Pakistan’s economy, the hidden threat

October 18, 2012

 

Not too long ago, if you were travelling from India to Pakistan, you couldn’t help but notice how well the modern airports, the six-lane motorway linking Islamabad to Lahore, and the well-planned tree-lined capital city compared to the sprawling chaos of New Delhi.  Indeed that motorway was South Asia’s first, long before India started to build its expressways, and in some ways Pakistan, which was a more open economy than India’s Licence Raj system and grew faster for decades until the 1990s, looked more like the developed Islamic states on its west than the poor cousins of South Asia.

But the tables have turned and the one-time economic star of the region is slipping behind its neighbours as it struggles with militant Islam, a near breakdown in ties with its greatest benefactor, the United States, and a civilian leadership that is struggling to hold its own under the boot of the powerful military while an assertive judiciary snaps at its heels.

For one of the longest stretches of time, Pakistan has been stuck in a low-income low-growth trap that is slowly strangling the economy of the world’s sixth most populous nation. Hobbled by a worsening energy shortage, a weak tax structure and falling investment, a failing economy itself has become another threat to the stability of the nation.

Nowadays a nuclear-armed nation of 180 million people is surrounded by hostile powers, desperately short of electricity with factories shutting down or moving to countries such as Bangladesh, while households struggle with one of the highest inflation rates in Asia.  An  estimated 80 million of that population are adults below the age of 20 which can either be a great resource and a consumer market or just as easily turn into a mighty pool of frustrated and alienated young people.

The International Monetary Fund said earlier this month that Pakistan faced a “challenging economic outlook” with growth expected to be in the 3 to 3.5 percent range in 2012/2013 which is the average expansion over the past five years.

Inflation has fallen recently but is expected to be back in double digits by the middle of next year unless Pakistan stops financing a widening fiscal deficit by printing more money, the IMF said.  Financial flows have weakened, and central bank reserves have fallen.

While growth is slowing across Asia including in India where the IMF for the first time lowered its forecast to just below 5 percent for 2012/13, Pakistan may well end up being the slowest growing emerging market.  It’s not just India’s giant economy that looms large over Pakistan, feeding an even greater sense of insecurity in the military establishment and the militant groups it has supported in the past, but even the smaller states in the subcontinent are pulling away.  Bangladesh is expected to grow 6.4 percent in the current year while Sri Lanka may come in at an even stronger 6.75 percent.

While the economies of India, Bangladesh and Sri Lanka are getting more inter-locked with the rest of the world and with each other, Pakistan’s share of trade is falling, according to a study published in The Express Tribune. In 1990 Pakistan’s volume of trade was 39 percent of its gross domestic product against India’s 15 percent and Bangladesh’s 20 percent. But by 2010 the tables had turned. India’s trade reached 50 percent of its GDP with the boom in services and its imports to feed an economy on the move, while Bangladesh moved up to 43 percent. Pakistan by contrast dropped to 32 percent as its exporters struggled to hold onto customers who worried about the country on the frontlines of the war against Islamist militants, and as the cost of business rose with 12-hour power cuts.  Its reliance on textiles – which account for nearly half of its exports – left it even more vulnerable to external shocks.

As one academic put it, you were likely to see more buyers in the lobby of a Dhaka hotel on any given day than in a Pakistani hotel for the whole year. It has gotten worse in recent years.  In the year ending June 2009, foreign direct investment and foreign portfolio investment was $2.64 billion, the following year it dropped to $2.08 billion and by this year it had slumped to $650 million.

Militant violence, chronic political instability, and the  poor state of government finances with the fiscal deficit running at over 5 percent of the GDP  have turned off investors. And because the deficit is so high and tax revenues so low, the government has ended up cutting back on funding in infrastructure and health in order to pay off its interest payments and subsidies. So while it is  buying time in the short-term, it is  effectively condemning the economy to years of low growth since sustained expansion requires  high infrastructure spending.

The crisis over energy, which has become such a pressing need that Pakistan is knocking on every door including India’s, is the result of decades of neglect.  The Asian Development Bank estimated  earlier this year that power and gas shortages were crimping GDP growth by between 3 and 4 percentage points each year.  The low long-term growth in turn depresses government revenues and creates budget deficits which again lead to less spending to resolve the country’s energy problems.

One glimmer of hope is the giant leap the country has quietly taken to normalise trade ties with India. Overland trade through the divided region of Punjab is set to expand significantly as Islamabad moves to prune a negative list of items for trade and implement Most Favoured Nations status to India despite opposition from  religious parties and militant groups. Until the Partition of 1947 the Punjab was a single economic space and as foreign affairs analyst C. Raja Mohan writes here, linked the subcontinent to broadly what is today’s Central Asia. The chief ministers of the two provinces are driving the change and if it takes off, we are likely to see a similar opening of old trade routes further down the border between the provinces of Sindh on the Pakistan side and Gujarat on the Indian side.

Trade is at the moment a paltry $2.7 billion, not counting the shipments routed through Dubai, but the two governments are targeting to raise the volume to $6 billion within the year. Businessmen think it can hit $10 billion if the restrictions were lifted.

 

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