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Economic Consequences Of The Iraq War For Pakistan
Dr.Akmal Hussain
Newspaper: Daily Times
Dated: January 02, 2003

As the US forces reach the final stages of deployment for the imminent war against Iraq, it may be time to analyze the economic consequences of such a war on Pakistan.

Let us begin by stating the current economic context at the global and national levels. It is now generally recognized that both the US and Japanese economies are in the throes of recession. Inspite of a negative real interest rate, investment has failed to increase and a severe shortage of aggregate demand persists in both these countries. Since the US and Japanese economies have historically constituted the powerhouse of the world's economy, therefore a recession in these economies means a slow down in export demand, investment and growth in almost every country of the world.

At the national level in Pakistan's economy a modicum of financial stabilization has been achieved with a substantial increase in the foreign exchange reserves and a reduction in the debt servicing burden to a tolerable level. Yet exchange rate stability remains fragile due to continued slow export growth and is also vulnerable to the shock of sudden capital outflows from bank deposits. At the same time private sector investment and GDP continues to stagnate while the narrow fiscal space constrains the government from large development expenditures to jump-start the economy. Therefore poverty and unemployment continues to grow and a severe shortage of basic services such as education, health, sanitation and transport persists. However the inflow of savings of the non-resident Pakistanis into the domestic economy, in the absence of opportunities for investment in manufacturing, is flowing into speculative activity in the stock market and real estate. Consequently while the real economy stagnates, both the stock market and real estate markets have become buoyant.

Having articulated the global and national economic contexts let us now analyze the short term and medium term consequences respectively, of another Middle East war. If as is expected the war lasts for less than two weeks then it could have four short term economic consequences for Pakistan: (i) The sudden cessation of oil production by Iraq and reduced supply of oil by OPEC countries in the face of the war related economic uncertainty, are likely to push up oil prices. The consequent sharp increase in Pakistan's oil import bill will increase the balance of payments deficit, erode foreign exchange reserves in the short term, accelerate inflation and create new pressures to further increase the price of electricity. In case the government is unable to pass on the higher oil import price to the consumer, the budget deficit for the current financial year could increase and the public sector development expenditure over the next six months may well be reduced. If these events were to occur, Pakistan's economy during the current financial year may face both higher unemployment and higher inflation. (ii) Even a short war in Iraq would fuel stock market speculative fears in Pakistan. Stock market prices, which are currently riding a high wave, would therefore fall in the immediate aftermath of the outbreak of hostilities in Iraq. Consequently the price of gold and real estate would increase further as speculators sell stock early and shift into safer assets. (iii) There is likely to be a reduced export demand for Pakistani products in the short term. This is because the increased tension in the Middle East immediately following the outbreak of war will induce both retailers and wholesalers of consumer items in that region to reduce inventories. As in the case of other South Asian countries there will therefore be a reduction in the export demand for Pakistan's products ranging from textiles, ball pens to chatni and masala. However for those items whose consumption usually shoots up during a military campaign, the demand is likely to increase if Pakistani exporters position themselves for quick supply. These items include packing material, toilet paper, tissues, dry battery cells, and sugar. (iv) Even the short term reduction in revenues and increased under utilization of production capacity of Pakistan's industry will mean lower profits and perhaps also lower dividends in the current fiscal year, resulting in reduced aggregate consumer demand. There would also be increased unemployment of casual labour, as manufacturing units reduce the number of work shifts.

Let us now identify some of the medium term consequences of a war in Iraq: (i) A tide of Arab nationalism is likely to be unleashed following a war in Iraq. This combined with existing restrictions on private financial deposits of Arabs in US and European banks, could induce both governments and individuals in some of the smaller gulf countries to transfer their funds into Pakistan's banks and financial assets. Consequently after an initial down turn of Pakistani stock market prices in the short term, there could be a sustained upsurge in these prices over the medium term, provided economic and political conditions in Pakistan remain stable. At the same time the State Bank's foreign exchange reserves could increase again in the medium term. (ii) If (and this is a big if) there is a smooth regime change in Iraq after the war, and the new regime is supported by Western countries, there would be a major economic reconstruction process in Iraq. The expected billions of dollars worth of ordinance used to destroy Iraq's infrastructure is likely to stimulate the US economy as its weapons inventories are replaced. Equally the billions of dollars worth of Western aid and investment for reconstructing that infrastructure after the war will generate a construction led boom in the Iraqi economy. The secondary multiplier effects of such investment are likely to generate demand for a wide range of contracts for export of construction materials, construction services and expertise for Pakistan's construction companies and institutions such as NESPAK and FWO. The specific industries for which export demand during the reconstruction boom in Iraq could be created would include cement, plastics, electrical and metallurgical industries. (iii) Banks, financial services, management services, and software products would be in high demand as Iraq's economy integrates with the world's economy and new economic initiatives in both the private and public sectors are undertaken to transform Iraq into a modern democratic state with a dynamic economy. If Pakistani firms in the private and public sectors are positioned to provide these services, the economic reconstruction of Iraq could provide a significant stimulant to Pakistan's economic growth.

We must remember however that in case the war in Iraq takes an unexpected turn and a desperate Saddam Hussain either unleashes a chemical weapon against invading forces, or Israel, then a nuclear weapon could be used against Iraq in retaliation. This would have incalculable consequences not only for the structure of international relations but for the regional and global economies. If such a case God forbid were to occur, Pakistan's economy and society would also be drawn into the vortex of disaster. If however the war is short and a smooth regime change occurs, then the consequences for Pakistan's economy would be adverse in the short term and positive in the medium term. The challenge for both the private sector and government is to position Pakistan's economy to bear the short-term shock and harness the considerable medium term economic opportunities that are likely to arise in the months ahead.

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