October 2015
2013-14
2011-12
2009-10
2007-08
2005-06
2003-04
2001-02
1999-00
1997-98
1995-96
Real GDP growth
1993-94
1991-92
1989-90
1987-88
1985-86
1983-84
1981-82
1979-80
10.0
1977-78
1975-76
1973-74
1971-72
1969-70
1967-68
1965-66
1963-64
1961-62
1959-60
100710
PAKISTAN DEVELOPMENT UPDATE
Pakistan: Actual and Trend Economic Growth, 1961-2015
Trend growth
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
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Pakistan Development Update
Table of Content
EXECUTIVE SUMMARY....................................................................................................................I
A.
RECENT ECONOMIC DEVELOPMENTS .......................................................................... 2
I.
Real Sector ............................................................................................................................................................ 2
II.
Fiscal Policy .......................................................................................................................................................... 4
III.
Debt Dynamics .................................................................................................................................................... 8
IV.
External Sector ..................................................................................................................................................... 9
V.
Monetary Policy And Aggregates .................................................................................................................... 13
VI.
Inflation ............................................................................................................................................................... 16
VII.
Financial Sector Developments ....................................................................................................................... 18
B.
OUTLOOK AND PROJECTIONS ......................................................................................... 21
I.
Near-Term Outlook is Positive on Continuation of the Reform Momentum ........................................ 21
II.
There are Substantial External as well as Domestic Risks to the Outlook............................................... 23
C.
PROGRESS ON STRUCTURAL REFORMS ....................................................................... 25
D.
SPECIAL SECTIONS ............................................................................................................ 27
I.
Why Investment is Low in Pakistan?.............................................................................................................. 27
II.
Fiscal Decentralization in Pakistan: Progress and Challenges .................................................................... 33
III.
Some Stylized Facts of Pakistan Economic Growth ................................................................................... 39
IV.
Federal Budget 2015/16 – Sectoral Analysis of Spending Priorities ......................................................... 45
V.
Fiscal Disaster Risk Assessment Report ........................................................................................................ 51
VI.
National Financial Inclusion Strategy ............................................................................................................. 55
October 2015
THE WORLD BANK
Pakistan Development Update
List of Acronyms
ADB
Accounting And Auditing Organization For
Islamic Finance Institutions
Asian Development Bank
AFI
Alliance For Financial Inclusion
MSME
AJK
BE
BISP
CCI
CIB
CLL
CNG
CPCE
CPI
CRR
CSF
DFID
DNA
DTA
EOBI
Azad Jammu And Kashmir
Budget Estimates
Benazir Income Support Programme
Council Of Common Interest
Credit Information Bureau
Concurrent List Of Legislation
Compressed Natural Gas
China Pakistan Economic Corridor
Consumer Price Index
Cash Reserve Requirement
Coalition Support Fund
Department For International Development
Damage And Need Assessment
Digital Transaction Accounts
Employment Old Age Benefit Institution
MTBs
NATO
NDA
NDM
NDMA
NEC
NER
NFA
NFC
NFIS
NFNE
NPLs
NPS
OMO
PARC
ERRA
Earthquake Reconstruction And Rehabilitation
PASSCO
ETPB
EU
FATA
FBR
FDI
FDRA
FIs
FLL
FPI
FY
GB
GCR
GDP
GIDC
GSP
GST
H1
H2
HEC
HP
IAP
IBA
IC
ICT
Evacuee Trust Property Board
European Union
Federally Administrated Tribal Areas
Federal Board Of Revenue
Foreign Direct Investment
Fiscal Disaster Risk Assessment
Financial Institutions
Federal Legislative List
Foreign Portfolio Investment
Fiscal Year
Gilgit Baltistan
Global Competiveness Report
Gross Domestic Product
Gas Infrastructure Development Cess
Generalized System Of Preferences
General Sales Tax
First Half (Of The Fiscal Year)
Second Half (Of The Fiscal Year)
Higher Education Commission
Hodrick-Prescott
Insurance Association Pakistan
Institute of Business Administration
Implementation Committee
Information And Communication Technology
PBA
PDF
PDMA
PIB
PKR
POL
POS
PPP
PRA
PRI
PSC
PSDP
PSE
PSO
PTA
Q1
Q2
Q3
RE
REER
RM
ROA
ROE
SBP
IDB
Inter-American Development Bank
SECP
IFI
IFS
IMF
IPPBNU
IRC
IT
International Financial Institutions
Internal Financial Statistics
International Monetary Fund
Institute Of Public Policy –
Beaconhouse National University
Interest Rate Corridor
Information Technology
SME
SOEs
SPDC
Marginal Propensity To Consume
Ministry Of Micro Small And Medium
Enterprises
Market Treasury Bill
North Atlantic Treaty Organization
Net Domestic Asset
National Disaster Management
National Disaster Management Authority
National Economic Council
Nominal Exchange Rate
Nat Foreign Asset
National Finance Commission
National Financial Inclusion Strategy
Non-Food Non-Energy
Non-Performing Loan
National Payment System
Open Market Operation
Pakistan Agriculture Research Council
Pakistan Agricultural Supplies And Shortage
Corporation
Pakistan Broadcasters Association
Pakistan Development Fund
Provincial Disaster Management Authority
Pakistan Investment Bond
Pakistan Rupee
Petroleum, Oil, & Lubricants
Point Of Sale
Public-Private Partnership
Punjab Revenue Authority
Pakistan Remittances Initiative
Private Sector Credit
Public Sector Development Program
Public Sector Enterprises
Pakistan State Oil
Pakistan Telecommunication Authority
First Quarter (Of The Fiscal Year)
Second Quarter (Of The Fiscal Year)
Third Quarter (Of The Fiscal Year)
Revised Estimates
Real Effective Exchange Rate
Reserve Money
Return On Asset
Return On Equity
State Bank Of Pakistan
Security And Exchange Commission Of
Pakistan
Small And Medium Enterprises
State Owned Enterprises
Social Policy And Development Center
SRB
Sindh Revenue Board
SRO
TDP
Statutory Regulatory Order
Temporary Displaced Persons
AAOIFI
October 2015
MP
Market Price
MPC
THE WORLD BANK
Pakistan Development Update
KIBOR
KP
KSE
KYC
LNG
LSM
M2
MDGs
MFB
MLT
Karachi Inter Bank Offer Rate
Khyber Pakhtunkhwa
Karachi Stock Exchange
Know-Your Customer
Liquefied Natural Gas
Large Scale Manufacturing
Broad Money
Millennium Development Goals
Micro Finance Banking
Medium And Long Term
October 2015
TFP
UAE
UBL
UK
USA
USD
WA
WAONR
Y-o-Y
Total Factor Productivity
United Arab Emirates
United Bank Limited
United Kingdom
United States Of America
United States Dollar
Weighted Average
Weighted Average Overnight Repo Rate
Year-On-Year
THE WORLD BANK
Pakistan Development Update
Acknowledgement
October 2015
This Update was prepared by Macroeconomic and Fiscal Management Global
Practice under the guidance of Shubham Chaudhuri (Practice Manager, GMFDR),
Rachid Benmessaoud (SACPK) and Illango Patchamuthu (Country Director,
Pakistan). Sector analyses were contributed by: Enrique Blanco Armas (Executive
Summary and Progress on Structural Reforms), Saadia Refaqat and Mohsina Atiq
(Real Sector), Mehwish Ashraf (Fiscal and Public Debt), Amna Sehar (Inflation),
Muhammad Waheed (Balance of Payments, Monetary Aggregates, and Medium-term
Outlook), and Sarmad Sheikh (Financial Sector Development). Special sections were
contributed by: Muhammad Waheed (Why Investment is Low in Pakistan? And,
Some Stylized Facts of Pakistan Economic Growth), Saadia Refaqat (Fiscal
Decentralization in Pakistan: Progress and Challenges), Mehwish Ashraf (Federal
Budget 2015/16 – Sectoral Analysis of Spending Priorities). Team would like to
acknowledge the contributions from other Global Practices; A brief on Fiscal Disaster
Risk Assessment Report by Haris Khan (GSURR) and, a section on National
Financial Inclusion Strategy by Sarmad Sheikh (GFMDR) and Gabi George Afram
(SACPK). This report has benefited from very useful comments from Deepak Mishra
(GMFDR), Anthony Cholst (SACPK), and Shahzad Sharjeel (SAREC). Special
thanks to Shabnam Naz (SACPK) and Anwer Ali (GMFDR) for their administrative
support during the process. The overall effort was led by Muhammad Waheed
(GMFDR).
THE WORLD BANK
Executive summary
A mild growth
recovery is
underway.
Pakistan’s economy posted GDP growth of 4.2 percent in FY2014/15 compared to
4.0 percent in the previous year, but below the 5.1 percent targeted growth envisaged
for FY2014/15 in the Annual Plan. On the demand side, investment and government
consumption posted strong growth. Private consumption was supported by record
high remittances in the order of US$18.7 billion in FY2014/15. The share of
investment in GDP remains relatively small, at 15.1 percent of GDP, about half of
the South Asian average at 30 percent. More worryingly, private investment as a share
of GDP has been declining and stood at 9.7 percent of GDP in FY2014/15. This low
investment has implications for Pakistan’s long term growth potential that has been
on a clear declining long run trend as discussed in special section III in this issue.
Lack of
complementary
public investments
and a weak
investment climate
are constraining
private sector
investment.
Several factors are contributing to this low investment normal. Constrained fiscal
space limits the government’s ability to make the necessary complementary public
investments. In addition, inconsistent trade and industrial policies create disincentives
for investors and contributes to weak business environment, as evidenced by
Pakistan’s ranking in most international surveys dealing with this issue, like the Global
Competitiveness Ranking. Another reason for the very low investment levels has to
do with the low domestic savings rate in Pakistan at below 10 percent of GDP, which
compares unfavorably with an average of around 25 percent in South Asia. Limited
access to financial markets, high dependency ratio and low returns on financial
instruments all contribute to this low rate of savings.
The services sector
continues to be the
main contributor to
growth.
More than two-thirds of the economy’s growth came from the services sector, while
industry and agriculture jointly contributed about one-third. In the agricultural sector,
crop performance remained weak owing to prolonged adverse weather and two years
of relatively low prices. In the industrial sector, the poor performance was primarily
the result of weak growth in the large-scale manufacturing sector, which achieved
growth of 2.4 percent against a target of 7 percent. Ongoing energy shortages, limited
external demand and structural bottlenecks all constrained industry growth. The weak
growth in the industrial sector also acted as a drag on related services sectors such as
trade and communications, which also posted relatively slow growth. On the positive
side, transport, finance and insurance and government services all posted strong
growth.
Government efforts
for fiscal
consolidation
continue, but
progress is slower
than anticipated.
The overall deficit for FY2014/15 was 5.3 percent of GDP, 0.3 percentage points
higher than the revised estimates. The declining trend represents a break from the
recent past, with deficits between 6 and 9 percent of GDP between FY2009-10 and
FY2012/13. The reduction in the deficit was achieved through curtailing the federal
development budget and above target non-tax revenues, while tax revenues continued
to fall short of targets. Energy subsidies remain large, although lower oil prices have
contributed to limiting the energy subsidy bill. Spending grew fastest at the provincial
level due to post 7th NFC award availability of higher resources, and devolution of
increased responsibilities (see special section II for a detailed discussion of Pakistan’s
current Fiscal Decentralization Framework). Total public debt stood at 64.6 percent
of GDP at the end of FY2014/15, a slight decline from the previous year. Domestic
debt continues to dominate the debt stock, despite healthy disbursements by the IFIs,
the continuation of the IMF program and the successful issuance of international
bonds.
I
A narrowing current
account deficit and
large external
financial inflows
suggest a significant
turnaround in the
external sector, a key
concern a few years
ago.
The current account deficit narrowed to US$2.6 billion (from US$3.1 billion in the
previous year), a result of record high remittances in the order of US$18.7 billion and
inflows in the services account of Coalition Support Fund (CSF). Remittances are
concentrated in oil producing countries (Saudi Arabia, UAE), the US and the UK.
Remittances from oil producing countries may be negatively affected by low oil prices,
but there are no sign of it yet. External financial inflows continued strong, although
lower than in the previous year. This is despite very weak Foreign Direct Investment
(FDI) inflows of 0.3 percent of GDP, the lowest in the last decade. As a result, the
balance of payments was positive for the second year in a row and international
reserves increased by US$4.4 billion to US$13.5 billion by end of FY2014/15 or more
than three months of next year’s imports (goods and services). The turnaround on
the external front has been quite impressive, which has also led international rating
agencies to upgrade the country’s sovereign credit ratings in recent months.
The trade deficit
widened, as non-oil
imports increased
due to improved
economic activity.
Exports declined in FY2014/15 and this decline was broad based, a result of both
low international prices of some of Pakistan’s export products as well as weak external
demand. Textiles, which account for about half of all exports, posted a significant
decline. Imports also declined, mainly due to lower international oil and commodity
prices, although to a lesser extent than exports. Non-oil imports increased
significantly, in particular metals, food, machinery and wood and paper products. As
a result, the trade deficit widened in absolute terms.
Reserves buildup
contributed to
stability in foreign
exchange markets,
which contributed to
low inflation.
As a result of the positive developments in the external sector, the Pakistan Rupee
(PKR) remained largely stable with a small depreciation of about 3.0 percent against
the US$ during FY2014/15. A relatively stable nominal exchange rate against the US$
and sharply falling inflation resulted in the REER appreciating by about 8.0 percent
during the period under review, which affected the competitiveness of the tradable
sector. Average inflation declined by around 4 percentage points to 4.5 percent in
FY2014/15, its lowest level in a decade, the result of declining oil prices being passed
on to consumers and a stable exchange rate. The decline in inflation was broad based,
with both food and non-food items contributing to the deceleration in inflation.
Improved
macroeconomic
conditions allowed
SBP to ease its policy
stance during
FY2014/15 while the
government
borrowed heavily
from the banking
sector.
The stability in PKR and the government decision to pass-on the benefit of falling
international oil prices eased inflation considerably. All this allowed State Bank of
Pakistan (SBP) to ease monetary policy through a cumulatively cut of its policy rate
by 350 bps in FY2014/15. While reserve money grew by 9.9 percent in FY2014/15,
broad money supply grew by 13.2 percent. Reserve money growth was influenced by
government efforts to limit borrowing from the SBP. At the same time, broad money
growth was driven by the government’s borrowing from the commercial banks to
finance the deficit and reduce financing from the SBP. As a result, government
borrowing from commercial banks expanded by PKR 1.3 trillion in FY2014/15,
compared to PKR 0.1 trillion in the previous year.
Credit to the private
sector remains
sluggish – a
combination of both
supply and demand
side conditions.
The private sector borrowed PKR 209 billion in FY2014/15, a decline from PKR 371
billion in the previous year. Structural bottlenecks as well as weak external demand
constrained business activity and credit demand by the private sector. A relatively high
real cost of borrowing as inflation declined at a much faster pace than lending rates
also played a role in subdued private sector credit demand. The fast increase in
borrowing by the government also tightened financing conditions – which may have
led to crowding out of private sector credit. The government has recently approved a
National Financial Inclusion Strategy and started its implementation, which may help
in reversing this trend. For a more detailed discussion please see section VI in this
volume.
II
The financial sector
remains strong with
improving banking
indicators and an
upward trend in
equity markets.
The banking sector achieved strong growth, driven primarily by increased
government borrowing. Risk indicators such as the capital adequacy ratio have
improved over the past year while profitability indicators also remain high. The equity
market saw considerable investor interest in FY2014/15, despite both domestic and
external turbulences, but the bond market continues to be dominated by government
bonds. As in most of the world, capital markets have seen some volatility over the
past few months.
Real GDP growth (at
factor cost) is
projected to register
4.5 percent in
FY2015/16, reaching
4.8 percent in
FY2016/17.
GDP growth is projected to accelerate to 4.5 percent in FY2015/16 and 4.8 percent
in FY2016/17, supported by strong services growth and a slight improvement in the
industry sector. This assumes that some of the constraints affecting the industry
sector, like power outages, will be addressed in the forecast period. Investment is
forecast to increase, given both greater fiscal space as well as an increase in private
sector investment as the government’s reform agenda begins to bear fruit.
Investments foreseen in the China Pakistan Economic Corridor will also contribute
to an increase in investment.
External risks have
increased – and
despite recent
reforms Pakistan has
limited buffers to
absorb major shocks.
External and internal balances are projected to improve. The current account will
reach around 1 percent of GDP during the forecast period – as it will be supported
by robust remittances and a continuation of external financial flows. Fiscal
consolidation is projected to continue, and the Government has an ambitious target
of reducing the deficit to 3.5 percent of GDP by FY2016/17. Debt levels are
projected to remain in a slowly declining trend while reserves have already achieved
more comfortable levels. But downside risks remains as a more volatile external
environment going forward may result in lower financial inflows. The slowdown of
the Chinese economy and slow recovery in the Euro zone will weaken external
demand, affecting both trade and investment. Low energy prices benefit Pakistan in
the form of lower energy subsidies and fuel imports – but it may eventually affect
remittances, which have been crucial in financing Pakistan’s persistent trade deficit
and supporting consumption.
Consistent
implementation of
the government’s
reform agenda will
be crucial to
maintain
macroeconomic
stability and
accelerate and
maintain growth.
Fiscal consolidation will require strong tax revenue efforts by the government as well
as gradual phasing-out of energy-related subsidies and of reduced support to lossmaking SOEs. Efforts to tighten fiscal policy will also need closer coordination with
the provinces, and ensuring that progress in the country’s decentralization effort
better aligns the province’s responsibilities with the increased resource envelop that
resulted from the 7th NFC award. Efforts to prevent major shocks to the
government’s fiscal stance should also include reducing the fiscal risks of the frequent
natural disasters affecting Pakistan – an issue discussed in detail in special section V.
On the external side, it will be important to increase efforts to attract more FDI from
the current low levels, by improving the overall business climate and address
regulatory weaknesses at the sectoral level that may be affecting the country’s ability
to attract investment. Continued implementation of the government’s reform agenda
to address structural bottlenecks, in particular in the energy sector, will also be crucial
to be able to attract more investment.
III
A. Recent Economic Developments
I.
Real Sector
Growth remained below Target, as Investment Lags
A mild recovery is
underway.
Following a steady path of recovery, Pakistan’s economy registered a GDP growth
rate of 4.24 percent in FY2014/15 compared to 4.03 percent in last year.
Nevertheless, this performance was below the 5.1 percent targeted growth rate
envisaged for FY2014/15 in the Annual Plan.
On the aggregate
demand side,
consumption
remained the largest
contributor to
growth despite low
growth in
FY2014/15.
It is quite typical for consumption to be the largest component of aggregate demand,
however, in the case of Pakistan, it constitutes a very large share of GDP at 90
percent1 and contributes 3 percentage points towards GDP growth (see Figure 1) 2,3.
This high level has been driven by private consumption primarily on the back of
sustained growth in home remittances over the years – which increased to a record
high US$ 18.7 billion in FY2014/15 (discussed in detail under the External Outlook
section). In the outgoing fiscal year, government consumption’s contribution to
growth has also been strong (see Figure 2).
Figure 1: Contribution to GDP Growth – Aggregate
Demand (percent change, y-o-y)
Total Consumption
Net Exports
8.0
Total Investment
GDP Growth (MP)
Figure 2: Consumption as Driving Force for Growth
(Percent)
Private Consumption
Total Consumption
5.0
6.0
4.0
4.0
3.0
2.0
2.0
1.0
Investment posted
above average
growth in FY2014/15
but investment levels
remain among the
lowest in South Asia.
FY15
FY14
FY13
FY12
FY11
FY10
-1.0
FY09
FY15
0.0
FY08
-4.0
Source: Economic Survey of Pakistan 2014/15
FY14
FY13
FY12
FY11
FY10
FY09
FY08
0.0
-2.0
Public Consumption
The share of investment in GDP is relatively small, increasing from 15.0 percent of
GDP in FY2013/14 to 15.1 percent of GDP in FY2014/15, driven by an increase in
public investment. Private investment declined from 10.0 percent of GDP in
FY2013/14 to 9.7 percent of GDP in FY2014/15 – the lowest level in the last three
years. Pakistan has very low investment rates when compared with its peers in South
Asia, with an average of 30 percent of GDP. A number of factors are responsible for
this including (a) volatile security situation in the country which has only recently
started to improve; (b) slow-down in the global economy, which is affecting foreign
Average for ten years (2005-2015)
Average for eight years (2008-2015)
3 A significant behavioral shift at the consumer level seems to be developing, as marginal
propensity to consume has increased sharply overtime. In 2000s, the private MPC was almost
71 percent, and this increased to 97 percent by FY2010/11.
