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Pakistan—Letter of Intent,
Memorandum of Economic and Financial Policies,
Technical Memorandum of Understanding

November 22, 2001

The following item is a Letter of Intent of the government of Pakistan, which describes the policies that Pakistan intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Pakistan, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Use the free Adobe Acrobat Reader to view MEFP Tables 1-2 and TMU Tables 1-5.

Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street, N.W.
Washington, D.C.  20431

Dear Mr. Köhler,

The government of Pakistan has adopted an economic reform program for 2001-2004, which aims to increase sustainable growth and strengthen basic social services as the central pillars of its poverty reduction strategy. To reach these goals, the government is determined to pursue sound macroeconomic policies, create the conditions for vibrant private sector development, and strengthen efforts on basic education and health as well as social safety nets. The details of the program are set out in the attached Memorandum on Economic and Financial Policies (MEFP) and the Interim Poverty Reduction Strategy Paper (I-PRSP). In support of this program, we request a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) in an amount equivalent to SDR 1,033.7 million (100 percent of quota).

The government will provide the Fund with information on a timely basis as might be requested in connection with the progress in implementing the PRGF-supported program.

The government of Pakistan believes that the policies and measures set forth in the MEFP and I-PRSP are adequate to achieve the objectives of the program, but will take any other measures as necessary for this purpose. The government will consult with the Managing Director, on its own initiative or at the request of the Managing Director, concerning the adoption of appropriate measures in accordance with the Fund's policies on such consultations. The government of Pakistan will seek to complete with the Fund the first review of the first-year PRGF-supported program no later than end-March 2002. Moreover, while the government of Pakistan has outstanding financial obligations to the Fund arising from loans under this arrangement, it will consult with the Fund from time to time, on its own initiative or at the request of the Managing Director, on Pakistan's economic and financial policies.

To facilitate wider distribution of the MEFP and I-PRSP, the government of Pakistan has authorized their publication by the Fund.

Sincerely yours,

Shaukat Aziz
Minister of Finance and Economic

Ishrat Husain
State Bank of Pakistan

Memorandum of Economic and Financial Policies
Technical Memorandum of Understanding

Memorandum of Economic and Financial Policies for 2001/02-2003/04

I. Introduction

1. Over the last two years, we have pursued with determination macroeconomic stabilization and wide ranging structural reforms, and all reviews under the recently expired Stand-By Arrangement were concluded as scheduled. To consolidate the progress achieved and to firmly set Pakistan's economy on a path towards high growth and poverty-reduction, we have launched an ambitious and far-reaching medium-term economic reform program, as laid out in detail in our interim Poverty Reduction Strategy Paper (I-PRSP), and for which we request Fund support under a three-year Poverty Reduction Growth Facility (PRGF) arrangement. In view of the consequences of the September 11 events, the outlook for Pakistan's economy is subject to higher-than-usual uncertainty, but this has only reinforced our determination to persist on the path of reform and macroeconomic stabilization. Successful implementation of the program will require strong and timely support of the international community, particularly in light of the adverse effects of recent events on Pakistan's economy.

II. Recent Economic Developments

2. In FY 2000/01, despite a severe drought and weakening external conditions, we preserved a stable macroeconomic environment and met targets under the Stand-By Arrangement. Careful economic management limited the negative impact of the worst drought in Pakistan's history, allowing the economy to grow by about 2.6 percent in 2000/01 despite an estimated 3 percent decline in agriculture output, and large increases in the energy import bill. Growth of large-scale manufacturing at about 8 percent suggests that the business community responded positively to the government's economic policies. The decision to let the rupee float led to a substantive real depreciation in 2000/01, which strengthened the competitiveness of our exporters and helped them weather weakening external demand. Cautious monetary and fiscal policy helped to contain the pass-through of the depreciation into domestic prices, and the rate of consumer price inflation for the year ending September 2001 slowed to 2.9 percent. The current account deficit, excluding official transfers, declined to 3.3 percent of GDP, with higher exports broadly offsetting higher imports of equipment by the manufacturing sector and a larger oil import bill. In the capital account, declining direct and portfolio investments were compensated by official aid and short-term capital inflows, which allowed the State Bank of Pakistan (SBP) to exceed its end-June 2001 target for international reserves. Reserves have grown further since and reached US$2 billion on November 2, 2001 compared to US$0.7 billion in June 2000. Partly because of lower-than-expected GDP growth and inflation, as well as the slower-than-expected impact of various administrative reforms, we have failed to meet the Central Board of Revenue (CBR) tax collection target for the year. Nonetheless, CBR revenue increased in 2000/01 by 0.4 percentage points of GDP with respect to the previous year. In response to the revenue shortfalls, we tightened nonpriority development expenditures, and the fiscal deficit was reduced to 5.2 percent of GDP, 0.1 percent below the program target, and compared to 6.5 percent in 1999/2000.

3. Under the Stand-By Arrangement, we implemented a wide range of structural reforms which we believe form a sound basis for our future reform agenda. As detailed in the MEFP for the last review under the Stand-By Arrangement, this includes:

  • Substantial tax reforms, notably the extension of GST to services, agricultural inputs, and retail trade; the introduction of provincial agricultural income taxes; elimination of income tax exemptions (for example, National Saving Schemes (NSS)) and promulgation of a reformed income tax law.

  • Improved governance in public finances and steps towards a streamlining of the civil service, such as separation of accounting and auditing functions, publication of quarterly fiscal accounts of the federal government, verified by the Accountant General Pakistan Revenue (AGPR); publication, for the first time, of an account of contingent liabilities and tax expenditures with the 2001/02 budget documents; a special audit of the Central Directorate for National Savings; and implementation of all remedial measures proposed in the context of the Fund's Safeguards Assessment of the SBP. A general framework to restructure and rightsizing the federal administration has been approved by cabinet at end-July 2001.

  • Trade liberalization through reduction in the maximum tariff to 30 percent and the number of tariff slabs to four (5, 10, 20, 30 percent); elimination of any discrimination in excise rates between imported and domestically produced goods; and the elimination of various quantitative restrictions and license requirements (for example, imports and exports of wheat, imports of oil products).

  • Market liberalization in the agricultural and energy sectors, through steps towards deregulation of wheat procurement procedures and pricing, far-reaching liberalization of oil product prices and marketing, and adjustments in electricity and gas tariffs to better reflect costs. However, the functioning of the automatic fuel adjustment clause encountered some difficulties and will need to be kept under review.

  • Progress in the liberalization of the financial sector and the foreign exchange regime, including by eliminating the subsidy element in the interest rate for the export finance scheme, and elimination of the limits imposed on the Nostro account positions of commercial banks.

