Pakistan Economy

The economy of Pakistan is the 27th largest economy in the world in terms of purchasing power, and the 45th largest in absolute dollar terms. Pakistan has a semi-industrialized economy, which mainly encompasses textiles, chemicals, food processing, agriculture and other industries.

By Pakistan Ministry of Finance

Riding on the strong economic fundamentals of last year Pakistan's economy has gathered greater momentum during the fiscal year 2003-04. Acceleration in growth accompanied by a sharp pick up in industrial production, a strong upsurge in investment, and a further strengthening of the external balance of payments have been the hallmarks of this year's performance. The pre-payment of high cost external debt, the strategic re-entry into the international capital markets through the floatation of a Eurobond and the re-basing of Pakistan's national accounts have been the other stellar occurrences of the fiscal year 2003-04. No efforts to revive the economy will be complete unless these macroeconomic gains are transferred to the masses in terms of an improved standard of living. The efforts of the last five years have started yielding positive results and this year has seen the incidence of poverty declining, enrolment in primary, middle and matric levels rising, and various quality of life indicators improving.

During this fiscal year, Pakistan succeeded in attaining; a higher than targeted growth in real GDP, powered by stellar growth in large-scale manufacturing and a continuing robust performance in services; a double-digit growth in per capita income, reaching $ 652; a strong rebound in investment, particularly in private sector investment owing to a rare confluence of various positive developments on the economic scene; low inflation and an investment-friendly interest rate environment; an unprecedented increase in credit to the private sector; sharp increases in the consumption of electricity and gas reflecting rising levels of economic activity; a reduction in the fiscal deficit; on target tax collection; a buoyant stock market with an all-time high aggregate market capitalization; a double-digit growth in exports and imports; workers' remittances maintaining their momentum with the current account balance remaining in surplus for the third year in a row; a continued accumulation of foreign exchange reserves and stability in the exchange rate; a sharp decline in the public and external debt burden; a lowering of the interest cost through the pre-payment of $ 1.17 billion of high cost external debt; and a successful return to the international capital markets through the floatation of a Eurobond.

From the grassroots perspective, the incidence of poverty has declined by 4.2 percentage points over 2001 figures. Other social indicators such as enrolment in primary, middle and matric levels; access to sanitation, safe drinking water, housing, electricity and gas have all showed marked improvements. Two successive years of strong growth along with over Rs.860 billion of cumulative spending over the last five years on social sector and poverty related programs is now beginning to bear fruit. Notwithstanding these improvements, much remains to be done, and this is that critical juncture in time when maintaining momentum through policy stability is paramount. While socio-economic and macroeconomic policies pursued during the year have had a strong influence on this across-the-board improvement, an increasingly broad and dynamic global recovery with industrial production and global trade picking up sharply, have aided Pakistan in this endeavor.

International Environment: Unlike in the past two to three years, this year has seen a relatively benign global economic environment after almost three years of weak and fragile growth in the world economy. A strong rebound in world trade, a robust recovery in the United States and emerging Asia, especially China, and the strongest showing for the Japanese economy since 1996 are offering grounds for optimism for the global economy in general and developing countries in particular. This optimism has encouraged the staff of the International Monetary Fund (IMF) to raise its forecast for global growth by about 0.5 percentage points to 4.6 percent in 2004 and 4.4 percent in 2005. Notwithstanding a strong and broad-based recovery in the major growth poles of the world economy, the Euro area is still exhibiting anemic growth of 1.7 percent for 2004. The United States has led the way with growth of 4.6 percent in 2004, supported by a resurgent Japan, with 3.4 percent. The growth momentum is exceptionally strong in emerging Asia where the Chinese economy is leading the way and is projected to grow by 8.5 percent in 2004. More robust income growth in the advanced economies is expected to stimulate activity in developing countries through trade, mainly in the form of higher export volumes. Developing countries including Pakistan have suffered from the slowdown in world trade in 2002, chiefly because of weak demand in the advanced economies. The pickup in global activity that began in 2003 and intensified in 2004 should translate into stronger and more sustained export growth for developing countries and this could be further augmented if progress is made in reducing trade barriers as envisaged in the Doha Round.

Notwithstanding a strong and broad-based recovery in the world economy there remain risks to the short-term outlook which will have a direct bearing on developing economies, including Pakistan. Oil prices have increased substantially from $ 26.5 per barrel in September 2003 to almost $ 42 per barrel on June 1, 2004. According to one estimate, a $ 5.0 per barrel increase in oil prices over the baseline price persisting for one full year will reduce global growth by 0.3 percent with an attendant impact on developing countries. Furthermore, the extra-ordinary rise in the price of oil fuels headline inflation which can have severe monetary policy implications. The stronger-than-expected global economic recovery, the depreciation of the US dollar against other major currencies, relatively low inventories, OPEC announcements of prospective production cuts, the 'fear factor' surrounding a possible disruption of supplies from the Middle East and some speculative activity have been mainly responsible for this unprecedented surge in oil prices. Without a stable and low oil price outlook, this global recovery seems tenuous at best.