1
2
2
direct investment and limiting domestic demand; and (c) energy shortages that limit
full capacity utilization. Low investment level is one of the main challenges facing
Pakistan’s economy today (also see special section I).
Low investment
levels are also a
result of a very low
savings rate.
Pakistan’s savings rate, at 13 percent, compares with an average savings rate in South
Asia of 23 percent (average for the past decade). Multiple factors account for this low
level of savings in Pakistan, including limited access to financial markets, high
propensity to consume, high dependency ratio and low real returns on financial
instruments.
On the supply side,
services sector
continued to lead
GDP growth
followed by industry
and agriculture.
More than half (2.91 percentage points out of 4.24) of the GDP growth came from
services while industry and agriculture contributed 0.73 and 0.6 percentage points
respectively (see Figure 3). Within agriculture, the overall crop performance
remained weak (see Table 1), growing by only 1.0 percent4 owing to prolonged
adverse weather and two years of relatively low prices. Agriculture was supported,
however, by the livestock, forestry and fishing subsectors which grew at 4.1 percent,
3.1 percent and 5.8 percent respectively.
Figure 3: Sectoral Contribution to GDP Growth
(percent) - Aggregate Supply
Agriculture
Services
6.0
Table 1: Performance of Agriculture – Growth Rate
(percent)
Industry
GDP Growth
5.0
4.0
2011/12
2012/13
2013/14R
2014/15P
Cotton
18.6
-4.1
-2.0
9.5
Rice
27.7
-10.1
22.8
3.0
Sugarcane
5.6
9.2
5.8
-7.1
Wheat
-6.9
3.1
7.3
-1.9
Maize
17
-2.7
17.2
-5.0
3.0
2.0
1.0
-2.0
Source: Economic Survey of Pakistan 2014/15
Performance in the
industrial sector,
which was targeted
to grow at 6.8
percent, was
disappointing as it
only grew at 3.6
percent in
FY2014/155.
FY15
FY14
FY13
FY12
FY11
FY10
FY09
-1.0
FY08
0.0
Source: Pakistan Bureau of Statistics; P: Provisional; R: Revised
The poor performance of industrial sector was solely on account of the Large-Scale
Manufacturing (LSM) sector which achieved a growth rate of only 2.4 percent against
an ambitious target of 7 percent. This target was based on expectations of an
improvement in energy supplies and export demand from EU markets under the GSP
Plus arrangement. The strong growth in automobiles sector (at 20 percent) and
construction subsectors (at 19 percent) remained an exception. Lower than expected
performance in other sectors dragged overall LSM growth down. A number of
reasons explain this outcome: (i) continued energy constraints, (ii) limited external
demand for textiles, (iii) decline in sugar crop production due to price disputes
between sugar crop growers and sugar mills, and (iv) extraordinary growth in some
subsectors like edible oil, Petroleum, Oil, & Lubricants (POL), and fertilizers in
FY2013/14 meant that some form of growth slowdown was expected in FY2014/15.
Within LSM, textile posted a cumulative growth rate of 0.5 percent in FY2014/15
4
5
Annual target was 3.3 percent while last year’s growth was registered at 3.2 percent
Compared to 4.5 percent in FY2013/14
3
compared to 1.5 percent in previous year and food posted a growth rate of -1.0
percent compared to a healthy 8.4 percent last year.
Services sector grew
by 5 percent in
FY2014/15,
compensating for the
low growth in
agriculture and
industry.
With an 18 percent share in GDP, wholesale and retail trade subsector posted growth
of 3.4 percent vis-à-vis 4 percent in FY2013/14 (see Table 2). This low growth was
mostly due to a direct spillover effect of weak LSM and crop performance in the
outgoing fiscal year. Similarly, transport, storage and communication grew by 4.2
percent in FY2014/15 compared to 4.6 percent in previous year mostly due to
slowdown in communications while air transport and railways continued to grow
steadily6. Growth in the services sector came from finance and insurance (6.2 percent,
compared to 4.2 percent in the previous year) and general government services (9.4
percent compared to 2.9 percent in FY2013/14), on account of an increase in
infrastructure spending and wages.
Table 2: Performance of Services – Growth Rate (percent)
2011/12
1.7
2012/13
3.5
2013/14
4.0
2014/15P
3.4
Share within
Services
2014/15P
31.0
4.6
4.0
4.6
4.2
22.7
13.4
Finance & Insurance
1.6
8.3
4.2
6.2
5.3
3.1
General Govt. Services
11.1
11.3
2.9
9.4
12.7
7
Housing Services
4.0
4.0
4.0
4.0
11.5
6.8
Other Private Services
6.4
5.3
6.3
5.9
16.8
9.9
Growth
Wholesale & Retail Trade
Transport, Storage &
Communication
Contribution to
Growth
2014/15P
18.3
Source: Pakistan Bureau of Statistics; P: Provisional; R: Revised
II.
Fiscal Policy
Fiscal Consolidation Remains on Track for the Second Consecutive Year
Fiscal consolidation
continues, albeit at a
slower pace than
anticipated.
The overall deficit for FY2014/15 turned out to be 5.3 percent of GDP, 0.3
percentage points higher than the revised estimates, owing to provincial increased
spending as well as tax revenue shortfalls. Nonetheless, the budget deficit declined
slightly from 5.6 percent of GDP observed in the previous fiscal year. The past two
years have been a break from the past four years (FY2009/10-FY2012/13) when the
fiscal deficit has hovered above 6 percent of GDP7 (see Figure 4). This break has
been a result of government efforts in tightening fiscal policy.
Railways posted a growth of 121 percent due to reduction in delays of passenger trains and
increase in freight trains. Air transport grew by 27 percent as fuel prices plunged and
operational efficiency was improved.
7 For FY2011/12, the deficit was a high as 8.8 percent of GDP.
6
4
Figure 4: Fiscal Deficit ( percent of GDP)
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
8.8
8.3
7.1
6.2
2009/10
2010/11
2011/12
2012/13
5.6
5.3
2013/14
2014/15
Source: Ministry of Finance
FBR taxes continue
to experience
shortfall.
The budget target for tax revenues – 86 percent of total revenues – for FY2014/15
was set at PKR 2,810 billion, which was revised downward during the year.
Provisional data points to a collection of PKR 2,594 billion – PKR 11 billion lower
than the last revised estimate of PKR 2,605 billion – on account of FBR revenues,
recording an annual growth of 14.2 percent viz.-a-viz. collection in the previous year8.
Weak performance of sales tax (with 42 percent share in FBR taxes) as well as direct
taxes (40 percent share) appears to be the reason behind this moderate growth (see
Table 3). The underlying factors have been the decline in oil prices, historical low
inflation, sluggish LSM sector activity as well as non-implementation of some revenue
measures introduced at the time of budget that were challenged in court9.
Consequently, in order to compensate for the shortfall resulting from these
developments, the government implemented a number of additional tax measures10
during the course of the year. These additional measures have been able to only
partially compensate for the shortfall in tax revenue. Despite these headwinds, the
tax-to-GDP ratio increased from 10.5 percent in FY2013/14 to 11.0 percent in
FY2014/15 – the increase coming from the federal government only. This has been
possible due to some progress towards improving the efficiency and effectiveness of
tax administration as well as phasing out of Statuary Regulatory Order (SRO) related
exemptions.
Last year, the growth was 17.4 percent.
These measures included 5 percent income tax on bonus shares and Gas Infrastructure
Development Cess (GIDC). The GIDC bill was only approved by the end of fiscal year, on
May 22, 2015. The bill will not only authorize the government to continue collecting the
GIDC, but will also provide retroactive legalization to the GIDC the government has been
collecting since 2011.
10 These included raising GST rate on petroleum products from 17 percent to 22 percent and
then to 27 percent, levying regulatory duties of 10 percent on imports of more than 300 items
and imposing a 2 percent withholding tax on non-filer service providers & importers.
8
9
5
Table 3: FBR Tax Collection
percent growth
PKR Billions (unless mentioned otherwise)
2012/13
2013/14
2014/15
2013/14
2014/15
736
884
1,029
20.2
16.4
1,200
1,388
1,565
15.6
12.7
Customs
240
241
306
0.6
27.0
Sales Tax
841
1,002
1,089
19.1
8.7
Federal Excises
119
145
170
21.4
17.2
1,936
2,272
2,594
17.4
14.2
Direct
Indirect
Total Taxes
Source: Federal Board of Revenue
Non-tax revenues
declined compared
to FY2013/14. They
were nonetheless
higher than
budgeted, on
account of healthy
central bank profits
as well as CSF
monies.
Normalization of interest receipts from SOEs as well as lower energy-related
proceeds contributed to a 7.7 percent decline in non-tax revenues in FY2014/15,
recorded at PKR 913 billion (see Table 4). Last year, the circular debt settlement
increased the revenues generated by SOEs considerably and thus, this year – without
any such development – the revenues from SOEs reverted to its past normal trend.
Moreover, collection in FY2013/14 was unusually high due to another one-off inflow
from Universal Access Fund of the Telecommunication Ministry. In the outgoing
fiscal year, the highlight has been the SBP profits that were to the tune of almost PKR
400 billion, 22 percent higher than those booked the previous year, mainly on account
of successful divestment of government shares in commercial banks11. Moreover,
defense receipts due to CSF12 proceeds were impressive and amounted to PKR 157
billion. Additionally, provinces showed notable effort towards non-tax revenue and
collected PKR 76 billion in aggregate, higher than PKR 49 billion collected in the
previous year.
Table 4: Non-Tax Revenues
percent growth
PKR billions (unless mentioned otherwise)
Federal
Profits Post Office Deptt./PTA
Interest (PSEs & Others)
Dividends
SBP Profits
Defense
Passport Fee
Development Surcharge on Gas
Discount Retained on Crude Price
Royalties on Oil/Gas
Others
Provincial
Total
Source: Ministry of Finance
2012/13
2013/14
2014/15
2013/14
2014/15
12
63
220
180
16
32
15
65
41
71
717
95
66
66
326
117
19
39
41
76
96
49
990
4
14
74
399
157
19
10
74
87
76
913
468.3
3.7
48.3
(35.0)
16.8
19.8
163.0
17.3
133.8
(30.7)
(96.1)
(78.4)
12.5
22.3
34.0
(1.2)
(100.0)
(76.2)
(3.1)
(9.2)
53.1
38.1
(7.7)
In FY2014/15, three capital market transactions were completed: United Bank Limited,
Allied Bank Limited and Habib Bank Limited; that were on the books of the central bank.
12 Coalition Support Fund (CSF) is reimbursement for logistic support provided by Pakistan
to North Atlantic Treaty Organization (NATO) troops in Afghanistan.
11
6
Weak revenue
performance
compelled the
government to rein
in expenditure in
order to reduce the
fiscal deficit.
Limited growth of expenditure as a share of GDP is solely due to curtailment of
development expenditure. In absolute terms, total expenditure amounted to PKR
5,392 billion in FY2014/15, 7.3 percent higher than in FY2013/14. Recurrent
expenditures were PKR 4,416 billion, 14.7 percent higher than those in FY2013/14,
while development spending was 2 percent lower (see Table 5).
Recurrent
expenditures
exceeded budgeted
amounts due to
SOEs-related
spending and
interest payments.
Grants (other than provinces) grew by 11 percent due to realization of contingent
liabilities and to support loss-making SOEs. Interest payments amounted to PKR
1,304 billion – a growth of 13.6 percent over FY2013/14 – and comprised 30 percent
of current expenditures. This increase has largely been on account of changes in the
domestic debt servicing schedule13. Moreover, defense spending was up by PKR 75
billion in view of increased requirements under the National Action Plan to combat
terrorism and improve security situation in the country. Energy subsidies remain
large, although lower oil prices have contributed to limiting the subsidy bill and a
significant reduction from the past year
Table 5: Summary of Pakistan Fiscal Operations
PKR billion (unless mentioned otherwise)
Total Revenue
Tax Revenue
Federal
Provincial
Non-Tax
Federal
Provincial
Expenditures
Current of which:
Interest
Subsidy
Defense
Development Expenditure
Net lending
Statistical Discrepancy
Fiscal Balance
percent of GDP
2012/13
2,949
2,232
2,081
151
717
646
71
4,816
3,660
991
305
541
777
363
16
(1,867)
(8.3)
2013/14
3,630
2,640
2,450
190
990
941
49
5,027
3,852
1,148
336
623
1,136
101
(62)
(1,397)
(5.6)
2014/15
3,937
3,024
2,818
206
913
838
76
5,392
4,416
1,304
265
698
1,113
27
(165)
(1,455)
(5.3)
22,379
25,068
27,384
percent growth
2013/14
2014/15
23.1
8.5
18.3
17.7
25.8
38.1
45.7
(31.0)
14.5
15.0
8.3
(7.7)
(11.0)
54.3
4.4
7.3
5.2
15.8
10.2
15.3
46.2
(72.2)
14.7
13.6
(21.1)
12.0
(2.0)
(72.9)
(25.2)
4.2
Memorandum items
GDP (nominal)
Source: Ministry of Finance
This time, unlike the
previous year,
provinces did not
contribute to fiscal
consolidation efforts
of the federal
government.
An increased spending role after the 18th Constitutional Amendment (see special
section II for further details) is manifested in a growth of 18.2 percent for
FY2014/15 for provincial recurrent spending, significantly higher than the 7.1
percent growth witnessed the previous year. Similarly, provincial development
expenditures increased to PKR 499 billion from PKR 431 billion in the previous year,
growing by almost 16 percent. As a result, provinces posted a small combined deficit
of PKR 9.8 billion (or 0.04 percent of GDP) for FY2014/15 contrary to revised
PIBs, with 34 percent share, dominate the domestic debt. New issuance is typically launched
at the start of a fiscal year and then the same issue is re-opened during all auctions of that year.
As a result, the bi-annual coupon payments appear in January and July, eventually increasing
the interest cost on domestic debt.
13
7
estimates that projected a surplus to the order of 0.5 percent of GDP. During the 7th
NFC Award, this is the second time when provinces have posted a combined deficit.
To meet fiscal
targets, the
government had to
significantly curtail
federal development
spending.
III.
Federal PSDP was reduced to PKR 489 billion from a higher-than-budgeted revised
allocation of PKR 542 billion. Nonetheless, the category underwent a moderate
growth of 12.4 percent in FY2014/15. The non-PSDP development spending was
cut to half (PKR 125 billion from PKR 270 billion spent in FY2013/14 due to
phasing-out of one-off items14.
Debt Dynamics
Total public debt
marginally declined
over the course of
the year.
As a Result of Continued Fiscal Consolidation, Public Debt Dynamics
Continue to Improve
As of end-June 2015, total public debt stood at 64.6 percent of GDP15 as compared
to the June 30, 2014 stock position of 64.9 percent (see Figure 5). In terms of its
composition, domestic debt dominated the stock in line with the past trend. In fact,
foreign currency public debt declined by 1.3 percentage points during the year and
closed FY2014/15 at 19.1 percent of GDP despite healthy IFI disbursements,
continued IMF program and successful launch of international Sukuk. This is
primarily due to translational gain16 observed during most of the fiscal year.
Figure 5: Trends in Public Debt
External
Domestic
Figure 6: Government Auction Profile, FY2014/15
Public Debt to GDP (RHS)
18,000
16,000
66%
FRDLA Threshold
64%
10,000
8,000
62%
6,000
4,000
60%
2,000
0
58%
FY12
FY13
FY14
FY15
Source: State Bank of Pakistan and staff calculations
Domestic debt was
created using both
long-term and short-
MTBs Target
PIBs Offered
PIBs Accepted
PIBs Target
2,500
12,000
FY11
MTBs Accepted
3,000
PKR billion
PKR billion
14,000
MTBs Offered
2,000
1,500
1,000
500
Q1
Q2
Q3
Q4
Source: State Bank of Pakistan and staff calculations
Resultantly, government was able to retire some of its central bank borrowings
thereby complying with the zero quarterly borrowing limit17. Domestic debt recorded
an increase of PKR 1.3 trillion in the portfolio, thereby closing FY2014/15 at PKR
The major being the Pakistan Development Fund receipts amounting to PKR 157 billion
that were booked under this head. These proceeds were in fact bilateral grant monies.
15 The total public debt is still above the threshold of 60 percent stipulated under the Fiscal
Responsibility & Debt Limitation Act 2005.
16 Translational gain observed during FY2014/15 implies the appreciation of US dollar against
major currencies. In Pakistan, external loans are contracted in various currencies but
disbursements are effectively converted into PKR. As PKR is not an internationally traded
currency, other currencies are bought and sold via selling and buying of USD. Hence, the
currency exposure of foreign debt originates from two sources: USD/other foreign currencies
and PKR/USD. This two pronged exchange rate risk is called translational gain/loss.
17 Specified in the SBP (Amendment) Act, 1956.
14
8
term funding
avenues.
12.3 trillion (or 44.8 percent of GDP). The year started with a continued interest in
PIBs18 facilitating the government to mop up proceeds comfortably above the preauction targets in the first half19. Market sentiments during the second half of
FY2014/15 seemed to shift towards Market Treasury Bills (MTBs)20 in view of policy
rate cuts and resultantly, the government started accepting offers over and above the
targeted amount in these short-term papers; the main thrust of the market being in
the 6-month and 12-month T-bills21. Nevertheless, scheduled banks’ interest in
Pakistan Investment Bonds (PIBs), on top of MTBs, was intact in these last two
quarters of FY2014/15 and the government was equally receptive (see Figure 6).
This interest of the banking industry points toward the financial sector’s preference
in risk-free sovereign instruments rather than investing in riskier ventures such as the
private sector (also discussed in the Monetary Developments section).
There have been
limited efforts to tap
into savings in
Islamic banks.
Despite huge deposits of idle liquidity parked in the books of Islamic banks22, efforts
to capitalize on it have been diminishing over time. The last auction of the 3-year
Government Ijarah Sukuk was held in June 2014 and a whole year has passed by
without any new instrument coming to surface. Implementation of the plans to
introduce short and medium-term Shariah-compliant papers will provide a levelplaying field to the Islamic financial sector and diversify the existing financing mix of
the government on domestic debt.
IV.
External Sector
Foreign Exchange Reserves Position Continued to Improve
A narrowing current
account deficit and
healthy financial
inflows are key
contributing factors
to an overall positive
external outlook.
Notwithstanding lower capital and financial inflows compared to the previous year, a
relatively modest current account deficit contributed to a positive overall balance of
US$2.6 billion for FY2014/15 against US$3.9 billion in the previous year. Pakistan
foreign exchange reserves build up continued, supporting stability in foreign exchange
market (see Table 6).
Table 6: Balance of Payments Summary
(US$ billion)
i. Current account (A+B+C+D)
A. Trade balance
Export
Import
B. Services net
of which: CSF
C. Income net
D. Current transfers net
of which Remittances
ii. Capital and Financial A/c
2013/14
-3.1
-16.7
25.1
41.8
-2.6
1.1
-3.9
20.1
15.8
7.4
2014/15
-2.6
-17.3
24.1
41.4
-2.8
1.5
-4.6
22.1
18.7
5.4
Pakistan Investment Bonds – the MLT market debt instrument – with maturity points of 3,
5, 7, 10, 15, 20 and 30-years.
19 During Q2, on aggregate, acceptance of bids for PIBs was more than two times the auction
target.
20 Market Treasury Bills – the short-term financing instrument – available in three tenors: 3months, 6-months & 12-months.
21 Out of total acceptance in H2-FY2014/15, both constituted 41 percent share.
22 The Financing to Deposits ratio (Liquidity indicator of Islamic banking) went down from
54.3 percent in December 2009 to 40 percent by end-June 2015, exhibiting a build-up of
liquidity in the Islamic banking institutions in recent years.
18
9
of which:
Direct investment
Portfolio investment
Other Investment Assets
Other Investment Liabilities
iii. Errors and omissions
Overall balance
SBP reserves (excl. CRR, sinking fund)
Memorandum Items
Current A/c Balance ( percent of GDP)
Trade Account ( percent of GDP)
Export growth percent
Import growth percent
Remittance growth percent
Financial & Capital A/c ( percent of GDP)
Source: State Bank of Pakistan
Several factors such
as strong workers’
remittances and CSF
inflows and on track
IMF program
contributed to this
benign outcome.
