# SUMMARY

Pakistan's 6.0% p.a. growth rate over the past two decades has been considered by some as a "development puzzle" because this growth performance has been accompanied by three major disconcerting factors-high fiscal and current account deficits, relatively low savings and investment rates, and poor human capital formation. What factors explain Pakistan's rapid growth? And, can Pakistan sustain this high rate of growth in the future without first addressing the three disconcerting factors noted above?

Using a standard statistical growdt analysis, the paper shows that, consistent with the predictions of economic theory, the main determinants of growdt have been: a rapid pace of physical capital accumulation, the positive contribution of labor force growth, greater competition from external trade, and a policy of economic liberalization since 1978. Although Pakistan's invrestment rate remains low by international standards, the fLxed investment rate grew steadily during the 1970s and then stabilized at around 17% of GDP p.a. since the mid-1980s. This allowed the capital stock, economy-wide and in the manufactring sector, to expand fairly rapidly which in tmrn supported a substantial increase in the capital labor ratios and average labor productivity. Although a rapidly growing population with low skills coupled with a tendency towards greater capital intensity of production weakened the contnbution of labor in explaining growth especially in the manufactrng sector, the expansion of labor force remained a significant determinant of overall output growth. The growth impact of these traditional factors was augmented by improvements in total factor productivity resulting from greater trade and other economic hiberalizaton that has happened in Pakistan since 1978.

The sustainability of this high growth performance over the medim-to-longer term in the fature is, however, doubtfil. In the past, the main reason why Pakistan was able to sustain high growth and avoid a fmiaucial crisis in the face of large fiscal and balance of payments defLeits Was ta the real inrest rates on both external and domestic debts were substantially negative during the 1970s. As a result, debt to GDP ratios continued to decline despite large fiscal and current account deficits. However, real interest rates tued positive during the 1980s. So, even though on average fiscal and current account deficits were lower in the 1980s, the interest burden of the domestic and external debts have increased significandy. The oudook for the 1990s is that both foreign and domestic real intest rates will remain significanly positive. In this situation, if Paldstan were to continue to run fiscal deficits of the same magnitude as in the past, a financial crisis is likely to emerge pretty rapidly.

It is not possible to avoid a "debt crisis" by funding large fiscal deficits through money creation. The analysis of this paper shows that Padistan's inflation target of 5% p.a. is consistent with "inflation tax revenue" in the 2-2.5 % of GDP range. The revenue would reach a maximum of 3-3.2% of GDP with an inflation rate of 20% p.a. A further -acceleration of inflation will cut the "inflatior, tax base" (real money balances) pretty rapidly so that the revenue proceeds from inflation will actually fall. Even trying to generate the maxinmm revenue of 3-3.2% of GDP from higher inflation tax (20%) is unwise. The adverse effects of this higher inflation on resource allocation and income distribution can be quite severe.

Using a macroeconomic consistency framework, the paper derives estimates of sustainable current account deficits (i.e. deficits that do not worsen external creditworthiness) in the range of