Pakistan
Request for Stand-By Arrangement-Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Pakistan
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International Monetary Fund
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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 2008/09–2009/10 seeks to restore the confidence of international and domestic investors by addressing the current macroeconomic imbalances while preserving social stability by protecting the poor. The program envisages a significant tightening of fiscal and monetary policies to bring down inflation and strengthen the external position, as well as several structural measures in the fiscal and financial sectors. The pace of adjustment seeks to balance the need to quickly restore macroeconomic stability with mobilizing the required domestic political support for the program, which is an essential precondition for its success.

A. Macroeconomic Framework

13. The authorities’ policies for the remainder of 2008/09 and for 2009/10 are aimed at stabilizing the macroeconomic situation; strengthening the international reserves position, including by stopping and ultimately reversing portfolio outflows; and easing the burden of adjustment on the poor. Real GDP growth is projected to slow to 3–3½ percent in 2008/09 in response to weaker aggregate demand growth and a deceleration in economic activity in Pakistan’s trading partners. The 12-month inflation rate is targeted to decline to 20 percent by June 2009, even after taking into account the impact of significant increases in administered prices (Table 1).

14. The external position is expected to strengthen significantly in 2008/09 in response to tighter financial policies, improved confidence, lower commodity prices, and higher disbursements from international financial institutions. The external current account deficit is projected to decline to 6½ percent of GDP in 2008/09 owing mainly to lower oil import prices and slower non-oil import growth. In the financial account of the balance of payments, the program envisages an increase in disbursements to the government by multilateral and bilateral creditors to $4.8 billion in 2008/09 ($2.5 billion in 2007/08), which includes $1.4 billion from the World Bank and $2.2 billion from the Asian Development Bank, of which $500 million was already disbursed in September. This increase will be more than offset, however, by sluggish FDI performance and significant outflows of portfolio and other investments. Given the need to rebuild reserves to at least $8.6 billion (the level prevailing at end-June 2008), an external financing gap of $4.7 billion is projected for 2008/09 (Table 2). This gap will be fully covered by access to Fund resources.

15. The program envisages further gains in macroeconomic stabilization in 2009/10. Real GDP growth would pick up to 4½–5 percent in 2009/10 owing to a recovery of confidence and investment. With further fiscal adjustment, the continuation of a tight monetary policy, and falling oil and food import prices, CPI inflation is projected to decline to 6 percent by June 2010. The external current account deficit would narrow further to 5.7 percent of GDP in 2009/10, while higher FDI and a resumption of portfolio flows would more than offset a decline in official disbursements. With a further targeted increase in international reserves to $11.3 billion by end-June 2010, a financing gap of $3.6 billion would remain in 2009/10. This gap will be filled with Fund resources and privatization proceeds, including from Global Depository Receipts (GDRs).

16. Successful implementation of the authorities’ program will lay the foundation for a significant improvement in macroeconomic conditions over the medium term. Real GDP growth is projected to increase gradually to 6½–7 percent a year by 2012/13, with inflation declining to 5 percent. Further fiscal consolidation by substantially raising tax revenue (a key condition for fiscal viability) and the continuation of a tight monetary policy stance should contribute to a gradual decline in the external current account deficit to about 3½ percent of GDP over the medium term.2 As a result of this improvement and increased capital inflows, international reserves would increase gradually to about $14.5 billion (2.6 months of imports) by end-June 2013 (Tables 5–7).

Table 5.

Pakistan: Medium-Term Macroeconomic Framework, 2004/05–2012/13

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

Difference between the overall balance and the current account balance.

Including privatization.

Ratio of gross official reserves to next year’s imports of goods and services (divided by 12).

Including grants and earthquake-related expenditures.

Excluding grants and earthquake-related expenditures.

Table 6.

Pakistan: Medium-Term Fiscal Framework, 2006/07–2012/13 1/

(In percent of GDP; unless otherwise indicated)

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

Projections based on a staff scenario with tighter fiscal and monetary policies.

Projection for 2007/08 includes as development expenditure 0.2 percent of GDP corresponding to items classified as current expenditure in earlier years. Reclassification is maintained in all projection years.

Spending related to the 2005 earthquake.

Table 7.

Pakistan: Balance of Payments, 2006/07–2012/13

(In millions of US 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 of commercial banks held with the State Bank of Pakistan (cash reserve requirements) and gold.

B. Fiscal Policy

17. The fiscal program envisages a reduction in the fiscal deficit to 4.2 percent of GDP in 2008/09, from 7.4 percent in 2007/08, to help reduce the external current account deficit and move toward a more sustainable fiscal position. At the same time, the authorities are committed to eliminating SBP financing of the government during October 1, 2008–June 30, 2009. Although the fiscal effort could arguably be more ambitious, the envisaged pace of adjustment is justified by the need to provide an appropriate level of poverty-related spending. Tax revenue is programmed to increase by ½ percentage point of GDP in 2008/09 on account of tax administration measures (MEFP, ¶9 and 15) and an increase of one percentage point in the general sales tax (GST) rate implemented when the budget was approved. Expenditure measures (2¾ percent of GDP) include the phasing out of energy subsidies and a better prioritization of development spending. The authorities have already raised domestic fuel prices, which, in combination with declining international fuel prices, has led to the elimination of fuel subsidies. They have also increased electricity tariffs by an average of 18 percent on September 5, and in close collaboration with the World Bank will prepare a plan, by end-December 2008, to complete the elimination of electricity subsidies by end-June 2009 (structural benchmark).

18. The program targets a further reduction in the fiscal deficit to 3.3 percent of GDP in 2009/10. On the revenue side, tax administration measures, an increase in excises on tobacco, and a reduction in exemptions are expected to yield an additional 0.8 percent of GDP (MEFP, ¶15). Total expenditure is programmed to remain broadly constant at about 19 percent of GDP in 2009/10, but the full-year effect of the elimination of energy subsidies will create room for increasing development spending by 0.9 percent of GDP (MEFP, ¶14) and for maintaining an adequate level of social safety net spending.

19. A strengthening and better targeting of social assistance constitute an essential element of the program. Specifically, the authorities intend to increase social safety net spending by 0.6 percentage points of GDP in 2008/09, to 0.9 percent of GDP, in order to protect the poor and cushion the impact of the elimination of subsidies on vulnerable groups (MEFP, ¶10). To this end, in close collaboration with the World Bank, the authorities will develop, by end-March 2009, a strategy and a time-bound action plan to strengthen the social safety net and improve targeting to the poor, including under the newly introduced Benazir Income Support Program. They will also implement short-term social support measures by scaling up other existing programs (structural benchmark, MEFP, ¶11). In addition, electricity tariffs already incorporate a “lifeline” minimum tariff that will shield low-income households consuming small amounts of electricity from a steep increase in tariffs. The authorities are seeking additional external assistance from bilateral donors in order to cover the cost of the expanded social safety net.

20. The authorities’ program incorporates a number of fiscal reforms that are critical to the achievement of the fiscal objectives. In the area of public financial management, the transition to a single treasury account will be completed by end-June 2009 (structural benchmark), which will help improve control on cash disbursements and overall cash management. Moreover, a better coordination among various government agencies on the design and implementation of the public investment program will strengthen project selection and execution (MEFP, ¶17). The authorities also intend to prepare a plan by end-March 2009 (structural benchmark, MEFP, ¶12) for addressing the large inter-corporate debt in the energy sector, with a view to proceeding with a gradual settlement of this debt with limited use of budgetary resources (MEFP, ¶12).

21. Medium-term fiscal consolidation will be supported by strong tax policy and administration measures, while allowing for higher spending in infrastructure and the social sectors. Specifically, the authorities’ medium-term fiscal framework assumes a further increase in tax revenue of at least 2½ percentage points of GDP (MEFP, ¶15). This revenue effort, along with declining interest payments, will make it possible to significantly increase development and social spending while reducing the fiscal deficit to 2.0–2.5 percent of GDP by 2012/13 (Table 6).

22. The authorities are committed to moving ahead with substantive tax policy and administration reform during the program period. Initially, the focus will be on tax administration measures, with an action plan expected to be finalized by end-December 2008 (structural benchmark, MEFP, ¶15). Subsequently, the government will reduce exemptions under the GST and harmonize the income and GST laws in the context of the 2009/10 budget discussions (performance criterion). Finally, a new draft VAT law will be submitted for public debate by end-2009. The full revenue impact of this law will materialize over the medium term.

C. Monetary and Exchange Rate Policy

23. The program envisages a tightening of monetary policy. As a first step in this direction, on November 12, 2008, the SBP raised the discount rate by 200 basis points, to 15 percent. The authorities believe that this action, together with further interest rate flexibility going forward, will be sufficient to protect the country’s reserve position and ensure that the domestic financing requirement of the government will be met entirely through market placements of government securities, without further recourse to SBP financing. The authorities are committed to increasing the discount rate further at the time of the Monetary Policy Statement at end-January 2009, or earlier, as needed, if the SBP’s actual net foreign assets fall short of monthly benchmarks established under the program.

