Pakistan Economics

Economic
Market Spotlight: The rapid deterioration of external accounts has led to a balance of payment crisis,
forcing the government to seek external assistance from the IMF after negotiations with bilateral and
multilateral organizations failed. The economy will slow considerable this year as a result of tighter fiscal
and monetary policy and weakening external demand for the important textile sector.
Credit Agencies
Moody’s: B3 Recent performance: After reaching a record 7.7% growth rate in FY 2004-05 (starting July 1st) GDP
growth slowed to a more sustainable pace of 6.0% in 2007-08 as political and macroeconomic instability
S&P: CCC+
took their toll on the country. Tighter domestic monetary conditions and a weakening of FDI and of US
Fitch: na demand (Pakistan’s main export market) also contributed to the slowdown, despite continued strong
Nominal GDP (2007) inflows of remittances from the diaspora. While the export sector has shown recent improvements,
USD 145.7 billions manufacturing output slowed in the first 2 quarters of the year, and even declined y/y in June (-4.1%).
With further tightening of monetary policy, austerity measures from the government and weakening
Population (2007):
external demand going forward, growth is expected to slow further this year.
164 millions
Fiscal policy: Last year’s populist budget, released in anticipation of the elections, promised to expand
Total Trade / GDP (2007):
price subsidies for politically sensitive items such as food, fertilizers and energy. Surging commodity
32.2% prices resulted in ballooning expenditure, which rose 43% y/y and 26% higher than initially budgeted for.
st
Currency: The fiscal deficit surged as well, from 4.5% of GDP in FY 2006-2007 (starting July 1 ) to an unsustainable
Pakistani rupee
level of 7.4% of GDP in 2007-2008. These and other spending measures were a major contributor to
rising inflationary pressures and macroeconomic instability. The new government now has no choice but
Exchange regime: to rein in spending, and the new budget has already penciled-in substantial cuts to electricity and fuel
Managed float subsidies, although the government had partly backtracked due to strong popular opposition. As a result,
Merchandise imports from the deficit for the 2008-2009 budget will improve to 5% of GDP.
Canada: (Jan-Aug 2008)
Monetary policy: With inflation rising to 23.98% in Sept-08 (a slight ease from August), the State Bank of
CAD 405 millions (+28.7%) Pakistan (SBP, the central bank) has been imposing price controls. Its key policy rate was raised to 13%
Main sources of Foreign in July, and the government issued price lists to retailers for the Holy Month of Ramadan to ease
Exchange (excl. FDI): pressures. The SBP’s inflation target is 6.5%. The SBP has been dealing with liquidity risk by injecting
Textile exports foreign currency and relaxing cash reserves by 100bp on Oct. 11th. Inflation is expected to remain at an
alarming level as it is being exacerbated by political instability, high oil prices, tight food supplies and a
Workers remittances
weakening currency. Additional interest rate hikes will most likely be a condition in the bailout package
Largest Merchandise Export that the government is currently negotiating with the IMF.
Destination:
USA (21.3 %)
External sector: The surge in oil prices in 2007 bolstered the import bill, triggering massive trade and
current account deficits, dwindling FX reserves and a depreciation of the rupee. The current account
Main imports: deficit now stands at around 9% of GDP a far cry from the 4% IMF forecast for the year and almost double
Machinery and transport the 4.7% recorded in 2006. In the past, FDI flows and remittances funded the previously more
equipment (26%) manageable shortfall. While remittances continue to increase rapidly (+27.9% in Sep-08), FDI inflows took
Mineral fuels (24%) a 47.9% y/y tumble as foreign investors have become quite concerned about the deteriorating economic
Risks to the Outlook and political situation. Foreign exchange reserves have plummeted to unprecedented lows at USD 7.3bn
Improvements in
in mid-October losing over two-thirds of their level at the start of the year and representing only 6 weeks of
security import cover. The currency has depreciated 32.4% year to date. The only upside to the picture is the still
Lower commodity manageable external debt at 26.6% of GDP in 2007.
prices
Outlook: Pakistan’s current economic turbulence may be appeased in the short term if enough funds are
Failure to reach or
implement IMF
pledged that would enable the country to fund the financing gap. Ongoing talks with the IMF have yet to
agreement materialize into actual terms and amounts for the rescue package without which the country will
Political instability undoubtedly default on its debt obligations. It is now unclear whether international donors will provide
November 2008 financial assistance without an IMF program aimed at structurally overhauling the economy. Despite the
Anne-Marie Shaker tremendous challenges that the economy currently faces, the medium term outlook for Pakistan is
ashaker@edc.ca nonetheless promising, provided the structural imbalances can be addressed and the necessary reforms
enacted. Political stability will therefore be key.

