Pakistan’s economy remains highly vulnerable because of continued security challenges, political uncertainty, and two recent and severe floods. Large fiscal deficits keep inflation high and limit growth, and the outlook for the short and medium term is not good.
Paul Ross, senior economist at the International Monetary Fund (IMF) and former IMF resident representative in Pakistan, presented the IMF’s recommendations to contain these vulnerabilities and place Pakistan on a growth trajectory. Milan Vaishnav, postdoctoral research fellow at the Center for Global Development, served as a discussant and Carnegie’s Ashley J. Tellis moderated.
The Hidden Threat
The media often focuses on the deteriorating security situation in Pakistan, but Pakistan’s feeble economy may prove a more dangerous—but less visible—threat, Tellis said. While Pakistan was held up decades ago as a shining example of economic progress in the developing world, Tellis explained that its economy is now anemic, hobbled by a low savings rate, weak tax structure, a low investment in human capital, and the country’s fraught political situation.
Diagnosing Pakistan’s Sickly Economy
Ross presented the IMF’s diagnosis of Pakistan’s economy:
Abundant Potential: Pakistan has abundant economic potential, Ross said. It is located in an economically dynamic neighborhood, is ready to massively benefit from increased regional trade, and has the potential demographic dividend of a young population eager for employment.Vulnerable to Shocks: Ross argued that the Pakistani economy was vulnerable to shocks due to its heavy dependence on certain imports and exports and its limited economic buffers. He explained that nearly half of Pakistan’s exports are in the textile sector and almost one-third of Pakistan’s imports are petroleum products. This relatively undiversified trade leaves Pakistan vulnerable to external price shocks. Moreover, Ross added, Islamabad does not have a buffer to deal with these shocks due to extremely low revenue, the product of a weak tax collection system. Additionally, most of the government’s revenues are either spent in areas of non-discretionary spending (interest payments) or as subsidies to politically powerful groups.
Poor Record of Performance: Pakistan has repeatedly sustained high budget deficits, Ross added. In order to mitigate the deficits, however, it has reduced its discretionary funding in areas like infrastructure and health in order to continue its interest payments and wasteful subsidies. While this may solve the short-term problems of budget deficits, Ross explained that it accentuates the long-term problems of low economic growth, since sustained growth requires higher infrastructure spending. He suggested that Pakistan’s constrained energy supply provides an example of this vicious cycle. The energy supply problems are the product of decades of neglect and decrease GDP growth by up to 10 percent each year. The low long-term economic growth, in turn, depresses the government’s revenues and creates budget deficits, which again leads to less spending to resolve Pakistan’s energy problems.
Further Problems: This economic malaise is compounded by problems of private sector credit, low savings rates, and low investment rates, Ross stated. The outcome of Pakistan’s economic woes is considerable underemployment and unpaid employment, high rates of inflation, and diminishing international reserves. Without policy changes, the short- and medium-term outlooks are dim, Ross predicted.
The Cure: Ross explained that the IMF had identified several policy changes that could be enacted in both the short- and medium-term to return Pakistan to a path of upward growth. In particular, Pakistan would need to enact fiscal, financial sector, and structural reforms. If Pakistan was able to do so, it would be able to contain vulnerabilities and move the economy to high and inclusive growth.
Treating the Disease and Not the Symptoms: Pakistan’s Political Economy
Vaishnav examined the underlying political problems that have caused Pakistan’s economic deterioration. In particular, he noted that the current focus on elections by Pakistani politicians would make it difficult to enact reform. Vaishnav identified three key questions going forward:
Foreign Aid: Vaishnav noted that Pakistanis are inconsistent about American aid – sometimes they claim to desperately need it, and other times, they reject it entirely. He raised the question: how would Pakistan’s leaders react to a U.S. aid cut-off?
International Institutions of Finance: Pakistan has relied heavily on the IMF in the past, he said. Last year, however, Pakistan did not agree to a $3 billion IMF package because of the tax and energy conditions that were attached. In a future crisis, Vaishnav asked, would the IMF re-engage with Pakistan? Will the IMF insist on reform, or will it yield to political pressure as it has historically done?
The Uneven Trade Balance: Vaishnav added that Pakistan has historically supported securing preferred trade access as a means of bolstering its economy. On this front, there have been good improvements with the EU and India, although the United States has yet to agree. Is there a way for international donors to work through these channels and affect this issue?
Tellis concluded by noting that there is huge economic opportunity for Pakistan if reforms are enacted. However, as Ross stated, consensus on these reforms seems to have eluded Pakistan. Tellis argued that there are two possible reasons for this lack of consensus: either there is an information deficit and leaders do not understand the value of these reforms for Pakistan as a whole, or one constituency in Pakistan is shifting costs onto another constituency. Tellis concluded by asking if the lack of consensus is rooted in the latter reason, then how can Pakistan and its friends work to fix this, particularly in the context of Pakistan’s democratic process?