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From Crisis to Hope

June 28 - July 04,1999

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  From Crisis to Hope

The economy is back on the track of recovery and we are confident in regaining the lost growth momentum

By Mohammad Ishaq Dar, Federal Minister of Finance, Economic Affairs and Commerce

Fiscal year 1998-99 which is going to end on June 30th of this year can be regarded as a memorable year in the economic history of Pakistan for a variety of reasons. First, Pakistan was subjected to external shocks of unprecedented nature which created serious difficulties for its balance of payments. Second, the skills of the country's economic managers were put to test as far as handling the crisis was concerned. Third, in the course of handling the crisis the economic managers had to travel "uncharted territories never taken before". Fourth, international economic environment remained inhospitable during the year which hampered the pace of economic recovery from the crisis. As Pakistan comes through the crisis it is a propitious time to take stock of developments in 1998-99, the way the external shocks were handled; and outline the present Government's agenda of stabilization and structural reforms in the medium term to ensure sustained economic growth and macro-economic stability. This is the subject matter of the present article.

2. Before I delve into the details of the subject matter it would not be out of place to mention briefly the country's state of the economy prior to the present Government taking charge of the state of affairs in February 1997. This will help the nation to assess the performance of the economic management of the present Government.

3. The nation may recall that prior to February 1997, Pakistan's economy was in the throes of severe macro-economic imbalances and deceleration of growth over the last few years. The hall-mark of the economy has been the declining economic growth, stagnant agriculture, shrinking industrial activity, double-digit-inflation, large fiscal and current account deficits, financial and administrative indiscipline, institutional decay, and above all, the country was lurching from one crisis to another. The year 1996-97 in particular, has been one of the worst years in the recent history of Pakistan. The real GDP growth recorded as low as 1.9 percent — far less than the country's population growth implying a decline in per capita income or living standard of the people; agriculture hardly registered any growth; large-scale manufacturing registered a negative growth rate of 2.1 percent; inflation persisted at double-digit (11.8%); and fiscal and current account deficits remained above 6 percent of GDP. Serious lapses in implementation of stabilization policies and structural reforms in the preceding three to four years along with exonomic mismanagement were mainly responsible for almost a total collapse of the economy.

4. The immediate challenges for the Government have been to revive economic activity in general and agriculture and industrial production in particular, and restore macro-economic stability. Soon after assuming office in February 1997, the present Government initiated comprehensive structural reforms and stabilization measures with aims at correcting the country's unsustainable macro-economic imbalances and reinvigorating growth. Major stabilization measures included tighter fiscal and monetary policies to contain aggregate demand. Major structural reforms on the other hand included tax and tariff reforms, banking and financial sector reforms, capital market reform, export promotion measures, agriculture incentive package, industrial revival package, and improving governance. Along with the stabilization measures and structural reforms, the present Government also pursued a prudent exchange rate policy to prevent appreciation of real effective exchange rate, thereby improving the country's external competitiveness.

5. The above listed measures yielded considerable initial success. The declining trend in economic activity was reversed. The real GDP grew by 4.3 percent in 1997-98 as against 1.9 percent in last year; agriculture which had stagnated in the preceding year grew by 3.8 percent in 1997-98 with wheat and sugarcane — the two major crops achieving record production; large-scale manufacturing registered an impressive recovery, grew by 7.6 percent against a decline of 2.1 percent in the preceding year; inflation declined sharply from nearly 12 percent to 7.8 percent; fiscal adjustment of nearly one percentage point was achieved, i.e. fiscal deficit was brought down to 5.4 percent of GDP from 6.4 percent in previous year despite the loss in revenue of about one percent of GDP due to the tax and tariff reforms introduced during the year, current account deficit was reduced by one-half, i.e. from 6.1 percent of GDP to 3.0 percent; the overall deficit of the seven key public sector enterprises was reduced from Rs 53.4 billion in 1996-97 to Rs 37.4 billion in 1997-98—an improvement of 30 percent and above all; the reforms in the banking and financial sector including the strengthening of regulatory and supervisory capacity of the State Bank of Pakistan successfully prevented the contagion effects of the East Asian crisis to infiltrate the economy through the banking and financial sector channels.