24. The SBP will pursue a flexible exchange rate policy, with intervention in the foreign exchange market geared to achieving the program’s monthly NFA targets and smoothing excessive exchange rate volatility. To facilitate this task, the SBP will phase out the provision of foreign exchange for oil imports, which will be shifted to the interbank market starting with the foreign exchange for furnace oil by February 1, 2009 (structural benchmark). The authorities will also eliminate the exchange restriction arising from the existing limit on advance payments for imports by January 31, 2010, and are committed not to impose or intensify existing restrictions or impose or modify multiple currency practices subject to Fund approval during the program period (MEFP, ¶21).

25. Several measures will be taken to improve liquidity management and monetary policy implementation. In particular, the coordination between the SBP and the treasury on forecasting the government cash flow requirements will be strengthened. To this end, quarterly volumes of treasury bill placements consistent with zero SBP financing of the budget during October 1, 2008–June 30, 2009 have been agreed between the two institutions. In addition, the SBP will adopt a more transparent liquidity management framework by end-June 2009. In line with Fund technical assistance and the recommendations made by a recent FSAP update mission (September 2008), this framework envisages the establishment of an interest rate corridor (MEFP, ¶19) and an increase in the frequency of the SBP’s policy meetings to enhance the responsiveness of monetary policy.

26. The authorities also intend to set up an inter-agency committee to review and strengthen the legal provisions relating to the operational independence of the SBP. By the time of the second program review, this committee will determine the steps to be taken in order to align SBP legislation with best international practices (MEFP, ¶24). The authorities intend to request Fund technical assistance for this purpose.

27. In the financial sector, some small and mid-sized banks are vulnerable to shocks. The authorities broadly agreed with the conclusions of stress tests conducted recently by Fund staff in the context of the FSAP update mission. These tests suggest that while large banks appear resilient to potential shocks (e.g., higher interest rates and exchange rate depreciation), some small and mid-sized banks are vulnerable to large interest rate increases and a related deterioration in credit quality. Recognizing these risks, the SBP is preparing a contingency plan for dealing with problem private banks, which will be ready by end-December 2008 (structural benchmark, MEFP, ¶22). Moreover, the SBP’s enforcement powers will be strengthened by submitting the necessary legislative amendments to parliament by end-June 2009 (performance criterion, MEFP, ¶23).

28. The floor on stock prices will be retained until macroeconomic conditions have improved. The authorities explained that if the floor on stock prices were to be maintained, Pakistan would most likely be removed from the MSCI (Morgan Stanley Capital International) emerging markets index, which would limit the ability of institutional investors to invest in Pakistan. They recognized, however, that it would be premature to remove the floor on stock prices before the macroeconomic situation stabilizes and investor confidence improves, as such a decision could lead to significant portfolio outflows and pressures on the reserves position. The authorities also indicated that they were considering to support the market through (i) a fund to be established by four state-owned financial institutions (with borrowing guaranteed by the government) to buy shares in seven large state-owned companies; and (ii) government guarantees of 12-month put options to insure investors against possible stock price declines. The staff argued against the use of public funds to support the market. At the end, the authorities agreed that the timing and terms under which the floor will be removed, including any use of public funds to support the market, will be decided after reaching understandings with Fund staff.

IV. Program Modalities

A. Program financing

29. Pakistan faces very sizeable financing needs during the program period. As noted above, staff estimates that even with the envisaged narrowing of the external current account deficit, the overall gross external financing needs would remain large (Table 8), particularly during the first year of the program, owing to continued pressures on the financial account. Notwithstanding the large commitments from multilateral sources already identified, private financial flows are expected to be insufficient to meet the balance of payments financing requirements. Privatization proceeds and additional support from bilateral donors would help reduce Pakistan’s external financing needs, but a sizable financing gap would remain taking into account the need to build up reserves from the current low levels.

Table 8.

Pakistan: Gross Financing Requirements and Financing Gaps, 2007/08–2009/10

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

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Sources: State Bank of Pakistan; and Fund staff estimates and projections.

30. The authorities have requested a 23-month SBA in the amount of SDR 5.169 billion (500 percent of quota). Fund support will help meet the balance of payments need. Following the first Fund disbursement of $3.1 billion (200 percent of quota), a limited portion of these resources is expected to be used for intervention to ensure orderly conditions in the foreign exchange market. Subsequently, increased donor support, a reduction in financial account pressures, and the remaining Fund disbursements will contribute to a significant increase in international reserves to a more comfortable level. The arrangement is subject to exceptional access policy. Box 1 contains an evaluation of the four criteria for exceptional access.3

Exceptional Access Criteria

Presently, Pakistan is mainly a current account case, but the situation is increasingly becoming aggravated by capital account pressures. Below is an evaluation of Pakistan’s situation in light of the four substantive criteria for exceptional access:

Criterion 1—exceptional balance of payments pressure in the capital account. In addition to the widening of the current account, the loss of investor confidence following the deterioration in Pakistan’s fiscal position, domestic political instability, and the decline in risk appetite in the wake of the global financial turmoil have resulted in a significant decline in capital inflows. (The decrease in capital inflows in 2007/08 compared with 2006/07 amounted to $2.5 billion or 163 percent of quota). Given Pakistan’s dependence on foreign capital inflows to finance its relatively large current account deficit, the reduction in these inflows contributed to a large loss of international reserves. Rebuilding the reserves position requires Fund financing beyond the normal access levels.

Criterion 2—sustainable debt position. Despite relatively large current account deficits in recent years, Pakistan’s external debt amounted to 27 percent of GDP at end-2007/08. This is mainly explained by the preponderance of FDI and low-interest official financing in the structure of capital inflows. Public and publicly-guaranteed debt, however, amounted to 58 percent of GDP at end-2007/08. The financing of the program would be consistent with a decline in debt ratios over the medium term, provided that the authorities fully implement the appropriate stabilization policies.

Criterion 3—access to private capital markets. Until recently, Pakistan had access to international financial markets by issuing Eurobonds, GDRs, and exchangeable bonds, as well as through nonresidents’ portfolio investment in domestic securities. However, FDI, which is the primary source of external inflows, appears to be holding up despite the recent sharp slowdown in other flows. It is expected that Pakistan can regain access to international capital markets and see a significant pickup in FDI in two to three years, provided the adjustment effort is successfully implemented.

Criterion 4—strong policy reform program. The government’s recent steps toward reducing the fiscal deficit in 2008/09 and its efforts to prepare a home-grown stabilization program demonstrate the authorities’ intent to address the current macroeconomic imbalances. The staff believes that Pakistan has sufficient institutional capacity to deliver the required adjustment, as evidenced by the successful implementation of Fund-supported programs during 2000/01–2004/05. However, while there are reasonable prospects for success if the authorities’ proposed policies are implemented, the risks to the program remain very high, as implementation can be affected by the difficult political, security, and economic conditions.

31. It is proposed that exceptional access be provided on SBA terms. The presumption is that exceptional access in capital account crises will be provided with resources of the Supplemental Reserve Facility (SRF), where SRF conditions apply. The SRF is geared toward “large short-term financing needs resulting from a sudden and disruptive loss of confidence reflected in pressure on the capital account and the member’s reserves.” However, as noted above, Pakistan is mainly a current account case and the balance of payments needs are unlikely to be short-lived. The country will have to undergo a prolonged current account adjustment, while facing capital account pressures that are likely to subside only gradually, particularly taking into account the prevailing global financial conditions. Therefore, the staff proposes a 23-month SBA arrangement with exceptional access under “upper credit tranche” terms.

B. Financial Risks to the Program and Capacity to Repay the Fund

32. Downside risks to the program are significant:

  • The political and security situation remains challenging. Program adjustment measures could further intensify existing social tensions associated with the difficult security situation, high inflation, frequent power outages, and increasing poverty. An escalation of these tensions may lead to a reversal of policies and a further sharp deterioration of political and economic conditions. Under these circumstances, a vigorous implementation of the measures aimed at strengthening the social safety net and reducing inflation is essential to address these risks and increase the chances of program success.

  • External sector developments are highly uncertain. A worse-than-expected economic downturn in trading partners, lower remittances from the Gulf Cooperation Council (GCC) countries, and a delayed resumption of foreign portfolio investment in Pakistan would lead to a larger-than-projected financing gap. The authorities’ commitment to adjust policies in response to these shocks (MEFP, ¶27) and the possible mobilization of additional concessional donors’ assistance (see below) should mitigate these risks.

