November 27, 2020
Pakistan Poised for Liftoff
After a lost decade under the failed economic leadership of Zardari and then Nawaz Sharif, Pakistan’s economy is finally poised to enter an upward spiral of strong economic growth that will transform the country in this coming decade. Two years of painful reforms, further slowed by the effects of COVID-19 on the world economy and Pakistan, are about to give way to real results. While pessimists are looking in the rear-view mirror, the road ahead should allow Pakistan to pick up economic speed and return to the high growth path of the 2000’s.
Pakistan’s economy grew over 6% annually under Musharraf, peaking at 9% growth in 2006, but once the PPP gained power in 2009, the economy began a painful slowdown and a spike in inflation, which peaked at over 20% in 2010. Growth averaged less than 4% for the five years of the PPP government, which was replaced by Nawaz Sharif’s PMLN in 2013. Sharif benefited from CPEC, the Chinese government’s massive investment plan in Pakistani infrastructure, which has yielded new motorways linking the major cities, and enough new power plants to cover the chronic shortage of electricity. Despite those strong positives, Sharif could not get growth to average much more than 4% for his five years, another extremely dismal performance. The economically illiterate decision to keep the Pakistan Rupee exchange rate fixed at about 99 to the US dollar for several years, even as the currency was losing its value due to inflation, left Pakistan with an extremely overvalued rupee. This crushed the Pakistan export sector, which saw basically no growth for a decade, while encouraging imports. The net result was a massive trade deficit that ballooned to 30 billion dollars by 2018. Where was Pakistan going to find the dollars to pay for all these imports? It relied on the large flow of remittance money coming from overseas Pakistanis, which amount to 20 billion dollars per year. This was able to balance the numbers till 2017, when imports exploded and the foreign exchange reserves of Pakistan began to collapse. By 2018, it was obvious that Pakistan faced a balance of payments crisis, and borrowing ten billion dollars from Saudi or China was not going to happen. The inevitable then occurred, to go hat in hand to the IMF.
By this point Nawaz Sharif and the PMLN had been defeated at the polls, though they claim that the deck was stacked against them by the army and the election was not fair. Regardless, the voters turned to Imran Khan and his PTI party. Khan was a blank slate, an unknown quantity who had a history of some rather concerning statements and religious sympathies with extremists. But in power, he moved quickly to form a technocratic governance team. The most pressing issue was concluding a deal with the IMF, and enacting reforms so that Pakistan would not be faced with this situation ever again. On both fronts, he succeeded. Two absolutely critical reforms occurred, first, allowing the rupee to float, meaning that its exchange rate was to be set by the market, and not by the government. While the PML-N has long believed that the laws of supply and demand, and the basics of all economics, do not apply within the borders of Pakistan, Imran Khan did not suffer from that intense delusion. Secondly, granting the State Bank of Pakistan true independence to set monetary policy, as any serious economy does with its central bank. Khan put highly capable in charge at the SBP, the Ministry of Commerce, and Ministry of Finance. The rupee fell to 165 to the dollar before stabilizing.
By early 2020, signs of improvement began to show up in the Pakistani economy. The current account deficit (basically the trade deficit plus the flow of remittance money) began to improve dramatically, falling from 6% of GDP to 1% of GDP as the trade deficit shrank. Exports in rupee terms began to rise sharply. Inflation, which had peaked at 14% in January 2020, finally seemed to turn the corner, as the SBP engaged in a tight money policy setting the policy rate at a very high 13.5%. Then COVID-19 hit, and the entire world economy slowed. Pakistan lost export customers, while the domestic economy contracted due to lockdowns.
But Pakistan rebounded rather quickly, as COVID-19 remained well-controlled in Pakistan for reasons that are still mysterious. Pakistan did much better than advanced Western nations, and also did much better than India. By the summer the economy was turning upward and with autumn, Pakistan’s economy is showing definite signs of vigor. The current account since July has actually been showing a surplus for the first time in the last few decades if not in Pakistan’s history. Foreign exchange reserves have already soared back over 20 billion dollars, and it is expected they will continue to accumulate for the foreseeable future, reaching a new all-time high within the next 12 months.
Industrial activity has picked up. It has climbed not just compared to the lockdown months in the spring, but are up 9% in October compared to October 2019. Cement sales, which track construction activity, blew past its all-time high in October too. Car, motorbike, and tractor sales were also up sharply in October compared with a year earlier.
