At the beginning of May, Pakistan’s army moved into the Swat valley, causing the local 2.5 million-strong population to move out. Six weeks later, the army is declaring victory over the Taliban. This may be optimistic given that Taliban leaders have not been captured as part of the offensive, but instead have relocated to Karachi or moved south into the Punjab – Pakistan’s industrial heartland and home to more than half the Pakistani population. Concern also remains about how consistent the army’s opposition will be, given how useful the insurgents were in fighting the Indian army in Kashmir and in supporting the Taliban against the much-distrusted US in Afghanistan.

One thing is certain however – the more entrenched conflict becomes, the greater the economic cost will be – particularly as the country’s manufacturing and economic base centred on Karachi and Lahore (the capital of the Punjab) comes under threat. If the Taliban were to establish a foothold in these centres, this would represent a considerable risk not just to the country, but to the region as a whole, threatening economic and political stability in India, the Persian Gulf and beyond.

The cost of conflict
Whatever the future holds, the country is already paying a high price for the conflict.

Around 60% of Pakistan’s national wealth each year is spent on defence. Another 30% goes to pay off the national debt. What is left has to pay for everything else.
The finance ministry has estimated that the internal strife of the past six years has cost the Pakistan economy US$35bn in direct damage and lost opportunities. Inflation is currently running at around 20%; government debt amounts to 60% of GDP; and fiscal revenue amounts to just 13% of Pakistan’s GDP. Combine these stresses with the loss of tax receipts from Karachi and Lahore and it is clear why government finances are coming under massive strain.

How is trade being affected?

Pakistan’s main trading partners are Japan, Saudi Arabia, the US, the UK and Germany. Primary exports include rice, cotton, textiles, petroleum products and leather goods, but volumes have been reducing since 2007-8.

Agriculture remains the single largest sector in Pakistan, contributing around 20% to GDP and employing approximately 40% of the workforce. Other key sectors include cotton and textiles. In 2007, Pakistan’s textile and clothing industry exported products worth US$10.8bn. However, exports started to fall in 2008 due to surging raw material prices, a domestic energy crisis, a shift in government policies away from subsidies, and falling demand in the global recession.

In these difficult circumstances, western businesses importing goods from Pakistan are starting to take mitigation measures to secure supply. For example, some textile buyers are forcing Pakistani exporters to fill orders from factories outside Pakistan as a precondition to placing big orders. Other companies are increasingly seeking to secure payment obligations via letters of credit confirmed by western banks or insured by credit and political risk insurers.

While restoring stability in the tribal areas and the Punjab remains a national and economic priority, there is some speculation that developments in Gwadar offer hope for Pakistan.

Gwadar is a fishing village on the Indian Ocean, well away from Taliban strongholds, where Chinese investors have constructed a brand new deep-water port. Land prices are booming, and there is speculation that Gwadar could become the ‘next Dubai’. The hope is that Gwadar may one day link towns in Central Asia to the burgeoning markets of India and China through pipelines, marine transport, and the Strait of Malacca.

Initiatives such as this could play a key role in returning Pakistan to economic stability longer term.

Managing the risks
On balance, although there are concerns that Pakistan is unstable, the recent pattern of popular resistance and the resounding rejection of Islamist parties at the 2008 elections bode well. The vast majority of the Pakistani populace have no interest in living under Taliban rule, the military is showing signs of mounting a more coherent response, and the region as a whole appears to be waking up to the need to support Pakistan politically and, most importantly, economically.

When it comes to the insurance market and its ability to help companies mitigate political and economic risks in Pakistan, insurers such as Beazley are faced with a complex array of risks to assess and price.

There is widespread opinion that until the global and local economic picture settles, anything outside some straightforward asset risks, and short-term payment risks at government level for strategic imports such as oil and petroleum products, is simply too risky. With regard to the bank sector in Pakistan, there is still capacity in the market for short-term payment risk, and the sector is showing some resilience to macro-economic issues. Insurers will be mindful, however, of the continuing heightened credit risk and the impact this will have on the banks.