  • The external and fiscal debt sustainability analyses (DSA) highlight a number of additional risk factors. The external DSA indicates that debt ratios will remain well contained in the medium term under the baseline scenario, with the external debt peaking at 33 percent of GDP in 2009/10 and gradually declining to below 29 percent by 2012/13 (Table 12). The fiscal DSA also projects that under the baseline scenario public debt ratios will decline from 58 percent of GDP in 2007/08 to 44 percent in 2013/14 (Table 13). However, an exchange rate overshooting could negatively affect the outlook for external and public debt sustainability (Figures 5–6). Other risk factors (e.g., higher interest rates, slower real GDP growth, a higher current account deficit, or lower FDI) and possible use of public funds to support the banking system would have a moderate impact on debt ratios. The external DSA also estimated the impact of a combined shock including lower growth, a higher current account deficit, lower FDI, and a 30 percent real depreciation, while the fiscal DSA estimated the effects of a combined shock including lower growth, a higher real interest rate, and a lower primary surplus. In both cases, debt ratios remain sustainable.

  • Notwithstanding the preponderance of downside risks, there are also a number of upside factors. These include a stronger-than-expected decline in commodity prices, a faster return of investor confidence, and larger-than-expected donor assistance. The realization of these upside factors could lead to a better balance of payments outcome, a higher reserve buildup, potentially stronger growth, and faster improvement in social indicators. If larger than expected external budget support becomes available, the first $500 million (0.3 percent of GDP per year) will be used to replace noncentral bank domestic government borrowing assumed in the program to cover additional social safety net spending. Any additional external financing beyond the first $500 million per year can be used to increase government spending, in particular development spending and security related outlays, up to a fiscal deficit of 4.7 percent of GDP in 2008/09 and 3.8 percent of GDP in 2009/10. This would result in somewhat higher growth and external current account deficits. Beyond those limits, any additional external financing will be assigned to retire government debt with the SBP and strengthen the SBP’s international reserves position.

Table 9.

Pakistan: Selected Vulnerability Indicators, 2005/06–2012/13

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

Debt at remaining maturity is defined as maturing short-, medium-, and long-term external official debt.

Current account deficit plus amortization of external debt.

Public sector covers general (consolidated) government.

Based on the end of period debt stock in year t-1, and the baseline assumptions for the relevant variables (i.e., growth, interest rates, inflation, exchange rates) in year t.

Overall balance plus debt amortization.

Net debt is defined as gross debt minus government deposits with the banking system.

Financial sector includes all commercial and specialized banks; for government debt also includes non-banks, but excludes State Bank of Pakistan.

For 2005/06 data are on a calendar year basis (e.g., the value for 2005/06 denotes the observation for end-December 2005).

Table 10.

Pakistan: Indicators of Fund Credit, 2008/09–2016/17

(In millions of SDR unless otherwise specified)

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Source: Fund staff projections.

For 2008/09 and 2009/10, debt service includes payments related to the EFF.

Table 11.

Pakistan: Access and Phasing under the Proposed Stand-By Arrangement, 2008–10

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Source: Fund staff.
Table 12.

Pakistan: Public Sector Debt Sustainability Framework, 2004/05–2013/14

(In percent of GDP, unless otherwise indicated)

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

General government gross debt; excludes external military debt, commercial debt, and short-term loans.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π(1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Table 13.

Pakistan: External Debt Sustainability Framework, 2004/05–2012/13

(In percent of GDP, unless otherwise indicated)

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

Projections based on a staff scenario with tighter fiscal and monetary policies.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

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

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Exports and imports of goods and services

Figure 5.
Figure 5.

Pakistan: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

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

Sources: Pakistani authorities; and Fund staff estimates and projections.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2009/10, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).
Figure 6.
Figure 6.

Pakistan: External Debt Sustainability—Bound Tests 1/

(External debt in percent of GDP)

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

Sources: Pakistani authorities; and Fund staff estimates and projections.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks.2/ Combined impact of shocks to growth, current account, FDI, and real depreciation.3/ Growh rate lower than the baseline scenarion by half of the ten-year standard deviation.4/ Current account deficit higher than the baseline scenario by half of the ten-year standard deviation.5/ Net flows of foreign direct investment are 50 percent lower than in the baseline scenario.6/ One-time real depreciation of 30 percent occurs in 2008/09.

33. Given its relatively moderate initial external debt burden, the staff believes that Pakistan will be able to discharge its obligations to the Fund in a timely manner, provided the authorities’ adjustment program is fully implemented. Fund credit outstanding will peak at SDR 5.5 billion in 2010/11 (67 percent of gross reserves), while debt service payments will reach about 22 percent of gross reserves and 8 percent of exports of goods and services in 2012/13 (Tables 9–10). The authorities’ past record of servicing Fund obligations has been very satisfactory and provides additional comfort.

C. Program Phasing and Monitoring

34. The SBA will cover 23 months and will be subject to quarterly reviews. As noted earlier, access will be frontloaded given the large financing needs at the beginning of the program; the remaining tranches will be disbursed according to the schedule presented in Table 11. In line with the procedures on the EFM, the staff intends to inform the Executive Board on implementation and market response to the program within one to two months after its approval.

35. Performance under the program will be monitored based on quarterly quantitative performance criteria (PC) and structural PCs and benchmarks (MEFP, Tables 1–2). Key quantitative PCs include floors on the SBP’s net foreign assets, ceilings on the SBP’s net domestic assets, ceilings on the budget deficit, and limits on SBP’s net credit to the government for end-December 2008, end-March 2009, and end-June 2009.4 Structural PCs and benchmarks focus on areas of macroeconomic relevance that are considered critical for achieving the program’s objectives, including the social safety net, tax reform, public financial management, monetary and exchange rate policy, and the SBP’s supervisory enforcement capacity and contingency planning (Box 2).

36. Safeguards. An updated safeguards assessment will be completed no later than at the time of the first review. In this context, the authorities are providing the required documentation and a Fund safeguards mission is expected to take place in January 2009.

Rationale for the Proposed Structural Conditionality under the SBA

Monetary and exchange rate policy

Subordinating foreign exchange intervention policy to the achievement of the SBP’s NFA targets is a key program commitment ensuring sufficient exchange rate flexibility, which is critical for achieving the program’s reserve targets and promoting current account adjustment. To fulfill this commitment, the SBP’s provision of foreign exchange for oil imports will be phased out according to a schedule (MEFP, ¶20), with the elimination of provisions for furnace oil by February 1, 2009 being the first step (structural benchmark, MFEP, ¶20).

Banking sector issues

The SBP and the government need to be fully prepared to address any potential strains in the banking system. To ensure an appropriate response, the SBP will finalize a contingency plan for handling problem private banks by end-December 2008 (structural benchmark, MEFP, ¶22). In addition, submitting amendments to the banking legislation to Parliament by end-June 2009 is essential to enhance the effectiveness of SBP enforcement powers in the areas of banking supervision (performance criterion, MEFP, ¶23).

Fiscal structural issues

To ensure the targeted reduction in the fiscal deficit and to help eliminate SBP financing of the government—key objectives under the program-- a number of structural performance criteria and benchmarks relating to expenditure and revenue measures, as well as fiscal management, have been introduced. A strong revenue effort is essential to significantly increase the tax-to-GDP ratio, which is low by international standards. To this end, a full description of required reforms in the area of tax administration, including an action plan for harmonizing the GST and income tax administration, will be finalized by end-December 2008 (structural benchmark, MFEP, ¶15); and the government will submit, by end-June 2009, draft legislative amendments to parliament to harmonize the income tax and GST laws and reduce exemptions (performance criterion, MFEP, ¶15). Regarding expenditure, in close collaboration with the World Bank, the government will finalize, by end-December 2008, the schedule for further electricity tariff adjustments during 2008/09 with a view to eliminating tariff differential subsidies by end-June 2009 (structural benchmark, MFEP, ¶9). With respect to fiscal management, the government will prepare a plan for eliminating the inter-corporate circular debt by end-March 2009 (structural benchmark, MFEP, ¶12; and the transition to a single treasury account will be completed by end-June 2009 (structural benchmark, ¶17).

Social protection measures

The design and implementation of a comprehensive system of targeted social assistance is an integral part of the program. In close collaboration with the World Bank, the government will develop a strategy and a time-bound action plan, by end-March 2009, for the adoption of specific measures to strengthen the social safety net and improve targeting to the poor (structural benchmark, MFEP, ¶11).

V. Staff Appraisal

37. Pakistan’s economy has reached a critical juncture. It has been severely affected by adverse security developments, large exogenous shocks, and policy inaction during the political transition to a new government. During this transition, there was a long delay in passing through to consumers the large increases in international oil and food prices, which resulted in a marked deterioration of the external and fiscal positions. Monetization of the fiscal deficit fueled inflationary pressures and contributed to a significant widening of the external current account deficit. At the same time, weakening investor confidence and the global financial turmoil resulted in a slowdown of capital inflows and, subsequently, a reversal of portfolio flows and capital flight. As a result, gross official reserves have declined sharply to a precarious level of less than one month of imports, even after a substantial depreciation of the rupee.

