It is the political stability, which is fundamentally required for growth on sound footings in all directions


Aug 23 - 29, 2004





The 57th Independence Day is being celebrated at an occasion when the nation is preparing to welcome Finance Minister Shaukat Aziz in his new assignment as the Prime Minister of the country.

People are pinning high hopes in Shaukat Aziz, the master mind of the current economic policies, that he would give them the economic freedom which is a dream even after 56 years of independence of this country. Contrary to the previous experiences when a Prime Minister from a certain political party served the party interests more than addressing the problems confronted to the people in general.

Pakistan came into being in 1947 as a result of a long struggle spanning over a century started from 1857, and unparallel sacrifices offered by the Muslims of the sub-continent to achieve the cherished goal of a separate homeland.

Though the dream of a separate homeland had come true under the dynamic leadership of Quaid-e-Azam Mohammad Ali Jinnah some 57 years ago, yet the nation was still struggling for sustainable social, political and economic independence.

The state of social development in our society is reflected in the torturous agony that more than 60 percent of the population was still living in the darkness of ignorance. The over commercialization of the noble profession of education has become the domain of the rich in the society. The excessive commercialization of education continues to grow unabated taking the education sector far away from the reach of the middle class or middle-income group of the society. Besides exorbitant price of education, the rampant corruption in the education department at all levels has played a dirty role in deteriorating the academic values and norms. It is the money not the brain that can get enhanced the marks in the exams to the desired level. The extremely poor state of governance in the education sector has also produced a breed of the so-called graduates who succeeded to get through the exams at gun point but obviously added to the crop of the corrupt as they managed to sneak into the government departments.

The state of health sector was also not an exception. I would like to give just one example. I personally know a young man who got multiple leg fractures in a road accident. The injured man who hails from what it is called lower middle class approached to an orthopedic hospital, much popular for its expertise in Karachi. I won't like to mention the name because of my social responsibility. The staff of that hospital refused treatment only because the poor young guy was unable to pay the exorbitant price of the treatment asked by the hospital. The remaining hospitals were equally same as far as the greed of money was concerned. Today, that young man is lying on the bed with the fractured leg because he cannot afford to pay the huge price. One can easily image that how many such lives are destroyed only because of the system. The situation calls that there should be a limit of charges for the specialists in surgery or medicine and also for the specialized educational institutions who are out to fleece the people in the name of specialization either in education or health sectors.


It is the political stability, which is fundamentally required for growth on sound footings in all directions. Unfortunately, this segment of vital importance also failed to deliver and to provide a direction to the nation. Contrary to the basic political principles to develop a consensus on national priorities, this sacred area of peoples benefit was badly infected due to growing polarization in the political forces of the country. The deterioration in this sector has reached to the extent that today, if I am not wrong, no political force in the country can claim to be the representative of the people from all corners of the country. It is highly depressing, disgusting and even shameful that major political forces have got a stigma or stamp of a certain demographic association, or a religious sect. Apart from general political slogans, it is the harsh fact of the day that party interest has become supreme as compared to the national interest. In certain cases, the approach of the political forces has infected so badly that they claim that the country may disintegrated if the power was not transferred to them. This was the state of affairs, which time and again provided opportunity to the armed forces to take the reign of the affairs into their hands. It was the hopeless strategy of certain major political forces in this country that they turn to power by raising impractical slogans and false promises and failed to fulfill at the end of the day. They also destroyed the economy of this poor country by excessive politicization in public sector organizations, major national projects, and the agriculture sector by bribing licenses in certain agro-based industries. The ultimate sufferers of this entire political hotchpotch, however, were the innocent citizens of this country.




Specifically speaking, Pakistan is an agriculture-based economy. Nature is kind enough to have given a strong agricultural base to Pakistan and has placed this country in a situation where it should not be subdued to any pressure from any corner of the world. It is, however, unfortunate that despite having a strong economic base, the overall economy has failed to deliver the desired results so far.

Although the country was better off today as compared to the state of affairs three four years back when our foreign reserves had declined even below one billion dollars, we were unable to honor out commitments of debt servicing on time, the international donors were reluctant to extend loan advances, the then rules have to borrow money from commercial lenders at the higher interest rates to avoid becoming a default state.

