Pakistan: Staff Report for the 2000 Article IV Consultation and Request for Stand-By Arrangement
Author: International Monetary Fund
Publication Date:
26 Jan 2001
ISBN:
9781451830477
Language:
English
Keywords:
ISCR; CR; revenue; financial support; food price inflation; CBR revenue; price; real GDP; balance of payments; private sector; budget deficit; debt service
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Pakistan showed good macroeconomic performance over the past years. Executive Directors welcomed the program, which aimed at strengthening the balance-of-payments position, rebuilding official reserves, and reducing public sector indebtedness. They emphasized the need for revenue mobilization, improving investor confidence, poverty alleviation, good governance, tightening fiscal and monetary policies, and improvement in the collection, quality of data, and transparency. They approved financial support for the country's economic developments under the Stand-By Arrangement.

Abstract

Pakistan showed good macroeconomic performance over the past years. Executive Directors welcomed the program, which aimed at strengthening the balance-of-payments position, rebuilding official reserves, and reducing public sector indebtedness. They emphasized the need for revenue mobilization, improving investor confidence, poverty alleviation, good governance, tightening fiscal and monetary policies, and improvement in the collection, quality of data, and transparency. They approved financial support for the country's economic developments under the Stand-By Arrangement.

I. Introduction and Background

1. Discussions for the 2000 Article IV consultation and an economic adjustment and reform program were held in Islamabad during May 17–June 3 and September 5–20, 2000.1 Mr. Aninat met with the Chief Executive of Pakistan in New York in September, and the Managing Director and Mr. Aninat met with the Finance Minister during the Annual Meetings in Prague. Initial program discussions were oriented toward an arrangement under the Poverty Reduction and Growth Facility (PRGF), but immediate stabilization requirements shifted the focus to a Stand-By Arrangement.

2. Arrangements under the Extended Fund Facility (EFF) and the Poverty Reduction and Growth Facility (PRGF), amounting to SDR 454.92 million (44 percent of quota) and SDR 682.38 million (66 percent of quota), respectively, that were approved on October 20, 1997, expired on October 19, 2000. The second annual PRGF arrangement and a purchase for the equivalent of SDR 352.7 million under the Compensatory and Contingency Financing Facility (CCFF) were approved by the Executive Board on January 14, 1999, at which time the last Article IV consultation was also concluded,2 while the third review under the extended arrangement was concluded on May 24, 1999. Subsequently, the program went off track and no further purchases under the arrangements were made. The Board discussed fiscal data revisions and misreporting issues on April 28, 2000, following which Pakistan repurchased the equivalent of SDR 40.95 million.3 As of September 30, 2000, total Fund credit and loans outstanding to Pakistan amounted to SDR 1,071.9 million (103.7 percent of quota).

3. In the last Executive Board discussion on Pakistan, Directors welcomed the steps the authorities were taking to strengthen fiscal reporting. Noting that Pakistan’s balance of payments position was fragile, Directors expressed the hope that the authorities could move forward expeditiously with a bold and wide-ranging reform program designed to achieve a high and sustainable growth path that could be supported by resources from the Fund. Directors felt that any new program would need to contain bold reforms that addressed the structural weaknesses in the economy, rely heavily on up-front policy actions to signal commitment to implementation, and be owned by the authorities.

4. Pakistan has had a series of adjustment and reform programs supported by Fund arrangements during the past decade. Policy implementation and economic performance have been disappointing. Tax revenue performance has repeatedly fallen short of program targets, public sector indebtedness—both external and domestic—has continued to rise, the external position has remained fragile, and economic growth has been low, while the number of people living in poverty has increased and Pakistan’s social indicators remain weak (Table 1). This weak performance stems in large part from the failure of successive governments to carry through sustained reforms to improve the efficiency of the tax system, meaningfully increase the extremely limited number of taxpayers, promote and diversify the structure of exports, and attract private sector investment. Sanctions imposed by bilateral official creditors following Pakistan’s nuclear tests in May 1998 exacerbated the fragile external position, and triggered a debt crisis that had been looming during much of the 1990s.

Table 1.

