Economic Rebound in Pakistan
By Nayyer Ali MD
Imran Khan has had a rough go during his first 18 months in office. Pakistan’s economy was in bad shape when he took over, and dramatic steps had to be undertaken to correct major imbalances that had built up over the last 10 years. These painful adjustments whacked the economy, causing growth to slow down to 3% and the stock market to plunge, while leaving the government little room to pursue development. But we are finally seeing these efforts start to bear fruit, and Pakistan’s economy is going to see growth return to a decent rate in 2020.
Nawaz Sharif, the previous Prime Minister, and Ishaq Dar, his Finance Minister, made a colossal mess of the economy. They had been gifted a massive infrastructure investment program by China, known as CPEC, that has dramatically increased electric power generation and laid new roads, ports, and other facilities throughout the country. In addition, worker remittances from abroad soared in the last decade to over 20 billion dollars per year. This should have created a vibrant economic environment with growth well over 7% per year. But Sharif made a mess of it. His biggest error was keeping the exchange rate grossly overvalued. This had the dual detriment of making Pakistani exports far too expensive to be competitive, while encouraging a surge of cheap imports into Pakistan. This had the predictable result of a massive trade deficit, with exports staying flat for several years at 25 billion dollars per year, while imports surged to almost 60 billion dollars.
The 20 billion dollars in remittances covered some of that imbalance, but by 2018, Pakistan was draining down its foreign exchange reserves to almost zero to cover the import bill. A balance of payments crisis developed, and the only way was to get 6 billion dollars from the IMF, but in return they demanded the exchange rate be allowed to move to fair market value.
Imran Khan made the deal with the IMF, and the rupee dropped from 105 to the dollar to 155 to the dollar. This was painful and inflationary in the short term, but it has worked. Exports have risen 30% in rupee terms and are now rising in dollar terms, while imports have come down by almost 15 billion dollars per year. The country is no longer bleeding foreign exchange as the Current Account moved into surplus in October for the first time in years.
In addition to getting the trade deficit under control, the budget was also wildly out of balance, with the government spending far more than it collected in taxes. This too was fueling inflation, which had surged to over 10% per year. Khan’s government has taken steps to cut spending and increase tax revenues, which needed to be done, but had the effect of slowing the economy.
Finally, the other main lever governments have to control inflation is the interest rate. Higher rates slow down business activity by making borrowing more expensive. In most advanced economies, interest rates are set by the Central Bank, such as the Federal Reserve in the US or the ECB in the Eurozone. Central banks should normally be kept free from political interference, as they need to sometimes hand out harsh medicine that politicians would prefer not to. In Pakistan, the State Bank controls interest rates, but it has not been traditionally fully independent. Imran Khan made the SBP independent in its policy making, and it has raised interest rates to 13% to control inflation. This has held back the economy, but inflation is going to slow in response to this, and once it does, the SBP will lower rates and economic growth will go much higher.
The stock market trades on what investors are expecting the future to look like. As such it turns higher when prospects begin to brighten even before the average person can see that in the street. Pakistani stocks have been surging since mid-August, and they gained 15% in value in November, making the KSE the best performing stock market for that month in the world. The market is saying that 2020 will be a good year for the economy.
The Pakistani political scene remains turbulent. The traditional parties that have dominated the landscape for decades, the PML-N led by Nawaz Sharif, and the PPP currently led by Benazir Bhutto’s son, remain patronage machines with long histories of corruption. It is important that the PTI and Imran Khan be given full five years to correct the errors of the past and prove they can do a better job. If Khan does that, he will win reelection in 2023, and Pakistani democracy will become much more stable.
Pakistan, despite a mixed record of governance since its founding, has come a long way in 70 years. Its economy has grown about 5% per year in the last 70, and its standard of living has risen ten-fold since 1947. In 2019, 9% of Pakistani households own a car, and over 50% have a motorcycle, only 1% owned cars 20 years ago. But per capita income is still at about 12% of the current American living standard. It can reach that with another 70 years of 5% growth, and it can do so even faster if it can follow good economic policies that push growth to 7% or higher per year. - nali@socal.rr.com
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