Economic History Of Pakistan

Analysis of Pakistani Industries

TABLE OF CONTENTS

TOPIC

Page No.

Introduction

2

Gross Domestic Product (GDP)

2

Inflation

5

Unemployment

7

Income Inequality

8

Balance of Payments

10

Foreign Trade

13

Exchange Rates

16

Foreign Direct Investment (FDI)

17

Pakistan’s Strengths and Weaknesses

19

World Trade Organization (WTO)

22

Conclusion

22

Bibliography

23

Appendix

24

Glossary

25

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Analysis of Pakistani Industries

INTRODUCTION At partition in 1947, the new government lacked the personnel, institutions, and resources to play a large role in developing the economy. To rise from such a state surely is a great task, especially when one’s borders are also insecure. Since then Pakistani officials have sought a high rate of economic growth in an effort to lift the population out of poverty. Rapid industrialization was viewed as a basic necessity and as a vehicle for economic growth. For more than two decades, economic expansion was substantial, and growth of industrial output was striking. In the 1960s, the country was considered a model for other developing countries. Rapid expansion of the economy, however, did not alleviate widespread poverty. In the 1970s and 1980s, although a high rate of growth was sought; greater attention was given to income distribution. In the early 1990s, a more equitable distribution of income remained an important but elusive goal of government policy.

GROSS DOMESTIC PRODUCT (GDP) The disruptions caused by partition, the cessation of trade with India, the strict control of imports, and the overvalued exchange rate necessitated immediate action on the part of the government. Government policies afforded liberal incentives to industrialization, while public development of the infrastructure complemented private investment. Some public manufacturing plants were established by government holding companies. Manufacturing proved highly profitable, attracting increasing private investments and reinvestment of profits. Except for large government investments in the Indus irrigation system, agriculture was left largely alone, and output stagnated in the 1950s. The broad outline of government policy in the 1950s and early 1960s involved squeezing the peasants and workers to finance industrial development. Much of the economy, and particularly industry, was eventually dominated by a small group of people, who were largely traders who migrated to Pakistan's cities, especially Karachi, at partition. These refugees brought modest capital, which they initially used to start trading firms. Many of these firms moved into industry in the 1950s as a response to government policies. Largely using their own resources, they accounted for the major part of investment and ownership in manufacturing during the first two decades after independence. Between 1947-1952 Pakistan’s average GDP was just 3%, however, in 1952, Korean War broke out and the overall demand of goods increased worldwide and Pakistan benefitted from it significantly with its GDP increased at a whooping rate of 9.4%. After Korean War ended there was a worldwide recession. However, Pakistan was the sole exporter of Jute at that time and Pakistan’s conditions didn’t get worse. Till 1958 Pakistan maintained an average GDP of 3%. If one examines Pakistan economic growth record, the 1960’s stands out as the decade with the best performance. Throughout 60’s Pakistan maintained the average GDP of 6.2%. The reason for this was Ayub Khan’s extensive industrialization and development. The high growth rate in large scale manufacturing continued in the first few years of the Ayub’s regime with the average

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Analysis of Pakistani Industries

for the period 1960-5 rising to a phenomenal 16.9%. In 1966 the GDP fell to 3.1% because of war with India but it continued to grow after that and reached as high as 9.8% in 1970. In 1971 Pakistan lost its east wing which became Bangladesh. It greatly affected our economy because East Pakistan was the major producer of Jute. Bhutto became the Prime Minister of Pakistan and he nationalized all the major industries of the country. This act of Bhutto discouraged the private sector and industrialists were no longer interested in investing in Pakistan. In 1972 GPD fell to just 1.2%. This occurred mainly because of war with India and also because Pakistan lost revenue which it used to earn from Bangladesh. Then Bhutto devalued the Rupee by 131% which boasted our exports by 153%. He introduced several reforms and public development projects because of which Pakistan was able to achieve the average growth rate of 7.5 till 1974. 1975, the height of Bhutto’s nationalization program, private sector investment was only 15% of the total. Cotton crop was also destroyed and there were several floods during his last years of rule. 1976 saw Pakistan’s worst floods, devastating large areas of cultivated land. All these factors caused Pakistan’s GDP to fall significantly and from 1974-1977, the average GDP was just 3.6%. Zia-ul-Haq revived the confidence in Private Sector to invest in the country again. The process of privatization was carried out gradually. The inflow of foreign aid from US and other countries increased because of Pakistan’s role in war against the USSR. This increased the income of local people and the domestic demand of goods and services increased. This aid also helped Zia regime to finance in the industrial sector. This all caused Pakistan’s GDP to grow by average 6.5% during1980-88 and at that time it was only exceeded by that of Korea, China and Hong Kong. During the period 1988-99, there were seven different governments and two elected prime ministers who were both elected twice. This was a highly uncertain period and no government completed their constitutional tenure. The economy of Pakistan slowed to an average annual growth of 3.8 percent during the 1990s (MSN Encarta). Factors contributing to the sluggish growth included corruption and mismanagement at the highest levels of government and the rise of ethnic and sectarian violence in Karachi and other urban centers. These factors shook investor confidence.

The economic performance of the 1990s was also related to the structural adjustment programs (SAPs) of the World Bank and the International Monetary Fund (IMF). Loans from these international lending agencies were subject to conditions on Pakistan’s national economic policies. Pakistan received its first formal loan in 1988. In Pakistan the primary focus of the IMF-sponsored program was to lower the budget and current-account deficits. These objectives Page 3

Analysis of Pakistani Industries

were to be achieved by reducing public expenditures and broadening the tax base. In addition, in 1992-1993 the IMF further insisted that Pakistan reduce defense expenditures, impose an agricultural tax, and improve methods of tax collection. These reforms were never fully implemented, however, and the IMF-sponsored program did not achieve the desired result. After Pakistan exploded a nuclear device in May 1998, it faced the imposition of international sanctions. Many countries including US and UK stopped importing goods from Pakistan which also affected our production. (Source: MSN Encarta)

During the time of General Pervez Musharraf, the economy grew at an average rate of 6.3 per cent a year. After Pakistan joined in the war against terror it received foreign aid of billions of dollars. Heavy development projects were launched and ignited the growth rate. 7 licenses were sold to cellular companies at a very high cost and many state owned companies were privatized. These firms started to perform well and their productivity increased. Tax collection increased by 18 percent during July-April 2007 and exports increased by 18.3 percent and imports up by 8.9 percent. Source (Pakistan Times). However, only the Services sector grew significantly and not the manufacturing sector. No major industries were set up and in 2008 when there was a worldwide recession, Pakistan’s economy suffered heavily.

