June 16, 2003
My authorities thank staff for fruitful discussions in the context of the fifth review under the PRGF and for a concise, balanced and well-written report on Pakistan’s accomplishments since the last review as well as the challenges that lie ahead.
The continued commitment to sound macroeconomic policies, favorable exogenous factors, including good rains, and continued high private capital inflows along with strong external support have produced impressive results. Economic growth in 2002/03, based on the latest information contained in the staff supplement, should exceed 5 percent, thanks to robust growth in agriculture and manufacturing; inflation is forecast to be lower than projected; and, the external current account and the overall balance of payments are expected to overperform relative to program targets, reflecting in part a surge in workers’ remittances to a new historical record. In the fiscal area, tax revenues were higher than the target in part due to overperformance by the Central Board of Revenue (CBR)—a trend which appears to have continued in April—and while I-PRSP expenditure growth has slowed somewhat, it still remains above the growth (21 percent) targeted for the year as a whole. All end-March quantitative performance criteria are likely to have been observed and the authorities are confident of meeting the end year fiscal deficit target.
Implementation of the agenda of structural reforms, outside the energy sector, was broadly on course, further progress was made with preparing the full PRSP, and a strategy was prepared to reduce abuse of the “benami” practice (Box 1 of the staff report). However, limited investor interest hindered progress with privatization. In the energy sector, while the government remained diligent in the application of the fortnightly automatic adjustment of petroleum prices, it did not see it politically and economically advisable to pass through all of the surge in fuel costs that occurred in the run-up to the war in Iraq onto higher electricity and gas prices. Since the oil price surge was considered as temporary and exceptional, it made the determination that passing much of the spike through would have been unduly disruptive to economic stability and hurt competitiveness. One consequence of the less-than-full pass-through was, however, that the performance of the two major power utilities, WAPDA and KESC was worse than targeted in their respective Financial Improvement Plans (FIPs). Their deficits in the current year are therefore expected to be higher than planned. Fortunately, overperformance of some nontax revenue items provided an offset to the additional financing needs of these utilities.
The policy framework for 2003/04 requires perseverance with the present macroeconomic policy mix marked by a tight fiscal and monetary policy stance, further improvement in the external position, a determined effort to raise further development and I-PRSP spending so as to make progress with closing Pakistan’s large “social gap” and alleviate poverty, and renewed efforts to implement what the authorities judge to be a more realistically ambitious FIP for WAPDA and KESC so as to durably reduce fiscal risks.
The new budget for 2003/04—the linchpin of the continued adjustment effort—which was presented on June 7 gives concrete expression to these goals, and its broad contours and structural content have been well described in the staff supplement. The staff would have preferred a more ambitious path of deficit reduction but have given due consideration to the high costs of sterilization, continued regional tensions, and the financial difficulties in the power sector. Nevertheless, reaching a consolidated fiscal deficit target of 4 percent of GDP in 2003/04 would still be a major landmark. On the revenue side, the budget contains important initiatives aimed at streamlining the tax system through, inter alia, a sweeping reduction in remaining income tax exemptions, and envisages a continuation of reforms in CBR to improve tax buoyancy and efficiency. Staff has expressed concerns regarding the cabinet decision to raise base salaries and pensions by 15 percent and by the decision to extend the special National Saving Scheme (NSS) for pensioners to widows. The authorities assure the Executive Board that the recent rise in salaries and pensions barely compensates for past inflation and would therefore be consistent with forthcoming reforms of the civil service and sustainability in the pension system. In regards to the special NSS scheme for widows, the authorities have responded to a long-standing demand from a relatively less well-off section of the society; they will ensure that documentation requirements will be stringent so as to preclude abuse of this privilege.
The authorities face a challenge in 2003/04 to forcefully implement the FIPs for WAPDA and KESC, two institutions which pose risks for the budget. They are, however, cognizant of the stakes involved and welcome the strengthened conditionality. To be sure, a significant part of WAPDA’s financial difficulties can be attributed to temporary factors such as the front loading of payments to Independent Power Producers (IPPs). As this bunching of payments is traversed and the Ghazi-Barotha hydropower plant comes on stream, WAPDA’s financial condition should improve significantly. Nevertheless, the authorities are alert to the need for WAPDA to be accountable for achieving durable improvements in line losses and billing, including in the difficult Federally Administered Tribal Area (FATA). The authorities’ commitment to ensuring successful implementation of the FIP in WAPDA and KESC is reflected in their undertaking not to pass on downward tariff adjustments unless they are assured that quarterly deficit targets are being adhered to.
Good progress continues to be made on social sector issues in terms of higher spending and the development of improved systems of monitoring social outcomes. However, there continues to be room for improving the quality of reporting on provincial and local government spending. This will require further efforts at capacity building and stricter adherence to existing accounting procedures.
Despite limited investor interest, the authorities remain committed to privatization. They expect to complete the sale of Pakistan State Oil within the next few months and, given some signs of investor interest, have reinvited expressions of interest for Habib Bank. The authorities remain open to a negotiated sale with the sole qualified investor in the case of KESC but will also, concurrently, explore the option of unbundling KESC and selling the power generation component.