PAKISTAN

ECONOMIC REPORT

April 7, 1999

The World BankPoverty Reduction and Economic ManagementSouth Asia Region

CURRENCY EQUIVALENTS

Currency Unit = Pakistan Rupee (Rs) at Official Exchange RateUS$1 = 25.895 1992/93

= 30.164 1993/94= 30.852 1994/95= 33.568 1995/96= 38.994 1996/97= 43.196 1997/98= 46.23 (December 1998)

FISCAL YEAR (FY)

July 1 ² June 30

LIST OF ACRONYMS

ADB Asian Development BankCAR Commission on Administrative RestructuringCBR Central Board of RevenueCEC Chief Ehtesab (Accountability) CommissionerCPI Consumer Price IndexDFIs Development Finance InstitutionsEB Ehtesab BureauESAF/EFF Enhanced Structural Adjustment Facility/Extended Fund FacilityFCAs Foreign Currency AccountsFCDs Foreign Currency DepositsGDP Gross Domestic ProductGHS Golden Handshake SchemeGOP Government of PakistanHBL Habib Bank LimitedIFIs International Financial InstitutionsIMF International Monetary FundIPPs Independent Power ProducersKESC Karachi Electric Supply CompanyLCs Letters of CreditNBFIs Non-Banking Financial InstitutionsNCBs Nationalized Commercial BanksNEPRA National Electric Power Regulatory AuthorityNGOs Non-Government OrganizationsNRSP National Rural Support ProgramO&M Operations and MaintenancePEPCO Pakistan Electric Power CompanyPRSP Punjab Rural Support ProgramSAP Social Action ProgramSBP State Bank of PakistanUBL United Bank LimitedWAPDA Water and Power Development Authority

Vice President: Mieko NishimizuCountry Director: Sadiq AhmedSector Manager: Roberto ZaghaTask Leader: Ghulam Qadir

PAKISTANECONOMIC REPORT

Table of Contents Page

Executive Summary i-iii

1. Crisis Management 1

2. Economic Policies and Outcomes, 1997/98 – 1998/99 2Growth and inflation 2Fiscal developments 2Monetary management 2External sector developments 3Conclusions 4

3. Strengthening Governance and Reducing Poverty 4Governance 4Power 5Banking 7Privatization 7Taxation 8Public expenditure 9Corruption 10Civil service reform 11Poverty reduction 13Human resource development 13

Statistical Appendix 1-21___________________This report was prepared by a World Bank team led by Ghulam Qadir and including Aiza Aslam, Rashid Aziz,William Byrd, Mudassir Khan, Shaheen Malik, Abdul Qadir, Shams ur Rehman, and John Wall. Besides providingdrafts for sections of the report, John Wall and William Byrd provided extensive editorial help and extremely usefulsuggestions for improving the content and presentation of the report. As team leader for the Economic ManagementCluster, John Wall provided overall guidance.

Sadiq Ahmed (Country Director, Pakistan and Afghanistan), Zoubida Allaoua, Regina Bendokat, Hugo Diaz, JamesHarrison, and Roberto Zagha (Sector Manager, SASPR) provided very useful comments.

Assistance from the Government of Pakistan in providing data required for the report and the Statistical Appendix isgratefully acknowledged. The report was discussed with the Government before being finalized.

Pakistan Economic Report

Executive Summary

1. Pakistan has once again survived a difficult economic crisis. It nevertheless still faces veryserious problems of poverty, slow growth and vulnerability in the balance of payments. Now is thetime to re-invigorate the country’s efforts to implement fundamental reforms to ensure sustainedrapid economic growth and poverty reduction.

2. The nuclear tests of May 1998, the economic sanctions that followed, and the related dryingup of most capital inflows led to severe financial difficulties. A combination of adroit domesticeconomic and financial management and international financial assistance have allowed Pakistan tocome through the immediate crisis without drastic disruption of economic activity. Unlike the crisiscountries in Southeast Asia, Pakistan maintained positive growth of GDP, single digit inflation, lowerinterest rates, exchange rate stability (after an initial spike), and reduced fiscal and external deficits.

3. To manage this crisis, Pakistan had to take drastic measures. It froze withdrawals of foreignexchange from foreign currency deposits (FCDs). It created a dual exchange rate regime. Itstrengthened its macroeconomic and structural policies by further reducing fiscal expenditure andraising tax rates beyond those in the 1998/99 budget. It stopped servicing debt payments other thanfor preferred creditors and asked banks to roll over some maturing debt. It went to the Paris Club forrescheduling of over $3 billion of debt service payments due in 1999 and 2000. It drew on theresources of international financial institutions (IMF, Asian Development Bank and World Bank) forcritical balance of payments support.

4. Pakistan also had some good luck on its side. Agricultural harvests in 1997 and 1998 wererelatively good, partly due to favorable weather conditions. International prices of petroleum andwheat fell further during 1998 and early 1999, helping ease both the external and fiscal deficits.Other world market prices contributed to a favorable shift in Pakistan’s terms of trade.

5. Most important, Pakistan had an on-going economic reform program since 1997 that helpedmitigate the effects of the crisis. Pakistan had reduced its fiscal deficit from 7.1 percent of GDP in1995/96 to 5.4 percent in 1997/98. The non-interest fiscal (primary) balance had been reversed froma deficit of 3.2 percent of GDP in 1993/94 to a surplus of 1.2 percent in 1997/98. The currentaccount deficit had fallen from 7.1 percent of GDP in 1995/96 to 3.2 percent in 1997/98. Thereforms in the banking sector initiated in 1997 paid off in the much strengthened regulatory andsupervisory capacity of the State Bank of Pakistan (SBP), better management of the nationalizedcommercial banks and enhanced ability of SBP to effectively manage monetary policy. Theseallowed the banking system to weather the financial storm without capsizing. Despite the crisis,banks and the banking courts continued and strengthened the loan recovery process, collecting Rs 20billion annually in 1997 and 1998 from non-performing loans.

6. External financing in support of the 1997 reform program temporarily stopped after May1998. However, the government acted swiftly to revive and even strengthen the original policycontent of the reform program, including strong up-front actions. The government changed themanagement of the Water and Power Development Authority (WAPDA); it also decided to separate

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the water and power wings, empower the National Electric Power Regulatory Authority (NEPRA) toset tariffs, and embark on a major arrears, theft and loss reduction campaign. It sought to renew thetax collection agency (Central Board of Revenue) with legal, procedural and institutional reforms.

7. Based on the revived reform program, the government sought assistance from internationalfinancial institutions (IFIs) and the Paris Club of bilateral donors. With the resumption of the IMF’sESAF/EFF program, balance of payments assistance from the World Bank, and refund of paymentsfor the purchase of F-16 planes by the United States, foreign exchange reserves increased from $415million on November 12, 1998 (the lowest level reached during the crisis) to $1,733 million onFebruary 11, 1999. Reserves increased further to $1,838 million on March 31 after disbursement of$200 million by the Asian Development Bank (ADB). As the external financing position becamerelatively more comfortable, restrictions on most payments were lifted, and the 30 percent cashrequirement for import LCs was discontinued. All in all, Pakistan has gained a crucial breathingspace, a window of opportunity to take a longer-term view and refocus on the key structuralconstraints while putting macroeconomic stabilization on a sustainable footing.

