Public Information Notices
Pakistan and the IMF
IMF Concludes Article IV Consultation with Pakistan
On November 29, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Pakistan.1
Over the last decade, long-standing structural weaknesses in the Pakistan economy—an inefficient tax system, narrow tax and export bases, substantial domestic and external debt, and low human capital—have held back growth, threatened financial stability, and resulted in widespread poverty. Economic adjustment and reform programs to address these weaknesses have, in the past, suffered from implementation slippages.
Overall economic performance in FY1999/2000 benefited from favorable supply conditions in the domestic agricultural sector.2 Real GDP growth is estimated to have picked up to 4.8 percent in 1999/2000, compared with 3.1 percent in the previous year. The bumper cotton crop helped the textile sector to rebound. Despite upward adjustments in domestic petroleum products prices, the stable rupee-dollar exchange rate and the decline in non-oil commodity prices helped moderate consumer price inflation to 3.6 percent (annual average), from 5.7 percent in the previous year.
With the favorable domestic supply conditions, the current account deficit (including official transfers) narrowed to 1.6 percent of GDP, from 3.8 percent of GDP in 1998/99, despite a deterioration in the terms of trade. Improved external demand conditions and increased domestic textile production boosted export growth. Total imports in U.S. dollar terms were unchanged from 1998/99, as the US$1.2 billion increase in oil imports, which was due to higher world prices, was broadly offset by lower food, defense, and project aid-related imports. Higher workers' remittances (private transfers) also improved the current account balance.
The overall external position was weakened in 1999/2000 by a significant decline in external financing, including from the international financial institutions (IFIs) and private capital outflows. Gross official reserves declined to US$0.9 billion (equivalent to 4.2 weeks of imports of goods and nonfactor services) at end-June 2000, from US$1.7 billion (7.8 weeks of imports) a year earlier. The external debt to GDP ratio amounted to 58 percent at end-1999/2000, while the external debt service after rescheduling amounted to 32 percent of current foreign exchange receipts.
Following a sizable fiscal consolidation in 1998/99, the budget deficit of the consolidated government widened to 6.4 percent of GDP in 1999/2000, from 6.1 percent of GDP in the previous year. Factors contributing to the deterioration included delayed adjustment in domestic petroleum prices; an increase in the government's interest bill; the settlement of accumulated tax refund arrears; the elimination of some local taxes at the beginning of the fiscal year; and an overrun in defense spending. Partly offsetting these effects on the budgetary position were higher nontax revenue; further cuts in development expenditure and net lending; collections from a tax amnesty; and an increase in Central Board of Revenue tax receipts. During the last two years, the ratio of net public debt to GDP stabilized at about 92 percent, as primary surpluses roughly offset the valuation effects of the rupee depreciation in 1998/99.
The monetary policy stance was eased during 1999/2000 in response to the moderation in inflation and weak private sector credit growth. Treasury bill yields were cut by 3 percentage points to 7.0-7.5 percent, while the central bank's discount rate was lowered by 2 percentage points to 11 percent. At the same time, the increased budget deficit and a sharp expansion in commodity operations (related to the procurement of the bumper wheat crop) fueled a significant rise in net credit to government, which accounted for two-thirds of the overall growth in broad money.
A number of important structural reform measures were implemented during 1999/2000 in the areas of public finance, public enterprises, and in the financial, international trade, agriculture, and energy sectors. In particular, the GST was extended to petroleum products, natural gas, and electricity. All tax whitener schemes were withdrawn through the removal of immunity from tax probe of newly invested funds. A major tax survey and registration drive was launched in an effort to widen the tax base. A mechanism for adjusting domestic prices of petroleum products on a quarterly basis in response to international price movements was put in place in December 1999. For key public enterprises, corporate and financial restructuring plans were drawn up and, for the Pakistan Steel Mills, Pakistan Railways, and power sector enterprises, implementation has commenced. In addition to an intensified loan recovery campaign, reforms in the financial sector included cuts in interest rates on National Savings Schemes (NSS) instruments by an average of 5.5 percentage points since May 1999, which decreased the spread between returns on NSS instruments and those for other instruments and helped in reducing market segmentation. Prices for furnace oil, which accounts for 40 percent of domestic petroleum consumption, were freed from July 2000.
