## _cr05409 ## Source details **Canonical URL:** [_cr05409](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05409.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05409.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05409.pdf.json) --- ### Executive summary — main findings and outlook - Macroeconomic performance continues to be strong, but inflationary and external pressures are evident. - Real GDP growth reached 8.4 percent in 2004/05 (July–June) and is expected to remain high. - Inflation: 12‑month inflation reached 11 percent in April 2005, before easing to 8.4 percent in August 2005. Core inflation has remained at 8 percent in 2005. - External sector: Rapid import growth moved the current account into deficit during 2004/05 despite higher workers’ remittances. - Poverty and social indicators: progress toward poverty reduction; high growth, including in agriculture, estimated to have raised disposable incomes. Further increases in health and education spending are needed to achieve the Millennium Development Goals. - Medium‑term outlook: favorable, conditional on substantial increases in investment (including private investment) and continued implementation of reforms. - Vulnerabilities: debt dynamics favorable; international reserves adequate; financial sector strengthened and standard stress tests show resilience. - Structural reform progress: sale (with management control) of 26 percent of the public telecommunication company; other privatizations under way; energy sector reforms lag. ### Recent economic developments — growth, inflation, external - Growth and composition: - Real GDP at factor costs (annual changes in percent): 2000/01 = 1.8; 2001/02 = 3.1; 2002/03 = 4.8; 2003/04 = 6.4; 2004/05 = 8.4; 2005/06 (proj.) = 7.0. - Growth in 2004/05 driven by strong domestic consumption and investment demand; manufacturing growth continued, partly export driven; timely rains contributed to bumper harvests. - Prices and monetary conditions: - Consumer prices (period average) (annual changes in percent): 2000/01 = 4.4; 2001/02 = 2.5; 2002/03 = 3.1; 2003/04 = 4.6; 2004/05 = 9.3; 2005/06 (proj.) = 9.0. - Asset prices: equity prices rose substantially over 3½ years before a correction in early 2005; a 65 percent increase during the first 2½ months of 2005 appears speculative; the market corrected by 25–30 percent in March 2005 and then stabilized (P/E ratios of around 12). - External sector and reserves: - Current account excluding official transfers (percent of GDP): 2000/01 = -2.7; 2001/02 = 0.1; 2002/03 = 3.8; 2003/04 = 1.4; 2004/05 = -1.6; 2005/06 (proj.) = -2.5. - Gross reserves (in millions of U.S. dollars): 2000/01 = 1,679; 2001/02 = 4,330; 2002/03 = 10,251; 2003/04 = 10,621; 2004/05 = 9,985; 2005/06 (proj.) = 12,006. - Reserves in months of next year imports of goods and services: 2000/01 = 1.7; 2001/02 = 3.7; 2002/03 = 6.4; 2003/04 = 5.2; 2004/05 = 4.1; 2005/06 (proj.) = 4.5. - External competitiveness and exchange rate: - Exchange rate described as floating but recently followed the U.S. dollar very closely. - Real effective exchange rate appreciated slightly in early 2005; competitiveness not judged a concern so far. ### Fiscal stance and public debt - Revenues and expenditures (percent of GDP): - Revenues (including grants): 2000/01 = 14.3; 2001/02 = 16.1; 2002/03 = 17.4; 2003/04 = 14.9; 2004/05 = 14.0; 2005/06 (proj.) = 13.2. - Tax revenues: 2000/01 = 10.6; 2001/02 = 10.9; 2002/03 = 11.5; 2003/04 = 11.1; 2004/05 = 10.0; 2005/06 (proj.) = 9.9. - Collected by Central Board of Revenues (percent of GDP): 2000/01 = 9.4; 2001/02 = 9.2; 2002/03 = 9.5; 2003/04 = 9.4; 2004/05 = 9.0; 2005/06 (proj.) = 9.1. - Expenditures (including statistical discrepancy): 2000/01 = 17.6; 2001/02 = 19.7; 2002/03 = 18.7; 2003/04 = 16.7; 2004/05 = 17.1; 2005/06 (proj.) = 16.8. - Budget balance (excluding grants): 2000/01 = -4.3; 2001/02 = -5.5; 2002/03 = -3.8; 2003/04 = -2.3; 2004/05 = -3.3; 2005/06 (proj.) = -3.8. - Public debt: - Government debt fell substantially to 61 percent of GDP (2004/05); total government debt series: 1999/00: 88.8; 2004/05: 61.1; 2005/06 (projection): 53.3 (percent of GDP). - Fiscal Responsibility Law mandates continued debt reduction by at least 2½ percent of GDP per year. ### Monetary policy and inflation dynamics - SBP actions and market rates: - The State Bank of Pakistan raised policy rates substantially since early 2005; six-month T-bill rate raised by more than 4 percentage points to 8 percent in May 2005. - Key interest rates remain slightly negative in real terms. - Monetary aggregates and credit: - Broad money growth high: Broad money (end of period, percentage change): 9.0 15.4 18.3 19.6 19.3 (2000/01–2004/05). - Private sector credit growth accelerated in 2002–05; private sector credit growth remained high at 31 percent (first-quarter 2005/06). - Reserve money growth initially did not slow because SBP provided substantial budget financing during 2004/05. - Capacity utilization (selected series, in percent): - Cement (Jun): 75.9 (2003/04 series) → 84.0 (2004/05 series) - Steel (Pak Steel) (Jun): 93.6 → 72.0 - Paper & paper board (Mar/Jun): reached 101.3 and 100.8 in 2004/05 series. ### External sector, trade, and oil price effects - Trade and current account: - The current account moved into deficit in 2004/05. - Textile exports rose by 15 percent in the first six months of 2005 over the same period in 2004 following the end of the textile quota system. - Faster import growth reflected higher oil prices and strong demand, including for machinery. - Reserves and financing: - Gross international reserves fell somewhat in 2004/05 to $10 billion (over four months of projected imports). - Privatization inflows expected to boost international reserves to $12 billion by end-2005/06. - Oil price impact and automatic adjustment mechanism: - About 40 percent of Pakistan’s energy consumption is petroleum-related, and virtually all petroleum products are imported. - Rising international oil prices resulted in a current account deterioration of 1 percent of GDP in 2004/05; similar impact projected for 2005/06. - The automatic oil price adjustment mechanism has been suspended; by May 2004 the average levy was zero, requiring outright subsidies and cross-subsidization. - In 2004/05, the fiscal deficit was about 1 percent of GDP higher due to lost revenues and increased subsidies. - Recent retail price increases in September and October largely offset the recent rise in oil prices. ### Financial sector soundness and reforms - Banking sector performance and indicators: - 2004: total assets and customer deposits grew by 20 percent and 22 percent, respectively; gross loans expanded by 38 percent. - Concentration declined: market share of the five largest banks fell to 56 percent from 62 percent in 1997. - After-tax return on assets reached 1.4 percent in the second quarter of 2005. - Financial soundness indicators (selected): - Capital adequacy ratio (CAR): 1997 4.5; 2004 10.5; 2005 10.9. - Gross NPLs to gross loans: 1997 23.6; 2004 11.6; 2005 10.6. - Net NPLs to capital: 1997 183.8; 2004 28.8; 2005 24.1. - Prudential measures and stress tests: - SBP mandated special provisioning for consumer financing: 1.5 percent (secured) and 5 percent (unsecured). - Stress tests indicate resilience to several shocks though vulnerability to interest rate, exchange rate, or equity price shocks has increased somewhat. ### Structural reforms, privatization, governance, and energy sector - Privatization: - Sale (with management control) of 26 percent of Pakistan Telecommunication Company Ltd.; winning bid amounted to $2.6 billion (2¼ percent of GDP). - Sales of Pakistan Steel and Pakistan Petroleum under way; Karachi Electric Supply Corporation sale delayed for nonpayment. - Energy sector: - Unbundling of power utility progressed but regional tariff framework remains outstanding; energy sector continues to pose a large drain on the budget. - Directors and staff urged completion of the new tariff framework so successor companies could operate independently. - Governance and implementation challenges: - Weak governance in some public sector institutions slows reform implementation. - Progress slower where broader institution building or provincial cooperation required (e.g., tax collection, energy). ### Key policy recommendations (staff view) - Short run: - Tighten macroeconomic policies somewhat to counter inflationary and external pressures: further tighten monetary policy (raise interest rates); modest fiscal tightening relative to the budget to reduce pressure on monetary policy. - Contain the 2005/06 deficit through additional revenue effort and tight expenditure control to keep it at last year’s level (3.3 percent of GDP). - Medium run: - Strengthen revenue mobilization: enhance compliance of existing taxpayers and develop quickly a strategy to extend the tax net into the service and agriculture sectors. - Sustain and accelerate structural reforms to attract private investment: expedite privatizations; continue public investment to ease bottlenecks in transportation, irrigation, and energy; address weak governance in public institutions. - Complete energy sector reforms to remove fiscal drains and improve the investment climate. - Continue to strengthen financial sector regulation and supervision, and implement follow‑up on FSSA recommendations. ### Earthquake (October 8, 2005) — impact and policy implications - Human and reconstruction needs: - Earthquake magnitude: 7.6 on the Richter scale. - Death toll estimated to exceed 54,000. - Over 70,000 people injured. - Nearly 4 million people affected in terms of loss of shelter and public amenities. - Relief for the next six months likely to cost $1–2 billion. - Initial estimates put total reconstruction costs at $5–10 billion over the next five to ten years. - So far, international aid pledges amount to $1.5 billion. - Macroeconomic impact: - The affected region accounts for a small fraction of national GDP, but economic activity in those areas was virtually wiped out. - GDP growth in 2005/06 could be at least 0.5 percent lower compared with the 7 percent projected prior to the earthquake. - Relief and reconstruction may add pressures on prices of nontradable goods (e.g., cement and construction materials). - Fiscal and external implications: - The fiscal deficit could be ½ to 1 percent of GDP higher than budgeted in 2005/06. - Government initial allocation for 2005/06: PRs 5 billion (less than 0.1 percent of GDP), to be increased as needs are assessed. - Reconstruction needs will put pressure on the fiscal position; new grant pledges and additional loans from multilateral development banks expected to help finance some costs. - Staff accepts some widening of the fiscal deficit seems warranted and unavoidable; monetary policy should focus on containing inflation and supporting the external position. - Authorities considering whether to request Emergency Natural Disaster Assistance from the Fund. ### Data, statistics, and dissemination - Monetary and balance of payments statistics: - Monetary statistics framework based on IMF Guide to Money and Banking Statistics (December 1984); classification broadly in line with the Monetary and Financial Statistics Manual (MFSM). - Balance of payments broadly in accordance with BPM5; SBP commenced publishing BPM5-based BOP on its website. - Data shortcomings and plans: - Fiscal data suffer from a large statistical discrepancy; government expenditure data by economic classification not available. - Quarterly national accounts incomplete; FBS preparing compilation of quarterly GDP data and considering rebasing to 2004/05. - Staff encourages continued implementation of ROSC recommendations and steps to subscribe to the Special Data Dissemination Standard. - Selected data dissemination indicators (as of September 22, 2005): - Exchange Rates: latest observation 7/30/04; frequency D. - Reserve/Base Money: latest observation 6/30/05; frequency M. - Consumer Price Index: latest observation July 2005; frequency M. - Central government revenue/expenditure: latest observation 2004/05; frequency A. *Source: IMF staff report for Pakistan (2005 Article IV Consultation); Supplementary Information; Ex Post Assessment excerpts from _cr05409.* ### 2005. The impact of this tragic event and possible implications for economic policy ### 2005. The impact of this tragic event and possible implications for economic policy ### Executive Summary — Main findings and outlook - Macroeconomic performance continues to be strong, but inflationary and external pressures are evident. - Real GDP growth reached 8.4 percent in 2004/05 (July–June) and is expected to remain high. - Inflation: 12‑month inflation reached 11 percent in April 2005, before easing to 8.4 percent in August 2005. Core inflation has remained at 8 percent in 2005. - External sector: Rapid import growth moved the current account into deficit during 2004/05 despite higher workers’ remittances. - Poverty and social indicators: Indicators point to progress toward poverty reduction; high growth, including in agriculture, is estimated to have raised disposable incomes. Further increases in health and education spending are needed to achieve the Millennium Development Goals. - Medium‑term outlook: Favorable, conditional on substantial increases in investment (including private investment) and continued implementation of reforms. - Vulnerabilities: Debt dynamics are favorable and international reserves are adequate; the financial sector has strengthened and standard stress tests show resilience. - Structural reform progress: Sale with management control of 26 percent of the public telecommunication company; other privatizations under way; energy sector reforms lag. ### Recent economic developments — growth, inflation, external indicators - Growth and composition: - Real GDP at factor costs (annual changes in percent): 2000/01 = 1.8; 2001/02 = 3.1; 2002/03 = 4.8; 2003/04 = 6.4; 2004/05 = 8.4; 2005/06 (proj.) = 7.0. - Growth in 2004/05 driven by strong domestic consumption and investment demand; manufacturing growth continued, partly export driven; timely rains contributed to bumper harvests. - Prices and monetary conditions: - Consumer prices (period average) (annual changes in percent): 2000/01 = 4.4; 2001/02 = 2.5; 2002/03 = 3.1; 2003/04 = 4.6; 2004/05 = 9.3; 2005/06 (proj.) = 9.0. - Asset prices and markets: Equity prices rose substantially over 3½ years before a correction in early 2005; a 65 percent increase during the first 2½ months of 2005 appears speculative; the market corrected by 25–30 percent in March 2005 and then stabilized (P/E ratios of around 12). - External sector and reserves: - Current account excluding official transfers (percent of GDP): 2000/01 = -2.7; 2001/02 = 0.1; 2002/03 = 3.8; 2003/04 = 1.4; 2004/05 = -1.6; 2005/06 (proj.) = -2.5. - Gross reserves (in millions of U.S. dollars): 2000/01 = 1,679; 2001/02 = 4,330; 2002/03 = 10,251; 2003/04 = 10,621; 2004/05 = 9,985; 2005/06 (proj.) = 12,006. - Reserves in months of next year imports of goods and services: 2000/01 = 1.7; 2001/02 = 3.7; 2002/03 = 6.4; 2003/04 = 5.2; 2004/05 = 4.1; 2005/06 (proj.) = 4.5. - External competitiveness and exchange rate: - The exchange rate is described as floating but recently followed the U.S. dollar very closely. - The real effective exchange rate appreciated slightly in early 2005; competitiveness is not judged a concern so far. ### Fiscal and monetary policy stance — recent actions and recommended adjustments - Fiscal outcomes and indicators: - Revenues (including grants) (percent of GDP): 2000/01 = 14.3; 2001/02 = 16.1; 2002/03 = 17.4; 2003/04 = 14.9; 2004/05 = 14.0; 2005/06 (proj.) = 13.2. - Tax revenues (percent of GDP): 2000/01 = 10.6; 2001/02 = 10.9; 2002/03 = 11.5; 2003/04 = 11.1; 2004/05 = 10.0; 2005/06 (proj.) = 9.9. - Collected by Central Board of Revenues (percent of GDP): 2000/01 = 9.4; 2001/02 = 9.2; 2002/03 = 9.5; 2003/04 = 9.4; 2004/05 = 9.0; 2005/06 (proj.) = 9.1. - Expenditures (including statistical discrepancy) (percent of GDP): 2000/01 = 17.6; 2001/02 = 19.7; 2002/03 = 18.7; 2003/04 = 16.7; 2004/05 = 17.1; 2005/06 (proj.) = 16.8. - Budget balance (excluding grants) (percent of GDP): 2000/01 = -4.3; 2001/02 = -5.5; 2002/03 = -3.8; 2003/04 = -2.3; 2004/05 = -3.3; 2005/06 (proj.) = -3.8. - Monetary policy and interest rates: - The State Bank of Pakistan (SBP) raised