1.5
2.8
0.2
1.0
-0.4
3.9
9.2
0.8
1.9
0.1
2.2
-0.1
2.6
13.5
-1.3
-6.8
1.1
3.8
13.8
3.0
-1.0
-6.4
-3.9
-0.9
18.2
2.0
The main factors contributing to an overall positive external outlook are (i) resilient
growth in workers’ remittances — which more than offset the trade deficit; (ii)
improved inflows in services account of Coalition Support Fund (CSF); and (iii)
substantial capital and financial flows through successful issuance of Sukuk and new
loans from IFIs. Official reserves reached US $13.5 billion at end-June 2015, covering
about three months of imports of goods and services. Pakistani rupee slightly
depreciated by 3.3 percent in FY2014/15. These positive developments have led the
international rating agencies to upgrade the country’s sovereign credit ratings in recent
months23.
External Current Account
The current account
narrowed to 1.0
percent of GDP in
FY2014/15 compared
to 1.3 percent of
GDP in FY2013/14.
Export performance was weak as it registered a decline of 3.9 percent in FY2014/15
over the previous year, compared to an anemic, albeit, positive growth of 1.1 percent
in FY2013/14. Imports also declined mainly due to lower international oil and
commodity prices (see Table 6). Nevertheless, trade deficit widened in absolute
terms. As has been the case for five few years, workers’ remittances grew strongly, by
average 16.2 percent, and reached an all-time high of US $18.7 billion—more than
off-setting the trade deficit. This and strong inflows in services account of Collation
Support Fund (CSF) resulted in overall current account deficit of US $2.6 billion—
lower by about US $ 0.5 billion compared to FY2013/14.
The demand for nonoil imports in
response to relatively
improved economic
activities has
somewhat offset the
favorable oil prices
effect on overall
import bill.
Imports witnessed a decline of 0.9 percent during FY2014/15 against 3.8 percent
growth in previous year. This contraction was primarily due to declining petroleum
group import bill – which declined by 17.8 percent (US $ 2.6 billion) during
FY2014/15 compared to FY2013/14. Although the volume of petroleum imports
also declined marginally, it was the price impact which caused the overall petroleum
group’s import bill to fall. Nevertheless, the decline in oil imports was nearly
neutralized by a significant rise in non-oil imports especially in metals, transport, food
group and machinery24. Disaggregated analysis of prices and quantity effects reveals
Moody’s and S&P have improved Pakistan’s outlook from ‘stable’ to ‘positive’ on 25th
March and 5th May, respectively.
24 Rise in domestic construction activities particularly in the public sector projects, LNG
terminal at Port Qasim, Faisalabad-Multan Motorway etc. were the main reasons behind a
surge in metal group imports.
23
10
that volume impact outweighs the price effect for imported good except for soyabean
oil.25
Slowing global
economy and drop in
international prices
resulted in the
exports contraction
which more than
offset the reduction
in the import bill.
The decline in exports was broad based and all the exports groups experienced a
decline with the exception of food group which posted growth of 3.6 percent on
account of higher exports of fruits, vegetables, spices and meat. Rice is an important
export for Pakistan which contributed around 46 percent in total food exports but
suffered because of drop in international rice price. Despite a healthy growth of 24.3
percent in volume, value of rice exports declined by 3.4 percent.
The decline in
exports is broad
based.
The main contributors to the decline in export growth is the textile sector which
accounts for about 56 percent in total exports; petroleum (naphtha and petroleum
products); jewelry, leather products, engineering goods, furniture, cement and guar
products. Overall decline in value of textile exports (by 1.0 percent) is mainly on
account of decrease in low value added exports which declined by 9.8 percent due to
structural bottlenecks and lower demand from China and Bangladesh26 – major
buyers of Pakistani cotton yarn and fabric. The Generalized Schemes of Preference
(GSP) plus status continued to infuse a positive impact on textile exports as high value
added textile exports grew by 5.4 percent and somewhat diluted the negative impact
of declining low value added textile exports (see Figure 7).
Figure 7: Growth in Value of Textile Export in FY2014/15
30.0
20.0
10.0
0.0
-10.0
-20.0
Low Value-added
Source: State Bank of Pakistan
Madeup Articles
Synthetic Textile
Readymade Garments
Tents,Canvas etc.
Towels
Bed Wear
Knitwear
Other Textile Material
Other Yarn
Cotton Carded
Cotton Cloth
Cotton Yarn
Raw Cotton
-30.0
High Value-added
Current transfers
During FY2014/15, current transfers increased to US $ 22.1 billion from US $20.1
(mainly workers’
billion in FY2013/14. This was mainly supported by increased workers’ remittances
remittances)
continued to support
current account.
The exceptional rise in price of soyabean oil reflecting the increase in tariffs on soyabean oil
import.
26 China is faced with lower exports of its high value added products due to lower demand
and recession in EU, therefore suppressing exports from Pakistan. Similarly Bangladesh is also
faced with lower exports to US and supply chain issues which resultantly led to lower imports
of fabric from Pakistan.
25
11
which posted a notable growth27 of 18.2 percent and reached US $ 18.7 billion. The
significance of these workers’ remittances cannot be over emphasized as these finance
almost 45 percent of the import bill (see Figure 8). Country wise data shows that
remittances from all major countries increased except the non–UK EU countries,
which contributes only 2 percent in total remittance and hence have a negligible
impact on overall volume and growth of remittances. The share of Saudi Arabia in
overall remittances was the largest (31 percent); with the United Arab Emirates (23
percent), the United States (14 percent) and United Kingdom (12 percent) together
contributing 80 percent in total remittances28. Further declines in oil prices could
affect remittances by affecting economic growth in oil producing countries—which
are the source of 65 percent of total remittance.
Figure 8: Worker's Remittances, a Main Stay for the Current Account
6.0
20.0
3.0
15.0
FY15
25.0
FY14
9.0
FY13
30.0
FY12
12.0
FY11
35.0
FY10
15.0
FY09
40.0
FY08
18.0
FY07
45.0
percent
As % of Imports (RHS)
21.0
FY06
US$ billion
Remittances
Source: State Bank of Pakistan
Capital and Financial Account
In FY2014/15, capital
and financial
account was in
surplus, albeit US$
2.0 billion lower than
in FY2013/14.
The capital and financial account posted a surplus of US$ 5.4 billion against US$ 7.4
billion last year, mainly on account of few healthy inflows including issuance of US$
1 billion worth of Sukuk bond in international market, loans from IFIs (including US$
987 from IDB and US$ 364 million from ADB) and privatization proceeds — albeit
relatively lower as compared to FY2013/1429. The surplus was 27 percent (0.7 percent
of GDP) lower compared to FY2013/14 and continued to be driven by debt creating
flows. FDI declined to 0.3 percent of GDP30 (US$ 0.8 billion) against 0.6 percent last
year — reaching its lowest level over last few years (see Figure 9). Overall, official
reserves reached US$ 13.5 billion by end-June FY2014/15 posting a significant
increase of US$ 4.4 billion from FY2013/14 (see Figure 10).
The key factors behind this growth are (i) increased numbers of workers going abroad,
particularly skilled and qualified workers, (ii) enforcement of anti-money laundering legislation
and (iii) implementation of Pakistan remittance initiatives (PRI) by the banking sector.
28Remittances from Saudi Arabia, UAE, USA and UK grew by 19.1 percent, 35.3 percent, 4.93
percent and 4.92 percent respectively in FY2014/15.
29 During FY2013/14, there was a notable increase in financial inflows from Euro and Sukuk
bonds sale proceeds, new loans from IFIs, spectrum auction fee, UBL divesture proceeds and
grant receipt under PDF.
30 Apart from China’s direct investment in telecom sector and motorcycle industry, no
significant contribution has been witnessed under direct investment in Pakistan.
27
12
Source: State Bank of Pakistan
Reserves buildup
continued to ease
forex market
expectation.
Jun-15
May-15
FY15
FY14
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
-0.7%
FY05
0.3%
Apr-15
1.3%
Mar-15
2.3%
Feb-15
3.3%
Jan-15
4.3%
Dec-14
5.3%
Nov-14
6.3%
3.3 months of
import coverage
14.0
13.0
12.0
11.0 2.3 months of
import coverage
10.0
9.0
8.0
7.0
6.0
5.0
Oct-14
Capital & Financial A/c
Sep-14
FPI
Aug-14
FDI
7.3%
Figure 10: SBP's Foreign Exchange Reserves - Month
End Position (Billion US $)
Jul-14
Figure 9: Capital & Financial Account ( percent of
GDP
Source: State Bank of Pakistan
The PKR remained largely stable with a small depreciation of about 3.0 percent
against the US$ during FY2014/15. A stable nominal exchange rate and sharply falling
inflation resulted in REER appreciating by 7.9 percent during the period under review
(see Figure 11).
Figure 11: Movement on Exchange Rate
NER
125.0
REER
120.0
115.0
110.0
105.0
100.0
95.0
90.0
Jun-15
May-15
Apr-15
Mar-15
Feb-15
Jan-15
Dec-14
Nov-14
Oct-14
Sep-14
Aug-14
Jul-14
Jun-14
May-14
Apr-14
Mar-14
Feb-14
Jan-14
85.0
Source: State Bank of Pakistan
V.
Monetary Policy and Aggregates
Higher Budgetary Borrowing remains a Leading Factor behind Monetary
Expansion
Improved
macroeconomic
indicators allowed
SBP to ease its
monetary policy
stance aggressively
during FY2014/15.
Strong workers’ remittance and CSF flows, and declining international oil prices
helped contain current account deficit to 0.8 percent of GDP. This coupled with
substantial inflows in capital and financial accounts resulted in a buildup in SBP’s
reserves thereby infusing stability in the foreign exchange market. As a result, the
PKR remained stable with a small depreciation of 3.3 percent against the US$ during
the year. The stability in PKR and the government decision to pass-on the benefit of
falling international oil prices eased inflation considerably. All this allowed SBP to
13
ease monetary policy through a cumulatively cut of its policy rate by 350 bps in
FY2014/15.31
Movement in
monetary aggregates
were largely dictated
by targets set in the
government’s reform
program agreed with
the IMF.
While reserve money growth decelerated for the third year in a row to 9.9 percent in
FY2014/15, broad money supply grew by 13.2 percent in FY2014/15, compared with
12.5 percent in FY2013/14. The behavior of reserve money was primarily influenced
by measures to limit government borrowing from SBP. This, along with the outright
sale of government securities to commercial banks, allowed the SBP to limit growth
of net domestic assets (NDA) for all quarters of the year. While these measures have
constrained growth in NDA, overall positive external balance allowed net foreign
assets (NFA) of central bank to expand, albeit slower than in FY2013/14 (see Table
7). The current account balance narrowed slightly during FY2014/15; but limited FDI
and capital and financial inflows led to a deceleration of NFA growth during the year,
particularly with regards to the central bank.
Broad money growth
was fundamentally
driven by the
government sector
borrowing for
budgetary support
and commodity
operations.
This is reflected in strong expansion in NDA of banking system which grew by 11.7
percent as compared to 9.1 percent in FY2013/14 (see Table 7). Although expansion
in NDA is in line with the monetary easing during the year, a significant part of this
growth came from the government sector instead of private sector. In absolute term,
the government borrowed PKR 861.0 billion for budgetary finance from the banking
system in FY2014/15, compared with PKR 303.0 billion in FY2013/14. Within the
banking system, the government heavily relied on commercial banks not only to
finance its budget deficit, but also to retire some of its borrowing from SBP. In
addition, in a declining interest rate environment, banks were also keen to lock-in
their funds in high yielding assets. As a result of this demand-supply dynamics, net
government borrowing from commercial banks expanded by PKR 1,335 billion in
FY2014/15 compared with only PKR 106.1 billion in FY2013/14.32
Table 7: Monetary Aggregates (Flow since end-June)
Flow
(PKR billion)
Net Foreign Assets
of which: SBP
Net Domestic Assets
Government borrowing:
Budgetary borrowing
from SBP
from Scheduled banks
Commodity operations
Non-govt sector borrowing:
Private sector
Public Sector Enterprises
Other Items
M2
Growth (YoY)
RM
Growth (YoY)
Currency in circulation
2013/14
332
357
778
327
303
197
106
25
438
371
67
13
1110
12.5
326
12.8
239.7
2014/15
218
239
1097
933
861
-474
1335
72
288
209
80
-124
1316
13.2
282
9.9
376.9
The newly introduced SBP target rate was set at 50 bps lower than the ceiling of the Interest
Rate Corridor (IRC). This implies that main policy rate has declined to 6.5 percent.
32 The substitution of borrowing from central bank to commercial banks would entail higher
“actual” debt servicing cost. Borrowings from central bank are virtually free as any interest
earned by central bank is eventually passed on to Government as transfer of profits and
becomes part of non-tax receipts.
31
14
Demand and Time Deposits
868.0
936.6
Source: State Bank of Pakistan,
Despite this easing,
overall market
liquidity conditions
remained tight as
indicated by
overnight repo rates.
The government, as part of its economic reform program with the IMF, limited
borrowing from the central bank, and instead resorted to increased borrowing from
commercial banks. To ease these liquidity issues, SBP stepped up its liquidity
injections through open market operations (OMOs). The volume of OMOs increased
sharply with a continuous rollover of OMOs throughout the year (see Figure 12).33
This relatively tight liquidity conditions resulted in overnight rates close to Interest
rate Corridor ceiling throughout the year (see Figure 13)
Fig 12: Liquidity Injections through OMOs (Billion
PKR)
Mop-ups
Fig 13: IRC and WA Overnight Repo Rate ( percent)
Injections
1200
1000
800
600
400
200
0
-200
-400
WAONR
Floor of IRC
Ceiling of IRC
SBP Target Rate
Source: State Bank of Pakistan
2-Jul-14
22-Jul-14
18-Aug-14
5-Sep-14
25-Sep-14
20-Oct-14
12-Nov-14
2-Dec-14
22-Dec-14
13-Jan-15
2-Feb-15
23-Feb-15
13-Mar-15
3-Apr-15
23-Apr-15
14-May-15
3-Jun-15
24-Jun-15
15-Jul-15
2-Jul-14
21-Jul-14
29-Aug-14
1-Oct-14
28-Oct-14
28-Nov-14
22-Dec-14
19-Jan-15
9-Feb-15
20-Feb-15
6-Mar-15
20-Mar-15
1-Apr-15
20-Apr-15
7-May-15
25-May-15
22-Jun-15
10-Jul-15
31-Jul-15
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
Source: State Bank of Pakistan
In addition to supply
side constraints,
there were several
demand side factors
that contributed to
low off take of
private sector credit.
The sharp fall in commodity prices and consequent reduced demand for working
capital and trade financing loans during the year coupled with energy constraints
remained key reasons behind this low demand for credit from the private sector. A
relatively high real cost of borrowing as inflation declined at a much faster pace than
lending rates also played a role in subdued private sector credit.34 Furthermore,
constraints arising from structural weaknesses of the economy like power shortages,
law & order, and weak external demand also played their role in curtailing overall
credit demand.
Slow credit off-take
in manufacturing
sector dragged
overall credit growth
in private sector.
Out of overall private sector credit, private businesses borrowed PKR 180 billion
during FY2014/15 compared to PKR 298 billion in FY2013/14. Sectoral analysis in
Table 8 indicates that overall slowdown in credit offtake was most pronounced in
manufacturing sector where it grew by only 4 percent in FY2014/1535 compared to
13 percent in FY2013/14. On the other hand, construction and ship breaking sectors
registered an uptake in credit.
For H1-FY2014/15, SBP injected on average PKR 161 billion through OMOs. This
increased on average to PKR 450 billion in H2-FY2014/15.
34 By end-June 2015, real weighted average lending rates in incremental credit was 5.44 percent.
35 This lower growth was fundamentally due to net retirement or slow off-take in textile, food
and Beverage sectors.
33
15
Table 8: Monetary Aggregates (Flow in PKR billion)
(PKR billion)
Loans to private sector businesses (a…+...h)
By sectors:
a. Agriculture
b. Manufacturing
Textile
Wearing apparel, readymade garments
Food products and beverages
Chemicals
Non-metallic mineral products
Leather
Others
c. Electricity, gas and water
d. Ship Breaking
e. Construction
f. Commerce and trade
g. Transport, storage and communication
h. Others businesses
2013/14
298.0
2014/15
179.5
30.7
187.2
43.2
-0.6
97.5
20.2
-13.2
-0.8
40.9
49.8
0.1
-1.1
16.4
27.3
-12.4
32.7
68.4
-8.4
-0.3
15.3
17.9
19.7
6.9
17.2
-11.4
11.0
13.6
13.7
29.5
22.0
Source: State Bank of Pakistan,
VI.
Inflation
Inflationary Pressure Softened, supported by Falling Global Commodity
Prices and Fiscal Consolidation
Inflationary pressure
substantially eased
during FY2014/15.
The average Consumer Price Index (CPI) inflation steadily declined by around 4
percentage points and reached 4.5 percent, its lowest level in a decade and well below
its previous level of 8.6 percent in preceding year and annual target of 8.0 percent (see
Figure 14). Similarly, year-on-year inflation exhibited a sharp fall particular from
October 2014 onward mainly due to fall in global oil price, which was duly passed on
to domestic consumers, and lower food prices (see Figure 15). Specifically, during
Q1-FY2014/15, year-on-year inflation declined only marginally from the 8.2 percent
to 7.7 percent by September 2014; after that it decelerated sharply in subsequent
months and reached 2.1 percent in April 2014. Since then, it inched up slightly to 3.2
till June 2015.36
Fig 14: Average Inflation Trends (12-m moving
average)
10.0
Trimmed Inflation
NFNE Inflation
Headline Inflation
Figure 15: Y-o-Y Inflation in FY2014/15
10.0
8.0
8.0
6.0
6.0
4.0
4.0
2.0
2.0
0.0
0.0
Source: Pakistan Bureau of Statistics
NFNE Inflation
Trimmed Inflation
Headline Inflation
Source: Pakistan Bureau of Statistics
This moderate trend continues to the first two months of FY2015/16 with y-o-y inflation
falling to 1.7 percent in August 2015.
36
16
During FY2014/15, year-on-year food inflation decelerated from 7.4 percent to 3.2
percent, whereas non-food inflation decelerated from 8.9 percent to 3.2 percent in
June 2015. The decline in international oil prices, which was regularly passed on to
domestic consumers, led to lower transportation cost, capping of piped gas tariffs and
only minor increase in electricity tariffs37 that kept energy prices low38. Whereas,
improved supply of commodities, particularly wheat and rice due to depressed
exports, coupled with timely imports of certain food items, contributed to low food
inflation during FY2014/15. Consequently contribution of food segment in Y-o-Y
inflation fell drastically from Nov 2014 onwards (see Figure 16). Within the food
group, the prices of perishable food items declined significantly as is evident from its
current year index reduction to 2.2 percent against 11 percent last year owing to
improved supply management of onion and tomato crops (see Figure 17).
Source: Pakistan Bureau of Statistics
Jun-15
May-15
Apr-15
Mar-15
Feb-15
Jan-15
Non-parishable Food
Dec-14
Nov-14
Oct-14
Parishable Food
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
Sep-14
Jun-15
May-15
Energy
Apr-15
Mar-15
Feb-15
Jan-15
Dec-14
Nov-14
Oct-14
Non-Food-Non-Energy
Sep-14
Jul-14
Aug-14
Food
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
Figure 17: Weighted Contribution in Y-o-Y Food
Inflation
Aug-14
Figure 16: Weighted Contribution in Y-o-Y Inflation
Jul-14
The decline in
inflation was broadbased with both food
and non-food
segments
contributed to this
easing.
Source: Pakistan Bureau of Statistics
Both measures of
core inflation, nonfood non-energy
(NFNE) and 20
percent trimmed,
gradually softened
during the period.
Lower raw material prices, particularly cotton and steel, and restrained aggregate
demand were the main reasons behind softening core inflationary pressure (Figure
14). Government’s fiscal consolidation and improved external accounts that kept
exchange rate stable also helped in containing the underlying inflationary pressure
during the year. Similarly, with the reduction in food and fuel prices, the growth in
prices of majority of commodities included in core inflation, particularly in second
half of the year, which has put downward pressure on core inflation.
The inflation outlook
is benign with
several factors
contributing to
easing of
expectations.
Average headline inflation could pick up modestly in FY2015/16 to 5.0 percent due
to base effects. Continuation of low crude oil prices also supports this trend. A
possible adverse impact of prevailing low food prices on next year crops production,
pick-up in aggregate demand on the back of historic low interest rates and weak
performance of commodity producing sectors represent upside risks for inflation.
