Pakistan's Economic Dilemma
Sreedhar, Sr. Fellow, IDSA
Since the beginning of 1987 a spate of writings have started appearing in both, the Pakistani and the international press, presenting a gloomy picture about the future of Pakistan. Some academics have called it a failed state while some others say it is a failing state. Some other described it in much stronger terms like "anarchic state." And the forecasts for the future of Pakistan include disintegration into more than one state to outright authoritarian regime. Many well wishers of Pakistan in its immediate neighbourhood also feel that things are not going in the right direction in Islamabad.
The reasons for this extraordinary impression are many and varied. The developments in Pakistan can no longer be considered as part of an evolution of the nation state of Pakistan. For an outsider, this gloomy picture of Pakistan is largely due to its failure on the economic front. And Pakistan's problems stem from three factors. Foremost among them would be the existing feudal order in the country. The economic assets of the country, especially land, are unevenly distributed all around. The print media, often carries reports of leaders possessing 20,000 acres, a phenomenon one cannot imagine in any other country in South Asia. The second factor concerns Pakistan's devoting a large part of its expenditure to defence. The armed forces themselves having been rulers of Pakistan for 25 years in its fifty years of existence, and the civilian authority, as and when it is allowed to rule, having drawn its legitimacy from the armed forces, the former have acquired a profile far higher than they deserve. This has automatically resulted in total distortion in resource allocations for defence and development. The third reason for the problems of Pakistan relate to debt burden. Until the 1990s, Pakistan survived by borrowing from the international monetary system. But thereafter, due to the changes in the international system, free lunches suddenly disappeared, and Pakistan's economy started feeling the pinch. Pakistan is today enmeshed in one of the classical models of debt trap—how to repay the old loans and yet keep the economy going. In the international monetary system, Pakistan's credibility is quickly getting eroded and this by itself, has created problems for fresh borrowing. In this paper an attempt has been made to assess the performance of Pakistan's economy in these three areas since independence, with a focus on the last decade—1987-1997.
Pakistan's economy during the past fifty years can be described as a classic example of a case where artificial prosperity was maintained by heavy doses of foreign aid and overseas remittances of Pakistanis. Though during the initial years a section of Pakistan ruling elite did think in terms of building a self reliant economy, it remained only a concept. Easy and cheap availability of goods and services through foreign aid discouraged the development of a large scale indigenous industry. At another level, Pakistan failed to do even the basics of economic development which most of the developing countries have done. Some of the macro level economic indicators point towards this. For instance, in case of population, Pakistan experiences one of the highest population growth rates (around 3 per cent) among the developing countries. This has brought greater stress on the already fragile socio-economic structure.
As regards land reforms, as will be discussed later, there has been no meaningful progress. This has resulted in absentee landlordism and low productivity per hectare of arable land. For instance, according to Census of Agriculture 1990, in Punjab province only one per cent land owners posses 26 per cent of the total cultivable land which is 26.6 million acres. Few from this class can actually be defined as growers and tillers as they are all feudal lords employing landless farmers and keeping them as serfs.
In the matter of savings, the easy availability of foreign aid has made Pakistan a nation of spenders only. The domestic savings ratio to the GDP/GNP remained one of the lowest among the developing countries. During the years 1985-90, average share of domestic savings to GNP was as low as 10.4 per cent. This showed considerable amount of improvement in the next five years (1990-95) to 14.1 per cent. Even then it still remains low as compared to other South Asian countries and this automatically results in low capital formation.
Another consequence of this is a double digit inflation. As can be seen from the table below, the average annual rate of inflation for the years 1990-1991 to 1996-1997 was over 10 per cent. This considerably, eroded the value of Pakistani rupee. In fact, according to Mansoor Ahmed, a Pakistani commentator, Pakistan devalued its currency by 31 per cent from January 1995 to May 1997, as against 12 per cent, 8 per cent and 18 per cent by India, Bangladesh and Sri Lanka respectively.
Inflation Rate 1960-1997
Year Rate of Inflation
Percentage of Amount Spent on Social Sector in National Budget
Science and Research 0.30
Sports & Recreational Activities 0.05
Rural Development 0.04
Source: Mansoor Ahmed, "Budget Created by Ostriches," The News, June 22, 1997.
