Ishrat Husain: Why do perceptions about the Pakistani economy differ?
Address by Dr Ishrat Husain, Governor of the State Bank of Pakistan, to the English Speaking Union
in Karachi, 5 July 2001.
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An extremely important question has been raised by several commentators and observers of Pakistan
economy: Why is it that the external donors believe that Pakistani economy is doing well while the
public and press in Pakistan think otherwise? This question needs to be analysed carefully and
dispassionately in order to identify the factors responsible for such differing perceptions. I have dwelt
on this subject earlier also but I thought I should deal with it at some length once again.
We should begin by specifying the initial expectations of the two groups. The external donors had
concluded that successive Pakistani Governments had entered into agreements during the last
10 years with promises of serious structural reforms but failed to deliver on most of these promises. In
their view Pakistan suffered from a serious credibility gap and, until and unless, the present
Government demonstrated a strong commitment and delivered most of those unfulfilled promises
upfront, there was no way Pakistan could qualify for any medium-term assistance. Pakistan, therefore,
was asked to prove its seriousness by first completing all those actions the previous governments had
promised but not fulfilled. These actions covered the entire range of economic activities and sectors
and affected every segment of the population. There were many actions which were required to be
taken and I have spelled them out elsewhere and will therefore not repeat them here.
It is not implied that these actions did not make any economic sense or were not justified in Pakistan's
own economic interests but the important point to note is that all these actions had to be completed
within a period of 12-15 months in order to qualify for the Stand-by-Arrangements (SBA), balance of
payments support loans from ADB and World Bank and rescheduling of external debt owed to bilateral
creditors. The timing, sequencing and phasing of these reforms were not necessarily those which the
Pakistani authorities would have preferred had they complete say in the matter.
The Government of Pakistan has either completed or is implementing most of the above actions. This
has established a favorable track record and restored the country's credibility among the international
financial community and bilateral donors. IMF has already released two tranches under the SBA and
the third tranche is likely to be released by mid-July. The World Bank has released the Structural
Adjustment Credit which would add $ 350 million to the country's foreign exchange reserves. The ADB
has so far provided $ 333 million. The country has been able to reschedule $ 2.8 billion which it had to
pay to external creditors this year. Despite this relief, it maybe pertinent to mention that the country still
had to pay $ 4 billion in cash foreign exchange out of its own resources to service its external debt.
The Pakistan Development Forum gave a resounding endorsement to the reforms Pakistan is
undertaking. Credit rating of Pakistan has improved. Overall, there is a perceptible and positive
change in Pakistan's standing with the international financial community. This is, therefore, the
genesis for the improved perception of external donors about Pakistan's economy.
In addition to the IMF program implementation there are some key reforms this Government has
embarked on its own - survey and documentation of the economy to widen the tax net and improve
tax compliance, devolution of power to the grass root level whereby the common people are
empowered and the old bureaucratic system is dismantled; accountability of those who had looted
national wealth in the past; recovery of bank loans from defaulters, utility bills and evaded taxes.
These measures, on the top of others implemented as part of the IMF program, have created their
own dynamics and shaken the foundations of the rent seeking culture prevalent in the economy for
such a long time. But the sad part is that the rent seekers, who were keeping the overall economy
buoyant have withdrawn from the scene. Consumption expenditures emanating from the rent-seeking
class are much lower than what they used to be in the past. Their investment activities have come to a
halt. Most of them are trying to find safe havens abroad for their wealth.
While the Group of external donors is pleased that the country had taken all the tough decisions which
were postponed by the previous governments for such a long time the same decisions and other
measures adopted by the Government, have created hardships domestically for several classes of
economic agents. What were the expectations of the various domestic classes? It may be pertinent to
recall that the expectations from the present Government were quite high as the country had faced an
atmosphere of uncertainty and despondency for a long time and the Military was considered as a
savior of the economy. The urban educated unemployed felt that new employment opportunities will
be created to absorb them. The fixed income groups thought that the wages, salaries and pensions
frozen since 1994 will be raised. The traders and service sectors were looking for a higher demand for
their goods and services translated into higher incomes for them. The rural income groups wanted the
prices of their agriculture output raised. The large industrialists clamored for more concessions and
exemptions in order to expand their operations.
As far as the press was concerned a number of those who write on economic issues are either retired
government officials subsisting on pensions and income from National Savings Schemes Certificates
or those earning salaries. Their incomes have remained fixed and thus eroded in real purchasing
power terms while the burden of higher expenditure particularly the utility bill charges hit them hard.
These columnists and reporters extrapolate their own experiences and those of their peers to depict
the adversity hitting the common man. They are therefore unsympathetic and unconvinced about any
good emanating from this reform package.
