37- JJ> 4 .:'., CIRCUATING CoPy RESTRICTED

TO BE RETURNED TO REPORTS DESK Report No. P1085

FtILE CcYThis report is for official use only by the Bank Group and specifically authorized organizationsor persons. It may not be published, quoted or cited without Bank Group authorization. TheBank Group does not accept responsibility for the accuracy or completeness of the report.

INTERNATIONAL DEVELOPMENT ASSOCIATION

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED CREDIT

TO

THE ISLAMIC REPUBLIC OF PAKISTAN

FOR AN

INDUSTRIAL IMPORTS PROGRAM

May 31, 1972

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Exchange Rate - Rps. 11.0 = US $1.00 *

Fiscal year ends June 30

* Country Data (Annex II)reflect, where applicable, pre-devaluationrupees as noted.

REPORT AND RECOMEDATION OF THE PRESIDENT TO THEEXECUTIVE DIRETORS ON A PROPOSED CREDIT TO THEISLAIC REPUBLIC OF PAKISTAN FOR AN IDUSTRIAL

IPORTS PROGRAM

1. I submit the foUoving report and recommendation on a proposeddevelopment credit to the Islamic Republic of Pakistan for the equivalentof US $50 million on standard IDA terms, to help finance the foreignexchange cost of industrial imports and fertilizer required during theperiod July 1, 1972 to June 30, 1973.

PART I - THE ECOONMY

Introduction

2. An economic report entitled "Economic Poaition and Prospectsof Pakistan" (R70-150, dated June 18, 1970) was distributed to the ExecutiveDirectors on July 28, 1970. A,summary of the Country Basic Data isattached as Annex II. An economic mission is scheduled to visit Pakistanin September to review the economic situation and prospects of the countryand progress in redefining development priorities. A Bank staff meterwif join an IMF review mission which wlll visit Pakistan in July 1972to review progress in the implementation of the recently announcedprogram of economic and financial reforms and to set credit ceilingsfor the standby arrangement after June 30, 1972. A mission iscurrently in Pakistan to review the power sector.

3. The application by the Goverrnment of Pakistan to the InternationalDevelopment Association for an industrial inports credit of $50 millioneqaivalent has been made against the background of the very difficultproblems of economic adjustment which the country is facing at the presenttine. The case for such a credit should be considered in the context ofthe Government's efforts to overcome these problems and to rebuild thebasis for development in Pakistan.

4. To these ends, the Government has already taken action, andintends to introduce further measures to improve substantially thegeneration and efficient use of resources for development. Thesemeasures will, however, take time to make themselves felt. In themeantime, the Government 'a imediate concern is to prevent any fartherslow-down in economic activity which, with its attendant social andpolitical problems, would seriously hamper the process of adjustment. Forthis reason the Government is seeking external assistance on a substantialscale. This assistance, to be effective, has to be quick-diabursing insupport of current economic activity. Apart from its application to IDA,the Govermnent has already obtained a standby of SDR 100 million from the

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IMF and 1i endeavoring to restore ita aid arrangements with the membersof the Pakistan Consortium to a normal basis.

Recent Developments

5. The severity of Pakistan'a current economic difficulties may beillustrated by recent trends in a number of key indicators . GDP atconstant prices stagnated during the past two years, following a periodof sustained growth in the 1960'e at an annual rate exceeding 6 percent.Thib deterioration reflects in part bad weather which particularlyaffected the wheat crop. However, ite underlying cause has been theprotracted decline in the growth of large-scale manufacturing output,from nearly 14 percent a year through 1967/68 to 2-3 percent in the pasttwo years.

6. Public development expenditures had by 1968/69 recovered fromthe effects of the 1965 war with India and two years of poor harveststo a level roughly equivalent to 10 percent of GDP. Since then, they havefallen to less than 6 percent of GDP, reflecting, mainly, the deteriorationin public savings, from nearly 3 percent of GDP to a current deficit of 1percent of GDP, which were squeezed between stagnating revenues and fastrising non-development outlays. At current prices, public developmentexpenditures declined from Rs. 3,200 million in 1968/69 to an estimatedlevel of RB. 2,400 million in the current fiscal year ending June 30,1972, which is being financed by bank credit on.a scale which cannot besustained, and by external assistance. In real terms the decline hasbeen even greater. As outlays on Indus/Tarbela have absorbed about Rs. 800million a year (excluding external grants), it has been very difficult toprovide adequate financing for other on-going development schemes, letalone for new ones.

7. Meaningful comparable data for private investment are notavailable, but there iB ample evidence that, because of lack of confidence,investment in the private sector has fallen considerably over the lastfew years. Rougb estimates suggest that total gross investment in 1971/72is down by about one fourth from the previous year and, at 12-13 percentof GDP, substantially below the level of about 18 percent prevailing throughthe late 1960's.

8. The imediate economic problems confronting Pakistan are alsoclearly shown in the balance of payuwnts. Late in 1969/70 and continuinginto 1970/71, in an attempt to revitalize industrial growth, which had for sometime suffered from inadequate supplies of imported materials, the authoritieseased restrictions on imports. Total imports in 1970/71 rose by about 10percent and imports other than food and capital equipment by 7 percent. Atthe same time, purchases of foreign exchange from East Pakistan fell sharplybecause of political disturbancea. The adverse effects of these two factorsfar exceeded the additions to receipts from exports and external assistance,forcing Pakistan to draw on its reserves, including SDR's, at a monthly rateof $16 million during the first nine months of the fiscal year. Since

reserves at the beginning of the year plus the 1971 allocation of SR?awere only $317 million, they fast approached a dangerously low level. Toavert an acute payments crisis, the authorities tightened import restrictionBfrcm January 1971 onwards, and in June of that year substantially raisedthe effective rupee cost of most imports through ad hoc adjustments in themultiple rate system. They also imposed a moratorium on payment of alarge part of Pakistan's debt service obligations to bilateral creditors.These measures, together with a further subatantial increase in exchangeearnings, succeeded recently in halting the steady decline in reserves.Gross reserves have since fluctuated around $200 million.

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WEST PAKISTAN - FOREIGN EXCHANGE BUDGEr(US $ Million)

1969/70 1970/71 1971/72(Provisional)

Receipts 828 932 1,053

Merchandis 1 Exports2/ 338 420 570Invisibles_ 175 141 168Foreign Aid 315 371 315

(Project)3/ (180) (255) (210)(Non-Project)4/ (135) (116) (105)

Payments 1,130 1,203 1,247

Public Sector Invisibles5/ 158 155 202Private Sector InvisiblesZ/ 71 74 84Debt Se <i.ce7/ 212 219 251Imports_ 689 755 710

Overall Deficit 302 271 194

Financed by:Moratorium on Debt Service - 28 118Imputed Exchange Receipts fromForeign Earnings of theEastern Province 251 133 7

Use of Reserves°/ 51 110 69

Source: Government of Pakistan, Finance Division, Economic Affairs Division,Central Statistical Office and IBRD staff estimates.

1/ On shipment basis as recorded by CSO.2/ For 69/70 and 70/71, estimated at eighty percent of corresponding figure

for the Western and Eastern Provinces taken together. The figure for1971/72 includes an estimated $10 million for repatriation of foreign ex-change under Martial Law Regulations 104 and 105 which required citizensof Pakistan, with certain exceptions, to declare their assets held abroadand to repatriate within a specific time their cash balances and proceedsfrom the sale of movable property; special directives were given alsoregarding immovable property. Funds surrendered under these Regulationsreceived bonus at the rate of 45 percent.

3/ Project aid disbursements as shown are reduced by 15 percent to allow forthe usually associated technical assistance component (the contra-entryfor which normally is not reflected in the foreign exchange budget).

4/ Including food aid.Including payments for defense imports.

6 For 1969/70 and 70/71, estimated at sixty-six percent of correspondingfigure for the Western and Eastern Provinces taken together.

7/ Assuming full service on all debt outstanding as of December 1971.9/ Including use of SDR's plus IMF credit facility, and residual balances.

9. However, the stabilization was achieved at very considerablecost to the economy because imports, other than food to meet shortagesof foodgrains, edible oils and sugar, had to be reduced significantly 1/while the introduction of the moratorium further complicated Pakistan'srelations with the Consortium which has made no new commitments of aidsince early 1971. Thus, projections for 1972/73, prepared a few monthsago, suggested that Pakistan faced the prospect of having to cut totalimports by a further 30 percent and imports for current production evenmore.

10. The difficult economic situation that has been describedabove can be traced principally to two causes: first, the failure ofprevious Administrations in Pakistan over a period of several years totake action appropriate to deal with a deteriorating economic situation;secondly, the economic consequences for Pakistan of political eventssince early 1971, culminating in the separation of the former Provinceof East Pakistan, which declared its independence and became Bangladesh.The situation has been aggravated further by rapidly rising debt serviceobligations -- from $212 million in 1969/70 to $251 million in 1971/72and $281 million in 1972/73 2/ __ and the decline in disbursements ofnon-project assistance (excluding food aid) -- from $135 million in1969/70 to $78 million in 1971/72, reflecting the absence of new commit-ments since early 1971, other than for food. Non-project aid disburse-ments (excluding food) from the existing pipeline in 1972/73 areexpected to be only $57 million.

11. Among the inadequacies of past economic policies, those rela-ting to the exchange and fiscal systems have had the most pervasiveadverse effects. Both systems as they had developed through numerousad hoc adjustments, had come to embody very severe distortions thatproved increasingly inimical to efficient use of resources for develop-ment; and both systems were ill suited, in Pakistan's changingeconomic circumstances, for the generation of resources for developmentat a pace commensurate with the country's needs.

12. The multiple exchange rate system was initially introduced asa simple two rate regime intended to promote industrialization whileprotecting the balance of payments, and to give special incentives toexports of manufactures. In the course of the 1960's, the exchange ratesystem underwent many ad hoc adaptations to changing circumstances --partly, in response to a tightening exchange situation, to raise theeffective price of exchange with a view to atrengthening export incen-tives and relieving pressures on the import control system; partly, in

1/ The figures shown in the foregoing table understate the extent ofthe reduction because they do not take account of imports under inter-wing trade which in 1969/70 amounted to about $l10 million at inter-national prices and which have since ceased.

2/ Based on all external debt contracted by Pakistan up to December 1971.

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response to the emergence of agriculture in the latter 1960's as apotential growth sector, to extend to the development of that sector(but with notable exceptions) the incentives previously given exclu--sively to industry.

13. By the end of the l960's, these adaptations had produced arange of effective prices of exchange so wide -- from Rs.3.10 to thedollar to Rs.20, including duties, other taxes and subsidies -- thatthe system could no longer function as a guide to the efficient alloca-tion of resources. In particular:

(a) On the export side, it discriminated greatly againstprimary products -- the rate being Rs.4.76 to thedollar as against about Rs. 8.50 for manufactures --at a time, when all indications were that strongprice incentives were necessary to promote increasedproduction of primary products for export.

(b) On the import side, the effective cost of exchange.for finished capital goods was about 60 percent lessthan for industrial raw material imports, clearlyfavoring the creation bf assets over their utiliza-tion, discouraging the development of the domesticcapital goods producing industry, and distortingfactor relations in favor of capital as againstlabor. These distortions were further reinforcedby the operation of the system of allocating importlicenses for industry, fiscal incentives for invest-ment, and the credit system. Further adaptation ofthe system in 1971 did not bring about essentialimprovements, except in the case of primary exports,the effective price of exchange for which.was raisedby Rs.0.90 per dollar, or nearly 20 percent. Thislargely accounted for the increase in the cotton cropin 1971/72 by about one third.

14. At the same time, the system required increasingly heavyreliance on quantitative restrictions to maintain the equilibriumbetween receipts and payments. The way in which these restrictionswere applied in controlling imports of industrial materials tended toreinforce the bias in the price system in favor of further additions ofproductive capacity, rather than increases in current production byfuller utilization of the existing capacity.

15. The fiscal system has suffered from the following weaknesses:

(a) The tax system has been highly inelastic with respect toincome so that, at any given set of tax rates, the shareof tax revenue in GDP has tended to fall over time,largely because income generated at the main sources ofgrowth -- manufacturing and, in the latter 196 0's,agriculture -- has either been excmpted altogether from

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taxation or subjected to more or less fixed payments.Furthermore, tax revenues have remained heavilydependent on importa -- customs duties and relatedlevies account roughly for 40 percent of total taxrevenues -- while imports have tended to decline inrelation to GDP. As a result, substantial tax measureswhich the Government has taken over the years merelysucceeded in maintaining the tax rate at about 10-12percent of ODP. This is low by cotparison with otherdeveloping countries, and certainly ±nadequate inrelation to Pakistan's needs. Present estimatesindicate that in the current fiscal year, tax revenuesdeclined by about 5 percent.

(b) The revenue syatem has been inequitable betweenincome groups and between sectors, particularlybetween agriculture and the rest of the economy.As a remedy for the first inequity, the share ofdirect taxation -- only about 17 percent of totaltax revenue and Just over 2 percent of GDP --needs to be raised considerably. The latterraises the whole question of agricultural taxation(as well as subsidy and price policies) on which agood deal of staff work was done in the Govermentin 1969/70, only to be shelved beeause the Govern-ment at the time was reluctant to move.

(c) Over time, a wide array of Interventions has beenbuilt into the fiscal system, on both the revenueand expenditure sides (exemptions or deductions intaxes, subsidies) which, apart fram being incertain instances mutually contradictory or inconflict with incentives and disincentives builtinto the exchange system, have on the whole provedto be no longer useful or to have become positivelyharmful.

16. As regards the second principal cause of Pakistan's presenteconomic difficulties -- its truncation by the separation of its formerEast wing -- it needs to be remembered that what used to be West andEast Pakistan never constituted a thoroughly integrated economic unit.The high cost of transport between the two wings and the absence ofappropriate policies limited integration. Nevertheless, the independenceof Bangladesh has affected Pakistan in two vital areas, the balance ofpayments and public financee, sggranating difficulties of economic adjust-ment which Pakistan was already experiencing. Whether there was, in theperiod immediately preceding separation, a net flow of resources to whatis now Pakistan or to Bangladesh is impossible to determine definitively,in view of the lack of comprehensive data, the distortions introduced by

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differential pricing, and the lack of a basis for judging what proportionof the cost of Central Government services should have been borne by theEast and how much of the external assistance obtained should have accruedto it.

17. First, in respect of the balance of payments, Pakistan, separatedfrom Bangladesh, has lost access to substantial amounts of foreign exchangewhich it used to purchase from the East tingg These purchases reflectedthe much greater degree of industrialization and the higher levels ofincome and expenditures in the West wing, and the fact that CentralGovernment expenditures were largely made in the West wing. As shown inthe table in paragraph 8, and on the assumptions set out in the footnotes,rough estimates place the amount of exchange so acquired by Pakistan atabout $250 million in 1969/70. At the same time, however, West Pakistanhad a sizeable surplus in inter-wing trade of Rs. 750 million, exportsbeing Rs. 1,665 million and imports Rs. 915 million. Because of wide dif-ferences in domestic prices it is difficult to translate these rupee figuresinto dollars at international prices. However, in rough orders of magnitude,exports might be put at $200 mlllion equivalent, imports at $110 million,and the trade surplus at $90 million.

18. Thus, even if it were possible immediately to convert inter-wingtrade into international trade, Pakistan's exchange gap would be about $130million larger than in 1969/70 (see table in paragraph 20). However, itshould be borne in mind that an important factor in this large increase inthe gap is the inclusion of the service of all the external debt contractedby Pakistan up to December 1971.

19. In fact, it would be unrealistic to expect that goods previouslyexported under inter-wing trade can immediately be converted into exportsto international markets. For some goods, notably cotton and cotton manu-factures, which have constituted about 30 percent of the total, diversionshould be fairly easy. For another 25 percent, comprising essentially riceand tobacco, it may be very difficult to find alternative markets. Theremainder consists very largely of a wide range of manufactures, many ofwhich Pakistan did not in the past export in sizeable quantities. The needto find new markets for them underscores the need noted above for adequateincentives for exports; inevitably, however, diversion of exp6rts will taketime. In contrast to these problems of adjustment on the export side, thereshould be no difficulty in switching to alternative sources of supply forgoods previously obtained under inter-wing trade. Moreover,, with the excep-tion of tea (27 percent of the total) and small quantities of essentialconsumer goods, these imports consisted of materials for production, andtherefore formed part of the supply of goods necessary to sustain production.

20. The pressures on the balance of payments or the level of economicactivity, by these problems of trade and other adjustments associated withthe separation of Bangladesh, are illustrated in the table below. It isimpossible to quantify all the balance of payments effects of separationand the table must be regarded purely as illustrative of orders of magni-tude. The figures for 1972/73 assume full diversion of inter-wing importsat the 1969/70 level.

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Estimated Foreign Trade Adjustments(US $ Million)

1969/70 1970/71 1971/72 1972/73

g&orts 589 553 577 600Normal_1/ 3d =3 497 7500Diversion - 34 73 100Imputed Exchange Receipts

from Foreign Earnings ofthe Eastern Province 251 133 7 .

Imports 689 755 710 800Normal W9 72E 69 0Diversion - 13 67 110

Balance -100 -202 -133 -200

1/ Shipment basis (excluding re-exports).

21. Public finance is the second area in which the separation ofBangladesh has created major problems. These derive essentially from thefact that the great bulk of the Central Government establishment, bothcivil and military, was located in the West Wlng. Thus the loss of centralrevenues from the East Wing, which constituted roughly one fourth of thetotal, was not associated with a corresponding reduction in non-developmentoutlays, particularly expenditures on defense services which, on the contrary,increased by about 40 percent during the past two years. As a result, centralnon-development expenditures (excluding debt service), which in 1969/70absorbed about 60 percent of revenue, in 1971/72 are practically equal tototal revenue. This has been a major factor in turning a current surplusof Pakistan's public sector of Rs. 1,000 million in 1969/70 into an estimatedcurrent deficit of about Ra. 500 million in 1971/72 (at comparable pre-devaluation prices).

