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Economic & Political Weekly EPW december 18, 2010 vol xlv no 51 39

Growth and Crisisin Pakistan’s Economy

Sushil Khanna

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 rst 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 ( [email protected]) is with

the Indian Institute of Management, Kolkata.

This essay looks at the political

economy of Pakistan during the

last two decades. Why has

Pakistan faced recurrent balance

of payments difculties? Are the

structure of production and

exports the culprits? The essay

rst seeks to throw light on thecurrent 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 Pakistan’s economic

policies from the days of

Z A Bhutto, touching upon the

structural weaknesses that haveplagued the economy.

Pakistan has been in the grip of a se-

rious economic crisis for the last

one year. High ination, deteriorat-

ing 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 be-

fore 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 seri-

ous economic situation in the country has

been almost entirely ignored. Similarly,

though the close political relationship be-tween the western countries (especially

the United States) and the Pakistani elites

and “establishment” (to borrow a popular

phrase in Pakistan to describe the mili-

tary, 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 dif-

cult 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 simul-

taneously are counted). If the World Bank’s

numerous crisis-related bailouts are added,

then Pakistan received assistance from

the Bretton Woods twins in 24 differentarrangements in the two decades since

Zia’s death in 1988 (Easterly 2001). Some

of these arrangements were negotiated and

launched even before the earlier program-

mes had been completed (Table 1, p 40).

Pakistan’s development during the last

two decades is in stark contrast to other

Asian economies. With low growth inincome and exports, Pakistan’s efforts at

liberalisation and deregulation have accen-

tuated the crisis. Poverty has shown a signi-

cant 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 policymak-

ing in Pakistan (except as an enthusiastic

proponent of large-scale denationalisation

and privatisation carried out by the mili-

tary and the civilian regimes). Since then,

American aid for the economic and social

sectors, as well as military aid and pay-

ments for mercenary services provided by

the Pakistani army, have become signi-

cant. Pakistan has sought and obtained

special concessions, like preferential ac-

cess for its exports, though the impact has

been marginal, given the phasing out of

the multi-bre agreement (MFA).

The IMF has been the most importantplayer in shaping economic policy in

Pakistan since 1988. Almost every major

domestic policy shift – like the denationali-

sation of banks and manufacturing units,

tax reforms, policies governing foreign cur-

rency deposits or even commercial disputes

between foreign rms and public utilities –

has borne the stamp of the IMF. Pakistan

thus provides another example of the limi-

tations and negative consequences of the

IMF’s 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 Sharif’s decision

to explode a nuclear device in 1998. How-

ever, it was only one in a series that hit

Pakistan in the decade preceding the ex-

plosion. As Japan and western donors im-

posed economic sanctions, the country

faced another serious balance of payments

crisis. His economic team’s botched attempt

to check capital ight (after the sanctions) worsened the situation, with the drying up

of foreign currency account (FCA) deposits



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december 18, 2010 vol xlv no 51 EPW Economic & Political Weekly40

Table 1: Pakistan – History of Arrangements with the IMF since 1988

IMFProgramme ToRunFor(Coverage) TotalAmount$Million Completed/Delayed/Suspended

Sanctioned Drawn

1 StructuralAdjustmentFacility(SAF) 1988-91(3-years) 516 516 Completedafterdelayofoneyear.

2 Stand-byArrangement(SBA) 1988-91(3-years) 259 259 Completedafterdelayofoneyear.

3 ContingencyandCompensatoryFinancingFaci li ty(CCFF) 1991-92(onet ime) 171.6 171.6 Onet imefacil ityinonetranche.

4 EmergencyAssistance 1992-93(onetime) 262 262 Onetimedrawninonetranche.

5 Stand-byArrangement 1993-94(1-1½years) 377 125.5 Suspendedin1993.

6 EnhancedStructuralAdjustmentFacility(ESAF) 1993-96(3-years) 849 290 Suspendedafteraboutayearplus.7 ExtendedFundFacility(EFF) 1993-96(3-years) 531 177 Suspendedafteraboutayearplus.

