DEMANDING THE IMPOSSIBLE - DEBT AND POVERTY IN PAKISTAN

By Susanna Mitchell
Jubilee Research

5^th December, 2002

Synopsis

After fourteen years on the sidelines, Pakistan has once again assumed a position of great strategic importance to the United States, this time as a crucial ally in the West’s so-called ‘war against terror’. This unenviable role places huge additional demands on the country’s economy at the end of a decade that has already witnessed a steady increase in poverty. (By FY 1999, some 47 million people, or roughly 35% of the population, were living below the poverty line, and the incidence is now estimated to be significantly higher.[1]) During this period, the servicing of Pakistan’s escalating external debt, which by FY2000/01 amounted to 54.9% of the country’s GDP, has severely curtailed pro-poor policies, and the costly support now required by the US makes it all the more imperative that this unsustainable burden be properly addressed.

This paper briefly outlines Pakistan’s geopolitical position. It examines the country’s economic policy and its evident failure to achieve poverty alleviation under the current IMF paradigm, and concludes that the Fund’s model most urgently needs to be replaced by an alternative solution.

Pakistan and the US: Geopolitics and the creation of odious debt

Pakistan’s political history has been, and unfortunately still remains extremely unstable. Her inception in 1947 as a dominion separate from India was violent in the extreme, and for 21 of her first 32 years as a formal republic (that is, between 1956 and General Zia-Ul Haq’s death in a plane crash in 1988), the country endured more or less flagrant military dictatorship. The ensuing period of democracy, ending with General Musharraf’s coup in 1999, was marred by corruption and factional fighting, particularly between the two main political parties, Benazir Bhutto’s Pakistan People’s Party (PPP) and the Pakistan Muslim League (PML) led by Nawaz Sharif. 

The recent general elections (October 2002) returned 103 seats for Quaid-e-Azam (PML-Q), the breakaway faction of the Pakistan Muslim League supportive of President Musharraf, and also threw up a new alliance of six Islamic parties (MMA) who campaigned on a strident anti-US platform and gained 52 seats. Shortly after the election, the PPP and Sharif’s PML united in an anti-military alliance for the restoration of democracy (ARD), thus briefly creating a majority coalition hostile to Quaid-e-Azam, with the MMA’s leader Maulana Fazlur Rehman poised to lead the new government. However, after five weeks of wrangling and intrigue, ARD was weakened by defections and lost its majority, and the new parliament elected Zafarullah Khan Jamali from the PML-Q as Prime Minister. This means that the incoming government no longer presents a direct challenge to Musharraf, but its majority is nonetheless very slender, and it may well be overthrown. In this event, it is doubtful whether an alternative grouping opposing the President’s policies would fare any better, for he has recently awarded himself sweeping powers to dissolve parliament should he so desire.

Exponents of democracy might be expected to deplore much of this volatile history, including President Musharraf’s present dictatorship, but in fact America’s relations with Pakistan have never been affected by the state of the latter’s internal politics. Rather, as Dennis Kux observes, ‘US interest in Pakistan has waxed and waned as administrations judged that country to be helpful or harmful to America’s global aims.[2]

Indeed, this intermittent attention has defined Pakistan’s entire history. From the very start, the country’s key geographical position between Afghanistan and India, together with her influence as an Islamic Republic, made her allegiance an important factor in particular phases of the struggle between the United States and the Soviet Union, while her support as a strategically placed Islamic state, proximate not only to Afghanistan but to Iran and Saudi Arabia, is now an vital factor in America’s ‘war against terror’.

During the first years of the Cold War, the US enthusiastically courted Pakistan as an ally, and between 1954 and 1965 extended significant military aid to the government. These loans reinforced the position of the army, who eventually seized power in 1958. They also contributed to the increased military strength that encouraged Ayub Khan to enter into war with India in 1965. 

By this time, however, the focus of US policy was shifting in South Asia, and the perpetual strife between Pakistan and India, together with Pakistan’s deepening alliance with China, had become a grave embarrassment to Washington. A US arms embargo was imposed in 1965 which lasted for ten years, and although communications were never totally severed, the relationship between the two countries dwindled and soured.

This period of relative neglect by the US ended abruptly with the Soviet invasion of Afghanistan in December 1979. Once again Pakistan was hailed as the indispensable ally of America, and over the next eight years its military dictator, General Zia-ul Haq, received some $7bn. in military and economic aid from the US. These odious loans, contracted by an undemocratic government and devoted to unproductive ends, formed the nub of a debt burden that would be serviced far into the future by the poor of Pakistan.

