I. Introduction

Following a series of adverse external shocks combined with, Pakistan’s 2019-23 EFF Program went off-track in 2022 and macroeconomic conditions deteriorated. Per the ex-post peer review assessment, before the expiry of the EFF program, the government that assumed power in around mid-CY22 took significant remedial measures and brought the EFF program back on track in August 2022 with the completion of seventh and eight reviews but, for technical reasons, the program could not be completed and was allowed to expire on June 30, 2023. Considering the strong commitment of the authorities to stay the course and the worsening economic situation at the time, the Fund approved the SBA (July 2023 to April 2024) to ensure momentum of corrective measures, anchor policy efforts and stabilize the economy. SBA 2023 was essentially a stabilization program, designed to function as a bridge between the two extended programs, therefore the new proposed program will build on the structural agenda of the previous EFF program.

The proposed new EFF arrangement is also firmly embedded in the ex-post peer review assessment. It is indeed a compendium of strong policy reforms. Steadfast implementation of the proposed program is expected not only to deepen the reforms introduced in the previous programs but, also to address the structural issues of the economy, which will take it towards sustainable and durable growth.

II. Economic Developments and Challenges

Pakistan’s strong performance under the SBA program improved macroeconomic stability that is strengthening. Owing to an appropriately tight monetary stance and fiscal prudence, inflation has come down to single digits (9.6 percent in August 2024) from its peak of 38 percent in May 2023, FX reserves have doubled to about five weeks of import, and the rupee remained generally stable. On the fiscal side, responsible fiscal management helped post a primary surplus of 0.9 percent of GDP in FY24 and the FY25 budget aims at achieving the headline primary surplus of 2.0 percent of the GDP.

While acknowledging that long-lasting structural issues are the main impediments to sustainable growth, the authorities are determined to address them in the context of the new program decisively. The authorities are committed to fiscal consolidation predicated on an ambitious structural reforms agenda in areas of revenue generation, cost structure in the energy sector, State Owned Enterprises (SOEs) governance, removal of concessions and exemptions, improving competitiveness and privatization.

Our authorities’ ownership and commitment to the reform agenda are well demonstrated by the completion of prior actions for the new program. These are politically costly but economically correct decisions to ensure that economic stability is not transient but sustained.

The current account deficit (CAD) has remained contained at 0.2 percent of the GDP reflecting contribution of the import compression. Going forward, import volumes are expected to increase, in line with the ongoing domestic economic recovery, which together with improvements in the country’s terms of trade and stronger exports and robust remittance inflows are expected to contain the CAD in FY25 and remain in the region of 1.0 percent of the GDP.

III. Fiscal Policy, Debt Sustainability and Public Investment Management for Climate Resilience

The planned consolidation will be grounded in an increase in the tax-to-GDP ratio. The annual budget for FY25 envisages the tax-to-GDP increasing by ~ 2 percentage points of GDP, to 12.3 GDP, rising further to 13.4 of GDP by the end of the program. The commitment is evident from the measures taken in historically difficult and politically challenging areas, including bringing the retailers in the tax net, reduction in slabs for Personal Income Tax (PIT), expansion of coverage of FED while enhancing its rate and removal of several tax concessions and exemptions. During the program period, it has been agreed that the agriculture income tax rates will be harmonized with the PIT and Urban Immovable Property Tax will also be restructured in consultation with the Fund.

Overall fiscal management has been an area of concern but fiscal discipline during and after the SBA has strengthened fiscal consolidation. Going forward, the authorities have taken three major decisions to improve fiscal management durably. Notably, the National Fiscal Pact to rebalance the federation and the federating units’ relationship, which has been agreed by the provinces in principle, under which taxes will be harmonized across jurisdictions to improve collections while protecting the social sector spending; Second, removal of tax concessions and exemptions to reduce tax expenditures is another important component of revenue mobilization. In the previous Fund programs, a continuous benchmark was in place not to introduce any new exemptions and concessions, but the existing ones continued to exist. However, starting with the Finance Act FY25, the authorities have abolished exemptions and concessions tax (yielding about 0.37 percent of the GDP). The GST on services regime is being moved from a positive list to a negative list.