policy rates substantially since early 2005. - Key interest rates remain slightly negative in real terms; monetary growth remains high and further increases in interest rates seem warranted. - Monetary tightening and government measures to increase food imports (including from India) helped ease inflation from 11 percent to 8.4 percent between April and August 2005. - Recommended fiscal adjustments: - A modest tightening of fiscal policies relative to the budget is recommended to alleviate demands on monetary policy. - Some additional revenue effort and tight expenditure control could contain the deficit at last year’s level. - Better revenue performance is needed to achieve medium‑term fiscal objectives and to raise social and development spending while reducing the debt‑to‑GDP ratio. - Immediate priorities: enhance compliance of existing taxpayers and quickly develop a strategy to extend the tax net into the service and agriculture sectors. ### Vulnerabilities, debt, and financial sector - Debt and reserves: - Debt‑to‑GDP ratios have improved sharply over recent years. - International reserves are judged adequate by staff benchmarks and comparison with peers. - Financial sector soundness: - The financial sector has strengthened; financial soundness indicators improved and standard stress tests show resilience. - Private sector credit growth accelerated in 2002–05, but provisioning and regulatory measures have been introduced (including additional provisioning requirement for consumer credit). - Exchange rate and external risk: - De facto exchange rate arrangement classified as floating; recent close tracking of the U.S. dollar noted. - Assessment indicates no immediate competitiveness concern despite slight real effective exchange rate appreciation in early 2005. ### Structural reforms, governance, and implementation challenges - Privatization and public enterprise reform: - Sale (with management control) of 26 percent of the public telecommunication company was the largest transaction to date. - Sale of several other important companies is under way; list of companies to be privatized expeditiously approved. - Energy sector: - Energy sector reforms are taking longer than envisaged; unbundling of power utility has progressed but regional tariff framework remains outstanding. - The energy sector continues to pose a large drain on the budget. - Governance and institutional capacity: - Weak governance in some public sector institutions remains a problem and slows implementation of reforms. - Progress was slower where broader institution building or cooperation from lower levels of government was needed (e.g., tax collection, energy). - Policy implementation highlights (Text Table 1 summary): - Debt reduction and limiting interest/exchange rate risk progressed; domestic borrowing remained mainly short term (less than 1 year), external borrowing largely concessional. - Revenue mobilization remains a shortfall: tax‑to‑GDP ratio fell in 2004/05 and projected flat in 2005/06. - Monetary policy tightened significantly; financial sector reforms advanced (AML/CFT law approved by Cabinet; Debt Office functional and debt policy being developed). - Medium‑term budget framework pilot rolled out to two line ministries; statistical improvements in progress but gaps remain (quarterly national accounts incomplete; fiscal data problems persist). ### Specific market and regulatory developments — stock market episode - Stock market boom and correction: - Equity prices rose substantially over the last 3½ years prior to the March 2005 correction. - A 65 percent increase during the first 2½ months of 2005 appears speculative. - The market corrected by 25–30 percent in March 2005; since then the market stabilized and remained up substantially on the year (P/E ratios of around 12). - Regulatory response: - Inquiry found abuses of the badla facility and group accounts that bypassed margin requirements. - Badla financing replaced with a “continuous funding system” requiring more due diligence by the creditor; group accounts prohibited. ### Key policy recommendations (staff view) - Short run: - Tighten macroeconomic policies somewhat to counter inflationary and external pressures: further tighten monetary policy (raise interest rates) given continued high monetary growth; modest fiscal tightening relative to the budget to reduce pressure on monetary policy. - Contain the 2005/06 deficit through additional revenue effort and tight expenditure control to keep it at last year’s level. - Medium run: - Strengthen revenue mobilization: enhance compliance of existing taxpayers and develop quickly a strategy to extend the tax net into the service and agriculture sectors. - Sustain and accelerate structural reforms to attract private investment: expedite privatizations, continue public investment to ease bottlenecks in transportation, irrigation, and energy, and address weak governance in public institutions. - Complete energy sector reforms to remove fiscal drains and improve investment climate. - Continue to strengthen financial sector regulation and supervision, and implement follow‑up on FSSA recommendations. *Source: 2005. The impact of this tragic event and possible implications for economic policy (IMF staff report).* ### 5. Despite higher worker’s remittances, ### _cr05409 - 5. Despite higher worker’s remittances, ### External developments and trade - The current account moved into deficit in 2004/05. - Exports and imports have grown rapidly. - Textile exports rose by 15 percent in the first six months of 2005 over the same period in 2004 following the end of the textile quota system. - Faster import growth reflected both higher oil prices and strong demand, including for machinery. - Gross international reserves fell somewhat in 2004/05 to $10 billion (over four months of projected imports), notwithstanding a continued increase in non-debt-creating inflows and substantial concessional financing by the Asian Development Bank and the World Bank Group. - Text Figure indicators (periods and series referenced in source): - Text Figure 4: Trade balance (in percent of GDP, left axis) and International reserves (billions of U.S. dollars, right axis) for 2000/01–2005/06. - Text Figure 5: Total exports, Cotton manufactures, Non-cotton manufactures (2000:1–2005:7; Annual average change in percent). - Text Figure 6: Total imports, Petroleum products, Machinery (2000:1–2005:7; Annual average change in percent). ### Fiscal developments and public debt - The overall deficit (excluding grants) was 3.3 percent of GDP in 2004/05, roughly in line with the budget, but up 1 percentage point over the 2003/04 outcome. - Compared with the budget, a drop in the tax-to-GDP ratio and modestly higher-than-budgeted spending were largely offset by higher nontax revenues. - The Central Board of Revenues (CBR) met its nominal target, but the tax ratio fell because of: - elimination of excises on petroleum products (to offset rising international oil prices), and - a number of tax relief measures. - Higher expenditures occurred mostly on account of defense and provincial development outlays; subsidies also increased, notably to the power utilities. - The Water and Power Development Authority’s (WAPDA) performance deteriorated again because of reduced availability of low-cost hydropower. - Government debt fell substantially to 61 percent of GDP. - Text Figure 7 indicates CBR revenue (right axis), Primary balance (including grants, left axis), and Overall balance (excluding grants, left axis) for 2000/01–2005/06. ### Monetary policy and inflation - The State Bank of Pakistan (SBP) tightened monetary policy significantly. - Inflation went into double digits; capacity utilization rates had reached 80–100 percent in some key industries. - Since the beginning of 2005, the SBP raised the six-month treasury bill (T-bill) rate by more than 4 percentage points to 8 percent in May, and has since kept it broadly unchanged. - Key interest rates still remain slightly negative in real terms. - Despite the tightening, reserve money growth has not yet slowed because the SBP provided substantial budget financing during 2004/05 as the government’s gross financing needs could not be fully met from the market at prevailing rates. - Consequently, monetary aggregates expanded rapidly. - Text Table 3: Capacity Utilization, 2003/04–2004/05 (selected series, in percent): - Edible oil & ghee: Sep. 39.0, Dec. 40.0, Mar. 39.1, Jun. 39.9, Sep. 38.9, Dec. 40.0, Mar. 40.2, Jun. 42.0 - Automobiles: Sep. 52.8, Dec. 59.8, Mar. 62.3, Jun. 67.0, Sep. 53.7, Dec. 58.3, Mar. 59.7, Jun. 65.4 - Electronics: Sep. 35.7, Dec. 40.8, Mar. 50.2, Jun. 59.8, Sep. 19.9, Dec. 22.0, Mar. 27.3, Jun. 31.4 - Cement: Sep. 72.3, Dec. 71.2, Mar. 73.3, Jun. 75.9, Sep. 83.4, Dec. 81.7, Mar. 79.9, Jun. 84.0 - Steel (Pak Steel): Sep. 92.0, Dec. 99.0, Mar. 90.0, Jun. 93.6, Sep. 98.0, Dec. 95.0, Mar. 91.0, Jun. 72.0 - Industrial chemicals: Sep. 83.5, Dec. 86.6, Mar. 87.9, Jun. 88.8, Sep. 95.6, Dec. 96.6, Mar. 97.6, Jun. 98.8 - Paper & paper board: Sep. 99.9, Dec. 98.2, Mar. 97.2, Jun. 97.2, Sep. 98.8, Dec. 99.7, Mar. 101.3, Jun. 100.8 - Text Figure 9: Contributions to Reserve Money Growth, 2000/01–2004/05 (Net foreign asset accumulation; Other; SBP financing of the budget deficit). - Text Figure 10: Monetary Growth, 2000:1–2005:6 (Year-on-year change in percent; Broad money, Private sector credit, Reserve money). ### Structural reforms and privatization - Progress has been made in structural reforms, notably privatization. - In June, the largest privatization transaction in Pakistan’s history occurred: the sale, together with management control, of 26 percent of the Pakistan Telecommunication Company Ltd. The winning bid amounted to $2.6 billion (2¼ percent of GDP). - The sale of several other major companies is under way, including Pakistan Steel and Pakistan Petroleum. - Sale of the Karachi Electric Supply Corporation was delayed as the auction winner did not meet the payment deadline; negotiations continue with the other auction participant. - Energy sector reforms have taken longer than envisaged. Some progress has been made in unbundling WAPDA, but individual distribution companies still cannot operate independently because their tariffs have not been set. ### Growth prospects, risks, and policy recommendations - Key challenges: sustain strong growth over the medium term, improve living standards, and tackle existing and emerging vulnerabilities. - Medium-term growth depends on addressing infrastructure bottlenecks and emerging skill shortages, and improving the investment climate. - Progress on poverty reduction will require further increases in social spending, particularly on health and education. - Raising the revenue ratio is essential to achieving growth, poverty reduction, and debt reduction objectives simultaneously. - Authorities are targeting growth in the 6–8 percent range over the medium term as the minimum to achieve development objectives and substantial poverty reduction. - Public infrastructure investments are needed in transportation, irrigation, and energy. - Reforms to improve the business and investment climate include streamlining the tax and judicial systems, overhauling regulations and procedures, labor reform, automation, e-government solutions, and one-stop shops. - The authorities view regional and global opportunities as promising (improved relations with India, reconstruction of Afghanistan, opening of Gwadar port). - Macroeconomic outlook for 2005/06: - Growth is projected at 7 percent as agricultural contribution returns to a more normal but positive level. - There is weather-related risk to agricultural output and downside risk from high international oil prices. - Many indicators show rising investment; national accounts may understate private investment. - Strong export growth is expected to continue if the textile industry adjusts successfully. - Inflation has settled in the 8–9 percent range; authorities see more signs of an immediate decline than staff. - The current account deficit is projected to widen, in part reflecting oil price increases. - Privatization inflows are expected to boost international reserves to $12 billion by end-2005/06. - Text Table 4: Investment Indicators, 2000/01–2004/05 (In percent of GDP): - Gross capital formation: 17.2, 16.8, 16.9, 17.3, 16.8 - Gross fixed capital formation: 15.8, 15.5, 15.3, 15.6, 15.3 - Government: 2.2, 2.9, 2.7, 2.9, 3.5 - Private: 13.7, 12.6, 12.6, 12.7, 11.8 - Change in inventories: 1.4, 1.3, 1.7, 1.7, 1.6 - Import of machinery: ......, 3.6, 4.4, 5.3 - Foreign direct investment: 0.5, 0.5, 0.7, 0.8, 1.1 - Commercial credit: 14.9, 13.9, 14.8, 17.1, 19.0 - 2005/06 budget: - Targets an increase in the overall deficit to 3.8 percent of GDP, reflecting a drop in nontax revenues only partly offset by expenditure restraint. - CBR revenue is projected to remain almost flat in percent of GDP; tax relief measures for exporters and manufacturing were introduced. - Expenditures envisaged to decline relative to GDP in several categories, including defense and subsidies; development outlays remain unchanged. - Even with the increase in the fiscal deficit, government debt would fall to 53 percent of GDP given a very favorable growth-interest differential and substantial privatization receipts. - Government actions on oil-price pressures: - Significant increases in petroleum retail prices were implemented in September and October. - The government is targeting modestly higher-than-budgeted CBR revenues and has increased nontax revenue projections. - Expenditures will be tightly controlled, with priority to achieving the development spending target. - Staff recommendations and cautions: - Staff called for containing the deficit to last year’s level to alleviate demands on monetary policy; a fiscal impulse seems untimely with the economy close to potential. - Absent containment, T-bill rate increases may be required that could crowd out the private sector, or the SBP might again provide substantial budget financing, adding to inflationary pressures. - Staff projects 12-month inflation at about 9 percent by June 2006, given lags in monetary policy transmission and recent petroleum price pass-through. - Risk that inflationary expectations become ingrained around 10 percent. - With a neutral fiscal stance and suitable monetary tightening, 12-month inflation could come down more quickly and import growth would decelerate more sharply. ### Oil price impact and automatic adjustment mechanism (Box 3) - About 40 percent of Pakistan’s energy consumption is petroleum-related, and virtually all petroleum products are imported. - Rising international oil prices resulted in a current account deterioration of 1 percent of GDP in 2004/05; a similar impact is projected for 2005/06. - The automatic oil price adjustment mechanism has been suspended. Previously, retail prices were adjusted fortnightly according to the import-parity price, generating up to 1 percent of GDP in revenues. - By May 2004, the average levy was zero, and the government had to provide an outright subsidy, in addition to some cross-subsidization between products. - In 2004/05, the fiscal deficit was about 1 percent of GDP higher due to lost revenues and increased subsidies. - Recent retail price increases in September and October largely offset the recent rise in oil prices; no significant additional pressures are expected if WEO oil price projections materialize. - Text Figure 11 shows Petroleum Levies (+) and Subsidies (-), 2003:6–2005:9 (In percent of unit retail price); the weighted series takes into account the relative quantity of each product sold. ### Exchange rate assessment - Staff noted that, based on the Reinhart/Rogoff approach, the Pakistani rupee appears to be de facto pegged to the U.S. dollar (Text Figure 14). - This has led to a minor real appreciation given relatively high domestic inflation (Text Figure 15). - The SBP views the rupee as appropriate or slightly undervalued relative to trading partners and competitors. - Staff agreed the real exchange rate level was broadly appropriate, citing strong export growth, rising market share, small variation of the real effective exchange rate, and a still limited current account deficit partly driven by investment activities. - Text Figure 14: De facto Exchange Rate Arrangement, 1999:5–2005:7 (Using parallel market Pakistani rupee-U.S. dollar exchange rate; 24-month moving average), with explanation of Reinhart/Rogoff classification thresholds. *Source: IMF country report content provided in the input PDF chapter.