Abstract
Press Release No.13/337
Title Page
Press Release No.13/337
FOR IMMEDIATE RELEASE
September 12, 2013
International Monetary Fund
Washington, D.C. 20431 USA
IMF Executive Board Concludes the 2013 Article IV Consultation with Pakistan
On September 4, 2013, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Discussions with Pakistan1 and approved a three-year arrangement under the Extended Fund Facility (EFF) for Pakistan in support of the authorities’ structural reform and growth program (see Press Release No. 13/322).
Economic performance in Pakistan has been substandard in recent years. GDP growth has averaged only 3 percent over the past five years, which is insufficient to significantly improve living standards or fully absorb the growing labor force. Severe problems with the electricity supply, a difficult security situation, the presence of loss-making public sector enterprises in key economic activities, a poor business climate, and a distorted trade regime have been important factors in anemic growth.
Headline inflation has fallen sharply in recent months, but underlying inflationary pressures remain. The external position has weakened significantly and central bank reserves have declined to US$6 billion (below 1½ months of imports) as of end-June 2013. The rupee depreciated around 5 percent against the dollar during the Fiscal Year 2012/13 (July-June), leaving the real effective exchange rate roughly unchanged.
The 2012/13 fiscal deficit (excluding grants) is estimated to be 8 percent of GDP, well above the original budget target of 4.7 percent of GDP due to slippages on both revenues and expenditures. The revenue shortfall is largely explained by the underperformance in tax collections in the previous fiscal year, inadequate tax administration, and a slowdown in economic activity. Higher expenditures reflect higher energy subsidies, including clearing the power sector arrears. Moreover, the provincial surplus envisaged in the budget has not materialized. With very low external financing, the deficit has been almost entirely domestically financed.
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Monetary policy continued to be accommodative to lift weak private investment and growth, in light of falling headline inflation. In 2012/13, the policy rate has been cut repeatedly by a cumulative 300 basis points to 9 percent, while direct financing of the large fiscal deficit continues to drive growth in monetary aggregates. However, this accommodative policy did not bear fruit in terms of private sector stimulus—private credit shrank in real terms.
The financial system is dominated by banks that have been relatively healthy as capital and liquidity indicators continue to be boosted by large holdings of government securities. Nevertheless, nonperforming loans remain high at 14.7 percent at end-March 2013 with few banks falling below minimum capital adequacy requirements.
Executive Board Assessment
Executive Directors noted that Pakistan’s economic vulnerabilities and crisis risks are high, with subpar growth and unsustainable fiscal and balance of payments positions. A lack of reliable electricity supply and a difficult security situation in large parts of the country have contributed to the deterioration.
Against this backdrop, Directors welcomed the authorities’ ambitious economic program aiming to reverse the current mix of large fiscal deficits, accommodative monetary policy, and low reserve coverage, and to foster sustained and inclusive growth. They stressed that short-term measures must be complemented by significant reforms in fiscal management, the monetary policy framework and financial markets, the energy sector, public sector enterprises, the business climate, and trade policy.
Directors highlighted that further consolidation will be required to ensure fiscal sustainability. While the 2013/14 federal budget represents an important initial step, a more efficient and equitable tax system is needed, and a significant increase in the tax-to-GDP ratio will be key to create room for social and investment spending while lowering the deficit. This will involve broadening the tax base through a reduction in exemptions and concessions, the extension of taxation to areas not fully covered by the tax net, and an overhaul of tax administration. Directors underscored that fiscal sustainability can only be achieved if the provinces are full partners in the adjustment effort.
Directors emphasized that monetary and exchange rate policies must be geared to rebuilding external buffers and to maintaining price stability over time. They stressed the need to cease direct lending to the government and underscored the importance of monetary policy independence in paving the way for improved price stability.
Directors underlined that continued financial sector stability and steps to deepen financial markets will contribute to boosting economic growth. They considered that risks to the banking sector are manageable, but encouraged the authorities to promptly address the undercapitalization of a few banks and to monitor closely non-performing loans.
Directors welcomed the authorities’ new energy policy, which is geared to addressing longstanding problems that constitute the most critical constraint on growth and have generated large fiscal costs. They encouraged the authorities to work closely with donors and secure broad-based support for the continued strong implementation of their energy sector strategy. Directors also called for efforts to liberalize the trade regime, restructure or privatize public sector enterprises, and improve the business climate to reduce rent-seeking behaviors and increase both foreign and domestic productive investment.
