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Now for the hard part

SEVERAL MONTHS before he was killed in a plane crash in August 1988, Pakistani military strongman General Mohammad Zia ul-Haq, who ruled the country with an iron hand for 11 years, reportedly complained to a small gathering of investors that he didn't understand their mind-set. "If only you guys had invested ten years ago, you all would have had spectacular returns," Zia chided.

"Sir," one of the investors is said to have responded, "if we had known you would be around for ten years, we would have indeed invested. We believed you when you said you were just an interim president."

Investors, and Pakistani citizens, might be forgiven for adopting a similar refrain today. Pakistan's leader, General Pervez Musharraf, has held power for four years following his ouster of Prime Minister Nawaz Sharif in a bloodless coup in October 1999. Since then he has stabilized a revolving-door government, tackled endemic corruption, overhauled and revitalized much of the country's sagging economy and strengthened its geopolitical standing by forging a close bond with the U.S. in its post­September 11 war on terror and, more recently, by beginning a tentative rapprochement with neighboring India.

Such a record ought to prompt cheers -- and an influx of investment dollars -- but Musharraf and his country must contend with continued skepticism. Despite economic strides, Pakistan remains afflicted with widespread, grinding poverty. Political tensions are high, fueled by rising Islamic militancy. The National Assembly, where Musharraf's allies hold a narrow majority, is stalemated; it has passed just one piece of major legislation since it was elected in October 2002. One issue appears to unite all opposition parties: How long will the upright and decisive Musharraf -- who added the presidency to his military leadership duties in June 2001 -- keep both positions? Opponents are agitating for him to resign as army head and surrender his otherwise unassailable power base.

In a wide-ranging interview with Institutional Investor at Army House, the official residence of the head of Pakistan's armed forces in Rawalpindi in August, Musharraf insisted that he will relinquish his role as armed forces chief, but he declined to give a timetable. Doing so, he said, would lessen his ability to enact needed reforms.

"If I give a date today, even though it may be one or two years or three years later, the countdown starts and one loses significance in whatever one wants to do," Musharraf told II (see page 48). "But when I say that I will remove it [the military title], one should trust. I never break my word."

Taking Musharraf at his word has proven to be a solid bet so far. He came into power vowing to attack corruption, restore democracy and reform the economy as part of his goal to create a moderate Muslim nation with a prosperous, stable middle class and modern, resilient democratic institutions. It's a dream shared by many of his fellow citizens. Former President Farooq Leghari says that "Musharraf's vision for the country is by and large accepted by the people." He has succeeded beyond most skeptics' expectations on the economic front; the political aspirations remain unfulfilled.

A crack economic team led by Finance Minister Shaukat Aziz, a onetime Citigroup executive, and aided by central bank chief Ishrat Hussain, a former World Bank economist, has implemented an aggressive program of corporate reform, debt repayment and privatization. Aided by billions of dollars of assistance and debt forgiveness from the U.S., they have wrung eye-catching results from Pakistan's once nearly bankrupt economy.

The list of achievements is impressive. Through the June fiscal year, GDP grew 5.1 percent, the second-best performance in Asia behind China. Budget deficits that routinely ran near 8 percent of GDP in the 1990s have been cut to about 4 percent; a current-account shortfall has become a surplus. The Karachi Stock Exchange rocketed 125 percent in the 12 months through June, the best performance in the world. Standard & Poor's recently upgraded Pakistan to B from CC, citing its economic reforms. The country plans shortly to prepay about $1 billion in outstanding International Monetary Fund, World Bank and Asian Development Bank borrowings, and is slated to launch a $250 million to $300 million global bond offering -- its first since 1997.

The hope now, Musharraf says, "is to transform the economic gains to the people of Pakistan for their emancipation and for the general good of the society, so that we are known as a very stable, balanced, progressive, dynamic Islamic country."

An urgent goal is to bring the poverty rate down to 25 percent from the country's own estimate of about 32 percent within three years. To do so, Pakistan needs to accelerate growth -- both the government and outside analysts agree that it must increase the 5.4 percent level expected this fiscal year to above 6 percent -- and sustain the faster pace for several years. But local and foreign investors remain unwilling to risk major long-term bets that might hasten growth. Foreign direct investment rose sharply last year to $800 million, up from $485 million in 2001, yet it fell well short of Aziz's $1 billion goal.

