Report No. 104831-PK PAKISTAN DEVELOPMENT UPDATE From Stability to Prosperity April 2016 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Table of contents Executive Summary........................................................................................................................ i A. Economic update ...................................................................................................................... 1 1. Economic growth developments .............................................................................................. 1 2. Fiscal update ...........................................................................................................6 3. Trade and balance of payments.............................................................................................. 11 4. Monetary, finance sector and inflation update........................................................................ 16 B. Outlook and upcoming challenges ...................................................................................... 24 1. Outlook ......................................................................................................... 24 2. Next steps on structural reform.............................................................................................. 27 3. Risks and challenges ......................................................................................................... 29 C. Special sections ....................................................................................................................... 31 1. How can Pakistan improve its export competitiveness?.......................................................... 31 2. Pakistan’s electricity sector reform—addressing the funding gap........................................... 36 3. The opportunities and challenges of Pakistan’s urbanization................................................. 41 4. Provincial development spending in Pakistan – the case of Punjab ........................................ 48 D. Appendix: Pakistan’s economy in pictures ......................................................................... 53 April 2016 THE WORLD BANK GROUP 2 Acronyms and Abbreviations ADP Annual Development Plan M-o-M Month-on-month bbl Barrel MW Megawatts CAD Current account deficit NDA Net domestic assets CPEC China-Pakistan Economic Corridor NEPRA National Electric Power Regulatory Authority CPPA-G Central Power Purchasing Agency Guarantee Limited NFA Net foreign assets CRR Cash reserve requirement NPLs Non-performing loans CSF Coalition Support Fund NTDC National Transmission & Despatch Company CY Current year OECD Organisation for Economic DISCOS Distribution companies Cooperation and Development EFF Extended Fund Facility OMO Open market operations EIU Economist Intelligence Unit OTRI Overall trade restrictiveness index EU European Union PSDP Public Sector Development Program FABS Financial Accounting and Budgeting PSX Pakistan Stock Exchange Limited System PTCL Pakistan Telecommunication FBR Federal Board of Revenue Company Limited FDI Foreign Direct Investment REER Real effective exchange rate GCC Gulf Cooperation Council RHS Right-hand side GDP Gross Domestic Product ROA Return on assets GST Goods and Services Tax ROE Return on equity H1FY First half of the financial year Rs. Pakistan Rupees H2FY Second half of the financial year SBP State Bank of Pakistan IMF International Monetary Fund SME Small and medium enterprises JICA Japan International Cooperation SoE State-owned enterprise Agency UAE United Arab Emirates KIBOR Karachi interbank offered rate UK United Kingdom KSE Karachi Stock Exchange US United states LGU Local government unit WAY Weighted average yield LHS Left-hand side WEO World Economic Outlook LNG Liquid natural gas Y-o-Y Year-on-year LSM Large-scale manufacturing Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Executive Summary South Asian South Asia emerged as the fastest growing region in the world in 2015, posting growth remains GDP growth of 7 percent. Weak oil and commodity prices, slowing capital flows strong amidst and shrinking global trade contributed towards a deceleration of growth in most global economic of the world’s economies. South Asia—as a net importer of oil—was an anomaly, turmoil growing significantly on the back of higher private consumption and public investment. Higher remittances and reserve buffers throughout the region offset the fall in exports caused by the drop in global demand. The region is set to maintain real GDP growth above 7 percent over the next few years. However, the tailwinds are now fading —capital flows have declined and remittances are starting to feel the reality of low oil prices. Aided by low oil Pakistan, while not growing as quickly as its neighbors, has continued its steady prices, Pakistan growth recovery in H1FY16. Strong growth in consumption, rising foreign continues to post exchange reserves, fast-growing workers’ remittances and a lower import bill moderate compensated for a significant fall in exports. Low oil prices generated a significant economic boost, driving a 9.1 percent fall in the import bill and reducing inflation performance significantly, in turn creating scope to reduce the policy rate. Private sector consumption, propelled by higher remittances and a loosened monetary policy, is expected to account for over half of FY16 GDP growth. The policy While exogenous factors such as oil prices and fast-growing remittances environment is undoubtedly contributed to Pakistan’s growth, the policy environment is also improving, improving. Macroeconomic stability has improved significantly over the last two particularly in to three years, as evident in the steady growth of foreign reserves, reduced fiscal terms of deficits and low inflation environment. Further, the government is methodically macroeconomic working through plans to improve the country’s grim investment climate by stability boosting electricity supply, improving access to credit and increasing tax revenue. While Pakistan continues to score very poorly on doing business indicators, there are some early signs of improvement as a result of these efforts. Private sector credit is showing signs of growth. And structural challenges have not prevented large-scale manufacturing from taking advantage of low global