Ask anyone in the corridors of power in Pakistan how the country would have coped with recent political and military turmoil had its finances been as weak as they were three years ago and you are likely to be greeted with a nervous smile.
Nobody cares to speculate what the outcome for Pakistan’s economy would have been had the September 11 attacks taken place three years ago, before general Pervez Musharraf and his team began to implement a reform programme. The same goes for the war in Afghanistan that has once again turned Pakistan into a frontline state, or the ensuing terrorist attacks and lawlessness that have driven out foreign investors, or last December’s nuclear showdown with India that cost the country at least $250 million in additional defence spending.
The fact that Pakistan’s economy was able to withstand these shocks and continue to expand indicates that the fundamentals are sound.
Now attention is focused on October 10, when Musharraf will in theory hand over to an elected civilian government. Most political observers agree that the military leader’s real genius lies in the fact that he does not fit the commonly perceived mould of the Third World putschist. When he ousted Narwaz Sharif in a bloodless coup, Musharraf did not unleash a wave of repression – there was no purge of political opponents, no martial law, no crackdown on the press. Instead, the general got on the phone to the top names of Pakistan’s financial diaspora. In short order leading Citibank and Bank of America executives were on their way home to engineer the country’s recovery.
“A programme of stability was quickly put into place and it was a success,” says Ali Raza, president of National Bank of Pakistan and a former Bank of America executive. “Things on the macro side have improved dramatically and the political changes have been of enormous benefit to the country. Today we are a more acceptable member of the international community and Pakistan could serve as a role model for other Muslim states, whose political leadership is held hostage by fanatical groups.”
Musharraf’s decision to support the US-led coalition fighting in Afghanistan brought the expected reward. By last December, Pakistan had successfully rescheduled more than $12 billion of bilateral Paris Club debt and was granted a $1.3 billion three-year poverty reduction and growth facility (PRGF) by the IMF.
In return, the IMF expects a continuing commitment to expansion of the country’s narrow tax base, maintenance of budgetary austerity, a bolstering of privatization efforts and a deepening of administrative reform. Enthusiasm is more muted on the chances of meeting these objectives.
“Although Pakistan has progressed in reducing impediments to growth, severe structural weaknesses such as a low savings rate, low-quality human capital and an ineffectual and corrupt tax administration constrain growth prospects,” says Chih Wai Liew, a country analyst at Standard & Poor’s.
For the moment, the country remains on hold awaiting the outcome of next month’s elections. The stand-off will be between Pakistan’s traditional two main political forces, the Pakistani People’s Party (PPP) and the Pakistan Muslim League (PML), whose policies revolve around the personalities of their respective exiled leaders, Benazir Bhutto and Nawaz Sharif. Bhutto faces a jail sentence if she returns from London and Sharif is barred from the country. However, Sharif’s younger brother Shahbaz has announced that he will lead the PML in the elections and Bhutto is expected to cut a deal with the government.
The key question is whether the return to parliamentary democracy will once again embroil Pakistan in a maelstrom of political intrigue and social unrest. The much-feared Islamic fundamentalists have been unmasked as a paper tiger. Despite the television footage of thousands of Quran-waving fanatics in the streets demanding the blood of godless westerners, these extremist parties have never won more than 10% of parliamentary seats.
Nevertheless, It would be wrong to play down the threat posed by the mullahs, whose madrasas are the breeding ground for Al-Qaeda terrorists who have shifted their base of operations from the mountains of Afghanistan to Karachi, according to the FBI, whose agents have made the capital’s Marriott Hotel their local headquarters.
One look at the Afghan border post at Torkham on the western tip of the Khyber Pass reveals the hopelessness of trying to stem the infiltration into Pakistan of Taliban and Al-Qaeda guerrillas. While Pakistani police in black shalwar kameez uniforms swing their lathis at the hordes of Afghan refugees pressing against the gates, the low-lying hills a few miles to the north and south provide easy passage to anyone determined to slip across the unguarded border.
Karachi’s streets have an unnerving edge and foreign investors are not keen to relocate to a city with such an appalling track record of terrorist attacks against foreign targets. Vince Harris is the last expatriate CEO holding out in the capital. Harris is chief executive of The Hub Power Co Ltd, a $1.6 billion non-recourse power scheme, Pakistan’s single largest FDI project, which is 26% owned by UK company International Power. The 1,290MW plant in Baluchistan province has the potential to provide 10% of Pakistan’s power needs.
