THE ECONOMIC CRISIS IN PAKISTAN AND THEIR SOLUTION

THE ECONOMIC CRISIS IN PAKISTAN AND

THEIR SOLUTIONS
Introduction

All the serious challenges Pakistan’s economy is facing today like very wide budget and
trade deficits, galloping inflation, increase in the level of poverty, power outages, water
shortages, closure of industries, food insecurity, etc, has diverted our attention from realizing
the very serious challenge that we have overcome. Since the 1950s we had a system in this
country where the Ministry of Finance and all the economic ministries were headed by World
Bank and IMF officials of Pakistan origin. With increase in the indebtedness of the country the
situation got from bad to worse. The worst period was the decade of the 1990s when not only
the economic ministries, but even prime ministers came from these institutions. During
negotiations between the Government of Pakistan (GOP) and the International Financial
Institutions (IFI)’s it was difficult to distinguish between the GOP and the (IFI)s, for both sides
comprised of IFI officials. These were very trying times for those of us who value
independence and economic sovereignty of the country.

Starting with this positive note let us now try to give some suggestions to the new
government on crisis management of the economy. But before we venture into discussing
specific problems and challenges let me present two broad observations. One that it is quite
acceptable for a country to deviate from its normal course during times of emergency and
ultimately come back to the designated path path. For example, the United States of America
states that it is committed to liberalization and globalization. Yet, in the aftermath of a crisis it
imposed a 30% tariff on the import of steel. Therefore, crisis management warrants we
deviate temporarily from liberalization to fix the distortion, and return to the path when
things return to normal. Second, in order to retain our economic sovereignty it will be better
not to resort to policy based lending.

Debt Management

The Debt/GDP ratio needs to be borne in mind when embarking upon further lending
from the IFIs. If the Debt/GDP ratio goes up to unacceptable limits, then the involvement of
IFIs in Pakistan’s economic affairs will be back and the elevation of elected representatives to
economic ministries will be a short lived phenomenon. Our experience shows that increase in
debt has led to installation of governments comprising of IFI officials of Pakistan origin. Thus
the very sovereignty of the country is at stake. Moreover it is in the interest of the country not
to increase the ratio as this is bound to increase the burden on our future generations.
The approach of the new Government in dealing with this problem appears to be in the right
direction. For example, recently the Finance Minister signed a debt development swap
agreement with the Italian Government for $100mn. This is a very desirable approach for it
breaks the deadlock between debt and development. This way Pakistan will be able to reduce
its debt burden, while at the same time bring development to the country.

Macroeconomic balance

The rate of growth of the economy during the last three four years improved a bit, but
was modest when compared with the rate of growth of our neighbors China and India.
Another feature of the growth phenomenon that needs to be looked into is the un-

PAGE 1
 THE ECONOMIC CRISIS IN PAKISTAN AND THEIR SOLUTION

sustainability of the growth rate. When the growth rate becomes a little respectable for two or
three years, prices start rising and almost immediately a clamour for a tight monetary policy
starts. Compare this with the Chinese experience, where the GDP grew at almost ten percent
during the last two decades before prices started rising. Why do prices start rising almost as
soon as the growth rate picks up? Are prices rising as a result of excess demand as a result of
government borrowings from the State Bank of Pakistan (SBP)? Or are prices rising due to
increase in the prices of oil, and the concomitant increase in prices of electricity, transport,
etc, which this increase brings about?

The two situations warrant very different approaches. If inflation is of the demand pull
type then tightening the monetary policy will, through dampening demand would bring prices
down. If, however, inflation is of the cost push type, then a tight monetary policy will make
matters worse. And that is what has been happening in Pakistan over the last few years.
Monetary policy has been used excessively to contain inflation, irrespective of whether it is of
the demand pull or cost push type. Even if prices are rising due to hoarding monetary policy
has been used and advocated to contain inflation. But such a tight monetary policy has
resulted in reducing the rate of growth of the economy, without reducing the rate of inflation.

