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Questions and Answers on the IMF Pakistan Program
March 30, 2009
1. What are the advantages to Pakistan of undertaking an IMF-backed program?
2. How did Pakistan get into these balance of payments difficulties to begin with?
3. What is the conditionality associated with this loan?
4. How has Pakistan performed under the Fund-supported Program?
5. What contingency measures are the authorities considering if things turn out worse than expected?
6. Why did the Fund initially ask Pakistan to raise interest rates when in other countries the Fund is suggesting monetary easing?
7. Going forward, is there room to lower interest rates?
8. At the G-20 summit in November, there was agreement among ministers that fiscal stimulus was necessary to help countries deal with the financial crisis. Why is the Fund advocating fiscal tightening in the case of Pakistan?
9. Is the Fund insisting on cutting back development expenditures? Military expenditures?
10. The program calls for fiscal restraint and monetary tightening. Won't this hinder the government's ability to invest in health and education?
11. The program calls for the removal of energy and electricity subsidies-which will adversely affect the poor. How does the program plan to protect the poor from these price increases?
12. Will agricultural income be taxed under the program?
13. What will the charges be for this loan? Is Pakistan paying more than other countries who are borrowing from the Fund? Why were the previous loans to Pakistan much cheaper?
14. Will the loan that Pakistan is receiving from the Fund be used to repay bondholders? Will it be used for anti-terrorism military operations?
15. What is the Fund’s view about the outcome of the donor meeting in Tokyo? How will the pledged money help Pakistan?
A. Financing from the IMF will contribute to easing the pace of adjustment, as well as to restoring macroeconomic stability and investor confidence. In particular, IMF financial support will help fill the external financing gap, rebuild international reserves, and catalyze additional external assistance from Pakistan’s development partners. Additional assistance from donors is essential to finance the expanded social safety net and allow for higher spending on development programs.
A. Pakistan’s macroeconomic situation deteriorated significantly in 2007/08 and the four months of 2008/09 on account of domestic and external factors. Adverse security developments, large exogenous price shocks (oil and food), and global financial turmoil buffeted the economy. These shocks, combined with policy inaction during the political transition to a new government led to slower growth, higher inflation, and a sharp deterioration of the external position.
A. The loan supports the authorities' program, which has two key objectives: (i) restoring macroeconomic stability and confidence in the economy through a significant tightening of macroeconomic policies, and (ii) ensuring social stability and adequate support for the poor. The conditionality associated with IMF financing reflects the targets and policies set out by the Government to meet these two objectives.
These targets, and the associated conditionality, focus on quarterly quantitative targets for: government borrowing from the State Bank of Pakistan (SBP), the budget deficit, international reserves and net domestic assets of the State Bank of Pakistan, contracting or guaranteeing of non-concessional loans by the public sector, and external arrears. There are also specific commitments for improving banking and tax legislation, strengthening the social safety net for poor households (including working with the World Bank to develop a more comprehensive and better targeted social safety net), phasing out electricity subsidies, reducing foreign exchange market intervention by the State Bank of Pakistan, working toward the elimination of inter-corporate circular debt, and adopting a single Treasury account.
A. Initial developments since the approval of the program have been generally positive. Policy implementation has been good and the program remains on track. All quantitative performance criteria and the structural benchmarks for the first program review were met. The exchange rate has been broadly stable, and the State Bank has been purchasing foreign exchange on a net basis. As a result, gross reserves have strengthened. Despite improved confidence, credit and broad money demand growth have been somewhat slower than originally envisaged. The end-December fiscal deficit target, which proved challenging, was achieved through a combination of revenue and expenditure measures. The roll-out of a scorecard as an objective targeting mechanism for identifying poor households has started, which constitutes an important step toward improving the effectiveness of the Benazir Income Support Program (BISP).
A. The authorities believe the program is well-designed and adequate to address the current economic challenges. However, if things turn out worse than expected and contingency measures become necessary, the authorities are open to considering a further tightening of fiscal and monetary policies. The authorities are also confident that additional financial support will be forthcoming from bilateral donors.
A. The Fund believes that each country's interest rate policy should reflect its own situation and economic objectives. In Pakistan's case, a tightening of monetary policy was necessary to restore confidence in the Pakistani rupee, help rebuild international reserves, and ensure that the domestic financing requirement of the government is met through market placements of government securities. To this end, higher interest rates were needed. The increase in interest rates in mid-November 2008 benefited domestic savers and reduced the implicit subsidy received by borrowers. It has also helped reduce inflation, which helps the poor.
