Saudi oil greases wheels of Pakistan's economy



By Nadeem Malik

29th August, 2001.

The Saudi Oil Facility (SOF) and strong fiscal management have helped Pakistan narrow its balance of payments and budget deficits since 1998.

The government has informed the International Monetary Fund (IMF) that Saudi Arabia has been extending oil as a grant and not as a loan since 1998. An IMF team is visiting Islamabad for its last review under the Stand-By Arrangement (SBA), and it has factored in US$850 million as an oil grant for fiscal 2001-02.

Pakistan needs to satisfy the IMF about the state of the economy so that the existing $596 million SBA can be replaced with a $2 billion-$2.5 billion new funding line in the shape of a Poverty Reduction Growth Facility (PRGF) before the end of this year.

The Saudis extended the friendly oil facility following the nuclear tests Islamabad conducted in May 1998 to alleviate the threat of an outright default, as the country was building a debt arrears in the wake of nuclear-related sanctions imposed by the developed world. "The authorities have confirmed that the SOF is grant, not a loan," the IMF stated in its report.

The report says that actual budget deficit for the current fiscal year would come down to 3.6 percent of gross domestic product (GDP) after accounting for the oil facility, against the publicly announced target of 4.9 percent of GDP. Last year, the government announced a deficit of 5.2 percent, which was actually 3.9 percent of GDP after adjusting the grant component.

Owing to this large grant component, the fund's management agreed to soften its rigid stance of 1 percent of GDP reduction in the fiscal deficit per annum until 2004. Now it must be scaled down from 5.2 percent to less than 3 percent by 2004. The IMF says that the SOF provides the needed cushion, justifying Islamabad's demand of a somewhat higher deficit to enhance public sector spending.

Pakistan's average GDP growth had decelerated in the 1990s to around 4 percent per annum; last year it ended at 2.6 percent due to droughts, a growing fiscal deficit and containment of public sector development budgets to slow the widening gap between revenues and expenditures.

The main reason of the stifling fiscal situation is the failure of federal tax revenues, which remained stuck at 16 percent of GDP. Taxes collected by the Central Board of Revenue (CBR) were dismal, declining in real terms from 12-13 percent of GDP to 11.7 percent of GDP in 2000-01. The corrupt and inefficient tax machinery failed to provide the needed support to the budget. There are estimates showing that roughly 8 percent of GDP (Rs280 billion or $4.4 billion per annum) is evaded in duties and taxes in Pakistan, largely with the connivance of the taxmen.

A former chairman of the revenue board has officially stated that 90 percent of the tax collectors are corrupt. He suspended 1,000 out of the 33,000 workforce, but failed to prove it in the courts of law due to legal hitches, and lavish immunities available under civil service rules.

The government of Pakistan is now trying to revamp the tax machinery on more modern lines. A high-level taskforce under the chairmanship of Shahid Hussain, a former senior vice president of the World Bank, has already submitted its report to the government. Implementation of this new model will start in the coming months after formal Cabinet approval.

On the expenditures side, the military regime has shown some tangible progress by containing nondevelopment current expenditures by almost 1 percent of GDP. Defense allocations have not only been brought down to 4.3 percent of GDP, but also frozen in nominal terms. However, allocations for the social sector and even the priority poverty related programs have also suffered due to austerity measures.

The reduction in the public sector development budget, which was serving as an engine of growth in the domestic market, has sharply declined from 7 percent of GDP in the late 1980s and early 1990s to 2.7 percent last year. Independent economists say that this change in the macroeconomic framework adversely affected the growth prospects of the economy, leading to growing unemployment and poverty in the country.

According to the International Labor Organization (ILO), unemployment doubled in the country from 3 percent to 6 percent in the 1990s. Some individual reports on the labor market say that workers on average have only 80 days of full-time work in a year. For the remainder, they either have part-time jobs or jobs not suited to them, or simply don't work.

The estimates of poverty vary widely depending on the factors of measurement. A report of the World Bank estimates 34 percent of Pakistanis live below the poverty line. However, some independent studies say that food-related poverty is above 40 percent in the country.