What should the new government do to contain inflation? First, it needs to determine
whether prices are rising as a result of demand pull factors or cost push factors. If prices are
rising due to demand pull factors then tightening the monetary policy will be an appropriate
policy. But if prices are raising due to cost push factors then we need to identify the factors
that are pushing up prices and find alternatives to these. The excessive use of monetary policy
to fix up every problem in the economy is hurting the economy.

Monopolies and cartels have played a major role in restricting output and escalating
prices in Pakistan. Most of the members of cartels are ministers and other influentials. It thus
took several years for the Government to convert the Monopoly Control Authority (MCA) into
Competition Commission. The new Government needs to make it effective, formulate a
Competition Policy and enforce it. The Competition Policy is the appropriate policy to deal
with the problems of monopolies, hoarding, excessive profit margins, etc. The research of
(Wizarat, 2003) shows that several industries have very high concentration ratios and
Herfindahl Indices. And when there is collusion between these firms it produces a monopoly
situation, with the concomitant reduction of output and increase in profit margins. The
Competition Commission needs to compute Concentration Ratios and Herfindahl Indices in
each industry and determine the acceptable levels for each industry. And if the concentration
level in any industry exceeds the acceptable level, then the Commission should ensure that
through promotion of competition, the industries are made to conform to desirable behavior
and conduct.

Budget Deficit

The budget deficit for the first six months of FY 07-08 was 3.6% of the GDP and the
likely figure for the 12 month period is expected in the range of 6% of the GDP. Most of this
was on account of increase in development expenditure in the run up to elections, energy
related subsidies and the inability of the government to increase and diversify the tax base.

First let us see how this deficit can be curtailed. First on measures to curtail the
expenditure. Here the approach of the new government appears correct. The Prime Minister’s
decision to reduce the expenditure on the Prime Minister’s house by 40 % is a step in the right
direction. Similar steps to reduce non development expenditure on other federal and

PAGE 2
 THE ECONOMIC CRISIS IN PAKISTAN AND THEIR SOLUTION

provincial ministries and civil administration, along with the Finance Minister’s statement of
looking into possibility of reducing the defense budget are steps in the right direction. These
need to be supplemented with resolve on the part of the Government to curtail borrowing
from the State Bank of Pakistan. This will not only reduce the budget deficit, but also ensure
that the demand pull is not the major contributor to soaring of prices. Tightening of the
monetary policy will no longer be required and appropriate policies that deal with cost push
inflation will take care of the problem.

On the revenue side, the government will have to tap new sources to generate receipts
in order to bridge the gap. New sources for generating tax revenues should be those sectors of
the economy where profits have increased in the past few years, but have not been brought
within the tax net. These include agriculture and service sectors, especially oil companies,
banks and financial institutions and real estate.

Current Account Deficit

The external account deficit has widened, and is expected to cross US$10.5 billion in
FY07-08, to over 6.6% of GDP. The IFIs will I am sure offer their credits to cover the deficit.
But it would be very imprudent to fill up the gap by borrowing from the IFIs. It will not only
increase the indebtedness of the country, worsen the Debt/GDP ratio, with adverse
implications on the politico-social structure of the country.

The Government has to devise both a short term as well a long term policy to deal with
the situation. In the short run the Government should scrutinize the imports of the country
and temporarily halt the import of non essential consumer goods, luxuries, etc, so that oil,
machinery, capital goods, which keep the wheels of industry moving are not stopped. This
would be a temporary deviation from policy and not abandonment of the present policies.
This has been the practice in all the countries that are faced with a crisis situation as
discussed earlier by the imposition of a 30% tariff on the import of steel in the aftermath of a
crisis by the United States. Other countries have also resorted to such deviations from policies
in order to crisis manage their economies. The long run solution entails that the Government
finds substitutes to the essential imports that are soaring the import bill. We need to switch
over to the use of oil substitutes to generate power, transport lubricants, etc, and to cut down
on travel cost by providing low cost housing to laborers at the work place, etc. These would
result in reducing the dependence on imported oil. If the import bill is getting inflated because
of import of machinery and capital goods from Europe, where due to the rise in the value of
the Euro, the prices are high and increasing continuously, we need to explore other markets
like the Chinese for the supply of these machineries and capital goods to us. Import
substitution of these goods within the country also needs to be explored.