* ### 20. But staff cautioned that further ### _cr05409 - 20. But staff cautioned that further ### Exchange rate and external competitiveness - Staff cautioned that further real exchange rate appreciation would undermine competitiveness. - Factors raising the need for nominal exchange rate flexibility: - deterioration in the terms of trade, - rapid import growth, - need for incentives for the textile sector. - Policy stance: - SBP reiterated its commitment to exchange rate flexibility but will continue to intervene to prevent excess volatility. - Assessment (Box 4): - Pakistan’s real effective exchange rate has been on a depreciating trend for the last five years, but modest appreciation in the first half of 2005 and a shift of the current account into deficit revived concerns about real exchange rate appropriateness. - Strong export performance and increased market share do not definitively indicate competitiveness because Pakistan is opening to trade and imports have also increased rapidly. - The widening trade deficit has been partly financed by a significant increase in private transfers. - Recent import surge has been fueled in good part by imports of machinery, suggesting cyclical explanations. - Cross-country PPP comparison does not show evidence of misalignment of the Pakistani rupee; bilateral market exchange rates lie mostly within, or close to, the illustrated band of ±1 standard deviation of the PPP exchange rate. ### Debt dynamics and vulnerabilities - Fiscal Responsibility Law: mandates continued debt reduction by at least 2½ percent of GDP per year. - Staff projections (assuming real growth steadies at 6 percent, external and domestic demand remain robust, and the fiscal deficit is restrained below 4 percent of GDP): - domestic and external debt continue on a downward path (Table 8 referenced). - debt reduction trajectory gradually flattens as the growth-interest rate differential narrows. - Ratios and risks: - debt-to-revenues and debt-to-exports ratios remain high due to relatively small government revenues and exports. - rollover and interest rate risks are modest; exchange rate risk comparable to other emerging markets. - debt sustainability tests: public debt path remains on a downward trend with shocks to growth or the primary fiscal balance; a large exchange rate depreciation would raise the debt-to-GDP ratio but it would subsequently return to its downward trend. - Authorities’ scenario: - growth rising to 8 percent in 2008/09, - fiscal deficit reduced to 3.3 percent of GDP in 2009/10 via stronger revenue mobilization. - Staff supported bringing the deficit down to the 2004/05 level as soon as possible but was cautious on revenue projections. - Alternative low-growth scenario: - government debt to GDP would stabilize at the 2005/06 level as lower revenue and higher interest costs push up the deficit. - current account deficit would be somewhat higher, calling for additional commercial borrowing by the government. - projections abstract from policy responses required under the Fiscal Responsibility Law. ### International reserves and reserve adequacy - Authorities considered current international reserves level adequate; argued modest fall in 2004/05 was not concerning because current account deficit largely covered by non-debt-creating flows. - No sustained pressures on the exchange rate; expected further increase in international reserves in 2005/06 due to external privatization receipts. - Staff welcomed sharp reserve increase since 2001; reserves allow Pakistan to catch up with similarly placed countries (Text Figures 17a and 17b). - Text Table 5. Pakistan: Benchmarks for Reserve Adequacy, 2003–04 (In millions of U.S. dollars) - Part A. Kim et al. (2004) - 2003: Imports (A) 4,041; Short-term external debt (B) 5,329; Foreigners' portfolio investment (C) 1,400; International Reserves Predicted (A)+(B)+(C*0.3) 9,790; Actual 10,941 - 2004: Imports (A) 5,061; Short-term external debt (B) 4,898; Foreigners' portfolio investment (C) 1,805; International Reserves Predicted (A)+(B)+(C*0.3) 10,500; Actual 9,799 - Part B. Wijnholds and Kapteyn (2001) - 2003: Short-term external debt (A) 5,329; Fraction of Broad Money 1/(10 percent) Lower range (B-lower) 3,957 Upper range (B-upper) 7,913; Country risk index (C) 0.58; International Reserves Predicted (A)+(B*C) Lower range 7,623 Upper range 9,918; Actual 10,941 - 2004: Short-term external debt (A) 4,898; Fraction of Broad Money 1/(10 percent) Lower range (B-lower) 4,676 Upper range (B-upper) 9,353; Country risk index (C) 0.54; International Reserves Predicted (A)+(B*C) Lower range 7,423 Upper range 9,949; Actual 9,799 - Staff noted importance of using privatization receipts in 2005/06 and beyond to build reserves as Pakistan integrates into the world economy. ### External financing and sovereign issuance - Authorities intend to continue tapping international capital markets once per year to maintain market presence. - Given availability of concessional financing and privatization receipts, Pakistan does not need market financing but seeks to maintain market presence. - Staff cautioned that external bonds should be designed to minimize build-up of rollover, exchange rate, and interest rate risks. ### Financial sector and banking system - Banking sector improvements: - 2004: total assets and customer deposits grew by 20 percent and 22 percent, respectively; gross loans expanded by 38 percent. - Concentration declined: market share of the five largest banks fell to 56 percent from 62 percent in 1997. - Consumer financing now accounts for over 10 percent of loans. - After-tax return on assets reached 1.4 percent in the second quarter of 2005. - Prudential concerns and responses: - Staff questioned whether another increase in the absolute minimum capital requirement was necessary given improving capital adequacy ratio. - Authorities argued some banks were too small and further consolidation was needed. - Staff cautioned that high credit growth may lead to compromised prudential standards; rapid credit expansion has resulted in a rebound in corporate indebtedness. - SBP mandated special provisioning requirements for secured and unsecured consumer financing of 1.5 percent and 5 percent, respectively. - Given improving nonperforming loan ratios, staff recommended tightening specific provisioning requirements to better prepare banks for future problems. - SBP operations and market development: - SBP increased frequency of open market operations and focused on stabilizing overnight rates, reducing volatility in banks’ funding costs. - Staff recommended SBP consider announcing a target band for the overnight rate and gradually replace T-bill rates with the overnight rate as the key intermediate monetary policy target. - Resumption of long-term government bond auctions envisaged in the 2005/06 budget should revive the secondary market and extend government debt maturity. - Banking system FSIs (Text Table 6: In percent; end-period where indicated): - Capital adequacy ratio (CAR): 1997 4.5; 2004 10.5; 2005 10.9 - Gross NPLs to gross loans: 1997 23.6; 2004 11.6; 2005 10.6 - Net NPLs to capital: 1997 183.8; 2004 28.8; 2005 24.1 - After tax return on average assets: 1997 -1.2; 2004 1.2; 2005 1.4 - Noninterest expense to total gross income: 1997 85.2; 2004 51.6; 2005 48.2 - Liquid assets to total assets: 1997 39.5; 2004 36.5; 2005 36.4 - Stress tests (Text Table 7 summary): - Resilience to a regulatory tightening has fallen marginally; vulnerability to a (severe) credit shock broadly unchanged. - Vulnerability to interest rate, exchange rate, or equity price shocks has increased somewhat. - Resilience to a property price crash has improved as reliance on real estate collateral has declined. - Stress test scenario results examples for the 12 largest commercial banks (No. of undercapitalized banks; percent deposit share in parentheses) show banks under various shocks (one-category reclassification of NPLs; 35 percent increase in NPLs; yield curve steepening; 10 percent rupee depreciation; 30 percent stock market decline; 50 percent real estate market decline) with specific impacts tabulated in the source. ### Institutional strengthening and market perception - Authorities have expanded the Debt Office and started developing a debt management strategy. - SBP has established a roadmap for Basel II implementation. - Steps taken to strengthen stock market regulation after excessive speculation in early 2005. - Pakistan’s EMBI+ spread relative to peers suggested markets viewed these developments favorably (Text Figure 19). ### Revenue mobilization and tax policy - CBR revenue declined in percent of GDP in 2004/05 and expected to remain roughly flat in 2005/06, reversing limited gains under the PRGF and curtailing fiscal space for social and development spending. - Authorities argued decline reflected transition costs of streamlining the tax system; staff regretted tax relief measures granted in last two budgets. - Staff concern: exemption from sales tax of the textile value added chain might undermine self-enforcing nature of the system; authorities argue it will increase CBR collection by preventing fraudulent refund claims. - CBR focus: enhance compliance of existing taxpayers; two-thirds of corporate tax filers reported declining or unchanged income in 2004/05, indicating scope to increase collection from existing taxpayers. - Staff recommendations: - Renew efforts to extend the tax net into agriculture and service sectors (including real estate and capital gains) to create a more efficient and equitable tax system and generate resources for social and development expenditures while maintaining fiscal sustainability. - Treat taxation of agriculture and services as part of National Finance Commission discussions on allocating tax revenues. ### Poverty, social spending, and human development - Authorities confident in poverty reduction gains driven by high growth, particularly in agriculture. - Indicators of wages and employment have recently risen significantly. - Pakistan Social and Living Standards Measurement Survey shows improvements in various health and education outcomes (Table 14 referenced). - UN Human Development Index: Pakistan ranked 135th out of 177 countries in 2005, up from 142nd in 2004. - Pakistan Integrated Household Survey results expected later in the year to provide additional poverty reduction information. - Staff cautioned that high inflation, if unchecked, could erode gains. - Staff encouraged authorities to further raise health and education spending: - Achieving Millennium Development Goals remains challenging. - Health and education expenditures still relatively low in international comparison (Tables 15 and 16 referenced). - Health and education spending increased substantially in recent years (Table 17 referenced) but are budgeted to remain broadly unchanged in real per capita terms during 2005/06, partly due to local capacity constraints. - Staff emphasized increasing quality and effectiveness of social spending via implementation of a medium-term budget framework and enhancing administrative and financial capacity at the district level. - Authorities intend to present a revised Poverty Reduction Strategy Paper in 2006. ### Data and statistical issues - Staff believes data are broadly adequate for effective surveillance (see Appendix III referenced). - Remaining data shortcomings: - fiscal data suffer from a large statistical discrepancy; - government expenditure data based on economic classification are not available; - early publication of quarterly national accounts would facilitate within-year analysis. - Staff encourages authorities to continue improving data based on recent ROSC recommendations and to take remaining steps to subscribe to the Special Data Dissemination Standard. *Source: _cr05409 - 20. But staff cautioned that further* ### 34. Pakistan’s economy continues to gain momentum. Reflecting strong domestic and ### _cr05409 - 34. Pakistan’s economy continues to gain momentum. Reflecting strong domestic and ### Economic outlook and growth momentum - Growth is projected to exceed 6 percent for the third consecutive year in 2005/06. - Growth drivers identified: - Strong domestic and external demand. - Rising private transfers, textile exports, and foreign investment. - Context: - Terms of trade have recently been unfavorable. - Security and governance concerns persist. - Some preliminary evidence that poorer segments are benefiting from strong growth. - Caveat: - The growth acceleration has been accompanied by inflationary pressures. - In 2004/05, the current account shifted into deficit. - Historical note: - "In all, macroeconomic performance has been remarkable given that 5–6 years ago the economy was in crisis." ### Ambitions for medium-term growth and constraints - Authorities’ target: "6–8 percent growth" seen as "probably the minimum needed to substantially reduce poverty over the medium term." - Key constraints to growth: lack of physical and human capital. - Policy priorities to support growth: - Ongoing boost in public spending to rectify transportation and irrigation infrastructure shortages is welcome. - Curtailing large energy subsidies and channeling additional resources into development and social spending, especially education and health, would further improve growth prospects. ### Fiscal framework, revenue, and public debt - Assessment: - The medium-term fiscal framework is "broadly appropriate." - Pakistan has reduced vulnerabilities greatly in recent years. - Key public and external debt indicators are projected to continue improving, though some remain very high by emerging market standards. - Staff welcomes approval of the Fiscal Responsibility Law providing framework for continued debt reduction while raising social expenditures. - Revenue challenge: - "Tax buoyancy has been a disappointment," partly due to tax relief measures and erosion of the tax base. - Need to bring previously untaxed sectors into the tax net. - The CBR’s focus on enhancing compliance of existing taxpayers is "probably appropriate" for short-term revenue generation. - A strategy to extend the tax net into the service and agriculture sectors needs to be developed in cooperation with the provinces. - Fiscal targets and recent figures (selected from tables): - Fiscal deficit target: 3.8 percent of GDP. - Last year’s level cited: 3.3 percent of GDP. - Revenue (including grants) in 2004/05: 14.0 (percent of GDP). - Expenditure (including statistical discrepancy) in 2004/05: 17.1 (percent of GDP). - Budget balance (excluding grants) in 2004/05: -3.3 (percent of GDP). - Total government debt in 2004/05: 61.1 (percent of GDP); projected 2005/06: 53.3 (percent of GDP). ### Monetary policy, inflation, and short-term risks - Short-term macro risks to manage: - Inflation "is still in the high single digits, with monetary growth yet to slow." - Without a rapid increase in exports, continued import growth at the current pace could result in an unsustainably high current account deficit. - Recommended stance: - "A modest tightening of monetary and fiscal policies is therefore needed." - SBP has put achieving low inflation at top of its agenda and "has raised interest rates significantly." - Rates should continue to be increased until lending and T-bill rates are "firmly positive in real terms" and there is evidence that inflationary pressures are abating. - Fiscal measures: additional pass-through of oil price increases (including reinstating the automatic fuel price adjustment mechanism), some limited further effort on the revenue side, and expenditure restraint. - These measures could keep the deficit to "last year’s level of 3.3 percent of GDP" and avoid too much burden falling on monetary policy. ### External competitiveness and exchange rate - Assessment: - Exchange rate policy has "served Pakistan relatively well"—contributed to strong export growth and reduced external vulnerabilities with only limited build-up of inflationary pressures. - Despite some minor recent real appreciation, the level of the real exchange rate is "still broadly appropriate." - "There appears to be limited room for further real appreciation." - Recommendation: - "Some nominal