IMF Concludes 2002 Article IV Consultation with Pakistan

The economic outlook remains clouded by regional and domestic security concerns. Real GDP growth and inflation were broadly in line with program projections in 2001–02. The balance of payments position unproved faster than expected. The budget deficit target for 2001–02 (as set during the first review) was met, despite a shortfall in the Central Board of Revenue (CBR). Broad money increased strongly in 2001–02, despite efforts to sterilize foreign exchange inflows. Reforms in the financial sector made significant progress.


The economic outlook remains clouded by regional and domestic security concerns. Real GDP growth and inflation were broadly in line with program projections in 2001–02. The balance of payments position unproved faster than expected. The budget deficit target for 2001–02 (as set during the first review) was met, despite a shortfall in the Central Board of Revenue (CBR). Broad money increased strongly in 2001–02, despite efforts to sterilize foreign exchange inflows. Reforms in the financial sector made significant progress.

On November 1, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the 2002 Article IV consultation with Pakistan.1


Pakistan entered the 21st century with both high poverty rates and severe macroeconomic imbalances. Several attempts at bringing the economy on a path of declining public debt in the 1990s failed due to repeated policy slippages, resulting in growing macroeconomic instability and external vulnerability. The government, in office since October 1999, therefore put at the heart of its initial economic strategy a program of macroeconomic adjustment. Following the successful completion of a stabilization program supported by an IMF Stand-By Arrangement, a medium-term reform strategy was set forth in Pakistan’s interim Poverty Reduction Strategy Paper that explicitly acknowledged that progress was needed on a broader front for several reasons to: (a) improve the investment climate in the country; (b) reduce the economy’s vulnerability to external or internal shocks; and (c) put the economy on a sustainable growth path, and ensure that growth translates into palpable improvements in living standards for the population at large, and the poor in particular. The policy package to achieve these objectives centered on fiscal adjustment to bring debt to sustainable levels while raising social- and poverty-related expenditure, and a wide range of governance reforms to stimulate private sector growth and improve social service delivery.

In the past two years, considerable progress was made in implementing this agenda, even while Pakistan’s economy was exposed to several negative shocks. A slowdown in the world economy, high oil prices, protracted drought, trade disruption in the wake of September 11, and regional and domestic security problems have increased uncertainty for business and hampered growth. Despite this unfavorable context, real GDP at factor costs grew by 3.6 percent in FY 2001/02 (ending in June 2002). Due to a large increase in worker remittances, real GNP growth was significantly higher. Average inflation in 2001/02 was 2.7 percent, one of the lowest in Pakistan’s history. However, inflation picked up in the first half of 2002, to 3.7 percent in the year through August 2002.

The external accounts recorded a dramatic turnaround and reserves were built up to levels unprecedented in Pakistan’s history. The current account excluding grants recorded a small surplus in 2001/02 on account of an improved trade balance and the surge in worker remittances. Combined with a substantial net exceptional financing in the form of debt rescheduling and program financing from international financial institutions, this allowed the State Bank of Pakistan (SBP) to build up foreign exchange reserves in the course of the year much faster than expected. At end-June 2002, gross official reserves stood at US$4.3 billion, equivalent to 17.5 weeks of next year’s imports of goods and nonfactor services, compared with US$1 billion at end-2000; by end-September 2002 reserves had risen to US$5.9 billion. Since late 2001, the Pakistani rupee has remained virtually stable against the U.S. dollar, with large foreign exchange purchases by the SBP, exclusively in the interbank market since June 2002.

Though revenue collection has been repeatedly below program targets, the overall fiscal situation improved in 2001/02. The budget deficit including grants decreased from 5.5 percent of GDP in 1999/2000 to 4.2 percent of GDP last fiscal year, despite sizable exceptional expenditures in 2001/02, such as the recapitalization of the Karachi Electric Supply Corporation (KESC) and the settlement of excess taxes paid by banks. Social-and poverty-related expenditure picked up significantly in the second half of the year, once the initial administrative problems of the newly elected local governments were overcome, and were only marginally lower than the target under the I-PRSP.

Broad money increased strongly in 2001/02. Though the SBP was successful at containing reserve money growth within program limits, owing to an aggressive sterilization of its foreign exchange purchases, the banking system’s net domestic assets recorded a slight increase partly on account of a moderate rise in credit to the private sector. As a consequence, the very large accumulation of net foreign assets by the banking system led to an almost 16 percent annual increase in broad money at end-June 2002. Interest rates have remained relatively stable since early 2002, with the yield on six-month treasury bills hovering around 6.5 percent after a sharp decrease in 2001.

The authorities’ comprehensive structural reform agenda, focusing on improved governance, was steadfastly implemented in the past two years. Progress has been made in particular in tax policy and tax administration reform, fiscal accountability and transparency, trade reform, energy pricing, privatization, and financial sector restructuring. Reform of social service delivery is also underway, with an ambitious devolution plan aimed at empowering the population at the grassroots level. In the wake of September 11, the privatization program has experienced delays for the more difficult cases (notably KESC), largely reflecting the difficulties in global equity markets and security concerns.

