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ASIAN DEVELOPMENT BANK

PRIVATE SECTOR ASSESSMENT


PAKISTAN

December 2008
CONTENTS
Page
EXECUTIVE SUMMARY i
SECTION I 1
THE PRIVATE SECTOR IN PAKISTAN – AN OVERVIEW AND CURRENT STATUS 1
1.1 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 1
1.2.2 The Public Sector Ascendant: 1972 – 1977 2
1.2.3 The Domino Years: 1977 - 1990 2
1.2.4 The Winds Of Change – 1990-1999 4
1.2.5 Reaping The Harvest – 1999 To Date 5
1.3 STRUCTURE AND COMPOSITION OF PAKISTAN’S PRIVATE SECTOR 7
1.4 EMPLOYMENT AND THE PRIVATE SECTOR AT THE NATIONAL LEVEL 10
1.5 SECTOR WISE CONTRIBUTION OF THE PRIVATE SECTOR 12
1.5.1 Agriculture 13
1.5.2 Mining and Quarrying 14
1.5.3 Manufacturing 14
1.5.4 Construction 16
1.5.5 Electricity Generation 17
1.5.6 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 23
2.2.1 The “Privatization For The People” Program 25
2.2.2 Lessons Learnt from Pakistan’s 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 IN
PAKISTAN 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
4.1.1 Employment Trends in the Informal Sector 49
4.1.2 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 SECTOR54
SECTION 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 IN
INFRASTRUCTURE 57
5.2.1 Undeveloped Financial Markets and Instruments 59
5.2.2 Structural and Policy Constraints: 60
5.3 PUBLIC PRIVATE PARTNERSHIPS (PPP) FOR INFRASTRUCTURE DEVELOPMENT61
5.3.1 Constraints for PPPs 61
5.3.2 Issues, Challenges, and Way Forward on Private Sector Participation in Key
Infrastructure 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 OPERATIONS
DEPARTMENT (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 86
II. Non Life Insurance Sector 87
APPENDIX 3: LIST OF PRIVATIZATIONS IN PAKISTAN 1999 – APRIL 2007 89
APPENDIX 4: CONSTRAINTS AND INTERVENTIONS FOR ENHANCING PRIVATE SECTOR
PARTICIPATION IN THE ENERGY SECTOR 91
APPENDIX 5: CONSTRAINTS AND POSSIBLE INTERVENTIONS FOR PRIVATE SECTOR
PARTICIPATION IN ROADS, RAILWAYS, AND PORTS 95
APPENDIX 6: CONSTRAINTS AND POSSIBLE INTERVENTIONS FOR PRIVATE SECTOR
PARTICIPATION IN THE WATER SECTOR 98
LIST OF TABLES

Table 1: Capital Market Growth and Development 6


Table 2: Structure of Savings and Investment (As Percent of GDP) 7
Table 3: Foreign Investment Inflows in Pakistan (Million $) 9
Table 4: Sector Wise FDI Inflows (Million $) 9
Table 5: Employment by Major Industry (%) 10
Table 6: Sectoral Concentration of Informal Labor Force Employment (%) 11
Table 7: Distribution of Enterprises by Employment Size 2005(percent) 12
Table 8: Sectoral Share in GDP (%, Constant Factor Cost) 13
Table 9: Asset Structure of the Insurance Industry 21
Table 10: Insurance Density in US$; insurance penetration (in percent) 22
Table 11: Government’s Incentives for Investment 27
Table 12: Country Wise Foreign Investment Inflows ($ million) 28
Table 13: Leading Foreign Investor Companies – Average Returns 29
Table 14: State of Pakistan’s Competitiveness 2007 42
Table 15: Formal and Informal Sectors- Distribution of Non- Agriculture Workers (%) 50
Table 16: Informal Sectors Workers- Distribution by Major Industry Divisions 50
Table 17: Pakistan. Revised GDP and Annual Value added of the Informal Sector (1999-2000)
51
Table 18: Credit to SMEs (Rs. million) 54
Table 19: Impact of Climate Change 55
Table 20: Comparative Infrastructure Indicators for Pakistan 56
Table 21: Sectors for Private Sector Investment in Pakistan (1999 – 2006) 57
Table 22: Total Installed Generation Capacity (MW) 62
Table 23: Potential Private Sector Hydropower Projects (Rs. million) 63
Table 24: Pakistan’s Teledensity in Comparison with other Regional Countries (%) 65
Table 25: Public Sector Interventions with PSD Focus: Some Examples 71
Table 26: Completed Assistance to the Private Sector ($ million) 74
Table 27: Ongoing Private Sector Assistance ($ million) 75
Table 28: Feedback from the Private Sector 78
Table 29: Recommendations for ADB Interventions for PSD 80

LIST OF FIGURES

Figure 1: Real Fixed Investment as percent of GDP 8


Figure 2: Main Sectors of Private Sector Investment FY2007 8
Figure 3: Sectoral Share in Generation of Electricity (%) 17
Figure 4: Increased Ownership of Local Private Banks 19
Figure 5: Ownership of NBFIs 20
Figure 6: Insurance Sector Profitability- 2005 21
Figure 7: Foreign Stake in Domestic Stock Market (as percent of aggregate market
capitalization) 26
Figure 8: GDP Growth (%) 34
Figure 9: Domestic Saving Rates in 2005 35
Figure 10: Electricity Demand and Supply Curve 37
Figure 11: Pakistan’s Governance Rankings 39
Figure 12: Pakistan’s Performance on the Doing Business Survey 40
Figure 13: Ranking of Investment Climate by City (perceptions of firms outside the city) 42
Figure 14a: GCI Rank on Institutions 45
Figure 14b: GCI Rankings on Infrastructure 45
Figure 14c: GCI Rankings on Health and Primary Education 45
Figure 14d: GCI Rankings on Market Efficiency 46
Figure 14e: GCI Rankings on Technological Readiness 46
Figure 14f: GCI Rankings on Business Sophistication 46
Figure 14g: GCI Rankings on Innovation 47
Figure 14h: GCI Rankings on Macroeconomy 47
Figure 14i: GCI Rankings on Higher Education and Training 47
Figure 15: Teledensity of Pakistan (%) 65
Figure 16: ADB’s Private Sector Assistance in Pakistan: Ongoing Portfolio 76
ABBREVIATIONS

ADB Asian Development Bank


CMDP Capital Market Development Program
CPS Country Partnership Strategy
DFI Development Finance Institution
FDI Foreign Direct Investment
GENCOs Generation Companies
GCI Global Competitiveness Index
GDP Gross Domestic Product
GDR Global Depository Receipt
GoP Government of Pakistan
HBL Habib Bank Limited
IFI International Finance Institution
IMF International Monetary Fund
IPO initial public offering
IPP independent power producers
MCA Monopoly Control Authority
MTDF Medium Term Development Framework
KESC Karachi Electric Supply Corporation
KPT Karachi Port Trust
KSE Karachi Stock Exchange
NCBs Nationalized Commercial Banks
NEPRA National Electric Power Regulatory Authority
NHA ` National Highway Authority
NICL National Insurance Company Limited
NRL National Refinery Limited
OGDCL Oil and Gas Development Corporation Limited
OGRA Oil and Gas Regulatory Authority
PC Privatization Commission
PEMRA Pakistan Electronic Media Regulatory Authority
PPID Pakistan Private Infrastructure Development
PPL Pakistan Petroleum Limited
PPP Public Private Partnerships
PRCL Pakistan Reinsurance Corporation Limited
PRSP Poverty Reduction Strategy Paper
PSA Private Sector Assessment
PSD Private Sector Development
PSO Pakistan State Oil
PSM Pakistan Stock Market Fund
PSO Pakistan State Oil Company Limited
PSOD Private Sector Operations Department
PTA Pakistan Telecommunications Authority
PTCL Pakistan Telecommunications Company Limited
REITs Real Estate Investment Trusts
SBP State Bank of Pakistan
SECP Securities and Exchange Commission of Pakistan
SLIC State Life Insurance Corporation
SME Small and Medium Enterprises
SOE State Owned Enterprise
TA Technical Assistance
UBL United Bank Limited
WAPDA Water and Power Development Authority
WLL 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., FY2008
ends on 30 June 2008.

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


EXECUTIVE SUMMARY

i. The Pakistani Private Sector: Since its inception in 1947, Pakistan has relied on the
private 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 sector
manifested 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 economic
activity. Beginning in the early 1990s, the Government of Pakistan pursued a strategy of
privatization, deregulation, liberalization and good governance to promote private sector
development. However, macroeconomic instability and political turmoil and uncertainty stood in
the 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 on
generating macroeconomic stability and creating an environment to encourage the private
sector to become the growth engine in the economy. The Privatization Act 2000, creation of a
Ministry of Privatization and Investment, setting up of a Board of Investment, legislative changes
to 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 ensure
formal 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 important
steps that underscored the Government’s recognition of the importance of macroeconomic
stability and a clear and transparent legislative framework to support a conducive business
environment in the country. The improved economic conditions and investment climate
generated both the fiscal space as well as opportunities for private sector led economic growth
through acceleration of the process of privatization, enhanced private sector investment, and
greater foreign direct and portfolio investment. As a result of the successful experience with
privatization, in Pakistan today, over 77% of the commercial banking sector, 100% of the textile
and telecommunications sector, and a significant part of the cement, sugar, automobile and
fertilizer sector are in the private sector. Within infrastructure development, besides
telecommunication, the private sector has been active in the power sector. It is a major
contributor to power generation and has also entered into the electricity distribution sector after
the privatization of the Karachi Electric Supply Corporation (KESC). Upstream and downstream
oil and gas remains a mix of public and private sector entities. However, key public sector
entities including the Oil and Gas Development Corporation Limited (OGDCL), Pakistan
Petroleum Limited (PPL) and Pakistan State Oil (PSO) are all on the Government’s privatization
list. Gas distribution is also slated for privatization. In the financial sector, in addition to
commercial banking, the domestic capital markets have also developed at a rapid pace with the
Karachi Stock exchange (as on June 29, 2007) emerging as the most important institution of
capital formation in Pakistan and voted as the most strongly performing stock market in
emerging Asia.

ii. Key Private Sector Development Issues:

a. Macroeconomic stability achieved in recent years has been critical in restoring


private sector confidence and catalyzing greater foreign and domestic private
investment. But in FY2008, the macroeconomic situation deteriorated significantly
because of the impact of higher oil and food prices and delayed policy response by the
Government in view of the difficult political conditions and the transition to a new
government that affected the reforms in the country. The result has been burgeoning
trade, current account, and fiscal deficits, a high rate of inflation, massive devaluation of
rupee, major drawdown of foreign reserves to finance the deficits in an environment of
weak 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 the


continuity of the present growth momentum based on sustained levels of private sector
activity and investment.

b. Private sector investment and growth in recent years has been mainly based in
the services sector especially telecommunications and financial sectors. Pakistan’s
manufacturing base over the years has remained narrow with a concentration of
investment in capacity enhancements and up gradation of facilities largely only in the
traditional textile sector. This sector accounts for 46% of total industrial output and
contributes 60% to Pakistan’s total exports. Such a high reliance on one single
subsector to deliver on industrial development is of concern. The situation also raises
the issue of whether Pakistan can sustain economic growth with a primarily services
sector oriented growth momentum without a corresponding deepening and broadening
of its manufacturing and industrial base. A structural transformation of the economy that
focuses on development of the commodity based sectors including industry and
agriculture 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 a
defined industrial policy, competitive policy, an investment policy, and stronger and
capacitated regulatory institutions in key sectors of the economy. As one example of the
latter, there is a need to strengthen the capacity of the Securities and Exchange
Commission with respect to regulating the non-bank financial sector including the
insurance 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 increased
substantially over the years without a corresponding increase in public and private
investment in power generation and strengthening of transmission and distribution
systems. There is a need for accelerated investments in the sector alongside reforms
and a strengthened regulatory and policy environment leading to uninterrupted and
sufficient availability of power for industrial, commercial, and domestic use. The private
sector is being considered by the Government as an increasingly significant partner in
the financing and delivery of infrastructure in the power and other sectors. However,
policy, legal and structural frameworks allowing public private partnerships need to be
developed and strengthened in many key sectors including, power, transport and water
to encourage private sector participation in infrastructure provision.

e. Pakistan provides good protection to investors but lacks efficient contract


enforcement structures which complicate and increase the cost of doing business.
Together with ineffective property rights regulations, low effectiveness of public sector
agencies, weak regulatory mechanisms, and overall security situation, these governance
related bottlenecks retard Pakistan’s international competitiveness. In addition,
inefficiencies and rigidities in the land and labor markets remain major constraints for
greater growth and dynamism of the private sector.

f. Lack of human resource development and availability of educated, healthy and


skilled labor are big issues in the competitiveness and growth of Pakistan’s private
sector. This results in distortions in terms of factor utilization by sectors, contributes to
unemployment and lowers factor productivity.
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g. Despite some financial deepening, Pakistan’s capital markets still lack financial
instruments and institutions specializing in long term debt, project, and infrastructure
finance. This constraint has far reaching impacts for private sector participation in
infrastructure development and is one of the key reasons for slow industrial growth and a
narrow industrial base.

iii. Government’s Policy and Planning Framework: As mentioned, Government policies


and mechanisms to promote private sector development have since the early 1990s focused on
privatization, deregulation, and liberalization as the cornerstones of its policy to achieve
sustained growth and structural transformation of the economy. The 1992 Economic Reforms
Act was a major milestone as it gave full legal protection to investors as well as to the
privatization process. Subsequently, the 2000 Privatization Act and creation of a number of new
regulatory agencies like the Securities and Exchange Commission Pakistan (SECP), Pakistan
Telecommunication Authority (PTA), National Electric Power Regulatory Authority (NEPRA), Oil
and Gas Regulatory Authority (OGRA), Pakistan Electronic Media Regulatory Authority
(PEMRA) and Private Power and Infrastructure Board (PPIB) to act as focal points to attract
foreign and domestic private investment underline the importance of private sector development
within the Government’s policy and planning framework.

The privatization process has had a major impact on private sector development as it not only
transferred ownership to the private sector, but also helped create appropriate regulatory and
governance structures for the sectors that were being privatized. During the period from
November 1999 to December 2006, from 49 transactions, assets worth PKR 418.6 billion were
privatized prominent amongst which were the privatization of Pakistan Telecommunications
Company Limited (PTCL), Habib Bank Limited (HBL), United Bank Limited (UBL), Karachi
Electricity Supply Company (KESC), National Refinery Limited (NRL) and a number of fertilizer
and cement companies. Today the telecommunications sector and the commercial banking
sector are in private sector hands and over 50% of the industrial sector has been successfully
privatized. The gas distribution system is also being prepared for privatization. The privatization
program, 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 Government
has focused on floating its shares in public entities in domestic and foreign capital markets via
global depository receipts (GDRs) such as the shares floated for the United Bank Limited and
the Oil and Gas Development Corporation on the London Stock Exchange. The impact of such
privatization 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 a
potentially weakening Rupee. The experience in FY2008 in which portfolio investment
witnessed a net inflow of only $41 million relative to a net inflow of $3.3 billion in FY2007 is a
manifestation of the unsustainability of portfolio investment inflows.

Pakistan’s liberal investment policy remains one of the most attractive in South Asia allowing
100% 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 in
attracting 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 and
allowing 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 a


special emphasis on private sector development as a key element of the strategy to achieve
sustained 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 base
and competitiveness of the economy through investments in human resources and in skills and
vocational training; strengthening product quality controls and enforcement of international
standards; fostering public-private partnerships; and vitalizing Pakistan’s capital markets.
Likewise, Pakistan’s Vision 2030 incorporates private sector development as a “key element” of
the Government’s 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),
ADB’s strategy to promote private sector development was operationalized through two
windows. The first were public sector programs that focused on helping to improve the business
environment and supported a more enabling policy and institutional framework for the private
sector. This included support for reforms and privatization in the finance, industry, power and
related sectors to create a level playing field for the private sector, and initiatives to develop
SMEs, 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 Business
Support 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 financial
sector. 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 not
materialize, however, because of legal and structural impediments. In 2006, ADB provided a
large program through which the private sector strategy was operationalized for supporting
private participation in infrastructure development. The second window was direct assistance to
the private sector in terms of loans and equity investments. In the event, this window remained
largely dormant and only one private sector project: a Small and Medium Enterprise Partial
Credit Guarantee facility $65 million was approved during the CSP period in 2003. Starting in
2007, the private sector window was once again revived with the largest-ever private sector loan
to Pakistan for the post-privatization rehabilitation, upgrade, and expansion of the KESC.

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

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

Key Outputs:
(a) Supportive legal, regulatory and structural reforms for the private sector with continued
emphasis on the financial services sector and the industrial and agriculture market development
sectors.
(b) Comprehensive policy and regulatory framework for private participation in infrastructure
development and delivery of municipal and other services.
(c) Greater private investment in key prioritized areas of infrastructure and finance supported
through a larger number of private sector operations that produce synergies with public sector
projects and programs
(d) Analytical work centered on developing Pakistan’s industrial policy including a major study
on the private sector business potential on the National Trade Corridor.
v

vi. Private Sector Development Links to CPS Focal Areas:

Focal Area 1: Reforms and Investment in Energy and Infrastructure Sectors. Private sector
participation in key infrastructure sectors is being supported through the Private Participation in
Infrastructure Development Program. A number of direct private sector projects in infrastructure
sectors 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 Structural


Transformation. Support is being provided for second generation reforms to create a level
playing field for the private sector targeting critical areas of infrastructure and finance. This
includes support for policy and regulatory reforms under the ongoing and proposed Private
Participation in Infrastructure Development (PPID) Program. In the financial sector, support is
being provided for second generation reforms for capital markets development (including in
areas of long term project finance, corporate debt markets, pension funds and REITs) and
access to financial services including microfinance, and SME. Support for reforms is also being
provided to enhance the competitiveness of Pakistani economy through a cluster “Accelerating
Economic Transformation Program”, that is supporting key reforms in the agriculture, energy,
industry, and financial sectors to raise productivity and efficiency in the commodity producing
sectors, address bottlenecks in the power sector, and improve supervision and regulation in the
banking sector. Crosscutting support for creating an enabling environment for private sector
development also forms a key part of the province-focused proposed resource management
and government efficiency improvement programs.

Focal Area 3: Development of the Urban Services. Private sector participation will be
supported in the development of urban infrastructure including water and sanitation through
privatization, concessions, or public private partnerships. Private sector delivery for municipal
services will be also supported. Assistance will be provided for reforms and investments in
market infrastructure to strengthen value chains and the role of the private sector in business
development.

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 key
focal areas of the CPS, particularly infrastructure development, will lead to improved
development effectiveness and results. Technical support from relevant PSD experts will be
solicited in the design and preparation of projects that have scope for involvement of the private
sector. 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 to
build synergies and greater complementarities in the design and delivery of private sector
related operations.
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 the
development of a coherent country strategy for private sector development (PSD). The PSA
within the framework of the Pakistani private sector’s history and recent performance reviews its
performance, achievements and challenges. This framework and review, in the context of the
PSA, 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 to
effectively deal with existing and emergent challenges.

2. The PSA attempts to advise on appropriate policies, strategies and interventions to


promote a competitive, strong and dynamic private sector that will contribute to long term
economic growth and sustained poverty reduction. The assessment builds upon ongoing
country economic and sector work and generates input in the preparation of ADB’s new country
partnership 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, if
ever, a producer of goods and services. Muslim historical traditions and legislature had
adequately protected property rights and fostered a spirit of free enterprise and the development
of a vibrant private sector. These traditions of a primarily private sector led economy were
passed on when Pakistan was created in 1947. The public sector at the time of partition
consisted only of the Railways, Telephone and Telegraph Department, the Post-Offices, Karachi
Port Trust, Radio Pakistan and some coal and salt mines. Government policy, circa 1948,
delimited public ownership to arms and ammunition, hydro-power generation, rail, telephone
and wireless equipment, and industries of national importance in which the private sector was
“unable 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 in
1948. It was in the early 1950s with the setting up of two government-owned banks - National
Bank of Pakistan (NBP) and Agricultural Development Bank of Pakistan (ADBP) - that the state
began to encroach upon the private sector in the financial arena. Initially, the role of the state
was curtailed as evidenced by the first two Five Year Plans that emphasized the importance of
the private sector as the “engine of growth” and stated that public sector enterprises would only
be established where the private sector did not invest, and even these would eventually be
divested to the private sector.
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5. The private sector centric policies continued under Field Marshal Ayub Khan’s
government 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 par
with Japan. The Ayub Khan period also saw the first manifestation of privatization as a public
policy tool when some industrial units that included jute, paper and sugar mills that were set up
and 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 the
private sector. By the end of the 1960s, however, the public sector began its slow and
inexorable advance into the territory dominated until now by the private sector, starting in the
machinery sector with the establishment of the Heavy Mechanical Complex, Taxila and the
Machine Tool Factory, Landhi. Meanwhile, the political and economic fallout of the 1965 and
1971 wars was surprisingly well weathered by the private sector and the economy continued to
grow and make gains. The inflow of western aid and the rising importance of Pakistan as a
major domino in the Cold War were significant in propping up the economy during these
periods.

1.2.2 The Public Sector Ascendant: 1972 – 1977

6. From 1972 to 1977, the then Pakistan Peoples Party's Government initiated a broad and
sweeping nationalization program under the political slogan of reversing concentration of wealth
that had occurred under the private sector led model of the 1960s, and ensuring meeting of
basic needs of all citizens. Government policies during this period were fueled by the
fashionable socialistic development paradigms of the time and were in line with the growing
trend of experimentation with command economy driven visions of economic growth,
empowerment of workers and rapid social sector development in many countries. These
policies 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 1973
26 vegetable ghee companies; and in 1974 all domestic private sector banks and remaining
insurance 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 and
cotton ginning factories nationalized, culminating with the nationalization of rice husking units in
1977. The private sector driven structure of the Pakistani economy had within a span of 5 years
been torn apart and reconstituted under a public sector led economic model. From an engine of
growth 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 and
an 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 expertise
that ensued set Pakistan’s future growth back in a major way. On an equally alarming note, the
much anticipated social sector revolution did not take place. Consequently, the anticipated
upward 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 show
improvement. In fact, the economy began to slow down and the political turmoil that followed
wiped away whatever gains had been achieved in the preceding years. The “hidden hand” of
the market was lost, private sector investment evaporated, and production and resource
allocation 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
3

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

10. The private sector was further encouraged by the introduction of fiscal incentives in
1982-83 such as tax holidays and exemptions and rebates in custom duty. The Companies
Ordinance also came under review and in 1986 the Companies Ordinance was totally revamped
and rationalized. The Sixth Five Year Plan (1983-1988) specifically adopted privatization as a
central theme, confining Government’s role to that of a facilitator of private sector investment
and an investor of last resort. After carrying out detailed reviews, the Government decided to
rationalize and consolidate the management and size of the public sector. Mergers and
regroupings of holding corporations and financial restructuring of individual enterprises were
carried out and chronically sick enterprises were earmarked for closing down or liquidation. Four
Pakistan Industrial Development Corporation units, four small Pakistan International Airlines
Corporation (PIAC) motels and three sugar and three textile units owned by provinces were
disinvested, while several other enterprises were liquidated. While the first steps towards
privatization related to sick units, clarification that this policy was not restricted to loss-making
enterprises only came through a Government announcement of a plan to sell shares of
profitable units to the general public, with a view to facilitating widespread participation in the
ownership 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 striking
however, that no major divestments from the public to the private sectors took place during this
period despite the fact that legal cover had been provided through the Transfer of Managed
Establishments Order 1978. It would appear at the same time that the private sector itself, not
yet 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-driven
financial structure, resulted in the creation of a massively inefficient financial sector. The public
sector owned banking system twisted price signals, misdirected credit flows and subverted
credit cycles. This was also the period when state-led the Development Finance Institutions
(DFIs) began loosening credit controls and building up infected lending portfolios. The
politicization of the banking sector and loosening of controls, inefficient staffing practices, and
provision of cheap subsidized capital to targeted "priority" sectors further distorted the financial
markets and led to inefficient allocation of resources. This culminated in distorted agricultural
and industrial sector growth and had far reaching systemic consequences that contributed to the
subsequent 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 the
political elite and public sector officials. With the financial sector becoming a captive tool to
further political and personal ends, a burgeoning ‘default culture’ emerged that led to rampant
corruption and opaque public sector policy and decision making. Window dressing, weak
regulation, and creative accounting kept the extent of the portfolio infection hidden, but this was
still estimated in 1989 to be very large engulfing over 70% of DFIs portfolios and over 40% of
commercial bank loan portfolios.
4

1.2.4 The Winds Of Change – 1990-1999

13. By the end of the 1980s, efforts to turn around the public enterprises with expert
management and substantial injection of capital had proved to be unsuccessful. Public Sector
Enterprises 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 preferential
policies such as tariff protection, special access to credit, government guarantees, tax
exemptions, and subsidies.

14. The cracks in the financial system had begun to appear in the early to mid 1980s but it
was in the early 1990s that a financial sector meltdown seemed a distinct possibility. Most of the
DFIs 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 and
economic holdings had clearly failed to deliver in terms of socio-economic development. What it
created was an inefficient and bankrupt financial sector that desperately needed reform. The
banking sector was plagued with inefficient management, overstaffing and high costs of
financial 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 planning
system. Agricultural growth remained stagnant with little or no change in traditional production
technologies and systems. Manpower quality deteriorated as the best and brightest migrated.

15. Aid flows, especially from the USA on which the Pakistani economy had become
dependent since the Soviet Union’s invasion of Afghanistan in 1979, slowed and became a
trickle soon after the Soviets were defeated and left Afghanistan. Funds for social sector and
poverty reduction programs were significantly reduced. The law and order continued to
deteriorate and political instability settled in.

16. With a stagnant economy, increasing population, and diminishing options, policy makers
were 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 reviving
private 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 and
a 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 had
finally run out of steam. Pakistan’s structural transformation model was based on the three basic
precepts of deregulation, good governance, and privatization with the aim to unleash private
sector forces to promote investment, growth, and employment creation.

