The government has for some time propounded an optimism that is predicated on selected financial indicators such as the rupee dollar exchange rate, the reserves and the inflation rate. What the official view ignores are the dynamics of the real economy represented by the constraints to the growth of agriculture and industry, and the level and efficiency of development expenditures. Some of the figures presented in the latest State Bank Report tend to reinforce the appearance that the economy is doing well. Yet focusing on the apparent, displaces attention from the real: The urgent policy issues that impact the lives of citizens such as hunger, livelihoods, health, education, housing and transport. It is these features of the real economy that need to be addressed for a more balanced assessment of the state of the economy. In this article we will first comment on the implications of improvements in financial indicators that are presented in the State Bank report. We will then briefly refer to the deepening crisis of the real economy and its medium term implications for the very financial indicators, which are being held up by officialdom as emblems of Pakistan's economic health.

It is undoubtedly true as the State Bank reports, that there has been a 6.7% appreciation of the rupee against the dollar and an improvement by US $ 2.7 billion in the current account of the balance of payments (with a similar improvement in the capital account). It is also true that there has been an increase in the foreign exchange reserves from US $ 3 billion at the beginning of fiscal year 2002 to US $ 6.4 billion at the end of the year 2002. The question is, are these improvements sustainable, or even symptomatic of current economic health?

The fact is that the reported increases in the rupee dollar exchange rate and the reserves are not the result of a new trend of foreign private capital being attracted by the Pakistani markets; nor are they representative of an accelerated growth of exports. Quite the contrary. Private foreign capital flows continue to be severely constrained by the serious law and order problems in the country, uncertain political situation, the lack of a tolerant and liberal social environment, and continuing tensions with India. The State Bank therefore may be stretching credibility when it suggests that the expected improvement in Pakistan's "sovereign rating" should attract greater foreign investment. Foreign investors are concerned about their life and limb at least as much as their assets. In a situation where all three are threatened by continuing incidents of violence, a mere short-term improvement in the foreign exchange reserves position cannot be expected to open the floodgates of private capital inflows.

The improvement in the foreign exchange reserves is not the result of a sustained acceleration in the export earnings either. (In fact export growth this year has been negative at 0.7% in fiscal year 2002). It is essentially due to: (a) the short-term phenomenon of Pakistanis transferring their savings from accounts abroad to accounts within the country due to the increased restrictions on parking funds abroad following 9/11. (b) The large inflows of US dollars into Afghanistan associated with efforts at 'political stabilization' in that country, and the over spill of such funds into the Pakistani market. Therefore the improvement in the rupee dollar exchange rate and the reserves is reflective of transient phenomena in the regional environment. It is neither the result of dynamic export growth, nor of a dramatic improvement in the institutional structure of markets and governance, which could attract foreign capital inflows on a sustainable basis. Therefore instead of getting a false sense of achievement the policy makers should focus on the danger of a sharp deterioration in the exchange rate and the reserves position in the foreseeable future. This could be triggered by exogenous shocks such as a large increase in oil prices following the expected US led war against Iraq, or an increase in defence expenditures resulting from an unexpected escalation of tensions with India.

Underlying the apparent improvements in some of the financial indicators is a deepening recession in the real economy. It is in the sphere of production, in agriculture and industry and the provision of basic services such as health, education, housing and transport where the economic welfare of citizens is located. It is also the basis of long-term financial stability. The key determinant of growth, employment, and poverty reduction in the real economy is the level of investment. It is this that not only has remained below the historical trend rate but compared to the preceding year, has actually fallen further. Investment as a percentage of GDP which was 18% in the late 1980s had declined to 15.9% in fiscal year 2001 and has declined further to 13.9% in the year under review. Underlying this is not only a continuing decline in private sector investment but also an inability of the government to substantially increase development expenditure. The former is rooted in low aggregate demand, continuing insecurity of citizens, rampant smuggling, and institutional constraints to investment such as poor infrastructure and lack of trained manpower. The government could in principle stimulate aggregate demand and induce private sector investment through the multiplier effect of sharply increased development expenditure. However it is unable to do so partly because of overall fiscal constraints and partly because of the need to maintain large and perhaps necessary military expenditures in the face of continued Indian intransigence.