6. On the basis of the trends observed in 1997-98, the year 1998-99 was envisaged to be the year of consolidation of growth and further restoration of macro-economic stability. Accordingly, reasonable targets for the key macro-economic variables were set for 1998-99 which included the following: real GDP to grow by 6 percent supported by 5.4 percent growth in agriculture, 7.2 percent in overall manufacturing, and 6.5 percent in large-scale manufacturing; inflation to remain at single digit, fiscal deficit to be reduced to 4.7 percent of GDP; money supply and bank credit to expand by 13.6 percent and 12.8 percent respectively; bank borrowing for budgetary support to amount Rs 43 billion; the CBR to collect Rs 354 billion tax revenue; exports and imports to grow by 15.6 percent and 4 percent, respectively; and current account deficit to be reduced further to 1.5 percent of GDP.

7. A series of epoch-making events that unfolded on the national and international scene during 1998-99 have not only precipitated a balance of payments crisis but also damaged our gains of last year and most importantly, interrupted the pace of implementing structural reforms and stabilization measures. On the domestic front, the imposition of economic sanctions leading to the suspension of new bilateral and multilateral disbursement for non-humanitarian assistance created serious difficulties for the country's balance of payments. It has had serious bearing also on the country's exchange rate in the open market. Pakistan had no option but to take various measures to protect the balance of payments from a total collapse. The measures included; a devaluation of rupee by 4.2 percent, introduction of dual exchange rate system, reduction in export finance interest rate from 11 percent to 8 percent, a 30 percent cash requirement for import L/Cs, restrictions on certain foreign payments in addition to accumulation of arrears on debt service of non-preferred creditors, and reduction in government expenditure.

8. A mild devaluation, dual exchange rate system and reduction in export finance interest rate were meant to improve external competitiveness and encourage exports. Dual exchange rate, 30 percent L/C cash margin and reduction in government expenditure were meant to discourage non-essential imports. These measures were aimed at narrowing the trade gap to the maximum and coupled with restrictions on certain foreign payments in addition to debt service of non-preferred creditors, were intended to protect a minimum level of foreign exchange reserves. As stated earlier, the whole exercise was to protect the country's balance of payments from a total collapse. These measures were expected to cause some side effects in terms of decline in import and import-related taxes which constitute roughly 40 percent of total taxes, and slowing down of the overall economic activity with consequential impact on tax collection. The deviation from the budget estimates was, therefore, quite natural to happen. Thus, there was a trade-off between protecting the country's balance of payments and tax collection target. The Government preferred to protect the country's balance of payments for its wide-ranging implications for the economy as well as for the national security. The Budget as well as the overall fiscal deficit target are therefore, being protected by curtailing government expenditure.

9. Pakistan followed a two pronged strategy after the imposition of economic sanctions. On the one hand, several measures, as stated above, were taken to minimize the adverse effects of economic sanctions and on the other, Pakistan continued its negotiation with the IMF to reactivate the stalled IMF Programme. After extensive negotiation, Pakistan succeeded in reaching an agreement with the IMF to reactivate the stalled Programme in December 1998. The International Financial Institutions like the World Bank and the Asian Development Bank have also restored their financial support. The Paris Club has rescheduled external debt to the extent of $ 3.3 billion on very favourable terms for a consolidation period up to December 2000. A combination of deft economic and financial management and support from the International Financial Institutions have helped Pakistan to come out of the crisis in a relatively shorter period of time compared with East Asian countries. Despite serious financial and foreign exchange difficulties no shortages of any essential commodity were witnessed. In a similar situation, most countries would have resorted to rationing of POL, food, and other consumer items. The prudent and effective policies pursued by the Government did not let the situation go to the extent of rationing of essential items. Even with a foreign exchange reserves as low as $ 415 million on November 12, 1998 essential items were allowed to be imported subject to 30 percent L/C cash margin.