Some skeptics question Pakistan's recent performance. Former prime minister Benazir Bhutto, who leads the Pakistan People's Party, the country's second-biggest, argues that the economy looks stronger than it really is because of Pakistan's post-9/11 "emergence as a key ally of the West, which has resulted in enormous handouts." Bhutto insists that "real internal drivers of growth are still not in place."

Feeding popular discontent -- and opposition to Musharraf -- is Pakistan's pervasive poverty. The United Nations Development Program recently reported that the number of poor people in Pakistan is increasing by 10 percent a year, or five times faster than the general population, and that 37 percent of the country's 145 million people live on less than $1 per day. Official unemployment figures -- which don't register Pakistan's huge numbers of underemployed -- hit 7.8 percent last year, up from 5.9 percent four years ago.

The political terrain is also holding back Musharraf and his administration. Remnants of the Al-Qaeda terrorist group and its Taliban backers are reportedly holed up in Pakistan's wild North-West Frontier Province, presumably aided by local sympathizers. In that province an increasingly popular Islamic coalition known as Muttahida Majlis-e-Amal (the United Action Front), which includes fundamentalist elements, won a majority in the local assembly and leads a second coalition that controls another provincial assembly in Baluchistan. MMA, now the country's third-largest political party, also holds 68 seats, about 20 percent, in the National Assembly.

As part of his plan to restore democracy, Musharraf allowed last October's National Assembly elections, the first since his coup. He took care the preceding August, however, to offer a presidential edict, sanctioned by the Supreme Court, that assures him unprecedented control. This new Legal Framework Order is a sweeping series of 29 constitutional amendments that give all of the government's post-coup decrees the force of law. Among its many provisions, the LFO allows Musharraf to disband the National Assembly if he chooses.

Musharraf's preemptive strike turned out to be well advised because the election results were a shocker. The PML-Q party (the Pakistan Muslim League; the "Q" refers to Quaid-e-Azam, or great leader, as Muhammad Ali Jinnah, the founder of the country, was known), with which Musharraf is aligned, won a scant two-seat majority only after cobbling together a coalition with several smaller parties and dissidents from Bhutto's Pakistan People's Party. Musharraf's allies fell well short of the two-thirds majority he would have needed to pass his constitutional amendments in the assembly. As a result, Musharraf has avoided bringing the LFO up for a legislative vote; instead he has governed mostly by decree.

Opponents believe the National Assembly should vote on these unprecedented amendments as well as Musharraf's dual leadership positions -- Pakistan's 30-year-old constitution does not permit one person to hold both jobs. Without the assembly's approval, they say, Musharraf's administration -- although he won the popular support of Pakistanis in an April 2002 referendum giving him a five-year term as president -- still lacks legislative legitimacy. "One man can't change the constitution. The constitution clearly says that requires a two-thirds majority in the National Assembly," says Hamid Khan, president of the Supreme Court Bar Association, a trade group for lawyers.

Although he strongly disagrees with this notion, Musharraf has opened discussions with the MMA over broadening the PML-Q coalition to create a government of national consensus. The aim would be to gain legislative support for his agenda and, longer term, put in place laws that can't be shunted aside easily when he is no longer around. Such certainty would encourage domestic and foreign investors alike.

Musharraf portrays Pakistan's choices in stark terms. "We are at a crossroad," he says. "Is the path one of confrontation, extremism, fundamentalism, intolerance, which the minority is trying to spread? Or is the path one of enlightened moderation?"

The crossroads is literal as well as metaphorical. Pakistan borders fundamentalist Iran; longtime rival India, with which it has been in a tense nuclear standoff over Kashmir; and a still-wobbly Afghanistan, where President Hamid Karzai has accused the Musharraf government of meddling.

"Some very serious analysts tell me that given what we have achieved in the past three years, we would be the darling of the investment community if we were not located in a bad neighborhood," says central bank head Hussain.

Some analysts, like Stephen Cohen, a senior fellow at the Brookings Institution in Washington and an expert on South Asian politics, downplay the country's internal dangers. "For now the dangers of Islamic extremism in Pakistan are grossly overblown," he says. They will only become more serious if Musharraf can't follow through on his promises of economic and political reform, he notes. "Pakistan isn't about to become the next Iran. Pakistan is deeply Islamic, but it is still a fairly moderate country."

Musharraf and his key policymakers want to keep it that way. "Political stability and economic stability are intertwined," says Hussain. "You cannot divorce one from another. You can have a spurt of growth but you cannot have sustained growth unless you have a predictable political transition process."

