Political economy of economic reforms in pakistan


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Political economy of economic reforms in pakistan

  1. 1. Political Economy of Economic Reforms inPakistanAlthough reform initiatives were taken by successive governments seriously,many of these could not be implemented properly because of politicalimperatives and a lack of commitment by the leadership.Freedom of Expression Fueling the FireMonday, October 01, 2012Economic reforms in Pakistan were designed to address structural weaknesses of the economyand imbalances under the structural adjustment programmes implemented within the frameworkof the International Monetary Fund and the World Bank since the late 1980s. The politicalsetting played an important role in the reform process and on the impact of the reforms andstructural adjustment measures implemented to correct the internal and external imbalances.Some of the important reforms and their impact on the economy of Pakistan are discussed in thefollowing paragraphs.Historically, the growth record of Pakistan (in its first 60 years of existence) was impressive andcomparable to any high-performing developing economy. The growth rate of gross domesticproduct (GDP) averaged about 6 per cent a year until the late 1980s, and poverty was reducedfrom 46 per cent to 18 per cent despite high population growth. The rate of inflation remainedlow during the period and per capita income almost doubled.But this performance of the economy and high growth can best be described as borrowed growth.The easy availability of funds from both domestic and foreign sources lured policy makers to
  2. 2. frame expansionary policies with large fiscal deficits. This resulted in faster growth ingovernment expenditure than revenue over the years. Because of the lavish spending, the budgetdeficit reached an unsustainable 9.4 per cent of GDP in the late 1980s. The current accountdeficit also rose, reaching 3.1 per cent of GDP by 1987-88. Domestic debt doubled to 43 per centof GDP while external debt rose from 31 to 42 per cent of GDP over the short period from 1980-81 to 1987-88. These imbalances in the macroeconomic indicators, mainly due to the structuralrigidities and distortions in the economy, caused an economic crisis in 1988 and compelled bythe international financial institutions (IFIs), i.e. International Monetary Fund (IMF), WorldBank (WB) and Asian Development Bank (ADB) to reform its economy. A comprehensivestructural adjustment and reform programme was developed by the Pakistan with the help ofthese institutions to address the structural issues and reform the economy. The IFIs extended thehelp by providing necessary resources to implement SAP. The progress on the implementation ofSAP was also monitored by the IFIs to keep the country on track. Pakistani government has sofar negotiated 13 stabilisation and structural adjustment programmes with international financialinstitutions since that time.Although the main objective of these programmes was to remove weaknesses and rigidities inthe economic structure and distortions in the incentive system in order to stabilise the economyand restore macroeconomic balance, the motivation that prompted successive governments toimplement these programmes was the short-term need to secure foreign liquidity infusions fromthe IFIs after the exhaustion of easily available international funding. The first reformprogramme was signed in 1988 which led to implementation of medium-term structuraladjustment measures. Subsequent policy reforms were a combination of short-term stabilisationmeasures and long-term structural adjustment measures. The short-term stabilisation measuresincluded tight monetary policy and fiscal discipline while the longer-term adjustment measuresincluded tariff rationalisation, removal of non-tariff barriers, price decontrols and removal ofexchange rate distortions.The fiscal measures were aimed at resource mobilisation through the restructuring of the incometax system, the removal of exemptions from customs duties on imports, introduction of a GeneralSales Tax, and the removal of price subsidies on public utilities. For the revival of the industrialsector and to attract foreign direct investment, measures were introduced to reduce state controlson foreign investment, encourage investment through incentive schemes and promotecompetition. The prices of oil products, gas and power were also rationalised to promoteefficiency, resource mobilisation and energy conservation. The agriculture sector reformsincluded the aligning of agricultural input and output prices and the gradual removal ofsubsidies.Although reform initiatives were taken by successive governments seriously, many of thesecould not be implemented properly because of political imperatives and a lack of commitment bythe leadership. The lack of political commitment arose from the frequent changes in government,especially during the period of economic reforms. Since 1988 there have been nine governments— four elected governments, four caretakers and one military government. In the early period ofreforms (1988-90) in particular, the democratically-elected government compromised on manyof its stands to keep the army at bay. General Ziaul Haq had given the presidency theconstitutional power to dismiss National Assembly and the prime minister, and this madesubsequent elected governments live in fear. They were right to do so because under this
