Pakistan's Macroeconomic Adjustment and Resumption of Growth, 1999-2004
Author: International Monetary Fund

Contributor Notes

Author(s) E-Mail Address: hlorie@imf.org; ziqbal2@imf.org
Publication Date:
01 Jul 2005
eISBN:
9781451861587
Language:
English
Keywords:
WP; national income; U.S. dollar; GDP ratio; market price; broad money; factor cost; Pakistan's performance; government gross investment; climate in Pakistan; export bias; survey indicator; breakdown of GDP growth
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The main findings are as follows: (1) an increase in private national saving during 2001-03 was the key contributor to the turnaround in Pakistan's external current account during this period; (2) while Pakistan's growth was mainly export-led before 2003-04, it was largely led by domestic demand in 2004, especially consumer demand but also private and public investment; and (3) the structural reforms implemented in Pakistan during the past four years should make the observed strengthening in domestic savings and rise in domestic investment permanent, auguring well for accelerated growth within a sustainable external balance. The country's growth prospects would be further enhanced by a more externally driven growth process, and by an acceleration of structural reforms to further improve productivity and the investment climate.

Abstract

The main findings are as follows: (1) an increase in private national saving during 2001-03 was the key contributor to the turnaround in Pakistan's external current account during this period; (2) while Pakistan's growth was mainly export-led before 2003-04, it was largely led by domestic demand in 2004, especially consumer demand but also private and public investment; and (3) the structural reforms implemented in Pakistan during the past four years should make the observed strengthening in domestic savings and rise in domestic investment permanent, auguring well for accelerated growth within a sustainable external balance. The country's growth prospects would be further enhanced by a more externally driven growth process, and by an acceleration of structural reforms to further improve productivity and the investment climate.

I. Introduction

Over the past four years, Pakistan has returned to a relatively high growth rate, which is estimated to have accelerated to more than 6 percent for fiscal year 2003–04. This turnaround followed three years of steady decline in growth during 1998–99 through 2000–01. Even in per capita terms, growth has been robust in recent years. Per capita income in U.S. dollars is estimated to have reached $652 in 2003–04, compared to $501 in 2000–01.2

The resumption of growth is especially impressive when viewed in the context of the substantial macroeconomic adjustment that took place in this period. While this adjustment has in part been driven by external factors, right policies played a key role, in particular the government of Pakistan’s commitment to fiscal consolidation and to the pursuit of a broad agenda of market-oriented structural reforms in the fiscal, banking, and corporate sectors. These reforms have aimed at increasing efficiency, including through privatization, transparency, and good governance, and generally improving the business environment.

This paper looks back at the sources of the macroeconomic adjustment and resumption of growth over the past four years by providing an in-depth quantitative analysis of various factors at play. Based on the 2003–04 findings, the paper also highlights the conditions needed to ensure that growth of more than 6 percent can be sustained in 2004–05 and beyond, while maintaining internal and external stability. Both demand and supply factors are analyzed, and while the emphasis is mainly on quantitative indicators, the paper also qualitatively assesses the impact of ongoing structural reforms undertaken in Pakistan. Finally, comparisons are made between Pakistan and selected emerging markets which have managed sustained high growth rates, focusing on key variables recognized as critical for accelerated growth.

Section II details the accounting framework to derive and analyze the behavior of key macroeconomic aggregates in 1999–2000 through 2003–04. Section III looks at the numbers and highlights: first, the sources of macroeconomic adjustment and, second, the sources of economic growth in the period. The main findings are (1) an increase in private national savings during 2001–03 was the key contributor to the turnaround in the external current account in the period. This increase reflected both an increase in disposable private national income and a sharp rise in the savings rate itself. A surge in net private transfers from abroad, enhanced by a post–September 11 portfolio shift by Pakistanis to the home country contributed to this outcome. But a significant improvement in the financial performance of the corporate sector appears to have been a key contributing factor as well; and (2) while growth was mainly export-led before 2003–04, it was largely led by domestic demand in 2004, especially consumer demand but also private and public investment. This assessment is generally supported by an analysis of the breakdown of growth looking at the production side. Section IV draws conclusions for the sustainability of high growth rates going forward. The favorable impact of structural reforms on the business environment and on financial deepening, as well as the improvement in the efficiency and profitability of the corporate sector, augur well for the sustainability of high growth rates, even if certain exceptionally favorable factors, including low international interest rates, level off. We argue that those structural reforms have permanently raised the prospects for higher savings and investment. However, a more externally driven growth would reduce the risk of it not being sustainable. Furthermore, international comparisons with fast growing emerging market economies suggest that Pakistan needs to further catchup in terms of investment levels, external trade orientation, and financial deepening. While Pakistan fares well with regard to the business environment within the South Asia region, it lags behind China and other Southeast Asian countries. Thus, Pakistan needs to further pursue outward-oriented policies to boost exports and encourage foreign direct investment; continue with a broad range of structural reforms aimed at improving the investment climate; focus on developing its human capital toward a more skilled and competitive labor force; accelerate reforms in agriculture to garner potential productivity gains; and strengthen the country’s productive infrastructure, in particular for water management, ports, rural roads, and energy supply.

II. A Simple Accounting Framework

We first outline an accounting framework to analyze the behavior of key macroeconomic aggregates consistent with GDP, fiscal accounts, and balance of payments data.3 The framework is in line with Pakistan’s national accounts methodology, but attempts to more clearly differentiate between nongovernment (private)4 and government (public) consumption, thus savings, and their determinants. Here, we limit government to the coverage of the consolidated budget, which allows a direct linkage between macroeconomic developments and the more visible fiscal policy stance.5

Regarding the macroeconomic adjustment over 2000–04, the analysis mainly focuses on the behavior of private and public consumption and savings, private and public gross investment, and external current account transactions expressed as ratios to GDP. Subsequently, the analysis assesses the contribution of these aggregates to growth by looking at their estimated real growth rates and contribution to overall growth. Further insights are gained by looking at the sectoral breakdown of growth from the production side. The role of productivity improvements is inferred from the observed behavior of incremental output-capital ratios.

