Ishrat Husain: Future challenges facing South Asian economies
Speech by Mr Ishrat Husain, Governor of the State Bank of Pakistan, at the Central Bank Anniversary
Lecture 2004, Colombo, Sri Lanka, 26 August 2004.
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The first decade of the 21st century is bringing about several fundamental structural changes in the
economies around the world. South Asian economies have to accelerate the pace of internal
transformation of their economies if they choose to benefit from the opportunities presented by these
structural changes. There is a need to shift from the old paradigm of dependence upon official aid and
putting blame on the unjust international economic order for their woes to the new paradigm of
becoming an active participant in the emerging globalized economy.
What are the key characteristics of this new globalized economy? First and foremost is an open
trading environment in which low cost and reliable producers of quality goods and services are able to
deliver them just in time will derive maximum gains. The countries in this environment will have to
compete for market shares in their quest for selling goods and services to the rest of the world.
Second, the integration of financial markets and liberal flows of cross border capital particularly foreign
direct investment provide ample scope for supplementing domestic savings and raising investment
levels to accelerate the pace of growth and poverty reduction. In South Asia, the earnings and
remittances of workers employed overseas do play a key role in accumulation of net foreign assets.
Third, rapid changes in information technology and communications can lead to efficiency
improvement in the utilization of capital and labour and thereby to total productivity increase. But, at
the same time, it places severe burden on the prospects of employment for unskilled labour. Fourth, a
silent revolution in expectations of the so far voiceless voters is taking place due to a perceptible
impact of electronic media and skilful management of these expectations and delivery of tangible
results against promises is assuming a new dimension in good governance.
This evening I would like to address the following question: To what extent are the South Asian
Economies prepared to face these four major challenges and what is the agenda that they should
follow in the next ten years or so? Before I share my views on this question, let me offer a few
thoughts on the process of decision-making that should be followed by the leaders of South Asia in
order to bring about the paradigm shift I have talked about.
Each country must begin by preparing a long-term vision and the road map to translate this vision into
action with milestones and timelines. This vision and road map must have a non-partisan and national
consensus and all political parties must be agreed and committed to the broad thrust and the direction
of the economy. Of course, there will be many nuances and approaches to implementation and the
road map will be altered in light of experience gained but, at least, the investors and economic actors
will be assured that there will be no abrupt reversals and significant derailments. China offers an
excellent example of this process where the vision and the road map adopted by Deng XaoPing has
been followed, with some modifications and alterations, by successive governments. The skeptics may
contest this conclusion by arguing that the same political party has remained in power since 1978.
While this is true, but the point I wish to underscore is that in plural democratic societies when even
the contesting political parties have a broad agreement on the vision and direction of the economy, the
voters will judge their performance by their relative success in implementing the programs, policies
and projects and bringing about an improvement in the living standards of their electorate during their
respective tenures. It is the differentiation in their relative performance that will distinguish the record
of one political party from the other and win and lose the support of the electorate.
Past achievements and current status.
Let me now turn to the substantive question that I have raised, i.e. the state of preparedness of the
South Asian economies in meeting these future challenges.
South Asia has shown a remarkable growth about at 5.6 percent in the last ten years which is above
the average of developing countries. Most countries have been able to achieve and maintained
macroeconomic stability i.e. low inflation, low domestic interest rates, stable and flexible exchange
rates. They have built up foreign exchange reserves to cushion themselves against external shocks.
Fiscal consolidation and discipline have begun to set in with fiscal deficits being brought down to
manageable levels.
Private sector has become the main vehicle for investment, production and distribution of goods and
services while state intervention has been limited to provision of physical infrastructure, social services
and other public goods in support of private investment and making markets function efficiently.
Trade liberalization has proceeded quite rapidly and average tariff rates have declined drastically.
Export promotion is being actively pursued and inward looking import substitution and protection of
domestic industry have been abandoned as principles of public policy.