8 Stand-byArrangement 1995-97(1-1½years) 600 277 1 ProgrammesuspendedinMarch1996.

216 150 2 ProgrammereactivatedinDecember1996.

3 Againsuspendedin1997

9 EnhancedStructuralAdjustmentFacility 1997-2000(3-years) 935 310 SuspendedinOctober1997.

10ExtendedFundFacility 1997-2000(3-years) 623 77 SuspendedinOctober1997.

11 EnhancedStructuralAdjustmentFacility 1998-2001(3-years) 637 53 SuspendedafternucleartestinMay1998and

(Reactivationof1997programme) reactivatedinJanuary1999.Againsuspendedin

September1999.

12ExtendedFundFacility 1998-2001(3-years) 557 77.6 SuspendedafternucleartestinMay1998and

(Reactivationof1997programme) reactivatedinJanuary1999.Againsuspendedin

September1999.

13 Contingenc yandCompensator yFinancingFacilit y Januar y1999(onetime) 495 495 Completedinonetranchedrawl.

14 PovertyReductionandGrowthFacility(PRGF) December2001 1,300 na Withdrawnin2004atPakrequest15Stand-by-Arrangement November2008 7,500 3,950 Firstinstalmentof$3.1bnreleasedin8November,

andsecondof$890millioninApril2009

Source:StateBankofPakistan(2000):“ChapterVIII-ExternalSector”, Annual Report 1999-2000,Karachi,andIMFwebsiteforlaterarrangements.

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 nance minister (later

prime minister) made efforts to stabilise the

macroeconomic situation by deating 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 stag-

nation. For two-three years Pakistan enjoyed

a current account surplus. Aziz was hailed

as the economic wizard who had convert-

ed 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 ination, wid-

ening trade and current account decits

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 legitima-cy 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 Mush-

arraf and Shaukat Aziz made of having

rescued Pakistan’s economy from endemiccrisis was premature. If we keep in mind

the fact that the current crisis in Pakistan

pre-dates the global nancial 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 difculties? 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 rst 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 Pakistan’s economic

policies from the days of Z A Bhutto, touch-

ing upon the structural weaknesses that

have plagued the economy.It is our hypothesis that the crisis faced

by Pakistan’s economy in the 1990s has its

roots in the nature of dependent develop-

ment that has long characterised Pakistan’s

economic strategy. The structural weak-

nesses are linked to the structure of produc-

tion, the level of human development and

nature of Pakistan’s economic integration

with the global economy. The close links

forged with the western powers, especially

the US, and the rewards of this special re-lationship undermined the potential for a

self-reliant and sustainable growth strategy.

Current Crisis

The current economic crisis has little to do

with the global nancial crisis and melt-

down; indeed, it preceded the more severe

manifestation of global crisis in September-

October 2008. Pakistan’s economic situa-

tion 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 difcult.

According to one version (of the crisis),

after the resignation of Prime Minister

Aziz, the subsequent interim administra-

tion abandoned any effort to manage the

looming economic crisis triggered by the

unprecedented increase in oil prices and

widening trade decit, along with a wid-ening current account decit. The trade

decit widened to $15 billion in 2007-08,



PERSPECTIVES


(up from $10 billion a year ago) and the

current account decit doubled to $14 billion

(Table 3). Similarly, the interim adminis-

tration failed to exercise scal restraint and

the budget decit 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 exchangereserves 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, ination (as

measured by the Consumer Price Index)

touched a new high of 22% in 2008-09.

