Economic Policy Reforms in Pakistan
1999-2006

Ishrat Husain 

Most of the news stories that are splashed about Pakistan in the Western and regional media are normally about the attacks by AI-Qaeda and Taliban in the border areas with Afghanistan, the assassination attempts on President Musharaf, the nuclear network of Dr. A. Qahdeer Khan, tensions with India and the earthquake of October 2005. The story of Pakistan's remarkable economic turnaround during the last six years is hardly known abroad with any sense of clarity or authenticity. 

For example how many people even in this august gathering are aware of the following facts: Pakistan's GDP growth rate has consistently averaged 6 percent plus during the last four years reaching 8.4 percent in the last fiscal year, per capita incomes have shot up to almost US$850, the incidence of poverty has declined from 34 percent to 25 percent, unemployment rate has gone down to 6.2 percent and the size of the economy has doubled to $130 billion. Large scale manufacturing has grown in double digits and the cumulative private sector credit by banking system in last three years was more than $15 billion compared to less than $10 billion in the previous ten years. These facts, when revealed, come either as shock, surprise or disbelief to most observers. 
	
On the external front, Pakistan successfully entered international capital markets in early 2004 and has received enthusiastic response every year since then. Every single sovereign bond issue was oversubscribed several times and the pricing was better than that of investment grade countries. This was a country on the verge of default in May 1998 and had been put in selective default category by S&P and Moody's. Today Pakistan's international credit rating is Ba2 - only three notches below investment grade. In 2006 Pakistan was able to 
A paper presented at the Conference on Economic Policy Reforms in Asia 
held at Stanford University, Palo Alto on June 1 -3,2006 
raise more than $1 billion in 30 year and 10 year sovereign bonds in the U.S. market at fine pricing and these bonds were heavily oversubscribed. Trade - GDP ratio has reached 38 percent - one of the highest in South Asia region. ) Exports have doubled in U.S. dollar terms in last four years attaining a level of $18 billion this year. 

FDI flows have been rising every year and amounted to more than $3 billion or 2.3 percent of GDP - the highest in South Asia. Private capital flows in form of workers' remittances and other current transfers are touching $9 billion annually. External debt and liabilities as ratio of GDP has declined from almost 52 percent to 28 percent and as a percentage of foreign exchange earnings down to 125 percent from almost 300 percent six years ago. The myth that Pakistan is highly dependent upon official foreign assistance and particularly that from U.S. Can be gauged from the fact that less than 9 percent of country's foreign exchange income is derived from official aid. ODA per capita is only $8 or 1 % of Gross National income. Forex reserves have risen from $1 billion in 1999-2000 to $13 billion in May 2006 representing about 6 months of imports. 

Of course, this exceptional economic performance in a short period of six and a half years has given rise to some new challenges. Inflation which was subdued at 4 percent or less in the first four years of economic recovery has accelerated to 8 percent this year. Current account which was surplus for the last three years has turned into a deficit of almost 4 percent of GDP due to oil price shock and almost 50 percent increase in imports of machinery and equipment. Income inequalities have begun to surface as the upper income and middle income groups have benefited disproportionately from the consumer boom in autos, consumer electronics, real estate and stock market. Just to give you one indicator-the domestic production of automobiles has jumped from 30,000 in 1999-00 to 200,000 cars this year. In addition another 50,000 cars are being imported. 
How was this turnaround achieved in such a short period of time? The strategy formulated in December 1999 and implemented faithfully since then was premised on the belief that it is only a multifaceted attack that combined macroeconomic stabilization, fundamental structural reforms and improved governance that would lead to sustainable growth and poverty reduction. We felt that crisis management or pursuing simply stabilization were not enough as these were short term palliatives and the risks and vulnerabilities of relapse would have remained untouched. Let me share with you the key ingredients of this strategy and the sequencing and phasing of the various policy actions taken to implement this strategy. These lessons in my view, as a development economist, have implications broader than those for Pakistan alone. 

The first and foremost measure was to find a durable solution to the external debt problem as it was the major cause of stress to the economy. Bulk of the debt was owed to multilateral institutions and the bilateral official creditors. The former was unassailable and thus the focus was centered on the bilateral debt reprofiling. To make any headway on that front, the country had to come to terms with the IMF. The problem here was that in the decade of the 1990s, Pakistan had entered into successive agreements with the Fund but never implemented anyone of them beyond the first or second tranche release. This had created a credibility gap for Pakistan among the international financial institutions. To resume any meaningful relations with the IMF, we had to establish a track record of performance before they could agree to debt restructuring. In 2000, Pakistan entered into a nine-month stand-by arrangement which involved a large number of prior policy actions, performance criteria and structural conditions. Only after the stand-by program was completed well before September 11,2001 to the full satisfaction of the IMF authorities that Pakistan was able to secure a long-term restructuring of its Paris Club debt. The popular notion that the Sept. 11 events helped Pakistan obtain favorable terms on its Paris Club debt is contrary to the facts. We had already reached an agreement well before Sept. 11 with the Fund on a three-year Poverty Reduction and Growth Facility (PRGF) of which the debt restructuring was an integral part. The success on the external debt front was absolutely essential for macroeconomic stability and we worked assiduously for almost a year prior to the approval of PRGF to fulfill all the conditions pre-requisite for obtaining debt repro filing on a long term basis. 