  • Preparatory steps towards privatizing and restructuring of state-owned companies, including launching the process for the privatization of the telecommunication company, one major state-owned bank, and government interests in nine oil fields. Numerous expressions of interest were received in each of these cases, and closure was envisaged by December 2001. However, recent events brought the process to a temporary halt. The drought, high oil prices, and insufficient tariff adjustments prior to 1999 added to the already deteriorating financial conditions of Water and Power Development Authority (WAPDA) and Karachi Electricity Supply Corporation (KESC). The process of corporatizing WAPDA's successor companies with the technical support of the World Bank continued, and with the technical and financial support of the Asian Development Bank (AsDB), we launched the preparation for the privatization of KESC. The finances of the national air carrier (Pakistan International Airlines (PIA)) also suffered from high oil prices, but PIA recently adopted a medium-term restructuring plan, based on cost-cutting measures in several areas, including a reduction in personnel.

III. Medium-Term Program Framework

4. The central aim of our economic strategy is to gradually raise growth closer to Pakistan's potential of at least 6 percent within a few years, while ensuring that the benefits are widely shared by the large number of poor in our country. As illustrated in greater detail in our I-PRSP, the focus of our strategy rests on sound macroeconomic policies compatible with a continuous increase in the share of public expenditure for social development and poverty reduction programs, in a framework of sustained fiscal adjustment. To move faster and more effectively towards our poverty reduction and social development objectives, the government is committed to strengthen governance, particularly by raising transparency and accountability in public resources management.

A. The Poverty Reduction Strategy

5. The government is strongly committed to undertaking specific actions to reduce the burden of poverty affecting the people of Pakistan. We believe that growth and the related income-generating opportunities are essential in reducing poverty over time, but we also know that in a context where about one-third of the population is poor, it is not possible to wait for the benefit of growth to trickle down and address the poverty issue. Policies to improve access to basic services such as primary education, preventive health care and population and welfare services, and measures that increase efficiency in the delivery of public services will take center stage over the coming year. The government has targeted quantified improvements in a series of monitorable social indicators in the area of education, health, and population welfare. To achieve those objectives, the government is committed to raising over time the resources allocated to programs deemed effective in supporting social development and responding to the poverty problem, as indicated in the I-PRSP. In addition, the government will develop institutional mechanisms and procedures to track a wide range of social and poverty related expenditures, along with progress on intermediate and final outcome indicators. Given the limited administrative capacity available at the moment, such monitoring will be limited for the first program year to a selected sub-group of social indicators; and expenditure monitoring will have to rely initially on provisional (unreconciled) quarterly data; such reports will be published to allow public participation in the monitoring process.

6. Moving towards the preparation of the final Poverty Reduction Strategy Paper (PRSP), the government will deepen its analysis of the current poverty situation and refine the objectives of the strategy. It will also define a firmer methodology for producing the social indicators it intends to track, which will be made explicit in the PRSP. For incorporation into the budget starting with fiscal year 2002/03, the government will prepare detailed costing plans for the different programs included in the poverty reduction strategy, and ensure that resource requirements are fully consistent with the fiscal objectives. All along the process towards the final PRSP, the government will ensure that the provinces and newly-elected local governments, which will be in charge of implementing most of these programs, fully share the objectives of the strategy, agree on the amounts of resources needed to achieve those targets falling under their responsibility, and have in place the necessary institutional mechanisms to monitor the expenditure and the progress towards the objectives.

B. Medium-Term Macroeconomic Objectives and Policies

7. The medium-term macroeconomic objectives are to gradually raise growth to 5.2 percent at the end of the program period, while keeping inflation at about 5 percent. While we expect some pickup in private investment as confidence returns, the tight external financing constraint and the limited room to expand public investment will contain the overall investment rate to about 17 percent of GDP through 2003/04. Realization of the growth target would thus rely mostly on enhanced productivity through structural reforms. The current account deficit (excluding official transfers) is projected to decline to 2.6 percent of GDP in 2003/04. A steady accumulation of foreign exchange reserves is targeted to raise reserves to the equivalent of at least three months of import by June 2004, which we see as the minimum for strengthening confidence in the government's ability to maintain macroeconomic stability.

8. The government's macroeconomic policy mix will be geared to consolidate macroeconomic stabilization, and reduce the public debt burden, while directing expenditure efforts at poverty reduction and social development. We are aware that the need to reduce the debt overhang must be sustained by substantial fiscal consolidation and a continuous reduction in the fiscal deficit over the program period. We therefore plan a sustained fiscal adjustment to reduce the budget deficit to 3.2 percent of GDP in 2003/04 and allow a reduction of our (net) public debt-to-GDP ratio to 83 percent. On the other hand, widespread and increasing poverty and large needs for basic infrastructure and services must be tackled through stepped-up social sector and development expenditures and by raising the efficiency of public expenditure. We expect our tax policy and tax administration reforms (see below) to generate a gradual but continuous improvement in our tax revenues to 14.3 percent of GDP by the end of the program period. To ensure a controlled execution of the budget, we will continue to release social sector allocations in full at the start of each fiscal exercise, while staggering the availability of other allocations according to revenue developments. In the 2002/03 budget exercise, we will likely need to make special budgetary allocations to fund a financial restructuring package needed to bring KESC to the point of sale.

9. The maintenance of a market-based and competitive exchange rate will remain at the core of our exchange rate policy, while the functioning of the foreign exchange market will be strengthened. The SBP will gradually discontinue its kerb market purchases and promote the integration of the kerb market into the interbank market so as to further reduce the spread between the two rates. We expect the recent narrowing of the spread to shift workers' remittances from the kerb to the interbank market, accelerating the integration of the two markets. Intervention in the inter-bank foreign exchange market will be limited at ensuring a smooth functioning of the interbank market, while ensuring the SBP's reserves accumulation objective under the program.

10. Monetary policy will be geared towards containing inflation and support a steadfast accumulation of reserves to reduce external vulnerability. The SBP will maintain a prudent monetary stance and we will use interest rates flexibly to preserve appropriately tight domestic liquidity conditions to ensure the inflation target, in view of the expected continued instability of money demand. In case of strong pressures on the exchange rate, monetary policy will be tightened. In addition, the SBP will deepen its analysis of the functioning of the monetary transmission mechanisms, while strengthening the operational framework of the interbank market for liquidity management purposes, in view of preparing the move to an inflation targeting framework towards the end of the program period.

