I. Introduction
During the last few
years Pakistan has witnessed
a sharp improvement
in its financial sector.
From a situation of
unsustainable fiscal
and balance of payment
deficits a few years
ago, the balance of
payments has turned
into a surplus and there
has been a sharp decline
in the fiscal deficit.
The fiscal deficit has
fallen to 4 per cent
of GDP, balance of payments
has a surplus equivalent
to 3.9 per cent of GDP,
foreign exchange reserves
have exceeded US$ 12.5
billion, exports are
growing at a rate of
more than 15 per cent,
workers' remittances
are expected to range
between US$ 3.5-US$
4.0 billion, the interest
rates have fallen to
less than 7 per cent,
rupee has stabilised
and the inflation rate
ranges between 3 to
4 per cent. The real
sector of the economy
has also shown improved
performance during 2002-03:
growth rates of GDP,
agriculture and the
large scale manufacturing
sector have been 5.1,
4.1 and 8.7 per cent,
respectively. Moreover,
the GDP growth is expected
to be more than a target
of 5.3 per cent for
the current year and
the growth rate of the
manufacturing sector
will be in double digits.
This indeed shows a
remarkable turn around
in the economy over
the last couple of years.
The rising growth rates
of per capita income
are expected to ease
the employment and poverty
situation.
The strong financial
macroeconomic indicators,
however, have so far
failed to raise the
rate of investment;
fixed investment in
2001-02 and 2002-03
has been just 13.1 per
cent of GDP. With this
level of investment,
the growth rates of
no more than 4 per cent
can be sustained in
the long run. Considering
that there is no longer
the debt-hangover and
due to the continuity
of the policies for
more than three years
and resolve of the government
to honour the agreements
reached by the previous
government, the perception
of investors is likely
to improve regarding
the investment climate
in Pakistan. It needs
to be underlined that
the higher levels of
investment are a pre-requisite
for sustained growth
of per capita incomes,
human development, employment
generation and better
living standards.
In this paper, I will
examine structural changes
brought about in the
fiscal, monetary and
financial sectors as
well as in the real
sector of the economy.
II. Fiscal
and Monetary Policies
Fiscal deficit as a
proportion of GDP is
a crucial variable both
for the stability of
the economy as well
as for investors' confidence.
High fiscal deficits
raise the inflation
rate and may crowd out
private investment.
Since high fiscal deficits
imply an increase in
the tax rates or a reduction
in the development expenditure
resulting in poor and
inadequate infrastructure,
investors are reluctant
to invest. Accordingly,
Pakistan has been grappling
with the handicap of
fiscal deficit. When
Pakistan signed the
first of many Structural
Adjustment and Stabilisation
Programs with the IMF,
the fiscal deficit in
1987-88 was as high
as 8.5 per cent of GDP;
by 1998-99 the fiscal
deficit was brought
down to 6.1 per cent.
While the deficit increased
to 6.6 percent in 1999-2000,
it had gradually declined
to 4.5 per cent by 2002-03
and the target for the
current year is 4.0
percent of GDP. A number
of factors have been
responsible for the
decline in the fiscal
deficit, including the
debt reprofiling, slow
growth of public debt,
decline in the interest
rates, reduction in
the development expenditure
and an increase in non-tax
revenues1.
We may also note that
in the process of reduction
in the fiscal deficit,
development expenditure
has fallen to such a
low level that it is
not even sufficient
for the provision of
physical and social
infrastructure2.
| Table
1: Budgetary Deficit
in Pakistan (as
percentage of GDP) |
| |
Total
Revenues |
Tax
Revenues |
|
Budgetary
Deficits |
Primary
Surplus |
| |
|
|
Total |
Non-
Development |
Interest
Payment |
Interest
Payment |
|
|
1987-88
1998-99
1999-00
2000-01
2001-02
2002-03 |
17.3
15.9
16.3
16.2
17.2
17.9 |
13.8
13.2
12.9
12.9
13.2
13.8 |
26.7
22.0
22.5
21.0
22.8
22.4 |
19.8
18.6
19.9
18.9
19.3
19.7 |
6.9
7.5
8.3
7.3
7.1
5.9 |
6.9
3.4
2.6
2.1
3.5
2.7 |
8.5
6.1
6.6
5.2
5.2
4.3 |
-1.6
1.4
1.7
2.1
2.5
1.6 |
| Source:
Pakistan Economic
Survey, various
issues. |
The long run viable
solution for a reduction
in the fiscal deficit
is to make the tax structure
elastic and progressive.
