Following is the Program Note of IMF on Pakistan economy. For more details, please visit: http://www.imf.org/external/np/country/notes/pakistan.htm
Current IMF-Supported Program
25-month, US$11.3 billion Stand-By Arrangement (SBA), originally approved by the IMF’s Executive Board on November 24, 2008 and augmented on August 7, 2009. The Board completed the third review of the program on December 23, 2009.
Until the economic crisis broke out in 2008, Pakistan had enjoyed a relatively robust economic performance. Warning signs emerged in 2007 and early 2008, as inflation began to rise and external imbalances arose, even though growth remained strong. Conditions worsened significantly in mid-2008 with the sharp increase in international food and fuel prices and the deterioration in the security situation. The widening fiscal deficit, due in large part to rising energy subsidies, was financed by credit from the central bank. As a result, the rupee depreciated and foreign currency reserves fell sharply. Inflation reached 25 percent in mid-2008, causing harm to vulnerable social groups.
Role of the IMF
In Fall 2008, the Pakistani authorities embarked on a stabilization program, supported by US$7.6 billion under a 23-month SBA. This exceptionally high level of financial support was necessary, given the country’s sizable external imbalances and the risk of large capital outflows. In August 2009, the IMF extended the program to 25 months and raised its support to US$11.3 billion to help address increased risks and financing needs. The program aims to:
* restore financial stability through a tightening of fiscal and monetary policies to bring down inflation and strengthen foreign currency reserves;
* protect the poor by strengthening the social safety net—this is a key element of the government’s policy strategy; and
* raise budgetary revenues through comprehensive tax reforms to enable significant increases in public investment and social spending required for achieving sustainable growth.
Progress to Date
The program got off to a good start and Pakistan’s economy has made progress toward stabilization. Macroeconomic imbalances have shrunk and inflation fell below 10 percent in mid-2009. More recently, however, inflation has been on the rise and reached 13 percent in March 2010. The exchange rate has become somewhat more flexible, and the current account deficit has narrowed considerably, helped by the decline in oil prices and a robust increase in workers’ remittances. As a result, foreign currency reserves have increased from US$3.3 billion in November 2008 (before the SBA approval) to US$11 billion in March 2010.
Fiscal policy continues to be affected by low economic activity and a difficult security environment. Following a series of interest rate increases in late 2008 and early 2009, demand for treasury bills increased, allowing the government to end its reliance on credit from the central bank. However, given the depressed economic activity, raising budget revenues proved difficult, and the authorities have been striving to maintain fiscal discipline by eliminating non-priority spending, while facing the need to accommodate additional large security spending. These efforts proved initially successful, but since July 2009, the authorities have repeatedly exceeded the quarterly budget deficit targets under the program.
Structural reforms have moved forward, but the agenda remains challenging. Important steps have been taken to strengthen bank supervision, bolster the social safety net, reform petroleum pricing and taxation, and liberalize the foreign exchange market. Also, significant steps have been made in preparation for the introduction of the value-added tax in July 2010. There has been some progress toward the reform in the electricity sector, but more needs to be done to eliminate the financial losses of electricity companies and other public enterprises, which impose a burden on public finances and pose a threat to macro-economic stability.
The Challenges Ahead
Modest signs of recovery in manufacturing (mainly in the textile sector) and exports suggest that the Pakistani economy is regaining momentum and economic growth in 2009/10 will reach, or even exceed, 3 percent, and could rise to 4 percent in 2010/11. However, adverse security developments continue to hurt domestic and foreign investors’ confidence, while electricity shortages continue to prevent the economy from achieving its potential. The pace and extent of the recovery of the global economy also remain uncertain.
Despite these risks, the program can continue to build on initial success in stabilizing the economy, but to achieve that, economic reform needs to command broad support. External donors made generous pledges to Pakistan at the donor meeting in Tokyo in April 2009; it is crucial that these pledges be disbursed promptly to support priority budget spending and reform. At the same time, however, external support should only be treated as a bridge to a greater domestic revenue effort, which will be indispensable to sustain development spending, achieve poverty reduction, and increase much-needed social outlays over the medium term. In this regard, the introduction of a broad-based value-added tax in July 2010 is essential.