## _cr1235

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---

### INTRODUCTION — summary findings and consensus on priorities
- Context and recent history
  - At the March 2009 Article IV consultation Pakistan was emerging from the 2008 crisis, supported by a Stand-By Arrangement (SBA) approved in November 2008.
  - The SBA went off-track in June 2010 (following the fourth review in May 2010) and stayed off-track until it expired at end-September 2011.
- Policy actions taken since 2008
  - Improvements in tax administration and removal of some tax exemptions.
  - Introduction of an interest rate corridor and a more market-based exchange rate regime.
  - Strengthened SBP enforcement powers for dealing with problem banks.
  - Domestic price increases: main petroleum products about 70 percent and electricity tariffs about 90 percent since early 2008.
  - Benazir Income Support Program (BISP) provided basic income support during shocks.
- Mission–authorities convergence on priorities
  - Policy priorities: tighter fiscal policy, a less accommodative monetary policy stance, and structural reforms (especially fiscal and energy sectors).
  - Need to build on the government’s New Growth Strategy to develop a comprehensive multi-year economic strategy with broad stakeholder buy-in.
  - Emphasis on correcting microeconomic and institutional problems: agricultural procurement and electricity subsidies, patronage, weak management, poor service delivery, governance and rent-seeking.

### BACKGROUND — key structural features and institutional constraints
- Endowments and opportunities
  - Pakistan’s geostrategic location and natural and human resource potential; expansion of regional trade and demographic dividend (about half of Pakistan’s population is under the age of 20).
- Political and security constraints
  - Civilian coalition government since 2008; judiciary and press more independent; military retains considerable political influence.
  - Political instability, rent-seeking, and patronage have undermined sustained economic reform and fiscal discipline; internal security remains a major challenge.
- Vulnerability to exogenous shocks
  - Repeated natural disasters, including two major floods in 2010 and 2011.
  - IMF emergency financial assistance to help cope with the aftermath of the 2010 floods amounted to US$451 million.
  - Narrow export base (cotton and textiles account for more than half of exports) and need to import oil and some food products.
- Fiscal structure and public finances
  - Government tax revenue is about 10 percent of GDP, one of the lowest in the world.
  - Number of taxpayers filing income tax returns is about 1 percent of the population.
  - Subsidies (mostly electricity) and interest payments consume almost half of government revenue; security spending uses up another quarter.
  - Subsidies to loss-making public-sector enterprises amounted to nearly 2 percent of GDP in 2010/11.
- Fiscal decentralization and challenges
  - Seventh NFC Award (from July 2010) allocated a much larger share of revenue to provinces; more than half of federally collected tax revenue is now transferred to provinces.
  - The 18th Constitutional Amendment (implemented July 2011) devolved additional expenditure responsibilities to provinces; assignment of responsibilities remains unclear in some areas.
  - Provincial own revenue is very low, creating incentives for fiscal indiscipline; recommendation for strengthened rules and a binding mechanism to coordinate provincial and federal fiscal targets.
- Energy sector constraints
  - Outages averaged eight hours a day in the summer of 2011.
  - Energy constraints estimated to cost about 2 percent of GDP in forgone growth.
  - Budgetary electricity subsidies reached about 1½ percent of GDP in 2010/11 (including 0.6 percent of GDP recognition of past subsidies).
  - Circular debt estimated at 3 percent of GDP; periodic government assumption of circular debt undermines public finances.
- Financial intermediation and credit
  - Private sector credit growth weak; bank lending to the private sector has declined in relation to GDP and been surpassed by lending to the public sector.
  - Bank financing of public sector and commodity operations, risk aversion, and rising private-sector NPLs have reduced bank willingness to lend to the private sector.
  - Limited competition and limited capital market development contribute to wide banking sector spreads.

### ECONOMIC OUTCOMES — growth, labor, savings, inflation, and external position
- Growth and labor market
  - Real GDP growth has been on a declining trend and relatively volatile; in the past four years real GDP growth averaged only 3 percent.
  - Official unemployment rate reported as 6 percent; unpaid employment estimated at 28 percent of the employed in the 2010/11 Labor Force Survey.
  - Estimated required average GDP growth of 7 percent per year to absorb about 2 million new labor market entrants annually.
- Savings and investment
  - Private investment has declined in recent years; public investment has fallen.
  - Private savings remain low compared to other countries in the region.
- Inflation and monetary–fiscal interaction
  - CPI inflation slipped below 10 percent in December 2011 to 9.7 percent year-on-year.
  - Staff analysis points to central bank financing of the fiscal deficit as an important driver of inflation.
  - Estimated inflation threshold for Pakistan: 9 percent (empirical estimate cited).
- External position and reserves
  - Surge in exports and strong remittances helped rebuild international reserves in 2010/11, but later deterioration in current account and weakening financial inflows put pressure on the rupee.
  - SBP intervened in spot and forward markets during July–December 2011 despite increased exchange rate flexibility.

### POLICY DISCUSSIONS — diagnostics and recommended actions
- Fiscal policy
  - Need for tighter fiscal policy to reduce vulnerabilities and build buffers.
  - Broaden the tax base and improve tax administration.
  - Reduce distortions from subsidies and loss-making public enterprises; limit budgetary transfers to PSEs and address circular debt in the energy sector.
  - Strengthen fiscal rules and intergovernmental fiscal frameworks to coordinate federal and provincial fiscal targets.
  - Short-term staff proposal to cap 2011/12 deficit at 5.7 percent of GDP (5½ percent including grants).
  - Suggested revenue and spending measures: tighten non-wage current spending, reduce non-power subsidies, re-introduce the special excise duty and income tax surcharge, raise the sales tax rate, minimize electricity subsidies, and keep provincial budgets in surplus.
  - Reformed General Sales Tax (GST) could generate up to 3 percent of GDP in additional tax revenue.
- Monetary and financial policies
  - Adopt a less accommodative monetary stance to contain inflationary pressures linked to fiscal financing.
  - Reduce reliance on central bank financing of the fiscal deficit; scale back large liquidity injections by the SBP.
  - Strengthen central bank operations and SBP autonomy; draft amendments under discussion in parliament do not ensure operational independence according to staff.
  - Address banking sector weaknesses, rising NPLs, limited competition, and limited capital market development to restore private credit growth.
  - Recommendations: resolve problem banks promptly, apply prudential regulations uniformly, pass explicit deposit insurance legislation, establish commercial courts to speed up loan recovery, and develop capital markets.
- Structural reforms and growth strategy
  - Implement structural reforms emphasized in the New Growth Strategy: tackle noncompetitive markets, poor governance, limited urban development, inadequate education, low openness, and limited innovation.
  - Reform the energy sector to reduce outages, achieve cost-recovery tariffs, improve collections, and eliminate circular debt buildup.
  - Improve public sector management and service delivery, limit patronage and rent-seeking, and develop a comprehensive economic strategy with stakeholder buy-in to promote inclusive growth.

### RISKS, VULNERABILITIES, AND MEDIUM-TERM CONCERNS
- Main vulnerabilities identified
  - Overly expansionary macroeconomic policies and weak structural reforms increasing vulnerability to shocks.
  - Persistent inflation, weak growth, rising balance-of-payments pressures, and few buffers to absorb shocks.
  - Political calendar (senate elections in March 2012 and parliamentary elections in 2013) likely to constrain reform momentum.
- Specific risk factors
  - Continued central bank financing of fiscal deficits could perpetuate inflation.
  - Energy-sector fiscal drains and recurrent circular debt undermine fiscal sustainability and crowd out private investment.
  - Fiscal decentralization without clear rules risks lack of coordination and fiscal indiscipline at subnational levels.
- Staff appraisal scenarios and outlook
  - In a scenario of unchanged policies (high fiscal deficits, accommodative monetary conditions, structural reform stasis) outcomes would include: growth remaining subpar, inflation excessive, reserves too low, social indicators disappointing.
  - Risks to the outlook are tilted to the downside; contingency planning is needed.

### BOX: Why is Inflation in Pakistan So High and Persistent?
- Main drivers
  - Central bank lending to finance fiscal deficits identified as a key driver.
  - Pre-2008 12-month CPI inflation average: 5.5 percent.
  - Inflation peak: 25 percent year-on-year in August 2008.
  - Inflation expectations (survey): around 15 percent.
  - Decline in reserves attributed in part to SBP spot market intervention: nearly US$2 billion.
  - Rupee depreciation cited: a 4½ percent depreciation against the US dollar.
  - Net swap/forward position movement: to US$1,625 million short as of end-December, 2011, from a long position of US$150 million at end-June 2011.
  - Nonperforming loans (gross NPLs): 16.7 percent of total loans at end-September 2011.
- Persistence and model evidence
  - Inflation persistence increased since 2008 and is higher than in regional peers.
  - A single-equation model found SBP lending to government statistically significant in explaining short-term headline CPI inflation, with significance for lagged inflation*, SBP claims on government*, global fuel price*, index of industrial activity (LSM) and interest rates*.
- Policy implications
  - Credibly adopt a less accommodative monetary policy stance.
  - Scale back large liquidity injections by the SBP and avoid direct government borrowing from the SBP.
  - Avoid switching government financing to commercial banks supported by SBP liquidity injections, as this preserves accommodative financing and inflationary pressures.

### FISCAL DEVELOPMENTS — deficit, revenue, spending, and medium-term strategy
- Fiscal developments and deficit size
  - General government deficit (excluding grants) reached 6.6 percent of GDP in 2010/11.
  - Budget recognized past electricity arrears of 0.6 percent of GDP; excluding arrears, the deficit reached 6 percent of GDP.
  - So far in 2011/12 (July to September), the fiscal deficit was 1.2 percent of GDP, lower than the 1.5 percent of GDP deficit recorded in the same period in 2010/11.
  - Staff argued the deficit was heading for 7 percent of GDP absent corrective measures.
- Revenue and spending dynamics
  - Tax revenue collections declined slightly as a percent of GDP; tax reform foundered due to insufficient political support.
  - Total spending declined by 1¼ percent of GDP, but high spending on subsidies, security, and interest, as well as a 15 percent salary increase, crowded out more productive spending.
  - Strong tax revenue in early 2011/12 partly reflects one-time factors.
- Medium-term fiscal strategy and structural measures
  - With gradual deficit reduction and continued low borrowing costs, public debt would be sustainable but remains high and vulnerable to shocks.
  - A substantial increase in tax revenue is necessary for sustainable deficit reduction.
  - Other revenue options: broader income tax regime and property taxes.
  - Spending priorities: resolve power sector problems and loss-making PSEs; phase out costly commodity operations financed by government-guaranteed bank loans (stock of commodity credits at 1½ percent of GDP); strengthen debt management and cash management.

### FISCAL DECENTRALIZATION — risks and remedial measures
- Key facts
  - Share of the divisible pool allocated to provinces: 47 percent in 2008/09; 56 percent in 2010/11 (65 percent of total FBR tax collection in that year); 57.5 percent in 2011/12 and thereafter.
  - Provinces’ own tax collection remains very low: less than 0.5 percent of national GDP (reported about 0.5 percent of GDP).
  - Additional devolved resources to provinces: about Rs 200 billion; devolved spending estimated at Rs 67–Rs 91 billion.
  - Federal medium-term target mentioned: reduce general government deficit to 3 percent of GDP.
- Risks from rapid decentralization
  - Vertical fiscal imbalance is large; rapid devolution risks fiscal indiscipline, overwhelmed provincial capacity, and weak incentives to raise own revenue.
- Proposed safeguards and measures
  - Modify rules governing the divisible pool (e.g., lower provincial share at the margin, or a “cap” indexed to a price index until deficit reduced to target such as 3 percent of GDP).
  - Tight controls on provincial borrowing and possible provincial equivalent of the 2005 federal Fiscal Responsibility and Debt Limitation Act.
  - Strengthen cooperation under the Council of Common Interest (CCI).
  - Improve provincial administrative capacity, data provision, and accountability.

### MONETARY AND FINANCIAL SECTOR — policy, indicators, and recommendations
- Monetary stance and SBP actions
  - SBP cut its policy rate by a cumulative 200 basis points to 12 percent in its first two Board meetings during 2011/12 (July and September 2011).
  - SBP lending to the budget declined since May 2011, aided by liquidity injections via open market operations to allow banks to purchase government paper.
  - Staff argued policy rate cuts were overly aggressive given uncertain inflation outlook and weakening external position.
  - Staff recommended allowing more exchange rate flexibility and building reserves during appreciation phases.
- Financial soundness and NPLs
  - Nonperforming loans (NPLs) to gross loans: 16.7 percent (Sept. 2011).
  - Regulatory capital to risk-weighted assets: 14.9 (Sept. 2011).
  - Provisions to NPLs: 65.8 (Sept. 2011).
  - Return on assets (after tax): 1.4 (Sept. 2011).
- Banking sector structure and risks
  - Financial sector assets about 40 percent of GDP; banks make up nearly 90 percent of the sector.
  - Capital adequacy overall nearly 15 percent of risk-weighted assets; minimum requirement 10 percent.
  - Holdings of government securities: 32 percent of assets; current holdings of government securities: Rs 2.2 trillion; staff estimate maximum holdings before forced cutback of private-sector credit approach Rs 3 trillion.
  - ADR capacity and projections: Capacity System Advances to Deposits Ratio (ADR) = 63.0 percent; Regulatory Limit for ADR = 70.0 percent; ADR buffer = 7.0 percentage points; Deposits = 5,418; Total Additional Capacity = 1,243; Needs Private Sector Credit = 3,432.
- Banking-sector policy recommendations
  - Strengthen supervision, limit regulatory forbearance, promptly restructure problem banks, apply prudential regulations uniformly, improve financial governance.
  - Pass deposit insurance legislation (possible fund size on the order of 5 percent of insured deposits) financed by levies on banks.
  - Establish commercial courts to speed loan recovery.
  - Develop capital markets, encourage managed funds, and improve transparency in company data and debt pricing.
  - Review and possibly revise macroprudential limits (debt-to-income ratio, single credit exposure limit), and consider strengthening SLR for foreign currency accounts and eliminating the 0.2 percent tax on daily deposit withdrawals exceeding Rs 25,000.