GDP Growth: Real GDP growth, once again, surpassed the target (5.3 %) with a headline number of 6.4 percent during 2003-04 compared to last year's 5.1 percent rate. This buoyant growth was aided by a 13.1 percent and 5.2 percent growth in the manufacturing and services sectors, respectively. The performance of agriculture fell short of the target by growing at 2.6 percent against a target of 4.2 percent and last year's achievement of 4.1 percent. When compared with other developing countries in general and East and Southeast Asian countries in particular, Pakistan's growth performance has been quite impressive. Developing nations grew, on average, by 6.1 percent while East and Southeast Asian countries like Hong Kong, Singapore, Korea, Indonesia, Malaysia, Philippines, Bangladesh and Sri Lanka registered growth rates ranging from 1.1 percent to 5.5 percent in 2003-04. Few countries in the region, namely China, India and Thailand grew faster than Pakistan during this period. Fiscal stimulus in the shape of large public sector spending and a conducive interest rate environment provided important support to this growth picture in Pakistan.

Agriculture: The slippage in agriculture was mainly attributable to the weak performance of both the major and minor crops. Major crops, accounting for 34 percent of agricultural value added, grew by 2.8 percent against an impressive recovery of 6.9 percent last year. The performance of two major crops, cotton and wheat, was lackluster as the cotton crop suffered from pest problems in Southern Punjab while wheat production was adversely affected by the lack of rain in March when the formation of wheat grain takes place. The size of the cotton crop is estimated at 10.0 million bales - 1.6 percent lower than last year while that of wheat is estimated at 19.767 million tons against a target of 20.0 million tons, a shortfall of 1.2 percent. The performance of rice and sugarcane - the other two major crops - has been modest at best with the rice crop estimated at 4.848 million tons - 8.3 percent higher than last year and sugarcane at 53.419 million tons - 2.6 percent higher than last year. These two crops are highly water intensive and the improved availability of water helped increase their production. Minor crops, accounting for 12 percent in agricultural value added showed a 'weak' performance, growing by only 1.7 percent. Widespread rains during the monsoon season of 2003 (July-September) and increased snow fall in the catchment areas contributed to an improvement in the water situation during the year. The canal head withdrawals in the Kharif 2003 and Rabi 2003-04 seasons were higher by 5.0 percent and 26.2 percent, respectively over the previous year. However, during winter (January-March 2004) the actual rainfall was 40 percent lower than normal and this had a severe impact on the wheat crop.

Manufacturing: One of the most important developments of the year has been the sharp acceleration in manufacturing growth. Overall manufacturing grew by 13.4 percent in 2003-04 against a target of 7.8 percent and last year's 6.9 percent. This impressive growth was underpinned by the highest ever growth recorded in large-scale manufacturing which accounts for 68 percent of overall manufacturing, and exhibited broad-based growth of 17.1 percent against a target of 8.8 percent and last year's 7.2 percent. Improvements in the macroeconomic environment, a decline in the cost of capital, the availability of consumer financing at affordable rates, strong growth in exports and a general feel good mood in the economy have been responsible for this unprecedented growth in large-scale manufacturing. Over the last four years, the large-scale manufacturing sector has grown at an average rate of almost 10 percent per annum thereby increasing its share in GDP from 9.6 percent to 11.8 percent. Major industries that registered double-digit growth include: sugar, cement, cooking oil, jeeps and cars, motorcycles, motor tyres etc.

Construction: Another star performer has been the construction sector registering a growth rate of 7.9 percent against a target of 5.4 percent and last year's growth of 3.1 percent. Housing and construction has been identified as one of the major drivers of growth and the government has taken various budgetary and non-budgetary measures to boost this sector which has responded positively despite higher input prices. Another star performer has been the electricity and gas distribution sector which registered a massive increase of 22.5 percent in 2003-04 against a decline of 2.6 percent last year.

Per Capita Income: The sharp rise in per capita income which was witnessed last year continued during 2003-04, albeit at a relatively slower pace owing to a decline in net factor income from abroad (mainly workers' remittances). The per capita income in dollar terms increased by 12.0 percent from $ 582 last year to $ 652 during the outgoing fiscal year. Last year per capita income in dollars grew by 15.7 percent on the back of a massive increase in net factor income from abroad resulting in a two year per capita income average growth rate of 13.9 percent per annum.

Investment: Total investment rose to 18.1 percent of GDP in 2003-04 against 16.7 percent last year. Most importantly, fixed investment rose sharply to 16.4 percent of GDP against 14.8 percent last year. What is highly encouraging is the significant rise in private sector investment -from 11.2 percent to 11.7 percent of GDP. This year's growth is overwhelmed by massive investment in large-scale manufacturing by the private sector which grew by 25.4 percent during the year. Two inter-related sectors, construction and ownership of dwellings grew by impressive rates of 23.5 percent and 25 percent respectively, implying heavy investment in the housing and construction sector. National savings as a percentage of GDP remained at around 20 percent on account of a significant improvement in the current account balance. It is noteworthy that the national savings rate has increased by 8.3 percentage points since 1998-99.

