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Insaf Research Wing Pakistan Tehreek-e-Insaf

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Finding solutions for a better Pakistan
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Policies For Growth
Stability of Pakistans Economy

rchwinginsafresearchwinginsafre May 29, 2011

searchwinginsafresearchwingins Author: Muhammad Ali Nisar

Committee: Economics

afresearchwinginsafresearchwin Dossier # 001

Version # 001

ginsafresearchwinginsafresearch Nature of Document: Plan

Committee on Economics Policies for Growth & Stability of Pakistans Economy

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

Table of Contents

Introduction 04

Overview of Pakistans Economy 04

Price Instability 4-5

Unemployment 5-6

Production (output) Growth 6-7

Twin Deficits (Fiscal & Balance of Payment 7-8

Financial Instability 8-9

Recommendations/Suggestions 9-11

Bibliography 12

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

Policies for
Banks, fiscal policy by Treasury or Ministry of
Finance and direct policies by Ministry of
Commerce. Similarly in Pakistan monetary
Growth & policy is the responsibility of State Bank of
Pakistan (SBP), Fiscal policy is formulated by

Stability of t h e Ministry of Finance and direct control

policies are formulated by the Ministry of


Overview of Pakistans Economy

Economy Pakistan has been categorized as
impoverished and an underdeveloped
country by the CIA World Fact (2010). The
total volume of Pakistans GDP according to
Introduction CIA statistics (2010) was $ 174.8 Billion with
Economic growth and stability are the basic the per capita income of $ 1049 (IMF: 2010)
objectives of any government. Macroeconomic which is quite low. The population has
policies are formulated to achieve these reached to 170 Millions (approx) and big
economic objectives. Performance of proportion of population about 24% (2005-06)
political administration can be easily gauged by is living below poverty line. Public debt has
their success in achievement of the following reached to $ 58 billion in 2010. The debt to
economy objectives: GDP ratio is 49.9 % therefore a huge
proportion of total government budget goes to
Price stability & Inflation control serve the cost of debt. The performance of
Pakistani economic policies could be easily
Employment judged by the unsuccessful story of economic
objectives achievement in the following
Growth in National Production paragraphs.

Balance of Payment Equilibrium

Price Instability
Stability in Financial Sector The role of price stability has mostly been
considered t o b e th e responsibility o f
monetary authority. In his recent speech to
Financial sector plays an important role in the Federation o f Chamber of Commerce
t h e development of all other sectors of t h e and Industry, Governor of the State Bank of
economy. After the recent financial crisis (2008- Pakistan (SBP) declared price stability as a
2009), the stability of t h e financial sector fundamental objective of monetary policy
has gained almost the same weight on (Kardar: 2010). It seems State Bank of
government priorities list as any other area of Pakistan has not been very successful to
concern. The crisis started from th e burst of control inflation in t h e past few years. One
housing market bubble caused by t h e of the major problems faced by the Pakistani
subprime mortgage markets and ended in a economy is t h e h i g h rate of inflation. A
deepest recession since the great depression dire part of inflation is food inflation, w h i c h
of the 1930s. is more prominent than non-food items. Food
groups consist of 40% of t h e consumer price
To achieve the economic growth and stability index (CPI) and prices of food group items
economics policies are used as tools. These have been increased by 86% from June 2007
are Fiscal policies, Monetary policies and to October 2010 (Kardar: 2010).
Trade policies or direct control policies like
tariffing, quotas etc. In most countries
monetary policy is formulated by Central

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

Consumer Price Index (CPI) was also accepted that the high interest
rates and government spending and deficit
FY General Food Non-Food has crowded out the private sector
investment and growth. But the excuse given
2008 12.0 17.6 7.9 for tight monetary policy was that as the
energy crises and law and order conditions
2009 20.8 23.7 18.4
are not v er y f a v o r a b l e i t is less likely
2010 11.7 12.5 11.1 t h a t th e p r i v a t e s e c t o r w o u l d b e
encouraged by the low interest rates. In very
mild language the governments trade policy
(support price of wheat) was also criticized.
Source: State Bank of Pakistan (SBP)
An interesting point here is although the SBP
The inflation statistics of Federal Bureau of agrees that tight monetary policy is harmful for
Statistics (FBS) from January to January economic growth lead by private investment
each year tells the worsening situation. and reason of inflation is not growth in money
supply, yet the bank is persistent on its
contractionary stance. In a latest statement
made by t h e SBP (2011) structural deficit
and excessive government borrowing from
SBP w e r e s t a t e d as reasons for high
inflation and external account imbalance.