### LABOR, GENDER, AND EMPLOYMENT — key indicators and implications
- Gender and labor market outcomes
  - Female labor force participation increased from "9.3 percent in 2000 to 15.6 percent in 2011".
  - Female participation remains less than one-third that of males; share of women in wage employment declined from 33 percent in 2000 to 21 percent in 2011.
  - Female employees earn around 63 percent of the average wage of males.
  - Over 63 percent of employed women work as (unpaid) contributing family workers.
  - Unemployment rates: females "8.9 percent", males "4.5 percent".
- Youth, population growth, and employment dynamics
  - Population growth rate: "2.2 percent (annual average)" over the last decade.
  - More than 40 percent of the population is below the age of 14.
  - Labor force projected growth: "3.4 percent per annum" implying more than 2 million people entering the labor force annually.
  - Estimated employment elasticity: "0.5"; required average GDP growth to absorb entrants: "7 percent per annum".
  - Staff baseline and reform scenario average GDP growth for 2011/12–2015/16: "3.5 and 4.7 percent, respectively".
  - Projected unemployment rate could rise to "10 or 13 percent in 2015/16".
- Labor market reform recommendations
  - Reform labor laws and institutions to increase labor market efficiency, increase female participation, reduce redundancy cost, and improve linkage between pay and productivity.
  - Institutionalize dynamic job-matching processes and invest in health and education to improve skills.

### EXTERNAL SECTOR, RESERVES, AND REMITTANCES
- Key external indicators and projections
  - Current account balance (percent of GDP): 2008/09 = -5.7; 2009/10 = -2.2; 2010/11 = 0.2; 2011/12 = -2.0.
  - Gross reserves (end-period, in millions of U.S. dollars): 2008/09 = 9,110; 2009/10 = 12,958; 2010/11 = 14,784; 2011/12 = 12,086.
  - Gross external financing needs (in millions of U.S. dollars): 2011/12 = 8,236; projected 2012/13 = 10,536; 2013/14 = 13,880.
- Workers’ remittances
  - Official remittance data understate actual flows; IOM household survey suggests only approximately 40 percent of remittances go through official channels.
  - Concentration: roughly ¾ of remittances come from Saudi Arabia, the United Arab Emirates, the United States, and the United Kingdom.
  - Remittances can be volatile month-to-month (example: US$1.3 billion in August 2011 to slightly below US$900 million in September).
  - Staff forecasts only modest increases in remittances over the medium term; caution advised against overreliance.

### DEBT SUSTAINABILITY AND SCENARIO ANALYSIS — highlights
- Public debt and projections
  - Total general government debt (percent of GDP): 2008/09 = 60.7; 2009/10 = 61.5; 2010/11 = 60.1; 2011/12 = 61.7.
  - Debt-stabilizing primary balance (public sector): -1.9 (implied).
  - Public sector gross financing requirement (percent of GDP): 2008/09 = 26.2; 2009/10 = 25.7; 2010/11 = 26.8; 2011/12 = 30.0.
- Stress-test scenarios
  - Scenarios include interest rate shock, growth shock, non-interest current account shock, combined shocks, real depreciation shock (one-time real depreciation of 30 percent in 2012/13), and contingent liabilities shock (10 percent of GDP in 2011/12 combined with a 30 percent depreciation).
  - Baseline external debt-to-GDP: 2008/09 = 32.1; 2009/10 = 31.6; 2010/11 = 28.5; 2011/12 = 25.3; projected decline to 21.4 by 2015/16.

### CAPITAL MARKETS, SAVINGS INSTRUMENTS, AND NONBANK FINANCE
- National Savings Scheme (NSS) and managed funds
  - NSS profit rate as of October 2011 for a six-month term: 12.4 percent.
  - NSS size: almost one-fourth that of bank deposits.
  - Managed funds assets: one-fifth the NSS.
  - Managed funds face high fees (1-3 percent), corporate tax rate of 35 percent (higher than 25 percent for associations of persons), and low investor confidence.
- Equity and debt markets
  - Listed market capitalization: Rs 3.3 trillion (24 percent of GDP).
  - Capital gains taxes: 10 percent (< six months), 7.5 percent (six months to one year), none (> one year).
  - Domestic debt market: bulk corporate issuance listed on KSE may only be traded by Karachi brokers; reference prices often based on a “matrix approach” in absence of trading activity.
- Policy recommendations for capital market development
  - Rationalize NSS pricing, improve corporate transparency, strengthen debt pricing and market-making, deepen equity opportunities, allow equity derivatives, permit bond cross-listing, encourage managed funds, and align tax treatment for managed funds.

### STATISTICAL ISSUES, DATA QUALITY, AND STANDARDS
- Data adequacy and coverage
  - Macroeconomic statistics broadly adequate for surveillance but important gaps exist in the real sector and fiscal and social (especially poverty) data.
  - FBS working on quarterly national accounts with rebasing to 2005/06; new CPI series introduced with rebasing to 2007/08 in August 2011.
  - Authorities intend to adopt GFSM 2001 methodology over the medium term; PIFRA supports improvements in financial reporting and auditing.
- SDDS and dissemination
  - Authorities stepped up efforts toward joining the Special Data Dissemination Standard (SDDS); an SDDS assessment mission scheduled in January 2012.
  - Requirements include monthly central government operations with one-month timeliness and quarterly national accounts and employment with one-quarter timeliness.
- Selected data points and publication status (as of Dec. 2011)
  - Exchange Rates: real time.
  - International Reserve Assets: Oct. 2011 / Nov. 2011 / M.
  - CPI: Nov. 2011 / Dec. 2011 / M.
  - Central government operations: Sep. 2011 / Nov. 2011 / Q.

### RELATIONS WITH THE WORLD BANK — summary of engagement
- World Bank CPS endorsed July 8, 2010 covering FY2010–FY2013; Progress Report presented December 20, 2011; CPS extended to include FY14.
- CPS strategic pillars: Improving Economic Governance; Improving Human Development and Social Protection; Improving Infrastructure to Support Growth; Improving Security and Reducing the Risk of Conflict.
- IFC and MIGA engagement: focus on infrastructure, financial markets, SME support, and guarantees in hydropower and microfinance.
- Key Bank engagement principles: fewer but larger operations; performance-based instruments; deepen provincial engagement; leverage partnerships; MDTF start small and scale up.

### CONCLUSION — overall assessment and priority actions
- Consolidation of public finances is essential to restore macroeconomic stability and create policy space.
- Priority reforms and actions:
  - Broaden the tax base (reformed GST, broader income tax, property taxes) and strengthen tax administration.
  - Tighten non-wage current spending, reduce untargeted subsidies, protect social spending.
  - Resolve power sector problems and restructure loss-making PSEs; phase out commodity operations.
  - Strengthen SBP independence, limit central bank financing of the budget, allow more exchange rate flexibility, and be ready to tighten monetary policy if inflation or external pressure increases.
  - Strengthen bank supervision, resolve problem banks promptly, establish deposit insurance, improve legal framework for debt recovery, and develop capital markets.
  - Implement labor market reforms, increase female participation, and invest in human capital to support inclusive growth.
- Without fundamental policy correction, prospects are challenging: growth too low to absorb labor entrants, inflation persistent, reserves vulnerable, and limited policy space to absorb shocks.

*IMF staff report (Pakistan: 2011 Article IV Report and Post-Program Monitoring).*

### 2011. The staff team comprised Messrs. Mazarei (head), Duenwald,

### _cr1235 - 2011. The staff team comprised Messrs. Mazarei (head), Duenwald,

### INTRODUCTION — summary findings and consensus on priorities
- Context and recent history
  - At the March 2009 Article IV consultation Pakistan was emerging from the 2008 crisis, supported by a Stand-By Arrangement (SBA) approved in November 2008.
  - The SBA went off-track in June 2010 (following the fourth review in May 2010) and stayed off-track until it expired at end-September 2011.
- Policy actions taken since 2008
  - Improvements in tax administration and removal of some tax exemptions.
  - Introduction of an interest rate corridor and a more market-based exchange rate regime.
  - Strengthened SBP enforcement powers for dealing with problem banks.
  - Domestic price increases: main petroleum products about 70 percent and electricity tariffs about 90 percent since early 2008.
  - Benazir Income Support Program (BISP) provided basic income support during shocks.
- Mission–authorities convergence on priorities
  - Policy priorities: tighter fiscal policy, a less accommodative monetary policy stance, and structural reforms (especially fiscal and energy sectors).
  - Need to build on the government’s New Growth Strategy to develop a comprehensive multi-year economic strategy with broad stakeholder buy-in.
  - Emphasis on correcting microeconomic and institutional problems: agricultural procurement and electricity subsidies, patronage, weak management, poor service delivery, governance and rent-seeking.

### BACKGROUND — key structural features and institutional constraints
- Endowments and opportunities
  - Pakistan’s geostrategic location and natural and human resource potential; expansion of regional trade and demographic dividend (about half of Pakistan’s population is under the age of 20).
- Political and security constraints
  - Civilian coalition government since 2008; judiciary and press more independent; military retains considerable political influence.
  - Political instability, rent-seeking, and patronage have undermined sustained economic reform and fiscal discipline; internal security remains a major challenge.
- Vulnerability to exogenous shocks
  - Repeated natural disasters, including two major floods in 2010 and 2011.
  - IMF emergency financial assistance to help cope with the aftermath of the 2010 floods amounted to US$451 million.
  - Narrow export base (cotton and textiles account for more than half of exports) and need to import oil and some food products.
- Fiscal structure and public finances
  - Government tax revenue is about 10 percent of GDP, one of the lowest in the world.
  - Number of taxpayers filing income tax returns is about 1 percent of the population.
  - Subsidies (mostly electricity) and interest payments consume almost half of government revenue; security spending uses up another quarter.
  - Subsidies to loss-making public-sector enterprises amounted to nearly 2 percent of GDP in 2010/11.
- Fiscal decentralization and challenges
  - Seventh NFC Award (from July 2010) allocated a much larger share of revenue to provinces; more than half of federally collected tax revenue is now transferred to provinces.
  - The 18th Constitutional Amendment (implemented July 2011) devolved additional expenditure responsibilities to provinces; assignment of responsibilities remains unclear in some areas.
  - Provincial own revenue is very low, creating incentives for fiscal indiscipline; recommendation for strengthened rules and a binding mechanism to coordinate provincial and federal fiscal targets.
- Energy sector constraints
  - Longstanding constrained and unpredictable energy supply; many reform plans prepared but not sustained.
  - Outages averaged eight hours a day in the summer of 2011.
  - Energy constraints estimated to cost about 2 percent of GDP in forgone growth.
  - Budgetary electricity subsidies reached about 1½ percent of GDP in 2010/11 (including 0.6 percent of GDP recognition of past subsidies).
  - Circular debt estimated at 3 percent of GDP; periodic government assumption of circular debt undermines public finances.
- Financial intermediation and credit
  - Private sector credit growth weak; bank lending to the private sector has declined in relation to GDP and been surpassed by lending to the public sector.
  - Bank financing of public sector and commodity operations, risk aversion, and rising private-sector NPLs have reduced bank willingness to lend to the private sector.
  - Limited competition and limited capital market development contribute to wide banking sector spreads.

### ECONOMIC OUTCOMES — growth, labor, savings, inflation, and external position
- Growth and labor market
  - Real GDP growth has been on a declining trend and relatively volatile; in the past four years real GDP growth averaged only 3 percent.
  - Official unemployment rate reported as 6 percent; underemployment and unpaid employment are major problems — unpaid employment estimated at 28 percent of the employed in the 2010/11 Labor Force Survey.
  - Estimated required average GDP growth of 7 percent per year to absorb about 2 million new labor market entrants annually.
- Savings and investment
  - Private investment has declined in recent years; public investment has fallen.
  - Private savings remain low compared to other countries in the region.
- Inflation and monetary–fiscal interaction
  - Inflation rose sharply in 2008 and has remained persistently in double digits until recent moderation.
  - CPI inflation slipped below 10 percent in December 2011 to 9.7 percent year-on-year.
  - Staff analysis points to central bank financing of the fiscal deficit as an important driver of inflation.
  - Estimated inflation threshold for Pakistan: 9 percent (empirical estimate cited).
- External position and reserves
  - Surge in exports and strong remittances helped rebuild international reserves in 2010/11, but later deterioration in current account and weakening financial inflows put pressure on the rupee.
  - SBP intervened in spot and forward markets during July–December 2011 despite increased exchange rate flexibility.

### POLICY DISCUSSIONS — diagnostics and recommended actions
- Fiscal policy
  - Need for tighter fiscal policy to reduce vulnerabilities and build buffers.
  - Address the weak fiscal structure by broadening the tax base and improving tax administration.
  - Reduce distortions from subsidies and loss-making public enterprises; limit budgetary transfers to PSEs and address circular debt in the energy sector.
  - Strengthen fiscal rules and intergovernmental fiscal frameworks to coordinate federal and provincial fiscal targets.
- Monetary and financial policies
  - Adopt a less accommodative monetary stance to contain inflationary pressures linked to fiscal financing.
  - Strengthen central bank operations and reduce reliance on central bank financing of the fiscal deficit.
  - Address banking sector weaknesses, NPLs, and limited competition to restore private credit growth.
- Structural reforms and growth strategy
  - Implement structural reforms emphasized in the New Growth Strategy: tackle noncompetitive markets, poor governance, limited urban development, inadequate education, low openness, and limited innovation.
  - Reform the energy sector to reduce outages, achieve cost-recovery tariffs, improve collections, and eliminate circular debt buildup.
  - Improve public sector management and service delivery, and limit patronage and rent-seeking that undermine efficiency.
  - Develop a comprehensive economic strategy with broad stakeholder buy-in to promote inclusive growth that allows all segments to contribute to and benefit from growth.

