Ahmad Faruqui

A Review of Pakistan’s Present Economic Situation  

With a capacity to affect regional and international stability, Pakistan is one of nine pivotal states in the developing world, according to Yale historian Paul Kennedy.  “A pivotal state is so important regionally that its collapse would spell transboundary mayhem: migration, communal violence, pollution, disease and so on.  A pivotal state’s steady economic progress and stability, on the other hand, would bolster its region’s economic vitality and political soundness and benefit American trade and investment.”3

However, unlike the nations of the Asia-Pacific region, which also gained independence during the post Second World War period, Pakistan remains a low-income country, with a per capita income of $470.  It has the world’s sixth or seventh largest population, of about 145 million.  Its military, armed with nuclear weapons, is the most powerful in the Muslim world.  However, in part because of its low rate of economic growth, and in part due to its complex history and geography, it has been struggling with ethnic strife and sectarian violence during the past two decades. 

In the sixties, the Harvard Development Advisory Service viewed Pakistan as a model developing country.  Growth in the gross domestic product (GDP) averaged six percent a year, about 50% higher than neighboring India’s four percent a year growth rate.  The rate of growth dipped to four percent a year in the seventies, in the aftermath of the military debacle in East Pakistan, the Arab Oil Embargo, and the large-scale nationalization of industry, banking and finance by the government of Prime Minister Zulfiqar Ali Bhutto.  The rate of growth picked up again in the eighties, despite the Soviet invasion of Afghanistan.  During the nineties, the economy slowed down to a crawl, as successive civilian regimes outdid each other in corruption and mismanagement. 

Due to decades of economic mismanagement in which fiscal and international trade deficits were incurred, foreign debt obligations rose to $38 billion, more than half of Pakistan’s current GDP of $65 billion.  Servicing of this debt consumes half of the national budget, and defense spending consumes about a quarter.  This leaves just a quarter for government administration, and for much needed economic, social and human development. This amount is clearly insufficient to make a dent in these often neglected, non-traditional dimensions of national security.

The economy has been unable to diversify itself from its heavy dependence on agriculture.  About 70% of the population resides in villages, which employ 45% of the people, and generate 25% of the gross national product.  Agricultural performance depends on factors that can be controlled and others that cannot be controlled.  The former include the quality of seeds, fertilizer and farming practices.  The latter include the quality of the soil, weather conditions and pest infestations.  In the case of Pakistan, the uncontrollable factors have often dominated the controllable ones, resulting in marked volatility in agricultural performance. 

During the 2000/01 fiscal year, problems triggered by the widespread drought in South Asia reduced GNP growth to 2.6%, not sufficient to cover the growth in population of 2.8%.4 About 38% of the population lives below the poverty line, defined by the World Bank as an income per person of less than one dollar a day.  The incidence of poverty in China is 4.6%, while in India it is 35%.5 Despondent with the bleak economic outlook of the country, many Pakistanis are anxious to emigrate.  A recent Gallup survey found that 62% of the adult population would like to go abroad to work, and that half of those wishing to work overseas do not wish to return home.  A similar survey carried out in 1984 found that only 17% of Pakistanis were eager to settle abroad.6

Law and order is under stress in the urban centres, due to high rates of youth unemployment, increasing inequalities in the distribution of income, and corruption in the police force.  Armed robberies, kidnappings and murders are not  infrequent occurrence.  Armed gangs that exploit ethnic and sectarian rivalries indulge in large-scale violence, some of which may well be placed at the door of the Indian Research and Analysis Wing (RAW).  The mandate of the federal government do not exist in many rural areas, particularly in Sindh and the Federally Administered Tribal Areas that border Afghanistan. The situation contrasts dramatically with the vision laid out by the nation’s founder, Mohammad Ali Jinnah, in his address to the Constituent Assembly, “The first duty of a Government is to maintain law and order, so that the life, property and religious beliefs of its subjects are fully protected by the State.”7