Inflation: Tame inflation has also been one of the hallmarks of this government's macroeconomic policies. The rate of inflation as measured by changes in the Consumer Price Index (CPI) averaged 3.9 percent during the first ten months of the current fiscal year against 3.3 percent in the same period last year. Food and non-food inflation averaged 4.9 percent and 3.1 percent respectively as against 3.1 percent and 3.4 percent during the same period last year. Much of the surge in food inflation over last year has been due to both demand and supply factors resulting in an increase in the prices of wheat, wheat flour, rice, meat, edible oil and onions. The government has taken various measures to improve the supply situation of wheat including the import of 1.0 million tons of wheat with a concurrent wheat export ban. Central Banks around the world tend to focus on core inflation, which excludes the impact of food and energy prices. Core inflation basically represents policy (fiscal, monetary, exchange rate) induced inflation. Core inflation remained quite subdued owing to prudent macroeconomic policies pursued during the year and averaged 3.3 percent against the headline (overall inflation) number of 3.9 percent for the ten months of the current fiscal year.

Monetary Policy: The State Bank of Pakistan (SBP) continued with an easy monetary policy stance during the current fiscal year with a view to reinforcing the growth momentum that had picked up last year. Accordingly, the interest rate environment not only remained investor-friendly but middle class borrowers also benefited from such environment. The monetary expansion target was set to the tune of Rs.230 billion or 11.1 percent higher than last year. The monetary expansion during the first nine months (July- March) of the current fiscal year amounted to almost Rs.255 billion (higher by 12.3%) compared with an expansion of Rs.211 billion (higher by 12 %) in the same period last year. In other words the monetary expansion target was overtaken in the first nine months of the fiscal year. Unlike the previous two years, when the bulk of the monetary expansion resulted from a strong build up in the net foreign assets of the banking system, this year saw an unprecedented increase in private sector credit amounting to Rs.245 billion against an increase of Rs.107 billion during the same period last year. This also reflects a renewed private sector confidence in the basic macroeconomic fundamentals of the country. Almost 52 percent of the credit to the private sector went to manufacturing (Rs.126.4 billion). The benefits of the low interest rate environment also filtered down to middle class consumers as evidenced by the substantial increase in personnel loans amounting to Rs.50 billion during July-March 2003-04.

Government borrowing for budgetary support amounted to Rs.54 billion against a borrowing target of Rs.15 billion for the whole year. Three factors are responsible for the higher than targeted borrowing for budgetary support by the government. Firstly, the government had to borrow heavily from the banking system to finance the pre-payment of $ 1.17 billion of high cost external debt to the Asian Development Bank (ADB). Secondly, lower than projected external receipts for the budget and finally, lower investment in the national saving schemes. The accumulation of net foreign assets of the banking system remained subdued at Rs.50.4 billion compared to an accumulation of Rs.257 billion in the same period last year. On the whole, broad money supply grew by 12.3 percent against a target of 11.1 percent. It is expected that the current fiscal year may likely end with monetary expansion of around 15 percent. Two successive years of higher than targeted monetary expansion may give rise to inflationary pressure. However, the Central Bank is closely watching the inflationary situation.

As a result of the easy monetary policy stance, the weighted average lending rate declined by 289 basis points - from 7.58 percent in June 2003 to 4.69 percent in March 2004. The weighted average deposit rate also declined, though at a much slower pace, that is, from 1.9 percent to 1.3 percent during the same period - a decline of only 60 basis points. During this period the efficiency of the banking system also improved significantly with the spread between the lending and deposit rates declining from 568 basis points to 339 basis points - an efficiency gain of 229 basis points. The yield on 6 - month treasury bills remained stable at 1.6 percent during the year. It would not be out of place to mention here that the easy monetary policy stance perused by the Central Bank over the last three years has succeeded in lowering the entire term structure of interest rates. The weighted average lending rate declined from 13.74 percent in June 2001 to 4.69 percent in March 2004 - a decline of 905 basis points in less than three years. Similarly the yield of 6 - month Treasury Bills, which was as high as 12.88 percent in June 2001, declined to 1.68 percent in March 2004 - a decline of 1120 basis points during the same period. The export refinance rate, which is linked to the 6 - month Treasury rate, declined from 11.1 percent in July 2001 to 1.5 percent at the end March 2004, a hefty decline of 960 basis points which has helped improve the external competitiveness of the Pakistani exporter.

Stock Market: Another landmark achievement of the outgoing fiscal year has been the impressive growth in the share index of the Karachi Stock Exchange (KSE) - rising from 3403 points on June 30, 2003 to 5430 points on April 30, 2004 - an increase of 2027 points or 59.6 percent during the period. The aggregate market capitalization also increased by 92.4 percent, from Rs.746.4 billion to Rs.1436 billion during the period under review. In terms of US dollars the market capitalization of the KSE surged to $ 25 billion from $ 12.92 billion during the period under review. A number of factors have contributed to the persistence of the bullish trend in the stock market which include: a continuation of pro-growth economic policies; a stable macroeconomic environment; an acceleration in economic growth; a stable exchange rate; a brisk pace of privatization through the capital markets; a visible improvement in the Pakistan - India relationship; the availability of adequate liquidity in the market; good operating and financial results from the majority of blue chip companies and appropriate reforms initiated by the Securities and Exchange Commission of Pakistan (SECP).

