Invest to catch up with the rest: IMF
By Nadeem Malik
ISLAMABAD 29-July: Pakistan needs to pursue outward-oriented policies to boost exports and encourage foreign direct investment, says a paper written by Henri Lorie and Zafar Iqbal, senior officials of the International Monetary Fund (IMF).
The working paper: Pakistan’s Macroeconomic Adjustment and Resumption of Growth, 1999-2004; reviews Pakistan’s actual performance during the period and also outlines an international comparison with fast growing emerging market economies, which suggest that Pakistan needs to catch up in terms of investment levels and external trade orientation. Some impediments to domestic and foreign investment, namely political and security risks, cannot easily be removed or offset with right economic policies; but this should be viewed as a challenge to do more and better than elsewhere in the region, it says.
Pakistan has received $1.68 billion in FDI and portfolio investment during 2004-05 and the volume of international trade reached a record $35 billion, including $14.4 billion of exports. However, a sustained increase in FFDI flows is the most critical requirement to maintain the growth rate, which touched 8.4 per cent last year, and to reduce poverty and unemployment.
"Pakistan fares well with regard to the business environment within the South Asia region, it lags behind China and other Southeast Asian countries.
Pakistan needs to continue with a broad range of structural reforms aimed at improving the investment climate; focus on developing its human capital toward a more skilled and competitive labour force; accelerate reforms in agriculture to garner potential productivity gains; and strengthen the country’s productive infrastructure, in particular for water management, ports, rural roads, and energy supply."
The study says that an increase in private national saving during 2001-03 was the key contributor to the turnaround in Pakistan’s external current account. Pakistan’s growth was mainly export-led before 2003-04, it was largely led by domestic demand in 2004, especially consumer demand but also private and public investment. "The structural reforms implemented in Pakistan during the past four years should make the observed strengthening in domestic savings and rise in domestic investment permanent, auguring well for accelerated growth within a sustainable external balance."
The paper observed that the growth prospects would be further enhanced by a more externally driven growth process, and by an acceleration of structural reforms to further improve productivity and the investment climate.
A surge in net private transfers from abroad and a significant improvement in the financial performance of the corporate sector have been a key contributing factor as well. After-tax profits of corporations listed on the Karachi Stock Exchange (KSE), which covers only about 700 corporations, alone rose by more than a full one per cent of GDP in the period 2001-03.
The turnaround in the external current account balance from a deficit of almost 2 per cent of GDP in 2000-01 to a surplus of close to 5 per cent of GDP in 2002-03 mainly reflected the sharp increase in national savings. National savings increased mainly on account of private national savings, which are estimated to have risen from 17 per cent to almost 22 per cent of GDP. Higher public savings contributed to about 1/4 of the external current account adjustment. Gross private and government investment changed little in per cent of GDP.
The sustained double-digit growth in export volumes was a remarkable source of growth during these years. The growth in investment was erratic, while the growth in consumption, although showing an upward trend, was relatively weak. The growth in export volumes was especially impressive in 2002-03, with all sectors (primary commodities, textile manufactures, and others) contributing to it. Inputs for textile and machinery (textile and others) appear to have led the recovery in import volumes. The acceleration in imports owed in part to the aircraft, ship, and boat category, but also to other machinery, as well as agricultural, metal, and other inputs. The breakdown of imports only partially supports the view that a broad-based surge in productive investments has mainly been driving the growth in imports, the paper maintained.
Services remained the main contributor to growth during 2000/01-2002/03 accounting for more than half of the overall GDP growth rate achieved. But manufacturing was the sector experiencing the faster growth in the period, averaging almost 7 per cent. Textile, which accounts for about 25 per cent of large-scale manufacturing production, was a significant contributor to growth, especially during the first two years of this period, which corroborates the earlier conclusion of an export-led economic recovery.
The significant pickup in large-scale manufacturing growth was broad-based, but appears on balance consistent with the view that domestic rather than external demand was the main engine of growth. Particularly impressive was the further acceleration of growth in automobiles and electronic equipment compared to 2002-03, as well as the high growth rates registered in food/beverages/tobacco, chemicals, cement, and leather products. There is little evidence of a significant pickup in exports of such products, except perhaps in the case of leather products and electronic equipment, with the latter possibly explaining part of the high growth rate in "other" exports.
Regarding sustainability, there is an important issue: The accommodating monetary policy could have encouraged a debt-financed domestic consumption and investment boom that might not be sustainable. As the interest rates begin to rise, consumers and businesses might cut back their consumption spending and investment plans, in the latter case, especially if they have been domestic rather than outward oriented.
The comparison with China, India and others show that countries, except the Philippines, have investment/GDP ratios significantly higher than Pakistan; and all display a higher level of financial deepening. Pakistan compares favourably with India (a much larger country) in terms of openness to international trade, it lags on all other comparator countries. The speed at which these countries (even India) have witnessed an increase in the volume of external trade in per cent of GDP over the past 20 years is remarkable. In contrast, Pakistan’s trade/GDP ratio has risen only marginally from the level of 30 per cent already achieved in the 1980s.
"Higher foreign direct investment in Pakistan would relax the foreign exchange constraint for imports, and support the increase in the investment/GDP ratio necessary to deliver the higher growth rates. With foreign direct investment, there should also be a productivity increasing transfer of technology. To be realistic, however, FDI should only be expected to increase significantly in Pakistan once domestic investment itself has taken off." The paper says that much has been done in recent years to improve the business climate in Pakistan, and Pakistan ranks well in this regard within the South Asia region. Among 22 indicators of the World Bank’s "Doing Business," Pakistan is doing better than other South Asian countries with regard to 13. It lags, however, significantly behind China and Thailand outside South Asia. The World Bank’s "Investment Climate Surveys" also suggest that Pakistan is behind India, China, and even the Philippines in terms of providing an enabling environment for investors.
The report highlighted areas that require attention, like property rights remain weak, including because of poor land record; there is still too much government intervention with the market mechanism in the case of some key commodities; red tape is still excessive, particularly at the provincial level; labour regulations have hindered the functioning of formal labour markets and employment; corruption remains a problem (Pakistan ranked 129 out of 146 countries in Transparency International Corruption Perception Index 2004); and the enforcement of contracts, financial obligations, and bankruptcy law, as well as the interpretation of tax laws remain difficult.
In addition, educational and more generally human development indicators remain quite weak in Pakistan, resulting in a workforce often ill equipped with the skills necessary for higher value-added productions.