8. Although Pakistan has managed to deal with the immediate crisis, its credibility withmultilateral, official and private creditors and investors has been seriously damaged. This is reflectedin the recent downgrading of Pakistan by international rating agencies, leading to loss in investorconfidence, sharply lower domestic investment and private remittances and a rise in the cost ofexternal financing. Other costs include those associated with the rescheduling of foreign debt by theParis Club and the freezing of FCDs. Moreover, disputes with the Independent Power Producers(IPPs) have significantly damaged Pakistan’s investment climate and relations with internationalinvestors. Unless the government re-builds its credibility in international financial markets andimplements policies to strengthen the balance of payments through stronger growth of exports andlarger inflows of foreign private capital, Pakistan will again run into serious balance of paymentsdifficulties when normal debt servicing resumes.

9. The post-May 1998 developments exposed the longstanding structural problems andvulnerabilities of Pakistan’s economy. The structural reforms initiated in the 1990s to tackle themhad been interrupted a number of times, eroding the credibility of the reform effort. To build a strongbasis for economic growth and poverty reduction, effective economic reforms need to beimplemented across a range of sectors. There are many areas where needed reforms are lagging,either in formulation or implementation. In recognition of these concerns, the government hasdeveloped a new Policy Framework Paper, which describes the government’s medium-term reformagenda. Effective and sustained implementation of this reform program will be essential for Pakistanto achieve its development objectives including poverty reduction. Commitment to these reforms hasto withstand strong opposition from interest groups such as employees of state-owned corporations,private traders, landlords, and government bureaucrats. The lingering effects of the crisis could leadto possible social discontent, arising from the difficult economic situation, lower growth, greaterpoverty and tough adjustment measures needed to address the balance of payments and fiscalproblems.

10. Against this backdrop, this report focuses on two fundamental, interrelated issues: improvinggovernance and reducing poverty.

11. Improving governance is a prerequisite for everything else. The most stubborn problem inPakistan’s macroeconomic and structural reforms is the long-term failure of fiscal revenues to rise as

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a share of GDP. A basic reason for this has been lax adherence to the rule of law in collecting fundsdue to the government (taxes) and public sector (bank loans and power tariffs). Failure to mobilizeadequate revenues has particularly hurt the provinces, with adverse implications for expenditures onsocial services. Poor governance has also led to inefficient use of public funds, including on capitalprojects outside the discipline of the budget and planning process; inadequate public sector spendingon physical and social infrastructure; and the legacy of using the civil service as a primary employer.This leads to a weakening of administration and a lowering of morale in government, making it moredifficult to reduce poverty, carry out the public’s business or implement needed reforms. However,some progress has been made in recent years in reducing non-productive public expenditures.

12. Strong and sustained commitment by the government will be needed to implement a medium-term program to strengthen governance and reduce corruption. To improve the credibility of theexisting accountability mechanism, the process should be made more transparent and objective byestablishing an autonomous, non-political agency to investigate cases of corruption. Legal andjudicial processes should be streamlined to protect property rights, ensure speedy and efficientresolution of business disputes, and enforce contractual obligations. To lay the foundation for aprofessional bureaucracy with incentives for integrity, comprehensive civil service reforms should becarefully designed and effectively implemented with appropriate sequencing. Such reforms, whichneed to be initiated urgently, should be one of the key components of the strategy for improvinggovernance.

13. On the poverty front, there is some evidence that the slowdown of economic growth in recentyears may have resulted in an increase in the incidence of poverty in the 1990s, even before thecurrent crisis. Thus, there is a compelling need for a clear strategy focussing on reviving andsustaining high economic growth (6 percent p.a. or more) in a stable macroeconomic environment(i.e. low fiscal and external deficits with single digit inflation). It includes provision of quality basicsocial services, particularly education, health and drinking water. It includes making sure there is anefficient and responsive social safety net program for the very poor. Sustained, high economicgrowth and low inflation in the prices of food and other mass consumption goods are very importantfor the welfare of the poor. Through better education and improved health, the life-long earningcapacity of the poor can be enhanced. The extremely poor and those whom basic social services andhigher growth cannot help over the medium term should be assisted through well-targeted socialsafety net programs. The existing social safety net, comprised of the Zakat Fund and Bait-ul-Maal,may be inadequate as presently operated to cushion the impact on the poor of the low growth of theeconomy expected in the current and next fiscal years.

14. The government alone cannot reduce poverty -- decentralized and participatory efforts ofcommunities, the private sector and other non-government organizations (NGOs) also will be crucial.In the past five years, there has been a major improvement in the collaboration between governmentand NGOs. This has led to substantial government funding of effective NGOs. The government hasalso established the Pakistan Poverty Alleviation Fund (PPAF) which will channel funds to NGOsworking at the community level. And efforts are underway to increase the involvement ofcommunities and NGOs in the Social Action Program (SAP). Hence, there is potential for creative,productive cooperation between government and civil society in effectively reducing poverty.

1. Crisis Management

1.1 Immediately after taking office in February 1997, the present government initiatedcomprehensive structural reforms and stabilization measures. The main objectives were toreinvigorate growth, reduce inflation, lower the fiscal deficit, and strengthen the balance ofpayments through improvement in Pakistan’s export competitiveness. Good initial progress wasmade in reducing fiscal and external imbalances, reviving growth, and lowering inflation in1997/98. The reform program, however, went off track following nuclear detonations by India andPakistan in May 1998.

1.2 Developments following the nuclear tests exposed Pakistan’s underlying vulnerability andprecipitated a balance of payments crisis. Although the crisis was quite serious, Pakistan’seconomy survived the external shock fairly well, for several reasons: (1) weak integration withinternational financial markets -- i.e. its external vulnerability was concentrated in the foreigncurrency deposits (FCDs), which were promptly frozen; (2) deft economic management, including avariety of actions to prevent overshooting of the exchange rate; (3) a large and robust informalsector which is not captured in the economic statistics; and (4) a relatively good food supplysituation and significant declines in international energy and food prices.

1.3 With a very low level of foreign exchange reserves, the immediate prospect of massivewithdrawals from FCDs posed a grave risk. The government chose to suspend withdrawals inforeign exchange from FCDs and to impose certain restrictions on other foreign payments. Pakistanalso built up substantial arrears on debt servicing and other foreign exchange obligations. Thesedevelopments adversely affected the confidence of local and foreign investors. The major creditrating agencies downgraded Pakistan to significantly lower quality ratings. Foreign privateinvestment, particularly portfolio investments, as well as overseas Pakistani workers’ remittances,sharply declined, further aggravating external imbalances. About $4 billion in expected privatecapital inflows did not materialize, while the Karachi Stock Exchange index declined by 51 percentbetween May 9 and July 14, 1998. The East Asian crisis also continued to hurt Pakistan’s exports.

1.4 In order to avoid loss of all foreign exchange reserves, the government imposed restrictionson certain foreign payments in addition to debt service. It established a temporary dual exchangerate system to offset the loss of export competitiveness while easing the pressure on the officialexchange rate, fixed at Rs46/US$1. Most imports and exports were put on the “composite exchangerate”, which was a weighted average of the official and a new floating inter-bank exchange rate. Asa result, the Pakistan rupee depreciated by 7.4 percent vis-à-vis the US dollar (as measured by thecomposite rate), between July 22, 1998 (start of the dual system) and November 11, 1998.Subsequently, the rupee stabilized and the composite rate on March 25, 1999 showed a depreciationof only 5.1 percent since the beginning of the dual exchange rate regime. A 30 percent advanceimport deposit also was introduced to discourage imports. Cash reserve and statutory liquidityrequirements were reduced to ease the anticipated squeeze on banks’ liquidity resulting fromwithdrawals from FCDs.

