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GLOBAL FINANCIAL CRISIS

IMPACT ON THE ECONOMY OF PAKISTAN
INTRODUCTION:

Capitalism, an economic system whereby land, labor, production, pricing and

distribution are all determined by the market, has a history of moving from
extended periods of rapid growth to relatively shorter periods of contraction.
The ongoing Global Financial Crisis 2008-09 actually has its roots in the
closing years of the 20th century when U.S. housing prices, after an uninterrupted,
multi-year escalation, began declining. By mid-2008, there was an almost striking
increase in mortgage delinquencies. This increase in delinquencies was followed by
an alarming loss in value of securities backed with housing mortgages.
And, this alarming loss in value meant an equally alarming decline in the capital of
America’s largest banks and trillion-dollar government-backed mortgage lenders
(like Freddie Mac and Fannie Mae; the government-backed mortgage lenders hold
some $5 trillion in mortgage-backed securities). Outside of the U.S., the Bank of
China and France’s BNP Paribas were the first international institutions to declare
substantial losses from subprime-related securities. Just underneath the U.S.
subprime debacle was the European subprime catastrophe. Ireland, Portugal, Spain
and Italy were the worst hit. The U.S. Federal Reserve, the European Central Bank,
the Bank of Japan, the Reserve Bank of Australia and the Bank of Canada all began
injecting huge chunks of liquidity into the banking system. France, Germany and the
United Kingdom announced more than €163 billion ($222 billion) of new bank
liquidity and €700 billion (nearly $1 trillion) in interbank loan guarantees. Towards
the end of 2007, it had become quite clear that the subprime mortgage problems
were truly global in nature. (Scribd, 2009)
The global financial crisis is hitting South Asia at a time when it is already
reeling from the adverse effects of a severe terms-of-trade shock. Countries have
responded by partially adjusting domestic fuel prices, cutting development
spending and tightening monetary policy. The adverse effects of these terms of
trade losses have been substantial, reflected in a slowdown of growth, worsening of
macroeconomic balances and huge inflationary pressures.
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The global financial crisis will likely worsen these trends, particularly on the
growth and balance of payments front. Slowdown in global economy will adversely
affect South Asian exports and could hurt income from remittances. Lower foreign
capital flows and harder terms will reduce domestic investment. Both will lower
growth prospects. (Scribd, 2009)
Pakistan is another country in South Asia that has been severely affected by
the financial crisis. In fact, Pakistan seems to be one of the hardest hit. Its economy,
already on the brink of collapse, is destined for bankruptcy because fleeing foreign
investors have caused a significant depreciation in its currency, the rupee. Pakistan
is also facing a serious liquidity crunch, with the only solution being international
support. Pakistan's request for Chinese support, however, has been denied because
of Pakistan's alleged involvement in terrorist activities in China's Muslim-dominated
areas. Saudi Arabia has refused to give Pakistan a financial concession on the oil
trade, as well. The only option for Pakistan is to approach the International
Monetary Fund, which will set highly stringent conditions for the nation. (Sidgel,
2009)

THE TERM ‘FINANCIAL CRISIS’:

The term financial crisis is applied broadly to a variety of situations in which

some financial institutions or assets suddenly lose a large part of their value. Many
financial crises are associated with banking panics, and many recessions coincided
with these panics. Other situations that are often called financial crises include
stock market crashes and the bursting of other financial bubbles, currency crises,
and sovereign defaults.
Many economists have offered theories about how financial crises develop
and how they could be prevented. There is little consensus, however, and financial
crises are still a regular occurrence around the world. (Wikipedia, 2009)

FINANCIAL CRISIS 2007-2009 (RECENT)

The financial crisis of 2007–2009 has been called the most serious financial
crisis since the Great Depression by leading economists, with its global effects
characterized by the failure of key businesses, declines in consumer wealth
estimated in the trillions of U.S. dollars, substantial financial commitments incurred
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by governments, and a significant decline in economic activity. Many causes have

been proposed, with varying weight assigned by experts. Both market-based and
regulatory solutions have been implemented or are under consideration, while
significant risks remain for the world economy. (Wikipedia, 2009)

CAUSE OF THE CRISIS:

It is not yet clear whether we stand at the start of a long fiscal crisis or one
that will pass relatively quickly, like most other post-World War II recessions. The
full extent will only become obvious in the years to come. But if we want to avoid
future deep financial meltdowns of this or even greater magnitude, we must
address the root causes which are summarized below: (Scribd, 2009)
• Credit boom and housing bubble: spread on credit instruments and the ratio of
housing pricing in relation to its rental income.
○ Fundamental mispricing in the capital markets – risk premiums were too
low and long-term volatility reflected a false belief that future short-term
volatility would stay at its current low. This is turn implied low credit
spreads and inflated prices of risky assets. One reason was the
tremendous growth of capitalistic societies in China, India and eastern
bloc of Europe. There were fast-growing, investment and savings driven
nations. Hence, capital from the second set of countries poured into
assets of the first set, leading to excess liquidity, low volatility and low
spreads.
As a result, massive shock to one of the asset market – housing led to a
wave of defaults in the mortgage sector.
• Mistakes made by the Fed and other central banks – keeping the federal funds
rate too low for too long created both the credit bubble and housing bubble. In
other words, with an artificially low fed funds target, banks gorged themselves
on cheap funding and made cheap loans available.
○ There has been great disparity in the quality and quantity of loans in the
recent years. In terms of quantity, there was an increase in low-rated
issuance – of shares rated B- or lower from 2004 to 2007. Moreover loans
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that were issued were mainly given to finance leveraged buyouts. Over
the same period average debt leverage ratios grew rapidly to levels never
seen previously.
○ In terms of quality, there was also a general increase in non
documentation and high loan-to-value subprime mortgages.
• Plus the failure to control poor underwriting standards in the mortgage markets –
no down payment, no verification of income, assets, and jobs (called NINJA – no
income, jobs, or assets), interest only mortgages, negative amortization, and
teaser rates were widespread among subprime, near-prime and even prime
mortgages. The Fed and other regulators generally supported these financial
innovations.
○ With defaults in interest payments and simultaneously in the ABSs, prices
drop drastically, leading to a huge loss of wealth causing severity of the
crisis. (Scribd, 2009)

IMPLICATIONS TO THE US ECONOMY

The US is going through the greatest financial crisis since the 1930s, as
reported by Fianncial Times. (Sameer Khatiwada)

Towards the end of 2007, it had become quite clear that the subprime
mortgage problems were truly global in nature. Of the $10 trillion around 50
percent belonged to Freddie Mac and Fannie Mae. By September 2008, the U.S.
Department of Treasury was forced to place both Freddie and Fannie into federal
conservatorship. On 15 September 2008, Lehman Brothers, one of America’s largest
financial services entity, filed for bankruptcy. On September 16, American
International Group (AIG), one of America’s largest insurer, saw its market value
dwindle by 95 percent (AIG’s share fell to $1.25 from a 52-week high of $70). (,
2009)

Notwithstanding, strenuous efforts by the US administration, including buying

up of toxic assets and recapitalization of financial institutions and stimulus
packages the world’s largest, US, is projected to contract by 2.9% till 2009 further
down from the positive growth of 1.1 % in the previous year. (State Bank of
Pakistan, 2009) This has resulted in severe loss to not only financial institutions but
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also the business and economic sector. Companies, including multinational that
invested in these Asset Backed Securities incurred huge losses as these
investments were made millions of Dollars. This resulted in a downward trend in
growth. Companies, in order to reduce costs started downsizing, cutting production
and because no one was there to buy (or didn’t have the capability to), these losses
tripled.

