Statement at Donor Meeting

Pakistan -- Statement by the IMF Staff Representative, Pakistan Development Forum

May 12, 2003

1. The Fund staff appreciates this opportunity to participate in the 2003 Pakistan Development Forum and to communicate our views on Pakistan's progress in implementing its economic adjustment program, as well as on the challenges that lie ahead.

2. As you know, Pakistan laid out a comprehensive reform strategy in the Interim Poverty Reduction Strategy Paper (I-PRSP), that is supported by a three-year Poverty Reduction and Growth Facility (PRGF) arrangement approved by the IMF Executive Board on December 6, 2001. The three main goals were to increase growth potential, improve social outcomes, and reduce vulnerability to shocks. Since the program was approved, four reviews have been completed and we are currently close to wrapping up the discussions for the fifth program review. So far, Pakistan has drawn SDR 431 million out of SDR 1.03 billion (100 percent of quota) approved by the Fund Board under the current arrangement.

3. Over the past two to three years, Pakistan has been highly successful in restoring and consolidating macroeconomic stability. This success, which reflects the implementation of sound macroeconomic policies combined with strong international economic support, is all the more remarkable since it was achieved despite several adverse shocks. A slowdown in the world economy, high oil prices, protracted drought, trade disruption in the wake of September 11, and regional and domestic security problems have increased uncertainty for businesses and hampered growth. In this unfavorable context, the overall economic performance has been quite encouraging. Real GDP growth averaged about 3.5 percent in 2000-02, and available data suggest that growth could be in the 4-5 percent range in 2002/03. Inflation is subdued, and this fiscal year is expected to be below the 4 percent expected under the program. Foreign Direct Investment is on track to nearly double this year, and the State Bank of Pakistan has built up its international reserves to levels unprecedented in Pakistan's history, now exceeding $9 billion, equivalent to about seven and a half months of imports. Owing to this comfortable cushion of reserves, and with the continuation of a flexible exchange rate policy, Pakistan has become much less vulnerable to external shocks.

4. Progress on the structural front has been strong in several areas. The government has streamlined the trade and exchange system and the tax system, and eliminated many exemptions. As outlined by H.E. the Minister of Finance, an ongoing fundamental reform of the tax administration will address many of the concerns expressed by businessmen and investors. The reform in particular aims at reducing direct contact between taxpayers and officials, strengthening audit functions, and modernizing the Central Board of Revenue (CBR) business practices. This has contributed to the strong revenue collection by the CBR this fiscal year. Fiscal transparency has considerably improved, including regular publication of fiscal accounts, of PRSP progress reports, and of public contingent liabilities. More generally, the authorities have established an outstanding track record of publishing their policy memoranda related to Fund-supported programs in recent years, including the often critical reports prepared by the staff. The oil and gas sectors have been significantly liberalized, with the introduction of market-oriented pricing and the sale of government stakes in this sector. The restructuring of the publicly-owned banks has moved ahead and has allowed the successful privatization of a nationalized bank (UBL) last fall. The major public enterprises have been made more accountable through the adoption of financial improvement plans, with quarterly targets and quarterly progress reports posted on the Ministry of Finance's website.

5. Looking ahead, the key challenge for the authorities remains to reduce poverty and the "social gap" from their present intolerable levels. While the measurement of poverty has fueled much debate recently in Pakistan, clearly poverty remains high. This outcome mostly reflects insufficient private investment and growth, the impact of drought on the rural regions, and inadequate provision of basic social services, as public spending on human development remains too low. Some of the main institutional causes of poverty, such as ownership of land and other assets and deep-rooted gender issues, have yet to be fully addressed.

