A Tale of Two Countries: Comparing India and Pakistan’s Economies

A common fate

Both India and Pakistan obtained their freedom from British colonial rule in the August of 1947. And like most developing countries, embarked on an import substitution based policy of industrialization. A protectionist climate was set up and a selective foreign investment strategy was evolved. As domestic industry and resources grew, these countries initiated a series of policy reforms in the 1980s, which were expedited in the 1990s. Both India and Pakistan are members of the WTO, and this galvanized their efforts at integrating their economies with the rest of the world. Opposition to international trade and globalisation was articulated rather vocally through the entrenched business class accustomed to protectionism. The arms race continued till both achieved nuclear capabilities having spent enormous moneys in doing so. Both faced sanctions after their nuclear tests, and are now grappling with worries on the economic front.


State of the Economy: India

India’s economic policy till economic reforms took place in the early 1990s, focused on a drive for self-sufficiency with a minimum of foreign participation. Reforms have since proceeded slowly—a large (and inefficient) public sector co-exists with a sizeable and diversified private sector. Agriculture is almost entirely in private hands. Health care, despite a large presence of public health care delivery systems, is largely in the hands of poorly equipped semi trained medical workers.

Despite India’s success in software and nuclear technology the country suffers the image of being a poor economy. With a per capita income of 450 US dollars, India is indeed a poor country. The World Bank’s World Development Report for 2000/2001 ranked India 162nd in the world, measured in terms of per capita income. Admittedly, per capita income that uses official exchange rates for conversion is not necessarily a good indicator, since it fails to capture the purchasing power of a currency. The India’s purchasing power parity (PPP) per capita income is 2390 US dollars. External debt stands at 99 billion dollars, the gross fiscal deficit as a percentage of the GDP is at a fragile 5.3%, the GDP growth rate is 5.3% and the foreign exchange reserves hover around the 62 billion dollar mark (i). 44.2% of the Indian population is estimated to be below the internationally accepted poverty line of 1 US dollar per day (ii). Poverty is also reflected in quality of life indicators. The UNDP’s Human Development Report for 2000 gives India a rank of 128th in the world, measured in terms of the human development index (HDI). Life expectancy at birth is 62.6 years, the infant mortality rate (per 1000 live births) is 69 and the adult literacy rate is 52.2%.

However, all these indicators have improved since Independence in 1947, as have other economic indicators. For example, in 1950-51 (India follows a financial year system from 1 April to 31 March of next year), life expectancy was 32.1 years and the adult literacy rate was 18.3%.

Till the end of the 1970s, real national income grew at an average annual rate of around 3.5%. Since the population rate of growth was around 2%, this meant that per capita real national income grew by only around 1.5%. This was clearly not enough to make an impact on poverty. The emphasis on self-reliance and import-substitution did have some benefits. A broad and diversified industrial base developed. In the initial years, there was a foreign exchange shortage and this had to be successfully managed. Self-reliance in food was an issue and beginning with the end of the 1960s, the Green Revolution (with an emphasis on hybrid seeds, chemical fertilizers and farm mechanization) gradually transformed India from a country that imported food to one that occasionally exports food. However, the Green Revolution is still limited to some States (Western Uttar Pradesh, Punjab and Haryana) and agricultural productivity levels are still low. The problem is to extend the Green Revolution to other States and increase productivity, perhaps with the use of biotechnology. After all, two-thirds of the Indian population is still employed in the rural sector, although agriculture contributes only 25% of GDP (gross domestic product). Industry chips in with another 25%, while services contribute 50%.

By the early 1980s, it was recognized that costs of State intervention were far more than benefits and some limited reforms were introduced. In the 1980s, the annual average rate of growth of real national income went up to 5.5%. A balance of payments crisis in 1990-91 drove a further set of reforms.

In the external sector, tariffs were brought down to an average of 24%, import licensing was eliminated, an administered exchange rate was replaced by a market-determined exchange rate that made the rupee convertible on the current account and export subsidies were unified across sectors and are progressively being eliminated. There was also a more open policy towards foreign direct investments (FDI) as opposed to the earlier emphasis on borrowing. FDI inflows are between 2.5 to 3 billion US dollars a year and the government has a target of increasing this to 10 billion. In the domestic economy, industrial licensing was eliminated and there have been several reforms in the financial sector, with the opening up of banking and insurance.

In PPP terms, India is the fourth largest economy in the world today, after the United States, China and Japan. At present rates of growth, it will overtake Japan between 2010 and 2015. By that time, the literacy rate should touch 85%, the percentage of population below the poverty line should drop to 15% or less and the infant mortality rate should drop to 35 per thousand. There is already a middle class of 300 million and an enormous explosion in consumption is in the offing. Together with China, India is destined to be the engine of world economic growth in the 21st century.

Almost three-quarters of India’s population make a livelihood from agriculture, forestry and fishing, accounting for about 30% of GDP. The majority of landholdings is in private hands, and is cultivated at subsistence level. With annual population growth of 1.8% over recent years, India will be the world’s most populous country in the next century. Its human development indicators are among the worst in the world. But India also has a large number of highly qualified professionals, as well as several internationally established industrial groups.