According to another version, the Mush-

arraf government came under pressure

from lawyers and other civil society organi-

sations 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

decit. 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 decit of $4.7

billion in 2005-06 and rose by 45% the very

next year to touch $6.8 billion; again dou-

bling in 2007-08. Similarly, the trade decit

had doubled during 2004-05 and 2005-06

(Table 3). Ination has been rising since2004-05 and touched 12% in 2007-08. All

this was long before the political crisis and

instability hit Pakistan. Shaukat Aziz and

his team were ensconced in ofce 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 devel-

oping 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 ina-

tionary 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

consumers. Rising ina-

tion was also adding to

alienation of the popu-

lace from the Musharraf

regime, while instability

was undermining the

condence of foreign

investors. Annual in-

ows of foreign direct

investment (FDI), which had been in the

range of $2 to 5 billion per annum from

2000, plunged during the period. Fortu-

nately there was little impact on workers

remittances and other transfer payments,

but they were not adequate to pay for the

widening trade decit (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 Arrange-

ment (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 macroeco-

nomic balance with more tranches. Amounts

equivalent to $3.1 billion were disbursed

in the rst few months, and have contin-

ued 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

international club of friendly western coun-

tries. President Zardari ew 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 nancial crisis and global slowdownhas lowered exports during the last two

years. But thanks to the decline in oil pric-

es and buoyant remittances from workers

abroad, the current account decit is sub-

stantially lower in the rst 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 sell-

offs of state assets. Commercial borrowings

remain frozen and it will be sometime be-

fore the external balance is restored.

The Economy under Musharraf

As mentioned above, the balance of pay-

ments 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 conict

and the tightened economic sanctions

only worsened the situation. But even be-fore Pakistan exploded the bomb in the

summer of 1998, its trade and balance of

payments were already in disarray. Ex-

ports were stagnant at around $8 billion

during the second half of 1990s, and with

the onset of the Asian crisis in 1997, mar-

ginally declined. Workers’ remittances too

were stagnant at around $1 billion mark

per annum (Table 3).

The current account decit had wid-

ened over the decade and was in the re-

gion of $3.8 bil lion by 1997, equivalent to

6% of GDP. Over the decade of the 1990s,

the State Bank of Pakistan (the central

bank), had managed this decit by en-

couraging both resident and non-resident

Pakistanis to deposit funds in FCA. This

had become a major source of capital in-

ows in the overall balance of payments

situation. Thus the current account decit

was met by rising FCA deposits at attrac-

tive rates, while the value of rupee was

controlled to rule out any depreciationthat may jeopardise the inow of deposits

(Mirakhor and Zaidi 2004).

Table 2: Pakistan – Balance of Payments under Civilian G overnments(1994-99,$million)

Items 1994-95 1995-96 1996-97 1997-98 1998-99

Exports(fob) 7,759 8,311 8,096 8,434 7,528

Imports(cif) -10,296 -12,015 -11,241 -10,301 -9,6131 TradeBalance -2,537 -3,704 -3,145 -1,867 -2,085

2 Services(Net) -2,384 -3,249 -3,659 -3,264 -2,618

3 PrivateUnrequitedTransfers(net) 2,437 2,378 2,958 3,210 2,274

(WorkersRemit tances) (1, 866) (1,461) (1,4 09) (1,490) (1,060)

4 CurrentAccount -2,484 -4,575 -3,846 -1,921 -2,429

Source:Pakistan, Economic Survey ,variousyears.

Table 3: Pakistan – Balance of Payments under the Musharr af Government(1999-2007,$million)

Items 1999-2000 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

Exports(fob) 8,190 8,933 9,140 10,889 12,396 14,401 16,388 17,119

Imports(cif) -9,602 -10,202 -9,434 -11,333 -13,604 -18,753 -24,647 -26,614

1 TradeBalance -1,412 -1,269 -294 -444 -1,208 -4,352 -8,259 -9,495

2 Services(Net) -2,794 -3,142 -2,617 -2,128 -3,594 -5,841 -7,304 -7,968

3 PrivateUnrequitedTransfers(net) 3,063 3,898 4,249 5,737 6,116 8,4 40 9,914 10,102

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

4 CurrentAccount -1,143 -513 1,338 3,165 1,314 -1,753 -5,649 -7,361

Source:Pakistan, Economic Survey ,variousyears.