“We are working to position Hub Co. to strengthen Pakistan’s investment environment through good relations with the government,” Harris says. This comes after a bitter politically motivated four-year dispute with the previous government that resulted in the company’s offices being sealed. The row badly damaged investor confidence in Pakistan, as the Sharif government had given a sourcing guarantee and then reneged on its commitment, claiming it was unhappy over the prospects of Hub paying its investors an 18% net return. “The military government is surprisingly commercial in outlook,” says Harris. “Despite our troubles, the dispute never went to court and it was resolved through negotiation. We have since paid three dividends in eight months, the equivalent of 80% of the original investment.”
Law and order apart, investors complain about a plethora of obstacles preventing them achieving an acceptable rate of return. Musharraf may have eliminated corruption at the top but businessmen having to deal with the middle echelons of the bureaucracy still encounter grasping hands every step of the way. They also complain that the Central Board of Revenue shows little sensitivity to investors.
The real threat to economic and financial stability would be a reform programme stalled by infighting between the two mainstream parties. Musharraf is determined to prevent the politicians derailing the process. To this end he is introducing a series of constitutional reforms that will allow him to retain at least firing if not hiring power.
These measures have raised a howl of protest from the country’s feisty press but few people in the street relish a return to the political turmoil that led to the ousting of the two previous prime ministers. And as one newspaper editor in Karachi notes: “Never have we enjoyed so much press freedom, and never has the government paid us so little attention.”
Whoever emerges victorious from next month’s poll cannot ignore the daunting economic challenges facing the country. The country’s bankers are in the forefront in praising the progress achieved since Musharraf took over. Pakistan, says Habib Bank’s chief executive Zakir Mahmood, is enjoying an economic spring the likes of which it hasn’t known for 25 years. “Moody’s has upgraded the country’s rating and there are no concerns about Pakistan’s ability to meet its external obligations,” he says. Union Bank CEO Muneer Kamal says the government “has remained steadfast on economic progress and the reform process has restored confidence”.
Yet the crucial privatization programme is sitting on a huge backlog that has been stalled since September 11, and foreign investment has all but evaporated, frightened off by the war in Afghanistan and personal security worries. The murder of a busload of French naval officers, the bombing of the US consulate in Karachi and sporadic attacks against other western and Christian targets has intensified those fears. Karachi in particular exudes an atmosphere of violence and lawlessness, with Pakistani businessmen and the few of their foreign counterparts left in the city moving about protected by security guards with pump-action shotguns and automatic weapons at the ready.
Privatization minister Altaf Saleem acknowledges that the September 11 factor has delayed the programme by six to eight months. “Losing six months from a three-year timeframe is a major setback,” he says. “But a lot is likely to happen in the next few months, with some of the projects carried forward for the next government to deal with.”
Saleem points out that JPMorgan, Merrill Lynch, Goldman Sachs and PricewaterhouseCoopers continue to work on some large projects, such as the sale of Oil & Gas Development Corp, Pakistan Telecom, Pakistan State Oil Co and Karachi Electric Supply Corp.
“Bear in mind that less than three years ago we started with nothing in the pipeline,” says Saleem. “The previous government had brought $40 million in transactions to the market in the same period of time. So far we’ve managed to sell off $600 million-worth of assets despite September 11 and the border showdown with India.” If in the coming months the government achieves its goal of divesting at least 51% of the assets it is currently working on, it will have added $3 billion to state coffers.
Selling off the banks
Pakistan’s restructured state banks are very much at the cutting edge of the privatization efforts, in terms of generating investor interest and setting benchmarks. Slightly more than 40% of the banking system remains under state ownership. The partial sell-off late last year of 10% of National Bank of Pakistan met with an enthusiastic response from retail investors, with the issue seven times oversubscribed. This raises confidence for a successful takeover of United Bank Ltd (UBL) by Pakistan’s private-sector Muslim Commercial Bank (MCB).
The bank came in with a Rs8.5 billion bid, but the government was confident it could push this it up to Rs12 billion ($202 million). It succeeded, and this secured the deal for MCB despite a last-minute counter-bid by Bestways, a consortium of Gulf investors. MCB’s acting president, Khalid Niaz Khawaja, makes no secret of United Bank’s star attraction. “UBL’s international operations give us immediate right of entry into prime banking markets abroad,” he says. United Bank operates a wholly-owned subsidiary in Zurich with a Swiss banking licence.
