## _cr1006 ## Source details **Canonical URL:** [_cr1006](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr1006.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr1006.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr1006.pdf.json) --- ### Executive Summary - Political and security uncertainties have increased, raising risks to the program and the reform agenda. - Military campaign in South Waziristan started in late October; significant security expenditure pressures and population outflow. - Real GDP growth projection for 2009/10: 3 percent. - Inflation outlook (y-o-y) revised from 9 to 11 percent. - Current account deficit projected at 4.2 percent of GDP (compared with 4.7 percent at the time of the second review). - Staff recommends completion of the third review under the Stand-By Arrangement. ### Recent Economic Developments and Outlook - Real activity and sectoral developments: - Wheat crop: 14 percent increase over the 2008 harvest, yielded a significant surplus. - Sugar output: declined by 23 percent. - Large-scale manufacturing: positive y-o-y growth in July–August 2009, driven mainly by cement; textile and automobile sectors show signs of revival. - Continued slump in credit to the private sector; investment remains low. - Inflation: - Headline and core inflation (y-o-y) dropped in October to 8.9 and 11 percent, respectively. - Headline inflation rose to 10.5 percent in November; core inflation reached 10.6 percent. - Price pressures driven by food and petroleum price increases and an electricity tariff hike in October. - External sector and reserves: - Official reserves increased to $11.2 billion at end-September (after adjusting for an earlier-than-expected SDR allocation of about $1.3 billion) but declined subsequently to about $10 billion in early December owing to substantial debt service payments and a shortfall in external financing. - SBP’s net foreign assets exceeded the end-September adjusted program floor by about $1.3 billion. - Workers’ remittances continued to increase and narrowed the current account deficit. - Trade deficit in July–October 2009 narrowed relative to July–October 2008 as lower imports more than offset export declines. - Exchange rates and competitiveness: - Rupee depreciated by about 3 percent vis-à-vis the U.S. dollar during July–mid-December 2009. - In real effective terms, the rupee appreciated by about 4.2 percent during September 2008–September 2009. - Financial markets and capital flows: - Broad money growth (y-o-y) picked up since June; bank credit to the private sector declined. - T-bill rates rose from just below 11½ percent in mid-July to 12¼ percent in November. - KSE index increased by about 60 percent during January–November, despite a recent sharp drop. - Renewed foreign inflows of about $300 million since end-June. - Moody’s improved Pakistan’s B3 rating outlook to “stable”; S&P upgraded Pakistan’s rating to “B-minus”. - EMBIG spread narrowed from 1,037 bps in June to 606 bps in early-December. - FDI during July–September was $463 million. - Banking sector: - Banks remain well-capitalized but NPLs continued to grow; bank profitability declined due to increased provisioning. - SBP stress tests on end-June data indicate system solvency even if all outstanding NPLs became irrecoverable. - Outlook and risks: - Downside risks to the outlook are high. ### Program Implementation and Fiscal Performance - Quantitative performance criteria: - All quantitative performance criteria for end-June and end-September were met, except the fiscal deficit target. - Up-to-date data indicate the end-June fiscal deficit target was missed by Rs. 118 billion (about 0.9 percent of GDP). - End-September fiscal deficit target missed by about 0.3 percent of GDP (headline deficit target missed by about 0.2 percent; adjustment for shortfall in external grants increased the overrun to 0.3 percent of GDP). - Fiscal slippage drivers: - First-quarter revenue shortfall ~0.6 percent of GDP relative to program target (split roughly evenly among tax revenue, nontax revenue, and grants). - Contributing factors: weak activity, shift in advanced income tax payments from September to October, lower grants, lower-than-expected Coalition Support Fund receipts. - Expenditure factors: higher security spending and early payment of wages for October ahead of Eid contributed 0.2 percent of GDP to the slippage. - Authorities’ corrective actions: - Compression of spending on goods and services and investment. - Mobilization of a transfer from the SBP equivalent to about ½ percent of GDP. - Social and IDP spending: - BISP spending amounted to Rs. 10.4 billion in the first quarter vs. Rs. 14 billion projected. - Spending on IDPs was about two-thirds of the Rs. 15.5 billion (about 0.1 percent of GDP) budgeted for the first quarter. ### Monetary Policy, Liquidity Management, and Financial Sector Measures - Policy rate actions: - Policy (SBP discount) rate lowered from 14 percent to 13 percent in August, and to 12.5 percent in November. - SBP proceeded with a reduction of the policy interest rate of 50 bps in November. - Interest rate corridor and liquidity: - In mid-August, SBP introduced an explicit interest rate corridor of 300 bps; overnight deposit facility set such that center is 150 bps below the policy rate. - SBP shortened periodicity of policy decisions from quarterly to bimonthly. - Following the corridor, fluctuations in the overnight repo rate have fallen significantly. - Significant liquidity injections by SBP in August–October supported public sector financing and seasonal currency demand. - SBP refinancing and provisioning: - Interest rates on the Export Finance Scheme: increased to 8 percent. - Interest rates on the Long Term Financing Facility: increased to 9.2–10.25 percent (depending on tenor). - Temporary changes in provisioning rules to promote restructuring of NPLs; rules expire automatically on June 30, 2010. - Expanding base of eligible collateral and allowing higher forced sale value. - Reducing provisioning requirements for restructured NPLs. - Measures to curb moral hazard: monthly reporting on rescheduled NPLs; benefits from relaxed provisioning ineligible for dividend payment and usable solely for strengthening bank reserves. - Continued recourse to preferential refinancing windows at the SBP estimated to result in quasi-fiscal costs amounting to 0.1–0.2 percent of GDP a year. - Financial sector soundness: - Gross NPL-to-loans ratio rose to 12.4 percent (gross NPLs increased nearly 6 percent in Q1 2009/10). - Several small banks need to merge or receive capital injections to meet minimum capital requirement increase from Rs. 5 billion to Rs. 6 billion at end-2009. - Fitch withdrew ratings of four major Pakistani banks; authorities noted limited material effect. ### Structural Reforms, VAT, Electricity, and Social Safety Nets - VAT and tax administration: - Target date for VAT introduction: July 1, 2010; described as ambitious but achievable. - Drafting workshop in early November produced plan for presenting VAT law to parliament by end-December (structural benchmark). - Estimated additional revenue from broad-based VAT could reach 3 percent of GDP per annum over the medium term. - On September 12, government approved regulations to form Inland Revenue Service (structural benchmark). Notifications on LTU and RTO revisions issued on November 11 (structural benchmark). - Draft law to be submitted to parliament by end-December 2009 (structural benchmark); legislation to harmonize tax laws by end-April, 2010. - Expedited sales tax refund system pilot in Islamabad, Karachi and Lahore; to be operational in all RTOs and LTUs by end-March, 2010 (structural benchmark). - Electricity sector and circular debt: - Tariffs raised on average on October 1 by 4¼ percent rather than by 6 percent; remaining 1¾ percent to be implemented together with regular quarterly adjustment due by December 20. - Authorities indicated electricity tariffs will be increased by an additional 12 percent on January 1, 2010. - Energy sector guarantee: government guaranteed Rs 85 billion (0.6 percent of GDP) in TFCs in mid-September to settle portion of circular debt. - Remaining circular debt of Rs 216 billion (1.3 percent of GDP) as of July 1, 2009, to be transferred to a holding company by end-March 2010. - Plan to eliminate electricity tariff differential subsidies by August 2010; cap tariff differential subsidy at Rs. 55 billion in 2009/10. - Social safety nets: - BISP program of Rs. 70 billion (0.5 percent of GDP) intended for five million families in 2009/10; rollout delayed, pilot completed in 15 districts. - Wasilla-ul-Haq credit program: interest-free loans of Rs. 300,000 ($3,600) to selected BISP beneficiaries. - Nationwide rollout of strengthened poverty scorecard expected by end 2010. ### Fiscal Policy Adjustments, Revenue Measures, and Contingencies - Fiscal targets and adjustments: - Fiscal deficit target for 2009/10 (excluding grants) maintained at 4.9 percent of GDP (authorities initially set 4.6 percent but raised to 4.9 percent based on assumed additional IDP grants). - Authorities requested waiver of nonobservance for end-September fiscal performance criterion and modification of end-December fiscal deficit target by Rs. 15 billion (0.1 percent of GDP). - To contain deficit at 4.9 percent of GDP, authorities will reprioritize spending, including cuts in development expenditure, and boost revenues. - Revenue measures: - Increase of the broad-based special excise duty rate from 1 to 5 percent; could yield about Rs. 28 billion in additional revenues in the second half of FY 2009/10 (about 0.4 percent of GDP on an annualized basis). - Tax administration measures: audits, automated refunds, measures to reduce under-reporting and nonfiling; FBR identified 13,000 under-reporting taxpayers and about one million non-filers. - Security-related spending: - Additional security spending currently estimated at Rs. 65 billion (0.4 percent of GDP); total additional spending could be higher. - Approximately 170,000 people have fled South Waziristan. - Donor financing sensitivity: - If Tokyo-related disbursements are substantially lower than projected, the deficit would need further reduction, possibly by up to 0.4 percent of GDP. - Under program framework, up to $1.4 billion (0.8 percent of GDP) in shortfalls of the projected $2.2 billion in Tokyo-related disbursements from bilateral donors would continue to be covered by Fund resources at year’s end. ### Program Financing, Adjustors, and Quantitative Rules (selected figures) - Tokyo-related disbursements (excluding multilateral sources) projected: - July 2009–December 2009: $1,177 million - July 2009–March 2010: $1,962 million - July 2009–June 2010: $2,220 million - Tokyo-related disbursements from multilateral sources projected: - July 2009–December 2009: $0 million - July 2009–March 2010: $100 million - July 2009–June 2010: $270 million - Projected net external program financing (exclusions applied): - July 2009–December 2009: -$928 million - July 2009–March 2010: -$1,082 million - July 2009–June 2010: -$171 million - Projected net IMF financing to the budget: - July 2009–December 2009: $1,072 million - July 2009–March 2010: $1,430 million - July 2009–June 2010: $0 million - SBP exposures and caps: - SBP’s net exposure under foreign exchange forwards and swaps was $2.035 billion at end-September 2009; capped at $2.5 billion for end-December 2009, end-March 2010, and end-June 2010. - Stock of foreign currency deposits of resident banks with the SBP was $779 million at end-September 2009. - Selected budgetary and debt stock lines (verbatim): - Total Outstanding Domestic Debt (A+B+C): 3,266.0 3,852.6 4,010.0 (In billion Rupees) — selected lines include Pakistan Investment Bonds (PIBs) 412.0 441.0 456.7; Market Treasury Bills (auction) 537.0 796.1 959.6; Total (A+B+C) 3,266.0 3,852.6 4,010.0. - Table: Net program financing for the budget (excl. Tokyo related disbursements, IDP grants, Fund financing to the budget) 1/ -166 -127 296 737 -64 -928 -1,082 -171 -171. ### Program Risks, Monitoring, and Conditionality - Main program risks: - Delays in mobilizing donor disbursements pledged in Tokyo. - Deterioration in trading partners’ demand lowering exports. - Smaller private capital flows. - Adverse security developments adding to budget pressures. - If activity weakens, increased risks to the financial sector. - Structural benchmarks and prior actions: - Prior actions for third review: (i) initiate taxpayer audits among 850 companies identified; (ii) government approval of an electronic payment and tax refund system. - Structural benchmarks for second half of 2009/10 include: - Expedited electronic sales tax refund system in all RTOs and LTUs by end-March, 2010. - Complete independent review of PIFRA by end-June 2010. - Move to a Single Treasury account by end-June 2010 (transition of large federal agencies and provincial accounts). - Introduce the VAT by July 1, 2010. - Reporting requirements (selected): - Monthly provisional statements on federal tax and nontax revenue within one month. - Monthly monetary data on a last-Saturday basis within two weeks; end-month and end-quarter versions within one month. - Daily data on exchange rates and SBP foreign exchange market operations within two business days or as specified. - Copies of new/revised ordinances/circulars on tax, FX, and banking regulations no later than three days after official issuance. ### Staff Appraisal, Board Actions, and Recommendations - Staff appraisal: - Policy stance helped bring inflation down from high levels last year and strengthened external position amid adverse security and political developments. - Underlying vulnerabilities remain high: continued revenue shortfalls, increase in NPLs, energy subsidies, and dependence on commodity imports. - Policy prescription: credible fiscal consolidation, flexible interest rate and exchange rate policies, improved governance. - Board action and outcome: - Executive Board completed the third review; approved disbursement equivalent to SDR 766.7 million. - Board approved waiver for non-observance of end-September ceiling on overall budget deficit missed by 0.3 percent of GDP. - SBA augmentation and extension details reaffirmed: 23-month SBA originally SDR 5.17 billion approved on November 24, 2008; augmented on August 7, 2009 to SDR 7.24 billion and extended to end 2010. - Staff recommendation: - Support for requested waiver of nonobservance for end-September fiscal deficit. - Support for modifications of end-December performance criteria on the fiscal deficit and on SBP’s NFA and NDA. - Recommendation to complete the third review and approve the fourth purchase under the SBA of SDR 766.7 million. *Source: IMF staff report and attachments (Third Supplementary Memorandum of Economic and Financial Policies; Technical Memorandum of Understanding; IMF Press Release No. 09/480; staff report excerpts).* ### Executive Summary ...................................................................................................... ### Executive Summary ### I. Background - Political and security uncertainties have increased, raising risks to the program and the reform agenda. - The military campaign in South Waziristan that started in late October has resulted in significant security expenditure pressures and an outflow of the population from this area. - Insurgent attacks in major cities and a fluid political situation continue to affect investor confidence. ### II. Recent Economic Developments and Outlook - Real activity and sectoral developments - Economic activity remains weak, although there are signs of recovery in some sectors. - Wheat crop showed a 14 percent increase over the 2008 harvest and yielded a significant surplus; sugar output declined by 23 percent. - Large-scale manufacturing showed positive y-o-y growth in July–August 2009, driven mainly by a jump in cement production; textile and automobile sectors show signs of revival. - Continued slump in credit to the private sector suggests investment remains low. - Inflation - Headline and core inflation (y-o-y) dropped in October to 8.9 and 11 percent, respectively. - Headline inflation rose to 10.5 percent in November; core inflation continued to decline and reached 10.6 percent. - Price pressures driven by food and petroleum price increases and an electricity tariff hike in October; fiscal stance, wheat price support, electricity shortages, and supply-side factors also contributed. - External sector and reserves - Trade deficit in July–October 2009 narrowed relative to the same period in 2008 as lower imports more than offset export declines. - Workers’ remittances continued to increase and contributed to a narrowing of the current account deficit. - Official reserves increased to $11.2 billion at end-September (after adjusting for an earlier-than-expected SDR allocation of about $1.3 billion) but declined subsequently to about $10 billion in early December owing to substantial debt service payments and a shortfall in external financing. - SBP’s net foreign assets exceeded the end-September adjusted program floor by about $1.3 billion. - External financing and Tokyo pledges - Disbursements of Tokyo-related assistance in 2009/10 have been delayed; the amount projected for 2009/10 has been reduced to $1.6 billion ($0.9 billion lower than envisaged at the time of the second review). - Availability and timing of disbursements beyond 2009/10 (originally estimated at over $3 billion) remain uncertain. - The U.S. Kerry-Lugar Bill authorizes aid of $1.5 billion a year during the U.S. fiscal years 2010–14. - Exchange rates and competitiveness - The rupee depreciated further by about 3 percent vis-à-vis the U.S. dollar during July–mid-December 2009. - In real effective terms, the rupee appreciated by about 4.2 percent during September 2008–September 2009. - Financial markets and capital flows - Broad money growth (y-o-y) has picked up since June, but bank credit to the private sector has declined despite policy rate cuts. - T-bill rates rose from just below 11½ percent in mid-July to 12¼ percent in November due to high government borrowing requirements. - Government borrowing included issuance of government-guaranteed Term Finance Certificates (TFCs) to regularize electricity sector circular debt. - Significant liquidity injections by the SBP in August–October supported public sector financing and seasonally higher currency demand. - KSE index increased by about 60 percent during January–November, despite a recent sharp drop. - Renewed foreign inflows of about $300 million since end-June. - Moody’s improved Pakistan’s B3 rating outlook to “stable” and S&P upgraded Pakistan’s rating to “B-minus”; EMBIG spread narrowed from 1,037 bps in June to 606 bps in early-December. - FDI during July–September was $463 million. - Banking sector soundness - Banks remain well-capitalized but nonperforming loans (NPLs) continued to grow and bank profitability declined due to increased provisioning. - Risk-weighted capital adequacy ratio (CAR) indicates the banking system would remain solvent even if all outstanding NPLs were to become irrecoverable; supported by SBP stress tests on end-June data. - Outlook and projections - Real GDP growth projection for 2009/10: 3 percent (unchanged). - Inflation outlook (y-o-y) revised from 9 to 11 percent. - Current account deficit projected at 4.2 percent of GDP (compared with 4.7 percent at the time of the second review). - Downside risks to the outlook are high. ### III. Program Implementation - Overall - All quantitative performance criteria for end-June and end-September were met, except the fiscal deficit target. - In August, the Executive Board approved a waiver of applicability of the quantitative performance criteria for end-June. - Up-to-date data indicate the end-June fiscal deficit target was missed by Rs. 118 billion (about 0.9 percent of GDP). - Fiscal performance and slippage - Fiscal deficit target for end-September was missed by about 0.3 percent of GDP (headline deficit target missed by about 0.2 percent; adjustment for shortfall in external grants increased the overrun to 0.3 percent of GDP). - Revenue shortfall in the first quarter of 2009/10 was about 0.6 percent of GDP relative to the program target (roughly evenly split among tax revenue, nontax revenue, and grants). - Contributing factors to the first quarter slippage: weak economic activity, shift in advanced income tax payments from September to October, lower grants, and lower-than-expected Coalition Support Fund receipts. - Authorities took measures to contain the slippage, including compression of spending on goods and services and investment and mobilization of a transfer from the SBP equivalent to about ½ percent of GDP. - On the expenditure side, higher security spending and early payment of wages for October ahead of Eid contributed 0.2 percent of GDP to the slippage. - Social and IDP spending - Spending under the Benazir Income Support Program (BISP) amounted to Rs. 10.4 billion in the first quarter, compared with Rs. 14 billion projected under the program. - Spending on IDPs was about two-thirds of the Rs. 15.5 billion (about 0.1 percent of GDP) budgeted for the first quarter of 2009/10, as the security situation in Swat stabilized faster than expected. ### IV. Monetary Policy and Financial Sector Issues - Monetary policy stance - The policy rate was lowered from 14 percent to 13 percent in August and to 12.5 percent in November. - SBP will continue to balance support for the fragile recovery with concerns about external stability and liquidity pressures from large government domestic financing needs. - Liquidity and market rates - Significant SBP liquidity injections in August–October helped meet public sector financing and seasonal currency demand while keeping the overnight repo rate within the policy corridor. - Government borrowing pressure pushed T-bill rates from just below 11½ percent in mid-July to 12¼ percent in November. - Financial sector health - NPLs increased and bank profitability declined due to provisioning, but CAR indicates solvency even under severe stress scenarios per SBP tests. - The increase in risk-weighted CAR reflected a further shift in banks’ assets toward government and government-guaranteed instruments. ### V. Structural Reforms and Fiscal Measures - Tax administration and VAT - Authorities implemented most critical structural reforms, though some with significant lags. - Steps were taken to improve tax administration and introduce a VAT; VAT is central to increasing revenue, reducing poverty and macro-vulnerabilities, and financing investment in human and physical capital. - Target date for VAT introduction: July 1, 2010 (described as ambitious, yet achievable, as underscored in the VAT action plan). - Vulnerabilities and reform imperatives - Underlying vulnerabilities remain high and have increased in some areas, fueled by continued revenue shortfalls, increase in NPLs, energy subsidies, and large dependence on commodity imports. - A credible fiscal consolidation, strengthened competitiveness over the medium term, and improved governance are indispensable for reducing these vulnerabilities. ### VI. Key Staff Recommendation - Staff recommends completion of the third review under the Stand-By Arrangement. *Source: Executive Summary (IMF country report executive summary).