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9 October 2023

Pakistan’s Missing Market

Sanjay Kathuria

As Pakistan lurches from one crisis to another, it needs a fundamental rethink of its geopolitical and economic strategy. Without it, any International Monetary Fund program—the most recent being a “stand-by arrangement” for around $3 billion, approved on July 12—only buys some time before the next cataclysm.

Pakistan must start putting sustainable and inclusive economic growth above all else, especially its elite-focused policies that have created a cycle of profligacy and austerity. Average annual economic growth between 2010 and 2022 has been lackluster, around 4 percent, and has been accompanied by a rise in Pakistan’s total debt as a share of its GDP, from 55 percent to 76 percent. Bangladesh, in contrast, grew at an annual average of 6.2 percent over the same period, while its debt to GDP ratio rose from 30 percent to 39 percent.

In addition to addressing spiraling debt, faster and more inclusive growth is the best pathway for the poor and vulnerable to join the middle class.

The big step Pakistan could take to reinvigorate growth would be to embrace trade with India, which is currently almost nonexistent. World Bank research, on which I worked, reveals that Pakistan’s exports could increase by 80 percent, with commensurate impacts on GDP and employment, if it had a normal trading relationship with India. Extrapolating from these estimates, Pakistan’s exports of goods, only a mere $31.5 billion in 2022, could be about $25 billion higher if trade with India was realized. Another World Bank study shows that India accounts for as much as 85 percent of Pakistan’s total unrealized trade potential.

Deeper economic engagement with India could also help address other acute problems in Pakistan’s economy, including rampant inflation, which has led to an increase in poverty over the last year; a rent-seeking private sector that constantly lobbies for protection and favorable tax treatment; and the long-standing energy crisis, exacerbated by the ongoing economic calamity. Given the free fall of Pakistan’s economy since 2022, trade with India could prove very valuable.

Trade with India has been virtually halted since 2019, following the Pulwama terrorist attack in India and the passage of the Jammu and Kashmir Reorganization Bill. Currently, Pakistan allows imports from India on an ad hoc basis. For trade to normalize in a way that allows Pakistan to reap its full benefits, Pakistan would need to first rescind the ban on imports from India, and India would need to remove the penal duty of 200 percent on Pakistani imports. These could be followed by Pakistan giving India “most-favored nation” status—the same tariff treatment as given to other trade partners—and India reinstating such status to Pakistan; both countries agreeing on a timeline for rationalizing tariffs; and Pakistan doing away with trade restrictions on land borders.

The effects would be swift. Under normal trading arrangements, Pakistan’s imports from India, like its exports, would increase significantly. Had Pakistan allowed standard imports from India, they would have helped alleviate back-breaking inflation affecting critical products such as wheat and onions (India is among the world’s top exporters), and mitigated the impact on the poor. Given the sensitivity to inflation in South Asia, the political benefits of inflation-reducing imports should not be underestimated.

Trade with India could also help increase competitive pressure and productivity in the domestic market. Moreover, the availability of an immense Indian export market could excite Pakistani entrepreneurs and introduce some added pressure on entrenched domestic industrialists. A larger market may also allow the incumbent players to be somewhat more generous in ceding space to potential competitors from Pakistan and India.

And then, on the energy front, India already exports power to Bangladesh and Nepal and has significant surplus capacity. Its solar power prices are amongst the lowest in the world. Given the easy geographical terrain, Pakistan can ameliorate its power crunch by importing power and refined petroleum from across the border in the Punjab, thereby fulfilling the promise of an earlier dialogue that stalled for political reasons. It might even herald a very promising renewable energy partnership.

In this way, a vibrant trading relationship with India can help Pakistan to realize significant structural gains in an organic rather than mandated manner: by inducing productivity improvement and innovation, reducing price distortions, and enabling higher inflows of foreign direct investment. These are well-known gains from trade, but given the immense underexploited potential of bilateral trade, such gains are likely to be quite important for the Pakistani economy.

