Musharraf’s Economic Deception – Part 1

Guest Post by Dr. Tariq Naeem

General Musharraf took over the reigns of power in 1999 from Nawaz Sharif with the Pakistan economy on the verge of bankruptcy. So desperate was the situation Nawaz Sharif toured the world visiting Pakistanis with a begging bowl requesting them to invest in Pakistan due to the sanctions imposed on Pakistan for carrying out nuclear tests. Incoherent, short-term policies had resulted in a minority of people benefiting immensely, who incidentally were directly linked to the Sharif family.

Both the IMF and the World Bank have consistently praised the Musharraf government for solid macroeconomic recovery and saving the Pakistan economy from the brink of economic collapse. They cite the $128bn generated under his tenure. Many commentators are eager to explain that the Musharraf government has made substantial macroeconomic reforms since taking over the economy in 1999. The argument of the few Musharraf loyalists being that he has brought a degree of stability to Pakistan that the country never knew under civilian rule.

Part 1 of this two part series will assess this claim and analyse the current state of Pakistan’s economy which shows it is in a far more precarious position:

Reform, reform, reform

Once the dust settled on Musharraf’s coup he set about organising the nation, he formed a small working cabinet consisting mainly of experts and technocrats in their respective fields. These individuals were selected on the basis of expertise in their respective fields including a new team of economic managers, which included expatriate Pakistanis working in international institutions. Several committees, constituted with experts drawn from both within and outside Pakistan whose job was to make recommendations on the content, phasing and implementation timelines of the various reforms Musharraf planned to turn round the economy.

The most important committee was the Debt Reduction Management headed by ex-Chief Economist of the World Bank. This committee’s recommendations formed the basis of subsequent actions in this area. Another committee, under the leadership of a former Senior Vice President of the World Bank and assisted by consultants from the Lahore University of Management Sciences, submitted a blue print for the reform of the Central Board of Revenue. Another group was commissioned to review financial sector reforms and the services of several ex-World Bank staff were secured for this purpose on a full time basis. An Agriculture Taxation Committee, headed by a former planning secretary, produced a consensus view on the introduction of agriculture tax by provincial governments. An Interim Poverty Strategy Paper was developed in consultation with stakeholders from both within the government as well as from civil society, laying out the broad contours of the road map for economic policies and reforms.

The strategy was, as Musharaf’s economic team put it:

• To effect a sustainable reduction in debt ratios (reduce debt)
• To reduce fiscal deficit through revenue mobilisation. (i.e balance government budgets)
• To restructure key public sector institutions and stop their losses (privatisation)
• To pursue a prudent monetary policy and hold inflation down. (Raise interest rates)
• To liberalise the foreign exchange regime and allow market forces to determine the level of exchange rate (remove all obstacles to currency transfer)
• To create a level playing field for all economic actors (removal of state subsidies to key industries)

Such objectives were to be met with a number of reforms or changes to the way the economy was previously run. What needs to be understood is such objectives were all geared towards gaining credibility abroad rather then deal with domestic woes. Musharaf’s team was composed of experts from the very institutions that had indebted Pakistan and insisted on policies that would reduce debt. They proposed a number of reforms to achieve the above objectives, which included:

• The privatisation of the banking and financial sector
• The removal and reductions of all tariffs which protected Pakistan industry and agriculture
• The privatisation of all public sector enterprises
• Sale of shares to public through stock exchanges
• Removal of subsidies and administered prices on agriculture commodities
• The removal of all barriers on agriculture exports and imports
• The removal of all price controls, leaving essential prices to market forces
• Removal of domestic price controls of petroleum products and aligned with international prices domestically

Privatisation: past and present

Misgivings about the concentration of wealth in Pakistan (both East and West at this time) were voiced in official circles as early as 1959, when it was noted by Credit Inquiry Committee of State Bank of Pakistan that 222 depositors were making use of 66% of the total credit facilities offered by Pakistan’s banking system. In a study in the same period by Gustav Papanek, who today is President of the Boston Institute for Developing Economies and Professor of Economics Emeritus at Boston University, however at the time he was Harvard advisor to Pakistan, established that 24 individuals, firms and companies controlled nearly all of the country’s industrial assets. Both the Awami League in East Pakistan and PPP in West Pakistan came to power promising nationalisation. The heavy concentration of wealth among non-Bengalis is considered one of the key factors leading to a separatist sentiment in East Pakistan, and members of the leading families admit that, in anticipation of separation, they moved all investment and headquarters to West Pakistan. Following the separation of East Pakistan, these families were dealt a heavy blow, as the assets of non-Bengalis over 1.5m rupees were nationalised in now separate Bangladesh.

