Pakistan’s bleak outlook lightened by the game-changer with India

Authors: Mohsin Khan and Shuja Nawaz, Atlantic Council

With a general parliamentary election likely to be held early in the year, and changes to the leadership of the army and judiciary due by the end of the year, Pakistan faces some daunting challenges as it enters 2013.

The new government will need to set the economy on track and attract sufficient external financing to avoid a potential balance-of-payments and currency crisis.

The political transition and the required economic reforms will not be easy tasks. They will be set against the backdrop of rising civil unrest inside the country; a continuing insurgency in the western provinces; the rise of radical Islamic fundamentalism; and a hard-to-disguise series of battles between the civil government and the military on the one hand, and the judiciary and both the government and the military on the other. The Supreme Court dismissed one prime minister, Yousaf Raza Gilani, in 2012 and barely avoided sending home his successor, Raja Pervez Ashraf, on the basis of a long-awaited and contentious letter to Swiss authorities that would allow them to reopen bribery charges against President Asif Ali Zardari. Yet, for the vast majority of the population, the threat of crime, unemployment, terrorism, political corruption and drugs is of greater concern than the political machinations currently going on in Pakistan.

The economic picture in Pakistan has remained quite grim since 2008. A growth rate hovering around 3 per cent, inflation running in double digits, fiscal deficits averaging 6–7 per cent of GDP and growing external imbalances all point to a bleak situation. The past year has generally followed this pattern with severe energy shortages and financing constraints forcing the manufacturing sector to operate at only 50–60 per cent of capacity. These constraints, compounded by political uncertainties and a deteriorating security situation, have caused both domestic and foreign investment to fall significantly, creating a scenario of low growth in future years, when 7–8 per cent growth per year is needed to provide jobs for the steadily growing population.

In a period of economic distress, however, there are some bright spots that give a degree of optimism for 2013 and beyond. First, the steady rise in the size of the middle class and in consumer spending, particularly on durables such as automobiles, motorcycles and mobile phones, suggests that official GDP figures have not captured the full picture of a large and growing informal economy in Pakistan. Second, workers’ remittances from abroad, which in 2012 will amount to US$13–14 billion, have fuelled consumer spending at home and checked the widening of external imbalances. And third, the government’s bold step of opening up trade talks with India, when it announced that it will grant its neighbour most favoured nation status by the end of 2012, could well be a game changer for the future economic development of Pakistan.

So what lies ahead for 2013 on the economic front? Unfortunately, it seems the official economy will limp along unless there are significant increases in energy supplies and domestic security improves. With large repayments to the IMF due in 2013, as well as incipient capital flight, the new government will face pressures on its foreign exchange reserves. Without serious tax reforms, the fiscal deficit will stay high and continue to be financed by borrowing from the banking system — effectively by printing money and pushing up interest rates and inflation.

If the new government wants to change this downward trajectory, it will need to undertake comprehensive energy and tax reforms and obtain additional external financing, possibly through another IMF program, and bilateral assistance from donors and multilateral assistance from banks. The government has a well-thought-out growth strategy that tackles these issues. As yet, the plan exists only on paper. It remains an open question whether the new government will have the political mandate or the ability to implement these needed reforms, or whether it will just try to muddle through as it has for the past few years.

Set against this background, next year’s elections pose a difficult set of choices for the people of Pakistan. Do they bring back the same old parties and leaders as before? Or turn to new faces? Old-style feudal and tribal politics, laced with sectarian influences, will likely dominate. The potential for the incumbent Pakistan Peoples Party and its allies to return to power cannot be discounted under these circumstances, as the party uses the power of the purse to seal pre-election alliances. In that case, yet another coalition government might be in the offing and unable to take the firm steps that the teetering economy demands. Despite these difficulties, the informal economy will continue to expand and offer employment opportunities; trade with India will be a catalyst in lowering tensions in the region; and the prospect of a military intervention seems less likely than before, given the rise of countervailing sources of power: the parliament, judiciary, civil society and an active media. These may be the only silver linings in the cloudy political and economic horizon for Pakistan.

Mohsin Khan is a Senior Fellow at the Rafik Hariri Middle East Center, the Atlantic Council. Shuja Nawaz is Director at the South Asia Center, the Atlantic Council.

This is part of a special feature on 2012 in review and the year ahead.

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