Amid signs of a sharp economic slowdown, Pakistan’s economic leaders were surprised to witness a slight surplus in the current account for the first nine months of the July-June financial year.
The IMF predicts that GDP growth will slow to 2.8% in 2010–11 from 4.8% in 2009–10. But according to figures released in April by Pakistan’s central bank, the current account showed a surplus of $99 million for the July-June period, up from a deficit of $3.1 billion in the same period during the previous financial year.
The current account contrasts with Pakistan’s persistently high trade deficit, which in the first nine months of the financial year stood at $8.01 billion as opposed to $8.2 billion in the same period for a year ago. The contrast arises mainly from a constant rise in remittances from expatriate Pakistanis working in the oil-rich Arab world.
Returning workers from the region, notably from Saudi Arabia, claim they have received larger bonuses in recent months as the authorities in the kingdom have added financial incentives to existing pay packages, as a bulwark against social unrest.
“Pakistan’s expatriate workers in the Middle East are all lining up to save the economy. They are earning more and sending more money back home,” says a central bank official speaking to Emerging Markets from Karachi.
Remittances, mostly from blue-collar Pakistani workers in the Middle East, have helped to compensate for gaps elsewhere. Pakistan’s economic growth for its financial year to June should hover around 3% of GDP.
But sceptics warn that the rise in remittances to an economy suffering from investor aversion needs further examination.
“The issue of the remittances is quite tricky. Why have they continued to rise when the number of Pakistani workers abroad if anything may have fallen?” says Ehtisham Ahmad, a former IMF economist now with the London School of Economics. “One explanation is ‘carry trades’ or taking advantage of high interest rates, reserves backed by the IMF and a stable exchange rate,” he adds. Ahmad wants the central bank and others to probe the trend of higher remittances.
He warns that the comfort Pakistani officials have drawn from the country’s foreign exchange reserves – estimated by the IMF to be approximately $14.5 billion – must be tempered because this sum includes roughly $9 billion which needs to be paid back to the IMF.
Meanwhile, struck by the failure to vigorously improve tax revenue collection, the International Monetary Fund continues to withhold more than $3 billion from a loan programme of more than $11.1 billion agreed in 2008.
The disagreement between the two sides revolves around Pakistan’s failure to prevent the budget deficit from rising to a dangerously high level of up to 8% of GDP in the financial year to June 2011 – significantly up from a target of 4.7%. While some of this increase is to cover ongoing reconstruction following last summer’s devastating floods, critics also cite ongoing structural problems, most notably Pakistan’s chronically low tax take.
News of the current account improvement, however, could give an impetus to improvements in the investment climate. “Sentiment may begin lifting slightly as the news of the current account makes the rounds,” says Muhammad Suhail, a Karachi-based commentator on business and economic issues. “At least for investors, there is a positive trend to watch. A current account surplus suggests that there would not be fresh pressure on the rupee, at least any time soon.”
MORALE BOOSTER
For Abdul Hafeez Shaikh, the finance minister, who visited Washington in April for discussions with the IMF to salvage the loan, news of the current account’s improvement comes as an unexpected morale booster. Shaikh, a respected economist, has pressed president Asif Ali Zardari and prime minister Yusuf Raza Gilani to allow tax reforms of the kind which raise the government’s revenue and reduce the deficit.
Senior finance ministry officials say, however, that the government is in no mood to allow tough measures to nail tax evaders in a country where just above 1% of the population pays income tax.
“The IMF’s main objection, which has stopped their support, only relates to Pakistan’s revenue problem,” says a finance ministry official in Islamabad. “Ironically, while the current account is improving significantly, we are just not in a position to reform other vital parts of the economy.”
The failure to undertake bold reforms while the current account improves risks condemning Pakistan to a year of low growth.
“Inflation, low growth and the inability of the government to pump up economic growth are the main features of Pakistan’s present-day challenges,” says Sakib Sherani, an economist and former adviser to the finance ministry in Islamabad. “Given the series of difficult challenges faced by Pakistan, we may be looking at a continuation of low economic growth and high inflation, which may unfortunately even be around for several years to come.”