Pakistan: Social Indicators

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Source: World Bank, World Development Indicators 1999.

5. The new government, shortly after assuming office in October 1999, announced that it would make a clean break from the past by forcefully implementing reforms to address these long-standing structural problems facing the economy. They set forth a wide-ranging reform agenda aimed at reducing poverty, improving governance, and sustaining a high rate of economic growth. While a number of steps have already been taken (as summarized in Appendix III), the design and sequenced implementation of a comprehensive policy package will take additional time to finalize. In the meantime, with the macroeconomic situation becoming even more fragile recently, a stabilization program—supported by Fund resources—needed to be put in place urgently to stem pressures on the rupee and return official reserves to more comfortable levels. The proposed program also contains many structural measures, culminating in several important reforms in the fiscal area with the 2001/02 budget, which are intended to pave the way for a medium-term successor program that could be supported under the PRGF.

6. In the attached letter dated November 4, 2000, the authorities request the approval of a Stand-By Arrangement until end-September 2001 in an amount of SDR 465 million in support of their economic program for 2000/01. The accompanying Memorandum on Economic and Financial Policies (MEFP) reviews economic developments and policies in 1999/2000, discusses the macroeconomic framework for the program, and describes the underpinning stabilization and structural policy measures.

II. Performance and Policies in 1999/2000

7. Overall economic performance in 1999/2000 benefited from favorable supply conditions in the domestic agricultural sector. However, adverse developments in Pakistan’s terms of trade, particularly the sharp rise in world oil prices, a decline in external financing, including from the international financial institutions (IFIs), private capital outflows, and a loosening of the stance of macroeconomic policies weakened the external position and further increased the economy’s vulnerability to shocks (Tables 2 and 3).

Table 2.

Pakistan; Macroeconomic Framework, 1995/96–2003/04

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Sources: Pakistan authorities; IMF, World Economic Outlook; and Fund staff calculations.

In U.S. dollar terms, import-based weights.

Unit value deflators for exports of goods and services of partner countries.

Includes public sector enterprises throughout the projection period even though some of them may be (partially) privatized.

The implicit interest rate on public debt is calculated as interest payments in percent of the end-of-period debt stock of the previous year. The growth-adjusted real interest rate is the implicit interest rate minus the nominal GDP growth rate.

In July 1996, 6-month treasury bills were replaced by 6-month short-term federal bonds.

Nominal rate minus average annual inflation rate as measured by the CPI.

Defined as sum of receipts from exports of merchandise and services exports, and from private transfers.

Scheduled debt service minus rescheduled debt service plus debt service on previously rescheduled debt.

The implicit interest rate on external public debt is calculated as interest payments in percent of the end-of-period debt stock of the previous year. The growth-adjusted real interest rate is based on the growth rate of current foreign exchange receipts.

Excluding gold and foreign assets relating to foreign currency deposits contracted after May 1998 (FE25s).

Short-term external debt includes public and private short-term at original maturity plus actual amortization payments on public medium-and long-term debt of the following year (including payments on debt that was rescheduled earlier), Rescheduled public short-term debt at original maturity is excluded from 1999/2000 onward, rescheduled private short-term debt at original maturity from 1998/99.

Table 3.

Pakistan: Indicators of External and Financial Vulnerability, 1995/96–2000/01

(In percent of GDP, unless otherwise noted)

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Sources: Pakistan authorities; and Fund staff estimates based on authorities’ data.

Including gold.

Excluding foreign assets relating to foreign currency deposits contracted after May 1998 (FE25s) and swap or forward operations.

Short-term external debt includes public and private short-term at original maturity plus actual amortization payments on public medium-and long-term debt of the following year (including payments on debt that was rescheduled earlier). Rescheduled public short-term debt at original maturity is excluded from 1999/2000 onward, rescheduled private short-term debt at original maturity from 1998/99.

Exports of goods and services including workers’ remittances.

Scheduled debt service minus rescheduled debt service plus debt service on previously rescheduled debt.

