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#5248, 20 March 2017

Regional Economy

Pakistan’s Economy: Significance of MSCI Elevation and FTSE Inclusion
Amita Batra
Professor of Economics, Centre for South Asian Studies, School of International Studies, JNU

Two positive developments that have been announced and will see implementation in the coming week and in the month of May augur rather well for an economy that has for long shown below average economic performance and weak macroeconomic fundamentals. Six companies listed on the Pakistan Stock Exchange have been included by FTSE in its Global Equity Index Asia Pacific Series for the first time, on 17 March, and Pakistan will be upgraded to the MSCI Emerging Markets (MSCI EM) index from the earlier higher risk Frontier Market index category later, in May. Pakistan was downgraded from the MSCI EM in 2008 following a temporary closure of the Karachi Stock Exchange. So, while this is not a first for Pakistan, when combined with other developments it contributes to positive investor sentiment, both domestic and foreign, and potential for a more economically sound Pakistan economy.

The MSCI indices provide a broad measure of equity market performance. MSCI EM is a free float adjusted market capitalisation index that is designed to measure equity markets’ performance of emerging markets. Index inclusion may have positive consequences in terms of increased integration with global financial markets, diversification of risk, and hence reduced capital costs. Essentially the stock market developments will give Pakistani firms the benefit of greater visibility and potentially positive returns. As an economy, this will imply easier access to global finance and foreign direct investment. This is a huge advantage for an economy for which financial constraint has been an overriding concern in its growth process. In the last decade, within a span of five years, Pakistan borrowed twice from the IMF. In 2008, Pakistan was given a loan of US$ 7.5 billion, and then US$ 6.6 billion in 2013 for economic stabilisation and growth. The situation may be in for a positive change now.

The other development that has initiated the build-up towards economic strength is the expansive investment plan towards infrastructure and energy sector as part of the China-Pakistan Economic Corridor (CPEC). The CPEC, which is a part of China’s ‘One Belt One Road’ initiative, a network of highways, railways and pipelines to connect Western China to Pakistan’s Gwadar Port on the Arabian sea, is expected to contribute to growth by reducing transportation and electricity bottlenecks. Owing to the US$ 46 billion investment by China in CPEC, Pakistan has shown a surge in investment since 2015 as against the deceleration in investment observed on an average in South Asia since 2011 (Global Economic Prospects, 2017). Also, power outages and electricity cuts have been major constraints in Pakistan’s growth process. Many studies have pointed towards the loss of GDP on account of energy shortage in Pakistan. Across these studies the economic costs on account of power and electricity shortage are estimated in the range of 4-10 per cent of GDP. The CPEC will help overcome these infrastructural constraints to growth in Pakistan.

In addition to the investment surge, the CPEC is expected, through its connectivity projects, to facilitate people, resource and goods movement. Put together, this is likely to translate into more employment and trade opportunities for Pakistan. Though, undoubtedly, the CPEC projects are at a nascent stage and there are doubts about their completion given the domestic and regional political equations as also the security situation along the corridor. But, reports of evident progress are also seen. In November 2016, China started operating the Gwadar Port by dispatching ships with goods brought by trucks from China to West Asia. Other projects, including the second phase of upgrading the Karakoram Highway and the highway linking Karachi to Lahore as also in the energy sector, have also reportedly progressed.

Improved economic health is further evident from the conclusion, by Pakistan, of the SDR 4.393 billion IMF Extended Fund Facility (EFF) programme specifically aimed at supporting reform and fiscal consolidation. Pakistan has been credited with undertaking reforms in easing out the energy constraint and it is expected that improvements in infrastructure will contribute to growth. Over the past three years the macroeconomic fundamentals have improved, fiscal and trade deficit reduced, and forex reserve position enahnced though largely on account of global oil price movement. The stock market has increased by 50 per cent since 2015. Growth projections for Pakistan are higher for both the fiscal year (FY) 2017 and 2018 relative to its FY 2016 performance. Notwithstanding the downside risks of political instability and slide back in the pace of reforms, Pakistan, with a projected rate of growth of over 5 per cent (Global Economic Prospects, 2017) for both years, is now expected to contribute to regional growth in South Asia.

Put in perspective, it is not that Pakistan has not seen episodes of high growth earlier in its economic history. There have been positive growth periods in the 1960s, 1970s and 1980s when Pakistan was among the faster growing economies in South Asia. However, growth has been in spurts and economic policy more ad-hoc than sustainable. Alternating between political regimes, democratic and military, meant frequent policy reversals and political and economic instability. Growth slowed down in the 1990s and over the last decade with increasing debt burden characterising the Pakistan economy. As geostrategic and geopolitical factors came to dominate economic policy and functioning, there was a steady deterioration in governance and institutions in the country.

However, the turnaround in Pakistan’s economic health this time appears to hold more promise given the simultaneity of positive developments. The potential for investment that the MSCI elevation and FTSE inclusion holds is significant. The weakness of repeated borrowings from the IMF is claimed to be diminishing with the loan facility having been concluded and tangible progress in domestic economic reforms. The underlying support from the Chinese investment in CPEC with its manifold beneficial implications is unprecedented.

So, anchored to the CPEC investment and supplemented by positive stock market and domestic liquidity developments, there is potentially an opportunity for Pakistan to strengthen its economy. On a stronger economic footing, will Pakistan make for a more stable South Asia or a more aggressive opponent to India? It may be time to reflect on the possibilities.

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