Pakistan; Challenges in Political-Economic Development ICEA Feb 13 th 2007

1. Pakistan; Challenges in Political-Economic DevelopmentICEA Feb 13th 2007 Professor Paul E M Reynolds LONDON Tel + 44 20 874 86788 Mob & SMS + 44 7974 188087 E mails paulreynolds@email.com paulemreynolds@gmail.com

2. Pakistan, showing NWFP, FATA & Northern Areas

3. Why is Pakistan important ? • Strategic geo-political & transport bridge Mid-East and India & China • 165-170m pop – More people in Pakistan than in Russia • Potential for Kashmir flare-up – risk of big impact on world growth • Border region with Afghanistan - Cross border raids, and question of Tribal Areas and Pashtun nationalism ? - Relationship with NATO/US military activity • Role in ‘War on Terror’ and Deobandi ideology (‘Talibs’ = ‘Students’) • Many internal factors that create risks of political instability • Nuclear armed state – and advanced delivery systems • Borders with Iran, Afghanistan, India, China, close Gulf States, C Asia • Important Diaspora – especially in the UK (and UK troops on its border !) • URGENCY: Presidential & National Assembly Elections Oct 2007 – unclear how political events will pan out

4. Pakistan; Challenges in Political-Economic DevelopmentMacro, micro & political conclusions.Needing to ‘break out of gridlock’, government is in a difficult position • Macroeconomic improvements good - but slow reforms in government, in regulation and within the ‘real economy’ retard investment & growth rates, hinder exports and undermine fiscal/structural sustainability of growth • Flow of FDI inflows now under threat, diaspora remittances up, but insufficient ‘real economy’ investment opportunities as final destination – consumer imports sucked in, savings rates low • Full-speed reforms across government needed, but gridlocked due to political uncertainty - helps the ‘reform resistance’ & ‘project silos’. Key decentralisation suffers from ‘unintended consequences’…. • BUT….political reform gridlocked by constitutional-political structures and the President’s need to please too many masters • Role of Tribal border (Afghan) areas and relationship with ‘The West’ is critical for political and economic reform

5. Economic performanceEconomy stabilised & growth path established

6. Fragility of economic progress • Public debt declined from 97% of GDP annual average 1990s - to 75.3% by 2002-3 & 56% 2005-6 • Annual fiscal deficits fell from an average (excl grants) of 6.4% of GDP, last 5 years of last decade, to 4.4% first 5 years of this decade(3.7% 2006-7 est.) • Average trade policy tariffs at ‘normal LDC’ levels after WTO memb. in 2001 • BUT………………BUT………….. • Industry still less than 20% of GDP • 2005/06 investment at 16.5% of GDP - too low for sustainable growth (World Bank - 27%+ required) • Growing current account deficit - driven by a widening trade gap as import growth outstrips export expansion - from 1.4% of GDP to 4% of GDP in 2005/6 – putting pressure on FX reserves • IMF says (2007) need to align demand & output growth (Privatisation-related FDI and internal borrowing one-offs) – But GoP points to import price-hikes as one-off (To be continued…..) • IMF ‘imperative’ - Higher savings and poverty reduction • IMF REMEDIES. Improve the investment climate, financial market reform, tax reform, improvements in public service delivery, and trade liberalization

7. Economic growth contextTrade & fiscal imbalances reduced…but… • Yr. to 2006 FDI up to $3.5bn (1/2 from telecoms). Investment from Gulf states. • Remittances $4.2bn in 2005/6 - biggest ever • Banking & electricity distribution privatisation ‘successful’ • ‘Poverty fell 10% 2001 – 2006’ (WB) • Cost of borrowing relatively low…..good GCC demand for Pakistani Govt paper • BUT……………………………………………… • But…. trade deficit $10bn and growing • FDI effects of privatisation slowing • Big increase in MTDB, up 52% 2006/7 despite quality-of-investment problems • Low national saving’s rate, 17 percent of GDP, due to fiscal deficits and negative interest rates • 4% of GDP spent on the military, possibly much higher, pressure on deficit • Only 28% of population is in the ‘workforce’, 32% of pop below poverty line • 1m Afghan refugees + ‘Trouble in Tribal Areas’

8. Real-economy problems requiring political will to challenge the interests of the bureaucracy & ‘crony capital’ across federal, provincial, & local government • Institutional complexity and bureaucratic turf problems • Legislation, regulation, ‘overenthusiastic regulation’ – some resistance to reforms • Govt. ‘Project culture’, weak systemic reform focus (‘policy silos’) • EXAMPLE 1. Contract enforcement • EXAMPLE 2. Admin barriers and ‘cost of doing business’ • Result – domestic investment opportunities, & ‘bottom up’ domestic growth, both dampened = inflationary pressure, monetary growth, import growth, pressure on FX reserves ?