Whereas over the 1990s,
the direct tax structure
was marred by withholding
taxes that made most
of such taxes essentially
indirect, the replacement
of such taxes with the
proper income taxes
would hopefully help
in improving the elasticity
of the tax structure
and making it progressive.
Major structural changes
have been made in indirect
taxes, the share of
domestic taxes has increased
and import duties are
being levied only for
protection purposes;
tariff rates have been
rationalised and the
maximum import duty
has been reduced to
25 per cent3. The share
of customs duties in
the total tax revenue
declined from 40.7 per
cent in 1987-88 to 21.0
in 1998-99 and further
to 10.4 per cent in
2001-02. Similarly,
the share of excise
duties has declined
from 18.8 per cent in
1987-88 to 8.6 per cent
by 2002-03. The share
of sales taxes, however,
increased from just
9.3 per cent in 1987-88
to 35.6 per cent by
2002-03. In the future,
the sales and income
taxes will be the two
main sources of tax
revenue; while tariffs
will be levied for protection
purposes and excise
taxes on products with
an attempt to reduce
consumption of certain
products.
| Table
2: Tax Structure
of Pakistan |
| (%age
share of tax revenues) |
| |
Direct
Taxes |
Indirect
Taxes |
| |
|
Total |
Tariffs |
Sales |
Excise
Duties |
1987-88
1998-99
1999-00
2000-01
2001-02
2002-03 |
13.3
27.0
28.5
29.1
30.8
27.7 |
86.7
73.0
72.3
75.8
69.4
72.3 |
40.7
20.1
15.2
14.7
10.0
12.5 |
9.3
17.6
28.8
34.8
34.9
35.6 |
18.8
16.0
14.1
11.4
10.2
8.6 |
| Source:
Based on data derived
from Pakistan Economic
Survey, various
issues. |
As pointed out earlier,
fiscal deficit and the
money supply are interrelated.
The pursuit of monetary
policy is rather difficult
when the financing of
the fiscal deficit absorbs
a large proportion of
the increase in credit.
Fortunately, because
of the decline in fiscal
deficit in recent years,
there is little demand
by the public sector
for the bank credit
and that has made it
easier for the State
Bank of Pakistan to
meet the credit needs
of the private sector
at low interest rates
without worrying too
much about inflationary
tendencies in the economy.
For example, in 1998-99
money supply was contained,
but credit to the private
sector increased sharply.
However, in the next
two years, credit demand
of the private sector
slackened due to various
reasons resulting in
excess liquidity with
banks. During the last
two years, the money
supply has increased
rather sharply because
State Bank of Pakistan
purchased foreign exchange
from the banks and open
market. Despite the
sterilisation,4
money supply increased
at rather high rates
of 15.4 and 18.0 per
cent in 2001-02, and
2002-03, respectively.
The increase in money
supply so far has not
fuelled inflation but
if the money holders
decide to spend, the
inflation rates would
tend to rise.
Table
3: Growth Rate of
Money Supply
(Percent) |
| |
Public
Sector
Borrowing |
Budgetary
Support |
Private
Sector |
Money
Supply
(M2) |
1987-88
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03 |
17.3
8.4
-11.8
13.3
-7.1
3.7
-11.6 |
13.3
9.5
-13.6
7.9
-6.0
2.9
-8.3 |
13.4
13.8
17.1
3.2
8.2
2.5
16.2 |
12.2
14.5
6.2
9.4
9.0
15.4
18.0 |
| Source:
Pakistan Economic
Survey, various
issues |
There have been important
developments in the monetary
sector over the last few
years. The State Bank
of Pakistan has been given
full autonomy and it is
using market based instruments
to: control the money
supply, auction the government
securities through bids,
develop secondary securities
market, withdraw restrictions
on the maximum and minimum
rates of return on the
deposits and improve the
State Bank's regulatory
and surveillance capacity.