On empirical grounds analyzing money

supply behavior in Pakistan, Ahmad & Ahmed
(2006) discouraged the idea of active
monetary policy and recommended unisons
with other intuitions. Considering all these
Source: - Federal Bureau of Statistics (2011)
factors, tight stance of monetary policy
In countries like t h e U.K monetary authority cannot be justified. The recent academic
sets an inflation target e.g. inflation target of research in t h e role of fiscal policy to
Bank of England is CPI at 2%. If inflation control inflation also urges to use fiscal
goes above or below the target by 1% the measure for price stability. Research on
Governor of the Bank o f Eng lan d has to French and British economic policies by Creel
write a letter to the exchequer explaining et al. (2009) showed that fiscal policy may
reasons for not meeting the target. Although dominate the monetary policy without having
the recent rate of inflation was 4% the Bank any negative influence. It seems that poor
of England is consistent with its easy fiscal discipline in Pakistan has resulted in a
monetary policy and all time low rate of NASH between fiscal and monetary authority,
interest at 0.5%. The stance of fiscal authority which is causing economic instability.
has been tight therefore it is expected to bring
down inflation by fiscal measures. Unemployment
Creation of employment opportunities is
Particularly speaking about inflation in
expected from elected governments. Although
Pakistan, although the discount rate has been
full employment does not exist because of a
high at 14% since November 2010, but it
natural rate of unemployment, which is the
was a failed attempt to control inflation by
level at which the demand of labour is at
curtailing the growth of money supply. The
equilibrium with t h e supply of labour.
causes of inflation in general as
However the average rate of unemployment
acknowledged by SBP in governors speech
in Pakistan from 1990 to 2009 has been
(Kardar: 2010) were output gap, inflation
5.88% (Federal Bureau of Statistics), which is
expectation and cost-push. Moreover over it
quite high. Moreover unlike developed

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

countries there is no job seeker support o r the world. The GDP growth had been very
allowance for the unemployed in Pakistan. In slow in the last few years.
present situation the rate of unemployment is
very high reflected by the following statistics: Gross Domestic Product (GDP)
Constant Prices
Rate of Unemployment (2003- 2011) Year GDP Growth (%)
2003 4.86
Year Unemployment Rate Change 2004 7.38
(%) (%) 2005 7.67
2006 6.15
2003 7.80 2007 5.64
2008 1.64
2004 7.70 (1.28) 2009 3.37
2010 4.79
2005 8.30 7.79
Source: IMF World Economic Outlook (2010)
2006 6.60 (20.48)
The period of moderate growth from 2004-07
2007 6.50 (1.52)
did not last long and growth slumped in 2008.
2008 5.60 (13.85) Increasing population also fads away the
economic growths impact on society. If we
2009 7.40 32.14 decompose the GDP, services (including
public sector and defense services)
2010 14.00 89.14 contributed more than half of total towards
national income.
2011 15.00 7.14
Pakistan Gross Domestic Production
(Sector wise)
Source: CIA World Fact book

Unemployment has increased by 168% since

2008. There are various reasons for high
unemployment rate in Pakistan; low Agriculture
investment, low savings, energy crisis, low
industrial growth, and use of machinery in
agriculture sector, poor law and order situation, Services
unfriendly environment for Small and Medium
Enterprises (SMEs). Last years devastating
floods are another major cause of high
Agriculture (21.8%) - Industry (23.6%) - Services
unemployment in affected areas of Pakistan.
Most of the factors are correlated with each
other; industry could not grow without Global financial crises and sluggish growth may
investment, uninterrupted energy supply at low have contributed to the deterioration of
cost and easy availability of factors of Pakistans economic growth; however, as
production including capital. The very high compared to the other developing and
interest rates in this regard discourage private emerging economies in the region e.g. India
sector investment decision. and China, Pakistans performance has been
very poor.
Production (output) Growth
A country like Pakistan where there are plenty
Pakistan is a developing country and in of resources available, contribution of
nominal GDP ranking it is at 47 position in agriculture and industry is highly insignificant.

