Remarks on the Economic Prospects of Pakistan made at the Nutshell Forum

The theme of this summit is finding the Bright Spots. This is a brave undertaking when talking about a country that has gone to the IMF on an average of once every four years during the last three decades; where one political party is threatening to shut down the capital for the second time in three years; and where surgical strikes may be occurring but not necessarily in the medical sector.

But is this time different? Are there really some bright spots out there that will continue to shine? Perhaps even grow in brightness rather than dim over time?

I am trained as an economist. So I am trained to be skeptical and to find progress only when looking backwards, in retrospect.

But I will restrain my cautionary instinct and go along with the spirit of this summit to find some bright spots for Pakistan.

I can see bright spots in three main areas: in the stabilization of our economy; in the prospect of substantial energy and transport investment from China under CPEC; and in some aspects of our education and research environment. Let me elaborate.

Stabilization of the economy

First, the economy. The bright spot here is that we have achieved macroeconomic stability after a period, barely three to five years ago, when our macroeconomic balances were seriously out of kilter. By this I mean that our fiscal position, our international reserve position and our inflation picture all look good. All my macro data come from the latest IMF review conducted in August 2016. These data show that our budget balance has improved from a deficit of 8.4% in FY13 to a deficit of only 4.3% in FY16. The tax to GDP ratio rose from 10% to 12.4% of GDP though most of this increase has occurred in the last fiscal year. Our international reserves have risen from around $6 billion in FY13 to around $18 billion at end June 2016 or from 1.5 months of import cover to 4.2 months. Inflation was running at 7.4% in FY13 and averaged only 2.9% in FY16.

And, in keeping with all of this, growth has moved up from 3.7% three years ago to 4.7% in FY16. Energy subsidies have been cut from 2% of GDP to 0.6% while the Benazir Income Support Program which helps very poor families has expanded its coverage from 3.78 million to 5.36 million beneficiaries while raising stipends from Rs. 3000 to Rs. 4700 per beneficiary per quarter.

And even the trade balance is slightly better at -0.9% in FY16 than the -1.1% in FY13. And this despite declining exports. Exports declined by 8.5% in FY16.

FY16 performance would have been even better had it not been for the setback in the agricultural sector, particularly in cotton. The agricultural sector declined by 0.2% last year and cotton output fell from 14 million bales to 10 million bales, more or less.

So the economy looks to be a bright spot from the point of view of macroeconomic balance. This is not to say all sectors are doing well or that long term growth prospects are necessarily great. But the macro picture does look healthy. In part this is due to the fact that oil prices have been low since the middle of 2014. This has helped a lot with respect to inflation as well as the fiscal and external position.

There is another aspect to the macroeconomic stabilization that is reassuring. This is the fact that the process was closely monitored by the IMF who backstopped our economy with a loan of $4.4 billion dollars that was disbursed in twelve tranches, one every three months for the last 36 months, after a review of the previous quarter's performance. This is the first time in a long while that Pakistan's economic managers have been able to maintain policy discipline for 3 years and to complete an IMF program. So both policy discipline and favorable external circumstances have been at play.

Around every bright spot there is usually an area of partial darkness. So it is with our case. While macroeconomic stabilization has been achieved, several structural problems remain unresolved. Let me touch upon these briefly.

Tax ratio: This has risen bust mostly because of the elimination of some tax concessions and exemptions, additional indirect taxes and some improvements in tax administration. While there has been some increase as well in the number of filers, the tax base continues to remain narrow as many types of income remain outside the tax net. Many services also remain exempt from the GST. And the IMF has all but given up on trying to introduce a VAT in Pakistan, a tax that has proved both productive and efficient in most other countries.

Public sector enterprises: Not many successes can be claimed on this front. Many public sector enterprises continue to remain a drain on fiscal resources while providing poor or indifferent services to the public. The PIA privatization effort came to an inglorious end and has been replaced by a corporatization plan. Attempts to sell the defunct Pakistan Steel Mills have gone nowhere yet.

