ISLAMABAD - Our Staff Reporter/Agencies - The International Monetary Fund warned Pakistan Thursday that economic growth could be worse than expected next year due to strict austerity measures built into a $6.7 billion rescue loan.
The Fund gave Pakistan a sobering assessment, saying its economy was at a high risk of deteriorating into crisis and growth was too slow to significantly improve people’s living standards.
A press release issued by the IMF on Thursday said its Executive Board on September 3 had concluded the Article IV Discussions with Pakistan and approved a three-year arrangement under the Extended Fund Facility (EFF) for Pakistan in support of the authorities’ structural reform and growth programme.
“Economic performance in Pakistan has been substandard in recent years,” the IMF said, adding that gross domestic product growth averaged only three per cent over the past five years. It however welcomed the new government’s economic reform programme.
“Executive directors noted that Pakistan’s economic vulnerabilities and crisis risks are high, with subpar growth and unsustainable fiscal and balance of payments positions.” “A lack of reliable electricity supply and a difficult security situation in large parts of the country have contributed to the deterioration,” the IMF said.
Pakistan is in the grip of its worst energy crisis in modern history which causes power outages up to 20 hours in parts of the country and has hammered industrial output. During the last five years, GDP has averaged only three percent, far short of the seven percent considered necessary to lift the country out of poverty and fully absorb the growing labour force. Central bank reserves have fallen to $6 billion, down from $14.78 billion in fiscal year 2010-11 and are enough only to cover imports for one and a half months.
Last week, the IMF agreed to extend Pakistan a three-year $6.7 billion loan, making an initial disbursement of $540 million available to the authorities. The loan is aimed at reducing Pakistan’s fiscal deficit - which neared nine percent of gross domestic product last year - to a more sustainable level and reform the energy sector to help resolve severe power cuts that have sapped growth potential. But future disbursements are dependent on the completion of tough economic reforms measured at quarterly reviews.
In Pakistan, a country of 180 million people, only around 250,000 people pay income tax and agriculture, which still accounts for 50 percent of the economy, is totally exempt. To repair the economy, Prime Minister Nawaz Sharif has promised to widen the tax base, improve the image of paying taxes and limit corruption.
The IMF said his budget for the fiscal year to June 30, 2014 “represents an important initial step” but cautioned that “a more efficient and equitable tax system is needed”. Austerity will also push down growth. Before Thursday, the IMF predicted growth of 3.5 percent of GDP but has revised that down to 2.5 percent if the necessary reforms are implemented.
In announcing the loan, the IMF said Pakistan’s adherence to the programme would likely encourage financial support from other donors. The Asian Development Bank has this week announced that it will invest $245 million in Pakistan’s power distribution systems.
Pakistan averted a balance of payments crisis in 2008 by securing a $11 billion IMF loan but that was suspended two years ago after economic and reform targets were missed. Chronic gas and electricity shortages, violent crime and a Taliban insurgency have all hampered growth and contributed to falling foreign investment in Pakistan.
The Pakistani rupee currency depreciated about five per cent against the dollar during the 2012/13 fiscal year. A decade ago annual economic growth rates were about 10 per cent. To secure the latest programme, Pakistan had to fulfil conditions set by the IMF, including slashing costly subsidies on electricity and sending out notices to 10,000 delinquent taxpayers.
The revenue shortfall is largely explained by the underperformance in tax collections in the previous fiscal year, inadequate tax administration, and a slowdown in economic activity. Higher expenditures reflect higher energy subsidies, including clearing the power sector arrears. Moreover, the provincial surplus envisaged in the budget has not materialized. With very low external financing, the deficit has been almost entirely domestically financed.
Monetary policy continued to be accommodative to lift weak private investment and growth, in light of falling headline inflation. In 2012/13, the policy rate has been cut repeatedly by a cumulative 300 basis points to 9 percent, while direct financing of the large fiscal deficit continues to drive growth in monetary aggregates. However, this accommodative policy did not bear fruit in terms of private sector stimulus-private credit shrank in real terms.
The financial system is dominated by banks that have been relatively healthy as capital and liquidity indicators continue to be boosted by large holdings of government securities. Nevertheless, nonperforming loans remain high at 14.7 percent at end-March 2013 with few banks falling below minimum capital adequacy requirements.
IMF directors welcomed the authorities’ ambitious economic programme aiming to reverse the current mix of large fiscal deficits, accommodative monetary policy, and low reserve coverage, and to foster sustained and inclusive growth. They stressed that short-term measures must be complemented by significant reforms in fiscal management, the monetary policy framework and financial markets, the energy sector, public sector enterprises, the business climate, and trade policy.
Directors highlighted that further consolidation will be required to ensure fiscal sustainability. While the 2013/14 federal budget represents an important initial step, a more efficient and equitable tax system is needed, and a significant increase in the tax-to-GDP ratio will be key to create room for social and investment spending while lowering the deficit. This will involve broadening the tax base through a reduction in exemptions and concessions, the extension of taxation to areas not fully covered by the tax net, and an overhaul of tax administration. Directors underscored that fiscal sustainability can only be achieved if the provinces are full partners in the adjustment effort.
Directors emphasized that monetary and exchange rate policies must be geared to rebuilding external buffers and to maintaining price stability over time. They stressed the need to cease direct lending to the government and underscored the importance of monetary policy independence in paving the way for improved price stability.
Directors underlined that continued financial sector stability and steps to deepen financial markets will contribute to boosting economic growth. They considered that risks to the banking sector are manageable, but encouraged the authorities to promptly address the undercapitalization of a few banks and to monitor closely non-performing loans.
Directors welcomed the authorities’ new energy policy, which is geared to addressing long-standing problems that constitute the most critical constraint on growth and have generated large fiscal costs. They encouraged the authorities to work closely with donors and secure broad-based support for the continued strong implementation of their energy sector strategy. Directors also called for efforts to liberalize the trade regime, restructure or privatize public sector enterprises, and improve the business climate to reduce rent-seeking behaviors and increase both foreign and domestic productive investment.
Directors stressed that protecting the most vulnerable from the impact of fiscal consolidation and price adjustments is a priority. They commended the authorities for their firm commitment to boosting targeted income support programmes, and encouraged a gradual expansion of coverage and benefits as savings from energy tariff adjustments and fiscal space are realized.
Directors recognized the risks to the programme from a delicate security situation, a further deterioration in the external environment, and potential constraints in legal, administrative, or technical capacity and resistance from vested interests to the reforms. They welcomed the authorities’ considerable efforts in undertaking prior actions, signalling their commitment to the programme‘s objectives and their willingness to take additional measures if necessary. They emphasized the importance of close collaboration with development partners, including through technical assistance, and continued strong political will and ownership for the programme‘s success.