State of Pakistan’s economy

ASMA HYDER

OVER the years, Pakistan has struggled to achieve macroeconomic stability and sustained economic growth. Its highly volatile growth experience1 resulted in increased uncertainty and lack of confidence both at the ends of the investor and consumer. Low investment,2 as a percentage of gross domestic product (GDP) growth in total factor productivity, stagnant exports and soaring external debt are all long-standing and persistent issues underlying the Pakistani economy.

Recently, there has been a rebasing exercise to measure the GDP of the country.3 This exercise provides a true assessment of the economy because over time, many new sectors have emerged and a few sectors were redefined. The present exercise reveals that the share of agriculture changed from 23% to 24%, the share of industry from 20.9% to 19.5% and the change in the share of the service sector in Pakistan’s overall GDP from 56% to 56.6%. These trivial changes in the percentage of GDP show that the economy’s structural formation has remained unchanged during the last 10 to 15 years.

Recently, with the shift of political regime change from Pakistan Muslim League Nawaz to Pakistan Tehreek-e-Insaf and now a newly formed government, Pakistan has had to face the challenges of the pandemic with quite limited fiscal space. This global health emergency further reflected the government’s weak capability to handle such an enormous health crisis accompanied by an economic crisis. This essay further sheds light and suggests a way forward for selected pressing issues, including available fiscal and monetary policy, and the external sector and provides a few comments on social sector initiatives of the present government.

Stagnant and recently shrinking fiscal space is one of the country’s biggest concerns. Low fiscal space affects all the sectors and restrains the government’s initiatives and expenditures. During the last three years, revenues have remained almost unchanged. However, the overall budget deficit has increased by almost 22% in 2020-21 as compared to 2016-17. A more upsetting indicator is proportional trends in current and development expenditures. In the same year, that is, 2020-21, the current expenditure increased by almost 17% as compared to expenditure levels in 2016-17, but development expenditure was cut by 50% as compared to the expenditure in 2016-17.4 The decrease in development expenditure and increase in current expenditure will have a rather compounding negative effect on the economy as well as on the budget in the coming years.

On the other hand, the long-lasting issue of circular debt in the energy sector grew chronic this time. The trade deficit increased by almost 106% during the current year, mainly due to considerable increases in imports against stagnant exports. According to the Pakistan Bureau of Statistics, the consumer price index rose by 12.3% at the end of 2021 as compared to the previous year. The continuous increase in pricing, especially food inflation, has eroded the purchasing power of middle- and lower-income groups. An increase in poverty and vulnerability is an apparent outcome of this bleak economic situation, along with the challenges of the Covid-19 pandemic.5 The growth of the private sector, despite a lower interest rate, shows a lack of entrepreneurial interest and a stagnant economy. Finally, Pakistan’s performance in the external sector in the region is very low, compared to other peer countries like India, Bangladesh and Vietnam.

The solutions for economic revival are deep-rooted and probably not limited to the political regime under the Pakistan Tehreek-e-Insaaf or the present coalition government. The nature of the political system and continuous long-term disruptions after independence did not allow Pakistan to build a robust structure with strong thought leadership, which requires continuity in the democratic system. The temporary authoritarian regimes led to high rent-seeking, discouraged positive changes or reforms and instead provided an incentive to maintain the status quo. One of the most pressing issues for the present government is the continuously shrinking fiscal space. Thus, to reduce the current expenditure, many departments and ministries like the board of investment, the ministry of technical training and professional education, the health services and coordination ministry and the planning commission are almost irrelevant in the post-devolution scenario. These government offices should be abolished and have their responsibilities transferred to provincial governments. The growing size of the governmental bodies increases current expenditure and compounds procedural inefficiencies. Besides these structural changes in the administrative system, there are many other simultaneous measures, like making thoughtful decisions on the allocation of resources for subsidies, ambitious tax reforms and improvement in the structure of the financial sector for better transactions – especially for remittances and foreign investments for improving the fiscal space available to the government.

The current subsidies by the government are disproportionally skewed toward the Water & Power Development Authority and K-Electric. Its attempts to manage the circular debt in the form of Independent Power Plants and Power Holding Private Limited seem to have failed in fixing the problem. No other solution exists for the energy sector except structural reforms to streamline the procedures. Several initiatives like the privatisation of distribution companies, improvements in metering, billing and the collection system, reduction in line losses and increased capacity through innovation and higher reliance on renewable energy can help to improve the performance of the energy sector. According to the National Electric Power Regulatory Authority report in 2020,6 investment is needed in transmission and distribution networks compared to installed capacity to generate electricity. The distribution companies should have financial and operational independence and follow sustainable business models. A significant reduction in the circular debt is inevitable to expand the fiscal space for the government.

Managing inflation and the affordability of commodities of daily use for lower- or even the middle-income group is also a challenge for almost every government. A few studies analysed that inflation in Pakistan is explained by supply-side constraints and market friction.7 The demand-side shocks explain less than 30% variability in inflation. Besides the increase in international oil and electricity prices in the country, the devaluation of Pakistani currency also contributed to inflation. Devaluation increased the prices of currency and the cost of production due to increase in imported inputs.

From the investors’ point of view, private investment is discouraged due to the increased cost of production, market uncertainty due to the Covid-19 pandemic and the high cost of doing business owing to market frictions. In this scenario, the monetary policy becomes redundant, and lowering the interest rate is not an effective policy option. However, the low-interest rate proved to be a cushion for the investors in maintaining their working capital. Thus, the sustainability of old ventures was somehow successfully maintained. Soon, the central bank should be ready to confront the after-effects of the pandemic, uncertain economic prospects, rising inflation and citizens’ expectations from the exchange rate.