Concurrently with the debt restructuring, the country embarked on the fiscal policy reforms and consolidation by raising tax revenues, reducing expenditures, cutting down subsidies of all kinds and containing the losses of public enterprises. Tax reforms were undertaken to widen tax base, remove direct contact between tax payers and tax collectors, introduce value-added tax as the major source of revenue, simplify tax administration and strengthen the capacity of the Central Board of Revenue. Although these reforms are still underway, the adoption of universal self assessment followed by random audit of selected tax returns, automation and reorganization of the tax machinery have begun to help improve tax collection although tax-GDP ratio has not yet improved to any significant extent. Fiscal deficit that used to hover around 7 percent of GDP in the 1990s declined to 3.5 percent in the last fiscal year. At the same time, outlays on public sector development expenditure tripled in this period, accelerating investment in infrastructure and human development. 

The next major thrust of the reform program was privatization of state-owned enterprises. Fortunately, the privatization process was initiated in 1991 under the Nawaz Sharif Government, continued under the Benazir Government, and further intensified under the Musharraf Government. Thus, there is a wide political consensus and support for privatization because of an underlying philosophy that the Government should not be in the business of running businesses but regulating the markets and laying down policies. Pakistan's record on privatization has been impressive and this has helped in stopping the hemorrhaging of public finances and easing the pressures on fiscal deficit. Pakistan's proceeds from privatization of banks, telecom, steel and other public enterprises were about $3 billion in the last few years. 

Financial sector reforms in Pakistan were also initiated early in the 1990s when new banking licenses were granted to private domestic banks to set up their shops along with the nationalized commercial banks and foreign banks. Although these reforms were implemented with fits and start, they were accelerated in 1997 when the Nawaz Sharif Government brought in professional managers and boards of directors consisting of reputable persons from the private sector to manage and oversee the nationalized commercial banks. The Central Bank was granted autonomy and the control of the Ministry of Finance over banking institutions was diluted. Excess labor was shed off through voluntary golden hand shake schemes and unprofitable branches were closed down. Further reforms were undertaken since 1999 when net non-performing loans of the banking system were brought down to less than 3 percent of total advances and loans, minimum Capital requirements were raised to $100 million, the quality of new loans was improved, mergers and consolidation of financial institutions eliminated a number of weaker players and the range of products and services offered by the banks was widened. But the most crucial policy action taken by the Government, in my view, was the privatization of Habib Bank, United Bank, and Allied Bank - three large nationalized commercial banks of the country. As a result of these reforms, the share of the private sector ownership of the banking assets has risen to 80 percent. The banks are highly profitable and the average lending rates had declined to as low as 5 percent as automation, on-line banking and multiple channels of delivery improved the efficiency of services and a healthy competitive environment set in. Agriculture credit, SME financing, consumer loans and microcredit have become mainstream products of the banking industry and the borrower base of the banking system has multiplied from 1 million to 4 million households. 
The middle and lower middle class which had been completely shut off from access to banking services are now enjoying car loans, mortgages, credit cards, consumer durables. Small farmers are using bank credit for buying chemical fertilizers, certified seeds, insecticides and weedicides, small implements and hiring tractor services. Small and medium entrepreneurs are expanding their fabrication and manufacturing capacities and upgrading technology. Landless labor and poor women in the rural areas are receiving loans for poultry, small livestock, sewing machines, etc. The main beneficiaries of these reforms are the customers of financial services although it must be recognized that market determined deposit rates have also declined significantly. But as the lending rates are surging upwards, deposit rates are also going to depict an upward movement. Trade liberalization has been undertaken in Pakistan for the last 15 years and the maximum tariff rate which was as high as 250-300 percent has been brought down to 25 percent while the average tariff rate is about 9 percent. Non-tariff barriers and para tariffs have been eliminated and the culture of providing selective concessions, exemptions and privileges to individual firms has given way to an across-the-board uniform rules and regulations. Protection to domestic industry is no longer a policy objective as in the globalized world efficiency can improve only under a competitive environment. The breaking down of these artificial barriers has led to significant productivity gains and manufactured exports now account for 90 percent of the total exports. Imports of all kinds of goods - capital, consumer, raw materials - are freely allowed into the country at negligible import duty rates. 

Foreign investment regime in Pakistan is also highly open and liberal. There are no restrictions or ceilings or prior approvals required for foreign investors to set up their business in Pakistan for any sector of the economy - agriculture, real estate, retail trade, manufacturing, services, banking, insurance and other financial services. As long as they bring in their initial foreign investment and register it with the Central Bank, the foreign investors are free to repatriate their profits, dividends, royalties, technical fees, debt servicing, etc. through their bankers without any prior approval. Foreign companies are allowed to raise funds from domestic sources, including bank loans, without any restrictions. They are treated equally with national firms in all respect and can bring in and out expatriate staff to run their businesses. 

