On behalf of our Pakistani authorities we would like to thank staff for their hard work and constructive interactions during the 12th and final review of the three-year EFF-supported program, as well as for a well-written and balanced report. Our authorities broadly agree with staff assessment and policy advice. They are also grateful to the Executive Board and management for their guidance and support throughout the program period.
Program discussions in 2013 were held in the backdrop of macroeconomic imbalances, structural weaknesses, power shortages, and security and political concerns which were holding back the economy and adversely impacting macroeconomic and financial stability. The program was designed on a rich reform agenda encompassing fiscal consolidation, including by strengthening revenue, reducing inflation, rebuilding foreign exchange reserves, enhancing financial sector stability, addressing energy bottlenecks, liberalizing trade, restructuring or divesting public sector enterprises, improving the business climate, and further protecting the most vulnerable segments of the population. In addition to a number of performance criteria and indicative targets, the program was monitored through an array of structural benchmarks (SBs) which over the three-year period totaled 47 and included enactment of 18 laws by parliament.
While program implementation was faced with some difficulties initially, mainly as result of a challenging political and security environment, it has significantly strengthened more recently. Indeed, stronger ownership has allowed a marked improvement in macroeconomic performance, steady reduction in vulnerabilities, and progress in growth-supporting structural reforms. In this respect, the major objectives of the program were achieved.
Performance under the 12th and last review continued to be satisfactory. All end-June 2016 performance criteria (PCs) and indicative targets were met, except two PCs on the overall budget deficit and Net Domestic Assets (NDA) of the State Bank of Pakistan (SBP), which were missed by small margins. Necessary corrective measures were taken to limit NDA by end-August to ensure an appropriate pace of monetary expansion and to cut non-priority expenditures so as to achieve the fiscal targets. The strong growth (20 percent) in tax revenue, although partially offset by a shortfall in nontax revenue, and the large over performance with respect to targeted cash transfers under the BISP and power sector arrears are noteworthy. Similarly, all SBs were met, except for notification of the multi-year tariff for three power distribution companies (DISCOs), which was delayed because of the continuing dispute with the regulator over the FY 2015/16 determined tariffs.
Economic Developments and Outlook
Macroeconomic performance and resilience has significantly improved under the program with growth reaching 4.7 percent in FY 2015/16 (highest in eight years). While staff is projecting growth to increase to 5 percent in FY 2016/17, the authorities have a more ambitious target of 5.7 percent, based on buoyant construction activity, higher growth in private sector credit, and greater contribution from the China-Pakistan Economic Corridor. Inflation has declined to low single digits, reflecting prudent monetary policy and lower oil and other commodity prices, and is expected to remain contained at 5.3 percent at end-FY 2016/17. Gross international reserves grew almost threefold from 1.5 months of imports in FY 2012/13 to 4.2 months in FY 2015/16 and are likely to reach 4.6 months of imports in FY 2016/17. After a continuous strong performance over the last three years, Pakistan’s equity market MSCI Pakistan index has been reclassified to Emerging Markets status, effective May 2017.
Fiscal consolidation has been at the heart of the program. The authorities have curtailed the budget deficit by 3.9 percentage points of GDP over the program period, to reach 4.6 percent of GDP (excluding grants) in FY 2015/16, and are targeting a deficit of 3.8 percent of GDP in FY 2016/17. This has been achieved through a number of measures to improve revenue collection and rationalize expenditure.
Through a combination of tax policy and administration measures, the tax-to-GDP ratio has improved by 2.4 percentage points over the program period. Major progress in this area include reducing tax concessions and exceptions and prohibiting new ones through issuance of SROs, unless under exceptional circumstances and special approval procedures, and differential taxation of filers and non-filers, as well as improvement in taxpayer identification and broadening of the tax base. To buttress efforts toward reducing tax evasion and avoidance, Pakistan recently became a signatory to the joint initiative of the Council of Europe and the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters on September 14, 2016. The authorities are targeting an increase in the tax-to-GDP ratio to 14.5 percent by FY 2019/20, and to this effect are working on a range of tax policy and administration measures in close coordination with the provinces.
As part of the fiscal consolidation strategy, the authorities have also kept a sharp focus on improving the composition of expenditures to support growth. Energy subsidies have been significantly reduced along with containment of other non-priority expenditures to create space for critical social and capital spending. The new public-private partnership (PPP) law, which has been submitted to the parliament, will provide a framework for greater private sector participation in infrastructure investment and will reduce the need for budget financing while limiting moral hazard and contingent liabilities. While gross public debt declined slightly since the onset of the program to reach 62 percent of GDP in FY 2014/15, it increased to 64.7 percent of GDP in FY 2015/16, including as a result of a buildup of government deposits. The authorities have adopted a medium-term debt management strategy under which they plan a gradual reduction in external borrowing while lengthening average maturity in domestic borrowing.
To strengthen long-term debt sustainability and to provide a rule-based fiscal policy the authorities have taken steps to further bolster public financial management by amending the Fiscal Responsibility and Debt Limitation Act 2005 to: (a) cap the federal budget deficit at 4 percent of GDP (excluding grants) for the next three fiscal years and 3.5 percent thereafter; (b) reduce the debt-to-GDP ratio to 60 percent by FY 2017/18 and bring it down gradually to 50 percent over a 15-year transition period; (c) define strong and clear escape clauses; and (d) establish explicit enforcement procedures and corrective mechanisms for treatment of deviations. The newly established Fiscal Coordination Committee will synchronize policy guidance and budget monitoring across provincial and federal governments.
