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Reforms lead the way

Interview - September 21, 2015

Up to March 2013, Pakistan’s reserves were near exhaustion, what could have brought an economic recession and a collapse of the rupee. Against this scenario, the newly-elected government of PM Nawaz Sharif was brave and introduced a sweeping reform program that has put the country back on track.


Please comment on the scope and impact of the reform program? How is Pakistan now in a much better shape than it was in 2013 in your opinion?  

Pakistan started broad-based reforms under EFF, covering resolution of structural issues, removal of energy shortages and inefficiencies, consolidation of fiscal accounts, strengthening of financial stability, and enhancement of central bank independence.  These reforms, along with the decline in oil prices, have definitely catalyzed significant improvement in macroeconomic conditions over the last two years.  In particular, Pakistan’s external position has improved considerably with sustained increase in foreign exchange reserves – reaching $18.8 billion by end July 2015 from the lowest of about $8 billion by end January 2014 – and stability in the foreign exchange market. 

Similarly, tax and energy sector reforms have helped in bringing the fiscal deficit down to lowest in seven years at approximately 5.3 percent of GDP in FY15, from 8.8 percent in FY12.  The credit for fixed investment has picked up, and real GDP growth was a notch higher at 4.2 percent in FY15.  On the other hand, year-on-year inflation has fallen to 12-year low at 1.8 percent in July 2015.  Monetary easing under these conditions is expected to further support recovery in the private sector investment, and promote a sustained increase in real GDP.  We expect real economic activity to pick up significantly in FY16, the target for real GDP growth is 5.5 percent.  

How has the reform proposed under the EFF framework to improve the country’s economic and financial governance affected the SBP?  

Let me make it clear that the improvement in overall macro environment (e.g., reduced pressures in foreign exchange market, fiscal account consolidation, and ease in inflationary pressures) has already allowed SBP to focus on growth, and reinforce transmission of monetary policy.   

Now coming to reforms under EFF, broadly speaking, this includes measures to enhance SBP’s autonomy, improve monetary policy framework, and strengthen SBP’s internal operations.   

In particular, the formulation of an independent monetary policy decision-making committee, would enhance operational independence of the central bank in the pursuit of price stability.  The proposed reforms would further improve the governance structure; strengthen personal autonomy of Board members; and ensure the financial autonomy of the SBP.  It is important to note SBP has already introduced measures to improve the interest rate corridor.   

These reforms, alongside with the remarkably improved macroeconomic indicators have put Pakistan’s economy on a higher growth trajectory. 

What will be the elements upon which this growth is to be built? What are the challenges looking forward? 

The government has already developed Vision 2025, which outlines a roadmap for Pakistan after extensive input and deliberations of all stakeholders.  This Vision aims to move Pakistan into a group of upper-middle-income countries by 2025, and this will require a GDP growth of over 8 percent during 2018-2025.  This growth will be based on following seven strategic objectives:  

  1. Developing social and human capital, and empowering women. 
  2. Achieving sustained, indigenous, and inclusive growth. 
  3. Strengthening governance through institutional reform and modernization of the public sector. 
  4. Ensuring energy, water, and food security.  
  5. Encouraging private Sector and entrepreneurship-led growth. 
  6. Developing a competitive knowledge economy through value addition. 
  7. Modernizing transport infrastructure and regional connectivity. 

We know achieving this high growth will be challenging.  The long struggle against terrorism continues to impose immense social, economic, and human costs; security situation, and the continuing energy shortages are constraining economic growth; and productivity is low due to inadequate investment in education, health and population welfare.   

The challenges are compounded by several adverse exogenous developments, especially the threat of climate change, the global slowdown and the continued stagnation in developed country import demand, as well as aid flows. 

Fiscal prudence and lower borrowing costs established by the SBP have led to a reinforcement of the country’s macroeconomic stability. 

What is the current situation and what is being done to uphold all the progress already achieved? 

Pakistan’s economy enjoys a stable macroeconomic environment.   

