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Temporary gains should not distract from pursuing reforms vigorously

Apr 01 - 07, 2002

Pakistan was able to record a historical overall surplus of about US$ 1.2 billion on its balance of payments during July-December 2001 period. This was despite the shock and aftermath of September 11 event, synchronized global recession and high tension at Indian borders. Although, the US-led war against terrorism created significant uncertainty about Pakistan's economy, the country emerged stronger. The sharp turnaround in domestic sentiments concerning the external sector has been reflected by the appreciation of Pak rupee and the unprecedented increase in foreign exchange reserves. Although, the donor support to Pakistan figures prominently, the reverse capital flight and stronger inflow of remittances also contributed significantly towards this improvement.

Despite the impressive balance of payment improvement, it is difficult to disentangle the temporary or transitory factors from the structural shifts because a number of underlying parameters changed in the post September 11 period. These were: synchronized global recession, disruption in normal economic activities, virtually no difference in the kerb and interbank exchange rate, reduction in crude oil prices and halt in smuggling to Afghanistan. The continuation of these trends in future will determine the balance of payments outcome. Yet there are some structural shifts which are visible. In addition to commitments for external grants and concessional loans, Paris Club creditors have approved the relief on debt servicing of about US$ one billion during the current fiscal year. The increase in textile quota and reduction in tariff by the European Union will lead to some modest improvement in exports.

While the setback in terms of revenue, exports and to some extent, industrial production was significant, the mind-set change in external sector allowed for an unprecedented surplus in the current account. To be more specific, the sharp fall in imports actually reduced trade deficit. Falling crude oil prices and reduction in quantities of POL products imported helped in not only reducing Pakistan's oil import bill but also allowed for higher import of non-oil and non-food products into the country. Furthermore, the gain in the external sector paved way to address the long-standing structural distortions created by the parallel foreign exchange market.

Prudent macroeconomic management allowed for the successful completion of the Standby Arrangement in September 2001. This in turn helped Pakistan negotiate a Poverty Reduction and Growth Facility (PRGF) with the IMF in November. This attainment of macroeconomic stability and enforcement of fiscal and monetary discipline allowed the country to absorb the shock of September 11 smoothly and with ease. The developments in the external sector and Moody's upgradation of Pakistan's credit rating improved the outlook for foreign direct and portfolio investment.


Despite its significance, the external debt is entangled with a lot of confusion mainly due to: 1) use of various definitions and technical terms; 2) limited disclosure of information; and data revision and changes in reporting formats. Consequently, even those familiar with the issue of Pakistan's external debt, find it difficult to follow important development in this area.

As of end-December 2001, Pakistan's total sovereign external debt and liabilities (EDL) were US$ 38 billion external debt at US$ 33 billion and foreign exchange liabilities at US$ 5 billion. In terms of external debt, public and publicly guaranteed debt amounted to US$ 28.9 billion. Commercial and IDB credit amounted to US$ 600 million and US$ 300 million respectively. On the other hand, private loans and credit amounted to US$ 2.3 billion. Another component of external debt is IMF loans, amounted to US$ 1.9 billion. The country also owes US$ 5 billion as foreign exchange liabilities. These are different from external debt in the sense that repayments are not structured by an set schedule; it is not generally solicited and is primarily held by residents. Interestingly, the increase in total EDL may not necessarily be due to borrowing alone. In fact, since Pakistan borrows in multiple currencies, any appreciation in the currency of the creditor would have an adverse impact on debt obligation.

With historical perspective, Pakistan has benefited in the past from a number of debts rescheduling from Paris Club. The first two rescheduling agreements, which were concluded in 1972 and 1974, were based on adhoc terms. The first rescheduling was the result of payment difficulties following the separation of East Pakistan in 1971. Subsequently, the unprecedented increase in oil prices in 1974 compelled Pakistan to seek debt rescheduling. Pakistan requested another rescheduling in 19981, following the second oil shock.

Following the acute balance of payments difficulties after the nuclear detonations in May 1998, Pakistan again approached the Paris Club in 1999. Since Pakistan was unable to build its repayment capacity, another round of rescheduling was sought from sovereign creditors in January 2001. The Paris Club agreed to restructure debt worth about US$ 1.8 billion.

Although Pakistan successfully completed the IMF's Standby Arrangement, the need for the third rescheduling in three years was obvious by the September 2001. It was Pakistan's enhanced international stature following September 11 that allowed for extraordinary terms from Paris Club creditors.

