Is Pakistan's economy facing potential collapse?

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Media captionYousuf Raza Gilani talks to the BBC's Nik Gowing

Pakistan's Prime Minister, Yousuf Raza Gilani, has told business leaders attending the World Economic Forum in Davos that his government is stable and Pakistan is open for business.

Mr Gilani tried to convince corporate bosses that despite all the worrying news coming out of Pakistan, his country remains one of the best destinations for foreign investment.

It's a tough sell on his part, not least because of the recent political tensions and a fragile security situation at home. But also because of the country's faltering economy, with its public finances in disarray and growth hampered by the steady erosion of investor confidence.

In fact, there are growing fears that with economic risks multiplying, the country could be heading towards a financial meltdown of sorts.

Structural imbalances

According to the International Monetary Fund (IMF), Pakistan's economy grew by only 2.4% last year, one of the lowest in the region and way behind India, Sri Lanka and Bangladesh.

At the heart of Pakistan's fiscal problem are some chronic structural imbalances. In a country of 180 million, less than 1% of people pay income tax. Billions of rupees of government revenue never make it into the treasury because of leakages, waste and corruption.

The country's public sector enterprises - such as, Pakistan International Airlines and Pakistan Railways - are ailing due to mismanagement and blatant inefficiencies. Industrial production and exports are hampered by crippling energy shortages, often leading to violent protests.

Absence of private sector investment means fewer jobs and a growing number of unemployed youths. Particularly unbearable for the majority of low-income Pakistani families was the unprecedented continuous double-digit inflation during most of Mr Gilani's four years in office.

'Inconsistency and confusion'

Critics of Mr Gilani say that in the face of his government's dismal economic performance, his upbeat statements show the government is either in denial or ignorant of realities.

"During the last four years, we have seen four governors change hands at the State Bank of Pakistan, four finance ministers, four finance secretaries, and five heads of the Central Board of Revenue," points out Dr Ashfaq Hasan Khan, a former adviser to Pakistan's Ministry of Finance.

Image caption Mr Gilani came to office in 2008 amid turmoil on the world's financial markets

"The level of turnover in the government's economic team only reflects the inconsistency and confusion with which they have handled the economy."

But Pakistani officials insist that after a difficult patch, the economy is showing signs of bouncing back. Figures from the first six months of the current fiscal year show significant improvement in remittances and exports - mostly led by cotton crop production, which was much better than expected.

With foreign exchange reserves at about $16bn (£10.2bn), the government says it is optimistic that the economy will grow at a little less than 4% this year.

Bumpy start

Economist S Akbar Zaidi believes there is a silver lining and rejects predictions of Pakistan's imminent economic collapse.

"Yes, Pakistan's economy is struggling, but it is not in a freefall or even on the verge of it," he says.

"In fact, in my view, the economy is doing surprisingly better than expected under the circumstances. The economy has shown itself to be much more resilient than many people would like to admit. With necessary structural reforms, Pakistan has all the potential to rise above its current low growth trap."

To be fair, Mr Gilani got off to a bumpy start when he came into office in 2008. It proved to be a disastrous year for Pakistan's economy, mainly due to external shocks it suffered from the sudden rise in world oil prices and the global financial turmoil.

The crisis forced Pakistan to turn to the IMF for support in order to shore up its depleting foreign exchange reserves.

The IMF gave Pakistan billions of dollars in return for its pledge to introduce the much needed fiscal and tax reforms, restructure its power sector, and cut food and energy subsidies. The government attempted to introduce some of the reforms, but soon backed off in the face of public opposition.

By 2010, the IMF was forced to suspend the release of its last two instalments over Pakistan's persistent failure to undertake painful, but long overdue, structural reforms.

Image caption There were public protests against gas shortages and price hikes in Rawalpindi, Pakistan earlier this year

Seen in this context, the IMF's recent experience with Pakistan has not been very reassuring. And yet, there are growing signs that Pakistan may have to go back to the lender for a bailout package, if the trade gap keeps growing and foreign assistance is not forthcoming.

In such a case, experts say, the negotiations will be much tougher, and conditions much harder.

Pre-election mood

Pakistan's economic managers hope it won't come down to that. But what if it does?

In that case, the timing of Pakistan's return to the IMF will be determined as much by the pace at which the economy sinks, as by political developments.

Parliamentary polls aren't due in Pakistan until this time next year. But the country already appears to have entered pre-election mode.

Unless dislodged earlier, Mr Gilani's government fully expects to present its last budget this June. Chances are it will be a populist budget aimed at pleasing voters to boost his party's chances of re-election a few months down the road.

The perceived policy paralysis of Mr Gilani's government in taking urgent and decisive measures is therefore likely to be stretched until the end of his term.

It would then be up to the new government to move quickly to address the country's chronic economic challenges.