Pakistan Country Update
|MOST LIKELY REGIMES AND THEIR PROBABILITIES|
|18-Month:||PPP-led Coalition 45% (40%)|
|Five-Year:||PML-N Coalition 45% (40%)|
|FORECASTS OF RISK TO INTERNATIONAL BUSINESS|
|Financial Transfer||Direct Investment||Export Market|
|( ) Indicates change in rating.||* Indicates forecast of a new regime.|
|KEY ECONOMIC FORECASTS|
|Real GDP Growth %||
|Current Account ($bn)|
Court Asserting Its Authority
In December 2009, a 17-member apex court headed by Chief Justice Iftikar Chaudhry declared the amnesty provisions of the controversial National Reconciliation Order (NRO) issued by President Pervez Musharraf in late 2007 to be null and void. The ruling implied the reopening of literally thousands of corruption cases against past and current government officials, including Defense Minister Chaudhry Ahmad Mukhtar, Interior Minister Rehman Malik, Water and Power Minister Raja Pervaiz Ashraf, and several of President Asif Ali Zardari’s close aides. Zardari himself was expected to be immune from prosecution by virtue of his office, but the court’s detailed ruling ordered the National Accountability Bureau (NAB) to reopen a series of money-laundering cases against the president.
Needless to say, the amnesty ruling was received with something less than quiet acceptance. The Central Executive Committee of the main governing Pakistan People’s Party (PPP) voted to challenge the validity of any prosecutions that are pursued, while simultaneously petitioning to reverse the court’s decision. For its part, the NAB refused to act on the court’s order for three months, and only made contact with authorities in Switzerland (where the money-laundering charges against Zardari originated) after top figures from the bureau were jailed for non-compliance.
Legal professionals have made a show of solidarity in support of the court, much as they did after Chaudhry and other members of the Supreme Court were pre-emptively removed by Musharraf shortly before they were due to issue a ruling on the legality of the former president’s re-election in 2007.
Attorney General Anwar Manoor Khan tendered his resignation to protest the government’s stance of non-cooperation with the NRO ruling, and the country’s lawyers staged a strike after Zardari rejected Chaudhry’s pick for chief justice of the Lahore High Court.
Zardari appeared to gain a reprieve in early June, when the government officially informed the Supreme Court that the Swiss cases against President Zardari, former Prime Minister Benazir Bhutto (the president’s late wife), and Bhutto’s mother had been thrown out by the prosecutor-general of Geneva in 2008. The cases were discharged “on merit,” rather than in response to the amnesty provisions of the NRO, and so, under Swiss law, cannot be reopened, even at Pakistan’s request. However, that has not satisfied the Supreme Court, which has demanded that Minister of Law Masood Chishti present evidence of a good-faith effort to carry out the courts’ order or appear in court to explain why he has failed to do so.
Parliamentary Rule Restored
The main opposition Pakistan Muslim League-Nawaz (PML-N) does not appear to be inclined to press the issue, or otherwise seek to force Zardari’s ouster before the completion of his term in office. In fact, it seems that PML-N leader Nawaz Sharif is quite content to let Zardari and the Supreme Court continue on their collision course, apparently judging that the battle will only benefit the PML-N when next it faces the PPP in a national election.
Sharif can afford to be patient, thanks to the approval in April 2010 of an 18th amendment to the constitution, which effectively reversed the concentration of executive power in the presidency that occurred under Musharraf. Among other changes, the 18th amendment removed the president’s authority to dissolve the Parliament and to appoint military chiefs, devolved some important responsibilities to the provinces, and abolished the two-term limit for prime ministers, clearing the way for Sharif to seek the premiership at the next general election.
Zardari is no doubt counting on his surrender of the most important powers of his office to buy him some political cover. The 18th amendment was approved with support from all the main parties, including the PPP, and was hailed (by Zardari and others) as an unprecedented voluntary transfer of power by a Pakistani leader. The clear expectation is that the goodwill generated by the president’s cooperation with the opposition will protect him from an impeachment effort or a push by the PML-N to bring an early end to the PPP- led government.
Indeed, Pakistan cannot afford a protracted power struggle between the Parliament and the president. There are too many challenges that must be addressed, including unrest in the troubled western provinces, the threat posed by religious extremists, power and food shortages that are compounding the hardship resulting from more general economic difficulties, and once-again prickly relations with India.
However, the prospect of several Cabinet members and numerous parliamentary lawmakers being marched into court to face prosecution on corruption charges hardly bodes well for political stability. Under such circumstances, it would not only be reasonable, but perhaps essential, that Prime Minister Yousaf Raza Gillani’s government step down and clear the way for an early election. Much will depend on the degree to which other parties, especially the PML-N, view such a course to be to their advantage.
Whether the rebalancing of power between the Parliament and the presidency resulting from the 18th amendment produces any benefit in terms of broader stability remains to be seen. In that regard, an outbreak of violence in the former North West Frontier Province (NWFP) over a provision of the 18th amendment – the one that renamed NWFP to Khyber Pakhtunkhwa – highlights the many potential sources of instability that are still present.
