My authorities thank staff, management, and the Executive Board for their advice, guidance, and support. As the staff report indicates, Pakistan’s performance under the Stand-By Arrangement was solid. In 2000/01, before September 11, manufacturing output recovered strongly, and inflation was kept under control despite the drought which constrained the overall GDP growth. The fiscal deficit was brought down to 5.2 percent of GDP, and official reserves rose to $1.7 billion at end-June 2001—more than double their level in the previous year. Significant strides were made in the implementation of structural reforms in the areas of tax policy, fiscal management and transparency, restructuring of the banking sector, and governance.

Pakistan has thus far established a good track record of policy implementation and has laid the foundation for higher sustainable growth and poverty reduction. My authorities have always felt that, as a poor and heavily indebted country, Pakistan can effectively address its economic problems only in the context of a medium-term framework, with an appropriate sequencing of reform measures supported by generous debt relief and concessional resources. They are therefore determined to build on the accomplishments of the reform process, initiated by the Government two years ago and, subsequently, supported by the Fund under the Stand-By Arrangement. In doing so, they will be focusing on the critical issues of poverty alleviation, higher growth, improved governance, and sustainable debt situation in the context of their new program to be supported by the PRGF.

The present macroeconomic situation in Pakistan is marked by downward revisions in activity amid a background of heightened uncertainty. The fallout from the September 11 events, the global slowdown, and the on-going military operations have had widespread negative effects on the economy. Latest data indicate that export growth has virtually come to a halt and that there has been a dramatic rise in freight and insurance costs, while the precipitous fall in imports has seriously impacted fiscal revenues. The balance of payments for 2001 has significantly worsened from earlier projection, with lower inflows of FDI and privatization proceeds. While recent indications of favorable crops suggest that the growth in agriculture could be well-sustained, reports of pest contamination make the cotton crop subject to wide margins of uncertainty. More positively, however, inflation has been subdued and international reserves have been built up to more comfortable levels, in part due to stepped-up purchases of the State Bank of Pakistan (SBP) in the interbank market to stem upward pressure on the exchange rate.

Assuming that military operations in the region give way to more normal conditions by early 2002, real GDP growth in 2001/02 is projected at 3.7 percent. However, this outcome is clouded by more than the usual degree of uncertainty. Even under a best case scenario of a timely cessation of military operations there are potential high risks to the economy, e.g., from cascading waves of new refugees until conditions in Afghanistan are normalized and all refugees repatriated, and continuing uncertainties attached to foreign and domestic investment. Already the fiscal position has come under pressure. The revised assumptions, again envisioning a return to normal conditions early next year, embody a revenue shortfall of 0.3 percent of GDP and a somewhat higher overall deficit to make room for additional social spending to be financed by grants.

At the heart of the authorities’ adjustment and reform strategy is the I-PRSP anchored on three pillars: raising economic growth, ensuring durable improvements in Pakistan’s social indicators, and strengthening the resilience of the economy. In line with these objectives, the authorities will pursue further fiscal consolidation based on a broadening of the tax base along with a reprioritization of public expenditure allocations in favor of the social sectors. They will also exert maximum effort to foster the development of the private sector by providing a stable macroeconomic environment and building confidence. Strengthening the economy’s resilience to cope with shocks will be pursued through, inter alia, a flexible exchange rate policy, a build-up of reserves, and attaining substantial reduction in the debt burden.

It is imperative that success is achieved in raising the tax revenue-to-GDP ratio in a sustainable and equitable manner to redress inadequacies in social services. Forceful and timely implementation of fundamental reform of the Central Board of Revenue (CBR) is the most critical element of the reform strategy. My authorities are committed to implementing the reform measures described in the I-PRSP and MEFP and outlined in Box 2 of the staff report. Their demonstrated ability to take tough decisions, in the face of resistance from vested interests over the past two years, should reassure the Board that reforms will be implemented. It should be recognized that, given the fundamental nature of the reforms being undertaken, which involve a sea change in the culture and administration of taxation, discrete and quantum progress is likely to take time to materialize.

