IMF Approves US$596 Million Stand-By Credit for Pakistan

The Executive Board of the International Monetary Fund (IMF) today approved a Stand-By credit for Pakistan until end-September 2001 in an amount equivalent to SDR 465 million (about US$596 million) to support the government's economic program for 2000-01. The decision will enable Pakistan to draw SDR 150 million (about US$192 million) immediately.

In commenting on the Executive Board discussion, Mr. Horst Köhler, Managing Director, said:

"The Pakistan authorities have put in place an economic adjustment and reform program, for which financial support under a Stand-By Arrangement has been approved by the Fund's Executive Board. The program aims to move Pakistan on to a high and sustainable growth path by strengthening the balance of payments position, rebuilding official reserves, and reducing public sector indebtedness. To support these objectives, the government has strengthened macroeconomic policies and has developed a wide-ranging structural reform agenda that emphasizes revenue mobilization, improving investor confidence, poverty alleviation, and good governance. The reform agenda has been drawn from a broad consultative process. Substantial improvement in the collection and quality of data and transparency is an integral part of the program.

"The program envisages a reduction in the overall budget deficit in 2000/01 to 5.2 percent of GDP, from 6.4 percent in 1999/2000, with further consolidation over the medium term. The budget target is to be achieved through increased tax collections with a widening of the tax base, improved tax administration, and strict expenditure controls. Since there is significant uncertainty surrounding the short-term impact of revenue measures on the budgetary position, the authorities should stand ready to take additional measures if revenues fall short of expectations. Steps have also been taken to increase spending by close to one-third on poverty reducing programs and to curtail less productive spending. Looking forward, continued improvement in revenue performance will be crucial for reducing the public debt burden and allowing more resources for tackling poverty on a lasting basis.

"A key element of the program is the maintenance of a competitive and flexible exchange rate that is determined by market forces. The transition to the flexible exchange rate regime has been facilitated by an increase in short-term interest rates to quell speculative pressures on the rupee. Once these pressures subside and the reserve position improves, there should be scope for a reduction in interest rates.

"Continued progress with structural reform will be necessary for attracting private investment, achieving high growth, and alleviating poverty. On the fiscal side, broadening the tax base, strengthening tax administration, and reforming the civil service will be of particular importance. In addition, steps to integrate financial markets, improve the financial position of public enterprises and banks, liberalize international trade, accelerate privatization, and enhance governance will be critical.

"The financing of the program will involve participation of the international financial institutions, official bilateral creditors, and the private sector. The Asian Development Bank and the World Bank will consider adjustment loans in support of Pakistan's structural reform efforts. A meeting of the Paris Club is expected in January 2001 to consider a request by Pakistan for a rescheduling of both its accumulated arrears and its debt service payments to Paris Club creditors falling due during the program period on pre-cutoff debt. The Pakistan authorities intend to seek comparable treatment from all other official bilateral and private creditors.

"The successful implementation of the program and the finalization of major structural reform plans, together with key initial steps, could pave the way over time for medium-term financial support from the Fund under the Poverty Reduction and Growth Facility," Mr. Köhler said.

ANNEX

Background

Over the past decade, long-standing structural weaknesses in Pakistan's economy-an inefficient tax system and a narrow tax base, an undiversified export base, large stocks of public and external debt, and low human capital-began to drag on growth and threaten financial stability. Pakistan's record in macroeconomic stabilization and structural reforms during this period was mixed, and adjustment and reform plans suffered from slippages in their implementation.

The new government, which took office in October 1999, recognized the need for a clean break from the past and the forceful implementation of reforms to address the long-standing structural problems facing the economy. They set forth a wide-ranging reform agenda aimed at reducing poverty, revenue mobilization, improving governance, and sustaining a high rate of economic growth. While a number of steps have already been taken, the design and sequenced implementation of a comprehensive policy package will take additional time to finalize. In the meantime, however, the external financial situation had become even more fragile, partly because of large debt service payments and increased capital outflows, as well as loose macroeconomic policies. To stem pressures on the rupee and bring official reserves to more comfortable levels, a stabilization program-supported by Fund resources-was needed urgently.

Macroeconomic Policies Under the Program

The program targets a substantial increase in gross official reserves to US$1.74 billion at end-June 2001, equivalent to 7.3 weeks of imports of goods and nonfactor services, that is to be achieved through a flexible exchange rate policy, monetary tightening, fiscal adjustment, and substantial exceptional financing. Improvements in the balance of payments position will also be helped by increased exports and sharply reduced private sector capital outflows brought about by a rebound in investor confidence.

A key element of the program is a market-determined exchange rate policy, which will reduce risks related to the vulnerability of the balance of payments. To facilitate a smooth transition to a market-determined exchange rate, the authorities have allowed for a sizable up-front exchange rate adjustment and tightened the monetary policy stance.

The program targets a reduction in the budget deficit in 2000/01 by 1.2 percentage points of GDP to 5.2 percent of GDP that is to be achieved despite increased social spending. A series of measures to increase tax collection, including steps to widen the tax base and contain current expenditures, are being implemented to support the fiscal consolidation process. Allocations for social and poverty reducing expenditure have been increased by 28 percent in 2000/01, equivalent to 0.4 percent of GDP.

Structural Reforms

The program includes a comprehensive agenda of structural fiscal reforms. Several initiatives are underway to strengthen tax administration and enforcement, and taxpayer registration. The sales tax net is being widened through the extension of the GST to services and to agricultural inputs. Taxation of agricultural incomes has been enhanced with the introduction of a two-tier tax from this fiscal year, comprising a fixed land-based tax as well as an income tax on large farmers. A fundamental overhaul of the income tax system is underway, and a new income tax law aiming at establishing a simple income tax based on genuine self-assessment with minimal exemptions and a less distorting rate structure is to be promulgated with the 2001/02 budget. Finally, efforts are being made to reduce GST, customs duty, and income tax exemptions.

The ambitious structural reform agenda also extends to other areas. The financial and organizational restructuring of public enterprise reform is proceeding with a view to reducing enterprises' burden on the budget and preparing them for eventual privatization. The medium-term trade liberalization program is built around a pre-announced series of further cuts in the maximum tariff rate and in the number of tariff slabs. In the financial sector, the rationalization of the pricing and structure of debt instruments issued by the National Savings Scheme is underway and will help to reduce market segmentation. Measures are also being taken to enhance the commercial orientation of the banking system and improve its financial position.

Financing Needs

In addition to the IMF's stand-by credit, Pakistan's reform program will be supported by financing from the Asian Development Bank, the World Bank, bilateral official creditors, and the private sector. The Paris Club has agreed to consider, in January 2001, rescheduling Pakistan's outstanding arrears and upcoming debt obligations to Paris Club creditors.

Pakistan joined the IMF on July 11, 1950, and its quota¹ is SDR 1,033.7 million (about US$1,323 million). Its outstanding use of IMF financing currently totals about SDR 1,077 million (about US$1,379 million).