Economic policy in the Musharraf era was a mixed bag of the good, the bad and the indifferent

Pakistan’s economy has witnessed many changes since October 1999, some for the better and others for the worse. The daunting challenge for the new government now is to build on the country’s economic strengths and arrest and reverse the decline in key areas of weakness

By Kaleem Omar

Let me first of all say that Prime Minister Shaukat Aziz, who was also Pakistan’s finance minister throughout the nearly nine-year period of President Pervez Musharraf’s rule, was not an “economic wizard.” Contrary to popular belief, Aziz was not an economist; he was a banker who rose through the ranks of the banking profession mainly on the basis of his public relations’ skills. How Musharraf came to choose him as finance minister back in October 1999 remains something of a mystery to this day.

Aziz was a consumer-finance man and showed himself in his true colours when he began to push for the deregulation of the banking sector, including sharply cutting loan interest rates, putting in place a regime that allowed banks to engage more liberally in giving consumer finance loans, and lifting restrictions on the number of branches that foreign banks could open in Pakistan.

As a result of these policies, the banking sector boomed and many foreign banks from the Middle East and other parts of the world came flocking to Pakistan. Banking profits soared, and banks were soon awash in liquidity, fueled partly by the diversion of home remittances by overseas Pakistanis from the informal havala system to regular banking channels.

Easy access to low-cost consumer finance led to a sharp rise in the sale of consumer goods such as cars, motor cycles, cell phones and home appliances. The sale of cell phones, in particular, registered a spectacular rise, with the total number of cell phones in the country soaring from less than 1 million a few years ago to 80 million today.

On the one hand, this rise in the number of cell phones vastly increased communications connectivity in Pakistan, allowing huge numbers of people across the country to talk to each other and conduct business transactions by phone. On the other hand, however, the absence of cell phone manufacturing plants in the country meant that all the phones had to be imported, adding to the country’s import bill and further widening the already growing trade gap.

The Musharraf-Aziz government, for its part, seemed to be oblivious to this negative aspect of the communications revolution, and often cited the huge increase in the number of cell phones as an example of the success of its economic policies.

Moreover, since the ever-increasing revenues earned by the cell phone companies (most of which were foreign-owned) were automatically included in the annual GDP figures (total value of goods and services) compiled by the Federal Bureau of Statistics, it allowed the government to claim that its economic policies had boosted the GDP growth rate to over six per cent – in marked contrast to the average growth rate of below four per cent that had been seen through most of the 1990s under the Nawaz Sharif and Benazir Bhutto governments.

What the Musharraf-Aziz government tended to gloss over, however, was that the bulk of the billions of rupees in revenue earned by the foreign-owned cell phone companies were being remitted abroad because the government had imposed no limit on such transfers. If one were to factor these transfers into the GDP equation, the economy’s growth rate, in real terms, would not have been as high as the government portrayed it to be.

Other types of statistical legerdemain were used by the government to support its argument that the country’s per capita income had risen dramatically in recent years, from about $ 450 in 1999 to about $ 1,000 in 2007. In making this case, the government chose to ignore the fact that a falling dollar required that the per capita income figure be proportionately scaled down to give a more realistic picture of the actual figure.

The government also tended to gloss over the fact that it had artificially propped up the value of the dollar against the rupee by directing the State Bank of Pakistan to regularly buy dollars from the open market. Under this arrangement, the State Bank was said to have bought several billion dollars from the open market over a four-year period. The government said it had propped up the rupee’s value to help exporters, arguing that a higher rupee-dollar exchange rate would have meant that exporters would have earned fewer dollars for their exports, thereby putting additional pressure on the country’s balance of payments.

While there was considerable merit in this argument, the downside of the State Bank’s interventionist operations in the currency market was that it made imports more expensive in rupee terms, fuelling inflation and driving up the prices of many types of goods, including capital goods. Higher-priced capital goods, in turn, increased the cost of expanding manufacturing plants or setting up new factories, resulting in a slowing down of the industrialisation process.

