Pakistan faced a challenging year in 1999, with GDP

SOUTH ASIA
143
Pakistan
The economy has been slowly recovering since the second half of 1999 because of improved agricul-
tural performance. However, the balance of payments remains fragile and the long economic stagna-
tion hampers the government’s efforts to reduce rampant poverty. Medium-term economic prospects
depend on political stability, structural reforms, and capital inflows.
RECENT TRENDS AND PROSPECTS
ing of the Paris Club later that month, the govern-
ment and bilateral creditors agreed to reschedule offi-
Pakistan faced a challenging year in 1999, with GDP cial debt worth $3.3 billion. In early July 1999, Pakistan
growth declining to 3.1 percent from 4.3 percent
concluded an agreement with the London Club for
in 1998. Following nuclear tests in late May 1998, eco-
rescheduling $877.3 million in commercial loans. All
nomic sanctions imposed by G7 countries seriously af-
these activities helped build up foreign exchange re-
fected the economy. Economic growth declined steeply
serves and revive economic growth. By the end of June
as investors lost confidence, private capital flows vir-
1999, foreign reserves reached $1.7 billion (two months
tually ceased, and the new official development assis-
of imports).
tance was suspended. Consequently, Pakistan faced a
Both savings and investment rates declined be-
severe foreign exchange crisis with foreign exchange
cause of slow economic growth and collapse of
reserves declining to $415 million in November 1998
investors’ confidence. Gross domestic investment
(two weeks of import equivalent). To prevent sover-
dropped from 17.1 percent of GDP in 1998 to 14.8 per-
eign default, the government adopted short-term
cent in 1999. The decline in investment in manufac-
emergency policies that included freezing foreign cur-
turing, construction, and energy sectors offset the rising
rency deposits held by both residents and nonresidents
fixed investment in agriculture, transportation, and
in domestic banks, adopting a dual exchange rate sys-
telecommunications by the private sector. Poor stock
tem, and delaying servicing of foreign debt.
market performance also contributed to the slower
In January 1999, the economic sanctions were
growth in investment, although public sector invest-
partially waived, and international financial institu-
ment increased by 12.6 percent in nominal terms. Gross
tions subsequently revived their assistance. At a meet-
national saving as percentage of gross national product
1999 refers to fiscal year 1998/99, ending 30 June.

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144
ASIAN DEVELOPMENT OUTLOOK 2000
also slowed from 14.2 percent in 1998 to 11.1 percent
ernment retired PRs68.4 billion of domestic debt be-
in 1999.
cause of a lower fiscal deficit and debt rescheduling.
The fiscal and monetary areas, however, showed
However, because of weakened investors’ confidence
encouraging signs. Structural reform measures to re-
and the recovery campaign for defaulted loans, credit
duce the fiscal deficit included: (a) increasing the gen-
expansion to the private sector was much slower than
eral sales tax rate from 12.5 to 15 percent, (b)
the previous year. Tight monetary policy, coupled with
increasing petroleum product tax rates, (c) reducing
prudent fiscal management and slower growth in
budgeted current consumption expenditures, and (d)
aggregate demand, helped weaken inflationary pres-
reducing the federal subsidy on wheat. Consequently,
sures. The inflation rate declined to 5.7 percent from
the fiscal deficit declined from 6.3 percent of GDP in
7.8 percent in 1998.
1997 to 5.6 percent in 1998, and further to 3.7 per-
Imports and exports in 1999 contracted by
cent in 1999. While the customs duty collection de-
10.7 percent and 6.7 percent, respectively. The Asian
clined sharply because of a reduction in tariff rates
financial crisis adversely affected exports, while gov-
and negative import growth, an increase in general
ernment policy measures pursued after the economic
sales tax revenues helped boost tax collection. Nontax
sanctions and slow growth in the industry sector con-
revenue collection also increased. Meanwhile, public
tributed to a sharp decrease in imports. In the service
expenditures were held in check, and total expendi-
sector, workers’ remittances and foreign currency
ture as a percent of GDP increased only marginally.
account deposits dropped sharply. Overall, the current
Actual development expenditure was 17 percent lower
account deficit was $1.8 billion or 2.7 percent of GDP,
than the budget target for 1999.
the same level as in 1998.
Because of tight monetary policy, the growth of
Economic performance in the first half of 2000
broad money (M2) remained at 6.3 percent in 1999,
exhibited a slow but fragile recovery. While industrial
slower than most years in the past decade. The gov-
growth remained sluggish because of low investment,
Table 2.17 Major Economic Indicators, Pakistan, 1997-2001
(percent)
Item
1997
1998
1999
2000
2001
GDP growtha
1.9
4.3
3.1
4.5
5.0
Gross domestic investment/GDP
17.7
17.1
14.8
15.1
15.9
Gross national savings/GNP
11.3
14.2
11.1
12.5
13.0
Inflation rate (consumer price index)
11.8
7.8
5.7
5.0
6.0
Money supply (M2) growth
12.2
14.5
6.3
10.0
9.0
Fiscal balance/GDP
-6.3
-5.6
-3.7
-3.7
-3.5
Merchandise exports growth
-2.6
4.2
-10.7
8.0
9.0
Merchandise imports growth
-6.4
-8.4
-6.7
9.5
9.0
Current account balance/GDP
-5.6
-2.7
-2.7
-2.5
-2.0
Debt-service ratio
24.7
—
—
—
—
— Not available.
a. Based on constant factor cost.
Sources: IMF (2000); State Bank of Pakistan (1999); Government of Pakistan (1999); staff estimates.