### RISKS, VULNERABILITIES, AND MEDIUM-TERM CONCERNS
- Main vulnerabilities identified
  - Overly expansionary macroeconomic policies and weak structural reforms increasing vulnerability to shocks.
  - Persistent inflation, weak growth, rising balance-of-payments pressures, and few buffers to absorb shocks.
  - Political calendar (senate elections in March 2012 and parliamentary elections in 2013) likely to constrain reform momentum.
- Specific risk factors
  - Continued central bank financing of fiscal deficits could perpetuate inflation.
  - Energy-sector fiscal drains and recurrent circular debt undermine fiscal sustainability and crowd out private investment.
  - Fiscal decentralization without clear rules risks lack of coordination and fiscal indiscipline at subnational levels.

*IMF staff report (Pakistan: 2011 Article IV Report and Post-Program Monitoring).*

### Box 2. Why is Inflation in Pakistan So High and Persistent?

### Box 2. Why is Inflation in Pakistan So High and Persistent?

### Main drivers of high inflation
- Central bank lending to finance fiscal deficits has been a key driving force behind the high inflation levels observed in the last few years.
- Before 2008, 12-month CPI inflation had averaged about 5.5 percent for more than a decade.
- In 2008, global commodity price shocks and a sharp depreciation of the rupee led to a spike in inflation, peaking at 25 percent year-on-year in August 2008.
- Global food and fuel price shocks were reflected in larger fiscal deficits through domestic price subsidies; with external financial inflows dwindling, these deficits were increasingly financed through the SBP, putting upward pressure on prices via excessive growth in SBP net domestic assets and exchange rate depreciation.
- The recent (since May 2011) decline in government borrowing from the SBP is noted as a welcome development, but a switch to government borrowing from commercial banks has been supported by large liquidity injections by the SBP, a policy with similar inflationary effects as direct central bank financing.

### Inflation persistence and expectations
- Inflation persistence (correlation between current and lagged inflation) has increased since 2008 and is higher than in regional peers; the increase in persistence implies it takes longer for inflation to return to equilibrium after shocks and inflation expectations respond more sluggishly to policy changes.
- Survey data indicates that inflation expectations have continuously remained at around 15 percent.
- Persistence could be due to:
  - Engrained inflationary expectations.
  - Institutional features.
  - CPI calculation problems.
- A model-based analysis confirms a statistically significant effect of SBP lending to government on inflation. A simple, single-equation model was estimated to explain short-term headline CPI inflation with the following explanatory variables (asterisks denote statistical significance of the estimated coefficients at the 5 percent level): inflation inertia (lagged inflation)*, SBP claims on government*, global food price, global fuel price*, index of industrial activity (LSM) and interest rates*.

### Monetary–fiscal interactions and policy implications
- Policy recommendation: The authorities can help reduce the level and persistence of inflation by credibly adopting a less accommodative monetary policy stance.
- Policy recommendation: To reduce inflation and increase the SBP’s policy credibility, large liquidity injections by the SBP should be scaled back and direct government borrowing from the SBP should be avoided.
- Concern: Switching government financing to commercial banks while supporting that switch with SBP liquidity injections effectively preserves accommodative financing and inflationary pressures.

### Supporting statistics and related macro indicators cited in the box
- Pre-2008 12-month CPI inflation average: 5.5 percent.
- Inflation peak: 25 percent year-on-year in August 2008.
- Inflation expectations (survey): around 15 percent.
- Decline in reserves attributed in part to SBP spot market intervention: nearly US$2 billion.
- Rupee depreciation cited: a 4½ percent depreciation against the US dollar.
- Net swap/forward position movement: to US$1,625 million short as of end-December, 2011, from a long position of US$150 million at end-June 2011.
- Nonperforming loans (gross NPLs): 16.7 percent of total loans at end-September 2011.
- Poverty rate cited: 17.2 percent in 2007/8 (with broader measures suggesting almost 50 percent).
- Note on new CPI: Pakistan has recently started publishing a new CPI series, but a long time series is not available; the former CPI series is used for this box.

*Source: Box 2. Why is Inflation in Pakistan So High and Persistent? (from the supplied IMF content unit).*

### 24.      Pakistan’s fiscal deficit has risen. The

### _cr1235 - 24.      Pakistan’s fiscal deficit has risen.

### Fiscal developments and deficit size
- General government deficit (excluding grants) reached 6.6 percent of GDP in 2010/11, the highest level since the 2008 crisis.
- The budget recognized past electricity arrears of 0.6 percent of GDP; excluding arrears, the deficit reached 6 percent of GDP.
- Deficit financing shifted from external and nonbank sources to bank financing (including the SBP).
- So far in 2011/12 (July to September), the fiscal deficit was 1.2 percent of GDP, lower than the 1.5 percent of GDP deficit recorded in the same period in 2010/11.
- Staff argued that the deficit was heading for 7 percent of GDP absent corrective measures.

### Revenue and spending dynamics
- Tax revenue collections declined slightly as a percent of GDP; tax reform foundered due to insufficient political support.
- Total spending declined by 1¼ percent of GDP, but high spending on subsidies, security, and interest, as well as a 15 percent salary increase, crowded out more productive spending.
- Strong tax revenue in early 2011/12 partly reflects one-time factors; revenue collection could weaken if the government reverses removal of tax exemptions and zero ratings.

### Short-term policy recommendation to cap 2011/12 deficit
- Staff proposed capping the 2011/12 deficit at 5.7 percent of GDP (5½ percent including grants).
- Suggested combination of spending and revenue measures:
  - Tighten non-wage current government spending, including reduction of non-power subsidies (e.g., wheat, fertilizers).
  - Re-introduce the special excise duty and income tax surcharge.
  - Raise the sales tax rate.
  - Minimize electricity subsidies and keep provincial budgets in surplus.

### Medium-term fiscal strategy and structural measures
- With gradual deficit reduction and continued low borrowing costs, Pakistan’s public debt would be sustainable but remains high and vulnerable to interest rate or exchange rate shocks.
- A substantial increase in tax revenue is necessary for sustainable deficit reduction.
- Reformed General Sales Tax (GST) could generate up to 3 percent of GDP in additional tax revenue.
- Other revenue options discussed: adopting a broader income tax regime and property taxes.
- Spending-side priorities:
  - Resolve problems in the power sector and loss-making PSEs to remove large drains on budgetary funds and make room for health, education, and better-targeted poverty alleviation.
  - Phase out costly commodity operations financed by government-guaranteed bank loans; the stock of commodity credits currently stands at 1½ percent of GDP.
  - Strengthen debt management to gradually extend maturities and reduce rollover and interest rate risks.
  - Strengthen government cash management given sizeable government deposits in the banking system.

### Fiscal decentralization risks and needs
- Large devolution of revenue to provinces with more limited devolution of spending responsibilities weakened the federal budget’s structural position and presents a risk to fiscal stability.
- Provinces need to raise more of their own tax revenues, including from property and agriculture, and improve capacity to manage new spending responsibilities.
- Greater clarity in assignment of responsibilities across government levels is needed to strengthen accountability.

### Authorities’ views on fiscal policy
- Authorities expressed determination to achieve the 4.7 percent of GDP deficit target for the year.
- They believed the target could be achieved via spending restraint, carryover effects from last fiscal year’s base-broadening measures (removing exemptions and zero ratings), collection of past due taxes, and improved tax administration and compliance (including risk-based tax audits and a campaign targeting wealthy nonpayers).
- On spending, they plan to keep nondiscretionary spending within budget limits and strictly contain electricity subsidies.
- The authorities plan to cut the deficit to 3 percent of GDP over the medium term and simplify the tax system by replacing the current general sales tax with a modern integrated reformed sales tax, continuing removal of exemptions and zero ratings, and relying on three main pillars: sales tax, income tax, and customs duties.
- Authorities recognize decentralization risks and were confident provinces would remain in surplus in 2011/12; they expressed interest in IMF technical assistance.

### Monetary and financial sector implications
- Monetary policy has accommodated fiscal deficits; SBP cut its policy rate by a cumulative 200 basis points to 12 percent in its first two Board meetings during 2011/12 (July and September 2011).
- SBP lending to the budget declined since May 2011, aided by liquidity injections via open market operations to allow banks to purchase government paper.
- Staff argued the SBP’s policy rate cuts were overly aggressive given uncertain inflation outlook and weakening external position; liquidity injections were seen as accommodating high fiscal deficits.
- Staff recommended allowing more exchange rate flexibility and building reserves during appreciation phases.
- Strengthening SBP autonomy is critical; draft amendments under discussion in parliament do not ensure operational independence according to staff.
- Staff urged steps to address rising NPLs, strengthen bank supervision, limit regulatory forbearance, promptly restructure problem banks, apply prudential regulations uniformly, and improve financial governance.
- Staff recommended passing legislation for explicit deposit insurance (prepared), possibly financed by levies on banks, and establishing commercial courts to speed up loan recovery.
- Development of capital markets should be a priority to allow corporations access to nonbank credit; authorities should encourage managed funds industry and greater transparency in company data.

### Financial sector actions and authorities’ measures
- Authorities reported close monitoring of NPLs and strengthening of credit assessment procedures.
- Authorities provided capital injection of Rs 8 billion to a public bank (with Rs 256 billion in assets), bringing total capital support from public funds to Rs 17 billion since 2008.
- Authorities agreed capital market development, particularly corporate debt markets, is a priority and outlined plans to promote depth and liquidity of equity and debt markets, improve transparency in margin financing and debt pricing, strengthen real-time data monitoring, encourage managed funds industry growth, and introduce new debt and commodity hedging instruments (e.g., new wheat futures contract).

### Structural reforms for sustained inclusive growth
- National consensus on structural reform is needed to raise productivity, competitiveness, and remove constraints on growth.
- Key priority: improve reliability and efficiency of energy supply; management overhaul to reduce technical and collection losses and strengthen bill collection.
- Strategy to restructure large loss-making PSEs could include privatization; divesting public stakes in banks is necessary to reduce state footprint.
- Improve investment climate via better regulation and governance, facilitate entry and exit of firms.
- Civil service reform needed to improve delivery of public services amid low tax collection and fiscal decentralization.
- Improve functioning of financial sector to channel savings to borrowers and raise companies’ access to capital markets.
- Strengthen social safety nets to support vulnerable populations.
- Authorities pursue trade liberalization to help diversify exports, including introducing a “negative list” of imports from India by February 2012, phasing out the negative list over time, enhancing SAFTA preferential arrangements, removing impediments to bilateral investments and bank branches, and SBP currency swap agreements with the People’s Bank of China and the Central Bank of Turkey.

### Other issues
- Pakistan’s AML/CFT regime needs improvement; the 2009 assessment highlighted important deficiencies many of which remain unaddressed.
- Authorities should regulate money service providers through an appropriate sanctions regime and increase the range of ML/FT preventive measures applicable to them.
- Major deficiencies include lack of adequate criminalization and effective implementation of sanctions against terrorist financing, and absence of effective controls for cross-border cash transactions.
- Authorities have stepped up enforcement efforts, including instructing foreign exchange companies to comply with AML/CFT requirements.

*PAKISTAN 2011 ARTICLE IV REPORT AND POST-PROGRAM MONITORING*

### 44.      In accordance with Fund policy,

### In accordance with Fund policy

### Post-Program Monitoring and Evaluations
- The Managing Director recommends the initiation of Post-Program Monitoring (PPM).
- Outstanding Fund credit to Pakistan exceeds the "200 percent of quota" threshold for PPM.
- There are no exceptional circumstances that would indicate that PPM is not warranted.
- The first PPM Board discussion is envisaged in "mid-2012".
- Pakistan is an exceptional access borrower from the Fund; therefore, an Ex-Post Evaluation (EPE) has begun and a report will be produced for the Board.

### Data Quality
- Macroeconomic statistics are broadly adequate for surveillance.
- Important gaps exist in the real sector.
- The quality of fiscal and social (especially poverty) data needs strengthening.
- The authorities are committed to strengthening data quality to better inform policy decisions and monitor outcomes.
- The authorities have recently stepped up efforts toward joining the Special Data Dissemination Standard (SDDS).

### Staff Appraisal — Outlook and Risks
- Without a fundamental policy correction, it will be difficult for Pakistan to maintain macroeconomic stability, raise living standards, and durably reduce poverty.
- In a scenario of unchanged policies, characterized by high fiscal deficits, accommodative monetary conditions, and structural reform stasis, outcomes would include:
  - growth remaining subpar,
  - inflation excessive,
  - reserves too low,
  - social indicators disappointing.
- The risks to the outlook are tilted to the downside and contingency planning is needed.
- Recent deterioration in Pakistan’s external position highlights macroeconomic risks, with looming pressures on the balance of payments from:
  - lower export prices,
  - weaker growth in remittances,
  - repayments to the Fund.
- Policy space to deal with further adverse shocks is limited.
- Additional significant risks include:
  - security problems,
  - risk of policy slippage in an election year,
  - the government’s high roll over needs,
  - lower-than-expected external financial inflows,
  - negative spillovers from the turmoil in Europe,
  - the high level of NPLs in the banking sector.
- The authorities should prepare and implement a plan to mitigate vulnerabilities.