Executive Board Assessment
Executive Directors noted that Pakistan's macroeconomic performance over the past year was favorable in several respects. Growth had picked up, aided in large part by favorable crops, inflation had eased, and the external current account deficit had narrowed substantially despite a large terms of trade shock. In addition, several key structural reforms were implemented, including the introduction of the petroleum price adjustment mechanism, the withdrawal of tax immunities, and the launch of intensified loan recovery and tax registration campaigns.
Notwithstanding these favorable developments, Directors observed that a deterioration in the capital account of the balance of payments, together with an easing of monetary policy at the time when the exchange rate was held stable, had weakened the external position and caused the rupee to come under pressure. Also, the budgetary position had deteriorated because of expenditure overruns and continued weak tax administration, which had resulted in lower-than-envisaged revenue gains.
The key policy challenges for the period immediately ahead will be to maintain macroeconomic discipline and improve the competitiveness of the economy and public debt dynamics. If policies to achieve these objectives are steadily carried out over time, private sector confidence would likely improve and the economy would move to a higher and durable growth path, which is essential for reducing poverty. Directors, therefore, welcomed the authorities' resolve to break from the past and improve governance and implement far-reaching structural reforms resolutely.
Directors agreed that fiscal consolidation—especially an improved revenue effort—is essential for restoring macroeconomic stability. They welcomed the reorientation of public spending to poverty-related expenditures and saw this shift in budgetary priorities as key to sustaining public support for the overall reform effort. Directors supported the targeted reduction in the budget deficit through measures to raise tax collection, tighten expenditure control mechanisms, and improve tax administration. However, in view of the uncertainty surrounding the attainment of the growth objectives of the program and the effectiveness of some of the fiscal measures, Directors urged the authorities to maintain a close watch over revenue and expenditure developments, and to respond expeditiously with additional measures as needed, to ensure that the budgetary target is met, while safeguarding social and poverty-related spending.
Directors agreed that fiscal consolidation needs to continue over the medium term to reduce the public debt burden and create room for a much-needed expansion in social spending, aimed at reducing poverty on a lasting basis. They noted that, in the past, weaknesses in revenue performance have undermined efforts to reduce the fiscal deficit. Directors therefore emphasized that structural fiscal reforms to broaden the revenue base and improve its buoyancy, as well as cuts in less productive expenditure, will be essential. In particular, they urged the authorities to implement envisaged timetables for the extension of the General Sales Tax to the retail sector and agricultural inputs, the overhaul of the income tax law with the 2001/02 budget, the further strengthening of tax administration, and the finalization of the civil service reform plan. Directors considered that faster progress in the drive to register large taxpayers and better revenue collection from the agricultural sector will be essential for the overall fiscal effort. They also noted that strengthening the institutional capacity of the Central Board of Revenue would help the authorities in their efforts to enhance revenue collection. In order to maintain fiscal discipline at the provincial level, Directors recommended that, as the proposed fiscal decentralization proceeds, expenditure responsibilities for different levels of government be assigned commensurate with any reallocation of resources. In general, they considered that structural reforms would be essential for bringing about greater transparency in the regulatory environment and providing greater confidence in the efficient management of public resources.
Directors noted the significant depreciation of the rupee in recent months and the authorities' commitment to allow the exchange rate to be determined by market forces. In this regard, they noted the recent tightening of the monetary policy stance and its likely positive effect to stabilize the exchange rate. Directors cautioned against any premature cut in interest rates, particularly in view of the very low level of official reserves. They urged the authorities to press ahead with measures to develop and deepen the inter-bank foreign exchange market. In this connection, several Directors underscored the importance of measures to check the growth of the kerb market, including through a reduction in the State Bank of Pakistan's purchases of foreign exchange from this market. Observing that the existence of two foreign exchange markets in Pakistan gives rise to the possibility of a multiple currency practice, Directors urged the authorities to ensure that all legitimate current account transactions are allowed to go through the inter-bank market.
