By: Gordon Little and Katherine Kokkinos
This is the first in a series of posts leading up to the CGA Scenarios Initiative’s conference on Pakistan in 2020. As we examine Pakistan’s drivers of change–economic and political, internal and external–we’ll continue to update the blog with information on Pakistan’s current conditions, as well as variability for the next decade. For more information on the Scenarios Initiative, please visit www.cgascenarios.wordpress.com
There are 185 million or so people in Pakistan (most of them in rural areas), but economic disarray, terrorism and poor foreign relations are barriers to the peoples’ economic opportunity. The country’s problems are integrated with those of its region, so the fate of Pakistan both shapes and is shaped by its immediate surroundings. Understanding its predicaments is crucial to getting acquainted with US foreign policy challenges across South Asia.
According to Business Monitor International, “unless Pakistan’s security and core infrastructure situation dramatically improves, it is difficult to envisage a big pick up in international interest over the near term”. Indeed, the sharp rise in the number of incidents of terrorism is estimated at a cumulative loss to the economy of $43 billion since 2005. Lost exports, damaged physical infrastructure, diversion of budgetary resources to military and security-related spending, capital and human flight, and high inflation are just a few effects of the violence on Pakistan’s economy.
Experts note that poor economic conditions are conducive to terrorist recruitment strategies, but terrorism constrains economic growth. Pakistan (with help from allies) will have to find a way to break this cycle of violence and poverty. Recent US proposals, such as the Reconstruction Opportunity Zone legislation, do not address fundamental incompatibilities with domestic needs and are seen locally as more beneficial to the United States than the Pakistani people.
Pakistan also suffers from an energy crisis, where current electricity generation capacity meets less than 80% of demand, and where energy prices increased by 15% last year. A leading driver of this unsustainable incapacity is rampant circular debt. Circular debt occurs when there is an imbalance between cash inflows and outflows – in other words, problems in the cash inflow of one entity cascade down to other segments of the payments chain. In Pakistan’s case, end-consumer tariffs were insufficient to recover the rising costs of power generation. Because of fiscal constraints, the government was not fully compensating Pepco–Pakistan’s core distribution entity in the energy sector–against the resulting losses. So Pepco began borrowing from banks in 2006 to compensate for the non-receipt of tariff subsidies from the government. But Pepco cannot repay the loans without becoming profitable…and so the circle goes.
The cumulative effect of this energy crisis on Pakistan’s economy was 2% of GDP in 2009-10. Additional energy-related challenges include volatile international oil prices, which further pressure the cost structure in Pakistan’s power generation sector. Without reliable energy, how can businesses expand?
The competitiveness of Pakistani goods and services is also dwindling. Its share of world exports declined over the last decade from 0.16% in 2002 to 0.13% in 2008, largely due to the security situation within the country. Some analysts are hopeful about recent talks of increasing trade with India, Afghanistan and China. However, the scant investment that currently takes place may actually be harming Pakistani business opportunities. For instance, China has begun to invest in construction and nuclear plants in Pakistan, decreasing the competitiveness of Pakistani goods in these sectors on their home soil. By and large, foreign direct investment is on the decline: FDI in FY09 totaled $3.2 billion as compared with $1.8 billion in FY10–these figures represent a 45% decline.
Pakistan relies on foreign aid to cover budgetary gaps. The International Monetary Fund implemented a US$11.3 billion Standby Arrangement (SBA) in November of 2008, though it is set to expire later this year. Under the agreement, Pakistan must meet a range of requirements around restoring financial stability, providing social safety nets, and raising budgetary revenues through tax reforms, though the awful 2010 floods have made it difficult to meet these ambitions. If Pakistan cannot meet its requirements, the IMF could pull out of the agreement. Where will Pakistan get the funding it needs? Is foreign aid being productively spent when it can’t change core economic problems? Will foreign investment, such as that from China, be able to supplant it, and what would this mean for Pakistan’s economy?
Other structural economic challenges that confront Pakistan, which we will research further over the course of the project, include:
~high budget deficits (expected at 6% for the current fiscal year)
~low tax-to-GDP ratio (10% in 2010)
~low investment spending (about 15.7% in 2010, as compared with India at 36%)
~poor educational facilities and education sub-sector spending
~high government corruption
~high food prices
~low productivity and an overall decline in agricultural sector–Pakistan’s largest employing sector
We consider economics a major driver of change as we imagine possible scenarios for Pakistan in 2020. Without economic growth, many goals for Pakistan and the region cannot be realized. Where do you think Pakistan should focus its resources? Are there any solutions for Pakistan’s economic constraints? What can the world community do to help? Leave a comment below and tell us what you consider to be Pakistan’s economic obstacles and opportunities.