17. Consequently, the foreign exchange regime was opened up in 1991, new banking
licenses 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 sector
was 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 foreign
investors. Privatization began to be viewed by 1991 as a potentially important policy tool to
attracting private sector investment and participation from the domestic and foreign markets The
first 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.
5

Regulatory bodies and their roles were reviewed. As a consequence, in 1994 the State Bank of
Pakistan gained complete autonomy and shortly afterwards began a major reform process
which resulted in strengthened regulation, guidelines and improved information disclosure
guidelines for the financial sector. As part of this process a number of independent regulatory
bodies were set up that included the Oil and Gas Regulatory Authority (OGRA), National
Electric Power Regulatory Authority (NEPRA), Pakistan Environmental Protection Agency (EPA)
and the Pakistan Telecommunication Authority (PTA). The Corporate Law Authority [now the
Securities and Exchange Commission of Pakistan (SECP)] was strengthened and its role
expanded. It was within this tripod (deregulation, liberalization and privatization) of interwoven
reform agents that the Pakistani private sector re-birthed as the primary economic engine of
growth.

1.2.5 Reaping The Harvest – 1999 To Date

19. Continuing with the pro-private sector policy framework of the 1990’s, under the new
Government in 1999, major structural, governance, and economic reforms began to be
implemented with a focus on generating macroeconomic stability and creating a friendly
business 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 Privatization
and Investment; the setting up of the Board of Investment; the Insurance Act 2001; new lender
friendly recovery laws to strengthen bank credit cycles; new legal structures for setting up and
operation of non-bank financial institutions; streamlined tax systems and more efficient import
and export regimes; legislative changes to the State Bank of Pakistan (SBP) Act empowering
the SBP to formulate, conduct and implement monetary policy; the creation of a Monetary and
Fiscal Board to ensure formal monetary and fiscal policy coordination; and the Fiscal
Responsibility and Debt Limitation Act 2005 mandating reduction in the revenue and fiscal
deficits and the total public debt were all important steps in this direction that further
strengthened and supported the Foreign Private Investment (Promotion & Protection) Act 1976
and the Protection of Economic Reforms Act, 1992. The impact of these far reaching measures
was improved macroeconomic stability, improved growth rates, and a more enabling investment
climate that generated both fiscal space and opportunities for private sector led growth. The
improved macroeconomic dimensions of the Pakistani economy led to a resurgence of
investors’ interest in the process of privatization and resulted in higher domestic and foreign
direct investment as well as portfolio investment.

20. Privatization remained a key economic reform during this period. Privatization
transactions completed over the past eight years include complex strategic sales of commercial
banks with the highlights being the two commercial banking giants- Habib Bank Limited (HBL)
and United Bank Limited (UBL), the privatization of Pakistan Telecommunications Company
Limited (PTCL), and the successful divestment of Karachi Electric Supply Company (KESC) and
the Pak-Arab and Pak-American Fertilizer companies. The Government also started a well
received “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 of
Pakistan (NBP), Oil and Gas Development Corporation, Sui Southern Gas Company (SSGC),
Pakistan Petroleum Limited (PPL), Kot Addu Power Company (KAPCO), PIAC, and UBL were
divested via Initial Public Offerings (IPOs), Public Offerings (POs) and Global Depository
Receipts (GDRs). These capital market transactions played a major role in deepening and
broadening the capital markets. Over 2.6 million Pakistanis bought shares worth Pak Rs. 24.3
billion through these transactions.
6

21. Today, over 77% of the commercial banking sector, 100% of the textile and
telecommunications sector and a significant majority of the cement, sugar, automobile and
fertilizer sector are in the private sector. The private sector is also a major contributor to power
generation 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 public
and 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 Government’s
privatization list. Gas distribution is also slated for privatization.

22. The domestic capital markets also developed at a rapid pace with the Karachi Stock
Exchange (KSE) emerging as the most dynamic. Between fiscal year FY 1 2003 and FY2008,
listed capital on the KSE increased from Rs. 313 billion to Rs. 635 billion, market capitalization
from Rs. 756 billion to Rs. 3.5 billion, and the KSE index from a high of 4,606 to 14,202 (Table
1).

23. FY2008 have been difficult years for Pakistan politically and economically with the
situation created by the judicial imbroglio that began in March 2007, declaration of emergency
on 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 jumps
in international oil and food prices, the slow down of capital inflows both because of the global
financial melt down and Pakistan’s domestic situation have had a strong adverse impact on
economic stability in Pakistan. Along with the reemergence of macroeconomic imbalances
particularly the rising current account and fiscal deficits and high inflation, this situation has led
to greater volatility in stock markets, a downgrading of sovereign credit ratings, and an outflow
of portfolio investment. Instability in economic fundamentals could result in impairing the present
growth momentum. It is essential that the new Government continues to prioritize improved
economic decision making and pursue important governance and sector reform to reduce the
cost 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

1
Fiscal year in Pakistan runs from 1 July to 30 June.
7

1.3 STRUCTURE AND COMPOSITION OF PAKISTAN’S PRIVATE SECTOR

24. The private sector in Pakistan is the major producer of goods and services in the
economy, the major contributor to investment, and the largest employer. While disaggregated
sector-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 sector
contribution to GDP at an aggregate level. Working from the national income accounts data with
figures for private sector consumption and investment and assuming that the bulk of exports
originate in the private sector, the private sector’s contribution to GDP at current factor cost is
estimated at an overwhelming 84 percent of total GDP. 2 If allowance for the undocumented
informal economy is made which is totally in the private sector, the latter’s contribution to GDP
would be even higher.

25. Of Pakistan’s total gross fixed investment of 21.3% of GDP in FY2008, private sector
investment is estimated at 15.6% of GDP. 3 Contributing about 73% of the total investment in
Pakistan 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 recent
years has been complemented by a significant increase in public sector investment in
infrastructure and social sectors. Primary sectors which have had robust growth in private sector
investment include manufacturing, mining and quarrying, construction, transport and
communication, and wholesale and retail trade (Figure 2).

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

Source: Ministry of Finance. Economic Adviser’s 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 in
national savings in FY2007 did not reverse this trend, and on the back of rising investment, the
saving-investment gap widened to 5% in FY2007, before spreading further around 8% in
FY2008 (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 investment
requirements attached to achieving the targeted 7%-8% growth rate in the medium-term. On the

2
Staff estimates.
3
Ministry of Finance, Government of Pakistan. Pakistan Economic Survey 2007-08. Islamabad.
8

other hand, financing of this gap through external resources on a sustainable basis is also not
viable given its implications for overall macroeconomic stability. The failure to increase national
savings could, therefore, in the medium-term stall investment and block growth.

Figure 1: Real Fixed Investment as percent of GDP


18.0

16.0 15.7 15.6


14.0 14.2
13.1
12.0
11.3 11.3
10.9
10.0 10.2

8.0

6.0 5.7 5.7 5.7


4.8
4.0 4.2 4.0 4.0 4.3

2.0

0.0
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08
Public Investment Private Investment P

Source: Pakistan Economic Survey 2007-08.

Figure 2: Main Sectors of Private Sector Investment FY2007

Areas with Nominal Growth

30

25

20
%Growth

15

10

0
Manufacturing Construction Transport Wholesale
and
Retail Trade

Source: Pakistan Economic Survey 2006-07.

27. Foreign Direct Investment: With limited domestic savings constraining domestic
investment, the Government resorted to promoting foreign direct investment through
encouraging 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 in
FY2003 before coming down to 5.2 $billlion in FY2008 (Table 3).
9

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


Private Public
Greenfield Privatization Total Foreign
Year Total FDI Portfolio Portfolio
Investment Proceeds Investment
Investment Investment
FY2002 357 128 485 (10) (483) (8.4)
FY2003 622 176 798 22 (261) 559.1
FY2004 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
Financial
-34.9 3.6 207.4 242.1 269.4 329.2 930.3 1607.6
Business
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
Privatization
- (127.4) (176.0) (198.8) (363.0) (1,540.3) (266.4) (133.2)
Proceeds
FDI Excluding
322.4 357.3 622.0 750.6 1,160.9 1,980.7 4,873.2 5019.6
Pvt. Proceeds
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 industry
was 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, the
privatization of large commercial banks brought in a significant level of FDI as did subsequent
mergers and acquisitions in the banking sector. Despite the politically turbulent and
economically 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 gas
explorations, 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
10

adversely impacted the confidence of short-term investors and the global economic slowdown
deterred 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 during
the same period. Employment increased in the construction sector, and only marginally in the
agriculture and manufacturing sectors, but stagnated or fell in the transport, trade and
community and social services sectors (Table 5). Labor force participation rates have also
demonstrated a small increase, rising from 30.4% in FY2004 to 31.8% in FY2007. Participation
rates 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 sector 4 , and 18.6 million in the
informal sector 5 . In the last five years, an estimated 8.6 million new jobs were created in the
private sector. With this increase in employment, the overall unemployment rate has decreased
from 8.3% in FY2002 to 6.5% in FY2005. 6 The informal sector is second only to the agriculture
sector as the largest generator of jobs in the private sector (Table 6). The sectoral concentration
of informal labor force employment shows the retail and personal service sectors as the leading
employers in the informal sector, followed by manufacturing, and community and social
services. With increased diversification of the economy to service oriented sectors, Box 1
indicates 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.

4
World Bank. 2007. Doing Business in South Asia. Washington D.C
5
Federal Bureau of Statistics. 2007. Pakistan Labor Force Survey 2006-07. Islamabad
6
Ministry of Finance. 2006. Pakistan Economic Survey 2006-07. Islamabad
11

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 7.31
Source: 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 enterprise
sector. Table 7 shows that small enterprises, comprising 1-4 people, employ almost 95% of the
total labor force. On the other hand, Pakistan has an insignificant ”medium” sector that employs
only 5% of the labor force. The proliferation of small businesses that employ the bulk of the
labor force in Pakistan and which in most cases do not graduate to the “middle” category
indicates lack of economies of scale, difficulties in accessing finance to grow in size and
12

complexity, and insufficient absorption of technology needed to scale up operations and


generate 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 0.46
Source: 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-wise


contribution of the private and public sectors. In what follows, an attempt is made to provide a
general 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. The
agriculture sector with a 20.9% contribution to GDP is almost wholly private sector owned. Most
of the mining and quarrying activities are also in the private sector. Within manufacturing with a
19.1% contribution to GDP, 100% of the textile sector (which consolidates 46% of the value
added in the manufacturing sector) and a significant majority of the cement, sugar, automobile
and fertilizer industries are in the private sector. So is the case with the construction sector. In
the services sector, the private sector owns over 77% of the commercial banking sector, a
majority 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 contributor
to 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.
13

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 its
contribution to total employment, is almost wholly in the private sector. Agriculture fuels
Pakistan’s 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 sector
owns agricultural land and generates primary and value added agricultural output. Public sector
involvement in the agriculture sector is mainly concentrated in providing and maintaining
irrigation infrastructure and developing waterways for cultivation as well as providing agriculture
extension services and supporting agriculture research.

35. The major issues pertaining to the agriculture sector from a private sector perspective
include inefficient agriculture and agriculture markets, distorted agricultural input and output
pricing, and a continued inability to price and manage water. A recent IMF paper 8 concluded
that in addition to removing market distortions, there is a need for fundamental improvements in
the market mechanisms in the agriculture sector, including reduction in government
interventions 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. A
review is required of what value addition processes can be adopted to generate a more
competitive and efficient agriculture sector. Key value adding areas where the private sector
could play a critical role include horticulture and livestock which have the potential to increase
agricultural productivity and incomes while also promoting the creation of intermediate and high

7
World Bank. 2006. Pakistan – Growth and Export Competitiveness. Islamabad
8
Lorie.H and Kiran. K. 2006. What Determines the Domestic Prices of Agricultural Commodities in Pakistan.
Islamabad
14

level agricultural service support systems and agro industrial activity in the SME and large
Industrial sectors. With an expanded focus on livestock and horticulture, the private sector could
profitably also invest in integrated transportation and delivery systems like standardized,
palletized containerized transportation networks for transportation of high value livestock and
horticultural produce. An expanded role of the private sector is also possible in food processing
and agro-farm machinery industries. Private sector investments could also be considered in
private sector hybrid seed production facilities. Inadequate cold chains are another weak area
where 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 sector
presence with only four public sector enterprises involved in mining. The stated policy of the
Government is to privatize even these companies. However, most private mining operations in
Pakistan are small in scale and not equipped in terms of size and complexity to effectively
exploit Pakistan’s rich mineral sector potential. There are 52 minerals under commercial
exploitation at present. Mineral deposits are owned by the respective provinces which can lease
out 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) in
1995 paved the way to expand and develop the mining sector through attracting private sector
investment. International mining companies have responded favorably to the NMP and
presently four of them are engaged in mineral exploration, development and exploitation
projects including for copper, coal, and zinc deposits. Import of machinery for the mineral sector
has been allowed free of tariffs and restrictions on repatriation of profits by foreign investors
were lifted in 2000.

38. There is however, no regulatory body to oversee the activities of mining firms in
Pakistan, and over-mining remains a major threat with significant consequences for the
environment. In a recent review of the mining sector 9 , it was concluded that that the major
obstacles 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 and
provincial government levels, opaque and cumbersome leasing procedures, poor definition and
enforcement of property rights with respect to the surface land, inefficiency in the duty
drawback/tax rebate system, lack of access to financing for the SME sector, and a poor
transportation network. Further work is necessary to identify priority areas for reform in the
mining sector in the country. To this end, an analysis of joint ventures and foreign investment in
the mining sector globally should be undertaken to develop appropriate policy, regulatory and
contractual structures based on international best practice to promote private sector investment
in the sector.

1.5.3 Manufacturing

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

40. Textile Sector: Privately owned, Pakistan’s textile sector is its most important
component of the manufacturing sector. It contributes 46% to the value added of manufacturing

9
World Bank. 2006. Pakistan – Growth and Export Competitiveness. Islamabad
15

sector as a whole and generates 8.8% of GDP. It is responsible for 60% of Pakistan’s total
exports, and provides employment to 38% of the manufacturing labor force 10 . To prepare for the
post-quota global trading environment that demands greater efficiency and an enhanced
competitiveness level, the textile sector invested close to $6 billion for balancing, modernization
and restructuring (BMR) during 1999-2006, with a focus on spinning, weaving, textile
processing, 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 growth
in FY2007. The stagnancy setting in textile exports is further confirmed by its continuing poor
performance in FY2008. This is a concern not only from the perspective of the textile industry
but also for the overall export performance of the country and the subsequent impact on the
trade account and the balance of payments. It also brings to the fore the need to have a
diversified industrial and export base to reduce dependence of the economy on any single
sector in the contemporary competitive global trading environment.

41. Food, Beverages and Tobacco: The major components of Pakistan’s food, beverages
and 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, and
beverages 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. Pakistan’s major
exports include rice, seafood, fruits, vegetables, tobacco and raw meat.

42. Automobile Sector: Pakistan’s automobile sector is wholly private sector owned. There
are 18 automobile assembling units in the private sector set up as joint ventures. There are also
47 units producing motorcycles. The automobile industry, however, continues to be of modest
size in terms of its contribution to GDP and employment particularly when compared to other
Asian economies like the Japan, Korea, Malaysia, China and Thailand which have all exploited
the catalytic role of the automobile industry in promoting broad based manufacturing sector
growth. The sector unfortunately has not had the desired impact in Pakistan for various
reasons. It continues to remain protected with high import duties and other barriers to entry and
competition 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 to
both domestic assemblers of motor vehicles as well as domestic producers of parts and
components. These policies discourage domestic and foreign competition and allows for small,
inefficient yet profitable domestic automobile producers. Unless these structural issues are
resolved, it might not be possible for an efficient Pakistani automobile sector to emerge at this
stage.

43. Fertilizer Industry: The fertilizer industry is totally in the private sector after successful
privatizations in recent years. It consists of 6 companies of which 4 are listed on the stock
exchanges. 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 capacity
and 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 competition
related issues, especially when the fertilizer industry is also marked by price distortions. The
Government subsidizes input costs for the industry by selling feedstock gas for urea (the major
fertilizer 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 farmers
use 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

10
Ibid
16

agricultural yields, while the runoff into waterways and water reservoirs has potentially serious
environmental and health consequences. The impact of the fertilizer subsidy on market
structure and long-term agricultural productivity needs to be studied and an appropriate policy
response 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 major
boom on the back of both greater domestic consumer demand for housing generated by higher
incomes as well as by the Government’s increased spending on public sector development
projects. The proposed mega infrastructure projects will continue to fuel growth in this sector. In
FY2007 cement sales grew by 31% to 17.53 million tons against the current total capacity of 24
million tons which is expected to rise to 37 million tons by the end of 2007 in light of capacity
expansion 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 in
FY2008.

45. Key Issues Private Participation in the Manufacturing Sector: Several generic
constraints 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 the
addressing of the skills gap for higher labor productivity and improving international
competitiveness. The second constraint is lack of electricity and power. Electricity shortage and
power outages place a huge burden on the manufacturing sector. The existing power subsidy
structure subsidizes power for agriculture and domestic consumption by charging
proportionately higher tariffs from the manufacturing sector. In the absence of vitally required
investments, the growing energy demand in the country will only exacerbate the power supply
deficit to the manufacturing sector situation in the future. The third constraint is the inefficient
factor markets especially for land and labor. Inefficient and archaic land registration and transfer
laws as well as rigidities in labor laws affect investments and growth in the manufacturing
sector. The new Employment Services Act should hopefully address the issue of labor market
flexibility 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 both
long term debt instruments as well as project finance. The SME sector in particular faces a
critical shortage of financial intermediation services. One of the important factors retarding
access to finance is the land registration and transfer system which has effectively removed
land 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. It
employs 2.5 million people. A recent revival in this sector has been led by international private
developers, 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 huge
investment requirements, the future prospects of the sector remain bright. The sector has the
potential to export services worth US$ 1 billion per year 11 . In 2007, the Karachi Stock Exchange
(KSE) listed its first real estate development company. But there remain various issues of
concern in the construction sector from the point of view of encouraging greater private
investment. First, due to lack of available financial services, very little credit penetration has
taken place with the bulk of investment in property still being financed through direct equity. In

11
Board of Investment. 2007. Available: http://pakboi.gov.pk
17

addition, due to high transfer fees, the transactions are undervalued. Another major issue is an
inefficient land registration system requiring interface with multiple official agencies that employ
archaic, complex and non-transparent record keeping. This adversely impacts property rights
and gives birth to legal issues that are known to drag on in courts for long periods and that
remove, in most cases, a very major asset – land – from the mix of viable collateral utilizable by
financial institutions. The SECP with the assistance of the ADB has recently developed licensing
structures for Real Estate Investment Trusts (REIT). However, under the existing land
registration and fee structures, the REIT structure may end up finding itself restricted to invest
only in large mega-projects. Initially, a closed-end structure is being introduced owing to high
redemption and systemic risk. This structure comprises of: i) a REIT Management Company
(RMC), ii) trustees; and iii) unit holders with buy-build-sell REITs and rental REITs formats.
Although many fiscal and legal issues remain, REITs have been launched by the SECP using
firewalls until such time that the appropriate legal and fiscal framework, particularly at the
provincial levels, can be developed.

1.5.5 Electricity Generation

47. The total installed electricity generation capacity in the country is about 19,478 MW, of
which 30% is generated by the private sector (Figure 3). After the restructuring of the Water and
Power Development Authority (WAPDA), four generation companies (GENCOs) have started
functioning as public limited companies.

Figure 3: Sectoral Share in Generation of Electricity (%)

Private Sector 30%

Public Sector 70%

Source: Private Power Infrastructure Board: http://www.ppib.gov.pk

48. There are currently 16 Independent Power Producers (IPPs) in the country generating
3943.81MW of electricity, which have been implemented on a build, own and operate (“BOO”)
basis, under the private power policy announced by the Government in 1994. The Hub Power
Project is the largest IPP, with a gross generation capacity of 1292 MW (Box 2).
18

Box 2: HUBCO- A Landmark Deal


The Hub Power Station is the first and largest power station to be financed by the private sector in
South Asia. Financial closure of the Project took place in January 1995. This was the first such project
to be successfully co-financed by the Government, the World Bank as well as international private
sector lenders and investors. It set the standards for the formulation of a private power framework in
Pakistan 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 in
operation. The Hub Power Company is listed on Karachi, Lahore, Islamabad and Luxembourg Stock
Exchanges, has the largest market capitalization of any private company in Pakistan, and has over
seventeen 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 in
recent years has been the largest contributor to growth and employs approximately one third of
the 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 poor
performance by the commodity-producing sectors.

50. Wholesale and Retail Trade: Mostly private, wholesale and retail trade has shown a
growing trend and employs a large part of the services sector labor force, with most jobs based
in 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 and
auctioneers. A significant portion of the domestic economy is linked to trade through its forward
and backward linkages.

51. Communications: Road transport and trucking is almost fully in the private sector. The
public sector still dominates the air and railways. The public Pakistan International Airlines
(PIA), however, faces growing competition from private airlines 12 that have come up strongly in
recent years. To attract private sector interest in the electronic media, the Government issued a
Pakistan Electronic Media Regulatory Ordinance in 2002, which allowed the establishment of
television channels in the private sector. Today, more than 50 private TV channels are on air in
Pakistan. Likewise, new FM band radio licenses have been issued and a number of private
channels are on air. In the telecommunication sector, with the creation of an enabling
investment environment in the sector, the mobile phone industry is dominated by the private
sector with several foreign affiliated companies providing a range of telecommunication
services. Largely, due to the mobile phone revolution in the private sector, telephone density in
Pakistan 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 includes
scheduled commercial banks, DFIs, and leasing and insurance companies.

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

12
Shaheen Air International, Aero Asia Airlines and Air Blue
19

was due to a gain in share of the local private banks (LPBs) (Figure 4). Privatization hastened a
decline in asset concentration within the banking sector and enabled consolidation of the
erstwhile 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 rapid
progress in Pakistan. Financial institutions have been allowed to establish full-fledged Islamic
Banks (IB) in the private sector, set up subsidiaries of existing commercial banks, and start
stand-alone Islamic banking branches of existing commercial banks.

55. Non Banking Financial Institutions (NBFIs): The ownership structure of the NBFI
sector 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 public
sector 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 taken
over the leading position in NBFIs. As part of the transformation process, the Industrial
Development Bank of Pakistan (IDBP), which was an active specialized institution, changed into
a specialized scheduled bank. The SME Bank which was previously a DFI has now become a
licensed commercial bank. The remaining DFIs are mostly foreign sponsored holding
companies 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 the
SME Bank has a serious possibility of privatization after having being granted a commercial
banking license.
20

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 private
sector. Joint ventures in the leasing sector comprise partnerships between the Government and
some governments in the Middle East and are in the public sector with no immediate plans on
divesting equity to the private sector. No public private partnerships exist at this time in the
leasing sector.

57. The Insurance Sector: Pakistan’s insurance sector comprises life insurance, non life
insurance, the reinsurance and takaful 13 industries. As highlighted in Table 9, public sector
ownership of the life insurance sector in 2006 (last year for which such data is available) was
very high at almost 65%. The reinsurance sector is totally in the public sector. The private sector
dominates the non-life insurance with only one public sector institution active in this sector. As
of 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 business
considerably 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 the
insurance industry in 2005 and, in particular, highlights the high profit margins in the life
insurance sector. Considering that the life insurance sector remains in the public sector and
relatively slow to roll out new products and adopt state of the art risk and actuarial models, any
injection of private sector dynamism could further boost the size and profitability of the life
insurance sector.

13
Takaful, the Islamic alternative to insurance is based on the concept of social solidarity, cooperation and mutual
indemnification of losses of members. It is a pact among a group of persons who agree to jointly indemnify the loss
or damage that may be inflicted on any of them, out of the fund they donate collectively.
21

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. Pakistan’s insurance density 14 is still very low, increasing from 2.7 in 2001 to 4.0 in 2004
with insurance penetration 15 remaining virtually constant during this period (Table 10). At these
levels, Pakistan’s insurance industry is substantially underdeveloped compared to many other
countries. Amongst the factors retarding its growth are highly skewed market concentration
patterns - the legacy of nationalization, a weak regulatory structure and governance systems
and a virtually nonexistent market for long term debt and investment instruments. The SECP
under 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

14
Insurance density is defined as gross premium per capita.
15
Insurance penetration is defined as gross premium as percent of GDP.
22

regulate the sector. Without strengthening regulatory capacity, it is not advisable to privatize the
large state owned insurance companies. More details on Pakistan’s insurance industry are
provided in Appendix 2.

Table 10: Insurance Density in US$; insurance penetration (in percent)

Source; Sigma, World Insurance in 2001, 2002, 2003, 2004


23

SECTION II

PUBLIC POLICY AND STRATEGY AND THE RISE OF THE PRIVATE SECTOR

2.1 MAJOR AGENTS OF CHANGE

60. Since 1999, the Government’s policy of economic structural transformation based on
deregulation, decentralization, economic liberalization, and privatization, has aimed to expand
and enhance the role of the private sector. With the implementation of the Government in reform
program on the mentioned lives, Pakistan was ranked among the top ten reforming countries in
the world in 2006 16 , although the rating slipped subsequently in 2008.

61. Privatization has been the most important component of the Government’s strategy for
invigorating economic growth, attracting investment, and creating opportunities for the private
sector. In addition to strategic sales where management control is divested, the Government
has used privatization to develop, broaden and deepen domestic capital markets. For this
reason, the Government has sold minority shares via the stock market in selected companies
before 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 into
domestic and foreign savings. Listing companies in the stock exchange will also improve
corporate governance, as companies will be forced to comply with the stringent reporting
requirements of the stock exchange and SECP.

2.2 PRIVATIZATION

62. Pakistan’s privatization experience is considered as being among the most successful in
South Asia. Privatization picked up in 1999 when a number of structural bottlenecks were
removed. The Privatization Act 2000 was promulgated, the macroeconomic environment was
reformed, regulatory frameworks were established 17 , a Ministry of Privatization and Investment
was 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 sectors
have been since concluded. Until December 2006, assets worth PKR 418.6 billion from 49
transactions had been privatized, prominent amongst which included the privatization of
Pakistan Telecommunication Company Limited (PTCL), HBL, UBL, KESC, NRL, and a number
of fertilizer and cement companies. As a case in point, Box 3 highlights the successful
privatization of Pakistan’s financial sector. The privatization program also played a major role in
the development of the capital markets by using domestic and foreign stock exchanges for
divesting equity of public sector enterprises. Major assets remaining on the privatization list
include two of the largest exploration and production companies in the oil and gas sector, that
is, the oil and Gas Development Company Limited (OGDCL) and Pakistan Petroleum Limited
(PPL), as well as the Pakistan State Oil Company Limited (PSO). Also stated for privatization
are key assets in the power sector such as electricity distribution companies and a power
generation company, besides several heavy industrial units and prime real estate properties. A
list of Government privatizations from 1999 onwards is in Appendix 3.

