Pakistan Business Forecast Report Q3 2009

Militants At The Gate

It is hard to overstate the challenges facing Pakistan in the latter half of 2009 and beyond, both in terms of domestic security and in bringing the economy back on an even keel. Worryingly, there has been no let-up in militant attacks as we go to press, with signs that many previously disparate insurgent groups may be coalescing and that the Taliban are gaining ground. The government, whose approval ratings are wilting, is facing difficult demands in trying to placate a disillusioned domestic electorate while maintaining cordial relationships with key international partners. Meanwhile, although the macroeconomic asymmetries built up in recent years are gradually being ameliorated, the pistons of economic growth are clearly conking out. The export sector has taken a particularly hard battering while private consumption, the primary driver of growth, is faltering too. Encouragingly, the international community remains committed to supporting Pakistan, but the question remains whether the resources granted can be deployed effectively in the absence of political stability and effective institutions.

The government's decision to reinstate chief justice Iftikhar Chaudhry bodes well for a restoration of stability within the polity. Although friction between different political players is unlikely to vanish, a calming of recent heightened tensions should enable the government to focus more on the formidable challenges facing the country, most notably the threat from Islamic militants and the sagging economy. The former problem shows few signs of improving with numerous attacks in the first months of 2009, including two guerrilla-style raids in Lahore, having underscored the magnitude of the threat Islamabad is facing. The government's signing of a peace deal with the Taliban in the Swat valley, where the quid pro quo demanded by the militants was the imposition of Sharia law, has been read by many as an admission of defeat and as setting an ominous precedent for the rest of the country.

The economy is on a path of, at least partial, recovery as far at the yawning twin deficits are concerned.

The IMF's US$7.6bn stand-by arrangement granted in November last year has helped the authorities stabilise the external accounts, as has falling international commodity prices. Although exports only account for a relatively small share of the economy, Pakistan will not emerge unscathed from the global economic slowdown. Two key channels, besides exports, through which damage will likely be felt are foreign direct investment and remittances from the Pakistani diaspora. In view of the dimming growth prospects and subsiding inflation, it is little surprise that the State Bank of Pakistan has been itching to lower interest rates. A 100bps cut, taking the benchmark discount rate to 14.0%, materialised at the quarterly meeting in April and we expect to see another 400bps lopped off over FY2009/10 (July-June).

The business environment in Pakistan will remain challenging for quite some time to come. Central deterrents for foreign investors are the parlous security conditions and the ongoing dire energy shortage, neither of which will be fixed overnight. Other major drawbacks include still entrenched corruption, a weak legal framework and a poorly educated workforce. Pakistan's main strengths lie in its comparative openness to foreign investment and still very low levels of taxation.