Reducing the fiscal deficit is a major policy issue. Simplifying the tax structure, lowering real interest rates and the politically difficult issues of disinvestment and a reduction in government subsidies are key to the problem. Further liberalisation will increase the role of domestic and foreign private-sector companies in a range of sectors. Sharp increases in the price of oil and further liberalisation of imports caused the merchandise trade deficit to widen in 2000; it reached US$12.2bn, compared with US$8.7bn in 1999. Goods exports in 2000 rose by 16.8%, and imports increased by 21.3%. An industrial slowdown in 2001 led to a slowdown in both imports and exports: consequently the trade deficit is estimated to have fallen to US$9.6bn.


State of the Economy: Pakistan

Pakistan’s economy has traditionally been heavily dependent on external sources. The phase of high growth in the 1960s came to an end with the break up of Pakistan in the early 1970s. And the economy registered falling rates of growth. In the 1990s, the country’s GDP growth rate slided down from 6 percent to 3 percent. The shortfall was mainly due to agriculture where production declined by 2.5 percent. The fall in investments did not help. The government’s debt started accelerating to reach a level above 100 percent of GDP. And the September 11 damage on account of the Afghan war is estimated to be upwards of $2 billion. Debt rescheduling and promises of grants and open markets from western countries have yet to register their presence. On a positive note, the rupee strengthened from Rs. 64 per US dollar in October 2001 to Rs. 60 per US dollar in January 2002. This has possible due to a regulation of the banking sector and remittances, and crackdown on hawala transactions.

According to the State Bank of Pakistan (SBP, the central bank), the merchandise trade deficit in the first eleven months of fiscal year 2001/02 (July-June) narrowed by 23.1% to US$1,195m. The fall was attributed to lower import volumes and oil prices.

From 2002/03, the surcharge on corporate incomes has been abolished and listed corporations pay 35% tax on profits. Banking corporations pay 50% tax in 2002/03. The number of personal income tax bands have been reduced from seven to five, with a minimum of 7.5% and maximum of 35%. Preferential rates apply in special industrial zones. Non-residents are exempt from tax on income earned from government securities and capital listed on the stock exchanges. Simplified rates of tax, from 0.5% to 1%, apply to income from the export of goods.

Pakistan’s economy has been hampered by the following factors:

1. Lack of an industrial Base: Over the decades, Pakistan developed a modest industrial base in steel, textiles, sugar, cement, leather goods, chemicals and plastics. Agriculture’s contribution to the overall output in the country has come down from 39 percent in 1969-70 to 25 percent in 2000-2001. At the same time, the share of the services sector increased from 38.4 percent to 50.3 percent during this period. The share of manufacturing has consistently remained around 16-17 percent during the past three decades. Large-scale manufacturing sector that grew at an average rate of 8.2 percent in the 1980s slowed down to an average rate of 4.4 percent in the first half of the 1990s and further to 2 percent in the latter half.
2. Low Investments and Savings: In the second half of the 1990s, total and fixed investment rates went down to 17 percent and 15.2 percent of GDP respectively, from 19.5 percent and 18 percent in the first half of the decade. Also, foreign investment has been consistently coming down since 1995-96. From $1400 million in 1995-96, it declined to $403 million in 1998-99. In 1999-2000, however, investments rose ever so slightly to $543 million.
3. Reliance on External Borrowings and Remittances: In the 1990s, remittances declined and export growth slowed down. As a result, the current account balance of payments deficit increased, touching 7 percent of GDP in 1995-96. Also, external debt quadrupled from $10 billion in 1980 to $40 billion in 2001. Pakistan has received foreign aid in the wake of the Afghan War in 2001, but the country is yet vulnerable to a debt trap.
4. Weak social sector development: Growing poverty and low standards of health and education have been a nagging problem. Nearly 35 percent of the population lives below the poverty line. Infant mortality rate is high (ten percent). Similarly, the drop out rate of children at the primary school level is as high as 50 percent. Unemployment is also a big problem. At least one out of every ten men in the organized sector is jobless. And while the country’s defence expenditure accounted for 4.5 percent of GDP, its development expenditure hardly accounted for 3.2 percent of GDP.

Conclusion

During his famous ‘bus journey’ in February 1999, the Indian Prime Minister announced the formation of the India-Pakistan Chamber of Commerce and Industry. But then Kargil happened and ruined relations between the two countries. India categorically refused any talks with Pakistan – on any matter. In recent years, there has been increased consensus regarding the significant trade potential that exists between the two countries. India’s unofficial and smuggled exports to Pakistan are estimated at US$1 billion, while the official figures are a mere US$ 94 million. Though officially only 600 items are under the list of imports to Pakistan, a much larger number find their way into Pakistan, from India to Bandar-e-Abbas in Iran, to Kabul and later to Peshawar. The selling price of these goods in Pakistan’s markets is that much more inflated due to this circuitous trading route.

Pakistan imports iron ore at a higher cost from Brazil and Australia. Cars and scooters produced in Pakistan are priced 50 per cent higher than Indian vehicles. Pakistan is the second-largest consumer of tea in the world, a market that can be exploited by India. Indian drugs are 30 per cent cheaper. Pakistan has banned the import of textile machinery from India and manufacturers import the machinery mostly from Germany. Pakistan’s annual demand for tyres stands at 10,00,000, whereas it produces only 200,000. Yet, it has imposed a 46.6 per cent duty on popular Indian truck tyres. Indian coffee is smuggled into Pakistan in a big way due to lack of official recognition.