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Insaf Research Wing Pakistan Tehreek-e-Insaf

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IRW
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Finding solutions for a better Pakistan
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Policies For Growth & Stability of Pakistanii Economy

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1st March, 2011

Muhammad Ali Nasir

searchwinginsafresearchwingins Committee: Economics

Dossier # 001

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Nature of Document: Plan

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Committee on Economics Economic Research: Pakistan

Insaf Research Wing (IRW) is a part of Pakistan Tehreek-e-Insaf (PTI) reporting to the secretary general. IRW
was created in 2009 to carry out research in order to find solutions for problems in Pakistan. The foremost goal
of IRW is to keep people of Pakistan and PTI informed and prepared.

The wing is composed of 9 committees. Each committee addresses issues related to its field of expertise. The
committees defined as of yet are (i) Socio-Political (ii) Information & Technology (iii) Economic (iv) Energy
(v) Healthcare (vi) Corruption (vii) Foreign Affairs (viii) Education (ix) Environment.

The research reports/papers are either commissioned by the central executive committee of PTI or committee
members of IRW. PTI members can also suggest IRW to consider researching on a matter they find important.
IRW welcomes any contributions in the form of scholarly work addressing important issues. Nevertheless, after
the author(s) sends the document it is peer reviewed before getting published. In the process of peer review
the document is technically analyzed and scrutinized. The procedure is necessary to maintain quality control.
However, varying opinions & ideas are not penalized.

Apart from working on research reports/papers which shed light on problems and provide basic solutions, IRW
aims to act as a conduit to the shadow cabinet and/or spokespersons aiding them with the task of preparing
extensive policies for PTI. These inputs are from several professionals who are well versed in the subject. IRW
also serves as a check on the reigning government’s policies.

The Wing does not follow a preset ideology while carrying out research. IRW does not endorse any opinion
presented in a published report/paper as an official position. Likewise, several research reports/paper on a
similar subject published by IRW can have contradictory recommendations though it should be noted that
these point of views are sole responsibility of the author(s). Very rarely when there is a complete consensus
on a certain research report/paper within IRW only then it is recommended to PTI for official perusal. Any
published document by the wing does not constitute it as an official position of PTI unless otherwise stated.

Insaf Research Wing works at a national level but its members are located throughout the world bringing in the
much needed international experience. IRW practices an open membership policy valid for all Pakistanis
regardless of religion or race. Nevertheless, members of other nationalities from international organizations
interested in helping Pakistan are always welcome to join IRW.

Published reports of IRW can be accessed on the website. The headquarter of IRW is located at PTI’s Central
Secretariat, Street No. 84, Sector G-6/4, Islamabad, Pakistan.

Copyright © 2011 by Pakistan Tehreek-e-Insaf All rights reserved.

The contents of this report/paper cannot be reproduced without prior permission of IRW.

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Table of Contents
Introduction

1.0 Overview of Pakistani Economy

2.0 Price Instability

3.0 Un- Employment

4.0 Production (output) Growth

5.0 Twin Deficits (Fiscal & Balance of Payment)

6.0 Financial Instability

7.0 Recommendations/ Suggestions

Bibliography

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Introduction

Economic growth and stability are the basic objectives of any government in a country.
Macroeconomic policies are formulated to achieve these economic objectives. Performance
of a political administration can be easily gauged by their success in achievement of
following economy objectives.

 Price stability & Inflation control

 Employment

 Growth in National Production

 Balance of Payment Equilibrium

 Stability in Financial Sector.

Financial Sector plays an important role in development of all other sectors of economy.
After recent financial crises (2008-2009) the Stability of Financial sector has gain almost
same weight on government priorities list as any other area of concern. The crises started
from burst of House market bubble caused by subprime mortgage markets and ended in a
deepest recession after great depression of 1930s.

To achieve the economic growth and stability economics policies are used as tools. These
are Fiscal policies, monetary policies and trade policies or direct control policies like tariff,
quotas e.t.c. In most of the countries the monetary policy is formulated by Central banks,
Fiscal policy by Treasury or Ministry of Finance and direct policies by ministry of commerce.
Similarly in Pakistan monetary policy is responsibility of State Bank of Pakistan (SBP), Fiscal
policy is formulated by Ministry of Finance and direct control policies are formulated by
ministry of commerce.

