Abstract
Pakistan’s economy continued to perform strongly owing to sound macroeconomic management and structural reform. Executive Directors advised that tight fiscal and monetary policies are required to reduce inflation and the external current account deficit while lessening pressures on real interest rates. They welcomed the enactment of the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CLT) ordinance. They underscored the need to modernize the energy sector’s regulatory and tariff framework and revive the privatization process. Directors urged action to strengthen public financial management.
1. This statement summarizes information that has become available since the issuance of the staff report on November 8, 2007. The new information does not change the thrust of the staff appraisal. However, the rise in international oil prices reinforces the importance of promptly addressing energy subsidies, while higher inflation and the reemergence of State Bank of Pakistan’s (SBP) financing of the budget point to the need to increase interest rates in the auctions of treasury bills.
2. Political uncertainties remain. President Musharraf appointed a caretaker government on November 15. After relinquishing the position of army chief of staff, he was sworn in for a second five-year term on November 29. General elections are scheduled for January 8. The economic team under the caretaker government remains unchanged. The stock market has largely recovered the losses it suffered following the declaration of a state of emergency. However, the EMBIG+ spread for Pakistani international bonds was 433 basis points as of December 11, compared with 214 basis points at end-June, and international rating agencies have changed the outlook on Pakistani debt from “stable” to “negative.”
3. The economy has shown considerable resilience to the domestic political tensions and the turbulence in international financial markets. Provisional data for activity in large-scale manufacturing show a growth of 7 percent in the first quarter of 2007/08. In the agricultural sector, the cotton harvest is estimated to have fallen short of last year’s good performance; however, a bumper sugar cane crop could make up for most of the shortfall. But inflationary pressures have intensified. The 12-month rate of inflation increased to 9.3 percent in October owing mainly to a substantial rise in food prices, with nonfood, nonenergy (core) inflation rising to 7.4 percent. As a result, average inflation was 7.6 percent in July–October 2007.
4. Based on the revised (higher) WEO oil prices of November 2007, the staff estimates that the external current account deficit could be 0.5 percentage points of GDP higher throughout the medium term than in the projections included in the staff report. However, preliminary information provided by the SBP for July–October 2007 suggests that the current account deficit narrowed relative to the same period of 2006. Export growth recovered to 11 percent, remittances and other transfers increased by 27 percent, and import growth moderated. Official disbursements and foreign direct investment increased slightly relative to the same period of 2006, but portfolio inflows reversed in November. Net international reserves fell by US$980 million since end-June 2007, to US$13.3 billion as of December 10, with the decline concentrated in November owing mainly to large oil and debt payments. The Pakistani rupee has depreciated by 1.2 percent since end-October, as the SBP has allowed for some exchange rate flexibility.
5. The fiscal position has deteriorated, owing mainly to expenditure overruns. The cash fiscal deficit reached 1.6 percent of annual GDP in the first quarter of 2007/08, compared with 0.5 percent in the same period of the previous fiscal year. Total revenue rose by 19 percent, but tax revenue turned out lower than originally anticipated. At the same time, total expenditure increased by 52 percent due to strong growth of development spending and higher than envisaged interest payments and energy subsidies. In the absence of adjustments in fuel prices and electricity tariffs, subsidies could exceed the amount budgeted for the fiscal year by more than 1½ percentage points of GDP. The authorities recognize the need for adjustments in energy prices and are taking steps to reduce the pace of development expenditures.
6. Broad money and reserve money growth (year-on-year) slowed to 18.4 percent and 14.1 percent, respectively, as of November 24, 2007, with credit to the private sector growing by 14.9 percent. During July–September, domestic financing of the government was provided mainly by commercial banks, and the SBP was able to offload some of its holdings of government securities. Starting in October, however, SBP’s financing of the government increased markedly, as commercial banks reduced their demand for treasury bills and investment bonds at prevailing interest rates. To reduce pressures in the foreign exchange market, in early December the SBP lowered temporarily the reserve requirement on foreign currency deposits from 20 percent to 10 percent.
7. Global Depository Receipts issues for government shares in two of the largest commercial banks are ready, but their launching has been postponed to early 2008 in view of current conditions in global financial markets.