Global Economic

Policy Institute

Pakistan; Challenges in Political-Economic

DevelopmentICEA Feb 13th 2007

Professor Paul E M Reynolds

LONDON

Tel + 44 20 874 86788

Mob & SMS + 44 7974 188087

E mails

paulreynolds@email.com

paulemreynolds@gmail.com

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Pakistan, showing NWFP, FATA & Northern Areas

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Why is Pakistan important ?

• Strategic geo-political & transport bridge Mid-East and India & China• 165-170m pop – More people in Pakistan than in Russia• Potential for Kashmir flare-up – risk of big impact on world growth• Border region with Afghanistan

- Cross border raids, and question of Tribal Areas and Pashtun nationalism ?- Relationship with NATO/US military activity

• Role in ‘War on Terror’ and Deobandi ideology (‘Talibs’ = ‘Students’)• Many internal factors that create risks of political instability• Nuclear armed state – and advanced delivery systems• Borders with Iran, Afghanistan, India, China, close Gulf States, C Asia• Important Diaspora – especially in the UK (and UK troops on its border !)

• URGENCY: Presidential & National Assembly Elections Oct 2007 – unclear how political events will pan out

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Pakistan; Challenges in Political-Economic Development

Macro, micro & political conclusions.

Needing to ‘break out of gridlock’, government is in a difficult position

1. Macroeconomic improvements good - but slow reforms in government, in regulation and within the ‘real economy’ retard investment & growth rates, hinder exports and undermine fiscal/structural sustainability of growth

2. Flow of FDI inflows now under threat, diaspora remittances up, but insufficient ‘real economy’ investment opportunities as final destination – consumer imports sucked in, savings rates low

3. Full-speed reforms across government needed, but gridlocked due to political uncertainty - helps the ‘reform resistance’ & ‘project silos’. Key decentralisation suffers from ‘unintended consequences’….

4. BUT….political reform gridlocked by constitutional-political structures and the President’s need to please too many masters

5. Role of Tribal border (Afghan) areas and relationship with ‘The West’ is critical for political and economic reform

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Economic performanceEconomy stabilised & growth path

establishedWB/IMF

1990s

2001/2

2002/3

2003/4

2004/5

2005/6

2006/7

GDP growth

4% 3.1% 4.7% 7.5% 8.6% 6.6% 6.5%est7% tgt

Inflation(Av.)

9.7% 2.5% 3.1% 4.6% 9.3% 7.9% 6.5%?

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Fragility of economic progress

• Public debt declined from 97% of GDP annual average 1990s - to 75.3% by 2002-3 & 56% 2005-6

• Annual fiscal deficits fell from an average (excl grants) of 6.4% of GDP, last 5 years of last decade, to 4.4% first 5 years of this decade (3.7% 2006-7 est.)

• Average trade policy tariffs at ‘normal LDC’ levels after WTO memb. in 2001

• BUT………………BUT…………..• Industry still less than 20% of GDP• 2005/06 investment at 16.5% of GDP - too low for sustainable

growth (World Bank - 27%+ required)• Growing current account deficit - driven by a widening trade gap

as import growth outstrips export expansion - from 1.4% of GDP to 4% of GDP in 2005/6 – putting pressure on FX reserves

• IMF says (2007) need to align demand & output growth (Privatisation-related FDI and internal borrowing one-offs) – But GoP points to import price-hikes as one-off (To be continued…..)

• IMF ‘imperative’ - Higher savings and poverty reduction• IMF REMEDIES. Improve the investment climate, financial market

reform, tax reform, improvements in public service delivery, and trade liberalization

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Economic growth contextTrade & fiscal imbalances reduced…

but…

• Yr. to 2006 FDI up to $3.5bn (1/2 from telecoms). Investment from Gulf states.

