July 3, 2002
1. This statement summarizes the information that has become available since the staff report (EBS/02/107) was circulated to the Executive Board on June 19, 2002. It does not change the thrust of the staff appraisal.
2. The information provided by the authorities indicates that all the prior actions listed in the June 18, 2002 Memorandum of Economic and Financial Policies (MEFP) have been taken.
3. The 2002/03 federal budget is consistent with the program’s fiscal objectives, notably a consolidated deficit of 4.4 percent of GDP.1 The budget speech provides an explicit commitment to the I-PRSP expenditure target for 2002/03 (4 percent of GDP). Staff will undertake a detailed assessment of the expenditure composition and the envisaged pro-poor expenditure restructuring once details of the provincial and district budgets are available.
4. The government has confirmed that the Ministry of Water and Power and the Ministry of Finance will be jointly in charge of quarterly reporting, including to the public, on the implementation of the Water and Power Development Authority’s (WAPDA) financial improvement plan as set out in the MEFP.
5. The authorities have issued rules and regulations pertaining to record-keeping under the universal self-assessment scheme for income tax, as well as the revised income and sales tax appeals and dispute resolution rules, both to become effective July 1, 2002.
Progress towards July 1, 2002 structural performance criteria
6. The federal budget for 2002/03 contains all major tax measures planned under the program. These include: implementation of a major income tax reform package effective for income earned from July 1, 2002; further rationalization of the excise tax system; the elimination of the sales tax exemptions for vegetable ghee and cooking oil; and the reduction of the maximum standard tariff rate to 25 percent (from 30 percent) and of the number of tariff slabs from 5 to 4. The very high special duty rates on vehicles were also reduced. The authorities specified a time-bound plan to reach a uniform corporate income tax rate of 35 percent in 5 years. Additional measures include the rationalization of various withholding taxes, elimination of certain subsidies to refineries, and the imposition of a 5–10 percent tariff on petroleum product imports. Increases in depreciation allowances and the amount of interest payments on housing loans that is tax-deductible are intended to stimulate investment, including in housing.
7. In a landmark reform, with the effectiveness of the income tax ordinance (promulgated in September 2001, for income earned from July 1, 2002) the government has introduced a universal income tax self-assessment system under the income tax on income earned from July 1, 2002 onwards, along with taxation of monetized perquisites and allowances. A brochure explaining the new system will be published in a few weeks. The Large Taxpayer Unit (LTU) in Karachi is on track to start operations on July 1; it will administer all domestic taxes in a functionally integrated manner for approximately 400 taxpayers.
Recent economic developments
8. Despite a significant increase in energy and transportation prices, the consumer price index (CPI) decreased by 0.8 percent in May, due to a drop in food prices. The 12-month increase in May was 2.9 percent, slightly below program projections. Official estimates published with the new budget revised projected real GDP growth for FY 2001/02 slightly upward to 3.6 percent (from 3.3 percent in the program), on account of stronger manufacturing and services. They also estimate real GNP growth at 5.2 percent, due to the very large increase in worker remittances.
9. Recent trade data confirmed a strong pick-up in trade flows. In U.S. dollar terms, exports increased by 6.7 percent in May 2002 year-on-year and imports surged by 18.7 percent. Worker remittances in July 2001-May 2002 more than doubled compared with the same period of FY 2000/01, to US$2.1 billion. Official reserves reached US$4.3 billion on June 28, 2002—much higher than the programmed US$3.5 billion—equivalent to about 4.3 months of imports of goods and nonfactor services. The State Bank of Pakistan (SBP) has continued to actively purchase foreign exchange, mostly on the interbank market. Purchases on the free (“kerb”) market fell to 27 percent of total in the quarter to June, compared with 37 percent during July 2001-March 2002, and completely ceased in June 2002.
10. Over the past weeks, the Pakistani rupee remained virtually stable against the U.S. dollar, and thus depreciated against the euro. The spread between the free and interbank markets averaged 0.6 percent in June, and never exceeded 2 percent. The stock market gained about 6 percent in the course of June.
11. Available data on federal revenue and expenditure indicate that the authorities remain on track to meet the end-June fiscal deficit target, while meeting of the Central Board of Revenue (CBR) revenue target seems unlikely. CBR revenue in May was higher than last year by about 9 percent, which confirmed the pickup observed since March. Highly preliminary data for June indicate that revenue in June again grew by about 9 percent year-on-year, indicating that the end-year target of PRs 414 billion would be missed by about PRs 13 billion. In April, performance of other federal revenue and expenditure was in line with projections. Capital spending was on track to surpass the projection for the fourth quarter, pointing to a further acceleration of I-PRSP spending. Defense outlays as well as domestic interest payments were lower than programmed, while other current expenditure was broadly in line with expectations.
12. With the budget, the authorities published a draft Fiscal Responsibility Law, inviting comments from the general public by July 15, with a view to enact the law by end-August 2002. The draft law would provide a good framework for fiscal transparency and sound fiscal policies. It prescribes the budget statements that the federal government has to provide on a regular basis, and sets a number of rules and targets for fiscal policy. Among these are achieving the “golden rule” no later than by end-June 2007, and reducing public debt to 60 percent of GDP by end-June 2012, while lowering debt by 2.5 percent of GDP each year, under the proviso that pro-poor public expenditures of at least 4 percent of GDP per year should be maintained.
13. On June 24, 2002 (6 days before a binding deadline) the Supreme Court set aside its judgment of December 1999 which upheld the decision of a lower court (the Federal Sharia Court) of 1991 requiring the transformation of the prevailing financial system into an interest-free one. The latest Supreme Court decision instructs the lower court to review its earlier decision through thorough comparative study of financial systems in other contemporary Muslim countries. The Pakistani authorities expect that this latest decision will lift the uncertainty initially caused by the 1991 decision, and that was exacerbated in 1999.
14. The authorities have taken the following two steps toward meeting the Special Data Dissemination Standards: publication of quarterly balance of payment statistics on the SBP’s website and issuance of an Advance Release Calendar for selected economic data (various price, foreign trade, and industrial production statistics) on the website of the Federal Bureau of Statistics.