Any upward adjustment in electricity and gas tariffs in the ongoing reform process
also poses upside risks to inflation.
Electricity tariffs were increased by 1.79 percent in November 2014.
Contribution of energy sector in Y-o-Y inflation turned negative from December 2014
onward.
37
38
17
VII.
Financial Sector Developments
Heavy Government Borrowing continues to Drive Financial Sector Indicators
and Crowd-Out Private Sector Credit
The banking system
remains robust
based on standard
solvency indicators,
with the capital
adequacy ratio well
over regulatory
requirements.
The key driver of this robustness has been a shift in risk behavior of banks from
private sector loans to risk free government securities. The banking sector has
achieved sizable growth, which is driven primarily by increased government
borrowing. Commercial banks hold about PKR 4.99 trillion of government domestic
debt as of May 2015, which is about 38 percent of total assets (see Figure 18).
Furthermore, investments in government securities constitute approximately 90
percent of total banking system investments. As a result of zero risk rating of
government debt for capital adequacy purposes, this significantly reduces risk
weighted assets of the banking system. For purposes of comparison, the capital to
total assets ratio has declined from 8.8 percent to 8.3 percent during FY2014/15,
while the capital adequacy ratio has increased from 15.1 percent to 17.2 percent during
the same period.
Profitability remains
high with return on
assets and return on
equity of 2.7 percent
and 27.5 percent
respectively for the
quarter ending in
June 2015.
This positive trend has persisted but is expected to weaken on the back of an
accommodative monetary policy stance which has reduced the policy rate by over 300
basis points in less than a year. As a result, the benchmark interest rate (6-month
KIBOR39) dropped to 7 percent while the policy rate is at 6.5 percent at the end of
June 2015.
Figure 18: Commercial Banks’ Exposure to
Government Debt
36%
35%
38%
30%
26%
4.0
25%
3.0
20%
5.0
2.0
1.0
3.6
2.0
3.9
15%
10%
2.7
5%
0.0
0%
FY11
FY12
FY13
Source: State Bank of Pakistan
Compared to
FY2013/14 when
private sector credit
grew by PKR 357
billion, the uptake of
FY14
FY15
June-14
Profit Before Tax ytd
35%
31%
5.0
(PKR billion)
40%
June -15
113
171
3,729
3,937
ROA Before Tax
2.1
2.7
ROE Before Tax
23.5
27.5
Advances to Deposits Ratio
47.7
45.7
Liquid Assets/Deposits
60.6
69.5
Capital Adequacy Ratio
15.1
17.2
Gross NPLs to Loans
12.8
12.4
Net NPLs to Loans
2.9
2.7
6 month KIBOR
10.2
7.0
Credit to Private Sector
% of Total Assets
Government Debt (PKR tln)
6.0
Table 9: Selected Key Indicators of the Banking Sector
(In percent)
Source: State Bank of Pakistan
One key highlight of FY2014/15 has been the increase in credit for long term
investment purposes of PKR 127 billion compared to PKR 71 billion in FY2013/14.
Non-performing loans (NPLs) remained stable at 12.4 percent of the overall loan
portfolio. Given adequate provisioning, net NPLs continued to decline, reaching 2.7
percent in June 2015. Year on Year, NPLs in Small and Medium Enterprises (SMEs)
39
Karachi Inter-bank Offer Rate (KIBOR) serves as the bench mark for commercial lending.
18
private sector credit
has slowed down
considerably in
FY2014/15, growing
by only PKR 195
billion.
decreased from 33.9 percent to 32.2 percent of all loans and NPLs in the consumer
sector decreased from 12.4 percent to 10.6 percent (see Table 9).
Equity Market has seen Considerable Investor Interest, but the Bond Market
is Still Dominated by the Government
The equity market
has maintained an
upward trend.
Despite reeling from multiple political shocks, Pakistan’s equity market retained its
upward momentum during FY2014/15 (see Figure 19). The KSE-100 Index grew by
16 percent during FY2014/15 compared to 41 percent in FY2013/14, on the back of
improving macroeconomic fundamentals and general investor confidence. Market
capitalization grew to PKR 7.2 trillion out of which foreign investors represent 10
percent. The upward trend in turnover volumes and the KSE-100 index has primarily
been driven by foreign portfolio investment, resilient corporate profitability,
increasing forex reserve levels and increased confidence shown by international
agencies. However, despite strong performance overall, the market is marred by high
volatility which has manifested itself most recently during July-August 2015 when the
market rose 3.9 percent in July but fell 5.9 percent in August.
Volume (millions)
40,000.0
KSE-100 Index
500
450
400
350
300
250
200
150
100
50
0
35,000.0
KSE-100 Index
30,000.0
25,000.0
20,000.0
15,000.0
10,000.0
5,000.0
Sep-15
Aug-15
Jul-15
Jun-15
May-15
Apr-15
Mar-15
Feb-15
Jan-15
Dec-14
Nov-14
Oct-14
Sep-14
Aug-14
Jul-14
Jun-14
May-14
Apr-14
Mar-14
Feb-14
Jan-14
0.0
Volume (millions)
Figure 19: KSE-100 Index and Volumes
Source: Karachi Stock Exchange
The bond market
consists mainly of
government debt,
while the corporate
bond market is
looking towards local
and international
Islamic debt capital
markets.
Since the introduction of Pakistan Investment Bonds in 2000, there has been an active
interest in medium- to long-term government debt. The yield curve has shifted
significantly over the past year due to a lower interest rate environment as well as
expectations over the long term (see Figure 20). The yield curve also reflects
expectations about the persistence of lower interest rates for up to 3-year tenors. Last
year, these expectations only spanned a 1-year period. During FY2014/15, the
sovereign bond market saw the issuance of US$ 2 billion worth of international
bonds. In addition, US$ 1 billion was raised from the Islamic capital markets through
Sukuk bonds. The Islamic bond market has shown promising signs in the domestic
corporate debt market as well. The capital market regulator issued Sukuk Rules in
February 2015 which are aligned with the Accounting and Auditing Organization for
Islamic Finance Institutions (AAOIFI), thus aiming for better governance and larger
appeal for international investors. Following the issuance of the rules, Karachi-based
19
utility K-Electric sold US$ 216 million worth of seven-year Islamic bonds, the largest
listed corporate Sukuk in the country.
Figure 20: Yield Curve
September-15
30-year
20-year
10-year
7-year
5-year
3-year
2-year
12-month
9-month
6-month
3-month
1-month
Percetage
July-14
14.0
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
Source: State Bank of Pakistan
20
B. Outlook and Projections
Near-Term Outlook
I.
Economic growth
is expected to
accelerate slightly
over the next two
years as
macroeconomic
indicators improve
and the reform
momentum
continues.
The outlook for Pakistan’s economy is supported by relatively low inflation,
particularly low oil prices, and continuous fiscal consolidation. Reforms are
expected to continue and support easing of energy constraints and improvements
in the economy’s competitiveness. Nonetheless, this outlook is subject to
substantial external and domestic risks. Investment levels remain low given weak
investors’ confidence. Removing infrastructure bottlenecks, especially in energy,
will be crucial to accelerate growth and its long-term sustainability. Security
situation, though improved, still affects growth prospects negatively.
Figure 21: GDP Growth Forecast—Gradual Increase to Continue amid Improving Fundamentals and Limited
Increase in Investment
Real GDP growth, at constant factor
prices
5.0
15.6
4.8
4.5
4.5
4.0
3.5
Total Investment (in percent of GDP)
3.8
3.6
4.0
4.2
3.7
15.4
15.3
15.1
15.0
15.0
15.0
15.1
15.1
14.7
14.4
14.1
14.1
13.8
3.0
13.5
FY11 FY12 FY13 FY14 FY15 FY16P FY17P
Source: Data from Pakistan Economic Survey and World
Bank staff estimates
Real GDP growth (at
factor cost) is
projected to register
4.5 percent in
FY2015/16, reaching
4.8 percent in
FY2016/17.
FY11 FY12 FY13 FY14 FY15 FY16P FY17P
Source: Data from Pakistan Economic Survey and World
Bank staff estimates
GDP growth during FY2015/16 is projected at 4.5 percent of GDP (compared to 4.2
percent in 2014/15), below the authorities’ estimate of 5.5 percent (see Figure 21).
On the supply side, economic growth would be driven largely by services sector which
comprises more than half of the economy. Agriculture sector, which is one-fifth of
the economy, is expected to grow at about 3 percent in FY2015/16 (see Figure 22).
Given forward linkages of the agricultural sector, improved performance would
support growth in the industry and services sectors also. Agricultural income also
provides critical support for domestic demand. The industrial sector is expected to
grow at 4.4 percent, lower than the official target of 6.4 percent. Services, which has
been a main stay for growth in the last few years, is expected to grow at about 5.2
percent in FY2015/16.
21
Figure 22: GDP Growth Forecast is underpinned by Slow Growth in Investment, Aided by Consumption
Growth; Consistent Services Sector Growth will be Crucial for Overall Growth
20.0
Private Consumption
Government Consumption
Gross Fixed Capital Investment
Agriculture
Industry
Services
6.0
5.0
15.0
4.0
10.0
3.0
2.0
5.0
1.0
0.0
0.0
Source: Data from Pakistan Economic Survey and World
Bank staff estimates
Source: Data from Pakistan Economic Survey and World
Bank staff estimates
Several factors are
constraining
industrial growth.
Dampened international demand, and falling output prices have been some of the key
constraints for major industries such as textiles. Power sector has remained under
pressure due to lower capacity utilization amid build-up of inter-corporate circular
debt.40 The outlook assumes that some of these issues will be resolved in the medium
term, given government efforts in that respect.
Household
consumption growth
is expected to
expand along with
economic activity.
Low inflation environment due to low commodity prices will support higher
household consumption. Nevertheless, for households in the agriculture sector, the
impact is not clear given that many will be net food sellers. State Bank of Pakistan
Consumer Confidence survey indicate an improved sentiments about the future
during FY2015/16. In addition, recent aggressive monetary policy easing may have a
positive lagged effect on overall consumption through higher spending on durables
in the medium term.
Increase in
investments is
predicated on the
implementation of
(CPEC) and other
infrastructure
projects.
Investment to GDP ratio is expected to grow from 15.1 percent in FY2014/15 to
15.4 percent in FY2016/17 (see Figure 21). Despite constrained fiscal space,
government is allocating significant resources for the public sector development
program. The public sector development program will be supported by investments
in energy and transport infrastructure foreseen in the China Pakistan Economic
Corridor (CPEC). Materialization of the planned government investment in energy
and infrastructure and improvement in security conditions are expected to encourage
private sector investment going forward.
Current account
deficit is projected to
register 1.0 percent of
GDP by FY2016/17
and will be
supported by robust
The trade deficit will widen in the near term but continued remittance inflows are
expected to finance much of it. Exports are projected to contract by half a percent in
the first year owing to tapered global demand and then grow marginally the following
year. Imports, however, are projected to post moderate growth due to CPEC-related
investments and higher domestic demand. The slowdown of the Chinese economy
and slow recovery in Euro zone will weaken external demand, more than
Essentially, the term refers to cash-flow problems in the power sector that arise due to the
factors like non-payment of electricity bills by consumers (public and private), transmission
losses, and delays in subsidy payments.
40
22
remittances in the
near term.
compensating for the potential positive impact of an acceleration of growth in the
US. A stable exchange rate and weak commodity prices will also limit the import bill.
The impact of low oil price will remain a dominant factor on the overall import bill.
The circular debt in the energy sector, which will limit PSO’s (largest oil market
company) liquidity, and new regulatory duties are also among the factors restricting
imports growth.
Fiscal consolidation
is expected to
continue.
Fiscal consolidation is projected to continue over the medium term on the
assumption of strong tax revenue efforts by the government as well as gradual
phasing-out of energy-related subsidies and of contingent liabilities on loss-making
SOEs. Resultantly, the fiscal deficit (including grants) is expected to decline to 4.2
percent of GDP in FY2015/16 and to 3.5 percent in the subsequent fiscal year.
Accordingly, reduced deficit financing will facilitate provision of bank credit to the
private sector, leading to increased economic activity.
Under the baseline
scenario, inflationary
pressures are likely
to remain contained.
In the short to medium run, inflationary pressures are expected to remain subdued.
It is expected that inflation would remain around 4-5 percent as international
commodity prices (especially of crude oil) are expected to stabilize at a new lower
normal. A stable PKR against US$ positively influence expectation of businesses
(since movements in the US$-PKR parity directly influence price setting by private
sector businesses). The recent IBA-SBP’s Consumer Confidence Survey trends
indicates lower inflationary expectations for the months ahead). The 1.8 percent YoY
monthly inflation in July, 2015 (the lowest since August, 2003) is the continuation of
the declining trend in CPI inflation in FY2015/16 as well. However, the supply
disruption of perishable food items due to seasonal floods and a possible hike in the
electricity and gas tariffs by the government pose up-side risks. In addition, recent
monetary easing may result in higher aggregate demand which may also result in
inflation uptick.
II.
Risks to the Outlook
Recent slowdown in
China and weak
recovery in the EU
represent to have
some downside risks
for external side.
Recent slowdown in China and a weak recovery in the EU may have direct and
indirect impact on Pakistan’s exports. First is the direct impact on trade, stemming
from both demand effects and exchange rate effects. China constitutes 10 percent of
Pakistan’s exports (roughly US $2.2 billion). Competitiveness of the textiles sector,
accounting for more than half of all exports, may be affected by recent appreciation
of the real effective exchange rate and compensate for slight improvements in
competitiveness otherwise. Remittances are expected to remain at current high levels,
but a further weakening of prices may negatively oil-producing countries where a large
share of the remittances originate.
Underperformance
in revenue collection
may pose downside
risk to fiscal
consolidation.
On the fiscal side, realization of tax revenue targets largely hinges upon the steady
implementation of the tax reform agenda. Fiscal consolidation may also be negatively
affected by delayed implementation of the government’s privatization agenda. Public
sector investment is expected to increase as a result of official Chinese government
support to the CPEC. Should the slowdown in China affect the level of this support,
public investment may be negatively affected. Deviation from targeted budget deficits
may force government to increase its financing from commercial banks which may
continue to crowd out private sector credit.
23
Structural
bottlenecks continue
to pose downside
risks.
Investment seems to be recovering only slowly, despite improvements in the
economy’s macroeconomic fundamentals. For economic growth to accelerate and be
sustained, key growth constraints like electricity shortages, cumbersome business
climate, complex trade regime, low access to finance and security situation need to be
addressed.
Any adverse shock in
overall economic
performance can
affect vulnerable
population.
High degree of vulnerability to poverty remains a substantial challenge. A very large
share of households are clustered around the poverty line and are a shock away from
falling back into poverty. Reliance on remittances and low commodity prices to
improve the lives of the poor and vulnerable is therefore a risky strategy. Sustainable
poverty reduction requires investment and job creation within the economy, as well
as efforts to substantially raise agricultural productivity, by building value chains,
improving technology adoption and reducing exposure to uninsured climate risks.
24
C. Progress on Structural Reforms
After a strong focus
on macroeconomic
stability over the past
two years – Pakistan
needs to continue
making progress in
the structural
reforms agenda.
Over the past two years, Pakistan has successfully implemented an economic reform
agenda with a strong focus on achieving external and internal balance. Aided by a
narrowing current account and strong external financial inflows, the external balance
has been positive over the past two years and international reserves have steadily
increased to reach over 3 months of imports. The fiscal deficits have also declined –
although by less than programmed, and debt levels are now in a downward trajectory.
Growth has also accelerated, but it remains well below potential at 4.2 percent in
FY2014/15. Investment remains low, and more worryingly private sector investment
has declined as a share of GDP over the past few years. It will be important for the
country to now focus on a reform agenda that accelerates growth and investment and
ensures its sustainability.
The government
continues with its
ambitious reform
agenda in the energy
sector.
Reforming the energy sector continues to be a top priority as the private sector
continues to be plagued by power outages. The poor performance of the energy
sector also inhibits much needed private sector investment in the sector and generates
significant fiscal outlays, in the form of energy subsidies and the accumulation of
circular debt that will ultimately have to be financed through the budget. The reform
program is laid out in the new energy policy approved in July 2013. The policy
foresees (i) adoption of a new tariff pricing formula, (ii) improved operating efficiency
and reduced losses within power distribution companies, (iii) increased efforts to
attract private sector investment to the sector, including the privatization of a number
of companies (both distribution and generation). In the past year, the Government
has implemented surcharges and adjusted prices with the objective of achieving full
cost recovery from consumers. The Government has also developed a mechanism to
monitor the accumulation of arrears in the sector (circular debt) and adopted a plan
for reducing the accumulation of arrears. This plan includes the improvement of
collections and reduction of operation costs and losses (through revenue-based load
management) and adoption of performance contracts to improve management of the
distribution companies. The Government is also implementing a number of demandside measures with regards to pricing, metering-infrastructure and adoption of
equipment standards for improved energy efficiency and conservation. On the
supply-side, the Government is improving the fuel-mix in electricity generation,
continues to invest and attract investment in generation, transmission and distribution
infrastructure. There are a number of large investments planned in the energy sector
over the next few years (including through the CPEC) that will add significant
generation capacity.
Increasing tax
revenues remains
high on the
government’s reform
agenda – and despite
significant revenue
growth performance
continues to be
below targets.
Pakistan has one of the lowest tax to GDP ratios in the world. The Government
adopted relatively ambitious targets to increase revenues from below 10 percent to 14
percent in only five years. The reform is laid out in the tax reform strategy adopted in
February 2014 and a 3-year plan for phasing out SRO-based tax exemptions in July
2014. The Government has started to implement this ambitious reform agenda,
including the elimination of a large number of SRO-based exemptions and the
authority to grant tax concessions or exemptions has now been transferred to
parliament. The Government is also implementing a series of measures to automatize
and streamline business processes, enhance tax administration through broadening
the tax base and improving compliance, enforcement and market analysis. At the
same time as broadening the tax base, the Government is also increasing efforts to
improve governance and reduce corruption in tax administration. With the devolution
of authority over a number of taxes to the provincial level, it is becoming increasingly
25
important to enhance capacity at the provincial level. Provinces have now authority
over services sales taxes, property taxes and agricultural income taxes, all taxes with
significant revenue potential which is currently not being exploited. Despite these
efforts – tax collection continues to be below targets, suggesting the need to maintain
the focus on this reform area and to accelerate efforts as appropriate.
Private investment
continues to be very
low – and more
worryingly seems to
be on a declining
trend.
Despite a more stable macroeconomic environment and government broader efforts
to attract investment, private investment is now on a declining trend, falling below 10
percent of GDP in FY2014/15. FDI is also on a declining trend, and at 0.3 percent
of GDP is the lowest in a decade and among the lowest in South Asia (for a discussion
on the reasons for such low levels of FDI and investment more broadly see special
section I). To reverse this trend, the Government of Pakistan adopted in October
2014 a plan to improve the investment climate. The reform plan covers a broad range
of issues to improve the investment climate, including measures to improve (i)
business start-up and registration, (ii) dealing with construction permits, (iii) accessing
credits, (iv) tax administration, (v) trade facilitation, and (vi) contract enforcement.
The Government has implemented a series of reforms over the past few years,
including the establishment of one-stop-shops, started the implementation of a
comprehensive tariff reform to improve trade competitiveness and the preparation
and adoption of a financial inclusion strategy in early 2015, which includes the
preparation and passing of a number of key laws including the Credit Bureau Act, the
Secured Transactions Law and the Deposit Protection Fund. A number of reforms
are under the responsibility of provincial authorities. To improve the business
environment at the subnational level, the Federal Government is enhancing
coordination with provinces and developing province-level implementation plans to
improve the business environment.
26
D. Special Section
I.
Why Investment is Low in Pakistan?
Pakistan’s
investment to GDP
ratio is low and
declining.
Pakistan has immense potential for profitable investments, considering its strategic
location and prospective market size. Despite this potential, the investment-to-GDP
ratio has consistently remained lower than other economies in the region; more
troubling is the declining trend of this ratio in recent years that reached a 35-year low
by end FY2013/14 (See Figures 23). Persistently low level of investments has
constrained growth potential. Hence, whenever the economy experienced demanddriven boosts, macro-economic imbalances emerged in the form of inflation, higher
imports and current account deficits. This section discusses some of the reasons
behind chronically low investment rates in Pakistan.