Rivalries between Punjab, the largest province with 56% of the population whose members dominate the nation’s military and civil services, and the three smaller provinces (Sindh, Frontier and Balochistan) have continuously increased.  These rivalries have already delayed the implementation of the last diennial population census from 1991 to 1998.  Problems in the allocation of water are now at the top of the list of  contentious issues.  The much-needed Kalabagh Dam project on the Indus River has been cancelled, due to the failure of Sindh and Frontier to resolve the issue of water rights with Punjab.  Its cancellation means that Pakistan would be denied 3,600 MW of low-cost hydropower that would have eliminated the need to import 20 million barrels of oil per year.  More importantly, it means that Pakistan will have to find other means with which to deal with the chronic problem of irrigation water shortage.  Every year, around 32 million-acre feet of water goes into the Arabian Sea.8

Until the recent Anglo-American war in Afghanistan, Pakistan’s major problem in foreign policy was the 54-year old conflict with India, much of it involving conflicting visions of national identity.  This conflict finds its most visible expression in the lingering dispute over Kashmir.  This conflict has involved many major and minor wars, the last one of which took place in the icy heights of Kargil in the spring of 1999.  Militarily, Pakistan’s performance has not been impressive in her wars with India,9 whose continuous military expansion has led to complementary enlargement of Pakistan’s military, particularly after the 1971 war with India that led to the loss of East Pakistan.   Expenditures on the military, account for about five percent of the GNP.  Because of the absence of strong domestic political institutions, and the presence of a strong feudal culture, the military has dominated Pakistan’s political landscape for more than half of its existence. 

Facing a 1:4 disparity in the conventional arms balance of power with India, Pakistan has been forced to develop a nuclear weapons programme. This programme operated under the doctrine of recessed deterrence till May 1998, when India’s nuclear tests forced the government of Pakistan to respond with its own tests within two weeks.  There was a general perception in Pakistan, triggered by remarks from hawkish cabinet members in New Delhi, that India may indulge in military adventurism unless cautioned of its cost.

  Relations with the US  

Geographically, Pakistan falls within the purview of the US Central Command (CENTCOM).  In the fifties, Pakistan was the only country that belonged to both the CENTO and SEATO alliances formed  to contain the expansion of communism in Asia.  It also had a bilateral military alliance with the US, and was provided substantial military hardware through the MAP programme to equip five-and-a-half infantry divisions and a dozen air force squadrons.  In the eighties, Pakistan served as a frontline state during the Soviet-Afghan war, and received $3.2 billion of military and economic assistance from the US.  Supplies included 40 F-16 A/B fighters, 20 AH-1S Cobra attack helicopters with TOW, heavy artillery, Sidewinder AAMs, Harpoon SSMs, and various infantry weapons including Stinger shoulder-launched SAMs.10

In the aftermath of the Afghan-Soviet war of the eighties, Pakistan became the accidental home to more than three million Afghan refugees.  The arrival of these refugees, several of whom were reportedly armed  according to their tribal traditions, heralded the arrival of the Kalashnikov culture in Pakistan.  Some engaged in narcotics trafficking.  And some others,  had acquired a religious bias prompted and patronized during the US-funded jihad against the Soviet Union.  Prior to the events of September 11, about 2.2 million refugees were estimated to be in Pakistan.  This had led some analysts to write about the rise of a jihadist culture in Pakistan.11 However, this analysis failed to recognize that a large portion of the educated middle class in Pakistan, and a major portion of the country’s intelligentsia, has been schooled in western educational institutions, both domestically and abroad.  It supports cooperation with the west, and actively opposes confrontation.  In addition, the Pakistani business community abjures violence and is interested in promoting economic growth.   General Musharraf was to tap into these segments of the Pakistani population to successfully forge a pro-US policy during the war against the Taliban, as discussed later in this paper.  

Prior to the events of September 11, Pakistan found itself at cross-purposes with the US in three areas12:  

·        The deposition of democratic rule, however corrupt, with the military rule, which took place in October 1999, and the ascendancy to the presidency by General Pervez Musharraf in the spring of 2001.

 

·        There was a perception in Washington [possibly Indian-fed] that Pakistan was allowing militant groups engaged in the Kashmir insurgency and connected with the Taliban and al-Qaida in Afghanistan to operate from Pakistani soil.13
 

·        Pakistan’s close military ties with China, including cooperation in the nuclear field, and the US interest in engaging India as the primary regional power in South Asia, partly with an eye to containing China.14  

            As discussed later in this paper, the Anglo-American war on the Taliban and al-Qaida militias in Afghanistan brought about a significant reversal in the frostiness that had set into US-Pakistani relations during the Clinton administration.
 