9. Ministry of Finance & Planning Ministry of Industry, Prod’n & SI Board of Investment Ministry of Commerce Ministry of Econ. Affairs (EAD) Monopoly Control Authority Housing & Works Div. Securities & Exchange Commission Planning Commission, 4 members National Reconstruction Bureau Economic Coordination Committee Public Sector Reform Committee Institutions responsible have overlaps & gaps in reform‘Diagnosticitis, policy silos & analysis-paralysis ?’New institutions to solve this problem ? • Cabinet Division (3 Depts) • Economic Council • Office of the Economic Adviser • Ministry of Law & Justice • National Comm. for Govt. Reforms • Civil Service Reform Unit • Law & Justice Commission • PM’s Secretariat • Ministry of IT • Ministry of Parliamentary Affairs • Competitiveness Support Fund • 4 Provinces, FATA, PATA • Trade Corridor Committee • Office of Private Public Partnerships • Federal Ministry of Tribal Areas • Ministry of Inter-Provincial Coop.

10. Wrong micro-economic reform tools ?‘Government spending versus government efforts’Huge political will required to overcome deep-rooted systemic problems & interests – does political uncertainty prevent this ? • Financial deepening reforms (NSS, Pakistani Investment Bonds) and reforms of intermediation system (Badla) underway - will make better use of remittances & other funds, and tax admin reform has increased receipts…………… ……but these are not the core problems….. • Credit expansion is a risk, and linked to remittances • Political limitations prevent expansion of the tax base • Too much reliance on more costly but less effective growth stimulation methods • …..Eg building business parks & giving tax breaks, rather than… - reform of regulations that inhibit capital goods imports - tackling ‘overenthusiastic interpretation of regulations’

11. Pakistan (example): Steps/time and cost of contract enforcement (Source World Bank 2006) • Case backlog - half are commercial - in the High Courts of Sindh and the Punjab number over a hundred thousand, and for the lower courts, in the millions - 40% land, 30% challenges to regulations, rest banking/employment • When cases do go forward, it takes, on average, more than 46 steps, more than a year and almost a third of the contract value to enforce a contract • System is ill-prepared for modernisation - new legal frameworks in complex areas such as foreign investment, insolvency, monopoly regulation, anti-money laundering, insider trading, and corporate governance

12. Real-world problems in economic development dampen investmentWB value-chain study of key sectors shows major structural, institutional & regulatory problems:Shrimps, textiles, marble, processed dairy, auto parts • High transport costs, high electricity costs (outages) limiting automation, labour market rigidities (temp workers used), access to finance (collateral & informational), imports costs (multiple permissions required etc), cash flow from duty drawback & custom rebate delays, high port charges, state control of input sectors, freight sector over-regulated, opaque land leasing & security of tenure - & resultant low capacity utilisation • Fees and taxes collected by the Government represent a quarter of export costs and come from three sources: the petrol tax (1 percent of export invoice), Export Development Fund (0.25 percent of export invoice), and unofficial, speed money payments (approximately Rs 1,250 per consignment). [Poor port governance contributes]. • Layers of taxes & levies to agents, the PAs, and ‘security payments’ add to costs. High tarrifs in many sectors. • Pakistan’s aggregate direct labor cost $0.75 /hour - higher than China’s $0.66 and India’s $0.40 – but productivity lower.