In terms of terrorism, America’s involvement in this war – in essence a conflict between an Afghan government backed by USSR forces, and a coalition of anti-Communist Muslim guerrillas – has also reaped a bitter harvest. The Muslim fighters were supported by Iran, and by America, China and Saudi Arabia who accessed the country through Pakistan. Together, Pakistan’s Inter Services Intelligence (ISI) and the CIA mounted a huge covert operation designed not only to marshal Afghan resistance against the USSR with in the country, but to expand it into a holy war of Muslim states within the Soviet Union. Over the years, around 100,000 radical mojahedin from 40 Islamic countries were recruited as soldiers, and after the Russian withdrawal from Afghanistan, this jihad spread to Chechnya, Kosovo and ultimately to Kashmir. The heroin plantations on the Afghan/Pakistan border, now denounced as the source of most of the supply of the drug to the West, were established and funded by the ISI to supplement the CIA’s financing of the hugely expensive hostilities. The Taliban movement, which later took power in Afghanistan in 1995, was also consolidated during this period, emerging as a product of the Islamic schools promoted and financed by President Zia-ul Haq.

After the Soviet withdrawal from Afghanistan, Pakistan again lost its significance for the United States. In 1990 Washington declared the country no longer eligible for aid, and during the following decade her continuing poor relations with India and her development of nuclear weapons were internationally condemned. Post September 11th, however, Pakistan's support has once again become of crucial importance to America, and the cloud of disapproval has evaporated. As a result, the IFIs are now bargaining intently with President Musharraf, who appears to be as adroit and tenacious a dictator as President Zia-ul Haq, and in November 2001, America signed an agreement providing $600m grant aid for direct budget and balance-of-payments support, a sum that forms part of a $1bn bilateral aid package, the remainder of which is target towards specific PRGF policies. The US has also promised a cancellation of $1bn from Pakistan's bilateral debt of $2.8bn, a write-off that will be made possible by a small up-front enabling credit of $200m, and is subject to the approval of Congress. 

Presumably these arrangements can be read as some measure of 'compensation' for Pakistan's co-operation with US political and military intentions. However, if it seems ironic that Pakistan should now be called upon to support a war waged against an enemy previously created by herself and her current allies, it is surely nothing less than outrageous that the country's poor should yet again be affected by the need to foot the bill for US foreign policy objectives.

Poverty and its causes

Tragically, it is beyond dispute that conditions have worsened for the poor of Pakistan over the last decade. Although poverty declined during the 70s and 80s, data from various statistical studies indicates that its incidence has risen from between 22 to 26 per cent in 1991, to between 32 to 35 per cent in 1999 (the last year for which statistical data is available), and has shown a particularly sharp rise since 1997.[3] This equates to 47 million people living in poverty, of whom 35 million inhabit rural areas. (Rural poverty has historically been higher than in the cities, and the disparity has recently become more pronounced). Unfortunately however, it is clear that the overall situation has continued to deteriorate, and these numbers have now grown considerably. As the Asian Development Bank (ADB) in their Poverty Assessment Report of June 2002 observes, ‘since 1999, growth has slowed even further, the fiscal squeeze has intensified, development spending has declined, and the country has experienced a severe drought. It is highly likely therefore, that the incidence of poverty in Pakistan now is significantly higher than in FY 1999.’[4]

While admitting that exogenous shocks such as drought and global recession have adversely affected the economy, the country’s Western creditors and their institutions typically conclude that bad governance and political instability lie at the root of the problem. They assert that if these were rectified, the usual package of macro-economic stabilisation and structural reform would lead to growth and a general increase in prosperity.

However, although it is true that tempestuous politics are not conducive to a thriving economy, it would appear that the bad policy decisions that have resulted in declining growth and rising poverty in Pakistan have been more the result of IFI-funded stabilisation and structural adjustment programmes than of political unrest. The economic legacy inherited from General Zia in 1988 already consisted of a huge and escalating external debt burden (including military loans, as we have seen above), and was further marked by a neglect of development expenditure. The IFI-led stabilisation and structural adjustment policies in the decade following his death have simply led to an increase in the debt, and inherently require continued cuts in development expenditure in order to transfer assets to creditors. Over this time, real wages have fallen, inequality and unemployment have increased, and human development indicators (HDIs) have lagged behind those of comparable low income developing countries in South Asia.  Moreover, although fiscal austerity measures have impacted adversely on the poor, debt servicing and defence spending requirements have prevented the fiscal deficit from falling in any substantial way. Indeed, for FY2002 the deficit has increased to 7.1% of GDP[5], not much lower than in 1988 when it stood at 8.5%, and considerably more than it was by 1990, when it stood at 6.5%.