prices for raw materials in H1FY16. Investment is also expected to pick up marginally in FY16 after remaining stagnant in FY15 at 15.1 percent of GDP, a dismal figure. Growth in FY16 is The growth outlook for FY16 remains modest with growth expected to increase expected to be slightly to 4.5 percent of GDP in FY16 from 4.2 percent in FY15, driven by large- moderate at scale manufacturing growth of 4.0-4.5 percent and services growth of over 4.5 percent, well 5 percent. The agriculture sector, after suffering a poor cotton harvest, is expected below the 5.5 to have slowed to between 2.0 and 2.5 percent for FY16, compared with percent target 2.9 percent in FY15. The near-term outlook will be supported by three major near-to-medium tailwinds—rising investments under the China Pakistan Economic Corridor (CPEC), persistently low international oil prices and the anticipated return of the Islamic Republic of Iran to the international community. The expected growth rate, however, remains well below the 5.5 percent target envisaged under Pakistan’s Annual Plan FY16 and the growth rates of its South Asia peers. A further growth revival will remain contingent on the government April 2016 THE WORLD BANK GROUP i Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate making further progress in addressing structural challenges like poor electricity availability, narrow fiscal space and inadequate access to credit. Fiscal Fiscal consolidation, one of the most urgent reform needs, has been central to the consolidation, a current government’s economic reform program. And the government’s key reform priority, commitment is delivering results. The Federal Board of Revenue (FBR) has is progressing posted an impressive 20 percent increase in tax revenue for the first eight months steadily—the FBR of FY16 on the back of a broad-based increase in direct and indirect tax is driving strong collection. While this is commendable, Pakistan continues to lag in realizing its tax revenue growth revenue potential. The tax revenue-to-GDP ratio has increased by 1.5 percentage points over the past three years to 11 percent in 2015, but it remains well below comparator emerging economies and less than half of the 22.3 percent tax capacity recently estimated by the IMF. …and expenditure Consolidated government expenditure registered a growth of only 8.1 percent, growth was meaning that the fiscal deficit was over 20 percent lower than that in H1FY15. restrained in This positive result was largely due to the federal government’s tight rein on its H1FY16, leading to recurrent expenditure, which grew less than 5 percent. Outlays for subsidies also a much reduced continued to decline, declining since H1FY13 from 0.7 percent of GDP to 0.27 fiscal deficit percent of GDP in H1FY16. A positive development has been the commitment of significant resources towards PSDP-related development spending in spite of the broader fiscal restraint—federal PSDP during H1FY16 grew by 24 percent while provincial PSDP registered a growth of 54 percent. Pakistan also Also contributing to Pakistan’s improved macroeconomic stability was its improved its improved external position. A lower current account deficit and relatively healthy external position, financial inflows contributed to the sustained build-up of foreign exchange strengthening reserves during H1FY16. However, this performance masks the structural macroeconomic weaknesses that continue to make the external sector vulnerable. Exports shrank stability by 11.1 percent as an uncertain global economy magnified existing domestic bottlenecks. Imports similarly declined by 9.1 percent during H1FY16. The 6.2 percent growth in workers’ remittances continued to compensate for the negative trade balance in absolute terms. However, this steady increase in remittances will come under pressure if oil prices remain low and Gulf Cooperation Council (GCC) countries—key destinations for Pakistan’s offshore workers—cut public expenditure. …but its narrow Pakistan exports to a small number of destination markets, making it vulnerable export base, poor to exogenous shocks. Low global commodity prices, depressed prospects of trade facilitation economic growth in export destinations and an appreciating Real Effective and protectionist Exchange Rate (REER) continue to drag on export performance. Furthermore, trade policies are Pakistan is constrained by domestic challenges including poor trade facilitation, a dragging on export high cost of doing business and protectionist trade policies. Vessel charges in competitiveness Karachi, for example, are almost 10 times those of Dubai or Singapore. Dwelling times for shipping containers are three times longer in Karachi than in developed countries or East Asia. Pakistan’s import tariffs are also almost twice as high as global averages, putting local manufacturers at a severe disadvantage if they aim to join global supply chains (by importing intermediate goods). 1 China’s CPEC- In the first eight months of FY16, the capital and financial account posted a driven investment surplus of US$ 3.13 billion, fractionally higher than the corresponding period in FY15 of US$ 3.09 billion. This positive outcome was made possible by some 1 See the special section on export competitiveness ( Section C1 ) for a fuller discussion of these issues. April 2016 THE WORLD BANK GROUP ii Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate has offset a decline improvement in foreign direct investment (primarily on account of inflows from in FDI from other China related to the CPEC), issuance of a US$ 0.5 billion Euro bond in the sources international market, and loans from IFIs. However, FDI from other countries has dried up, likely due to global economic uncertainty. Official reserves reached US$ 16.1 billion in the final week of March 2016, an increase of US$ 2.5 billion in the nine months since the start of the financial year. The Rupee remained largely stable in nominal terms against the US dollar with a small depreciation of 2.8 percent during the first nine months of FY16. Inflation was low While cheap oil imports kept inflation low in H1FY16, the broad-based decline in in H1FY16 but is y-o-y inflation seen in FY15 seems to have bottomed out. Headline inflation now starting to registered at 3.3 percent at the start of H2FY16 compared with 1.9 percent at the inch upwards