Figure 23: Investment Trends in Pakistan (in percent)
Investment to GDP ratio
25.0
10 Year Average
20.0
15.0
10.0
5.0
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0.0
Source: Pakistan Bureau of Statistics
Low public
investments have
been unable to
remove
infrastructure
bottlenecks.
The empirical literature does not provide a clear evidence of the impact of public
investment vis-à-vis private investment in Pakistan—the crowding-in phenomenon.
However, less-than-desired public investment in important sectors like infrastructure,
energy, human capital and transport, has clearly been weighing heavily on the
country’s growth prospects, as suggested by the latest Investment Climate Analysis
prepared by the World Bank in 2009, which, among other constraints for private
sector development, highlighted the quality and availability of infrastructure,
particularly energy. Gas and power shortages have become the norm, and the
country’s performance in logistics lags behind most developing countries (see Table
10).
27
Table 10: Logistics Performance Index (ranking among 160 countries)
Overall
Singapore
5
Malaysia
25
China
28
South Africa
34
Indonesia
53
India
54
Pakistan
72
Source: Haver Analytics,
Pakistan’s low
investment will place
it at a disadvantaged
position among peer
countries going
forward.
Customs
Infrastructure
International
shipments
3
27
38
42
55
65
58
2
26
23
38
56
58
69
6
10
22
25
74
44
56
Logistics
quality and
competence
8
32
35
24
41
52
75
Tracking
and tracing
Timeliness
11
23
29
41
58
57
86
9
31
36
33
50
51
123
Emerging economies typically focus on better infrastructure—road, transportation,
energy—to attract and facilitate private investment. As shown in Figure 24,
investment-to-GDP ratio in Sri Lanka, Bangladesh, Thailand Cambodia, and India
has remained higher than in Pakistan in the last 10 years. More worrying is the fact
that during the last 5 years, this ratio has declined to even lower levels despite huge
infrastructure needs. Pakistan’s domestic savings rate, which hovers around 10
percent of GDP for the last decade, limits the scope to increase investment.
Figure 24: Investment to GDP ratio
1980s
70.0
1990s
2000s
2010s
60.0
50.0
40.0
30.0
20.0
10.0
0.0
Bhutan
China
Source: Pakistan Bureau of Statistics
Limited fiscal space
is partly to blame for
the low public
investment level.
Nepal
India
Sri Lanka
Bangladesh
Pakistan
One of the major reasons for low public investment in Pakistan has been the limited
fiscal space due to low tax revenues—a legacy of suboptimal tax structure—and high
current expenditures, leaving limited space for public investments. Current
expenditures exhibit structural rigidities due to large debt servicing cost and
significant amount of subsidies, e.g. in FY2014 public investment to resolve the
energy crisis amounted to PKR 115 billion, while energy subsidies amounted to PKR
309 billion on the same year. Another implication of high fiscal deficit is its financing
through borrowing from commercial banks. This has effectively crowded out private
sector from the credit market (see Figure 25). 41 In fact, commercial banks overall
Overall deposit of commercial Banks increase by PKR1100 billion while government
borrowing from commercial banks increased by PKR1335 billion during FY2014/15.
41
28
deposit increased by PKR 1,100 billion during FY2014/15 while government
borrowing from commercial banks increased by PKR 1,335 billion, effectively
squeezing private sector from credit markets. Pakistan’s long-term debt market is not
developed, and lack of depth in financial markets is a constraint to undertake largescale projects.
Figure 25: Government vs Private Sector Credit (PSC) as % of GDP—Crowding Out
Government Borrowing (Stock)
PSC (Stock)
30.0
25.0
20.0
15.0
10.0
5.0
FY2015
FY2014
FY2013
FY2012
FY2011
FY2010
FY2009
FY2008
FY2007
FY2006
FY2005
0.0
Source: State Bank of Pakistan
A relatively shallow
financial market is
unable to fulfill long
term investment
needs.
Banking sector deposit to GDP is about 32 percent at end June 2014. Most of these
deposits are of shorter maturity (Table 11) creating a mismatch between commercial
banks assets and liabilities. This clearly hampers the ability of banks to advance longer
term advance which are generally required to make capital investment. In addition,
private corporate debt market is in its early stages with very few companies able to
issue long term certificates to finance new investments or expansions. Out of total
122 listed term finance certificates up till end February 2015, only 20 are outstanding
so far. A total of PKR 135 billion were raised of which PKR 30 billion is outstanding.
With this limited success, investors have limited options to finance long term
investments.
Table11: Banking Sector Deposits by Term of Maturity (percent)
Fixed
Current/Call Saving < 6 months
Jun-08
27
41
Jun-09
29
39
Jun-10
29
39
Jun-11
31
38
Jun-12
31
39
Jun-13
32
41
Jun-14
37
39
Source: State Bank of Pakistan,
The Public-Private
Partnerships (PPP)
framework needs to
be strengthened.
14
14
14
13
12
11
10
>6 & <1
years
5
4
3
4
3
3
3
1 to 2 years 2 to 3 years
7
9
10
10
11
9
8
1
1
1
0
0
0
0
3 to 4
years
2
1
1
1
1
1
1
4 to 5 years
1
1
0
0
0
0
0
>
5years
3
2
2
3
2
2
2
Where governments cannot directly finance infrastructure projects, these collaborate
with the private sector. All over the world, the private sector goes hand in hand in
financing the requirements for strategically important sectors like energy, transport,
telecom and water & sewerage. The private sector can also bring improved
management skills to the operation of infrastructure services. Table 12 below shows
29
that Pakistan has a relatively small number of projects where it successfully reached
financial closure. In terms of amount, Pakistan attracted about US$ 35 billion in PPP
compared to US$ 338 billion by India and about US$ 500 billion in Brazil over the
past 25 years. Not only is Pakistan quite behind other emerging economies in terms
of number of projects; but more importantly, the distribution is skewed towards one
sector. A major reason for low private participation in Pakistan has been due to a
weak legal framework, which outlines the modus operandi of private sector
involvement in financing and operating infrastructure facilities.42 The provinces are
seeking to fill this void, with Sindh and Baluchistan provincial assemblies passing a
public-private partnership bill in 2010 and Punjab and Khyber Pakhtunkhwa passing
such a bill in March 2014.43
Table 12: Sector-wise Number of Projects reaching Financial Closure in Public Private Partnership (1990-2014)
Total
Projects
Airport
Pakistan
83
1
India
847
7
Brazil
748
17
Russia
337
8
China
1204
17
Mexico
240
6
Source: http://ppi.worldbank.org/
Electricity
Natural Gas
Railroads
Roads
Seaports
Telecom
Water and
Sewerage
63
356
407
102
323
46
2
5
17
3
199
31
0
8
19
2
15
8
0
387
72
3
139
70
8
38
53
11
74
28
9
37
36
186
4
15
0
14
128
23
433
37
Lack of coherent and
consistent industrial
and trade policies are
impeding investors’
confidence.
Inconsistencies in policies for different sectors over time have dented investors’
confidence. Incidents like the Independent Power Producers-Government stand-off
in the late 1990s; litigation over Reko Diq mining lease; contract enforcement issues
with Engro Fertilizer; and, frequent changes in Compressed Natural Gas (CNG)
policy have affected the interest of potential investors in Pakistan. Government
capacity in terms of designing and analyzing investment agreements, including in
terms of forecasting demand and supply, needs strengthening. Investments that need
uninterrupted gas supplies (e.g. fertilizer) are now facing operational constraints given
gas shortages. The lack of coherence in the country’s trade and industrial policies has
also played a key role in reducing industrial investments. More specifically, tariff
policies have not been supplemented by a comprehensive industrial strategy to
improve the competitiveness of local firms. Entry in some sectors is difficult. Burki
(2008) observed that industrial policies were made either as part of medium-term
development plans or in response to some crisis the country was facing. He states
that, “the frequent changes in industrial policy have kept the industrial sector relatively
backward compared to the developments in other large Asian economies”.
Foreign investors
have better options
available elsewhere.
Foreign Direct Investment (FDI) has been declining over a number of years and
compared to other countries’ performance is a point of concern.44 (see Figure 26)
FDI is also highly concentrated in a small number of sectors and countries of origin.
In the last 15 years almost 60 percent of FDI went to three sectors: oil and gas
exploration, communications and financial business. Such high concentration means
Financing infrastructure and development projects in Pakistan has over the years been made
directly from budget allocations; therefore there is a lack of institutional and regulatory
capacity, which is necessary to facilitate private participation in infrastructure provision.
43 Source: Provincial Assembly of Sindh
(http://www.pas.gov.pk/index.php/acts/details/en/19/127); Provincial Assembly of KP
(http://www.pakp.gov.pk/2013/acts/the-khyber-pakhtunkhwa-public-private-partnershipact2014/);
44 FDI in FY2014/15 stood at US$ 642 million against US$ 1,541 million in FY2013/14.
42
30
that negative developments in these sectors can have a disproportionate impact on
overall FDI, e.g. the law and order situation in the exploration areas has deterred FDI
in oil and gas exploration45 which has dragged down overall FDI in the country. In
terms of sources of FDI, the US, UK and UAE jointly contribute on average 60
percent of total FDI making Pakistan highly vulnerable to economic conditions or
changing perceptions of investors in these countries.
Figure 26: FDI as percentage of GDP
3.3
3.5
3.1
3.0
2.5
2.5
2.2
2.0
1.5
1.3
1.2
1.0
0.7
0.3
0.5
0.5
0.6
0.2
0.0
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
Source: State Bank of Pakistan
Pakistan’s share in
overall global
investment flow is
low and falling.
The Inward FDI Performance Index46 measures the amount of FDI that countries
receive relative to the size of their economy (GDP). A value greater than 1 suggests
that the economy has received more FDI relative to its economic size, while a value
below 1 suggests that it has received less FDI. The inward FDI performance index
for Pakistan suggests that over the years, the country has lost momentum in attracting
FDI. In contrast, some other countries in the group have either stabilized or improved
(see Table 13). Initially, the fall in FDI flows to Pakistan was considered to be in line
with global trends as most of the countries in the region were facing similar declines.
However, while the FDI flows to a number of peer countries have stabilized or
resumed recently, they continued to fall for Pakistan.
Table 13: Inward FDI Performance Index
2004
2005
2006
Pakistan
0.62
0.87
1.07
India
0.47
0.42
0.73
Bangladesh
0.42
0.61
0.4
Bhutan
0.73
0.35
2.73
Sri Lanka
0.66
0.52
0.58
Nepal
0
0.01
-0.03
Indonesia
0.43
1.36
0.46
China
1.82
1.48
0.89
South Asia
0.58
0.52
0.67
Developing
1.78
1.45
1.15
Economies
Source: Data from IFS and staff calculations
45
46
2007
1.04
0.59
0.24
0.07
0.53
0.02
0.45
0.67
0.54
2008
1.23
1.24
0.41
0.54
0.63
0
0.62
0.81
0.99
2009
0.7
1.29
0.34
2.73
0.46
0.15
0.44
0.9
1
2010
0.52
0.73
0.37
0.88
0.44
0.24
0.88
0.87
0.63
2011
0.26
0.79
0.39
0.59
0.69
0.22
0.95
0.71
0.64
2012
0.22
0.71
0.56
0.64
0.87
0.28
1.19
0.79
0.62
2013
0.3
0.75
0.54
0.55
0.71
0.21
1.09
0.68
0.63
1.1
1.28
1.46
1.39
1.24
1.53
1.45
Many of exploration blocks are adjacent to FATA and in Baluchistan province)
It is the ratio of a country´s share in global FDI flows to its share in global GDP.
31
Business
environment needs
improvement.
Pakistan’s poor global ranking in business environment remains one of the key
reasons that the country has not been able to attract sufficient investment. Almost all
global indicators regarding governance and competitiveness show that Pakistan is far
below compared to its regional peers (see Table 14). Efforts to improve the
governance and the country’s investment climate should improve Pakistan’s ability to
attract investment.
Table 14: Comparison of Global Competitiveness Ranking and Governance Index
Global Competitiveness Rankings (2013/14)*
Overall
Ranking
Institut
ions
Infrastruc
ture
Pakistan
133
123
121
India
60
72
85
Bangladesh
110
131
132
Bhutan
109
44
87
Sri Lanka
65
54
73
Nepal
117
127
144
China
29
47
48
Source: Data from IFS and authors’ calculations
Governance Indicators (2014)**
Macro
Environment
Political
Stability
Govt.
Effective
ness
Regulatory
Quality
Rule of
Law
Control of
Corruption
145
110
79
109
120
41
10
0.95
12.32
7.58
70.14
26.07
14.22
27.01
23.44
47.37
22.49
64.59
45.93
18.18
54.07
24.88
33.97
20.57
13.88
47.85
22.01
42.58
20.85
52.61
22.75
59.24
46.45
26.07
39.81
17.7
35.89
20.57
77.99
51.67
29.19
46.89
How to exit from low There is an immediate need to bolster investors’ confidence on the economy.
investment horizon? Government reform efforts in privatization, removal of energy bottle necks, and
simplifying and making tax laws more transparent are all steps in the right direction.
But perhaps more needs to be done to revive overall investment activity especially
FDI. Just facilitating foreign investors without making efforts to revive domestic
investment may not yield the desired results. It will be unrealistic to expect foreign
businesses to invest in Pakistan when its own private sector is not investing. This
regime should ideally be designed in such a manner that motivates and induces
industries to invest, innovate and reinvest. Improvements in the investment climate
will also need public investments in infrastructure and improved logistics.
32
II. Fiscal Decentralization in Pakistan: Progress and Challenges
The 18th
Amendment
promulgated in 2010
is viewed as the most
comprehensive
attempt at
constitutional reform
since the 1973
Constitution was
adopted by Pakistan.
Amongst other political reforms, the amendment sought to increase provincial
autonomy and restore the fiscal relationship between the center and provinces. It
abolished the Concurrent List of Legislation (CLL)47 and reassigned the functions to
provincial governments (except electricity) and also made changes in the Federal
Legislative List (FLL)48 with a view to increase provincial influence. Resultantly, the
provinces gained complete control over all public services within their jurisdiction
and control over all local government institutions. The center mostly retained
functions relating to natural resources, electricity, communications, and regulatory
frameworks and cross border relationships of trade and finance.
The Amendment and
the 7th NFC Award
that preceded it also
sought to expand the
resource envelope of
the provinces in
order to respond to
the larger service
delivery mandate.
For one, provinces were given authority over sales tax on services, considered to be
a dynamic and buoyant tax (estimates for Pakistan suggest it could yield revenues of
0.5 percent to 1.0 percent of the GDP). In addition other taxes such as those on
immovable property, estate and inheritance, and zakat and usher (religious taxes) were
reverted back to the provinces. The NFC Award of 2009 was also considered a
significant milestone in terms of altering the distribution of resources between the
center and the provinces. It broke from the past and introduced a multifactor formula
that included not just population share but also poverty, inverse population density
and provincial tax effort. Overall share of the provinces was also increased from 47.5
percent to 56 percent in the first year of NFC Award (2010/11) and 57.5 percent in
the remaining years of the Award (see Table 15).
Table 15: The 7th NFC Award (2009) for Federal Divisible Pool Transfers to Provinces
56%-57.5% of the following sources of Federal revenues:
Personal and corporate income taxes, wealth tax, sales tax, excise duties on tea, tobacco,
sugar, betel nut and other excises.
Population – 82% weight
Poverty – 10.3% weight
Provincial tax effort – 5%
Inverse of Provincial Population density – 2.7% weight
Provincial Shares in NFC Allocation:
Total Pool
Formula for provincial
allocation
Provincial shares
In Population
Punjab: 57.4%
Punjab: 51.7%
Sindh: 23.7%
Sindh: 24.6
KPK: 13.8%
KPK: 14.6%
Baluchistan: 5.1%
Baluchistan: 9.1%
Source: Retrieved from Devolution in Pakistan-Fourth Annual Report by IPP-BNU, 2011
The reform process
augmented the
influence of
The 18th Amendment strengthened the Council of Common Interests (CCI), a
Constitutional body entrusted with decision making, monitoring, supervision and
control over matters included in the Federal Legislative List Part II49, by including the
The CLL was introduced as part of the 1973 Constitutional Amendment that listed
responsibilities shared by the federal and provincial governments to allow an interim period
before these responsibilities are fully entrusted upon the provinces.
48 The FLL consists of two lists – Part I and II. The former contains functions allocated
exclusively to the Federal government while the latter consists of subjects which are a joint
provincial and Federal responsibility under the Council of Common Interests (CCI).
49 This list was expanded through the 18 th Amendment and now includes the following:
railways, minerals, oil and natural gas, hazardous materials, industrial policy, electricity, major
ports, Federal regulatory authorities, national planning and economic coordination,
supervision and management of public debt, census, provincial police powers beyond
47
33
provinces in the
fiscal institutional
framework.
Prime Minister as the Chairperson and requiring the Council to meet at least once
every ninety days (see Table 16). In addition to the CCI, the composition of the
National Economic Council (NEC) was altered to increase representation of the
provinces and remove discretionary powers of the President in terms of its
composition (see Table 17).
Table 16: Changes in the Composition of CCI due to
18th Amendment
Before
After
 Chief Ministers of the
 Prime Minister
Provinces
(Chair)
 Equal number of
 Chief Ministers
members from Federal
of the Provinces
government
 Three members
(Prime Minister will be the
from Federal
Chair if he/she is a member;
government
otherwise a Federal minister
nominated by the President)
Table 17: Changes in the Composition of NEC after
the 18th Amendment
Before
After
 Prime Minister
 Prime Minister (Chair)
(Chair)
 Chief Ministers of the
 One member from
Provinces
each province
 One member from
nominated by the
each province
President on
nominated by Chief
recommendation
Minister
of provincial
 Four other members
government
as the Prime Minister
may nominate from
time to time
Source: The Constitution of the Islamic Republic of Pakistan Source: Retrieved from Devolution and Social Development1973, The Ideal Publishers, Karachi, 2011
SPDC Annual Review 2011/12
Roadmap of Devolution
The reform process
was steered by an
Implementation
Committee (IC) set
up at the Federal
level comprising of
members of
Parliament
representing the
leading political
parties of Pakistan.
The IC expired on 30 June, 2011 and the role of resolving outstanding issues has now
been passed on to the Council of Common Interests (CCI). A 2014 report by Jinnah
Institute estimates that a total of 201 functions, institutions and organizations were
to be devolved to the provinces, re-allocated within the Federal government, or
abolished as a result of this process. Of these, 103 functions ended up being devolved,
while other were abolished or retained at the Federal level. Seventeen Federal
ministries/divisions, mostly relating to social sectors were abolished while eight new
ministries/divisions were created to manage retained functions in devolved subjects
(SPDC 2012).50 The reforms affected functions of 61,000 Federal employees of
which approximately 15,000 were transferred to the provinces whereas the remaining
were placed either in the surplus pool or temporarily deputed under Section 10 of the
Civil Servants Act.
A key area of
contention was the
various vertical
programs51 in
devolved social
sectors.
Provinces were reluctant to take ownership of these initiatives thus the CCI directed
the Federal government to continue supporting several such programs till 2014/15.
The budgets of top three programs during 2014/14 were PKR 11 billion for National
Program for Family Planning and Primary Health Care, PKR 3.6 billion for the
Population Welfare Program Punjab, and PKR 2.8 billion for Expanded Program on
Immunization. The Federal government also retained several autonomous bodies and
attached departments where mandates overlapped between the center and the
provinces, such as the Higher Education Commission (HEC), Pakistan Agriculture
provincial boundaries, legal, regulation of legal, medical and other professions, standards in
education and research, interprovincial coordination and conflict resolution.
50 Social Policy and Development Centre. (2011). Social Development in Pakistan Annual
Review 2011/12. Karachi: Social Policy and Development Centre.
51 In Pakistan, Federal financing of provincial projects has been an important instrument of
fiscal equalization, Vertical programs refers to such programs.
34
Research Council (PARC), Pakistan Agricultural Supplies and Storage Corporation
(PASSCO), and the Planning Commission.
Fiscal Implications for Federal and Provincial Governments
The 7th NFC Award
and 18th
Constitutional
Amendment aimed
to strengthen the
federation through
increasing fiscal
autonomy of the
provinces, increasing
their share in
revenues, and
expanding their role
in public service
delivery.
The goal of fiscal decentralization is to improve the efficiency of public service
delivery by increasing the agency of provincial governments in determining
development priorities and raising revenues. A review of fiscal trends at the provincial
level reveals that some progress is being made towards realizing the goals of
decentralization. However issues of political economy and capacity continue to create
challenges.
