Statement at Donor Meeting

Statement by the International Monetary Fund, Delivered by Mohsin S. Khan, Director, Middle East and Central Asia Department -- At the Pakistan Development Forum

March 19, 2004

1. The 2004 Pakistan Development Forum (PDF) provides a timely opportunity to discuss Pakistan's recently finalized Poverty Reduction Strategy Paper (PRSP) "Accelerating Economic Growth and Reducing Poverty: The Road Ahead." Last week the IMF Executive Board endorsed Pakistan's PRSP as a comprehensive and feasible poverty reduction strategy, and a good framework for further reform after the expiration of the Fund program. The Fund staff appreciates this opportunity to comment on Pakistan's economic developments and outlook.

2. The Pakistani economic reform program has been supported by the IMF with a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF). This program was approved by the IMF Executive Board in December 2001 and it will be completed in December 2004. Since its approval, seven program reviews have been completed successfully and discussions for the eighth review are scheduled for April.

3. In light of the considerable improvement in economic fundamentals during recent years, the authorities have indicated to us that they will not request a successor arrangement to the current PRGF. This will be a very important milestone for Pakistan following a long history of financial assistance from the IMF. The authorities should be commended for adhering to their commitments under the PRGF and for the impressive economic achievements. Of course, the IMF will continue to work closely with the Pakistani authorities, but in a different mode. As part of our surveillance mandate, we will offer advice on macroeconomic stabilization and reforms, and particularly on how economic growth could be strengthened further over the medium term. We will also provide technical assistance in the monetary and fiscal areas, as requested by the Pakistani authorities. In this context, a Financial Sector Assessment Program (FSAP) is currently underway, and the results are expected to be published later this year.

4. Pakistan has come a long way in a short period. By the late 1990s, Pakistan was facing a very difficult economic situation. Intermittent attempts in the past to carry through adjustment and reform programs were too often followed by policy reversals and thus failed to generate positive results. Economic growth averaged an historically low 3 percent in the late 1990s, barely exceeding the population growth rate. For years, the fiscal deficit remained well above 6 percent of GDP. This caused a continuous increase in public sector indebtedness and required a growing share of government resources to be used for interest payments. Eventually, the country experienced a debt crisis.

5. Against this background, the main objectives of the current PRGF program were (a) to extract the country from a debt trap; (b) to accelerate economic growth; and thus (c) to contribute to an improvement in social indicators.

6. Pakistan's public debt burden has been reduced considerably. Key to this has been the reduction in the government deficit, which has been lowered by more than 2 percentage points of GDP since FY 1999/2000, as well as the rescheduling of Pakistan's external debt. The ratio of public debt to GDP declined from almost 110 percent in 2000/01 to an estimated 85 percent in the current fiscal year. Pakistan's external public debt has fallen from 55 percent of GDP in FY 1999/2000 to an estimated 42 percent of GDP in the current year. Combined with an improved external position that has allowed the State Bank of Pakistan (SBP) to rebuild its international reserves to over $10 billion, Pakistan has become much less vulnerable to external shocks. But it is not out of the woods yet. Debt indicators are still high and reducing these further to sustainable levels will require continued fiscal adjustment and strong economic growth.

7. Growth has recovered. Growth has picked up significantly in the last few years and is expected to reach 5½ percent this fiscal year. The recovery has been broad-based, and is driven in part by strong export growth.

8. Key to restoring growth has been the authorities' determined implementation of sound financial policies and structural reforms. In the macroeconomic area, the crucial elements have been the sizable fiscal adjustment and a monetary policy geared first toward achieving and then maintaining low inflation.

9. Meanwhile, considerable improvements have been made in the past several years in establishing a more favorable business environment to foster private sector development.

In this context:

· Tax reform has been geared toward reducing top tariff rates, while eliminating numerous exemptions. A fundamental reform of the tax administration is underway. Self-assessment has been introduced, and audit functions are being strengthened.

· Financial sector reform has resulted in a healthier and more competitive banking system. Key to this reform has been privatization and strengthening of bank supervision. As a result, financial intermediation has deepened, and consumer and mortgage lending are supporting the current recovery.

· Enterprise reform has made major public enterprises more accountable through the adoption and publication of financial improvement plans. Impressive results have been achieved by some enterprises, such as Pakistan Steel. However, other enterprises, notably in the power sector, still have a long way to go. To enhance competition and transparency, various regulatory authorities have been set up.

These policies have reduced distortions and increased efficiency, and also lifted uncertainty about the future course of economic policies. Thus, they have established a solid basis for future economic growth, though improving the environment for private sector activity is essential in this context.

10. Unfortunately, the available data show little evidence of a reduction in poverty. The most recent poverty data are for 2000/01 and thus fail to reflect the increase in economic activity in recent years. But there is no question that a large part of Pakistan's population still remains below or close to the poverty line, and that many do not have proper access to health and education services. Thus, while Pakistan has come a long way, there are considerable challenges ahead to translate stronger macroeconomic indicators into lower poverty.