Nine foreign and domestic investors have so far shown an interest in the upcoming privatization of Habib Bank. The privatization commission should have cleaned out its bank portfolio in the next few months, leaving only the central bank to gradually wind down its state holding once a substitute system is devised to replace the official functions it now performs, such as paying civil servants’ salaries and pensions.
The banks’ latest set of results indicate that life carries on beyond the headlines, with the economy moving at a reasonable clip. Most of the banks began implementing dramatic cost-cutting measures after Musharraf took power.
Habib Bank has reduced its headcount by some 9,000, says Mahmood, who was brought in from Crédit Agricole Indosuez. “We have been through a five-year restructuring,” he says. “We’ve now cleaned out the system and plugged all the holes with a very good second-level management team brought in from HSBC, Bank of America, Citibank, SocGen and elsewhere. These people have a full understanding of best practice.”
National Bank this year achieved a record three-fold increase in pre-tax profits to Rs3 billion after going through a painful restructuring. “With inflation running at around 3%, currency stability and a high level of foreign reserves, we are looking at a generally positive environment,” says Raza. “It’s important to note that a lot of structural improvements, like sales tax reform, had already started before September 11. I would be looking for a higher rate of economic activity in six to eight months from now.”
Union Bank, which has taken over Bank of America’s local operations and is now acquiring Dubai-based Emirates Bank, intends to grow its balance sheet to the $1 billion level that Kamal believes is necessary to compete effectively in Pakistan’s banking market in the next two to three years.
Rawalpindi-based Askari Commercial Bank has spent the past traumatic year developing the industry’s most sophisticated banking IT system, with real-time branch connection, full internet banking services and Pakistan’s first countrywide ATM network. “We are competing through technology,” says Kalim-ur-Rahman, the bank’s chief executive. Askari brought in people from Grindlays and several Middle Eastern banks to manage a multi-front expansion in credit cards, trade finance, mortgages, SME financing and e-banking. “The key is to add on more business while holding the line on staff costs,” he says. Muslim Commercial Bank has also been on an IT spending spree and now claims to operate the largest online retail banking network in South Asia. “The network now covers 75% of all our banking transactions,” says Niaz Khawaja.
Zubyr Soomro, chairman of the Pakistan Banks Association, is upbeat about the banks’ ability to prosper in adversity, thanks to the reforms initiated under the previous government and reinforced by Musharraf’s team. “Reformist legislation was put in place covering labour relations, debt recovery processes and the autonomy of government-owned banks,” he says. “By the time September 11 struck the banks had been through years of qualitative procedures and were better placed to confront the repercussions of that event. Hence 2001 was a year of strong profitability for the banks.”
September 11 was ironically one of the drivers of that profitability. Last year was a bad time for the nearly 500 money-changing operations around the world that thrive on funnelling workers’ remittances into Pakistan. For years, these hundi wallahs based in the Gulf, the US and elsewhere have been doing a brisk business in transferring huge sums through their systems which, even mainstream bankers admit, are highly efficient.
Currency flows back into regulated channels
But the political upheaval that erupted in the wake of September 11 has frightened off most of the hundreds of thousands of Pakistani workers abroad, who now prefer to use official bank channels. They fear that the emphasis on “know your customer” could lead to a freezing of funds flowing through these unofficial channels. Also, with Kabul effectively shut down the drop in Pakistan’s huge smuggling trade has reduced the demand for illegal dollars. The Afghan capital is traditionally the turnround point for smuggled goods landed in Karachi finding their way back into Pakistan.
Pakistani banks are now offering competitive rates on deposits. The result: before September 11 Muslim Commercial Bank’s foreign currency accounts stood at $40 million. The figure is now $160 million. Askari Bank is working with one of these dealers based in New York and expects to be handling $120 million a year in remittances. “Until now, workers’ remittances were coming in through the back door,” says Azhar Hamid, chief executive of Standard Chartered Grindlays in Pakistan. “The official flow of funds reached a peak of $2.6 billion in 1993 and by 2000 they had tapered off to $800 million, meaning that $1.6 billion was not going into the reserves. I believe we’re now looking at a minimum inflow of $2.5 billion for the current financial year.”