A Program of Economic Reform

22. The immediate economic difficulties as described above are insharp contrast to Pakistan's economic strength which justifies optimismabout longer-term prospects. Pakistan already possesses a well developedirrigation system, the productivity of which will be strengthened greatlywhen additional water becomes available from the Tarbela Dam in 1976.This, together with achievement of self-sufficiency in foodgrains opensup the prospect of substantial increases in agricultural production as landuse patterns change. Pakistan already has a strong and fairly diversifiedindustrial base which was described in the Bank report circulated in

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19701{ Its entrepreneurs have proved themselves capable of rapidly expandingproduction, not only for the damestic market but also for export, and the laborforce is easily trainable and hard working.

23. Having, during its initial months in office, been preoccupiedwith the political aspects of its task, President 3hutto's Administrationthen turned its attention to the difficult economic problems facing Pakistan.Recognizing that Pakistan can overcome its current difficulties and realizeits potential for development in the longer run only by thorough improvementof the economi-c policy framework, it has embarked on a comprehensive economicand financial program. Its purpose is to restore conditions conducive todevelopment by effecting substantial improvements in the mobilization ofresources, both foreign and domestic, and in the efficiency of their use.

24. The crucial importance of a suitable exchange rate system to itsefforts of rebuilding a basis for development was recognized and on May 12,1972 the Government announced a fundamental reform which raised the parvalue of the Pakistani rupee from Rs. 4.76 to Rs. 11.00 to the US dollar,abolished the previously existing system of multiple exchange rates, andintroduced measures designed to move towards a more liberal import policy.The contents of the reform and an analysis of its effects are presentedin detail in the recent IMF documents in Annexes IV and V.

25. For the reasons explained above, a thorough-going reform of theexchange system has long been regarded as essential to the resumptionof adequate growth of exports and of production and investment.. TheGovernment, with the reforms recently announced, has acted effectivelyto remedy a crucial weakness in Pakistan's economic policy framework, whichhas had pervasive effect on the economy, both on the mobilization and onthe use of resources for development. In particular, the reform:

(a) on the export side, raised the average rupee proceeds perdollar by about 20 percent; and by 30 percent for primaryproducts, after allowing for export duties;

(b) on the payments side, increased the effective rate forimports, on the average, by 40 percent and for invisiblepayments, including debt service, by 117 percent, the averagefor all payments being 66 percent;

1/ Industrialization of Pakistan, The Record, The Problems and TheProspects (R70-53; April 2, 1970)..

(c) through the new import policy provides for the elimination of allquotas, categories and entitlements as existed under the old scheme.Two basic "lists" replace the former regime of various categoriesof imports: the free list and the tied list. The latter is confinedto some 25 items financed under aid and barter, while most importsare on the free list comprising about 320 items. In addition, afew specified commodities, such as coal, fertilizer, rail andtrack material, electricity generating and transmission equipment,etc., are reserved for public sector import only, and certain luxurygoods continue to be banned.

26. As Pakistan's exchange system has for so long been marked by quanti-tative restrictions and numerous complexities, it is difficult to quantify theeffects of the reform on the balance of payments. It is reasonable to expectthat exchange receipts will, over time, increase substantially; exports ofcommodities have, in the past, proved highly elastic with respect to price.Most of Pakistan's exports represent only a small fraction of world trade and theprice elasticity of demand for them is high, so that Pakistan should be ableto increase its export volume considerably without a significant effect onprices; diversion to foreign markets of goods previously shipped under inter-wing trade should be easier.

27. The reforms will probably have only a very limited effect on thelevel of payments as import liberalization is accompanied by a substantialincrease in effective rates for imports. However, the structure of importsshould be significantly affected because, by eliminating the artificiallylow effective rate for imports of capital goods and the system of allocatinglicenses to individual users in the manufacturing sector, the use of existingcapacity and development of the domestic capital goods producing industryshould be encouraged.

28. While certain adjustments of the fiscal system have been made con-currently with the introduction of the exchange reform and import liberalization,the Government recognizes that the next steps must be directed towards a fun-damental reform of the fiscal system and containment of non-development expen-ditures. As the Government foresees a considerably enlarged role for the publicsector, the ultimate objective of such a reform must be to raise the sharesof public savings and public development expenditures above the levels of 3and 10 percent of GDP, respectively, achieved in 1968/69. In view of the deter-ioration that has since occurred and the low levels to which public savings anddevelopment outlays have fallen, it will undoubtedly take time to achieve thenecessary improvements, in part because measures to raise public savings willhave to be designed so as to be compatible with other important objectives offiscal reform, in particular, achievement of greater equity and the eliminationof the distorting effects on resource allocation contained in the presentfiscal system.

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290 The Government intends to introduce measures in the next budget,due to be announced before the end of June, that will improve the working ofthe fiscal system in the financial year beginning July 1, 1972. To help preparerevenue measures, the Taxation Commission has been reconstituted and instructedto make proposals for the 1972/73 budget. An important objective of that budgetwill be-to raise significantly the contribution of donestically generated re-sources to public development, while reducing reliance on bank credit, andthereby to make possible a substantial increase in public development expenditures.

30. Meanwhile, the Government has introduced measures to bring about reformsin agriculture, industry, and financial institutions. A land reform programwas announced on March 1, and action is being taken to regulate relations betweenlandlords and tenants. With the objective of improving efficiency and combat-ting tax evasion in the manufacturing sector, the Government replaced the managersof all private companies in ten basic industries!/ by Government appointeesand the system of managing agencies was abolished. In the financial sphere,the State Bank's control over private commercial banks and their credit policieshas been greatly expanded with the objective of ensuring a more effective andequitable distribution of funds among the various sectors of the economy withspecial regard also to smaller and less priviledged borrowers, particularlyin agriculture and industry; in this connection a National Credit ConsultatiteCouncil wvith public and private representation is being formed. To deal withpressing social problems, a public works program and new programs in educationand health were anhounced.

31. For most of these policies, particularly those in the social field,detailed and staged plans remain to be worked out. At the same time, theGovernment is engaged in a, review of priorities for public development whichhas become necessary because the Fourth Five-Year Plan, adopted in mid-1970, is nolonger relevant in the light of the change in circumstances resulting from theseparation of the East wing. The Government is also considering how best to:reorganize public development planning to give effect to the increased respon-sibility allocated to the Provincial Governments. Work on an interim develop-ment program is planned to be completed and the results announced, in conjunctionwith the budget for 1972/73.

Aid Requirements

32. Comprehensive reforms along the lines described in the preceding sectionshould provide the basis for the restoration of an adequate rate of development.However, the measures already taken, in particular the exchange reform and imp ortliberalization, and those to be taken in connection with the budget for 1972/73,will take time to make themselves felt. In the meantime, to facilitate adjustmentand to avoid a sharp decline in imports which would further complicate an alreadydifficult economic situation, Pakistan will require external assistance ona scale substantially larger than it would normally need.

1/ Iron and steel; basic metals, heavy engineering, heavy electrical, motorvehicle assembly and manufacture tractor assembly and manufacture, heavyand basic chemicals, petrochemicals, cement and public utilities.

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33. Present projections of the balance of payments for 1972/73, asshown below, indicat that Pakistan will require a net transfer of resourcesfrom abroad in the order of $285 million.

Balance of Payments(US $ Million)

1969/70 1972/73

Receipts Lco51t6j3Merchandise Exports- 3 XInvisibles 175 168

Payments 918 102Merchandise Iiports 9 80Public Sector nvsibles 158 168Private Sector Invisibles 71 84

Deficit on Goods and Services 405 284Imputed Exchange Receipts from

Foreign Eamings of theEastern Province 251 ---

Net Foreign Transfers, inoludinguse of reserves 154 264

I/ Shiipment basis

34. As shown in the table, exchange earnings are projected to be about75 percent higher in 1972/73 than they were three years ago. A relatively moderateincrease in foreign imports is expectedj assuming essentially a restoration of thelevel in 1969/70 plus substitution of additional requirements of about $110 millionpreviously met fron interwing trade, bringing the total to about $800 million.This projection, however, contains a considerable element of uncertainty as theultimate impact of the recent import liberalization measures in connection withthe exchange reform is, as yet, difficult to gauge. Moreover, while there werevery small imports of foodgrains in 1969/70, such imports are estimated to besubstantial (possibly as high as $50 million) in 1972/73 to overcome shortagesdue to poor wheat crops in the past two years because of drought and to safeguardagainst price pressures following devaluation. Thus, the above import projectionsactually imply a considerable constraint on total non-food imports and, therefore,are to be considered a minimum requirement to sustain economic activity at a levelcompatible with the objective of rebuilding the base for development. In regardto exports it must be observed that the very favorable performance in 1971/72,reflecting largely a bumper cotton crop supported by high international prices,cannot be expected to be repeated. The cotton crop may well remain below thisyear's level and cotton prices already show a declining trend. Thus, exportprojections too have to be viewed with ame caution.

35. To determine gross aid requirements to make possible the net transferestimated above, Pakistan's debt service obligations have to be taken intoaccount. As shown in the table below, debt service obligations, estimatedon this basis,. amount to $281 million in 1972/73, as compared to $212 millionin 1969/70.

Total Deficit and Financing(US $ Million)

1969/70 1972/73

Requirements

Deficit on Goods and Services 437 284Debt Service 212 281

Total 649 565

Financing

Imputed Exchange Receipts from Foreign Earningsof the Eastern Province 251 -

External Financing (including use of reserves) 398 -

Total 649

The 1972/73 requirement could be met as follows:Existing credits for projects 150Existing credits for commodities and food 118Additional financing requirements 297

Total 565

36. The Government has approached the IMF, the members of the PakistanConsortium and IDA to help cover the residual deficit of about $300 million.On May 17, 1972, the IMF Board approved Pakistan's request for a stand-bycredit of SDR 100 million, to provide net credit, after taking account ofrepurchases due during the period, of SDR 74 million. Recourse to theFund is essential to cover the time until longer-term financing becomesavailable and generally to supplement Pakistan's reserves in supportingthe exchange reform.

37. The Government's immediate objective must be -- and is -- therestoration of conditions conducive to adequate development and, in thatcontext, the maintenance of a reasonable level of economic activity tofacilitate the structural adjustments which are necessary. For externalassistance to be effective in supporting this objective it must be in aform suitable for financing imports for productive use of existing capa-city and be disbursed quickly.

38. To meet part of the financing requirements on the basis of theprojected deficit, the bilateral members of the Consortium in a meetingon May 26 agreed -- subject to concomitant bilateral arrangementsexpected to be completed shortly -- to extend debt relief to Pakistanequivalent to approximately US$234 million over the period from May 1,1971 to June 30, 1973; of this amount about US$90 million will provide

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additional relief during fiscal year 1972/73. The Government of Pakistanhas also asked the Consortium (and non-Consortium) countries to make newcommitments of cammodity assistance. It is hoped that such commitmentswill be made shortly and in an amount sufficient to provide disbursementsof up to $130 million in 1972/73.

39. Commitments of such assistance to Pakistan, before the separa-tion of Bangladesh, have not in recent years exceeded $150 million, sothat the amount requested from the Consortium is very large. Even ifit is fully met, the remaining gap would be much too large for Pakistanto finance from its reserres and by drawings on the IMF. The proposedprogram credit, by helping to bridge this gap, would be Important inmaking more effective other external assistance, and in improving theprospect that the far-reaching measures of exchange reform and importliberalization recently introduced will be effective in restoring therate of economic and social development.

40. Thus, the IDA credit would be part of a financing plan forthe projected deficit as follows:

(US$ million)

Projected Deficit 300

Financing:

Bilateral Assistance 220Disbursement from New Commitmentsof Commodity Aid (130)

Debt Relief (90)

IDA Imports Program Credit 50

Sub-total 270

Use of Reserves and/or INF Stand-by Credit 30

Total 30Q0.

The above $30 million to be provided out of reserves and the IMF standbycredit would correspondingly increase if disbursements from new bilateralcommodity aid commitments fell short of the estimated $130 million.

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PARr-Il - BANK GROUP OPERATIONS

41. The Bank and IDA have made thirty-one loans and thirty-eightdevelopment credits to Pakistan since 1952, in the following sectors:agriculture, transport, power, education, water supply and sewerage,communication and industry. The Bank Group has participated in thejoint financing of the projects financed through the Indus Basin andTarbela Development Funds and is the Administrator of these funds.Bank/IDA comitments as at April 30, 1972 totalled $1,173W,3 million,representing about 23 percent of Pakistan's total outstanding external debt.Of this total, fourteen projects accounting for $383.1 million were in theWest wing, including five projects which were administered by agenciesoperating in both wings, and twelve projects accounting 'for $137.6 millionwere in the East Wing. Annex I contains a summary statement of Bank loans,IDA credits and IFC investments as of April 30, 1972, and notes on progressin the execution of projects.

42. As the Executive Directors are aware, in December 1971 disburse-ments on all outstanding loans and credits for beneficiaries in EastPakistan were suspended. I expect to make-recommendations to the Execu-tive Directors with regard to the undisbursed balances on these loans andcredits as soon as current discussions with the governments have beencompleted. In the meantime, the Government of Pakistan, for the timebeing, is continuing to carry the liability for servicing the debt withrespect to commitments attributable to projects In what was East Pakistan.Action as reported in my memorandum to Executive Directors of April 4,1972 (R72-74) is being taken, with the support of Sweden and in consulta-tion with the Government of Bangladesh, with a view to resuming work onthese projects.

43. IFC has made eleven investments in Pakistan totalling aboutUS $26 million, including one in Bangladesh, Karnaphuli Paper Mills Ltd.(US $6.23 million), of which IFC currently holds US $15.4 million net ofcancellations, repayments and participations. IFS has some preliminaryapplications under consideration for investments in Pakistan.

44. This is the only lending operation in Pakistan which will bepresented for consideration this fiscal year.

45. The Bank Group's strategy in the next few months will be toassist, as Chairman of the Pakistan Consortium, the Government and theConsortium countries in reaching agreement on longer term debt reliefproposals, and to prepare, towards the end of this calendar year, anassessment of the economic situation and of the progress being made indevelopment planning in order to help establish the priorities for futuredevelopment assistance.

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PART III - THE PROJECT

46. In support of recent economic reforms, the Government has requestedassistance in the form of an imports program credit from the Association.The proposed credit of US $50 million would complement the assistance by themember countries of the Pakistan Consortium and the IMF referred to inparagraph 36.

47. A mission to formulate the credit proposal visited Pakistan inMarch 1972. It had discussions with the Government and with industryrepresentatives and visited 24 large manufacturing enterprises, mainly inthe engineering sector, to assess the present situation and import needsof industry. Negotiations were held in Washington on May 19 through 25,1972. Pakistan was represented by a team headed by Mr. Zafar Iqbal,Joint Secretary, Economic Affairs Division, Government of Pakistan.

48. The Bank report "Industrialization of Pakistan"'/ dated March 10,1970, describes in full the past record, the problems and prospects ofindustry in Pakistan. The problems outlined in the report are low capacityutilization, unsteady and insufficient supply of imported raw materials,components and spare parts and widespread and increasing differences, atthe official exchange rate, between the domestic and foreign prices ofindustrial goods. The recent internal disturbances and hostilities withIndia have further aggravated these problems. Due to the lack of foreignexchange, low public and private investment expenditure and to some extentthe loss of the market in East Pakistan, average"'oapacity utilization inindustry is lower than ever. For example, in the engineering industry,which is heavily dependent on imported materials, it has fallen even lowerthan the 40-50 percent of 1969 to 30-40 percent.

49. The reforms now initiated by the Government offer the possibilityof overcoming these problems and of returning to reasonable levels ofcapacity utilization. The change in the parity of the rupee brings thedomestic price level of industrial goods back on to a comparable basiswith international prices. Equally important, the Government has substantiallychanged and simplified its import licensing system. As mentioned above,Pakistan has operated a complicated system of multiple exchange rates,import licenses and import entitlements, which has now been abolished.

50. The basic strategy of the new import policy is to minimize theadministrative controls and complications. Import licenses remain, butsolely as a means of registering imports. Apart from a limited range ofcommodities exclusively reserved for procurement against tied aid or barter,

1/ Industrialization of Pakistan, The Record, The Problems and TheProspects (R70-53; April 2, 1970),

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imports will be permitted from world-wide sources. Import of machineryand equipment of up to Rs. 200,000 against cash and up to Rs. 500,000against barter or credits, will be allowed freely. Imports of machineryon a bigger scale will continue to be sanctioned subject to review bythe Ministry of Industries.

51. As explained in Part I above, public development expenditureshave fallen drastically during the current fiscal year. Private invest-ment, because of lack of confidence, has fallen considerably over alonger period. With the Government's actions to improve mobilizationof resources and its plans to increase public development expenditures,confidence appears to have returned and industrialists generally seemoptimistic about the prospects of industry. The loss of the market inEast Pakistan had comparatively little effect on industry as a whole.The cotton industry which sold the highest share of its output to theEast Wing, is also the industry with the best prospects to shift toother export markets. Other manufacturing industries (including theengineering industry), sold on an average only 6 percent of outputto the East Wing, and the loss of that market had comparatively littleeffect. Prospects for a return of industry to its pre-war level ofactivity are good, provided sufficient imported materials can be madeavailable. Ample capacity to manufacture a wide variety of goods domes-tically is available, and businesses are liquid. Industrial relations,after considerable disruptions and upheavals, now appear to be improving.