Financial sector and capital market reforms have been stepped up in almost all the countries and are
at various stages of implementation. New laws and regulatory mechanisms have been adopted to
strengthen the banking sector and securities markets. Directed credit and credit ceilings, administered
and subsidized interest rates have gradually given way to market-based allocation of credit and
determination of prices.
India has become a leader in outsourcing of information technology enabled services. Low wages,
large English speaking technical manpower, availability of venture capital and networking with the U.S.
firms have brought about a major expansion in I.T. exports. Pharmaceuticals, health care,
biotechnology, research and development are also beginning to attract attention from multinational
companies. Indian firms are also beginning to acquire firms abroad and are integrating themselves in
the global economy. However, other countries in the region are still way behind and have a lot of
catching up to do. Services sectors account for 60 percent of the output of developed countries and
many services are becoming mobile across border due to breakthrough in technology and
communication. Thus the outsourcing of services is a sensible strategy.
These improvements in macroeconomic fundamentals have led to up gradation of credit worthiness of
India and more recently Pakistan. Both the countries have established access to international bond
market at fine pricing. It will, therefore, be fair to surmise that economic fundamentals have improved
to a very large extent in all the South Asian countries in the last decade or so. Broad political
consensus on the content and direction of economic policies and their credible and consistent pursuit
should provide some signal to the markets that the South Asian economies can be relied upon in the
exchange of goods and services and inflow of capital.
Agenda for the future.
However, the challenges ahead and tasks for economic managers in the region are simply daunting.
Sri Lanka and India have almost one quarter of their population living below the poverty line. The
estimates for Bangladesh are in the mid 40 percent, while Pakistan has one-third of its population
living below the poverty line. Unemployment rates are quite high and Human Development indicators
are dismally low. Moreover, these task have to be pursued in the context of a more volatile economic
environment - both domestic, as well as, international. Capital inflows and outflows have much greater
potential to destabilize markets, exchange rate and interest rates.
Technological, communication and media revolution especially the satellite television and cable
channels have raised the expectations of the common man through the demonstration effect of
conspicuous consumption by powerful and affluent classes. These expectations are placing enormous
pressures on the ruling classes for providing access to basic necessities of life to the majority of the
population. At the same time, the state apparatus for delivery of these services in most South Asian
countries has become largely dysfunctional due to induction of poor quality personnel, corruption,
inertia, waste and institutional decay. How to narrow this widening gap between the rising expectations
of the common man and the declining capacity of state institutions is one of the most difficult tasks for
the leaders of South Asia.
South Asia is lagging behind the East Asian economies and have a lot of catching up to do and, that
too, in the shortest period of time. I do not wish to go into the details of all the comparative indicators
of the two regions which are well known to all of us, but suffice to say that we are way behind China,
Indonesia, Malaysia, Thailand and the Philippines both in levels as well as the rate of improvement.
What can be done to reduce poverty and unemployment and catch up with the East Asia? We should
recognize this region is our benchmark against which we should evaluate our performance although it
is our biggest competitor in the global markets, particularly China, which is becoming an industrial
giant. Let me offer some thoughts on this issue but also hasten to add that these are by no mean
exhaustive and are being presented only in the spirit of provoking a broader debate and discussion in
our countries on this important subject.
(a) Between 1980 and 2001, South Asia received $17 billion as Official Development Assistance
(ODA). However, between 1990 and 2001 ODA inflows have declined both in per capita
terms as well as percent of GDP. There was a change in the composition of external capital
inflows with a declining share of aid in relation to other types of inflows. This change in
composition suggests that the influence of the official donors and particularly the
International Financial Institutions (IFIs) is thus likely to wane in the future while that of the
fund managers, rating agencies, equity research houses, investment banks and multinational
companies is likely to gain ascendancy. Thus, credibility of economic policies pursued by the
countries assumes a much important role than the relationships nurtured with donors and the
IFIs. The market's power to penalize imprudent policies and breach of commitment is more
damaging to the economy than the slippages in the observance of IMF or World Bank
conditionalities. If we recall Mexico had to suffer heavily when the incoming Zedillo regime
reversed the pre-commitment made by the Salinas regime to the markets on the exchange
rate. The country witnessed huge and sudden capital outflows, depreciation of currency,
inflation and economic recession. To keep access to the international financial markets the
South Asian Countries will have to maintain not only open and liberal foreign exchange
regimes, sound and robust financial sector but pursue consistent, credible and transparent
economic policies.