* ### 16. In general, monetary policy has been cautious. The SBP discount rate was lowered ### _cr1006 - 16. In general, monetary policy has been cautious. The SBP discount rate was lowered ### Monetary policy actions and stance - The SBP discount rate was lowered from 14 percent to 13 percent in August, and to 12.5 percent in November, but real interest rates remained positive. - Rate cuts were limited because of concerns about remaining inflation pressures, the fiscal slippage in the first quarter, and the availability of external financing. - The SBP proceeded with a reduction of the policy interest rate of 50 bps in November. Staff would have given greater weight to inflation risks and preferred a more cautious stance. ### Liquidity management framework and interest corridor - In mid-August, the SBP introduced an explicit interest rate corridor of 300 bps (between the discount rate and the rate on the newly established overnight deposit facility). - The SBP shortened the periodicity of monetary policy decisions from quarterly to bimonthly to facilitate more frequent adjustments of policy rates. - Following the introduction of the corridor, fluctuations in the overnight repo rate have fallen significantly. - The SBP will strengthen its liquidity management operations to ensure that the overnight repo rate remains close to the center of the interest rate corridor (150 bps below the policy rate). - The SBP will continue to manage liquidity injections (or mop-ups) to deal solely with temporary liquidity fluctuations and stabilize short-term interest rates. Persistent liquidity pressures will be addressed by adjusting the overall monetary policy stance. ### SBP refinancing facilities and provisioning measures - Interest rates on the Export Finance Scheme and the Long Term Financing Facility have been increased to 8 percent and 9.2–10.25 percent (depending on tenor), respectively. - The SBP introduced temporary changes in provisioning rules to promote the restructuring of NPLs by creditors; the new rules will expire automatically on June 30, 2010, and include: - expanding the base of eligible collateral and allowing a higher forced sale value; and - reducing provisioning requirements for restructured NPLs. - Measures to curb moral hazard from possible “ever-greening” include requiring monthly reporting on the rescheduled NPLs and making the benefits derived from relaxed provisioning ineligible for dividend payment and usable solely for strengthening bank reserves. - Continued recourse to preferential refinancing windows at the SBP is estimated to result in quasi-fiscal costs amounting to 0.1–0.2 percent of GDP a year. ### Key structural reforms implemented and in progress - Legislative amendments to enhance SBP enforcement powers in banking supervision were sent to parliament in early October; amendments to the SBP law to strengthen the central bank’s operational independence will be submitted to parliament by December 20. - The SBP has appointed a nine-member Monetary Policy Committee whose role and legal status are included in the proposed amendments to the SBP Act. - Tax administration reforms: On September 12, the government approved regulations to form a new occupational group (Inland Revenue Service) in the Federal Bureau of Revenue (FBR). On October 28, a presidential ordinance harmonized income tax and general sales tax laws. On November 11, the FBR issued notifications to revise the structures of Large Taxpayer Units (LTU) and Regional Taxpayer Offices (RTO). - Limits on provincial borrowing: Ceilings on the overdraft to provinces from the SBP (equal to six weeks of the respective provincial wage bills) were established in early October; provincial overdrafts outstanding at end-June have been converted into loans to be amortized over four years. - VAT preparation: A September 2009 conference launched consultation on the VAT; a drafting workshop in early November produced a plan for presenting the VAT law to parliament by end-December (structural benchmark). Preliminary government understandings reached that VAT revenues attributable to services would be distributed to the provinces before the divisible pool. - Electricity tariffs: Tariffs were raised on average on October 1 by 4¼ percent rather than by 6 percent; the remaining 1¾ percent to be implemented together with the regular quarterly adjustment due by December 20. Authorities indicated electricity tariffs will be increased by an additional 12 percent on January 1, 2010. - Energy sector guarantee: In mid-September, the government guaranteed Rs 85 billion (0.6 percent of GDP) in TFCs to settle a portion of the energy sector’s “circular debt.” - BISP rollout delayed: The program of Rs. 70 billion (0.5 percent of GDP) intended to provide support for five million families in 2009/10 and to be extended to seven million families by 2010/11—only part of BISP resources budgeted for 2009/10 is expected to be delivered using the new enhanced targeting system. A pilot was completed in 15 districts. - Wasilla-ul-Haq credit program: Interest-free loans of Rs. 300,000 ($3,600) will be given to selected BISP beneficiaries. - Remaining circular debt of Rs 216 billion (1.3 percent of GDP) as of July 1, 2009, will be transferred to a holding company under the Ministry of Water and Power by end-March 2010; exact amount may change once an audit is completed. ### Fiscal policy: performance, adjustments, and risks - Discussions focused on ensuring fiscal policy achieves the deficit target of 4.9 percent of GDP (excluding grants), while providing for additional security expenditures. - The 2009/10 budget deficit target (excluding grants) is 4.6 percent of GDP; based on assumed additional budgetary grants for IDPs, the authorities increased the fiscal deficit target (excluding grants) to 4.9 percent of GDP. - The authorities request a waiver of nonobservance for the end-September performance criterion on the overall budget deficit and seek to relax the end-December fiscal deficit target by 0.1 percentage of GDP to accommodate urgent security expenditures. - To contain the annual deficit at 4.9 percent of GDP and make room for higher security outlays, the authorities will reprioritize spending—including cuts in development expenditure—and boost revenues. - Identified measures include reduction of exemptions for the capital value tax and contingency expenditure measures (lower-priority development expenditure and subsidies). - Additional security spending (over and above the budgeted amounts) is currently estimated at Rs. 65 billion (0.4 percent of GDP); total additional security spending could be higher depending on campaign course. - Approximately 170,000 people have fled South Waziristan. - If Tokyo-related disbursements are substantially lower than projected, the deficit would need to be reduced further, possibly by up to 0.4 percent of GDP. - Under the program framework, up to $1.4 billion (0.8 percent of GDP) in shortfalls of the projected $2.2 billion in Tokyo-related disbursements from bilateral donors would continue to be covered by Fund resources at year’s end. ### Revenue measures and fiscal outlook risks - The authorities decided to increase the broad-based special excise duty rate from 1 to 5 percent, which could yield about Rs. 28 billion in additional revenues in the second half of FY 2009/10 (about 0.4 percent of GDP on an annualized basis). - Tax administration measures include tax audits, automated refunds, and measures to reduce under-reporting and nonfiling. - Fiscal outlook risks include: - (i) a worsened security situation hurting confidence and economic activity with adverse implications for revenue; - (ii) simultaneous tax administration reforms and introduction of the VAT creating significant workload that could temporarily weaken tax collections; - (iii) failure to implement agreed electricity tariff adjustment increasing pressure for power subsidies; - (iv) difficulty sustaining spending compression, especially with rising security-related spending pressures; and - (v) external financing being lower than projected. - Timely disbursement of pledged foreign financing is critical. On current projections, IMF budget financing would extend beyond end-June 2010 to cover a shortfall in Tokyo-related disbursements from bilateral donors of about $700 million. ### Structural benchmarks and public financial management steps - Proposed structural benchmarks for the second half of 2009/10 include: - Implement an expedited electronic sales tax refund system in all RTOs and LTUs by end-March, 2010. - Complete an independent review of PIFRA by end-June 2010 to improve fiscal reporting and lay the basis for commitment control. - Move to a Single Treasury account by completing the transition of deposits of the largest federal spending agencies to a single treasury account and the transition of provincial government accounts to the assignment account mechanism by end-June 2010. - Introduce the VAT by July 1, 2010. - The Ministry of Finance will: (i) conduct a survey of federal government entities accounting jointly for 90 percent of remaining cash balances in commercial banks; (ii) transfer remaining balances to the TSA and close all commercial bank accounts of those agencies by end-June 2010; and (iii) complete transition of all provincial government accounts to the assignment account mechanism by end-June 2010. - To improve budget preparation, execution, and reporting, the Ministry of Finance will: (i) strengthen the medium-term budget framework to ensure recurrent costs of development programs are reflected in annual budgets; and (ii) launch an independent review—to be completed by end-June 2010—of the Project for Improving Financial Reporting and Auditing (PIFRA). ### Monetary and exchange rate policy guidance - Remaining inflation pressures and increased domestic financing of the public sector prevent the SBP from easing monetary policy to support growth. - The SBP will continue to balance support for the fragile recovery with concerns about external stability and liquidity pressures arising from the government’s large domestic financing needs. - The SBP intends to continue to capitalize on the improved external current account outlook to further strengthen reserves and has decided to complete the phasing out of direct foreign exchange provision for oil imports ahead of schedule. - Given the improved current account outlook, the SBP will continue to build reserves; consequently, the net foreign assets targets under the program have been raised. - The SBP announced in early December that it will cease provision of foreign exchange for crude oil imports by December 14, 2009. - The SBP will maintain a flexible exchange rate policy to ensure that targets are met; greater exchange rate flexibility would enhance the effectiveness of the interest rate corridor and reduce reliance on open market operations to manage liquidity. - The end-December target for the SBP’s net domestic assets has also been modified. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 31. Discussions on financial sector issues focused on the decline in private sector ### _cr1006 - 31. Discussions on financial sector issues focused on the decline in private sector ### Financial sector developments and risks - Key focus: decline in private sector credit, increase in NPLs, and actions to help several small banks meet enhanced minimum capital requirements. - Drivers of decline in private sector credit: - Increased risk aversion among banks leading to a shift in lending away from the private sector to the government and government-guaranteed paper. - Lower demand for working capital. - Since mid-2008/09, a significant part of domestic credit channeled to government-guaranteed commodity operations (mainly related to wheat procurement). - SBP concerns and actions: - The SBP remains concerned that continued risk aversion by banks may further limit lending to enterprises and hinder the economic recovery. - The SBP thinks that the growth of NPLs does not threaten banking system stability but believes banks have not been sufficiently proactive in seeking repayment or restructuring of NPLs, compounding the credit slump. - To overcome inertia, the SBP recently introduced temporary changes to the provisioning rules with respect to the rescheduled NPLs which aim to promote bilateral workouts and contribute to a resumption of credit. - The SBP clarified that the changes to the provisioning rules and rescheduling of NPLs will not result in a reclassification of NPLs. - The SBP agreed with the staff that intensified on- and off-site supervision should seek to avoid moral hazard from this temporary change in provisioning rules. - Capital requirements and bank consolidation: - Banks are generally well-capitalized, but several small banks will need to merge or receive capital injections to meet the new minimum capital requirements (increased from Rs. 5 billion at present to Rs. 6 billion at end-2009). - Plans to this effect have been agreed upon between bank owners/shareholders and the SBP. - External assessments and market signals: - Fitch recently withdrew the ratings of four major Pakistani banks, pointing to lack of investor interest and significant asset quality challenges that these banks may face over the medium term. The authorities clarified that this decision was unlikely to have any material effect as the Fitch rating was not solicited by these banks, whose activity is largely oriented to the domestic market. ### Program financing and capacity to repay the Fund - Overall assessment: - External financing remains adequate despite the projected shortfall in Tokyo-related disbursements. - Higher remittances and other transfers are expected to more than compensate for the shortfall. - Gross reserves are envisaged to strengthen further, notwithstanding some increase in political and security uncertainty. - The assessment of Pakistan’s capacity to repay the Fund remains broadly unchanged, but is subject to higher downside risks. - While higher reserves provide a cushion, uncertainties are also higher, including those linked to donor financing and commodity price trends. ### Staff appraisal — implementation, vulnerabilities, and policy priorities - Program implementation: - Program implementation has been uneven but most key reforms are moving forward. - Delays in the implementation of structural reforms were partly the result of institutional inertia and political pressures. - Considering difficult security circumstances and unfavorable domestic and external economic conditions, the authorities have made significant efforts to stay the course on stabilization and structural reform. - Underlying vulnerabilities: - Despite the strengthened external position and better market sentiment, Pakistan’s underlying vulnerabilities remain high and have increased in some areas. - Specific vulnerabilities: continued revenue shortfalls, weak credit performance, energy subsidies, and large dependence on commodity imports. - Policy prescription: credible fiscal consolidation, together with flexible interest rate and exchange rate policies and improved governance, are indispensable for reducing vulnerabilities and improving economic performance. - Fiscal management: - The fiscal slippage in the first quarter of 2009/10 points to the need for better planning and use of contingencies. - Some factors leading to the fiscal overrun were known in advance, and the slippage may have been prevented. - Authorities are encouraged to avoid further fiscal slippages to build confidence in economic policies; identified contingencies should make this feasible and reduce risk to the fiscal program. - New slippages would also heighten the risk to capacity to repay the Fund. - The authorities’ resolve to maintain the 2009/10 fiscal target will help preserve macroeconomic stability and limit potential crowding out of the private sector. - Timely disbursement of pledged foreign financing will facilitate fiscal management and avoid excessive recourse to domestic borrowing. - Tax and safety-net reforms: - The introduction of the VAT and associated administrative reforms must proceed as planned. - The VAT is central for strengthening revenue to reduce poverty and macro-vulnerabilities and finance needed investment in human and physical capital. - The target date of July 1, 2010 for the VAT introduction is ambitious, but achievable. - Passage of the VAT law by end-April 2010 is a key milestone. - Meeting the benchmarks for submission of the VAT law to parliament and introducing the automated tax refund system will play pivotal roles. - It is important to address the delay in the nationwide rollout of the strengthened targeting system for the social safety net; strengthening the social safety net is crucial to maintain social stability and ease hardship related to macroeconomic adjustment. - Monetary and exchange rate policy: - Monetary policy should continue to be cautious and accompanied by exchange rate flexibility. - The SBP should focus on counteracting ongoing inflation pressures from sources beyond its control; its primary focus should remain to strengthen its foreign reserves position and foster bank soundness. - The SBP should remain vigilant that bank lending decisions are economically sound and be alert to moral hazard risks related to regulatory forbearance. - The interest rate corridor has been working smoothly but could be better integrated in monetary policy objectives. - The SBP should take advantage of its increased independence and clarify its policy objectives, which will help ensure that interest rate policy is properly interpreted by the market. - Greater exchange rate flexibility would help the effectiveness of the interest rate corridor. *Source: IMF staff report excerpt.* ### 41. Despite the challenges faced, the authorities have made significant efforts to keep ### _cr1006 - 41. Despite the challenges faced, the authorities have made significant efforts to keep ### Program assessment and staff recommendation - Staff finds that the overall policy stance has: - helped bring inflation down from the high levels last year, - strengthened the external position, - furthered macroeconomic stabilization amid adverse security developments, weak external demand, and a rapidly changing political environment. - Some factors behind the nonobservance of the end-September fiscal deficit performance criterion were temporary; the authorities have identified measures to augment revenue and control expenditure. - Progress has been made in tax, electricity and financial sector reforms, demonstrating the authorities’ determination to press ahead with reforms in these key areas. - Based on updated commitments in the attached SMEFP, staff: - supports the requested waiver of nonobservance for the end-September quantitative performance criterion on the fiscal deficit, - supports the modifications of the end-December performance criteria on the fiscal deficit and on the net foreign assets and net domestic assets of the SBP, - recommends the completion of the third review. ### Fiscal nonobservance, waiver request, and modifications requested by authorities - The authorities request a waiver of nonobservance for the end-September 2009 quantitative performance criterion on the fiscal deficit. - The original deficit target was missed by about 0.2 percent of GDP. - Adjusting for the shortfall in external grants increased the overrun to 0.3 percent of GDP. - Causes of the fiscal overrun included: - delay in receipt of a large service payment, - extension of the period for advance income tax payments to October 15, 2009, - an advance salary payment to federal and provincial employees in September due to the Eid holiday, - higher security spending. - The authorities also request: - (i) a modification of the end-December 2009 performance criterion on the fiscal deficit to increase it by Rs. 15 billion (0.1 percent of GDP) to allow space for urgent military spending and avoid undue cuts in other priority spending; - (ii) a modification of the end-December 2009 performance criterion on the net foreign assets and net domestic assets of the State Bank of Pakistan to reflect revised projections; - (iii) establishment of performance criteria for end-March 2010 and end-June 2010. ### Policy stance, corrective measures, and conditionality - Authorities identified measures to augment revenue and control expenditure to address the fiscal overrun. - The government updated its economic program for 2009/10 in the Third Supplementary Memorandum of Economic and Financial Policies (SMEFP) submitted with the Letter of Intent dated December 11, 2009. - The government requested that the Executive Board: - complete the third review under the Stand-By Arrangement (SBA), - approve the fourth purchase under the SBA of SDR 766.7 million. - The authorities consented to publication of their Letter of Intent, the attached SMEFP, the revised Technical Memorandum of Understanding, and the related staff report. ### Key procedural and program details highlighted - The Letter of Intent and SMEFP reflect: - the program’s advancement despite military campaigns in Swat and South Waziristan increasing budget outlays for security, - the impact of depressed global economic activity and higher oil prices on Pakistan’s domestic economy, trade, and external financing, - the authorities’ readiness to take additional measures as appropriate and to consult with the Fund in accordance with Fund policies. - The authorities committed to provide the Fund with requested information to monitor progress in implementing economic and financial policies. *Source: IMF staff report and authorities’ Letter of Intent and attachments (Third Supplementary Memorandum of Economic and Financial Policies, Technical Memorandum of Understanding).* ### 1. This memorandum supplements our Memorandum on Economic and Financial ### This memorandum supplements our Memorandum on Economic and Financial Policies (MEFP) for 2008/09–09/10 ### Recent economic developments - Stabilization program has advanced despite challenging circumstances including military campaigns in Swat and South Waziristan; the South Waziristan campaign was not anticipated at the time of the budget formulation. - Headline inflation declined from 25 percent in October 2008 to 8.9 percent in October 2009. - The rupee has remained stable at around Rs. 83–84 per U.S. dollar in recent months. - Gross foreign exchange reserves reached $10.1 billion as of end-November, 2009. - Market demand for Treasury bills has remained stable. - All quantitative performance criteria for end-September 2009 were observed, except for the budget deficit target, which was exceeded by 0.3 percent of annual GDP (original target missed by about 0.2 percent of GDP; target adjusted downward for shortfall in external grants, increasing the overrun to 0.3 percent of GDP). - Signs of revival in economic activity despite electricity shortages, weak external demand, and security concerns: pick-up in output in some sectors, increased economic confidence, rising stock market index, sovereign credit rating raised, and declines in spreads on Pakistan sovereign bonds. - Slippage in fiscal performance in Q1 2009/10 mainly due to four factors totaling 0.8 percent of GDP: (i) delay in a large service payment; (ii) extension of the period for advance income tax payments to October 15, 2009; (iii) advanced salary payment to federal and provincial employees in September due to Eid; (iv) higher security spending. Fiscal slippage limited to 0.3 percent of GDP through expenditure control. - Monetary policy: SBP reduced the discount rate by 100 bps percent to 13 percent in August, and cut rates by 50 bps on November 25; SBP introduced an interest rate corridor on August 17. - External support from donors is lagging relative to pledges at Tokyo in April 2009. ### Policies for the remainder of 2009/10 — macro framework and projections - Objectives: consolidate macroeconomic stability, reduce poverty, and lay basis for high and sustained growth while coping with difficult security situation and providing social safety nets. - Key program projections: - Real GDP growth expected: 3 percent. - Projection for consumer price inflation through end-June 2010: 11 percent (year-on-year). - External current account deficit expected to decline to 4.2 percent of GDP. - Improved current account position attributed to significant improvement in expected remittances owing to the Pakistan Remittance Initiative. - Early disbursement of donor support pledged in Tokyo is needed to protect budgeted social and development spending and finance support for internally displaced persons (IDPs). ### Fiscal policy — targets, measures, and structural actions - Fiscal deficit target for 2009/10 unchanged at 4.9 percent of GDP (excluding grants). - Measures to offset mounting fiscal