52. The proposed credit would be used to finance part of the importsrequired in 1972/73 by a wide range of manufacturing industries, includingtextiles, chemicals,paper making, leather goods, plastics and engineering.In addition, for the purpose of securing sufficient compound and phosphaticfertilizer for the crop to be planted in October, 1972, the credit wouldalso finance that part of the Government's program for the import of suchfertilizer which cannot be procured and financed from bilateral sources intime. Not more than $3-5 million of the credit will be disbursed on thesefertilizer imports. Items which will not be financed from the Credit areconsumer goods, military equipment,iteme custemarily imported for the publicsector under project aid and items reserved for procurement from designatedcountries. The list of'categories of goods to be financed out of the pro-ceeds of the Credit is included in Annex III.

53. In 1970/71 imports of the eligible goods, excluding fertilizer,amounted to $237 million. It is expected that imports in 1972/73 may reachthe 1970/71 level so that the proposed credit would finance about 20-25percent of industry's requirements of these goods. Some bilateral aid willalso be used to finance industrial and fertilizer imports. On the basis ofpast usage, if bilateral commodity aid amounts to $130 million, approximately$20 million will be used to import fertilizers and pesticides, $20 million willbe allocated for other public sector users, and about $90 million will be usedto finance private sector industrial imports. As the proposed credit andbilateral aid taken together will probably be substantially lower than therequirements of eligible goods, no difficulty is foreseen in disbursing the

- 19 -

credit as well as bilateral aid. Furthermore, as much of the bilateral aidmay become available somewhat later than the proposed credit, disbursementsare likely to be rapid.

54. Most of the imports to be financed by the credit would be directimports by the private firms through normal commercial channels. TheTrading Corporation of Pakistan (TGP), a state corporation, is the designatedimporter of a limited number of items where economies can be secured byimporting in bulk. Of these items, pig iron, steel strip, non-ferrousmetals, newsprint, pharmaceutical raw materials, wood pulp and manmadefibers may be financed by the IDA credit. Total annual requirements ofthese items amount to about $25 million. Part of the imports of theseitems may be financed by bilateral aid and it is, therefore, impossibleto make an estimate as to what share of the IDA credit would be used forimports through TCP. The Ministry of Agriculture is the designated govern-ment agency for the procurement of fertilizer. The Government has agreedthat goods and services to be procured through TCP or the Ministry ofAgriculture and to be financed out of the credit will be procured on thebasis of international competition. In passing on imports to industrialusers, TOP charges its actual cost plus a service fee ranging from 2-4percent, depending of the scale of the purchases.

55. For the time being, Pakistan is continuing to allow Commonwealthpreferences on a limited number of items. However, in the case of purchasesby TCP and the Ministry of Agriculture, tenders will be evaluated on thebasis of c.i.f. prices, so that tariff preferences will not be taken intoaccount.

56. All disbursements, covering the c.i.f. cost of qualifying imports,would be on a reimbursement basis. For administrative convenience,qualifying imports costing less than $5,000 would be ineligible for reimburse-ment. Wh-le no retrospective financing would be allowed, it is intendedto permit disbursement in respect of goods imported under licenses issuedbefore the date of the credit and paid for after June 30, 1972. The StateBank of Pakistan will be responsible for collecting, through nominatedbanks, invoices, evidence of shipment and evidence that the supplier hadreceived payment. Such evidence will be forwarded to the Bank in supportof withdrawal applications. The State Bank will also provide a certifica-tion in each case that the goods have been supplied from member countriesof the Bank or Switzerland and that they had not been financed already byany bilateral source or by another international development finance insti-tution. The credit should be disbursed over a period of nine to twelvemonths.

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PART IV - LEGAL INSTRUMENTSAND AUTHORITY

57. The draft Credit Agreement between the Association and the IslamicRepublic of Pakistan and the Recommendation of the Committee provided forin Article V, Section l(d) of the Articles of Agreement, are being distri-buted to the Executive Directors separately.

58. Under Section 7.02 of the draft Development Credit Agreement, the

Association would be entitled to suspend further disbursement if, after

reviewing with the Government the progress made in implementing the variouseconomic and financial measures taken, it determines that the purpose ofthe Credit, i.e., the support of the successful implementation of the Govern-ment's economic and financial program, is not likely to be achieved.

59. I am satisfied that the proposed development credit w'ould complywith the Articles-of Agreement of the Association.

PART V - RECOMMENDATION

60. I recommend that the Executive Directors approve the proposed credit.

Attachments Robert S. McNamaraPresident

May 31, 1972

ANNEX IPage 1 of 5

THE STATUS OF BANK GROUP OPERATIONS IN PAKISTAN

STATEMENT OF BANK LOANS AND IDA CREDITS(as at April 30, 1972)

Amount (US $ Million)Loan or Less Cancellations

Credit Undis-Number Year Borrower Purpose Bank IDA bursed

Loans and credits fully disbursed 352.8 222.9Loans and credits being disbursed

266 1960 Pakistan Indus (multipurpose) 90.0 - 18.550 196)4 Pakistan Education - 8.5 3.3

376 196)4 Karachi Port Port Development 17.0 - 4.354 1964 Pakistan Highways - 17.0 1.4

106 1967 Pakistan Lahore Water Supply - 1.8 0.01548 1968 Pakistan Tarbela (multipurpose) 25.0 - 25.0549 1968 Dawood Hercules Fertilizer 32.0 - 0.002578 1968 Pakistan W.P. Highways II 1.1 - 0.1145 1969 Pakistan Telecommunications - 16.0 6.8590 1969 PICIC Industrial Development 40.0 - 3.8597 1969 SNGPL Sui Northern Gas II 8.0 - 0.2621 1969 Pakistan Western Railway 14.5 - 9.7157 1969 Pakistan Agricultural Bank III - 30.0 13.3177 1970 Pakistan Ind. Development (IDBP) - 20.0 11.6696 1970 SNGPL Sui Northern Gas III 19.2 - 6.7S-9 1970 Pakistan Port Engineering - 1.0 0.6186 1970 Pakistan Telecommunications II - 15.0 15.0206 1970 Pakistan Engineering Education - 4.0 4.0213 1970 Pakistan W.P. Power Distribution - 23.0 23.0

Sub-Total 2 7.31

Credits on which disbursements are suspended41 1963 Pakistan Dacca Water Supply - 13.2 7.242 1963 Pakistan Chittagong Water Supply - 7.0 3.749 1964 Pakistan Education 4.5 0.853 1964 Pakistan Highways 22.5 18.983 1966 Pakistan Foodgrain Storage - 19.2 0.887 1966 Pakistan Education II - 13.0 9.0

S-8 1969 Pakistan Dacca SW Irrigation (Eng.) - 0.8 0.06S-10 1970 Pakistan Irrigation Engineering - 2.4 1.1184 1970 Pakistan Chandpur II Irrigation - 13.0 12.4192 1970 Palcistan Small Industries - 3.0 2.8208 1970 Pakistan Tubewells - 14.0 13.9228 1971 Pakistan Reconstruction - 25.0 25.0

Sub-Total - 93 95. 6Total 599.6 496.8Of W[hich Has Been Repaid 171.1 0.45Total Now Outstanding 2 79-6Amount Sold 22.3O" Which Has Been Repaid 20.8 1.5Total Now Held by Bank & IDA 427.0 496.35

Total Undisbursed 68.3 174.67 242.97

ANNEX IPage 2 of 5

STATEMENT OF IFC INVESTMENTS(as at April 30, 1972)

Amount in US$ MillionYear Investment Type of Business Loan Equity Total

1958 Steel Corp. of Pakistan Rolled Steel Products 0.63 - o.63Ltd.

1959 Adanjee Industries Ltd. Textiles 0.75 - 0.75

1962- Ismail Cement Industries Cement 5.25 0.42 5.671965 Ltd.

1963- PICIC Development Financing - o.49 0.491969

1965 Crescent Jute Products Textiles 1.95 - 1.95Ltd.

1965 Packages Ltd. Paper Products 2.31 o.84 3.15

1967 Pakistan Paper Corp. Ltd. Paper 3.20 2.02 5.22

1969 Dawood Hercules Chemicals Fertilizers 1.00 2.92 3.92Ltd.

1969 Karnaphuli Paper Mills Pulp and Paper 5.60 0.63 6.23Ltd.

Total Gross Commitments 20.69 7.32 28.01

Less Cancellations, Terminations,Repaymients and Sales 11.74 0.91 12.65

Total Cmnmitments Now Held by IFC 8.95 6.41 15.36

Total Undisbursed 1.00 - 1.00

ANNEX IPage 3 of 5

C. PROJECTS IN EXECUTION

US$90.0 million (Indus Basin) loan of September 19, 1960 (Ln. 266)

All major project items (except Tarbela Dam) completed. Settlementof a number of claims and some remedial works outstanding. No fur-ther disbursement of Bank Loan is expected during remainder of thiscalendar year.

US$17.0 million (Karachi Port) loan of May 14, 1964 (Ln. 376)

Postponement of the Closing Date will be necessary. A supervisionmission is scheduled for June. The present Closing Date is June 30, 1972.

US$25.0 million (Tarbela Dam) loan of July 10, 1968 (Ln. 548)

Loan was limited to residual financing, therefore no disbursementsare expected until FY 1976. Good progress is being maintained on theworks.

US$32.0 million (Fertilizer) loan of July 10, 1968 (Ln. 549)

Construction work was completed in July 1971 and commercial productionwas started in February 1972. Only $1,900 is undisbursed.

US$1.1 million (Highways) loan of December 20, 1968 (Ln. 578)

A mission is tentatively scheduled for June to discuss therecommendations of the consultants' transportation study with theGovernment.

US$40.0 million (Development Finance Company) loan of March 21, 1969(Ln. 590)

Disbursement in full is expected by the Closing Date. A supervisionmission is tentatively scheduled for September 1972.

US$8.0 million (Gas Transmission) loan of May 13, 1969 (Ln. 597)

Project is virtually completed. A supervision mission visited theproject in early May.

US$19.2 million (Gas Transmission) loan of June 29, 1970 (Ln. 696)

The recent hostilities have delayed execution of this project and alsocaused cost increases. The nature and amount of these are beingascertained by the supervision mission which visited the project inearly May.

ANNEX IPage 4 of 5

US$14.5 million (Railways) loan of June 26, 1969 (Ln. 621)

No problems expected. Most recently, the Association has approvedthe Borrower's request to extend MIS Sofrerail's contract to includeimplementation of their recommendations and a study of some aspectsof the management of Pakistan Western Railways.

US$8.5 million (Education) credit of March 25., 1964 (Cr. 50)

Procurement for polytechnics in Sind and Punjab can,be completedbefore the Closing Date. At Agricultural University Lyallpur', con-struction cannot be completed by the Closing Date, but teachingbuildings should be substantially completed and equipped. The Govern-ment of Pakistan has requested postponement of the Closing Datefor an unspecified period, reallocation of the proceeds of the Creditto purchase additional instructional equipment for the AgriculturalUniversity amounting to $250,000, and increase in the reimbursementpercentage for local expenditures on construction to 25% (from 10%).This request is under consideration.

US$17.0 million (Highways) 'credit of June 11, 1964 (Cr. 54)

Construction is completed. The Association has approved a thirdpostponement of the Closing Date (to December 31, 1972) to permitthe settlement of contractors' outstanding claims.

US$1.75 million (Lahore-Water Supply, Sewerage and Drainage) credit ofMay 12, 1967 (Cr.,106)

SIDA participation is $1.75 million equivalent. The project is vir-tually completed. Lahore Improvement Trust (LIT) requested a changein withdrawal ratio between IDA and SIDA credits. The'Associationhas agreed to LIT's request in order to allow full utilization of bothcredits.

US$16.0 million (Telecommunications) credit of March 6, 1969 (Cr. 145)

Procurement problems are now largely resolved. A supervision missionwhich visited Pakistan in May discussed a revision of theproject in light of the suspension of those parts of it which arein East Pakistan. Postponement of the-Closing Date by about one yearis expected. The present Closing'Date is December 31, 1972.

US$15.0 million (Telecommunications) credit of May 22, 1970 (Cr. 186)

See Credit 145-PAK.

US$30.0 million. (Agricultural Development Bank) credit of June 26, 1969(Cr. 157)

Disbursements continue to be far behind schedule. Tractor supplieshave been disrupted because the Government has not issued licensessince September 1971. Lending for tubewells is continuing slowly asa result of difficulties in WAPDA providing electrical connections,due to power shortages. Postponement of the Closing Date by twelveto eighteen months is likely. The present Closing Date is June 30, 1972.

ANNEX IPage 5 of 5

US$20.0 million (Development Finance Company) credit of February 11,1970 (Cr. 177)

IDBP'a immediate future has been uncertain for some time as a resultof thela*c of a clear.industriaal policy and a change in ManagingDirector. A supervision mission is tentatively scheduled for lateJune.

US$4.0 million (Engineering Education) credit of June 29, 1970 (Cr. 206)

Construction scheduled to start in January 1973. Procurement isnot yet started. No major disbursements are expected during thecalendar year except for payments to consultants.

US$23.0 million (Electric Power Transmission and Distribution) creditof August 14, 1970 (Cr. 213)

After initial delays, the project has started to make some progress.Contracts have been awarded for power transformers ($4.7 millionequivalent), and for the Dharki-Rohri 132 KV transmission line ($h22,000equivalent). Bids for substations phase I (estimated foreign exchangecost $5.6 million) and power transformers phase II (estimated foreignexchange cost $2.4 million) have been opened but evaluation reportsare not yet received. Bids for 11 KV switch gear (estimated foreignexchange cost $1.6 million) and substations phase II (estimated foreignexchange cost $2.8 million) should have been opened but no informationhas been received about them. WAPDA has requested financing fromthe Credit for additional special transmission work in Lahore (totalcost about $1.0 million equivalent, of which $0.6 million equivalentis in foreign exchange), which will need a revision of the projectdescription in the Credit Agreement. This request is under.consider-ation.

US$1.0 million (Port Ehgineering) credit of June 10, 1970 (Cr. S-9)

Final report of engineering feasibility study was completed in mid-May. A preappraisal mission is scheduled for early June.