IV. The structural Reform Agenda

11. We will implement an ambitious reform agenda aimed at raising growth, reducing poverty, and restoring the confidence of private investors in the potential of our economy. The key areas of our agenda include: restructuring of public expenditure towards growth-enhancing and poverty-reducing outlays; improving monitoring and transparency in public finances; tax policy and tax administration reform, public enterprise restructuring and privatization; and financial sector and foreign exchange market reforms. In all these areas, the central challenge is to address governance problems that remain a major obstacle to higher growth and better social services. Two additional dimensions of governance will be tackled. First, we will assess existing regulation and procedures affecting the interaction between the administration and the business community with a view of eliminating red tape and, with it, corruption opportunities. Second, with the support of the AsDB, we are undertaking a long-term "access to justice" reform program aimed at strengthening the rule of law and enhancing the transparency and accessibility of the legal system by modernizing the court system at all levels and strengthening capacity, effectiveness, and accountability of law enforcement agents. A detailed matrix outlining the timeline for the measures we intend to take over the medium term are included as an annex to our I-PRSP. Critical measures to be taken in the current fiscal year are listed in Table 2.

Refocusing public expenditures

12. Over the medium term, we plan to allocate a rapidly growing share of budgetary expenditure to growth-enhancing and poverty-reducing outlays. Specifically, we aim to increase the development budget by 1.2 percentage points of GDP over the three-year period, and broadly defined social and poverty-related expenditure by 0.6 percentage points. A start has been made with the 2001/02 budget, while further plans will be formulated once various major initiatives (such as the education reform strategy detailed in the I-PRSP) are costed and appropriate monitoring mechanisms are in place. At the same time, we will reduce the share of other categories of spending, including the defense related expenditure. The devolution initiative will play a key role in this strategy, as it empowers local communities to formulate and implement development strategies that correspond to local needs. Starting from next fiscal year, the districts will be in charge of preparing their own budgets, based on transfers from the provincial governments and their own resources, while being permanently subject to a "balanced budget" constraint that does not allow them to borrow from scheduled banks or the SBP. The hiring of civil servants will not be devolved to local governments over the program period.

Monitoring and transparency in Public Finances

13. Over the program period, we intend to take measures aimed at the entwined objectives of strengthening public resource management, improving transparency and access to information on public finances, and reducing corruption opportunities in the interaction between the administration and the private sector. A cornerstone of our governance strategy is again the devolution outlined above. Local governments and recently established citizen boards will be key in monitoring social service delivery and ensure that resources reach intended recipients; we expect that a key role will be played by women, which hold at least 30 percent of all local council seats. We are committed to establishing dedicated institutional mechanisms to track social development and poverty alleviation expenditures, and outcomes at the federal, provincial, and district level. Along with the implementation of our Poverty Reduction Strategy, we will regularly report to the public on our actions and outcomes. With the technical and financial support of the World Bank, we intend to implement a follow-up project to Pakistan Improvement of Financial Reporting and Accounting (PIFRA) aimed at reorganizing and modernizing our system of government accounting with the objective of establishing comprehensive recording, reconciliation, and reporting procedures. To increase accountability of public resource management, we will reform our public procurement regulation and practices with technical guidance from the World Bank.

14. During the current fiscal year, the following initiatives will be implemented. First, based on the reporting framework for social development and poverty reduction expenditures, and outcomes described in the I-PRSP, we will publish, within a delay of three months, a table on the quarterly execution of those expenditures, starting in November 2001, with annual data relative to FY 2000/01. Such data will be somewhat provisional, because in the current accounting and auditing framework, the decentralized nature of most social expenditure makes it impossible in the short term to provide fully reconciled data for the expenditure of the local governments. A few intermediate social targets and outcome indicators expected to be responsive to the selected expenditures will be reported yearly by the Poverty Center under the Planning Commission.

15. Second, building upon progress made under the Stand-By Arrangement, we will improve more generally the regular fiscal data reporting and publication. The provincial Fiscal Monitoring Committees will prepare and publish quarterly reports on progress made in fiscal accounting and data reconciliation, and fiscal transparency. Training of accounting staff at the provincial and district level will be intensified, especially in Sindh and Punjab, where progress in fiscal accounting has so far lagged behind. These and other efforts will benefit from World Bank assistance through provincial lending operations, as well as a follow-up project to PIFRA. In our final PRSP, we will commit to a path towards a full reconciliation of expenditure data at the provincial and district level within a reasonable timeframe.

16. Third, at the federal level, we will seek to improve the accounting of foreign-financed development expenditures, publish an analytical mid-year review of budget implementation no later than end-February 2002, and intensify the preparatory work for the implementation of a Medium-Term Budget Framework (MTBF). A preliminary MTBF will be prepared with the 2002/03 budget, refining our medium-term budget projections, deepening the budget's analytical underpinnings (for example, by an extended analysis of contingent liabilities, tax expenditures, and fiscal risks), analyzing follow-up capital costs, as well as recurrent cost implications of projects included in the Public Sector Development Program (PSDP), and preparing for the three-year expenditure programs in the health and education sectors linking performance indicators with costs. The latter will provide a necessary input into the preparation of the full PRSP.

Tax policy

17. To raise the revenue needed to finance development and social services, tax reform is aimed at reducing a range of exemptions, while gradually unifying corporate income tax rates towards 35 percent. Over the program period, we will neither introduce any new exemptions, nor extend the coverage or the period of time-bound preferential tax treatment. Excise taxation will be simplified and taxation of diesel brought closer in line with the taxation of other petroleum products, also for environmental reasons.

18. As detailed in Table 2 during FY 2001/02, the government will take a number of steps to strengthen the GST regime, and prepare by March 2002 a review of the experience with the higher sales tax rate (20 percent) on certain inputs, with a view to return to a single rate if that measure is found to have brought little additional revenue or compliance. The new income tax law has already been promulgated. It provides for self assessment to be universally implemented starting with filing of income tax returns for income earned from July 1, 2002, based on strengthened taxpayer services, and backed by strong audit and new book-keeping requirements that will become effective July 1, 2002. Within the 2002/03 budget law, further steps will be taken to reduce exemptions, eliminate at least two minor withholding taxes, and bring various corporate tax rates closer together. During the remainder of this fiscal year and beyond, we will also intensify taxpayer information and education activities.

19. As regards other taxes, we will streamline with the 2002/03 budget our excise tax system by: (a) eliminating at least six minor excise taxes (on polyester chips, electric batteries, metal containers, advertising agents, shipping agents, and travel agents), while recuperating the ensuing revenue losses through increases in the excise tax rates on other products (for example, beverages); (b) set a uniform ad valorem tax rate on domestically produced and imported cement; and (c) reduce the number of different excise tax rates. In light of the ongoing 2002 National Finance Award discussions, we will review the scope for unifying the petroleum levy and gas surcharge with the respective excises on these products.

