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Talking Problems of Pakistan and their solution


In February 1997, Nawaz Sharif became Prime Minister of Pakistan. He made improving the economy his top priority, emphasizing liberalization and privatization of the economy. During his previous term in office (1990-93), Nawaz Sharif began the process by successfully privatizing eighty small- and medium-size factories. But many sectors of the economy were still state controlled in 1997, so economic revival was not an easy task for Sharif's government. Among the biggest challenges faced by the new government was the question of relations with the IMF, which were severely strained under Benazir Bhutto because of corruption and economic misgovernance by her government. Prime Minister Sharif was able to improve relations with the IMF, but they remained cordial only for a short period of time. The second biggest challenge for Sharif's government was to avoid default on its foreign obligations. When Benazir Bhutto's second government was dismissed in November 1996, foreign exchange reserves had sunk to below $630 million, or just enough to finance a little over four week's imports. This was in contrast to debt repayment of just over $600 million due in December 1997. In order to cope with this precarious situation, Sharif made a direct plea to Pakistanis living abroad to make foreign exchange deposits to help tide the country over with its debt obligations. The third challenge for the Sharif government was to control the rising domestic debt, which reached 90 percent of the GDP in 1996-97. The fourth challenge was to control the accelerating trends in poverty, which were on the rise in the 1990s.
Towards the end of 1997, Pakistan again found itself in political crisis. [6] This political instability greatly affected the economy and had an especially great impact on foreign investment. Domestic businessmen put investment decisions on hold. In addition, several necessary, but sensitive, decisions were postponed. The government had done nothing to act on its commitment to reduce the number of federal government employees from 300,000 to 200,000 by the end of November. The government also promised international agencies that it would protect public sector power corporations—such as the Water and Power Development Authority (WAPDA), Karachi Electric Supply Corporation (KESC), and Sui Northern Gas Company—from imminent bankruptcy by raising utility rates from 20 to 50 percent. But Sharif balked at taking such decisions in the politically charged environment that prevailed in the country.
At the beginning of 1998, Nawaz Sharif's government claimed that the country's economic prospects were improving. But in reality, the economic scene remained cheerless, if not bleak, and negatively affected by the deteriorating law and order situation in the country. Several other factors also undermined confidence. The government, despite its electoral mandate, had shied away from taking tough, but necessary, fiscal decisions. In addition the government did little to achieve the macroeconomic targets set out in its loan program with the IMF.
In May 1998, Pakistan conducted nuclear tests, which resulted in economic sanctions from the international community. These sanctions greatly affected the already poor economy. However, the situation changed at the end of the year when the United Sates began to relax the sanctions and encouraged international financial institutions to provide help to Pakistan. In November, the United States lifted some of the economic sanctions on India (which also tested nuclear weapons in 1998) and Pakistan after securing their commitments to practice non-proliferation. However, according to the Economist Intelligence Unit (EIU):
The sanctions imposed on Pakistan by the USA are not significant in terms of potential American assistance to Pakistan; in fact, the US government has not given any economic loans or grants to Pakistan since the USA aid was cut off to Islamabad in 1990 following Pakistan's refusal to freeze its nuclear program. However, they have indirectly affected other resources of assistance: the IMF, World Bank and Asian Development Bank will not resume economic assistance until the US and other G8 countries have signaled that they will not block approval.[ii] [7]
It was again towards the end of 1998 that Pakistan faced another severe political crisis. Sharif enforced his Shariat Bill to impose Islamic law, which prompted widespread opposition from minorities, human rights groups, and even some Islamic groups, who complained that it would undermine rights guaranteed in the 1973 constitution while simply serving to distract from more important issues.[iii] [8] Civil strife increased in Karachi and the Mutthida Quami Movement (MQM) ended its coalition with the Pakistan Muslim League Nawaz (PML-N) party. Subsequently, Sharif dismissed the government in Sindh and imposed central government rule in the province. Furthermore, the army chief resigned amid rumors about an imminent military coup in the country, which was followed by an intensification of the political crisis in October 1999, when the military took over the reins of government. All these factors adversely affected the economy as political uncertainty led to the evaporation of foreign investors' confidence.
Reflecting on the results of Nawaz Sharif's second government, now an attempt will be made to analyze the performance of Pakistan's economy based on analysis of its macroeconomic indicators.

The most common way to measure poverty is based on income or consumption levels. A person is considered poor if his or her consumption or income level falls below a minimum level necessary to meet basic needs. This minimum level is usually called the poverty line. The World Bank uses reference lines set at $1 and $2 per day in the 1999 Purchasing Power Parity (PPP) terms (where PPPs measure relative purchasing power by comparison to other countries). It was estimated that in 1999, 2.2 billion people worldwide had consumption levels below $1 a day—23 percent of the population of the developing world, with an additional 2.8 billion living on less than $2 a day.[iv] [9] In Pakistan, 31 percent of the population lives on less than $1 a day, while 85 percent lives on less than $2 a day.[v] [10] Furthermore, Pakistan has a per capita income of $420 a year. Recently the World Bank began including many other factors besides income levels to measure poverty. These non-income indicators include health, education, and access to basic services.[vi] [11] In these terms, Pakistan has, for example, an adult literacy rate of 42 percent for males and 71 percent for females.[vii] [12] In the health sector, nearly one in ten children die before reaching the age of five.[viii] [13]
The government of Pakistan uses a different yardstick for measuring the poverty in the country and sets its own poverty line. Instead of applying the universal formula of one dollar a day of earnings per capita to count the absolute poor, it now considers a monthly income of PRs 748, enough to afford 2,350 calories a day, or almost PRs 1,000 less, as being poor. Those having less than that income are held as too poor now. What that means is that, instead of an income of PRs 1,710 a month on the basis of PRs 57 for a dollar for 30 days, one has to get PRs 25 per day or PRs 748 in a month not to be regarded as poor.[ix] [14]
The incidence of poverty increased in Pakistan during the 1990s.[x] [15] A report from the Asian Development Bank, "Country Strategy and Program 2002-2006, Pakistan," outlines the economic reversal that occurred in the 1990s. Poverty increased from 26.6 percent in 1992 to 32.2 percent in 1999, with the total number of poor increasing by more than 12 million people. Poverty is most intense in rural areas, where about three-fourths of the poor live. The failure of economic growth to keep up with a burgeoning workforce (growing at an average rate of 2.4 percent a year) exacerbated these trends. Structural causes of economic failure, such as an expanding foreign debt and economic mismanagement, were joined by a failure to invest in growth in human development, in areas like education, health care, and other basic social services. Private investment faltered also, driven by political uncertainty.[xi] [16] According to some studies, caloric-based poverty in effect doubled from 17.4 percent in 1987-88 to 32.6 percent in 1998-99.[xii] [17] As a result, Pakistan became less competitive as economic globalization expanded in the 1990s.
The government of General Pervez Musharraf made poverty alleviation its top priority, a platform it supported by the allocation of more resources for poverty reduction.[xiii] [18] The first pillar of this strategy is macroeconomic stabilization and resumption of economic growth. In the past, Pakistan has struggled to achieve macroeconomic stability. The country faced a debt payment crisis in 1998, investor confidence was at the lowest ebb, links with the international community were disrupted, and financial reserves were so low that the country was at the brink of default. By 1999, the public debt of Pakistan became unsustainable, with debt servicing pre-empting more than half of revenues, and external and domestic debt exceeding the country's GDP. The government of General Musharraf rectified this worsening economic situation in the next three years and, as a result, in 2002 inflation had fallen to less than 4 percent, the fiscal deficit was brought down to 5 percent, external debt indicators improved, public debt servicing declined, the exchange rate stabilized, and exports were growing at the rate of 16 percent. Foreign currency reserves reached $10 billion. This improvement in all the macroeconomic indicators enhanced the image of the country internationally.
The second pillar of Musharraf's poverty alleviation strategy is improved governance. Governance has improved due to reform of the public sector. The government especially emphasized accountability, transparency, and predictability in decision-making. The government introduced a political devolution plan whereby administrative, functional, and financial responsibilities for the delivery of social services are delegated to district governments. Discretionary powers of government officials have been reduced and placed under the administrative control of the elected representatives of the people.
Structural reforms constitute the third pillar of the poverty alleviation strategy. Broad based reforms in tax administration, trade liberalization, and the financial sector form the core. In tax administration, the Central Board of Revenue is being restructured, while the tax base has been widened. Trade liberalization has resulted in tariff rationalization, removal of various restrictions on exports and imports, and deregulation. Financial sector reforms have already resulted in a sound and healthy banking system, a buoyant stock market, a growing corporate debt market, and the strengthening of regulation and supervision.
The fourth pillar of the strategy is poverty-targeted interventions. Prominent among these are education sector reforms, healthcare for all, population planning, Zakat, the Khushali program for employment generation through public works, a food support program, and the Khushali bank.[xiv] [19] The Zakat system has been revamped to provide financial grants to the beneficiaries to start small enterprise or other income generating activities. The food support program subsidizes wheat flour for those below a certain threshold of monthly income. Khushali program funds are allocated to local governments to create and improve the physical infrastructure, while creating employment. The Khushali bank is a micro-finance institution, which provides small loans to the poor under supervised group guarantee schemes.[xv] [20]