However, the infected
portfolio of banks is
still large and the decline
in non-performing loans
5
would help in reducing
the spread between deposits
and lending rates and
a further reduction in
the interest rate which
at present is around 7
per cent. Prudent monetary
policy has helped in bringing
stability to the economy
and the inflation rates
that used to be in double
digits up to 1996-97 have
declined to less than
4 per cent.
| Period |
Consumer
Price Index |
Wholesale
Price Index |
GDP
Deflator |
1987-88
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03 |
6.3
11.8
7.8
5.7
3.6
4.4
3.5
3.1 |
10.0
13.0
6.6
6.3
1.8
6.2
2.1
5.9 |
9.6
13.3
7.7
5.9
2.8
6.0
3.2
4.5 |
| Source:
Pakistan Economic
Survey, various
issues. |
III. Trade
and Balance of Payments
Pakistan has been pursuing
a liberal import policy
for more than a decade.
There are only a few
products on the negative
list or subject to procedural
requirements, and none
of these are due to
balance of payments
or protection reasons.
Similarly, except for
a very few primary goods,
exports are not subject
to any restrictions
or procedural requirements.
Almost all manufactured
goods are provided with
duty-draw back, export
finance facility and
income tax rebates.
These facilities, in
recent years, have also
been extended to small
and indirect exporters6.
With liberalisation
of imports and reduction
in the anti-export bias,
there has been sharp
increase in the openness
of the economy: from
28.3 per cent of GDP
in 1987-88, it has increased
to 32.4 per cent of
GDP in 2002-03.
| Table
5: Degree of Openness
in Pakistan's Economy
(% of GDP) |
| |
1987-88 |
1992-93 |
1997-98 |
2001-02 |
2002-03 |
Exports
Imports
Degree of openness |
11.6
16.7
28.3 |
13.2
19.6
32.8 |
13.6
16.6
30.2 |
15.5
16.0
31.5 |
15.8
16.6
32.4 |
| Source:
Pakistan Economic
Survey, various
issues. |
The exchange rate is
a crucial variable in
the export competitiveness
and the allocation of
resources. Because of
the double digit inflation
rates in the 90s, there
have been frequent devaluations
of the Pakistani rupee.
However, because devaluation
was less than the increase
in the relative inflation
rate, the competitiveness
of the exporters was
eroded. By 1997-98,
the real exchange rate
had in fact appreciated
by 8.7 per cent. However,
since 1999 Pakistan
is pursing an active
exchange rate policy
and the rupee has been
floated over the last
couple of years, though
the State Bank has made
major interventions
in the market. The Pakistani
rupee is convertible
at the current account,
resident Pakistanis,
including firms and
companies, are allowed
to maintain foreign
currency accounts in
Pakistan and rules governing
private sector's foreign
borrowing have been
liberalised, especially
where no government
guarantee is required.
During 1998-99, when
sanctions were imposed
on Pakistan, both exports
and imports went down
rather significantly.
Whereas exports gradually
increased- during 2002-03-
they grew at a rate
of 22.2 per cent7- the
imports stagnated due
to low levels of economic
activity. However, in
2002-03 imports increased
by 19.2 per cent. Because
of sharp increase in
workers remittances
as well as in the decline
in the trade surplus
and the interest payments,
the current account
balance of payments
in both years 2001-02
and 2002-03 turned into
surplus.