THE CRISIS GETTING GLOBAL

Countries around the world had invested in these defaulted securities,

unaware of the fact that returns from them would eventually end up in them paying
instead. By the end of 2007 everyone around the world was aware of the fact that a
crisis is budding. The crisis rapidly developed and spread into a global economic
shock, resulting in a number of European bank failures, declines in various stock
indexes, and large reductions in the market value of equities and commodities.
Moreover, the de-leveraging of financial institutions, as assets were sold to pay
back obligations that could not be refinanced in frozen credit markets, further
accelerated the liquidity crisis and caused a decrease in international trade.
EUROPE
The global financial crisis is already causing a considerable slowdown in
most developed countries. Governments around the world are trying to contain the
crisis, but many suggest the worst is not yet over. Stock markets are down more
than 40% from their recent highs. Investment banks have collapsed, rescue
packages are drawn up involving more than a trillion US dollars, and interest rates
have been cut around the world in what looks like a coordinated response. Leading
indicators of global economic activity, such as shipping rates, are declining at
alarming rates. (Sameer Khatiwada)
The $10 trillion mortgage market went into a state of severe turmoil. Outside
of the U.S., the Bank of China and France’s BNP Paribas were the first international
institutions to declare substantial losses from subprime-related securities. Just
underneath the U.S. subprime debacle was the European subprime catastrophe.
Ireland, Portugal, Spain and Italy were the worst hit. The U.S. Federal Reserve, the
European Central Bank, the Bank of Japan, the Reserve Bank of Australia and the
Bank of Canada all began injecting huge chunks of liquidity into the banking
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system. France, Germany and the United Kingdom announced more than €163
billion ($222 billion) of new bank liquidity and €700 billion (nearly $1 trillion) in
interbank loan guarantees. (, 2009)
The world economy is likely to contract by 1.3 % in 2009 with almost all
developed countries are to post negative growth. Despite stimulus packages and
government action of unprecedented scale and nature, advanced economies are
expected to contract by 3.8% in 2009. (State Bank of Pakistan, 2009)
Countries relying on trade as a primary mean of boosting economic growth
saw trade volumes disappear as contractions starts in trading partners.
Growth in world trade volume fell to 3.3% in 2008, as compared to 7.2% in
2007, and is expected to contract substantially by 11% till the end of 2009. (State
Bank of Pakistan, 2009)
AFRICA
Growth performances vary considerable among developed and developing
countries. As for Africa, IMF World Economic Outlook
report in April 2008, a decline in world growth of one percentage point would lead
to a 0.5 percentage point drop in Africa’s GDP, so the effects of global turmoil on
Africa (via trade, FDI, aid) would be quite high. The correlation between African GDP
and World GDP since 1980 is 0.5, but between 2000 and 2007, it was only 0.2. As
there have been significant structural changes (and a move into services that were
able to withstand competition much better) as well as the rise of China, African
growth has temporarily decoupled from OECD GDP. (Sameer Khatiwada) However,
there are worrying signs. The combination of high food prices and high oil prices has
meant that, while the current account of oil and food importers was in balance by
2003, it was in deficit by 4% in 2007. Inflation has also doubled. Many developing
and especially small and African countries are, therefore, in a bad position to face
yet another crisis. The terms of trade shock tend to be highest in small importing
countries such as Fiji, Dominica, Swaziland. However, African countries such as
Kenya, Malawi, Tanzania are projected to have faced terms of trade shocks of
greater than 5% of GDP (World Bank paper for the October 2008 Commonwealth
Finance Ministers meeting).
ASIA
East Asia is diverging as much as it did during the last significant global
economic downturn in the early 1990s. Several Asian countries have build up
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healthy government reserves, and solid export performances has helped their
strong current account position. However, there are also signs of a slowdown in
Asia, the engine of recent world growth. In the space of a couple of months, the
Asian Development Bank has revised its forecast for Asian countries downwards by
1-2 percentage points. The IMF growth forecasts have been revised significantly,
especially for the UK (-1.8 percentage points down from the last forecast for 2009),
but also India (-1.1 percentage points down to 6.9% real GDP growth), and China
and Africa (both down by -0.5 percentage points to 9.3% and 6.3% respectively).
(Sameer Khatiwada)
The magnitude of the crisis will depend on the response of the USA and EU. Trillion
dollar rescue packages are launched around the world, but while the markets may
eventually respond, the UK is already in a recession. Its magnitude will depend, in
part, on how accommodative monetary policy can be, with the recent interest rate
cut a sure sign the authorities are concerned more about the financial crisis than
recent inflationary pressures. There is less scope for expansionary fiscal policy – in
fact these rescue measures have increased public debt. (, 2009)
GCC
In the case of Gulf Cooperation Countries and impact of global financial crisis
on the economies of these countries was severe. The slump in the global demand
and its impact on oil prices has reduced the surplus petrodollar, which is now having
impact on the development projects. (The News, 2009)
Financial system as the backbone of economy and that was why the financial
crunch brought the economy down affecting US, UK, Japan, India, Asia—all going
down with decline in economic growth. (Dawn News, 2009)

THE CRISIS ENTERING EMERGING ECONOMIES

Initially the view was that the financial crisis that began in the US and then
spread to Europe would not seriously affect the economies of the developing
countries. Most developing countries were not closely linked to the global financial
system based in the US. However, very soon it became clear that developing
countries including Pakistan would be affected by the global financial crisis.
Developed countries have been worst hit but so have developing countries like
Pakistan. (Zubair, 2009)
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The new growth power houses in china and India are experiencing worst kind
of slowdown in economic growth mainly because of the sub-prime meltdown in the
US and the ensuing financial and credit crunch around the world. (State Bank of
Pakistan, 2009)

The global financial crisis is hitting emerging economies at a time when it is already
reeling from the adverse effects of a severe terms-of-trade shock. Countries have
responded by partially adjusting domestic fuel prices, cutting development
spending and tightening monetary policy. The adverse effects of these terms of
trade losses have been substantial, reflected in a slowdown of growth, worsening of
macroeconomic balances and huge inflationary pressures.

The South Asian economies are already limping from the adverse effects of
the huge terms of trade shock of the past 6 years. The reduction in global
petroleum and food prices observed over the past few months provides a silver
lining for South Asia in an otherwise difficult external environment. Yet this silver
lining is now heavily clouded by the emerging global financial crisis that poses
tremendous downside risks to South Asia. These risks can transmit from both the
financial sector in terms of volume and price of foreign capital flows as well as from
the real sector based on adverse effects of a global slowdown on South Asian
exports, possible downward pressure on remittances, and slowdown in private and
public investment owing to higher interest rates as well as lower export demand.
(World Bank, 2008)

Exports from developing countries are projected to contract by 6.4% during

the same period and developing economies started experiencing substantial
slowdown in growth in 2008, with real GDP growing at 6.1% as compared to robust
growth of 8.3% in 2007. Growth in these countries is projected to slowdown further
to 1.6% in 2009. (State Bank of Pakistan, 2009)

The global financial crisis will likely worsen these trends, particularly on the
growth and balance of payments front. Slowdown in global economy will adversely
affect South Asian exports and could hurt income from remittances. Lower foreign
capital flows and harder terms will reduce domestic investment. Both will lower
growth prospects. (World Bank, 2008)
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South Asia – constituting a belt of emerging economies, is fortunate to have a

broadly resilient financial sector due to a combination of past financial sector
reforms and capital controls that insulate these economies to a great extent from
the risk of a financial crisis transmitted from abroad. However, individual country
risks vary substantially as the macroeconomic performances, financial sector health
and exposure to foreign capital markets differ considerably by countries. (World
Bank, 2008)

The financial crisis that has spanned the globe has had an especially strong
impact in countries beset by political uncertainty. Analysts say weak governments
saddled with poorly performing economies are more vulnerable to social unrest and
armed insurgency.

The growing fiscal deficits due to food and fuel subsidies and rising inflation
suggest that South Asian countries have basically run out of fiscal space and do not
have the option of riding out further shocks with expansionary fiscal and monetary
policies. So, in the near term growth will need to fall to absorb the shock from the
financial crisis. The policy option of full pass-through of fuel and fertilizer prices to
consumers is not politically viable, although further reduction in gap between
domestic and international prices and better targeting of open-ended subsidies are
possible options, especially in Pakistan which faces the largest macroeconomic
imbalances. (Dawn News, 2008)

According to analysts, Pakistan is one of the most prominent examples of a

nation where economic pressures are feeding unrest and threatening a wobbly
government. (Thomas, 2009)

The trickle-down effect of this crisis has gone from the developed to the less
developed parts of the world. Pakistan is no exception; the combined effects of a
global food, fuel and financial crisis took quite a toll on the economy as the current
account balance and fiscal deficits increased, inflation surged and growth slowed.
(Garewal, 2009)

In emerging economies, the slowdown manifested itself through various

channels like volatility in the financial markets led to a flight of capital. Emerging
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economies have already seen the spreads on sovereign and corporate debt
widening, and a retreat in equity prices as a result of the global crunch. East Asian
tigers Malaysia, Thailand, Korea, Philippines, and Singapore all are prospective
candidates for posting negative growth. The effects of adverse developments at
global level have been felt unevenly and countries with weaker macroeconomic
fundamental, however, are taking a bigger hit. The impact of the meltdown might
be compensated to some extent through boosting local demand. But vigilance by
the policy-makers around the developing countries is needed to lessen the severity
of downside risks posed to current crisis. (State Bank of Pakistan, 2009)
Over the medium term, there is substantial scope for domestic resource
mobilization through the tax system that will play a key role in regaining the growth
momentum. All South Asian countries can benefit from it. (Dawn News, 2008)

THE FINANCIAL CRISIS AND PAKISTAN

The world is thus engulfed in a new hydra-headed crisis, with three essential
components: food, fuel and finance. The three components have different
geographical origins and their effect on different segments of the globe and their
inhabitants is highly uneven. But the transmission of these crises in the global
economy has become much easier and faster since the regime of liberalization of
trade, capital flows, deregulation and privatization was imposed through the
Washington Consensus in the early 1990s in the name of achieving higher growth
and reducing global poverty.
Pakistan is affected by all the three components of the mega-crisis in varying
degrees. But its economic managers have always tried to deal with such crises
individually, rather than as a whole, and in an ad hoc, rather than a systematic
manner. (Naseem, 2008)

Pakistan’s financial crisis predates the Global Financial Crisis. For the past
several years, Pakistan has been running an unsustainable budgetary as well as
trade deficits. The Government of Pakistan, with expected revenues of around $20
billion, routinely spends some $26 billion a year thus incurring a budget deficit of
over 7 percent of GDP. On the trade front, accumulated exports hardly ever cross
the $20 billion a year mark but imports end up exceeding $35 billion; a trade deficit
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in excess of $15 billion a year and a current account deficit of over $1 billion a
month. In 2007-08, Pakistan’s balance of payment (BOP) crisis, as a consequence of
$147 a barrel oil and a spike in commodity price, meant a frightful depletion of
foreign exchange reserves down to a less than 3-months import-cover. Inflation, in
the meanwhile, shot up to over 24 percent and Pakistan stood caught in a vicious
cycle of stagflation--economic stagnation plus high inflation. (Scribd, 2009)

High fiscal and current account deficits, rapid inflation, low reserves, a weak
currency and a declining economy have put Pakistan in a very difficult situation.
(Dawn News, 2008)