Tax Administration

20. Tax administration reform is a cornerstone in our institutional reform agenda. A major overhaul of the CBR will be implemented over the program period. It aims at increasing the agency's effectiveness, reduce corruption opportunities, and raise the buoyancy of the tax system through organizational restructuring, self-assessment, elimination of personal contacts between taxpayers and collectors, simplified processes, revised terms and conditions for employment of CBR officials, and improved IT management. The reform of the CBR will need to be supported by extensive technical and financial assistance from the Fund, the World Bank, and others (for example, DFID). We will press for similar reforms at the provincial level.

21. As a first step, the government will approve shortly a medium-term reform strategy and action plan for fundamental CBR reform, and appoint a Supervisory Council (with 3-4 senior government officials, reporting directly to the Minister of Finance) to oversee the reform. The CBR will restructure its headquarters by end-February 2002 by formally establishing the functions of human resource management, IT, taxpayer facilitation, audit, legal affairs, and administration, and appoint one senior member to lead each of these functions. The new senior CBR team will prepare, for implementation with the 2002/03 budget, revised recruitment policies (with greater emphasis on skills that match the CBR's needs), incentive- and merit-based remuneration and promotion mechanisms (financed from special agency allowances linked to the modernization program), training, and a program for placing unnecessary staff in the surplus pool. In parallel, the CBR will continue to strengthen sales tax audit and enforcement activities, with monthly sales tax audit targets for the remainder of the fiscal year. A pilot Large Taxpayer Unit (LTU), based on a functional organization and encompassing all domestic taxes, will be established by end-June 2002 in one of the major cities of Pakistan. With a view to resolve deficiencies in the appeals and dispute resolution process, we will prepare by March 2002 proposals for improvements, especially with regard to the sales tax tribunals, to be implemented with the next budget.

Trade policy

22. The government is firmly committed to further trade liberalization over the medium term to reduce further the anti-export bias, promote competitive and efficient industries, and encourage investment in sectors in which Pakistan has a comparative advantage. Measures in this respect would include a reduction of the maximum tariff to 25 percent effective July 1, 2002; streamlining the number of statutory orders (SROs) that exempt certain industries from import duties from 13 to 6 by June 2003 and eliminating those remaining by June 2004; and, as agreed with the WTO, phase out Trade Related Investment Measures (TRIMs). The government does not maintain and will not introduce any quantitative import restrictions beyond the standard restrictions related to security, health, public morale, and religious and cultural concerns.

Public enterprises restructuring and privatization

23. Our original privatization program has suffered a temporary set back due to the regional uncertainty following the event of September 11; nonetheless the government's commitment to advance on this road is unchanged. We will move ahead early with two small operations involving the sale of remaining public shares in Muslim Commercial Bank and Allied Bank and with the sale through the stock market of 5 percent of the capital of National Bank of Pakistan (NBP). In the context of the restructuring and privatization program for the three large nationalized banks supported by the World Bank, and expected to be completed by the end of 2003, we plan to bring United Bank Limited (UBL) to the point of sale by end-May 2002. Pakistan Telecommunications Company Limited (PTCL), the national telecommunication company, will be brought to the point of sale in early 2002, and one generation and one distribution company originating from the restructuring of WAPDA later in 2002. Approval by cabinet of a new regulatory system of oil and gas operations, distribution and pricing that is being elaborated (with assistance from the World Bank) will allow us to move fast towards privatizing Pakistan State Oil (PSO) and OGDCL (where financial advisors have already completed their due diligence), and Pakistan Petroleum Limited (PPL), and the two gas distribution companies (where financial advisors contracts will be signed in early 2002). In order to bring KESC to the point of sale by July 2002, through transparent and open public offer for sale, the cabinet will approve a privatization strategy for KESC by end-2001. The strategy will include the set-up of an adequate transitional regulatory framework, a decision concerning the financial structure of the operation, and an arrangement in principle to provide continued police and army support in enforcing bill collection, and reducing theft for a transitory period.

24. To proceed towards establishing a well functioning, competitive, and mainly privately-owned power sector, some changes in the existing regulatory framework and its functioning are crucial, such as to ensure that the automatic fuel adjustment clause becomes fully automatic. We will also resume by March regular adjustment of gas tariffs in line with market developments. The planned new energy sector investor framework will not provide any tax concessions or guaranteed rates of return. With the objective of making the large public enterprises more accountable to their shareholder and to the taxpayers, who ultimately bear the cost of the subsidies needed to keep the companies operating, the government will conclude by end-December 2001 memoranda of understanding with KESC, WAPDA, PIA, Pakistan Railways, and Pakistan Steel Mills involving performance targets and regular reporting on such targets, as well as needed adjustments in tariffs and prices.

Pension and civil service reform

25. In collaboration with the World Bank, we intend to establish an Actuarial Office over the next few months, and with a view to ensure a sustainable pension system, prepare a public pension reform package, including proposals for parametric reforms (for example, retirement age, commutation factors) of the pension system for existing employees, and a new contributory pension system for new entrants. The latter should become effective with the 2002/03 budget. Regarding civil service reform, we will implement the right- and downsizing plan approved by the Cabinet in July 2001 for all federal ministries, and will curb total recruitment with a view to achieve an annual 2 percent decline in the government payroll through 2003/04. Further details for federal and provincial rightsizing programs will be worked out during the remainder of this fiscal year so that they could be implemented also with the next budget. During this fiscal year and next, another pay reform will be prepared that will be ready for implementation, together with the pension reform outline above, with the 2003/04 budget.

Financial sector and foreign exchange market reforms

26. The SBP has prepared a draft comprehensive strategy for the modernization and strengthening of the financial sector, which will be a key component of Pakistan's poverty reduction strategy. The strategy aims to develop a market-oriented, mainly privately-owned financial sector performing efficient financial intermediation. The main policy objectives include: (a) promoting sound, efficient, and competitive financial institutions; (b) widening the availability of financial instruments and services; (c) enhancing transparency and cost-effectiveness of financial markets; and (d) strengthening the capacity of financial regulatory agencies while reinforcing their autonomy. The assessment and suggestions of the forthcoming Financial Sector Assessment Program (FSAP) mission will be further input in the formulation of the strategy, which will be incorporated into the program. The SBP will, in particular, explore ways on how to ensure effective supervision in areas such as anti-money laundering. On the transition to an Islamic banking system, the government will develop, and seek Supreme Court approval for, an evolutionary approach that will allow and encourage the development of Islamic banking in parallel with traditional practices to allow customers maximum choice; at the same time the SBP's capacity to appropriately regulate and monitor Islamic finance products and operators will be strengthened. To avoid subsidization of the export finance scheme, the refinance rate charged by the SBP to commercial banks will be set monthly at a level equal to the average six-month treasury bill auction rate of the preceding month, with banks free to set the rate to customers. Finally, by mid-2002, we will eliminate all remaining mandatory elements related to the implementation of indicative credit allocations to specific sectors, and will ensure that all nationalized banks operate according to commercial principles.

