Shamshad Akhtar: Pakistan - an investment friendly destination
Speech by Dr Shamshad Akhtar, Governor of the State Bank of Pakistan, at the Pakistan Investment
Conference organised by Euromoney, Islamabad, 22 February 2007.
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I. Introduction
Pakistan has undergone significant economic and political transformation. Sound macroeconomic
management, backed by market oriented policies and a conducive incentive regime, together with
political stability and effective regulatory framework have enabled Pakistan to emerge as a viable and
investment friendly destination.
Today, I propose to (i) review recent developments and their implications on macroeconomic stability,
which has been the subject of much debate with the rising fiscal and current account imbalances; (ii)
share the story of Pakistan's economic turnaround and transformation and the factors driving it - this
turnaround has helped the country achieve a higher sustainable economic growth that has raised
income levels while making some inroads into poverty reduction and employment generation; and (iii)
finally offer a perspective on what lends confidence in sustainability of high economic growth, while
underscoring that this is possible only if key challenges are effectively addressed to unleash the full
economic potential of the country that offers lucrative opportunities for foreign investment.
II. Macroeconomic management
After a period of low fiscal deficits which scaled down to its
Macroeconomic stability is here to stay.
lowest level (2.4 percent of GDP) in FY04 and emergence of a surplus on external current account, of
4.9 percent of GDP, in FY03 Pakistan opted to concentrate on stimulating broad based growth and
dealing with its increasing infrastructure and social constraints that, unless dealt with immediately,
threatened growth prospects. To achieve these goals, Pakistan has had to offer fiscal and monetary
stimulus over FY02-FY04, which did complicate macroeconomic management. Indeed, a widening of
macroeconomic imbalances relative to the FY04 period was inevitable as the country had to break
away from the past to put the economy on a more robust and sustainable path.
To set the economy on this course, the Government launched an all time high and aggressive public
investment program of $7.3 billion (allowing it to grow by 32.2% in real terms) that constituted 28% of
total expenditures. A significant part of these development expenditures was devoted to completing
ongoing and launching new development initiatives for physical and social infrastructure. At the same
time, liberal and diversified availability of private sector credit stimulated growth across the board in a
number of sectors. The growing investment and consumption demands and requirements have
widened trade deficit as imports grew by over 35% in the preceding two years (FY05-06). While
macroeconomic imbalances enhanced demand pressures, they have stimulated economic growth to
7.4% on average over FY05-07.
Macroeconomic stability was managed by a combination of policies and availability of foreign inflows
supported by enhanced investor confidence and presence of global liquidity. Firstly, the central bank
has adopted a hawkish monetary stance for almost two years which has now paid dividends as
inflationary pressures emerging from rising aggregate demand have been mitigated - CPI and core
inflation on a year-on-year basis is down from 11.1% and 7.8% in FY05 to 6.6% and 5.3%,
respectively effective January 2007 - an all time low relative to June 2004. Secondly, higher
remittances inflows (rising from $1.1 billion in FY01 to $5.5 billion in FY07) have helped finance, on an
average, 98% of trade deficit. Thirdly, the privatization program was pursued effectively along with a
drive to attract foreign direct investment - both of which mobilized cumulatively $10.0 billion and
helped finance 75% of the country's external current account deficit during FY05-FY07. Fourthly, the
reduction in debt/GDP ratio in line with the dictates of the Fiscal Responsibility Act has helped
enhance the sustainability of macroeconomic imbalances. Finally, due to strong foreign inflows
coupled with effective reserve management Pakistan has, over 6 years, built up its SBP reserves,
which are set to reach over $14 billion by end June 2007 thereby offering more than 6 months of
import coverage. Positive economic developments over the past few years have facilitated Pakistan's
return to international credit markets and all the sovereign issues have been over subscribed with tight
spreads - enabling establishment of a yield curve in a remarkably short time.
Together, these developments have jolted up the investment/GDP levels, which are expected to grow
to 21% in FY07, after stagnating at the level of 17% over the previous five years. These achievements
appear more significant if viewed in context of Pakistan's proven economic exogenous shocks such as
the rising international oil prices which accounted for 1.9% of GDP (and 20% of the trade deficit), and
expenditure demands for earthquake related relief and rehabilitation efforts that accounted for another
0.8% GDP. Continued economic vigilance on emerging trends is however critical to strike a balance
between growth and macroeconomic sustainability.