Economic Indicators Pakistan Manufacturing Output Index

02-06 avg. 2007 2008 2009 35 (y/y % change)
GDP (% growth, real) 5.8 6.0 6.0 4.2 30

Inflation (%, year-end) 6.1 7.6 21.6 15.3 25

20
Fiscal Balance (% of GDP) -3.0 -4.5 -7.4 -5.0
15
Exports (% growth) 13.3 6.3 15.8 6.7
10
Imports (% growth) 22.3 7.7 24.6 1.6
5
Current Account (% of GDP) 0.0 -5.7 -7.7 -6.5
0
Reserves (month of imports) 5.2 3.9 2.3 2.4 -5Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan-
External Debt (% of GDP) 36.8 26.6 25.8 24.0 -10 03 03 04 04 05 05 06 06 07 07 08

Debt Service ratio 11.2 10.9 7.6 9.1 -15

Currency (per USD, year-end) 59.1 61.2 70.9 74.2 -20
Source: EIU, EDC Economics
Source: Haver Analytics
 Pakistan Economics
General Political Environment: Pakistan’s political environment has undergone enormous
change over the past year. President Pervez Musharraf’s dominance of the political scene since a
Political
bloodless coup in 1999 began unravelling in 2007 as Musharraf resigned as President and as
Chief of Army Staff, signalling an end to military rule in Pakistan. Political Structure
Federal Parliamentary
Democracy
The February 2008 elections brought about a change in government as Musharraf’s party, the
Pakistan Muslim League-Quaid (PML-Q) was ousted. The Pakistan People’s Party (PPP), which President
had been led by Benazir Bhutto until her assassination in Dec. 2007, fared the best followed by the Asif Ali Zardari
Pakistan Muslim League-Nawaz (PML-N). Given that no single party succeeded in gaining a
parliamentary majority, a coalition – the Pakistan Democratic Alliance (PDA) – was created. The Prime Minister
PPP led by Asif Ali Zardari and the PML-N led by Nawaz Sharif – two parties that campaigned to Yusuf Raza Gilani
varying degrees on an anti-Musharraf platform – formed the PDA; however, there are several
factors which undermined its effectiveness. Legislative Bodies
• National Assembly (the
In August the PML-N, announced that the party would be withdrawing from the ruling coalition due lower housel): 342 seats
to several issues on which they remained divided. In spite of the PML-N’s withdrawal, the PPP-led • Senate (upper house):
government still has a parliamentary majority thanks to its own seats and those of its partners, and 100 seats
has continued governing. In fact, since the collapse of the coalition the PPP has further
strengthened its position as its leader, Zaradari, was elected president in September. Major Parties
• Pakistan Peoples Party
The PPP-led government is expected to survive over the short term; however, it is difficult to (PPP) 87 seats
predict how long the government will survive without the PML-N. As evinced by recent events, • Pakistan Muslim League-
Nawaz (PML-N) 67 seats.
building coalitions is difficult in a country as political volatile as Pakistan and these coalitions are
• Pakistan Muslim League –
even more difficult to maintain. Given that any coalition formed will include several smaller parties Quaid (PML-Q) 40 seats–
with differing interests, it will be difficult for the PPP to keep the union together. This will become supports Musharraf
more difficult when the PML-N becomes a more active force in opposition and seeks to gain the
support of smaller parties as well. Last Elections
Legislative: February 2008
Given these issues and the fact that both the PPP and the PML-N retain considerable support in Presidential: 2008
Pakistan, it is likely that the PPP-led government will not succeed in building a sustainable
Next Elections
coalition of sufficient strength to retain power and elections will be called at some point in 2009.
• Legislative: 2013
The unfolding economic crisis in Pakistan, and the government’s sinking popularity stemming from
• Presidential: 2013
the crisis, also lessens the likelihood of the present government’s long term survival. However,
elections would change little as these two parties will remain the two most popular parties and are
widely expected to dominate Pakistan’s political scene over the medium to long term. The Press Freedom Survey:
likelihood of a military takeover increases as the economic crisis – and the government’s apparent • 2007 Score: 63 Not Free
incapability to deal with it – deepens. (0: Free; 100: Not Free)
freedomhouse.org
Investment Environment: The government welcomes foreign investment in Pakistan and has
hastened the privatisation of public sector assets. Key challenges include highly under- Control of Corruption
Index:
developed strategic infrastructure and an antiquated taxation system. Administrative
• 2007 Score: -0.83
organizations are generally regarded as corrupt and ineffective. The government has a track (-2.5: Worst; +2.5: Best)
record in bringing unilateral changes to investors’ contracts. Corruption and issues of worldbank.org
commercial morality remain areas of concern.

Political Violence: The greatest security threat facing Pakistan is that posed by Islamist and
other militant groups operating in the country’s tribal areas bordering Afghanistan. These groups
have launched attacks against security forces, political officials and increasingly Western targets November 2008
(including the 2008 bombings of the Marriot Hotel and of the Danish Embassy in Islamabad) Peter Whelan
throughout the country. Al-Qaida and the Pakistan and Afghan Taliban are examples of such pwhelan@edc.ca
groups operating in the tribal areas, which are virtual ‘no-go’ areas.

The government’s perceived bias towards Punjab, Pakistan’s most affluent province, has
caused disgruntlement amongst the underdeveloped, yet resource-rich provinces in the
hinterland, particularly Baluchistan. This unrest often leads to political violence as militants have
taken to sabotaging strategic infrastructure, such as natural gas lines, in recent years.

Political Outlook
Legislative elections in February 2008 effectively ended the period of military rule that had been in place since 1999. A coalition
made up of secular parties was formed but quickly fell apart. The PPP is now in control of the legislature and of the presidency
following Zardari’s victory in the presidential election in September 2008. Pakistan faces two very significant challenges. The first
is related to the ongoing attacks that occur throughout the country undertaken by militant groups based in the Afghan border
areas. The second is the rapidly worsening economic situation in the country.