The external side of the economy, coupled with the above investment climate, is under threat due to a steep rise in the trade deficit. In recent years, the imports of machinery, vehicles and vaccines kept the import bill very high. Nevertheless, sales tax and customs duties contributed positively to the Federal Board of Revenue’s collection with a high increase in imports.

The government’s expectations from remittances, Roshan Digital Accounts and expected growth in exports seem challenging to improve the external-facing side of the economy. To handle this situation, drastic measures are required. In fact, the share of exports in the GDP has been consistently decreasing over the last two decades. Most of the peer countries in the region report a relatively higher percentage of export share in the GDP. One reason for the growing trade deficit, among many other factors, is the lower level of competitiveness. For instance, despite subsidies and concessions for the textile sector (which is the largest contributor to Pakistani exports), it still lacks diversification and sophistication. The number of product varieties has significantly reduced during the past decade, and Pakistan fell in the world ranking of product varieties exported from the 38th percentile to the 45th percentile (Pakistan Development Update 2021). Similarly, regional and international market integration has proven to be a successful strategy for many Southeast Asian countries like Vietnam and Singapore.8 Pakistan should consider importing raw materials and producing finished goods for exports.

Increasing productivity at the firm level is a significant challenge for local producers. The data shows that Pakistani firms’ productivity does not increase with their age like many other countries.9 Besides these significant challenges, many other constraints like certification and labelling of products, marketing, branding, registration, lack of preferential trade agreements and licensing discourage many exporters. In this aspect, the government can play a role in helping these small but potential manufacturers. To fix the challenges of the external sector, reforms of integrated nature are essential. To design such reforms, there is a need for dialogue among the private firms, government and relevant departments like training institutions, national tariff commissions, the industry of commerce and the federal board of revenue. All stakeholders should work together to figure out how to enhance competitiveness, productivity and the capabilities of local businesses.

The present government upscaled social protection during the Covid-19 outbreak through the Ehsaas programme Almost PKR 179.8 billion (S$ 1.34 billion) were distributed as one-time emergency cash assistance to 14.8 million beneficiaries at the risk of falling into extreme poverty. According to a World Bank report, Pakistan is ranked fourth10 in terms of coverage of cash transfers through its social protection programme. Another flagship initiative is the Sehat Saholat health card, which increases the purchasing power of the population from the lowest social strata. However, increasing the purchasing power will only work if there is enough supply of adequate health services, including access to doctors, nurses and beds. According to World Bank statistics, there are 1.1 physicians available for 1,000 people, 0.4 nurses or midwives for 1,000 people, and one hospital bed for 1,600 people. Without addressing these supply-side constraints, any such initiatives from the demand-side would barely work. Thus, like other sectors, there is a need to introduce reforms in the health sector. Investments should be diverted toward improving public health facilities; there is a need for analysing doctor/paramedic staffing and regionwise population to doctor ratio. Finally, a framework for the production, distribution and pricing mechanisms of pharmaceutical products is required for better healthcare in the country.

With more than 67% of the population under 30 years of age, and approximately two million people are expected to enter the labour market annually, Pakistan needs serious planning. An ambitious reform agenda is required for long-term persistent economic growth and sustainable development. As discussed above, the previous and current governments repeated ad hoc approaches to address crucial issues of Pakistan’s economy are stacking up into matters of grave concern.

Footnotes :

1. As reported in ‘Statistical Supplement’, Pakistan Economic Survey 2020-21, Finance Division, Government of Pakistan, it was 6.8% in 1960s, 3.5% in 2000s, 0.4% in 2008-09, 3.7% in 2012-13, 4.6% in 2015-16, 5.5% in 2017-18, 2.1% in 2018-19, -0.5% in 2019-20 and 3.9% in 2020-21.

2. The gross fixed capital formation (as a percentage of the GDP) in Pakistan in 2020 was 15%; in Bangladesh 30%; in India 27%; and the average of South Asia was 26%. Similarly, Pakistan’s average investment share of nominal GDP in the last 60 years was 17.5%.

3. Pakistan Economic Survey 2020-21. Finance Division, Government of Pakistan.

4. In a recent rebasing exercise, the base year was changed from 2005-06 to 2015-16 for measuring GDP.

5. The poverty rate declined by 40% over the last two decades to 24.3% in 2015, but the IMP projects a sharp reversal, with up to 40% of Pakistan living below the poverty line during the pandemic. UNDP, June 2020.

6. National Electric Power Regulatory Authority, State of Industry Report, Government of Pakistan, 2020.

7. M. Nasir and W.S. Malik, The Contemporaneous Correlation of Structural Shocks and Inflation Output Variability in Pakistan’, The Pakistan Development Review, 2011, pp. 145-162; F.U. Rehman and W.S. Malik, A Structural VAR (SVAR) Approach to the Cost Channel of Monetary Policy. University Library Munich, Germany and F.U. Rehman and M. Nasir, The Need for Accommodating Monetary Policy. The State of Pakistan’s Economy: During the Pandemic and Beyond: 2021-22, Edited by L.S. Farooq and M. Asif, IBA Press, Karachi.

8. A. Nakhuda, ‘Need for Export-Oriented Strategies’, Daily Tribune, January 2022.

9. N.U. Rehman, ‘Network Alliances and Firms’ Performance: A Panel Data Analysis of Pakistani SMEs’, Eurasian Bus Rev 6, 2016, pp. 37-52.

10. Social Protection and Job Responses to Covid-19: A Real-Time Review of the Country Measures, Pakistan Development Update: Reviving Exports. World Bank Report, May 2021.