Health

Although life expectancy, at 63.6 for 2002, is not far below the average of 67.3 for similar economies in the region, other HDIs are very much lower. The latest figures here are for 2000, and show infant mortality standing at 83.3 per 1,000 (compare Thailand 27.9, Indonesia 40.9, Bangladesh 60), and under-5 mortality at 110 (Thailand 33.2, Indonesia 51.4,  Bangladesh 82.6). There is a high incidence of avoidable death from malaria, tuberculosis, childhood infections, micro-nutrient deficiencies and poor hygiene practices, and public health programmes and facilities remain weak and inadequate. Water borne diseases are also widespread because 17% of the urban, and 47% of the rural population has no access to clean drinking water.

At the moment, one hospital bed is available per 1490 people, and one doctor per 1516, but the majority of hospitals and doctors are in cities and towns, and the rural population, with its higher incidence of poverty, is thus doubly disadvantaged.

Nonetheless, despite the urgent and acknowledged need to strengthen the healthcare system at all levels, public health expenditure, which fell from 0.8% of GNP in 1996, has remained static at 0.7% of GNP.  Since the country has a population growth of 2.4% (the population nearly doubled between 1975 and 2000, from 71 million to 138 million) and GNI fell from $60,265m in1966 to $59,620 in 2000[6], this stagnant level of expenditure on health presents a very dismal picture indeed.

Education

Education is the most important factor that distinguished the poor from the non-poor in Pakistan. The ADB’s 2002 survey found that the proportion of literate household heads in poor households was almost half that in non-poor households. Moreover poor households had 75% more children than non-poor households, and most of these were not receiving education, thus perpetuating the problem and further increasing the urban- rural divide. This situation also has a close bearing on health and nutrition problems. For instance, infants born to the least educated mothers have twice the risk of dying within the first year, while PIHS data shows that there is 60% more chance of finding malnourished children in households where the mother is illiterate.

Disastrously however, only 1.6% of GNI  is being spent on education, and school enrolment has not improved during the 1990s. Indeed, although the primary gross enrolment rate has remained unchanged at 71% since 1991, the net primary enrolment rate[7] has shown a decline from 46% to 42% during the decade. Compounding this problem further, 47% of children from the poorest quintile are estimated to drop out of school before completing primary education. According to the 1998 census, Pakistan’s adult literacy rate (15 and above) was 42.7%, 55.3% for men and 29% for women.

Gender

The incidence of poverty is higher among women than among men in Pakistan. Cultural norms define women’s roles primarily in the reproductive sphere, and men are seen as the bread-winners (there are only 13.7% of women in the labour force, compared to 70.4% men). This perception results in comparably less social investment in women, and as can be seen from the statistics on literacy above, women suffer from poverty of opportunity from an early age. Improvement in the education sector is critically needed to deal with this problem.

It should be noted, however, that the ADB survey does indicate that the gender gap in literacy rates is now considerably reduced in lower age groups, particularly among urban 10-14 year olds, although more than 50% of the girls in this age group remain out of school in rural areas.

Debt

In the year 2000/01, Pakistan’s total external debt stood at 54.9% of GDP. In the same year domestic debt reached almost 50% of GDP, giving rise to a net public debt of 103% of GDP.

External Debt

Pakistan’s total external debt now stands at $32.8bn[8] According to the IMF’s Country Report No. 02/141, July 2002, the country’s total external public and publicly-guaranteed debt (EDT) and debt service (TDS) as a percentage of exports (XGS) and GDP are projected as follows:

* Note that this figure represents nearly four times the amount of aid received for the same year (1.2% of GNI).

Borrowing from the IFIs continues, conditional on their moulding and surveillance of the country’s economic policies. In December, 2001 The IMF approved Pakistan’s request for a 3-year arrangement under its Poverty Reduction and Growth Facility[9] of SDR $1.03 bn. (about $1.4bn) Four disbursements of SDR 86.1 have now been made in March, April, July and November 2002. This brings total disbursements under the IMF programme to SDR345.64 m. (about US$456m)

Also in December 2001, the Paris Club[10] offered a new restructuring package to deal with that part of Pakistan’s external debt owed to its members ($13,300m of the total EDT of $32,800m). For the first time, this agreement covered debt stocks as well as service payments on debt owed at the cut-off date of September 1997. Pakistan was granted a repayment period of 38 years with a grace period of 15 years for ODA loans, and 23 years with a grace period of 5 years for non-ODA loans. The Club also decided to defer for 3 years all debt repayments on post cut-off date debts and interest on restructured loans falling due between 30th November 2001 and June 30^th 2002. 20% of interest payments due in the next two years will also be deferred.

