The sheer scale of the recent floods in Pakistan threatens to send the country into an economic decline, and could even tip the military into seizing power, says Simon Wilson.
How has the flood affected Pakistan’s economy?
The full extent of the damage remains to be seen. But it is clear that the floods have left a lasting legacy of infrastructural damage, put at $15bn by the Pakistan government. Bridges, roads, power plants and communications networks have been lost or wrecked across the country. As for farming, the floods have washed away an estimated 30%-40% of the entire area of cultivation (7.3 million hectares), with crops worth $1bn ruined (according to World Bank estimates). Cotton and sugarcane – the two most vital crops – have been disproportionately hit. Some 200,000 head of livestock are thought to have perished.
How important is agriculture?
The country, which is the world’s sixth-largest by population, is the fourth-biggest producer of cotton and milk, and tenth biggest wheat producer. Other big crops include sugarcane, wheat, chickpeas, mangoes and apricots. What’s more, two-thirds of the population is dependent on agriculture for employment, either directly or indirectly. The main manufacturing sectors – apparel and other textiles, accounting for 60% of exports – rely on the cotton crop. The fear now is that in an economy that already has double-digit rates of interest, inflation and unemployment, the devastation wrought by the floods will lead to a full-scale economic collapse.
What’s the worst-case scenario?
Pakistan faces an immediate-term economic crisis: both exports and domestic consumption are all but certain to crash in the aftermath of the historic floods. Some analysts expect Pakistan’s decent growth (4.1% last year) to be cut in half; others think it may fall to zero. The question is whether this will send Pakistan into a downward economic spiral. Renewed social and political dislocation may trigger unmanageable mass migration from the countryside to the cities. An upsurge in support for Islamist and separatist movements is expected, especially in the northwest. Moreover, many commentators have speculated that a further collapse in state authority could once again tip the military into seizing power.
What will stop that?
Pakistan has been building up its democratic institutions, albeit slowly. Optimists point to the free, flourishing news media and a strong judiciary. It has lower levels of hunger and child malnutrition than neighbouring India too.
But Pakistan also suffers huge inequality. Incredible wealth exists in the country; there are superb private schools, for example. But many areas have no schools at all. And the state has never succeeded in persuading its elite to pay their way when it comes to tax. Nawaz Sharif, the former PM and opposition leader, is one of the country’s richest men, yet he paid next to no income tax last year. Currently, tax collection amounts to a paltry 10% of GDP. As author Mohsin Hamid recently argued in the FT, if Pakistan could increase its tax take to India’s 17%, or Sri Lanka’s 15%, the additional money raised would far exceed all the foreign aid the country currently receives.
What do financial markets think?
Broadly, they expect Pakistan to cope in the medium term. The spread on Pakistan five-year credit default swaps (ie, the premium paid to insure against a default or restructuring of the country’s sovereign debt) is very high, compared to big Western economies. But even as the floods gathered momentum in recent weeks that spread has remained steady. That’s a sign that financial investors believe fresh support from the International Monetary Fund (IMF) and the United States will work to prevent a serious fiscal crisis in Pakistan. Earlier this week the spread on five-year swaps was around 1,100 basis points, in line with other high-risk issuers, such as Venezuela, but well below early-2009 highs of more than 2,100 basis points.
Meanwhile, the main stock index, the KSE-100, is down 7% so far in August. But over the course of 2010 it is up 4%, broadly in line with other emerging market indexes. The Pakistan rupee hit a record low against the US dollar of 85.85 on 2 August, but since then it has rallied. That’s partly because currency markets expect the inflows of harder currencies from Pakistanis living abroad to increase as help is sent to families coping with the floods. In recent years these remittances have contributed a hefty 10% of GDP.
What’s the biggest risk?
Inflation. Even before the floods, the rate of inflation in Pakistan stood at 12.3% in July. Since then, food prices have more than doubled in markets across the country, and look likely to rise still further. If inflation takes off, that will put further pressure on the rupee. Such a scenario would make it harder for the country to service its debts, including £11bn owed to
the IMF.
Is a military takeover likely?
Only if the state proves unable to contain the tensions that have been exacerbated by the flooding. The signs are not good. So far, President Zardawi’s handling of the crisis hasn’t impressed many people. And national unity has been shredded because the floods have devastated the poorest and least literate areas of the country. Religious extremists thrive in Kyber Pakhtoonkhwa, southern Punjab, northern Sind and Balochistan. By contrast, wealthy areas (central Punjab, Karachi) have escaped the disaster. At the forefront of many minds in Pakistan is the precedent of 1970-1971. Then, a horrific cyclone – and the West Pakistan government’s callous response to it – hastened the breakaway of East Pakistan as an independent Bangladesh.