oL �o No. 71-MK

PakistanGrowth Through AdjustmentMarch"1,"

EMEA Regional Office

FOR OFFICIAL USE ONLY

ony in the performance of t.er official duties. ft,, tents may not otherwisebe discosed without World Bank ~iihorization.

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CURRENCY EQUIVALENTS /a(annual averages)

Ra per US$1.00 US$ per Re 1.00

FY79 9.90 C0.101FY80 9.90 0.101FY81 9.90 0.101FY82 10.55 0.095FY83 12.75 0.078FY84 13.48 0.074FY85 15.16 0.066FY86 16.13 0.062FY87 17.17 0.058

/a Since January 8, 1982, the exchange rate for the rupee has been managedwith respect to a weighted basket of currencies.

GOVERNMENT OF PAKISTANFISCAL YEAR

July 1 to June 30

Note: Historical data in the report refer only to the present nationof Pakistan, i.e. the former West Pakistan, unless otherwisespecifically noted.

FOR ocMaAL US. ONLY

LIST OF ABBREVIATIONS AND ACRONYMS

ADP - Annual Development ProgramBMR - Balancing, Modernization, and ReplacementCCIE - Chief Controller of Imports and ExportsCIPC - Central Investment Promotion ComitteeDFC - Development Finance CorporationEEC - Economic Coordination ComuitteeGCP - Ghee Corporation of PakistanGDP - Gross Domestic ProductGOP - Government of PakistanIPB - Investment Promotion BoardMOF - Ministry of FinanceNCB - Nationalized Commercial BanksNRP - Nominal Rates of ProtectionNSS - National Savings SchemesNTB - Non-Tariff BarriersNTRC - National Tax Reform CommissionPBC - Pakistan Banking CouncilPOL - Petroleum, Oil, and LubricantsPSM - Pakistan Steel MillSBP - State Bank of PakistanVAT - Value Added Tax

This document has a mstrtied distribution and may be usd by recipients only in the performanceof their official duties. Its contents may not otherwise be discosed without World Bank authorization.

GROWTH TRROUGH ADJUSTMENT

PAKISTAN

Table of Contents

Page No.

W NUAIY AND CONCLUSIONS i - xv

Cbapter I: Recent Economic Development 2

Econoic Growth ........................ 1

Savings and Investment .... .... . 5

Employment and Wages .......................... 7

Public Finances ................. . ............. 10

Money, Credit and Prices......... 17

Balance of Payments .......... ....... . .... 20

Chapter II: Improving Fiscal Performance................... 25

A. Controlling the Fiscal Deficit ............ 25

- Fiscal Deficit as a Saving-Investment Gap 25- Accommodating the Deficit ............... 27- Financable Fiscal Deficit Consistent with

Macro-economic Targets ................ 30

B. Recommended Fiscal Policy Changes .......... 32- Streamlining Government Expenditures .... 34- Resource Mobilization ................... 43- Improved Cost Recovery for Public Services . 53

Appendix to Chapter II 57

Chapter III: Trade and Industrial Regulatory Policies ......... 63

A. Trade Policy Regime ... .. . . ....................... . 64- Introduction ....... .................... ... 64- Non-tariff Barriers * ...................... 64

This report utilizes the results of a mission which visited Pakistan inSeptember-October 1987 as well as sector reports on trade, regulatory, andfinancial sector policies. The mission was composed of Lorene Yap, missionleader; Tercan Baysan and Kee Cheok Cheong, headquarters; Mete Dv:rdag,Shcamhad Akhtar, and Rashid Aziz, resident mission; and Kenan Bulutoglu,consultant. William McCleary contributed the tax section of chapter II.Shideh Hadian and Tulay Ozerol provided research assistance.

-it1-

- Nominal Tariff Structure ........ ..... 68- Export Regime and Anti-Export bias ........ 72- Scope, Timing, and Sequencing of a Proposed

Trade Policy Reform Program ...... ..... 75- Phase One: Imediate Trade Reforms (FY89-91

for most measures) 76- Phase Two: Medium-Term Changes (e.g.,

beginning in FY90 for about 3 years 77

B. Industrial Regulatory Policies . .. 86- Purpose and Consequences of Regulation .... 86- Recent Changes in Regulatory Policies ..... 88- Recommendations: .................. . .... . 91

Appendix to Chapter III ...... ................... 93

Chapter IV: Financial Sector Reform ... 97

Introduction ..................................... 97

Domestic Debt .................................... 98

Monetary and Credit Management ................. .. 100

Commercial Banking System ...... .................. 102

Capital Markets .................................. 104

Scope and Phasing of Reform .................... .. 104

Reform of the Banking System ................... .. 105

Debt Financing Strategy ....... ................... 107

Monetary Management ........ ...................... 108

Chapter V: Recommended Five-Year Adiustment Program 110

A. The Proposed Development Policy Agenda ....... 110

B. The Medium-Term Macro-economic Outlook . 117- Investment, Savings, Real Income Growth . 117- Balance of Payments . 117- External Capital Requirements . 121- Debt Servicing Capacity . 122- The Alternative to the Proposed Reform

Program . 122

C. Consistency Framework for FYV9-90 ... 124- Savings-Investment Balance . .. 125- Breakdown of External Balance . 127- Financial Balances ... 127- Summary ... 130

Appendix to Chapter V .... 132

STATISTICAL APPENDIX . 133

-iii-

Table of Contents (continued)

List of Tables in Text

Page No.

Su=ary and Concluasions

Table 1 - Proposed Consolidated Budget Magnitudes,FY89-93 .......................... ****....... v

Table 2 - Sequencing the Policy Agenda ............. .... xii

Chapter I: - Recent Economic Developments

Table I.1 - Growth and Structure of GDP, 1983/84-1986/87 ..... 3Table 1.2 - Resource Availability and Use, 1983/84-1986/87 ... 6Table I.3 - Trends in Employment and Wages, 1971/72-1984/85 .. 9Table I.4 - Summary of Consolidated Public Finance,

1980/81-1986/87 . .. ... ... 11Table I.5 - Composition of Total Expenditures,

1980/81-1986/87 -................... . .......--.. 13Table T.6 - Annual Developmcnt Plan, 1982/83-1987/88 15Table I.7 - Consolidated Revenues, 1980/81-1987/88 16Table 1.8 - Summary Annual Credit Planning, 1984/85-1986/87 18Table 1.9 - Balance of Payments, 1983/84-1986/87 ........... 21Table 1.10 - Incentive and Trade Indicators, 1980/81-1986/87 22Table 1.11 - Structure of Foreign Trade, 1980/81-1986/87..... 23

Chapter II: Improving Fiscal Performances

Table II.1 - Investment, Savings and Net Borrowing ............ 26Table II.2 - Sources of Finance for Fiscal Deficits ........... 27Table II.3 - Government Capital Transactions ........ 0.. ....... 29Table II.4 - The Ratio o0 Gross National Product to Money,

1984/85 - 1986/87 .. ........................... 29Table II.5 - Proposed Budgetary Scenario, 1988/89-1992/93 ..... 33Table II.6 - Structure and Growth of Government Expenditure,

1980/81-1986/87 ......... . o.. o..35Table II.7 - Proposed Federal and Provincial Subsidies .... *.... 38Table 11.8 - Structure and Growth of Provincial Revenues,

Expenditures and Inter-Government Transactions . 42Table II.9 - Comparative Tax Structure ........................ 45Table II.10 - Proposed Revenue Improvements, 1988/89-1992/93 ... 54

Chapter III: Trade and Industrial Regulatory Policies

Table III.1 - Incidence of Banned and RestrictedItems by Major Commodity Classification,1986/87 ............. ................................. 66

Table III.2 - Unweighted Averages and FrequencyDistribution of Tariffs and NRPs, 1986/87 ..... 69

Table III.3 - Effective Exchange Rates for Exports and Import,and Their Ratio . ..... ........ . ... . 74

Table III.4 - Implications for Import Expenditures and CustomsRevenues ....... ...... ..... a.*79

-iv-Table of Contents (continued)

List of Tables in Text

Paxe No.

Table III.5 - Implications for Import Expenditures, Phase One:Simulation Results ... . ................. .. ....... 81

Table III.6 - Implications for Import Expenditures, Phase Two:Simulation Results ............... . ..... **. . 83

Table III.7 - Summary Table - Implications for Import Expendituresand Customs Revenues: Simulation Results ..... 84

Table A.1 - Impact on Import Expenditure and Customs Revenues:Simulation Results - Low Elasticity Scenario .. 93

Table A.2 - Impact on Import Expenditure and Customs Revenues:Simulation Results - High Elasticity Scenario . 95

Chapter IV: Financial Sector Reform

Table IV.1 - Domestic Credit to Private Sector as Percentageof Expanded Money Supply (M2), 1985 ......... 0.... 101

Chapter V: Recommended Five-Year Adiustment Program

Table V.1 - Recommended Policy Agenda, 1988/89-1992/93 ...... 113Table V.2 - Key Economic Indicators for Adjustment Scenario,

FY88-95 . .. ...................... * 118Table V.3 - Balance of Payments Projections for Adjustment

Scenario, ?Y88-97 ....... ..... *.... 0060* 119Table V.4 - External Capital Requirements for Adjustment

Scenario, FY89-93 ........ ........ *** 121Table V.5 - The Alternativs Status Quo Scenario, FY88-95 .... 123Table V.6 - Investment, Sa'ings and Net Borrowing ....... 126Table V.7 - Balance of Payments Capital Account ....... 128Table V.8 - Government Capital Transactions .......... 129Table V.9 - Non-Government Sector Capital Account ........... 131

i

PUI3TU - ECONOIC IEICATUcow Omr" I eCeutry mim i Pakista.

id-JIl Puoatlum faills.) 99 Pages 1.1 31964 Per Capita WP isMt 31M Set Prepareil kptW 1907

A. bors iif krm Somitc ProecKt 3. kawth but It pe mmr)

(free cornet price Wst) (from cnstst price dW.

lYib 197 lo low4 IlK lIp 1165-73 19734 191K-U INS IlMp

km rnsiti Prdt C.P. l60.0 100.0 111.6 Iw$ I00. 100.0 5.4 5.4 4.1 1.3 7.2Sot lagidir loee 7.4 9.1 1I.I 10.3 10.5 ILI . .. .

ogicults, 37.2 23.3 24.3 21.3 22.1 22. 4.7 23i 2.1 9.9 4.1uw-r, 10.4 19.9 23.3 23.3 25.0 25.3 4.b .2 Li3 7.9 7.3is# mbick ~iotyiqv) 13.4 14.5 15L0 33.1 17.7 15L5 4.2 5.3 10.1 0.4 4.5Sonic. 34. 38.2 39.9 42.2 42.4 42.5 5.4 4.2 4.3 3.0 7.1

Soures uslae 0.3 21. 11. 1. -I23 -10.2 . .

laptsotef WS 3L5 13.4 I2.3 11.4 10.3 12.0 4.5 4.2 5.0 4.2i 32.iep.ts of .S 14.0 14.2 23.3 23.0 23.1 22.2 -1.3 9.1 2.3 7.1 1.5

Total Ezpudtwes 10.3 102.1 111.5 111.4 112.3 110.2 4.0 4.3 5.4 9.1 3.4

iota 66~~34. 19.9 93.2 94.5 75.0 92.2 5.1 4.3 5.3 3.3 2.3Private V.eueptiom 74.1 70.3 33.3 32.4 03.2 31.4 5.0 4.7 4.4 3.9 1.Ieoea) dever.oet - 10.3 11.4 9.9 12.0 11.1 10.4 4.2 4.0 10.5 0.0 9.3

inns leotic Investut 21.5 12.9 13.2 17.1 17.3 14.3 -0.1 4.0 5.3 10.7 9.5Fived Invaitemt 21.3 11.4 17.4 15.2 15.4 15.1I -1.4 4.7 4.3 12.5begs in Stock 0.1 1.5 0.31 1.9 1.7 1.7.. .

Grossueutic Saving 13.1 10.1 4.3 5.5 5.0 7.8 2.2 -5.3 3.4 7.9 37.9Sot Fctsr Jaco.. -0.4 0.7 4.7 3.3 4.9 5.5 . .

Not Cwrr.t Traisfrs .. 2.9 9.0 10.3 9.3 10.1 . .

Innss Natinal Saving .. 13.7 22.5 24.4 21.7 23.4 11.0 3.3 7.5 4.9; 14.3

In sillims of LCW. 1945 1973 190 1934 193 1904p(at custemt ll0 prices) - - - --- - -

kmr Iceetac Product 105 142 231 299 324 347 5.4 5.4 4.1 3.3 7.2Capitattoulqurt 20 25 29 27 27 32 1.5 2.7 0.4A 17.6Terns of Trade Adjustmt 4 3 0 -11 -10 -13 . .

krm. kwIe tc Inogin 110 145 233 200 313 329 5.1 5.2 5.5 3.7 5.1irm. Ustiou Product 104 144 234 319 341 344 5.9 4.5 4 7.1 4.7Irosn Natiosa lnogi 103 147 254 340 331 344 5.3 4.3 5.5 7.5 4.4

------ (1930II a 200 -- -I flilsto Rit" (I P.a.)-C. Prices huie. 191 190 191 1994 lYE i93p 194573 19730 1900-34 193 Ilimp

Consumeer Prig. (IFS 44 100.0 123.3 129.2 139.9 150.4 157.4 4.7 12.9 1.2 7.5 4.3oduale Prices IIFS 63) 100.0 121.0 124.0 139.2 144.4 .. 4.4 12.9 7.4 3.7

1hlicit UP Dflator 100.0 120.7 127.9 140.1 147.0 154.0 4.3 12.7 3.1 5.5 4.7Implicit Epqe oedi s Deflator 100.0 12.3 134.5 140.0 154.0 144.2 4 .1 12.3 9.0 5.4 4.5

3. Other lodicaters 1945-73 1973-10 1930-05

both atas ( P.m.): * p~ preliminary dktaPpslatun 3.0 3.1 3.1Labs Ferce 2.3 3.5 2.3kmr kihteu Inc. P.C. 2.2 3.1 2.4Privaote Cemptim P.C. 2.9 3.5 2.5

140ut flestiitysIeputa (lE) I UP (MP) -0.2 1.7 0.4

"adss livip Rates:km flatimel Saving .. 37.0 13.0kim Imutc Orriel 4. -1.9 40.5

i0 (pried orawmus) 3.9 3.1 2.7

bowe of Tota 1945 197 190 lYlipLab F.. in - - - -

OpIceltas 59.9 57.1 54.4 50.4loduty 15.7 17.0 15.7 14.0Services 24.4 24.4 29.7 33.4Total 100.0 100.0 200.0 200.0

PUT - miiDSU

l_ dIi (311 toll Vale at Cvrut Prim l1 3lli.. 1Is

L bstb"a r Ewts 13 112 91 114 1x 1164 190 1I2 111 iP lUp 3934.

IM Cotm 300 12.2 11. 39.1 14.l 251.4 335 244 34 13L m 517au 1A 37.2 63 31. L9 13217 422 311 21 422 220 342Co iwv me 95.7 134.2 131.9 123 I5. 33 M7 26 217 242 279bttA 0ae 1L 167 33L9 121.7 1n 131.5 244 271 23 3m 334 313- dwu 137 121 11 1529 13 1413_w bpwt I= 1114 1144 IL 1144 1413

Tea biOmhs Ivprts P 36 109. 124.4 133. 121.3 131.1 1 234 2 I 232 3 1 249 24

F. briiul lapts

FOW 3P9 374 32 34 25 41lPL ad 3t4w bry L" 15.5 4.! 100.7 95.9 .5 low0 1IE 17 14" 130 1071B uW ts 35 4163 4111 435 441 4914

r e b_eIher Itw agite _dcapital be"d

Tital lbrcbaadi lpwpts CIF 100 120.5 120.3 125.1 130.1 141.7 391 4270 4305 511 U5 00

S. Term if Trae (310 a 103 113 12 113 I94 115 lIMF

lbcrd. Experts Price lid= 100.0 9.3 90.3 3.4 .4 95.0 p * prliiwy datahrarc. Ilpwts Price 1.E. 10.0 4.5 94.1 9.1 92.1 5.1Nrchkdiu Twn of Trae 100.0 4.3 9.9 W.1 94.0 112.4

S dillims (at cerrut primes)

M. bloace of Pamti 19o 12 3"3 1"4 15 1Ylp

Exports of Idsand J FS 295 3055 3420 3440 3246 30wchkadls (FM3) 2342 2320 2435 2t 2440 299

Um-Factor bnrvicn 43 735 734 77 7M7 U3

Inpts of _s aId NS 5711 4u1 M4 7054 7113 7345NmclmsluI (FU) 45 577 5421 59"4 4013 *I9No-Factor Swvicn M 914 975 1040 107 124

lsrce elance -2757 -3434 -3174 -304 -3101 -3410

ltt Facttr ltm -23 -321 -420 43 -514 -4(Uetarst Wr 3M3) 24 254 310 313 312 3M

llt Cereat Trt fwa 2142 45 340 3352 3091 3350Iwkws ruittucul 1747 2227 20 2739 2457 2432

Crrnlt kurnt alace, -7 -1100 -13 -49 -120 -73

LU_Twe Capital lf la M3 521 4 394 410 73UrKtt llst_tt 72 123 29 44 76 InofficIal Capital .. .. .. .. .. ..Set Lt Lu (6 dt) m 307 225 5 24 405ltbr LT Irflm l(btl -317 -473 357 -22 U 225

Titlg Ubr It_ Illtl It7 44 72 171 -133 Kllt ert-twr Capital 7 40 73 I37 -124 Caplti Flm LE.I. S 0 0 0 0 0Errn nd 34ii. 21 -25 -7 34 - -12

Deo Is Set barnum 335 122 -1144 129 low3 -ht Credit fr IIF -02 31 443 -U5 -5 -J5low km" Dow

t - icat.a iCtNMl 217 -273 -153 144 1133 34

As diwa of Wahummcg hlac -11.5 -11.9 -11.0 -11.4 -12.3 -15.5latent Pat mts 1.0 0.3 1.1 1.0 1.0 1.1barit k mt ldace -3.4 -3.4 -0.4 -2.2 -4.1 -2.4

_OW_WO [tamIst -aalt bo i (oil. Ul 4M 99 * 973 1034 7 709borI ie). kId (oil. M) 1U 173 240 3421 142 145Official I-otds IWM ) 9." 10.1 12.7 33.4 15.14 I.L13ld EN ff. 1- kw I 300.0 133.39 1.34 101.70 95L4 u.SW 1Willim of cwrt U3) 2403 39 2301 31075 31549 33304

Papa 3 of3

be"u sofU P1i ktlk Mtn It c.a.1

. kWiptCm. Federal Revs. 19t0 191 13 I4 19p 1u40 0-3 19n2 19035 19

Corrut kieiptI 1 14.3 1-.1 17.9 14.7 17.2 U.5 7.3 7.4 5.1crept bpolidtr" 15.0 14.4 14.3 17.3 130 1 1LI I.4 13.4 0.3 9.3

ure.-t hipt 1ut 1.3 2.4 0.5 0.1 -1.3 -0.1 9.2 15.4 4.7 710

Captal houapts *

Capital -1phitern 3.0 7.7 7.3 4.1 4.7 4.9 4.0 -13.5 14.9 59b a1l hflclt 4.2 5.3 7.0 - .0 7.1 7.7 11.1 -9.1I 34. 4.U

Offitiol Capital kr.toloterua 3wrremir. hwt) 2.9 1.7 1.4 1.2 1.1 1.4 -14.5 -10.1 -3.7 103.0bbtic LOt sok Fimmci3l 0.4 2.0 3.9 2.9 2.7 5.0 100.0 -00.7 -2.4 17271mt tiit -3FimKi 2.7 1.7 1.7 1.9 4.0 1.1 -0.3 19.1 121.3 409.

Not sItaboeets (lii sillimo) lit Nototudiag 6 SlebuU IMP oil.)3. Eatwra Cpital Fl2n,Dubt

ad lkitt b r tim 1930 197 1232 1933 194 15 Ip WO 192 1I33 1W4 197 i

Pdic I Pilicly OwartMi LT 373 1404 230 510 245 401 313 949 975 9991 10714 11723

fficial Crditws 70 420 311 406 427 413 24 101 34 WO? 9925 1031 tltllaterl 239 29! 220 33 234 244 1322 219 2307 271 344 30

2. Dn ich S -10 30 11 7 31 37 330 340 351 7 33 47of hich ItIA 70 142 1 9 121 104 131 321 1051 1145 1254 1391

lDlaIteal 415 324 91 47 142 174 643 MIS 4577 33 434 7535

Private Cruditors 143 444 -I1I 174 -132 -17 520 U 71 943 739 79L iU r to -9 32 32 -7 7 1o1 12t 154 III 179 192FIuK.ial Nokats 153 453 -112 143 -175 -24 341 741 435 7 410 401

PrIvate hmre rteed LT 2 3 -5 -7 21 4 13 39 34 26 24 30Ttal LT 37 1072 225 113 244 405 3OM 913 973 10017 10740 II7M

IIIF Nt Credit -s 409 279 -53 -152 -32 32 114 1 1241 124 1034ot Lrt-Two Capital 387 490 72 137 -124 3 77 331 47 44 7 79

Totdl WmIld iNg IW & ot I 959 1971 1232 457 -32 471 992 11235 11653 11494 I27? 1333

3. ad IDA Ratios 1930 193 193 iWO4 1to MO3

Shrs, of Total Log-Twou m p *pr.liaiwy data1. iM .1 of TT - 3.74 3.4 3.5 3.57 3.42 4.032. 1i4 .f Total 9.32 10.79 11.70 12.54 12.95 13.S I3I1 a If Total 13.07 14.28 15.2 1:.11 14.57 17.29Nova of Total LT hit Services,1. IMn I of Total 9.72 9.24 54 4.13 5.43 7.02. IN I f Total 1.53 1. 1.25 1.93 1.94 2.33L 13313A asSI of Total 11.30 11.14 4.91 3.35 7.33 9.47

1. LqTT Ie ti zpts 22.49 305.47 274. 274.9 315.54 294.212. 15 Cruit,Eprts 12.71 3.5 33.94 34.35 3.20 24.103. 11Aut-TW. litIEPuts 24.50 10.39 13.75 11.97 21.21 19.914. LI*4IT NUhllpwta 329.90 352.44 329.07 320.94 373. 342.29

rn O-tmr Stin

1. LqTuI Uit/ 34.43 31.33 33. 32.23 34.04 35.302. 1F Creditl 1.59 3.11 4.79 3.99 4.01 3.113. wt-Two lit/UP 3.07 1.41 1.49 1. 0 2.29 2.374. LIhifa M W 41.34 34.72 40.4 V7.43 40.34 40.79

lit BevicsAfszWts

C. Pitc bwrutu LT 19 17.94 29.99 25.55 31.24 24.332. tvat Nrh'inteo LT 0.23 0.44 0.47 0.33 0.43 0L433 Toa LT Mt bugs 20.00 13.33 30.44 25.94 31.74 27.234. LU Nopdchn * swv Do.5 haest Noly a3 lit 24. loaw 100*41'T lA.i

SUMMARY AND CONCLUSIONS

Introduction

i. Pakistan's overall economic performance has improved since the late1970's, and compares favorably with other developing countries. Real GNPgrowth has averaged 6-72 per annum since 1977. With the population growingabout 32 annually, per capita income growth has been about 3-4S per year.Inflation has been moderate, dropping to an average rate of less than 51 inthe past three years. Helped by the Middle East boom, open unemployment hasnot been a problem to date. Pakistan's balance of payments has been accept-able, although in recent years, substantially increased short-term borrowingand drawdown in gross reserves have been needed than in previous years. Thedebt service ratio, while manageable, has been increasing rapidly in recentyears, reaching an estimated 28% in FY88, in part because of the buildup ofshort-term external debt since 'Y86 and repayments to the IMF.

ii. Important policy changes have been occurring since the early 1980s.The Government has made progress in moving away from an extensively regulatedto a more market-oriented economy. The pace has been faster in areas ofindustrial investment, pricing, and import monopoly deregulation and flexibleexchange rate management, and slower in trade liberalization and disinvestmentin public enterprises. Since 1980, the Government has been aligningprocurement prices with border prices for most agricultural products, and hasgradually dismantled subsidy programs for pesticides, seeds, nitrogenousfertilizers, and public mechanization services. It has also been openingdomestic trade for several major commodities to the private sector.

iii. In accordance with the Sixth Plan strategy, the Government has beenreasonably successful in redirecting public development expenditure towardpriority sectors - energy, education, and health -- although there have beenshortfalls in targets. At the same time, it has been reorienting infrastruct-ure investments. In recognition of the need for better water delivery, forexample, the Government has redirected investments in this area from newlarge-scale irrigation schemes toward rehabilitation of existing irrigationand drainage systems and on-farm water management. However, the fiscaldeficit has been increasing -- from 5% of GDP in the early 1980's to almost 9%in FY87 -- and higher domestic bank and non-bank borrowing, as well asexternal borrowing, have been used to compensate for deteriorating publicsavings. In effect, development expenditures in the Sixth Plan have beenfinanced by borrowed funds.

iv. The Government is now preparing its Seventh Five-Year Plan forFY89-93. The economic decisions in this Plan involve difficult politicalchoices. Major Plan objectives -- employment growth, poverty alleviation,human resource development through education and health -- require sustainedrapid economic growth and increased government spending. How much can beachieved in the Seventh Plan will depend in large part on the size of theresource mobilization effort and expenditure restructuring, as well as thedegree to which market signals and competition are allowed to take precedence

-ii-

over regulation in influencing economic decisions. The Seventh Plan strategy,therefore, will involve the decision about whether the country will accept astrong adjustment effort now in return for higher increases in income,employment and social benefits for the growing population in the longer run.

The Development Policy Agenda

v. An appropriate development policy agenda to achieve sustainedeconomic growth of about 6S annually in the medium-term should be directedtoward correcting present macroeconomic problems -- notably the large fiscaldeficit but also a vulnerable balance of payments position - and supportingstructural changes favorable to efficient industrialization and urbanization.High priority should be given to strengthening the domestic sources of growth,through better incentives for increasing productivity in industry anaagriculture, and domestic resource mobilization, as external factors, such asthe fallotf in Middle East markets and employment and protectionism indeveloped countries, become less favoreble. To avoid compromising longer-termdevelopment, conservative economic management which provides both an adequatecushion to handle unexpe^~ted problems and the preconditions for undertakingstructural reforms continues to be important.

vi. In effect, the easier stage of development has passed. Pakistan mustnow increase its agricultural yields through intensive rather than extensivemethods and diversify its agricultural production. It needs to introduce moreforeign and domestic competition to improve efficiency of industrial firms.It needs an educated labor force which will contribute to development.Finally, it has to renovate and expand its aging and inadequate infrastructuresystems to support production, as well as extend to its population theeducation, health, and living standards that other countries at similar percapita levels currently enjoy. The private sector has been given the majorresponsibility for economic expansion. However, the Government must providethe right policy environment and the initiative and resources to improve thehuman and physical infrastructure base of the country.

vii. To achieve sustained growth and development, major areas for policyaction in the next five years are the following:

(a) reduction of the consolidated budget deficit through publicresource mobilization and expenditure restraint andrestructuring;

(b) budget restructuring to permit a gradual expansion in physicalinfrastructure and human capital investments and complementaryrecurrent expenditures consistent with resource availability;

(c) trade liberalization, consisting both of export promotion andimport liberalization which replaces bans with tariffs,eliminates most duty exemptions, and reduces the average leveland dispersion of tariffs;

(d) reform of financial markets, including improving the financialhealth of the banking system; and

-iii-

(e) continued effective deregulation of price, trade, and investmentin industrial and agricultural sectors.

This agenda is discussed in more detail below. It is important to note herethat it focuses only on the more immediate bottlenecks. It both complementsand is essential to the success of the Government's sectoral plans foragriculture, energy and infrastructure development and poverty alleviation.It also should be supplemented with an active population policy and naturalresource/environmental management strategy.

FY87 Economic Performance

viii. Aggregate economic performance in FY87 continued to be satisfactory.Real GDP growth was 4.92, inflation was 3.91, and the current account deficitdropped to an unusually low 2.01 of GNP due to the growth in traditionalexports and improvements in the terms of trade. While real industrial growthwas 7.6X, agricultural growth was below average -- 2.21 - because of post-harvest rain damage to the wheat crop. Both investment and savings alsoincreased as a percentage of GNP.

ix. Several important macroeconomic problems, however, remained unchanged.First, the consolidated federal and provincial budget deficit coutinued toexpand, reaching 8.9% of GDP in FY87 from 7.71 in the previous two years.Current expenditures continued to grow faster than GDP without a correspondingincrease in revenues. In FY87, the largest increases came from defense andinterest payments, which together account for 55% of current expenditures;social and economic services, partly in support of the Prime Minister'sFive-Point Program; and from subsidies. This larger deficit required, as inprevious years, higher domestic as well as external borrowing, with the majorshare of the financing coming from non-bank sources. It also caused furtherdeterioration in the Government's current fiscal balance - i.e., Governmentsavings -- which reached a negative 1.8% of GDP in FY87.

x. Second, the balance of payments remains vulnerable to external andinternal shocks outside the control of the authorities - primarily because ofthe large trade gap between imports and exports; reliance on traditionalcommodities, notably rice, cotton, and cotton textiles, which lack thepotential for long-term growth; and the use of worker remittances, which havebeen falling for several years. FY87 was no exception. The large drop in thetrade deficit in FY87 was due to a growth in raw cotton, rice, and cotton-basedmanufactured exports, as well as to a declining petroleum import bill andlower world prices of imported edible oils. In addition, gross foreignexchange reserves remained at about six weeks of imports - too low to meetunexpected short-term fluctuations in foreign exchange needs. Again in FY87,foreign exchange reserves were substantially exceeded by the country'sshort-term external liabilities.

xi. Third, despite the reported increases in investment and savings ratesin FY87, at 15.7X and 13.71, respectively, they still appear to be too low tosupport long-term economic growth of about 6%, given the need to rehabilitateand expand the public capital stock, improve social services, and updateindustrial technology. Moreover, the private sector has been the major

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generator of savings. The already low public savings rate (including publicenterprises) fell in FY87, as federal and provincial government dissavingsworsened. As in previous years, a substantial transfer of private savings wasneeded to finance the Government's fiscal deficit.

xii. Fourth, provision of adequate credit to the private sector andappropriate buildup of foreign exchange reserves are not likely to becompatible with the Government's price stability guidelines as ling as largebudget deficits need to be financed. While money supply growth (14X) waswithin the range consistent with low inflation in FY87, the large credit needsfor budgetary support and 171 growth in credit to the private sector wereaccompanied by another year's drawdown in net foreign assets, instead of aplanned buildup.

xiii. Labor market difficulties also are beginning to emerge. Recentemployrwnt and wage trends suggest a less positive situation for the Sevenththan for the Sixth Plan. The domestic labor market to date has been able toabsorb, at rising real wages in key sectors, the increases in the domesticlabor force, with the help of the Middle East oil boom. Without this escapevalve - there is now a small reverse flow of migrants - domestic sources ofgrowth must bear the responsibility for employment growth of at least 3% peryear, to absorb new labor force entrants. This problem alone underscores theneed for continued rapid economic growth.

xiv. In summary, macro-economic and structural adjustments are needed toprevent a possible future economic crisis and to improve the economy'scapacity to provide employment and better living standards for the growingpopulation. In FY87, Pakistan benefitted from the improvement in its terms oftrade and strong demand for its major export products. These positivefactors, however, masked less favorable fundamentals. The large fiscaldeficit, together with the large trade imbalance and low foreign exchangereserves, severely limit the country's flexibility in coping with unexpectedproblems. Moreover, steady increases in investment and savings requirecontinuing liberalization of the economy, notably in trade, finance, anddomestic regulation of investmer.t and prices. These economic issues, withrecommendations for change, are summarized below.

Maior Economic Issues

xv. Control of Budget Deficits. The long-term climate for growth and theability of the Government to support development are threatened by the largeand growing deficits. By increasing government borrowing, prindrily fromdomestic sources, deficits have resulted in a rapid accumulation ofdebt-servicing obligations. The stock of domestic debt outstanding has beengrowing at over 20% annually since FY80, and external non-military debt, atabout 6.5% per year in U.S. dollars. Growing interest payments -- nowrepresenting about 20X of current expenditures -- both create new pressuresfor future borrowing and reduce the Government's flexibility in futurespending. In addition, the large borrowing requirements "crowd out" privateinvestment. Non-bank borrowing, the principal financing source, carries thedanger of preempting private investment, while bank borrowing could limitcredit expansion to the private sector, given government norms for moneysupply growth and the pressing need to increase foreign reserves.

Alternatively, the deficits could put pressure on prices, if authoritieschoose to expand the money supply beyond usual conservative targets instead ofsqueezing private sector credit.

xvi. The large budget deficits also put pressure on imperts. The largecurrent account deficits prior to FY87, coupled with the need to supple-ment official mediu_- and long-term assistance with higher cost short-term andcomiercial borrowing, have contributed to the growth in the debt serviceratio-from 14S in FY83 to 28S in FY88. Creditworthiness consider-ations, therefore, require a reduction in the fiscal deficit as well asimprovement in the trade balance and careful debt management.

xvii. Fiscal deficits of 8-91 of GDP, therefore, are not sustainable bothin terms of internal and external balance. A fiscal deficit which isconsistent with medium-term macro-economic targets of real GDP growth of about6S per year, 62 annual inflation, and maintenance of the current public sectorexternal debt to GDP ratio should be in the range of 51 of GDP, depending onthe rate of depreciation of the rupee. In FY88, the Government expects toreverse the worsening fiscal trend. Continuation of the deficit reductioneffort, until the deficit reaches about 51 of GDP in FY91, would beappropriate for improved macroeconomic management.

xviii. Table 1 summarizes a suggested budgetary scenario for deficitreduction. The scenario focuses on increasing the Government's revenueraising capacity, improving government savings and protecting recurrentexpenditures for economic and social services in the process. However,streamlining current expenditures and reducing subsidies are equallyimportant. Because it will take time to implement major tax changes, thefirst two years of the program are expected to be more stringent than the lastthree. Current expenditures as a percent of GDP initially would need to fallslightly, primarily from reduction in subsidy levels and in growth ofexpenditures other than subsidies, interest payments, and other transfers.

Table 1: Proposed Consolidated Budget Magnitudes, FY89-93(Percent of GDP)

EstimatedFY88 FY89 FY90 FY91 FY92 FY93

Current Expenditures 19.0 17.4 17.4 17.6 18.1 18.2Non-Transfer Expenditures 12.4 12.0 12.2 12.5 13.2 13.4

Transfers (Subsidies,Interest, Other) 6.7 5.2 5.2 5.1 4.9 4.8

Development Expenditures 7.0 6.9 7.2 7.4 7.8 8.0

Total Revenues (Tax,Non-tax, Autonomous BodyContributions) 18.0 18.1 19.1 20.2 21.1 21.5

Budget Deficit -8.1 /a -6.2 -5.5 -4.8 -4.8 -4.7

/a Estimates in February 1988 were within a range of 8.1%-8.31.

Source: Table II.5.

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Development expenditures should increase gradually. By the end of five years,holding the share of current expenditures in GDP to about the expected FY88level would leave room for development expenditures to increase by about 12 ofGDP. Total revenues, however, would reed to increase by over 3X of GDP.Because expected cotton export receipts temporarily increase revenues in FY88.the addition to taxes over the period would be larger, in the range of 41 ofGDP.

xix. In this scenario, a significant budget restructuring would have toaccompany deficit reduction. The major elements would include:

(a) A substantial resource mobilization effort which, in theprocess, would improve the efficiency, equity, and elasticity ofthe tax system (see below).

(b) A shift in the composition of spending toward required economicand social infrastructure expenditures (both ADP and recurrent),together with better investment programming of majorinfrastructure sectors and improved pricing and fees to covercosts.

(c) Reduction in government transfers to the private sector,initially from eliminating fertilizer subsidies and furtherreducing wheat subsidies, and by avoiding Cotton ExportCorporation losses as long as world cotton prices remainreasonably high; reduced deficit financing would result in lowertotal interest payments as a proportion of GDP, furthercontributing to the fall in transfer payments.

(d) Restraining the growth of non-transfer current expendituresthrough cost-savings and prioritizing expenditures, temporarilydelinking nominal wage increases from inflation for military andcivilian personnel and reducing employment levels by attritionfor the first few years, and better programming of requiredpersonnel and materials expenditure with the availability ofbuildings and equipment in public service provision.

(e) Continued disinvestment of public enterprises, with betterincentives for financial and operational autonomy andaccountability for departments and enterprises which remainunder public ownership.

(f) A revision of central/provincial government revenue sharing toreverse the growing provincial fiscal imbalances and to promoteprovincial revenue generation. With the provinces bearing thebulk of the responsibility for public services and domesticsecurity, and with a growth in their interest liabilities due tothe switch in ADP financing from federal grants to loans, theirexpenditure obligations now far exceed their own revenue baseplus the revenue-sharing arrangements prescribed in 1974. Thereis little incentive to raise their own resources, since thefederal government covers their deficits, which by FY87constituted over 20% of the consolidated budget deficit.

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The new revenue-sharing formula currently under discussion wouldchange this situation. (Other suggestions for improvingprovincial finances, such as privatizing tubewells, increasingwater charges, and introducing a land tax are also dircussed inthis report.)

xx. Resource Mobilization. Long-term development requires both highernational savings rates and an increase in government savings rates, to reducethe extensive use of private savings to finance the fiscal deficit. Publicresource mobilization has been particularly weak. In FY83, governmentbudgetary savings turned negative and have been deteriorating steadily sincethen. In FY87, the government sector (excluding public enterprises) absorbednon-government savings equivalent to over 6X of GDP to finance its spending.

xxi. A substantial resource mobilization effort by Government is essentialto finance the investment and recurrent expenditures needed for development.This is recognized within the Government. Resource mobilization is animportant part of the Seventh Plan. The National Assembly subcommittee whichreviewed the National Tax Reform Commission report recommended a number of taxproposals, including taxation of agricultural incomes. In addition, ongoingtechnical preparation involves the services of international t:ax consultants.

xxii. The biggest potential comes from strengthening Pakistan's tax base,although improving the revenue surpluses of public departments and autonomousentities (as part of a more general efficiency effort) and better costzecovery on social services would make important contributions. Tax revenueshave accounted for about 13% of GDP throughout the 1980s. This is a lowpercentage, when compared with other countries and with Pakistan's expenditurerequirements. In addition, Pakistan obtains a relatively low percentage ofits revenues from direct taxes and is unusually dependent on tax revenue fromforeign trade. Indirect taxation accounts for over 85% of tax revenues, withtaxation of foreign trade--import duties, sales taxes on imported goods, andexport taxes - accounting for 45% of total taxes. Maintaining tax revenuesat 13% of GDP has required frequent rate increases and ad hoc surcharges. Theincome elasticity of the tax system is low because of the narrowness of thetax base and the large number of exemptions to the sales, excise tax andincome taxes, as well as to customs duties. Income taxes account for only 15%of tax revenues, with most of it from corporate sources and with agricultureincomes and capital gains exempted. In addition, provincial taxes account foronly 52 of the consolidated tax base.

xxiii. The proposals below would therefore broaden the tax base and increasethe elasticity of the tax system by shifting the emphasis in indirect taxationtoward domestic consumption (of both domestic and foreign products) andraising the contribution of the income tax. These reforms would not onlyimprove the Government's fiscal position; they would also minimize distortionson private sector production and investment decisions, ensure that the poorare not taxed beyond their ability to pay, and minimize the administrativecosts of compliance and collection. The proposed tax changes could, as a veryrough estimate, generate additional revenues equivalent to 4-5% of GDP, oncethey are fully implemented.

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xxiv. The first recommendation is to develop a broad-based tax on domesticconsumption which does not impose differential treatment on differentproducts, stages of production, or domestic versus foreign production. Thecoverage of the existing sales tax could be expanded simply by drasticallycurtailing exemptions. Given some of the features of the existing salestax--notably coverage of both domestic products and imports, and allowance fortaxes on inputs to be credited against taxes paid on outputs--it would berelatively easy to move further to a consumption-type value added tax, imposedat the manufacturer's level. While further preparation is required, the taxseems within Pakistan's administrative capacity to implement.

xxv. A number of suggestions, already employed in other countries, toimprove the income tax are given in the report. A key way to broaden itscoverage, however, is to subject agricultural income to taxation. Theexemption of agricultural incomes is inequitable and inefficient, andencourages taxpayers to disguise income from other sources as agriculturalincome in order to avoid taxation. An agricultural income tax is likely to becontroversial. Enforcement at the federal level is apt to be difficult, andconstitutionally, such a tax seems to be within provincial jurisdiction.Nonetheless, at t4- federal level, it would be desirable to eliminate theexemption of agricultural income, in line with the proposal of the NationalTax Reform Commission, to prevent tax evasion on non-agricultural income. Inaddition, a land tax to capture presumptive agricultural income is recommendedin order to improve the provincial revenue base.

xxvi. Trade and Industrial Regulatory Policies. Industrial performance inPakistan, as shown in the rapid growth of manufacturing output and privateindustrial investment, has improved since the late 1970s. However, growth anddiversificaticn of manufactured exports have proceeded more slowly, and thecost structure and poor product quality in many industries prevent them fromcompeting effectively with imports. Fragmentation of production among many,inefficiently small firms characterize some industries which would benefitfrom economies of scale. A reform of the trade regime together with theremoval of remaining barriers to domestic investment are important stepstoward improving industrial efficiency.

xxvii. Trade Regime. While the Government has taken steps to liberalizetrade since the early 1980s, the existing trade regime is still biased infavor of domestic production. Domestic markets are insulated from foreigncompetition through non-tariff barriers (NTBs) and high tariffs. In 1986,about 29% of domestic industrial value added still was protected by importbans, and another 3.7% by various forms of import restrictions, such as valuelimits on cash imports of machinery and millwork. Even after a number oftariff changes, Pakistan's current average (nominal) tariff rates still arehigh among developing countries. About 50% of all tariff categories carryduties in excess of 75%, the impact of which is compounded by s-%rcharges andthe sales tax. Tariffs above 100% are especially prevalent for cunsumergoods. At the same time, Pakistan's tariff structure contains a substantialnumber of duty free categories and exemptions. In addition, smuggling reducesthe level of protection of some items, particularly consumer goods.

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xxviii. This complex system has produced an inconsistent structure ofprotection which lacks transparency and whose impacts on industrialinvestments are difficult to determine. The high tariffs and extensive NTBsprovide high protection for some products; however, exemptions, baggageallowance, and extensive smuggling reduce the extent of protection for otherproducts, especially consumer goods, well below the statutory rates.Therefore, trade policy reforms to simplify the system and to establish a moreneutral trade regime are needed, both to eliminate the bias toward domesticproduction, while providing adequate protection to infant industries, and toexpose the domestic economy to more foreign competition.

xxvix. Therefore, important elements in the Government's medium-term policyagenda should be the following:

(i) A program of trade l7beralization which would start (1) with thereplacement of import bans and restrictions with tariffprotection (with the exception of those instituted for health,safety, religious, and security purposes) and reduction ofprohibitively high and redundant tariffs; followed by (2) asubstantial reduction in the average level and dispersion oftariffs;

(ii) Maintenance of export promotion measures pertaining to freeaccess to imports, but elimination of other duty free importsand duty concessions (with the exception of the free baggageallowance, the size of which ought to be gradually reduced).

(iii) Continuation of an active exchange rate policy with the value ofthe real effective exchange rate guided by balance of paymentsobjectives.

xxx. Simulation results suggest that Pakistan could undertake thisrecommended trade reform program without worsening its trade balance or itsrevenue collections. For the first phase of the import liberalizationprogram, imports could be held in check with a modest nominal devaluation overa three-year period, and the revenue effect is expected to be positive.Reductions in maximum tariff levels below 100t are expected to be coordinatedwith export growth; otherwise, further currency depreciation would be neededto avoid a deterioration in the trade deficit. Wbile expected revenues forthis second phase could drop below that of the first phase, they might stillbe larger than collections prior to the start of the liberalization program.

xxxi. Complementary Domestic Deregulation. To be effective, trade policyreform must be accompanied by effective and comprehensive deregulation ofproduction and markets in order to ensure the needed supply response.Domestic competition is also important in developing Pakistan's large internalmarket. The Government in earlier years relied heavily on investmentsanctioning, price controls and other regulatory policies to cotnter some ofthe adverse effects of a protectionist trade regime and avoid the excesses ofa free market system. However, these industrial regulatory policies generallywere not effective or had perverse effects. Consequently, parallel to its

attempts to liberalize the trade regime, the Government has been relaxing itscontrol over domestic activities. It has made progress in decontrollingprices, relaxing the approval procedure for new industrial investments, andreducing the scope of government import monopolies.

xxxii. Domestic deregulation of price and trade should be continued in bothagriculture and industry. Of the remaining investment-related sanctions,removal of the remaining import-related sanctions and infrastructure approvalswould be desirable. Despite the liberalization of investment sanctioningprocedures, projects continue to require approvals if their machinery and rawmaterial imports not financed by credits from development finance institutionsexceed the established ceilings. The second remaining constraint is locationclearances from provincial governments. Provincial location policies have twomain objectives: to ration scarce urban infrastructure and to promoteregional equity by dispersing industrial production. The former could beimproved further by moving toward a price-based allocation ofinfrastructure/utility services, where prices reflect the full economic costsof supplying these services. A more socially desirable location pattern couldbe encouraged by additional charges to cover pollution and congestion, inplace of discretionary administrative controls. However, experience of othercountries shows that dispersal of industries to more backward regions isextremely difficult to accomplish, even with fiscal incentives for thoseregions.

xxxiii. Financial Sector Reform. Pakistan's banking sector is reasonablywell developed, despite the relatively low level of per capita income and lowsavings rate. Since nationalization in 1974, financial savings, number ofdepositors, and loans outstanding have increased at a healthy rate.Islamization of the banking system has established some flexibility in theloan/deposit rate structure. By and large, real interest rates/returns onbank deposits and loans are positive.

xxxiv. There is concern, however, about the banking system's ability tomobilize and allocate savings to support a rapidly growing economy, or to helpin the transition to a less regulated economy. There are a number ofinstitutional problems which increase the inefficiencies of the system,undermining its financial viability and solvency. Principal ones include (a)the use of credit controls and mandatory credit and investment programs,several of which carry below-market rates; (b) the lack of competition andautonomy in the nationalized banking system; (c) imprudent borrowing andlending practices and an ineffective debt recovery framework; and (d) aninadequate regulatory and supervisory structure. In addition, the size of thegovernment's domestic debt and its inappropriate interest rate structure arecreating distortions in the financial system; moreover, they generatepressures for a more accommodative credit policy to avoid crowding out of theprivate sector. The high level of forced investment in government securitiesalong with the subsidized credit programs essentially constrain bankprofitability and limit banks' flexibility of action.

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xxOCv. Modification of the Government's borrowing strategy would also helpthe financial sector. To finance the increasing budget deficits, theGovernment generally has kept external debt manageable and avoided large-scalereliance on monetary financing. However, it has relied heavily on domesticborrowing, especially from non-bank sources. Funds raised through thesesavings schemes carry high interest rates (12-16% tax free), while borrowingfrom commercial banks through the forced purchase of Treasury bills carry lowrates (0.5-6.0S). The combination yields an average interest cost of around6.5X (1985/86). This borrowing strategy has several undesirable character-istics: (a) the maturity distribution of the debt is heavily short-term; (b)the rate structure of the debt is administratively determined, with what seemto be unduly high tax-free rates on essentially risk-free savings schemes; and(c) there is undue reliance on non-bank savings schemes relative to commercialbank borrowing, even though the latter under present monetary/credit rules isnot much different, in terms of its monetary impact, from the non-bankborrowing.

xxxvi. Credit ceilings and high liquid asset requirements, instituted formonetary management, also are well-suited for handling the large governmentborrowings without undue inflationary pressure. However, they inhibit bankdiscretion, discourage the raising of term deposits, and put the burden ofmonetary management on controlling credit to the private sector.

-XXvii. One of the most critical banking sector reforms, therefore, is theimprovement of the financial health of nationalized commercial banks, throughactions on non-performing loans, better credit appraisal procedures, capital-ization, and more management autonomy. More competition; improved banksupervision, including better accounting and auditing standards and improvedsupervisory authority for the State Bank for all financial institutions; andreduction of directed credit programs, with agreed means for covering addi-tional costs of these programs and more flexibility within overall creditceilings, are also important.

xxxviii. Reducing the highly administrative nature of the Government'sborrowing strategy and its monetary and credit management are alsorecommended. The first step toward a more market-oriented approach tomonetary and debt management should be the market determination of interestrates, starting with rationalization of interest rates on short-termgovernment securities, auctioning of Treasury bills, and abolition of interestrate subsidies.

The Recommended Reform Program, FY89-93

xxxix. The specific policy reforms are summarized in Table 2, with thereforms in the first two years designated as Phase I and subsequent ones, asPhase II. The sequencing of the measures is as important to the success ofthe recommended program as the policy reforms themselves. It is difficult tomove ahead with structural reforms without a manageable fiscal deficit, andsupporting exchange rate and conservative monetary policies, to maintain bothinternal and external balance. Of the three, it is the fiscal deficit whichis out of line. Consequently, a major tax and expenditure control effort toreduce the fiscal deficit has the highest priority.

Table 2: Seauencina the Policy Aaenda

Major Areas Phase I Phase II(Begin FY89 for about 2 years) (Se"n FY9O/91 for about 3 years)

I. Fiscal PolicDeficit Reduction Reduce deficit to about SX of GOP by FY91. Maintain deficit of about 5% of GOP or less after FY91.

Reduce growth in current expenditures and maintain Smll increase in share of development expndituresdevelopment expenditures/GOP share at levels consistent with and social services consistent with resourceresource availability, availability.

Reduce subsidies and improve targetting.

Accelerate disinvestment and improve accountability, Rationalize sick public enterprises and furtherefficiency of public entities. progress in disinvestment.

Implement new Federal/provincial revenue sharing formula.

Resource Mobilization Begin reform of tax system, by instituting value added or Continue tax reform progra. involvingexpanded sales tax and initiating changes in direct taxes. broadening the income tax and introducing provincial-

based revenue measures in coordination with rationali-zation of custom duties. chare..

Improve tax administration.

Continue regular increases in tariffs, prices of revenue-producing entitites, and extend cost recovery to otherpublic services.

II. Trade Pnlic Continue export promotion. Rationalize the tariff structure.

Eliminate non-tariff import barriers, reduce dutyexemtions/concessions, and reduce tariffs exceeding120X. Begin process of tariff rationalization.

III. Domestic Dereaulation Continue, extend deregulation for major crops (cotton, rice,wheat).

Reduce formal and informal price controls on remainingmanufactured products.

Facilitate industrtal investment by eliminating remaining Simplify bankruptcy, foreclosure, restructuring,investment sanctioning, removing remaining import restrict- and merger laws to deal with sick industries.ions on investment products, and rely more on infrastruc-ture pricing than on administrative clearances to influencefirm location.

IV. Financial Sector Imrove efficiency of banking system. Increase competition. through privatization or

partial disinvestment of Governmnt-ownM4 comercialbanks.

Begin improvgment of regulatory frmawork conductive todevelopment of financial system with adequate safeguards.

Initiate medi1u-term program to liberalize and restructure Improve debt *anagnt stratey of Governent by

interest rates on deposits, loans, and government instruments. establishment of a regular auction systm_ forgovernment securities, and dvelonp t of a secondarysecurities _rket.

V. Comulementary Macro- Continue conservative monetary policy to insure sufficient As in Phase I.

Economic Policies credit to private sector and a build-up in foreign reserveswithout inflationary pressures.

Continue active exchange rate policy to support balance of As in Phase I.

payments objectives. espec ally as import liberalization

measures take hold.

d.'I.'

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xxx=. A large fiscal deficit makes import liberalization risky, as excessdemand spills over into imports, and could negate the benefits of introducingmore of a market orientation into the financial sector, as extensive govern-ment borrowing pushes up interest rates. Consequently, reforms in both areasmust be accompanied by deficit reduction. With a more manageable macro-economic situation, the country also would be able to weather the immediaterepercussions of structural reforms in the real sectors of the economy. Bothtrade liberalization and domestic deregulation, by opening up protected areasto competition and by changing relative prices, will involve substantialadjustments for firms and workers. Close government management of thetransition is required. So is a healthy financial sector, which can providethe credit needed to help firms adapt and which can survive a substantialchange in profitability of its loan portfolio. The financial viability of thebanking system is already being questioned. Therefore, improving theefficiency and financial condition of the banking system ideally shouldprecede full implementation of the trade liberalization program, which ispotentially more disruptive than removal of the remaining regulatory barriers.

Macroeconomic Outlook with the Adjustment Program

xxxxi. This proposed reform program would improve Pakistan's ability tomaintain strong economic growth of about 6% per year over the medium-term,with concomitant increases in investment and savings, improved balance ofpayments, and enhanced creditworthiness. In the first three years, theprogram would involve a temporary reduction in real GDP growth, to about 5.5%per annum, which would still permit real growth in per capita consumption.

xxxxii. The alternative to this adjustment effort is much less attractive.While present GDP growth rates are likely to be feasible for several moreyears vithout undertaking this reform agenda, they are not sustainable overthe long-run. Lack of sufficient fiscal and balance of payments margins tocushion the economy from unexpected shocks increases the risk of an economiccrisis. The domestic and foreign debt build-up would eventually cause seriousdebt service problems; it would affect external creditworthiness, limit theincreases possible in government investment and related recurrent expenditurein the face of growing debt service claims on budgetary resources, andrestrict financing for private investment. The existing weaknesses in thebalance of payments would worsen; the large fiscal deficit would increase thetrade deficit, and export promotion, without complementary import liberal-ization, would not be likely to change the structure of exports signifi-cantly. Domestic productivity growth would be slow, without a reduction inprice-cost distortions and increasing competition. The underpinnings forsustained rapid growth of GDP and employment thus would be undermined. Inshort, maintenance of the status quo would, in the lonzer-run, result in anundesirable slowing down of the industrialization and modernization process.

xxxxiii. The recommended adjustment program is compatible with 5.5% real GDPgrowth, reasonable price stability, and external balance. A simple net flowof funds analysis for the first two years, which involve the biggestadjustments, shows that the proposed program satisfies the followingrequirements:

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(i) The savings-investment balances are consistent with the envisagedfiscal policies and the external balance objective. Although theimprovement in government savings reduces the non-government sector'ssurplus substantially, there are enough non-government resources forboth government deficit financing and for private investment.