Good governance is an important element of economic stability and growth. It provides a system in which people have access to justice and the writ of the law is enforced. Along with other factors, poor governance breeds corruption and hinders economic development. It would be pertinent to mention at this juncture one definition of good governance. According to the World Bank, governance is "the exercise of authority, control, management, power of government."[xvi] [21]
The World Bank emphasizes that good governance is central to creating and sustaining an environment that fosters strong and equitable development, and is an essential component of sound economic policies. Government plays a critical role in the provision of public goods and services. It establishes the rules that make markets work efficiently and, more problematically, it corrects for market failures. In order to play this role, governments need revenues to produce public goods and services. This in turn requires the system of accountability, adequate and reliable information, and efficiency in resource management and the delivery of public services.[xvii] [22]
Pakistan failed in all of the areas associated with good governance since 1947, in general, and in the 1990s, in particular. The civilian governments played havoc with the governance indicators. Weak governance has been an important source of macroeconomic difficulties, particularly in the 1990s. It contributed to slowing Pakistan's economic growth; reduced the effectiveness of public expenditures; weakened the overall macroeconomic management; undermined investor's confidence; encouraged tax evasion, loan defaults, and non-payment of utility bills; and fostered corruption. Furthermore, key governance problems included poor fiscal performance, mismanagement of domestic and external debt; social exclusion of the poor, women, and minorities from access to basic services; poor public sector performance; inefficient and ineffective intergovernmental relations between the federal government and the provinces; marginalization of local governments; and a loss of trust by the common citizenry in public institutions, especially in the administration of justice and police.
Corruption and poor governance have deeply affected the economy of Pakistan. Past civilian governments were corrupt and made money through illegal means, thereby increasing instability in the country. In 1997, under the caretaker government of Meraj Khalid, a team was formed to provide estimates of economic loss to Pakistan during the regime of Benazir Bhutto (1993-96). The team headed by Shahid Javed Burki and assisted by Hafiz Pasha "estimated the cost to the country of political corruption and inefficiency at 20 to 25 percent of its 1996-97 GDP. Translated into monetary terms, this was equivalent to some $15 billion."[xviii] [23] This cost was estimated on the basis of the losses incurred by the most important sectors of the economy, such as banking and public sector corporations like WAPDA and KESC.
When General Pervez Musharraf took over in October 1999, there was a dire need to take measures to improve governance and introduce structural reform in the basic governance infrastructure. These governance reforms were also long desired by the international financial institutions. In order to improve governance in the country, General Musharraf implemented a wide range of structural reforms, including:
  • Restructuring and right-sizing of the civil services
  • Rationalization of pay and pensions finalized
  • Increased autonomy granted to Federal Public Service Commission (FPSC)
  • Strong focus on training and improved procedures for performance assessment
  • Devolution of political power to the grassroots level
  • Judicial reforms
  • Police reforms
  • National anti-corruption strategy
  • Freedom of information act promulgated
  • Pakistan Public Procurement Authority established[xix] [24]
As a result of reforms in governance, Transparency International (a German-based organization) in its recent report on government corruption clearly stated, "corruption at the top levels of government has very significantly declined."[xx] [25] The World Bank also supports reforms initiated by the Government to improve its effectiveness at federal, provincial, and district levels. The ongoing Project to Improve Financial Reporting and Auditing (PIFRA) has enabled the government to develop a new accounting model, which consists of revised forms, principles, and methods of accounting and financial reporting to establish an integrated financial management system in Pakistan. The PIFRA project also provides for the introduction of a double entry computerized General Ledger System for all government financial transactions in a phased manner. The basic purpose of this system is to make government bookkeeping more effective and efficient, reducing opportunities for corruption. It will make the financial business of the government more transparent and timely.
Governance reforms have been opposed by a powerful status quo of vested interests and severe fiscal constraints that put additional restraints on the reform agenda. However, the government's record of implementing reform commitments made in 1999—in particular providing a legal basis for devolution and police reforms, ensuring the complete separation of judicial and executive powers, and completing the local government elections on schedule—suggests readiness to confront issues that have plagued the country since independence.
Debt Burden