The administration of military ruler General Pervez Musharraf Musharraf recently announced it would increase public sector spending to spur economic activity in the country, which according to the official claims would provide jobs to at least 1 million people over the next three years. A detailed development plan covering several major infrastructure projects has been officially announced.

However, there are concerns over the whole budgetary framework, monitoring of expenditures and the quality of the fiscal data. Since the detection of a misreported Rs90 billion between 1997-99, the credibility of official data is at stake. The military authorities traced this fudging soon after taking over in a bloodless coup in October 1999.

The IMF has extended technical support to the authorities and a comprehensive accounting and auditing reform program is being implemented with the help of the World Bank. The accounting, reconciliation and auditing procedures, both at the federal and provincial levels, have been revamped to make them more transparent and reliable. However, the problem is not fully over as it takes much time in reconciling data, particularly from provincial governments. The IMF report stressed the need to improve it further. For the fiscal year ending June 30, the ministry of finance is still sorting out details of unclassified expenditures, which according to the authorities relate to development and social sector spending at the provincial and local levels.

The IMF recently expressed apprehension that large unclassified expenditures of almost 0.9 percent of GDP may have gone to defense or other sectors last year. However, the ministry of finance has officially assured the fund management that releases for defense were being handled and monitored separately, dispelling any doubts about misallocations. The IMF mission and the ministry officials have sorted out almost 60 percent of these expenditure outlays. Final accounts will be made public by end-September or early October, according to the ministry of finance.

The IMF officials have, however, asked the authorities to develop a system to track down all expenditures in a timely and reliable manner, particularly for poverty related and social sector programs. "There should be a system to analyze a particular sector or a program at the end of the every quarter to know the quality of expenditures, its outcome or impediments. It's only possible if there exists an efficient system of reporting," state officials of the Bretton Woods Institutions.

The IMF mission was due to conclude its talks with the government on Tuesday night for the last tranche of $130 million under the SBA. If Pakistan qualifies for it, it will be the first time in its history that Islamabad would successfully complete any IMF facility.

The ministry of finance had officially claimed that all the program targets have been met, except for the tax revenue target. The CBR collected Rs394 billion against the revised estimates of Rs406.7 billion. The donors' community has partly acknowledged the official excuses of drought-related shortfalls in tax revenues.

However, the fund management has strongly insisted on having an agreement reached on a macroeconomic and budgetary framework for fiscal 2001-02 before forwarding the loan tranche approval to the executive board. This would also require the government to present three-year projections, which should also be consistent with the proposed Poverty Reduction and Growth Facility.

The government wants to switch over to the PRGF soon after the expiry of the SBA in September. The IMF delegation, headed by Klause Enders, has, however, informed Finance Minister Shaukat Aziz that another IMF team will visit Islamabad in October to review the progress from July to end-September, and to formulate a joint IMF/World Bank Poverty Reduction Strategy Paper (PRSP), which will form the basis of the next facility.

After factoring in $850 million under the Saudi Oil Facility, Pakistan faces a financing gap of $3.4 billion during current fiscal year, and $3 billion during each of the next two years. It is expected that the SOF will remain available until 2004. New multilateral flows and debt rescheduling from the official bilateral creditors at the Paris Club and the commercial creditors at the London Club would cover this gap.

Aziz has officially said that the government will contact the Paris Club creditors soon after striking a deal with the fund management for a medium-term package. He is likely to visit Washington by the end of September to have further discussions with the Bretton Woods Institutions and major bilateral creditors, the United States and Japan.

However, the overall balance of payments situation has improved tremendously from a $3.5 billion deficit in 1998-99 to an estimate of $2.3 billion during 2001-02 (excluding grants). This comparatively improved position would also help expand official foreign exchange reserves to $2.3 billion by June 2002. This does not includes $1.6 billion of private Foreign Currency Deposits (FCDs) held by commercial banks, which are technically part of the reserves.

These macro indicators do not show a rosy picture. There is hardly any room for complacency. However, it definitely indicates a trend that the economy is coming out of its deep fiscal hole, with the IMF projecting 4 percent GDP growth and 5 percent inflation for 2001-02.

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