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1) Overview of Pakistani Economy

Pakistan has been categorized as impoverished and underdeveloped country according to
the CIA World Fact (2010). The total volume of Pakistan’s GDP according to CIA statistics
(2010) was $ 174.8 Billion with the per capita income of $ 1049 (IMF: 2010) which is quite
low. The population has reached to 170 Millions (approx) and big proportion of population
about 24% (2005-06) is living below poverty line. Public debt has reached to $ 58 billion in
2010. The debt to GDP ratio is 49.9 % therefore a huge proportion of total government
budget goes to serve the cost of debt. The performance of Pakistani economics policies
could be easily judged by the unsuccessful story of economic objectives achievement in
following paragraphs.

2) Price Instability
The role of price stability has mostly been considered has responsibility of monetary
authority. In his recent speech to Federation of Chamber of commerce and industry
Governor of State Bank of Pakistan (SBP) declared price stability as a Fundamental objective
of monetary policy (Kardar: 2010) It seems State Bank of Pakistan has not been very
successful to control the inflation in past few years. One of the major problems faced by
Pakistani economy is very huge rate of inflation. Even we don’t question the credibility,
accuracy and political influence on these statistics. There is very high inflation which engulfs
the real economic growth and squeezes the living of poor segment of society. Another awful
part of inflation is the food inflation which is more prominent than non-food items. Food
groups consist of 40% of CPI and prices of food group items have been increased by 86%
between June 2007 to October 2010(Kardar: 2010)

Consumer Price Index

FY General Food Non-Food
2008 12.0 17.6 7.9
2009 20.8 23.7 18.4
2010 11.7 12.5 11.1
Source: - State Bank of Pakistan

The inflation statics of Federal Bureau of Statistics (FBS) from January to January each year
tells that’s situation is rather worst.

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Source: - Federal Bureau of Statistics (2011)

In countries like U.K the monetary authority sets an inflation target e.g. inflation target of
Bank of England is CPI at 2%. If inflation goes above or below the target by 1% the
Governor of the Bank has to write a letter to exchequer explaining reasons of not meeting
the target. Although the recent rate of inflation was 4% however the Bank of England is
consistent with it easy monetary policy and all time low rate of interest at 0.5%. The stance
of fiscal authority has been tight therefore it is expected to bring the inflation down by fiscal
measures.

Particularly speaking about inflation in Pakistan although, the discount rates have been very
high 14.00% since November 2010, but it looks like a failed attempt to control inflation by
curtailing the growth of money supply. The causes of inflation in general as acknowledged
by SBP in Governor’s speech (Kardar: 2010) were output gap, inflation expectation and cost
push. Moreover over it was also accepted that the high interest rates and Government
spending and deficit has crowded out the private sector investment and growth. But the
excuse given for tight monetary policy was that as the energy crises and law and order
conditions are not very favorable it is less likely that the private sector would be
encouraged by the low interest rates. In very mild language the government trade policy
(support price of wheat) was also criticized. An interesting point here is although the SBP
agrees that tight monetary policy is harmful for economic growth lead by private investment
and reason of inflation is not growth in money supply, yet Bank is persistent on
contractionary stance. In a latest statement made by SBP (2011) declared structural deficit

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and excessive Government borrowing from SBP as reason of 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 factors tight stance of monetary policy
cannot be justified. The recent academic research in role of fiscal policy to control the
inflation also urges to use fiscal measure for price stability. Research about French & British
economic policies by Creel et al. (2009) showed that Fiscal policy may dominate the
monetary policy without having any negative influence. It seems that poor fiscal discipline in
Pakistan has resulted in a NASH between fiscal and monetary authority which is causing
economic instability.

3) Unemployment
Creation of employment opportunities is expected from elected governments. Although full
employment does not exist because of a Natural Rate of unemployment which is the level at
which the demand of labour is at equilibrium with supply of labour. However the average
rate of unemployment in Pakistan from 1990 to 2009 has been 5.88% (Federal Bureau of
Statistics) which is quite high. Moreover unlike developed counties there is no job seeker
support or allowance for unemployed in Pakistan. In present situation the rate of
unemployment is very high in Pakistan reflected by following statistics.

