Pakistan; Challenges in PoliticalGlobal Economic Policy Institute

Economic Development ICEA Feb 13th 2007

Professor Paul E M Reynolds

LONDON Tel + 44 20 874 86788

Mob & SMS + 44 7974 188087

E mails

paulreynolds@email.com
paulemreynolds@gmail.com

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Pakistan, showing NWFP, FATA & Northern Areas

Why is Pakistan important ?

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Strategic geo-political & transport bridge Mid-East and India & China 165-170m pop More people in Pakistan than in Russia Potential for Kashmir flare-up risk of big impact on world growth Border region with Afghanistan - Cross border raids, and question of Tribal Areas and Pashtun nationalism ? - Relationship with NATO/US military activity Role in War on Terror and Deobandi ideology (Talibs = Students) Many internal factors that create risks of political instability Nuclear armed state and advanced delivery systems Borders with Iran, Afghanistan, India, China, close Gulf States, C Asia Important Diaspora especially in the UK (and UK troops on its border !)

URGENCY: Presidential & National Assembly Elections Oct 2007

unclear how political events will pan out

Pakistan; Challenges in Political-Economic Development

Macro, micro & political conclusions.

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Needing to break out of gridlock, government is in a difficult position

1.

2. 3.

4. 5.

Macroeconomic improvements good - but slow reforms in government, in regulation and within the real economy retard investment & growth rates, hinder exports and undermine fiscal/structural sustainability of growth Flow of FDI inflows now under threat, diaspora remittances up, but insufficient real economy investment opportunities as final destination consumer imports sucked in, savings rates low Full-speed reforms across government needed, but gridlocked due to political uncertainty - helps the reform resistance & project silos. Key decentralisation suffers from unintended consequences. BUT.political reform gridlocked by constitutional-political structures and the Presidents need to please too many masters

Role of Tribal border (Afghan) areas and relationship with The West is critical for political and economic reform

Economy stabilised & growth path established

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Economic performance
2001/2 3.1% 2002/3 4.7% 2003/4 7.5% 2004/5 8.6%

WB/IMF

1990s 4%

2005/6 6.6%

2006/7 6.5%est

GDP growth
Inflatio n (Av.)

7% tgt
9.7% 2.5% 3.1% 4.6% 9.3% 7.9% 6.5%?

Fragility of economic progress

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Public debt declined from 97% of GDP annual average 1990s - to 75.3% by 20023 & 56% 2005-6 Annual fiscal deficits fell from an average (excl grants) of 6.4% of GDP, last 5 years of last decade, to 4.4% first 5 years of this decade (3.7% 2006-7 est.) Average trade policy tariffs at normal LDC levels after WTO memb. in 2001
BUTBUT..

Industry still less than 20% of GDP 2005/06 investment at 16.5% of GDP - too low for sustainable growth (World Bank - 27%+ required) Growing current account deficit - driven by a widening trade gap as import growth outstrips export expansion - from 1.4% of GDP to 4% of GDP in 2005/6 putting pressure on FX reserves

IMF says (2007) need to align demand & output growth (Privatisation-related
FDI and internal borrowing one-offs) But GoP points to import price-hikes as one-off (To be continued..) IMF imperative - Higher savings and poverty reduction IMF REMEDIES. Improve the investment climate, financial market reform, tax reform, improvements in public service delivery, and trade liberalization

Trade & fiscal imbalances reducedbut

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Economic growth context

Yr. to 2006 FDI up to $3.5bn (1/2 from telecoms). Investment from Gulf states. Remittances $4.2bn in 2005/6 - biggest ever Banking & electricity distribution privatisation successful Poverty fell 10% 2001 2006 (WB) Cost of borrowing relatively low..good GCC demand for Pakistani Govt paper BUT But. trade deficit $10bn and growing FDI effects of privatisation slowing Big increase in MTDB, up 52% 2006/7 despite quality-of-investment problems Low national savings rate, 17 percent of GDP, due to fiscal deficits and negative interest rates 4% of GDP spent on the military, possibly much higher, pressure on deficit Only 28% of population is in the workforce, 32% of pop below poverty line 1m Afghan refugees + Trouble in Tribal Areas

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political will to challenge the interests of the bureaucracy & crony capital across federal, provincial, & local government

Real-economy problems requiring

Institutional complexity and bureaucratic turf problems

Legislation, regulation, overenthusiastic regulation some resistance to reforms

Govt. Project culture, weak systemic reform focus (policy silos)

EXAMPLE 1. Contract enforcement

EXAMPLE 2. Admin barriers and cost of doing business

Result domestic investment opportunities, & bottom up

domestic growth, both dampened = inflationary pressure, monetary growth, import growth, pressure on FX reserves ?