8. Growth and inflation performance in 1999/2000 was generally favorable. According to preliminary estimates, real GDP growth picked up to 4.8 percent in 1999/2000, compared with 3.1 percent in the previous year (Chart 1 and Appendix IV).4 Overall growth was buoyed by a 7 percent expansion in agricultural output, with bumper cotton and wheat harvests more than offsetting the effect of a decline in sugarcane output on agricultural production. Domestic manufacturing of sugar fell sharply as a result, contributing to a contraction in overall large-scale manufacturing activity by 0.8 percent. Activity in other large-scale manufacturing sectors rose by 5.8 percent, compared with an increase of 4.6 percent in 1998/99, with the textile sector registering particularly strong growth. Despite upward adjustments in domestic petroleum products prices, the stable rupee-dollar exchange rate and the decline in non-oil commodity prices helped moderate consumer price inflation to 3.6 percent (annual average), from 5.7 percent in the previous year. Excluding food and fuel prices, the underlying 12-month rate of inflation declined steadily over the course of the year.

Chart 1
Chart 1

Pakistan: Output and Inflation, 1994–2000

Citation: IMF Staff Country Reports 2001, 024; 10.5089/9781451830477.002.A001

Source: Data provided by the Pakistan authorities.

9. Notwithstanding a major contraction in the external current account deficit, a sharp deterioration in the capital account resulted in a marked weakening in the overall external balance during 1999/2000. The current account deficit (including official transfers) narrowed to US$1 billion (1.6 percent of GDP), from US$2.2 billion (3.8 percent of GDP) in 1998/99, despite a deterioration in the terms of trade by 9.5 percent (which, by itself, would have widened the trade deficit by 1.5 percent of GDP) during the year (Table 4 and Chart 2). Improved external demand conditions and increased domestic textile production—which benefited from the buoyant cotton crop—maintained export growth at 8.5 percent in U.S. dollar terms. The US$1.2 billion increase in the value of oil imports due to higher world prices was broadly offset by lower food, defense, and project aid-related imports. As a result, total imports were flat in U.S. dollar terms. Increased workers’ remittances (private transfers) also improved the recorded current account balance.5 In the capital account, while bilateral official financing flows were positive, net flows from multilateral creditors declined sharply and private outflows were substantial, reflecting cautious investor sentiment. Consequently, gross official reserves declined to US$0.9 billion (equivalent to 4.2 weeks of imports of goods and nonfactor services) at end-June 2000, from US$1.7 billion (7.8 weeks of imports) a year earlier. The value of the rupee in the interbank foreign exchange market was held constant against the U.S. dollar during the year, which, together with the expansionary monetary stance, contributed to the steady decline in official reserves (Chart 3). The rupee also held firm against the dollar in the kerb market in 1999/2000. The average value of the rupee in real effective terms during 1999/2000 was broadly unchanged from its average value in the previous year. The external debt to GDP ratio amounted to 58 percent, while scheduled external debt service amounted to 64 percent of exports and private transfers, which is extremely high.6

Chart 2
Chart 2

Pakistan: External Sector Developments, 1994–2000

Citation: IMF Staff Country Reports 2001, 024; 10.5089/9781451830477.002.A001

Source: Data provided by the Pakistan authorities.1/ Customs basis.2/ Including official transfers.3/ Excluding short-term swap and forward commitments.
Chart 3
Chart 3

Pakistan: Exchange Rate and Stock Market Developments, 1995–2000

Citation: IMF Staff Country Reports 2001, 024; 10.5089/9781451830477.002.A001

Source: Data provided by Pakistan authorities; and staff estimates.
Table 4.

Pakistan: Medium-term Balance of Payments, 1995/96–2003/04

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Sources: State Bank of Pakistan; Ministry of Finance; and Fund staff estimates.

Includes all financing from Saudi Arabia for oil imports that has already been agreed through 2001/02; future IBRD, IDA and AsDB disbursements are included in exceptional financing.

Eurobond repayment in 1999/00 shown as capital outflow, with rescheduling shown in exceptional financing

Includes repayment of US$300 million in UAE’s deposits.