The debt burden has long been a very serious problem for Pakistan, but was especially so in the 1990s.[xxi] [26] The civilian governments not only amassed large amounts of foreign debt, but also used this debt for meeting the current expenditures of government. In 1998, Pakistan was hovering on the brink of default. Its foreign exchange reserves, which were $1.3 billion on the eve of the May nuclear tests, fell to $400 million by mid November 1998. A confidential report prepared by State Bank of Pakistan outlined the precariousness of the debt profile. According to the report, "in 1998-99 (fiscal year ending June 30th), Pakistan's external debt repayments total $7.9 billion, including $5.6 billion in debt amortization and $2.2 billion in interest payments; of this amount, $1.6 billion was payable to non-Muslim countries, $1.1 billion to IMF and World Bank and the rest was paying for short term borrowing."[xxii] [27] The report also noted the precarious position of reserves at $930 million at the end of June, meaning the country would have to default on international debt, if the allied Muslim countries were unable to inject cash resources to keep Pakistan afloat until the sanctions were lifted.
Pakistan's debt situation reached an unsustainable level by 1999 because of the persistence of the current account and fiscal deficits during the 1990s. These twin deficits resulted in explosive accumulation of both domestic and external debt.[xxiii] [28]
Domestic debt was growing at an annual average rate of 16 percent during the period 1990-99, reaching almost 52 percent of GDP by 1999-2000, up from 44.1 percent in 1990-91. In other words, the domestic debt grew by fourfold—rising from PRs 488 billion to PRs 1,642 billion in one decade. Pakistan's total debt and external liabilities grew by an average rate of 6.4 percent per annum during 1990-99. It stood at $23 billion in 1990-91 and reached almost $38 billion by 1998-99. This sharp increase in the total debt resulted in the increase of debt servicing liabilities in the 1990s. In 1990-91, almost 40 percent of revenues were consumed by debt servicing, while in 1998-99 debt servicing was consuming 63.5 percent of the national budget, leaving 36.5 percent to be spent on defense, civil administration, and development works.[xxiv] [29]
The main reasons for this accumulated debt can be described as follows:
  • The rising trends in the non-development expenditures (debt servicing and defense) have been the cause of rising debt. The major chunk of the budget is consumed by these elements.
  • The persistence of the low growth rate of the economy also compelled the successive governments to resort to external debt. Throughout the decade of 1990s, Pakistan's growth rate remained under 5 percent.
  • Economic mismanagement and corruption by the civilian governments resulted in the loss of public exchequer. In order to fulfill their agendas, the civilian governments resorted to external debt.
  • Corruption by successive governments in Pakistan also compelled the country to opt for foreign borrowing to meet the current expenditures of the government.

Table 1.1: Trends in External Debt and Foreign Exchange Liabilities (US$ billion)
Total External Debt
Foreign Exchange Liabilities
Total External Debt and Foreign Exchange Liabilities
Source: Ashfaque Hasan Khan, "Economic Performance during 1999-2002," Ministry of Finance, Government of Pakistan,

Table 1.2: Debt Servicing

As % of GDP
As % of Current Expenditure
As % of Total Revenue
Source: Ashfaque Hasan Khan, "Economic Performance during 1999-2002," Ministry of Finance, Government of Pakistan,
As shown by Tables 1.1 and 1.2, the rising trend in both domestic and external debt resulted in a serious problem for Pakistan in a number of ways.
First, it crowds out public finances by pre-empting 56 percent of budgetary revenues, necessitating cut backs on essential public expenditures for promoting growth and poverty reduction. Second, it forces the economic managers to continue borrowing for meeting even the non-development and recurrent expenditures to run the state. Third, the annual external debt service payments falling due every year amount to $6-7 billion, which consume more than two-thirds of export earnings. This burden is totally disproportionate to the capacity of any developing country in the world, since Pakistan will pay most of its earnings to its creditors and will have very little left for imports of goods and services.[xxv] [30]
For the reasons mentioned above, the government of Pakistan must find a solution to its debt problem.
When General Musharraf came to power in October 1999, external debt and foreign exchange liabilities stood at $38 billion. It should be pointed out that the Musharraf government has done well on the debt management side. It has not only slowed down the pace of acquiring new or additional debt, but also brought down the level of debt servicing, thereby increasing foreign exchange reserves. The military government formulated a debt management strategy, which had the following features:
  • Seeking debt relief from lenders and using the savings solely for poverty reduction programs
  • Reserving privatization proceeds exclusively for retirement of public debt
  • Reducing the cost of borrowing through lowering of the interest rates on government schemes
  • Gradually eliminating all borrowings for non-development expenditures
  • Privatizing public sector corporations in the oil and gas sector to achieve greater efficiency, provide for investment resources, and generate funds for debt retirement
  • Constituting a high level debt management committee, under the chairmanship of an expert, with the governor of the State Bank and other senior government officials as members, to suggest measures for establishment of an efficient debt management system and for reducing the debt servicing burden
  • Increasing the flow of remittances through official channels
  • Relying on non-debt creating inflows (e.g., grants and foreign direct investment)[xxvi] [31]
As a result of this debt management strategy, domestic debt declined from 51.7 percent of the GDP in 1999-2000 to 47.0 percent in 2001-02, a reduction of 4.7 percentage points of the GDP. The external debt and foreign exchange liabilities now stand at $36.5 billion, down from approximately $38 billion in 1998-99—a reduction of $1.5 billion or from 62.3 percent of the GDP to 58.8 percent. Debt servicing as a percentage of total revenue, which stood at 63.5 percent in 1998-99, declined to 49.7 percent in 2001.[xxvii] [32]
Gross Domestic Product (GDP) Growth Rate

Although it lagged behind East Asian countries (the so-called "tigers") and China during the last two decades, Pakistan's growth rate remained high in comparison with the other countries of South Asia until the 1980s. Pakistan's growth rate also exceeded many African and Latin American countries.[xxviii] [33] However, Pakistan's GDP growth rate became sluggish during the 1990s.[xxix] [34] As against an average growth rate of 6.1 percent in the 1980s, it slowed down to 5.1 percent and then to 4 percent during the first and second half of the 1990s, respectively. On the other hand, the population growth rate remained high, leading to a decline in the per capita income of the country.
In part, the variability in the GDP growth rate is because Pakistan's economy still has a large agriculture component. Although this sector only contributes about 25 percent of the GDP, it employs half of the workforce. Pakistan's major exports (textiles, finished fabric goods, and yarn) are dependent on the outcome of the cotton crop. Weather variability, pests, disease, and other natural calamities contribute to volatility in agriculture production levels. Wide variations in policies for government support to agriculture, compounded by economic difficulties that restrict availability of key inputs like seeds and pesticides, exacerbate nature's obstacles to crop production. With agriculture such a significant part of the economy, agricultural production is highly correlated to Pakistan's overall economic performance.[xxx] [35] When the agricultural sector has performed well, the GDP has been high. Agriculture is extremely important not only for its contribution to the GDP, but also because of its importance for the manufacturing sector.
In addition to agricultural factors, other principle causes of the slow-down in the growth rate were the continued low rates of savings and investments; governance problems hindering the effective use of public resources; structural problems in large-scale manufacturing; and considerable financial and political instability. Macroeconomic policies failed to halt the growing imbalances in the budget and external accounts, and policymakers did not realize the economic dangers of growing financial vulnerability.[xxxi] [36] Recent growth rate trends in the GDP are given on the next page in tabular form.
Table 1.3: GDP Growth Rate Trends

Real GDP
Major Crops
Large Scale
Services Sector
Source: Various issues of Economic Survey of Pakistan (Islamabad: Ministry of Finance, Government of Pakistan).
Foreign Investment

