'Pakistan achieves remarkable turnaround during 2000-04'

Pakistan achieved a remarkable turnaround during 2000-04, marked by a sharp macroeconomic adjustments towards sustainable external balance and a resumption, followed by acceleration in economic growth. However, some impediments to domestic and foreign investment, namely political and security risks cannot easily be removed or offset with right economic policies, but this should be viewed as a challenge to do more and better than elsewhere in the region.
This was stated in a working paper of IMF on the subject of "Pakistan's Macroeconomic Adjustment and Resumption of Growth, 1999-2004", which was released recently. This working paper has been prepared by Henri Lorie and Zafar Iqbal, Senior Resident Representatives of the IMF in Pakistan and Senior Economist in the IMF Resident Representative Office in Pakistan, respectively.
THE MAIN THREE FINDINGS ARE (1) an increase in private national saving during 2001-03 was the key contributor to the turnaround in Pakistan's external current account during this period.
(2) while Pakistan's growth was mainly export-led before 2003-04, it was largely led by domestic demand in 2004, especially consumer demand but also private and public investment, and
(3) the structural reforms implemented in Pakistan during the past four years had made the observed strengthening in domestic savings and rise in domestic investment permanent, auguring well for accelerated growth within a sustainable external balance.
The country's growth prospects would be further enhanced by a more externally driven growth process, and by an acceleration of structural reforms to further improve productivity and the investment climate.
According to report, the adjustment was mainly driven by a rise in private savings, though fiscal consolidation helped as well. Both, the favourable external factors, post-September 11, and greater domestic confidence, resulted in a significant increase in private remittances from abroad and in foreign currency deposits of residents.
Structural reforms in the banking and corporate sectors contributed to rebuilding domestic confidence as well as to enhancing productivity and profitability. These factors combined to increase the private savings rate and strengthen the incentives to invest.
Net exports were the key driving force behind the restoration of growth early in the period, but consumption as well as investment led the acceleration of growth in 2003-04. While this suggests vulnerability with regard to sustainability of accelerated growth, the structural reforms implemented in Pakistan should lead to a permanent rise in both savings and investment, auguring well for sustainable higher growth rates.
These reforms have improved Pakistan's performance in terms of variables generally recognised as important for higher growth. Nevertheless, Pakistan appears to still lag behind other competitor Asian countries in this regard.
Further advancing structural reforms on a broad front, while maintaining overall macroeconomic stability and paying close attention to the human development effort that will determine the effectiveness of these reforms, should allow Pakistan to catch up with the fast growing economies of Asia.
Much has been done in recent years to improve the business climate in Pakistan and Pakistan ranks well in this regard within the South Asia region. Thirteenth among 22 indicators of the World Bank's "Doing Business," and Pakistan is doing better than other South Asian countries. It lags, however, significantly behind China and Thailand outside South Asia.
The World Bank's "Investment Climate Surveys" also suggest that Pakistan is behind India, China, and even the Philippines in terms of providing an enabling environment for investors. Clearly, further progress can be made in Pakistan. For instance, property rights remain weak, mainly because of poor land record.
There is still too much government intervention with the market mechanism in the case of some key commodities. Red tape is still excessive, particularly at the provincial level.
Labour regulations have hindered the functioning of formal labour markets and employment. Corruption remains a problem (Pakistan ranked 129 out of 146 countries in Transparency International Corruption Perception Index 2004), and the enforcement of contracts, financial obligations, and bankruptcy law, as well as the interpretation of tax laws remain difficult.
In addition, educational and more generally human development indicators remain quite weak in Pakistan, resulting in a workforce often ill equipped with the skills necessary for higher value-added productions.
Finally, there is much room for improving the physical infrastructure of the country, the current state of which contributes to the high costs of doing business.
Of course, some impediments to domestic and foreign investment, namely political and security risks cannot easily be removed or offset with right economic policies but this should be viewed as a challenge to do more and better than elsewhere in the region.
With agriculture still representing close to 25 percent of GDP, growth in this sector and in related rural activities will have to pick up for the objective of significantly higher overall GDP growth rates to be sustained in the near term.
The scope for productivity gains appears to be still large, land remains under-utilised, and the market infrastructure in the rural areas remains weak. Recent positive developments, if sustained, could boost the prospects for large productivity gains.
They include greater availability of bank financing for agriculture (from a low base) and the decision to increase public sector development programme expenditures for improving water availability (lining of canals and watercourses) and for rural infrastructure (roads to market).
