Illusory Bonanza for Pakistan

Many Indians think Pakistan has squeezed far more financial advantage out of the US campaign against the Taliban than India has. The USA and Japan have lifted the 1998 economic sanctions imposed on both India and Pakistan, but Pakistan has got a string of other goodies too. The IMF has sanctioned additional installments of an ongoing loan despite Pakistan’s failure to meet key conditions like revenue targets. The IMF is now working on a new poverty reduction loan to Pakistan, and the World Bank has just announced a new loan too. The European Union has abolished tariffs on Pakistani garments, a key export of that country. The US has announced aid of $100 million, and Colin Powell has hinted that $500 million more may be on its way. But all this pales before the massive debt relief of up to $2 billion Pakistan seeks, and will probably get.

That may look like a financial coup, but the gains are largely illusory, for two reasons. First, Pakistan’s economy is going to suffer enormous damage by joining the US action in Afghanistan. Second, the history of debt relief shows that recipients are typically as badly or worse off after a dose of debt relief than before.

Start by looking at the abolition of European tariffs on Pakistani garments. This may seem a huge gain. But no European importer wants to place orders on a country in a potential war zone, being ripped apart by street riots. Western businessmen are cancelling outstanding contracts in Pakistan, despite pleas from the US State Department (as reported by Chidanand Rajghatta). The British cricket tour of India is in jeopardy because many British cricketers feel unsafe even in India, which is well away from the conflict zone. That gives you an inkling of how dangerous Pakistan looks to any foreigner. So foreign trade, investment, tourism and much else in Pakistan is going to collapse.

Pakistan was flooded with millions of refugees after the Soviet invasion in 1979, many of whom did not return. Pakistan is now getting a second wave of refugees, who may be even more reluctant to return. The first wave brought in illicit arms and drugs that became a millstone around Pakistan’s neck. The new wave of refugees will bring even more illicit arms and drugs. So Pakistan is going to pay a heavy price for Afghanistan II, and I doubt if all the aid and debt relief it gets will compensate.

Besides, debt relief rarely helps an indebted country. Two years ago, Western nations launched a program to rescue around three dozen HIPCs ( Highly Indebted Poor Countries), offering massive debt forgiveness as part of an overall package for reducing poverty. Pakistan has so far been kept out of this list because, historically, it has had access to commercial capital. But now Pakistan may get into the favoured list.

Will this help? William Easterly of the World Bank has written a brilliant paper explaining why HIPCs are so poor and indebted. He notes that HIPCs remain poor and indebted despite three rounds of debt relief spread over almost two decades. Many have worse debt ratios today than when the debt relief process began. Why?

Easterly creates a model of predatory states where rulers have short time-horizons, want to reap short-term patronage gains from foreign aid, and are not interested in long term gains from wise spending. Such states will borrow to the hilt, spend freely to benefit favoured lobbies, and leave the country bust.

What will happen if donors provide debt relief? States let off the hook will once again borrow as much as they can and cream off what they can, till they are as badly off as before.

Can this be stemmed by conditions attached to new loans by donors? Not really. Even if conditions thwart misspending of new flows, a bad ruler can always run down existing national assets to maintain his style of spending.

Do the heavily indebted poor countries actually correspond to this model? Easterly runs some economic tests, and finds a pretty good fit. No wonder past rounds of debt relief have achieved so little.

All is not lost. The performance of the HIPCs has got somewhat better in recent years. If the attitude of rulers has really changed in these countries, the outcomes will be better too. But note that this happy result depends on internal change, not on mere debt relief.

Exactly the same is true of Pakistan. It is in trouble not because it has borrowed too much, but because it has used the money unproductively. Always remember, borrowing is an excellent strategy if you use the money productively. The Tatas and Birlas have traditionally been the biggest borrowers in India, and have used borrowing to make themselves rich. But drunkards and junkies that borrowed for unproductive activities are bust.

Pakistan got large sums from Western donors after the Soviet invasion of Afghanistan in 1979. But even concessional loans have to be repaid, so more aid meant more debt. Because this was poorly used, the debt became unsustainable.

Massive aid to Pakistan after 1979 did not make it rich. Gross mismanagement by venal, incompetent rulers meant wasteful spending, eroding institutions and political loot. The billions Pakistan got during Afghanistan I left it bust. The billions it will now get for Afghanistan II will have the same result unless Pakistan puts its house in order and greatly improves governance and prudence. That is something Pakistanis will have to do themselves–it cannot be provided by foreign donors.

So, do not think Pakistan has been very clever in managing the Osama affair to its economic advantage. On the contrary, it is merely getting some limited compensation for the economic mess it has been forced into by US action. Nobody in India should envy Pakistan for getting billions in debt relief. We are much better off.

What do you think?