IMF Executive Board Concludes 2015 Article IV Consultation with Pakistan
Starting from a difficult position in 2013, Pakistan has made substantial progress in reducing near-term economic vulnerabilities. Economic growth gradually increased from 3.7 percent in fiscal year (FY) 2012/13 to 4.2 percent in FY2014/15. During the same period, efforts to reduce power subsidies and raise tax revenue have lowered the budget deficit from 8.4 to 5.4 percent of GDP, although part of this adjustment reflected clearance of quasi-fiscal liabilities in the energy sector in 2013. Monetary and financial sector policies have remained prudent in recent years, and the banking system remains sound. Inflation has declined significantly, helped in part by low international commodity prices.
The external position has recently strengthened although medium-term vulnerabilities remain. Helped by low oil prices and strong remittances, the external current account deficit narrowed to one percent of GDP in FY2014/15 and foreign exchange reserves of the SBP have been rebuilt from 1.5 months of imports in FY2012/13 to 3.8 months of imports in September 2015. However, foreign direct investment (FDI) fell by a half in FY2014/15, albeit with some recovery since, and exports have declined. The economy’s competitiveness has been hampered by security issues, a business climate that lags regional peers and a real effective exchange rate appreciation of 17 percent over the past two years.
Long-standing structural impediments and a difficult security setting remain key obstacles to growth and investment. Pervasive tax evasion combined with still prevalent tax exemptions and loss-making state-owned enterprises constrain the fiscal space for public investment and social spending. The resulting reliance on domestic financing risks to reduce access to credit and investment by the private sector. Despite recent improvements, the energy sector still accumulates payment arrears and is unable to meet growing demand. Several growth-supporting structural reforms are in various stages of preparation or implementation, including in the energy sector, privatization/ restructuring of public enterprises, tax administration, as well as monetary and financial sector policies.
Pakistan’s macroeconomic outlook is favorable, contingent on sustained implementation of key reforms, amid downside risks emanating from a more challenging external environment. In the medium term, growth is expected to reach about 5.5 percent, and inflation is expected to gradually rebound to the SBP’s target of mid-single digits.
Executive Board Assessment2
Directors welcomed Pakistan’s continued improvement in economic activity and the fiscal and external positions, on the back of low oil prices and strong remittances. They commended the authorities for significantly reducing near-term vulnerabilities in recent years. Directors noted nevertheless that longstanding structural weaknesses and security concerns continue to hold back growth prospects. They emphasized the need to boost potential growth and enhance the economy’s resilience and competitiveness. Achieving these objectives will require sustained fiscal consolidation, swift execution of the economic reform program, and a further build-up of international reserves.
Directors stressed the importance of further reducing public debt to more sustainable levels, while preserving room for higher spending on critical infrastructure, educational, and social programs. They welcomed the additional measures taken to close the revenue shortfall and encouraged comprehensive, front-loaded reforms to mobilize revenue, including by
base-broadening, streamlining concessions and exemptions, improving tax compliance, and enhancing coordination with provincial tax authorities. At the same time, Directors saw a need to continue strengthening frameworks for public debt and financial management, further reducing energy subsidies, and restructuring or privatizing loss-making public enterprises.
Directors agreed that monetary policy should remain prudent and focused on price stability. They supported targeting positive real interest rates and keeping inflation expectations well anchored. Directors commended the authorities for progress in improving the monetary policy framework, notably the establishment of an independent monetary policy committee. They encouraged further steps to enhance monetary policy transmission and prepare for a shift toward inflation targeting over the medium term, as circumstances permit. Directors encouraged the authorities to implement the remaining recommendations of the 2013 safeguards assessment, aimed at enhancing central bank independence and reducing fiscal dominance.
Directors observed that the banking sector remains sound and profitable, and good progress has been made with bank capitalization. They supported ongoing efforts to bolster
regulatory and supervisory frameworks, set up a deposit insurance scheme, and improve access to finance. Directors also stressed the need to continue strengthening the framework against money laundering and the financing of terrorism, including by widening the coverage of tax crimes.
Directors underlined the importance of advancing critical structural reforms to restore competitiveness and foster medium-term, inclusive growth. They called for continued effort in the areas of energy sector reform, privatization, the business climate, and trade integration. Greater exchange rate flexibility would help absorb exogenous shocks and complement a comprehensive strategy for improving export performance. Directors also encouraged initiatives to promote gender equality and expand targeted social protection.
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