27. In view of fully complying with Pakistan's obligations under Article VIII of the Fund's Articles, the SBP will review its foreign exchange regulations and eliminate any requirement or obligation limiting current account convertibility. In addition, the manual of foreign exchange regulations is being reviewed with the objective of streamlining the existing regulations and eliminating ambiguities, to reduce the hassle-factor for small transactions that has contributed to the expansion of the kerb market. In order to gradually integrate the kerb and interbank market operations, the SBP will promote a consolidation of the currently large numbers of relatively unregulated moneychangers into foreign exchange companies, which will be subject to more stringent capital requirements, disclosure obligations and prudential supervision by the SBP. Banks will be allowed to create their own exchange companies.

V. Macroeconomic Policies for 2001/02

28. During the first year of the program, we target a moderate increase in growth in FY 2001/02 to 3.7 percent (from 2.7 percent last year), with inflation limited to 5 percent. The projections reflect, on the one hand, a downward revision of industry and service output due to September 11 and the ensuing regional tensions, and on the other hand, better prospects for agricultural output, especially regarding sugar cane and cotton. Our projections critically assume that normal economic activity will resume by late 2001, supporting a growth rate in the manufacturing sector of about 4 percent. The projections are obviously highly sensitive to regional developments and vulnerable to the protraction of uncertainty.

29. Following severe disruptions in international trade operations in the aftermath of September 11, aggravated by large increase in freight, insurance, and financing costs, we expect trade to recover to its normal pattern starting in late 2001. Under this assumption, we expect no annual export growth (in U.S. dollar terms) in 2001/02. This reflects, on the volume side, the effects of the global slow-down in world demand and of temporary dislocation linked to the regional tensions; the volume decline is compounded by a large decline in the international price of cotton, causing a major reduction in the unit value of our textile exports. However, these effects can be partially offset if our major trading partners were to increase quotas on textile and clothing exports and to reduce tariffs; we are highly encouraged by the recent proposal of the European Commission in this regard. Furthermore, also to effectively raise our exports, we are seeking to channel part of the international relief effort in favor of Afghan refugees (administered through the U.N.) through the Pakistani economy by encouraging active participation of domestic suppliers in the bidding for the delivery of food, tents, and basic consumption items to the refugees or into Afghanistan; the projections assume exports of at least US$100 million on this account. Import growth will also slow down, reflecting downward pressure on international prices of oil and other basic commodities resulting from slowing world demand, as well as lower domestic activity. On balance, we expect a slight worsening of our trade balance. The service balance is broadly unchanged despite sharply higher freight and insurance premia and reduced travel receipts, reflecting the lower value of imports and associated insurance/freight costs, as well as reduced travel by residents. In the event, we project an increase in the current account deficit, excluding official transfers, to 3.6 percent of GDP. The capital account balance is expected to worsen, compared with last year, mainly on account of higher debt service and lower projected FDI inflows (including privatization), as it may take some time to restore investor confidence in the region following recent events. We consider it, however, essential to pursue an ambitious build up of our stock of international reserves, to help us better weather exogenous shocks, which would otherwise be reflected in greater volatility of the exchange rate, and support the planned liberalization of the foreign exchange market. We, therefore, maintain an objective of building official reserves to US$2.3 billion (equivalent to about 9.4 weeks of next year's imports) by June 2002. As a result, substantial financing requirements will have to be met through exceptional support of the international community (see below).

30. Fiscal adjustment remains the pillar of the government macroeconomic adjustment effort and the linchpin of our debt reduction strategy. Although revenue was lower than expected, according to preliminary estimates and the budget deficit (excluding grants) during the first quarter of the current fiscal year (July-September 2001) was broadly on track, at PRs 54.5 billion. Revenue fell short of expectation in part because of lower custom and sales tax revenue after September 11. However, revenue was also affected by the slowdown in imports during July and August, and the acceleration of refunds to exporters. The latter effect is one-off and we do not expect this level of refunds to affect net tax collection in the future. Given the current circumstances, and under the proviso that by late 2001 the situation in the region is back to normal, we estimate that revenue losses associated with the impact of September 11 for the year would be in the order of PRs 12 billion (0.3 percent of GDP), mainly explained by lower import duties and sales tax revenue. Expenditures will be kept within the budget limits to ensure the deficit (excluding grants) is contained at PRs 202 billion, or 5.3 percent of GDP. However, if actual budgetary grants received were to go beyond PRs 25 billion, the government will use additional amounts, for up to PRs 15 billion, to increase allocations in specific social sector programs as listed in the TMU (Table 4). The first such program to be enhanced is the Khushal Pakistan Program, comprising small-scale, labor-intensive community projects, which we expect to have a significant poverty alleviation impact. Any grants in kind or in cash directed to support security or operational expenditures related to the current tension, as well as grants targeted for the Afghan refugees in Pakistan, are not covered in our projections. It may not be possible to include grants in kind in our budgetary operations; we will, however, make our best efforts to keep track of those grants and related expenditure. Regarding the outlays related to the downsizing of the nationalized banks, bridge loans of the SBP to the banks to finance nonbudgeted expenditure will be limited to PRs 2.5 billions in 2001/02, and such bridge lending will be eliminated in 2002/03. We are prepared to take contingency measures as needed to preserve fiscal stability in the face of unforeseen developments, in particular, in case of an unexpected prolonged duration of current regional tension. Such measures would involve notably cuts in nonpriority expenditure. We are also committed to undertake additional tax revenue measures, if the underlying tax-collection trend would fall short from the targeted path. Such measures could include an increased petroleum levy, or accelerated elimination of GST exemptions.