First, external sector has improved considerably: current account deficit has narrowed to less than one percent of GDP; SBP’s liquid foreign exchange reserves could finance more than 3-months of the country’s import bill; and PKR has largely been stable.   

Second, inflation has declined to a decade’s low of 4.5 percent in FY15, compared with the 8.6 percent in the previous year.  This reduction is broad-based, as all measures of core inflation recorded noticeable decline during the year.  Inflation expectations also remained at ease for most of the year.  In fact, all three indices of inflation expectations recorded decline in 5 out of 6 surveys conducted during the year.   

Third, there was a notable reduction in fiscal deficit together with a favorable change in its sources of funding.   

Fourth, the real GDP growth at 4.24 percent is the highest level since FY08.   

The remarkable progress is acknowledged by the IFIs.  IMF program is on track, and we have successfully concluded 8th review under the program few days back.  Moody's Investor Service has upgraded Pakistan’s credit rating by a notch, and assigned a stable outlook.   

Fortunately, these positive developments and improving business sentiments have created much needed room for the policy makers to focus on a comprehensive reform and growth strategy.  To further strengthen this hard earned macroeconomic stability and to unleash the growth potential, Pakistan is following a well-defined reform process to deal with structural rigidities.   

First, fiscal sector will benefit from the privatization of loss making PSEs, which would help free up fiscal resources for the development of infrastructure.  Tax revenues are also likely to benefit from extensive reforms in the taxation system.   

Second, the investment activity is expected to improve because: (a) energy shortage is likely to ease further; (b) as a result of the on-going campaign to eliminate terrorism, law & order situation has significantly improved; (c) positive assessment of the economy by IFIs and credit rating agencies, would help improve investors’ confidence; (d) foreign direct investment would gain from inflows under China-Pakistan Economic Corridor (CPEC); and (e) historic low interest rates will also support investment activity. 


Finally, construction activity is set to gain from mega infrastructure projects, and growing private sector residential projects.  Work on road construction under CPEC is likely to gather pace during the year.  Manufacturing sector would be a major beneficiary as the construction and allied industries are likely to gain from this increasing activity.   

The IMF hailed the state of the financial sector, putting inclusiveness at the core of the agenda. 

Which policies have served to reinforce the sector? What is the picture of the Pakistani financial sector nowadays? Does the financial market offer new opportunities for investments or new entrants? 

Considerable reforms in Pakistan’s banking system have been undertaken to significantly strengthen its soundness, profitability, efficiency and diversity which include:  

Development and implementation of prudential measures: After deregulation of banking sector in Pakistan in 1990s, the SBP developed and implemented prudential measures (FPT) leading to more professional, transparent and responsible management practices in banks/DFIs;  

Adoption of Anti Money Laundering framework: SBP has also been actively following-up with banks to have compliance policies in accordance with international framework on AML / CFT. Recently we are out of grey list of FATF based on completion of its action plan and demonstration of effectiveness of AML/CFT regime in Pakistan; 

The design and implementation of “Financial Inclusion Program (FIP)”:  this includes risk sharing initiatives, smart grant facilities for capacity development, innovation and market infrastructure development since 2008 primarily for sustainable development and growth of the microfinance sector, branchless banking, and SME finance;  

The establishment of a specialized microfinance credit information bureau (m-CIB) in 2009;  

The launch of a nationwide Financial Literacy Program in 2012; and  

In line with our policy to keep our banks compliant with the global standards and best practices in financial sector, Basel III has also been recently implemented on banks operating in Pakistan.  

As regards to the performance of the banking sector in Pakistan, it has shown remarkable growth and resilience.  

The overall asset of financial sector are US$ 147 billion as of June 2015 (compared to US$ 116 billion as of Jun-12) – around 55 percent of GDP.  Banking sector is the dominant player, with around 88 percent share in overall assets of the financial sector.  

Banks are well capitalized with an average CAR of more than 17.5% across the industry, substantially higher than internationally required CAR of 10%.  This signifies not only the stability, but also the potential of our banking sector for further leveraging and providing credit. 