Rate of unemployment (2003- 2011)

Year Unemployment Rate (%) Change (%)
2003 7.80
2004 7.70 (1.28)
2005 8.30 7.79
2006 6.60 (20.48)
2007 6.50 (1.52)
2008 5.60 (13.85)
2009 7.40 32.14
2010 14.00 89.14
2011 15.00 7.14
Source: CIA world Fact book

Unemployment has been increased by 168% since 2008. There are various reason of high
unemployment in Pakistan, low investment, low savings, energy crises, low industrial growth,
and use of machinery in agriculture sector, poor law and order situation, unfriendly
environment for small and medium enterprises (SMEs). Recent flood is also a major cause of

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high unemployment in affected areas of Pakistan. Most of the factors are correlated with
each other; industry could not grow without investment, uninterrupted energy supply at low
cost and easy availability of factors of production including capital. The very high interest
rates in this regard discourage private sector investment decision.

4) Production (output) Growth

Pakistan is a developing country and in Nominal GDP ranking it is at 47th position in the
world. The GDP growth had been very slow in last few years.

Gross domestic product, constant prices

Years GDP Growth (%)
2003 4.86
2004 7.38
2005 7.67
2006 6.15
2007 5.64
2008 1.64
2009 3.37
2010 4.79
Source: - IMF world Economic outlook (2010)

The period of moderate growth from 2004-07 did not last very long and growth slumped in
2008. Increasing population also fads away the economic growth’s impact on society. If we
decompose the GDP, services (including public sector and defense services) contributed
more than half of total towards national income.
Pakistan Gross Domestic Production (Sector wise)

Agriculture(21.8 %)
Industry (23.6%)
Services(54.6%)

Source: CIA Fact Book (2011)

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Global financial crises and sluggish growth may have contributed to deterioration of
Pakistan’s economic growth however as compare to other developing and emerging
economies in the region e.g. India and China Pakistan’s performance has been very poor.
A country like Pakistan where there are plentiful resources available, contribution of
agriculture and industry is not very significant. Slow growth and poor contribution of
Agriculture and industry to national income also results in poor contribution to tax
revenues and exports. It further results in twin deficits i.e. fiscal and balance of payment.

5) Twin Deficits (Fiscal & Balance of Payment)

Pakistan is running a deficit in its both balances of payment and fiscal account. The debt to
GDP has risen to 49.9% with $ 58 billion of external debt. The Statistics released by SBP
(2011) showed that deficit commitment at the beginning of fiscal year which was 4% of GDP
(Rs 685 billion) has been revised after flood to
4.7% of GDP (Rs 812 billion). Moreover the deficit
in current account was - $ 3.9 billion in 2010.
The trade imbalance (exports minus Imports) was
$ 11.5 Billion which has made significant
contribution towards current account deficit.

A major positive contribution was remittances of

$ 8.9 billion which absorbed the trade imbalance
to some extent. It is worth mentioning here that
in Coalition Support Fund (CSF) only $ 0.743
Billion were realized. Exports growth had been
faster (2.9%) than imports which decline by -1.7 %.

If we look on the balance of payment account it is

very clear that major reason of deficit is trade
imbalance, imports are well above the exports.
Therefore, even the huge remittances could not
fully balance the trade. I would also say here that
the remittances are less volatile than other Source: - SBP Monetary Policy Statement (2011)

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elements of balance of payment account as overseas Pakistanis consistently make

contribution. Therefore we need to focus more on the 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 sector to borrow at high
cost of capital. The credit for working capital rose to 97% in first half of FY-2011 as
compare to same period in previous year, but the credit for fixed investment declined from
Rs 43.4 Billions to Rs 6.7 billion. This was an absolutely awful part of poor investment
scenario. Another problem visible in banking sector is the decline in credit to deposit ratio
although the deposits in banking sector increased. Most probably it has been due to the high
level of Non Performing Loans reached close to Rs 500 in first quarter of current financial
year (SBP: 2011) which discouraged banks to lend to private sector. Moreover the high
demands of Public Sector Enterprises also limited the availability of credit to private sector.

Alarmingly the Government borrowing from SBP increased to 1500 Billion in mid December
(SBP: 2011). This shows a huge disproportion between public and private sector borrowing
which indicates that tight monetary policy is discouraging private sector to contribute in
national income and job creation. Although the private sector is more efficient and
innovative than public sector but the motivation is profit. High cost of production and
energy crises adversely effects private sector initiatives and results in huge trade imbalances

In future the Government intention to reduce its deficit which could ease the inflation
pressure seems unrealistic. The reforms on GST have been postponed, moreover
continuous subsidy on energy and legal restrictions on Government borrowing limit have
not been implemented. It clearly shows that the government is not going further with its
own plans due to its credibility and political unpopularity.

