Public Information Notices

Pakistan and the IMF

Public Information Notice (PIN) No. 99/4
January 27, 1999
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes Article IV Consultation with Pakistan

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On January 14, 1999 the Executive Board concluded the Article IV consultation with Pakistan1.


In 1997/98, macroeconomic performance was generally favorable reflecting the combined impact of tighter demand management policies, favorable exogenous factors, and progress in structural reforms. It is estimated that economic growth was 5.4 percent, on account of a strong performance of agriculture as well as a recovery in industrial sectors. Average consumer price inflation (year-on-year) declined to about 8.0 percent.

The 1997/98 budget deficit target was achieved as shortfalls in revenues from customs duties and the General Sales Tax (GST) were offset by higher than programmed petroleum surcharge revenues and lower current expenditure. The overall deficit of several major public enterprises contracted reflecting, inter alia, the financial impact of the 21 percent electricity tariff increase adopted in March 1998. However, the liquidity position of a number of enterprises deteriorated and intra public sector arrears increased. Following an 8.0 percent devaluation in October 1997, the rupee appreciated by 2.9 percent in real effective terms on a June to June basis.

The external current account deficit (excluding official transfers) contracted to 3.2 percent of GDP in 1997/98, with the bulk of the adjustment registered in the trade accounts. Exports increased by only about 4 percent, despite good performance in a range of primary commodities and nontraditional manufactures. The sluggish export growth was largely due to falling prices of cotton and cotton based products and slow sales of textiles, partly attributable to the Asian financial crisis. Imports declined by 8 percent reflecting the declines in petroleum product prices, and a fall in imports of power generating machinery as major investments in power plants neared completion. In the capital account, inflows of long-term private capital declined sharply and net flows of private short-term capital turned negative, as the domestic political developments and the crisis in East Asia affected investor confidence. By end-June, gross official reserves had declined to US$932 million, equivalent to one month of imports.

Progress was made in implementing structural reforms during 1997/98. In the banking sector, the State Bank strengthened prudential regulations, and took measures to improve the capital base of the nationalized banking system and redress administrative weaknesses in financial institutions. Also, a marketable foreign currency bond was issued, treasury bills were introduced to replace the short-term federal bonds, and steps were taken to develop and liberalize the foreign exchange market. In the fiscal area, GST exemptions for sugar and edible oils were removed, and legislation extending the GST to the retail stage was adopted, but setbacks were encountered in enforcing the GST at the manufacturing stage. However, major delays occurred in the implementation of a comprehensive restructuring program for the energy sector and a weakening investment climate contributed to delays in privatization.

Following the nuclear tests of May 1998 and the imposition of economic sanctions, the government took several policy measures to stave off an external crisis. In the fiscal area, these measures included most importantly an increase in retail prices of gasoline by 25 percent, a revision in the structure of tariffs on telephone calls, and reductions in planned development expenditure. The rupee was devalued on June 26, 1998, and a dual exchange rate system was adopted on July 22, 1998, exchange restrictions were introduced, and withdrawals from foreign currency deposits in foreign exchange were suspended. As for monetary policy, reserve and statutory liquidity requirements were temporarily reduced to ease the anticipated pressures arising from foreign currency deposit withdrawals on banks’ liquidity. In the event, and notwithstanding the sharp decline in imports, external arrears on account of current account payments and debt service obligations reached US$1.6 billion and the stock of official reserves declined to about US$450 million by end-November 1998.

Executive Board Assessment

Executive Directors welcomed improvements in Pakistan’s macroeconomic performance in 1997/98, which generally compared well in relation to the targets under the program supported by the ESAF and the Extended Arrangement. Economic growth picked up as targeted, inflation decelerated faster than programmed, and the external current account deficit was halved to a level much lower than the program target.

While recognizing progress made in a number of structural reform areas, Directors noted, however, that the implementation of certain fiscal reforms fell short of the program objectives, the restructuring of public enterprises was delayed, and important vulnerabilities were not adequately addressed. They expressed concern in particular about the dependence of the balance of payments on highly market sensitive financing; the State Bank of Pakistan’s large uncovered forward exchange position; increasing dependence of budget revenues on receipts from petroleum surcharges, while the domestic tax base remained narrow; the financial difficulties of the Water and Power Development Authority (WAPDA); and the high level of nonperforming loans in the banking system.

Directors noted that the nuclear bomb tests in May, the subsequent sanctions, and the loss of market confidence have engendered a precarious economic situation in 1998/99, including the accumulation of substantial external payment arrears.

Against this background, Directors welcomed the authorities’ program of macroeconomic policies and structural reforms in the context of a revised medium-term framework under the ESAF and Extended Arrangements. Most of these Directors emphasized that the program, if steadfastly and forcefully implemented, would help address the adverse effects of recent shocks and lay the basis for achieving sustainable high rates of growth over the medium term. Furthermore, several Directors stressed that avoidance of slippages was particularly important in light of the need to make a decisive break from the past record of stop-and-go policies and establishing a good track record. In this regard, Directors underscored the importance of strong and timely monitoring of implementation of envisaged policy actions. Some Directors, however, felt that, given the difficulty of the economic situation, and the seriousness of the problems, the policy package was not sufficiently front loaded. Directors welcomed the authorities’ intention to make public their reform agenda through the issuance of the Policy Framework Paper.