Agriculture

The government needs to develop its vision for agriculture. How does it want to use
agriculture for meeting the needs of the country. My vision for the agricultural sector is two
fold. First, use it to make the country self sufficient in food and industrial raw material.
Second, use it for providing high value added exports. Export of organic fruits and vegetables
can fetch good prices in the international markets. Instead of waiting for any type of land
reforms that will redistribute land to peasants, which seems quite unlikely, it will be advisable
for the government to distribute fallow land to the peasants and provide bank credit to
purchase inputs, manure, seeds, etc. Since this land has not been cultivated before, its yield

PAGE 3
 THE ECONOMIC CRISIS IN PAKISTAN AND THEIR SOLUTION

will be good. These small farmers should be encouraged to produce food items like fruits,
vegetables, rice, wheat, pulses, corn, barley, etc, both for the home market as well as for
exports. This will make the country self sufficient in food, earn foreign exchange and thus
reduce the deficit, improve the environment and health of the population by making healthy
food items available to the population.

Industry

The government also needs to decide about the kind of industrial structure it should
promote. Even during the 1960s when we used industrial policy very effectively, the tendency
to produce a wide range of commodities and the grant of across the board fiscal incentives
created imbalances. Formulating an industrial policy for the future necessitates that we
evaluate our strengths and weaknesses objectively and dispassionately. Both the principles of
static and dynamic comparative advantage should figure in such a policy formulation. The
industrialization of the under-developed areas should initially be based on the static
comparative advantage of these areas. Such industrialization can be reinforced with industry-
cum-area specific fiscal incentives. This will ensure a viable industrial structure in the rural
and hitherto under-developed areas. At the same time, a dynamic comparative advantage
should be nurtured in selected industries at the national level. Extreme care needs to be
exercised in the choice of these industries. First, these should be a select group of industries
and not a multifarious lot. Second, the country must possess some strengths in these
industries. Third, the income elasticity of demand for the products of these industries must be
high. This is how we can construct a viable industrial structure in Pakistan. (see Wizarat
2002)

Water and Power

Water and power scarcity are going to pose a major obstacle to the strategies
suggested above. Therefore, development of water and power development projects should
be given top most priority by the government. Power policy of the government should have
both a short term as well a long term plan. Bridging the gap between supply and demand in
the short run, when supply cannot be increased should focus on demand management and
reducing transmission losses. Both Commercial and domestic consumption of power has to
reflect the fact that there is a serious power crisis in the country. Ostentatious consumption of
electricity has to be banned with immediate effect. Lightening of wedding halls, hotels, public
buildings has to be banned. Celebration of religious and public events by lighting up buildings
will have to be postponed to times when the balance between supply and demand has been
restored. Till such time we will have to make do with decorating our buildings, lawns and
parks with flags, buntings and balloons. Domestic consumption of electricity can also be
brought down by educating the public and making them realize that it is in their own interest
not to waste energy. In the long run the increase in supply should be through developing
alternative sources of generating power like wind and solar energy instead of oil. This will not
only be environmentally friendly, but will also restore balance in the external account.
Vertically integrated industrial units producing their own power and selling it to other units
also will also increase the supply position as well as help to bring down the cost of production
of domestic manufacturing.

Water development projects are an absolute necessity for the agricultural

development envisaged earlier. The government should try and bear the following in mind
while developing water development projects. One, there are already great deal of

PAGE 4
 THE ECONOMIC CRISIS IN PAKISTAN AND THEIR SOLUTION

controversies with regard to water development projects in the country. Therefore instead of
creating any further controversies, it will be better to start with projects which do not arouse
the passions of the people of any province. Second, it will be preferable to start off with
medium to small projects.