1.5 Beyond these immediate financial measures, the government responded swiftly to reviveand strengthen its 1997 reform program, including strong up-front actions. Based on this reformprogram, the government sought assistance from international financial institutions (IFIs) and theParis Club of bilateral donors. With the resumption of the IMF’s ESAF/EFF program, balance ofpayments assistance from the World Bank, and refund of payments for F-16 planes by the United

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States of America, foreign exchange reserves increased from $415 million on November 12, 1998(lowest level reached during the crisis) to $ 1,733 million on February 11, 1999. Reserves furtherincreased to $1,838 million on March 31 after disbursement of $200 million by the AsianDevelopment Bank (ADB) under the newly approved Trade, Export Promotion and Industry Loan.As the external financing position became relatively more comfortable, Pakistan removed mostrestrictions on current account transactions ahead of the schedule agreed upon under the ESAF/EFFprogram. All in all, Pakistan has gained a crucial breathing space, a window of opportunity to takea longer-term view and refocus on the key structural constraints while putting macroeconomicstabilization on a sustainable footing.

2. Economic Policies and Outcomes, 1997/98 – 1998/99

2.1 Growth and inflation: The recovery of economic growth that had begun in 1997/98 wasarrested by the post-May 1998 developments (Table 2.1). Compression of imports necessitated byshortage of foreign exchange, a sharp decline in both foreign and domestic investment, and lowerdemand for exports adversely affected the manufacturing sector. Value-added in large-scalemanufacturing is projected to grow by only 2.4 percent, sharply down from 6.2 percent in 1997/98.Growth of the agricultural sector, too, is expected to be only about half the level of last year. For1998/99, real GDP growth is now forecast at about 3 percent. Inflation (at 6.5- 7.0 percent) isexpected to be somewhat lower than in 1997/98 because of continuation of tight monetary and fiscalpolicies, good performance of food crops, and lower international prices of major imports andexports.

2.2 Fiscal developments: While Pakistan succeeded in lowering the overall budget deficit from6.3 percent of GDP in 1996/97 to 5.4 percent in 1997/98, it has done so mainly through cuts in bothcurrent and development expenditures and much higher-than-budgeted receipts from the PetroleumDevelopment Surcharge (PDS). Because of weak tax administration, a reduction in tax rates, lowerimports (particularly in the post-May 1998 period) and generally sluggish economic activity, taxrevenues have consistently fallen short of the budget target by a wide margin. Tax revenues areexpected to remain below the target for 1998/99 as a whole. While the federal revenue shortfallwill be partly made up by higher-than-budgeted growth of receipts from the PDS, the fiscal positionof the provinces will continue to be constrained, with adverse implications for expenditures on theSocial Action Program (SAP) and other high priority programs.

2.3 Monetary management: Several amendments were made in banking laws in the last twoyears to give greater autonomy to the State Bank of Pakistan (SBP) in the formulation of monetarypolicy and to enhance SBP’s authority in banking supervision and regulation. The management ofthe nationalized commercial banks (NCBs) was replaced with professional bankers from the privatesector. These reforms have resulted in an improvement in monetary management and havestrengthened the banking system. As a result, the banking system was able to weather the recentfinancial crisis and escape a loss of confidence following the freezing of withdrawals in foreigncurrency from FCDs.

2.4 In the face of fiscal and external imbalances, SBP has pursued a relatively tight monetarypolicy in the last three years (Table 2.1). During the first eight months of 1998/99, SBP continuedto pursue a tight monetary stance, when broad money increased by only 2.9 percent. For the year asa whole, money supply is projected to increase by 5 percent, compared with monetary growth of

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14.2 percent in 1997/98. As a result of various policy measures adopted by SBP (a cut in thestatutory liquidity ratio and lowering of the discount rate), interest rates have fallen in the last oneand a half years. The weighted average rate of return on new bank loans declined from 17.2 percentp.a. in 1996/97 to 16.5 percent in 1997/98. Five major commercial banks have recently cut theirlending rates by an average of two percentage points.

Preliminary

Outcome Projections 1/

Item 1980-90 1990-95 1995/96 1996/97 1997/98 1998/99

GDP (at factor cost) 6.1 5.1 5.2 1.3 5.4 3.0

GDP per capita 2.9 2.0 2.3 -1.4 2.6 0.2

Private consumption per capita 1.8 2.0 4.4 -3.5 -3.5 -0.9

M2 2/ 14.0 19.3 13.8 12.2 14.2 5.0

Inflation (CPI) 7.1 11.5 10.8 11.8 7.8 7.0

Inflation (WPI) 7.7 11.8 11.1 13.0 6.6

Exports (valued in US$) 7.7 9.5 7.1 -2.6 4.2 -4.4

Imports (valued in US$) 4.3 6.8 16.7 -6.4 -8.2 -16.8

Current account balance/GDP 3/ -4.4 -4.5 -7.1 -6.2 -3.2 -3.0

External debt stock/GDP 3/ 43.1 43.6 43.5 45.9 46.0 52.8

Debt service (DOD)/exports 3/ 4/ 29.1 27.9 30.5 34.3 31.5 34.3

Gross reserves (in weeks of imports-cif 5/ ) 7.2 6.7 8.2 4.9 4.3 8.1

Government fiscal deficit/GDP 3/ -7.2 -7.1 -7.1 -6.5 -5.5 -4.5

Gross investment/GDP 3/ 18.7 19.4 18.7 17.4 17.3 15.5 Public investment 9.2 8.5 8.1 6.9 5.8 6.0

Private investment 6/ 9.5 10.9 10.6 10.5 11.4 9.5

Gross domestic savings/GDP 3/ 9.8 14.3 12.3 12.4 15.5 14.0

Gross national savings/GDP 3/ 14.6 14.9 11.6 11.2 14.0 12.5 Public savings 1.6 2.3 1.5 0.9 1.4 0.7

Private savings 13.0 12.6 10.1 10.3 12.5 11.8

1/ IMF & Government of Pakistan’s projections (as of end February 1999). Projections are preliminary and

subject to revision.

2/ Figures from 1990/91 onward include Resident Foreign Currency Deposits (RFCDs).

3/ Long-term trend is the average of 10 years, while other years show the yearly ratios.

4/ Ratio of medium- and long-term debt service to exports of goods and non-factor services.

5/ Imports of goods and non-factor services.

6/ Includes changes in stocks.

Note: Ratios are calculated with respect to GDP at market prices.

Source: Government of Pakistan and IMF and World Bank staff estimates.

TABLE 2.1: SUMMARY OF MACROECONOMIC INDICATORS

(yearly % change unless otherwise indicated)

at constant 1980/81 prices

at current prices

Long-term

trend Outcome

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2.5 External sector developments: There was a significant improvement in the balance ofpayments in 1997/98, with the current account deficit (excluding official transfers) declining to 3.2percent of GDP from 6.2 percent in 1996/97, mainly because of the lower deficit on trade andservices accounts and higher workers’ remittances. However, the external sector was seriouslyaffected by the economic sanctions imposed after nuclear tests in May 1998 and relateddevelopments. Erosion of investor confidence following the freeze on FCDs led to a sharp declinein foreign private capital inflows and workers’ remittances. These adverse developments, alongwith suspension of new economic assistance by major donors, pushed Pakistan’s foreign exchangereserves down from US$1,533 million at the end of April 1998 to US$415 million (the lowest levelreached during the crisis) by November 12, 1998, hardly sufficient to finance 2.3 weeks’ imports.In the first eight months of 1998/99, exports and imports declined by 12 percent and 17 percent,respectively. Workers’ remittances were down by 34 percent and foreign private investmentdeclined by 57 percent. For 1998/99 as a whole, the current account deficit is projected to go downslightly to 3.0 percent of GDP from 3.2 percent in 1997/98, mainly on account of importcompression, which is not sustainable.