start of H1FY16. Similarly, y-o-y core inflation (non-food, non-energy) started inching upwards in December 2015, touching 4.7 percent in March 2016 after a low of 3.4 percent in September. However these inflation measures are still significantly lower than those witnessed in the same period last year, likely allowing a continued low policy rate. Monetary easing A 50 basis point cut in the monetary policy rate in H1FY16 brought it to a continued in decade’s low of 6.0 percent. However, the uptick in headline inflation since H1FY16 but has October 2015 has arrested the slide in the policy rate. Monetary aggregates now been halted in remained on course, with broad money supply growing by 13 percent during response to an H1FY16 compared to 10.9 percent in the same period last year. The government uptick in inflation continued to retire its debt to the State Bank of Pakistan (SBP) while borrowing substantially from the scheduled banks, thus expanding the net domestic assets of scheduled banks by 6.8 percent in December 2015. However, fiscal consolidation has led to a decline in government’s incremental borrowing needs. This, coupled with lower interest rates, led to an encouraging increase in lending to the private sector by 9.7 percent as of March 11, 2016 (y-o-y). Lower interest The banking sector remains robust, largely because of heavy investment in risk- rates and the free government securities. Commercial banks hold about Rs. 6.1 trillion of government’s government domestic debt as of December 2015, equal to 43 percent of their fiscal consolidation total assets. Furthermore, investments in government securities constitute will create approximate 90 percent of total banking system investments. While profitability pressures for the remained high for the quarter ending December 2015, it is expected to come banking sector under pressure in the current environment of low interest rates and reduced government borrowing. Commercial banks have started to look towards riskier asset classes as SME lending grew marginally by 3.7 percent after a downward trend over the preceding five years. Going forward, growth in the sector is thus expected to reflect the slow recovery in the real sector. Growth is expected The outlook for FY16 to FY19 is for moderately higher economic growth. to pick up slightly Growth acceleration will be gradual, driven by strengthening investment flows in the medium- and productivity gains in services, large-scale manufacturing and construction. term driven by These sectors should benefit from expected reforms leading to decreased investment and electricity load-shedding and improvements in the business climate. Gross fixed productivity gains investment is expected to increase from 13.4 percent of GDP in FY15 to 14.2 in services and percent by FY19, primarily due to the CPEC lifting foreign direct investment manufacturing flows over the medium-term. Any demand-driven economic expansion as a result of CPEC’s implementation is expected to be limited in the short-run as increased investment will likely be offset by a significant increase in imports. However, April 2016 THE WORLD BANK GROUP iii Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate supply-side effects facilitated by higher power generation capacity and better infrastructure will be beneficial for the economy in the medium- to long-term. …but this outcome To achieve growth comparable to its South Asian neighbors, however, Pakistan will depend on the will need to achieve steady progress in the key pillars of its medium-term reform government program. In the electricity sector, the ambitious expansion in generation will need persisting with its to be matched by investments in transmission and distribution. Privatization of structural reform distribution will be a necessary step toward funding these upgrades, as will agenda elimination of circular debt. In lifting tax revenues, efforts may need to focus on strengthening authorities’ capacity to monitor and enforce compliance through market analysis, access to data and increased recourse to tax audits. Successful completion of the CPEC will also be crucial to addressing Pakistan’s low investment rates. Domestic reforms These structural reforms are particularly important given the shifting winds likely will be particularly to affect the Pakistan economy. While the country is currently benefitting from a important if China CPEC-driven spike in Chinese investment, fast-growing remittances and low oil slows further and prices, these factors all face downside risk. A further slowdown in China would GCC countries cut deliver a knock to Pakistan’s exports and FDI. And low oil prices, if sustained, are public expenditure likely to drive GCC economies to cut public expenditure, thereby reducing remittances to Pakistan from these countries. The new poverty Pakistan’s recent adoption of a new poverty line is a hopeful sign that line will allow inclusive growth will continue to be a policy focus. Pakistan registered a policymakers to continuously declining poverty trend on the poverty line set in 2001. By 2014, focus on inclusive poverty rates fell below 10%, making the old poverty line less policy-relevant. The growth new poverty line incorporates changes in the economy over the past 10 to 15 years, and sets a higher bar for inclusive development. The new line identifies almost 30 percent of the population as poor, which is close to 60 million people—as compared to 20 million people who were identified as poor on the old poverty line. This implies the country has committed to focusing more on pro- poor and inclusive development policies. Stronger growth is The recent pick-up in growth is encouraging, but at 4.5 percent, it remains within Pakistan’s modest—not sufficient to create jobs for the large number of youth joining the grasp workforce every year, and significantly below the growth path that some countries have taken to become strong and confident middle income countries. GDP per capita only increased by about 50 percent over the past 25 years, which is far lower than most of its peers. GDP growth rates closer to that of China would quadruple Pakistan’s GDP per capita within a generation. Given the strong relationship between growth and poverty in Pakistan, strong growth would also allow Pakistan to make a more significant dent on its recently revised