Pakistan points with pride to the resilience its economic reform programme has shown in the face of a number of major unanticipated ‘stress tests’.
Crude prices spiralling to $78 a barrel in a country that imports 80% of its oil requirements, the knock-on effect of the Asian meltdown, a devastating earthquake that left 73,000 dead, violent clashes between the army and tribesmen on the border with Afghanistan where Al Qaeda and Taliban militants are holed up, plus relentless US pressure on president Pervez Musharraf to root out the terrorists after 9/11, which in itself catapulted Pakistan into the role of a frontline state – all these shocks to the system have failed to put the brakes on an economy on course to achieve 7% growth this year.
Brink of collapse
When Mr Musharraf seized power in a bloodless coup in 1999, Pakistan was on the verge of default. Prime minister Shaukat Aziz, then finance minister, put in place an urgent package of macroeconomic reforms aimed at stabilising the economy. At that time, Pakistan was facing an external debt of $37bn, coupled with huge fiscal and current account deficits. Domestic debt stood at 100% of gross domestic product (GDP). Tax revenue was almost non-existent, exports were stagnated and foreign exchange reserves had shrunk to a dangerously low level. There was talk of isolation and a total breakdown in expenditure controls and relationships with bilateral and multi-lateral agencies. The stabilisation plan was highlighted by exchange rate liberalisation and the strengthening of foreign reserves, which now stand at $13bn compared with $1bn when the programme was launched. In this period, domestic debt as a percentage of GDP has been managed down to half the 1999 level.
That is not to say that Pakistan has eliminated the imbalances in its economy. The current account and trade deficits persist, fuelled largely by strong demand for raw materials and equipment. Farrukh H Khan, chief executive of investment bank BMA Capital, is confident the deficits are manageable. “It should not be a big issue this year,” he says. “We have strong foreign direct investment (FDI) inflows, along with remittances and the ability to borrow in the international markets. But longer term, imports and exports need to come into balance.
“Despite these problems, Pakistan has been one of the world’s most dramatic turnaround stories. Domestic demand has been the engine of growth, as it has in China and India. Between 20 million and 30 million people now earn $8000 to $10,000 a year, making the current rate of growth sustainable for at least another two or three years. Those living below the poverty level account for 25% of the population, compared with 33% a few years ago.”
Mr Khan says that the general election later this year does not pose a threat to the reform process. “Even if Mr Musharraf loses, the three main parties, despite their political differences, hold more or less the same economic agenda. The difference is that this government has been the most aggressive in taking the reforms forward.”
Banks lead reform
Nowhere have these reform efforts been more apparent than in the banking sector. Seven years ago, more than 80% of the banking system was under state ownership. That figure has since been reversed, with nearly 90% in private hands. The consolidation process continues; Standard Chartered was the latest of the big-ticket acquirers, having recently paid nearly $500m for Union Bank, one of the most dynamic players in Pakistan’s banking sector. The central bank wants to see more foreign buyers in the market (see interview, page 144) and it looks like more corporate activity is on the cards. ABN AMRO’s takeover of mid-size player My Bank is all but a done deal, Barclays is strongly rumoured to be preparing a bid, possibly for Muslim Commercial Bank, and global giants HSBC and Citibank are seeking to expand their retail networks.
“This government fast-tracked its privatisation programme when it came into office and part of that process was to clean up the banking system’s balance sheets and non-performing loan portfolios,” says Badar Kazmi, chief executive of Standard Chartered in Pakistan. “In 2000, we saw a fast-changing competitive landscape, with the number of foreign banks in the country dwindling from 25 to about 10, once the soft windows of arbitrage opportunities disappeared with higher interest rates. We saw that being number one was not enough, as local players were gaining market share and hiring staff from international banks. We saw Union Bank as our main competitor and it soon became apparent that it was a logical fit with our business. Thanks to our experience with the Grindlays acquisition, we were able to fast-track the Union Bank integration.”