Privatization

The government should take an overview of the present privatization policy of the
previous government. The typical neo liberal argument in favour of privatization of State
Owned Enterprises (SOEs) is government failure, as most of the SOEs have been inefficient
and a burden on the national exchequer. But what about institutions in the private sector that
have also been failures? What to do when there is both government failure as well as market
failure? There are so many such examples in Pakistan where there is both government failure
as well as market failure. Take the case of the Karachi Electric Supply Corporation (KESC). Its
performance was pathetic and it was a burden on the national exchequer when it was an SOE.
But its performance has deteriorated when it ceased to be an SOE and became a privatized
unit. It appears that there are certain features which remained constant to both the pre and
post privatized KESC. Moreover, the KESC also continues to be a burden on the national
exchequer. Since it was not making payments to WAPDA which prompted the City Nazim to
offer them money to make these payments. The KESC is thus continuing to be a burden on the
national exchequer. Its performance in terms of providing this essential service has also
deteriorated significantly. We have many other such examples in higher education
institutions, where there is both government failure as well as market failure? The new
government needs to do some innovative thinking on how to respond to these situations.

The government also needs to evolve a policy towards the privatization of strategic
assets of the country. For we see that in-spite of being committed to liberalization policies,
governments do protect their vital national interests. For example, when the privatization of
some port services to an Arab country was going ahead, public opinion forced the US
government to back track from its earlier stance and refrained from awarding the running of
the port to an Arab company.

Poverty and Income Distribution

Over the last about two decades policies have been generating poverty and the poverty
alleviation programs instead of making a dent on poverty, have resulted in elitist capture.
Pakistan has been converted into a country of ten millionaires and ten million baggers, with
the state having to take care of the ten million baggers. How should the government deal with
poverty and income distribution issues? Provision of infrastructure, giving assets like land to
agricultural peasants along with the development of a viable industrial structure will through
expanding employment alleviate poverty. These could be supplemented by micro finance
schemes to encourage small entrepreneurs.

Distribution of income can also be improved by targeting the supply of education and
health services to the poorer segments of the society. In view of the serious problems
encountered in the past in the supply of these services to the population, particularly in the
rural areas, totally different and innovative approaches will have to be adopted. These are not
being discussed here, but can be presented in a seminar on provision of health care and
education to the poor in Pakistan. Another suggestion to reduce the disparity between the
wealthy and the poor is to increase the share of direct taxes in total taxes, for in the past the

PAGE 5
 THE ECONOMIC CRISIS IN PAKISTAN AND THEIR SOLUTION

tax structure has become more regressive as a result of increase in the share of indirect taxes
in total taxes.

Institutional Back up

Economic research institutes in the country have to play their role by providing their
input, evaluating government performance and providing policy guide lines. But these
institutes are faced with a decline and/or are being used for political agendas. A public sector
economic research organization has a PhD in Mass Communication as its head; another also
has a head whose qualifications do not match the requirements of the research institute. Most
of the research institutes in the country are under the control of a lobby that it has political
ambitions. So the chattering class of the country is controlled by a lobby which will not be
very charitable to the government. Even if the government performs well, it will not be in
their personal interest to admit about their good performance. Moreover, the lobby is very
powerful and resourceful. So even if any institution is not within its ambit, it will not take very
long to bring these under control. In such a situation, who will provide the research input to
the new government? Who will evaluate the performance of the government honestly? And
who will provide correct policy guidelines to the government free of any personal interest or
axe to grind? In this scenario should the government establish new institutes to provide these
services to the government? Or should it try to reform the existing institutes, purge them of
politics, bring competent and independent leadership to the fore front? It is the latter option
that will be preferable as it will avoid wastage of public resources and extend the control of
the government to institutions which will be beyond reform if left any longer.

PAGE 6