Pakistan is going through a critical phase at this juncture. The country was
already facing economic burdens because of its participation in the war on terror.
According to the government of Pakistan, it has suffered economic losses worth
US$34 billion so far because of the war. While the aid that it received is far below.
The continued global economic crisis has hit Pakistan hard. Remittances sent to the
country by the overseas Pakistanis have declined over the years in terms of value.
Pakistan is one of the most prominent examples of a nation where economic
pressures are feeding unrest. According to some observers, Taliban can take
advantage of the bad economic conditions of the country. Shuja Nawaz, director of
the South Asia Center at the Atlantic Council argues that “Well, I don’t know if
they’re paying much attention to the economic news, but the Taliban know only
that when the government is unable to deliver services, and when there is
unhappiness among the general population because food prices have gone up
tremendously, gasoline is not available, electricity shortages are rampant, that it is
much easier to convince the people that the Taliban have the solution rather than
the government,.” (Garewal, 2009)

Pakistan now has the lowest credit rating in the developing world. According
to John Chambers, managing director with Standard & Poor, “only Seychelles has a
lower rating and it has already defaulted on its debt”. None of these developments
are related to the financial problems faced by the industrial countries. In fact, there
will be positive short-term impact on Pakistan of the current economic turmoil in the
developed world. Pakistan’s external account situation is the result in part of the
large increase in the import bill. This happened because of the unrelenting increase
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in the prices of oil and several agricultural commodities imported by the country.
Both food and energy price indices continued to increase through 2007-08; with the
oil price increase outpacing the increase in the price rises of internationally traded
agricultural products. The financial crisis has suddenly reversed these trends. The
price of oil has declined by 50 percent in a couple of months while the prices of
traded food crops have registered significant drops. This should provide Pakistan
with some relief and stop the rapid hemorrhaging in its foreign exchange reserves.
(Peiris, 2009)

The country’s ability to borrow externally is already heavily constrained and

bond spreads are very high. The global financial crisis means that non-official
foreign capital flows will be even more expensive than now. (Dawn News, 2008)

Just two years ago, economic commentators were describing Pakistan as a

success story under former military strongman President Pervez Musharraf and
speculated that it would be the “next Asian Tiger”. (Peiris, 2009)

Pakistan’s recent period of economic growth was based on a combination of

export expansion and inward foreign direct investment (FDI). Pakistan was able to
finance its modest trade and capital account deficits in part due to the inward FDI
and in part due to remittances from overseas Pakistanis.

In 2007 and 2008, a rise in fuel and food prices, combined with political
instability, led to a rapid rise in inflation, a spike in the trade and current account
deficits, and a devaluation of the Pakistani rupee. Although global fuel and food
prices are on the decline, the U.S. financial crisis has precipitated a possibly
extended global recession. For Pakistan, a global recession will likely reduce
demand for its exports, inward FDI flows and overseas remittances. Official Pakistan
estimates for inward foreign direct investment in 2009 reportedly show a decline of
over 32% when compared to last year. After seven years of generally strong
economic growth, Pakistan’s economy ran into problems in 2008. Real GDP growth,
which had been averaging above 7% per year since fiscal year 2000/2001, declined
to 5.8% in fiscal year 2007/2008 and is expected to decline to 2.5% in fiscal year
2008/2009.17 Pakistan’s consumer price index (CPI), which had fluctuated around
7%-9% for several years, jumped to over 25% during the summer of 2008, primarily
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due to a sharp increase in global food and energy prices. More alarming, however,
was the dramatic decline in Pakistan’s foreign exchange reserves, which
plummeted from over $14 billion in June 2007 to $3.4 billion in October 2008, driven
by a rapidly deteriorating current account balance. In the autumn of 2008, Pakistan
was in danger of defaulting on its sovereign debt. (Michael F. Martin, 2009)

With Pakistan’s current security situation in the Northern Region and even in
the more developed parts of the country, mounting economic hardships and
frustration over poor governance have given rise to greater radicalization. Growth
has stalled in Pakistan, while prices of food and fuel are up. Inflation, while down
slightly from last year, still hovers at around 20 percent. Shuja Nawaz, director of
the South Asia Center at the Atlantic Council, says such ingredients are a classic
recipe for radicalization.

The impact of any financial implosion would certainly compound the

country’s political crisis which is already being intensified by US demands for the
Pakistani army to step up its war on Islamist militias along the border with
Afghanistan. Its support for the bogus “war on terror” has been transformed into an
argument for financial aid. As a Pakistani official explained to the New York Times:
“A selling point to us even has been, if the economy really collapses this is going to
mean civil strife and strikes, and put the war on terror in jeopardy.”

A top secret National Intelligence Estimate (NIE) drafted by US intelligence

agencies and leaked to the media last week, summed up the situation in Pakistan as
“no money, no energy, no government”. According to McClatchy newspapers, the
NIE warned that the government was facing an accelerating economic crisis that
includes food and energy shortages, escalating fuel costs, a sinking currency and a
massive flight of foreign capital accelerated by an escalating insurgency. (Michael F.
Martin, 2009)

SECTORAL IMPACT OF THE CRISIS IN PAKISTAN

Though the impact of this crisis varies from country to country, but no
country will be left alone to benefit or detriment from the prevailing crisis. Analysts
believe that countries with large macro-economic balances, poor governance and
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regulation are more prone to the negative effects of the crisis. According to a report
presented by the Overseas Development Institute, UK, the economic, financial as
well as social impacts could include:
○ Weaker export revenues
○ Further pressure on current accounts and Balance of Payments (BOP)
○ Lower investment and growth rates
○ Lost employment
○ Lower growth translating into poverty
○ More crime, weaker health systems and even more difficulties meeting
the Millennium Development Goals

In Pakistan, the sectors that are most severely hit could include financial,
business and social. A précis of all the sectors that are hit by the current crisis and
the subsequent increase in price of commodities and energy, and their present
performance could help explain where the country is heading. (Velde, 2008)

External Sector Impact

The country’s macroeconomic environment is affected by intensification of

war on terror and deepening of the global financial crisis which penetrated into the
domestic economy through a route of substantial decline in Pakistan’s exports and
a visible drop in foreign direct inflows. Although contraction in export receipts is
more than compensated by massive import compression emanating from global
crash of crude oil and commodity prices, the external sector vulnerabilities remain a
threat. Pakistan’s economy continues to remain exposed to the vagaries of
international developments as well as internal security environment. (State Bank of
Pakistan, 2009)

When people stop borrowing, and start saving to pay off debt, it acts like a
shrink in money supply. Thus goods and services get cheaper, and money (in this
case USD because worldwide debt is mostly in denominated in USD) get more
valuable compared to other things. Economies that depend on exports are also
effected because others such as US and Europe start importing less.

 EXPORTS
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The financial crisis made countries realize that they don’t have much to spend
on external goods and that recovery is possible only if demand as well as
production for internal goods is increased. As a result, countries that hugely relied
on exports like Pakistan suffered huge losses. Even their most loyal customer, the
U.S. didn’t have the capacity to pay for exports. As a result, the export sector of
Pakistan was badly hit. Its major exports included textiles, surgical instruments,
sport goods etc. The recent Economic Survey of Pakistan 2008-2009 reports,
‘exports started to face heat of global financial crisis since November 2008 and the
contraction of world over demand has exacerbated export contraction. The exports
witnessed negative growth of 2.6 percent — declining from $ 16.4 billion last year
to $ 16.0 billion in July-April 2008-09.’ (State Bank of Pakistan, 2009)

 IMPORTS

The surge in global energy and commodity prices coupled with poor agricultural
production in Pakistan over the past two years had played havoc to the country’s
import expenditure. However, the recent lowering of these prices did provide some
relief to the country’s trade deficit.

Imports registered a negative growth of 9.8 percent in July-April 2009. The

imports stood at $26.77 billion as against $28.715 billion in the comparable period
of last year. The growth in imports reflects impact of substantial fall in oil and food
imports in monetary terms and these two items were responsible for 80 percent of
additional imports bill last year. Import compression measures coupled with
massive fall in international oil prices have started paying dividends. (State Bank of
Pakistan, 2009)

As a result, the continued decrease in exports, is, after three years, was
outstripped by the decrease in import bill which improved the trade deficit by 12.3%
in the year 2009

Financial Sector Impact

 FOREIGN EXCHANGE
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Pakistan’s exchange reserves declined markedly throughout 2008. The State

Bank of Pakistan’s holdings of foreign exchange reserves fell from $14.2 billion at
the end of October 2007 to $3.4 billion at the end of October 2008. (Michael F.
Martin, 2009)

Exchange rate after remaining stable for more than 4 years, lost significant
value against the US dollar and depreciated by 21% during March–December 2008.
Most of the depreciation of rupee against dollar was recorded in post November
2007 owing to combination of factors like political uncertainty, trade related
outflows and speculative activities. This was another implication of the financial
crisis that also contributed to a massive increase in the inflation rate of the country,
hence, lowering the living standards even more.

