PAKISTAN Economic Update

Stabilization efforts since November 2008 together with a decline in international commodity prices have

succeeded in reducing external imbalances, rebuilding foreign exchange reserves, and lowering inflation

in Pakistan. However, the macroeconomic situation remains fragile and the medium-term outlook

uncertain. Progress with the implementation of reforms has been uneven, with inadequate measures

taken to boost revenue mobilization and control public spending. The volatile political and security

environment has complicated policy-making and made the implementation of stabilization measures

challenging. Also, while the acute phase of the global financial crisis seems to be ending, global

recovery will be gradual and take time. In the meantime, there are significant risks to exports,

remittances and external financing. The fiscal year 2009/10 looks difficult.

Economic activity significantly slowed down in 2008/09. The current account deficit narrowed to 5.1

percent of GDP driven by a sharp contraction in imports which exceeded that in exports, and growing

workers’ remittances. While remittances increased, financial inflows (such as FDI and portfolio

investment) dropped sharply—by over 37 percent—owing to macroeconomic instability, deteriorating

security situation and global recession. Despite these developments, thanks to IMF disbursements, SBP

foreign exchange reserves rebounded to about US$9.1 billion (2.9 months of imports) by end-June 2009.

However, fiscal problems continued during 2008/09 and the fiscal deficit target was exceeded by 0.9

percent of GDP, amounting to 5.2 percent of GDP. Overall revenues fell substantially short of the target

—by one percentage point of GDP—primarily owing to a drop in tax revenues as the economic slowdown

reduced the buoyancy of Pakistan’s two main tax bases (manufacturing and imports). FBR tax revenues

declined from 9.8 to 8.8 percent of GDP. At the same time, federal government’s attempts to control

spending were thwarted by high provincial spending.

The first two months of 2009/10 suggest that fiscal instability will continue, and the first quarter fiscal

deficit target will likely be missed. Revenues have continued underperforming: FBR tax collection during

July-August 2009 increased only by 3.6 percent compared to 19.5 percent required to reach the annual

target. Also, provincial governments have continued spending at high levels, and power subsidies have

remained unaddressed by the federal government.

Failure to raise revenues going forward would further heighten Pakistan’s vulnerability to shocks, and

jeopardize country’s development efforts by limiting resources available for planned investments in

human and physical infrastructure. There is a risk that Pakistan may repeat past mistakes. Pakistan’s

high economic growth in the earlier part of this decade was in part explained by heavy reliance on

external financing and on expansionary fiscal stance, while revenues and savings remained stagnant.

This reliance on external financing left the economy vulnerable to external shocks, which came in

2007/08 and, in the absence of corrective measures, led to a balance of payments crisis. To reduce the

economy’s vulnerability to shocks and avoid the repeat of past mistakes, stepping up domestic revenue

mobilization would be critical.