In recent years, developing countries—such as China, India, Hong Kong, Malaysia, Indonesia, and Thailand—have attracted a lot of foreign direct investment (FDI). The inflow of FDI to Pakistan has, however, remained far from encouraging despite numerous incentives offered to foreign investors, particularly after the initiation in 1992 of the liberalization program. In the early 1990s, the country began to attract a respectable amount of foreign capital, a significant amount of it for the development of the power sector. Taking note of the large size of the Pakistani population, transnational corporations came in to develop markets for beverages and fast food. Today, the most important areas of FDI in Pakistan are energy, chemicals, foods and beverages, machinery, construction, textiles, and the power sector. Attractive incentives apart, Pakistan's population of about 149 million offers vast potential for the marketing of both consumer and durable goods. At the same time Pakistan's geographic contiguity with Central Asian republics also has the potential to serve as a gateway to foreign investors for extending their marketing activities into the countries of that region.
Despite all of these factors, FDI in Pakistan has been on the decline. These declining trends in FDI have resulted from public policy and the changing geo-strategic environment of Pakistan. According to the Economist Intelligence Unit's 2001 report on Pakistan:
Among the major reasons for the poor position with regard to foreign investment is the generally negative perception of Pakistan in international business circles. Images of gun-toting, anti-western Islamic fundamentalists, sectarian warfare and rumors of war with India are common enough. Nor does it help to know that there is an unaccountable military regime in office, while the judiciary appears incapable of delivering independent judgments in the event of clash of interests between the foreign or the domestic investors on the one hand and the government on the other. Finally, the significant exodus of indigenous capital and entrepreneurs to Canada, the US, and elsewhere in the last few weeks is hardly encouraging for potential foreign investors.[xxxii] [37]
Furthermore, the war in Afghanistan and Pakistan's status as a frontline state against terrorism create fears of instability among foreign investors. Other important factors for the declining trends in Pakistan's FDI include: the East Asian financial crisis of 1997; economic sanctions and the freezing of foreign currency accounts after the May 1998 nuclear tests; crises with the independent power producers (IPPs),[xxxiii] [38] particularly the way these issues were handled by the Sharif government; the low level of foreign exchange reserves and threat of default on external payment obligations; and disarrayed and unstable relations with international financial institutions.[xxxiv] [39]
On November 24, 1997, the Sharif government launched a new investment policy. It was aimed at improving the business environment and opening up new sectors to foreign investment. Until then, only the manufacturing sector, which accounts for 20 percent of the GDP, was open for foreign investment. However, the new policy opened up for foreign investment in other sectors like infrastructure, housing and real estate, agriculture, health and education, and wholesale and retail trading.[xxxv] [40] Furthermore, the government extended tax and tariff concessions to foreign investors in these areas. In addition, foreign investors were granted immunity from disclosing the sources of their capital and all the local and foreign investors were granted exemptions from customs duties and sales tax on imports of machinery not manufactured in Pakistan. The new policy divided the industry into four categories—value-added or export industry, high technology, priority, and agriculture-based.[xxxvi] [41] The government hoped to attract at least $5 billion in private foreign investment in the following three years as a result of this policy. However, political instability and perceptions of rising violence remained as deterrents to investors, as do lackluster macroeconomic conditions. Moreover, the investment policy violated the terms of the agreement signed with the IMF, under which no tax holidays or exemptions were to be granted.
The total foreign investment during the 1996-97 fiscal year was $950 million, a 27.3 percent decrease from the previous year's level. Of this, FDI accounted for only $682 million, compared with $1.1 billion in the previous year.[xxxvii] [42] Despite the efforts of the Sharif government, foreign investors did not respond to the government incentive program designed to appeal to them. The then US ambassador to Islamabad, Thomas Simon, highlighted impediments to capital flow, citing "frequent reviews of power generation policies of the government, frequent changes in the policy planning, a bad law and order situation, and uncertainties at the macro-economic level."[xxxviii] [43]
The most important event regarding foreign investment during the Sharif regime was the prime minister's attack on the independent power producers (IPPs). The government's main charge was that IPPs were offered high power supply rates and profit margins because Benazir Bhutto and her husband Asif Ali Zardari took commission and kickbacks from the companies involved. As a result, Sharif claimed that Water and Power Development Authority (WAPDA)—which is obligated to buy power from IPPs—is facing bankruptcy because it cannot afford to buy private power at the prohibitive rates negotiated with them.
A second event that had a major impact on foreign investment in Pakistan was the nuclear tests of May 1998. Following the tests, the Sharif government announced the freezing of all domestic and foreign exchange accounts. These accounts were worth around $11 billion, of which $7 billion belonged to resident Pakistanis, $2.5 billion to non-resident Pakistanis, and $1.5 billion were institutional swap funds with private sector banks.[xxxix] [44] Sharif argued that with external reserves of only $1.3 billion, he could ill-afford a potential run on foreign currency deposits following a loss of confidence caused by the sanctions. However, this decision of the government backfired and had two repercussions. First, the decision pushed the rupee/dollar exchange rate from PRs 46:$1 to PRs 49:$1. Second, foreign exchange remittances by expatriate Pakistanis plunged from an average of about $4 million a day to under $1 million a day, leading to a rapid decline in reserves.
Furthermore, foreign investment was also affected by the "Kargil crisis" between India and Pakistan in 1999. The crisis created an environment of instability in the South Asian region due to the imminent threat of war between India and Pakistan. Foreign investors were particularly concerned with the situation, putting their investment decisions on hold. This is evident from the fact that during fiscal year 1998-99, foreign direct investment in Pakistan totaled just $296 million, compared with $436 million in the previous fiscal year. Thus, the major factors for decline in foreign investment in Pakistan during fiscal 1998-99 were the IPPs dispute, the nuclear tests, and the Kargil crisis. Furthermore, the imposition of certain foreign exchange controls and delays in processing foreign exchange demands also caused problems for foreign companies invested in Pakistan.
Faced with these crises, the government of General Musharraf successfully tackled the issue of improving the atmosphere for foreign investment in the country. It resolved issues with the IPPs, negotiated a softening of economic sanctions with the United States, and improved Pakistan's credibility with the IFIs. On December 15, 1999, Shaukat Aziz, Pakistan's finance minister, announced specific measures to restore business confidence. The salient features were:
  • All existing tax exemptions were to be withdrawn in the June 2000 budget.
  • The tax was to be simplified in the June budget by stressing transparent and voluntary self-assessment schemes.
  • A retail General Sales Tax (GST) and agriculture income tax were to be imposed in the June budget.
  • Foreign exchange remittances of profit, dividends, and royalties were once again to be allowed without prior permission of the State Bank of Pakistan.
  • Central excise duty was withdrawn on credit card and other business transactions.
  • Only foreigners were to be allowed to open foreign exchange deposit accounts in local banks in an effort to assist the dollarization of the economy.
  • Foreign exchange bearer certificates were discontinued and income tax immunities available to government bondholders were withdrawn in order to stop money laundering.
  • Tax rates on government securities and bonds were cut.
  • Pakistan's Euro-bond debt was successfully rescheduled.[xl] [45]
In early 2001, the government successfully resolved its dispute with Hub Power Company (HUBCO). This was a welcome step, and since then the flow of foreign investment into the country has increased. This improvement was particularly encouraging given that it is an accepted fact that raising foreign investment from a low and declining path to a higher and sustainable path is a daunting task. The flow of foreign investment does not increase overnight. Foreign investment stood at $475 million in 2001-02, higher then the $403 million figure of 1998-99. Details of Pakistan's foreign investment performance are presented graphically in Table 1.4 below.