Higher tax revenues will need to be accompanied by a significant reorientation of public expenditures with declining defense and interest payments, to make room for a projected increase in development and poverty-related expenditures. The I-PRSP targets in education and health reflect the urgency of catching-up in an area where Pakistan has performed poorly even when the economy grew strongly. In addition to higher spending levels, the authorities expect significant efficiency gains in the delivery of social services arising from the ongoing fiscal devolution initiative that should help strengthen the formulation of projects and the monitoring of expenditures. They recognize the importance of having a system in place for tracking social expenditures and key intermediate targets as well as for timely reporting of performance. While a good start has been made in this regard, the authorities are aware of the challenges they face in this area as they move toward a full PRSP. They welcome the envisaged joint Bank-Fund study on the poverty and social impact analysis (PSIA) of reform measures.

The scope and depth of other reforms being implemented are fully described in the I-PRSP and MEFP. These include better governance and transparency in public finances, deeper civil service as well as a pension reform to place the system on an actuarially sound footing. The reform agenda also includes the exchange system (including, efforts to speed up the integration of the official and kerb market and converting moneychangers into foreign exchange companies under strict SBP supervision) continued efforts to restructure and privatize the state-owned entities in the banking, financial and energy sector, and further agriculture and trade liberalization. The authorities look forward to the FSAP mission, which has now been rescheduled to early 2002, and stand fully committed to implementing best-practice prudential and anti-money laundering regulations.

In sum, despite the tensions and uncertainties surrounding short-term prospects, the authorities intend to be vigilant and resolute in their reform efforts and stand ready to take prompt corrective action, if warranted. They believe their program is ambitious and offers a hope for durably raising the living standards of their people. Their strong ownership of the program is reflected in the transparent and participatory approach that has underlaid the I-PRSP and the recognition of areas where more work needs to be done.

As noted earlier, the September 11 events and recent developments in the region have led to significant revisions of the balance of payments projections, requiring substantial exceptional financing in over the program period. For 2001/02, based on present assumptions, the program is fully financed, thanks to exceptional support in terms of bilateral grant pledges, enhanced market access for exports, and support from IFIs. On the latter, the authorities had hoped that the strength of the program, the financial needs of the country, and their performance under the Stand-By Arrangement would have justified a larger access than presently envisioned. They are still hopeful that the Board will consider their request for higher access favorably.

As staff underscore, the success of Pakistan’s PRGF program hinges on a “clear and credible path towards a sustainable external debt position.” Appendix IV demonstrates that, given Pakistan’s high debt burden, achieving debt sustainability could only be possible if the country is granted substantial support from its creditors in form of significant reduction of the external debt stock in NPV terms. In the absence of such support, there is a high risk that the economy will remain trapped in a low-growth equilibrium with a rising incidence of unemployment and poverty (as resources for the latter are pre-empted by heavy debt service payments), and a debt overhang that will continue to cast a pall of uncertainty over the economy and discourage private investment. For these reasons, my authorities hope that the Board will strongly endorse their efforts to seek a substantial debt relief at the forthcoming meeting of the Paris Club on terms that are fully compatible with the ground realities that would have classified Pakistan for debt relief under the enhanced HIPC-Initiative rather than as an IDA-blend country. Only then can Pakistan reach a sustainable external debt position with sufficient fiscal room to break out of the present low equilibrium and reduce the level of poverty widely recognized as a breeding ground for the types of problems faced today by the world community.

Provided that such a debt relief is forthcoming, my authorities view the main risk to the program to emanate from the prolongation of the conflict in the region and an increase in the magnitude and intensity of associated deleterious effects, which would impact the economy in more serious ways than presently assumed. Should this risk materialize, they will consult promptly with the Fund.