10.2 4.7 20.8 15.8 5 4.3 higher prices for imported esFY08 14.6 10.3 4 22.1 18 4.4 7.4 sential inputs with low price FY09P 14.6 11.3 3.8 18.6 15.8 2.8 4.3 (Figures prior to FY 2000 are not comparable with later years due to change in elasticity. The paper warns that definitions.) Source: Pakistan, Economic Surveys. depending excessively on higher
Table 7: Pakistan Structure of Exports (% of total )
Commodity 1990-91 1994-95 1999-2000 2004-05 2007-08 Economic & Political Weekly EPW

interest rates will make firms reluctant to use debt financing and lead to a sharp reduction in investment and long run growth. This is precisely what Pakistan has experienced repeatedly during the last two decades. A closer study of the IMFs so-called PRGF of 2001 (which was based on the Memorandum of Economic and Financial Policies from Central Bank Governor Husain and the then Finance Minister Aziz) is instructive of the kind of policies IMF has repeatedly imposed on Pakistan. It had several draconian conditions, 14 of which were cited by the authors as prior actions. These included devaluation of the Pakistani rupee by at least 12%, increase of 3% in interest rates, import tariff reduction and negotiations with the World Bank for further reforms in the structural areas. What is more amazing is the requirement that the commercial dispute between the public sector power companies (HUBCO and Karachi Petroleum Company) with a multinational power generation company to be settled to the satisfaction of all parties an unusual and unprecedented condition requiring Pakistan to settle a commercial dispute between a foreign investor and a public utility. The government also promised to accelerate privatisation of public utilities, which became an important driver of increased FDI flows. The most significant of these was the sale of Habib Bank and Pakistan Telecom to foreign investors. Even before the IMF conditions were in place, the Aziz government was already implementing a fiscal squeeze with a sharp decline in the average development expenditure. It squeezed the development expenditure and demand, lowering the economic growth to below population growth by 2001. Khan (2007), who has assessed the economic and development record of the Musharraf regime, argues that there was an increase of 2 percentage points in the open unemployment rate while real wages of skilled and unskilled workers declined by 4 to 9% despite the construction boom. Using data from World Development Indicators, he demonstrates that macroeconomic stability was achieved by sharply squeezing development expenditure. What is more significant, Khan claims that during

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Table 9: Comparative Economic Performance under Civilian and Military Governments
Pakistan

Civilian Governments Military Government 1988-89 to 1998-99 1999-2000 to 2005-06

Overall fiscal deficit as a % of GDP Military expenditure as a % of GDP Development expenditure as a % of GDP Tax revenue as a % of GDP Growth in money supply (M2) Public investment as a % of GDP Private investment as a % of GDP FDI as a % of GDP Domestic savings as a % of GDP Aid as a % of GNI Aid as a % of federal government expenditure

7 5.82 5.02 13.55 15.12 7.81 9.09 0.85 10.24 2.21 9.76
1991-99

Change in poverty gap at $1/day Change in poverty gap at $2/day Change in headcount poverty ratio at $1/day Change in headcount poverty ratio at $2/day
Source: Khan, Shahrukh Rafi (2007), Tables 1 and 4.

84.8 49.7 72.0 25.4

the military regime, there was a sharp rise in poverty (Table 9). Further, headcount poverty as well as the poverty gap rose during 1999-2006 (Government of Pakistan estimates however show a decline between 2001 and 2006). In other words, the so-called stability under the IMFsponsored programme imposed a high cost on the average Pakistani. Felipe and Lim (2008), while analysing the constraints on Pakistans development and inability to tackle its recurrent BOP crisis, point to the low level of human development, and absence of skilled technical manpower and engineers. This, they argue, is the real supply constraint and call for greater investment in human development and technical education. IMF-led stabilisation programmes that actually squeezed demand to control inflation may have harmed the economy even more. The two authors find a powerful link between expansionary policies and moderate inflation with strong economic growth. Under the IMFs hegemony Pakistan has repeatedly squeezed its public expenditures, especially development and social expenditures. Khan (2007) points to the low level of education and poor social indicators under IMF-supported military regimes that have constrained Pakistans ability to cope with its growth challenges.

