Ishrat Husain: Economy of Pakistan - past, present and future
Keynote address by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Conference on
Islamization and the Pakistani Economy, Washington DC, 27 January 2004.
* * *
In this shrinking global village internet chats, cable TV, talk shows and transmissions through satellite
dishes have made perceptions more powerful than realities in influencing public opinion. There is a
widely held perception in Pakistan - right or wrong - that the popular American view of the U.S.S.R. as
an evil empire and communism as a threat to economic and social stability of the world is beginning to
resonate itself with Islam replacing communism and Pakistan and other Muslim countries, standing in
for the USSR.
Those who hold this perception point out, as an example, to the recent Council of Foreign Relations -
Asia Society Task Force Report which aptly sums up the popular American view about Pakistan in the
following sentence: "Pakistan presents one of the most complex and difficult challenges facing US
diplomacy. Its political instability, entrenched Islamist extremism, economic and social weaknesses
and dangerous hostility towards India have cast dark shadows over this nuclear-armed nation".
It is in this context that the Woodrow Wilson Center deserves our commendation for organizing this
Conference to explore in depth one of the elements of this newly emerging conventional wisdom about
Islam and Pakistan - although each one of the components of the above statement deserves further
analysis and discourse to sift out the facts from myths.
I hope that the candid discussion today will enlighten many of us, clarify a number of issues and
debunk some of the popular myths surrounding Islam and Pakistan's economic direction.
I have chosen to focus my remarks today on the one aspect of Pakistan and Islam that is, in my view,
hardly discussed, least known but creates a lot of jitters in the U.S. This issue has received increased
importance since the elections of October 2002 when an alliance of religious parties won power in the
province of NWFP. I propose to walk you through the past and current trends of Pakistani economy,
sketch the future direction and offer my own assessment of how the adoption of an Islamic economy, if
it indeed happens, will affect Pakistan's future.
This paper is divided into six sections.
The first section deals with the past achievements and failures of Pakistan's economy. The second
section presents a synopsis of economic performance during 1999-2003 - a period of intensive
restructuring and reforms of the economy.
Section III distils the policy lessons learnt from the historical and most recent experience of Pakistan's
economic management. Section IV attempts to lay down the contours of the future direction of
Pakistan's economy based on the lessons learnt and development experience gained from in-country
and crosscountry record.
Section V assesses as to how the attempts to introduce Islamic economic model in the country, if
successful, will impact upon this future direction. The final section provides insights into the economic
prospects of Pakistan in the medium term.
Section I
Past achievements and failures:
Pakistan was one of the few developing countries that had achieved an average growth rate of over
5 percent over a four decade period ending 1988-89. Consequently, the incidence of poverty had
declined from 40 percent to 18 percent by the end of the 1980s. Table I lays down the main economic
and social indicators in 1947 and compare them with 2003. The overall picture that emerges from a
dispassionate examination of these indicators is that of a country having made significant economic
achievements but a disappointing record of social development. The salient features of Pakistan's
economic history are:
• A Country with 30 million people in 1947 couldn't feed itself and had to import all its food
requirements from abroad. In 2002, the farmers of Pakistan were not only able to fulfill the
domestic needs of wheat, rice, sugar, milk of 145 million people at a much higher per capita
consumption level, but also exported wheat and rice to the rest of the world.
• An average Pakistani earns about $500 in 2003 compared to less than $100 in 1947. In US
current Dollar terms the per capita income has expanded more than five fold and in constant
terms three times.
• Agriculture production has risen five times with cotton attaining a level of more than
10 million bales compared to 1 million bales in 1947. Pakistan has emerged as one of the
leading world exporter of textiles.
• Pakistan hardly had any manufacturing industries in 1947. Five decades later, the
manufacturing production index is 12,000 with the base of 100 in 1947. Steel, cement,
automobiles, sugar, fertilizer, cloth and vegetable ghee, industrial chemicals, refined
petroleum and a variety of other industries manufacture products not only for the domestic
market but in many cases for the world market too.
• Per capita electricity generation in 2003 was 10,160kwh compared to 100 in 1947.
Pakistan's vast irrigation network of large storage reservoirs and dams, barrages, link canals
constructed during the last five decades has enabled the country to double the area under
cultivation to 22 million hectares. Tubewell irrigation provides almost one third of additional
water to supplement canal irrigation.
