Pakistan

Pakistan’s economy faces considerable challenges. Floods in summer 2010 hit agricultural output and
damaged transport and communication. Still high inflation, though recently falling, may well accelerate.
Fiscal developments are worrisome: the rollback in recent oil price rises, a partial increase in electricity
tariffs, delays in carrying out revenue-increasing measures, broad tax exemptions for residents of flood-
affected areas, and continued heavy fiscal support to state-owned enterprises add to pressures on the
fiscal deficit. The current account balance is improving, but capital and financial inflows continue to
decline. Still, despite devastation and economic distress, growth will likely stay positive.

Economic performance
3.20.1  GDP growth by sector
Pakistan’s economic performance in FY2010 (ended June 2010) and into GDP Agriculture Industry Services
FY2011 reflects largely the same structural weaknesses that contributed %
6.8
to its FY2008 macroeconomic crisis. Energy shortages and security issues 9
5.8
held the economic rebound for FY2010 to 4.1% (Figure 3.20.1), slowing 3.7
4.1 6

growth for FY2008–FY2010 to an average of only 3%, well below the 8% 1.2 3
needed to create jobs for the predominately young population. 0
Little recent progress has therefore been made in raising per capita -3
incomes or reducing poverty. Delays in implementing policy measures 2006 07 08 09 10
and fiscal management practices necessary for macro stability have Source: Ministry of Finance. Pakistan Economic Survey
2009–10. http://www.finance.gov.pk
undermined investment in infrastructure and production capacity.
The modest expansion in FY2010 benefited from fiscal and monetary
policies in FY2009 that eased macroeconomic imbalances by year-end,
and from a decline in inflation that improved consumer confidence.
Higher remittances provided additional support to an expansion of
private consumption, as did improvements in rural income from increases
in administered commodity prices. Heightened security concerns lifted
public consumption, pushing total consumption’s contribution to growth
to nearly 80%.
From the supply side, transitory improvements in large-scale
manufacturing partly reversed 2 years of declines and supported a
recovery in services, led by wholesale and retail trade. Agriculture 3.20.2  Fixed investment
expanded by a modest 2%, due to weak performance by major crops. % of GDP
22
The fragility of the recovery was underscored by continued investment
contractions. Infrastructure shortages and security issues contributed 18

to a 5.1% decline of gross private capital formation. Gross fixed capital 14

formation contracted by 2.0% in FY2010, coming on the heels of an 11.3% 10

decline the previous year. 6
FY2010 also saw a third consecutive year of declines in investment 2006 07 08 09 10
Source: Ministry of Finance. Pakistan Economic Survey
in large-scale manufacturing (down 15.4%) and electricity and gas (11.0% 2009–10. http://www.finance.gov.pk
lower). Overall, the steady decline in total gross fixed investment as a

This chapter was written by Dawn Elizabeth Rehm of the Central and West Asia
Department, ADB, Manila; and Farzana Noshab of the Pakistan Resident Mission, ADB,
Islamabad.
Economic trends and prospects in developing Asia: South Asia Pakistan   169

3.20.3  Fiscal indicators

share of GDP from 20.5% in FY2006 to 15.0% in FY2010 will crimp future
Fiscal deficit Expenditure Revenue
growth prospects (Figure 3.20.2). Private savings have similarly declined, % of GDP
owing in part to the failure of key asset rates to keep pace with inflation, 24
leading to either negligible or negative real returns. 16
Pakistan’s fiscal balance deteriorated in FY2010, reflecting delays 8
in putting through planned policy measures to improve revenue
0
performance and limit the burden on the deficit of losses at state-owned
-8
enterprises (SOEs) and of energy-related subsidies. It widened from 5.3% 2006 07 08 09 10
of GDP in FY2009 to 6.3% in FY2010 (Figure 3.20.3), well in excess of the Sources: Ministry of Finance. Pakistan Economic Survey
(revised) target of 5.1%. Revenue targets in the FY2010 budget, too, were 2009–10 and Fiscal Operations July to June 2009–10. http://
www.finance.gov.pk
missed and Federal Board of Revenue (FBR) tax receipts continued to
decline as a share of GDP, reaching a 30-year low of 9.0% in FY2010.
3.20.4  Year-on-year inflation
Pakistan’s current budget expenditure is relatively rigid, and it is
General Food Core trimmed
difficult to offset overruns in one category with reductions in another. %
Inflexible current expenditure (such as security, interest, and pensions) 25
alone absorbed revenue of 7.4% of GDP in FY2010, or about 82% of FBR 20
tax receipts. Subsidies amounted to another 1.7% of GDP. 15
The government sharply curtailed the federal public sector
10
development program (PSDP) to 3.5% of GDP to ease deficit pressure.
5
Federal government borrowing from the State Bank of Pakistan (SBP), the 2007 08 09 Jul Oct Jan Apr Jul Oct Jan
central bank, as well as from commercial banks rose to PRs339.7 billion FY 09 10 11