38. The authorities’ program for the remainder of 2008/09 and for 2009/10 seeks to address the current macroeconomic imbalances while preserving social stability and protecting the poor. The envisaged fiscal and monetary tightening will help bring down inflation and reduce the external current account deficit. At the same time, scaled up donor support associated with the program and a restoration of investor confidence are expected to help strengthen Pakistan’s weak international reserves position. A forceful and sustained implementation is key to the success of the program.

39. Fiscal consolidation is essential to put the public finances on a sustainable path and eliminate SBP financing of the government. The authorities have prepared a comprehensive package of revenue and expenditure measures to support a substantial fiscal adjustment effort in 2008/09 and 2009/10. The fiscal program focuses on phasing out energy subsidies and significantly strengthening tax revenue, which is exceptionally low by international standards, while accommodating an expanded and more effective social safety net. The government already implemented a significant adjustment in domestic fuel prices that led to the elimination of fuel subsidies. Completing the elimination of electricity subsidies would help achieve the program budget targets, while reducing distortions and providing a supportive environment for needed investment in the power sector. Implementing the tax policy and administration measures envisaged in the program will require sustained efforts and strong political determination. These reforms are critical to reduce the fiscal deficit while allowing for sufficient resources for social and development spending.

40. Putting in place a comprehensive and effective social safety net is a key priority of the program. In particular, there is an urgent need to improve targeting and delivery mechanisms. While a more comprehensive and well-targeted social safety net is being designed with World Bank assistance, other existing social support programs could usefully be scaled up.

41. Public financial management reforms should also be pursued decisively. Efforts in this area are necessary to ensure transparency and accountability in the use of public funds, and improve budget cash management. A plan for addressing the inter-corporate circular debt in the energy sector should be developed without further delay.

42. Fiscal efforts should continue beyond the program period by focusing primarily on further strengthening revenue mobilization. This will permit reducing the fiscal deficit to 2–2½ percent of GDP, while allowing for significantly higher spending in infrastructure and the social sectors. In particular, strong measures will be necessary to broaden the GST base, significantly reduce income tax exemptions, and further improve tax enforcement.

43. A tighter monetary policy is essential to protect the country’s international reserves position, help bring down inflation, and avoid further central bank financing of the government. The recent increase in the SBP’s discount rate is a step in the right direction, and the authorities should be ready to raise the discount rate further if the monthly program benchmarks for reserves are not achieved or the results of the treasury bill auctions prove insufficient to eliminate SBP financing of the government. In addition, the SBP and the treasury should improve coordination in forecasting the government’s cash flow and domestic debt management in order to ensure the targeted placement of treasury bills with commercial banks and non-banks. A decisive implementation of reforms aimed at strengthening the SBP’s operational independence and improving liquidity management will increase the credibility and agility of monetary policy.

44. Moreover, exchange rate flexibility is needed for achieving the program’s reserves targets. As part of efforts in this area, the schedule for eliminating the SBP’s allocation of foreign exchange for oil imports should be adhered to. Given the authorities’ intention to eliminate the exchange restriction related to advance payments for imports by end-January 2010, the staff proposes the approval of this restriction, which is temporary, nondiscriminatory among Fund members, and was imposed for balance of payments reasons.

45. Financial sector vulnerabilities need to be monitored closely and an appropriate crisis management framework should be put in place without delay. In particular, the SBP should finalize promptly contingency plans for handling problem banks and its enforcement powers should be strengthened by amending the present legislation. If liquidity pressures reoccur, the SBP should focus on providing targeted support to solvent banks and to seek the resolution of insolvent banks, rather than resorting to generalized injections of liquidity. Given the weak external position, it is important that the removal of the current floor on stock prices take place only after the macroeconomic situation has stabilized and investor confidence has improved. In addition, the authorities should avoid using public funds to support stock prices.

46. The exceptional level of access under the proposed arrangement (500 percent of quota) is justified by Pakistan’s balance of payments needs. While there are reasonable prospects for success if the authorities implement the envisaged policies, the risks to the program and financial stability remain high. These risks arise from security uncertainties, possible policy reversals, a more severe-than-anticipated slowdown in trading partners, lower-than-expected private capital inflows, and the possible negative impact of removing the floor on stock prices on portfolio flows. However, in the absence of Fund financing, Pakistan is likely to experience a severe balance of payments crisis, which would impose significant hardship on the population and may have region-wide spillover effects. The proposed level of access is consistent with medium-term external and debt sustainability provided the program is implemented as envisaged and any unforeseen shocks are addressed promptly.

47. There is an urgent need to mobilize additional donor assistance to strengthen Pakistan’s resilience to possible shocks and ease the burden of adjustment on the poor. Additional concessional financing (preferably in the form of grants) will allow for higher social and development spending, enhancing social stability and the domestic political support for the program. It will also contribute to a faster accumulation of international reserves, thereby bolstering investor confidence and Pakistan’s external viability.

48. In view of Pakistan’s balance of payments needs and the comprehensive package of adjustment measures proposed by the authorities, the staff supports the authorities’ request for an SBA in the amount of SDR 5.169 billion.

Table 14.

Pakistan: External Debt, 2004/05–2015/16

(In millions of U.S. dollars, outstanding as end of each fiscal year)

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

Attachment I. Pakistan: Letter of Intent

November 20, 2008

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, D.C. 20431

Dear Mr. Strauss-Kahn:

The Pakistani authorities have held discussions with Fund staff for a 23-month Stand-By Arrangement in support of the government’s program for 2008/09–2009/10. Based on these discussions, the attached Memorandum on Economic and Financial Policies (MEFP) reviews economic developments and policies during 2007/08–2009/10, and discusses the underpinning stabilization and structural policies. In support of the policies in the attached MEFP, the government requests that the Executive Board of the Fund approve a Stand-By Arrangement with exceptional access in an amount of SDR 5.169 billion.

The Government of Pakistan will provide the Fund with such information as the Fund may request in connection with Pakistan’s progress in implementing its economic and financial policies. The government believes that the policies set out in the attached MEFP are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for this purpose. Pakistan will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund’s policies on such consultations.

Sincerely yours,

/s/

Shaukat Tarin

Advisor to the Prime Minister

on Finance and Economic Affairs

/s/

Shamshad Akhtar

Governor

State Bank of Pakistan

Attachment II. Pakistan: Memorandum of Economic and Financial Policies for 2008/09–2009/10

The Government of Pakistan has adopted a comprehensive program of macroeconomic stabilization and sustainable development. This memorandum sets out Pakistan’s economic and financial policies for November 2008–June 2010, to be supported by the International Monetary Fund (IMF) under a 23-month Stand-By Arrangement (SBA).

VI. Recent Economic Developments

1. In the last decade, Pakistan’s economy witnessed a major economic transformation. The country’s real GDP increased from $60 billion in 2000/01 to $170 billion in 2007/08 (fiscal year starts July 1st), with per capita income rising from under $500 to over $1,000. During the same period, the volume of international trade increased from about $20 billion to nearly $60 billion. For most of this period, real GDP grew at more than 7 percent a year with relative price stability. The improved macroeconomic performance enabled Pakistan to re-enter the international capital markets in the mid-2000s. Large capital inflows financed the current account deficit and contributed to an increase in gross official reserves to $14.3 billion (3.8 months of imports) at end-June 2007. Buoyant output growth, low inflation, and the government’s social policies contributed to a reduction in poverty and an improvement in many social indicators.

2. This strong macroeconomic performance resulted from the implementation of a series of important structural reforms. In the early 2000s, with financial support from international financial institutions (IFIs), including the IMF, the World Bank, and the Asian Development Bank, the government expanded the role of markets in the economy, privatized a number of large state-owned enterprises, established market-based regulatory bodies, and took steps to reduce the cost of doing business in Pakistan.

3. The macroeconomic situation, however, deteriorated significantly in 2007/08 and the first four months of 2008/09 owing to adverse security developments, large exogenous price shocks (oil and food), global financial turmoil, and policy inaction during the political transition to the new government. Specifically:

  • Real GDP growth slowed to 5.8 percent in 2007/08 (6.8 percent in 2006/07), reflecting weaker performance of the agricultural and manufacturing sectors.

  • Headline CPI 12-month inflation rose to 25 percent in October 2008, with core inflation (excluding energy and food) increasing to 18 percent.

  • The external current account deficit widened to about $14 billion or 8½ percent of GDP in 2007/08. The growth of exports and workers’ remittances recovered, but total imports rose by more than 30 percent owing to an increase of $4 billion (2½ percent of GDP) in the value of oil imports and strong aggregate demand growth. With the surplus in the financial account of the balance of payments declining to $7.7 billion, from $10.1 billion in 2006/07, this led to a decline in the gross international reserves of the State Bank of Pakistan (SBP) of $5.7 billion, to $8.6 billion at end-June 2008. Reserves dwindled further to $3.4 billion (less than one month of imports) as of end-October 2008.