16
World Bank. 2006. Doing Business in 2006. Washington D.C
17
Regulatory agencies for electricity, oil and gas, and telecommunications were set up and existing regulators such
as the SBP and the SECP were strengthened.
24

64. The privatization process has catalyzed reforms for further liberalization of the economy
as well as taxation reforms. The banking sector privatizations, for example, gave the impetus for
tax reform where tax rates for banks were brought down in line with corporate rates from over
50% to 35%. The PTCL transaction was key in liberalizing the telecom sector by opening up the
sector to competition and in helping to create an effective regulatory environment. Privatization,
through the mechanism of strategic sales, has also contributed to injecting best management
practices from the private sector. Privatization of state-owned entities is expected to cut waste,
reduce corruption, and improve the coverage and quality of services- such as in the financial
sector.

65. The privatization program, however, suffered a setback in early 2007 when the
privatization of the Pakistan Steel Mills (PSM) was struck down by the Supreme Court of
Pakistan. Following this decision, the Government has focused on floating its shares in public
entities in domestic and foreign capital markets via global depository receipts (GDRs) such as
the shares floated for UBL and the Oil and Gas Development Corporation (OGDC) on the
London Stock Exchange. The impact of such privatization which in essence generates portfolio
investment on the economy needs to be, however, reviewed carefully given the volatility
attached to such foreign inflows especially with a weakening rupee.

66. Recent attempts to privatize Pakistan State Oil, a major privatization transaction, have
also run into legal problems. Past transactions like that of the telecommunications giant PTCL
and the KESC are also coming under some critique with the detractors of privatization citing
amongst other reasons poor service delivery by the private sector in the post privatization
situation. In the case of KESC, post privatization electricity outages have resulted in violent
demonstrations in Karachi.

67. Factors that appear to have derailed the privatization process are multidimensional. The
privatization program successfully handled “category one” 18 and some “category two” 19
privatizations that included the banking sector transactions. But when it came to more complex
sectors like infrastructure, telecommunications, and power, issues pertaining to future service
delivery could not be adequately addressed during the strategic sale process. The success
yardstick for privatization continued to be the successful divestment of an entity and not its
continued post privatization service delivery. Another major factor that appears to have
negatively impacted the privatization program is the lack of continuity, stability and institutional
memory at the Privatization Commission (PC) itself. After a period of almost six years of well
managed operations, the PC saw, within a time span of a year, three different ministers at its
helm and at least four secretaries. The PC has also witnessed a very high turnover in its
consultants during the same period. At the same time, PC’s communication with stakeholders
suffered as public perceptions of the privatization process and its transparency turned negative.

68. The Government was unable to mount an effective defense against the storm of criticism
unleashed by the PSM judgment. Privatization, fundamentally being a political act requires a
broad based support at both the political and other institutional levels, and issues generating

18
Category one privatizations generally constitute simple transactions generally of small profitable industrial units that
are easy to divest and which do not generate regulatory market concentration, and competitiveness issues.
19
Category two privatizations are more complex, require complex structuring and require that regulatory,
competitiveness, monopoly power and market concentration issues amongst others be addressed. Complex
transactions in the financial services, energy, telecommunications and some components of the power distribution
sectors fall under this category. Category three privatizations need to tackle a number of strategic, social and
political issues as well as those issues identified for category two transactions. The examples of category three
sectors are health care, education, water supply, railways, ports, airlines etc.
25

controversy need to be promptly addressed. Another structural issue was that the modes of
privatization so far followed were restricted to capital market operations like IPOs, POs, GDRs
and strategic sales. In light of the experience gained, the Government must also begin to view
privatization from a broader perspective and go beyond the current simple divestment structures
of strategic sales and capital market transactions and experiment with public private partnership
based approaches, management contracts, mutualization, concessions, and atomized private
sector holding structures.

Box 3: Pakistan’s Banking Sector Privatization Program

By 2004, following successful privatization, over 77% of Pakistan’s banking sector had
come under private ownership, and following its lethargic performance in the post-nationalization
period, developed greater efficiency and rising profitability. The table below compares Pakistan’s
banking sector performance in 1997 when 80% of the banking sector was in the public sector with
that of 2004 when only 20% was left in the public sector post privatization. The various indicators
measuring asset quality in terms of reduction in the proportion of non-performing loans, return on
assets, and incomes, demonstrate a very significant turn around and improvement. From
investment banking to commercial banking to consumer banking a major overhaul of financial
services is underway. The growth in the consumer banking industry, in particular, has been
spectacular and provided opportunities to the middle class to avail housing and automobile loans
at affordable rates. However, starting in the FY2007, with rising interest rates, the performance of
the consumer banking has been affected, and some banks have developed higher infection rates
in their consumer loan portfolios. Overall profitability of the banking industry has, however,
continued to remain robust.

Commercial Banking Sector Indicators - 1997 vs 2004


1997 (80% public 2004 (20% public
sector owned) sector owned)
Asset Quality: NPLs to Total Loans 20.1% 9.0%
Return on Assets (after tax) -1.3% (loss) 1.3%
ROE after tax -36.2 %(loss) 19.8%
Net Interest Income/Gross Income 46.5% 62.5%
Cost / Income (efficiency) (lower the percentage the 85.8 51.8
higher the efficiency)
Source: Table developed from data found in SBP Banking System Review 2006

2.2.1 The “Privatization For The People” Program

69. The ‘Privatization for the People Program’ was launched in February 2002 to offer
shares in public enterprises to the general public. This program’s several objectives were: to
create ownership and enthusiasm for privatization among the public; to directly pass on the
benefits of the privatization program to large segments of the public; to bring new companies for
listing into the stock market thereby broadening the base of the stock market; to offer good
investment opportunities to middle class investors and to benefit from the transparent
procedures available for privatization through the stock market and create a larger group of
stockholders in Pakistan.

70. The Government in 2006 also began floating Global Depositary Receipts (GDRs) in a
move to attract foreign portfolio investment and to increase Pakistan’s visibility in the
international marketplace. Figure 7 shows that this has led to a significant increase in foreign
ownership of equities in Pakistan’s domestic stock market- from less than 3% of aggregate
market capitalization in October 2005 to over 6% by February 2007. Primarily using the London
26

20
also refers to the same issue when it states “The recent
surge in portfolio investment, particularly in the stock market, has both positive and negative
implications. On the one hand, these flows helped finance the country’s current account deficit,
but on the other hand, there are some concerns in terms of volatility attached with these flows
since their abrupt withdrawal can adversely affect the domestic stock prices and the stability of
the domestic currency”.

Figure 7: Foreign Stake in Domestic Stock Market (as percent of aggregate market
capitalization)

Source: State Bank of Pakistan. 2007.Third Quarter Report FY2007. Karachi

2.2.2 Lessons Learnt from Pakistan’s Experience with Privatization

71. The privatization process has contributed substantially to raising the role and profile of
the private sector in economic activity. In structuring privatization deals, however, adequate
attention to post-privatization service delivery needs to be ensured to fulfill the efficiency
purpose of privatization and create political acceptance of the privatization process. To this end,
the privatization policy should focus at the medium and the long term instead of merely targeted
to achieving immediate divestment and transfer of ownership to finance the public sector
deficits. In this regard, privatization must be undertaken under the ambit of a well defined
privatization policy with adequate legal cover. Importantly, the utilization of the proceeds from
privatization need to be predetermined and made public so that the political imperatives of
politicians and short term ends of policy makers are curbed. Intergenerational accounting and
considering privatization proceeds as what they are: one off non-recurring proceeds could lead
to greater scrutiny and caution in applying privatization proceeds to overcome immediate budget
constraints. Finally, adherence to transparent privatization procedures that ensure accountability
at all levels of Government should be ensured and not compromised for the sake of political
expediency.

2.3 DEREGULATION AND ECONOMIC LIBERALIZATION

72. Besides privatization, the Government’s investment friendly policies marked by


deregulation and liberalization have had a marked impact on investment, with a particularly
significant acceleration in foreign direct investment. Amongst the highlights of the lliberal

20
State Bank of Pakistan. 2007. Third Quarter Report for Fiscal Year 2007. Karachi
27

investment policies being pursued by Pakistan include equal treatment to local and foreign
investors, opening up of almost all economic sectors to FDI, and allowing foreign equity
ownership of up to 100% with no or few Government permissions required. In addition,
attractive incentives have been put in place that allow hassle-free remittance of capital, profits,
dividends, royalty, technical and franchise fees. Export processing zones and industrial estates
providing attractive incentives have been set up with more planned in various parts of the
country. Pakistan has also zero rated the import of raw material for export manufacturing.
Pakistan currently has bilateral agreements with a number of countries, with specific investment
protection agreements with 46 countries and avoidance of double taxation agreements with 52
countries.

73. Tariff reforms Implemented include an across the board significant reduction in tariffs
since 1999 with the maximum tariff set at 25% and reduced import duty on 4,000 items.
Taxation reforms have broadened the tax base, eliminated multiplicity of taxes, and introduced a
universal self assessment system for tax collection that has made the taxation process more
efficient 21 . Highlights of Pakistan’s liberal investment policies are summarized in Table 11.

Table 11: Government’s Incentives for Investment


Non -Manufacturing Sectors
Policy Parameters Manufacturing Sector Infrastructure & Services including IT &
Agriculture
Social Telecom Services
Not required except for Not required except specific licenses from concerned
Govt. Permission
specified industries* agencies.
Remittance of capital,
profits, dividends, Allowed Allowed
etc.
Upper Limit of foreign
100% 100% 100% 100%
equity allowed
Minimum Investment
No 0.3 0.3 0.15
Amount (M $)
Customs duty on
5% 0% 5% 0-5%
import of PME
Tax relief (IDA, % of
50% 50%
PME cost)
No restriction for Allowed as per guidelines - Initial lump-sum upto
Royalty & Technical
payment of royalty & $100,000 - Max Rate 5% of net sales - Initial period 5
Fee
technical fee. years
* Specified Industries: PME= Plant, Machinery and
- Arms and ammunitions Equipment
- High Explosives. IDA= Initial Depreciation
- Radioactive substances Allowance
- Security Printing, Currency and Mint.
- No new unit for the manufacturing of alcohol, except, industrial
alcohol
Source: Board of Investment: http://www.boi.gov.pk

21
In the 2007-08 budget, in an effort to curb imports and raise more revenues to contain the trade and fiscal deficits,
the Government once again raised the maximum tariff to 30-35% and imposed higher duties on non-essential
imports. It remain to be seen if these were temporary measures and would be withdrawn with the anticipated
reduction in trade and fiscal deficits.
28

74. With the opening up of the economy, Pakistan has attracted FDI from many countries.
Table 12 shows the origins of foreign investment flows into Pakistan. The US, UAE and UK
were the most significant sources for investment in FY2007. Among these countries, in FY2008,
Norway and Malaysia were the other two major investors. The overall investor country mix
consists of both regional and global investors. New major investors include Peoples Republic of
China and the UAE. Foreign companies in recent years have generated healthy returns from
investments in Pakistan that demonstrates the profitability of FDI in the country (Table 12).

Table 12: Country Wise Foreign Investment Inflows ($ million)


Country FY2006 FY2007 FY2008
Direct Portfolio Total Direct Portfolio Total Direct Portfolio Total
Australia 31.3 31.3 72.0 -6.4 65.5 69.6 -73.2 -3.6
Germany 28.6 -3.5 25.1 78.9 7.0 85.9 69.6 -0.5 69.1
Hong Kong 24.0 31.2 55.2 32.6 -72.6 -40.0 339.8 -245.5 94.3
Japan 57.0 -8.7 48.2 64.4 3.9 68.4 131.2 9.9 141.1
Kuwait 18.1 2.9 21.0 65.9 17.0 82.9 36.0 28.3 64.3
Luxembourg 23.5 -1.0 22.5 13.0 -0.4 12.6 -0.4 39.3 38.9
Mauritius 87.0 -4.1 83.0 77.6 13.0 90.6 99.6 5.9 105.5
Netherlands 121.1 -0.7 120.4 771.8 6.2 778.0 121.6 24.5 146.1
Norway 252.6 252.6 25.1 0.0 25.1 275.0 0.0 275.0
Saudi
277.8 0.8 278.5 104.9 0.1 105.0 46.2 -1.6 44.6
Arabia
Singapore 9.9 5.6 15.5 20.9 118.2 139.1 24.8 19.6 44.4
Switzerland 170.6 11.6 182.2 175.0 -127.4 47.6 169.3 -97.8 71.5
U.A.E 1424.5 63.3 1488.0 662.2 14.9 677.0 588.6 4.3 592.9
U.K 244.0 -19.5 224.5 860.0 960.1 1820.1 460.2 -125.1 335.1
U.S.A 516.7 303.8 820.5 913.3 853.4 1766.8 1309.3 439.2 1748.5
Others 225.7 -30.2 195.5 1202.4 33.3 1235.7 1412.4 -8.0 1404.4
Source: State Bank of Pakistan: http://www.sbp.org.pk

75. The Government is attempting to increase foreign investment particularly in the energy
and infrastructure sectors. With the existing electricity and gas shortfalls, the Government is
very keen to source foreign investment in setting up power projects all over Pakistan. 27 power
projects costing around US $8 billion are in the process of being set up in the country over the
next 7-8 years and will require an average of about US $1 billion investment every year.
Provincial governments too have become proactive in attracting foreign investors. The
Government of Punjab, for example, in collaboration with 60 Korean companies, is working
towards the establishment of a Korean industrial estate for high-tech manufacturing in Lahore. A
similar industrial estate for Chinese investors is also in the works.

76. Pakistan has provided lucrative business for international investors. Table 13 below
provides evidence of the high returns that foreign companies have been able to generate from
investment in Pakistan.
29

Table 13: Leading Foreign Investor Companies – Average Returns


Company Sector 1999 2000 2001 2002 2003 Average

Shell Pakistan Oil and Gas 22% 27% 20% 18% 21% 22%

Hubco Power 24% - 39% 28% 24% 29%

British Oxygen Company Industrial Gas 27% 25% 11% 43% 48% 31%

Glaxo SmithKline Pharmaceutical 19% 22% 8% 15% - 16%

Unilever Consumer Items 52% 106% 45% 148% - 88%

Gillette Pakistan Consumer Goods 33% 33% - 41% - 36%

Colgate Pakistan -do- 18% 21% - 31% 36% 27%

Nestle Milkpak Food 33% 32% 25% 75% - 41%

General Tyre Tyres 21% 29% - 23% 24% 25%

Siemens Engineering Engineering 10% 20% 17% 22% 19% 18%


Source: Board of Investment. 2007. Available: http://www.boi.gov.pk

2.4 REGULATORY STRUCTURES: PROGRESS AND ISSUES

77. Over time, Pakistan has substantially improved its legal and regulatory structures to
create an enabling business environment for private sector development. Yet, issues remain in
terms of the managerial and technical capacity of regulators, their autonomy and independence,
and reports of government interventions in regulatory decisions. To enhance private sector
participation, it is critical that regulatory agencies are appropriately empowered, have the
requisite capacity, and are able to operate independently and with full autonomy to regulate
private business and promote investors’ confidence.

78. The major statutes that govern and regulate corporate activity are the Securities and
Exchange Ordinance, 1969; Companies Ordinance, 1984 and the Securities and Exchange
Commission of Pakistan Act, 1997 and subsequent modifications. The primary regulatory body
that governs corporate entities in the private sector is the SECP. (formerly Corporate Law
Authority created in 1984). Besides the SECP, other key regulators include the State Bank of
Pakistan (SBP) that came into being in 1948 and the Competition Commission of Pakistan
(formerly the Monopoly Control Authority formed in 1970). Important sector regulators include:
the National Electric Power Regulatory Authority (NEPRA), Oil and Gas Regulatory Authority
(OGRA), Pakistan Electronic Media Regulatory Authority (PEMRA), and the Pakistan
Telecommunications Authority (PTA). The establishment of regulatory bodies in the new sectors
was a result mainly of the large scale privatization of public sector entities operating in these
sectors.

79. Securities and Exchange Commission of Pakistan (SECP): SECP is the main
regulatory body charged with the responsibility to develop and foster an efficient corporate
sector and capital markets within an effective governance and regulatory framework. The SECP
regulates the corporate sector based on a comprehensive set of statutes, rules, regulations,
guidelines and orders. The Securities and Exchange Commission of Pakistan Act was
promulgated in December 1997 and the SECP came into being on 1 January 1999 after the
30

Corporate Law Authority was restructured under the ADB-assisted Capital Market Development
Plan (CMDP) approved in 2007.

80. The authority of the SECP was extensively widened since its creation to include the
regulation of the insurance sector, non-banking financial companies and pension funds. For
non-banking financial companies alone, the SECP licenses, regulates and governs investment
financial services providers, leasing companies, housing finance services, venture capital
investment, discounting services, investment advisory services, real estate investment trusts
and asset management services. But, SECP faces issues of capacity and autonomy in
governance. On capacity, the SECP has recently experienced an exodus of experienced
personnel due to its inability to retain quality manpower. The capacity and capability of any
regulator is as good as the quality of its manpower and it is essential that a regulator like the
SECP maintain its systemic memory by implementing human resource policies that enhance
retention.

81. Besides regulating the banking sector, under the ADB-assisted Accelerating Economic
Transformation Program in 2008, the SBP has been made responsible for regulating and
supervising the framework for consolidated supervision of financial conglomerate, provides it
with greater regulatory powers over parties who control banks and banking groups, and gives it
the power to license, regulated, and supervise all deposit-taking institutions.

82. On autonomy in governance, the SECP Act vested executive authority in five
commissioners appointed by the President of Pakistan and having security of tenure once
appointed. Policy oversight was the function of a nine-member policy board that was to
comprise of five eminent professionals: the SECP chairman and three federal government
secretaries (ex officio members) and the Deputy Governor of the SBP. However, under the
Finance Bill of 2007, the policy board was expanded to 10 members with the Prime Minister or
his nominee as Chairman of the Board who is empowered with a casting vote in case of a tie
between board members. The impact of this change on the performance and autonomy of the
SECP is being currently debated.

83. State Bank of Pakistan (SBP): The SBP is Pakistan’s central bank and regulator of the
banking sector. Under the State Bank of Pakistan Order 1948, SBP was charged with the duty
to "regulate the issue of bank notes and keeping of reserves with a view to securing monetary
stability in Pakistan and generally to operate the currency and credit system of the country to its
advantage". Its role was expanded under the State Bank of Pakistan Act 1956 to "regulate the
monetary and credit system of Pakistan and to foster its growth in the best national interest with
a view to securing monetary stability and fuller utilization of the country’s productive resources".
In February 1994, the State Bank was finally granted autonomy, which was further enhanced in
1997. The SBP has authority to regulate the banking sector, implement monetary policy and
control government borrowing.

84. However, despite being a financial sector regulator, SBP continues to hold a significant
amount of equity in a number of financial institutions generating a potential conflict of interest
situation. While the SBP has so far managed this dual role quite professionally, the privatization
program has successfully reduced its majority shareholding concentrations in financial
institutions and its minority holdings are also being reduced through various domestic and
offshore capital market instruments.

85. Competition Commission of Pakistan: A Monopoly Control Authority (MCA) was


established in August 1971 under section 8 of the Monopolies and Restrictive Trade Practices
31

Ordinance 1970 (MRTPO) to protect against undue concentration of economic power, growth of
unreasonable monopoly power and unreasonably restrictive trade practices. The MRTPO,
however, had major limitations in terms of scope and coverage. A Competition Ordinance (CO)
was finally promulgated in 2007 to bridge the gaps in the existing MRTPO, and under this
ordinance, the MCA was transformed into the Competition Commission of Pakistan (CCP). The
new law focuses on fostering greater competition, reducing barriers to entry, curbing abuse of
market power and providing discretionary power to the CCP to be able to determine optimal
market concentration. In light of the powers granted to it under the CO of 2007, it is important
that the CCP is provided necessary independence and autonomy for the effective discharge of
its functions, and develops the requisite capacity to promote a competitive and efficient
economy.

86. National Electric Power Regulatory Authority (NEPRA): NEPRA was formed in 1997
to introduce transparent and judicious regulation in the power sector based on sound
commercial principles. NEPRA's main responsibilities are to issue licences for generation,
transmission and distribution of electric power; establish and enforce standards to ensure
quality and safety of operation and supply of electric power to consumers; approve investment
and power acquisition programs of the utility companies; and determine tariffs for generation,
transmission and distribution of electric power. NEPRA regulates the power sector to promote a
competitive structure for the industry and ensure the co-ordinated, reliable and adequate supply
of electric power. In light of the existing electricity crisis in Pakistan, NEPRA’s role as a regulator
has come under some critique 22 . It is essential that NEPRA be further strengthened and an
efficient regulatory, governance, tariff and licensing regime evolved to meet the existing and
emerging energy sector challenges.

2.5 GOVERNMENT STRATEGY FOR PRIVATE SECTOR DEVELOPMENT

87. Building on public policy and regulatory improvements introduced in recent year, the
Medium Term Development Framework (MTDF:2005-2010) of the Government places a special
emphasis on private sector development as a key element of the strategy to achieve sustained
growth. Under the MTDF, the Government is supporting private sector development through:

(i) Strengthening the privatization policy and improving the business climate to
catalyze the private sector;
(ii) Upgrading of education and skills and creating necessary public institutional
arrangements including improvement of information and communication
technology (ICT) infrastructure to strengthen the knowledge base and
competitiveness of the economy;
(iii) Strengthening skills and vocational training for improving the quality of workforce
in the private sector for higher productivity;
(iv) Improving quality, productivity, and standards to enhance conformity of Pakistani
products with WTO requirements through restructuring quality standards
institutions, defining clear performance standards, and strengthening the
environment for intellectual property rights protection;
(v) Fostering public-private partnerships through improving the legal and regulatory
environment for PPPs and addressing institutional and capacity issues;
(vi) Vitalizing Pakistan’s capital markets through developing bond markets,
encouraging institutional investment, and strengthening corporate governance.

22
ADB. 2007. Constraints to Private Sector Investment in Infrastructure. Manila
32

88. These components taken together constitute the way forward for the Government’s
strategy on private sector development. Side-by-side, the Vision 2030 approved in 2007
incorporates private sector development as a “key element” of the Government’s long-term
thinking on sustainable development in the country. The Vision takes note of structural factors
impeding the development of the private sector and argues the need for streamlining public
regulatory and administrative procedures to reduce the cost of doing business in the country.
Like the MTDF, the Vision 2030 is strongly supportive of public-private partnerships and
recognizes the need to “facilitate provision of resources, technical expertise, outreach, and
financial mechanisms’ to develop an enabling environment for PPPs in the country.
33

SECTION III

KEY CHALLENGES AND THE WAY FORWARD FOR PRIVATE SECTOR DEVELOPMENT
IN PAKISTAN

89. Pakistan’s private sector has developed and matured significantly on the back of the
overall improved macroeconomic environment and strengthened business conditions marked by
privatization and liberalization of the economy. Major challenges, however, continue to confront
the private sector. The macroeconomic outlook faces renewed problems arising from rising
deficits and inflation and a major financing gap that threatens the fiscal space for public
investment. The business environment is still saddled with governance and institutional
bottlenecks and rigidities in factor markets that raise the cost of doing business and impact on
Pakistan’s international competitiveness. The private sector itself faces major tasks of
introducing improved business operational procedures, strengthening corporate governance
and accountability to shareholders, diversifying into non-traditional sectors to take advantage of
international markets conditions, and adopting modern technology and raising the quality of
human resources for higher productivity and value added. This section attempts to relate these
challenges to the prospects for private sector development in Pakistan and identifies key areas
for improvement in the business environment to catalyze higher private sector participation in
economic development.

3.1 MAJOR MACROECONOMIC AND INFRASTRUCTURE CHALLENGES

90. The implementation of economic reform program in recent years and the growth spurt
this released placed Pakistan amongst the fastest growing Asian economies with the growth
rate averaging around 7.5% between FY2004-FY2007 (figure 8). Growth subsequently came
down but still remained resilient at 5.8% in FY2008. Pakistan’s story in this regard demonstrates
the impact of macroeconomic discipline and commitment to reform in turning the economy and
generating strong private sector led drivers for high growth.

91. During the latter half of the nineties, Pakistan had developed numerous economic
problems. The per capita GDP growth rate averaged less than 1% per annum. Foreign
exchange reserves at one point covered only 2 weeks of imports and public debt hovered at
over 90% of GDP. The impact of the macroeconomic situation was far reaching, restricted the
Government’s fiscal space and led to deteriorating physical and social services infrastructure.
Economic reform had become inevitable in these circumstances. Reforms that began in the late
1990s accelerated the process of change and pushed forward a clear agenda of
macroeconomic stabilization based on fiscal, monetary and structural reform. These reforms
resulted in greater fiscal discipline, increased revenue flows, stabilized the exchange rate,
curbed inflation, reduced transfers to hemorrhaging public sector entities, strengthened
regulatory structures and systems, promoted good governance, and accelerated the pace of
deregulation and privatization. Macroeconomic stability also generated fiscal space for the
government to increase investments in the social and pro-poor sectors and enhance spending
for infrastructure development. Embedded within this strategy was the core vision that the
primary agent and driver of growth was the private sector that had to be supported through the
three key policy pillars of privatization, liberalization and good governance.
34

Figure 8: GDP Growth (%)


10.0
9.0
9.0
8.0 7.5
6.8
7.0
5.8 5.8
6.0
4.7
5.0
4.0
3.1
3.0
2.0
2.0
1.0
0.0
2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08

Source: Ministry of Finance. 2008. Pakistan Economic Survey 2007-08. Islamabad.

92. Rising Macroeconomic Imbalances: The economy, however, came full circle in
FY2008. The biggest challenge to macroeconomic stability at present is the reemergence of the
twin deficits –fiscal and external over the last two years. After averaging 3.1% between FY2003
and FY2005, the fiscal deficit increased to 4.3% in FY2006 and hovered at around the same
level in FY2007. Due to a continued expansionary fiscal policy on the back of rising current
expenditures but stagnant tax to GDP ratios fiscal deficit jumped further up to 7.4% of GDP in
FY2008; thus significantly exceeding the Government’s fiscal deficit target of 4.0% of GDP for
the year. A sharp deterioration in the fiscal account significantly undermined the hard won fiscal
space for continuing social sector investment and infrastructure development spending at the
levels required. Fiscal profligacy in the absence of commensurate increase in revenues
indicates the recurrence of a higher debt burden which in turn will constrict fiscal space even
further because of higher debt service payments. Greater government borrowings to finance the
deficit, which have witnessed a record increase of Rs.584 billion during FY2008, significantly
crowded out credit to the private sector that intern had negative impact on the private sector
investment. A key challenge in maintaining higher public spending is the restructuring of the
taxation system to increase its scope to cover more of the hitherto untaxed informal economy in
Pakistan which by some estimates exceeds the formal economy by a factor of 2.