Pakistan’s banks are proving to be shrewd in operating as private sector businesses. Muslim Commercial Bank (MCB), for instance, has just filed an expression of interest to bid for Pakistan State Oil, the soon-to-be privatised government petroleum products marketing company. “We see this as an opportunity to grow our point of sales network and get closer to our customers by providing ATMs in PSO’s petrol stations,” says the bank’s chief executive, Mohammad Aftab Manzoor. “We can also run their fuel cards off our own credit and debit card network.”
Credit boom
Like other banks, MCB is enjoying a boom in consumer lending, which this year accounts for 10% of the total portfolio, and which M. Manzoor estimates could rise to 25% in the next three years thanks to rapid expansion in the credit card and personal loan segments. “There is massive room for growth in Pakistan,” he says. “The country has only 26 million account holders out of a population of 160 million.” On the possible tie-up with a foreign bank, Mr Manzoor says it is the board’s wish to remain independent, though MCB would be open to “a mutually beneficial alliance” if one were to arise.
The local banks are aware of the competition from abroad, particularly in recruiting and retaining qualified staff. “One of the keys is the demand for people such as risk managers,” says Masood Karim Shaikh, who heads corporate and investment banking at National Bank of Pakistan. Foreign banks have been putting pressure on wages, which in some cases have been pushed up three or four times as foreigners poach staff from Pakistani banks. Local employees taken on at 50,000 rupees a month will often leave after three months to work for an international bank with a starting salary of 80,000 rupees plus car. “The second big challenge is information technology, but here we are looking at between three and five years to bring new systems on line,” says Mr Shaikh.
Media scare tactics
By almost all measures it is a good story, although the image of fanatical mullahs with big beards and guns continues to dominate the media, raising concerns about personal security as well as Pakistan’s political stability.
Reza-ur Rahim, head of investment banking at JP Morgan in Karachi, says the law and order scare has been blown out of proportion. “It’s the CNN effect,” he says. “Bad news gets reported, good news less so. It’s a perception issue that puts these concerns on the desktop of foreign investors. We need to portray the softer side of Pakistan, because the actual situation is quite different to what people see on their television screens. A lot is going well in Pakistan. FDI is up, privatisation is moving ahead, the deficit is under control, poverty is reducing and the government is not letting the upcoming elections dictate their policy decisions.”
Salim Raza, chief executive of Pakistan Business Council, a policy sounding board for the government, agrees that the state of lawlessness is more perceived than real. “From the outside, Pakistan may look like a security risk, but we are not experiencing a structurally unstable situation,” he says. “It is important for investors to come and see the story for themselves and we need to put more effort into pushing the brand.”
Forward planning
The next step for Pakistan is to push forward the second generation of reforms. Ashfaque H Khan, director-general of the government’s debt office, is the person responsible for monitoring the implementation of the new Fiscal Responsibility and Debt Limitation Act, which binds current and future governments to abide by prudent economic policies. “We have already achieved some of the targets laid down in this law,” says Mr Khan. “For instance, the law states that by the 2012/13 fiscal year, public debt should not be more than 60% of GDP, whereas it has already been reduced to the 52% level. The government is obliged to reduce public debt by 2.5 percentage points relative to GDP each year, but in fact we’ve been averaging a 6.5 point yearly reduction. We are also obliged to ensure that by the next fiscal year, total revenue should be at least equal to current expenditures, and the government must not guarantee borrowings by the public sector by more than 2% of GDP in any given year. Finally, the government has to spend at least 4.5% of GDP on poverty alleviation and double the education budget by 2012/13. We have already exceeded that target.”
Business-led revolution
Mr Khan is confident that once the current high demand for imported capital goods has been satisfied, the current account deficit will decline to normal levels. “There are already signs that this is happening,” he says. “Imports were growing at 35%-45% in the past two years, but they have slowed to 9% in the first seven months of this fiscal year. Moreover, workers’ remittances are growing at 25%, compared to our expectations of 6%-7% for this year. This is being fuelled largely by higher wages in oil-exporting countries and the fact that our banks have been proactive in facilitating remittances.”
Mr Raza of the Pakistan Business Council says the second generation of economic reforms has to come from private initiative. “Business must point the way,” he says. “Pakistanis are investing in their country, which decidedly shows a shift in confidence. We need to harvest and develop this. This is all leading to a much more interactive process between government and business.”