31. Monetary policy will remain geared to keep inflation in check while supporting the targeted accumulation of international reserves. As we are not yet in a position to move to inflation targeting, we will maintain a quantitative framework for monetary policy implementation, based on targets for the SBP's net domestic and net foreign assets. We envisage an expansion of broad money by 9.1 percent for 2001/02, which would allow a substantial increase in credit to the private sector given the fiscal targets. This quantitative framework will need to be kept under continuous review, given the uncertainties about money demand. In particular, the uncertainty triggered by the events of September 11 events has initially pushed up the demand for cash, creating pressures on bank liquidity. Given the recent remarkable inflation performance and the risks of declining domestic activity, the strength of the rupee, in spite of the central bank's aggressive buying on the interbank market, and declining international interest rates, the SBP has decided to reduce the discount rate by 200 basis points to 10 percent in October. However, we will closely monitor monetary developments and stand ready to raise interest rates as needed to preserve the inflation objective and achieve the net foreign assets (NFA) and net domestic assets (NDA) targets.

32. Concerning exchange rate policy, the SBP will maintain a fully flexible market determined exchange rate and proceed towards the unification of the kerb and interbank market rates. Intervention in the foreign exchange market will be limited to smoothing volatility and to pursue the targeted build-up of reserves. To further integrate the interbank with the kerb market and allow the phasing out of SBP purchases in the kerb market, the SBP will, over the coming months, reform the existing regulatory framework through several steps: first, it will pursue the consolidation of money changers in exchange companies that can be brought under appropriate supervision. Second, scheduled banks will be allowed to set up exchange companies themselves, and to purchase foreign exchange from exchange companies at freely negotiated rates. Third, to reduce the complexities of foreign exchange regulations, which may contribute to diverting transactions towards the kerb market, the foreign exchange manual will be drastically simplified. Finally, the commercial backing requirement will be lifted to allow interbank foreign exchange operations unrelated to payments and transfers for current international transactions.

VI. Statistical Issues

33. Our plan to improve the quality and the dissemination of economic statistics, particularly in the domain of national accounts, has progressed significantly during 2000/01, and we intend to advance further on this front during the course of the program. Concerning real sector statistics, we plan to strengthen the reliability of our GDP statistics by sector of origin on the basis of the findings of the sectoral studies under preparation, which will be completed according to the following schedule:

  • Slaughtering, water supply, transport (excluding shipping), and financial institutions (November 2001).

  • Electricity, trade, capital formation, saving, consumption of fixed capital, and forestry (December 2001).

  • Agricultural crops, small scale manufacturing, nonprofit institutions and housing, constructions, and large scale manufacturing (March 2002).

The results of these studies will strengthen the basis for constructing the estimates necessary to establish 1999/2000 as the new base year of our national accounts. We intend to start publishing real GDP statistics using the new base year in 2002.

34. With the objective of improving the quality of the existing GDP deflator, and ultimately the reliability of our National Accounts at constant prices, we will continue implementing the plan designed with Fund technical assistance to publish adequate producer price indices (PPIs) for the different sectors of the economy. As a first step, we are committed to start monthly publication of product-based PPIs for four agricultural and 50 non agricultural products by December 2001.The project is scheduled to be completed at the end of the program period.

35. As part of the forthcoming mission from the Fund Statistics Department for the data module of the Review of Standard and Codes (ROSC), we will assess the status of our economic statistics and establish an action plan to address existing shortcomings in different areas, with the objective of subscribing to the Special Data Dissemination Standards towards the end of the program period.

36. In the context of our poverty reduction strategy framework, the Federal Bureau of Statistics, several ministerial departments, and other administrative agencies will need to devote substantial efforts to the collection, elaboration, and analysis of data that are crucial for monitoring the implementation of the poverty-reduction strategy and our success in meeting its objectives. For this purpose, we will establish a clear allocation of responsibility and credible coordination to ensure the effective flow of data from the primary sources to those in charge of exploiting and analyzing them. In the final PRSP, we will determine the final set of social indicators we want to target, indicate the methodology to assess progress towards achieving targets and establish procedures for adequate monitoring.

VII. Program Financing and Debt Issues

37. Pakistan will need to mobilize large financial support from the international community to cover the external financing gap of the next three years, after taking into account expected disbursements from the World Bank (US$1.5 billion) and the AsDB (US$1.5 billion). To cover the gap, we will seek additional multilateral financing, further rescheduling from Paris Club and other bilateral creditors on concessional terms, and grants from bilateral donors, including the extension of the Saudi oil grant beyond September 2002. We will also seek to complete voluntary refinancing of the special U.S. dollar bond (issued in exchange for foreign currency deposits frozen in 1998 and mostly held by residents), as this also represents a claim on our reserves, although it is not part of our external debt. For FY 2001/02, we have clear indications regarding bilateral grants and the lifting of textile imports restrictions in the E.U., although some of these elements will still need parliamentary approval to become effective. We will do our part to ensure timely disbursements of the World Bank and AsDB program loans by pursuing the related policy reforms, and will work closely with the relief agencies to ensure active participation by Pakistan suppliers in supplying food and relief items to Afghanistan and Afghan refugees.

38. Beyond covering the financing gap, one of the government's key objective is to achieve a return to a sustainable external debt levels at the end of the three-year program, which we consider critical to enhance business and investor confidence. Our exit strategy from the current debt overhang involves seeking external financing at highly concessional terms, along with a substantial debt restructuring in order to reduce the net present value of the external public debt to sustainable levels. We, therefore, intend to approach the Paris Club and other bilateral creditors to request the needed flow relief along with a debt stock restructuring on concessional terms.

VIII. Risks and Contingencies

39. As discussed above, the projections and policies underlying our program are predicated on a resolution of the current regional tensions by end-2001 and a return to normal conditions for economic activity and trade. Should current tensions prevail for much longer, the adverse effects on the Pakistani economy could be much larger. In particular, were regional tensions at currents levels to prevail for another two quarters, that is, through the end of the current fiscal year, and prevent a return to normal economic activity, we would estimate that our balance of payments would deteriorate by another US$0.6 billion, growth would probably be close to nil, and nonagricultural and tax revenue would fall by another 0.6 percent of GDP. These estimates are, of course, subject to very large uncertainty. In such circumstances, we would activate the fiscal contingencies described above in order to contain fiscal imbalances. Flexibility of the exchange rate would be another critical element in the defense of external balances, although we would, if needed, allow some use of reserves to avoid dislocation and preserve orderly external trade activity and debt servicing. We would also quickly seek additional donor support. Should such a situation arise, we would obviously consult rapidly with the Fund on any further action needed to preserve macroeconomic stability.