10. The above mentioned developments have cleared the air of uncertainty surrounding the economy. The economic situation has stabilized and the signs of economic revival are quite visible. Foreign exchange reserves stands at over $ 1.7 billion despite making payments to the extent of around $ 2.0 billion since January, 1999. The stability in the exchange rate regime has been attained which is vital for a viable balance of payments. We have now moved to unified market-based exchange rate system. The index of Karachi Stock Exchange has crossed 1300 points as against a low level of 766 in July 1998. Inflationary pressures have been contained to around 6 percent. Imports have exhibited rising trends since January 1999 which is a clear demonstration of the fact that economic revival is taking place, though the pace is relatively slow. Exports are also improving in a sense that the rate of decline is shrinking.

MEASURES TAKEN DURING MARCH/MAY 1999 TO REVIVE THE ECONOMY

- Complete removd of 30% L/C cash margin

- Duty draw back rates of more than 300 exportable items have been rationalized. This will cost the national exchequer an additional Rs 5.7 billion.

- The number of SROs relating to duty draw back has been reduced from 114 to only 4. This will facilitate exports.

- To ensure transparency and facilitate easy access these SROs have been put on the web site of the CBR for the first time in the history of the country.

- Scope of items eligible for export refinance has been enlarged.

- As part of the on-going tariff reform the maximum duty on imports has been reduced from 45% to 35% with the exception of automobiles.

- The number of non-zero tariff slab has been reduced from 5 to 4 with rates: 35%, 25%, 15% and 10%.

- Custom duties on Thousands of items covered under 3239 tariff lines have been reduced as under:

Customs Duty Rates Number of

Existing Revised from Tariff Lines

Category of Goods 31 -03 - 1999 Affected

 

Consumer Goods 45% 35% 2089

Intermediary Goods 35% 25% 363

Chemicals and Components 25% 15% 196

Basic Raw Materials 15% 10% 591

Total 3239

 

- Restrictions imposed after the economic sanctions on sale of foreign exchange by the banking system for travel, education and health have been lifted.

- Electricity tariff for industrial, commercial consumers have been reduced.

- The REPO (3 days) rate has been reduced by the SBP as part of reducing the entire structure of interest rate from 18 percent on July 1, 1998 to 13 percent on May 19, 1999.

- The treasury bill weighted average rates have also came down as under:

Date 3-Months 6-Months 12-Months

February 15, 1999 12.714 13.299 13.811

March 4, 1999 12.370 12.958 BIDS REJECTED

March 26, 1999 10.733 11.350 11.804

 

- Five commercial banks accounting for 75% of market share have decided to reduce lending rate by 2 percentage points.

- Pakistan has now moved to a unified market-based exchange rate system since May 19, 1999.

11. The Government views the crisis as an opportunity to redouble its efforts to implement structural reforms and stabilization measures initiated since March 1997. The Government is of the view that much more is needed to restore macro-economic stability, sustained economic growth and promoting human development and poverty alleviation. True to its commitment, with growing improvement in overall economic situation and foreign exchange reserves the Government has already embarked on the path of adjustment and reforms. During the months of March/May 1999 a series of wide-ranging measures were taken to reinvigorate economic growth and promote exports, the details of which are documented in Box-1. These measures include the rolling back of some of the policies taken earlier to minimize the adverse effects of economic sanctions. For example, the 30 percent L/C cash margin was totally withdrawn, capital control has been removed to a large extent, restrictions imposed on sale of foreign exchange by banking system for travel, education and health have been lifted and the normal facility of buying foreign exchange at the inter-bank rate through the banking system has been restored. The other measures such as reduction in maximum duty on imports, lowering of electricity tariff for industrial and commercial consumers, and lowering of lending rates are intended to revive economic activity. The measures such as rationalization of duty draw back, reducing the number of SROs relating to duty draw back, enlarging the scope of items eligible for export refinance, reduction in the maximum custom duty to 35 percent (with the exception of automobiles) and reducing in the number of non-zero tariff slab will go a long way in promoting exports. Pakistan commitment with adjustment and reform can be seen from the fact that even in the midst of difficulties, unprecedented in the country's economic history, the Government continued its effort to move towards a market-based exchange rate regime and finally on May 19, 1999 Pakistan did adopted a unified market-based exchange rate system. This achievement was made possible because through prudent fiscal, monetary and exchange rate policies the Government succeeded in attaining stability in the exchange rate regime.