Institutions responsible have overlaps & gaps in reform

New institutions to solve this problem ?

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Diagnosticitis, policy silos & analysis-paralysis ?

Ministry of Finance & Planning Ministry of Industry, Prodn & SI Board of Investment Ministry of Commerce Ministry of Econ. Affairs (EAD) Monopoly Control Authority Housing & Works Div. Securities & Exchange Commission Planning Commission, 4 members National Reconstruction Bureau Economic Coordination Committee Public Sector Reform Committee

Cabinet Division (3 Depts) Economic Council Office of the Economic Adviser Ministry of Law & Justice National Comm. for Govt. Reforms Civil Service Reform Unit Law & Justice Commission PMs Secretariat Ministry of IT Ministry of Parliamentary Affairs Competitiveness Support Fund 4 Provinces, FATA, PATA Trade Corridor Committee Office of Private Public Partnerships Federal Ministry of Tribal Areas Ministry of Inter-Provincial Coop.

Wrong micro-economic reform tools ?

Government spending versus government efforts
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Huge political will required to overcome deep-rooted systemic problems & interests does political uncertainty prevent this ?

Financial deepening reforms (NSS, Pakistani Investment Bonds) and reforms of intermediation system (Badla) underway - will make better use of remittances & other funds, and tax admin reform has increased receipts

but these are not the core problems..

Credit expansion is a risk, and linked to remittances Political limitations prevent expansion of the tax base Too much reliance on more costly but less effective growth stimulation methods ..Eg building business parks & giving tax breaks, rather than - reform of regulations that inhibit capital goods imports - tackling overenthusiastic interpretation of regulations

Pakistan (example): Steps/time and cost of contract enforcement (Source World Bank 2006)
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Figure 3.4a Steps and Tim e to Enforce a Contract 50 40 30 20 10 0
No Steps Time

Figure 3.4b Cost to Enforce a Contract 500 400 300 200 100 0 60 50 40 30 20 10 0
(%of contract value)

India

China

China

Nepal

Thailand

Bangladesh

Thailand

Bangladesh

Sri Lanka

Malaysia

Nepal

India

Philippines

South Asia

Case backlog - half are commercial - in the High Courts of Sindh and the Punjab number over a hundred thousand, and for the lower courts, in the millions - 40% land, 30% challenges to regulations, rest banking/employment When cases do go forward, it takes, on average, more than 46 steps, more than a year and almost a third of the contract value to enforce a contract System is ill-prepared for modernisation - new legal frameworks in complex areas such as foreign investment, insolvency, monopoly regulation, anti-money laundering, insider trading, and corporate governance

South Asia

Philippines

Sri Lanka

Malaysia

Pakistan

Pakistan

Turkey

Vietnam

Turkey

Vietnam

Real-world problems in economic development dampen investment

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WB value-chain study of key sectors shows major structural, institutional & regulatory problems: Shrimps, textiles, marble, processed dairy, auto parts

High transport costs, high electricity costs (outages) limiting automation, labour market rigidities (temp workers used), access to finance (collateral & informational), imports costs (multiple permissions required etc), cash flow from duty drawback & custom rebate delays, high port charges, state control of input sectors, freight sector over-regulated, opaque land leasing & security of tenure - & resultant low capacity utilisation Fees and taxes collected by the Government represent a quarter of export costs and come from three sources: the petrol tax (1 percent of export invoice), Export Development Fund (0.25 percent of export invoice), and unofficial, speed money payments (approximately Rs 1,250 per consignment). [Poor port governance contributes]. Layers of taxes & levies to agents, the PAs, and security payments add to costs. High tarrifs in many sectors. Pakistans aggregate direct labor cost $0.75 /hour - higher than Chinas $0.66 and Indias $0.40 but productivity lower.

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Resistance to pro-growth regulatory reforms ?

2004/5 World Bank project on regulatory reform Impact

has been minimal

published.

2005 Better business regulations IFC. Admin barriers report not 2006 IFC/World Bank business regulations, pending

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Future economic reform challenges

Regulatory quality and the link to rent-seeking Poor domestic export performance relative to expectations, and the lack of investment to overcome high costs Capital infrastructure problems access to debt & equity finance for export development, and absence of venture capital & real sector investment funds Low growth productivity in the use of inward financing from remittances and capital repatriation This challenge combined with industrial and labour rigidities/monopolistic markets = not enough productive places to put the money How to apply telecom sectors success in attracting investment to other regulatorydependent sectors like electricity, water, transport and hydrocarbons. How to address investment and economic growth inhibitors (How to support the Ministry of Law & Justice in tidying up of existing legislation and regulations) Addressing urgent need to tackle problems created by the separate MTBF and MTDF, (eg poor use of assets, lower investment) How to address the negative impact on domestic investment and growth arising from the domestic financing of the budget deficit.

