Pakistan
Request for Stand-By Arrangement-Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Pakistan
Author: International Monetary Fund
Publication Date:
02 Dec 2008
eISBN:
9781451830736
Language:
English
Keywords:
ISCR; CR; Pakistan; government; financing; fund; financial support; short-term debt; long-term debt; public funds; central bank; cash flow; Global; widening current account deficit
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Pakistan’s authorities have requested a 23-month Stand-By Arrangement for SDR 5.169 billion in support of their macroeconomic stabilization program. The authorities’ program envisages a tightening of fiscal and monetary policies to bring down inflation and reduce the external current account deficit to more sustainable levels. The pace of adjustment seeks to balance the need to address the current macroeconomic imbalances with protecting social stability. The program envisages important reforms in tax policy and administration and public financial management.

Abstract

Pakistan’s authorities have requested a 23-month Stand-By Arrangement for SDR 5.169 billion in support of their macroeconomic stabilization program. The authorities’ program envisages a tightening of fiscal and monetary policies to bring down inflation and reduce the external current account deficit to more sustainable levels. The pace of adjustment seeks to balance the need to address the current macroeconomic imbalances with protecting social stability. The program envisages important reforms in tax policy and administration and public financial management.

I. Introduction

1. From the early 2000s to mid-2007, Pakistan’s macroeconomic performance was robust. During the period 2000/01–2004/05, when Pakistan successfully implemented two Fund-supported programs (an SBA and a three-year arrangement under the Poverty Reduction and Growth Facility), real GDP growth averaged 5 percent a year with relative price stability.1 The improved macroeconomic performance enabled the country to re-enter international capital markets in the mid-2000s. During 2005/06–2006/07, higher foreign direct investment (FDI) and portfolio inflows financed a strengthening of the international reserves position, despite a widening current account deficit. The external debt declined to 27 percent of GDP, and gross official reserves rose to $14.3 billion (3.8 months of imports) at end-2006/07. At the same time, real GDP grew by more than 7 percent a year owing to a significant policy stimulus and the foreign-financed increase in investment, while inflation remained at around 7 percent.

2. The macroeconomic situation, however, deteriorated significantly in 2007/08 and the first four months of 2008/09 on account of domestic and external factors. Adverse security developments, large exogenous price shocks (oil and food), and global financial turmoil buffeted the economy. These shocks, combined with policy inaction during the political transition to a new government and large central bank financing of the growing fiscal deficit led to slower growth, higher inflation, and a sharp deterioration of the external position.

3. Against this background, the Pakistani authorities have embarked upon a program to restore macroeconomic stability while protecting the poor and vulnerable during the process of adjustment. To support this program, they have requested a 23-month SBA in an amount equivalent to 500 percent of quota, with front-loaded access. The exceptional access is consistent with the size of Pakistan’s balance of payments need, while the front-loading is justified by the necessity to bolster the country’s international reserve position at the outset of the program.

II. Recent Developments

4. Economic activity has slowed. Real GDP growth decelerated to 5.8 percent in 2007/08, from 6.8 percent in 2006/07, as both investment and consumption were negatively affected by weakened confidence, reduced foreign exchange inflows, and adverse security developments (Table 1 and Figure 1). Available indicators suggest that growth in the manufacturing sector decelerated markedly in the first quarter of 2008/09.

Table 1.

Pakistan: Selected Economic Indicators, 2004/05–2009/10 1/

(Population: 160.9 million (2007/08))

(Per capita GDP: $1,042 (2007/08))

(Poverty rate: 23.9 percent (2004/05))

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Sources: Pakistani authorities; and Fund 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.

Expenditure on social assistance in 2008/09 is budgeted at 0.6 percent of GDP. The program will target an additional 0.3 percent of GDP.

Calculated as interest payments in percent of the end-of-period debt stock of the previous year.

Excluding gold and foreign deposits of commercial banks held with the State Bank of Pakistan.

Figure 1.
Figure 1.

Pakistan: Output and Inflation Indicators, 2003/04–2007/08

Citation: IMF Staff Country Reports 2008, 364; 10.5089/9781451830736.002.A001

Sources: Pakistani authorities; and Fund staff estimates.1/ At factor cost.

5. Inflation has been on the rise since early 2008. Twelve-month headline CPI inflation rose to 25 percent in October 2008 owing to strong domestic demand growth, rising fuel and food import prices, and a depreciation of the rupee of more than 30 percent since end-March 2008. Core inflation (excluding energy and food) increased to 18.3 percent in October.

6. The external position has deteriorated significantly. The external current account deficit widened to 14 billion or 8½ percent of GDP in 2007/08, from 4.8 percent in 2006/07, reflecting higher oil import prices and continued strong aggregate demand growth. This, combined with a sharp decline in capital inflows, in particular portfolio investment (Figure 2), led to a drop in gross international reserves from $14.3 billion at end-June 2007 to a critically low level of $3.4 billion (less than 1 month of imports) at end-October 2008.

Figure 2.
Figure 2.