Table 1.4: Foreign Investment

Foreign Investment (US$ million)
Source: Ashfaque Hasan Khan, "Economic Performance during 1999-2002," Ministry of Finance, Government of Pakistan,

Ten main factors—which might be called the ten checkpoints or "Ten Commandments"—govern a country's ability to attract foreign investment. In the case of Pakistan during the 1990s, all these factors were lacking or were weak in some way. These factors are:
1)Political stability
2)The law and order situation
3)Economic strength
4)Government economic policies
5)Government bureaucracy
6)A positive local business climate
7)Physical infrastructure
8)Quality of labor force
9)Quality of life
10)Welcoming attitude[xli] [46]
Substantial improvement in the above-mentioned factors occurred during the government of General Musharraf. The military government pursued sound economic policies, which restored macroeconomic stability in the country. This led to improvement in the country's credibility among international donors and restored foreign investor confidence. Consequently, foreign investment increased in Pakistan. But, in order to compete with the other developing countries in the areas of foreign investment, Pakistan must continue improvement in each of these areas.
Foreign Trade

There exist strong relationships between export growth and overall economic growth, in general, and manufactured export growth and overall economic growth, in particular. Those countries that have been most successful in expanding their manufactured exports have not only achieved higher economic growth, but also succeeded in alleviating poverty. This has indeed been the case in East Asia. Pakistan's exports fluctuated widely during the last fifty years. Exports received little or no attention during the 1950s, registering an average decline of 5.7 percent per annum. Exports recovered in the 1960s and grew at an average rate of 10.7 percent per annum. The 1970s witnessed acceleration in export growth, to an average rate of 22.3 percent.[xlii] [47] The 1980s and the 1990s then saw a decline in export rates in comparison with the 1970s.
When viewed against the experiences of many successful developing countries, Pakistan's export performance during the 1990s has been lackluster.[xliii] [48] The main reason for this is that, unlike many East Asian countries, Pakistan has not adopted an effective trade liberalization regime. Another reason for the fluctuating export rate has been the variation in agricultural production, which is largely dependent upon weather conditions. The decline in agricultural production not only affected exports, but also had a great bearing upon the manufacturing sector. Furthermore, changing geo-strategic conditions after the September 11 terrorist attacks greatly affected exports. For example, the war on terrorism in Afghanistan made Pakistani exports vulnerable, and the continuous tension and threat of war with India has similar effects. For these reasons, Pakistan's trade deficit has remained and continues to be among the most important areas of concern for successive governments.
When Sharif became prime minister in 1997, he introduced tariff reforms. These reforms were aimed at the liberalization of the economy. Furthermore, these reforms provided for tariff cuts on imports, reducing the top rates for customs duties from 65 percent to 45 percent. Automobiles were the only exception where the previous rates remained in force. Duties on imported machinery for industry were also fixed at standard 10 percent. These tariff reforms were aimed at achieving three objectives:
1)To discourage smuggling, estimated to cost the Pakistani economy at least PRs 100 billion (~$2.5 billion) annually
2)To force industry to become more competitive
3)To meet part of the requirements put forward by the IMF for gaining new loans[xliv] [49]
On July 17, 1997, the then commerce minister, Ishaq Dar, unveiled an ambitious new trade policy to increase exports from $8.26 billion in 1996-97 to $9.58 billion in 1997-98, and to reduce the merchandise trade gap from $3.4 billion in 1996-97 to $2.3 billion in 1997-98.[xlv] [50] The new trade policy also reduced the interest rate for exporters, whereby 50 percent of the admissible duty drawbacks to exporters will be paid within three days of presentation of the documents; and import duties on a host of raw materials for export of finished goods were reduced or eliminated altogether. The import of a few items like chilies and pharmaceuticals were allowed from India. Furthermore, the new trade policy removed the restrictions on importation of gold and silver. Sales tax exemptions were granted to imported raw materials and components to be used by the export suppliers against international tenders.
According to Ishaq Dar, as a result of this trade policy, exports rose by 5 percent in dollar terms in the first seven months of fiscal year 1997-98, while imports contracted by 8 percent. Consequently, the merchandise trade gap narrowed by about $780 million in the first seven months of 1997-98.[xlvi] [51] However, the narrowing trade gap was not all good news. Falling machinery imports suggest that industrial growth remained lackluster, while the contraction in the petroleum bill reflected a softening in international oil market prices.
On June 15, 1998, the government introduced its trade policy for fiscal year 1998-99. The main purpose of the policy was to reduce the trade deficit by increasing exports and reducing imports. In the new policy, the export target was set at $10 billion, up by 17.6 percent compared with an estimated $8.5 billion in the last financial year. The imports for 1998-99 were projected to remain at approximately the same level as the prior year, i.e. $10.05 billion, thereby eliminating the merchandise trade deficit in 1998-99. The government claimed that it would achieve its export goals by "improving and modernizing export incentives" and "strengthening institutional export mechanisms" for its export regime. Among the export incentives offered were:
  • Exporter refund claims were to be settled within thirty days.
  • The State Bank of Pakistan (SBP) at 8 percent interest instead of the existing 11 percent interest rate made export refinance funds for at least PRs 25 billion ($570 million) available.
  • Companies classed as export processing units (those exporting 70 percent of their production) were allowed to import inputs without payment of customs duties.
  • A ban on exports of fifteen particular items was lifted.[xlvii] [52]
  • The private sector was allowed to export coke, rock salt, and caustic soda which were previously exportable by the public sector only.
  • Restrictions on export quotas were lifted on maize, grains, soda ash, breeding camels, native birds, and cement.[xlviii] [53]
The trade policy also introduced certain measures for rationalizing the import regime. The main features of these measures have been given below:
  • Import duties on gold were to be reduced by 40 percent.
  • Import of scrap plastic was banned.
  • Import of diagnostic/testing/analytical equipment was allowed to non-resident Pakistanis paying in foreign exchange.
  • Import of second-hand machinery, except computers, was banned.
  • Maximum import duties on many items were reduced from 45 percent to 35 percent.[xlix] [54]
According to the Federal Bureau of Statistics (FBS), exports fell by 10.5 percent in the fiscal year 1998 to $7.72 billion from $8.63 billion in 1997. Meanwhile, imports contracted by 8.2 percent, from $10.12 billion to $9.29 billion, causing the trade deficit to widen slightly by $79 million to $1.57 billion.[l] [55]
According to the IMF's "International Financial Statistics" report, merchandise exports rose by 6 percent in the first half of 1999, from PRs 190 billion to PRs 202 billion. Imports, however, rose by nearly 23 percent from PRs 206 billion to PRs 252 billion. In dollar terms, exports fell by 0.7 percent, year to year, while imports rose by almost 15 percent.[li] [56] Petroleum products and machinery dominated imports, while the main exports remained cotton fabric and rice.
In 2001, the military government of General Musharraf took two important measures in the area of foreign trade. These measures were to explore different markets and diversify trade and, secondly, to reduce imports. In the area of trade diversification, Pakistan improved its trade ties with different countries. Some results, even if small, were evident: Pakistan's exports to China went up by 75 percent; to the United Arab Emirates (UAE) and Saudi Arabia by 25 percent each; to Bangladesh by 20 percent; to Indonesia by 161 percent; and to Korea and Australia by 9 percent each.[lii] [57] Other than the UAE and Saudi Arabia, all other countries are referred to as non-traditional markets in the context of Pakistan's previous export patterns. Furthermore, efforts were made to improve trade relations with Kenya, Nigeria, and Syria. In addition, the military government provided the following incentives to exporters:
  • Exporters who posted at least a ten percent growth over the prior year's exports were allowed to retain 50 percent of the additional exports in their local foreign currency account. They could use this amount for the purchase of machinery, equipment, raw materials, and payment of commissions and promotional expenses.
  • Export development charges were waived on additional exports.
  • Exporters who demonstrated better performance were given monetary rewards. An "incentive scheme" that sought to reward three categories of exporters (large, medium, and small) for increases in overall exports, entering new markets, value addition, etc., was devised. An amount of PRs 2 billion was allocated for this project.[liii] [58]
With regard to trade liberalization, on June 30, 2002, the maximum trade tariffs were reduced from 30 percent to 25 percent.[liv] [59] The government established three tariff categories with duty rates of 25 percent, 15 percent, and 5 percent. However, Pakistan's trade policy in 2002 continued to ban thirty items, mostly on religious, environmental, security, and health grounds. Automobiles continued to face high duties ranging between 80 percent and 200 percent. But there remains a great need to continue efforts for trade liberalization and diversification of exports for the economy's improvement. As a result of these measures introduced by the government, Pakistan's exports reached $9 billion in 2000-01 for the first time ever. Imports remained stable at $10 billion in the same period, thereby reducing the trade deficit. Details of Pakistan's imports and exports since 1990 are given below in Table 1.5.
Table 1.5: Foreign Trade (US$ million)
Trade Deficit
Trade deficit as % of GDP
Source: Ashfaque Hasan Khan, "Economic Performance during 1999-2002," Ministry of Finance, Government of Pakistan, also State Bank of Pakistan, Economic Data,
Summary of Pakistan's Macroeconomic Performance