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

Slow growth and poor contribution of sector to borrow at high cost of capital. The
agriculture and industry to the national income credit for working capital rose to 97% in t h e
also results in poor contribution to tax revenues first half of FY-2011 as compared to the
and exports. It further results in twin deficits same period in previous year, but the credit
i.e. fiscal and balance of payment. for fixed investment declined from Rs. 43.4
billions to Rs. 6.7 billion. Another problem
Twin Deficits (Fiscal & Balance of visible in the banking sector is the decline in
Payment credit to deposit ratio although the deposits in
banking sector increased. Most probably it has
Pakistan is running a deficit in its both
been due to the high level of nonp erforming
balance of payment and fiscal account. The
loans w h i c h reached close to Rs 500 in t h e
debt to GDP has risen to 49.9% with $ 58
first quarter of the current financial year
billion of external debt. The statistics
(SBP: 2011), which discouraged banks to
released by SBP (2011) showed that deficit
lend to private sector. Moreover, the high
commitment at the beginning of fiscal year
demands of public sector enterprises also
was 4% of GDP (Rs. 685 billion) after t h e
limited the availability of credit to the private
floods to 4.7% of GDP (Rs. 812 billion).
Moreover the deficit in current account was
$ 3.9 billion in 2010. Alarmingly the government borrowing from
SBP increased to 1500 billion in mid
The trade imbalance (exports minus imports)
December (SBP: 2011). This shows a huge
was $ 11.5 billion, which has made significant
disproportion between public and private
contribution towards the current account
sector borrowing, which indicates that tight
monetary policy, is discouraging private
A major positive contribution was remittances sector to contribute to national income a n d
of $ 8.9 billion, which absorbed the trade j o b c rea tion . Although t h e private sector is
imbalance to some extent. It is worth more efficient and innovative than public
mentioning here that in Coalition Support Fund sector but the motivation is profit. High cost
( CSF) only $ 0.743 billion were realized. of production and energy crisis adversely
Exports growth had been faster (2.9%) than effects private sector initiatives and results in
imports which declined by -1.7 %. huge trade imbalances

If we look on the balance of payment account In future the governments intention to reduce
it is very clear that major reason of deficit is its deficit, which could ease the inflation
trade imbalance, imports are well above the pressure, seems unrealistic. The reforms on
exports. Therefore, even the huge general sales tax (GST) have been postponed,
remittances could not fully balance the trade. moreover continuous subsidy on energy and
It i s u s e f u l t o m e n t i o n here that the legal restrictions on government borrowing
remittances are less volatile than other limit have not been implemented. It clearly
elements of balance of payment account as shows that the government is not going
overseas Pakistanis consistently make further with its own plans due to its credibility
contribution. Therefore we need to focus more and political unpopularity.
on trade imbalances.

The credit availed by the private sector during

2nd quarter of FY- 2011 increased to Rs211
billion which was Rs199 billion in the
corresponding period last year. It could be a
positive sign if it had been due to easy and
cheap availability of capital. But it was an
increased cost of production (including
expensive imports), which compelled private

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

budget would negatively affect future

prospect of t h e economy. According to SBP
(2011) subsidies could result in further losses
of RS 25 to Rs. 35 billion by the end of fiscal
term. There has been no progress made in
the plan to raise Rs. 55 billion from t h e
issuance of new technology license to mobile
companies. This situation has created a
huge fiscal imbalance, which is growing
consistently and in future could be a major
problem for the Pakistani economy.

Financial Instability
After t h e recent banking crisis (2008-09) in
major economies of the world started by the
financial services industry. The role of the
financial sector in economic growth and
stability cannot be neglected. A s a r e s u l t
economic stability is now associated with
financial stability.

