These are, once again, days of optimism for Indo-Pak ties. The future looks promising. On Thursday, Prime Minister Manmohan Singh met his Pakistani counterpart, Yousaf Raza Gilani, in Maldives. The two want to quickly implement a liberalized visa regime, enabling people from across the border to travel easily. A week ago, Islamabad agreed to confer the status of the “most-favoured nation" (MFN) on its eastern neighbour. Already, many in New Delhi detect the makings of a “peace constituency" across the Radcliffe Line.

Pakistan’s Prime Minister Yousef Raza Gilani. Photo: Bloomberg

At the moment, Pakistan is experiencing severe economic and political strains. It has just said goodbye to a standby arrangement started in 2008 with the International Monetary Fund (IMF). It was one of the many IMF programmes in Pakistan’s history that had to be terminated as the reforms agreed to could not be launched. That is not all, its fiscal deficit touched 6.2% of the gross domestic product, or GDP, in 2010-11 (against a target of 4%). In 2011-12, this is expected to remain at the same level; once again, the targeted level is 4% of GDP. The immediate impact of the ending of IMF support, however, will be on the country’s external sector. After six years, the country’s current account turned positive in 2010-11 (0.2% of GDP). Now, the very next year, it is expected to go negative (one estimate pegs it at -1.7% of GDP).

It is interesting to look at the country’s improving balance of payments, for that tells a larger political and economic story. This began in 2008-09. It was not a sudden improvement in export performance, or a contraction in imports, that led this. Instead, it was a dramatic rise in “invisibles"—from a meagre $1.1 billion in 2007-08 to a huge $4.8 billion—that made this difference. In 2011, a substantial fraction of these invisibles was accounted for by the financial support from the US in the form of coalition support funds and flood-related grants.

In fact, during 2002-2011, the US gave Pakistan $20 billion, though much of this money ($13.3 billion, approximately) was reimbursements for military support. It is this money that fuelled the “boom" of the Pervez Musharraf years.

This is not the first time this has happened in Pakistan’s history. From 1980 to roughly 1990—the Zia-ul-Haq years—the country was a “frontline state". The US was generous with financial help. At that time, too, this money helped fuel a consumption boom. Little was spent on building vital physical and social infrastructure. Once the Americans “abandoned" Pakistan, its economy suffered a hard landing.

In both these cycles—from 1980-1990 and 2002-2011—Pakistan’s leaders exploited their country’s geography for accessing easy money. On both occasions, they did little to address the structural weaknesses of the economy—slow growth and the inability to raise the country’s tax-to-GDP ratio. It is unlikely that there will be a Great Power intervention in Afghanistan of the Soviet and American kind in the years ahead. Resultantly, the link between geographic advantage and economic gain has been broken.

Pakistan’s leaders are too smart not to realize this. Time and again, history has shown that countries that don’t recognize changes in their external environment and fail to adjust to new realities are swept away. Pakistan’s greatly enlarged relations with China are one aspect of its changing worldview. It would be tempting to claim that trade liberalization with India is also a part of this framework. This interpretation should be taken with a pinch of salt.

The fact is that Pakistan is trying to resuscitate its failing economy. Domestically, it has little ability to raise taxes and curb expenditures. The country is ruled by an oligarchy that never pays any taxes. Today, less than 1% of its population pays direct taxes. Very few countries—at a comparable stage of development—can claim this dubious distinction. The concentration of wealth and political power makes fiscal reforms very difficult, if not impossible. Under such circumstances, it is easier to open trade with a hostile country than attempt any foolhardy reforms at home.

The gains from a liberalized trade regime are likely to accrue much more to Pakistan than India. In 2010-11, total trade between the two countries amounted to $2.6 billion. Once the MFN status kicks in, this figure may go up by a couple of billion dollars more. Even if it touches $10 billion in the years ahead, it would account for only a small fraction of India’s trade, but it will certainly count for something in Pakistan. Freer trade is, undoubtedly, a positive step. But too much should not be read into it, and it certainly is no ground for ballooning expectations and premonitions of peace.

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Siddharth Singh is Editor (Views) at Mint.