(ii) The allocation of net inflow of external resources among thegovernment, private and banking sectors is consistent with theirrequirements. More importantly, the banking sector would be able tostrengthen its foreign exchange reserve position, which currentlystands at a low level.

(iii) The monetary (ard credit) expansion that would satisfy the pricestability objective is also sufficient to satisfy the investmentcredit and money balances requirements of the private sector. Withmonetary expansion equal to the envisaged growth in nominal GDP,reasonable government borrowing levels from both the State Bank andcommercial banks would allow a decline in government non-bankborrowing as well as increased availability of bank financing for theprivate sector.

xxiv. Over the medium-term, the macroeconomic outlook would continue toimprove with full implementation of the policy agenda described above. Higherprivate investment would be stimulated by a reduction in domestic budgetfinancing and a less regulated and more competitive environment. With theshare of ADP investment also increasing to meet growing economic and socialinfrastructure requirements, total investment could rise to almost 20% of GDPby FY93. Savings performance would also improve, initially from theGovernment's revenue efforts. While private savings is likely to fallinitially as the impact of higher taxes and expenditure restraint is felt, itwould respond in the medium-term to improved savings and investment incentives.

xCxxv. While Pakistan's balance of payments prospects depend partly ondevelopments in the world economy, trade liberalization and domesticderegulation policies would contribute to opening its economy. With improvedcompetitiveness, real export growth of about 6.7% per annum is envisaged, withthe bulk of this growth coming from manufactured products. Real import growthwould be 3.5% per annum, reflecting import substitution in energy and edibleoils and more efficient import use. More rapid growth of exports relative toimports would ensure a manageable current account deficit, which is expectedto drop to about 2.4% of GDP by FY91. This would permit a gradual buildup ofgross foreign exchange reserves to restore coverage to two months of importsduring this period. Pakistan's improving creditworthiness would justifymodest real growth in official aid commitments, divided primarily betweenconcessional and nonconcessional borrowing, complemented by small butincreasing doses of commercial financing during the 1990s. With this leveland composition of external borrowing, debt service would continue to improve,reaching 201 of exports of goods, services, and transfers by the mid-1990s.

Chapter I: Recent Economic Develo2gents

1.01 Aggregate economic performance in FY87 1/ continued to be good, interms of GDP growth, low inflation, and an exceptionally small current accountdeficit. More resources were allocated to the Prime Minister's Five-PointProgram and other development projects. However, several important problemsof the economy remained unchanged:

(a) The consolidated federal and provincial budget deficit continued toexpand, reaching almost 9% of GDP in FY87, as current expenditurescontinued to grow without a corresponding increase in revenues. Thislarger deficit required, as in previous years, higher domestic aswell as external bo.trowing.

(b) The balance of payments structure remains vulnerable to external andinternal shocks outsid;e the control of the authorities. The currentaccount relies heavily on traditional cotton, cotton textile, andrice exports, which lack the potential for long-term growth; and onworker remittances, which have been falling for several years. Grossforeign exchange reserves continue to be too low to meet unexpectedshort-term fluctuations in foreign exchange needs. Of particularconcern is the low level of foreign exchange reserves relative to themuch larger short-term external liabilities of the banking system.

(c) The external debt ratio continued to increase, as has happened sincethe early 1980s. Maintaining the country's creditworthiness standingin the external community will require careful management of thecurrent account balance, the magnitude and terms of externa2financing, and the reserve position.

(d) Despite reported increases in investment and savings rates in FY87,they still appear too low to support long-term economic growth athistorical rates, given the need to rehabilitate and extend thepublic capital stock and expand social services. Moreover, thepublic savings rate is low, with positive public enterprise savingsoffsetting the dissaving of the federal and provincial gover-ments.As in previous years, a substantial transfer of private savings wasneeded to finance the Government's fiscal deficit in FY87.

(e) Money supply growth was within the range consistent with lowinflation (as mneasured by the CPI). Yet sufficient credit expansionfor budgetary support and for the private sector was made possible inpart through a drawdown in net foreign assets. For the secondconsecutive year, there was a reduction in net foreign assets,instead of a planned build-up.

1.02 The employment and wage trends at the end of the Sixth Plan suggest aless positive picture for the future, since migration to the Middle East can

1/ For brevity, the year 1986/87 is referred to as FY87. Therefore, theSixth Plan period is FY84-88.

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no longer be counted on to offset the rapid growth in the labor force.Although employment continues to grow, real wages for unskilled constructionworkers, which typically reflects the tightness of the market for unskilledurban workers, have been falling for several years.

Economic Growth

1.03 Pakistan's economy continued to grow at a reasonable rate (4.9S) inFY87, though below the average GDP growth rate of 6.6X per annum for the firstfour years of the Sixth Plan. Table IA1 provides the historical trends inaggregate and sectoral growth. In agriculture, rice and cotton productionreached record levels, and sugarcane output, which declined in FY86, alsoshowed some recovery. While the original wheat crop was also good,post-harvest losses from heavy rains reduced wheat output to 12 million tons,almost 141 less than the previous year. Reflect!n! these losses in outputreduced agricultural growth to 2.2X in FY87 avn lov;4ed the healthy 4.42average growth in the sector recorded since the oeg .ning of the Sixth Plan to3.5X.

1.04 Favorable government policies have contributed to this growth inrecent years. Support/procurement prices for crops have generally been set inline with long-run international parity prices, and provide adequateincentives to farmers (Table I.10). Input subsidies for non-nitrogenousfertilizers are in place, although others (for pesticides, seeds, nitrogenousfertilizer, and tractor hire) have been phased out in recent years. 1/Farmers also receive economic subsidies for irrigation water, estimated atRs 1.4 billion in FY86, while efforts have been made to increase farmers'access to institutional credit at concessional terms. 2/ Finally the sectorhas been exempt from the income tax; while other taxes, including thereligious-based Ushr and Zakat, are levied on agricultural land and/or output,their resulting revenue is small. 3/

1/ Currently, phosphatic and potassic fertilizers are subsidized to theextent of 50% to 300% of their domestic sale prices, taking about Rs 1.6billion of budgetary resources in FY88. In addition, an implicit subsidyfor urea still exists, in that the natural gas input price for themanufacture of urea is lower than its price for other uses.

2/ These include a State Bank credit guarantee scheme covering 501 of thenationalized commercial banks' losses on agricultural credits andinterest-free loans from commercial banks and cooperatives.

3/ A recent study (S.K. Qureshi, S.J. Malik, and A.N. Siddiqui, "Some Aspectsof Agricultural Price and Taxation Policies in Pakistan", PIDE, September1985) showed that the the incidence of direct and commodity taxes onagricultural value added between FY73 and FY84 never reached 4% and wasless than 11 in the last year cited. However, implicit taxation resultingfrom domestic producer prices of major crops being lower thaninternational prices was significant until FY82.

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Table 1.1: GROWTH AND STRUCTURE OF GOP. 1963/84 - 1986/87

Percentage ShareAnnual Percentage Growth /r, of GOP /a

Sixth Average idPlan 1983/84-

Target 1983/84 1964/83 198S/86 1986/87 1986/87 1982/83 1986/87

AgrLiultur Li -6.0 12.2 I La 21 5 2. 241

Major crops 3.6 -13.8 18.0 7.4 n.a n.a 15.4 n.aMinor crops 7.0 1.2 3.3 3.4 n.a n.a 4.2 n.aOther Agr. La 6.0 6.1 6.8 6.1 5.7 6.2 8.2 8.3

IndustkrY n.a I10. 6.0. 1L .. L 6 .LZ 4iA ILLManufacturing 9.3 8.2 8.4 7.8 7.7 8.0 16.9 18.2

Large scale 10.0 7.7 8.0 7.3 7.0 7.5 12.4 13.1Small scale 7.3 9.4 9.4 9.4 9.4 9.4 4.5 S.1

Other Industry Lb n.a 16.4 4.5 12.7 7.6 10.2 8.0 11.0

Services SL2 7.1 ILA 6L1 _5-3 6La 47L 3 4LL

GDP at mrketprices LA LA 9. z 1 _2 fi. 1lO.O 100.0

GNPe at marketarices 6A L4 4.91 Li2 La LA 109.2 10L45

La Includes livestock. fishing, and forestry.Lk Includes mining and quarrying; construction; and electricity, gas and water.LC At 1959/60 prices.Ld From the base of 1982/83.LU At current prices.

Source: Statistical Appendix, Table 7.

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1.05 Despite recent rapid growth, the sector remains structurallyvulnerable for several reasons. First, while Pakistan possesses extensivephysical infrastructure, institutional support for agriculture remainsinadequate. In particular, coverage and quality of provincial extensionservices, and linkages with agricultural research require improvement. Bettertargetting of agricultural credit to farmers in greatest need is necessary.Streamlining marketing services is also essential to the Government's exportpromotion efforts. Second, poor water management and inadequate operation andmaintenance of irrigation infrastructure have contributed to waterlogging andsalinity. As a consequence, crop yields have been low. Finally, agriculturaldiversification has not materialized. Growth in the minor crops has fallenfar short of Sixth Plan targets in the absence of appropriate supportpolicies. Markets for the new crops still need to be developed, and marketingprocedures and grading standards established.

1.06 The large jumps in yields, such as for cotton in FY86-87, resultingfrom introduction of better varieties cannot be relied upon to ensure thefuture growth of agriculture. Appropriate government programs and policiesthat ensure adequate infrastructure and its maintenance, and provideincentives to farmers are crucial for long-term growth. Hence, investment infarm-to-market roads and protection of priority investments within theframework of a long-term investment plan for the water sector, as well asprovision for adequate allocations for recurrent expenditure, are required toensure proper infrastructure support. Domestic resource mobilization,therefore, is key to ensuring future growth in this sector. Subsidy reductionfor non-nitrogenous fertilizers and an adequate level of water charges thatreflect beneficiaries' capacity to pay also are important to this resourcemobilization effort. Maintaining output prices close to border parity prices,and encouragement of private sector investments in the water sector would alsoensure adequate incentives for efficient agricultural growth.

1.07 The growth rate of manufacturing in FY87, while substantial (7.7X),was lower than the earlier years of the Sixth Plan period. As Table I.1shows, this was primarily due to the performance of large scale manufacturing,whose growth rate fell from 7.7% in FY84 to 7.02 in FY87. Much of the slowingdown in large scale manufacturing stemmed from a decline in the production ofcotton cloth, vegetable products and some chemicals and slower growth in pigiron. The largest increases in output have come from cotton yarn, sugar,cement, steel products, tractors and bicycles as a result of additions toproduction capacity and better capacity utilization (Annex Table 19). Inaddition, output, investment and exports in the small scale, unorganizedsector (which produces garments, towels, hosiery, leather products, etc.) havebeen increasing rapidly in recent years.

1.08 Industrial growth has been encouraged by an improvement in theindustrial policy environment for private sector initiative, in accord withSixth Plan objectives. The composition of industrial investment has shiftedheavily toward the private sector. Private industrial investment expanded byalmost 23% p.a. in real terms during the Plan period, as against a 7% annualincrease in total industrial investment. In total, over 72% of totalindustrial investment during FY84-87 was contributed by the private sector.The restriction that public manufacturing investment be limited to thecompletion of ongoing projects and to rehabilitation of existing plantscontributed to this outcome. Public enterprise disinvestment has proceeded

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slowly. Although a disinvestment of Rs 2 billion in shares of public sectorindustrial units has been included in the budget since FY86, only one smallindustrial unit (Tarbela Textiles) has been sold to date.

1.09 Government efforts to reduce controls on private industrialinvestment continued in FY87. Relevant actions consisted of (a) an increasein the sanctioning limit from Rs 300 million ($17 million) to Rs 500 million($29 million); (b) the removal of 11 industries from the specified list forwhich sanctioning was required irrespective of investment size, therebyeffectJvely removing this barrier to most manufacturing investment; and (c)the announcement of a "one window facility" for industrial investors, whichwould reduce the need for multiple approvals for any investment projecZ.Steps to deregulate production, pricing, and trade in cement, vegetable ghee,and nitrogenous fertilizers have been taken. Exchange rate management seemsto have avoided adverse effects on the competitiveness of manufacturedexports. However, while the Government has taken periodic steps to liberalizetrade since the early 1980s, the prctection system still favors importsubstitution over exporting. These points are described in more detail inchapter III.

Savings and Investment

1.10 The FY87 growth performance essentially follows the trend of the lastfour years (FY84-87), when total resources available to Pakistan grew in realterms at a lower rate than GDP (6.6Z p.a. versus 7.12 p.a.) 1/. This was dueto the decline in net external resources. Table I.2 shows the marked shift inthe pattern of resource use during FY84-87, from external to domesticsources. The inflow of net external resources (factor incomes and externalfinancing) declined from about 11% of GNP in the first two years of the Planto 9.0X in FY86 and 6.3% in FY87, due to growing interest payments on foreigndebt and falling remittances, as well as to the unusually low externalfinancing in the latter year.

1.11 The fall in external resources was accompanied by a rise in the grossdomestic savings rate from about 51 of GNP in FY84 to over 91 by FY87. Grossnational savings increased more slowly, as the increase in domestic savingswas partially offset by falling net factor income from abroad. Caution isrequired in interpreting this savings (and consumption) trend. Althoughfinancial savings may have increased, the recorded savings increases in FY86and FY87 appear too large to attribute to a change in behavior. Statisticalproblems may also be responsible for this result.

1.12 The improvement in the national savings rate originated solely fromthe private sector. Public savings (including public enterprises) have fallenin most years since the early 1980s, as federal and provincial governmentshave incurred growing deficits, as a proportion of GNP, on their fiscalcurrent account. This situation, coupled with a steady public investment/GNPratio, has rendered the Government a growing source of excess demand in theeconomy, as reflected by growing net government borrowing rising from 7.2% ofGNP in FY85 to 8.51 in FY87.

1/ Statistical Annex, Table 9.

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Table 12: RESOURCE AVAILABILITY ANO USE. 1983/84 - 1986/87(Percentage of GNP at current prices)

Sixth Plan Average ActualTarget 1983/84 19848S5 1985/86 1986/87 1983/84-1986/87

GOP at market prices 92.3 92.3 93.6 94.5 95.7 94.2Net factor income LA 7.7 7.7 6.4 SS 4.3 5.8GAP at farket prices 100.0 100.0 100.0 100.0 100.0 100.0Current accountbalance Lb 2.7 3.1 4.9 3.5 2.0 3.3

Resource Availability 102.7 103.1 104.9 103.5 102.0 103.3

Resource Usa

Consumption 84.9 87.4 89.2 87.7 86.3 87.6Private 74.2 76.0 77.8 76.2 74.1 76.0Public 10.7 11.4 11.4 11.5 12.2 11.6

G6oss investment 17.8 15.7 15.7 15.7 15.7 15.7Fixed investment 15.9 14.0 14.0 14.2 14.1 14.1Private (6.8) (5.7) (5.8) (5.8) (5.7) (5.7)Public (9.1) (8.3) (8.2) (8.4) (8.4) (8.4)

Inventories l 9 1.7 1.7 1.6 1.6 1.6

H nrandu, itin:Gross domestic savings 7.3 4.9 4.4 6.8 9.4 6.6Gross national savings 15.1 12.6 10.8 12.3 13.7 12.3

Public (1.9) (0.4) (1.5) (0.4) (1.1)Private (10.7) (10.4) (10.8) (13.3) (11.2)

External resources Lc 10.4 10.7 11.3 9.0 6.3 9.2

La Includes current private transfers. Private transfers are treated as factor income in Pakistan.Lk Positive figures represent deficits on the current account of balance of payments.LI Factor incomes and external financing.

Source: Statistical Appendix. Tables 8 and 10.

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1.13 Gross investment increased in FY87 remained at 15.7X of GNP, the samelevel as in the first three years of the Sixth Plan. Although privateindustrial investment has been increasing, public investment in electricity,gas, and other non-manufacturing parastatals, as well as in general governmentaccelerated such that total public investment growth has kept pace with thatof private investment.

1.14 The investment rate in Pakistan is unusually low in relation tohistorical GDP growth rates. It is implausible that the Pakistan economyoperates as efficiently as implied by the low incremental capital-outputratios (ICORs) of around 2.7. 1/ A more likely explanation might be thatPakistan has, over the past decade, been depleting its existing capital stockand neglecting maintenance and replacement investment, thus attaining highincome growth with low investment at the expense of future growth. This isvisible in the public infrastructure systems - undermaintained highways,railways, and irrigation networks, and by the low level of investment untilrecently in the social sectors. It is also possible, however, that Pakistan'slow ICOR is partly statistical, the result of underestimation of investment inits national accounts. This is plausible, given the importance of small farmand non-farm entrepreneurs and a large "black" economy, whose investments arehard to estimate. Whatever the reason, it is prudent to assume that ICORswill be higher in the future. The composition of future investment, withheavy infrastructure requirements for energy, transport and highways, andurban renewal as well as the new emphasis on social sectors, will entail morecapital per unit of output, and therefore higher rates of investment.

1.15 The prevailing rates of investment and savings appear to be too lowto support future economic growth on the order of 6% per year on a sustainedbasis. Long-term development, therefore, requires (a) higher national savingsrates, (b) an increase in public savings rates, to reduce the current largediversion of private savings for public sector use (Table II.1), and (c)increases in the investment rate, with the expectation of higher ICORs.

Employment and Wages

1.16 With the help of the Middle East oil boom, the domestic labor marketto date has been able to absorb, at rising reai wageb i& key betLV-8 thcincreases in the domestic labor force. Labor force and wage data extend onlyto FY86. 2/ However, the analysis below, based primarily on data for FY79 toFY85, 3/ provides a reasonably accurate picture of labor market trends for theSixth Plan period to date.

1/ Ten developing economies with low growth had, over the period of 1960-84,ICORs ranging between 4.0 and 12.1, and fourteen countries with highgrowth had ICORs between 2.7 and 4.5. See: IBRD, World DevelopmentReport, 1986, p. 27.

2/ Construction wages only are available up to FY87.

3/ Labor force data for FY86 contain some irregularities, the most importantamong which is an increasing share of employment in agriculture.

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1.17 Pakistan's domestic labor force, officially estimated at about 28million in FY85, grew 2.3S per annum between FY79 and FY85, considerably belowthat estimated for much of the 1970s (Table I.3). Deceleration in labor forcegrowth resulted mainly from a falling labor force participation rate (LFPR) I/but also from migration, particularly to the Middle East. From a trickle inthe early 1970s, outmigration of workers to the Middle East accelerated toaround 170,000 per annum in FY81, by which time some 1.7 to 2 million workerswere estimated to be in these countries. However, after FY82, the number ofoutmigrants declined while that of returning migrants increased, so that byFY85, there was a net return flow of some 30,000 persons.

1.18 With an expanding economy and substantial inflows of migrantremittances, employment kept pace with the growth of the labor force. Overallemployment growth was 2.2% per annum according to official statistics. Thesectoral composition of the work force also continued to change, asagriculture fell in importance relative to construction and serviceactivities. By FY85, the share of workers in agriculture was about 50%(compared to 57% in FY72), a result of both the slower growth of the sectorrelative to the rest of the economy and lower labor absorption, possibly theconsequence of technological improvements and labor supply constraints. Theshare of workers in manufacturing remained constant (between 13 and 142 duringthe same period) despite the sector's rapid output growth, in part because ofrising capital intensity and labor legislation covering large scale manu-facturing. The official statistics may also have underestimated employmentgrowth in small scale manufacturing. Comparison of the 1983/84 and 1976/77Surveys of Small Scale and Household Manufacturing indicated that employmentin the small scale sector grew 80% between these years. The sha:e ofconstruction rose, as did that of other service activities, so that by FY85,they employed about 351 of the work force.

1.19 Low rates of open unemployment are consistent with the above trendsin employment growth. Unemployment was reported to be less than 4% sinceFY79. As is typical of developing countries, urban unemployment exceeds ruralunemployment (5% compared to 3.11 in FY86), and youth unemployment is higherthan the national average, averaging about 72 for those between ages 10 and24. Unemployment among the educated, a subset of the above, is also high,particuiarly in urban areas, and rising; unemployment rates for those withprimary and secondary education increased from 5% in FY83 to over 7% by FY86.Unlike open unemployment, underemployment, defined in terms of working lessthan 35 hours per week, is mainly a rural, seasonal phenomenon; 12% of therural labor force were in this category in FY86, compared to 3.5% of the urban

1/ The LFPR is defined as the ratio of the labor force to the working agepopulation (aged 10 and above), in percent. High population growth notonly increased the share of the population in the youngest age groups,thereby raising dependency and reducing the share of the working agepopulation, but also lowered the LFPR since the proportion of the youngworkforce, among whom participation rates are typically lower, was alsoincreased. Thus, while those aged 10-24 increased from 431 of the laborforce in FY79 to 451 in FY85, the LFPR fell from 461 to 441.

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Table I.3: TRENDS IN EMPLOYMENT AND WAGES1971/72-1984/85 /a

Millions S Increase p.a.1972 1978/79 1984/85 1972/79 1978/79-1984/85

Population 63.7 78.9 94.7 3.1 3.1Economically ActivePopulation (LAP) 41.9 53.1 63.3 3.4 3.0

Labor Force 19.5 24.5 28.0 3.3 2.3Employed 19.1 23.7 27.0 3.1 2.2Unemployed 0.4 0.9 1.0 11.6 3.0

EAP/Population 65.7 67.3 66.9Labor Force Participation (%) 46.6/c 46.1 44.2 -0.2 -0.7Unemployment Rate (X) 2.0 3.5 3.7

Real Wage Indexes (1970=100)Agriculture /d 105 138 215/e 4.0 11.7Large Scale Mfg. 107 157 l91/e 3.6 4.0Small Scale Mfg. /f - 100 123 - 3.0Construction 102 143 126 4.9 -2.5

/a Data for 1972 are from the Population Census, those for 1978/79 and1984/85 are based on Labor Force Surveys.

/a Labor force as a percentage of economically active population.

/c Based on the Household Economic and Demographic Survey 1973.

/d Agricultural casual labor.

/e Data are for 1983/84.

if Data are for 1976/77 and 1983/84.

Sources: Population Census 1972; Labor Force Surveys, 1978/79 and 1984/85.

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labor force. Official data show underemployment to have varied between 92 and14% between FY79 and FY86. However, given the doubts about the reliability ofthese estimates, little can be said about trends in underemployment.

1.20 Reflecting the strong demand for labor and amount of outmigration,wages in the agricultural and manufacturing sectors since FY79 have recordedsignificant increases, a continuation of trends since the mid-1970s. Inagriculture, average real wages for male casual workers increased at over 11lp.a. since FY79. Wage increases of about 4S p.a. occurred in large scalemanufacturing, while the small scale subsector experienced more modest wageincreases (3X p.a.). However, with the reverse flow of migrants to the MiddleEast, the bulk of whom are construction workers, the earlier real growth inconstruction wages has been arrested; real wages of unskilled constructionlabor in 1987 were about 8% lower than in 1982. Although there are no data onservice sector wages, it is possible that the unskilled segment of the serviceworkforce, especially those in small-scale informal sector actirities, mayalso be experiencing a stagnating or even a drop in real wages.

1.21 The information to date suggests that the employment/wage picture forthe end of the Sixth Plan may be less positive than in earlier years,especially in urban activities. Net outmigration has reversed, although thenumbers to date are not major. Real wages for unskilled construction workers,typically a good indication of the market for unskilled urban workers, havebeen falling since 1982. However, a nationwide labor surplus does not seem tobe a problem yet. Manufacturing employment continues to grow, at over 5%,with continued improvement in real wages. While employment growth inagriculture has been slow (about 2% per year), the high real wage growth inthe sector since the late 1970s and anecdotal evidence suggest a continuingshortage of agricultural workers around industrial centers.

Public Finances

1.22 In the early eighties, resource constraints were accommodated byexpenditure restraint, to the detriment of socio-economic services and otherrequired development outlays. Since then, a more expansionary fiscal stance,together with the Government's commitment to redress these past neglects underthe Sixth Five-Year Plan, has aggravated the budgetary situaLion. Budgetarydeficits increased from about 6% of GDP prior to the Sixth Plan (average ofFY81-83) to almost 9% of GDP in FY87, as current expenditures expanded rapidlywithout a corresponding revenue effort. Similarly, government savings (thedifference between revenues and current expenditures) deteriorated markedly.Government savings, about 2% of GDP in FY81-82, moved into deficit over thePlan period, reaching a negative 1.8% of GDP in FY87. The expenditure andrevenue trends and structure are briefly highlighted below and in Table I.4;they are discussed at greater length in Chapter II. They show that, tosupport the country's development objectives, resource mobilization togetherwith a change in the tax structure, control and restructuring of currentexpenditures in favor of development-related programs, and protection ofdevelopment expenditures will be needed as part of deficit reduction.

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Table r.4: SUMMARY OF CONSOLIDATEO PUBLIC FINANCE. 1980/81 - 1986/87(Million Rupees)

n0/F1 1981/a2 1942/1n5071 1Z43/84 1ZWALSAA 19f Z 219

Revenue 47.002 51,L3L1 Sq.795 72iL290 77.403 19.E77 952i5Q0Tax LA 38.846 43.003 49,240 58,255 61,212 72.636 78.187Non-Tax 8.156 8,927 10.555 14,035 16,191 17,241 21.363

Contribution of AutonomousBodies 2.019 1.909 2,286 2.565 2.639 2.942 2,788

Net Lending & EquityParticipation - - - - - - 400

ExpHlditure 63La639 71.1013 87UiL7Z 100.002 116.819 134.502 15fi-413Current Zh 40.296 46.338 60.201 73.411 85.270 97.094 113.544Developwent 23.343 24.675 27.436 26.591 31,549 37.408 42.869

Overall Deficit -14.618 -17.1Z74 -25.556 2S.1Z 47 -36.777 -41.6a3 -53.675

Financing Ext. Resources (net) 7.741 5-345 5.700 5.0C1 S.169 8.584 11.327

Ext. Resources (gross) 11.374 11,263 14,434 13,512 14,200 19,346 23.081Project Aid (3,602) (3,686) (4.833) (4.589) (7,378) (10,486) (12.943)Non-Project Aid (7.772) (7.577) (9.601) (8.923) (6.822) (8.860) (10.138)

Oebt Repayment (external) 3.633 5.918 8.734 8.511 9,031 10.762 11.754Dtmstic non-bank (net) 4,522 6 313 13Z732 12.280 12.873 27.001.c 30Lfi6l

Domestic bank borrowinc (net) 2.355 5-516 6.124 7L86fi 18J735 6,l9B 11 747

Mem ltens(as X of GOP at current prices)Total revenues LA 17.6 16.7 17.1 17.9 16.7 17.1 17.1

lax revenues 14.0 13.4 13.6 13.9 12.8 13.4 13.0Hon-tax revenues 2.9 2.8 2.9 3.4 3.4 3.2 3.6

Expenditures 22.9 22.1 24.2 23.9 24.4 24.8 26.1Current 14.5 14.4 16.6 17.6 17.8 17.9 18.9Development 8.4 7.7 7.6 6.4 6.6 6.9 7.1

Overall deficit 5.3 5.3 7.1 6.0 7.7 7.7 8.9External financing (net) 2.8 1.7 1.6 1.2 1.1 1.6 1.9Oomestic non-bank financing 1.6 2.0 3.8 2.9 2.7 S.0 S.1Domestic bank financing 0.8 1.7 1.7 1.9 3.9 1.1 2.0

/a Includes surcharges./b Includes fertilizer subsidy and excludes irrigation expenditure. which are

offset against irrigation charges and included in non-tax revenue.Zc Proceeds from sales of Special National Fund Bonds (SNFBs) which were financed

by bank credit to the private sector (Rs 11 billion) were used to repayoutstanding Bank credit for coimmodity operations. These transactions have beenexcluded from the budget so as to maintain comparability with earlier years.

I/ Includes contributions of autonomous bodies and receipts of sale from publicenterprises.

Source: Ministry of Finance.

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1.23 Prime Minister's Five-Point Program. In recognition of the country'spoorly developed human resource base, the Government in its Sixth DevelopmentP3an formulated a major agenda for social development to improve literacy,education, health and basic public services for the population. However,results achieved after two and a half years were sufficiently poor to call foran extraordinary effort to safeguard the social sector priorities and targetsof the Plan. The Government's response was the announcement of the PrimeMinister's Five-Point Economic and Social Program for 1986-90. At the heartof the Five-Poin. Program is the development of rural areas and the improve-improvement of the social-economic status of the rural population, throughbetter education and health services, provision of potable water andsanitation facilities, more roads and housing improvements.

1.24 Since the announcement of the Program there has been a significantincrease of financial allocations to the social sectors, especially theeducation sector. Annual allocations to education almost doubled between FY85and FY87 and have reached 2.5% of GNP, compared with 1.5% in the Fifth Plan.In FY87, 451 of development expenditures (ADP) was for the Five-Point Program,a 17% increase over the previous year's expenditures. Additional funds werealso provided outside the ADP to provinces for additional recurrentexpenditure on education. With this recent increase, Pakistan is spendingabout 10% of combined federal and provincial current expenditures on thesocial sectors. While this compares poorly with other developing countries -which soend, on average, between 15% and 20% - resource constraints mayrequire a more efficient use of available funds rather than a large increasein allocations.

1.25 Current Expenditures. Over the Sixth Plan period, the consolidatedcurrent expenditures of the federal and provincial governments increased (innominal terms) by 17.21 per annum compared to a 13.5% annual growth in GDP.As Table 1.5 shows, the share of almost all categories, as a percentage ofGDP, increased substantially over the plan period to date. The majorexception was development expenditures.

1.26 The current expenditure portion of the budget is dominated by defenseand interest payments, which together account for almost 55% of the total.Efforts to control current expenditure growth, therefore, depend on theGovernment'E ability to control these two categories. The impact of the rapidgrowth in domestic debt-over 20% per year since FY80-is visible in thegrowth of interest liabilities. While both foreign and domestic interestpayments have grown rapidly, the larger increase has occurred in the domesticinterest portion. Table I.5 shows the relative magnitudes of each.

1.27 Although direct subsidies have remained at less than 2% of GDP, theymore than doubled in nominal terms since FY83 and are almost 10% of recurrentexpenditures. The major subsidies are for wheat, fertilizer, and the PakistanSteel Mill. Together, they accounted for over 60% of total subsidies in FY87.

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Iabl 1-9L: COMPOSITION OF TOTAL EXPENfITURES. 1980/81-1986/87

(% OF GOP)

12SRLA1 IM112 I9aL2l2 ]UL8a4 1M84/85 1085/86 1Afi/9A7

Consuption Expenditures 10.3 10.7 12.2 12.7 12.9 12.6 13.26eneral Admin. & Law & Order 1.7 1.8 2.0 2.3 2.3 2.2 2.2Defense S.S 5.$ 6.4 6.4 6.7 6.6 6.7Cownamity Services O.S O.S 0.6 0.7 0.7 0.7 0.7Social Services 1.4 1.4 1.7 2.0 1.9 2.0 2.3Economic Services La 1.2 1.2 1.S 1.3 1.3 1.1 1.3

Transfer Paymnts 4.5 4.1 4.7 5.4 5.6 S.9 6.4Subsidies Lb 1.8 1.3 1.3 1.S 1.4 1.S 1.7Interest payments 2.1 2.4 3.0 3.4 3.S 3.7 4.0

Foreign 1.0 1.0 1.3 1.4 1.4 1.4 1.4Domestic 1.1 1.4 1.7 1.9 2.1 2.3 2.6

Grants to Local Authorities 0.2 0.1 0.1 0.2 0.4 0.4 0.4Social Services La 0.4 0.3 0.3 0.3 0.3 0.3 0.3

Oevelopment 8.4 7.7 7.6 6.4 6.6 6.9 7.1

TOTAL EXPENDITURES La 23.2 22.5 24.5 24.5 25.1 25.4 26.7

La Irrigation expenditure is included in Table I.S but not in Table 1.4.Lb Includes fertilizer subsidy.La Refers to pensions and education stipends.

Source: Finance Oivision

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1.28 The growth in current expenditures reflects in part increasingtransfers to the provinces. Because of the inability of provinces to meetrecurrent liabilities from their own resources or from revenue sharingprovisions, federal grant transfers to the provinces rose from Rs 0.9 billionin FY81 to Rsl2 billion in FY87, an amount equivalent to the federal taxtransfers to them. Once a new revenue sharing formula is agreed upon--adecision is expected this fiscal year--these transfers should grow more slowly.

1.29 Development Expenditures. In contrast to the trend in currentexpenditures, developmenL expenditures (ADP) in the past four years havefallen as a percent of GDP although they have grown in real terms. In FY87,development expenditures as a share of GDP (7.1S) were lower than they hadbeen prior to the Sixth Plan (an average 7.9% of GDP for FY81 - FY83). Withinthe Sixth Plan period, however, its share has been increasing since the poorFY84 crop year. Nonetheless, the implementation rate of the Sixth Plandevelopment program is expected to be almost 90X, 1/ an improvement over theFifth Plan's implementation rate of 711.

1.30 Table I.6 shows the distribution of ADP expenditures by sectorrelative to the Sixth Plan targets. Education and health shares in the totalstand at 7.5% and 5.62, close tc the Plan targets. In the last two years, inparticular, a sizable proportion of ADP was used to accommodate the PrimeMinister's Program, as is reflected in the recent rise in expenditures forsocial, physical planning and housing, and rural development programs. Whilehaving grown significantly relative to the Fifth Plan, the shares of severalother priority sectors are below the levels proposed under the Sixth Plan. Todate, the cumulative share of energy in ADP is 29% as against the projectedlevel of 361, and the water and transport and communication shares are alsoslightly lower than the targets.

1.31 Revenues. Pakistan's revenue raising efforts in recent years havefallen significantly short of expenditure requirements. Over the past fouryears, total government (federal plus provincial) revenues have been stable atabout 17% of GDP. Table I.7 shows Pakistan's revenue performance during the1980s. Almost 801 of total revenue comes from taxes, the rest from therevenue surpluses of government departments and autonomous bodies and fromnon-tax receipts. Within tax revenues, 95% is derived from federal taxes and51, from provincial taxes. Indirect taxation accounts for the bulk (over 851)of tax revenues, with taxation on foreign trade--import duties, sales taxes onimported goods, and export taxes--a major source (45% of total taxes).

1.32 Tax revenues have been maintained at 13% of GDP throughout theperiod. This close to unitary buoyancy of the tax system has only beenpossible with frequent rate increases and ad hoc changes in existing taxes,and implicit and explicit surcharges, primarily on petroleum products tocapture the windfall gains generated by falling world petroleum prices in1986. The main culprits in the relatively slow tax revenue growth have beenthe personal and company income taxes and the sales and excise taxes. Income

1/ Excludes fertilizer subsidies. Calculated as the sum of FY84-FY87 actualplus FY88 estimated levels.

table 1,6: ANNUAL DEVELOPMENT PROGRAM. 1982J83 - 1987/88(Million Rupees)

1938814 - 198713*

Sixth Plan Target 1987/fU Total La S Of

1953/84 - 1987/88 1983/84 1984/85 1985/86 1986/87 Estimate Total

Ab unt (not) /a of Total

Agriculture 10.587 5.0 1,445 1,419 1,394 1,730 2.18S 8,17n 4.2

Fertilizer subsidytb 2,652 1.3 1,466 1,501 2,408 2,026 1.600 9,001 4.7

Water 28,088 13.4 4,071 3,905 4,976 5,430 8,130 23,591 12.2

Energy (including 75,661 36.0 7,174 10,896 10,802 12,865 14,447 56,184 29.1

power and fuel)Industry 7.438 3.5 1,994 1,597 691 386 362 5,030 2.6

1inerals 2,188 1.1 217 246 221 242 259 1,185 0.6

Physical planning and 12.687 6.0 2,456 2,748 2,952 5,060 4,96$ 18,184 9.4

housingTransport and 33,249 15.8 5,013 5,542 5,859 5,887 5,628 27,929 14.4

comunicationsEducation 16,476 7.9 1,655 1,976 2,905 3,642 3,963 14,141 7.3

Manpower 893 0.4 287 206 163 130 210 996 0.5

Health 11,375 5.4 1,563 1,700 1,766 2,428 3,106 10,S63 5.5

Rural Development 1,878 0.9 947 1,042 1,530 1,485 2,602 7.606 3.9

Population Planning 2,494 1.2 338 405 456 483 571 2.2S3 1.2

and social welfareOther 1- 4,374 2.1 945 899 687 3,141 2,969 8,641 4.5

Less shortfall - - - - - - - (996.0) (0.1)

Total ADP 14 210.000 100.0 29.571 34.082 36.810 U4 935 5 000 192.9 1J00

L& Subsectoral allocations have been adJusted for 12.5X operational shortfallin respect of total Gross Sixth Plan allocation of Rs 230 billion.

Lb Finance Division estimate.La Includes Special Programs for Women; Manpower, Social Welfare and others;

Mass Media; and Culture, Sports and Tourism.fg The development expenditures figure in Table I.4 as provided by the Finance

Division norwally differs from the total ADP figure in Table 1.6 supplied by

the Planning Division. Part of the difference is due to the inclusion of

fertilizer subsidies in ADP in Table 1.6 but not in Table 1.4.

LS :Ym of 1983/84-1986/87 actuals and 1987/88 estimated levels.

Source: Planning and Development Division.

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Table I.7: CONSOLIDATED REVENUES. 1980/81-1987/88(1 OF GOP)

% Share ofTotal Taxes

ING/Al 1981182 15lL2/12 1983/84 198M/85 lsa89/ 19war^ 19 r286

Tax Revenues 14.0 13.4 13.6 13.9 12.8 13.4 13.0 100.0

Direct Taxes 2.8 2.9 2.7 2.4 2.2 1.9 1.8 13.9

Individual and co anyincome taxes 2.5 2.6 2.4 2.1 1.9 1.8 1.7 13.1

Taxes on capital La 0.3 0.3 0.3 0.3 0.3 0.1 0.1 0.6

Major indirect taxes 10.2 9.8 10.3 10.9 10.1 10.9 10.6 82.0Ilport duties 4.9 4.6 S.0 5.0 4.8 5.2 S.1 39.3Excise duties 3.7 3.6 3.6 3.7 3.2 2.9 2.5 19.4Sales tax 1.0 1.0 1.0 1.1 1.0 1.0 0.9 7.3On Imports 0.9 0.8 0.8 0.9 0.8 0.7 0.8 5.8On Doestic Transactions 0.1 0.2 0.2 0.2 0.2 0.3 0.2 1.S

Surcharges 0.6 0.6 0.7 1.1 1.1 1.8 2.1 15.8Petroleum products 0.3 0.3 0.5 0.6 0.6 1.1 1.7 13.4Fertilizer 0.1 0.1 0.1 0.2 0.2 0.1 0.0 -Natural gas 0.2 0.2 0.1 0.3 0.3 0.6 0.3 2.4

Export taxes 0.3 0.1 0.1 0.1 0.1 0.2 0.0 0.3

Other 0.7 0.6 OS 0.4 0.4 0.4 0.5 4.0

Non-tax Revenues Lb 2.9 2.8 2.9 3.4 3.4 3.2 3.6

Contribution of autonosousbodies 0.7 0.6 0.6 0.6 OS O.S OS

TOTAL REVENUES 17.6 16.7 17.1 17.9 16.7 17.1 17.1

la Federal wealth, estate and gift taxes, and provincial and property taxes.Includes receipts from sale of public enterprises.

Source: Planning and Developent Division

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taxes have fallen as a share of total revenues, because of exemptions of largeclasses of income, including agricultural incomes; tax holidays for certaintypes of investment; and, more recently, increases in the personal exemptionlevel and reductions in tax rates. Sales and excise taxes, which togetherprovide around 25S of total tax revenues, have been eroded by numerousexemptions.

1.33 Revenue performance in FY87 suffered from these weaknesses in the taxstructure. Although overall revenues increased by 10.81 (relative to 11.51GDP growth), tax revenues increased only 7.62 due to a decline in excisecollections and in income tax revenues, as the reduced marginal income taxrates became effective, and a shortfall in expected surcharge receipts frompetroleum and natural gas. However, import duties exceeded budgetaryestimates, reflecting a number of factors including a significant rise inimports of sugar, edible oils, and machinery, and depreciation of the rupee.

1.34 Financing the Deficit. The large and growing budget deficits havebeeni financed by borrowing from both external and domestic sources. (Thistopic is discussed at length in chapters II and IV). During the first fouryears of the Plan, there was a heav_- reliance on domestic borrowing,particularly on non-bank sources. FY87 was typical. External financingaccounted for 21% of deficit financing, with non-bank borrowing accounting for581 and bank financing, the remaining 211. As a result, the stock ofgovernment domestic debt increased from Rs 103.6 billion to Rs 235 billionduring the Plan period. By FY87, domestic debt amounted to 40% of GDP, andexternal debt, another 41% of GDP. A continuation of the large deficits, withits implications for debt servicing, will soon require the Government tochoose between increasing tax revenues or working with sharply decreasingresources to carry out the normal duties of government.

Money, Credit and Prices

1.35 Monetary and credit policy in Pakistan is conducted on the basis ofan Annual Credit Plan (ACP). This plan sets ceilings on the expansion ofcredit by commercial banks, mandatory minimum allocations for prioritysectors, and indicative allocations for the others. It also takes intoaccount the Government's credit needs and expected changes in net foreignassets. Monetary expansion, through this arrangement, has been kept at a ratecommensurate with the nominal growth of output during the Sixth Plan period todate, although it has exceeded the target of the ACPs. As indicated in TableI.8, the money supply (M2, comprising currency, demand deposits and time andsavings deposits) grew 151 in FY86 and 14% in FY87 as against the ACP targetsof 101 and 12%, respectively.

1.36 The actual factors behind the money supply growth also have usuallydiffered considerably from those envisaged in the ACPs. In FY87, as in otheryears, budgetary support to finance the growing fiscal deficit increased morerapidly than planned, although contractions in credit for commodity operationsand a smaller than planned increase in credit to public enterprises kept totalpublic sector credit flows for FY87 at the nominal levels for FY86. Privatesector credit flows also substantially exceeded initial plans, continuing theSixth Plan trend of a rising private sector share. The expansionary impact ofthese unplanned increases were partly offset by unant4 --'.ed declines in netforeign assets of the banking system, the third consecutive decline in the

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Table I.: SUMHARY ANNUAL CREDIT PLANNING, 1984/85-1986/87 La(million rupees)

1984/8519S8 199fi/97ACP Actual ACP Actual ACP Actual

Honey and Quasi-Honey 18,016 20.638 18.099 27,206 25,039 29.293

Foreign Assets (net) -2.620 -17.472 3.500 -2.119 6.930 -413

Domestic Credit (net) 20.679 38,110 14,599 29,325 18,109 29.706Credit to Government 5.620 18.273 -170 8.628L/ 4,000 10.162(Budgetary Support) (5.820) (18.313) (-20) (6.098) (-) (10.922)(Comodity Operation) (-200) (-711) (-150) (3.702) (4.000) (-226)

Credit to Public Entps. 4.000 3.877 2.500 3.591 2.500 765Credit to Private Sec. 13,559 13.919 14,769 19,3SOLh 14.109 21.252Other Items -2.500 2.041 -2.500 -2,244 -2.500 -2,473

Memm Items (I change)Honey and Quasi Honey 11 13 10 15 12 14Damestic Credit 13 24 7 15 8 13Credit to Government 7 23 - 9 4 11Credit to Private Sect. 17 18 16 21 12 17Credit to Public Entps. 15 14 8 12 7 2GOP (in market prices) 15 14 13 13 12 12

La Annual Credit Plan (ACP) figures are the original targets/ceilings; they arerevised as deemed necessary in the course of the year.

Lb Adjusted for SNFB operation (see footnote "c to Table 1.4).

Source: State Bank of Pakistan.

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plan period. Although the FY87 decline was smaller than in previous years,the cumulative decline in foreign reserves brought the banking system's netforeign asset position by end-June, 1987 to a negative t762 million.

1.37 The share of the private sector in total credit has increasedfrom 50-55Z prior to the Sixth Plan to about 70% during the last two years.Various credit allocations directed toward the private sector have contributedto this increase: (i) the allocation of a specific amount, within the overallbank credit ceiling, to the private sector for fixed industrial investment andagriculture; (ii) the two mandatory credit schemes for small industry andbusiness, and for agriculture; and (iii) the concessionary credit schemes asin the case of the Export Finance Scheme and for financing domestic sales andexports of locally manufactured machinery. Given the present need to rebuildforeign exchange reserves, continued real growth in private sector credit islikely to be incompatible with the Government's price stability objectivesunless budget deficit financing is substantially reduced.

1.38 Pakistan was one of the few developing countries that succeeded inkeeping inflation under control during the 1970s (12.3% per annum) and theearly 1980s (about 10%), despite the dramatic surge in international petroleumprices and in interest rates. During the first four years of the Sixth Plan,inflation continued abating, with the consumer price index (C°I) decliningfrom 8.3% in FY84 to 3.9% in FY87 (the corresponding rates of GDP deflator are9.6% and 5.4%) 1/. Inflation has been controlled with a conservative monetarypolicy, a high rate of growth in agricultural production, the use of importsto assure availability of a number of key commodities (e.g. edible oil, tea,milk products, and at times, wheat) at stable prices, and declining prices ofmajor imports, e.g., petroleum and edible oils. Smuggling of consumer goodsalso has helped absorb the growing purchasing power of the population.

1.39 Even so, the FY87 inflation rate was unusually low and is not likelyto continue in FY88. The failure to contain the fiscal deficit in FY87 hasadded to excess demand. Substantial increases in the prices of minor crops,adversely affected by weather, have been noted. Foreign exchange reserves,limited to 6 weeks of imports, possibly may require some restraint inimports. Finally, world prices of Pakistan's major imports, particularlypetroleum and fertilizer (and edible oils), have been increasing recently.The average CPS for July-December, 1987 rose by 6.6% compared to that in thecorresponding period of 1986. The equivalent increase for the wholesaleprice index was 10.42.

1/ The inclusion of a considerable number of commodities with administeredprices in the price indexes complicates the estimate of inflation.However, there are no parallel markets with higher prices for price-controlled commodities. Moreover, the inflation trend depicted by the CPIand GDP deflator is also confirmed by the "sensitive price indicat.lr"comprising 37 essential commodities whose prices are market-determined.

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Balance of Payments

1.40 Compared to the rest of the 1980s, Pakistan's current account deficitwas exceptionally low in FY87, declining from about $1.7 billion (52 of GNP)in FY85 to $720 million (2.0S of GNP) (Table I.9). This is largely becausePakistan was able to maintain the large export volumes achieved in FY86, withsome improvement in export prices (Table I.10). Rapid export growth in FY87originated mainly from cotton, rice and cotton-based manufactures. Withrecord crops from favorable weather, better seed varieties and greater use offertilizers, FY87 exports of cotton and rice (other than Basmati) remained atthe record levels achieved in FY86 despite falling world prices. Exports ofyarn and ready-made garments increased 65% and 501 in volume compared to FY86,with an improvement in price. However, Basmati rice exports declined 28% involume terms because of weakening market conditions. Non-traditional exports,while increasing 61 in real terms, have also done less well than the moretraditional exports. Continued stagnation in the value of imports at about $6billion a year also helped contain the trade deficit. The decline in theimport bill for crude oil and petroleum prices and increased domestic crudeoil production, as well as the fall in world prices for edible oils, were themajor contributing factors, while the real depreciation of the rupee (TableI.10) helped to restrain other imports.

1.41 Developments in the invisible balance and the capital account havebeen less positive. Continuing a trend begun in the early 1980s, workerremittance inflows in FY87 dropped to $2.3 billion, from $2.6 billion in FY86and $2.9 billion in FY83. Net medium and long-term capital inflows alsodropped in FY87, below the level of previous plan years. However, increasednet MLT inflows prior to FY87, together with more short-term borrowing andrepayment of obligations to the IMF, have increased debt service payments.Debt service rose from 14% of exports of goods, services and transfers in FY83to 311 in FY87.

1.42 1Notwithstanding the atypical improvement in the current accountdeficit in FY87, Pakistan's balance of payments remains structurally fragile.Pakistan's export growth has come primarily from traditional exports, all ofwhich are primary commodities or primary commodity-based. At about 60% of thetotal, the share of cotton, rice and cotton-based manufactures has not changedsignificantly since FY80, although there has been a shift from raw cotton andrice to cotton manufactures (Table 1.11). Export volume growth, whichaveraged 7.5% annum between FY81 and FY86, was offset by a 271 drop in theexport price index during this period. Hence, export performance remainshostage to variation in domestic output and fluctuations in internationalcommodity prices, and in the case of cotton manufactures, to risingprotectionism in importing countries. Diversification into non-traditionalexports, such as cutlery, selected engineering goods, and fruits andvegetables, is occurring. However, the process has been slow. Despite realdepreciation of the rupee by 401 since FY81 (Table I.10), the "other"category of exports has not increased its share in the total (Table I.11).The domestic relative price structure continues to favor production for thedomestic market over exports (Chapter III). The trade regime, despite changessince 1980, still provides high levels of protection through quantitativerestrictions and tariffs. Without a reform of this incentive structure, anexport promotion strategy which relies primarily on a flexible exchange ratepolicy and direct fiscal and financial incentives for exports will not besufficient to offset the import substitution bias of the present trade regime.

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TableA I9 BALANCE OF PAYMENTS. 1983/64 - 1986/87( US$ million )

1983/84 1964/8S 198/S86 1986/87

Current Account Balaner -1.,3j -1.6fa -123fi Z-1

Trade ftlmce ~ -3 324 -3sS52 -2 b42 -2.29

Exports (f.o.b) 2.669 2,457 2.942 3.498Imports (f.o.b) -S.993 -6.009 -S.984 -5.792

Services (net) -714 -815 -1.017 -982Private transfers (net) 3.007 2.687 2.822 2,557of whtch: workers' (2.737) (2.446) (2,596) (2.278)remittances

Capital Account Balance M.l 2!2 1 25 25Official Transfers (net) MAf 2l3of wAich: refugee assistance (155) (135) (135) (129)

Lona-Term Caoital (net) M5A % ii HaPublic & publicly guar. 393 424 433 333Project, food.commodity aid LA 388 364 516 344Disbursements (880) (876) (1.073) (1,017)Amortization (-492) (-512) (-5S7) (-673)

Other public (net) Lb 5 60 - 83 - 11Private (net) 65 109 200 129

Short-Term Capital (net) .. -31 1Q2iOfficial (net) L/ 56 - 31 163 110Foreign ExchangeBearer Certificates (0) (0) (148) (64)

Errors and Omissions -1 - 31 =26 1

Basic Balance MM8 81 - 7 2i2

Met Foreign Assets(increase=-)1M M12 z _23.IMF (net) -iS -82 -250 -358Purchases 0 0 0 0Repurchases -1S -82 -250 -358

Other Central & CommercialBanks (increases=-) 203 901 257 116Gross reserves (-=increase) 180 1.036 -146 46Foreign Currency Deposits 102 -49 496 403Other (net) LO -79 -86 - 93 -333

Hemo ItemsGross official reserves 1.731 668 915 864Reserves in weeks imports ofgoods and services 11.7 4.5 6.0 5.8Current account deficit as% GNP 3.1 5.0 3.5 2.0

LA Official and guaranteed loans. adjusted for debt relief.Lb Mainly commercial bank borrowing of over one-year maturity, including

IMF Trust Fund, and rescheduled amortization.Lr Commercial bank and 1DB borrowing of one year maturity or less.L Incl, deposits of foreign monetary authorities and other deposits (net).

Source: Ministry of Finance & Economic Affairs and staff estimates.

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Table I..10: INCENTIVE ANO TRADE INDICATORS. 1980/81 - 1986/87

(percent)

1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87

Incentive Indicators

1. Real Effective Exchange RateIndex, 1980/81=100 La 100 96 83 82 81 70 60Annual Change -3.7 -13.8 -0.7 -1.5 -13.7 -14.6

2. Real Interest RatesShort-term Deposit Rate Lb - 1.8 3.3 -0.1 5.4 5.0 5.4Long-term Lending Rate 1.8 1.8 3.6 1.3 7.8 8.3 8.1

3. Index of Real WagesAgriculture 100 112 119 - - - 133Manufacture La 100 101 106 113 - - -Construction 100 97 95 90 - - 92

4. Agricultural Prices:Oamestic/International LdCotton 87 113 95 112 76 114 110Sasmati Rice 65 66 68 67 54 55 66Irri Rice 70 94 97 95 118 115 125Wheat 64 102 98 103 90 120 112Sugar - 165 206 200 257 228 169

External Trade Indicators

5. Volume Index of Major ExportsRice 100 77 73 102 58 106 100Raw Cotton 1CO 71 78 30 81 198 197Cotton Yarn 100 100 141 107 132 166 273Cotton Fabrics 100 117 121 133 137 143 138

6. Export Shares in World TradeRice 10.7 10.4 8.4 13.3 11.0 17.4 -Cotton 7.4 6.2 6.4 8.3 3.1 14.1 -Textile Yarn & Thread 1.6 1.6 2.0 2.6 2.1 2.8 -Cotton Fabric 3.4 4.2 4.4 5.8 5.4 5.7 -

7. Manufactured ExportsReal Growth Rate 19.6 -4.1 25.8 S.3 -13.3 4.6 14.8Value as Share of Total 44.9 52.0 56.6 57.3 53.5 49.5 52.7Exports

8. Corodity Terms of TradeIndex, 1980/81=100 100 88.8 89.0 94.9 93.4 89.8 97.6Annual Change - -11.2 0.1 6.6 -1.6 -3.9 +8.7Export Price Index 100 92.3 82.7 87.2 81.1 72.8 76.1Iport Price Index 100 104.0 92.9 91.9 86.8 81.1 78.8

LA Weighted index of data for 14 major trade partners (including petroleum). withOecemer 1981=100.