• The road and highway network in Pakistan spans 250,000 km - more than five times the
length inherited in 1947. Modern motorways and super highways and four lane national
highways link the entire country along with secondary and tertiary roads.
• Natural gas was discovered in the country in the 1950s and has been augmented over time.
As of now, almost 26 billion cubic meters of natural gas is generated, transmitted and
distributed for industrial, commercial and domestic consumption.
• Private consumption standards have kept pace with the rise in income. There are 30 road
vehicles for 1000 persons in 2001 relative to only one vehicle for the same number of
population in 1947. Phone connections per 1,000 persons have risen to 28.6 from 0.4. TV
sets which were nonexistent adorn 26.3 out of every 1,000 houses.
These achievements in income, consumption, agriculture and industrial production are extremely
impressive and have lifted millions of people out of poverty levels. But these do pale into insignificance
when looked against the missed opportunities. The largest setback to the country has been the
neglect of human development. Had adult literacy rate been close to 100 instead of close to 50 today,
it is my estimate that the per capita income would have reached at least $1000 instead of $500.
Pakistan's manufactured exports in the 1960s were higher than those of Malaysia, Thailand,
Philippines and Indonesia. Had investment in educating the population and upgrading the training,
skills and health of the labour force been up to the level of East Asian Countries and a policy of
openness to world market would have been maintained without any break, Pakistan's exports would
have been at least $100 billion instead of paltry $12 billion. Had the population growth rate been
reduced from 3 percent to 2 percent, the problems of congestion and shortages in the level of
infrastructure and social services would have been avoided, the poor would have obtained better
access to education and health and the incidence of poverty would have been much lower than what it
is today.
But as if this neglect of human development was not enough, the country slacked in the 1990s and
began to slip in growth, exports, revenues, and development spending and got entrapped into deep
morass of external and domestic indebtedness. As a result the incidence of poverty rose from
18 percent in 1988-89 to 33 percent by the end of the 1990s. This was due to both fundamental
structural and institutional problems as well as to poor governance and frequent changes in political
regimes. With short life spans, succeeding governments were hesitant, if not outright unwilling, to
reform the rent-seeking activities of the ruling elite- consisting of a small class of politicians,
bureaucrats businessmen, feudal landlords and other vested interests and desisted from taking tough
unpopular economic decisions to set the economy right. Understandably, they were more preoccupied
with the imperatives of retaining political power and making such decisions could have further exposed
them to the risk of removal from office. Moreover, the average lifespan of two to three years was
clearly inadequate for meaningful policy or institutional change. The external environment was also
unfavourable as the inability of successive governments to meet their commitments with international
financial institutions led to a serious credibility gap among the donors and intermittent withdrawal of
assistance. The event of May 1998, when Pakistan conducted its first nuclear test, and its aftermath
led to further economic isolation of Pakistan and a considerable erosion of confidence by domestic
and non-resident Pakistanis. Economic sanctions were imposed against Pakistan by the western
governments. By the late 1990s Pakistan had entered almost a critical state of paralysis and
stagnation in its economy particularly in its external sector. The freezing of foreign currency accounts
had resulted in a significant drop in workers' remittances, export growth was negative, IMF programme
and World Bank assistance were suspended, bilateral donors had terminated their aid while debt
payments due were in far excess of the liquid foreign exchange resources the country possessed.
Pakistan was almost at the brink of default on its external payments.
Section II
Economic performance 1999-2003:
It was at this stage that the military government under General Pervez Musharraf assumed power in
October 1999. The initial period was devoted by the economic team of the new government in
managing the crisis and making sure that the country avoided default. A comprehensive programme of
reform was designed and implemented with vigour and pursued in earnest, so as to put the economy
on the path of recovery and revival. The military government did not face the same constraints and
compulsions as the politically elected governments. It was therefore better suited to take unpopular
decisions such as imposing general sales tax, raising prices of petroleum, utilities and removing
subsidies so badly needed to bring about fiscal discipline and reduce the debt burden. The IMF and
the World Bank were invited to enter into negotiations on new stand-by and structural adjustment
programmes.