Directors stressed that protecting the most vulnerable from the impact of fiscal consolidation and price adjustments is a priority. They commended the authorities for their firm commitment to boosting targeted income support programs, and encouraged a gradual expansion of coverage and benefits as savings from energy tariff adjustments and fiscal space are realized.
Directors recognized the risks to the program from a delicate security situation, a further deterioration in the external environment, and potential constraints in legal, administrative, or technical capacity and resistance from vested interests to the reforms. They welcomed the authorities’ considerable efforts in undertaking prior actions, signaling their commitment to the program’s objectives and their willingness to take additional measures if necessary. They emphasized the importance of close collaboration with development partners, including through technical assistance, and continued strong political will and ownership for the program’s success.
Pakistan: Selected Economic Indicators, 2009/10–2013/14 1/
Fiscal year ends June 30.
Including changes in inventories.
Excluding gold, foreign deposits held with the State Bank of Pakistan, and net of outstanding short-term foreign currency swap and forward contracts.
An increase is a real appreciation.
Pakistan: Selected Economic Indicators, 2009/10–2013/14 1/
| Estimates | Baseline | Program | ||||||
|---|---|---|---|---|---|---|---|---|
| 2009/10 | 2010/11 | 2011/12 | 2012/13 | 2013/14 | ||||
| Real Economy (change in percent) | ||||||||
| Real GDP | 2.6 | 3.7 | 4.4 | 3.6 | 3.3 | 2.5 | ||
| Total domestic demand | 11.1 | 22.0 | 12.9 | 12.1 | 12.6 | 11.6 | ||
| Private consumption | 13.3 | 25.2 | 11.8 | 12.0 | 12.9 | 11.8 | ||
| Gross fixed investment 2/ | 0.3 | 8.4 | 16.9 | 8.1 | 9.5 | 16.4 | ||
| Foreign balance | ||||||||
| Merchandise exports, U.S. dollars (percent change) | 2.9 | 28.9 | -2.6 | 0.2 | 9.6 | 11.4 | ||
| Merchandise imports, U.S. dollars (growth rate; in percent) | -1.7 | 14.9 | 12.8 | -1.6 | 7.3 | 6.9 | ||
| Consumer prices (period average) | 10.1 | 13.7 | 11.0 | 7.4 | 8.2 | 7.9 | ||
| Consumer prices (end of period) | 11.8 | 13.3 | 11.3 | 5.9 | 10.5 | 10.0 | ||
| Unemployment rate (average, in percent) | 5.6 | 6.0 | 6.5 | 6.7 | 6.8 | 6.9 | ||
| Gross domestic investment (percent of GDP) | 15.8 | 14.1 | 14.9 | 14.2 | 14.1 | 14.9 | ||
| Gross domestic saving (percent of GDP) | 13.6 | 14.2 | 12.9 | 13.3 | 12.5 | 14.3 | ||
| General government (percent of GDP) | ||||||||
| Overall balance | -6.2 | -7.1 | -8.8 | -8.0 | -8.1 | -5.8 | ||
| Primary balance | -1.6 | -2.9 | -4.0 | -3.7 | -3.0 | -0.9 | ||
| Debt | 61.5 | 59.5 | 63.8 | 66.2 | 69.2 | 66.6 | ||
| Money and credit (end period, percent change) | ||||||||
| Broad money | 12.5 | 15.9 | 14.1 | 15.9 | 17.7 | 13.8 | ||
| Lending to private sector | 3.9 | 4.0 | 7.5 | -0.6 | 8.0 | 8.5 | ||
| Interest rates (percent) | ||||||||
| Policy rate | 12.5 | 14.0 | 12.0 | … | … | … | ||
| T-bill yield (6-month, average) | 12.3 | 13.3 | 12.3 | … | … | … | ||
| Balance of payments | ||||||||
| Goods and services, and income balance(percent of GDP) | -9.3 | -7.2 | -9.8 | -8.4 | -9.3 | -8.4 | ||
| Current account (percent of GDP) | -2.2 | 0.1 | -2.1 | -1.0 | -1.6 | -0.6 | ||
| Reserves (in billions of U.S. dollars) 3/ | 12,958 | 14,784 | 10,799 | 6,008 | 2,283 | 9,566 | ||
| Exchange rate | ||||||||
| Rupees per U.S. dollar(period average, percent change) | 7.6 | 2.2 | 4.1 | … | … | … | ||
| Real effective exchange rate (annual average, percent change) 4/ | 0.9 | 6.1 | 2.7 | … | … | … | ||
| Quota at the Fund | SDR 1033.7 million | |||||||
Fiscal year ends June 30.