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Analysis of Pakistani Industries

INFLATION1 Inflation means a sustained rise in prices. Inflation can be Creeping, walking or trotting, running, hyper or gallop, demand pull, cost push, mixed, markup or stagflation according to velocity and nature. Inflation is caused by some demand side factors (Increase in nominal money supply, Increase in disposable income, Expansion of Credit, Deficit Financing Policy, Black money spending, Repayment of Public Debts, Expansion of the Private Sector, Increasing Public Expenditures) and some Supply side factors (Shortage of factors of production or inputs, Industrial Disputes, Natural Calamities, Artificial Scarcities, Increase in exports (excess exports), Global factors, Neglecting the production of consumer goods, Application of law of diminishing returns) Inflation rates from 1991 to 1995 have ranged between 9.25 and 12.9 percent. The high rates of monetary expansion, low rate of economic growth in three out of the five years and adjustment in administered prices contributed to the relatively high rates of inflation. Growth in international prices (in dollar terms) has been moderate or negative. Except in 1995 when price of tradable (in rupee terms) increased by 19 percent. Substantial depreciation of the exchange rate in 1990 and in 1994 also resulted in a relatively sharp increase in the price of tradable (in rupee terms) in these two years. The pressure on international reserves and an appreciation of the real exchange rate necessitated depreciation in 1994. The pressure on the exchange rate and reserves was caused because of the fiscal and monetary indiscipline during 1991-1993. The period also marked a major thrust in economic liberalization of the economy. The rate of economic growth, which had flattered in 1989 and 1990, recovered strongly in the next two years. The recovery was short lived as growth rate plummeted in 1993 to its lowest level in over two decades. The rate of monetary growth which had been brought down to 4.6 percent in 1989 climbed up to 12.6 percent in 1990 and since then has been in the region of 16 to 18 percent except in 1992 when it reached an unprecedented 30 percent. High budget deficits during these years 1

Most of the material has been taken from the article ‘Forecasting Inflation in Developing Nations: The Case of Pakistan’, details in reference sheet

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Analysis of Pakistani Industries

contributed to the monetary expansion. In 1994 the rate of monetary growth was 16 percent, although budget deficit was brought down to 5.8 percent of the GDP. The growth in money supply in 1994 was mainly on account of accumulation of net foreign assets rather than domestic credit creation. As mentioned above, the buildup of foreign reserves had become necessary because of a drawdown of reserves in the previous years. Thus the reasons for the increase in money supply in 1994 were qualitatively very different from those in the previous three years. Pakistan has experienced sustained inflation hovering between 10.0 to 13.0 percent range during the first eight years of the 1990s. Not surprisingly, one of the thorniest issues in Pakistan’s policy arena during those periods has been how to put inflation under effective control The persistence of a double-digit inflation along with large fiscal deficit (7.0% of GDP) have been the major source of macroeconomic imbalances in the 1990s. There has been a general agreement that the excessive growth in money supply, the supply side bottlenecks, the adjustment in government – administered prices, the imported inflation (pass through of exchange rate adjustment), escalations in indirect taxes, and inflationary expectations has the major factors responsible for the persistence of a double-digit inflation during most periods of the 1990s. Both food and nonfood inflation contributed to the persistence of the double-digit inflation. Food and non-food inflation averaged 11.6 percent and 10.3 percent, respectively during the eight years of the 1990s. During Fiscal / Financial Year 2002 (FY02) despite the aftermath of events of September 11 and continuation of a drought-like situation in the country. Better availability of essential commodities, due to improved production of food and non-food items as well as the food stocks for prior periods, had a moderating influence on inflation. Inflation Among the most appreciated developments, during fiscal year 2005-06, was the significant abatement of price pressure over the course of the year. For the first ten months of the fiscal year July–April 2005-06, all important barometers of price pressure in the economy indicated a steady deceleration in inflation. Inflation during the first ten months July-April of the current fiscal year is estimated at 8.0 percent as against 9.3 percent in the same period last year. April 2005 (last-time it was at 15.7 percent in May 1994), yielded handsome dividend in the shape of overall inflation decelerating to 6.2 percent and food inflation to 3.6 percent in April 2006. The expenditure on food items constitutes bulk of the monthly expenditure of the poor segment of the society. Sharp increases in the prices of some of the strategic food items put pressure on the poor. The higher inflationary trend in Pakistan over the last two years has been the outcome of pressure that emanated from demand and supply sides. Four years of strong economic growth has given rise to the income levels of various segments of the society. The rising level of income have strengthened domestic demand and put upward pressure on prices of essential commodities. Supply side pressure emanated from a variety of factors, prominent among those are: increase in support price of wheat for three years in a row, shortage of wheat owing to less than the targeted production, mismanagement in wheat operation in one of the wheat deficit province, inter-provincial ban on the movement of wheat resulting in sharp increases in prices of wheat and wheat flour. Lower production of sugar due to a relatively lower production of sugarcane and a sharp increase in the international prices of sugar brought about by a significant diversion of sugarcane into ethanol (petroleum substitute), by the largest producer, Brazil, also contributed in building inflationary pressure in Pakistan. Inflation is one of the obstacles on the way of development. In Pakistan, it has squeezed the major part of the population. It needs to be controlled by strategic planning. Domestic production should be encouraged instead of imports; investment should be given preference in consumer goods instead of luxuries, Agriculture sector should be given subsidies, foreign investment Page 6

Analysis of Pakistani Industries

should be attracted, and developed countries should be requested for financial and managerial assistance. And lastly a strong monitoring system should be established on different levels in order to have a sound evaluation of the process at every stage.