III. Economic turnaround and transformation
High economic growth is accompanied by structural changes. Compared to the rest of Emerging
Asia, recent economic growth track record puts Pakistan's GDP growth rate in the top half of the
region's fast-growing economies. Underlying this has been a significant, albeit slow, structural
transformation. The main features of this transformation have been:
(i) The emergence of a vibrant and buoyant services sector, which grew by 8.8% in FY2006
and now accounts for 52.3% of GDP - this has been led by developments in the finance &
insurance, wholesale & retail trade, transport, storage and communication sub-sectors.
(ii) Growth in large scale manufacturing sector (over 14% on average over past three years
compared to average growth of 3.5% in the 1990's) led by textile sector, which benefited
from opportunities emerging from post MFA regime, 36.8% growth in automobiles, 45.5% in
electrical goods, 19.6% in cement, and 32.1% in fertilizer etc. in the last three years. Besides
new capacity additions, this growth was stimulated by rising real consumption expenditure
and construction demand. Capacity enhancement and utilization is at an all time peak.
Industrial growth is accompanied by a degree of industrial diversification and emergence of
new entrepreneurial class, though more effort is warranted to move Pakistani industry away
from its traditional dependence on resource-based and low technology based processes.
(iii) Having achieved self-sufficiency in major crops well in 1980's, Pakistan's agriculture sector
has benefited from improvements in pricing regime for major crops, deregulation of inputs
and trade liberalization. Excluding crop failures due to bad weather, agriculture grew on
average in last 3 years by over 3.8%. According to Food and Agriculture Organization (FAO)
Pakistan is ranked 4th in cotton, 5th in sugar, 9th in wheat and 12th in rice production in the
world. In addition, Pakistan is ranked among the top ten producers in several of the minor
crops, which are mostly fruits and vegetables. The remaining half of the agriculture value
addition is contributed by non-crop sector mainly livestock, which has helped Pakistan rank
as the 5th largest producer of milk.
IV. Factors contributing to economic turnaround
Enhanced market orientation and openness. Opening its markets in late 1980s, Pakistan has
amplified and deepened its structural reforms over the last 5 years. Keeping aside ideological or
philosophical consideration and the Government's fiscal compulsions, industrial, trade and price
liberalization has infused high degree of competition which is auguring well for efficient allocation and
use of resources. Private sector is allowed in all strategic sectors such as oil, gas, telecommunication
and other services sector on a competitive basis which are supported by sound sector policies.
Service providers in telecom are emerging as large giants and have enhanced country's wireless
penetration to reach 29% in November 2006 with the total cellular subscribers at 46 million. Moreover,
the intense competition has also reduced call costs, increased outreach and offered increased
services to the customers. The increasing penetration will invariably play a part towards increasing the
market potential of a host of other activities conducted through cell phones such as banking,
remittances etc.
Since early 1990s, Privatization Commissions has processed 161 privatization transactions resulting in
sell off of public assets of Rs. 378 billion. All manufacturing sector, 80% of the banking assets and
strategic stakes of utility companies have been sold off to private sector. With scaling back of
government's role, the share of private sector in investment has risen steadily from merely 7.8% of
GDP in 1980's to over 13% of GDP in FY 2006. At the same time the share of public consumption
expenditure has reduced over time to less than 10% and now private consumption expenditure
accounts for more than 90%.
Banking sector is catalyzing real sector development. Banking sector reforms are far reaching.
Aside from their impact on depth and efficiency of financial intermediation, the profitability of banks has
allowed them to earn high returns, which has attracted foreign interest and encouraged existing
owners to expand and/or strengthen their businesses. Banks have not only cleaned up their own
balance sheets but have impacted real sector development in a number of ways. The private credit
growth in last few years has been significant reaching over 30% in FY06. Private credit grew from
insignificant levels to over Rs. 400 billion in FY06. The credit expansion fuelled economic activity,
while reviving and enhancing industrial and other capacities. Credit diversification has helped achieve
a degree of economic diversification too. While the corporate sector accounts for almost half, within it
all segments of industry received higher credit. Of the total outstanding, agriculture credit constituted
6.4% but more phenomenally, it grew by almost 4-5 times. Credit was also made available to non-crop
sector by laying down guidelines for promoting credit access to livestock, fisheries and dairy sector.
Improved access to SMEs was also possible and its share in total outstanding grew to 16.1%.
Consumer financing, which was not available in the past, rose to 14.3% of the total outstanding.
Companies' access to required level of financing, foreign loans, swaps and derivatives etc. have all
been accommodated to allow market to innovate and expand. There is considerable scope for banks
to enhance their business through extending financial penetration and outreach both across country
and sectors.