The State Bank has cut a deal with these overseas dealers (see interview with Ishrat Husain) offering them a two-year grace period to legitimize their operations by linking up with Pakistani banks.
The only perceived threat to the banks was pressure from the Supreme Court to impose Islamic banking. Musharraf’s handling of this problem was a set piece of political artfulness. A watered-down version of the Sharia system was introduced in the 1980s by another military ruler, Zia al Huq. The controversy was over how far to go in implementing a no-interest payment policy in accordance with a fundamentalist interpretation of Islamic law. The issue languished in the supreme court until it was reopened under Narwaz Sharif.
By the time Musharraf seized power from Sharif, the court had handed down a hardline judgment requiring full implementation of Islamic banking by June 2001. Musharraf went to the court and obtained a one-year extension of the deadline. He then pressed his case for a complete reversal of the ruling. The judges found themselves boxed into a corner and managed to wriggle out by dumping the case on the federal Sharia court. Musharraf kept up the pressure. He then issued a petition to have the case reviewed in the light of how Sharia is implemented in other Muslim counties.
“To the Sharia court’s embarrassment, the government pointed out that the only country with a full-fledged Islamic banking system is Sudan, hardly an example of a successful economy,” says the CEO of a Karachi-based bank. “The mullahs are now pondering this and there is little doubt that in the coming months the case will die a quiet and natural death.”
On the path to growth
Shaukat Aziz, finance minister of Pakistan, talks to Euromoney’s Jules Stewart about efforts to boost economic growth and build up foreign reserves
Can you outline what you have achieved in terms of economic progress in the wake of September 11?
The reform process this government began to put in place three years ago involved better fiscal discipline, higher emphasis on growth, poverty reduction and good governance.
The financial year ended June 30 has been a good one for Pakistan from a macroeconomic standpoint. GDP growth was 3.6% in real terms and our target for this year is 4.5%, which we consider quite realistic and achievable.
We started this year in the context of a slowdown in the global economy, a drought, then came September 11 and the military showdown with India in December. In spite of this, we continued to follow the path of fiscal discipline and our underlying deficit came in at 4.9% of GDP.
But this contains a number of one-offs and the published figure will be higher.
We also improved our debt numbers, so that the foreign debt came down to $36 billion from $38 billion, while on the domestic side we achieved a reduction from PRs1.7 trillion to Rs1.6 trillion. Revenue figures crossed the PRs400 billion mark for the first time, even taking into account the cancellation of export orders, increased insurance rates and lower domestic consumption as a result of September 11.
There was no flight of capital, no run on the banks and in fact today our reserves have risen above $7 billion from $3 billion before the terrorist attacks on the US. In short, we have pursued a path of reform that allowed us to confront these crises. The message is that if you can conduct sound structural reforms, you are in a better position to face unforeseen events.
What are you doing to ensure the continuity of this reform process?
The president is staying on and he will ensure that whatever key reforms have been achieved will be protected. Some of the team players may continue in the bureaucracy, although this is down to the new elected executive to decide. Moreover, all the structural reforms we have initiated are linked to programmes of the World Bank, ADB and the IMF.
So we have covenants that will influence any new government to follow, otherwise the red flag will go up and the flow of funds will evaporate. Going forward, this new government will look to the support of the donors.
We are trying to institutionalize these reforms, not personalize them.
You have become very much the face of Pakistan to foreign investors. What are your personal aspirations after the general elections?
This is something for the president and the new prime minister to decide. At this stage I think it’s premature to say who will stay and who will go.
How can you achieve a higher rate of growth if investors are shying away?
We see a number of possibilities. We are looking at higher public spending plus a better performance by agriculture. Farming represents 25% of our GDP so water availability has a tremendous impact.
Also, private-sector investment, particularly in textiles which accounts for 60% of our industry, is going to be higher, with a lot of new production coming on stream.
Other sectors such as engineering and auto manufacturing are doing very well. By the way, today you have to wait six months to buy a new car.
Do you see any scope for Pakistan going to the capital markets in the near future?
I think that we may want to look at a bond issue after the elections with a view to setting a benchmark, although there are no immediate liquidity needs. We’re sitting on seven and a half months of imports.
But I think it’s a good time to go and establish a benchmark, assuming the dust settles on external events. We have a good story to tell in macroeconomic management and in staying on track with our commitments, a high degree of transparency and eradication of corruption at the top.
