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Pakistan: A year of extraordinary challenge

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In Brief

Pakistan faced a number of serious challenges in the year 2008 — more than any other country in the region. The transition from military rule to a democratically elected political regime was difficult. The terms of trade sent shocks to the economy through severe fluctuations in oil and commodity prices, the quality of economic governance was sub-optimal and Pakistan’s ‘frontline’ status in the war against terror proved to be exceptionally disruptive. The assassination of Pakistan’s leading politician, the highly respected Benazir Bhutto, created a huge vacuum in the political landscape. Although the general elections were held peacefully and were (by and large) fair and transparent the loss of the top leadership of the winning party led to a long unsettling period marked by prolonged uncertainty.

On the regional front, aggression from Taliban and Al Qaeda, which has so far been limited to the ungovernable and hostile terrain of the border areas between Pakistan and Afghanistan, spilled over to some of the settled districts of the North West Frontier province, including Peshawar, causing immense loss of life and property, and widespread fear amongst the general populace.  On the eastern borders, however, the new government, reiterated the policy of strengthening friendly relations with India, and initially made some positive overtures.

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Both the previous and interim governments in 2007 and 2008 compromised the sound economic management that was characteristic of Pakistan in the new millennium, largely for the sake of political expediency. Crucial decisions to adjust the economy in light of domestic and external shocks were postponed.

The incoming government also did not take corrective measures in a timely manner. As a consequence, macroeconomic stability caved in, both external and fiscal imbalances became too onerous to contain, investor confidence eroded and credit rating agencies lowered Pakistan’s sovereign rating. This hesitation lingered over a six month period of agony,(in which foreign exchange reserves were depleted by more than half, the currency depreciated by 25 per cent, the stock market lost almost $50 billion in market capitalization, inflation reached 25 per cent and government borrowing from the Central Bank touched a record high), the Government decided to enter into a standby agreement with the IMF in November 2008. The silver lining in 2008 was Pakistan’s reformed banking sector, which proved resilient in withstanding the tremors from the global financial crisis.

This 22-month agreement with the IMF will form the framework through which economic policies will be pursued, and it is envisaged that macroeconomic stability will be restored in this period.

However, economic growth projections have been lowered to the 4-5 per cent range for 2009. Consequently, unemployment and poverty are likely to resurface after undergoing consistent decline over the past seven years. If the Government adheres to the performance targets agreed to with the IMF, and maintains fiscal discipline, it is likely to pull itself out of this trough and once again reach the 7-8 per cent growth rates that were recorded between 2002 and 2007.

However, the recently heightened tension between India and Pakistan in the aftermath of Mumbai does not augur well for the economy. Pakistani troops are already stationed on the western borders with Afghanistan. If relations with India take a turn for the worst it is likely that troops will have to be deployed on the eastern border too. The concomitant rise in security and defense expenditure would put a huge strain on public finances, impairing Pakistan’s ability to meet fiscal deficit targets and putting it well off the track mandated by the IMF agreement. Hopes of a revival in foreign direct investment to fill the domestic saving/investment gap in 2009 under an improved economic management scenario will also suffer setbacks.

To avoid this scenario from materialising, there is an urgent need for Pakistan and India to return to the composite dialogue they have been pursuing for the last several years.

Ishrat Husain is Dean and Director of the Institute of Business Administration, Karachi. Dr Husain was formerly Governor of the State Bank of Pakistan, and prior to that the director for Central Asian Republics at the World Bank. At the World Bank he was also Chief Economist for Africa and Chief Economist for the East Asian and the Pacific region.

This is part of the special feature: Reflections on developments in Asia in 2008 and the year ahead

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