UNEMPLOYMENT Unemployment is one of the major problems of Pakistan. It is the root cause of several other problems and is a result of a number of problems. High unemployment results in wastage of resources and depression of income. And most certainly it also effects the social and emotional life of a person. It is very unfortunate but true that searching for statistics regarding the unemployment rate of Pakistan, it is nearly impossible to find relevant figures due to a lack of base data and massive governmental tempering of statistics which have made the validity of the available data questionable. In 1955, there was a survey held which tried to give the false impression of full employment in the agriculture sector. However this proved wrong when in 1965 a survey was held and it was found that the economy of Pakistan was most stagnant in the region and a 50% ratio of un- and underemployed labor to the total working force could be taken as nearer to reality.2 In all the five-year plan starting from 1955, policies were included at the reduction of unemployment, however due to inadequate efforts on the part of the government most of them proved wane. According to labor force survey 2001-02, Pakistan labor force stands at 43.17 million and 3.6 million people were of active labor market, looking for a job. Recent trend indicates that unemployment rate increased from 7.8 percent in FY00 to 8.3 percent in FY02. However it again fell to 7.7% in FY04. According to an article by Dr. Ishrat Hussain the main reasons for the decline in unemployment during this time is “inefficient utilization of factors of production that 2

Dr. Khushi M.Khan “Unemployment and the People’s Works Programme”

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Analysis of Pakistani Industries

was a characteristic of public sector dominated economy has been minimized as a result of structural reforms in tariffs, taxation, financial markets and privatization. The demand for labor inputs per unit of output has consequently been reduced due to this compositional shift from the public to private sector employment. At the same time labor force participation rate is on an upward incline because of the entry of large number of females. High unemployment rates under these conditions of productivity and efficiency gains are therefore not surprising.” Regional disparity is evident with regard to unemployment rate. Urban unemployment rate (9.8 percent) was higher than the rural one (7.5 percent). This also includes the disguised unemployment in agriculture sector in the form of unpaid family helpers. According to an article by Dr Ishrat Hussain, the unemployment rate of Pakistan was 6% in October 1999, and it rose to 8% in October 2004. There are a number of reasons for unemployment in Pakistan, firstly, there is a serious mismatch between the jobs demanded by the emerging needs of the economy and the supply of skills and trained manpower in the country. While the economy is moving towards sophisticated sectors such as telecommunications, information technology, oil and gas, financial services, engineering goods the universities and colleges are turning out hundreds of thousands of graduates in Arts, Humanities and languages. This mismatch has created waste and misallocation of resources on one hand and the shortages of essential skills required to keep the wheels of the economy moving. There is also a lack of technical and vocational training to fill out the gaps between the demand if skills and their availability, and so there large number of experienced technicians and professionals who have migrated to the Middle East and elsewhere.

INCOME

INEQUALITY

Economic inequality refers to disparities in the distribution of economic assets and income. The term typically refers to inequality among individuals and groups within a society (Wikipedia). Various studies on income inequality in Pakistan show different estimates but the one most commonly used in the studies is the Gini coefficient. The Gini coefficient is a measure of statistical dispersion most prominently used as a measure of inequality of income distribution or inequality of wealth distribution. It is defined as a ratio with values between 0 and 1: A low Gini coefficient indicates more equal income or wealth distribution, while a high Gini coefficient indicates more unequal distribution. 0 corresponds to Page 8

Analysis of Pakistani Industries

perfect equality (everyone having exactly the same income) and 1 corresponds to perfect inequality (where one person has all the income, while everyone else has zero income). (www.Wikipedia.com) In studies conducted for Pakistan, Gini coefficient is generally higher in the urban than in the rural areas because: • Urban labor force is more diversified in terms of skill, education, union membership, coverage by the minimum wage legislation and therefore the wage incomes are more unevenly distributed than in rural areas; • Income from self-employment is more concentrated in urban areas than in rural areas because urban self-employed ranges from wealthy businessmen to poor workers whereas the rural selfemployed are mostly in informal sector enterprises. The Gini coefficients show different trends over time and across urban and rural areas. In the urban areas Gini coefficient increased from 0.3698 to 0.4068 over 1963-67 but declined to 0.3694 by 1969-70. In urban areas, the poorest 20% lost the income share and the richest 20% gained significantly over the period 1963-67 but in the subsequent period changes in the shares reversed. Income inequalities in rural areas, on the other hand, declined from 0.3543 to 0.3122 over the 1963-70 period. The shares of various income values also show similar trends. The increase in income inequalities in urban areas up to 1967 indicate that high growth was job-less and real wage rates had been declining. Improvements in gini coefficient in the subsequent period of the 1960s may have been due to increase in wages and legislation aimed at protecting the workers as a response to the demonstrations against the government policies that had led to rising income inequalities. The decline in inequalities in rural areas seems to have been due to green revolution – divisible technology – which might have benefited the poor as well. Gini coefficient increased from 0.3394 to 0.3946 over 1970-79 periods, break-up of this value is the increase in rural areas from 0.3122 to 0.3450 and in urban areas from 0.3694 to 0.4118. This is contrary to the general perception because land reforms, nationalization of major industrial and financial undertakings of the government focus on the basic needs strategy during the period were expected to result in lower income inequalities. Probably the sharp increase in inflation during the period had taken a toll of the poor resulting in a reduction in the share of income of the poor and the middle class. Moreover, the banks were nationalized in the 1970s on the pretext that the small producers did not have access to credit. During the 1980s Gini coefficient in both the rural and urban areas declined sharply over 197988 from 0.3450 to 0.3227 and from 0.4118 to 0.3782 respectively. Overall Gini coefficient declined from 0.3946 to 0.3608. The main factor behind the improved trends in income inequalities in 1980s has been the increases in employment and real wages in the agriculture and manufacturing sectors. Whereas in the next three years, 1988-91, Gini coefficient in the urban areas remained somewhat constant, however it increased sharply in the rural areas. The ratios of shares of lowest and highest income values also show sharp increases in income inequalities. In the rural areas the Gini coefficient declined but there has been mixed trend in urban areas up to 1996-97. However, to a smaller extent in the rural areas and to a large extent in the urban areas income inequalities Page 9