pressures (electricity sector, higher security outlays): - First-quarter budget overrun to be reversed mostly in Q2; higher income tax collections in October are encouraging; advance salary payment in September compensated by lower payments in October. - Federal Board of Revenue (FBR) collections target: Rs. 1,396 billion for 2009/10. Higher international oil price and planned increase in electricity tariffs expected to boost customs and sales tax revenue, offsetting weaker excise and direct tax receipts. - In Q3 2009/10: increase rate of existing special excise duty, and—if needed—reduce capital value tax exemptions. - Electricity tariff differential subsidies for the year will be contained at Rs. 55 billion; measures to make up for delay in monthly fuel price adjustments and possible gas shortages through quarterly tariff adjustment in mid-December. - Seeking from donors 0.3 percent of GDP in grants to help cover expenditures on IDPs; if grants fall short, the deficit (excluding grants) would be reduced correspondingly while protecting expenditures on IDPs, social safety net, and education. - Provincial borrowing and fiscal controls: - Borrowing by provinces limited to Ways and Means advances equivalent to six weeks of provincial wages and salaries totaling Rs. 47 billion; SBP and provinces signed agreements and are enforcing limits. - Conversion agreements: Punjab overdraft Rs. 50.9 billion and Baluchistan overdraft Rs. 8.8 billion to four-year loans with interest equal to the 6-month T-bill rate, repaid in monthly installments; government provided a guarantee to the SBP for these loans on November 23, 2009. - Regular monthly meetings between Federal Ministry of Finance and Provincial Finance Departments to monitor provincial financial positions. - Broad-based VAT introduction and revenue implications: - Plan to introduce a broad-based VAT by July 1, 2010; estimated additional revenue could reach 3 percent of GDP per annum over the medium term. - Revenue largely from removing domestic zero rating and reducing exemptions. - Consultations started with a seminar in September; drafting workshop in early November. - Time-bound action plan: - Draft law finalized in early December and submitted to parliament by end-December 2009 (structural benchmark). - Legislation to harmonize existing tax laws with the VAT law to be submitted by end-April, 2010. - Regulations for full implementation prepared for July 1, 2010. Full implementation of the VAT by July 1, 2010 is a key objective and a structural benchmark. - Tax administration reform and implementation actions: - Achievement: establishment of a functionally structured tax administration within the FBR integrating responsibilities for domestic taxes. - Actions taken or to be adopted: - On September 12, government established an Inland Revenue Service as a new occupational group within the FBR (structural benchmark). - Ordinance to harmonize the income tax and existing GST law issued on October 28; to be amended given the new VAT law and submitted to parliament by end-April 2010. - Notification to revise structures of Regional Taxpayer Offices (RTOs) and Large Taxpayer Units (LTUs) issued on November 11 (structural benchmark). - Option for retailers with turnover over Rs. 10 million to choose presumptive tax regime will be eliminated in the new VAT law. - FBR compliance and enforcement initiatives: - Identified 13,000 under-reporting taxpayers and about one million taxpayers (about 40 percent of the taxpayers with tax identification number) who do not file tax returns. Focus on under-reporting taxpayers. - Letter to under-reporting taxpayers to invite filing and settlement of prospective unpaid taxes by end-December 2009. - Letters to identified non-filers at the rate of 100,000 per month will begin by January 1, 2010, preceded by a publicity campaign starting in November. - Where voluntary approach fails, legal claims procedures will be instituted for noncompliant and nonfiling taxpayers. - Tax audit and enforcement plans approved by FBR Board: 850 companies (15 percent of large taxpayers) identified for audit by FBR or external auditors; plan to complete most audits by end-March. - Strengthening auditing capacity of the FBR planned and commitment to conduct audits regularly. - Tax refunds and electronic systems: - Government approved strengthened electronic payment and refund system. - Technical meetings with banks held; technical committee established to finalize procedures. - Expedited sales tax refund system piloted in Islamabad, Karachi and Lahore; pilots to be completed and evaluated by end-December, 2009. - Rollout nationwide after evaluation; expedited sales tax refund system to be operational in all RTOs and LTUs by end-March, 2010 (structural benchmark) and ready for VAT introduction. - Other fiscal measures: - Subsidies for companies borrowing under SBP’s Export Financing Scheme and Long-Term Financing Facility introduced to move quasi-fiscal subsidies to budget outlays; impact on budget expected to be offset by higher profit transfers from the SBP. - Social safety net strengthening: - Pilot phase of strengthened poverty scorecard for Benazir Income Support Program (BISP) completed; nationwide rollout preparations underway. - Nationwide rollout delayed; expected completion by end 2010, after which all BISP recipients will be selected using the scorecard. - Interim measures: local Tehsil offices, grievance and complaint mechanisms, test alternative payment methods. - September 2009: introduced Wasilla-ul-Haq credit program as potential graduation strategy; plan to revisit design and ensure institutional capacity before expanding graduation programs. - Budget expenditure management and PIFRA: - Plan to invigorate PIFRA reforms; independent review of PIFRA with Fund technical assistance to be completed by end-June 2010 (structural benchmark). - Review aims to improve reporting, lay basis for commitment control, and assess institutional location for PIFRA. - 2010/11 budget framework to link current and development spending under MTBF to improve expenditure planning and predictability. - Treasury Single Account / assignment account transition: - All disbursements for entities under assignment account framework to pass through zero-balance assignment account; measures to prevent leakage into commercial bank accounts. - With World Bank technical assistance, survey of remaining balances with commercial banks of largest federal spending agencies initiated in November 2009. - Funds remaining in commercial banks to be transferred to the Federal Consolidated Fund by end-June 2010, ensuring banking sector liquidity not affected. - All provincial governments to complete transition of accounts to assignment account mechanism by end-June, 2010 (structural benchmark). - Electricity sector reform, tariffs, and circular debt: - Plan developed with World Bank and Asian Development Bank staffs to eliminate electricity tariff differential subsidies by August 2010. - First adjustment of electricity tariffs partly implemented on October 1, 2009; remainder to be implemented in December. - Tariffs to be adjusted further in stages to reach cost recovery by August 2010; cap tariff differential subsidy at Rs. 55 billion in 2009/10. - Automatic monthly surcharge for changes in fuel prices and power purchase costs implemented on October 30 (delayed from end-August); electricity tariffs to be adjusted monthly by middle of each month. - First quarterly determination of overall electricity tariffs by NEPRA completed on December 10 and to be notified by December 20, 2009; regular quarterly determinations and notifications to continue. - Ordinance amending NEPRA Act (issued in July) providing for monthly surcharge and quarterly determination renewed to keep amendments in force. - Progress on circular debt resolution: - Holding Company under Ministry of Water and Power established; Board of Directors appointed. - Holding Company issued Rs. 85 billion of Term Finance Certificates (TFCs) on September 30 with government guarantee; TFCs now traded at the stock exchange. - Transfer of bulk of remaining circular debt of Rs. 216 billion expected by end-March, 2010; government has serviced this debt since July 1, 2009. - International firm audited debt from 2008/09 and earlier years slated to be assumed by the Holding Company. - Regular monthly meetings with stakeholders instituted to ensure subsidy needs remain at or below targeted levels. - Government guarantees and debt management: - Flow of new guarantees published monthly on Ministry of Finance website; total outstanding stock of government guarantees to be published monthly by end-March 2010. - Preparing a medium-term debt management strategy to improve coordination of fiscal and monetary policies, support capital market development, mobilize savings, and develop nonbank financing. - Strategy to set criteria for currency composition, interest rate basis, and maturity structure of public and publicly guaranteed (domestic and foreign) debt, and strengthen coordination between Ministry of Finance, SBP, and Central Directorate for National Saving. ### Monetary and exchange rate policies — recent actions and framework - Monetary policy continued to focus on price stability. - SBP actions: - Reduced discount rate by 100 bps percent to 13 percent in August. - Cut rates by 50 bps on November 25, 2009. - Introduced an interest rate corridor on August 17, 2009 to enhance monetary management and signaling of policy stance. - Exchange rate context: - Rationale for policy stance includes fiscal uncertainties and expected inflationary pressures from higher energy and food prices. *Memorandum on Economic and Financial Policies (MEFP) supplement for 2008/09–09/10, with first and second supplements dated March 16 and July 29, 2009.* ### 22. The SBP’s primary monetary policy objective is to reduce inflation while ### _cr1006 - 22. The SBP’s primary monetary policy objective is to reduce inflation while ### Monetary policy framework and objectives - Primary objective: reduce inflation while continuing to strengthen the international reserve position. - Decisions to adjust the SBP policy rate will take into account: - the recent improvement in inflation; - supply-side price shocks; - fiscal uncertainties. - SBP liquidity management objective: ensure the smooth functioning of the domestic market. - Introduction of new framework: - A corridor of 300 basis points for the over-night money-market repo rate was introduced. - Objective of the corridor: reduce volatility of short-term interest rates and improve transmission of monetary policy signals. - Observed outcome: limited volatility in the weighted average overnight repo rate to date. - Possible enhancements: measures related to reserve requirements and the associated maintenance period. - Coordination: SBP and the government will continue to enhance coordination and communication to strengthen the liquidity-forecasting framework. ### Exchange rate policy and foreign exchange operations - Exchange rate stance: continue to pursue a flexible exchange rate policy to strengthen the external position and maintain competitiveness. - Foreign exchange market interventions: largely aimed at achieving the program’s NFA targets. - Specific policy change: SBP phased out the provision of foreign exchange for oil imports; SBP notified market it will cease to provide foreign exchange for imports of crude oil effective December 14, 2009. ### Refinancing schemes and interest rate adjustments - Objective: rationalize SBP refinancing schemes and eliminate subsidies resulting from below-market interest rates. - Actions taken: - Interest rate for the Export Financing Scheme (EFS) increased on November 1 to 8 percent. - Interest rate for the Long-Term Financing Facility (LTFF) increased on November 1 to 9.2–10.25 percent (depending on tenor). - Future steps: - Bring rates to the level of benchmarks of weighted average yield on six-month T-bills and yields of the same tenor for Pakistani Investment Bonds, respectively. - Gradual increases to reach