Fiscal Policy: Prudent fiscal management is the foundation of a stable macroeconomic environment. Weak fiscal balance has been the major source of macroeconomic difficulties in the not too distant past. After almost five years of extensive efforts through the reform of the tax system and tax administration Pakistan has succeeded in attaining fiscal stability. The overall fiscal deficit that averaged nearly 7.0 percent of the GDP in the 1990s has declined to 3.3 percent in the outgoing fiscal year. The revenue deficit has been narrowed from 3.0 percent of GDP in the late 1990s to 0.2 percent and the primary balance has remained in surplus for the last many years. Public debt as percentage of GDP has also declined sharply and is now moving towards a sustainable level.

Pakistan has made considerable gain on fiscal side during 2003-04. The overall fiscal deficit declined from 3.7 percent of GDP in 2002-03 to 3.3 percent in 2003-04. The Central Board of Revenue (CBR) is targeted to collect Rs.510 billion - 10.5 percent higher than last year. The overall tax revenue is targeted to increase by 8.1 percent while on the expenditure side, total expenditure is estimated to rise by 6.6 percent but most of the increase is coming from the Public Sector Development Program (PSDP) - up by 17.6 percent. Current expenditure remains at last year's level with almost no growth. Interest payments and defense spending used to be the two largest items of overall expenditure followed by PSDP. As a result of prudent fiscal management, the share of interest payment in total outlay has declined sharply from 29.7 percent in 2001-02 to 21.1 percent in 2003-04. The share of defense in total outlay has remained stagnant at around 18.0 percent but that of PSDP, increased from 15.3 percent to 15.9 percent over the same period. As a percentage of GDP, interest payments have been declining while defense spending remained stagnant at 3.3 percent.

Another development on the fiscal side has been the near elimination of the revenue deficit in 2003-04. Over the last two years the revenue deficit has declined from Rs.76 billion (or 1.3% of GDP) to Rs.13.3 billion (or 0.2% of GDP). As per the Fiscal Responsibility Law the elimination of the revenue deficit was targeted to be achieved by 2007-08. However, Pakistan has almost reached the target four years in advance. Similarly, Pakistan has maintained a surplus in the primary balance over the last several years.

As a result of considerable improvement in fiscal balance, the public debt situation has improved immensely in recent years. Not only has the pace of accumulation been slowed but the burden of public debt has declined as well. During the outgoing fiscal year, public debt grew by only 2.8 percent. As percentage of GDP, public debt has declined from 75.2 percent last year to 69.7 percent in 2003-04 - a sharp decline of 5.0 percentage points in one year is a major achievement. Since public debt is a charge on the budget therefore its burden must be viewed in relation to government revenue. Public debt was 503.7 percent of total revenue last year; it has now declined to 487.7 percent in the current fiscal year.

Pakistan has made considerable gains toward fiscal consolidation. The overall fiscal deficit has been narrowed, the revenue deficit has nearly been eliminated and a primary surplus has been maintained for some time. Resultantly, public debt is fast moving towards a sustainable level. Even in countries with better fiscal management, maintaining and building on progress will be a continuing challenge. What is required is a prolonged commitment to fiscal discipline, which will come through a rule-based fiscal policy. Pakistan has already drafted a rule-based fiscal policy, enshrined in the Fiscal Responsibility and Debt Limitation Law, which has been approved by the Cabinet and has been sent to the Parliament for legislation.

Balance of Payments: Pakistan's external balance of payments gained further strength during the year under review. Both exports and imports registered robust growth; healthy increases in foreign exchange reserves continued despite heavy pre-payment of external debt; and the current account balance continued to remain in surplus for the third year in a row. A strong and broad-based recovery in the global economy also helped firm-up demand for Pakistani exportable goods. The inflow of workers' remittances continued its rising momentum, albeit at a slower pace; the exchange rate remained stable; and a substantial increase in FDI was recorded.

Exports: Exports grew by 13.1 percent during July-April 2003-04 against a hefty increase of 20.8 percent during the same period last year. When viewed against the backdrop of stellar growth (20.8%) last year, a higher double-digit growth rate in exports is one of the major achievements of the outgoing fiscal year. Given the performance of the first 10 months of the current fiscal year exports are likely to cross the target of $ 12.1 billion for the whole year. The higher unit values of exports, deeper penetration into the European and US markets, a sharp decline in the Export Refinance rate, and a competitive exchange rate have contributed to the surge in exports during the year. The surge in exports is underpinned by a strong growth in textile manufacturers and 'others' exports Textile manufacturers, accounting for 65.4 percent of total exports, registered an increase of 14.3 percent while 'other' exports covering 9.2 percent of total exports, grew by a hefty 48.6 percent. Almost 71 percent of the contribution to overall export growth came from textile manufactures and 26 percent came from 'other' exports. Primary commodities exports registered a decline of 1.5 percent mainly on account of very little export of wheat this year. Excluding the exports of wheat, primary commodities exports show an impressive growth of 12.8 percent. It is also encouraging to see the exports of engineering goods picking up at a much sharper pace. This year, exports of engineering goods grew by 33.4 percent - rising from $ 55.1 million to $ 73.5 million.