Debt levels in Pakistan become a concern primarily due to volatile and unsustainable economic growth and a narrow revenue base. Under the new proposed Fund program, the authorities aim to deal with the immediate issues and resolve the structural impediments to decisively address the underlying reasons. With lower tax-to-GDP levels, even moderate debt servicing does not leave enough space for maneuverability and therefore the resultant under-investment in drivers of sustainable and inclusive economic growth such as education, health, skill development, R&D etc. Sustained improvements in the fiscal position with greater focus on revenues, lengthening of domestic debt maturities, and efforts to diversify the investor base in government securities are expected to strengthen debt sustainability in the medium term. The government has recently introduced a contributory pension scheme for new employees to end the increase in unfunded pension liabilities. The authorities are keen to take measures within and outside the program modalities to reduce the fiscal burden.

On expenditure rationalization, in addition to reduction in government footprint, and the privatization, multiple other initiatives are being taken. The authorities plan to undertake a holistic assessment of Special Economic Zones and Export Processing Zones to gradually phase out the existing incentives subject to contractual obligations. Phasing out of the incentives coupled with the decision to grant no such incentives in the future will help reduce the associated fiscal costs and create a level playing field and a more predictable business environment. The energy subsidies have been contained at 1 percent of the GDP in the annual budget for FY25 by adjusting tariffs and introducing cost-side reforms. Besides, revenue mobilization and expenditure rationalization improvements in the PFM, economic data compilation and automation have been prioritized with the technical assistance of the Fund.

We welcome staff’s recognition of the government’s strong performance towards the adoption of C-PIMA recommendations. The authorities hope to leverage the Fund program and their own reform agenda to mobilize sufficient climate financing to catalyze the adoption with the assistance of other development partners and MDBs. Creation of the Climate Change Authority and preparation of the National Disaster Risk Financing Strategy and National Climate Finance Strategy are various components of the overall efforts by our authorities to re-orient policy formulation and firmly embed reforms to create a more integrated and resilient planning and management framework for climate.

IV. Energy Sector Policies

The authorities are committed to restoring the energy sector’s financial viability to mitigate macro-fiscal risks. To reduce market distortions, significant measures, including automaticity and implementation of tariff adjustments in the power sector, have been taken in line with the advice of the Fund and other multilateral partners. These reform measures in the power sector have also significantly reduced fiscal hemorrhaging and stabilized the nominal power sector circular debt (CD) flow. On the gas side, the collection of credible data on CD and greater transparency have helped in building momentum for the reforms. The authorities are cognizant of the structural inefficiencies in the generation, transmission, distribution and payment recovery of electricity and gas, and the importance of cost-side reforms, and are prepared to address them in the next phase of reforms in consultation with the Fund, the World Bank and Asian Development Bank (ADB). These reforms are being prioritized to create a more conducive environment for businesses by making energy more affordable and exports more competitive without perpetuating market distortions.

V. Social Protection and Social Sector Expenditure

To make up for the under-investment in human capital over time, the FY25 annual budget envisages an increasingly higher primary surplus while enhancing social protection and human capital expenditure. Around 40 percent of the 250 million population is below the poverty line. Adverse macroeconomic conditions and under-investment over time have direct implications on integration into the labor force, quality of human capital and opportunities for social mobility. At the federal level, allocation to BISP has increased by 0.5 percent of the GDP (27 percent higher compared to FY24), will be directed towards enhanced coverage and higher generosity level while protecting the same in real terms through inflation indexation. Beyond social protection, gradual enhancement of investments in the health and education sector is agreed upon under the proposed Fund arrangement. The greater fiscal space leading to a higher investment in human capital is predicated on the rationalization of primary expenditure through a reduced public sector footprint and the enhanced role of provinces in social sector investments and resource mobilization leading to a higher tax-to-GDP ratio.

VI. Monetary, Exchange Rate and Current Account Balance

The restrictive and well-calibrated monetary stance by the State Bank of Pakistan (SBP) supported by prudent fiscal management has helped contain demand and bring down inflation significantly more than market expectations. The favorable movement in global oil and food prices also contributed. Recognizing the internal and external uncertainties, the monetary stance will remain cautious with a sizable positive real policy rate (currently about 10 ppts ex-post). The authorities believe that the restrictive stance contributed significantly to driving FY25 average inflation below the earlier forecast range of 11.5—13.5 percent.