ANNEX 1I

Forma No. 81.02 WRDBN RU(5-72) WRDBN RU

COUNTRY DATA

COUJNTRY: Pakistan (West)

~~~ 794,613 ~~~~~~~~~~~~~~~~~~POPULATION: 60.07 mlllian 1970/71 DENSITY: 76 per ko

Nate of Growt 2.7 8 (fram 1969/70 to 1970/71) Thu= 316 Per km of to) tivatod l1nd

POP0trATCON CRARACTERISRTICU: HEALTH,:

CUde. mrtA Rate (per, 1,021) 0 1968 -Paoplstloa per physician 1970 4,361.

Crdteth Nate (Per 1,000)1 2C 1968Polt.np hsialbd 17 196Infant Mortality (per 1,000 lve births) (year.oaalmprheptlhl 170,9

jN,COMr DISTRI.BUTION: DIS~~~~~~~~~~~~~R1TRIBUTION OP LAND OWNERNSHIP

hjgheeotqaltina ) Nat available .of I-od oc-d by tap 107. o-areq ~~~~~~~~~~~ %~~~~7 of load owood by ..melest 10% macar) Rat availble

ACCrftI '10 P0TAB11 W4hrER (7 of pop.lotio-) ACCESSO'I0 ELECTRICITY' (7. of popalarlo-l

Rorol )Not -milahle nro)Rt av,abla .

0fTiOtN: GoOP.,ect. yar PERCAPITA: 814.6 1970/71 EDUCATICON:Caori clkNIA frrorvet yer At au~et factar _Tiktersay rate 11% 1961

Per capita Protein Rotate Cgraoone) (yswr) )c/A ost and at offiolal Primay schoil anrolmert (8) 4.6% 1970

parity rate of Ro.11R0S0 00G10T1C PROD100T (1970/71 (siae)4.76 per UI 8) AMML (COMP¶OUND) DATE, Opl Gop GROWTH (%, oonstanxt factor o..st)

GKP -t ... k.t prices 9,181 lui-.O ~~~~~~~~~~~~~1960 161-1964/6t 1965/66-1969/70 1970/71

Gro.. lI-.tstOat 1,575 17.0Grosa Cutlooci Soviage i,195 13.0 Agiouitur 3.7 5.6 -2.2

Corroat A-mocot Balanme 380 4.2 Induotry 2/ 13.1 7.5 2.9

Osporta of Goode, ((PU 8480 9.2 lervicee 6.8 .u42.8Teporte of Cod.NES 1,228 13.4. COPto _

OUTPUT. 0B0R PUORCE AllDPRODU0C'T0ITY IN -1970/71: (GDP estimates at ourret fc,otor coot)

faita Oddod .r,r r ~~~~~~~~~~~~~Voice idleS Par dorker

Agriculture 3.262 37.5 02 88 11.9 43Tud.aotry 2.123 24.3 . 2l8g12

Totl/Roerogo NM 100.0 25. 109 9 -. 100

PUBLIC PINA) CIT INl 1970/71

Co....lidated Csatr.1 and Pravimakl Govr,amea domamtst, e F l Ca. rmeIdRAouont %of Orp (R.. Milli..) 0--- of7 GDP-aoara.

Current R-1p- m~~~(s. illion) % of COP last tao years 5/1 drvot % of GOP last tam years 5/Correot Rrorlpcs r~~~~ ~ ~~~~~,182 16.4. 16.5 5,551 12.7 10.7

Ro:1-D-veopoe..t Empemdittree (tool. tranafers) 6,768 15.4. 14.8 6,158 14.1 13.8Correot Scro1os/Defi.tot 411. 0.9 1.6 - 607 - 1.1. 1.2

D-ovoim..eot.lopeeditare 2,810 6.4. 6.8 2,629 6.0 6.7bt-isrol .ioltar~.c (gross) 1,249 2.8 2.8 2,249 2.8 2.8

PRICES 01I0 CREITO?amd of year: (R,oleoalo Prima Iodeo 2m-b Crotll to Pobio leotor Both Cre1It to lrlvcto Ivotor

~~ 1P68/69 108am~~~~~~Id. 1959/60.100 % Chuwg (oct) % mh-mCe (-.n'ct) achaogo

PY 1969/70 132 15PG 197.1/71 137 + 3.8 (Na separt'e figure for West Paknistano)

Pebroamy 1970 138 Pab O.. ' 1971 148 +7.2

R3ALANCE Op PAYMENTS1 fIn last tom years) US OERCRANDIIE EXPORTS (Aveare af the last three X.ear)1968/69.1970/71 2/

R ... __ Hoo Rw Cotton 50 16

RMeoteh d. .P,t. 3 30 205 Cotton Mooc"tantr 113 30

T-ivlibles 3/ 175 1LI Rime 30 6Leather and Leather looads 30 8

Pezoonte Irot Flak 14. 4

Imisiblo. oi ~~~~~~~~~~~~~~~~Ohes12713bnvialilas ~~~~~~~229 229

Publio ISotor (58 (155) Total 372 100

Private Smctor (71) (74)bit lervAcs ~~~~~~212 219

Pntrestp. . 83N EXTERNAL. DEW ON JUnE 30. 1970

____________ __ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~($Inv.)Overall flefimit -617 ~~~~ ~ ~~~~~~~~-612 Melian and Long-tern Credits, Poblim 2928

Edocomed by Roo~~~~~~~~~~~~~~N.-Gouraoteed Priv.at M0.TForeign Aid 9 315 371Moratoriumo or. Debt Osroime 28 Total Outstanding and Diebuorsad

Purhase of Foreign Excanege fromthe Eastern Provinos21 3

Use 0, Offi..1 Re.--- 5151 110 DENT 0 ER0ICERNATIO 197o/n7 1.0%

XRO/TIh L0911N1. APRIL 30. 1972 9/(8 mL.)IBRD lIDA

Outstanding and Disbursed 406 32-Uadiiabrsed 68 79

Outatanding incl. Undlebursed 4.74 10'

Nate of EunhanIge,, RS $1.01 R A. 1.76 Dots: lMaY 31, 1972Rupee 1.00 US0 8_0.21

Dooartmnet: South Asia

.1 M-aotuaturing, miniog, qoar.rying, monstruction, electricity, gas, eater mad aOootaryeroa.2/ E.mluding re-poorts.

Incloluding Workers' remittances.WProeiot aid disbu,rsaents 00ncoluded are reduced by 15 Perceot to adjust for tamally ontainmd serio.s

ooonal.v oot remarrdoas a0 moatr-entry in the forsige esohange budget.51 lomludlng 'toe of SD"0s PIus DI credit, and residual balances.

AlTotal debt burds (iooloeive of East Pakcistan,) related to West Pakistan,'sa foreign soohooge earnings only.13 Eamiuding inter-wing emports.

JThose loans and credits &lolh wer intended for disbursemnt in both wings are treated as for West Pakistan osly.2/1969/70 mad 1970/71 aoveas..

ANNEX IIIPage 1 of 2

PAKISTAN - INDUSTRIAL IMPORTS PROJECT

CREDIT AND PROJECT SUMMARY

Borrower: Islamic Republic of Pakistan

Amount: Equivalent in various currencies of US $50million.

Terms: Standard

Project Description: Provision of foreign exchange to pay forimports of industrial raw and semi-finishedmaterials, components, spare parts andmiscellaneous items of manufacturing equip-ment and fertilizers to oupport Pakistan'sprogram of economic development.

Procurement Arrangements: Mainly by private importers through commercialchannels. Some items to be bulked for importby Trading Corporation of Pakistan afterinternational competition. Compound andphosphate fertilizer, up to $5 millionafter international competition to beprocured by the Ministry of Agriculture.The categories of goods eligible fordisbursement are the following:

Raw vegetable materialsTanning and dyeing extractsVegetable oilsSalt sulphur chemicals and compoundsPhosphatic fertilizerPlastic materialsRubberRaw hides and skinsIndustrial woodPaper and paper boardSilk and textile materialsFire brick and graphiteIndustrial glassIron and steelNon-ferrous metalsManufactures of metalBoilersElectrical machinery and equipmentMechanical machinery and equipmentCommercial and industrial vechiles, partsthereof other than passenger cars

ANNEX IIIPage 2 of 2

Estinaated Disbursements: September 72 Quarter $ 5 million

December 72 Quarter $10 million

March 73 Quarter $20 million

June 73 Quarter $J5 million

ANNEX IVCONFIDEATIAL

INTERNATIONAL MONETARY FUND

Pakistan: Change of Par Value and Wider Margins

Prepared by the Middle Eastern Department andthe Exchange and Trade Relations Department

(In consultation with the Legal and Treasurer's Departments)

Approved by Ernest Sture and John W. Gunter

May 8, 1972

I. Introduction

In a letter dated May 4, 1972 (Appendix III) Pakistan has proposeda change in the par value of the Pakistan rupee from 0.186621 gram of finegold to 0.0744103 gram of fine gold per Pakistan rupee in accordance wit}Article IV, Section 5, that is to correct a fundamental disequilibrium. 1It is proposed that the change would be effective on May 11, 1972 at 10 p.m.Washington time. The Government of Pakistan has also stated that it availsitself of the wider margins under Executive Board Decision No. 3463-(71/126),adopted December 18, 1971, and that it will use the United States-dollar asits intervention currency.

The new par value now proposed represents a decrease in the gold valueof the Pakistan rupee of 60.13 per cent and corresponds to 11.9428 Pakistanrupees per special drawing right or, 0.0837321 special drawing right perPakistan rupee. At the new par values, the United States dollar is equalto 11 Pakistan rupees per U.S. dollar.

The proposed change is to be supported by a financial program submittedto the Fund in2/onnection with a stand-by arrangement which is the subjectof EBS/72/150.- Details of recent economic developments are described inthat paper.

II. Background to the Proposed Change

For many years Pakistan has operated a complex exchange and trade systeminvolving multiple e change rates and substantial reliance on exchange andtrade restrictions.3" The system utilized an Zxport Bonus Scheme introducedin 1959 as a stimulus to exporters. Exporters of specified commodities wereissued "bonus vouchers" up to specified percentages of their export proceeds.

1/ The initial par value of the Pakistan rupee agreed with the Fund onMarch 19, 1951, was 0.268601 gram of fine gold per rupee. This was changedto the present par value on July 30, 1955.2/ A Fund mission consisting of M4essrs. John W. Gunter, A. S. Gerakis,

J. Rose, S. Cnossen and H. Baas discussed the exchange reform and financialprogram with the Pakistan authorities in Islamabad, February 17-24, 1972.3/ The system is described in detail in SM/70/198 and SM/70/210. Changes

in the system since January 1, 1971 are set out in Appendix II.

- 2 -

These vouchers could be sold to importers as a form of entitlement to theimport of a range of specified goods or could be used. by the exportersthemselves for imports additional to licensed entitlements. While allpurchase and sale transactions of exchange itself were based on the exist-ing par value rate (PRs 4.7619 per US$1), effective exchange rates wreredetermined by: whether or not transactions were subject to the receiptor surrender of bonus vouchers: the percentage of the value of an exporttransaction for which vouchers were given or of an import transaction forwhich they were required; and the current market rate for vouchers. Overtime the scheme was subject to continual modifications reflecting thestate of the balance of payments and the use of multiple currency practicesin an effort to promote various economic and social objectives. Suchmodifications were achieved by: changes in the lists of export and importitems and, later, invisible payments and receipts covered by the scheme;in the rates of bonus epplied to transactions covered by the scheme; andin the period of validity of bonus vouchers and the timing of theirsurrender.

While the scheme doubtless contributed to the good experience Pakistanenjoyed for some years in the expansion of manufactured exports, it failedto produce an exchange rate system serving an appropriate pricing function.Despite the fact that the par value became increasingly unrealistic overtime, a large volume of transactions, including public sector paymentsand receipts and imports under aid and bilateral trade, continued to beeffected at that rate (although some such imports were subject to "equali-zation" taxes). On the other hand, the other rates for transactions coveredby the scheme were progressively depreciated so that the spread betweeneffective rates widened. Demand for imports remained excessive and thecontrol systemi was under continuous pressure in trying to rationalize thedistribution of available exchange resources for imports; in addition, therewas a stringent control over invisible payments. Complemented by the effectsof other policies, exchange policy resulted in serious distortions inresource allocation.

The existing exchange rate structure is set out in Table 1. Thestructure of the import licensing system is given in Appendix I and detailedchanges in the exchange and trade system since January 1971 in Appendix II.

- 3 -

Table 1. Exchange Rate Structure-/

(Pakistan rupees per U.S. dollar)

Buying Selling

Official 4.76 Public sector Official 4.78 Public sector pay-invisibles and ments, imports underprivate sector aid/barter andinvisibles not invisibles notreceiving bonus subject to bonus

10% bonus 5.66 Primary goods; someprivate sectorinvisibles

35% bonus 7.92 Jute and cottonmanufactures

45% bonus 8.83 All other manu- 45% bonus 8.86 Certain invisiblesfactures and trans-actions 50% bonus 9.32 More essential non-

aid imports andcertain invisibles(so-called 'cash-cum bonus" rate)

100% bonus 13.86 INonessential imports,all imports in excessof licensed allocationand all other permittedtransactions

1/ Calculated on basis of market rate for bonus vouchers of PRs 190 perPRs 100 vouchers; actual market rates have been close to this rate in recentweeks.

During 1971, external policies reflected an extreme tightness in theforeign exchange position. Foreign exchange reserves fell from $343 millionin March 1970 to $174 million in iarch 1971 (equivalent to about five weeks9payments on current and capital account). In April 1971, the Governmentunilaterally declared a moratorium on a large part of its debt serviceobligations. Moreover, the half-yearly import program (January.-June), whichitself had been more restrictive in terms of new import prohibitions, under-went a severely restrictive revision at that time. More items were prohibited

- 4 -

and imports were made more costly by movements of items to import listssubject to more depreciated exchange rates. The import program for July-December 1971 remained essentially unchanged, but as nonproject aidavailabilities dwindled because the aid pipeline was not being replenished,many raw materials which had been available to industry from aid at theofficial rate (PRs 4.78 per US$1) could only be procured with free exchangeat the most depreciated selling rate (PRs 13.86 per US$1). Announcementof the import program for January-June 1972 was delayed until mid-Februaryand while structurally it remained virtually unchanged as compared to theprevious program, there was a continuing severe constraint on exchangeresources for its financing.

During 1971, exports from (West) Pakistan showed a strong growth,manufactured exports being assured of necessary imported inputs on aprivileged basis. There was also a continuing extension of the mostdepreciated buying rate (45 per cent bonus) to a widening range of invisiblereceipts. Exchange reserves, which, after the belt-tightening of April1971 as well as the impact of some temporary factors, had risen from $174million at end-March to $221 million at end°August and were at $217 millionat end-November, came under heavy pressure thereafter and fell to $190million at end-January 1972, despite the allocation of SDR 25 million inthat month.

In September 1971 the exchange rate for the Palcistan rupee, previouslypegged to sterling, was pegged to the U.S. dollar. In late December 1971,in response to the Managing Director's enquiry, the State Bank of Pakistaninformed the Fund that Pakistan would maintain unchanged its official ratefor rupees in terms of dollars.

III. The Proposed Exchange Reform

As a key element in a reformulation of economic policy, the Pakistanauthorities have decided to unify the exchange rate system at a fixed rateof US$1 = PRs 11. They believe that it is essential to adopt a fixed ratherthan transitionally floating rate in order to ensure public confidence inthe change. They feel confident that the proposed new par value is realisticand will support their intention to eliminate progressively nontariff traderestrictions and payments restrictions. The reform and the supportingstabilization program should, in their view, enable Pakistan to eliminateany further decline in net external reserves by not later than June 1974(see letter of intent for reouested stand-by arrangement).

As regards the import regime, it is proposed to establish a singlelicensable list including a large number of commodities for which allexisting restrictions will be eliminated and licenses issued freely.This list will conk-ain the bulk of raw materials, spare partsand componenits needed for industry. All imports not on the list will beprohibited. Given the balance of payments situation, the liberalizationpolicy cannot be pressed further immediately, but extensions in its coveragewill be feasible in due course, when foreign exchange receipts respond to

- 5 -

the devaluation. Mloreover, the existing structure of industry has developedbehind highly protective barriers and a rapid move to comprehensive liberali-zation might be quite disruptive. Therefore, the policy will be to reduceprogressively nontariff restrictions on imports as the pattern of domesticindustry is rationalized and its competitive ability is improved. Further-more, the authorities are undertaking a comprehensive review of the tariffschedule. While a primary objective of this review will be to raiserevenues,I' it is also intended to increase the use of the tariff as aninstrument of protection.

Some exceptions to the complete freedom of imports of items on thelicensable list will be made due to difficulties in the absorption of tiedaid and bilateral payments balances. Hitherto, this has been ensuredthrough the exchange system by giving tied aid and bilateral imports thepreferential official (par value) rate. To replace this loss of incentivefor the use of nonconvertible exchange resources by importers, it may benecessary to use fiscal measures and/or quantitative restrictions. It isexpected, however, that such measures will be applied on a limited scale;imports affected will probably be considerably less than one fifth of totalimports. Concurrent with import liberalization, there is to be a movementtoward liberalization of payments for current invisible transactions.

On the side of receipts, the Government will apply the followingduties on exports as temporary measures designed to siphon away windfallprofits which would otherwise accrue to exporters, and to raise revenuefor the budget:

Approximate export duty-/Commodities (In Pakistan rupees per US$1)

1. Raw cotton, cotton waste, hidesand skins 4.50

2. Wool 3.503. Quality (Basmati) rice 3.004. Cotton yarn, tanned and semi-

tanned leather 2.005. Fish, other primary commodities,

grey cloth 1.50

As indicated below, despite these duties, incentives for export productionwill be improved significantly during the initial period after the devalu-ation, and it is intended to encourage exports further with a gradualreduction of taxation.

1/ Tariff rates will be reduced on average less than in proportion tothe devaluation, so that the landed cost of imports will rise somewhat morethan the increase in effective exchange rates.2/ Some of the duties will be specific so that the indicated effective

taxes are approximate.

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IV. Balance of Payments and Related Effects of the Reform

In appraising the extent of the devaluation proposed by the Pakistanauthorities, the exchange rate to be established by the reform (afterallowing for export duties) should be measured against the rates in effectbefore the reform. There are a number of conceptual problems in makingsuch comparisons and, moreover, not all of the data needed in order tocompute averages for broad categories of transactions are available.Therefore, the figures given in Table 2 should be treated with some cautionand regarded as indicating orders of magnitude, rather than precise measure-ments. This table shows that the average rate for exports, due allowancebeing made for the export duties, will rise by about 20 per cent; the ratesfor individual export commodities will be between 15 per cent and 25 percent higher in rupee terms than those presently in force. For invisiblereceipts, including emigrant remittances, the average rate will go up byabout 55 per cent and for total receipts (exports, invisibles and foreignaid) by almost 45 per cent. On the side of imports, the new par value willbe somewhat lower than the bonus rate currently applicable to about one fifthof total import payments; on the other hand, it will be considerably abovethe cash-cum-bonus rate and almost two and one-half times asl,high as theofficial rate, which now applies to 55 per cent of imports.- On theaverage, the effective rate for imports will increase by about 40 per cent.The average rates for invisible payments, including debt service, and fortotal payments, will rise by 117 per cent and 66 per cent, respectively.Thus, it is apparent that the exchange reform would involve a majordepreciation of effective exchange rates. It should be noted that thedepreciation of the rate structure shown in Table 2 would be additionalto the devaluation which has been achieved since August 1971 vis-a-visPakistan's trading partners as a group by pegging the Pakistan rupee tothe U.S. dollar.

Owing to Pakistan's prolonged reliance on restrictions and other com-plexities, it is difficult to predict the balance of payments effects ofthe reform. However, it is reasonable to expect that there will be asubstantial increase in exchange receipts. Production of many export goodsshould prove sensitive to price incentives (for example, the record cottoncrop in 1971 is attributed, at least in part, to bonus on exports announcedin July 1970). 'The price elasticity of demand for the exports of Pakistanis high; since these exports represent small fractions of the respectiveworld totals, they can be increased significantly with little or no declinein their international prices. Moreover, the devaluation should facilitateefforts to export to foreign countries commodities previously sold in thesheltered market of the Eastern Province. With regard to invisible receipts,a staff study suggests that the largest, most immediate impact on exchangeincome would be in this category, particularly emigrant and other remittances;to some extent this would reflect. a reversal of capital outflows caused byexpectations of a devaluation.

1/ No allowance has been made for 1;equalization" taxes imposed on someaiT&-financed imports at the official rate to adjust their landed costs morenearly to similar imports financed at the cash-cum-bonus rate. the overallpicture presented in Table 2 is only marginally affected by this omission.

Table 2. Effective Costs of Foreign Exchange (Adjusted for Export Duties) Before and After Reform