PAKISTAN'S ECONOMY IS IN MUCH BETTER SHAPE today than it was when Musharraf took control. In October 1999 "no financial agency would touch us with a barge pole," says Waseem Haqqie, a former General Motors sales executive in the Middle East, who as head of the country's Board of Investment, seeks to attract investors to Pakistan.

After it responded to India's nuclear weapons tests with its own nuclear detonation in 1998, Pakistan became an international pariah largely cut off from assistance and markets in the U.S. and Europe. Before that, Bhutto's Pakistan People's Party and Sharif's Pakistan Muslim League party (which is not the same as the Musharraf-affiliated PML-Q), which each held power twice in the 1990s, were unable to get budget deficits under control or rein in bloated state-owned enterprises.

Pakistan's net foreign exchange reserves had slumped to a meager $300 million to $400 million in late 1999, enough to cover only three months' imports. Total debt and liabilities had soared to $38 billion, or 3.35 times foreign exchange earnings. The 1999 budget deficit had jumped to 7 percent of Pakistan's then $47.5 billion GDP, and nearly 65 percent of total revenue was going to finance the shortfall.

Rampant corruption particularly galled Musharraf, who is said to value personal integrity above almost anything else. In 1996 Pakistan was rated the world's second-most-corrupt country, after Nigeria, by Berlin-based Transparency International, which assesses the prevalence of bribery and other official misconduct around the world. Just this past summer a Swiss investigating magistrate said he found sufficient evidence that Bhutto and her husband, Asif Ali Zardari, had taken bribes from two Swiss firms back when she ran Pakistan nine years ago that he recommended that local police pursue the case. Depending on their findings, the case may go to a Swiss court, where Bhutto, who denies the allegations, tells II she and her husband will present a "vigorous" defense.

Just a month after taking office, Musharraf set up the National Accountability Bureau and gave it extensive powers to investigate and prosecute corrupt officials. To date it has convicted 270 people on corruption-related charges and has another 231 cases in progress. Pakistan dropped to 26th out of 102 countries in TI's 2002 survey, although it's hardly corruption-free. In a survey of 1,724 urban and suburban members of Pakistan's middle class conducted in 2001 and 2002, TI found that every respondent who sought police help was asked for a bribe of some sort. "Results are not 100 percent," Musharraf conceded of NAB's efforts in a national address last November. "But whatever work they have done, I want to tell you it has never been done in the history of Pakistan."

Lacking formal training in economics or finance, Musharraf sought qualified help. In short order he recruited Finance Minister Aziz, who had worked all over the world for Citigroup and was at the time the head of its global finance effort, and central bank chief Hussain, who had run the World Bank's Southeast Asia economic research. With Musharraf providing political backing, they have aimed to "cut the role of government, and thus corruption, through deregulation and privatization; clean up the banking sector; attract new investments; reform tax administration; and, most fundamentally, improve the crushing debt situation," notes Sakib Sherani, the Pakistan economist for ABN Amro Bank in Karachi.

"We quickly diagnosed the problems we were facing: unsustainable fiscal deficits, lack of growth and precarious balance of payments," says Aziz.

Of course, rapidly rising U.S. aid and debt-forgiveness in return for Musharraf's crucial support for the Bush administration's war on terror have given the government ample room to maneuver. From a piddling $5 million in 2001, U.S. assistance to Pakistan surged to slightly more than $1 billion in 2002. This year about $560 million in assistance has been allocated and an additional $1 billion in debt canceled. Bush has requested another $395 million from Congress for aid to Pakistan this year. During Musharraf's June visit to the White House, Bush promised to press to establish a five-year, $3 billion aid package for Pakistan, with annual installments of $600 million beginning in fiscal 2005. This is a substantial help to a country whose total budget this year is $15 billion.

Pakistan has also gotten some unexpected bookkeeping aid from the U.S.'s war on terrorism. Last year Pakistanis working abroad sent $4.3 billion in remittances back home, up from $1.6 billion just two years before. Why the jump? When the U.S. government helped shut down many of the informal hawala and hundi channels of money transfers in 2002, the banking system started to receive more of these funds. Now coming in through official channels, the money gets counted toward Pakistan's current account. With 5 million to 6 million Pakistanis living abroad and more of this money expected to arrive through banks, there is easily room for official tabulations of remittances to top $6 billion a year, say experts.