III. Key Findings

A. Macroeconomic Balances

The macroeconomic balances derived for 1999–2000 through 2003–04 based on the above accounting framework are presented in Table 1 and Annex Table 1 and illustrated in Figure 1. For the analysis, it is convenient to break down the last four years into two subperiods.

Table 1.

Pakistan: Macroeconomic Balances, 1999/2000–2003/04

(In percent of GDP at market prices, unless otherwise indicated; new base)

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Figure 1.
Figure 1.

Pakistan: Macroeconomic Adjustment, 1999/2000–2003/04

Citation: IMF Working Papers 2005, 139; 10.5089/9781451861587.001.A001

2000–01 Through 2002–03

The turnaround in the external current account balance from a deficit of almost 2 percent of GDP in 2000–01 to a surplus of close to 5 percent of GDP in 2002–03 mainly reflected the sharp increase in national savings.

National savings increased mainly on account of private national savings, which are estimated to have risen from 17 percent to almost 22 percent of GDP. Higher public savings contributed to about 1/4 of the external current account adjustment. Gross private and government investment changed little in percent of GDP.

Higher private national savings reflected in part higher private national income in connection with the significant increase in net private transfers from abroad (remittances and foreign currency deposits of residents-FCAs) by almost 4 percentage points of GDP. Disposable gross private national income in percent of GDP increased much less, and this is apparently due to two main factors: an increase in revenues collected by government, as part of fiscal consolidation, and a decline in domestic interest payments made by government (reflecting both lower market interest rates and the phasing out of the subsidy element in the interest rates on the National Saving Scheme’s instruments).6

The main explanatory factor for the turnaround in the external current account was an increase in the private national savings rate7 from a low of about 18 percent to 23 percent in the period (Figure 2). Household behavior in line with application of the permanent income hypothesis could in part account for this increase. But since the increase in disposable gross private national income in percent of GDP was only modest, as just mentioned, other factors must have been at play. Foremost, the much improved financial performance of the corporate sector (both private and public) should have been a major contributor to the higher savings rate. This would reflect the direct impact of retained earnings on savings and the greater propensity to save out of distributed earnings. As shown in Table 2, after-tax profits of corporations listed on the Karachi Stock Exchange (KSE), which covers only about 700 corporations, alone rose by more than a full 1 percent of GDP in the period 2001–03.8

Figure 2.
Figure 2.

Pakistan: Private Savings Behavior, 1999/2000–2003/04

Citation: IMF Working Papers 2005, 139; 10.5089/9781451861587.001.A001

Table 2.

Pakistan: Profits of Companies Listed on the Karachi Stock Exchange, 2001–03

(In millions of Pakistani rupees)

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Source: Karachi Stock Exchange website (http://www.kse.com).

2003–04

A leveling-off in net private transfers from abroad and a decline in the savings rate contributed to a decline in national savings in 2003–04 by about 2 percentage points of GDP to just below 20 percent. At the same time there was an increase in investment, both private and public, by about 1 ½ percentage points to just above 18 percent of GDP, with a concomitant decline in the external current account balance. The downward correction in the private savings rate could reflect, on the households’ side, the working of the permanent income hypothesis. It also correlates with the banking system’s success in intermediating more of the abundant liquidity to the household and enterprise sectors. It is worth noting that national savings remained significantly higher than at the beginning of the period under review. This development, if continued, would augur well for the sustainability of higher rates of economic growth.

B. Sources of Growth

1. Demand Side

By analyzing the sources of the acceleration in growth from the demand side, we built a constant 1999–2000 prices series of national accounts aggregates highlighted above; the deflators used (Annex Table 2) are from the Federal Bureau of Statistics (FBS).9 From the results in Tables 3a and 3b, Annex Table 3, and also illustrated in Figure 3, we draw the following observations.

Table 3a.

Pakistan: Real Growth Rates (Demand Side), 2000/01–2003/04

(In percent, new base)

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Table 3b.

Pakistan: Contributions to Real Growth Rates (Demand Side), 2000/01–2003/04

(In percent, new base)

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Figure 3.
Figure 3.

Pakistan: Breakdown of GDP Growth (Demand Side), 2000/01–2003/04

Citation: IMF Working Papers 2005, 139; 10.5089/9781451861587.001.A001

2000–01 Through 2002–03

The sustained double digit growth in export volumes was a remarkable source of growth during these years. The growth in investment was erratic, while the growth in consumption, although showing an upward trend, was relatively weak. The growth in export volumes was especially impressive in 2002–03, with all sectors (primary commodities, textile manufactures, and others) contributing to it (Tables 4a and 4b). Inputs for textile and machinery (textile and others) appear to have led the recovery in import volumes in this year (Tables 5a and 5b).

Table 4a:

Pakistan: Major Exports, 1999/2000–2003/04

(Value: million U.S. dollar; Unit value: U.S. dollar)

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Source: Federal Bureau of Statistics.
Table 4b.

Pakistan: Major Exports, 1999/2000–2003/04

(Percentage change over corresponding period)

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Source: Federal Bureau of Statistics.
Table 5a.

Pakistan: Major Imports, 1999/2000–2003/04

(Value: million U.S. dollar; unit value: U.S.dollar)

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Source: Federal Bureau of Statistics.