Government ambition to increase Tax revenue seems not very practical because there is
already high level of tax evasion of Rs 796 billion according to World Bank reports. This is
huge Tax avoidance, approximately equal to annual budget deficit. In this scenario increasing
taxes or introduction of new taxes would discourage current tax payers. In 1st & 2nd

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quarter of current financial year the revenues grows by 11.2% and 15% whereas the target
was 26% annual growth, the total target of revenue collection was Rs 1667 Billion but FBR
has only collected Rs 661 Billion in first half of the year (SBP: 2011). On the expenditure
side there had been considerable reductions made in development heads. However there
had been huge subsidies given in energy, food and transfers. The reduction in development
budget would negatively effects the future prospect of economy. According to SBP (2011)
subsidies could results 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 issuance of new
technology licence to mobile companies. This situation has created a huge fiscal imbalance
which is growing consistently and in future could be a major problem for Pakistani economy.

6) Financial Instability
After recent recession (2008-09) in major economics which was started from financial
crises, we cannot neglect the role of financial sector in economic growth and stability. The
economic stability now is associated with financial stability.

The Banking sector is supervised and regulated by State Bank of Pakistan. 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 and reserve
requirement ration of 5% which seems quite reasonable to encourage lending. However,
unfortunately the financial sector could not play a major role, which is a reason of slow and
instable economic growth. According to SBP (2011), in banking sector the Non Performing
Loans (NPLs) have reached near to level of Rs 500 Billions. Due to high discount rate, law
and order situation, energy crises and mostly importantly political influence, the banking
sector could not provided substantial capital support to production sector (agriculture &
industry). At present, the Government borrowing from July-Jan 2011 has been Rs 355.2
billion which contributed about 78% in monetary expansion. The Government has not only
become major user of banking resources but also caused inflationary pressure by excessive
borrowing.

The dream of Islamic banking in Pakistan is as old as Pakistan. Even in the constitution of the
Islamic Republic of Pakistan article 38(f) states that: “The State shall eliminate Riba as early

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as possible.” In 1980s efforts were made to introduce Islamic banking in Pakistan but the
model failed due to certain reason cannot be covered under scope of this paper. However
in January 2002 new lisence was issued to Al-Meezan Investment Bank Ltd to open a fully
operational Meezan Islamic Bank. At present there are 6 licensed Islamic banks (IBs) and 12
conventional banks have licenses to operate Islamic banking branches (IBBs). According to
SBP1 the total assets of the Islamic banking industry are over Rs. 225 billion as of 30th June,
2008 which accounts for a market share of 4.5% of total banking industry assets. Total
branch network of the industry comprises of more than 330 branches with presence in over
50 cities & towns covering all the four provinces of the country and AJK. The development
of Islamic banking in Pakistan is appreciable; however there is a lot more this sector can
contribute to economy in future.

The Small & Medium Enterprises (SMEs) plays important role in economic development;
Taiwan, Korea and China are best examples of SMEs role in development of these counties.
In Pakistan unfortunately financial sector has not played significant role to improve SMEs
culture. There had been two institutions established SMEDA and SME Bank, however poor
condition of SMEs reflects performance of these intuitions. Although there are some
measures SBP is considering to take e.g. draft Prudential Regulations for the SMEs,
consideration of Credit Information Bureau and urging banks to lend to SMEs, however No
remarkable efforts have been made practically. Putting together the energy crises, law and
order situation and high inflation with none availability of low cost capital to SMEs, there are
no signs of development in this sector.

There are three stock markets in Pakistan, Karachi Stock Exchange is the largest with total
capitalization of Rs 3,388,801,907.65 and 655 listed companies. However the volatility of
market is very high KSE-100 index has declined from 15500 points in April to 2008 to below
5000 points in January 2009, although it has significantly recovered in January
2011(Bloomberg:2011)2. This level of volatility discourages investors, poor law and order
situation, sluggish industrial growth and insiders trading are the major problems of Pakistani
stock markets. Tight monetary policy (high interest rates) also negatively affects stock
markets by announcement and credit channels. Moreover the discounted value of future

1
http://www.sbp.org.pk/departments/pdf/StrategicPlanPDF/Strategy%20Paper-Final.pdf
2
http://www.bloomberg.com/apps/quote?ticker=KSE100:IND

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profits also decreases which discourage investment in equity markets. These effects are
prominent in Pakistani markets since the SBP tighten its stance3.