Today, the sector is very much profitable and thriving. The before tax RoA and RoE of the sector were 2.2% and 24.3%, respectively.  This achievement is one of the most prominent success stories, as is evident from the level of confidence shown by foreign investors on this sector.  Out of 21 locally incorporated private banks, the foreign investors are the majority shareholders in more than 15 banks, which represent almost 50% of the total assets of the banking industry. Similarly, out of 10 microfinance banks, 5 entities are owned by foreign shareholdings, while 2 other MFBs have almost 50% foreign shareholdings. 

Banks in Pakistan mainly focus on traditional model of banking that involves receiving deposits and extend lending.  The asset quality of our banks have also improved, and the credit risk to our banks is lower than many regional and peer countries, such as Turkey, India, Indonesia, Malaysia and Sri Lanka etc; 

The banking sector of Pakistan – with consistent track of profitability (ROE 27%) – is an important area to invest.  Not only large banks are performing well, middle-tier banks have also evolved into good shape in terms of growth, profitability, and solvency.  

Being an emerging economy with decent projected GDP growth figures, there is enormous room for expansion in our banking sector.  Our national investment policies are quite liberal, and we welcome foreign investors; they not only bring in investments in our country, but also share with our banks their experiences of business model and governance. 

There is a huge growth potential in the banking sector, as large size of population in Pakistan is still unbanked or under-banked.  Of more than 180 million population, only 12% have access to financial services.  In recent few years, the experience of joint venture of telecommunication companies and banks to provide financial services, mainly remittances, through branchless banking, have been highly successful. 

The investment climate in Pakistan is conducive for new entrants, with its enabling regulatory environment, developing markets, a burgeoning population of employable youth, and a profitable financial sector.   

In sum, Pakistan’s economy is gradually improving, helped by prudent monetary and fiscal policies, strong capital inflows, robust remittances, and advancing technology; positioning it as a country with high growth potential, and offering one of the best investment opportunities. 

Traditionally one of the major weaknesses of the country, the external sector has shown strong signs of improvement: there is a “notable” surplus in the current account and forex, reaching a fresh high of about $19 billion in reserves that can pay up to three months on import bills. 

What would you attribute these strong improvements to? What are the implications and effects of a more stable external position? 

Prudent monetary policy stance by SBP, and measures taken by the government to curtail its fiscal deficit (by containing expenditures and generating additional revenues) have moderated aggregate demand, and helped in containing the external current account deficit to low levels.   

Fall in international oil prices, and a steady growth in worker remittances in the country also helped in improving Pakistan balance of payment and Fx reserves positions.   

Furthermore, successful implementation of IMF program has paved the way for capital and financial inflows from multilateral and bilateral donors.  Moreover, government decision to tap the international bond market, and the overwhelming response of investors in Pakistan’s Bond issuance, continued Coalition Support Fund money, and SBP’s efforts to buildup foreign exchange reserves, helped in maintaining the upward trajectory of foreign exchange reserves. 

Improvement in the external position has brought stability in financial markets and improved confidence in the economy.  More recently, foreseeing much reduced external sector risks than before due to the improvement in BOP and improved foreign exchange reserves position, the international rating agencies have endorsed an overall stability in Pakistan’s economy by upgrading country’s credit rating.   

Pakistan’s foreign exchange reserves have now import coverage of more than three months, as an acknowledgment of this improved scenario, World Bank has also restored its program loan financing for Pakistan.  All these developments, have improved the investor’s confidence that will help in increasing FDI flows in the economy.  Finally, the government has recently signed an agreement with China for China Pak Economic Corridor (CPEC) which is likely to bring considerable FDI in the country.  

The investment community describes now Pakistan as “the best undiscovered investment opportunity in emerging or frontier markets”. With these improvements, the country has regained access to key sources of finance (IBRD) and it is back on the international investors’ radar. 

How have these recent developments attracted investments into the country? What has been the evolution of FDI inflows? 

As mentioned earlier, the government initiated a decisive military offense against militants in tribal areas.  A crackdown against various terrorist factions that had crippled Karachi – its financial hub, is also in full swing.  These operations have brought a tangible improvement.  People feel safe now; businesses are not interrupted with extortion threats or strikes; and retail sales have firmed up.   