Pakistan’s Future Outlook  

One of the main reasons for Pakistan's abysmal economic performance is poor governance and corruption in the administration, caused by the failure to develop robust political institutions.  As much as a quarter of the GNP may have been lost to these twin problems, representing a total of some $15 billion.15  In a sample of 85 countries, Transparency International found that Pakistan in 1998 was more corrupt than 71 of the nations in the sample, with only Russia, Indonesia, Nigeria and some Latin American countries being more corrupt than Pakistan.  India was ranked 66^th.16

However, under enlightened leadership that uses the right set of policy instruments, Pakistan can once again attain the old level of growth performance, without exacerbating income inequalities.17 There is a regional precedent, represented by the turnaround in India’s growth profile during the nineties when India raised its GNP growth rate from the historical average of three to four percent to six to eight percent.

Pakistan’s future is predetermined to a degree by its demographics, its low levels of spending on human and social development over the past several decades, and by the need to pay off its staggering foreign and domestic debts.  Additionally, Pakistan’s future is determined by developments in its external environment.  However, Pakistan’s future is imprisoned by external events and past trends.  Its leaders have a tremendous influence on Pakistan’s future development, through the policy choices they make.  For example, they may choose to follow a cooperative or confrontational policy toward their neighbours.  They may choose to stay within the budget constraint or run budget deficits.  They may choose to emphasize social and human development programmes that improve the economic welfare of the common man or buy expensive weapon systems that bring about no such improvement.   Thus, in the final analysis, Pakistan’s future development rests in the hands of its leaders.  As stated in the Holy Quran, God does not change the condition of a people until they change what is in themselves.18  Some commentators interpret this verse to be saying, “God does not alter a nation’s condition unless it changes its economic and social conditions.”

 

Scenarios of Future Development19

 

            Forecasting social, political and economic phenomena remains an inexact science, requiring much judgment and speculation.  Given the wide variance in Pakistan’s historical evolution, the possible futures that await Pakistan span a wide range.  There is a temptation to focus on probable scenarios of the future, but this often eliminates high-impact scenarios that could occur under the right set of circumstances.  Events such as the fall of the Berlin Wall or the first Arab Oil Embargo have no finite probability of occurrence, and thus tend to blindside analysts when they do occur.  To avoid falling into this analytical trap, we have laid out five scenarios that encompass a range of possible futures for Pakistan.  Two of the scenarios are extremely low probability scenarios, but would have a significant impact on the people of Pakistan if they were to occur.  Thus, policy makers would be well advised to consider them, in addition to reviewing the other three more-likely scenarios.  

(1)               Super High Performance.  Pakistan will incorporate the best features of the “East Asian” miracle.  In this Utopian scenario, GNP will grow at eight to nine percent a year, allowing per capita income to rise by five to six percent a year.  Poverty levels will decline to less than 15% of the population.20 While extremely unlikely, this scenario is still within the realm of possibilities.  Pakistan’s military has finally recognized that economic progress holds the key to the nation’s future.  In a recent speech, President General Pervez Musharraf noted that while Pakistan has military muscle and is a nuclear power, it does not have matching economic strength and is thus a weak state. “We have to strengthen our economy in order to create a balance with our military power.”21 This scenario is likely if the following conditions prevail: a high investment rate in the range of 35-40% of GNP; fiscal surplus of two percent of GNP, brought about by expansion of the tax base and reduction in unproductive government expenditures; low levels of foreign debt; a liberalized economic system with significant incentives for private enterprise and a modicum of red tape; a booming IT sector; inspired political leadership and governance; institution of checks and balances between the three branches of government; democratic rule; domestic harmony; a foreign policy focused on cooperation and peace; defense spending at 2% of GDP; conversion of SAARC into a free trade area; extensive economic trade and commerce between Pakistan and India.22  

(2)               High Performance.  Pakistan will have the features that characterized it in the early sixties, when it seemed primed to hit the “take off” stage and evolve into a middle-income power.  The scenario will be characterized by GNP growth at six to seven percent a year, allowing per capita income to grow by three to four percent a year.  Poverty levels will be around 25%.  This scenario is likely if the following conditions prevail: an investment rate in the range of 30%; diminished income inequalities and regional disparities; foreign policy that seeks to move toward cooperation and peace, with just a few interludes of conflict with neighboring powers; defense spending at 4% of GNP; civilian government control; well developed physical and social infrastructure; successful economic cooperation with Iran, Turkey, and the Central Asian republics through the Economic Cooperation Organization.   