(Amounts in millions of U.S. dollars; rates in Pakistan rnpees ner U.S. dollar)

Effective Return Effective RatesAfter Before After Before

Receipts Amount Reform Reform Payments Amount Reform Reform

Exports 536 9.30 T.7T- Imports T04 11.00 7.834/!

Raw cotton; cotton waste; h_des At officiel r.ate before reform 384 11.00 4.78and skins 101 6.50 5.66 At cash-oun-bonus rate before -

Wool i 7.50 5.66 reform 166 11.00 9.32Quality rice (Basmati) 38, 8.00- 5.66 At bonus rate before reform 153 11.00 13.86Cotton yarn: semitsnned, tannedleather 101 9.00 7.92 Invisibles and debt service

Fish; other primary exports; (interest and princi9al) 52 11'.Ogrey cloth 86 9.50 5.66; Public sector., including defense

7.92 Other manufactured extorts 206 11.00 T.92; i93ports 332 11.00 4.78;

o.83 - Private sector 193 11.00 4.78;

Invisibles2/ 347 11.00 L.9>/ 9.32

Bublic sector 236. 11.00 4.76 Grand total 1.2 11.00 6.642/Private sector- 111' 11.00 4.76;

5.66;7.92

Capital (aid) receipts 221 11.00 T4.76

Grand total 903 10.00 6.90

Sources: State Bank of Pakistan, Ministry of Commerce and Central Statistical Office.1M Calculated from data provided by the State Bank of Pakistan shoving export receipts end volume of bonus vouchers issued to exporters

in July-December 1971. The data are totals for the Western and the Eastern provinces taken together. The average rate for Paki,stanseparately has been computed after deducting from the respiective totals receints and vouchers issued for exports of raw jute and jutemanufactures (almost all of which relate to exports from the Eastern province).

/ Including private transfer receipts.3/ Based on State Bank totals for both provinces taKen together for July-Iecember 1971; it was assumed tnat private sector invisible

receipts at the official rate were negligible.4/ Computed from data of the Central Statistical Office shoving total imports on the basis of customs returns for July-December 1971 and

from data of the Ministry of Commerce (see Appendix I) showing private sector imoorts licensed by the Chief Comptroller of Imports and Exports.It has been assumed that public sector cash-cum-bonus imnorts in these six months snmoi,jted to PRs 50 million.

Notes: The anounts of receipts and payments shown in this table are based on the foreign exchange budget for 1971/72. In computingaverage effective rates for the pre-reform system the price of the bonus voucher vas taken as equal to 190 per cent of its face value. -Dueto rounding, components may not add uD to the respective totals exactly in the table.

- 8 -

The effects on payments are somewhat more uncertain. The liberalizationmeasures accompanying the reform will have an expansionary influence, whilethe substantial increase in the effective rates for im.ports and other pay-ments and the contemplated adjustments in tariffs will curtail effectivedemand for foreign exchange. Many imported items may be expected to risein price domestically, and it seems unlikely that foreign exchange expendi-tures will change greatly from the pre-reform level.

Pakistan is in the process of working out with its creditors revisedarrangements on external debt involving relief for a substantial partof its debt service obligations falling due in the 26 months endingin June 19T3; it is expected that there will also be discussions withthe IBRD and members of the Pakistan Consortium regarding the pledging ofnew aid for the development program.

The impact of the reform on exchange receipts and import demand coupledwith what appear to be reasonable expectations of the results of thesenegotiations with the Consortium (and non-Consortium members), suggest thatthe payments deficit would be considerably reduced in 1972/73 and that thetarget of eliminating the further deterioration of the reserve position byJune 1974 is realistic. It must be borne in mind that the scope of bannedimports is to be initially substantial. A broadening of the coverage ofthe liberalization to include additional commodities would no doubt leadto an increase in the size of the import bill; thus such broadening is tobe approached gradually as the balance of payments position improves.

Another important effect of the reform would be to help improve theallocation of resources. One of the principal benefits will result fromthe elimination of the artificially low effective rate for capital goodsimports. This rate had provided an incentive for excessive expansion ofindustrial capacity in some areas. It had also been a factor inhibitingthe growth of the domestic capital goods industry and in particulr theengineering industry; as emphasized in a study by the IBRD staffl' theseindustries were caught in a cost-price squeeze, since they were forced tocompete with imports at the official rate while having to use raw materialsand spare parts imported mainly at the more depreciated cash-cum-bonus rate.With the adoption of more realistic rates for exports, investment in exportindustries will be stimulated. Lastly the liberalization policy will makepossible a more rational distribution of imports among users.

1/ International Bank for Reconstruction and Development, Industrializationof Pakistan: The Record, the Problers and the Prospects, March 10, 1970,Volume 1, page 23.

- 9 -

V. Staff Appraisal

Pakistan has been experiencing severe balance of payments problemsfor a number of years. Domestic financial and economic policies havecontributed heavily to this, but a more direct cause has been the inadequateexchange rate system. Past efforts to revise and simplify the system haveproved ineffective, although they did lead to some degree of depreciation.While the system made possible a marked increase in industrial exports, italso encouraged the growth of demand for imports. This demand could not bemet by the rising volume of export receipts and the sizable inflow of capitaland, as a result, the authorities were obliged to rely heavily on quanti-tative restrictions with distorting effects on production and investment.

The reform now proposed involves a steep devaluation and unificationof the exchange system and some liberalization of imports. It may beexpected to strengthen Pakistan's competitive position, lead to a consider-able increase in exchange receipts and slow down the growth in the demandfor imports. Therefore, coupled with the arrangements for reschedulingpart of the country's debt service obligations and for a resueptionof foreign commodity aid, the reform should make possible within a reasonableperiod of time the elimination of the existing deficit in the externalsector; moreover, it should contribute to a-more rational use of thecountry's scarce resources. With the improvement of the balance of payments,the authorities will be able to extend the scope of import liberalizationand this will have further beneficial effects on the competitive abilityof the economy and on resource allocation.

The conclusion of the staff is that the proposed par value appears tobe realistic, falling within the range appropriate for the correction ofthe fundamental disequilibrium in Pakistan's balance of payments. It shouldbe emphasized, however, that it will be essential for the reform to besupported by a resolute implementation of domestic financial policiesdesigned to prevent the emergence of inflationary pressures. Such policiesare outlined in the letter of intent requesting a stand-by arrangementwith the Fund.

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VI. Recommended Decisions

The following decisions are accordingly recommended for the considerationof the Executive Directors:

I. 1. The Government of Pakistan has proposed a change in the

par value of the Pakistan rupee to become eff'ective

May 11, 1972. .The proposed par value is:

0.0744103 gram of fine gold per Pakistan rupee

418.000 Pakistan rupees per troy ounce of fine gold.

2. The Fund concurs in this proposal.

3. This par value corresponds to PRs 11.9428 per one special

drawing right.

II. The Fund notes that Pakistan is availing itself of wider

margins under paragraph 1 of Executive Board Decision No.

3463-(71/126), adopted December 18, 1971.

- 11 - APPENDIX I

Pakistan: Structure of the Imnort Licensing System

There are four types of import licensing for the private sectorwith items listed on (a) a Free List, (b) a Licensable List, (c) a Cash-cum-bonus List, and (d) a Bonus List. The following is only a broadsummary of the "List" system, there being a myriad of subsidiary con-ditions, qualifications and exceptions.

(a) Free List imports are financed from aid and bilateral balances andare restricted to "entitlement" holders on a first come first servedbasis with payment at the official rate (PRs 4.78 per US$1). Regionaland subregional allocations are made to ensure that different parts ofthe country get an equitable share of these imports. Items on the listare those negotiated with aid donors and bilateral partners and, whilethe number of items is limited, the list includes important categoriesof goods such as specified iron and steel items, chemicals and toolsand workshop equipment.

(b) Licensable List imports are also now financed only from aid andbilateral balances and are specifically licensed to authorizedindustrialists and commercial importers with payment at the officialrate (PRs 4.78 per US$1). The Chief Controller of Imports and Exportsdraws up a detailed budget fixing ceilings for each item. Items onthe list are those consumer goods and raw materials which are con-sidered essential and prices of which are to be kept low, includingmedicines, books and specified agricultural equipment.

(c) Cash-cum-bonus List imports are financed from Pakistan's ownforeign exchange resources subject to surrender of bonus vouchersequivalent to 50 per cent of the exchange cost of the import, resultingcurrently in an effective rate of about PRs 9.32 per US$1. The basisof licensing is determined by the Chief Controller. Items on the listare a mixture of raw materials and more essential consumer goods.Additionally, there is a Raw Material Replenishment Scheme whereby allexporters--industry and trade--extorting certain goods may obtainlicences for the import of specific items required for the productionof the respective exports, payments for such items being on a cash-cum-bonus basis.

(d) Bonus List imports are financed from Pakistan's own foreignexchange resources subject to surrender of bonus vouchers equivalent to100 per cent of the exchange cost of the import, resulting currently inan effective rate of about PRs 13.86 per USl1. There are no quantita-tive restrictions on bonus imports. Items on the list are mostly lessessential consumer goods with some raw material and machinery items,but items on any of the other lists may be imported on bonus terms.

- 12 -

Details of licensing of private sector imports by category of

licensing 1968/69 through to the first half of 1971/72 are given in

Appendix Table 1. The Table chiefly illustrates the sharp decline in

the rupee value of licensed imports in 1971, particularly in the second

half, attributable to the termination of Licensable List imports from

Pakistan's own resources in April 1971 (such imports having henceforth

to be financed on a cash-cum-bonus basis) and the decline in aid availa-

bility in the second half of the year. Chiefly as a result of these

factors and the movement of cash-cum-bonus list items to the basis of

bonus financing also in April 1971, there was a substantial rise in

bonus list imports. Effectively, both the volume of imports declinedsharply and their average cost in rupee terms was increased sharply.

Table 1. Pakistan: Private Sectot Imports by Category of Licensing-/

(In millions of rupees)

- Per Per Per Per Per Per PerCent Cent Cent Cent Cent Cent Cent

July- Share Jan.- Share July- Share Jan.- Share July- Share Jan.-- Share July- ShareDec. in June in Dec. in Jure in Dec. in June in Dec in1968 Total 1969 Total 1969 Total 1970 Total 1970 Total 1971 Total 1971- Total

I. Pakistan's own resources

1. Free List (Barter) 91.1 8.9 57.2 5.8 83.4 6.9 42.5 3.9 88.9 ,6.9 86.3 8.7 77.9 .9.8

2. Licensable List 223.5 21.8 25T.5 26.2 304.2 25.4 259.5 23.8 217.9 16.9 98.4 9*§ -

3. Cash-cum-bonus List 135.6 13.2 242.4 214.7 300.6 25.1 385.0 35.3 324.2 25.1 182.9 18.4 285.2 35.8

4. Edibie oils underP.L. 480 on cash-cum-bonus ters -/ 36.9 2.9 38.1 3.8 17.8 .2.2

5. Bonus List 285.7 27.9 235.8 24.0 251.0 20.9 269.3 24.7 259.8 20.2 358.8 36.2 325.8 )o.8

Total 735.9 18 792.9 80.7 939.2 3 956.3 87.7 927.7 72.0 764.5 7 706 88.6

II. Aid

Free and L#icensable Lists(and edible oils oncash-cum-bopus)3/ 288.9 28.2 189.0 19.3 260.1 21.7 134.4 12.3 359.7 28.0 228.8 9 0 .7 11.4

Grand total 1024.8981.9 1,199.3 1,090.7 1,287.4 993.3 797.14

Source: Chief Comptroller of Imports and Exports, Government of Pakistan.

1/ In addition to imports covered by the licensing system, the private sector also receives imports through the operations of financialagencies such as the Pakistan Industrial Credit and Investment Corporation and the Industrial Development Bank of Pakistan. In 1969/70total imports of PRs 5,100 million were made up of Dublic sector imoorts of PRs a8O million (17 per-cent) and private sector imports ofPRs 4,210 million of which PRs 2,290 million (45 per cent of total imports) was under licensing and PRs 1,920 million (38 per cent of totalimports) was through the agencies outside the licensing system.

2/ Provisional accounting which somewhat understates actual imports.3/ In the first half year of 1970/71 import of edible oils under P.L. 480 was made subject to surrender of 50 per cent bonus vouchers.

In this table therefore the bonus element is costed in Section I and the cash element in Section II (Aid).

- 14 - APPPWDIX II

Pakistan: Changes in Exchange and Trade System since January 1971

1971

March 5. The facility for writers and journalists to use foreignexchange earnings for the import of articles for their personal use waswithdrawn but the 45 per cent bonus given to such earnings repatriatedto Pakistan was extended to artists' earnings.

March 11. Special exchange facilities were extended to pilgrims toIran and Iraq for Ziarat.

April 15. Delegated authorities to authorized dealers coveringremittances for specified subscriptions, membership fees, purchases ofacademic and technical literature, and reimbursement of specified chargesoverseas on export cargoes were withdrawn.

April 24. The import program for the half-year was revised: 46 itemson the bonus import list were prohibited and 28 items on the licensablelist financed from Pakistan's own exchange resources (including gasolineand petroleum products) were moved to the cash-cum-bonus list. Whileimport duties were reduced or abolished for some affected items, a regulatoryimport duty of 25 per cent was applied with specified exceptions to importson the free and licensable lists financed from aid and under bilateralarrangements. With the exception of edible oils, licensing for exportsunder the Raw Material Replenishment Scheme and of 36 items retained forEast Pakistan only, the existing cash-cum-bonus import list was suspended,items on the list having henceforth to be financed at the full bonus rate.Restrictions on inter-wing trade and regulations permitting the surrenderof bonus vouchers at the time of receipt of shipping documents rather thanat the time of application for import licenses were liberalized.

April 24. The rate of bonus on exports of jute woolpacks was raisedfrom 35 per cent to 45 per cent.

April 28. Forty five per cent bonus was extended to receipts byPakistani architects and consultants for services provided abroad.

May 6. Forty five per cent bonus was extended to foreign exchangeearnings of Pakistani shipping companies from conference pools.

June 3. The rate of bonus on exports of flourspar/flourite wasraised from 35 per cent to 45 per cent.

June 27. The import program, announced for the second half-year,involved only minor changes..

July 10. The bonus on raw jute exports was raised from 10 per centto 15 per cent.

- 15 -

July 19. Remittances-by foreign-owned enterprises for Head Officeexpenses abroad, previously effected at the official rate, were to beeffected at the cash-cum-bonus rate.

July 22. Forty five per cent bonus was extended to foreign exchangecommissions on imports earned after July 8 by registered indenting agents.

July 30. The amount of Pakistan currency notes which persons otherthan those travelling on category "A" visas could take into Pakistan wasreduced from PRs 80 to PRs 20.

September 17. The Pakistan rupee, previously pegged to sterling,was pegged to the U.S. dollar with the State Bank selling spot U.S.dollars at PRs 4.7775 per U.S. dollar and buying spot dollars atPRs 4.7619: the Bank, however, would continue to deal in sterling withauthorized dealers at rates based on New York quotations.

October 18. Forty five per cent bonus was extended to certain cashdonations received in foreign exchange for relief and rehabilitation inEast Pakistan.

October 18. The annual exchange allocations for Haj travel wereannounced. For travel by air and first class by sea, bonus vouchers hadto be surrendered. For second class travel by sea, exchange could beobtained at the cash-cum-bonus rate, while for third class travel by sea,exchange could be purchased at the official rate.

November 24. Prohibitions were introduced on the export of specifiedmetal manufactures and animal and food products other than to Afghanistan.

November 24. The period of validity of bonus vouchers was extendedfrom 21 days to 42 days.

November 27. Forty five per cent bonus was extended to inwardremittances of foreign exchange for services provided abroad by Pakistaniengineers and consultants.

November 30. Payment of foreign port charges and specified freightcharges were made subject to surrender of bonus vouchers equivalent to50 per cent of the remittance.

December 5. The period of validity of bonus vouchers was extendedfrom 42 days to 90 days.

December 6. The Central Government undertook to buy during thesucceeding two months export bonus vouchers for spot delivery at apremium of 175 per cent.

December 6. Existing regulations blocking the accounts of Indiannationals were extended to the accounts of the Indian High Commission.

- 16 -

December 9. The State Bank, while honoring outstanding forwardsterling contracts, otherwise restricted its exchange dealings toU.S. dollars.

December 11. Forty five per cent bonus was extended to inwardremittances for the National Defence Fund.

December 18. All permits and approvals for remittances issued bythe Offices of the State Bank in East Pakistan were declared invalid.

December 20. The official exchange rates for buying and sellingU.S. dollars were maintained and there were no changes in exchangeregulations and practices.

December 29. Forty five per cent bonus was extended to foreignexchange received as management fees for services rendered abroad byPakistanis.

December 30. Bonus vouchers issued in East Pakistan withoutauthentication by a State Bank office in West Pakistan were deemedinvalid.

1972

January 3. All citizens of Pakistan except students and workersabroad were required to declare and surrender all assets held abroadunless they were held with the permission of the State Bank.

January 13. Repatriation of foreign exchange and the proceeds ofmovable properties in accordance with the requirements of January 3 wasto be effected by January 25 and February 15, respectively. Forty fiveper cent bonus was extended to repatriated foreign exchange and the rupeeproceeds were exempted from all taxes.

January 18. Restrictions on the bank accounts of the Indian HighCommission and their personnel were lifted.

February 8. The terminal dates for the declaration of foreign assets,repatriation of foreign exchange and proceeds of movable properties wereamended to February 15, February 29 and March 15, respectively.

February 12. The import policy of July-December 1971 was to becontinued largely unchanged for January-June 1972. An amount of PRs 20million was to be made available on a cash-cum-bonus basis for investmentin export industries and access to balancing, modernization and replacementmachinery for export industries under the Raw Material Replenishment Schemewas liberalized.

- 17 - APPENDIX III

Minister for FinanceEconomic Affairs & Development

Government of Pakistan

Islamabad, the _Iay 1972.

Dear Mr. Schweitzer,

While Pakistan has for many years maintained multiple currencypractices, you are aware that we have had an objective of unificationof the exchange rate system at a realistic level. The Government hasnow undertaken a review of the existing system and its implications forthe new economic programmes it is intended to formulate and implement.This review indicates that the time is now propitious for the move to aunitary exchange rate and a concurrent movement toward liberalization ofimport trade restrictions.

The Government therefore now proposes to establish with the concur-rence of the IMF a par value of 0.0744103 gram of fine gold per Pakistanrupee. The Government intends to avail itself of wider margins on thebasis of this rate, in accordance with Executive Board Decision No. 3463,December 18, 1971, with the U.S. dollar as the intervention currency.The proposed change in par value is necessary to correct a fundamentaldisequilibrium in the balance of payments of Pakistan.

