private sector assessment

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ASIAN DEVELOPMENT BANK

PRIVATE SECTOR ASSESSMENTPAKISTAN

December 2008


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CONTENTS

Page

EXECUTIVE SUMMARY i

SECTION I 1

THE PRIVATE SECTOR IN PAKISTAN AN OVERVIEW AND CURRENT STATUS 11.1 INTRODUCTION TO THE PRIVATE SECTOR ASSESSMENT 1

1.2 THE PRIVATE SECTOR IN PAKISTAN A HISTORICAL PERSPECTIVE 1

1.2.1 The Golden Years: 1947 1970 11.2.2 The Public Sector Ascendant: 1972 1977 21.2.3 The Domino Years: 1977 - 1990 21.2.4 The Winds Of Change 1990-1999 41.2.5 Reaping The Harvest 1999 To Date 5

1.3 STRUCTURE AND COMPOSITION OF PAKISTANS PRIVATE SECTOR 7

1.4 EMPLOYMENT AND THE PRIVATE SECTOR AT THE NATIONAL LEVEL 10

1.5 SECTOR WISE CONTRIBUTION OF THE PRIVATE SECTOR 121.5.1 Agriculture 131.5.2 Mining and Quarrying 141.5.3 Manufacturing 141.5.4 Construction 161.5.5 Electricity Generation 171.5.6 Services Sector 18

SECTION II 23

PUBLIC POLICY AND STRATEGY AND THE RISE OF THE PRIVATE SECTOR 23

2.1 MAJOR AGENTS OF CHANGE 23

2.2 PRIVATIZATION 232.2.1 The Privatization For The People Program 252.2.2 Lessons Learnt from Pakistans Experience with Privatization 26

2.3 DEREGULATION AND ECONOMIC LIBERALIZATION 26

2.4 REGULATORY STRUCTURES: PROGRESS AND ISSUES 29

2.5 GOVERNMENT STRATEGY FOR PRIVATE SECTOR DEVELOPMENT 31

SECTION III 33

KEY CHALLENGES AND THE WAY FORWARD FOR PRIVATE SECTOR DEVELOPMENT INPAKISTAN 33

3.1 MAJOR MACROECONOMIC AND INFRASTRUCTURE CHALLENGES 33

3.2 GOVERNANCE AND INSTITUTIONAL BOTTLENECKS 38

3.3 CONSTRAINTS TO DOING BUSINESS IN PAKISTAN 39

SECTION IV 49

THE MISSING LINKS 49

4.1 THE SME and INFORMAL SECTORS: 49


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4.1.1 Employment Trends in the Informal Sector 494.1.2 Estimation of the Informal Sector's Contribution to GDP 51

4.2 THE FUTURE OF THE INFORMAL SECTOR IN PAKISTAN 51

4.3 SMALL AND MEDIUM ENTERPRISE SECTOR 52

4.4 CLIMATE CHANGE AND IMPACT ON THE ECONOMY AND THE PRIVATE SECTOR54SECTION V 56

THE ROLE OF THE PRIVATE SECTOR IN INFRASTRUCTURE DEVELOPMENT 56

5.1 PRIVATE SECTOR INVESTMENT IN INFRASTRUCTURE: 56

5.2 CONSTRAINTS IN PAKISTAN TO PRIVATE SECTOR INVESTMENT ININFRASTRUCTURE 57

5.2.1 Undeveloped Financial Markets and Instruments 595.2.2 Structural and Policy Constraints: 60

5.3 PUBLIC PRIVATE PARTNERSHIPS (PPP) FOR INFRASTRUCTURE DEVELOPMENT61

5.3.1 Constraints for PPPs 615.3.2 Issues, Challenges, and Way Forward on Private Sector Participation in KeyInfrastructure Sectors in Pakistan 62

5.4 RECOMMENDATIONS FOR PROMOTING PPP IN PAKISTAN 69

SECTION VI 70

6.1 ADB AND PRIVATE SECTOR DEVELOPMENT IN PAKISTAN 70

6.2 ASSISTANCE TO THE PUBLIC SECTOR FOR DEVELOPING THE PRIVATE SECTOR70

6.3 PRIVATE SECTOR ASSISTANCE THROUGH THE PRIVATE SECTOR OPERATIONSDEPARTMENT (PSOD) 73

SECTION VII 78

THE PRIVATE SECTOR SPEAKS 78

SECTION VIII 80

RECOMMENDATIONS FOR FUTURE ADB INTERVENTIONS 80

APPENDICES

APPENDIX 1: PAKISTAN'S INVESTMENT INCENTIVES AT A GLANCE 85

APPENDIX 2: PAKISTAN'S INSURANCE SECTOR 86

I. Life Insurance Sector 86II. Non Life Insurance Sector 87

APPENDIX 3: LIST OF PRIVATIZATIONS IN PAKISTAN 1999 APRIL 2007 89

APPENDIX 4: CONSTRAINTS AND INTERVENTIONS FOR ENHANCING PRIVATE SECTORPARTICIPATION IN THE ENERGY SECTOR 91

APPENDIX 5: CONSTRAINTS AND POSSIBLE INTERVENTIONS FOR PRIVATE SECTORPARTICIPATION IN ROADS, RAILWAYS, AND PORTS 95

APPENDIX 6: CONSTRAINTS AND POSSIBLE INTERVENTIONS FOR PRIVATE SECTORPARTICIPATION IN THE WATER SECTOR 98


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LIST OF TABLES

Table 1: Capital Market Growth and Development 6Table 2: Structure of Savings and Investment (As Percent of GDP) 7Table 3: Foreign Investment Inflows in Pakistan (Million $) 9Table 4: Sector Wise FDI Inflows (Million $) 9Table 5: Employment by Major Industry (%) 10Table 6: Sectoral Concentration of Informal Labor Force Employment (%) 11Table 7: Distribution of Enterprises by Employment Size 2005(percent) 12Table 8: Sectoral Share in GDP (%, Constant Factor Cost) 13Table 9: Asset Structure of the Insurance Industry 21Table 10: Insurance Density in US$; insurance penetration (in percent) 22Table 11: Governments Incentives for Investment 27Table 12: Country Wise Foreign Investment Inflows ($ million) 28Table 13: Leading Foreign Investor Companies Average Returns 29Table 14: State of Pakistans Competitiveness 2007 42Table 15: Formal and Informal Sectors- Distribution of Non- Agriculture Workers (%) 50

Table 16: Informal Sectors Workers- Distribution by Major Industry Divisions 50Table 17: Pakistan. Revised GDP and Annual Value added of the Informal Sector (1999-2000)

51Table 18: Credit to SMEs (Rs. million) 54Table 19: Impact of Climate Change 55Table 20: Comparative Infrastructure Indicators for Pakistan 56Table 21: Sectors for Private Sector Investment in Pakistan (1999 2006) 57Table 22: Total Installed Generation Capacity (MW) 62Table 23: Potential Private Sector Hydropower Projects (Rs. million) 63Table 24: Pakistans Teledensity in Comparison with other Regional Countries (%) 65Table 25: Public Sector Interventions with PSD Focus: Some Examples 71Table 26: Completed Assistance to the Private Sector ($ million) 74

Table 27: Ongoing Private Sector Assistance ($ million) 75Table 28: Feedback from the Private Sector 78Table 29: Recommendations for ADB Interventions for PSD 80LIST OF FIGURES

Figure 1: Real Fixed Investment as percent of GDP 8Figure 2: Main Sectors of Private Sector Investment FY2007 8Figure 3: Sectoral Share in Generation of Electricity (%) 17Figure 4: Increased Ownership of Local Private Banks 19Figure 5: Ownership of NBFIs 20Figure 6: Insurance Sector Profitability- 2005 21

Figure 7: Foreign Stake in Domestic Stock Market (as percent of aggregate marketcapitalization) 26

Figure 8: GDP Growth (%) 34Figure 9: Domestic Saving Rates in 2005 35Figure 10: Electricity Demand and Supply Curve 37Figure 11: Pakistans Governance Rankings 39Figure 12: Pakistans Performance on the Doing Business Survey 40Figure 13: Ranking of Investment Climate by City (perceptions of firms outside the city) 42


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Figure 14a: GCI Rank on Institutions 45Figure 14b: GCI Rankings on Infrastructure 45Figure 14c: GCI Rankings on Health and Primary Education 45Figure 14d: GCI Rankings on Market Efficiency 46Figure 14e: GCI Rankings on Technological Readiness 46Figure 14f: GCI Rankings on Business Sophistication 46

Figure 14g: GCI Rankings on Innovation 47Figure 14h: GCI Rankings on Macroeconomy 47Figure 14i: GCI Rankings on Higher Education and Training 47Figure 15: Teledensity of Pakistan (%) 65Figure 16: ADBs Private Sector Assistance in Pakistan: Ongoing Portfolio 76


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ABBREVIATIONS

ADB Asian Development BankCMDP Capital Market Development ProgramCPS Country Partnership StrategyDFI Development Finance Institution

FDI Foreign Direct InvestmentGENCOs Generation CompaniesGCI Global Competitiveness IndexGDP Gross Domestic ProductGDR Global Depository ReceiptGoP Government of PakistanHBL Habib Bank LimitedIFI International Finance InstitutionIMF International Monetary FundIPO initial public offeringIPP independent power producersMCA Monopoly Control Authority