Like all bubbles, the low-interest-rate bubble, too, had to burst one day. Within a few years, loan interest rates again began to rise steeply, soaring from a low of about five per cent per annum in 2002-03 to over 15 per cent today for business loans and 22 per cent for consumer finance loans.

Among other things, this rise in interest rates led to a decline in loan-financed car and motor cycle sales, with the number of vehicles sold by local assembly plants falling by as much as 40 per cent in some cases in fiscal 2007-08.

According to a ten-year (1997-2007) review of human development in South Asia prepared by the Islamabad-based Mahbub-ul-Haq Development Centre and published by the Pakistan branch of the Oxford University Press in 2008, Pakistan’s high GDP growth over the last five years has reduced income poverty in a significant manner and raised average living standards, but the country continues to grapple with issues that are fundamental to improve its abysmal human development levels.

The Development Centre’s report says that after a period of low growth throughout the 1990s, the annual growth figure for Pakistan has been hovering around the 7 per cent level since 2003-04. According to the report, the current growth momentum of the country’s economy is largely the result of greater financial and trade integration and the good performances of the services and manufacturing sectors.

Although growth to GDP has received strong support from foreign direct investment, the overall savings and investment levels in Pakistan continue to be unsatisfactory. The share of agriculture in GDP has declined to about 27 per cent, implying that the country’s economy is undergoing significant structural changes.

Some of these changes are of a positive nature, but others have resulted in negative consequences. For one thing, despite the increasing urbanisation seen in recent years, over 60 per cent of the country’s population still lives in rural areas, where employment opportunities are limited, the infrastructure is in poor shape (or even virtually non-existent in some areas), and civic services (including utility services and healthcare) leave a great deal to be desired. The quality of education in government-run schools in the rural areas is very bad, and thousands of primary and secondary schools are in shambles, lacking even such basic facilities as drinking water and toilets. Many village schools don’t even have teachers, books and other teaching-materials – making a mockery of the very idea of education.

Higher education is a federal subject, and the Musharraf-Aziz government has to be given credit for setting up a Higher Education Commission and for significantly increasing the budget allocation for higher education, including a substantially expanded Ph.D. programme. Teachers’ salaries in universities have also been substantially increased, in order to attract good Pakistani teachers working abroad back to their own country’s educational institutions.

But school education is the responsibility of the provincial governments. Schoolteachers’ salaries in government-run schools are still very low, making it very difficult – if not impossible – for such schools to attract good teachers. A truck driver or a carpenter or even a cook earns more money than a provincial schoolteacher. This needs to change in a hurry, if we are to ever have any hope of improving the quality of education in government-run schools.

The Development Centre’s report notes that Pakistan’s economy has to address several serious challenges.

The headcount index of poverty, which had increased from 25.8 per cent in 1996-97 to 34.7 per cent in 34.5 per cent in 2000-01 saw a decline of more than ten percentage points over the following four years, according to government figures (though these figures are disputed by many independent analysts). However, the gap between rural and urban poverty incidence has not seen any reduction, with the headcount index for rural areas roughly twice that of urban Pakistan.

Secondly, rising inequalities – income and non-income – have led to a weaker link between economic growth and poverty reduction in the country. There has been a gradual erosion of the consumption share of the lowest 20 per cent of the population and the consequent widening of the rich-poor gap. This widening gap adds to social tensions in society, which, in turn, leads to all sorts of other problems, including a worsening law and order situation.

Thirdly, two-thirds of the rural households in Pakistan are landless and in almost similar proportion lack access to tap water. Even those rural households that do have access to tap water face the problem of often being supplied with water that is not fit to drink, and is dangerous to health. Many urban households too suffer from the same problem. Doctors say that almost 80 per cent of all children admitted to hospitals in this country are those suffering from water-borne diseases – the direct result of drinking contaminated water.