L Profit/loss sharing account deposits of six months to one year.Lc Large scale manufacturing only.Lg Export parity basis.

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Table 1g 11: STRUCTURE OF FOREIGN TRAIE. 1980/81-1986/87(Percentage)

Share in the Total Annual 6rodth a1980-81 1983-84 1984-85 1985/86 1986/87 1980/61-198/87

Exorts 100.0 1o.L 1IL0.0 11,J lA IAZ

Raw Cotton 17.8 4.8 11.4 17.3 12.1 -2.7Cotton Manufactures 22.8 33.9 35.0 35.8 42.3 1S.0Rice 19.1 15.3 8.7 11.S 8.0 -10.3Fish/Fish Preparations 1.9 2.7 3.2 2.7 3.0 11.9Leather 3.0 5.3 6.0 6.0 6.4 17.SCarpets and Rugs 7.6 6.3 S.3 S.0 5.4 -2.0Synthetic Textile Fabrics 4.3 3.9 1.7 1.6 4.3 3.5Others 23.4 27.7 28.7 20.1 18.4 -0.3

0orLE IQ-.,a 100 0 100l 0 1000 100A0 -2.L1

Crude Oil 18.4 15.8 16.0 11.7 7.7 -13.7POL Products 10.0 9.3 8.2 6.7 7.5 7.0Fertilizer 6.6 2.0 2.0 2.3 3.5 -49.4Edible Oil 4.9 8.5 7.7 6.7 4.4 -2.8Tea 2.0 2.9 3.6 2.1 2.9 4.2Machinery/Capital Goads 27.8 31.8 32.3 36.5 36.6 4.4Others 30.3 29.7 30.2 34.0 37.4 -0.1

a/ Percentage growth in dollar values.

Source: Statistical Appendix. Tables 12-15.

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1.43 The large imbalance between exports and imports, with the lattertwice the former (FY87 being the significant exception), also underlinesPakistan's balance of payments vulnerability. Since the mid-1970s, Pakistanhas relied heavily on worker remittances, to offset the trade imbalance andreduce the current account deficit. The size of these inflows is nowuncertain. Therefore, improving the structure of exports is critical to abetter trade balance, given the need for future increases in imports as theeconomy expands. Low import prices are unlikely to continue in the yearsahead; indeed, crude oil prices are projected to recover to over $20 perbarrel after 1990 from the current $17-18, while edible oil prices a eexpected to rise by 252 over the same period.

1.44 The weakness on the capital account is reflected in the low level ofgross reserves. During the Sixth Plan period to date, Pakistan's grossofficial reserves were sharply eroded-from $1.9 billion (equivalent to nearly4 months of imports) at the end of FY83 to $864 million (equivalent to 6 weeksof imports) by the end of FY87, and further to about $600 million by fall1987. As a result, any deterioration in the current account balance wouldhave to be financed by short-term borrowing, with negative consequences fordebt servicing and Pakistan's creditworthiness. Foreign exchange reserves arealready much lower than the country's short-term liabilities, estimated at$2.1 billion at end-FY87 ($0.2 billion of foreign exchange bearer certifi-cates, $0.4 billion of foreign monetary authorities' deposits, and $1.5billion of commercial banks' liabilities). Therefore, even this source offinancing may be difficult to obtain.

1.45 With the low reserve position and high debt service ratio, Pakistanno longer can sustain pre-FY87 current account deficits of over 3Z of GDP. Aprogressive reduction in these deficits to well below 32 is needed to maintaincreditworthiness. Building up reserves will require obtaining more externalresources at terms which would not materially affect Pakistan's ability toservice its debt. The gradual shift to non-concessional borrowing, which isalready occurring, itself implies progressively larger debt service payments.Debt service considerations are important. From being only 46% of grossreserves in FY83, total debt service payments were 2.6 times the level ofgross reserves in FY87.

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Chapter II: Improving Fiscal Performance

A. Controlling the Fiscal Deficit

2.01 The overall fiscal deficit has now grown too large (about 91 of GDP inFY87 and an estimated 8.1-8.3S in FY88) to be manageable without disturbingexternal and domestic financial stability of the economy. The large deficitshave resulted in a rapid accumulation of debt servicing obligations both ondomestic and external debt. Growing interest payments create new pressures forfuture borrowing and reduce the Governnent's flexibility in future spending.The continuation of large borrowing requirements will undoubtedly "crowd out"private investment, with constrained credit and interest rate pressures.Non-bank borrowing, the principal financing source, carries the danger ofpreempting private investment, while bank borrowing could limit credit exnanaionto the private sector or put pressure on prices. The large budget deficitsaffect the balance of payments as well. Current account deficits have typicallyexceeded 3% of GNP in the 1980s, with the exceptionally good FY87 performanceunlikely to be sustained. With the external debt servicing ratio now at about28S, lower current account deficits will be needed to maintain creditworthinessin the international community.

2.02 Both the growth of total expenditure (which rose from 22.91 of GDP inFY81 to 26.11 in FY87) and the weak and sluggish revenue effort (yieldingbetween 16-17% of GDP) have contributed to the large and growing deficits. Thepresent chapter examines the structure and financing of the deficit vis-a-visthe rest of the economy in recent years and develops revenue and expenditurerecommendations for reducing it to a manageable size.

2.03 A realistic budget scenario which would be consistent with economicstability while still providing for essential government services would involvea reduction in the deficit from 8.3% of GDP in FY87 to 4.81 in FY91. While someof the improvements would come from constraining less essential governmentexpenditures, it is clear that much of the adjustment would have to come fromincreased tax effort, with more cost recovery for government-provided goods andservices. The Government has begun taking steps to contain the growing fiscaldeficit. The FY88 deficit is expected to be slightly less than the FY87deficit. The Government also is preparing for an expanded tax effort. Resourcemobilization is an important part of the Seventh Plan, which is now beingdrafted. The National Assembly subcommittee's review of the National Tax ReformConmisasion report puts forth a series of tax proposals, including taxation ofagricultural incomes. In addition, ongoing work at the technical level includes-the services of international tax consultants.

Fiscal Deficit as a Saving-Investment Gap

2.04 The overall fiscal deficit results from the Government's spending onits capital account (investment and capital transfers) more than it saves on itsbudgetary current account. Pakistan's revenue effort is one of the lowest amongthe countries of its per capita income level. Moreover, the already low levelof revenue is eroded significantly by current income transfers to the non-government sectors 1/, mainly in the form of interest payments on domestic and

l/ "Government" is defined as federal and provincial governments, and governmentdepartments which are included in the budget (including Post Office, tradingcorporations, OGDC, WAPDA, TVC, the fertilizer corporation). Other publicenterprises are included with the private sector in "non-government".

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and foreign debt and current subsidies. Almost one-third of governmentrevenue is returned as income transfers to the non-government sector, leavingonly the equivalent of 11-12S of GNP as government disposable income, whichhas not been adequate to cover even consumption. Table II.1 provides moredetail.

T:able II.1: INVESTMENT, SAVINGS AND NET BORROWING(Percent of GNP at Current Prices)

1985/86 1986/87

GOVERNMENT SECTOR /aNet Income 11.1 10.6Consumption 11.4 12.0Savings -0.3 -1.5Investment (ADP) 6.5 6.7Development Subsidies 0.4 0.4Net Lending/Borrowing -7.2 -8.5

NON-GOVERNMENT SECTORDisposable Income /b 88.9 89.4Consumption 76.3 74.4Savings 12.6 15.1Development Subsidies 0.4 0.4Investment 9.2 8.9Net Lending/Borrowing 3.8 6.5

TOTAL BORROWINGS (net)=BOP Current Account Balance -3.5 -2.0

/a Federal and provincial. Excludes public enterprises (primarily inmanufacturing) which are not part of the consolidated budget.

/b Current transfers raised disposable income by 5.4% of GDP in 1985/86 andby 5.92 in 1986/87.

2.05 Indeed, in FY86 and FY87, Government (federal and provincial)dissavings were 0.3Z and 1.52 of GNP 1/, respectively, indicating that theGovernment has recently not been making any contribution to the mobiliza-tion of resources for development. With development expenditures anddevelopment subsidies amounting to about 7% of GNP in both FY86 and FY87, netgovernment borrowing of 7.2% of GNP in the former year and 8.5Z in the latterwere required. 2/ To finance its excess spending, the Government has absorbed

1/ This analysis is given in terms of GNP, rather than GDP. These figures donot include public enterprises.

2/ Equivalent to 7.7% and 8.92 of GDP, respectively.

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all the additional resources (excess of imports over exports) made availableto the economy by external sources and reserve drawdown (aounting to 3.51 ofGNP in FY86 and 2.11 in FY87). For the same purpose it has also absorbed asizeable part of nongovernment savings. Such nongovernment savings, whichotherwise might have been used for private investment, were as large as 3.8Sand 6.41 of GhP in FY86 and FY87, respective'iy. 1/

Accomodating the Deficit

2.06 The actual sources of financing used by the Government in recentyears have changed in importance over the 1980s, as shown in Table I1.2. Theshare of external financing in total deficit financing declined from 531 inFY81 to just above 20S in FY86 and FY87, with an associated rise in domesticborrowing. Even with this decreased reliance on external financing, thecurrent account deficit has averaged 3.41 of GNP and the debt service ratiohas increased to 28S. In spite of the increased domestic borrowing, Pakistanhas avoided inflationary effects that usually accompany such large andpersistent fiscal deficits by relying heavily on non-bank financing. Inrecent years, only between 15-22Z of the overall fiscal deficit has beencovered by bank financing while 57-651 was financed by non-bank sources.Table II.3 shows the full capital transactions of the Government for FY86 andFY87.

Table II.2: SOURCES OF FINANCE FOR FISCAL DEFICITS

1980/81 1983/84 1984/85 1985/86 1986/87 1987/88(Estimate)

Overall Fiscal Deficit(billion rupees) 14.6 25.1 36.8 41.7 54.1 52.91 of GNP 4.9 5.6 7.2 7.3 8.6 7.61 of GDP 5.3 6.0 7.7 7.7 9.0 7.9

Sources of Financing (%) 100.0 100.0 100.0 100.0 100.0 100.0External Aid (net) 53.0 19.9 14.1 20.6 21.0 21.9Domestic Borrowing (net) 47.0 80.1 85.9 79.4 79.0 78.1Non-Bank 30.9 48.8 35.0 64.8 57.3 63.6Bank Financing 16.1 31.3 50.9 14.6 21.7 14.5

1/ It is not likely that (part of) these savings came from additional realincome aud savings resulting from excess spending (fiscal stimuli) of thegovernment. Despite the presence of large unused capacity in industry,many serious constraints (e.g. inadequate power and other infrastructure,shortage of skilled manpower, limited export markets, etc.) limit theexpansion of production. More importantly, the Government has beenpursuing a relatively tight monetary and credit policy to checkexpansionary effects of the Government's excess spending. Under theseconditions most, if not all, of the nongovernment savings diverted to thegovernment budget as a result of deficit financing is likely to have beenobtained through "crowding-out" of private expenditure rather than throughadditional savings from an (a la Keynesian) expansion of employment andincome.

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2.07 Bank financing of the fiscal deficits in recent years has beenobtained solely, on a net basis, from the commercial banks as the increases ingovernment borrowing from the SBP have been more than offset by the growth ofgovernment deposits with the same (Table II.3). Thus, in FY86 and FY87, netclaims of the SBP on the Government were reduced by almost Rs 4.4 billion andRs 1.3 billion, respectively, resulting in parallel contractions in themonetary base and the money stock.

2.08 The financing of the fiscal deficits through the commercial banksamounted to about Rs 10.5 billion in FY86 and Rs 13.0 billion in FY87, mostlythrough the purchase of Treasury Bills.l/ The extent to which thedistribution of bank resources is skewed in favor of the government sector asa result of the Government's borrowing policies can be seen as well in termsof net flows (advances minus deposits) between the banks and other sectors 2/.Commercial banks channelled two-thirds of the funds obtained from the SBP andthe foreign sector to the Government and one-third to the non-governmentsector (on a net basis) in FY86 and the entire amount to the Government inFY87.

2.09 Economic Costs of Growing Domestic Borrowing. In view of theGovernment's conservative monetary policy, the large amount of governmentdomestic borrowing cannot continue indefinitely without limiting creditexpansion to the private sector. It also puts pressure on interest rates. Aswill be discussed further in Chapter IV, the large amount of non-bankborrowing required annually causes the Government to set attractive rates onsavings schemes - 12-15% annually tax free - which are offset by the lowrates on T-bills sold to banks and other financial institutions. Both in fact -

contribute to high real interest rates. The high interest rates on savingsschemes effectively set the floor on lending rates; furthermore, the low -

T-bill yields increase the overall cost of funds to banks and, hence, affecttheir lending rates.

2.10 The quantitative ceilings on bank lending put pressure on interestrates in the informal credit markets as well as the formal one. To the extentthat higher interest rates attract foreign exchange funds from abroad, likeworkers' remittances and deposits from foreign banks, there would be pressureon the exchange rate as well.

l/ As will be shown in Chapter IV, the banks essentially are forced topurchase government debt rather than expand credit to the private sectorbecause of the tight credit ceilings and high statutory requirement tomaintain a certain proportion (currently 35%, including 5% in cashreserves) of total deposit liabilities in liquid assets. The reserverequirement car only be met by holding cash and government securities(T-Bills) with low yields (0.5-6.5X).

2/ This can be seen from a simple net flow of funds matrix for Pakistandeveloped by bank staff for use as a consistency framework for theproposed medium-term program.

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Table II.3: GOVERNMENT CAPITAL TRANSACTIONS(Million Rs at Current Prices)

1985/86 1986/87

FOREIGN BORROWING (Net) 9.774 12.127Project and Non-Project Aid 19,346 23,081FlBC 1,190 800Debt Repayment -10,762 -11,754

NON-BANK FINANCIVG (Net) 25,772 29,775Non-Bank Borrowing 33,439 27,250Recoveries of Loans 2,297 2,860Debt Repayment -11,380 -1,279Others (net) a/ 1,416 944

BANK FINANCING (Net) 6,098 11,747 b/State Bank -4,351 -1,285Cosmercial Banks 10,449 13,032

NET GOVERNMENTSECTOR FINANCING 41,644 53.649

Source: Ministry of Finance.

a/ Composed of the sale of public enterprise shares, loans and investment,and "change in deposits" maintained for special type of funds e.g.,Pension Funds of Railways and Post Office and Resident Flood Relief orAfghan Regugee Funds.

b/ Preliminary estimate.

2.11 Even with the Government's large deficit financing and stringentmonetary policies, more credit could have been made available to the privatesector had the public reduced its money balances in response to risinginterest rates. This does not, however, seem to be happening in Pakistan asindicated by falling income velocity of money (Table II.4). The public seemsto regard government bonds as savings, not as good substitutes for money,particularly in the absence of a satisfactory secondary market for them.

Table II.4: THE RATIO OF GROSS NATIONAL PRODUCTTO MONEY, 1984/85 - 1986/87

1984/85 1985/86 1986/87

GNP/Currency 9.05 9.07 8.40GNP/Narrow Money /a 4.29 4.26 3.96GNP/Broad Money /b 2.78 2.72 2.61

/a Currency and demand deposits./b Currency, demand deposits, and saving and time deposits.

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2.12 Another adverse effect of large deficits is the growing burden ofservicing the debt. Taken together, the servicing of both domestic andforeign debt now requires almost 251 of government revenue compared to lessthan 15 in the beginning of the 1980s. 1/ If fiscal deficits continue at8-9X of GDP, interest payments would exceed 30% of revenues by the mid-90s.

Financable Fiscal Deficit Consistent with Macro-Economic Targets

2.13 To improve the country's long-term foundation for economicdevelopment, the fiscal deficit must be brought down to a sustainable level.A sustainable deficit is one which permits an acceptable level of economicexpansion within a framework of price stability and debt accumulationcompatible with reasonable domestic and external debt servicing ratios. Theeconomic scenario associated with the proposed reform agenda, described inChapter V. puLb the sustainable deficit at about 52 of GDP. In this scenario,a temporary reZuction of GDP growth to 5.51 per year for three years is theprice to pay for making the macro-economic and structural adjustmentsnecessary for supporting more rapid economic growth in the medium-term. Asecond method of calculating this deficit, described below, gives an estimateof 5-6S of GDP, with medium-term macroeconomic targets of moderate inflationof 61 per year, 61 real GDP growth, and maintenance of the current publicsector external debt to GDP ratio at 401. The major financing sources. -external, monetary (central bank) and domestic (non-bank private sector andbanks) contribute the following: 2/

(a) At a real growth rate of 61, efforts to maintain the 401 externalpublic sector debt to GDP ratio 3/ would set the limit onexternal budgetary financing at 0.91-1.61 of GDP. The magnitudeof foreign financing of the fiscal deficit compatible with theexternal debt target depends on the rate of rupee depreciation.A real depreciation of the rupee against the major currencieswould increase the real rupee value of the foreign debt and,therefore, raise the debt-to-GDP ratio above the target level.In recent years, the rupee has depreciated in real terms at anaverage rate of 4.81 p.a. If it is assumed that GOP wouldcontinue with a lower, say 4S, annual real depreciation of therupee because of the recent fall in the rate of domesticinflation, then the allowable amount of external financing wouldbe equal to 0.91 of GDP. With a real depreciation of 21 -equivalent, say, to 6% inflation in Pakistan against 41 worldinflation - the amount of external budgetary financing would beabout 1.61 of GDP. It should be noted that total externalborrowing would be higher by the amount of private sectorborrowing.

1/ The overall fiscal deficit and required financing are calculated as net ofdebt amortization. Therefore, the borrowing efforts on a gross basis aremuch greater than implied by the fiscal deficit.

2/ The calculation method is given in the annex to this chapter.

3/ A ratio of 40X, given the terms of the debt, corresponds to a reasonabledebt service ratio.

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(b) Domestic borrowing, especially from nonbank sources, has increased byover 20S per year in the 1980s. Such continued growth in thepublic's holding of government debt is problematic, both because ofthe debt service implications and a limit to the public's willingnessto continue purchasing savings instruments. In the long-term, thenonbank private sector's capacity to absorb new government debt wouldbe limited by the growth of financial savings. If it is assumedthat, in the medium-term, domestic private sector savings would beabout 101 of GDP, and half of these would be placed in financialassets, then funds in the amount of 5Z of GDP would be available fromthe nonbank private sector for financing fiscal deficits and formeeting the private sector's credit needs through the bankingsystem. Obviously, the Government's borrowing strategy, monetarypolicy, and banks' capacity to compete with the Government willdetermine the distribution of these funds between the two ultimateusers. But, as the Government uses more market-oriented borrowing(see Chapter IV) and the attractiveness of private investmentincreases, then a more balanced distribution of financial savingsbetween the two sectors than what has taken place in recent yearswould be observed. On these grounds, it appears realistic to set theGovernment's domestic borrowing limit at about 2.51 of GDP, asopposed to 5.91 realized in FY86.

(c) Real income growth and inflation together would permit monetaryfinancing of almost 21 of GDP. The inflationary impact of monetaryfinancing through the expansion of base money 1/ will depend on theexpansion of demand for money. To the extent that economic unitsdesire to hold real money balances in a certain proportion to realincome, monetary expansion could take place in line with real growthof GDP without creating inflationary pressures. Also, if the currentrates of inflation have been moderate and stable, further monetaryexpansion - in addition to the seigniorage component - could beundertaken to acconmodate the increased transactions demand for moneythat is caused by ongoing inflation. This is the "inflationary tax"source of revenue for the Government. Given that in recent years thereserve money to GDP ratio has remained at about 0.156, theseigniorage component of monetary expansion (the reserve money ratiomultiplied by real GDP growth) would allow monetary financing in anamount equivalent to about 0.94% of GDP, and the inflationary taxcomponent (the reserve money ratio times the inflation rate) wouldpermit an additional amount of monetary financing of the samemagnitude.

2.14 When all three sources of financing fiscal deficits are added, thetotal financable deficit that is consistent with the stated macroeconomicobjectives amounts to 5.3% of GDP with a 4% p.a. real depreciation of thecurrency. With a 21 annual real depreciation, total financing could be about61 of GDP.

I/ Also referred to as "high powered money", which consists of currency heldoutside the banking system and assets held by conunercial banks asreserves. Reserve assets serve as the base for multiple expansion ofdeposits by banks.

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B. Recommended Fiscal Policy ChanRes

2.15 Table II.5 shows the recommended scenario for reducing theconsolidated budget deficit over three years, until it reaches a sustainablelevel of about 5X in FY91. These changes focus primarily on increasing therevenue raising capacity of the government, in order to finance the growinginvestment and recurrent expenditure requirements for economic and socialinfrastructure provis±on. However, streamlining current expenditures andreducing subsidies are equally important.

2.16 Because it will take time to implement major tax changes, the firsttwo years of the program would be more stringent than the last three. Thegrowth of current expenditures (excluding transfers) would need to be reduced,subsidy levels cut, and development expenditures kept at about 71 of GDP. Atthe end of five years, current expenditures as a share of GDP would be nohigher than it was in FY88, thereby permitting an increase in developmentexpenditures by slightly more than 1% of GDP. Total revenues would increaseby over 32 of GDP. These actions would result in a rise in government savings(revenues less current expenditures) of over 4% of GDP, as the overall budgetdeficit falls from an estimated 8.1-8.3% of GDP in FY88 to about 5% of GDP inFY91.

2.17 The recommended budget restructuring reflected in these numbers isdirected toward accomplishing the following changes in the medium-term:

(i) a substantial resource mobilization effort which, in the process,would improve the efficiency, equity, and elasticity of the taxsystem.

(ii) Real growth in economic and social infrastructure expenditures(capital and recurrent) consistent with resource availability, anddevelopment or refinement of core investment programming for majorinfrastructure sectors (agriculture/irrigation, transport, energy);

(iii) Containing the growth of current expenditures, through expenditurerationalization and a reduction and better targeting of subsidies;

(iv) A better balance between capital and recurrent expenditure, topreserve and better utilize the public capital stock;

(v) Continued disinvestment of publ,c enterprises, with increasedincentives for financial and operational autonomy and accountabilityfor entities which remain under Government ownership;

(vi) A revision of central/provincial government revenue sharing topromote provincial revenue generation and adequate provision ofservices; and

(vii) A substantial reduction in borrowing with reduced recourse to bothdomestic bank and nonbank financing and external borrowing consistentwith medium-term balance of payments viability.

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laklL IJS: Proposed Budgetery Scenario 1988/89-1992/93(Percent of GOP)

Actual Estimated --------- Proosed-----1986/87 1987/88 1988/89 1989/90 1990/91 1991/92 1992/93

Total Exvmpditure (1) 2Z"i I245.j 15. Z6L2Current Expendituresless Transfers (2) 12.5 12.4 12.0 12.2 12.5 13.2 13.4

Transfers (3) 6.4 6.7 5.4 5.2 S.1 4.9 4.8Subsidies 1.7 1.5 1.0 0.8 0.7 0.6 O.SInterest 4.0 4.1 3.9 3.9 3.9 3.8 3.8Others 0.7 1.1 0.5 O.S O.S 0.5 O.S

Current Expenditures (4)-(2)+(3) 18.9 19.0 17.4 17.4 17.6 18.1 18.2

Oevelopment Expenditures (5) 7.1 7.0 6.9 7.2 7.4 '.8 8.0

Total Revenuea (6) lIZ Il. ILl l9.1 QIl2 VUZL ZJJTax Revenues 13.0 13.6 13.7 14.7 15.7 16.5 16.9Won-tax Revenues A/ 3.6 3.7 3.8 3.8 3.9 4.0 4.0Autonomous Body Contributions 0.5 0.7 0.6 0.6 0.6 0.6 0.6

Dudgt DflLtit (7)=(6M-(1) L1 ALI k/ -6.2 5. LA -2

Govenment Savings (8)=(6)-(4) -1.8 -1.1 0.7 +1.7 +2.6 +3.0 +3.3

a/ Includes disinvestment.

h/ Estimates made in February 1988 were within a range of 8.1-8.3% of GOP.

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Streamlining Government Expenditures

2.18 The most salient features of the pattern of growth of differentcategories of government expenditure since the beginning of the 1980's, asshown in Table II.6, are the following:

(i) Pakistan enjoyed substantially more current expenditure (collectiveconsumption) in FY87 than in FY81, both in real per capita terms andas a percent of GDP. On a per capita basis, all the major currentexpenditure categories increased at similar rates, except for socialand economic services which surged in FY87 due to the PrimeMinister's Five-Point Program.

(ii) The increases in defense, which accounted for half of governmentconsumption during this period, have reduced the resources availablefor development expenditures and for improvement of living standards.

(iii) Per capita transfer payments in real terms increased the most (802)over the period FY81-87, due to the growth in interest payments.Direct subsidies, however, also increased in per capita terms.

(iv) Development expenditures have suffered as a result of the increase incurrent expenditures. Per capita development expenditures in realterms have stagnated since FY81. The ADP share in total expendituresdeclined by 251 over the same period.

2.19 These historical developments influence the expenditure strategy thatthe Government should pursue over the medium to long-term as part of itsefforts to bring the fiscal deficit under control. First, consumption andtransfer expenditures should be controlled in order to protect and increasedevelopment expenditure. Redressing the present serious shortages of economicand social infrastructure and poor education, health and public servicestandards is a focus of the Seventh Plan, as well as the Five-Point Program.However, given the resource constraint and the need to curtail the fiscaldeficit, the increase in development expenditures (ADP) over the medium-termis dependent on revenue gains and savings in other expenditure categories. Assuggested in Table II.5, an increase in the government investment/GDP ratiocould not begin until FY90; by FY93, ADP expenditures would be 82 of GDP, animprovement over the 72 level in FY87. Equally important, the ADP programshould include a better ordering of priorities and coordination withsupporting recurrent expenditures, as well as more reliance on private sectorparticipation, where possible, to supplement government investment.

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Table II.6: STRUCTURE AND GROWTH OF GOVERNMENTEXPENDITURE, 1980/81-1986/87

1980/81 1983/84 1984/85 1985/86 1986/87

Indexes of p.c. Real Expenditure /aCurrent Expenditure /b 100.0 130.5 137.7 140.7 152.3Social & Economic Services 100.0 130.8 133.8 132.7 156.7Defense Expenditure 100.0 126.6 137.7 142.6 150.5General Administration /c 100.0 142.0 145.6 150.2 151.5

Transfer Payments /d 100.0 133.4 145.3 162.4 182.4Development Expenditure (ADP) 100.0 82.3 89.3 98.2 105.4

S of Total ExpenditureCurrent Expenditure /b 45.0 52.2 51.4 49.8 49.5(Defense expenditure) (23.6) (26.3) (26.7) (26.0) (25.2)

Transfer Payments 19.0 21.7 22.2 22.9 23.6(Interest Payments) (9.1) (13.9) (13.9) (14.4) (14.9)(Subsidies) (7.6) (6.0) (5.8) (5.9) (6.3)(Others) (2.3) (1.8) (2.5) (2.6) (2.4)

Development Expenditure 36.0 26.1 26.4 27.3 26.9

X of GDPCurrent Expenditure 10.3 12.7 12.9 12.6 13.2(Defense expenditure) (5.5) (6.4) (6.7) (6.6) (6.7)

Transfer Payments 4.5 5.4 5.6 5.9 6.4(Interest Payments) (2.1) (3.4) (3.5) (3.7) (4.0)(Subsidies) (1.8) (1.5) (1.4) (1.5) (1.7)(Others) (0.6) (0.5) (0.7) (0.7) (0.7)

Development Expenditure 8.4 6.4 6.6 6.9 7.1

/a Per capita real expenditure deflated by GNP price deflator./b Includes irrigation O&M expenditures. Excludes transfer payments./c Including law and order./d Includes interest payments, subsidies, grants to local authorities, and

social transfers (education and pensions).

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2.20 Second, the historical growth in government consumption expenditureswould need to be reduced. At the same time, allowance needs to be made forneeded increases in operation and maintenance expenditures, in line withincreases in economic and social infrastructure ADP expenditures. In thefirst two years of the program, a drop in the consumption/GDP ratio might benecessary - although the real level would be maintained - while a concurrenteffort is made to shift its composition toward development-related recurrentexpenditures.

2.21 Finally, the subsidy component in transfer payments should bereduced. Although about two-thirds of transfer payments are interest chargeswhich offer little scope for adjustment in the short-term, a reduction indeficit financing would eventually reduce the debt servicing claim onbudgetary resources. Over the five-year period, a reduction in subsidies from1.71 of GDP in FY87 to 0.51 in FY93 should be feasible.

2.22 Three suggestions - relating to defense expenditures, salaries, andsubsidies - are given below for restraining the growth of current expenditure.

2.23 Defense Expenditures. Defense imposes a large constraint onPakistan's economic development in general and on improving its budgetaryposition in particular. By international standards, Pakistan devotes anexceptionally high share, about 251 1/, of its total expenditures to defense.The corresponding ratio for low income, lower middle income and industrializedeconomies in 1985 stood at 18.61, 14.21 and 16.81, respectively. Whilenational security considerations in view of the present geo-politicalconditions limit the scope for restricting the growth of military expenditure,there should be some potential for savings through improved cost-effectivenessby streamlining the planning, budgeting and monitoring of defenseexpenditures. Constraining the growth in military personnel expenses inparallel to a similar restraint on civil service salaries, for instance, wouldhelp reduce the growth of military expenditures relative to that of GDP overthe medium-term until the fiscal deficit is brought under control.

2.24 Salaries have contributed recently to the rapid growth of currentexpenditures. About 201 of the increase (excluding subsidies and interestpayments) in FY85 and one-third in FY86 were caused by increases in wages andpensions. The erosion of real wages of public sector workers since the 1970swas slowed down in 1985 with the partial indexation of wages to inflation andannual increases in certain allowances. At the same time, some wagecompression between the higher and lower grades has occurred because of limitson wage increases at the upper end of the scale. The main factor behind thegrowth in wages and salaries, however, has been the growth in government

1/ Since military capital expenditures financed out of the non-budgetarysources (e.g., special funds or foreign military credit) are not includedin the budget, this proportion understates Pakistan's defense spending.

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employment. Currently, excluding the armed forces, the public sector employsnearly two million persons (7% of the labor force), with half of these paidfrom the consolidated budget. Public pressures on the Government to createemployment, particularly for the educated unemployed, have led to emphasizingemployment generation, most recently as an objective of the Five-PointProgram. 1/ As a result, there is substantial overstaffing in many areas atthe expense of other, often complementary, personnel.

2.25 The overstaffing of public services is a common problem in allcountries. However, restraints in the growth of the wage bill cannot beavoided if the current government expenditure (less transfers)/GDP ratio is tobe constrained over the next three years. One suggestion is to reduce thegovernment work force by attrition and delink nominal wage increases frominflation, thus effectively holding nominal wage increases to below that ofinflation temporarily. The Government has already imposed controls on thecreation of new positions in the federal government, and no vacancies arebeing filled in FY88. In the longer-run, a more effective approach would beto undertake a comprehensive review of the civil service to change thecomposition, eliminate redundancies, and restructure wages.

2.26 The current and development subsidies taken together have doubledbetween FY81-88, presently absorbing 8.7% of current revenues. 2/ The majorsubsidies, as shown in Table II.7, are for wheat, export losses on cotton,non-nitrogenous fertilizers, steel mill losses, and past liabilities on edibleoil and sugar. The Government has been endeavoring to reduce subsidiesthrough recent initiatives. Further effort is needed to cut subsidies from1.7X of GDP in FY87 to, say, 0.5% in FY93, through elimination of some andbetter targetting of others. Fertilizer subsidies should be eliminated inline with government plans, wheat subsidies reduced further, and edible oiland sugar subsidies kept from reappearing. Rising international prices ofcotton should eliminate the Cotton Export Corporation's losses for the nextfew years, but they could reemerge when world cotton prices decline in thefuture. In addition, the Government is expected to continue paying theguaranteed high fixed return on Participation Term Certificates of the

1/ This is to be achieved through extensive construction activities and jobguarantees to doctors, engineers and teachers. More effort should bemade, instead, to stimulate the use of professionals like doctors andengineers in the private sector.

2/ Total subsidies would be much larger if they included the hidden subsidiesscattered across different functional heads under the recurrentexpenditures and indirect subsidies provided through inadequate pricingpolicy (e.g. low fees and user charges in education, health, transport,water, and services). For example, in FY87 Government incurred Rs 2.3billion in settling: (i) bad debt liabilities of the public enterprisesprior to their divestiture, and (ii) losses/operational shortfalls of thePakistan Railways and Karachi Shipyard and Engineering Works Ltd. None ofthese appear as a subsidy in the budget.

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Table II.7: PROPOSED FEDERAL AND PROVINCIAL SUBSIDIES(Billion Rupees)

1986/87 1987/88Actuals Estimate 1988/89 1989/90 1990/91 1991/92 1992/93

Food 4.5 4.1 2.5 2.0 2.0 2.0 2.0

Wheat 3.4 2.7 2.5 2.0 2.0 2.0 2.0Edible Oil - 0.6 /a - - - - -Sugar 1.1 /a 0.8 /b - - - - -

Other 5.5 6.0 5.2 5.1 4.8 4.5 3.9

Fertilizer 2.0 1.6 1.2 0.8 0.5 0.2 -Pakistan Steel 1.2 1.2 1.2 1.2 1.2 1.2 1.2Cotton Export Corp. 2.1 2.7Others 0.2 /c 0.5 /c 2.8 3.1 3.1 3.1 2.7

Total Subsidies 10.0 10.1 7.7 7.1 6.8 6.5 5.9

X of GDP 1.7 1.5 1.0 0.8 0.7 0.6 0.5

Source: Planning and Development Division and Mission Estimates.

/a Liabilities of past trading losses.

/b Equivalent to the difference between the landed cost of imported sugar(including the regulatory duty) and the domestic price. This subsidy isoffset by the revenue from the regulatory duty.

/c Tubewells subsidy only through 1987/88; subsequently, this category wouldinclude such possible items as adjustment assistance to workers andconsumers, other poverty-related assistance in line with Governmentobjectives, and future cotton trading losses in periods of low cottonprices.

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Pakistan Steel Mill (PSM) until PSM is able to pay off the returns out of itsimproved cash generation. This situation could continue through FY92.However, to relieve the budget of both cotton export losses and PSMliabilities, the Government should consider privatizing the Cotton ExportCorporation, and should reduce PSM overheads and divest its ancillary units.

2.27 The wheat subsidy in Pakistan, which dates back to independence in1947, increased sharply in the 1980s. At its height (FY86), it reachedRs 3.8 billion (4.22 of current revenue), compared to just over Rs I billion(2.11) in FY81. Following changes in the subsidy system in April 1987, 2/ theFY88 budget allocated about Rs 3 billion for it, although the actual outcomemay be higher.

2.28 Under the current system the Government continues to procure wheat ata fixed price (presently Rs 2.15 per kg) and stands ready to sell at the sameprice to private mills and other intermediaries as much as they require. Thedistribution cost and other incidentals, which are met fr-.tm the governmentbudget, currently result in a subsidy of Rs 0.60 per kg whuat compared to Rs0.80 per kg prior to de-rationing, but could increase depending on the wheatharvest and the volume of procurement by the Government. The Bank recommendsa phase out of this general subsidy within five years, and the substitution ofa wheat subsidy limited to the needy. The present Pystem is available to richand poor alike, and benefits the urban population more than rural population.Identifying the eligible population for a more targetted subsidy requires moreadministrative work. It could be achieved through specifically targettedcompensatory programs for the poor and nutritionally vulnerable groups, suchas food stamps; food distribution via health centers, clinics, schools andother/welfare centers; and food-for-work schemes. 2/ At the same time,Government intervention in the wheat trade would be reduced. It would thenregulate the market mainly through periodic interventions, via regulation of astrategic stock, and allow the private sector to perform the major marketfunctions.

1/ Until mid-April 1987, the subsidy was administered through a rationingsystem. Every family head was entitled to purchase from a ration shop agiven quantity of flour for each family member, amounting to about 45% ofaverage per capita wheat requirements on an annual basis. The amount ofsubsidy (the difference between the ration shop price and open marketprice of wheat flour) enjoyed by the consumer has continuously declinedwith the larger increases of the ration shop prices; it was about 10-20%of the market price in early 1987. The rationing system was greatlyabused, however (misuses of funds, pilferages, bogus ration cards, tradingof ration entitlements, etc.), and therefore, was abolished.

2/ Targeted food programs are used throughout both the developed anddeveloping world. There is an extensive literature on the subject. Fortheir use in developing countries, see, for example, A. Mateus, TargetingFood Subsidies for the Needy, World Bank staff working Paper, 1987, No.617; S. Horton, A Survey of Food Subsidy Programs in Selected Countries,Dept. of Economics, University of Toronto, 1985; World Bank, Morocco:Compensatory Programs for Reducing Food Subsidies, 1986 (Yellow Coverdraft report).

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2.29 The fertilizer subsidy has been an important element in theGovernment's policy to promote agricultural production by providing the farmerwith low-cost imports. It has fluctuated between Rs 1.5 billion and Rs 2.5billion a year since FY81, depending on the volume and prices of fertilizerimports, domestic production, and the Government's fertilizer priceadjustments, which have usually fallen short of the increases in worldfertilizer prices. In FY87, the decline in world fertilizer prices andderegulation of nitrogenous fertilizer prices in May 1986 helped reduce thesubsidy to Rs 2 billion. The FY88 estimate is Rs 1.6 billion for phosphateand potash fertilizer subsidies, which are almost entirely imported.

2.30 The Government has decided to phase out the current fertilizersubsidies through equal annual reductions of the current subsidy rate over aperiod of four years for phosphate (the principal type) and eight years forpotash fertilizers. This is to be attained through annual price adjustmentsin line with international price trends; cost reduction measures inprocurement, marketing and distribution; and possible substitution of low costpotash fertilizer imports. This program will be supported by emphasizing farm-level adaptive research and extension services to raise the efficiency offertilizer use. This phase-out, which the Bank endorses, is desirable formore than budgetary reasons. The fertilizer subsidy has now served itsobjective of educating the farmer in its use and benefits. The subsidybenefits particularly the large farmers since they have greater access to thecomplementary inputs. In addition, the Government's policy of deregulatingagricultural output prices, combined with the setting of floor procurementprices at or above world prices, should provide appropriate incentives toagriculture without the fertilizer subsidy.

2.31 Inter-Governmental Fiscal Relations. A major factor contributing tothe growing fiscal imbalance in Pakistan is the rise in provincial budgetarydeficits. Excluding other forms of federal assistance extended to provinces,the revenue deficit grants alone escalated to Rs 11.5 billion in FY87,constituting over 20 of the overall consolidated budgetary deficit. Thefinancial situation of the provinces originates from the inherent structuralweaknesses of inter-governmental fiscal relations and the federal government'spractice of covering the provincial deficits. At present, the demarcation ofthe financial powers and expenditure obligations between the federal andprovincial governments are governed by the 1973 Constitution. While therevenue jurisdiction of the two tiers is clearly delineated with the federalgovernment enjoying wide fiscal powers and controlling relatively more elasticsources of revenues, the expenditure obligations - excluding defense, foreignaffairs, banking and commerce and transport and communications - are expectedto be shared by the center and provinces. As is shown below, the

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provinces have come to bear the bulk of responsibility in the provision ofpublic services and maintenance of law and order. These expenditures farexceed their revenue base, which provinces have had no incentive to improve,plus the revenue-sharing arrangements prescribed by the National FinanceComission in 1974. As a result, the provincial surpluses on current account1/ of Rs 0.3 billion in FY81 had turned into sizeable deficits of Rs16.4 billion by FY87 (0.1 and -2.71 of GDP, respectively). The provincesrely on federal assistance to meet 551 2/ of recurrent liabilities and almost1001 of development expenditures. The strengthening of provincial finances,with improved revenue effort, is hence critical for a feasible reduction inthe overall fiscal deficit.

2.32 Table II.8 shows historical provincial budget trends during FY81-87.Provincial expenditures grew at a faster pace (19.41 per annum) than currentrevenues (9.42 per annum). On the expenditure side, three features standout. First, growing interest liabilities of the provinces have beenresponsible for the increase in provincial expenditures. These interestobligations arise from a switch from grant to loan financing of the provinces'ADP by the federal government. The share of the federal grant component infinancing of provinces' ADP declined from 691 in FY81 to 61 in FY87. Second,the provinces' role in virtually all fur.ctions entrusted to them has beengrowing. In education, the share of provinces in total recurrent expendituresrose from 811 in FY81 to 84% in 1987; in health, from 751 to 801; in communityservices, from 49% to 571; in law and order, from 531 to 631; and insubsidies, from 211 to 311. In irrigation, provinces have always undertakenalmost 991 of the total federal and provincial current expenditures. Third,the development component of provincial expenditures, given their highrecurrent liabilities, fell from 292 in FY81 to 241 in FY87. Some of therise in consumption expenditures of provinces has been induced by the federalgovernment. The wheat subsidy, 1001 of which is currently borne by provinces;wage indexation of salaries of provincial employees which affects virtuallyall functional heads; and implementation of the Prime Minister's program arerelevant examples.

2.33 The sluggish growth in provincial receipts also contributed to thedeterioration in provincial finances. The major revenue source for provincesis the federal tax transfers from the divisible pool: 801 of revenues fromthe income tax, sales tax, export duties and full proceeds from the royalty onnatural gas and gift tax. Following the slow growth in income tax receiptsand abolishment of the gift tax, the share of federal tax transfers 3/ in

1/ Refers to the difference between current revenues (excluding revenuedeficit grants) and current expenditures (including interest payments onfederal loans).

2/ In addition to revenue deficit and other budgetary support provided to theprovinces, it includes development grants for education.

3/ The federal taxes shared with the provinces grew at a much slower pace,i.e., at 9.61 between FY81-87 compared to 12.81 recorded for all federaltaxes.

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Table I1.8: STRUCTURE AND GROWTH OF PROVINCIAL REVENUES,EXPENDITURES AND INTER-GOVERNMENTAL TRANSACTIONS

Average1980/81 1983/84 1986/87 Annual Growth

Rate X /c

S of Current Revenues 9.4Federal Tax Sharing 67.8 65.6 61.4 7.6Provincial Tax Receipts 18.4 17.5 16.5 7.4Provincial Non-Tax Receipts /a 13.8 16.9 22.1 18.4

S of Total Expenditures 19.4Current Expenditures 59.0 64.9 59.6 19.6Interest Payments /b 12.5 10.9 16.5 25.1Development Expenditures 28.5 24.2 23.9 16.0

Net Federal Transfers toProvinces (Rs. bill.) 2.4 7.9 18.4 40.5Gross Federal Transfers 4.7 11.5 27.3 34.2

Revenue Deficit Grants 0.9 4.7 11.5 52.9Education Grants 0.0 0.0 4.8 0.0Other Budgetary Support 0.2,; 0.7 0.5 16.5Development Expenditures Assist. 3.6 6.1 10.5 19.7Loans (1.1) (5.8) (9.9) 44.2Grants (2.51 (0.3) (0.6) -21.2

Provincial Transfers toFed.Govt.(Rs. bill.) 2.3 3.6 8.9 25.2Interest Liabilities 0.2 0.4 0.6 20.0Repayment of Loans 2.1 3.2 8.3 25.7

Source: Ministry of Finance.

/a Included irrigation receipts./b Includes interest expenditures on federal loans./c 1986/87 over 1980/81.

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provincial current revenues fell from 68% in FY81 to 612 in FY87. Theprovincial share also declined, and now barely captures one-half percent ofGDP. Offsetting these trends were non-tax receipts. User charges (excludingreceipts from water charges), however, play a peripheral role in provincialfinances.

2.34 Sizeable transfers of federal resources in addition to therevenue-sharing arrangements have been required. Net federal transfers 1/experienced almost an eightfold increase in seven years, from 16S to 35X ofthe overall fiscal deficits. The reduction of heavy dependence on federalfunds calls for a comprehensive review of the inter-governmental fiscalarrangements. As a first step, a new tax sharing formula, under theresponsibility of the National Finance Commission, is expected to beincorporated in the FY89 budget. The Bank endorses this action. Bycurtailing unlimited and unconditional access by the provinces to federalgrants for budgetary support, the new revenue-sharing arrangement is expectedto encourage provinces to undertake more resource efforts. A more effectivebroadening of their revenue base would be achieved as part of the process oftax reform, which would have to address revenue-sharing in the process ofwidening the base of the sales and income taxes.

2.35 Several suggestions for expanding provinces' own revenue base in themedium-term are given in the next section. In addition, the plannedgovernment program to privatize its public tubewells would help reduce thedeficits of provincial governments, which are responsible for the operatingand maintenance (O&M) irrigation costs. The overall cost-recovery rate forO&M expenses of the irrigation system declined from 54% in FY83 to 402 inFY87, primarily because of rapid expansion in O&M expenditures. There hasalso been a substantial lag in water rate adjustments. To achieve full O&Mcost recovery, the Government had the choice of raising water rates annually,and/or privatizing tubewells, which currently absorb almost 50% of irrigationO&M expenditures. Achieving this goal through water charges alone would haverequired a 40% annual increase in these charges. Therefore, the Governmentdecided instead to transfer existing public tubewells to farmer groups,suspend the public sector replacement program of deteriorated tubewells, andrefrain from investing in new tubewells. With the objective of achieving fullcost recovery within an eight-year period, prcvincial budget pressures wouldbe tzlieved substantially in the medium-term.

Resource Mobilization 2/

2.36 The biggest potential for resource mobilization comes from improvingPakistan's tax base, although improving the revenue surpluses of publicdepartments and autonomous entities and better cost recovery on publicly

1/ After deducting debt-servicing liabilities on federal loans (Table II.8).

2/ This section draws on a number of tax studies, including the National TaxReform Commission Report, December 1986; M. Gillis, "Comments on the NTRCReport," April 1987; K. Bulutoglu. "Tax Reiform in Pakistan," November1987; and various tax-oriented reports by E. Ahmad and N. Stern.

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provided services are also important. An effort on all three fronts will benecessary to maintain the expected FY88 revenue base at 17.5X of GDP (181 ifexpected cotton export tax receipts are included). Continuous changes to thetax system, plus ad hoc surcharges and public service price increases, havebeen necessary to maintain this revenue/GDP ratio over the 1980s. Withoutfurther efforts at improving revenue generation of public entities (especiallythe public utilities), service fees, and tax administration, this revenue basecould not be maintained. 1/ Additional effort to raise revenues from about17.5% to over 212 of GDP in five years is expected to come primarily from taxreforms. In the first year of the program, however, reducing duty exemptionsand replacing bans with tariffs is likely to augment the revenue base by about0.5Z of GDP (Rs. 3.5 billion). Reduction of explicit subsidies (e.g.fertilizers, wheat, and other commodities) were treated in the previoussection. In view of the difficulty of raising fees of public servicesespecially before quality is improved, only a small contribution -- 0.21 ofGDP -- is expected to come from education, health, and water charges over thenext five years. The discussion below therefore focuses on tax reform toraise the present revenue base.

2.37 Need ior Reform of Present Tax Structure. Pakistan's tax structurewas described in Table I.7 in Chapter I. Three features of Pakistan's taxstructure stand out in comparison with other countries, as shown in TableII.9. First, at about 131, its tax/GDP ratio is low when compared with mostother countries. The comparable figures for all developing countries were17.5% while those for Sub-Saharan African countries and East Asian countrieswere 17.61 and 16.8X, respectively. Secondly, Pakistan obtains a relativelylow percentage of its revenues from direct (mainly personal and company incometax) sources - 18.61 versus 29.31 for all LDCs, 30.3% for Sub-Saharan Africa,and 43.3% for East Asia. Lastly, taxes on foreign trade form an exceptionallyhigh share of total tax revenues (40.51), higher than most countries in thetable except for Sri Lanka, Gambia, Cote d'Ivoire, and Mauritius, all smalleconomies with a relatively large external trade sector.

2.38 Deficiencies in the present tax system limit its revenue generationcapacity and account for significant distortions in the allocation ofresources: an overreliance on taxation of imports, narrow coverage ofdomestic production, and excessive exemptions of types of income (e.g. fringebenefits, agricultural income). The recommendations made below would broadenthe tax base and increase the elasticity of the tax system by shifting theemphasis in indirect taxation toward domestic consumption (of both domesticand foreign products) and extending the coverage of the income tax. Thesereforms would not only raise sufficient revenues to keep budgetary deficits ata manageable level. They would also minimize the distortions on private

1/ The current revenue base of 17.5% of GDP (excluding cotton export taxreceipts) would fall to less than 16% of GDP by FY93, if FY80-87 revenueto GDP elasticities were applied to the five-year period. The calculatedelasticities are: direct taxes (0.5), indirect taxes less surcharges(0.8), surcharges (2.8), non-tax revenues (1.3), and autonomous bodiescontributions (0.4).

'al Le 11.9: Comparative l'ax Structure(Shares of Total Tax Revenue)

Does,tc tao. O,nIncona 1p*@a goods and seeV-Cos Foreo,n Tead

0w O0wr1

p r sal. S1*. WealtCmit mijd- tWS- 1E. Es- cii eie,d

(3961 Team./ .id- Cor.e- e.er. Em- mart pet See- Pro-Cmt. Veers dollars) 00P Total woo rate 06Oer TotaI VAT Cie" flUmr Total dati. dutie 0ther ri4t *ftA other

Pakis at" lo6IlU -0 13.1 15.61 5.77 3.6 U a.. 40.61 7.77 32.64 a.. 40.45 36.65 1 42 216 a . 0.32 0.01

Sanladeo 1,77-76 140 6.1 :5.19 13.51 1.67 n.*. 41.15 I6."0 23.04 1.21 3620 S 92 2.35 *12 I a * .17 2 10

$%lag, 1,76-61 VW0 15.6 6. S7 14.56 22.09 a.e. 30.36 20.55 4 43 2.S0 2426 24 26 a.a. n e. n.m. 3.34 0.35

Indio 1970-61 260 15. 15.2? 7.17 7.63 0.46 62.61 0.62 23.03 2. 96 1765 I640 0.1U 0 m * 1.26 3 01

Sr; lgb. i 1970-8l 300 X9.6 13.6 5.26 0.30 a. a. 29.75 14.14 14.64 O." 6 2.91 21.3 3144 007 m * . 0.52 2 94

GMAIN 1676-76 270 15.0 14.6 S. 536 .3 0.73 3.91 n.e. 0.63 2.67 70.63 S1.U 0 3012 0.11 Ose 3 23 0 35

Gina., 1961-83 400 5.5 26.1 13.32 12.06 0-95 36.01 4.16 29.20 2.65 37.11 IS.0 13.29 893 00 m 0 02 e E

eImrym 1979-01 42 35.4 32.70 n a. . n.r 40.96 26.73 10.75 3.J0 22.U 21.65 0.61 ma m e 2 2S 143

Liberia 1961-63 520 25.4 36.64 27.65 6.6 0.52 27.73 2.63 12.64 12.26 32.63 32.10 0.49 0.24 .* ? 163

1ndommis 3960-62 530 20.9 61.20 1.90 74.70 4.60 10.6 4.62 4.64 1.13 567 4I IJ so M.D. ma . 1.46 0 6s

Thmlmd 1960-62 770 13.5 20.70 661 it 79 n a. 49 00 2006 22.61 6.12 23.04 20 1 I 0 .m 3.30 5 96

Philippime 196-02 60 11.2 22.5 3S0.64 12.04 ma. 46- 3 1469 20.13 11.4 24.7n 23 60 I 2 0 14 n.r 4 I 3 9

CA d'IwOlr 11190-62 1.200 20.4 34.05 5. 6. 9 .S 0.47 26.62 1O.04 9.07 1.11 46.32 35.09 It 23 a a 10.36 2.33 0.2

ft"lWoo 16I-03 1,270 10.7 36.30 10.2 6.01 n.e. 20.66 1.12 32.45 7.10 56.22 37.3 16.f6 0.-5 n.. S.04 1.96

Tor-ke 1i794-1 1,5 4 16.6 60.2. a O.S .6 6." 4.04 24.06 3.33 6.79 3. 75 9.07 6 4 A.. 0.62 am. 2.36 4.21

Xeres. 3,9. of 191-63 1.700 16.3 26.0 14.03 12.57 n.m. 51.49 24.71 15.50 11.20 16.40 35 46 n.e. M.a. 1.25 1.11 S.IS

Ibala 1794-1 3.640 22.0 41.62 9.27 32.43 0.02 19.63 5.93 0.44 5.77 35.09 16 5 19.322 n. 0.53 0.52 1.43

Source: Vito Tangi t mwbntitativ. Characteristiec of Tam Systems in Developins Coastrieam.in 0. Isbary anJ M. Starn Tl Theor o Tnastiom for Develeoins Cowntri(.eford Umniversity Proms. 1667). wp. 212.215.

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sector production and investment decisions, 1/ ensure that the poor are nottaxed or charged beyond their ability to pay, and minimize the administrativeCosts of compliance and collection.

2.39 The tax recommendations follow the general principles relating toefficiency objectives:

(i) To the fullest extent possible, indirect taxation should be levied onfinal consumption irrespective of origin. This would involveshifting the emphasis in taxation toward domestic consumption andaway from taxation of inputs which leads to production inefficienciesor imported goods which provides incentives for high-cost domesticproducts.

(ii) To ensure greater horizontal and vertical equity and minimizeallocative inefficiences, different types of income should be treatedequally.

(iii) To minimize adverse incentive effects on saving and investment or onwork effort and discourage evasion, high marginal rates of incometaxation'(personal or company) should be avoided.

(iv) Since the prices of most publicly provided goods and services arebelow their (marginal) economic costs, raising prices would raisegovernment revenues (or public enterprise profits) while leading to amore efficient allocation of resources; in cases of excess demand,for example, it can lead to greater production and consumption of agood consumers were willing to pay a higher price for. Presently inPakistan, raising revenue from improved cost recovery is, in mostcases, at the margin more efficient than from additional taxation.

1/ In diverting resources to the public sector, different types of taxesimpose varying degrees of distortions on the workings of a marketeconomy. For example, income taxes affect the returns from labor and fromholding real or financial assets and hence affect people's willingness tosupply labor services or to save and invest. Tariffs on foreign productsallow domestic firms to raise prices above world prices and in manyinstances help to encourage the development of inefficient importsubstituting firms. These inefficiencies - referred to as the welfarecosts or deadweight losses of taxation - are costs additional to theactual resources transferred to the government. From an efficiency pointof view, taxes with low deadweight losses are more desirable and choosinga mix of taxes which minimized the total deadweight loss to society ofraising a given amount of revenue would be an important objective of taxpolicy.