Analysis of Pakistani Industries

have increased since then. Gini coefficient increased in rural areas from 0.3517 to 0.3762 and in urban areas from 0.3691 to 0.4615 over the 1997-2002 period. Whereas the income inequality in 1996-97 had been low, the inequalities have been the maximum in the 1990s compared to any time period in the history of Pakistan. The gini coefficient in 2000-01 shows a marginal decline only because of a decline in the rural areas. In the urban areas, however, income inequality increased rapidly. The urban income distribution in 2001-02 turned out to be the most unequal. On the basis of 2004-05 PLSM data, government has recently announced a sharp reduction in the proportion of poor below the poverty line. Pakistan has all along relied on indirect taxes which are generally regressive. However both because the indirect tax rates on the products consumed by the rich were higher as well as progressive, the incidence of taxes up to 1988 was higher on richer sections of the society. However the decline in corporate income tax rates and tariff rationalization policies have benefited the producers, while with the broadening of sale tax base, the tax burden on the poor has increased.

BALANCE

OF

PAYMENTS

The balance of payments (BoP) means a systematic record of all the economic transactions between residents of a country with the rest of the world during a given period of time. It covers exchange of visible (merchandise) and invisible (services) items. The balance of trade (BoT) covers the exchange of visible items only. Deficit in balance of payments means that the import bill exceeds the export bill. During pre-plan period (1948-49 to 1954-55), Pakistan's performance in the foreign trade sector was reasonably good, however due to lack of industrial base Pakistan was unable to export its agricultural produce. It had surplus Balance of Trade up to 1954-55. The year 1955-56 was the last year in which Pakistan had a favorable balance of trade. After that it ran into BOP problems due to an overvalued exchange rate and so our exports became uncompetitive. Since that time, Pakistan has been facing a serious problem of deficit in its Balance of Trade and Balance of Payment. In 1971, Pakistan's exports decreased considerably and its imports surged, especially of capital goods, thus creating a trade deficit. A number of Pakistanis during this time migrated to the Middle East. Workers’ remittances, especially from the Middle East countries, increased tremendously which helped a great in stabilizing the BoP. 3

The deficit in Balance of Trade was $836 million on an average while current account deficit in BoP was $699 million on an average between 1971-72 and 1977-78 (the tenure of late Mr. Z. A. Bhutto). The trade deficit as percentage of GNP remained 6.3 per cent while current account deficit in BoP remained 5.6 per cent on an average during 1971-72 to 1977-78. The problem of deficit in balance of payments by Mohammad Ishaq Javed and Dr. Shaikh Muhammad Ashfaq 3

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Analysis of Pakistani Industries

Pakistan's balance of payments was highly dependent on workers’ remittances but these remittances were not sustained over a long period of time. They increased after 1971-72. There was a sudden upsurge in the workers’ remittances in late seventies and early eighties. It grew up from $107 million in 1971-72 to a peak level of $2989 million in 1982-83 and exceeded the total merchandise export of $2627 million. The BoP position deteriorated during Zia's regime (1978-79 to 1984-85). The inflow of workers’ remittances continued increasing, especially from the Middle East, from 1977-78 to 1982-83 and reached a peak level of $2886 million in 1982-83. This inflow gradually decreased in the last two years of his regime. The magnitude of workers' remittances from 1978-79 to 1984-85 was $1849 million on an average. The trade deficit as percentage of GNP rose to 9.9 per cent while current account deficit in BoP on an average decreased to 3.7 per cent in this period. The external BoP gained strength during Junejo's period from 1985-86 to 1987-88. Exports grew on an average by 33 per cent while imports decreased during first two years while increased in the last year. Export remained at a level of $3601 million on an average during this period. Deficit in the balance of trade decreased to $2631 million and current account deficit in the BoP decreased to $1211 million on an average during these years. The magnitude of workers’ remittances on an average between 1985-86 and 1987-88 was $2295 million. However, these inflows began tapering off since 1982-83, excluding inflows from Kuwait in 1994-95. This year workers’ remittances were $ 1866 million. After 1994-95, workers remittances depicted a declining trend. The current account deficit in balance of payment declined to 3.1 per cent during 1985-86 and 1987-88. The BoP position witnessed a significant improvement during first tenures of both Ms. Benazir Bhutto (1988-89 to 1990-91) and Mohammad Nawaz Sharif (1991-92 to 1993-94). The deficit in BoT decreased to $2728 million on an average between 1988-89 to 1990-91 and to $2501million on an average during 1991-92 to 1993-94. The current account deficit in BoP fell to $1998 million on an average between 1988-89 to 199091and to $2333 million on average between 1991-92 and 1993-94. This reveals that BoP and BoT remained stabilized during the first tenures of both- Benazir and Nawaz Sharif - (1988-89 to 1993-94). Trade deficit as a percentage of GDP stabilized on an average around 4.7 per cent during Benazir's and Nawaz's tenures. The current account BoP as a percentage of GDP on an average was 4.7 per cent in Benazir's period while 4.6 per cent in Nawaz's period. Pakistan's external balance of payment deteriorated in the second tenure of Ms. Benazir (1994-95 to 1996-97). The deficit in BoT and current account deficit in BoP increased to $3128 million and $3635 million on an average between 1994-95 and 1996-97 respectively. Trade deficit as a percentage of GDP on an average was 4.7 per cent while deficit in current account balance of payments increased to 5.8 per cent. There was a sudden upsurge in the inflow of workers’ remittances from Kuwait and were $1866 million in 1994-95. This inflow could not maintain its momentum and was reduced in the following two years of Benazir's government. Page 11

