IMF Executive Board Concludes 2006 Article IV Consultation with Pakistan

The demand pressures associated with the large terms-of-trade gains are reflected in a fast real appreciation of the ruble, although more of this has come through nominal appreciation during the last year. The risks to the outlook are evenly balanced and depend mostly on oil price developments. Current policies raise medium-term risks. IMF staff welcomed the greater focus on inflation control, but cautioned that additional exchange rate flexibility would be needed to meet the end-2006 target, especially at a time when demand pressures are exacerbated by fiscal relaxation.


The demand pressures associated with the large terms-of-trade gains are reflected in a fast real appreciation of the ruble, although more of this has come through nominal appreciation during the last year. The risks to the outlook are evenly balanced and depend mostly on oil price developments. Current policies raise medium-term risks. IMF staff welcomed the greater focus on inflation control, but cautioned that additional exchange rate flexibility would be needed to meet the end-2006 target, especially at a time when demand pressures are exacerbated by fiscal relaxation.


Pakistan’s recent economic performance has been impressive. Growth has accelerated, improvements in public spending and wide-ranging structural reforms have reduced the debt burden and increased efficiency, and pro-poor policies have helped lower poverty rates. The devastating earthquake of October 2005 left a heavy toll in terms of human lives and physical and social infrastructure, but had relatively minor effects on macroeconomic indicators (except for an increase in government spending) owing mainly to the small share of the affected areas in the overall economy.

Economic developments during the fiscal year ending in June 2006 were favorable, with buoyant real GDP growth and inflation declining to 7.6 percent. The external current account deficit, however, increased to US$5 billion (3.9 percent of GDP), from US$1.5 billion (1.4 percent of GDP) a year earlier. Record-high net capital flows (mainly from foreign direct investment—including privatization) more than covered the larger deficit and allowed for a build up of nearly US$1 billion in official international reserves. The interbank market exchange rate was broadly unchanged from end-June 2005.

The fiscal deficit exceeded the original budget target for 2005/06 owing to earthquake-related spending. Excluding the latter, revenues and expenditures rose by roughly the same amounts compared to the outturn in the previous fiscal year. The government debt-to-GDP ratio fell to 56 percent by the end of June, below the 60 percent ceiling stipulated in the 2005 Fiscal Responsibility Law. The budget for 2006/07 targets a deficit of 4.2 percent of GDP (excluding grants), unchanged from the estimated outturn for 2005/06.

The growth of broad money and bank credit to the private sector decelerated in 2005/06, but private sector credit continued to expand at a relatively strong pace. Bank lending rates became increasingly positive in real terms as inflation declined; the real return on bank deposits remained negative. The State Bank of Pakistan’s (SBP) claims on the government rose by more than total government borrowing from the banking system, as the SBP absorbed treasury bills that commercial banks did not roll over upon redemption. In July 2006, the SBP tightened monetary conditions by raising reserve and liquidity requirements on bank deposits and the discount rate.

Foreign investors’ interest in Pakistan increased significantly in 2005/06. Foreign direct investment inflows, excluding privatization, rose by 70 percent, and foreign demand for Pakistani bonds was strong. Government divestiture from electricity and telecommunications entities generated large foreign exchange inflows and revitalized the privatization process.

Progress on structural reforms, other than privatization, was mixed. Reforms to broaden the income tax base and streamline rates continued, and the legal framework for investor protection was strengthened. However, implementation of the schedule of higher regional electricity tariffs, a key step for continued reform of the power sector, remains pending, and progress on trade liberalization slowed.

Executive Board Assessment

Executive Directors commended Pakistan’s impressive macroeconomic performance since 2001. They welcomed in particular the acceleration in output growth, the steady decline in debt ratios, and the fall in poverty rates. Directors noted that Pakistan’s strong track record on the macroeconomic and structural reform fronts had made the country increasingly attractive to foreign investors, as shown by the record-high inflows of foreign direct investment (FDI) during 2005/06 and the favorable terms obtained on recent sovereign bond placements in the international capital markets.

