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Pakistan Economic Summary by the International Monetary Fund
Last Updated: December 23, 2009
Background
Until the current economic crisis broke 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. Growing fiscal deficits, due in large part to energy subsidies, were financed by the central bank through the expansion of the money supply. As a result, inflation reached 25 percent in mid-2008, the rupee depreciated, and foreign currency reserves fell sharply. The high rate of inflation was particularly harmful to vulnerable social groups. Events urgently needed to be brought under control.
Role of the IMF
In Fall 2008, the Pakistani authorities embarked on a stabilization program to address the current crisis, supported by US$7.6 billion under a 23-month SBA. This exceptional financial support was necessary given the country’s sizeable external imbalances and the risk of large capital outflows. In August 2009, the IMF raised its support to US$11.3 billion to address increased risks and financing needs, and extended the program to 25 months. 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 continued to stabilize. Macroeconomic imbalances have shrunk and inflation has fallen. The exchange rate has become somewhat more flexible and foreign currency reserves have increased from US$3.3 billion in November 2008 (before the SBA approval) to US$9.9 billion in mid-December 2009.
Demand for treasury bills has increased, allowing the government to retire some of its debt to the central bank. After an initial increase in the policy rate of 200 basis points in November 2008, as the economic and financial situation improved, the authorities were able to lower the policy interest rate by 250 basis points in three steps since April 2009. Raising budget revenues, however, has been challenging and the authorities are striving to maintain fiscal discipline by eliminating non-priority spending. Nevertheless, the budget deficit target (excluding grants) for end-September 2009 and for 2008/09 was missed by 0.3 and 0.9 percentage points of GDP, respectively. At the same time, the current account deficit has narrowed considerably, helped by the decline in oil prices, and inflation has dropped to 10.5 percent in November 2009. Important steps have been taken to strengthen bank supervision, reform the electricity sector, and strengthen the social safety net.
The Challenges Ahead
Notwithstanding some recent signs of recovery, global economic activity has declined since the beginning of the current program and affected economic activity in Pakistan. Although there are modest signs of recovery in some sectors, manufacturing (mainly in the textile sector) activity remains depressed, with a related drop in exports. The political and security situation remains challenging; economic reform does not command broad support and adverse security developments continue to hurt the confidence of domestic and foreign investors. As a result, projected for economic growth for 2009/10 is a modest 3 percent.
Looking forward, Pakistan’s economic program is subject to an unusual degree of uncertainty from both domestic and external factors. Domestic security is requiring higher budget expenditures that put increasing pressure on the fiscal position. Externally, the pace and extent of the recovery of the global economy remains uncertain. Despite these risks, the program can continue to build on initial success in stabilizing the economy. 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. To facilitate orderly budget execution, the IMF is providing bridge financing until this pledged donor support materializes. To sustain additional spending over the medium term, however, it remains crucial that Pakistan raise tax revenue. In this regard, the introduction of a broad-based value-added tax in July 2010 is essential.
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Pakistan's 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.
Last Updated: December 23, 2009
Background
Until the current economic crisis broke 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. Growing fiscal deficits, due in large part to energy subsidies, were financed by the central bank through the expansion of the money supply. As a result, inflation reached 25 percent in mid-2008, the rupee depreciated, and foreign currency reserves fell sharply. The high rate of inflation was particularly harmful to vulnerable social groups. Events urgently needed to be brought under control.
Role of the IMF
In Fall 2008, the Pakistani authorities embarked on a stabilization program to address the current crisis, supported by US$7.6 billion under a 23-month SBA. This exceptional financial support was necessary given the country’s sizeable external imbalances and the risk of large capital outflows. In August 2009, the IMF raised its support to US$11.3 billion to address increased risks and financing needs, and extended the program to 25 months. 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 continued to stabilize. Macroeconomic imbalances have shrunk and inflation has fallen. The exchange rate has become somewhat more flexible and foreign currency reserves have increased from US$3.3 billion in November 2008 (before the SBA approval) to US$9.9 billion in mid-December 2009.
Demand for treasury bills has increased, allowing the government to retire some of its debt to the central bank. After an initial increase in the policy rate of 200 basis points in November 2008, as the economic and financial situation improved, the authorities were able to lower the policy interest rate by 250 basis points in three steps since April 2009. Raising budget revenues, however, has been challenging and the authorities are striving to maintain fiscal discipline by eliminating non-priority spending. Nevertheless, the budget deficit target (excluding grants) for end-September 2009 and for 2008/09 was missed by 0.3 and 0.9 percentage points of GDP, respectively. At the same time, the current account deficit has narrowed considerably, helped by the decline in oil prices, and inflation has dropped to 10.5 percent in November 2009. Important steps have been taken to strengthen bank supervision, reform the electricity sector, and strengthen the social safety net.
The Challenges Ahead
Notwithstanding some recent signs of recovery, global economic activity has declined since the beginning of the current program and affected economic activity in Pakistan. Although there are modest signs of recovery in some sectors, manufacturing (mainly in the textile sector) activity remains depressed, with a related drop in exports. The political and security situation remains challenging; economic reform does not command broad support and adverse security developments continue to hurt the confidence of domestic and foreign investors. As a result, projected for economic growth for 2009/10 is a modest 3 percent.
Looking forward, Pakistan’s economic program is subject to an unusual degree of uncertainty from both domestic and external factors. Domestic security is requiring higher budget expenditures that put increasing pressure on the fiscal position. Externally, the pace and extent of the recovery of the global economy remains uncertain. Despite these risks, the program can continue to build on initial success in stabilizing the economy. 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. To facilitate orderly budget execution, the IMF is providing bridge financing until this pledged donor support materializes. To sustain additional spending over the medium term, however, it remains crucial that Pakistan raise tax revenue. In this regard, the introduction of a broad-based value-added tax in July 2010 is essential.
----------------------------------
Pakistan's 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.
