FAISALABAD (October 12 2008): To achieve sustained growth, Pakistan needs to deepen its industrial base, as well as to improve its performance in agriculture and services. While the share of the manufacturing sector in total output is not low (nearly 20 percent), it has remained stagnant since the 1970s.
In an updated project report of Accelerating Economic Transformation Program (AETP), prepared by J. Miranda, Director General, Central and West Asia Regional Department of Asian Development Bank and their team, it was pointed out that the share of manufacturing value added accounted for by high-technology products is low and has remained so during the last 40 years.
Pakistan 's exports per capita are low, and it continues to compete with exports from even poorer countries (eg, rice, cotton yarn, undergarments, cotton bed linen, and other woven fabrics). Labour productivity has increased very slowly since the 1970s with an annual growth rate of only 2.6percent.
Unless the production and trade structure of the economy is transformed to enable it to compete effectively in global markets, Pakistan 's 6-7percent real GDP growth per annum is unsustainable. ADB report said that Pakistan's economy has been seriously affected by the skyrocketing international prices of oil and food.
The severity of the exogenous shocks, aggravated by the uncertainties surrounding the recent political transition, has been felt on several fronts over the last fiscal year (June 2007-July 2008) the year-on-year overall domestic inflation reaching 24percent from 7percent; deterioration in the external accounts with current account deficit widening to 8.5percent of GDP from 4.8percent; depreciation of the Pakistani rupee (PRs) by 22percent; foreign exchange reserves declining by more than 40percent to $6 billion (about 1.5 months of imports); and unprecedented fuel, food and electricity subsidy needs, which rose four-fold to PRs 408 billion ($6 billion) from their original budgeted level.
Symptomatic of the declining investor confidence, the Karachi stock index dropped by more than 35percent during April-July 2008, and the spreads on sovereign debt have surpassed 1,100 basis points at end-August 2008 from less than 200 basis points in early 2007. The outcome of all this has been a decline in real gross domestic product (GDP) growth to 5.8percent from 7percent during the previous year.
ADB report observed that these challenges facing Pakistan have come despite steady real GDP growth of 7.3percent on average per year during FY2004-FY2007. But they have also come in the context of, as well as due to, persistent fiscal, trade and investment imbalances and lack of any significant structural changes in the economy.
ADB EXPERTS OBSERVE THAT PAKISTAN NOW NEEDS TO TRANSFORM ITSELF IN THREE DIRECTIONS: First, it has to address the immediate distortions facing the economy, particularly in the agriculture and energy sectors. The pricing and procurement system for wheat needs to be restructured, and subsidies better targeted to benefit the poor and vulnerable.
Untargeted wheat subsidies cost the Government PRs 40 billion ($600 million) in fiscal year (FY) 2008. In the electricity sector, Pakistan does not yet have an automatic tariff adjustment mechanism. The Government needs to reform the subsidy system in the sector, since it has not been able to settle the payments owed to distribution companies, which has resulted in a vicious circular debt problem and debt overhang. This needs to be addressed urgently to resolve the present energy crisis.
Electricity subsidies are estimated to have cost Rs 133 billion in FY2008 ($2 billion). In addition to these subsidy needs, an estimated $1.6 billion is required to partially protect the poor.
Second, Pakistan needs to strengthen financial inter-mediation to facilitate structural transformation. At the macro level, the Government has relied heavily on the central bank for its fiscal requirements, a practice that needs to be reversed. In parallel, the legal and regulatory framework should be strengthened to manage risks more effectively in the financial sector, promote consumer confidence, and deepen financial inter-mediation.
Third, over the medium to long term, the production and trade structure of the economy needs to be transformed so Pakistan can compete more effectively in the global economy. A deeper industrial base is vital, along with a more productive agricultural sector, greater value creation in the service sector, and far greater export sophistication.
To achieve this, the Government has to (i) address short-term policy and institutional distortions, (ii) identify industries where it might compete on a global scale, and (iii) attract private sector investments. ADB has worked in the past with Pakistan alongside other development partners to support reforms and investments in all three directions.
