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Political Economy of Economic Reforms in Pakistan

Although reform initiatives were taken by successive governments seriously, many of these could not be implemented properly because of political imperatives and a lack of commitment by the leadership.

Economic reforms in Pakistan were designed to address structural weaknesses of the economy and imbalances under the structural adjustment programmes implemented within the framework of the International Monetary Fund and the World Bank since the late 1980s. The political setting played an important role in the reform process and on the impact of the reforms and structural 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 the following paragraphs.

Historically, the growth record of Pakistan (in its first 60 years of existence) was impressive and comparable to any high-performing developing economy. The growth rate of gross domestic product (GDP) averaged about 6 per cent a year until the late 1980s, and poverty was reduced from 46 per cent to 18 per cent despite high population growth. The rate of inflation remained low 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 frame expansionary policies with large fiscal deficits. This resulted in faster growth in government expenditure than revenue over the years. Because of the lavish spending, the budget deficit reached an unsustainable 9.4 per cent of GDP in the late 1980s. The current account deficit also rose, reaching 3.1 per cent of GDP by 1987-88. Domestic debt doubled to 43 per cent of 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 structural rigidities and distortions in the economy, caused an economic crisis in 1988 and compelled by the international financial institutions (IFIs), i.e. International Monetary Fund (IMF), World Bank (WB) and Asian Development Bank (ADB) to reform its economy. A comprehensive structural adjustment and reform programme was developed by the Pakistan with the help of these institutions to address the structural issues and reform the economy. The IFIs extended the help by providing necessary resources to implement SAP. The progress on the implementation of SAP was also monitored by the IFIs to keep the country on track. Pakistani government has so far negotiated 13 stabilisation and structural adjustment programmes with international financial institutions since that time.

Although the main objective of these programmes was to remove weaknesses and rigidities in the economic structure and distortions in the incentive system in order to stabilise the economy and restore macroeconomic balance, the motivation that prompted successive governments to implement these programmes was the short-term need to secure foreign liquidity infusions from the IFIs after the exhaustion of easily available international funding. The first reform programme was signed in 1988 which led to implementation of medium-term structural adjustment measures. Subsequent policy reforms were a combination of short-term stabilisation measures and long-term structural adjustment measures. The short-term stabilisation measures included tight monetary policy and fiscal discipline while the longer-term adjustment measures included tariff rationalisation, removal of non-tariff barriers, price decontrols and removal of exchange rate distortions.

The fiscal measures were aimed at resource mobilisation through the restructuring of the income tax system, the removal of exemptions from customs duties on imports, introduction of a General Sales Tax, and the removal of price subsidies on public utilities. For the revival of the industrial sector and to attract foreign direct investment, measures were introduced to reduce state controls on foreign investment, encourage investment through incentive schemes and promote competition. The prices of oil products, gas and power were also rationalised to promote efficiency, resource mobilisation and energy conservation. The agriculture sector reforms included the aligning of agricultural input and output prices and the gradual removal of subsidies.Although reform initiatives were taken by successive governments seriously, many of these could not be implemented properly because of political imperatives and a lack of commitment by the 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 of reforms (1988-90) in particular, the democratically-elected government compromised on many of its stands to keep the army at bay. General Ziaul Haq had given the presidency the constitutional power to dismiss National Assembly and the prime minister, and this made subsequent elected governments live in fear. They were right to do so because under this provision, three elected governments were dismissed by the president prematurely and without completion of their tenure between 1990 and 1996. Because efforts have been half-hearted, the expected outcomes of the economic reforms such as rapid economic expansion, export-led growth, 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 and comparable to any high-performing developing economy. The growth rate of gross domestic product (GDP) averaged about 6 per cent a year until the late 1980s, and poverty was reduced from 46 per cent to 18 per cent despite high population growth.
 
 Financial sector reforms were a part of the major adjustment and reform programme. Compared to other types of reforms, however, the financial sector reforms launched in the early 1990s were a success story that not only promoted efficiency in the sector but also set higher standards of service quality. A number of measures were introduced, such as privatisation of state-owned banks, the setting of market-based lending rates, and the phasing out of concessional interest and direct 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, privatisation and liberalisation have been used to develop the financial sector. However, the nationalisation of the Zulfikar Ali Bhutto regime failed miserably to give the desired results. In view of the poor service delivery and weak financial position of the sector, the government of Nawaz Sharif in 1990 began to initiate the policies of privatisation and liberalisation to bring improvements in financial services and to implement a number of reforms. However, the main reforms to liberalise financial services were made during the regime of Pervez Musharraf. His reforms included the establishment of new institutions, strengthening of old institutions and formulation of new regulations. These reforms strengthened the base of the financial institutions and enhanced the confidence of the public in these institutions by making the overall system quite transparent. These reforms created an environment conducive to the growth and development of the financial sector.Prior to 1990, the financial sector was heavily controlled. Interest rates were administratively set and were usually negative in real terms. Monetary policy was conducted primarily through direct allocation of credit. The money market was under-developed, and bond and equity markets were virtually non-existent.

Commercial banks often had to lend to priority sectors with little concern for the borrowing firm’s profitability. Before the opening of the non-bank financial sector for private investment in the mid-1980s, state-owned financial institutions held almost 94 per cent of the assets of the entire financial sector. Moreover, financial institutions were in a precarious state because of high intermediation costs resulting from overstaffing, large numbers of loss-incurring branches, poor governance with low quality banking services, accumulation of non-performing loans and inadequate 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 rate devaluation and reversal of capital flows. Capital flight and disrupted credit allocation further worsened the efficiency of banking sector. These inefficiencies and distortions in turn caused severe macroeconomic difficulties and distorted economic growth.

The reforms and restructuring measures were undertaken with a view to bringing back financial discipline and improving the operational efficiency of the financial sector. The reforms were aimed at establishing a market-based system of financial intermediation and government financing, conducting monetary policy more efficiently through greater reliance on indirect instruments and contributing to the rapid development of the stock market. The reforms were also designed to correct the distortions implicit in the administered structure of returns on various financial instruments, to abolish the directed and subsidized credit schemes, to allow free entry of private banks in the financial sector in order to enhance the competition and efficiency in the financial 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 of policy makers who wanted to implement these reforms with honesty. Credit for the successful implementation of reforms goes to the Musharraf government, particularly to the Prime Minister Shaukat Aziz who, as a banker, was aware of the importance of this sector and the dynamic role it plays in the overall performance of the economy. He gathered a dedicated team of professionals who designed and implemented reforms and corrective measures for the smooth functioning 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 a vibrant and dynamic financial sector catering to the needs of the economy. One can draw the lesson from the reforms experience that when there is political will, it is not difficult to implement the most difficult decisions for better outcomes.Although Pakistan has successfully restructured its financial sector within a very short span of time, sustaining the performance of the financial sector is now an important task. This requires the 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;
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 prevent bankruptcies 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 early warning system and prompt corrective actions are also needed. Furthermore, without improving the corporate governance and expanding the investor base, the capital markets cannot be developed. More openness, together with added transparency and disclosure of information, should contribute significantly to financial restructuring of the economy.

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