The assassination of opposition leader Benazir Bhutto threatens to derail the country's strong economic performance of the past five years that had been partly fuelled by foreign investors. A national election to return the country to civilian rule has been put back six weeks to February 18, but there will be no economic honeymoon for the winners.
Instead, the new leadership will have to contend with a growing external deficit that could prove increasingly difficult to fund since the country's perceived investment risk has shot up, which will keep foreign investors at bay. The incumbent government had been hoping to fund the deficit through a combination of increased foreign investment, sales of state equity in global share listings and through bond issues on international markets.
But analysts say that is not likely any more. "This will be a big concern for the government," said Asif Qureshi, head of research at brokerage Invisor Securities.
"The foreign inflows have and will slow down and nobody is willing to take fresh investment decisions till the visibility on the political front gets better," he said. "This means that the government will find it difficult to fund the external deficit." That is likely to mean further pressure on the rupee, which slumped this week to a six-year low against the dollar.
VOID: Until recent months, Pakistan had been an increasingly popular destination for foreign investment, partly because the military ruler, President Pervez Musharraf, introduced liberal economic policies after he came to power in a 1999 coup.
The economy has grown at an average annual rate of 7.0 percent since 2002. The Karachi Stock Exchange (KSE) has shot up almost 900 percent this decade. But the killing of Benazir Bhutto has left an economic void since she was seen as the only opposition leader with genuine national appeal and strong foreign backing.
The economy suffered almost $2 billion in losses in the two days of violence that erupted after her murder last week, initial government estimates show. Businesses shut down as government and private property came under attack.
"Bhutto's assassination has blocked off foreign portfolio inflows, and it looks clear it will hurt investor appetite...," London-based Citigroup economist Mushtaq Khan said in a report. "In our view, the external sector is the most vulnerable part of Pakistan's economy as the political uncertainty plays out."
Foreign investment in the first five months of the current fiscal year has dropped 19.3 percent to $1.82 billion from the year-ago period, led by a sharp fall in portfolio investment due to growing political uncertainty, central bank data shows. In fiscal 2006-07, total foreign investment in Pakistan had almost doubled to $8.43 billion.
The foreign exchange is vital to fund country's growing external deficit, such as in its current account, the broadest measure of a country's trade with the rest of the world. The current account deficit has been growing steadily and stood at an alarming $4.8 billion during July-November or about 3 percent of gross domestic product.
TWIN DEFICITS: Remittances from Overseas Pakistani workers have been a hardy source of national income up 23.6 percent to $2.59 billion during July-November but Mushtaq Khan said even these could wane if the political situation did not improve. Risks of credit ratings downgrade also remain, as the uncertainty is bound to hurt the already wide fiscal deficit.
"The government is basically faced with a twin deficit situation," said Sakib Sherani, chief economist at ABN Amro Bank in Islamabad, referring to both external and fiscal gaps. "By deferring the polls, it is also deferring the increase in fuel prices, which will increase the fiscal deficit, and also the trade deficit by subsidising fuel consumption."
The fiscal deficit was equal to 1.6 percent of GDP in the quarter ended September 30, 2007. The government's target for the 2007-08 (July-June) fiscal deficit is 4.0 percent of GDP. It aims to promote economic growth of 7.2 percent in the same period.
Government fuel subsidies, under pressure from record high world oil prices that hit $100 a barrel this week, are expected to cost the government around Rs 130 billion ($2.1 billion) in 2007-08. But with the political climate volatile, raising pump prices is not an option for fear of sparking even greater unrest.
A senior finance official said the losses resulting from the damage to government property would have to be accounted for in the budget. "Between now and the end of the fiscal year, we will have to make up for the budget deficit," said the official, who declined to be identified. "We will try to do that through a combination of increased revenues, tariff changes and reduction in expenditures. But it is not an easy job, to say the least."
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