However, with successful signing of Standby arrangements with the IMF, the
rupee got back some of its lost value. With substantial import compression and
revival of external inflows from abroad in the current fiscal year, the exchange rate
will remain stable at around Rs.80-82 per dollar. (State Bank of Pakistan, 2009)

 BANKING SECTOR

State Bank of Pakistan’s (SBP) Financial Stability Review 2007-08 reports that,
“Pakistan’s banking sector has remained remarkably strong and resilient, despite
facing pressures emanating from weakening macroeconomic environment since
late 2007.” (, 2009)

According to Fitch Ratings, the international credit rating agency dual

headquartered in New York and London, “the Pakistani banking system has, over
the last decade, gradually evolved from a weak state-owned system to a slightly
healthier and active private sector driven system.” (Scribd, 2009)

But as of end-2008, data from the banking sector confirms a slowdown (after a
multi-year growth pattern). As of October 2008, total deposits fell from Rs3.77
trillion in September to Rs3.67 trillion. Provisions for losses over the same period
went up from Rs173 billion in September to Rs178.9 billion in October. In the
meanwhile, the SBP has jacked up economy-wide rates of interest (the 3-month
treasury bill auction has seen a jump from 9.09 percent in January 2008 to 14
 17

percent as of January 2009 and bank lending rates are as high as 20 percent).
Overall, Pakistan’s banking sector hasn’t been as prone to external shocks as have
been banks in Europe. To be certain, liquidity is tight but that has little to do with
the Global Financial Crisis and more to do with heavy government borrowing from
the banking sector and thus tight liquidity and the ‘crowding out’ of the private
sector.(, 2009)

Market analyst Muhammad Suhail told the Los Angeles Times last week: “The
global crisis has really added fuel to the fire. There was a time window earlier this
year to address all this, and we missed it.” The drying up of credit internationally
has hit Pakistan hard with the banking system suffering a severe liquidity problem.
Overnight call rates rose to high levels ranging from 32 to 40 percent, despite the
injection of 54 billion rupees into the financial system by the central bank. (Michael
F. Martin, 2009)

 CIRCULAR DEBT

On 26 January 2009, Raja Pervaiz Ashraf, Minister for Water and Power, told the
Senate that the “federal government will settle half of the Rs400 billion circular
debt by the end of January.”

Circular debt arises when the Government of Pakistan owes—and is unable to

pay - billions of rupees to Oil Marketing Companies (OMC) and to Independent
Power Producers (IPPs). As a consequence, OMCs are unable to either import oil or
supply oil to IPPs. In return, IPPs are unable to generate electricity and refineries are
unable to open LC’s to import crude oil. According to BMA, a leading financial
services entity, “The circular debt problem is seriously impacting the operations of
the entire energy value chain. Due to low cash balances and liquidity as a result of
the debt problem, the companies have to resort to short term financing at high
interest rates. Refineries are having problems opening LC’s to import crude oil due
to mounting payables and receivables. The same can be said about the OMC sector
including the fact that financing costs in the entire energy sector have skyrocketed.
IPP’s like HUBCO and KAPCO are also having difficulty purchasing oil and continuing
operations.” (, 2009)
 18

 STOCK MARKET

The Karachi Stock Exchange (KSE) is Pakistan’s largest and the most liquid
exchange. It was the “Best Performing Stock Market of the World for the year
2002.” As of the last trading day of December 2008, KSE had a total of 653
companies listed with an accumulated market capitalization of Rs1.85 trillion ($23
billion). On 26 December 2007, KSE, as represented by the KSE-100 Index, closed at
14,814 points, its highest close ever, with a market capitalization of Rs4.57 trillion
($58 billion). As of 23 January 2009, KSE-100 Index stood at 4,929 points with a
market capitalization of Rs1.58 trillion ($20 billion), a loss of over 65 percent from
its highest point ever. According to estimates of the State Bank of Pakistan (SBP),
foreign investment into the KSE stands at around $500 million. Other estimates put
foreign investment at around 20 percent of the total free float. During calendar
2006 as well as 2007 foreign investors were quite actively investing into KSE-listed
securities. In September 2007, Standard & Poor’s cut its outlook for Pakistan’s credit
rating to “stable” from “positive” on concern that “security was deteriorating.” On 5
November 2007, Moody’s Investors Service announced that Pakistan’s credit rating
had been placed “under review.” Towards the end of 2007, the uncertainties of the
upcoming general election, a troubling macroeconomic scenario, an active
insurgency in the Federally Administered Tribal Areas (FATA), double-digit inflation,
a ballooning trade deficit, an unsustainable budgetary deficit and a worrying
depletion in foreign currency reserves had all brought dark, threatening clouds over
the KSE. (State Bank of Pakistan, 2009)

Thought much of this precipitous decline is related to equity market which

has fallen by over 62% (as on December 2008) since touching its peak in April
2008. While issues related to the macroeconomic scenario and shaky political
environment fuelled anxiety among investors community and contributed to a fall in
value, a dearth of adequate corporate governance measures aggravated the
situation. Supplementing the extensive weakness was the diminishing foreign
interest in the equity markets of Pakistan. (State Bank of Pakistan, 2009)

The Daily Times warned on October 14: “The recent decline in the Pakistan
stock market suggests that the bubble has burst and experts fear that this is likely
 19

to spread to the real estate market, which like the stock market is ‘irrationally
overpriced’.” (Garewal, 2009)

 EXTERNAL AND FISCAL BALANCE

Pakistan has been facing balance of payments (BOP) pressures from

expansionary fiscal and monetary policies; the terms of trade shocks accelerated
the deterioration. The large loss of income from the terms of trade shock was
partially compensated by rising remittances. Nevertheless there has been a
negative impact on the external balances of most South Asian countries. Pakistan
suffered the most rapid deterioration in the current account balance, which turned
from a surplus of around 4 percent of GDP in 2003 to a deficit of over 8 percent in
2008. However, this rate witnessed a rare development in the beginning of the year
2009; it shrank by 23.5%. (State Bank of Pakistan, 2009)

Current account deficit shrank to $ 8.5 billion as against $ 11.2 billion last year.
In the month of February 2009, the current account witnessed a surplus which is a
rare development in Pakistan economy. This was first monthly surplus since June
2007. It turned to deficit in March and April 2009. (State Bank of Pakistan, 2009)

These differential effects reflect a number of factors including: the relative

magnitude of terms of trade shocks, the differences in compensating growth of
remittances, and policy responses. (World Bank, 2008)
 20

 FISCAL BALANCE

The severity of the macroeconomic imbalances in the last fiscal year once
again reinforces the importance of fiscal prudence for sustainable economic growth.
The overhang from 2007-08 continued to haunt adjustment efforts. The fiscal
consolidation efforts faced headwinds like deteriorating security environment,
domestic political uncertainties along with the deepening of the global financial
crisis and overall depressed macroeconomic environment. The unanticipated
persistence of inflationary pressures on the economy kept fiscal policy options
limited. The shrinking revenues constrict government’s ability to pursue counter
cyclical policy. (State Bank of Pakistan, 2009)
The fiscal deficit widened most for Pakistan, rising from 2.4 percent of GDP in
2004 to 7.4 percent in 2008. (World Bank, 2008)

There has been significant improvement in fiscal performance during 2008-09

due to the policy shift, with the overall fiscal deficit estimated to have dropped to
4.3 percent of annual GDP. The fiscal improvement in 2008-09 has largely based on
reduction of oil subsidies and a slash on development spending. Going forward
Pakistan needs a substantial increase in resource base to augment its development
efforts and fiscal consolidation efforts has to come from enhanced revenue base
because we have already exhausted options for expenditure cuts. Pakistan’s future
economic development crucially hinges upon additional resource mobilization and
 21

for this end extending the tax base to unexplored sectors is very crucial. (State
Bank of Pakistan, 2009)

 INFLATION

As inflationary pressures across the globe continue to dissipate, sparking

deflationary concerns in even some countries like Thailand and India which shared
pain of galloping inflation with Pakistan a few months ago, Pakistan still faces high
double-digit inflation. Although all the price indices like the CPI including core
inflation have shown a downward trend in recent months, the decline has been
subject to stiff downward rigidity. The month on month increase in food and
nonfood inflation in the last three months (February- April) has been especially
disappointing. Going forward the government has to rationalize electricity tariff
which will be inflationary in nature.

Rising food and fuel prices have been a major source of inflationary pressure
in South Asian countries especially Pakistan. In Pakistan, food prices made a bigger
impact on inflation than fuel, and wheat prices more than doubled, due to poor
domestic production and export restrictions. The combined effects of lower food
and fuel prices along with demand management are reducing inflationary pressure
in most South Asian countries but conditions have not been that favorable in case of
Pakistan. (World Bank, 2008)

This year core inflation rose to 18% from the 14.7% last year. This year
inflation accelerated at rapid pace mainly because of food prices which increased as
result of high prices of widely consumable items such wheat, wheat flour, sugar and
meat etc, owing to their supply shortage. Other major factors that effected
domestic prices include phasing out of subsidies on petroleum products, upward
revision of support prices of wheat by above 50 percent thus pushing up the retail
prices of wheat and wheat flour across the country. (State Bank of Pakistan, 2009)
 22

Economic/Business Sector Impact

Economic activity is the life blood of a nation. For a country to survive it is
important that its economy is sound and prosperous and that business activity
flourishes. But the global credit crunch and liquidity problems of many transnational
corporations have already led to net capital outflows from emerging markets,
halting new investment projects. Finally, banks in many emerging market
economies are vulnerable to a global liquidity crunch due to short-term international
financing exposure and risky lending practices. Put otherwise, new waves of crises
in emerging market economies appear rather unavoidable, much more so in
countries that have not built up sufficient international reserves or have not run
fiscal surpluses, Pakistan, is an example of which.