Analysis of Pakistani Industries

The magnitude of inflow of workers remittances from 1994-95 to 1996-97 on an average was $1578 million. This adverse performance in foreign balance of payment was due to the weak macroeconomic management and lack of commitments to undertake difficult structural reforms. The overall balance of payment position during the second tenure of Nawaz Sharif (1997-98 to 1999-00) witnessed a significant improvement despite the adverse external environment. However, a number of fiscal and monetary activities were implemented which discouraged free trade and economic transactions abroad, for instance the freezing of FCAs, Hub Power Dispute and Political uncertainty eroded the confidence in the economy. Both current account deficit in BoP and BoT decreased in this period. The deficit in the balance of trade decreased to $1788 million while current account in the BoP decreased to $1833 million during 1997-98 and 1999-00 despite the sanctions imposed by the G-8 countries on bilateral and multilateral lending as a consequence of Pakistan's nuclear tests in May 1998. The deficit in the balance of trade as percentage of GDP on an average declined to 2.5 per cent while current account deficit in balance of payments declined to 2.9 per cent on an average during 1997-98 and 1999-00. Workers' remittances exhibited a declining trend during these years. The magnitude of workers remittance on an average was $1178 million. The economy started showing signs of improvement with the start of Musharaf's regime. His government launched a comprehensive set of economic stabilization and structural reform measures. The government took steps in the early 2000s to liberalize and deregulate the exchange and payments regime. Pakistan moved to a dual exchange rate system in 2000. Pakistan's exports increased from $7.8 billion in 1999-00 to $9.2 billion in FY00-01. The deficit in Balance of Trade (BoT) decreased to $1269 million while current account BoP decreased to $513 million in FY00-01. In 1999-00 workers’ remittances were reduced to $ 983 million. After the event of September 11, FY01 workers’ remittances increased tremendously especially from USA, UK and other European countries and reached to $4237 million in FY02-03. One major structural problem of exports is that it is based on relatively low value added products. Pakistan's exports are highly concentrated in cotton group, leather group, rice, synthetic textiles and sports goods. However the imports rely on a limited number of commodities namely machinery, petroleum & petroleum products, chemicals, transport equipments, edible oil, iron and steel, fertilizer and tea. There was a sharp decline in trade deficit in FY01-02. The trade deficit fell by 75.5 per cent to $286 million over the level of $ 1338 million of FY00-01. The current account deficit in balance of payment emerged with a surplus of $913 million in FY01-02. The magnitude of surplus in current account BoP for FY01-02 was $1338 million, for FY02-03 $ 3165 million and for FY03-04 (July-March FY03-04) was $1369 million. Export growth in 2000/01 was primarily due to higher exports of primary commodities such as rice, raw cotton, and fish, and other manufactures such as leather, carpets, sporting goods, and surgical instruments. Imports increased in 2000/01 primarily due to higher imports of petroleum and petroleum products, and machinery.

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Analysis of Pakistani Industries

These five categories of exports accounted for 82.6 per cent of the total exports during 2002-03. Among these five categories cotton group alone contributed around 63.3 per cent of total exports, followed by leather (6.2 per cent) and synthetic textiles (5.1 per cent) and rice (5.0 per cent). Such a high degree of concentration of exports in few items has led to instability in export earnings. Pakistan’s balance of payments showed a deficit of $ 6,878 million in its current account balance during 2006-07 as against a deficit of $ 4,990 million during 2005-06. The capital and financial account showed a net inflow of $ 10,449 million and increased by $ 4,378 million over net inflows of previous year resulting in an increase of $ 2,396 million in overall surplus during the year 2006-07. Although Pakistan is trading with a large number of countries, yet major portion of imports comes from a few selected countries. Almost 50 per cent of imports come from USA, Japan, Kuwait, Saudi Arabia, Germany, the UK and Malaysia. Such a high degree of geographic concentration of imports is undesirable and is in favor of exporting countries.

FOREIGN

TRADE

Pakistan’s balance of payments has always been in the deficit mainly because successive governments of Pakistan have focused on saving the foreign exchange rather than earning it. On the one hand, there has been an anti-export bias and on the other hand a very complex system of foreign exchange control to contain the imports to levels of foreign exchange availability. Foreign trade is important to the economy because of the country's need to import a variety of products. Imports have exceeded exports in almost every year since 1950, and Pakistan had a deficit on its balance of trade each year from FY 1973 through FY 1992. In FY 1991, exports were US$5.9 billion, compared with imports of US$8.4 billion, which resulted in a deficit of US$2.5 billion. In FY 1992, exports rose to an estimated US$6.9 billion, but imports reached an estimated US$9.3 billion, resulting in a trade deficit of US$2.4 billion. Economists forecast a trade deficit of around US$2.5 billion for FY 1993. Pakistan's terms of trade , expressed in an index set at 100 in FY 1981, were 78.0 in FY 1991 and 82.7 in FY 1992.

Crude oil and refined products are significant imports. Their value varies with internal demand and changes in the world oil price. In FY 1982, oil products accounted for around 30 percent of Pakistan's imports, falling to an annual average of 15 percent in FY 1987 to FY 1990, rising to over 21 percent in FY 1991, but dropping back to 15 percent in FY 1992. Other important categories of imports in FY 1992 included non electrical machinery (24 percent), chemicals (10 percent), transportation equipment (9 percent), and edible oils (4 percent). Although import-substitution industrialization policies favored domestic manufacturing of substitutes for imports, officials also encouraged manufactured exports in the 1950s and 1960s. In the early 1980s, incentives were again provided to industrialists to increase manufactured exports. There was some diversification during the late 1980s as the share of manufactured goods rose. This share of primary goods fell from 35 percent to 16 percent between FY 1986 and FY 1993. During the same period, the share of semi manufactures rose from 16 percent to 20 percent, and that of manufactured goods rose from 49 percent to 64 percent. Page 13