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But once the western countries imposed

sanctions on Pakistan after its nuclear ex-

plosion, 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 with-

drew disbursal of the already sanctioned

Extended Fund Facility and Structural Adjustment Facility in 1998, the situation

became worse, leading to capital ight 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 difcult 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 under-

mined its credibility and accentuated

capital ight 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 -

nance minister, with the explicit mandate

to tackle the balance of payments crisis.He even cited this crisis and this appoint-

ment as a justication 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 nancial situa-

tion, 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 situ-

ation faced many challenges. International

sanctions were in place, bilateral aid had

been cut off and the IMF /World Bank dis-

bursement of sanctioned facilities was tardy.

Without the IMF assistance, the rst two

years of the Musharraf regime were dif-cult. However, Aziz put in place policies

that would meet the IMF’s approval, as he

pleaded for resumption of assistance. He

imposed a severe squeeze on demand, rais-

ing interest rates and cutting back on public

spending. The so-called “development ex-

penditure” was pushed down to a new low

of 2% of GDP. He also eased restrictions on

FCA, though this did not immediately reverse

the ight from foreign currency deposits.Thanks to the severe demand compression

and accompanied deation, 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, Pakistan’s 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 Pakistan’s burgeoning

debt. Pakistan also demanded and re-

ceived some increase in its textile export

quota and soon exports began to increase.

What is more fortuitous, American efforts

to check nancing to terrorists by actions toplug the illegal ow of cross-border funds

(“hawala” ) and closer supervision of bank-

ing 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 suc-

cessive years of draught and poor rains.

With excellent monsoon precipitation, agri-

cultural 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, Pakistan’s

economic challenge became manageable.

Thanks to the earlier demand compres-

sion, average ination during the ve 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 regimeclaimed to have carried out radical scal

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 scal decit 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 throughofcial channels, the “national” savings

(domestic savings remained constant at

15-18% range) began to rise. National sav-

ings rose from 17.6% of GDP in 1998 to an

all-time high of 28% in 2003. Simultane-

ously, due to large-scale privatisation and

sale of public sector companies to foreign-

ers, FDI inows too surged. However, FDI

was limited to the telecom and nancial

sector. Thanks to these trends, foreign ex-

change reserves rose, touching a high of

$13 billion in 2004 and $17 billion in 2007.

Shaukat Aziz and his team of econo-

mists claimed unparallel success in sta-

bilising the economy and in restoring

macroeconomic balances, pushing up in-

vestment 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 be-

yond December 2004.The architects of the turnaround, namely,

Shaukat Aziz and Ishrat Husain were

joined by the IMF in this bout of self-

congratulations and adulation. Musharraf

rewarded Aziz by making him the prime

minister in the summer of 2004. With macro-

stability and substantial foreign inows, his

economic managers began to expand de-

mand and substantially increased develop-

ment outlays, especially on education and

irrigation. However, this stability was short-

lived. As Pakistan abandoned the IMF pro-

gramme in 2004, ination 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 2004-

05 to 6-6.5%. But by 2007, the political sit-

uation began to change rapidly. As Mushar-

raf faced an increasingly united opposition

and challenge to his regime from the judici-

ary and other sections, these economic

gains were further whittled way. As he be-

came 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 commodi-

ties. The trade decit began to grow and

the balance of payments was in crisis.

Domestic prices of food and other commod-

ities rose, fuelling disenchantment with the

military regime. When he departed in late

2008, Musharraf left the country in a biggermess 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 trau-

matic 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 wing’s total ex-

ports and 20% of imports, there was an ur-

gent need for Pakistan to nd new markets

for these products. The economy also faced

large external shocks due to the fourfold

increase in petroleum prices by the Organi-

sation 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 decit.

Zulkar Ali Bhutto, who came to power

after the end of the military regime respon-

sible for the break-up of the country, rep-

resented the populist policies of an elected

leader who aspired to develop a strong

and resurgent Pakistan. His emphasis was

on large-scale manufacturing and indus-

trialisation 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 conict where Bangladesh was

carved out of Pakistan. Bhutto’s 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 in-

vestment and modernisation and laid thefoundation of heavy industry, like steel in

public sector, along with nationalisation

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 concen-

trated in the public sector, a signicant pro-portion diverted to the capital goods sector.