Including changes in inventories.
Excluding gold, foreign deposits held with the State Bank of Pakistan, and net of outstanding short-term foreign currency swap and forward contracts.
An increase is a real appreciation.
Pakistan: Selected Economic Indicators, 2009/10–2013/14 1/
| Estimates | Baseline | Program | ||||||
|---|---|---|---|---|---|---|---|---|
| 2009/10 | 2010/11 | 2011/12 | 2012/13 | 2013/14 | ||||
| Real Economy (change in percent) | ||||||||
| Real GDP | 2.6 | 3.7 | 4.4 | 3.6 | 3.3 | 2.5 | ||
| Total domestic demand | 11.1 | 22.0 | 12.9 | 12.1 | 12.6 | 11.6 | ||
| Private consumption | 13.3 | 25.2 | 11.8 | 12.0 | 12.9 | 11.8 | ||
| Gross fixed investment 2/ | 0.3 | 8.4 | 16.9 | 8.1 | 9.5 | 16.4 | ||
| Foreign balance | ||||||||
| Merchandise exports, U.S. dollars (percent change) | 2.9 | 28.9 | -2.6 | 0.2 | 9.6 | 11.4 | ||
| Merchandise imports, U.S. dollars (growth rate; in percent) | -1.7 | 14.9 | 12.8 | -1.6 | 7.3 | 6.9 | ||
| Consumer prices (period average) | 10.1 | 13.7 | 11.0 | 7.4 | 8.2 | 7.9 | ||
| Consumer prices (end of period) | 11.8 | 13.3 | 11.3 | 5.9 | 10.5 | 10.0 | ||
| Unemployment rate (average, in percent) | 5.6 | 6.0 | 6.5 | 6.7 | 6.8 | 6.9 | ||
| Gross domestic investment (percent of GDP) | 15.8 | 14.1 | 14.9 | 14.2 | 14.1 | 14.9 | ||
| Gross domestic saving (percent of GDP) | 13.6 | 14.2 | 12.9 | 13.3 | 12.5 | 14.3 | ||
| General government (percent of GDP) | ||||||||
| Overall balance | -6.2 | -7.1 | -8.8 | -8.0 | -8.1 | -5.8 | ||
| Primary balance | -1.6 | -2.9 | -4.0 | -3.7 | -3.0 | -0.9 | ||
| Debt | 61.5 | 59.5 | 63.8 | 66.2 | 69.2 | 66.6 | ||
| Money and credit (end period, percent change) | ||||||||
| Broad money | 12.5 | 15.9 | 14.1 | 15.9 | 17.7 | 13.8 | ||
| Lending to private sector | 3.9 | 4.0 | 7.5 | -0.6 | 8.0 | 8.5 | ||
| Interest rates (percent) | ||||||||
| Policy rate | 12.5 | 14.0 | 12.0 | … | … | … | ||
| T-bill yield (6-month, average) | 12.3 | 13.3 | 12.3 | … | … | … | ||
| Balance of payments | ||||||||
| Goods and services, and income balance(percent of GDP) | -9.3 | -7.2 | -9.8 | -8.4 | -9.3 | -8.4 | ||
| Current account (percent of GDP) | -2.2 | 0.1 | -2.1 | -1.0 | -1.6 | -0.6 | ||
| Reserves (in billions of U.S. dollars) 3/ | 12,958 | 14,784 | 10,799 | 6,008 | 2,283 | 9,566 | ||
| Exchange rate | ||||||||
| Rupees per U.S. dollar(period average, percent change) | 7.6 | 2.2 | 4.1 | … | … | … | ||
| Real effective exchange rate (annual average, percent change) 4/ | 0.9 | 6.1 | 2.7 | … | … | … | ||
| Quota at the Fund | SDR 1033.7 million | |||||||
Fiscal year ends June 30.
Including changes in inventories.
Excluding gold, foreign deposits held with the State Bank of Pakistan, and net of outstanding short-term foreign currency swap and forward contracts.
