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Asia-PacificJuly 3 2017

Can Pakistan hold its nerve and sustain economic growth?

Pakistan’s GDP growth is up, its budget deficit is down and the China-Pakistan Economic Corridor promises to bring with it major investment. But observers are warning against government complacency as its privatisation programme stalls and power debts remain unpaid. 
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Pakistan economy

There were 28 foreign leaders, mostly from developing countries, at Beijing’s Belt and Road conference in May. None had quite as much riding on China’s ambitious trade scheme as Pakistan’s prime minister, Nawaz Sharif, given that the positive outlook of Pakistan’s economy mostly flows from the China-Pakistan Economic Corridor (CPEC).

On the face of it, the broader Pakistani economy is looking healthy. Gross domestic product (GDP) growth has been improving for the past few years, making Pakistan “one of the top performers of south Asia”, in the words of the World Bank. If growth for the financial year ending in June 2017 lives up to World Bank estimates of 5.2%, up from 4.7% the previous year, it would be Pakistan's best performance for nine years.

A mixed picture

Economic growth has inched up from 3.7% in 2013, the year in which the centre-right Pakistan Muslim League (Nawaz) government took office. It has implemented a series of economic reforms in conjunction with a three-year International Monetary Fund (IMF) loan programme, which ended in 2016.

Improvements were made in tax revenue collection, which led to a narrowing of the budget deficit. The government’s debt-to-GDP ratio (including obligations to the IMF) increased by about 2.5% during the programme, to 65%. But some progress was made towards the elimination of ‘circular debt’, which involves the chain of the non-payment of electricity bills, which culminates in regular load-shedding and is the bane of commerce and industry in the country. Indeed, a privatisation programme was launched to counter this problem.

Inflation has come down to acceptable levels (though it is starting to rise again, as explained in our interview with Pakistan's acting central bank governor and interest rates have been stable. The banking system remains healthy and private sector credit has continued to grow in the current financial year. Pakistan moved up a few places in the World Bank’s Ease of Doing Business Index in 2016 – thanks to improvements in land registration, credit information and customs procedures – but still ranks only 144th overall out of 186 countries.

Importantly, the security issues that flared up under the previous government have largely been addressed, and businesses say they feel more secure than at any time in the past 10 years.

And while 2016’s output figures were hurt by a disastrous cotton crop – textiles account for nearly two-thirds of the country's exports – this year’s crop is considerably better. Even so, there have been reports of 500,000 jobs lost in the textiles industry as factories close. Bangladesh and Vietnam are competing successfully for international textile orders, partly on price and partly because Pakistan’s power blackouts play havoc with delivery deadlines.

Booming consumption

With Pakistan's textile exports falling in value, if not in volume, exports as a whole have been declining. So growth is powered largely by a growing middle class and domestic consumption, which accounted for 92% of GDP in financial year 2016.

A measure of this trend is the 205% increase in the number of cars on Pakistan's roads between 2006 and 2016. Consumption is boosted further by the increasing availability of consumer finance (see article on Pakistan's banks on page 76).

The bi-monthly IBA-SBP Consumer Confidence Index, compiled by the central bank in conjunction with Karachi’s Institute of Business Administration, reached an all-time high in March 2017, though it had eased back slightly by May.

Rising consumer demand has not gone unnoticed abroad, and inward direct investment, though still lower than many officials in the country would like, has been picking up. Renault and Hyundai, along with affiliate Kai, have announced plans to start assembling vehicles in partnership with local companies. Audi has bought land for a plant in Karachi, and Volkswagen subsequently announced it would assemble its T6 transporter and Amarok pick-up truck in the city.

Other examples of international interest include Royal FrieslandCampina, a Dutch dairy company which paid $450m for a majority stake in packaged milk producer Engro Foods. Meanwhile, Turkish electrical appliance maker Arçelik cited Pakistan’s “increasingly prosperous working and middle class” when it paid $258m for Dawlance, a local appliance maker.

Corridor hopes

The project on which the government is pinning most hope for the country’s economic future, however, is the CPEC. Designed as a trade shortcut between China on Pakistan’s northern border and the Arabian Sea, to replace many thousands of kilometres of sea voyage, CPEC will see China invest $55bn in building power plants, roads and railways throughout Pakistan.

New facilities have already been completed at the port of Gwadar, on Pakistan’s south coast, which are now on long lease to China. The first trade convoy from the north arrived there in November 2016. Some $35bn is due to be spent on new power plants, to eliminate the electricity shortages that have been so damaging to industry and investment.

Other headline projects include the reconstruction of the Karachi-Peshawar railway and a new motorway along the same route. Special economic zones will be set up to attract Chinese companies, while Chinese firms will fund and operate the power plants. Elsewhere they will do much of the construction work, though this will essentially be paid for by Pakistan, with money largely borrowed from Chinese banks.

There were already fears in some quarters that the CPEC was putting too many eggs in one basket for Pakistan. China already accounts for nearly two-thirds of Pakistan’s $23bn trade deficit. If some of these very strategic projects fail, they could simply be taken over by Chinese banks, or they could turn out to be expensive white elephants.

Nonetheless, the CPEC is already contributing to Pakistan's economic growth, directly and indirectly, though it is also contributing to the trade deficit by adding to imports. The projects could account for 20% of GDP over the next five years and add three percentage points to growth, according to the Pakistan Business Council, which represents the country’s largest private sector companies. Pakistani cement and steel companies have been expanding capacity significantly in order to benefit.

So far, so positive; yet with the CPEC apparently in the bag and the IMF programme at an end, the Pakistani government is coming under criticism for letting some of its good work slide. Meanwhile, 2018's general election looms.

Stalling reforms

In the face of political and employee resistance, Pakistan's privatisation has gone into reverse. Privatisation minister Mohammad Zubair, a one-time IBM executive, moved to become governor of Sindh province in February and no successor has been named. Pakistan International Airlines and Pakistan Steel Mills remain in state hands, bleeding cash expensively. Even more seriously, the stalled attempts to privatise electricity generators and distributors have also slowed reforms in the sector, leading to a resurgence of circular debt.

Fiscal discipline seems to have relaxed alongside the departure of the IMF. The fiscal deficit fell from 8.5% of GDP in financial year 2013 to 4.6% in financial year 2016. However, the deficit for the first half of financial year 2017 was 2.4% of GDP, compared with 1.8% for the first half of financial year 2016. Tax revenues for the period grew by a mere 6%, compared with 20% the previous year.

The trade deficit is growing and foreign exchange reserves, while much improved compared with 2013, have been declining. A strong rupee, overvalued by as much as 20% according to the IMF, is doing no favours to exporters.

Meanwhile, remittances, in the form of much-needed hard currency, are declining for the first time in a decade, and the overall balance of payments was in deficit during July to March in financial year 2017 to the tune of $1.1bn, compared with a surplus of $1.5bn in the same period in financial year 2016.

What is more, after the CPEC there appears to be no plan B. Sirajuddin Aziz, CEO of HabibMetro Bank, finds the pattern of trade disturbing. “I don’t see any development of new exports or markets, just the same old trading patterns,” he says. Mr Aziz believes, for example, that Pakistani light industrial goods could compete on quality in African markets such as Tanzania and Ethiopia.

All things being equal, the performance of the Pakistani economy should continue to improve. But the government is coming under pressure to behave as it did when the IMF was breathing down its neck. The World Bank – which in its latest development update says: “Pakistan’s continued growth will rely upon sustained progress on structural reforms… and further strengthening of the international economy” – is forecasting economic growth of 5.5% in 2018 and 5.8% the year after, but only if the country can avoid the various potential hazards.

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