IMF sets eight new structural benchmarks for Pakistan

ISLAMABAD: Warning of a volatile political environment and external shocks to Pakistan’s economy, the IMF has placed eight new structural benchmarks including an anti-corruption institutional framework for scrutinizing the wealth of public office holders such as cabinet members, parliamentarians, and bureaucrats.

For the revival of the IMF programme after a pause of seven months since February 2022 when the PTI-led government provided unfunded subsidies, now the IMF has asked Islamabad to increase the weighted average power price in October 2022 by about 10 percent over its end-December 2021 level.

The IMF also placed structural benchmarks for a targeted increase of the BISP Kafalat beneficiary base to 9 million families using the National Socio-Economic Registry (NSER) by the end of June 2023, the second finalization of the combined annual re-basing (AR) for FY22 and FY23 to take effect on October 1, 2022, the third submission to NEPRA of petitions for the (i) FY23-July FPA by end-August; and (ii) FY23-Q1 Quarterly Tariff Adjustment (QTA) by end-October which will ensure full recovery of the revenue requirement (including lost revenue from the delayed first-stage Annual Rebasing FYs22-23 in July 2022) within FY23Q2 by end Sep 2022, the fourth adoption of a comprehensive strategy to address high levels of Non Performing Loans (NPLs) in some banks, including by requiring bank-specific plans for reducing NPLs, and to write-off fully provisioned NPLs by end-June 2023, fifth initiate orderly liquidation (resolution) of either or both of the two currently undercapitalized private sector banks by end-May 2023.

 The sixth structural benchmark placed by the IMF incorporates submission to the cabinet of amendments to align Pakistan’s early intervention, bank resolution, and crisis management arrangements with international good practices, in line with IMF staff recommendations for end-Oct 2022, the seventh operationalization of a Central Monitoring Unit (CMU) within the Ministry of Finance till end-Jan 2023, and the eighth publication of a comprehensive review of the anticorruption institutional framework (including the National Accountability Bureau) by a task force with participation and inputs from reputable independent experts with international experience and civil society organizations.

The IMF staff report states that amid a volatile political environment and external shocks, Pakistan faces again the need to address significant imbalances and rising risks. The domestic and external imbalances reflect large fiscal policy slippages, a delayed monetary response to inflationary pressures, and spillovers from the war in Ukraine. As a result, the fiscal and current account deficits have widened considerably, reserves have fallen to a low level, and inflation is at its highest level in a decade. The new government has agreed to a set of corrective policies to ensure financial stability, but strong ownership, firm implementation, and domestic support would be critical for the policy strategy to succeed.

The fiscal adjustment planned for FY23, it states, provides a narrow path forward but would require consistent and decisive policy implementation. The FY23 budget proposes a very ambitious adjustment targeting a small primary surplus.

Sustained implementation of this budget while avoiding further policy slippages is crucial to address imbalances, reduce elevated vulnerabilities and build confidence. Meeting the agreed schedule of increases in the Petroleum Development Levy (PDL) and energy tariffs is particularly important, as they will generate much-needed revenues, strengthen the financial viability of the energy sector, reduce fiscal and external risks, and improve the provision of electricity.

Achieving the budgeted adjustment would require steadfast efforts to reduce risks related to (i) the staggering increases in the PDL (with risks policy reversals) and administrative capacity needed to ensure the yields from novel tax measures; (ii) large planned provincial surpluses; and (iii) a tight federal current spending envelope in a pre-election year. The authorities’ revenue and spending contingencies provide some mitigation, but additional measures may be needed if these prove insufficient.

Going forward, the IMF states that it will be critical to implement reforms that bring Pakistan toward a more effective, efficient, and equitable tax system; in particular, completing the overdue Personal Income Tax (PIT) reforms.

More efforts are needed to reduce poverty, enhance social programs, and protect the most vulnerable by building fiscal space and improving coordination. Although staff supports using temporary measures to protect large swathes of the population against fuel price increases, it reiterated the need to enhance transfers to families already covered by BISP, especially in a high inflation environment. Scaling-up of social spending targeted to the most vulnerable remains critical for inclusion, and while staff welcomed plans to continue with the targeted expansion of the BISP beneficiary base, it restated the importance of improving a well-targeted social safety net program (i.e., BISP) through a comprehensive, fully financed, and coordinated upscaling. The IMF staff also cautioned against the introduction of new programs which can undermine protection of the most vulnerable. Continuing to mobilize additional revenue and careful expenditure management remain critical to creating the necessary space, while keeping public debt on a downward trajectory.