93. The external current account deficit likewise has rapidly grown over the last two years,
reaching 4.9% of GDP in FY2007 compared to 3.9% of GDP in the preceding fiscal year.
Continued high oil and food prices during have translated into large import payments, and with
exports insufficient to fund imports, resulted in a further deterioration in the current account
deficit which reached at 8.4% in FY2008. The burgeoning deficits on the income and services
accounts have put added pressure on the external account. In the absence of a significant and
sustained increase in exports, a sharp deterioration in the balance of payments situation has
imposed a major constraint on Pakistan’s future growth prospects. As a result, GDP target for
FY2009 has been lowered to 3.5%. It is thus critical that a conducive business environment is
provided to the private sector to increase investment, production and, exports, to address the
large imbalance in the external account. It is essential in this regard that the private sector itself
becomes sufficiently competitive in international markets to generate exports at a level that
ensures that the balance of payment constraint does not limit the economy to a sub-optimal low
level growth equilibrium.
35

94. The continued tightening of monetary policy by the SBP in response to the rising
inflationary pressure has resulted in repeated upward adjustment of interest rates over the last
couple of years. The discount rate increased from 7.5% in FY2005 to 9.5% in December 2007
and further to 13.0% by July 2008 and 15% by November 2008. While important from the
perspective of maintaining macroeconomic stability in an environment of high inflation, a tight
monetary policy could restrict access to credit for the private sector and raise the cost of
borrowing for investment, particularly when Government borrowings from the banking system to
finance the fiscal deficit are significant. Nevertheless, the real interest rate in Pakistan at 3.9% is
still low at this point. Thus, an argument could be made that monetary tightening is currently not
constraining private investment in a major way. Still, there will be a limit to which interest rates
could be raised before a trade-off with growth and investment sets in. Inflation, therefore, needs
to be contained through policy and administrative fiscal restraint measures. To obviate the need
for frequent upward adjustments in interest rates that could prejudice private sector economic
activity, investment, and growth, excessive Government borrowing from the State Bank that is
monetizing the fiscal deficit and fueling inflation would need to be controlled. The spike in food
prices, the major contributor to headline inflation, will also need to be arrested through
appropriate supply side responses. Continued efforts at substitution of energy resources will be
critical, particularly through exploiting the hydropower potential of the country, to curb the sever
impact of oil prices in the medium term.

95. Low national savings and investment rates remain a major constraint to growth. After a
significant improvement in investment from around 22.1% of GDP in FY2006 to 23% of GDP in
FY2007, and in national savings from 17.2% of GDP to 18% of GDP in the same period, both
investment and saving rates declined to 21.6% and 13.9% respectively in FY2008. At this level,
Pakistan’s savings and investment rates remain far too low compared to other faster growing
countries such as China and India. Figure 9 shows, that Pakistan’s saving rate in 2005 was
about half of India’s and only about a third of that of the Peoples Republic of China. Unless
higher domestic savings are mobilized, the dependency on external inflows to finance required
investment levels will increase, which could adversely impact economic stability given the
volatility attached to such inflows.

Figure 9: Domestic Saving Rates in 2005


Domestic Saving Rates

50
45
40
Saving Rates

35
30
25
20
15
10
5
0
China India Pakistan
Country

Source: ADB. 2006. Key Indicators 2006: Measuring Policy Effectiveness in health and Education. Manila.

96. Slow Progress towards Structural Transformation: Structural transformation of the


economy and a shift towards higher value adding sectors is critical to sustain Pakistan’s growth
momentum - in line with the experience of other faster growing developing economies in Asia.
36

Starting from a largely agrarian base, Pakistan’s structural transformation requires an increasing
share of the industrial and manufacturing sector in value added that creates larger employment
opportunities and generates higher value exports for growth. To the contrary, Pakistan, from
being a dominantly agricultural economy in terms of contribution to GDP, has become a largely
services sector economy with services contributing more than half of the total GDP in FY2007
(Table 8 of Section 1). The share of the manufacturing sector has grown more slowly and
reached only 19% of GDP in FY2007 compared to the Peoples Republic of China (35%), the
Republic of Korea (24.7%), Indonesia (28%), and Malaysia (29.8%). The question for Pakistan
is whether the present pattern of growth is sustainable and if the services sectors can continue
to grow without growth and transformation within the industrial and manufacturing sectors, given
that the demand for services stems to a great extent from these sectors. The answer for the
most part is that sustaining growth requires faster industrialization at the stage where Pakistan
is currently at in turn of growth.

97. Pakistan’s industrial and exports base continues to be narrow with the textile industry
being the single most important industrial sector and the primary generator of export earnings.
There is an urgent need to strengthen and diversify the manufacturing export base, both in
terms of products and destination of imports, in view of the current concentration of exports in a
small number of sectors, principally textiles and rice, leather and petroleum products and three
major destinations: the US, EU, and the UAE. The textile sector, along with the sugar industry,
is based directly on agriculture sectors inputs. But little has been achieved in either improving
agriculture productivity or broadening the scope of the industrial sector. It is due to a lack of a
cohesive vision that takes a holistic view of the various sectors within an integrated framework
that Pakistan’s agriculture and manufacturing sectors continue to under-perform.

98. With no major investment activities planned, and most manufacturing units already
running near full capacities, the growth rate in the manufacturing sector has slowed down from
14.0% in FY2004 to 8.2% in FY2007 and further to 5.4% in FY2008. Future growth from this
sector will only come about if the current narrow manufacturing base is expanded by adding non
traditional sectors. It is difficult to conceive a continuing process of structural transformation
without accelerating industrial growth and a deepening and widening of Pakistan’s industrial
base. It is essential that the Pakistani public and private sectors identify either traditional
industrial transformational sector(s) like automobile and consumer electronics or non traditional
ones like aviation, alternate energy and defense to develop core competencies and efficiencies
that generates change up and down the value chains and results in greater diversity and
specialization.

99. Services sector growth, while impressive, needs to be sustained by developing a more
conductive policy environment that helps cover the existing gaps. For example in the financial
services industry, there is still a dearth of financial institutions that specialize in project finance
and long term credit products, venture finance and small and medium enterprises (SME)
lending. There is also a need for more microfinance institutions given the still very low
convergence of poor households by these institutions. Capital markets need to generate
stronger corporate debt markets and support the creation of more institutional investors like
mutual funds and pension funds that provide alternate avenues for savings and investment to
commercial banks. The information technology sector has big potential and can become a more
significant contributor to growth as witnessed in India and Africa where telecommunications and
financial sectors have converged to create virtual financial institutions and markets using cellular
telecommunications systems.
37

100. Crippling Energy Deficit: A major challenge to growth, industrialization and private
sector development in Pakistan is the emerging energy crisis manifested in frequent load
shedding and unreliability of power supply that lead to increased costs of production and
decreased factor productivity, and results in loss of international competitiveness. Electricity
demand is outstripping supply by a wide margin, and by 2010, demand is expected to
exceed supply by approximately 5,500 MW (Figure 10).

Figure 10: Electricity Demand and Supply Curve


20584
20500
Firm Supply (M W ) 19080
19500 Demand (M W )

18500 17689
Megawatts

17500 16548

16500
15483
15046 15082
15500
14336

14500 15072 15091 15055 15055 15055


14642
13500
13831
13071
12500
2003 2004 2005 2006 2007 2008 2009 2010
Year
Source: Private Power Infrastructure Board: http://www.ppib.gov.pk

101. Repeated business surveys have identified insufficient power and energy as a binding
constraint to growth and development of the industrial sector. For example, survey 23 of 650
small and medium enterprises (SMEs) in the manufacturing sector found that almost 80% of the
SMEs did not intend to make new investments over the next few years mainly because of
expensive and unreliable electricity. There is an urgent need to increase electricity generation,
improve the quality of electricity distribution system, and find a suitable set of alternatives to the
fast depleting national gas fields. Alternate sources of energy like renewables offer potential for
Pakistan which besides hydel include bio diesels, wind turbines, solar thermal and solar
photovoltaic. Coal is abundant in Pakistan but in most cases is of poor quality. Still, the
Government’s 2030 Energy Security Action Plan has identified coal as a major source of
energy. Given its complexity and checkered history of piece meal planning approaches that
failed to deliver, it is now essential to prepare and adopt an integrated vision and
implementation strategy for the comprehensive development of the energy sector in Pakistan.

102. The private sector in Pakistan has been engaged in power generation since the 1990s
with the advent of the independent power producers (IPPs). The emphasis of the Government is
on expanding the role of the private sector in energy and other infrastructure development

23
Undertaken by the Lahore University of Management Sciences in 2003 and reported in Haq, M. 2005.
Entrepreneurship, Private Investment, Economic Growth. The Lahore Journal of Economics, Special Edition,
September 2005.
38

recognizing that public sector development resources will be insufficient to meet the emerging
infrastructure requirements generated by economic growth, urbanization, and an expanding
population base. This is not an easy task as the private sector has seldom been a major player
in emerging economies in the development of infrastructure given long project gestation
periods, uncertain political horizons, and lagged returns. Still, given Pakistan’s early success in
attracting the private sector in the power sector, it is conceivable that a mix of privatization,
greenfield projects and public-private partnerships could generate greater opportunities and
interest the private sector in investing in infrastructure development in the country. Even in the
power sector, however, the breach of power purchase agreements by the Government in the
case of the IPPs in the late 1990s remained a barrier to entry for new private sector investors
but now new power producers in the private sector are again becoming active and investing in
various projects in the country. Consistency of policy and macroeconomic and political stability,
the ability of the Government to create appropriate pricing, regulatory and contractual
structures, and the availability of long term finance are some of the most critical elements for
building a larger and more vibrant roles of the private sector in infrastructure development in
Pakistan.

3.2 GOVERNANCE AND INSTITUTIONAL BOTTLENECKS

103. Both domestic and foreign investors both look to a country’s governance indicators in
terms of political stability, law and order, and transaction costs of doing business when making
investments decisions. Foreign investors especially rate governance very high within their
decision framework regarding offshore investment locations. Pakistan’s governance indicators
are comparatively poor relatively to many other countries at similar levels of development which
seems as distinctive for new potential investors and drags Pakistan down on the
competitiveness ladder relative to many other countries in the region. Figure 11 illustrates
Pakistan’s rankings 24 across six dimensions of governance over the1998-2006 period.
Rankings for voice and accountability and political stability deteriorated over this period,
remained the same for control of corruption (although with deterioration between 2002 and
2006), and improved for government effectiveness and regulatory quality. The latter
improvement was expected under the Government’s economic structural reform program
focused on strengthening the enabling environment including regulatory structures for private
sector development. But even for those governance indicators in which there was improvement,
Pakistan’s comparative percentile rankings remain low, threatening the economy’s international
competitiveness and its standing as an investment destination relative to other countries in the
region. Governance reforms in Pakistan, therefore, have to continue and expedited for the
country to improve its governance rankings and, in doing so, ameliorate perceptions of
institutional failure and instability that have come to the fore particularly over the past year.

24
Taken from the Worldwide Governance Indicators (WGI). The Worldwide Governance Indicators (WGI) reports
aggregate and individual governance indicators for 212 countries and territories over the period 1996–2006, for six
dimensions of governance, namely; i) voice and accountability, ii) political stability and absence of violence, iii)
government effectiveness, iv) rule of law, v) regulatory quality and vi) control of corruption. The aggregate
indicators combine the views of a large number of enterprise, citizen and expert survey respondents in industrial
and developing countries. The individual data sources underlying the aggregate indicators are drawn from a
diverse variety of survey institutes, think tanks, and non-governmental organizations.
39

Figure 11: Pakistan’s Governance Rankings

90th-100th Percentile 50th-75th Percentile 10th-25th Percentile


75th-90th Percentile 25th-50th Percentile 0th-10th Percentile
Source: Kaufmann D., A. Kraay, and M. Mastruzzi. 2007. Governance Matters VI: Governance Indicators
for 1996-2006. World Bank: Washington D.C

3.3 CONSTRAINTS TO DOING BUSINESS IN PAKISTAN

104. Pakistan’s reform initiatives have resulted in improvements in the business


environment and a reduction in the cost of doing business. The 2007 Doing Business in South
Asia report 25 ranks Pakistan 74 in a list of 175 countries and second in South Asia in terms of
the private sector’s ease of doing business in the country. Pakistan’s performance on the doing
business survey is summarized in Figure 12. The figure shows the strong and weak aspects of
Pakistan’s business environment. Pakistan ranks above the global average in starting and
closing a business, registering property, obtaining credit, and protecting investors. Areas where
Pakistan overall ranks below the global average include dealing with licenses, employing
workers, paying taxes, trading across borders and enforcing contracts. Critical issues in these
weaker areas are examined below.

25
World Bank. 2007. Doing Business in South Asia 2007. Washington D.C
40

Figure 12: Pakistan’s Performance on the Doing Business Survey

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

105. Enforcing Contracts: Pakistan’s worst performance on the doing business indicators is
on enforcing contracts. Ranked way down at 163rd in the global comparison, this is the Achilles’
heel of Pakistan’s business community. It takes as much as 880 days to enforce a commercial
contract in Pakistan, requires 5 procedures, and costs an average of 23% of a claim’s value. It
is critical, therefore, to develop effective and efficient contract enforcement mechanisms to
reduce delays and bring down the cost of doing business. Improved contract enforcement
through emphasizing tax and labor market reforms, strengthening judicial and adjudication
systems, and streamlining customs, licensing, and other regulatory procedures will promote
formalization of the economy, generate greater public sector revenues, and result in higher
private sector investment. Reforms are underway to improve contract enforcement include
setting up of specialized administrative and judicial tribunals to resolve tax, banking, customs,
labor disputes on a fast track basis, and establishing alternate dispute resolution mechanisms.
But, these and other related reforms have to be pursued with commitment over the long-term to
lead to result in strengthened property rights protection and greater private sector confidence for
higher investment.

106. Dealing with Licenses: Obtaining licenses in Pakistan is complicated, requiring 12


procedures and costing almost 10 times the per-capita income (double the South Asian
average), which relegates Pakistan to the 89th position globally on this indicator. The cost of
obtaining licenses differs from province to province, mainly because of the differential in the cost
of utility connections. Karachi, Pakistan’s main commercial city, is among the most expensive to
obtain a business license as a result of the high cost of obtaining water, sewerage and
electricity connections in the city. Pakistan’s poor rating on license thus also shows the lagging
state of its basic infrastructure that translates directly into relatively high costs of doing business.
41

107. Employing Workers: Pakistan’s rigid labor market conditions are manifested in its low
rank on the doing business indicator for employing workers. Pakistan is ranked at the 126th
position globally on this indicator. Pakistan’s labor code enforces strict hiring conditions through
rules governing temporary contracts and minimum wage. Social security payments or payroll
taxes associated with hiring a new worker amount to 12% of the salary which is relatively high in
the regional context. Firing conditions are relatively easier, but an employer must still pay the
equivalent of 90 weeks of salary in severance, penalties and notice to dismiss a worker which is
again comparatively high in the regional and global context. Such labor market rigidities have a
negative impact on foreign direct investment flows as capital and investment move to countries
with fewer or no labor market rigidities. For, example, countries such as China, New Zealand,
Malaysia and Singapore put no limit on term contracts in labor markets. Recognizing the need
to reform the labor market, the Government is taking steps to streamline and modernize labor
codes, increase flexibility in hiring and firing, and lower costs of compliance.

108. Paying Taxes: Despite a relatively low tax rate for commercial profit, Pakistan ranks at a
low 140th position on paying taxes, with tax administration remaining a key area of weakness
notwithstanding some recent improvements. A standard business establishment has to make as
many as 47 tax payments to various government agencies, and spends annually an average of
560 hours to file taxes. Tax reform is essential to broaden the tax base, further reduce average
tax rates, and rationalize the number of taxes as well as the involved procedures. Reforms
currently underway include setting up of large and medium taxpayers units in major cities,
introducing e-filing of taxes, improving the system tax refunds, and establishing an easier
codified taxation system that reduces individual discretion of the tax authorities. With this
progress, Pakistan’s current ranking is an improvement over its 143rd rank on this indicator in
2006.

109. Trading Across Borders: Custom reforms in Pakistan have reduced the time it takes to
export from 33 to 24 days and import from 39 to 19 days. However, Pakistan still ranks at a low
91st and 51st on these two indicators respectively. 8 documents are required for export purposes
and 12 for import which is high in the regional context. Import and export costs have to be
brought down through streamlining documentation requirements and improving processes for
clearance. At the same time, modernization of ports and transportation systems is essential to
exploit Pakistan’s strategic regional location to expand regional and global trade.

110. Intra-country Differences in the Business Environment: There is considerable


variation in the performance of Pakistan’s major cities on the doing business indicators. For
example, business start up costs are 25% higher in Karachi compared to other cities such as
Faisalabad, Lahore, Sialkot and Peshawar that have eliminated stamp duty and reduced start
up costs. In an investment climate survey, with respondents from the national business
community, Karachi ranked second in terms of its investment friendliness, with Lahore first
ranked as the choicest place for investment (Figure 13). The survey confirmed significant
disparities between larger and smaller cities in terms of investment climate. For example, lack of
skilled labor in the cities of Hyderabad and Sukkur raise business costs relative to Karachi. In
addition, the law and order situation in smaller cities is of concern: businessmen cited the poor
law and order as the foremost barrier to investment in the cities located in interior Sindh.
42

Figure 13: Ranking of Investment Climate by City (perceptions of firms outside the city)

Percent
1
Best
Better
No Better
0.5 Worst

- 0.5

Quetta Peshawar Islamabad Sialkot Karachi


-1 Sukkur Hyderabad Gujranwala Faisalabad Lahore

Source: Investment Climate Assessment, Small and Medium Enterprise Development Authority and the World Bank.
2001.

3.4 PAKISTAN’S LAGGING COMPETITIVENESS

111. Competitiveness is key for private sector development. A State of Pakistan’s


Competitiveness 2007 Report 26 compares Pakistan’s rankings on the global competitiveness
index (GCI) 27 with a selected group of countries in the region (Table 14).

Table 14: State of Pakistan’s Competitiveness 2007

Source: Competitiveness Support Fund. 2007. The State of Pakistan’s Competitiveness 2007. Islamabad.

26
Competitiveness Support Fund. 2007. State of Pakistan’s Competitiveness. Islamabad.
27
World Economic Forum. 2007. Global Competitiveness Report.
43

112. It is apparent for the table that, Pakistan’s very low rank on health and primary education
as well as higher education and training come out as among the most critical holding back
Pakistan’s competitiveness. Interviews with members of the business community undertaken as
part of the private sector assessment confirmed that the low quality of human resource skills
available had increasingly become their main concern. (See Section VIII). Pakistan’s ranking is
comparatively better for infrastructure, business sophistication, innovation and market efficiency.

113. But, it is apparent from Table 14 that each country included in the comparison has its
highs and lows on the competitiveness rankings, with the exception of Malaysia which seems to
rank high on all indicators. Bangladesh, for example, faces challenges on institutions,
infrastructure and health and primary education. The Peoples Republic of China’s major
strength is its macro economy, with a strong showing on infrastructure and health and primary
education. India’s strengths are its institutions and infrastructure. Sri Lanka scores very high on
primary education and health care. A brief overview of Pakistan’s ranking on selected GCI
indicators and sub-indicators follows.

114. Institutions: Within institutions, Pakistan ranks the worst on the security indicator
among all the sub-indicators for institutions (Figure 14a). This needs no explanation - the law
and order situation has to improve to enhance the country’s competitiveness. As is evident from
the figure, the ranking for property rights protection, private sector accountability, and corporate
ethics also deteriorated between 2005 and 2006.

115. Infrastructure: Pakistan’s infrastructure ratings are mixed (Figure 14b). It ranks low on
the quality of electricity supply and telephone lines (although mobile phones have recently led to
a substantial improvement in the country’s tele-density). Pakistan ranks relatively better on the
quality of transport and railway infrastructure despite some slippage in 2006 in the former.
Pakistan’s overall infrastructure rank improved in 2006 over the rank in 2005.

116. Health and Primary Education: Pakistan’s dismal rankings on key social sector
indicators including primary school enrolments, infant mortality, and malaria prevalence are
confirmed in 16c. Rankings on many social indicators slipped further in 2006. Overall,
Pakistan’s ranking on heath and primary education was the worst among all the GCI indicators
and brings out the challenge of development of human resources in any strategy to enhance
Pakistan’s international competitiveness.

117. Higher Education and Training: Pakistan ranks low and generally behind its
comparative group on higher education and training. Despite some improvements in the quality
of the educational system (ranked 74th), staff training and quality of management schools
(ranked 71st), Pakistan continues to lag on enrolment for secondary and tertiary education.

118. Market Efficiency: Figure 14d shows that while Pakistan’s market efficiency rankings in
2005 were relatively high, there was a marked deterioration in 2006. Pakistan’s rankings on the
all three sub-indicators: sophistication of financial markets; flexibility of labor markets; and
distortions in good markets worsened between 2005 and 2006. This clearly indicates the need
to deepen structural reforms to improve functioning of factor markets for greater efficiency and
competitiveness.

119. Technological Readiness: Pakistan at the 77th position is ranked low on technological
readiness (Figure 14e). The low technology ranking is also linked to Pakistan’s poor
performance on the education and human resource development indicators mentioned before.
44

Between 2005 and 2006, there was a marked deterioration of Pakistan’s ranking on firm-level
technology adoption and technology transfer through FDI –most of the FDI. This is because in
Pakistan in recent years has been centered in the services industry and has bypassed the
manufacturing sector where the gains from technology improvements facilitated by FDI would
have been the highest.

120. Business Sophistication: Pakistan scores well at 47th place with a relatively high rank
in value chain presence, nature of competitive advantage, production process sophistication,
local supplier quality and local supplier quantity (Figure 14f).

121. Innovation: Pakistan’s relatively good rank of 60 in the GCI is driven by improvements
indicators measuring capacity for innovation, university/Industry research collaboration, and
company spending on R&D. A larger improvement in Pakistan’s rank on innovation is, however,
held back because of lack of availability of scientists and engineers (linked again to the issue of
poor quality of human resources) and inadequate intellectual property protection. Given the poor
quality of human resources, the country’s comparatively high rank on innovation comes as
somewhat of a surprise. In all probability, this rank reflects the fact that the private sector
entities selected for purposes of data collection comprised the top 120-125 corporate and
multinationals operating in the country. This group could naturally be expected to have attained
a higher degree of technological innovation than, for example, firms operating in the SME
sector. Thus with a more representative sample, it is likely that Pakistan would have scored
lower on the innovation indicator.

122. Implications of the GCI Results on the Role of Public and Private Sectors: The GCI
findings confirm the many challenges confronted by Pakistan’s public and private sectors to
achieve higher international competitiveness. Keeping the results of the competitiveness survey
in view, the focus of the public sector at this point has to be on developing the necessary
institutional frameworks, maintaining a stable macroeconomic framework, improving
infrastructure, especially in the energy sector, and improving the quality and outreach of
education and healthcare delivery mechanisms. The private sector has to also contribute in all
these areas, particularly in strengthening private provision of public goods including
infrastructure and social services to bridge the existing deficits that cannot be met by the public
sector alone. In addition, the private sector has to lead in improving technological readiness in
the manufacturing and services sector, investing more resources in research and development,
and adopting international standards of corporate management and sophisticated business
practices for greater efficiency and higher competitiveness.
45

Figure 14a: GCI Rank on Institutions

Figure 14b: GCI Rankings on Infrastructure

Figure 14c: GCI Rankings on Health and Primary Education


46

Figure 14d: GCI Rankings on Market Efficiency

Figure 14e: GCI Rankings on Technological Readiness

Figure 14f: GCI Rankings on Business Sophistication


47

Figure 14g: GCI Rankings on Innovation

Figure 14h: GCI Rankings on Macroeconomy

Figure 14i: GCI Rankings on Higher Education and Training

Source: Competitiveness Support Fund. 2007. The State of Pakistan’s Competitiveness 2007. Islamabad
48

3.5 SUMMARIZING THE WAY FORWARD FOR PRIVATE SECTOR DEVELOPMENT:

123. The World Wide Governance Indicators, the Doing Business in Pakistan report, and the
Global Competitiveness Index (GCI) provide valuable insights into the governance, structural,
and private sector specific factors that impedes Pakistan’s international competitiveness, raises
the cost of doing business, and hampers the general business environment in the country. The
following three factors come out as the critical ones from the point of view of developing the
private sector in Pakistan.

124. Institutions and Governance The rankings have identified a critical need for
strengthening contract enforcement mechanisms, improving property rights protection, and
streamlining regulatory systems to improve the business environment for the private sector. The
need for labor market reforms, strengthening the taxation system and improving licensing and
customs procedures was also highlighted. Last but not the least, the analysis highlighted
political stability and improvement in the law and order situation, and control of corruption as key
elements of the strategy to strengthen private sector development in the country.

125. Infrastructure Development The analysis noted Pakistan’s very low rank on electricity
supply. This indeed is becoming a binding constraint to Pakistan’s industrial development,
particularly in view of the current electricity crisis, and needs to be overcome on an emergency
basis. Although Pakistan seems to have fared better on transport systems, still there is a clear
need for substantial improvements with respect to road and rail networks, ports and airports.

126. Improving the Quality of the Workforce: Among the most complex and structural
challenges in the development of the private sector is developing educated, skilled, and in-
demand human resources. Pakistan’s social sector delivery service mechanisms are dismal and
rank amongst the lowest in the world. Technical education and vocational training systems
remain supply driven and are not effectively connected to market demand. The result is a lack
of quality manpower in all sectors that reduces total factor productivity of the economy.
Development of human resources though focusing on primary, secondary, tertiary education
and health sciences, and starting vocational and technical training system to better respond to
the market demand for labor is thus a must for Pakistan to strengthen its international
competitiveness.
49

SECTION IV

THE MISSING LINKS

127. This section identifies two-admittedly disparate areas that have been so far under
emphasized but which have a great impact with respect to strengthening private sector
development and sustaining future economic growth. The first area is that of the informal sector
and SMEs. While generally looked at as separate, the two have a complex relationship whose
dynamics need to be clearly understood. These sectors remain critical from the perspective of
employment creation. The second area is that of climate change. While at first sight it might
seem out of place to highlight in the private sector assessment an issue which is understood
mainly as an environmental concern, the fact of the matter is that climate change patterns have
an intrinsic link with challenges and opportunities for the private sector such as with respect to
the performance of the agriculture sector (largely private sector driven), or introduction of clean
renewable energies and modernizing public transportation systems, in both of which the private
sector can have a key role. A related area of private sector involvement is the linkage between
capital markets and climate change that is permeating through increased capital market funds
available for investment in clean technologies.

