December 04 , 2009
What Killed the Pak Economy in 2008?
After a long stretch of rapid economic growth, the Pakistani economy ground to a halt in 2008. GDP growth collapsed, the budget deficit ballooned, inflation surged to 25%, the stock market collapsed, and the rupee lost a third of its value against the dollar. Only now are we starting to see some return to growth but the mystery remains: what happened in 2008?
Through 2007 the economy had enjoyed an excellent decade. GDP growth averaged almost 7% per year, the rupee had been stable at 60 per dollar, extreme poverty had declined by about a third, and industrial production had surged. Exports had doubled and taxes collected by the government had tripled. So what went wrong?
There are basically three theories put forward. The first blames Musharraf, the second blames Zardari, and the last blames the global economy. The truth requires all three.
Musharraf has been blamed for allowing "imbalances" to build up that made 2008 inevitable. These include allowing interest rates to stay too low in 2007, thereby contributing to a runup in inflation and overheating of the economy. In addition, excess domestic demand was increasing the trade deficit, which was going to put pressure on the currency. Finally, Musharraf had not invested in expanding the electrical generating capacity in the country, which finally caught up in late 2007 with resulting widespread load-shedding and generalized electrical shortages.
Shaukat Aziz has answered these charges by pointing out that when he left office in late 2007, the inflation rate was still only 7%, and that this was driven by oil prices that had doubled to 60 dollars per barrel. Besides, the central bank was independent and Aziz had no direct control of monetary policy (though the head of the central bank was appointed by Musharraf). Aziz does admit that they miscalculated how much faster electrical demand was going to grow during the brisk economic years (electric demand grew 15% per year compared with the economy doing 6-7%). On the flip side, Aziz pointed out that the debt burden had been controlled and brought down from 100% of GDP to 55%, an acceptable number.
Zardari has been accused of mismanaging the economic crisis that the PPP inherited after taking power in spring of 2008. For several months there was no real economic planning, and various crises built while the government dithered. The aborted alliance with the PMLN had put Ishaq Dar, who is grossly incompetent at economics, in charge of the Ministry of Finance for a few critical months, and he was responsible for putting together the budget due in June 2008. Meanwhile, inflation greatly accelerated, the financial situation deteriorated, and investor confidence collapsed. With that the rupee had to be devalued rapidly resulting in capital flight and a near-evaporation of the forex reserves. To stabilize the situation, Zardari had to submit Pakistan back to IMF control in exchange for an emergency loan of 7 billion dollars. The IMF demanded, and got a steep reduction in social spending, including on education and health, in order to close a growing budget deficit.
The third theory blames the commodity price surges of late 2007 and 2008 as the main culprits. In 2007 prices for a whole variety of globally traded commodities began to surge.
Most importantly, given the nature of the Pak economy, were oil and wheat. Pakistan is a heavily oil-dependent economy, and uses almost no coal and modest amounts of natural gas. The huge rise in global oil prices, from 20 to 60 dollars between 2002 and 2007, followed by a further spike to 150 dollars in mid-2008, caused huge trade imbalances for Pakistan.
Oil import bills soared and could not be paid for by exports and remittances. Meanwhile, wheat prices also soared. It was difficult for the government to keep wheat both plentiful and cheap in Pakistan, as there was great incentive for smugglers to move wheat to Afghanistan or elsewhere to get higher prices. Wheat shortages developed, and the government was forced to spend large sums on subsidizing both wheat and oil to the public. These large unanticipated expenditures, combined with lower tax revenues due to a slowing economy, created large budget deficits, going from 4% to 7% of GDP.
Most of that increase was in subsidies which surged from 1% to almost 4% of GDP.
Pakistan could have sustained one of these insults. If Aziz and Musharraf had built another 2-3 gigawatts of electric generating capacity and if they had put in place a somewhat tighter monetary policy in 2006 then inflation would still have been 3% and stable in late 2007. If Zardari and the civilians who took over in early 2008 had done a more professional job of handling the economic crises at hand perhaps inflation would not have surged as much, and Pakistan could have avoided borrowing 7 billion from the IMF. The economy may also have retained some growth momentum instead of totally turning flat. And obviously, if the oil and wheat price shocks had not happened, Pakistan would have been much better off.
The global recession that hit in late-2008 just made a bad situation even worse. At least Pakistan's banking sector did not get caught up in the global mania and has come through unscathed. But all three of these happened, and the result was zero economic growth from July 2008 to June 2009.
This fiscal year is shaping up better. Car sales are up, and tax revenues are rising again, faster than inflation. Inflation has fallen back to 8%, and this has allowed interest rates to come down from sky-high levels. If we can get back to normal, there is no reason Pakistan cannot return to 7% growth per year. Currently, GDP per capita is about 2750 dollars. The lower end of developed country status is around 15000 dollars per capita, which means 2-3 doublings would get Pakistan to that level. This can be done in 25 years of 7% growth. Time to get to it.