  3. 3. provision, three elected governments were dismissed by the president prematurely and withoutcompletion of their tenure between 1990 and 1996. Because efforts have been half-hearted, theexpected outcomes of the economic reforms such as rapid economic expansion, export-ledgrowth, higher incomes for all groups, expanded health and education benefits, better housing,and building of a social safety net have yet to be realised. Historically, the growth record of Pakistan (in its first 60 years of existence) was impressive andcomparable to any high-performing developing economy. The growth rate of gross domesticproduct (GDP) averaged about 6 per cent a year until the late 1980s, and poverty was reducedfrom 46 per cent to 18 per cent despite high population growth. Financial sector reforms were a part of the major adjustment and reform programme. Comparedto other types of reforms, however, the financial sector reforms launched in the early 1990s werea success story that not only promoted efficiency in the sector but also set higher standards ofservice quality. A number of measures were introduced, such as privatisation of state-ownedbanks, the setting of market-based lending rates, and the phasing out of concessional interest anddirect credit schemes. Some of the reasons for the success of these reforms are explained below.Since independence in 1947, different policies such as deregulation, nationalisation, privatisationand liberalisation have been used to develop the financial sector. However, the nationalisation ofthe Zulfikar Ali Bhutto regime failed miserably to give the desired results. In view of the poorservice delivery and weak financial position of the sector, the government of Nawaz Sharif in1990 began to initiate the policies of privatisation and liberalisation to bring improvements infinancial services and to implement a number of reforms. However, the main reforms toliberalise financial services were made during the regime of Pervez Musharraf. His reformsincluded the establishment of new institutions, strengthening of old institutions and formulationof new regulations. These reforms strengthened the base of the financial institutions andenhanced the confidence of the public in these institutions by making the overall system quitetransparent. These reforms created an environment conducive to the growth and development ofthe financial sector.Prior to 1990, the financial sector was heavily controlled. Interest rates were administratively setand were usually negative in real terms. Monetary policy was conducted primarily through directallocation of credit. The money market was under-developed, and bond and equity markets werevirtually non-existent.Commercial banks often had to lend to priority sectors with little concern for the borrowingfirms profitability. Before the opening of the non-bank financial sector for private investment inthe mid-1980s, state-owned financial institutions held almost 94 per cent of the assets of theentire financial sector. Moreover, financial institutions were in a precarious state because of highintermediation costs resulting from overstaffing, large numbers of loss-incurring branches, poorgovernance with low quality banking services, accumulation of non-performing loans andinadequate market capitalization. In brief, the financial sector was weak on governance,accounting standards, market discipline, prudential regulation and legal infrastructure.These problems increased the exposure of financial institutions to a variety of external threats,including a decline in asset values, market contagion, speculative attacks, exchange ratedevaluation and reversal of capital flows. Capital flight and disrupted credit allocation further
  4. 4. worsened the efficiency of banking sector. These inefficiencies and distortions in turn causedsevere macroeconomic difficulties and distorted economic growth.The reforms and restructuring measures were undertaken with a view to bringing back financialdiscipline and improving the operational efficiency of the financial sector. The reforms wereaimed at establishing a market-based system of financial intermediation and governmentfinancing, conducting monetary policy more efficiently through greater reliance on indirectinstruments and contributing to the rapid development of the stock market. The reforms werealso designed to correct the distortions implicit in the administered structure of returns on variousfinancial instruments, to abolish the directed and subsidized credit schemes, to allow free entryof private banks in the financial sector in order to enhance the competition and efficiency in thefinancial sector and to strengthen the supervisory role of State Bank of Pakistan.These reforms of financial services are the result of the political commitment and resolve ofpolicy makers who wanted to implement these reforms with honesty. Credit for the successfulimplementation of reforms goes to the Musharraf government, particularly to the Prime MinisterShaukat Aziz who, as a banker, was aware of the importance of this sector and the dynamic roleit plays in the overall performance of the economy. He gathered a dedicated team ofprofessionals who designed and implemented reforms and corrective measures for the smoothfunctioning of the financial institutions. This was all done with the full support of the President,who watched these developments with keen interest but without interference. The outcome is avibrant and dynamic financial sector catering to the needs of the economy. One can draw thelesson from the reforms experience that when there is political will, it is not difficult toimplement the most difficult decisions for better outcomes.Although Pakistan has successfully restructured its financial sector within a very short span oftime, sustaining the performance of the financial sector is now an important task. This requiresthe following aspects to be addressed:• macroeconomic stability;• a greater degree of consolidation for a strong and robust banking sector;• a better prudent regulatory and supervisory framework;
  5. 5. • the maturation and reorientation of the financial industry;• a more diverse and competitive financial system;• stronger corporate governance, and a more effective risk management and mitigation system;• a socially inclusive financial system capable of facilitating the access to financial services;• better-developed legal infrastructure for financial supervision, especially to preventbankruptcies and foreclosures;• reform of the secrecy laws to ensure transparency; and• ensuring deposit insurance schemes.Such measures are warranted to maintain stakeholders’ confidence in the economy. An earlywarning system and prompt corrective actions are also needed. Furthermore, without improvingthe corporate governance and expanding the investor base, the capital markets cannot bedeveloped. More openness, together with added transparency and disclosure of information,should contribute significantly to financial restructuring of the economy.Dr Zafar Mueen Nasir