I have also described earlier, how Pakistan has been able to improve its external account position.   

With improved security situation and a more comfortable external account, foreign investors are now tracking Pakistan. And why not? This country offers immense potential due to a large domestic market, as well as its geographical location that provides a gateway to central Asian countries.  The first tangible success is the start of development work on infrastructure and energy projects under the CPEC.   

While China is increasing its stakes in Pakistan in various other sectors like telecom, and renewable energy, etc, Japanese investors have also shown keen interest in investing in Pakistan’s automobiles and coal-based energy projects.  Similarly Russian and Korean firms are also planning to enhance investment in Pakistan’s infrastructure and energy sectors. 

With stabilization now on grasp, the policy focus seems to have shifted towards economic growth, as the recent monetary easing moves of the SBP suggests. 

What does the SBP pursues with this action? What have been the effects of this policy so far? 

Steady improvement in external sector, containment of fiscal deficit, and benign inflation outlook provide much needed room for monetary policy to support investment and economic activity in the economy.   

Monetary easing, combined with improving security situation and gradually easing energy related issues, is expected to positively impact investment, which has remained a key concern for economic growth in recent years.   

The off-take of credit of Rs208.7 billion during FY15, as compared to the past three year’s average credit uptake of Rs113 billion (excluding exceptional FY14) is quite healthy.  An important highlight of FY15 has been the uptick in credit for fixed investment purposes; Rs126.9 billion as opposed to Rs71.4 billion in FY14.  

Realization of planned investment in energy and infrastructure projects under CPEC, amid improving investor confidence, as reflected by recent upgrade by international rating agencies, is expected to further strengthen these trends.   

The construction and real estate sectors are already showing buoyancy, as indicated by their continued credit uptake in FY15.  Banking sector is relatively healthy, and monetary easing has led to a slightly higher spread (risk premium) between the lending and risk free rates, which will possibly make lending slightly more attractive.  We, therefore, expect the momentum in private sector credit off-take to pickup further in the coming months. 

In the last revision of Pakistan’s Strategic Vision of Foreign Policy (July, 2014), the US is regarded as “a key partner in trade and investment, counter-terrorism, and regional stability”, a view that is shared in Washington, as stated in the continuous high-level exchanges that the countries have been maintaining since 2013. 

The aforementioned vision was a first step in the resumption of the strategic dialogue. How has this bilateral forum served to lead common efforts to tackle issues of common concern? 

We don’t have information on the achievement of bilateral forum between Pakistan and the US.  However, following background from Strategic Vision of Foreign Policy would be useful in handling this question: 

Objectives of Strategic Vision for Foreign Policy:  

  1. To safeguard Pakistan’s Security and eliminate the growing culture of extremism, intolerance and violence from the society through concerted political and military strategies, and a policy of non-interference in the affairs of other countries; 
  2. To make economic revival and sustained development, the center piece of foreign policy; 
  3. To have a peaceful neighborhood on priority; 
  4. To turn Pakistan’s strategic geographical location from a liability into an asset through trade, transport and energy connectivity with China, Central Asia and West Asia.  

Strengthening ties with USA: 

  1. Mutual interest and mutual trust are keys to strategic relationship with USA; 
  2. US is a major partner in trade and investment, counter-terrorism and regional stability; 
  3. Pakistan is working sincerely and meaningfully to address each others’ concerns; 
  4. During 2014 visit to Washington, PM placed his emphasis on enhanced market access, US investments in energy and other projects and security cooperation, counter-terrorism, and people-to-people exchanges.    

The US is a major source of FDI in Pakistan: with a total stock of US$1.2bn, it accounts for over 10% of the total FDI. What are the most attractive sectors of investment for US companies? What is the impact of these investments on both countries’ job creation and development? 

US has been the largest source of FDI in Pakistan over the years.  Even in FY15, it had a share of 32 percent in Pakistan’s total net FDI inflows.  Sectors, like power and oil & gas exploration, information technology have been attractive for the US investors.   