Zulfiqar Ali Bhutto ushered in the era of nationalisation with key industrial units coming under government control. The shock of nationalisation and loss of millions in assets for the leading industrial families resulted in the absence of any large industrial projects. Business leaders had became risk-averse, avoiding the capital-intensive industries, which were easy to seize, but are also key engines of growth and employment. Many of the leading families left Pakistan in the 1970s, withdrawing capital permanently for investment in the West.

In 1988, Benazir Bhutto’s government commissioned a privatisation plan from Rothschild and Son, which recommended Thatcher style privatisation through the stock exchange. When Benazir’s government was dismissed in 1990 Nawaz Sharif continued western style privatisation identifying 115 units for privatisation. The Musharraf government has continued with the privatisation drive and sold off remaining enterprises. The most important aspect of Musharraf’s economic reform package has been the wide scale mass sell-off of state industry, energy, and telecommunications, banking and public enterprises.

The justification for the privatisation policies was that the units were performing poorly, and that their sale would generate much-valued revenue for the state. However, in practice the promised gains amounted to nothing. Although the Musharraf government championed the privatisation programme as bringing competition, competitiveness and efficiencies to their respective sectors they were sold below their market values to make them attractive. They were sold by placing them on the stock market which led to them being bought by speculative investors only interested in short term gains and the proceeds were used to reduce the mounting debt burden.

Foreign Direct Investment (FDI)

Pakistan has been praised heavily for deregulating its economy allowing foreign multinationals to invest in Pakistan taking advantage of its mineral resources. Foreign direct investment (FDI) has soared to $2.2 billion in 2006; by the end of 2007 FDI will be $7 billion. Pakistan assembles Suzuki’s, defence equipment (submarines, tanks, and radars), salt, marble, onyx, engineering goods, and many other items. BMW, Toyota, and Honda have also invested in manufacturing facilities in the country.

However the sustainability of such a policy for domestic development has to be questioned. The usefulness of foreign direct investment, whereby foreign investors bring their capital and repatriate their earnings, profits, debt servicing, royalties, technical fees and even capital, without any restrictions in reality brings no benefit to Pakistan. Under the guise of globalisation many western companies place production facilities in the Third world making use of lax laws, cheap labour then sell the very same items for extortionate prices abroad.

Pakistan has not become an important destination for investors as India has over the last decade. India offers the promise of political stability, a legal system that can protect investors, a highly trained workforce, and a fairly large rate of domestic savings. It also has a large domestic market, which is of interest to foreign companies. Pakistan, on the other hand, is a country with a high level of illiteracy (only 54% of people above the age of 15 can read or write), in which political instability continues to threaten the pursuit of economic policies that could be sustained. If foreign investors have been attracted to the country it is only those who either are tapping the large market for basic goods for their own consumption. When the government claims that it has made possible large foreign direct investment into the country, it does not mention that FDI has come in the form of purchase of domestic cigarette manufacturing by America’s Altria group, or by an expansion in the presence of food and beverage companies such as Pepsi Cola and McDonald’s.

But investment in consumer products and domestic services cannot be the basis of long-term sustainable growth. The vulnerability of the economy to external funds was revealed by the data on investments and its sources by the finance ministry. During the Musharraf period, the rate of investment has increased by a third, from 17.2% of GDP in 2001-02 to 23% in 2006-07. However domestic savings have declined from 17.8% to 16.1% of GDP in the same period. This means that the economy is even more dependent on foreign flows than was the case in the 1990s. This dependence may not mean that the continuing political support of western governments and development institutions such as the World Bank is absolutely critical for economic progress. But there is now reliance on foreign companies and the money they invest in Pakistan. Hence Pakistans reliance on foreign funds has changed from international institutes to international companies. The claim of Islamabad that the economy is now moving on a sustainable course and that it will not be derailed by political storms is hard to accept. This is because a reliance on foreign funds can never be sustainable as foreign companies will choose the cheapest markets for production facilities that will not always be Pakistan; hence any economy which relies on foreign investment remains vulnerable to external shocks.

