Salman Shah, finance minister of Pakistan from 2004 to March 2008, tells ADITI PHADNIS what went wrong with his country’s economy.
Pakistan’s real reforms story begins in 1999. It moves ahead at a great clip and achieves unparalleled success till 2006. It chugs along between 2006 and 2008. Today Pakistan is on the verge of bankruptcy. What went wrong?
After the induction of the General Musharraf government in October 1999, second-generation reforms were launched to transform the real and financial economy along with rebuilding government institutions under an International Monetary Fund (IMF) programme. This yielded good results. Pakistan graduated from the programme in 2004 and since then has been tapping global markets very successfully. In a World Bank-IFC Report called “Doing Business in 2006: South Asian countries pick up reforms race”, Pakistan was declared the top reformer in the South Asian region and the number 10 reformer globally. Pakistan’s privatisation programme was one of the most advanced in the region, attracting investments from all regions, particularly West Asia, East Asia and Europe. All public sector holdings were to be privatised. Opportunities existed in infrastructure, the financial sector, power, oil and gas, manufacturing and ship-building. We established a new competition authority, a new statistical authority, reinforced our securities and exchange commission, and deepened our capital markets. We are demutualising our stock markets and introducing new systems to ensure transparency. We rationalised and reduced the number of taxes, created a system that widened the tax net. We are improving our labour laws and deregulating arcane rules that have stifled our industry and commerce.
Pakistan re-entered the international capital markets on February 12, 2004. We issued $500-million five-year Eurobonds due in 2009. Encouraged by the response, we circulated Islamic Sukuk bonds worth $600 million in January 2005, 10-year Eurobonds worth $500 million, 30-year $300-million worth of bonds in 2006 and 10-year bonds worth $750 million in 2007. We completed a $813-million GDR issue in 2006 and a $750-million GDR issue in 2007. In 2007, foreign investments crossed the $8-billion mark. The debt-to-GDP ratio continues to decline and touched 55 per cent in 2008, a far cry from the over 100 per cent in 2000. In May 2007, we issued US dollar global bonds. The bonds were a huge success — they were oversubscribed seven times, amounting to $3.5 billion, though we were seeking only $500 million. The spread was less than 200 points above the US government 10-year securities. In December 2007, when Benazir Bhutto was assassinated, the spread jumped to 600 basis points. However, after the elections, the investor community welcomed the peaceful transition by pushing down the spread to 500 points. The stock market also reacted favourably and jumped to 15,800, the highest point in our history, in April 2008. Since then, lack of focus on economic issues due to political transition has led to the collapse of the stock market to 9,000 points and the spread has jumped to almost 1,200 points.
So what happened between April 2008 and today?
In this period we have had three finance secretaries and three finance ministers. In April-May 2008, the government planned a major capital account transaction to generate dollar inflows because dollar outflows were considerable due to high oil prices and the resultant oil import bill. The new government cancelled the transaction, which would have brought $4-5 billion — the exact amount that we’re negotiating with the IMF now. This disrupted dollar inflows. Investors lost confidence and began moving out.
What was the transaction that was cancelled?
The privatisation that was delayed was of Pakistan State Oil. We had some good investors, including BP, Shell, Petronas, Kuwait investment houses… this would have sent our dollar reserves soaring.
Why cancel it then?
The new regime said it would relook at not just this but everything. So the signals that went out were not positive. The enormous increase in oil prices and the resultant outflow of dollars added more pressure on the reserves and the currency. Indirectly, the loss was probably twice as much as foreign investors withdrew to the sidelines and domestic investors moved their investments overseas. While the government failed to take advantage of the window of opportunity, a privately-owned bank, taking advantage of the great valuations in April 2008, privately placed some 20 per cent of its equity with a foreign bank for $850 million. If the government had not cancelled its transactions, it could have generated sufficient flows to prevent the meltdown that ensued. Reserves drawdown would have been avoided, the spread on our international bonds would have narrowed to the May 2007 levels, borrowing from the State Bank would have been halved and the government would have had a stable environment for tackling the high oil import bill and food inflation. Our current predicament is clearly a creation of our own.
What could have been done in April-May 2008 with the market at 15,700 points cannot be done in September-October 2008 with the market at 9,100 points. The international markets are closed to us. We have to wait until our markets get back to their historical levels and investor confidence is restored.
But things are improving. Food and commodity prices are down, the macro situation is better, inflation is not an issue. Right now, the priority is to make people consume more.
Would you say that this happened because reforms in Pakistan were wide but not deep, lacked political consensus and became hostage to politics?
The new government is learning fast. It realises we are living in a globalised world and managing the economy has to be in line with the global realities. So populism won’t really work. Politics taking over economics is a weak point of South Asian culture. Consider the East Asian nations, Malaysia, Thailand, Korea. There’s no politics in economics because people’s lives have changed as a result of economics.
But in the three countries you have mentioned, politics spills out of economics and cronyism is a central element. Doesn’t that worry you about Pakistan — that if you allow the private sector so much play in the economy, there’s danger of cronyism?
No, I think privatisation is good and the role of the public sector needs to be diminished. The public sector is a legacy of the 1970s and 1980s that we have rolled back with some success in Pakistan. The government is still very big in energy and infrastructure, we need to get more private sector involvement. I certainly don’t subscribe to the thesis that privatisation amounts to selling the family silver. The people deserve more efficiency, better service, more competition. Public sector banks had 25 per cent non-performing assets (NPAs). Now there are no NPAs and we have a central bank which has tough regulatory powers.
But your question was also, were reforms deep-rooted enough? That will come with time. There has been growth in South Asia only in the last decade. People have seen a lot of magic potions. They are skeptical and suspicious of new things. But if we can ensure 10-12 per cent growth for the next few years, they will buy the argument that reforms are good.
At the moment they see no hope. In Pakistan, wheat was so terribly short just a few months ago, there was a riot-like situation…
Pakistani wheat vanishing from shops was a temporary supply-side problem. It was not a structural flaw. As you know, there was a between $200-500 per tonne difference in the price of domestic wheat and that being sold globally. Wheat was being smuggled out of Pakistan to Central Asia and the government had no means of stopping this. But the damage was done and it had an impact in the elections. The solution is to deregulate agricultural prices so that farmers can produce for the global markets. If prices get out of reach, the government must give a direct subsidy. But we should get away from price controls and instead create a social security net to grapple with crises if they occur.