poverty estimate of almost 60 million people. April 2016 THE WORLD BANK GROUP iv Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate A. Economic update 1. Economic growth developments Amid global The global economy slowed in 2015, growing at just 2.4 percent compared with economic turmoil, 2.6 percent in 2014. Weak oil and commodity prices, slowing capital flows and South Asian shrinking global trade contributed towards a deceleration in most developed and growth has emerging economies. South Asia—led by India—was an anomaly, registering the remained strong highest GDP growth in the world at 7 percent as the region benefited from lower international oil prices (being a net oil importer) and relative resilience to external shocks. South Asia is expected to maintain real GDP growth above 7 percent over the next few years. Domestic demand will remain the main driver of growth across the region, and export growth will also weakly recover. However, the tailwinds are fading —capital flows have slowed and remittances are beginning to feel the reality of low oil prices, which is oil-producing economies to cut investment and hire fewer foreign workers. Nonetheless, the region remains sheltered by a strong external position (due to limited trade exposure) and a low inflation environment, albeit with a recent up-tick. On the domestic front, fiscal management has remained a challenge with weak revenue collection in the context of political challenges. Pakistan’s modest Pakistan—while not growing as quickly as its neighbors—has continued its economic recovery modest growth recovery. Growth in FY16 is expected to pick up to 4.5 percent continues, from 4.2 percent in FY 2015. Like the rest of the region, Pakistan is benefitting April 2016 THE WORLD BANK GROUP 1 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate supported by low from low oil prices, which have reduced the trade deficit (in spite of a notable oil prices, high decline in exports) and increased consumption. Fast-growing remittances and remittances and rising investments under the China Pakistan Economic Corridor 2 (CPEC) have CPEC investment also supported growth in H1FY16. However, growth remains well below the 5.5 percent target envisaged in Pakistan’s Annual Plan FY16 and the South Asia average of 7.5 percent. Structural The effects of the high remittances and low oil price windfall (driving such high challenges prevent growth rates in the rest of South Asia) are somewhat hampered in Pakistan by its Pakistan from continuing domestic structural challenges. Unreliable electricity supply, limited growing as quickly fiscal space and a poor business environment continue to impede investment. as its neighbors Further, Pakistan has been steadily losing market share in global trade because its exports are concentrated in slowing markets, trade facilitation is poor and its trade policy is protectionist and complex (see Section C1). The government is The government has made great strides in increasing foreign reserves and has making progress recently made progress in power sector and revenue reforms3 but its ambitious on the structural reform agenda is necessarily a medium- to long- term plan. (See Section C2 for reforms that will be an in-depth discussion on the status of electricity sector reforms.) Given the risks essential to presented by the current global economic situation, these reforms will be safeguard growth necessary to safeguard Pakistan’s growth. In particular, while low oil prices boosted consumption and reduced the import bill in H1FY16, sustained cheap oil may reduce public investment in GCC countries, ultimately lowering Pakistan’s remittance receipts. A continued slowdown in China will also be damaging, reducing demand for Pakistan’s exports and stifling the recent foreign investment boost driven by the CPEC.4 Investment may be Investment, a key ongoing challenge in Pakistan’s economy5, is expected to beginning to increase marginally in FY16 on the back of increased national savings and public recover, and spending on infrastructure, mostly CPEC. Private sector loans for long-term policymakers have investment have increased substantially in H1FY16 compared with the targeted Pakistan’s corresponding period in the previous year. However, while national savings tend historically low to be the most reliable source of funds for investment, Pakistan’s historical rate of savings rate savings has been very low. National savings were 10 percent of GDP in the 1960s, increasing to 15 percent in the 2000s but remaining below that level ever since. Furthermore, Pakistan’s saving rate is low when compared to that of its regional counterparts: a five-year average of almost 13 percent compared to India’s 32 percent, Bangladesh’s 30 percent and Sri Lanka’s 25 percent6 . For FY16, the government’s Annual Plan has identified a savings rate target of 16.8 percent rate. This, however, seems optimistic given the lack of complementary policies and historical obstacles that continue to persist including high propensity to consume, 2 The CPEC will connect Western China to the Arabian Sea via the Gwadar port and with an estimated cost of US$ 45 billion until 2030 and will consist of publicly funded transport projects (US$ 11 billion) and privately funded energy projects (US$ 33 billion) – Global Economic Prospects January 2016, World Bank 3 See Section B2 for further discussion of the government’s progress in structural reform 4 See Chapter 3 for further discussion of the growth outlook and risks 5 Section D1 in the Fall 2015 Pakistan Development Update outlined several reasons why investment is low in Pakistan, including low public infrastructure investment driven by limited fiscal space, a shallow financial market, a lack of coherent industrial and trade policies, and a poor business environment. 6 Saving and Investment in Pakistan – Amjad Ali (State Bank of Pakistan, Staff Notes, January 2016) April 2016 THE WORLD BANK GROUP 2 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate high dependency ratio, lower real returns on financial instruments as well as a lack of access to and trust in financial markets and institutions. Figure 1: Consumption contributes the largest to Figure 2: ...with private consumption largest GDP expenditure... component of total Measured in percent Measured in percent Total Consumption Total Investment Public Consumption Private Consumption Net Exports GDP Growth (MP) Total Consumption 7.0 5.0 6.