The banking sector i n P a k i s t a n is

supervised and regulated by t h e State
Bank of Pakistan (SBP). There are 41
scheduled banks, 6 development finance
intuitions, and 2 micro finance banks
operating in Pakistan. Banks are to maintain
minimum paid up capital level of Rs.1 Billion
Source: SBP Monetary Policy Statement (2011)
and reserve requirement ration of 5%. This
seems quite reasonable to encourage
lending. According to SBP (2011), in banking
sector the non performing loans (NPLs) have
Government ambition to increase tax reached near to level of Rs. 500 billions. Due
revenue seems impractical because of high to high discount rate, law and order situation,
level of tax evasion, Rs. 796 billion according energy crisis and mostly importantly political
to the World Bank reports. This amounts to influence, the banking sector could not
huge tax avoidance, approximately equal to provide substantial capital support to the
the annual budget deficit. In this scenario production sector (agriculture & industry). At
increasing taxes or introduction of new taxes present, the government borrowing from July
would discourage current taxpayers. In the 1st 2010 - Jan 2011 has been Rs. 355.2 billion,
and 2nd quarter of th e current financial year which contributed about 78% in monetary
the revenue growth w a s 11.2% and 15% expansion. The government has not only
whereas the target was 26% annual growth. become a major user of banking resources
The total target of revenue collection was Rs. but also causing inflationary pressure by
1667 b illion but FBR collected o n l y Rs. 661 excessive borrowing.
b illion in t h e first half of the year (SBP:
2011). On the expenditure side there had The dream of Islamic banking in Pakistan is as
been considerable reductions made in old as Pakistan itself. Even in the constitution
development heads. However there had been of the Islamic Republic of Pakistan article
huge subsidies given in energy, food and 38(f) states that: The State shall eliminate
transfers. The reduction in development riba as early as possible. In 1980s efforts

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

were made to introduce Islamic banking in volatility of market is very high KSE-100 index
Pakistan but the model failed due to certain has declined from 15500 points in April to
reasons w h i c h cannot be covered under 2008 to below 5000 points in January
t h e scope of this paper. However in January 2009, although it has significantly
2002 new license was issued to Al-Meezan recovered in January 2011(Bloomberg: 2011)2.
Investment Bank Ltd to open a fully This level of volatility discourages investors;
operational Meezan Islamic Bank. At present poor law and order situation, sluggish
there are 6 licensed Islamic B anks (IBs) and industrial growth and insiders trading are
12 conventional banks w h i c h have licenses major problems for Pakistani stock markets.
to operate Islamic banking branches (IBBs). Tight monetary policy (high interest rates)
According to SBP1 the total assets of the also negatively affects stock markets by
Islamic banking industry are over Rs. 225 announcement and credit channels. Moreover
billion as of 30th June 2008, which accounts the discounted value of future profits also
for a market share of 4.5% of t h e total decreases, which discourages investment in
banking industry assets. Total branch the equity markets. These effects are
network of the industry comprises more than prominent in Pakistani markets since the SBP
330 branches with presence in over 50 cities tightened its stance3.
and towns covering all the four provinces of
the country and AJK. The development of Recommendations
Islamic banking in Pakistan is appreciable;
Considering the present situation of the
however there is a lot more this sector can
Pakistani economy. The author would like to
contribute to the economy in future.
make the following recommendations.
The Small & Medium Enterprises (SMEs)
Monetary Policy
play an important role in economic
development; Taiwan, Korea and China are 1) The State Bank must abandon its tight
prime examples of the role of SMEs in the monetary policy to support economic growth
development of these counties. In Pakistan and development. As it is acknowledged by
unfortunately t h e financial sector has not the SBP that the inflation is not due to
played significant role to improve SMEs excessive monetary growth but other factors
culture. There had been two institutions e.g. fiscal deficit, energy crisis and supply
established SMEDA and SME Bank, however shock. There is no reason to adopt a tight
poor condition of SMEs reflects performance of monetary stance. It is important to mention
these institutions. Although there are some here that interest payment leaves less money
measures SBP is considering taking e .g . for tax deductions, therefore high interest rates
d r a f t p r u d e n t i a l regulations for the SMEs, also results in less revenue for the treasury.
consideration of the credit information bureau
and urging banks to lend to the SMEs; 2) Banking sector should be encouraged to
however no efforts have been made practical. supply liquidity to the production sector
Together w i t h the energy crisis, law and (agriculture & industry) and investment
order situation, high inflation and limited activities. Interest rates must be dropped
availability of low cost capital to the SMEs, significantly to enable banking sector to
there are no signs of development in this perform its role. Economic growth by these
sector. measures would stabilize economy by
decreasing output gap and bringing down
There are three stock markets in Pakistan; prices by matching demand.
Karachi Stock Exchange is the largest with
total capitalization of Rs. 3, 388, 801, 907 .65 2
and 655 listed companies. However the
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PlanPDF/Strategy%20Paper-Final.pdf es

