Saving Pakistan’s Economy

L to R: Joseph Snyder, Khaleel Ahmed, Mosin S. Khan (Asia Society)

WASHINGTON, December 3, 2008 – Since late 2007, Pakistan has been faced with a set of serious issues: an unstable political climate, increasing domestic security threats, diplomatic pressure from the United States, and over the last year an economy on the brink of failure. How did Pakistan get into this situation and how can the country regain economic stability?

At a discussion co-hosted by Asia Society and The Atlantic Council, panelists Mohsin S. Khan, senior fellow at the Peterson Institute and former director of the Middle East and Central Asia Department of the International Monetary Fund; Khaleel Ahmed, chief investment officer in IFC's Global Financial Markets department, and moderator Joseph Snyder of The Atlantic Council, provided insights and possible solutions to Pakistan’s economic troubles.

Khan provided an overview of the Pakistan’s macro-economic situation. He remarked that the GDP growth rate is 2-3% this year,which implied a recession considering Pakistan’s high population growth rate. Inflation is hovering around 25%, having tripled since the period 2004-2006. The central bank’s gross foreign reserves tumbled to $3.5 billion in November, representing less than one-month’s import value, and at the same time the government is running an $11 billion budget deficit. In brief, Pakistan needs $10 billion to bridge its current financing gap.

Accroding to Khan, there were a number of factors that led Pakistan to this dire economic situation, but the two main causes were a rapidly rising subsidy bill for spiraling energy costs in 2008 and extremely low tax revenues, which combined to cause an increasingly large fiscal deficit. The government tried to finance this deficit by borrowing from the central bank, but the increased liquidity, in turn, caused double-digit inflation and a significant loss of foreign exchange reserves. The fact that the former government was running for reelection, coupled with ongoing political and security instability, discouraged Pakistan’s politicians from dealing with many of these key economic issues.

Khan believes it will take Pakistan four to five years to recover from this economic crisis. However, there are recent signs of improvement. The newly-elected government has agreed to accept a $7.6 billion loan over a 23 month period from the IMF. In return, they have adopted a program which aims at phasing out government subsidies, eliminating the government’s borrowing from the central bank, tightening monetary policy, and shifting energy oil payments to market prices. Once the IMF Agreement was signed, several other countries and international financial institutions such as the World Bank, ADB, China, the UAE, and Saudi Arabia also pledged support funds for Pakistan.

Ahmed’s remarks were focused on Pakistan’s banking sector, which he said is in a "much better situation" since the denationalization of the banking sector, which started in 1994. Nevertheless, although it is now private, the banking sector is still greatly influenced by the Ministry of Finance. The Central Bank’s supervision of commercial banks needs to continue to improve and a key issue is whether the central bank can become more independent of government officials and policy during aperiod of increased political and security instability. Overall, the financial sector has been buffeted by both internal and external turmoil and it is expected that there will be some consolidation of financial institutions.