A. The authorities have lowered the policy interest rate by 100 basis points on April 20, 2009. Looking forward, there may be scope for lowering interest rates further, provided that inflation continues to decline, international reserves are further strengthened, and the government continues to avoid recourse to SBP financing.
A. Not all countries are in a position to undertake fiscal stimulus. Some emerging economies (China, for example) and some advanced economies (such as the U.S.) have stronger fiscal and external positions, and a fiscal stimulus is needed to deal with recessionary pressures associated with the global financial crisis. Pakistan, on the other hand, faces severe balance of payments pressures stemming in part from loose financial policies. The global financial crisis is a contributory but not the principal cause of macroeconomic imbalances in Pakistan. Further, although economic activity has slowed, Pakistan’s, the economy is still growing. Accordingly, fiscal and monetary tightening are needed to address Pakistan’s macroeconomic imbalances.
A. The Government’s program targets a reduction in the budget deficit to more sustainable levels. The program seeks to achieve this reduction by raising revenues and restraining expenditures in 2008/09, including by phasing out fuel and electricity subsidies and better prioritizing development spending. Fund staff is more concerned about aggregate spending and the revenue targets than their detailed composition. However, given the importance of adequate funding for priority development projects in Pakistan, the Fund-supported program includes adjustors’ allowing for higher than projected development spending if external assistance turns out to be higher than envisaged in the program. The program also makes specific provisions to ensure an appropriate level of poverty-related spending in 2008/09 and the future. The elimination of energy subsidies is expected to create fiscal space for higher development expenditures in 2009/10. Military expenditures were not part of the discussions.
A. Fiscal restraint and monetary tightening should not hinder the government's ability to invest in health and education, and the program allows for continued spending in these areas, as well as for expanding the social safety net. Over the medium term, the strong tax effort envisaged in the program will help create the fiscal space needed for higher expenditures on health, education, and physical infrastructure.
A. Developing an effective and well financed social safety net to ease the burden of macroeconomic adjustment on the poor is a high priority, which the Fund fully supports. The Government’s program envisages strengthening and better targeting the social safety net to protect the poor and cushion the impact of the elimination of subsidies on vulnerable groups. Social safety net spending is targeted to increase by 0.6 percentage points of GDP in 2008/09, to 0.9 percent of GDP, and the government agreed with World Bank staff on a reform of the Benazir Income Support Program (BISP) through the introduction of an objective targeting mechanism. This reform is based on a scorecard system for identification of poor households. The roll-out of this system in 16 districts (pilot phase) is expected to be completed by May 2009, while the roll-out to all 130 districts would be completed between December 2009 and June 2010. Also, electricity tariffs incorporate a “lifeline” minimum tariff that will shield low-income households consuming small amounts of electricity from tariff increases. Additional external assistance is being sought from bilateral donors to cover the cost of the expanded social safety net.
The targeted reduction in inflation will also help the poor. The poor are most severely affected by the current high level of inflation because they do not have the ability to protect themselves through investment in assets such as foreign exchange and real estate.
A. The IMF-supported program does not envisage a new tax on agricultural income.
A. Pakistan is paying the same rate as other countries that have stand-by arrangements. Stand-by arrangements are subject to the IMF's market-related interest rate, known as the "rate of charge," and carry a level based surcharge. Large loans, i.e., credit above 200 percent of a member’s quota carry a surcharge of 100 basis points above the regular rate of charge, and the surcharge rises to 200 basis points for use of credit above 300 percent of quota. Based on today's interest rates, the average charge that Pakistan would pay when it has the full amount of $7.6 billion outstanding is about 3 percent.
In the past, Pakistan had both stand-by arrangements and an arrangement under the Poverty Reduction and Growth Facility (PRGF). Loans under the PRGF carry an annual interest rate of 0.5 percent. However, PRGF loan amounts available are limited to a maximum of 185 percent of quota for the initial three-year arrangement, and then to 90 percent of quota for second time the facility is used. Given Pakistan's large financing needs, borrowing under the PRGF was not an option.
A. Disbursements of the IMF loan will be made to the State Bank of Pakistan to rebuild the international reserves position. At the same time, the program assumes that the government will remain current in all its external obligations. The IMF money will not be used to finance budgetary expenditures nor anti-terrorism military operations.
A. The donor meeting was very successful and delivered financial assistance of $5 billion. The money will provide Pakistan with much needed additional fiscal space in these difficult times and help finance social spending. This generous support from donors is very welcome with domestic revenues under pressure because of the recession. To sustain the additional spending in the medium term, however, it remains crucial that Pakistan raises tax revenue.
For more information on the program see: http://www.imf.org/external/pubs/cat/longres.cfm?sk=22517.0
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