The role of the Service Sector

The services sector has been the driving force behind Musharraf’s so called success. It is now 54% of Pakistan’s economy but employs only 36% of the population. The regime has failed to develop foundations of a modern, competitive, and productive economy and as a result its reliance has been on services sector, real estate, and the stock market. The real productive sectors of the economy, both industry and agriculture have been completely ignored.

The privatisation programme saw most of Pakistan’s assets end up on the stock market; by 2004 Pakistan’s KSE 100 Index was the best-performing stock market index in the world as declared by the international magazine “Business Week.[1] The stock market capitalisation of listed companies in Pakistan was valued at $10 billion in 2005 by the World Bank. Transport, storage, communications, finance, and insurance accounted for most of the services sector.

The property sector has expanded twenty-threefold since 2001, particularly in metropolises like Lahore. However the Karachi Chamber of Commerce and Industry estimated in late 2006 that the overall production of housing units in Pakistan has to be increased to 500 000 units annually to address 6 million backlog of housing in Pakistan for meeting the housing shortfall in next 20 years. The report notes that the present housing stock is also rapidly ageing and an estimate suggests that more than 50% of stock is over 50 years old. It is also estimated that 50 percent of the urban population now lives in slums and squatter settlements. The report said that meeting the backlog in housing, besides replacement of out-lived housing units is beyond the financial resources of the government. This necessitates putting in place a framework to facilitate financing from the private sector and mobilise non-government resources for a market-based housing finance system.[2]

Pakistan has a population of 160 million, the 5th largest in the world and only generates $128 billion a year, this is the equivalent of Israel which does so with a population of 7 million (the size of Lahore). Half of this wealth is being generated from the services sector, which employs only a minority of the population. Hence only the rich have benefited from Musharrafs policies as it is they who consume, spend and sustain the service sector which ultimately caters for them. The majority of people are unable to spend on real estate, purchase shares of the stock market or buy luxury goods as 72% of Pakistan live on less then $2 a day (World Bank, 2006). The size of the services sector shows Musharraf’s policies have been developed for the rich, by the rich and to sustain the rich.

Pakistani Debt continues to rise

General Musharraf’s regime has broken all records in borrowing and has pushed the country into a debt trap. Recent State Bank reports showed the government had borrowed a staggering amount of over $15 billion in the past four years, as the country’s total debt and liabilities had peaked to an all time high of $40 billion. Such debt apart from additional borrowing is also composed of rescheduled debt as the Musharraf government continued borrowing to fund basic government duties and the inability to generate sufficient wealth from the domestic economy. Such amounts of debt have never existed in the history of Pakistan. By the end of 2004, the total external debt was $33 billion. If the government had stopped borrowing as it claimed, the country’s total debt would have declined to $23 billion based upon Pakistan’s regular yearly payments by the end of June 2007.

With the absence of basic industry in Pakistan, imports have become critical and have been rising due to this. Pakistan now faces an all time high trade deficit. Pakistan has borrowed over $3 billion during 2006-2007. The figures reveal that the huge borrowing was made to pay debt and continuous current account deficits. This is because the Pakistan government was unable to provide for the basic needs of the country, were forced to import larger amounts from in excess of exports and this has resulted in a deficit. Average annual payment of debt servicing has reached $3.3 billion in 2007. The current account deficit for the fiscal year ending on June 30, 2007 had increased by 41% reaching $7 billion. Instead of focusing on increasing exports the Musharraf government is relying on unreliable sources like foreign direct investment (FDI), remittances by overseas Pakistanis and privatisation to meet the gap.

This clearly shows the Musharraf regime’s lack of vision has failed to develop the foundations of a productive economy. In previous eight years its reliance has been on the services sector, real estate, and stock market. The real productive sectors of the economy, both industry and agriculture, were ignored. The infrastructure in Pakistan has not been upgraded and as a result the country now faces a serious energy crisis. The social sectors continue to be neglected with expenditure for education and health sectors much lower than those of previous governments.

Poverty

Although Pakistan generates $128 billion the people of Pakistan see very little of this wealth and live in severe poverty. Wealth distribution represents a glaring failure on part of the Musharraf government as its policies have only benefited the select few, life for most Pakistani’s is a daily struggle of making ends meet which has got even worse since Musharraf took over. Depending on which measure is used the World Bank puts 17% of the population living on less then $1 a day whilst 73% of the population lives on less then $2 a day. The World Bank also puts 33% (the size of South Korea) of the population living under the poverty line, another measure, which is a national estimate based on population-weighted subgroup estimates which is decided by national governments.

