The present government has done remarkably well in  getting the economy on the road to growth and introducing many reforms. Despite the gains, macro-economic fundamentals and foundations are  now on shaky grounds and dark clouds of vulnerability are showing on the horizon, as discussed below .  

Growth is  Likely to Slacken

A clear danger  is the fundamental weakness in the growth strategy, which is inward looking and mostly driven by  consumption  Almost all  developing countries which have followed an inward looking growth strategy  have booms followed by busts.  Pakistan  cannot sustain growth  through expansion of telephony,  real  estate and stock market bubble,  and domestically produced white goods  and vehicles under cover of protectionist policies. In neighboring India, while domestic consumption has been an important driver of  growth, equally important  contributors have been  export and investment. India’s exports ( as % of GDP) increased from 13% in 2000 to almost 20% in 2006. Pakistan has hovered around 15-16 % during this period. India’s investment rate is around 30% while Pakistan is woefully low at 16 %. Without a rapid  increase in exports, and investments especially in export sectors,  not only growth will soon peter out , but in a few years  the country could be faced with severe balance of payment crisis  .    Pakistan needs an aggressive program to address export competitiveness constraints and an equally  aggressive exchange rate policy. Export must be nurtured by leadership to become national obsession, rather than real estate development. .

 Looming Balance of Payment Crisis

The growing and unsustainable levels of current account deficits and the inappropriate manner in which it is being financed, is a potential landmine. Reserves have dropped  to  under   4 months and could  go down to dangerously low levels in  two years. On the other hand , India’s reserves have mushroomed to over  one years’ worth of imports, with higher growth rates and lower inflation than Pakistan.  Pakistan is  imprudently following a policy of financing the current account deficit in any which way possible, rather than addressing the root cause of the imbalances and attempting to reduce the imbalances.. Using  remittances and foreign investments  in service sectors , portfolio investments  and GDR  issues ,  as a major source of financing current account deficits  ( and fiscal deficits)  is  a misguided and inappropriate strategy. And the gap will rise when Pakistan runs out of selling public assets to foreign investors.    While  foreign investor’s interest in Pakistan is a good sign, for which the present leadership should be commended, almost all FDI is in sectors that generate local revenues  while the future FDI obligations ( in terms of  dividends and foreign loans) are in foreign currency. Moreover, the benefits of the FDI  foreign exchange inflows are one time,  because they are being consumed, , while the potential foreign obligations are perpetual and long term . FDI may not have a contractual payback as loans, but it is not a free lunch. In fact dividend payments on FDI are usually very high, to account for the higher risks.   Pakistan needs more FDI in export manufacturing and far less in golf courses, fast food chains, speculative portfolio flows and fancy high rise buildings. This  foreign financed consumption binge is great, especially for the rich, but without a much higher and sustainable export and investment growth, the party would be soon over. As always the disastrous consequences of  low growth  would be borne by the poor. Given the macro vulnerabilities, the high levels of service sector FDIs is something to worry about rather than gloat about.  With any slackening of  growth,  which is around the corner,  the current FDI strategy  will  haunt Pakistan  

 Soft Fiscal Management and Unsound Expenditure Policies

 Stagnant fiscal revenues and increasingly populist  public expenditure policy and management , is another  major danger sign There is no way that Pakistan can sustain high growth and provide its citizens with decent public services, without a major increase in tax revenues.  Comprehensive and aggressive federal/provincial tax reforms are needed, especially to expand tax base and also capture the enormous wealth generated in the services sectors like capital markets, real estate and retail. It is unthinkable that the club of the elite , comprising the main beneficiaries of the capital market and real estate boom, is by and large exempt from tax. This asset price bubble has not  benefited Pakistan; thus the capital market performance has been dismal in raising funds for new investment,  which should be its main goal,  while the real estate boom has made housing out  of reach for most Pakistanis. Exempting these sectors from the tax net is not only regressive, but distorts  investment incentives.  Why would a business invest in export manufacturing, or any manufacturing, when it could get much higher tax free returns in the stock market or real estate ! Taxing these sectors will burst the bubble, which will only hurt the few hundred thousand participating in the stock ,  but  make land affordable for the millions of less affluent and middle-income folks.

Populist programs are creeping into the budget. The enormous subsidy on power, which mostly benefits the non-poor ( most  poor don’t have access to commercial energy) , is  glaring example of  a populist   expenditure policy..  Another worrisome example is the quality of the public sector development program ( PSDP) . While the PSDP has increased , so has the share of  projects with questionable  economic benefits.  Public investment decision making suffers from  personalized decision making, inclusion of  projects with questionable  returns, and poor quality  benefits analysis of  new projects. High PSDP will only contribute to growth if the underlying projects have adequate economic returns. PSDP is too much ‘brick and mortar’ centered, with inadequate  attention to achieving development results.

Ticking time bomb of Poverty and Growing Inequalities

There are around 40-45 million poor and perhaps the same number close to the poverty line, who have  limited access to decent education, health, economic opportunities and assets. While the share of people  below the poverty line  has gone down ( a statistic which, along with growth and inflation numbers,  suffers from severe credibility with people) , life for these 80-90 million has largely remained unchanged.   There is more national interest in stock markets and real estate developments, and much less in making sure that the poor are actually getting  greater  access to  better quality of life.  Therefore the present development strategy is   widely perceived as one  for the elite, of the elite and by the elite. A much more aggressive  and  effective poverty reduction strategy is  needed to ensure that these 80-90 million people have  a stake in the  market based economic system and to address the gross and growing  inequalities.  Dramatic increase in pro-poor expenditures on the ground ( not that resulting from salary increases of teachers and counting police expenditures as pro-poor) are affordable and doable, by switching expenditures from questionable  PSDP projects , unjustified  subsidies and wasteful current expenditures.

Policies undermining the Federation

Inadequate and timely attention to “economics of the federation”.  could lead to a break-up.  Pakistan is a unique federation. No other large federation, India, USA, Brazil, Russia, etc faces  this “manufacturing defect”, where one federating unit has  disproportionate and overbearing influence ( perceived and real) . The present government has increased resource flows to the smaller provinces, which is a very good step. However there are a few  key policies that need a paradigm shift to strengthen the “federating glue” and overcome the historical sense of deprivation .

There is urgent need to have a  market based  natural resource pricing , for water and gas. The present pricing and sharing of profits/royalties is unfair to Balochistan and NWFP, and has largely benefited the energy consuming population in  Punjab and Karachi. Imagine the resource transfer to Balochistan and NWFP, over  last 40 years, if the prices were market prices – prices that Pakistan was paying for imported energy. Imagine if  Balochistan received the same price of gas as Pakistan is now willing to give to Iran. A market based pricing, along with a system that distributes the  additional  gains to  the province and directly to its citizens  ( eg sharing of Alaska pipeline dividends) needs to be put in place. Another worrisome issue is the growing  disparities in economic and social progress between Punjab (and  Karachi ) and  the rest of the provinces. Punjab is galloping away, while the smaller provinces and rural Sindh  are  being left behind, both in a reality and perception..   It will become  untenable in a few years,

In conclusion, it is vital that the recent success does not blindside policy makers to the serious challenges around the corner and the weak   growth foundations on which the present success is built upon. There are emerging  signs that the future is being compromised for the present.  Bold steps, and a change in growth and development strategy, are needed to ensure that the growth is sustainable and the strategy is credibly seen as one that is for the people, of the people , and by the people.

( The writer is a former Operations  Advisor at the World Bank)