IX. Program Monitoring

40. The new PRGF arrangement will involve quarterly reviews and disbursements. The period for the first year of the program is October 2001-September 2002. The first review will be completed by end-March 2002 and will focus on the implementation of macroeconomic policies, progress in tax administration reforms, and progress in monitoring fiscal expenditure, especially for social expenditures and outcomes. The second review will be completed by end-June 2002. Quantitative performance criteria and benchmarks are indicated in Table 1, structural performance criteria, benchmarks, and measures that are to be implemented prior to the consideration of the program by the Executive Board are listed in Table 2. Definitions of monitoring variables, adjustors, and program reporting requirements are described in the attached Technical Memorandum of Understanding. Quarterly external financing assurances reviews will also apply, as part of the regular reviews under the program.

Technical Memorandum of Understanding on the Program Supported by

Poverty Reduction and Growth Facility

(November 2001)

1. This memorandum sets out the understandings between the Pakistan authorities and the Fund staff relating to the monitoring of the first year under the PRGF-supported program (October 2001-September 2002). It specifies the adjustors for the quantitative performance criteria and indicative targets set out in Table 1 of the MEFP; the content and frequency of the data to be provided for monitoring the financial program; the mechanism for monitoring the structural performance criteria and structural benchmarks as listed in Table 2 of the MEFP; and definitions of the relevant financial variables.

I. Adjustors

2. The floors on the net foreign assets (NFA) of the SBP will be adjusted: (a) upward/downward by the cumulative excess/shortfall in net external program financing (as defined below), downward adjustments will be capped at US$250 million; (b) upward/downward by the cumulative excess/shortfall in external cash budget grants (as defined below).

3. The ceilings on the net domestic assets (NDA) of the SBP and on net bank borrowing by the government will be adjusted downward/upward by the cumulative excess/shortfall in net external program financing (as defined below) evaluated at the exchange rate as of end-June 2001 (PRs 63.98 per U.S. dollar). The upward adjustment will be capped, however, at US$250 million.

4. The ceilings on the NDA of the SBP will also be adjusted downward/upward by the amount of: (a) any cumulative excess/shortfall in external cash budget grants above program levels; (b) banks' rupee reserves freed/seized by any reduction/increase of the daily CRR of 4 percent; (c) banks' reserves freed/seized by any reduction/increase in the total reserve requirements on foreign currency deposits of 25 percent; and (d) any reduction/increase in the reservable deposit base that is related to definitional changes, as per the following formula: deltaNDA = deltarB0 + r0delta∆B + deltardeltaB, where r0 denotes the reserve requirement ratio prior to any change; B0 denotes the level of the reservable deposits in the initial definition ; deltar is the change in the reserve requirement ratio; and deltaB denotes the change in the reservable deposits as a result of definitional changes.

5. The ceilings on the consolidated government fiscal deficit excluding grants will be adjusted upward for any excess in the external cash budget grants for budget support above PRs 25 billion. The upward adjustment will be capped at PRs 5 billion at end-December 2001, PRs 10 billion at end-March 2002, and PRs 15 billion at end-June 2002. Upward adjustments in the deficit will have to be matched by identical increases in actual budgetary expenditures above the program levels for the categories listed in Table 4 (with the restriction that additional spending for federal police and civil armed forces will be limited to PRs 1 billion).

II. Financial Program Reporting Requirements

6. The following information, including any revisions to historical data, will be provided to the Middle Eastern Department of the Fund through the office of the Senior Resident Representative of the IMF in Pakistan, within the delays indicated:

  • Monthly provisional statements on federal tax and nontax revenue, within one month.

  • Deposits into and withdrawals from the privatization accounts for each quarter of 2000/01. Withdrawals will be reported with the following breakdown: (a) those which constitute budgetary use of privatization proceeds; (b) those which constitute costs of privatization; and (c) other (with explanation of the purpose of other withdrawals), within one month.

  • Quarterly statements on budgetary capital receipts and disbursements, including repayments of bonds, recovery of loans from provinces and "others", within two months.

  • Monthly (unreconciled) provisional data on federal expenditure, within one month.

  • Quarterly statement on consolidated budgetary expenditure, with federal data approved by the AGPR, within two months.

  • Quarterly provisional data (from AGPR and AG) on social sector and poverty-related budgetary expenditures, as defined below, as well as on the subcategories eligible for additional grant-financed expenditure, as defined in Table 4.

  • Quarterly data on the stock of domestic government debt, broken down by instrument, within two months.

  • Quarterly data on budgetary arrears to and from WAPDA (see Table 2), within two months.

  • Monthly provisional data on external budget financing and net external program financing proceeds from the Saudi oil facility, and cash external grants for budget support (as defined below), within one month.

  • Quarterly data on the revenues and expenditures of the five public enterprises as per Tables 5(a) to 5(e), within two months (WAPDA, KESC, PIA, Pakistan Steel Mill Corporation, Pakistan Railways).

  • The following monthly monetary data on a last-Saturday basis, both at current and program exchange rates, within four weeks:

      (i) monetary survey;
      (ii) accounts of the SBP;
      (iii) consolidated accounts of the scheduled banks; and
      (iv) banks' lending to the government;

  • The same tables as in the preceding item, but on an end-quarter basis (last business day), both at current and program exchange rates, within six weeks.

  • Daily data on SBP's sales and purchases in the kerb and interbank foreign exchange markets, swaps and forward outright sales, within two business days.

  • Monthly data on the outstanding stock of the SBP's forward foreign currency operations, including swaps and outright forward sales and purchases, within one month. The terms of any new transactions will also be provided.

  • Monthly data on the SBP's foreign exchange reserves, with details on the currencies, instruments, and institutions in which the reserves are held, within one month.

  • Quarterly data on bank credit to the nine major public enterprises (with breakdown), and on SBP bridge loans to naturalized banks in the context of the BSAC and any other quasi-fiscal operations, within six weeks.

  • The following quarterly data on external debt, within six weeks:

      (i) Stock of public and publicly-guaranteed external debt (including deferred payments arrangements), by maturity (initial maturities of up to and including one year, and over one year), by creditor and by debtor (central government and publicly guaranteed), and for Paris Club debt, with breakdown in pre- and post-cutoff date stock.

      (ii) Loan-by-loan detail of the contracted new medium- and long-term nonconcessional public and publicly-guaranteed external debt with separate identification of the contraction of debt with an initial maturity of over one year and up to and including five years; grace periods and scheduled repayments; currency denominations; and interest rates; and

      (iii) Monthly statements on rescheduling agreements on public- and publicly-guaranteed debt reached with creditors;

  • Monthly data on external payments arrears on public- and publicly-guaranteed debt with details as in (i) of the preceding item.

  • Copies of new or revised ordinances/circulars regarding changes in: tax policy, tax administration, foreign exchange market regulations, and banking regulations no later than three days after official issuance, or notification that ordinances have been posted on the CBR and SBP website.