Pakistan: External Sector Indicators, 2003–08

Citation: IMF Staff Country Reports 2008, 364; 10.5089/9781451830736.002.A001

Sources: Pakistani authorities; and Fund staff estimates.

7. The fiscal deficit (excluding grants) is estimated to have risen to 7.4 percent of GDP in 2007/08, from 4.3 percent in 2006/07. This deterioration in the fiscal position is mainly attributable to a substantial increase in energy and food subsidies (in a context of rising international prices that were not passed through to consumers), higher than envisaged interest payments, and additional security-related expenditures (Tables 3a–3b and Figure 3).

Table 2.

Pakistan: Balance of Payments, 2006/07–2009/10

(In millions of U.S. dollars; unless otherwise indicated)

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Sources: Pakistani authorities; and Fund staff estimates and projections.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

Excluding foreign currency deposits held with the State Bank of Pakistan (cash reserve requirements) and gold.

Table 3a.

Pakistan: Consolidated Government Budget, 2006/07–2009/10

(In billions of Pakistani rupees)

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Sources: Pakistani authorities for historical data; and Fund staff for estimates and projections.

In 2007/08, PRs 23 billion (0.2 percent of GDP) of current expenditure was reclassified as development expenditure.

Includes statistical discrepancy and spending related to the 2005 earthquake.

Table 3b.

Pakistan: Consolidated Government Budget, 2006/07–2009/10

(In percent of GDP; unless otherwise indicated)

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Sources: Pakistani authorities for historical data; and Fund staff for estimates and projections.

In 2007/08, PRs 23 billion (0.2 percent of GDP) of current expenditure was reclassified as development expenditure.

Includes statistical discrepancy and spending related to the 2005 earthquake.

Figure 3.
Figure 3.

Pakistan: Budget Indicators, 2003/04–2007/08

Citation: IMF Staff Country Reports 2008, 364; 10.5089/9781451830736.002.A001

Sources: Pakistani authorities; and Fund staff estimates.

8. Increases in interest rates were insufficient in light of the rise in inflation, and the State Bank of Pakistan (SBP) accommodated the government’s large domestic financing needs. The SBP increased its discount rate in several steps by 350 basis points starting in June 2007, to 13 percent in July 2008. Cut-off interest rates in the bi-weekly auctions of treasury bills largely followed the changes in the discount rate, but were not sufficiently attractive to commercial banks. As a result, commercial banks reduced their holdings of treasury bills, and SBP financing of the government reached PRs 950 billion ($12 billion) during July 2007–October 2008 (Table 4 and Figure 4). Negative real interest rates resulted in a slowdown in rupee deposit growth and an increase in foreign currency deposits, while credit growth to the private sector accelerated to 20 percent by September 2008.

Figure 4.
Figure 4.

Pakistan: Monetary and Credit Indicators, 2003/04–2007/08

Citation: IMF Staff Country Reports 2008, 364; 10.5089/9781451830736.002.A001

Sources: Pakistani authorities; and Fund staff estimates.
Table 4.

Pakistan: Monetary Survey and Analytical Balance Sheet of the State Bank of Pakistan, 2005/06–2009/10

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Sources: Pakistani authorities for historical data; and Fund staff estimates and projections.

Denominator is the stock of broad (reserve) money at the end of the previous year.

Includes valuation adjustments.

9. The banking system was well capitalized and liquid based on the latest data available as of end-June 2008, but liquidity problems emerged recently. Some small and mid-sized banks have recently experienced serious liquidity problems because of deposit withdrawals, which prompted the authorities to reduce the cash reserve requirement by 4 percentage points in two steps during October–November, and to broaden the range of assets that can be used to meet the statutory liquidity requirement. The SBP also facilitated mergers of some non-viable banks with sound banks.

Pakistan: Financial Soundness Indicators for the Banking System, 2005–08

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Source: Pakistani authorities.

10. Financial market indicators have also deteriorated markedly. The EMBIG spread of Pakistani sovereign bonds has risen to above 2,000 basis points, and the Karachi KSE-100 stock index, after climbing to record highs by end-April 2008, dropped by 40 percent by late August 2008. In response, on August 27, 2008, the authorities imposed a price floor on all stock prices, which has led to a virtual halt in trading.

11. Faced with increasing pressures in the foreign exchange market, in May 2008, the authorities adopted several exchange measures consisting of: (i) a 25 percent limit on advance payments for imports of goods (an exchange restriction subject to Fund approval under Article VIII, Section 2(a)); (ii) the requirement for exchange bureaus to repatriate foreign exchange from their accounts abroad and to sell 25 percent of any foreign exchange receipts in the interbank market; (iii) prior SBP consent for outward remittances of more than $50,000 upon verification of the bona fide nature of the payment; and (iv) a margin requirement of 35 percent for the opening of letters of credit for non-essential imports. With regard to this latter measure, which was introduced at a later date, staff is obtaining additional information from the authorities in order to assess its jurisdictional implications. In addition, the government recently imposed regulatory duties on imports of luxury items.

III. The Authorities’ Program

12. The authorities’ economic program for 2008/09–