MTDF Medium Term Development FrameworkKESC Karachi Electric Supply CorporationKPT Karachi Port TrustKSE Karachi Stock ExchangeNCBs Nationalized Commercial BanksNEPRA National Electric Power Regulatory AuthorityNHA ` National Highway AuthorityNICL National Insurance Company LimitedNRL National Refinery LimitedOGDCL Oil and Gas Development Corporation LimitedOGRA Oil and Gas Regulatory AuthorityPC Privatization Commission

PEMRA Pakistan Electronic Media Regulatory AuthorityPPID Pakistan Private Infrastructure DevelopmentPPL Pakistan Petroleum LimitedPPP Public Private PartnershipsPRCL Pakistan Reinsurance Corporation LimitedPRSP Poverty Reduction Strategy PaperPSA Private Sector AssessmentPSD Private Sector DevelopmentPSO Pakistan State OilPSM Pakistan Stock Market FundPSO Pakistan State Oil Company LimitedPSOD Private Sector Operations Department

PTA Pakistan Telecommunications AuthorityPTCL Pakistan Telecommunications Company LimitedREITs Real Estate Investment TrustsSBP State Bank of PakistanSECP Securities and Exchange Commission of PakistanSLIC State Life Insurance CorporationSME Small and Medium EnterprisesSOE State Owned EnterpriseTA Technical Assistance


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UBL United Bank LimitedWAPDA Water and Power Development AuthorityWLL Wireless Local Loop

NOTES

(i) The fiscal year (FY) of the Government of Pakistan and its agencies ends on 30 June.FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2008ends on 30 June 2008.

(ii) In this report, "$" refers to US dollars.


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EXECUTIVE SUMMARY

i. The Pakistani Private Sector: Since its inception in 1947, Pakistan has relied on theprivate sector as the primary producer of goods and services. The early 1970s, however,witnessed a crippling shift towards a command economy and a subordinated private sectormanifested through a policy of nationalization. The 1980s and onwards witnessed a reversal of

this paradigm and the private sector again began to emerge and lead investment and economicactivity. Beginning in the early 1990s, the Government of Pakistan pursued a strategy ofprivatization, deregulation, liberalization and good governance to promote private sectordevelopment. However, macroeconomic instability and political turmoil and uncertainty stood inthe way of the successful implementation of this strategy. Under a new Government in 1999,major structural, governance, and economic reforms began to be implemented with a focus ongenerating macroeconomic stability and creating an environment to encourage the privatesector to become the growth engine in the economy. The Privatization Act 2000, creation of aMinistry of Privatization and Investment, setting up of a Board of Investment, legislative changesto the State Bank of Pakistan (SBP) Act empowering the SBP/SBP Central Board to formulate,conduct and implement monetary policy, the creation of a Monetary and Fiscal Board to ensureformal monetary and fiscal policy coordination, and a Fiscal Responsibility and Debt Limitation

Act 2005 mandating reduction in revenue deficit and reducing total public debt were importantsteps that underscored the Governments recognition of the importance of macroeconomicstability and a clear and transparent legislative framework to support a conducive businessenvironment in the country. The improved economic conditions and investment climategenerated both the fiscal space as well as opportunities for private sector led economic growththrough acceleration of the process of privatization, enhanced private sector investment, andgreater foreign direct and portfolio investment. As a result of the successful experience withprivatization, in Pakistan today, over 77% of the commercial banking sector, 100% of the textileand telecommunications sector, and a significant part of the cement, sugar, automobile andfertilizer sector are in the private sector. Within infrastructure development, besidestelecommunication, the private sector has been active in the power sector. It is a majorcontributor to power generation and has also entered into the electricity distribution sector after

the privatization of the Karachi Electric Supply Corporation (KESC). Upstream and downstreamoil and gas remains a mix of public and private sector entities. However, key public sectorentities including the Oil and Gas Development Corporation Limited (OGDCL), PakistanPetroleum Limited (PPL) and Pakistan State Oil (PSO) are all on the Governments privatizationlist. Gas distribution is also slated for privatization. In the financial sector, in addition tocommercial banking, the domestic capital markets have also developed at a rapid pace with theKarachi Stock exchange (as on June 29, 2007) emerging as the most important institution ofcapital formation in Pakistan and voted as the most strongly performing stock market inemerging Asia.

ii. Key Private Sector Development Issues:

a. Macroeconomic stability achieved in recent years has been critical in restoringprivate sector confidence and catalyzing greater foreign and domestic privateinvestment. But in FY2008, the macroeconomic situation deteriorated significantlybecause of the impact of higher oil and food prices and delayed policy response by theGovernment in view of the difficult political conditions and the transition to a newgovernment that affected the reforms in the country. The result has been burgeoningtrade, current account, and fiscal deficits, a high rate of inflation, massive devaluation ofrupee, major drawdown of foreign reserves to finance the deficits in an environment ofweak capital inflows, and a rising level of domestic and foreign debt. Macroeconomic


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fundamentals need to be protected and economic stability restored to ensure thecontinuity of the present growth momentum based on sustained levels of private sectoractivity and investment.

b. Private sector investment and growth in recent years has been mainly based inthe services sector especially telecommunications and financial sectors. Pakistans

manufacturing base over the years has remained narrow with a concentration ofinvestment in capacity enhancements and up gradation of facilities largely only in thetraditional textile sector. This sector accounts for 46% of total industrial output andcontributes 60% to Pakistans total exports. Such a high reliance on one singlesubsector to deliver on industrial development is of concern. The situation also raisesthe issue of whether Pakistan can sustain economic growth with a primarily servicessector oriented growth momentum without a corresponding deepening and broadeningof its manufacturing and industrial base. A structural transformation of the economy thatfocuses on development of the commodity based sectors including industry andagriculture is needed to ensure long-term sustained economic growth.

c. The enabling environment for private sector development needs to be further

strengthened within an improved policy and regulatory framework that consists of adefined industrial policy, competitive policy, an investment policy, and stronger andcapacitated regulatory institutions in key sectors of the economy. As one example of thelatter, there is a need to strengthen the capacity of the Securities and ExchangeCommission with respect to regulating the non-bank financial sector including theinsurance sector.

d. A key constraint to private sector growth is the critical infrastructure deficit,particularly in the power sector. The demand-supply gap for power has increasedsubstantially over the years without a corresponding increase in public and privateinvestment in power generation and strengthening of transmission and distributionsystems. There is a need for accelerated investments in the sector alongside reforms

and a strengthened regulatory and policy environment leading to uninterrupted andsufficient availability of power for industrial, commercial, and domestic use. The privatesector is being considered by the Government as an increasingly significant partner inthe financing and delivery of infrastructure in the power and other sectors. However,policy, legal and structural frameworks allowing public private partnerships need to bedeveloped and strengthened in many key sectors including, power, transport and waterto encourage private sector participation in infrastructure provision.

e. Pakistan provides good protection to investors but lacks efficient contractenforcement structures which complicate and increase the cost of doing business.Together with ineffective property rights regulations, low effectiveness of public sectoragencies, weak regulatory mechanisms, and overall security situation, these governance

related bottlenecks retard Pakistans international competitiveness. In addition,inefficiencies and rigidities in the land and labor markets remain major constraints forgreater growth and dynamism of the private sector.

f. Lack of human resource development and availability of educated, healthy andskilled labor are big issues in the competitiveness and growth of Pakistans privatesector. This results in distortions in terms of factor utilization by sectors, contributes tounemployment and lowers factor productivity.


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g. Despite some financial deepening, Pakistans capital markets still lack financialinstruments and institutions specializing in long term debt, project, and infrastructurefinance. This constraint has far reaching impacts for private sector participation ininfrastructure development and is one of the key reasons for slow industrial growth and anarrow industrial base.

iii. Governments Policy and Planning Framework: As mentioned, Government policiesand mechanisms to promote private sector development have since the early 1990s focused onprivatization, deregulation, and liberalization as the cornerstones of its policy to achievesustained growth and structural transformation of the economy. The 1992 Economic ReformsAct was a major milestone as it gave full legal protection to investors as well as to theprivatization process. Subsequently, the 2000 Privatization Act and creation of a number of newregulatory agencies like the Securities and Exchange Commission Pakistan (SECP), PakistanTelecommunication Authority (PTA), National Electric Power Regulatory Authority (NEPRA), Oiland Gas Regulatory Authority (OGRA), Pakistan Electronic Media Regulatory Authority(PEMRA) and Private Power and Infrastructure Board (PPIB) to act as focal points to attractforeign and domestic private investment underline the importance of private sector developmentwithin the Governments policy and planning framework.