  • 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, mainly because of 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. The deficit was largely covered through SBP financing.

  • To contain inflationary pressures, between July 2007 and July 2008 the SBP increased its discount rate in several steps by 350 basis points, to 13 percent. Despite these increases, SBP financing of the government continued in July–October 2008.

  • The banking system was well capitalized and liquid as of end-June 2008, but liquidity problems have emerged recently. Domestic pressures and the global financial crisis led to rising dollarization and an outflow of deposits from the system during July-October, which contributed to a deterioration of liquidity conditions. In response to an escalation of liquidity pressures in October, the SBP recently reduced the reserve requirement by 4 percentage points and eased liquidity requirements. In addition, the SBP has encouraged the merger of four small banks. These measures have stabilized liquidity conditions in recent weeks.

  • Financial market indicators have deteriorated. After climbing to new record highs by end-April 2008, the Karachi KSE-100 index dropped by one third, prompting the Karachi Stock Exchange Board to impose a floor on the decline of all stock prices on August 27, 2008. The EMBIG spread has increased to over 2,000 basis points. The rupee has depreciated by 30 percent since end-March 2008, reflecting growing foreign exchange market pressures. In May 2008, the SBP adopted, on a temporary basis, several exchange measures aimed at reducing these pressures. In addition, the government has recently imposed regulatory duties on imports of luxury items.

VII. Stabilization policies

A. Macroeconomic outlook and policies

4. The government’s financial policies for the remainder of 2008/09 and for 2009/10 are aimed at stabilizing the macroeconomic situation and restoring investor confidence. The government’s program envisages a significant fiscal consolidation, and the SBP will tighten monetary policy to lower inflation and strengthen the international reserves position. As a result of these policies, the 12-month inflation rate is projected to decline to 20 percent at end-June 2009, even after taking into account the impact of significant increases in administered energy prices. Real GDP growth would slow further to 3–3½ percent in 2008/09 in response to the tightening of macroeconomic policies and a deceleration of growth in Pakistan’s trading partners.

5. The tighter financial policies, higher disbursements from IFIs, lower commodity prices, and restored confidence are expected to contribute to a significant strengthening of the external position in 2008/09. Specifically, the external current account deficit is projected to narrow to $10.6 billion (6.5 percent of GDP) owing mainly to slower aggregate demand growth and lower oil import prices. At the same time, the surplus in the financial account would decline to $6.2 billion, as an increase in disbursements from IFIs (to about $4 billion) would be more than offset by weaker FDI and portfolio flows relative to 2007/08, reflecting in part the impact of the global financial turmoil. Given the target to increase gross official reserves to $8.6 billion by end-June 2009 (the level prevailing at end-June 2008), the residual financing gap of $4.7 billion will be covered by drawing on IMF resources. To further bolster confidence, the government is seeking additional financial support from donors.

6. The government’s medium-term strategy seeks to achieve high sustained growth and significantly reduce poverty, while ensuring external and fiscal sustainability. Following the initial stabilization effort in 2008/09, real GDP growth would increase to 5 percent in 2009/10, and is projected to rise gradually to 6½–7 percent a year by 2012/13, based on a significant increase in investment and further progress in structural reforms. Average inflation is targeted to decline to 13 percent in 2009/10, and to 5 percent by 2012/13. Prudent demand management policies would contribute to a gradual decline in the external current account deficit to 5.7 percent of GDP in 2009/10, and further to 3.6 percent of GDP by 2012/13. This, along with the expected pickup in capital inflows, would help increase gross international reserves to $14.5 billion (2.6 months of projected imports) by 2012/13, while reducing the external debt to 29 percent of GDP. The external financing gap for 2009/10, which is projected at $3.6 billion, will be covered by disbursements from the IMF and GDR proceeds. External financing gaps will be fully eliminated by the end of the SBA.

B. Fiscal policy

7. The fiscal deficit (excluding grants) is targeted to decline to 4.2 percent of GDP (PRs 562 billion) in 2008/09, from 7.4 percent in 2007/08. This fiscal effort is necessary to help reduce the external current account deficit, move toward a sustainable fiscal position, and eliminate SBP financing of the government. To achieve the 2008/09 deficit target, the government will increase tax revenue by 0.6 percentage points of GDP and reduce non-interest current expenditure by about 1½ percentage points of GDP, mainly through the elimination of oil subsidies by December 2008 and electricity subsidies by June 2009. At the same time, domestically-financed development spending will be reduced by about 1 percentage point of GDP through better project prioritization.

8. The government has already implemented a number of measures consistent with the envisaged fiscal adjustment in 2008/09. Specifically, petroleum prices have been adjusted three times since June 2008, which has led to the complete elimination of petroleum subsidies. At the same time, electricity tariffs were adjusted by an average of 18 percent effective September 5, 2008. In addition, steps have been taken to slow the pace of development spending, the research and development subsidy for the textile industry has been fully eliminated, wheat procurement prices have been raised to international levels, and the general sales tax (GST) rate has been raised by one percentage point to 16 percent.

9. The government plans to take additional fiscal measures in 2008/09. As noted above, electricity tariff differential subsidies will be fully eliminated by end-June 2009. To achieve this objective, the average base tariff will be further increased during 2008/09 according to a schedule to be agreed with the World Bank by end-December 2008 (structural benchmark), and the government will use fuel and other surcharges, as necessary. The implementation of the electricity tariff increases will be followed up in the context of the program reviews. On the revenue side, further steps will be taken during the remainder of the fiscal year to strengthen tax enforcement. Moreover, fuel prices will continue to be adjusted to pass through changes in international prices.

10. An expanded and effective social safety net constitutes an integral part of the authorities’ program. In this regard, several measures are envisaged to protect vulnerable groups that might be adversely affected by inflation and the economic slowdown. The fiscal program for 2008/09 envisages an increase in social safety net spending of 0.6 percentage points of GDP, to 0.9 percent of GDP. To this end, the government has launched the Benazir Income Support Program (BISP), for which the budget already allocated PRs 34 billion (0.3 percent of GDP). The design of the BISP, in particular the targeting of transfers and the delivery mechanism, will be reviewed in the first half of 2009, in consultation with the World Bank. The government also plans to expand social safety net spending by an additional 0.3 percent of GDP, for which further external assistance (mainly in the form of grants) is being sought from donors. While a more comprehensive and better-targeted social safety net is being designed, these additional funds will be allocated to scale up other existing programs, in particular cash transfers under the Bait-ul-Mal program. Also, part of the additional resources could be used to cover larger than envisaged electricity subsidies for poor households.

11. Putting in place a more comprehensive and well-targeted social safety net is a key priority under the program. To that end, in close cooperation with the World Bank, the government will prepare, by end-March 2009, a strategy and a time-bound action plan for the adoption of specific measures. The first program review will assess progress in this area. The resources allocated to the short-term protection measures described above will be used for funding the newly designed social safety net in 2009/10.

12. The government will prepare, by end-March 2009, a plan for eliminating the inter-corporate circular debt within the fiscal deficit target. The plan will clearly identify all elements of circular debt, including (i) the identification of all debts owed and due among the corporations, duly reconciled; (ii) the determination of the validity of the claims; (iii) a schedule by which respective entities will discharge their liabilities to each other; and (iv) a timeframe during which the Federal Adjuster will use his powers to make adjustments, in case of failure, to adhere to the approved schedule.

13. The targeted reduction in the fiscal deficit in 2008/09 will help eliminate SBP financing of the budget. The government is committed to limiting SBP financing of the budget to zero on a cumulative basis during October 1, 2008–June 30, 2009. During this period, the fiscal deficit will be fully financed by available external disbursements (which have already been committed), the acceleration of the privatization process, the issuance of treasury bills, and other domestic financing instruments, including Pakistan Investment Bonds, Ijara Sukuk, and National Savings Scheme (NSS) instruments.

14. A further reduction in the fiscal deficit to 3.3 percent of GDP is envisaged for 2009/10. The fiscal effort will be facilitated by the full-year effect of the elimination of energy subsidies by end-2008/09 and declining interest payments, following large bullet payments in the three-year period ending in 2009/10.

15. Consistent with the government’s objective of substantially increasing tax revenue, a number of tax policy and administration measures are envisaged during the program period. Specifically, an integrated tax administration organization on a functional basis will be established at the Federal Board of Revenue (FBR) (integrating both the income tax and sales tax administration). In addition, audits will be reintroduced as part of a risk-based audit strategy that will be implemented by end-December 2008. A full description of the required reforms, together with an action plan will be provided to the IMF by end-December 2008, following a planned seminar to review tax policy and administration. As part of this process, the government plans to harmonize the income tax and GST laws, including for tax administration purposes, and reduce exemptions for both taxes. To that end, it will submit legislative amendments to parliament by end-June 2009. In addition, the excises on tobacco will be increased in the context of the 2009/10 budget. Following the seminar in December 2008, the government will initiate a process to implement a full VAT with minimal exemptions, to be administered by the FBR. Draft legislation for the VAT is expected to be ready for public debate by end-2009. The first program review will focus on the progress in developing the government’s tax reform agenda.