• Remittances $4.2bn in 2005/6 - biggest ever• Banking & electricity distribution privatisation ‘successful’• ‘Poverty fell 10% 2001 – 2006’ (WB)• Cost of borrowing relatively low…..good GCC demand for Pakistani Govt

paper• BUT………………………………………………• But…. trade deficit $10bn and growing• FDI effects of privatisation slowing• Big increase in MTDB, up 52% 2006/7 despite quality-of-investment

problems• Low national saving’s rate, 17 percent of GDP, due to fiscal deficits and

negative interest rates • 4% of GDP spent on the military, possibly much higher, pressure on deficit• Only 28% of population is in the ‘workforce’, 32% of pop below poverty line• 1m Afghan refugees + ‘Trouble in Tribal Areas’

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Real-economy problems requiring political will to

challenge the interests of the bureaucracy & ‘crony capital’ across federal, provincial, &

local government• Institutional complexity and bureaucratic turf problems

• Legislation, regulation, ‘overenthusiastic regulation’ – some resistance to reforms

• Govt. ‘Project culture’, weak systemic reform focus (‘policy silos’)

• EXAMPLE 1. Contract enforcement

• EXAMPLE 2. Admin barriers and ‘cost of doing business’

• Result – domestic investment opportunities, & ‘bottom up’ domestic growth, both dampened = inflationary pressure, monetary growth, import growth, pressure on FX reserves ?

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Institutions responsible have overlaps & gaps in reform

‘Diagnosticitis, policy silos & analysis-paralysis ?’New institutions to solve this

problem ?• Cabinet Division (3 Depts)• Economic Council• Office of the Economic Adviser• Ministry of Law & Justice• National Comm. for Govt.

Reforms• Civil Service Reform Unit• Law & Justice Commission• PM’s Secretariat• Ministry of IT• Ministry of Parliamentary Affairs• Competitiveness Support Fund• 4 Provinces, FATA, PATA• Trade Corridor Committee• Office of Private Public

Partnerships• Federal Ministry of Tribal Areas• Ministry of Inter-Provincial

Coop.

• Ministry of Finance & Planning• Ministry of Industry, Prod’n &

SI• Board of Investment• Ministry of Commerce• Ministry of Econ. Affairs (EAD)• Monopoly Control Authority• Housing & Works Div.• Securities & Exchange

Commission• Planning Commission, 4

members• National Reconstruction

Bureau• Economic Coordination

Committee• Public Sector Reform

Committee

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Wrong micro-economic reform tools ?

‘Government spending versus government efforts’

Huge political will required to overcome deep-rooted systemic problems & interests – does political

uncertainty prevent this ?

• Financial deepening reforms (NSS, Pakistani Investment Bonds) and reforms of intermediation system (Badla) underway - will make better use of remittances & other funds, and tax admin reform has increased receipts……………

……but these are not the core problems…..

• Credit expansion is a risk, and linked to remittances• Political limitations prevent expansion of the tax base• Too much reliance on more costly but less effective growth

stimulation methods

• …..Eg building business parks & giving tax breaks, rather than…- reform of regulations that inhibit capital goods imports- tackling ‘overenthusiastic interpretation of regulations’

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Pakistan (example): Steps/time and cost of

contract enforcement (Source World Bank 2006)

Figure 3.4a Steps and Time to Enforce a Contract

0

10

20

30

40

50

Sri

Lan

ka

Tu

rkey

Ch

ina

Ph

ilip

pin

es

Th

ailan

d

Nep

al

Ban

gla

desh

So

uth

Asia

Mala

ysia

Vie

tnam

Ind

ia

Pakis

tan 0

100

200

300

400

500No Steps Time

Figure 3.4bCost to Enforce a Contract

(% of contract value)

0

10

20

30

40

50

60

Tu

rkey

Th

ailan

d

Mala

ysia

Ban

gla

desh

Sri

Lan

ka

Ch

ina

Nep

al

Vie

tnam

Pakis

tan

So

uth

Asia

Ind

ia

Ph

ilip

pin

es

• Case backlog - half are commercial - in the High Courts of Sindh and the Punjab number over a hundred thousand, and for the lower courts, in the millions - 40% land, 30% challenges to regulations, rest banking/employment

• When cases do go forward, it takes, on average, more than 46 steps, more than a year and almost a third of the contract value to enforce a contract

• System is ill-prepared for modernisation - new legal frameworks in complex areas such as foreign investment, insolvency, monopoly regulation, anti-money laundering, insider trading, and corporate governance