The privatization process has had a major impact on private sector development as it not onlytransferred ownership to the private sector, but also helped create appropriate regulatory andgovernance structures for the sectors that were being privatized. During the period fromNovember 1999 to December 2006, from 49 transactions, assets worth PKR 418.6 billion wereprivatized prominent amongst which were the privatization of Pakistan TelecommunicationsCompany Limited (PTCL), Habib Bank Limited (HBL), United Bank Limited (UBL), KarachiElectricity Supply Company (KESC), National Refinery Limited (NRL) and a number of fertilizerand cement companies. Today the telecommunications sector and the commercial bankingsector are in private sector hands and over 50% of the industrial sector has been successfullyprivatized. The gas distribution system is also being prepared for privatization. The privatizationprogram, however, suffered a setback in early 2007 when the Pakistan Steel Mills privatization

was struck down by the Supreme Court of Pakistan. Following this decision, the Governmenthas focused on floating its shares in public entities in domestic and foreign capital markets viaglobal depository receipts (GDRs) such as the shares floated for the United Bank Limited andthe Oil and Gas Development Corporation on the London Stock Exchange. The impact of suchprivatization on the economy which, in essence, generates portfolio investment needs to be,however, reviewed carefully given the volatility attached to such foreign inflows especially with apotentially weakening Rupee. The experience in FY2008 in which portfolio investmentwitnessed a net inflow of only $41 million relative to a net inflow of $3.3 billion in FY2007 is amanifestation of the unsustainability of portfolio investment inflows.

Pakistans liberal investment policy remains one of the most attractive in South Asia allowing100% ownership to foreign investors in a vast number of sectors and allowing remittance of

capital, profits and dividends etc without any regulatory approvals. This has been key inattracting both foreign direct investment as well as portfolio investment. This could be, however,further improved by creating a level playing field between domestic and foreign investors andallowing domestic investors to tap international capital markets directly through, for example,utilizing currency swaps and hedging mechanisms.

The Medium Term Development Framework (MTDF:2005-2010) of the Government places aspecial emphasis on private sector development as a key element of the strategy to achievesustained growth. Under the MTDF, private sector development is being supported through


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improving the business climate to catalyze the private sector; strengthening the knowledge baseand competitiveness of the economy through investments in human resources and in skills andvocational training; strengthening product quality controls and enforcement of internationalstandards; fostering public-private partnerships; and vitalizing Pakistans capital markets.Likewise, Pakistans Vision 2030 incorporates private sector development as a key element ofthe Governments long-term thinking on sustainable development in the country and notes the

need to reduce the cost of doing business to promote private sector activity in the country.

iv. ADB Experience with Private Sector Development: During the last CSP (2002-2006),ADBs strategy to promote private sector development was operationalized through twowindows. The first were public sector programs that focused on helping to improve the businessenvironment and supported a more enabling policy and institutional framework for the privatesector. This included support for reforms and privatization in the finance, industry, power andrelated sectors to create a level playing field for the private sector, and initiatives to developSMEs, rural finance, and agribusiness to deepen and diversify private sector activities.

With respect to the Latter, the development of an SME policy was supported, and a BusinessSupport Fund for SMEs along with a support fund for agribusinesses, were set up under ADB-

assisted operations. ADB also supported reforms in the capital markets and stock exchanges,as well as strengthening of regulatory structures and capacity development in the financialsector. Support for privatization during the CSP period includes the KESC and the SME Bank.The targeted privatization of gas sector entities as well as that of the insurance sector could notmaterialize, however, because of legal and structural impediments. In 2006, ADB provided alarge program through which the private sector strategy was operationalized for supportingprivate participation in infrastructure development. The second window was direct assistance tothe private sector in terms of loans and equity investments. In the event, this window remainedlargely dormant and only one private sector project: a Small and Medium Enterprise PartialCredit Guarantee facility $65 million was approved during the CSP period in 2003. Starting in2007, the private sector window was once again revived with the largest-ever private sector loanto Pakistan for the post-privatization rehabilitation, upgrade, and expansion of the KESC.

v. Intended Private Sector Outcomes and Key Outputs Supported by ADB Under theNew Country Partnership Strategy (CPS):

Outcomes: Improved business environment for private sector development. Greater privatesector participation in key areas of infrastructure development and delivery of services. Higherinternational competitiveness of the private sector.

Key Outputs:(a) Supportive legal, regulatory and structural reforms for the private sector with continuedemphasis on the financial services sector and the industrial and agriculture market developmentsectors.

(b) Comprehensive policy and regulatory framework for private participation in infrastructuredevelopment and delivery of municipal and other services.(c) Greater private investment in key prioritized areas of infrastructure and finance supportedthrough a larger number of private sector operations that produce synergies with public sectorprojects and programs(d) Analytical work centered on developing Pakistans industrial policy including a major studyon the private sector business potential on the National Trade Corridor.


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vi. Private Sector Development Links to CPS Focal Areas:

Focal Area 1: Reforms and Investment in Energy and Infrastructure Sectors. Private sectorparticipation in key infrastructure sectors is being supported through the Private Participation inInfrastructure Development Program. A number of direct private sector projects in infrastructuresectors particularly in the power and energy sectors will also be supported. Private sector

projects in the transport and communication sectors and the water sector will be also explored.

Focal Area 2: Reforms to Strengthen Governance and Promote StructuralTransformation. Support is being provided for second generation reforms to create a levelplaying field for the private sector targeting critical areas of infrastructure and finance. Thisincludes support for policy and regulatory reforms under the ongoing and proposed PrivateParticipation in Infrastructure Development (PPID) Program. In the financial sector, support isbeing provided for second generation reforms for capital markets development (including inareas of long term project finance, corporate debt markets, pension funds and REITs) andaccess to financial services including microfinance, and SME. Support for reforms is also beingprovided to enhance the competitiveness of Pakistani economy through a cluster AcceleratingEconomic Transformation Program, that is supporting key reforms in the agriculture, energy,

industry, and financial sectors to raise productivity and efficiency in the commodity producingsectors, address bottlenecks in the power sector, and improve supervision and regulation in thebanking sector. Crosscutting support for creating an enabling environment for private sectordevelopment also forms a key part of the province-focused proposed resource managementand government efficiency improvement programs.

Focal Area 3: Development of the Urban Services. Private sector participation will besupported in the development of urban infrastructure including water and sanitation throughprivatization, concessions, or public private partnerships. Private sector delivery for municipalservices will be also supported. Assistance will be provided for reforms and investments inmarket infrastructure to strengthen value chains and the role of the private sector in businessdevelopment.

Focal Area 4: Effective Implementation of Projects and Programs and Capacity Building.The emphasis on developing synergies between private and public sector operations in the keyfocal areas of the CPS, particularly infrastructure development, will lead to improveddevelopment effectiveness and results. Technical support from relevant PSD experts will besolicited in the design and preparation of projects that have scope for involvement of the privatesector. This will improve the quality of entry at projects and result in improved implementation.Greater coordination and harmonization with other development partners will be ensured tobuild synergies and greater complementarities in the design and delivery of private sectorrelated operations.


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SECTION I

THE PRIVATE SECTOR IN PAKISTAN AN OVERVIEW AND CURRENT STATUS

1.1 INTRODUCTION TO THE PRIVATE SECTOR ASSESSMENT

1. The private sector assessment (PSA) for Pakistan undertakes to assist in thedevelopment of a coherent country strategy for private sector development (PSD). The PSAwithin the framework of the Pakistani private sectors history and recent performance reviews itsperformance, achievements and challenges. This framework and review, in the context of thePSA, provides for the Pakistani private sector:

a forward looking strategic vision on its evolving role; an idea of its effectiveness as an agent of structural economic transformation;

and an identification of its development needs and the development of appropriate,

sustainable and realistic interventions at policy and implementation levels toeffectively deal with existing and emergent challenges.

2. The PSA attempts to advise on appropriate policies, strategies and interventions topromote a competitive, strong and dynamic private sector that will contribute to long termeconomic growth and sustained poverty reduction. The assessment builds upon ongoingcountry economic and sector work and generates input in the preparation of ADBs new countrypartnership strategy (CPS) for Pakistan.

1.2 THE PRIVATE SECTOR IN PAKISTAN A HISTORICAL PERSPECTIVE

1.2.1 The Golden Years: 1947 1970

3. Pakistan emerged in 1947 with the historical traditions of a free and competitive private

sector. From the days of the Mughal Empires to the British Raj in India, the state was seldom, ifever, a producer of goods and services. Muslim historical traditions and legislature hadadequately protected property rights and fostered a spirit of free enterprise and the developmentof a vibrant private sector. These traditions of a primarily private sector led economy werepassed on when Pakistan was created in 1947. The public sector at the time of partitionconsisted only of the Railways, Telephone and Telegraph Department, the Post-Offices, KarachiPort Trust, Radio Pakistan and some coal and salt mines. Government policy, circa 1948,delimited public ownership to arms and ammunition, hydro-power generation, rail, telephoneand wireless equipment, and industries of national importance in which the private sector wasunable or unwilling to invest.

4. Prior to the creation of Pakistan, British banks were the dominant financial institutions. In

the 1940s indigenous banks emerged. The State Bank of Pakistan (SBP) came into being in1948. It was in the early 1950s with the setting up of two government-owned banks - NationalBank of Pakistan (NBP) and Agricultural Development Bank of Pakistan (ADBP) - that the statebegan to encroach upon the private sector in the financial arena. Initially, the role of the statewas curtailed as evidenced by the first two Five Year Plans that emphasized the importance ofthe private sector as the engine of growth and stated that public sector enterprises would onlybe established where the private sector did not invest, and even these would eventually bedivested to the private sector.