Although the canvas of reform in Pakistan was vast and corrective action required on a number of
fronts, there was a conscious effort to focus on achieving macroeconomic stability, on certain key
priority structural reforms and improving economic governance. The structural reforms included
privatization, financial sector restructuring, trade liberalization, picking up pace towards deregulation of
the economy and generally moving towards a market-led economic regime. A stand-by IMF
programme was put in place in November 2000, which was successfully implemented followed by a
three-year Poverty Reduction and Growth Facility (PRGP), which will expire in November 2004. What
have been the outcomes of the economic reforms undertaken during the past four years?
Macroeconomic stability:
There has been considerable progress in achieving macroeconomic stability. Strong fiscal adjustment
has led to primary budgetary surplus and significant reduction of the fiscal deficits. Current account
has turned around from chronic deficit to a surplus of more than 5 percent of GDP, mainly due to
renewed export growth and resurgence of workers' remittances. Monetary aggregates have been
contained and inflation rate is below 4 percent. External debt burden has been reduced in absolute
terms from $38 to $35 billion and as a proportion of GDP from 62.5% to 46%. The risk of default on
external debt, which loomed large on the horizon in 1999 and 2000, was mitigated and the country's
capacity to service its restructured debt has considerably improved. Exchange rate has not only
stabilized but appreciated during the last two years. Table II shows the changes in the key economic
indicators between October 1999 and September 2003.
Structural reforms - privatization, deregulation, liberalization:
The Musharraf Government actively pursued an aggressive and transparent privatization plan whose
thrust was sale of assets in the oil and gas industry as well as in the banking, telecommunications and
energy sectors, to strategic investors, with foreign investors encouraged to participate in the
privatization process. This plan is being followed by the newly elected government under Prime
Minister Jamali.
To demonstrate the seriousness of the government in encouraging foreign investment flows in
Pakistan; there has been a major, and perceptible liberalization of the foreign exchange regime.
Foreign investors can now bring in and take back their capital, remit profits, dividends and fees etc.,
without any restrictions. Foreign Portfolio Investors (FPI) can also enter and exit the market without
any restrictions or prior approvals. In the Karachi Stock Exchange with a market capitalization of
$15 billion, over 700 listed companies showed average returns of 15 per cent that were higher than
those in most emerging countries. This makes Pakistan an attractive place to invest for foreign
portfolio investors. As part of this liberalization, non-residents and residents are allowed to maintain
and operate foreign currency deposit accounts, and a market-based exchange rate in the inter-bank
market is at work.
Allied to this effort, the trade regime has been opened up and the maximum tariff rate has been cut
down to 25 per cent with only four slabs and the average tariff rate is down to 14 percent.
The financial sector too, has been restructured and opened up to competition. Foreign and domestic
private banks currently operating in Pakistan have been able to increase their market share to more
than 60 percent of assets and deposits. The interest rate structure has been deregulated and
monetary policy uses indirect tools such as open market operations, discount rates etc. Domestic
interest rates on lending have dropped to as low as 5 percent from 20 percent substantially reducing
financial costs of businesses.
Central to the economic reforms process has been a clear progression towards deregulation of the
economy. Prices of petroleum products, gas, energy, agricultural commodities and other key inputs
are determined by market. Imports and domestic marketing of petroleum products have been
deregulated and opened up to the private sector. The markets do not always function effectively.
Independent regulatory agencies have been set up to protect the interests of consumers and
end-users of utilities and public services. Despite this movement towards a liberalized and deregulated
regime, old habits die-hard. Bureaucratic hassles at lower levels continue to be irritants for the
business community.
Tax reforms:
Taxation reform has figured prominently on the government's agenda, as this is another area where
the business community has innumerable grievances and dissatisfaction with the arbitrary nature of
tax administration. Tax reforms are aimed at broadening the tax base, bringing in tax evaders under
the tax net, minimizing personal interaction between tax payer and tax collector, eliminating the
multiplicity of taxes and ultimately reducing the tax rate over time. A massive survey and
documentation drive was undertaken to widen the tax base, extend incidence to all sectors of the
economy and develop the data for purposes of assessment. Despite these reforms, the business
community remains dissatisfied with the performance and attitude of tax officials particularly at the
lower level. Complaints of delays in refunds of sales tax persisted throughout the three-year period.