2.6 Pakistan’s external debt has increased significantly during the 1990s, mainly due to growthof private debt. Total external debt, inclusive of private sector debt, increased from $27.5 billion in1993/94 to $32.6 billion in 1997/98, equivalent to 50.6 percent of GNP. With non-residents’foreign currency deposits in the banking system and non-bank financial institutions (NBFIs) added,the total external debt of the country amounts to $37.1 billion. Since the opening up of the externalcapital account in 1991, private non-guaranteed debt, which is mostly short-term, has more thandoubled, increasing from $1.4 billion in 1992/93 to $3.0 billion in 1997/98. The debt-service ratiorose sharply from 25.7 percent in 1993/94 to 34.3 percent in 1996/97, before declining to 31.5percent in 1997/98, mainly because of a decline in amortization. There will be a sharp spike in bothPakistan’s debt-to-GDP ratio and its debt service to export ratio in 1998/99 due to debt reschedulingand the extraordinary financing required to withstand the financial crisis.

2.7 Conclusions: Pakistan needs to vigorously pursue macroeconomic stabilization policies ona sustained basis. The recent reduction in the fiscal deficit has been brought about mainly throughcuts in public expenditure and a windfall increase in receipts from oil surcharges. Importcompression has been the main factor behind the improvement in the balance of payments. In thecontext of a more open and vibrant economy, emphasis must shift to increasing and diversifyingexports through maintaining a competitive exchange rate and export facilitation measures.Similarly, there is a need to increase revenues by strengthening tax administration and broadeningthe tax base. In the past, repeated attempts to stabilize the economy have failed because ofunderlying structural constraints. Hence addressing the country’s deep and persistent structuralproblems is essential for sustained improvement in the balance of payments and fiscal position andresumption of rapid economic growth. (The needed reforms are discussed in detail in Pakistan’sPolicy Framework Paper.)

3. Strengthening Governance and Reducing Poverty

3.1 Governance: Underlying most of the economic problems faced by Pakistan is the “crisis ofgovernance”. This has contributed to the recent slowdown of economic growth and increase inpoverty. Governance problems have greatly constrained and distorted the development of theprivate sector, depressed tax collections (through tax evasion and granting of tax exemptions and

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concessions), contributed to arrears in payment of utility bills and the huge build up of the non-performing portfolio of the banking system, hampered the effectiveness of public expenditure, andopened the way for massive waste in public enterprises. Sectarian strife and law and orderproblems in Karachi and some other urban centers are adversely affecting economic activity.Heightened concerns for personal security, faulty enforcement of contracts, and an uncertain policyenvironment are discouraging domestic as well as foreign investors. The government is fully awareof governance problems and has highlighted them in its Pakistan 2010 Vision Statement issued inFebruary 1998. A good beginning has been made in addressing financial governance issues in keyareas of public economic management. In early 1998 the government set up the Good GovernanceGroup (GGG) to serve as a focal point for development and implementation of the reform agendafor improving governance. The Group has recently submitted its recommendations, formulatedthrough a broad-based consultative process, to the Prime Minister. But there is still a long way togo. In particular, the reform agenda needs to be broadened to address governance issues as theyrelate to public administration reform, judicial reform, and citizen participation in the developmentprocess, especially women.

3.2 Power: A stark example of poor governance is provided by the public power utilities.Theft of electricity (in most cases in connivance with the staff of these utilities), overstaffing, grossinefficiency, and poor bill collection have brought WAPDA and the Karachi Electric SupplyCompany (KESC), the two state-owned power utilities, to the brink of collapse. Sharp increases inthe average cost of electricity generation related to an increase in the number of private sectorthermal generation plants coming on line, combined with delays in adjusting tariffs to reflect thesehigher costs, have further aggravated the financial weakness of the power utilities. Negotiationswith the Independent Power Producers (IPPs) for voluntary tariff reductions got mired in anapproach that mixed corruption charges and contract disputes. There was a substantial build-up ofcross-arrears between the government, the utilities and the fuel suppliers that is only now beinguntangled.

3.3 Several measures were taken to address these problems in the short run. Electricity tariffswere raised by an average of 21 percent in March 1998, which included a much needed reduction incross-subsidies to households and agricultural tubewells. Efforts have been made, partlysuccessfully, to collect arrears of electricity bills from all levels of government, but the unpaidelectricity bills of the federal and provincial government agencies are still very large. Thegovernment has inducted armed forces personnel for collecting overdue electricity bills from privateconsumers and for checking theft of electricity. The successful drive against illegal connections hasled to a fall in sales demand (in peak load of up to 1,000 MW), as illegal connections are beingremoved by WAPDA as well as by the consumers themselves. While this decline in load reducesWAPDA’s costs, it also adds to its excess generation capacity, at least until demand builds up toabsorb it. To encourage greater use of electricity and reduce cross-subsidization, the governmentafter approval from the National Electric Power Regulatory Authority (NEPRA) has recentlynotified new electricity tariffs, implying an average tariff increase of 9.4 percent. The tariff fordomestic consumers is being raised by 10.3 percent on average, while the average industrial tariffwill decline by 7.8 percent. There will be no significant change in the tariff for commercial users.All agricultural consumption will be billed on a metered basis, implying an effective averageincrease of 64 percent.

3.4 WAPDA’s finances remain in a perilous state. Although bill collection from privateconsumers is greatly improved (100 percent of billing through February 1999), collection from

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government agencies is still a serious problem. Unpaid bills (many in dispute) have mounted, fromRs 15 billion as of end-June 1998 to Rs 28 billion by end-February 1999. KESC owes WAPDA Rs8 billion. The reconciliation process to settle outstanding government bills designed in December1998 is not functioning yet. The theft and loss reduction campaign so far has led to a temporary fallin demand rather than a rise in cash collection. Operation and maintenance costs are neverthelesshigher than expected, resulting in a severe liquidity squeeze. WAPDA has further built up arrearson some of its payables, including payments to contractors and debt service to GOP. It also has cutcapital expenditure well below planned levels. WAPDA finances are likely to get worse beforethey get better; another 1,000 MW of generating capacity will be commissioned before July 1999,and a further 500 MW of capacity in the following few months. These are plants built by IPPswhich will mean a capacity cost to WAPDA.

3.5 To address WAPDA’s structural inefficiencies, the government adopted a medium-termreform program aimed at establishing a financially viable and efficiently run electric power system.This included breaking WAPDA’s Power Wing into twelve autonomous, financially viable andefficiently operated entities for generation , transmission, and distribution. The twelve companies --eight distribution companies, three generation companies and the national transmission company --have been registered. Pakistan Electric Power Company (PEPCO), a special purpose company, hasbeen established to assist the new companies to carry out autonomously the business activities ofthe former Power Wing of WAPDA with independent Boards of Directors, financial statements, andlegal and regulatory legitimization. The government has appointed the PEPCO Board andexecutives. It has also been building the necessary regulatory framework under which suchcorporations will operate. NEPRA started its operations in December 1997 and has formulatedrules for issuing licenses for new power distribution and transmission companies. The federalgovernment submitted the WAPDA Act Amendment to the National Assembly, and its enactment isexpected in the current session. Some progress in resolving IPP issues has been made, althoughmuch more is needed.