levels two percentage points below the benchmarks by end-September 2010. - Rates will equal their benchmarks by end-September 2011. ### Financial sector soundness and regulatory actions - Overall commitment: ensure financial stability and closely monitor financial sector soundness. - Recent indicators (through end-September): - Gross nonperforming loans (NPLs) increased by nearly 6 percent in the first quarter of 2009/10. - Gross NPL-to-loans ratio rose to 12.4 percent. - Banks remained generally well-capitalized and profitable, though profitability was lower than in the same period of 2008/09. - A few banks with capital deficiencies have either capital injection plans in place or are in active dialogue with the central bank to decide on strategy to meet capital adequacy targets (end-December 2009). - Shift of bank assets from private sector lending to investment in government paper and lending to public sector enterprises improved the average risk-adjusted capital adequacy ratio (CAR) of the banking sector. - SBP regulatory changes to facilitate NPL restructuring: - Increase in the benefit of forced sale value of collateral from 30 percent to 40 percent for calculating provisioning requirements. - Additional interim instructions on classification/provisioning requirements to facilitate rescheduling or restructuring of NPLs. - Measures to limit moral hazard and ever-greening of NPLs: - Monthly reporting on rescheduled NPLs. - Limiting the benefit from a change in provisions only to increase general reserves and not for payment of cash or dividends to shareholders. - SBP encouraged banks to coordinate recovery proceedings against defaulting groups/companies with substantial exposure across banks. - Legislative and institutional reforms: - Amendments to the Banking Companies Ordinance submitted to Parliament on October 2, 2009 (structural benchmark); approved by the parliament’s standing committee on Finance and Revenue on November 3, 2009 and submitted for plenary discussion and approval. - Amendments to the SBP law to enhance the SBP’s operational independence to be submitted to Parliament by December 20, 2009. - SBP announced composition of the nine-member Monetary Policy Committee of the SBP Board, which started work in November 2009. - Consultations on the new bankruptcy law (Corporate Rehabilitation Act) reached a final stage: - Draft revised law submitted to the Minister of Finance on November 16, 2009. - Submission to parliament expected by end-March, 2010. ### Program risks and monitoring - Main risks to the program: - Delays in mobilizing disbursements of donor support, limiting scope for higher expenditure and adding pressure on budget and domestic financing. - Deterioration in outlook for Pakistan’s trading partners leading to lower export demand. - Smaller private capital flows, partly mitigated by the Pakistan Remittance Initiative. - Adverse security developments adding to budget pressures. - If economic activity weakens, increased risks to the financial sector. - Program review and performance criteria: - Program subject to quarterly program reviews and quarterly performance criteria for 2009/10. - Request to revise end-December 2009 performance criterion on the fiscal deficit to allow space for urgent security spending and avoid undue cuts in other priority spending. - Request to revise end-December performance criteria on the net foreign assets and net domestic assets of the SBP to reflect updated projections. - Quarterly performance criteria to be set for end-March 2010 and end-June 2010. - The attached Technical Memorandum of Understanding (TMU) replaces the TMU of July 29, 2009. - Prior actions for the third review (for Board consideration of staff report): - (i) initiate taxpayer audits among the 850 companies identified for audit by either the FBR or external auditors; - (ii) government approval of an electronic payment and tax refund system. - New proposed structural benchmarks: - (i) implement expedited sales tax refund system in all RTOs and LTUs by end-March, 2010; - (ii) introduction of the VAT by July 1, 2010; - (iii) complete an independent review of PIFRA by end-June 2010 to improve reporting, lay the basis for commitment control, and assess institutional location for PIFRA. ### Program financing and quantitative targets (high-level) - Program financing status: The program remains fully financed but disbursement of the assistance pledged in Tokyo is crucial. - (Detailed quantitative criteria and memorandum items are presented in Table 1 and Table 2 of the source text, including targets and actuals for variables such as NFA of the SBP, NDA of the SBP, net government borrowing from SBP, overall budget deficit, ceilings on external debt, and memorandum financing items.) *Source: IMF staff report content provided in the supplied PDF excerpt.* ### 10. Net IMF financing to the budget is defined as the difference between Fund ### _cr1006 - 10. Net IMF financing to the budget is defined as the difference between Fund ### Definitions and scope - Net IMF financing to the budget: difference between Fund disbursements credited to the budget and repayments from the budget through the Ministry of Finance’s dedicated account for Fund financing at the SBP. - Net external budget financing: net external program financing minus privatization receipts, minus budget support grants, plus all other external loans for financing of public projects or other federal or provincial budget expenditures, plus transfers of external privatization receipts from the privatization account to the budget, plus net IMF financing to the budget. - Net domestic nonbank financing of the budget: domestic privatization receipts transferred to the budget, plus the change during each reporting period in the stock of (i) permanent debt (nonbank holdings of prize bonds, all federal bonds, and securities), (ii) floating debt held by nonbanks, (iii) unfunded debt (NSS debt, Postal Life Insurance, and GPF), (iv) net deposits and reserves received by the government (public accounts deposits), (v) any other government borrowing from domestic nonbank sources net of repayments; minus (vi) government deposits with NBFIs. - Nonbank holdings of permanent and floating debt = total debt outstanding (as reported by the SBP) minus holdings of banks as per the monetary survey. - Total T-bill and other relevant government debt are valued at discount value and exclude accrued interest. ### External debt definitions and parameters - The performance criterion on contracting or guaranteeing of medium-term and long-term nonconcessional external debt applies to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (adopted by the IMF Executive Board on August 24, 2000) and also to commitments contracted or guaranteed for which value has not been received. - Excluded from this performance criterion: - (i) foreign currency deposit liabilities of the SBP; - (ii) the outstanding stock of FEBCs, DBCs, and FCBCs. - Short-term external debt: debt with original maturity of up to and including one year (per Footnote 1 definition). - Medium- and long-term external debt: debt with initial maturity of over one year. - Nonconcessional borrowing: borrowing with a grant element of less than 35 percent. - External payment arrears: unpaid debt service by the government beyond the due date under the contract and any grace period. - Discount rates for grant element calculation: - six-month and ten-year Commercial Interest Reference Rates (CIRRs) averages, as computed by the Strategy and Policy Review Department of the IMF. - Six-month CIRRs updated mid-February and mid-August (covering the six-month period preceding the date of update). - Ten-year CIRRs averages updated mid-December (covering a period of 10 years preceding the date of the update). - Use six-month CIRRs averages for loans whose maturity is less than 15 years. - Use ten-year CIRRs averages for loans whose maturity is equal or more than 15 years. ### Tokyo-related disbursements - Definition: disbursements of donor support (loans and grants) pledged at the donor conference held in Tokyo on April 17, 2009. - Tokyo-related disbursements (excluding multilateral sources) projected: - July 2009–December 2009: $1,177 million - July 2009–March 2010: $1,962 million - July 2009–June 2010: $2,220 million - Tokyo-related disbursements from multilateral sources projected: - July 2009–December 2009: $0 million - July 2009–March 2010: $100 million - July 2009–June 2010: $270 million ### Adjustors — net external program financing - Net external program financing excludes any budget grants related to IDPs, program portion of Tokyo-related disbursements, and Fund financing to the budget. - Projected net external program financing (exclusions applied): - July 2009–December 2009: -$928 million - July 2009–March 2010: -$1,082 million - July 2009–June 2010: -$171 million - Excess rule (U.S. dollar terms): if actual cumulative net external program financing is higher than projected by more than $500 million, excess = actual minus projected minus $500 million. Convert excess to rupee terms using fixed accounting exchange rate of Rs. 83 per $1. - Ceiling on consolidated overall budget deficit (excluding grants) will be adjusted upward for cumulative excess in net external program financing in rupee terms for up to: - Rs. 73.5 billion at end-December 2009 - Rs. 73.5 billion at end-March 2010 - Rs. 73.5 billion at end-June 2010 - Definition of "surplus net external program financing in U.S. dollar terms": cumulative excesses in U.S. dollar terms minus the maximum cumulative amounts specified for end-December 2009, end-March 2010, and end-June 2010 converted at Rs. 83 per $1. Surplus in rupee terms = surplus in U.S. dollar terms × Rs. 83 per $1. - Adjustments when surplus occurs: - Floors on the NFA of the SBP adjusted upward by cumulative surplus net external program financing in U.S. dollar terms. - Ceilings on the NDA of the SBP and net borrowing from the SBP by the government adjusted downward by cumulative surplus net external program financing in rupee terms. - Shortfall rule (U.S. dollar terms): if actual cumulative net external program financing is lower than projected, shortfall = projected minus actual. - a. Floor on the NFA of the SBP adjusted downward by cumulative shortfall in U.S. dollar terms. - b. Ceiling on the NDA of the SBP adjusted upward by cumulative shortfall converted into rupees at Rs. 83 per $1. - c. Ceiling on net borrowing from the SBP by the government is not subject to adjustment. ### Adjustors — Tokyo-related disbursements (excluding multilateral sources) - Shortfall definition: projected minus actual in U.S. dollar terms; convert to rupee terms at Rs. 83 per $1. - If shortfall in rupee terms exceeds Rs. 117.94 billion, the ceiling on the consolidated overall budget deficit (excluding grants) is adjusted downward up to: - Rs. 29.49 billion at end-September 2009 - Rs. 58.97 billion at end-December 2009 - Rs. 58.97 billion at end-March 2010 - Rs. 58.97 billion at end-June 2010 - (Equivalent to $0.71 billion valued at Rs. 83 per $1) - Additional adjustments for shortfall: - b. Floor on the NFA of the SBP adjusted downward by cumulative shortfall in U.S. dollar terms. - c. Ceiling on the NDA of the SBP adjusted upward by cumulative shortfall in rupee terms. ### Adjustors — Tokyo-related disbursements from multilateral sources - Shortfall definition and conversion: projected minus actual in U.S. dollar terms; convert to rupee terms at Rs. 83 per $1. - If shortfall occurs: - a. Ceiling on the consolidated overall budget deficit (excluding grants) adjusted downward by shortfall in rupee terms. - b. Floor on the NFA of the SBP adjusted downward by shortfall in U.S. dollar terms. - c. Ceiling on the NDA of the SBP adjusted upward by shortfall in rupee terms. - d. Ceiling on net borrowing from the SBP by the government will not be adjusted. ### Adjustor — net IMF (Fund) financing to the budget - Projected net IMF financing to the budget: - July 2009–December 2009: $1,072 million - July 2009–March 2010: $1,430 million - July 2009–June 2010: $0 million - Difference definition: actual net Fund financing in U.S. dollar terms converted using actual SDR/U.S. dollar exchange rates minus the projected amount. - If difference exists: - a. Floor on the NFA of the SBP adjusted by the difference in U.S. dollar terms (upward if positive, downward if negative). - b. Ceiling on the NDA of the SBP adjusted by subtracting the difference converted into rupees at Rs. 83 per $1 (downward if difference is positive, upward if negative). ### Adjustor — SDR allocations - Difference definition: actual SDR allocation in U.S. dollar terms (converted using actual SDR/dollar exchange rates) minus projected amount (Table 2). - If difference exists: - a. Floor on the NFA of the SBP adjusted by the difference in U.S. dollar terms (upward if positive, downward if negative). - b. Ceiling on the NDA of the SBP adjusted by subtracting the difference converted into rupees at Rs. 83 per $1 (downward if difference is positive, upward if negative). ### Adjustor — external project grants excluding IDP grants and Tokyo-related grants - If external project grants (excluding IDP and Tokyo-related) differ from program assumptions (see Table 2), the ceiling on the consolidated overall budget deficit (excluding grants) will be adjusted upward or downward for the cumulative excess or shortfall. - This adjustor will not be applied in addition to any adjustment made under paragraphs 19, 25a, and 27a. ### Adjustor — total IDP grants (project and budget) - If total IDP grants differ from program assumptions (see Table 2), the ceiling on the consolidated overall budget deficit (excluding grants) will be adjusted upward or downward for the cumulative excess or shortfall. - Any shortfall in the period July–December 2009 will not be applied to the ceiling for this period. - This adjustor will not be applied in addition to adjustments under paragraphs 19, 25a, and 27a. ### Adjustor — changes in regulations on required reserves - Ceilings on the NDA of the SBP adjusted by the amount of: - (i) banks’ Pakistani rupee reserves freed/seized by any reduction/increase of the daily CRR relative to baseline assumption; and - (ii) any reduction/increase in the reservable deposit base related to definitional changes. - Formula: ∆NDA = ∆r B0 + r0 ∆B + ∆r ∆B, where: - r0 denotes the reserve requirement ratio prior to any change; - B0 denotes the level of the reservable deposits in the initial definition; - ∆r is the change in the reserve requirement ratio; - ∆B denotes the change in the reservable deposits as a result of definitional changes. - SBP will consult IMF staff in case of significant liquidity and other financial sector pressures to reach understanding on appropriate monetary policy response. ### Adjustor — SBP’s net position under foreign exchange forwards and swaps - NFA target of the SBP will be adjusted upward/downward by the amount of the increase/decrease in the net SBP’s position under foreign exchange forwards and swaps. - SBP’s net exposure under foreign exchange forwards and swaps was $2.035 billion at end-September 2009. - Maximum SBP’s net exposure under foreign exchange forwards and swaps is capped at $2.5 billion for end-December 2009, end-March 2010, and end-June 2010. ### Adjustor — foreign currency deposits of resident banks with the SBP - NFA target of the SBP will be adjusted upward/downward by the amount of increase/decrease in foreign currency deposits of resident banks with the SBP. - Stock of foreign currency deposits of resident banks with the SBP was $779 million at end-September 2009. *Source: _cr1006 - 10. Net IMF financing to the budget is defined as the difference between Fund* ### 36. The following information, including any revisions to historical data, will be provided ### _cr1006 - 36. The following information, including any revisions to historical data, will be provided ### Reporting requirements to the Middle East and Central Asia Department (via Resident Representative) - Monthly provisional statements on federal tax and nontax revenue, within one month. - Deposits into and withdrawals from the privatization accounts for each quarter, within one month. Withdrawals to be reported with breakdown: (i) budgetary use of privatization proceeds; (ii) costs of privatization; and (iii) other (with explanation), and breakdown between domestic and external privatization receipts. - Quarterly statements on budgetary capital receipts and disbursements, including repayments of bonds, recovery of loans from provinces and “others,” within two months. - Monthly (unreconciled) provisional data on federal expenditure and net lending (with separate data on disbursements and repayments), within one month. - Quarterly statement on consolidated budgetary expenditure, with federal data approved by the Accountant General Pakistan Revenue (AGPR), within two months. - Quarterly numbers on expenditure on social programs. - Quarterly data on the stock of domestic government debt, broken down by instrument, within one month (Table 3). - Quarterly data on WAPDA receivables within one month. - Monthly data on Outstanding Audited Price Differential Claims. - Monthly data on external budget financing, including: - (i) loan-by-loan program disbursements in U.S. dollar terms and rupee terms converted at exchange rates prevailing at the time of each transaction; - (ii) cumulative amortization in U.S. dollar terms and rupee terms converted at exchange rates prevailing at the time of each transaction; and - (iii) cumulative project loan disbursements in U.S. dollar terms and in rupees converted at exchange rates prevailing at the time of each transaction. - Tokyo and IDP related disbursement should be indicated separately. - Monthly data on Banks’ Budgetary Support (Table 1) within one month. - Monthly monetary data on a last-Saturday basis within two weeks: - (i) monetary survey; - (ii) accounts of the SBP; - (iii) consolidated accounts of the scheduled banks; - (iv) banks’ lending to the government; - (v) detailed table on net foreign assets (both for the SBP and scheduled banks); and - (vi) detailed table of scheduled banks’ reserves with the SBP. - Same tables as preceding item, but on an end-month and end-quarter basis (last business day), both at current and program exchange rates, within one month. - SBP Table on outstanding stock of foreign currency deposits, amended to include classification of new FCA according to the residency of the holder. - Daily data on exchange rates (interbank, retail market, and Telegraphic Transfers for SBP purchases in the retail market), SBP’s sales and purchases in the foreign exchange markets, swaps and forward outright sales, within two business days. - Monthly data on the outstanding stock of the SBP’s forward foreign currency operations, including swaps and outright forward sales and purchases, within two weeks. The terms of any new transactions (including rollover/renewal of existing ones) will also be provided. - Monthly data on the SBP’s foreign exchange reserves, with details on the currencies, instruments, and institutions in which the reserves are held, within one month. - Monthly data on SBP direct or bridge loans to nationalized banks in the context of the restructuring and privatization operation, within four weeks. - Monthly data on any other quasi-fiscal operations undertaken by the SBP, on behalf of the government. - Monthly data on SBP holding of discounted export finance credit under the export finance scheme, within one month. - Monthly data on outstanding credit to agriculture under the Agriculture Mandatory Credit Targets, within one month. - External debt data, within one month: - (i) Quarterly stock of public- and publicly-guaranteed external debt (including deferred payments arrangements), by maturity (initial maturities of up to and including one year, and over one year), by creditor and by debtor (central government and publicly guaranteed); - (ii) Quarterly contracting or guaranteeing of nonconcessional medium- and long-term government debt; and - (iii) Information on any rescheduling on public- and publicly-guaranteed debt reached with creditors. - Quarterly data on external payments arrears on public and publicly guaranteed debt with details as in (i) above within one month. - Copies of new or revised ordinances/circulars regarding changes in tax policy, tax administration, foreign exchange market regulations, and banking regulations no later than three days after official issuance, or notification that ordinances have been posted on the Federal Board or Revenue (FBR) and SBP websites. - Copies of official notification of changes in gas and electricity tariffs and any surcharges (automatic or structural) and in ex-refinery petroleum product prices as well as of gas and petroleum surcharges/levies. - Monthly data on the import parity prices as well as central depot prices of the six major oil products, within one month. - Quarterly data on KESC and WAPDA loans and debt outstanding, within one month. - Upon adoption of the plan for elimination of inter-corporate circular debt, monthly reports on inter-corporate circular debt will be reported within one month. - Information on new liabilities incurred or guaranteed by the government in settling the circular-debt, including government guarantees of Term Financing Certificates (TFCs) issued by Pakistan Electric Power Company (PEPCO). Information to include size of government exposure, duration of guarantee or claim, and any other provisions relevant for the government’s exposure. - Information on the transactions between the Ministry of Finance and the SBP with regard to the use of Fund resources for budget purposes on monthly basis. ### Selected budgetary and financing figures presented in the chapter (verbatim) - Net Govt. Borrowings (Cash basis) 1,629,9911,669,0041,704,451 - 1,129,5161,046,9051,089,735 - 500,475622,098614,716 - Table 1. Pakistan Budgetary Support (In million Rupees) — Source: State Bank of Pakistan - Table 2. Pakistan: External Financing For Budget for 2008/09 and 2009/10 (In millions of U.S. dollars) — selected lines (verbatim from table): - Project Aid2483312683191,1652312661,2369992,732 - Grants, of which2321502962722285265599 - Program Loans4948116778152,797414366001,1002,150 - Budget financing from the Fund...............745354354-733719 - Amortization7008028103792,6914789389493222,687 - Net budget financing824521,1421,9039126682,3033,4803,480 - Net program financing for the budget (excl. Tokyo related disbursements, IDP grants, Fund financing to the budget) 1/ -166-127296737-64-928-1,082-171-171 - Tokyo-related disbursements (excl. multilateral sources) 1/ 00003421,1771,9622,2202,220 - Table 3. Pakistan: Total Outstanding Domestic Debt (In billion Rupees) — selected stock lines (verbatim): - A.Permanent Debt608.0 678.0 717.1 - Market Loans3.0 2.9 2.9 - Pakistan Investment Bonds (PIBs)412.0 441.0 456.7 - Prize Bonds183.0 197.4 207.4 - B.Floating Debt1,637.0 1,904.0 1,970.4 - Market Treasury Bills (auction)537.0 796.1 959.6 - MTBs for Replenishment*1,100.0 1,107.9 1,010.8 - C.Unfunded Debt 1,020.0 1,270.5 1,322.5 - Total (A+B+C)3,266.0 3,852.6 4,010.0 - Note: * Inclusive of outright sale of MTBs to commercial banks. Source: State Bank of Pakistan (Statistics & DWH Department). ### Institutional, program, and surveillance context (key figures and dates) - Prepared by Middle East and Central Asia Department — December 14, 2009. - Membership Status: Joined: 07/11/1950; Article VIII. - Quota 1,033.70 100.00 (SDR Million; % Quota). - Fund Holdings of Currency 4,436.22 429.16 (SDR Million; % Quota). - Net cumulative allocation 988.56 100.00 (SDR Million; % Allocation). - Stand-by Arrangements outstanding: 3,402.64 329.17 (SDR Million; % Quota). - Latest Stand-By Approval Date 11/24/2008; Expiration 10/23/2010; Amount Approved 7,235.90 (SDR Million); Amount Drawn 3,402.64 (SDR Million). - Projected Payments to the Fund (SDR Million; based on existing use of resources and present holdings of SDRs): - Forthcoming 2009 2010 2011 2012 2013 - Principal 43.07 172.28 172.28 1,418.11 1,787.46 - Charges/Interest 13.79 52.53 51.66 42.21 20.43 - Total 56.86 224.81 223.95 1,460.32 1,807.89 - Exchange rate regime: dual exchange rate unified on May 19, 1999; classification as floating; restriction maintained: 25 percent limit on advance payments for imports of goods (subject to Fund approval). Authorities eliminated cash margin requirements on letters of credit in June 2009. - Last Article IV consultation discussed by Executive Board on March 23, 2009 (Country Report 09/ 123). - Safeguards: full safeguards assessment under Stand-By Arrangement approved November 2008; update safeguards assessment underway in relation to augmentation of access under the Stand-By Arrangement. - Resident Representative: stationed in Islamabad since August 1991; current resident representative Mr. Paul Ross took up his post in October 2008. *Prepared by Middle East and Central Asia Department — Informational Annex (December 14, 2009).