For many investors, a continuing failure by the government to tackle long periods of electricity cuts has become a major irritant. In cities like Faisalabad, the centre of the country’s textile sector, local factories typically remain without electricity for up to eight hours a day.
Elsewhere too, in places such as Karachi, a similar series of recurring power cuts has prompted protests from businessmen and industrialists. “We don’t live in the cave age: electricity is essential for the smooth development of any economy, and Pakistan is no different from anywhere else,” says a business leader connected to the Karachi chamber of commerce and industry.
Another economic disincentive is the continuing militancy that has plagued parts of Pakistan since the country joined the US-led so-called global war on terror following the 2001 terrorist attacks in New York. In the past decade, sites chosen for attacks by militants have ranged from high-profile military targets to hotels, shopping centres and mosques. This has in turn prompted new foreign businesses looking at Pakistan for future investment to turn their back on the country and search for investment opportunities in other parts of Asia.
While Zardari, Gilani and other leaders repeatedly cite their promise to oversee a continued anti-militant campaign, few are convinced that the conflict between pro-Taliban and pro-Al Qaeda militants versus the country’s security forces will come to an end any time soon.
MIDDLE EAST UNCERTAINTY
Pakistan’s proximity to the Middle East with its recent unrest and pro-democracy protests has added to concerns over the country’s outlook. The security situation in the Middle East poses challenges for Pakistan. These include scenarios such as the forced return of Pakistani expatriates from a country in turmoil, to the sharp escalation of oil prices adding to Pakistan’s trade deficit, and possibly even reversing the modest gain made by the country’s current account deficit.
Given Pakistan’s fragile economic situation, economists warn that further significant unrest in the Middle East could have serious negative ramifications for Pakistan’s economic future.
Indeed, anger and unrest on the streets of Pakistan point towards a wider challenge. Almost a third of Pakistan’s population of 180 million live below the poverty line, posing a major challenge in economic and political terms.
SOCIAL UNREST
Sahar Saeed, an Islamabad college student who will graduate this summer with an arts degree, complains about “no opportunities wherever I turn”. In the past two months in preparation for her graduation, Saeed says she has sent over 200 applications. “Wherever I go, it is the same story. Employers say they are not hiring, but in fact they are either throwing out people or encouraging them to leave.”
Among impoverished Pakistanis, a similar feeling of resentment prevails. “Many people who live on meagre salaries either starve or steal to make ends meet,” says Nabeel Masih, a young taxi driver. “Inflation is bad but the worst hit area is inflation around food.” Masih has no access to economic data but claims to spend half of his monthly wage on the “kitchen budget”, which he says used to be a quarter of his wage “three or four years ago”.
In an environment where the risk to the economy has far from receded, Suhail warns that the budget for the next financial year which begins in July “will have to be built upon reforming the tax structure; the budget deficit is just not sustainable”.
But leaders from the ruling Pakistan People’s Party (PPP) say the government will need to balance public opinion ahead of elections – due in 2013 – against pressure to reform the economy. According to leading political figures, this is all the more vital for a country where the military has ruled for half of its 64 years of existence while democracy is still gaining ground.
“If we inflict more pain on our people, there will be political consequences when the elections take place,” says a senior PPP official. “I understand the IMF wants us to tighten the screws, but how does the IMF deal with the political backlash?”
Suhail and Sherani warn that without putting in place credible economic reforms, Pakistan’s outlook will only deteriorate. Economists likewise warn that a failure to begin the process of reform will also delay the resumption of the IMF loan programme.
A finance ministry official in Islamabad who works with Shaikh says: “The government is caught in a difficult trap – like a Catch-22 situation. Without a bold set of reforms, especially tax reforms, Pakistan’s future will not improve. But in undertaking tough reforms, the government faces tremendous political risks.”