Economic stability taking hold in Pakistan

Political uncertainty, chronic insecurity and a budget deficit inflated by spending to tackle a Taliban insurgency are all threats to recovery, but the outlook is far brighter than when Pakistan was on the brink of default in 2008.

“In terms of the economy, stabilisation seems to be taking hold ... progress has been made,” Paul Ross of the International Monetary Fund said in an interview with Reuters.

Pakistan turned to the IMF for an emergency package of loans in November 2008, when inflation was 25 percent, central bank reserves were the equivalent of just one month of imports and the current account deficit had widened to 8.5 percent of gross domestic product for fiscal year 2007/08.

Now, inflation has dropped to 13 percent, reserves are four months of imports and the current account deficit is set to be around 2-3 percent of GDP this fiscal year ending June 30.

Even among risky “frontier markets” Pakistan is seen as too long a shot for many investors due to its insecurity, poor governance, corruption and crippling power shortages.

Indeed, foreign direct investment (FDI) has almost halved over the past year, standing at just $1.77 billion in the first 10 months of fiscal 2009/10 fiscal year. In Vietnam, by comparison, the government expects FDI of $10-11 billion in 2010.

However, there has been an upturn in foreign portfolio investment as the economy has improved, with net inflows into the stock market of $508.7 million in the first 10 months compared with an outflow of $392 million in the year-earlier period.

CDS spreads narrowing

Ross pointed to a narrowing of the spread on Pakistan’s sovereign CDS, used to insure against sovereign debt default, as a signal of returning confidence in Pakistan’s economy.

The 5-year credit default swap spread started to drop steadily at the end of February from levels above 900 basis points. It dropped as low as 675 this month before rising again in line with global trends as Eurozone tremors spooked markets. It was at 750 on Tuesday.

“The security situation adds to uncertainty, which investors don’t like, but if the economic stability deepens further I would expect CDS spreads to come down some more,” Ross said.

The IMF agreed this month to release a fifth tranche of the $11 billion loan agreed in 2008 after Pakistan sought a waiver on some of its targets, including for the budget deficit, which the government has targeted at 5.1 percent of GDP for 2009/10.

The government’s initial forecast for the budget deficit was 4.9 percent of GDP for fiscal year 2009/10.

The government, which will unveil its budget for 2010/11 on June 5, is now expecting GDP growth of 4.5 percent for the next fiscal year starting July 1.

The government is expecting 4.1 percent GDP growth for fiscal year 2009/10.

However, Ross said a rise to the Asia emerging markets growth rate of 8 percent will require a leap in the tax-to-revenue rate, which is just 9 percent of GDP. Plans for a value-added tax face significant opposition and there are currently fewer than 2 million taxpayers from a population of 170 million.

This leaves no domestic cushion for the government in the case of an economic shock, constantly forcing it to look externally for assistance, and it limits the resources available for investment in health, education and infrastructure.