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p. 34 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia People’s Republic of China Southeast Asia South Asia Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia : South Asia

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Pakistan

Economic performance improved in 2000, to the highest rate of GDP growth since 1996. However, large and unsustainable fiscal deficits and an unstable external situation kept the economy under stress. The medium-term outlook depends on the pace of structural reforms and an improvement in the balance of payments.

Recent Trends and Prospects

Appreciable improvement in agricultural performance, together with a modest acceleration in industry and services, boosted real GDP growth from 3.1 percent in 1999 to 4.8 percent in 2000, the economy’s best performance since 1996. A bountiful harvest propelled real agricultural value-added growth from about 2 percent in 1999 to over 7 percent in 2000. Bumper cotton and wheat harvests more than offset a decline in the sugarcane harvest with the result that real value added in crops expanded by 10 percent. Yet the poor sugarcane harvest contributed to a collapse in sugar production that slowed the growth of real manufacturing value added. However, this was more than made up for by a strong recovery in construction and faster growth in electricity and gas so that industrial growth rose from 2.5 percent in 1999 to 3.0 percent in 2000. Real services value-added growth increased to 4.5 percent with stronger improvements in commerce, transport, communications, and public administration.

With a prolonged period of relatively poor economic performance, due in part to political turbulence, the incidence of poverty is estimated to have risen from below 18 percent in 1988 to over 32 percent in 1999. Low economic growth rates in Pakistan, compared with elsewhere in South Asia over the past several years, are linked to rates of savings and investment that are among the lowest in the subregion. As a proportion of GDP, gross investment remained at 15.0 percent in 2000 but still below the 18.9 percent level achieved in 1996. Gross domestic savings increased to 14.0 percent of GDP in 2000 from 12.3 percent of GDP in the previous year.

Large fiscal deficits continue to pose a major challenge to the Government as it strives to lift economic performance. In 2000, total revenues as a share of GDP improved to 17.2 percent from 16.3 percent in 1999. Total expenditures in 2000 rose marginally to 23.4 percent of GDP from 22.4 percent in 1999. This moderate rise in expenditures was achieved by reducing development spending. Current expenditures increased to 20 percent of GDP, their highest share since 1996, primarily because of a larger interest bill (which now represents 34 percent of total expenditures compared with about 24 percent in 1996). Overall, the consolidated budget deficit rose to PRs206.3 billion or 6.5 percent of GDP in 2000, from 6.1 percent in 1999. Nearly two thirds of the deficit was financed domestically. Public debt equaled 92 percent of GDP in 2000.

While growth in the money supply during 2000 was relatively modest, the composition of growth was very different from that expected. Government borrowing was much higher than projected while net lending to the nongovernment sector was reduced sharply during the year, despite an easing in monetary policy as reflected in reductions in the central bank’s discount rate and treasury bond yields. Broad money supply (M2) grew by 9.4 percent in 2000, faster than the 8.4 percent pace of nominal GDP growth, but still quite low. This contributed to a further decline in the inflation rate to 3.6 percent in 2000 from 5.7 percent in 1999. Lower non-oil commodity prices also helped keep inflation in check, despite higher fuel prices.

Gross official reserves fell by nearly half from $1.7 billion in 1999 to $0.9 billion in 2000, or about four weeks of imports of goods and services, as large capital outflows swamped an improvement in the current account deficit. The narrowing current account deficit (from 3.9 percent of GDP in 1999 to 1.6 percent in 2000) was attributable to a reduction in the trade deficit and a 35 percent increase in net private transfers. The trade deficit shrank to 2.3 percent of GDP because exports grew strongly while imports were contained. Exports, recovering from a contraction in 1999 and responding to strong external demand, grew by 8.4 percent in dollar terms. Exports of cotton manufactures, which account for about 60 percent of the total value of exports, expanded by over 12 percent. The near doubling of the import bill for petroleum products was offset by reductions in virtually every other category of imports, in part because of lower non-oil commodity prices.

The Government’s efforts to maintain the value of the rupee relative to the dollar in an environment of falling investor confidence and large-scale private outflows cost the Government additional reserves. In real effective terms, the rupee remained roughly stable on average over the course of 2000. Total external public and publicly guaranteed debt was about 51 percent of GDP in 2000. External debt service on medium- and long-term debt rose as a percentage of exports of goods, nonfactor services, and private transfers, to 30.4 percent in 2000 from 29.4 percent in 1999.