(2.3% of GDP), reflecting a widening deficit and lower external financing. Note: Core trimmed inflation eliminates extreme outlying
Escalating losses from SOEs reached an estimated 1.7% of GDP for sample observations from the calculated average.
Sources: State Bank of Pakistan. Annual Report 2009–2010
FY2010, adding to pressures. and Economic Data. http://www.sbp.org.pk (accessed
Inflation fell to 11.7% in FY2010 from 20.8% in FY2009 (Figure 3.20.4). 11 March 2011).

As it moderated, the SBP lowered the policy rate in steps from 14% to
12.5%. Broad money expanded by 12.5%, much faster than the 9.6% of the 3.20.5  Current account indicators
previous year. Current account balance Trade balance
Developments in the external balances were mixed (Figure 3.20.5): Exports Imports
% of GDP
the current account deficit narrowed, as imports declined by 1.7% with
24
weaknesses in key industries (such as steel and oil refining) and a slump
in investment; exports expanded by a modest 2.9% on higher exports 12
of textiles, rice, and pharmaceuticals. Improvements in the service and
0
income accounts contributed.
Yet financing the current account deficit became more difficult over -12
2006 07 08 09 10
the year: the capital and financial accounts fell by almost 13.4%, after a
Source: State Bank of Pakistan. Economic Data. http://www.
26.2% decrease the year before. Foreign direct investment flows continued sbp.org.pk (accessed 11 March 2011).
their downward path in response to infrastructure and security concerns,
with communications, transport, and power accounting for much of the
decline. 3.20.6  Public debt and interest payments
Gross reserves improved, benefiting from International Monetary Domestic interest payment
Foreign interest payment
Fund (IMF) releases under a stand-by arrangement, rising to $16.8 billion Domestic public debt
by end-FY2010. The nominal exchange rate depreciated by 6.3%, but External debt and liabilities
% of GDP
inflation—high relative to trading partners’—lifted the real exchange rate % of GDP
5 70
by 1.0%. 4 56
Pakistan’s public debt (excluding guarantees) as a share of GDP 3 42
continued to climb in FY2010 (Figure 3.20.6). Government domestic debt 2 28
amounted to 37.0% of GDP, including commodity debt and liabilities 1 14
of SOEs. External debt rose to 31.9% of GDP, including 0.6% of GDP 0 0
2007 08 09 10
in external liabilities of SOEs. Interest payments due on domestic debt Sources: State Bank of Pakistan. Annual Report 2009–2010
represent a heavy burden, accounting for 3.9% of GDP in FY2010, or and Statistical Bulletin March 2011. http://www.sbp.org.pk.
170   Asian Development Outlook 2011

43% of FBR revenue. External debt amortization payments, excluding 3.20.1  Selected economic indicators (%)
amounts owed to the IMF, are relatively stable for FY2010–FY2013 at
2011 2012
about $3.3 billion. Amounts due for FY2012 and beyond will be raised
GDP growth 2.5 3.7
substantially by repayment obligations to the IMF.
Inflation 16.0 13.0
Government borrowing in the form of advances for commodity
Current account balance -1.7 -2.3
operations rose sharply in FY2009, in response to the bumper crop and (share of GDP)
increases in government-set procurement prices for wheat. With domestic Source: ADB estimates.
prices higher than international prices, excess inventory was not sold. As
this inventory looked as if it would not be sold nor loans repaid, banks’
lending rates for government commodity operations rose, to exceed those 3.20.7  Large scale manufacturing index
for the private sector. 1999−2000 = 100
250
200