The government has also become a more assertive tax collector. In 1999 it brought in $5.3 billion in taxes. Outpacing economic growth, tax revenues climbed to $8 billion in 2002 through a combination of stricter enforcement and more effective collection of a general sales tax on goods and services.

Privatization efforts are another potentially big source of revenue. After nearly two decades operating as a near-socialist state, Pakistan began a program of privatization in 1982 under General Zia. But poor markets and frequent changes in government caused repeated delays in the program. From 1990 to 2000 just $1.1 billion was raised from private investors. Musharraf's administration has jump-started the process, raising $607 million from 1999 through 2001 and $1.75 billion last year; its goal for the next 12 months or so is to privatize about two dozen companies and raise up to $6 billion.

Coming hand in glove with privatization, reform of state-owned enterprises is also beginning to ease the burden on government coffers. State enterprises last year lost $800 million, but that is down from $2 billion in annual red ink before Musharraf's administration. Some loss makers, such as the state airline PIA, were turned around; others were sold off. This year losses at state enterprises should drop to $500 million. Central banker Hussain says next year should be close to breakeven.

Lower subsidies for these businesses "will free up money for things like infrastructure, education, hospitals, poverty alleviation," says Hussain. "This is just the sort of virtuous circle Pakistan needs to get into."

Aziz and Hussain have tried to wring inefficiencies out of several major Pakistani industries, including banking, which the Sharif administration had already begun to reform. Traditionally, Pakistani banks had been victims of politically motivated lending, poor management and delinquent borrowers. Under Musharraf more than 30,000 bank employees have lost their jobs as a result of restructuring, says Hussain, and new Pakistani senior executives have been recruited from foreign banks.

The government and these new executive teams have pushed thorough-going reform. Following the $215 million privatization of $2.7 billion-in-assets United Bank last year and the expected sale of Habib Bank, the country's second largest, with $7 billion in assets, more than 80 percent of banking assets will be privately held, says Hussain. What's more, the government has also cracked down hard on deadbeats: Nonperforming loans at commercial banks have dropped from more than 25 percent of the total loan book in 1999 to just above 9 percent.

Unencumbered by bad debt at its banks and less pressured by public sector borrowing demands, the central bank has been able to cut its benchmark rate from nearly 19 percent four years ago to a recent low of just 7 percent. Lower rates have brought many benefits. By making mortgages more affordable, the government has kick-started a housing boom and helped double property prices in cities like Karachi. "To build houses you need cement, doors, paints, all sorts of construction materials," says Hussain. "The multiplier effect of a housing boom is incredible. It creates jobs. It generates growth." The halving of auto loan rates, to 8 percent, has created an eight-month waiting list to buy locally assembled subcompact Japanese cars.

Agriculture, which makes up 25 percent of GDP and employs 44 percent of the population, has also had a strong run. Cheaper farm loans and good weather have made Pakistan a net exporter of wheat and sugar. Other exports, primarily cotton, yarn and textiles, rose 21 percent in the last fiscal year, to slightly more than $11 billion, because of improved access to European markets and a surge in prices. As a result of the export boom, the government, which traditionally ran big current-account deficits, had a surplus of roughly $3 billion last year and forecasts exports to surge 10 percent this year, to $12.9 billion.

To sustain growth the government is trying to put Pakistan's location to work. "We see Pakistan as a hub that lies between Central Asia and the Middle East," says the Board of Investment's Haqqie. "We can leverage on our strategic location if we build the infrastructure." Pakistan is constructing a coastal highway connecting Karachi with a new port in Gwadur, which will, in turn, be connected by additional new roadways to other parts of the country and to landlocked Afghanistan. The port and highway system, at a total cost of $6 billion, will bring trade from a number of Central Asian republics through Pakistan.

FOR ALL THESE EFFORTS, THE BENEFITS ARE ONLY slowly trickling down to Pakistan's massive number of poor people. Per capita income in Pakistan last year was just $492, less than half the Philippines' $1,000.

Musharraf's political opponents believe technocrats like Aziz and Hussain are merely nibbling at the edges of Pakistan's deep-seated problems. Senator Khurshid Ahmad, vice president of Jama'at-e-Islami Pakistan, a leading Islamic opposition party and a major partner in the MMA alliance, contends that Musharraf's economic policies pay "lip service" to reform. He believes massive land reform is needed. "Six hundred families own half the farmland," he says. "There's no indication that the government is interested in land reform, because they are all landlords."