Pakistan’s single biggest industrial sector, its textile industry, mostly based around Faisalabad, is booming. With a competitive Rupee, the industry is enjoying huge growth in orders. The Faisalabad companies are operating at 100% capacity and investing in expansion. The mill owners are even complaining about labor shortages. Prospects in Faisalabad are so positive an international airport and expo center is now planned.
Consumers in Pakistan are also spending in force. Profits in Pakistan’s consumer goods sectors is up 26% over a year ago. Pharmaceutical companies are showing very strong revenue growth over 2019. Overall sales growth compared to a year ago in the consumer staple sector is up 23%. For example, Pak Elektron reported soaring sales and profits due to strong purchases of its refrigerators and air conditioners. The positive performance of the economy is confirmed by tax receipts, which is hard data that tracks economic activity very closely. Despite all the pandemic headwinds, Pakistan has been meeting its revenue targets. Meanwhile, foreign direct investment in October was over 300 million dollars, a 10-month high.
Inflation, which peaked at 14% in early 2020, has fallen sharply to under 9% by October. Core inflation, stripping out volatile food and energy prices, is even lower. This has allowed the SBP to cut interest rates almost in half, to 7%, which will act to sharply boost economic activity. Critics claimed that too sharp a drop in interest rates would result in a sharp drop in the now freely-floating rupee, but that has not happened. In fact, due to the current account surplus, there is no significant downward pressure on the rupee, which has actually strengthened a bit during this year. Gallup has been polling Pakistanis quarterly on consumer confidence, a new and very useful private sector source of data of how Pakistanis are feeling about the economy. In the third quarter ending in October, consumer confidence soared to 89 from 79. This is still somewhat depressed from “average conditions” which correspond to a value of 100, but the trajectory in strongly in the right direction.
Pakistan is at the cusp of entering a high growth cycle underpinned by stable macroeconomic conditions and policies. The economy should respond with vigorous growth going forward. As it is, Pakistan will end 2020 with mildly positive growth, compared with India, whose economy will contract 10%, a massive drop, or the 3-6% drop occurring in the US and EU states. But 2021 will likely be a very good year.
Are there any black clouds out there? Two that are obvious. First is the pandemic. Pakistan has mysteriously avoided a serious public health catastrophe, and while the government has taken the issue seriously from Day 1, it remains hard to explain why Pakistan has done so much better than Western nations or its nearby peers such as India and Iran. If the pandemic was to somehow swell, forcing a national lockdown, that would create a significant economic setback, though it would be temporary. It looks like the vaccines are almost here, with three major trials already showing positive results, and several more due to report in next 6 weeks. The Chinese actually have a vaccine based on fairly simple technology, they use inactivated dead virus and inject that into patients. The Chinese vaccine has not completed a Phase Three trial proving it works, but the government has already given this vaccine to several hundred thousand Chinese, particularly in their military and in Chinese traveling overseas for work. So far, according to the Chinese government, there has been no documented infection in anyone receiving this vaccine. That is very promising if true, and Pakistan is well-positioned to access large supplies of this vaccine if it is unable to obtain Western vaccines in a timely manner, which will be mostly distributed to the US and EU first.
The second issue Pakistan needs to grapple with is inflation. While overall inflation has slowed this year, it is still higher than the 5% rate that Pakistan has averaged for the last few decades. More importantly, much of the recent inflation has been rather sharp among staple food items like sugar, potatoes, tomatoes, onions, eggs, ghee, chicken, and flour. When these prices rise they make life particularly difficult for the poorest, who spend the bulk of their earnings on food. The government does not directly control food prices, they are set by supply and demand, like all else. But government policies can have an impact. Where there are shortages causing price spikes, the government needs to improve supplies of the critical items. It has moved to do so, by importing wheat and by starting the sugar cane crushing season to improve sugar supplies. There already seems to be some slowdown or even decline in prices of some of these items. The SBP feels that the food price spikes are temporary and will not continue long term, but for now they are creating real hardships.
Despite that, the overall picture looks quite good. Pakistan should see decent growth this fiscal year ending in June 2021, perhaps reaching 4% or higher, and from there it should accelerate to 6-7%. The long term goal must be to keep growth at 7% for the next three decades, a pace at which Pakistan will finally transform into a developed country.
