Neighbour's woes

Woes Pakistan’s economy has fallen in and out of crisis quickly in the past. But, with its friends refusing to help, how will it pull itself out of the latest mess?

Pakistan is smack in the middle of a serious economic meltdown. Its list of woes are tortuously long and varied: purchasing power is being strangulated by a 25 per cent inflation rate. The Government has borrowed a whopping Rs 1.4 trillion from the Central Bank to fund its spending. The fiscal deficit is at a tenth of GDP. The rupee has devalued by 25 per cent in just three months and the nuclear state’s reserves of foreign exchange have dwindled to less than $6.9 billion—barely enough to buy nine weeks of imports. For the last two-and-a-half months, the stock market in Karachi has remained practically closed.

What could possibly explain such economic carnage? After all, the economy was chugging along at a healthy 7 per cent clip for the past five years. The Karachi Stock Exchange (KSE) was a darling amongst the global investment community and its KSE-100 Index was the best-performing stock market index in the world for the first four years of this decade.

A lot of it has to do with the political situation in the country. In the past decade, Pakistan has frequently suffered bouts of insecurity, but the last year has been extraordinarily wrenching. Fighting extremists in the North-West Frontier Province (NWFP), Baluchistan and the tribal areas has sapped the country considerably. The brutal assassination of Benazir Bhutto, the scary regularity of suicide bombings—the most recent one resulting in the spectacular torching of the Marriott Hotel in Islamabad—and the see-saw battles for power between General Musharraf and the Chief Justice of the Supreme Court have scared much of the world away from the country. Not surprisingly, Foreign Direct Investments (FDI) has plummeted— from a peak of approximately $8 billion to $3.5 billion for the current fiscal year. Even wealthy locals have taken much of their money out and stashed it in Dubai, as they do everytime things go awry in Pakistan.

However, insecurity aside, one of the big mistakes the government made was the decision to not pass on price increases, linked to big rises in global commodity prices, to its public. This sent the country’s fiscal and external current account deficits to breaking point. Low capital inflows simply couldn’t cover its oil import bill which is now a hefty 6.9 per cent of GDP. Then, when the burden on state coffers became unbearable, Pakistan passed on the price effect to its people. This has had a devastating effect on many ordinary Pakistanis. Food prices, for instance, rose by 34 per cent in August this year, forcing Pakistan to station paramilitary forces at flour mills in Baluchistan. “The salaried and poor are the worst hit,” says Karachi-based social scientist Akbar Zaidi. He adds that there are reports of mothers left with little option but to put up their children for adoption.

Here’s another fact that explains Pakistan’s current mess: the country is practically broke. It spent $3.6 billion on imports in September, including a $1.5 billion petrol bill that was close to twice what it spent a year earlier, but earned only $1.9 billion from its exports. Resorting to reserves to plug the current account deficit resulted in a sharp depreciation in the exchange rate: The Pakistani rupee has fallen 33 per cent in just a year. On the domestic account, the stagnating tax-to-GDP ratio left the government with little recourse but to borrow from its Central Bank to fund Pakistan’s subsidies on fuel that have piled up to Rs 175 billion. Plus, it’s external debts are many and mounting: Pakistan has $3 billion in commercial foreign debt and $38 billion in IMF concessionary loans that have to be serviced with money that it doesn’t have. If this wasn’t already enough to send an economy into a tailspin, along came the subprime-related global credit crunch. Exorbitant input and credit costs coupled with low demand have hobbled key industries. Chinese bike makers in Pakistan have shut down 14 production units and chopped up to 30 per cent of their workforce. Flag bearer, Pakistan International Airlines, has announced 5,000 jobs cut (28 per cent of the workforce) after failing to get funds from the cash-strapped government. Industrial production shrank 5 per cent in April-May 2008 after growing 6.3 per cent on an average during the last five years.

None of Pakistan’s buddies seems to want to help it out. President Asif Ali Zardari made fund-raising trips to old allies Saudi Arabia and the United States—both of which played important roles in the country’s historical engagement with the then-Mujahideen and now-Taliban—but came back empty handed. Ditto with China. After stalling for a while, the country has finally swallowed the bitter pill of seeking out another IMF loan totalling $7.6 billion—but these borrowings come with stringent requirements, like the slashing of fiscal deficit and import tariffs.

Through its past economic setbacks, Pakistan’s economy showed steely resilience—the post Bangladesh war bounce-back took all of 24 months, for example. Each time an external shock induced a funding crisis for Pakistan, the world’s interest in keeping things cool in this volatile nuclear state resulted in cash injections. Pakistan’s rich elite, a recession-proof class, played recovery agents, quickly reversing their capital’s flight back into evergreen industries such as opticals and surgical instruments. This time around, Pakistan’s misery has been compounded by several crises all kicking in at the same time. Problems are compounded by an inept Zardari-led administration, which hasn’t been able to get things right when Pakistan most needs it to. For the country to get back on track—and it will, with many economists predicting that inflation will drop to single digits in 2010 while growth will return to a 5 per cent clip—the country needs to get its debt in order and resolve the abysmal credit rating (CCC, which suggests likely default) that S&P and Moody’s have given it. This way it can access cheaper funds to inject into a cashstrapped economy. Still, it has a very serious problem with extremist insurgencies in many parts of the country. “It’s difficult to see the political problem causing the economic crisis in Pakistan abating until the Afghanistan issue is solved,” says Indian economist Rathin Roy, who has worked on the neighbouring economy. Not good news for a country that needs all the help it can get.