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2.40 The recommendations also adhere to equity considerations -- i.e.raising additional revenues while minimizing adverse impacts on the poor - byexempting poorer groups from income taxation (as is already the case inPakistan), and employing zero or low indirect tax rates on items essential tothe poor and (a few) higher rates on income-elastic goods. Targettingsubsidies toward the lowest groups while ending explicit subsidies (or theprovision of public goods and services below cost) on products mainly consumedby higher income groups are also part of the recommended program. Targettingsubsidies (e.g. wheat) was discussed in the previous section. Moving towardgreater cost recovery in a number of areas where coiisumption is confined tothe upper income groups or where there is no overriding social objective forsubsidization (e.g. irrigation, secondary and higher education, urbanhospitals) are discussed below.

2.41 Indirect Taxation: Broad-based Consumption Tax. The objective forindirect taxation is to shift the emphasis from imports toward a broad-basedtax on domestic consumption that is neutral between products made in Pakistanand imports. This would involve a modification of Pakistan's present salesand excise taxes. In principle, all goods produced/manufactured in Pakistanand sold wholesale are now subject to a sales tax, but practice has differedfrom principle. So many products have been granted exemptions that the salestax now resembles a special consumption or excise tax rather than abroad-based consumption tax. In addition, differential coverage anddifferential rates between domestic products and imports (with higher ratesfor imports) have meant that the tax has "protective effects" in addition tothose generated by the tariff system. In the FY87 budget, the rates fordomestic products and imports were made equal, but unequal coverage stillleaves some protective effects intact. Cascading of the sales tax throughseveral stages of production has been avoided in Pakistan by making taxes oninputs deductible from taxes on outputs,, similar to the procedures under avalue-added tax (VAT). Because of the large number of exemptions, the salestax on domestic production yields very little (only 0.22 of GDP in FY87), thebulk of the revenue coming from imports. Even so, total sales tax revenuesamount to only 1% of GDP. Limited coverage and the widespread use of specificrather than ad valorem rates have limited the effectiveness of the excisetax. Only 41 products are covered and 7 alone account for almost 90% ofrevenue: tobacco, sugar, cement, POL products, natural gas, vegetable oil,and beverages in descending order of revenue contribution. Since the early1980's, revenue from excise taxes have fallen from 3.8% to 2.51 of GDP.

2.42 The simplest way, administratively, to develop a broad-basedconsumption tax would be to expand the coverage of the existing sales tax bydrastically curtailing the number of exempted manufactured products. Thepresent sales tax taxes domestic products and imports at the same rate (exceptfor the differential coverage), covers imported goods extensively, ar.d allowstaxes paid on inputs to be credited against taxes paid on outputs. Cuttingthe excessive number of exemptions would serve the objective of increasing thetax burden on domestic consumption. However, given existing practices underthe sales tax, it would come very close to instituting a value-added tax(VAT), the main differences being the unresolved issues of how to handleexports and investment. In this case, the preferred solution would be toimplement a VAT - i.e. a manufacturers' level, consumption-type VAT imposed onthe distinction principle and collected by the tax-credit method.

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2.43 The steps required to move from the present sales tax to such a VATare as follows: (a) extend the coverage of taxation to (virtually) allproducts at the manufacturer's level; (b) retain the practice of taxingdomestic products and imports at the same rate; (c) continue to allow thepractice of crediting taxes on inputs (including capital goods) against taxeson outputs; (d) free manufactured exports from the VAT by not taxing exportedoutput and rebating all the taxes paid on inputs (i.e. so-called"zero-rating"). The above VAT, imposed at a single rate with no exemptions,is likely to be mildly progressive; the reason is that unprocessed food, whichbulks large in the consumption of the poor, does not pass through amanufactured stage.

2.44 The greatest advantage of the proposed VAT is its ability to raisesubstantial amounts of revenue without attendant distortions between differentproducts, different stages of production, or domestic and foreign production.The tax is within Pakistan's administrative capabilities to implement. Todate, it has been adopted in a number of less developed countries, usuallywith very favorable revenue-generating results within 2-3 years ofimplementation. In the form outlined above, it has been implemented inFrance, Colombia, and, more recently, Indonesia; the first two countries usedthe experience gained to move the system to cover the retail level. As notedabove, the proposed VAT would not impact unfavorably upon the poor. Furtherprogressivity could be built into the system by comi ning the VAT with asystem of excise taxes at various rates designed to tax "luxury consumption"(e.g. radios and television sets, refrigerators, and motor cars) or productsharmful to health (e.g. tobaccco). The excises should be at ad valorem (notspecific) rates and should apply equally to domestic and foreign productswhich is not the case at present.

2.45 The introduction of a VAT could occur in FY89, in order to begin theprocess of increasing the contribution of non-trade related taxes to totalrevenues. It is importaat, moreover, that the tax and trade policy changes beclosely coordinated, in order to avoid adverse effects on revenues,production, and exports. Trade policy reforms (Chapter III), involving firstthe elimination of bans, import restrictions, and concessional duty rates, andreduction of very high tariffs, followed by a more general reduction of tariffrates, are expected to have a positive impact on government revenues in thefirst phase. Although it is difficult to predict with certainty, thesimulation results in Chapter III suggest that the two phases together couldbe revenue-neutral.

2.46 Direct Taxation. The broad proposals outlined below are aimed atwidening the tax base and at reducing the differential incentives granted toholders of various kinds of real and financial assets. As such, the proposalsshould simplify tax administration, lead to greater equity (both horizontaland vertical), and improve resource allocation by making income from differentsources subject to more equal tax treatment. By subjecting a largerproportion of the nation's income to taxation, the contribution (andelasticity) of the income tax system would be significantly increased.

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2.47 Taxes on income, both versonal and company, currently yield only 131of total tax revenue, a share which has been declining in recent years. Partof this decline has been the result of increases in the standard exemption (toRs. 24,000 per household) under the personal income tax and reductions in thenumber of tax brackets and in the highest marginal rates under both taxes, butthere are a number of other factors that are responsible for the poorperformance of income taxation. The personal income tax is levied at marginalrates of 5X-45X on incomes above the Rs 24,000 exemption level. The existingtax suffers from a number of deficiencies: poor coverage of taxpayers; anarrow tax base riddled by exceptions and exemptions; and poor integrationwith the company tax. Despite recent efforts by the Central Board of Revenue,the number of taxpayers remains under 11 of the population which is very lowby international standards, and the bulk of the revenue collected iscontributed by large taxpayers. Underreporting is prevalent among the middleclasses and the self-employed and, coupled with generous exemptions, leads toa low tax base.

2.48 The most notable exemptions include (a) all of agricultural income(see paras. 2.51-5.> below); (b) investment allowances granting tax relief forqualifying financial investments equivalent of up to 1/3 of annual inno,e(with a cap of Rs 50,000); 1/ qualifying investments include inter aliarecognized provident funds, life insurance premiums, defense savingscertificates; shares of specified holding, investment and publicly-listedcompanies; (c) an exemption of varying amounts of interest income depending onthe source (e.g. national savings deposits, post office savings deposits,government securities); (d) dividends of up to Rs 15,000 from the followingsources (e.g. public unit and mutual funds, companies listed on the exchange,profit and loss accounts witn banks); and (e) fringe benefits received fromemployers (e.g. housing, transport). There is a substantial overlap in theinstitutions/instrumints receiving tax relief in points (b), (c), and (d). Inaddition, while Pakistan's tax law provides for the taxation of capital gains,the law has not been applied; as is the case with agricultural income, thisprovides another means for avoiding taxation.

2.49 The company income tax has two components, an income tax of 301 and asuper tax of 25% (351 for banking companies). However, rebates are given fornon-banking companies so that the nominal rates end up at 40% for companieslisted on the stock exchange, 501 for most other (non-bank) companies, and 65%for banks. Depreciation rates are: 10% per year for factories and workshops;51 for other buildings, and 10% for plant and machinery. In the first year,an initial allowance is added-10 for buildings and 40% for plant andmachinery, but total allowable depreciation over an asset's lifetime remainsits original cost. Company dividends are taxable except for the firstRs 15,000 received from institutions such as those listed in paragraph 2.51,point (d). The company income tax is complicated by a number of tax incentives

1/ The tax relief is calculated as the average rate of tax times the amountinvested (where the latter cannot exceed one third of income or Rs 50,000whichever is smaller). Since the average rate of tax rises with income,relief is greater for high income groups.

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originally designed to promote various economic and social objectives: forexample, tax holidays or tax reductions for firms investing in certain backwardareas, certain industries, or in balancing, modernization and replacement.These incentives have been too generous, considering the need to raise publicrevenues, while at the same time they have not accomplished (or evencontributed significantly to) their original intentions; the incentives havenot directed resources in the desired directions and firms that are receivingtax relief often would have made the investment in any event.

2.50 The key income taxation proposals are:

(i) Subject agricultural income to taxation (paras. 2.51-53 below) andreinstate the practice of capital gains taxation.

(ii) Given a personal exemption that is generous by internationalstandards (four times per capita GNP), it would be desirable to holdthe level constant for several years and merge the first (5X) andsecond (15X) tax brackets. These proposals would drive more personsinto the tax net and would subject people who were quite well off bylocal standards to a higher rate of tax.

(iii) Subject employer fringe benefits to taxation, or, perhaps easieradministratively, do not allow employers to deduct them as costs ofdoing business.

(iv) Substantially reduce future use of tax incentives (holidays, etc.) asmeans of encouraging investments in backward locations or specifiedindustries. Worldwide experience generally has shown such incentivesto be ineffective and the revenue losses they entail must be made upby heavier taxation of other activities.

(v) End the differential incentives given to purchases of certain typesof financial instruments (and the double incentives given to some whoqualify for both the investment allowance and tax exemptions fortheir dividends/interest) by moving to a system which treats allsavings instruments equally. To do this, a combination of aninvestment credit and tax withholding for interest/dividends on allfinancial instruments is worthy of consideration.

(vi) Move toward a system in which the marginal effective tax rate on newinvestment is zero. There are two alternative approaches to thisobjective. The first is to allow full deduction of investment costsin the first year but no deductions of the inter3st charges onfinancing in the first or subsequent years (the so-called"full-expensing" method). An alternative approach would be to allowthe deductions of "economic" depreciation and interest in each yearof an investment's lifetime.

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2.51 ARricultural Income Taxation. Despite the fact that agricultureaccounts for 23X of GDP and 52S of the employed labor force, the contributionof the sector to government income is low and falling. Given Government'spolicy of bringing agricultural prices in line with world prices, the taxationof agricultural exports has declined substantially. The exemption ofagricultural incomes from taxation is inequitable (since it means that incomefrom different sources is taxed differently) and inefficient (since itprovides an incentive for an inordinate amount of production resources to flowinto agriculture); it also encourages taxpayers to disguise income from othersources as agriculture income in order to evade taxation. Ushr, an Islamictax on net income earned from various crops, yields less than 0.31 ofagricultural value added.

2.52 A tax on agricultural income, therefore, is desirable on the groundsof equity, efficiency, and evasion reduction. Since the present personalincome tax exempts incomes below Rs 24,000 per year, its application to theagricultural sector would exempt over 702 of farmers, leaving the remaining301 who generate over 50% of agricultural income subject to tax. Thefollowing proposal of the National Taxation Reform Commission is primarilydirected to reducing evasion of non-agricultural income taxation, rather thansubstantially raising agricultural income tax collections, and a betterstructure of incentives. It recommends: (a) taxing agricultural incomesabove double the exemption level (Rs 48,000); (b) filing of income tax formsfor those above Rs 48,000 would be voluntary and subject to self-assessment;(c) anyone who had not filed such a form would not be allowed to attributemore than Rs 48,000 in income to agricultural sources; (d) farmers not filingan income tax would be subject to a presumptive tax on a base equal to thepresumed income from his land less Rs 48,000. 1/ Thus, the potentialtaxpayer/landholder is subject to a dilemma: failure to file an income taxform subjects him to a presumptive tax and denies him the ability to claimlarge amounts on income earned from agricultural pursuits. Coupled with aprovision for the taxation of capital gains, implementation of this proposalcould substantially improve income tax receipts.

2.53 An alternative proposal for taxing agricultural income directly atthe provincial level would be a land tax to capture presumptive income. 2/According to the 1980 Agricultural Census, 77% of land owned - amounting toless than 30% of the total owned area - were in holdings of less than 12.5acres. The Ahmad/Stern proposal would levy a flat tax, equivalent to about14% of value added in agriculture, on land holdings in excess of 12.5 acres.In 1980/81 terms, this represented a modest Rs 150 per taxable acre, yet wouldyield additional tax revenues of '.3% of GDP. As discussed in the previoussection, the provincial tax base aeeds to be broadened. If a land or otheragricultural-based tax is politically unacceptable, the provinces most likelywould have to rely more on user charges and on periodic rate changes onexisting taxes, fees, and surcharges to improve their revenues.

1/ The presumptive tax would have a ceiling.

2/ E. Ahmad and N. Stern, "Fiscal Policy for the Seventh Five Year Plan,"November 1987.

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2.54 Tax Administration. In addition to the need to change tax rates andstructure, improvements in tax administration could also realize substantialnet gains in revenue. Some of the recomendations made above to broadendefinitions, end exemptions, and eliminate distinctions between differenttypes of income or transactions should simplify the tax code and ease problemsof tax administration. However, it is clear that there are still a number ofproblems, that are clearly reflected in taxpayer dissatisfaction with thesystem and in the poor coverage and widespread evasion. Improvements inadministration should involve (a) tax procedures; (b) taxpayer identification;(c) assessment; (d) audits; and (e) analysis.

2.55 In Pakistan, there is no general tax procedure law that specifies therights and duties of taxpayers and tax administrators, the steps involved inassessment and collection, and the means by which disputes are resolved. Lackof transparency in the system has created substantial mistrust betweentaxpayers and administrators. A number of countries have passed laws whichcover tax procedures, assessment methods, evidence, bookkeeping rules, and thesettlemen. of disputes. While the number of taxpayers doubled between FY80and FY84, the fraction of the population covered is still low and the largeproportion of revenues collected from large f4 rms ii indicative of poorcoverage of small and medium-sized establishments. Improved coverage willinvolve intensified use of field surveys, coordination between income andsales taxation collection information, the introduction of unique taxpayeridentification numbers, and c!mputerization of registers and information.

2.56 Self-assessment has made an important contribution to the increase inthe number of income taxpayers, but its success has been marred by excessiveexamination of declared incomes and resulting disputes. It would be simplerfor the Central Board of Revenue to accept and finalize all self-assessments(with supporting documentation) and then proceed to detailed scrutiny andpossible audit of returns on a random sample basis according to an annualprogram. At the same time, granting immunity from scrutiny and audit totaxpayers whose self-assessments are 20% or more higher than last year shouldbe dropped. Tax evasion is too high for Pakistan to be able to afford sucheasy escape from possible audit. To improve coverage of small businesses,increased use of lump-sum presumptive (income and/or sales) taxes based on setcriteria would be desirable; such businesses could be given the option ofchoosing to be taxed on the basis of actual incomes. To reduce the potentialfor taxpayer harassment, it would also be desirable to make procedures moretransparent, make the authority of individual tax officers clear, and limitthe right of administrative assessment to higher level conmissions. Atpresent the Central Board of Revenue has no capacity for the analysis of taxpolicy and reform. A cell should be set up, staffed with experiencedeconomists and tax administrators, and charged with responsibility ofanalyzing the equity, efficiency and revenue impacts of potential tax changes.

2.57 Summary of Proposed Tax Changes. In summary, the revenue effort isexpected to consist of the following taxes:

(a) a broad-based consumption tax, which could yield additionalrevenues of about 2.0% of GDP;

(b) income tax reforms, including the elimination of theagricultural income exemption along the lines of the NTRCproposal, which might yield additional revenues of about 1.0Xof GDP;

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(c) a land tax or other provincial-based tax, which might generateadditional revenues of 1.0-1.32 of GDP; and

(d) substitution of trade tariffs for bans and reduction of dutyconcessions, which could raise revenues by at least 0.52 of GDP.

Improved tax administration would be important in maintaining the presentrevenue base at about 172 of GDP.

2.58 The revenue estimates are a ballpark figure, derived from otherstudies 1/, intended solely to show general magnitudes. Timing is alsodifficult to predict. The full revenue potential of these suggested taxes--4.5-4.8Z of GDP - would not be rea'lized until after FY93. With aGovernment-financed team of international tax consultants just beginning towork on the feasibility of expanding the sales tax or introducing avalue-added tax, implementation is not likely to begin before mid-FY89. Theother taxes, which still need preparation, would realistically not beintroduced and generating revenue until several years from now. The land taxor other provincial tax would require considerable study; in Table II.10, itis shown as going into effect after the 1990 elections. The bottom panel ofthe table shows the additional revlenues likely to be generated by each ofthese taxes, by fiscal year. The top panel shows the impact on total taxcollections.

Improved Cost Recovery for Public Services

2.59 Raising fees and prices to cover costs of publicly produced goods andservices are an important part of the program. The reduction/elimination ofsubsidies for wheat, fertilizer, and other commodities and the privatizationof public tubewells have already been covered in the previous section.Additional cost recovery efforts for education, health, and surface irrigationservices are discussed below. Together, they are apt to raise governmentnon-tax receipts by about 0.22 of GDP in FY91-93.

2.60 Education. More resources are needed to improve the quality ofpublic education in Pakistan. With minor variations and exceptions, publicsector education and training are currently provided free or at nominalcharge. In the Punjab, a small fee of Rs 2 per month is charged for primaryeducation. At college level, tuition fees range between Rs 20-25 per monthand at university, between Rs 25-32 per month. These latter fees representless than 101 of annual operating costs of colleges and universities and acase can be made for their increase. Because participation in Pakistan'sprimary schools is currently very low, especially among girls, and for reasonsof equity, higher fees are not recommended for primary and lower secondary

1/ See references in footnote 1 at beginning of the revenue section andPakistan Sixth Plan Prospects and Future Prospects, World Bank Report No.6533-PAK, February 26, 1987.

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Table 11.10: PROPOSED REVENUE IMPROVEMENTS, 1988/89-1992193(Percent of GDP)

Estimate1987/88 1988/89 1989/90 1990/91 1991/92 1992/93

A. Revenue Ratios

Total Revenues /a 18.0 18.1 19.1 20.2 21.1 21.5Taxes 13.6 13.7 14.7 15.7 16.5 16.9Direct 1.9 1.9 2.2 2.5 3.0 3.3Indirect (excl.cotton receipts) 11.2 11.8 12.5 13.2 13.5 13.6Cotton ExportReceipts 0.5 - - - - -

Non-taxes /b 3.7 3.8 3..8 3.9 4.0 4.0

AutonomousBody Contributions 0.7 0.6 0.6 0.6 0.6 0.6

B. Additional TaxCollections

Total +0.6 +1.0 +1.0 +0.8 +0.4Direct Tax ElementsPersonal & Corporate 0.0 +0.3 +0.3 +0.3 0.0Land Tax 0.0 0.0 0.0 +0.2 +0.3

Indirect Tax ElementsConsumption Tax +0.2 +0.7 +0.7 +0.3 +0.1Customs Duties +0.4 0.0 0.0 0.0 0.0

C. Additional User Charges 0.0 0.0 +0.1 +0.1 0.0

Ia The projected iacrease in total revenues is less than the projectedincrease in additional tax collections, because windfall cotton exportreceipts temporarily augment tax revenues in 1987/88.

/b Includes disinvestment.

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education. 1/ Rowever, in view of the resource constraint facing the sectorand the compelling demands of primary education, it is suggested that fees inhigher education be increased, to say 301 of total operating costs. Revenueraised would amount to about Rs 500 million at current levels of enrollmentand prices, and could rise to about Re 750 million by FY93. An annualscholarship fund - estimated to cost about Re 100 million - would be necessaryto assist students from poorer backgrounds.

2.61 Some responsibilitity for delivery of education services can be givento the private sector, in view of the pre-1972 existence of a robust privatesector and recent experience with private primary, secondary anduniversities. At the primary level, it is estimated that as much as tenpercent of total enrollment may already be enrolled in private schools.Howe"~rer, it is unlikely that private schools will ever play a major roleoutside urban areas, and in rural areas it will remain the responsibility ofthe public sector to provide schools.

2.62. Health. While the overall amount spent on health care in Pakistan isnot unusually low (3.5 percent of GNP), public expenditure on health,especially recurrent expenditure, is below that of other countries of similarper capita income. (Health services claim 4.5 percent of total governmentexpenditure, just over 1 percent of GDP in Pakistan). An estimated sixty-fivepercent of expenditure on health care originates in the private sector andover seventy-five percent of recurrent expenditure is accounted for here.Government, however, dominates expenditure on the capital budget. In terms ofuse of health facilities, visits to private practitioners are far morefrequent than attendance at public health facilities, especially in urbanareas. This pattern reflects both the poor coverage and quality of the publichealth service, and in urban areas the over-crowding of public hospitals.Therefore, while the private sector would continue to provide the bulk of thehealth care, better cost recovery is needed to improve public health service,particularly for primary health care' and for serving rural and poorresidents. Use of the public health service is virtually free - the mean feeper visit to all public health facilities is only one or two rupees. Overall,an estimated 5.5 percent of the recurrent outlay on the public health serviceis recovered through user charges. Use of private health facilities, incontrast, is more costly. The average cost per visit to a privatepractitioner is Rs 50, to a private hospital Rs 65, and to a traditionalhealer, Rs 30. Average expenditure on health care is estimated at Rs 165 permonth per household, representing approximately 6 percent of average monthlyhousehold expenditure.

2.63 Therefore, it is realistic to set higher targets for health fees inPakistan, as the quality of service is improved. Recovering 20X-252 of the

1/ It may be necessary for parents of primary and secondary school children,however, to continue to contribute to the costs of books, althoughassistance, especially for the poor, would be desirable.

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total expenditure on hospital services by 1990, from combinations of usercharges and charges on doctors using their rights of private practice, isrecommended. In primary health care, a 10X recovery goal is not achievable inthe same time frame, but nevertheless should be established as a target forthe end of the Seventh Plan period and beyond.

9.64 Water Charges. Although most of the irrigation O&M cost-recovery gapis expected to be met by the privatization of public tubewells, any shortfallwould have to be met by increasing water rates and improving assessment andcollection. At the moment, Punjab is recovering almost 90X of itsexpenditures on surface irrigation and subsurface drainage. In contrast,Sind's recovery rate is only 50X. Improving collections, particularly inSind, is likely to be sufficient to eliminate this gap, now estimated at aboutRs 200 million. Improved collections are expected to occur by FY92, with anyresidual covered by higher water charges in the next year.

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APPENDIX TO CHAPTER II 1/

CONSISTENCY OF FISCAL DEFICITS AND MACROECONOMIC TARGETS

In order to determine the magnitudes of financable deficits that areconsistent with given sets of macroeconomic targets, one needs to look at thegovernment budget identity linking expenditure categories to sources offinancing. Using the following definitions:

D = Non-interest deficit of the public sector in local currency terms.B = Total claims on the public sector held domestically outside

the Central Bank, in local currency terms.B*- Total claims on the public sector held by foreigners, in

"dollar" terms; (B' is to be measured as net of "netforeign assets"holdings of the Central Bank).

E = Nominal exchange rate (e.g., rupees per US dollar).e = Real exchange rate (i.e., purchasing-power-parity adjusted

exchange rate, representing the relative price of foreign goodsin terms of domestic goods); note that e equals E-P'/P.

P = Domestic price index (e.g., CPI).P*= Foreign price index (might be represented by a trade-weighted

average of CPI of home country's major trading partners).t = Domestic rate of inflation.i = Nominal domestic currency interest rate.i*= Nominal foreign currency interest rate.M = Nominal stock of "money" (reserve money in the present context).r = Domestic real interest rate: r i-11r* = Foreign real interest rate: r* =it-$*d = D/P: real non-interest deficit expressed in terms of domestic

goods.b = B/P: public sector's domestically held debt in real terms

(expressed in terms of domestic goods).b's B*/P*: public sector's external debt in real terms

(expressed in terms of foreign goods).

We can then write the budget identity:

D/P+iB/P+i*(B*/P*)e=BIP+B*e/P*+N/P (1)

1/ This annex draws on the analysis developed in: World Bank, FiscalPolicy and Tax Reform in Turkey, Report No. 6374-TU, Vol. II, July 1987.

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Equation (1) links the public sector's non-interest budget deficit plusinterest payments on domestic and foreign debt (i.e., the expenditure side),all expressed in real terms, to sources of financing, which represent the netchange in (real value of) public sector liabilities.l/ Thus, B represents new(i.e., net additional) domestic borrowing from the non-bank public and theco e rcial banking system, B stands for fresh (net) external borrowing, andN for monetary financing, all in nominal terms.

However in order to capture the government's claim on real resourcesadequately, both sides of Equation (1) must be adjusted for the inflationaryerosion of internal and external debt. Thus, subtracting:

_> '/p-fr (B*e)/p*

from both sides, and inserting the relevant real interest rates, we derive

d+rb+r*b =b+b'e+M/P (2)

where, the left-hand side of the identity now includes real rather thannominal interest payments. On the right-hand side (i.e., financing),inflationary erosion VB (and I*B*) is subtracted from the nominalincreases in the public sector's domestic (and external) debt obligations, B(ja).

Equation (2) must be adjusted further to take into account capitallosses on outstanding foreign debt due to changes in the real exchange rate,since such losses are part of the servicing cost of foreign debt and hence,should be included in the deficit measure, even though they may not requirecurrent financing. A sustained real depreciation (8le='>o) raises the cost ofservicing external debt. Inserting this latter adjustment into Equation (2)gives:

d+rb+(r +e)b*ee=b+be+eb *e+M/p (3)

or

d+rb+(r*+')b*e=b+(b*e)+;/p (3)

Finally, A/p (the real value of the nominal increase in money supply) can beexpressed in terms of its two components, i.e., I (change in real moneybalances) and Pm (rate of domestic inflation times real money balances).2/The first of these components of monetary financing, A, could be referred to

1/ A " " over a variable is used as a short-hand notation to representeither the time derivate of the relevant variable, e.g. B = dB/dt (in thecontinuous time context) or the magnitude of change in the variable, i.e.,i = AB (in the discrete time context). Similarly, a "A' over a variableis used to represent the rate of change of that variable per unit of time.

2/ NmM A2/ Note that mathematically " (i.e., Mip) equals A/p - Pm.

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as the seignorage revenue component, and the second, Pm, as the inflation taxcomponent. By replacing these two components in Equation (3), we obtain thebudget identity that is relevant for the analysis of financable deficits thatare consistent with given sets of macroeconomic targets:

d+rb+(r*4e)b*e4b+(b e)+m+Pm (4)

and the latter equation could be expressed in an analytically more meaningfulform when it is divided through by real GDP, y:

d + r b+ (r+e) b*e = b+(b e) + I + Pm (5)

y y y y y y y

Equation (5) is really what we are looking for. On the right-handside, all the three sources of financing (domestic, external, and monetary),defined in real terms, are expressed as a proportion of real income.

Consistency of Fiscal Deficits and Macroeconomic Targets

The government's budget constraint, which is represented by Equation(5), could be used to check the consistency between fiscal deficits andmacroeconomic targets. Fiscal deficits can be financed through (i) externalborrowing, (ii) domestic borrowing from non-bank private sector and thecommercial banking system by issuing interest bearing domestic debtinstruments, and (iii) through resource to central bank borrowing (i.e., byissuing money), which constitutes monetary financing. Macroeconomic targets,such as targets for the growth of real GDP, external debt, and inflation rate,place a limit on each of these financing sources. Sum of all these limitsgives a total financable deficit that is consistent with macroeconomictargets. In the event that the actual deficit exceeds the latter magnitude,at least one macroeconomic target will be unattainable or changes in fiscalpolicy will be needed.

The extent of foreign financing will be constrained by targets setfor external balance and the desired evolution of external debt, say, as aproportion of GDP and/or of expected foreign exchange earnings. Similarly,the amount of domestic borrowing may be limited by the Government's desire notto raise the debt/output ratio.

For example, if the government's debt strategy is a simple one, suchas trying to maintain stable debt-to-output ratios, then the target values forthe ratio of domestic and foreign debt to output, b = b/y and b* = b*e/y,in turn imply certain limits on the growth of real domestic and externaldebt. Thus, ths maintenance of b and bV imply that b cannot grow fasterthan y and b* not faster than y/e. In short, the following must hold:

b = g b, b*=(g-c) b* (6)

or

b = g b, b*e/y = (g-c)b (7)

y

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where g is the real growth rate, j/y, and c equals the rate of realdepreciation of the exchange, e/e. The left-hand side of Equations (6) and (7)state that the increase in the real value of public sector's domestic debtheld outside the Central Bank must equal,as a proportion of real GDP, the realgrowth rate times the target domestic debt/output ratio. When translated intonominal terms, the latter condition becomes:

* _ AB = gb Y + PB (8)

where Y stands for nominal GDP, PB gives the inflationary erosion of domesticpublic sector debt. For example, if we assume 61 real growth (g = 0.06) ands = 0.23 (which is the last three years' average rate for Pakistan), and applyPakistan's actual 1985/86 figures for the remaining variables, Equation (8)would imply a domestic financing limit that is about 3.41 of nominal GDP.

Note however that in the main text, following a different line ofreasoning rather than using the above developed relationships, we stated that,for Pakistan, the limit on the magnitude of domestic financing appears to beabout 2.51 of GDP. In recent years, GOP's strategy has been to let the demandside determine the size of domestic non-bank borrowing, instead of trying tofollow a strategy of fixed debt/output ratio. Thus, the latter figurereflects what the Government could realistically expect to raise from thissource, given the domestic savings rate and the pattern of financial savings.

As for the right-hand side relationships given in Equations (6) and(7), these show the limits on external financing. The latter equations implythat if the rate of real depreciation of the exchange rate, c, equals the realgrowth rate, g, then the real magnitude of external public debt (expressed interms of foreign goods) must remain constant if the debt/output ratio, V,is to remain constant. In this case, the nominal magnitude of external debt(in "dollars") may increase at the rate of foreign inflation, p . Forexample, at 31 foreign inflation, and when g = c, GOP can resort to externalfinancing amounting to approximately 11 of nominal GDP. 1/ If, on the otherhand, the rate of real deprecation is to be sustained at 41 p.a. and the realgrowth rate is taken as 61, then the external financing that could beundertaken would be about 1.76X of GDP. 2/ Of course, a strong exportperformance and/or favorable borrowing terms may affect the external borrowingstrategy, and the Government may opt for larger external borrowing even thoughthis may lead to an increase in the debt/output ratio.

1/ On the basis of 1986 figures of US $11.7 billion public sector externaldebt and US $33.3 billion GDP.

2/ Using the recent figures (see Footnote 1), this amounts to about US$585-600 million.

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This brings us to limits on the third source of deficit financing,i.e., monetary financing. The inflationary impact of monetary financingthrough the expansion of reserve money (or base money) vill depend on theexpansion of demand for money. To the extent that economic units desire tohold real money balances, for any given rate of inflation, in a certainproportion to real income 1U, monetary expansion can take place in line withreal growth of GDP without accelerating inflation. This is the source ofseigniorage revenue that the government can obtain through monetary expansion,and this form of non-inflationary monetary financing can be increased as realgrowth accelerates. Also, even in the absence of real growth, at positiveinflation rates, economic units may wish to increase their holdings of nominalmoney balances in order to offset inflation related erosion in their realmoney holdings. This inflationary erosion can be seen as a form of taxation.Hence, monetary expansion can be undertaken to accomodate the additionaldemand for nominal money balances. This expansion need to be consistent withthe "target" rate of inflation. Note that at moderate inflation rates, theinflation tax revenue increases with the inflation rate. However, at higherrates of inflation, demand for money may fall, thus reducing the inflation taxbase. 2/

Due to moderate inflation rates, the ratio of reserve money to GDPhas been fairly stable in Pakistan in the 1980s, averaging 0.156. Taking thisratio, and assuming as target rates 61 real growth and 61 inflation, theGovernment can resort to monetary financing to the extent of 1.9% of GDP,consisting of seignorage component (0.94% of GDP) and inflation tax component(0.94% of GDP).

When all three sources of financing fiscal deficits in Pakistan areadded, the total financable deficit that it consistent with the above assumedmacroeconomic targets (which are consistent with recent trends) amounts to 5.4- 61 of GDP, depending on whether the rate of real depreciation is 6% or 4%.

Of course, it is possible to derive a matrix of values for financabledeficits by setting different target values for rates of economic growth,inflation, real depreciation, and debt to output ratios. For this purpose,the budget identity defined earlier is expressed in a more simpler form belowas a consistency condition. It can be used directly to construct such a matrix.

1/ This "certain proportion", which links real income to demand for realmoney balances (therefore, to demand for reserve money), may varydepending on the changes in the opportunity cost of holding money, which,in turn, depends on interest rates and expected inflation.

2/ It needs to be mentioned that the appropriate definition of "money" in thecontext of deficit financing is "reserve money" or base money.

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Consistency Condition. Equation (5) above can be stated as a consistencycondition by inserting the target values for the ratio of domestic and foreigndebt to output (i.e., b = b/y and b* = b*e/y) and making the appropriatedefinitional substitutions and performing necessary mathematicalmanipulations. These adjustments yield:

d+rb+r*bi*gb+(g-c )b+(g+J)i (9)

where g is the real growth rate (y/y), c is the rate of real depreciation(e/e), P is inflation rate, d is defined as d/y, m is defined as m/y, and Tand b are the debt-output ratios as defined before. Equation (9) simplyimplies that the non-interest 0aficit d plus real interest payments on foreignand domestic debt cannot exceed what can be financed through debt issue attarget debt-output ratios [g(b+b*+m)1 plus the inflation tax D minus thecapital loss due to real depreciation of exchange rate cbA.

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Chapter III: Trade and Industrial Regulatory Policies

3.01 Industrial performance in Pakistan has improved since the late1970s. With reduced regulation and renewed encouragement of privateinvestment since 1977, the manufacturing GDP grew at an annual average rate of9.52 between 1977 and 1986. This constitutes a significant improvement whencompared with the 3.3X annual growth rate of manufacturing GDP experienced inthe 1970-77 period, during which the nationalization of many industriesdiscouraged private sector investment. Consequently, the share of manu-facturing in GDP rose from 16.5X in FY81 to 17.2% in FY86, reversing thedeclining trend of the 1970s. The growth of private investment in industryalso has been strongly positive since FY78. Most of this was accounted for byinvestment in medium- and large-scale industry, which grew at an average of18.22 per annum during FY78 - FY85 while total private industrial investmentexpanded at 15.6% per annum.

3.02 Despite strong output growth, manufactured export performance hasbeen mixed. The real growth rate of manufactured exports in recent years hasvaried between a 45% increase in FY83 and a 3Z decline in FY85. Thecontribution of manufactured goods to exports has increased gradually butslowly, from 44% to 502 between 1970 and 1986, in line with the growingimportance of manufacturing in GDP 1/. Moreover, while there has been someprogress toward export diversification, cotton textiles continue to dominatemanufactured exports.

3.03 The Government's efforts to reestablish the private sector'sconfidence since the late 1970s with continued emphasis on export promotion,attempts to liberalize imports, and the ongoing efforts to reduce domesticcontrols over investment and prices have contributed to the expansion ofindustrial activity in Pakistan. However, the positive impact of theseliberalization initiatives has come as much through a more liberal attitudetoward private investment as through liberalization.

3.04 Of particular concern is the trade regime. For any further domesticderegulation to be effective in improving resource allocation, the traderegime, specifically the import regime, must be reformed. The major problemis that the existing trade regime, despite the reform efforts of the 1980s,still seems to be biased in favor of import-substituting production. Domesticmarkets are insulated from foreign competition through non-tariff barriers andhigh tariffs. Together, protection and domestic policies (intended forpreventing monopolistic tendencies) have encouraged fragmentation ofproduction among many, inefficiently small firms in some industries.

1/ These figures exclude semi-manufactures. Source: Federal Bureau ofStatistics, Pakistan: Statistical Yearbook, various issues.

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3.05 Consequently, significant trade policy reforms to establish a moreneutral trade regime are needed, to eliminate the remaining distortions in thedomestic relative price structure in favor of production for the domesticmarket and to expose the domestic economy to foreign competition. Thesechanges would stimulate a more efficient resource allocation patternconsistent with Pakistan's long-term comparative advantage. In addition,trade reforms need to be accompanied by the removal of remaining barriers todomestic factor mobility through the continued implementation of thederegulation policy, reforms in the financial sector, and appropriate fiscaland exchange rate policies. Trade liberalization and domestic deregulationpolicies are the focus of this chapter.

A. Trade Policy Regime 1/

Introduction

3.06 Since the early 1980's, the Government of Pakistan has taken periodicsteps to liberalize trade. The measures undertaken initially were aimed atremoving most of the additional non-tariff barriers introduced in the late1970s in response to the second oil shock and resulting foreign exchangestringency. However, subsequent liberalization steps appear to have beenundertaken as part of a long-term objective of establishing a more outward-oriented production structure. The recent trade policy changes have not beensubstantial enough to establish a more neutral trade regime. There is a needfor a strong and credible commitment and concerted effoft in the near andmedium term to reduce non-tariff barriers and rationalize the tariffstructure, by reducing the average tariff rate and eliminating exemptions.

Non-tariff Barriers

3.07 A significant reduction in the scope of non-tariff barriers and theadoption of a negative import system were major improvements in the importregime in the early 1980s. In 1980, when Pakistan's import regime reached itsmost restrictive stage, about 41% of the domestic industrial value added wasprotected by import bans, and another 22X by various forms of importrestrictions. By 1986, the equivalent percentages were 29% and 3.72,respectively. 2/ This was achieved by two types of measures. First, explicitimport quotas on non-capital imports were essentially removed. The number ofcommodity categories subject to import licensing value ceilings was reducedfrom 406 in 1980/81 to 5 consumer goods in July 1983. Second, banned and

1/ This section draws heavily from The Trade Regime in Pakistan, World BankReport No. 7005-PAK, November 1987.

2/ In early 1987, GOP lifted remaining controls/restrictions on imports offertilizers, thus, in effect, freeing an additional 2.91 of domesticmanufacturing value-added from import restrictions. More recently, thetrade policy statement of June 1987, which is to be in effect for the nextthree years, made 136 items (mostly raw material and intermediate importsused in export industries) freely importable but, at the same time, bannedimports of selected engineering goods.

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restricted imports were slowly liberalized. Between December 1980 and June1983, about 100 commodity categories, consisting of mostly raw materials andcapital goods, were added to the free list. In July 1983, the Governmentswitched from a positive to a negative list system which explicitly listedbanned and restricted imports. With the announcement of the FY84 ImportPolicy Order under the negative system, 148 items were made freely import-able. Additional items were debanned in September 1983 (70 items), July 1986(9 categories), July 1985 (3 items), and July 1986 (about 6 trivial items).

3.08 However, Pakistan continues to depend on import bans and restrictionsfor protection. Prior to the trade policy announcement in June 1987, about391 of all 4-digit commodity categories listed in the Customs Tariff Schedulestill remained on the negative list. Approximately 561 of these banned itemswere consumer goods (including items banned for religious/security reasons,fruits, vegetables, and export products), and another 301, raw materials forconsumer goods. 1/ In addition, there are more than 100 broadly definedcom_odity categories, divided into sublists, on the Restricted Import List 2/(Table III.1). Also, distinct from these bans and restrictions, value limitson cash imports of machinery and millwork are still being maintained inconjunction with overall investment sanctioning rules.

3.09 The value limits on cash machinery imports have expanded continuouslyfor new units and for the expansion of existing units not falling within therestricted list of industries for which investment sanctioning automaticallyapplies. They were raised from Rs 2.5 million in FY81 to Rs 50 million fornew units and Rs 30 million for the expansion of existing units in FY87, andto Rs 50 million for the latter in FY88. By contrast, value limits on otherimports of machinery and millwork have been maintained at much lower limitsfor: (i) commercial importers (Rs 2.5 million until FY88 when it was raised toRs 10 million), (ii) new units/expansion in existing units falling withinrestricted list of industries (Rs 2.5 million until FY88, when it was raisedto Rs 50 million), and (iii) imports for balancing, modernization, andreplacement (BMR) purposes (increased from Rs 2.5 million in FY81 to only

1/ As regards the broad import commodity categories, 521 of consumer goods,22% of intermediate, and 11% of capital goods are subject to importprohibitions. GOP officials indicate that, in terms of individual tariffcategories, banned items amount to about 10% of a total of approximately3500 tariff entries.

2/ The Restricted Import List consists of various sublists, each containingimports subject to a certain type of import restriction. These sublistsinclude: (i) an explicit import quota list, consisting of only 5 consumergoods; (ii) a Tied List, containing 20 commodity categories which can onlybe imported from specified sources; (iii) items importable by publicsector agencies only, (iv) items importable by specified industrialconsumers only; (v) items importable subject to specific conditions; (vi)requirements of 12 specified industries listed in 12 appendices,containing about 780 individual items, mostly capital goods; ard finally(vii) a list of items importable by actual users.

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Iable .11U.: PAKISTAN: Incidence of Banned and Restricted Itemsby Kajor Commodity Classification: 1986/87 La

(Incidence in percentages)

Total Consumer Raw Hat. for Raw Kat. for Capitalnumer of goods cons. goods cap. goods goodscomodity ------------------------categories in X

1. Negative List(4-digit categories) 395 56 30 6 8

2. Restricted List

a Part A Lb S 100b Part B a 20 65 5 5 25c. Part C L 28 39 7 4 50

d. Items importable byindustrial consumers 20 20 15 25 40

-. Imports by actual users 11 27 9 9 55

f. Items importable subjectto specific conditions 28 18 32 14 36

g. Requirements of 12specified industries 780 individual, mostly capital goods

La Further liberalization, especially for the negative list, has occurredwith the 1987/88 Import Policy Order.

Lb Import quota list.s_ Tied List.Lg Items importable by public sector agencies only.

Source: Staff estimates.

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Rs 5 million in FY87 and to Rs 10 million in FY88). 1/ Given the realdepreciation of the rupee in the 1980s, these value limits suggest thatceilings on machinery imports have either declined or remained low in quantityterms.

3.10 Impact of NTBs. The official position on import bans andrestrictions, as expressed in the Import Policy Orders, states that Pakistan'snon-tariff barriers serve two purposes: to provide "assured" protection toimport-competing industries, and to restrict imports of luxury consumergoods. In practice, however, NTBs generate more serious distortions, withgreater resource allocation inefficiencies, than direct price protectionobtained through tariffs. As is well known, import bans/restrictions breakthe link between domestic and international relative prices, pushing theeconomy further away from resource allocation patterns consistent with thecountry's comparative advantage. NTBs work to create monopolies andoligopolies through the elimination of foreign competition in industries wherescale economics are important. Government attempts to regulate and controlsuch markets rarely achieve the level of efficiency generated by the spur offoreign competition. In other indtistries where the domestic market is toosmall to support production at a minimum efficient scale, NTBs, combined withexisting investment sanctioning procedures, allow several firms to operateprofitably in the small domestic market with no pressure to improve their costcompetitiveness. Examples of fragmentation of production are evident in someof Pakistan's manufacturing industries, such as transport equipment, polyesteryarn, electrical mschinery and household appliances.

3.11 As in the case of other countries, import bans/restrictions andprohibitively high tariffe have made smuggling and other forms of illegaltrade a profitable enterprise in Pakistan. Large volumes of banned goodsapparently come through illegal channels, smuggled through uncontrollableborders and customs. Due to smuggling (estimated to be over $1 billionannually 2/), some industries (e.g., automative and engineering) are actuallynot enjoying the absolute protection that NTBs are meant to provide.Notwithstanding its positive effects on resource allocation, smuggling isneither socially nor economically a desirable way of improving resourceallocation. Moreover, smuggling also deprives the Government of potentiallyavailable tax revenues in the form of tariffs, indirect taxes, and incometaxes.

3.12 There is no reason for maintaining import bans/restrictions, exceptto meet non-economic objectives (e.g., health, safety, religious, and nationalsecurity). Less costly protection could be provided through tariffs,

1/ An exception is the textile industry, which was granted higher valuelimits in FY87 on machinery imports for BMR purposes. Depending on theexisting capacity, an integrated textile unit can now benefit from largervalue limits on imports of machinery, ranging from Rs 15 million to Rs50 million.

2/ Equivalent to about Rs 20 billion. Source: GOP, National Taxation ReformCommission Report, December 1986. It is very difficuzlt to estimate theactual extent of smuggling; however, it is a widely held view in Pakistanthat smuggling is substantial .

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initially set high enough to avoid unacceptable levels of adjustment costs butlow enough to encourage higher production efficiency. Potential unfair tradepractices such as predatory uumping could be tackled through the tradesafeguards under the GATT. With tariffs fixed at reasonable levels (asrecomiended below), smuggling might drop off. A suitable combination oftariffs and excise taxes (levied regardless of source of supply) could berelied upon to contain consumption of e.g. luxury goods without encouragingtheir domestic production.

Nominal Tariff Structure

3.13 A number of import tariff/tax changes were implemented in the 1980s.These included: (i) the setting of tariff rates for newly liberalized items,with subsequent rate changes as domestic market conditions changed; (ii) theintroduction of a 51 surcharge on c.i.f. value of all imports in FY83, withthe exception of baggage allowances and parcel post, followed by another 51surcharge (Iqra) imposed in FY86; (iii) FY85 tariff removals/cuts on importsof some non-competing machinery and inputs to the engineering industry, tariff_ncreases on imports of some machinery items for which domestically producedsubstitutes were available, and also tariff increases on imports of rawmaterials used by the pharmaceutical industries; and (iv) the major tariffalterations of the FY87 budget. By far the most comprehensive of thesechanges were those undertaken with the FY87 budget, when most rates were cutand some were raised, the number of tariff slabs was reduced from 17 to 10,and a uniform 12.51 sales tax replaced previous rates that varied acrosscoonodities. These recent changes reduced the economy-wide (unweighted)average tariff by almost 11 percentage points from 772 to 661, though thedispersion of tariffs has remained the same (Table III.2). Among the majorcommodity categories, the largest proportionate decline was in capital goods.1/

3.14 Notwithstanding the FY87 tariff changes, Pakistan's current average(nominal) tariff rates still rank at the top, along with India's, amongdeveloping countries. About 50Z of all tariff categories, and 84Z of consumergoods carry customs duties in excess of 75Z. The effects of high customsduties on landed costs of imports are compounded further by surcharges and thesales tax. As shown by the averages and frequency distribution of nominalrates of protection (NRPs) - defined so as to include all import taxes -presented in the lower half of Table III.2, larger f-vctions of imports ineach category are pushed up into 100l and above import tax levels. Whereasonly 131 of goods in all categories have nominal tariffs above 1001, over 491of all tariff categories have NRPs in excess of 1001. This is particularlypronounced in the case of consumer goods. Some of these high tariffs --notably those on garments and textile items which Pakistan successfully

1/ The average tariff for capital goods declined from 611 to 51X. Withinthis category, tariffs for some machinery, mainly non-competitive, wereeither halved or reduced to zero from their previous 20-401 range. Tariffcuts for intermediate goods were the smallest both in absolute and inproportional terms, reducing the average from 611 to 581. Tariffs onintermediate goods remain very high by international standards. Amongintermediate imports, only tariffs on industrial raw materials were cut byas much as 50 to 1001, thus reducing them to the 0-20% range. As regardsconsumer goods, recent tariff changes have reduced the average tariff onthese from 1171 to 1001.

Table III. 2: Mlitn 1u t.d Oiwaps mw frqrm u istcsyi,te oftar lirffs ad of0: It ltl ad ,lwnl

241611 ISIC

111 MIII 10111 mm cn1 luinliari CM x Fr lost NW raw an bt a. 3 4l RIha *,m

erwq laf8 W5 11.9 31.4 41.5 11.4 51.3 51.1 3.0 93.6 111.1 51.3 43.6 46.6 1.3 49.4 B.9

Uamwi liatim 532 46.3 17.3 51.2 52.9 53.6 43.4 15.4 54.1 44.4 41.1 S6.0 33.1 39.6 .S 3.6

t#fiff tamp Ills

I - 25 21.3 31.6 10.1 24.5 3.t 23.9 42.3 12.4 19.2 6.0 29.1 I1.4 1.1 25.5 4.2 10.1

2 - so 1.4 23.6 32.9 16. 5.5 29.2 12.4 19.2 5.5 3.5 21.6 36.S 11.4 16. 12.4 41.5

So - is S.3 I3 6.6 5.3 t.6 11.4 2.5 12.4 2.2 6.6 5.6 5.4 4.1 21.6 I.5 39.2

it- IN 2.3 35.9 51.9 31.2 44.6 36.3 35.9 46.5 36.1 56.6 31.1 X.4 63.3 12.4 32.1 4.3

8o- 12 LI 1.1 0.0 4.2 12.5 2. 4.3 2.0 2.0 27.4 11.9 5.2 0.0 1.0 L.4 2.5

la - 156 1.3 6.5 0.6 6.0 23.4 0.S 2.5 L2 46.6 l0.1 6.6 0.4 13.2 1.8 1.3 6.S

1I - In 0.1 0.0 0.6 0.1 0.0 0.4 6.6 L. 0.6 0 0.0 0.1 6.6 1.5 6.0 6.

314 - 2 0.2 0.0 L.I 0.2 6.0 0.1 6.0 0.0 .6 0.0 0.0 1.0 0.0 6.0 0.6 0.I

) 0.4 0.0 0. 0.5 1.2 6.3 0.1 2. 0.6 6.4 0. 0.1 L. 1.. .1 6.0 0

bAwap 111.? 14.3 4.9 99. n 45.4 IU.4 6.4 122.4 133.1 346.3 62.3 U.? I8.5 U.S 4.6 121.0

s twi m iatim 41.s US. 22.4 40.I 71.1 31.6 55.3 1N. 19.8 55.3 56.3 45.1 4U.6 46. 14.4 14.6

UV Ith

O - 25 * 12.4 2. 130.3 .9 3.0 83.4 11.2 2.4 17.4 0.0 38.9 11.4 1.1 3.6 11.0 2.4

2 - 51 34.9 9.1 48.6 13.0 4.0 4.5 19.I 15.3 2.6 1.9 21.5 10.1 1.1 24.2 21.5 1.5

I - is 1 184.4 39.2 14.9 3.5 24.1 13.4 16.2 5.4 1.9 15.6 21.3 I.I 13.9 14.1 2.1

14 - III 1.6 9. 4.3 1.1 4.5 11.3 1.1 13.3 2.2 11.0 5.0 4.4 4.1 28.3 4.4 12.0

101 - U1U IL0 13. 2.5 19.0 19t. 31.6 19.6 11.2 13.3 32.1 4.9 23.3 3. 24.6 ILI 24.0

13t: 1% IM .l 1:1 IM: 2* 1 11:4 IN N IM: 14 9 :1 t:M 1:1 kl 11:1 IN +.IJ - 2 LI 0. 6.6 4.2 9.3 0.5 3.4 2.4 4.2 0.0 4.6 3.3 13.2 0.5 6.9 83.0

) 2M 1.3 0.4 6.0 0.0 23.3 1.? 2.4 3.4 31.1 11.3 6.0 1.1 0.0 .15 1.3 130.4

WIN= Of In-triff lariws rlli

iroibited 3I. 34.2 3.6 24.5 52.2 21.1 11.3 52.5 SL 31.0 I8. 21 24.6 30.1 9.9 43.2

msticto. 1.6 6.9 0.0 L. 4.5 3.4 14.0 5.4 2.9 0.1 1.6 4.2 80.1 1.3 11.6 3.4

mntrictud 45.4 43.0 94.2 45.6 43.4 75.6 1.1 42.1 43.2 4.0 1.2 4.9 41. 5.S ILl 53.1

rw otd no# tisd

SIsal hId Of t rstttiam S CinS My a Sal& ta 4* wctbln 1131Icmtm My * Saln taxl

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exports - are redundant or are ineffective because of smuggling. This isillustrated by the fact that the ad valorem equivalent of export incentivesfor these export categories is less than the current average import duty rateof 94S on textile imports.

3.15 Another notable feature of Pakistan's nominal tariff structure is thesubstantial number of duty free categories and full/partial duty exemptions.There are about 250 duty free categories, consisting of many "essentialgoods", including major itms such as petroleum products, machine tools,agricultural machinery, pharmaceuticals, pesticides, insecticides,fertilizers, some data processing machines, and cereals. At the same time,there are a large number of duty exemptions and concessionary tariff rates. I/The large number of duty free imports and partial/full duty exemptions narrowthe import tax base thus leading to a concentration in the incidence oftariffs, cause discriminations and anomalies in the implementation of thetariff system, induce rent-seeking activities, and encourage uneconomicproduction mix and technologies. With such extensive exemptions, theproportion of actual imports that are subject to tariff duties has rangedbetween 43% and 482 in recent years. (These figures do not take into accountthe massive amounts of consumer goods brought in by Pakistani workers underthe duty free baggage allowance scheme, which is itself very liberal).Consequently, the effective duty rates based on the actual incidence of importlevies are muhn lower that the statutory rates. For example, prior to theFY87 tariff changes, while the economy-wide (unweighted) average tariff was771, the actual duty rate had averaged 48% in the first half of the 1980s. 2/

3.16 Given that imports of many finished consumer goods and competingmachinery are banned, a narrow import tax base as described above implies thatthe main burden of Pakistan's import duties falls on imports of raw materials,intermediates, and capital goods. Nearly 801 of all import duties arecollected from 21 commodity groups that account for less than half of thetotal value of imports. In FY85, 392 of all import duties were collected fromsome 10 categories of industrial raw materials which constituted only 14% oftotal value of imports. Resulting high duty rates on imported inputs andmachinery mean lower effective protection rates for many domestically producedgoods than those intended, especially when combined with competition

1/ While it is difficult to evaluate the importance of these concessions,almost one-third of the latest Customs Tariff book is devoted to tables ofconcessions, listing particular industries, institutions, geographicregions, and domestically produced goods thaL are eligible for thespecified full/partial duty and surcharge concessior.s on imports ofce.tain machinery, parts/components, and intermediate goods. Source: GOP,Central Board of Revenue, Pakistan Customs Tariff and Allied Notificationand Orders, Fourth Edition, October 1986, Islamabad.