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

3) Particularly for the development of SMEs imports. Moreover road tax particularly on
and industry in rural areas, SBP should vehicles would contribute to increasing
provide loans to t h e banking sector at low revenue.
discount rates. Banks must be bound to use
these funds for SMEs and industry 9) In Information Technology, gaming is a big
development. Moreover, SMEs applying for industry, investment in professional education
loans should be registered with the credit to develop a work force specialized in game
rating agencies and their credit history software development would be very useful.
maintained. Furthermore, financial support to software
houses would also help to develop and grow
Fiscal Policy this industry.

4) There should be a government spending Islamic Banking

review to analyze each head of expenditure,
and efforts must be made to minimize 10) To shift more towards Islamic banking, the
wasteful spending. Austerity measures should current Islamic banks should be facilitated.
be adopted at each level. Banks are advised and allowed to open new
branches particularly in rural area. Islamic
5) Tax evasion must be reduced; it would not and conventional banking could go side by side
only overcome the deficit of budget but also to contribute in economic growth. It would not
bring down inflation. The empirical research only creates jobs but also provide liquidity
also supports even prefers the role of the fiscal especially in those area where
policy in inflation control instead of tight conventional banking does not due to the
monetary policy. religious aspect.

Trade Policy Development Projects

6) The subsidies e.g. wheat price support puts 11) Infrastructure projects should be started in
huge pressure on the exchequer as the rich partnership with the private sector, particularly
class does not pay any tax and the salaried in t h e energy and development sector. It
class bear the burden. Therefore, subsidies could be in the form of shared equity, to
should be gradually eliminated. To keep low initiate the project and when the revenues
prices, export and smuggling of these items are realized the private partner could
should not be allowed. Moreover, imports gradually return the public sector investment.
from the international markets must be
allowed either at low tariff or no tariff to 12) Pakistan must use each and every
match the demand and keep the price at source of energy production i.e. Solar,
equilibrium. Best example is the sugar crisis Nuclear, Wind, Coal, Thermal etc. to produce
when artificial supply shock surged the prices more energy than its domestic requirement. It
to record high levels. is important to mention here that Pakistan has
t h e potential to produce energy from almost
7) The stance of t h e government has been every source and importantly there is an
to cut the demand to keep the prices low, increasing need of electricity in India in future
which is against the concept of welfare. The (approx 950,000 MW4).
supply should be increased to keep the prices
low; an example could be allowing import of
foods items and issuance of license to open
new sugar mills.

8) In the automobile industry, there must be no

restriction on automobile imports. Government
can generate huge amount of revenues by ywatch/news/article_1184013.php/India_envisa
putting tariffs on automobile and their part

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Committee on Economics Policies for Growth & Stability of Pakistans Economy

Financial Stability

13) The role of Pakistans Security & Exchange

Commission (SEC) should be enhanced to
control the financial and corporate sector
instability. There should be an additional
department in SBP to work as a market
watchdog so that insider trading and illegal
activities could be monitored.

14) As part of privatization, IPOs of public

sectors enterprises should be issued to
promote investment culture in Pakistan.

About the Author

The author is an economist by profession. He is
a graduate of BA Economics, MBA Finance,
MSc Finance, PHD Macroeconomic Policies
Interaction & Effects on Financial & Economic
Stability. He has 10 years professional work
experience in the field of economic and finance.


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Committee on Economics Policies for Growth & Stability of Pakistans Economy

Ahmad, N. & Ahmed, F. (2006) The Long-run
and Short-run Endogeneity of Money Supply in
Pakistan: An Empirical Investigation, SBP-
Research Bulletin, Volume 2, and Number 1.

Creel, J. Veroni, P.M., and Saraceno, F.

(2009) Fiscal policy is back in France and the
United Kingdom!, Journal of Post Keynesian
Economics / Summer , Vol. 31, No. 4 645.

Kardar, S. H (2010), Understanding Inflation

and SBPs Monetary Policy Stance, Address
at the Federation of Pakistan Chamber of
Commerce and Industry, 13th December.

State Bank of Pakistan (2011), Monetary

Policy Statement, January.

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