An increase is a real appreciation.
Statement by Jafar Mojarrad, Executive Director for Pakistan and Muhammad Sethi, Senior Advisor to Executive Director September 4, 2013
Our Pakistani authorities are appreciative of staff hard work and constructive discussions under the Article IV consultation and program negotiations, which have yielded consensus on how to address the macroeconomic imbalances and foster growth over the medium term. The authorities are fully aware of the challenges and are determined to press ahead with critical reforms to boost growth and restore macroeconomic stability, thereby setting the stage for a more vigorous momentum of reforms that will help shore up confidence, mobilize external support, and attract foreign and domestic investment. In support of their program, the authorities have requested a 36-month arrangement under the Extended Fund Facility (EFF), which they believe is appropriate to provide financing over a sufficiently long period to meet stabilization and structural reform needs.
As clearly laid out in the Memorandum of Economic and Financial Policies (MEFP) and the staff report, a difficult regional security environment, the devastating effects of the floods, domestic political challenges, and external shocks over the past several years have adversely impacted growth and macroeconomic stability in Pakistan. In this context, and despite its best efforts, the previous government was not able to stay the course of stabilization and reform and complete the last reviews under the 2008 SBA, which expired in September 2011, and discussions on a new program could not be finalized. In the meantime, the overall macroeconomic situation continued to deteriorate, with rising fiscal and current account deficits, and increased pressure on reserves reflecting the unfavorable external and domestic environment compounded by weaknesses in policy implementation.
The successful democratic transition, the first from an elected government in the country’s history, has brought to power a government at the center of the political spectrum with strong parliamentary majority. The new government has a clear mandate and the political support to pursue economic reforms involving difficult policy choices, which are critical for correcting macroeconomic imbalances and putting the economy on a high and inclusive growth path.
The overall economic program is comprehensive and well calibrated to achieve macroeconomic stability and improve growth prospects over the medium-term. The envisaged policy mix of fiscal consolidation, prudent monetary policy, and appropriate exchange rate policy will help secure macroeconomic stability, while the planned structural reforms, along with a strengthening of the social safety net, will help improve the business climate, boost investment, and soften the impact of fiscal consolidation on growth and the poor. The authorities agree that downside risks are high, as indicated in the report, but believe that their strong determination to implement the envisaged reforms, as evidenced by the upfront actions taken, offers an important upside. The authorities look forward to the program catalyzing adequate and timely donor support to fill any remaining financing gap.
Fiscal consolidation
Based on past experience, the authorities are aware that the outcome of the reform program critically hinges on their ability to achieve fiscal consolidation to put public debt on a sustainable trajectory, increase fiscal space for priority social and infrastructure investment, and release resources for private sector development. Under the proposed program, the authorities aim at reducing the fiscal deficit to around 3½ percent of GDP by FY 2016/17, entailing a fiscal consolidation of about 4–4 ½ percent of GDP over three years. In this regard, as indicated by staff, the new government has implemented upfront measures towards fiscal adjustment of 2 percent of GDP, including measures envisaged in the 2013/14 budget. On the revenue side, these include among others a new levy on natural gas, higher rates of GST, corporate minimum tax, and personal income tax for higher income bracket, as well as increases in excises and fees. Furthermore, building on earlier efforts, tax administration reform will be strengthened through improved Federal Board of Revenue access to information, an increase in the number of risk-based tax audits, and enhanced assessment, collection, and prosecution procedures. In this regard, the issuance of 10,000 tax notices based on large potential fiscal liabilities (prior action), is an important first step in this area. In addition, further measures aimed at widening the tax base will be implemented during the program period, including by reducing tax exemptions and restricting the use of statutory regulatory orders (SROs).
A major leap forward on the expenditure side is the commitment to phase out electricity subsidy over the life of the program, along with the strengthening of the social safety net. The first round of adjustment has been achieved by eliminating tariff differential subsidy amounting to 0.75 percent of GDP through increasing weighted average tariff for commercial, industrial, bulk and large consumers. Further tariff subsidy reductions are envisaged in the following years to reach a maximum subsidy of 0.3 percent of GDP, as indicated in the MEFP. In addition, nonwage current expenditures have been reduced through a 30 percent across the board cut from this year’s budget allocations, equivalent to 0.15 percent of GDP. While some scaling back of the budgeted increase in capital spending is envisaged this year, the authorities intend to preserve investment expenditure as fiscal space is realized. The ratification of the fiscal commitments by the Council of Common Interest, which includes representatives of the provinces (implemented as a prior action), will ensure full contribution of all levels of Government to fiscal consolidation.
