Pakistan’s Ramadan heat wave, aggravated by daily power outages and killing thousands, has obscured upbeat economic and financial sector performance diverting subcontinent attention from India. Unlike previous IMF programs, compliance has been strong with the current $6.5 billion one with improved growth, inflation, balance of payments, and structural reform indicators. After successful external bond placements last year, rating agencies upgraded the sovereign to the “B” range with a positive outlook, and index provider MSCI in May signaled a potential return to core emerging market from frontier status after a record privatization offering from Habib Bank. On infrastructure and security, the Chinese pledge of a medium-term $45 billion package under the Silk Road initiative may be a breakthrough, even if durable gains cannot yet be claimed across the range of commercial and geopolitical challenges.
The IMF’s latest review put GDP growth over 4%, on 2% inflation with lower oil prices. Domestic demand has been a main driver through respective 5% and 20% increases in construction and car sales, and textile exports accounting for half the total have been steady. The budget deficit has been trimmed below 5% of GDP on marginal tax collection strides, with less than 1% of the 200 million population in the net. Corruption and land ownership loopholes persist, but additional fuel and retail levies have generated revenue for more targeted defense and social spending. The central bank in May cut the benchmark interest rate to 7%, a 40-year low. It reduced direct government lending and will get additional monetary policy and supervisory independence under new legislation.
When Prime Minister Nawaz Sharif turned to the Fund a year and a half ago upon election, the international reserve position was in crisis, but it has since more than doubled to $18 billion, about three months’ imports. The currency is stable against the dollar and the current account gap is just 1 percent of GDP. The 40 percent oil import cost drop, combined with billions of dollars of remittances from the Gulf and elsewhere, explain the shift, with foreign direct and portfolio investment still weak. To attract these inflows, the government is working to elevate its middle World Bank ‘Doing Business’ ranking, and it may also scrap a capital gains tax contained in the latest budget.
State enterprise sales are another component of the strategy, with airline, rail, and steel companies to be offered after restructuring, and a half-dozen power industry units slated for divestiture by year-end. According to experts, the current energy shortfall is over 5000 megawatts and one-quarter of capacity is wasted through leakage and illegal diversion. Diesel and furnace oil are the chief sources, and development of alternatives including hydro and solar is now a priority and a $20 billion long-term gas supply contract was signed with Qatar. China promised to build plants under the Silk Road plan, and the sub-region may also expand cooperation through recent free trade agreements reviving the SAARC grouping.
Three-quarters of the $1 billion Habib Bank stake went to foreign institutional investors, as they like the sector’s prospects and single-digit price-earnings ratios half of India’s. US-based ETF house Global X launched a dedicated country fund in April on resumed private sector credit activity. According to official statistics, capital adequacy stands at 17 percent of assets and non-performing loans are 13 percent. Banks are diversifying from government securities and have created a deposit protection fund. They changed practice to comply with international anti-money laundering rules after a period on the Financial Action Task Force blacklist.
Public debt at 60 percent of GDP is still high and the IMF has warned that “sustainable economic transformation” has yet to be achieved despite the historic oil price break. At least 5-7 percent output growth is needed to overcome entrenched poverty, and the 10 percent tax/GDP ratio is at the emerging market bottom. The Sharif administration can claim progress but is on notice that despite external calm, electricity and policy shocks should also intensify at home to warrant eventual official and private capital flow graduation.
Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.
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