The Hazara people make up about 30% of the province’s population and the Hazara Division was the largest third-tier administrative unit in the NWFP prior to the abolition of divisions in 2000. The Hazara, along with other nonPashtun groups, fiercely objected to naming the region Pakhtunkhwa, which literally means “province of the Pashtun,” and launched violent protests across Pakistan following the announcement of the change. Several people were killed and the unrest temporarily delayed approval of the amendment. Although the provision renaming NWFP was approved along with the rest of the 18th amendment, the issue of Hazara autonomy, which has been largely dormant since the 1980s, could re-emerge down the road.
Meanwhile, the ongoing insurgency in the western provinces adjoining Afghanistan continues unabated, while the threat of terrorist attacks elsewhere in the country persists. The domestic media frequently report the capture or death of Taliban commanders, but it is difficult to know for certain whether these achievements are making a real dent in the problem.
The army claims that the Swat Valley is once again under control – with 200,000 displaced persons successfully returned to the Swat and Malakand districts – and, since late 2009, the military has announced the pacification of South Waziristan and Bajaur. However, the army remains engaged in varying levels of combat in the Swat, South Waziristan, Bajaur, Orakzai, and Khyber regions. Even assuming some of these areas are largely under control, sustaining the gains made in recent months will require significant resources for reconstruction and investment in the region’s economic development and integration with the interior of the country.
The military is currently planning to expand operations to North Waziristan, where militants who fled from South Waziristan are suspected to be regrouping. Thus far, tribesmen and the government are holding to the terms of a 2008 peace agreement. However, the US has applied pressure on Islamabad to launch a counterinsurgency effort in the province, after the Taliban claimed responsibility for a failed terrorist attack in New York City. The relationship between the Taliban and the Pakistan-born US citizen who has been arrested for plotting the attack is not entirely clear, but the incident has in any case contributed to heightened tensions between Pakistan and the US, especially after Foreign Minister Mahmood Qureshi suggested that the failed bomb attempt in New York might have been intended as an act of retaliation for US drone attacks in Pakistan.
Pakistan opposes the use of drones to carry out airstrikes against extremist encampments in its territory, which officials in Islamabad have complained is a violation of Pakistan’s sovereignty. Although some have also questioned the practice on human rights grounds, owing to the number of civilian deaths that have resulted, the fact that Pakistan has requested drone technology from the US to use on its own terms to fight terror on the Afghan border suggests that sovereignty is the main issue.
Islamabad has never fully succeeded in imposing its authority on the western tribal areas, which have generally viewed the central government with suspicion, and the presence of counterinsurgency forces and US drones has done little to improve that situation. Efforts to build a stronger relationship between the center and the provinces are currently under way. In November 2009, the National Finance Commission agreed on a new national formula for the distribution of fiscal resources to the provinces, with 42% determined by population, 10.6% by levels of poverty and socioeconomic backwardness, 5% by revenue collection, and 3% by area. As the most backward of the provinces and the victim of a long-running federal counterinsurgency campaign, Balochistan will receive the largest share of divisible funds under the new plan.
However, real autonomy is not a realistic near- or medium-term prospect for any of the provinces, as the formal devolution of political authority would require a constitutional amendment, and the probability of securing the necessary support in the Parliament would be rather low.
Seeking a Thaw in Relations with Iran and India
The Iran-Pakistan border was reopened in March, after being closed for several months due to a terrorist attack launched from inside Pakistan. The thawing of relations was confirmed when the two countries signed a gas pipeline deal in the same month. The pipeline project holds the promise of much-needed jobs and a boost to Pakistan’s inadequate domestic energy supply.
However, the project has been threatened by US efforts to impose tighter sanctions on Iran, a prospect that has further added to tensions between Islamabad and Washington. Moreover, India is a third party to the deal, which has been under discussion for the past four years, and Delhi continues to voice objections to the pricing and, especially, the security provisions in the agreement, which is not a trivial matter, given that the pipeline will pass through Balochistan.
Relations with India were finally normalized after a 14-month freeze following the November 2008 attacks in Mumbai, and peace talks are scheduled to resume in July 2010. While the official revival of talks is positive, it remains to be seen if the two nations will achieve any practical improvements on shared issues such as water and Kashmir, where both sides periodically report exchanges of gunfire between their military forces. India would like to limit talks to terrorism, which it considers top priority, but Pakistan would prefer to have a full agenda. In that regard, Pakistan is especially alarmed by the marked increase in India’s defense budget this year.
In truth, the risk of war between Pakistan and India is currently quite remote. That said, it is unlikely that the upcoming talks will do much to ease the tensions that have dominated relations between the two countries since November 2008, let alone produce any major breakthrough.
Foreign Aid Less Than Expected
Pakistan continues (and will continue indefinitely) to depend on substantial foreign financial assistance if it is to enjoy even a modicum of economic stability over the medium term. In August 2009, the IMF agreed to provide an additional $3.2 billion in aid to Pakistan, on top of the $7.6 billion bailout loan approved in November 2008.
