Although Pakistan's economy has not met all government targets, its macro fundamentals are strong and the China Pakistan Economic Corridor is generating a lot of optimism. Is this enough to attract more foreign direct investment into the country? Edward Russell-Walling reports.
In June 2016, when Pakistan’s finance minister Ishaq Dar presented his pre-budget Pakistan Economic Survey for financial year 2015-16, he had to acknowledge that several key targets had been missed. The Pakistani media, not known for its temperance, howled its displeasure. And yet the economic mood in the country is more positive than it has been for some time.
Certainly, the 4.7% headline gross domestic product (GDP) growth figure for the year ending June 2016, as estimated by the Pakistan Bureau of Statistics, fell short of the government's 5.5% target. One reason for that was the catastrophic failure of this year's all-important cotton crop, with production in Punjab reportedly down by 45%. Though wheat and sugar cane did well, the rice harvest was also poor. Consequently, agricultural output did not meet its 3.9% growth target but fell by 0.2%.
Even so, 4.7% GDP growth represents Pakistan's best performance since 2008, before the financial crisis and global recession, and makes this the third consecutive year of 4%-plus growth. The result is a sense that economic stagnation has been arrested and that the economy is on a firmer footing. Growth was supported by the industrial (notably automobiles and construction) and services sectors, which beat their own targets by small margins.
Another disappointment, however, was the promised improvement in tax collection. The government had targeted a 12.5% tax-to-GDP ratio, but in the end could only manage 8.4%. In a country where only 1.5 million out of more than 180 million people pay tax, enlarging the tax base is crucially important. Some bankers say that Pakistan's relative economic health makes this a good time for government to take on the communities that do not pay taxes, such as retail and property. Taxing agricultural income, currently exempt from federal tax, would seem an obvious next step, but this will be a much longer battle. The government hopes to increase tax revenues by 16% in financial year 2016-17.
Strong macro
Pakistan's budget deficit has fallen, nonetheless, from 5.3% of GDP to 4.3%, and the government is projecting a further drop to 3.8% in the current financial year. The economy has benefited from falling oil prices, and consumer price index inflation was down from 8.6% to 4.5%. While exports continued to decline – not in volume but, as commodity prices fell, in value – the current account deficit has also narrowed.
The exchange rate has been stable for the past couple of years and foreign reserves held by the central and commercial banks reached a historic high of $21.6bn at the end of May. They were supported by a 5.6% increase in remittances from Pakistanis working abroad (principally in the Gulf states, but also in the UK and US) to about $19bn. As cheap oil ends the Gulf construction boom, these remittances are at risk, however.
It was a near-empty foreign reserves tank that forced Pakistan to seek help in 2013 from the International Monetary Fund (IMF), which obliged with a three-year $6.6bn loan. The arrangement is nearing its end without incident, and a 12th and final IMF review is scheduled for August. While reportedly "angered" by Pakistan's failure to meet its privatisation promises (see story on privatisation in Pakistan, page XX), the IMF said that reforms were continuing to strengthen macroeconomic stability, public finances and foreign exchange reserves. It added that growth remained "robust" and forecast GDP growth in financial year 2016-17 of 4.7% (against the government's projection of 5.7%), helped by lower oil prices, rising investment, improvements in energy supply, buoyant construction and acceleration of credit growth.
CPEC optimism
Since the current government has chosen to pursue investment-led rather than consumption-led growth, "rising investment" is considered crucial. Foreign direct investment grew by 5.4% in Pakistan in 2015, largely as a result of Chinese investment in the energy sector. Indeed, the prospect of major investment in the China Pakistan Economic Corridor (CPEC) is perhaps the largest single reason for the present economic optimism.
CPEC will connect Xinjiang, a region on China's north-western border, with Port Gwadar on Pakistan's south-west coast. By creating a corridor to the Arabian Sea for China's exports and imports, including oil, it will obviate the need for long sea voyages around south-east Asia. The $46bn series of projects will, Pakistan hopes, create 700,000 jobs in the next 15 years and add 2 percentage points to the country's GDP.