13. Resistance to pro-growth regulatory reforms ? • 2004/5 World Bank project on regulatory reform ’Impact has been minimal’ • 2005 Better business regulations IFC. Admin barriers report not published. • 2006 IFC/World Bank business regulations, pending…

14. Future economic reform challenges • Regulatory quality and the link to rent-seeking • Poor domestic export performance relative to expectations, and the lack of investment to overcome high costs • Capital infrastructure problems – access to debt & equity finance for export development, and absence of venture capital & ‘real sector’ investment funds • Low ‘growth productivity’ in the use of inward financing from remittances and capital repatriation • This challenge combined with industrial and labour rigidities/monopolistic markets = ‘not enough productive places to put the money’ • How to apply telecom sector’s success in attracting investment to other ‘regulatory-dependent’ sectors like electricity, water, transport and hydrocarbons. • How to address investment and economic growth inhibitors (How to support the Ministry of Law & Justice in tidying up of existing legislation and regulations) • Addressing urgent need to tackle problems created by the separate MTBF and MTDF, (eg poor use of assets, lower investment) • How to address the negative impact on domestic investment and growth arising from the domestic financing of the budget deficit.

15. Fiscal decentralisation issuesPakistan is highly centralised fiscallyGrowth & political reform requires changeReforms started in 2001 but within existing structures • Sub-national governments in Pakistan - very low sub-national tax collection rates by international comparisons • Only 0.9 percent in GDP of revenues in 2005/6. India’s - 6.1 percent, or 7 percent based on more recent figures (World Bank 2005:xxvii) • Provinces in Pakistan are highly dependent on federal shared revenues and grants – complex system. • All provinces receive identical per capita levels of divisible pool allocations • All provinces are characterized by low own revenue mobilization, although some differences are evident across provinces.

16. Fiscal Decentralization in Major Developing Country Federations

17. Unequal regional incomes Table 1: Key Indicators for Pakistan’s Disparate Federation

18. Complex system of Provincial financing

19. The status of the Tribal Areas ‘across the Durand Line’ • Historical Afghan territorial claims over Pashtun NWFP, PATA, FATA, & Pashtun areas in Baluchistan • Administered by Punjab British Commissioner, then 1901 direct Delhi rule of NWFP Province - settled & FATA tribal areas separate, both as NWFP Afghan buffer zone • Separate status, continued post-independence – constitutional FATA buffer zone and tool against Pashtun nationalism on both sides of the border; not elected (A247). NWFP Governor formally represents President • Pre- & post- colonial regimes – ‘no troops deal’ with (paid) Maliks & Lungis • Frontier Crimes Regulations (1901 to today), FATA de facto constitutionally separate, Presidential control, Political Agent rule in FATA agencies ‘absolute’ • President has authority over all governance & military arrangements in FATA (1973 constitution A247/5). Via primary legislation – FCR, permits detention-no-trial • PAs – (executive-judiciary-legislature) appoint own para-militaries – can fire Maliks – appoint Maliks to Jirga courts – no full appellate path or normal rights • FATA areas a channel for very large-scale US funds to Afghan mujahadeen during Soviet occupation – but govt. wary of Pashtun cross-border nationalism • 1980-2000 – roots of ISI culture & skill balancing different Pashtun interests

20. The role of FATA in the Pakistani Political System • 12 seats in the National Assembly, 8 in the Senate, elected by appointed (all male) FATA Maliks in the pay of the Presidency/military & each easily dismissed • But parliament cannot legislate on FATA, and general Pakistani laws do not fully apply in FATA • FATA parliamentarians linked to pro-Deobani groups (JUI-F) • No representation over FATA, or in NWFP legislature • Alleged tit-for-tat: support in parliament, for peace, arms/drugs trade, & Deobandi ‘freedom to act’ without political competition • Political parties & national/regional secular political groups banned in FATA Since Afghan Soviet occupation, (& huge US mujahadeen financing), pro-Deobandis groups & Maliks have grown under such political ‘cover’, and replaced ‘old school Maliks’ • JUI-F – coalition partners of govt. in Balochistan ! • Presidency has inherited this system – propped by ‘negotiated balance’ • President’s international trump card: better to accept a complex negotiated balance than risk a Deobandi government /Pashtun state (may well be true !)