With fast depleting international reserves there is growing fear that the
country may be forced into defaulting on its foreign obligations. It was because of
the fear that on October 6, Standard and Poor’s and Moody’s, two of the world’s
largest rating agencies, downgraded Pakistani bonds. This has created a panic and
investors have begin to fear whether Pakistan will be able to pay them back.
(Garewal, 2009)

 TEXTILE SECTOR
 23

Pakistan Textile Industry is facing an uncertain environment. Following few

factors, increase in input cost of minimum wage by 50 percent, increasing interest
rates, non-guaranteed energy supplies, lack of R&D and reduction in cotton
production, put a negative impact on the industry’s competitiveness internationally.
Because of the entire situation the companies are downsizing, production units are
shutting down; around 500,000 of the workers have already lost their jobs. After
surviving from the load-shedding scenario the industry has yet to survive the gas
load shedding scenario as authorities have informed the industry that they would
not be to supply power for the additional load and only the sanctioned load will be
supplied during the times to come. (Scribd, 2009)

Moreover, the textile industry of Pakistan has always been dependant on

assistance for its growth. Prior, the abolition of quotas by the developed countries
caused huge costs to the industry as it could not come at par with other emerging
markets like India and China in terms of technology and man power. Now with the
financial crunch, it is hit even harder due to further decline in its exports.

 MANUFACTURING AND SERVICES SECTOR

In the wake of above mentioned international and domestic environment the

economy lost significant growth momentum owing to massive contraction in the
industrial sector. The economic growth of 2.0 percent achieved during 2008-09
seems reasonable albeit it implies definite slippage against 4.1 percent growth of
the last year and this year’s target of 4.5 percent. However, it should be looked in
the backdrop of global recession where positive growth is an exception and
international developments where real GDP in Pakistan’s main trading partners is
estimated to contract by almost 3 percent on average in 2009, depressing the
external demand for Pakistan’s exports. The domestic environment was also not
supportive to the growth momentum. The industrial sector in general and large-
scale manufacturing in particular has contributed to this slowdown in economic
growth by posting dismal performance. The poor show of the LSM is understandable
in the context of acute energy shortages and constrained international demand for
Pakistan’s manufactured exports. The massive downward correction in services
sector’s growth is mainly because of poor show of the financial sector beside
 24

saturation level attained in the communication sub-sector. (State Bank of Pakistan,

2009)

The services sector has compensated some of the lost growth of the industrial
sector by growing at 3.6 percent and provided much needed sanity to economic
growth. Barring social services and public administration & defense almost all sub-
sectors of services sector felt the pinch of recessionary trend. (State Bank of
Pakistan, 2009)

Social Sector Impacts

Every dilemma that enters the society has its social costs that the country
has to bear. With Pakistan, a country already with a high rate of unemployment or
semi-employment and poverty the financial crunch only worsened the situation.

 POVERTY AND UNEMPLOYMENT

Food prices have a significant bearing on poverty incidence. A review of price

trends of essential items during 2007-08 indicates that the major portion of food
inflation during this period stemmed from hike in the prices consumed by the poor
household such as wheat, flour, rice, edible oil, vegetables and pulses. Since April
2007, the economy has witnessed over 200% increase in the price of palm oil; and
an increase of 150% in wheat prices, while over 100% increase in the price of oil in
the international market. (State Bank of Pakistan, 2009)

The government estimates that about 25 percent of the population of 169 million
is living below the poverty line of $1 a day, but other sources put the figure far
higher. An Oxfam report released this month estimated that “the number of poor in
the country has risen from 60 to 77 million because of food inflation”. It found that
the poorest 20 percent spent 50 to 58 percent of their income just to buy cereals.
(Garewal, 2009)

The Report of a UN Inter Agency Assessment Mission fielded during June-July

2008 found that food security in Pakistan in 2007-08 had significantly worsened as
a result of food price hike. The total number of households falling into this category
was estimated to be seven million households or about 45 million people in 2008.
 25

The survey further indicates that more than 40 percent of households reported no
change in income in 2008 since last year. Forty five percent of the population
working as employees witnessed decrease in their real wages. The Report shows an
increase in the share of severely food insecure population, from 23 percent in 2005-
06 to 28 percent in 2008. The main findings indicate that the high food prices are
undermining poverty reduction gains, as food expenditures comprise a large share
of the poor’s total expenditures and food price hike has severely eroded poor
household purchasing power. The Task Force on Food Security based on the World
Bank estimates of head count ratio of 29.2 percent in 2004-05 poverty estimated
that poverty head count increased to 33.8 percent in 2007-08 and 36.1 percent in
2008 09 or about 62 million people in 2008-09 were below the poverty line.

Moreover, economic growth has slowed down considerably during the last
three years. The industry and construction sectors have contracted due to the
domestic slowdown and energy shortage and also due to global recession. Thus job
absorbing capacity of the economy shrank. (State Bank of Pakistan, 2009) People
are being laid-off especially from foreign or multi-national companies in order to
reduce costs through downsizing. It has become even tougher for a freshman to find
a suitable job than it was five years from now.

According to one estimate, Pakistan’s unemployment rate in urban areas is nearly

40% and in rural areas over 60%. (Michael F. Martin, 2009)

Increase in poverty means, decrease in the average standard of living, poor

health and education, low-paying job, more population which again makes it difficult
to sustain their needs.

DID FINANCIAL CRISIS BENEFIT PAKISTAN

So far the only sector that has shown growth prospects, despite the economic
crunch has been the agricultural sector. While the rest of the South Asian
economies suffered a huge loss of income from a severe terms-of-trade shock owing
to the surge in global commodity prices, Pakistan and India actually gained, being
significant rice exporters. (However, loss came from higher petroleum prices, where
all countries lost.)(World Bank, 2008)
 26

This year too, the sector performed exceptionally well on the back of
extraordinary performance of major crops (mainly wheat, gram and rice).(State
Bank of Pakistan, 2009)

GROWTH PROSPECTS

Since 1980, South Asia has been on a rising growth path, reaching a peak of
9 percent in 2006. Growth has been on a declining trend since then. In particular,
the adjustment to the terms of trade shock brought about a slowdown in growth in
2008 for all South countries, notwithstanding the benefits of a strong agriculture
recovery. The onset of the global financial crisis suggests a significant slowdown in
South Asia’s growth prospects for 2009-1O. The slowdown will be particularly
notable for Pakistan. Pakistan’s economy is already facing difficulties; the financial
crisis will aggravate it. (World Bank, 2008)

In attempting to weather the storm, Pakistan has some significant

advantages, including a fairly diversified economy. Three million citizens working
abroad send home about $6.5 billion in annual remittances. Very few bank assets
are tied up in mortgages. The government has begun to move away from subsidies
that are a drag on the economy. (State Bank of Pakistan, 2009)
 27

Moreover, many foreign banks are optimistic about investing in Pakistan. A

recent example is UK’s second largest bank Barclays which started its operations on
Pakistan last year. ‘Pakistani banking industry has huge potential to grow and we
will grow with this potential,’ said Vinit Chandra, Chief Executive Global Retail and
Commercial Banking Emerging Markets. Barclays Bank sees Pakistan as one of the
best performers in the wake of the global financial crisis which sunk many global
banks in the US and European countries. ‘I think Pakistan banking industry is the
hero as the industry has surplus liquidity while not a single bank failed here,’ he
said. He said banks are cautious over lending because of rising high non-performing
loans (NPLs) and slow economic growth. He said global crisis impacted Pakistan also
but the impact was much lesser than the disastrous impacts on other countries.

‘Even two per cent economic growth is not the worst performance if we see
the growth of economies on other part of the planet,’ he said. ‘This is because
Pakistan is a domestically-driven economy which received less negative impact of
global crisis and recession.’ (Iqbal, 2009)

STEPS TAKEN TO TACKLE THE SITUATION

INTERNATIONALLY

Since the start of the global financial crisis, various governments have taken
extraordinary measures to pull out of recession. These include stimulus packages
 28

by governments, lowering of discount rates by central banks, bringing in new

regulations to ensure risks are taken care of, buying of shares of private enterprises
by the state, etc. The concept of the free-market economy as the world had known
for several decades has been shattered. (Zubair, 2009)

On 11 October 2008, finance ministers from the Group of Seven, G-7,

Canada, France, Germany, Italy, Japan, the U.K. and the U.S. met in Washington but
“failed to agree on a concrete plan to address the crisis.” On October 13, several
European countries nationalized their banks in an attempt to increase liquidity. On
November 14, leaders from twenty major economies gathered in Washington to
design a joint effort towards regulating the global financial sector. (, 2009)

An unprecedented global economic crisis demands unprecedented initiatives

to restore growth. The World Bank Group is helping with the financial rescue but
believes that we must remain focused on the human rescue for the many millions
left behind. The Bank is calling for developed countries to pledge the equivalent of
0.7 percent of their stimulus packages, or as much as they can in additional money,
to a global vulnerability fund to help developing countries, which can't afford
bailouts and deficits. (Iqbal, 2009)

International Crisis Group senior vice-president Mark Schneider says non-

military aid should be an integral part of the U.S. counterinsurgency strategy
against al-Qaida and Taliban fighters taking sanctuary inside Pakistan's border
areas.

"The fundamental objective of the counterinsurgency strategy when you're

working with a government is to strengthen that government's capability to
broaden its legitimacy. And it broadens its legitimacy by governing, extending
services, creating jobs, providing economic opportunity for the population, and
providing some kind of, as I said, citizen security and rule of law," he said. (Thomas,
2009)

Moreover, U.S. Senator, John Kerry has indicated that he and Senator Richard
Lugar, “will soon introduce our Enhanced Partnership with Pakistan legislation.” The
 29

legislation is expected to be similar to the ‘Enhanced Partnership with Pakistan Act

of 2008’ which will be designed to improve the economic situation in Pakistan.