Thus, the setting up of the Pakistan Steel

Mill Corporation and a nuclear reprocess-

ing facility became symbols of the regime’s

strategy to diversify the industrial base.

Though the export boom after the rst

oil shock of 1973 helped nd 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 intensi-

ed the demand for imports. While ex-

ports 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 pay-

ments crisis that continues to this day.

In contrast, Zia-ul-Haq, who replaced

Bhutto after the coup d’état, relied on Islam

and private enterprise to consolidate his

power. This would take Pakistan along a

path that would shape the politics and eco-nomics 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 econ-

omy beneted from a number of special

factors, both domestic and external. Whileinvestment in large public sector projects

did not lead to high growth in the Bhutto

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, com-

pletion of the long gestation period Indus

Basin Tarbela Dam helped unleash unprec-

edented 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).

Pakistan’s per capita income in the early

1990s was about 25% higher than India

(close to $500 per head compared to India’s

$390). The average Pakistani was better

fed and clothed than the average Indian.

While 52% of India’s 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 work-

ing in west Asia, with large remittances

that helped nance the trade decit. 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 macro-

economic 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 rela-

tionship to the global economy, as com-

pared with that of India and a few other

south Asian countries.

On rst 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 sector’s

share in output has fallen to about 20-22%. Yet this similarity hides several fundamen-

tal differences in the underlying structure



PERSPECTIVES


Table 4: Output Structure – Selected SAARC Countries (%ofGDPatcurrentfactorcost)

1990 2000 2007

Pakistan

Agriculture 26.0 25.9 19.6

Industry 25.2 23.3 26.8

Services 48.8 50.7 53.7

India

Agriculture 29.3 23.4 17.6 Industry 26.9 26.2 29.4

Services 43.8 50.5 52.9

SriLanka


Industry 28.9 27.8 29.9

Services 46.9 56.6 58.4

Bangladesh


Industry 21.5 25.3 28.5

Services 48.3 49.2 52.6

Source:AsianDevelopmentBank: Key Indicators, 2008.

Table 5: Savings and Investment – Selected SAARC

Countries(%ofGDPatcurrentmarketprices) 1990 2000 2007

Pakistan

Grossdomesticsaving 13.5 16.0 14.7

Grossnationalsaving 24.7 20.1 24.0

Grossdomesticcapitalformation 18.9 17.2 23.0

India




SriLanka




Bangladesh





Pakistan’s 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

decits, and an export sector that has notexpanded relative to the economy. Paki-

stan’s merchandise exports as a percent-

age 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 econo-

mies have succeeded in substantially rais-

ing the ratio of exports to GDP (Table 6). It

is most dramatic in the case of Bangla-

desh, where the share of exports since

1990 has risen by more than three times to

touch the 18% mark. India too has in-

creased 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

decit in services trade. Given Pakistan’s

small and declining share, the export sector

has a marginal impact on GDP growth.

Trade decits have been large and till thehawala crackdown in 2002, the current

account decits too were large. The large

current account decits have led to per-

sistent 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 limi-

tations, as the stock of public enterprises

is limited and soon gets exhausted.

Felipe et al (2009) look at the con-

straints 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 bind-

ing constraint in Pakistan’s economy. This

arises from the country’s inability to

change the structure of its industrial out-

put and its exports. Despite once being

Asia’s 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,

Pakistan’s 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 competi-tiveness. A World Bank study using “Inte-

grated Value Chain Analyses” for selected

products nds that domestic cost are higher

due to poor infrastructure and acute scar-

city of skilled workers and engineers. But

a more important reason seems to be the

structure of exports. As Table 7 shows, the

structure of Pakistan’s exports has not

changed for more than two (or three) dec-

ades. Textiles constitute two-thirds of ex-

ports. If other traditional commodities

like leather, sports goods, etc, are includ-

ed, then 80% of Pakistan’s exports consti-

tute low technology and low value added

commodities. The phasing out of the MFA

from 2005 has already begun to threaten

Pakistan’s textile exports from competi-

tors 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 in-

dustries, like food products (sugar, dairy,etc) and others like sports goods, non-

metallic products (cement), and handicrafts

Table 6: Balance of Payments Structure – SelectedSAARC Countries (%ofGDPatcurrentmarketprices)