A key question is whether Pakistan’s military, which in effect wields veto power, would go along with this trade-centered approach. It might—for both tactical, short-term reasons, and for longer-term security benefits. During the very hopeful 2011-2012 attempts to normalize trade between India and Pakistan, it was vested economic interests (such as the agriculture, automobile, and pharmaceutical lobbies), rather than the army, that prevented the final steps from being taken. Now that Pakistan is suffering from unprecedented economic hardship, the army has become a partner in an “economic revival plan” that focuses on exports and foreign investment. Given the plan’s focus on dollar inflows and investment, the army may not be averse to reaping the benefits of engaging with the “enemy” economy.

In addition, the army might prefer to not have two active borders to deal with. Pakistan’s relations with Afghanistan have deteriorated over the past two years, and consequently, its defense forces are quite busy on its Western border as they deal with cross-border and local attacks against the military and civilian population from the Taliban. In this situation, a quiet border with India—a cease-fire between Pakistan and India has largely held since February 2021—is an attractive proposition. Cordial trade relations could help in meeting that goal.

Besides, the traditional approach to defining security, one that focuses on military capabilities, is becoming increasingly problematic for Pakistan. A more sustainable vision of national security would emphasize human and economic development, and there are signs that military leaders are heeding this. In a speech in 2021, Pakistan’s then-chief of army staff, Gen. Qamar Javed Bajwa, linked national security with economic progress and regional cooperation, and highlighted stable India-Pakistan relations as “…a key to unlock the untapped potential of South and Central Asia.”

Under the right conditions, these voices could gain more traction. There are indications that Pakistan’s current army chief, Gen. Asim Munir, may not be averse to such a vision. And trade cooperation does not imply that Pakistan (or India, for that matter) must give up on its core concerns. Even deep trade engagements can coexist with major differences between countries, as can be seen in the China-India or China-Taiwan economic relationships.

For its part, India can and should play a constructive and proactive role in making trade the centerpiece of a new relationship with Pakistan, because it is very much in its own interest to do so.

Why? Like Pakistan, India does not want tension on two fronts, and would be happy to have with a quiet Pakistan border as it concentrates its military energies on the Line of Actual Control with China. Trade is a less contentious route to create a fresh start in a frayed relationship, compared to long-festering disputes regarding Kashmir, Siachen, Sir Creek, cross-border terrorism, and so on.

The commercial gains for India are not trivial either. Like Bangladesh, India’s fifth largest export market, Pakistan could be as big or bigger partner if trade relations were normalized. And, as part of the overall picture, the smaller ecosystems, such as those on the Punjab and Kashmir border and the line of control, should not be forgotten. For example, a study on the Indian side showed that 9,354 families in Amritsar, a city located next to the Wagah-Attari land border, were directly impacted by the 2019 suspension of trade between India and Pakistan.

Finally, India knows that the current equilibrium on the border need not last forever. To improve the chances of long-term peace consistent with its global vision of being a great power and friend to the world, India should steer its rivalry with Pakistan in a direction that focuses on interlocking economic benefits, creating constituencies with a vested interest in peace.

One last wild card is how China would view a meaningful economic and trade relationship between India and Pakistan. If we accept the logic that China’s interest in Pakistan is mostly strategic rather than economic, then China may not worry too much. Commercially, China would be quite confident that its dominant position in Pakistan’s imports—its share was 28.3 percent in 2021—is unlikely to be much disturbed by prospective imports from India.

In fact, trade ties between its two neighbors may even lead to some long-term commercial gains for China, if Chinese foreign direct investment in Pakistani companies enables the latter to ramp up their exports to India. Finally, China’s loans to Pakistan are close to $30 billion, and like any other creditor, it would want to be repaid rather than having to keep extending new loans or rolling over existing ones.

Pakistan faces a calamitous economic situation that has been conflated with extraordinary political and governance challenges. To give itself a chance to overcome this, it needs to take advantage of the large and dynamic Indian market and put itself in a position to benefit from cheaper imports and competitively priced energy, including renewable energy. If necessary, it should take unilateral measures to make this happen, because its immediate gains from a renewed relationship are higher than those for India.

But India’s short-term gains from such an outcome are far from small, and its likely future gains even bigger. India should therefore be proactive, or at the very least constructive and generous, in its approach to a renewal of trade ties.

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