With regard to spending on social programs under the 2013/14 budget, the authorities have increased allocation for Benazir Income Support Program (BISP, the largest targeted social assistance program) to enable an extended outreach to over 5.7 million families through conditional cash transfers for primary education. It is expected that by the end of the program, 24 percent of the population (6.6 million families) would be covered under the basic cash transfer program.
Monetary and exchange rate policies
Monetary policy has been a subject of intense discussion between the authorities and staff. While the authorities recognize the importance of adjusting the policy rate as needed to mitigate inflation risks, they firmly believe that the recent cuts were warranted by the declining headline inflation and the need to support growth. In the same vein, the authorities’ intervention policy in the foreign exchange market has been motivated by the need to smooth out exchange rate volatility and strengthen market confidence by further building reserves. In this regard, and as a prior action, the SBP has purchased US$125 million in the foreign exchange market on a net basis since July1.
In view of the uncertainty surrounding the macroeconomic environment, adequate flexibility will be needed in calibrating the monetary and exchange rate measures and their timing to specific circumstances in the future, which cannot be predicted with a reasonable degree of certainty. The SBP has also expressed reservations on the methodology used by Fund staff for the calculation of core inflation, and look forward to further consideration of the issue in the context of the first review of the EFF.
The Selected Issue Paper on the performance of monetary policy in Pakistan makes interesting reading, but regrettably has not benefited from a thorough review and comments from the SBP before its circulation to the Board. The authorities have reservations about the methodology used and the accuracy of the assessment underlying the paper’s main conclusions, and will be sending detailed comments to staff, which they hope will be taken into consideration before finalizing the paper for publication. If needed, the authorities stand ready to have extensive discussions with staff on these and related issues at an appropriate time.
Structural reforms
The authorities are cognizant of the fact that in the long run, structural reforms hold the key to stronger growth, both by enhancing the overall efficiency of the economy and supporting long term fiscal sustainability. Energy sector reform remains the top priority, in view of its poor performance and the significant adverse costs to the economy and the budget. The first major step taken in this regard has been the preparation of a comprehensive energy policy, which addresses structural, governance, and regulatory issues. The Prime Minister chairs a high level national committee on energy which meets regularly to take stock of progress made under this policy. In the short term, the supply gap is being tackled by clearing payment arrears and improving governance of the power transmission and distribution system that currently records high losses due to poor infrastructure, mismanagement and theft of electricity. The long term plans focus on generating affordable electricity for commercial and industrial use by improving the energy mix and building generation capacity that can sustain Pakistan’s needs in the future while promoting a culture of energy conservation and responsibility.
Providing a conducive and business friendly environment for investment is also high on the list of government priorities. The “one stop shop” will provide easy access to a number of government departments and agencies under one roof. The authorities continue to engage with other development partners in strengthening the Board of Investment and streamlining procedures for establishing businesses in Pakistan. Implementation of the ambitious program of restructuring and privatization of public enterprises, along with further trade liberalization and improved SMEs’ access to financing under the SBP’s Financial Inclusion Program, would further strengthen private sector role, increase competitiveness, and enhance growth potential.
Financial sector reform
As indicated in the report, the banking sector is generally well capitalized and liquid. A few banks representing less than 7 percent of the system face financial pressures. These are being addressed through fresh injections of equity or mergers. Introduction of a deposit insurance scheme is under consideration to further stabilize the banking system. Besides, a new legislation for corporate rehabilitation is also under discussion with relevant stakeholders to improve the recovery mechanism. The authorities recognize the need for close monitoring of the financial system and are in the process of further strengthening the supervisory and enforcement power of the regulator.
Conclusion
The incoming government led by Prime Minister Mian Nawaz Sharif is fully committed to stay the course of prudent policies and bold structural reforms under the proposed EFF-supported program. The authorities are cognizant of the challenges they are facing but are confident that the difficult but necessary path of adjustment and reform that they have chosen will help them achieve their ambitious goals of higher growth and employment with macroeconomic stability. They are committed to taking the necessary measures as required to ensure the achievement of their program objectives. They look forward to the continued support from management and the Board.
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.