| Table
6: Trends in Balance
of Payments |
| Years |
Exports |
Imports |
Trade
Balance |
Remittances |
Current
Account |
1987-88
1995-96
1998-99
1999-00
2000-01
2001-02
2002-03 |
4362
8311
7528
8190
8933
9140
10889 |
6919
12015
9613
9602
10202
9434
11425 |
-2557
-3704
-2085
-1412
-1269
-294
-536 |
2013
1461
1060
983
1087
2389
4237 |
-1682
-4575
-2429
-1143
-513
+1338
+3028 |
| Source:
Pakistan Economic
Survey, various
issues. |
Foreign exchange reserves
are required for stability
of the exchange rate,
ensuring sustainability
of government policies,
especially trade policies,
to improve the credit
rating of a country,
to help in increasing
the investment levels
and to insulate the
economy from a variety
of internal and external
shocks. The experience
of a large number of
developing countries,
including Pakistan,
shows that inadequate
foreign exchange reserves
force them to suspend
policies, which impacts
adversely on the levels
of investment, growth,
employment and poverty.
Foreign exchange reserves
in Pakistan have traditionally
been low and they rarely
crossed US$ 2 billion.
After the imposition
of sanctions in 1998,
the reserves had been
hovering around US$
1 billion and with rather
high debt servicing,
Pakistan was on the
verge of default. However,
because of the reduction
in trade deficit, the
sharp increase in workers
remittances and deposits
of overseas Pakistanis,
and due to capital inflows,
instead of hundi or
informal channels, the
foreign exchange reserves
have increased sharply.
The foreign exchange
reserves have crossed
US$ 12.5 billion8 of
which around US$ 11
billion are owned by
the State Bank of Pakistan
and the remaining are
resident and non-resident
accounts with commercial
banks. The increase
in the foreign exchange
reserves and the expectations
that they may increase
further has definitely
improved the creditworthiness
of Pakistan and is well
reflected in its credit
ratings. At the same
time it needs to be
underscored that accumulation
of reserves beyond an
optimal level is costly
and has to be avoided.
IV. Trends
in Debt and Debt Servicing
Whenever public debt,
especially foreign debt,
assumes significant
proportions, resource
inflows dry out and
sometimes there is transfer
of resources from the
debtor counties. Investment
tends to fall as the
debt rises beyond safe
limits, investible resources
fall due to sharp increases
in debt servicing, investors
loose confidence, demand
falls to low levels,
interest rates start
rising and there is
massive capital flight.
Since the debt servicing
assumed alarming proportions
in the mid nineties,
it is no wonder that
the debt problem has
been haunting the policy
makers.
Public debt increased
from Rs. 538 billion
in 1987-88 to Rs. 3077
billion in 1998-99 and
further to Rs. 3783
billion by 2000-01,
i.e., 79.8, 104.7 and
113.5 per cent of GDP,
respectively. Internal
debt increased from
Rs. 290.1 billion in
1987-88 to Rs. 1392.5
billion in 1998-99 and
further to Rs. 1731
billion by 2000-01.
Similarly, external
obligations increased
from Rs. 247.9 billion
in 1987/88, to Rs. 1614.4
billion in 1998-99,
and to Rs. 2059.5 billion
in 2000-01. However,
the total debt has stabilised
and, as a percentage
of GDP, has declined
to 95.1 per cent in
the last couple of years.
A number of factors
have been responsible
for this turnaround.
Firstly, there have
been smaller budget
deficits and at least
a part of them have
been financed through
grants rather than loans.
Secondly, some of the
debt has been written
off, while some has
been converted into
debt-social sector spending
swaps. Third, there
has been a reduction
in the interest rate
and the borrowing for
repayment has been less
costly. Fourthly, the
appreciation of the
rupee against the dollar
has also meant a reduction
in foreign debt denominated
in the local currency.
| Table
7: Profile of Domestic
and External Debt |
| |
| |
FY
99 |
FY
00 |
FY01 |
FY02 |
FY03 |
| Total
Debt |
3,077.0 |
3,336.8 |
3,884.5 |
3,783.0 |
3,821.6 |
1.