### Fundamental Problems Identified
- Governance and institutional problems undermine the country’s fiscal position.
- Fiscal management complexity has been compounded by fiscal decentralization.
- Unpredictable and widespread power outages are stifling growth.
- Power sector subsidies are poorly targeted and have squeezed out social spending.
- Large public sector enterprises with soft budget constraints continue to sap fiscal resources.
- The government’s commodity operations also strain fiscal resources.
- Interenterprise arrears in the energy sector ("circular debt") undermine budget discipline and clog the financial system.
- Financial intermediation to the private sector has declined to low levels, with the banking system supplying more credit to the public than to the private sector.

### Policy Recommendations — Fiscal Consolidation
- Consolidation of the public finances is the starting point to set the economy on the right course.
- Staff welcomes authorities’ efforts to remove tax exemptions and zero ratings, including in the agriculture sector.
- A more sizeable increase in tax revenue is needed. Possible measures include:
  - a reformed GST,
  - a broader income tax regime,
  - introducing a property tax,
  - re-introducing the special excise duty and income tax surcharge,
  - raising the sales tax rate.
- On the spending side, it is critical to:
  - tighten non-wage current spending,
  - reduce untargeted subsidies,
  - protect social spending.
- Loss-making public sector enterprises needed to be restructured.
- Commodity operations should be scaled back and phased out.
- Given substantial rollover risks of domestic government debt, carefully managing the government’s growing debt load through extending maturities is a priority.
- Rules of the game for fiscal decentralization (for instance those relating to provincial borrowing) need clarification.
- Incentives of the provinces to raise their own revenue should be better aligned with requirements of sound public finances.

### Policy Recommendations — Monetary and Exchange Rate Policy
- Monetary and exchange rate policy needs to better contain inflation and external risks.
- At its November 2011 policy meeting, the SBP decided to keep its policy rate unchanged.
- Any further contemplation of monetary policy loosening should await clearer disinflation signals.
- The SBP should be ready to tighten policy if inflation or external pressure increases.
- Greater exchange rate flexibility is called for to facilitate external adjustment and safeguard foreign reserves, which are projected to decline.
- Based on standard analysis, staff considers the rupee to be somewhat overvalued relative to fundamentals.
- Declining reserves, strains in global financial markets, and commodity price variability suggest considerable uncertainty about the extent of overvaluation.
- Reducing inflation will require comprehensive fiscal reforms and greater central bank independence.
- Fiscal consolidation would free monetary policy to pursue inflation objectives.
- A more independent central bank would be better able to resist pressures to finance the government deficit, either directly or indirectly.
- Lower inflation would help the poor.

### Policy Recommendations — Financial Sector
- Although capital adequacy ratios remain strong, increasing NPLs present risks to financial stability.
- High concentrations of bank assets in government securities also present risks.
- Action is needed to address the NPLs and bank supervision should be strengthened.
- Remaining problem banks need to be resolved without delay.
- Closely monitoring vulnerabilities should remain a key priority.
- Addressing financial governance problems in some institutions is necessary.
- Establishing an explicit deposit insurance mechanism would boost confidence in the banking sector.
- Simplifying the collateral recovery process would benefit the sector.
- A stronger financial sector, coupled with less government borrowing, would provide resources for needed private sector investment.

### Conclusion
- Pakistan has the potential to do much better.
- Sustained higher and inclusive growth is needed to reduce poverty and meet the large employment challenge.
- Growth prospects hinge on:
  - improving the policy mix,
  - relieving infrastructural bottlenecks, especially in the energy sector,
  - strengthening human capital,
  - ensuring a competitive business environment.
- In designing its reform strategy, the government will need to maintain a robust social safety net to support vulnerable parts of the population.

*Source: PAKISTAN 2011 ARTICLE IV REPORT AND POST-PROGRAM MONITORING — STAFF APPRAISAL*

### 55.      It is recommended that the next

### _cr1235 - 55.      It is recommended that the next

### Key recommendation
- It is recommended that the next Article IV Consultation with Pakistan take place on the standard 12-month cycle.

### Country context and headline indicators
- Population: 173.5 million (2010/11)
- Per capita GDP: US$1,179 (2010/11)
- Poverty rate: 17.2 percent (2007/08)

### Recent and projected macroeconomic performance (selected)
- Real GDP at factor cost:
  - 2009/10: 1.7
  - 2010/11: 3.8
  - 2011/12 (Estimate/Projection entries mixed in source): 2.4; 3.4 (two series appear)
  - Medium-term projection (Table 6): 3.5 (2012/13–2015/16 each year)
- GDP deflator at factor cost:
  - 2009/10: 20.0
  - 2010/11: 11.9
  - 2011/12: 18.8; 12.0 (two series)
- Consumer prices (period average):
  - 2009/10: 17.6
  - 2010/11: 10.1
  - 2011/12: 13.7; 12.0 (two series)
- Consumer prices (end of period):
  - 2009/10: 9.6
  - 2010/11: 11.8
  - 2011/12: 13.3; 11.0 (two series)
- Real per capita GDP (percentage change):
  - 2009/10: -2.6
  - 2010/11: 1.6
  - 2011/12: 0.3; 1.3 (two series)

### External sector and reserves
- Current account balance (in percent of GDP):
  - 2008/09: -5.7
  - 2009/10: -2.2
  - 2010/11: 0.2
  - 2011/12: -2.0
  - Medium-term projections (2012/13–2015/16): -2.0, -3.0, -3.3, -3.7 (Table 6)
- Gross reserves (end-period, in millions of U.S. dollars):
  - 2008/09: 9,110
  - 2009/10: 12,958
  - 2010/11: 14,784
  - 2011/12: 12,086
  - Projected: 9,816 (2012/13); 7,153 (2013/14); 7,584 (2014/15); 8,779 (2015/16)
- Gross external financing needs (in millions of U.S. dollars):
  - 2008/09: 12,196
  - 2009/10: 7,749
  - 2010/11: 2,631
  - 2011/12: 8,236
  - Projected: 10,536 (2012/13); 13,880 (2013/14); 13,102 (2014/15); 13,898 (2015/16)
- External public and publicly guaranteed debt (in percent of GDP):
  - 2008/09: 18.2
  - 2009/10: 17.7
  - 2010/11: 15.3
  - 2011/12: 15.8
- External debt (in millions of U.S. dollars):
  - 2008/09: 52,000
  - 2009/10: 55,901
  - 2010/11: 60,116
  - 2011/12: 59,010
  - Projected: 57,644 (2012/13); 56,199 (2013/14); 57,560 (2014/15); 60,656 (2015/16)

### Fiscal position and public debt
- Revenue and grants (in percent of GDP / selected years):
  - 2008/09: 14.7
  - 2009/10: 14.4
  - 2010/11: 12.8
  - 2011/12 (projection variants): 13.7; 12.7
- Expenditure (including statistical discrepancy, in percent of GDP / selected):
  - 2008/09: 19.9
  - 2009/10: 20.3
  - 2010/11: 18.9
  - 2011/12 (projection variants): 19.5; 18.3
- Overall balance (including grants, in percent of GDP):
  - 2008/09: -5.2
  - 2009/10: -5.9
  - 2010/11: -6.1
  - 2011/12 (projections): -6.7; -4.2; -5.5 (various table entries reflecting authorities/staff/baseline/reform)
- Primary balance (including grants, in percent of GDP):
  - 2009/10: -1.6
  - 2010/11: -2.3
  - 2011/12: -2.9
- Total general government debt (in percent of GDP):
  - 2008/09: 60.7
  - 2009/10: 61.5
  - 2010/11: 60.1
  - 2011/12: 61.7
  - Medium-term projections (Table 6): 60.2 (2012/13); 58.3 (2013/14); 56.2 (2014/15); 54.6 (2015/16)
- Public sector gross financing requirement (in percent of GDP):
  - 2008/09: 26.2
  - 2009/10: 25.7
  - 2010/11: 26.8
  - 2011/12: 30.0
  - Projected: 30.3 (2012/13); 30.3 (2013/14); 28.5 (2014/15); 27.1 (2015/16)

### Debt sustainability and scenario analysis (highlights)
- External debt-to-GDP (baseline):
  - 2008/09: 32.1
  - 2009/10: 31.6
  - 2010/11: 28.5
  - 2011/12: 25.3
  - Projected decline to 21.4 by 2015/16
- Public sector debt (baseline, percent of GDP):
  - 2008/09: 60.7
  - 2009/10: 61.5
  - 2010/11: 60.1
  - 2011/12: 61.7
  - Projected: 60.2 (2012/13); 58.3 (2013/14); 56.2 (2014/15); 54.6 (2015/16)
- Debt-stabilizing primary balance (public sector): -1.9 (implied in Table 10)
- Stress test scenarios illustrated include:
  - Interest rate shock (permanent one-half standard deviation)
  - Growth shock (permanent one-half standard deviation)
  - Non-interest current account shock
  - Combined shocks
  - Real depreciation shock (one-time real depreciation of 30 percent in 2012/13 noted in Figure 4/5 captions)
  - Contingent liabilities shock (10 percent of GDP in 2011/12 combined with a 30 percent depreciation in one scenario)
- Projections include scenario boxes showing baseline averages and historical averages; key baseline averages cited:
  - Baseline real GDP growth figures referenced: 3.8; 4.2; 4.1 (context in figures)
  - Baseline scenario historical averages and shocks presented in Figures 4–6 and Tables 9–10 (detailed numeric scenario outputs in source figures and tables)

### Financial sector and monetary indicators
- Broad money (annual changes, percent):
  - 2008/09: 9.6
  - 2009/10: 12.5
  - 2010/11: 15.9
  - 2011/12: 14.9 (projection)
- Reserve money (annual changes, percent):
  - 2008/09: 1.9
  - 2009/10: 11.4
  - 2010/11: 17.1
  - 2011/12: 13.3 (projection)
- Private credit (percentage change):
  - 2008/09: 0.7
  - 2009/10: 3.9
  - 2010/11: 4.0
  - 2011/12: 3.4
- Financial soundness (Table 5, selected):
  - Regulatory capital to risk-weighted assets: 10.5 (2004) rising to 14.9 (Sept. 2011)
  - Nonperforming loans (NPLs) to gross loans: 11.6 (2004) to 16.7 (Sept. 2011)
  - Provisions to NPLs: 70.4 (2004) to 65.8 (Sept. 2011)
  - Return on assets (after tax): 1.2 (2004) to 1.4 (Sept. 2011)

### Fiscal policy and reform scenarios (Table 3 / Figures)
- Baseline and Reform scenarios compared for 2006/07–2015/16 show:
  - Fiscal balance (percent of GDP): baseline and reform paths plotted with reform improving fiscal balance over time (figures present trends)
  - Public debt (percent of GDP): reform scenario shows lower public debt relative to baseline by 2015/16
  - Real GDP growth (y-y percent change): reform scenario shows slightly higher growth compared to baseline
  - FDI (in U.S. dollar billions): reform scenario shows higher FDI inflows than baseline
  - SBP gross international reserves (in U.S. dollar billions): reform scenario shows stronger reserve accumulation than baseline

### Key projections and medium-term framework (Table 6 summary)
- Gross national saving (percent of GDP):
  - 2008/09: 12.5
  - 2009/10: 13.1
  - 2010/11: 13.6
  - 2011/12: 11.4
  - Projected trend: 11.2 (2012/13); 10.6 (2013/14); 10.2 (2014/15); 9.9 (2015/16)
- Gross capital formation (percent of GDP):
  - 2008/09: 18.2
  - 2009/10: 15.4
  - 2010/11: 13.4
  - 2011/12: 13.4
  - Projected: 13.2; 13.6; 13.5; 13.6 (2012/13–2015/16)
- Nominal GDP (in billions of U.S. dollars, Table 2 / Table 6):
  - 2008/09: 161,819 (Table 2 shows 161,819)
  - 2009/10: 176,870
  - 2010/11: 210,566
  - 2011/12: 233,476
  - Projected: 244,899 (2012/13); 256,918 (2013/14); 269,838 (2014/15); 283,781 (2015/16)

### Policy-relevant indicators for surveillance
- Gross financing need under baseline (right scale in debt sustainability figures): highlighted as an important metric across scenarios.
- Public sector debt-to-revenue ratio (Table 10):
  - 2008/09: 412.6
  - 2009/10: 428.2
  - 2010/11: 470.9
  - 2011/12: 484.8
- Key macro assumptions underpinning baseline (Table 10):
  - Real GDP growth (market prices): 3.2 (2008/09), 5.9 (2009/10), 1.1 (2010/11), 3.5 (2011/12 onward)
  - Average nominal interest rate on public debt: 10.5 (2008/09), 8.3 (2009/10), 7.7 (2010/11), 7.3 (2011/12), rising to 9.6 (2015/16)
  - Inflation rate (GDP deflator): 20.3 (2008/09), 10.1 (2009/10), 20.5 (2010/11), 11.9 (2011/12), rising to 14.0 (2015/16)

*Source: 2011 ARTICLE IV REPORT AND POST-PROGRAM MONITORING — PAKISTAN (tables, figures, and projections as presented in the source content).*

### Appendix 1. Fiscal Decentralization in Pakistan: Too Much, Too Fast?

### Appendix 1. Fiscal Decentralization in Pakistan: Too Much, Too Fast?

### NFC Awards, 18th Constitutional Amendment, and recent shifts
- The 7th NFC Award (agreed in 2009) and the 18th Constitutional Amendment significantly increased funds and spending responsibilities transferred to the provinces.
- Share of the divisible pool allocated to provinces:
  - 47 percent in 2008/09
  - 56 percent in 2010/11 (65 percent of total FBR tax collection in that year)
  - 57.5 percent in 2011/12 and thereafter
- New criteria under the 7th NFC Award and their weights:
  - Population: 82 percent
  - Poverty: 10.3 percent
  - Revenue collection: 5 percent
  - Inverse population density: 2.7 percent
- Effect on provincial shares: the share of the poorest province, Baluchistan, almost doubled with a corresponding reduction in Punjab’s share.
- Other transfers (straight transfers, special grants) were increased sharply in 2010/11.
- Constitutional change: provincial borrowing in domestic or international markets is subject to limits and conditions specified by the National Economic Council (NEC).