4.1 THE SME and INFORMAL SECTORS:

128. The informal sector in Pakistan, despite being a major employer and contributor to
economic activity in Pakistan remains virtually uncharted. The nature, structure and issues that
impact the informal sector are neither properly documented nor researched. The Government
does not have a vision or strategy for the informal sector, which is a significant disconnect,
given the sector’s importance for labor adsorption and the growth of the private sector.

129. Pakistan does not have quantitative data on the contribution of the informal sector to
GDP. Employment data for the informal sector is available in the Labor Force Survey (LFS). The
LFS includes all household enterprises owned and operated by own-account workers in the
informal sector. Excluded are all the informal enterprises engaged in agricultural activities or
wholly engaged in non-market production. Consisting of primarily self–employed entrepreneurs
in a variety of sectors, the informal sector remains a main source of job creation and
employment in the country.

4.1.1 Employment Trends in the Informal Sector

130. According to the LFS, the informal sector during FY2006 accounted for 72.9% of the
employment outside the agriculture sector, somewhat higher (75%) in rural areas than that of
urban areas (71%). Table 15 captures the employment statistics in the informal sector. The
informal sector's share in overall employment in the non-agriculture sector has been rising
consistently over the years. It surged by five percentage points from 65% in FY2002 to 70% in
FY2004 and to 73% in FY2006. In terms of gender, the concentration of male workers in the
informal sector is higher was both the rural and urban areas. Table 16 shows that the largest
informal sector employer was wholesale and retail trade with 34.5% of total employment in the
sector in FY2006. This was followed by manufacturing sector at 21.3%.

131. Formal sector activities, due to logistics and facilities, are more concentrated in urban
areas (29% of total workforce in the formal sector) as compared to rural areas (25%).
50

Table 15: Formal and Informal Sectors- Distribution of Non- Agriculture Workers (%)

Source: Federal Bureau of Statistics. 2006. Pakistan Labor Force Survey 2005-06. Islamabad

132. Location, age and education have a major impact on employment patterns in the
informal sector. According to a study, there is a concentration of very young and very old
workers in the informal sector (82.5% of very young and 80.6 % of very old workers are
employed in the informal sector), but this sector is not too attractive for those aged between 30-
39 years 28 . This study also notes that the informal sector has the maximum concentration of
illiterate workers and a minimum representation of workers with secondary or tertiary level of
education; approximately, 45% workers of the informal sector had never received any formal
education.

Table 16: Informal Sectors Workers- Distribution by Major Industry Divisions

Source: Federal Bureau of Statistics. 2006. Pakistan Labor Force Survey 2005-06. Islamabad

28
Gennari, P. 2004. The Estimation of Employment and Value Added of Informal Sector in Pakistan" Bangkok.
(UNESCAP)
51

4.1.2 Estimation of the Informal Sector's Contribution to GDP

133. The same study estimates 29 the contribution of the informal sector to be 21.2% to GDP
based on 2000 numbers (Table 17). The contribution of informal sector to GDP is substantial in
the construction and wholesale and retail trade. The sector's contribution to transport and
communications (24.6%) and to social, community and personal services (28.3%) is also large.
In manufacturing, the value added produced in the informal sector is estimated at just over 15%
of total output.

Table 17: Pakistan. Revised GDP and Annual Value added of the Informal Sector (1999-
2000)

Source: Gennari, P. 2004. The Estimation of Employment and Value Added of Informal Sector in Pakistan" Bangkok.
(UNESCAP)

4.2 THE FUTURE OF THE INFORMAL SECTOR IN PAKISTAN

134. Pakistan’s Poverty Reduction Strategy Paper (PRSP) 30 projects that high economic
growth will promote employment in the formal sector and would lead to reduced reliance on the
informal sector as the key provider of jobs in the economy. In a study 31 , however, the Swedish
International Development Cooperation Agency (SIDA) contested the view that the informal
economy is somehow transitory and that rapid economic growth would replace the informal
sector with the formal sector as the key employer. The study notes that “the informal economy
can no longer be considered as a temporary phenomenon. Furthermore, the informal economy
has been observed to have more of a fixed character in countries where incomes and assets
are not equitably distributed. It seems that if economic growth is not accompanied by
improvements in employment levels and income distribution, the informal economy does not
shrink”.

135. If this latter perspective holds true, and certainly some of the conditions mentioned in the
SIDA report such as inequity in incomes and assets do appear to exist in Pakistan, it would be
wrong to assume that the informal sector would shrink in importance with economic growth. It
would be more appropriate to plan how the efficiency and productivity of the informal sector
could be enhanced so that its capacity to generate better quality employment opportunities is
enhanced. In this regard, the obstacles faced by the informal sector would need to be
29
Gennar.P. 2004. The Estimation Of Employment And Value Added of Informal Sector In Pakistan. Bangkok.
30
Ministry of Finance. 2003. Poverty Reduction Strategy Paper-I. Islamabad
31
Becker F. K.. 2004. Fact Finding Study on Informal Economy. SIDA
52

addressed. Included in the list of obstacles are infrastructure bottlenecks such as lack of power
and electricity and insufficient access to transport; institutional factors such as poor skills base
and lack of access to education and training opportunities for the labor force and inadequate
property rights protection; and economic issues including limited access to technology and lack
of access to credit (see Box 5).

Box 4: Key Issues in Development of the Informal Economy

– Infrastructure issues
– Poor infrastructure such as transport, storage facilities, water, and electricity.
– Lack of working premises.
– Poorly developed physical markets.
– Institutional issues
– No access to formal training and, as a result, lack of skills in particular
as regards basic economic skills and managerial expertise.
– Lack of formal schooling sometimes even resulting in illiteracy.
– Limited access to land and property rights.
– Limited access to formal finance and banking institutions.
– Reliance on self-supporting and informal institutional arrangements.
– Too restrictive or cumbersome taxation systems and labor laws.
– Excessive government regulations in areas such as business startup,
in particular as regards cumbersome, time demanding and
costly procedures for business registration.
– Limited access to employers´ organizations, i.e. limited possibilities
to exercise influence.
– Lack of access to official social security schemes.
– Lack of information on prices, viability of products, etc.
– Fewer market opportunities due for instance to non-compliance to
international standards.
– Economic issues
– Excessive registration and transaction costs of starting or operating
businesses.
– Limited access to technology.
– Lack of opportunities for bulk purchase of inputs.
– Lack of working capital: credit has to be obtained from informal
sources such as friends or relatives or non-banking financial
agencies with unfavorable terms.
– Insufficient funds do not allow for further investments.
Source: Becker. K. 2004. Fact Finding Study on Informal Economy. Stockholm

136. Given its importance for employment creation and its significant contribution to GDP,
Pakistan’s private sector development strategy needs to recognize the criticality of the
(presently) non-transitory nature of the informal sector and the need to promote enabling
conditions under which the sector continues to effectively contribute to the national economy
and employment.

4.3 SMALL AND MEDIUM ENTERPRISE SECTOR

137. The bulk of Pakistan’s informal sector comprises of individual agents and small and
micro enterprises. Pakistan’s small and micro-enterprise sector is a primary generator of jobs.
Over 99% of enterprises with a work force of less then 50 people 32 are based in the informal

32
Source: Federal Bureau of Statistics. 2005. Economic Census 2005. Islamabad
53

sector. The country, however, lacks a medium-sized enterprise sector as most small enterprises
are unable to scale up operations and graduate to the “medium sized” category of enterprises.

138. In the above context, a key reason for the ‘M’ in the SME sector having not developed is
that Pakistan’s financial sector lacks specialized financial institutions to nurture growth of small
enterprises to medium sized enterprises. The lack of dedicated SME sector financial institutions
is attributable to the lack of orientation and capacity to undertake cash flow based lending, with
almost all lending being asset based. In addition, the human resources required to undertake
SME financing on a large scale are not in place. The inefficient, unduly complex, and archaic
land registration and transfer system removes land from the list of acceptable collateral and
creates additional complication for SMEs seeking formal sector finance. The result is that
despite a number of initiatives over the past decade, credit disbursed to the SME sector in
FY2007 for various sectors had fallen to a pitiful Rs.26.5 billion from Rs.43.2 billion in FY2006
(Table 18). SME credit extension remains inadequate due to structural weakness, including lack
of information and documentation, reluctance to disclose financial data, asset based lending,
lack of information and awareness pertaining to SME lending products at the level of the
consumer, complex lending processes, and dependence on collateral based lending. In the total
private sector credit disbursement of Rs. 1,669.7 33 billion in FY2007, the share of the SME
sector was a shocking 1.7%. Pakistan has only one dedicated financial institution for the SME
sector-the SME Bank Limited. The SME Bank’s share in SME financing is only about 5%.
While the SBP has been pushing for an expansion of credit to the SME sector and has had
some success in this regard much more needs to be done. While the number of SME borrowers
has increased from 67,000 in 2002 to 168,000 in 2006, the quantum in light of the size of the
SME sector is still very low 34 .

139. The SME Bank is now slated for privatization. The privatization of the SME Bank has
been supported by ADB under the SME Sector Development Program approved in 2005. The
Privatization Commission (PC) constituted a transaction committee and initiated the transaction
on 12 February 2007. A fundamental structural flaw in ensuring that the SME Bank continues to
dedicate its support for the SME sector is that the bank has been granted a commercial banking
license providing it with a strong motivation to enter into mainstream commercial banking which
could impact its role as a dedicated financial services provider for the SME sector. Privatization
in these circumstances could lead to the SME Bank being taken over by another commercial
bank with the attraction of the commercial banking license, since risks with SME sector remain
very high and are a major deterrent for financing in the sector whereas commercial banking is a
well established highly profitable business. This, if happens, could lead to a further contraction
in available credit to the SME sector.

140. In support of SME development, various labor laws have been revised through an
extensive consultative process with stakeholders. As a result, new policy directions in the form
of a Labor Protection Policy and a Labor Inspection Policy have been released with necessary
amendments incorporated in the Factories Act of 1934. These policies balance worker’s welfare
in the SME Sector with the need to rationalize the cost of doing business for SME enterprises. A
Small and Medium Enterprise Development Authority is facilitating development of SME clusters
by establishing Common Facility Centre in all provinces with focus on process-technology
related services. For example the first CFC Sanitary-ware Development Centre is being set up
in Gujranwala. However, given the overwhelming importance of the SME sector in generating

33
State Bank of Pakistan. 2007. SBP Annual Report 2006-07, Vol I. Karachi
34
State Bank of Pakistan. 2007. SBP Banking Sector Review 2006. Karachi
54

employment opportunities and contribution in value added, there is a need for continued
emphasis on improving access to finance for SMEs, provision of business development
services, to facilitate SMEs growth, and strengthening the overall enabling environment within
which SMEs are facilitated to achieve their full growth and employment potential.

Table 18: Credit to SMEs (Rs. million)

Source: State Bank of Pakistan. 2007. Financial Stability Review. Karachi

4.4 CLIMATE CHANGE AND IMPACT ON THE ECONOMY AND THE PRIVATE SECTOR

141. Climate has a major impact on Pakistan’s economy with agriculture being a primary
productive sector and the largest employer, and with a manufacturing sector dominated by the
textile sector that has strong backward linkages with the agriculture sector. Despite being
private sector driven, the agriculture sector in Pakistan is inefficient and has suffered in recent
years due to droughts and environmental factors like water logging and salinity. A review of total
factor productivity in the 1993 – 2003 period suggests that no growth took place 35 in the
agriculture sector with the major reasons being deterioration of the natural resource base,
drought, reduced effectiveness of agricultural extension and outreach services and long term
deterioration of water and soil quality. The impact of climate change, by making weather
patterns erratic and reducing reliability of availability of water, would further reduce agricultural
productivity and lead to food and raw material shortages, and result in major livelihood and jobs
in the agriculture sector.

142. The adverse impacts of climate change are now well established. Table 19 summarizes
key vulnerable sectors that could be affected by climate change. Pakistan, lying in the Arid and
semi Arid Asian zone, would be affected because of the impact of climate change on food
security and water resources followed by human health, impact on settlements and losses in
biodiversity.

35
World Bank. 2006. Pakistan – Growth and Export Competitiveness. Islamabad
55

Table 19: Impact of Climate Change

Source: Intergovernmental Panel on Climate Change. 2001. Climate Change 2001: Impacts, Adaptation, and
Vulnerability. Geneva.

143. In view of the above, Pakistan needs to mount a serious response to the challenge of
climate change. To do this, it is essential to understand and analyze the vulnerabilities of
Pakistan’s economy, especially in as much as these relate to the agriculture and industry
sectors. Based on such analysis, measures need to be developed in close partnership with the
private sector to evolve climate change coping strategies and generate innovative solutions to
the challenge. Fiscal measures as well as investment initiatives to direct and stimulate private
sector investment in appropriate clean energy technologies are essential. The potential impact
of climate change must also be factored into medium and long term infrastructure development
projects. This is especially important for infrastructural development projects that have long
gestation periods such as dams, integrated water management systems, coastal developments
and ports to name a few.

144. Europe has taken the lead to develop market based mechanisms in the private sector to
work towards addressing the climate change challenge. The weekly “Economist” magazine
maintains that Europe was home to the majority of carbon emission trading valued at a total of
€40 billion 36 . Banks such as HSBC and ABN AMRO are actively financing investments in green
technologies. The United States too is catching up with the Citibank having promised $50 billion
in investment over the next 10 years to fight climate change. The Financial Times notes that
individuals are also increasingly investing through mutual funds in renewable energy
technologies including wind and social power 37 . Again most “retail” investments of this sort are
happening in Europe. Notwithstanding the recent international financial melt-down, these
developments in the international financial markets can over time have a significant
demonstration effect on domestic capital markets in emerging and developing economies
including Pakistan to raise private sector investment for climate change initiatives. Deepening of
financial markets, development of the mutual funds industry, and mobilizing greater domestic
savings are critical in galvanizing private sector investment in climate change in less developed
countries.

36
The Economist. 15-21 March, 2008. The Greening of Wall Street.(www.economist.com)
37
The Financial Times. 24 March 2008. Investment is Key in Climate Change Battle. (www.ft.com)
56

SECTION V

THE ROLE OF THE PRIVATE SECTOR IN INFRASTRUCTURE DEVELOPMENT

145. Pakistan's physical infrastructure is inadequate in comparison with world standards and
has been identified as one of the critical reasons holding back more rapid economic growth in
the country. The infrastructure sector in the country consists of power, telecommunications,
roads, ports, railway, air transport, urban infrastructure, information technology cyber parks, and
industrial estates. The public sector has been the main provider of basic infrastructure in
Pakistan. However, given the major unmet needs and limited fiscal space, the Government’s
capacity to address the infrastructure deficit is severely constrained. To augment limited public
resources for infrastructure, private sector participation in infrastructure development has to be
encouraged by creating the necessary enabling environment for increased private sector
involvement. Supporting private sector participation in infrastructure development, therefore has
to be a key element of ADB`s new Country Partnership Strategy (CPS) for Pakistan.

146. Table 20 compares Pakistan’s infrastructure indicators with those of South Asia, low
income countries as a whole, and the OECD countries. While Pakistan holds up generally well
on infrastructure sector performance compared to other South Asian and low income countries,
it is clearly way below the averages for the OECD countries. Pakistan’s electricity and power
infrastructure has already come under major strain, and there is a danger that the infrastructure
sector in its totality will become a major bottleneck for continued growth and development
unless a well designed long term strategy to enhance infrastructure investment and expand
private sector participation in infrastructure development is evolved and implemented.

Table 20: Comparative Infrastructure Indicators for Pakistan


South Asia Low Income OECD
Indicators Pakistan
Average Countries Average
GNI per capita, Atlas method (current
600 806 411 33,470
US$)
Access to electricity (% of population) 53 33 25
Electric power consumption (kwh per
363 241 401 8769
capita)
Improved water source (% of population
90 72 64 99
with access
Improved sanitation facilities (% of
54 48 38
population with access)
Total telephone subscribers per 100
8 11 8
inhabitants
Source: Private Participation in Infrastructure Database. 2007. Available: http://www.ppi.worldbank.org

5.1 PRIVATE SECTOR INVESTMENT IN INFRASTRUCTURE:

147. The potential of the private sector to meet Pakistan’s pressing infrastructure needs is
largely untapped. Thus far, Government initiatives to promote the private sector’s role have only
succeeded to a certain extent with private sector investment having come in the power and
cellular telecommunications sectors. The private sector is now also setting up an oil terminal at
the Karachi Port. There is also a proposal to set up an urban mass transit system in Karachi by
the private sector. But attempts to privatize the road infrastructure, for example, have met with
little success. As another example, other than a public-private desalination project in Karachi,
57

the private sector has not financed any water supply and sanitation projects or projects targeted
at solid waste management.

148. Available data (see Table 21) indicates that Pakistan had total private sector investment
in infrastructure of US$17.206 billion during 1990 – 2006, with a major concentration (96%) in
the energy and telecom sectors. There was very little private investment in transport and no
investment in water and sewerage sectors. A large proportion of private sector infrastructure
investment was in greenfield projects 38 . This has come about due to a slower than expected
privatization of public sector infrastructure assets, lack of appropriate public sector assets to
divest, and dearth of attractive sectoral policies. Greenfield projects in the energy and telecom
sectors reflect investors’ desires to enter sectors where pricing, cost, and governance structures
are well defined.

Table 21: Sectors for Private Sector Investment in Pakistan (1999 – 2006)
Greenfield
Sector Concession Divestiture project Total
Energy 0 740 5,997 6,738
Telecom 0 4,047 5,678 9,725
Transport 283 0 460 743
Water and
0 0 0 0
sewerage
Total 283 4,787 12,136 17,206
Source: Private Participation in Infrastructure Database. 2007. Available: http://www.ppi.worldbank.org

149. Despite the laggard interest of the private sector so far, the Government remains keen to
tap private sector participation and investment in the infrastructure sector. The MTDF for 2005-
2010 has earmarked $16 billion for public sector investment in the infrastructure sector.
Pakistan’s total requirements for infrastructure development over the next five years are in the
range of $ 40 billion, but are much higher at about $65 billion if the planned large water storage
dams are also included. The funding gap between the total requirements and the available
Governments’ public sector resource is expected to be filled by the private sector. Such a
strategy, however, seems very ambitious given the existing constraints to private sector
participation in infrastructure development. Box 5 provides an international perspective on
experiences with private sector participation in infrastructure development. This basically
confirms that most private investment has concentrated in the power and energy sectors and
that a number of challenges are faced by the private sector in the other infrastructure sectors.
With respect to the latter, Box 6 highlights a number of a number of controversial infrastructure
deals involving the private sector.

5.2 CONSTRAINTS IN PAKISTAN TO PRIVATE SECTOR INVESTMENT IN


INFRASTRUCTURE

150. Private sector domestic investment and FDI inflows in infrastructure development in
Pakistan are still very low despite a record overall increase of both domestic and incoming
foreign investment in recent years. Besides the generic constraint to investment arising from the
security situation in Pakistan and political events particularly in 2007 and 2008, two key factors
hampering investment and infrastructure include underdeveloped financial markets and
instruments and structural and policy constraints.

38
Greenfield projects are new factories, power plants, airports which are built from scratch on Greenfield land
58

Box 5: The Global Perspective on Private Sector Participation in Infrastructure – Lessons & Policy
Implications

Beginning with limited private participation in the infrastructure sector globally in the 1980s, private investment
reached a high of US$ 110 billion in 1997-981 (Figure 43). This increasing trend was reversed after the East
Asian currency crisis and private investment declined until 2004, after which it picked up again in 2004 and
2005. Like the case with Pakistan, the largest concentration of private sector investment globally in infrastructure
is in the telecoms and energy sectors.

Figure : Substantial New Growth in Investment

Source: Private Participation in Infrastructure Database. 2007. Available: http://www.ppi.worldbank.org

The current international trend of private sector investment in infrastructure is based upon a greater emphasis
on risk mitigation strategies concentrating in a few sectors like telecom, energy and transport where the
regulatory and pricing structures are easier to design, model and enforce. The larger share of investment going
to telecommunications suggests that sponsors are giving priority to sectors where consumer prices tend to be
set at levels fully covering costs and where undue political intervention is relatively less frequent. Second, the
focus on greenfield projects suggests that sponsors are seeking protection from political and regulatory risks.
Indeed, in energy and water, greenfield projects primarily involve bulk facilities (power plants, water treatment
plants) and include off-take agreements with a public party, shielding private operators from the politically
sensitive consumer market. Also, the major modality for participation in infrastructure development are
management and lease contracts, which require no private investment to reduce private sector risks.

Governments in developing countries since the late 1980s have sought private sector investment in
infrastructure to generate fiscal space, tap offshore capital resources, inject new technology, develop domestic
capital markets and generate greater efficiencies in the delivery of services. The tools for attracting private
investment have ranged from privatization to greenfield projects to concessions. The unrealistic hype generated
by some governments regarding the capacities and capabilities of the private sector were punctured in the late
1990s by a few well-publicized private sector failures (see Box 6). These were generally caused by poor initial
privatization design, short term political and economic policies particularly those geared towards meeting
immediate budgetary concerns, and regulatory failures and inability of investors to model unforeseen force
majeure events into their business models. In some cases, the presence of foreign investment, especially in
essential services sectors also generated political and social fallout that resulted in higher political risk ratings
and the return requirements led to resentment and political turmoil. The sectors where the highest frequency of
failure occurred were in water concessions and energy (Independent Power Producers). Analysis of private
sector failures in infrastructure delivery is essential for identifying the root causes of failure, so that transaction
designs can be improved and made more robust to mitigate most generic flaws.
59

Box 6: High-Profile Controversies Involving Private Infrastructure

East Asia
• Takeover of Bangkok Second Stage Expressway (1993)
• Cancellation of Dabhol power plant (1994)
• Renegotiation of Independent Power Producer (IPP) contracts in Indonesia, Pakistan and
the Philippines (1998)
• Abandonment of Manila water concession (2001)
• Abandonment of Manila airport concession (2004)

Latin America
• Mexican toll road bankruptcies (1995)
• Cancellation of Tucuman water concession (1996)
• Cancellation of Cochamba water concession (2000)
• Cancellation of Arequipa electricity concession (2002)
• Argentina’s economic crisis and devaluation threatens to bankrupt private utilities (2002)

Industrialized Countries
• California’s electricity crisis (2000)
• Railtrack bankruptcy (2001)

Source: Gomez, A.Jose, Dominique Lorraine and Meg Osius. 2004. The Future of Private Infrastructure. Cambridge
Massacheutts: Taubman Center for State and Local Government Kennedy School of Government, Harvard
University.

5.2.1 Undeveloped Financial Markets and Instruments

151. The bulk of private sector financing for infrastructure development in Pakistan,
concentrated in the telecommunication and financial sectors, has been generated offshore and
entered Pakistan as FDI. In order to encourage private sector financing in other infrastructure
sectors like road networks and transportation and water and sanitation, it will be essential to tap
domestic financial markets given that foreign capital would be less likely to flow in these “riskier”
sectors. However a major constraint to generating domestic sources is the absence of a
secondary market in debt securities and the Government’ pre-emption of funds of large public
sector savings institutions like the State Life Insurance Company and provident and pension
funds – some of the potential major providers of long-term investment funds. The absence of an
active market in long-term debt securities is a major reason for the dearth of local financing in
the amount and tenor required to finance infrastructure.

152. Considering the large investment requirements for infrastructure development, direct
financing from financial institutions would be insufficient given the balance sheet and credit
exposure limitations of these institutions. The alternative would be to raise funds directly from
the public. To do this would require, in conjunction with ongoing capital market reforms, raising
institutional capabilities and developing financing instruments that more appropriately meet the
long-term financing requirements of infrastructure projects so that resources can be mobilized
on a sustained basis. Over time, financial institutions should develop the requisite skills for
formulating, developing, appraising, supervising, and providing advice to infrastructure projects
in the different sub sectors. The ultimate objective is to develop a mechanism where private
financing would be available without the need for multilateral or Government support. Over the
long-term, only an efficient and properly functioning banking sector and capital market can
sustain large-scale infrastructure financing in the country. At present, the capacity of Pakistan’s
60

capital market remains limited relative to requirements and lacks the needed depth of
instruments and maturity profile to meet the complex financing requirements of infrastructure
projects, which typically have very long gestation periods. While some progress in developing a
corporate bond market was made during the period 2000 – 2003 using typically term finance
certificates (corporate debt paper issued in Pakistan with maturity generally not exceeding five
years), the stock market boom and low interest rates effectively stopped further growth and
development of the market for longer term maturity bonds. In addition, markets or instruments
do not exist at present for zero coupon municipal bonds in Pakistan due in part to the legal
constraint on local and provincial government to directly issue debt.

5.2.2 Structural and Policy Constraints:

153. Public and Political Support: It will be important to develop political consensus and
public support for private sector participation in infrastructure especially for privatizations and
concessions. To this end, privatization of essential services should not be treated as an end in
itself–rather the focus should be on ensuring clear improvement in service delivery, higher
coverage, and rationalized pricing. Removing of massive subsidies and price distortions would
require effective publicity campaigns to generate support. Transparent renegotiation systems,
fair arbitration and buy-back options would be required to deal with contingent possibilities.
Regulatory discretion needs to be designed and used within well designed structures and
systems where public consensus and support are maintained.

154. Development of Appropriate Divestment and Regulatory Structures: Appropriate


divestment structures – privatizations, concessions, and lease and management contracts need
to be coupled with adequate regulatory capacity. Optimal durations of concessions and lease
and management contracts need to be determined for each sector or category of divestment.
Contract structures, especially in long term contracts of 10 years or more, should cater to the
potential origination of disputes due to contingencies or events not earlier envisaged. The
degree of regulation, discretionary regulatory power and capacities of the regulator to regulate
needs to be based on individual sectoral requirements. In natural monopolies where market
power is evident, stronger regulatory powers and capacities need to be developed while in
those sectors where monopoly power is weak or there is sufficient competition, regulation needs
to be rationalized.

155. Identification of Public and Private Sector Roles and Concentrations: Not all
infrastructure sectors are suitable for private management or ownership. Nuclear power plants
and urban water distribution systems 39 , for example, are not particularly attractive privatization
or pure private sector candidates. PPPs can, however, be undertaken where complementarities
between private and public sectors are enhanced. For example, bulk water supply by the private
sector with public sector distribution and private sector collection could be a model in municipal
water supply that creates complementarities.