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0 1.0 0.0 1.0 -1.0 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 0.0 -2.0 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 -3.0 -1.0 Source: Economic Survey of Pakistan 2014-15 Source: Economic Survey of Pakistan 2014-15 On the demand On the demand side, growth in FY16 is being driven by consumption, which side, growth is accounted for an 88 percent share in GDP last year. Contributing over 4 driven by percentage points towards GDP growth7 (see Figure 1), consumption appears to consumption be dominated by private consumption, supported by sustained growth in remittances and a looser monetary stance. However, recent trends are showing some departures from historical norms, as the share of the public sector within overall consumption is growing stronger (see Figure 2). On the supply The most significant supply side shock in FY16 is a disastrous cotton harvest, side, the disastrous whose full effects have not yet been felt. Agricultural growth is expected to slow cotton harvest has to between 2.0 and 2.5 percent, below the 2.9 percent witnessed in FY15. Cotton slowed agricultural production remained 30 percent below FY16 target and 22 percent below last growth year’s production of 14.0 million bales (see Table 1).8 This was driven by a combination of factors, including a prolonged cold spell and severe pest attacks, and led to crop losses concentrated in Southern Punjab and Sindh. In addition, the depressed price of cotton may have reduced farmers’ incentive to invest in good quality pesticides and inputs. Rice production also fell 4 percent from FY15 production levels as a result of rising production costs, a heavy downpour in July 7 Average for eight years (2008-2015) 8 Most of the crop losses occurred in Southern Punjab, the cotton belt of the country, where output fell by 30 percent while almost 23 percent shortfall took place in Sindh – Pakistan Central Cotton Committee April 2016 THE WORLD BANK GROUP 3 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 2015 and large carryover stocks. Amongst Kharif 9 crops, it was only sugarcane whose production increased although it nonetheless remained below its FY target (see Table 1). The poor Kharif crop performance may be compensated somewhat by higher growth in livestock and a favourable outlook for wheat, which is expected to be a bumper crop. Table 1: Agricultural production was below target for major crops Production in millions of tons Percent FY15 P FY16T FY16P FY16P /FY15 P FY16p/FY16T Cotton* 14.0 15.5 10.9 -22% -30% Sugarcane 62.8 68.0 65.4 4% -4% Rice 7.0 6.9 6.6 -6% -4% Wheat 25.5 26.0 26.0 2% 0% Maize 4.7 3.7 4.8 2% 30% T: Target, P: Provisional *Millions of bales Source: Targets based on Annual Plan, FY15, Government Planning Commission. Provisional estimates based on World Bank Staff estimates The industry sector After a dismal performance in FY15, industrial sector growth has a more favorable is expected to grow outlook in FY16. Large-scale manufacturing (LSM) has already achieved 3.9 faster in FY16, percent growth in H1FY16 compared to a meagre 2.7 percent in H1FY15. LSM, driven by growth in which comprises more than half the industry sector, is being supported by growth large-scale in several key sub-categories, including food, beverages and tobacco; automobiles; manufacturing fertilizers; petroleum; pharmaceuticals; and cement production all of which benefited from the persistently low prices of raw materials and inputs. These sectors, comprising almost 51 percent of LSM, grew by an average of 12 percent y- o-y in H1FY16 with Figure 3: Quantum growth in LSM (m-o-m) automobiles posting the highest growth rate of 20.0% 32 percent followed by 15.0% fertilizers at 15 percent 10.0% and petroleum products 5.0% at 8 percent. The textiles sector continued 0.0% May-15 Jan-16 Jan-15 Feb-15 Jun-15 Mar-15 Apr-15 Oct-14 Oct-15 Jul-14 Jul-15 Aug-14 Sep-14 Aug-15 Sep-15 Nov-14 Dec-14 Nov-15 Dec-15 to suffer from subdued -5.0% demand in the -10.0% European market, Source: Pakistan Bureau of Statistics growing y-o-y by 1 percent with local manufacturers losing export share to competitors India and Vietnam. While manufacturers continue to face a lack of access to credit, a slowdown in global demand and power shortages, LSM is nonetheless expected to enjoy growth of 4.0 to 4.5 percent, below the 6 percent target but well above last year’s disappointing performance of 2.4 percent. This growth will be supported by healthy cotton yarn manufacturing, significant increase in construction activities, increased production and financing of automobiles from both commercial and 9 Includes cotton, rice and sugarcane – season: July to October April 2016 THE WORLD BANK GROUP 4 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate government schemes10 and recent LNG imports which are expected to improve energy supply to the industrial sector. The services sector The services sector remains the strongest contributor to growth on the supply remains the main side, comprising more than half of GDP in FY15 with an expected growth of contributor to around 5.3 percent in FY16. This is slightly better than the 5 percent growth growth witnessed last year and considerably better than the 4.4 percent growth in FY14. While all services sub-sectors are expected to grow, the primary drivers will be transport, storage and communication; finance and insurance; and wholesale and retail trade. In particular, transport, storage and communication, which comprises almost 23 percent of the services sector, is expected to perform well in FY16. This is on account of a hefty increase in automobile (60 percent increase in Q1FY16) and petroleum sales, an improved financial position of Pakistan Railways and higher cargo handling at ports. Communication is also expected to recover after no growth in FY15 due to higher numbers of broadband users, improved cellular and tele-density and lower PTCL losses in H1F16 compared to H1FY15. ‘Messy’ and A recent World Bank study has highlighted the likely cost of South Asia’s current ‘hidden’ approach to urbanization. While studies have illustrated the potential productivity urbanization is an benefits of rapid urbanization, South Asia’s cities have largely