It is estimated that Pakistan will experience a saving of between $2.7bn and $3bn in the 3-year PRGF period, and $8.5bn to $11.1bn over the grace period from the Paris Club deal. However, although it is understood that Pakistan had been hoping for Naples terms, with cancellation of 67% of debts, there has been no debt cancellation.  Thus, although immediate payments have been placed in abeyance, the country’s long term debt will continue to accumulate

Domestic Debt

Net Domestic Government Debt for 2000/2001 amounted to 43.3% of GDP.

Projections for 2001/2 …. 44.1% of GDP

                     2002/3…. 40.6% of GDP

                      2003/4…. 37.5% of GDP    

Net Public Debt for 2000/2001 amounted to 103% of GDP

Projections for 2001/2 …95.5% of GDP

                      2002/3 …90.5% of GDP

                                  2003/4 …84.6% of GDP[11]

As the above figures make plain, the country is carrying a debt burden that is unsustainable.

Poverty Reduction

Throughout the last decade the Government of Pakistan and the International Financial Institutions (IFIs) have all professed a determination to tackle the problem of poverty. Unfortunately, however, their efforts to do so by way of the usual structural adjustment measures have been notably unsuccessful.

In 1993 the government introduced a Social Action Plan to try to improve the nation’s depressing social indicators, but in the event, political instability and the increasingly tight macro-economic squeeze of the structural adjustment policies of the middle 90s undermined the project. Both management of and investment in the programme fell short of the committed levels, and its objectives remained unrealised.[12] Instead, as we have seen, the incidence of poverty continued to rise.

In 1999 the ADB proclaimed poverty reduction to be their ‘overarching goal’, and their Poverty Reduction Strategy was approved in November of that year. In June 2002, they completed a comprehensive draft poverty assessment, to be used in implementing the Strategy. At much the same time, and in keeping with World Bank and IMF requirements for the continuation of concessional lending, an Interim Poverty Reduction Strategy Paper (I-PRSP) was prepared by the government. This was submitted in November 2001, with the full PRSP due this Autumn. Unfortunately, despite the democratic rhetoric surrounding the process, the contents of this PRSP remain rooted in the familiar structural adjustment policies designed by the IFIs.

As a result, the old paradox of fiscal squeeze and pro-poor policy is still unresolved. Indeed, the ADB itself freely admits this, commenting that ‘with regard to the debt burden, increasing debt service requirements resulted in a growing fiscal squeeze, which in turn led to a declining proportion of GDP being spent on development and social sectors in the 1990s’.[13]

Jubilee Research is in perfect agreement here: this is one of the reasons why Pakistan’s debt may be termed ‘unsustainable’. It is evidently impossible for the country to finance a proper level of social expenditure while laying aside more than half its precious revenue resources to service its present crippling level of debt.[14]

The direct and damaging trade-off between expenditure on interest payments and development is shown in Table 1 below. Here we see development expenditure declining from 6.4% of GDP in FY1991 to 3.9% in FY1998, and to 2.8% of GDP in the last fiscal year. This represents a fall in real terms from Rs.65.3bn in FY1991 to Rs. 47.6bn in FY2001. On the other hand, interest payments have risen from 5.5% to 8.0% of GDP over the same period.                        

Table 1. Revenue and Expenditure as % of GDP

Source: Pakistan Economic Survey,  ADB Poverty Assessment – Pakistan 2002

Defence Expenditure

Pakistan has long been embroiled in a costly arms race, and its defence spending has accordingly constituted a crippling drain on the economy. Recent events have put additional pressure on this sector, and due to the mobilisation of Pakistani forces along the border with India, defence spending increased from 3.8% of GDP in FY2001 to 4.1% in FY2002.[15] Thus for FY2001, debt service and defence spending combined amounted to almost 70% of total revenues, and 86.8% of tax revenues. In order to rectify this lamentable situation, the defence budget as well as the debt burden would have to be reduced to sustainable proportions. Regrettably, however, Pakistan’s renewed role as America’s strategic ally will instead serve to increase future military expenditure.

Taxation

The percentage of revenues to GDP is very low in Pakistan (see table 1 above), and under the fiscal stabilisation policies required by the IMF, the taxation system has become progressively more regressive. Government Sales Tax (GST) which, as an indirect tax, affects the poor much more severely than it does the rich, has risen from 20% in FY1997 to 45% in FY2003. ‘As the result of ongoing tax reforms’ observes the ADB approvingly, ‘GST is emerging as the tax of the future.’[16]

The outcome of this shift is an increase in the price of basic commodities; out of 51 items in daily usage, 37 have seen an average increase of 20% during the last two and a half years. These include vital foods such as wheat, flour, sugar, pulses, meat, tea, cooking oil and vegetable ghee, and utilities such as gas, electricity, telephone and petroleum products. Medicine is now also subject to 15% GST.