Against these expectations what were the ground realities and what options were available. The
preceding five year period had resulted in stagnant per capita incomes, no new large scale
investment, rising unemployment and underemployment, worsening incidence of poverty, declining
public expenditures and expanding fiscal deficits, an exceptionally high debt servicing burden, and
dysfunctional public sector corporations hemorrhaging public finances. Under these conditions, the
new Government was faced with two choices. The first option was to adopt a populist approach and
use large scale public expenditures to create new employment opportunities, contracts for private
sector, raise the level of aggregate demand and subsidise electricity, petroleum and gas prices so that
the consumers are protected from increase in prices. In order to do so, an expansionary fiscal policy
and an accommodating monetary policy were required to be pursued. In the short-term this set of
policies would have won the applause from all classes domestically. From the viewpoint of the present
Government, which was in office for three years, this would have been an attractive and expedient
solution because the disastrous consequences of these actions over the medium term would have
been faced by their successors and not by them.
What would have been the consequences of following this policy option? The country would have
been forced to default on its external debt, fiscal deficit would have been around 10 per cent of GDP
financed by borrowing, inflation rates would have hit the roof hurting the poor more than any one else,
external and public debt burdens would have escalated, and private investors would have found an
environment of macroeconomic instability. The international financial institutions would have shunned
Pakistan as a pariah economy and Pakistan would have been isolated from global economy.
But this Government instead chose the second but more difficult option as it felt that strong
fundamental structural reforms had to be put in place, the institutional decay had to be arrested
through better governance, transparency, and debt relief had to be obtained from international
creditors to revive the economy on a sustainable basis and to reduce dependence on the International
Monetary Fund in the 3-5 year time horizon. The country can reassert its economic sovereignty and
get out of the stranglehold of the IMF programs by adopting a strategy in which it can generate
sufficient resources to take care of its financing needs over this period. What are the elements of this
strategy? First, we must establish our credibility, secure some fiscal space to undertake employment
generating development expenditure, avoid contracting short-term expensive debt, and augment our
foreign exchange earning. The rulers were also of the opinion that the benefits of economic revival
should be shared by a wide majority of the population and not by a chosen few. This simultaneous
pursuit of macroeconomic stabilization, structural reforms, improvement in economic governance and
poverty alleviation required a course of action for which the rescheduling of external debt and
assistance from the international financial institutions was a sine qua non.
The tough measures taken by the present government, though quite right and desirable, are hardly
expected to be welcomed. How can the simultaneous burden of higher utility prices, rising petroleum
prices, increase in prices of imported goods due to depreciating exchange rate and lowering of returns
on National Savings Scheme be borne by a class whose household incomes are at a standstill? Thus
the reaction of the wage earners, salaried class, the pensioners and other fixed income groups who
form the bulk of our middle class is quite understandable and their perception about the economy is
quite different from those of the outsiders. To the educated youth, who were expecting the present
government to revive the economy quickly so that employment opportunities could become available
to them, the curtailing of development expenditure for attaining the fiscal deficit target was a
disappointment. Neither the employment opportunities through higher public expenditures could be
expanded nor the crowding-in of private investment could take place.
But the more troubling aspect is that those who are engaged in spreading and disseminating the
negative perception and sentiments about the economy are the interest groups who were the
beneficiaries of the old system and are likely to be big losers, if the proposed structural reforms are
fully implemented and take hold. The main line of resistance comes from these particular groups. Let
us examine how their interests are going to be compromised. Most of the "people" who are vocal
against the current reforms belong to the class populated by politicians, bureaucrats, business
leaders, land owners, traders and professionals. It should be clarified that we are not including all
persons who pursue these professions but only those who have been the beneficiaries of the old
system of the past. Each one of this vested group is hurt by the deep-rooted structural reforms which
the present government is attempting to undertake. This group of politicians and bureaucrats strongly
believe that their power and privileges will be eroded if the devolution to district governments takes
place according to the plan. Some of the former and prospective members of the provincial and
national assemblies consider the nazims and deputy nazims as their potential rivals in which the latter
are likely to have more administrative and financial authority and will thus divert the public attention
and importance away from the MPAs and MNAs. The award of development projects and government
contracts, the postings and transfers of key officials which they could easily manipulate with the active
connivance of a few bureaucrats, will no longer be possible. The Deputy Commissioners and their
class are unhappy that they had joined the civil service to wield undivided authority over the population
in their jurisdictions. It is unpalatable to them to take orders from half literate elected nazims - many of
whom would have had difficulty in getting an appointment from the Deputy Commissioner under the
existing set-up. The officials of other 13 departments who will now formally report to the District
Coordination Officer are resentful that they will no longer be able to evade responsibility which they
presently can under the loose and undefined supervisory arrangements in place.
Those business leaders, who had amassed wealth not by dint of hard work, enterprise or innovation
but by evading taxes, defaulting on bank loans, stealing electricity and getting SROs issued to favour
them selectively have indeed stopped "investing". But to think of it, was it real investment or a hand
out from the public exchequer to chosen few which was then invested in their own names. Those
chosen under one political set up had to wait out for a couple of years while other chosen few availed
of their turn. The accountability, tax survey and recovery of loans and utility bills are pinching them for
the first time. They are being forced to part with some of the ill-gotten gains they had made and their
reaction is that of wrath and hostility.
The big landlords have, also for the first time, been unsuccessful in thwarting the imposition of
agriculture income tax. The avenue for leakages in non-agriculture income tax has been closed by
clubbing the incomes from both sources. So this is a double whammy for a very influential group which
has so far enjoyed the corridors of power without any restraint on their wealth accumulation or sharing
it with the State.