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SOUTH ASIA
145
an improvement in agriculture sector performance par-
ous year. The current account deficit narrowed to $1.8
tially offset it. The cotton crop reached 10.5 million
billion in 1999, owing to a substantial reduction in
bales, about 20 percent higher than the previous year,
services payments and imports. The foreign exchange
and the rice crop improved as well. Revenue collec-
reserves stood at $1.5 billion in January 2000 (two
tion in the first five months was about 20 percent
months of imports), and the exchange rate remained
higher than the previous year and slightly above the
stable (see figure 2.16).
target level. Because of tight monetary policy and slug-
The medium-term outlook depends critically on
gish economic growth, from July to December 1999
political stability and the pace of economic reforms. If
the inflation rate remained low at 3.4 percent, in con-
the government promptly implements major structural
trast with 6 percent during the same period in 1998.
reforms and maintains macroeconomic stability, GDP
Despite sustained improvement in trade and
growth is projected to be 4.5 percent in 2000 and
current account balances, the balance of payments
5 percent in 2001. While industry growth may remain
remained fragile. Export earnings during the first half
stagnant because of slow investment growth and some
of 2000 picked up by 7.4 percent, but imports increased
structural adjustment measures—such as increases in
significantly by 11.5 percent, mainly because of the
tax rates and input prices—the agriculture sector could
sharp rise in world market prices of petroleum
rebound because of increased agricultural investment
products. Consequently, the trade deficit reached
by the government. Inflation is expected to rise in the
$783 million during the first half of 2000, compared
second half of 2000 as money supply increases. Because
with $563 million during the same period the previ-
of the expected increase in tax collection, the fiscal