The Central Board of Revenue (CBR) is being restructured to improve tax administration including
taxpayer facilitation.
Economic governance:
The most dramatic shift introduced by the military government is in promoting good economic
governance. Transparency, consistency, predictability and rule-based decision-making have begun to
take roots. Discretionary powers have been significantly curtailed. Freedom of press and access to
information has had a salutary effect on the behaviour of decision makers. The other pillars of good
governance are, (a) devolution of power to the local governments who will have the administrative and
financial authority to deliver public services to all citizens, and (b) an accountability process which will
take to task those indulging in corruption through a rigorous process of detection, investigation and
prosecution.
Despite these positive outcomes and their impact on the business community and other stakeholders,
within the country as well as abroad, the incidence of poverty is still quite high and unemployment
rates are worrisome. The challenge therefore for the next phase of the reform process is to accelerate
growth rate and reduce poverty and unemployment.
Section III
Policy lessons learnt:
I now turn to the policy lessons learnt from the experience of last 50 years and the success achieved
in reforming and restructuring Pakistan's economy during the last four years. With experiments
running from state controls, liberalization, socialism, reversal to market mechanism, deregulation and
privatization, there is today almost a consensus on the broad contours of economic policy in the
country although the modalities, policy instruments and nuances differ as they ought to. My reading of
the last 15 years suggests that the general thrust of Pakistan's economic policies broadly reflects the
following lessons learnt from the past:
(a) Central planning has been a failure as it leads to low productivity, lack of innovation, lack of
incentives, poor quality goods and services and low investment in human resources.
Bureaucratic judgment is a poor substitute for market's judgment on allocation of scarce
resources.
(b) Licensing to open, operate, expand, close business by the government functionaries is a
sure way to promote rent-seeking in the economy for the benefits of a few while keeping the
majority poor. The basic business decisions should not be made for the businessmen by the
bureaucrats.
(c) Public sector ownership and management of business, production, distribution and trade do
not capture the commanding heights but lead to a fall into the deep morass of inefficiency,
waste and corruption.
(d) Import substitution behind high tariffs not only protects a few thousand inefficient producers
but also penalizes the millions of consumers with shoddy and expensive goods, which they
do not particularly want. Profits at world prices are negative in these protected industries
thus leading to inefficient utilization of capital and labour.
(e) Over regulation, controls and inspection of all kinds on the private sector not only hike up the
cost of doing businesses, subdues entrepreneurship but also make a few wily politicians and
bureaucrats rich at the expense of the prosperity of the country. Private monopolies and
oligopolies were nurtured under the cover of these controls.
(f) High tax rates on individuals and corporates are counter-productive as they raise costs,
discourage effort and initiatives and lead to widespread tax evasion and have unintended
consequences of lowering overall revenue collection.
(g) Banks and financial institutions owned and managed in public sector offering cheaper credit
and/or directed credit have a pernicious effect on economic growth as credit decisions are
made on the basis of political connections rather than on the merit of the proposal. Value
subtracting enterprises are set up while real opportunities for businesses that contribute to
output and employment are missed.
(h) Administered prices of key commodities and utilities are the worst possible means of
insulating the poor segment of the population from the onslaught of market forces. Instead
these prices create shortages in the economy and hit the poor hardest by denying them
access to essential commodities or services.
(i) Subsidies on inputs such as fertilizers, seeds, electricity, water, gas, petroleum, etc. incur
heavy budgetary costs but benefit the well-to-do classes and highly influential individuals
rather than those for whom the subsidies are intended.
(j) Foreign investment and multinational corporations are not evils that should be shunned but
are the most important conduits for transfer of technology, managerial skills, organizational
innovation in addition to much needed capital and foreign exchange. They should be
welcomed and made to feel comfortable in their operations.
Future direction:
The lessons learnt from its historical experience, the development literature based on Cross-Country
record and the imperatives of globalization have led to emergence of a broad consensus on some key
policies and parameters.
These views are shared by majority political parties, military, businesses, bureaucracy and other
stakeholders in Pakistan. It will be fair to surmise that investors in Pakistan should feel confident that
the future direction of economic policy making will be guided by the following principles although in a
dynamic and ever changing world, economic management will have to be responsive to the needs of
the time and events.
i. Outward-looking strategy that promotes exports and integrates Pakistan into the world
economy is in the best interest of the country for accelerating growth and reducing poverty.
