Pakistan: Risk Assessment
Country Risk Rating
Business Climate Rating
- Large internal market buoyed by dynamic demographics
- Substantial remittances from expatriate workers
- Inexpensive and plentiful labour
- Positive outlook for economic corridor with China
- Significant provider of Islamic finance
- Very tense geopolitical environment and high degree of domestic insecurity (terrorism)
- Widespread informal economy (40% of GDP) and weak fiscal resources (16% of GDP)
- Energy dependency
- Inadequate sanitation, agriculture, and education infrastructure
- Province of Balochistan is lagging far behind on development as is the countryside generally
- Frequent shortages of electricity and water
- Underdeveloped financial system
- Poor sectoral diversification and concentration in a few low value-added sectors
- 40% of labor force works in agriculture and thus depends on the weather and on world prices
One of the Most Dynamic Economies of South Asia…
Activity will likely continue to remain strong in 2018, even if a slight deceleration is likely to occur in the second half of the year. Household consumption (81% of GDP) is set to remain dynamic. After suffering in 2017 due to the slowdown of construction in Gulf Cooperation Council countries, expatriate transfers from the region (62% of the total) should benefit from its recovery, particularly marked in the United Arab Emirates (22% of flows). This will offset the tightening of monetary policy (leading rate rose from 5.75% to 7.5% between January and July 2018) aimed at moderating demand and inflationary pressures linked to the depreciation of the rupee and the rise in energy prices. On the other hand, investment (only 15% of GDP), already constrained by a mediocre business environment, could decelerate further due to a drop in confidence in the face of deteriorating balances. This would also affect investment in transport and electricity infrastructures under the China-Pakistan Economic Corridor (CPEC) between the Chinese region of Xinjiang and the port of Gwadar (South-West Pakistan). On a more positive note, services (60% of GDP), industry (20%) – notably mining and automotive –, and agriculture (20% of GDP) – with sugar cane, cotton, rice, and wheat – will benefit from the vitality of consumption.
…At the Cost of Weakened Public and External Accounts
Thanks to the measures recommended by the International Monetary Fund, the budget position improved markedly during the period of the latest financing agreement between 2013 and 2016. The fiscal deficit (excluding grants) fell from 8.5% to 4.6% of GDP. However, this trend has since reversed, due to a less sustained increase in tax receipts, largely due to the fall in household taxation in April 2018, combined with an increase in expenditure before the July 2018 legislative elections. At the same time, the deterioration could be temporary and fiscal efforts could resume. Public debt, still 60% domestic and denominated in local currency despite increased recourse to external financing, has increased considerably and will continue to weigh heavily on the much-solicited banking system, leading to a crowding out effect on private business investment, which is in great demand.
The current account deficit deepened in 2017-18 because of a widening trade deficit. This latter should decrease with the recovery in exports encouraged by the devaluation of the rupee, and the sharp deceleration in imports linked to the stabilization of oil prices and the reduction in purchases linked to the CPEC. The trade deficit (10% of GDP in 2018) will remain the main contributor to the imbalance. This is explained by weak Pakistani exports (less than 10% of GDP), more than half of which consists of textile products (home linen, clothing, cotton yarn), and the rest broken down between agricultural products (sugar, rice) and a small share of manufactured products. Competition from low-cost neighboring countries in the textile sector is exacerbated by the overvaluation of the real effective exchange rate, despite the fact that the Pakistani central bank allowed the rupee to depreciate by 16% against the US dollar between January and July 2018. This is in addition to import pressure resulting from strong domestic demand exceeding growth potential.
Remittances from expatriate workers (7% of GDP) will partially offset the trade deficit. The remaining deficit, as well as the deficit (3%) associated with services and outgoing dividends and interest payments, is financed by the increasing recourse to indebtedness since 2016 with China and, incidentally, on the markets, as well as by a drawdown on reserves (which fell to the equivalent of 1.7 months of imports in June 2018). However, the external debt – 80% owned by the public sector – still represents only 31% of GDP, and is largely long-term and subscribed at concessional rates. FDI is minimal, with most CPEC investments financed by Chinese loans. The new government plans to conclude a new financing programme with the IMF in order to ease the external accounts. The United States has indicated that the financing should not be used to service China-owned debt.
A Democratic Transition That Does Not End Insecurity and Military Influence
Despite a campaign punctuated by terrorist acts led by the Pakistani Taliban, the parliamentary elections on the 25th July 2018 were the second episode of democratic transition. With 116 deputies out of 270, Imran Khan's Pakistan Tehreek-e-insaf, or Justice Party (PTI) – which focused its campaign on the fight against corruption, religious orthodoxy, and anti-Americanism – became the leading political force, ahead of the Pakistan Muslim League (PML-N) and the Popular Party (64 and 43 seats respectively). PTI will have to find additional support, probably among the deputies of small or independent parties, and will have to contend with provinces (3 out of 4, including Punjab and Sindh, the two largest) that are led by opposing parties. The losing parties have accused the army – which has come to power several times in the past and is a foreign and security policy maker – of having worked for Imran Khan's victory, in particular by having its main adversaries disqualified by the courts. Pakistan’s rapprochement with India will remain difficult because of the Kashmir conflict between the two countries. China will remain the main economic partner with the development of the China-Pakistan Economic Corridor (CPEC). The often-stormy relationship with the United States over Afghanistan and terrorism will remain marked by military cooperation.