Imports: Imports grew by 19.0 percent during the first ten months (July - April) of the current fiscal year against a hefty increase of 22.5 percent in the same period last year. Most importantly, non-food non-oil imports are up by almost 32 percent against 23.5 percent last year. The exceptionally strong growth in non-food non-oil imports is one of the leading indicators of a surge in domestic economic activity. The salient features of this year's performance of imports include: impressive growth in the import of the machinery, chemical, metal and textile groups. The petroleum group registered a decline of 7.7 percent on account of 27.4 percent decline in the imports of petroleum products. In quantity terms, the import of petroleum products was down by 42.2 percent on account of a continuing surge in POL output by local refineries, an increased use of gas in industries and electricity generation, and lesser reliance on fuel oil-based thermal electricity owing to higher electricity generation through hydel. The major contributors to this year's rise in imports are the machinery group (27.1 %), followed by the agricultural / chemical group (22%), and metal group (7.0 %). The share of oil bills remained unchanged at 26.6 percent since last year. However, if the unprecedented rise in oil prices persists then given the rising level of economic activity Pakistan's oil bill is likely to cross $ 3.0 billion in 2004-05. If extrapolated for the remaining two months of the year, total imports may likely be in the neighbourhood of $ 14.5 billion for the whole fiscal year. As a result of the developments in exports and imports, the trade gap has widened from $ 1251.5 million to $ 2011.4 million during the first 10 months of the current fiscal year, showing a deterioration of 60.7 percent. Given the stronger than anticipated surge in domestic economic activity, the widening of the trade gap in the short-run is quite normal. The year is expected to close at a trade deficit of around $ 2.5 billion against the yearly target of $ 0.7 billion.

Remittances: The inflow of workers' remittances continued to maintain its momentum, albeit at a slower pace during the current fiscal year. However, when viewed against the yearly target of $3.6 billion, the performance has been impressive. The last fiscal year was an extra-ordinary year for the inflow of workers' remittances at $ 4.23 billion. Realizing the fact that a one-time adjustment has taken place, the current year target was set at $ 3.6 billion or $ 300 million per month. During the first ten months (July-April) of the current fiscal year, the flow of remittances was $ 3.21 billion or $ 321 million per month against $ 3.53 billion in the same period last year. Two points need to be noted as far as the inflow of remittances is concerned. First, as stated above, a one-time adjustment took place last year which is not expected to be repeated this year. Accordingly, against the actual receipt of $ 4.23 billion last year the target for the current year was set at $ 3.6 billion. Given the average monthly trend of inflows, the year is going to end with remittances of $ 3.8 billion. Second, last year's remittances also included $ 126 million which came through the Hajj Sponsorship Scheme. With the continuing build up in foreign exchange reserves the government decided not to launch the said Scheme this year. To that extent, the flow of remittances was expected to be less compared with last year. The United States remained the single largest source of cash remittances accounting for 31.5 percent, followed by the UAE with 15.8 percent and Saudi Arabia with a 14.8 percent share.

Current Account Balance: Sustaining a current account surplus for the third year in a row has been another major achievement for the outgoing fiscal year. The current account balance, excluding official transfers, remained in surplus at $ 1369 million (1.4% of GDP) during July-March 2003-04. However, the surplus was $ 2706 million during the same period last year. The contraction in the magnitude of the surplus was the outcome of higher deficits in the trade and services accounts as well as lower inflow of workers' remittances. Given the rising levels of domestic economic activity and the persistence of higher oil prices in international markets, imports are likely to grow at a higher pace, leading to a further widening of the trade balance. As a consequence, Pakistan may face difficulties in sustaining the surplus in the current account in the next fiscal year.

FDI: Pakistan has succeeded in attracting $ 760 million in foreign direct investment (FDI) during July-April 2003-04 against $ 696 million in the same period last year, thereby registering an increase of 9.3 percent. By the end of the current fiscal year, FDI is expected to cross $ 1.0 billion on account of the issuance of two cellular licenses amounting to $ 291 million each, the half proceeds of which are expected to be received before the end of the fiscal year. The bulk of the FDI has come in the oil and gas, transport and communication, and banking sectors. These three areas have accounted for 71 percent of the FDI this year. Almost 85 percent of the FDI has come from Switzerland, the United States, the United Kingdom, the UAE and Saudi Arabia.

Privatization: The privatization program has progressed at a much faster pace this year. By end-March 2004, Pakistan had completed or approved 139 transactions with gross proceeds of Rs.134 billion. Of this, a sum of Rs.33.1 billion was received during the first nine months (July-March) of the current fiscal year. A new feature of the privatization program has been the offering of shares to the general public through the stock market, which was well received. For example, in the case of OGDCL, 97,000 applicants purchased shares whose subsequent value increased by over Rs.8 billion. The response in the SSGC offering has been even greater with over a quarter million small applicants receiving shares through a transparent balloting process.

Foreign Exchange Reserves: Pakistan's foreign exchange reserves continued to rise despite the pre-payment of $ 1.17 billion of high cost external debt. By end-April 2004, foreign exchange reserves stood at $ 12.5 billion, sufficient to provide cover for almost one year of imports. In other words, Pakistan added $ 1.8 billion to its reserves during July-April 2003-04. The continued build up in foreign exchange reserves has provided strength to the Pakistani rupee viz, the US dollar. The inter-bank exchange rate per US dollar averaged Rs.57.46 in April 2004 as against Rs.57.74 in July 2003, showing a nominal appreciation of 0.5 percent. In general, Pakistan's exchange rate viz the US dollar has remained stable during the period under review.