succumbed to emerging concern congestion pressures, resulting in urbanization that is occurring most quickly in sprawls at the margins of cities (‘messy’ urbanization) and outside the administrative boundaries of urban areas (‘hidden’ urbanization). An independent measure of agglomeration found in 2010 that over 55 percent of Pakistan’s population was living in urban areas, compared with official estimates of only 36 percent11 . The unguided nature of urbanization is curtailing the potential productivity benefits of agglomeration, and driving the proliferation of urban slums and poverty. Developing an effective policy response to congestion pressures will be a long and complex process, but the Pakistan government has made a strong start—the Pakistan’s Vision 2025 program places cities at the center of national policy for sustained and inclusive economic growth. (See Section C3 for a further discussion on the challenges facing Pakistan’s urbanization. ) Pakistan’s growth In summary, Pakistan’s economic recovery is promising , but it is fueled equally by is bolstered by domestic policy and exogenous factors such as low oil prices. While sizeable exogenous domestic growth constraints persist, the government’s efforts to strengthen factors—more macroeconomic stability are well progressed and its structural reforms may be just robust growth will beginning to yield results. To further boost growth and insure against global rely on resolving uncertainty, Pakistan must continue to make progress in its energy sector reforms structural and other improvements to the investment climate. Fiscal consolidation efforts— challenges which now have some momentum —will be a crucial foundation for the rest of the government’s ambitious reform agenda. 10 Vehicle sales surged by 66 percent in H1FY16 aided by strong consumer spending and well-marketed and easy auto-financing. Note, however, the Punjab government continued to provide taxi cabs in the province under the Apna Rozgar Scheme but the scheme will conclude in February 2016, possibly reducing overall automobile sales for FY16. 11 Source: World Bank, 2015; Leveraging Urbanization in South Asia . See special section on urbanization for further discussion. April 2016 THE WORLD BANK GROUP 5 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 2. Fiscal update Pakistan’s fiscal Pakistan’s fiscal position has undergone a significant consolidation over the last three balance is years as the fiscal deficit (excluding grants) has declined from 8.5 percent of GDP in improving due FY12 to 5.4 percent of GDP in FY15. Two factors explain this apparent departure to greater from the past. First, the elected government appears to be more committed to fiscal discipline and discipline. Second, the government has prepared an economic reform program with an economic fiscal consolidation as a cornerstone. The program is supported by the IMF under the reform program Extended Fund Facility (EFF), which commits the government to actions that lower the fiscal deficit. Table 2: Summary of Pakistan Fiscal Operations Rs. billion unless mentioned otherwise Percent grow th Budget H1FY14 H1FY15 H1FY16 H1FY15 H1FY16 FY16 Total Revenue 4,622 1,665 1,749 2,005 5 15 Tax Revenue 3,702 1,172 1,361 1,639 16 20 Federal 3,418 1,084 1,266 1,517 17 20 Provincial 283 88 95 122 8 29 Non-Tax 921 493 388 366 -21 -6 Federal 883 468 363 335 -22 -8 Provincial 38 25 25 31 -3 27 Expenditures (booked) 5,950 2,214 2,320 2,529 5 9 Current of which: 4,276 1,888 1,989 2,104 5 6 interest 1,280 598 573 632 -4 10 subsidy 138 136 117 82 -14 -30 defense 781 295 330 303 12 -8 Development Exp. 1,678 316 286 417 -10 46 Net lending -4 98 45 7 Statistical Discrepancy n.a. -8 81 -9 Fiscal Balance -1,328 -540 -652 -515 21 -21 % of GDP -4.3 -2.1 -2.2 -1.7 Memorandum items: GDP (nominal) 30,672 25,402 29,708 30,672 Source: Ministry of Finance The fiscal deficit of The fiscal consolidation appears to be on track during H1FY16. The fiscal deficit the consolidated of the consolidated government during H1FY16 stood at 1.7 percent of GDP – government has the smallest half-year deficit in the last three years (see Table 2). Total fallen to 1.7 expenditure registered growth of 8.1 percent while total revenues registered percent of GDP robust growth of 14.6 percent on the back of 20 percent growth in tax revenues due to restraint in of the consolidated government. The federal government continued to hold federal recurrent recurrent spending under tight rein—federal recurrent spending grew by 3.7 expenditure and a percent compared to 2.4 percent in the same period last year. But the same can’t 20 percent increase be said for the provincial governments—provincial recurrent spending registered in tax revenues an increase on the previous year of 25 percent. However, as the bulk of recurrent spending takes place at the federal level (with a 70 percent share), the consolidated government recurrent spending has been kept in-check. This, coupled with strong April 2016 THE WORLD BANK GROUP 6 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate tax revenue performance has been instrumental in generating a primary surplus (excluding interest payments) of 0.40 percent of GDP during H1FY16. Table 3: FBR Tax Collection, July 2015-February 2016 Rs. billion unless mentioned otherwise Budget Percent Grow th FY16 FY14 FY15 FY16 H1FY15 H1FY16 Direct 1,348 500 599 676 19.8 12.9 Indirect 1,756 861 939 1126 9.1 19.9 Customs 299 147 181 241 23.1 33.1 Sales Tax 1,250 636 669 786 5.3 17.4 Federal Excises 206 78 89 99 13.7 12.1 Total Taxes 3,104 1,032 1,172 1,385 13.6 18.2 Source: Federal Board of Revenue The remarkable Total revenue performance of the consolidated Government is showing a revenue increase in remarkable turnaround on the back of strong performance by the Federal Board H1FY16 is the of Revenue (FBR). FBR revenue during H1FY16 showed robust growth of result of a 18 percent, only marginally lower than the 20 percent growth required to meet the concerted effort by FY16 revenue target of Rs. 3,104 billion. This is quite remarkable given tax the Federal Board collection during Q1FY16 stood at just Rs. 600 billion. Following a Q1 result that of Revenue was well below target, the government adopted quick remedial measures to correct the shortfall before the end of the first half of FY16.12 While these measures were effective at