Crunch time for Pakistan

Focus on the Asian subcontinent: economic penalties and unfavourable trading conditions are putting mounting pressure on the region; Sanctions could be the catalyst that sparks a foreign debt crisis

IN RESPONSE to prime minister Nawaz Sharif's call for austerity, Pakistan's chief justice, Ajmal Mian, recently returned his Mercedes SL320 luxury saloon to the government pool. Ministers attending cabinet meetings now tuck in to "simple food" rather than the usual four-course lunches.

These cosmetic gestures come a bit late in the day for a government which has failed to address the economy's myriad problems after 15 months in power, and is now facing the loss of about $1.5bn (pounds 900m) in new aid because of US-led sanctions in the wake of the nuclear tests last month. This may bring the crisis to a head as it could force the country into a debt default.

"This is crunch time for Pakistan," said Shahed Sadullah, editor of London- based newspaper The Daily Jang. "But the basic problem in Pakistan is the high level of corruption and uncollected taxes."

Mr Sharif's government, which came to power in February last year, promised to tackle this and modernise the economy. Instead, defence spending and interest payments still absorb over 70 per cent of the budget, while only about 21 per cent of tax revenue is collected - and out of that, more than 7 per cent reportedly ends up in the pockets of the collectors.

Former prime minister Benazir Bhutto and her husband Asif Zardari, known as Mr Ten Per Cent because of his reputation for taking a cut in any business deal, are involved in a number of foreign court cases on allegations they stole up to pounds 1bn during her three-year rule.

These tales of corruption have served as an excuse for Mr Sharif's government to insist on renegotiating foreign contracts with private power producers (IPPs) signed under Ms Bhutto's regime. Ten of the 21 IPPs have agreed to cut their electricity tariffs. However, the Hub Power Company, seen as a key case, has not proved amenable. It produces about 20 per cent of Pakistan's electricity and numbers among its international shareholders the UK's National Power and Japan's Mitsui & Co. The World Bank lent up to $225m to the project.

Officially, the government has gone to court to stop profit repatriation; illegally, the government has "harassed" Hubco employees, according to the company. Local staff have been subjected to police searches and, last month, over 35 expatriate staff and families were kept under house arrest at the plant compound.

"The whole fiasco with the IPPs is an example of the government shooting themselves in the foot. No foreign company will go into Pakistan, as they know the government will do this," said Sam Mahtani, Pakistan fund manager at Foreign & Colonial Emerging Markets.

Foreign investment has already dwindled, halving to about $1.2bn in the last two years, say analysts. The Asian crisis, which has made investors nervous of emerging markets, has exacerbated the problem. Privatisation, which requires foreign investors, has also been dealt a severe blow.

Yet expectations were high when Mr Sharif's government came to power. A majority in parliament and the backing of the military appeared to give him a strong base from which to tackle much-needed reforms. A $1.6bn IMF programme - the seventh in 10 years - gave his government financial clout.

Among its priorities was increasing tax revenues - currently only about 1 per cent of the population pay tax - so that tax receipts could form the backbone of government finance, rather than loans.

The lack of tax receipts means the government cannot rely on fiscal policy to finance the country, making foreign debt even more important.

The powerful land-owning class and industrialists are still able to get away with paying little if any tax, while traders, who form a support base for Mr Sharif, didn't like the sound of a sales tax and it was withdrawn.

Cronyism also affects internal debt. There is up to $4bn in domestic, non-performing loans to the private and quasi-private sector. The loans tend to be to friends of those in power, according to one source.

There are a few points in the government's favour. It is, at least, tackling reform of the over-manned, inefficient banking system. It also gave independence to the central bank.

Furthermore, blame for the state of the economy cannot be laid entirely at this government's door. "Sharif inherited an economy where the patient was already ill," said Mr Mahtani.

Years of mismanagement have left Pakistan with a sad legacy. In the five years to 1995, the number of absolute poor increased by 75 per cent to 42 million, according to government figures. Less than 50 per cent of the population has electricity.

Over the years, Pakistan has managed to avoid financial collapse through international donor agency loans, cash hand-outs from the US government during the communist era and money from wealthy Arab countries who see it as a bulwark of Islam.

External debt to gross domestic product is 48 per cent, double that of India, and the main reason a freeze on future loans will prove so harmful. But already the US administration has hinted that if Pakistan signs the Comprehensive Test Ban Treaty, sanctions might not be put into place.

Some analysts believe a financial crisis unavoidable for Pakistan and a default on foreign debt is a possibility. Pakistan has only $1.4bn in reserves, equal to six weeks of imports, while short-term foreign debt stands at $1bn and has to be rolled over and refinanced regularly. Foreign banks will probably insist on raising the cost at each refinancing because of the increased political and economic risk. Meanwhile, about $2.5bn in interest and principal foreign debt repayments is due by the end of the year, while medium and long-term debt is $35bn.

After the explosions, Moody's downgraded the nation's credit rating to "B3" as did Standard & Poor's. Pakistan is now the lowest-rated nation in the world, along with Indonesia.

Some analysts believe that with popular support for Mr Sharif at a high on the back of the nuclear tests, his government could come out with a tough budget and impose it.

Others, though, say that Pakistani governments are very good at making promises, but not great at keeping them. In the last decade, six IMF programmes have been aborted mid-term as the country failed to meet its targets. Whether or not this might be the seventh is anybody's guess.

Copyright IOS & Bloomberg.

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