Monetary policy needs to be proactive and data-driven to reduce inflation towards the target. The staff welcomed recent policy rate hikes and stressed the need to continue a tight monetary policy to reduce inflation and support efforts to address external imbalances. Monetary policy should remain forward-looking and data-driven to anchor inflation within the SBP’s objective of 5–7 percent over the medium term. Phasing out the refinancing schemes that support purposes outside of the SBP’s core mandate is also important to improve the functioning of monetary policy.

A market-determined exchange rate and limited SBP interventions remain crucial to absorbing external shocks, maintaining competitiveness, and rebuilding international reserves. Staff encouraged the authorities to strengthen resilience, including by building reserve buffers, and limiting interventions in the foreign exchange market. Allowing greater exchange rate flexibility to address external pressures will help safeguard and improve reserve buffers towards more prudent levels. Strong macroeconomic policies and structural reforms will help further build confidence in the rupee and resolve external imbalances.

Maintaining financial stability warrants close oversight of financial institutions and decisive action to address undercapitalized financial institutions. The SBP should accelerate the recapitalization process using their existing powers to strengthen financial sector resilience. Moreover, lending targets on housing present risks to financial stability and the prudent allocation of credit.

The staff stressed that strengthening the bank resolution and crisis management frameworks should be a key priority to safeguard financial stability and welcomed the adoption of amendments to the SBP Act as an important step toward strengthening the central bank’s independence, governance, and mandate. The new Act will enable the SBP to move closer to formally adopting an inflation target regime.

The Fund staff also welcomed the completion of the AML/CFT 2018 and 2021 Action Plans and urged the authorities to sustain their efforts to mitigate ML/TF risks, including from tax evasion, corruption, and other financial crimes.

Advancing electricity sector reforms is essential. Restoring the sector’s financial viability, and reducing its adverse spillovers on the budget, the financial sector, and the real economy remains a priority. In this regard, timely follow through of the proposed energy tariff increases in FY23 will be key. It also remains critical to update the Circular Debt Management Plan (CDMP) for FY23 to reduce CD and costs, align power tariffs with the cost structure, and improve targeting of power subsidies to the most vulnerable.

The staff welcomed the OGRA Act Amendments which support regular recovery requirements in the gas sector but urged speeding up efforts to establish reliable CD data in the sector, a gas CDMP, and CD projection capacity.

Risks remain high and tilted to the downside on both domestic and external fronts. The macroeconomic outlook remains clouded amid strong external headwinds stemming from high food and fuel prices as a consequence of the war in Ukraine, and tighter global financial conditions. The domestic front, the need to tackle high inflation and undo the effects of the large fiscal slippage of FY22 will return growth to a more sustainable pace as fiscal and monetary policies tighten. The challenging political climate could weaken reform and policy implementation, and undermine Pakistan’s adjustment path, debt sustainability, and growth potential. Moreover, reform fatigue, the political cycle and weak governance and anticorruption institutions could quickly narrow the window to undertake critical reforms. Advanced economy tapering, geopolitical tensions, and waning reform efforts could affect external financing conditions. Close program monitoring, supportive TA, and financing assurances from key lenders somewhat mitigate those risks.

While recognizing risks, the staff supported the authorities’ request for completion of the combined seventh and eighth review under the EFF. In view of the authorities’ recent efforts to strengthen program performance and implement corrective measures, staff also supports: (i) granting waivers of non-observance for both the missed quantitative and continuous PCs at end-June 2022; (ii) augmenting access by SDR 720 million (around 36 percent of quota), extending the program and rephasing access consistent with the modified review schedule; (iii) setting new quantitative targets for end-September 2022, end-December 2022, and end-March 2023; (iv) making the purchase related to the seventh and eighth EFF review available for budget support to address their BOP needs; and (v) approving the new and intensified exchange restrictions as well as modified for a period of twelve months, because they are temporary, non-discriminatory, and needed for balance of payment (BOP) reasons, the report concluded.