The impact of these taxes on the poor dwarfs the paltry increases in poverty related expenditures adopted by the government, and it is clear that the whole balance of the tax system must be redirected towards a redistribution of wealth in the country if poverty reduction is to be achieved.

Assessment

As the Institute for Policy Studies in Pakistan observes in its analysis of the 2002/03 budget, ‘the real health of an economy can be determined by GDP and its growth, increase in exports, rise in investment, per capita income and its just distribution, employment and tax revenues…’After fourteen years of almost unbroken ‘stabilisation’ policies, let us briefly summarise the state of these critical indicators.

In FY2001, GDP grew by 2.5% - a rise which, given an annual population growth of 2.4%, means that per capita income virtually failed to increase at all. In fact, most estimates show per capita income to be decreasing steadily, falling from $493 in 1996/97 to $429 in 2002.[17] This year (FY2002) real GDP was targeted at 4%, and is now estimated at 3.3%, although it remains uncertain that this revised figure will be reached. However, GNP growth (which includes net factor incomes from abroad) will be considerably higher than usual, because the post September 11 climate has resulted in an unprecedented increase in remittances, which totalled $2.39bn for the year[18]. 

This year there has been a rise in exchange reserves, also partly attributable to these remittances, which has been enthusiastically welcomed. However, the main factor in the increase is the State Bank of Pakistan’s purchase of more than $3bn on the open market – money that is surely desperately needed to increase employment and investment. As far as the latter goes, the declining trend that has been evident over the last decade persists, with nominal fixed gross investment declining by 5.9% for FY2002. This decline has been most evident in investment by the public sector.[19]

Industry and agriculture (except for the livestock sub-sector) are both in recession, and there has been a particularly dismal performance by large-scale manufacturing. Unemployment is rising, up from 5.89% in 1999 to 7.82% in 2002[20]. Exports have fallen, and the improvement noted in the balance of payments is attributable to falling imports.

This picture is not one of a thriving economy, let alone one where a just distribution of resources precludes an increase in the incidence of poverty. Rather it indicates that there is something seriously wrong with the nature of the economic policies that are being pursued by Pakistan. We suggest here that these policies are failing because they are dictated by the country’s creditors, whose primary concern is to safeguard their own assets, if necessary at the expense of the human rights of the country’s population. They are thus essentially extractive policies, and the paradigm within which they operate is predicated on debt, and the huge leverage it gives creditors and their institutions over debtor countries. Without this leverage, it would be impossible for the IFIs to impose on developing nations the deflationary packages that in effect transfer their precious and scarce resources into the coffers of the industrialised world.

In Pakistan, these deflationary measures are destroying the resilience of the domestic economy. As revenues have been directed away from vital industrial and public sector development, and poor-sensitive expenditures have been pared to a minimum, unemployment has risen, national savings and investment have dropped, and production and exports have slowed. There is now much evidence to show that fiscal deficits can better be financed from domestic resources than from foreign currency deposits,[21] but this cannot be achieved successfully in the present climate. Nor can an uneducated and unhealthy workforce, rising inequality and regressive taxation create a prosperous country, for such conditions deplete the social capital so critical to economic success.

It is therefore crucial that the vicious circle created by creditor-led policies be broken, and this can only be done if a new solution is found that will reduce the country’s debt burden to sustainable levels. Without such a measure, it seems plain that the resources remaining within the economy will be insufficient to enable the country either to implement necessary pro-poor policies, or to kick start the economy into a virtuous circle of wellbeing and growth.

As things stand, Pakistan is caught in a classic debt-trap, incapable of staving off insolvency except by undertaking more debt-creating loans, and unable to revitalise her economy because of deflationary creditor pressure. As ever, the poor are the main victims of this disaster, and unless the country achieves radical debt reduction, their number will continue to rise. America’s renewed demands for costly strategic support make this situation all the more intolerable, and the West’s continued extraction of Pakistan’s scarce resources all the more disgraceful.

We accordingly suggest that Pakistan calls for a debt moratorium, with temporary capital controls to protect her currency while her position is reviewed, and we recommend that a Jubilee Framework[22] be put in place to establish an independent body under a neutral mediator to assess her debt burden, and devise an appropriate solution that will return the country to economic sustainability.