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146
ASIAN DEVELOPMENT OUTLOOK 2000
deficit is forecast to decline to 3.7 percent of GDP in
is facing a high input cost structure, the nominal aver-
2000 and 3.5 percent the next year. Resolving several
age interest rate needs to be reduced at least 3-4 per-
export issues, such as financing for letters of credit,
centage points. This may require a corresponding
would maintain robust growth of exports, which are
reduction in deposit rates on the National Savings
projected to grow by 8 percent in 2000 and 9 percent
Scheme. The sustained large budget deficit, financed
in 2001. Imports may grow at a slightly higher rate.
by government borrowing from financial markets, is
The current account deficit is projected at 2.5 percent
the major cause of these high real interest rates. It
and 2 percent of GDP in 2000 and 2001, respectively.
crowds out financial resources available for lending
to the private sector and increases the cost of bor-
ISSUES IN ECONOMIC MANAGEMENT
rowing. Therefore, reducing the budget deficit is
essential.
Although Pakistan emerged gradually from the worst
phase of the crisis, the economic situation remains
POLICY AND DEVELOPMENT ISSUES
fragile. Some of the emergency measures taken over
the last two years have long-term adverse implications
Pakistan has once again approached a crossroad. The
for economic development. Credibility with official
new government faces difficult challenges that include
and private creditors was seriously damaged because
slow economic growth; extremely low private sector
of freezing foreign currency accounts and delaying
confidence; unsustainable domestic and foreign debt
servicing of foreign debt. A significant decline in pub-
obligations; and a rapid rise in the number of the poor,
lic spending on development programs could also harm
both in rural and urban areas.
the long-term growth potential.
The new government urgently needs to under-
The primary area of concern remains the
take fundamental reforms. Aside from speeding up
balance-of-payments position. The traditional sources
economic growth and structural reforms, Pakistan
of capital inflows—foreign aid, short-term commer-
must address social issues and improve governance,
cial lending, and portfolio investments—are expected
with special attention to social development and pro-
to weaken in coming years. The deterioration in the
tecting poor and vulnerable groups.
terms of trade threatens the ability to achieve the
Weak governance, both structural and systemic,
trade deficit target of $1.2 billion in 2000. While the
has contributed to poor economic performance and
debt rescheduling provides a two-year relief period
weak social development. Laws and regulations are
for debt service, in January 2001 the government will
inadequately enforced and public control over major
have to resume a substantial repayment of foreign
institutions is ineffective. Another major cause is
debt. Because foreign aid is the only reliable source
politicization and corruption, which weaken the civil
of capital inflows, increasing disbursement of foreign
service and cause mismanagement of public resources.
aid projects and fulfilling policy reforms promptly are
Furthermore, the government policy has not been ef-
crucial for improving the balance of payments. In par-
fective in vital functions, such as raising fiscal rev-
ticular, export sector issues need to be vigorously ad-
enues, targeting and implementing programs to assist
dressed, including providing export finance for
selected groups or regions, ensuring that public as-
indirect exporters and small and medium-size enter-
sets are efficiently used and well-maintained, and pro-
prises, improving product quality and marketing, and
tecting the citizens’ lives and livelihood. Finally,
allowing better access to technical information to in-
improvised and inconsistent policies contribute to
crease industrial competitiveness. Resolving the on-
economic instability and unpredictability, discourage
going dispute with independent power producers is
long-term investment, and create problems related
vital for restructuring the power sector and regaining
to lack of transparency.
foreign investors’ confidence.
To address these issues, the following areas need
The high interest rates of about 10 percent in
urgent policy attention:
real terms discourage private investment. To encour-
• Implementing transparent public management
age demand for bank credit from a private sector that
procedures and regulations to ensure accountability

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SOUTH ASIA
147
• Enforcing laws and regulations, particularly those
be accelerated through decentralizing decisionmaking
regarding taxation, debt recovery, and human rights
and project implementation, and rigorously supervis-
• Undertaking judicial and legal reform to pro-
ing the use of SAP resources.
mote social justice, economic development, and
In the current difficult economic situation, pub-
investors’ confidence
lic investment for strengthening and expanding so-
• Enacting public administration reforms, in-
cial service delivery under SAP II runs the risk of being
cluding downsizing the civil service and estab-
reduced. Protection for its funding is necessary, and
lishing incentive and control systems based
greater efforts are needed to involve nongovernment
on performance
organizations in designing and providing social
• Improving corporate governance and speeding
services. An improved policy environment and new
up privatization of state-owned enterprises
mechanisms for government–nongovernment orga-
• Improving public resource management, par-
nization cooperation are needed. While nongovern-
ticularly public expenditure control and debt
ment organizations can contribute much to the social
management
and economic development, they need external as-
• Decentralizing the government structure and
sistance to improve institutional capacity, cost effec-
encouraging local governments to adopt policy
tiveness, accountability, and transparency. Because
innovations that improve efficiency.
the poor are adversely affected by drastic structural
During the past eight years, the Social Action
reforms, strong measures are needed in the short term
Program (SAP) has improved social services. SAP was
to protect them.
introduced in the early 1990s to expand basic social
In the longer term, structural issues affecting the
services, including primary education, basic health,
delivery of basic social services and other poverty in-
family planning, and rural water supply and sanita-
terventions should be addressed. Given the strong link
tion. SAP has increased the primary school participa-
between poverty and human development, especially
tion from 69 to 73 percent, contraceptive use from
in the rural areas, basic social services in education,
14 to 22 percent, access to safe water from 47 to 55
nutrition, health, and population control need im-
percent of the population, and average life expect-
provement. Participatory integrated rural development
ancy from 58 to 62.5 years. In its second phase, SAP II
programs are needed, including rural infrastructure
continues to emphasize better provision of these ba-
development, microfinance improvement, and em-
sic services as well as population control. These can
ployment generation.

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