2/ The latter is based on calculations that exclude duty free imports; withthe inclusion of duty free imports, the resulting effective average tariffrate would have been even lower; (source: The Trade Regime in Pakistan,Chapter III, Table 3.5).

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from imports coming in through smuggling and baggage allowances. Such areverse escalation of actual tariffs is detrimental to the growth prospects ofpotential export sectors which, because of their small or nonexisting exportactivities, are unable to benefit from export incentives and, therefore,unable to offset the impact of high import duties on their raw material andother intermediate input costs. An active exchange rate policy alone cannotoffset the cost disadvantage of potential export sectors. The poor exportperformance of Pakistan's non-traditional export sectors, such as someengineering industries in the 1980s, despite the change in exchange ratepolicy, attests to this difficulty.

3.17 In addition, the existing full/partial duty exemptions have createdamny cbses of discrimination and anomalies in Pakistan's tariff system. First,in many instances commercial importers are discriminated against in favor ofindustrial importers. Second, there are also cases where public sectoragencies are treated favorably in granting duty exemptions. 1/ Third, in somecases differential tariff rates are levied on imports of the same goodsdepending on their end-uses. Another important aspect of tariffexemptions/concessions is the real resource cost of implementing such acomplex system - including the cost of delays in completing importtransactions, importing concessionary items beyond production needs for thepurpose of resale or stockpiling, and skewing production primarily to becomeeligible for concessionary rates.

3.18 To suimmarize, Pakistan's import regime provides high and extremelyuneven levels of protection afforded to various domestic industries, with manycommodities benefiting from almost absolute protection (subject to the factthat smuggling re'_ricts these levels). Due to exemptions, baggage allowancesand extensive smuggling, some products enjoy lower nominal protection thanthose implied by the statutory tariff rates. This combination of heavyprotection and extensive exemptions and import leakages (formal and informal)has fostelid an inconsistent structure of protection with indeterminate and,perhaps, continuously changing effects on the incentives for industrialinvestmentq. As a result, socially suboptimal production and investmentdecisions in terms of production mix, diversification and plant scale arebeing undertaken while other economic opportunities are foregone. Finally, asa result of the complexity and diverse effects of various elements of theprotective structure, it is very difficult for the Government to determine theeffects of the present import regime and thus administer the protective systemin a way that supports Pakistan's economic objectives.

3.19 The most recent changes in the trade policy, announced in the June1987, introduced some changes on the import side, but these fell short of asignificant reform in the import regime. Furthermore, the encouragement of

1/ For specific examples of discriminations and anomalies caused by dutyexemptions and concessionary tariffs see: The National Taxation ReformCommission, Final Report, December 1986; and The Trade Regime in Pakistan,Chapter III.

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countertrade arrangements has an adverse effect on trade liberalization. TheNew Trade Po'licy of June 29, 1987, which is to be in effect for the next threeyears, removed 136 items (mostly raw materials and intermediate inputs thatare particularly important for export industries) from the Negative andRestricted lists. While this was a positive step, imports of some engineeringgoods (transformers, switch gears, boiler, diesel generators. cranes, pumps,and sugar plants) were banned. These two sets of changes left the proportionof domestic manufacturing value-added protected by NTBs essentiallyunchanged. 1/ Furthermore, the import license fee was raised from 21 to 41 ofthe c.i.f. value of imports, in effect, increasing the landed costs by 2percentage points across-the-board. Except for the duty free status grantedto import of cotton yarn, there were no changes in the customs duty rates.

Export Regime and Anti-Export Bias

3.20 Notable features of Pakistan's export regime are various exportcontrol measures, intended mainly to stabilize domestic prices of "essential"agricultural products and to monitor/affect export prices, and export promotionmeasures aimed at expanding manufactured exports.

3.21 In the 1980s, the adoption of a flexible exchange rate system was byfar the most important measure undertaken to encourage export growth. Inaddition, since the late 19?0s there has been a continuous effort to improvethe effectiveness of some of the existing export incentive schemes - namely,the duty/tax drawback system, compensatory export rebates (which was abolishedin May, 1986), and concessionary export financing. The Government's continuedemphasis on export promotion was also reflected in some positive measuresintroduced with the announcement of the New Trade Policy in June 1987. Theseinclude: (i) the inclusion of 5% import surcharge, 5% Iqra, and 4% importlicense fee under the duty drawback system; (ii) opening of rice and cottonexports to the private sector; (iii) liberalization of imports of some rawmaterials and intermediate inputs of export industries as mentioned earlier;(iv) the establishment of a Special Credit Wing for exporters at the CentralBank; (v) the provision of foreign exchange to promote marketing of goodsabroad, and the authorization to re-export; (vi) linking income tax con-cessions on export earnings to the value-added content of exports; and finally(vii) the introduction of a value-added criterion in the allocation of textileexport quotas in addition to historical performance criteria.

3.22 While exchange rate depreciation helps maintain export competit-iveness, and fiscal and financial incentives are useful in stimulatingexports, they need to be accompanied by deeper reforms of the trade regime inorder to significantly influence the composition of trade. The fundamentalproblem is that Pakistan's export growth prospects are being adverselyaffected by the remaining import-substituting bias of the trade regime.Despite the recent trade reforms, the existence of an anti-export bias isdemonstrated by the quantitative evidence provided in Table III.3, whichpresents estimates of "effective exchange rates (EER)" fcir imports and exports

1/ The Trade Regime in Pakistan, Table A2.9, Annex.

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and their ratios. V/ The latter ratios can be utilized as a summary index ofthe neutrality/non-neutrality of a trade regime. Neutrality is implied if theratio is one; a ratio greater than one implies a bias toward import substi-tution and against export promotion. Results of EER calculations demonstratethe existence of an import substitution bias that appears to have increasedslightly over time. 2/ The reduction in the bias achieved through tariff cutshas been more than offset by the imposition of import surcharges, and theelimination of compensatory rebates in mid-1986. Similar results are obtainedeven when duty exemptions and concessionary tariffs are considered, as shownby ratios obtained using import EERs based on actual import duties collected(EE$2) rather than the statutory rates (EERml). Even though the former setsof ratios are lower compared to those based on statutory rates of duty, theyare still substantially greater than unity and show a tendency to increaseover time.

1/ In the present context, EERs refer to nominal rates adjusted for importtaxes, scarcity premiums, and any export incentives that are in effect.For imports, EERs therefore represent domestic market value of importsworth one unit of foreign currency. Similarly, for exports they representdomestic currency proceeds from exports worth one unit of foreigncu-rency. In the calculations of import EERs, no attempts were made totake scarcity rents attributable to non-tariff barriers into account dueto the unavailability of information on domestic and international pricecomparisons. The U.S. dollar was used as the reference currency in EERcalculations.

2/ Note that domestic sales taxes (levied on ex-factory plus excise taxvalues) offset the protective effect of sales taxes imposed on (cif. pluscustoms duty value of) imports of similar commodities. Therefore, whenEERs for imports and exports are compared, sales taxes levied on importsshould be excluded from the calculation of import EERs. On the otherhand, excise taxes that are levied only on domestic production of certaincommodities tend to reduce the protective effect of tariffs and,therefore, ad valorem equivalents of these taxes should be deducted fromimport taxes in the calculation of EERs for imports. These adjustmentshave not been made when EERs are compared. For this reason the ratios ofEERs for imports and exports presented in Table III.3 overestimate theextent of the anti-export bias. Nonetheless, this overestimation ispartially offset by the fact that "non-competing" imports were alsoincluded in the calculation of import EERs (this was due to the difficultyinvolved in identifying non-competing imports). Since, generally,non-competing imports carry lower tariffs, their inclusion tends to reduceEER estimates for imports. In short, while the ratios of EERs for importsand exports given in Table III.3 tend to overestimate the anti-exportbias, the extent of overestimation cannot be large enough to alter thebasic conclusions reached here.

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Table 111.3: EFFECTIVE EXCHANGE RATES FOR EXPORTS AND IMPORT, AND THEiR RATIO

1980/81 1984/85 1986/874V

1. Nominal exchange rate (Rs/S) - period averages 9.90 1S.1S 17.002. .ERs for Imorts: La

A. All importsa. Based on statutory import levies

(EERml) 19.27 30.25 33.35b. Based on actual import taxes

collected (EERm2) 15.74 25.90 n.a.8. Import EER by Com odity Categories:

a. Consumer gondsEERml 25.74 40.15 40.03EERm2 19.01 27.30 n.a.

b. Raw materials for consumer goodsEERmlEERm2 15.92 30.75 n.a.

c. Raw materials for capital goodsEERmlEERm2 15.25 23.76 n.a.

d. Capital goodsEERml 18.13 28.50 30.60EERm2 14.81 24.09 n.a.

e. Textile productsEERnl 24.95 38.94 38.76EERm2 n.a. n.a. n.a.

3. EERs for Exports: LbA. All Export (EERx) 11.02 17.18 17.92B. Export EERs by conmodity categories Le

a. Raw cotton 8.91 13.64 15.50b. Rice 9.90 15.15 17.00c. Cotton yarn 11.66 16.45 17.19d. Cotton cloth 11.75 17.75 18.22e. Leather products 10.49 16.66 18.69f. Carpets 10.99 18.50 18.63g. Ready made garments 16.25 23.79 25.00

4. EUR Ratios:A. EERml/EERx 1.75 1.76 1.86B. EERm2/EERx 1.43 1.S1 n.a.C. (EERx for manufactured exports/EERx for

primary agr. exports) 1.25 1.27 1.21

A/ Customs duties, sales tax, and surcharges are included in the calculations.Due to unavailability of information on domestic and international prices, noattempt was made to take scarcity premiums resulting from non-tariff barriersinto account.

b/ Duty and tax drawbacks, compensatory rebates (until mid-1986). and the subsidycomponents of concessionary export credited and included in the calculations.

/ Further disaggregation was not possible because of lack of detailed data.4/ July-November period.

SOURCE: Staff estimates

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3.23 The ratios of EERs for manufactured exports relative to primaryagricultural exports (given in the last row of Table III.3) are also greaterthan unity, Lhus demonstrating the existence of a bias against primaryagriculturiA exports. 1/ The receot decline in these ratios simply reflectsthe withdr-wal of compensatory rebates previously afforded to manufacturedexports. 2/

3.24 Both the qualitative and quantitative evidence suggest thatPakistan's trade regime is still biased in favor of import-substitutingproduction. It is true that the apparent comparative advantage in the tradi-tional export items such as rice, cotton, cotton textile, carpets, and leatherproducts has enabled Pakistan to export these products despite the fact thatexport EERs for these categories remained below import EERs. But, thepreceding results also show that to maintain this comparative advantage andencourage the development of a more diversified export base, exporting mustbecome an economically attractive activity in the long-term.

Scope, Timing and Sequencing of a Proposed Trade Policy Reform Program

3.25 Significant trade policy reforms, including the removal of NTBs infavor of tariff protection, elimination of duty concessions/exemptions andexport taxes, and the rationalization of tariffs to provide a more uniform andlower protective structure are needed to achieve a neutral trade regime.Simplification and improved transparency of the system are important aspectsof the reform program. Implementing these reforms will take time. Domesticindustries will need to adjust to changing incentives if major disruptions areto be avoided. Tariff reductions must be coordinated with control of thefiscal deficit, to avoid excessive import growth. In addition, government

1/ It is worth mentioning that primary agricultural exports do not benefitfrom export incentives afforded to manufactured products. This biasagainst agricultural exports is further enhanced by export taxes imposedon export of raw cotton (10% ad valorem), lamb hides and skins (10X), onmolasses (25X). Export taxes are intended for maintaining relativelylower domestic prices for the latter products, thereby encouraging theirfurther processing domestically. For details of other export controls(specifically, export bans, quotas, quality controls, and minimum exportprices), which affect mainly primary exports, see: The Trade Regime inPakistan, Chapter III.

2/ Note that in comparing EERs for manufactured exports and primaryagricultural exports, duty/tax drawbacks should be excluded from theestimates of EERs for the former category. Because these standard rebatessimply compensate exporters of manufactured goods for the import dutiesand other taxes paid, they do not constitute a net subsidy. (Primaryagricultural goods rarely use taxed inputs.) In addition, the subsidycomponent of income tax concessions afforded to manufactured exportsshould be included in calculating EERs for manufactured exports.Estimates presented in Table III.3 do not incorporate these twoadjustments. However, since these adjustments would have affected theestimates of manufactured export EERs in opposite directions, theconclusions implied by the results of Table III.3 would not change.

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revenues rely heavily on trade-related taxes. About half of all tax revenuescome from imports alone. This situation has two major implications for tradereform: first, trade reform cannot be separated from domestic tax refonr;second, as it will take time to develop alternative revenue sources aiud.mplement tax reforms, the short-term agenda for trade reforms must inter aliaaddress the implications for government revenues.

3.26 The two-phased trade reform program outlined below appears practicalfor Pakistan. The first phase would consist of changes that could beimplemented in the short-term, with minimum economic disruption and probablenet additions to tariff revenues. The second phase would proceed gradually,in line with containment of the budget deficit. A pre-announced schedule oftariff reductions, with both rates and the timing specified in advance, woulaenable firms to prepare for the transition.

PHASE ONE: Immediate Trade Reforms (FY89 for most measures)

3.27 (i) Replace existing bana and restrictions with tariff protection(except for those regulations instituted for non-economicobjectives such as health, safety, religious, and nationalsecurity purposes), and also remove the remaining value limitson imports of machinery and millwork;

(ii) abolish surcharges (except for Iqra) and raise the customs dutyon duty-free items to at least 10X;

(iii)lower prohibitively high tariffs (as suggested below);

(iv) maintain the export promotion measures supporting freer accessto imports, and reduce duty exemptions/concessions (with theexception of inputs for export products and the duty-freebaggage allowance, whose scope ought to be gradually reduced);

(v) rationalize the tariff structure to remove various anomalies(including specific duties) and eliminate cases of extremecascading and reverse cascading by the degree of processing inproduction; and

(vi) introduce speciLl excise taxes on consumption of "luxury goods".

3.28 Although the primary intent of this first phase is to move away fromnon-tariff barriers and concessions toward tariff protection, it would alsobe advisable to reduce extremely high tariffs. Leading candidates forsubstantial reduction are tariffs that are so high as to inhibitall"permitted" imports or that divert imports from legal to illegal channels.Maximum tariffs would be about 120X. To curb "luxury consumption," specialexcise taxes on domestic consumption of luxury items (regardless of source ofsupply) could be introduced concurrently with reduction in the high tariffrates. This combination would have the advantage of containing import demandfor such items without, at the same time, stimulating domestic production.At the other end, the 10% surcharge currently levied on all items, exceptbaggage allowances, might be incorporated into the tariff duty system byraising statutory rates accordingly. This approach would effectivelyintroduce a 10% minimum customs duty on what are now dut-free imports.

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Although this would not change the de facto situation, it would simplify andrationalize the system. By the end of the fir-t phase, therefore, the tariffduty range could be narrowed to, say, the 10-120X from the present 10-435%range.

PHASE TWO -- Medium-Term Changes (e.g. beginning in FY90 for about 3 years)

3.29 (M) Lower all tariff rates from a maximum ceiling of,say, 120Xinitially, and gradually reduce these maximum ceilings, insuccessive years, to about 50-60G in 2-3 years; and continue toreduce the tariff band and mean tariff levels and dispersion;

(ii) Complete the phase out of non-export related dutyexemptions/concessions and the differential treatment of imports.

Simulation Results

3.30 Simulation results based on 1985/86 import and tariff data 1/ suggestthat Pakistan could undertake this recommended trade reform program withoutworsening its trade balance or tariff revenues. For the first phase of the

1/ The World Bank's SINTIA-T Program (Software for Industrial Trade andIncentives and Analysis) calculates average rates of protection andhypothetical import revenues based on all elements of the nominal tariffstructure and import values at the 8-10 digit BTN level. For thesimulation exercise each commodity item is assigned a unique ad-valoremstatutory tariff rate, a sales tax of 12.51 or zero, a flat duty of 101,and an import value based on 1985-86 customs data. In addition, each itemis identified according to whether it is on the negative or "free" list,allowing for isolation and modification of the list of banned items.Simulations allow for modification of all or part of the four variables(the flat duty is either included or exc'luded from the broader analysis,but cannot be modified at the commodity level), and permit the analysis ofdiscrete changes on all or part of the customs regime. Average tariffrates are calculated as the unweighted mean of rates within a givensubsector. In addition, the program can calculate the nominal rate ofprotection (NRP) which is defined as the statutory tariff + sales tax +flat duty + tariff * sales tax (all ad valorem rates). Thus, whencalculating total customs duty revenues, SINTIA-T applies this formula tospecific commodity import values and aggregates the results by subsector.In addition, the user can opt between zero and non-zero importelasticities when simulating changes, as well as simultaneous changes indevaluation/reevaluation of the Rupee. Note, however, that SINTIA-TProgram cannot handle endogenously the dynamic expansion of import demanddue to economic growth, because it is a static model.

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program -- the removal of import bans and other restrictions, at least partialelimination of duty exemptions and concessions, and the lowering of hightariffs to 120% imports could be held in check with a modest nominaldevaluation over a three-year period. The revenue effect would be positive.However, further reductions in maximum tariff levels to 50-60X (Phase II)would require export increases and/or a larger devaluation in order to avoidan expansion in the trade deficit. The stimulation results below, it shouldbe noted, are subject to the usual limitations of static analysis, and arereported here for illustrative purposes only.

3.31 Phase I Effect on Imports. The elimination of all duty concessionsand exemptions in the existing tariff code is estimated separately from theremoval of import bans and the lowering of present tariffs, and is included inthe base case. Absence of detailed data on the exact incidence andutilization of duty concessions and exemptions led to this particularformulation of the base case. If the statutory tariff rate were levied on allimports, thereby eliminating all concessions and exemptions, additionalcustoms revenues (over FY86 total revenues of around Rs 32 billion' might bebetween Rs. 3.5-6 billion and Rs 30 billion with imports unchanged. The upperlimit is not likely, since imports are not apt to remain unchanged with asudden, total removal of concessions. If concessions are removed gradually,so as to avoid a negative effect on imports and hence on production costs,then the short-term revenue impact would be substantially less. The lowerlimit is based on a partial tariff increase (equivalent to a 10-15 percentagepoint additional increase) on duty-exempted and concessionary items. 1/ Evenwith the lower limit, the revenue impact of at least partially removing dutyexemptions and concessions on government revenue would be positive, givingsome flexibility to the Government in rationalizing the tariff structure.

3.32 With the removal of bans, the import value could expand by about 11%(Table III.4); this is in comparison to the base case, which already containsthe removal of concessions. This estimate is based on an assumption that theimport demand for banned items would be equal to approximately 101 of domesticvalue of production. 2/ Since banned items cannot be imported now (even

1/ The estimate was calculated in the following way. Since approximately 55%of imports entered duty free in 1985/86 (on the basis of figures given inthe NTRC report) and duty free categories accounted for about 27% of Rs89 billion worth of imports, this means that imports totalling approxi-approximately Rs 25 billion came in under duty exemptions, and part of theremaining imports (Rs 40 billion) benefited from partial duty conses-sions. If the amcunt of imports paying concessionary rates was about Rs10-15 billion, then a 10 percentage point (additional) tariff on dutyexempted and concessionary items might have generated Rs 3.5-4.0 billionadditional revenues (or Rs 5.3-6.0 billion if the tariff rates were to behigher by 15 percentage points).

2/ This figure is used as a benchmark, but was adjusted for sectors where 101of domestic production fell short of current import level of banned items.

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Table 111.4: lmlications For 1wort Exenditre and Cstom Reven(Phse Oai Reorn Withot Dvaluatim: Simulation Relts)

1. Impact on Import Expenditures

Acteal Value of Imports R 69127 million

Impact of Pha One Neusres: Imports(Nlliom Ru)'

I Chmnqe in mortsTariff Range aw Cste ho ans over the as. Case

No cherq 89127 9663 10.92210-1202:Low elasticity cast "417 11.5512High *listicity cse 99"15 11.77%

11. I4pact on Customs Revenus

ACtual Custom Revenues: Rs 31921 million

Impact of Phase One easures: Customs Revenues(tlillion Rs)

X Change in ReveuesTariff Range late Case No Sans over the ase Case

No change 61536 91096 31.79110-1202:Low elasticity case 80507 30.931High elisticity case 90774 31.262

'Exchange rate: Rk i0. 13j2S$1-Pwriod average for 1985/96.

IMPORT ELASTICITY ASSUMPTIONSOLo" High

Elasticity ElasticityScenario Scenrio

Agriculture (ram sat.) -1.00 -1.00lining (ras oat.) -1.00 -1.00Food, Div., Tobacco -0.75 -1.50Textile, Leather -0.75 -1.00Hood, Paper -0.75 -1.00Che., Petrol., Coal Prods. -0.75 -1.50Igmtal Nierals -0.75 -1.00asic NIetal Ind. 0.75 -1.00

tetalt Prods., Nathinery -1.0 -2.00Other mansfacturing -0.75 -1.25t Siulation solutions wre also obtained with iwort elisticity

figures that are waller (in absolute terms) than those listedhere under the lou and high elasticity scnarios. Since the baictonclusions wre similar, reults of other simlations wer notpres"ted in the text.

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though notional tariffs are assigned to them), it is difficult to predict whatimports are likely to be if bans were liftee and notional tariffs charged.The 10 assumption is not unrealistic. The liberalization of banned importswould not necessarily lead to a large expansion in imports, despite theexistence of potential pent-up demand for banned goods. 1/ Indeed, if highimport duties are activated (through the use of either the existing highnotional tariffs or 120S as reco mended) and excise taxes on the consumptionof luxury items are introduced as proposed, then it is unlikely that, afterdebanning, imports of these items would be larger than the benchmarkmagnitudes used in the simulations.

3.33 When debanning is accompanied by the lowering of high tariffs to amaximum ceiling of 120X, the expansion of imports may vary between only 11.61(low elasticity case) and 11.81 (high elasticity case). The latter resultindicates that at rates as h'gh as 1201, tariffs would constitute asignificant import barrier to debanned items. In addition, the simultaneousremoval of tariff concessions/exemptions would in all likelihood lead to afall in imports (though this cannot be included in the simulations), thusoffsetting at least part of the likely expansion in imports following theremoval of bans.

3.34 The effect of removing bans and lowering high tariffs on importlevels will also depend on the extent of nominal devaluation of the rupee.The stimulation results in Table III.5 suggest that the rate of increase ofimports expressed in foreign currency (US dollars) could be contained in thefirst phase of the proposed trade reforms with a devaluation of reasonablemagnitude. The higher the import demand elasticity and the rate ofdevaluation, the smaller (larger) would be the increase (decrease) in demandfor foreign exchange. 2/ A deva-a4icn on the order of 101 (151), if importelasticities are high (low), might t-. sufficient to keep import expenditures(in US dollars) from expanding (i.e., negligible change from the base level)with khase I reforms. Exports are assumed unchanged. To the extent thatexport performance benefits from such a devaluation, the trade balance mightin fact improve in the post-reform period.

3.35 Phase I Impact on Import Duty Revenues. According to simulationresults, the revenue impact of removing import bans could be quite favorable(Table III.4). Compared to the base case, which already incorporates asignificant increase in revenues due to the removal of tariffconcessions/exemptions, import duty revenues could increase by about 321 after

1/ Note also that part of the pent-up demand is already being met by smuggledgoods. Debalning might, at least partially, divert these illegal inflows-together with their own sources of foreign exchange financing-to formalchannels without a substantial jump in actual imports.

2/ If import elasticities are low, imports expressed in rupees are likely toexpand. This is because smaller reductions in the physical volume ofimports would be more than offset by the increases in the rupee price ofimported goods following a devaluation. Whereas, in the case of higherimport elasticities, the stimulation results indicate that a devaluation(ranging from 52 to 202), undertaken with the debanning and lowering ofhigh tariff to 1201, would lead to a lower expansion in imports expressedin rupees. However, for balance of payments purposes, what is reallyimportant is the impact on demand for foreign exchange.

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Table *II.5: Implications For lomort £xpe,diturs. Phase Onh: Sioulation Remults

lort Value

(Nilli R) ( Ibillion US 8) Excham Rato

Base Case 69127 3522 /a B :613YuUUl

A. LCo Elasticity Scenario:I Chao in iports(S)

Systen (hillion Rus) (illion US *) over the lase Cm…~~ ------------------ …

A. I r Bans and12Ze Nas. TariffRate:

No Devaluation 99417 6160 11.555l Devaluation 100784 5947 7.7010 Devaluation 101484 5716 3.50152 Devaluation 101961 5495 -0.50

B. High Elasticity Scenario:2 Change in loports(S)

System (Million Rs) (Million US 8) over the Dasn Case

9.1 No Bans and1201 Max. TariffRate:

No Devaluation 99615 6172 11.775; ODvaluation 96684 5823 5.4510 levaluatiom 97208 5476 -0.83152 Devaluation 95170 5129 -7.14

* Period average for 1965/1U6.a: This import filyre i US idolars was derived by applying th period averag eschage rate

IRS 1h 139i0961) for 1I15/66 to the rupee value of imports. The latter is from te detailedcustoms data providW by the Karacki Custom n oust, which accounts for 90-952 of Pakistan'simports. This is ooe of the reasOns why the dollar import figure used here (i.e., USS 5522cillion) is less thau the actual total imports reported by the Fdral Bureau of Statisticsli.e., US 35941 for 1965/66. It is also possible that some isports in 1965/6 were actuallysubjKet to a higwer exchage rate than the period average used in the calculations. Thiswoud also explain part of the discrepancy between the to import figur exprnsse inUS dollars.

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the liberalization of banned items and by 31X if, in addition, very hightariff rates are lowered to a maximum rate of 1202. Although the extent ofimport penetration after removal of bans was assumed, removing bans is likelyto have a significant positive impact on government revenues. If some illegaltrade is diverted to legal channels as import bans are lifted and prohibi-tively high tariffs are lowered, import duty revenues also would increase.

3.36 Phase II Impact on Imports and Revenues. Phase II simulations aresummarized in Table III.6. Significant reductions in the maximum tariff ratebelow 1001 could cause substantial pressure on imports and, therefore, thetrade balance unless coupled with the export stimulus of the first phase ofthe trade liberalization program, fiscal deficit reduction, and an activeexchange rate policy. The simulation results in Table III.6 illustrate thedevsluation which might be needed if imports were not allowed to grow. Theyshow that neutralizing the impact on imports (expressed in US dollars) fromlifting bans and lowering maximum tariffs to 1002 might require nominaldevaluation on the order of 102 (151), dep ding on the import elasticity.Devaluation of perhaps 201 (251) is apt to be needed to reduce maximum tariffsto 601, while leaving imports in US dollars unchanged. The impact on customsrevenues of lowering tariffs is likely to be negative. However, customsrevenues would not necessarily fall below the level of the base case, even iftariff levels were reduced to 601 and if devaluation is within the above range.

3.37 Sunmary. Table III.7 summarizes the probable effect on imports andon customs revenues of both phases of the recommended trade policy reformprogram. As rnoted earlier, the simi.lations have solely an illustrativefunction. They show that the remoial of import bans and dutyconcessions/exemptions could havez a significant positive impact on import dutyrevenues without creating much pressure on the trade balance. Moreover,although tariff revenues are positively related to tariff levels, ceterisparibus, a drop in tariff levels is likely to be at least revenue-neutral, fora maximum tariff as low as 601 and accompanying nominal devaluations in therange of 10-251.

3.38 Reductions in the tariff range would need to be accompanied bydevaluations in order to keep the expansion of import demand for foreignexchange in line with growth in export earnings. This static analysisprovided an upper bound to the devaluation estimates, since exports areassumed to remain constant as the rupee depreciates. For the first phase,10-151 nominal .evaluations over a three-year period might be sufficient.This magnitude is not out of line with the rate of depreciation undertaken inthe 1980s, when the actual nominal rate of depreciation of the rupee againstthe US dollar fluctuated between 41 and 301, for an annual average rate of121. Reducing the tariff structure to a maximum 601 tariff rate, however, inthe second phase might require larger currency adjustments. In thelow-elasticity case - the more difficult case -- nominal devaluations on theorder of 20-251 might be needed to keep the trade balance constant if exportsdo not increase. Consequently, tariff reductions in the second phase wouldhave to be done gradually - over, say, a three-year period - to allow enoughexport growth and diversification to permit imports to grow without upsettingthe trade balance.

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Table 111.6 : Implications for lport Expenditurns n han Tuog Simulation lneults

Isport Yalue

(lillion Rs) (lNillion US S1 Exchange RNto

Bisa Case 89127 5522 Rs 16.1395*- 1

A. Los Elasticity Sc"rio:I Champ in lmportsIS)

System (pillion RA) (Nlliain US S) over the hite Case._.__....... .. --- -- -- - - --. - ._. ----- _--_...-. __ _ ..............._

A. I No kas and100I Nax. TariffRate:

No Devaluation 100398 6221 12.6651 Devaluation 101850 6010 8.84101 Dnvaluation 102641 5782 4.7115Z Devaluation 103231 5562 0.72201 Devaluation 103467 5342 -3.26251 Devaluation 103348 5123 -7.23

A.2 No Dans and60a lax. TariffRate:

No Devaluation 107539 6663 20.6652 Devaluation 109600 6468 17.13102 Devaluation 111045 6255 13.27152 Devaluation 112304 6051 9.56202 Devaluation 113233 5847 5.09252 Devaluation 113833 5643 2.19

B. High Elasticity Scenario:2 Change in lsports(SI

Systee (Million Rs) (Million US $V over the Base Case

6.1 No Bas and1002 Rax. TariffRate:

No Devaluation 100972 6256 13.2952 Devaluation 100218 5914 7.10102 Devaluation 96673 5569 0.8515Z hDvaluation 96971 5224 -5.40201 Devaluation 94513 4680 -11.63252 Devaluation 91499 4535 -11.87

0.2 No has and602 Nax. TariffRate:

No Devaluation 110960 6075 24.505Z Devaluation 111702 6592 19.38102 Devaluation 111310 6270 13.54151 Devaluation 110399 5948 7.71202 Devaluation 109969 5626 1.86252 Devluation 107020 5305 -3.93

* Period av rage for 1965/66.

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TUble 111.7 : 5w Y Tarit lplicitims For ltort EsUflitur and Custoe e"vnuvesSlulatio Rsults

A. LON ELASTICITY SCINMII:

lowt t Cuituoo Rev"iws...... ......... _ _.... ...... ........... --------------- __-_-

Ow rthe Over th(Nillion USV Ws aCase Mfillion h h am Cm

kwse Case 5522 61536

PASE ONE

iA.1 No 6kns andj 1202 fx. Tariff rate: 6160 11.55 60507 30.13

and:10D hvaluation 5716 3.50 82240 33.65152 Devaluation 5495 -0.50 82676 34.35202 Devaluation 5273 -4.51 82825 34.60252 h valuation 5051 -8.53 82667 34.37

PHASE TOO

A.2 No Bans and1002 Wax. Tariff rates 6221 12.66 79622 29.39

and:101 Devaluation 5781 4.71 81493 32.43152 Devaluation 5562 0.72 02014 33.21201 Devaluation 5342 -3.26 82258 33.67252 Devaluation 5123 -7.23 82225 33.62

A.3 No Bans and602 Nix. Tariff rates 6b63 20.66 71617 16.38

and:102 Devaluation 6255 13.27 74123 20.45152 Devaluation 6051 9.51 75059 21.90201 kvaluatios 5847 5.89 75784 23.15252 valuatio 5643 2.19 76296 23.99

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Table Ili. 7: ICotinuve

3. HIGH ELASTICITY SCE"!10O

lwts Custo n evu ns

2 Cbae 2 ChaeeOver the Ovrr the

(Hilimon US s* !au Caste (illion Re) Sale Case

law Case 5522 41534

3.1 No ans and1201 Max. Tariff rate3 6172 11.77 80174 31.26and:

101 Devaluation 5476 -0.83 79078 29.5115 Devaluation 5128 -7.14 77557 26.04201 Devaluation 4U20 -12.57 75592 22.B425l kevaluation 4432 -19.74 73182 19.93

PHASE TWO

9.2 No Bans and1002 Max. Tariff rate: 6256 13.29 00225 30.37

and:102 Devaluation 5569 0.a5 76854 28.15152 Devaluation 5224 -5.40 77501 25.94202 Devaluation 4080 -11.63 75717 23.05252 Devaluation 4535 -17.87 73502 19.45

9.2 o Bans and602 Max. Tariff ratet 6875 24.50 74126 20.46and:102 Devaluation 6210 13.54 74713 21.41152 kDvaluatia. 5948 7.71 74280 20.71202 kevaluation 5626 I.88 73513 19.46252 Devaluatioa 5305 -3.93 72413 17.69

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B. INDUSTRIAL REGULATORY POLICIES

Purpose and Consequences of Regulation

3.39 In Pakistan, as in other countries pursuing an import-substitutingindustrialization strategy, interventionist regulatory policies have playedan important role in the allocation of resources within and among indus-tries. While credit/interest controls have been used to mobilize financialresources toward priority sectors, the investment sanctioning mechanism hascomplemented/supported the protectionist trade regime in directing realresources into priority areas. It also was meant to create some degree ofcompetition in domestic markets since non-tariff barriers (NTBs) andprohibitively high tariffs more or less eliminated foreign competition.

3.40 More generally, investment sanctioning, price controls, and otherpolicies sought, through regulation, to foster efficient industrial devel-opment without the possible adverse developments of a free market system inthe presence of trade distortions:

(i) investment sanctioning, besides encouraging investment inpriority areas, was designed to prevent both excessive marketentry as well as excessive concentration of ownership. It alsoserved as an instrument in controlling the demand for foreignexchange;

(ii) cost-plus pricing served the objectives of guaranteeing anestablished rate of return to investors, ensuring the survivalof incumbent firms, and restraining the exercise of monopolypower;

(iii) restrictions on firm closure and measures to provide financialassistance to sick industries were aimed at preventing capacityfrom sitting idle;

(iv) avoidance of labor unrest is an important objective of laborregulations and other restrictions on exit; and

(v) location restrictions and incentives are used to ration scarceinfrastructure such as water and electricity and to promotedispersal of new investments.

3.41 When several interrelated policies, such as a highly protectionistimport regime and domestic regulatory and financial policies, affectindustrial activity, it becomes difficult to identify the impact of eachpolicy on the performance of manufacturing industries. Empirical evidence ispartial, difficult to obtain, and often conflicting. However, a recentassessment by the World Bank 1/ suggests that the industrial regulatorypolicies were not effective.

1/ For a detailed coverage of Pakistan's industrial regulatory policies,their impact on industrial efficiency, growth, competition, and anassessment of recent changes in the regulatory policies, see: World Bank,Pakistan: Industrial Regulatory Policies, January 1988. The followingsubsections draw heavily on the findings of this report.

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3.42 Sanctioning rules limiting access to imported machinery and rawmaterials led to several inefficient outcomes. Fir.. in some industriesexperienced excessive entry behind high trade barriers into a small domesticmarket. This is the case of the Automobile industry, where a proliferation ofmodels entails uneconomically short production runs. In polyester fiber andyarn, high trade barriers have led to excessive vertical integration intopolymerization, where Pakistan's liwited domestic market does not allow costminimizing production scales.

3.43 Atteopcs to prevent excess capacity have met with little uccess.First, statistics on existing industry capacity are notoriously unlreliable.Out of 14,000 registered enterprises, as many as 7,000 may no longer exist infact. Second, although forecasts of investment requirements under theindustrial investment schedule of the five-year plan have often been highlyinaccurate, they at times have been used to restrict new investment. This hascaused capacity to lag behind demand in cotton spinning and in polyester.

; Third, in industries such as ghee where equipment and inputs can be obtainedlocally, capacity has expanded outside the official system while sanctionedfirms have been constrained from expanding in order to lower unit costs.

3.44 Efforts to restructure or close firms are hampered by bankregulations and practices limiting write-offs and loan loss provisions.Consequently, physical assets which are still valuable cannot be sold to beused again but sit idle. In some cases loss-making firms continue to besupported by bank credit, which limits the finance available to new or growinginvestments while arrears accumulate in declining firms. Productiveredeployment of workers is inhibited by pressures to maintain loss-makingfirms instead of closing them and financing retraining schemes for workers.

3.45 Sanctioning has somewhat limited concentration of ownership at thecost of inefficiently small firm sizes in some industries, such as polyester.In addition, concentration has been controlled in cases where competitivepressures to discipline potential monopoly behavior exist. Although polyesterfiber and yarn production is dominated by a few firms, they face substantialcompetition from legal and illegal imports, as well as domestic cotton andother synthetic fiber substitutes. Furthermore, sanctioning limitsconcentration by controlling market shares, which is the most difficult taskfor any potential oligopoly to coordinate. Sanctioning thus actuallyfacilitates oligopolistic coordination among firms and forestalls aggressiveefforts to compete for shares. Import competition or export rivalry wouldprovide a more effective check on market power in industries where minimumefficient scale is large relative to the domestic market.

3.46 In some industries, price controls historically have reduced theextent of direct price competition, minimized incentives for cost reduction,and induced black market activities. The price of vegetable ghee in Pakistanhas been maintained (until recently by GOP directly) well below internationalprices. Both ghee and edible oils are smuggled into Afghanistan and India,where domestic price levels are higher. Price controls on products in highlyoligopolistic industries such as cement and fertilizer eliminated the need toengage in collusive pricing behavior, and it is not clear that government-setprices were successful in eliminating monopoly profits in these industries.At the same time, price controls precluded price competition. At the

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individual plant level in fertilizer and cement, for instance, taxes andsubsidies kept retail prices fixed while maintaining set profit marginsthrough differences in ex-factory prices. In 1984-85 the ex-factory cost ofurea ranged from Rs 1,746 to Rs 3,320 per ton while the same retail price wasmaintained through taxes/subsidies, disallowing price competition by the lowcost producers. In the cement industry, shortages in the 1970s and early1980s, caused by sanctioning constraints and price controls, led to a blackmarket within the economy.

Recent Changes in Regulatory Policies

3.47 Parallel with the attempts to liberalize the trade regime, since theearly 1980s the Government has been taking decisive steps to eliminate some ofthe industrial problems caused by regulatory policies. Indeed, thederegulation process gained momentum following the announcement of the 1984Industrial Policy Statement, and a more systematic approach to deregulationwas adopted with the formation of a Deregulation Commission in 1985. Effortshave emphasized relaxation of investment sanctioning regulations and pricedecontrols.

3.48 Investment Sanctioning. Investment sanctioning (licensing) policiesconsist of criteria that require private investors to obtain clearance fromfederal and provincial governments prior to establishing certain new projectsor expanding existing capacity. The need for prior authorization and thelevel at which it is decided depend on the project's size, location and theamount of machinery and raw materials to be imported. The decision to issuethe sanction may be taken at the level of one of four development financecorporations (DFCs), the Central Investment Promotion Committee (CIPC), theMinistry of Industries or the Economic Coordination Committee (ECC) of theCabinet, depending on the size and characteristics of the proposed project.The sanction letter is issued either by a DFC or by the Investment PromotionBoard (IPB), acting on behalf of the CIPC (an inter-ministerial body that inturn acts for the Ministry of Industries or the ECC).

3.49 An investment sanction is required for projects that: (i) involveinvestment costs in excess of a pre-determined size limit (Rs 500 million, or$29 million); or (ii) require imported inputs which exceed 60% of theproject's total annual material input costs, if they also exceed 20% of fixedassets; or (iii) involve direct foreign investment; or (iv) are on the list ofSpecified Industries. Each of these constitutes a reason for requiring aninvestment sanction. The list of Specified Industries includes industries forreasons of: (i) national security and defense; (ii) religious andsocio-economic considerations; (iii) price regulation; (iv) indigenizationrequirements; (v) projects of national importance; and (vi) capacityutilization.

3.50 In addition, as described in the preceding section on the traderegime, there are also import license value limits on cash imports ofmachinery and millwork. Imports of industrial inputs in large quantities maybe approved on the basis of sanctioned capacity. Thus, the Chief Controllerof Imports and Exports (CCIE) can issue import licenses to firms withoutinvestment sanctions only when small amounts are involved, on the basis ofpassbooks issued by provincial authorities. Beyond specified limits, theamount of machinery and annual raw material imports for which CCIE can

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issue licenses is specified in the investment sanction. 1/ Firms which dependon imported raw materials or equipment financed out of retained earnings faceimport license value limits. To this extent, investment sanctions implicitlyset quantitative restrictions on capital and raw material imports, thusserving as a non-price rationing mechanism for allocating foreign exchange.

3.51 Since the late 1970s, investment sanctioning has been liberalized inseveral important ways. The criteria for projects requiring governmentapproval through the sanctioning process have been eased gradually raising thesize limit for projects requiring a sanction from Rs 5 million in 1979, to Rs300 million in 1984, and to Rs 500 million in 1987. The number of industrieson the Specified Industries list, for which a sanction is required regardlessof project size, also has been reduced. Until 1987, the Specified Listconsisted of twenty-three industries. In 1987 most of them were removed:defense-oriented electronics, basic steel, basic metals and alloys, heavymechanical and heavy electrical plants, basic chemicals, petro-chemicals,public utilities, ships, aircrafts and railway locomotives, fertilizers,cement, sugar, and cotton spinning. Thus, whereas prior to 1987, subsectorson the Specified List accounted for 40X of total industrial output (based on1980/81 Census of Manufacturing Industries data), those remaining after the1987 liberalization (see para. 3.66) account for 71 only. It should be noted,however, that large-scale industries such as fertilizer and cement effectivelystill require a sanction under the size criterion, as most projects exceed theRs 500 million (about $29 million at the June 1987 exchange rate) size limit.

3.52 Liberalization of sanctioning requirements and raising of importlicense value limits on imports of machinery have certainly contributed to theimproved general investment climate in Pakistan. Real investment inmanufacturing grew at 61 p.a. between 1982 and 1987. During the period1983-86, a total of 1,236 new sanctions, with a value of Rs 48,805 millionwere approved. The value of investment sanctioned annually increased almost1401 in real terms between FY78 and FY86.

3.53 Based on this experience, not only is further deregulation likely tobe beneficial, it also would provide a clear signal to the private sector thatold practices of government interference in investment decisions are notlikely to be revived. To this effect the size limit could be completelyabolished and the specified list further reduced (see paragraph 3.64).Furthermore, as part of the overall trade policy reform,remaining importrelated sanctioning requirements could be phased out. Government involvementwould thus shift from direct interference in investment decisions to settingof indirect policies and reporting requirements would replace sanctioningprocedures.

1/ Currently, prior approval from an investment sanctioning authority isneeded to obtain import licenses for: (i) machinery imports not financedby credits from development finance institutions which exceed Rs 50million ($2.9 million) for new and expansion projects, or exceeding Rs 10million ($0.6 million) for balancing, modernization and rehabilitation -this limit ranges between Rs 5 million and Rs 50 million for the textileindustry; (ii) imports of second-hand machinery, except if financedthrough a non-repatriable investment; and (iii) annual material inputswhich exceed 60X of the project's total material input costs, if they alsoexceed 201 of fixed assets.

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3.54 Pricing Policies. Historically, the Government has controlled pricesof manufactured goods in order to: (i) redistribute income and minimizepolitical disruption by keeping prices of critical consumer goods low andstable (ghee, pharmaceuticals); (ii) stimulate downstream industries bykeeping down prices of intermediate products (fertilizer, fuel); and (iii)stimulate investment by ensuring an adequate return (cement). Ex-factory andretail prices for a wide range of products have been regulated through acombination of informal guidelines and official procedures at both theprovincial and the federal levels. In the 1970s, ex-factory prices ofselected industrial products were set, either directly or by adding sufficientmargins to costs to allow a 15X to 20% return on equity for a plant operatingat a specified capacity utilization level.

3.55 The Government, however, has recognized that price controls candiscourage production, and that cost-plus pricing discourages cost reduction.In the 1984 Industrial Policy Statement, the Government declared its intentionto move from cost-plus pricing to pricing based on supply and demand forces.Most products are now free from price controls.

3.56 Price controls on cement after the industry was nationalized in 1972resulted in shortages relative to increased demand. In 1978, the Governmentlifted the ban on private investment and introduced a guaranteed 151 to 20%return on equity. The target rate was applied plant-by-plant on the basis offixed and variable costs at 90% capacity utilization. A variable developmentsurcharge was added (or subsidy subtracted) to yield a uniform ex-factoryprice. Freight charges also were subsidized to distant locations to equalizeretail prices. In 1985, price controls were abandoned for the privatesector.

3.57 Prior to 1986 t-he return on equity, and ex-factory and retail pricesfor nitrogenous fertilizer plants were fixed by the Economic CoordinationCommittee, in consultation with appropriate ministries. As in cement, uniformretail prices for fertilizer were set while ex-factory prices were determinedby applying return-on-equity formulae to individual plants. When producers'costs plus agreed profits exceeded retail prices, GOP provided a developmentsubsidy; plants with costs plus agreed profits falling below the retail pricewere required to pay a development surcharge. Marketing expenses also werefixed for each factory separately. In May 1986, ex-factory and retail priceswere decontrolled for nitrogenous fertilizers (but not for phosphatic andpotassic fertilizers). Nevertheless, informal pressures have been createdthrough a policy of recommended prices.

3.58 Until April 1986, short-term stability in domestic ghee prices wasmaintained by controls on both edible oil imports and local cottonseed oil,which the Ghee Corporation of Pakistan (GCP) purchased and distributed at setprices. To stabilize the domestic price of imported edible oil (the maininput for ghee), a variable customs duty was levied on its imports. SinceApril 1986 private ghee producers have been free to import edible oil and toset prices.

3.59 The Government continues to control prices of refinery products,motor vehicles, drugs, pharmaceuticals and bicycles. Vehicle prices arehowever, liberalized de facto because official price ceilings are set higherthan the market will bear. Although formal price controls on bicycles were

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lifted in July 1979, prices continue to be regulated informally by theprovincial Minister of Industries who must be consulted if a producer wants toraise prices.

Recoimendations

3.60 Reducing unnecessary regulation of the domestic economy is anessential complement to the trade policy reforms for developing anexport-oriented production structure in line with the country's comparativeadvantage. An equally important point to remember is that, as Pakistan shiftstoward more neutral trade policies, the rationale for investment sanctioningand price controls (except in the traditional areas of price intervention -i.e., agriculture, and natural monopolies) would also disappear.

3.61 With the deregulation of the 1980s, only a few regulatory policiesremain impediments to investment--e.g., import restrictions and infrastructureclearances. The following changes should be undertaken simultaneously withthose of the first phase of the trade policy reform program.

3.62 Import Restrictions. As discussed above, under a program of tradeliberalization, the removal of the remaining import license value limits onmachinery imports and rer-val of the investment sanctioning requirement inthose cases where imported raw material inputs exceed 60Z of total inputs usedare essential initial steps for further effective deregulation of investmentactivity in Pakistan.

3.63 Sanctievinir. Following the removal of all quantitative restrictionson imports of machin.iy, millwork and raw materials, it is recommended thatall sanctioning requirements based on project size (presently Rs 500 million)be abolished. Although the current restrictions are not particularly onerous,they 4- not appear to be necessary, either. Investment sanctions in the pastrarely contributed to the stated aims of controlling market power orpreventing excess capacity, nor did they effectively direct resources intopriority areas.

3.64 A further reduction of the "Specified List" of industries requiringsanctions for projects regardless of size would also be desirable. Today onlya few sectors remain on the specified list: industries of special concern fornational security and defense; those regulated for religious and socialreasons (alcoholic beverages); industries subject to indigenization programs(e.g., electrical appliances, cars, etc.); vegetable ghee, and drugs andpharmaceuticals. Industries subject to indigenization rules and vegetableghee should be taken off the list. A proper mix cf trade policy, domesticcompetition, excise taxation and restructuring programs is more likelv toimprove performance of these industries. Drugs and pharmaceuticals wtiich alsocontinue to be subject to price controls could simply be subjected to domestichealth and safety standards. However, in view of important health and safetyissues involved, a review of the feasibility of such a policy should beinitiated first.

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3.65 Price Decontrols. Government's efforts to move toward a market-basedsystem of price determination should continue. Some areas formally deregu-lated are still effectively controlled through indirect means; effectivederegulation in these areas, e.g., fertilizers, is still needed. At the sametime, regulated prices for the natural monopoly industries which producenontradables (e.g., utilities) would remain. These should reflect theeconomic cost of supplying such goods/services.

3.66 Location Clearances. Depending on the location and nature of theproposed investment, clearance from the provincial government must be acquiredbefore an investment sanction will be issued or even considered. Provinciallocation policies have two main objectives: to ration scarce urbaninfrastructure, and to promote regional equity by dispersing industrialproduction. Provincial location clearances for investment projects wouldcontinue to be needed in the short-term to ration scarce infrastructure(water, gas, sewerage, electricity). However, the Government should movestill further towards rationing infrastructure services by price, i.e., bycharging prices that reflect economic costs of supplying such services. Inthis way the Government would allocate services to the most economic projects;provide a source of funds for more speedy removal of infrastructurebottlenecks; and tap a new domestic source of revenue at a time whenadditional sources are needed to improve the budget. Environmental concernscould be addressed by charging special taxes or surcharges reflecting the costof pollution or other damage to the community, as well as by zoningregulations. Evidence from other countries shows that high prices whichreflect the true opportunity costs of space and infrastructure services inurban centers are more important than location policies in pushing out firms(those that use space and high cost urban infrastructure services intensively)away from crowded urban areas. 1/

1/ Kyu Sik Lee, "Employment Location in the Developing Metropolis: AnEmpirical Study of Bogota and Cali, Colombia", The World Bank, February1987; Kyu Sik Lee, "Evaluation of Industrial Location Policies for UrbanDeconcentration, Phases I and II", The World Bank, RPO 672-58/91 , 1987.

- 93 -Appendix to Chapter III

Table Al. impact on import Expenditure and Customs Revenues: Simulation Results(Million Rupeea)

Low Elasticity Scenario

lrt Valum I_ot Duty enue......... ............... ....... ............ . ..............................................

Tariff 5S a c 5X b cscnario No *nw DOm1. X Chane X Chan No Mmn Deval. X Chn Change

No Change 96,862.5 100,t10.6 1.3 1.3 81,096.0 62,179.7 1.3 1.310-120 99,416.8 100,7t3.8 1.9 1.4 60,506.8 81,640.7 0.7 1.410-100 100,397.9 101,849.8 3.0 1.4 79,621.5 60,61S.8 *0.3 1.510-80 102,533.1 104,166.7 5.4 1.6 77,425.5 78,721.0 -2.9 1.710-60 107,S38.5 109,600.2 10.9 1.9 71,616.7 73,072.2 -9.9 2.010-50 110,287.7 112,583.3 13.9 2.1 67,833.9 69,327.3 -14.5 2.2

IWort Vatue Iqrt Duty Revenue.... .... ............................. ....... ..................................................... ..... ..--------

Tariff 10X a c 10X b cSconario No Sans Devat. X Change X Change No Sens Devat. X Change X Change

No Change 96,862.5 100,29.9 2.0 2.0 81,096.0 82,719.4 2.0 2.010-120 99,416.8 101,484.0 2.7 2.1 80,506.8 82,240.2 1.4 2.210-100 100,397.9 102,641.0 3.8 2.2 79,621.5 81,493.4 0.5 2.410-80 102,533.1 105,151.8 6.4 2.6 77,425.5 79,533.5 -1.9 2.710-60 107,538.5 111,044.7 12.3 3.3 71,616.7 74,123.3 -8.6 3.510-50 110,287.7 114,279.3 15.6 3.6 67,833.9 70,457.4 -13.1 3.9

lport Value Import Duty Revenue

Tariff IS a c 15X b cScenario No San Deval. X Chan X Change No Sans Devat. X Change X Chnge

No Chnge 98,862.5 101,273.6 2.4 2.4 81,096.0 83,068.8 2.5 2.510-120 99,416.8 101,980.7 3.2 2.6 60,506.8 82,676.1 1.9 2.710-100 100,397.9 103,231.0 4.4 2.8 79,621.5 82,014.1 1.1 3.010-80 102,S33.1 105,940.6 7.2 3.3 77,425.5 80,203.3 -1.1 3.610-60 107,538.5 112,303.6 13.6 4.4 71,616.7 75,059.3 -7.4 4.810-50 110,287.7 11S,795.3 17.1 S.0 67,833.9 71,485.5 -11.9 5.4

Iport Value Import Duty Revenue

Tariff 20X a c 20X b cScenario No mns Devl. X Chane Chone No Sans naval. X Chnge X Change

No Change 96,862.5 101,3S7.5 2.5 2.5 81,096.0 83,163.4 2.5 2.510-120 99,416.8 102,119.5 3.3 2.7 80,506.8 82,824.9 2.1 2.910-100 100,397.9 103,466.7 4.7 3.1 79,621.5 82,257.9 1.4 3.310-60 102,S33.1 106,382.4 7.6 3.8 77,425.5 80,617.0 -0.6 4.110-60 107,S38.5 113,233.1 14.S 5.3 71,616.7 73,7M3.7 -6.6 5.810-50 110,287.7 116,991.5 18.3 6.1 67,833.9 72,324.6 -10.8 6.6

a. % change in compar4son to Rs 98,862.5 million worth of imports.b. X change in comparison to Rs 81,096 million import duty revenues.c. X change from simulation magnitudes corre4ponding to the same tariff scenarios

but without any devaluation.

- 94. -

Appendix to Chapter 111

Table Al (Continued)

I_at Vetu Iort Duty e*vmn

Tariff 252 25XSenrio no km bowl. X Cher.$ X chag No so" Dewt. char" 2 ChowgeNo OWChs 96,062.5 101,001.3 2.2 2.2 81,096.0 82,943.2 2.3 2.310-120 99,416.8 101,900.4 3.1 2.5 80,s0.8 182,636.5 2.0 2.710-100 100,397.9 103,347.9 4.5 2.9 79,621.5 82,225.0 1.4 3.310-80 102,533.1 106,477.2 7.7 3.8 77,625.5 80.774.7 -0.4 4.310-60 10?,538.5 113,M.2 15.1 5.9 71,616.7 76,296.4 -5.9 6.510-so 110,257.7 117,067.7 19.2 6.9 67,033.9 72,974.5 -10.0 7.6

- 95 -Appendix to Chapter III

'fable A2. ~pact on Import Expenditures and Customs Revenues: Simulation Results(Millton Rupees)

High Elasticity Scenario

lport Vclur Import Duty eovenue,,,,.......................... ............................. .................