Analysis of Pakistani Industries

Nonetheless, in the early 1990s the export base remained primarily dependent on two agricultural products, cotton and rice, which were subject to great variations in output and demand. In FY 1992, raw cotton, cotton yarn, cotton cloth, and cotton waste accounted for 37 percent of all exports. Other important exports were ready made garments (15 percent), synthetic textiles (6 percent), and rice (6 percent). In the early 1990s, Pakistan's balance of trade remained particularly vulnerable to changes in the world economy and bad weather. Sharp increases in crude oil prices, such as those of 197981 and 1990, raised the nation's import bill significantly. Total exports, on the other hand, were more sensitive to agricultural production. The decline in cotton production in FY 1993, for instance, seriously affected the export level. Sources for imports and markets for exports were widely scattered, and they fluctuated from year to year. In the early 1990s, the United States and Japan were Pakistan's most important trading partners. In FY 1993, however the United States accounted for 13.7 percent of Pakistan's exports and 11.2 percent of its imports. Japan accounted for 6.6 percent of exports and 14.2 percent of imports. Germany, Britain, and Saudi Arabia were also important trading partners. The subsequent decade saw a considerable increase in the trade statistics due to several expansionary policies adopted by President Parvez Musharraf. Overall exports of the economy booted by more than 100 % from $8.5 billion, which were stated when Musharraf took the office till $18.5 billion annually in the Fiscal year 2007. The growth too of its major leading export boosting sector was seen quite considerably. Textile industry which accounts for a major percentage of Pakistan’s exports from a poultry $5.2 billion to a massive $11.2 billion (source Mirza Rohail B Economic Comparison 1999-2007 and beyond). On the import bill however the decade saw a considerable increase in imports but, however unlike the previous decades, this era was marked by heavy import of massive capital tools to boost the industrial competitively and pace. On the other hand, apart from petroleum import increase, the deficit on the Balance of Payments dropped by 14% average annually.

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Analysis of Pakistani Industries

Now almost 50 per cent of imports come from USA, Japan, Kuwait, Saudi Arabia, Germany, the UK and Malaysia. Such a high degree of geographic concentration of imports is undesirable and is in favor of exporting countries.

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EXCHANGE RATES During the past five decades, Pakistan's foreign exchange regime has been moving towards a deregulated and market-oriented direction: Before the 1970s, Pakistan linked its currency, rupee, to the Pound Sterling. With the economic influence of the USA getting more apparent, in 1971, Pakistan linked rupee to the U.S. Dollar. In 1972 Bhutto devalued Pakistani rupee by 131%. The exchange rate at that time was $1= PKR 11. This act significantly increased our export revenue. Despite the loss of East Pakistan’s exportable produce, West Pakistan doubled its foreign exchange earnings. However, in 1973, OPEC increased the price of oil and Pakistan had to pay higher price to import oil. During that year there was a worldwide recession and the demand for goods and services decreased throughout the world which also caused Pakistan’s export to decline. All these factors greatly damaged Pakistan’s economy. Pakistan fell into a budget deficit in 1982, when the strengthening U.S. Dollar made remittances abroad through official channels slumped. In this view, Pakistan put the rupee on a controlled floating basis. In 1998, to alleviate the financial crisis in Pakistan, the authorities adopted a multiple exchange rate system, which comprised of an official rate (pegged to U.S. dollar), a Floating Interbank Rate (FIBR), and a composite rate (combines the official and FIBR rates). Export proceeds, home remittances, invisible flows, and "non-essential" imports can be traded at the FIBR rate.

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From 1999-2007 during Musharraf’s rule, the exchange rate remained stable at $1=PKR 60. The reason for this was high amount of foreign air and remittances inflow in Pakistan. In 2008 due to sky rocketing rates of oil and unstable political and security conditions, Pakistan felt short of it foreign reserves and the price of $1 reached all time high to PKR 86.7. Currently the exchange rate of Pakistani Rupee is $1=PKR 79.36 (10 Feb, 2009) The historical exchange rates of Pakistan are as follows:

FOREIGN DIRECT INVESTMENT (FDI) FDI plays an important role in the economic growth of the host country, especially if it is accompanied by sound economic policies and greater openness (hec.gov). It also tends to crowd in local investment and it promotes growth, increases competitiveness and exports. Pakistan was an agricultural economy upon its independence in 1947. It lacked the industrial capacity to process locally produced agricultural raw material, as well as the funds to create new capital. So the was a need on the part of the government to obtain funds from abroad to invest it in the local industries, and improve the country’s manufacturing capacity. Different types of industrial policies have been implemented in different times with a changing focus on either the private sector or the public sector. The private sector was the main vehicle for industrial investment during the 1950s and the 1960s and the involvement of the public sector was restricted to very few industries. It was set that in the event of private capital not forthcoming for the development of any particular industry of national importance, the public sector might set up a limited number of standard units. Foreign investment was not allowed in the field of banking, insurance, and commerce. On 1 January 1972, the GOP issued an Economic Reforms Order taking over the management of ten major categories of industries, 7 commercial banks, development financial institutions, and insurance companies. In 1975 there was another round of nationalization of small-sized agroprocessing units. The sudden shift toward nationalization of private sector industrial units shattered private investors’ confidence. After the dismal performance of the industrial sector following the 1972 nationalization, a change occurred in September 1978 in the government’s approach toward the role of the public and private sectors. The role of the public sector was restricted to consolidating existing enterprises, and further government investment in this sector was strictly restricted. The role of the public sector was elaborated in the industrial policy statement enunciated in June 1984. The statement reiterated that the government would continue to pursue a pattern of a mixed economy. The industrial policy statement of 1984 not only accorded equal importance to the public and private sectors but also encouraged the private sector to come forward. However, the process of privatization was not initiated. Had this been initiated, Pakistan might have attracted a considerable amount of foreign direct investment in subsequent periods.