Aziz would prefer to give the recent batch of reforms time to work. "Rome was not built in a day," he says.

To accelerate the pace of change, the government is about to launch its most ambitious series of privatizations yet -- $2 billion worth in the next few months, according to Abdul Hafeez Shaikh, the minister for Privatization and Investment. On the auction block is not just Habib Bank but also Pakistan State Oil Co., Faisalabad Electricity Supply Co. and Jamshoro Power Co., among others.

"Ninety percent of the proceeds from privatization will be used to retire debt, and the rest will be spent on poverty alleviation programs," says Hussain.

But to sell all these companies Pakistan needs more than last year's $800 million in foreign investment. Aziz has targeted $1.4 billion this year. Pakistan is doing everything it can to lure the foreigners. "There is no restriction on foreigners to go into any industry, there's no restriction on the amount of equity or on the amount of money that can be repatriated," says Shaikh.

So far, Pakistan's enticements haven't had much impact. "Pakistan has not been an interesting investment proposition for many years," says A. Shabu Qureshi, who is trying to launch a Pakistani private equity fund. But Qureshi, whose firm is affiliated with Washington, D.C.­based Emerging Markets Partnership, thinks the environment is changing. "It's still off the map for foreign investors, but the country is now beginning to look interesting. We're looking at a five-year period and feel there are opportunities now at this early part of the cycle."

Foreign investors might pay more attention if Pakistanis themselves showed more confidence in their country's future. Domestic investment dropped more than 10 percent last year. Notes a Western diplomat in Islamabad: "Most Pakistani investment is going into the stock market and property, not into productive sectors. The smart local money that sees opportunity is not willing to look to the long-term future." Foreign multinational companies, he says, "are keeping their powder dry; they want to see the local smart money playing first."

Former prime minister and bitter Musharraf foe Bhutto says security is the main issue scaring off foreigners. "The Musharraf regime has failed to curb militants and militias. There are growing attacks on police, on worshipers in mosques, on people in churches and hospitals. The growth of the religious right and daily reports of violence are also frightening investors. Unless Musharraf can tackle the perception of terrorism, Pakistan isn't going to see investments grow." Western diplomats privately agree, noting that Karachi, Pakistan's principal seaport, is generally viewed as one of the world's most dangerous cities.

A sustained period of political stability would no doubt coax more investors off the sidelines. With the backing of the mostly moderate Islamic military, and unprecedented political power, Musharraf is Pakistan's unrivaled leader. That -- not religious issues -- provokes the divisiveness that has helped grind the legislative process to a halt. Since the October elections, the National Assembly has passed only the budget. And even then microphones had to be muted while Aziz read a summary to overcome heckling from opposition politicians.

Although its political system may struggle to adapt to this new form of guided democracy under Musharraf, Pakistan's economy continues to grow and the Karachi exchange rose another 32 percent in July and August. Says one local investor: "What Pakistan needs now is just to stay the course for a few more years until the economic drivers are in place for sustainable growth that cuts poverty and creates employment."

Staying the course, however, has never been Pakistan's strong point. If Musharraf is to succeed where so many of his predecessors have failed, he needs to push the country's near-term growth rate a little higher -- and foster a viable, functioning political system.


General Pervez Musharraf came to political power in October 1999 when his army colleagues took control of Pakistan after then­prime minister Nawaz Sharif tried to fire him. Musharraf was at the time flying home from Sri Lanka. "When I landed I was the head of a country," he recalls.

A lifelong soldier, Musharraf was initially considered an unlikely statesman, but the 60-year-old has led Pakistan's transformation from an international outcast, because of its 1998 nuclear bomb test, to a prominent player in the U.S.'s global war on terrorism. Nearly bankrupt when Musharraf took over, Pakistan's economy, with U.S. financial help, has made huge strides over the past four years. However, Musharraf still faces gridlock in Pakistan's National Assembly and big risks ranging from terrorism to growing religious fundamentalism to occasional threats from neighbors like India.

Born in New Delhi, India, Musharraf, the son of a diplomat, was educated at St. Patrick's High School in Karachi and then at Forman Christian College in Lahore. He joined the Pakistan Military Academy in 1961 and received medals for valor and bravery in action during the 1965 war with India. Sharif appointed Musharraf army chief of the staff in October 1998.