In recent years, Pakistan has made considerable progress in achieving macroeconomic stability. There has been a considerable improvement in all the macroeconomic indicators. It is evident from the primary budgetary surplus; reduction of quasi-fiscal deficits; turnaround in the current account deficit to a surplus; improvement in tax collection; renewed export growth rate; lowering of the inflation rate; increase in the GDP growth rate; reasonable amount of foreign exchange reserves; decline in trade deficit; and reduction in external debt of the country. In addition, monetary aggregates have been contained, the exchange rate has been stabilized, and worker remittances have been improved significantly. The risk of default on external debt, which loomed large on the horizon in 1999 and 2000, has been mitigated and the country's capacity to service its restructured debt has improved. However, the economy of Pakistan is still at the take-off stage and faces many daunting challenges. Poverty and unemployment are still high, posing serious challenges to the policy makers in Islamabad. The government of Pakistan has launched a poverty alleviation strategy with the help of the IMF and the World Bank; still, 33 percent of the people live below the poverty line. The rising population and lack of employment opportunities create persistent unemployment problems in the country. In addition to unemployment, underemployment is even higher in the country. There is a need to devise a comprehensive employment strategy to tackle this gigantic problem. For the purpose of brevity, the performance of the major macroeconomic indicators is given below in Table 1.6.
Table 1.6: Changes in Key Macroeconomic Indicators

October 1999
June 2003
Change in the Indicator
GDP Growth Rate
4.2 %
5.1 %
5.7 %
3.3 %
Fiscal Deficit/GDP
-6.1 %
-4.0 %
Current Account/GDP
-3.2 %
+ 7.1 %
Domestic Debt/GDP
52.0 %
43.4 %
External Debt
$37 billion
$35 billion
$88 million per month
$350 million per month
$7.8 billion
$11.1 billion
Tax Revenue
PRs 391 billion
PRs 460 billion
Rupee-Dollar Parity
Foreign Direct Investment
$472 million
$800 million
Foreign Exchange Reserves
$1.6 billion
$9.9 billion
Poverty Incidence
33 %
Data not available but perhaps rising
Poverty Related Expenditure
PRs 133 billion
PRs 161 billion
6 %
8 %
Source: Ishrat Husain, "Economy of Pakistan: Past, Present and Future," a paper presented at the seminar on Pakistan Ideology held by Pakistan Study Center, University of Sindh, at Karachi on August 12, 2003,
Having described the macroeconomic performance of Pakistan during the last six years (1997-2003), in the next part an attempt will be made to analyze the role of the IMF and the World Bank in the economy of Pakistan. The role of the IMF and World Bank has been crucial in the macroeconomic stability of Pakistan from 1997-2003 for a variety of reasons. These institutions provided assistance to Pakistan in carrying out its reform programs. The IMF has helped Pakistan in achieving balance of payments stability and fighting poverty, the two major macroeconomic indicators. Meanwhile, the World Bank has supported the government in restructuring the economy by supporting the structural reforms taken by the military government. In addition, the World Bank has supported the government's good governance reforms and provided material and technical support to carry out financial sector reforms in the country. As a result of the improved relations between the IMF, the World Bank, and Pakistan, the IFIs have increased their assistance to Pakistan.


DURING his recent visit to Washington, Prime Minister Shaukat Aziz spoke repeatedly about the openness of the economy he and his economic team manage. “We are perhaps the developing world’s most open economy,” he told his audiences. “You can come and invest whatever you wish and wherever you wish. You can take 100 per cent or 0 per cent share in the company in which you wish to invest. It is your choice, not the government’s.” In that respect, Pakistan is South Asia’s most open economy, certainly more than that of India. But India is on the move.

A day after Aziz’s final public appearance in the United States’ capital, the cabinet in India took the decision to open that country’s large retail sector to foreign participation. “Consent to permit 51 per cent foreign investment in single brand retail operations was the most striking among a package of measures aimed at signalling the Indian government’s determination to kick start a stalled programme of economic reforms,” wrote the Financial Times about the new Indian initiative.

This was a modest level of opening and it came with several restraints. In announcing the decision by his government, Kamal Nath, the Indian commerce minister said that “companies will be allowed to sell goods sold internationally under a single brand. Retailers of multiple brands, even if they are made by the same company, will not be allowed.”

Constraints notwithstanding, foreign retailers including Wal-Mart, the world’s largest, are lining up to move into India. The new Indian policy, considerably more restricted than the one followed across the country’s northern border — in Pakistan — will still lead to large foreign investment in the sector. Foreign companies, while not totally delighted by the small Indian gesture, are likely to move into the country with billions of dollars of investment. Why are foreigners so eager to go to India but reluctant to come to Pakistan?

One answer is the larger size of the Indian market. In 2005 the size of the Indian retail market was estimated at $258 billion and, according to Technopak, a consulting firm, it is set to grow to $411 billion within five years. The sector is currently dominated by nine million “mom and pop corner stores.” India is admittedly large and becoming larger, but Pakistan is small only by comparison to its neighbour. Otherwise it offers a large and rapidly expanding market. It should also attract foreign interest and investment.

