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Reviving Investment In The Shadows Of War
Dr.Akmal Hussain
Newspaper: Daily Times
Dated: Thursday, June 06, 2002

The regime of president Musharraf has done well in holding firm to its strategic objective of economic revival in the face of the rhetoric of war unleashed by India. In concretely addressing the concerns of the international community with respect to cross border infiltration, and in renewing the offer to meet Prime Minister Vajpayee, (with the new dimension of "no conditions"), Pakistan may have won the first round in the deadly game initiated by India.

The Indian game was to use military mobilisation as a means of achieving its strategic objective of engineering the collapse of Pakistan's economy. This was being done firstly by bleeding Pakistan financially from the military mobilisation, and at the same time through a carefully calibrated rhetoric of war, to pressurize the world community into cutting off Pakistan's financial lifelines. Essential to India's strategy in this context was to convince the Western world that it would not initiate a generalized conventional war, even while taking the rhetoric of war to a fever pitch.

After President Musharraf's quick and reasoned response, the pressure of international diplomacy is now likely to be placed on India. With the continued presence of the two armies in a war posture and rising casualties in artillery exchanges across the line of control, no body will believe in India's assurance that the status quo can be indefinitely maintained without an unacceptable level of risk of the two countries tripping into a full scale conventional war. Worse still, there is asymmetry of forces at the conventional level, neither country has a second strike nuclear capability and the flying time of missiles from silo to target is less than three minutes. Given these facts the probability of a conventional war leading to a nuclear exchange whether by design or miscalculation, would also be unacceptably high to most leaders in the Western world. Therefore India's persistent avoidance of peace talks while continuing to use the threat of war as a diplomatic strategy may not be sustainable any more. The likelihood therefore is that peace talks whether direct or indirect will begin in Almaty and a de-escalation of the present military situation will be negotiated at some point.

Since the diplomatic tide may have turned in Pakistan's favour we might as well face a question that is sure to arise as the first consequence of peace: How to induce an increase in private sector investment? It may be useful at this stage to consider the major economic factors that influence investment. These are:

(1) Worldwide experience of market economies has shown that most of private sector investment in manufacturing is financed from corporate profits. This is particularly true in Pakistan's case. Therefore it may be advisable to review the present high rates of corporate taxes in Pakistan. In the past governments have instituted high rates of corporate taxes in order to achieve revenue targets in a situation where the tax base is narrow. Such a policy has now become counter productive since high tax rates may be a factor in low investment, growth and therefore low revenues. It may be advisable to achieve high government revenues by lowering the tax rates, inducing higher growth and broadening the tax base more energetically. The government may well find that the elasticity of corporate tax rates with respect to government revenues is high, in view of the large positive effect on investment and growth resulting from lower tax rates.

(2) Tax cuts during a period of recession are used in many countries (including the current government in the U.S.) as a device for increasing disposable incomes of people and thereby increasing consumption and aggregate demand, which ultimately have a positive effect on investment and growth.

(3) Relatively low rates of return on investment in the manufacturing sector in Pakistan to-day constitutes another constraint to increased investment. The following four factors underlie low rates of return on investment in the manufacturing sector: (a) The structure of manufacturing industry is still distorted in favour of low value added, low skill industries. The constraints to diversification in the manufacturing towards high value added export based industries need to be addressed urgently. (b) Lack of industry specific skilled manpower at the shop floor adversely affects rates of return due to low labour productivity, machine damage and high consumption of spare parts and tools due to incompetent machine operators. (c) Poor quality of infrastructure. This includes poor transmission quality and high voltage fluctuations of electricity; lack of ancillary infrastructure for industries such as machine maintenance and production of spares and tools; and poor quality of roads, railways and communications. These serve to increase average costs per unit of output in industry. (d) High interest rates on bank credit constrict net profit margins of industries. Although in recent months the State Bank has made an important contribution by bringing down interest rates there is need for a further reduction.

There is a close relationship between wealth and investment. If people are losing the dollar value of their assets such as real estate and rupees savings in the form of bank deposits, then their capacity to invest is also reduced. In this regard the sharp depreciation of the exchange rate in Pakistan from approximately Rupees 34 per dollar in 1996 to Rupees 60 per dollar in the year 2002 means that the dollar value of assets and savings of people in Pakistan has been sharply reduced in a situation where their rupee value has not significantly increased. It is therefore important to maintain exchange rate stability in the future and prevent the rupee from depreciating further.

The best form of defiance to India's strategy of undermining Pakistan's economy is to devise policies to strengthen it even in the shadows of war. It is necessary therefore to engage in critical thinking, and planning policy actions to increase investment. Having deflected the threat of war, we must now be prepared to face the consequences of peace.

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