Management of the Pakistan Economy - Books

Book: Policy Challenges for Macroeconomic Management and Growth in Pakistan

Editor’s Note

Chapter No. 01

State of the Pakistan Economy Estimates of Annual Growth in Pakistan: Financial Year 2023
Moazam Mahmood, Azam Chaudhry, Seemab Sajid, Amna Noor Fatima and Aimal Tanvir

The Lahore School of Economics macro model forecasts a marginal GDP growth of 0.05% for Pakistan's fiscal year 2023. This minimal expansion is attributed to a combination of supply and demand shocks. Supply shocks include flood damage and import constraints arising from a balance-of-payments crisis. Demand shocks stem from reduced income due to supply shocks and a persistent current account deficit. Inflation, reaching 33.3%, is primarily driven by exchange rate depreciation, with the fiscal deficit and global commodity prices playing secondary roles. The model projects a modest GDP growth of 2.71% for FY 2024, contingent on mitigating supply and demand shocks. However, Pakistan faces significant challenges, including low foreign exchange reserves, a looming current account deficit, and the urgent need for fiscal and monetary policy reforms to address these issues.

Chapter No. 02

Exchange Rate Management: A Case Study of Pakistan 2013-2023
Rashid Amjad and Almazia Shahzad

Pakistan’s most recent economic crisis as witnessed in the 2019-2023 period (high inflation, low growth, low foreign exchange reserves) has also seen the longest period of implementation of a market determined exchange rate regime as part of the IMF conditionalities under its three-year program starting March 2019. This paper analyses this shift away from a managed exchange rate regime towards a market determined regime, over a period of ten years i.e. 2013-2023. We find that between July 2019 and February 2023, the nominal exchange rate depreciated by 114.5 percent against the US Dollar, while the REER index showed a depreciation of 17.4 percent, it has not resulted in a significant increase in exports and imports have remained persistently high. Our analysis shows that even large depreciations do not override the inelastic response of exports to changes in the value of the Pakistani Rupee. We further find that demand for imports is driven by our domestic growth which is stimulated by large fiscal deficit. We also find that compared to other key macroeconomic variables, fiscal deficit contributes the most to building exchange rate depreciation pressures. In the light of these findings we argue that while a market driven exchange rate is a better means of ensuring competitiveness, it still requires prudent degree of management to ensure short-medium term stability in the exchange rate. However, the reserve levels can override any attempt at exchange rate stabilisation.

Chapter No. 03

A Roadmap to Diversifying Pakistan's Exports: Operationalizing the Product Space
Azam Chaudhry and Gul Andaman

Pakistan has not been able to significantly increase exports or diversify its export base towards higher value-added products which has both contributed to its perpetual balance of payments problems and impeded growth. To address this, it is crucial to identify potential new exports that are not only relatively closer to the current export basket but also those products that have the potential to lead to higher value-added exports. This paper explores new categories of merchandise exports by incorporating the methodology developed by Hausmann and Klinger (2007), Hausmann et al. (2007), and Hidalgo et al. (2007). It operationalizes the concept of product space and identifies new products for Pakistan which are closer to prevailing production capabilities as well as new products that are of higher sophistication. Using the same methodology, this paper also analyzes the change in export basket of Pakistan from 2017 to 2021 and evaluates whether and to what extent the new categories recommended in 2017 have become part of 2021 export basket.

Chapter No. 04

The Global Gig Economy: Pakistan’s Opportunity to Become a Leader in Service Exports?
Theresa Thompson Chaudhry and Hamna Ahmad

Freelancers in Pakistan earned around $400 million in both FY21 and FY22, accounting for about 15% of the $2.6 billion ICT exports. Pakistan’s IT exports have been rising in absolute terms and as a share of service exports over the past few years, but it still stands far behind countries like the Philippines and India. Further, it has a long way to go before it rivals the importance of remittances to Pakistan from abroad, which stood at $31.2 billion in FY22. To learn more about the landscape of freelancing in Pakistan, we scraped the data on Pakistan-based freelancers from two popular sites. Most of the 9,495 Pakistani freelancers advertising their services on Freelancer.com are based in Punjab and Sindh. The most advertised skills are programming, web and app development, followed by design, research/writing, photography, and marketing. Nearly three-quarters of the workers listed have earned money through the site. Firms charge the highest hourly rate on average and have completed the greatest number of jobs. Men charge around $2.40 more per hour than women and have higher total earnings despite completing fewer transactions. Women have the highest repeat hire rate compared to both men and firms. Earnings and hourly rates are increasing (at a decreasing rate) in terms of freelancers’ experience and percentage of jobs completed on time. Average ratings, however, have no statistically significant impact on either total earnings hourly rates of freelancing work. In contrast, only 1,100 out of 85,314 freelancers (1.3 percent) advertising their services on the site Guru.com, had ever completed a transaction. Men earn more per transaction, but earnings in the last year were roughly equal for men and women.

