Pakistan’s Economy: Fighting More than One War

Dr. Mushtaq A. Khan has been the Chief Economic Advisor of Pakistan’s central bank, the State Bank of Pakistan (SBP), since 2009, with an earlier stint at SBP during 2000-2002. He has also served as the Chief Economist at ABN-AMRO Bank, Pakistan; Country Strategist of Citibank, UAE and Pakistan; Cluster Economist (Middle East & North Africa) for Citigroup, London; and as a consultant to the World Bank and Asian Development Bank. Dr. Khan has a PhD in Economics from Stanford University and a BA from Vassar College. He was the Woodrow Wilson Pakistan Scholar for 2005-2006 in Washington DC. 

What are your reflections on the economic consequences of the war on terror? On the one hand, substantial human and economic costs have been borne due to collateral damage, particularly suicide bombings in major cities. But on the other hand, considerable foreign aid and payments (like the Coalition Support Fund) are also tied to involvement in the war. How do you think the overall economy was affected?

Given the multidimensional impact on the economy, it is very difficult to quantify the damage to the economy, but I can tell you the impact has been profoundly negative. We just hope this War on Terror ends soon – it’s been 12 years.

One thing must be made very clear. Pakistan is not being compensated in any way for the tremendous damage its economy has faced, and is still facing, because of the war in Afghanistan. Coalition Support Fund coming from NATO countries is only reimbursements for logistical services that the Pakistan Army has already provided. Terrorist bombings and the infiltration of militants into the country have made some parts of the country inaccessible, while the resulting lawlessness has encouraged some domestic political groups to rely on kidnapping and extortion to further their aims.  Businesses are considering relocating outside the country and business families are moving abroad. In this environment, fixed investment and expansion plans are held up. Capital that would otherwise be re-invested in Pakistan is kept abroad; professionals are considering emigration.

In your opinion, what is the one key challenge Pakistan’s economy faces today? 

Energy has now come to dominate policymaking circles, even though the inability to generate adequate tax revenues remains a persistent problem. Inadequate supply and growing demand has forced the government to allocate gas and power without a game plan to resolve the underlying problem. Some end-user tariffs are too low, which encourages overconsumption. Inadequate exploration and production of natural gas means domestic production remains stagnant, and bill recovery from some users is very low. These are manifestations of the poorly managed public sector enterprises (PSEs) that dominate the distribution of gas and power, and power generation in Pakistan. A passive energy policy dating back a decade has put the country into this position.

The central bank enhanced its focus on energy sector issues in recent years. Indeed, the SBP has been accredited with producing very high quality analysis on Pakistan’s power sector. What motivated your commitment to this research?

As I said earlier, energy now tops the list because it impacts almost all sectors of the economy. For instance, inflation fell during 2013 because administered prices – like energy – did not increase, and in the case of gas, tariffs were actually lowered (this is now being reversed). Secondly, the federal government faced huge fiscal deficits in the past three years because of delayed subsidy payments to the power sector (linked to the fact that user tariffs did not increase as they should have). Thirdly, commercial banks’ lending to energy-related PSEs, to fill the gap because of delayed subsidy payments from the government, further squeezed out the private sector. Moreover, a lack of sufficient energy has hit the manufacturing sector and export industries, and inadequate domestic natural gas has forced the power sector to rely on imported furnace oil, which increased the country’s external deficit. The list goes on.

In my view, orthodox neoclassical economics pays little attention to energy as a key factor of production, or as the root cause for stubborn fiscal problems. Perhaps this explains why energy challenges have not been adequately addressed.

What is needed for a long-term resolution of problems in the energy sector?

A holistic approach. At present, there are two federal government ministries that handle energy – one, the Ministry of Water and Power that focuses on power generation and distribution, and the Ministry of Petroleum and Natural Resources, which oversees exploration activities, oil and gas distributors, and how much oil needs to be imported.  We need to reconsider our priority of users of power and gas, rationalize tariffs to enhance the effectiveness of energy use, restructure and privatize generation and distribution PSEs, incentivize gas exploration to increase domestic production, and not open up more demand for energy. We need to focus on the economics and not just short-term political considerations.

The SBP adopted a rather unusual policy stance in 2012 when it essentially shocked the markets by a 150 basis point reduction in the discount rate, followed by another 100 basis point cut in the following months. What motivated this policy, and did it achieve the intended outcome?

Yes, these cuts surprised the market, but you have to understand the context for these decisions. One, banks were not lending much to the private sector, and two, they were quite happy placing most of their available funds into government T-bills.

Internal research showed that the government was behaving as a rate insensitive dominant borrower. Higher interest rates do not discourage government spending financed by borrowing. We sensed that banks would only be incentivized to lend to the private sector if their revenues from lending to the government would be brought down. Although banks did pause and started reengaging with the private sector, the IMF program the government entered into in mid-2013 was not consistent with this policy direction. So yes, our monetary policy stance did not achieve the results we were hoping for.

The “New Growth Framework”, laid out by the Planning Commission in 2012, envisioned private sector-led growth, with a smaller role of government. Given the influence that government has in Pakistan’s economy, how important do you think expansionary fiscal policy is for growth? Do you believe that the private sector is ready to drive growth on its own? 

Over the past few decades, it would be more accurate to talk about fiscal slippages than an intentional expansionary fiscal policy. Furthermore, it would be unrealistic and a little naïve to categorically state that the government’s role in the economy must be minimized.

The government has to take tough decisions about restructuring PSEs: dealing with overstaffing and pricing of products and services. It needs to actively create a conducive environment for the private sector, and to manage the poor law and order situation emanating from the war in Afghanistan. It must also pursue an active fiscal policy to focus on human resource development (health, education, and training). The government must also look into strategic partnerships with neighboring countries to create opportunities that the private sector can avail. Lastly, the government must not shy away from guiding the private sector, as successful examples in South East Asia (and China) have shown.

Feature photo: cc/(Ejaz Asi)