increasing revenue, however, it is worth noting that some may also dampen Pakistan’s export competitiveness (if increased duties raise the price of intermediate inputs for exporters, for example). As a result of this effort, collections from direct and indirect taxes grew by almost 13 percent and 20 percent respectively. More importantly, growth within indirect taxes remained broad-based,13 with customs, sales tax, and federal excise duty growing by 33 percent, 17 percent, and 15 percent respectively. Sales tax performance exhibited the most improvement, moving from a contraction of 1.9 percent during Q1FY16 to a growth of 15 percent despite the overall deceleration in international fuel prices and subsequently lower inflation rate.14 Robustness in customs duties can be attributed to increased tariffs on imported items as well as the impact of 12 These include: (i) imposition of regulatory duty in the range of 5 to 10 percent on 61 new imported items (projected to yield Rs. 4.5 billion); (ii) enhancing regulatory duty by 5 percent on 289 imported items (Rs. 4.5 billion); (iii) increasing Federal Excise Duty on cigarettes (Rs. 6.5 billion), (iv) additional one percent customs duty across the board except the exempted items (Rs. 21 billion); and (iv) additional regulatory duty on imported used and old cars (Rs. 2.5 billion). 13 In FY15, Government removed concessions and exemptions within direct and indirect taxes amounting to Rs. 105 billion. In FY16, the GoP has committed to further removal of exemptions amounting to Rs. 120 billion. Moreover, the government has strictly limited the authorization of administrative tax concessions and exemptions through Statutory Regulatory Orders (SROs) to be temporary and only applicable in a number of exceptional circumstances. Furthermore, The Parliament approved legislation that permanently removed the FBR’s authority to grant tax concessions or exemptions, except in a number of specified circumstances in which the Economic Coordination Committee of the Cabinet can grant exemptions or concessions on a temporary basis. 14 Part of this performance can be attributed to increasing sales tax rate on petroleum products over this period. April 2016 THE WORLD BANK GROUP 7 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate reforms carried out over the past two years, including removal of exemptions, concessions and curtailment of powers to issue SROs. However, deeply- There is no doubt this turnaround in FBR performance is noteworthy but it rooted problems should not take policymakers’ focus from the real issues in Pakistan’s tax need to be regime—narrow tax bases, extensive use of tax concessions and exemptions, addressed before weaknesses in revenue administration, and low taxpayer compliance. Pakistan Pakistan’s tax faces significant challenges in realizing its tax revenue potential and thereby, in regime will reach providing the much-desired fiscal space for growth. While the tax revenue-to- its tax capacity of GDP ratio has increased by 1.5 percentage points over the past three years to 11 22.3 percent of percent in 2015, it remains significantly below comparator emerging market GDP—or double economies and is only half of the IMF’s estimated tax capacity of the country. 15 current revenues Thus, a more concerted effort is required over the medium- to long-term to ensure that Pakistan reaches its maximum tax capacity. Table 4: Non-Tax Revenues Rs. billion unless mentioned otherwise % Grow th H1FY14 H1FY15 H1FY16 H1FY15 H1FY16 Mark-up (PSEs and others) 58.1 4.1 2.2 -93 -46 Dividends 28.3 39.5 31.4 40 -21 SBP Profits 145.0 137.5 122.6 -5 -11 Defense (incl. CSF) 38.2 80.2 78.2 110 -2 Passport and other fees 7.3 7.2 6.2 -2 -14 Discount ret. on local crude price 8.3 5.4 4.2 -35 -22 Royalties on Oil/Gas 36.8 40.9 31.5 11 -23 Others 117.3 48.6 58.4 -59 20 Provincial 25.4 24.6 31.3 -3 27 Total 493.5 388.0 365.9 -21 -6 Source: Ministry of Finance Non-tax revenues Non-tax revenues posted Rs. 366 billion, representing a contraction of 6 percent fell by 6 percent, or Rs. 22 billion compared to H1FY15. Although this is not an insignificant fall due to falling oil from H1FY14, collection in that year was abnormally high due to the accrual of prices one-off inflows including the universal service fund and the mark-up received from PSEs against the circular debt16 settlement. The revenue collected vide discount retained on crude oil and windfall levy declined for the third consecutive year due to declining international petroleum prices. Similarly, royalties on gas and oil also declined due to a price effect. Meanwhile, other major components such as State Bank of Pakistan (SBP) profits, and Coalition Support Fund (CSF) inflows continued to support the non-tax revenues to some extent. 15 A recent estimate by IMF puts Pakistan’s tax capacity to be around 22.3 percent of GDP (source: IMF Country Report 16/2). 16 Circular debt refers to the cash shortfall within the Central Power Purchasing Agency (CPPA). The revenue received by the CPPA from electricity distribution companies (as determined by the regulatory authority) and from government subsidies does not cover costs, leading to underutilization of existing capacity and the build-up of arrears. April 2016 THE WORLD BANK GROUP 8 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate Table 5: Analysis of Consolidated Spending Rs. billion unless mentioned otherwise Percent growth H1FY14 H1FY15 H1FY16 FY15 FY16 Total expenditures 2,208 2,332 2,520 5.6 8.1 Current 1,888 1,920 2,104 1.7 9.6 Federal 1,353 1,386 1,437 2.4 3.7 Interest payments 598 573 632 -4.2 10.4 Domestic 559 524 578 -6.2 10.2 External 38 48 55 25.6 13.3 Pensions 85 73 108 -13.8 48.6 Grant 116 156 160 34.3 2.6 Defense 295 330 303 11.6 -8.0 Public Order and Safety 39 44 47 12.9 7.3 Health & education 32 33 37 2.8 12.4 Others 189 178 149 -5.6 -16.3 Provincial 535 535 668 0.0 24.9 Development 245 321 426 30.9 32.6 PSDP 215 269 378 25.6 40.3 Federal 121 126 156 4.1 24.2 Provincial 94 144 222 53.2 54.4 Other dev. Expenditures 31 52 48 68.3 -7.2 - Net-lending 83 10 -2 -88.4 119.0 Source: Ministry of Finance Consolidated Sluggish growth in recurrent spending at the federal level remained the key factor government behind the success of the consolidation effort. Total expenditure of the spending growth consolidated government during H1FY16 grew at