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Foreign investment was also encouraged in industrial projects involving advanced technology and heavy capital outlay like engineering, basic chemicals, petrochemicals, electronics, and other capital goods industries. In order to encourage foreign direct investment in export-oriented industries, an Export Processing Zone (EPZ) was set up in Karachi. Apart from foreign investors, overseas Pakistanis were also encouraged to invest in industrial projects in the EPZ. The concessions and facilities offered by the EPZ included duty-free imports and exports of goods and tax exemptions. Pakistan began to implement a more liberal foreign investment policy as part of its overall economic reform program toward the end of the 1980s. In the 1990s, to facilitate foreign investment no special registration was required for FDI, and the same rules and regulations were applied to FDI as to domestic investors. The requirement for government approval of foreign investment was removed, with the exception of a few industries such as arms and ammunition, security printing, currency and mint, high explosives, radioactive substances, and alcoholic beverages. In all industrial sectors other than those indicated above, not only foreign equity participation of up to 100% was allowed but also, foreign investors can purchase equity in existing industrial companies. A number of fiscal incentives such as a three-year tax holiday to all industries throughout Pakistan set up between 1 December 1990 and 30 June 1995. Investments in delineated rural areas, industrial zones, and less developed areas enjoyed five and eight years tax holiday respectively, together with special custom duty and sales tax concessions. The import policy was also liberalized considerably. There is a strong perception among foreign investors that the pro-business policies and inducement used to attract prospective new investors are somehow weak given realities when they actually begin to set up and operate their business in Pakistan. During 2000s, government based its investment policies on the principle of privatization, deregulation, fiscal incentives and liberal remittance of profits and capital. The policy was based on promoting investment in sophisticated, high-tech and export-oriented industries while almost the entire economic activity in other fields, encompassing agriculture, services, infrastructure, social sectors, etc. were thrown open for foreign investment with identical fiscal incentives and other facilities, including loan financing from local banks. A number of incentives were given by the government in the recent investment policies. This was indeed a welcome move but it is yet to be seen whether the investment interest having remained on the sidelines would at all show a positive response to the latest package of incentives. (Muhammad Zakaria)

Trends in Foreign Direct Investment The success of FDI policies can be judged by the size of the inflows of capital. Pakistan has been making efforts to attract FDI and such efforts have been intensified with the advent of deregulation, privatization, and liberalization policies initiated at the end of the 1980s. Page 18

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There were inflows of foreign investment in Pakistan during 1976-1997. The amount of foreign investment rose from a tiny $10.7 million in 1976/1977 to $1296 million in 1995/1996, thus growing at the annual compound growth rate of 25.7 percent. However, it declined to $950 million in 1996/1997. The increase here is mainly due to the liberalization policies. Foreign participation appears to be the major factor responsible for the increase in portfolio investment in the 1990s, due to the above mentioned incentives. The decline in international interest rates was also important in portfolio allocations toward Pakistani assets. With globalization, numerous international portfolio funds were created that were invested in emerging capital markets seeking for better returns. Pakistan was among the first countries in emerging markets to take measures to open up its stock markets to foreign investors. The amount of foreign investment rose from $ -8.4 million in 2001-02 to $8416 million in 200607. However, it declined to $2985 million in 2007-08. Foreign direct investment (FDI) including privatization proceeds finally touched US$3.531 billion in 2005-06, as reported by the State Bank. The FDIwithout privatization proceeds also showed a healthy figure close to $2 billion. The FDI landed mostly in telecommunication sector, which attracted the highest amount. The FDI without privatization remained at $1,980.7 million and large share of this amount went to the sectors like construction, food, Chemicals and trade Oil and gas exploration proved once again the attractive area for the FDI and total $312.7 million were invested in this sector Privatization of Karachi Electric Supply Company (KESC) made the power sector figures attractive by showing an inflow of $320.6 million as FDI during the whole year. It included the privatization proceeds of $255 million. Analysts said that the inflow of FDI without privatization was also encouraging and some new sectors like food, real estate and construction have developed attraction for foreign investment. US and UK have been the major sources of FDI in Pakistan, although the shares of both US and UK have fluctuated widely, falling as low as 8.8% for the US and 4.7% for the UK and rising as high as 63.7% and 35.2%, respectively. The share of the US has been, by far, the greatest. It may be noted that Japan, which has emerged as a major investor globally has annually invested very little in Pakistan. Factors Influencing the flow of FDI in Pakistan In a study by Ashfaque H. Khan and Yun-Hwan Kim, the major reasons were mentioned which were responsible for Pakistan being unable to attract adequate FDI, like its counterparts, Malaysia, China, Thailand and India have been able to attract. In view of these determinants, the fundamental requirement that governs foreign investment in Pakistan revolves around ten main factors. These are political stability; law and order; economic strength; government economic policies; government bureaucracy; local business environment; infrastructure; quality of labor force; quality of life; and welcoming attitude. Page 19

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In a more in-depth discussion, it has been found that Pakistan’s business strength includes:Abundant Land and Natural Resources Geo-strategic Location Trained Workforce Investment Policies Infrastructure and Legal Systems Financial Markets

Weaknesses Law and Order Political Stability Economic Strength Government Bureaucracy: Local Business Environment Transparency of Regulatory System Protection of Property Rights Infrastructure High Business Cost Labor Force Quality of Life Judicial System Welcoming Attitude Child Labor Tax Structure

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Recommendations4: Government of Pakistan should take the following steps on priority basis to enhance both domestic and foreign investment in the country:Law and Order: Satisfactory law and order situation is critical to attract investment in Pakistan. The country’s political leadership must take practical steps to improve law and order situation particularly in the major “growth poles” of the country including Karachi. Political Stability: Satisfactory political stability is also critical to attract investment. Macroeconomic Stability: Pakistan’s fiscal and balance of payment situations and foreign exchange reserves position is under considerable strain for some time making the macroeconomic environment less conducive for foreign investors. Some drastic and far reaching measures are needed to reduce the fiscal deficit on the one hand and to raise trade surplus and foreign exchange reserves on the other. Removal of Bureaucratic Hurdles: Although the investment approval requirement has been removed, numerous permits and clearances from different government agencies at national, regional, and local levels are still applied to investors, causing delays to complete the process. The authorities should streamline administrative procedures regarding approval and official clearances. The laws and regulations should be simplified, updated, modernized, and transparent, and their discretionary application must be discouraged. Fiscal Incentives: Fiscal incentives should be given liberally by the government to investors. Import of plant and machinery for new industries may be allowed duty free in case such machinery is not manufactured in Pakistan. Tax relief in the form of accelerated depreciation allowance may also be available to priority industries, besides the availability of similar relief to existing industries undertaking balancing, modernization and expansion in production facilities. Credit Facilities: Foreign firms operating in Pakistan are currently facing cash flow problems. That these firms cannot borrow more than their equity capital has further aggravated the cash flow problem. There is a need to review credit facilities given to investors. Labor Laws: Overprotective labor laws do not encourage productivity and frighten away much needed productive investment. There is a need to rationalize the labor laws and multiple levies on employment that inhibit business expansion and job creation. Infrastructure: In most infrastructure services, Pakistan is highly deficient as compared with many developing countries that have attracted higher levels of foreign investment. If Pakistan wants to catch up gradually with the development of the economies of East and Southeast Asia, it will have to investment more in the areas of education and physical infrastructure. Confidence-building Measure: The close relationship between private and public sector is essential to build confidence. It is suggested that a forum may be established where the private and public sectors could sit together to discuss business promotion-related issues. This kind of partnership between the government and private sector will help restore investor’s confidence. 4

These have been taken from an article by Ashfaque H. Khan and Yun-Hwan Kim, details in Reference Sheet.