As regards import liberalization, it will not be possible for thisto be comprehensive at the initial stage but it is intended to undertakea full review of the effects of existing tariff and non-tariff restrictionswith, inter alia, an objective of progressively reducing reliance on thelatter over time. On the export side, the exchange rate change wouldrequire imposition of some export duties in order to avoid excessive bene-fits to certain exporters. We have had the opportunity to inform the Fundstaff of our intentions in these respects and of the financial programmeto be undertaken in support of this reform.

It is proposed to bring the new par value into effect at 8.00 A.M.local time May.12, 1972.

Yours sincerely,

/s/

(Dr. Mubashir Hasan)

Mr. Pierre-Paul Schweitzer,Managing Director,International Monetary Fund,WASHINGTON D.C.

ANNE VCONFIDENTIAL

INTERNATIONAL MONETARY FUND

Pakistan - Request for a Stand-By Arrangement

Prepared by the Middle Eastern Department andthe Exchange and Trade Relations Department&/

(In consultation with the Fiscal Affairs, Legaland Treasurer's Departments)

Approved by John W. Gunter and Donald K. Palmer

May 9, 1972

I. Introduction

In a letter dated May 4, 1972, the Minister of Finance has requestedon behalf of the Government of Pakistan a stand-by arrangement for one yearin an amount equivalent to SDR 100 million. Since this amount exceeds 25per cent of Pakistan's quota, a waiver is required under Article V, Section4 of the Fund Agreement. Copies of the letter and the proposed stand-byarrangement are annexed. This stand-by arrangement would support an exchangereform, which is the subject of EBS/72/149, and the domestic financialpolicies described below. Purchases under the requested stand-by arrangementwould not, without the consent of the Fund, exceed the equivalent of: SDR 50million prior to August 1, 1972; SDR 67 million prior to November 1, 1972;and SDR 84 million prior to February 1, 1973.

Pakistan's present quota is equal to SDR 235 million. As of the end ofMarch 1972, Pakistan had purchased from the Fund a gross amount equivalentto SDR 150.5 million, and repurchased the equivalent of SDR 76.4 million; asa result of these and certain other transactions,a/ the Fund's holdings ofPakistan rupees were equal to 118 per cent of quota. Pakistan is obligatedto make repurchases totaling the equivalent of SDR 78.5 million, mainly undera schedule agreed by the Executive Directors (Decision No. 3453-(71/118),adopted November 22, 1971) in reltion to a stand-by arrangement of SDR 75million approved in October 1968.- Assuming that these repurchases are

1/ A staff team consisting of Messrs. John W. Gunter, A. S. Gerakis,J. Rose, S. Cnossen and H. Baas visited Islamabad during February 17-24and discussed with the Pakistan authorities the exchange reform describedin EBS/72/149 and the financial program explained in the present paper.2/ Pakistan's currency subscription on its initial quota was equal to 96.5

per cent of quota. The gold subscription in connection with its quota increasein November 1970 was reduced by SDR 4.4 million in accordance with paragraph5 of Resolution No. 25-3 of the Board of Governors. Moreover, Pakistan haspaid in Pakistan rupees some charges on balances in excess of quota.3/ Specifically, Pakistan is to make four repurchases each equivalent to

approximately SDR 0.9 million in November 1972, 1973, 1974 and 1975: theserepurchases are related to the mitigation of the gold subscription on thequota increase in 1970. Of the eight repurchases relating to the stand-byarrangement of 1968, the first equivalent to SDR 5 million is to be made inSeptember 1972; the remaining seven, each equivalent to SDR 10 million, areto be effected in: December 1972; March, June, September and December 1973;and March and July 1974.

carried out as scheduled and that the proposed stand-by arrangement equivalentto SDR 100 million is utilized fully, Fund holdings of Pakistan rupees willamount to 139 per cent of quota on June 30, 1972 (see Table 1) and to slightlyunder 150 per cent of quota when the stand-by arrangement expires.

Table 1. Changes in Fund Holdings of Pakistan Rupees Duringthe Life of the Proposed Stand-By Arrangement

(In millions of special drawlng rights)

Fund's HoldingsPer cent

Purchases Repurchases Amount of Quota

1972

March 31 277.6 118.1May, 50.0 327.6 139.4August 1 17.0 344.6 146.6September 22 5.0 339.6 144.5November 1 17.0 356.6 151.7November 27 0.9 355 7 151.4December 22 1.0 345.7 147.1

1973

February 1 16.0 361.7 153.9March 22 10.0 351.7 149.7

Pakistan is a participant in the Special Drawing Account and has beenallocated a total of SDR 81.6 million. Of this amount, Pakistan has usedSDR 43.9 million, of which SDR 25.9 million for repurchases and in paymentof charges with the General Account and SDR 18.0 million to obtain currencyfrom other participants designated by the Fund. As of the end of March 1972,Pakistan's holdings of special drawing rights amounted to SDR 37.7 millionrepresenting 46.2 per cent of its net cumulative allocation.

II. Recent Economic Developments and Policies

Over the long run, Pakistan-/ has achieved substantial economic progressfeatured by high rates of growth of G0IP and exports. In thle last two years,however, political developments and other factors have combined to interruptthis favorable situation. Economic activity has slowed down. The budget hasincurred sizable deficits and credit expansion has exceeded appropriatelimits. Considerable increases in prices and a rise in the unemploymentrate have led to extensive labor unrest. Moreover, the external positionhas been under severe pressure and reserves have declined appreciably, despitethe moratorium declared by Pakistan on part of its debt service obligations.

1. ?ational income and production

During the decade of the 1960s Pakistan's rate of growth in real termswas about 6.3 per cent per annum, or approximately 3.6 per cent on a percapita basis (Table 2). Political developments in 1970/71, together withunfavorable weather conditions for agriculture led to a small decline inGDP; the slowdown in economic activity w7as particularly pronounced in thelast four months of the year. According to present forecasts, GDP willincrease by somewhat less than 3 per cent in the current financial year1971/72; it is expected that the value of agricultural production in constantprices will rise by 4-5 per cent, that industrial product on will increase3-4 per cent and that services will decrease mar4nally.

1/ Unless otherwise stated, all the data in this paper for Pakistanrelate to the western territories. For purposes of clarification, it hassometimes been necessary to refer to Patistan as the Western Province anddistinguish it from the territory hereinEfter referred to as the EasternProvince.2/ The percentage increases in GDP in the decade ended in 1969/70 and in

the year 1970/71 have been calculated on the basis of the data in Table 2.These data do not allocate between the Western and Eastern Provincesthe totals for three economic sectors (see footnotes to this table). Anappropriate allowance for such an allocation might lead to the conclusionthat GDP increased slightly in 1970/71. These three items were allocatedin the above-mentioned forecast for 1971/72.

Table 2. Gross Domestic Product at Factor Cost

(In millions of Pakisten rupees atconstant 1959-60 prices)

1959/60 1967/68 1968/69 1969/70 1970/71

Agriculture 7,711 10,982 11,478 12,215 11,770Major crops 3,882 6,078 6,408 7,038 6,522Minor crops 893 1,406 1,516 1,536 1,517Livestock 2,837 3,307 3,373 3,440 3,508Fishing and forestry 99 191 181 201 223

Mining and quarrying 70 137 141 144 147

Manufacturing 2,018 4,267 4,634 5,156 5,300Large-scale 1,159 3,209 3,548 4,042 4,156Small-scale 859 1,058 1,086 1,114 1,144

Construction 427 1,037 1,317 1,357 1,390Electricity, gas, etc. 87 224 251 276 300Transportation, storage and

communications 921 1,729 1,823 1,875 1,918Wholesale and retail trade 2,105 3,754 4,020 4,365 4,275Banking and insurance Ownership of' dwellings 837 1,067 1,099 1,127 1,156Public administration and

defense 397 760 782 853 994Services 1,411 1,954 2,031 2,106 2,191

Total gross domesticproduct 15,984 25,911 27,576 29,474 29,441

Source: Central Statistical Office.

Note: Above estimates do not include the data for the three items notallocated between provinces in the past, i.e'., Pakistan International Airlines,part of central public administration and defense, and banking and insurance.The unallocated amounts are (in millions of Pakistan runees):

1959-60 999i967-68 2,0601968-69 2,2201969-70 2,4241970-71 2,746

The overall projection for agricultural production in 1971/72 is basedon an estimate that the wheat crop (to be harvested in April-June) willamount to about 6.8 million tons, higher than in 1970/71, but considerablyshort of the record crop of 7.2 million tons in 1969/70 (Table 3); in thelast two years wheat has been adversely affected by a continuing drough,twhich appears to have come to an end recently. Of the other major cropssugarcane is expected to be down for the second consecutive year. Riceproduction is projected at a record level of about 2.4 million tons. Theestimate of the cotton crop harvested in September-October 1971 placesthat crop at almost 3.8 million bales, 26 per cent above the previous peaklevel; this most encouraging performance was due to a number of factors,including the additional inceZyive given to the cotton grower through theexchange system in July 1970.-

Table 3. Selected Agricultural Statistics

Estimates-1959/G0 1968/69 1969/70 1970/71 1971/72

WheatArea (thousand acres) 12,055 15,221 15,393 14,972Production (thousand tons) 3,847 6,513 7,179 6,401 6,8o0Yield (maunds per acre) 8.7 11.6 12.7 11.6

RiceArea (thousand acres) 2,974 3,842 3,877 3,651Production (thousand tons) 979 2,000 2,346 2,077 2,400Yield (maunds per acre) 10.7 14.2 16.5 15.5

SugarcaneArea (thousand acres) 9e0 1,336 1,532 1,420 1,350Production (thousand tons) 10,494 21,624 25,952 20,874 i,400Yield (maunds per acre) 291.5 440.7 461.1 400.2

CottonArea (thousand acres) 3,313 4,308 4,338 4,285Production (thousand bales) 1,639 2,961 3,015 2,957 3,800Yield (maunds per acre) 2.3 3.3 3.3 3.3

Sources: Central Statistical Office and Ministry of Finance.

1/ Estimates prepared by Ministry, of Finance. The cotton and sugar cropsand part of the rice crop have been harvested already. The wheat crop willbe harvested in the period April-June.

1/ When bonus at the rate of 10 per cent was granted to cotton and otherprimary commodities.

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The continuing slowdown in industrial production is attributable tothree principal reasons. (1) So far, it has not proved possible to divertto foreign countries more than a relatively small fraction of the exportspreviously shipped to the Eastern Province. (2) There has been a fall ininvestment activity reflecting a cttback in the development program as wellas fears that a substantial segment of industry would be nationalized.(3) The persistent shortages of imported inputs which have plagued domesticand import substituting (but not export) industries have increased recentlydue to the restrictive measures taken in order to cope with the intensifiedpressures on the external sector. The effect of these factors is illustratedrespectively by the current low production levels in the cigarette, cementand tire industries. Ho%rever, a number of the country's major industries,including cotton yarn and textiles, vegetable products, sugar and fertilizerhave not been affected; during the first half of 1971/72, output in theseindustries was higher than in the comparable period of the previous fiscalyear, in some instances considerably so.L/

The Government which assumed power on December 20, 1971 has undertakenmajor reforms affecting the agricultural and industrial sectors. On March 1President Bhutto announced a far-reaching land reform. The existing ceilingson individual ownership of 1,000 nonirrigated and 500 irrigated acres are tobe reduced, respectively, t9,300 and 150 acres, or to an area equivalent to15,000 produce index units,- whichever is greater; an additional areaequivalent to 3,000 produce index units is to be allowed to owners who havemade specified investments on their land, such as installing a tubewell. Noceiling is to be placed on family owniership and educational institutions areexempted from the reform. On the other hand, civil servants, excludingthose in the armed forces, will not be permitted to retain an area in excessof 100 acres acquired by them during their tenure in office or after retire-ment. All land taken over by the Government will be distributed to farmersfree of charge. No compensation is to be paid to the former landlords, butevery effort will be made to facilitate consolidation of their remainingholdings. The timetable for the reform is as follows: (1) Declarationsof holdings are to be submitted by April 30. (2) Decisions regarding con-fiscation of land will be made by June 15. (3) These decisions will beimplemented by July 1.

1/ Thus, output of fertilizer almost doubled owing to the completion ofnew plants. Output of sugar was 19 per cent higher, but this increase wasin a sense more apparent than real, since it reflected the earlier harvestof the sugarcane crop. Despite the loss of the market in the EasternProvince, production of cotton yarn and textiles was up 13 per cent and 6per cent, respectively.2/ The produce index takes into account: (a) the average acreage of each

crop on each class of land; (b) the average yield per acre; and (c) theaverage price obtainable. This index has been devised in an attempt toassure that land left to individual owners following a land reform is of anapproximately equal value.

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The President also announced measures to regulate landlord/tenantrelations. These are aimed at: protecting the tenant against arbitraryeviction; assuring that the water rate, agricultural taxes and the cost ofseed will be borne by the landlord, and that the cost of remaining inputsis shared equally between the landowner and his tenant; and giving thetenant the right of pre.-emption in the event of sale of the land he tills.

The new Government has also implemented significant changes in industrialpolicy. In ten "basic industries"1! the managers of all companies were re*-placed by gcv-;nment appointees. The stated objectives of this measure areto improve eff-iciency and combat tax evasion. No nationalization or confis-cation of pro-perty is involved and, therefore, indemnification of shareholderswill not be r-oluired. It appears that this measure is to be applied to arelatively small part of the industrial sector; some of the major industries,including textiles, have been specifically exempted. Secondly, the existingsystem of "managing agencies" (under which one was permitted to organize acompany, raise most of the capital by selling stock to the public, but retainfor oneself the right to appoint the manager) was eliminated. It has beenemphasized that these two measures do not affect the rights of foreigninvestors.

2. Government finance

Table 4 shows the available budgetary statistics consolidating thedata for revenues and disbursements of the Central Government with those ofthe four provinces of Pakistan!2/ for the current fiscal year and, in orderto provide some degree of comparison, for the previous two fiscal years.On the basis of these data it can be computed that current revenues amountto between 15 per cent and 17 per cent of gross domestic product.3/ Non-development (i.e., current) expenditure is usually of a somewhat smallerorder of magnitude, but it has been rising rapidly on account of largeroutlays for defense which are now equal to more than half of all currentexpenditure and approximately 9 per cent of gross domestic product. Normallythe Government realizes a surplus on its current operations. The size ofthe development program has been decreasing in recent years, not only inrelation to GDP but also in absolute terms (i.e., by almost PRs 700 millionor 23 per cent between 1969/70 and 1971/72). There is a large 'overalldeficit" (i.e., investment expenditure minus or plus the surplus or deficitin the current budget) financed by: foreign loans and grants; "net capitalreceipts," which include such items as nonbank borrowing and sales of capitalassets by the public sector; and substantial borrowing from the bankingsystem. In forecasting Treasury reliance on bank financing, particularlyover periods shorter than one fiscal year, it is useful to distinguish betweenthe deficit of the budget proper and borrowing for the Government's commodityoperations (i.e., operations to support prices of major agricultural cropsand to stockpile agricultural inputs) which have a strong seasonal element;unfortunately, this breakdown is available for the current fiscal year only.4

1/ i.e., iron and steel, basic metals, heavy engineering, heavy electri-cal, motor vehicle assembly and manufacture, tractor assembly and manufacture,heavy and basic chemicals, petrochemnicals, cement and public utilities.2/ i.e., the Punjab, Sind, the Northwestern Frontier Province and

Baluchistan.3/ In current prices.El More specifically, the available data comprise actuals for the first

half and projections for the second half of 1971/72.

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Table 4. Summary of Government Budgets-1/

(In millions of Pakist an rapees)

1970/71 1971/721969/70 Provisional RevisedActuals Actuals Estimates

1. Revenues 6 892 7,182 6,849a. Tax revenue 552604 5,333b. Nontax revenue 1,543 1,578 1,516

2. Nondevelopment (i.e., current)expenditure 5,900 6,725 7,274

a. Defense 2,662 3,200 3,8702,b. Interest payments 991 1,18o 931-c. Civil administration and

other expenditures 2,248 2,345 2,473

3. Revenue (i.e., current) surplus!deficit (-) (3=1-2) 992 457 -426

4. Development expenditure 2,990 2,810 2,320

5. Overall deficit (5=4-2) financedby: 1,998 2,353 2,746

a. External aid 1,129 1,249 863Project aid (355) (431) (205)Indus Basin loans (233) (271) (235)Commodity aid (543) (5b6) (423)

b. Net capital receipts 70 188 797c. Eorrowing from baniking system

of wrhich: 799 916 1,086Budget proper (n.a.) (n.a.) (1,180)Commodity operations (n.a.) (n.a.) (-90)

Source: Ministry of Finance.

1/ Consolidated f'gures for the operations of Central and ProvincialGovernments in Pakistan.2/ Excluding PBs 445 million on account of the debt moratorium.

As compared to the provisional actuals for the previous year, the revisedestimates for 1971/72 project a decline in revenues and a sharp increase innondevelopment expenditure, mainly due to aeTense outlays; a5 a result therewill be a sizable deficit in the current budget. Despite a steep cutbackin the development progrem and the moratorium on debt service obligations,the overall deficit is expected to increase considerably. The authoritiesanticipate that both foreign aid and net capital receipts will be large,but that the former will be distinctly lower and the latter appreciablyhigher than in the preceding year. Borrowing from the banking system willbe very heavy, estimated at PRs 1,086 million; this figure takes into accountthe projection that the Government's commodity operations will have a con-_tractionary impact of PRs 94 million. These revised estimates may not proveentirely accurate. In particular, they seem to reflect an overstatement ofprovincial revenues and net capital receipts; in addition, it is unlikelythat the full amount of foreign aid assumed will be in fact received. Ifow-ever, these shortfalls on the revenue side will be probably offset by adecreape in investment expenditure below the anticipated level. It wouldseem, thXerefore, that the estimate of borrowing from the banding system isrealistic.

In July-December 1971, reflecting heavy expenditures in the EasternProvince, Treasujry reliance on the banking system for both provinces amounte4to PRs },800 million, more than in any other comparable period in the past.1However, according to the authorities, in Pakistan itself the budget properrecorded a deficit of only PBs 280 million, while commodity operations werecontractionary to the extent of PRs 334 million. In view of these resultsfor the first six months and the ebove-mentioned forecasts for fiscal 1971/72as a whole, the Pakistan authorities expect that in the second half of theyear, there will be a budget deficit of PRs 900 million and that commodityoperations will be expansionary in line wTith seasonal patterns by PRs 240million.2/ hence, total Treasury borrowing from thie banking system in thisperiod is estimated at PRs 1,140 million.