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Real-world problems in economic development

dampen investmentWB value-chain study of key sectors

shows major structural, institutional & regulatory problems:

Shrimps, textiles, marble, processed dairy, auto parts

• High transport costs, high electricity costs (outages) limiting automation, labour market rigidities (temp workers used), access to finance (collateral & informational), imports costs (multiple permissions required etc), cash flow from duty drawback & custom rebate delays, high port charges, state control of input sectors, freight sector over-regulated, opaque land leasing & security of tenure - & resultant low capacity utilisation

• Fees and taxes collected by the Government represent a quarter of export costs and come from three sources: the petrol tax (1 percent of export invoice), Export Development Fund (0.25 percent of export invoice), and unofficial, speed money payments (approximately Rs 1,250 per consignment). [Poor port governance contributes].

• Layers of taxes & levies to agents, the PAs, and ‘security payments’ add to costs. High tarrifs in many sectors.

• Pakistan’s aggregate direct labor cost $0.75 /hour - higher than China’s $0.66 and India’s $0.40 – but productivity lower.

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Resistance to pro-growth regulatory

reforms ?

• 2004/5 World Bank project on regulatory reform ’Impact has been minimal’

• 2005 Better business regulations IFC. Admin barriers report not published.

• 2006 IFC/World Bank business regulations, pending…

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Future economic reform challenges

• Regulatory quality and the link to rent-seeking• Poor domestic export performance relative to expectations, and the lack of

investment to overcome high costs • Capital infrastructure problems – access to debt & equity finance for export

development, and absence of venture capital & ‘real sector’ investment funds• Low ‘growth productivity’ in the use of inward financing from remittances and

capital repatriation• This challenge combined with industrial and labour rigidities/monopolistic

markets = ‘not enough productive places to put the money’• How to apply telecom sector’s success in attracting investment to other

‘regulatory-dependent’ sectors like electricity, water, transport and hydrocarbons.

• How to address investment and economic growth inhibitors (How to support the Ministry of Law & Justice in tidying up of existing legislation and regulations)

• Addressing urgent need to tackle problems created by the separate MTBF and MTDF, (eg poor use of assets, lower investment)

• How to address the negative impact on domestic investment and growth arising from the domestic financing of the budget deficit.

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Fiscal decentralisation issues

Pakistan is highly centralised fiscally

Growth & political reform requires change

Reforms started in 2001 but within existing structures

• Sub-national governments in Pakistan - very low sub-national tax collection rates by international comparisons

• Only 0.9 percent in GDP of revenues in 2005/6. India’s - 6.1 percent, or 7 percent based on more recent figures (World Bank 2005:xxvii)

• Provinces in Pakistan are highly dependent on federal shared revenues and grants – complex system.

• All provinces receive identical per capita levels of divisible pool allocations

• All provinces are characterized by low own revenue mobilization, although some differences are evident across provinces.

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Fiscal Decentralization in Major Developing Country Federations

•Federation, Developing Country •Sub-National Expenditures (% Total)

•Sub-National Expenditures (% GDP)

•Sub-National Own Revenues (% Total National Revenues)

•Sub-National Own Revenues (% GDP)

•(I) •(II) •(III) •(IV)

•Pakistan* •34.2 •6.3 •7.0 •0.9

•India •49.2 •10.8 •33.8 •6.1

•Ethiopia •35.9 •9.5 •18.7 •3.0

•Nigeria •38 •13.6 •10.7 •3.18

•South Africa •56.5 •18.9 •18.9 •6.1

•Argentina •44.4 •12.4 •44.2 •8.4

•Brazil •41.7 •15.3 •39.0 •10.5

•Mexico* •41 •7.4 •25.5 •4.5

•Venezuela •19.6 •~ •~15 •~

•Russia •38.5 •12.7 •32.4 •13.0

•Malaysia •11.0 •2.4 •9.1 •2.4

•Source: Figures for Pakistan are FY2005/6 budget. IMF GFS (10/2005), most recent year available, WB Reports for unavailable countries (italics). As share of central, state, and local government, net of onward transfers by central and stage governments. Sub-National Revenues do not include financing. *Alternative to GFS expenditure figures for Mexico using World Bank (World Bank 2004; 2004).