39
Price of water generally covers a smaller share of costs than prices of other utilities thus requiring government
subsidies or higher tariffs which generates political controversy and interference. Also, being capital intensive, it is
not amenable to short term contracts but long term contracts can lead to serious disputes.
61

5.3 PUBLIC PRIVATE PARTNERSHIPS (PPP) FOR INFRASTRUCTURE


DEVELOPMENT 40

156. Through an ADB supported initiative, 41 the Government is aiming to establish an


enabling framework and environment for promoting public-private partnerships for infrastructure
development. This includes developing a Public-Private Partnership (PPP) policy framework,
developing institutional capacity to close PPP deals, and providing long term infrastructure
financing. The Government’s focal point for developing this policy framework and institutional
capacity is the Infrastructure Project Development Facility (IPDF), whereas the long term
financing will be channeled through an Infrastructure Project Financing Facility (IPFF). Key
constraints to developing viable PPPs for infrastructure development are broadly similar to the
ones that impede pure private sector investment in infrastructure projects. Some of the key
constraints include the following.

5.3.1 Constraints for PPPs

157. Lack of Explicit PPP Policy: Pakistan until recently did not have any policy framework
for promoting PPPs in infrastructure development. The IPDF in September 2007 formulated a
PPP policy document. This document, however, remains a draft and legal and policy support at
the federal, provincial and local government levels to encourage PPP initiatives remains
unclear. The PPP policy needs to, therefore, be applied at the earliest to provide clarity on the
Government’s strategic approach to public-private partnership.

158. Lack of Capacity and Structural Issues: Due to lack of experience, the capacity in the
public sector for promoting and developing PPPs for infrastructure development is limited,
particularly in terms of disaggregating and allocating risks and effectively managing the
competing interests of the private sector focused on project revenues and the public’s sector
emphasis on asset creation. The lack of the public sector’s institutional capability to prepare
viable PPPs means that priority areas for private sector participation are not properly identified
and feasible projects not developed for bidding. The lack of financial engineering expertise
brought about by a lack of appropriate financial instruments, financial institutions and immature
domestic debt markets generates difficulties in packaging projects that could be successfully
offered for financing.

159. These constraints generate major challenges for the implementation of PPP centric
infrastructure development envisioned by the Government. In addition, PPP projects in many
sectors, especially in hydel power generation, water supply, sanitation, solid waste management
and urban transportation fall under provincial and/or local government jurisdictions. Capacity
levels at lower levels of government are generally even more inadequate to deal with the private
sector and address challenges posed by PPPs as there is a complete lack of appropriate
institutional structures and processes, systems and procedures, and capable dedicated staff.

160. Ineffective Public Procurement Mechanisms: The current public procurement laws as
well as public procurement approval processes are cumbersome and outdated. It is unclear the

40
Public Private Partnership (PPP) is a partnership between the public and private sector for the purpose of
delivering a project or service traditionally provided by the public sector. Public Private Partnership recognizes that
both the public sector and the private sector have certain advantages relative to the other in the performance of
specific tasks. By allowing each sector to do what it does best, public services and infrastructure can be provided in
the most economically efficient manner.
41
ADB. 2006. Report and Recommendations of the President to the Board of Directors for a loan to Islamic Republic
of Pakistan on Enhancing Private Participation in Infrastructure. Manila.
62

extent to which PPP projects need to follow these laws and procedures. The Government’s
project approval system through the PC-Is at this point does not require PPP option analysis for
projects. There is, therefore, no compulsion to seriously consider private sector participation in
projects to be extended under the public sector development program.

161. Financing Constraints: Financing is a major concern for PPP projects in the absence
of long-term financing requirements. Financial institutions in most cases lack the skills for
appraising PPP infrastructure projects from a risk and viability perspective in the various sub-
sectors.

5.3.2 Issues, Challenges, and Way Forward on Private Sector Participation in


Key Infrastructure Sectors in Pakistan

162. Power Sector: In 1993/94, the Government decided to allow private sector participation
in power generation with a package of incentives and guaranteed returns on investment. Today,
there are 14 independent power producers (IPPs) in Pakistan. Their total installed capacity at
5,859 MW is about 30% of the total installed electricity generation capacity in Pakistan (Table
22). In addition to the IPPs, one hydel power plant has also been commissioned by the private
sector. A Private Power and Infrastructure Board (PPIB) was set up in 1994 to implement the
Government’s power policy of 1994 for the private sector and act as a single window facility for
investors. Though the power policy enabled quick setting up of private power plants, procedural
drawbacks including the absence of international competitive bidding procedures, unstaggered
timing of the plants’ commissioning, poor planning of the location of the power plants,
inappropriate choice of fuel, and guaranteed high power prices to IPPs, presented a number of
fiscal, financial, and transparency related issues in the evaluation of the IPP projects. The
payments to the IPPs subsequently had a large adverse impact on the budget. The tariff issues
with the IPPs have been since amicably resolved.

Table 22: Total Installed Generation Capacity (MW)

Source: Ministry of Finance. 2007. Pakistan Economic Survey 2006-07. Islamabad

163. A National Electrical Power Regulatory Authority (NEPRA) was established in 1997 to
regulate the power sector and issue licenses, enforce standards, approve investment and power
acquisition programs of utility companies and determine tariffs for generation, transmission and
distribution of electric power. However, NEPRA’s independence has remained undermined due
to inadequacies in the NEPRA Act and the lack of rule based regulatory oversight. At the same
63

time, private sector participation remained limited mainly to power generation whereas the
present policy allows private sector participation in distribution as well (but not in transmission).
So far, the Karachi Electric Supply Company is the only one that has been privatized and, is,
therefore, the only distribution company in the private sector. Attempts to privatize the
Faisalabad and Peshawar Electric Supply Companies have so far not been successful due to
bottlenecks created by the existing regulatory structures and the economic viability of these
companies under the existing tariff regimes. Appendix 4 lists the generic constraints to private
sector investment in the energy sector. However, the process of restructuring of distribution
companies is underway with the process of rationalization, unbundling and corporatization,
which will facilitate the ultimate privatization of these companies.

164. Pakistan water sector strategy identifies a major role for the private sector in hydel
projects that provide both water resources as well as energy but states that the environment is
not conducive to private sector investment. 42 Table 23 details the major identified potential
private sector hydropower projects identified by the Government. These projects have, however,
so far not elicited much interest from the private sector given the absence of an enabling
regulatory and legal environment and tariff policy. The NEPRA Act, for example, is not even
applicable to the Azad Jammu and Kashmir (AJK) and the Federally Administered Northern
Areas (FANA), which are rich in hydel potential and offer the greatest possibilities for private
sector involvement in energy sector.

Table 23: Potential Private Sector Hydropower Projects (Rs. million)

Source: Ministry of Finance. 2007. Pakistan Economic Survey2006-07. Islamabad

165. To plug the increasing gap between the supply and demand of electric power, the
Government is increasingly looking into alternative energy possibilities and an Alternative
Energy Development Board (AEDB) was established in 2006 in the office of the Prime Minister.
The AEDB has issued letters of interest (LOIs) to eighty two national and international
companies for proposals to generate 700 MW of power through wind energy by 2010 and 9700
MW by year 2030. However, implementation remains weak and slow.

42
Ministry of Water and Power. 2002. Pakistan Water Sector Strategy. Islamabad. (Funded by the ADB under TA
3130-PAK: Water Resources Strategy Study)
64

166. The overall business environment for PPPs in the power sector needs to be substantially
strengthened. There is confusion about the roles of the PPIB, therefore, AEDB and IPDF and
possible duplication in their activities. Since the Government is the guarantor, it is directly
involved in the preparation of project documents, which further complicates the situation.
Several agencies have jurisdiction over projects simultaneously, which adds to the complexity of
implementing projects.

167. The diminishing reserves of gas have caused the Government to be more cautious in
committing gas supply for life cycles of power projects. This has severely impacted development
of gas-based thermal projects in the private sector. Investors under the existing policy
environment also have to bear cost escalation risks for civil construction in hydel projects. Tariff
issues spill over to the wind energy sector too, where the tariffs remain unsettled and tax breaks
undefined, leading to the projects' quoted costs being revised lower by the regulator. This
results in distorted tariff determination which in turn leads to a lack of interest and investment in
the sector. The exclusive franchise rights to state-owned distribution companies (DISCOs)
inhibit private investment in the distribution sub-sector. The current legal constraints also restrict
the development of small scale or grid-isolated distribution networks from meeting local
distribution needs. 43

168. Gas: In view of high petroleum prices, gas has gained critical importance as a low-cost
fuel in Pakistan. Natural gas is used in general industry to prepare consumer items, to produce
cement and also to generate electricity. Compressed natural gas (CNG) is a popular choice as
fuel for cars. The private sector is taking advantage of the low price of CNG to convert vehicles
from petrol to gas. In the last year alone there has been a 35 percent increase in the number of
vehicles running on CNG in the country. Pakistan has become the largest user of CNG in Asia
and third largest user in the world after Argentina and Brazil. There are many private companies
involved in gas exploration and production activities. There are two public sector companies
involved in gas exploration namely the Oil and Gas Development Company Limited (OGDCL)
and the Pakistan Petroleum Limited (PPL). The Government is providing incentives to the
private sector for import of liquefied natural gas (LNG). For this purpose, it developed the first
ever LNG policy in FY2006. There are plans to develop an offshore LNG terminal at Port Qasim
to boost import and availability of LNG in the country.

169. Telecommunications: Private sector participation in development of the


telecommunications sector in Pakistan is a success story. The telecom sector is now almost
entirely in private sector hands and continues to witness very high growth rates. The tele-
density in the country has reached an all time high of 40.2 percent (end of April 2007) compared
to only 2.8 percent at the end of 2000 (Table 24 and Figure 15). This has made Pakistan a lead
performer in the sector in the subregion. Revenues of telecom companies that had already
reached Rs.193 billion in FY2006, and crossed Rs.240 billion in FY2007.

170. The telecom sector’s success is based on the Government’s policy of liberalizing and
privatizing the sector and the setting up of a strong regulator, the Pakistan Telecommunication
Authority (PTA), based on international best practice. The fact that the telecom sector allows
pricing that fully covers costs, generates generally low political pressures and has well mapped
risks and risk mitigation strategies, makes it a sector of choice for private sector infrastructure
investment. Pakistan Telecommunications Limited (PTCL) is still the market leader with a share
of 98 percent of fixed line subscribers. PTCL was privatized on 12 March 2006 with the

43
ADB. 2005. Constraints to Private Sector Investment in Infrastructure. Manila. (produced under ADB funded
technical assistance Loan 2178)
65

Emirates Telecommunications Company Etisalat purchasing a 26% stake of PTCL for $2.5
billion.

Table 24: Pakistan’s Teledensity in Comparison with other Regional Countries (%)
FY2003 FY2004 FY2005 FY2006 FY2007*
Pakistan 4.3 6.3 11.9 26.2 40.2
Sri Lanka 12.2 16.6 23.4 29.0 37.0
India 7.1 8.9 11.5 12.8 15.4
Bangladesh 1.6 2.0 4.5 9.0 15.0
Nepal 1.8 2.0 3.0 3.5 6.5
Teledensity includes fixed, WLL and mobile
*As of 30th April 2007
Source: Ministry of Finance. 2007. Pakistan Economic Survey 2006-07. Islamabad.

Figure 15: Teledensity of Pakistan (%)

T eledensity of Pakistan

40

35

30

25
Fixed
%

20 Cellular
WLL
15

10

0
2001-02 2002-03 2003-04 2004-05 2005-06 Mar-07

Source: Ministry of Finance. 2007. Pakistan Economic Survey 2006-07. Islamabad

171. The cellular mobile industry is completely private and has grown tremendously in recent
years. The number of mobile users has risen from 12.7 million in 2005 to 68.5 million by August
2007. 44 Mobile phone coverage now extends to one third (35%) of the country’s total population.
As shown in Figure 15, the cellular component of teledensity has increased dramatically from
1.16 percent to a substantial 35.79 percent between 2001 and 2007. Wireless Local Loop (WLL)
phones have also begun to penetrate the local market. There is intense competition amongst
the cellular operators to provide competitive services. The result is lower tariffs, expanded
networks, customized services and high tech services.

172. Roads: Despite large public sector investments in the road sector led by the National
Highway Authority (NHA) at the federal level, the present road network is under rising pressure
because of higher traffic flows that are outpacing increases in capacity. At the same time,
railways continues to be a dilapidated sector that leads to 95% of the domestic freight sector

44
Pakistan Telecommunication Authority. 2007. Annual Report 2007. Islamabad
66

being carried by roads. 45 However, there is little or no private sector investment in the roads
sector. Keeping in view the large unmet requirements of the road sector, the NHA has on offer
build-operate-transfer projects for national highways since 1997. The NHA issued a policy
framework in 1999 and incentives to attract private sector participation on national highway
projects but these efforts have not borne fruit. Of the two projects awarded to the private sector
by the NHA, one contract was cancelled and is now under litigation while the other project
developer was unable to mobilize the finances required for constructing the road project.

173. NHA has a further six BOT projects in the pipeline with a total estimated cost of $ 150
million. The Provincial Government in Punjab has also taken several steps to increase private
sector participation in the roads sector, including the establishment of a dedicated private sector
cell in the Communications and Works Department as well as establishing a Punjab Road
Infrastructure Company where toll revenues are deposited to be used for pre-feasibility studies
for road infrastructure. The Sindh Government is also considering the construction of its
provincial roads by the private sector but not much work has so far been carried out. With the
limited success so far, an in-depth analysis should assess the impediments to the
implementation of the current policy, incentives, and the legal framework to attract private sector
development for roads development. The capacity of the concerned agencies to conduct pre-
feasibility studies and prepare road projects for tendering, the issues of land acquisition, and the
lack of setting of the toll fee at reasonable levels, are amongst the main concerns that would
need to be addressed from the perspective of the private sector to encourage greater
investment into the sector.

174. There is no PPP Policy framework for the roads sector despite recognition for its need in
the MTDF (2005-2010). "PPP Option Analysis" is not considered a legal requirement at the
feasibility stage of projects and there is ambiguity in the definition of legal boundaries of the
respective mandates of the federal and provincial road agencies in concluding PPP deals in the
sector. Lack of legal power to assign toll receivables, and guarantee against opening alternate
routes increases risk and impedes private sector investment in financing highway projects.
Appendix 5 details a list of constraints of private sector investment in roads and railways.

175. National Trade Corridor: The "National Trade Corridor" (NTC) is a flagship initiative of
the Government aimed at revamping the whole transport sector including ports, roads, railways
and aviation. Its underlying objective is to “decrease the cost of doing business through
improvements in the trade logistics 46 ". The NTC emphasizes enhanced private sector
participation in transport and use of modern technology to increase sector efficiency and
improve asset management with consolidation, up gradation, and maintenance of the existing
system. An efficient and well integrated transport system will develop a competitive economy
and create vast opportunities to reduce poverty. It will also ensure safe mobility and augment
regional connectivity. The NTC is contemplated as a stepping stone towards establishing an
energy and industry corridors in future. Progress is being made in implementing the NTC but
major constraints remain in attracting greater private sector participation in the various
infrastructure sectors that comprise the integrated vision of the NTC.

176. Urban Mass Transit Systems: After decades of neglect, urban mass transit systems
are again receiving attention, particularly in the major cities of Karachi and Lahore. However,
private sector participation has so far not been meaningfully solicited in developing urban mass
transit systems. Past attempts like the Punjab Urban Mass Transit Program in 1998, and the

45
World Bank. 2007. Transport Competitiveness in Pakistan. Islamabad
46
Ministry of Finance. 2007. Pakistan Economic Survey 2006-07. Islamabad
67

revival of the Karachi Circular Railways Project made little progress and never achieved their
designed level of capacity or invited any significant degree of private sector participation. A
Lahore Mass Transit System is being planned with very strong support from the Punjab
Government. Technical assistance from ADB will help prepare the project. The Government of
Punjab is keen to attract private sector participation in the project and anticipates that about half
of the investment required from the project will come from the private sector.

177. Railways: There has been almost no private sector activity in the railways sector. Plans
to privatize railways and allow the private sector access to the sector in the freight, freight
handling, and transportation areas have not been implemented. The railways sector continues
to languish and lose ground to road transportation despite Pakistan’s geographical and
locational advantages for developing an efficient and profitable rail network. Consequently,
Pakistan Railways is a non profitable, technically insolvent public sector entity, which is
beholden to the Government for debt servicing, asset replacement and pension payments. The
Railways Act has remained unchanged since 1890. While the Act allows for private sector
participation in railways, it establishes the Government in conflicting roles both as a competitor
and regulator. This Act needs revision to produce effective PPPs in the railways sector 47 . In
addition, a business plan developed for 2005-2011 that emphasizes private sector participation
in an attempt to increase responsiveness, efficiency and competitiveness of the railways sector
needs to be expeditiously implemented.

178. Airlines: The public sector owned Pakistan International Airlines (PIA) is still the
dominant player in Pakistan’s aviation industry in terms of market concentration. The private
sector, however, operates four out of the five domestic airlines in Pakistan, spearheaded by
Airblue, Pakistan’s fastest growing private airline. PIA is inefficient, bloated by overstaffing and
unprofitable. PIA’s losses after taxes significantly increased from Pak Rs. 4.5 billion in 2005 to
Pak Rs. 13.2 billion in 2006 48 ; it carried 2.5% less passengers; its old planes were grounded;
and it was refused landing rights in the EU because of flight safety and maintenance concerns.
Based on the development, PIA posted Rs.38.4 billion losses by the end September 2008,
compared to a Rs.10 billion loss in the same period last year. Previous attempts to privatize PIA
were aborted because of pressure from the highly organized anti-privatization labor unions, lack
of real political will, and the poor financial health and structural inefficiency of the airline that
made it unattractive for the private sector. After a series of set backs in 2007 including
management problems, the privatization of PIA appears to be back on the agenda. But without
political will and a well developed and an effectively executed privatization plan, this will
continue to prove difficult.

179. Airports: After being dominated fully by the public sector, the private sector is slowly
becoming active in the development of airports. The regulator – Pakistan’s Civil Aviation
Authority - is proposing private participation in the development of a new international airport at
Islamabad. Private sector participation is also being solicited for the new international airport
proposed at Gwadar. The private sector has already built an airport at Sialkot on a build, own,
and operate basis.

180. Sea Ports: The bulk of Pakistan’s international trade, about 40 million tons per annum of
dry and liquid cargo, is handled by the two seaports of Karachi and Port Qasim, located about
50 kms from each other. Both these ports are state owned as is the new port developed at
Gwadar. Some functions at these ports have, however, been handed over to the private sector.

47
ADB. 2005. Technical Assistance to Pakistan for Support of Infrastructure Investment. Manila
48
Pakistan International Airlines. 2007. Annual Report 2006. Karachi
68

The Karachi Port Trust (KPT) adopted a Landlord Port Strategy in 1997 under which KPT would
own the basic infrastructure and land but lease out regular operations. Accordingly crane
operations and crawler crane operations have been given to private operators. The KPT
awarded the development of an international container terminal to the private sector on a BOT
basis. It also has a proposal to develop a bulk cargo terminal as well as a cargo village through
the private sector. Port Qasim too has a privately operated container terminal. The management
and operations of the new Gwadar port have been also leased out to the private sector by
appointing the Singapore Port Authority (SPA) in-charge of management and operation of the
port under a 40 year agreement with the Gwadar Port Authority.

181. The role of the private sector in port operations, continues to be constrained because of
significant bottlenecks. Under KPT Act of 1886, the scope of PPPs in port operations remains
limited to leasing out specific functions. There is an absence of a clear, transparent and detailed
PPP framework in legal and policy terms to attract a greater private sector role in ports
management. The port authorities remain victims of a governance over-centralization
constraint' 49 , which is inbuilt into the port statutes. The lack of regulation by contract fails to
develop a level playing field for the private sector. This results in discriminatory treatment of port
operators.

182. Water Supply and Sanitation: Water supply systems are owned, managed, and
operated by public sector agencies through water supply and sewerage boards. Lack of private
sector participation, deteriorating institutional capacities of key water sector institutions,
inadequate operation and maintenance funding, and poor cost recovery are among the key
issues faced in the water sector. Poor management of existing networks suggests that efficiency
could be greatly improved by introducing private operators and measures to provide an
adequate revenue stream. Globally, the reasons why private sector investment is not generally
forthcoming in the water supply and sanitation sector include: the complexity involved in
designing flexible pricing models to ensure that costs are met over a medium to long term; the
high political interference in the sector; and limited capacities of local governments to deal with
complex PPP issues. Pakistan also faces the same issues in this sector. From a private sector
perspective, major constraints to increased private investment in the sector in Pakistan include
absence of a legal and policy related PPP framework and lack of a rules-based framework for
PPP transactions. Also, the National Water Policy is still not approved despite the fact that is
was drafted four years ago. Consequently, no urban water supply and sanitation projects have
so far been undertaken with private sector participation. The IPDF is currently working on
developing a number of water supply and sanitation projects for private sector participation
under a PPP framework.

183. Solid Waste Management: Poorly serviced by the public sector, with no participation by
the private sector, Pakistan’s existing capacity to dispose off solid waste in Pakistan is
estimated at only 25% of the total solid waste generated by municipalities and industries in the
country. The main issues in solid waste management are inadequate and inappropriate
collection and disposal of solid wastes, and lack of monitoring, collection and disposal of
municipal and industrial solid wastes. Private participation in solid waste management is being
pursued by the Government and is a priority area for setting up PPPs. Unfortunately, however,
solid waste management is a service that have even globally failed to attract much private
sector interest due in great part to high risks and lack of effective and adaptive pricing
mechanisms. Consequently, there has not been much progress so far in attracting private
investment in solid waste management.
49
ADB. 2005. Technical Assistance to Pakistan for Support of Infrastructure Investment- Pakistan. Manila
69

5.4 RECOMMENDATIONS FOR PROMOTING PPP IN PAKISTAN

184. The PPP policy framework and accompanying laws and regulations need to be finalized
and approved at the earliest. The capacity in the public sector to develop PPP projects for
private sector financing needs to be strengthened by bringing in outside expertise as necessary.
The feasibilities for infrastructure projects in the key sectors prepared in the public sector should
mandatorily examine the scope and opportunity for private sector participation. Capital markets
need to be deepened and encouraged to provide long-term finance to support the role of the
private sector in infrastructure development.

185. Given that the responsibility for development of many infrastructure sectors rests with
the provincial and local governments, these lower tiers of government must be fully involved in
the identification of PPP projects and in closing deals with private sector parties. To do this,
provincial and local governments need to significantly build up their capacity to partner with the
private sector on infrastructure projects. Provincial and local government, could also consider
becoming stakeholders in the IPDF. The IPDF itself needs to be strengthened and its range of
services expanded to include training for both the public and private sectors in the development
of PPP projects.

186. To overcome financing issues, the establishment of the IPFF needs to be expedited to
promote availability of long-term rupee financing to meet the needs of infrastructure investment.
The IPFF should have an independent board with representation from the private sector to
ensure that financing decisions are transparent and made on merit. At a subsequent stage, the
possibility of privatizing both IPDF and IPFF with a minimum 50% stake divested to the private
sector should be explored.
70

SECTION VI

6.1 ADB AND PRIVATE SECTOR DEVELOPMENT IN PAKISTAN

187. The critical role of the private sector in supporting Pakistan’s development is not a
subject of debate. How to strengthen and support, the private sector under an improved
enabling framework and environment is the real issue and challenge. From the analysis of the
previous sections, the key constraints to private sector development in Pakistan could be
summarized as the following: unstable political environment and a deteriorated security
situation; macroeconomic deterioration; institutional problems including weak regulatory
structures, poor property rights protection and contract enforcement; ineffective policy and legal
framework for private sector investment and PPP; and low capacity of state agencies to interact
and collaborate with the private sector; inefficient pricing regimes; dilapidated infrastructure with
major shortfalls in the energy sector and bottlenecks in the transportation sector; inadequate
access to long-term capital and project finance; and a weak and narrow manufacturing base.
Important constraints that have yet to be tackled in any effective manner are issues of how to
develop the SME sector and how to address the issues and requirements of the informal sector.

188. To effectively tackle these challenges and constraints, ADB is assisting in supporting an
enabling environment to reduce the cost of doing business for the private sector, and leveraging
equity and debt finance to promote greater private sector in infrastructure, finance, and other
sectors. ADB’s focus on private sector development (PSD) in its developing member countries
rests on the following four pillars. 50

• Governance in the public and private sectors, including privatization of state-


owned enterprises
• Financial Intermediation, through financial sector reform, promotion of long-term
capital markets, local currency financing, and support for small- and medium-
sized enterprises
• Public-Private Partnerships in physical and social infrastructure, as well as
agricultural and rural sector development
• Regional and Subregional Cooperation to support inter-developing member
country cooperation toward common goals

189. ADB’S support for the development of the private sector in Pakistan has been
channelled through the two windows of public sector operations and private sector operations.
The former has focused on improvement in the governance, regulatory, and institutional
frameworks to provide a supportive environment for development of the private sector in the
country through policy-based budget support. The latter has provided direct financial support for
private sector investments in key priority sectors through a combination of debt and equity
finance.

6.2 ASSISTANCE TO THE PUBLIC SECTOR FOR DEVELOPING THE PRIVATE


SECTOR

190. Selected examples of ADB’s assistance in Pakistan to create an enabling environment


for private sector development are summarized in Tables 25. As an example, a Capital Markets
Development Program (CMDP) approved in 1997 helped improved corporate governance
structures by transforming the erstwhile Corporate Law Authority into the Securities and
50
ADB. 2007. Available: http://www.adb.org
71

Exchange Commission and developed its institutional capacity. It also helped in broadening
Pakistan’s capital markets and making them more robust and efficient. Subsequent reforms in
the non-bank financial sector were supported through a Financial Markets and Governance
Program (FMGP) approved in 2002 that assisted in further strengthening of regulatory
capacities and introducing a framework for mobilization of long-term resources for savings and
investment through market-based financial instruments and institutional investment. A key
contribution of the FMGP was supporting the entrance of asset management companies in
Pakistan’s capital markets. Continuing with the financial sector, a Second Generation Capital
Markets Reform Program approved in 2007 aims to increase resource mobilization through the
capital markets for productive investment and employment generation by providing efficient
savings vehicles for retail and institutional investors, and diversified funding sources for
enterprises.