Tariff 5X a c 5X b cScenario No Sano Ovel. X Chaor X Chng N Wo S Deval. X Ch,~ X ChOnm

wo Ch"ge 96,62.5 97,37.4 -1.0 *1.0 81,096.0 80,360.9 -0.9 -0.910-120 99,615.3 96,683.8 -0.2 -0.9 80,774.4 60,153.3 -1.2 -0.810*100 100,972.4 100,218.1 1.4 -0.7 80.224.? 79,781.6 -1.6 -0.610-60 103,956.4 103,663.8 4.8 -0.3 78,716.0 78,660.2 -3.0 -0.110-60 l1O,959.7 111,701.9 13.0 0.7 74,126.1 74,813.8 -7.7 0.910-50 114,828.7 116,174.5 17.5 1.2 70,831.2 71,835.2 -11.4 1.4

tIort Value Import Duty Revn............................................ ..............................................

Tariff lOX a c lOX b cScenario No Sans DOvt. X Change Change No Bums DbYvI. S Change X Change

No Chane 96,862.5 96,348.7 -2.5 -2.5 81,096.0 79,211.6 -2.3 -2.310-120 99,615.3 97,207.6 -1.7 -2.4 80,774.4 79,077.5 -2.5 -2.110-100 100,972.4 96,872.6 0.0 -2.1 80,224.7 78,656.1 -2.8 -1.710-60 103,956.4 102,580.0 3.8 -1.3 78,716.0 78,014.0 -3.8 -0.910-60 110,959.7 111,310.1 12.6 0.3 74,126.1 74,713.2 -7.9 0.810-50 114,82b.7 116,153.4 17.5 1.2 70,831.2 71,963.2 -11.3 1.6

Import Value loport Duty Revenue............................................ ........................................................................ .......................

Tarff tSX a c is% b cScenario No Sans Deval. X Change X Change No Sons bevel. X Change X Change

No Change 98,862.S 94,246.4 -4.7 -4.7 81,096.0 77,587.9 -4.3 -4.310-120 99,615.3 95,170.0 -3.7 -4.5 80,774.4 77,557.0 -4.4 -4.010-100 100,972.4 96,970.9 -1.9 -4.0 80,224.7 77,501.0 -4.4 -3.410-80 103,956.4 100,970.8 2.1 -2.9 78,716.0 76,968.6 -5.1 -2.210-60 110f959.7 110,399.2 11.7 -0.5 74,126.1 74,279.6 -8.4 0.210-50 114,828.7 115,627.4 17.0 0.7 70,831.2 71,791.8 -11.5 1.4

Import WIu lport Duty Revee.............................. ................................................................ ..............................................

Tariff 20X a c 20% b cScenario No kmn. Oaval. X Change Chang No Sans Oevel. X Change X Change

No Change 96,862.5 91,580.5 -7.4 -7.4 81,096.0 75,510.0 -6.9 -6.910-120 99,615.3 92,571.0 -6.4 -7.1 80,774.4 75,591.7 -6.8 -6.410-100 100,972.4 94,513.1 -4.4 -6.4 60,224.7 75,716.5 -6.6 -5.610-80 103,956.4 96,816.2 0.0 -4.9 78,716.0 75,523.9 -6.9 -4.110-60 110,959.7 106,969.0 10.2 -1.8 74,126.1 73,512.9 -9.4 -0.810-50 114,828.7 114,S96.6 15.9 -0.2 70,831.2 71,321.0 -12.1 0.7

a. 2 change in comparison to Rs 98,862.5 million worth of imports.b. 2 change in comparison to Rs 81,096 million import duty revenues.c. 2 change from simulation magnitudes corresponding to the same tariff scenarios

but without any devaluation.

- 96 -

Appendix to Chapter III

Table A2. (Continued)

iqX_t value luport DuMY evenue

Tariff 25X 252Scenario law Del. lChae 2 an No Ia cev&i. 2 Cu. X Chanes

No Change 96,862.5 . .350.9 -10.6 -10.6 $1,096.0 72,977.8 -10.0 -10.010-120 99,615.3 09,410.6 -9.6 -10.2 60,774.4 73,161.? -9.6 -9.410-100 100,972.4 91,499.1 -7.4 -9.4 80.224.7 73,502.4 -9.4 -8.410-60 103,956.4 9W,116.2 -2.8 -7.5 78,716.0 73,679.9 -9.1 -6.410-60 110,959.7 107,019.7 8.3 -3.6 74,126.1 72,413.2 -10.7 -2.310-50 114,828.7 113,060.9 14.4 -1.5 70,831.2 70,550.9 -13.0 -0.4

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Chapter IV: Financial Sector Refor. I/

Introduction

4.01 Pakistan's banking sector is reasonably well developed, despite therelatively low level of per capita income and low rate of savings. As in mostdeveloping countries, it is the mainstay of the financial system in Pakistansince equity and bond markets are poorly developed. Since nationalization ofthe banks in 1974, the Government has aggressively promoted growth of bankingin the country and has used it as the major tool for achieving the followingmacro-economic and socio-political goals:

(a) promotion of financial savings;

(b) allocation of credit to priority sectors in line with plannedpriorities;

(c) captive source of funds for financing the budget deficits; and

(d) greater access to credit by the general public.

4.02 Progress toward these objectives has been appreciable:

(a) financial deepening has increaced significantly; thus financialsavings (banks deposits and savings schemes) as a percentage ofGNP increased from about 30X in FY75 to 431 in FY87;

(b) bank deposits grew by 101 per annum in real terms during thisperiod, as against zero growth in the prior decade. The numberof depositors increased from about 7.2 million to 21.5 million;

(c) loans outstanding also increased by 10% per annum in real termscompared to 0% between 1962-74, and number of borrowers Increasedfrom 365,000 to about 1.1 million. More importantly, credit toagricultute, industry and exports increased significantly;

(d) about 352 of the banking system's assets are made up ofgovernment securities.

4.03 In the last few years, the Government has taken additional steps tobroaden the development and improve the efficiency and performance of thesector. Islamization of the banking system, which has put returns on a largepart of the deposit and credit instruments on a profit/loss sharing (PLS)basis, has established some flexibility in the loan/deposit rate structures.By and large, real interest rates/returns on bank deposits and loans arepositive. New financial institutions and instruments, such as tradeableforeign exchange certificates and special bearer bonds, have also beenintroduced.

1/ This chapter is based on Pakistan-Financial Sector Review, draft,December 1987.

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4.04 To maintain Pakistan's historical record of economic growth andmoderate inflation, the economy will have to be more open, domestic resourcemobilization improved significantly, and deregulation accelerated. A keyissue, therefore, is the ability of the financial system to support theseobjectives. The financial system will have to assume a more important role inmobilixing savings and in allocating them efficiently. It needs to beresponsive to the changing intermediation needs of the economy, and towithstand the changes in business profitability caused by increasing domesticand foreign competition.

4.05 There is concern about the banking system's ability to function asefficiently and respond as flexibly as will be necessary to meet thesechallenges. There are institutional problems which increase theinefficiencies of the system, undermining its viability and solvency.Government policies also play a role. The size of the Government's domesticdebt and the inappropriate interest rate structure are creating distortions inthe financial system; in addition, they generate pressures for a moreaccommodative credit policy to avoid crowding out. The high level of forcedinvestment in government securities along with a large volume of subsidizedcredit constrain bank profitability and limit banks' flexibility of action.

4.06 Principal institutional problems are:

(a) a significant part of the resources are allocated administrativelythrough the use of selective credit controls and mandatorycredit and investment programs, several of which carry belowmarket rates. The combined effects of these controls hasundermined the allocative efficiency and profitability of thefinancial system, reduced incentive to mobilize deposits, andsegmented financial markets;

(b) over 95% of the institutional credit markets are dominated bygovernment financial institutions, which raises serious doubtsabout the ability of the markets to become competitive andinnovative. Due to barriers to entry, the commercial bankingsystem is dominated by the nationalized commercial banks whoseability to operate efficiently is impaired by lack of autonomy,gradual decline in quality of lending and service, increasinglevels of arrears and a highly unionized work force;

(c) credit indiscipline has increased because of imprudent borrowingand lending and an ineffective debt recovery framework;

(d) the regulatory and supervisory structure has not developed inline with the growth, sophistication and needs of the financialsystem.

Domestic Debt

4.07 The single most important factor distorting the financial system isthe large amount of government borrowing required to finance the large fiscaldeficits. Despite its borrowing requirements, the Government has keptexternal debt manageable and avoided large-scale reliance on inflationary

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monetary finance. However, it has relied heavily on domestic borrowing, withparticular emphasis on non-bank sources. For the period FY83 - FY86, averagedeficits of 6.8S of GDP were financed as follows: 3.3S (non-bank), 0.92(comercial banks), 1.2X (monetary), and 1.4S (externalj. As will be seenbelow, this borrowing strategy is not the most efficient, from the point ofview of cost-effectiveness of debt financing and flexible monetarymanagement. Furthermore, it has negative consequences on the development offinancial markets, because of the size of the debt, its large array ofinstruments and interest rates, and the credit ceilings imposed on comercialbanks to avoid inflationary consequences.

4.08 The increasing deficits of this decade have led to a sharp rise indomestic debt. Debt has increased 3.5 times in six years -- from about Rs58.9 billion in FY80 to Rs 235 billion in FY87. Domestic debt as a percent ofGDP rose from 25% in FY80 to 37Z in FY87. In comparison to credit outstandingto the private sector by the banking system (about Rs 100 billion), governmentdebt is 2.4 times larger.

4.09 The Government's domestic debt is comprised of the following threetypes: (i) unfunded debt, which is largely made up of national savingsschemes (NSS) and is aimed at the general public. It accounts for 44X ofdomestic debt and yields about 12-16% tax free; (ii) floating debt largelycomprises ad-hoc and regular T-bills held by the central bank and commercialbanks. It comprises about 437 of debt and has rates ranging from 0.57. - 6.07p.a. All banks are required to keep 30S of their deposits in government paper(the liquid asset requirement), most of which are T-bills which yield 67 andare available on tap. In addition, the Government has issued specialTreasurysecurities to capture funds of institutions like insurance companies; theseare at varying rates and maturities and are tax-free; (iii) permanent debtwhich includes long-term market loans with maturities of 7-20 years and ratesof 8.5 - 147. It is largely held by institutions like insurance companies andcommercial banks. It comprises the remaining 13% of the debt.

4.10 The Government's borrowing strategy is to raise as much as it canfrom non-bank borrowing (unfunded debt), in the belief that funds raisedthrough savings schemes represent true savings while commercial and centralbank financing is inherently inflationary. However, to raise increasingamounts from the public, the Government feels that it must pay attractiverates. Its second recourse for financing is through the purchase of T-billsby the commercial banks to satisfy the liquid asset requirement. 1/ Inaddition, credit ceilings result in excess liquidity for banks, which also ischanneled into T-bills. Remaining gaps are financed through permanent debt,with the residual made up by monetary financing by the central bank. Byoffsetting the high interest rates paid on national savings schemes (NSS) withthe low rates in the captive T-bill market--the two largest components ofdebt-the actual interest cost of tae domestic debt is relatively low, around6.5X in FY86.

1/ The 30% liquid asset requirement was initially established for monetarycontrol purposes. In recent years, this requirement has become animportant non-monetary source of deficit financing; however, with risingdeficits, the Government has had to resort more to monetary financing(ad-hoc T-bills).

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4.11 However, the present strategy has several undesirable characteristics:

(a) The maturity distribution of the debt is heavily short-term. Inthe mid-70s about 451 of the debt was of short-term maturity,while currently it is about 711. The reliance on short-termfinancing is not desirable as it generates regular outflows andis accompanied by heavy refunding needs.

(b) The rate structure of debt is highly skewed andadministratively determined. About 30S is at rates between0.5-3S, 20S at rates between 8-12S and the remaining 30% at ratesbetween 12-201. There is little secondary market trading so thatth;c is no benchmark rate that serves as a guide to price thev.clo- kinds of government paper.

(c) The Covernment appears to be paying unduly high tax-free rates onits saving schemes which far exceed the rates on competingalternatives. Thus, one scheme pays 12.5% (for individuals) and151 (for companies) tax-free for a six-month certificate (Khaas)compared to 8-101 taxable return on a six-month bank deposit.First, it is not clear that the Government needs to pay such highrates. It discourages banks from using their vast network ofbranches to mobilize domestic deposits. Institutional depositorsare taking advantage of the high liquidity of Khaas certificatesand using them for cash management purposes. Many firms getdouble benefits; they invest their surplus cash in theseinstruments getting tax-free returns and then use thesesecurities to get loans, the interest on which istax-deductible. Second, government borrowing overemphasizes therole of savings schemes. Under the present system, theassumption that these non-bank saving schemes are inherently lessliquid, and by implication less inflationary, than bank financingis not entirely correct. Since monetization of governmentsecurities held by banks is prevented, because of creditceilings, this part of government debt is not different--in termsof its monetary impact--than the government debt held byinsurance companies, non-financial corporations, or the public atlarge.

Monetary and Credit Management

4.12 Credit ceilings and high liquid asset requirements, while designedwith other objectives in mind, are well-suited for handling the largegovernment borrowings without undue inflationary pressure. However, theyconstrain competition and inhibit efficient banking operations.

4.13 The main instrument used for credit control is ceilings on domesticcredit expansion (i.e., net increase of credit to government, public andprivate sectors from the banking system). Each year, targets for creditexpansion are based on the desired level of monetary (M2) expansion andexpected changes in net foreign assets. Credit is allocated among thegovernment/public enterprises and private sector according to need, with thelatter generally absorbing the brunt of the adjustment as government creditneeds have expanded with rising deficits. Ceilings to individual banks in any

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year are then allocated in relation to their share of total bank deposits theprevious year. In the absence of any instruments for open market operations,it is one of the few available effective tools in the hands of the State Bankof Pakistan (SBP) for controlling the money supply.

4.14 All scheduled banks are required to maintain at least 302 of theirdeposits in low-)ielding government securities - the liquid asset requirement- over and above the 52 cash requirement. This high forced investment,whileessentially a monetary control tool, not only siphons off a large part of thefinancial resources for government, but also because of low yields imposesa substantial tax (Rs 2.2 billion in 1986) on the financial system. Also, itdiscourages raising of term deposits.

4.15 As a result of credit ceilings and high liquid asset requirements,the Government captures funds without an associated expansion in the moneysupply. The Government borrows from SBP through ad-hoc bills, which is almostlike an overdraft facility. As a result of credit ceilings, banks always haveexcess liquidity (roughly 5-8S of deposits) over and above their reserverequirements. With rising deficits, this liquidity is now also used tofinance government borrowings through purchase of 'tap' T-bills. Because SBPhas limited control over the credit expansion resulting from these governmentborrowings, its principal means of monetary control is credit to the privatesector.

4.16 Under the present system, a large share of the financial resourcesare preempted by the public sector. Thus, over a ten-year period 1976-86,about 35t of the increase in monetary assets was accounted for by theGovernment and 152 by the public enterprises. Large government borrowings, ina tight credit regime, limit the amount of credit available to the privatesector, particularly the more dynamic small scale and service sectors. Toavoid crowding out, the SBP has been following a more accommodative policy,which has put pressure on external reserves. Even so, as Table IV.1 shows,the banking system provides less credit to the private sector (relative tomonetary assets) than other developing countries.

Table IV.l: DOMESTIC CREDIT TO PRIVATE SECTOR ASPERCENTAGE OF EXPANDED MONEY SUPPLY (M2)

1985

Pakistan 50

India 64Bangladesh 64Sri Lanka 76

Korea 135Indonesia 80Thailand 80Kenya 73Egypt 32

Source: International Financial Statistics. Reproduced in Pakistan-FinancialSector Review, December 1987.

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Comercial Bankins System

4.17 The performance of the nationalized commercial banks (NCBs), whichaccount for about 90S of bank deposits and 802 of bank loans, determines theefficiency of the entire banking system. While NCBs have consistentlyreported profits, declared dividends, and paid bonuses, their financialposition seems to be less positive. As a percentage of assets, NCB capital is2.9S, a low percentage in relation to other countries as well as in relationto the riskiness of their asset portfolio. Although exact information isunavailable, the declining profitability and other rough estimates suggestthat the level of non-performing loans is high. Rough estimates suggestpossible arrears of around 25-302. This weakness in asset quality isattributable to poor debt recovery procedures, imprudent lending, lack ofcommercially profitable lending to state enterprises, and lack ofaccountability and adequate managerial antonomy since nationalization. A highlevel of non-performing loans not only threatens banks' viability; by loweringreturns on the assets side, it lowers rates on deposits, thereby affectingresource mobilization objectives.

4.18 Because of the problem of non-performing loans and low rates onmandatory programs, spreads are inadequate. The average interest spread(average interest income minus average cost of deposits) on interest-earningassets was 2.6S in 1986 compared to average administrative costs of around2.7X. This differential, however, was more than offset by fee and commissionincome, which averaged about 1.1%.

4.19 Lack of Competition. This performance is largely attributable to theenvironment in which the banks operate. The banking system is highlyconcentrated-three NCBs account for about 751 of the commercial bankingloans-due to mergers at the time of nationalization, lack of competitiveforces, and barriers to entry of new institutions. Individually, there areconstraints on NCBs' profit maximization due to their lack of autonomy andperception of the staff that they are government servants, and theirinstitutions are government entities. Adverse effects of government policieson credit ceilings, administered interest rates and mandatory lendir.g, whichtogether reduce the incentive to compete for new business, also reinforce theadministered nature of the NCBs.

4.20 Credit Controls and Portfolio Distribution. High reserverequirements; mandatory programs for agriculture, exports, small business, andlocally manufactured machinery, some of which are at subsidized rates; andcredit ceilings have not only reduced the discretionary portfolio but alsoaggravated the credit squeeze. Thus, rough estimates indicate that only abouta third of the outstanding portfolio is subject to management discretion. Onan incremental basis the situation is even worse; during 1986, NCBs haddiscretion on only about Rs 2 billion of loans. Although the administereddistribution of credit may have performed an important role in furthering theGovernment's socio-economic objectives, it is not evident that the benefitsunambiguously outweigh costs. The system seems to have undermined che"fiduciary character" of the NCBs, by crowding out creditworthy new or smallerprivate sector clients, accentuating concentration of loans, and encouragingpoor credit practices.

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4.21 Deposits. Bank deposits, while in need of strengthening, suffer fromseveral problems which cannot be corrected isamediately. First, rates ongovernment savings schemes are 3-4S higher than bank deposits, making bankdeposits a favored instrument only for transaction purposes and for obtainingbank loans. Moreover, rates on bank deposits are low and, for savings andterm deposits below one year (which account for about 60S of the deposits),occasionally negative in real termu after account is taken of Zakat deductions.Second, the reserve requirements and excess liquidity, in the face of creditceilings, act as a disincentive to raise deposit rates. Third, the lowprofitability of NCBs as a result of non-performing loans and reluctance toraise lending rates limit their ability to raise deposit rates. NCBs haveonly marginally increased their lending rates since rates were freed, and maybe settling for lower profits or using compensating deposits to boost theireffective lending rate in order to avoid government or public criticism.

4.22 Problems with Bank Regulation and Supervision. In order to improvethe banking system, better banking supervision is needed. First, there is nota clear-cut separation of responsibilities and control among various entities.Legally the NCBs are owned by SBP, rather than the iederal Government, whichmakes the SBP an owner as well as a supervisor. The Pakistan Banking Council(PBC), while legally an advisory council, is perceived by the NCBs asvirtually being a "de facto" Super Board. Officials of both PBC and theMinistry of Finance sit on the boards of NCBs. The present institutionalarrangements have both positive and adverse features. The establishment ofPBC has created an important buffer between government and the banks.However, at the same time, it has created the unsatisfactory situation of twooverseeing bodies, i.e. PBC and the Government. Thus the interrelationshipbetwcen the banks, SBP, PBC and the Government lacks clarity, and there isinsufficient institutional separation to prevent conflict of interest.

4.23 Although the SBP's supervision and inspection system is generallyadequate, there is definitely need for further strengthening to copeeffectively with the existing problem of asset quality, the changing structureof the financial system, and the large size of the banking system. Regulationsneed to be reviewed. The present statutory capital adequacy requirements(7.51 of deposit liabilities as of December 1972) are out of date, and need tobe revised upward. In fact, NCBs currently have a much higher, though stillinadequate, ratio. The present prudential exposure limits--the maximum loanto an individual firm cannot exceed 201 of capital and reserves--are notunreasonable relative to other countries. However, lower limits would be moredesirable given both the present concentration of banks and credit.Theoretically, as few as 25 large customers could shake the solvency of theentire NCB system. Finally, the information content of banks' audit reports,as specified by the Banking Act, as well as the present statutory and otherreporting requirements need to be improved, for they do not provide thesupervisory authorities or the public with a good picture of the health of thebanks.

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4.24 More generally, supervisory and regulatory arrangements of creditmarkets in Pakistan have developed in a piecemeal manner. Legislation oftenhas not kept pace with the development of the financial sophistication interms of the services provided in the market place. Commercial banks and thespecialized banks are supervised by SBP, and the non-bank institutions by theMinistry of Finance. Consequently, as a result of this fragmented supervisorystructure as well as deliberate policy, different institutions have differingregulations regarding tax treatment, reserve requirements, and advertisementfor deposits. These non-uniform regulations create uneven incentives and mayresult in unnecessary proliferation of institutions. It is time to reviewthese regulations, to determine whether the resulting credit market structureis consistent with objectives of resource mobilization and allocation, withadequate safeguards for depositors.

Capital Markets

4.25 Historically, the capital markets have played a relatively minor rolein the mobilization of capital, accounting for less than 12 of total privatefixed investment in Pakistan. Despite the 450Z increase in listings in thelast 25 years, the number of companies listed on the market is only a smallproportion (2.4X) of the estimated 15,000 closely held companies. Companiesare unwilling to go public for a number of reasons. Among the most importantis the higher cost of equity compared to debt, with easy access by large firmsto DFI loans, and the reluctance to dilute shareholding. The bond andcommercial paper market is not well developed because of high returns onrisk-free assets and prohibition (under companies ordinance) against corporateentities issuing bonds or debentures. With returns on Khaas certificates atlf -ax free, borrowers are unwilling to issue commercial paper at theserat s, since short-term working capital finance is available to premiercompanies at about 13X.

4.26 The use of capital markets for substantial mobilization of capital isnot likely to happen soon. However, it is important to put into place anadequate regulatory framework for sound development of this part of thefinancial market. At the moment, inadequate regulation and supervision is aproblem. The current number of supervisory agencies, sometimes withoverlapping areas of responsibility, results in inconsistent treatment betweeninstitutions. Partly because of staffing shortages, the agencies exercisetheir supervisory functions in a passive mode, by reviewing information whichis required to be submitted to it rather than through spot checks orindependent investigation. Without strong accounting and auditing require-ments, it is difficult to determine a company's true financial position.Furthermore, the stock exchanges are currently largely self-regulated.Finally, enforcement is weak. The value of any regulatory system as adeterrent and enforcement mechanism also depends on the effectiveness of thelegal system. The lengthy delays in the legal system for enforcing corporatelegislation and commercial contracts seriously impede enforcement.

Scope and Phasing of Reforms

4.27 The proposed reforms, designed to improve resource mobilization andallocation, can be broken down into three, partially overlapping, phases. Inthe first phase - of 2-3 years duration - the main focus would be on

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improving the efficiency and profitability and restoring the viability of theNCBs; these banks hold the key to the establishment of an efficient financialsystem and therefore addressing their problems need urgent attention. In thesecond phase - of about 2-3 years duration -- the focus would be on providinggreater flexibility in the system of monetary controls, initiating a programto raise government debt through the market, reducing the interest ratedistortions, and strengthening the regulatory and supervisory framework. Theinitiation of the marketable debt program is assumed to coincide with theexpected reduction in deficits to manageable levels. In the third phase --perhaps 7-8 years from now- the focus would be on completing the transitionto a largely market-oriented approach to monetary and debt managementfeaturing open market operations, and the reduction in the share of government-owned financial institutions through the establishment of private bank andprivatization/disinvestment of NCBs.

4.28 The recommended reform agenda takes into account the followingconsiderations. First, reform would need to be gradual, considering thehighly regulated natvire of the system for the past two decades and thedifficulty in predicting the response of the system to change. Second,financial sector reforms need to be coordinated with reforms in the realsectors and other macro-economic policies, particularly reduction in fiscaldeficits, to avoid financial instability. Third, liberalization would need tobe coordinated with building up of supervisory capacity and, more importantly,a legal framework to ensure effective sanctions against abuse.

4G29 Some reduction of the fiscal deficit from existing levels must precedeseveral financial sector reforms. If the deficit remained at current levels,fine tuning of the existing debt strategy would not have significantbeneficial effects. The sheer magnitude of the deficits and the accompanyingadverse effects would dwarf any beneficial impact of a better strategy.Notably, a more market approach to borrowing, under a high deficit situation,could lead to large interest rate increases as well as severe crowding out.While improving the financial condition of the banking system can and shouldbegin soon, a lasting restructuring-involving the establishment of morecompetitive deposit rates, significantly improved portfolio quality, andimprovement of the return and use of liquid assets now being channeled intoGovernment T-bills-would not be possible without a red iction in (and arationalization in the terms of) government borrowing.

Reform of the Banking System

4.30 Improving the health of the banking system must be given high priorityin a structural adjustment program, so 'hat banks can both provide the creditneeded to help firms adapt and to survive a substantial change inprofitability of their loan portfolio.

4.31 Increasing Competition. A more competitive banking environment iscrucial. In recent years, the Government has taken some initiatives (partialfreeing up of lending/deposit rates, allowance of new non-bank financialinstitutions) to increase competition. Together with reforming the regulatoryframework, this process should be accelerated. A reduction in thegovernment-owned segment of the banking system to around 502 over the nextdecade is recommended, through a combination of privatization/partialdisinvestment of NCBs, and removal of restrictions on entry by private banks.

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In the short-run, a clearer commitment and increased effort to make NCBs moreautonomous and able to respond to increasing competition is needed. Increasingautonomy, specifically on personnel matters, and more accountability of NCBsalone would improve performance. Steps such as providing each NCB Board withfull authority on organizational structure, management policies, appointments,promotions, and salaries of managers and staff, and loan write-offs, as wellas limiting the operational role of PBC and the Ministry of Finance, should betaken imediately. However, allowing entry by the private sector wouldprovide a much needed impetus to banking competition and efficiency. Thestrengthening of the regulatory and supervisory framework would ensure thatthe private banks' ownership pattern and portfolio behavior are in line withsound banking practices and socio-economic objectives laid down bygovernment.

4.32 Improving Banking Practices. On the asset side, there are a numberof practices related to non-performing loans and underlying credit decisionswhich need immediate attention:

(a) Debt recovery. Better collection procedures are urgently needed.First, however, NCBs need to undertake a comprehensive portfolioaudit to accurately assess the extent of the arrears problems inorder to establish a sensible strategy for debt collection.

(b) Better credit policies and management also need to be reviewedand improved. Among the topics for review are: (i) creditevaluation criteria, putting equal emphasis on cash flow andcollateral; (ii) requiring sponsors to contribute more equity(i.e,. 40% or so) and reducing the use of bridge loans forfinancing part of the equity to be raised from the public, inorder to raise the stakes of sponsors in their projects; (iii)appropriate attention to working capital needs in proposedprojects, in order to forestall poor loan repayment performancedue to a shortage of working capital; and (iv) strengtheningportfolio supervision and monitoring.

(c) Introduction of transparent and uniform standards onnon-performing loans. This would involve better accountingpolicies for non-perfurmig .oans; iatroduction of loan.delinquency and debt recovery performance as an objectivecriterion for loan classification; flagging troubled projectsearly with a new "three month overdue" loan category; andsuspending all accrued interest on loans more than 90 daysoverdue and on loans that are classified as substandard, doubtfulor loss, and treating as income only when collected on a cashbasis.

4.33 Interest Rate and Credit Allocation Changes. The following measurescan be taken in the short-term to improve a bank's discretion on its portfolio,thereby improving its flexibility of action:

(a) Flexibility within the basic credit allocation system.As banks become more autonomous, the separate allocations to theprivate and public sectors could be eliminated. Improved creditpolicies and debt recovery would also obviate the need for

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separate allocations for working capital and term losns. Whileallocations for the mandatory programs (small business/industry,small agriculture, and exports) may be needed, their share intotal credit should not be allowed to expand.

(b) Interest rate change. Increasing rates on subsidized creditprograms to, say, 10-llS, equivalent to the 1-2 year deposit rateand the one-year proposed rate on Khaas certificates, withbelow-market rates funded by government budget transfers ratherthan by the banks themselves, would raise banks' income andpromote better use of the credit. In addition, establishment ofa minimum profit sharing rate--equivalent for instance to the3-year deposit rate (like the "prime rate" in developed markets)-- would put a reasonable floor on projects financed by NCBs inline with the cost of funds.

4.34 Strengthening the deposit side would have to be phased in gradually.Raising deposit rates would be beneficial to attracting more deposits;however, one would expect this to be effective only (i) as credit ceilingsbecome less tight, as the fiscal deficit is reduced; (ii) after free marketrates for government securities are established, permitting deposit rates tobe more closely aligned to the market rate, and (iii) after the quality of theportfolio has improved.

4.35 Better Supervision and Regulation. It is recommended that allsupervision and inspection of commercial banks be consolidated in SBP, andthat PBC give up its inspection function for that of management audit. Italso would be desirable to expand SBP's regulatory function to include alldeposit taking and lending institutions. Such functions would includeapproving new institutions, setting rules and regulations, and on-siteinspections. Since all of these institutions - banks, leasing companies,investment companies, Modarabas, and DFIs to a lesser extent - are engaged insimilar deposit-borrowing-lending activities, having one regulator wouldensure uniformity in design and application of regulations. However, thisexpansion of responsibility wc,uld need to take into account staff constraintsfaced by SBP. Unlike many countries, Pakistan's central bank is not able toattract the best financial professionals, because of poor salaries, unionism,and general decline in SBP's position of eminence. Unless SBP can demonstrateintellectual leadership and high professional standards, the pace of financialinnovation and deregulation is likely to be slow.

4.36 Specific regulations also need to be reviewed and upgraded, asneeded. Those which seem most important relate to (i) raising the level ofcapital adequacy to international standards-about 8-10 of risk-adjustedassets, for exa ple, which is equivalent to the proposed OECD average; (ii)lowering prudential exposure limits; and (iii) tightening audit requirementsand improving statutory reporting.

Debt Financing Strategy

4.37 Outlined below is a debt financing strategy that would meet theGovernment's requirements in a cost-effective manner, while facilitating

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effective monetary control as well as reducing distortions and segmentation ofthe financial markets. Th.e strategy involves:

(a) Rationalizing the interest rate and maturity structure of thesavings schemes by setting up a yield curve which increases withthe length of maturity, and is anchored to a market-determinedbenchmark such as a short-term Government security sold atauction. This would involve a reduction of most NSS rates and anincrease in auction-determined T-bill rates;

(b) initiating a regular auction program to raise more funds,wholesale, from the general public by increasing the range andattractiveness of marketable securities. Such sales would beginat the short end of the maturity spectrum, perhaps with six-monthmaturities, and be extended to longer maturities as investorinterest and the development of the secondary market permit; and

(c) using the national savings schemes to mobilize longer-term fundswhile meeting short-term financing requirements through the saleof marketable securities.

4.38 As a consequence of the above recommendations, the inflow of fundsinto NSS would decline as it becomes less attractive particularly to the largeinvestors, who would prefer the marketable securities. Overall, the fundsavailable to the Government would not decline; moreover, with the reduction ofdeficits, borrowing needs would decline and a slow down of NSS funds could beeasily absorbed without resorting to monetary financing. In such a situation,these changes would be expected to reduce interest costs, despite a reductionof most NSS rates and an increase in marketable debt rates. It has beenestimated that the Government could gain Rs 17 billion over a nine-year periodwith the recommended strategy. 1/ Moreover, the establishment of a market-determined rate for a risk-free government security would also result in morerational pricing, by banks, of private credit.

Monetary Management

4.39 Moving from credit controls to open market operations in monetarymanagement is desirable for the long-run. However, there are several pre-requisites to adoption:

(a) substantial reduction in the fiscal deficit;

(b) development of active primary and secondary markets forgovernment securities;

(c) improvement in the financial condition of the banking system; and

(d) development of reserve management and related skills amongcommercial banks and the SBP, in order to handle the new system.

1/ Pakistan - Financial Sector Review, Volume II, Chapter IV.

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4.40 It is likely to be at least a decade before open market operationscan be used as the principal inst-.ment of monetary policy. In light of theradical change involved, a graduatcd approach is needed:

(a) In the first stage the SBP would conduct open market operationsto manage actively the reserves cf the banking system on ashort-term basis. Control of the money supply would continue todepend on the credit control program, while the SBP gainsexperience in reserve management. The Ministry of Finance wouldintroduce a market Treasury bill, ineligible for meeting liquidasset requirements, as a means of establishing market ratesattractive to the non-bank public.

(b) The next stage involves using open market operations to modifyinterest rates with a view to controlling deposit growth. TheSBP would open a new discount window at a penalty to theovernight inter-bank rate. The MOF would sell additional seriesof marketable government securities to broaden the range ofissues available to non-banks.

(c) In stage three, when the State Bank has developed reasonablecompetence in managing monetary growth with the new tools, thecredit control program could be phased out.

4.41 The switch from an administered to a market-oriented system ofmonetary and debt management would increase government flexibility in monetarypolicy in ways more conductive to efficient banking operations. It would alsoresult in the dev-lopment of the financial system in ways consistent in agrowing and increasingly sophisticated economy. Non-inflationary financing ofgovernment debt would be strengthened with a functioning government securitiesmarket, including a distribution system involving bank and non-bank financialinstitutions. The increase in short-term securities available would enablebusinesses, institutions, and individuals to meet their liquidity needs safelyand efficiently. And the development of an active secondary market forgovernment issues would stimulate the growth of markets for short andmedium-term private debt. The yield curve for government issues would providea benchmark for the pricing of private paper, and the trading and investmentmanagement skills developed in the government securities market would betransferable to the private securities market. Finally, a flexible monetarypolicy and government securities market would make it easier to adjust marketinterest rates in accordance with international conditions, thus enabling theGovernment to affect international capital outflows.

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Chapter V: Recommended Five-Year Adjustment Program

A. The Proposed Developent Policy Asenda

5.01 The Government's development objectives involve continuation of rapidgrowth, as part of the industrial transformation of the country, in order toprovide lasting increases in incomes, employment, and social benefits for agrowing population. As has been analyzed in the preceding chapters, internaland external constraints will make it difficult to maintain the high growthrates of the past without further adjustment. Pakistan has already beguninitiating policy changes favorable to industrialization in line with itscomparative advantage and export-oriented growth. The recommended develop-ment policy agenda sunmmarized below calls primarily for a sustained fiscaladjustment effort and an acceleration of structural reforms in order toimprove the foundation for economic growth with internal and externalstability over the medium-term.

5.02 The major areas for policy action in the next five years are thefollowing:

(a) public resource mobilization, principally from a major taxeffort but also from public sector price and user chargeincreases, to reduce the fiscal deficit while permitting agradual expansion in physical infrastructure and human capitalinvestments consistent with resource availability;

(b) reduction of the current fiscal deficit, until the deficitreaches about 5% of GDP in 1991, and budget restructuringfeaturing a more elastic tax system and higher tax shares inGDP, reduction in the growth of current expenditures and lowersubsidies, a growing current surplus, a growing share ofdevelopment expenditures, new Federal/provincial revenue sharingarrangements which would encourage provincial revenue efforts,and adequate provisions for recurrent expenditures in properbalance with development spending;

(c) introduction of a phased program of trade liberalizationconsisting both of export promotion and import liberalization;

(d) continued domestic deregulation, by extending marketderegulation to major agricultural crops and remainingmanufactured products; and by reducing further the remainingcontrols or sanctions on industrial investments; and

(e) reform of financial markets, starting with improving the healthof the banking system, and moving toward rationalization ofinterest rates together with more market-oriented debt financingand monetary and credit management.

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5.03 These recommended actions would complement the Government's sectoralagenda for agriculture, energy, infrastructure, social services and povertyalleviation. Other subjects meriting attention now include population policyand natural resource/environmental management. Ignoring them would seriouslylimit the country's long-term development potential.

5.04 The specific policy recomendations in each of these five major areaswere discussed in chapters II-IV and are summarized later in Table V.1,together with their sequencing. By correcting the present macro-economicimbalances-primarily caused by the large fiscal deficits-and improving thepolicy and institutional framework for development, this recommended programwould improve the basis for sustained economic growth of at least 6X per yearin the medium-term with moderate inflation and improved creditworthiness. Inthe first three years, however, slightly lower real GDP growth of about 5.51is likely to occur in the process of improving the macro-balance in theeconomy. By the end of the five-year program period, with fewer unnecessarycontrols, less price distortions, and more competition, the economy would besubstantially stronger and more efficient than it is now. The Government'sclaims on private and external resources would be consistent with financialstability and would not jeopardize the growth in private sector activity.Yet, by streamlining and coordinating its development and recurrentexpenditures and improving its revenue base, the Government would be betterable to undertake its traditional functions of providing social services andeconomic infrastructure.

5.05 Visible economic changes in the medium-term would include:

(a) An increase in the aggregate investment rate from both publicand private sectors.

(b) A bigger savings effort, especially by the Government.

(c) Improvement in coverage and quality of economic and socialinfrastructure services.

(d) Faster industrial and agricultural productivity growth, withmore production directed toward the export market and,consequently, a more diversified export base.

(e) Possible stimulus to employment growth from the outward-orienteddevelopment strategy, which inter alia would better utilize thecountry's labor and other resource endowments.

5.06 Sequencing. Careful sequencing is key to the success of therecommended policy agenda. The ability to move ahead with structural reformsdepends on reduction of the fiscal deficit, together with support of exchangerate and conservative monetary policies, to maintain both internal and externalbalance. Consequently, a major tax and expenditure control effort - the twoprincipal ways to achieve deficit reduction without unduly squeezinginfrastructure and social expenditures -- have the highest priorities. Becauseit takes time to achieve significant revenue increases, the first two years ofthe program would be more stringent than the next three. Possible magnitudes,described earlier in detail in chapter II, are summarized later in Table V.2.

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5.07 With a more manageable macro-economic situation, the country would beable to weather the immediate repercussions of structural reforms in the realsectors of the economy. Both trade liberalization and domestic deregulation,by opening up protected areas to competition and by changing relative prices,will involve substantial adjustments for firms. In order to avoid undue shut-downs of potentially viable establishments, trade liberalization and domesticderegulation will require close Government management of the transition.Restructuring investments for companies and special adjustment assistance toworkers and perhaps even consumers may be needed.

5.08 The trade policy reforms must be sequenced carefully with fiscaladjustments. Until the excess demand generated from large fiscal deficits isreduced, import liberalization runs the risk of substantially increasingimports. Consequently, as the fiscal deficit is being reduced, the tradepolicy reform should be directed first at replacing non-tariff barriers withtariffs and at reducing duty exemptions and concessions, neither of which isexpected to affect imports substantially. Significant tariff rationalizationand reduction in the maximum tariffs would follow, keeping pace with thereduction in the pudget deficit and with export development. Maintaining arealistic exchange rate would be important to keep the trade balance fromdeteriorating. In addition, rationalization and reduction of tariffs must becoo-iinated with the domestic tax effort. Implementation of the expandedsales or value added tax, expected to begin in FY89, would take several yearsto achieve its full revenue target; therefore, it is appropriate to staggertariff reductions over the five-year period. Revenue gains in FY89 would comepartly from the reduction of duty exemptions and substitution of tariffs forbans. However, as tax reform proceeds, trade-related taxes would fall inrelative terms.

5.09 An important ingredient in the adjustmant process is a healthyfinancial sector, which can provide the credit needed to help firms adapt andwhich can survive a substantial change in profitability of its loanportfolio. Ideally, then, the first financial sector reforms - improving theefficiency and financial condition of the nationalized banking system --should precede major structural reforms in the real sector, particularly thesecond phase of trade liberalization. However, financial sector reform willnot be successful unless accompanied by reduction in the budget deficit, inorder to reduce the pressures on the financial system caused by extensivegovernment borrowing.

5.10 Table V.1 lays out the recommended sequencing of the specificelements of the policy agenda for the next five years. The more immediateactions are given within the first two years, although completion may takemore than that period of time. Each measure usually takes more than one yearto implement. Given the regulated nature of the areas to be liberalized andthe adjustments involved, reform would need to be gradual with carefulmonitoring of responses to policy changes. Some of the policy actions arealso expected to take more than five years to complete. The "Post-FY93"column indicates the policies which fit into this category.

TAMLYE V: KCMEN0( POLZCY AGEDA. 19U/89 - 92/93

-- " e I -- ---- Phase ----

Kay Obiecties Policy AtgnM FU U fil En r

I . Fiscal Poli1cyOeficit Reduction Annual reduction until deficit x x x

has reached 5% of GU in FY91.

Deficits at 5% level or less thereafter. x x

Expenditure Rationalization Curtailment of growth of current expenditures. includingtransfers through:

(a) masures such as reuction in workforce x x x x xthrough attrition and nominal wa" Increasesbelow that of Inflation, rationalization ofexpenditures, coordination of progr,s indifferent ministries.(b) continued reduction in subsidies (i.e., Weat. x x x x x

fertilizer).

iNrove Efficiency of Accelerate disinvestment in public enterprises,Public Enterprises as wll as improving efficiency of entities

r_mining in public sphere through:(a) lncrnased autonony, accountability nd better x x x x x

cost control/magemnt practices.(b) rustructure "unprofitable public enterprises. x x

Zprovemmt In ADP Address social and physical infrastructure requiremnts, x x x x xwhile initially keping AOP/GDP ratio at currentlevels, by prioritizing investmnts, especially inmJor sectors; improving minteane andrehabilitation; coordinating pace of investmntwith provision of recurrent expenitures to usethe investments effectively, and ncouragingprivate sector participation, ubre desirable andfeasible,

Revenue Sharing !aplemnt new Federal/provincial revenue sharing xformula.

Resource Nobilization Tax Reform:(a) Institute expanded sales or value added tax. x x(b) mprove tax administration. x x(c) Uroaen personal nd company incom tax base, x x

by such means as rducing exeptions andreinstatemnt of capital gains taxation.(d) Institute agricultural land tax or other x x x x

provincial-based taxes to improve princialrevenue basc.(e) Coordinate the rationalintion of tra x x x x

tariff strueture, other chares with above (Se U)

Fn EfU Eil E fi ftl Eiklm

Continue reoular increases in public sector tariffs x x x x xto improve budgetary surpluses of revenue-producingentities, and extend cost recovery to other publiclyprovided services.

Deficit Financing Reduced growth in government borrowing, with x x xreduced recourse to domestic bank and non-bankfinancing and external borrowing consistent withmedium-term balance of payments viability.

II. Trade PolicyExport Promotion Maintain fiscal and financial export promotion x x x x x

incentives (as reflected in Trade Policy Statementof June 1987) supporting freer access to imports.

Elimination of Non-Tariff Undertake initial import policy reforms aimed atBarriers (NTBs) eliminating NTBs and simplifying tariff structure:

(a) Replace existing bans with tariff x x xprotection.(b) Resove value limits on cash imports of machinery xand millwork-(c) Replace all import restrictions that specifyimporters and/or sources of financing by tariffs. x(d) Reduce duty exeptions and concessions (with x x xexception of duty-free baggage allowance).(e) Lower prohibitively high and redundant tariffs, xwith substitution of special excise taxes on luxury goods;maxima tariff would be in range of 120%.(f) Raise minimun duty to at least 10%; and abolish ximport surcharge (except for Iqra).(9) Rationalize tariff structure to remove anomalies x(including specific duties) and extreme or reverse cascading.

Rationalization of Tariff Further trade liberalization:Structure (a) Lower all tariff rates gradually from maxima x x x x x

ceiling of 120% to 50-60% in 3 year period;subsequently continue to narrow the tartff band.and reduce mean tariff level and dispersion.(b) Complete phase out of duty exevtions/ x x x xconcessions, including a reduction in the baggageallowance.

III. Daostic DereaulatinRemoval of Import Remove import license limits on machinery imported x xRestrictions on Investment on cash basis (See U1) and remove investment sanctioning

requirement where Imported raw material inputs exceedboth 60% of total inputs and 20% of total assets.

Removal of Remaining Abolish remaining sanctioning requirements x xInvestment Sanctioning based on project size (now Rs 500 million).Requirements

Fi El fill nl LM f2l iflll

Limit further the industries on the "Specified x xList.* to those associated with national security.religious, and special health and safety concerns.

Simplify bankruptcy, foreclosure, restructuring andand mrger laws to deal with sick industries afterappropriate study. x x x

Continui 1ion of Price and Reduce formal and informl price controls on _nufactured x x xMarketi, Deregulation products (ex. motor vehicles, drugs, pharmaceuticals).

Continue, extend dregu.lation to major crops (cotton, rice. x x x x xwheat), eventually limiting government intervention topreventing extrem price fluctuations and othermarket safeguards.

Location Clearances Move toward charging prices that reflecteconomic costs of providing infrastructure x x x x xservices (water, sewerage, gas electricity)and provide resources for additional requiredinvestment.

IV. Financial Sector ReformsEfficient and CoPetitive loProve efficiency, profitability and restoreBanking System viability of nationalized commercial banks

(ICB) by:(a) Iproving banking practices including x x x

improved project appraisal criteria and projectassessmnt, and introduction of transparent, uniformstandards on non-performing loans.

(b) Strengthening regulatory/supervisory frumork, x x x xincluding responsibilies of State Sank (SUP), whileproviding sufficient autonomW to bank nagment.

(c) ImProvins portfolio flexibility in short-run x x xby limiting expansion of mandatory credit progrmand raising the interest rates on subsidizedcredit (below).

(d) Establish effective legal and administrative frawork x x xfor debt recovery and sanctions against willful defaults.

Increase comtition, through privatization/partial x x x xdisinvestmnt of NC3s.

FnYu MI an t-farket-Oriented Debt Rationalize tiw interest rate and m_turity structure x x

of savings scem es by setting up yield curve h1ichincreases with lenoth of maturity and is anchored toawtion-determined govenuant security rate

Initiate regular auction program for goverrnent securities, x x x x xstartins with 6-month maturities and gradually extnding tolonger maturities as investor interest and develoPmentof secondary market permit.

Development of secondary market for government securities. x x x x

Gradually change mix of government borrowing. using savings x x x xschemes for longer-tera funds and marketable securities formeting short-term requirements (marketable securities couldbe used for long-term financing as well. once currentyield curve is revised).

Market-Oriented Mnetary/ Short-term changes within present credit allocationCredit Management system to improve banks' operating flexibility:

(a) Hold the ratio of mandatory to total allocation xfor private sector credit at the FY88 level (net basis).(b) Increase interest rates on subsidized credit prograns x x xto at least cover inflation.

Development of Efficient Inprove the regulatory fra ework. x x x x xCapital Markets

V. Cam1entarvMacro-Ecgnninc Policies Continue conservative monetary policy to insure sufficient x x x x x

credit to private sector and build-up in foreign exchangereserves without inflationary pressures.

Continue active exchange rate policy to support balance x x x x xof payments objectives, especially as import liberaliza-tion measures take effect.

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B. The Medium-term Macro-economic Outlook

5.11 The medium-term economic benefits from adoption of this policy agendaare sumarized, using key economic indicators, for tne program period FY8 -93in Tables V.2 and V.3. FY94-95 magnitudes are also given, to illustrate thepost-program performance of the economy. In the short-term, a temporary dropin real GDP growth to 5.5S per annum is likely to occur, with containment ofthe fiscal and current account deficits. Even with this temporary reductionin growth, per capita consumption is expected to grow, though more slowly thanit would in subsequent years.

Investment, Savings, Real Income Growth.

5.12 With full implementation of the policy agenda described above,improved resource mobilization and expenditure restraints and rationalizationwould reduce the budget deficit from the estimated FY88 level of slightly morethan 8% of GDP to about 5% in FY91. At the same time, a lower budget deficitwould diminish government domestic borrowing from 6.S to 3.2% of GDP byFY91. This reduced borrowing would release resources for private investmentas interest rates decline slightly, credit ceilings are relaxed, and moreself-financing is available. Private investment would also be stimulated by aless regulated and more competitive environment, and supported by a gradualincrease in government economic and social infrastructure investment. Totalinvestment would rise from about 16.5% of GDP in FY88 to almost 20% by FY93,with a slight increase in the private sector share.

5.13 Savings performance would also improve. The improvement would comeprimarily from the government side during the first few years. TheGovernment's revenue efforts would increase public savings from a netdissaving of over 1% of GDP in FY88 to savings of about 3.01 of GDP by FY93.Private savings may well fall initially, as the impact of higher taxes andlower government spending is felt, before improving in response to the bettereconomic environment. As a result, the ratio of gross domestic savings to GDPis apt to rise from about 10% in FY88 to almost 15% in FY93.

5.14 An increase in the incremental capital-output ratio (ICOR) - fromabout 2.7 i.L the 1980s to about 3 for the program period -- is a feature ofthis scenario. (The historically low ICORS are discussed in para. 1.14.)Although more efficient investments would result from the adjustment program,large capital investments are needed to relieve present social and physicalinfrastructure bottlenecks and replace the aging public capital stock and theoutmoded technology in certain industrial subsectors. This renovation andexpansion of the capital stock are critical to support annual real GDP growthof 6% or more over the medium-term.

Balance of Payments

5.15 Pakistan's balance of payments prospects depend on developments inthe world economy as well as on domestic policies. Economic growth ofindustrial countries has been well below 3% per annum since 1985, although

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TABLE V.2: KEY ECONOMIC INDICATORS FOR ADJUSTMENT SCENARIOFYNU - FY9S

AverageFY84-87 FY68 FY59 FY90 FY91 FY92 FY93 FY94 FY95

National AccountsGOP Growth Rate 6.9 6.0 SS 5.5 5.5 6.0 6.0 6.5 6.5GNP/Capita Growth Rate 3.9 3.0 2.3 2.4 2.5 3.0 3.0 3.5 3.5Consuption/Capita Growth Rate 2.4 2.7 1.8 1.1 1.2 1.5 2.2 3.1 2.7Gross Investment/GOP 17.3 16.5 16.4 17.4 18.1 19.1 19.6 19.7 20.0Domestic Savings/GOP 7.1 9.7 10.4 l1.S 12.6 13.8 14.5 14.9 15.5National Savings/GOP 13.9 13.9 13.8 14.8 15.7 16.6 17.1 17.1 17.4Public Investment/GOP A/ 6.7 7.0 6.9 7.2 7.4 7.8 8.0 8.0 8.0Public Savings/GOP b/ -1.4 -1.1 0.7 1.7 2.6 3.0 3.3 3.3 3.3Private Investment/GOP L/ 10.7 9.5 9.S 10.2 10.7 11.3 11.6 11.7 12.0Private savings/GOP 15.2 1S.1 13.1 13.1 13.1 13.6 13.8 13.8 14.2Private/Total Investment 60.2 57.6 57.9 58.S S9.1 59.2 59.2 59.4 60.0ICOR 2.7 2.8 3.0 3.0 3.2 3.0 3.2 3.0 3.0

Consolidated BudgetGovernment Revenues/GOP 17.4 18.0 18.1 19.1 20.2 21.1 21.5 21.7 21.7Government Expenditures/GOP 25.1 26.0 24.3 24.6 25.0 25.9 26.2 26.4 26.4Current Expenditures/GOP 18.6 18.7 17.4 17.4 17.6 18.1 18.2 18.4 18.4Deficit (-)/GOP 7.6 -8.1 -6.2 -5.4 -4.8 -4.8 -4.7 -4.7 -4.7Govt Non-Bank Borrowing/GOP 3.9 4.6 3.0 2.5 2.1 2.3 2.2 2.1 2.1Govt Bank Borrowing/GOP 2.2 1.8 1.6 1.3 1.1 0.7 0.7 0.9 0.9External Borrowing/GOP 1.S 1.7 1.S 1.6 1.6 1.7 1.8 1.7 1.7Oomestic Debt/GOP 37.2 41.0 41.1 40.5 39.3 38.7 38.4 38.0 37.7

A/ Government Development Expenditure/GDP.b/ Government Budget Deficit on Current Account/GOP.S/ Includes public enterprises investments.

lble V.3: PISTAN : MAIME F 9491139 93EC13 - AI3EI SCEIII

295$ IHillielI

Es. Pr.jrttt

FYN F3 FY, FM3 F0 Fml F92 F93 FT9t F"S F9% F9

Eaprts iq.f.l 3793 439 5231 393 m 71U 7UI21 ot 9922 1112t 123bArc1i t 29N2 34 4329 49 540 5911 1 U 99 710 37 "91 19UNm4-Frctwr S rn *51 m 952 1019 102 1171 1253 IS41 1U5 3 1642 l79

Isata fr ail 7211 4971 757 S25 1124 9331 9it lost 1lips 121* 1337 1SIlbrrclbwdi (4.) 59 5792 k54 1157 734 7733 245 m1 9415 127 11133 22111I -Facter lrvicn 2m 1179 2137 13U 140 I5U 156 170 1o 2M5 2A 257

huwc. 3a1c, -3413 -2575 -2571 -2421 -2312 -2139 -21" -2231 -2251 -2211 -22 -2302

Itt Factr Pltas -4 -701 -733 -1 -24 52 -976 -1013 -1W -112i -1192 -12hceipts 112 115 121 62 124 132 111 137 220 32 30Ppets 752 O1U IN 9s 203 1074 H* 1173 312W 141 2457 I

lIturnt 593 662 765 WI 919 9U9 990 134 1110 llS 129 1411Profits 1o 154 92 107 Its 129 to 159 12 in

bt Carrat Trmnfars 2322 2557 234 2230 2230 2123 2130 2130 210 20 30 30

Cwrat krcut Mines -2IW3 -719 -9U4 -1037 -203 -%1 -103I -1113 -1214 -1293 -1 -2529 F

RifKt Frsip la tmt Iff to a 105 Iff If5 266 16 Jos 166 oI 1is

Officil Irats 4U 33 421 439 452 411 49 494 1" 524 5* 33

li Ptulic NL3 Surreq 443 322 341 5U3 6l Hl ffl "97 lo7 It 123 1321iron imbrb mts 1305 1231 12E1 1515 122 16% 1ei 193 26l 2217 231 3PriKipi h,ay ts n97 915 940 1001 1oll 10 9 %6 fell 10on 1117 1223

bt Privat. MT hrrmig 55 22 10 55 2 -21 4 s3 53 92 91, I0:m% Iwlinets 55 202 70 223 71 4a 134 III 13 23? 39 23riKiph **aput 0 1I1 60 5S 9 1 U4 74 a3 9 III In

owt-Ta rS 3rrumi 154 109 1u0 12 12 12 12 12 12 12 12 12

Erroru ad Oiniun plu Capiltal *.iJ I -I 10 9 -0 0 0 0 0 0 0 0 0

ClE ai Nit Fuwip but. 1- is ircram) 7 -242 -67 -97 -176 -292 -431 -532 442 -122 1n sn

ft lten

RHal Exprt Urath late 93) 32.4 9.6 13.0 1.1 I.E 1.3 6.9 6.1 6.0 6.9 7.0 7.3Hal lwrt 0r9t. late ID) 6.6 0 3.9 I.E 2.5 4.3 4.3 4.7 4.9 4.9 5. 43.Ctrrat kr_t/OEP IS) -3.3 -2.1 -2.5 -2.6 -2.5 -2.4 -2.5 -2.5 -2.6 -2.6 -2.7 -2.3hbt SIrvcaisErWt. f tSU ID) 25.7 31.1 23.1 21.1 24.0 22.1 21.0 21.2 26.2 29.5 29.5 13231 1.rvice1iP (IU 5.3 6.3 5.7 5.4 5.4 5.2 S.0 5.1 s.0 4.3 5.0 5.arms Ilnrys 9 oil.) 915 114 525 347 1163 1513 231 213 2533 3243 3J6 45

mks of iprwts of 311) t.0 5.3 3.1 4.7 6.2 7.6 3., 9.7 1I.7 12.1 12.8 22.S

%a aclies Oit rvli9f.