Banking sector has grown both in size and strength and is positioned well to meet economy's
requirements as it grows. Ownership and structural changes in banking system will facilitate this
process. Foreign interest and presence has grown and at present foreign stake comes to 47% of total
paid-up capital of all the financial institutions regulated by State Bank of Pakistan. Structural changes
have been significant. Besides higher standards of corporate governance at management and board
level, the banks are adhering to SBP prudential regulations which are consistent with BIS standards.
Technology is being fast adopted and over 45% of bank branches are connected with head office,
along side growth in ATMs, debit and credit cards.
Foreign investment is flowing in. Economic activity has and will be further boosted by efficiency
gains once the full impact of foreign investment is realized after the completion of projects financed by
FDI. During FY04-06, Pakistan has cumulatively attracted $8 billion foreign investment flows - 26.5%
was sale proceeds of public assets and 49.2% from FDI, with remaining coming from foreign portfolio
investment. These foreign inflows have come into banking, telecom and oil and gas sectors primarily.
Prospects are that Pakistan will attract about US$6.0 billion in FY07 - an all time high annual flow.
Going forward, foreign investment is expected to be more diversified and will support infrastructure
development, manufacturing, tourism and hotel industry etc. The strong interest in Pakistan stems
from (i) growing investor confidence in the economy, (ii) comfort to foreign investors that they are
treated at par with domestic investors (and in some respects even better), (iii) high returns on
investments as evident from exceptional corporate and banking profitability and (iv) supportive and
stable policies.
Besides full foreign ownership, investors can repatriate their capital, dividends and profits and there is
no restriction on the level of royalty payments. Foreign investors are eligible for low import duties
between 5 and 10% on plant and equipment and a first year tax allowance on profits of between 50
and 90% of the cost of plant and equipment. Measures have also been taken to introduce an
Intellectual Property Rights regime compatible with the WTO. Rules governing FDI have been
significantly liberalized. Furthermore, the investment climate has improved as a result of policy
initiatives such as the streamlining of procedures required to start a business and the measures taken
to minimize the time that businesses spend dealing with government inspections. To facilitate foreign
portfolio investment, Special Rupee Convertible Account (SCRA) has been established to allow
remittances and non-residents to bring money in and out of Pakistan. The amount accumulated in this
account can be used for purchasing as well as trading shares quoted in the stock exchange as well as
other approved securities. Foreign exchange regime has also been liberalized and exchange controls
have been lifted.
Business processes are being rationalized and simplified. Reforms, both of incentive and
administrative regime, have helped Pakistan to improve its ranking in the Survey conducted by the
World Bank on 'Doing Business in 2007.' Pakistan now ranks 51 in the time to import (which has
reduced from 39 days to 19 days) as trade logistics and customs procedures were streamlined and
scores well on the indicators related to starting a business (54th out of 175) and protecting investors
(19th out of 175).
V. Growth sustainability and prospects
Pakistan's real GDP growth rate has risen in recent years, averaging 7.4% in the preceding three
years. This is well above the long-term (50 years) average growth rate of 5 percent. The strong growth
momentum has stressed the productive capacity of the economy as evident in macroeconomic
indicators such as rising inflationary pressures and a widening external current account deficit. These
developments naturally raise questions regarding economy's potential to sustain this momentum.
The current growth momentum in the range of 7% can indeed be maintained, though this requires:
careful calibration of macroeconomic management and removing bottlenecks that are impeding growth
and economic diversification. With declining poverty1 and growing employment opportunities, viability
of Pakistani market is further enhanced as domestic private consumption has been supported by
improved incomes and remittances.
To ensure sustainable economic growth, Pakistan will need to maintain macroeconomic stability by
gradually reducing the twin deficits. Besides prudent expenditure management, this will require
broadening of the tax base to effectively finance growing expenditure obligations. Sustainability of
external current account deficit calls for raising exports earnings to finance the increasing imports
requirement. Imports will remain strong as the economy's requirements for capital and intermediate
goods for industry grow. Balance of payment position will benefit from industrial diversification which is
critical for export diversification as well as for encouraging import substitution (particularly in food
commodities) where Pakistan has competitive advantages. Any pressures on aggregate demand
because of slippages will need monetary tightening as central bank would remain committed to the
objective of price stability.
To realize these goals, Pakistan needs to now direct investment flows, both domestic and foreign, to
areas which can help stimulate industry and its diversification, and help remove gaps and bottlenecks
in the infrastructure. Pakistan offers opportunities to exploit gas and coal reserves suitable for power
generation and hydroelectricity generation. The geographical proximity to energy rich regions, Iran and
Central Asia, position Pakistan to emerge as a regional hub for energy. The investment requirements
for the development of energy sector are in the range of $20 billion in medium term to around US $150
billion by 2030. National Trade Corridor Plan (NTCP) equally offers opportunities to connect all major
physical infrastructures such as ports, roads, railways, aviation etc. Besides connecting Pakistan with
its neighbors it will enhance trade and improve market access, while saving fuel and transport costs.