Productivity enhancing land reform, reduction of government intervention in the development and working of competitive markets in agriculture, and strengthening of research and extension services would increase the prospects for accelerated growth in the sector.
Over the past four years, Pakistan has returned to a relatively high growth rate, which is estimated to have accelerated to more than 6 percent for fiscal year 2003-04.
This turnaround followed three years of steady decline in growth during 1998-99 through 2000-01. Even in per capita terms, growth has been robust in recent years. Per capita income in US dollars is estimated to have reached 652 dollars in 2003-04, as compared to 501 dollars in 2000-01.
The resumption of growth is especially impressive when viewed in the context of the substantial macroeconomic adjustment that took place in this period. While this adjustment has in part been driven by external factors, right policies played a key role, in particular the government of Pakistan's commitment to fiscal consolidation and to the pursuit of a broad agenda of market-oriented structural reforms in the fiscal, banking, and corporate sectors.
These reforms have aimed at increasing efficiency, through privatisation, transparency, and good governance, and generally improving the business environment.
This paper looks back at the sources of the macroeconomic adjustment and resumption of growth over the past four years by providing an in-depth quantitative analysis of various factors at play. Based on the 2003-04 findings, the paper also highlights the conditions needed to ensure that growth of more than 6 percent can be sustained in 2004-05 and beyond, while maintaining internal and external stability.
Both demand and supply factors are analysed, and while the emphasis is mainly on quantitative indicators, the paper also qualitatively assesses the impact of ongoing structural reforms undertaken in Pakistan.
Finally, comparisons are made between Pakistan and selected emerging markets, which have managed sustained high growth rates, focusing on key variables recognised as critical for accelerated growth.
This assessment is generally supported by an analysis of the breakdown of growth looking at the production side. The favourable impact of structural reforms on the business environment and on financial deepening, as well as the improvement in the efficiency and profitability of the corporate sector, augur well for the sustainability of high growth rates, even if certain exceptionally favourable factors, including low international interest rates, level off.
Both experts argued that those structural reforms have permanently raised the prospects for higher savings and investment.
However, a more externally driven growth would reduce the risk of it not being sustainable. Furthermore, international comparisons with fast growing emerging market economies suggest that Pakistan needs to further catch up in terms of investment levels, external trade orientation, and financial deepening.
While Pakistan fares well with regard to the business environment within the South Asia region, it lags behind China and other Southeast Asian countries.
Thus, Pakistan needs to further pursue outward-oriented policies to boost exports and encourage foreign direct investment, continue with a broad range of structural reforms aimed at improving the investment climate, focus on developing its human capital toward a more skilled and competitive labour force, accelerate reforms in agriculture to garner potential productivity gains, and strengthen the country's productive infrastructure, in particular for water management, ports, rural roads, and energy supply.
Industry became the largest contributor to growth in 2003-04, accounting for almost half of the 6.5 percent real GDP growth achieved. This mainly reflected large-scale manufacturing, which posted a growth rate of more than 18 percent for the year. But within industry, construction and especially electricity, gas, and water supply, registered significant gains as well.
The significant pickup in large-scale manufacturing growth in the year was broad-based, but appears on balance consistent with the view that domestic rather than external demand was the main engine of growth. Particularly impressive was the further acceleration of growth in automobiles and electronic equipment compared to 2002-03, as well as the high growth rates registered in food/beverages/tobacco, chemicals, cement, and leather products.
The food and beverage and automobile sectors each contributed more to real GDP growth than textile. There is little evidence of a significant pickup in exports of such products, except perhaps in the case of leather products and electronic equipment, with the latter possibly explaining part of the high growth rate in "other" exports.
There was a rapid recovery in the incremental output-capital ratio (GDP growth rate divided by the (lagged) investment to GDP ratio) during 2000-04, from barely 0.1 to almost 0.4. While this is consistent with an improvement in "efficiency," the development also likely reflects the impact of cyclical recovery on productivity.
Assuming that the incremental output-capital ratio of 0.36 achieved in 2003-04 applies to 2004-05, the higher investment-to-GDP ratio of 18.1 percent of 2003-04 would be consistent with a real GDP growth rate of 6.5 percent. Notwithstanding the scope for further improvement in efficiency, a significant acceleration in growth above 6.5 percent will necessitate a further rise in the investment/GDP ratio.