Pakistan has already received nearly $12 billion in aid from the United States
since 2001, the bulk of it for counterterrorism. It obtained a $7.6 billion loan from
the International Monetary Fund and is to be seeking an additional $4.5 billion.
(Thomas, 2009)

NATIONALLY

Pakistan is facing difficulties in financing its current and fiscal account deficit
in the current year. The State Bank of Pakistan has made its intentions very clear
through monetary policy statement that it is not going to be the financer of the
deficit anymore. The privatization is not the right proposition in the given
circumstances. The National Savings is not the right choice because of its poor
organizational structure and product development. The government could tap this
source only through inflating interest rates and that would be disastrous to the
financial sector. National Saving schemes are mobilizing their deposits from the
pool of investors willing to spare resources for the longer term and any preferential
treatment may be detrimental for other competing counterparts like commercial
banks. (Dawn News, 2008)

Foreign ministers of Pakistan's major donors agreed on Friday to form a

partnership with Islamabad "to develop a comprehensive and coordinated approach
to the security, development, and political needs of the border".

At the beginning of the current fiscal year (2008-2009), Pakistan’s economy

was confronted with four major challenges which posed threat to Pakistan’s
recovery and socio-economic growth including

i. Regaining macroeconomic stability

ii. Poverty reduction
iii. Fiscal retrenchment and
iv. Weakness in the external account. (State Bank of Pakistan, 2009)
 30

In order to ensure that macroeconomic difficulties do not further slowdown

the pace of job creation and adversely affect poverty reduction, the government
has recently reached an agreement with IMF for a US $ 7.6 billion package.

For the first time, IMF has accepted Pakistan’s homegrown proposals/programs
which have two main objectives:
(i) to restore the confidence of domestic and external investors by
addressing macroeconomic imbalances through a tightening of fiscal and
monetary policies until visible signs of demand curtailment; and
(ii) to protect the poor and preserve social stability through well-targeted
and adequately funded social safety nets. The government’s new broad-
based program for economic stabilization was mainly focused on
rationalization of expenditures, removal of unproductive subsidies to
reduce the burden on the budget; significant cuts in expenditures to
reduce budgetary deficit and a tight monetary policy to fight inflation.

The government adopted the following measures to address the above

challenges:

a) Strong adjustments in the petroleum prices were undertaken to reduce the

budget deficit;
b) Significant cuts were made in the expenditures to curtail aggregate demand;
c) Tight monetary policy was followed by the State Bank of Pakistan to contain
inflationary spiral;
d) Electricity tariffs were periodically adjusted to rationalize energy prices;
e) Government adopted a Nine-Point Program for economic and social recovery
encompassing the following elements:
i. Macroeconomic Stability and Real Sector Growth
ii. Protecting the Poor and the Vulnerable
iii. Increasing Productivity and Value Addition in Agriculture
iv. Integrated Energy Development Program
v. Making Industry Internationally Competitive
vi. Human Capital Development
vii. Removing Infrastructure Bottlenecks through Public Private Partnerships
(PPPs)
 31

viii.Capital and Finance for Development

ix. Governance for a Just and Fair System
a) Prioritized the scarce government expenditures available for development-
related programs;
b) Directed immediate support to the most vulnerable groups through the Benazir
Income Support Programme (BISP). These are small (Rs.1000 per month per
family) cash grants channeled through women to help satisfy the most
fundamental needs of vulnerable households. Currently reaching 3.5 million poor
households, the scope of the programme is expected to expand to 7.0 million
households in 2009-10;
c) Implemented improved and transparent targeting of Benazir Income Support
Programme (BISP) and other programmes aimed at the poor and the vulnerable
groups.
d) Intensified public-private partnerships with the objective of making private
investments, including foreign investors, the most important funding source for
economic development; and
e) Reinforced the importance of sound governance, managerial and systemic
mechanisms to ensure that investments in the social sector are cost-effective
and aimed at output-oriented service delivery. (State Bank of Pakistan, 2009)

Pakistan’s stabilization programme is supported by the Stand-By Arrangement

(SBA) with the IMF approved on November 24, 2008. The SBA envisaged a
significant tightening of fiscal and monetary policies to bring down inflation and
strengthen the external position adopting several structural measures in the fiscal
and financial sectors including strengthening of the social safety net. In addition, to
stabilize the macroeconomic situation, the Programme aimed at addressing some of
Pakistan’s long standing economic problems. In particular, it called for a
comprehensive tax reform to raise budgetary revenue and phase out the electricity
subsidies to create greater fiscal space for public investment and social spending.
Initial developments in the economy since the implementation of the Programme
have been positive:
✔ The exchange rate has broadly stabilized enabling the State Bank of Pakistan
(SBP) to buy foreign exchange on a net basis.
 32

✔ SBP reserves have strengthened from US$ 3.5 billion at end October 2008 to
US$ 7.1 billion on end March 2009.
✔ T-Bill auctions have been consistently oversubscribed with wide participation
of banks enabling the government to retire some of its debt to the SBP
✔ Headline Consumer Price Index (CPI) inflation is estimated to have declined
from 25.3 percent in August 2008 to 17.2 percent in April 2009.
✔ The overall fiscal deficit is estimated to have been restricted to 4.3 percent in
2008-09.

 POVERTY REDUCTION
Poverty Reduction Strategy (PRSP)

The government is conscious of the cost being imposed on poor families from
the sharp escalation in food prices. Many of these needs are strongly linked and
need to be addressed holistically — unless health services are improved, the
incidence of ill health will continue to rise; unless educational retention is improved,
children will never be able to exit from poverty because they will be concentrated in
low-return employment or remain unemployable. It is, therefore, important to
address primary needs via social protection, while simultaneously focusing on the
mechanisms that ensure that the exit from absolute poverty is permanent for the
majority of the vulnerable and a large proportion of the chronically poor. The
national Poverty Reduction Strategy covers the three-year PRSP-II period of 2008-09
– 2010-11 while also providing a framework for thinking well beyond this timeframe
and is, therefore, to be viewed as an approach to a long-term national economic
strategy that has its main focus on reduction of poverty.

Benazir Income Support Programme (BISP)

The sharp rise in international oil and food prices last year and the global
financial crisis not only adversely impacted the macroeconomic indicators in
Pakistan but also increased the number of the poorest of the poor. Recognizing the
urgent need to protect the poor and the vulnerable, the Government of Pakistan
(GoP) launched the Benazir Income Support Programme (BISP) in 2008 as its main
social safety net programme. This programme would serve as a platform to provide
cash transfers to the vulnerable identified on the basis of a poverty scorecard and
 33

would be backed by an exit strategy. This strategy includes imparting training to

one member of each vulnerable family to sustain itself. The Programme also
envisages a workfare initiative through social mobilization. BISP intends to cover 3.4
million families or 22.75 million people in the current year. In the next year, the
government intends to at least double the allocation for BISP to cover 7 million
families. (Thomas, 2009)

 INFLATION

To contain inflation within desirable limits, the government took various

measures such as government expenditure through stringent fiscal discipline,
supply augment arrangements through imports and smooth distribution network of
essential commodities. Throughout the year, the Economic Coordination Committee
(ECC) keep a constant watch over prices and supply of essential commodities in
their fortnightly meetings And come up with recommendations to improve supply.
(State Bank of Pakistan, 2009)

 MONEY AND CREDIT

In the light of continued inflationary buildup and increasing pressures in the

foreign exchange market, the SBP announced a package of monetary measures on
May 21, 2008 that included;

i. An increase of 150 bps in discount rate to 12 percent;

ii. An increase of 100 bps in CRR and SLR to 9 percent and 19 percent,
respectively for banking institutions
iii. Introduction of a margin requirement for the opening of letter of credit for
imports (excluding food and oil) of 35 percent, and
iv. Establishment of a floor of 5 percent on the rate of return on profit and loss
sharing and saving accounts.

Following a slight reversal in the mounting inflation, the SBP announced a

decline of 100 bps on April 20, 2009. SBP’s tight monetary policy and rationalization
of fiscal subsidies and expenditure controls are the key factors that contributed a
reasonable progress towards macroeconomic stability. Although the fiscal and
 34

external current account deficit reduced during the last year, still it remains high
along with the risk of slippages. (State Bank of Pakistan, 2009)

CHALLENGES AND RECOMMENDATIONS

Growing fiscal deficits due to food and fuel subsidies and rising inflation
suggest that South Asian countries have basically run out of fiscal space and do not
have the option of riding out further shocks with expansionary fiscal and monetary
policies. So, in the near term growth will need to fall to absorb the shock from the
financial crisis. Indeed, as noted, all South Asian countries have responded with
some degree of monetary tightening and cutbacks in development spending, and
have also adjusted domestic fuel and fertilizer prices in varying degrees to stem the
widening of the fiscal deficit. However, with the following policy recommendations,
middle-income countries can also decrease the impact of the financial crunch in the
long run. There is a need to act, even if it requires questioning conventional wisdom
in such central aspects as the role of the state and the market in post-crisis
conditions.