Pakistan has set up an infrastructure Project Development Facility to facilitate initiation of these
projects through credit enhancement and financing institutions are geared up to adopt different
approaches and modalities to leverage and intermediate financing flows for infrastructure.
Opportunities also exist to enhance production by enhancing productivity, efficiency and economic
diversification. To diversify, Pakistan has to make inroads into the medium and high-end technology
products such as electronic goods, automobiles, engineering goods etc. and to look for newer
markets. In agriculture, implementation of mega water resources projects will enhance crop yields.
Besides increasing value-addition, market-based pricing (e.g. as done for rice and wheat),
improvements in transmission of pricing signals to farmers (e.g. through introduction of a commodity
futures market), development of crop insurance (particularly to encourage the raising of new cash
crops such as oilseeds) and improvement in transportation and storage infrastructure will contribute to
enhancing agricultural productivity. Development of agro-based industry and processing and
packaging of products would further stimulate export of these products to the neighboring Middle
Eastern markets.
With a strong base of economically active population, Pakistan has an edge as it is a low wage
economy - average wage is close to $75-$100 a month for unskilled workers, $100-$200 for skilled
and for managerial workers, it ranges from $200-$500 a month. To enhance skills, an aggressive
technical education and skill development program exists under the Medium Term Development
Framework. Investment climate will benefit further from the ongoing efforts and strong commitment to
rule of law, developing a competent and efficient government sector, less cumbersome regulations
and control of corruption.
Finally, besides banking sector, the large financing requirements of infrastructure and of agriculture
sector (ranging above Rs130 b) can be met but require financial diversification. The long-term
domestic debt market is still under-developed and corporate debt issues account for less than 1% of
GDP. Similarly, Pakistan boasts an extremely liquid equity market but it remains dogged by high
degree of speculative transactions that have led to periodic bouts of instability and claims of market
manipulation. Given the importance of long-term debt markets to support investment, particularly in
infrastructure projects, to increase domestic savings, and improve the risk profile of commercial banks
(which currently face mismatches in lending and deposit profiles), Pakistan needs to foster
development of long-term institutional savings industry (pension and provident funds, mutual funds,
etc.), implement capital market reforms aimed at encouraging investment rather than speculation, and
improve risk management in the financial sector to ensure financial sector stability.
Conclusion
In conclusion, Pakistan offers endless possibilities with its vast untapped resources. The country is set
to grow at a rate of 7% per annum which should help to further raise its per capita income from
US$847 per annum to US$ 1557 by 2015. Demand is expected to get stronger as incomes rise further
and assuming current population growth trends persist. Pakistan's strategic geopolitical position, due
to its proximity to India and China as well as to the oil rich Middle East and untouched central Asia with
vast natural resources, potentially carries opportunities which to date have not been properly
exploited. Promising for private sector would be the large infrastructure projects which would offer high
return in long term but would help enhance access and efficiency in movement of goods within and
outside Pakistan.
If done right, Pakistan can easily integrate itself into the export value added chain of the region as
there is adequate room for further growth; investment in these sectors is thus highly feasible. For
example, Pakistan still stands relatively low in terms of motorization when compared globally and even
within the region. Automakers need to take this into account as the demand clearly exceeds supply.
Likewise the supply of electronic goods is still short of the potential demand and any increases will be
absorbed by the population which is growing and expected to double over the next 25 years.
In future, the demand for energy, cement, fertilizer, and leather products is expected to increase. The
energy demand over the next five years is expected to grow at a rate of 7.4 percent per annum and
over the next 25 years it is expected to be 7 times the present demand.2 Thus the sectors, particularly
those discussed above, remain attractive for foreign investors due to strong consumer spending
patterns and rising industrial activity depicted by past trends and strong future demand. Likewise,
banking sector has to position itself to extend its outreach, which will play a key role in sustainability
and in diversifying risks. For long term sustainability and to maximize the development impact, small
and medium enterprises should be encouraged and further developed as they will be able to fast
restructure themselves as and when warranted and will play a more critical role in employment
generation.
Besides bringing in much needed capital, increased foreign presence is expected to help Pakistan
integrate better globally and regionally, enhance skills and techniques and transfer and increase
usage of technology. It is our belief - so far reinforced by experience - that private sector participation
and foreign investment are going to be the cornerstone of our future economic strategy.