Domestic Debt
2. External Debt
3. Explicit liabilitiesa
|
1,392.5
1,614.4
70.1 |
1,578.8
1,682.7
75.4 |
1,731.0
2,059.5
94.0 |
1,717.9
2,005.6
59.5 |
1,852.4
1,927.7
41.6 |
| As
Percent of GDP |
Total
Debt
Domestic Debt
External Debt
Explicit Liabilities |
104.7
47.4
54.9
2.4 |
106.0
50.2
53.5
2.4 |
113.5
50.6
60.2
2.7 |
104.3
47.3
55.3
1.6 |
95.1
46.1
48.0
1.0 |
| Total
Public Debt Servicing |
343.1 |
366.3 |
340.3 |
431.2 |
304.7 |
Total
Public Interest
Payments
i. Domestic
ii. Foreign
iii. Explicit liabilities
Repayment of Principalb |
220.1
178.9
38.0
3.2
123.0 |
269.2
218.7
44.9
5.6
97.1 |
254.4
195.4
51.2
7.8
85.9 |
266.3
199.6
61.1
5.6
164.9 |
241.3
198.0
39.8
3.5
63.4 |
| Ratio
of External Debt
Servicing to |
Export
Earnings
Foreign Exchange
Earnings |
35.3
23.6 |
36.5
23.4 |
38.0
23.7 |
44.8
26.5 |
28.8
16.0 |
| Ratio
of Total Public
Debt Servicing to |
Tax
revenue
Total revenue
Total expenditure
Current expenditure |
87.8
73.2
53.0
62.7 |
90.3
71.5
51.7
58.5 |
77.1
61.5
47.4
52.7 |
90.2
69.1
52.2
61.6 |
54.8
42.3
33.9
39.0 |
| Source:
Pakistan Economic
Survey, various
issues. |
a)
Explicit Liabilities
include Special
US$ Bonds, FEBCs,
FCBCs and DBCs;
of which Special
US$ Bond is a foreign
liability, while
FEBCs, FCBCs and
DBCs are also foreign
liabilities payable
in Rupees.
b) Repayment of
principal includes
repayment of foreign
debt and short-term
credit.
Source: State Bank
of Pakistan, Annual
Report, 2002-03.
The debt servicing
as a percentage
of exports, foreign
exchange earnings,
or public revenues
has declined significantly.
This has been rather
helpful in the reduction
of the fiscal deficit
and the creation
of a fiscal space
that can be used
to increase development
expenditure. As
is well known, if
the public investment
is in the physical
and social infrastructures,
it crowds in private
investment. |
V. Growth,
Savings, Investment
and Productivity
The growth of GDP depends
on production factors
such as labour and capital,
and the levels of productivity.
We may note that the
productivity of labour
depends on the human
resources incorporated
in labour. Similarly,
accumulation of capital
through new investments
also results in embodied
technology resulting
in an increase in productivity
levels. In this section,
we examine the growth
rates of output, savings
and investment, human
resource development
and the growth of productivity.
Growth of GDP decelerated
in the 1990s. Whereas
in the 1980s GDP grew
at a rate of 6.5 per
cent, the growth rates
decelerated to 3.2 per
cent over the 1999-2002
period. Similarly, the
growth rates of agriculture
and manufacturing decelerated
from 5.4 and 9.2 per
cent in the 1980s to
1.0 and 4.9 per cent,
respectively, during
the 1999-2002 period.
However, the growth
rate of GDP increased
to 5.1 per cent in 2002-03,
and those of agriculture
and manufacturing to
4.1 and 7.7 per cent.
The large scale manufacturing
sector registered a
growth rate of 8.7 per
cent. Both because of
the increase in GDP
and the sharp increase
in worker' remittances,
the per capita income
has grown at a rate
of 6.6 per cent. For
the year 2003-04 the
growth rate of GDP is
expected to range between
5.5 and 6.0 per cent
with manufacturing growth
in the double digit.
| Table
8: Compound Growth
Rates at Constant
Factor Cost |
| Years |
1980s |
1987-88
to
1992-93 |
1992-93
to
1998-99 |
1998-99
to
|