(3)               Medium Performance.  Pakistan will have the features that characterized it in the eighties, without the conflicts created by the Afghan-Soviet war.  The scenario will be characterized by GNP growth at four to five percent a year, allowing per capita income to grow by one to two percent a year.  Poverty levels will range from 45% to 55%.  This scenario is likely to occur if the following conditions prevail: investment rates in the range of 20%; stabilization of macroeconomic imbalances; national security would continue to be equated with military muscle; a confrontational foreign policy with India would continue; there would be tacit support to militant groups in Kashmir; involvement in Afghanistan would continue with a desire to seek strategic influence; military rule; and defense spending at 6% of GNP.

(4)               Low Performance.  Pakistan will have the features that characterized it in the fifties and nineties, with a change of government taking place every two to three years.  There will be anemic growth in GNP of three to four percent a year, and per capita income will stagnate.  Poverty levels will be in excess of 65%.  This scenario is likely if the following conditions prevail: investment rates in the range of 15%; deterioration in macroeconomic imbalances; governments that lack the will to make tough decisions; rent seeking behavior by oligarchs (feudal lords and civil service); increased militarism; adventurism in foreign policy; defense spending at 8% of GDP; heightened inequalities in income distribution; civil discord; inter-provincial rivalries; ignorance and religiosity; serious deterioration in law and order; institutional meltdown23; soaring foreign debt, leading to bankruptcy; government unable to pay salaries to government workers; erosion of national sovereignty.24  

(5)               Super Low Performance.  Pakistan would face a desperate situation.  In this dystopian scenario, GNP growth will be zero, and per capita incomes would decrease by two to three percent a year.  Poverty levels will be in excess of 80%, and public services will become dysfunctional. The military will disintegrate.  There will be complete break down of law and order in either urban or rural areas.  Special interest groups will bring the political decision making to a halt. Social cohesion will break and leaders of tribes, clans, and sects will dominate and demand loyalty.  There will be extreme inequalities of income.  This scenario is likely if the following conditions prevail: investment rate under 10%; macroeconomic imbalances in excess of 10% of GNP; high population growth; rising levels of illiteracy; and no respect for minorities and women. 

 

_{The US War Against Terrorism}  

Soon after the September 11, 2001 tragedy, the US identified Osama bin Laden as the prime suspect in the attacks on the World Trade Centre and the Pentagon.  President George W. Bush asked the Taliban militia to hand him over, since it was widely believed they had given refuge to the al-Qaida terrorist network run by Osama bin Laden.  Simultaneously  Pakistan was given options to join the US in the war against terrorism.   Within a few days, President General Pervez Musharraf  offered Pakistan’s “unstinted cooperation” to the US, and turned Pakistan’s Afghan policy by 180-degrees. On the US request, Pakistan  provided the Anglo-American coalition with the use of  requisite air and recovery bases, logistical support, intelligence about the terrorist camps in Afghanistan, and airspace/corridor for carrier-based strike fighters and cruise missiles.  Without this support, the US would not have been able to launch its war against the Taliban and al-Qaida network forces on October 7. 

The US was unable to create a broad-based coalition of countries along the lines of what it had been able to create during the Gulf War of 1991.  No hard evidence was presented, in order to preserve the intelligence sources that had provided the evidence.  Only Britain joined with the US in the military campaign, creating a coalition of two.  The Anglo-American coalition of forces pursued the bombing of Afghanistan with great zeal and intensity, from four aircraft carriers and several other surface and submarine platforms operating from the waters of the Arabian Sea.  In addition, B-52 bombers operated from the island of Diego Garcia and B-2 bombers flew missions from Missouri.  By mid-November, this air campaign took its toll on the Taliban and al-Qaida forces.  The Taliban yielded Mazar-e-Sharif without any significant resistance, and abandoned Kabul  without a fight.  Within a few weeks, they had surrendered the rest of the country including the strategic city of Kandahar, where the movement had began.   