In May 2010, the IMF released another $1.13 billion tranche to support the economy, despite Pakistan’s failure to meet its deficit target or adhere to borrowing limits. The IMF has adjusted the targets on which the 2010/2011 budget is to be based, in recognition of the financial obligations imposed by security threats and Pakistan’s difficulties obtaining committed funds from other sources.
Based on the recommendations of the IMF, the general sales tax is to be replaced with a more productive value-added tax (VAT) and subsidies to power companies will be reduced, with the financial loss offset by a 6% increase in utility tariffs. The IMF has committed $11.2 billion to Pakistan and the delivery of the most recent tranche in May brings total disbursements thus far to $8.7 billion. The IMF has agreed to combine the remaining three tranches under the current loan program into two payments, the last to be delivered in December, provided the conditions for disbursement of the remainder of the loan are met.
As of early July, the Finance Ministry reported difficulties convincing the provinces to back the VAT, and despite the increase in tariffs, the Pakistan Electric Power Company (Pepco) is facing a massive shortfall owing to higher fuel costs. Finance officials are due to meet with IMF officials to discuss how they plan to implement the VAT by October 1, and what steps they will take to close Pepco’s financing gap, which, in a worst case scenario, could require a significant additional increase in electric power tariffs. Not surprisingly, officials are also weighing their options in the event that IMF funds are withheld.
Pakistan stands to gain $1.5 billion (over five years) in additional aid from the US under the proposed Kerry-Lugar bill, but the terms of the agreement remain a subject of heated debate in the Parliament and among the broader public in Pakistan. The proposed aid was requested by Zardari, but is vehemently opposed by the other major parties, as well as the military brass, who have criticized guidelines regarding competence and ethics contained in the Kerry- Lugar bill to be an insult to Pakistan. The US has assured that it has no desire to micromanage Pakistan’s internal affairs, but has refused to amend the offending text in the bill.
Much of the increased aid is earmarked for improvements to infrastructure and other projects designed to improve living conditions, which is in line with the ramped-up civilian strategy unveiled by the US State Department in January. The fear is that it will instead end up in the pockets of corrupt officials or be used for military purposes that are counter to US interests, such as increasing Pakistan’s ability to withstand an attack from India.
Regardless of the outcome of the debate, Zardari will be weakened in the process. His seeming lack of concern over the implications of the conditions attached to the US aid has not gone unnoticed by the military, whose willingness to support the president will be crucial not only to Zardari’s perceived usefulness to the government in Washington, but also to the survival of his presidency in the event of a political crisis. The controversy has also helped to stoke already widespread anti-US sentiment within Pakistan, to the benefit of the PML-N, which has wrapped itself in the mantle of national pride.
Economy Kicks Weakly
After slowing to an eight-year low of just 1.7% in 2008/2009, real GDP growth (at factor cost) is estimated to have rebounded to a solid, if unspectacular, 4.1% in the fiscal year to June 30, 2010. Economic expansion has been fueled primarily by growth in the large-scale manufacturing sector and the services sector. The Finance Ministry is forecasting a modest uptick in the real GDP growth rate to 4.5% in the 2010/2011 fiscal year, but disruptions resulting from power and water shortages, and delays in the disbursement of foreign economic assistance are expected to hold growth closer to 4% in the fiscal year that began on July 1.
The moderately positive growth data has been overshadowed by worrisome trends in other indicators. The expense of waging war against insurgents in the northwest of the country contributed to a larger-than-programmed budget deficit, and an attempt to narrow the fiscal gap by cutting energy subsidies proved insufficient to reduce the deficit to the target of 4.9% of GDP. The delay in securing funds committed in 2009 by the so-called Friends of Democratic Pakistan forced the government to increase borrowing from the central bank by 14.5% in the 12-month period to April 2010. The IMF has agreed to a 5.1% deficit target for 2010/2011, but insists that Pakistan must boost revenue by introducing a VAT.
Inflation has eased somewhat since surging to an annual average of 20.3% in 2008, but has remained stubbornly in double digits for more than two years. The consumer price index rose by 13.1% (year-on-year) in May 2010, and will fall gradually over the coming months, largely owing to a base effect. However, hikes in electricity prices will keep inflation firmly in double digits this year, at an average of 12.5%, and the rate could be higher if the government succeeds in putting a VAT in place by October 1. The possibility that external factors might trigger a rise in the cost of food or fuel imports poses a further upside risk to the forecast.
Austerity measures demanded by the IMF contributed to a weakening of domestic demand that in combination with lower commodities prices resulted in a steep drop in imports in 2009. Faster economic growth will be accompanied by stronger domestic demand, which coupled with higher prices for imports of food and fuel will push the imports bill upward at a rapid pace in 2010, resulting in a widening of the trade deficit. However, healthy inflows of remittances will widen the transfers surplus, and the services surplus is also expected to increase in the coming year. As a result, the current account deficit is forecast to narrow to $2.8 billion in 2010.
Economic Forecasts for the Three Alternative Regimes
|PML-N Coalition||PPP-led Coalition||Military-Civilian|