A risk-taker, Musharraf in the spring of 1999 ordered troops across the so-called line of control that separates the Pakistani and Indian armies in the disputed territory of Kashmir. Musharraf's surprise move allowed him to take the strategically important town of Kargil, but the stunning military gambit created an international crisis for Pakistan. Humiliated, Sharif had to arrange a retreat to avoid a bigger conflict. As a result, he started to maneuver to fire Musharraf, precipitating the coup.

After September 11, Musharraf took another big gamble, abandoning Afghanistan's Taliban -- which for years had received support from Pakistan's intelligence agency -- and giving his allegiance to the U.S.'s anti-terrorism campaign. The switch risked a political backlash from Pakistan's Islamic fundamentalists.

"A leader is meant to take risks," says Musharraf. "From my professional grooming I have learned to take risks and to accept risks and dangers."

Musharraf recently sat down with Institutional Investor Hong Kong Bureau Chief Kevin Hamlin for a 45-minute interview at Army House, the official residence of the head of Pakistan's armed forces, in Rawalpindi.

Institutional Investor: Your government has established the foundations for economic growth, but do you agree that now you face a tougher challenge: alleviating poverty?

Musharraf: Yes, absolutely. Economic growth has to trickle down for poverty alleviation. For the first time we have turned it around, and it decreased by 0.3 percent last year. We need to bring poverty down to about 25 percent from about 31.8 percent now in the next three years. All the megaprojects now under development have a double aim: economic revival and poverty alleviation. The communications infrastructure, the water projects, the canals are going to create hundreds of thousands of jobs while they are under construction, and they are going to alleviate poverty when they are completed.

Former prime minister Benazir Bhutto says that you got lucky, that your cooperation with the U.S. in the war on terror enabled you to get aid handouts that funded the economic turnaround. What's your response?

She suffers from sour-grapes syndrome. She couldn't achieve anything twice [while prime minister]; and she has the audacity to be talking and commenting on what I . . . I think it's below my dignity to even reply to all the propaganda she spreads about Pakistan and against me, against the army. This was an emotional outburst [laughter].

Now let me come to the reality. Certainly, 9/11 did assist, yes, but we had created a record in our GDP growth on July 1, 2001. Let this not be underestimated. We had then crossed $3 billion [in unencumbered net foreign reserves, which are net foreign reserves minus the foreign currency deposits held by Pakistani banks] and that was before 9/11, so what is she talking of? Our exports had crossed $9 billion in 2001; that was another record for Pakistan. That was before 9/11, so what is she talking of? We had started reducing our debt, and the fiscal deficit was controlled before 9/11. She is just manipulating figures for those who don't understand. All 9/11 did was assist us with debt rescheduling, and because of that, debt servicing has been reduced, and that has done us good. Investment shied away from Pakistan because of 9/11, so in some ways it also had a very negative impact.

Only one major piece of legislation has passed the National Assembly since last October's elections because of your thin majority. Are you losing patience?

The immediate concern has been to revive the economy of Pakistan and revive all the corporations of Pakistan and alleviate poverty. As far as this is concerned, whatever legislation is required can be executed because the government enjoys a simple [51 percent] majority in the assembly. Our budget was passed without a problem, although there was so much hue and cry. What cannot be done is amend the constitution, which requires a two-thirds majority in the assembly. Fine, we don't need to amend the constitution, because what amendments were required have been done [by presidential decree with Supreme Court affirmation]. So it doesn't really disturb me in the short term. Yet it does create a very negative impact on democracy in this country. That is what is disturbing.

You said you would restore democracy but that you must guide the country toward that goal. Does the assembly's inaction show that Pakistan is not yet ready for democracy?

I've never said I'm going to restore democracy. I have restored democracy. There should be no doubt of that. There's no question of [whether I am] going to restore democracy. Democracy was never being followed in Pakistan. When we came into government, the four areas of focus were economic revival, poverty alleviation, good governance and political restructuring.

In political restructuring we thought that there are two malaises that need to be checked and corrected. One was that the people of Pakistan were not participating in governance. So we held local elections. We have empowered the people of Pakistan, we have empowered the women of Pakistan, we have empowered the minorities, we have empowered the peasants and workers of Pakistan. This is democracy at the grassroots level that we brought about.

The other problem was that there were no checks and balances on the people running the government itself. We introduced these checks and balances through the Legal Framework Order [which gives Musharraf powers that include the ability to dissolve the National Assembly]. The LFO came as a package amending the constitution, which was allowed to me by the Supreme Court of Pakistan.