Maintaining a flexible exchange rate management and a more independent central bank have been among the strong areas of reform under the Fund programs. The new legislation made inflation the central bank’s primary objective and ended the lending to the government. The rupee has remained generally stable without major intervention and interbank and open market spread remains within the agreed band. Improved macroeconomic indicators, exchange rate stability, and continued refrainment from any restrictions of current account payments including repatriation of profits will encourage investors and help in making the overall business environment more conducive.

To address the high levels of borrowing from domestic the authorities are taking steps to deepen the capital and financial markets and improve public debt management. MoF’s continued focus on addressing the fiscal imbalances, lengthening domestic maturities, reducing gross financing needs, and improving cash management by scaling up the TSA reforms—will remain central to the efforts to bring these borrowing levels to more moderate levels. Furthermore, SBP also plans to complete the advanced-stage winding-up of the undercapitalized banks and enhance the institutional framework, surveillance, inclusive access to financial services through digital solutions – and credit risk management.

VII. Implementation of AML/CFT Framework

Pakistan exited the FATF grey list in 2022 and continues to make good progress in making the institutional frameworks more robust. In 2023, Pakistan established the National AML/CFT Authority, which is now driving the National AML/CFT Strategy and leading the national efforts to address risks and remove deficiencies identified in the 2023 National Risk Assessment, by coordinating the efforts of various national and subnational entities including financial sector regulators, tax collecting authorities, banks, and anti-corruption agencies. The establishment of a legal entity with a complete legal framework will improve coordination and help sustain the hard-earned gains and catalyze future efforts.

VIII. SOE Governance, De-regulation, Privatization and Competitiveness

a. SOE Governance

Improving SOE Governance continues to be one of the important pillars of the authorities’ reform agenda. On the advice of the Fund and with the technical assistance of ADB, of Pakistan formulated a SOE Policy, (promulgated the SOE Act in 2023) and established a Central Monitoring Unit at the MoF, and the process of aligning the statutes of different SOEs with the SOE Act is underway. Four such statutes have already been amended and several other statutes including of Sovereign Wealth Fund will be harmonized in FY25.

b. De-regulation and Privatization

Deregulation of the product markets and the end of price setting of commodities are being prioritized to remove distortions. The government recognizes that it needs to exit the commercial space, particularly in sectors where successful private entities already exist, to create more space for the private sector. On price-setting, the federal and provincial governments have agreed in principle to refrain from announcing the support prices for raw commodities and limiting the procurement programs to the extend of food security purposes.

This will not only help mitigate fiscal and debt sustainability risks but also improve public services, bring in investment and phase out the government’s role in price setting. Currently, Pakistan International Airlines and one of the DISCOs are at the advanced stage of privatization.

c. International Trade and Barriers to Trade

The authorities are determined to remove barriers to international trade and not to increase trade-weighted average customs duties and tariffs. National Tariff Policy 2019-24 has expired and under the new Policy, the authorities aim to reduce tariffs every year during FY25-29. The authorities are also committed to reducing non-trade barriers and removing some of the trade distortions, including export subsidies. On the process side, Pakistan Single Window will further expand to the federating units.

d. Competitiveness and Investment

In addition to the support coming from the improved macroeconomic conditions, flexible exchange rate system and removal of trade barriers, several reforms are being introduced to improve competitiveness and expand the export base. Reforms in the regulatory framework under the program and the renewed emphasis on human capital investment and robust yet consistent and investment-friendly regulatory regime are expected to attract FDI and private investment.

IX. Concluding Remarks

Pakistan has shown remarkable resilience and commitment to economic recovery despite multiple shocks. The authorities have made politically costly and socially painful decisions to strengthen macro stability and remain committed to taking this further to ensure that the economy is on a durable growth path. With the belief that the proposed EFF will help neutralize the risks highlighted by staff, the authorities request approval by the Executive Board of the proposed EFF. The authorities would also like to assure the Board of their program ownership and their unflinching commitment to the path it has taken in the complex environment despite socio-political challenges. The Pakistani authorities look forward to continued support from the Executive Board, Management, and Staff.