Pakistan is facing ‘serious economic challenges’ and it needs to carry out a set of comprehensive economic reforms, the International Monetary Fund said hours after it approved financial assistance of USD 6.7 billion to prevent it from a brink of economic collapse.

“Pakistan is facing serious economic challenges. Overall vulnerabilities and crisis risks are high, with subpar growth and unsustainable fiscal and balance of payments positions,” said Nemat Shafik, the IMF Deputy Managing Director and Acting Chair.

Pakistan’s 2013-14 federal budget represents an important initial step towards the needed fiscal consolidation, she said.

“However to ensure medium-term fiscal sustainability and create fiscal space for social and investment spending, it is important to raise the tax-to-GDP ratio, including by broadening the tax base through a reduction in exemptions and concessions and extending taxation to areas currently not fully covered by the tax net,” she said.

Tax administration overhaul is also required, and provinces should contribute fully to the adjustment effort, she added.

The IMF official said that monetary and exchange rate policies should be geared to rebuilding external buffers, direct lending to the government should cease and efforts to improve independence of monetary policy need to be stepped up to pave the way for improved price stability.

Shafik said that risks to the banking sector are manageable, although the undercapitalisation of vulnerable banks needs to be addressed.

“To achieve sustained and inclusive growth, short-term macroeconomic measures must be complemented by significant structural and governance reforms.

“The recently announced energy policy will address the long-standing problems in the sector, which constitute the most crucial constraint on growth and have generated large fiscal costs,” said Shafik.

In addition, the trade regime and public sector enterprises needs to be liberalised, she said.

Noting that protecting the most vulnerable from the direct and indirect impacts of fiscal consolidation and price adjustments is a priority, she said coverage and benefits of these programs should be expanded as savings from tariff adjustments and fiscal space are realised.

According to IMF, Pakistan’s growth trajectory has borne the tolls of both internal security and macroeconomic imbalances, as well as an uncertain global and regional environment.

These factors, along with the country’s longstanding structural problems, mainly in the energy sector, have kept growth below the level needed to reduce poverty and absorb the growing labour force, it said.

 

Power outages, resulting from many years of financial and governance problems and averaging about 8-10 hours a day, together with devastating floods and a difficult security situation have contributed to the anemic growth, it noted.

GDP growth has averaged only three per cent over the past five years. Private domestic investment has dropped from 14 per cent of GDP in 2007-08 to around 11 per cent in 2012-13 due to a difficult business climate.

With capital flows virtually drying up, central bank reserves have declined to critical levels, falling by some 45 per cent in the past year alone.

As of end June 2013, reserves stood at USD 6 billion.

Much effort is needed to boost confidence in order to attract foreign direct investment in line with Pakistan’s long-term growth potential, the IMF said.

The new Pak Government has put in place an ambitious economic reform program aimed at reversing the current large fiscal deficits, fostering inclusive growth and addressing short and medium term problems.

They have already implemented key measures to ensure a strong start, including fiscal consolidation measures totalling two per cent of GDP, adjusting electricity tariffs as part of a new comprehensive energy policy, reorienting monetary policy to rebuild foreign exchange reserves, in addition to reducing inflation, and launching a decisive tax enforcement program.

These measures are expected to reduce the budget deficit to sustainable levels, reduce crowding-out of private investment, and containinginflation over the medium-term, the IMF said.