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Unequal regional incomes

Table 1: Key Indicators for Pakistan’s Disparate Federation

Population Share GDP Per Capita (2004/5)

Area

Human Development

IndexNumber of Local

Governments

%/million Rs.

%/km2 Index

Balochistan 5.1 % NA 45.2% 0.499 26

NWFP 13.8% 35,211 9.7% 0.51 24

Punjab 57.4% 47,131 26.8% 0.557 35

SINDH 23.7% 61,563 18.3% 0.549 21

Total/Average

128.4 -

1.5 0.541 106

Source: World Bank, UNDP 2003 Human Development Report (p. 11)

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Complex system of Provincial financing

Per Capita Rs., 2005/6 projected

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

Subven/Other

Legacy

DivPool

Shared

OSR

Source: World Bank compilation of provincial budgets

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The status of the Tribal Areas ‘across

the Durand Line’• Historical Afghan territorial claims over Pashtun NWFP, PATA, FATA, & Pashtun areas in Baluchistan

• Administered by Punjab British Commissioner, then 1901 direct Delhi rule of NWFP Province - settled & FATA tribal areas separate, both as NWFP Afghan buffer zone

• Separate status, continued post-independence – constitutional FATA buffer zone and tool against Pashtun nationalism on both sides of the border; not elected (A247). NWFP Governor formally represents President

• Pre- & post- colonial regimes – ‘no troops deal’ with (paid) Maliks & Lungis

• Frontier Crimes Regulations (1901 to today), FATA de facto constitutionally separate, Presidential control, Political Agent rule in FATA agencies ‘absolute’

• President has authority over all governance & military arrangements in FATA (1973 constitution A247/5). Via primary legislation – FCR, permits detention-no-trial

• PAs – (executive-judiciary-legislature) appoint own para-militaries – can fire Maliks – appoint Maliks to Jirga courts – no full appellate path or normal rights

• FATA areas a channel for very large-scale US funds to Afghan mujahadeen during Soviet occupation – but govt. wary of Pashtun cross-border nationalism

• 1980-2000 – roots of ISI culture & skill balancing different Pashtun interests

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The role of FATA in the Pakistani Political

System• 12 seats in the National Assembly, 8 in the Senate, elected by appointed (all male) FATA Maliks in the pay of the Presidency/military & each easily dismissed

• But parliament cannot legislate on FATA, and general Pakistani laws do not fully apply in FATA

• FATA parliamentarians linked to pro-Deobani groups (JUI-F)• No representation over FATA, or in NWFP legislature• Alleged tit-for-tat: support in parliament, for peace, arms/drugs

trade, & Deobandi ‘freedom to act’ without political competition• Political parties & national/regional secular political groups banned in

FATA Since Afghan Soviet occupation, (& huge US mujahadeen financing), pro-Deobandis groups & Maliks have grown under such political ‘cover’, and replaced ‘old school Maliks’

• JUI-F – coalition partners of govt. in Balochistan !• Presidency has inherited this system – propped by ‘negotiated balance’

• President’s international trump card: better to accept a complex negotiated balance than risk a Deobandi government /Pashtun state (may well be true !)

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Complex governance: a simplificationDifficult to reform

FATAs(Mostly Pashtun).

3m pop. on Pakistan side.

7 ‘Agencies’.

PATAs

North West Frontier Province

Settled areas ‘Districts’

PresidencyGovernmen

t

Prime Minister.Cabinet.Donors.

FATA Development Authority

7 Political AgentsNaib-

tehsildar(Exec,

judiciary, legislature)

SAFRON

Funding.Donor

projects.