Includes repayment of FCDs held in banks and non-bank financial institutions in 1999/2000 (reschedulings of US$1.1 billion shown as exceptional fin

Consists of accumulated arreas from July to September 2000 (U$375 million) less clearance of all arrears to bilateral creditors from March to September 2000 (US$837 million).

Includes US$1.1 billion in FCDs, US$300 million in deposits at the SBP, and USS500 million in deposits at the NBP.

Includes repayment and roll over of the Kuwait deposit due August 2000.

The financing gap is assumed to be filled with a flow rescheduling by Paris Club creditors and other bilateral creditors covering arrears accumulated as of September 30, 2000 (US$837 million) and maturities falling due October 2000-June 2001 (US$836 million) on pre-cutoff debt

Excludes FE25s and swap operations.

10. Following a sizable fiscal consolidation in 1998/99, the budgetary position deteriorated in 1999/2000. The budget deficit of the consolidated government widened to 6.5 percent of GDP, from 6.1 percent of GDP in the previous year (Table 5 and Ct 4).7 This was due to a number of factors, including the delayed adjustments in domestic petroleum prices, which lowered petroleum-related revenue by 0.7 percent of GDP;8 an increase in the government’s interest bill (by 0.4 percent of GDP); the settlement of accumulated tax refund arrears (0.3 percent of GDP); and provincial transfers to municipal governments in lieu of local taxes that were abolished at the beginning of the fiscal year (0.6 percent of GDP). In addition, while defense spending declined by 0.2 percent of GDP, a lapse in expenditure control mechanisms allowed defense outlays to exceed the budgeted level by 0.3 percent of GDP. Partly offsetting these effects on the budgetary position were higher nontax revenue (0.4 percent of GDP, mainly on account of higher profit transfers from the SBP), further cuts in development expenditure and net lending (0.4 percent of GDP), collections from a tax amnesty scheme (0.3 percent of GDP), and an increase in Central Board of Revenue (CBR) tax receipts (0.2 percent of GDP). The increased tax collection came from sales taxes, both on account of stronger collection effort as well as a broadening of the GST base.9 Collection of income taxes, customs duties, and excise taxes declined in relation to GDP. Past cumulative primary budget deficits and exchange rate-related valuation effects have resulted in a large stock of net public debt (92 percent of GDP at end-1999/2000), and the associated interest bill increased to 7¾percent of GDP.10 During the last two years, the debt-to-GDP ratio stabilized, as primary surpluses roughly offset the valuation effects of the rupee depreciation in 1998/99.

Table 5.

Pakistan: Summary of Consolidated Federal and Provincial Budgetary Operations, 1993/94–2000/01

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Sources: Ministry of Finance; and Fund staff estimates and projections.
Chart 4
Chart 4

Pakistan: Fiscal Developments, 1993–2000

Citation: IMF Staff Country Reports 2001, 024; 10.5089/9781451830477.002.A001

Source: Data provided by the Pakistan authorities.1/ Gross public debt less government deposits with the banking system.

Revision of Fiscal Data, 1993/94–1998/99

The revision of the fiscal accounts for the years 1993/94–1998/99 has now been completed with technical assistance from the Fund. An initial round of revisions focusing on the years 1998/99 and 1997/98 had concluded that the deficit was 1.5 and 2 percent of GDP, respectively, larger than previously reported (see EBS/00/65).

Fiscal deficits in the period 1993/94–1996/97 were also revised upward, albeit by a smaller margin (by about 0.5 percent of GDP in all years except for 1994/95 where the deficit remained unchanged). While deficit corrections in 1997/98 and 1998/99 were driven mainly by the interest bill and defense expenditure financed from additional nonbank sources,1 the pattern was less clear than in the preceding years. Expenditure tended to be revised upward on account of development expenditure, the interest bill, and defense outlays. Revenue was generally reduced due to lower nontax revenues and also lower CBR revenues, although revenue related to the petroleum/gas surcharges was larger than previously reported. The associated additional financing came mainly from nonbank sources in 1993/94, external sources in 1995/96, and the banking system in 1996/97.