### Fiscal structure and key statistics
- Provinces’ own tax collection remains very low: less than 0.5 percent of national GDP.
- Provincial own revenue is reported at about 0.5 percent of GDP.
- Pakistan’s vertical fiscal imbalance is large (vertical fiscal imbalance defined as the share of sub-national own spending (excluding transfers paid) not financed through own revenue (excluding transfers received)); average excluding Pakistan = 41 percent.
- The share of provincial spending in total general government spending is about 30 percent.
- Estimates related to the 7th NFC devolution:
  - Additional devolved resources to provinces: about Rs 200 billion
  - Devolved spending estimated at Rs 67–Rs 91 billion
- Federal medium-term target mentioned: reduce general government deficit to 3 percent of GDP.
- Provincial fiscal behavior noted: following federal example, provinces introduced a sizable salary increase in FY 2010/11, which absorbed a large share of additionally transferred revenue.

### Benefits and risks of rapid and extensive decentralization
- Potential benefits:
  - Improved quality of provided services if decentralization is well designed and implemented.
- Key risks identified:
  1. Limits on the federal government’s ability to conduct counter-cyclical stabilization policies when control over revenue and spending is reduced.
  2. Incentive problems from provinces’ heavy dependence on shared revenues and transfers, leading to weak incentives to raise own revenue and economize on spending.
  3. Unsynchronized and unbalanced devolution (resources preceding spending responsibilities) exacerbating fiscal strains; example: Rs 200 billion devolved resources vs. Rs 67–Rs 91 billion devolved spending.
  4. Rapid augmentation of provincial resources could overwhelm provinces’ capacity to spend effectively, risking disruption of services (health, food) and misallocation.
  5. Increased perceived or actual regional inequality and weakened service delivery could complicate center–province policy cooperation and hinder fiscal sustainability efforts.

### Preconditions and measures to make decentralization work better
- Overarching objective: ensure decentralization does not jeopardize federal capacity to reduce fiscal deficit and public debt; decentralization must be accompanied by prudent fiscal behavior by both federal and provincial governments.
- Fiscal rules and revenue-sharing options proposed:
  - Modify rules governing the divisible pool so additional revenue mobilized by the federal government does not automatically flow to provinces.
  - Example options:
    - Apply, at the margin, a lower provincial share of the pool when growth of the pool exceeds a specified floor (for example, nominal GDP growth).
    - Define provincial receipts from the pool as a “fixed” nominal amount indexed annually to a relevant price index (a “cap”), potentially maintained until the general government deficit is reduced to a target level (e.g., 3 percent of GDP).
- Provincial revenue mobilization priorities and potential tax bases:
  - Potential revenue sources: GST on services (potential varies by province), agriculture income tax, and strengthening tax on immoveable property.
  - Constraints identified: low taxable capacity, large rural and informal sectors, limited administrative capacity, exemptions and preferential treatments, and political resistance to taxing certain bases.
  - Note: failure to implement reformed GST undermines devolution’s success.
- Borrowing controls and rules:
  - Provincial borrowing should be tightly controlled, covering domestic and international markets and domestic bank borrowing (including borrowing from the central bank and provincial banks).
  - Consider introducing a provincial equivalent of the 2005 federal Fiscal Responsibility and Debt Limitation Act.
  - Alternative: a borrowing rule linking permitted provincial borrowing to their tax and non-tax revenue.
  - In the near term, provinces are expected to run temporary surpluses to help limit the general government deficit; achieving this requires cooperative agreement between federal government and provinces.
- Institutional cooperation and oversight:
  - Strengthen cooperation under the Council of Common Interest (CCI) to negotiate conformity between sub-national policies and macroeconomic objectives.
  - CCI’s role as conflict-resolution mechanism has been strengthened by the 18th Amendment and could play an important role in promoting cooperative approaches.
- Capacity and accountability improvements:
  - Two key prerequisites: strong accountability of service providers and policymakers, and strengthened administrative capacity at provincial level.
  - Priorities:
    - Reduce overlap of spending responsibilities and assign clear responsibility for provision of public goods and services at different levels of government.
    - Strengthen data provision on provincial spending, including functional classification data and data on actual versus budgeted spending, to improve budget implementation assessment and accountability.
  - Improved data availability and reporting would enhance the electorate’s ability to hold provincial officials accountable.

*Source: Appendix 1. Fiscal Decentralization in Pakistan: Too Much, Too Fast?*

### Conclusion

### _cr1235 - Conclusion

### Fiscal decentralization and fiscal sustainability
- The stepped-up fiscal decentralization as a result of the 7th NFC Award and the 18th Constitution Amendment provides additional significant resources and responsibilities to the provinces and, if well managed, has the potential to improve the delivery of public goods and services.
- Pakistan’s fiscal vulnerability is high and needs to be addressed urgently due to persistent weakness in tax collection and spending pressures.
- Large and unbalanced devolution of funds and spending responsibilities to the provinces left the federal budget in a weaker structural position.
- Substantial strengthening of fiscal discipline at both the federal and the provincial levels is crucial for restoring fiscal sustainability.
- Without stronger tax revenue and sounder public finance, the decentralization is unlikely to deliver the expected benefits.
- A clear assignment of responsibilities at different levels of government and better provision of data on budget implementation are needed to strengthen accountability and the quality of service delivery.

*Prepared by Mustafa Saiyid — material in subsequent appendices prepared by other authors as indicated.*

### Financial sector structure and challenges
- The financial sector in Pakistan is dominated by banks; developing the nonbank sector and capital markets could:
  - provide a greater variety of savings instruments to help stimulate domestic savings;
  - expand sources of credit available to the private sector;
  - transfer asset risk away from bank balance sheets to investors willing to bear it for commensurate return.
- Authorities are encouraged to lower barriers to development of capital markets, especially from national savings instruments, and to continue to improve transparency of information in both equity and debt markets.
- Further progress in commodities markets, particularly in the agricultural sector, could help producers hedge price risk and contribute to greater stability of banking sector deposits.

### Banking spreads and causes
- Banking sector spreads between lending and deposit rates are relatively wide on a cross-country basis.
  - Averaging more than 650 bps for the overall banking sector over a two-year period through September 2011, the spread is relatively wide compared with the median for a large number of countries.
  - The spread has generally increased in recent years but came down sharply during 2011 after 200 bps of policy rate cuts.
- Possible explanations for wide spreads:
  - Low deposit rates driven by deposits held mainly for transactional purposes while savings are invested in the National Savings Scheme (NSS).
  - Limited competition in rural areas and small towns allowing banks to offer the legal minimum deposit rate of 5 percent per year and still attract deposits.
  - High lending rates because corporations are forced to borrow from banks in the absence of capital markets financing and because of high risk premia associated with corporate governance and transparency issues.
  - Present composition of bank balance sheets—with rising holdings of government securities and a large share of rate-insensitive deposits—might be driving the wide banking sector spread.

### Alternatives to bank deposits and market structure
- Alternatives to bank deposits for savings include:
  - the NSS;
  - managed funds;
  - direct holdings of equities and bonds (via brokers);
  - investment products offered by insurance companies.
- NSS characteristics and impact:
  - As of October 2011, the profit rate on the NSS is set at 12.4 percent for a term of six months.
  - There is no upper limit on investment, no management fee, no redemption penalty, and no tax implication.
  - The overall size of the schemes is almost one-fourth that of bank deposits.
  - In October 2011, the administered rate of return on the NSS for a six-month period has sometimes exceeded that on a five-year Pakistan Investment Bond.
  - In March 2000, the government decided to restrict institutional investment in the NSS to reduce distortions in the term structure of interest rates.
- Managed funds:
  - Managed funds have assets of only one-fifth the NSS.
  - Challenges: performance after fees and liquidity (fees are high at 1-3 percent); fragmented and mostly unfunded pension system; loss of investor confidence after stock market closure Aug–Dec 2008; lawsuits stuck in courts in the absence of tribunals administered by the SECP.
  - Managed funds are subject to the corporate tax rate of 35 percent, which is higher than the 25 percent rate applicable to associations of persons—a discrepancy that may be pushing investment activity out to unregulated and unlicensed operations.
  - Funded corporate schemes are estimated at Rs 200 billion (US$2.4 billion); recently initiated public schemes amount to Rs 1.3 billion (US$15.5 million).

### Equity and debt market characteristics
- Equity market:
  - Listed market capitalization of Rs 3.3 trillion (24 percent of GDP).
  - Appreciated by about 130 percent over a two-year period through November 2011.
  - Capital gains taxes: 10 percent for holding periods less than six months, 7.5 percent for six months to one year; and none for more than one year.
  - Concerns: transparency of listed company information; market concerns that shareholder funds from listed companies may be directed to unlisted affiliates.
  - There are 651 listed companies versus some 10,000 unlisted companies with assets of more than Rs 7.5 million; only a small number of unlisted companies provide filing information to the SECP.
  - Changes to the “badla” system of informal margin financing are being finalized; new rules should provide adequate safeguards in light of losses suffered in 2008 when the market was closed for four months.
- Domestic debt market:
  - Limited activity: banks prefer government over corporate debt because of favorable impact on capital and liquidity positions; few significant institutional buyers.
  - Corporates prefer bank financing over capital markets due to onerous listing and reporting requirements.
  - Operational issues: bulk of corporate issuance listed on the Karachi Stock Exchange (KSE) may only be traded by Karachi brokers; reference prices for bonds are often based on a “matrix approach” in absence of trading activity.
  - The online bond trading system could improve price discovery and report trades in listed and unlisted bonds.
  - Problems with the matrix pricing approach include: assumptions of bond characteristic similarity; static credit risk premium tied to ratings; two agencies providing different ratings create ambiguity.

### Insurance and commodity markets
- Insurance industry:
  - Provides coverage of Rs 87 billion (0.6 percent of GDP) and is dominated by a state-owned life insurer.
- Commodity futures and PME:
  - Pakistan Mercantile Exchange (PME) has futures contracts in two precious metals (gold, silver); three agricultural products (rice, palm oil, wheat); crude oil; and three-month KIBOR.
  - Challenges: storage and delivery problems for some agricultural contracts (cotton, sugar); difficulty obtaining impartial grading of reference commodities; contracts based on local definitions of weights and measures are less actively traded than those based on international specifications.

### Policy recommendations for capital markets development
- Rationalize profit rates on NSS instruments by pricing the government guarantee and liquidity appropriately.
- Improve transparency of company information; explore ways to improve quality of information on listed companies to include links with unlisted subsidiaries and strengthen supervision in the area of unlisted companies.
- Continue to improve transparency in the pricing of debt instruments; strengthen processes for reporting defaulted bonds to exchanges; improve pricing mechanism for debt by reducing reliance on a matrix system, potentially by identifying specialized market makers who could offer two-way quotes.
- Deepen the opportunity set for equity investment; encourage listed companies to expand free float, and explore ways to bring unlisted companies into the listed market.
- Establish regulations for equity derivatives to allow options and warrants that help corporates lower the cost of share issuance and allow investors to hedge positions more efficiently.
- Allow cross-listing of bonds on multiple exchanges and permit brokers outside Karachi to transact in bonds locally to help increase liquidity.
- Encourage development of managed funds; encourage fund providers to offer products classified by risk tolerance; seek consistency in the corporate tax rate applied to the managed funds industry with that applied to associations of persons.

*PAKISTAN 2011 ARTICLE IV REPORT AND POST-PROGRAM MONITORING — Conclusion and associated appendices as provided in the source content.*

### 9.3 percent in 2000 to 15.6 percent in 2011, it

### _cr1235 - 9.3 percent in 2000 to 15.6 percent in 2011, it

### Gender and labor market outcomes
- Female labor force participation increased from "9.3 percent in 2000 to 15.6 percent in 2011".
- Female participation remains less than one-third that of males in Pakistan and is the lowest in South Asia, where it averages 44 percent.
- Share of women working in wage employment declined from 33 percent in 2000 to 21 percent in 2011.
- Female employees earn around 63 percent of the average wage of males.
- Over 63 percent of employed women work as (unpaid) contributing family workers.
- Unemployment rates: females "8.9 percent", males "4.5 percent".
- Conclusion: low female participation and share in wage employment reflect cultural and societal preferences and much lower education and literacy levels for women than for men; increasing female education and literacy levels should help improve female participation and employment opportunities.

### Youth, population growth, and employment dynamics
- Pakistan’s population growth rate: "2.2 percent (annual average)" over the last decade.
- More than 40 percent of the population is below the age of 14.
- Youth unemployment: decreased from "13.3 percent to 7.5 percent" during 2000/01–2006/07; increased to over "10 percent in 2010/11".
- Youth unemployment in 2010/11 is about "2.6 times the unemployment rate for adults aged over 25 years".
- Historical role: Pakistan has been an exporter of labor since early 1970s; over "5.7 million Pakistanis are registered as working abroad".
- Policy measures to date: microcredit facilities and vocational training programs; limited by financial and administrative capacity constraints.