exchange rate flexibility could be needed quite soon to protect competitiveness, if the inflation differential is not reduced." ### Structural reforms and sectoral priorities - Structural agenda to pursue forcefully: - Improve governance in all public institutions; governance in key macroeconomic institutions has clearly improved but problems remain in the energy sector, judiciary, and other areas. - Acceleration of privatization program is welcome; expected result: better service delivery and cheaper inputs in key sectors. - Complete reforms of the regulatory and tariff framework for the power sector to allow privatization to start in earnest and ensure competitive, reliable power supply. - Reforms of fiscal reporting and expenditure management should be accelerated; monitor efficiency of expenditures closely. ### Financial sector reforms and vulnerabilities - Progress: - "Impressive financial sector reforms have resulted in a healthier and more competitive banking system." - Remaining concern: - Rapid private sector credit growth could be a future vulnerability. - Policy prescriptions: - Given current strength, tighten provisioning requirements. - Stabilize short-term interest rates and make them the key intermediate monetary policy target; pursue aggressively. ### Social outcomes, poverty, and public spending - Evidence and needs: - "Some reduction in poverty, and improvement in social indicators, appears to have taken place." - Poverty rate (memorandum): 32.1 percent (2000/01). - Unemployment rate: 7.7 percent (2004/05). - Policy implication: - Poverty reduction "needs to be at the top of the policy agenda." - Larger increases in health and education spending than budgeted for 2005/06 and better service delivery at the local level are needed to make substantial progress toward the Millennium Development Goals. ### Exchange restriction on payments for current international transactions - Current status: - "Pakistan maintains an exchange restriction on payments for current international transactions that should be lifted." - Under this restriction, advance payments for certain imports are limited to 50 percent (see Appendix I). - Fund staff position: - Staff is not proposing approval given the lack of a timetable for lifting the restriction, though authorities are working to ease it. ### Debt sustainability and stress tests (selected indicators and scenarios) - External debt ratio and projections (selected): - External government/publicly guaranteed debt in 2004/05: 191.8 (in percent of exports? — figures presented in table context). - Gross external financing need under baseline (table notes): various year-specific figures; baseline gross financing need in narrative boxes: Baseline:6.2; Scenario:5.2; Historical:4.1 (context: likely in percent or absolute—presented unchanged as in source). - Public debt dynamics (selected): - Public sector debt: 1999/00: 83.8; 2004/05: 61.1; 2005/06 (projection): 53.3 (percent of GDP). - Change in public sector debt in 2004/05: -6.8 (percent of GDP). - Identified debt-creating flows and automatic debt dynamics broken out in tables; alternative scenarios and bound tests include a one-time 30 percent real depreciation scenario and combinations of shocks. - Key macro assumptions used in stress tests (presented verbatim): - Real GDP growth baseline projections: 2005/06 onward: 6.0; 6.0; 6.0; 6.0; 6.2 (as shown in tables). - Exchange rate appreciation (US dollar value of local currency, change in percent): various historical and projected values preserved in tables. - Growth of exports (US dollar terms, in percent) and imports presented explicitly in tables for historical and projected years. - Stress-test outcomes highlighted: - Bound and scenario tests reported in tables (e.g., B5 One time 30 percent real depreciation in 2006 shows large increases in debt ratios). ### Operational note and follow-up - It is expected that the next Article IV consultation take place "within the standard 12 month cycle." *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05409.pdf* ### 2004. The staff report (IMF Country Report No. 04/411) was discussed by the Executive ### _cr05409 - 2004. The staff report (IMF Country Report No. 04/411) was discussed by the Executive Board on December 1, 2004. ### IX. Safeguards Assessments - The State Bank of Pakistan (SBP) was subject to a full safeguards assessment under the Stand-By Arrangement that expired on September 30, 2001. - The safeguards assessment, which included a safeguards mission to the SBP, was completed on February 13, 2001. - The staff’s findings and recommendations were reported in IMF Country Report No. 01/58, Appendix IV. - The authorities have implemented all of the recommended remedial measures that were included under SBA conditionality. - No new critical vulnerabilities were identified under Pakistan’s subsequent PRGF Arrangement. ### X. ROSCs - Fiscal Transparency Module 11/28/2000 (refer to www.imf.org) - Fiscal Transparency Module—Update 11/22/2004 IMF Country Report No. 04/416 - Financial System Stability Assessment 6/23/2004 IMF Country Report No. 04/215 - Data Module and Detailed Assessment Using the Data Quality Assessment Framework 11/29/2004 IMF Country Report No. 04/398 ### XI. Recent Technical Assistance - FAD: - January–February 2000: assisted with the revision of fiscal data and advised on measures to strengthen fiscal reporting and accounting systems. - August 2000: joint FAD-STA mission reviewed progress and assisted in preparation of revised fiscal data for 1993/94–1998/99. - September 2000: TA on overhauling the income tax law. - January 2001: advice on priorities and strategies for improving tax collection operations of the CBR. - May 2001: follow-up mission on income tax policy. - August 2001: assisted in preparation of tax administration reforms. - January 2002: advised on fiscal data management, quality, and transparency. - January 2003: assisted in reviewing and preparing tax administration reforms. - March 2003: advised on customs administration reform. - April 2004: advised on improving fiscal reporting at the subnational level. - MFD: - July 2000: joint MFD/MCD mission on transformation to an Islamic-finance-compliant financial system. - September 2000: TA on enhancing market orientation of the foreign exchange market. - February 2001: TA on design of public finance investment compatible with Islamic finance principles. - November/December 2004: joint MFD/World Bank mission on public debt reform. - March/April 2005: TA on development of the insurance sector. - STA: - May/June 2000: mission reviewed compilation of data most important for program design and monitoring. - July 2000: follow-up mission developed time-bound measures to improve national accounts statistics. - January 2001: expert provided advice and training to the Federal Bureau of Statistics for a three-stage development of producer price indices. - February 2002: mission reviewed external sector statistics and advised on steps to subscribe to the SDDS. - April/May 2005: mission provided TA on national accounts and consumer price statistics. - LEG: - May/July 2001: LEG consultant assisted in preparation of the new income tax law, promulgated in September 2001. ### XII. Resident Representative - A resident representative has been stationed in Islamabad since August 1991. ### APPENDIX II — Pakistan: Relations with the World Bank Group - Pakistan’s Poverty Reduction Strategy Paper (PSRP) for 2002/03 to 2007/08 completed in December 2003; Bank-Fund Joint Staff Assessment (JSA) discussed by IMF Board on March 8, 2004 and World Bank Board on March 11, 2004, endorsed the PRSP. - Fund leads policy dialogue on macroeconomic policies; World Bank complements with structural reform and sector investments (power, oil and gas, transport, water, banking). - World Bank Group assistance objective: help Pakistan reduce poverty by supporting the government’s Poverty Reduction Strategy. - Program priorities: (a) strengthen macroeconomic stability and government effectiveness; (b) improve business environment for growth; (c) improve equity via pro-poor and pro-gender equity policies. - CAS presented June 11, 2002; CAS Progress Report presented April 20, 2004; new CAS for FY2006-2009 being prepared. - World Bank lending program features development policy lending, support for public expenditure management, tax administration reforms, safe and sound banking, efficient public utilities, and structural fiscal and governance reforms. - Specific approvals and projects: - Tax Administration Reform Project approved in FY 2005. - Project to Improving Financial Reporting and Auditing (PIFRA) II approved in September 2005. - Structural and sector adjustment credits for Punjab, Sindh and NWFP. - First Poverty Reduction Support Credit approved in September 2004. - World Bank Group support to social sectors: education, public health, maternal and child health, family planning; provincial and local government capacity building emphasized. - Rural sector support: community-based infrastructure (water supply and sanitation), irrigation investment projects, micro-credit, Community Infrastructure and Services Project (CIP), Pakistan Poverty Alleviation Fund (PPAF); follow-on PPAF, CIP and on-farm water management projects approved in FY 2004. - IBRD and IDA approvals since 1952: - 88 loans totaling $7,372.7 million (IBRD). - 125 credits totaling $8,501.2 million (IDA). - Since 2003, Bank lending totaled $2,088.3 million. - As of July 30, 2005: 169 outstanding IBRD and IDA loans and credits representing a total obligation of $9,070 million. - World Bank active portfolio in Pakistan: 17 lending operations with a total commitment of $1,089 million, of which $874 million is undisbursed. - Disbursements: - In 2004/05, $984 million were disbursed. - For 2005/06, a disbursement of $936 million is expected. ### APPENDIX II — Table 1 highlights (Pakistan: World Bank Lending FY 2003–05) - Projects, fiscal year, approved amount, and disbursed amounts (in millions of U.S. dollars, as of Sep 30, 2005) include: - Community Infrastructure & Services 2003: 20.0 approved, 8.2 disbursed - Banking Sector Technical Assistance 2003: 26.5 approved, 14.2 disbursed - Sindh Structural Adjustment Credit 2003: 100.0 approved, 106.4 disbursed - NWFP Structural Adjustment Credit 2003: 90.0 approved, 95.8 disbursed - Partnership for Polio Eradication 2003: 20.0 approved, 20.0 disbursed - HIV/AIDS Prevention Project 2003: 37.1 approved, 8.2 disbursed - National Education Assessment System 2003: 3.6 approved, 0.5 disbursed - Highways Rehabilitation 2004: 200.0 approved, 25.2 disbursed - Poverty Alleviation Fund II' 2004: 238.0 approved, 84.1 disbursed - Punjab Education Reform Program 2004: 100.0 approved, 100.6 disbursed - Sindh On-Farm Water Management Project 2004: 61.1 approved, 2.9 disbursed - NWFP Community Infrastructure II (CIP2) 2004: 37.1 approved, 2.1 disbursed - PK Public Sector Capacity Building Project 2004: 55.0 approved, 10.5 disbursed - NWFP SAC II 2004: 90.0 approved, 90.0 disbursed - Poverty Reduction Support Credit I 2005: 300.0 approved, 300.0 disbursed - Tax Administration Reform Project 2005: 102.9 approved, 3.1 disbursed - Banking Sector Development Policy Credit 2005: 300.0 approved, 300.0 disbursed - Taunsa Barrage Emergency Rehabilitation 2005: 123.0 approved, 3.1 disbursed - Punjab Education Reform II 2006: 100.0 approved, 100.0 disbursed - Improving Financial Reporting and Auditing II 2006: 84.0 approved, 0.0 disbursed ### Bank-Fund collaboration in specific areas - Financial sector reforms: - Transformation from predominantly state-owned banking to a healthier, market-based system primarily privately owned. - Strengthening legal and regulatory environment, transparency, corporate governance, and credit culture. - Support via Technical Assistance to the Banking Sector project, Banking Sector Restructuring and Privatization Project (FY 2002), and Banking Sector Adjustment Credit (FY 2005). - Joint World Bank/Fund Financial Sector Assessment Program (FSAP) completed in FY 2004. - Power sector reforms: - PRGF arrangement conditionality included energy tariff adjustments and other power sector reforms to reduce fiscal burden. - World Bank led unbundling and corporatization of WAPDA with aim to privatize generation and transmission. - Support for comprehensive medium-term adjustment program to improve electric services at lower cost and higher reliability. - Planned investment lending to focus on modernization of distribution systems to improve efficiency and reduce technical losses. - Public expenditure management: - World Bank supports reform program to improve timeliness and accuracy of financial reporting and auditing and overall accountability. - Support through PIFRA project; follow-on PIFRA II to continue modernization of national accounting and audit systems. - Analytical support: Country Financial Accountability Assessment (CFAA) completed in FY 2003; provincial financial accountability assessments for Sindh, Punjab, and NWFP. - Policy measures on financial management included as prior actions for World Bank structural adjustment lending. - Procurement reforms supported through TA and development policy lending. - Tax policy and administration reforms: - Fund led tax policy reforms; income tax reform package effective July 1, 2002. - Program launched for fundamental restructuring of the Central Board of Revenues (CBR) to improve tax administration efficiency; supported by both World Bank and Fund. - PRGF structural performance criteria included adoption of tax policy changes and implementation of CBR reform. - World Bank tax administration reform project approved in FY 2005 to support CBR reforms. ### APPENDIX III — Pakistan: Statistical Issues - Data adequacy and reporting: - Staff believes data reporting and accounting procedures are broadly adequate for effective surveillance and program monitoring. - Authorities provide routine monthly data on external trade, prices, federal government expenditures and tax revenues, government bank borrowing, and money. - Daily data via resident representative’s office on international reserves, exchange rates, and the Karachi Stock Exchange index. - A data ROSC was published in December 2004; follow-up STA TA missions have assisted in addressing key recommendations. - GDDS and SDDS participation: - Pakistan has participated in the General Data Dissemination System (GDDS) since 2003. - Pakistan meets recommendations for coverage, periodicity, and timeliness of most GDDS data categories, except timeliness of GDP and lack of annual data on wages/earnings. - For subscription to the Special Data Dissemination Standard (SDDS), Pakistan will need to disseminate: - (a) monthly analytical accounts of the SBP with a timeliness of two weeks; - (b) monthly transaction data on central government operations with a timeliness of one month; - (c) quarterly data on the national accounts, employment, unemployment, wages/earnings, and external debt, all with a timeliness of one quarter; - (d) more detailed breakdown of data on central government debt and external debt; - (e) annual data on its international investment position; - (f) update and expand the metadata on compilation and dissemination practices. - National accounts and rebasing: - FBS completed a revision of national accounts to align with the 1993 System of National Accounts (1993 SNA); base year moved from 1980/81 to 1999/2000. - FBS intends to carry out another rebasing for 2004/05 and is preparing compilation of quarterly GDP data. - IMF Quarterly National Accounts (QNA) mission visited Pakistan in April–June 2005 to assist development of QNA and advise on dwelling rent component of the CPI. - Quarterly data sources are limited; considerable use is made of forecasts and quarterly allocations in line with production calendars. - Mission identified deficiencies in annual compilation methods and provided recommendations. - FBS is investigating feasibility of compiling quarterly employment/unemployment data and disseminating data on wages/salaries. - Price indices: - FBS produces CPI, WPI, and sensitive price indicator (SPI). - CPI and WPI compiled monthly; SPI compiled weekly and consists of 46 essential commodities for the lowest income group. - Plans to introduce COICOP classification and complete development of a Producer Price Index (PPI) with base year 1999/2000; IMF mission provided advice. - Government Finance Statistics (GFS): - GFS lack data on general government finances due to inadequate reporting by provinces and local governments. - Concepts and definitions broadly based on A Manual on Government Finance Statistics, 1986 (GFSM 1986), except treatment of privatization proceeds resembles GFSM 2001 methodology. - Scope of GFS is budgetary central government; extra-budgetary funds not covered. - Classification and sectorization follow GFSM 1986 standards only to a limited extent; institutional sectors not explicitly defined. - Local governments included with provincial governments; classification of expenditure mixes economic and functional classifications. - Basis of recording GFS is on, or close to, a cash basis; transactions recorded on a gross basis. - Corrective transactions are not necessarily made in the original period, as required by GFSM 1986. - Plans for GFS improvement are taking place within the Project for the Improvement of Financial Reporting and Auditing (PIFRA). - No specific plans to migrate to GFSM 2001, but MOF will consider adopting GFSM 2001 in the long term. *IMF Country Report No. 04/411 (staff report discussed December 1, 2004).