External Debt: Until a few years ago Pakistan was facing serious difficulties in meeting its external debt obligations. Not only was the stock of external debt and foreign exchange liabilities growing at a breakneck pace but the debt carrying capacity remained stagnant. Consequently, the debt burden (external debt and foreign exchange liabilities as a percentage of foreign exchange earnings) reached an unsustainable level of 335.4 percent by 1998-99. Following a credible strategy of debt reduction, Pakistan has not only succeeded in reducing the stock of external debt and liabilities but at the same time built-up a substantial stock of foreign exchange reserves. The stock of external debt and liabilities were as high as $ 37.9 billion at the end of the 1990s but had been brought down to $35.8 billion by end March 2004 - a decline of over $ 2 billion. The surplus in the current account coupled with a continued build-up in foreign exchange reserves and higher foreign exchange earnings and the prepayment of expensive debt are the major factors responsible for the reduction in the total stock of debt and liabilities. As a percentage of GDP, external debt and liabilities stood at 51.7 percent in end June 2000, declined to 43 percent in end June 2003 and further to 37.8 percent by end March 2004. Similarly, external debt and liabilities as a percentage of foreign exchange earnings declined from 297.3 percent in 1999-2000 to 181.1 percent in 2002-03 and further to 168.7 percent by end March 2004. These statistics suggest that Pakistan's external debt burden has declined substantially over the last four years and is now fast approaching sustainable levels.

Pre-Payment: Pre-payment of expensive debt has been one of the major events of the outgoing fiscal year. In the backdrop of a strong build-up in foreign exchange reserves associated with rising foreign exchange earnings, Pakistan considered it appropriate to pre-pay some of its expensive debt to improve the country's debt profile. Accordingly Pakistan pre-paid $ 1.17 billion worth of expensive loans to the ADB on January 29, 2004. These loans carried interest rates ranging from 6.3% to 11% with maturities between FY 2005 and FY 2019. The prepayment exercise clearly indicates the exceptionally strong external liquidity position of the country.

Euro Bond: The second major event of the outgoing fiscal year has been a successful return to the international capital markets after a gap of over half a decade. Pakistan issued $ 500 million five year tenor regulation-S Euro Bonds due 2009, lead managed by JP Morgan, Deutsche Bank and ABN Amro Bank. The transaction has attracted strong demand from high quality and diversified international investors and was four times oversubscribe resulting in the tightest possible pricing. The success of this transaction reflects a vote of confidence by the international investor community in Pakistan's economic policies and reform agenda. The Pakistani Bond was priced at 370 bps above US Treasury (3.046) to yield 6.75 percent was considered very tight compared with emerging market peers. The Pakistani bond was priced some 50 bps inside the Philippines, despite the fact that it is rated 3-notches lower. It also looked tight against Turkey which is rated one notch above Pakistan. Furthermore, Pakistan's paper was also tighter when compared with the weighted average spread of 435 bps for emerging market bonds at the time of the Pakistan's deal. It is encouraging to note that Pakistan's Paper since February 12, 2004 has been trading in the secondary market at a premium and as of April 23, 2004 the spread further tightened to 276 bps - an improvement of 94 bps and a yield to maturity of 6.26 percent from 6.75 percent. As part of a dynamic debt management process, Pakistan transacted an interest rate swap to lower the interest cost of its bonds. The deal was done with Standard Chartered Bank @ 3.2275 percent over 6-month LIBOR with protection against a sharp unexpected rise in interest rates. For the first time in the country's history, the government undertook such an exercise to reduce the country's debt burden and as such is building in-house capacity to monitor the global markets. It would not be out of place to mention here that out of 37 PRGF countries, Pakistan is the first to demonstrate its ability to raise funds from the international capital markets. No PRGF country barring Pakistan has ever been successful in transitioning from IMF resources to funding through the capital markets.

Re-basing of National Accounts: The third major event of the outgoing fiscal year has been the re-basing of Pakistan's national accounts from 1980-81 to 1999-2000. It is well-known that structural changes do take place in production as well as in the relative prices of various products in an economy over a period of time. Besides, on account of continuous developments and innovations a lot of new products appear in the market and at the same time due to obsolescence many old products disappear. Larger quality changes also result in the non-comparability of goods and services between far apart periods. On the demand side, consumption and investment patterns also experience structural changes. All these factors demand that the national accounts series be re-based periodically to capture the structural changes in the economy and depict the true picture of the level of economic activity.