Chapter No. 05

Access to Foreign Markets: An Analysis of the Pak-China FTA
Nida Jamil, Theresa Chaudhry & Azam Chaudhry

This study analyzes the impact of the Pakistan-China Free Trade Agreement (FTA) on Pakistan's textile industry, summarizing the work of Jamil, Chaudhry, & Chaudhry (2021,2023). Using firm-level data from the Census of Manufacturing Industries in Punjab, Pakistan from 2000, 2005, and 2010, we examine changes in productivity, quality, input usage, product mix, prices, and markups for textile firms before and after the FTA implementation. While the FTA led to small productivity and quality gains for exporting firms (6-8% and 1-2%, respectively), these gains were limited primarily to the spinning segment, which received the largest tariff reductions. Exporting firms increased labor and material inputs but did not significantly increase capital investment. They also reduced their product scope and lowered prices more than marginal costs fell, resulting in decreased markups. We estimate demand elasticities for different textile segments, finding that interior and clothing segments are the most elastic, suggesting potential for increased market share if given greater access. Finally, we find evidence of positive productivity and quality spillovers from exporting to nearby non-exporting firms, particularly for upstream producers. Overall, our results indicate that while the FTA increased trade flows, it did not substantially improve productivity or competitiveness for Pakistani textile firms in the short term.

Chapter No. 06

Monetary Policy in the time of Corona: Lessons from Pakistan
Murtaza Syed and Naved Hamid

The paper examines the performance of Pakistan’s monetary policy during the COVID-19 pandemic (2020-2022), a period that ended with a serious balance-of-payments crisis, precipitous decline in foreign exchange reserves and soaring inflation. The initial policy response to the COVID-19 pandemic, well-coordinated fiscal and monetary policy, proved relatively favorable for Pakistan’s economic performance. However, by end-FY2022 the country was in deepening economic distress because monetary policy effectiveness was undermined by internal and external shocks, namely the Russia-Ukraine War and internal political turmoil, and the situation was exacerbated by unplanned fiscal expansion and unwarranted delays in IMF program. In this context, the paper discusses possible explanations for Pakistan’s economic crisis, evaluates the role of monetary policy in this crisis, and offers recommendations for future policymakers. It concludes that even if monetary policy had been tightened earlier and more aggressively, and the unconventional stimulus injected into the economy had been smaller, it is doubtful that SBP could have single-handedly prevented the economic crisis. The main lessons that are derived for policy makers are that there is a need for significantly better real-time economic data to counter the increasing complexity of the challenges posed; SBP should maintain a healthy degree of skepticism and caution regarding fiscal projections by the Ministry of Finance, especially during times of political stress such as the national elections; SBP must recognize that the exchange rate can be extremely volatile when international reserves fall below a certain minimum level, which can impact domestic inflation significantly, and it should be extremely conservative in its assessment of expected capital inflows; and finally, it should be aware that supply shocks can evolve into more persistent issues, especially if they are recurrent and prolonged.

Chapter No. 07

Inflation Surges under Incomplete Markets*
Ahmed Pirzada

Why did inflation in Pakistan increase from 13.8 percent in May 2022 to the peak of 38 percent in May 2023? Similar surges in inflation are also observed across other developing economies at times of financial stress. This short paper presents a small open economy model where current and expected future risk affects both domestic and CPI inflation. This is due to the assumption of incomplete markets which gives rise to deviations in the uncovered interest rate parity (UIP) condition, also known as excess returns or risk premium. This paper uses the model to demonstrate that the surge in inflation in Pakistan was primarily attributed to the sharp increase in risk premium rather than other factors frequently discussed in popular discourse such as cost shocks, differential in policy rates, inflation expectations, and money supply.

Chapter No. 08

Third Time Lucky? A Comparative Perspective of IMF Programmes in Pakistan, 2000, 2013, and 2023
Matthew McCartney

Pakistan spent much of 2022 mired in economic crisis and in 2023 the IMF arrived to negotiate an agreement, economic reforms in exchange for a large loan. It would be easy to be pessimistic about the prospects of Pakistan completing the 2023 vintage IMF programme and its multitude of conditionalities. Pakistan has signed off on more than 20 such agreements since 1958 and failed to complete all but one of them. There are grounds for optimism. Pakistan responded successfully to both the 2000-01 and 2013-16 IMF programmes in respect to a wide-range of economic and policy variables. This paper draws on a theoretical framework from Mancur Olson – the distinction between ‘roving’ and ‘settled’ bandits - to help think about the wider political economy that allowed Pakistan to (briefly) implement successful economic reform during these two periods. This paper uses this theoretical perspective to think about whether Pakistan will successfully complete the 2023 IMF programme. The tantalising conclusion is that Pakistan is more likely to do so if the criminal convictions against Nawaz Sharif are dropped and he is allowed to run for political office in the 2024 general election.

