Pakistan: Risk Assessment

Country Rating¹

Rating: D

Business Climate Rating¹

Rating: C

Risk Assessment²

Economic growth impeded by floods
In 2011, the impact of the unprecedented floods in August 2010 on farm production (22% of GDP) and livestock will hinder economic growth. Domestic demand will remain sluggish with over 10% of the population directly affected by the natural catastrophe. And average inflation will trend up due to increased demand for construction materials and generally tighter conditions on the supply side. But the good performance of transfers from migrants, spurred by government incentives, is expected to facilitate limiting somewhat the decline in consumption. The slowdown in demand abroad meanwhile will undermine the dynamism of the automotive industry and the electronic sector, which drove manufacturing production (24% of GDP) in 2010. And frequent power breakdowns will continue to impede development of the economy and the business environment. There is little likelihood of energy sector reform, postponed several times in the past, being finalized in 2011.

Precarious financial position
On the verge of a liquidity crisis in 2008, Pakistan received aid from the IMF amounting to $24 billion over five years (12% of GDP) with government foreign debt increasing accordingly. In 2011, servicing public debt could become difficult. As a matter of fact, fiscal spending - structurally undermined by the scale of the debt service (which represents nearly a third of revenues) and by Islamabad's military spending commitments (over 20% of revenues) - are to rise substantially in the wake of the floods to meet the needs for emergency aid and reconstruction programmes. As such, the actual disbursement of the promised international aid will be crucial to financing a fiscal budget substantially revised upward for 2011. But payment of the last tranche of the IMF Confirmation Agreement and release of financing granted by the World Bank remain subject to the launch of a series of reforms notably focused on enlarging the tax base and modernizing the energy sector, which will entail price increases and privatization of distribution. With Pakistan's weak export base and large external financing needs, its financial position will moreover remain exposed to high risks: shortage and volatility of foreign investment, exchange-rate volatility, and increase in oil prices.

Unstable political and security situation
Pakistan is prey to insecurity and exposed to inordinately high geopolitical risks, mainly in western provinces bordering on Afghanistan, which tends to increase the wariness of foreign investors and impede the recovery of foreign direct investment. Any risk of a power grab by the Taliban seems to be under control, however, with the United States focusing their efforts on avoiding destabilization of a nuclear-armed country. The situation also ensures Pakistan of financial support from the international community. But this international support also has perverse effects on political stability to the extent that opposition parties and a population largely pervaded by anti-Western sentiment denounce foreign interference. And the conditions attached the IMF program constitute major constraints apt to stoke public unrest and weaken the government. The natural catastrophe in 2010 further complicated an already difficult humanitarian and political situation. President Zardari will thus have limited room for manoeuvre in taking up the political and economic challenges that Pakistan will face in 2011.

Strengths

• Strategic geographic position in Central Asia conducive to support from the international community
• Substantial inflows of transfers from expatriates living mainly in the Gulf area and the United States
• Comparative advantage in textile

Weaknesses

• Foreign direct investment and structural reform deterred by regional geopolitical tensions and domestic political instability
• Dependence on imports and foreign capital
• National deficiencies in irrigation infrastructure and education
• Vulnerability of the energy sector, frequent supply breakdowns