In Conclusion
Military dictators like Zia and Musharraf have claimed that under their regimes, Pakistan restored macroeconomic stability

and growth. True, these were episodes of faster growth, but this was 3.94 largely at the expense 3.36 of social investment 2.94 and development prior10.73 ities. The poor were left 14.37 to what trickled down. 4.67 Recurrent IMF program11.4 mes that required fiscal 0.79 stabilisation led to a 6.53 squeeze on develop1.82 ment expenditure. 10.75 1999-2002 The bias against pub% change lic sector investment in 29.7 new and emerging areas 18.7 has prevented invest2.71 ment in the areas the 12.2 private sector has been unwilling to invest in. The total break with Bhuttos strategy of establishing modern heavy industry has undermined Pakistans ability to change the structure of production, from low value products towards high value technology-intensive production. The Zardari government thus faces immense challenges. Its main challenge is to stabilise the economy in the short run and invest in social and human development in the long run so that Pakistan is able to lay the foundation for long-term sustainable growth that is more inclusive. Failure to do so can only accentuate the social tensions. The first signs are not very hopeful. Under the IMF tutelage, the new government has once again adopted policies that mimic the Musharraf/Aziz era. The reasons for repeated crises, according to the report of a panel of economists appointed by the Planning Commission, include neglect of social indicators, a skewed distribution of assets, weak institutions of governance, inward looking economic policies and structures, poor levels and rates of savings and investment (largely owing to inequitable tax structures and the reluctance of the elite to contribute to the financing of economic growth on the basis of their capacity to bear such a burden) resulting in the heavy dependence on external assistance (Pakistan 2010). Pakistan today stands out as an outlier in south Asia. Despite a fairly open trade and foreign investment regime, it is the economy that has failed to gain from such liberalisation. Pakistans recurrent economic

crises, even as the rest of Asia was riding a wave of strong growth, have to be seen in the light of its weak and narrow structure of industrial production and low savings as well as exports. Pakistans economic constraints and problems seem to be even more intractable than the political, ethnic and regional tensions. Democracy and decentralisation should be partly able to address these tensions. The economy seems to be hobbled by constraints of technological backwardness, poor human resources and declining competitiveness even in traditional industries like cotton and leather. Any break will require long-term intervention and well-developed industrial policy. Given the enormous influence of the IMF and the World Bank, to whom such intervention is anathema, it is unlikely that Pakistan will soon embark on such a course.
Note
1 This is a group among the founding members were Britain, France, Germany, the United States, China, the United Arab Emirates, Canada, Turkey, Australia and Italy that was formed in September 2008 to extend support to the Government of Pakistan in its efforts to consolidate democracy and to support social and economic development in the country.

References
ADB (2001): Pakistan: Country Operational Strategy Study, Asian Development Bank, Manila, at http://www.adb.org. Easterly, William (2001): The Political Economy of Growth Without Development: A Case Study of Pakistan, Development Research Group, World Bank. Felipe, J and J Lim (2008): An Analysis of Pakistans Macroeconomic Situation and Prospects, ADB Working Paper No 136, Manila. Felipe, J, J S L McCombie and K Naqvi (2009): Is Pakistans Growth Rate Balance of Payment Constrained? ADB Working Paper No 160, Manila. Hasan, Parvez (1998): Pakistan Economy at Cross Roads: Past Policies and Present Imperatives (Karachi: Oxford University Press). Husain, Ishrat (2005): Economy of Pakistan, speech downloaded from http://sbp.org.pk/speech/ Economy_of_Pakistan_2005.pdf (2005): Speech at Indian Business School, Hyderabad, October. IMF (2008): Pakistan: Letter of Intent, Memorandum of Economic and Financial Policies and Technical MoU, November. Khan, S R, ed. (1999): Fifty-Years of Pakistans Economy (Karachi: Oxford University Press). Khan, Shahrukh Rafi (2007): Pakistans Economy since 1999: Has There Been Real Progress?, South Asia Economic Journal, Vol 8, No 2, pp 317-34. Lorie, Henri and Zafar Iqbal (2005): Pakistans Macroeconomic Adjustment and Resumption of Growth, 1999-2004, IMF Working paper WP/05/139. Pakistan, Economic Survey, various years. Pakistan (2010): Final Report of the Panel of Economists, Planning Commission. World Bank (2006): Pakistan: Growth and Export Competitiveness, Report No 35499-PK, Poverty Reduction and Economic Management Unit, South Asia Region, Washington DC.
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