Directors noted that during 2005/06 the Pakistani economy had withstood well the impact of large negative shocks, including the tragic earthquake of October 2005, a sharp rise in international oil prices, and unfavorable weather conditions. Although these shocks had limited the scope for fiscal maneuver, growth had remained buoyant, inflation had declined slightly and the import coverage of reserves had remained stable.

Directors nonetheless noted the risks to the outlook, including the continued strength of domestic demand, and its adverse effects on the trade and current account deficits as well as on the pace of disinflation during 2005/06. They noted also the authorities’ view that macroeconomic imbalances would decline without the need for further changes in the stance of policies envisaged for the current fiscal year, and welcomed the government’s commitment to tighten monetary policy, if warranted. However, most Directors felt that macroeconomic policies during 2006/07 should be more effectively geared at reducing domestic demand and strengthening the balance of payments position. To this effect, many considered that a further tightening of monetary policy (including by allowing higher cutoff rates at treasury bill auctions) should not be delayed to help strengthen the external position and allow the government to meet its inflation target. Most Directors considered that to be effective, monetary policy should be supported by exchange rate flexibility and a fiscal policy that keeps this year’s budget deficit (excluding grants and earthquake-related expenditures) at least at the level of 2005/06.

Directors stressed that, beyond 2006/07, Pakistan’s macroeconomic policies should aim at ensuring that the external current account deficit-to-GDP ratio remains on a declining path with a steady build up of reserves. In this regard, they encouraged the authorities to adopt a policy stance that maintains real interest rates at positive levels accompanied by a close monitoring of credit growth, and a fiscal consolidation program that lowers the overall fiscal deficit to a sustainable level over the medium term.

Directors viewed the favorable prospects for sizable FDI inflows as important for future gains in productivity and investment, but also as presenting challenges for macroeconomic policy in the years ahead. They highlighted that continued reliance on FDI inflows of uncertain size and timing would require a large degree of flexibility in economic policymaking. In this connection, Directors stressed the need to improve the government’s capacity to generate timely policy responses to shortfalls of external financing arising from negative balance of payments shocks. Directors were of the view that those shocks should generally require monetary policy and exchange rate responses, but also envisaged a role for fiscal tightening in cases where the shocks are large, or more permanent in nature. Directors cautioned that the option of resorting to the use of international reserves to cover shortfalls of external financing (especially those stemming from delays in FDI-related flows) ought to be used sparingly.

Directors viewed structural reforms conducive to higher saving and investment, an improved business climate, and well-targeted poverty-related spending as critical for sustaining growth and poverty reduction over the medium term. They encouraged the authorities to quickly complete the reform of the regulatory and tariff framework for the power sector, and step up efforts to broaden the tax base and further curtail tax exemptions. Directors also saw scope for improving the government’s debt management strategy, including by increasing the issuance of long-term marketable securities and reducing its reliance on treasury bills and the National Savings Schemes (NSS) to finance the fiscal deficit. Directors welcomed the initiatives underway to modernize the NSS and reform the system of broker-financing of stock trading, but noted that these should be followed quickly with measures that enable the integration of the NSS with local financial markets.

Directors welcomed the authorities’ commitment to maintaining a liberal trade regime and their determination to contribute to the success of the Doha round of trade talks. They called on the authorities to resist pressures to reinstate ad-hoc tariff and nontariff measures and broaden export subsidy schemes.

Directors encouraged the authorities to further improve the quality and timeliness of data, including by reporting fiscal data on an economic classification. They also urged the authorities to expedite the process of subscribing to the Special Data Dissemination Standard.

Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The Staff Report for the 2006 Article IV Consultation with Pakistan is also available.

Pakistan: Selected Economic Indicators, 2001/02–2005/06 1/

(In percent of GDP, unless otherwise noted)

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Sources: Pakistani authorities; and IMF staff estimates and projections

Fiscal year ends June 30.

Including changes in inventories. Investment data recorded by the Federal Bureau of Statistics are said to underreport true activity.

Excluding gold, foreign deposits held with the State Bank of Pakistan, and net of outstanding short-term foreign currency swap and forward contracts.

An increase is a real appreciation.


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.

Pakistan: Staff Report for the 2006 Article IV Consultation
Author: International Monetary Fund