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5. The private sector centric policies continued under Field Marshal Ayub Khansgovernment that ruled Pakistan from 1958 to 1969. It was a period of unprecedented growth,and the industrial sector grew at a pace that far outstripped China and S. Korea and was on parwith Japan. The Ayub Khan period also saw the first manifestation of privatization as a publicpolicy tool when some industrial units that included jute, paper and sugar mills that were set upand successfully run by Pakistan Industrial Development Corporation were divested to the

private sector. The focus then, as now, was to stimulate the growth and development of theprivate sector. By the end of the 1960s, however, the public sector began its slow andinexorable advance into the territory dominated until now by the private sector, starting in themachinery sector with the establishment of the Heavy Mechanical Complex, Taxila and theMachine Tool Factory, Landhi. Meanwhile, the political and economic fallout of the 1965 and1971 wars was surprisingly well weathered by the private sector and the economy continued togrow and make gains. The inflow of western aid and the rising importance of Pakistan as amajor domino in the Cold War were significant in propping up the economy during theseperiods.

1.2.2 The Public Sector Ascendant: 1972 1977

6. From 1972 to 1977, the then Pakistan Peoples Party's Government initiated a broad andsweeping nationalization program under the political slogan of reversing concentration of wealththat had occurred under the private sector led model of the 1960s, and ensuring meeting ofbasic needs of all citizens. Government policies during this period were fueled by thefashionable socialistic development paradigms of the time and were in line with the growingtrend of experimentation with command economy driven visions of economic growth,empowerment of workers and rapid social sector development in many countries. Thesepolicies curbed, bridled and delimited the private sector with ultimately disastrous results.

7. In 1972, 32 basic industries and 3 life insurance companies were nationalized; in 197326 vegetable ghee companies; and in 1974 all domestic private sector banks and remaininginsurance companies were nationalized along with petroleum marketing and shipping

companies. 1976 saw the control of the State extend to even the SME sector with flour mills andcotton ginning factories nationalized, culminating with the nationalization of rice husking units in1977. The private sector driven structure of the Pakistani economy had within a span of 5 yearsbeen torn apart and reconstituted under a public sector led economic model. From an engine ofgrowth in the 1960s, the private sector became the bogeyman of the 1970s.

8. By 1976, however, the same forces that had ushered in the wave of nationalization andan ever expanding public sector role, realized that they may have gone too far. It was however,too late. The damage to the private sector had been done and the flight of capital and expertisethat ensued set Pakistans future growth back in a major way. On an equally alarming note, themuch anticipated social sector revolution did not take place. Consequently, the anticipatedupward movement in per capita incomes did not materialize and the then-in-vogue equivalents

of current quality of life indicators dealing with health care, poverty and education did not showimprovement. In fact, the economy began to slow down and the political turmoil that followedwiped away whatever gains had been achieved in the preceding years. The hidden hand ofthe market was lost, private sector investment evaporated, and production and resourceallocation decisions made in the private sector resulted in a marked slow-down of the economy.

1.2.3 The Domino Years: 1977 - 1990

9. The government of General Zia-ul-Haq that came into power in 1977 began the process


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of unraveling the huge and expanding public sector and regaining the confidence of the privatesector. The first major legal initiative to restore the confidence of the private sector - theTransfer of Managed Establishments Order was promulgated in 1978. This order provided thelegal cover for the return of the nationalized units back to their owners. As a consequence, allthe rice-husking units, flour mills and cotton ginning units were denationalized along with twolight-engineering units and a steamship company.

10. The private sector was further encouraged by the introduction of fiscal incentives in1982-83 such as tax holidays and exemptions and rebates in custom duty. The CompaniesOrdinance also came under review and in 1986 the Companies Ordinance was totally revampedand rationalized. The Sixth Five Year Plan (1983-1988) specifically adopted privatization as acentral theme, confining Governments role to that of a facilitator of private sector investmentand an investor of last resort. After carrying out detailed reviews, the Government decided torationalize and consolidate the management and size of the public sector. Mergers andregroupings of holding corporations and financial restructuring of individual enterprises werecarried out and chronically sick enterprises were earmarked for closing down or liquidation. FourPakistan Industrial Development Corporation units, four small Pakistan International AirlinesCorporation (PIAC) motels and three sugar and three textile units owned by provinces were

disinvested, while several other enterprises were liquidated. While the first steps towardsprivatization related to sick units, clarification that this policy was not restricted to loss-makingenterprises only came through a Government announcement of a plan to sell shares ofprofitable units to the general public, with a view to facilitating widespread participation in theownership of public enterprises. Accordingly, 10% shares of PIAC were floated in 1988.

11. However, other than the relatively small industrial units mentioned above, it was strikinghowever, that no major divestments from the public to the private sectors took place during thisperiod despite the fact that legal cover had been provided through the Transfer of ManagedEstablishments Order 1978. It would appear at the same time that the private sector itself, notyet recovered from the shocks of nationalization, had no will, capacity or interest in privatization.The financial system to a great extent also remained public sector owned during this period with

a concentration of over 90% of all financial services. This public sector dominated banks-drivenfinancial structure, resulted in the creation of a massively inefficient financial sector. The publicsector owned banking system twisted price signals, misdirected credit flows and subvertedcredit cycles. This was also the period when state-led the Development Finance Institutions(DFIs) began loosening credit controls and building up infected lending portfolios. Thepoliticization of the banking sector and loosening of controls, inefficient staffing practices, andprovision of cheap subsidized capital to targeted "priority" sectors further distorted the financialmarkets and led to inefficient allocation of resources. This culminated in distorted agriculturaland industrial sector growth and had far reaching systemic consequences that contributed to thesubsequent economic crises in the 1990s.

12. Continuing state control of the financial and other economic sectors eroded governance

structures and systems and led to a concentration of economic power in the hands of thepolitical elite and public sector officials. With the financial sector becoming a captive tool tofurther political and personal ends, a burgeoning default culture emerged that led to rampantcorruption and opaque public sector policy and decision making. Window dressing, weakregulation, and creative accounting kept the extent of the portfolio infection hidden, but this wasstill estimated in 1989 to be very large engulfing over 70% of DFIs portfolios and over 40% ofcommercial bank loan portfolios.


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1.2.4 The Winds Of Change 1990-1999

13. By the end of the 1980s, efforts to turn around the public enterprises with expertmanagement and substantial injection of capital had proved to be unsuccessful. Public SectorEnterprises continued to suffer from the classic ills associated with state-owned industry inefficiency, mismanagement, over-staffing, low productivity, poor quality, high costs, mounting

losses and rising debt. Many enterprises managed to survive only because of preferentialpolicies such as tariff protection, special access to credit, government guarantees, taxexemptions, and subsidies.

14. The cracks in the financial system had begun to appear in the early to mid 1980s but itwas in the early 1990s that a financial sector meltdown seemed a distinct possibility. Most of theDFIs had loan portfolio infections of over 40% with the Nationalized Commercial Banks (NCBs)following suit. The policy of state control over governance and management of financial andeconomic holdings had clearly failed to deliver in terms of socio-economic development. What itcreated was an inefficient and bankrupt financial sector that desperately needed reform. Thebanking sector was plagued with inefficient management, overstaffing and high costs offinancial intermediation. This placed a high priority on reform of the banking sector. Industrial

growth was misdirected by distorted price signals emerging from a still centralized planningsystem. Agricultural growth remained stagnant with little or no change in traditional productiontechnologies and systems. Manpower quality deteriorated as the best and brightest migrated.

15. Aid flows, especially from the USA on which the Pakistani economy had becomedependent since the Soviet Unions invasion of Afghanistan in 1979, slowed and became atrickle soon after the Soviets were defeated and left Afghanistan. Funds for social sector andpoverty reduction programs were significantly reduced. The law and order continued todeteriorate and political instability settled in.

16. With a stagnant economy, increasing population, and diminishing options, policy makerswere forced to rethink the role of the state and the private sector in the economic sphere. The

turn of events prompted the Government to initiate a major reform program aimed at revivingprivate sector confidence and investment through providing an enabling business environment.The winds of change sweeping the world at the time planted seeds of reform, deregulation,liberalization and privatization. Pakistan was to be fertile ground for these agents of change anda program of economic structural transformation rooted in the private sector slowly took shape.These agents of change were cultivated by the state out of necessity as the public sector hadfinally run out of steam. Pakistans structural transformation model was based on the three basicprecepts of deregulation, good governance, and privatization with the aim to unleash privatesector forces to promote investment, growth, and employment creation.

17. Consequently, the foreign exchange regime was opened up in 1991, new bankinglicenses in the private sector were issued, and the huge quantum of red tape necessary to

undertake business activity was rationalized. Protection to the investors and the private sectorwas provided for in the 1992 Economic Reforms Act that provided legal cover against re-nationalization and protected the rights and interests of private sector domestic and foreigninvestors. Privatization began to be viewed by 1991 as a potentially important policy tool toattracting private sector investment and participation from the domestic and foreign markets Thefirst steps were taken and they were big ones. A number of industrial units and two large banks

Allied Bank Limited and Muslim Commercial Bank were privatized in 1991-1992.