The traders and professionals in the service sector are unhappy because they have also been brought
under the tax net through GST. But it is not the GST, which they can pass on to the consumers in full
that is bothering them, but the disclosure of their sales and profits upon which income tax can be
levied. If you have gotten away by not paying any taxes for that long, won't you resist this new
dispensation.
Thus it is obvious that the losers from the structural reforms underway are identifiable, alive and
kicking while the winners are to emerge in some distant future provided these reforms are continued
and sustained over an extended period of time. For example, several thousand workers will
immediately lose jobs as a result of the restructuring and downsizing of the nationalized commercial
banks. The benefits to the economy will occur over time when the lending and deposit rates are
improved and service standards upgraded. The difficulties and problems the businesses are facing in
relation to tax administration will be resolved when the reforms pertaining to the restructuring of CBR
are completed. This will take some time to show results but the exporters are facing liquidity problems
today. The limited efforts to target the poor through rural and urban Khushali Program, the Food
Support Program, the Micro-credit Bank and Zakat, are so diffused and wide spread and their
beneficiaries are so disorganized and inarticulate that they do not make any perceptible difference.
It must be conceded that there are adverse consequences of these perceptions held by the domestic
constituents. Private sector investment and consumption spending will not resume until businesses
and households change their perceptions and regain confidence. Unfortunately, exogenous factors
such as severe drought and consequential slump in agriculture production, high international prices of
petroleum products and decline in unit prices of textile exports have made the situation even more
difficult. A less than 3 per cent rise in GDP is hardly inspiring to regain confidence in the economy.
How can the perceptions of these two groups be ever reconciled or would they continue to differ? No
Government - Civilian or Military - can afford to ignore the genuine aspirations of its domestic
constituents. But there is a transition period before which the new goal of shared and equitable growth
can be achieved. In a society where sifarish, connections and exchange of favors have propelled the
governance of the country for such long time it is very difficult to change the mind set or the prevailing
value system. Equally difficult is to convince that any ruling class can take decisions which are not
based on their personal interests. For the next three to five years, Pakistan has to stay the course,
continue on the reform path it has set for itself steadfastly and bring about fundamental structural
changes in our governance and institutional structure. This hard struggle is the only sure way to
reduce our vulnerabilities and dependence on the IMF. Why can't this be done now or earlier?
Because the resource generation capacity of the economy is still and will remain below the debt
servicing obligations for several years. Once we have attained the stage where our fiscal and external
accounts are no longer in such a state of chronic imbalances as they are today we will be able to
attain our economic sovereignty. This will provide the Government ample fiscal space for increasing
development expenditures, expanding infrastructure facilities and thus enabling the private sector to
reduce its cost of production and distribution, and most importantly allow public sector to invest in
technology, skill development, training and other aspects of high level manpower upgradation which
will help our competitiveness in global market place. At the same time, the rules of game for the
private sector have to be changed where privileges, protection and pampering of a chosen few should
give way to a level playing field for all where work ethic, enterprising behavior and productivity
enhancement are rewarded. The community and non-government organizations should also engage
along with the local governments in promoting primary education, basic health services, potable water
supply and sanitation to the vast majority of the population. This public-private-community partnership
will lead Pakistan into the era of self-reliance, economic growth and social stability and poverty
alleviation.
There are those who argue that alternative solutions which gives primacy to growth should have been
adopted. As an economist I am not quite sure as to how this can be done on a sustainable basis.
Economic management involves trade offs and choices among various competing demands.
Government can, of course, inject a lot of money to give a jump start the economy and create
employment throughout the country. This was indeed done until the mid 1990s and what were the
results - burgeoning fiscal deficits, increased domestic and foreign borrowing, inefficient and
dysfunctional institutions and inability today to service our debts fully. Is this what we want again?
We can insulate the consumers of electricity, gas and petroleum by freezing the prices they pay.
Again, the utility companies will have no funds to invest in expansion, modernization, maintenance.
We will have outages, shortages, shutdowns at a much larger scale hurting our agriculture and
industry. Alternatively, the Government may have to provide subsidies out of the budget. But given the
fact that it can hardly meet its current expenditures out of its revenues, it will have to borrow and
increase our indebtedness. Is this a good choice for the country?
To sum up, the differing perceptions have arisen due to mismatch in timings of reforms undertaken by
the present government. The international financial community is pleased that we have undertaken
within a short span of time all those tough measures which were committed by the previous
governments but were never implemented. Thus our credibility in their eyes has been restored. But
the impact of these measures in an environment of stagnant incomes, declining investment for past
several years and limited fiscal space was quite severe on domestic economic agents. This has been
further exacerbated by some other fundamental structural reforms which have hurt the interests of the
traditional rent-seeking classes in the country. The benefits from these reforms will accrue after a
lapse of at least 3-5 years. The losers are visible right now but the gainers will emerge in distant
future. The perception of the people and press in Pakistan should, therefore, be viewed in this context.