Power and oil & gas exploration sector still has a lot of potential to attract investment, given further exploration and production possibilities.  Recently, the US and Pakistan have agreed to facilitate and accelerate private investment in clean energy projects with the aim to add at least 3,000 megawatts to Pakistan’s national grid within next 3-5 years.  In addition, food, tobacco, and other consumer goods are also potential sectors for foreign investment in view of growing middle-class and increasing consumerism in our economy.   

Lately, the American Business Council of Pakistan conducted a ‘perception survey’ which revealed that despite deteriorating law and order situation, 80 percent respondents were optimistic about Pakistan’s economic future in the longer run.  In addition, 85 percent of respondents rated the business climate of Pakistan as satisfactory.  This indicates a marked improvement over the previous survey ( 2013-14), when only 56 percent of participants rated the business climate as satisfactory.   The results of this survey were also reflected in the actual flows of FDI.  Net FDI inflows from US increased to US$ 238.7 million during FY15, on top of US$ 212 million in FY14.   

The impact of these investments would be beneficial for Pakistan and US.  FDI will help generate employment, raise productivity, transfer of technology, enhance exports, and contribute to the long-term economic vision of Pakistan.  The resultant economic growth of Pakistan will create more opportunities for US investors to invest in the emerging and accelerating sectors.   

With 15% of the total exports (over US$ 3.6bn), the US is a main trading partner of Pakistan. What can be done to increase the level of sales to the US and to enhance Pakistan’s position in this regard? 

The US is the largest importer in the world, and is the single-most important trading partner for Pakistan.   

Pakistan’s exports to the US are heavily concentrated in textiles items, in which Pakistan faces tough competition from other Asian countries, like Vietnam, Bangladesh and India.   

Lately, the agreement on Trans-Pacific Partnership would put Pakistan in a more disadvantageous position against Vietnam, which is likely to get duty-free access in the US market under the agreement. 

Ever since Pakistan became strategic partner of the US in the war against terrorism, there is a tangible consensus among government officials and businesses in the country that what Pakistan really wants, as compensation, is not aid, but trade.  Therefore, it had been seeking concessional access to the US market.   

And this suits interest of the US as well: increased activity in labor-intensive sectors would help reduce unemployment from Pakistan, which had been a key factor causing extremism in the country.  Please note that if the US grants concessionary access to Pakistan’s cotton textiles, it would benefit Pakistan without hurting the US textile industry (which is largely based on man-made fiber). 

The US and Pakistan have been negotiating a Bilateral Investment Treaty that could deepen further the already vibrant economic relationship. What could be the benefits of the BIT for both nations? 

In theory, Bilateral Investment Treaty (BIT) is beneficial as it facilitates foreign investors in terms of free movement of capital, access to international arbitration, and restrictions against government expropriation.  By reducing investors’ exposure to political risk (ex-expropriation) and uncertain business environments, BIT attracts more investments.  I believe the real benefit from signing and ratifying BITs would be in the form increased likelihood of concluding a free trade agreement (FTA) with the US.   

Private investment can be a significant driver of economic development and poverty reduction through several channels.  These channels include: (a) increase in financial, technical, and human resources; (b) introduction of new technology and management practices; (c) support to local business suppliers; (d) reduced dependence on foreign aid and external debt to support development-related activities; and (e) more financing for local business activity and expansion through debt and equity instruments. 

Additional Information  

Pakistan and USA began negotiating the investment treaty in 2004.  Talks had stalled several times due to the inclusion of certain clauses that deal with investment in defense programs.  

In 2012, the US introduced a new template for BIT, which carried retrospective implications.  Pakistan also had concerns about clauses on international arbitration for business disputes.  On the other hand, Pakistan is preparing its own template of the BIT, which it would share with the US.  Pakistan is currently developing the draft “negative list” of sectors they wish to exclude from their commitments under the BIT. 

It is encouraging that Pakistan and the US continue to negotiate and meet regularly on economic and strategic issues.  Once concluded, it would serve as a commitment device to sustain future government policy, especially in the area of property rights that ultimately ensure more FDI and protects investors’ interest.