3.6 Transforming WAPDA’s financial situation calls for much more work. The first and mostpressing step is to rapidly reconcile disputed bills, collect the reconciled amounts from governmentagencies and then ensure they remain current on a monthly basis. The second is to further reduceindustrial and commercial theft of electricity which still is large. Even if all bills were paid up andthis year’s goals for theft reduction are all met, WAPDA would still be making losses, afterreducing its payables, including debt service, to planned levels.

3.7 WAPDA has structural problems to overcome in its pricing policies and the demand forelectricity. Even after recent rationalization of power tariffs, industrial and commercial tariffs arequite high in Pakistan; they still cross-subsidize the low household and agricultural charges.WAPDA has over-invested in electric power generation; it probably has at least 1,000 MW ofexcess capacity (relative to peak load in the summer months) at the outset of 1999; there is anadditional 1,000 MW of capacity recently freed up due to theft and loss reduction; and WAPDAwill add 1,500 MW of new capacity during 1999. WAPDA needs to further rationalize the structureof tariff rates, while maintaining financial health.

3.8 Specifically, the government needs to:

 Further reduce cross-subsidies to households and agricultural tubewells and increasethe average level of tariffs to reflect costs.

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 Complete the corporatization process of the Power Wing of WAPDA and expedite thecommercialization program of the new companies.

 Implement theft and loss reduction programs and introduce other efficiencyimprovements.

 Establish a sustainable mechanism for collecting bills from both public and privateconsumers so that the level of accounts receivable reaches normal business levels.

 Accelerate the corporatization and privatization program for the electricity distributioncompanies.

 Resolve all outstanding IPP issues and maintain normal commercial relations.

3.9 Banking: In 1996, the banking system was on the verge of collapse due to the breakdownof governance and loss of financial discipline. Over the years there had been widespread politicalinterference in both lending and loan recovery by banks, and borrowers had come to expect not torepay loans they took, especially from the state-owned banks. As a result, the stock of non-performing loans (NPLs) grew by almost 600 percent between end-June 1989 and end-June 1998,when the total amount of NPLs stood at Rs 146 billion. NPLs of nationalized commercial banks(NCBs) constituted 29 percent of their total loan portfolio.

3.10 The reform program implemented since December 1997, with support from the World Bank,has stemmed the hemorrhage caused by politically motivated lending and operating losses.Corporate governance has been improved through changes in management of the state-owned banksand protection given to the new management from political interference. The legal and judicialprocesses for recovery of loans have been strengthened. Operating losses have been reducedthrough staff separations and closures of non-viable bank branches. Cash recoveries of NPLsimproved significantly in the past two years, with Rs 43 billion collected between January 1997 andJanuary 1999 as a result of concerted efforts of the banks and the improved legal framework. Thestock of NPLs started to decline during the first half of 1998/99 and stood at Rs 134 billion as ofend-December 1998. SBP has set targets for banks to bring the ratio of the stock of NPLs tooutstanding advances down to 10 percent over the next three years. The public sector banks anddevelopment finance institutions (DFIs) have undergone substantial restructuring in preparation fortheir privatization. Both Habib Bank Limited (HBL) and United Bank Limited (UBL) havedrastically reduced losses and have been re-capitalized, improving their capital adequacy. HBL hasbeen advertised for sale, and eight expressions of interest (EOIs) have been received. Ten partieshave submitted EOIs to become underwriters for the sale of the remaining 49 percent governmentequity in the Allied Bank Limited (ABL).

3.11 These achievements are fragile and need protection to be sustained. Of highest priority isthe need to preserve the progress in the banking sector by avoiding political interference in thefunctioning of public sector banks, including directed credit schemes. Earmarking credit for specialprograms has a very dismal history in Pakistan and elsewhere. Much remains to be done to furtherstrengthen banking regulation and supervision, and develop a well-functioning legal and judicialsystem. The government needs to further strengthen the process of execution of court decrees forrecovery of bank loans and improve SBP’s capacity to serve as an effective regulator andsupervisor. At the same time, privatization needs to be accelerated while ensuring that banks andNBFIs are sold to sponsors that bring in internationally recognized good corporate governance. Tocontain the cost of future bank failures, a deposit insurance scheme will need to be implementedover the medium term, after the banking system is privatized.

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3.12 Privatization: After having privatized mostly smaller industrial units in the first half of the1990s, Pakistan entered the more difficult phase of privatizing problem banks and large, poorlymanaged utilities and transportation companies. This requires extensive legislative and regulatorychanges and financial and organizational restructuring, including changing management,downsizing, and adoption of prudent operational policies prior to privatization actually taking place.Actual sale of units was held up pending these actions. Many of these activities were nearingcompletion when nuclear tests, economic sanctions, and the conflict with the IPPs adverselyaffected investor confidence and stalled privatization. Nevertheless, during this period thegovernment continued with its program of privatizing enterprises which did not require majorrestructuring. Over the past year, three industrial units, two small commercial banks, and fiveservice sector companies were privatized. In addition, financial advisors have been appointed forseven major financial institutions and for Pakistan Telecommunications Corporation Limited(PTCL). Efforts are being made to bring PTCL to the market by the end of 1999. Preparationactivities for the privatization of power companies also are being actively pursued.

3.13 Taxation: A fundamental element of good governance is an efficient, effective andequitable tax system. Despite new tax measures in almost every budget in recent years, the tax-to-GDP ratio has stagnated at a low level (13 percent). This is due to an overly complex tax regime, anarrow tax base, an inequitable tax burden, weak tax administration, widespread tax evasion, andrapid growth of a tax-free informal sector in the economy. The tax department has suffered fromprofound institutional weaknesses related to poor skills, low pay, lack of adequate financialcontrols, excessive scope for discretion and rent seeking by individual staff, and lack oftransparency in tax assessment and collection procedures.

3.14 In recent years, progress has been made in reforming the sales tax, income tax, and importtariffs. Significant amendments were made in the General Sales Tax (GST) law in June 1996,expanding the horizontal coverage at the manufacturing and import stages, removing excise-likefeatures, and establishing a turnover threshold for registration. This was followed by introductionof compulsory GST registration of importers, wholesalers, and distributors; effective extension ofGST to textiles and steel; improvements in refund procedures; and strengthening of collection.Also, GST rates were unified into a single standard rate of 12.5 percent in the 1997/98 budget andraised to 15 percent in December 1998. GST has been extended to the retail stage, althoughimplementation is lagging. The National Assembly (NA) has recently approved amendments inlaws governing GST and import tariffs to eliminate the discretionary authority of the Central Boardof Revenue (CBR) to grant exemptions and alter tax rates. Now only the NA has these powers.Discussions with the provinces are ongoing on how to create the legislative foundation for GST onservices (sales tax on services is a provincial subject under the Constitution).

3.15 The concept of income for tax purposes has been widened to include perquisites in cash andkind, and certain deductions have been reduced. The maximum personal income tax rate has beenreduced to 20 percent from 35 percent, while rates of corporate tax also have been reduced. In 1997the maximum tariff rate on imports was reduced from 65 percent to 45 percent, the number of slabswas reduced from 14 to 5, and the 10 percent regulatory duty introduced in October 1995 waseliminated, except for a few items. The government has recently further lowered the maximumtariff rate on imports to 35 percent and reduced the number of non-zero tariff slabs to four. Also,the government has increased and rationalized the rates of duty drawback for exports.

