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Text File | 1994-05-02 | 27KB | 511 lines

<text> <title> Pakistan: Economic Policy </title> <article> <hdr> Economic Policy and Trade Practices: Pakistan </hdr> <body> 1. General Policy Framework Pakistan is a relatively poor country, but has the resources and entrepreneurial skill to support rapid economic growth. In fact, real growth of Gross Domestic Product (GDP) averaged 6.2 percent per year over the decade of the 1980's, with moderate inflation. Serious fiscal imbalances, however, arose due to structural problems in the economy, including chronic losses by state-run industrial units; an inefficient, debt-ridden, nationalized banking sector; widespread evasion and corruption in the tax system; administrative and financial barriers to trade and investment; and a host of inefficiencies created by bureaucratic interference in economic decision-making. As a result, Pakistan's budget and current account deficits reached unsustainable levels by decade's end. In FY 1989, the government launched a four-year, IMF-sponsored structural adjustment program to reduce the deficits to manageable levels. The budget deficit, which exceeded eight percent of GDP in FY 1991, has been financed through domestic borrowing (treasury bills, long-term bonds, a national savings scheme, and compulsory bank lending) and external financing (both commercial and concessional loans). With IMF assistance, deficit financing has been rationalized with the introduction of an auction system for government securities, elimination of costly on-tap debt instruments, and tighter control over borrowing from the State Bank of Pakistan (the central bank). Defense was the largest spending category in the FY 1991 budget, consuming 29 percent of total expenditures. Development was second, with 28 percent of expenditures, and debt service was third, with 22 percent. For FY 1991, the Government has adopted stringent fiscal and monetary policies designed to reduce the budget deficit to 4.8 percent of GDP. This will entail cuts in the Government's non-defense expenditures, new direct and indirect tax measures to expand revenues, and increases in administered prices to reduce subsidies. To restore monetary discipline, the Government has substantially reduced central bank holdings of government debt, increased commercial bank reserve requirements, raised its discount rate on government securities, and eliminated a subsidized rediscount scheme for cotton procurement. The Government continues to rely on credit ceilings as its primary monetary policy tool, but plans to shift to a market-based system utilizing interest rates to allocate credit once there is sufficient depth in the new securities markets to permit open market operations. The Pressler Amendment to the Foreign Assistance Act requires that the President certify each year that "Pakistan does not possess a nuclear explosive device and that the proposed U.S. assistance program will reduce significantly the risk that Pakistan will possess a nuclear explosive device." The President did not make that certification in October 1990 nor in October 1991. Hence the U.S. was unable to provide new economic assistance or any military aid in FY 1991. However, under Pressler, AID can continue a "windup program" of aid monies obligated prior to FY 1991. 2. Exchange Rate Policies Pakistan's exchange rate policy is based on a managed float, with the State Bank regularly adjusting the value of the rupee against major international currencies, using the U.S. dollar as an intervention currency to determine other rates. The rupee has depreciated about 25 percent against the dollar over the last two fiscal years, a major factor behind Pakistan's recent export growth. Foreign exchange controls were significantly liberalized during FY 1991. Individuals and firms resident in Pakistan may now hold foreign currency bank accounts and freely move foreign currency into and out of the country. Companies with foreign direct investment (other than foreign banks) may remit profits and capital without prior state bank approval. Similar liberal remittance procedures were extended for the first time to foreign portfolio investment in Pakistan's capital market. Other measures make it easier for individuals and firms to obtain foreign exchange for a variety of specific purposes. The Government's objective is to make the Pakistan rupee freely convertible once economic conditions make it possible to do so. 3. Structural Policies In FY 1991, the newly-installed government of Prime Minister Nawaz Sharif launched an ambitious program of privatization, deregulation, and economic reform aimed at reducing structural impediments in the economy. Despite resistance from the bureaucracy and labor unions, within a year the Government had successfully denationalized several industrial units and financial institutions, and was actively seeking buyers for the rest. With assistance from the U.S. Agency for International Development and other donors, the Government was making plans to privatize two multi-billion dollar utilities, the Pakistan Telecommunications Corporation (PTC) and the Water and Power Development Authority (WAPDA). In all cases, bidding was open to foreign investors, though foreign investment in Pakistani banks is permitted on a non-repatriable basis only. The Government retains considerable power to control prices in many sectors of the economy. The use of direct price controls has been largely eliminated, although prices in the pharmaceuticals industry remain under control. Foreign drug companies can register products in Pakistan only at a price acceptable to the government. In some cases, companies have opted not to introduce products to the Pakistan market because the price established by the Government was too low. In FY 1991, however, prices for some pharmaceuticals and other products were raised significantly, enabling manufacturers to restore profitability in several lines. Although direct price controls are no longer prevalent, public sector entities involved in banking, manufacturing, services, and trade frequently influence market prices in accordance with government policy or political considerations. These corporations use government stocks to affect market prices for essential commodities if the prices vary greatly from the government-fixed support price. Other state-owned corporations can set prices for their products with little regard to generating a positive return on equity. Examples include fertilizer, tractors, steel products and castings, and cement. This is especially true for wheat and edible oil (ghee), where the Government's artificially low prices stimulate consumption and smuggling to neighboring countries where prices are less controlled. As a part of its structural adjustment program, the Government has begun to rationalize public sector prices. In addition, the on-going privatization program will reduce or eliminate the economic leverage of many firms now in the public sector. In the past, Pakistan was an occasional importer of wheat. The country's wheat production has lagged behind population growth, however, and for the past several years, Pakistan has imported significant amounts of U.S. wheat. Credit guarantees from USDA's Commodity Credit Corporation (GSM-102) have been used to finance most of these wheat purchases. Moreover, between 70 and 80 percent of the vegetable oil consumed in Pakistan is imported. Vegetable oil imports are roughly 75 percent palm oil, mostly from Malaysia, and 25 percent soybean oil from Brazil and the United States. U.S. soybean oil imports are also financed under Commodity Credit Corporation (GSM-102) guarantees. U.S. soybean oil accounts for about 10 percent of total vegetable oil imports. Pakistan's inefficient tax system captures only a small proportion of the taxable revenues in the country and is heavily dependent on indirect taxes on trade and commodi