### Employment growth requirements and projections
- Labor force projected growth: "3.4 percent per annum" (average for past decade), implying more than 2 million people entering the labor force annually.
- Estimated employment elasticity of GDP growth: "0.5".
- Required average GDP growth to absorb new entrants: "7 percent per annum".
- Staff baseline and reform scenario average GDP growth for 2011/12–2015/16: "3.5 and 4.7 percent, respectively".
- Based on staff projections, unemployment rate would increase to "10 or 13 percent in 2015/16".
- Table 2 exact figures:
  - 2010/11 Labor force (in millions): "58.1"
  - 2010/11 Unemployment rate (in percent): "6.0"
  - 2015/16 Labor force (in millions): "68.7"
  - Average projected annual real GDP growth rate for 2011/12-2015/16 (in percent): "3.5-4.9"
  - 2015/16 Unemployment rate (in percent): "10.0-13.0"
  - Required annual real GDP growth rate for 2011-2016 to absorb entrants (in percent): "7.2"

### Labor market efficiency and reform needs
- Pakistan ranked "136 out of 142 countries" in labor market efficiency in the World Economic Forum’s Global Competitiveness Report 2011/12, slipping further behind 23 countries since 2007/08.
- Report recommendations: increase female participation in the labor force significantly, reduce redundancy cost, improve linkage between pay and productivity.
- Highlighted issue: inflexibility in wage determination as wages are generally set outside a centralized bargaining process.
- Policy imperatives: reform labor laws and institutions to balance fundamental rights to workers and increased labor market efficiency and productivity; institutionalize dynamic matching processes to address youth unemployment; interventions in health and education to improve skills and close the gender gap.

### Banking sector vulnerabilities — overview
- Financial sector assets about "40 percent of GDP".
- Banks make up nearly 90 percent of the sector.
- Banking system composition (December 2010 source):
  - Financial sector assets: "8,150" PKR billion (100 percent)
  - Banking system: "7,138" PKR billion (88 percent)
  - Public banks: "1,358" PKR billion (17 percent)
  - Local Private banks: "5,404" PKR billion (66 percent)
  - Foreign banks: "234" PKR billion (3 percent)
  - Other-Specialized: "142" PKR billion (2 percent)
  - Nonbank financial institutions: "1,013" PKR billion (12 percent)
- Within banking: private "76 percent", public "17 percent", foreign "3 percent", specialized "2 percent"; total number of banks: 38 (23 private, 5 public).

### Capitalization, liquidity, and profitability
- Capital adequacy: overall banking system capital ratio nearly "15 percent" of risk-weighted assets; minimum requirement "10 percent".
- Holdings of government securities: "32 percent of assets".
- After-tax return on equity of banks: "14.1 percent" as of September 2011.
- Average system provisions were at "66 percent of NPLs".
- Macroprudential measures in place include dynamic provisioning and limits on size of credit and foreign currency exposures.
- Authorities developing draft legislation for consolidated supervision of bank holding groups.

### Nonperforming loans (NPLs) — levels and causes
- Overall NPLs rose to "16.7 percent as of end-September 2011".
- Corporate sector NPLs: "17.7 percent of the total through end-September".
- NPLs are elevated on agricultural and consumer loans, though these categories are relatively small proportions of total lending.
- Cash recovery in case of default estimated at roughly "30 percent of NPLs over time".
- Rising NPLs traced to weak underwriting and deterioration in the macroeconomic environment.
- Theoretical vs actual underwriting quality indicates public and specialized banks have been less successful in assessing borrower creditworthiness.
- Specific NPL levels at September 2011 (extrapolation context):
  - Public banks "25.2 percent"
  - Specialized banks "30.9 percent"
- Extrapolation note: five-year NPL trend would lead to system-wide NPLs of "21 percent by 2014" (staff scenario).

### Bank capital needs and stress considerations
- Table 2 (estimates, end-June 2011) (all amounts in billions of PKR):
  - Total Capital: Public "124", Local Private "508", Foreign "42", Specialized "9", All Banks "682"
  - Assets: Public "1,438", Local Private "5,923", Foreign "258", Specialized "143", All Banks "7,763"
  - Risk Weighted Assets: Public "940", Local Private "3,380", Foreign "142", Specialized "121", All Banks "4,583"
  - CAR (percent): Public "13.2", Local Private "15.0", Foreign "29.4", Specialized "7.3", All Banks "14.9"
  - Estimated After-Tax Return on Assets (percent): Public "1.1", Local Private "1.4", Foreign "1.6", Specialized "0.3", All Banks "1.4"
  - Estimated Earnings over 3 Years: Public "48", Local Private "255", Foreign "13", Specialized "1", All Banks "317"
  - Potential losses (net of provisions): Public "58", Local Private "41", Foreign "4", Specialized "1", All Banks "104"
  - Capital Need: Specialized banks could require an additional "3" (Rs billion) even considering potential earnings on existing assets.
- Assessment: overall system expected to absorb credit deterioration in the medium term, but individual banks could come under pressure; specialized banks presently undercapitalized.

### Shift into government securities and system absorption limits
- Banks are increasing holdings of government securities as private-sector NPLs rise.
- Current holdings of government securities: "Rs 2.2 trillion".
- Staff estimate maximum holdings before forced cutback of private-sector credit: approach "Rs 3 trillion".
- Deposit growth has supported government securities holdings: deposit growth "16 percent" in recent years.
- System advances to deposits ratio (ADR) and capacity (Table 3, all amounts in billions of Pakistani rupees):
  - Capacity System Advances to Deposits Ratio (ADR) in percent: "63.0"
  - Regulatory Limit for ADR (percent): "70.0"
  - ADR buffer (percentage points): "7.0"
  - Deposits: "5,418"
  - Lending Space from ADR Buffer: "378"
  - Projected Deposit Growth: "16.0"
  - Lending Space from Deposit Growth: "865"
  - Total Additional Capacity: "1,243"
  - Needs Private Sector Credit: "3,432"
  - Private Sector Credit Growth (percent): "3.6"
  - Private Sector Credit Needed: "123"
  - Circular Debt: "310"
  - Additional government debt banks could absorb: "810"
  - Present Bank Holdings of Government Securities: "2,259"
  - Maximum Holdings of Government Securities: "3,068"

### Risks from delayed restructuring and governance issues
- Lengthy or delayed restructuring of problem banks increases systemic risk.
- One public bank expected to meet minimum capital requirement only in five years’ time.
- Restructuring decisions for two largest specialized banks were taken only recently after being several years overdue.
- Past SBP constraints: SBP identified governance and lending problems but was unable to take remedial action earlier due to political resistance; example of imprudent/fraudulent lending includes one loan of "Rs 10 billion advanced without collateral".
- Policy implication: bolster independence of the bank supervisory authority and expand its enforcement powers.

### Policy recommendations (banking and labor)
- Banking sector recommendations:
  - Consider swift restructuring of problem banks; balance allowing time for balance-sheet repair against costs borne by counterparties and creditors.
  - Undertake comprehensive review of coverage and quality of borrower credit data available to banks; assess the existing online credit registry (e-CIB) for data quality, coverage, and effective use by banks.
  - Review dynamic provisioning approach; SBP discretion over threshold of bank profitability could make provision requirement uncertain for banks.
  - Strengthen banks’ ability to assess credit risk by improving the scope and quality of information available on borrowers.
  - Legal system reforms to accommodate faster recovery on defaulted loans.
  - Seek to pass explicit deposit insurance legislation to strengthen confidence in the banking system.
- Labor market and growth recommendations:
  - Reform labor laws and institutions to increase labor market efficiency, including increasing female participation, reducing redundancy cost, and improving linkage between pay and productivity.
  - Implement policies to alleviate key constraints to economic growth: unreliable electricity supply, fiscal and external vulnerabilities, low productivity, poor public service delivery, weak governance, and policy uncertainty.
  - Policy interventions in health and education to improve skills, close the gender gap, and improve the quality and productivity of human capital.
  - Institutionalize dynamic job-matching processes to address youth unemployment.
  - Sustain high, inclusive growth to create more and better jobs and absorb a rapidly growing labor force.

*Source: Pakistan 2011 Article IV Report and Post-Program Monitoring (excerpt).*

### 14.1 percent is below that in the boom years

### _cr1235 - 14.1 percent is below that in the boom years

### Banking sector provisions and nonperforming loans (NPLs)
- Report notes that "14.1 percent is below that in the boom years of 2005–06, and (general) provisions are correspondingly lower."
- Recommendation: Authorities "may wish to reconsider this approach as (general) provision requirements are lower at a time when NPLs are high relative to historical norms."

### Macroprudential limits and credit risk management
- Goal: "not to restrict opportunities for extension of private-sector credit but to ensure that banks are capable of handling risks posed."
- Debt-to-income ratio for loans to individuals:
  - Present limit: "monthly debt payments to income is set at 50 percent."
  - Observation: "in other countries, might include mortgage payments but would still be considered high."
  - Recommendation: "The authorities may wish to review the existing limit... to determine if banks are able to capture the full scope of borrower debt payments."
- Single credit exposure limit:
  - Present limit: "30 percent of equity, which includes loans that are fully secured by collateral."
  - Comparative guidance: "somewhat higher than in other countries."
  - BCBS recommendation cited: "a size limit on individual credit exposure should not exceed 25 percent of regulatory capital of bank or banking group."

### Legal framework for debt recovery
- Recommendation: "Initiate dialogue with relevant players regarding establishment of commercial courts to speed up recovery process for loans in default."
- Rationale: "Present recovery rates appear much lower than in other countries because of difficulties in the legal process."
- Suggested action: "undertake a comprehensive review of creditor rights, debt recovery, and the corporate and personal insolvency regime, which would include the effectiveness of courts and the legal process."

### Deposit insurance, liquidity, and deposit growth
- Deposit insurance:
  - Importance: "To strengthen confidence in the banking system, it is important to pass legislation for explicit deposit insurance."
  - Status: "A draft law for deposit insurance has been in the pipeline for a few years but the SBP indicated that passage was unlikely until after the 2012 elections."
  - Recommendation: "The authorities should seek to implement the existing proposal, eventually using a risk-based levy on banks."
  - Suggested fund size: "could be on the order of 5 percent of insured deposits, as in many other countries."
- Statutory liquidity and cash reserve requirements:
  - Cash reserve requirement (CRR) for rupee accounts: "5 percent."
  - Statutory liquidity requirement (SLR): "19 percent for rupee accounts and 15 percent for foreign currency accounts."
  - Note: "The SLR requirement for foreign currency accounts is lower than for rupee accounts because the reserve is held with the SBP rather than at the banks themselves."
  - Recommendation: "Consider strengthening the statutory liquidity requirement for foreign currency accounts."
- Deposit growth and tax on withdrawals:
  - Current tax: "0.2 percent on daily deposit withdrawals exceeding Rs 25,000."
  - Observation: "is not conducive to banking sector deposit growth and is hurting system liquidity."
  - Recommendation: "The authorities may wish to consider elimination of this tax."

### Appendix 5 — Workers’ remittances: trends, data issues, and risks
- Role of remittances:
  - "Remittance inflows to Pakistan have increased significantly, recently, and have become instrumental in financing the trade deficits and allowing Pakistan to rebuild its foreign exchange reserves."
  - Pakistan "has been one of the few large recipients of remittances to benefit from positive real growth in remittances in 2009–10."
  - Remittances: "have a positive impact on economic growth and reducing poverty, while being much less volatile than other sources of foreign exchange (FDI and portfolio inflows)."
- Data coverage and measurement issues:
  - Official remittance data "reflect transactions on account of 'family maintenance' and routed through official channels only."
  - IOM household survey (548 Pakistani households with at least one family member working in Saudi Arabia) result: "only approximately 40 percent of remittances go through official channels, while the rest are transferred through unofficial channels, friends and relatives, and migrants themselves."
  - Implication: "official data significantly underestimate remittances in Pakistan."
  - Counterpoint: Official data "could also include one-time capital transfers from migrants returning permanently to Pakistan, or any other transfers reported by the remitter to be for 'family maintenance,' including transfers by nonresidents for speculative purposes (which may be reversed rapidly in the event of an adverse shock)." These would "tend to overestimate remittances in Pakistan."
- Factors supporting recent remittance strength:
  - Historical context: "remittances have historically been quite strong, especially in the 1970s and early 1980s."
  - Policy and surveillance: "liberalization of Pakistan’s foreign exchange system in 2000, and greater surveillance of private transfers after 9/11 may explain the large increase in official remittances in 2002."
  - Research findings (Kock and Sun, 2011): recent performance reflects "(i) significant worker migration; and (ii) higher skill levels, and hence higher incomes, of migrating workers."
  - Migration trends: "the outflow of workers has increased significantly since 2006, and recent monthly data points to continued strength in outflows."
  - Host-country demand: "large oil revenues and long-term infrastructure needs in GCC countries, a major destination for Pakistani migrants, are expected to continue to attract migrant workers."
  - Policy measures: Pakistan Remittance Initiative (PRI) features:
    - "(i) reimbursement by the Government of Pakistan through the SBP of 25 Saudi Riyal equivalent per transaction to banks in Pakistan so that no charges for remitting are asked of the remitter or the beneficiary; and (ii) reimbursement of some marketing expenses by banks to facilitate home remittance flows through official channels."
  - Evidence on fee sensitivity: "A recent study by Yang (2011) supports the view that the response of remittances to fee reduction can be quite large."
- Use of remittances and sensitivity to returns:
  - IOM household survey: "close to 17 percent of remittances are used to finance real estate and agricultural machinery, while 21 percent goes to savings."
  - Vulnerability: "In the event of a change in returns on investment in Pakistan, perhaps as a result of a significant change in monetary policy stance (e.g., a sharp decline in the policy rate as has occurred in October 2011), these remittances could decline abruptly."
  - Example of volatility: "remittances can adjust quite rapidly, declining from US$1.3 billion in August 2011 to slightly below US$900 million in September."
- Concentration and countercyclical factors:
  - Source concentration: "roughly ¾ of Pakistan’s remittances come from Saudi Arabia, the United Arab Emirates, the United States, and the United Kingdom."
  - Countercyclical behavior: "strength of remittances could also reflect temporary factors... partly reflect the typical countercyclical behavior of remittances observed by Chami et al. (2009), especially following the earthquake in 2008 and the devastating floods in 2010."
  - Exchange rate and interest rate effects: "the relative stability of the Pakistan rupee against the U.S. dollar, coupled with relatively high domestic interest rates in Pakistan, may have resulted in higher-than-normal remittances."
- Staff outlook and policy implication:
  - Caution: "temporary factors may also have played a role, and may reverse, suggesting that a cautious approach should be taken to relying on remittances to safeguard external stability."
  - Forecast stance: "the staff’s macroeconomic framework for Pakistan forecasts only modest increases in remittances over the medium term."