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3.16 In the face of a pressing need to increase spending on essential operations and maintenance(O&M), basic social services, and public investment in high-priority projects, the tax-GDP rationeeds to be raised in order to create fiscal space for higher spending. In this regard, the governmentmust take the following measures:

 Establish an autonomous, efficient and equitable tax administration with a wellfunctioning Pakistan Revenue Authority.

 Extend the GST and income tax base to more taxpayers while reducing taxes on foreigntrade.

 Increase the yield of provincial agricultural tax by reducing exemptions, updatingassessments, and raising the tax rates.

 Establish a tax payment culture where everyone, irrespective of his/her position, pays tax.

3.17 Key elements of the strategy for increasing the yield from agricultural income tax wouldinclude: (1) the adoption of a land-based system of taxation in all provinces modeled along the linescurrently in place in the Punjab; (2) lowering of the exemption threshold for irrigated land across allprovinces; and (3) harmonizing rates of tax (per acre) on irrigated land at the Punjab level across allprovinces.

3.18 Public expenditure: With stagnant tax revenues, falling non-tax revenues, and deficitreduction occurring through expenditure cuts, the structure of public expenditures has deterioratedin recent years. Defense and interest now absorb more than two-thirds of total federal expenditure,pre-empting nearly all federal tax revenues. In the case of the provinces, the bulk of expenditure istaken up by establishment costs (civil servants’ salaries, benefits, and pensions), interest payments,and subsidies. Development spending (previously the largest category) and non-wage O&M havebeen squeezed. Expenditures on social services are still very low by international standards despitesubstantial increases in recent years under the Social Action Program (SAP). The waste andineffectiveness of much public expenditure sharply reduce its development impact.

3.19 During the last two years, the government has made substantial expenditure cutbacks,resulting in a two percentage point reduction in consolidated budgetary spending as a share of GDPdespite the increasing interest burden. Both development and defense expenditures have beendrastically reduced, with their ratios to GDP declining from 4.3 percent and 5.5 percent,respectively, in 1995/96 to 3.2 percent and 4.8 percent in 1997/98.

3.20 The expenditure squeeze in the provinces has been even more severe than at the federallevel, seriously affecting their development programs and their non-wage O&M. Further cutswould dangerously undermine the quality of public sector physical and social infrastructure.

3.21 In this highly constrained fiscal environment, Pakistan faces stark choices in reorienting itspublic expenditure. There is an urgent need to spend more on: (1) essential non-wage O&M in keysectors like drainage and irrigation and roads; (2) basic social services, especially quality enhancingexpenditures (e.g. teaching materials, medicines); and, to the extent possible, (3) public investmentin high-priority development projects (the budgetary Public Sector Development Program has beenhalved as a percentage of GDP in the 1990s). This means that it is essential to subject all publiccapital expenditure programs to the discipline of the budgetary and planning process, so that thetough trade-offs will be clear. Pakistan can only afford so much public spending, a leveldetermined by the availability of public resources. These limits must be respected, or macro

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stability will be lost. Over the medium and long run, good public expenditure managementrequires:

 Rethinking the role of government at all levels to serve as the basis for restructuringpublic expenditures. The recent effort of the Committee on Downsizing of the FederalGovernment to systematically assess government departments and public sector enterprisesneeds to be pursued further and integrated into regular budgetary decisionmaking.

 An integrated medium-term approach to planning and budgeting of public spending,based on revenue projections over a multi-year horizon. Annual budgets and programallocations should be consistent with the medium-term framework, and sustainable levelsof recurrent expenditures would determine sectoral investment programs rather than viceversa.

 Effectively prioritizing among broad spending categories, with sharp increases inessential non-wage O&M in key sectors, higher spending on basic social services, and anincrease in public investment in high-priority projects. Lower-priority spending needs tobe cut to make room for these increases.

 Ensuring greater accountability for public expenditures by strengthening and separatingthe auditing and accounting functions of the government; promoting effective reviews ofpublic expenditures by the National and Provincial Assemblies; deterring and punishingcorruption; decentralization and other measures to bring expenditure decisionmakingcloser to beneficiaries; and legalizing and enhancing the public’s access to information onpublic expenditures.

3.22 Corruption: Corruption,1 a manifestation of poor governance, is hurting the economy byraising transaction costs and uncertainty. A 1994 World Bank Survey of 200 business firms inPakistan revealed that a significant amount of time was wasted in numerous unpredictableinteractions with petty and higher-level bureaucrats seeking bribes. Entrepreneurs reportedspending about 12 percent of their own and their management’s time and 5 percent of theiremployees’ time dealing with tax and regulatory requirements. Also, corruption depresseseconomic growth by lowering investment and distorting the composition of public investment.Only a part of the amount appearing in budget documents as expenditure on public projects mayactually get spent on these projects; the rest is siphoned off by government functionaries andcontractors. One study estimated that the value for money obtained in government construction ofschool buildings may be only 50-65 percent.2 A significant segment of users of governmentsupplied economic services and public utilities have to pay bribes to government functionaries toget access to these services and utilities. Even if these are considered part of the cost of doingbusiness, there is an economic loss as these payments are not available for expansion andimprovement in the quality of public services. Illegal cutting of trees in the Northern Areas ofPakistan in connivance with officers of the Forestry Department contributes to degradation of theenvironment. Non-merit-based appointments of school teachers, widespread cheating inexaminations conducted by the government, and tampering with marking of answer books erode thequality of education.

1 In the last three annual corruption surveys, Transparency International has ranked Pakistan as the second, fifth, andeleventh most corrupt country in the world.

2 Hassan Masood, “Report on Price Comparability Study of School Buildings Construction,” May 1997, prepared forthe World Bank.

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3.23 Recognizing corruption as a major governance issue, the last interim government (November1996-February 1997) created the office of the Chief Ehtesab (Accountability) Commissioner (CEC)in November 1996. The present government enacted the Ehtesab Act in April 1997, whichcontinued the office of the CEC. The provisions of the Act cover activities of senior bureaucrats(grade 18 and above) and politicians at both provincial and federal levels who were in office afterNovember 1990. The CEC is appointed by the federal government from among incumbent or pastjudges of the Supreme Court, in consultation with the Leader of the Opposition in the NationalAssembly and the Chief Justice of Pakistan, for a non-renewable term of four years. The 1997Ehtesab Act has also established an Ehtesab Bureau (EB) attached to the Prime Minister’sSecretariat. The CEC has to refer all cases to the EB for investigation. Only after the EB oncompletion of its investigation concludes that the case needs to be referred to the court, can the CECinitiate proceedings in the High Court.

3.24 Strong and sustained commitment by the government will be needed to implement amedium-term program to improve governance and reduce corruption. This would include:

Á Improving the accountability process by maintaining an autonomous and non-politicalagency for investigating cases of corruption, and using more effectively the existinginstruments to enforce rules governing the conduct of government employees and politicaloffice holders.

Á Strengthening the legal and judicial system (more courts; more, better trained judges;streamlined procedures) to protect property rights, ensure speedy and efficient resolution ofbusiness disputes, and enforce contractual obligations.

Á Ensuring transparent and competitive public procurement and contracting practicesto reduce kickbacks and enhance the effectiveness of public expenditure for greaterdevelopment impact.

Á Implementing well thought-out and comprehensive civil service reforms (discussedbelow) to lay the foundation for a professional bureaucracy with incentives for integrity.