The revised deficit path shows the deficit peaking at 7.8 percent of GDP in 1995/96 followed by a period marked by uneven success of consolidation efforts. Previously reported data had suggested strong and sustained fiscal consolidation setting in after the deficit had touched 7.2 percent of GDP in 1995/96 (see Figure 1).2

Fiscal consolidation was mainly brought about by compressing development expenditure/net lending (from 5.2 percent of GDP in 1995/96 to 2.6 percent in 1999/2000) and reducing military spending (from 5.6 percent of GDP in 1995/96 to 4.7 percent in 1999/2000). These effects more than compensated for pressures from a rising interest bill (from 6.2 to 7.7 percent of GDP) and declining revenues (from 17.5 to 16.1 percent of GDP) in the wake of tariff reductions (see Table 5).

Inadequate reconciliation processes in the past have meant that not all expenditures and revenues have been properly recorded in the audited accounts, from which the revised fiscal data series has been constructed. This leads to unidentified expenditures over the period ranging between -0.3 to +0.7 percent of GDP. The authorities are continuing to carry out some work to explain major past discrepancies, but highest priority has been given to reestablishing reconciliation processes, which should lead to better quality fiscal data in the future.

Figure 1.
Figure 1.

Pakistan Fiscal Data Path 1993/94–1999/2000

Citation: IMF Staff Country Reports 2001, 024; 10.5089/9781451830477.002.A001

1 In 1997/98, higher than previously reported development expenditure and lower revenues were also important factors.2 In the series “previously reported data”, deficits in percent of GDP differ from figures reported in earlier Fund documents reflecting GDP revisions.

11. A program has been launched to improve the financial performance of public enterprises and prepare them for eventual privatization. Corporate and financial restructuring plans for many key enterprises were drawn up and, for the Pakistan Steel Mills, Pakistan Railway, and power sector enterprises, implementation commenced. In addition, corporate management structures were put in place. As a result, the financial position of many enterprises has already begun to turn around. Although the net operating surplus (including interest charges) of the seven large enterprises remained flat in relation to GDP in 1999/2000, the net surplus and current balance of five of the seven enterprises increased by 0.3 percent of GDP (Table 6).

Table 6.

Pakistan: Summary Accounts of Seven Key Public Sector Enterprises, 1995/96–2000/01

(In millions of Pakistan Rupees)

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Source: Pakistan authorities; and Fund staff estimates.

Gross operating revenue minus operating expenditure (accrual basis).

Gross operating surplus plus other revenue minus other expenditure plus noncash expenditure (depreciation).

Revenue minus expenditure.

12. The stance of monetary policy was eased during the course of the year in response to the moderation in inflation and weak private sector credit growth. Treasury bill yields were cut by around 3 percentage points during the year to 7.0–7.5 percent, and the SBP’s discount rate was lowered by 2 percentage points to 11 percent (Chart 5). Banks responded by reducing their holdings of government securities and increasing their excess reserves. At the same time, demand for cash picked up in response to cuts in banks’ deposit interest rates (by about 2 percentage points) as well as the launch of an intensified loan recovery campaign and the tax survey and registration drive. As a result, reserve money growth surged to 25 percent by end-1999/2000, from under 8 percent at end-1998/99 (Table 7). Broad money growth also picked up to 9.4 percent—approximately equal to the pace of expansion of nominal GDP—with the increase in currency in circulation more than offsetting a more subdued expansion in banking system deposits, which was dampened by a continued drawdown in residents’ frozen foreign currency deposits (FCDs) (Table 8). Correspondingly, the money multiplier fell sharply as the ratio of currency to deposits climbed to 34 percent in June 2000, compared with 29 percent in June 1999. On the assets side, net bank borrowing by the government to finance the budget deficit and an expansion in bank credit to finance commodity operations (related to the procurement of the bumper wheat crop) accounted for around two thirds of the growth in broad money. Notwithstanding the cut in banks’ lending rates by 1.0–1.5 percentage points, credit to the private sector grew by only 2.5 percent, reflecting a variety of factors as detailed in Appendix IV.

Table 7.

Pakistan: Accounts of the State Bank of Pakistan, 1995/96–2000/01

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Source: State Bank of Pakistan; and Fund staff estimates.