Fiscal Trends at
Provincial Level in
Post 18th
Amendment Period.
During 2010/11 to 2014/15 – as a result of changes introduced by 7th NFC Award
in terms of divisible pool of taxes52 – almost PKR 865 billion additional resources
have been shared with the provinces (see Figure 27) when compared to a
continuation of the 6th NFC Award. To understand whether this increase in
resources translated into achieving decentralization objectives, it needs to be looked
into where these additional funds went.
Analysis of
provincial finances
shows that the
additional resource
transfer to the
provinces has largely
been directed
towards higher
recurrent spending
rather than
development.
In the period 2010/11 to 2014/15, growth in recurrent expenditure was 27 percent
whereas development expenditure grew at 15 percent in real terms. While there is
need to increase the proportion of budget for development projects, it is encouraging
to see a shift towards service delivery in development priorities of the provinces in
the post reform period.53 Social services now has the largest share in provinces’ overall
development budget at 29 percent (see Figure 28) in contrast to pre-NFC period
when infrastructure related subjects received the highest budgets (such as
transportation/construction and agriculture/irrigation). Moreover, provincial social
service spending over the four years of 7th NFC Award have risen by 45 percent.
On the revenue side,
provincial revenue
This increase is largely driven by the reversion of GST on services to the provinces
and thus does not translate into increasing the national resource pie. Provinces need
Which included increasing the vertical share of the province, increasing the divisible pool
pie, etc. (see section 1.4 of full policy note for details).
53 According to Global Competitiveness Report (GCR) 2014/15, quality of road infrastructure in
Pakistan is ranked at 75 out of 144 countries, while India is and Bangladesh are ranked at 76
and 117 respectively. Similarly for quality of port infrastructure indicator, Pakistan is ranked at 59
while India and Bangladesh are ranked at 76 and 93 respectively. However, Pakistan ranking
in social sector indicators drops in comparison to the regional peers. For example, infant
mortality indicators of GCR ranks Pakistan at 137 out of 144 countries compared to 115 and 104
ranking for India and Bangladesh respectively. On quality of education indicator, Pakistan is
ranked at 119 out of 144 countries compared to 88 and 108 ranking for India and Bangladesh.
For infant mortality indicators, Pakistan is ranked at 137 out of 144 countries compared to 115
and 104 ranking for India and Bangladesh.
52
35
collection indicators
have improved
significantly during
the period,
increasing from 0.23
percent of GDP to
0.32 percent of GDP.
to focus on strengthening own revenue collection effort to contribute to expanding
the country’s small revenue base. Effectively tapping tax bases such as agricultural
income and immovable property could help raise provincial revenues equivalent to
nearly one percent of the GDP.
Figure 27: Enhanced Divisible Pool Transfers as a
result of Change in the Award
1500
Divisible pool transfers (6th NFC proj. post
2009/10)
Divisible pool transfers (7th NFC actual)
Figure 28: Provincial Current Expenditures : Shares of
Major Expense Categories (2009/10- 2013/14)
Interest
Subsidies
General Admin.
Law & Order
Social Services
Others
2013/14
1200
2012/13
PKR
900
2011/12
600
2010/11
300
2009/10
0
2009/10 2010/11 2011/12 2012/13 2013/14
Source: 6th NFC estimates are based on staff calculations
Weak capacity at the
provincial level made
spending these
additional resources
challenging.
Shares
0%
20%
40%
Source: Based on staff estimates
60%
80%
100%
As a result, provinces generated sizeable surpluses during 2010/11 (first year of the
Award), and recent two years. While this has helped alleviate the federal deficit at the
national level, which has been under pressure during this period (discussed below),
improving absorption capacity of provinces is important if objectives of
decentralization are to be fully realized.
Table 18: Provincial Own-Tax Revenues (real terms)
(PKR billions)
2009/10
2010/11
2011/12
2012/13
2013/14
Actual
Punjab
Sindh
K-PK
Baluchistan
Pakistan
% of GDP
Memo:
GDP (mp)
2014/15
Budget
Up to Q3
Estimate
64.8
28.9
42.1
27.1
7.6
3.1
1.4
0.8
115.9
59.9
18.4
13.3
1.4
0.6
33.9
16.8
14.2
1.8
0.5
33.4
20.6
29.5
1.8
0.5
52.4
35.3
31.1
1.9
0.5
68.8
41.2
33.8
5.0
1.2
81.2
0.23
0.18
0.26
0.31
0.32
0.40
0.22
14,867
18,276
20,047
22,379
25,068
29,078
27,384
Note1: * Collection responsibility taken over by SRB of Sales Tax on Services in 2011/12.
** Collection responsibility taken over by PRA of Sales Tax on Services in 2012/13.
*** Collection responsibility taken over by KPK of Sales Tax on Services in 2013/14.
Note2: The premise of 7th NFC Award was to increase the overall tax-to-GDP ratio to 15 percent while increasing the
provincial taxes to 1.15 percent.
Source: Ministry of Finance (Fiscal Operations)
Fiscal Implication for the Federal Government
The post 18th
Amendment period
Not only have the reforms created a significant squeeze on the Federal government’s
resources, they have also coincided with a period of higher pressure on spending due
36
has been particularly
challenging for the
Federal government.
to higher security related operations, energy crisis and the accumulation of circular
debt, and other unforeseen events such as the floods in 2010, 2011 and 2014. Fiscal
deficit of the consolidated government remained high for four years subsequent to
the 7th NFC Award and 18th Amendment, before finally declining to 5.3 percent of
GDP in FY2014/15.54
The fiscal imbalance
was partially
exacerbated by a
decrease in Federal
resources due to
lowering of its share
in Federal tax
revenues (at a ceiling
of 42.5 percent)55
without a
corresponding
decrease in its
responsibilities.
Best practice in devolution recommends “finances follow function” i.e. functional
decentralization should precede redistribution of resources. The sequencing of
reforms in Pakistan has led to fiscal challenge since the 7th NFC Award (higher
resource transfers) preceded the 18th Amendment (transfers of responsibilities). As a
result, provinces disassociated the link between the two reforms. They had already
committed additional resources to increase current expenditures before the
Amendment was promulgated, leaving little room for assuming responsibilities in
devolved areas. The Federal government’s budget during 2010/11 for current
expenditure in devolved subjects (ministries/divisions) stood at PKR 22 billion
(excluding the HEC) and should have converted into savings for the Federal
government. However, no savings materialized as:
 66 percent of anticipated savings went towards the 8 new ministries created
to manage retained functions and inter-provincial coordination;
 Most of the staff in devolved ministries/divisions remained on the federal
government’s payroll;
 Nearly 16 vertical programs in health and population continued to be funded
by the Federal government with a fiscal implication of almost PKR 18 billion
per annum.
 The fiscal challenge at Federal level are likely to continue as the current
vertical sharing arrangement i.e. the 7th NFC Award has been extended for
another year by the President.
Unresolved Issues
There are numerous
issues which remain
unresolved as a
result of the
decentralization
process.
This include, the fate of several state institutions such as the Higher Education
Commission, Employment Old Age Benefit Institution (EOBI), Workers Welfare
Fund, and Evacuee Trust Property Board (ETPB), amongst others, remains
undecided and are being contested in the Supreme Court by provincial and federal
governments. Issues of ownership and revenue sharing in oil and natural gas sectors
also remain outstanding. These pending issues need immediate attention and focus.
Conclusion and Way Forward
The 18th
Constitutional
Amendment must be
seen as an important
first step in a broad
based agenda for
reforms in the multiorder governance
Countries which have successfully integrated it within their governance systems have
done so over decades of consistent effort. Moreover, Pakistan also needs to correct
its mistake in sequencing of the devolution process i.e. for finances to follow
functions. Currently the process in Pakistan appears to be evolving organically instead
of strategically. To ensure Pakistan makes progress on the agenda, there is a need to
chart a clear roadmap and identify ‘champions’ at the provincial and federal level who
not only lead the process but also help strengthen inter-provincial coordination. The
CCI would appear to be a natural candidate to take the lead. It is important to define
This decline has been attributed not to any structural improvements in the government’s
finances but rather due to higher revenues from one off inflows and non-settlement of the
circular debt during the year (SBP Annual Report 2014).
55 Since over 90 percent of all tax revenues are raised by the Federal government, the fiscal
envelope for both the Federal and provincial governments is defined (mostly) by the NFC
Awards.
54
37
system in Pakistan.
Devolution however
is a dynamic process
and much works
remains to be done.
its leadership role in not just resolving inter government disputes arising from the
devolution process but also shaping the decentralization roadmap. The InterProvincial Coordination Division can provide a coordinating platform as well to help
address regional disparities and enable equitable inter government relations.
38
III. Some Stylized Facts of Pakistan Economic Growth
Pakistan low
investment will place
it at a disadvantaged
position among peer
countries going
forward.
This section explores stylized facts of Pakistan’ growth patterns. The analysis suggests
that Pakistan’s economic growth has been a story of scarce growth spurts and
declining long run trend in growth potential. Using a growth accounting framework,
it also analyzes the role factor accumulation and technological progress over the long
term.
An economy which
is unable to sustain
longer period of high
growth.
Since independence Pakistan economy has been characterized by both high growth
episodes as well as economic downturns. The 1960s, 1980s and the period of 19992005 are characterized as high growth episodes while 1970s, 1990s and the period of
2006-2011 experienced low growth. The average growth rate during high growth
episodes was 6.7 percent while it remained around 3 percent during low growth
periods56 (see Table 19). Over the past few years, the economy has shown some
recovery but still growing below 5 percent. Generally the periods of relatively strong
growth tend to be associated with increased investment and trade, real exchange rate
depreciations, and with political stability57. Moreover, high levels of external aid and
ability to push through reforms also contributed to growth spurts. As the economy
has a very low domestic saving rate (as percentage to GDP)58, Pakistan has remained
dependent on foreign saving inflows to sustain its investments.
The economy’s
growth pattern is full
of short cycles of
rapid growth
followed by
stagnation.
On average, the economy grew at an average annual rate of slightly above 5 percent59
during the last six decades and few impressive high growth episodes with an average
of around 7 percent. However, these episodes tends not to be sustained (see Table
19). For instance, since 1962, there have been only two periods where growth
consistently remained above 5 percent per annum for more than 4 years. Hence,
episodes of robust growth are frequent, but not sustained. This is not the case in many
comparable countries in the region such as India, China, Malaysia and South Korea,
which have all managed to grow at relatively high rates for a considerable period of
time. In contrast, Pakistan’s economic growth is characterized as less volatile. Over
the last five decades, the volatility of its GDP growth, as measured by the standard
deviation of the growth rate of real GDP, was 2.1 percent; near about the average in
South East Asia60. However, this has been increasing in recent times, rising from 1.4
in the 1980s to 2.5 in the 2000s.
High growth is assumed to be greater than 5 percent per annum.
Haussmann, Pritchett and Rodrik (2004) define growth accelerations as periods with an
increase of GDP per-capita growth of 2 percentage points or more for at least 8 years.
Accounting for population dynamics, in Pakistan such a figure would be roughly equivalent to
GDP growth of at least 5 percent.
58 For last several year National Saving to GDP ratio is below 15 percent.
59 This rate is much lower than the 7.0 percent, the government estimates is needed to absorb
youth employment (Pakistan: Framework for Economic Growth, Planning Commission
2011).
60 World Bank, 2010, “Pakistan Country Partnership Strategy, Report No.53553-PK.”
56
57
39
Table 19: Growth Pattern
Periods
FY62-FY66
FY68-FY70
FY73-FY74
FY78-FY83
FY85-FY88
FY91-FY92
FY95-FY96
FY04-FY08
High Growth > 5%
Episodes of
Growth
(Consecutive
Years)
5
3
2
6
4
2
2
5
Total
29
Source: Pakistan Bureau of Statistics
Agriculture sector
has strong influence
on overall growth
performance due to
its strong forward
linkages with
industry and services
sectors.
Average
Growth
7.10%
7.40%
6.90%
6.90%
6.80%
6.60%
5.40%
6.60%
6.70%
Periods
FY67
FY71-FY72
FY75-FY77
FY84
FY89-FY90
FY93-FY94
FY97-FY03
FY09
FY10-FY15
Total
Low Growth < 5%
Episodes of
Growth
(Consecutive
Years)
1
2
3
1
2
2
7
1
6
25
Total
Average
Growth
3.70%
1.60%
3.30%
3.90%
4.60%
3.40%
3.30%
0.40%
3.70%
3.10%
Years
Average
Growth
55
5.20%
Although agriculture contribution to GDP has gradually halved its share of GDP
from 47 percent in 1960 to 21 percent in 2015, Figure 29 shows the existence of a
high correlation between real GDP and real agricultural GDP—even though such
correlation weakens in the 2000s from 80 percent to 35 percent till 2015, whereas
such correlations with services and industrial sector GDPs strengthen overtime (with
95 percent and 87 percent respectively in 2000s)— as share of services and industrial
sector increased and services sector has the largest share in the economy61. Political
uncertainty and natural disasters have also contributed to growth slowdown. Looking
closely at Pakistan’s economic history, above average growth rates in the 1960s and
1980s coincided with episodes of reform and economic and political stability along
with high levels of external aid. In contrast, during the 1970s and 1990s, political
disruption, economic uncertainty and regional tensions were accompanied by few or
incomplete reforms and, toward the end of the 1990s, macroeconomic instability and
the resulting inability of policymakers to implement and sustain policies necessary for
growth and poverty reduction. In addition, natural disasters have taken their toll and
explain a few episodes of growth deceleration. This is certainly the case of the late
2000s—a period that witnessed four natural disasters. See section V for a more
detailed discussion about disaster risk reduction financing.
On average agriculture sector has around 47 percent share in total employment followed by
services sector with 33 percent and industry sector with 20 percent in employment.
61
40
Figure 29: Correlation between Agricultural & Real GDP Growth Rates (%)
2014-15
2012-13
2010-11
2008-09
2006-07
2004-05
2002-03
2000-01
1998-99
1996-97
1994-95
1992-93
1988-89
Agriculture
1986-87
1984-85
1982-83
1980-81
1978-79
1976-77
1974-75
1972-73
1970-71
1968-69
1966-67
1964-65
1962-63
1960-61
Real GDP
1990-91
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
-8.0
Source: Pakistan Bureau of Statistics
Low saving-low
investment trap has
reduced the growth
potential.
Pakistan’s economy is on a declining long run trend both in potential and actual
growth. Perhaps more concerning than the inability to sustain growth spurts over
long periods of time, is the steady fall in the economy’s potential62, which would
suggest the country has gradually eroded its wealth over time. Low national savings
has resulted in low investments.63 Results suggests that potential growth has been
falling over the past 55 years and actual growth is below trend, i.e. the economy is
underperforming (Figures 30).
Figure 30: Pakistan: Actual and Trend Economic Growth, 1961-2015
2013-14
2011-12
2009-10
2007-08
2005-06
2003-04
2001-02
1999-00
1997-98
1995-96
1991-92
1989-90
Trend growth
1987-88
1985-86
1983-84
1981-82
1979-80
1977-78
1975-76
1973-74
1971-72
1969-70
1967-68
1965-66
1963-64
1961-62
1959-60
Real GDP growth
1993-94
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
Source: Pakistan Bureau of Statistics
Long term declining
growth can be
associated to falling
investment in
physical
infrastructure and
labor productivity.
The findings of a growth accounting model often provide useful insights about the
reasons underlying such decline. This framework is used following Bosworth and
Collins (2007). GDP growth in Pakistan decelerated from 6.1 percent in 1980s to 4.4
percent in the 1990s, before mildly recovering to 4.5 percent in the 2000s and
remained around 4 percent till 2015 (see Table 20). Sectoral analysis show that all
three sectors (agriculture, industry and services) exhibited similar trends. For instance,
the industry and services sector were more dynamic with growth rate of 7.7 percent
Hodrick-Prescott (HP) filtering technique is used to estimate potential growth trend.
On average, over last four decades, investment to GDP ratio remained below 20 percent.
In last 5 years, this ratio is hovering around 15 percent.
62
63
41
and 6.6 percent in 1980s, which sharply decelerated to average 2.8 percent and 4.7
percent during last five year till 2015. Whereas agriculture sector showed steady
decline with average growth of 3.6 percent during last 35 years.
Decomposition of
the output per
worker growth into
its contributing
factors shows that
growth in Pakistan
has been mainly
driven by capital
accumulation and
productivity growth,
with human capital
contributing
relatively less.
Labor productivity—measured by output per worker—has been steadily declining
from 4.3 percent in 1980s to 1.2 percent in 2000s and then slightly increased on
average in last 5 years. Among its regional peers, Pakistani labor is the least productive
and the gap has increased in the last two decades64. It appears that labor productivity
in recent years is increasing due to better human capital contribution.65 The
contribution of physical capital to labor productivity has decreased over time. This
deceleration is accompanied by steady decline in investment (as a ratio to GDP) from
average 20 percent in 1980 to 14 percent since 2011 onwards. Private investment
which picked up and reached 15 percent in 2005-06, led by the private
telecommunication sector, has now declined to less than 10 percent of GDP in 2015
due low investor confidence and challenging structural bottlenecks.
Table 20: Pakistan Sources of Growth, Total Economy and Major Sectors, 1980-2015
(Average annual percentage rate of change)
Investment
Output
as % of
Employment
Per
Period
GDP
Growth
Worker
(constant
Growth
prices 2005)
FY81-FY90
6.1
19.86
1.8
4.3
FY91-FY00
4.4
20.44
2.4
1.9
Total
FY01-FY10
4.5
17.68
3.3
1.2
Economy
FY11-FY15
3.9
13.79
1.6
2.3
FY81-FY15
4.8
18.53
2.5
2.3
FY81-FY90
4.0
4.45
1.8
2.2
FY91-FY00
4.4
4.79
1.6
2.8
Agriculture FY01-FY10
2.6
3.48
2.5
0.1
FY11-FY15
3.0
3.02
0.7
2.2
FY81-FY15
3.6
4.07
2.0
1.5
FY81-FY90
7.7
5.82
2.0
5.6
FY91-FY00
4.2
6.91
1.0
3.2
Industry
FY01-FY10
5.7
5.09
4.8
0.8
FY11-FY15
2.8
2.51
3.4
-0.6
FY81-FY15
5.5
5.45
2.9
2.5
FY81-FY90
6.6
10.17
2.8
3.6
FY91-FY00
4.5
9.50
3.7
0.8
Services
FY01-FY10
4.9
9.32
3.4
1.4
FY11-FY15
4.7
8.25
1.7
3.0
FY81-FY15
5.2
9.46
3.2
1.9
Source: Pakistan Bureau of Statistics and World Bank Staff calculations
Real
Output
Growth
Contribution of
human capital in
Output per worker: % Contribution of
Physical
Capital
Human
Capital
Arable
Land
TFP
2.3
1.1
0.3
0.1
1.0
4.1
1.5
0.2
0.5
1.7
3.6
3.3
-0.9
-1.9
1.3
1.2
0.4
0.3
0.3
0.6
0.9
-0.2
0.4
0.9
0.5
0.4
-0.1
0.1
0.4
0.2
0.7
-0.1
0.4
0.6
0.3
1.2
-0.3
0.9
1.1
0.7
-0.2
-0.3
-0.3
0.0
-0.2
-0.7
-0.6
-1.4
0.1
-0.8
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
1.3
1.2
0.8
1.3
1.0
-1.4
2.0
1.2
1.3
0.6
1.3
0.1
1.3
0.7
0.9
1.2
0.7
0.2
1.5
0.7
The contribution of human capital66 was somewhat significant in the 1980s and
turned negative in 1990s, but rose again in the 2000s. However, with fast growing
Government of Pakistan. 2011. “Pakistan: Framework for Economic Growth.” Planning
Commission, Islamabad.
65 As measured by average school years which are increasing over time.
66 Following Bosworth and Collins (2007), human capital has been measured by adjusting
number of workers for their average years of schooling by assuming that each additional year
64
42
labor productivity
has enhanced in
recent years.
labor supply and very low enrollment in primary education rate, Pakistan appears to
be evolving toward an economy intensive in unskilled labor, which limits its potential
for raising its labor productivity. More recently, contribution of human capital’s
contribution in output per worker has improved. TFP contribution has also been
relevant, but dramatically declining to about half from 1980s to 2000s. However,
these have recovered in last 5 years to 1.3 percent on average still below mediumterm average of 2.0 in East Asia67. Productivity has increased the most in the services
sector, led by a significant improvement in productivity in the past five years (Table
20).