3.25 Civil service reform: Pakistan’s chronic governance problems cannot be addressed withoutimplementing well-designed, comprehensive civil service reforms. A meaningful civil servicereform can benefit Pakistan in many ways: (1) it can foster economic growth and sustained povertyreduction by reducing the obstacles to private sector development that the poorly performing publicsector now creates; (2) expand the poor’s access to good-quality basic social services; (3) increaseresources for priority spending by containing personnel expenditures; and (4) address seriousproblems of governance and corruption.

3.26 At present, the country’s civil service suffers from serious problems including: (1) an over-centralized organizational structure as well as rigid, often irrelevant, and unevenly enforced rulesand management; (2) an inappropriate skills mix, reflecting the past role of the state as a primaryprovider of employment, erosion of real wages of high-level officials, and the closed nature of thecivil service; (3) seriously eroded internal and external accountability; (4) politicization of civilservice decisionmaking; (5) widespread corruption; (6) increasing public sector wage costs whichare crowding out high-priority non-wage expenditures; and (7) rising pension costs. As has beenamply demonstrated by Pakistan’s past experience with several unsuccessful efforts to improve thefunctioning of the civil service, these interrelated problems are not amenable to piecemeal solutions

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but rather require a broad and sustained effort to fundamentally transform Pakistan’s publicadministration.

3.27 The present government has engaged in several initiatives to streamline the civil service.These include an effort by the Committee on Downsizing of the Federal Government to assesspublic sector entities in terms of whether they should continue to exist and in what form and size; a“golden handshake scheme” (GHS) to encourage early retirement/departure by surplus federalgovernment employees; and extensive work by the Commission on Administrative Restructuring(CAR) leading to recommendations on the restructuring of federal agencies. The GHS was put onhold in late 1997 due to lack of budgetary resources to fund the separation payments as well asparliamentary and labor opposition. The report of the CAR is expected to be put before the Cabinetin the near future.

3.28 As is demonstrated by Pakistan’s own as well as international experience, civil servicereform is a highly sensitive and difficult area. If they are not well-designed, implemented in aconsistent, sustained manner, or backed up by national ownership and strong political will, reformefforts will fail. A clear vision of the role of the state, including the different roles of federal,provincial, and local governments, forms the starting point for civil service reform. This wouldimply key government roles in: (1) reducing poverty; (2) effective, transparent, evenhandedregulation; (3) effective provision of basic social services; (4) exit from direct public sectorinvolvement in commercially-oriented activities best left to the private sector; (5) governmentshedding the role of directly generating employment; (6) provision of public information; and (7)effective administration of justice and maintenance of law and order. Other prerequisites forsuccessful implementation of civil service reforms include broad national ownership of the reforms;a long-term vision of the goals and the type of civil service being aspired to; appropriate sequencingof reforms; willingness to endure in the difficult and long implementation period; and an adequatelevel of institutional capacity to support the civil service reform process.

3.29 Downsizing should not be undertaken for its own sake but rather as part of the broader effortto improve the incentives, management, and skills base of the civil service. Determination of theadequacy of compensation levels for the civil service should be based on careful, in-depth country-specific analysis and comparison with comparable private sector skills – raising pay alone will notresolve the deep-seated performance and governance problems that characterize Pakistan’s publicadministration. In fact, internal and external accountability of the civil service need to bestrengthened through a stronger performance evaluation system, less frequent rotation of seniorstaff, improved information systems, better audit, reinvigoration of the Public Accounts Committeeof Parliament, and assured public access to information from the public sector.

3.30 Now is an opportune time for Pakistan to initiate a fundamental restructuring of its civilservice. The combination of an emerging national consensus on the need for change, a reform-minded political leadership with a strong electoral mandate, and the imperative of fiscal austerity inthese difficult times should, if well exploited, enable Pakistan to move into the 21st century withvery good prospects for a reinvigorated, responsive, and accountable civil service to carry forwardthe country’s development agenda. Core elements of a civil service reform program would includethe following:

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 Improvements in personnel and wage bill management, which are crucial for getting ahandle on the size and cost of the civil service and in monitoring implementation ofreforms.

 Strengthening accountability and better performance. Downsizing and obtaining new skills. Devolution of localized functions to local governments, initially on a pilot basis. Compensation reform, including pay, allowances and pensions.

3.31 Poverty reduction: Recently released 1993/94 household survey data suggest that, afterdeclining in the 1980s, the incidence of poverty increased in the early 1990s. If so, this riseprobably has continued due to a further slowdown in economic growth and reduced flow ofworkers’ remittances from the Middle East more recently. The expectation that Pakistan willexperience even slower growth (about 3 percent per annum in 1998/99 and 1999/00) in the next fewyears raises the prospect of a further rise in the incidence of poverty.

3.32 In view of the difficult and uncertain prospects lying ahead, Pakistan should continue topursue and further strengthen its strategy for poverty reduction over the medium term. Pakistan’sexperience as well as that of other countries amply demonstrates that sustained poverty reduction ispossible only if there is sustained economic growth. Also, macroeconomic stability andaccompanying low inflation in the prices of food and other mass consumption goods are veryimportant for the welfare of the poor. Finally, labor-intensive export growth will increaseemployment opportunities. Hence, consistent and sustained implementation of structural reformsand the stabilization program to put the economy back on a higher growth path is essential forsustained poverty reduction.

3.33 A key part of the poverty reduction strategy should be based on provision of adequate basicsocial services - particularly elementary education and basic health services - to a much higherproportion of the poor. Only through better education and improved health can the life-long earningcapacity of the poor be enhanced. No other government intervention can be so effective inimproving the longer-term prospects of the poor. The Social Action Program (SAP), theGovernment’s main program for improving the quality and availability of these basic services,needs to be sustained and revitalized.

3.34 The existing social safety net, comprised of the Zakat Fund and Bait-ul-Maal, may beinadequate as presently operated to cushion the impact on the poor of the low growth of theeconomy (particularly in per-capita terms) expected in the current and next fiscal years. Throughbetter administration of these programs and by diverting resources from non-targeted programs likethe wheat subsidy, the impact of these programs can be greatly enhanced. In addition to publicsector programs, decentralized and participatory efforts of communities, the private sector, and non-government organizations (NGOs) will be needed to reduce poverty. In the past five years,collaboration between the government and NGOs has improved, leading to substantial governmentfunding of effective NGOs. With technical assistance from the World Bank, the government has setup the Pakistan Poverty Alleviation Fund (PPAF) which will channel funds to NGOs at communitylevel. And efforts are also underway to increase the involvement of communities and NGOs in theSAP.

3.35 Human resource development: Despite some progress made under the SAP in recentyears, Pakistan’s human development indicators are still at unacceptably low levels. The slow pace

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of human resource development has adversely affected the country’s medium to long-term growthprospects, as low levels of education and poor health constrain the growth of labor productivity inboth agriculture and manufacturing. Without an educated population, social and politicaldevelopment also are retarded. Basic health and education can help the poor to make more effectiveuse of their most abundant resource -- their time and their labor -- enabling them to grow, learn, andadapt to changing opportunities as the economy grows. Improving the availability and quality ofthese services is thus a core part of an effective strategy to reduce poverty.