Back in 2004, the Musharraf-Aziz government launched a scheme to install more than 6,000 filtration plants across the country to provide safe drinking water for all by the end of the year 2007. But the scheme has been beset with a host of problems from the outset, including technical flaws as well as bureaucratic in-fighting between various federal ministries and between the federal government and the four provincial governments. In the last months of the Musharraf-Aziz government, work on the scheme appeared to have fizzled out altogether and no one seems to know exactly how many filtration plants have actually been installed and commissioned and what quality of water they are producing.

The same goes for the government’s scheme to provide electricity to every village in Pakistan by the end of 2007. Thousands of villages are still without electricity. All this suggests that the governmental hype surrounding the safe drinking water scheme and the electricity scheme was more of a political ploy aimed at garnering votes for the then-ruling PML(Q) party in the February 18, 2008 elections than a genuine commitment on the then-government’s part.

In short, the seemingly high GDP growth in Pakistan since 2003-04 has yet to be directed in an adequate manner towards the betterment of the deprived and marginalized.

Fourthly, as the Development Centre’s report notes, the agriculture sector still accounts for more than 43 per cent of total employment in the country, but labour absorption in the non-agriculture sector has been relatively sluggish. A low labour force participation rate, underemployment, a high incidence of child labour, falling real wages for unskilled labour, a growing proportion of unemployed and the flourishing informal economy (which is undocumented and outside the tax net) are critical issues plaguing the labour market in Pakistan.

In terms of human development, too, progress in Pakistan in recent years has been unsatisfactory. The average life expectancy has been stagnant between 1995 and 2005, though there has been a modest decline in infant mortality. The overall adult literacy rate is still very low at 50 per cent. It is even lower in backward areas such as vast chunks of Balochistan and the Federally Administered Tribal Areas (which are home to more than 5 million tribal people). It is lower still amongst rural women. In some rural areas the figure is an abysmally low 6 per cent.

Between 1990 and 2000, the literacy rate in Pakistan grew by an annual average rate of 0.6 per cent of the population. Although there has been some improvement since then, the annual increase in literacy is still less than 1.5 per cent of the population. At this rate, it will take Pakistan another 50 years or more to achieve full literacy.

This is a shameful state of affairs, and the new government needs to make boosting the literacy rate a matter of the highest priority.

Currently, Pakistan is spending a paltry 2.4 per cent of its GDP on education and health, a ratio that has gone down since 1995. Even an impoverished country like war-ravaged Somalia (which didn’t even have a government for much of the 1990s and the early years of the new millennium) spends a much bigger percentage of its GDP on education and health than Pakistan.

Looking at the overall state of Pakistan’s economy today (including its increasingly high inflation rate, its burgeoning trade deficit fueled by the high price of oil imports, its dwindling foreign exchange reserves which have fallen by over $ 6 billion since last September, its stagnant levels of exports, its low industrial productivity, its growing per-capita water shortages, and its chronic electricity shortages), one needs to remember that these and other economic problems are not all of the Musharraf-Aziz government’s making. Some of these problems have been with us since long before Musharraf took over, while others – such as the high price of imported oil – are problems over which the government had no control.

What the new PPP-led coalition government needs to do now, however, is to quickly get on with the task of formulating policies and putting in place effective implementation and monitoring mechanisms aimed at boosting GDP growth to get the economy out of the doldrums and back on track towards a better standard of living for Pakistan’s whole population, including, above all, the deprived and marginalised. As the poet Robert Frost once famously observed, “The only way to play tennis is to play it.”