Business climate: Pakistan's business climate ranking has slipped from 136 in 2015 to 138 in 2016 (out of 189 economies). While this is not a big change, the fact that Pakistan was doing much better many years ago and that its current ranking is in the bottom quintile is alarming. This may be contributing to the continued lack of dynamism in the private investment rate which continues to languish around 10% of GDP, far too low to support the growth trajectory of 6% and more that the country needs to manage its employment challenge.

Public debt: The public debt stood at 65% of GDP at end-FY16. This is uncomfortably high for a developing country. Fortunately, the prospects of interest rate and oil price shocks appear low but sustainability could be threatened by shocks from other sources as well. For example, if policy discipline breaks down in the run-up to the general elections in 2018, sustainability questions could arise because of the large public debt. In this regard, recent amendments to the Fiscal Restraint and Debt Limitation law provide some comfort that checks have been put in place to maintain fiscal discipline via caps of 4% on the budget deficit ratio for the next two years and a 50% target set for the public debt to be achieved over the next fifteen years.

Exports. Exports are a weak point of the economy. Export performance cannot have been helped by the 18% or so appreciation in the real effective exchange rate of the rupee (as reported by the IMF). Export prospects are not bright either because global demand is weak, as seen in anemic growth forecasts for the major industrialized economies. The IMF thinks risks to the external balance are tilted to the downside.

China Pakistan Economic Corridor

The second bright spot I see is CPEC. As you know, this involves a package of projects mostly in the energy and transportation sectors of around $28 billion in the early years to 2020 or so and another $16-22 billion dollars in the next decade. Of the $28 billion in the next few years, about $19 billion is expected to be in the form of FDI by Chinese IPPs, mostly in energy projects, and about $6.7 billion in the form of concessional loans mostly for transportation sector projects.

The injection of this much investment in the economy in the next few years is bound to boost the economy, and generate employment. This is the bright spot part of the deal. However, there are concerns that the power purchase agreements being negotiated with the Chinese IPPs will be very expensive in the long run, for both Pakistani consumers and taxpayers. One deal has already encountered problems with NEPRA whose solution I understand is being negotiated in non-regulatory settings. Let's wait and see.

However, it is worth noting that CPEC represents a major commitment from a neighboring Great Power to entwine a part of its western regional economy with ours through transport connections and long term economic investments. At a time when our principal aid donor is showing signs of breaking off with us it is helpful to have an alternative. I see CPEC as a good foreign policy option. CPEC will give us strategic depth within our own country. As a major transport corridor is built down the middle of the country over the next ten years or so, China will acquire a big stake in keeping this corridor safe and secure. In China's stake will lie our own security as well. From a foreign policy perspective, this seems like a very bright spot.

Research success

A third bright spot lies in the area of higher education and research. Not many people follow this carefully but I do since this is my domain. Recently, the Thomson-Reuters group which tracks academic research citation volumes and impact reported that Pakistan had performed better in this area over the last 10 years than all four BRICs combined. Specifically, Pakistan had a higher rate of Highly Cited Papers than the BRIC countries, especially in the Engineering and Natural Science areas.

What do we make of this? Citations are broadly accepted as a measure of academic and scientific quality. If we take the Thomson-Reuters results at face value, it means that the investments Pakistan has been making in higher education and research in the last twenty years or so have begun to pay off and the country is acquiring a domestic base of scientific research personnel that is generating papers that other academics around the world are finding useful and interesting and worthy of citation. If so, this is a bright spot and could serve as a leading indicator of science-related commercial activities to come.

This finding has been roundly attacked by some who think that the numbers are bogus and misleading and that research activity in Pakistan continues to be of very low quality. Arguments have been made that Pakistani academics have found ways to generate high citations through support networks and that these have no solid claim to quality or impact.

I do not know where the truth lies. But only 98 HCP papers are involved so I am sure somebody will find a way to assess their quality in a different way, not involving citations, and we will get another read on whether we have found a bright spot or not.

Let me stop here and summarize on a positive note. On the economic front, there are several bright spots. On balance, the economic outlook for Pakistan is much better now than it was a few years ago. Politics, on the other hand, is another story.