16. The government’s fiscal consolidation efforts will continue over the medium term. The government’s fiscal framework assumes a further reduction in the fiscal deficit to 2–2½ percent of GDP by 2012/13. Fiscal consolidation will be supported by a strong tax effort, which will allow for higher spending in infrastructure and the social sectors. Specifically, the government is committed to increasing tax revenue by at least 3½ percentage points of GDP over the medium term as a result of measures to broaden the GST base, significantly reduce income tax exemptions, and further improve tax enforcement.

17. The government will continue to press ahead with public financial management reforms, in line with fiscal ROSC recommendations. Immediate priority will be given to completing the on-going gradual implementation of a single treasury account. This will involve the consolidation of government funds in its account with the SBP, from which withdrawals will be made only when actual payments are due. Existing funds held outside the SBP account will be transferred by end-June 2009. Furthermore, the coordination between the Planning Commission, which manages the developmental budget, and the Ministry of Finance will be strengthened in the context of the implementation of the medium-term budget framework.

C. Monetary policy, exchange rate policy, and financial sector issues

18. The program envisages a significant tightening of monetary policy. To that end, the SBP recently increased its discount rate by 200 basis points, to 15 percent. Following this first step, interest rate policy will be sufficiently flexible to protect the reserves position, bring down inflation, and allow the government to place T-bills and other securities with commercial banks and non-banks in order to avoid further central bank financing of the budget. A further increase in the discount rate will be considered at the time of the monetary policy statement scheduled for end-January 2009. However, the discount rate will be raised earlier if the actual reserves for end-November and end-December 2008 fall short of the program monthly floors on the SBP’s net foreign assets. In addition, if the volume of T-bills placed in the auction scheduled for November 19 falls short of the announced target, understandings will be reached with Fund staff on corrective measures in order to meet the program targets.

19. The conduct of monetary policy will be facilitated by significant improvements in liquidity management, including by improving the forecasting of the government’s cash flow position. As part of these efforts, the SBP and the Ministry of Finance have agreed on quarterly volumes of treasury bill placements consistent with zero SBP financing of the budget during October 1, 2008–June 30, 2009. The SBP has issued an auction calendar for November-December 2008 on November 1st, 2008, and in the future will issue a calendar every quarter one month in advance. In addition, the SBP will review the current procedures for liquidity management, and will adopt and publicize a transparent liquidity management framework by end-July 2009 as part of its Monetary Policy Statement. This framework will contain the following key elements:

  • The announcement of an explicit corridor for money market interest rates: the SBP’s reverse repo rate will be the ceiling, and a standing repo facility to absorb excess liquidity from commercial banks will serve as the floor of the proposed explicit corridor;

  • The treasury will provide the SBP with T-bills, as needed, to conduct its open market operations.

20. The SBP is committed to pursuing a flexible exchange rate policy. To that end, intervention in the foreign exchange market (including the provision of foreign exchange for oil imports) will be aimed at meeting the program’s reserve targets. This primary objective will be facilitated by phasing out the SBP’s provision of foreign exchange for oil imports according to the following schedule:

  • Furnace oil—by February 1, 2009.

  • Diesel and other refined products—by August 1, 2009.

  • Crude oil—by February 1, 2010.

21. During the program period, the SBP intends to eliminate any exchange restriction subject to approval under Article VIII of the IMF’s Articles of Agreement. Specifically, the exchange restriction on advance import payments against letters of credit will be eliminated by end-January 2010, subject to a marked improvement in the balance of payments position. No intensification of existing restrictions and no new exchange restrictions or multiple currency practices will be introduced during the program period.

22. The SBP will prepare a contingency plan to deal with problem private banks by end-December 2008. The plan will contain criteria for SBP liquidity support, assessment of bank problems, and intervention procedures. The SBP has already dealt with problem banks through mergers. Looking ahead, if there are severe strains in the interbank market and interbank lending guarantees appear necessary, these guarantees will be provided in limited amounts only to solvent banks.

23. To enhance the effectiveness of SBP enforcement powers, necessary amendments to the Banking Companies Ordinance will be submitted to Parliament by end-June 2009. These amendments will strengthen the SBP’s ability to (i) change management in banks; (ii) impose losses on shareholders by writing down their capital; (iii) intervene and take ownership of banks; (iv) appoint administrators to operate banks; and (v) restructure banks.

24. The legal provisions relating to the operational independence of the SBP will be reviewed. These provisions will be strengthened based on the recommendations of an interagency committee that will be established by mid-November 2008, and taking into account technical recommendations from the IMF. The second program review will focus on specific details regarding required legislative changes in this area.

25. The government believes that market confidence will improve significantly once the Fund-supported program is approved and the international reserves position is strengthened. Therefore, it does not intend to remove the current floor on stock prices until after the program is in place. In any event, the timing and terms under which the floor on stock prices will be removed, including any use of public funds to support the stock market, will be decided after reaching understandings with Fund staff.

VIII. Risks and contingencies

26. Larger-than-expected external budget support may become available in 2008/09 and 2009/10. In such a case, any additional external budget support to cover increased social safety net spending up to $500 million per year (0.3 percent of GDP) will be used to replace non-central bank domestic borrowing assumed under the program. Provided that downside risks do not materialize, the government will use any additional external budget financing beyond the first $500 million per year to further increase spending, up to a fiscal deficit of 4.7 percent of GDP in 2008/09 and 3.8 percent of GDP in 2009/10. Any external financing support exceeding these limits will be used to retire government debt with the SBP and strengthen the SBP’s international reserves position.

27. Key economic and financial downside risks to the program include lower-than-expected private capital inflows, a reversal of the current trend of declining oil prices, and a more severe-than-anticipated economic slowdown in trading partner countries. If these risks materialize, the government stands ready to adjust its policies, in close consultation with IMF staff, to ensure the achievement of a sustainable external position by the end of the program period.

IX. Program monitoring

28. The program will be subject to quarterly reviews and quarterly performance criteria as set out in the technical memorandum of understanding (TMU). Completion of the first two reviews scheduled for end-March 2009 and end-June 2009 will require observance of the quantitative performance criteria for end-December 2008 and end-March 2009, respectively, as specified in Table 1.

29. An updated safeguards assessment of the SBP will be conducted in the context of the first review.

30. The government authorizes the IMF to publish the Letter of Intent, its attachments, and the related staff report.

Table 1.

Pakistan: Quantitative Targets, december 2008-June 2010

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Notes:

denotes performance citeria.

Excludes IMF.

Table 2.

Pakistan—Prior actions, Structural Performance Criteria and Benchmarks

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Table 3.

Pakistan: SBP Monthly NFA Targets (In millions of U.S. dollars)

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

End-December target is a performance criterion subject to adjustors as specified in the TMU.

Attachment III. Pakistan: Technical Memorandum of Understanding (TMU) on the Program Supported Under the Stand-By Arrangement

November 20, 2008

1. With effect from November 1, 2008, this Technical Memorandum of Understanding (TMU) describes the monitoring arrangements under the SBA-supported program. Throughout, unless otherwise stated, “government” is meant to comprise the federal and provincial governments.

I. Definitions of Monitoring Variables

Valuation of foreign exchange denominated assets, liabilities, and foreign exchange flows

2. For the purposes of monitoring under the program, all assets and liabilities as well as debt contracted, denominated in SDRs or in currencies other than the U.S. dollar, will be converted into U.S. dollars at the exchange rates prevailing at test dates, as posted by the State Bank of Pakistan (SBP) on its web site. Net external budget financing and external cash grants will be converted into Pakistani rupees at the exchange rates prevailing at the day of the transaction, as posted by the SBP on its web site, unless otherwise indicated.

3. Reserve money (RM) is defined as the sum of: currency outside scheduled banks (deposit money banks); scheduled banks’ domestic cash in vaults; scheduled banks’ required and excess rupee and foreign exchange deposits with the State Bank of Pakistan (SBP); and deposits of the rest of the economy with the SBP, excluding those held by the federal and provincial governments and the SBP staff retirement accounts.

4. Net foreign assets (NFA) of the SBP are defined as the difference between its foreign assets and foreign liabilities. Foreign assets of the SBP consist of gold, foreign exchange, balances held outside Pakistan, foreign securities, foreign bills purchased and discounted, the reserve position with the IMF, and SDR holdings. The definition of foreign assets of the SBP will be consistent with the IMF Data Template on International Reserves and Foreign Currency Liquidity. Gold will be valued at $20.27 per troy ounce per fine troy ounce. Foreign liabilities of the SBP include outstanding IMF credits, deposits with the SBP of foreign governments, foreign central banks, foreign deposit money banks, international organizations, and foreign nonbank financial institutions (NBFI).