COMPARATIVE PERFORMANCE OF KEY ECONOMIC INDICATORSCOMPARATIVE PERFORMANCE OF KEY ECONOMIC INDICATORS

          Unit     1998-99        1999-00        2000-01        2001-02        2002-03        2003-04        2004-05          2005-06        2006-07        2007-08

(I)  Real Sector

Real GDP Growth      %       4.2     3.9     1.8     3.1     4.7     7.5     9.0     6.6     7.0     5.5-6.0(P)

Agriculture     %       1.9     6.1     -2.2    0.1     4.3     2.3     6.5     1.6     5.0     --

Large Scale Manufacturing   %       3.6     1.5     11.0    3.5     7.2     18.1    19.9    10.7    8.8     4.8    

Investment    % of GDP      15.6    17.4    17.2    16.8    16.9    16.6    18.1    21.7    23.0    --

National Savings       % of GDP      11.7    15.8    16.5    18.6    20.8    17.9    17.5    17.7    18.1    --

Inflation        %       5.7     3.6     4.4     3.5     3.1     4.6     9.3     7.9     7.8     110-120(P)

   - Food Inflation     %       5.9     2.2     3.6     2.5     2.9     6.0     12.5    6.9     10.3    --

   - Non-Food Inflation         %       5.6     4.7     5.1     4.3     3.2     3.6     7.1     8.6     6.0     --

   - Core Inflation      %       6.2     4.4     4.2     3.6     2.6     3.7     7.6     7.1     5.5     --

(II)  Fiscal Sector

Revenue Collection (CBR)     Billion Rs        308.5  346.6  396.4  403.9  461.6  518.8  591     713     846     --

Fiscal Deficit   % of GDP      6.1     5.4     4.3     4.3     3.7     2.4     3.3     4.2     4.2     3.6

Public Debt     % of GDP      100.4  94.8    82.8    79.7    75.1    67.1    62.2    57.2    55.2    --

   - of which foreign currency

   Denominated        % of GDP      53.1    45.8    42.3    40.8    36.7    32.0    29.4    26.6    24.6    --

Debt Servicing          % of Total     64.0    63.8    57.0    51.1    35.7    31.1    30.4    27.5    25.4    --

          Revenue       

(III)  External Sector

Exports (f.o.b)         Billion $         7.5     8.2     8.9     9.1     10.9    12.4    14.5    16.5    17.1    16.3(P)         

Imports (f.o.b)         Billion $         9.6     9.6     10.2    9.4     11.3    13.7    19.0    25.0    27.0    38.0(P)

Trade Deficit  Billion $         -2.1    -1.4    -1.3    -0.3    -0.4    -1.3    -4.5    -8.4    -9.9    10.7

Remittances   Billion $         1.1     1.0     1.1     2.4     4.2     3.8     4.2     4.6     5.5     6.2-6.7(P)

Current Account Balance      % of GDP      -4.1    -1.6    -0.7    0.1     3.8     1.4     -1.6    -3.9    -4.9    7.0

          Billion $         -2.43   -1.14   -0.51   1.34    3.17    1.31    -1.77   -5.0    -7.0    --

Total Foreign Investment     Million $         403.3  543.4  182.0  474.7  820.1  921.7  1676.6 4485.5 8428.3 3.6

Foreign Direct Investment    Million $         376.0  470.0  322.4  484.7  798.0  949.4  1524   3521   5125   --

External Debt and Forex Liab         Billion $         37.6    37.9    37.1    36.5    35.5    35.3    35.8    37.3          40.2    --

External Debt and Liabilities  % of Forex    347.1  297.2  259.5  236.8  181.2  164.9  137.2  117.3  122.5  --

          Earnings

Foreign Exchange Reserves  Billion $         1.7     1.3     3.2     6.3     10.7    12.3    12.6    12.8    15.7    --

(IV)  Monetary & Capital Market

Weighted Avg. Lending Rate %       15.4    14.0    13.7    13.1    7.58    5.05    8.2     10.2    10.6    --

Credit to Private Sector       Billion Rs.       103.0  18.0    48.6    53.0    168.0  325.0  390.3  401.8  356.3  --

Stock Market (KSE Index)    1991=100      1055   1521   1366   1770   3403   5279   7450   9989   13772  --

Market Capitalization Billion Rs.       286     392     339     408     746     1357.5 2036.7 2766.4 3980.8 --

Market Capitalization Billion $         5.7     6.7     5.8     6.8     12.8    23.4    34.3    45.7    65.3    --

(P)  : SBP Projection

Source: Ministry of Finance