Prospects 150 Large sc

100
Severe floods in July–August 2010 have affected FY2011’s prospects. 50
Damage was less severe than initially feared, but agriculture and 0
communications were hit hard. Total damage is put at more than Jul Jan Jul Jan Jul Jan Jul
2007 08 09 10
$10 billion, half in agriculture. For other areas, notably power and Sources: Ministry of Finance. Pakistan Economic Survey
transport, damage was mild but widespread. 2009–10. http://www.finance.gov.pk; Federal Bureau of
Statistics. http://www.statpak.gov.pk (accessed 11 March
Information for the first 6 months of FY2011 points to a 1.7% 2011).
contraction of large-scale manufacturing centered on textiles,
food processing, and petroleum products, bringing the large-scale
manufacturing index for September 2010 to its lowest since July 2007
(Figure 3.20.7).
With growth prospects reduced to 2.5% for FY2011 (Figure 3.20.8), 3.20.8  GDP growth
average growth for FY2008–FY2011 is seen falling to 2.9%. Persistent %
8
energy shortages and security issues are expected to hold growth to 3.7%
for FY2012, providing scant improvement on recent trends. 6
4.5
Inflation accelerated after the floods, to 15.7% in September, reflecting 4
2.5
actual and expected shortages. It remained above 15% through December, 2
falling to 14.2% in January owing to a government-freeze on oil and 0
electricity prices. It is expected to stay high through FY2011, for an 2006 07 08 09 10 2011 2011
(pre- (post-
average annual 16.0%, and is then expected to recede in FY2012 to 13.0% flood) flood)
(moderation in international food prices is likely to be at least partly Forecast

offset by electricity price rises). Sources: Ministry of Finance. Pakistan Economic Survey
2009–10. http://www.finance.gov.pk; ADB estimates.
Pakistan began FY2011 with a budget that was based on policy
measures that proved difficult to carry out. Revenue targets called for 26%
growth of tax receipts, well over the 5-year average of 14%. Meeting them
would have been hard even if a reformed General Sales Tax had come
into effect. A reformed tax was initially scheduled for July 2010, but the 3.20.9  Federal Board of Revenue tax
process remains politically contentious, and any changes to the tax will collection
Level Share
have a limited effect on FY2011 receipts.
PRs billion % of GDP
This tardiness, combined with the impact of the floods and wide tax 1,400 1,327 12
exemptions for those in flood-affected areas, held FBR tax revenue growth 1,200 1,157 10
to 10.9% in the first 7 months of FY2011, making a further decline in the 1,007
1,000 8
tax-to-GDP ratio likely (Figure 3.20.9). (Total fiscal resources have also 847
800 770 6
been affected by declines in nontax revenue.) 713 695

Current expenditure was under pressure due to a 50% wage increase 600
2006 07 08 09 10 Jul−Jan
4

for government workers, exacerbated by government failure to budget 2010 Jul−Jan

2011
adequately for subsidies needed to cover the gap between notified Source: State Bank of Pakistan. http://www.sbp.org.pk
and cost-recovery electricity tariffs. An annual budget allocation of (accessed 11 March 2011).
Economic trends and prospects in developing Asia: South Asia Pakistan   171

PRs30 billion to cover the tariff differential turned out well short of 3.20.10  Public sector development program
expected cost, and because of lack of policy measures total energy-related Level Share
PRs billion % of GDP
subsidies are expected to reach PRs200 billion. Part of this gap was to 700 8
be covered by 2% monthly increases in electricity tariffs to bring them
525 6
into line with cost recovery. Energy-related circular debt (due to payment
350 4
arrears in the sector), which stood at PRs446 billion at end-FY2010, is
175 2
expected to surge by end-FY2011.
For a third year, overruns on recurrent spending were met with a 0 0
A T A T A T A T T
compression of the federal PSDP (Figure 3.20.10). For the first half of FY2007 FY08 FY09 FY10 FY11
FY2011, only PRs66 billion was made available for PSDP activities, less A = Actual; T = Target.
than 25% of the PRs280 billion earmarked in the FY2011 federal budget, Source: Ministry of Finance. Fiscal Operations. Various issues.
http://www.finance.gov.pk
with spending limited to key projects and priority development programs.
The federal PSDP for FY2011 faced a further cut of PRs100 billion on
a lack of resources. The government is giving priority to completing
projects. The remainder of the PSDP (PRs373 billion) in the combined
provincial budgets is also under substantial pressure from resource
constraints.
With a fiscal deficit at 2.9% of GDP in the first half of FY2011, the
annual fiscal target was also revised to 5.5% under the weight of higher
international food and energy prices, escalating subsidies, and subdued
revenue performance. 3.20.11  Budgetary and private sector credit
With lower foreign funding, deficit financing is expected to rely Net government borrowing for budgetary support
heavily on the domestic banking system. After easing in FY2010, Private sector credit
PRs billion
government borrowing from that source has surged in FY2011, reaching 600
PRs379 billion by 12 February, compared with PRs330.4 billion for FY2010
as a whole (Figure 3.20.11). Of this, about 34% reflected borrowing from 400

the SBP, consistent with commitments from the government in late 200
January to roll back borrowing from the SBP to September 2010 levels.
Credit to the private sector picked up but remained on the low side 0
2005 06 07 08 09 10 11
for various reasons. Banks expressed a preference for low-risk lending Note: 2011 data cover the period July 2010 to February 2011.
to government to offset flood-related increases in nonperforming loans, Source: State Bank of Pakistan. http://www.sbp.org.pk
while weak postflood economic activity and rising borrowing costs held (accessed 11 March 2011).

back demand for borrowing.