191. An Accelerating Economic Transformation Program approved in 2008 seeks to


strengthen the supervisory and regulatory environment for the banking sector and support
greater autonomy of the State Bank of Pakistan. A Microfinance Sector Development Program
helped introduce the legal framework and prudential regulations for the microfinance sector and
assisted in the establishment of the largest microfinance bank in the country. A subsequent
Access to Financial Services Program approved in 2006 aims to increase access to financial
services by the self employed as well as micro and small enterprise companies. A Trade, Export
Promotion and Industry Program assisted in liberalizing the economy through rationalizing tariff
regimes and improving customs procedures and systems. An SME Sector Development
Program supported the privatization of the SME Bank and established a Business Support Fund
that provides equity support to ease the financial constraint on SMEs.

Table 25: Public Sector Interventions with PSD Focus: Some Examples
SECTOR YEAR AMOUNT DESCRIPTION
Capital Market 1997 US$ 250 This loan was designed to augment the mobilization of
Development million long-term resources and improve efficiency of
Program allocation through a diversified and competitive capital
(CMDP) market. Results achieved included modernized
infrastructure of the stock exchanges and
establishment of the Securities and Exchange
Commission of Pakistan as an autonomous regulatory
body replacing the Corporate Law Authority, which
improved market efficiency and transparency

Trade, Export March US$ 300 The Program focused on supporting trade
Promotion, and 1999 million liberalization and modernization of trade policies. The
Industry Program was designed to achieve higher and
Program (TEPI) sustainable private sector, export led economic
growth by promoting competition, and outward
orientation, The Program helped in lowering and
rationalizing tariff rates and reducing non-tariff
barriers. Privatization and restructuring of state-owned
enterprises was also supported.
Micro Finance 2000 US$ 150 The assistance helped in the creation of a policy
Sector million environment and institutional framework to extend the
Development outreach of microfinance institutions and encourage
Program greater private sector provision of microfinance.
(MSDP) 24,750 Community Organizations (COs) were
organized as delivery points for financial and social
services. MSDP supported the establishment of the
72

first microfinance bank (Khushali Bank).


Access to 2001 US$ 350 The AJP's objectives were to improve access to
Justice million justice of citizens through securing and sustaining
Program (AJP) entitlements and creating conditions conducive to pro-
poor growth by fostering investor confidence. The
program carried out policy provisions for speedy
disposal of corporate and business cases.
Sindh Road Dec, US$ 223 This intervention supported reforms to provide the
Sector 2001 million framework for overall sector development as well as
Development policy and institutional reforms and investments
Program leading to creation of opportunities for private sector
(RSDP) development. The program assisted in strengthening
the local contracting industry and road institutions
through establishing an effective policy and regulatory
enabling environment.
Financial (Non- 2002 US$ 260 The FMGP was aimed at facilitating private sector-led
bank) Markets million growth, productivity growth and enhanced social
and protection by improving mobilization of long-term
Governance resources for savings and investment through market-
Program based financial instruments and institutions. The
(FMGP) Program focused on improving corporate governance
to improve investor confidence, increasing depth and
diversity of financial intermediation through new
capital market issues for saving and investment;
improving operational efficiency and risk management
of intermediaries and reducing financial sector
vulnerabilities.
Small and 2003 US$ 220 SMEDP was designed to improve access to finance
Medium million and business development services for SMEs. It
Enterprise supported the Government in policy reforms to
Development improve the business climate with an emphasis on
Program leveraging private sector interventions, and
(SMEDP) strengthening private financial services and business
development services intermediaries in building up the
requisite capabilities to serve SMEs. The Program
also supported the privatization of the SME Bank. The
program supported the establishment of a Business
Support Fund for SME entrepreneurs.
Punjab Dec, US$ 500 The PRMP included a private sector development
Resource 2003 million component, which focused on creating a more
Management conducive environment for both the development of
Program private sector institutions as well as exploring the
(PRMP) modalities of effecting PPPs in service delivery and
infrastructure development.
Agriculture 2005 US$ 31 The intervention was designed to support institutional
Diversification million reforms to strengthen the role of the private sector in
and commercial agriculture with a focus on dairy and
Agribusiness horticulture subsectors. The Project supported the
Development establishment of an agribusiness support fund to
program provide financial assistance to agriculture
entrepreneurs in setting agribusiness enterprises. to
Access to 2006 US$ 320 Designed to build upon the policy and institutional
Financial million framework established under the first MSDP, the
Services Program is focused on extending the outreach of
microfinance institutions and encouraging greater
73

private sector and NGO involvement in provision of


microfinance.

Private 2006 US$ 400 The Program's planned outcomes include enhanced
Participation million private sector participation in infrastructure and utility
Infrastructure investment and maintenance to reduce the
Program government's fiscal burden and provide better
infrastructure services to consumers. The program will
address key constraints to Private Participation in
Infrastructure by (i) establishing an overall policy,
legal, and regulatory framework for PPI; and (ii)
deepening policy, legal, regulatory, and institutional
reforms in priority subsectors, including power,
highways, and water.
Second 2007 US$ 400 This Program will continue ADB’s support for reforms
Generation million in the capital markets with a view to support the
Reform for development of institutional investors to facilitate long-
Capital Markets term capital formation and increase the demand for
Development securities; improve the efficiency of securities markets
to increase the supply of corporate securities and
optimize the allocation of financial resources into
productive investment; and strengthen the
governance of capital markets to improve market
transparency and protect investors.
Accelerating 2008 US$ 500 The Program will continue to foster mobilization of
Economic Million financial resources and help in developing strong
Transformation financial institutions that are better able to channel
Program investments to their most productive uses. Under
which, a set of reforms are planned in the financial
sector to boost public and investor confidence,
including, strengthening of SBP’s overall autonomy
and governance and the specifically regulating and
supervising financial institutions; consolidating
supervision of financial conglomerates; strengthening
the anti-money laundering (AML) regime, and
strengthening payment systems and consumer
protection for depositors and borrowers.
Source: Asian Development Bank

6.3 PRIVATE SECTOR ASSISTANCE THROUGH THE PRIVATE SECTOR OPERATIONS


DEPARTMENT (PSOD)

192. ADB’s direct support to the private sector has focused on those areas that are critical
from an economic development perspective but in which the private sector on its own faces
barriers to entry for multifarious reasons including business risk and lack of access to capital
and finance. Historically, PSOD's support for private sector development in Pakistan has
focused on the financial sector including capital markets, and the infrastructure sector through
provision of equity and debt financing, advisory services, and monitoring portfolio and
management risk.

193. ADB had financed 42 private sector investments in Pakistan totaling $721 million as of
end December 2007. These investments have been in the financial sector, capital markets and
banking, power (thermal and hydro), oil and gas, and cement industries. Completed private
74

sector investments are listed in Table 26 and ongoing investments in Table 27. The majority of
the recently approved ongoing interventions are in the power sector, with one investment in an
equity fund (Figure 16).

Table 26: Completed Assistance to the Private Sector ($ million)


Equity
Investment
Date Comp
/ Company LOE Investment Underwriting OCR Total Combined
Approved Loan
Loan No
7114/1395 10-Oct-95 Pakistan Industrial 0.000 0.000 0.000 15.000 15.000 0.000 15.000
Leasing Corp. Ltd. III
7113/1394 10-Oct-95 Orix Leasing 0.000 0.000 0.000 20.000 20.000 0.000 20.000
Pakistan Ltd. III
7112/1393 10-Oct-95 National 0.000 0.000 0.000 15.000 15.000 0.000 15.000
Development
Leasing Corp. Ltd. IV
7111/1392 10-Oct-95 Atlas BOT Lease Co. 0.000 0.000 0.000 10.000 10.000 0.000 10.000
Ltd. II
7093/1255 30-Sep-93 Fauji Oil Terminal 0.000 1.000 0.000 19.000 20.000 11.800 31.800
and Distribution Co.
Ltd.
7086 13-Aug-92 PAK Asian Fund 0.000 2.600 0.000 0.000 2.600 0.000 2.600
7080/1135 26-Nov-91 Pakistan Industrial 0.000 0.000 0.000 8.000 8.000 0.000 8.000
Leasing Corp. Ltd. II
7079/1134 26-Nov-91 Pakistan Industrial 0.000 0.000 0.000 5.000 5.000 0.000 5.000
and Commercial
Leasing
7078/1133 26-Nov-91 Orix Leasing 0.000 0.000 0.000 10.000 10.000 0.000 10.000
Pakistan Ltd. II
7077/1132 26-Nov-91 National Dev. 0.000 0.000 0.000 10.000 10.000 0.000 10.000
Leasing Corp. Ltd. III
7076/1131 26-Nov-91 Crescent Investment 0.000 0.000 0.000 10.000 10.000 0.000 10.000
Bank
7075/1130 26-Nov-91 Atlas BOT Lease Co. 0.000 0.000 0.000 5.000 5.000 0.000 5.000
Ltd.
7074/1129 26-Nov-91 Asian Leasing Corp. 0.000 0.000 0.000 7.000 7.000 0.000 7.000
Ltd. II
7017/0856 28-Jun-91 Pakistan Industrial 0.000 0.208 0.000 0.000 0.208 0.000 0.208
Leasing Corp. Ltd.
7066 13-Dec-90 Atlas BOT 0.000 0.920 0.000 0.000 0.920 0.000 0.920
Investment Bank Ltd.
7057 13-Sep-90 International Asset 0.000 0.030 0.000 0.000 0.030 0.000 0.030
Management Co.
7056 13-Sep-90 Pakistan Investment 0.000 0.000 4.320 0.000 4.320 0.000 4.320
Fund Inc.
7017/0856 27-Aug-90 Pakistan Industrial 0.000 0.227 0.000 0.000 0.227 0.000 0.227
Leasing Corp. Ltd.
7050- 26-Apr-90 Asian Leasing Corp. 0.000 0.000 0.000 0.000 0.000 2.000 2.000
C/1008 Ltd.
7049- 26-Apr-90 Orix Leasing 0.000 0.000 0.000 0.000 0.000 5.000 5.000
C/1007 Pakistan Ltd.
7027-C 8-Mar-90 National 0.000 0.000 0.000 0.000 0.000 5.000 5.000
Development
Leasing Corporation
Ltd. II
7050/1008 21-Dec-89 Asian Leasing Corp. 0.000 0.000 0.000 3.000 3.000 0.000 3.000
Ltd.
7049/1007 21-Dec-89 Orix Leasing 0.000 0.000 0.000 5.000 5.000 0.000 5.000
Pakistan Ltd.
75

Equity
Investment
Date Comp
/ Company LOE Investment Underwriting OCR Total Combined
Approved Loan
Loan No
7047/1003 19-Dec-89 Fauji Fertilizer Co. 0.000 0.000 0.000 30.000 30.000 20.000 50.000
Ltd.
7042/0989 21-Nov-89 Pioneer Cement 0.000 3.500 0.000 11.500 15.000 21.100 36.100
Limited
7034/0958 25-Apr-89 Pakistan Synthetics 0.000 1.200 0.000 4.300 5.500 0.000 5.500
Ltd.
7027/0913 27-Oct-88 National Dev. 0.000 0.000 0.000 15.000 15.000 0.000 15.000
Leasing Corp. Ltd. II
7003/1393 29-Sep-88 National Dev. 0.000 0.165 0.000 0.000 0.165 0.000 0.165
Leasing Corp. Ltd.
7017/0856 10-Nov-87 Pakistan Industrial 0.000 0.575 0.000 2.000 2.575 0.000 2.575
Leasing Corp. Ltd.
7011/0814 9-Dec-86 National Dev. 0.000 0.000 0.000 5.000 5.000 0.000 5.000
Leasing Corp. Ltd.
7009 9-Dec-86 National Dev. 5.000 0.000 0.000 0.000 5.000 0.000 5.000
Finance Corp. and
Bankers Equity Ltd.
7010/0809 4-Dec-86 Cherat Cement 0.000 0.000 0.000 0.000 0.000 0.000 0.000
7003/1393 13-Dec-84 National 0.000 0.420 0.000 0.000 0.420 0.000 0.420
Development
Leasing Corp. Ltd.
7002 20-Dec-83 Bankers Equity Ltd. 2.000 0.000 0.000 0.000 2.000 0.000 2.000
Total 7.000 10.845 4.320 209.8 231.965 64.9 296.865
LOE = Line of Equity; OCR = OCR is direct LIBOR based loan; BOT = build-own-transfer; SME PCG = small and
medium enterprise partial credit guarantee.
Source: Asian Development Bank.

Table 27: Ongoing Private Sector Assistance ($ million)

Investment Date
Company Investment OCR Total Comp Loan Combined
/Loan No Approved
30-Oct-07 Daharki Power a 2.750 0.000 2.750 0.000 46.750 b
7257 17-Jul-07 JS Equity Fund a 20.000 0.000 20.000 0.000 20.000
7254/2329 29-May-07 KESC: Post Privatization 0.000 150.000 150.000 0.000 150.000
Rehabilitation, Upgrade
and Expansion
7222 21-Nov-05 New Bong Escape Hydro 0.000 37.300 0.000 0.000 37.30
Power
7190/3709 19-Dec-03 SME PCG Facility 0.000 0.000 0.000 0.000 65.000
7166 7-Dec-00 Pakistan Export Finance 2.000 0.000 2.000 0.000 2.000
Guarantee
7126/1434 23-Apr-96 Fauji Kabirwala Power 5.300 32.000 37.300 65.000 102.300
Co. Ltd.
7062 4-Dec-90 Pakistan Venture Capital 1.160 0.000 1.160 0.000 1.160
Ltd.
Total 31.210 219.300 213.210 65.000 424.510
a= Approved, but not yet signed
b = Includes a guarantee of $44 million
Source: Asian Development Bank.
76

Figure 16: ADB’s Private Sector Assistance in Pakistan: Ongoing Portfolio

Finance, 16%
Industry, 5%

Energy, 79%

Finance Industry Energy


Source Asian Development Bank Database

194. Complementarities between ADB’s Public and Private Sector Operations: The
focus of ADB’s private sector interventions on the financial, energy, renewable energy and
power sectors in Pakistan is complementary to the emphasis of ADB’s public sector operations
under which the same sectors receive a significant amount of assistance. For example, in
accordance with Government policy, ADB is supporting power generation in the private sector
through the Fauji Kabirwala Power Company and Daharki Power, while at the same time ADB is
providing assistance for strengthening power transmission and distribution systems in the
private sector.

195. ADB’s Private Sector Opertions Division (PSOD) is integrated within the developmental
vision of the institution and plays an important in furthering its mission and objectives. By
focusing on sectors which are important from a development perspective, while leaving away
those in which the private sector is already fully mobilized and active, ADB’s private sector
operations seeks to leverage assistance to promote private sector investment in areas into
which the latter would otherwise find difficult to enter. A recent example in this case is ADB’s
approved assistance to the private sector in the area of hydel based generation for the New
Bong Escape Hydro Power Project – this is the first ever hydel generation project in the private
sector.

196. To further strengthen its effectiveness and impact, ADB’s private sector operations could
consider moving away from sector specific investment policies to project specific policies. For
example, the PSOD currently is not considering investments in Pakistan’s telecommunications
sector given the abundance of private sector interest in the sector. But there remain niche areas
within the telecommunication sector that are underserved by existing private sector service
providers such as business-to-business and secondary market consumer interfaces, for
example, Moblie-commerce and banking access over mobile phones are areas which can
supplement Pakistan’s poorly developed low-income personal finance sector. Such specific
projects and activities could be considered for assistance given their major developmental
payoffs, even when the telecommunication sector as a whole might not as such be in need of
ADB’s private sector assistance.
77

197. Need for Greater Synergy: Despite the complementarities noted in para 190, there is
still a need to strengthen the functional ties and interlinkages between ADB’s public and private
sector assistance to move towards greater strategic harmonization. For example, an impact
issue in this regard is the clarification of the role of pure private sector investment (supported by
PSOD) relative to public-private partnerships (PPPs) (supported though public sector
operations), in the infrastructure development sector. In this case, processing and approvals of
public sector projects, PPP projects, and private sector projects in infrastructure follow parallel
tracks with few points of convergence. This results in sometimes incongruent objectives and
designs of public and private sector operations and conflicting advice and message to country
clients.

198. For better coordinated public and private sector operations, inputs from the private
sector side into public sector operations, and vice versa, should be sought and incorporated at
an early stage. By doing this, PSOD’s strategic advantage of being able to better harmonize
with public sector operations by being a department of ADB (unlike IFC which has a separate
status in the World Bank Group) will be better utilized. The resulting strengthened “public private
partnership” within ADB could generate greater synergies and lead to more successful public
and private operations. This “partnership” could go beyond the infrastructure sector to, for
example, the agricultural sector where a public sector program to improve efficiency in the
agriculture sector could, for instance, complement an ADB assisted private sector investment to
develop a viable bioengineering industry and introduce hybrid seed manufacturing in the
country.
78

SECTION VII

THE PRIVATE SECTOR SPEAKS

199. An attempt was made to undertake consultations with selected members of the business
community during the process of the preparation of this PSA. A series of unstructured meetings
and interviews with commercial bankers, heads of mutual funds, domestic and international
investment bankers and industrialists were carried out which posed the following set of
questions: (i) what factors are most important for private sector development (PSD)?; (ii) what
role has the Government played in promoting PSD and how far has it succeeded?; (iii) what role
has the private sector played in PSD and has that role been sufficient?; and (iv) what does the
future hold for continued PSD and growth in Pakistan? Table 28 captures the most important
challenges and issues that emerged from the perspective of the private sector from this process
of consultations.

200. The consultations showed that the private sector in Pakistan values and has made use
of the relatively stable years, politically and economically, of the initial years of the new
millennium. Accesses to cheap capital, deregulation, privatization and macroeconomic stability
all helped the private sector to grow and expand. The major constraints articulated by the
private sector remain in the area of energy shortages, inadequate human resource availability,
and the deteriorated security situation and political transition in the lead up to national elections.
The once again worsened macroeconomic indicators are also a cause of concern for the private
sector. With respect to the latter, lack of attention to education and health sectors has generated
major supply constraints for the private sector. The private sector has grown in size and
complexity the services industry with the financial services and telecommunications sectors
being key examples of this success. However in the manufacturing sectors, growth has been
seen only in a few traditional sectors like textiles with little or no diversification into new areas.
Table 28 summarizes the input and concerns of the private sector representatives consulted in
the process of the preparation of the assessment.

Table 28: Feedback from the Private Sector


Questions Posed Private Sector Responses
• What factors are • The most important factors in order of importance were:
most important for o Economic and political stability
private sector o Access to cheap capital
development o Deregulation
(PSD)? o Privatization

• What role has the • The Government’s positive role in promoting PSD has been
Government through:
played in o Strengthening economic and political stability
promoting PSD o Private sector friendly policies of liberalization, deregulation
and how far has it and privatization
succeeded? o Tax reforms and other structural reforms

• Areas where not enough has been done and which will impede
PSD are:
o Energy and electricity shortfall and the impending crisis
o Deteriorating quality of governance
o Human resource crunch and lack of quality, trained and
79

educated manpower 51
o Inadequate physical infrastructure especially transport and
ports
o Deterioration in macroeconomic and political stability
o Inability to provide environment for expansion of limited
productive base
• What role has the • Private sector responded to new economic environment by:
private sector o Generating high growth in the services sector
played in PSD and o Participating in privatization
has that role been o Expanding, rebalancing, and modernizing productive assets
sufficient? o Developing an efficient financial services sector
• The private sector has been deficient in:
o Creating self-regulating structures and systems
o Rent seeking continues in some sectors (textiles and
automobile sectors were most often mentioned)
o Its inability to enter new productive areas
• What does the • Consensus amongst both Pakistani and foreign investors that
future hold for the unstable political and economic environment will pass and
continued PSD that fundamentals are in place that will continue to catalyze
and growth? private sector investment.

• Pakistani investors feel that the pace of change in both the


political and economic dimensions has for the time being
increased uncertainty for the private sector. However the
private sector now has a greater voice in policymaking. No
foreseeable Government structure post elections can neglect
the private sector or materially change the policy environment.
The private sector remains generally confident about the long-
term prospects of the economy.

51
This is such a critical issue that, for example, commercial bankers feel that acquiring manpower is a justifiable
reason for bank acquisitions.
80

SECTION VIII

RECOMMENDATIONS FOR FUTURE ADB INTERVENTIONS

201. The structure, challenges, constraints, and the way forward for private sector
development in Pakistan have been documented in detail in prevailing chapters. This chapter
recommends interventions for ADB’s consideration that will have the potential to generate
demonstrable impacts in the short, medium and long term for private sector development in
Pakistan.

202. As mentioned in the previous chapter, ADB has provided support for PSD in terms of
both direct interventions and public sector interventions that support the creation of a conducive
environment for private sector development. What is important is that future interventions from
both public and private sector windows be well coordinated and synergetic. It is far better to
target a few critical areas for intervention that support and magnify impacts than to have a very
wide scope of activities that do not generate sufficient critical mass to achieve desired results.

203. A set of proposed interventions follows the table 29 below split across sectors and areas
to be supported by private and public sector wisdom in the short, medium and long term. The
areas selected within which the interventions are proposed stem from the critical issues and
challenges identified in the Assessment for promoting the private sector in Pakistan.

Table 29: Recommendations for ADB Interventions for PSD


AREA/SECTOR PROPOSED INTERVENTION WINDOW:
Public Sector /
Private Sector
I. Strengthening the (i) Technical Assistance (TA) to assess the Public Sector
Framework for PSD effectiveness and impact of regulatory bodies
established by the Government in various key
sectors within a comparative framework developed
based on international regulatory best practices.
(ii) Policy-based support for strengthening regulatory
reforms in key sectors to promote an improved
business environment. Policy based regulatory as
well as capacity development assistance could also
be provided to strengthen contract enforcement for
effective property rights protection.
II. Financial Markets (i) Support for improving access of the SME sector to Public / Private
and Improving formal sources of finance. Credit mechanisms and Sector
Access to Finance innovative financial products for the SME sector need
to be developed to ease the financial constraint in the
growth of small enterprises and their maturation into
medium-sized enterprises. Such support should also
encompass access to improved technologies for
SMEs also and strengthening of their human
resource base strengthened for higher productivity
and value added. Continuing support could be
considered to private sector financial institutions to
improve and enhance financing for SMEs. Such
support could be built on lessons learnt from previous
assistance by the ADB for SME sector development.
81

(ii) A TA to review options for developing the Public Sector


regulatory capacity of the Government in the
insurance sector whether by strengthening the
SECP, by creating a new Regulator, or by assisting
in the rationalization of functions between the SECP
and the Ministry of Commerce.

(iii) Support for the reinsurance sector by ADB Private Sector


acquiring a minority stake in Pakistan Reinsurance
Company Limited (PRCL) along with a private sector
partner and creating a public-private specialized
entity that could develop reinsurance capacities.
Support could also be considered for the State Life
Insurance Company (SLICP).

(iv) Assistance through the private sector in poor Private Sector


friendly financial initiatives. Mobile-commerce and
banking access through mobile phones are areas
which can supplement the poorly developed
Pakistani low income personal finance sector.
Proposed support for projects allowing subscribers to
transfer balance amounts to others which can then
be cashed as well as EBay type services where
buy/sell information is circulated to ‘matched’
subscribers using SMS text messages and
subsequently payments made using ‘mobile wallet’
technologies can have major poverty alleviating
impacts
(v) Continued assistance for deepening of financial Public Sector
sectors and supporting development of longer
maturity financial products to support project finance
III. Privatization (i) TA to review Pakistan’s privatization program, Private Sector
analyse effectiveness of divestment tools in various
sectors vis-à-vis international best practice, and
identify successes, failures, and impact of Pakistan’s
privatization program. The results of the study could
help the Government sharpen the future strategic
direction of its privatization program.

IV. Informal Sector (i) Support to help develop better understanding of Private Sector
the issues faced by the informal sector. Based on the
findings, a program could be developed to provide
targeted assistance to address the critical identified
challenges to the development of the informal sector.

V. Support Private Efforts initiated under the ADB-assisted Private Public Sector
Participation in Participation in Infrastructure Program are proposed and Private
Infrastructure to be continued. ADB could work together with the Sector
Development Government to ensure that the envisioned steps to
improve the enabling environment for private sector
82

investment are taken. In particular, ADB’s assistance


would need to focus on establishing appropriate PPP
structures and policies and regulatory frameworks.
Assistance is also required to develop innovative
financial tools for infrastructure project finance to
meet local requirements and conditions. ADB’s
PSOD should seek to encourage, promote, and
leverage private sector assessment in areas where it
has so far not been forthcoming: renewable energy,
transport, and water supply and sanitation. The
PSOD can play a catalyzing role in generating
appropriate, sustainable and beneficial PPP projects

VI. Energy (i) A TA to develop climate risk mitigating products for Public Sector
Environment and the insurance sector especially for crop insurance and Private
Climate change and catastrophe insurance Sector

(ii) A TA to develop a carbon trading regime in


Pakistan beyond outright sale of carbon credits as is
currently underway. Technical assistance to develop
fiscal incentives to promote clean energy
investments.

(iii) Enhancing support for investments in clean /


renewable power projects for ADB to act as a bridge
to attract socially responsible funds and alternate
energy investors.

VII. Manufacturing (i) Support the Government in the preparation of a Public Sector
and Mining comprehensive industrialization strategy and policy
that seeks to eliminate current constraints-
regulatory, institutional, financial, infrastructure
related and others to attract higher domestic and
international private sector investment in the
industrial and manufacturing sectors.
(ii) A TA to identify reasons for the lack of Public Sector
development in the automobile sector with
suggestions on how to promote this ‘industry of
industries’ for accelerated economic growth.
(iii) A TA to identify priority areas in the mining sector Public Sector
for reforms at both the federal and provincial levels.
An analysis of joint ventures and foreign investment
in the mining sector globally could be undertaken in
order to develop policy, regulatory and contractual
structures based on international best practice for the
provincial and federal governments to interface with
domestic and foreign investors and get the best
possible benefit from such investment.
VIII. Strengthening (i) A Program to support the role of the private sector Private and
the role of the private in agricultural development. Medium-sized Public Sectors
83

sector in agriculture agricultural commodity procuring, sourcing and


forwarding agencies can be set up in the private
sector with adequate systems of quality assurance
and health safety standards that can supply premium
products like tropical fruits and seafood to high end
markets such as Europe and the Far East where
today the few Pakistani items that do make it to
supermarkets are sold at steep discounts relative to
other producing countries.