*Source: _cr1235 - 14.1 percent is below that in the boom years*

### ANNEX II: RELATIONS WITH THE WORLD BANK

### ANNEX II: RELATIONS WITH THE WORLD BANK (As of January 2012)

### Overview
- Pakistan is among the largest recipients of World Bank financial assistance.
- The World Bank Group program in Pakistan consists of an integrated package of financial support, including IBRD lending, concessional IDA credits, Trust Funds and Grants administered by the Bank on behalf of other development partners, Multi-Donor Trust Fund (MDTF) for Khyber Pakhtunkhwa (KP), Federally Administered Tribal Areas (FATA) and Balochistan, IFC investments, and MIGA guarantees, along with complementary analytical and advisory services.

### Country Partnership Strategy (CPS)
- The CPS outlines the Bank’s strategic approach to helping Pakistan achieve its development goals over a four year period.
- The Bank Group’s Board of Directors endorsed a Country Partnership Strategy for Pakistan on July 8, 2010, covering fiscal years 2010 through 2013.
- The goal of the strategy is to help steer Pakistan’s economy back onto a path of high growth by addressing key long-term constraints to growth: weak revenue mobilization, unreliable energy supply, and a fragile security situation.
- A CPS Progress Report was presented to the World Bank’s Board on December 20, 2011. The Progress Report:
  - Confirms that the overall strategic goal remains valid and consistent with the priorities of the Government of Pakistan as articulated in its New Framework for Growth Strategy (NFGS).
  - Keeps the partnership centered on the existing strategic pillars of the CPS: economic governance; human development and social protection; infrastructure; and security and conflict risk reduction.
  - Agreed with the Government to extend the CPS period to include FY14.

### CPS Strategic Pillars
- Improving Economic Governance.
  - Addressing shortcomings of Pakistan’s economic management is critical for restoring macroeconomic stability and reducing reversals.
  - Enhancing domestic revenue mobilization is an urgent priority for the Bank during the CPS period.
  - Strengthening public expenditure management at all levels of government will complement this focus.
  - The strategy focuses on governance of markets to strengthen Pakistan’s competitiveness by addressing barriers to competition and factor market rigidities (including constraints in access to finance).
- Improving Human Development and Social Protection.
  - Focus on building resilience at the level of families and individuals.
  - Support increased spending on human development along with reforms to improve governance and accountability in service provision.
  - In education, support government programs combining supply side interventions and demand-side measures to improve access to education with a focus on equity to address regional and gender imbalances.
  - In social protection, support the Benazir Income Support Program (BISP) with a focus on increasing its targeting efficiency and strengthening its operation.
  - Aim to scale up support to strengthen health management systems and improve service delivery.
  - Given increased frequency of natural disasters, bring additional focus and assistance on the Disaster Risk Management (DRM) agenda.
- Improving Infrastructure to Support Growth.
  - Supply expansion and improving reliability and efficiency of power and gas systems are central to Pakistan’s growth.
  - Power is the most pressing need in infrastructure; the Bank Group supports policies for financial sustainability, expansion of generation in a least cost manner, and improvement in the efficiency of transmission and distribution.
- Improving Security and Reducing the Risk of Conflict.
  - Conflict in KP and FATA threatens vulnerable and marginalized populations and challenges economic stability nationally.
  - The Bank seeks to help Pakistan cope with consequences of conflict while reducing prospects of future conflicts.
  - The MDTF for KP, FATA and Balochistan is the Bank’s principal instrument for strategic engagement in crisis hit regions in partnership with other development partners.

### IFC and MIGA Engagement
- IFC:
  - Integral part of the World Bank Group’s program in Pakistan.
  - Strategy seeks to expand investments in sectors with highest potential development impact: infrastructure (e.g. renewable energy, ports), financial markets (e.g. SME support through access to finance, housing finance), and manufacturing and services (e.g. agribusiness, technical education).
  - Focused on advisory programs to improve the business enabling environment, strengthen financial markets, and support development of small businesses.
- MIGA:
  - Pakistan is a focus country; MIGA has provided guarantees in hydropower and microfinance.
  - Strategy seeks to support investments into IDA countries, South-South investments, complex infrastructure projects, and investments into conflict-affected areas.

### Key Principles of Bank Engagement Going Forward
- Deliver fewer but larger operations to focus limited resources on strategic areas where needs are greatest.
- Increase the use of performance-based instruments.
- Strengthen attention to implementation, results and communications.
- Deepen engagement with the provinces, requiring significant attention to capacity support.
- Leverage partnerships for shared objectives.
- For MDTF, start small and scale up success.
- The Bank does not expect to provide policy support in the near term given weak conditions for macro-economic reform, but will remain engaged on revenue mobilization and power through analytical work, ongoing projects and exploring results based operations.

### IBRD/IDA Financial Operations since FY2006
- IBRD/IDA financial operations since FY2006 are summarized below:
- Pakistan: World Bank Group Financial Operations
- (In millions of U.S. dollars)
- 
-                                FY2006  FY2007                               FY2008                               FY2009  FY2010  FY2011
- Commitments                                                                                    
-         IBRD 315100 174 00261
-         IDA 1,161726 296   1,609300   1,292
- Disbursements                                                                              
-         IBRD 149154 56 918634
-         IDA 1,0611030 267 848697773
- Repayments                                                                                          
-         IBRD 289265 270 253205158
-         IDA 117170 143 224165169

### World Bank Contact
- Eugenia M. Marinova, Senior Country Officer
- Telephone: (202) 473-3557
- emarinova@worldbank.org

*Source: ANNEX II: RELATIONS WITH THE WORLD BANK (As of January 2012).*

### ANNEX IV: STATISTICAL ISSUES

### ANNEX IV: STATISTICAL ISSUES

### I. Assessment of Data Adequacy for Surveillance
- General:
  - Data provision has some shortcomings, but broadly adequate for surveillance.
- National Accounts:
  - In 2004, the Federal Bureau of Statistics (FBS) completed a revision to bring national accounts into line with the 1993 System of National Accounts (1993 SNA).
  - Informal economic activities need to be better captured; newly emerging activities (e.g., information technology sector) continue to pose challenges.
  - FBS is working on producing quarterly national accounts (QNA), to be completed with a rebasing of the national accounts to the year 2005/06.
  - FBS has compiled and started releasing quarterly employment/unemployment data (first release February 2011, included 5 years of historical data) and is investigating feasibility of disseminating data on wages/salaries.
- Price statistics:
  - FBS produces three price indices: the CPI, the wholesale price index (WPI), and the sensitive price indicator (SPI).
  - CPI and WPI compiled monthly; SPI compiled weekly and consists of 46 essential commodities consumed by the lowest income group.
  - CPI and WPI concepts and definitions follow international guidelines.
  - FBS introduced COICOP classification with rebasing of indices to 2007/08 in August 2011; changes included updated weights and expanded item and geographic coverage.
  - Plans and IMF technical assistance are in place to develop a Producer Price Index (PPI).
- Government finance statistics (GFS):
  - Concepts and definitions broadly based on GFSM 1986, except privatization proceeds included below the line.
  - Scope of central government data limited: does not cover extra budgetary funds.
  - Classification and sectorization follow GFSM 1986 standards to a limited extent.
  - Expenditure classification deviates from GFSM 1986 because economic and functional classifications are mixed; defense and government administration expenditures not clearly identified by economic classification.
  - Basis of recording GFS is on, or close to, a cash basis; transactions recorded on a gross basis; corrective transactions not necessarily made in the original period as required by GFSM 1986.
  - Authorities intend to adopt GFSM 2001 methodology over the medium term; have compiled with staff assistance fiscal table in GFSM 2001 presentation.
  - Further improvements needed; progress being made in the context of the Project for the Improvement of Financial Reporting and Auditing (PIFRA).
  - Budgetary central government operations data regularly reported for publication in the GFS Yearbook using the GFSM 2001 framework, but no data reported on transactions in nonfinancial and financial assets and liabilities.
  - Authorities do not report higher frequency data for inclusion in the IFS.
- Monetary statistics:
  - ROSC mission found scope of monetary statistics comprehensive.
  - Classification and sectorization of the monetary survey compiled by the State Bank of Pakistan’s (SBP) Statistics Department broadly in line with the Monetary and Financial Statistics Manual (MFSM).
  - Basis for recording flows and stocks largely consistent with MFSM; SBP has indicated intention to adopt MFSM to further improve monetary statistics.
  - Reassessment in November 2006 found implementation of MFSM guidelines on sectorization of institutional units, classification of financial instruments, and recording of repos.
  - New reporting framework for other depository corporations designed and being implemented.
  - Progress resolving discrepancies in interbank positions between SBP and scheduled banks.
  - SBP reported Standardized Report Forms for central bank (1SR), other depository corporations (2SR), and monetary aggregates (5SR) to the Fund for publication in the IFS.
- Balance of payments:
  - Since Q3 2003 (July–September), Pakistan’s balance of payments statements prepared according to BPM5.
  - 2007 Fund TA mission recommended closer alignment of some recording practices with BPM5 (residency, sectorization, consistency across related data sets); a number of improvements made.
  - Differences between trade data sources (customs records for FBS and exchange records for SBP) for exports and imports have been widening; most differences can be reconciled ex post; authorities working to narrow differences before publication.
- International investment position:
  - Annual IIP data compiled and published on the SBP website; since 2010 SBP has started publishing quarterly IIP data.
  - Annual data available back to 2003.

### II. Data Standards and Quality
- Participation and assessments:
  - Pakistan participates in the General Data Dissemination System (GDDS) since 2003, meeting recommendations for coverage, periodicity, and timeliness of most GDDS data categories.
  - Authorities are keen to subscribe to the Special Data Dissemination Standard (SDDS); an SDDS assessment mission scheduled in January 2012.
  - The Report on the Observance of Standards and Codes (ROSC)—Data Module, a Response by the Authorities, and a Detailed Assessment Using the Data Quality Assessment Framework (DQAF) were published in December 2004.
  - A ROSC reassessment focusing on monetary statistics was conducted in November 2006 and published in February 2007. An update to the ROSC on fiscal transparency was published in April 2008.
- Requirements for SDDS subscription (areas Pakistan will need to disseminate or improve):
  - (a) Monthly data on central government operations with a timeliness of one month.
  - (b) Quarterly data on the national accounts, employment and unemployment, wages/earnings, and external debt, all with a timeliness of one quarter.
  - (c) More detailed breakdown of data on central government debt and external debt.
  - (d) Update and expand metadata on compilation and dissemination practices.

### Table of Common Indicators Required for Surveillance (as of December, 2011)
- Coverage in the table: variables include Exchange Rates; International Reserve Assets and Reserve Liabilities of the Monetary Authorities; Reserve/Base Money; Broad Money; Central Bank Balance Sheet; Consolidated Balance Sheet of the Banking System; Interest Rate; Consumer Price Index; Revenue, Expenditure, Balance and Composition of Financing—General Government and Central Government; Stocks of Central Government and Central Government-Guaranteed Debt; External Current Account Balance; Exports and Imports; GDP/GNP; Gross External Debt; International Investment Position.
- Selected entries (Date of latest observation / Date received / Frequency of Data / Frequency of Reporting / Frequency of Publication / Methodological Soundness / Accuracy and Reliability):
  - Exchange Rates: real time / real time / D / D / D
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Oct. 2011 / Nov. 2011 / M / M / M
  - Reserve/Base Money: Oct. 2011 / Nov. 2011 / M / M / M — Data Quality: O, O, O, LO (methodological soundness); O, O, O, O, LO (accuracy/reliability)
  - Broad Money: Oct. 2011 / Nov. 2011 / M / M / M
  - Central Bank Balance Sheet: Nov. 2011 / Dec. 2011 / M / M / M
  - Consolidated Balance Sheet of the Banking System: Nov. 2011 / Dec. 2011 / M / M / M
  - Interest Rate: Nov. 2011 / Dec. 2011 / M / M / M
  - Consumer Price Index: Nov. 2011 / Dec. 2011 / M / M / M — Data Quality: O, LO, LO, O (methodological); O, LO, O, O, O (accuracy)
  - Revenue, Expenditure, Balance and Composition of Financing—General Government: Sep. 2011 / Nov. 2011 / Q / Q / Q — Data Quality: LO, LO, LNO, LO (methodological); O, O, LO, LO, LO (accuracy)
  - GDP/GNP: 2010/11 / Jul. 2011 / A / A / A — Data Quality: LO, LNO, LO, LO (methodological); LNO, LNO, O, LNO, O (accuracy)
  - International Investment Position: Mar. 2011 / Aug. 2011 / A/Q / A/Q / A/Q
- Footnotes emphasize exact coverage, recording bases, and definitions (e.g., central government scope, components of reserve assets, note that fiscal year runs July 1 to June 30, and methodological assessment codes O, LO, LNO, NO).

