Challenges and prospects

In order to address the lack of understanding of the economic policies and reforms being pursued by this government by many in media, at the outset, it will be instructive to provide a context and a backdrop to our current economic situation. I will do this by answering two related questions: 1) Where Are We? and, 2) How Did We Get Here?
As you are aware, Pakistan experienced an episode of high growth rate of the economy - lasting 4 years - between 2004 and 2007. During this period, the economy grew by an average of 7.3 percent each year, with most macroeconomic indicators depicting positive momentum. Foreign direct investment in the economy, privatisation receipts, foreign exchange reserves, and bank borrowing by the private sector - all rose to record highs.
In addition, economic prosperity "appeared" to be wide spread. What was true for Pakistan was true for the global economy. For several years prior to the start of the global financial crisis in 2007, the world was experiencing an unprecedented economic boom - one of the longest periods of economic expansion, and the most sustained and robust increases in per capita incomes the world has ever known.
In addition, it was the most globally diversified and geographically widespread period of economic growth in history, with both developed and developing countries from all continents and regions participating. However, in the summer of 2007, this supposedly "miracle" global economy suddenly and dramatically plunged into the depths of the severest recession in living memory, skirting close to one of the greatest "depressions" in all of economic history.
SO WHAT HAPPENED?The dramatic unravelling of the global economy, and Pakistan's own economic difficulties since then, reveal the "weak" foundations on which both expansions were built. The root cause for the dramatic rise - and equally dramatic fall - of Pakistan and the world economy was the policy of "easy credit" promoting excessive consumption in the economy.
As we have known all along, but seem to forget in the heady days of growth: debt-financed consumption beyond a certain point is ultimately unsustainable - whether by households, by individual firms, or by countries. If the debt is not used to expand the productive capacity of the economy, but is used to finance current consumption, there will always be a problem at some stage.
So what do the numbers tell us about Pakistan's economic performance between 2001 and 2008?
1) Pakistan's growth was driven largely by private consumption and not by investment. While private consumption rose from 74 percent of GDP to 79 percent of GDP, investment rose more modestly.
2) Total public debt - that you and I and our future generations have to pay - went up massively, from Rs 3.8 trillion in FY2004 to Rs 5.9 trillion in FY2008, an increase of 56 percent in four years. A large part of the increase in debt servicing that the budget is currently burdened with dates back to the irresponsible fiscal management of the 2004-2008 period.
3) Out of this, the previous government printed currency to the tune of Rs 720 billion (ie borrowed from SBP) in just two years, fuelling inflation massively in the economy.
4) The fiscal deficit - representing the cumulative new borrowing the government has to undertake - rose to nearly 8 percent of GDP in 2007/08.
5) In absolute terms, this was Rs 781 billion - the highest ever deficit run by Pakistan in its history.
6) Borrowing by the private sector rose seven fold between 2004 and 2007 - much of it channelled not into new manufacturing plants but into investment in the Karachi Stock Exchange or the property market in Dubai.
7) On the external side, the current account deficit swung from a nominal surplus to a deficit of 8.5 percent of GDP.
8) Imports rose 2.5 times during this period, while export growth was only 1.5 times. By 2008, Pakistan's exports were financing only 47 percent of its import bill. While oil imports constituted a large part of the total import bill, imports of consumer goods - cars, mobile phones, durables, fashion accessories, and food items such as fresh vegetables and fruits, among a range of other non-essential goods, had risen enormously, accounting for a substantial part of the non-oil import bill.
In essence, Pakistan's economic policies were providing jobs and stimulus to the economies of its trading partners - not to its own economy! I am sure you will agree this was an unacceptable situation. What was true for explaining the remarkable expansion in both the global as well as Pakistan's economy, was also true for explaining the downward spiral in both cases.
Not for the first time Pakistan underwent a "boom-bust" growth cycle. Policymakers repeated the same economic growth-model - and hence, the same mistakes - of the past, by trying to grow the economy on external assistance and borrowed money.
If we "map" what economists call the incentives framework in the economy we find the following features:
-- No capital gains tax on equity investments (which led to foregone tax revenue for the government of Rs 120 billion in 2007 alone);
-- No capital gains tax on real estate transactions;
-- A heavy promotion of consumer credit;
-- A liberal import regime;
Under this incentives framework, Pakistan's domestic manufacturing base was being replaced by imports, and new investment was being diverted to trading rather than manufacturing. Unfortunately, while there was political and economic stability for several years between 2002 and 2008 - an ideal environment for serious, deep-rooted structural reform - instead there was an absence of meaningful reforms in critical areas of the economy.