5. Net domestic assets (NDA) of the SBP are defined as the difference between the RM and the NFA of the SBP.

6. Net borrowing from the banking system by the government is defined as the difference between the banking system’s claims, on a cash basis, on the federal, provincial, and local governments and the deposits of the federal, provincial, and local governments with the banking system, including district government funds balances. For the purposes of this memorandum, claims on government exclude: credit for commodity operations; government deposits exclude outstanding balances in the Zakat Fund and balances in the various privatization accounts kept by the government in the banking system. The stock of bonds which were issued to banks in substitution of outstanding nonperforming loans to certain public entities, and which are being fully serviced by the government, are included in banking system claims on government. Table 1 summarizes the calculations of net borrowing from the banking system by the government.

Table 1.

Pakistan: Budgetary Support, June-November 2008

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Source: State Bank of Pakistan.

7. Net borrowing from the SBP by the government is defined as SBP claims on the government minus government deposits with the SBP. SBP claims on the government include government securities, treasury bills, ways and means advances, treasury currency, and debtor balances. SBP claims on the government exclude accrued profits on government securities. Government deposits with the SBP exclude the Zakat Fund and Privatization accounts (Table 1).

8. The definition of the overall budget deficit (excluding grants) under the program will be the consolidated budget deficit, excluding grants, and including the operations of district governments financed from local funds. It will be measured by the sum of (a) total net financing to the federal, provincial, and local governments; and (b) total external grants to the federal and provincial governments. The former is defined as the sum of (i) net external budget financing (see ¶10); (ii) net borrowing from the banking system (as defined above); and (iii) net domestic nonbank financing (see ¶11). The total external grants are defined as the sum of project grants, cash external grants for budgetary support, capital grants reflecting the principal amounts of external debt cancellation or swaps, and other grants.

9. Net external program financing is defined to include external privatization receipts; budget support grants; budget support loans from multilateral (other than the IMF, but including World Bank and Asian Development Bank (AsDB) budget support and structural adjustment loans), official bilateral budget support loans, and private sector sources (e.g., bonds); rescheduled government debt service and change in stock of external debt service arrears net of government debt amortization due on foreign loans, the latter including any accelerated amortization including related to debt swaps or debt cancellation recorded as capital grants. It also includes foreign loans onlent to financial institutions and companies (public or private) and emergency relief lending. Program financing excludes all external financing counted as reserve liabilities of the SBP (defined above). Amounts projected for net external program financing and external grants are provided in Table 2.

Table 2.

Pakistan: External Program Financing For Budget for 2008/09

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Sources: Pakistani authorities; and Fund staff projections.

10. Net external budget financing is defined as net external program financing minus privatization receipts, minus budget support grants, plus all other external loans for the financing of public projects or other federal or provincial budget expenditures, plus transfers of external privatization receipts from the privatization account to the budget.

11. Net domestic nonbank financing of the budget is defined as follows: domestic privatization receipts transferred from the privatization accounts to the budget, plus the change, during each reporting period, in the stock of (a) permanent debt, which consists of nonbank holdings of prize bonds, all federal bonds, and securities; plus (b) floating debt held by nonbanks; plus (c) unfunded debt, which consists of National Savings Scheme (NSS) debt, Postal Life Insurance, and the General Provident Fund (GPF); plus (d) net deposits and reserves received by the government (public accounts deposits); plus (e) any other government borrowing from domestic nonbank sources net of repayments; minus (f) government deposits with NBFIs. Nonbank holdings of permanent and floating debt is defined as total debt outstanding, as reported by the SBP, minus holdings of banks as per the monetary survey. Total treasury bill and other relevant government debt is valued at discount value and excluding accrued interest.

External debt

12. The performance criterion on contracting or guaranteeing of medium-term and long-term nonconcessional external debt by the government or the SBP applies not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (adopted by the IMF Executive Board on August 24, 2000), but also to commitments contracted or guaranteed for which value has not been received.1 Excluded from this performance criterion are (a) foreign currency deposit liabilities of the SBP; and (b) the outstanding stock of debt of Foreign Exchange Bearer Certificates (FEBCs), Deposit Bearer Certificates (DBCs), and Foreign Currency Bearer Certificates (FCBCs). The performance criterion setting a limit on the outstanding stock of short-term external debt refers to debt (as defined in Footnote 1) with original maturity of up to and including one year. Medium- and long-term external debt comprises debt with initial maturity of over one year.

13. Nonconcessional borrowing is defined as borrowing with a grant element of less than 35 percent, following the methodology set out in the “Guidelines on Performance Criteria with Respect to Foreign Borrowing—Change in Implementation of Revised Guidelines” (http://www.imf.org). The discount rates used to calculate the grant element will be the six-month and ten-year Commercial Interest Reference Rates (CIRRs) averages, as computed by the Strategy and Policy Review Department of the IMF. Six-month CIRRs are updated mid-February and mid-August (covering the six-month period preceding the date of update) and the ten-year CIRRs averages are updated mid-December (covering a period of 10 years preceding the date of the update). Six-month CIRRs averages are to be used for loans whose maturity is less than 15 years, while ten-year CIRRs averages are to be used for loans whose maturity is equal or more than 15 years.

II. Adjustors

Adjustors related to net external program financing

14. Adjusters to program targets will be implemented if the actual cumulative net external program financing in U.S. dollar terms is different from its projected value.

15. If the actual cumulative net external program financing in U.S. dollar terms is higher than its projected value by more than $500 million, the excess net external program financing in U.S. dollar terms is defined as follows: actual external program financing in U.S. dollar terms minus projected net external program financing in U.S. dollar terms minus $500 million. The excess net external program financing in U.S. dollar terms multiplied by a fixed accounting exchange rate of RPs 80 per $1 represents the excess net external program financing in rupee terms.

16. The ceiling on the consolidated overall budget deficit (excluding grants) will be adjusted upward for the cumulative excess in net external program financing in rupee terms for up to PRs 27.0 billion at end-December 2008, PRs 67.0 billion at end-March 2009, and PRs 67.0 billion at end-June 2009.

17. The cumulative excess net external program financing in U.S. dollar terms may exceed the cumulative maximum limits specified in paragraph 16 for end-December 2008, end-March 2009, and end-June 2009, when converted into U.S. dollar terms at a fixed accounting exchange rate of PRs 80 per $1. In such a case, the cumulative excesses in net external program financing in U.S. dollar terms minus the maximum cumulative amounts specified for end-December 2008, end-March 2009, and end-June 2009 converted into U.S. dollar terms at a fixed accounting exchange rate of PRs 80 per $1 are defined as “surplus net external program financing in U.S. dollar terms.” The latter amount multiplied by a fixed accounting exchange rate of PRs 80 per $1 constitutes “surplus net external program financing in rupee terms.”

18. The floors on the NFA of the SBP will be adjusted upward by the cumulative surplus net external program financing in U.S. dollar terms as defined above.

19. The ceilings on the NDA of the SBP and net borrowing from the SBP by the government will be adjusted downward by the cumulative surplus net external program financing in rupee terms as defined above.

20. If the actual cumulative net external program financing in U.S. dollar terms is lower than its projected value, the shortfall in net external program financing in U.S. dollar terms is defined as the difference between its projected and actual values in U.S. dollar terms. In such a case:

  • a. The floor on the NFA of the SBP is adjusted downward by the amount equivalent to 50 percent of the cumulative shortfall in net external program financing in U.S. dollar terms.

  • b. The ceiling on the NDA of the SBP is adjusted upward by the amount equivalent to 50 percent of the cumulative shortfall in net external program financing in U.S. dollar terms converted into rupees at a fixed accounting exchange rate of PRs 80 per $1.

  • c. The ceiling on net borrowing from the SBP by the government is not subject to adjustment.

Adjustor related to project grants

21. If the amount of project grants is higher than assumed under the program, the ceiling on the consolidated overall budget deficit (excluding grants) will be adjusted upward for the cumulative excess in project grants. This adjustor is applied in addition to any adjustment to the consolidated overall budget deficit (excluding grants) that is made under paragraph 16.

Adjustor related to changes in regulations on required reserves

22. The ceilings on the NDA of the SBP will also be adjusted downward/upward by the amount of (a) banks’ Pakistani rupee reserves freed/seized by any reduction/increase of the daily CRR relative to the baseline assumption; and (b) any reduction/increase in the reservable deposit base that is related to definitional changes, as per the following formula: ΔNDA = ΔrB0 + r0ΔB + ΔrAB, where r0 denotes the reserve requirement ratio prior to any change; B0 denotes the level of the reservable deposits in the initial definition; Δr is the change in the reserve requirement ratio; and ΔB denotes the change in the reservable deposits as a result of definitional changes. In case of significant liquidity and other financial sector pressures, the SBP will engage in consultations with the IMF staff in order to reach understanding on appropriate monetary policy response.

