Islamabad cannot pay its debt interest, nor cover subsidies or defence spending, which could become an anti-Zardari campaign platform within months.
Pakistan printing cash as fast as it can
ISLAMABAD // Pakistan's massive financial problems threaten political stability in the country, as the Asian Development Bank (ADB) yesterday warned in a report that the economy is living on borrowed time.
Political insiders in Islamabad said the tottering economy could within months become a platform for a campaign, led behind the scenes by the country's powerful military, to weaken the government of Asif Ali Zardari, the president. There was more bad news as the United States said it would link its future financial aid to tax reform, including stricter tax collection from the wealthy. "This is one of my pet peeves: countries that will not tax their elites but expect us to come in and help them serve their people are just not going to get the kind of help from us that they have been getting," Hillary Clinton, the US secretary of state, said about Pakistan yesterday at a conference in New York.
The alarms rang by the ADB, Asia's equivalent to the World Bank, in its latest economic update were clear. It said the Pakistani government was borrowing from the central bank to fund its operations. It has been printing huge sums of extra cash to pay its bills, helping to fuel a resurgence of inflation over the past year to an annual rate of more than 12 per cent in June from about nine per cent in October 2009.
The government was printing the money because its revenues were insufficient to pay the interest on its massive debt and cover its defence spending, consumer subsidies and pensions, the ADB said. It said the cost of keeping afloat state corporations, whose total losses represented 1.6 of the country's gross domestic product (GDP) last year, was also distorting the government's finances. As well, Pakistan's three years of slower economic growth - induced by political instability and violence as well as the global economic uncertainties - has slashed government revenue. It totals nine per cent of GDP, which is the broad measure of a nation's economy, among the lowest rates in the world.
More recently, the massive cost of reconstruction after recent floods, which have affected 20 million people, only underscores the need for the government to create "fiscal space" by withdrawing remaining subsidies and raising taxes, the ADB said. The Pakistani government had privately hoped that international sympathy for the victims of the floods would persuade its creditors to either lend it more money, or reschedule payments on its foreign debt of US$50 billion (Dh184bn).
Instead, the International Monetary Fund (IMF), Pakistan's biggest creditor, last month told Hafeez Sheikh, the minister of finance, that payments from an $11bn emergency-loan programme would be frozen until something was done to fix Pakistan's tax collection system. Taxes are a growing issue for Washington. "There's got to be some reciprocity here. Because one of the things that is now happening in Pakistan is … you cannot have a tax rate of nine per cent of GDP when big landholders and all the other elites do not pay anything, or pay so little that it's laughable," Mrs Clinton said.
Countries such as Pakistan would no longer receive "the kind of help from us that historically they may have" without initiating serious economic reform, she said. Pakistan's ministry of finance issued a statement yesterday saying two days of negotiations with the country's four provincial governments had resulted in an agreement on the introduction of a reformed value-added tax on consumer transactions.
The introduction of the tax, expected within weeks, would fulfil a major demand of the IMF and should trigger the release of withheld loans after meetings this month. However, the tenuous relations between the United States and Pakistan, and between power players within Pakistan, could see politics overshadow economics, political insiders said. Mrs Clinton also expressed resentment about lingering popular mistrust of the US in Pakistan. "After the flood, US aid did a terrific job in being the first to respond. But we have to fight to get the US government's label on our material because a lot of our aid workers and our NGO partners are afraid to have association with the US government."
The Pakistani military is largely responsible for the mistrust. Since handing back power, after nine years of direct rule, to civilian politicians after February 2008 elections, the army chief, Gen Pervez Kayani, has worked to restore the military's tarnished public image, notably during flood-relief operations. At the same time, he has steadily sought to re-establish the military's sway in national affairs, using the military's many sympathisers in Pakistan's media to paint Mr Zardari as a corrupt opportunist.
Until a breakthrough in December brokered by US military commanders, the military had resented the Obama administration's previous insistence on dealing exclusively with the civilian government. Since then, the military has pushed its challenge. On Monday, Gen Kayani made a rare visit to the presidency to pressure Mr Zardari and Yousaf Raza Gilani, the prime minister, into backing down from a confrontation with the country's Supreme Court.
As they met, the Supreme Court accepted the government's request that it not apply to the president its November 2009 order, which struck down a controversial amnesty law, until his appeal against corruption convictions was heard. The court could have invoked a constitutional clause empowering it to call in the army to enforce its order to the government to arrest politicians and officials who had benefitted from the amnesty, and reinstate charges ranging from corruption to murder.
Political insiders said the latest ruling would create enough breathing space before a conference of international donors in November, where Pakistan would lobby for reconstruction funds. After that, another move against the Zardari administration could be in the cards, the insiders said.