* ### 6. The analytical framework for monetary statistics reflects concepts and definitions that ### _cr05409 - 6. The analytical framework for monetary statistics reflects concepts and definitions that ### Monetary statistics framework and plans - The analytical framework for monetary statistics is based on the IMF’s Guide to Money and Banking Statistics in International Finance Statistics of December 1984. - The scope of the monetary statistics is comprehensive. - The classification and sectorization of the monetary survey compiled by SBP’s Statistics Department for reporting to the IMF and for internal use are broadly in line with the Monetary and Financial Statistics Manual (MFSM). - The basis for recording flows and stocks is largely consistent with MFSM and the SBP will continue to adopt the MFSM in order to further improve monetary statistics. - SBP planned actions: - (a) disaggregate data on nonfinancial corporations and households within the private sector; - (b) collect data on nonbank financial institutions to expand the coverage of the monetary aggregates; and - (c) disseminate the analytical accounts of the SBP within two weeks after the end of the reference month. ### Balance of payments statistics: concepts, coverage, and issues - Pakistan’s balance of payments statistics are compiled broadly in accordance with the concepts and definitions of the Balance of Payments Manual, Fifth Edition (BPM5). - Presentation and dissemination: - The presentation of the balance of payments on the web and in SBP publications remained mostly based on BPM4, though SBP had commenced publishing the balance of payments based on BPM5 on its website. - Scope and residency exceptions: - In general, the scope of the balance of payments pertaining to residency conforms to BPM5. - Exceptions include enterprises operating in the export processing zones and offshore banks, which are regarded as nonresidents. - Pakistani nationals residing abroad but owning a dwelling in Pakistan are considered residents. - Classification and recording: - Classification and sectorization systems follow BPM5 to some extent. - The basis for recording transactions follows best international practices. - Identified shortcomings from the 2004 ROSC: - Treatment of oil exports under product sharing agreements. - Estimation of reinvested earnings. - Absence of revision studies. - Developments: - International investment position data are now compiled. - SBP planned actions for the external sector: - (a) continue the implementation of BPM5; and - (b) disseminate the metadata for the template on International Reserves and Foreign Currency Liquidity on the SBP website. ### Data dissemination and data quality indicators (selected points from Table of Common Indicators as of September 22, 2005) - Exchange Rates: - Date of latest observation: 7/30/04 - Date received: 9/30/04 - Frequency of data: D - Frequency of reporting: D - Frequency of publication: D - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: - Reserve/Base Money: - Date of latest observation: 6/30/05 - Date received: 7/28/05 - Frequency of data: M - Frequency of reporting: M - Frequency of publication: M - Data Quality – Methodological soundness: LO, O, LNO, LO - Data Quality – Accuracy and reliability: LNO, LO, O, O, O - Broad Money: - Date of latest observation: 6/30/05 - Date received: 7/28/05 - Frequency of data: M - Frequency of reporting: M - Frequency of publication: M - Central Bank Balance Sheet: - Date of latest observation: 6/30/05 - Date received: 7/28/05 - Frequency of data: M - Frequency of reporting: M - Frequency of publication: M - Interest Rates: - Date of latest observation: June 2005 - Date received: 7/06/05 - Frequency of data: M - Frequency of reporting: M - Frequency of publication: M - Consumer Price Index: - Date of latest observation: July 2005 - Date received: 9/14/05 - Frequency of data: M - Frequency of reporting: M - Frequency of publication: M - Data Quality – Methodological soundness: O, LO, LO, O - Data Quality – Accuracy and reliability: O, LO, O, O, O - Revenue, Expenditure, Balance and Composition of Financing – Central Government: - Date of latest observation: 2004/05 - Date received: 8/01/05 - Frequency of data: A - Frequency of reporting: A - Frequency of publication: A - Data Quality – Methodological soundness: LO, LO, LNO, LO - Data Quality – Accuracy and reliability: O, O, LO, LO, LO - External Current Account Balance: - Date of latest observation: Aug 2004 - Date received: 9/10/04 - Frequency of data: M - Frequency of reporting: M - Frequency of publication: M - Data Quality – Methodological soundness: LO, LO, LO, O - Data Quality – Accuracy and reliability: O, O, O, O, LNO - GDP/GNP: - Date of latest observation: 2003 - Date received: 8/27/04 - Frequency of data: A - Frequency of reporting: A - Frequency of publication: A - Data Quality – Methodological soundness: LO, LNO, LO, LO - Data Quality – Accuracy and reliability: LNO, LNO, O, LNO, O - Gross External Debt: - Date of latest observation: Q4 2003/2004 - Date received: 8/27/04 - Frequency of data: Q - Frequency of reporting: Q - Frequency of publication: Q ### Earthquake (October 8, 2005) — economic impact and policy implications (from Supplementary Information) - Human and immediate relief needs: - Earthquake magnitude: 7.6 on the Richter scale. - Death toll estimated to exceed 54,000. - Over 70,000 people were injured. - Nearly 4 million people are affected in terms of loss of shelter and public amenities. - Relief for the next six months (tents, medical aid, helicopters, etc.) is likely to cost $1–2 billion. - Initial estimates put total reconstruction costs at $5–10 billion over the next five to ten years. - So far, international aid pledges amount to $1.5 billion. - A U.N. sponsored donor conference took place on October 26. - A high-level conference on reconstruction was expected to take place in Islamabad on November 19. - Macroeconomic impact and projections: - The affected region accounts for a small fraction of national GDP, but economic activity in those areas was virtually wiped out. - GDP growth in 2005/06 could be at least 0.5 percent lower compared with the 7 percent projected prior to the earthquake. - Relief and reconstruction efforts may add pressures on prices of nontradable goods (e.g., cement and construction materials), with little impact on food prices because of ample stocks. - Over the medium term, reconstruction of fixed assets may have a positive impact on growth. - Fiscal and external implications: - The fiscal deficit could be ½ to 1 percent of GDP higher than budgeted in 2005/06. - Government initial allocation for 2005/06: PRs 5 billion (less than 0.1 percent of GDP), to be increased as needs are assessed. - Emergency relief mostly provided by the Pakistani army, international agencies, and nongovernmental organizations; in-kind foreign grants and private donations will not be recorded in the budget and will be partly channeled through off-budget funds, such as the President’s Relief Fund. - Reconstruction needs over the next five years will put pressure on the fiscal position, though authorities intend to accommodate part of reconstruction costs within the existing public sector development program allocation. - New grant pledges and additional loans from multilateral development banks expected to help finance some costs. - A possible widening of the external current account deficit in 2005/06 should be largely balanced by additional grants. - Short-run pressures on reserves could emerge if external assistance lags urgent spending needs. - Policy guidance: - Staff accepts that some widening of the fiscal deficit seems warranted and unavoidable in the aftermath of the earthquake. - The additional uncertainties reinforce the need for a monetary policy geared towards containing inflation and supporting the external position. - Staff will work with authorities to prepare a revised macroeconomic framework. - Authorities are considering whether to request Emergency Natural Disaster Assistance from the Fund. ### Recent first-quarter 2005/06 macro developments (selected indicators and trends) - Inflation: - Year-on-year inflation in September was 8.5 percent (about the same as in August). - Revenue and money aggregates: - Central Board of Revenue collection increased by 19 percent in July–September over the same period last year. - Broad money growth slowed to 17½ percent year-on-year at end-August. - Reserve money growth slowed to 15 percent at end-August. - Private sector credit growth remained high at 31 percent. - External sector through July–September: - External current account deficit widened to $1.2 billion in July/August 2006. - Import growth reached 52 percent in July–September over the same period in 2004/05. - Export growth was 19 percent in July–September over the same period in 2004/05. - During July–September, gross official reserves declined by $0.5 billion, to $9.5 billion. - Expected multilateral loans, additional grants, and the planned Eurobond issue were expected to help maintain official reserves. - Privatization: - Privatization of the telecommunications company was delayed; the October 28 deadline for completion of the sale of 26 percent was not met. - Authorities considering whether the deal can still be completed; if not, other public assets would be sold to make up part of the shortfall, possibly via Global Depository Receipts. - An agreement was reached with a domestic investor group on the sale of the Karachi Electric Supply Company. *International Monetary Fund — Staff Report for the 2005 Article IV Consultation; Supplementary Information; Ex Post Assessment of Longer-Term Program Engagement (selected excerpts).* ### 3. The Independent Evaluation Office (IEO), in its 2002 report evaluating the ### _cr05409 - 3. The Independent Evaluation Office (IEO), in its 2002 report evaluating the ### IEO assessment of pre-1999 programs and institutional lessons - The IEO (2002) assessed Pakistan’s program performance until 1999 and found limited achievements tied to: - "considerable political and regional instability" - program design and implementation problems, including: - insufficient government ownership of programs - inability to sustain reform and adjustment beyond a short period - overoptimistic macroeconomic assumptions - unrealistic expectations about the pace and breadth of structural reforms - insufficient accounting for limitations in implementation capacity - inadequate prioritization of the reform agenda - Institutional roots of design and implementation problems identified by the IEO: - decisions heavily influenced by (a) geopolitical considerations; (b) difficulty of withholding initial benefit of the doubt to new governments on stated policy objectives; (c) reluctance to disengage when a country faces difficulties; (d) presumption of short- to medium-term involvement only; and (e) collaboration with the World Bank that did not always yield effective integration of priorities and timeframes. - IEO main lesson from Pakistan’s prolonged-use experience: - need for greater selectivity based on a candid assessment of ownership - disengage from a country if necessary - tailor program design to country-specific circumstances and long-term needs - focus on key institutional changes ### Program conditionality (2000–04): scope, focus, and implementation - Evolution and scope - Conditionality became increasingly extensive after 1999. - 2000 SBA and 2001 PRGF augmented quantitative conditionality with: - a floor on Central Board of Revenues (CBR) revenues - a ceiling on accumulation of budgetary arrears to WAPDA - PRGF: limits on SBP’s foreign exchange reserves held with banks and limits on foreign currency swap and forward sales between the SBP and residents - The total of 56 PCs, benchmarks and prior actions in the 2000 SBA versus a Fund-wide average of 19 conditions in GRA-supported programs. - Structural conditionality peaked in the 2000 SBA and was reduced steadily during 2001–04 PRGF as performance improved and the Fund sought to streamline conditionality. - Only in the last program year did the number of structural conditions (15) approach the Fundwide average for PRGF-supported programs (14). - Composition and focus of structural conditionality - Tax system improvement measures dominated conditionality in the 2000 SBA and the 2001 PRGF. - General economic management measures (e.g., budget promulgation consistent with program, exchange rate depreciation) were numerous in the 2000 SBA but declined sharply thereafter. - During the PRGF, conditionality emphasized financial sector reforms and public enterprise reforms aimed at budget savings (aligning NSS yields to market rates, restructuring the energy sector to reduce dependence on budget support). - Implementation performance and waivers - No review of the 2000 SBA or the 2001–04 PRGF was completed without requesting at least one waiver; on average, two waivers were requested per review. - Waiver and implementation statistics (selected): - SBA total conditions (prior actions, structural PCs, structural benchmarks): 56 in the first year (breakdown shown in Table 2 of source). - Waiver rates for quantitative performance criteria: - Pakistan SBA: 10 percent - Pakistan PRGF: 4 percent - Average GRA-supported programs (2001–03): 11 percent - Average PRGF-supported programs (2001–03): 16 percent - Waiver rates for structural performance criteria: - Pakistan SBA: 25 percent - Pakistan PRGF: 45 percent - Average GRA-supported programs (2001–03): 50 percent - Average PRGF-supported programs (2001–03): 42 percent - Lapsed structural performance criteria: - Pakistan: 6 percent not implemented at all - Fund-wide average (2001–03): 14–15 percent not implemented - Implementation rate (including delays and offsets) for Pakistan’s structural performance criteria: 92 percent (SBA), 91 percent (PRGF 1), 100 percent (PRGF 2), 94 percent (entire arrangement) as tabulated in the source. - Waivers often reflected delays rather than outright non-implementation; energy sector measures were particularly prone to delays due to political or technical hurdles. - Implicit waiver rates for structural benchmarks: - Pakistan SBA: 53 percent - Pakistan PRGF: 41 percent - Average GRA (2001–03): 49 percent - Average PRGF (2001–03): 43 percent ### Goals, macroeconomic strategy, and realized outcomes (post-1999 focus) - Program objectives (SBA and PRGF) - 2000 SBA immediate objective: quickly reduce macroeconomic imbalances through tightening fiscal and monetary policy; allow exchange rate to adjust to market forces; pursue structural reforms to enhance growth potential and reduce poverty; establish a track record to enable a medium-term PRGF. - PRGF (approved December 2001) objectives: increase growth, reduce vulnerability to shocks, improve social indicators. - Macroeconomic policies: further fiscal adjustment to reduce public debt, increase revenue intake, reduce transfers to state-owned entities to create room for social spending. - External support and Paris Club rescheduling obtained to alleviate external debt burden. - Monetary policy: aim for low inflation to replenish foreign exchange reserves and reduce external vulnerabilities. - Structural