How often should the base be changed? The international practice of re-basing national accounts vary considerably across countries with some re-basing after five years, others after ten years and even others every year. In the Asian region, the majority of the countries, namely Bangladesh, Hong Kong, China, India, Nepal, Philippines, Sri Lanka and Thailand undertake their re-basing exercise every ten years while Macau, Malaysia, Republic of Korea and Singapore undertake this exercise at a gap of five years. As opposed to international practices, as well as practices followed in the Asian region, Pakistan delayed the re-basing of the national accounts for two decades. As such, many structural changes which took place since 1980-81 until 1999-2000 on the production and consumption structure of the economy were not captured in the country's national accounts. The national accounts estimates based on a benchmark of 1980-81 became antiquated and could not capture the structural changes that occurred during the last twenty years. As such, a number of economic areas remained either uncovered or under-reported and accordingly under-estimated the size of the national income.

Taking cognizance of facts narrated above, the Annual Plan Coordination Committee (APCC) in its meeting in 1997 recommended to re-base the national accounts of Pakistan to make the GDP and investment figures more realistic. The journey of the re-basing exercise that began in 1997 culminated in July 2003. During the period various technical committees were set up, a number of studies were undertaken and reviewed by the experts inside and outside the country. The National Accounts Committee in its meeting held in December, 2003 finally approved the re-basing exercise and accordingly the national accounts were re-based from 1980-81 to 1999-2000. As a result of re-basing, coverage of data has engulfed a new range of products, enterprises and economic activities such as, courier services, travel agencies, mobile phones, etc. The coverage of manufacturing items has been increased from 91 to 128. Accordingly, the size of the overall GDP in 1999-2000 increased by 19.5 percent, agriculture by 18.5 percent, industries by 18.0 percent and services by 20.8 percent over the old base. Per capita income in US dollar term was estimated at $526 for the year 1999-2000 compared to $441 according to the old base. Similarly fixed investment showed an improvement of 34.3 percent in 1999-2000 mainly due to improved coverage.

Notwithstanding these improvements there are many activities which are still to be covered in these accounts (especially IT related). Newly emerging activities taking place at a breathtaking pace pose challenges to the national accounts. The National Accounts Committee accordingly has decided to regularly re-base national accounts every five years with the next re-basing exercise beginning in 2004-05. Timely re-basing will make national accounts more representative and will depict the true picture of the economy.

Poverty: The discussion so far points to the fact that Pakistan's economy has gained more strength during the outgoing fiscal year. All its macroeconomic indicators show marked improvements over last year. The macroeconomic policies and reform programs pursued over the last five years have not only made the economy healthier but also set the stage for taking the economy on a higher growth path. Have such policies and programs improved the living conditions of the people? Have they reduced poverty and improved social indicators? These are valid and frequently asked questions. The government believes that the efforts to strengthen the economy will not be completed unless macroeconomic gains trickle-down to masses in terms of improved living conditions.

Encouraged by two years of strong growth (5.1% in 2002-03 and 6.4% in 2003-04) and over Rs. 860 billion of cumulative spending on the social sector and poverty related programs over the last five years, the government asked the Federal Bureau of Statistics (FBS) to conduct a sample Survey of Household Consumption Expenditure (HCES) with a view to gauging the impact of the macroeconomic and social sectors on the living conditions of the people of Pakistan. The Survey, covering 5046 rural and urban households (One-third of the sample covered in PIHS 2000-01) from all the four provinces of Pakistan, was conducted during April 19, 2004 to May 06,2004. The findings of the Survey are highly encouraging. Not only has the incidence of poverty shown a significant decline but other social indicators as well as indicators that represent the living conditions of the people have shown marked improvements over 2000-01. The Center for Research on Poverty Reduction and Income Distribution (CRPRID), Planning Commission, estimated the incidence of poverty using the primary data from the Survey. The results show that the incidence of the poverty at the national level has declined by 4.2 percentage points with both urban and rural poverty showing significant decline in 2004 compared with 2000-01. These results are not surprising as the Survey shows that there has been a 35 percent increase in the average monthly consumption expenditure of households. Notwithstanding a decline in the incidence of poverty, these results should be taken as indicative, as they do not cover the entire period of 2004. The purpose of this exercise was to gauge the impact of the government's macroeconomic and social sector policies on the living conditions of the people. The results simply suggest that the rising trends in poverty have been arrested and that a reversal has begun to take shape.

Other social indicators and the indicators representing the living conditions of the people have exhibited significant improvements over 2000-01 as well as over 1998 Census results. For example, the number of Households living in one room homes shows a significant decline while that of households living in 2 to 4 rooms houses have increased significantly in 2004 compared with 1998. The other indicators of living conditions such as major source of drinking water, the type of toilet used, sanitation, the use of electricity as a source of lighting and the use of gas as cooking fuel, show a significant improvements over the last 3 to 6 years. Furthermore, all education related statistics show significant improvements with the gross enrolment at the primary level increasing from 72 percent to 87 percent - a 15 percentage points increase. These results are highly encouraging as they show that strong economic growth along with massive spending on social sector and poverty related programs are now beginning to yield dividends in terms of declining poverty and improvements in living conditions as well as in social indicators.

Going Forward

Pakistan has lived through a difficult and testing period. After five years of hard work the complexion of economy has changed altogether. It is no longer fragile and its balance of payments is no more vulnerable to external shocks. Wide-ranging structural reforms, prudent macroeconomic policies, financial discipline and a consistency and continuity in policies, not seen before, have transformed Pakistan into a stable and resurgent economy in 2003-04. The stage is now set for economic growth to accelerate with the private sector expected to play the leading role in taking the economy on a higher growth trajectory.