Tne Government has devoted considerable attention to strengthening thecountry's tax system. In October 1970 it appointed a Taxation Commissionwhich submitted an interim report in June 1971. This report dealt mainlywith direct taxes, i.e., the income and corporation tax, and taxes oncapital, in particular, the net wealth, estate and gift tax; recommendationswere also made with regard to excise duties and provincial and local taxes.Many of the Commission's mroposals regarding direct taxes have been imple-mentea. In respect of the income tax, the personal, investment and conveyanceallowances have been reduced and provisions on perquisites and capital gainstightened; the tax holiday provision has been suspended for one year andundistributed profits of companies are nowr subject to a higher rate of tax.The excise duty on tobacco has also been increased and a duty imposed onbank checks. The Commission is now engaged in a study of taxation of agri-cultural income and other possible revenue measares.

1/ This figure is based on the monetary statist ics which until December1971 were available only for both provinces together and not separately foreach province.2/ Largely on account of government purchases from the wheat crop which

will be harvested in April-June 1972.

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3. Money, credit, prices and wages

The official monetary statistics, Mhich are compiled by th.e Sotate Bankof Pakistan, are available only as totals for the Western and EasternProvinces taken together; no data have been compiled for Pakistan (i.e., theWestern Province) separately. Unofficial estimates made by the ResearchP'partment of the State Bank indicate tentatively that domestic liquidityand private sector credit in Pakistan accounted for about 75 per cent and70 per cent of the respective totals for both provinces. So far, however,it has not been pcssible to break down convincingly the other principalheadings of the monetary accounts.

Nevertheless, on the basis of all the available information, it isclear that in both 1970/Ti and the first half of 1971/72 the increase innet domestic credit was excessive. The main expansionary factor was thebudget deficit. Bank financing of the private sector rose significantlyin 1970/71, but it was distinctly sluggish in July*-December 1971 reflectingthe slowdown in economic activity. Despite the sharp decline in net foreignassets in both these periods, monetary expansion was sharply out of linewith the growth requirements of the economy.

There appear to have been considerable increases in prices in the last18 months or so. The indices shown in Table 5 indicate that wholesaleprices rose by about 11 per cent and the cost of living (for clerical)wage eari2'3rs) in Karachi by 12 per cent. It should be noted, however, thatdue to various deficiencies in their coverage and weighting system, theseindices are believed to lunderstate actual price movements.

Table 5. Price Indices

Consumer Prices for ClericalWholesa'le Prices Wage Earners in Karachi

- 959/60 = 100 ) (1961 = iso)1966/67 124 1231967/68 126 1.281968/69 130 1311969/70 132 1361970/71 137 1ih

1971 January 138 144February 138 144March 138 144April 133 145May 138 145June 13° 148July 141 150August 143 150September 143 150October 144 152November 145 151December 146 153

Source: Central Statistical Office.

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The recent inflationary trend together with the rising level ofunemployment have led to considerable labor unrest featured by extensivestrikes and ;'gheraos` (i.e., demonstrating workers lock management in thepremises of an industrial and other plant and do not allow it to leaveuntil it accedes to their demands); there have also been instances of moreviolent protest. Against this background of developments, the Presidenthas announced a new Labor Policy which provides inter alia that: (1) theshare of wages in annual profits will be raised from 2 per cent to 4 percear.; (2) workers will receive 10 per cent cf additionel profits zesultingfrom increesed troductivity; and (3) tne 2 per cent levy on wages for theexisting heal th insurance plan will be &colished and the contribution ofemv.oyers raised frcm 4 per cent to 6 per cent. Other measures in the newPolicy aim at strengthening labor unions, redressing individual grievancesequitably, laying down improved procedures for the settlement of collectivedisputes, preventing arbitrary dismissals of employees, improving fringebenefits and so forth. On the cther hand, the President stated that theGovernment does not intend to raise minimum wages at the present time, sincesuch a move would tend to intensify inflationary presslres. Mfiore recently,the Government decreed salary increases of between 10 per cent and 40 percent for the "nongazetted" (i .e. , lower level ) ti-vil service employeesl.

4. Balance of payments

In recent years Pakistan ':ias had a substantial balance of paymentsdeficit with foreign countries, On the other hand, it realized a surplusvis-a-vis the Eastern Province with which, in effect, it purchased foreignexchange from that Prcvince to finance para,of its international deficit.Table 6 gives foreign exchange budget data- for Pakistan, actuals for19610/70 and 1970/71 and proiections for the second half of 1971/72 and for1972173; it should be noted that these projections do not allow for theeffects of the exchange reform. In preparing this table, the authoritieshave attempted to divide foreign aid between the Eastern Province and theWestern Province, but they have allocated to Pakistan all foreign exchangeexpenditures of the two Provinces combined for debt service and defenseimports. While this method tends to overstate materially Pakistan's inter-national deficit in the past, it serves to present a realistic picture ofthe situation at the present time. As regards transactions with the EasternProvince only trade statistics are available; they show that Pakistan's tradesurplus amounted to $157 million (at the official rate) in 1969/70 and to$121 million in 1970/71. It is also believed that Pakistan had a substantialsurplus on services reflecting receipts under the headings of transportation,blanking and insurance, profits and dividends.

1/ It is estimated that this increase will add to the budget a burden ofPBs 68 million annually. However, this additional expenditure will be partlyor wholly offset by another recent government decision to pension off beforethe mandatory age of retirement 1,300 civil servants whose conduct in officehas been judged reprehensible by committees appointed for that purpose.2/ The foreign exchange budget differs in some respects from the usual

balance of payments presentation.

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Table 6. Foreign Exchange Budget

(In millions of U.S. dollars)

1971/72July- Jan.-

1969/70 1970/71 Dec. June Total 1972/73

Receipts 860 1'000 429 515 944 903Merchandise exports 336 443 227 267 494 535Invisiblesl/ 175 141 68 88 156 147Foreign aid2_/ 347 416 134 160 294 221

(Project) (212) (300) (107) (103) (209) (175)(Nonproject) (135) (116) (27) (57) (84) (46)

Payments 1,130 ',2o4 552 615 1,167 1,229

Public sector invisibles3/ 158 155 86 73 159 168Private sector invisibles4/ 71 74 36 36 72 84Debt service5/ 212 219 111 139 250 273Imports 689 756 319 367 686 704

Overall deficit, financed by:6/ 270 204 123 100 223 326

Decline in official reserves 16 77 39Moratorium on debt service -- 28 67Purchases of exchange from

the Eastern Province 254 99 7

Source: Ministry of Finance.

1/ Eighty per cent of corresponding figure for the Western and EasternProvinces taken together. The figure for the second half of 1971/72 includesan estimate of $8-11 million for repatriation of foreign exchange underMartial Law Regulations 104 and 105. These Regulations instructed citizensof Pakistan, with certain exceptions, to declare assets held abroad byFebruary 15, 1972 and to repatriate by February 29, 1972 and March 15, 1972,respectively, their cash balances and proceeds from the sale of movableproperty; additional directives were to have been issued regarding immovableproperty. Funds surrendered under these Regulations receive bonus at therate of 45 per cent.2/ Figures for project aid disbursements have been reduced by 15 per cent

to allow for the technical assistance component (the contra-entry for whichhas been omitted from the estimates).3/ Including payments for defense imports and debt service.1/ Sixty-six per cent of corresponding figure for the Western and Eastern

Provinces taken together.5/ Assuming full payment for both the W4estern and Eastern Provinces.6/ It is expected that in the second half of 1971/72 and in 1972/73 this

deficit will be financed also by arrangements with creditors to reschedulepart of Pakistan's debt service obligations and by new commitments ofcommodity aid from IDA, the members of the Consortium and other countries.

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As indicated in the table, in 1969/70 Pakistan's international deficit(i.e., the "overall deficit," using the terminology of the Pakistanauthorities), was equal to .$270 millions this deficit was financed to theextent of $254 million by purchases of foreign exchange from the EasternProvince and to the extent of $16 million by a drawdown of reserves. In1970/71 Pakistan's exports increased substantially, thus resuming the upwardtrend which had been interrupted in the two preceding years; the gains inexport receipts were mainly due to higher international prices for cotton,the continued growth of certain nontraditional exports and some diversionto foreign countries of some exports previously shipped to the EasternProvince. There was also a considerable increase in foreign aid. At thesame time, import payments increased and invisible receipts declined due inpart to speculation inspired by rumors of devaluation. Pakistan's "overallbalance of payments deficit"i (as defined in the table) declined noticeably.However, the political difficulties in the latter half of 1970/71 led to aconsiderable decrease in the receipts of the Eastern Province from the restof the world and, therefore, in the volume of foreign exchange which Pakistancould purchase from that region. As a result, Pakistan's external positioncame under severe pressure; reserves were drawn down by $77 million and theauthorities imposed a moratorium on part of their debt service obligations.

In light of the available actuals for the first half of the year, theauthorities project that in 1971/72 exports will again rise considerably.A/There may be a small increase in invisible receipts, reflecting m7inly somerepatriation of funds under rviartial Law Regulations 104 and 105.2? Moreover,imports will decline appreciably. On the other hand it is known that foreignaid will be substantially below the level of the previous year and debtservice considerably larger; indeed, if all debt obligations were discharged,the net inflow of resources from abroad would be only $44 million as comparedwith $135 million and $197 million in the two preceding years. The expectedoverall deficit of $223 million is somewhat larger ihan in 1970/71. Thisdeficit will be covered in part by using reserves.31 For the remaining part,it is hoped that additional financing will be obtained througb arrangementswith Consortium and non-Consortium coantries.

For 1972/73 the projections of the authorities place the deficit inthe external sector at $326 million. However, negotiations among Consortiumcountries, as well as negotiations between Pakistan and the non-Consortiumcountries, for a total amount of debt relief of $100.million have nowreached an advanced stage. Furthermore, there will probably be some newnonproject assistance from the members of the Consortium and mainland Chinaand a sizable industrial imports credit (commodity aid) from IDA. As aconsequence of the devaluation, export and other receipts should increaseand Fund assistance should bridge most of the remaining gap, but there mayalso be some decline in reserves. It is expected that reserve losses willcome to an end by the end of 1973/74.

1/ Despite the interruption in December and their normal seasonal pattern,exports in July-December 1971 amounted to more than half of the total for1970/71.2/ See footnote 1 on page 12.3/ There was a reserve loss amounting to $39 million in July-December 1971

followed by a gain of $9 million in January 1972 (including the allocationof SDR 25 million).

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III. Analysis of the Reform

The program described in the attached letter of intent contains twobasic elements: an exchange reform which has been analyzed in detail inEBS/72/149 and financial policies designed to eliminate excessive expansionof bank credit and permit an acceleration of the development effort. Itis recognized that the financial aspect of the program is essential to therealization of the benefits expected from the exchange reform.

Fiscal policy

During the second half of the current fiscal year ending June 30, 1972Treasury reliance on the banking system will amount to PRs 1,140 million,of wbich PRs 240 million will be needed to finance the seasonal requirementsof the Government's commodity operations. This deficit is higher than wouldhave been desirable in different circumstancest' and the authorities recognizethat it should be curtailed in the next fiscal year 1972/73. At the sametime, however, it will be necessary to increase investment expenditure inorder to step up the country's lagging development effort. A major effortwill be required, therefore, both to curtail current expenditures and toincrease revenue. The details of the budget are to be worked out prior toJune 30, 1972 and will be discussed with a staff mission to visit Pakistanin July (see below).

As indicated earlier in this report, the Taxation Commission has beeninstructed to study and propose new revenue measures for the 1972/73 budget;inter alia the Commission will explore ways to increase agricultural taxation,which is regarded as unduly low under existing arrangements. In the nearfuture, the Government intends to review and raise public utility rates, forelectricity and water in particular; subsidies are to be scrutinized also, witha view to reducing them progressively over time. The authorities are awarethat effective tax administration can be an important factor in increasingrevenue and they hope to enact for this purpose a new income tax law, whichhas been drafted with Fund technical assistance.

The net budgetary impact of the exchange reform and associated measuresis. expected to be approximately neutral. The rupee cost of the Government'sexpenditure abroad, mainly on imports of defense equipment and debt service,will rise following the devaluation, though the burden of this additionalexpenditure on the budget will be eased considerably by the expected agree-ments with creditor countries regarding a rescheduling of Pakistan's externaldebt. In view of the fact that the reform will tend to raise costs and prices,the authorities have decided to increase subsidies on certain importantagricultural inputs, in particular fertilizer and pesticides; furthermore,they may alleviate to a limited extent through subsidies or adjustments intariffs the price effects on items weighted heavily in the cost of living ofthe lower income groups. Some additional expenditure may also be incurreddue to higher prices of goods procured locally by the Government. Hlowever,these increases in budgetary costs are to be offset by increases in receipts

1/ See discussion on credit ceilings on page 15.

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from three principal sources. In the first place, substantial revenue willaccrue from the export duties described in EBS/72/i49. Secondly, counterpartfunds froia foreign commodity assistance aiid from the expected "program loan"from IDA will rise considerably. Thirdly, receipts from import duties willincrease since the intention of the Government is to reduce tariff rates onthe average less than in proportion to the devaluation.

Credit Dolicy

The financial program of the Pakistan authorities is designed to limitthe bal ce of payments deficit to the afore-mentioned projection of PRs 490million- in the January-June period; in view of the real factors inherentin the present situation, an attempt to curtail the deficit below that levelwould have serious adverse effects on the economy. A second objective of theprogram is to contain the increase in prices to that which is in fact unavoid-able as a consequence of the exchange reform. To assist in achieving theseobjectives, a ceiling is established on the banking system's net claims ongovernment plus its gross claims on the private sector. In the six monthsending in June 1972, total credit under these headings will not be allowedto increase by more than PRs 1,540 million; given the assumed deficit in theexternal sector and given the expected contraction of PRs 100-150 million in'Bother items"' in the monetary accounts, a volume of bank financing equal tothe maximum permissible under the ceiling woul5/leed to an expansion indomestic liquidity of the order of 5 per cent.- Seen against the backgroundof the slowdown in the economy, such an increase may appear to be undulylarge. However, owing to the price effects of the devaluation, nominalincomes are likely to rise more than 5 per cent in the period discussed.Therefore, the anticipated expansion in domestic liquidity will tend to havethe desired restrictive impact on the balance of payments and to preventprice increases from causes other than the devaluation. The overall ceilingof PRs 1,540 million assumes, as noted earlier, a budget deficit of PRs 1,140million leaving an amount of PRs 400 million for financing of the privatesector. Such an allocation of credit between the public and private sectorsmay be justified in part, in light of the current slowdown in the economy.However, with the expected pickup in economic activity, the budget deficitwill need to be reduced considerably in the next fiscal year and the sharesof the two sectors in total bank credit changed appreciably. It was notconsidered feasible to formulate credit ceilings for 1972/73 in view ofpresent uncertainties and the fact that budget plans for that year have notyet been wrorked out. Such ceilings wi].l be discussed at the time of thereview in July. It is recognized that they should provide for a slower rateof monetary expansion in line with the real growth in the monetized sectorof the economy.

1/ As shown in Table 6 the authorities project an overall deficit of $100million in January-June 1972, of which they hope to cover .39 million with adebt moratorium to be arranged with creditor countries. The remainingeffective deficit of $61 million, part of which will have been incurred beforethe devaluation, has been converted above at an average rate of US$1 = PRs 8.2/ This calculation assumes that domestic liquidity (on December 31, 1971)

amounted to about PRs 18 billion, in line with the estimates of the ResearchDepartment of the State Bank of Pakistan referred to on page 10 above.

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It would have been preferable to establish the credit ceiling on netdomestic assets, including "other items," rather than on net claims ongovernment plus gross claims on the private sector. iiowever, in the comingmonths the sorting out of the monetary accounts as a consequence of theseparation of the Eastern Province is likely to lead to erratic movementsin "other items" of the banking system. Thle feasibility of including 'otheritems" in the ceilings for 1972/73 will be considered during the July review.

In order to strengthen control over credit and as a step toward pushingthe interest rate structure up to a realistic level, the discount rate willbe raised from 5 per cent to 6 per cent before June 30, 1972 and appropriateadjustments made in lending and deposit rates of the commercial banks as wellas in rates paid on new issues of government securities. The need for alarger adjustment in interest rates in due course is recognized, and thislimited first step reflects concern with present depressed conditions inthe private sector. Should the demand for credit prove much stronger thanis currently anticipated, further upward adjustments in interest rates willbe considered.

Other provisions

Other provisions of the program relate to liberalization of trade andpayments, bilateral payments agreemenits and foreign debt. The policy withregard to liberalization and measures to assure the utilization of tied aidare discussed in EBS/72/149 relating to the exchange reform. The programincludes an undertaking by the authorities not to conclude additionalbilateral agreements with Fund member countries and to take steps for thepurpose of terminating the three existing agreements with members of theFund, i.e., with Ceylon, Nepal and Yugoslavia. As regards foreign debt,the Government intends to continue stringent controls on external borrow-ing by the private sector and to permit the public sector to contractshort-term supplier credit only in exceptional circumstances.

Review

The program described above is to be reviewed with the Fund staff earlyin the fiscal year 1972/73, probably in July. The review will focus on thefunctioning of the new exchange system, progress toward liberalization ofimports, export taxation, the budget plans for 1972/73 and the credit ceil-ings for that year. The use of Fund resources after June 30, 1972, issubject to the establishment of appropriate credit ceilings for the remainderof the period of the stand-by arrangement and the observance of theseceilings.