In addition, the write off of US$ 1 billion of bilateral debt from the US will also reduce the external debt burden. This, together with the extraordinary increase in foreign exchange reserve, would not only improve Pakistan's international liquidity position, but also provide an opportunity to exit from IMF programme after the completion of the current PRGF.

There is a need to further consolidate these gains. Since multilateral debt cannot be rescheduled or re-profiled, non-concessional loans from the World Bank, Asian Development Bank and IMF are being substituted by new loans on soft terms. The government is also refraining from contracting new commercial or short-term loans. The government is also focusing more on retiring expensive short-term commercial debt.

The government plans to gradually curtail external debt and liabilities. Although, this seems difficult to believe, the current account surplus posted during July-December 2001 period and substantial gains from recent developments in the external sector can make this task within reach.


During this period Pakistan's external trade suffered the most serious short-term setback in the shape of imposition of War Risk Surcharge and reported cancellation of orders for exports. While it is too early to assess the exact impact, as the long-term benefits may outweigh the short-term losses. Pakistan is also expected to benefit from the reconstruction and rebuilding of Afghanistan.

In the above stated backdrop, Pakistan's trade performance during the period was not disappointing. Pakistan's trade deficit was US$ 417.6 million, showing an improvement of 54.7 per cent over the same period of last year. Despite a fall of around half a per cent in export earnings, the lower trade deficit was mainly due to a 9.6 per cent decline in imports. The ratio of exports to imports also went up from 82.9 per cent in year 2000 to 91.4 per cent in year 2001. Excluding POL import, which has been a continuous strain on Pakistan's balance of payment position, the trade account registered a surplus of over US$ 930 million.

Total exports were for US$ 4.458 billion. This fell short of the target of US$ 5.05 billion for the half year. The slowdown of economic activities across the globe, particularly in the major markets of the US and EU posed immense challenge to Pakistan's exports. The appreciation in the value of Pak rupee during the second quarter also worked against the exporters.

Under these circumstances, maintaining the last year's export level, with just a small decline of 0.4 per cent is itself a significant achievement. Pakistan's major exports including POL, leather, readymade garments, towels, bedware, surgical instrument, footwear, cotton fabrics, and yarn were able to show moderate to impressive quantitative increase over the corresponding period of last year. However, unit prices continued to deteriorate over the period resulting in an overall loss of US$ 182 million in export earnings

Quarterly analysis indicates that in second quarter, export revenues declined by 2.5 per cent, against a growth of 1.8 per cent in first quarter. However the actual impact of the crisis would not be known till the second half of the current fiscal year as the industry was so far engaged to accomplish the export orders which were already in the pipeline.

Export of textiles amounted to US$ 2.862 billion, registering a 1.4 per cent improvement. Though higher quantitative exports contributed additional earnings of over US$ 209 million, the negative price effect of US$ 175.9 million reduced this gain to just US$ 33.5 million. Export of cotton yarn at US$ 469.3 million was 7 per cent lower compared to the same period last year. Bedware exports showed a marked improvement in terms of both value and volume and amounted to US$ 453.4 million. Readymade garments fetched US$ 433.3 million, registering a 5.2 per cent growth. A 28.5 per cent increase in volume resulted in an enhanced earnings of US$ 117 million. However, the advantage was lost by over 18 per cent fall in average export price. POL exports, despite falling international prices, registered a growth of nearly 14 per cent and earned US$ 98 million mainly due to commencement of PARCO which exported 121.7 thousand tonnes of motor gasoline.

Imports amounted to US$ 4.875 billion, registering a 9.6 per cent decline over the corresponding period of last year. Lower imports of food items and reduction in the POL import bill were mainly responsible for this decline. Excluding POL, imports declined by a very small margin of less than one per cent. Whereas non-food and non-oil imports, showed a significant growth of around 6 per cent.

Import of machinery, except textile machinery has been declining over the years, indicating an industrial stagnation and poor investor confidence. In fact it declined by 7 per cent from US$ 977 million to about US$ 909 million. However reflecting the continuation of BMR drive textile sector imported machinery worth US$ 233.4 as compared to US$ 164 million, an increase of over 42 per cent. Import of construction machinery registered nearly 54 per cent increase.

Fertilizer accounted for US$ 141 million in the import bill, an increase of 13 per cent. This was on account of a 44 per cent increase in quantity. This can be attributed to larger import of DAP due to discontinuation of DAP production by FFC-Jordan.