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there are signs of improvement. 1/ Also of relevance to Pakistan is theprojected modest growth of the oil exporting countries as a result of thestagnation of oil prices. These are expected to remain at about $18 perbarrel up to 1990, and then rise gradually to $25 by 1995. The positiveimpact of the lower import bill for petroleum and petroleum products is offsetby declining remittances from migrant workers.

5.16 Even with modest world trade growth, currently projected at 41 perannum, further progress on trade liberalization and domestic deregulation withcontinuation of an active exchange rate policy would contribute to openingPakistan's economy. With improved competitiveness of Pakistan's exports, realexport growth of 6.7X per annum can be envisaged and the share of exports inGDP would increase. As exports of primary commodities (mainly raw cotton andrice) are projected to grow 3-42 annually in real terms, in line with thegrowth of output, the bulk of the increase in exports would come frommanufactured -oducts. Among the latter, while Pakistan's cotton goods arelikely to encounter increasing quota restrictions over the medium term,non-traditional processed or manufactured exports, including leather products,processed food, some engineering goods and chemicals, are likely to be a majorsource of growth, provided efforts are made to improve product quality.Prospects are also good for expansion of high valued agricultural exports suchas spices, fruits and vegetables, again provided quality and marketing areimproved.

5.17 Import growth, in line with the average for the Sixth Plan Period todate, is expected to be 3.5% per annum in real terms up to FY93, but wouldaccelerate to an average 4.9% subsequently. The current account deficitreduction affects import growth hardest in the first year, when imports growonly about 21 in real terms. The first import liberalization measures are notexpected to have a marked impact on imports; import substitution in energy andedible oil would also moderate import growth. Recent oil discoveries haveincreased estimated recoverable reserves, while efforts to improve producerpricing incentives in the energy sector have brightened prospects for highergas production. With respect to edible oil, improvements in relative pricesfor oilseeds and in cropping practices, as well as measures to deregulate theedible oil industry, would reduce Pakistan's dependence on imports of edibleoil. After FY93, increasing imports of intermediate and capital goods, fromimport liberalization as well as the rapid expansion of the economy, would bepossible with a continued improvement in the trade balance.

5.18 The above projections would result in a falling current accountdeficit, as a share of GDP, through FY91, with a slight increase thereafter aspermitted by continued improvement in the debt service ratio (Table V.3).This improvement in the balance of payments would enhance Pakistan'screditworthiness, by enabling it to finance its borrowing needs fromtraditional sources and rebuild its gross reserves. The projections envisagea gradual buildup of reserves from about 3 weeks of imports to 10 weeks overthe period. The external capital requirements and debt servicing capacity arediscussed in the ni.xt sections.

1/ See World Bank: "Short Term Outlook for the Developing Countries and theInternational Economy", Economic Analysis and Projections Department, July1987. Although inflation has remained modest, the overall outlook of theworld economy continues to be constrained by the tentative policiescurrently being pursued to correct the internal and external imbalances inthe OECD countries.

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External Capital Requirements

5.19 Under this scenario, Pakistan's improving creditworthiness wouldjustify modest real growth in official aid comitments, 40S on concessionalterms and 40S on non-concessional terms, complemented by small but increasingdoses of co ercial financing. Over the next five years (FY89-93), totalcapital inflows of $11.3 billion (or an annual average of $2.3 billion) wouldbe required (Table V.4). The curreit account deficit (including interestpayments) and debt repayment would account for 482 and 391, respectively, oftotal requirements. Amortization would make up 471 of total debt service. Agross reserve buildup of about $1.6 billion, 13S of total capital require-ments, is also needed, given the current low level of reserves. Disbursementsof public medium- and long-term assistance are projected to meet 96S of totalrequirements; the remainder would come from borrowing on commercial terms.While aid would increase in real terms, and would continue to account forclose to 90S of total disbursements, the terms of such assistance are likelyto harden as progressively larger proportions of aid are contracted onnon-concessional terms. In the projections, non-concessional aiddisbursements are assumed to account for over 351 of total officialdisbursements in FY89-93 compared with 24% in earlier years (FY85-88).

TABLE V.4: EXTERNAL CAPITAL REQUIREMENTS FORADJUSTMENT SCENARIO, FY89 - FY93

Annual AverageUS$ billion Percentage

Capital Requirements 2.3 100.0

Current Account Deficit (excl. Interest) 0.1 4.4Interest 1.0 43.5Amortization 0.9 39.1Short-term and Other Capital (Net) 0.0 0.0Increase in Gross Reserves 0.3 13.0

Sources 2.3 100.0

Public 2.2 95.6Official 1.9 82.6Grants 0.4 17.4Concessional Loans 0.8 34.8Non-Concessional Loans 0.7 30.4

Other Public 0.3 13.0Private 0.1 4.4

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Debt Servicing Capacity

5.20 Pakistan's external indebtedness and debt servicing capacity would bewithin a reasonable range. As of end-December 1986, the total level ofdisbursed and outstanding external debt was $14.7 billion, of which 89Xconsisted of medium- and long-term dteot. Concessional assistance accountedfor some 721 of total public debt. The average maturity of public MLT debt isestimated at about 26 years with an average interest rate of 51. With theabove external capital inflows, debt outstanding and disbursed would remainapproximately constant in real terms during FY88-93, with annual nominal growthof 3.71. The recent sharp increase in the debt service ratio -- from 141 ofexports of goods and services and transfers in FY83 to an estimated 281 inFY88 (including repayments to the IMF) 1/ -- and the corresponding reductionin reserve coverage (from an average 147% for FY82-84 of total debt service to241 in FY88) are worrying trends which are being corrected with the adjustmentprogram. The debt service ratio would fall to 21% by the end of the programperiod, with continuing improvement in subsequent years (Table V.3), asborrowing is kept at modest levels and at reasonable terms and as export growthis strengthened. More broadly, the macroeconomic and structural reforms inthe recommended program would improve the country's creditworthiness, byreducing the country's vulnerability to exogenous shocks, improving theflexibility of economic management, and generally improving the basis forsustained growth.

The Alternat-ve to the Proposed Reform Program

5.21 The reform program, while necessary for long-term development andcontinued real income growth, would require the Government's sustained commit-ment to adjustments in several difficult areas. It would require freeing theeconomy from undue government regulation, thereby trusting more to the marketfor resource allocation and investment decisions. It would open the relativelyprotected domestic market to foreign and local competition. It would alsorequire a large resource mobilization effort and restraint in expendituregrowth until the fiscal deficit is reduced to manageable levels. Thesechanges would hurt vested interests. It would involve significant adjustmentsin the way many business and government now operate. It could affect consumerbudgets adversely, especially during the transition period.

5.22 Consequently, the Government may be tempted instead to maintain thestatus quo-to avoid major fiscal policy reforms, including resourcemobilization; make only limited efforts in further domestic deregulation andin correction of sectoral distortions; and avoid significant importliberalizatinn. In all likelihood, it would continue with both a reasonablyprudent monetary policy and exchange rate policy. The budget deficit mightwell remain at about 91 of GDP, with foreign savings used as a partialsubstitute for domestic savings to support growth.

5.23 Maintaining the status quo is feasible for several years, providedthat external factors remain favorable, adverse weather does not materially

1/ The debt service definition in previous CEMs did not include short-terminterest payments and repayments of deposits of foreign monetaryauthorities. Exclusion of these items would have reduced the debt serviceratio by about 21 in FY87.

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Table Vij: THE ALTERNATIVE STATUS QUO SCENARIO. FY88-95

FY88 FY89 FY90 FY91 FY92 FY93 FY94 FY95

National AccountsGOP Growth Rate 6.0 6.0 5.7 5.0 5.0 4.5 4.0 3.SCUP Growth Rate 6.0 5.8 5.6 4.9 4.9 4.4 3.9 3.3GCP/Capita Growth Rate 3.0 2.7 2.6 1.9 1.9 1.4 0.9 0.3Consumption/Capita Growth Rate 2.7 3.1 2.9 1.9 2.1 2.7 2.0 0.7Gross Investment/GOP 16.5 16.0 15.9 15.8 15.8 14.5 13.6 13.2Domestic Savings/GOP 9.7 9.6 9.5 9.5 9.5 8.5 7.7 7.5National Savings/GDP 13.9 13.2 12.7 12.6 12.2 10.9 9.6 9.1Public Investment/GDP A/ 7.0 7.0 7.2 7.2 7.2 6.9 6.5 6.4Public Savings/GDP I/ -1.1 -1.2 -1.1 -1.2 -1.5 -2.2 -2.5 -3.0Private Investment/GOP r/ 9.5 9.0 8.7 8.6 8.6 7.6 7.1 6.8Private Savings/GOP 1S.1 14.4 14.0 14.0 13.9 13.2 12.2 12.2Qatio of Private/Total Investment 57.6 56.3 54.7 54.4 54.4 52.4 52.2 51.5ICOR 2.8 2.8 2.8 3.2 3.2 3.5 3.6 3.9

Consolidated BudoetGovernment Revenues/GDP 18.0 17.4 17.5 17.6 17.8 17.8 17.8 17.8Government Expenditures/GOP 26.0 25.6 25.8 26.0 26.5 26.8 26.8 27.2Deficit (-)/GDP -8.1 -8.2 -8.3 -8.4 -8.7 -9.1 -9.0 -9.4Govt Domestic Borrowing/GOP 6.4 6.9 7.0 7.2 7.2 7.6 7.5 7.8

Salance of PaMnentsDebt Service/XGS 28.1 26.1 25.9 26.0 27.8 29.5 29.5 30.2Debt Service/GOP 5.7 5.4 5.8 6.1 6.5 7.0 7.1 7.4Interest/GOP 2.0 2.0 2.3 2.4 2.5 2.7 2.8 2.9Export Growth Rate 13.0 6.1 6.2 S.1 4.8 4.8 4.4 4.4Import Growth Rate 3.9 3.8 3.7 3.5 3.2 2.9 2.8 2.7Current Account Deficit/GDP 2.5 2.8 3.1 3.2 3.6 3.6 4.0 4.1

A/ Government Development Expenditure/GDP.h/ Government Budget Deficit on Current Account/GOP../ Includes public enterprises investments.

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hurt agricultural output, and aid inflows continue to increase. However,it isnot sustainable over the long-run. Table V.5 shows the set of summaryindicators. A major difficulty with this scenario is the debt build-up. Theexternal debt service ratio would remain at uncomfortably high levels, giventhe potential instability of foreign exchange receipts. The domestic debtservice requirements, with negative impacts on interest rates, claim ongovernment resources, credit availability, and inflation, are a significantbottleneck as domestic borrowing reaches 7-8S of GDP annually. The domesticdebt/GDP ratio would increase rapidly from slightly over 402 in FY88 to 551 byFY93. In addition, government non-bank borrowing requirements would have tobe far in excess of today's level of about 52 of GDP and of expected feasiblelimits, requiring a large shift to monetary financing. External debtservicing would increase to 301 with more international borrowing. Moreover,the Government would need financing on commercial terms exceeding US$400million per year in net terms after 1990, far more than Pakistan is able toborrow from the international capital markets on a sustained basis.

5.24 In addition, the production underpinnings for sustained 61 growthwould drop, as industry and agriculture become less competitive, incentivesfor private investment fall, and the public sector is unable to supplyrequired infrastructure and public/social services. Thus, current growthrates of about 61 per annum could be sustained only through the end of thedecade under this status quo scenario. Subsequently, real growth rates of3-41 per year are more likely, with attendant problems for growth in consump-tion per capita and employment and an undesirable slowdown in the industriali-zation and modernization process.

5.25 Finally, the existing weaknesses in the balance of payments wouldworsen, affecting Pakistan's creditworthiness and its ability to borrow fromboth official and commercial sources. Even with active export promotion,manufactured export growth rates would not be as high as in the adjustmentscenario, as firms supply first the preferred domestic market and do notimprove their cost structures rapidly enough to compete in internationalmarkets. Import growth would also have to be contained, contributing to thedrop in investment and in GDP growth. If export promotion were lesssuccessful, import growth were higher, or cotton exporte and workers'iemittances less buoyant than projected, net borrowing needs would escalateeven faster, pushing the externa'l debt service ratio to well over 30% by theearly 1990s.

C. Consistency Framework for FY89-90

5.26 The reform program recommended in this report has been shown to becompatible with a 6% annual growth in real GDP over the medium to long-term,although it would involve a small reduction in growth during the first threeyears. However, its implementation could be upset, especially in the earlyyears, by financial constraints. This section examines whether the largefiscal deficit can be both reduced and financed without disrupting investmentgrowth and price stability. More specifically, it is designed to determinewhether an investment ratio of about 17% of GDP (and therefore 5.5% GDPgrowth) can be achieved in the next two years, in light of other claims onresources, the expected current account deficit, and monetary policyobjectives. It examines whether the resources available forgrowth-government savings, private savings, and external borrowing-can bechanneled to private and public investment according to the envisaged

_ LswJ _

breakdown. Because deficit financing effectively has first claim on much ofthe country's resources, the real question is whether private investment ofabout 10 of GDP can be realized. The analysis below gives a positive answer.

5.27 A simple net flow of funds framework is the basis for the analysis.Three macro-economic balances in the economy are involved. First, are thesectorai savings-investment balances consistent with the envisaged fiscalpolicies and the external balance objective? Second, is the allocation of netinflow of external resources (foreign savings) among the government, private,and banking sectors consistent with their requirements? Third, is the monetary(and credit) expansion that would satisfy the price stability objective alsosufficient to satisfy the investment and other requirements?

Savings-Investment Balance

5.28 Table V.6 shows the pattern of resource use in the government and non-government (private) 1/ sectors. To reduce the fiscal deficit, developmentexpenditures would increase minimally from 6.71 of GNP in FY87 to 7.0% inFY90, while government savings would improve from (negative) -1.5% of GNP to1.8%. 2/ Of particular importance is the need to raise non-governmentinvestment. An increase in investment in 1987/88 is expected to result fromthe cotton producers' and the textile sector's response to increased worldprices for raw cotton and cotton manufactures. Also, as will be seen below,the availability of credit, which is one of the most important determinants ofprivate investment, is not expected to be a constraining factor. Since it isthe government policy to encourage private investment, while confining its owninvestment to infrastructure and public services, the non-governmentinvestment/GNP ratio can be expected to increase to almost 10% of GNP by FY90.

5.29 At the same time, the non-government savings ra-te is expected to fallduring the first part of the adjustment period. In order to cut the fiscaldeficit, the Government is expected to bolster its revenue effort while alsochecking its transfer payments (e.g., subsidies) to the private sector. As aresult, the Government's net income/GNP ratio would grow over the medium term,leaving for the non-government sector a disposable income of only 86.51 of GNPin FY90 compared to 89.41 in FY87. In an effort to maintain its consumption,the sector is likely to reduce its savings rate as its disposable incomedeclines. Thus, non-government savings would drop from about 15.0% of GNP inFY87 to 12.6% in FY90 but would gradually improve over the longer term. Anyfall in real interest rates (which provide a strong inducement to privatesavings) due to the curtailment of the fiscal deficit would also have adepressing effect on the non-government savings ratio.

5.30 While its surplus is expected to shrink from 6.5% of GNP in FY87 to2.8% in FY90, the non-government sector remains a surplus sector. Therefore,the availability of its savings for both deficit financing by government andits own investment should not be a problem, provided that the financial systemsuccessfully performs its intermediation functions.

1/ The non-government sector, which includes public enterprises, is a proxyfor the private sector.

2/ The quantitative magnitudes in this section are given in terms of GNPrather than GDP.

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Table V.6: INVESTMENT, SAVINGS AND NET BORROWING

1985/86 1986/87 1987/88 1988/89 1989/90Expected

Million Rs at Current Prices

GOVERNMENT SECTORNet Income a/ 63,885 66,766 81,200 97,464 118,838Consumption 65,752 75,946 84,722 90,978 103,202Savings (1,867) (9,180) (3,522) 6,486 15,636Investment 37,353 42,425 46,934 52,300 61,317Development Subsidies 2,424 2,044 1,618 1,200 800Net Lending/Borrowing (41,644) (53,649) (52,074) (47,014) (46,481)

NON-GOVERNMENT SECTORDisposable Income b/ 510,850 565,266 618,621 686,747 760,894Consumption 438,602 469,971 521,470 588,526 650,422Savings 72,248 95,295 97,151 98,221 110,472Devt Subsidies 2,424 2,044 1,618 1,200 800Investment 52,966 56,035 63,666 72,006 86,441Net Lending/Borrowing 21,706 41,304 35,103 27,415 24,831

Govt+Nongovt Net Borrow.BOP Current A/C Balance (19,938) (12,345) (16,971) (19,599) (21,650)

Percent of GNP at Current Prices

GOVERNMENT SECTORNet Iacome 11.1 10.6S 11.62 12.4S 13.52Consumption 11.4% 12.01 12.11 11.61 11.71Savings -0.32 -1.5S -0.52 0.81 1.81Investment (ADP) 6.51 6.71 6.71 6.71 7.01Development Subsidies 0.4% 0.41 0.21 0.21 0.11Net Lending/Borrowing 7.21 8.51 -7.41 -6.01 -5.31

NONGOVERNMENT SECTORDisposable Income 88.91 89.41 88.41 87.61 86.51Consumption 76.31 74.41 74.51 75.01 73.91Savings 12.6% 15.11 13.91 12.51 12.61Investment 9.21 8.91 9.11 9.21 9.81Development Subsidies 0.41 0.41 0.21 0.21 0.11Net Lending/Borrowing 3.81 6.51 5.01 3.51 2.81

Govt+Nongovt Net Borrow.-BOP Current A/C Balance -3.51 -2.01 -2.41 -2.51 -2.5%

a/ Defined as current revenue minus transfer payments.

b/ GNP minus government net income.

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Breakdown of External Balance

5.31 Net external resources equivalent to 2.5S of GNP can be expectedduring FY88-90. While higher than the FY87 level, it represents a markedimprovement over the flows required to finance the large current accountdeficits (3-5S of GNP) during 1983/84 - 1985/86. l/ Although the Governmentreceived on average about 701 of the grants and medium- and long-term loansextended to Pakistan in recent years, the private sector is expected to receivea larger share in the future as it takes more responsibility for output growthand Government investment is focused more on less import-intensive socialservice projects.

5.32 Table V.7 illustrates a possible breakdown of foreign capital inflowbetween the government and the non-government sectors, which is, as will beshown below, also consistent with the financing requirements of the twosectors. Owing to a decline in external resources as a percent of GDP, theproportion of investment financed by such resources would fall between FY86-87and FY89-90 in both the government sector (from an average of 271 to 221) andin the private sector (from 12% to about 101). The reductiou in externalresources would be substituted by increased government savings and by morebank borrowing by the private sector.

5.33 In FY89 and FY90, the banking sector is also expected to absorb partof the external resources in order to increase gross foreign reserves. IMFrepurchase obligations will amount to about $250 million a year over the nextcouple of years.

Financial Balances

5.34 Government Deficit Financing. Table V.8 shows a possible scenario ofgovernment deficit financing that is consistent with the macro-economic frame-work. 2/ Several features of this budgetary financing scenario are worthnoting:

(a) External financing, as a share of net government financing, isexpected to increase from 23% in recent years to 28% in FY90, even

l/ From the standpoint of overall macro-balance in the economy, the Governmentappears to be using, in addition to the surplus of the non-governmentsector, all the net inflow of external resources. But this is rather anational accounting interpretation of the fact that the Government's excessspending is financed by resources which are equivalent to the surpluses ofthe non-government and foreign sectors (the government and non-governmentsectors) and reserve changes of the banking sector (Table V.7).

2/ It has been constructed by taking net capita. transfers from abroad asgiven (Table V.6) and by assigning "likely" values to all capitaltransactions (other than non-bank borrowing) with the domestic non-banksector which are relatively small and stable. (Debt repayment in FY86-87and recoveries of loans in FY87 were unusually large because of thewhitener bonds operations). The appropriate levels of non-bank and bankfinancing are determined with the help of a balance sheet of the SBP asexplained in the annex of this chapter.

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Table V.7: B.ALNCE OF PAYMENTS CAPITAL ACCOUNT

(Million Rs at Current Prices)

1985/86 1986/87 1987/88 1988/89 1989/90Expected

GOVERNMENT SECTOR 9,774 12,127 9,805 11,503 13,539Nonproject Aid a/ 8,860 10,138 19,948 19,619 21,584Project Aid 10,486 12,943 0 0 0FEBC 1,190 800 0 0 0Debt Repayment 10,762 11,754 10,143 8,116 8,045

NON-GOVERNMENT SECTOR 9,208 3,694 5,441 4,365 11,693Private Foreign Capital 2,339 1,854 1,496 1,984 2,259Investment Credits 1,967 1,530 0 0 0FEEC 1,177 135 0 0 0Other Borrowing b/ 6,205 4,128 10,347 13,185 23,145Debt Repayment 2,480 3,953 6,402 10,804 13,711

BANKING SECTOR 956 (3,476) 1,725 3,731 (3,582)State Bank (6,975) (6,876) (3,555) (1,938) (3,582)Bank Deposits 0 (1,360) (1,408) (861) 0Reserve Changes (6,975) (5,516) 2,147 (1,077) (3,582)

Scheduled Banks 7,931 3,400 5,280 5,669 0Bank Deposits 7,931 3,400 5,280 5,669 0Other Assets, Net 0 0 0 0 0

NET EXTERNAL FINANCING 19,938 12,345 16,971 19,599 21,650

MemorandumNet Ext. Funds/Investment

Government 26.2 28.6 20.9 22.0 22.1Non-Government 17.4 6.6 8.5 6.1 13.5

a/ Including project aid for 1987/88 - 1989/90.

b/ Including investment credits for 1987/88 - 1989/90.

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Table V.8: GOVERNMENT CAPITAL TRANSACTIONS

(Millions Rs at Current Prices)

1985/86 1986/87 1987/88 1988/89 1989/90ExDected

DOMESTIC (Non-Bank)Sale of Pub. Ent. Shares 0 400 400 400 400Change in Bank Deposits 3,194 2,164 3,000 2,000 2,000Loans and Investments 1,778 1,620 1,500 2,500 3,000Debt Repayment 11,380 1,279 20,000 2,000 2,000Recoveries of Loans 2,297 2,860 16,500 2,500 3,000Non-Bank Borrowing a/ 33,439 27,250 31,780 22,973 21,476Net Capital Transfersfrom Non-Govt Sector b/ 25,772 29,775 30,180 23,373 21,876

FOREIGNNon-Project Aid c/ 8,860 10,138 19,948 19,619 21,584Project Aid 10,486 12,943 0 0 0FEBC 1,190 800 0 0 0Debt Repayment 10,762 11,754 10,143 8,116 8,045Net Capital Transfersfrom Abroad 9,774 12,127 9,805 11,503 13,539

DOMESTIC BANKSState Bank (4,351) (1,285) 4,666 6,004 7,187Scheduled Banks 10,449 13,032 7,423 6,134 3,879Net Bank Financing 6,098 11,747 12,089 12,137 11,066

NET GOVT SECTOR FINANCING 41,644 53,649 52,074 47,014 46,481

MemorandumNon-bank Borrowing2 of GNP 5.8 4.3 4.5 2.9 2.4S of GDP 6.2 4.5 4.7 3.0 2.5

Net Bank Financing2 of GNP 1.1 1.9 1.7 1.5 1.3S of GDP 1.1 2.0 1.8 1.6 1.3

Net External FinancingZ of GNP 1.7 1.9 1.4 1.4 1.5X of GDP 1.8 2.0 1.5 1.5 1.6

a/ Refers to receipts from various components of domestic debt as given inthe budget documents minus receipts from FEBC, disinvestment of publicenterprise shares, and other small payments.

b/ This item corresponds to the non-bank financing (net) figure in Table ifreceipts from FEBC are included.

c/ Including project aid for 1987/88 -1989/90.

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though part of the foreign resources is for a reserve build-up andfor the private sector.

(b) Non-bank financing is expected to fall markedly, a positive featureof fiscal deficit containment. Non-bank borrowing falls from about5S of GNP in FY86-87 to 2.4X in FY90. This level of non-bankborrowing would permit continuation of the Government's policy tolimit commercial bank borrowing. In addition, it allows theGovernment to continue to offer savings programs, which have becomean institutionalized feature of private saving behavior. Net bankborrowing would gradually decline from 1.91 of GNP in FY87 to 1.31 inFY90, thus allowing adequate expansion in money and credit for therequirements of the non-government sector without disrupting pricestability. This amount of commercial bank borrowing is expected tobe commensurate with the banks' requirement for increased liquidassets (Treasury Bills) to maintain the statutory liquid assets ratioof 301 against deposits, as well as the public's demand for increasedcurrency holdings.

(c) Recommended borrowing from SBP (i.e. monetary financing) falls withinan acceptable range. That is, it is in line with the money supplytarget and the currency/deposit composition within the target. Theannex to this chapter provides a detailed explanation.

5.35 Credit Availability for Non-Government Sector. The non-governmentsector, having large funds in excess of its investment requirements, shouldnot experience any financing constraint on its investment plans. This,however, assumes that the financial sector would mobilize sufficient funds forthe credit expansion required by the non-government sector. Table V.9, whichsummarizes the non-government sector's transactions with other sectors, showexplicitly that this can be achieved. Indeed, the sector's net credit use inFY89 - FY90 would be 56% larger than in the previous two years. The totalavailability of credit from the external sources, SBP and commercial bankswould increase from about 32% of the sector's investment (or 31 of GNP) inFY87 to about 40S of investment (or 3.91 of GNP) in FY89-90.

Summary

5.36 The above scenario of financing a rising investment rate with priceand balance of payments stability will depend on satisfactory progress in thereform program. Particularly important is the improvement in governmentrevenue performance and control of current expenditures, so that the overallfiscal deficit could be contained as assumed in the above scenario.Similarly, continued deregulation and liberalization of trade and industry areessential to raise the aggregate savings and investment rates as well as toavoid bottlenecks in the flow of resources. The monetary policy and financialsector reforms are equally essential requirements for the successfulrealization of this flow of funds scenario. The need to rationalize the leveland structure of interest rates in line with market conditions; and to relax,then gradually eliminate, the use of quantitative ceilings in credit policydeserve special mention as desirable medium-term actions. In addition, theeventual deregulation of the financial sector could quicken the development ofnew savings instruments (e.g., building society or S&L shares and deposits,capital market securities, investment trusts, etc.) as substitutes togovernment securities.

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Table V.9: NON-GOVERNMENT SECTOR CAPITAL ACCOUNT

(Millions Rs at Current Prices)

Net lAnding to: 1985/86 1986/87 1987/88 1988/89 1989/90Expected

Government 25,772 29,775 30,180 23,373 21,876Foreign Sector a/ (9,208) (3,694) (5,441) (4,365) (11,693)Banking Sector 5,142 15,223 10,364 8,406 14,648SBP 4,221 7,974 5,612 4,790 7,613Currency 6,597 li,367 8,612 7,790 10,613Borrowing a/ (2,376) (3,393) (3,000) (3,000) (3,000)

Co= ercial Banks 921 7,249 4,752 3,617 7,034Deposits 17,409 18,223 20,116 26,901 26,939Borrowing a/ (16,488) (10,974) (15,364) (23,285) (19,905)

Net Surplus/Lending 21,706 41,304 35,103 27,415 24,831

MemorandumTotal Borrowing/Investment a/ 53.0 32.2 37.4 42.6 40.0

a/ Non-government sector's borrowing components.

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Appendix to Chapter V

DETERMINING THE LEVEL OF GOVERNMENT BORMOWING FROM SBP

5.37 The discussion in chapter V of government borrowing from the bankingsector as well as non-bank sources has emphasized that borrowing from the SBPshould be in line with the target for growth in the money supply. Table V.8has presented the suggested levels of government borrowing from the SBP during1987/88 - 1989/90 that would be consistent with the monetary expansion, andhence, the inflation target of the proposed program. This note explains howthe government borrowing from the SBP has been determined with the help of an"anticipated" balance sheet of the SBP as shown in the table below.

FACTORS DETERMINING CURRENCY INCREASE(CONSOLIDATED BALANCE SHEET OF SBP)

Million Re at Current Prices

Changes in: 1985/86 1986/87 1987/88 1988/89 1989/90Expected

Govt Net Borrow. from SBP (4,351) (1,285) 4,666 6,004 7,187(-) Foreign Loans to SBP (6,975) (6,876) (3,555) (1,938) (3,582)(-) Banks' Net Position

with SBP (3,100) (2,062) 1,609 2,152 2,155(+) SBP Net Lend. to NonGov 2,376 3,393 3,000 3,000 3,000(-) Unclassified Items 1,503 (321) 1,000 1,000 1,000

(-) Currency outside Banks 6,597 11,367 8,612 7,790 10,613

5.38 The above balance sheet of the SBP has been constructed on the basisof a definitional identity that the amount of currency created by a centralbank is equal to the increase in its assets (claims on other sectors) minusthe increase in its liabilities. The currency increase is determined withreference to the money growth target, which is set equal to the growth targetfor nominal GDP. The envisaged growth in the money supply would beapportioned between currency and commercial bank deposits according to therecently observed preferences of the public as to holding cash vis-a-vis bankdeposits and GNP. In recent years, the public holdings of currency anddeposits have stood at a ratio of 1:3 while the GNP/currency ratio declinedfrom 9.05 in 1984/85 to 9.07 in 1985/86 and 8.40 in 1986/87. In light ofthese, the increases in currency have been estimated.

5.39 Several categories of SBP capital transactions with other sectors inthe above table can be taken as given or assigned pre-determined values. Netforeign borrowing by the SBP is taken from the envisaged balance of paymentscapital account (Table V.7). SBP net lending to the non-government sector,mostly to the non-bank financial institutions and some special developmentfunds, started only in 1982 and has since grown steadily; this can be expectedto continue in the coming years too, as indicated above. Unclassified items

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in the SBP balance sheet mainly refers to changes in the physical assets,paid-up capital and own reserves, and could be assumed to have, on average,small positive values over the medium-term as has been done here. Thus, thereremain only two categories of SBP transactions, namely those with theGovernment and commercial banks, that must be determined in order to completeits balance sheet so as to allow for the envisaged increase in currency.

5.40 Co rercial banks' net position with the SBP may change for tworeasons: First, banks' balances (deposits) with the SBP held as reservesagainst their deposit liabilities may change in response to changes in suchliabilities. Recently, banks have maintained balances with the SBP to thetune of 7-81 of their deposit liabilities even though the statutory reserverequirement (cash ratio) was 51. Second, commercial banks borrow from the SBPfor on - lending to private investors, mostly within various subsidized creditschemes for priority sectors/subsectors. In 1985/86 and 1986/87, theco _ercial banks borrowed from the SBP more than the increase in theirreserves (deposits) with the SBP. For the period 1987/88 - 1988/89 it isassumed that commercial banks' balances with the SBP will increase by theamount required to maintain their "observed" cash ratio vis-a-vis depositliauilities [i.e., 81 x (increase in money supply - increase in currency)].Thus, government borrowing from the SBP during these three years is found as aresidual, which would in turn determine the need for non-bank borrowing tofinance the fiscal deficit.

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STATISTICAL APPENDIX

Table of Contents

Table No.

Table 1 Pakistan - National Accounts Su-mary (Millions of Rupees atCurrent Prices)

Table 2 Pakistan - National Accounts Summary (Millions of US$ atConstant 1980/81 Prices)

Table 3 Pakistan - Balance of PaymentsTable 4 Pakistan - Macroeconomic BalanceTable 5 Key Economic VariablesTable 6 Gross Domestic Product at Current Factor Cost, 1976/77-1987/88Table 7 Gross Domestic Product at Constant Factor Cost, 1976/77-1987/88Table 8 Gross Domestic Expenditure at Current Market Prices, 1976/77-1987/88Table 9 Gross Domestic Expenditure at Constant Prices, 1980/81-1987/88Table 10 Gross Domestic and National Savings at Current Prices, 1977/78-1987/88Table 11 Gross Domestic and National Savings at Constant Prices, 1980/81-1987/88Table 12 Composition of Imports, 1974/75-1986/87Table 13 Volume, Value, and Unit Value of Major Imports, 1977/78-1986/87Table 14 Composition of Exports, 1976/77-1986/87Table 15 Volume, Value and Ur-it Value of Major Exports, 1977/78-1987/88Table 16 Service Payments, Commitments, Disbursements and Outstanding

Amounts of External Public Debt as of December 31, 1986: TotalTable 17 Service Payments, Commitments, Disbursements and Outstanding

Amounts of External Public Debt as of December 31, 1986: By TypeTable 18 Indices of Agricultural Production, 1975/76-1986/87Table 19 Production of Selected Industrial Items, 1976/77-1987/88Table 20 Wholesale Price Index Numbers, 1976/77-1987/88Table 21 Consumer Price Index Numbers, 1977/78-1987/88

Table 1: PAKISTAN - NATIONAL ACCOUNTS SW4ARY

(millions of Rupees at Current Prices)

1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1M"7/

Gross DomesticProduct (Y) 277,961 321,840 362,165 418,201 477,982 542.560 600,174 671,450

Resource Gap(M-X) 29,878 38,254 40,577 48,560 57,519 51,503 39.548 40,102Imports(+nfs) 64,023 69,556 85,051 96,161 107.805 116,741 120,741 137,838Exports(genfs) 34,145 31,302 44,474 47,601 49,890 65,238 81,193 97,736

Total Expenditures 307,839 360,094 402,742 466,761 535.897 594.063 639,722 711,S52

Consumption (C) 260,366 303,062 339,299 395.833 455,500 503,744 541,262 600,952General Goveriuent 28,998 34,337 42,499 51,549 58.080 66,038 76,242 87,600Private 231,368 268,725 296,800 344,284 397,420 437,706 465,018 513,352

Investment 47,473 57,032 63,443 70,928 80,397 90,319 98,460 110.600Fixed Investment 42,973 49.174 56.742 63,439 71,797 81,319 88,500 100,200 I

Changes in Stocks 4,500 7,858 6.701 7,489 8.600 9.000 9,960 10,400 LA

Domestic SavingsSd = Y-C 17,59S 18,778 22,866 22,368 22,482 38,316 58,912 70,498Net Factor Income -2.584 -3,117 -5,289 -5,939 -7,671 31,586 Lr 27,196 L& 23,164 LaCurrent Transfers 22,196 25,188 38,747 40,594 40,326National Saving 37.207 40,849 56,324 57.023 55,137 70,402 86,108 93,682

Average Exchange Rates:Rupees per USS 9.900 10.552 12.750 13.500 15.160 16.139 17.179 17.300Rupees per SOR 11.523 12.234 13.888 14.243 15.274 LA 18.140 La 22.897 La 23.710 Lb

La Average of four quarters' end-of-period rates (IFS series "aa).

Lb As of February 22, 1988.

Lr Sum of net factor income and current transfers.

Table 2: PAKISTAN - NATIONAL ACCOtUTS StIHARY La

Millions of US$ Lh at Constant 1980/81 Prices)

1980/8t 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88

Gross DomesticProduct 28,077 27,931 24,607 24,516 23,537 23,781 24,067 24,891Terms of Trade Effect - -338 -361 -151 -175 -348 -22 -76Gross Domestic Income 28.077 27,593 24,246 24,365 23,362 23,433 24.045 24,815

Resource Gap 3,018 3.273 2,664 2,873 2,875 2,393 1,717 1,848Imports(g + nfs) 6,467 5,950 s,s87 5.689 5,347 5,454 5,376 5,961Capacity of Imports 3,449 2,677 2,923 2,816 2,472 3,061 3,659 4,113(Exports(g * nfs)) 3,449 3,015 3,284 2.968 2,648 3,408 3,681 4,188

Total Expenditures 31,095 30,866 26,910 27,238 26,237 25.826 25,762 26,663

Consimuption 26,300 25,604 22,261 22,663 21,802 21,388 21,134 21,864General Government 2,929 2,993 2,758 2,789 2,733 2.723 2.827 3,000Private 23,371 22,611 19,503 19,874 19,069 18,665 18.307 18.864

Investment 4.795 5,262 4,648 4,575 4,433 4,438 4,628 4,800Fixed Investment 4,341 -4,569 4,183 4,129 4,000 4,031 4,243 4,411Changes in Stocks 454 693 465 446 433 407 385 389

Domestic Saying 1,777 1,990 1,984 1.702 1,559 2,045 2,911 2,952Net Factor Income -135 -304 -391 -362 -420 -430 1.2251, 1.028LcCurrent Transfers 2,116 2,192 2,589 2.412 2.039 2,025National Saving 3,758 3,878 4,182 3,752 3,179 3.517 4.136 3,980

Deflators (1980/81=100)Gross Domestic Product 1.000 1.092 1.154 1.264 1.340 1.406 1.456 1.566Imports (g + nfs) 1.000 1.108 1.194 1.252 1.330 1.322 1.335 1.375Exports (g + nfs) 1.000 0.984 1.062 1.188 1.243 1.183 1.298 1.350Total Expenditures 1.000 1.106 1.174 1.269 1.347 1.417 1.454 1.557Government consumption 1.000 1.087 1.208 1.369 1.402 1.503 1.S70 1.688Private Consamption 1.000 1.126 1.194 1.283 1.375 1.442 1.473 1.575Fixed Investment 1.000 1.042 1.064 1.138 1.184 1.2S0 1.294 1.392Changes in Stocks 1.000 1.074 1.130 1.245 1.309 1.369 1.436 1.544

Exchange Rate Index(US cents per rupee) 1.000 0.938 0.776 0.733 0.653 0.613 0.576 O.S72

La Based on earlier official estimates provided to the mission in September 1987.

Lb Converted in USS on the basis of official exchange rate specified in Table 1.

L& Sum of net factor income and current transfers.

AU i: PMCISTAII - ANU OF PAYHOSTS

(millions f1 US I at C.aunt Prices;

1980/61 11I/ 1982/6S 1983/4 1964/4 1961/U 3966107 1167/96 La

EXPORS ( + nfs) 3,462 3,652 3,416 2.429 3,259 3,a 4,433 5.261Merhanise (fob) 2,112 2,319 2,63 2,66 2,457 2,942 3,14 4,229Won-factor Service 6U 73S m m771 42 67 on 9

DUS ( + nfs) 6.467 6,47 *,S,6 7,0" 7.126 7,227 7,014 7.57VrdhMise (fob) 5.54 5,769 $5,61 6,002 ,669 5,9"4 Sm2 6540

Non-factor Services 963 91 972 1.056 1,111 1,243 lin 1.36U

KSOUPCE ALAUCE -3.05 -,3627 -3,171 -3.619 -3,661 -3,416 -2.581 -2,56

Net Factor Income -261.0 -320 426 -429 -511 -638 -695 -733Factor Receipts 95.4 1SO 121 193 1" 116 96 121Factor PaymEnts 3S6.4 4s0 541 622 671 754 791 654(HILT Interest Paid) 236.7 453 425 471 462 475 525 s19

Net Current Transfers 2,242.0 2,412 3.081 3.048 2.687 2.422 2U557 2.32STransfer Receipts 2,243 2,413 3,052 3.049 2,688 2,526 2.572 2.345Transfer Paymmnts 1 1 1 1 1 6 15 7

CURRENT BALANCE -1,024 -1,535 -511 -1,000 -1,685 -1.234 -719 -964

LT Capital InflowDirect Investment 111.4 n.a n.a n.a 141 191 62 UAOfficial Grant Aid 277.2 4.21 327 299 39 465 33 n.aOfficial H & LTLoans (net) 351.0 437 592 385 S53 406 277 756 LbDisbursomnts 714.7 929 1.002 880 864 1,060 1.615 1.497fepayents 363.7 492 417 492 513 654 738 741

Other HILT (net) 261.3 106 279 70 --- 22 24 ---

Net Credit fro D1F 251.0 374 426 -15 -52 -250 -358 -318Disbursements 382.0 605 507 --- --- --- --- ---Repayments 131.0 131 51 1S 52 250 35U 21

Net Short-term Capital 52.5 20 35 SS 48 -16 67 1lOCapital Flows KEI 9.0 11 17 79 -217 LI 622 La 163 /C- ° &Errors and Omissions --- 9 is 33 -47 -29 7 ---

Change in GrossReserves

i- indicates increase) -310 249 -1,102 132 1.P99 -104 94 341

LA Preliminary Estimate.

Lh Includes Grants.

LS Leludes FEKCs Foreign Curroncy Oeposits. other short-term flows (not)and outstaning e*#port bills.

n a Not available

Soure: Planning Division

Table 4: PAKISTAN - MACROECONOHIC BALANCE

(percent of GNP LA)

Investment-Savings 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/8

1. Foreian Savinas

Current AccountBalance -3.4 -4.7 -1.8 -3.1 -4.9 -3.5 -2.0 2.4

2. Private Sector

Gross DomesticInvestment 6.3 6.0 6.2 6.4 6.5 6.4 6.3 6.7

Fixed Investment 5.7 5.2 5.5 5.7 5.8 5.8 5.7 6.2Change in Stocks 0.6 0.8 0.7 0.7 0.7 0.6 0.6 0.5National Savings 8.6 8.7 13.1 10.7 10.4 10.7 13.4 11.9Investment-Savings -2.3 -2.7 -6.9 -4.3 -3.9 -4.4 -7.1 -5.2

3. Public Sector

Gross DomesticInvestment 9.7 10.6 9.8 9.3 9.2 9.4 9.4 9.2Fixed Investment 8.8 9.1 8.8 8.3 8.2 8.4 8.4 8.2Change in Stocks 0.9 1.5 1.0 1.0 1.0 1.0 1.0 1.0National Savings 3.9 3.1 1.2 1.9 0.4 1.5 0.4 1.6Investment-Savings 5.8 7.5 8.6 7.4 8.8 7.9 9.8 7.6

4. Public and Private

Investment-Savings 3.5 4.8 1.8 3.1 4.9 3.6 1.9 2.4

Nmowrandum Ite

Share of GrossDomestic Investmentfinanced by ForeignSavings (M) 21.6 28.4 11.2 19.6 31.4 22.1 12.5 15.3

La GNP at market prices

Table 5: KEY ECO9OFlC VARIABLES(percent)

1980/81 1981/82 1982/83 1983/84 1984/85 1965/06 1966/47

Incentive Indicators

1. Real Effective Exchange RateIndex, 1980/81=100 LA 100 96 83 82 81 70 60Annual Change -3.7 -13.8 -0.7 -1.5 -13.7 -14.6

2. Real Interest RatesShort-term Deposit Rate Lb - 1.8 3.3 -0.1 5.4 5.0 5.4Long-term Lending Rate 1.8 1.8 3.6 1.3 7.8 8.3 8.1

3. Index of Real WagesAgriculture 100 112 119 - - - 133Manufacture LC 100 101 106 113 - - -

Construction 100 97 95 90 - - 924. Agricultural Prices:

Domestic/International LdCotton 87 113 95 112 76 114 110Basmati Rice 65 66 68 67 54 55 66Irri Rice 70 94 97 95 118 115 125Wheat 64 102 98 103 90 120 112Sugar - 165 206 200 257 228 169

External Trade Indicators

S. Volume Index of Major ExportsRice 100 77 73 102 58 106 100Raw Cotton 100 71 78 30 41 19" 197Cotton Yarn 100 100 141 107 132 1(.. 273Cotton Fabrics 100 117 121 133 137 143 138

6. Export Shares in World TradeRice 10.7 10.4 8.4 13.3 11.0 17.4 -Cotton 7.4 6.2 6.4 8.3 3.1 14.1 -Textile Yarn a Thread 1.6 1.6 2.0 2.6 2.1 2.8 -Cotton Fabric 3.4 4.2 4.4 5.8 5.4 5.7 -

7. Manufactured ExportsReal Growth Rate 19.6 -4.1 25.8 5.3 -13.3 4.6 14.8Value as Share of Total 44.9 52.0 56.6 57.3 53.5 49.5 52.7Exports

8. Comuodity Terms of TradeIndex, 1980/81=100 100 88.8 89.0 94.9 93.4 89.8 97.6Annual Change - -11.2 0.1 6.6 -1.6 -3.9 +8.7Export Price Index 100 92.3 82.7 87.2 81.1 72.8 76.1Import Price Index 100 104.0 92.9 91.9 36.8 81.1 78.3

La Weighted index of data for 14 major trade partners (including Petroleum), withDecember 1981=100.

Lb Profit/loss sharing account deposits of six months to one year.Lri Large scale manufacturing only.LA Export parity basis.

Iable_6: GROSS DOMESTIC PRODUCT AT CURIENT FACTOR COST, 1976/77-1987/ U JA(aillion rupees)

Item 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1963/84 1904/85 1968/61 1946/67 1917/8U

Agriculture 43.968 50.567 54.147 62.164 71.699 83,426 90,715 92.165 108.872 118.670 129,623 lS9.372Major crops 22,4U0 26,738 29,157 34,081 40,354 47,100 50.364 46,040 55,527 60.311 4,814Lb 89.4671kMinor crops 7,205 8,182 8,658 9.912 11.203 13.130 13,660 15,653 17,290 18,59 --- ---Livestock 13,356 14,272 .14,822 16,668 18,090 20.761 23,846 27,4560 32,134 35,769 40,122 44,740Fishing 675 964 1,065 1.017 1,523 2.044 2.493 2,681 3.544 3.66 4,6U7j& 5,1665fForestry 292 411 445 486 529 391 352 341 378 391 --- ---Mining and quarrying 1,261 1,317 1,464 2,239 3,149 3,578 4.19" 5.006 7,153 11,448 12,971 14,574Manufacturing 20,389 24.022 27.484 33,553 40,969 48.419 55,201 67,475 75.030 83.670 9,307 112,046Large scale 14,695 17,381 19.806 24,274 29,791 35,740 40,465 49,254 54.578 68,534 70,685 *0,166Small scale 5,694 6.642 7,678 9.279 11.178 12,679 14,736 18,221 26.452 23.136 27,622 31.8U0Construction 7,513 8.674 9,667 11,906 11.449 12,247 14,567 19,325 26.464 36.421 34.383 38.813Electricity, gas and water 1,916 2,448 3,397 4,789 5,928 6,436 7,274 8,610 8,738 11.116 11,875 13.342Transport, storage &comuinications 9.268 11.282 13.181 15,486 19,370 22,937 25,704 30,659 34.793 39,429 43,307 48,424 iComnerce 21,051 24,983 28.381 33,759 40,592 49,738 55,031 61,559 72,173 81,645 88,138 96,013 eFinancial institutions andinsurance 3.573 4,273 4,931 S,35* 5,549 7,311 9,383 12.079 13,370 14.855 16,144 17,8U4Ownership of dwellings 5,043 5,631 6,221 7,137 8,309 9,506 10,258 11,442 12,577 13,623 14,668 16,023Public administration & defense 10,371 13,155 13,859 16.263 19,257 21,466 26.467 33.133 36.714 42,653 46.,01 51,77"Services 11,609 13,572 15,306 17,950 21,325 24,770 27,391 31,215 35.004 28,866 42,665 47.577GOP at factor cost 135,982 159,925 178,038 210,602 247,596 289,834 326,190 372,748 430,889 485,210 538,454 597,856Indirect taxes less subsidies 13,766 16,494 17,071 23,926 30,365 32,006 35,975 45,453 47,093 57,353 61,726 73,686GOP at mrket prices 149,748 176.419 195,109 234,528 277.961 321,840 362,165 418,201 477,982 542,156 600,174 671,450

LA Figures for 1986/87 are provisional, and for 1987/88 are revised projections.

Lk Includes Minor Crops.

L& Includes Forestry.

Source: Planning and Oevelopment Division.

Table 7: GROSS DOHESTIC PRODUCT AT CONSTANT FACTOR COST 1976/77-1987/U La(million 1959/60 rupees)

Item 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 1964/IS 98/"l 19"/87 1967/88

Agriculture 14.004 14.399 14.845 15.826 16.405 16,992 17,637 16,571 18.600 19.8" 20,233 20,688Major crops 7,944 8,11S 8.315 9,105 9,463 9,836 10.213 8.865 10.388 11.1" 13,664 b 13,748aMinor crops 1,920 1,962 2.086 2,125 2,125 2,189 2,251 2.278 2,353 2,433 - -Ltvestock 3.997 4.133 4,274 4,418 4,574 4,742 4,941 5.251 5,584 5.943 6,288 6,646Fishing 98 131 139 127 153 154 168 178 187 192 281 Li 294LCForestry 45 58 94 90 90 71 64 59 88 GO -

Mining and quarrying 206 212 221 250 283 306 319 326 401 4"7 524 SS5Manufacturing 6,707 7,411 8,025 8,870 9,837 11,212 12,032 13,013 14.102 15,207 16,372 17,687Large scale 4,834 5,362 5,783 6,417 7,153 8,276 8,820 9,499 10,258 11.002 11.772 12.655Small scale 1,873 2,049 2,242 2.453 2,684 2.936 3.212 3.514 3244 4,265 4,660 1,032

Construction 2,076 2,248 2,371 2.644 2,749 2.836 3,175 3,727 ,838 4,217 4.55 4,8"Electricity, gas and water 1,143 1,244 1,366 1,531 1.698 1,777 1,916 2,249 2.345 2,7n9 2,U85 32073Transport, storage & comnications 2.653 3,029 3,275 3,495 3,776 4,042 S,356 4,821 5.156 5.590 5.925 6.269Commerce 5.875 6,460 6,880 7,399 7,913 8.765 9,326 9,680 10.696 11,490 12.630 12.680Financial institutions andinsurance 1,124 1,256 1,337 1,312 1,197 1,436 1.762 2,105 2,196 2.32S 2,437 2.S59

Ownership of dwellings 1.418 1,469 1,522 1,577 1,634 1,693 1,754 1,817 1,363 1.951 2,621 2,8"4 Public administration & defense 4,13S 4.657 4,906 S.209 5,761 5,844 6,169 6,656 7.377 7,707 6,169 a, 0Services 3,060 3,319 3,510 3,711 3,924 4,149 4,387 4.639 4.9S 5,187 S.4U3 S,79GOP at factor cost 42,401 45,704 48,258 51.824 55,177 59.052 62,833 65,606 71,499 76,686 U8.653 34,958Indirect taxes less subsidies 3,822 4,243 4,117 5,137 5,764 5,657 6,038 6,934 6,830 7,f95 8,148 9,124GOP at market prices 46,223 49,947 52.375 56,961 60.941 64,709 68,871 72,540 78,329 4.636 88,1 *4.082

LA Figures for 1986/87 are provisional, and for 1987/88 are revised projections.Lb Includes Minor Crops.L/ Includes Forestry.

Source: Planning and Development Division.