The blatant inequality is something all the people of Pakistan can see. The Pakistan Economic Survey 2006-07 acknowledges that the gap between the rich and the poor in the country widened in the period 2001 and 2005 (when the two surveys that have provided the data were held). The ratio of the income of the richest 20% and the poorest 20% went up from 3.76 to 4.15. The Gini Coefficient, which is universally regarded as an efficient measure of income equality, changed from 0.2752 to 0.2976 (that is for the worse). The thrust towards privatisation of facilities in the social sectors, especially education and health, has made these services more costly and less affordable for the common man. People are now compelled to spend more on most basic necessities. The government’s own figures say that the poor are now spending 14.6% more (as compared to 2001) on health. Ironically, the rich are spending 6% less – thanks to the better food, environment and living conditions they can afford. The poor are spending 50% more on transport and 11% more on food. The Musharraf regime has attempted to gloss the figures over by juggling around with statistics and definitions. Such shifts in the yardsticks adopted have distorted results beyond belief. For instance, a new methodology has led the government to change the poverty line figure in 2001. Thus an income of Rs878 per month per capita has been taken as the poverty line. This amount is at complete odds with the facts on the ground. Not surprisingly, the figures cited by the government for people living below the poverty line have come to be widely questioned. With poverty alleviation being the buzzword in Pakistan’s economic development and a key criterion for aid givers, policymakers are desperately trying to prove the success of their strategy in terms of falling poverty levels. What is so shocking is the fact that although the situation of most of Pakistan is one of abject poverty according to the UN’s Food and Agriculture Organisation, Pakistan in 2005 was the worlds:

• Largest producer of Ghee
• 2nd largest producer of Chickpeas
• 4th largest producer of Apricot, Cotton and Sugarcane
• 5th largest producer of Milk and Onion
• 6th largest producer of Date Palm
• 7th largest producer of Mango
• 8th largest producer of Tangerines, mandarin orange and Rice
• 9th largest producer of Wheat, and
• 10th largest producer of Oranges

Inflation has also pushed many people into poverty as prices continue to rise. Add to this the increase of the general sales tax (GST), life for most Pakistanis has become more difficult in the last decade. The huge surge in prices has been caused by huge increase in money supply particularly private credit, which has risen by an astounding average annual rate of 25% over the last five years. Such credit has caused considerable damage to the economy and the country’s poverty stricken citizens. The credit has fuelled inflation, which officially stands at 10%. However that is the average price increase, most essential items have risen much higher in price including staple foods like flour and cooking oil. During the last six years essential kitchen items have increased by 200% – 300%. Opposition MP Ahsan Iqbal exposed the Musharraf government emphasising “The government policies are pushing the country towards a serious crisis. The cost of borrowing could be a threat to the country’s economy as, he said. “The State Bank has been purchasing billions of dollars from the local market by flooding the local currency and creating inflation in the country.[3]

Conclusions

The Musharraf strategy for the economy is comparable to using ointment to deal with a tooth ache; it may psychologically make one feel better but in no way deals with underlying problem making the inevitable pain to re-surface at a later time. Musharraf has managed to win the hearts of the West as he has opened the economy to them and rescheduled debt which 8 years ago was on the verge of being defaulted. Domestically only a handful of people have benefited from the wealth the economy has generated who could be considered Musharraf’s support base. However many of those who live in Pakistan have not been fooled by Musharraf’s polices and for them the recent state of emergency symbolises the beginning of the end of Musharraf. So desperate is Musharraf he recently awarded his core generals plots of land ensuring they do not desert him. Pakistani economists continue to argue free markets has brought much success to Pakistan however has not been the case as most of Pakistan’s economic policies are short term, political and not sustainable for the well-being of the nation. Hence although the economy may be growing Pakistan’s economy remains dysfunctional and unable to cater for its own citizens. Hence the economy needs a complete overhaul not mere cosmetic surgery. As Shahid Javed Burki, former vice president of World Bank who was in charge of the bank’s Latin American division when Mexico was hit by a financial crisis in 1994 put it “Pakistan is facing symptoms that preceded the Mexican financial crisis more than 10 years ago. He points to the nation’s current account deficit, excessive speculative business activity and weak banking system is all heading in only one direction.[4]

In part 2 policies will be presented on how the Pakistan economy should be structured and a vision for the future direction of the economy.