(b) Along with sound economic policies there is growing evidence about the critical role of good
governance and institutional quality in the growth-poverty reduction nexus. The features of
weak governance that is normally associated with South Asia are corruption, political
patronage, lack of transparency, low observance of rule of law, absence of level playing field,
heavy tilt in delivery of scarce of public goods and services towards the privileged and elite
classes.
The political leaders are now beginning to realize that the disenchantment of the electorate
with these poor governance practices increases the burden of incumbency and puts their
survival at serious risk. Thus, improved governance should be on the top of the agenda of all
political parties in South Asia if they are interested in assuring their electoral sustenance.
Bureaucratic hassles, long drawn procedures, un-even application of rules and regulations,
excessive discretionary powers in the hands of lower level bureaucracy, shortages of
essential infrastructure facilities and low productivity of labor force have made the region not
such an attractive place for foreign investors. Consequently, Foreign Direct Investment (FDI)
has not yet made any significant impact on the economies of the region. FDI accounts for
0.5% of GDP with India receiving $3-4 billion annually and Pakistan about $1 billion. Portfolio
investment to India had taken an upward trend but suffered a set back in the aftermath of the
recent elections.
A major overhaul of the structure of Civil Service, Judiciary, Police and Local Government
Institutions, Business process re-engineering and inculcation of modern management
practices will be required in all the countries of the region.
(c) Political and geopolitical risks in the region are still quite elevated. The long standing hostility
between India and Pakistan, the acquisition of nuclear and missile capability by the two
countries and the consequential sanctions imposed upon them, the active frontline status of
Pakistan in the war against terrorism, the prolonged civil war between Tamil Tigers and the
government in Sri Lanka, and the frequent strikes called by the opposition parties against the
government in power in Bangladesh have added risks to doing business and locating
investment in these countries. The external perceptions about our region are, therefore,
heavily biased due to these risks. The sooner we can overcome these problems, the better
off the region will be a reliable trading partner, active participant in the international capital
markets and a choice location for foreign investment.
(d) Investment in education and human development in countries other than Sri Lanka has been
inadequate in volume, deficient in quality and lacking in relevance. The most recent census
data for 2001 shows that India's literacy rate has gone up to 64 percent but female literacy
rate is less than 50 percent. It also demonstrates that at least one third of its population and
labor force is not fully equipped to take up the ever changing and more complex tasks of the
economy trying to outclass other competing countries. In Pakistan and Bangladesh almost
half of their population and two-third of female population are illiterate. This large proportion
of women among illiterates is a cause for serious concern.
Sri Lanka is the only country in the region with almost one hundred percent literacy. But this
full literacy level raises another stark fact in our face i.e., the growing imbalance between the
demand for skills imposed by market economic forces and the supply of skills produced by
our educational institutions. There is a surfeit of highly educated graduates who are not
employable and there is a shortage of workers who can carry out routine technical jobs in
production and service. India produces good quality Science and Engineering graduates
every year who can cater to the high end of the job market but lack of attention to
nonUniversity technical education and its quality have created wide gaps at the middle end of
the job market. This situation is much aggravated in Pakistan and Bangladesh where the
issues of quality, relevance and numbers are all intertwined. Sri Lanka has no problem with
the numbers but high level of unemployment among University graduates testifies to this
mismatch in the skills. The widespread frustration among the parents and graduates on one
hand and a high level of dissatisfaction among the employers in finding the right persons for
the right jobs are further evidence of the imbalance in labor market.
