PAKISTAN: Frame by frame
Pakistan’s ongoing political tumult has left a federal budget in grave danger of being starved of funds – with potentially dire consequences for the economy
Even by Pakistani standards, the last year has been stormy. Domestic politics has been convulsed by a drawn-out standoff between the government and the Supreme Court and the approach of elections, while the international front has seen Pakistans relationship with America veering dangerously close to a permanent rupture.
We have a high tolerance for political volatility, finance minister Hafeez Shaikh tells Emerging Markets when asked to comment on how the political rollercoaster has impacted his efforts to bring stability to Pakistans economy. In most other countries, events of the sort we have seen would spill over into the economy, but our economy is more resilient and has withstood the storms quite well.
The events of the past year have been dramatic. Starting in the fall of 2011, Pakistan has seen the sudden emergence of a powerful third force on its political scene in the form of the Pakistan Tehreek Insaf (PTI), led by the charismatic cricketer-turned-politician Imran Khan. The PTI held a rally in Karachi on December 25 that attracted record crowds, and became the turning point in the partys emergence as a major political force from there onwards.
The same moment found the ruling coalition bogged down on two fronts. Its fragile yet crucial relationship with the US suffered a serious setback in November, in the wake of an American airstrike on a Pakistan army border outpost that resulted in the death of 24 Pakistani army personnel. Following the attack, Pakistan shut down all Nato supply lines running through the country and demanded a formal apology from the US.
Torturous diplomacy ensued until July of 2012 when a carefully-worded apology was delivered by Secretary of State Clinton to Pakistans foreign minister Hina Khar. Nato supplies resumed shortly after that, and an additional $1.1 billion payment was released by the US on August 2 under the Coalition Support Fund, designed to reimburse Pakistan for the support it gives the US in its counter-insurgency operations.
But the period of estrangement between the two allies saw inflows into the Pakistani economy come under stress. Apart from exports and remittances, all other inflows were reduced to a trickle, prompting the State Bank to warn in its annual report that the state of affairs must be brought to an expeditious end. Pakistan must make all efforts to resume financial inflows, the report stated, hinting at the dangers of a prolonged dry spell.
Pakistans growing isolation from the world community has imposed myriad costs on the economy. According to Ijaz Nabi, professor of economics at the Lahore University of Management Sciences and country director of the International Growth Center, the war on terror and the divergent pressures that grow out of it have made it difficult for Pakistan to do well in areas where it enjoys a comparative advantage.
In textiles, for instance, the most value-added portion of the cotton-based export industry, Pakistani manufacturers have found it difficult to interact with their foreign buyers. There are more buyers in the lobby of a hotel in Dhaka on any given day than there are in Pakistan in an entire year, says Nabi, highlighting the sorts of challenges that the war on terror has placed on the countrys economy. On the domestic front, the ruling coalition has walked a tight rope between the various political actors that populate the stage in Pakistan.
The Supreme Court has demanded the government reopen graft proceedings against the president in Swiss courts, a demand the government has rejected on the grounds that the president enjoys immunity from prosecution. This has led to a protracted standoff that has seen one prime minister disqualified from office and the country in thrall while economic problems linger. The standoff was prolonged in late September, with the Supreme Court giving the government until October 5 (at the time of writing) to draft a letter to the Swiss authorities to reopen the proceedings. The corruption allegations date back to the mid-1990s when president Asif Ali Zardaris wife, Benazir Bhutto, served as prime minister. Both Bhutto who was assassinated in 2007 and Zardari have denied any wrongdoing and have said the bribe-taking accusations against them were politically motivated.
INTO THE PROVINCES
The provincial governments have emerged as important economic stakeholders after the last National Finance Commission (NFC) Award, which has devolved the majority of government revenues to the provinces in a grand experiment at restructuring the federation. Finance minister Hafeez Shaikh points to the award as the main reason behind the governments mounting fiscal difficulties, saying that 77% of federal receipts are now transferred to the provinces. Everything the federal government does has to be managed in the remainder [23%], he says. Debt servicing, subsidies, defence, all federal expenditures now have to be met from the very small fiscal space left for the federal government. Pakistan ran a record high deficit in fiscal year ended June 2012, coming in at 8.5% of GDP.