General Musharraf had predicted the defeat of the Taliban, even though it took a lot longer to occur than he (or any other analyst) had anticipated.  The end for the Taliban came suddenly.  It appears that several factors led to their sudden collapse.  First, they had been heavily dependent on Pakistani supplies of fuel and logistics.  Thus, when Pakistan decided to cut off that vital supply line, in the words of General Musharraf, their days were numbered.”  Second, the US hit them with everything in its arsenal short of nuclear weapons.  It dropped  the 15,000 kg Daisy Cutter bombs to terrorize, demoralize, and kill the Taliban troops in their trenches and concealed positions and Taliban fighters  were forced out in the open. Finally, it became apparent that for all the rhetorics, the Taliban were neither well trained or organized nor well equipped to fight a modern hi-tech war.  The aerial decimation of their mortal enemy was a real morale boost for the rag tag fighters of the Northern Alliance, who had lost all but 10% of the country to the Taliban in 1996.  They simply rested and watched the US air show, from the safety of the hills.  In the meantime, the Russians had stepped in and supplied the Northern Alliance with T-54/55 tanks, truck-mounted multi-barreled rocket launchers, and new uniforms.  

When the signal was given, these fighters began an offensive campaign against literally no opposition.  Even in the mountains and caves of Tora Bora, which seemed to be an impregnable fortress when Osama bin Laden occupied the high ground, resistance was slight.  Interviews with captives revealed that the fighters were poorly equipped, with limited supplies of food and heating arrangements.25 

 

Impact of the War on Pakistan  

Pakistan’s economy took a major hit from the war.  Foreign companies suspended their investments in Pakistan, as it had become a war zone.  There was a widespread expectation that terrorist acts would be committed in Pakistan by the al-Qaida fighters, but none occurred.  Pakistani exports fell by a third.  Experts estimate that the economy lost $2 billion of business.  The textile sector, accounting for more than 50% of Pakistan’s $10 billion annual exports and for 60% of the industrial workforce, was especially hard hit.  The Pakistani economy grew at 2.6% in fiscal 2000/01, less than the rate of population growth.  The official forecast for fiscal 2001/02 has been lowered from 4% to 3.7%.  An independent foreign bank forecast that economic growth in fiscal 2001/02 would be even lower, at 2.5-3.1%.         

In a recent press release, the International Monetary Fund commented26:

 

Pakistan's economic outlook is now clouded by considerable uncertainty in view of the impact of September 11 events and the ongoing slowdown in world demand, which adversely affect Pakistan's prospects for growth, exports, and capital flows... Available data point to a deterioration of the real economy. In the period July-October 2001, there was sluggish export growth of 1.9 percent in U.S. dollar terms, compared to the same period a year earlier…Cancellations of export orders since mid-September, especially from the United States, have affected export prospects and appear to have slowed investment and production. Imports dropped by 9.9 percent compared to the year-earlier period. Price developments through October have remained benign and the 12-month CPI inflation rate remained at 2.7 percent.

 

Preliminary indications are that the budget deficit for the quarter July-September 2001 was slightly higher than programmed, reflecting mainly shortfalls in non-tax revenue, and even though overall expenditure was on track. Tax collection in recent months has been negatively affected by the large decline in imports and higher-than-expected tax refunds to exporters, but was in line with program assumptions through October. Preliminary indications are that revenues in November were more adversely affected.

 

International reserves reached US$2.8 billion in early December, the highest level in a number of years. This reflects large disbursements of foreign grant assistance and repatriation of holdings abroad by Pakistani residents in recent months, allowing the State Bank of Pakistan (SBP) to step up, in October-November, its foreign exchange purchases on the inter-bank market.

 

            Initial UN estimates were that as a result of the war, Pakistan may have to absorb another 1.5 million Afghan refugees, but much smaller numbers have in fact moved into Pakistan.  If the situation in Afghanistan stabilizes, with the advent of the interim administration, flow of refugees into Pakistan, may stop and those that had been resident there for a long time may in fact begin to go back However, some uncertainty on this account may continue to prevail.