Chapter No. 09

The Relationship between Fiscal Policy and BOP Constraints: A Crisis is a Terrible Thing to Waste
Moazam Mahmood, Azam Chaudhry and Shamyla Chaudry

Pakistan’s current crisis converges on balance of payments (BOPs). Several factors contribute to this crisis, including a significant and growing Current Account (CA) deficit, debt repayments, dwindling foreign exchange reserves, a depreciating rupee and a high budget deficit. These issues are further compounded by rising inflation, stagnating output growth and the stringent requirements of the International Monetary Fund (IMF) program on macro fundamentals. At the core of this crisis lies an acute shortage of foreign exchange reserves. Consequently, the current economic predicament is often characterized as a balance of payments crunch, with primary analytical and policy focus on the current account deficit. This paper looks at fiscal expenditures to establish two propositions: Firstly, there is a strong positive relationship between Pakistan’s fiscal deficit and current account deficit, where the fiscal deficit further exacerbates the current account deficit and capital financial account deficit on account of tradeables and global capital flows. Secondly, to accurately reflect this relationship, the National Income Accounting framework needs revision.

Chapter No. 10

Tax Revenue Mobilization in Pakistan: Challenges and Recommendations
Arshad Hasan and Naeem Sheikh

Pakistan's economy has been grappling with the challenge of revenue mobilization for decades. This issue has reached a critical juncture where the nation's economic growth, the well-being of its citizens, and even its sovereignty are at stake. Despite numerous policy initiatives and reforms, previous efforts have fallen short of delivering sustainable results. This paper aims to conduct a comprehensive evaluation of Pakistan's revenue mobilization system and identify the critical factors that have been overlooked in past reform endeavors. Our findings suggest that trust is the missing linchpin. Previous reforms have failed to prioritize establishing trust with the most crucial stakeholder in the system: the taxpayer. To address this issue, we recommend that future reform initiatives focus on enhancing governance and structure, improving facilitation, strengthening enforcement and compliance through the implementation of a robust risk management framework, monitoring economic activities and combating smuggling. By prioritizing these areas, Pakistan can foster a more equitable and efficient tax system that promotes economic growth and development.

Chapter No. 11

Moving on to Export-Led Growth – Some Financial and Institutional Issues for Pakistan
Jamshed Y. Uppal

Following Pakistan's recent Stand-By Arrangement with the International Monetary Fund (IMF) there is a growing realization that the country needs to identify and implement appropriate restructuring measures that can break the recurrent cycles of economic crisis. Several economists have advocated shifting the economic policies' emphasis to export-led growth from the traditional import-substitution. Such a reorientation would not only require economic adjustments, but also political, social, and cultural changes. The paper focuses on the implications of such a transition for the political, economic and financial institutions. I lay out the institutional changes necessary to effectively support the economy’s reorientation toward export-led growth. The paper focuses on the following areas in which public policy can create a supporting and complementary environment for export growth: (1) exchange rate policy, (2) trade and long-term financing for upgrading export capacity, (3) strengthening country’s competitiveness, (4) capital flows and foreign direct investment (FDI) and (5) fiscal discipline. The political and cultural dimensions of the needed policies for each area are discussed. The paper concludes that to enable exportled economic growth, Pakistan needs an integrated long-term strategy that incorporates measures to strengthen financial, political, and social institutions.

Chapter No. 12

The Development and Regulation of the Capital Market in Pakistan
Khalid A. Mirza

This reflective note, drawing on the author’s 40+ years relevant global and local experience, highlights the crucial role of regulation in economic governance. It emphasizes the challenging environment for regulation and capital market development in most emerging economies; including Pakistan. Specific shortcomings in Pakistan’s capital market are identified: the regulator’s lack of independence and ineffectiveness, the monopolistic structure of the capital market, burdensome regulations, inadequate securities financing, and the absence of robust investment banking. To address these issues, the paper proposes the following corrective measures: ensuring the SECP is appropriately led and staffed, licensing at least one additional, stock exchange and competing support institutions, rationalizing the capital market regulatory framework, re-introducing workable “Badla” financing, and promoting broad-based investment banking in Pakistan.