The authorities have continued to expand the coverage of the BISP. The number of beneficiary households for unconditional cash transfers has increased by 42 percent during the program period, along with an increase in stipends by 57 percent. The education-related conditional cash transfers have so far reached 1.3 million school-going children and its coverage will continue to increase.
Monetary and Exchange Rate Policies
Monetary and exchange rate policies were successful in maintaining price stability and building foreign reserves, including through the SBP spot purchases, with the objective of strengthening buffers against shocks. The authorities will maintain exchange rate flexibility and continue to improve trade competitiveness. The SBP will also continue to set the policy rate in a forward-looking fashion to maintain positive real interest rates and anchor inflation. Following the policy rate cut in May 2016, the SBP remains prepared to increase the policy rate should inflationary pressures reemerge.
Significant progress has been made in strengthening the autonomy and governance of the SBP during the program period including by amending the SBP law. The independent Monetary Policy Committee (MPC) of the central bank is now holding its meetings regularly, and its minutes are being published. In order to further strengthen the SBP’s autonomy the authorities will continue with implementation of remaining recommendations of the 2013 Safeguards Assessment. SBP’s analytical capabilities are also being enhanced in support of introduction of a flexible inflation targeting framework in the medium-term along with improved policy transparency and greater dissemination of information about inflation expectations and forecasts.
The banking sector remains well-capitalized and profitable, liquidity indicators are strengthening, and although NPLs remain high, they are on the decline and well-provisioned. Important reforms have been carried out in the regulatory and supervisory framework during the program period to foster financial sector performance and resilience, which has allowed the much needed increase in credit to the private sector. Private sector credit grew by 11.1 percent in FY 2015/16 compared to an average growth rate of 5.9 percent during the period FY 2011/12-2014/15. The authorities remain committed to enhancing the stability of the banking sector and further deepening the financial system. They will also continue in particular with the phased implementation of Basel III regulatory norms with the aim of completing it by 2019.
The authorities attach high priority to completing the public sector enterprises (PSEs) reform, which is crucial for fiscal consolidation and for improving economic growth performance. They had initiated an ambitious restructuring and divestment plan to improve PSE performance and to attract private sector participation. After initial successes, labor tensions and political opposition led the authorities to revisit plans for private sector participation resulting in revised timelines and mode of divestment for Pakistan International Airlines (PIA), Pakistan Steel and the power distribution companies. The transaction structure for PIA is being finalized while the Pakistan Steel privatization process, which had slowed down after expression of interest by the provincial authorities, has resumed following inconclusive discussions. In the interim, steps have, however, been taken to restructure the identified PSEs so as to make them more efficient, with improved service delivery, and by curtailing losses. After undergoing an intensive restructuring plan the Pakistan Railways, in particular, has shown significant improvement in freight and passenger services which has had a positive impact on the company’s revenues and service delivery.
Continuing the energy sector reform is crucial in view of the serious issues at stake for the fiscal, economic and social landscape. Sustained efforts have helped in reducing budgetary subsidies and containing the accumulation of arrears, and have brought about important operational improvements in the performance of DISCOs. Stringent monitoring and enforcement, upgraded electricity transmission and distribution network, enhanced revenue-based load management and incentives to collectors have resulted in reduction in distribution losses and higher collection over the program period. With these improvements the DISCOs, starting with FESCO at first and followed by IESCO and LESCO, would now be offered for sale in the stock market through IPOs. The authorities have completed considerable preparatory work in this regard, and the proceeds from these IPOs would be utilized to reduce the stock of outstanding circular debt.
Gas sector reforms have proceeded well with tariff incentives to the gas production companies resulting in a 13 percent increase in the domestic gas supply and LNG imports, significantly contributing to the overall improvement in the supply situation. Unbundling of gas transmission system is also designed to improve competition in the sector.
After reversals in 2015, when Pakistan slipped by two positions in the World Bank Doing Business rankings, the authorities have adopted a comprehensive country-wide reform strategy with assistance from the World Bank in February 2016. Initial success has already been achieved, including rationalization of the fee structure to reduce costs of opening a new business, development of a new electronic tax filing procedure, legislation to allow use of movable property as collateral for getting credit, amendments to Credit Bureau Act and issuance of related regulations, and enactment of the Corporate Restructuring Companies Act to set up companies to take over assets of bankrupt firms. The authorities are now working towards implementation of comprehensive business climate reforms to enhance growth performance while improving inclusion through greater access to resources to the marginalized sections of the population.
After successful completion of the EFF-supported program, the authorities remain resolved to continue with prudent economic policies and structural reforms to preserve the hard-won economic gains and achieve their growth and job creation objectives. They look forward to continued close cooperation and policy dialogue with the Fund and to continue to benefit from its valuable technical assistance. On behalf of our authorities we request completion of the twelfth and last review of the EFF-supported program, and for waivers for nonobservance of the end-June PCs on the budget deficit and NDA.