Tariff reductions have been quite drastic from 220 percent to current maximum of 25 percent
helping the businesses to become cost competitive. Anti-export bias has been significantly
removed and export promotion is the stated policy objective.
ii. Private sector is the main vehicle for producing and exchanging goods and services for the
domestic economy as well as the rest of the world. Prices should be determined by the
market forces but monopolies regulated by independent agencies.
iii. The role of the state is to provide security of life and property, have an independent judiciary
that can arbitrate disputes and enforce contracts, build physical infrastructure, nurture
human skills and train manpower and maintain an enabling macroeconomic and regulatory
environment in which businesses can flourish.
iv. Public sector enterprises and government trading houses should be privatized through a
transparent process so that the Government can focus its attention on its basic
responsibilities to the citizens. Selling these enterprises to private entrepreneurs has stopped
the hemorrhaging of government finances.
v. Pakistan will continue to have a liberal foreign exchange and low tariff regime without
recourse to any non-tariff barriers. Raw materials, components, machinery and equipment,
consumer goods can enter the country free of restrictions. Foreign investors are free to bring
in and repatriate capital, dividends, profits, remittances, royalties, etc. without any approvals.
vi. The value of Pakistani currency in relation to other foreign currencies will be determined
through supply and demand in the foreign exchange markets and not by administrative fiat of
the Central Bank. A freefloating exchange rate policy is being pursued at present and will
continue in the future.
vii. The Central Bank or the Government no longer controls interest rates on government
securities, corporate borrowing, deposits, etc. They are totally deregulated and the banks are
free to charge the spreads according to risk assessment of the borrowers. There are no
priority sectors to which credit is directed. Government is not allowed to borrow from the
banking system beyond a specified limit.
viii. Foreign companies, individuals, multinational corporations can own 100 percent shares in
locally incorporated or unincorporated firms. They can raise equity through national stock
markets, borrow from the local banking system and sell their goods or services abroad or
domestically. They enjoy a level playing field with the domestic investors and do not face any
barriers to entry or exit. They can expand capital or wind up business without permission
from any government department.
ix. Consumers have choices to purchase foreign goods or domestically produced goods. This
has compelled the domestic manufacturers to improve the quality and reduce the prices of
their products or face extinction at the hands of imported goods. The competitiveness of
industry has been boosted by the unhindered availability of foreign goods.
Impact of islamization on the future direction:
I now turn to the main theme of the Conference today. The basic premise of this Conference is that
there are many protagonists in Pakistan who are pushing the country towards adopting an Islamic
economic system. Western analysts and observers view such a move with apprehension and feel that
this will lead to Pakistan's decoupling from the global economic system and its isolation from
mainstream economic thinking. In their minds such behaviour will create greater instability and amplify
risks for the rest of the world.
Pakistan is a moderate and progressive Islamic country that is committed to the war against
extremism and terrorism and, thus, any suggestion that it will adopt policies that may be risky for the
rest of the world is untenable. President Musharraf is already paying a high price in combating the
menace of terrorism and extremism in the country. These policies may have short- term costs but are
essential to set the country on its course of enlightened moderation.
Unfortunately, most of the assumptions and premises on which the hypotheses about the Islamic
economic system have been constructed are seriously flawed. Pakistan is and will remain a
responsible member of international community and is committed to utilize the vast opportunities
provided by globalization and financial integration of world markets for the benefit of its population.
There is no suggestion whatsoever by any significant group of people or political parties in favour of
isolation or withdrawal from international economic system. Secondly, the pre-conditions for a robust
and well functioning Islamic economic system are missing in Pakistan. The Islamic moral values that
emphasize integrity, honesty, truthfulness and full disclosure and transparency are not yet widely
practiced by Pakistani businesses. Once these pre-conditions are established the adoption of a real
Islamic economic system will lead to superior welfare outcome for the majority of Pakistani population.
