Economic strength the best weapon against any aggression

SHABBIR KAZMI, Special Correspondent
Aug 14 - 20, 2006

In his latest address to the nation, after Israel's attack on Lebanon, President Pervez Musharraf said that sovereignty of any country that suffers from fragile economy could not be ensured. While celebrating the Independence Day it is necessary to keep these words in mind and count the strengths Pakistan enjoys as well as the weaknesses it suffers from. Well wishers and critics may have different opinions, but the overwhelming consensus could be that in the recent past Pakistan has emerged stronger, both in terms of economy as well as defense.

According to many analysts Pakistan's economic turnaround has been remarkable and impressive. This becomes more obvious, if one keeps in mind the pre-2000 scenario when macroeconomic imbalances and huge debt servicing threatened medium term economic outlook. The achievements have been realized amid high oil prices, growing global and regional competition both for investment and trade and the fiscal consequences of the earthquake that rocked northern parts of Pakistan in 2005. Pakistan after successfully completing IMF's structural adjustment program decided to follow home-grown plans to face the emerging challenges effectively and efficiently.

Pakistan's GDP growth at 8.6% surpassed the average economic growth of 8.2% recorded by many emerging economies of Asia. This significant across the board growth of all the productive sectors has been primarily led by higher consumption. The aggregate demand was at an all time high because the per capita income grew and public had easy access to credit for many years in a row. Four fold increase in remittances inflow during five years further contributed to strong demand.

Sound fiscal management helped the country in reducing its fiscal deficit, from an average of 7% of GDP in the 1990s to around 4% in recent years. Although, the deficit levels are higher than the desired levels these reflect the impact of reduction in the collection of the Petroleum Development Levy (PDL) as the government decided not to pass on the oil price increase to the domestic consumers. The tax/GDP ratio, despite higher than targeted collections depicted nominal growth. Transfers to provincial governments remained high. Unforeseen spending on earthquake did not allow the government to raise both infrastructure and social expenditures.

As regards agriculture sector, it is encouraging that the farmers have responded positively to the increased access to credit and private sector participation has led to better return for major crops. This has also contributed to higher growth in the non-farm sector, livestock and dairy. As a result, the growth of both farm and non-farm activities has gathered pace.

Growing demand, led by improving credit access and export supportive polices, enabled industries to achieve full or higher level of capacity utilization in a number of critical sectors that include textiles, cement, steel, automobile, paper and paper board. Having achieved near-full capacity utilization most of the industries have undertaken massive capacity expansion plans. The largest investment has been made in textiles, telecommunication, oil and gas exploration and production. Part of the expanded production capacities in various sector have already come online and work on remaining projects is going on at a faster pace.

The services sector is emerging as a vibrant industry, which is not only contributing directly to real GDP growth, but is also supporting the productive sectors' performance. As a result of privatization of HBL and UBL massive foreign direct investment came into the country. The latest announcement by the Standard Chartered Bank regarding acquisition of about 81% shares of Union Bank opens new vistas for other foreign banks to acquire smaller local banks. The central bank's decision to raise the minimum paid-up capital of commercial banks to Rs 6 billion is expected to lead to a few mergers and acquisitions.

Pakistan's trade openness, as measured by the trade to GDP ratio - an indicator of global integration - has risen from about 26% to 32% during last five years. More significantly, Pakistan, while maintaining its edge in textiles has managed to diversify its export structure. Share of non-textile exports in total exports has grown from 35% to 41% during this period, reflecting a shift from agriculture and primary commodity exports to labor intensive, higher value added manufacturing exports. Within the textile sector, share of the medium to high value-added products (knitwear, bed linen, readymade garments, towels and synthetic textiles) has improved. Pakistan has been benefiting from textile quota phase-out.

Economic performance has benefited from a highly supportive and accommodative monetary policy. The low interest rate environment over the last four years has facilitated a sharp growth in private sector credit. Higher level of financing to the manufacturing and agriculture sectors, through consumer and personal loans, trade and commerce financing has helped in achieving higher GDP. Consequently, broad money growth exceeded nominal GDP growth and fuelled aggregate demand pressures that translated and manifested itself in a sharp rise in inflation. Monetary policy, its conduct and transmission mechanism has also benefited from the structural transformation of the economy and the banking system.

Effective economic management and liberalization has helped Pakistan in achieving economic stability as well as setting the stage for further economic restructuring and industrial development. However, analysts also hint towards various short-term risks and vulnerabilities. The fiscal deficit is expected to remain high and continued stagnation of the tax/GDP ratio, despite enhanced tax collection will continue to haunt the economic managers. Simultaneously, high current account as well as trade deficit is likely to put pressure on foreign exchange reserves as well as exchange rate. While about one-fourth of the trade deficit stems from the rise in oil prices, the broad based growth in imports of machinery, capital goods and raw material augurs well for fresh investments and enhancement of industrial capacities.