Low savings resulting in low capital formation have in turn, resulted in the absence of any meaningful industrialization even in core sectors like iron and steel, power and transport and communications. One can attribute this poor performance of the Pakistani economy to a number of factors. Pakistani ruling elite's one line agenda, 'that it has to do better than Indian Republic in the quickest possible time,' has made them adopt short cut methods. Pakistan made itself a party to the alliance system of Cold War politics of 1950s and 1960s. This enabled it to obtain liberal doses of military and economic aid. Instead of spending this aid in building the economy, it was squandered away by creating an artificial prosperity.
When the Cold War was coming to an end, the 1970s oil boom in the nearby manpower starved Persian Gulf enabled Pakistan to export manpower in large numbers. This overseas Pakistani remittances sustained the economy in 1970s. When the oil boom was petering out by the end of 1970s, the former Soviet Union's invasion of Afghanistan in December 1979 took place. Pakistan made full use of this extraordinary development and got actively involved in the Cold War politics. This enabled Pakistan to again obtain heavy doses of foreign aid. Though this aid was not as massive as it was in 1950s and 1960s, it did help Pakistan to keep going. However, with the Soviet Union's withdrawal from Afghanistan in 1989, suddenly the bubble burst and the distortions created by Afghan refugees further complicated an otherwise delicately poised economy.
Feudal Social Structure
Like all developing countries, since independence, agriculture has continued to be the mainstay of Pakistan's economy. More than 75 per cent of the population depends directly or indirectly on agriculture for their livelihood. According to the latest data available, the agriculture sector contributes around 60 per cent to the GNP of Pakistan.
However, the special feature of Pakistani agriculture is its feudal structure. According to a study published in 1997, there are about 49 million acres of cultivated lands in Pakistan. Out of it, nine percent is under small farms of less than five acres, 43 per cent under medium farms of 5 to 25 acres and another 43 per cent under big farms of over 25 acres. The landlords numbering 800,000 own 11 million acres.
While other developing countries, especially in South Asia, brought in land reforms immediately after independence and reduced the role of landed aristocracy in the overall governance of the State, the same has not happened in Pakistan for a number of reasons. Foremost among them would be that it was the Muslim aristocracy of Northern India who were getting marginalized in the colonial period of the Indian subcontinent, who in reality whipped the slogan of a separate homeland for the Muslims. They found in Qaidi-i-Azam Mohammad Ali Jinnah, a person who could articulate their cause. Within months of the birth of Pakistan, the Quaidi-i-Azam realised how he was made use of by this class and accepted his mistake in creating Pakistan.2
That is a different story. Even after 50 years of independence, the feudal landlords, continue to maintain their stranglehold on the nation state of Pakistan. According to Abul Fazal, the agrarian system that Pakistan inherited upon independence was one suspended between stable dependent agrarian relations, which no longer had a legal basis though, and an aborted capitalist relationship between the peasant and the landlords. "We did not face a crisis because firstly, lands in Punjab and Sindh were still relatively freshly reclaimed, yielding good harvests, and secondly, the Hindu moneylenders having left, the drain on the indebted landlords revenues on account of repayment of loans had ended. The contradiction between the defacto dependence of the peasant on the landlord and his dejure independence is manifested in the fact that although the lands were growing cash crops for the world market and were entirely a part of the commodity exchange, the landlord's relationship with the peasant continued to be pro-capitalist. It was still characterized by super exploitation, actual insecurity of tenure and lawlessness. This double aspect of the landlord class in Pakistan—a commodity relationship with the world market and a coercive relationship with the peasant—appears to have imparted a stability to the formation, especially in Sindh and Southern Punjab. The reason was a lack of industry which could mechanize agriculture and absorb the surplus labour power enabling the peasants to escape the situation of dependence."3
Fazal goes on to add that this landlord class never allowed any land reforms which could alter the social equilibrium to any significant extent during the entire 50 years of independence. The two attempts to implement land reforms in 1959 and 1972 were more cosmetic than anything substantial. It was only during Z.A. Bhutto's tenure (1972-77), that the feudal landlords struck at the nascent industrial bourgeoisie by nationalization of industries.4
This extraordinary situation resulted in three aberrations in Pakistan polity. First, with a majority of the population living in villages, they were dependent on the landlord for their survival. In a way, they were at the mercy of the landlord to undertake any meaningful economic activity. Secondly, this resulted in a complete economic hold of the landlord class over the masses. It enabled them to get people of their choice elected to the National Assembly and Provincial Assemblies. According to one commentator, because of the complete economic hold of the Zamindars over their riaya only the nominees of the landlords were returned to the Assemblies. Lastly, because of their timely participation in the Pakistani movement and the leadership role thrust on them by the absence of adequate Muslim presence in other fields of economic endeavour, it was the landed aristocracy that grabbed the sinews of state power at an early stage. And they have succeeded since then to block any measure designed to extend social justice.