While the investment will encompass roads, railways, bridges and other infrastructure, the lion's share will be channelled into electricity generation and transmission, to address the country's chronic power shortages. "We are fast-tracking some power projects and will add 10,000 megawatts to the system by 2018," says Ahsan Iqbal, minister for planning and development. That is double the current supply and demand gap of 5000 megawatts.
Imports via a new liquefied natural gas terminal at Port Qasim are allowing uninterrupted gas supplies to industry and may start to replace expensive fuel oil in existing electricity generation. Much of the new generation will rely on cheap coal, which Pakistan has in abundance, though it will also come from wind and the world's largest solar plant. Construction will be by private consortia, financed by soft loans from Chinese banks, with the participation of big Pakistani banks. CPEC remains exposed to any further separatist unrest in Baluchistan, through which it passes, and, perhaps, further slowdown in China.
Attracting auto investment
Most of CPEC's investment is yet to come. For the time being, 2015's total investment levels in Pakistan of just under 16% of GDP are short of the government's manifesto target of 20% and a long way from the 30% levels of Pakistan's south Asian peers. Energy shortages have been a key deterrent to investment, so solving them will make a difference.
The country is keen to attract investment from another foreign car manufacturer, to join Honda, Toyota and Suzuki, who already produce locally. "They are all very profitable," says Miftah Ismail, minister of state and chairman of Pakistan's Board of Investment. "The market is big enough to support one more manufacturer and I would like to see a firm commitment from one of them by the end of the calendar year."
Mr Ismail says that Fiat is studying the Pakistani market, as are Renault and VW's Audi. "We have a middle class of 60 million people and that will be 100 million by 2025," he points out. "They are able to afford consumer durables, so if you have global ambitions, you can't afford to ignore Pakistan – which is still very cheap."
The Pakistani consumer certainly has the attention of some international operators. Coca-Cola and Procter & Gamble are both expanding their local investments. FrieslandCampina International, a Dutch dairy co-operative, is paying $460m for 51% of Engro Foods, one of the biggest chips on the Pakistan Stock Exchange. This is the largest private sector takeover by a foreign firm in Pakistan's history.
Barriers to FDI
The biggest bar to investment in Pakistan, alongside energy blackouts, has been security, and here too there has been some progress. Terrorism-related deaths have fallen by more than 70% since their 2010 peak as the army's war on the Pakistani Taliban bears some fruit. The Taliban's ability to disappear into Afghanistan and reappear at will means that a final resolution may be some time coming. Nonetheless, Renaissance Capital's global chief economist, Charles Robertson, has been quoted as saying that, on a per capita basis, a person is more likely to be killed by a gun in the US than to die as a result of terrorism in Pakistan. Gangsterism and political violence in Karachi are also greatly reduced, thanks to the efforts of the Rangers, a provincial paramilitary force.
Mr Iqbal and his planners set great store by two other potential developments – peace in Afghanistan, which could pave the way to more trade with central Asia, and an opening up of trade with India. Neither seems likely to happen any time soon. But the government's reform efforts may have generated a different kind of prize for Pakistan – an upgrade from MSCI's Frontier Index to its Emerging Markets Index.
That would mean parting with its 8.8% weighting for perhaps about 0.2% of a much larger index, but it would put the Pakistan Stock Exchange (PSE) more visibly on the international investment map. Foreign ownership of PSE stocks has remained flat at about 30% for some years.
"When Qatar and the United Arab Emirates were selected for the Emerging Markets Index they enjoyed foreign inflows of about $400m," says Nasdeem Naqvi, the exchange's managing director. And as investment minister Mr Ismail says, Pakistan is cheap. It currently trades at about nine times prospective earnings, compared with an MSCI emerging market multiple of more than 11. So new investors might think they are getting a bargain.