Today the economic and financial situation of the country is entirely different from what it was 4 years ago. Even people having a certain mind set, who oppose for the sake of opposition may not deny the fact that the macro-economic fundamentals were never so strong as they are today. Our foreign exchange reserves are over $12 billion, the country had never crossed the psychological barrier of $10 billion right from its inception. Today we comfortably achieved the export target of $12.2 billion and the current export target of $13.7 billion also seems well within reach at the end of the year. Our home remittances also crossed $4 billion during the last two years. Our balance of payment also improved. Above all these achievements, the most satisfying factor is the nation was gradually coming out of the huge foreign debt-trap. You just go back into 4 years back and recall the tone in which the international donors used to talk to the leaders of Pakistan, and they use to run from pillar to post with a begging bowl in their hands. Today, the strong and tightening strings of that debt trap have started loosening. We are about to say goodbye to the IMF. Could be imagine to say good bye to any international donor just four years back, it is a reality which should be acknowledged by those who really love this country. One should, however, bear in mind that all these economic achievements were not solely, the country has achieved during recent years are politically supported which have no doubt given a breathing space to our economy to grow on sound footings and fulfill the expectations of the people of this country. The real contribution of the industrial or agriculture sector does not represent the actual potential and depth of our economy. It is the time that the active players of the economy should carve a place for themselves in the world market so that they could move without political support if the wind starts blowing in the opposite direction. For the economic land marks achieved so far, however, give a sense of economic recovery and sovereignty to the nation for which the credit goes to the present team of the economic managers led by President, General Pervez Musharaf. It is really heartening to see that the economic stability has arrived at a stage when we are preparing to survive from our own resources without further assistance from the International Monetary Fund.

A memorandum addressed to the IMF by the State Bank of Pakistan and the Ministry of Finance gives a real insight of the state of economy in Pakistan.


"Pakistan's government remains committed to implementing the economic strategy set out in the Poverty Reduction Strategy Paper (PRSP), published in December 2003, supported by the Poverty Reduction and Growth Facility (PRGF) arrangement.

The strategy aims to create an enabling environment for sustained high growth, job creation, and poverty reduction.

We held discussions with Fund staff in April 2004 for the eighth review under the PRGF arrangement.

In light of these discussions, the attached Memorandum of Economic and Financial Policies (MEFP) reviews economic developments and policy implementation through December 2003 and beyond under the arrangement, updates the macroeconomic framework, and discusses the financial policies and the structural reform program for the remainder of 2004. It supplements the MEFP dated November 22, 2001, as well as the supplementary MEFPs dated March 12, 2002, June 18, 2002, October 16, 2002, February 8, 2003, May 29, 2003 and October 11, 2003.

All quantitative performance criteria for end-December 2003 were met. Moreover, structural performance criteria were met, except for minor deviations on (a) effective transfer of ownership of Habib Bank Limited by end-December 2003; (b) preparation of an action plan by end-October 2003 for establishing a transparent regulatory framework for regional electricity tariff setting by end-December 2003; (c) notification of electricity tariff adjustments within 30 days of the determination by the National Electric Power Regulatory Agency (NEPRA); (d) not implementing downward electricity tariff adjustment determined by NEPRA unless the respective utility met its accrual balance target in the previous quarter.

The effective transfer of ownership of Habib Bank Limited took place in February 2004 upon request of the investor, although we had accepted the bid on December 29, 2003. While we had prepared the action plan for establishing a transparent electricity tariff policy in October 2003, the announcement of the electricity tariff guidelines for NEPRA was delayed until May 2004 to allow for comprehensive discussions with the World Bank on developing a financial recovery plan for the power sector. The downward tariff adjustment for the Karachi Electric Supply Company (KESC), determined by NEPRA in mid-January 2004, was notified only in mid-April after we had confirmed that the accrual balance of the preceding quarter was met and to allow time for discussions on the overall subsidy policy. Finally, we notified a downward electricity tariff adjustment for the Water and Power Development Authority (WAPDA) in November 2003, even though WAPDA missed its accrual balance target for end-September 2003, albeit by a very small margin. However, we delayed the notification until we were confident that WAPDA would meet its cumulative end-December 2003 target, which it did by a comfortable margin.

The government has also reassessed its needs for external non-concessional borrowing. In particular, a larger-than-expected guarantee for external borrowing by Pakistan International Airlines (PIA) has been provided on favorable terms to proceed with its fleet renewal and build on its successful business turnaround. PIA should be able to service this loan out of its own resources. To accommodate this guarantee, the $500 million Eurobond issue and other smaller loans, we would need to increase the ceiling on contracting of non-concessional loans to $1 billion, still less than prepayment of expensive external debt that we effected earlier this year.