  • Monthly data on the import parity prices as well as central depot prices of the six major oil products, within one month.

III. Definitions of Monitoring Variables

Valuation of Foreign Exchange Denominated Assets and Liabilities

7. For the purposes of monitoring under the program, all assets and liabilities denominated in SDRs and in currencies other than the U.S. dollar will be converted into U.S. dollars at their rates prevailing as of June 30, 2001, as published in the IFS. The U.S. dollar value of all foreign assets and liabilities will be converted into Pakistan rupees at the end-June 2001 exchange rate of PRs 63.98 per U.S. dollar.

Reserve money

8. Reserve money (RM) is defined as the sum of: currency outside scheduled banks (deposit money banks); scheduled banks' domestic cash in vaults; scheduled banks' required and excess rupee as well as foreign exchange deposits with the SBP; and deposits of the rest of the economy with the SBP excluding those held by the federal government, the provincial governments, Cotton Export Corporation (CEC), Rice Export Corporation of Pakistan (RECP), and counterpart funds.

Net foreign Assets of the SBP

9. The NFA of the SBP are defined as the difference between its foreign assets and foreign liabilities. Foreign assets of the SBP consist of gold, foreign exchange, balances held outside Pakistan, foreign securities, foreign bills purchased and discounted, net IMF position and SDR holdings. The definition of foreign assets of the SBP will be fully consistent with the Data Template on International Reserves and Foreign Currency Liquidity. Gold will be valued at SDR 35 per fine troy ounce. Foreign liabilities of the SBP include deposits with the SBP of foreign governments, foreign central banks, foreign deposit money banks, and international organizations. 1

Net domestic assets of the SBP

10. The NDA of the SBP are defined as the difference between reserve money and the NFA of the SBP.

Net borrowing from the banking system by the government

11. Net borrowing from the banking system by the government is defined as the difference between the banking system's claims on the central and provincial governments and the deposits of the central and provincial governments with the banking system. For purposes of this memorandum, claims on government exclude credit for commodity operations; government deposits exclude Zakat deposits.

Overall budget deficit (excluding grants)

12. The definition of the budget deficit under the program will be the consolidated budget deficit excluding grants. It will be measured from below the line by the sum of: (a) the total net financing to the federal and provincial governments; and (b) the total external grants to the federal and provincial governments. The former is defined as the sum of net external budget financing (defined below), net borrowing from the banking system (as defined above), and net domestic nonbank financing (defined below). The latter is defined as the sum of project grants, the rupee counterpart of the Saudi oil facility, and the cash external grants for budgetary support.

13. Net external budget financing is defined as net external program financing plus all other external loans for the financing of public projects or other federal or provincial budget expenditures. Net external program financing is defined to include external privatization receipts, budget support loans from multilateral (other than the Fund), bilateral, and private sector sources, and rescheduled debt service net of government debt amortization due on foreign-currency denominated public loans. It includes foreign loans onlent to, financial institutions and companies (public or private), emergency relief lending, and the World Bank's BSAC. Program financing excludes all external financing counted as reserve liabilities of the SBP (defined to include all net deposits of foreign banks and agencies with the SBP, and net purchases and disbursements from the IMF). Amounts assumed for net external program financing and external grants are provided in Tables 1(a) and 1(b).

Net domestic nonbank financing of the budget

14. Net domestic nonbank financing is defined as domestic privatization receipts plus the change, during each fiscal year, in the stock of: (a) permanent debt, which consists of non-bank holdings of prize bonds, all federal bonds and securities (including the new Pakistan Investment Bonds); plus (b) floating debt held by nonbanks; plus (c) public account (or unfunded debt), which consists of NSS debt, Postal Life Insurance, and the Provident Fund; plus (d) stock of deposits and reserves received by the government; plus (e) suspense account; plus (f) any other government borrowing from domestic sources net of repayments; minus (g) government deposits with NBFIs.

15. Nonbank holdings of permanent and floating debt is defined as total debt outstanding, as reported by the SBP, minus holdings of banks as per the monetary survey. Total treasury bill and other relevant government debt is valued at discount value.

Net credit to public sector enterprises

16. Banking system's credit from July 1, 2001, to all public sector enterprises, net of outstanding deposits on the special account with the SBP for payments on public enterprises' rescheduled debt.

Public and publicly guaranteed external debt

17. The performance criteria on contracting of noncessional medium- and long-term public and publicly guaranteed external debt and on contracting of short-term public and publicly-guaranteed external debt apply not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (adopted on August 24, 2000), but also to commitments contracted or guaranteed for which value has not been received. Public and publicly-guaranteed external debt also includes the following: (a) guarantees provided by the SBP; (b) partial credit guarantees from external creditors, if covered by a government counter guarantee; and (c) external debt contracted by state-owned enterprises or banks when they are clearly only motivated by balance of payments considerations. It excludes: (a) the foreign currency deposit liabilities of the banking system; and (b) the outstanding stocks of FEBCs, DBCs, and FCBCs. Short-term external debt is defined as loans with original maturity of up to and including one year. Medium- and long-term external debt consists of debt with initial maturity of over one year. The external debt will be expressed in U.S. dollar terms, with debts in currencies other than the U.S. dollar converted into U.S. dollars at the market rates of the respective currencies prevailing on June 30, 2001 as published in IFS.

Nonconcessional borrowing

18. Nonconcessional borrowing is defined as borrowing with a grant-element of at least 35 percent, following the methodology set out in the staff report SM/96/86 and approved by the IMF Executive Board on April 5, 1996. The discount rates used to calculate the grant element will be the six-month and ten-year Commercial Interest Reference Rates (CIRRs) averages, as computed by the Policy Review Department of the Fund. Six-month CIRRS are updated mid-February and mid-August ( covering the six-month period preceding the date of update) and the ten-year CIRRS averages are updated mid-December (covering a period of 10 years preceding the date of the update). Six-month CIRRs averages are to be used for loans whose maturity is less than 15 years, while ten-year CIRRs averages are to be used for loans whose maturity is equal or more than 15 years.

Budgetary arrears to WAPDA

19. Budgetary arrears to WAPDA are defined as electricity bills of public entities overdue by more than 30 days, as reported by WAPDA in Table 2.

20. Poverty-related and social public spending ("I-PRSP expenditure") consists of central provincial and district government spending under the current budget and the Public Sector Development Program, as defined in Table 3.

1 The definition of net foreign assets of the SBP used here implies that, for program monitoring purposes, disbursements and/or purchases from the Fund are to be recorded in the monetary accounts as external liabilities of the SBP, rather than deposits of the government.