This also resulted in the slow and systematic elimination of middle class. The rich became richer and poor became poorer. While this type of social transformation was taking place, the landlord, in an attempt to protect his interests, started building up the state machinery in the name of enforcing law and order and the armed forces in the name of threat to territorial integrity from India.5
As has been mentioned earlier, prosperity on the agricultural front in the initial years and the liberal doses of economic aid from the West due to Cold War politics enabled the ruling elite to present a picture of economic prosperity to the rest of the world. By an accident of history and geography, the Pakistani neighborhood, Afghanistan, Iran, China and some parts of the Soviet Republic were doing much worse in terms of economic development and social justice, as compared to Pakistan in 1950-1970. This led to a false sense of satisfaction even among the people of Pakistan.
The defeat of the Pakistan army in the war of December 1971 with India and the disintegration of the country into two did give a jolt to the Pakistan psyche, but it proved to be short lived. Subsequently, the end of the Cold War in the international order might have denied aid from the West, but the oil boom of the Persian Gulf more than compensated Pakistan in terms of resource availability. In fact, the overseas remittances of Pakistan touched an all time high of $3-4 billion per annum and economy looked prosperous with conspicuous consumption becoming rampant.
The feudal class had their nominee, Z.A. Bhutto replacing army in political power. When Bhutto overstepped his limits and was thinking in terms of restructuring the Pakistan polity with his second land reforms programme, he was removed from power and the armed forces were reinstalled. The next decade saw military at the helm of affairs and its quest to legitimize its rule. In the process, all types of compromises were made with the social structure and the economy. The end result of this spell of military rule was the process of economic development becoming a low priority and the feudal structure being allowed to remain intact. The return of democracy in 1987 has not altered the situation in any significant way. In fact, the armed forces continue to remain at the helm of affairs and protect the interests of the feudal class.6
In the chequered history of Pakistan, by a series of accidents, the armed forces acquired predominant position in the Pakistan polity. This is not an extraordinary development per se. Similar developments have occurred in many other developing countries, on the pretext that power flows from the barrel of a gun. Like the armed forces of any other country, those in Pakistan too are unidimensional in their overall approach to nation building. They have lacked the vision and perception of what constitutes nation building. This is understandable because of their long years of training that has conditioned them to fight the adversary only.
Therefore, this unidimensional approach of Pakistani armed forces for the governance of the state, resulted in skewed priorities, with defence expenditure becoming priority number one. As usual, rationalizations for this type of expenditure were offered on account of a threat from India. In this process, though, Pakistan's socio-economic structure was messed up. With even the civilian governments, as and when they acquired power (except for Z.A. Bhutto years), having to look to the armed forces for legitimacy and to remain in power, there was no check on this aspect of the budget. The best example one can cite in this context is the present Prime Minister of Pakistan, Nawaz Sharif, who immediately after assuming office in Feb. 1997 made a 'courtesy' call on the Chief of the Army Staff.
As a result, the incidence of defence expenditure on Pakistani economy became one of the highest in this part of the world. As can be seen from Charts I and II at the end of the article, during the decade 1987-1997, except for two years, 1990-1991 and 1991-92, defence expenditure always exceeded developmental expenditure.7 In fact, during the years 1987-92, with the return of democracy to Pakistan, an effort was made by the elected governments to bring some semblance between the two. Both Benazir Bhutto and Nawaz Sharif during their first terms as Prime Ministers tried to keep a parity between the developmental and defence expenditures. But both paid a heavy price by getting removed from their power in extraordinary circumstances. And in both cases, the role of armed forces in unseating the elected government is well known. This has exposed the vulnerabilities of the elected governments who have tended to stay away from bringing any discipline on defence expenditure.