On this basis, and in view of the policies set out in the attached MEFP, including the measures to strengthen our power sector reform strategy, the government requests waivers for the non-observance of the structural performance criteria listed above, modification of the performance criterion discussed above, and the completion of the eighth review.

The government will provide the Fund with such information as the Fund may request in connection with Pakistan's progress in implementing the economic and financial policies, and achieving the objectives of the program. The government believes that the policies set out in the attached MEFP are adequate to achieve the objectives of the program, but will take any further measures that may become appropriate for this purpose. The government of Pakistan will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund's policies on such consultation.


Pakistan continues to make solid progress under its economic program supported by the current arrangement under the IMF's Poverty Reduction and Growth Facility (PRGF).

Economic growth has recovered and is strengthening, while inflation has remained low. Fiscal and external vulnerabilities have been reduced through a reduction in fiscal imbalances. The debt situation continues to improve toward sustainable levels, while the strengthened external position has allowed the State Bank of Pakistan (SBP) to rebuild its international reserves.

Notwithstanding the economic successes, the challenges ahead include reducing poverty, creating job opportunities, and improving social indicators. We have outlined our strategy to meet these challenges in our Poverty Reduction Strategy Paper (PRSP) entitled "Accelerating Economic Growth and Reducing Poverty: The Road Ahead," which was completed by end-2003.

As part of our overall strategy described in the PRSP, this Memorandum of Economic and Financial Policies sets out our economic policies for the remainder of 2003/04 and for 2004/05. The government remains strongly committed to its reform agenda. We recognize that sound macroeconomic policies and further structural reforms are needed to create and maintain an environment conducive to private sector growth. We also recognize that while economic growth is necessary, it is not a sufficient condition to reduce poverty. Thus, apart from focusing on growth, our policies also aim to reduce poverty through greater social inclusion, including through human development and devolution of political and economic power.


Macroeconomic performance continues to be favorable. The 5.3 percent economic growth target for 2003/04 (July-June) is expected to be exceeded, reflecting strong growth across all sectors. Twelve-month inflation reached 5.3 percent in March 2004, compared with 1.9 percent at end-June 2003, following a temporary surge in food prices in the last months of 2003. Inflation in July-March 2003/04 was 3.7 percent, slightly higher than in the same period a year before, but still below the 4 percent inflation target for 2003/04 as a whole.

The external position remains strong. Exports and imports (on f.o.b. basis) grew by 16.5 and 16.8 percent in U.S. dollar terms, respectively, in the first nine months of 2003/04, following very high growth rates in the previous year. This, coupled with still sizable private transfers, implies that the current account continues to show a sizable surplus. Despite a reduction in SBP purchases of foreign exchange in the inter bank market in recent months and the early repayment of loans to the Asian Development Bank (ADB), equivalent to $1.1 billion.

Pakistan successfully re-entered international capital markets, with the issuance of a $500 million, five-year Eurobond in February 2004. The overall setting for this issue proved favorable in view of Pakistan's improved fundamentals and the issue was four times oversubscribed. With a 63/4 percent coupon rate and issued at par, the yield spread was 370 bps over U.S. treasury bonds, significantly lower than prevailing yields on bonds of many other emerging economies, with similar, and in some cases better, credit ratings.



All quantitative performance criteria for end-December 2003 have been met. Similarly, almost all indicative targets for end-September and end-December have been met. Exceptions were the end-September and end-December targets for social and poverty-related spending that were missed by a very small margin, though we believe that these preliminary data may somewhat understate actual expenditures. Reconciliation of preliminary expenditure data has typically resulted in some upward revisions, for example for 2002/03. Thus, there is a high probability that actual expenditure may have exceeded the end-September and end-December targets. However, full reconciliation is only done on an annual basis and not for quarterly data. Another exception is the end-September accrual balance target for the Water and Power Development Authority (WAPDA), which was missed, also by only a very small margin. However, the end-September shortfall in WAPDA's accrual balance was made up by end-December.

Budget execution is on track. The overall deficit (excluding grants) for the consolidated government was lower than programmed in the first half of 2003/04, with higher-than-targeted revenues and lower expenditures in most categories, except for defense.

Revenue collection by the Central Board of Revenue (CBR) exceeded the end-December target by a comfortable margin. Preliminary data indicate that these trends have continued in recent months.

Monetary growth continued to be strong, driven mainly by strong private sector credit growth. Broad money grew by 18.5 percent in 2003, while reserve money grew by 16.5 percent. Credit to the private sector accelerated to 28.5 percent. This rapid pace of monetary expansion reflects a much stronger-than-expected increase in money demand.