Deregulation of oil and gas, telecommunication and civil aviation sectors have also brought about significant positive results. Oil and gas exploration activity has stepped up in recent years and constant discovery and production from new gas fields operated by private sector companies have added new capacity to meet the growing energy needs of the country. Independent power producers - both domestic and foreign private companies - have played a critical role in filling in electricity generation requirements of Pakistan. Telecommunication has witnessed a boom since the private sector companies were allowed licenses to operate cellular phones. One million new cellular phone connections are being added every month and the number of phones has already reached about 27 million or a penetration rate of almost 20 percent. Long distance international and local loop monopoly of Pakistan Telecommunications Corporation has been broken and new licenses including for wireless local loop have been issued. The customers are reaping rich dividends as the prices of phone calls - local, long distance, international - are currently only a fraction of the previous rates. One of the advantages of privatization of the state monopoly, i.e., the PTCL would be felt in form of higher bandwidth penetration that has lagged behind other Asian countries. 

Since the government recently announced the policy of allowing the private operators to fly on international routes, there has been a big uptake in the aviation business. Domestic airfares have been cut by PIA which had almost a monopoly and seat load factor has reached an all time high. PIA and the private airlines are all scrambling for new planes to meet the pent up demand for air travel. 

The cornerstone of the governance agenda is the devolution plan which transfers powers and responsibilities, including those related to social services from the federal and provincial governments to local levels. This plan was put into effect in 2001. The main premise of the devolution plan is the belief that development effort at the local level should be driven by priorities set by elected local representatives, as opposed to bureaucrats sitting in provincial and federal capitals. Devolution of power will thus strengthen governance by increasing decentralization, transparency, accountability of administrative operations, and people's participation in their local affairs. However, in the meanwhile the transition has created its own set of dislocations and disruptions in the delivery of services that need to be addressed. 

Other essential ingredients for improving economic governance are the separation of policy and regulatory functions, which were earlier combined within the ministry. Regulatory agencies have been set up for economic activities such as banking, finance, aviation, telecommunications, power, oil, gas etc. The regulatory structures are now independent of the ministry and enjoy quasijudicial powers. The Chairman and Board members enjoy security of tenure and cannot be arbitrarily removed. They are not answerable to any executive authority and hold public hearings and consultations with stakeholders. 

The National Accountability Bureau (NAB) has been functioning quite effectively for the last five years as the main anti-corruption agency. A large number of high government officials, politicians and businessmen have been sentenced to prison, subjected to heavy fines and disqualified from holding public office for twenty-one years on charges of corruption after conviction in the courts of law. Major loan and tax defaulters were also investigated, prosecuted and forced to repay their overdue loans and taxes. 

Civil service reforms aimed at improving recruitment, training, performance management, career progression, right sizing of ministries and attached departments, and improving compensation for government employees are part of the second generation reforms of the government for building strong institutions in the country. In order to depoliticize recruitment, promotions and career development, the independence and responsibilities of the Federal Public Service Commission (FPSC) have been enhanced and is now fully in charge of merit based recruitment and promotions. The Civil Service Act has been amended to reflect performance based career progression and would enable the government to retire civil servants who are inefficient and/or corrupt. The public sector educational training infrastructure is also being restructured to strengthen skill based training of civil servants at all levels. 
The reforms in some of the most important federal institutions - the Central Board of Revenue (CBR), Securities and Exchange Commission (SECP), the State Bank of Pakistan (SBP) and Pakistan Railways - initiated some years ago - are already beginning to take some hold and making a difference as far as governance is concerned. 

Reforms in access to justice will deal with delays in the provision of justice, case management, automation, and court formation systems. In addition, human resources, management information systems and the infrastructure supporting judicial system are being revamped and upgraded. Small Causes Courts have been established to provide relief to the poor who have small claims. 

Despite these reforms, Pakistan is facing many difficult challenges and will continue to face new unforeseen challenges. There is no room for complacency. One fourth of the population still lives below the poverty line. Human Development Indicators remain low as almost half of the population is illiterate, infant and maternal mortality rates are high, access to quality education and health care particularly by the poor is limited, income and regional inequalities are widespread, infrastructure shortages and deficiencies persist, skill shortages are taking a toll in the economy's productivity while at the same time, there is high unemployment and underemployment. Most worrying to me is that Pakistan's image abroad is quite negative. Foreigners are reluctant to visit Pakistan as they perceive the country to be a dangerous place. The worldwide preoccupation with the large economies of China and India and the ever-increasing quest to enter these markets is also working to the disadvantage of countries such as Pakistan. But the lesson we have learned is that there is no point in complaining and whining about this but to get on with the job, to work even harder, to overcome these deficiencies and constraints and to hope for the best. 

Thank you.