Government borrowing from domestic banks in the first few months of the current fiscal year is now nearly twice what it was in the same period last year, coming in at 324 billion rupees ($3.4 billion), most of which is accounted for by the federal government and not the provinces, according to data from the State Bank.
The politics of managing a coalition government in Pakistan have become very difficult indeed in the wake of the NFC award, says Ijaz Nabi. Provincial transfers should have been made conditional on improved revenue performance by provinces, he says.
This view is shared by others, and some have argued that a stand-still arrangement of some sort may become necessary to stop the large provincial transfers until they have developed the capacity to utilize the additional resources effectively; new revenue sources must be found to compensate the federal government for the revenue loss it has had to suffer on account of the award.
Sakib Sherani, who served as principal economic adviser to former finance minister Shaukat Tarin, under whose leadership the NFC award was negotiated, said in a widely-read article that servicing the fiscal transfers to the provinces was contingent on additional resource mobilization [by the federal government]. While the introduction of VAT was explicitly discussed in the NFC deliberations as a prerequisite for the framework to be viable, it was not made a formal, binding part of the NFC agreement. This was a mistake.
Others point to the failure in arranging additional revenue lines, and the failure to devolve expenditure heads to the provinces as important stumbling blocks in the effort to stabilize the governments increasingly precarious fiscal situation.
Meekal Ahmed, who has served as adviser to the executive director for Pakistan on the board of the IMF, believes the failure to reform is the root of the governments problems, saying that for the past four and half years there have been no reforms, even of the cosmetic variety, that the government has been able to implement. He describes the governments strategy as financing with no adjustment and adds that he cannot recall a similar long period of policy paralysis in Pakistans history.
Given the large-scale devolution of fiscal authority and governance responsibilities to the provinces, the largest of which the Punjab is controlled by the opposition party, any attempt to fix Pakistans fiscal situation necessarily becomes a political exercise as much as it is an economic one. The question of fiscal responsibility should be seen as a national one, and not simply as a federal one, says finance minister Hafeez Shaikh, urging a wider dialogue and ownership of the countrys fiscal health involving provincial authorities as well.
Complicating the picture is the arrival of the elections. A date for the polls has not been announced yet, but they must be held before March 2013. Already the government has been approving development projects in large amounts with Rs360 billion ($3.8 billion) set to be spent on a Public Sector Development Programme during this fiscal year, and press reports have suggested that a large plan is being drawn up to spend on power sector subsidies. The finance minister did not deny these reports, but declined to provide numbers on the size of the borrowing that may be coming, saying only that it will not exceed what it has been in the past few years.
Fiscal policy is not the only area affected by multiple decision-making centres. One of the governments biggest accomplishments has been the normalizing of trade ties with neighbouring India. In November 2011, the federal cabinet agreed to grant Most Favoured Nation trading status to India, although the actual grant of MFN has yet to be made. Nevertheless, coming in the shadow of the 2008 Mumbai attacks, moving the trade talks forward has been a big achievement widely hailed by business bodies in Pakistan.
Trade liberalization with India could have gone much further were it not for politics, says Nabi, who has worked extensively on the subject. He thinks the government could have made far more progress on this front, but it is not the sole decision maker on this issue. The pace of progress has been affected by other players. He declines to identify the other players, but it is widely understood in Pakistan that sections within the defence establishment would prefer to continue seeing India as a strategic competitor rather than a trading partner.
Pakistans economic performance has had to find its way through a political labyrinth in the past year. The countrys growing isolation has been matched by a fractious and noisy political stage, which has often drowned out the voices of reform. The finance minister personified the situation in his last budget speech, as he strained to be heard in a noisy and riotous parliament in which opposition lawmakers were shouting slogans, trying to cover his voice. In the end, he had to cut his speech short and resume his seat as the shouting gave way to jostling and a fist fight. A better metaphor for the economys predicament would be hard to find.