The drought specter looming over agriculture for almost two years has undermined the growth of the sector and in turn caused slackness in overall economic growth. To mitigate the adverse impact, stakeholders are engaged in searching various alternatives including substitution among crops from more water intensive to less, where feasible. During the current fiscal year some shift occured from rice to cotton. Though, this instant change reflects the farmer's enthusiasm to match changing environment, it could not bring the matching impact on the size of respective crops due to the decline in per hectare yield of the crops. Based on the available data on area and production of various crops, growth prospects are consistent with the targeted growth of agriculture sector as a whole.

There was a 16.5 increase in gross disbursement of credit to agriculture sector. Purpose-wise breakup revealed that 19.4 per cent increase was registered in production loans, while development loan declined by 2.6 per cent. It was also observed that commercial banks were more aggressive in extending credit to agriculture sector. Entry of five private banks in the field of agriculture financing was a major breakthrough. Though, new entrants disbursed about Rs 244 million, the main achievement was change in attitude of private commercial banks towards agriculture financing. This became possible on account of the policy changes made by the central bank during last couple of years.


The KSE-100 index shed over 116 points in just three trading days following the September 11, 2001. With sudden change in market sentiments, most of the players were caught off guard. Due to the decline in market value of investment financed by Badla , these players were trapped in rising cost of Badla finance. As a result of timely intervention by the government in the second quarter, expectations were that Pakistan would reap significant benefits. However, subsequent development in relationships with India caused some dent Even though the Indian government continued with its rhetoric, the market rebounded strongly with the start of year 2002.

Since restoration of investors confidence became a priority, both the regulators and stock exchanges have been playing an important role. The successful introduction of T+3 system and the various other measures have improved market efficiency and transparency. There are still certain weaknesses that need to be addressed. These include poor disclosure by the companies. There is a need to learn from Enron fiasco, highlighting the issue of poor accounting disclosure. This demands improving both internal and external auditing standards. The myth of self-regulation that is prevalent in accounting industry needs to be addressed without any delay.

Also, the issue of Badla financing, which now and then creates tremors in the market, needs proper regulation. As a matter of fact, brokers simultaneously acting as intermediaries and Badla financiers present clear conflict of interest situation.

An area which is a source of encouragement is the corporate debt market, showing an immense growth. Twelve new issues were floated since the commencement of this fiscal year. More issues of TFCs are in the pipeline. The central bank has also allowed commercial banks to issue TFCs to augment their supplementary capital. These issues will be unsecured, with a minimum maturity term of 5 years and must be rated 'A' by credit rating agencies. This will allow banks to raise funds to match their medium term requirements.


According to a report, Pakistan has received US$ 254.5 million foreign direct investment during first eight months of current financial year as compared to US$ 199 million during the same period of last year. The investors from USA invested US$ 148.5 million but at the same time US$ 12 million were withdrawn from portfolio investment. The other significant investment came from the UK and the UAE totalling to over US$ 35 million. The oil and gas exploration sector attracted bulk of the investment amounting to about US$ 105 million. It is expected that with the establishment of Oil and Gas Regulatory Authority investment in this sector will further grow. Another sector, pharmaceuticals, which is already dominated by multinational companies offers enormous potential for foreign investors. However, the outlook for this sector is directly dependent on the pricing policy of pharmaceutical products followed by the government. Unless the key issues are resolved investment in the sector may not become a reality.


Speedy and smooth privatization not only offers opportunities for local investors but can also fetch sizable foreign investment. Lately, the sale of 90 per cent share of Pak Saudi Fertilizer has confirmed the GoP's commitment but also fetched an attractive deal. Earlier, 10 per cent shares of National Bank of Pakistan were offered to general public. This has paved way for the sale of shares of Habib Bank and privatization of United Bank. The GoP has also invited Expression of Interest (EoI) for the sale of 51% to 74% shares of Karachi Electric Supply Corporation (KESC). Looking at the market size and inherent potential, its financial advisor and the GoP aims to conclude the deal by end September this year.


Despite the increased foreign assistance and favourable external developments, there are still many unknowns and imponderables. Exports are expected to remain under pressure. Pakistan should not deviate for a moment from the course of economic reforms and restructuring which are aimed at enhancing the competitiveness of its real and financial sectors. The country must continue the process of building its institutional strengths and improving economic fundamentals and reduce the perceived risk. This require a three pronged approach; continued implementation of prudent macroeconomic policies; vigorous pursuit of sectoral reforms; and focused interventions for poverty alleviation.

Macroeconomic stability should be maintained by gradually reducing the fiscal and current account deficits, and keeping the inflation low. More importantly, gains from improved economic governance, which are possible through provision of level playing field, transparency in decision-making, and predictability and continuity of economic policies should be institutionalized. This is a long and daunting agenda and temporary gains should not distract us from pursuing reforms vigorously.