In addition, there is an apprehension that some hardcore elements of the Taliban militia and al-Qaida operatives may survive the bombing campaign, and find refuge in the “high country” of Afghanistan or Pakistan, regroup in due course of time to wage a guerilla war against the Northern Alliance, cause disruption in the process of normalization in Afghanistan and/or create internal problems for Pakistan. However, in view of the ongoing search and hunt operations and the casualties already sustained, their ability and potential are expected to be much limited.

 

_{The Need for Foreign Economic Assistance}  

The effects as enumerated above would be highly unfavourable to the war against global terrorism.  Conditions of economic deprivation and social uncertainty breed terrorists, who see little to lose and a lot to gain by engaging in suicidal acts of violence that target civilians.  Such outcomes can be prevented if the Western powers come to Pakistan’s assistance and implement a massive programme of social, political and economic reconstruction.  The money spent on such a reconstruction programme is money well spent, and should be regarded as a premium insuring against serious consequences.

Pakistan’s national security and stability are a fundamental precondition to reviving business confidence and promoting economic growth.  Given the complex nature of Pakistan’s domestic and international problems, its economic revival cannot simply be guaranteed by providing economic aid.  It is, in fact, inextricably linked to implementing social, political and economic reforms.

Over the past several years, law and order in Pakistan’s major urban centres has deteriorated to a serious level.  Under such conditions, it is unlikely that foreign investment will come to Pakistan.  In fact, there will be a flight of capital, as domestic investment goes offshore in search of safer havens.   Without investment, economic growth will not occur, and the rising population will be unable to find jobs.  Large-scale urban unemployment, especially among the youth, has led to frustration and discontentment  in Pakistan,  which in turn has given boost to crime and violence. Obviously such conditions ultimately spawn terrorism.

To reward Pakistan for its cooperation in the war against global terrorism, and to improve its national stability, U.S. President George W. Bush offered $1 billion in economic aid to Pakistan at a joint press conference held in New York City on November 11, 2001 with Pakistan’s President Pervez Musharraf.   This amount however falls far short of meeting Pakistan’s real needs.  Measured in real purchasing power, the Bush aid package is similar to President Jimmy Carter’s offer of $400 million in 1980 to help Pakistan cope with the Soviet invasion of Afghanistan.  Carter’s package would be worth $800 million in today’s dollars.  In 1981, President Reagan upgraded Carter’s offer, and provided Pakistan $3.2 billion in economic and military aid.  The value of this package would be $5.7 billion in year 2001 dollars, or $71 per capita, since Pakistan’s population then was 80 million.  In contrast, the Bush’s package of $1 billion translated into about $7 per capita.

There is a serious risk that Pakistan’s economy may not be able to weather the after effects of the current Afghan war, since the war has come on the heel of a long period of economic stagnation, made worse by a multi-year drought that has affected all the economies of South Asia.  To prevent the economy from sliding into the low-growth Scenarios 4 or 5 described earlier in the paper, Pakistan will need a significantly larger aid package than has been offered by President Bush.   Pakistan now has an extra 60 million mouths to feed than it did in 1981, and its domestic social and political conditions are a whole lot worse, because of the chronic presence of almost three million Afghan refugees from the first Afghan war, and the expected arrival of several more from the current Afghan war.  Even if the per capita amount were held at $71 Reagan’s package would amount to $10 billion for a population of 140 million—10 times the Bush package. 

While this may seem to be an unrealistic amount of money, it is commensurate with Pakistan’s needs, size, and status as a “pivotal state”.   It is important to note that, on a per capita basis, this aid package would still be an order-of-magnitude lower than what the West has spent on other recent reconstruction projects.  For example, costs have ranged from $700 per capita in the case of East Timor to roughly $1,500 per capita in the West Bank and Gaza.  After a civil war ended in Mozambique in 1992, the West spent a total of $6.5 billion on that nation of 17 million, or about $400 per capita.27 The US has recently offered $4 billion to the Philippines, to reward it for joining in the global war against terrorism.  During the Gulf War, it provided nearly $8 billion in economic aid to Egypt, and additionally provided direct military support.28 To put issues in historical perspective, it is useful to review the experiences of South Korea and Taiwan in the 1950s and early 1960s. The first had been hurt by war much worse than the second, but in both cases, the US wanted to help key security partners build up their economies in short order.   The US provided roughly $50 to $75 per capita per year for more than a decade, making for an aggregate total ranging from $500 to $1,000 per capita.29