How can the Islamization of the economy affect this future direction of Pakistan economy and improve
the welfare of its people compared to the present system? The extensions that the true practice and
application of Islamic economic model can bring about will, in fact, help in overcoming the weaknesses
inherent in the capitalist model of economy. Before that, let us recapitulate the basic principles upon
which Islamic economic system is built upon.
Unlike positive economics the entire edifice of Islamic economy is built upon a set of objectives or
maqasid. In other words, Islamic economics is normative in nature with the objective of the Shariah
being to promote the well being of all mankind which lies in safeguarding their faith, their human self,
their intellect, their posterity and their wealth.
At the micro level, the precepts of profit maximization and utility maximization are retained intact but
are supplemented by a set of interlinked objective functions. Islamic system tries to promote a balance
between market, family, society and the state. It does so by promoting both the material and the
spiritual urges of the human self, foster peace of mind, enhance family and social solidarity. Some
western thinkers and anti-globalization activists decry the western economic model as being
suppressive of collective human rights, community and social well being, disruptive of family values
and too much focused on selfish individual interests. Behavioral economists have also begun to
challenge the assumption of rationality in the choices and preferences an individual makes in
day-to-day life. Thus, the merit of Islamic economic model therefore lies in its extension of western
model in some fundamental and beneficial ways. It introduces into the objective function an additional
argument which keeps self interest within the bounds of social interest by limiting individual
preferences to conform with social priorities and eliminating or minimizing the use of resources for
purposes that frustrate the realization of the social vision. This may help promote harmony between
self-interest and social interest.
This second argument complements the market mechanism by making the allocation and distribution
of resources subject to a double layer of filters. It attacks the problem by first changing the behaviour
and preference scale in keeping with the demands of the normative goals. Claims on resources are
then exposed to the second filter of market prices. In this process, the influence that initial resource
endowments are able to exercise in the allocation and distribution of resources may be reduced
substantially. Faith tries to accomplish this by giving self-interest a longer-term perspective - stretching
it beyond the span of the world to the Hereafter. This interest in Hereafter cannot be served except by
fulfilling his or her social obligations. This may induce individuals to voluntarily hold their claims on
resources within the limits of general well being and thus create harmony between self-interest and
social interest even when the two are in conflict.
The promotion of simple living and the reduction of wasteful and conspicuous consumption may help
reduce excessive claims on resources and thereby release a greater volume of resources for
needfulfillment by others who are not so well off. It may also help promote higher savings and investment
and thereby raise employment and growth.
At the macro level, Islamic economic model in its ideal form tends to combine the positive aspects of
the capitalist economy and socialist economy while minimizing their negative consequences. Capitalist
economy based on private property and market mechanism allocates resources efficiently but as it
takes initial resource endowment as given, equity considerations do not figure in this system. Socialist
system is very much concerned with equity and welfare of its population and ensures benefits from
cradle to grave for its citizens. But as it relies on state ownership and bureaucracy it is poor in
allocating resources thus creating inefficiency, waste and value subtraction. Islamic System
overcomes the deficiencies of both the systems as it is solidly based on private property and market
mechanism but has also explicitly built in equity and distribution through compulsory deduction of
Zakat i.e. transfer payments from the asset holders to the poor segments of the population. The
western economic model is criticized today as it is unable to address the issues of unemployment,
poverty and income inequities in developing countries. Islamic economic model addresses the
distribution issues explicitly after market has allocated the gains. It does so by a compulsory deduction
of 2.5 percent of tangible wealth and net asset holdings from the incomes generated by the market
mechanism for transfer among the vulnerable, sick, handicapped, indigenes and poor segments of the
society. Although the deduction is compulsory the transfers are made voluntarily by the well-to-do to
their poor relatives, neighbours and other whom they know to have legitimate needs. Thus the
leakages, waste and corruption that are inherent in a state administered system of welfare payments
are conspicuous by their absence under this system. Only really deserving persons and families or
mustahaqeen receives these payments. In Pakistan, it is estimated that private transfers made
voluntarily to the poor account for 2 percent of GDP annually. These welfare payments are a potent
force in reducing poverty, helping the vulnerable to earn their own livelihoods and lower income
disparities.
At the sectoral level, the introduction of Islamic banking should result in deepening of the financial
sector. There are believers in Islamic Faith who do not use the Conventional banking system because
of their strongly held views tha