(e) This skill imbalance and lack of employability has serious repercussions for the composition
and growth of the basket of goods that can be exported. The most dynamic and rapid
growing sectors of exports in the world market today and in the medium term are those
associated with high technology and to some extent medium technology. While India is
making some headway in increasing its penetration of high technology exports the record of
other countries in the region is not very promising. They are still stuck in the low technology
exports particularly textiles and clothing which have a declining shares in the world trade.
Thus the need to overcome the skill obsolescence and turn towards medium and high
technology exports was never as apparent as it is today.
One particular means through which this change in the composition of exports can be
accelerated is by removing the barriers and constraints in the way of foreign investors and
Multinational Corporations (MNCs). FDI is an important force for integration for this as MNCs
have set up supply chains and integrated production networks that tend to locate each stage
of production in the country with the lowest cost. Affiliates of a MNC in one country often
export to another for eventual sales in a third country market. These affiliates act as the
on-the-job training grounds for the acquisition and dissemination of the skills needed for
production and minimizing costs. These skills are then disseminated and multiplied
throughout other firms in the country.
(f) There is a very little intra-regional trade-taking place in South Asia. Intraregional trade has
remained stagnant at less than 2% of the total trade in the last twenty-five years. A study
carried out by the Pakistan Ministry of Commerce in 1996 concluded that due to low
transportation costs, cultural similarities which influence taste and cause profitable
complementarities to emerge and low transaction costs, the economic benefits of liberalizing
trade with India outweigh costs. Despite this, the trade between the two neighbouring
countries has remained negligible. Regional trading arrangements have made a huge
difference in North America, Europe and East Asia, but they have been unsuccessful in
South Asia. The recent attempt to revitalize SAARC is in the right direction and will stimulate
trade and growth but only to the extent that it unleashes competition that lowers domestic
prices, enables achieving economies of scale and acquiring new technology.
SAFTA arrangements can be successful in the coming year but they require a number of
important preparatory measures. These are described below:
•
Trade facilitation through expeditious border crossings, quick custom clearance,
efficient port facilities, improved transport links should precede or take place
simultaneously with the expansion of volume of cross border trade.
• Domestic tax, tariff and subsidy policies that affect production and trade incentives
should be harmonized to avoid recurrence of trade disputes and frequent use of anti
dumping laws. As India provides a lot of subsidies to its producers in various forms
and shapes the smaller countries are hesitant to allow MFN status to India. The
recourse to a long negative list that restricts the volume of trade should be avoided at
all costs.
•
Macroeconomic policies such as fiscal and monetary policies should be harmonized to
achieve a stable, non-discriminating macroeconomic environment for all the countries
in the region
•
Supporting institutions to manage and facilitate integration, for example, setting
standards, establishing regional development funds and for dispute resolution should
be created.
•
Communication and transport infrastructure between the bordering countries should
be improved and upgraded to facilitate increased trade and factor mobility.
•
Legal regulations for investor protection, intellectual property rights enforcement,
antitrust law, commercial law, labor relations, financial institutions should be harmonized.
• Financial markets should be widened and regulatory changes introduced to promote
cross-border investment, listings, syndication, bond issues, etc.
(g) South Asian countries should tap the enormous potential of their large expatriate population
in mobilizing investment capital, foreign exchange earnings, skilled manpower and exports of
ethnic products and services. India, Pakistan, Bangladesh and Sri Lanka together receive
about $20 billion of remittances from their workers annually but their contribution in domestic
capital formation is insignificant. Unlike overseas Chinese Community that has played a
substantial role in foreign direct investment, nonresident Indians have been a source, to
some extent, of professional, technical and managerial skills but not much in terms of large
financial outlays. The non-resident deposits transferred to India account for only a miniscule
proportion of their wealth holdings abroad. These flows are quite stable in nature and should
be able to augment domestic savings for accelerating the pace of investment without
creating future debt obligations. Innovative products and investment vehicles to attract the
savings of nonresident South Asians should be encouraged with the help of regulatory
agencies.
