An economy on the mend

Pakistan has no shortage of challenges to deal with. While many countries have been battling with the pressures of the global financial crisis, for Pakistan it is merely one element of the struggle. Threats to its national security, as well political volatility and domestic economic turmoil, are as great if not greater risks than those arising from the credit crunch.

It is all a far cry from the first half of the last decade. A rocketing stock market, GDP growth storming along at 7 per cent, considerable progress in privatisation of the banking sector and rapid expansion in telecoms all contributed in a dynamic mix.

But the combination of increasing instabilities, economic and political, brought the country to crisis point in 2008, forcing it to turn to the International Monetary Fund (IMF) for help.

Rising militancy along the country's western border, rising global commodity prices, notably in oil and food, and a crash in the rupee all hurt the economy. Shortage of power supply hit the main manufacturing base and largest earner of foreign exchange, namely the textile sector, accounting for 66 per cent of merchandise exports.

Trade and current account deficits deteriorated sharply, so too inflation (to 25 per cent), with a budget deficit boosted by energy subsidies being monetised by the central bank.

At that juncture the global financial crisis really kicked in. Exports fell, and multinationals in the country trimmed their operations. The stock market slumped as domestic and foreign investors alike pulled out. Declining foreign reserves rounded off what was a catalogue of misfortune.

IMF to the rescue

In 2009 the economic crisis eased a little, and fiscal and payments imbalances narrowed. Foreign reserves rose, boosted by official aid. But inflation remained high and growth retreated, reflecting lower government investment, trying to control the fiscal deficit, though military spending continued to impose a strain.

At the beginning of this year the IMF disbursed a $1.2 billion (about Dh4.4 billion) loan instalment, taking the total amount Pakistan has received to $6.5 billion, aimed at bolstering the balance of payments to avert default on foreign loans. The original total loan of $7.6 billion has been extended to $11.3 billion.

Accepting support from the IMF is not without its conditions, including the elimination of all subsidies on energy, slashing government spending, and raising taxes. As is often the case with such packages, it was not a popular medicine. The assistance comes with ongoing scrutiny. Last month the IMF issued a relatively upbeat statement saying that "Pakistan's programme is progressing well. All quantitative performance criteria for end-December >were observed, except for the budget deficit target, which was exceeded by a small margin". The communiqué went on, "the early signs of recovery in some sectors and the improved external position are encouraging", but that "the growth outlook is subject to risks: most prominently the domestic security situation and reliability of electricity supply, as well as the pace of global economic recovery". A qualified endorsement.

Towards a stable outlook

In a world very much focused these days on creditworthiness, this IMF involvement has enabled the rating agencies to take a slightly more favourable view. Moody's commented that a change in outlook from ‘negative' to ‘stable' reflected "the stabilisation of economic and financial strength, albeit at low levels". Their report, published at the end of last year, went on: "The country's growth downturn is bottoming out, near-term external liquidity has improved, and macroeconomic imbalances are on the mend".

It's not only from the IMF that Pakistan has been receiving assistance. Early last year nearly 30 countries and international organisations met in Tokyo to offer financial support to Pakistan in its fight against Islamic extremism. The US pledge of $1 billion was described as a down-payment on the previously announced $1.5 billion already promised for each of the next five years. The European Union promised $640 million over four years, while reports said Saudi Arabia had pledged $700 billion over two years.

Not surprisingly, one area where funds have not been flowing in so much is from foreign direct investment (FDI). Having reached record levels, escalating from $1 billion in 1999 to $8.4 billion in the financial year 2006/07, latest figures show that FDI fell nearly 55 per cent in the first seven months of the current fiscal year, according to the State Bank of Pakistan (SBP), to $1.18 billion from $2.59 billion a year earlier. Concerns about the political and security situations are clearly deterring international investors.

One positive note has been the high levels of remittances of non-resident Pakistanis working overseas. They have been on the rise since 2001, helping keep the current account deficit in check. Growing more than sixfold, they amounted to 4.7 per cent of GDP in 2009, up from 1.5 per cent in 2001. The US, Saudi Arabia, and the UAE are the largest source countries, contributing almost two-thirds between them.

What sign, then, of an upturn? According to the State Bank of Pakistan (SBP) there is a chink of light, with the prospect of returning to macroeconomic stability and a forecast of full year GDP growth of 3.3 per cent, slightly higher than the 2.0 per cent seen in 2009. Similar muted expressions of optimism have come from the Asian Development Bank, which states that agriculture is expected to continue its strong growth on the back of increased public spending on the sector. Similarly, industry is forecast to turn marginally positive as the commissioning of new power plants reduces electricity outages. However, the pace of growth in exporting sectors will depend on the scale of recovery in Pakistan's main trading partners.

The current account deficit is likely to narrow further in 2010, down to below 4.8 per cent from last year's figure of 5.3 per cent, according to SBP's projections, although a revival in import demand from manufacturing and rising oil prices may limit that improvement. Inflation is projected by the SBP to decelerate, more than halving to nearer the target of 9 per cent. Combined with a continued depreciation of the exchange rate, that is expected to help sustain export competitiveness.

Foreign aid

Under the IMF's watch, Pakistan has targeted an increase in its fiscal deficit to 4.9 per cent of GDP (2009/10) from 4.3 per cent (2008/09). A key factor in the budget is that the government is counting on foreign aid to fund almost a third of next year's shortfall. The introduction later this year of value-added tax is intended to close the gap.

The risks, nonetheless, remain there: most notably for an energy-deficit country that of a rising oil price, but particularly also the cost of funding the effort against insurgency, and the impact this threat has on the business community's willingness to invest.

Any sustained upturn in the economy is predicated on stabilisation of the security situation. However, support of the international community, and modest signs of growth in the domestic economy, may be seen as an early tilt back in the right direction.