Tabkle GROSS DOMESTIC EXPENDITURE AT CURRENT MARKET PRICES, 1976/77-1987/8 Ia(million rupees)

Item 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1993/84 1984/55 1965/86 1916/87 1987/38

Available Resources 164,330 192.744 218,652 261.792 307.839 360,094 402.742 466.761 535.897 594.063 639.722 711,552

CQnsumti-Qn 135,474 161,239 183,776 218,447 260,366 303,062 339.29" 395,833 455,500 503.744 S41,262 608.952

Private 118.760 142,123 163.437 194,912 231.368 268,725 296.800 344,284 397,420 437,706 465,018 513,352Public 16,714 19,116 20.239 23.535 28,998 34,337 42,49" 51S549 58,050 66,038 71,244 U 7,600

Gross DOmstic Investment 28,856 31.505 34.876 43,345 47,473 57,032 63.443 70.928 80,397 90,319 98.400 116,600

Gross fixed investment 27,856 30,505 33,126 41.345 42,973 49,174 56,742 63.439 71,797 81,319 U.500 100,200Private 9,215 10.254 11,271 14.925 16.874 17,916 21,738 25.64S 29.712 33,307 35S,500 43.100Public 18,641 20.251 21,856 26.420 26.099 31,258 35.003 37,794 42,085 48,012 53,000 S7,100

Changes in stocks 1.000 1,000 1,750 2,000 4.500 7,858 6,701 7,489 8.600 9.080 9o,90 10)400

External Resource Balance -14.582 -16.325 -23,543 -27,264 -29,878 -38,254 -40,577 -48,560 -57.915 -51,503 -39,548 -48,102

Exports (G. & N.F.S.) 13,900 16,315 20,859 29.255 34,145 31,302 44.474 47,601 49.890 65.238 81,193 97,736Imports (G. & N.F.S.) 28,482 32,640 44,402 56,519 64,023 69,556 85,051 96.161 107,805 116,741 120,741 137.838

GOP at Market Prices 149,748 176.419 195,109 234.528 277,961 321,840 362,165 418.201 477,982 542,560 600.174 671,450

Net factor income from abroad 4,178 10,346 12,514 15,979 19,612 22,071 33,458 34,655 32,655 31 .56 27,196 23.184

GNP at Market Prices 153,926 186.765 207,623 250,507 297,573 343,911 395,623 452.856 510,637 S74,146 627,370 694,634

La Figures for 1986/87 are provisional and for 1987/88 are revised projections.

Source: Planning and Development Division.

Takb7e9: GROSS DOMESTIC EXPENDITURE AT CONSTANT PRICES, 1980/81-1987/88 La(million 1980/81 rupees)

Item 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88

Available Resources 307,839 325,697 343,089 367,706 397,736 416,810 442,S72 461,292

Consiumption 260,366 270,170 283,830 305,945 330,527 345,186 363,066 378,240

Private 231,368 238,590 248,661 268,298 289,091 301,239 314,490 326,344Public 28,998 31,580 35,169 37,647 41,436 43,947 48,S76 51,896

Gross Domestic Investment 47,473 55,527 59,259 61,761 67,209 71,624 79,506 83,052

Gross fixed investment 42,973 48,210 53,329 55,746 60,639 65,050 72,890 76,315Private 16,874 17,565 20,431 22,535 25,094 26,643 29,191 32,624Public 26,099 30,645 32,898 33,211 35,128 39,650 43,081 43,691

Changes in stocks 4,500 7,317 5,930 6,015 6,570 6,574 6,616 6,737

External Resource Ralance -29,878 -30,965 -29,354 -36,738 -40,919 -33,005 -29,119 -30,677

Exports (G. & N.F.S.) 34,145 31,811 41,878 40,068 40,137 55,009 63,232 72,452Imorts (G. & N.F.S.) 64,023 62,776 71,232 76,806 81,056 88,014 92,351 103,129

GOP at Market Prices 277,961 294,732 313,735 330,968 356,817 383,808 413,453 430,615

Net factor income from abroad 19,612 19,920 28,022 27,680 24,553 23,760 21,052 17,787

GNP at market Prices 297,573 314,652 341,757 358,648 381,370 407,565 434,505 448,402

LA Figures for 1986/87 are provisional, and for 1987/88 are revised projections. Based onearlier official estimates provided to the mission in September 1987.

Source: Planning and Development Division.

Table 10: GROSS DOMESTIC AND NATIONAL SAVINGS AT CURRENT PRICES, 1977/78-1987/8 UA(million rupees)

Item 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 1984/8t 1985/86 19J6/87 1987/8U

GNP at market prices 186.765 207.623 20.50i 297.I73 343.911 39S.623 42.1A56 510,6S4 p741" 4 6h27370 6I4.63GDP at market prices 176,419 195.109 234.528 277,961 321.840 362.165 418,201 477,982 542,550 600.174 671,450Consumption 161,239 183,776 218,447 260,366 303,062 339.299 395,833 455,500 503,744 541,262 600,952

Gross domestic savings I5.180 11,333 16.,081 17.595 18.778 22.86 2236 222.482 38.816 58.912 70.498

Net factor incomefrom abroad 10,346 12,514 15,979 19,612 22,071 33,458 34,655 32,655 31,586 27,196 23,184

Gross national savings 25.526 23.847 32.060 37.207 40.849 56.324 57L023 5S.127 70.402 L6.108 9362.6Public savings 3.185 2,075 5,149 11,557 10,775 4,630 8,682 1,810 8,810 2,240 11.320Private savings 22,341 2?.772 26,911 25,650 30,074 51,694 48,341 53,327 61,592 83,868 82,362

Gross domestic savingsrate Lb Li A.A i6> Si. 5_83 _ii 31A AM.I 4.071 19.So

Gross national savingsrate LC LI7 ILl 12. 12.50 11.87 14.24 12.59 1Q.0 12.25 13.73 13.49Public savings rate 1.7 1.0 2.1 3.88 3.13 1.17 1.92 0.36 1.53 0.36 1.63Private savings rate 12.0 10.5 10.7 8.62 8.74 13.07 10.67 10.44 10.73 13.37 11.86

La Figures for 1986/87 are provisional, and for 1987/88 are revised projections.Lb Percent of GOP./c Percent of GNP.

Source: Planning and Development Division.

TableJ l: G6OSS DOMESTIC AND NATIONAL SAVINGS AT CONSTANT PRICES, 1960/81-1967/6 La(million 1980/81 rupms)

Item 1980/81 1981/82 1982/83 1983/84 1984/65 1985/6 1966/87 1987/6U

GDP at market prices 27.,961 294.732 313.735 3I0.968 356.817 3A3IL05 4134.I 4t0lf.iSTerms of trade effect - -3,563 -4,607 -2,043 -2,649 -5,611 -379 -1,304

Gross domestic income 277Z 961 291.169 309.128 328.925 3S4.168 378.194 413074 4293.11Consumption 260,366 270,170 283,830 305,945 350,527 345,186 363,066 378,240

Gross domestic savings 17.595 20.999 25.298 22.980 23.641 33.008 50L008 51.C71Net factor incometo/from abroad 19.612 12Z 920 2L.022 27,680 24iJ5l 23.Z60 21.1112 177Z7

Gross national savings 37.207 40.91 S3.320 50.660 48.194 56.78 71.060 6fi.8sGNP at market prices 297.S73 314,652 341.757 358.648 381.370 407.565 434.505 44U .402

MMIes:Ex.ports as capacityto import 34,145 28,248 37,271 38,025 37,488 49,398 62,853 71,148 U

Exports at constant 34,145 31,811 41,878 40,068 40,137 55,009 63,232 72,452 F(1980/81) prices $>

Terms of trade effect - -3,563 -4,607 -2,043 -2,649 -5,611 -379 -1,304 Ln

/A Figures for 1986/87 are provisional and for 1987/88 are revised projections.Based on earlier official estimates provided to the mission in Septeaber 1987.

Source: Planning and Development Division.

Tabl 2: COMPOSITION OF IMPORTS, 1974/75-1986/87 Lk(million rupees)

Item 1974/75 1975/76 1976/77 1977/78 1978/79 1979/S0 1980/81 1981/82 1982/83 198/84 1984/85 1985/86 1986/87

Capital Goods 6 15 7LI 1 8750 9L316 10 970 162679 14.8U2 17503 21135 24 419 29 3 ll9S 3 41

Iron and steel bars 58 45 38 57 30 100 76 65 82 a 9 108 11$Plates and sheets of iron 690 512 775 768 1.067 1,542 1.512 1,514 1,730 2.260 2.059 1.727 1.862

and steelmoop and strip iron - 53 17 21 29 28 26 44 42 64 73 143 147Rails and ralway track 4 93 78 26 78 207 s3 60 5 1 78 41 -Iron and steel wire 53 60 53 59 79 82 SO SS 66 78 108 115Tubes, pipes and fittings 147 412 366 139 222 270 281 410 425 297 5t9 945 902Power generating mchinery 21 129 259 204 458 414 560 852 1,312 1,281 2.826 2.728 2,261

other than electricAgricultural machinery 29S 534 837 939 1,090 1.480 1,048 1 '! 1.943 2,226 1,891 1,583 1,53Textile and leather machinery 14 714 581 S73 501 635 739 o2 877 997 1,393 1,69 2,04machine for special industries 205 407 547 573 528 540 828 837 1.070 2,307 1.912 1,820 2.147Electric power machinery 272 433 383 532 633 561 742 604 736 999 940 1,629 99Road motor vehicles 505 843 1.059 1,141 1,598 2.299 2,345 3,030 3.077 4,560 4,552 5,258 5,539Others 3.88 2.941 3.757 4,284 4,657 8.521 6.617 7,792 9.770 9,333 12.528 15.46 16.093

Consuer Goods 4L714 42337 1 651 S SSS L.M8 27SO0 72775 * 407 9 I ]10. 14.272 1Z i42 1Z 21

Wheat 2,461 1,785 660 1,337 3,505 1,041 633 300 873 858 2,756 4,720 1.184Other food 931 1,281 1,386 2,078 1,871 2,517 2,983 3,148 3,618 4,459 5,210 5,131 7 851Petroleum products 424 390 601 723 926 1,886 1,774 1,661 2,118 1,984 2,418 2.063 1,862Medicines and drugs 186 272 348 513 601 751 936 1,222 1,390 1,800 1.974 2,252 2,638 Printed matter 34 21 24 49 71 167 100 97 92 98 110 134 186 oOthers 678 SU 632 as8 868 1,138 1.340 1,479 1,502 1,547 1,916 2,142 2,492

Raw Materials lO LS9 8970 10.611 12]944 17.7Z 222750 30.887 33 571 27 423 41 542 4A43 41.31 2377

Crude petroleum 2,145 2,526 2,711 3,380 3,046 5,857 9,840 12,121 12,891 12,149 14.374 10,640 7,083PetroleLm products Lb 745 827 772 815 1,274 2,940 3.585 4,264 S5,24 5,028 4.970 4.082 5.031Edible oil 1.297 1,047 1,478 1,353 2,953 2.295 2,625 3,450 3,670 6.518 6,954 6,129 4,062Chemicals 625 483 550 648 814 895 1,212 823 1,132 1,532 1,591 2,070 2,878Dyeing and tanning materials 203 208 208 363 311 392 462 493 57s 613 6U2 728 1,042Fertilizers 960 559 623 1,048 2.808 2,711 3,537 393 2,117 1,539 1,790 2,079 3,247Chemical materials, I.E.S. 388 449 629 449 429 444 550 754 875 1,201 1,802 2.090 2,657Pig iron, sponge forms of iron 280 64 39 47 96 14 120 53 65 U 108 75Ingot & primary forms of iron 481 134 243 295 330 329 383 360 207 117 24 31 122Non-ferrous etals N.E.S. 7 3 4 5 2 2 5 3 1 2 2 4 SIron and steel forgings 17 48 18 11 14 1S 20 9 11 22 1s 31 36Copper 127 42 SO 86 78 133 184 145 178 222 227 292 328AlLuinua 106 35 188 140 135 211 234 356 232 322 407 344 46Others 2,678 2,545 3.098 4,304 S,286 6,380 8.130 9,847 9,896 12,189 13,489 12,694 15,325

Total La 20,925 20,44s 23,012 27,815 36,388 46,929 53,544 59,482 68,151 76,707 89,778 90,946 92,431

La On arrival basis (Customs data).

L Petroleum Products other than consiner goods.

jg Differ from balance of payments figures minly due to the exclusion here of military imports.

Source: Federal Bureau of Statistics.

Table 13: VOLUME, VALUE AND UNIT VALUE OF HAJOR IMPORTS, 1977/78-1986/87 LA

1977/78 1978/79 1979/80 1980/81 1961/82 1982/83 1983/84 1984/8S 1985/86 1986/87

Malor ImportsVolume 5,583 6.683 7,958 7,350 7,120 7,395 7,566 7,563 7,128 8,523Value 875 1,183 1,680 2,278 2,193 2,137 2,248 2,244 1,676 1,375

Unit value 157 177 211 319 319 289 297 296 -235 162

Crude OhVolume 3,368 2,946 4,619 3,955 4,478 4.019 4,108 4,365 3,727 3,714Value 341 308 592 994 1,143 989 915 948 659 412Unit value 103 104 128 251 259 236 213 217 177 III

POL ProductsVolume 1,281 1,681 1,820 1,652 1,634 1,923 2,015 1,954 1,949 3,001

Value 5SS 222 488 541 540 574 547 488 380 401

Unit value 121 133 268 325 337 302 250 250 19S 134

Fertilizervolume 604 1,575 1,112 1,203 314 717 490 496 544 1,005Value 104 284 274 357 85 167 114 118 129 187

Unit value 175 180 246 278 269 233 233 238 237 16

Edible OilVoluse 268 420 346 467 624 655 857 664 825 710

Value 148 268 230 266 321 276 482 459 373 224

Unit value 595 651 667 570 514 431 641 691 458 326

IPAVolume 62 61 61 73 70 81 96 84 83 93

Value 127 101 96 120 103 131 190 231 135 154

Unit value 2,085 1,652 1,531 1,583 1,487 1,617 1,979 2,750 1,627 1,656

Othelr ImrtsValue (CIF) 1,935 2,493 3,060 3,131 3,429 3,220 3,437 3.662 3,958 4.002

Total ImoortsValue (CIF)L L2.1 3l676 4.740 5.409 5.622 S.357 5.685 S.906 5L64 LI5

La On arrival basis. Volumes in thousand metric tons. value in million US dollars and unit value in USdollars. Figures for 1986/87 are provisional an uals.

Lb Differ from balance of payments figures mainly due to the exclusion here of military imports.

Source: Planning and Development Division.

Tablu 14: COMMOSITIS OF E0XPOTS, 1976/77-1986/87 /A(million rupees)

1976/77 1977/78 1978/79 1979/80 1960/31 1981/82 1982/65 1983/54 1984/68 l98/66 1906/57

Raw cotton 292.1 1,102.0 655.2 3,321.0 5,203.4 2,938.2 3,896.6 1,771.5 4,368.0 5,290.5 7,675.7Cotton yarn 1,171.7 1,059.5 1,956.1 2,038.0 2,050.0 2,074.9 3,145.9 2,930.8 3,973.5 4,511.3 8,709.1Cotton cloth 1,603.3 1,741.2 2,135.2 2,416.0 2,389.6 2.949.1 3,579.0 4,856.1 4,637.8 5,083.0 5,931.1Rice 2,477.9 2,408.5 3,380.0 4,179.3 5,601.6 4,127.9 3,682.6 5,688.4 3,339.7 5,527.2 5,052.6Fish and fishpreparations 381.3 341.4 462.0 530.5 559.2 789.2 897.1 1,007.1 1,231.0 1,334.9 1,929.7

Tanned leather 647.4 636.5 1,247.3 1,264.4 891.9 1,152.2 1,195.0 1,971.7 2,325.2 2,900.0 4,079.0Carpets and rugs 911.9 1,170.8 1,764.7 2,198.4 2,242.8 1,678.5 1,912.9 2,322.7 2,030.7 2,692.7 3,439.0POL products 268.5 625.9 607.9 1,?64.2 1,675.2 2,047.3 985.0 543.0 525.0 507.1 443.7Sports goods 199.1 194.9 212.1 244.6 312.3 319.5 442.0 665.0 673.6 786.6 1,000.1Raw wool 76.2 72.7 100.0 95.0 50.0 112.0 169.0 171.4 261.2 274.0 314.8Others 3,264.5 3,627.1 4,404.5 5,358.7 8,303.5 8,081.1 14,536.6 15,410.6 14,613.7 17,684.9 24,693.2

Total 11.293.9 12980.5 16.925.0 23410.1 29.279.5 262.2 ̂ L 34.441.7 37.338.6 37.979.4 49,592,2 63.268.0

La On shipment basis; data differ from the balance of payments values due to leads and lags in payments.

Source: Federal Bureau of Statistics. ao

Table 1S: VOLUME. VALUE AND UNIT VALUE OF HAJO EXPORS, 1977/78-1987/U A

1977/78 1978/79 1979/S0 1980/S1 1981/42 1982/83 1963/84 1964/SS 1906/1 1996/37 1967/86

Raw CottoVolume (N.Kg) 101.00 55.00 251.00 325.00 231.30 254.92 93.22 263.046 68. U 646. 9 5"4.36Value 110.10 66.20 335.30 525.60 264.00 305.62 131.44 279.66 513." 446.OO 696.SPrice (S/Kg) 1.09 1.20 1.34 1.62 1.14 1.20 1.34 1.66 .." 0.71 1.26

WMLRIMVolue (000 MT) 280.00 180.00 320.00 410.00 261.81 237.74 405.93 174.10 260.96 188.00 200.H6Value 124.00 135.40 225.50 290.00 165.42 148.24 143.84 110.06 173.66 14.96 146.96Price ($/NT) 442.86 752.22 704.69 707.32 708.22 623.54 600.69 632.00 665." 713.90 730.00

Dther RiceVOlis (009) T) 600.00 830.00 770.00 830.00 689.22 667.10 859.10 545.0 1,05.6.H 10652:N4 1,060.60Value 119.30 206.00 196.70 275.80 205.85 141.49 178.14 112.0 169.09 161.9 193.00Price (S3/T) 198.83 248.17 255.45 332.29 298.67 212.10 207.36 205.06 160.66 1Is." 193.00

Cotton YarnVolue. (N.Kg) 60.00 97.90 ".90 95.20 95.60 134.10 101.81 125.8 157.64 259.66 -Value 107.00 197.60 205.90 207.00 196.67 247.51 217.42 261.93 279.29 566.93 S03.9Price (S/K() 1.78 2.02 2.06 2.17 2.06 1.85 2.14 2.08 1.77 1.95 _

Cotton CIothVolune (N.Sq.Mtr) 453.50 531.80 545.80 50.90 584.30 605.33 664.38 687.62 727.48 693.50 -

Value 175.70 215.70 244.20 241.40 279.50 281.59 360.24 305.88 314.96 341.23 520.00Price (S/Sq.mtr) 0.39 0.41 0.45 0.4U 0.48 0.47 0.54 0.44 0.43 6.64 -

LeatherVoluwm (N.Sq.htr) 8.70 12.70 10.20 8.80 11.01 10.74 16.64 15.67 17.63 22.32 -

Value 64.30 124.00 127.70 90.10 109.21 94.02 144.27 151.28 177.96 237.43 285.60Price (S/Sq.Htr) 7.39 9.76 12.52 10.24 9.92 8.75 8.79 9.76 16." 10.64 -

Volue (H.Sq.Ntr) 1.90 2.50 2.70 2.50 1.93 2.23 4.69 2.07 2.69 2.76 -

Value 118.30 174.80 222.10 226.60 159.10 1SO.50 172.31 133.67 166.04 206.60 225.60Price ($/Sq.Ntr) 62.26 69.92 82.26 90.64 82.44 67.49 36.74 64.67 62.61 72.64 -

£12' and PreparationsVolume (NJKgs) 13.40 13.60 13.20 19.70 18.20 16.58 27.63 36.34 35. 9 39.98 -Value 34.50 14.70 53.60 56.50 74.87 70.58 74.71 81.15 82.70 112.40 135.60Price (5/Kg) 2.57 1.08 4.06 2.87 4.11 4.26 2.70 2.23 2.31 2.82 -

Guar & ProductsVolume (NT) 90.00 110.00 90.00 50.00 60.00 60.00 70.06 66.93 72.96 74.96 -Value 20.50 27.50 33.60 28.90 28.90 21.90 25.91 22.48 27.50 33.85 -

Price (S/T) 0.23 0.25 0.37 0.58 0.48 0.37 0.37 6.14 0.38 6.46 -

Volume (N. Doz) 1.93 2.54 3.78 4.51 4.89 5.70 9.13 7.19 10.27 1S.44 -Value 29.80 38.10 53.90 75.30 94.20 117.83 160.58 132.71 216.40 355.38 366.96Price (S/DOI) 15.44 1S.00 14.26 16.70 19.26 20.67 17.59 18.46 20.16 23.65 -

Synth, Tax. Feb.Volume (H.Sq.Htr) 31.30 10.30 S.10 90.80 12.30 140.24 66.14 28.60 99.90 277.68 -Value S.SS 6.56 5.45 128.48 23.50 220.12 107.70 41.94 49.76 137.20 -Price ($/Sq.Htr) 0.50 0.64 1.07 1.41 1.91 1.57 1.63 1.47 6.56 6.49 -

R^w woolVolume (N.Kg) 4.90 5.30 4.20 2.70 5.80 7.14 8.24 10.76 9.72 8.6" -Value 7.37 10.10 9.59 5.05 10.62 12.50 12.71 17.20 16.66 18.32 -Price (S/Kg) 1.50 1.91 2.28 1.87 1.83 1.75 1.S4 1.66 1.73 2.13 -

Value 384.58 492.94 651.16 806.77 832.16 582.10 936.73 839.66 892.8 992.74 1383.94

Total ExportsValue 1.311.00 1.709.60 2.364.70 2.957.SO 244 4.00 2il64.00 2.76&.00 L2491.02 2,078Z 0 S.601L00 4 L44.04

La On shipment basis. Values in million US dollars and differ from the balance of paywents values due to leads and lass in *6r nts.

Source: Planning and Developent Division.

Table 16

SERVICE PAYMENTS. COMMITMENTS, DISBURSEMENTS AND OUTSTANDING AMOUNTS OF EXTERNAL PUBLIC DESTPROJECTIONS BASED ON DEBT OUTSTANDING INCLUDING UNDISBURSED AS OF DEC 31, 1986

INCLUDES ONLY DEBT COMMITTED 000000 - DEC 31. 1986DEBT REPAYABLE IN FOREIGN CURRENCY ANM GOOOS

(IN THOUSANDS OF U.S. DOLLARS)* * * TABLE TOTAL * * *

DATE : DEBT OUTSTANDING AT T R A N S A C T I O N S D U R I N G P E R I O D OTHER CHANGES

: END OF PERIOD

DISBURSED: INCLUDING : COMMIT- DISBURSE- : S E R V I C E P A Y M E N T S CANCEL- ADJUST-

: ONLY : UNDISBuRSED : MENTS NENTS :-----------L-----------:----------- LATIONS * : MENT *.: PRINCIPAL INTEREST TOTAL

: (1) : (2) : (3) : (4) : (5) : (6) (7) (3) (9)

197012 3.064,011 4,581,969 951.013 489,308 115.455 77,274 192.729 13.376

197112 3.607.076 4.795.303 370.643 635.906 91.650 58.979 150,629 197.896 132,195

197212 3,797.506 4,780.900 332,460 294,255 105,049 74,899 179.948 296.889 55.075

197312 4,234,378 5,383.805 634,613 342.389 107,144 85.234 192.373 131,462 256,898

197412 4.636.358 6.750.069 1.7783038 822,633 114,639 F3.738 198,377 357.572 60.437

197512 5.093.937 6.799,553 53,256 862.120 148,467 101.425 249,392 37,965 -227.340

197612 6.002.679 7.880.730 1,148,383 900.570 151.520 129.485 231,005 53.154 137.510

197712 6.798.842 83805,322 911.225 790.695 181.332 142,453 323.735 18.342 213.491

197812 7,585.078 9,930.803 1,039,907 769.421 206.944 182,074 389.013 34.325 326.843

197912 8,001.197 10,648,783 1,246,165 882.269 300,175 213,594 513.769 201,115 -26.895

198012 8,785.251 11.466,321 1,286.727 1.218,677 345,629 247,735 593,364 11,651 -111.909

198112 8,826,876 11,886.773 1,331,573 743,267 341.947 197,049 533,996 115,876 -453,293

198212 9,699,329 12,649,972 1,372.921 1,385.419 322,318 249,609 571,927 42.349 -244.555

198312 9,752,968 13.264.902 1,656,066 1,018,594 766,438 313.014 1,079,452 19,577 -255,141 0

198412 10.006.781 13.383,839 1,246,677 1,198,582 614.029 314,895 923,924 54,960 -453.751

198512 10.734.884 15,001.778 1.822,361 1.0C8.681 752,441 309.335 1.061,776 17S,683 718.707

198612 11.764,474 17.222,778 2,116.430 1.112,548 707,640 355,028 1,062,663 131.605 943,815

* * a THE FOLLOWIWG FIGURES ARE PROJECTED * * *

198712 11,936,288 16.354,119 - 1,040,472 866,116 381.106 1,247,222 - -2,543

198812 12,354.243 15.465,315 - 1.306,762 883,813 395,477 1.284,290 - 9

198912 12.609,340 14.662.503 - 1,057,915 802.820 407,896 1.210,716 - 8

199012 12,649,064 13,930.272 - 771.955 732,228 411,375 1,143,603 - -3

199112 12.533.251 13.289.076 - 525,406 641.230 406.449 1.049,670 - 34

199212 12.191.314 12,619,567 - 327.586 669.529 394.160 1.063.639 - 20

199312 11,733.934 11,949,162 - 213,029 670,415 373,027 1,043,442 - 10

199412 11,197.486 11,262,633 - 150,031 686,532 351,539 1,038.121 - 3

* Projected amounts In this column are amounts excluded from projections because of unknown terms.

This column shows the amount of arithmetic Imbalance in the amount outstanding Including und1sbured from one period tothe next. The most common causes of imbalances are changes In exchange rates and transfers of dcbts from one categoryto another in the table.

Table 17

SERVICE PAYMENTS. COMMITMENTS. DISBURSEMENTS AND OUTSTANDING AOUNTS OF EXTERNAL PUBLIC DEBTPROJECTIONS BASED ON DEBT OUTSTANDING INCLUDING UNDISBURSED AS OF DEC 31, 1986

INCLUDES ONLY OEBT COMMITTED 000000 - DEC 31, 1986DEBT REPAYABLE IN FOREIGN CURRENCY AND GOODS

(IN THOUSANDS OF U.S. DOLLARS)FINANCE CODE CONCESSIONAL

CREDITOR TYPE :JLTILATERAL LOANSDATE DEBT OUTSTANDING AT T R A N S A C T I O N S D U R I N G P E R I O D OTHER CHANGES

END OF PERIOD

DISBURSED INCLUDING COMMIT- DISBURSE- S E R V I C E P A Y N E N T S CANCEL- ADJUST-ONLY UNDISBURSED RENTS MENTS ----------- ----------- ----------- LATIONS N:ENT *.

PRINCIPAL INTEREST TOTAL(1) (2) (3) (4) (5) (6) (7) (a) (9)

197012 473.108 753.776 99.400 33.17B 16.740 13.742 30.402 6.420 -197112 479.090 710.522 25.000 39.916 14.631 13.249 27.850 34.356 -19.267197212 521,000 693.461 68.200 26,457 12,158 12,425 24.553 100.716 27.613197312 579.929 731.464 63,000 82.599 12.479 15,654 28.133 45.745 33.227197412 644.243 552.531 134.850 78.097 13.783 14.351 28.134 - -197512 644.396 863.442 72,000 60,018 10,313 15.029 25.342 44.48 -6.288197612 721,424 1.064,373 217.850 93,675 16.647 22.173 39.420 272 -197712 560.919 1,256.675 204.572 151.483 12,960 17.12S 30.065 255 975197812 1.028,049 1.610.229 366.281 178.281 14.923 19.395 34.318 1.576 3,772197912 1,124,394 1.860.544 279.023 110,115 1S.190 20.653 35.843 1S.000 1.752195012 1.373,959 2.399.033 S70.274 277.874 15,624 21.630 37,2S4 S7 -16.404198112 1.470.629 2,653.502 313,780 141.487 20.750 20.033 40.75 3.000 -35.561198212 1.673.004 2,929,853 323,666 237,502 16,860 19.490 36.358 3.956 -26.499 -198312 1.810,732 3.271.28S 412.396 187.962 24,959 23.429 43,355 1.539 -44.466198412 2,031,825 3,557,466 413.595 296,070 41,152 23,924 65,076 8,382 -78.170198512 2.316.016 4.013.491 431,894 275,248 56,971 24.870 53.841 9.697 172.797195612 2.555,064 4.581,019 513.716 266,367 109,406 33.800 143,206 49,727 212.947

* * * THE FOLLOWING FIGURES ARE PROJECTED * * *

198712 2.812,357 4.48S5,132 - 353,157 95.880 27,741 123,621 - -7198812 3.097,998 4.384.714 - 386.059 100,421 29.208 129.629 - 3198912 3,383,451 4,294,056 - 376,111 90,65S 30,656 121,313 - -3199012 3,622,796 4.213,122 - 320,280 80,936 31,961 112,897 - 2199112 3,797,558 4,146.4S5 - 241,432 66,672 33.083 99,755 - 5199212 3.333.706 4,075.27 - 157,325 71,178 33.623 104.301 - t199312 3,915,472 4,001,624 - 105,418 73,656 33.791 107.447 - 2199412 3,899,474 3.920,481 - 65.144 81,143 34.033 115,176 -

Projected amounts In this column are amounts excluded from projections because of unknown terms.

This column shows the amount of arithmetic imbalance in the amount outstanding Including undlsbursed from one period tothe next. The most common causes of imbalances are changes In exchange rates and transfers of debts from one categoryto another In the table.

Table 17 2SERVICE PAYMENTS. COMITMENTS. DISBURSEMENTS AND OUTSTANDING AMOUNTS OF EXTERNAL PUBLIC DEBT

PROJECTIONS BASED ON DEBT OUTSTANDING INCLUDING UNDISBURSED AS OF DEC 31. 1986INCLUDES ONLY DEBT COMMITTED 000000 - DEC 31. 1986

DEBT REPAYABLE IN FOREIGN CURRENCY AND GOODS(IN THOUSANDS OF U.S. DOLLARS)

FINANCE CODE CONCESSIONALCREDITOR TYPE BILATERAL LOANS

DATE DECT OUTSTANDING AT T R A N S A C T I O N S D U R I N G P E R I OD OTHER CHANGES: END OF PERIOD

DISBURSED INCLUDING COWIT- DISBURSE- S E R V I C E P A Y M E N T S CANCEL- ADJUST-: ONLY UNDISBURSED MENTS MENTS ---------------------- : ----- : LATIONS * MENT ** : .: : PRINCIPAL INTEREST TOTAL: (1) (2) (3) (4) (5) (6) (7) (3) (9)

197012 1.906.058 2.764.014 586.747 274.142 22.294 29.157 51.451 S.244 -

197112 2.250,996 2.964.402 255,132 383.937 12.663 15.412 28.075 125.535 83,454197212 2.407.232 3.087,406 224.835 185.469 12.570 21,644 34.214 124,066 34.825197312 2.601.755 3.430.010 348.564 226.575 10,572 22.266 32.838 80.351 84,963197412 3.002.937 4.638.955 1.334.102 553,818 9.551 26.849 36.400 219.214 103.606197512 3.564.361 4.786.260 295.480 653.785 26.572 44,420 70,992 6.559 -115.044197612 4,431.266 5.561,189 582.626 627.682 24.371 59.400 83.771 11.667 226.361197712 5.001.319 6.184.620 435.211 384.271 31.726 73.214 104.940 17.506 237.452197812 5.596.454 6.917.092 510,410 437,164 52.954 88,663 141.617 13.429 288.445197912 5.875,160 7.284.028 671.430 552,523 119.192 112,077 231.269 148.034 -37.268198012 6.171.445 7.379.483 348.618 539.618 181.318 128.599 309.917 2.796 -69.049198112 6,219,870 7.257.758 406,305 479.183 141.440 71.099 212,539 31.400 -355.190198212 6.354.902 7,222.663 331,928 435.414 159.463 96.891 256.354 29.061 -178.499198312 6.334.823 7.174,101 352.265 338.425 209.888 128.348 338.236 15.050 -175.889198412 6.120.702 6.932,951 349.315 288,227 232.191 130.976 363.167 19.248 -339.026198512 6,:i0.812 7.643.187 467.852 307,402 258.601 137,575 396,176 95 501.080198612 7.210.015 8.230.127 267.884 449.770 308.552 158.072 466.624 60.258 687.866

. * * THE FOLLOWING FIGURES ARE PROJECTED * * *

198712 7.263.148 7,893.639 - 389.624 336.488 165.412 501.900 - -198812 7.217.612 7.523.966 - 324.142 369.679 165,829 535.508 - 6198912 7.007.160 7.139.562 - 173.955 384.413 162,616 547.029 - 9199012 6.727.051 6.778.883 - 80.572 360.676 155.868 516.544 - -3199112 6.455.808 6.474.1093 - 33.563 304.815 151.629 456.444 - 25199212 6.155.605 6.161.893 - 12.009 312.218 144.743 456.961 - 18199312 5.843.685 5,845.115 - 4.864 316.789 137,624 454,413 - 11199412 5.507.072 5.507,106 - 1.397 338.011 132.509 470.520 - 2

* Projected amounts in this column are amounts excluded from projections because of unknown terms.

This column shows the amount of arithmetic imbalance in the amount outstanding Including und1sbursed from one pertod tothe next. The most co_on causes of Imbalances are changes In exchange rates and transfers of debts from one categoryto another in the table.

Table 17 3

SERVICE PAYMENTS. COMMITMENTS. DISBURSEMENTS AND OUTSTANDING AMOUNTS OF EXTERNAL PUBLIC DEBT

PROJECTIONS BASED ON DEBT OUTSTANDING INCLUDING UNDISBURSED AS OF DEC 31, 196-

INCLUDES ONLY DEBT COMMITTED 000000 - DEC 31, 1986DEBT REPAYABLE IN FOREIGN CURRENCY AND GOODS

(IN THOUSANDS OF U.S. DOLLARS)FINANCE CODE NON-CONCESSIONALCREDITOR TYPE :JLTILATERAL LOANS

DATE DEST OUTSTANDING AT T R A N S A C T I O N S D U R I N G P E R I 0 5 OTHER CHANGES

: END OF PERIOD

: DISBURSED INCLUDING COMMIT- DISBURSE- S E R V I C E P A Y M E N T S CANCEL- ADJUST-

: CGNLY UNDISBURSED MENTS :ENTS ----------- ----------- ---- : LATIONS * :ENT *-

PRINCIPAL INTEREST TOTAL

: (1) (2) . (3) (4) (5) (6) (7) (8) (9)

197012 141.287 242,311 56.050 60.773 6.229 6,930 13,159 -

197112 i89.849 250,952 - 38.502 10.610 105,96 21.206 3 19.254

197212 183.710 240.427 20.300 11,186 17.325 12.255 29,560 13.500 -

197312 168,541 216,128 - 9.016 18,887 14.003 32.950 5.412 -

197412 171.361 364.061 165.020 19.907 17.085 13.460 30.545 2 -

197512 224.005 442,022 123,000 97,683 11,167 11,602 22,660 33.871 -1

197612 269.796 506,453 87.800 58.602 12,811 24,843 37.654 10.558 -

197712 314,468 596,682 103,000 56,942 12.269 22,729 34,99 502 -

197812 376.531 654,514 73,765 77,851 15.790 30,921 46,711 144 1

197912 415,929 624.290 6,527 74.740 35,342 38,074 73,416 1.408 -1

198012 443,110 647,390 56.300 52.415 25,236 40.366 65.602 7.966 2

198112 444,385 678.254 66,475 36.982 35,707 38,332 74,039 69 165

198212 519,527 871,748 230.652 110.751 35,943 35,352 71,295 *59 -356 W

198312 575,857 1,083,182 253.500 97.038 39,803 45,644 85.447 1.045 -1.218

198412 678,091 1,169.170 136.000 146.659 43.159 46.209 89.368 S,588 -1.265

198512 747,810 1.660.960 570.200 120.957 53,160 56.741 109.901 27.226 1,976

198612 843,108 2,699,886 1,133,469 188,132 93,507 82.951 176.456 1,706 672

* * * THE FOLLOWING FIGURES ARE PROJECTED * * *

198712 999,166 2,638.175 - 217,769 61.691 100.982 162.673 - -20

198812 1,329,453 2,569.990 - 398.472 68.185 126,916 195,101 - -

198912 1.590,153 2,488.681 - 342.009 81,309 152,091 233.400 - -

199012 1,775,556 2,379,156 - 294,928 109,525 172.040 281.565 - -

199112 1,848.309 2,229.387 - 222,523 149,770 182,396 332.166 - 1

199212 1,822,814 2,051,659 - 152,234 177,729 182,871 360,600 - 1

199312 1.743,815 1,870,944 - 101,716 180,715 176,602 357.317 - -

199412 1,651,865 1.695,969 - 83.025 174,975 167,295 342.270 - -

Projected amounts in this column are amounts excluded from projections bOcause of unknown terms.

*. This column shows the amount of arithmetic Imbalance In the amount outstanding Including undasbursed from one period to

the next. The most common causes of Imbalances are changes In exchange rates and transfers of debts from one category

to another in the table.

Table 17SERVICE PAYMENTS. COMMITMENTS. DISBURSEMENTS AND OUTSTANDING AMOUNTS OF EXTERNAL PUBLIC DEBT

PROJECTIONS BASED ON DEBT OUTSTANDING INCLUDING UNDISBURSED AS OF DEC 31, 19S6INCLUDES ONLY OEBT COMMITTED 000000 - OEC 31. 1986

DEBT REPAYABLE IN FOREIGN CURRENCY AND GOODS(IN THOUSANDS OF U.S. DOLLARS)

FINANCE CODE NON-CONCESSIONALCREDITOR TYPE BILATERAL LOANS

DATE DEBT OUTSTANDING AT T R A N S A C T I O N S D U R I N G P E R I O D OTHER CHANGESEND OF PERIOD

DISBURSED INCLUDING COMMIT- DISBURSE- S E R V I C E P A Y M E N T S CANCEL- ADJUST-ONLY UNDISSURSED MENTS MENTS ----------- ----------- ----------- LATIONS MENT *-

PRINCIPAL INTEREST TOTAL(1) (2) (3) (4) (5) (6) (7) (8) (9)

197012 263.318 345.204 68,481 52.132 25.636 14.088 39.724 374 -197112 337.952 393.525 45.150 71.366 9.678 8.136 17.814 S.166 21.015197212 353.900 357.230 8.804 44.077 27.823 17.844 45,667 14,609 -2,667197312 607.933 671.078 194,154 6.757 19.313 18.787 38.100 7.800 146.307197412 550.881 557,755 40.636 8:.329 35,975 18.274 54.249 77.540 -40.444197512 415.588 419.937 4.647 5146 60.836 20.106 00.944 227 -81.402197612 336.764 409.301 135.655 '!.448 55.047 12.060 67.107 22.233 -69.011197712 305,412 337.082 40.837 81,555 77.691 17.777 95.468 259 -35.106197812 251.252 284.484 5.623 2.753 61.400 16.242 77.e42 2,241 5.420197912 219.506 346,925 141.000 33.648 49.986 13.481 63.467 33.030 4.457198012 270.896 375.476 69.715 92.293 34.964 I4.zs98 49.362 - -6.200198112 225.214 305.210 65.355 8.202 43.656 16,504 60.160 0,72 -t.C003198212 262.867 340.975 66.319 66.517 18.502 14.463 32.965 3.219 -8.333193312 242.230 576,826 289.580 32.161 48.434 19.361 67.795 293 -5.002198412 232.9S3 624.862 135,438 64.632 68.682 24.861 93.543 10.235 -8.485198512 331.026 792,068 228.586 150.976 54.266 23,856 78.122 13.444 6.330198612 363.366 829.914 118.064 103.828 75.135 26.304 101.439 19.827 14.744

* * THE FOLLOWING FIGURES ARE PROdECTED * * *

198712 252.710 671.204 - 48.054 158.501 31.814 190.315 - -209198312 280.984 523.649 - 175.829 147.557 31.774 179.331 - 2198912 325.263 417.068 - 150.S61 106.582 31.687 139.269 - 1199012 283.762 314.744 - 65.823 102.325 29.092 131.417 - 1199112 247,638 253.494 - 20.127 61.251 23.801 35.052 - 1199212 196.917 190.465 - 4.308 55.029 19.646 74,675 - -199312 143.552 144.069 - 1.031 54.394 15.631 70.025 - -2199412 89.790 89.792 - 515 54.2Y9 11.533 65,862 - 2

Projected amunts In this column aro amounts excluded from projections becaus of unknown terms.

* This column shows the amount of arithwetic Imbalance in the amount outstanding Including undisbursed from one period tothe next. The most co_on caus"s of Imbalances are changes In exchange rates and transfers of debts from orm categoryto another In the table.

Table 17

SERVICE PAYMENTS. COMMITMENTS, DISBURSEMENTS AND OUTSTANDING AMOUNTS OF EXTERNAL PUBLIC DEBTPROJECTIONS BASED ON DEBT OUTSTANDING INCLUDING UNDISBURSED AS OF DEC 31. 1956

INCLUDES ONLY DEBT COMITTED 000000 - DEC 31. 1986DEBT REPAYABLE IN FOREIGN CURRENCY AND GOODS

(IN THOUSANDS OF U.S. DOLLARS)FINANCE CODE: PRIVATE FINANCING

CREDITOR TYPE: SUPPLIERS CREDITSDATE DEBT OUTSTANDING AT T R A N S A C T I O N S D U R I N G P E R I OD OTHER CHANGES

: END OF PERIOD

DISBURSED INCLUDING COMMIT- DISBURSE- S E R V I C E P A Y N E N T S CANCEL- ADJUST-ONLY UNDISWURSED MENTS MENTS ---------------------- : ----- : LATIONS * MENT *

: : : PRINCIPAL INTEREST TOTAL: (1) : (2) (3) (4) (5) (6) (7) (8) (9)

197012 235.432 390.273 96.941 55.836 34,195 11,207 45.402 1.106 -197112 279.399 391.981 35.479 63.778 29.476 9,132 38.606 29.780 25,443197212 266.884 328,364 8.681 20.218 28.241 8,860 37.101 35,351 -5.706197312 220,461 231,156 16.897 14.519 32.808 9.407 42.215 41.767 -9,530197412 160.275 185.415 9,795 16.966 27.980 6.813 34,793 50.489 -7.067197512 132.424 143,237 5.447 15.170 23.412 S.131 26.543 2.120 -21.393197612 111.216 148,144 49.590 16.114 20.191 4.253 24,444 8.402 -16.090197712 142.541 204,766 70.836 48.317 18.243 4.806 23,051 289 4.318197812 171.724 229.471 43.255 49,157 27.753 13.229 40.982 3.960 13.163197912 174.702 230.756 44,658 43.734 41.137 12.025 53.162 3.616 1.380198012 180.337 207.167 19,180 47.301 37.511 13.804 S1.315 832 4.426198112 146.880 261.742 104,188 14.793 31.456 12.256 43.712 520 -17.637198212 127.954 249,935 34.706 22.096 31.818 10.697 42.515 4.651 -10.014198312 154.302 252.611 35.742 57.636 25.797 8.890 34,687 902 -6.367198412 181.326 271.293 49.999 57.405 25,862 9.460 35,322 314 -5.141198512 179,274 240.406 32.654 18.030 24.532 6.942 31,474 45,226 6.217198612 192.159 226,295 - 28.987 21.641 13.144 34,785 85 7.615

* * * THE FOLLOWING FIGURES ARE PROJECTED * * *

198712 164.913 191.163 - 7.886 35.047 12.832 47.879 - -8S198812 142.957 158,699 - 10.508 32.464 10.930 43,394 - -198912 118.279 12S.809 - 8,213 32.892 9.039 41.931 - 2199012 94.379 97,050 - 4.858 28,756 7.058 35,814 - -3199112 72,163 72.254 - 2,581 24,796 5,321 30,117 - -199212 50,605 50,605 - 92 21,651 3.817 2S.468 - 2199312 32,349 32.349 - - 18.256 2,513 20.7S9 - -t99412 17.623 17.623 - - 14,726 1,474 16.200 - -

* Projected amounts In this column are amounts excluded from projections because of unknown terms.

** This column shows the amount of arithmetic Imbalance In the amount outstanding including undisurse from one period tothe next. The most comon causes of imbalances are changes in exchange rates and transfers of debts from one categoryto another In the table.

Table 17SERVICE PAYMENTS. COMITMENTS. DISBURSEMENTS AND OUTSTANDING AMOUNTS OF EXTERNAL PtiLIC DEST

PROJECTIONS BASED ON DEBT OUTSTANING INCLUDING UNDISBURSED AS OF DEC 31t 19"INCLUDES ONLY DEBT CO1MITTEO 000000 - DEC 31, 1986

DEBT REPAYABLE IN FOREIGN CURRENCY AND GOODS(IN THOUSANDS OF U.S. DOLLARS)

FINANCE CODE: PRIVATE FINANCINGCREDITOR TYPE : FINANCIAL INSTITUTIONS

DATE DEBT OTSTANDING T : T R A N S A C T I O N S D u R I N G P E R I O D OTHER CHANES: END OF PERIOD

DISBURSED: INCLUDING : COMMIT- DISBURSE- S E R V I C E P A Y M E N T S CANCEL- :ADUST-: ONLY : UNDISBURSED : MENTS : MENTS :-----------:---------------------: LATIONS * : MENT *

PRINCIPAL: INTEREST TOTAL: (1) : (2) : (3) (4) : (5) : (6) : (7) : (5) : (9)

197012 44.806 866391 43.394 13.247 10,361 2.150 12.511 233 -197112 69.760 63.921 9.e82 38,407 14,592 2.454 17.046 56 2,2n197212 64.780 74.012 1.640 6,848 6.932 1.871 6,603 5,627 1,01O197312 55.759 73,969 11.996 2,923 13.065 5,067 16,142 267 .431197412 106,661 151,352 93.635 66,516 10.265 3,i9i 14.256 10.327 4.340197512 118.163 144.655 12.662 30,318 16.167 5.235 21,402 - -3.212197612 132.213 191,320 74,862 40.049 22.453 6.156 28.6f0 2 -5.742197712 174.183 225,497 56,769 68.127 286443 6.300 35.243 1 5.852197812 161,066 235,013 40,573 24.215 34.124 13.624 47.746 12.975 16.042197912 191.506 301.940 103,527 67.509 39.322 17,254 56.612 27. 2.755196012 340.504 457,772 222,640 209,176 50,976 28.930 79.914 - -15.032196112 319.898 730,307 375,470 62,620 66.938 328620 10, 758 15 -332962198212 761.075 1,034.798 385,650 513.139 59,732 72,706 132244a 1.073 -20.354198312 635,024 906.397 312.603 305.372 417.557 67.342 504,839 748 -22,19198412 761,884 233.095 162.030 345,589 202.983 79,465 282,443 11,193 -21,656196512 609.946 651,666 91.175 128,068 302.911 59.351 362.262 - 30,307198612 600.742 655,537 83.297 75,464 99.397 40,757 140,154 - 19,971

* . * THE FOLLOWING FIGURES ARE PROJECTED * * *

198712 443.994 474,806 - 23,982 178.509 42.325 220.034 - -2.-222198812 285.239 304,297 - 11,752 170,507 30.820 201.327 - -2195912 185.034 197.327 - 6,766 106,969 21,805 125.774 - -1199012 140.520 147.317 - 5.494 50,010 15,356 65,366 -199112 111.775 113.393 - 5,180 33.926 12.219 46.145 - 2199212 61.667 81.667 - 1.618 31.724 9,460 4C.164 - -2199312 55.061 55.061 - - 26.605 6.86b 3%,471 - -1199412 31.662 31.662 - - 23.398 4,695 26,093 - -1

Projected aounts in this column are amounts excluded from projections because of unknown terms.

.* This column shows the amount of arIthmtIc Imbalance In the amount outstanding Including und1sburcod from one period tothe next. The most common causes of Imbalances or. changes In exchange rates and transfers of debts from one categoryto another in the tibl.

lable 18: INDICES OF AGRICULTURAL PRODUCTION, 1975/76-1986/87(1959/60=100)

Item 1975/76 1976/77 19W7/78 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 1984/851A 1986/86 1986/87 /A

Food crops 2Q1 2Q2 2Q1 222 212 am1 211 2.1 2±1 25Z 2in 212

Rice 263 275 296 329 323 314 345 346 336 333 293 354Wheat 222 234 214 2S5 278 294 289 318 278 299 356 310Barley 94 89 87 93 85 127 114 133 101 95 96 100Jowar (Sorohtu) 121 112 122 108 107 99 97 95 95 99 94 101BaJra (M1illet) 94 95 97 96 84 65 83 67 78 86 78 65Maize 165 154 166 161 177 196 188 203 205 208 204 224Gram 99 107 101 88 51 55 48 81 86 8 96 95

Non-fts< croPs 237 2V 22 2 2in 222 1 11 317 A 22 in m

Sugarcane 240 277 282 256 258 304 343 305 322 301 261 281Rape and mustard 112 124 9 104 103 106 100 103 91 98 103 113Sesamum 138 150 163 238 238 225 213 138 11 175 188 1SOTobacco 95 120 121 111 128 110 113 107 131 142 128 128

Cotton 122 IAI 192 162 250 245 212 Zn 170 11 417 112

All crops 221 2 22 211 2 211 111 301 211 21 21 211

La Provisional.

Source: Ministry of Planning and Development.

Table 19: PRODUCTION OF SELECTED INDUSTRIAL ITEMS, 1976/77-1987/88

Item Unit of quantity 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/187L 1997/ULh

Cotton yarn Million kgs 282.6 297.9 327.8 362.9 375.0 430.2 448.4 431.6 431.7 482.2 58U.4 S96.0Cotton cloth Million sq.met. 408.3 391.3 339.4 342.3 307.9 325.0 33S.5 296.6 271.8 253.5 237.9 283.0Cigarettes Billions 28.4 31.3 32.5 34.6 35.9 38.1 38.2 40.1 38.9 39.6 46.0 46.0Refined sugar 1000 metric tons 736.3 860.8 607.3 585.8 851.3 1,301.3 1,127.0 1,145.1 1,306.1 1,116.0 1,285.9 1350.0Vegetable ghee 325.9 360.3 422.3 452.2 504.9 531.3 512.6 594.8 640.3 612.0 68.7 600.0Cement s 3,224.0 3,071.0 3,224.0 3,343.0 3,S38.2 3,657.0 3,938.0 4,503.0 4,698.0 4,980.0 5,400.0 64875.0Fertilizers 824.2 812.7 938.5 1,176.8 1,605.2 1,952.1 2,575.0 2,675.7 2,714.1 2,733.9 2,7 0.0 2.845.0Paper board andchip board * 21.4 22.4 49.7 51.3 59.2 59.7 58.8 61.8 69.1 63.0 68.9 75.0

Safety matches Million boxes 780.8 1,139.4 1,275.1 1,444.3 1,672.6 1,337.2 1,402.6 1,690.0 1,765.1 1,8".1 2,129.6 2,324.0Chemicals 1000 metric tons 130.2 166.0 179.8 194.6 200.1 214.6 214.5 235.5 248.7 260.4 278.0 297.0Mild steelproducts 269.6 315.3 362.4 420.9 494.7 550.8 636.7 654.2 718.5 731.7 782.3 833.0

Jute goods 33.9 33.4 37.0 41.8 50.2 56.0 66.4 84.0 78.2 100.0 112.0 120.0Cycle rubber ptyres, tubes 1000 nos. 7,592 8,695 7,885 9,o04 9,497 9,753 9,210 9,908 11,112 10,268.0 11,000 11,500

Coke Metric tons 345,873 369,949 369,500 451,245 610,059.0 787,296 1,007,350 1Pig iron * 382,447 462,625 490,856 706.016 48,438.0 897,200 1.221,750Billets - 40,323 179,921 259,121 253S,513.0 253,800 30,000 i.

H.R sheets eoand coils 16,348 196,794 397,362 514,000 630,000 1

C.R. sheetsand coils 18,870 92,915 - -

Formed sections S 4,491 3,037 4,600 5,000Cars Nos. 4,120 9,229 13,215 15,178 16,500 18,000Trucks * 3,161 3,148 4,183 S,149 2,899 3,075 3,644 2,883 2,797 2,215 2,300 3,200Buses U 1,037 520 1,176 1,930 513 285 765 624 619 616 625 700Jeeps (4x4) 2,192 1,620 1,219 1,641 1,682 1,511 2,138 2,119 1,715 2,321 2,500 2,950Light Coqferc ialvehicles * 1,927 1,394 8,347 5,961 8,391 11,170 10,978 11,599 12,392 11,563 11,600 12,500

Motor cycles/scooters/rickshaws 23,729 37.408 51,798 65,953 53.174 24,903 34,452 54,017 52,905 60,404 68.250 77,130

LA Provisional.Lb Projections.

Source: Planning and Development Division.

Table 20e WHOLESALE PRICE INDEX NUMUERS. 1976/77-1967/8U(197S/76 = 100)

Item 1976/77 1977/73 1978/79 1979/80 1980/31 1961/62 1982/3U 1963/54 1964/35 195186 1906/37 1 "7/8U La

General 111.92 120.81 128.85 144.73 163.69 176.16 152.27 201.38 20B.92 217.38 223.53 247.63

Food 113.76 124.41 126.33 137.15 155.02 175.55 173.66 191.22 215.23 214.67 224.26 241.29

Raw materials 108.17 118.44 139.02 142.57 152.47 157.66 158.99 199.66 1. 181.1S 263.95 235.48

Fuel, lighting t lubricants 105.05 106.77 124.3a 176.25 231.93 243.64 262.23 275.40 290.14 329.72 322.96 349.46

ma,wfactures 112.44 119.89 126.67 139.91 154.04 1S9.11 169.08 19.80 194.16 197.96 212.80 225.63

Building materials 114.94 126.25 151.66 197.52 204.73 201.41 200.48 216.S0 223.96 240.36 247.91 278.07

La July - December

Source: Federal Bureau of Statistics.

Table 21: CONSUMER PRICE INDEX NUMBERS. 1977/78-1987/88 La(1975/76=100)

Commodity Group 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1946/87 19d7/88 Lb

Genera) 120.48 128.47 142.23 159.81 175.79 183.67 199.03 213.87 224.21 232.88 246.96

Food and beverages 120.92 128.28 139.19 157.40 178.74 182.27 197.96 212.18 217.33 226.13 245.50

Apparel 126.82 133.50 145.79 156.65 168.39 189.45 212.73 239.47 256.44 266.72 252.48

Housing and household operations 117.75 125.68 139.42 156.54 165.95 172.19 179.59 189.70 193.64 202.94 208.00

Miscellaneous 118.95 129.64 153.00 172.57 182.21 198.34 217.88 233.75 258.31 270.8S 279.17

La Combined indices of industrial. conmercial. and government employees.

Lb July - December

Source: Federal Bureau of Statistics

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