18. Good governance was the glue that was to hold the structural reform initiative together.


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Regulatory bodies and their roles were reviewed. As a consequence, in 1994 the State Bank ofPakistan gained complete autonomy and shortly afterwards began a major reform processwhich resulted in strengthened regulation, guidelines and improved information disclosureguidelines for the financial sector. As part of this process a number of independent regulatorybodies were set up that included the Oil and Gas Regulatory Authority (OGRA), NationalElectric Power Regulatory Authority (NEPRA), Pakistan Environmental Protection Agency (EPA)

and the Pakistan Telecommunication Authority (PTA). The Corporate Law Authority [now theSecurities and Exchange Commission of Pakistan (SECP)] was strengthened and its roleexpanded. It was within this tripod (deregulation, liberalization and privatization) of interwovenreform agents that the Pakistani private sector re-birthed as the primary economic engine ofgrowth.

1.2.5 Reaping The Harvest 1999 To Date

19. Continuing with the pro-private sector policy framework of the 1990s, under the newGovernment in 1999, major structural, governance, and economic reforms began to beimplemented with a focus on generating macroeconomic stability and creating a friendlybusiness environment for the private sector (for example see Appendix 1 on incentives provided

for attracting investment). The Privatization Act 2000; the creation of a Ministry of Privatizationand Investment; the setting up of the Board of Investment; the Insurance Act 2001; new lenderfriendly recovery laws to strengthen bank credit cycles; new legal structures for setting up andoperation of non-bank financial institutions; streamlined tax systems and more efficient importand export regimes; legislative changes to the State Bank of Pakistan (SBP) Act empoweringthe SBP to formulate, conduct and implement monetary policy; the creation of a Monetary andFiscal Board to ensure formal monetary and fiscal policy coordination; and the FiscalResponsibility and Debt Limitation Act 2005 mandating reduction in the revenue and fiscaldeficits and the total public debt were all important steps in this direction that furtherstrengthened and supported the Foreign Private Investment (Promotion & Protection) Act 1976and the Protection of Economic Reforms Act, 1992. The impact of these far reaching measureswas improved macroeconomic stability, improved growth rates, and a more enabling investment

climate that generated both fiscal space and opportunities for private sector led growth. Theimproved macroeconomic dimensions of the Pakistani economy led to a resurgence ofinvestors interest in the process of privatization and resulted in higher domestic and foreigndirect investment as well as portfolio investment.

20. Privatization remained a key economic reform during this period. Privatizationtransactions completed over the past eight years include complex strategic sales of commercialbanks with the highlights being the two commercial banking giants- Habib Bank Limited (HBL)and United Bank Limited (UBL), the privatization of Pakistan Telecommunications CompanyLimited (PTCL), and the successful divestment of Karachi Electric Supply Company (KESC) andthe Pak-Arab and Pak-American Fertilizer companies. The Government also started a wellreceived privatization for the people program under which public sector entity shares were

divested into domestic stock markets. Shares of 7 entities that included the National Bank ofPakistan (NBP), Oil and Gas Development Corporation, Sui Southern Gas Company (SSGC),Pakistan Petroleum Limited (PPL), Kot Addu Power Company (KAPCO), PIAC, and UBL weredivested via Initial Public Offerings (IPOs), Public Offerings (POs) and Global DepositoryReceipts (GDRs). These capital market transactions played a major role in deepening andbroadening the capital markets. Over 2.6 million Pakistanis bought shares worth Pak Rs. 24.3billion through these transactions.


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21. Today, over 77% of the commercial banking sector, 100% of the textile andtelecommunications sector and a significant majority of the cement, sugar, automobile andfertilizer sector are in the private sector. The private sector is also a major contributor to powergeneration and has entered into electricity distribution sector after the privatization of KESC.Upstream and downstream oil and gas production and distribution remains with a mix of publicand private sector entities with a focus, however, on the privatization of OGDCL, Pakistan

Petroleum Limited (PPL) and Pakistan State Oil (PSO), which are all on the Governmentsprivatization list. Gas distribution is also slated for privatization.

22. The domestic capital markets also developed at a rapid pace with the Karachi StockExchange (KSE) emerging as the most dynamic. Between fiscal year FY12003 and FY2008,listed capital on the KSE increased from Rs. 313 billion to Rs. 635 billion, market capitalizationfrom Rs. 756 billion to Rs. 3.5 billion, and the KSE index from a high of 4,606 to 14,202 (Table1).

23. FY2008 have been difficult years for Pakistan politically and economically with thesituation created by the judicial imbroglio that began in March 2007, declaration of emergencyon 3 November, the assassination of Benazir Bhutto on 27 December, and the uncertainty

during the run-up to the general elections held on 18 February 2008. The large quantum jumpsin international oil and food prices, the slow down of capital inflows both because of the globalfinancial melt down and Pakistans domestic situation have had a strong adverse impact oneconomic stability in Pakistan. Along with the reemergence of macroeconomic imbalancesparticularly the rising current account and fiscal deficits and high inflation, this situation has ledto greater volatility in stock markets, a downgrading of sovereign credit ratings, and an outflowof portfolio investment. Instability in economic fundamentals could result in impairing the presentgrowth momentum. It is essential that the new Government continues to prioritize improvedeconomic decision making and pursue important governance and sector reform to reduce thecost of doing business and improve the business environment for private sector investment.

Table 1: Capital Market Growth and Development

Source: State Bank of Pakistan. Annual Report 2007-08. Karachi

1Fiscal year in Pakistan runs from 1 July to 30 June.


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1.3 STRUCTURE AND COMPOSITION OF PAKISTANS PRIVATE SECTOR

24. The private sector in Pakistan is the major producer of goods and services in theeconomy, the major contributor to investment, and the largest employer. While disaggregatedsector-wise data identifying specific contribution by the private sector in the various sectors of

the economy is not available, it is possible to generate an estimate of the private sectorcontribution to GDP at an aggregate level. Working from the national income accounts data withfigures for private sector consumption and investment and assuming that the bulk of exportsoriginate in the private sector, the private sectors contribution to GDP at current factor cost isestimated at an overwhelming 84 percent of total GDP. 2 If allowance for the undocumentedinformal economy is made which is totally in the private sector, the latters contribution to GDPwould be even higher.

25. Of Pakistans total gross fixed investment of 21.3% of GDP in FY2008, private sectorinvestment is estimated at 15.6% of GDP. 3 Contributing about 73% of the total investment inPakistan in FY2007 compared to about 65% in FY2001, private sector investment grew rapidly,until FY2008 when it fell on account of the worsened economic fundamentals amidst deepening

political uncertainty (Table 2 and Figure 1). The overall increase in private investment in recentyears has been complemented by a significant increase in public sector investment ininfrastructure and social sectors. Primary sectors which have had robust growth in private sectorinvestment include manufacturing, mining and quarrying, construction, transport andcommunication, and wholesale and retail trade (Figure 2).

Table 2: Structure of Savings and Investment (As Percent of GDP)

Source: Ministry of Finance. Economic Advisers Wing Calculations (P=Provisional)

26. With the growth increase in investment untill FY2007, accompanied by a deceleration in

national savings, the savings-investment gap has significantly widened. The improvement innational savings in FY2007 did not reverse this trend, and on the back of rising investment, thesaving-investment gap widened to 5% in FY2007, before spreading further around 8% inFY2008 (Table 2). Unless national savings can be increased at a faster pace, the saving-investment gap could increase further in the coming years given the large investmentrequirements attached to achieving the targeted 7%-8% growth rate in the medium-term. On the

2Staff estimates.

3Ministry of Finance, Government of Pakistan. Pakistan Economic Survey 2007-08. Islamabad.


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other hand, financing of this gap through external resources on a sustainable basis is also notviable given its implications for overall macroeconomic stability. The failure to increase nationalsavings could, therefore, in the medium-term stall investment and block growth.

Figure 1: Real Fixed Investment as percent of GDP

5.7

4.2 4.0 4.0 4.34.8

5.7 5.7

10.2

11.3 11.310.9

13.1

15.7 15.6

14.2

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

PPublic Investment Private Investment

Source: Pakistan Economic Survey 2007-08.

Figure 2: Main Sectors of Private Sector Investment FY2007

Areas with Nominal Growth

0

5

10

15

20

25

30

Manufacturing Construction Transport Wholesale

and

Retail Trade

%Growt

Source: Pakistan Economic Survey 2006-07.

27. Foreign Direct Investment: With limited domestic savings constraining domesticinvestment, the Government resorted to promoting foreign direct investment throughencouraging greenfield investments, privatization of public assets, and portfolio investment.Total foreign investment jumped to a record $8.4 billion in FY2007 against only $559 million inFY2003 before coming down to 5.2 $billlion in FY2008 (Table 3).