6. Higher sustainable growth is the element most needed to make a significant dent in poverty. Growth needs to rise to at least 5-6 percent within a few years, without endangering hard-won stabilization gains. The Fund staff shares the authorities' view that current macroeconomic policies remain appropriate to foster high growth, reduce vulnerability, and ensure public debt sustainability. This policy mix is centered on a flexible exchange rate, allowing monetary policy to target low inflation. Because of the high inflows of private capital and remittances, the authorities need to strike a careful balance between allowing some appreciation of the Pakistani rupee, or using the opportunity to further build reserves and allowing a continued rapid expansion of monetary aggregates. However, the most important and difficult element of macroeconomic policies will be continued fiscal adjustment to reduce public debt. Further implementation of structural reforms, centered on improving governance at all levels of the state and the further liberalization of the economy, will be essential to boost productivity growth. Crucial governance reforms include the adoption of a fiscal responsibility law, an anti-money laundering law, a strategy to reduce the abuse of `Benami' practice, but also measures to ensure the reliable provision of key public services. IMF technical assistance is contributing to a customs reform that will lower business costs in Pakistan by simplifying and streamlining customs procedures and reduce the scope for corruption. Fund staff believes that these measures, tackling directly governance problems, are far more effective in boosting growth than say tax concessions or subsidies.

7. Well-designed social policies are also crucial to reduce poverty and the social gap. The Fund staff welcomes the progress in preparing a full PRSP, and is impressed by the draft summary already presented to the PDF . The increase in social spending during the last two years is a step in the right direction but more needs to be done, through a continued restructuring of public expenditure to achieve a sustained shift towards social spending. This has to go hand-in-hand with better monitoring of how these resources are spent, to ensure that additional spending really improves social services delivery. The ambitious devolution plan launched in mid-2001 should help strengthening monitoring and feedback from local beneficiaries. Devolution has also added new challenges, as the local governments will need strong support for building capacity in accounting, fiscal reporting, auditing, financial management, and expenditure control. Accountability at the lower levels will require clarity in expenditure assignments as well as appropriate own-source resources.

8. Recent developments in the area of structural reforms have highlighted the difficult challenges that lie ahead. The authorities deserve credit for sticking to the rules-based adjustments for petroleum product prices, and Fund staff remains hopeful that major privatizations will soon be carried out in the banking and energy sectors in 2003, despite a diffiocult situation in global equity markets. Fund staff appreciates the strong socio-political pressures during the recent extraordinary run up in international oil prices and geopolitical tensions related to Iraq, that led to the government's delayed and only partial implementation of the utility tariffs determined by the sector regulators. However, we are concerned that this will further weaken the financial situation of gas and power utilities, put additional burdens on the budget, and may reduce investors' interest in enterprises in the energy sector.

9. Fundamental reform of the power sector remains critical for addressing the main risk to fiscal adjustment, for reducing the budgetray burden of huge subsidies to the power sector, and for laying the foundations for higher growth. Part of WAPDA's current financial imbalances reflect temporary factors such as the frontloading of payments to the independent power producers and high investments to get the Ghazi-Barotha hydropower plant on stream. However, this should not distract from the need to forcefully implement its financial improvement plan. WAPDA and similarly KESC need to be held accountable for achieving the programmed improvements in line losses and in collecting bills from the private sector. Much more than it has done so far, the government needs to help in addressing the law-and order issues hampering bill collection in FATA, improve the timely verification and payment of public sector bills, and allow utility tariffs to reflect costs. Completion of the unbundling and corporatization of WAPDA will also be essential to better localize WAPDA's problems and clear the way for gradual privatization. Finally, a clear pricing framework will be needed for WAPDA's corporate successors, reflecting efficiency differences among the various companies.

10. There are hopeful signs that the regional tensions are waning, reducing risks to the reform program and opening tremendous opportunities for trade and investment. However, the government will still need to tackle other risks to the implementation of the reform program, such as pressures from various interest groups. Given Pakistan's track record over the last three years, we are confident that the government will hold the reform program on course. We look forward to an ambitious PRSP fully owned by the authorities and resulting from broad-based consultation with provincial and local governments, civil society, and outreach efforts to record the concerns of the poor. We look forward to an ambitious 2003/04 budget, including further tax reform, ambitious CBR revenue targets, and a deficit target consistent with a further substantial decrease of the public debt to GDP ratio. Pakistan deserves strong support for such a reform program. We would like to wish continued success to the authorities and to assure them and the international community of the Fund's readiness to continue assisting Pakistan in moving forward through policy advice, technical assistance and financial support.