By the end of 1980s a stage had been reached in Pakistan budget where any developmental work needed to be done with borrowed funds. The situation had become worse by the turn of the decade with the aid inflow becoming necessary to repay the instalments of old debts. To put it differently, the net aid available for development started getting lesser and lesser. With other macro economic parameters already in disarray, the economy started experiencing hyperinflation.
There is near unanimity among Pakistan's economists and their well wishers from outside that its economy has been mismanaged since its independence in 1947. The little development that took place in 1950s and 1960s was accidental and not due to governmental policies. In addition, the absence of institutional frameworks for the governance of the state to channelize the aspirations of people has resulted in a chaotic situation. In normal circumstances, the people only would have suffered. As has been mentioned earlier the money that flowed into the Pakistani economy was largely borrowed from both external and internal sources. The money so borrowed was not used for any productive purposes. This automatically resulted not in the creation of any economic assets which could repay the loans. The borrowed money kept an artificial prosperity in the beginning, but as the years passed, Pakistan got caught in the classical 'debt trap' scenario feared by most of the developmental economists.
According to Aftab Ahmad Khan, a Pakistani commentator, the country's total public debt burden was estimated to be around Rs (P) 1.02 trillion by the end of June 1997. This includes $2 billion added by the caretaker government who managed the country between November 1996 to February 13, 1997 who contracted a rolling debt at high interest rate of 17 to 22 per cent. In addition, there is a short term debt of $10 billion borrowed with interest liability of 7.5 per cent. As a percentage of Gross Domestic Product, Pakistan's total public debt would be around 90 per cent.8
Internal Debt of Pakistan, 1987-97
Years Permanent Floating Unfunded Total Debt as % of Debt Debt Debt GDP
1987-88 63,791 127,524 98782 290,097 43.4
1988-89 78,827 135,238 119,245 333,210 43.3
1989-90 98,703 144,978 137,630 381,211 44.5
1990-91 157,012 150,929 140,220 448,162 43.9
1991-92 185,070 197,252 142,754 525,076 43.3
1992-93 245,470 215,820 150,236 611,526 45.6
1993-94 264,173 257,638 189,216 711,027 45.4
1994-95 290,133 294,232 223,315 807,680 42.9
1995-96 291,270 361,298 265,952 918,520 42.3
1996-97 305,525 384,298 308,211 1,000,03 39.9
Source: Government of Pakistan, 1996-97 Economic Survey, (Islamabad, 1997), p.129.
Gross Disbursement and Net Aid Transfers
Year Gross Debt Net Net
Disbur- service Transfers Transfers as
sement Payments** % of Gross
1970-71 612 182 430 70
1971-72 409 122 287 70
1972-73 355 193 162 46
1973-74 498 197 301 60
1974-75 1,019 259 760 75
1975-76 1,064 288 776 73
1976-77 961 355 606 63
1977-78 856 374 482 56
1978-79 948 494 454 48
1979-80 1,077 656 421 38
1980-81 861 675 186 21
1981-82 809 632 177 22
1982-83 1,123 800 323 29
1983-84 1,021 892 129 13
1984-85 1,107 959 148 13
1985-86 1,393 1,059 334 4
1986-87 1,268 1,223 45 3
1987-88 1,660 1,228 432 26
1988-89 23,400 1,237 1,103 47
1989-90 19,850 1,331 654 33
1990-91 2,044 1,316 728 30
1991-92 2,366 1,513 853 36
1992-93 2,437 1,648 789 32
1993-94 2,530 1,748 784 31
1994-95 2,571 2,042 529 21
1995-96 2,555 2,136 491 16
1996-97 (E) 2,351 2,309 42 2
Note: Relief assistance for Afghan refugees, commercial credits for PIA and short term credits have been excluded from the Gross Disbursement. **Excluding interest on short term borrowing and IMF charges. E: estimated.
Sources: Government of Pakistan, 1996-97, Economic Survey (Islamabad, 1997), p.88; Aftab Ahmad Khan, "Massive Growth in Public Debt: Implications for the Economy," The News, July 28, 1997.