Meanwhile, the strong credit growth appears to reflect the buoyant economy, low interest rates, and ample liquidity in banks. The rate of monetary and credit expansion remained high in the first few months of 2004.

Further progress was made in implementing structural reform measures, although some delays occurred in the area of tax policy and administration, the introduction of universal self-assessment has been successful. Guidelines for presumptive taxation of non-filers under the sales tax were issued in December 2003. No new exemptions have been granted regarding income tax, customs duties, or the general sales tax (GST). Significant progress has been made toward opening an additional large taxpayer unit (LTU) in Lahore and five medium taxpayer units (MTU) in regional centers. Work for compiling a database of taxpayers covered by these new units was completed in March 2004.



We expect that the National Finance Commission award, when finalized, will strengthen and consolidate the devolution process by allocating a larger share of the divisible tax pool to provinces.

In the energy sector, an action plan for establishing a transparent regulatory framework for the setting of electricity tariffs was prepared by late October 2003, with a view to implementing these actions in the following months. However, the implementation of this plan has been delayed, and the petitions for the determination of structural tariffs for WAPDA's successor entities, filed by end-June 2003 with the National Electric Power Regulatory Agency (NEPRA), are all still pending for the distribution entities (the transmission and most of the generation petitions have now been finalized). We are working closely with the World Bank to develop a medium-term recovery plan for the sector. Electricity tariffs were reduced in November 2003 in accordance with the automatic tariff adjustment, despite that WAPDA had missed its accrual balance target under its Financial Improvement Plan (FIP) in the preceding quarter, albeit by a very small margin. The financial performance of both WAPDA and the Karachi Electric Supply Company (KESC) improved significantly in the last quarter of 2003, however, largely reflecting a greater availability of hydropower in the case of WAPDA, but also a reduction in technical and operational losses.

As a result, both entities met the end-December targets under their FIPs by considerable margins. Notification of the electricity tariff for KESC, determined by NEPRA in mid-January 2004 under the automatic tariff adjustment, has been notified on April 15, 2004.

The delay was mainly due to discussions on overall subsidy policy and confirmation of the accrued balance of the preceding quarter.

In the area of financial sector reform, a bid for a majority stake in Habib Bank Limited (HBL) was accepted on December 29, 2003. The transfer of ownership was completed by end-February 2004, and the new owner has taken over HBL's management.

With this transaction, nearly 80 percent of the country's banking sector assets are now in private hands. National Savings Schemes (NSS) rates were adjusted on January 1, 2004, to better align them with interest rates on Pakistan Investment Bonds (PIB).



We are aiming for economic growth of above 6 percent annually, over the medium term, to significantly reduce poverty. This is ambitious, but achievable. Economic growth in 2003/04 is expected to be about 6.4 percent, while for 2004/05, a growth rate of 6 percent. The financial performance of Pakistan International Airlines and Pakistan Steel Mills also exceeded targets under their FIPs in the first half of 2003/04, contrary to that of Pakistan Railways, which suffered from a sharp drop in oil transport and a reduction in tariffs for transit trade to Afghanistan.

6.5 percent growth could very well be realized, building on the current momentum and provided that external demand and local weather conditions remain favorable. Average inflation for 2003/04 is expected to be close to, or moderately above, the 4 percent target. Inflation will be targeted not to exceed 5 percent in 2004/05.



The government is determined to meet its fiscal targets and will be ready to take additional steps, including expenditure cuts, in the event of any unexpected weakening in revenue performance in the last quarter.

We are fully aware that the budget for 2004/05 will need to balance the need for accelerating growth through increased social and development spending and further debt reduction. We believe that both of these objectives can be achieved with the right mix of fiscal policies. The continued decline in the debt ratio will contribute to further lowering the claim of debt service obligations on scarce government resources. We will have to maintain defense outlays at 3.9 percent of GDP to meet the newly arisen challenges along the Afghan border. At the same time, we remain committed to our PRSP agenda and will also increase social and poverty-related spending in 2004/05 to PRs 278 billion (5.6 percent of GDP). To create the necessary fiscal space for this, fiscal policy will continue to need to focus on strengthening revenue collection and reducing subsidies to loss-making public enterprises by improving their performance. We expect CBR revenue to grow somewhat faster than nominal GDP growth to Rs 576 billion, as a result of past and ongoing reforms.