One of the points the prime minister repeatedly underscored in his speeches was the size of the Pakistani middle class. He didn’t offer any numbers but those are not hard to estimate. If by the “middle class” is meant the segment of the population that has the disposable income to spend on the products large retailers would like to sell, then a third of Pakistan’s population of 156 million falls into that category. That means 52 million people with combined incomes of $78 billion and a per capita income of $1,500. If these people spend 20 per cent of their income on goods that large retail shops would be interested in putting on their shelves, this means a market of $16 billion. This is probably increasing at the rate of 10 per cent a year and will, by 2010, amount to $23 billion.

Given the size and openness of the Pakistani economy, why are foreigners not attracted to the country? Why has India become such a flavour of the day and why does Pakistan continue to be shunned by foreign investors? Why aren’t foreign investors attracted by the attributes Prime Minister Aziz kept referring to in his many speeches. I have attempted to answer this question in previous articles. I will go over some new ground today.

A commentator in a letter written to this newspaper in response to some of my earlier writings about India said that I was taken in by Indian propaganda and was ignoring the Indian reality. He couldn’t have been more off-base in his reaction. Let me briefly recount as to what is really happening with respect to foreign investors’ interest in our neighbour by offering some concrete examples.

In the space of a few days in December 2005, three of the biggest companies in the United States — JP Morgan Chase, Intel, and Microsoft — announced plans to create a total of more than 7,500 jobs in high value areas such as research and development and processing complex derivative trades. As a newspaper commentator wrote: “But for those worried about sluggish job creation by the US economy there was a snag. The jobs would all be in India. Worse, they would be jobs that in the past would have been in the US.”

What is even more important and impressive from the Indian perspective is the fact that some of these companies have decided to bet their future on India. Under JP Morgan’s plan, 20 per cent of the global workforce of its investment bank will be in India by the end of 2007. HSBC, one of the world’s largest banks operating out of London, has similar plans with regard to its requirement for financial skills. In an entirely different field — computer sciences and IT services — companies such as Microsoft, IBM, Intel, AMD, plan to locate significant parts of their research operations in India. What attracts them most to India is the quality of human resource available in that country. For foreign companies the attractions of India are not just costs — which industry analysts estimate at about 40 per cent below US levels — but also the quality of staff being produced by Indian universities.

According to Veronique Weill, head of operations at JP Morgan’s investment bank, “the quality of people we hire (in India) is extraordinary and their level of loyalty to the company unbeatable.” One of the many areas in which public policy continues to fail in Pakistan — a subject to which I will return momentarily — is the inability of the educational system to produce in significant numbers the same quality of people graduating from India’s science and technology institutions.

What is most troubling for Pakistan is that it is losing ground not only to India, a country that also has a large and young population. It does not even figure in the “back-up” plans drawn up by foreign corporations for addressing growing shortage of skills in their home countries. According to one knowledgeable analyst, “to avoid being too concentrated in one country, JP Morgan is already looking at other potential off-shoring locations mainly in Eastern Europe, but also China and the Philippines.” How can Pakistan get on the corporate maps of America and Europe? Why has public policy failed in that respect?

The most difficult problem Pakistan faces is the perception about it being the epicentre of Islamic extremism on the verge of an explosion in both political and social areas. Not only that, many influential voices in the United States in particular, are not convinced that Islamabad is doing all that is needed to put down Islamic extremists.

In an editorial the day after Prime Minister Aziz left town, The Washington Post not only advocated unilateral US action against extremists if Islamabad failed to act on its own. It resorted to name calling. Calling President Pervez Musharraf, “a meretricious military ruler,” it advised the administration of President George W. Bush that “if targets can be located, they should be attacked — with or without General Musharraf’s cooperation.”

The newspaper had a long list of complaints against the Pakistani leader. “Gen Musharraf has never directed his forces against the Pushtun militants who use Pakistan as a base to wage war against American and Afghan forces across the border. He has never dismantled the Islamic extremist groups that carry out terrorist attacks against India. He has never cleaned up the Islamic madressahs that serve as breeding grounds for suicide bombers. He has pardoned and protected the greatest criminal proliferators of nuclear weapons technology in history, A.Q. Khan, who aided Libya, North Korea and Iran. And he has broken promises to give up his military office or return Pakistan to democracy.”

If the visit by the prime minister was meant to change some influential minds about the way they view his country, it cannot be counted as a great success. The Post’s editorial could not be seen as a ringing endorsement of a country in which American corporations could do business. This segment of opinion-makers in Washington was not prepared to recognize that by following mindlessly the American dictat, President Musharraf’s regime — in fact any regime in Pakistan — could not expect to stay in power by totally alienating its own people. It was also ironical that even after the occupation of Iraq and the use of lethal force against the insurgency in that country, the US was not able to capture or kill Zarqawi, the Jordanian militant. It expected Pakistan to do that with respect to Osama bin Laden and Ayman al Zawahiri with considerably smaller resources and in much more difficult terrain.

While improving Pakistan’s image with respect to its participation in the struggle against Islamic extremism is not fully in Islamabad’s control, what it could do is to measurably improve the quality of its human resource. Here the public policy continues to fail in spite of the large amounts of new money committed to investment in higher education and skill development. Much of the effort under President Musharraf has been directed towards the use of public funds to open new avenues for advance education for Pakistani students.

Only time will tell whether this initiative will bear fruit. What the government could have done but didn’t do was to establish new institutions or significantly improve those that are already operating in a few areas where Pakistan could carve out a place for itself. An approach that was built on public-private partnership would have been very helpful in this area of human resource development.

Some specific initiatives could still be taken. The government could invite the private sector to establish some institutions of excellence — for instance a health sciences institute in Lahore, an advance engineering and technology institute in Karachi, an urban planning institute at Hyderabad, a small scale engineering institute at Muzaffarabad, a transport institute at Peshawar, a banking and finance institute at Islamabad, and an agricultural sciences institute at Faisalabad.

These are some examples of the kinds of initiatives the state should take to avail itself of the advantage of a large and young population that could bring immense economic benefits to the country. In not developing such a strategy Pakistan is rapidly losing ground to other populous countries. It is still not too late to plan for the future and make a real attempt to move forward.

I AM going to add one more metaphor to the mixed metaphors I have already used as the basis of this series of articles on what should be Pakistan’s approach to the world outside. I believe that Pakistan sits atop a number of faultlines that, left unattended, will periodically shake the state’s edifice.

The most serious of these is various sects and interpretations of Islam that rub against one another in the geographic space that Pakistan currently occupies. Tolerating the rise of extremist Islam will produce a clash between these tectonic plates and create a chaotic situation not in just in Pakistan but in the entire Muslim world.

At the same time Pakistan’s geographic location puts it at the natural crossroads of international commerce. Pakistan could help connect the energy-rich countries in Central Asia and the Middle East with the energy-deficit China, India and Japan — Asia’s three economic giants. This will not be the first time that the space currently occupied by Pakistan connected the East with the West. It was the fabled Silk Road that brought the twain together centuries ago. It could happen once again and to Pakistan’s great advantage.