7) Recommendations: - Considering present situation of Pakistani economy

mentioned so far, I would like to make following recommendation.

Monetary Policy:-
1. The State Bank must quit its very tight monetary policy to support economic growth
and development. As it is even acknowledged by the SBP that the inflation is not due
to excessive monetary growth but other factor e.g. fiscal deficit, energy crises and
supply shock. There is no reason to adopt very tight monetary stance. It is important
to mention here that interest payment leaves less money for tax deductions,
therefore high interest rates also results in less revenue for Treasury.

2. Banking sectors should be encouraged to supply liquidity to production sector

(Agriculture & industry) and investment activities. Interest rates must be dropped
significantly to enable banking sector to perform its role. Economic growth by these
measures would stabilize economy by decreasing output gap and bring prices down
by matching demand.

3. Particularly for development of SMEs and industry in rural areas, SBP should provide
loan to banking sector at very low discount rates. Banks must be bounded to use
these funds for SMEs and Industry development. Moreover SMEs apply for loans
should be registered with credit rating agencies and their credit history must be
maintained.

Fiscal Policy:-
4. There should be a Government Spending review to analyse each head of
expenditure, and efforts must be made to minimize wasteful spending. Austerity
measures should be taken at each level.

3
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aDFkw4sRLuk8&refer=world_indices

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5. Tax evasion must be reduced; it would not only overcome the deficit of budget but
also work in bringing inflation down. The empirical research also support even prefer
the role of fiscal policy in inflation control instead of monetary tightening.

Trade Policy
6. The subsidies e.g. wheat price support e.t.c put huge pressure on exchequer pocket
and at the end of the day poor have to bear the burden as rich class doesn’t pay tax.
Therefore subsidies should be gradually eliminated. To keep the price low
export/smuggling of these items should not be allowed. Moreover imports from
international markets must be allowed either at low tariff or No tariff to match the
demand and keep the price at equilibrium. Best example is the sugar crises when
artificial supply shock surged the prices to record high level.

7. The stance of Government has been to cut the Demand to keep the prices low,
which is against the concept of welfare. The supply should be increased to keep the
prices low; an example could be allowing import of foods items and issuance of
lisence to open new sugar mills.

8. In automobile industry, there must be no restriction on automobile imports,

Government could get huge amount of revenuers by putting tariff on automobile and
their parts imports. Moreover road tax particularly on vehicles would contribute to
revenues.

9. In Information Technology, gaming is a big industry now, investment in professional

education to develop a work force specialized in game software development would
be very useful. Furthermore, financial support to software houses would also help to
grow this industry

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Islamic Banking:-

10. To shift more towards Islamic banking, the current Islamic banks should be
facilitated. Banks are advised and allowed to open new branches particularly in rural
area. Islamic and conventional banking could go side by side to contribute in
economic growth. It would not only creates jobs but also provide liquidity in those
area where conventional banking doesn’t due to religious aspect.

Development Projects
11. Infrastructure projects should be started in partnership with private sector,
particular in energy and development sector. It could be in the form of shared
equity, to start the project and when the revenues are realized the private partner
could gradually return the public sector investment.

12. Pakistan must use each and every source of energy production i.e. Solar, Nuclear,
Wind, coal e.t.c. to produce energy more than its domestic requirement. I must say
here that Pakistan has potential to produce energy from almost every source and
very importantly there is an increasing need of electricity in India in future (approx
950,000 MW4). Therefore Pakistan should produce electricity to export to India.

Financial Stability

13. The role of Pakistan Security & Exchange Commission should be enhanced to
control financial and corporate sector instability. There should be an additional
department in S.B.P to work as a market watch dog so that insider trading and illegal
activities could be monitored.

14. In a longer term as a part of privatization, IPOs of Public Sectors Enterprises should
be issued to promote investment culture in Pakistan,

http://www.monstersandcritics.com/news/energywatch/news/article_1184013.php/India_envisages_about_9500
00_MW_power_requirement_by_2030

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Bibliography

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 SBP’s 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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