reforms: improve investor confidence and private-sector environment. - Achievements (selected quantitative outcomes) - Real per capita GDP growth: - accelerated from "close to zero" in 2000/01 to "over 6 percent" in 2004/05. - Drivers of growth: - initial rebound in exports with double-digit growth rates - later strong agricultural production due to favorable weather conditions - contribution of total factor productivity to growth increased sharply - investment ratio broadly unchanged at 16–17 percent of GDP since 1999/2000 - domestic demand became main driver of growth by 2004/05 - Current account (excluding official transfers): - shifted from a surplus of "almost 4 percent of GDP" in 2002/03 to a deficit of "almost 2 percent of GDP" in 2004/05 - Fiscal consolidation and public debt: - government debt ratio declined from "almost 90 percent of GDP" in 2000/01 to "60 percent of GDP" in 2004/05 - overall fiscal deficit (excluding grants) declined from "6.6 percent of GDP" in 1999/2000 to "about 3 percent of GDP" in 2004/05 - fiscal consolidation achieved largely via increases in nontax revenues and savings on the interest bill (restructuring of external debts, falling domestic real interest rates) - Social spending and poverty: - social- and poverty-related expenditures were raised by "over 1 percentage point of GDP" over the last three years, or by "over 30 percent in real per capita terms" - however, level of social spending remained "quite low in comparison with other developing countries" - headcount poverty rate had increased from "25 percent" in the early 1990s to "32 percent in 2000/01" (context for the crisis period) - External reserves and import coverage (selected figures and trends noted in Table 4 discussion): - gross international reserves and months of imports improved substantially between 1999/2000 and 2004/05, supporting reduced external vulnerabilities - Observed trade-offs and limits - While goals on raising social spending and reducing the debt burden were realized, the report notes that: - more could have been accomplished with greater progress in raising the tax-to-GDP ratio - more could have been achieved by further reducing transfers to state-owned enterprises ### Structure of the Ex Post Assessment and issues addressed - This report focuses on the post-1999 period and addresses: - description of conditionality in Fund-supported programs during 2000–04 (Section II.A) - economic achievements and areas with limited or absent progress (Section II.B) - main issues in the Ex Post Assessment (Section III), including: - causes of the change in performance after 1999 (Section III.A) - appropriateness of Fund conditionality (Section III.B) - design of the monetary program (Section III.C) - whether Fund-recommended policies helped reduce poverty (Section III.D) - appropriateness of the size of Fund financial support (Section III.E) - whether Fund-Bank collaboration contributed to program success (Section III.F) - whether the Fund’s involvement changed following the 2002 IEO report (Section III.G) - Section IV concludes with lessons for the Fund derived from Pakistan’s experience *Source: IMF Ex Post Assessment (text as provided).* ### 17. External vulnerabilities have ### 17. External vulnerabilities have ### External position and reserves - External public and publicly guaranteed debt declined to 28 percent of GDP by end-2004/05, down from a peak of 45 percent three years earlier. - The balance of payments improved with strong export growth and sizable remittances. - International reserves were rebuilt to cover about five months of imports of goods and nonfactor services. - Reserves covered over 250 percent of short-term external liabilities at end-2004/05 (up from a mere 11 percent in 1999/2000). ### Inflation and monetary policy - Inflation remained low and stable until mid-2003, but began to pick up in the second half of 2003 as the economy started to grow strongly. - The SBP was slow to tighten monetary policy; key policy interest rates have been negative in real terms since 2003. - The 12-month rate of inflation reached double digits in March 2005 for the first time since September 1997 and is currently at 8.4 percent. - Money demand increased steadily as confidence recovered, allowing the SBP earlier to reduce interest rates while inflation stayed in the low single digits. ### Structural reform progress - Notable achievements: - Continued liberalization of trade and the exchange regime after 1999. - Strong progress in financial sector reform: the banking sector is now largely privately owned, more competitive and efficient after restructuring and privatization. - Strengthening of supervision and prudential regulations (as noted in the recent Financial System Stability Assessment, IMF Country Report No. 04/215). - Improvement in banks’ financial soundness indicators and substantial reduction in dollarization. - Strengthened and more taxpayer-friendly tax and customs administration; customs tariffs and tax rates were reduced and rationalized. - Approval of the Fiscal Responsibility Law in 2005, establishing legal targets for reducing the public debt burden and reporting requirements. - Reduced role of the state through an extensive privatization program and improved regulatory frameworks in telecommunications, electricity, and oil and gas. ### What has not been achieved - Tax revenue: - The tax-to-GDP ratio has remained broadly unchanged at about 11 percent since the late 1990s and dipped in 2004/05. - Revenue reforms improved taxation efficiency for existing taxpayers, but the number of taxpayers did not increase enough to raise the tax-to-GDP ratio. - Large parts of the agricultural and services sectors remain outside the tax net. - Quasi-fiscal deficit of public utilities: - Subsidies and net lending to power sector companies have remained well over 1 percent of GDP. - Large technical losses persist; tariffs do not cover cost; allegations of corruption are widespread. - Governance: - Improvements in fiscal and monetary management, the financial sector, and some tax administration areas, but overall governance lags behind most South Asian neighbors. - Corruption is widespread in public service delivery and contributes to power sector losses and the low tax ratio. ### Social outcomes and remaining uncertainties - Poverty: - Despite economic recovery and increased social spending, it is unclear whether poverty has declined; comparable household survey data to 2000/01 will only become available toward the end of 2005. - Average per capita incomes have risen by over 40 percent in U.S. dollar terms since 2000/01. - Agricultural production has increased, but distributional effects in rural areas remain unclear. - Social indicators (selected improvements over 2000/01–2004/05): - Population ever attended school: 51 → 55 (percent). - Gross enrollment at primary level: 72 → 86 (percent). - Literacy (10 years and older): 45 → 53 (percent); Male 58 → 65, Female 32 → 40. - Children aged 12–23 immunized: 53 → 77 (percent). - Treatment of diarrhea in children 5 years and under: 83 → 91 (percent). - Despite higher social spending, levels remain relatively low compared with some countries in the region and some social indicators remain modest compared with other low-income countries. ### Drivers of the post-1999 change - Political economy and ownership: - Pre-2000 weak performance reflected political instability and limited program ownership by eight successive governments. - The 1999 government placed the economy at the top of its agenda; top leadership and experienced technocrats were mobilized to take difficult decisions and address corruption at the top. - External support and its role: - Joining the coalition against terror in September 2001 mobilized considerable external financial support, including grants and Paris Club debt rescheduling on very favorable terms. - International support (including exceptional debt treatment and fresh donor cash) contributed to improvements in fiscal and external positions in 2001/02. - Increase in private transfers (remittances), rather than official support, was the main factor behind the rise in foreign exchange reserves. - The combination of external support and domestic policy adjustment helped restore confidence, lower interest rates, and reduce the domestic interest bill. ### Conditionality and program design assessment - 2000 SBA conditionality: - Structural conditions in the 2000 SBA exceeded Fundwide averages and were not limited to macrorelevant and critical areas. - The broad array of conditions reflected a desire to establish a good track record after weak prior performance; many structural benchmarks and quantitative performance criteria were emphasized. - The 2000 SBA succeeded in establishing a track record, but the extent of conditionality created the impression among some officials that the program was punitive. - 2001 PRGF arrangement: - Conditionality became more parsimonious and was publicly claimed by the government as its own program. - Focused on three critical areas: (a) strengthening the tax system and expenditure management; (b) increasing the role of markets in the financial system; and (c) improving the performance of state-owned enterprises and governance, notably in the energy sector. - Effectiveness and limits of conditionality: - While tax and energy sector reforms were critical ex ante, many individual structural conditions were not clearly critical, tailored, or fully owned—particularly those requiring provincial cooperation (e.g., taxing agricultural incomes). - Performance shortfalls: revenue intake did not increase as planned, and transfers to the energy sector remained large. - Policy implementation constraints reflected political resistance from interest groups and lack of ownership at lower levels of government. ### Implicit policy priorities and recommendations reflected in the analysis - Prioritize broadening the tax base—especially in agriculture and services—to raise the tax-to-GDP ratio above about 11 percent. - Address quasi-fiscal deficits in the power sector to reduce subsidies and net lending well over 1 percent of GDP. - Strengthen governance and anticorruption measures to improve public service delivery, recover utility revenues, and support tax collection. - Maintain prudential monetary policy responsiveness to rising inflation to avoid prolonged negative real interest rates. - Ensure structural conditionality is parsimonious, critical, tailored, and owned at all government levels to improve implementation success. *Source: IMF staff report excerpt (chapter/section 17 and related sections).* ### 36. Political constraints also prevented the government from moving faster and ### _cr05409 - 36. Political constraints also prevented the government from moving faster and ### Power sector reforms and conditionality - Political constraints prevented the government from moving faster and more decisively on power sector reforms. - Electricity tariffs and bill collection remained among the most difficult political issues. - Tariffs have been raised over the past decade, but not enough to cover rising costs or needed investment to repair and expand the system. - Heavy Fund conditionality in the energy sector reflected limited success of the World Bank’s efforts to push reforms. - With the World Bank stepping back at the time, energy sector conditionality was included in the SBA and PRGF to reduce the large drain posed by this sector on the budget. - Progress noted: - Putting up KESC for sale. - Break-up of WAPDA. - Design of a new tariff and subsidy regime. - Persistent problems: - Technical losses in the system remained high. - Tariff collection weak. - Overall sector performance did not improve much. - Conclusion: Conditionality was not sufficiently tailored to address the sector’s deep-rooted problems; reform is a long-term process with limited scope for quick results within a program’s horizon. ### Structural conditionality and institutional constraints - Fund structural conditionality focused mostly on: - Tariff structures. - Financial performance of companies. - Privatization. - Conditions were often met but mostly after delays; slippages were frequently granted waivers and not deemed serious enough to interrupt programs. - Structural reforms requiring long-term institution building and cooperation beyond the central government were ill-suited to Fund structural conditionality. - Approaches tried in tax and energy areas included: - Developing broad sectoral plans. - Large numbers of detailed measures. - Setting quantitative targets for tax collection or quasi-fiscal deficits. - Lack of adequate World Bank involvement and full government ownership at all levels led to failure of these approaches to deliver. ### Monetary program design and performance - The monetary program used the standard approach: floors for net international reserves (NIR) and ceilings for net domestic assets (NDA) of the central bank. - Post-September 11 large capital inflows (notably unexpectedly high private transfers) facilitated overperformance on the NIR target; NDA target met through partial sterilization. - Monetary growth accelerated in 2001/02, leading to strong credit growth and a pickup in inflation as the exchange rate was not allowed to appreciate substantially and sterilization was reversed. - Key questions raised: - Should staff have insisted on greater exchange rate flexibility to contain inflation? - Should the program have set ceilings for reserve money rather than NDA? ### Exchange rate, competitiveness, and reserve money targeting - Assessment found no evidence of a real exchange rate undervaluation; the 2003–04 real exchange rate levels appeared broadly consistent with a sustainable balance. - The CPI-based real effective exchange rate (REER) had, on average, been depreciating by about 1 percent per year since mid-1990s, partly explaining strong export growth in 2001–04. - Argument: Had reserve money been a performance criterion together with an NIR floor, monetary expansion could have been contained through more aggressive sterilization and higher interest rates, entailing greater exchange rate flexibility and less reserve build-up. - Political economy: Such an option lacked ownership given authorities’ objectives to establish a strong reserve position, preserve competitiveness, and keep interest rates low. - The root of the acceleration of inflation was attributed to the authorities’ emphasis on growth over control of inflation. ### Timeline of monetary developments and drivers of expansion - In August/September 2003, authorities and staff believed in a structural upward shift in money demand; inflation remained below 2 percent in June–August 2004. - Fiscal policy aimed to save the bulk of official grants or allocate them to development expenditures while containing other expenditures. - Since mid-2003, monetary expansion became driven by domestic sources rather than capital inflows. - SBP policy shift: slowed accumulation of reserves and cut sterilization operations starting in 2003/04. - NDA became the source of monetary expansion as the central bank began financing the budget when commercial banks were no longer willing to roll-over treasury bills as interest rates were held negative in real terms. - Private sector credit growth acceleration: from 2.5 percent of the initial broad money stock in 2002/03 to 14.3 percent in 2003/04. - By late 2003 staff were concerned about steady inflation increases; authorities preferred not to tighten monetary policy to avoid choking off growth momentum, viewing inflation increases as largely temporary supply-side factors (notably rise in the wheat support price). - Only in 2005 did the central bank start tightening monetary policy more forcefully, though interest rates remained negative in real terms. ### Program targets, hindsight, and staff advice - In retrospect, NDA targets were insufficiently restrictive given the acceleration of inflation since June 2003. - At program design, inflation was below the program target of 5 percent until March 2004; quantitative targets for the last PRGF review were set in August/September 2003. - From December 2003 staff consistently advised authorities to tighten monetary policy by raising interest rates faster. - The program design was judged justified ex ante due to: - Evidence on program ownership. - Conservative velocity