Fiscal decentralisation issues

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Growth & political reform requires change

Reforms started in 2001 but within existing structures

Pakistan is highly centralised fiscally

Sub-national governments in Pakistan - very low subnational tax collection rates by international comparisons Only 0.9 percent in GDP of revenues in 2005/6. Indias - 6.1 percent, or 7 percent based on more recent figures (World Bank 2005:xxvii) Provinces in Pakistan are highly dependent on federal shared revenues and grants complex system. All provinces receive identical per capita levels of divisible pool allocations All provinces are characterized by low own revenue mobilization, although some differences are evident across provinces.

Fiscal Decentralization in Major Developing Country Federations

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Federation, Developing Country

Sub-National Expenditures (% Total)

Sub-National Expenditures (% GDP)

Sub-National Own Revenues (% Total National Revenues)

Sub-National Own Revenues (% GDP)

(I)

(II)

(III)

(IV)

Pakistan* India Ethiopia Nigeria

34.2 49.2 35.9 38

6.3 10.8 9.5 13.6

7.0 33.8 18.7 10.7

0.9 6.1 3.0 3.18

South Africa
Argentina Brazil Mexico* Venezuela Russia

56.5
44.4 41.7 41 19.6 38.5

18.9
12.4 15.3 7.4 ~ 12.7

18.9
44.2 39.0 25.5 ~15 32.4

6.1
8.4 10.5 4.5 ~ 13.0

Malaysia

11.0

2.4

9.1

2.4

Source: Figures for Pakistan are FY2005/6 budget. IMF GFS (10/2005), most recent year available, WB Reports for unavailable countries (italics). As share of central, state, and local government, net of onward transfers by central and stage governments. Sub-National Revenues do not include financing. *Alternative to GFS expenditure figures for Mexico using World Bank (World Bank 2004; 2004).

Unequal regional incomes

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Table 1: Key Indicators for Pakistans Disparate Federation

Population Share

GDP Per Capita (2004/5) Human Development Index Number of Local Governments

Area %/million Rs. %/km2 Balochistan NWFP Punjab SINDH 5.1 % 13.8% 57.4% 23.7% 128.4 Total/Average Source: World Bank, UNDP 2003 Human Development Report (p. 11) NA 35,211 47,131 61,563 1.5 45.2% 9.7% 26.8% 18.3%

Index 0.499 0.51 0.557 0.549 26 24 35 21

0.541

106

Complex system of Provincial financing

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Per Capita Rs., 2005/6 projected

5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0

Subven/Other Legacy DivPool Shared OSR

Source: World Bank compilation of provincial budgets

Ba lu ch is

Na tio na l

Pu nj ab

NW FP

Si nd h

ta n

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The status of the Tribal Areas across the Durand Line

Historical Afghan territorial claims over Pashtun NWFP, PATA, FATA, & Pashtun areas in Baluchistan Administered by Punjab British Commissioner, then 1901 direct Delhi rule of NWFP Province - settled & FATA tribal areas separate, both as NWFP Afghan buffer zone Separate status, continued post-independence constitutional FATA buffer zone and tool against Pashtun nationalism on both sides of the border; not elected (A247). NWFP Governor formally represents President Pre- & post- colonial regimes no troops deal with (paid) Maliks & Lungis Frontier Crimes Regulations (1901 to today), FATA de facto constitutionally separate, Presidential control, Political Agent rule in FATA agencies absolute President has authority over all governance & military arrangements in FATA (1973 constitution A247/5). Via primary legislation FCR, permits detention-no-trial PAs (executive-judiciary-legislature) appoint own para-militaries can fire Maliks appoint Maliks to Jirga courts no full appellate path or normal rights FATA areas a channel for very large-scale US funds to Afghan mujahadeen during Soviet occupation but govt. wary of Pashtun cross-border nationalism 1980-2000 roots of ISI culture & skill balancing different Pashtun interests

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The role of FATA in the Pakistani Political System

12 seats in the National Assembly, 8 in the Senate, elected by appointed (all male) FATA Maliks in the pay of the Presidency/military & each easily dismissed
But parliament cannot legislate on FATA, and general Pakistani laws do not fully apply in FATA FATA parliamentarians linked to pro-Deobani groups (JUI-F) No representation over FATA, or in NWFP legislature Alleged tit-for-tat: support in parliament, for peace, arms/drugs trade, & Deobandi freedom to act without political competition Political parties & national/regional secular political groups banned in FATA Since Afghan Soviet occupation, (& huge US mujahadeen financing), proDeobandis groups & Maliks have grown under such political cover, and replaced old school Maliks JUI-F coalition partners of govt. in Balochistan ! Presidency has inherited this system propped by negotiated balance

Presidents international trump card: better to accept a complex negotiated

balance than risk a Deobandi government /Pashtun state (may well be true !)