21. Presidency Government Prime Minister. Cabinet. Donors. PEACE AGREEMENT 7 Political Agents Naib-tehsildar (Exec, judiciary, legislature) SAFRON Balochistan North West Frontier Province Settled areas ‘Districts’ Prov’l FATA Secretariat Agency Councils PATAs Funding. Donor projects. FATAs (Mostly Pashtun). 3m pop. on Pakistan side. 7 ‘Agencies’. Maliks FATA Development Authority Inter-Tribal Jirga Lungis Complex governance: a simplificationDifficult to reform

22. Reform and/or ResolutionMilitary interventions – part of the solution or part of the problem ? • Parliament can normalise rights and court system (FCR was removed from NWFP and Balochistan) • Supreme Court can strike down FCR as unconstitutional • FATA could become part of PATA under NWFP • But instead… • 2000/1 NRB Devolution Plan excluded FAA • Provisional Agency Councils appointed by tribal Jirgas • Military action continues, (but seen as ‘demonstration effects to USA’ – counterproductive ?) (ICG Dec 2006)

23. Can economic growth address political issues in Tribal areas ?Will reform strengthen or weaken the government ? • Per capita income $500. 60% below poverty line. • 97% female illiteracy (male 71%). • But…. • Need to demonstrate success against foreign fighters etc • Buying of permits and ‘rent-seeking’ will decline • Decline of 20 year old arms & drug trade - & military %s (army allows vibrant trade & doesn’t require ‘permits’) • Pashtun nationalists & Deobandis may turn on govt. • Parliamentary support would be lost • NWFP JUI-F and Balochistan support may be lost

24. The near impossible task of serving many masters. Is the outcome a kind of political gridlock ? The view from the Presidency ? Donors & foreign NGOs Domestic elite, landowners, govt. influencers, & ‘crony capitalism’ USA Local NGOs, pro-democracy groups Govt. Ministries Military, Governors, & PAs I.S.I. Presidency Head of State Tribal Elders Drug & arms traders Deobanis & Pashtun Nationalists Foreign fighters ?

25. Info flow Donors & foreign NGOs USA ‘War on Terror’ issues Domestic elite, landowners, govt. influencers, & ‘crony capitalism’ Local NGOs, pro-democracy groups Govt. Ministries Military, Governors, & PAs I.S.I. Presidency Head of State Info barrier Tribal Elders Drug & arms traders Deobanis & Pashtun Nationalists Foreign fighters ? ‘Show me something’Reform versus ‘uncovering’ foreign fighters

26. The Inter-Jirga Peace AgreementWhy did they fight, why did they agree ?A counterproductive brutal search for foreign militants ? LOW-LEVEL WAR • June 2002 - US pressure – troops to capture MO, OBL etc • March 2004 – search for foreign militants ‘Tribes refused’ (‘failed’ – Former ISI General ICG 2006) • Govt. ‘sued for peace’ June 2004 • Nov 204 agreement – amnesty, cash, BUT hand over foreign militants, & stop cross-border attacks • Feb/March 2005, 6-point peace plan with JUI-F over South Waziristan • Escalation - heavy casualties in March 2006 battles • Effectiveness of ‘official’ institutions declines • Military pressure on the President • New (military) NWFP Governor May 2006 • North Waziristan Ceasefire June 2006 signed with JUI-F and Deobandis/Pashtun nationalists • North Waziristan Peace agreement with Deobandis Sept 2006 • Oct 2006 ‘Cross border raids on UK & US troops up’ (Gen Jones NATO) • Foreign militants found are few – and mostly 20-year settlers from the anti-Soviet war (Tajiks, Uzbeks)

27. The Sept 2006 Peace Agreement • GoP to halt all ground & air attacks • GoP to release prisoners • Checkpoints removed • Financial compensation of combatants for losses • Tribal privileges and ‘salaries’ restored • GoP to return weapons and allow open carrying of weapons • Foreign-born militants to respect local laws • Cross-border trade (legal & ‘illegal’) restored • Combatants to halt all cross-border attacks • Return to official institutions – no parallel bodies • GoP troops relocated • Joint 10-member Council to oversee Agreement

28. Conclusions • Good quality macroeconomic management in Pakistan under difficult conditions – but risks from microeconomic realities • Deep-rooted problems in ‘real economy’ reforms and reform within government. • Political barriers to real-economy reforms are tenacious – strong political will needed domestically & internationally • Chain of causality ? Economic reform enables political reform or vice versa ? Symptoms of gridlock on both. • Military demonstration effects for the USA & NATO, may be counterproductive. (How to break the ‘information barrier’ ?) • Political reliance on Tribals & ISI (Deobandis indirectly) is an accidental Western creation. • International support for political reform, especially in Tribal areas, needed to untangle gridlock and accelerate economic reform.