Contribution of total
factor productivity in
overall labor
productivity is low,
compared to peer
countries.
Literature identified several factors contributed to the low TFP in Pakistan compared
to many of its peer countries. The underlying factor have been the overall
macroeconomic environment, financial developments, limited FDI and human
capital and technological developments. Evidence indicates that TFP growth in
Pakistan was particularly strong in periods where the macroeconomic environment
improved and political stability ensued68. Low levels of science and technological
growth also appeared to be closely correlated with low TFP growth69. There is also
evidence from literature that the TFP decline in 1990s was a result of macroeconomic
factors70 whereby the need to curtail the fiscal deficit was mainly done through cutting
development expenditure and social sector expenditures, which negatively affected
human capital. The above mentioned results are consistent with literature, which
highlighting that high TFP growth is associated with macroeconomic stability, high
level of investments, low inflation and external inflows.71 During 1980, a period of
relatively high productivity growth, all sectors benefitted from price stability,
significant external inflows and the impact of large investment made by public sector
in 1970s72.
More recently, lack
of investment has
held back labor
productivity growth,
with improved
human capital in
services sector
contributing
strongly.
The recent low contribution of capital to productivity is in line with the overall low
investment levels in the economy in the last 5 years. Labor productivity growth in
recent years can also be associated with demographic transitions effects. Pakistan is
passing demographic transition as working age population (15-64) has been
increasing73 and which in turn can yield a demographic dividend — an opportunity
provided by the changing age structure when the growth rate of labor force is higher
than the growth rate of the total population. This has been the result of declining
fertility rates, and thus lower dependency ratio has implications for economic growth.
In addition, last 5 years also saw a rise in utilization of telecommunication services,
raises workers’ productivity by a given percentage. In this analysis this is assumed to be 7
percent.
67 International Monetary Fund (IMF). 2004. Pakistan: Selected Issues and Statistical Economy.”
68 World Bank. 2006. “Pakistan Growth and Competitiveness, Report No. 35499-PK.”
Washington D.C.
69 Mahmood, Zafar, and Rehana Siddiqui. 2000. “State of Technology and Productivity in
Pakistan’s Manufacturing Industries: Some Strategic Directions to Build Technological
Competence.” The Pakistan Development Review. 39(1):1-21
70 Sabir, M. and Qazi M. Ahmed. 2003, “Macroeconomic reforms and Total factor productivity
growth in Pakistan: an empirical analysis”, Conference Paper International Atlantic Economic
Conference.
71 Khan, S.U, 2006, “Macroeconomic Determinants of Total Factor Productivity in Pakistan”,
SBP Research Bulletin.
72 1970s large public sector investment projects were Tarbela Dam projects that increased
irrigation water availability, the hydel power projects and other in fertilizers and cement sector.
73 Planning Commission of Pakistan, 2011, “Pakistan: New Growth Framework”, Government
of Pakistan.
43
and an enhanced focus on technical and vocational education. This better
connectivity and easy transfer of information, and improved skills may have resulted
in higher human capital contribution in labor productivity. More specifically, looking
at services sector, human capital contributed the most in last 5 years.
44
IV. Federal Budget 2015/16 – Sectoral Analysis of Spending Priorities74
Federal Budget
2015/16 envisages a
reduction of 1.0
percent of GDP in
total expenditures of
the Federal
government from
14.1 percent in
FY2014/1575 to 13.1
percent in
FY2015/16.
This curtailment relies solely on 1.3 percent of GDP decline in recurrent spending
while development spending is expected to increase by 0.3 percent of GDP. In
absolute terms, total spending is budgeted at PKR 4,030 billion for FY2015/16
translating into a growth of about 4.4 percent. While the recurrent expenditures
are set to contract by 0.6 percent viz-a-viz last year and reach PKR 3,166 billion by
the end of the on-going fiscal year, a 28 percent increase in development outlay has
been programmed amounting to a size of PKR 864 billion. In terms of GDP, federal
development expenditures are budgeted to increase from 2.0 percent of GDP in
FY2014/15 to 2.3 percent for the current fiscal year. Of this, more than 80 percent
has been allocated under the budget 2015/16 Public Sector Development Programme
(PSDP). Another 12 percent comprises of the flagship cash transfer programme
(BISP) that falls outside the PSDP bracket. The remaining includes fertilizer subsidy
(traditionally parked under this head), lump sum provision of misc. items, and some other
items.
There are structural
rigidities within
recurrent budget.
Given the rigid nature of non-development spending historically, the three top most
heads appear to be interest payments (with 40 percent share in total recurrent
expenditure), defense affairs (25 percent) and general administration – 14 percent (see
Figure 31). It is apparent that the increased security related spending (manifested by
an upsurge in budgeted spending for Defense and Law & Order for FY2015/16) has
been accommodated by cutting the budget of general public service. This is
encouraging despite the 7.5 percent increase in public sector wage bill announced in
the Budget. Grants, mostly directed towards the SOEs, still appear to be making 13
percent of the total recurrent spending despite government’s commitment to move
ahead with reforms to restructure the loss-making enterprises.
Higher public
investment is
expected to crowd in
private sector.
In the Budget speech, the Federal Minister for Finance alluded to concerted efforts
being made to attract private investment, in addition to increasing public investment,
through a variety of mechanisms such as promoting public private partnerships, FDI,
and creating special economic zones with fiscal incentives. Key priorities under the
Federal annual development plan are listed below (see Table 21 and Figure 32). After
infrastructure, rest of the categories appear to be shrinking their allocations towards
the PSDP primarily to make space for ‘New Programmes’ that has only been added to
the development portfolio during the last fiscal year.
74
75
This section has been prepared by Mehwish Ashraf (Research Analyst, GMFDR).
As per the revised estimates (of authorities) announced at the time of budget.
45
Figure 31: Composition of Federal Current Expenditures
100%
General Administration
Defense
Law and Order
Social Services
Economic Services
Grants
Interest Payments
Others
90%
80%
39.9%
42.3%
40.4%
70%
60%
1.5%
50%
40%
1.7%
11.8%
2.8%
30%
2.4%
13.1%
1.9%
2.8%
2.4%
3.0%
2.8%
22.4%
22.6%
24.7%
16.4%
17.1%
13.9%
Budget
Revised
Budget
20%
10%
12.9%
0%
2014/15
Source: Ministry of Finance (Fiscal Operations)
Figure 32: PSDP Allocation, FY2015/16
New
Programm
es
17%
Special
Programmes…
2015/16
Figure 33: Infrastructure Sectoral Allocation,
FY2015/16
Ports &
Shipping
3%
Railways
11%
Water
8%
Power
29%
Special Areas
Programmes
6%
Others
7%
Economic
Services
1%
Social
Infrastructure
Services
55%
6%
Source: Data from Pakistan Economic Survey and World
Bank staff estimates
Highways
41%
Atomic
Energy
8%
Source: Data from Pakistan Economic Survey and World
Bank staff estimates
Infrastructure is one Infrastructure is set to receive the highest – 55 percent – allocation with a budget of
on the biggest
PKR 386 billion. Within this sub-sector, highways together with power projects are
priority in the
expected to make up 70 percent of the total infrastructure allocation (see Figure 33).
development budget. National Highway Authority76 (PKR 160 billion): Construction of motorways stand
prominent in the current year plan with almost PKR 76 billion allocation.
Interestingly, out of the three motorway schemes, Multan-Sukkur Motorway worth
PKR 50 billion is the only approved project implying an expected speedy execution
of this road project. Additionally, operationalizing the Western and Northern
alignment of China Pakistan Economic Corridor (CPEC) appears to be another
salient feature of this year, approximating to PKR 58 billion.
Power (PKR. 112 billion): Within energy related projects, four allocations stand out:
Dasu Hydro Power Project (PKR 52.4 billion), two new LNG Based Power projects77
76
77
In Pakistan, National Highway Authority is mandated to look after the ‘highways’ sector.
Baloki and Haveli Bahadursha.
46
(PKR 45 billion), and installation of new Coal Fired Power Plants at Jamshoro (PKR
20 billion)78. Inclusion of these projects point towards government efforts to explore
avenues other than the conventional fuel-based power generation.
Railways (PKR 41 billion), Water and Atomic Energy (PKR 30 billion each) sub-sectors are
tilted towards completion of on-going schemes. Importantly, CPEC-related railway
projects of about PKR 2 billion as well as Chasma Nuclear Power Project Unit worth
PKR 26 billion have also been planned for the current year. Moreover, allocation for
Ports & Shipping has been increased by almost 4 times from PKR 2.6 billion last year
to PKR 12 billion for FY2015/16 owing to construction of Gwadar port under the
first phase of CPEC.
Table 21: Federal Public Sector Development Program 2015/16
'(PKR Million)
2014/15
Budget
Infrastructure
Water
Power
Atomic Energy
Pakistan Nuclear Regulatory
Authority
Petroleum & Natural Resources
Communications
Highways
Ports & Shipping
Railways
Social Services
Education
Higher Education
Capital Administration and
Development
National Health Services,
Regulations and Coordination
Climate Change
Economic Services
Food, Agriculture and Livestock
Industries and Investment
Information and Media
Development
Information Technology and
Telecommunications
Textile
Others
Cabinet Division
Commerce Division
Defense Division
Establishment Division
Finance Division
Foreign Affairs
Interior Division
Law and Justice Division
Narcotics Control Division
Planning and Development
Division
78
2015/16
Revised
Budget
2014/15
%
Change
2015/16
Shares
Percent Change
2014/15
2015/16
Budget
Revised
Budget
Budget
23.5%
-30.6%
76.5%
-40.9%
24.0%
-34.6%
128.0%
-48.7%
59.6
8.3
12.1
9.8
55.2
4.3
16.0
4.3
Total
Total
Total
312,808
43,427
63,613
51,475
311,723
46,058
49,253
59,275
386,452
30,120
112,288
30,409
RE Vs
BE
-0.3%
6.1%
-22.6%
15.2%
230
230
321
0.0%
39.6%
39.6%
0.0
0.0
167
191
111,563
2,576
39,566
52,366
3,451
20,069
167
5,153
109,445
2,576
39,566
58,063
3,375
25,042
349
365
159,600
12,000
41,000
43,672
2,207
20,500
0.0%
2597.9%
-1.9%
0.0%
0.0%
10.9%
-2.2%
24.8%
109.0%
91.1%
43.1%
365.8%
3.6%
-16.6%
-36.0%
2.1%
109.0%
-92.9%
45.8%
365.8%
3.6%
-24.8%
-34.6%
-18.1%
0.0
0.0
21.3
0.5
7.5
10.0
0.7
3.8
0.0
0.1
22.8
1.7
5.9
6.2
0.3
2.9
1,806
1,806
1,043
0.0%
-42.2%
-42.2%
0.3
0.1
27,015
27,815
19,882
3.0%
-26.4%
-28.5%
5.1
2.8
25
3,528
1,071
1,148
25
3,468
1,071
1,151
40
3,770
1,500
791
0.0%
-1.7%
0.0%
0.3%
60.0%
6.9%
40.1%
-31.1%
60.0%
8.7%
40.1%
-31.3%
0.0
0.7
0.2
0.2
0.0
0.5
0.2
0.1
424
391
391
-7.8%
-7.8%
0.0%
0.1
0.1
556
526
923
-5.4%
66.0%
75.5%
0.1
0.1
329
62,339
2,078
363
4,363
165
11,062
255
3,900
2,352
324
329
48,056
5,767
364
6,381
165
14,075
255
3,930
2,352
328
165
47,667
654
876
7,158
149
9,135
60
8,300
1,500
230
-0.1%
-22.9%
177.5%
0.3%
46.3%
0.0%
27.2%
0.0%
0.8%
0.0%
1.2%
-49.9%
-23.5%
-68.5%
141.3%
64.1%
-9.7%
-17.4%
-76.5%
112.8%
-36.2%
-29.0%
-49.8%
-0.8%
-88.7%
140.7%
12.2%
-9.7%
-35.1%
-76.5%
111.2%
-36.2%
-29.9%
0.1
11.9
0.4
0.1
0.8
0.0
2.1
0.0
0.7
0.4
0.1
0.0
6.8
0.1
0.1
1.0
0.0
1.3
0.0
1.2
0.2
0.0
32,878
6,265
14,000
-80.9%
-57.4%
123.5%
6.3
2.0
With ADB assistance of PKR 8 billion.
47
Science and Technological
Research Division
Statistics Division
Works Division
Others
904
1,211
1,060
34.0%
17.3%
-12.5%
0.2
0.2
240
1,934
1,521
278
4,415
2,270
100
2,590
1,855
15.8%
128.3%
49.2%
-58.3%
33.9%
22.0%
-64.0%
-41.3%
-18.3%
0.0
0.4
0.3
0.0
0.4
0.3
Special Areas Programmes
Kashmir Affairs and Gilgit
Baltistan
States and Frontier Regions
40,457
41,190
42,937
1.8%
6.1%
4.2%
7.7
6.1
21,357
22,090
23,237
3.4%
8.8%
5.2%
4.1
3.3
19,100
19,100
19,700
0.0%
3.1%
3.1%
3.6
2.8
Special Programmes
Pak MDGs & Community Dev.
Program
Fed. Dev. Prog./Projects for
Provinces & Special Areas
ERRA
53,500
42,500
55,500
-20.6%
3.7%
30.6%
10.2
7.9
12,500
27,500
20,000
120.0%
60.0%
-27.3%
2.4
2.9
36,000
10,000
28,500
-72.2%
-20.8%
185.0%
6.9
4.1
5,000
5,000
7,000
0.0%
40.0%
40.0%
1.0
1.0
-
59,000
120,000
103.4%
0.0
17.1
-
52,000
100,000
--
--
92.3%
0.0
14.3
-
7,000
20,000
--
--
185.7%
0.0
2.9
524,998
564,000
699,998
7.4%
33.3%
24.1%
New Programmes
Special Development Programme
for TDPs and Security Enhancement
Prime Minister's Youth
Programme
Total Federal PSDP
Source: Ministry of Planning, Development & Reforms
Social and economic
sector, too, received
significant
allocations.
Social Services: In Pakistan, the fiscal architecture has undergone a considerable shift
post 18th Constitutional Amendment79, thereby devolving the social subjects largely
to the provinces. Nonetheless, higher education and curriculum development remains
the responsibility of Federal government. Higher Education Commission is set to receive
PKR 20.5 billion this year. Moreover, the Federal government continues financing of
vertical health programmes80,81. As these projects are approaching their culminations,
the allocation has declined over time (for instance, from PKR 28 billion last year to
PKR 20 billion in the FY2015/16 Federal PSDP). Thus, the share of social services
sector in Federal PSDP is budgeted to fall from 10 percent in FY2014/15 to 6 percent
in FY2015/16 (or from PKR 58 billion to PKR 43.7 billion).
Economic Services: Almost similar allocations to the ones last year have been made
for food, agriculture & livestock82; IT; telecommunications; textile; and media for
2015/16, aggregating to PKR 3.8 billion. Private sector largely dominate the latter
economic sectors in Pakistan, explaining low public investment levels.
Promulgated on April 19, 2010.
Vertical programmes include 9 schemes on health and 7 on population planning, and appear
under the National Health Services, Regulations & Coordination Division in the PSDP
allocations.
81 By passing the Award before the 18th Amendment, the federal government violated the basic
rule of decentralization sequencing i.e. ‘finance follows function’. As a result, the provinces
disassociated the transfer of responsibilities emanating from the 18 th Amendment from the
additional resources allocated under the 7th NFC Award. The federal government thus ended
up retaining several big ticket vertical programs within the devolved subjects, which continue
to command a significant share of the federal PSDP. This squeeze is likely to continue as the
next NFC Award appears to be delayed by at least a year and the 2015/16 federal budget has
been prepared on the basis of continuation of the current Award. (Source: Fiscal Decentralization
in Pakistan – A Forgotten Agenda, by Saadia Refaqat, The World Bank Policy Paper Series on
Pakistan 2015, Islamabad, forthcoming).
82 A provincial subject post 18th Constitutional Amendment.
79
80
48
Figure 34: PSDP Allocation for Federal Divisions, FY2015/16
Works Division
5%
Others
4%
Science and
Technological Research
Division
2%
Cabinet Division
1%
Commerce Division
2%
Defense Division
15%
Finance Division
19%
Planning and
Development Division
30%
Interior Division
18%
Narcotics Control
Division
1%
Law and Justice
Division
3%
Source: Ministry of Planning, Development & Reforms
FY2015/16
development budget
also focused on some
special areas and
sectors, and started
some new initiatives.
Others: This sector includes development projects envisaged by various Federal
Divisions (see Figure 34) and has been allocated PKR 47.7 billion for the on-going
fiscal year. Most notably, Planning and Development Division has been allocated
PKR 14 billion, compared to only PKR 6.2 billion spent by the division in
FY2014/15. This allocation includes a block allocation of PKR 9.7 billion for unfunded or underfunded important projects. This scheme appeared in FY2014/15 and
amounted to PKR 27 billion. The considerable reduction in allocation of almost PKR
17 billion in just one year indicates that most of the priority spending is being financed
from the regular PSDP, thereby leading to improved transparency with respect to
block allocations. Finance Division has been allocated PKR 9 billion, mostly for
provincial projects, including PKR 2 billion for Gwadar Development Authority and
PKR 1 billion for development of Ziarat Town. Moreover, allocation for Interior
Division almost doubled to PKR 8.3 billion, the apparent reason being security related
augmented spending. Similarly, Defense Division is set to receive PKR 7.2 billion in
this year.
Special Areas: For FY2015/16, PKR 43 billion has been allocated for development
projects in special areas – Azad Jammu and Kashmir (AJK), Gilgit Baltistan (GB),
Northern Areas and Federally Administered Tribal Areas (FATA) – that are otherwise
not included in the resource distribution framework of the federation.
Special Programmes: Two of these projects appeared in the Federal PSDP list last
year and are budgeted to continue this year. However, these largely encompass block
allocations on (i) MDGs & community development (PKR 20 billion), and (ii) federal
development program/projects in provinces & special areas (PKR 28.5 billion). In
Pakistan, where federal financing of provincial projects has been an important
instrument of fiscal equalization, yet given that the provincial PSDP itself has been
increased by an almost parallel 26 percent, the financing of provincial programs from
49
the federal budget needs to be limited. Spending on earthquake reconstruction and
rehabilitation83 is projected at PKR 7 billion.
New Programmes: This category – with 17 percent share – comes second after
infrastructure as the Federal government priority for 2015/16. Allocation for two new
programs that appeared in the revised estimates of last year, Special Development
Programme for Temporary Displaced Persons (TDPs) & Security Enhancements and
Prime Minister’s Youth Programme, is budgeted to continue and to increase. Former
is allocated PKR 100 billion while latter is set to receive PKR 20 billion for 2015/16.
Benazir Income Support Programme: BISP, as it is abbreviated, was launched in
July 2008 with an immediate objective of consumption smoothening and cushioning
the negative effects of slow economic growth, the food crisis and inflation on the
poor, particularly women, through the provision of cash transfers of PKR 1,000 per
month84 to eligible families. The non-PSDP item is an important pillar of
government’s development agenda as the project focuses on poverty eradication and
women empowerment over the long term. The programme has been allocated PKR
102 billion for 2015/16, representing more than 155 percent increase since
FY2012/13. Moreover, out-reach of this cash transfer programme is envisaged to
expand to 5.3 million beneficiaries by the end of next financial year, showing an
increase of 29 percent since FY2012/13.
Established on 24 October, 2005 as a direct response to deadly earthquake of October 5
(7.6 on the Richter scale) in North-Western Pakistan, ERRA is an independent, autonomous,
and federal institution of Pakistan tasked and responsible for the operational planning,
coordinating, monitoring, and regulating the reconstruction and rehabilitation operations in
the earthquake affected areas of the country.
84 The monthly installment was enhanced to PKR 1,200 per month w.e.f. July 1, 2013 by the
present government and has now been fixed at PKR 1,500 per month w.e.f. July 1, 2014.
83
50
V. Fiscal Disaster Risk Assessment Report
The Fiscal Disaster
Risk Assessment
(FDRA) Report has
been prepared by the
World Bank on the
request of the
National Disaster
Management
Authority (NDMA).
It has been formulated over the last two years in close partnership with the Ministry
of Finance (MoF), the Securities and Exchange Commission of Pakistan (SECP), the
Provincial Disaster Management Authorities (PDMAs) and the Provincial Finance
Departments. The objective of the section is to highlight fiscal impacts of frequent
natural disasters on the budget of the Government of Pakistan and to present options
for a national disaster risk financing strategy drawn from international best practices.