12. The Government's efforts, as stated above to revive economic stability and promote exports in shortest possible period of time have been hampered by the inhospitable international economic environment. The unprecedented depth and severity of the recession in the crisis countries of East Asia and its contagion effects on the rest of the world have slowed down global economic activity. Brazil, Indonesia, Russia, and 33 other developing and transition economies are likely to witness a decline in per capita income in 1998 and 1999. The slow down in economic activity has also caused deceleration in the growth of world trade. The export prices of major agricultural commodities and raw materials have collapsed. Pakistan, being a member of developing countries cannot remain wholly immune to these unfavourable developments. In fact, the prices of Pakistan's major export items in international market have declined in the range of 1 to 29 percent.

13. Although the economic sanctions and the developments thereafter have interrupted the pace of implementing structural reforms and stabilization measures these have certainty not dented the resolve of the Government to accelerate its efforts once again. Achieving fiscal consolidation and financial discipline in short-to-medium term lie at the heart of structural reforms. Past efforts to achieve fiscal consolidation were not very successful due to the structural weaknesses of our tax system and tax administration. The Government has already started addressing the structural weaknesses by broadening the tax base to hitherto untaxed or under taxed sectors, shifting the incidence from imports and investment to consumption and income, revamping the tax administration, and improving the health of the public sector enterprises. These plans are under different stages of implementation.

14. Good governance along with stabilization and structural reforms are essential to achieve sustained economic growth. Weak governance has constrained Pakistan's economic growth and also contributed to macro-economic imbalances. The governance problems have severely reduced the effectiveness of public expenditure and tax collection machinery, and weakened the macro-economic management. The present Government has taken a number of measures over the last two years to improve governance and is committed to improve further in medium term because it serves as the third pillar in achieving sustained economic growth along with stabilization and structural reforms, the other two pillars.

15. While structural reforms and stabilization measures can bring substantial medium-to-long term growth benefits, these can have adverse effects on the economically weaker social groups in the short-run. The adverse effects of adjustment and reform on the poor and vulnerable need to be addressed through well-targeted and cost-effective social safety nets. This is also essential for enhancing social viability of structural reform programme. The present Government is fully aware of the issue and committed to shield the most vulnerable from the adjustment costs. A variety of measures have already been taken in this direction. The Social Action Programme (SAP) covering the critical areas of elementary education, basic health, population welfare, and water supply and sanitation in rural areas is already in operation. Despite financial difficulties, the allocation for SAP has been exempted from budgetary cuts, the Prime Minister's Programme of Self Employment has been launched, the Small and Medium Enterprise Development Authority (SMEDA) has been established to promote larger employment generating enterprises, the Poverty Alleviation Fund has also been established to assist the poor communities in income generation activities, and recently the Prime Minister has launched a Programme of Infra-structural Development that include construction of farm-to-market road, village electrification, lining of water channels, desilting of canals, installation of tube wells in arid regions etc. These programmes will help in alleviating poverty and ensuring wider dispersal of benefits of growth and development. These measures notwithstanding, the Government believes that sustainable economic growth accompanied by macro-economic stability is ultimately the most powerful means of reducing poverty over the medium-term.

16. Last one year has indeed been the most difficult and challenging year for Pakistan's economic policy-making. The difficulties created by economic sanctions were of crisis proportion but the present Government managed to take the country out of the crisis in shortest period of time. A combination of adroit economic and financial management, support from the International Financial Institutions and above all, the courage and determination of the people of Pakistan are mainly responsible for the early resolution of the crisis. The economy is back on the track of recovery and we are confident in regaining the lost growth momentum. Hope in the future prospects of Pakistan has been restored. The journey from crisis to hope has been difficult but we managed to overcome with determination.