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Identification of Potential Investors and Sectors: To promote investment government should identify potential countries. Government should move from traditional investors (USA, UK, Japan, Saudi Arabia, UAE, Libya, Lebanon) to new directions (China, Malaysia, Korea). Government should also identify new sectors for investment (mining and quarrying, tourism, construction, etc.) rather than focusing on traditional sectors (financial business, textiles, oil and gas, etc.) Improvement in Tax Structure: There is an urgent need to reduce the number of taxes and contributions, to streamline tax regulations and administrative procedures, and most importantly to reduce the contact of firms with a large number of tax and contributions collecting agencies. There is also a need to examine tariffs of plant and machinery with a view to substantially reducing them. Transfer of Technology: There should be no restriction on payment of royalty and/or technical service fees for the manufacturing sector. There should be Intellectual and Industrial Property Rights in conformity of WTO Agreements.

WORLD TRADE ORGANIZATION (WTO) The World Trade Organization (WTO) is the international organization dealing with the rules of trade between nations. It is the most powerful legislative and judicial body in the world. By promoting the "free trade" agenda of multinational corporations above the interests of local communities, working families, and the environment, the WTO has systematically undermined democracy around the world. Established in 1995, the World Trade Organization (WTO) is a powerful global commerce agency, which transformed the General Agreement on Tariffs and Trade (GATT) into an enforceable global commerce code. The WTO is one of the main mechanisms of corporate globalization. The WTO agreements are, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct their business. WTO rules can be enforced through sanctions. This gives the WTO more power than any other international body. The WTO's authority even eclipses national governments. Under the WTO's system of corporate-managed trade, economic efficiency, reflected in shortrun corporate profits, dominates other values. Decisions affecting the economy are to be confined to the private sector, while social and environmental costs are borne by the public.

CONCLUSION Pakistan has achieved macroeconomic stability, introduced structural reforms, improved economic governance and resumed the path for high growth rates. But there is no room for complacency as we are confronted with challenges of poverty reduction, employment generation, balanced regional growth, upgrading social indicators and containing inflation. Page 22

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The second generation reforms aimed at strengthening the country’s institutions and their capacity to deliver basic services along with the continuation of sound and consistent economic policy and investment in human development and infrastructure will be able to steer the country on the right course. There is a need to understand that “development is more of an integrated process, it's not just a list of projects”. (Dr. Kaiser Bengali)

Reference Sheet: • •

• • •

• • •

• • •

• • • • •

•

Article: Income Inequalities In Pakistan And A Strategy To Reduce Income Inequalities by A.R. Kemal Foreign Direct Investment In Pakistan: Policy Issues And Operational Implications by Ashfaque H. Khan and Yun-Hwan Kim, EDRC REPORT SERIES NO. 66 http://countrystudies.us/pakistan/47.htm foreign trade Education, Employment And Economic Development In Pakistan By Ishrat Husain1 Dr. Khushi M.Khan “Unemployment and the People’s Works Programme” http://www.springerlink.com/content/e23473415h246m35/ www.hec.gov.pk www.sbp.org.pk www.google.com MSN Encarta Articles by Dr. Kaiser Bengali www.wikipedia.com World Currency Yearbook. (WCY) IMF Annual Report on Exchange Arrangement and Exchange Restriction. (IMF) "2000 Country Reports on Economic Policy and Trade Practices: Pakistan", the Bureau of Economic and Business Affairs, U.S. Department of State, March 2001 (CR2000) "2001 Country Reports on Economic Policy and Trade Practices: Pakistan", the Bureau of Economic and Business Affairs, U.S. Department of State, February 2002 (CR2001) Forecasting Inflation in Developing Nations: The Case of Pakistan*by Muhammad Abdus Salam, Shazia Salam and Mete Feridun; International Research Journal of Finance and Economics; ISSN 1450-2887 Issue 3 (2006) The problem of deficit in balance of payments by Mohammad Ishaq Javed and Dr. Shaikh Muhammad Ashfaq

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Appendix LONG-TERM STRUCTURAL CHANGE AND GROWTH

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The table above has been taken from the site of State Bank of Pakistan. http://www.sbp.org.pk/about/speech/economic_management_policies/2005/Econom y_of_Pakistan_Expo_2005.pd

Glossary

Agriculture: The process of growing crops by cultivating large areas of soil.

Gini Coefficient: The Gini coefficient is a measure of statistical dispersion most prominently used as a measure of inequality of income distribution or inequality of wealth distribution.

Balance of Payments (BoP): a systematic record of all the economic transactions between residents of a country with the rest of the world during a given period of time.

Gross Domestic Product (GDP): The total value of a nation's output, income, or expenditure produced within a nation's physical borders within a year.

Exports: Goods and services that are produced domestically and sold to buyers in another country.

Gross National Product (GNP): A country's total output of goods and services from all forms of economic activity measured at market prices for a calendar year.

Foreign Direct Investment: Investment made by a foreign individual or company in productive capacity of another country.

Imports: Goods or service that are produced in another country and sold domestically. Page 25

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Industrialization: The development of industry on an extensive scale. Inflation: The general rise in prices across the economy over a year. Martial Law: The suspension of normal civil law and its replacement by strict military control. Often declared during times of civil unrest. Nationalization: The act of taking formerly private assets into public or state ownership Political unemployment: Political corruption is the use of governmental powers by government officials for illegitimate private gain Privatization: The transfer of a company or organization from government to private ownership and control Tax: a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state. Unemployment: It is the state in which a person is without work, available to work, and is currently seeking work.

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