(ii) Possible investment in the private sector in Private Sector


biotechnology and hybrid seed production. Specific
areas of support in this regard include corporate
farming, integrated food handling and distributions
systems incorporating standardized, containerized
cold chain fresh food handling systems and modern
grain storage systems along with strengthening of
agricultural commodity markets.
84

LIST OF APPENDIXES

Appendix 1: Pakistan's Investment Incentives at a Glance

Appendix 2: Pakistan’s Insurance Sector

Appendix 3: Privatization in Pakistan 1999-2007

Appendix 4: Constraints and Interventions for Enhancing Private Sector Participation in the
Energy Sector

Appendix 5: Constraints and Possible Interventions for Private Sector Participation in Roads,
Railways, and Ports

Appendix 6: Constraints and Possible Intervention for Private Sector Participation in the Water
Sector
Appendix 1 85

APPENDIX 1: PAKISTAN'S INVESTMENT INCENTIVES AT A GLANCE

¾ All economic sectors open to Foreign Direct Investment


¾ Foreign investment fully protected
¾ Equal treatment to local and foreign investors.
¾ 100 % foreign equity on repatriable basis allowed
¾ No Government sanction required.
¾ Attractive tax / tariff incentives package.
¾ Remittance of Royalty, Technical and Franchise Fee, Capital, Profits, Dividends
allowed
¾ Zero rated sales tax on import of plant, machinery and equipment
¾ Initial Depreciation Allowance at the rate of 50% is permissible on an “eligible
depreciable asset” placed into service in Pakistan for the first time in a tax year.
¾ Amortization of pre-commencement expenses allowed at the rate of 20%
annually.
¾ Amortization of intangible assets allowed over a period of ten years.
¾ Rationalization and lowering of corporate tax rates
¾ Full repatriation of capital, capital gains, dividends and profits allowed.
¾ No restriction on payment of royalty and/or technical service fees for the
manufacturing sector.
¾ Agreements on Avoidance of Double Taxation with 52 countries
¾ Bilateral Agreements on promotion and protection of investment with 46
countries.

Source: Board of Investment. 2007. Available: http://www.boipak.gov.pk. Please see the BOI website for more
details.
86 Appendix 2

APPENDIX 2: PAKISTAN'S INSURANCE SECTOR

I. Life Insurance Sector

1. The life insurance business in Pakistan was nationalized on March 18, 1972. Effective
November 1, 1972, the management of life insurance companies was consolidated and
entrusted to the State Life Insurance Corporation of Pakistan (SLIC). The life insurance industry
since then is a virtual monopoly of SLIC that has a market concentration of 75% (Figure A2.1).
In 1992, entry of the private sector into the life insurance sector was permitted but under the
specific provision that general and life insurance businesses be managed by separate legal
entities. Since then, two multinational and two domestic companies have entered into life
insurance with a combined market share of 25%.

Figure A2.1: Share in Gross Premium of Life Insurance

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

2. SLIC’s market concentration has created a virtual monopoly environment resulting in


strong barriers to entry for other players as potential competitors find it extremely difficult to
create a niche in the market. The asset composition of SLIC comprises largely of investments in
National Saving Certificates (NSC). These are, however, reducing over time as maturities occur
(Figure A2.2). A major current issue for the insurance sector and the life insurance sector in
particular is that government regulations now disallow the retention of new NSCs by insurance
companies. Because of this insurance companies have begun to invest in equities. But
because, the corporate debt and bond markets in Pakistan are still shallow and undeveloped,
the insurance sector is not able to play its role in the development of long term financial
resources.

Figure A2.2: Investment Composition of Life Insurance Companies

Source: State Bank of Pakistan. 2005. Financial Sector Assessment 2005. Karachi.
Appendix 2 87

3. An analysis of the performance of the life insurance sector reveals only a slight
improvement between 2001 and 2005 on indicators of capital adequacy, operating efficiency
liquidity ratios (Table A2.1). On the other hand, return on assets (ROA) and assets quality
deteriorated during this period.

Table A2.1: Financial Soundness Indicators of Life Insurance

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

II. Non Life Insurance Sector

4. The non life insurance sector is dominated by a small group of large companies along
with a host of small companies. There are 46 local and foreign insurance companies in the non-
life sector with 43 companies in the private sector and 3 in the public sector 52 . Over 80% of the
general insurance business is underwritten by local companies and the rest by foreign
companies. The market concentration is oligopolistic: approximately 71% of the business is
underwritten by 5 large companies whereas the remaining 29% is shared by 47 companies. The
share of private sector companies in net premiums and assets in the non life sector have been
generally increasing (Table A2.2). Between 2001 and 2005, the share of domestic non life
insurance companies’ assets grew from 55.2% to 65.5% whereas the share of public sector
companies fell from 40.7% to 31.6%.

Table A2.2: Ownership Structure of Non-Life Insurance Sector

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

52
State Bank of Pakistan. 2005. Financial Sector Assessment 2005. Karachi.
88 Appendix 2

5. The non life insurance sector is expanding as a result of a surge in industrial and trade
activities: a rise in auto-sales on the back of increased credit availability to private sector in
recent years resulting in higher motor insurance; the boom in the real estate market resulting in
higher fire insurance; and the rise in involvement of multinationals and private firms in business
generating an increased demand for insurance services. Resultantly, net premium income of
non-life insurance industry witnessed a 27% growth, with all the major areas registering double-
digit growth. High growth rates in the non-life insurance sector during this period between 2001
and 2005 were generated by both declines in claims ratios and increasing operational efficiency
(Table A2.3). The Return on Assets of non-life insurance companies also increased from 7.7%
in 2001 to 10.9% in 2005.

Table A2.3: Financial Soundness Indicators of Non-Life Insurance Industry

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

6. Reinsurance is an important part of the non-life insurance business as it allows greater


retention capacity, leads to greater capacity within the domestic insurance industry, and can be
useful in reducing the country’s foreign exchange burden. The public sector Pakistan
Reinsurance Corporation Limited (PRCL) is currently the only provider of reinsurance services.
PRCL’s attempts to increase reinsurance coverage in Pakistan have not been particularly
successful in the absence of measures such as pooling schemes and greater use of loss
reinsurance protection systems. PRCL’s institutional capacity needs strengthening with the
ultimate objective of privatization for it to become an efficient facilitator of reinsurance services
in the country.
Appendix 3 89

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


No. Unit Name Sale Price Date of Buyer Name
(Rs. Transfer
Millions)
Banking and Finance
1 United Bank Ltd. (51%) 12,350.0 Oct-02 Consortium of Bestway & Abu
Dhabi Group
2 Bank Alfalah (30%) 620.0 Dec-02 Abu Dhabi Group
3. Habib Bank (51%) 22,409.0 Dec-03 Aga Khan Fund for Economic
Development
Capital Market Transactions
4 Muslim Commercial Bank (6.8%) 563.2 Jan-01 MCB Employees-PF & Pension-F
5 Muslim Commercial Bank (4.4%) 364.0 Nov-01 MCB Employees-PF & Pension-F
6 NBP 10% shares IPO (37,300,000) 373.0 Feb-02 Listing/Public Offer
7 Muslim Commercial Bank (CDC 664.0 Oct-02 General Public Thru Stock
24,024,560 shares) Exchange
8 Pakistan Oil Fields Limited (CDC 5,138.0 Oct-02 General Public Thru Stock
28,546,810 shares) Exchange
9 Attock Refinery Limited (CDC 10,206,000 1,039.0 Jan-03 General Public Thru Stock
shares) Exchange
10 Investment Corporation of Pakistan (ICP) 175.0 Sep-02 ABAMCO
Lot – A
11 ICP Lot – B 303.0 Oct-02 PICIC
12 ICP – SEMF 787.0 Apr-03 PICIC
13 NBP 10% shares SPO (37,303,932) 782.0 Nov-02 General Public Thru Stock
Exchange
14 DG Khan Cement shares (CDC) 63.0 Dec-02 General Public Thru Stock
Exchange
15 OGDCL 5% shares IPO (215,046,420) 6,851.0 Nov-03 General Public Thru Stock
Exchange
16 SSGC10% shares SPO (67,117,000) 1,734.0 Feb-04 General Public Thru Stock
Exchange
17 PIA 5.8% shares SPO 1,215.1 Jul-04 General Public Thru Stock
Exchange
18 PPL15% shares IPO (102,875,000) 5,632.6 Jul-04 General Public Thru Stock
Exchange
19 KAPCO 20% shares IPO (160,798,500) 4,814.8 Apr-05 General Public Thru Stock
Exchange
20 UBL 4.2% shares IPO (21,867,000) 1,087.2 Aug-05 General Public Thru Stock
Exchange
21 OGDCL - GDR (408,588,000) 46,963.0 Dec-06 GDR offering to international &
domestic institutions
22 OGDCL SPO (21,505,000) 2,300.0 Apr-07 General Public Thru Stock
Exchange
Energy Sector
23 Kot Addu (Escrow A/c) 1,033.0 Apr-02 National Power
24 SSGC LPG business 369.0 Aug-00 Caltex Oil Pak.(Pvt) Ltd.
25 SNGPL LPG business 142.0 Oct-01 Shell Gas LPG Pakistan
26 Badin II (Revised) 516.1 Jun-02 BP Pakistan & Occidental
Pakistan
27 Adhi 681.4 May-02 Pakistan Oil Field
28 Dhurnal 230.7 May-02 Western Acquisition
29 Ratana 32.0 May-02 Western Acquisition
30 Badin I 8,599.1 Jun-02 BP Pakistan and Occidental
90 Appendix 3

Pakistan
31 Turkwal 120.3 Jun-02 Attock Oil Company
32 NRL (51% shares) 16,415 May-05 Consortium of Attock Refinery Ltd.
KESC (73% GOP shares) 15,859.7 Nov-05 Hassan Associates
Others
34 26% (1.326 billion) B class shares of 155,000.0 Jul-05 Etiselat UAE
PTCL
35 Carrier Telephone Industries 500.0 Oct-05 Siemens Pakistan Engineering
Ltd.
36 Associated Cement Rohri 255.0 Nov-03 National Transport Khi
37 Thatta Cement 793.0 Jan-04 Al Abbass Group
38 10% additional shares – Dandot Cement 8.3 Oct-04 EMG
39 10% additional shares – Kohat Cement 40.7 Oct-04 EMG
40 Mustehkam Cement Limited 3,204.9 Nov-05 Bestway Cement Limited
41 National Petrocarbon (add’l 10% shares) 2.3 Mar-02 Happy Trading
42 Khuram Chemicals (additional 10%) 6.0 Oct-03 Pfizer Pakistan
43 10% additional shares – Ittehad 26.1 Oct-04 EMG
Chemicals
44 Pak Saudi Fertilizers Ltd. (90%) 7,335.9 May & Fauji Fertilizers
Sep-02
45 Pak Saudi Fertilizers Ltd. (10%) 815.0 Sep-02 Fauji Fertilizers Ltd.
46 Pak Arab Fertilizers (Pvt) Ltd. (94.8%) 14,125.6 May-05 Export Reliance- Consortium
47 Pak Amercian Fertilizers (100%) 15,949.0 Jul-06 Azgard 9
48 Lyallpur Chemical & Fertilizers 280.2 Dec-06 Al Hamd Chemical (Pvt) Limited
49 Punjab Veg. Ghee 18.7 May-99 Canal Associates
50 Burma Oil 20.1 Jan-00 Home Products Intl
51 E&M Oil Mills 94.0 Jul-02 Star Cotton Corp. Ltd.
52 Maqbool Oil Company Ltd. 27.6 Jul-02 Madina Enterprises
53 Kohinoor Oil Mills 80.7 May-04 Iqbal Khan
54 Bolan Textile Mills 128.0 Oct-05 Sadaf Enterprises
55 Lasbela Textile Mills 156.0 Nov-06 Raees Ahmed
56 National Tubewell Const Corp. 18.6 Sep-99 Through Auction
57 Duty Free Shops 12.5 Sep-99 Weitnaur Holding Ltd.
58 Republic Motors (Plot) 6.3 Nov-99 Muhammad Mushtaq
59 Al Haroon Building Karachi 110.0 Sep-02 LG Group
60 International Advertising (Pvt) Ltd. 5.0 Apr-05 EMG
61 Federal Lodges - 1- 4 39.2 Jan-99 Hussain Global Assoc.
62 Dean's Hotel 364.0 Dec-99 Shahid Gul & Partners
63 Falletti's Hotel Lahore 1,211.0 Jul-04 4B Marketing
Total 360,859.9
Source: Privatization Commission, Government of Pakistan
Appendix 4 91

APPENDIX 4: CONSTRAINTS AND INTERVENTIONS FOR ENHANCING PRIVATE SECTOR


PARTICIPATION IN THE ENERGY SECTOR 53
Constraint to Private Sector Intervention Measure Proposed
1. Regulation continues to be ‘reactive’ Revision to National Electric Power Regulatory
rather than ‘proactive’ Authority (NEPRA) Act required

Amendment to NEPRA Act, requiring quarterly


preparation and dissemination of studies that cover:
• sector structure,
• status of implementation of Government policies
and the regulator’s role in such implementation,
• impediments to sectoral growth and regulator’s
proposed measures for addressing these,
• development plans of the sector players,
• consumer issues and the regulator’s vision

2. No ex-ante guidance on tariff for PPIs Revision to NEPRA Act required


in thermal, hydel, wind, distribution Amendment of NEPRA Act to regulate end-use
and transmission sub-sectors; no tariffs only to be undertaken when DISCOs are
predictability of tariffs privatized; as public sector is impervious to financial
consequences of a regulatory default

Codify NEPRA tariff principles by issuance as a


‘regulation’ after distillation from its tariff
determinations

3. Rule-based framework required under Revision to NEPRA Act required


Section 32 of the NEPRA Act to
‘minimize regulatory oversight’ of • Notify NEPRA (Investment Standards and
contracts remains absent even after Procedures ) Rules
10 years
• Notify NEPRA (Power Acquisition
Standards and Procedures) Rules

After undertaking necessary consultations on the


proposed drafts with sector stake holders including
the consumers
4. NEPRA Act does not provide any Set-up a multi-sectoral regulatory appellate tribunal
avenue for appeal against its
decisions Amend NEPRA Act to provide for appeal before the
High Court in the same manner as a ‘revision’ lies
under the Civil Procedure Code
5. Rules in critical areas, despite Whole sale revision to NEPRA Act required
NEPRA Act requirements, are still not Make rules required under the Act including on
made uniform accounting standards, uniform industry
standards, and others
6. Regulator’s capacity is sub-optimal • NEPRA members should have sectoral
experience
• Enhance tariff cell’s capacity
• Add research sections for each regulated
activity

53
ADB. 2006.Constraints to Private Sector Investment in Infrastructure. Manila. (TA 4635 PAK).
92 Appendix 4

Constraint to Private Sector Intervention Measure Proposed


• Build a power sector economics cell
7. The regulatory and executive policy Whole sale revision to NEPRA Act required
making functions are completely
muddled
8. Implementing agencies such as PPIB, Create a CCI Secretariat with a PPP Policy
AEDB, SHYDO, PPDB and Sind
Power Cell are not duly empowered;
any decision making of significance
remains centralized with the highest
echelons of the Government
9. No ‘market-based’ facilities exist as Identify and develop market-based facilities as
substitutes for Government substitutes for Government Guarantees
guarantees – the Government
becomes a direct contracting party in
project documents

10. Multitude of agencies with jurisdiction Create CCI Secretariat with a PPP Policy
over the projects
11. Capacity Constraints Develop a capacity building program – focus on
CCI Secretariat proposal
12. Application of Pakistan law to Seeking ruling from the Ministry of Law for
transaction documents application of foreign law to be allowed
13. Access to land is problematic due to Develop a ‘land-bank’ policy in close coordination
small holdings, and the fact that land with NTDC and consistent with its system
is a provincial and local government expansion plans. Government can acquire land and
subject having prolonged procedure – maintain a land-bank for identified projects
also the land records system is
outdated and unreliable
14. Competitive Bidding Procedures and Create CCI Secretariat with a PPP Policy
the accompanying contractual
frameworks are not finalized Develop Competitive Bidding Procedures and
documentation on a priority basis
entire portfolio of projects in pipe-line
is of unsolicited projects that
constrains international players who
do not have established political and
business alliances in the country
15. Diminishing gas reserves and Expedite exploration
impending privatization of gas utilities
has led to Government withdrawing Expedite work on LNG import and IPI Gas pipeline
its commitments for gas supply projects

16. Profit on bank deposits being taxed CBR to issue interpretation circular that the
by some assessing officers despite exemption under Clause 132, Part 1(exemption
the income from power generation from total income) of Second Schedule (Exemption
being exempt from income tax & Tax Concessions) of the Income Tax Ordinance
2001 also applies to profit on bank deposits
17. Cost-escalation risk for civil NEPRA to issue a circular stating that feasibility
construction in hydel projects is not study costs for site examination will be allowed in
efficiently allocated; the project tariff as a percentage of the EPC Costs
sponsors are required exclusively to
Appendix 4 93

Constraint to Private Sector Intervention Measure Proposed


bear this risk Amend current PPA for hydel projects on the basis
of practice notes or recommendations of
internationally recognized standards, such as those
by FIDIC
18. NEPRA Act is not applicable to AJK Cause AJK Council to apply (at least) NEPRA’s
where significant hydel sites are tariff making and licensing powers in AJK for
located; that prevents direct tariff projects that are located in AJK but the project
rights being acquired by the project companies for which are incorporated in Pakistan

19. The Government does not commit to Initiate a deeper review of the issues involved.
issuing sovereign guarantees in Build consensus between the AJK Government, the
respect of projects developed in AJK AJK Council and the Government of Pakistan.
– AJK Government insists on signing
the project documents itself, when the
executive power for this rests with the
AJK Council
20. Hydel tariffs are not predictable; there NEPRA may issue a framework tariff order that sets
is no precedent for cost-recovery tariff out the parameters and notional (realistic) values
determination by the regulator in the for one of the selected sites, that can then be
hydel sector extrapolated to specific projects

NEPRA to issue tariff guidelines for hydel tariff.


These to cover civil construction cost escalation
issue, either by requiring NTDC to absorb this
under internationally accepted norms or by enabling
the cost of a highly detailed feasibility and civil
construction risks study to be a pass-through in the
tariff.
21. Wind energy tariffs remain unsettled; Conduct an independent study into international
NEPRA does not accept projects’ projects costs for 50 MW projects in countries with
quoted costs, and does not offer any commonalities with Pakistan and make it available
realistic upfront tariffs for public consultation
22. Energy Purchase Agreement for wind Cause the Ministry of Water and Power to allow:
projects is modeled after the PPA for • partial commissioning;
thermal projects that leads to • remove technical acceptance tests that are
anomalous technical and financial not applicable to wind energy technology;
consequences and
• eliminate provisions that are no longer
required in view of the Grid Code to make
the EPA bankable
23. Land lease terms for wind projects Cause the GoS to issue a new ‘statement of
issued by the Government of Sindh conditions’ under the Colonisation of Government
(GoS) make the project unfinanceable Lands Act – this is permitted under the Act

These include unrestricted right of


withdrawal of lease by the GoS and
restrictions on creation of security
over land in favor of lenders
24. Grid Code requires amendments to Cause NEPRA, NTDC and Alternate Energy
accommodate wind energy projects Development Board to form a common task force to
review and amend the Grid Code
94 Appendix 4

Constraint to Private Sector Intervention Measure Proposed


25. There is no framework comprising of NEPRA to issue a framework for PPI in
indicative tariffs and other terms and transmission sector under Section 19 of the NEPRA
conditions for PPI in transmission Act
sector
26. Exclusive franchise rights to DISCOs Whole sale revision to NEPRA Act required
inhibit PPI in the distribution sub-
sector Amend Section 21 of NEPRA Act to subject
exclusive franchise rights to mandatory obligation to
Small scale or grid-isolated serve within defined time-limits and parameters,
distribution networks cannot be failing which PPI should be enabled as a BOT
established under the current legal project until full-cost recovery by the project
framework
NEPRA to develop an ‘outsourcing’ framework that
applies to all grid-isolated or small-scale networks
that are declined for construction by DISCOs within
the time frame required by end users
Appendix 5 95

APPENDIX 5: CONSTRAINTS AND POSSIBLE INTERVENTIONS FOR PRIVATE SECTOR


PARTICIPATION IN ROADS, RAILWAYS, AND PORTS 54
Constraint Intervention Measure Proposed
1 Decision making for National Highway Authority Amendment to NHA Act for further
(NHA) projects is over-centralized with the empowerment of NHA
Government– projects above Rs.100 million have
to be approved by the National Highway Council
and then by the CDWP/ECNEC

2 No Policy Framework for PPP in place Announce Policy Framework and


Package of Incentives for roads at the
federal level proposed under ADB TA:
4508 (PAK): Facilitating Public-Private
Partnership Initiative in National Highway
Development

Provincial and local government levels to


adopt the Federal Policy for RRPS

3 No guidelines and procedures for NHA to act as Develop PPP procedures framework for
‘PPP Cell’ for provincial and intra-district roads project referral by provincial and local
governments to NHA

4 NHA Act does not permit: Amend NHA Act to provide for these
• Assignment of toll receivable statutory measures to reduce project risk
• Security over project roads and facilitate project financing
• Guarantee against alternate routes
This enhances project risk
5 No legal requirement for a PPP Option Analysis Provide for a mandatory requirement for
PPP Option Analysis in the NHA Act
and/or the policy framework and
package of incentives
6 PPP in district roads is constrained by the Amend Section 54 (and other related
restriction under the Local Government Ordinance provisions) of the LGO
(LGO) on financing of PPP development projects
by user fees or charges
7 Railways Act 1890, and allied legislations are Pass a ‘consolidation and restatement’
archaic and do not serve contemporary day PPI single Act
requirements
8 The Railway Regulatory Authority (RRA) is The Federal Government to issue a
dysfunctional Gazette notification to bring the entire
Railway Regulatory Authority Ordinance
2002 (RRAO 2002) in force
Appoint members of the RRA

9 Government continues to be the regulator of the As in point 8 above


sector
10 Absence of: Amend Section 28 of the RRAO to
• Policy / PPP Framework for the intended substitute Council of Common Interests
industry and market structure (CCI) for the Federal Government for
• contents of licenses to be issued by the issuance of policy guidelines

54
ADB. 2006.Constraints to Private Sector Investment in Infrastructure. Manila. (TA 4635 PAK).
96 Appendix 5

Constraint Intervention Measure Proposed


RRA
• permitted tariff structures
• bidding documents and framework for
CCI to issue ‘Policy Guideline’ under
licenses
Section 28 of the Railway Regulatory
• templates for track access agreements Authority Ordinance
Appoint members of the RRA

11 Enable PPI in railway infrastructure (tracks) CCI to issue ‘Policy Guideline’ under
Section 28 of the Railway Regulatory
Authority Ordinance

12 Pakistan Railways functioning as a Government Corporatize Pakistan Railways and


department with inadequate cost and accounting cause accounts to be prepared under the
systems that prevent costing of lines of business Companies Ordinance, 1984. Pass the
(freight, passenger, infrastructure, etc) Railways Corporatization Act
13 Decision of ECC that only Pakistani operators Allow 100% foreign ownership of
allowed to operate freight and passenger lines of Pakistani companies in the railway sub-
business being interpreted to mean that a sector, as it is allowed in several other
Pakistani joint venture partner is required sectors (power, telecommunications,
manufacturing, etc.)
14 Absence of a clear, transparent and sufficiently Develop multi-sectoral PPP Framework
detailed PPP Framework in legal and policy (Chapter 2 and Annexure A-5)
terms.

Replace port statutes with new ones that


incorporate contemporary international
best practices

15 The policy choice of 'landlord ports' is not Develop multi-sectoral PPP Framework
reflected in the port statutes; the law does not
restrict port authorities undertaking port
operations in competition with their 'tenants'. Replace port statutes with new ones that
incorporate contemporary international
best practices
Insert another chapter in all port statutes
that details landlord concept and
delineates the landlord versus tenant
functions

16 Regulation by contract has not ensured a level Develop multi-sectoral PPP Framework
playing field; the port statutes are not effective in
preventing discriminatory treatment of operators Replace port statutes with new ones that
incorporate contemporary international
best practices
Insert another chapter in all port statutes
prohibiting sole sourcing / direct
negotiations and setting out anti-
competition provisions
Appendix 5 97

Constraint Intervention Measure Proposed


17 All port authorities suffer form the ‘Governance Replace port statutes with new ones that
Over-centralization Constraint”: this is built into incorporate contemporary international
the port statutes. The strategic steps noted under best practices
the Government’s Medium Term Development
Framework (MTDF: 2005-2010) towards
management reform, corporatization and Pass legislation that introduces norms of
autonomous status for the port authorities remain corporate governance in statutory
unrealized. corporations and authorities

18 The boards of port authorities do not carry Eligibility criteria to be provided in port
adequate experience of port operations. statutes that require at least one-third
Board members to have experience of
port operations
98 Appendix 6

APPENDIX 6: CONSTRAINTS AND POSSIBLE INTERVENTIONS FOR PRIVATE SECTOR


PARTICIPATION IN THE WATER SECTOR 55
Constraint Intervention Measure Proposed
1 The National Water Policy remains a draft 4 years Approve and issue the National Water
after it was developed Policy after addressing the Constitutional
and Legal Constraints identified
2 Water storage projects are uneconomic unless Adopt enabling measures recommended for
integrated with hydropower generation the hydropower sector

3 No PPP Law in existence Establish enabling PPP Law

4 The Power Policy 2002 is insufficient to address Specify hydropower sector measures within
legal, regulatory and financial issues specific to the the power policy
hydropower sector

5 Current outlook views all major storage projects for Under the study into modular approach to
implementation by WAPDA with public expenditure development of large storage projects (as
opposed to turn-key approach), e.g. power
works as a ring-fenced project
6 Legal restriction on local governments against Make necessary amendments to the
financing of development projects by user fees or relevant sections of the LGOs
charges
Establish enabling PPP provincial laws

7 The absence of a rules-based framework that caters Establish enabling PPP provincial laws
to the financial viability of urban water supply PPP
projects by providing for:
• statutory – as opposed to contractual remedies
for restraining breach and award of
compensation for early termination
• cost-recovery tariffs;
• elimination of political influence in management
and staffing;
• disconnection for default; and
• a range of options other than BOT, such as
management contracts or leases that focus on
maintenance and rehabilitation of existing
networks that are fast deteriorating.

8 No policy framework for: Establish enabling PPP policy frameworks


• Ring-fencing of projects in financial and for water supply projects
managerial terms

• Targeted and transparent subsidy mechanisms


to address affordability issue (that is cited as
the most significant economic constraint to
PPP in urban water supply)

55
ADB. 2006.Constraints to Private Sector Investment in Infrastructure. Manila. (TA 4635 PAK).

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