Statement by Abbas Mirakhor, Executive Director and Meekal A. Ahmed, Advisor to the Executive Director for Pakistan

This paper assesses Pakistan’s Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) and Request for Waiver of Performance Criterion. Developments in the first months of 2002 indicate further progress toward the program’s macroeconomic objectives. Progress on the structural front was broadly in line with the program, in particular in the area of tax administration, fiscal transparency, and privatization. All but one of the performance criteria for end-March 2002 were met. The authorities request a waiver for the nonobservance of the performance criterion on Central Board of Revenue (CBR) revenue.

Abstract

This paper assesses Pakistan’s Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) and Request for Waiver of Performance Criterion. Developments in the first months of 2002 indicate further progress toward the program’s macroeconomic objectives. Progress on the structural front was broadly in line with the program, in particular in the area of tax administration, fiscal transparency, and privatization. All but one of the performance criteria for end-March 2002 were met. The authorities request a waiver for the nonobservance of the performance criterion on Central Board of Revenue (CBR) revenue.

July 3, 2002

Key Points

  • Despite an extraordinarily difficult economic and political environment, overall performance under the PRGF was broadly satisfactory;

  • The recent budget for 2002/03 goes beyond the financial framework under the PRGF and incorporates additional measures. It makes room for social and development spending and provides for effective monitoring;

  • The authorities will be vigilant in the conduct of monetary policy given the instability in money demand. There is no intention at all to target the exchange rate;

  • CBR reforms and privatization are high on the authorities’ agenda. On the latter, while some concrete successes are expected, security concerns, and the difficulties facing the global telecommunications sector, will make the task more challenging;

  • Financial improvement and restructuring plans for major public enterprises will be monitored quarterly and the results published to strengthen accountability.

We thank staff for an excellent paper which portrays well the authorities’ accomplishments and the challenges that lie ahead. Despite an extraordinarily difficult economic and political environment, and the lingering effects of the September 11 events, Pakistan has continued making steady progress under the PRGF arrangement, strengthening the foundations for macroeconomic stability, while continuing to implement key structural reforms. Real GDP growth in 2001/02 is expected to be around 3.6 percent (with real GNP growth of 5.2 percent due to the surge in workers’ remittances), inflationary pressures have remained quiescent, the exchange rate has been stable, and the balance of payments position has strengthened significantly. In addition, structural reforms were on track with the authorities pushing ahead with the elimination of the GST exemption on fertilizers and an increase in gas prices despite strong domestic opposition. A few privatization operations were concluded, bids for United Bank Limited (UBL) were received, and the process of privatizing Karachi Electric Supply Corporation (KESC) moved a step forward with the recapitalization of the company.

While agreeing that performance, in some instances, was not fully up to expectation, more recent developments are encouraging. To be sure, there was, once again, a shortfall in Central Board of Revenue (CBR) tax receipts. Nevertheless, (i) the fiscal deficit target for end-March was met with a wide margin, thanks to tight expenditure control and overperformance with respect to non-tax revenue; and (ii) there were indications that CBR revenues were starting to pick up suggesting that the effects of the on-going reforms were beginning to be felt.

Similarly, the shortfall in poverty-related expenditures was reduced, with third quarter spending up sharply, as the operational capacity of local governments started to improve. Finally, regarding the delays in price adjustments, the authorities were faced with international oil prices that had spiked to $3G7bbl and difficult socio-political circumstances, including simmering public discontent over natural gas price increases and the elimination of the GST exemption on pharmaceuticals. In the circumstances, they judged it prudent to proceed cautiously. However, they were firmly committed to fully implement the measures as soon as possible. This was done shortly after with limited impact on the budget.

As the staff supplement notes, the budget for 2002/03 not only contains all the major tax measures that had been planned under the program, but also incorporates additional measures. Of particular note is the elimination of the GST exemption on vegetable ghee and cooking oil, a reduction in the maximum external tariff to 25 percent, as well as a reduction in the number of tariff slabs from 5 to 4, a “landmark reform” of a genuine, universal self-assessment system under the income tax, and a new fiscal responsibility law which is not part of program conditionality. Notwithstanding the tight fiscal framework, the budget entails a major rationalization of expenditure towards higher social and development spending. The World Bank, the U.K. and other donors are assisting the authorities to improve the monitoring of I-PRSP expenditures, and baseline data should be ready by end-2002.

Monetary policy will be geared toward safeguarding Pakistan’s impressive progress in bringing inflation down to very modest levels. Given the uncertainties over the recent shift in money demand, the authorities intend to remain vigilant and respond promptly to any development that may threaten the inflation target. On exchange rate policy, they have no intention to target or underwrite “any particular level or range of the exchange rate,” given the difficulty in making a judgment as to whether or not the recent appreciation of the Pakistani rupee represents a move to a “sustainable equilibrium.” Accordingly, market forces will be allowed full play, and any risk of a “sudden loss of confidence” will be met with a judicious adjustment in the stance of macroeconomic policy.

The authorities recognize that making further progress with their ambitious structural reform agenda will be central to building confidence and raising Pakistan’s growth potential. They are cognizant of the importance of a “strong political willingness to enforce tax collection.” Reforms of the CBR are, clearly, critical if room is to be created to durably raise pro-poor spending and meet the targets established in the I-PRSP. The staff paper notes that CBR reforms are “gathering momentum” and, with the hoped-for return to a more normal domestic and external environment in 2002/03, CBR revenues should continue to improve and targets be met.

Privatization remains high on the authorities’ list of priorities. KESC has been brought a step closer to privatization following financial restructuring, while plans to sell stakes in the fertilizer, oil marketing, oil and gas development, telecommunication, and banking sectors by summer/early fall are on track. Nevertheless, the authorities realize that existing security concerns and the weak financial situation of the international telecom sector could inhibit investor interest in the telecommunication and power sectors. A medium-term financial improvement plan (FIP) for the Water & Power Development Authority (WAPDA), translated into quarterly performance targets with close monitoring, has been developed in consultation with the World Bank. The authorities will also monitor the implementation of restructuring strategies for other major public enterprises to ensure that public entities are held accountable for their performance. They hope that the World Bank will provide any advice and assistance that may be required to ensure that these restructuring strategies are implemented rigorously.

In the financial sector, banking sector reforms are proceeding as planned, prudential regulations are being modernized, particularly for small and medium-sized industry and consumer financing, and a new central bank law will be enacted by end-October aimed at strengthening its independence in line with Fund safeguard assessment recommendations. The authorities hope that an FSAP mission can be sent to Pakistan at an early date to advise them, inter alia, on developing best-practice anti-money laundering and anti-terrorist financing regulations. Finally, the central bank has recently prepared a regulatory framework for the transformation of moneychangers into foreign exchange companies, marking a further step towards unification of the interbank and kerb markets for foreign exchange.

The staff note that in the light of recent tensions in the region, the risks to Pakistan’s economic program have “strongly risen.” Clearly, an exacerbation of tensions, or their prolongation at a high level, would hinder the authorities’ adjustment and reform efforts. However, the authorities are hopeful of a more benign scenario where tensions will gradually abate and the situation returns to normal. They can then turn their fullest attention to the real issues at hand—fostering the nascent recovery of business confidence and pressing ahead with their growth and poverty reduction strategy.

Pakistan: Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility and Request for Waiver of Performance Criterion
Author: International Monetary Fund