We held elections as per the mandate of the Supreme Court of Pakistan, as per the promise that I gave to the nation. So now there's a provincial government in place, there's a National Assembly in place, there's a Senate in place. So how come anyone can ever think that there's no democracy? Other than that, we have total freedom of speech; the media is absolutely free. These are revolutionary steps that nobody ever dared to do in the past over 50 years of this nation. Now where is democracy not functioning?

Is how long you remain as both president and army chief negotiable with opposition parties?

Negotiable to the extent that I do realize that this is not the best of arrangements. The president should not also be chief of the army staff. I will remove the hat of the army chief, but I don't want to give a date. If I give a date today, even though it may be one or two years or three years later [his five-year presidential term, beginning from an April 2002 referendum, ends in 2007], the countdown starts and one loses significance in whatever one wants to do. Therefore I don't want to give any date, but when I say that I will remove it, one should trust. I never break my word. I haven't broken it in the past. Leave the date to me.

Foreign investors view Pakistan as a high-risk country. What is your message to them about the risk level here?

The world's perception of Pakistan is unfortunately not correct in that Pakistan is considered to be a country where there is extremism and fundamentalism. Pakistan is a moderate, progressive Islamic state. The vast majority of Pakistanis are religious all right, but they are not extremists. There is only a small minority of extremists involved in this sectarian and religious extremism, and they are involved in this intolerant projection of our religion; they bring a bad name to our religion. The world has to distinguish between a religious Muslim and an extremist, fundamentalist Muslim. We are a moderate country, and we have to suppress this extremist minority by motivating the vast majority to stand up and have a voice in national affairs. I'm sure that with correct policies we will be able to address the problem, and Pakistan will in the future emerge and be seen as a moderate, progressive and enlightened Islamic state.

What is your vision for Pakistan?

We have to follow a path of enlightened moderation. I am telling the country that we are at a crossroad. We have to decide for ourselves what is the path forward. Is the path one of confrontation, extremism, fundamentalism, intolerance, which the minority is trying to spread? Or is the path one of enlightened moderation? We have improved the macroeconomic area. My vision is to transform the economic gains to the people of Pakistan for their emancipation and for the general good of our society so that we are known as a very stable, balanced, progressive, dynamic Islamic country.


Shaukat Aziz was an executive vice president running global finance for Citigroup in New York in November 1999 when he received a phone call from an aide to Pervez Musharraf. The Pakistani general had just seized power and was looking to staff his administration with experienced professionals. "Somehow he had heard about me," the 54-year-old Aziz recalls. "I was told that he wanted to meet me. One thing led to the other, and I was offered the post of Finance minister."

Aziz's brief was as simple as it was daunting: He was asked to put Pakistan's nearly bankrupt economy back on track.

Pursuing an aggressive program of debt reduction, structural reform and privatization, the Karachi-born Aziz has mostly succeeded. The country's budget deficit has dropped from 6.6 percent of GDP in 1999-2000 fiscal year to 4.6 percent in the most recent fiscal year, banks have been restructured and recapitalized, and more than a dozen companies have been shifted from the government to private hands. In December Standard & Poor's elevated Pakistan's debt rating from CC to B.

The son of a Pakistani diplomat, Aziz graduated from Gordon College Rawalpindi in Pakistan and holds an MBA from the Institute of Business Administration at the University of Karachi. He started as a Citibank trainee in Karachi 33 years ago and has at various times run the bank's Malaysian operations, its London-based emerging-markets division and, from Singapore, its Asia-Pacific corporate and investment banking businesses. He was put in charge of corporate planning in 1996 and not long afterward global finance.

Aziz recently discussed Pakistan's economic accomplishments and outlook with Institutional Investor Hong Kong Bureau Chief Kevin Hamlin and Contributor Assif Shameen in his ministry's Islamabad office.

Institutional Investor: Pakistan has come a long way since December 1999, when it was a pariah state with economic sanctions and was on the verge of defaulting on International Monetary Fund loans. How did you turn the country around?

Aziz: We quickly diagnosed the problems we were facing: unsustainable fiscal deficits, lack of growth and a precarious balance of payments. We first went about getting macroeconomic stability. We put in place a wide-ranging structural reform agenda. We also reduced the level of debt, which then allowed us to gradually cut interest rates, which in turn permitted us to gain the fiscal space to divert public expenditure toward health, education, development of infrastructure and poverty alleviation.