We have endeavored to expeditiously reduce the external debt burden through early repayments of $1.1 billion in expensive debt, refinancing, and to restore our credit ratings in the global capital market. At the same time, we have re-entered international capital markets through an issuance of a $500 million, five-year sovereign bond, with a view to establish an effective international pricing benchmark to facilitate foreign investors in gauging Pakistan risk. In addition, we needed to extend a guarantee for borrowing by PIA on highly favorable terms to proceed with its fleet renewal and build on its successful business turnaround. In the event, the contracting of new non-concessional external debt will exceed the limit agreed under the existing PRGF arrangement for June 2004. In light of the rationales for these new borrowing needs, and given our improving debt capacity (including on account of the prepayment), we request that the limit in the contracting of non-concessional loans be increased to $1 billion.


Monetary policy will remain geared toward maintaining low inflation. The risks for a further upsurge in inflation are expected to be limited because of weak import prices of most non-energy products, the strong Pakistani rupee, and the positive outlook for agricultural output. Nevertheless, with average inflation close to the target, and given the rapid pace of monetary expansion, including strong growth of private sector credit, rising wholesale and asset prices, and the very low level of short-term interest rates, the SBP will continue to carefully monitor inflation developments. The SBP has already tightened its policy stance slightly in the last few months short-term interest rates have already begun to rise marginally and will be ready to tighten further should any renewed inflationary pressures arise. In addition, the SBP has reduced its purchases in the foreign exchange market in recent months to help slow down the rate of monetary expansion and contain inflationary pressures.

For the months ahead, SBP operations in the foreign exchange market will be limited to smooth short-term fluctuations, and the SBP will not resist sustained pressures for the Pakistani rupee/U.S. dollar exchange rate to appreciate.

The indicative monetary program for 2004/05 assumes a modest further strengthening in money demand, with broad money and reserve money growing by 12.8 percent and 9.3 percent, respectively.


We will continue to build on the considerable progress already made in tax policy and administration reform. The 2004/05 budget will contain measures removing income and sales tax exemptions, as well as other base-broadening measures, yielding a total of Rs 5 billion. In addition, we intend to implement an action plan on extending GST coverage to additional services after approval of the cabinet and provincial governments/legislatures. Furthermore, in line with our strategy to rationalize our tax and tariff regime, in order to stimulate private investment, the 2004/05 budget will continue to reduce the corporate income tax rates, as per the pre-announced roadmap in the income tax ordinance, reduce excise rates on certain products, and rationalize import duties on raw materials and equipment.




A more regular monitoring of social indicators will help our efforts to increase the effectiveness of social and poverty-related spending. A full Core Welfare Indicators Questionnaire (CWIQ), covering 77,000 subjects throughout the country, started in June 2004. The results from this survey will become available in time to serve as input for the 2005/06 budget discussions. We have broadened the definition of social and poverty-related spending to include law and order, justice, and rural electrification, as the PRSP consultation process made it clear that these policy areas are important for addressing rural poverty.

We aim to make further progress in strengthening expenditure management and fiscal transparency. In 2003/04, we released budgetary funds on a timely basis, and thus allowed ministries to operate without facing financing constraints. Consequently, we were able to largely execute our spending plans on social and poverty-related expenditures, as well as the Public Sector Development Program (PSDP). Further improvements have been made in reconciliation of fiscal data. With support from the U.K.'s Department for International Development (DFID), we have begun developing a medium-term budget framework. A pilot costing and projection exercise was undertaken to improve budgeting health and population welfare ministries. Based on lessons learned, consultancy support is being arranged to develop a costing model that can assist the two ministries in budgeting their expenditure.

Subsequently, the model will be rolled out to all other ministries. A Government Finance Statistics (GFS) compatible New Accounting Model (NAM) is being used for the 2004/05 budget for the federal government.

The North West Frontier Province is undertaking this exercise in a parallel mode. The NAM-based accounting is being introduced in the provinces in a phased manner.

Further progress is being made in the implementation of our national anti-corruption strategy. The National Accountability Bureau (NAB) has been focusing on raising awareness, enforcement, and prevention. The NAB is working in close coordination with the provincial anti-corruption agencies. Vigilance units have been set up in several government departments, to which the NAB provides support. An awareness campaign has been started with workshops and discussions in civil service academies, banks, and other private sector bodies, and a broad media campaign was started in January 2004. We will continue our efforts to contain the "Benami" practice (whereby assets are held in the name of a person who is not the true beneficiary). The "Benami" task force submitted its report to the cabinet in October 2003, and we will start implementing the recommendations after approval by the Cabinet and provinces and initiate legislation to prohibit "Benami" transactions and holdings.