3.36 Pakistan’s human development indicators, especially those for women, fall significantlybelow those of countries with comparable levels of per-capita income. Only 40 percent of thepopulation is literate (28 percent of women), compared with 49 percent in South Asia and 53percent in low-income countries. The gross primary school enrollment of 70 percent comparesunfavorably with the South Asia regional average of 100 percent and the average of 104 percent forlow-income countries. Enrollment for girls is only 62 percent (as against 80 percent for boys)comparing unfavorably with 105 percent each for Bangladesh and Sri Lanka and 91 percent forIndia. Achieving an increase in literacy and a reduction in the number of young people living inpoverty is further limited by the fact that nearly half of the students in the lowest economic quintiledrop out of primary school, whereas only 2.5 percent of students from the richest quintile drop out.About two-fifths of the population is without access to safe drinking water and more than half hasno access to sanitation. Infant mortality of 88 per 1,000 live births is higher than the average of 73in South Asian countries and 83 for low-income countries. Pakistan’s population growth rate of 2.6percent remains among the highest in the world and frustrates efforts to increase the coverage ofsocial services.

3.37 To address these problems, the government initiated the SAP in 1993. Under the first phaseof the SAP (1992/93-1997/98), important steps were taken including introduction of merit-basedrecruitment criteria for teachers and health personnel and use of rational site selection criteria forlocating and opening new schools and health clinics. One important outcome has been that primaryschool enrollment increased, particularly for girls in rural areas. Population growth has fallen from3.1 percent per annum in 1981 to 2.6 percent in 1998. Immunization coverage also has improved,with the percentage of fully immunized children 5 years and younger increasing from 25 percent in1991 to 51 percent in 1996/97. Increasingly, the design and implementation of social serviceprograms involve active participation from communities and NGOs.

3.38 To make further progress in the social sectors, the second phase of the SAP was initiated in1997/98. The focus is on improving the quality of services and the outcomes of those services asmeasured by increased learning, improved health, lower incidence of water and sanitation relateddiseases, and lower fertility rates. Improving quality is also essential to increasing demand foraccess to these services. Quality improvements are to be achieved by focusing on non-salarymeasures including technical and managerial skill development, improved learning and trainingmaterials, ensuring availability of key supplies, fostering improved monitoring, and improvinggovernance through reducing absenteeism, recruiting teachers and health personnel on merit, andpromoting community participation in monitoring and decisionmaking. Long-term financialsustainability is being sought through adequate budget allocations and expanding opportunities forservice delivery by the private sector and NGO providers. In the past year significant progress hasbeen made in developing and supporting parent-teacher associations and NGO-operated primaryschools; recruitment of technically competent staff in government population programs hasincreased; technical studies designed to improve health interventions and to shape health delivery

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strategies have been started; and new procedures for implementing and transferring water schemesto communities have been initiated.

3.39 Despite some progress under the SAP, much remains to be done. Moreover, the fiscalposition of provincial governments, which finance the bulk of public expenditure on social sectors(education, health, rural water supply), has come under great stress in recent years. Deterioration ofthe overall fiscal resource position, mainly reflecting low tax collections in recent years, hascontributed to the fiscal difficulties of the provinces. There is a real threat that provincialexpenditures on SAP activities will be substantially below budgeted levels in 1998/99, as they werein 1997/98. During the first half of 1998/99, however, provincial SAP expenditures have been cutproportionally less than other non-interest provincial expenditures, in contrast to 1997/98. In thisrelative sense, SAP seems to be protected at the provincial level. Expenditures on key federalprograms, Federal Areas programs, and non-salary expenditures, however, have been plagued bylate and low releases of funds and other bureaucratic delays, undermining the impact and quality ofmany critical programs, notably the Expanded Program of Immunization (EPI).

3.40 Besides protecting and further increasing budget allocations for the social sectors, there is aneed to increase the effectiveness of these expenditures by improving governance and the designand management of basic social service programs. The most important areas for improvementinclude: a) building the institutional capacity of SAP-related line departments to plan, design andimplement measures to improve service delivery; b) halting the rapid, indiscriminate and disruptivetransfer of key managers in these departments so that program improvements can be sustained; c)reducing absenteeism and providing more effective supervision, professional guidance and in-service training; d) devolving greater responsibilities to sub-provincial and community levels in acarefully developed sequence so that the benefits of decentralization can be achieved whileminimizing the risks; e) reducing political interference, especially in site selection, vehicle use, andstaff transfers and postings; f) making effective use of community participation through suchorganizations as parent-teacher associations and district health committees; and g) reducing theinnumerable delays in releasing and spending non-salary recurrent budgets.

PAKISTAN

ECONOMIC REPORT

STATISTICAL APPENDIX

PAKISTANECONOMIC REPORT

STATISTICAL APPENDIX

Table of Contents Page

Table 1 Sectoral Growth Rates at Constant 1980/81 Factor Cost, 1992/93 - 1997/98........... 1Table 2 Gross Domestic Expenditure as Percentage of GDP (MP), 1989/90 - 1997/98........ 1Table 3 Growth Rates -- Gross Domestic Expenditure........................................................ 2Table 4 Fixed Capital Formation by Economic Sector at Current Market Prices................. 2Table 5 Summary Balance of Payments, 1990/91 - 1997/98............................................... 3Table 6 Composition of Merchandise Exports, 1990/91 - 1997/98...................................... 4Table 7 Composition of Merchandise Imports, 1990/91 - 1997/98...................................... 5Table 8 Foreign Exchange Rates.......................................................................................... 6Table 9 Medium and Long-Term Public and Publicly Guaranteed Debt: Annual

Commitments, Disbursements, Service Payments and External Debt Outstanding.. 7Table 10 Medium and Long-Term Public and Publicly Guaranteed Outstanding Debt by

Creditor Countries/Agencies................................................................................... 8Table 11 Selected External Civilian Debt Indicators, 1991/92 - 1997/98.............................. 9Table 12 Summary of Public Finances, 1990/91 - 1998/99................................................... 10Table 13 Public Sector Development Program, 1997/98 - 1998/99...................................... 11Table 14 The Core Development Program, 1997/98 and 1998/99......................................... 12Table 15 Monetary Survey, 1990/91 - 1997/98...................................................................... 13Table 16 Factors Affecting Domestic Liquidity, 1990/91 - 1997/98...................................... 14Table 17 Interest Rates on Bank Deposits and Advances, 1993 - 1998................................. 15Table 18 Agricultural Production and Inputs, 1991/92 - 1997/98.......................................... 16Table 19 Foodgrain Utilization, 1990/91 - 1997/98............................................................... 17Table 20 Support Prices of Agricultural Commodities, 1990/91 - 1997/98, and Retail

Sale Prices of Fertilizers, 1989/90 - 1996/97........................................................... 18Table 21 Production of Selected Industrial Items, 1990/91 - 1997/98................................... 19Table 22 Energy Balance Sheet, 1989/90- - 1997/98.............................................................. 20Table 23 Price Indices, 1990/91 - 1997/98............................................................................. 21Table 24 Changes in Price Indices and GDP Deflator, 1990/91 - 1997/98............................ 21

________________Note: This Statistical Appendix consists of historical series (through 1997/98) of the main economic data for Pakistan. Thecategories of data include: National Accounts, Balance of Payments, External Debt, Public Finances, Monetary Statistics,Agriculture, Industry, Energy, and Prices. The sources of all the information provided are Government of Pakistan agencies andpublications; the latter include the Economic Survey, the State Bank of Pakistan’s Annual Report, Economic Survey StatisticalSupplement, and the Federal and Provincial Governments’ Budget documents. Those interested in more details or raw data areencouraged to consult these sources. Most data for 1997/98 are provisional and subject to revision. Some of the data presentedhere may differ from adjusted data used in International Monetary Fund and World Bank publications, including the text of thisreport, due to differences in definition, adjustments in the data for other reasons, or staff estimates.