○ Further reduction of the gap between domestic and international prices and
better targeting of open-ended subsidies are possible options especially in
Pakistan which faces the largest macroeconomic imbalances.
○ Tightening of demand and hence compression in imports, especially in
countries like Pakistan and Sri Lanka. Demand management will obviously
need to focus on the right mix between fiscal and monetary policies with a
view to ensuring that there is enough liquidity in the short-term to avoid a
financial crunch while also ensuring that aggregate demand falls to reduce
inflation and improve the macroeconomic balances.
○ Domestic resource mobilization in the medium-term through the tax system
that will play a key role to regain the growth momentum. All South Asian
countries can benefit from it. In the short term, countries have tended to cut
development spending to contain the rise in fiscal deficits, which is
contributing to the growth slowdown.
○ Better expenditure management is also a medium-term option for reconciling
stabilization with growth objectives.
 35

○ Refocusing policy attention to the next phase of structural and institutional

reforms will also help growth to recover.(World Bank, 2008) Going forward
the government has to pursue aggressive trade diplomacy to augment its
access to external markets, beside ignite its efforts to diversify exports to
optimal exploitation of export potential. (State Bank of Pakistan, 2009)
○ The government can overcome the financial crisis and repair the economy by
providing proper incentives and infusing confidence into resident as well as
overseas Pakistanis
○ Pakistanis living abroad should be encouraged to invest in Pakistan by
redressing their genuine reservations and providing them with a level playing
field. Overseas Pakistanis have the potential to change the economic outlook
of the country. 2

Dr. Hafiz A. Pasha, in a conference in the Pakistan Society of Development

Economist, said that short time ago, the foreign exchange reserves of Pakistan
sharply declined, currency was depreciating, high inflation, high trade deficit and
Pakistan was almost near to bankruptcy. The panel of economists prepared
completely independent report. The report looked at the short-term macro
economic framework, social protection strategy and development strategy and
institutional framework for development. Dr Ishrat Husain, former Governor State
Bank of Pakistan while chairing the session on Global Financial Crisis organized said:

○ Pakistan has to pursue active monetary and fiscal policies to deal with the
global financial crisis which is affecting our economy,”

Moreover, there should be:

○ Mobilization of domestic resources rather than depending too much on

external sources and foreign debt. This will lead to debt un-sustainability.
○ Institutions should be developed for capacity building. There must be
coordination in the monetary policy and fiscal policy coordination, trade
and exchange rate policy and the policy on social protection.
○ The service sector tax and excise duty be increased
 36

Analysts think it is a dilemma that Pakistan moved too fast on the trade
liberalization, she should retreat on trade liberalization. The reduction in tariff over
the time led to the import consumption society and this is not sustainable for long
time. (Garewal, 2009)

○ Maximize efficiency by being clear about short-run and long-run

objectives and corresponding regulatory tools.
○ Reward more those institutions that performed well relative to those
that do not.
○ Increase coordination among global central banks and worldwide
financial stability regulators (Viral V. Acharya, 2009)
○ Reforms in the regulatory framework to include tighter scrutiny and
check over the performance and working of all financial as well as non-
financial institutions
○ Encourage investors to do more saving and less consumption of
income
○ Expansion of public investment which will indirectly improve
consumers’ confidence, to the extent that there is significant job
creation involved. Investment by the government in creating a social
safety net can also have a favorable impact on consumers’ attitudes. If
consumers feel more protected when facing catastrophic
circumstances regarding health, the loss of a job, extreme poverty,
social security, and so on, they will be induced to have more of a
propensity to spend and less to keep precautionary savings.
○ Incorporate knowledge. Moving toward a knowledge- based economy
will increasingly become a necessary condition for any export- led
strategy to be really successful— that is, to consistently increase
productivity and improve the economy’s competitiveness.
In the globalized economy, and more so as a consequence of the
current crisis, the challenge of how to persuade society to seriously
make this turn toward high- quality education, research and
development, joint private- public partnerships to develop innovative
visions of the future, and the like is becoming one of the key strategic
issues for middle- income economies.
 37

Much explaining and persuading will be required for a multi-layered program

of reforms to be undertaken and accepted by the general public. The changes
required in the quality of the labor force, in the way labor markets operate in order
to increase productivity, and in the new institutions required to provide economic
security to those changing or losing jobs are all essential to accelerate the transition
toward a knowledge- based economy. Implementing these reforms again represents
a major challenge for governments and policy makers. (Viral V. Acharya, 2009) But
the long run advantages once the reforms and the requisite supporting institutions
are in place are huge. These reforms serve as a cushion for a country’s economy in
distressed times.

CONCLUSION AND REMARKS

In the context of the current economic and financial crisis, one advantage of
what is now happening in public discussion is that there are fewer “I know it all” or
“The markets will fix it” approaches. Fewer economists are telling policy makers
“We told you so.” Instead, the shared sentiment for both politicians and decision
makers and regulators is “How could we not have seen what was coming?”
Much explaining and persuading will be required for a multilayered program of
reforms to be undertaken and accepted by the general public.
Essentially, a new conventional wisdom will need to emerge encompassing six main
points:
○ Markets will work better if there is more regulation, not less.
○ What is produced and traded should be more in accord with the needed
new, high- quality jobs.
○ Labor and education reforms should be undertaken. To be successful,
these will need to be supported by a wide spectrum of political opinion.
(Viral V. Acharya, 2009)
○ Time will be needed to gradually expand coverage in basic social services
until all participants in the labor force, both so- called insiders and
outsiders, are included.
○ The only way to introduce flexibility in the labor market will be to point
toward guaranteed universal social security, health care, and
 38

unemployment insurance coverage for workers with different types of

employment contracts.
○ All these changes will require additional resources, and some countries
have more of a margin to increase tax revenues than others. For those
with little margin, innovative formulas relying on a mix of public revenues,
targeted household savings, and solidarity funds should be tried, as some
countries in Latin America and Europe are experimenting with.

Nevertheless, Pakistan’s economy still faces pressures from uncertain

security environment, higher inflation driven by spike in food prices, the acute
power shortages, and bewildering stock market, perceptible contraction in the
large-scale manufacturing and slowdown in services sector; lower than anticipated
inflows and growing absolute financing requirements. Abatement of inflationary
pressure remained oblivious and prices depicted stubbornness. The current
slowdown is substantially different from the deceleration of the 1990s or early
2000s. The aggressive monetary tightening posture of the
SBP has witnessed a reversal in the last monetary policy statement by notional
downward adjustment of policy rate in April 2009 to ensure that stubbornness of
monetary policy might not hemorrhage the economic activity. The recent monetary
policy has tried to strike a balance between sustaining the growth momentum and
containing the inflation in stabilization mode. (State Bank of Pakistan, 2009)
The International Monetary Fund has recently argued for reforms in middle-
income countries that include four main components (IMF 2009b):
1. systemic regulation, meaning that all financial institutions must be
incorporated in an inclusive supervisory framework— not only banks but also
insurance companies, investment funds, mutual funds, and other companies
operating with mortgages, derivatives, and so on;
2. “consolidated supervision,” referring to financial conglomerates, international
banks, regional banks, and other related financial institutions, which should
be supervised not only at the national level but also in coordination with
regulators in the advanced economies;
3. an avoidance of the procyclical nature of capital requirements, and of
provisions required from banks and other financial institutions, which should
 39

be increased during boom years so as to be better able to deal with

nonperforming loans in downswings; and
4. supervision by central banks of the price of assets, to anticipate and regulate
when systemic risk emerges. (Viral V. Acharya, 2009)
This rather detailed description of changes suggested by none other than the
guardian of orthodoxy and good financial behavior, the International Monetary
Fund, serves the purpose of calling attention to the enormous challenge that is the
political economy of regulatory reform. And this can be illustrated even more clearly
by quoting from the editorial page in a recent issue of the Economist, referring to
the difficulties of changing regulation: “Financiers tend to gain the advantage over
their overseers. They are better paid, better qualified and more influential than the
regulators. Legislators are easily seduced by booms and lobbies. Voters are
ignorant and bored by regulation.” It would be hard to find a more accurate
description of the difficulties that must be faced when one attempts to undertake a
systemic overhaul of regulatory frameworks, either in advanced or middle- income
economies. (Michael F. Martin, 2009)
Sharp spike in the international price of crude along with an unprecedented
jump in commodity prices were the two major external culprits behind Pakistan’s
macroeconomic imbalance. Oil has since come down from a high of $147 a barrel to
under $40 a barrel while commodity prices have experienced a drastic trimming.
The two put together shall provide long-needed relief to Pakistan’s trade account
(and inflation).
The other side of the coin is that the world economy is slowing down like
never before. Consider this: America buys nearly 30 percent of Pakistan’s exports.
America is our only major trading partner with which we have a trade surplus.
American investors account for nearly 30 percent of Foreign Direct Investment (FDI)
into Pakistan. And, America is slowing down like never before. The Global Financial
Crisis and the accompanying global credit crunch had a minor direct impact on
Pakistan. But, Pakistan’s economy remains in the thickest of woods. For FY 2008-09,
Pakistan needs a colossal $13.4 billion foreign inflow of capital. Of the $13.4 billion,
IMF’s contribution is expected to be $4.7 billon and Pakistan still needs to find other
multilateral and bilateral donors to bridge the whopping gap.(, 2009)
 40

Pakistani Prime Minister Yousuf Raza Gilani has said that Pakistan wants
"trade not aid." But Mark Schneider says Pakistan needs both to survive.

"What you really need is trade and aid because trade doesn't do anything
with respect to building a police force or training judges or training teachers. That
comes about from government services. And so you need both aid to help
strengthen those government agencies, and you need trade to permit the
expansion of an economy," he said.