### Public Information Notice & Executive Board Assessment — Key Findings and Projections
- Background and macro setting:
  - Pakistan faced external and domestic shocks, political uncertainty, and security problems; actions and reforms under the recently expired Stand-By Arrangement helped avoid a full-blown crisis in 2008/09.
  - Policy actions included establishment of an interest rate corridor, a more market-based exchange rate regime, strengthening SBP enforcement powers, substantial increases in electricity tariffs and domestic petroleum prices, and the Benazir Income Support Program (BISP).
  - Recent unresolved structural problems (especially in the energy sector), two major floods, difficulties implementing reforms, and a challenging global environment have limited growth and employment creation and left few buffers to absorb shocks.
- Recent performance and near-term outlook (staff projections and assessments):
  - In 2010/11, real GDP expanded by 2.4 percent.
  - Inflation persistently in double digits; unemployment high when underemployment and unpaid employment are included.
  - Fiscal deficit widened to 6.6 percent of GDP in 2010/11.
  - SBP’s foreign exchange reserves declined by about $2 billion in the last six months (prior to the PIN).
  - On current policies, near- and medium-term prospects are challenging: growth would remain too low to absorb labor force entrants; inflation would remain high; external position would weaken further.
  - 2011/12 projections: real GDP growth projected at 3.4 percent and average CPI inflation at 12 percent.
  - External risks: deterioration of current account due to lower cotton/textile prices, sharp slowdown in remittances growth, difficulties attracting external financing, and beginning of repayments to the IMF; reserves projected at $12.1 billion by end 2011/12.
  - Fiscal outlook: In absence of corrective measures, fiscal deficit likely to reach 7 percent of GDP, much higher than government’s revised budget target of 4.7 percent.
  - Considerable downside risks, including global environment deterioration and concerns about policy weakening ahead of senate elections in 2012 and parliamentary elections in 2013.
- Executive Directors’ recommendations:
  - Reorient macroeconomic and structural policies to stem near-term risks and lay foundation for durable, inclusive medium-term growth.
  - Reduce fiscal deficit to preserve macroeconomic stability and reconstitute policy buffers; take more resolute action to mobilize revenues and rationalize public expenditure.
  - Specific fiscal measures with merit: further broaden tax base, restructure public enterprises, eliminate poorly targeted subsidies, phase out commodity procurement operations, strengthen framework for fiscal devolution, and improve incentives for provincial governments to raise revenue.
  - Monetary and exchange rate policy: tighten monetary policy if inflation or external pressures increase; curtail central bank financing of the budget; secure greater operational independence of the central bank; increase exchange rate flexibility to facilitate external adjustment and safeguard reserves.
  - Financial sector: strengthen supervisory oversight; improve mechanisms for resolving problem banks; prompt establishment of a bank-financed deposit insurance scheme; address deficiencies in anti–money laundering and counter-terrorism financing regimes.
  - Structural reforms: high priority on improving business environment, boosting external competitiveness, and upgrading the power sector; support development of private sector participation.
  - Directors welcomed authorities’ decision to subscribe to the Fund’s Special Data Dissemination Standard.

### Table 1. Pakistan: Selected Economic Indicators, 2008/09–2011/12 (selected rows)
- Population: 173.5 million (2010/11)
- Per capita GDP: US$1,179 (2010/11)
- Poverty rate: 17.2 percent (2007/08)
- Output and prices (Annual percentage change):
  - Real GDP at factor cost: 2008/09 = 1.7; 2009/10 = 3.8; 2010/11 = 2.4; 2011/12 (Projection) = 3.4
  - GDP deflator at factor cost: 2008/09 = 20.0; 2009/10 = 11.9; 2010/11 = 18.8; 2011/12 = 12.0
  - Consumer prices (period average): 2008/09 = 17.6; 2009/10 = 10.1; 2010/11 = 13.7; 2011/12 = 12.0
  - Consumer prices (end of period): 2008/09 = 9.6; 2009/10 = 11.8; 2010/11 = 13.3; 2011/12 = 11.0
  - Pakistani rupees per U.S. dollar (period average): 2008/09 = 25.8; 2009/10 = 6.7; 2010/11 = 2.3; 2011/12 = ...
- Public finances (In percent of GDP):
  - Gross saving: 2008/09 = 12.5; 2009/10 = 13.1; 2010/11 = 13.6; 2011/12 = 11.4
    - Government saving: 2008/09 = -2.1; 2009/10 = -2.4; 2010/11 = -3.6; 2011/12 = -3.6
    - Nongovernment saving (including public sector enterprises): 2008/09 = 14.5; 2009/10 = 15.5; 2010/11 = 17.2; 2011/12 = 15.0
  - Gross capital formation: 2008/09 = 18.2; 2009/10 = 15.4; 2010/11 = 13.4; 2011/12 = 13.4
    - Government: 3.1; 3.5; 2.6; 3.1 (2008/09–2011/12)
    - Nongovernment (including public sector enterprises): 15.1; 11.9; 10.8; 10.3 (2008/09–2011/12)
  - Revenue and grants: 2008/09 = 14.7; 2009/10 = 14.4; 2010/11 = 12.8; 2011/12 = 12.7
  - Expenditure (including statistical discrepancy): 2008/09 = 19.9; 2009/10 = 20.3; 2010/11 = 18.9; 2011/12 = 19.5
  - Budget balance (including grants): 2008/09 = -5.2; 2009/10 = -5.9; 2010/11 = -6.1; 2011/12 = -6.7
  - Budget balance (excluding grants): -5.3; -6.2; -6.6; -6.9 (2008/09–2011/12)
  - Primary balance: -0.2; -1.6; -2.3; -2.9 (2008/09–2011/12)
  - Total general government debt 4/: 2008/09 = 60.7; 2009/10 = 61.5; 2010/11 = 60.1; 2011/12 = 61.7
    - External general government debt: 30.4; 30.1; 26.8; 24.9 (2008/09–2011/12)
    - Domestic general government debt: 30.3; 31.4; 33.3; 36.9 (2008/09–2011/12)
- Monetary sector (Annual changes in percent of initial stock of broad money, unless otherwise indicated):
  - Net foreign assets: -3.2; 0.5; 4.1; -3.3 (2008/09–2011/12)
  - Net domestic assets: 12.8; 11.9; 11.8; 18.2
  - Broad money: 9.6; 12.5; 15.9; 14.9
  - Reserve Money: 1.9; 11.4; 17.1; 13.3
  - Private credit (percentage change): 0.7; 3.9; 4.0; 3.4
  - Six-month treasury bill rate (period average, in percent): 13.1; 12.2; 13.7; ...
- External sector:
  - Merchandise exports, U.S. dollars (percentage change): -6.4; 2.9; 29.3; -1.8
  - Merchandise imports, U.S. dollars (percentage change): -10.3; -1.7; 14.5; 9.2
  - Current account balance (in percent of GDP): -5.7; -2.2; 0.2; -2.0
  - External public and publicly guaranteed debt (percent of exports of goods and services, unless otherwise indicated): 182.2; 177.3; 153.4; 158.5
  - Debt service: 21.6; 23.0; 13.8; 18.3
  - Gross reserves (in millions of U.S. dollars) 5/: 2008/09 = 9,110; 2009/10 = 12,958; 2010/11 = 14,784; 2011/12 (Projection) = 12,086
  - Gross reserves (In months of next year's imports of goods and services): 2.9; 3.6; 3.7; 2.9
- Memorandum items:
  - Real effective exchange rate (annual average, percentage change): -2.1; 1.0; 6.1; ...
  - Terms of trade (percentage change): 1.9; 4.5; -3.2; ...
  - Real per capita GDP (percentage change): -2.6; 1.6; 0.3; 1.3
  - GDP at market prices (in billions of Pakistani rupees): 12,724; 14,837; 18,063; 20,918
  - GDP at market prices (in billions of U.S. dollars): 161.8; 176.9; 210.6; 233.5

*Source: ANNEX IV: STATISTICAL ISSUES (As of December 12, 2011) — Pakistan 2011 Article IV Report and Post-Program Monitoring — Informational Annex.*

### 15.5 percent in December 2010.

### _cr1235 - 15.5 percent in December 2010.

### Fiscal consolidation and revenue mobilization
- 15.5 percent in December 2010.
- Fiscal consolidation remains a fundamental challenge; efforts under way to enhance revenue mobilization through tax administration efficiency gains and strengthen expenditure management.
- Major reforms by the Federal Board of Revenue (FBR):
  - Bringing in untaxed sectors into the net.
  - Major sales tax exemptions and zero-ratings withdrawn; exemptions restricted to food, health, education, and agriculture.
  - Improved compliance through better monitoring and risk-based audit to detect non-payments and irregular input adjustments of sales tax.
  - Fully automated refund processing system rolled out for taxpayers.
- Key fiscal performance indicators:
  - Revenue collection by FBR during the first half of FY12 indicates an increase of 27.1 percent over the corresponding period in FY11.
  - Total expenditure during July–December 2011 amounted to 45 percent of the budget instead of the allocated 50 percent.
  - Authorities are confident that maintaining current trends would help achieve fiscal targets for the year.
  - Authorities committed to bringing the deficit down to 3 percent of GDP over the medium term.
- Tax reform priorities:
  - Broadening the tax base through additional revenue measures.
  - Simplification of the system and improved administration.
  - Continued reduction in exemptions and renewed efforts toward consensus on a reformed GST.
- Expenditure-side reforms:
  - Medium-term budgetary framework (MTBF).
  - Project to improve financial reporting and auditing (PIFRA).
  - Budget Strategy Paper introduced to monitor government performance under output based budgeting.
  - MTBF placed before the parliament after Cabinet approval, as required under the Fiscal Responsibility and Debt Limitation Act 2005.

### Monetary policy and exchange rate management
- Monetary policy contributed to inflation decline during most of 2010; core inflation fell sharply towards the end of 2011.
- Authorities assess monetary conditions preemptively and will only loosen policy stance once inflation is on a firm declining trend.
- Coordination efforts to continue between the Ministry of Finance and the SBP to maintain effective monetary policy.
- Exchange rate and reserve management:
  - Staff report Figure 2 shows the 30–day moving average of daily net purchases and sales of foreign exchange by the SBP has hovered close to zero since July 2009, suggesting commitment to maintaining exchange rate flexibility while safeguarding reserves.

### External sector developments and outlook
- FY11 external sector benefited from high international commodity prices and buoyancy in workers’ remittances.
- For the first time in six years, the current account was in surplus during FY11.
- Export performance: exports expanded in both volume and price.
- Workers’ remittances boosted by increasing use of banking instead of informal transfer channels.
- Expected inflows:
  - Authorities expect significant foreign inflows from the auction of 3G mobile licenses in March 2012 and part of the Coalition Support Fund (CSF) due.
- Risks:
  - Authorities recognize risks to the external sector emanating from the Euro area; potential moderate fallout on Pakistan except through another oil shock.

### Structural reforms (power sector and PSEs)
- Focus on power sector and three key Public Sector Enterprises (PSEs).
- Electricity tariffs have been raised by ninety percent since 2008 after tariff rationalization.
- Power Sector Recovery Plan 2011 priorities:
  - Improving governance and financial restructuring.
  - Facilitating recovery of Federal and Provincial government arrears and enforcing collection from the private sector and PSEs.
  - Ambitious investment program to improve supply conditions and reduce the budgetary burden.
- Governance reforms and restructuring plans adopted and being implemented for the steel mill, railways, and airlines companies to strengthen financial positions and consider future options.
- Steps to promote trade and economic ties between Pakistan and India highlighted as important for regional cooperation and export growth.

### Fiscal decentralization, technical assistance, and financial sector strengthening
- Fiscal decentralization challenges:
  - Assignment of responsibilities, building capacity, and raising own-source revenues are critical to sustain macroeconomic stability and manage risks and costs during the transition.
  - Authorities have requested technical assistance from the Fund to help manage transition.
- Financial sector priorities:
  - Strengthen supervision, financial deepening, and increase competition.
  - Authorities agree with staff that further steps are needed to strengthen bank supervision and reduce NPLs.
  - Gross NPLs are generally expected to rise in the context of low growth and declining private lending, but strong supervision and provisioning requirements should help mitigate risks.
  - Increase in private sector credit during FY12 is encouraging despite weak external demand for textiles.
- AML/CFT and regulatory measures:
  - Anti-Money Laundering Bill enacted in March 2010 to address deficiencies and bring regime in compliance with FATF standards.
  - Financial Monitoring Unit established and made fully operational.
  - Money exchange companies brought under SBP regulatory fold with on-sight inspections by law enforcement agencies.
  - Authorities agreed with FATF to further strengthen criminalization of terrorist financing and confiscation of assets.

### Debt sustainability and reserves
- Authorities committed to improving debt indicators to preserve debt sustainability.
- Projections and vulnerabilities:
  - Public and external debt-to-GDP ratios expected to decline in the baseline scenario over the medium term.
  - Under the combined shock scenario, these ratios are projected only marginally higher than the baseline.
  - Level of external debt projected at around 25 percent for end 2015, well below emerging markets average.
  - Debt vulnerability appears subdued, with gross financing needs indicating a declining trend; none of the shocks show a rising debt to GDP ratio.
- Gross international reserves (GIR) and short-term debt:
  - GIR in percent of short-term (ST) debt at remaining maturity is projected to fall in FY12–13 but remains above 100 percent and is projected to increase significantly in outer years.
  - Authorities intend to follow prudent borrowing and improve assets/liabilities management to mitigate potential risks.

### Conclusion
- Authorities remain committed to sound macroeconomic management and implementation of structural reforms despite the expiration of the arrangement with the Fund.
- Commitment aims to preserve macroeconomic stability and harness growth potential in the run up to the senate and parliamentary elections.
- Authorities look forward to continued close cooperation and engagement with the Fund, including post-program monitoring.

*Source: _cr1235 - 15.5 percent in December 2010.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1235.pdf_