Directors urged the authorities to pursue forcefully their program of fiscal consolidation. Effective actions to address the serious and longstanding problems in this area would be vital to signaling the authorities’ resolve and commitment to reform. Most Directors believed that the targeted budget deficit reduction in 1998/99 was appropriate, given the decline in growth and the less than full-year impact of most measures. They were encouraged by the recent fiscal actions to this end, including the increase ahead of schedule of the General Sales Tax (GST) rate. Nevertheless, to achieve the target, they underscored the importance not only of implementing the programmed measures, but also of taking additional measures should slippages in fiscal performance occur. Directors also noted the authorities’ commitment to reduce the deficit further in 1999/2000 and to further fiscal consolidation over the medium term. They emphasized that the credibility of these commitments will depend on the expeditious implementation of the envisaged fiscal reforms that center around improving the level and structure of taxation, as well as enhancing the composition and effectiveness of expenditure. Directors observed that budgetary reform in Pakistan assumes particular importance, given its limited revenue base and low tax buoyancy, on the one hand, and the sizeable social needs and infrastructure expenditure demands on the other. To this end, they emphasized the crucial importance of strengthening the revenue base, and endorsed the planned extension of the GST to the services sector, petroleum products, electricity, and agricultural inputs, and also the strengthening of tax administration. Some Directors pointed out that, to be fully effective, several of these measures would need to be accompanied by improvements in the structure of tax administration. On the expenditure side, Directors welcomed the attention to enhancing social services and poverty alleviation.

Directors attached great importance to the long overdue reform of agricultural income taxation. They urged the authorities to develop expeditiously a package of measures that will steadily raise the revenue from agricultural income taxation to levels that are comparable to other countries with a large agricultural sector. The consensus was that, without meaningful andpermanent revenue increases, including from this potentially major source, fiscal consolidation cannot be achieved without jeopardizing basic government services.

While welcoming the increased role of market forces in the determination of the exchange rate, several Directors noted with concern that the transitional exchange rate was not very transparent and involved a number of distortions. Hence, they attached high importance to the authorities’ commitment to move to a market-determined unified exchange rate. They emphasized that, in order to ease constraints on exchange rate policy and reduce the burden on monetary policy in maintaining external stability, it is essential to resolve the problem of the still large stock of foreign currency deposits, without creating large contingent liabilities in the medium term that would be difficult to manage. Directors welcomed the authorities’ intention to monitor monetary developments closely, and urged them to implement an active interest rate policy and adjust the monetary program, as needed, to achieve the program’s inflation and external objectives. A few Directors expressed concern about the introduction of directed lending schemes.

Directors stressed the importance of steadfast implementation of the authorities’ structural reform agenda, and of efforts to promote governance and increase transparency. The problem of child labor also was raised by several Directors as a serious concern. They considered improvements in the financial performance of the public sector enterprises, especially those in the power sector, as absolutely essential for the success of the program. To this end, they urged the authorities to finalize detailed restructuring plans for WAPDA and the Karachi Electricity Supply Corporation expeditiously, and for WAPDA to implement the tariff decision of the National Electric Power Regulatory Authority, and to formulate a comprehensive plan for the elimination of outstanding stocks of payables and receivables by March 1999. Directors welcomed the progress made in resolving disputes with the independent power producers in an orderly framework, which is essential to contain the already significant adverse impact on the investment climate and investor confidence. With regard to privatization, Directors encouraged the authorities to press ahead with all necessary steps, most importantly with enhancing the financial integrity of public sector financial institutions, so as to allow a reacceleration of the privatization process as conditions improve. With regard to banking reform, they emphasized the importance of continued efforts, including strengthening of prudential regulations.

Directors noted that, despite progress in recent years, Pakistan’s trade system remained restrictive. They encouraged the authorities to move forward with the planned reform of the tariff system and the elimination of nontariff barriers. They also encouraged the authorities to lift the temporary exchange restrictions that were imposed in mid-1998, and to eliminate arrears on current account and private capital transactions according to the agreed schedule—steps that were essential for the recovery of investor confidence.

With regard to external adjustment, Directors noted that, despite a projected substantial improvement in the trade balance and a fairly modest targeted increase in foreign exchange reserves, large exceptional financing will be required to close the financing gaps in 1998/99 and 1999/2000. They urged the authorities to closely monitor the implementation of programs supported by the World Bank, the Asian Development Bank, and other creditors and donors to ensure timely disbursement of the requested financial assistance. They were also encouraged that the authorities have already initiated discussions with bilateral official and commercialcreditors seeking a comprehensive rescheduling of public and publicly guaranteed debt, as well as appropriate participation of the private sector in the financing of the program.

Pakistan: Selected Economic Indicators

1993/94 1994/95 1995/96 1996/97 1997/98

Changes in Percent
Domestic Economy
Real GDP 4.5 5.2 5.2 1.3 5.4
Consumer price index1 11.8 12.1 10.3 12.5 6.5

In millions of U.S. dollars
External Economy
Current account
excluding official transfers - 1,904 - 2,413 - 4,820 - 3,851 - 2,076
In percent of GDP - 3.6 - 3.9 - 7.5 - 6.2 - 3.2
Gross official reserves2 2,302 2,741 2,053 1,141 932
In weeks of imports2 12.6 12.7 8.2 4.9 4.3
External debt service ratio3 22.7 23.8 25.3 28.2 24.3
External public debt4 49.3 45.4 43.5 45.9 46.0

In percent
Financial variables
Interest rate 12.4 11.8 12.8 15.6 15.1
Budgetary balance4 - 6.7 - 6.9 - 7.1 - 6.4 - 5.5
Domestic debt4 43.9 41.4 41.3 42.7 41.9
Broad money5 18.0 17.2 13.8 12.2 12.9

Sources: Pakistan authorities; and IMF staff estimates.

2Excluding gold.
3Medium- and long-term debt service in percent of goods, services and receipts of private transfers.
4In percent of GDP.
5Annual change.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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