Notwithstanding the major successes on the socio-economic front, the progress made so far is not commensurate with the country's considerable potential. Although stronger, the economy of Pakistan has many challenges lying ahead. Maintaining and building on the macroeconomic stability; and sustaining and further accelerating the growth momentum will be the continuing challenges. Linked with these are the challenges of job creation, poverty alleviation, minimizing social inequality and strengthening the country's physical infrastructure.

The stage is now set for growth to accelerate from 6.4 percent this year to 8.0 percent over the next three to four years. An essential foundation for sustaining this higher growth is the pursuance of sound macroeconomic policies, the key elements of which include fiscal discipline, appropriate monetary and exchange rate policies, and prudent debt management. The centrality of economic growth in addressing the challenges listed above is beyond doubt. Economic growth reduces poverty because average incomes of the poor typically tend to rise proportionately with the average income of the population. This result is robust overtime and across countries and regions. At the macro level, growth implies greater availability of government resources to improve the quantity and quality of education, health, water supply, sanitation, and other services. At the micro level, growth creates employment opportunities, increases income and reduces poverty. To achieve 7-8 percent growth in the next three to four years sectors like agriculture, small and medium enterprises (SMEs), housing and construction, oil and gas, and information technology and telecommunications will have to play the central role. Of these, agriculture, SMEs and housing and construction are expected to generate pro-poor growth - essential in addressing the income distribution issue. With the country's population growing at less than 2.0 percent per annum over the next three to four years, real per capita income is projected to rise by 5.5 - 6.0 percent per annum. This is the growth in per capita income which will be required to substantially reduce poverty and unemployment in the country.

Structural change is the essence of development while reform is a dynamic concept. The country must continue to adjust itself with the changing domestic and external environment. Over the last five years Pakistan has introduced wide-ranging reforms in various sectors of the economy. These reforms have started yielding dividends in terms of higher growth and macroeconomic stability. To achieve 7-8 percent growth on a sustained basis Pakistan needs to introduce a second-generation of reforms over the next 4 -5 years. This reform agenda must concentrate on strengthening institutions, improving the competitiveness of industries, building a robust financial system and further strengthening of the tax administration. The current upturn in the economy offers the ideal opportunity to implement reforms needed to deliver faster growth that is sustainable in the long run. It is reassuring to see the government's unwavering commitment to pursue the reform program in the coming years.

Few policies have promoted socio-economic development as successfully as effective investment in human resources. No nation can progress without a strong human capital base and investment in this area will be as essential as sound macroeconomic policies in achieving the desired economic boom. Education is central to overall human resource development. While basic education develops basic skills related to literacy and numeracy, higher education especially at the tertiary level involves specialization in fields of study and occupation relevant to developing technological capability. Better access of the poor to education and health care, and a better quality of these services, expand opportunities for them to improve their own well-being. This calls for allocating adequate government resources to spending on human capital development. It is reassuring to see that the government has allocated substantial resources to the social sector in the PSDP for 2004-05. Most importantly, the allocation for higher education has increased by 84 percent in 2004-05. This is an important step in the right direction. Cutting across this agenda is the empowerment of women by removing barriers to their fuller participation in the development process. Promoting gender equality is not only an important social goal but is also essential for the achievement of the broader development goals. Studies find that gender equality contributes to better education and health outcomes. More recent cross-country research has found that gender inequalities in education impede economic growth.

Good quality infrastructure is essential for promoting and sustaining strong growth, necessary to reduce poverty. Pakistan has already moved to a higher growth trajectory and has targeted a 7-8 percent rate in the next three to four years. To achieve and sustain this Pakistan needs to invest heavily in infrastructure -water, power, roads, highways, ports, transport and communications. Heavy investment in infrastructure is also needed to take advantage of Pakistan's strategic location in the region for expanding regional cooperation in trade and commerce. In particular, Pakistan can serve as a bridge between East and West Asia, as well as the entry port for Afghanistan and the Central Asian Republics. It is in this perspective that the main theme of this year's Pakistan Development Forum (PDF) was infrastructure development. Realizing the importance of infrastructure the government has allocated Rs.87 billion for the fiscal year 2004-05 - 28 percent higher than last year. Allocation to infrastructure amounts to 59 percent of the total Federal Government PSDP (Rs.148 billion). This is a step in right direction. Increased investment in infrastructure alone, however, is not the answer as it must be underpinned by improvements in governance to ensure effectiveness and sustainability.

Pakistan's economy has gained more strength during the outgoing fiscal year. All its macro economic indicators show marked improvement over last year. The macro-economic policies and reforms programmes pursued over the last five years have not only made the economy healthier but also set the stage for taking the economy on a higher growth path. The fruits of macro economic gains have also started trickling down to the poor. A strong economic growth along with massive spending on social sector and poverty related programmes are now beginning to yield dividends in terms of declining poverty and improvements in living conditions as well as in social indicators. Much progress has been made but much remains to be done. Maintaining the momentum and building on the gains will be both vital and challenging. Sound macro economic policies, financial discipline, continuity of policies, political and regional stability will be the key to sustain the momentum.