By Tomasz Janowski
ISLAMABAD (Reuters) - Pakistan's economy is in its worst shape in nearly a decade and yet there is a sense of hope that the incoming government not only seems to know what is needed to fix it but, for once, may also have enough determination and clout to do it.
Former prime minister Nawaz Sharif swept back to power in last month's election, riding a wave of public anger at rival Pakistan People's Party's failure to tackle endemic corruption, power cuts and militant violence.
Voters hope that armed with a solid parliamentary majority Sharif, who takes office on Wednesday, has a better shot at fixing the economy than his predecessors, beset by internal strife and strained relations with the powerful military.
Stakes are high not just for Sharif, 63, who won his third chance to lead the 180-million nation largely by making economic revival and fixing government finances the centerpiece of his policy platform.
Economic turnaround is also essential to ensure greater political stability in the nuclear-armed nation, which is a key ally in the U.S. fight against Islamist militancy.
Economists say it will take years to fully revive a long-neglected economy starved of power and investment that has seen it slip behind its neighbors including arch rival India.
"This is not a country which lives beyond its means. It doesn't have the means," says Werner Liepach, country director at Asian Development Bank.
The government must start collecting taxes it is owed and overhaul power companies so they can produce enough electricity and stop draining public funds that have kept them afloat.
Less than a million Pakistanis pay income taxes, fiscal deficits run at close to 8 percent of gross domestic product and a big chunk of government revenue is used up subsidizing a power sector that covers just over half the country's needs.
Pakistan's economy will expand 3.5 percent in fiscal 2012/13, the International Monetary Fund says, from a peak of 9 percent in 2004. The rupee, meanwhile, has lost almost 40 percent of its value against the dollar since the last election in 2008.
Sagging exports and debt repayments have nearly halved official currency reserves over the past year to $6.5 billion in late May. That is just enough to cover five weeks of imports.
The ADB estimates that about $500 million flows out of Pakistan every month, meaning that it may not have enough to meet about $5 billion in loan repayments due this year and next.
Economists say Pakistan has vast potential for growth with a location at the crossroads between the Gulf nations, Central Asia, China and India and a young and growing population.
But Sharif is also inheriting a country barely in control of its northeastern areas, plagued by militant and sectarian violence.
A U.S. drone strike that killed a top militant commander last week further complicates Sharif's efforts to hold peace talks with the militants.
Yet lenders, economists and ordinary Pakistanis are willing to give the new administration the benefit of the doubt.
"The economy was just not on the previous government's radar," said Ashfaque Khan, dean of NUST Business School in Islamabad. "But the new government appears very serious about it."
ADB's Liepach agrees.
"If we are talking about whether there is a momentum for reform, I do think there is," he says.
Lenders, rating agencies and commentators also say that Sharif's economic policy ticks a lot of the right boxes.
There is a promise to revive growth by boosting investment funded by improved tax revenues and subsidy cuts. There is a plan to turn around loss-making state-owned firms including Pakistan International Airlines, Pakistan Steel Mills and the National Shipping Corporation.
There is also a plan to diversify Pakistan's energy mix to help end 20-hour power cuts and a promise to bolster business ties with India.
Sharif's team plans to make an emergency cash injection of $5 billion to break a chain of payment arrears that has paralyzed the power sector. The money would be raised through the sale of treasury bills.
The administration is also considering taxing heavy electricity users, plugging tax loopholes, cutting the number of ministries and slashing by a third the non-development federal budget.
Sartaj Aziz, set to serve as Sharif's chief policy adviser, says once reforms are under way the government will discuss a possible loan from the IMF to meet its international obligations.
"We've encouraged them to develop their own (economic) program and when they feel ready, we are very eager to work with them," IMF Deputy Managing Director Nemat Shafik said.
Economists warn that time is short, but Aziz says three months should be enough to see the effects of the new policies.
Sharif, who was toppled by the military 14 years ago, will be hard pressed for excuses if he fails to deliver.
"This is not Japan where we are at the frontiers of economic science," one international financial analyst said. "The problems that Pakistan is facing are well known and have been already successfully tackled before."
(Additional reporting by Mehreen Zahra-Malik in Islamabad and Martin Dokoupil in Dubai; Editing by Sanjeev Miglani)
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