Some analysts believe the combination of insurgency and ineffectual

governance may prompt the military to step back into the political arena again, as it
has done for more than half of Pakistan's nearly 62-year history.1

As David Blair, a well-known diplomatic editor said, President Asif Ali Zardari
needs a mere £6 billion to avoid defaulting on his debts and stave off the immediate
threat of bankruptcy. This sum is only 0.3 per cent of the amount now devoted to
saving the global financial system.

For the amount that Britain is prepared to spend to salvage its banks - £500
billion - Pakistan could be rescued no less than 83 times over. Since the terrorist
attacks on September 11, America has given Pakistan £5 billion of aid. This is barely
one per cent of the £458 billion that Washington may be forced to spend on saving
Wall Street.

Bereft of oil and possessing little natural wealth, Pakistan has suffered
decades of economic failure and stagnation. Ten years ago, it came within a whisker
of formally defaulting on its debts and declaring itself bankrupt. So the country's
leaders have become perennial seekers of bailouts.

Yet for once, the stigma attached to being an international beggar has
entirely disappeared. Today, almost every government is besieged by formerly well-
heeled beggars - and most are seeking far larger sums than Pakistan with its 165
million people.

In this time of crisis, saving a valued ally has never seemed so cheap. (Blair, 2008)

The meltdown of the American financial system is also believed by the

experts to have a few lessons for Pakistan to learn. First, we immediately need to
strength regulations of the markets to stave off any big crisis that we can’t afford to
 41

have. Second, the government should help the capital market to restore investor
confidence in our economy.

In fact, I believe that there may be positive short-term impact on Pakistan of

the current economic turmoil in the developed world. Pakistan’s external account
situation is the result in part of the large increase in the import bill. This happened
because of the unrelenting increase in the prices of oil and several agricultural
commodities imported by the country. Both food and energy price indices continued
to increase through 2007-08, with the oil price increase outpacing the increase in
the price rises of internationally traded agricultural products. The financial crisis has
suddenly reversed these trends. The price of oil has declined by 50 per cent in a
couple of months while the prices of traded food crops have registered significant
drops. This should provide Pakistan with some relief and stop the rapid
hemorrhaging in its foreign exchange reserves. The structure of the Pakistani
economy and the structure of its financial system will protect the country from
feeling the full impact of the financial crisis in America and Europe. Pakistan is
poorly integrated with the global economy. This means that the shocks being felt in
developed countries will not be felt to any great extent in Pakistan. It will be spared
the consequences of the unraveling in many parts of the western financial
structure. It now appears that the financial crises that have gripped America and
Europe will also affect the real economies of these countries. Most experts now
believe that America and Europe at this time stand at the threshold of deep
recessions. The first signs of these have already begun to appear. In September,
America lost 160,000 jobs; it is expected that by the end of the year there will be a
reduction of one million jobs in the United States. Job losses result in declines in
spending.

Consumer spending is the main engine of growth in the United States. If it

declines significantly, the economy will go into recession. That is likely to happen.
Once an economy is in recession, there is a negative impact on imports. We will see
a fairly large reduction in the American imports. Of the developing world, the
country that will be affected most severely will be China which depends on exports
to the United States to drive its trade oriented economy. The affect on China will be
felt by a number of countries in its neighborhood who have become important
suppliers of parts and components to the rapidly transforming Chinese production
 42

system. While China has a large trade surplus with the United States, it has begun
to run trade deficits with many East Asian countries. Trade, in other words, will
transmit to many developing countries the shocks of the current financial crisis in
the western world. Here again, Pakistan is likely to be protected by the
underdeveloped status of its trading sector. While the United States is Pakistan’s
single largest trading partner, a recession in America will not have a significant
impact on either the quantum or value of exports. Most of these are in textiles
which, as the economists suggest, are not highly dependent on incomes. Even
though Pakistan may escape the immediate negative consequence of the turmoil in
the West, there will be long-term consequences. One of them is the possible impact
on remittances from the United States. Over the years the US has become the
single most important source of remittances for Pakistan, a good part of which
originates not with the Pakistani workers of which there are not too many in
America but from the professionals whose incomes will suffer if the US goes into a
long and deep recession. What has become the single largest source of external
finance for Pakistan may come under pressure.

The government needs to gain investors’ confidence and sustain

development expenditure, particularly for infrastructure and education. Without
these actions, it will be very difficult for Pakistan to attract foreign investment.

The regulations put in place by the State Bank of Pakistan over the last many
years have helped Pakistan emerge out of this crisis relatively unscathed. No
financial institution collapsed, unlike the banks in the US and Europe, and the
government did not need to step in to buy shares of failing institutions. We did have
a high percentage of write-offs in Pakistan but nothing compared to amounts that
were written off in the US and Europe.

The economy has been on a rollercoaster ride ever since the country gained
independence more than six decades ago. At this time it is going through one of its
periodic downturns. This one is more severe than many experienced in the past.
The reason is not hard to understand.

The country is passing through a perfect storm; dealing simultaneously with a

number of crises. All of these are not related to economics; some have their origin
in politics, some in the structure of the society and some in the rise of Islamic
extremism.
 43

Given the ongoing struggle with Islamic extremists in which Pakistan now has
taken a decisive position, the country will manage to receive a significant infusion of
capital. This will come mostly from official sources and will go largely to the
government in support of the budget and of the various programmes and policies
favoured by the donors.

Private capital flows needed by the entrepreneurial classes will only become
available when the country becomes an attractive destination for the investors. For
that to happen, the government will need to do a great deal of hard work. Some of
this is needed to make the economy more competitive.

the latest report issued by the Islamabad-based Competitive Support Fund to point
out the numerous weaknesses in the current structure of the economy. These had
resulted in Pakistan slipping by nine places in the ranking of the countries on the
competitive scale by the World Economic Forum. These weaknesses need to be
removed in order to place the economy on a higher plane of growth and
development.

One way of doing this is to bring to the economy the capacity to innovate. This is
largely absent at the moment although, as the report points out, there are inherent
advantages present which include a very young population. The median age of
Pakistan’s population is 18.2 years – which means that tens of millions of young
people are entering the workforce every year. Properly equipped with education and
appropriate skills, they could lend enormous dynamism to the economy. Left alone
to their devices they will only swell the ranks of the disgruntled.

The other advantage Pakistan has is the capacity to adapt new technologies and
new ways of doing things when conditions are right. This was amply demonstrated
in the late ‘sixties and the early ‘seventies when the farming community – in
particular the medium sized farmers – quickly adopted the technology associated
with high-yielding seeds developed in Mexico (wheat) and rice (the Philippines).

The importance economists have begun to place on innovation as a driver of growth

and development is of relatively recent vintage. Development economics began its
life as a separate discipline by suggesting that by the transfer of low productivity
labour from the countryside to industry and modern commerce personal incomes
 44

would increase, markets would expand, and new opportunities would become
available. All this would increase the rate of economic growth.

But the development of the modern sector needed more than the transfer of labour
from less to more productive part of the economy. It also needed capital. This led to
the development of production functions in which labour and capital were the two
variables. It is only recently that economic model builders have introduced
knowledge – and hence innovation – as a direct determinant of growth. This
represents an enormous change in thinking which has not been fully factored in the
work of economic policymakers. At this critical time in its history, the country
certainly needs a lot of foreign capital. But to move towards an economic structure
that will sustain high levels of growth, it also needs an economy that can innovate.

‘Building a national innovation ecosystem for Pakistan is a complex and nuanced

process containing many components. These include tax policies, government
procurement, and protection of intellectual property rights. They include building
the infrastructure for innovation and industry-university linkages. They include
supporting entrepreneurs and businesses in general and in their technology
identification and acquisition efforts. They include specialized support, such as
business incubators and tech parks. They include strengthening education at all
levels to encourage innovation and strengthening the ability of the financial sector
to support commercially viable innovation. They include policies as straightforward
as support for those wishing to file patents to more complex initiatives such as
changing cultural attitudes towards risk.’ (Garewal, 2009)

Pakistan’s past economic performance and inadequate financial discipline

have made it difficult to pass through the global crisis with minimum damage,
unless, we immediately adopt and demonstrate immaculate financial discipline in
coming years, Wahab added. (Dawn News, 2009)

Syed Javed Hasan, Chief Executive Officer, IGI Funds, stressed the need for
improving Pakistan’s financial discipline on both, individual and government levels,
and stressed the understanding that the crisis was not a short-term problem but
one that could last longer. (Dawn News, 2009)
The banking in Pakistan too is stressed because the other leg of the financial
system, the securities market is not developed. For the financial system to cope
with demands of an emerging economy with so much potential, it needs the other
 45

pillar to be strengthened to provide a sound foundation for an expanding economy.

“No decent person can wish others to suffer but the crisis in the West has
created a situation pregnant with immense possibilities for Pakistan”, a senior
banker told Dawn. (n good)

Whatever the outcome, it is clear that good governance is key to steering

Pakistan, and the rest of the world, out of a global recession. It will take cooperation
at an international level and for many governments to not only make the decisions
that are right for their domestic situations, but also work together with their
counterparts abroad to find a solution to mend this problem and reduce its trickle-
down effect on real economies.

In sum, there is a light on the other side of the tunnel; this crisis can be
converted into a great opportunity but the demand of the hour is proper and timely
planning with motivation, and a sincere struggle at the global level to pass through
this trial. If world leaders fail to deal with this issue, it can be taken as a chance by
“terrorist organizations” to utilize the deprived sections of the global society for the
attainment of their desired goals. As Shakespeare stated in Julius Caesar, “There is
a tide in the affairs of men, which taken at the flood, leads on to fortune. Omitted,
all the voyage of their life is bound in shallows and in miseries.”

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