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Table 3: Foreign Investment Inflows in Pakistan (Million $)

YearGreenfieldInvestment

PrivatizationProceeds

Total FDIPrivate

PortfolioInvestment

PublicPortfolio

Investment

Total ForeignInvestment

FY2002 357 128 485 (10) (483) (8.4)

FY2003 622 176 798 22 (261) 559.1FY2004 750 199 949 (28) 339 1,260.7

FY2005 1,161 363 1,524 153 458 2,134.6

FY2006 1,981 1,540 3,521 351 613 4,485.0

FY2007 4,873 266 5,139 1,821 1,468 8,428.0

FY2008 5019.6 133.2 5153 19.3 20.8 5193.0

Source: Board of Investment. 2008. (http://www.boi.gov.pk)

Table 4: Sector Wise FDI Inflows (Million $)

Sector FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008

Oil and Gas 80.7 268.2 186.8 202.4 193.8 312.7 545.1 634.8

FinancialBusiness

-34.9 3.6 207.4 242.1 269.4 329.2 930.3 1607.6

Textiles 4.6 18.5 26.1 35.4 39.3 47 59.4 30.1

Trade 13.2 34.2 39.1 35.6 52.1 118 173.4 175.5

Construction 12.5 12.8 17.6 32 42.7 89.5 157.1 88.5

Power 39.9 36.4 32.8 -14.2 73.4 320.6 204.6 70.3

Chemical 20.3 10.6 86.1 15.3 51 62.9 46.2 78.0

Transport 45.2 21.4 87.4 8.8 10.6 18.4 30.2 73.0

Communication NA 12.8 24.3 221.9 517.6 1937.7 1898.7 1625.3

Others 140.9 66.2 90.4 170.1 274 285 1094.6 769.7

Total 322.4 484.7 798 949.4 1523.9 3521 5139.6 5152.8

PrivatizationProceeds

- (127.4) (176.0) (198.8) (363.0) (1,540.3) (266.4) (133.2)

FDI ExcludingPvt. Proceeds

322.4 357.3 622.0 750.6 1,160.9 1,980.7 4,873.2 5019.6

Source: Board of Investment: 2008. http://www.boi.gov.pk

28. Much of the foreign direct investment came into the services industry (Table 4),particularly telecommunications and services industry. FDI in the telecommunication industrywas catalyzed by the privatization of the Pakistan Telecommunication Company Limited (PTCL)

and the entry of foreign cellular phone companies in the market. In the financial sector, theprivatization of large commercial banks brought in a significant level of FDI as did subsequentmergers and acquisitions in the banking sector. Despite the politically turbulent andeconomically difficult FY2008, FDI remained resilient and totaled at $5.2 billion. As in the past,the bulk of FDI in FY2008 came into the sectors of telecommunications, oil and gasexplorations, financial businesses, construction, trade, cement, and automobiles and transport.Portfolio investment, however, was a different story. Portfolio investment fell drastically from$3.3 billion in FY2007, to $ 40 million in FY2008, as domestic political and economic crisis
http://www.boi.gov.pk/http://www.boi.gov.pk/http://www.boi.gov.pk/http://www.boi.gov.pk/


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adversely impacted the confidence of short-term investors and the global economic slowdowndeterred portfolio investment inflows into the country.

1.4 EMPLOYMENT AND THE PRIVATE SECTOR AT THE NATIONAL LEVEL

29. The size of the labor force swelled to over 50.33 million in FY2007, up from 45 million in

FY2004. The number of the employed increased to almost 47.7 million from 42 million duringthe same period. Employment increased in the construction sector, and only marginally in theagriculture and manufacturing sectors, but stagnated or fell in the transport, trade andcommunity and social services sectors (Table 5). Labor force participation rates have alsodemonstrated a small increase, rising from 30.4% in FY2004 to 31.8% in FY2007. Participationrates appear to have increased in both urban and rural areas and for both males and females.

Table 5: Employment by Major Industry (%)

Source: Federal Bureau of Statistics, Pakistan Labor Force Survey 2006-07. Pakistan, Islamabad

30. The private sector employs 7 million workers in the formal sector4, and 18.6 million in theinformal sector5. In the last five years, an estimated 8.6 million new jobs were created in theprivate sector. With this increase in employment, the overall unemployment rate has decreasedfrom 8.3% in FY2002 to 6.5% in FY2005.6 The informal sector is second only to the agriculturesector as the largest generator of jobs in the private sector (Table 6). The sectoral concentrationof informal labor force employment shows the retail and personal service sectors as the leadingemployers in the informal sector, followed by manufacturing, and community and socialservices. With increased diversification of the economy to service oriented sectors, Box 1indicates that most jobs are being created in the telecommunication sector, hospitality industry,IT and banking. At the same time, job generation is on the decline in public sector corporations,

nationalized banks, the public education sector, ministries and their related departments.

4World Bank. 2007. Doing Business in South Asia. Washington D.C

5Federal Bureau of Statistics. 2007. Pakistan Labor Force Survey 2006-07. Islamabad

6Ministry of Finance. 2006. Pakistan Economic Survey 2006-07. Islamabad


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Table 6: Sectoral Concentration of Informal Labor Force Employment (%)Agriculture Labor Force 43.37

Non- Agriculture Labor Force 56.63

Informal Labor Force 41.25

Mining and Quarrying 0.04

Manufacturing 8.80

Electricity, gas and water 0.01

Construction 5.69

Wholesale, Retail Trade, Restaurants and Hotels 14.23

Transport and Communication 4.57

Financing, Insurance, Real Estate and Business Services 0.59

Community, Social and Personal Services 7.31Source: Federal Bureau of Statistics. 2007. Pakistan Labor Force Survey 2006-07. Islamabad.

Box 1: Emerging Employment Scenario in Pakistan

Source: Article by Dr. Ishrat Hussain, Monthly Industrial Bulletin, January 2006

31. The vast majority of jobs in the private sector are generated in the small enterprisesector. Table 7 shows that small enterprises, comprising 1-4 people, employ almost 95% of thetotal labor force. On the other hand, Pakistan has an insignificant medium sector that employsonly 5% of the labor force. The proliferation of small businesses that employ the bulk of thelabor force in Pakistan and which in most cases do not graduate to the middle categoryindicates lack of economies of scale, difficulties in accessing finance to grow in size and


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complexity, and insufficient absorption of technology needed to scale up operations andgenerate greater employment opportunities possible in large sized companies.

Table 7: Distribution of Enterprises by Employment Size 2005(percent)

Relative Distribution (%)

Employment Size Pakistan Punjab Sindh NWFP Balochistan Islamabad

Small (1-4) 94.45 95.07 93.86 92.32 96.72 87.87

Medium (5-49) 5.49 4.89 6.04 7.63 3.22 11.67

Large (50 & above) 0.06 0.04 0.10 0.05 0.06 0.46Source: Federal Bureau of Statistics. 2005. Economic Census 2005. Islamabad

1.5 SECTOR WISE CONTRIBUTION OF THE PRIVATE SECTOR

32. As already mentioned, there are no disaggregated statistics pertaining to sector-wisecontribution of the private and public sectors. In what follows, an attempt is made to provide ageneral idea of the role and contribution of the private sector in the major sectors of the

economy based on available information and credible assumptions.

33. The contribution of the key sectors to the economy is captured in Table 8. Theagriculture sector with a 20.9% contribution to GDP is almost wholly private sector owned. Mostof the mining and quarrying activities are also in the private sector. Within manufacturing with a19.1% contribution to GDP, 100% of the textile sector (which consolidates 46% of the valueadded in the manufacturing sector) and a significant majority of the cement, sugar, automobileand fertilizer industries are in the private sector. So is the case with the construction sector. Inthe services sector, the private sector owns over 77% of the commercial banking sector, amajority of the general insurance sector, a significant portion of the transport and storage sector,and almost 100% of the wholesale and retail trade. The private sector is also a major contributorto power generation and has entered into the electricity distribution sector after the privatization

of KESC. A brief description of the role of the private sector in each of these key sectors follows.


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Table 8: Sectoral Share in GDP (%, Constant Factor Cost)

Source: Ministry of Finance. Pakistan Economic Survey 2007-08. Islamabad.

1.5.1 Agriculture

34. Agriculture, which is the largest sector of the national economy in terms of itscontribution to total employment, is almost wholly in the private sector. Agriculture fuelsPakistans export base as it is the main supplier of raw materials for the export oriented industry(mainly textiles) and supports nearly two thirds of merchandise exports 7. The private sectorowns agricultural land and generates primary and value added agricultural output. Public sector

involvement in the agriculture sector is mainly concentrated in providing and maintainingirrigation infrastructure and developing waterways for cultivation as well as providing agricultureextension services and supporting agriculture research.

35. The major issues pertaining to the agriculture sector from a private sector perspectiveinclude inefficient agriculture and agriculture markets, distorted agricultural input and outputpricing, and a continued inability to price and manage water. A recent IMF paper8 concludedthat in addition to removing market distortions, there is a need for fundamental improvements inthe market mechanisms in the agriculture sector, including reduction in governmentinterventions and enforcement of more competitive behaviors.

36. Comprehensive private sector led agricultural growth requires strengthening the linkage

with modern infrastructure, appropriate technology adoption, and the manufacturing base. Areview is required of what value addition processes can be adopted to generate a morecompetitive and efficient agriculture sector. Key value adding areas where the private sectorcould play a critical role include horticulture and livestock which have the potential to increaseagricultural productivity and incomes while also promoting the creation of intermediate and high

7World Bank. 2006. Pakistan Growth and Export Competitiveness. Islamabad

8Lorie.H and Kiran. K. 2006. What Determines the Domestic Prices of Agricultural Commodities in Pakistan.Islamabad


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level agricultural service support systems and agro industrial activity in the SME and largeIndustrial sectors. With an expanded focus on livestock and horticulture, the private sector couldprofitably also invest in integrated transportation and delivery systems like standardized,palletized containerized transportation networks for transportation of high value livestock andhorticultural produce. An expanded role of the private sector is also possible in food processingand agro-farm machinery industries. Private sector investments could also be considered in

private sector hybrid seed production facilities. Inadequate cold chains are another weak areawhere the role of the private sector can be encouraged.