1990 2000 2007

Pakistan

Exports 12.5 11.6 12.1

Imports -18.8 -13.6 -18.8

Balanceongoods -6.3 -2.0 -6.8

Currentaccountbalance -3.4 -0.3 -4.8

Overallbalance 1.0 -5.5 2.6India

Exports 5.7 9.7 14.0

Imports -8.6 -12.4 -21.9



Overallbalance -0.8 1.3 8.1

SriLanka

Exports 25.0 33.0 23.9

Imports -33.9 -43.8 -34.9



Overallbalance 1.5 -3.1 1.6

Bangladesh Exports 5.1 12.5 17.8

Imports -11.6 -16.6 -22.9


Currentaccountbalance -1.5 -0.9 1.4

Overallbalance ... 0.4 2.2


and the relationship of the two economies

to the world economy. While India has

grown largely on domestic savings and in-

vestment, Pakistan has long nanced its

investment from foreign savings – loans

from non-residents and bilateral and mul-

tilateral aid. It is characterised by low do-

mestic savings (about 15% of GDP) and

rather low levels of investment, even com-

pared to a poorer economy like Bangla-

desh. 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 epi-

sodes of recurrent balance of payments

problems and IMF bailouts have to be ana-lysed by looking at Pakistan’s engagement

with the global economy.



PERSPECTIVES


constitute another 24%. The weight of

even medium technology sectors like

chemicals, engineering and transport

equipment has remained relatively low,

with fertiliser and petroleum rening ac-

counting for half the chemical production.

Machinery constitutes only 5% of total

value added.

The state’s ability to raise resources has

been limited. The total tax revenue to GDP

which was in the range of 12-13% in the

1990s has hovered around 10-11% of GDP.

What is even more striking, military ex-

penditure has exceeded development ex-

penditure in most years. Debt repayment

and defence have absorbed 55-60% of the

total outlay (Table 8).

Pakistan under the IMF

Pakistan has been under the shadow of IMF-mandated structural adjustment pro-

grammes from the early 1990s. It is well

known that these programmes result in

deation and a squeeze on demand to

stabilise the macroeconomic im-

balances. Repeated deations

have the consequence of under-

mining investment. Hence it is

not surprising that every time

Pakistan experiences an episode

of increase in growth and invest-

ments, it also runs up an unsus-tainable current account decit

and therefore growth is quickly

aborted by a policy of credit

squeezes, increase in interest rates and re-

duction in import of capital goods due to

currency devaluations.

The austerity measures also result in

sharp cuts in social sector spending and a

decline in social indicators such as health

and education and increase in poverty

rates. Though IMF often clothes its condi-

tions as “poverty reduction strategy”, there

is little doubt that these policies are likely

to worsen the condition of the poor and

undermine growth and employment in

the name of macroeconomic stability.

The fact Pakistan has found it difcult

to raise its domestic savings and invest-

ments can be directly attributed to the

long shadow of the IMF and its mandated

policies. Thus the latest IMF supported

programme which began in 2008 has

resulted in a sharp decline in capitalformation. Gross xed capital formation

(GFCF) has declined by 0.6% for the econ-

omy as a whole in 2009-10 compared to

the earlier year while the GFCF in the

private sector has declined by

3.5% and by 5% in private manu-

facturing and as much as 13%

in large-scale manufacturing.

Simultaneously, foreign invest-

ment also declined by 32%

(Pakistan’s Economic Survey 2010).

Overall, xed investment in the

economy during 2009 contract-

ed by as much as 2.3% of GDP.