As on June 30, 1997, the total outstanding internal debt amounted to Rs. 1,000.34 billion. The trend in domestic indebtedness of the Federal government is depicted in Table III. The rapid accumulation of domestic debt has resulted in mounting interest payments, which have escalated from Rs. 3.4 billion in 1980-81 to Rs. 153.9 billion in 1997-98 (budget estimates).9
Debt servicing is the single largest item of expenditure in the federal budget. In the current year's budget (1997-98), it is estimated at Rs. 247.86 billion, which amounts to around 54 per cent of current expenditure and 78 per cent of the total tax revenue.10
Growing interest payments have created new pressures for future borrowing and reduced the government's flexibility in future spending. They have curtailed high priority development and welfare expenditures. Large levels of government borrowing in the public sector has also crowded out private investment.
Another disturbing aspect of Pakistan's domestic debt profile is the amount of interest paid on domestic debt. During 1996-97, it constituted 142 per cent of the net increase in domestic debt as compared to around 26 per cent in 1985-86. This clearly indicates the dangerous pace at which Pakistan is heading towards a situation of debt trap i.e. when increased borrowing is not sufficient to pay even return of earlier domestic debt.
Fiscal and monetary policies are inextricably linked with debt management. The sequence of fiscal-monetary nexus in Pakistan is detailed below. The authorities have generally sought to finance the budgetary deficit at a low rate and the rate of interest in respect of government securities was kept well below the market rate on loans of comparable maturity. As the process gathered momentum, the market borrowing of the government increased. These large borrowings were undertaken through captive investors at lower and lower real rates of interest.12 As the borrowing requirement exceeded available resources for investment in government securities, there was increased monetization of the fiscal deficit. The authorities then endeavoured to take the rearguard action of increasing liquidity ratio and prescribing a credit-deposit ratio which resulted in an erosion of the profitability of captive institutions (largely banks).
The captive institutions became uncompetitive vis-a-vis other non-bank financial intermediaries and in an attempt to shore up the profitability of banks and under IMF pressure, interest rates on government securities were raised to reflect market realities.
The limits of borrowing were quickly reached and it became quite obvious that unless there was a real adjustment of the fiscal deficit to sustainable levels, the system would explode as the fiscal authorities would be caught in a vicious circle of offering higher and higher rates of return which would raise the cost of borrowing to unacceptable levels.13 Increasing the monetized deficit in this difficult situation could unleash a growth of primary liquidity with consequential acceleration in inflation. It, thus, became crystal clear that an unsustainable deficit was bound to have a destabilishing impact on the economy.
In Pakistan's case, the International Monetary Fund (IMF) feels that a fiscal deficit in excess of 5 per cent of GDP could have adverse macro-economic consequences including an inordinate increase in public debt as well with the persistence of uncomfortable inflationary pressure. In the current fiscal year (1997-98), however, the official target is to reduce the consolidated fiscal deficit to 5 per cent of GDP as compared with about 6.2 per cent in 1996-97.
As in the case of domestic debt, external debt and its servicing have shown a rising trend in recent years. Unfortunately, external debt management in Pakistan has not been characterized by a careful determination of sustainable amount of borrowing in an integrated macro-economic framework. Foreign debt has been used to close the savings-investment gap and foreign exchange gap. For instance, in the fiscal year 1996-97, gross investment outlays were estimated at Rs. 455.5 billion or 18.4 per cent of GNP. National saving financed 61.8 per cent of gross investment while the balance 38.2 per cent was financed by foreign savings.14 The availability of foreign exchange has also been inadequate as indicated by the deficit in the current account of the balance of payment which in 1995-96 around $4.5 billion.
Financing of large current account deficits has saddled the country with a huge burden of external debt and its servicing. The total disbursed and outstanding external debt of Pakistan (including short, medium and long term debt and foreign private unguaranteed credits) at the end of June 1997 amounted to $29.6 billion indicating an increase of 2.7 per cent over the previous year 1995-96. It constituted 47.9 per cent of GDP, as against 46.6 per cent in 1995-96.15
With an increase in the absolute amount of medium and long term debt and frequent recourse to short term loans, external debt servicing has almost doubled in five years from $2,380 million in 1990-91 it went upto $4,336 million in 1995-96.16 A disturbing feature of the country's external debt profile is steady increase in the proportion of short and medium term debt from 10.5 per cent in 1990-91 to 19.3 per cent in 1995-96.17
With the passage of time, concessional external financing showed a declining trend and it is increasingly being substituted by successive government's by short term loans. With respect to long term loans, net transfers as a percentage of gross disbursements have declined significantly from 30 percent to 1990-91 to 2 percent in 1996-97.