South Asian countries have so far missed the boat by not becoming a part of global value chain and
participating in international supplier chain arrangements. There is no single business model for
participating in this chain and there can be many phases of transition and many modes of involvement.
For example, joint ventures, franchising, purchasing by international firms, licensing, sub-contracting,
fully owned firm, original equipment, manufacturing, original design and manufacturing, strategic
partnerships for technology, overseas acquisition of equity are the diverse means whereby developing
country enterprises can gain wide access to international markets at their own level of capability, climb
the technology ladder and benefit from globalization. East Asia is a major participant in this global
supply chain and produces parts and components for a variety of manufactures. It is time that South
Asian countries do make an attempt to get engaged in this value chain.
Finally, I turn to the impact of WTO. I wish to clear the confusion that as if something drastic or
unexpected or unknown is going to hit us in the near future due to WTO. All the countries in the region
are already members of this organization since 1995 and have made binding commitments to
maximum tariffs. In some cases the applied tariffs are lower than the bound tariffs. In actual practice,
the South Asian countries have liberalized their imports and have been flooded with cheaper imports
from China in the recent years. There could be no greater threat to the survival of domestic industry
than competition from Chinese goods. Some industrial firms could not face the onslaught of this
invasion and have died. Others have taken up by the challenge by cutting the fat, taking up the slack,
becoming cost efficient, improving quality are competing with the new entrants. Thus the process of
restructuring and transition is ongoing and should not pose any systematic threat to the industries of
the region.
What we all seem to be focusing upon is the abolition of the textile quotas under the Multi-fiber
agreement and the adoption of new agreement on Clothing and Textiles in January 2005. The impact
of this new pattern of textile trade on the economies of South Asia region is highly varied and
differentiated. Most simulation studies and modeling exercises carried by the World Bank, USITC and
independent consulting firms give credence to the view that China followed by India and Pakistan will
be the main beneficiaries of the abolition of quotas. These countries are all vertically integrated i.e.,
from producing cotton all the way to finishing, dyeing, stitching, etc. and enjoy low wage costs and low
raw material costs. Pakistan, for example, has invested $3 to 4 billion during the past five years to
modernize and acquire state-of-the-art machinery that can produce quality goods according to the
varying specifications and changing demand patterns of the buyers. On the other hand it is not
obvious if all the ready made garment exporting firms in Bangladesh and Sri Lanka will be able to
survive in the post 2005 markets. Both countries are seized of this problem and are taking measures
to assist their firms and their workers.
Whatever the benefits of regional trading blocks they are no substitute for participation in multilateral
trade arrangements. Multilateral arrangements provide a much larger market to exploit which is
several times the size of any regional block, enlarge the market access substantially and permit wider
competition, larger scale of operation and greater specialization all of which increase productivity and
growth. Thus the successful completion of Doha Development Round is very much in the interests of
South Asian countries but the deferential impact on the various countries in the region has to be
handled carefully, imaginatively and expeditiously. Short-term adjustment costs to the workers and
business have to be absorbed in the long run interest of expansion in those activities in which these
countries have dynamic comparative advantage.
Conclusion
South Asian countries have undergone remarkable improvement in their economic landscape during
the last ten years or so and despite many vicissitudes and shocks have been able to maintain positive
growth momentum. The challenges for the coming decade are however, of different nature. While the
policy reform and good management of the past will certainly help the internal transformation of these
economies the task facing the leaders of these countries are formidable. To maximize the benefits
from globalisation and thus help reduce the incidence of poverty the future agenda should focus on
good governance and institutional reform, investment in skilled manpower, shift away from low
technology exports, aligning with international value chain of production, attracting foreign private
capital flows including that from expatiate nationals, promoting intra-regional trade and mitigating
political and geopolitical risks.