FOR EXAMPLE:
-- The Tax-to-GDP ratio stagnated / declined to its lowest level in the history of Pakistan.
-- No restructuring of Public Sector Enterprises (PSEs) took place. As a result these entities continue to place a heavy burden on consumers and taxpayers- to the tune of Rs 250 billion a year.
-- The size of the Public Sector Development Programme (PSDP) grew manifold, without a commensurate increase in either tax revenues to finance the increase, or any improvement in the absorptive capacity of different tiers of government to identify, implement and monitor projects.
-- As a result, not only did government borrowing shoot up, but it also created a huge backlog of unfinished projects (called throw-forward) of several trillion Rupees - a sign of serious fiscal mis-management.
-- The stock of both external as well as domestic debt rose sharply. The growth episode of 2003-2007 did manage to reduce headcount poverty, but as has been demonstrated since the last number was released for 2007/08, the gains were transient and have not been sustained.
In addition, with no changes to the institutional framework, any poverty-reduction that took place was incidental to the growth process, and not central to it. That is the key point that I will re-emphasise. Under the growth model that has been used in Pakistan, poverty outcomes have been driven more by chance than by policy. So this is the major paradigm change we are working to achieve.
NINE POINT PLAN Cognizant of the limitations of the growth strategy followed in the past, which has invariably produced boom-bust cycles, and has invariably been followed at various intervals by a balance of payments crisis, the present government is embarking on a fundamental change of the development paradigm.
The new growth strategy is embodied in the government's "Nine-Point" plan, which seeks to foster sustainable and more equitable growth by means of structural improvements in the productive sectors of Pakistan's economy.
The nine areas that have been identified for serious and sustained policy intervention include:
1) Macroeconomic stabilisation
2) Social Protection
3) Agriculture
4) Energy
5) Improving industrial competitiveness
6) Infrastructure development through innovative use of Public-Private Partnership (PPP) models
7) Increasing the depth of Capital Markets
8) Human Capital
9) Administrative and Governance reform
While we have embarked on our journey of fundamental reform in the economy in extremely challenging circumstances - with the largest deployment of our armed forces in active combat within Pakistan's borders since 2008; the largest populations of internally displaced people (IDPs) in the world; and the severest economic conditions of the global economy since the Great Depression of the 1930s - we have already met some initial successes.
THESE INCLUDE:
1) A reduction of the fiscal deficit to 5.2 percent of GDP in 2008/09, a fiscal adjustment of over 2.4 percent of GDP in less than a year,
2) A containment of the external current account deficit to 5.3 percent of GDP, from 8.5 percent;
3) A build up of foreign exchange reserves to over US $16 billion, from their low of under US $6 billion in October 2008;
4) One critical element of the improvement in the Fx reserves position has been the sharp rise in worker remittances into Pakistan. Since the launch in May this year of our special initiative called the Pakistan Remittance Initiative (PRI), remittances have increased nearly 25 percent year-on-year. In September 2009, worker remittances through official channels crossed US $800 million for the first time in the history of country.
5) Inflation has been brought down from 25 percent in October 2008, to 10.5 percent as of November 2009;
6) Based on our plans and our implementation so far, the international credit rating agencies have upgraded Pakistan by one notch;
7) The prices of Pakistan's outstanding Eurobonds have surged, making them amongst the strongest performers in emerging markets;
8) Foreign portfolio investment in the Karachi Stock Exchange (KSE) has surged to nearly US $350 million since July 2009.
9) The KSE-100 index has recorded impressive gains since January, 2009.
These are early successes. We recognise we have just started and have a long way to go. If we succeed in implementing the Nine-Point Plan, we will manage to move Pakistan's growth rate to a higher - and more sustainable - trajectory. In addition, the growth will be qualitatively different as it will be more equitable, and will achieve greater - and more longer-lasting - poverty reduction.
A significant outcome of success will be that Pakistan's economic sovereignty will be restored, as its reliance on external assistance - and external "leverage" - will be curtailed. Pakistan's vast domestic resources - human, physical, and/or financial - will have been harnessed.
On the flip side, not achieving any meaningful measure of success will consign Pakistan to low rates of economic growth and investment, low levels of job creation in the backdrop of rising numbers of youth entering the labour force, and the inability of the state to fulfil its basic social contract to an ever-larger part of the population. Failure in our plan to restructure Pakistan's economy is not an option.
(The writer is country's finance minister)