Pakistan: It Pays to Be Uncle Sam's Pal

U.S. aid--and reform--are improving the country's fortunes fast

It looks like a recipe for economic disaster. Twice in the past year, Pakistan has come to the brink of war with neighboring India. Its commercial capital, Karachi, has been plagued with sectarian killings and violence against foreigners. And its farmers are reeling from a three-year drought. So why is Pakistan's economy looking healthier than ever? The answer: some smart reforms, combined with increased international aid in the wake of the terrorist attacks of September 11.

Despite its many woes, Pakistan is enjoying a measure of economic stability it hasn't seen for decades. Its economy is expected to grow by 4.5% in the fiscal year ending in June, up from 3.6% last year. Foreign-exchange reserves have jumped from $3.2 billion in July, 2001, to a record $10.2 billion this March. And a strong recovery in the textile sector has helped boost exports by 19% since July. "There has been a total macroeconomic turnaround...and that has made Pakistan attractive," says Karachi Stock Exchange Chairman Firozuddin Cassim.

Key to Pakistan's improving fortunes has been President Pervez Musharraf's willingness to lend a hand in the war on terrorism. To reward its new ally, Washington paved the way for $1.5 billion in new grants, more than $5 billion in loans, and a rescheduling of $12.5 billion in bilateral debt with the Paris Club of creditor nations. Musharraf has made some smart policy moves, too. He has pushed ahead with privatization, selling off United Bank Ltd. -- the country's third-largest -- and several mutual funds. Two money-losing state-owned banks have been reorganized, and both are now profitable. The country's biggest company -- Pakistan State Oil Co. -- and the fixed-line phone monopoly are expected to be taken private this year. And import tariffs have been reduced from about 45% to just 25% as a condition of getting IMF aid.

Still, it's not quite time to break out the party hats. There are ongoing concerns about security, and Musharraf's control over vast areas of Pakistan is tenuous at best. And one-third of Pakistanis earn less than $1 a day, a problem Musharraf will have to deal with if he wants to avoid social strife.

One big challenge is a lack of investment. For the past three years, outlays for new plants and equipment have been stalled at about 16% of gross domestic product, well below India's 23% and China's 38%. While it appeared investment might grow a bit this year, the war in Iraq has dealt a blow to Pakistan's progress. "The invisible impact of the war is already there," says Haroon Farooki, chairman of a trade group representing 2,200 Karachi manufacturers. About 40% of the group's members had planned fresh investment this year, but most of them are now "taking a wait-and-see attitude," Farooki says.

Critics say the government needs more vision. The current macroeconomic climate should boost growth, but Pakistan lacks "a more well-thought-out and longer-term economic strategy," says Sakib Sherani, chief economist at ABN Amro Bank in Islamabad. He says Musharraf and his team should set targets for growth in various sectors, and then promote those sectors by aiming public spending at projects that will attract further private funds.

Government officials insist they're on the right track. Privatization & Investment Minister Abdul Hafeez Shaikh says he will jazz up investment promotion efforts, and by 2006 he expects to raise investment to 20% of GDP by cutting back on red tape. One example: He plans to slash the number of government agencies monitoring factories. "If we are to generate jobs and...improve the quality of life, the focus has to be on investment," he says. Meanwhile, Musharraf says an ongoing crackdown on Islamic militants should help woo now-scarce foreign investors back to the country.

Pakistan is in surprisingly good shape these days, it's true. But Musharraf may still need to fiddle with the recipe if he wants to be sure of cooking up lasting stability.

By Naween A. Mangi in Karachi

    Before it's here, it's on the Bloomberg Terminal.