In absolute terms, Pakistan's foreign debt may not look large, but in relation to some key indicators like Gross Domestic Product, export earnings or total foreign exchange earnings, it assumes increasingly unmanageable proportions. Even excluding interest on short term borrowing and IMF charges, Pakistan's annual debt servicing has escalated from $1.3 billion in 1990-91 to $2.1 billion in 1995-96. Of this interest payment alone now amounts to $745 million.
According to one commentator, on the whole, the net transfer of credits as percentage of gross disbursements is as low as 2 per cent in 1994-95, as compared to nearly 90 per cent 3 decades back, 70 per cent two decades earlier and 30 per cent fifteen years ago. Another official projection reveals that transfer of concessional credits in 1995-96, was hardly $388 million close to the absolute figure of $325 million more than thirty years ago when that amount could buy goods and services many times more. All this has stemmed from the fact that repayments in the form of interest and principal instalment have moved from $17 million in 1960-61 to $2,100 million in 1995-96.
Pakistan's debt trap has been very effectively explained by Dr. Farukh Saleem in an interesting article in the News. According to Dr. Saleem, today Pakistan is trapped in a vicious debt trap whereby it needs to borrow more than Rs. 60 crore (600 million) every single day of the calendar year to survive. That translates into an additional debt of Rs. 5 crore (50 million) every working hour of the day, Rs. 8 lakhs (800,00) every minute or close Rs. 15,000 every second.18
From the above analysis, two things become obvious. First, if corrective measures are not taken Pakistan is virtually in a debt trap of the classical model. The closest one can think of is the experience of Mexico. But Mexico is endowed with abundant hydrocarbon reserves, which the developed world continuously need for their energy requirements. Hence the US was willing to bail it out quickly.19
Unfortunately, Pakistan is not endowed with any strategic natural resources and the ruling elite is unwilling to acknowledge this fact. In the process, during its 50 years of independence, Pakistan has became a nation of spendthrifts. And after 50 years of independence, the elite is still not willing to tighten their belts to make the economy self reliant.
Secondly, with international capital getting scarce with almost every passing day, Pakistan may find it exceedingly difficult to attract more capital or economic aid at liberal terms in the coming years. With people's aspirations rising higher and the ruling elite not making a concerted effort to meet them, Pakistan's economic picture looks gloomy. Anything can happen at any time to the country. Atleast, that is the picture it presents in its 50th year of independence.
1. For the section on feudal strucutre in Pakistan, I largely depended on a two part article by M. Abdul Fazl, "Feudalism," The Nation, June 10 & 11, June 1997. Also see Ishtiaq Ahmed's two part article "Feudalism in Pakistan," The Nation, May 22-23, 1997.
6. Ibid. Also see, Rasheed Rahman, "Ayub and Bhuttos Land Reforms," The Nation, September 9, 1997.
7. Here I took the entire developmental expenditure of both Federal and provincial governments into consideration for comparison with the defence expenditure because provincial governments in Pakistan do play a significant role in developmental process.
8. Aftab Ahmed Khan, 'Massive growth in Public Debt', The News, July 28, 1997. Also see, Shahid Kandar, 'Can We Repay Our debt?" The Nation, December 21, 1997.
10. Ibid., Also see Farooq Saleem 'Pakistan Under a Mountain of Debt', The News, March 16, 1997.
16. Ibid. Also see 1996-97 Economic Survey.
18. Farooq Saleem. n. 10.
19. A report in Khaleej Times says that the International Monetary Fund advised Pakistan to cut its defence expenditure immediately and divert the funds to developmental expenditure. The IMF also made it clear that it was not willing to bail out Pakistan like it did for the ASEAN countries. See Khaleej Times, February 14, 1998.