The pace of government borrowing from the banking system has
supported a rapid expansion of broad money and reserve money: broad
money growth for FY2011 through 26 February 2011 was much higher
(7.7%) than in the same period of FY2010 (5.7%); the equivalent figures for
reserve money were 14.9.% and 10.6%.
In response to the increase in inflation and growing evidence of its
likely persistence, the SBP increased the policy rate in three successive
50 basis point increments from August 2010 to end-November 2010,
bringing the rate back to 14.0% and reversing the cuts of FY2010 3.20.12  Policy rate
(Figure 3.20.12). In January 2011, the SBP left the policy rate unchanged, %
partly on the basis of commitments from the government to limit 15

borrowing from the central bank. 13

Fiscal prospects for FY2012 are likely to improve as the political Policy ra

environment eases sufficiently to implement the revenue-enhancing and 11

fiscal-management initiatives. Progress is expected in implementing 9

reforms for the energy sector consistent with a move toward financial 2007 09 Jul Oct Jan Apr Jul Oct Jan
08 09 10 11
viability with a phased elimination of subsidy requirements, leaving Source: State Bank of Pakistan. Annual Report 2009–2010.
enhanced fiscal space for development programs. http://www.sbp.org.pk
172   Asian Development Outlook 2011

The extensive pickup of Treasury bills bought by the SBP through 3.20.13  Foreign exchange reserves
December 2010 reflected government reluctance to allow auction cutoff Total liquid reserves
With commercial banks
rates to rise enough for commercial banks to participate. Without a With State Bank of Pakistan
sufficient increase in 1-year bill rates, most purchases have shifted to $ million
shorter maturities of 3 and 6 months. In recent auctions, most banks’ bids 18

for bills with a maturity longer than 6 months have not been high enough 12
to be accepted. But with an average maturity falling to 1.5 years, the
possibility of roll-over risk and disorder in the auction market rises. The 6

likely outcome is that, in time, the government will have to pay higher 0
interest rates to fund its borrowing requirements. 2001 02 03 04 05 06 07 08 09 10 12Feb
11
Pakistan’s external reserves reached a record high of $17.4 billion in Source: State Bank of Pakistan. http://www.sbp.org.pk
early February 2011 (Figure 3.20.13), amounting to more than 5 months (accessed 11 March 2011).
of imports of goods and services. This buildup essentially reflects IMF
releases of $7.1 billion under the stand-by arrangement, an additional
$450 million in emergency support in September 2010, and support from
the Coalition Support Fund ($633 million) at end-December 2010. The
central bank’s holdings of liquid foreign exchange reserves ended FY2010
at $13.9 billion.
While import growth remains modest, a significant expansion of
exports during the first 7 months of FY2011 moved the current account 3.20.14  Foreign direct and portfolio
deficit into near balance, at 0.5% of GDP, but it is expected to widen investment, net inflows
to 1.7% for full-year FY2011, reflecting higher international food and Direct Portfolio
$ billion
commodity prices. For the first 7 months of FY2011, exports of textiles 9
and rice showed strong growth in value terms, mainly on higher world 6
prices. Remittances increased further, broadly in line with inflation, but 3
0
non-debt-creating inflows continued to decline, with private FDI inflows -3
about 16% below the same period of the previous year (Figure 3.20.14). 2003 04 05 06 07 08 09 10 A B
The current account deficit is expected to edge upward in FY2012 to A = July 2009–Jan 2010; B = July 2010–Jan 2011.
2.3% of GDP as projected declines in global food and commodity prices Source: State Bank of Pakistan. http://www.sbp.org.pk
(accessed 11 March 2011).
are more than offset by the impact of improved growth and increased
demand for imports, including for postflood reconstruction.

Development challenges
The government recognizes that current subsidy requirements and
support for SOEs are incompatible with creating the fiscal space needed to
support investment in infrastructure and technology for a diversified and
higher-value-added export base. The current pattern of lower imports,
lower development spending, and exploding unproductive current
outlays undermines domestic and external confidence in the economy’s
prospects and deters investment. Pakistan therefore needs to develop a
systematically transparent revenue policy, and operate it effectively.
Elsewhere, energy shortfalls are lowering real growth by at least
2 percentage points annually. While the federal government increased
electricity tariffs by 37% in FY2010, its decision not to push through with
incremental monthly step-ups represents a reversal of its efforts to reach
cost recovery. Again, it will be critical to design and implement policies
that bring the sector to financial viability.