* ### 4. In line with Pakistan’s recent performance and the government’s request for increased ### _cr1006 - 4. In line with Pakistan’s recent performance and the government’s request for increased ### CAS lending and IFC strategy - The CAS outlines a substantial increase in the volume of lending to Pakistan through FY2009. - Expansion in lending will take place primarily in infrastructure (mainly in energy, water, and transport) and human development. - One priority is to continue to assist in addressing the impact of the October 2005 earthquake—up to $1 billion will be used to support reconstruction and recovery. - Overall, a flexible lending program of up to $6.5 billion is set forth in the CAS. - About half of this amount ($3.1 billion) will take the form of IDA credits. - Policy-based lending will account for up to half of planned financial support. - The IFC strategy in Pakistan seeks to increase investments with a target range of $500–600 million during the FY2006–09 period. - IFC activity will focus on three main sectors: financial, SME and infrastructure. - IFC has initiated a substantial TA program in Pakistan to build capacity and address constraints of the SME, infrastructure and financial sectors. ### IBRD/IDA financial operations since FY2002 (key figures) - Commitments (In millions of U.S. dollars) - IBRD: FY2002 ... ... 50 347 315 100 - IDA: 800 297 731 500 1,161 885 - Disbursements (In millions of U.S. dollars) - IBRD: 38 40 13 203 149 154 - IDA: 830 316 290 778 1,061 1,030 - Repayments (In millions of U.S. dollars) - IBRD: 255 257 277 299 289 265 - IDA: 71 83 96 111 117 170 - Debt Disbursed and Outstanding (In millions of U.S. dollars) - IBRD: 2,820 2,706 2,526 2,406 2,247 2,132 - IDA: 5,097 5,604 6,020 6,651 7,627 8,700 ### IMF Staff Representative statement — developments and near-term implications (as of December 23, 2009) - These developments do not alter the thrust of the staff appraisal. - Political and legal developments - On December 16, the Supreme Court declared the 2007 National Reconciliation Ordinance (NRO) invalid, allowing investigations and court cases to proceed. - Dubai World standstill - The standstill on the debt of Dubai World has had a limited impact on the Pakistani economy and the banking system. - Two Pakistani banks have exposure to the United Arab Emirates. One bank has Abu Dhabi exposure and is not affected by the standstill. The other bank, with exposure to Dubai World, has adequate capital to absorb any losses, according to the State Bank of Pakistan. - Confidence in the banking system in Pakistan has been steady, with the interbank market working normally and deposits unaffected. - Dubai accounts for 5–10 percent of trade and financial flows; direct impact on trade and financial flows is likely to be small. - Rapid remittance growth experienced in July–November (29 percent) may not continue if expatriate Pakistanis lose jobs in Dubai. - After a limited initial impact, Pakistan’s sovereign and CDS spreads have been little affected. - Fiscal federalism and VAT facilitation - The National Finance Commission concluded its work and agreed revenue sharing for fiscal years 2010/11–2015/16. - Provinces’ share rises to 57.5 percent in 2011/12 compared to 47.5 percent currently. - Revenue distribution was reallocated with a larger share going to Baluchistan; the arrangement helps facilitate the introduction of a VAT. - Implemented policy commitments from the Third Supplementary Memorandum of Economic and Financial Policies - Tax audits have commenced (a prior action). The Federal Board of Revenue (FBR) has identified 921 companies and associations for audit. Audits started on December 12; auditors posted to regional tax offices. - Electricity reform: the notification (implementation) of the quarterly tariff adjustment was done on December 21, 2009. - On December 21, the government submitted amendments to the State Bank of Pakistan (SBP) Act to parliament to increase the SBP’s operational autonomy. Staff reviewed draft amendments sent by the SBP to the government, but has not yet seen the final version submitted to parliament. - Austerity and public sector reform (federal cabinet, December 16) - A set of austerity measures approved to achieve cost effective governance through rationalization of expenditure, better resource use, process re-engineering and efficiency of operation. - Plans include reduction in number of federal ministries and departments, devolution of responsibilities to provinces, restructuring of eight public sector enterprises with a view to privatizing them, improving the budgetary process, and overhauling the implementation of the public sector development program. - Expenditures on utilities, furnishings, and use of vehicles will be standardized and reduced. - Remuneration of government employees is under review with the objective of moving towards a pay for performance model with monetization of benefits. ### IMF Press Release No. 09/480 — Third review under Stand-By Arrangement (December 23, 2009) - The Executive Board completed the third review of Pakistan’s performance under the SBA. - Completion of the review enables immediate disbursement of an amount equivalent to SDR 766.7 million (about US$1.2 billion), bringing total disbursements under the program to an amount equivalent to SDR 4.17 billion (about US$6.54 billion). - The Executive Board approved Pakistan’s request for a waiver for the non-observance of the end-September performance criterion on the ceiling of the overall budget deficit, which was missed by a margin of 0.3 percent of GDP. - SBA background and augmentation - The 23-month SBA in an amount equivalent to SDR 5.17 billion (about US$8.11 billion) was approved on November 24, 2008. - On August 7, 2009, the SBA was augmented to an amount equivalent to SDR 7.24 billion (about US$11.35 billion) and extended to end 2010. ### Selected Board and mission observations and recommendations - Murilo Portugal, Deputy Managing Director and Acting Chair: assessment highlights and priorities - Recognized significant efforts to stay the course on stabilization and structural reform despite weak external demand and a difficult security and political environment. - Noted that inflation has declined, the external position strengthened, and tangible progress made in tax, electricity, and financial sector reforms. - Identified key vulnerabilities: low revenue collection, large energy subsidies, and weak private sector credit. - Recommended: credible fiscal consolidation supported by flexible interest rate and exchange rate policies, further structural reforms, and improved governance to reduce vulnerabilities. - Emphasized: adherence to the 2009/10 fiscal target, resolute implementation of tax administration reforms, timely disbursement of pledged foreign financing, introduction of the VAT and associated administrative reforms scheduled for July 1, 2010, nationwide rollout of strengthened targeting system for social safety net, cautious monetary policy stance, maintaining a flexible exchange rate policy, harmonizing the interest rate corridor with monetary policy objectives, and continued vigilance to ensure bank lending decisions are economically sound and to avoid moral hazard risks. - Statement by Mr. Mojarrad and Mr. Ahmad (Executive Director and Advisor for Pakistan) - Acknowledged Fund’s role in supporting stabilization via the SBA and catalytic role with donors; reserves buoyant, core inflation brought down, financial sector solvent. - Observed that stress tests indicate banks are well placed to sustain shocks; interest rate corridor is working; Pakistan Remittance Initiative encouraged channeling remittances through official channels and anticipated decline in remittances has not materialized. - Noted subdued private sector demand for credit; industry and trading remain depressed despite some improvement in growth and an excellent wheat harvest. - Fiscal performance and revenue issues: - Revenue decline largely due to exogenous reductions in activity levels—more than offsetting the increase in the standard rate of GST during 2008/9. - Restructuring in the Federal Board of Revenue since 2009 contributed to revenue decline, especially given legal challenges to the creation of an Inland Revenue Service since March 2009. - Despite imposition of the Petroleum Levy since July 2009 and drastic reductions in public investment, the fiscal deficit target for end September was narrowly missed; slippages largely made up since then mainly due to tight controls over investment spending. - Government intends to meet the budget target for the year; authorities have agreed with staff to invoke a second-best measure, if necessary, involving an increase in the special excise surcharges that effectively raise tariffs. - Structural reform progress and political economy: - Noted significant progress on structural reform despite security situation. - Highlighted the recent National Finance Commission award as first in twelve years and as evidence of broad-based support for reforms. - Tax administration and VAT reform: - Historical context: Pakistan has had a VAT since 1990 (called GST previously) that did not work well due to administrative weaknesses, refunds issues, and suspension of the auditing function in 2004. - Resurrection of tax administration reforms in 2008 led to integration of functions and creation of the Inland Revenue Service in 2009, despite High Court challenges. - Audit process resurrected with a random audit process in public view to enhance transparency; a new draft law for the taxation of goods and services has been prepared with international expert assistance and is being discussed with stakeholders. - Government intends to submit the law to Parliament by end-December as agreed under the program, though binding Parliament to a specific passage date may be counterproductive. - Emphasized the need for an automated VAT refunds mechanism fully tested before full rollout to avoid large-scale leakages; strengthening audit capability is key. - Treasury Single Account (TSA) - Government established zero-balance assignment accounts to prevent accretion to balances outside the Federal Consolidated Fund/TSA. - A Bank Technical Assistance mission in September 2009 addressed the stock of balances held in commercial banks; a survey found most balances due to donor legal requirements or not strictly government funds (e.g., autonomous university income). - Remaining balances that should be in the TSA will be transferred as agreed by end of the fiscal year, considering impact on the banking system. - External financing and program dependence - The budget and Fund-supported program remain predicated on disbursements from the Friends of Pakistan promised in Tokyo. - Continued success under the program depends on these resources materializing within the envisaged timeframe. *Italic: Source: IMF staff report and press release materials (Statement by the IMF Staff Representative on Pakistan; Press Release No. 09/480; Statement by Mr. Mojarrad and Mr. Ahmad), December 23, 2009.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr1006.pdf_