Sharif’s capital start

When prime minister Nawaz Sharif came to power in February, Pakistan’s balance of payments deficit was out of control, it had lost the trust of the IMF, and its fiscal situation was so serious that default on loans to international lenders seemed inevitable. Five months on, Pakistan is on the slow path to economic recovery. Reserves have improved, morale in the private sector is higher, and the IMF appears on the brink of extending further funds.

Pakistan is back in the fold of financially respectable nations. The turnaround has been accomplished by a government committed to stimulating business and the private sector at the expense of the state-owned entities. A programme to curtail government and bureaucracy, tackle corruption, and speed up privatization won over the financial community.

“We have some hope at last,” says Rubina Atif, deputy secretary at the Karachi Stock Exchange, which rose 7% in the days following the arrival of the new government. Adds Sajjad Razvi, Citibank’s country manager: “There is a lot of onus on the private sector. The government has done its bit for recovery. Now business must reciprocate.” This it has done, to a limited extent, in responding to prime minister Sharif’s request for funds to help stave off economic collapse.

At home, businessmen came forward with their own money to prop up the country’s dwindling reserves. Pakistanis living abroad also paid up. They were called on to deposit at least $1,000 in the country over the next two to five years, to help relieve the national debt. Personal letters of thanks from the prime minister were offered to those who deposited between $100,000 and $1 million. Special medals were given to those who deposited in excess of $1 million. A total of $200 million was raised from this appeal, of which 75% was in interest-bearing fixed deposits, 20% in the form of donations, and 5% in interest-free fixed deposits.

The bond markets were also apparently prepared to help. It has been estimated that in excess of $1 billion was pledged for a $150 million, five-year Pakistan Telecommunications Corporation (PakTelecom) exchangeable bond, issued immediately after the election. The issue size was raised to $160 million. When the country came to the international capital markets in May, seeking $100 million, the mood was still favourable. Stephen Finch, the director of new issues at ANZ, the bank that led the three-year floating-rate Eurobond, commented: “It went down very well. It’s no big secret that Pakistan had its troubles at the end of last year. But the new government is very pro-business. Its liberal deregulation policies have come to the fore, and there is an opportunity to buy into the new story at yields that still reflect the troubles of the past.”

Investors, who included Middle Eastern, US and European buyers of high-yield instruments, were paid handsomely for their support. The three-year floating-rate Eurobond was sold at 395 basis points over treasuries. The price has since narrowed in appreciation of the growing confidence in the Sharif administration. Now the State Bank of Pakistan is widely expected to capitalize on the new-found faith, and make further visits to the markets in the course of the coming year. Observers say Pakistan is seeking to raise between $200 million and $500 million with a further Eurobond issue later this year. The planned issue will be underpinned by the estimated $1.4 billion in annual overseas worker remittances.

In the five months following the arrival of the new government, there has been some improvement in the country’s financial position. Pakistan’s foreign exchange reserves have doubled from $500 million to more than $1 billion. However, the country’s annual debt repayment obligations are estimated by bankers at about $3 billion. A monthly trade deficit of about $300 million must also be financed. The finance minister, Sartaj Aziz, set the tone in his business-friendly budget in June which aimed to kick-start the economy with a supply side boost. Import tariffs, personal and corporate taxation, and general sales tax were all reduced to free business from the economic constraints imposed by earlier governments.

“Our overriding objective is to revitalize the economy and in particular the industrial sector,” said Aziz. The finance minister set his sights on a 6% growth rate, double last year’s, but little more than the average over the last 10 years, and targeted to recoup lost ground. He forecasts a 15% growth in exports (outstripping a modest 5% increase in imports), and a reduction in inflation from 13% to between 8% and 9% over the year. Import tariffs were slashed from 65% to 45% for all items except cars.