Balochistan

Maliks

Lungis

Prov’l FATA Secretariat

Agency Counci

ls

Inter-Tribal Jirga

PEACE AGREEMENT

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Reform and/or Resolution

Military interventions – part of the solution or part of the

problem ? • Parliament can normalise rights and court system

(FCR was removed from NWFP and Balochistan)• Supreme Court can strike down FCR as

unconstitutional• FATA could become part of PATA under NWFP• But instead…• 2000/1 NRB Devolution Plan excluded FAA• Provisional Agency Councils appointed by tribal Jirgas• Military action continues, (but seen as ‘demonstration

effects to USA’ – counterproductive ?) (ICG Dec 2006)

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Can economic growth address political issues in

Tribal areas ?Will reform strengthen or weaken the

government ?• Per capita income $500. 60% below poverty line.• 97% female illiteracy (male 71%). • But….• Need to demonstrate success against foreign

fighters etc• Buying of permits and ‘rent-seeking’ will decline• Decline of 20 year old arms & drug trade - &

military %s(army allows vibrant trade & doesn’t require ‘permits’)

• Pashtun nationalists & Deobandis may turn on govt.• Parliamentary support would be lost• NWFP JUI-F and Balochistan support may be lost

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Foreign fighters ?

PresidencyHead of State

Govt.Ministries

I.S.I.

Donors & foreign NGOs

Drug & arms traders

Domestic elite, landowners, govt. influencers, & ‘crony capitalism’

Deobanis & Pashtun

Nationalists

USA

Tribal Elders

Local NGOs, pro-democracy groups

The view from the Presidency ?The view from the Presidency ?

Military, Governors, & PAs

The near impossible task of serving many masters.

Is the outcome a kind of political gridlock ?

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‘Show me something’Reform versus ‘uncovering’

foreign fighters

Foreign fighters ?

PresidencyHead of

State

Govt.Ministrie

s

I.S.I.

Donors & foreign NGOs

Drug & arms traders

Domestic elite, landowners, govt. influencers, & ‘crony

capitalism’

Deobanis & Pashtun Nationalists

USA‘War on Terror’

issues

Tribal Elders

Local NGOs,pro-

democracygroups Military,

Governors,& PAs

Info flow

Info barrier

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The Inter-Jirga Peace AgreementWhy did they fight, why did they

agree ?A counterproductive brutal search for

foreign militants ?LOW-LEVEL WAR

• June 2002 - US pressure – troops to capture MO, OBL etc• March 2004 – search for foreign militants ‘Tribes refused’

(‘failed’ – Former ISI General ICG 2006)• Govt. ‘sued for peace’ June 2004• Nov 204 agreement – amnesty, cash, BUT hand over foreign

militants, & stop cross-border attacks• Feb/March 2005, 6-point peace plan with JUI-F over South

Waziristan• Escalation - heavy casualties in March 2006 battles• Effectiveness of ‘official’ institutions declines• Military pressure on the President• New (military) NWFP Governor May 2006• North Waziristan Ceasefire June 2006 signed with JUI-F and

Deobandis/Pashtun nationalists• North Waziristan Peace agreement with Deobandis Sept 2006• Oct 2006 ‘Cross border raids on UK & US troops up’ (Gen Jones

NATO)

• Foreign militants found are few – and mostly 20-year settlers from the anti-Soviet war (Tajiks, Uzbeks)

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The Sept 2006 Peace Agreement

• GoP to halt all ground & air attacks• GoP to release prisoners• Checkpoints removed• Financial compensation of combatants for losses• Tribal privileges and ‘salaries’ restored• GoP to return weapons and allow open carrying of

weapons• Foreign-born militants to respect local laws• Cross-border trade (legal & ‘illegal’) restored• Combatants to halt all cross-border attacks• Return to official institutions – no parallel bodies• GoP troops relocated• Joint 10-member Council to oversee Agreement

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Conclusions

• Good quality macroeconomic management in Pakistan under difficult conditions – but risks from microeconomic realities

• Deep-rooted problems in ‘real economy’ reforms and reform within government.

• Political barriers to real-economy reforms are tenacious – strong political will needed domestically & internationally

• Chain of causality ? Economic reform enables political reform or vice versa ? Symptoms of gridlock on both.

• Military demonstration effects for the USA & NATO, may be counterproductive. (How to break the ‘information barrier’ ?)

• Political reliance on Tribals & ISI (Deobandis indirectly) is an accidental Western creation.

• International support for political reform, especially in Tribal areas, needed to untangle gridlock and accelerate economic reform.