Dr Aasim Husain is a former senior official of the IMF, where he worked for over 30 years. In a recent paper for the Washington-based Atlantic Council titled "Rescuing Pakistan’s Economy," he outlines the reasons for Pakistan’s poor economic performance in the past and how to unlock better performance in the future.
I asked him a few questions on those topics.
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Ahmad Faruqui: Moody’s has upgraded Pakistan’s credit rating but it has just moved up in the C category. Is that something to be excited about?
Aasim Husain: An upgrade is certainly good news. It reflects the rating agency’s assessment that Pakistan’s economic outlook has improved, and risks have moderated. Because of it, Pakistan will be able to borrow abroad a little more easily and at slightly better terms. It should also help attract more foreign investment.
But there is also a downside. If the enhanced ability to borrow overseas prompts the government to re-start borrowing abroad on commercial terms, we could quickly find ourselves back in the near-crisis situation of 2022-23. Recall that at the time Pakistan’s annual gross external financing requirement—that is, the dollars needed to repay foreign debts, interest, and the shortfall in trade—was more than five times the dollar reserves held by the State Bank. What saved Pakistan then was the fact that almost all of Pakistan’s external debt was to official creditors, who could be persuaded to roll it over once an IMF program was in place. Other countries, like Sri Lanka, Ghana, Zambia, etc., who owed more to private creditors, had no choice but to default and undergo a much more painful crisis.
Also, even with the recent upgrade, Pakistan’s rating remains many steps below investment grade. That means that borrowing abroad will continue to be very expensive as investors will still demand a sizable risk premium. Moreover, borrowing in foreign currency also carries exchange rate risk, which means that the rupee amount needed to repay the loans increases dramatically whenever the country runs short of foreign exchange and the rupee comes under pressure.
AF: In the 1960s, Pakistan experienced remarkable economic growth, prompting some to say it was poised to take off. What went wrong? Why did Pakistan not become an Asian Tiger?
AH: Five decades ago, Pakistan had the strongest economy in South Asia, outperforming India, Bangladesh, and even Sri Lanka in terms of per capita income. Today, Pakistan’s per capita income is half that of its neighbours, and it trails them in education, health care, and most other development indicators.
"If Pakistan’s population growth had grown over the past quarter century at a pace comparable to neighbouring countries, saving and investment would have been much higher, and the economy today would have been 30-45% larger!"
The two principal errors on the policy side have been rupee overvaluation and fiscal profligacy. Borrowing in foreign currency to pay for imports has harmed domestic industries—whether export oriented or import substituting—by making it harder for them to compete against imports because the rupee was stronger than warranted by fundamentals. And whenever foreign loans dried up, policymakers had no choice but to devalue the rupee sharply, causing pain for everyone.
The other policy error—persistent large fiscal deficits reflecting the government’s inability to live within its means—has translated into a massive buildup of debt. By 2022-23, interest payments on public debt were eating up well over half of the government’s revenue, leaving little space to meet even basic needs. Moreover, high government borrowing from the banking system has crowded out the already meagre funds available for private investment, further undermining the competitiveness of domestic industry.
Apart from policy mismanagement, an often overlooked but equally important factor holding back Pakistan’s economic performance was rapid population growth. Pakistan’s population has more than quadrupled over the past half-century, while population growth has slowed dramatically in Bangladesh, India, and Sri Lanka. As a result, the rate of household savings in Pakistan has been only one fifth as high as in the neighbouring countries because—put crudely—there have been “more mouths to feed.” Low saving has translated into low investment because of the limited availability of financing, which in turn has held back economic growth.
AF: Economic growth has tended to be higher during periods of military rule. Is that because of better economic policies, political stability or US aid?
AH: I don’t think it is possible to establish a causal relationship. Extended episodes of scaled up US-led international support have indeed coincided with periods of military rule, such as in the 1980s and early 2000s. The associated inflows boosted economic growth, but only temporarily. Over time, those inflows ended up hurting the economy because they supported large budget deficits, which translated into a heavy future interest burden, and an overvalued rupee, which hurt the competitiveness of Pakistani industry and held back its growth and employment creation. When the inflows stopped, growth plummeted, and economic crises followed.
AF: How can an economy that borrows heavily from abroad, whose domestic savings and investment rates are low, and whose tax revenues do not cover government expenditures get out of the poverty trap?
AH: The challenge may seem daunting, but the experience of the rest of South Asia suggests that stronger economic performance is achievable. It is essential to reduce the budget deficit to curb debt accumulation, and to maintain an exchange rate that supports the competitiveness of domestic industry.
In addition, population growth must slow. If Pakistan’s population growth had grown over the past quarter century at a pace comparable to neighbouring countries, saving and investment would have been much higher, and the economy today would have been 30-45% larger! Had Pakistan been able to educate its population better and keep pace with its health indicators, the resulting improvement in human capital would have translated into an even larger expansion in the size of the economy.
AF: When it was East Pakistan, Bangladesh was economically consistently behind what was then West Pakistan. A reversal of fortunes occurred soon after East Pakistan seceded. What was Bangladesh able to do that Pakistan was unable to do?
AH: Bangladesh was able to achieve a dramatic slowdown in its population growth. That raised its domestic savings, which averaged around 25% of GDP over the last decade. As a result, investment rose to 30% of GDP, boosting growth and generating employment. By comparison, Pakistan’s saving rate was under 10%, and investment averaged only around 12%. No wonder, then, that economic performance lagged.
A key element in Bangladesh’s success was the expanded economic role of women. Microfinance institutions like Grameen Bank lent almost exclusively to women, enabling them to launch small-scale businesses. Moreover, the rapidly growing garment sector mainly employed women. The resulting economic empowerment of women not only raised economic output directly, but probably also increased women’s voice in household fertility and children’s education decisions, further restraining population growth and boosting economic growth indirectly.
AF: After 1991, India’s economy began to move rapidly ahead of Pakistan’s. What were the ingredients of India’s success?
AH: India’s deep structural reforms in the early 1990s indeed unleashed a marked acceleration of economic growth. The dismantling of severe import restrictions and the debilitating “license raj” was critical. A factor that is often overlooked is that, like Bangladesh, India was able to achieve slower population growth. That helped boost domestic saving—and consequently investment—from around 15% of GDP on average in the 1980s to nearly 30% over the last decade. Again, no surprise then that India’s economic performance was much stronger than Pakistan’s, which was able to muster much lower savings and investment.