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IV. Staff Appraisal

In the staff appraisal to EBS/72/140 dealing with the exchange reform,it is noted that Pakistants external payments problems for a number of yearshave been due to both domestic financial policies and an inadequate exchangerate system. The authorities have stated their determination to embark ona comprehensive financial program, containing appropriate external anddomestic policies to rectify the balance of payments problem within areasonable period. With regard to exchange policy, it is concluded inEBS/72/149 that the "proposed new par value appears to be realistic, fallingwithin the acceptable range appropriate for the correction of the fundamentaldisequilibrium in Pakistan's balance of payments."

The domestic financial policies described in the letter of intent aredesigned to prevent the emergence of inflationary pressures which woulderode the benefits of the exchange reform. The details of domestic financialpolicies have in many respects yet to be worked out. As the authoritiesrecognize, much will depend on the quality of the measures to be applied,including the 1972/73 budget and the credit ceilings for that year. Itshould be recognized also that the implementation of an effective stabili-zation policy in existing circumstances will be a difficult task and willrequire determination on the part of the Pakistan authorities. A staffmission is to visit Pakistan in July to review the plans for 1972173 andto reach understandings on the credit ceilings to be established for theperiod after June 30, 1972.

The authorities intend to implement the program in such a manner thatit will make an important contribution to the restoration of a satisfactorygrowth rate in both the short and longer run. Thus, the exchange reformwill stimulate export production and assist the economy to recover from thepresent slowdown. Furthermore, an important objective of fiscal policy isnot only to hold total Treasury reliance on the banking system withinappropriate limits, but also to increase investment expenditure by thepublic sector. The improved allocation of resources, which is expected asa consequence of the devaluation and import liberalization, should also tendto increase the rate of growth over the longer run.

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V. Proposed Decision

The following draft decision is submitted for the consideration ofthe Executive Board:

The Government of Pakistan has requested a stand-by

arrangement for a period of one year and for the equivalent

of SDR 100 million. The Fund approves the stand-by arrange-

ment attached to EBS/72/150 and grants any necessary waiver

of the conditions of Article V, Section 3 (a)(iii), of the

Articles of Agreement.

Stand-By Arrangement

1. Annexed hereto is a letter dated May 4, 1972 from the .'rristerof Finance setting forth the objectives and policies which the authoritiesof Pakistan will pursue.

2. The International Monetary Fund grants this stand-by arrangementto support these objectives and policies.

3. Pakistan will remain in close consultation with the Fund duringthe period of the stand-by arrangement and, in particular, will consultwith the Fund in accordance with paragraph 16 of the annexed letter. Theseconsultations may include correspondence and visits of the officials of theFund to Pakistan or of representatives of Pakistan to Washington, D.C. Forthe purpose of these consultations, Pakistan will keep the Fund informed ofdevelopments in the exchange, trade, credit and fiscal situation throughreports at intervals or dates requested by the Fund during the period thestand-by arrangement is in effect.

4. For a period of one year from May 18, 1972, Pakistan will havethe right, after making full use of any gold tranche that it may have, tomake purchases from the Fund in the currencies of other members in exchangefor its currency in an amount equivalent to SDR 100 million provided that:

(i) purchases under the stand-.by arrangement shall not,without the consent of the Fund, exceed the equivalentof SDR 50 million until August 1, 1972, SDR 67 millionuntil November 1, 1972 and SDR 84 million untilFebruary 1, 1973; and

(ii) the right of Pakistan to make purchases under thestand-by arrangement shall be subject to paragraph 15of the annexed letter to the extent that such purchaseswould increase the Fund's holdings of the Pakistanrupee beyond the first credit tranche. If at any timethe limit in (i) above would prevent a purchase underthe stand-by arrangement that would not increase theFund's holdings of the Pakistan rupee beyond the firstcredit tranche, the limit will not apply to thatpurchase.

The amounts available in accordance with this paragraph 4 shall be augmentedby amounts equivalent to repurchases in respect to purchases under thestand-by arrangement, unless when any such repurchase is made, Pakistaninforms the Fund that it does not wish the stand-by arrangement to beaugmented by the amount of that repurchase.

5. Pakistan will pay charges for this stand-by arrangement in accord-ance with Executive Board Decisions Kos. 270-(53/95), adopted December 23,1953; 876-(59/15), adopted April 27, 1959; and 1345-(62/23), adopted May 23,1962.

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6. Subject to paragraph 4 above, Pakistan will have the right toengage in transactions covered by this stand-by arrangement withoutfurther review by the Fund. This right can *be suspended only with respectto requests received by the Fund after (a) a formal ineligibility, or (b)a decision of the Executive Board to suspend transactions, either generally(under Article XVI, Section 1 (a)(ii)) or in order to consider a proposal,made by an Executive Director or the Managing Director, formally to suppressor to limit the eligibility of Pakistan. When notice of a decision offormal ineligibility or of a decision to consider a proposal is givenpursuant to this paragraph 6, purchases under the stand-by arrangementwill be resumed only after consultation has taken place between the Fundand Pakistan and understandings have been reached regarding the circum-stances in which such purchases can be resumed.

7. Not later than three years after each purchase of exchange byPakistan under this stand-by arrangement, Pakistan will repurchase anequivalent amount of Pakistan rupees from the Fund; provided that, ifthe Pakistan rupees held by the Fund as a result of transactions underthis stand-by arrangement are reduced by repurchases under Article V,Section 7, or otherwise, such reductions shall be credited against theearliest amounts that become payable under this paragraph 7. Repurchasesshall be made in gold, or in convertible currencies acceptable to theFund, or in special drawing rights, in accordance with the Fund's policiesand practices at the time of repurchase.

Minister for FinanceEconomic Affairs & Development

Government of Pakistan

Islamabad, the Miay 4, 1972.

D.O.No.2054/FS/S/72.

Dear Mr. Schweitzer,

In my letter of iMay 4, 1972, I communicated to you the Government ofPakistan's decision to establish a new par value with the concurrence ofthe Fund, effective May 12, 1972. The previously existing exchange ratesystem will be abolished and in its place a single rate structure based ona new par value of 0.0744103 gram of fine gold per Pakistan rupee will beadopted. The Government considers this fundamental reform essential toeliminating the existing disequilibrium in Pakistan's external paymentsand restoring conditions for a resumption of an adequate growth in pro-duction, exports and investment.

2. However, the Government realizes that in order to attain these objectives,the exchange reform will have to be accompanied by appropriate financialmeasures and is accordingly embarking on a comprehensive financial programme.The principal measures which have been or will be adopted and the policieswhich we will pursue within the 'territory administered by the Government ofPakistan axe set out below. These measures, which will have to be pursuedover several years, together with the exchange reform should enable Pakistanto reduce its balance of payments deficit which may be expected to continuethrough the fiscal year 1972-73 and to eliminate anby further decline in netexternal reserves by the end of the following year.

3. In view of the low level of our foreign exchange reserves and the timeit will take for the remedial measures to take effect, financial assistancefrom the International Monetary Fund is needed. Therefore, the Government ofPakistan requests a one-year stand-by arrangement in the amount of SDR 100million.

4. The programme to deal with the balance of payments problem describedin this letter is based on the premise of a continuation of financial aassistance from the consortium of countries which have been providing suchassistance in support of the development programme for a number of years.Discussions are under way within the Consortium, and it is expected thatPakistan will receive substantial additional assistance which will includedebt relief on an agreed basis and additional pledges of non-projectcommodity aid. The latter, it is hoped, will permit a buildup of thepipeline of commodity aid which is now at a rather low level. The principalreasons for requesting Fund assistance are to provide financing during theperiod of time needed to reconstitute this pipeline and to meet any unfore-seen pressures arising from the exchange reform. Although there continuesto be a sizable pipeline of project financing, new pledges will also be

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needed soon to provide a basis for accelerating the development effort.Pakistan is also seeking to import some wheat under U.S. P.L. 483 arrange-ments, made necessary by the short crop in 1971, and. alditioaal finarcialassistance from non-consortium sources for the development programme.

5. The Government is faced with a difficult financial problem growingout of recent developments, which have made necessary a sharp cutback indevelopment expenditures and heavy reliance on domestic bank financing ofthe public sector deficit. Thus, it is imperative not only to increasethe domestic funds available for developmenit in order to make effective useof the expected increase in external assistance and to restore the growthof the econoy at a reasonable rate, but also to assure that the bank-financed deficit will not threaten.a renewal of inflation which wouldundermine the new exchange rate and again give rise to distortions in theeconomy.

6. The adjustments being made in the fiscal system concurrently with theintroduetion of the new exchange rate are described below:

(a) A number of commodities will be subject to export duties (seeAttachment 1) including raw cotton, rice, cotton yarn, wool and hides andskins. In the absence of such duties the application of the new rate tothese commodities would result in substantial windfall profits with seriousinflationary consequences. In all cases, however, a substantial increasein export incentive is being provided, and it is expected that these dutieswill be gradually reduced with a view to providing ample incentive forcontinued expansion of production and export of these items.

(b) In adJusting customs duties on imports some changes will be madeto correct existing anomalies, which in some cases will involve revenuelosses, but overall the policy will be to assure that there is a net increaseof revenue from this source.

(c) As a result of the exchange reform, there will be substantialincreases in some domestic costs and prices. It will be necessary toalleviate this burden in relation to some of the items entering into thecost of living of the lower-income groups and the prices of certain importedinputs of strategic economic importance. However, many of these items havebeen or will be adjusted upward in price to some extent and the deficit fromthese measures will be offset fully by other adjustments.

(d) A particular problem which may arise from the exchange reform isthe utilisation of tied aid and bilateral balances. Hitherto this has beenensured through the exchange system by application of the preferentialofficial rate to import procurements uith these resources. With the lossof this exchange rate expedient, some fiscal incentive may have to be givenfor aid and barter imports wherever necessary to compensate for the loss ofthe exchange rate incentive. To the extent that donors untie aid and ourexports can gain unrestricted access to non-bilateral markets, this difficultywill be eased.

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7. In the existing circumstances it is inevitable that the budget deficitwill be for several months larger than desirable, perhaps involving net bankfinancing of the Central and Provincial Governments of about PRs 900 millionfrom December 31, 1971 to June 30, 1972. There will also be a need forseasonal financing of commodity operations rising by about PRs 240 millionduring this period to a peak in June. The performance could turn out to bebetter than this, but the numerous uncertainties make it impossible to counton it.

8. For the next fiscal year beginning July 1, 1972 a major improvement inthe budget will be made. Stringent controls vill be imposed on nondevelop-ment expenditures, and a tight rein will also be imposed on subsidies. Areview of rates charged by public utilities is expected to improve therevenue situation as is the intensified effort in the field of tax admini-stration. The 1972-73 budget will include new revenue measures. Particularattention will be given to the income tax as its effective implementationwill meet the Government's objective of achieving greater equity. To thisend the Government aims for a speedy adoption of a new income tax law asthe basis for a better administration of this tax. The Taxation Commissionhas also been reconstituted and instructed to make proposals for next year'sbudget. In the longer run the Government intends to remodel the fiscalsystem in order to attain a better balance in the pattern of taxationbetween the agricultural and the non-agricultural sectors of the economy.It is not feasible at this time to establish a firm limit on the budgetdeficit, but it will be greatly reduced compared to that expected in 1971-72and will be consistent with the overall credit limitation consideredappropriate for the economy as a whole.

9. As indicated above, the public sector may require net bank credit ofas much as PRs 1,140 million, partly for seasonal requirements, betweenend December 1971 and June 30, 1972. Private sector credit requirementsfrom the banking system, taking into account some expected recovery inactivity and the impact of the exchange reform on costs and prices, areestimated at about PBs 400 million for the same period. At no time duringthe period up to and including June 30, 1972 will the total of these twoelements exceed the level of PBs 25,243 million outstanding on December 31,1971, by more than PRs 1,540 million subject to adjustment for changes ingovernment moratorium deposits. It is recognized that this rate of creditexpansion is high in relation to the growth of the economiy and quarterlyceilings on the net domestic assets of the banking system will be establishedfor 1972-73 on a much lower relative rate of expansion. These ceilings willtake into account seasonal factors and will be closely related to theestimated growth of the economy in real terms with due allowance for theexpanding money-using sector of the economy. With regard to the creditceilings to apply in l972--73, understandings will be reached with the Fundwhen adequate information is found to be available to make satisfactoryJudgments.

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10. It is felt that an upward adjustment in the interest rate structureis needed, particularly as economic recovery gains momentum, although thereis some question whether this action should be taken immediately. However,the discount rate of the State Bank of Pakistan will be increased from 5 percent to at least 6 per cent by June 30, 1972 and other appropriate adjust-ments made simultaneously in lending and deposit rates of the commercialbanks. A similar adjustment will be made for new issues of governmentobligations. If the demand for credit by the private sector is much strongerthan has been projected in paragraph 9, further upward adjustments in interestrates may be made as a measure of restraint and in order that an appropriatelevel of rates for the pricing of capital may be attained.

11. With the introduction of the new exchange system and the adjustments incustoms duties, it will be possible to make a move toward a more liberalimport policy. While this pol-cy will have to be approached with somecaution in the early stages of this programme, liberalisation will be pressedas rapidly as circumstances permit. Reference has, however, already beenmade in paragraph 6 (d) to the problem of ensuring the utilization of tiedaid and bilateral balances. In this respect, as a possible supplementary oralternative means to some fiscal incentives, it may be necessary to imposerestrictions on the import of a limited number of items with freely con-vertible exchange so that demand for those items is met with availablenonconvertible exchange resources. Concurrent with import liberalisation,the intention is to move toward liberalisation of current invisible payments.

12. Pakistan maintains bilateral payments agreements with Nepal, Ceylonand Yugoslavia, and payments arrangements also exist under the RegionalCooperation Agreement with Iran and Turkey. In addition, bilateral pay-ments agreements are in effect with a number of countries not members ofthe Fund. It is the Government's policy not to conclude additional bilateralpayments agreements with members of the Fund and it will take steps with aview to terminating the three existing agreements with Fund members duringthe period of the stand-by arrangement.

13. As regards external borrowing, intergovernmental loans are underdiscussion with the Consortium. All foreign borrowing by the private sectoris controlled. Such borrowing by the banking system is negligible andaccess to foreign supplier credits is limited to export industries underspecified conditions. It is the intention that these controls should becontinued and that the public sector should contract short-term suppliercredit only in exceptional circumstances.

14. Early in fiscal year 1972-73 the programme described in this letterwill be reviewed with the Fund. Particular attention will be paid to thefunctioning of the new exchange system and the progress toward importliberalisation and to the 1972-73 budget and the credit ceilings to beestablished for that fiscal year.

15. During any period of the stand-by arrangement in which (1) multiplecurrency practices, restrictions on the making of payments and transferscurrent international transactions or bilateral payments arrangements withFund members have been introduced or intensified; or (2) the limit on bankcredit set forth in third sentence of 9th paragraph is not observed; or(3) any restrictions on imports have been introduced or intensified otherthan in accordance with paragraph 11; or (4) in the period following June 30,1972 understandings about limits on credit have not been reached or are notobserved, Pakistan will not request any purchase under stand-by arrangementwhich would raise Fund's holdings of its currency beyond first credit tranche,except after reaching understanding with Fund regarding circumstances inwhich such purchases may be made.

16. The Government believes that the policies set forth in this letterare adequate to achieve the objectives of the programme but will take anyfurther measures that may become appropriate for this purpose. Duringthe period of the stand-by arrangement, Palkistan will consult the Fund onthe adoption of any measures that may be appropriate at the initiative ofPakistan or whenever the Managing Director requests consultation becauseany of the criteria in paragraph 15 above have not been observed or becausehe considers that consultation on the programme is desirable. In addition,after the period of the stand-by arrangement and while any Fund holdings ofPakistan's currency above the first credit tranche include currency result-ing from purchases under the stand-by arrangement, Pakistan will consultthe Fund from time to time, at the initiative of Pakistan or at the requestof the Managing Director, concerning Pakistan's balance of payments policies.

17. Before requesting any purchase under the proposed stand-by arrangement,the Government of Pakistan will consult with the Managing Director on theparticular currencies to be purchased from the Fund.

Sincerely yours,

/s/

(Dr. Mubashir Hasan)

Mr. Pierre-Paul Schweitzer,Managing Director,International Monetary Fund,WASHINGTON, D.C.

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Attachment 1

List of cowmodities which will be subject to export duities.

1. Raw cotton

2. Cotton waste

3. Cotton yarn

4. Grey cloth

5. Rice (Basmeti)

6. Rice (coarse)

7. Raw wool

8. Raw hides and skins

9. Semitanned and tanned skins

10. Oil cake