Three years ago 64 percent of revenue was spent on debt servicing. Today it's down to 36 percent. From huge deficits on our balance of payments, we are now running a current-account surplus. Our exports have picked up; our revenues are up through massive reforms in tax collections. Nearly four years ago we entered into a new IMF program, which will end next year. Our intention is to exit the IMF program on schedule.

So you think Pakistan is at a takeoff stage?

We are now entering second-generation reforms. No country can expect a major shift in its macroeconomic situation if it is not accompanied by structural reforms. Today Pakistan is a happening place. But there is still a lot more to do. The challenge is to transfer the benefits to the people, but a lot of these things take time. The key is that we have a process in place. The poverty level in the country is still high, at about 32 percent, but if we can get GDP growth to 6.5 to 7 percent, then we believe we will start to make dents there.

What structural reforms have you put in place?

Pakistan has reformed in many areas, be it petroleum, capital markets, banking. In petroleum we came up with a clear policy on oil exploration and imports. We gave investors a reasonable rate of return. We separated policymaking from regulation and business. Clarity of policy is critical for any investor. Four years ago crude and refined oil was imported by a government ministry. The ministry now just makes policies. There is the Oil and Gas Regulatory Authority, which regulates, and private companies like Shell, Texaco and Total, which import, distribute and retail petroleum products. What do bureaucrats know about importing or selling oil? We have done away with subsidies in oil. Oil prices are linked to global market prices. The regulator just makes sure that oil companies don't step out of line on prices. That's what structural reforms are all about -- deregulation, freedom.

Over the past 20 years, successive governments have been privatizing, but the state sector is still fairly large. Is the pace of privatization sufficient?

One of the major challenges we face is the state-owned enterprise. The privatization program is picking up steam, but we still have the power sector, which is a major drain on the government. We have in the past 12 months privatized United Bank, the third-biggest bank in the country. Next on the block is [second-largest] Habib Bank and Pakistan State Oil Co. We have also sold some equity in National Bank [of Pakistan], which is the largest, though we intend to retain majority control. There are now good standards of corporate governance at these banks. Their management has to respond to shareholders and boards of directors rather than to bureaucrats in Islamabad.

What are you doing to attract more foreign investment?

We have already put one of the most liberal investment regimes in place. Could we do more? Absolutely. But Pakistan has been in a region that has been subject to a lot of shocks. Investors need to see stability, and they need to see continuity. That is what we are getting this year and in the financial year that just closed in June, when we almost doubled our foreign direct investment to more than $800 million -- still small, but it's heading in the right direction, because people see continuity of policies. We now have an elected government.

The unique thing for Pakistan is its location. We bridge South Asia with Central Asia and the Middle East. We are right in the middle. Pakistan is a natural place for manufacturing. Capital costs are very low. Interest rates are now about 3 percent prime. Our infrastructure and productivity are improving, and our labor costs are still low.

What growth drivers are you putting in place?

Because of excess liquidity and low interest rates, consumer credit has arrived in Pakistan. Pakistan is set for a construction and housing boom. I'll give you an example. A housing project called Creek City was launched in Karachi recently, 300 luxury apartments, and they got 11,000 applications.

Pakistan is reportedly readying a large Eurobond issue at a time when it is prepaying the World Bank and the IMF. Why?

Pakistan is migrating in the next 12 months from a strictly multilateral borrowing approach to a more market-driven approach. We will still borrow from the World Bank and the Asian Development Bank, but the IMF program will go away. We will migrate back to the international financial markets. We don't need the liquidity, but we want to renew investor relationships.









Analysts and investors welcome Pakistan's economic turnaround, but they don't credit it completely to President Pervez Musharraf's reforms. Many attribute Pakistan's 6-point advance from last year (it rose from 110th place to 96th place) inInstitutional Investor's semiannual Country Credit survey of sovereign credit analysts (see page 73) to the increased U.S. aid offered in return for the Musharraf government's backing for the U.S.-led war on terrorism. "The U.S. is going to be very helpful to them, and that in turn will help their economy," says David Ahern, a credit analyst at Allied Irish Bank in Dublin. Others argue that Pakistan's government deserves some credit: Musharraf "has brought some stability and a reasonably good economic team," notes Rolf De Veer, an economist at ABN Amro in Amsterdam. That "has resulted in better economic performance over the past two years."