The increase in the GDP growth to 3.6% in fiscal year 2002 has been called "reasonable" in some quarters. In exercising reason this figure must be seen in the perspective of three facts: (i) The 3.6% growth rate is just over half the historical trend growth rate of GDP in Pakistan (6.5%). (ii) The 3.6% GDP growth in per capita terms, represents an increase of only 0.8%. Given the highly unequal distribution of productive assets in Pakistan, an increase of 0.8% in per capita incomes suggests in fact that the income of the bottom 30% of the people has declined further in absolute terms. (iii) The 3.6% growth in GDP was fueled mainly by the services sector (as the State Bank figures show), and is not founded in the growth of the production sectors. Let us examine these sectors in turn:

The growth in agriculture which was minus 2.6% in fiscal year 2001 has increased to 1.4% this year. However it is important to point out that first, this is far below the historical trend rate of over 5%. Second even this abysmally low agriculture growth rate of 1.4% is essentially due to a growth in the livestock sector. The growth rate of major crops continues to be negative. As discussed in my earlier article in this newspaper (May 9, 2002), stagnation in the output growth rate of major crops is rooted in institutional and structural factors that need to be urgently addressed. These include inadequate availability of water in the root zone of crops, declining fertility of soils, and lack of research in replenishing the potency of existing seed varieties. The structural weakness of the agriculture sector lies not only in a slow down but also increased instability of growth. This has a relatively greater adverse impact on the poor peasants who are not positioned to face the increased frequency of bad harvests. Thus slower and more unstable growth in agriculture is accelerating rural poverty which is intensifying social tensions in the rural areas. It is also accelerating rural urban migration and the build up of large urban populations living in un-serviced localities (Kutchi abadis).

In manufacturing as in the case of agriculture not only is the growth rate far below the historical trend rate but has actually declined further in the fiscal year 2002. (For example the growth rate of the large scale manufacturing sector was 8.6% in the fiscal year 2001 and has halved to 4.4% in fiscal year 2002). Growth in this sector continues to deteriorate partly because of the deflationary policies followed during the last decade in compliance with IMF conditionalities. It is also the result of institutional constraints such as distortions in the tax structure and lack of ancillary infrastructure which results in higher capital costs of private sector projects. To give an example of the distortions in government policy, while there is an 18.5% generalized sales tax, together with import duties on industrial raw materials, smuggling of imported manufactured goods continues unabated. Worse still counterfeit copies of branded Pakistani manufactured goods are being illegally imported into the domestic market thereby wrecking havoc on Pakistan's industry.

We have argued that the economic malaise at one level lies in the continued decline in investment, and growth in both the agriculture and manufacturing sectors of the real economy. At another level it lies in the crisis of governance. This is inducing a slow down in the growth of exports which if allowed to persist is likely to trigger a decline in the exchange rate and reserves position from which so much political mileage has been made.

At the same time slow GDP growth will continue to generate high budget deficits due to low revenue growth regardless of the 'financial discipline' imposed by this or any foreseeable government. Consider, inspite of the government's tight control over expenditures, budget deficit as a percentage of GDP increased from 5.3% in fiscal year 2001 to 6.6% in fiscal year 2002. Indeed, as we have seen in the last decade the financial discipline so assiduously pursued by the IMF, translated itself in Pakistan into lower development expenditures, which further intensified the economic recession.

Yet the State Bank persists with the IMF mantra of maintaining the 'stabilization' policies which essentially means continuing with the deflationary policies of expenditure control pursued over the last decade. What is the stabilization that is being sought? IMF policies have certainly reduced the inflation rate, marginally reduced the budget deficits and improved the capital account of the balance of payments through IMF induced capital flows. Yet GDP growth has declined over the decade, poverty has increased sharply, and the provision of basic services such as health and education remains abysmally low. At the same time the availability of water to the farmers has declined due to inadequate budgetary funds for maintenance of the irrigation system. In short the economic woes of the majority of the people have increased to an alarming level. If this is 'stabilization', then it is the stability of the graveyard. Even the IMF at the highest level has engaged in a policy review of the stabilization programs it has propounded over the last decade. Yet Pakistan's official circles persist with a prescription that has made the patient worse rather than better.

While the financial indicators have improved, the real economy has declined. Continued deterioration in the real economy means rising poverty, unemployment and social distress. It is these issues in the realm of the real economy, its structure and dynamics, which could have been addressed in a State Bank report that purports to assess the state of the economy. To turn a phrase from T.S. Eliot, between the idea of financial improvement and the reality of economic decline, falls the shadow. The shadow of official obfuscation and public pain.