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The author is grateful to Nadeem Haque, Mahmood Hasan Khan, Abbas Mirakhor, Azizali Mohammed, Shuja Nawaz, Delano Villanueva, and Arshad Zaman for helpful discussions and comments, and to Ravina Malkani for providing excellent assistance.
This paper has been prepared for publication in “Studies in the Modern Political Economy of Pakistan,” edited by W.E. James and S. Roy, University of Hawaii, East-West Center, 1990.
This follows the categorization of policies suggested by Khan (1987). It should be noted that exchange rate policy also has demand-side effects, although typically the expenditure-switching effect is given greater emphasis.
For more detailed discussions of economic performance during the 1970s and 1980s, see Ahmad and Amjad (1984) and Asian Development Bank (1985). The 1970s experience is also described in Baqai (1979) and Burki (1981).
Between 1972 and 1986 Pakistan had received grants and concessional loans amounting to over $17 billion.
Dell (1980) and Killick (1981), among others, argue that these external factors were primarily responsible for the balance of payments difficulties of all developing countries. See also Khan and Knight (1982), and (1983) for a somewhat different view.
This does not mean that the other objectives are totally unimportant, rather that they have been apparently less significant from the standpoint of macroeconomic policy.
In some sense, this can be seen as a contradiction in terms--the Planning Commission reducing the role of the government and of itself. However, by expanding the areas of the economy in which the private sector could participate, the Plans and the Planning Commission was doing precisely this.
This approach considers the balance of payments to be a reflection of the desire of residents to accumulate or run down their stock of money balances. In this framework, with fixed exchange rates, an expansion of the domestic component of the money stock--domestic credit--induces the public to dispose of surplus money by buying foreign goods and securities, leaving output and prices unaffected. There is thus a one-for-one relationship between the balance of payments and domestic credit expansion. For a discussion of this approach, see Frenkel and Johnson (1976) and IMF (1977).
The transformation of the banking system into an Islamic system during the last few years has led to the replacement of interest-based transactions with profit and loss sharing arrangements. The government has less control over the rates of return implicit in the latter, although it can, and does, influence these rates. For a description of Islamic banking as practiced in Pakistan, see Iqbal and Mirakhor (1987) and Ahmad (1987).
For an analysis of Pakistan’s exchange rate policy, see Khan (1986). The main theoretical aspects of exchange rate policy in developing economies have been discussed in numerous papers, including Johnson (1976), Dornbusch (1981), and Khan (1987).
Exchange and trade restrictions have been in force in Pakistan since independence in 1947; see Islam (1981). The evolution of the system of controls is described in Kemal (1987a). See Tirmazi (1987) for a comprehensive discussion of export subsidies and taxes.
See Khan (1989) for a discussion of how foreign exchange controls have been circumvented in recent years, as well as the steps taken by the government to relax some of these restrictions.
For a description of the trends in workers remittances, and their impact on the Pakistan economy, see Burney (1987).
Other estimates, for example by the Karachi Chamber of Commerce, put outflows at $3-4 billion over a similar period.
For simplicity it is assumed here that all foreign assets are held by the central bank, so that a change in net foreign assets (R) is equal to the balance of payments of the country. This is a reasonably valid assumption to make for Pakistan.
In countries where alternative financial assets are readily available one would also include the rate of return on these as an additional opportunity cost variable. However, for most developing countries, including Pakistan, the more appropriate specification turns out to be (2). as interest rates seldom turn out to have a statistically significant effect. For evidence on Pakistan, see Hasan, Kadir, and Mahmud (1988).
In the equation M is the stock of broad money balances (M2), y is real GNP, and P is the consumer price index. We approximated the expected rate of inflation by the previous period’s percentage change in the consumer price index (Ṗt-1). T-values are reported in parentheses below the coefficients; R2 is the coefficient of determination; D.W. is the Durbin-Watson statistic; and ρ is the estimated coefficient of first-order autocorrelation.
R is the domestic-currency value of net foreign reserves, and D is domestic credit of the banking system. T-values are presented in parentheses below the coefficients; R2 is the coefficient of determination; D.W. is the Durbin-Watson test statistic; and ρ is the estimated coefficient of first-order autocorrelation.
In 1972/73 defense expenditure was about 43 percent of total current expenditure and 8 percent of GNP.
For example, in 1973/74 the Government of Iran provided a medium-term loan of $250 million on very easy terms.
See, for example, Lahiri (1988). Of course this specification is highly simplified, but it is not the purpose here to model savings behavior in any detail.
The variables are defined in the text. T-values are reported in parentheses below the coefficients; R2 is the coefficient of determination; and D.W. is the Durbin-Watson test statistic.
Obviously there are omitted variables, such as the exchange rate, terms of trade, etc., from the specification, so that one would not expect a particularly close fit. See Khan and Knight (1983) for a more general specification of the current account equation for developing countries.
ΔD is the change in domestic credit and FD is the fiscal deficit. T-values are reported in parentheses below the coefficients; R2 is the coefficient of determination; our D.W. is the Durbin-Watson test statistic.
The highly restrictive nature of the import regime became apparent when the government compiled a list of imports that were banned. This list covered more than 6000 items, even though it was evident that for a large number of them there was apparently no domestic demand.
T-values are reported in parentheses below the coefficients; R2 is the coefficient of determination; and D.W. is the Durbin-Watson test statistic.
Note that we consider only remittances received through banking channels. Unrecorded remittances would also be expected to be equally sensitive to exchange rate changes.
In a sense the fiscal deficits became almost self-perpetuating in nature. Increased fiscal deficits were financed by external and domestic borrowing, and the interest payments on the increased stock of debt led to additional expenditures and further deficits.