In early 2001, the Government concluded negotiating a program with the International Monetary Fund (IMF) under which various reforms were agreed on. Some reforms have already been implemented, such as the liberalization of the exchange rate in July 2000. Although these measures are expected to boost investor confidence and thus private investment, real GDP growth is forecast to remain sluggish over the next two years. Manufacturing is likely to exhibit robust growth as cotton manufactures continue to expand. However, the agriculture sector will probably find it difficult to match its 2000 growth rate, particularly with drought conditions in the early part of the fiscal year and a shortage of irrigation water to sustain expansion. GDP growth is, therefore, projected to remain under 5 percent a year in 2001–2002. Nevertheless, as delayed increases in administered energy prices and the effects of recent rupee depreciation are passed on to consumers, a significant increase in inflation to 6.0 percent is expected in 2001. Under the IMF agreement, the Government is committed to reducing the fiscal deficit to 5.2 percent of GDP in 2001. On the external front, with recent reforms, particularly the rupee depreciation, double-digit export growth is expected in the next two years. Imports are likely to grow at a slower pace than exports, helping contain the current account deficit.

Issues in Economic Management

The new Government that came to power in October 1999 faces a comprehensive reform agenda to reverse a decade of economic malaise, which was due to political instability and which has resulted in rising poverty and socioeconomic inequality. However, containing the fiscal and external deficits is an immediate priority. A prolonged period of budget deficits in excess of 6 percent of GDP has left Pakistan with a huge debt, with debt service accounting for a large share of the budget. While seeking debt relief through the Paris Club, the Government undertook several measures in 2000 to reduce the deficit. These included revenue measures such as expansion of coverage for the sales and income taxes, tax amnesty schemes to encourage compliance, and a tax survey and registration program to widen the tax base. On the expenditure side, it reduced the implicit fuel subsidy by initiating an adjustment program to ensure that local petroleum product prices reflected actual import prices. To ensure that the target of reducing the deficit to 5.2 percent of GDP in 2001 is met, strict implementation of the new revenue measures is essential, particularly in respect to administration and collection of taxes in the newly covered areas such as agriculture and services. In addition, expenditure controls must include containment of defense spending as well as targeted spending cuts if revenue collection lags.

Another major issue concerns the foreign exchange difficulties that led to the IMF standby arrangement in November 2000, and that, therefore, enabled other multilateral development banks to resume assistance to Pakistan. Exchange rate liberalization was a significant reform, particularly in light of the large fiscal deficits and crumbling investor confidence that drove reserves down to about $1 billion in September 2000, at which level they stabilized. However, the economy’s foreign exchange requirements are still large and further debt relief is critical. Under the IMF standby arrangement, the Government will receive $1.5 billion. The Government obtained $1.8 billion through a second round of debt rescheduling with the Paris Club in January 2001. But further assistance from IMF, which is scheduled to be provided in the latter half of 2001 in the form of a Poverty Reduction and Growth Facility loan (such loans have an explicit focus on poverty reduction in the context of a growth-oriented strategy), depends on the progress of the Government’s structural reforms, including trade liberalization measures to boost foreign exchange earnings. Under the standby arrangement, for example, the Government has already eliminated several administrative measures that inhibited exports and agreed to continue with tariff reductions that were begun in 2000.

Policy and Development Issues

Longer term, additional reforms to reduce the fiscal deficit or to increase government capacity to facilitate social development is essential if the Government is to achieve its development objectives, including faster economic growth and poverty reduction.

Public expenditure management is weak, partly because it has tended to be associated with expenditure controls, and partly because the rules and regulations are frequently bypassed. Furthermore, interference by political leaders, lack of transparency in public expenditure management, weak institutional capacity, and weak accountability have plagued public expenditure management. Expenditure controls are needed to impose a hard budget constraint, but excessive preoccupation by provincial finance departments with expenditure controls may become an obstacle to smooth and efficient government functioning.

The Government’s use of expenditure controls is perhaps a consequence of overcentralized state functions and authority. The Government publicly highlighted the issue of overcentralization as soon as it came to power and stressed that devolution would be a cornerstone of its reform program. A detailed devolution proposal, prepared by the National Reconstruction Bureau, was finalized in August 2000. On 31 December 2000, elections to local bodies were held in 18 districts. In certain regards, however, the devolution plan lacks concrete details, including (i) the fiscal transfer mechanisms between provincial and local governments, (ii) the local governments’ revenue base, (iii) the implications of devolution for provincial administrative structures and staffing, and (iv) the details of local government functional responsibilities for social and economic services.

The low level of investment stems partly from high government borrowing, and partly from low savings rates. If recent reform efforts in the financial sector are sustained, savings rates should increase. These efforts include (i) plans for expedited privatization of state-owned banks, (ii) improving the legal and judicial process for enforcement of financial contracts, (iii) centralizing the regulatory authority in the State Bank of Pakistan, (iv) reducing interest rates on National Savings Schemes, and (v) improving the environment for prudential regulations and supervision of financial institutions so as to meet international standards. At the moment though, the financial sector is weak. Despite a recent national loan recovery drive, the banks still carry many nonperforming loans, which need to be reduced.

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