Given its pre-eminent position in the world community, the US should take the lead in creating a consortium of all major western powers--including the British, French, Japanese, German, and Italian—to strengthen Pakistan’s national security.  This is not to suggest that the Western powers should focus on the military dimension, since Pakistan is already militarized beyond its economic capacity.   Instead, the package should be used to develop social, political and economic institutions that are the bedrock for national security.  The funds should be funneled through the World Bank, the International Monetary Fund, and the Asian Development Bank, and would likely comprise a mixture of loans at concessional rates, debt rescheduling and possibly forgiveness of the principal amount of some debts.  In a recent editorial, the Financial Times has argued against writing down the debt, since that would make it impossible to hold Pakistan to its promises.  “Only after Pakistan has maintained good performance for several more years should the debt stock itself be reduced.”30 To make the package affordable to the donor countries, and to allow Pakistan to use it efficiently, the package should be disbursed over several years.  

Of Pakistan’s total debt of $38 billion, only the bilateral portion can be rescheduled. Pakistan’s largest creditor is Japan, to whom Pakistan owes $5 billion, and the next largest creditor is the US, to whom Pakistan owes $3 billion.   Working with the Paris Club, Pakistan is seeking to reschedule a total of $12 billion of bilateral debt.  The government is seeking lowering of interest rates, partial write-offs and debt for social sector swaps.  The International Monetary Fund and the World Bank have committed to offer Pakistan a Poverty Reduction Growth Facility valued at $1.3 billion.  In addition, the international community has indicated its strong support for Pakistan’s package of structural reforms over the next three years, with exceptional financial assistance of about $9.5 billion in the form of bilateral support, including debt relief, and assistance from international financial institutions.  As of this writing, this commitment has not been put down in writing.

 

The Pakistani Quid Pro Quo  

            The aid package should be made conditional on Pakistan achieving several social, political, and economic goals that would contribute to the welfare of its people and to the security of the region.  The package should provide strong incentives to achieving all the goals.  As veteran US analysts Stephen Cohen and Dennis Kux pointed out at a workshop organized by the Georgetown University Center for Strategic and International Studies on November 27, 2001, aid money that is squandered or siphoned off can actually cause more damage.  Five specific goals that could form the blueprint of an “Aid to Pakistan” package are discussed below:

 

• Political Reform.  A long-term relationship between the US and Pakistan is not possible unless Pakistan returns to democracy.  National elections should therefore be held, consistent with the judgment of the Supreme Court of Pakistan.  However, there should be checks and balances on the powers of the elected representatives.   Democratic regimes during the 1990s headed by Benazir Bhutto and Nawaz Sharif proved to be among the most venal and incompetent in Pakistan’s history.  The military government has tried to focus on devolution of power to local bodies and provincial governments. The experiment has still to show its positive results.  During his recent visit to the US, President Musharraf indicated that even though he would not contest the national elections, he intends to continue as President.  Specific provisions should be implemented that would limit his tenure as head of state to a five-year term.  The constitutional separation of powers should be honoured, in order to strengthen the institutions of democracy in Pakistan.  Steps should be taken to eliminate recurrence of military intervention in Pakistan.  One option is to give the army a constitutional role in deposing a “rogue government,” and then holding elections within 90 days.  Additional steps should be undertaken to create a more balanced distribution of powers between the four provinces that would eliminate inter-regional rivalries.  These rivalries might diminish if the number of provinces is increased from four to twelve, and if the resulting population distribution is more balanced than the current situation where 56% of the population resides in one province.31  Two of Pakistan’s immediate neighbours—Iran and India-- have dealt with this issue by having two dozen provinces or states.  A much smaller country, Switzerland, has more than 50 cantons.  