assumptions. - Very low inflation rates at the time. - Hindsight: tighter ceilings for central bank NDA could have slowed inflation by forcing more rapid interest rate increases. ### PRGF, growth, and poverty reduction - The PRGF-supported program aimed to reduce poverty by establishing conditions for higher, sustainable growth and by creating room for higher social spending; it did not include specific measures targeted at the poor. - A poverty reduction strategy was developed and, if implemented, is expected to reduce poverty over the medium and long term. - Socio-economic structure considerations: - Small, very well-educated upper class. - Still relatively small middle class. - Very large, mostly rural, lower class that is poorly educated and has little or no assets. - Implication: It will require a prolonged period of strong growth for low-income groups to accumulate assets and reduce vulnerability. - Assessment of outcomes during PRGF: - Growth resumed. - A poverty reduction strategy was developed. - Social spending increased in line with expectations. - Some social indicators improved. - It appears likely that poverty decreased, but poverty remains widespread. - Social spending and devolution: - Major efficiency gains expected from devolution at the time of PRGF request; devolution and capacity building take time. - Political devolution had not been fully followed by financial and administrative devolution, limiting local governments’ ability to carry out responsibilities. - Fund involvement in financial devolution would have required positions on division of resources among provinces and districts—a highly complex and sensitive political issue unlikely to be helpful. - Potential adverse measures for the poor included: - Adjustment of energy prices. - Reducing subsidies on or taxation of agricultural inputs. - Expanding the coverage of the sales tax. - Alignment of NSS instruments with market interest rates. - No social impact analyses were conducted, and no specific consideration was given to strengthening the social safety net. - Existing social safety net schemes (Kushal Pakistan Program, Food Support Program, Zakat) were largely viewed as black boxes by staff; allocation of budget support to these schemes was left to government discretion. ### Size and impact of the 2001 PRGF arrangement - Pakistan’s 2001 PRGF was the largest PRGF in nominal terms and one of the five largest in terms of quota (100 percent). - Context in fall 2001: - World economy weakening after September 11. - War expected in neighboring Afghanistan. - Shrinking export orders and increasing shipping costs due to war risks. - Export growth projections revised downwards, creating a sizable balance of payments need. - The large PRGF reflected both international political considerations and real economic needs. - Mission briefing called for access of 60 percent of quota; authorities requested higher access and received political support of major shareholders. - At the Board meeting some Executive Directors argued access should have been higher given strong policy track record. - Effects of large PRGF loan: - Very effective in signaling international community confidence. - Catalyzed public and private financial flows. - Encouraged Paris Club creditors to provide generous debt relief. - Encouraged World Bank and AsDB to commit major financial support packages. - Helped rebuild domestic confidence and encouraged large private inflows, especially remittances. - Hindsight: Pakistan’s balance of payments appears overfinanced. - Large official and private inflows contributed to high money growth and inflationary pressures. - Pakistan drew only 83 percent of the PRGF loan. - A larger-than-targeted increase in official reserves could have allowed refraining from drawings or repaying more expensive external debt earlier, accelerating debt reduction. - Tradeoff: Smaller financial support might not have achieved the same confidence effect; vulnerabilities remain, suggesting Fund support for the balance of payments was justified on economic grounds. ### Fund–Bank collaboration - Good cooperation between World Bank and Fund staffs, especially during the 2000–02 crisis period. - Division of responsibilities: - World Bank led support for bank reforms (especially privatization) through a sectoral loan; key elements were incorporated in the PRGF. - Fund focused on reform of the NSS. - In tax policy/administration: Fund provided strategic advice; World Bank provided financial resources to modernize tax administration. - On poverty alleviation: Fund pressed for increased macro-level spending and improved reporting; World Bank focused on building capacity in regions delivering health and education. - Energy sector cooperation was intense but more difficult due to differing objectives: - World Bank aimed for a power system based on international best practices in the medium term and stepped back when authorities lacked commitment. - Fund sought short-run reduction of electricity subsidies as a major fiscal drain and could not step away. - World Bank skepticism about partial measures and perceived lack of ownership may have weakened measures. - Overall: Lack of commitment by several energy sector stakeholders (outside the Ministry of Finance) undermined power sector reform; more systematic reconciliation of long- and short-term objectives might have helped but political commitment was decisive. *Italic: Source: _cr05409 - 36. Political constraints also prevented the government from moving faster and* ### 60. In contrast to the IEO’s findings for the period until 1999, program design in the ### In contrast to the IEO’s findings for the period until 1999, program design in the ### Program design and projection accuracy (2000–04) - Staff working on Pakistan from 2000 felt no pressure to conclude programs or reviews, regardless of possible catalytic effects, even after the events of September 11. - There was considerable skepticism at the Board regarding Pakistan, especially in 2000/01; this was reflected in the wide array of conditionality in the 2000 SBA. - Program projections after 2000 were satisfactory: - On average, the growth rate of GDP was overestimated by only 0.3 percentage points (compared to 1.5 percentage points in the previous programs according to the IEO). - For merchandise exports, the average forecast error was close to -4.5 percent, mostly due to conservative projections over the last two years. - The current account tended to overperform, mainly because of the abrupt and sustained increase in private transfers that was picked up by the projections only with a delay. - Fiscal balance projections under both the SBA and the PRGF were satisfactory although revenue forecasts were overly optimistic. - Figure 17 (described) compares program/review point estimates and actual data for: - Real GDP (Annual percentage change) - Merchandise Exports (In millions of U.S. dollars) - Gross National Saving (In percent of GDP) - Gross Capital Formation (In percent of GDP) - Current Account (Including official transfers; in percent of GDP) - Private Transfers (In millions of U.S. dollars) - Budget Balance (Excluding grants; in percent of GDP) - Budgetary Revenue (Excluding grants; in percent of GDP) ### Conditionality, selectivity, and program content - Recent programs focused on consolidating macroeconomic stability, reducing vulnerability, and ensuring an increase in social spending. - Public debt sustainability was a central issue in the PRGF-supported program and determined the required amount of fiscal adjustment. - Structural conditionality: - Focused on critical issues but could have been more selective; individual measures subject to conditionality were often not critical. - Results varied with authorities’ commitment and ability to overcome vested interests. - Areas requiring cooperation at lower levels of government or in public enterprises showed less satisfactory progress. - On waivers and program interruption: - It could be argued the Fund should not have granted waivers for frequent breaches of structural performance criteria given disappointing performance in tax and energy reforms. - Countervailing considerations: macroeconomic objectives and fiscal targets were being met or exceeded; structural policies were making progress in many other areas; overall waiver rates were lower than average in Fund programs; program interruption could have been highly disruptive and undermined reform efforts. ### Structural reform design and division of labor with other IFIs - Fund structural conditionality is best suited to areas where a few individual measures taken by the central government can bring progress. - Where prolonged institution-building and capacity-enhancement are needed, particularly outside the Fund’s core expertise, World Bank (and other IFIs) involvement is essential; the Fund should not embark on such reforms without the World Bank fully on board. - For sectors like power/energy: - Rather than setting its own specific conditionality for the power sector, Fund staff could have focused on the overall quasi-fiscal deficit and asked World Bank staff to design specific short-run performance measures (raise average tariff, strengthen bill collection, reduce losses), even if fundamental energy sector reform lacked commitment. - This would have required a clear accord at senior management level. ### Ownership, implementation capacity, and political economy - Program ownership is decisive and can vary across issues depending on political, economic, and security factors. - Three key lessons on designing structural conditionality: - Identifying critical issues is easier than finding individual measures that are macrorelevant and critical to program success. - Ownership and political constraints need assessment at the level of specific reforms; without ownership at all necessary levels, effective implementation is virtually impossible. - If a measure is truly critical but lacks political will, there may be a case for stepping back, but Fund staff need caution and humility in judging what is truly critical. - Fund advice on tax reforms should balance increasing tax ratios with developing an efficient, client-friendly system based on best practices: - Political will and implementation capacity to bring new taxpayers into the net need explicit assessment when setting conditionality. - If true commitment or technical capacity is lacking, revenue-losing efficiency reforms may need to be delayed. - In hindsight, reduction of tariffs and other revenue-losing measures could have been delayed until alternative revenue sources were fully implemented. - As interest costs are likely to rise and nontax revenues may not continue to increase at the same pace as in the last few years, broadening the tax base will be crucial to meet rising demand for social and development spending while reducing the debt burden. ### Macroeconomic management and monetary policy - Pakistan’s real exchange rate did not appear to have been significantly undervalued. - A real appreciation could have made it more difficult for Pakistan’s textile manufacturers to position themselves ahead of the elimination of the quota regime. - With hindsight, the SBP appears to have made the right choice when it was leaning against a nominal appreciation. - However, the SBP should have moved faster in raising interest rates once inflation started to pick up, as was recommended by staff. - The overriding objective in monetary policy was to contain inflation; the SBP tightened monetary policy in recent months to combat inflation. ### Poverty, governance, and social spending - High expectations may have been created regarding poverty reduction and improved governance because of heavy emphasis in staff reports, even in the absence of specific targets. - Some progress was made, but challenges remain significant, and disappointment was often expressed by the Board. - Staff could have emphasized socio-political constraints more and that a longer time period would be needed to address these problems. - Fund staff should not overpromise short-run poverty reduction: - Poverty is often caused by deeply ingrained socio-economic factors. - Apart from focusing on growth in average per capita incomes, staff can press for more and better targeted social spending and better management of such programs, but these may not suffice to address poverty in the short run. - Better macroeconomic governance and transparency can be achieved even in difficult program cases, but overall perceptions of governance are often determined by performance in utilities, civil service, law and order, and the judiciary—areas outside the Fund’s mandate; achieving tangible governance results through Fund-supported programs should not be oversold. ### Outcomes, risks, and remaining challenges - Without Fund (and World Bank) support during the 1990s, the economic situation at the end of that decade might well have been worse; counterfactuals are speculative. - By 2000, Pakistan had a fairly liberal trade and exchange system as opposed to protectionism and exchange controls; continued Fund support probably ensured fewer hurdles for a more committed government in 2001. - Large, up-front Fund financial support together with strong domestic policy implementation can catalyze public and private sector support even amid political and security uncertainty. - To consolidate success, perseverance is required and authorities and Fund staff must be prepared to deal with shocks and avoid policy slippages. - Ongoing risks and challenges identified: - Risk of excessive inflation has become apparent. - Tax revenue continues to lack buoyancy. - Energy sector reforms are not yet complete. - Governance needs further strengthening in public institutions to ensure that benefits of growth reach the poor. ### Cooperation and future Fund role - Pakistan and the Fund will need to continue close cooperation. - In surveillance and technical assistance, Fund staff will continue to advise on: - The macroeconomic policy mix; - Financial, fiscal, and external vulnerabilities; - Creation of fiscal space to allow for increased social and development spending. *Source: IMF staff text (Pakistan ex post assessment, 2000–04 and related statements and observations).