Adjustor related to the SBP’s net position under foreign exchange forwards and swaps

23. An adjustor to the NFA target of the SBP will be implemented to reflect changes in the SBP’s net position under foreign exchange forwards and swaps. Specifically, the NFA target of the SBP will be adjusted upward/downward by the amount of the increase/decrease in the net SBP’s position under foreign exchange forwards and swaps. The maximum SBP’s net exposure under foreign exchange forwards and swaps is capped at $2.75 billion as of end-December 2008, end-March 2009, and end-June 2009. The SBP’s net exposure under foreign exchange forwards and swaps was $1.9 billion at end-September 2008.

Adjustor related to foreign currency deposits of resident banks with the SBP

24. An adjustor to the NFA target of the SBP will be implemented to reflect changes in foreign currency deposits of resident banks. Specifically, the NFA target of the SBP will be adjusted upward/downward by the amount of increase/decrease in foreign currency deposits of resident banks with the SBP. The stock of foreign currency deposits with resident banks was $832 million at end-September 2008.

III. Program Reporting Requirements

25. The following information, including any revisions to historical data, will be provided to the Middle East and Central Asia Department of the IMF through the office of the Resident Representative of the IMF in Pakistan, within the timeframe indicated:

  • Monthly provisional statements on federal tax and nontax revenue, within one month.

  • Deposits into and withdrawals from the privatization accounts for each quarter, within one month. Withdrawals will be reported with the following breakdown (a) those which constitute budgetary use of privatization proceeds; (b) those which constitute costs of privatization; and (c) other (with explanation of the purpose of other withdrawals), as well as with the breakdown between domestic and external privatization receipts.

  • Quarterly statements on budgetary capital receipts and disbursements, including repayments of bonds, recovery of loans from provinces and “others,” within two months.

  • Monthly (unreconciled) provisional data on federal expenditure and net lending (with separate data on disbursements and repayments), within one month.

  • Quarterly statement on consolidated budgetary expenditure, with federal data approved by the Accountant General Pakistan Revenue (AGPR), within two months.

  • Quarterly numbers on expenditure on social programs.

  • Quarterly data on the stock of domestic government debt, broken down by instrument, within one month (Table 3).

  • Quarterly data on WAPDA receivables within one month.

  • Monthly data on Outstanding Audited Price Differential Claims.

  • Monthly data on external budget financing, including (i) loan-by-loan program disbursements in U.S. dollar terms and rupee terms converted at exchange rates prevailing at the time of each transaction; (ii) cumulative amortization in U.S. dollar terms and rupee terms converted at exchange rates prevailing at the time of each transaction; and (iii) cumulative project loan disbursements in U.S. dollar terms and in rupees converted at exchange rates prevailing at the time of each transaction.

  • Monthly data on Banks’ Budgetary Support (Table 1) within one month.

  • The following monthly monetary data on a last-Saturday basis within two weeks:

    • (i) monetary survey;

    • (ii) accounts of the SBP;

    • (iii) consolidated accounts of the scheduled banks;

    • (iv) banks’ lending to the government;

    • (v) detailed table on net foreign assets (both for the SBP and scheduled banks);

    • (vi) detailed table of scheduled banks’ reserves with the SBP.

  • The same tables as in the preceding item, but on an end-month and end-quarter basis (last business day), both at current and program exchange rates, within one month.

  • The SBP Table on outstanding stock of foreign currency deposits, amended to include the classification of new FCA according to the residency of the holder.

  • Daily data on exchange rates (interbank, retail market, and Telegraphic Transfers for SBP purchases in the retail market), SBP’s sales and purchases in the foreign exchange markets, swaps and forward outright sales, within two business days.

  • Monthly data on the outstanding stock of the SBP’s forward foreign currency operations, including swaps and outright forward sales and purchases, within two weeks. The terms of any new transactions (including rollover/renewal of existing ones) will also be provided.

  • Monthly data on the SBP’s foreign exchange reserves, with details on the currencies, instruments, and institutions in which the reserves are held, within one month.

  • Monthly data on SBP direct or bridge loans to nationalized banks in the context of the restructuring and privatization operation, within four weeks.

  • Monthly data on any other quasi-fiscal operations undertaken by the SBP, on behalf of the government.

  • Monthly data on SBP holding of discounted export finance credit under the export finance scheme, within one month.

  • Monthly data on outstanding credit to agriculture under the Agriculture Mandatory Credit Targets, within one month.

  • The following data on external debt, within one month:

    • (i) Quarterly stock of public- and publicly-guaranteed external debt (including deferred payments arrangements), by maturity (initial maturities of up to and including one year, and over one year), by creditor and by debtor (central government and publicly guaranteed);

    • (ii) Quarterly contracting or guaranteeing of nonconcessional medium- and long-term government debt; and

    • (iii) Information on any rescheduling on public- and publicly-guaranteed debt reached with creditors.

  • Quarterly data on external payments arrears on public and publicly guaranteed debt with details as in (i) of the preceding item within one month.

  • Copies of new or revised ordinances/circulars regarding changes in: tax policy, tax administration, foreign exchange market regulations, and banking regulations no later than three days after official issuance, or notification that ordinances have been posted on the Federal Board or Revenue (FBR) and SBP websites.

  • Copies of official notification of changes in gas and electricity tariffs and any surcharges (automatic or structural) and in ex-refinery petroleum product prices as well as of gas and petroleum surcharges/levies.

  • Monthly data on the import parity prices as well as central depot prices of the six major oil products, within one month.

  • Quarterly data on KESC and WAPDA loans and debt outstanding, within one month.

  • Upon the adoption of the plan for the elimination of inter-corporate circular debt, monthly reports on inter-corporate circular debt will be reported within 1 month.

Table 3.

Pakistan: Domestic Debt Outstanding, Jun. 2007-Sept. 2008

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Source: State Bank of Pakistan.

Inclusive of outright sale of MTBs to commercial banks.

1

For a more detailed assessment of Pakistan’s performance during this period see Pakistan—Ex Post Assessment of Longer-Term Program Engagement (Country Report No. 05/408).

2

While the projected current account deficits for 2008/09 and 2009/10 are high, the adjustment scenario envisaged in the program is expected to reduce the deficit to slightly below the current account norm under the macroeconomic balance approach over the medium term (implying broad alignment of the exchange rate with fundamentals). However, the medium-term deficit would still be above the NFA-stabilizing current account deficit, implying a 12 percent overvaluation under the external sustainability approach.

3

Management informed the Executive Board about a potential need for exceptional access and its intention to invoke the exceptional financing mechanism on October 20, 2008, and the staff updated the Board on progress on exceptional access on October 29, 2008 and November 14, 2008. exceptional access on October 29, 2008 and November 14, 2008.

4

The establishment of performance criteria for a 12-month period is not proposed because of substantial uncertainties on economic trends.

1

The definition of debt set forth in No. 9 of the guidelines reads as follows: “(a) For the purpose of this guideline, the term “debt” will be understood to mean a current, that is, not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, that is, advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyer’s credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) supplier’s credits, that is, contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, that is, arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property. (b) Under the definition of debt set out in point 9 (a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (for example, payment on delivery) will not give rise to debt.”

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Cover IMF Staff Country Reports
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
Volume/Issue:
Volume 2008: Issue 364
Publisher:
International Monetary Fund
ISBN:
9781451830736
ISSN:
1934-7685
Pages:
95
DOI:
https://doi.org/10.5089/9781451830736.002
  • Figure 1.
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    Figure 1.

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

  • Figure 2.
    View in gallery
    Figure 2.

    Pakistan: External Sector Indicators, 2003–08

  • Figure 3.
    View in gallery
    Figure 3.

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

  • Figure 4.
    View in gallery
    Figure 4.

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

  • Figure 5.
    View in gallery
    Figure 5.

    Pakistan: Public Debt Sustainability: Bound Tests 1/

    (Public debt in percent of GDP)

  • Figure 6.
    View in gallery
    Figure 6.

    Pakistan: External Debt Sustainability—Bound Tests 1/

    (External debt in percent of GDP)

Figure 1.

Pakistan: Output and Inflation Indicators, 2003/04–2007/08
Figure 2.

Pakistan: External Sector Indicators, 2003–08
Figure 3.

Pakistan: Budget Indicators, 2003/04–2007/08
Figure 4.

Pakistan: Monetary and Credit Indicators, 2003/04–2007/08
Figure 5.

Pakistan: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)
Figure 6.

Pakistan: External Debt Sustainability—Bound Tests 1/

(External debt in percent of GDP)