An Asian Development Bank

working paper on Pakistan

(Felipe and Lim 2008) warns

that raising interest rates to

check ination dampens invest-

ment prospects while depreciat-

ing the currency may induce

higher prices for imported es-

sential inputs with low priceelasticity. The paper warns that

depending excessively on higher

interest rates will make rms reluctant to

use debt nancing 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 IMF’s 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%, in-

crease 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 re-

quirement that the commercial dispute

between the public sector power compa-

nies (HUBCO and Karachi Petroleum Com-

pany) with a multinational power genera-

tion company to be settled to the “satisfac-

tion of all parties” – an unusual and un-

precedented condition – requiring Paki-

stan to settle a commercial dispute be-

tween a foreign investor and a public util-

ity. The government also promised to ac-celerate privatisation of public utilities,

which became an important driver of in-

creased FDI ows. The most signicant 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 scal 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 Indi-

cators, he demonstrates that macroeconomic

stability was achieved by sharply squeez-ing development expenditure. What is

more signicant, Khan claims that during

Table 7: Pakistan – Structure of Expor ts (%oftotal)

Commodity 1990-91 1994-95 1999-2000 2004-05 2007-08

Cotton 61 58.7 61 57.4 61.5

Leather 9.1 8 6.3 5.8 4.5

Rice 5.6 5.6 6.3 6.5 6.6

Synthetictextiles 5.7 7.1 5.3 2.1 3

Sportsgoods 2.2 3.2 3.3 2.1 1.6

Sub-total 83.6 82.6 82.2 73.9 77.2

Others 10.7 12.9 17.8 26.1 22.8

Total 100 100 100 100 100

Totalexports($million) 6,131 7,759 8,190 14,482 20,122

Source:Pakistan, Economic Survey s,variousyears.

Table 8: Pakistan’s Fiscal Indicators

Revenue Expenditure Overall

Year TotalRev Tax Non-Tax Total Current Development Fiscal Deficit

FY92 19.2 13.7 5.5 26.5 19 7.5 8.7

FY93 18.1 13.4 4.7 26.2 20.5 5.7 8.1

FY94 17.5 13.4 4.1 23.4 18.8 4.6 5.9

FY95 17.3 13.8 3.5 22.9 18.5 4.4 5.6

FY96 17.9 14.4 3.5 24.4 20 4.4 6.5FY97 15.8 13.4 2.4 22.3 18.8 3.5 6.4

FY98 16 13.2 2.8 23.7 19.8 3.9 7.7

FY99 15.9 13.3 2.7 22 18.6 3.3 5

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

FY02 14 10.7 3.3 18.5 15.7 2.8 4.3

FY03 14.8 11.4 3.4 18.8 16.2 2.6 3.7

FY04 14.2 11 3.2 16.5 13.7 2.8 2.3

FY05 13.8 10.1 3.7 16.8 13.3 3.5 3.3

FY06 14.1 10.5 3.6 18.4 13.6 4.8 4.3

FY07 14.9 10.2 4.7 20.8 15.8 5 4.3

FY08 14.6 10.3 4 22.1 18 4.4 7.4

FY09P 14.6 11.3 3.8 18.6 15.8 2.8 4.3(FigurespriortoFY2000arenotcomparablewithlateryearsduetochangeindefinitions.)Source:Pakistan, Economic Surveys.



PERSPECTIVES


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 Paki-

stan estimates however show a decline

between 2001 and 2006). In other words,

the so-called stability under the IMF-

sponsored programme imposed a high

cost on the average Pakistani.

Felipe and Lim (2008), while analysing

the constraints on Pakistan’s development

and inability to tackle its recurrent BOP crisis, point to the low level of human de-

velopment, and absence of skilled techni-

cal 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 in-

ation may have harmed the economy even

more. The two authors nd a powerful link

between expansionary policies and mode-

rate ination with strong economic growth.

Under the IMF’s hegemony Pakistan has

repeatedly squeezed its public expendi-

tures, 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 Pakistan’s

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

largely at the expense

of social investment

and development prior-

ities. The poor were left

to what “trickled down”.Recurrent IMF program-

mes that required scal

stabilisation led to a

squeeze on develop-

ment expenditure.