As regards other structural reforms, Directors welcomed, in particular, the envisaged reforms of the National Savings Scheme and the export finance scheme, and measures to enhance the commercial orientation and financial position of the banking system. They noted the progress that had been made in resolving tariff disputes with independent power producers and urged the expeditious resolution of the remaining dispute with Hub Power Corporation, which has clouded investor sentiment toward Pakistan. Directors welcomed the restructuring of state-owned enterprises, such as the Water and Power Development Authority and the Karachi Electric Supply Corporation, and stressed the importance of improving the management of these enterprises. They welcomed the announcement of the trade liberalization plan, which would help create a more competitive domestic environment. Looking forward, Directors underscored the importance of reforms in the areas of privatization, the energy sector, and governance to energize the private sector and attract foreign direct investment flows, thereby enhancing Pakistan's growth potential.
Directors noted the authorities' efforts to improve the quality, timeliness, and reporting of data-especially with respect to fiscal accounts. With continuing data weaknesses hampering the analysis of economic and financial market developments, they welcomed the authorities' plan to implement the recommendations of the fiscal module of the Report on the Observance of Standards and Codes and the launch of the program to improve national accounts statistics.
Directors regretted that the recently completed revisions to the historical fiscal data gave rise to incorrect data reporting to the Fund on at least two occasions during 1993/94-1996/97. These constituted breaches of Pakistan's obligations under Article VIII, Section 5 of the Articles of Agreement. However, in view of the remedial actions taken by the authorities since early 2000 to improve fiscal data accounting and reporting, including the audit of the operations of the Central Directorate of National Savings, Directors did not consider that any further actions were needed.
Directors welcomed the authorities' decision to publish the staff report.
|Pakistan: Selected Economic and Financial Indicators, 1996/97-2000/01 1/|
|(Annual changes in percent)|
|Output and prices|
|Real GDP at factor costs||1.7||3.5||3.1||4.8||4.5|
|Consumer prices (annual average)||11.8||7.8||5.7||3.6||6.0|
|(In percent of GDP)|
|Savings and investment|
|Gross national savings||12.3||15.0||11.2||13.3||13.9|
|Gross capital formation||18.0||17.7||15.0||15.0||15.5|
|Net public debt||87.5||89.4||91.9||91.6||93.8|
|(Annual changes in percent of initial stock of broad money)|
|Net foreign assets||-2.5||-2.7||1.6||1.5||5.6|
|Net domestic assets||14.7||17.3||4.5||7.8||5.7|
|credit to the private sector||7.3||8.1||8.5||1.4||6.9|
|net credit to government||7.5||4.5||-3.9||3.1||-1.2|
|6-month treasury bill rate
(in percent, annual average) 2/
|(In percent of GDP)|
|Merchandise trade balance||-5.0||-3.0||-3.6||-2.3||-1.8|
|Current account including official transfers||-5.7||-2.7||-3.8||-1.6||-1.6|
|(In percent of current foreign exchange receipts 3/)|
|Total public and private external debt||280.1||270.2||323.1||281.6||266.2|
|Actual debt service 4/||56.4||55.8||43.7||35.2||28.9|
|In weeks of next years' imports of goods and nonfactor services||4.4||3.9||7.8||4.2||7.3|
Sources: Pakistan authorities; IMF, World Economic Outlook; and IMF staff calculations.
|1/ Pakistan's fiscal year runs from July 1 to June 30.|
|2/ In July 1996, 6-month treasury bills were replaced by 6-month short-term federal bonds.|
|3/ Defined as sum of receipts from exports of merchandise and services exports, and from private transfers.|
|4/ Scheduled debt service minus rescheduled debt service plus debt service on previously rescheduled debt.|
|5/ Excluding gold, foreign assets relating to foreign currency deposits contracted after May 1998 (FE25s), and foreign assets relating to short-term swap and forward operations.|
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 Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
2 Pakistan's fiscal year runs from July 1 to June 30.
IMF EXTERNAL RELATIONS DEPARTMENT