* ### 3.3 million have become homeless, and thousands of survivors face death from exposure; ### _cr05409 - 3.3 million have become homeless, and thousands of survivors face death from exposure; ### Humanitarian impact - "3.3 million have become homeless, and thousands of survivors face death from exposure; entire villages have been living outdoors in increasingly harsh conditions, with many, including children, lacking warm clothing or blankets." - Authorities and volunteers from all over Pakistan are doing their utmost, but they need help. ### Macroeconomic overview and growth performance - Economic growth reached 8.4 percent in 2004/05 and is expected to remain high despite the deterioration in the terms of trade. - Economic growth has averaged 5½ percent per year since 1960. - Real per capita GDP has been growing at about 2¾ percent per year since 1960, implying real incomes have more than tripled during this period. - Recent growth acceleration has come largely from an increase in total factor productivity (TFP). - Robust TFP growth is attributed in part to the growing contribution of the services sector and limited need for new investment owing to the slump of the late 1990s and excess capacity. - Investment rose last year and new capacity will come on stream during 2005/06, though national accounts data may understate private investment because of incomplete coverage of firms. ### Fiscal policy - Government targeted fiscal deficit of 3.8 percent of GDP and has taken steps to protect this target in the wake of recent international oil price hikes, including significant increases in petroleum retail prices in September and October. - Central Board of Revenue (CBR) tax collection declined when measured as a percent of GDP in 2004/05; tax buoyancy has been low. - CBR work showed two-thirds of corporate tax filers had reported declining or unchanged income in 2004/05 even though overall growth had accelerated. - Authorities expect additional efforts to lead to higher collections from existing taxpayers. - Key measures and objectives: - CBR reform project, supported by the World Bank, to enhance revenue collection. - Move to greater reliance on self-assessment and risk-based auditing to improve efficiency and taxpayer-friendliness. - Need to extend the tax net into the service and agriculture sectors; process requires cooperation of provincial governments. - Government is targeting higher social and development spending while further reducing the debt-to-GDP ratio. - Emphasis on increasing the quality and effectiveness of social spending through a medium-term budget framework and enhanced district-level capacity. - Fiscal Responsibility Law mandates continued debt reduction by at least 2½ percent of GDP per year. - Staff projects domestic and external debt to continue on their downward path, and international reserves to remain at adequate levels. ### Poverty reduction and social spending - Authorities reiterate commitment to poverty reduction as a top priority. - Determination to increase spending in health and education as essential for achieving the Millennium Development Goals. - Pakistan Social and Living Standards Measurement Survey results show improvements in various health and education outcomes. - Significant increases noted in indicators for wages and employment; high growth in agriculture estimated to have raised disposable incomes in rural areas. - Pakistan improved its ranking in the 2005 United Nation’s Human Development Index. - Data from a household survey to be released later this year will provide further information on poverty outcomes. ### Monetary policy and inflation - Overriding objective of monetary policy is to contain inflation. - Authorities have tightened monetary policy significantly. - Combination of monetary tightening and measures to increase domestic food supply should be sufficient to achieve the 8 percent inflation target in 2005/06. - Since the beginning of 2005, the SBP raised the six-month treasury bill (T-bill) rate by more than 4 percentage points to 8 percent in May. - SBP stated readiness to raise T-bill rates further, if necessary. ### Exchange rate and external sector - Exchange rate policy: SBP committed to exchange rate flexibility; intervention limited to preventing excess volatility. - Sharp increase in international reserves since 2001 has allowed Pakistan to catch up with similarly-placed countries; further increase in reserves expected in 2005/06. - Real effective exchange rate has been on a depreciating trend for the last five years. - Modest appreciation in the first half of 2005 and shift of the current account into deficit should not raise concerns about appropriateness of the real exchange rate. - Strong export performance, shift toward manufactured exports, and increase in market share cited as indicators of competitiveness. - Widening trade deficit has been partly financed by a significant increase in private transfers. - Recent surge in imports mainly due to imports of machinery; once installed, equipment expected to boost export-oriented industries. ### Financial sector resilience and supervision - Considerable progress in strengthening the financial sector: banking system more competitive and banks’ financial soundness indicators improved. - Sector shows resilience in standard stress tests performed by Fund and SBP staff. - High rate of credit growth could raise prudential concerns because of a rebound in corporate indebtedness, but stress tests show corporate vulnerabilities generally declining and in line with comparator countries. - SBP mandated special provisioning requirements for consumer financing: 1.5 percent for secured consumer financing and 5 percent for unsecured consumer financing. ### Investment climate, governance, and privatization - Structural reform agenda pursued forcefully; business climate and governance in key macroeconomic institutions have clearly improved. - 2005 Doing Business survey of the World Bank shows progress in enhancing the business climate; Pakistan compares well within the region. - Improving governance in all public institutions remains a high priority to create an environment conducive to investment. - Major privatization milestone: sale of 26 percent of the telecommunication company with management control; winning bid amounted to $2.6 billion (2¼ percent of GDP). - Sales of other major companies, including Pakistan Steel and Pakistan Petroleum, are underway. ### Ex post assessment of Fund-supported program engagement (2000–04) - Main finding: Pakistan’s Fund-supported programs during 2000–04 had been successful because of the authorities’ strong ownership. - New government after 2000 addressed economic difficulties with commitment to break from past trends; considerable progress made in most areas including financial sector and public enterprise reforms. - 2000 Stand-by Arrangement (SBA) and 2001 three-year PRGF arrangement were successfully completed without extensions. - Areas of slower progress: those requiring broader institution building or provincial cooperation (e.g., significant expansion of the tax base). - Conditionality issues: - Structural conditionality peaked in the 2000 SBA: total of 56 PCs, benchmarks and prior actions—nearly three times the Fund-wide average of 19 conditions in GRA-supported programs. - Following the 2000 SBA, structural conditionality was reduced gradually, but Pakistan remained burdened with an excessive number of structural conditions; only in the last program year did their number approach the Fund-wide average for PRGF-supported programs, albeit slightly higher. - Waiver rates were comparable to or lower than average Fund-supported programs despite larger number of conditions; frequency of waiver requests was lower than average and most waivers were for delays rather than outright nonimplementation. - Staff concluded that conditionality in the 2000 SBA "clearly did not meet the test of parsimony" and that "structural conditionality focused on critical issues, but could have been more selective—individual measures subject to conditionality were often not critical." - Overall conclusion: Fund structural conditionality was not well-suited for areas requiring longer-term institution building and cooperation beyond the central government. - Authorities elected not to draw the last tranche under the PRGF arrangement or seek a successor arrangement because of vastly improved external situation and successful re-entry into international financial markets. ### Governance of program implementation and communication issues - Authorities expressed frustration with frequent need for waivers of structural performance criteria, even for minor deviations or brief delays, and requested the Fund review its procedures for deciding whether a performance criterion has been met. - Noted apparent inconsistency regarding reporting and communication on specific measures (example reference to SRO 207 and communications between Resident Representative and CBR officials). ### Public Information Notice highlights (PIN No. 05/157) - IMF Executive Board concluded the 2005 Article IV Consultations with Pakistan on November 2, 2005. - In 2004/05 (July/June), macroeconomic performance continued to be favorable despite some inflationary and external pressures. - 12-month inflation reached 11 percent in April 2005, before easing to 8.4 percent in August. - Strong growth, including in agriculture, combined with rising wages and employment according to some indicators, is expected to have yielded some reduction in poverty. - Fiscal targets for 2004/05 were broadly met, with the overall deficit (excluding grants) at [text cut off in source]. *Source: IMF staff report and Public Information Notice (PIN No. 05/157), November 17, 2005.* ### 3.3 percent of GDP. Government debt was reduced to just below 60 percent of GDP. ### _cr05409 - 3.3 percent of GDP. Government debt was reduced to just below 60 percent of GDP. ### Fiscal developments - Tax-to-GDP ratio fell due to: - elimination of excises on petroleum products to offset the impact of rising international oil prices, and - a number of tax relief measures in the 2004/05 budget. - Public finances (selected outcomes): - Government debt was reduced to just below 60 percent of GDP. - The 2005/06 budget targets a deficit (excluding grants) of 3.8 percent of GDP. - Even with the increase in the fiscal deficit, government debt would fall to 52 percent of GDP. - Measures to contain fiscal pressures from rising international oil prices: - Significant increase in domestic retail prices of petroleum products implemented in September and October. - Expenditures will be tightly controlled, with priority to achieving the development expenditure target. - Concerns and recommendations from Directors: - Meeting medium-term fiscal objectives requires a marked improvement in revenue performance. - Disappointment at the lack of progress over the last five years in raising the ratio of tax revenue to GDP. - Urged authorities to extend the tax net to the services sector and work with provincial governments to have the agricultural sector pay its fair share of taxes. - Commended authorities for passing on much of the increase in international oil prices to consumers and recommended continuation of this policy. - Adoption of the Fiscal Responsibility Law that requires a further reduction of the debt burden was welcomed. ### Monetary policy and inflation - The State Bank of Pakistan (SBP) response: - Concerned with double digit inflation and high capacity utilization, the SBP tightened monetary policy. - Since the beginning of 2005, the SBP raised the six-month treasury bill rate by more than 4 percentage points to 8 percent in May, but has kept it broadly unchanged since then; key interest rates remain slightly negative in real terms. - Despite tightening, reserve money growth has not slowed because the SBP provided substantial budget financing during the year as the government’s gross financing needs could not be fully met from the market at prevailing rates. - Directors’ views: - Expressed concern about the increase in inflation in the last two years and the widening of the current account deficit. - Commended the SBP for raising interest rates sharply in the first half of 2005; some urged further increases if inflationary pressures persist. - Stressed the need to sterilize effectively central bank financing of the budget. - Advised the SBP to monitor credit development carefully given strong credit growth. ### External sector and reserves - Current account and trade: - Despite higher worker’s remittances, the current account moved into deficit in 2004/05. - Exports, particularly textile exports following the end of the textile quota system, performed well in the first six months of 2005. - Imports grew even faster, reflecting higher oil prices and strong demand, including for machinery. - Reserves and exchange rate: - Gross reserves fell somewhat in 2004/05, notwithstanding a continued increase in non-debt-creating inflows and substantial concessional financing. - The real effective exchange rate has appreciated modestly over the last few months given the stable U.S. dollar–Pakistani rupee exchange rate and the substantial inflation differential. - Directors cautioned that relief and reconstruction efforts (post-earthquake) could add further pressures on both prices and the balance of payments. ### Structural reforms and privatization - Progress and transactions: - Progress has been made on the government’s structural reform agenda, in particular privatization. - In June 2005, the largest transaction so far in Pakistan’s privatization program took place, with the sale of 26 percent, together with management control, of a large telecommunication company. - The sale of several other major companies is underway. - Energy sector: - Energy sector reforms have again proven to take longer than envisaged. - The unbundling of the other large power utility is almost complete, but individual distribution companies cannot start to operate independently because regional tariffs have yet to be notified. - Directors expressed concern about the electricity sector’s sizable drain on the budget and urged stepped-up reform; urged completion of the new tariff framework so successor companies of the Water and Power Development Authority could start functioning independently. - Governance and business climate: - Directors urged continuation of structural reforms aimed at improving the business environment and governance. - Directors were encouraged by prospects of the Karachi Electric Supply Corporation being transferred into private hands. ### IMF cooperation, program performance, and reconstruction needs - Cooperation outcomes: - Cooperation with the Fund has been fruitful; the 2000 Stand-by Arrangement and the 2001–04 PRGF were in large part implemented steadfastly. - Many recommendations from the 2004 Article IV consultations have been implemented. - An ex post assessment noted a tax anomaly correction resulted in an insignificant deviation from a structural performance criterion without any effect on fiscal outcomes; this did not change the Fund’s favorable assessment of policy implementation under the program. - Executive Board assessment and earthquake response: - Executive Directors expressed sympathy and condolences for the loss of life and large-scale destruction caused by the recent earthquake in northern Pakistan. - They welcomed international pledges of support and called for substantial additional assistance, especially grants, to help the government overcome the crisis without adversely affecting broader economic policies. - Several Directors noted they would support a request for Emergency Natural Disaster Assistance from the Fund, if the Pakistani authorities were to make such a request. - Directors welcomed the authorities’ determination to maintain macrostability in the face of the earthquake and noted that some widening of the budget deficit in 2005/06 might be unavoidable but would not significantly alter the declining trend of Pakistan’s debt indicators. - Data and transparency: - Directors encouraged authorities to further improve the quality and timeliness of data, including data on the domestic debt, to allow better analysis and policy formulation and with a view to subscribing to the Special Data Dissemination Standard. ### Selected quantitative indicators (preserving original figures as presented) - Overall macro outcomes and monetary indicators (2000/01–2004/05 table excerpts): - Real GDP growth, at factor costs (percentage change): 1.8 3.1 4.8 6.4 8.4 - Consumer prices (period average, percentage change): 4.4 2.5 3.1 4.6 9.3 - Consumer prices (end of period, percentage change): 2.5 3.4 1.9 8.5 8.7 - Gross national savings: 15.6 19.0 22.0 19.3 15.6 - Gross capital formation 2/: 17.2 16.8 16.9 17.3 16.8 - GDP at market prices (in billions of Pakistani rupees): 4,163 4,402 4,823 5,533 6,548 - Public finances (selected): - Revenue (including grants): 14.3 16.1 17.4 14.9 14.0 - Expenditure (including statistical discrepancy): 17.6 19.7 18.7 16.7 17.1 - Budget balance (excluding grants): -4.3 -5.5 -3.8 -2.3 -3.3 - Budget balance (including grants): -3.3 -3.6 -1.4 -1.8 -3.0 - Primary balance (including grants): 2.3 2.0 2.9 1.8 0.2 - Total government debt: 88.8 80.2 74.3 67.8 61.1 - Monetary sector highlights: - Net foreign assets (end of period, change in percent of broad money): 5.1 13.4 18.9 2.1 2.2 - Net domestic assets (end of period, change in percent of broad money): 3.9 2.0 -0.4 17.5 17.1 - Broad money (end of period, percentage change): 9.0 15.4 18.3 19.6 19.3 - Six-month treasury bill rate (period average, in percent): 10.4 8.1 4.1 1.7 4.7 - External sector highlights: - Merchandise exports: 12.5 12.7 13.2 12.9 13.0 - Merchandise imports: 14.3 13.1 13.7 14.1 17.0 - Current account excluding official transfers: -2.7 0.1 3.8 1.4 -1.6 - Current account including official transfers: -1.6 2.2 5.1 2.0 -1.3 - External public and publicly guaranteed debt (in percent of exports of goods and nonfactor services): 309.4 295.8 238.0 218.2 191.8 - Gross reserves (in millions of U.S. dollars) 3/: 1,679 4,330 10,251 10,621 9,985 - In months of next year imports of goods and services: 1.7 3.7 6.9 5.0 4.1 - Pakistani rupees per U.S. dollar (period average): 58.3 61.3 58.4 57.5 59.3 - Real effective exchange rate (annual average, percentage change): -2.5 -1.1 -1.5 -3.4 -0.1 *Source: International Monetary Fund, excerpt from _cr05409.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05409.pdf_