The bias against pub-

lic sector investment in

new and emerging areas

has prevented invest-

ment in the areas the

private sector has been

unwilling to invest in. The total break with

Bhutto’s strategy of establishing modern

heavy industry has undermined Pakistan’s

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 sustainablegrowth that is more inclusive. Failure to do

so can only accentuate the social tensions.

The rst 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, accord-

ing to the report of a panel of economists

appointed by the Planning Commission,

include “neglect of social indicators, a

skewed distribution of assets, weak institu-

tions of governance, inward looking eco-

nomic 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

nancing of economic growth on the basis

of their capacity to bear such a burden) re-

sulting 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 theeconomy that has failed to gain from such

liberalisation. Pakistan’s recurrent economic

crises, even as the rest of Asia was r iding 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.

Pakistan’s economic constraints and

problems seem to be even more intractable

than the political, ethnic and regional ten-sions. Democracy and decentralisation

should be partly able to address these

tensions. The economy seems to be hobbled

by constraints of technological backward-

ness, poor human resources and declining

competitiveness even in traditional indus-

tries like cotton and leather. Any break

will require long-term intervention and

well-developed industrial policy. Given

the enormous inuence 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,

Austral ia and Italy – that was formed in Septem-ber 2008 to extend support to the Government of Pakistan “in its efforts to consolidate democracy”and to “support social and economic developmentin the country”.

References

ADB (2001): Pakistan: Country Operational StrategyStudy, Asian Development Bank, Manila, athttp://www.adb.org.

Easterly, William (2001): “The Political Economy of Growth Without Development: A Case Study of Pa-kistan”, Development Research Group, World Bank.

Felipe, J and J Lim (2008): “An Analysis of Pakistan’sMacroeconomic Situation and Prospects”, ADBWorking Paper No 136, Manila.

Felipe, J, J S L McCombie and K Naqvi (2009): “IsPakistan’s Growth Rate Balance of Payment Con-strained?” 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”, speechdownloaded from http://sbp.org.pk/speech/

Economy_of_Pakistan_2005.pdf – (2005): “Speech at Indian Business School”,Hyderabad, October.

IMF (2008): “Pakis tan: Letter of Intent, Memorandumof Economic and Financial Policies and TechnicalMoU”, November.

Khan, S R, ed. (1999): Fifty-Years of Pakistan’s Economy (Karachi: Oxford University Press).

Khan, Shahrukh Ra (2007): “Pakistan’s 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): “Pakistan’s Macro-economic 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 Econo-mists, Planning Commission.

World Bank (2006): Pakistan: Growth and ExportCompetitiveness, Report No 35499-PK, Poverty Reduction and Economic Management Unit,South Asia Region, Washington DC.

Table 9: Comparative Economic Performance under Civ ilian andMilitary Governments

Pakistan CivilianGovernments MilitaryGovernment

1988-89to1998-99 1999-2000to2005-06

Overallfiscaldeficitasa%ofGDP 7 3.94

Militaryexpenditureasa%ofGDP 5.82 3.36

Developmentexpenditureasa%ofGDP 5.02 2.94

Taxrevenueasa%ofGDP 13.55 10.73

Growthinmoneysupply(M2) 15.12 14.37Publicinvestmentasa%ofGDP 7.81 4.67

Privateinvestmentasa%ofGDP 9.09 11.4

FDIasa%ofGDP 0.85 0.79

Domesticsavingsasa%ofGDP 10.24 6.53

Aidasa%ofGNI 2.21 1.82

Aidasa%offederalgovernmente xpenditure 9.76 10.75

1991-99 1999-2002

%change

Changeinpovertygapat$1/day –84.8 29.7

Changeinpovertygapat$2/day –49.7 18.7

Changeinheadcountpovert yratioat$1/day –72.0 2.71

Changeinheadcountpovert yratioat$2/day –25.4 12.2

Source:Khan,ShahrukhRafi(2007),Tables1and4.

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