Complex governance: a simplification

Difficult to reform
Global Economic Policy Institute Presidency Government Prime Minister. Cabinet. Donors.

PEACE AGREEMENT

7 Political Agents
Naib-tehsildar (Exec, judiciary, legislature)

North West Frontier Province Settled areas Districts

SAFRON Balochistan

Agency Councils

Provl FATA Secretariat

PATAs

Funding. Donor projects.

Maliks
FATA Development Authority

Lungis

FATAs (Mostly Pashtun). 3m pop. on Pakistan side. 7 Agencies.

Inter-Tribal Jirga

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Military interventions part of the solution or part of the problem ?

Reform and/or Resolution

Parliament can normalise rights and court system (FCR was removed from NWFP and Balochistan) Supreme Court can strike down FCR as unconstitutional FATA could become part of PATA under NWFP But instead 2000/1 NRB Devolution Plan excluded FAA Provisional Agency Councils appointed by tribal Jirgas Military action continues, (but seen as demonstration effects to USA counterproductive ?) (ICG Dec 2006)

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Will reform strengthen or weaken the government ?

Can economic growth address political issues in Tribal areas ?

Per capita income $500. 60% below poverty line. 97% female illiteracy (male 71%). But. Need to demonstrate success against foreign fighters etc Buying of permits and rent-seeking will decline Decline of 20 year old arms & drug trade - & military %s (army allows vibrant trade & doesnt require permits) Pashtun nationalists & Deobandis may turn on govt. Parliamentary support would be lost NWFP JUI-F and Balochistan support may be lost

The near impossible task of serving many masters.

Is the outcome a kind of political gridlock ?

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The view from the Presidency ?

Donors & foreign NGOs USA

Domestic elite, landowners, govt. influencers, & crony capitalism

Local NGOs, pro-democracy groups

Govt. Ministries Military, Governors, & PAs Presidency Head of State Tribal Elders Drug & arms traders I.S.I.

Deobanis & Pashtun Nationalists

Foreign fighters ?

Reform versus uncovering foreign fighters

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Show me something

Donors & foreign NGOs

USA War on Terror issues

Domestic elite, landowners, govt. influencers, & crony capitalism

Local NGOs, pro-democracy groups

Govt. Ministries Military, Governors, & PAs Presidency Head of State Tribal Elders Drug & arms traders I.S.I.

Info barrier

Deobanis & Pashtun Nationalists

Foreign fighters ?

A counterproductive brutal search for foreign militants ?

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Why did they fight, why did they agree ?

LOW-LEVEL WAR

The Inter-Jirga Peace Agreement

June 2002 - US pressure troops to capture MO, OBL etc March 2004 search for foreign militants Tribes refused (failed Former ISI General ICG 2006) Govt. sued for peace June 2004 Nov 204 agreement amnesty, cash, BUT hand over foreign militants, & stop crossborder attacks Feb/March 2005, 6-point peace plan with JUI-F over South Waziristan Escalation - heavy casualties in March 2006 battles Effectiveness of official institutions declines Military pressure on the President New (military) NWFP Governor May 2006 North Waziristan Ceasefire June 2006 signed with JUI-F and Deobandis/Pashtun nationalists North Waziristan Peace agreement with Deobandis Sept 2006 Oct 2006 Cross border raids on UK & US troops up (Gen Jones NATO) Foreign militants found are few and mostly 20-year settlers from the anti-Soviet war (Tajiks, Uzbeks)

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The Sept 2006 Peace Agreement

GoP to halt all ground & air attacks GoP to release prisoners Checkpoints removed Financial compensation of combatants for losses Tribal privileges and salaries restored GoP to return weapons and allow open carrying of weapons Foreign-born militants to respect local laws Cross-border trade (legal & illegal) restored Combatants to halt all cross-border attacks Return to official institutions no parallel bodies GoP troops relocated Joint 10-member Council to oversee Agreement

Conclusions
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Good quality macroeconomic management in Pakistan under difficult conditions but risks from microeconomic realities Deep-rooted problems in real economy reforms and reform within government. Political barriers to real-economy reforms are tenacious strong political will needed domestically & internationally Chain of causality ? Economic reform enables political reform or vice versa ? Symptoms of gridlock on both. Military demonstration effects for the USA & NATO, may be counterproductive. (How to break the information barrier ?) Political reliance on Tribals & ISI (Deobandis indirectly) is an accidental Western creation. International support for political reform, especially in Tribal areas, needed to untangle gridlock and accelerate economic reform.