The challenges now facing the country are diverse and significant that immediate assistance is needed to address the short term constraints and to provide safety nets for the poor, while paving way for boosting Pakistan 's competitiveness, they added.
To address the present macroeconomic challenges, ADB experts mentioned that Pakistan Government has adopted a four point stabilisation plan, working in tandem with the State Bank of Pakistan (SBP).
It has also sought technical advice from development partners, including the International Monetary Fund (IMF), the World Bank and ADB in developing the plan, which focuses on: (i) ensuring price stability and effective demand management through interest rate adjustments; (ii) pass-through of subsidies while protecting the poor from economic shocks; (iii) shoring up foreign exchange reserves; and (iv) restoring fiscal discipline and reducing borrowing from SBP.
Commenting over the Medium-term agenda, ADB experts said that as it deals with the short-term challenges during the current fiscal year (by June 2009), the Government also plans to launch medium-term structural reforms in two key directions.
Increasing infrastructure investments in power and transport is a key part of its strategy, besides adopting measures to deepen Pakistan's industrial base and making its agriculture sector more productive. The Government plans to achieve this by rationalising its own involvement in key economic sectors, and by attracting greater private sector participation.
The fiscal space generated will help ensure adequate social safety nets as well as adequate spending on health, education and other priorities. In parallel, Pakistan also has adopted a framework for a medium-term financial sector strategy to strengthen financial inter-mediation and promote confidence. The proposal comprises (i) a program cluster for the Accelerating Economic Transformation Program (AETP) with four subprograms totalling $1.8 billion to $2 billion, (ii) two loans totalling $500 million equivalent for subprogram 1 of the AETP, and (iii) a technical assistance (TA) grant of $800,000.
The proceeds of subprogram 1 will be used by the Government mainly to cushion the impact of food and fuel inflation through the provision of targeted safety nets for the affected segments of the population. Of the $500 million for subprogram 1, $200 million will be from Asian Development Fund (ADF) resources.
The AETP will help Pakistan achieve and sustain higher economic growth in the medium term. The expected outcome of the AETP is structural economic transformation through (i) removal of short-term distortions in the agriculture and energy sectors; (ii) strengthening of financial inter-mediation; and (iii) development and implementation of a national structural transformation strategy.
Highlighting Special Features, ADB experts said that the AETP would help Pakistan address the challenges posed by the ongoing food and energy crisis in a systematic manner. Subprogram-1 is also one of ADB's responses to the food crisis in the region, a response that was first announced by the President at the ADB Annual Meeting in May 2008 and recently set forth in the paper ADB's Response to the Food Crisis.
ADB has worked with other development partners on the short-term as well as the medium-term issues. On macroeconomic stabilisation measures, ADB has relied on advice from the IMF and the World Bank and exchanged views with other bilateral partners. Part of the short and medium-term agenda, as it relates to agriculture, infrastructure and finance sector issues, is well grounded in ongoing investment and policy support by ADB and other partners.
Regular dialogue has taken place, including in finalising the AETP actions, with the concerned partners. The structural transformation agenda is new and being developed. Several institutions support investment climate and competitiveness reforms, with some specialising in selected sectors.
Once the principal studies under the AETP are completed by early 2009 ADB will co-ordinate closely with all stakeholders in helping the Government chalk out the future reform directions. The AETP will not only help stabilise the macroeconomic situation but also benefit target groups affected by fuel and food inflation.
IT WILL HELP: (i) Meet the large and immediate fiscal needs. (ii) The Government transition from the current system of inefficient and untargeted subsidies toward a targeted safety net program for the poor. Beginning with about 2 million households immediately, and expanding to cover 5 million households during the 2008-2009 fiscal year if the safety net program implementation is smooth, the AETP could potentially target up to 9 million households.
(iii) It will raise public confidence in the banking system through a depositor protection scheme, and stronger financial intermediaries that are better able to mobilise and allocate resources and risks. (iv) It will open the way for structural transformation. (v) It will cut transaction costs for businesses by reducing red tape and improving the investment climate. (vi) Overall, the AETP framework will enable ADB to sustain policy dialogue on structural reform in sectors where ADB has been actively involved through past and current investments.