Executive Board Assessment

Executive Directors noted that despite various adverse shocks, which took a toll on economic activity, Pakistan has succeeded in consolidating macroeconomic stability over the past two years. Growth appears to be picking up, inflation remains subdued, and the external accounts have strengthened considerably owing to high worker remittances, sizable capital inflows, and, more recently, improved export performance. The strong external position has allowed the central bank to build official reserves to unprecedented levels, reducing its vulnerability to external shocks. Structural reforms have focused on tax policy and administration, energy pricing, privatization, fiscal accountability, transparency, and governance. Directors were encouraged that the fiscal deficit has declined and social sector spending is increasing as local governments have become operational. The Central Board of Revenue (CBR) revenue shortfall through June 2002 is, however, regrettable and calls for a decisive effort to reinforce revenue collection.

Notwithstanding these overall favorable developments, Directors observed that the high public debt burden continues to constrain needed investments in human development and infrastructure, and that private investment and economic growth remain insufficient to reduce rapidly Pakistan’s high rate of poverty. The key policy challenges for the medium term are therefore to improve the public debt dynamics further through fiscal adjustment, and to address Pakistan’s “social gap” through enhanced provision of basic social services. Directors stressed that progress on these fronts will critically depend on stronger tax collection efforts and improved financial performance of public enterprises, especially the utility companies. They urged the authorities to step up the allocation of resources to basic education and health as well as to ensure the efficient use of these resources, which will be key to improving productivity and growth prospects. Ongoing steps to improve the monitoring of social spending were welcomed.

Directors viewed Pakistan’s near-term economic outlook as broadly encouraging, with recent data confirming a continued recovery in exports, imports, and tax revenue. At the same time, however, downside risks remain, including the risk that the reform efforts will not be sustained over a sufficiently long period of time, or that the current reforms will take longer than assumed to produce a strong impact. Directors drew comfort from the improved resilience of Pakistan’s debt dynamics to various shocks, provided recent reforms are not reversed, and from the authorities’ demonstrated ability to hold the program broadly on course in a difficult environment. Building on this, they stressed that the central task for the new government will be to deal resolutely with the remaining challenges, while further broadening and deepening the ownership of the reform effort in the period ahead. Important, in this regard, will be continued strong efforts to explain the rationale for reform to the population, and further sustained improvements in governance and the delivery of social services.

Directors considered the proposed macroeconomic policy mix for the near future to be appropriate. Monetary policy will be geared toward keeping inflation low, within the current flexible exchange rate system, and continued fiscal adjustment will aim at further improving public debt dynamics. Monetary and price developments will nevertheless need to be kept under close watch, and the authorities should be ready to consider a moderate tightening of monetary policy if needed. Most Directors saw merit in continued sterilized intervention to contain the real appreciation of the Pakistani rupee in the face of continuous strong capital inflows. Some Directors, however, cautioned that this is unlikely to be a solution over the longer term, and that competition-enhancing structural measures are a more effective approach to deal with upward pressures on the external value of the currency.

Directors supported the further reduction of the budget deficit planned for next year. Noting that the budgetary position remains vulnerable and subject to regional tensions, they urged the authorities to ensure the attainment of the revenue objectives and to keep tight control over expenditure, while protecting social and poverty-related spending. In this regard, Directors highlighted, in particular, the need for carefully following through on CBR reforms, and several Directors suggested to explore the feasibility of more ambitious revenue plans going forward. A number of Directors also urged the authorities to continue exploring the possibility for savings on defense expenditures.

Directors welcomed the focus of the structural reform agenda on improved governance across a broad range of areas, and strongly supported the continuation of these efforts to improve conditions for private sector development and growth. They emphasized that delays or loss of momentum in implementing the reform agenda would work at cross-purposes with the aim of reducing poverty. Directors welcomed the publication of a draft fiscal responsibility and debt reduction ordinance for public comment, and encouraged the authorities to consider further simplifying its specifications and extending its application to provinces and local governments. They supported the ongoing reforms in the financial sector, including the planned reduction in government ownership in the banking industry and the closer alignment of National Savings Scheme instruments with market conditions. Directors encouraged the authorities to continue working closely with Pakistan’s development partners to address the remaining weaknesses in the financial sector, including further strengthening of the regulatory environment and the resolution of nonperforming loans. They looked forward to the smooth development of Islamic banking alongside conventional banking, and passage of anti-money laundering legislation in line with international standards, and were hopeful that an Financial Sector Assessment Program could soon be conducted.

Directors commended the recent efforts to restructure public enterprises, but noted that a considerable agenda remains. They urged the authorities to accelerate the reform of the two power utilities to contain their drain on the budget, and in particular, to ensure timely tariff adjustments and step up efforts to improve receivables collection. While welcoming steps to make major public enterprises more accountable to the public, Directors underscored the importance of accelerating privatization, especially in the power and telecoms sectors.

Directors expressed reservation about plans to support the restructuring and/or investment programs of various public enterprises with “one-off” budgetary transfers. They cautioned that such plans should be part of a clearly articulated strategy to restructure, privatize, or liquidate them, and that their cost should be part of the budget process rather than being brought up in an ad hoc fashion after the budget was passed.

Directors welcomed the authorities’ efforts to improve the quality, timeliness, and reporting of data. They looked forward to further steps to address remaining weaknesses that hamper the analysis of economic and financial market developments, and to Pakistan’s participation in the General Data Dissemination System.

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF’s assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

Pakistan: Selected Economic Indicators 1/

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Sources: Data provided by Pakistani authorities, and IMF staff.

Pakistan’s fiscal year runs from July 1 to June 30.


Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. This PIN summarizes the views of the Executive Board as expressed during the November 1, 2002 Executive Board discussion based on the staff report.