Historical Economic
and Fiscal Impact of
Natural Disasters. In
Pakistan,
approximately 3
million people are
affected by natural
catastrophes each
year, which equates
to approximately 1.6
percent of the total
population.
According to an analysis of historical natural disaster data, since 1973 approximately
77 percent of the all the people affected by natural disasters were impacted by
flooding events. Eighty seven percent of the people affected by natural catastrophes
were resident in Punjab and Sindh. Since 1973 there have been 11 natural catastrophe
events that - were they to occur in the present day - could affect over four million
people in Pakistan. Pakistan is vulnerable to a number of adverse natural events and
has experienced a wide range of disasters over the past 40 years, including floods,
earthquakes, droughts, cyclones and tsunamis. These hazards are further exacerbated
by growing urbanization, increased vulnerability and shifting climatic patterns, that
can result in the occurrence of increasingly severe natural disasters. Over the past
decade, damages and losses resulting from natural disasters in Pakistan have exceeded
US$ 18 billion. As the population and asset base of Pakistan increases, so does its
economic exposure to natural disasters. A summary of the economic impact of
selected natural disasters since 2005 is shown in the Table 22.
Table22: Estimated Economic Impact of Major Natural Disasters in Pakistan since 2005
Estimated Losses (both US$M, and as percentage of GDP) are as at time of event
Estimated Losses
Estimated Losses as % of
Event
Provinces impacted
(US$M)
national GDP
Earthquake (2005)
AJK and KPK
2,857
2.6%
Sindh and Baluchistan
322
0.2%
Floods (2010)
Entire country
10,500
6.0%
Floods (2011)
Sindh and Baluchistan
3,730
1.8%
Cyclone Yemyin (2007)
Source: Preliminary Damage and Needs Assessments (DNA)
There remains a lack
of standardization in
procedures related to
disaster risk
management across
provinces, despite
specifications in the
NDM 2010 Act.
In general, the disaster risk management system defined in the NDM Act of 2010 and
national disaster response plans are not followed in full at the provincial level. Across
the provinces approaches vary, in the case of Punjab disasters are typically managed
following instructions given in war books such as the financial war book; elsewhere
instructions in the Natural Calamities Act, 1958 are followed. At present, there are no
institutional mechanisms to calculate the financial impacts of disasters within the
federal or provincial exchequers. Following a disaster, with the support of the World
Bank and Asian Development Bank (ADB), the GoP undertakes a Damage and
Needs Assessment (DNA) which estimates the direct losses as well as the
reconstruction costs by sector and province across both the public and private sector.
51
Figure 35: Post-Disaster Cost Estimates by Phase for Four Selected Major Natural Catastrophes in Pakistan
Millions US$
Relief
Recovery
Reconstruction
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
2005 Earthquake
2007 Cyclone Yemyin
2010 Floods
2011 Floods
Source: Flash Appeals, Humanitarian Response Plans and Damage and Needs Assessments
The post-disaster
financial
responsibilities of
provincial
governments are not
well defined.
At the provincial level, although the financial responsibilities of governments are not
defined, generally they can be broadly categorized as Emergency Relief, Recovery and
Reconstruction and Livelihoods Assistance to Affected Populations. In addition to
these expenditures, other relief mechanisms may be provided. In Punjab, for instance,
short term waivers on taxes on water and land are common following a disaster. In
certain cases waiver of interest on agriculture loans are allowed as well as a delay in
the repayment of these loans.
Since 2005, estimates of the total costs through the three post-disaster phases have
exceeded US$5 billion on two occasions. Total estimates for post-disaster costs for
the 2005 earthquake and the 2010 floods were approximately $US5.2 billion and
US$8.7 billion respectively. Estimates made during the respective preliminary damage
and needs assessments for four selected events since 2005 are shown in the following
Figure.
Donor assistance can
represent a
significant, although
uncertain, part of
financing natural
disasters, indeed
since 2005 donor
assistance has
accounted for
between
approximately 60%
and 80% of total
post-disaster
expenditures during
the relief and
recovery phases.
For example, following the 2005 earthquake approximately US$520 million (62%) of
a total estimated expenditure of US$845 million for relief and recovery came from
international donors. For the 2007 Cyclone Yemyin, international donor assistance
accounted for approximately 59% of total relief and recovery spending (US$21
million of a total of US$36.2 million). In 2010 and 2011, following the devastating
flood events, donors contributed 81% (US$1.37 billion) and 65% (US$157 million)
of the relief and recovery spending. This information is summarized in Figure 36.
However, it should be noted in the Figure 35 above that the total costs of the events
summarized are between 4 and 7 times greater than the expenditures contributed to
recovery and reconstruction. Thus, while donor financing plays an important role in
financing recovery and reconstruction, it accounts for only 5%-16% percent of the
financing needs.
Pakistan faces a
major financing
Preliminary analysis of the Fiscal Disaster Risk Assessment Report estimates the
annual economic impact of flooding at between US$ 1.2 billion and US$ 1.8 billion,
52
challenge arising
from natural
catastrophes, with
flooding causing an
estimated annual
economic impact of
between 3 and 4
percent of the
Federal Budget.
equivalent to between 0.5 percent and 0.8 percent of national GDP; however
simulations show that a major flood event (occurring, on average, once every 100
years) could cause losses in excess of US$ 15.5 billion, which equates to around 7
percent of national GDP, equivalent to almost 40 percent of the Federal Budget.
While the Government tries to meet the needs arising from the aftermath of natural
disasters, the funding gaps especially for reconstruction of affected infrastructure lead
to its deterioration especially the protective capacity resulting in additional losses in
proceeding disaster events.
Figure 36: Financing of Post-Disaster Operations in Pakistan
Emergency
Response/Relief
Disaster phase
Budgetary
vehicle
Contingency budget,
supplementary budgets
Financing
sources
Federal/provincial/
district budget
Recovery
Contingency budget,
supplementary budgets
Federal/provincial/
district budget
Reconstruction
Annual public sector
development programme
Federal/provincial
budget
Source: Flash Appeals, Humanitarian Response Plans and Damage and Needs Assessments.
The annual expected
earthquake loss to
residential
properties/housing
sector alone is
approximately US$ 1
billion and that once
every 100 years these
losses are expected
to exceed US$18.7
billion.
A recurrence of the 2005 earthquake would cause a present day economic loss of
approximately US$ 2.8 billion which is almost double as compared to the losses
caused to the housing sector by the 2005 earthquake. The contingent liability of the
government due to natural disasters can create significant fiscal risk. However the
GoP’s contingent liability is not clearly defined in law and makes a fiscal risk
assessment difficult to perform. Beyond its explicit contingent liability and associated
spending needs (such as the reconstruction of public assets and infrastructure), the
government may have a moral and social responsibility (implicit contingent liability)
to assist the population in the aftermath of an extreme disaster event. For example,
the government provides not only emergency assistance (e.g. food, shelters and
medical supplies) but it can also finance recovery and reconstruction activities such
as assistance for the rebuilding of low-income housing. Contingent liabilities arising
through the establishment of disaster-linked social protection schemes also need to
be considered in such an analysis.
53
Figure 37: Financing of Post-Disaster Operations in Pakistan
Source: Flash Appeals, Humanitarian Response Plans and Damage and Needs Assessments.
Way forward.
A comprehensive national disaster risk financing strategy should be designed to
improve the capacity of the GoP to access immediate financial resources in the event
of a national disaster and to ensure that required funds are efficiently delivered to
beneficiaries, while maintaining the fiscal balance. The strategy should follow the
operational framework of: (i) assess risk; (ii) arrange financial solutions; and (ii) deliver
funds to beneficiaries.
54
VI. National Financial Inclusion Strategy
Access to Financial Services Contributes to Economic Empowerment, which
is a Key Challenge for Pakistan
Access to financial
services contributes
to economic
empowerment,
which is a key
challenge for
Pakistan.
Evidence suggests that financial inclusion is positively related to income levels as well
as a more equitable income distribution. Theoretical and empirical economic research
over the years has shown that financial inclusion as measured through access to and
usage of financial sector products is positively correlated with growth and
employment generation. At the macro level, greater inclusion causally impacts
economic growth through lower transaction costs, enhanced deposits base, and
efficient distribution of risk across the financial sector. At the micro level, financial
inclusion fosters development through enhanced access to credit, increased
household consumption, and consumption smoothing through savings.
Pakistan has been a
pioneer in
championing
reforms aimed at
providing an
enabling
environment for
financial inclusion
for over a decade.
There have been a large number of significant milestones which include: the creation
of a regulatory framework for MFBs (2001); the expansion and modernization of the
online credit information bureau (e-CIB, 2005); the adoption of Branchless Banking
Regulations (2008, amended in 2011); the adoption of a tiered approach to knowyour-customer (KYC) requirements; the establishment of a specialized microfinance
credit information bureau (m-CIB, 2009-2012); and the launch of a nationwide
Financial Literacy Program (2012). As a result, the enabling environment for
microfinance is ranked among the world’s best, according to the Economist’s Global
Microscope 2014.
Despite these
sustained efforts, the
level of financial
inclusion remains
very low.
Pakistan is home to 5.2% of the world’s unbanked population and only 13.0%
Pakistani adults have an account with a formal financial institution, making the
financial inclusion agenda important from a country as well as global context.85 The
gender divide remains a key challenge to address, as women are largely financial
excluded. Only 4.8% women are included in the formal financial sector compared to
the South Asian average of 37.4%. Additionally, those who are included have a narrow
range of credit and savings products to choose from, while not having access to other
specialized financial services such as insurance, pensions, and agriculture and MSME
finance.
Around 50 countries
worldwide have set
national targets for
financial
access/inclusion.
This is evidence of the global recognition of the importance of financial inclusion to
income distribution and growth. Given that about 25 countries account for over 73%
of the world’s financially excluded population, there has been a global call for action
for Universal Financial Access by 2020, through ambitious country-led reforms which
enable transformative and technology-led business models that would lower costs,
manage risks, and improve access to financial services for low-income individuals and
MSMEs.
85 World Bank Global Financial Inclusion Database (Global Findex 2014).
55
Pakistan has realized the National Financial Inclusion Strategies have
allowed for Accelerated Progress
While SBP has been
very proactive in
promoting an
inclusive financial
sector, many of the
issues that need to
be addressed fall
outside of its
regulatory mandate.
For example, a number of longstanding problems cannot be solved without legislative
changes, but important draft bills, including those on secured transactions, deposit
insurance, insolvency and credit bureaus, have been in an uncertain legislative process
for years. Progress towards a more inclusive financial system has also been slowed
because of limited commitment and weak coordination between several government
and private sector stakeholders.
Weaknesses in the
basic financial sector
infrastructure and
the legal and judicial
framework
discourage lending,
particularly to those
perceived as riskier
borrowers.
The supply of credit to underserved markets is further depressed by: poor contract
enforcement, serious deficiencies in land titling and registration, the absence of a
secured transactions framework and electronic collateral registry for moveable
collateral and the inability to enforce collateral outside of the slow and unpredictable
judicial system.
Lack of capacity in
both financial
institutions and
clients is also a
constraint to greater
financial inclusion.
Most financial institutions have focused on the upper end of the business and retail
markets and have not developed the skills, techniques and products required to serve
other market segments profitably. Microfinance providers have developed this
knowledge for microfinance clients, but there is a large “missing middle” which is
currently not being served. On the client side, a basic lack of financial literacy and
awareness serves to limit demand for financial products and services.
Given the positive
welfare effects of
increased financial
inclusion, and a
global push for
inclusive growth, as
highlighted by the
commitments made
by the G-20 nations
and Alliance for
Financial Inclusion
(AFI), the State Bank
of Pakistan (SBP) in
collaboration with
the World Bank,
launched a National
Financial Inclusion
Strategy for Pakistan
in May 2015.
The NFIS has been agreed to at the national level following extensive consultations
with the stakeholders. It is being championed by the SBP, with shared leadership from
the Ministry of Finance (MoF) and the Securities and Exchange Commission of
Pakistan (SECP). The stated vision for financial inclusion in Pakistan is that:
“individuals and firms can access and use a range of quality payments, savings, credit
and insurance services which meet their needs with dignity and fairness”. A set of cross
cutting conditions – the key enablers – will need to be put in place as they will lay the
foundations for implementing this vision. The key enablers cut across all priority
sectors, and are; (1) public and private sector commitment to the NFIS and
coordination; (2) enabling legal and regulatory environment; (3) adequate supervisory
and judicial capacity; and (4) financial, payments and information and communications
technology (ICT) infrastructure. The key enablers will support targeted actions – the
drivers – aimed at increasing access and developing an ecosystem of financial services
that will have the quality and features required by the Pakistani population and
enterprises. These drivers are: (i) promoting Digital Transaction Accounts (DTAs) and
reaching scale through bulk payments; (ii) expanding and diversifying access points;
(iii) improving capacity of financial service providers; and (iv) increasing levels of
financial capability.
56
Pakistan’s National Financial Inclusion Strategy Framework
The current network
to distribute
financial services in
Pakistan falls short,
particularly in rural
areas, and it does not
permit all firms and
individuals,
especially women, to
have easy and
convenient access to
even basic accounts.
Hence, the NFIS prioritizes the need to increase and diversify financial service access
points such as bank branches, bank agents, ATMs, POS, mobile money agents and
remote access through mobile phones and the internet. The vision aspires to having
universal access to formal accounts, not be limited to simply traditional savings and
checking accounts but would also include digital transactional accounts (DTAs) such
as branchless banking accounts. Universal access to formal accounts depends on a
balanced KYC regime, improvements in the national payment system (NPS), and on
shifting large payment streams from cash to digital platforms. These large payment
streams include wages in the public and private sectors, government-to-business
(G2B) payments, social cash transfers, other government-to-person (G2P) payment
streams such as pensions, and also P2G (person to government) payments such as
fees and taxes.
Figure 38: National Financial Inclusion Strategy - Framework for Action
PRODUCT ECOSYSTEM
Diverse set of tailored and responsible financial products (savings,
credit, insurance…), available to all
DRIVER 1: DTAs
• Expand Access to
Digital Transaction
Accounts (DTAs)
• Drive Scale and Viability
- digitize payments
DRIVER 2: ACCESS
POINTS
• Expand and Diversify
Access Points
DRIVER 3: FINANCIAL
SERVICE PROVIDERS
• Providers develop
systems, knowledge,
products to serve new
market segments
profitably and safely
DRIVER 4: FINANCIAL
CAPABILITY
• Raise Financial
Awareness & Capability
(Consumers, SMEs)
ENABLER 4: Financial/Payments/ICT Infrastructure
ENABLER 3: Supervisory & Judicial Capacity
ENABLER 2: Enabling Legal and Regulatory Environment
ENABLER 1: Public & Private Sector Commitment, Coordination
Aspiring to a large
increase in the
number of adults
with accounts is a
necessary but
insufficient
condition to meet
the objectives of the
NFIS.
Individuals and firms must also have the convenience, tools and confidence to use a
range of quality services through these accounts, including simple payments,
remittances, savings, credit and insurance products. These services should be
provided in both conventional and Islamic-compliant structures. The NFIS calls for
the development of a varied set of financial services that meet the needs of consumers
and respects their right to dignity and fairness, with a special focus on historically
marginalized segments such as low-income households (e.g., small farmers), women,
and micro- and small-enterprises. This will require coordinated and parallel efforts
with the goals of:
 Diversifying the range of basic payments, remittance and savings products
offered to the Pakistani population and enterprises through DTAs and bank
accounts;
57






The World Bank also
provided ten detailed
technical notes
which
complemented the
National Financial
Inclusion Strategy.
Increasing the financing opportunities for urban and rural micro-, small- and
medium-enterprises, including agricultural finance for men and women small
farmers;
Increasing penetration of insurance services;
Bringing pensions to more workers, including those in the informal sector;
Developing housing finance products, including for low-income segments;
Fostering Islamic finance to serve those who prefer Islamic products or who
are excluded or underserved due to their religious beliefs; and
Ensuring consumer protection and increasing financial awareness and
literacy, as two foundational pillars for responsible inclusion.
The technical notes covered a detailed analysis of the respective subject areas and
proposed reform actions related to development of each area, both from a financial
inclusion perspective as well as from a sector development focus. The priority areas
included:
1. Digital Transactional Accounts – digitization; more access points to
achieve scale / viability
2. MSME Finance – enabling policy and legal environment for product
diversification
3. Agricultural Finance – enabling legal framework, and capacity of FIs and
farmers
4. Islamic Finance – capacity building and policy / regulations to further
diversify sector and products
5. Housing Finance – housing policy; property registration reforms; market
development
6. Payments Systems – digitization; payments infrastructure; interoperability;
remittances
7. Secured Transactions – legal framework and market/credit infrastructure
8. Insurance – supervision and capacity of sector for outreach and market
development
9. Pensions – expand pensions to more workers and digitize payments
10. Consumer Protection and Financial Literacy – widespread awareness,
investor education and standards
There is Considerable Momentum leading to Implementation for which
Coordinated Support is Necessary
The commitment to
achieving results is
collectively shared by
policy makers,
regulators, private
sector stakeholders,
and international
development
partners.
The NFIS has put
forth a vision, a
framework, a
coordination
The National Financial Inclusion Strategy has been developed at a particularly
opportune moment for Pakistan as technological innovation now allows financial
institutions to capture economies of scale, while expansion of branchless banking
offers unprecedented opportunities to transform not only the financial sector, but the
broader economy as a whole. The timing is right to utilize the enabling environment
to deliver significant impacts towards financial inclusion.
Policymakers, regulators and other financial sector stakeholders are already using the
NFIS framework to guide the financial inclusion reform agenda. The Finance
Minister has led the way by endorsing and launching the NFIS in May 2015, as well
as constituting and chairing the National Financial Inclusion Council.
58
structure, an action
plan, and measurable
targets – all critical
elements to drive
implementation.
Implementation has
already begun.
Critical policy level measures have been taken, such as Pakistan joining the global
Better then Cash Alliance focused on digitizing government payment platforms.
Legislative improvements are underway, such as passing of the Credit Bureaus Act
and approval of the secured transactions bill for onward submission to the Parliament
– both activities were supported by the NFIS86. Such policy reforms are
complemented by regulatory reforms such as the introduction of a new account
category called "Asaan Account" in June 2015 with simplified account opening
requirements/procedures for low-income low-risk customers. The NFIS has also
allowed for a more focused sub-sectoral planning process, such as with the launch of
the Microfinance Growth Strategy which highlights a critical funding and human
resource gap within the microfinance sector. Similarly, the World Bank will be
providing support to develop Pakistan’s national payments system strategy, which
would cover a comprehensive framework to guide the development of the national
payments system.
Figure 39: National Financial Inclusion Strategy - Framework for Action
National Financial Inclusion Council
Ministry
of Finance
Finance
Minister
Finance Secretary, Governor, SBP
Chairman, SECP, Chairman, PTA, Chairman,
FBR, Secretaries, Provincial Finance
Departments, Chief Commissioner ICT, co-Opted
Members
SBP
Governor
Technical level representatives from MoF,
SBP, SECP, PTA, PBA, IAP etc.
Technical Committees / Consultative Working Groups
Digital
payments
Agriculture
finance
Housing
Finance
Awareness and
literacy
MSME finance
Pensions
Gender
Islamic finance
Insurance
NFIS Secretariat
National Financial Inclusion Steering Committee
Updates the NFIS
Action Plan, conducts
data aggregation,
reporting to the
Steering Committee,
M&E, research,
technical and
administrative support
to lead agencies.
Source: Financial Inclusion Strategy
Coordinated support
is the key to
implement reform
The scope, scale and timelines for reforms imply that there is a need for an effective
coordination structure not only within the government and private sector, but also
coordinated support from international development partners. Currently, the World
Nonetheless, there is a need to strengthen the implementation process particularly for legislative
reforms so that they achieve the core principle of reform actions.
86
59
actions needed to
meet the ambitious
financial inclusion
targets.
Bank Group, UKAID Department for International Development (DFID) and the
Bill and Melinda Gates Foundation are leading the way in donor support to financial
inclusion. There are several complementarities in their programs which will form the
basis for successful support to the financial inclusion reform agenda. The World Bank
Group’s program focuses on (i) technical assistance for the NFIS coordination
structure, payments systems, SME finance, and consumer protection and financial
literacy, and (ii) financial support for investments in upgrading the countries financial
infrastructure and liquidity support to specialized banks and the microfinance sector.
60