A New Chance for Pakistan

Western aid could boost its moribund economy--if corruption is controlled

When Osama bin Laden recently exhorted Pakistanis to launch a holy war against America, his call resounded with a 29-year-old truck driver named Ahmed. In recent years, Ahmed (his only name) has had an increasingly difficult time eking out a living hauling cotton to Pakistan's main port and business center, Karachi. Like many poor Pakistanis, he believes bin Laden and his cohorts have the answer to their problems. "I support holy war," Ahmed says, as he washes his 1991 Nissan truck with a rag.

As Pakistan joins America's antiterror coalition, its government faces a daunting double task: quelling such pockets of popular support for Islamic extremists and turning Pakistan into a functioning country. Much will depend on prudent management and more aid from abroad. "Pakistan's economic problems are self-inflicted," says Finance Minister Shaukat Aziz. "The single most important contributor historically has been bad governance and corruption."

Indeed, because of decades of economic mismanagement, the current military regime of President Pervez Musharraf spends most of its budget servicing a $37 billion foreign debt. Much of the rest goes for defense. That leaves precious little for education, infrastructure, and social programs--all desperately needed in a country where fully half the population can't read and some 42 million of its 130 million people earn well under a dollar a day. Foreign investors have long since lost faith in Pakistan, and so have many local business owners. "Growth is slow because people are not investing," says Rafiq Habib, an executive at the Habib group of companies, which makes everything from paper bags to Toyotas. "Because of the instability, people prefer to keep their money in their pockets."

Pakistan has been an economic backwater for so long that it's hard for its citizens to imagine anything different. But now, in the wake of the terror attacks, its economy is poised to get a boost. When Musharraf pledged support for America's war on terrorism, Pakistan once again became a key U.S. ally--as it was in the 1980s during the war against the Soviets in neighboring Afghanistan.

Washington is already rewarding Islamabad. The U.S. has lifted sanctions imposed after Pakistan detonated nuclear bombs in 1998. And it has moved up the rescheduling of $379 million in government-to-government debt. More is expected from other donors at a meeting of the Paris Club of government creditors later this year. The U.S. also is likely to back moves by the World Bank and International Monetary Fund to provide billions in aid and more loans. Says Aziz: "The IMF and Paris Club will give the economy a tremendous boost in terms of our external account and domestic growth."

So will stepped-up economic reforms. Since becoming Finance Minister in 1999, Aziz, a former Citibank exec, has started privatizing state-run industries, pruning public payrolls, and partially phasing out costly energy subsidies. Thanks to these efforts, on the eve of the Sept. 11 attacks, Pakistan was credited for the first time ever with adhering to an IMF program and was slated to receive $131 million, the fourth and final tranche of a 10-month IMF program negotiated last December.

CLAMPING DOWN. The government also has boosted revenues. Last year, Islamabad introduced a 15% to 22% general sales tax and in 1999 clamped down on rampant income tax evasion. The result: a 14% jump in tax revenues in a year that saw the economy grow just 2.6%. Combined with spending cuts, that helped trim the fiscal deficit to 5.3% of gross domestic product in fiscal 2000 from 6.4% the year before. While some Pakistanis say Aziz should have gone further, Sakib Sherani, chief economist at ABN Amro Bank in Islamabad, says, "I'd give the government program a thumbs-up."

Still, Pakistan remains a dangerous place to do business. In July, Shaukat Mirza, managing director of Pakistan State Oil (PSO), was shot to death on his way to work. Why he was gunned down remains unclear, but he had been trying to root out corruption. Says a Pakistani banker living in New York: "How are you going to invest in a country where the head of the PSO is shot in downtown Karachi?"

Indeed, overseas investors have been giving Pakistan a wide berth. Last fiscal year, foreign investment was a paltry $425 million. And the steady devaluation of the Pakistani rupee since the early 1990s, combined with market manipulation on the Karachi Stock Exchange, has kept overseas portfolio investors away. Earlier this year, J.P. Morgan Chase & Co., one of the last foreign companies to hold a seat on the exchange, closed its brokerage operation.

So far, Western companies in Pakistan have reported no attacks since bin Laden called for a Pakistani jihad against America. Caltex Oil Pakistan Ltd. Managing Director Arshad Nasar says that apart from interruptions to traffic caused by pro-Taliban demonstrations, "nothing has taken place that would affect business." Still, he has beefed up security around Caltex' distribution depot at Karachi's port, and he now varies his routes and schedule.

Pakistani businesses, and especially the crucial textiles and garment industries that account for 60% of exports, were already hurting before the terror strike. Zafar Chaudhury, general manager of Ammar Textiles, the nation's largest garment maker, was looking for new markets to offset declining orders from the likes of the Gap (GPS ), Tommy Hilfiger (TOM ), and Levi Strauss. The impending war has dashed those hopes.

LONG TERM? What Pakistan needs, it is widely agreed, is a kind of Marshall Plan that not only would pump money into the economy but also rebuild institutions. "We should ask for something to follow through after the problem is solved that helps society come back to normalcy," says Zahid Adamjee, a scion of one of Pakistan's oldest and most prominent business families. Humayun Bashir, general manager for IBM's Pakistan operations, is skeptical about a long-term commitment from Washington. "Now, Pakistan finds itself on the right side of a lot of things," he says. "But I don't know for how long."

Other execs wonder if their own government can be trusted with a new flood of international largesse. Most Pakistanis believe billions in previous foreign loans ended up in the bank accounts of the generals and politicians. For his part, Finance Minister Aziz insists that aid and debt relief will be used properly and could ease the sting of reform as the government goes about privatizing state industries, improving tax collection even more, and further reining in government spending. "If we get more [aid], our ability to reform will increase," he says.

Still, the doubters are everywhere. As a nation, says Habib, "we don't live within our means. The biggest guilty party is the army, and they're in charge." Still, the elected civilians of previous governments were no panacea either. So Pakistani businesspeople, skeptical as they are of the outcome, have no choice but to trust Musharraf and Aziz--and their new American friends.

By Frederik Balfour in Karachi and Manjeet Kripalani in Bombay

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