1.5.2 Mining and Quarrying

37. The mining and quarrying sector is mainly private with a diminishing public sectorpresence with only four public sector enterprises involved in mining. The stated policy of theGovernment is to privatize even these companies. However, most private mining operations inPakistan are small in scale and not equipped in terms of size and complexity to effectivelyexploit Pakistans rich mineral sector potential. There are 52 minerals under commercialexploitation at present. Mineral deposits are owned by the respective provinces which can leaseout concessions to private sector parties and pay appropriate compensation in the event a

discovery is made on private land. The implementation of a National Mineral Policy (NMP) in1995 paved the way to expand and develop the mining sector through attracting private sectorinvestment. International mining companies have responded favorably to the NMP andpresently four of them are engaged in mineral exploration, development and exploitationprojects including for copper, coal, and zinc deposits. Import of machinery for the mineral sectorhas been allowed free of tariffs and restrictions on repatriation of profits by foreign investorswere lifted in 2000.

38. There is however, no regulatory body to oversee the activities of mining firms inPakistan, and over-mining remains a major threat with significant consequences for theenvironment. In a recent review of the mining sector9, it was concluded that that the majorobstacles to the growth and development of this sector were inefficient mining methods and

tools and techniques, lack of coordinated regulation and intervention at the federal andprovincial government levels, opaque and cumbersome leasing procedures, poor definition andenforcement of property rights with respect to the surface land, inefficiency in the dutydrawback/tax rebate system, lack of access to financing for the SME sector, and a poortransportation network. Further work is necessary to identify priority areas for reform in themining sector in the country. To this end, an analysis of joint ventures and foreign investment inthe mining sector globally should be undertaken to develop appropriate policy, regulatory andcontractual structures based on international best practice to promote private sector investmentin the sector.

1.5.3 Manufacturing

39. The manufacturing sector in Pakistan is almost totally in the private sector with theexception of a few heavy capital goods industries identified as important from a strategicperspective. Major manufacturing sub-sectors in Pakistan include: textile which is the largest interms of value added; food, beverage and tobacco; cement; and automobiles.

40. Textile Sector: Privately owned, Pakistans textile sector is its most importantcomponent of the manufacturing sector. It contributes 46% to the value added of manufacturing

9World Bank. 2006. Pakistan Growth and Export Competitiveness. Islamabad


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sector as a whole and generates 8.8% of GDP. It is responsible for 60% of Pakistans totalexports, and provides employment to 38% of the manufacturing labor force 10. To prepare for thepost-quota global trading environment that demands greater efficiency and an enhancedcompetitiveness level, the textile sector invested close to $6 billion for balancing, modernizationand restructuring (BMR) during 1999-2006, with a focus on spinning, weaving, textileprocessing, and making up sectors. After faring well for the first year in the post quota

environment, textile exports dramatically slowed down and showed only a very marginal growthin FY2007. The stagnancy setting in textile exports is further confirmed by its continuing poorperformance in FY2008. This is a concern not only from the perspective of the textile industrybut also for the overall export performance of the country and the subsequent impact on thetrade account and the balance of payments. It also brings to the fore the need to have adiversified industrial and export base to reduce dependence of the economy on any singlesector in the contemporary competitive global trading environment.

41. Food, Beverages and Tobacco: The major components of Pakistans food, beveragesand tobacco industry are vegetable ghee, sugar, cigarettes, cooking oil, wheat milling, tea,beverages and cigarettes. In FY2008 the sector grew by around 9%, with sugar, tea, andbeverages growing at particularly strong rates of 34.2%, 12.4%, and 24.3% respectively. The

sector constitutes more than 14% of the large scale manufacturing in Pakistan. Pakistans majorexports include rice, seafood, fruits, vegetables, tobacco and raw meat.

42. Automobile Sector: Pakistans automobile sector is wholly private sector owned. Thereare 18 automobile assembling units in the private sector set up as joint ventures. There are also47 units producing motorcycles. The automobile industry, however, continues to be of modestsize in terms of its contribution to GDP and employment particularly when compared to otherAsian economies like the Japan, Korea, Malaysia, China and Thailand which have all exploitedthe catalytic role of the automobile industry in promoting broad based manufacturing sectorgrowth. The sector unfortunately has not had the desired impact in Pakistan for variousreasons. It continues to remain protected with high import duties and other barriers to entry andcompetition which make it uncompetitive. The deletion program mandates a certain portion of

domestically produced content. In doing so, the program provides non-tariff based protection toboth domestic assemblers of motor vehicles as well as domestic producers of parts andcomponents. These policies discourage domestic and foreign competition and allows for small,inefficient yet profitable domestic automobile producers. Unless these structural issues areresolved, it might not be possible for an efficient Pakistani automobile sector to emerge at thisstage.

43. Fertilizer Industry: The fertilizer industry is totally in the private sector after successfulprivatizations in recent years. It consists of 6 companies of which 4 are listed on the stockexchanges. Fauji Fertilizer is the major player in the market with a market concentration of 44%with Engro following at 17% market concentration. Engro is on its way to expanding its capacityand by 2010 it is expected that its market share will increase to 35%. The structure of the

fertilizer industry is thus expected to become a virtual duopoly, raising potential competitionrelated issues, especially when the fertilizer industry is also marked by price distortions. TheGovernment subsidizes input costs for the industry by selling feedstock gas for urea (the majorfertilizer produced in Pakistan) at approximately 50% of that charged for commercial usage.This subsidy has had a significant impact on increasing fertilizer use as a majority of the farmersuse urea without conducting proper soil tests to identify fertilizer and micronutrient requirement.The danger is that excessive fertilizer use can have a detrimental impact on land quality and

10Ibid


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agricultural yields, while the runoff into waterways and water reservoirs has potentially seriousenvironmental and health consequences. The impact of the fertilizer subsidy on marketstructure and long-term agricultural productivity needs to be studied and an appropriate policyresponse formed to mitigate its adverse impacts.

44. Cement Industry: The cement industry consists of 27 firms all owned by the private

sector of which 21 are listed on the stock exchanges. The cement industry is witnessing a majorboom on the back of both greater domestic consumer demand for housing generated by higherincomes as well as by the Governments increased spending on public sector developmentprojects. The proposed mega infrastructure projects will continue to fuel growth in this sector. InFY2007 cement sales grew by 31% to 17.53 million tons against the current total capacity of 24million tons which is expected to rise to 37 million tons by the end of 2007 in light of capacityexpansion underway. Cement exports also increased significantly in FY2007 to $103 million from $98 million in FY2006.Cement exports increased further very strongly to $354 million inFY2008.

45. Key Issues Private Participation in the Manufacturing Sector: Several genericconstraints impact the level and quality of private sector participation in the manufacturing

sector. The first constraint stems from the lack of quality manpower which requires theaddressing of the skills gap for higher labor productivity and improving internationalcompetitiveness. The second constraint is lack of electricity and power. Electricity shortage andpower outages place a huge burden on the manufacturing sector. The existing power subsidystructure subsidizes power for agriculture and domestic consumption by chargingproportionately higher tariffs from the manufacturing sector. In the absence of vitally requiredinvestments, the growing energy demand in the country will only exacerbate the power supplydeficit to the manufacturing sector situation in the future. The third constraint is the inefficientfactor markets especially for land and labor. Inefficient and archaic land registration and transferlaws as well as rigidities in labor laws affect investments and growth in the manufacturingsector. The new Employment Services Act should hopefully address the issue of labor marketflexibility by allowing temporary labor contracts as well as rationalizing many of the existing laws

governing labor welfare and levies. Finally, availability of long term finance remains an issue.This, coupled with undeveloped corporate debt markets, generates an unfulfilled need for bothlong term debt instruments as well as project finance. The SME sector in particular faces acritical shortage of financial intermediation services. One of the important factors retardingaccess to finance is the land registration and transfer system which has effectively removedland from the pool of acceptable collateral in many cases.

1.5.4 Construction

46. The construction sector in Pakistan is also almost wholly in the private sector. Itemploys 2.5 million people. A recent revival in this sector has been led by international privatedevelopers, mainly from the Middle East on the back of the growing housing requirements of an

expanding population. Also, given the expanding public sector development program and hugeinvestment requirements, the future prospects of the sector remain bright. The sector has thepotential to export services worth US$ 1 billion per year11. In 2007, the Karachi Stock Exchange(KSE) listed its first real estate development company. But there remain various issues ofconcern in the construction sector from the point of view of encouraging greater privateinvestment. First, due to lack of available financial services, very little credit penetration hastaken place with the bulk of investment in property still being financed through direct equity. In

11Board of Investment. 2007. Available: http://pakboi.gov.pk


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Box 2: HUBCO- A Landmark Deal

The Hub Power Station is the first and largest power station to be financed by the private sector inSouth Asia. Financial closure of the Project took place in January 1995. This was the first such projectto be successfully co-financed by the Government, the World Bank as well as international privatesector lenders and investors. It set the standards for the formulation of a private power framework inPakistan which has since generated substantial interest from international investors in the sector.