• Human and Social Development.  The recommendations of the Human Development Report, issued annually by Non-governmental Organizations such as the Mahbub-ul-Haq Centre, should be used to create guidelines for spending priorities.  Wise government policies will heal societal divisions, and divisive policies will add to them.  Policies that bring down the rate of population growth would have significant benefits. Educational programmes will improve the literacy rate, and improve the nation’s competitiveness.  Public health programmes will improve the quality of life by bringing potable water and sanitation to a larger segment of the population, and preventing the spread of infectious diseases that can sharply diminish productivity.  Illiteracy rates need to come down from their incredibly high levels: 67% for females (above age 15) and 38% for males. Corruption in Pakistan has been a recurrent problem, and has severely impacted the Social Action Programme (SAP). To prevent corruption from occurring in the first place, Pakistan should introduce business ethics courses in the education curriculum of Pakistan’s civil service academies.  In addition, it should eliminate the incentive for corruption by directing the bulk of the monies to the private sector, Non-Governmental Organizations, and community organizations.  This will ensure that the money is spent efficiently, and produces high returns that exceed the concessional interest rates that are promised by donors.  If the multilateral financial institutions such as the World Bank and the Asian Development Bank bundle their soft loans with hard loans, Pakistan’s debt situation would worsen if the soft loans do not produce returns that exceed the costs of the hard loans.     

·        Economic Reconstruction.  A significant portion of the funds should be spent on economic development.  The ideal set of policies would lead to speedy retirement of existing debt, the accumulation of foreign exchange reserves, increased rates of domestic savings and investments, leading to rapid but sustained economic growth, reduction in income inequalities, and reduction in poverty levels.   Economic development would also lead to improvements in the nation’s physical and social infrastructure, a pre-requisite to Pakistan’s transition to a middle-income country.  It would be best if the government of Pakistan did not try to implement the development programmes through its various ministries, but instead focused on providing transparent subsidies for delivery of services by non-government institutions.   Such an approach, often called “output-based aid,” was the subject of a recent clinic sponsored by the World Bank.  It takes the approach of delegating service delivery to a third party (such as a private company or Non-Governmental Organization) under contracts that link the payment of subsidies to the outputs or results actually delivered to target beneficiaries. The intended result is a sharper focus on objectives, better incentives for efficiency and innovation, more accountability for the use of public resources, and new opportunities for mobilizing private financing for basic service provision.  The dual challenges of improving the efficiency and responsiveness of service delivery to the poor, and improving the targeting of subsidy support to those most in need, are considerable. Output-based schemes need to deal with a number of key design issues including:  (a) Ensuring that the services reflect the needs and preferences of the poor and take account of their willingness to pay (b) Effective targeting of services in areas where information is poor, administrative capacity is weak, and corruption a very real threat (c) Designing incentives for service providers that inspire innovation and expanded service, while keeping risks at a manageable level (d) Economizing on administrative costs as we move from pilots to broader output-based schemes.  Promising cases involving output-based aid include programmes to provide water services to the poor in Paraguay, rural electrification in India and Chile, and provision of rural payphones in Chile and Peru. 

• Peace with India.  Pakistan should be encouraged to adopt a flexible approach in resolving the dispute with India over Kashmir.  This would include sustaining an active dialogue with the Indian government, preventing the activation of the Line-of-Control (LoC), reigning in the religious groups and hardliners for hostile rhetorics against India, and creating a demilitarized zone around the LoC that may eventually be expanded to include the entire region of Jammu and Kashmir.  Clearly, this effort can only succeed if India cooperates in good faith with Pakistan.  Thus, similar modalities should be inserted into aid programmes directed toward India.  

• Significant Cuts in its Defense Spending.  While many have recognized that the military is Pakistan’s strongest institution, it is debatable if Pakistan’s national security interests are served by having the world’s sixth or seventh largest military.  A major portion of the national budget, which could be spent on social and economic development, is devoted to military spending.  Thus, no amount of the $10 billion aid package should be used by Pakistan to purchase arms or munitions.  A limited amount of training and organizational assistance may be provided to the Pakistani military.  The US military, which has a long history of cooperation with its Pakistani counterparts, should consider reinstating its programme for exchanging senior officers with Pakistan.  In addition, it should offer to participate in joint exercises with the Pakistani military.  Pakistan should be encouraged to focus on the development of a professional military that pursues realistic goals that are within the means of the country.  Operations should be characterized by true joint-­ness, and inter-service rivalries that lead to fiscal excesses and turf wars should be eliminated.  Most importantly, there should be transparency in fiscal matters, civilian oversight over military spending, and documented improvements in the efficiency of military spending. n