11. Pakistan's PRSP provides a solid framework for the country's efforts toward sustainable growth and poverty reduction. It appropriately puts poverty reduction at the top of the policy agenda. Moreover, it recognizes that economic growth is a necessary, but not a sufficient condition to reduce poverty. The PRSP also emphasizes that poverty reflects social, political, and economic exclusion. A lack of access to basic public services, markets, and institutions impedes the ability of the poor to improve their living standards. Thus, apart from growth, the second main condition to reduce poverty is greater social inclusion, including through human development and devolution. The PRSP sets out a comprehensive agenda to attack poverty, although we are looking forward to a more specific implementation plan as part of the next progress report.

12. To help lift a significant share of the population out of poverty, economic growth will need to continue at rates of at least 5-6 percent annually over the medium term. This is ambitious, but achievable. For 2004/05, a growth rate of 5½-6 percent could very well be realized, building on the current momentum, provided that external demand and local weather conditions remain favorable. But maintaining growth rates of 6 percent and higher over the medium term will require a substantial increase in private and public investment, accompanied by significant improvements in productivity.

13. Private investment requires macroeconomic and financial stability, as well as stable security and political conditions. Recent developments in this area, such as the agreement on the Legal Framework Order and improvements in the relations with India, are most welcome and encouraging.

14. Investment also requires the continuation of economic policies that are conducive to growth. In this regard, we welcome the authorities' commitment to further reduce Pakistan's debt overhang through continued fiscal adjustment, as well as the SBP's commitment to maintain the hard-won gains of low inflation. Given the expected key role of private sector activity in generating growth, the PRSP also identifies key reforms necessary to reduce the cost of doing business. These include ongoing tax and financial sector reforms, deregulation, labor market reform, and improving governance. In addition, the PRSP envisages a large increase in public sector investment that is intended to address infrastructure bottlenecks and improve the delivery of services such as power, telecommunications, and especially irrigation.

15. Beyond achieving more rapid economic growth, poverty reduction also requires substantial investment in human capital and an improvement in public service delivery. This entails not only an increase in social expenditures, but also an increase in the effectiveness of those expenditures. The latter involves building adequate institutional capacity and improving governance at the local level. Looking at the 2003 UNDP Human Development Indicators, one area that jumps out as being a major factor in holding back Pakistan's development is poor education. Improved public service delivery is particularly needed in the rural areas, not only to achieve universal primary school enrollment, but also to ensure an effective delivery of basic health care.

16. The fiscal framework presented in the PRSP balances the need for increased social spending and further debt reduction. Both of these objectives can be achieved with the right mix of fiscal policies. Provided growth remains strong, a fairly modest improvement in the overall fiscal balance in percent of GDP should suffice to further reduce debt ratios, as envisaged in the draft Fiscal Responsibility Law and in the PRSP. This will lower the claim of debt service obligations on scarce government resources. At the same time, fiscal policy will need to focus on strengthening revenue collection and reducing subsidies to loss-making public enterprises by improving their performance. These actions combined are projected to create the fiscal space to increase social and development spending, by 1½ and 2¼ percentage-point of GDP, respectively, during 2003-08. In the revenue mobilization area, given the generally low rate of revenue collection, we would encourage the authorities to intensify efforts to strengthen tax administration and to set a more ambitious revenue path than envisaged under the PRSP.

17. Crucial to creating adequate fiscal space for increased social expenditures will be further power sector reform. Reducing the power sector's reliance on budget transfers, while improving service delivery, will be a particular challenge. In the short run, the authorities will need to ensure that the Water and Power Development Authority (WAPDA) and the Karachi Electric Supply Corporation (KESC) meet the targets for 2003/04 and that subsidies do not exceed their budget allocations. The unbundling and corporatization of WAPDA needs to be completed swiftly to better localize structural problems and clear the way for gradual privatization. In addition, the framework for setting electricity tariffs will need to be strictly maintained. We welcome the authorities' intention to formulate a medium-term Power Sector Recovery Plan directed at improving governance and accountability, including by accelerating privatization, reducing costs, reforming tariff and subsidy policies, and establishing a policy framework that ensures that investments are fully funded. Implementation of this plan should place the power sector on a path toward financial viability and expand access to reliable power supplies.

18. Successful devolution will be key to achieving the authorities' objective to improve the quality of and access to public services at the local level. The PRSP incorporates a fundamental change in the relationship between decision makers, public service providers, and the population. Significant progress in implementing political devolution has already been made. As a result, provincial and local governments now share a greater responsibility for the achievement of the poverty reduction and development goals. But successful devolution will require the clear alignment of roles, responsibilities, and accountabilities between the different tiers of government. This can only become possible when political devolution is followed up by administrative devolution, combined with the transfer of adequate financial resources to provincial and local governments.

IV. Conclusion

19. Pakistan is clearly on the right course, though significant gains in the fight against poverty are not yet visible. Given the authorities' track record over the last few years, we in the IMF are optimistic that strong growth will continue, setting the stage for a reduction in poverty. Ultimately, Pakistan's growth outlook will depend on the authorities' ability to continue with sound fiscal and monetary policies and to maintain the momentum of advancing broad-based structural reforms to foster private sector development. Strengthening implementation capacity will be crucial to improving public service delivery to the poor as well as adequate resources being provided to key social sectors. The PRSP provides a strong and credible strategy for the coming years to achieve a lasting reduction in poverty. We wish the authorities continued success and assure them that the IMF is committed to work closely with the Pakistani authorities in the future.