Finally, I am of the view that the pillars on which Pakistan has rested the structure of its foreign affairs are basically shaky. These were built when the country was young and had many fears that go with growing up in a difficult environment. Pakistan is now nearly sixty years old and it needs an edifice built on more sturdy pillars.

This faultlines-crossroads-pillars mixed metaphor suggests that in designing economic policies and relations with the world outside Pakistan’s policymakers should factor geography into the equation. They should take full cognizance of the fact that the faultlines that exist below the surface pose a series of serious dangers against which the country needs to be protected. At the same time the prospect of turning the country into a hub of international commerce should be fully taken into account in crafting domestic policies.

Unfortunately for several decades Pakistan’s policy makers let history trump geography. Four pillars were constructed over which a structure was built that proved to be particularly fragile. The first of these was persistent hostility towards India, justified on the ground that several generations of Indian leadership had not reconciled themselves to the emergence of Pakistan as an independent state, carved out of the land that Hindu fundamentalists regarded as their god-given domain. Pakistan shivered in anticipatory pain whenever some powerful groups in India talked about Hindutva as the philosophy of the Indian state.

The second pillar was erected to correct the mischief done by the departing British rulers of India as they partitioned their empire on religious grounds. The British used their well-tested divide-and-rule formula for governing other people while assigning Muslim and non-Muslim areas to Pakistan and India respectively. There is no reason why they should have left the choice of joining one of the two successor countries to the princes that ruled hundreds of states that were an integral part of their Indian empire.

After all London had never permitted the princes such discretion when it was in charge itself. The British decision was aimed at sowing the seeds of conflict in the area they had once governed so that they could retain some influence, perhaps as arbitrators. This was the genesis of the problem of Kashmir that has engaged Pakistan and India for close to sixty years and sapped so much energy out of Pakistan.

The third pillar was erected to take care of the felt need to define a Muslim identity for the country that was created in the name of religion. While there is no doubt that Mohammad Ali Jinnah, Pakistan’s founding father, did not wish to create an Islamic state, he nevertheless wanted to give the country a Muslim identity. This would have involved close relations with the Muslim world. It was never clear — and it is not clear to this day — how Pakistan should anchor its “Muslimness” in a world in which individual nation states seek to maximize their own interests rather than promote those of some abstract identity such as an Islamic Ummah.

Several other Muslim states — in particular those that were carved out of the Ottoman Empire — also struggled to answer the same question. Some of them sought to do it in terms of Pan-Arabism as advocated by leaders such as Egypt’s Gamal Nasser. Some other tried to create a loosely defined arrangement within the context of Pan-Islamism. None of these attempts really succeeded. As the French Islamic scholar Olivier Roy has observed in his book, Globalized Islam, while most Muslim states moved away from this preoccupation with finding a supra-national identity, this quest was never fully abandoned by Pakistan.

Islamic parties in Pakistan continued to weigh in with the demand that the state should even sacrifice its own interests in order to pursue a Pan-Islamic agenda. These parties are prepared to call out their supporters to agitate violently on the streets whenever there is a hint that the country may be about to define its foreign strategy only to take care of its own narrow interests.

The fourth pillar of state policy was constructed on the ground that supported the third pillar. This was to oppose Israel, the only other country besides Pakistan to have been created with religion as the defining concept. Given the circumstances of their birth there should have been greater empathy and understanding between the two countries. Instead Pakistan chose to oppose the Jewish state. For a long time Pakistani passports informed their holders that the documents they carried were valid for all countries of the world but the state of Israel.

Pakistan’s opposition to the Jewish state was based on what its leaders viewed as a conflict between Islam and Judaism. That was not the reason why most of the Arab states withheld recognition from Israel. I remember a conversation at Harvard University in 1967 with a Palestinian student who asked with some puzzlement as to why the Pakistanis were prepared to shed blood in their support. His question came following rioting in the streets of Lahore demanding active participation by the Pakistani state in the 1967 Arab-Israeli war. “We are fighting the Jews not because of religion but because they have expelled our people from our land and occupied it. This is a war over land; it is not a religious war,” he told me. But Pakistan never understood the difference; it doesn’t even today, a point to which I will return in a moment.

It was on these four pillars that Pakistan over time built a shaky structure. This structure was costly to maintain and would have come crashing down unless some new pillars were erected to support it. This is what the government headed by President Pervez Musharraf seems to be doing at this time. The only problem with the new strategy is that it is undertaking a massive shift in policy by using stealth as the instrument for demolishing an old structure before building a new one. President Musharraf should state openly and boldly that this is now the time to bring about a massive change in the way we look at the world outside.

It is wise on his part to begin to define Pakistan’s foreign policy in terms of the country’s long-term strategic interests and not on the basis of correcting the wrongs done in the distant past or on the basis of some romantic notions about creating a multi-state Ummah. But bringing about this long-needed shift in policy stance by stealth will consume time whereas the need for change is urgent. Also I don’t believe that it is prudent to explain this shift in policy in terms of old cliches rather than one based on realism and pragmatism.

The Istanbul meeting on September 1 between the foreign ministers of Pakistan and Israel was extensively reported in the mainstream American press. “Pakistan believes that by engaging Israel diplomatically, it can help resolve the Middle East crisis,” Khurshid Mahmud Kasuri, Pakistan’s Foreign Minister, explained to the press in a telephone interview from Istanbul. The minister said Pakistan had no immediate plans to formally recognize Israel, a step he said would come only “following progress toward the solution of the Palestinian problem”. This is precisely the wrong position to take.

There is no reason that Pakistan should carry on its shoulders the weight of the problems that confront the Middle East in defining its relations with an important country and an important community. Pakistan’s relations with Israel and the Jewish community should evolve on the basis of its own interests rather than on the basis of the interests of a vaguely defined Islamic Ummah.

Unfortunately, the Jewish community is also casting the evolution of its relations with Pakistan in light of Israel’s approach to the Muslim world. On September 17, President Musharraf is speaking at a dinner hosted by the Council for World Jewry. Some people of Pakistani origin have been invited to attend the dinner. The letter of invitation from Jack Rosen, Chairman of the Council, mentions a visit to Islamabad by him and Phil Baum and David Twersky which was undertaken “to find authentic political and religious leaders in the Muslim world with whom we can engage in a serious dialogue.”

The address by the Pakistani president is described as a historic opportunity “which will be carefully scrutinized in many parts of the world. It will have consequences.” It is an important event since President Musharraf is the “head of a large and devout constituency”. He has “repeatedly spoken out against extremism in the Muslim world. His doctrine of ‘enlightened moderation’ encourages Muslims to embrace pluralism, openness and tolerance”.

In sum, the reason why Pakistan should evolve a working relationship with the Jewish state and the Jewish diaspora is not because of the large size of its Muslim population. It should not even try to serve as a bridge between the Muslim populations around the globe and the Jewish people. This is a heavy burden to carry for a country such as Pakistan. Instead of spelling out these grandiose objectives, Pakistan should develop relations with Israel and the Jewish community in the United States and Europe since that would bring it many rewards. It is in Pakistan’s interest to steer itself in the extremely turbulent international waters of today, focusing only on its own goals and minding its own interests.

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