Ishaq Dar, federal minister for commerce, commented: “We are trying to reduce import tariffs on raw materials, eliminating duties on engineering industry’s machinery and lowering interest rates on bank loans, in order to revitalize the manufacturing sector and boost exports.” Income tax rates were halved in the budget, bringing them all within a 5% to 20% band. Tax rates for public limited companies were cut from 33% to 30%. The general sales tax was reduced from 18% to 12.5%. More fiscal reforms are expected later in the year, aimed at simplifying the system and bringing more Pakistanis within the tax net. In a country with a population of 140 million, only a million people pay income tax.

One key observer of the new government in Islamabad was the IMF. Its previous standby loan agreement had collapsed in March when Pakistan failed to meet performance criteria. Now the IMF is thought to have given the budget its approval and agreed to upgrade the republic from a standby to an enhanced structural adjustment facility in September, provided the Sharif reforms show evidence of success. The IMF is believed to have accepted that Pakistan will not be able to reduce its budget deficit to 4% of GDP in the current financial year. Instead, it is apparently prepared to go along with Aziz’s more modest target for 1997-98 of 5%.

One of the most important aims of the budget was to stimulate foreign investors’ interest. “We want to make ourselves more attractive to foreign investors by improving the tax structure, just like other countries in the Asia Pacific region,” says Raana Ahsan, staff officer to the secretary at the Board of Investment. “These countries have opened their doors to investors, by offering tax holidays and exemptions, lower tax and tariff rates and 100% zero-rated duty on export-oriented projects.” Pakistan is now preparing an incentive package, which, says Ahsan, “will match the best in the region”.

The government has talked much about its commitment to privatization, and the sell-off of PakTelecom in the coming year will be a test. PakTelecom is regarded as the most attractive of Pakistan’s state-owned companies, although concerns over the company’s future have caused its share price to tumble over the past 12 months. The latest financial results were more encouraging, however, partly because of a write-off of bad debts worth Rs1.54 billion ($38 million) in the first half. Pushing the privatization of PakTelecom has been difficult. The government has struggled to find a strategic shareholder who could also be an industrial partner. The country’s powerful defence services have also highlighted the national security implications of the sale, obliging the government to agree to use some of the privatization proceeds to set up a separate telephone service for their use.

But there are other, potentially more damaging complications. Should the government act on recommendations to cut the company’s workforce by a quarter, 55,000 people would be out of a job. Union resistance would be inevitable. The legacy of delays and the lack of transparency surrounding large asset sales such as PakTelecom still troubles the business community.

The new government has taken heed of business concerns and cut back bureaucracy. The fertilizer, oil and gas industries, among others, are listed for privatization. Less attractive, perhaps, is Pakistan Railways, which is being prepared for sale. The dilapidated state of the system will make this a particular challenge. Observers of the privatization process are encouraged by Sharif’s previous record as prime minister between 1990 and 1993. At that time he adopted deregulatory policies and sought to privatize many of Pakistan’s state-owned industries. Of the 118 enterprises which were identified by his government as eligible for privatization, 67 were sold, a success rate of 57%. This rate slowed during the subsequent Bhutto-led administration.

Although a large number of companies, encompassing the whole spectrum of Pakistan’s state-owned companies, were put up for sale, little was achieved. The failure resulted from the various ministries safeguarding their own interests, and lack of investor interest. Following the fall of prime minister Benazir Bhutto, the caretaker government made strong efforts to reawaken interest from investors. The Jinnah airport terminal in Karachi, and various seaports and public sector development finance institutions, were all identified for sale. Now the political heat is on for quick disposals to prove to the IMF and international investors that the government really means business.

Pakistan can already point to one big success in private power generation. In Hubco, it has the biggest private power station in the whole of east Asia. The $1.6 billion power plant, operated by National Power, the UK power group, provides 13% of Pakistan’s power. The financial arrangements for Hubco have provided a model for the country’s private power policy and the impetus for similar deals. Pakistan’s private power policy of 1994 offered average bulk tariff rates of 6.6 cents a unit for the first 10 years, long-term supply contracts, foreign currency guarantees, income and corporate tax exemptions and a series of additional sales tax and other concessions.

The deal has been important in engendering investor confidence in Pakistan, formerly regarded as a politically risky state for such large infrastructure projects. This, in turn, bodes well for the new administration’s privatization programme.