By Sid Verma
The most profound political turmoil in years has so far failed to dent investor confidence
Never in its 60-year history have Pakistan’s institutions clashed so obstinately against each other as this year: executive against judiciary, civil society against the military, secularists against Islamists, and much of the population against the establishment. Pervez Musharraf’s relentless bid for re-election has only fanned the flames.
The next few months will be crucial, not only for Pakistan’s democratic transition, but also for its precarious investment climate. The spectre of political risk has long loomed over Pakistan, yet – barring a recent pick-up in volatility – capital continues to gush in.
There are two main reasons for this: the country’s pro-western foreign policy and a far-reaching economic reform programme. Musharraf’s post-9/11 dividend for his unflinching support for the US’s “war on terror”, has provided the Islamic Republic with an avalanche of economic aid. This, combined with the administration’s liberal economic reforms, has seen the economy expand by an average 7% over the last four years, with the country’s equity-market rising 13-fold since Musharraf’s coup in 1999.
As Emerging Markets went to press, the Supreme Court was scheduled to hear proceedings against the legality of Musharraf’s October 6 re-election, while a desperate marriage of convenience between Benazir Bhuto’s liberal Pakistan People’s Party (PPP) and the president looked more likely.
By early October, as the general’s hold on power strengthened, so too did the capital pour back. In recent weeks, investor sentiment has been buffeted by political turbulence, most severely in early August, which witnessed over $100 million in outflows. Surprisingly, investment flows remained fairly stable in the preceding months, despite the furore over the president’s dismissal of the country’s top judge and a military operation in a radical mosque that polarized the nation.
Jehangir Karamat, Pakistan’s former chief of army staff and an ex-US ambassador, argues that the military, which has in effect ruled the country for 32 years, will ultimately decide the tenure of any presidential candidate. “There should be no significant weakening of the president’s position, because he has the support of the military,” he tells Emerging Markets. In this regard, Musharraf’s appointment of his ally and deputy, general Ashfaq Kayani as chief of army staff, suggests that his grip on power is safe.
With parliamentary elections due in January and no political party capable of mustering a majority, Musharraf is likely to continue his strategy of uniting an awkward but broad coalition of liberals (Bhutto’s PPP), conservatives and Islamists – the Pakistan Muslim League (Qaid), which could remain a source of future instability.
Growing pains
State Bank of Pakistan governor Shamshad Akhtar argues that political volatility is an inevitable growth pain in an emerging democracy. “These short-term tensions are occurring because democracy is being restored in one form or another. These problems have risen because of the democratic institutions that the military government has nurtured,” she tells Emerging Markets.
She argues that from the chaos, a new re-invigorated political culture will emerge with more robust institutions. “It is natural that, sooner or later, big political parties will have to be part and parcel of politics in Pakistan. They have grassroots following, so if the natural process unveils, one would hope the political system will be stronger than in the past,” she says.
Akhtar argues that the economy in any case will be supported by a sound banking sector, which is already 80% privatized and provides a strong capital base, loan growth and foreign capital inflows. She is adamant that economic reforms are well entrenched, and that Pakistan’s risk premium has more to do with instability on the ground than an interventionist economic policy.
“Banks are now in the private sector, so owners are not going to take any political interference easily. In fact, there would be a huge hue and cry.” She concludes that sustainable economic growth and structural reforms are well entrenched in the conflict-ridden nation. “It will be difficult for any government to unwind the economic success story of Pakistan. And if they do that, they will risk being ousted very soon.”
Cause for concern
Crucially, the country has some ability to stave off an abrupt outflow of capital in the event of a political catastrophe, with foreign exchange reserves having climbed to $16 billion since Musharraf came to power. What’s more, recent political instability has not undermined economic policy continuity. For instance, privatization kick-started by the Bhutto government in 1988 has been followed through by nine successive administrations.
Yet, according to Sakib Sherani, chief economist at ABN Amro in Islamabad, investors have been lulled into a false sense of security. “Foreign investors have this benign view that, in Pakistan, there is noise in the system, but once you get used to things, everything pans out,” he tells Emerging Markets. But he warns that a polarized nation with an immature political culture and weak institutions, suggests the economy may have witnessed above-potential growth in recent years.
“I think now we are moving in a new paradigm. The centre of gravity may not be with Musharraf any more, and it is far from certain if things will be stable under his expected coalition with Bhutto. Given Pakistan’s weak institutional framework, in the medium term, there is serious cause for concern.”
Pakistan’s economic gains have relied on its pro-western stance. But given the tense political climate and a groundswell of antagonism – not to mention populist posturing of candidates in a US election year – sound economic policies look more certain for Pakistan than friendly US relations.