Several other medium sized power projects have been consequently completed and are now inoperation. The Hub Power Company is listed on Karachi, Lahore, Islamabad and Luxembourg StockExchanges, has the largest market capitalization of any private company in Pakistan, and has overseventeen thousand (17,000) Pakistani and international shareholders.

1.5.6 Services Sector

49. The services sector in Pakistan consists mainly of wholesale and retail trade, transport,storage and communications, and financial and insurance services. The services sector inrecent years has been the largest contributor to growth and employs approximately one third ofthe workforce of Pakistan. The services sector has been steadily gaining a larger share of the

economy over the past few years, lending support to overall growth during years of poorperformance by the commodity-producing sectors.

50. Wholesale and Retail Trade: Mostly private, wholesale and retail trade has shown agrowing trend and employs a large part of the services sector labor force, with most jobs basedin the informal sector. Sub-areas in the wholesale and trade sector include, among others,import and export of goods, activities of purchase and sale agents, and those of brokers andauctioneers. A significant portion of the domestic economy is linked to trade through its forwardand backward linkages.

51. Communications: Road transport and trucking is almost fully in the private sector. Thepublic sector still dominates the air and railways. The public Pakistan International Airlines(PIA), however, faces growing competition from private airlines12 that have come up strongly inrecent years. To attract private sector interest in the electronic media, the Government issued aPakistan Electronic Media Regulatory Ordinance in 2002, which allowed the establishment oftelevision channels in the private sector. Today, more than 50 private TV channels are on air inPakistan. Likewise, new FM band radio licenses have been issued and a number of privatechannels are on air. In the telecommunication sector, with the creation of an enablinginvestment environment in the sector, the mobile phone industry is dominated by the privatesector with several foreign affiliated companies providing a range of telecommunicationservices. Largely, due to the mobile phone revolution in the private sector, telephone density inPakistan has increased dramatically from 4.4% in FY2003 to 46.9% in FY2007.

52. Finance: Besides the State Bank of Pakistan, the finance and insurance sector includesscheduled commercial banks, DFIs, and leasing and insurance companies.

53. Commercial Banks: The banking sector has seen a major shift in ownership from thepublic to the private sector following a successful financial sector privatization program. Theshare of private sector banks in aggregate assets of the banking industry surged from below 44percent in 2000 to above 77 percent in 2005. The entire increase in the private sector ownership

12Shaheen Air International, Aero Asia Airlines and Air Blue


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was due to a gain in share of the local private banks (LPBs) (Figure 4). Privatization hastened adecline in asset concentration within the banking sector and enabled consolidation of theerstwhile weak financial institutions.

Figure 4: Increased Ownership of Local Private Banks

Source: State Bank of Pakistan. 2005. Pakistan Financial Sector Assessment 2005. Karachi

54. Since 2002, the Islamic financial sector, in particular Islamic banking, has made rapidprogress in Pakistan. Financial institutions have been allowed to establish full-fledged IslamicBanks (IB) in the private sector, set up subsidiaries of existing commercial banks, and startstand-alone Islamic banking branches of existing commercial banks.

55. Non Banking Financial Institutions (NBFIs): The ownership structure of the NBFIsector has also changed considerably between FY2001 and FY2005 (Figure 5). All major public

sector DFIs have been either liquidated or merged with the banking institutions, and the publicsector closed-end mutual funds were taken over by the private asset management companies.With the transformation of leading public sector DFIs, market enabled mutual funds have takenover the leading position in NBFIs. As part of the transformation process, the IndustrialDevelopment Bank of Pakistan (IDBP), which was an active specialized institution, changed intoa specialized scheduled bank. The SME Bank which was previously a DFI has now become alicensed commercial bank. The remaining DFIs are mostly foreign sponsored holdingcompanies such as Pak Libya Holding Company and Pak-Kuwait Investment Company.Attempts to privatize IDBP and the SME Bank are underway. At this point, however, only theSME Bank has a serious possibility of privatization after having being granted a commercialbanking license.


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Figure 5: Ownership of NBFIs

Source: Source: State Bank of Pakistan. 2005. Pakistan Financial Sector Assessment 2005. Karachi

56. In leasing, the biggest company - the National Development Leasing Corporation(NDLC) - is a singular public sector company, while the majority of its shares are in the privatesector. Joint ventures in the leasing sector comprise partnerships between the Government andsome governments in the Middle East and are in the public sector with no immediate plans ondivesting equity to the private sector. No public private partnerships exist at this time in theleasing sector.

57. The Insurance Sector: Pakistans insurance sector comprises life insurance, non lifeinsurance, the reinsurance and takaful13 industries. As highlighted in Table 9, public sectorownership of the life insurance sector in 2006 (last year for which such data is available) wasvery high at almost 65%. The reinsurance sector is totally in the public sector. The private sectordominates the non-life insurance with only one public sector institution active in this sector. Asof September 30 2006, there were 5 life insurance companies, 52 non-life insurance companies,1 takaful operator and 1 reinsurance company.

58. Both the life insurance and non life insurance companies expanded their businessconsiderably in recent years, leading to rising profits of the insurance industry which totaled Rs.6.9 billion in 2005 compared to Rs 4.0 billion in 2004. Figure 6 indicates the profitability of theinsurance industry in 2005 and, in particular, highlights the high profit margins in the lifeinsurance sector. Considering that the life insurance sector remains in the public sector andrelatively slow to roll out new products and adopt state of the art risk and actuarial models, anyinjection of private sector dynamism could further boost the size and profitability of the lifeinsurance sector.

13Takaful, the Islamic alternative to insurance is based on the concept of social solidarity, cooperation and mutualindemnification of losses of members. It is a pact among a group of persons who agree to jointly indemnify the lossor damage that may be inflicted on any of them, out of the fund they donate collectively.


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Table 9: Asset Structure of the Insurance Industry

Source: Source: State Bank of Pakistan. 2006. Pakistan Financial Stability Review 2006. Karachi

Figure 6: Insurance Sector Profitability- 2005

Source: Source: State Bank of Pakistan. 2005. Pakistan Financial Sector Assessment 2005. Karachi

59. Pakistans insurance density14 is still very low, increasing from 2.7 in 2001 to 4.0 in 2004with insurance penetration15 remaining virtually constant during this period (Table 10). At theselevels, Pakistans insurance industry is substantially underdeveloped compared to many other

countries. Amongst the factors retarding its growth are highly skewed market concentrationpatterns - the legacy of nationalization, a weak regulatory structure and governance systemsand a virtually nonexistent market for long term debt and investment instruments. The SECPunder the Insurance Ordinance 2000 took over as the formal regulator of the insurance industry.The SECP is still in the process of creating the requisite infrastructure and in-house capability to

14Insurance density is defined as gross premium per capita.

15Insurance penetration is defined as gross premium as percent of GDP.


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SECTION II

PUBLIC POLICY AND STRATEGY AND THE RISE OF THE PRIVATE SECTOR

2.1 MAJOR AGENTS OF CHANGE

60. Since 1999, the Governments policy of economic structural transformation based onderegulation, decentralization, economic liberalization, and privatization, has aimed to expandand enhance the role of the private sector. With the implementation of the Government in reformprogram on the mentioned lives, Pakistan was ranked among the top ten reforming countries inthe world in 200616, although the rating slipped subsequently in 2008.

61. Privatization has been the most important component of the Governments strategy forinvigorating economic growth, attracting investment, and creating opportunities for the privatesector. In addition to strategic sales where management control is divested, the Governmenthas used privatization to develop, broaden and deepen domestic capital markets. For thisreason, the Government has sold minority shares via the stock market in selected companiesbefore or after the transfer of management control. Listing and selling companies in the local

stock exchanges is likely to give a much-needed boost to the stock markets and help tap intodomestic and foreign savings. Listing companies in the stock exchange will also improvecorporate governance, as companies will be forced to comply with the stringent reportingrequirements of the stock exchange and SECP.

2.2 PRIVATIZATION

62. Pakistans privatization experience is considered as being among the most successful inSouth Asia. Privatization picked up in 1999 when a number of structural bottlenecks wereremoved. The Privatization Act 2000 was promulgated, the macroeconomic environment wasreformed, regulatory frameworks were established17, a Ministry of Privatization and Investmentwas created, a high-powered Cabinet Committee on Privatization (CCOP) was formed, and the

Board of the Privatization Commission was strengthened.

63. A number of strategic sales in the financial, energy, electricity and manufacturing sectorshave been since concluded. Until December 2006, assets worth PKR 418.6 billion from 49transactions had been privatized, prominent amongst which included the privatization ofPakistan Telecommunication Company Limited (PTCL), HBL, UBL, KESC, NRL, and a numberof fertilizer and cement companies. As a case in point, Box 3 highlights the successfulprivatization of Pakistans financial sector. The privatization program also played a major role inthe development of the capital markets by using domestic and foreign stock exchanges fordive

private sector assessment

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