a moderate 8.1 percent or was restrained, slightly above the 5.6 percent growth registered during the same period last year. driven largely by This reflected tight control by the federal government, whose recurrent federal discipline expenditure grew by less than 5 percent for the second consecutive year. in recurrent Although interest payments and pensions grew more quickly during H1FY16 spending compared to same period last year, federal grants (to SoE’s and provinces) 17, defense spending, and public order and safety expenditures remained almost at the same level as last year. The consolidation effort was further supported by a decline in the subsidy bill—which was Rs. 35 billion lower than the same period last year. It is important to note that this marks the fourth consecutive year of decline in the subsidy bill—from 0.7 percent of GDP in H1FY13 to 0.27 percent of GDP in H1FY16. On the other hand, in a clear break from past trend, the federal government continue to direct significant resources towards PSDP-related development spending. Federal PSDP during H1FY16 grew by 24 percent while provincial PSDP registered 54 percent growth. (See Section C4 for an exploration of the systemic challenges facing Punjab’s development budget 17 Reflecting lesser financial support for the SOEs. April 2016 THE WORLD BANK GROUP 9 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate process.) On the other hand, non-PSDP related development spending (comprising largely of Benazir income support program, which has a 60 percent share) remained under tight control with expenditure totaling Rs. 4 billion less than H1FY15. Looking at this trend, it is clear that expense under this category will remain underspent by Rs. 25-35 billion compared to the targeted allocation of Rs. 164 billion. The provincial The fiscal consolidation effort during H1FY16 continued to be supported by the governments have provincial governments, which registered a combined surplus of 0.5 percent of achieved a surplus GDP. Nevertheless, the budgeted assumption of Rs. 279 billion or 0.9 percent of of 0.5 percent of GDP surplus coming from the provinces at the end of FY16 is unrealistic given GDP, although provincial spending typically picks up during the third and last quarter of the fiscal this is likely to year. For example, the H1FY15 provincial surplus of 0.49 percent of GDP diminish diminished to a mere 0.01 percent of GDP by the end of the fiscal year. considerably Nonetheless, the existence of a provincial surplus in the first half of FY16 is before the end of noteworthy given the 50 percent growth in provincial PSDP. It is clear that, the fiscal year despite the ongoing consolidation effort, spending cuts are not falling disproportionally on the development side—which has been a practice in the past. This is a positive development and bodes well for providing necessary stimulus for the country’s sluggish growth. Total public debt As of end-December 2015, total public debt stood at 63.2 percent of GDP18, 1.9 has temporarily percentage points higher than the December 2014 stock of 61.3 percent (see increased, but is Figure 4) primarily due to temporary buildup of government deposits with SBP expected to decline during H1FY16. Thus, domestic debt dominated the stock in line with the past before the end of trend. On the other hand, foreign currency public debt increased marginally by 0.5 FY16 as fiscal percentage points during this period due to disbursements under multilateral consolidation loans, the ongoing IMF program 19, substantial commercial borrowings and a continues US$500 million Eurobond issued in September 2015. However, this trajectory is expected to return to a declining trend by the end of the fiscal year and continue thereafter as fiscal consolidation efforts continue and temporary factors subside. Figure 4: Trends in Public Debt External and domestic debt measured in Rs. Trillion (LHS) while public debt to GDP is measured in percent (RHS) Domestic External Public Debt to GDP (RHS) 20 70.0 18 FRDLA Threshold 16 65.0 14 12 60.0 10 8 55.0 6 4 50.0 2 0 45.0 FY14 FY15 FY11 FY12 FY13 FY15 FY16 H1- H1- Source: State Bank of Pakistan and staff calculations 18 The total public debt is still above the threshold of 60 percent stipulated under the Fiscal Responsibility & Debt Limitation Act 2005. 19 With the completion of IMF-SBA repayments, net flow in IMF debt during H1FY16 pertain to the 8 th and 9 th review disbursements under EFF. April 2016 THE WORLD BANK GROUP 10 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate 3. Trade and balance of payments Pakistan has A lower current improved its account deficit and Table 6: Balance of Payment Summary external position, relatively healthy US$ billion strengthening financial inflows H1FY15 H1FY16 i. Current account (A+B+C+D) -2.5 -1.5 foreign reserves contributed to a A. Trade balance -10.0 -9.3 and maintaining a sustained build-up of Export 12.2 10.8 surplus in the foreign exchange Import 22.1 20.1 capital and reserves during B. Services net -1.5 -1.0 financial account H1FY16. Exports of which: CSF 0.7 0.7 shrank as an uncertain C. Incom e net -2.3 -2.4 global economy D. Current transfers net 11.3 11.3 Of w hich Remittances 9.2 9.7 magnified existing ii. Capital and Financial A/c 2.9 4.2 internal bottlenecks. of which: Similarly, imports Direct investment 0.6 0.6 declined too —and by a Portfolio investment 1.2 0.2 larger margin in Other Investment Assets 0.2 -0.1 absolute terms—thus Other Investment Liabilities 1.8 3.2 resulting in a lower iii. Errors and omissions 0.1 -0.3 trade deficit. Receipts Overall balance 0.5 2.5 from the coalition SBP reserves (excl. CRR, sinking support fund and fund) 10.6 15.9 continued strong M emorandum Items Current A/c Balance (% of GDP) -0.9 -0.5 remittance inflows also Trade Account (% of GDP) -3.7 -3.1 supported a lower Financial & Capital A/c (% of GDP) 1.1 1.5 current account deficit Export growth % -2.4 -11.1 during H1FY16. This, Import growth % 4.6 -9.1 coupled with healthy Remittance growth % 17.5 6.2 inflows in the capital Source: State Bank of Pakistan and financial account, resulted in reserve accumulation, and stability in the foreign exchange market. The current The current account deficit (CAD) amounted to 0.5 percent of GDP in account deficit is H1FY16—narrowing to almost half of the last year’s level (see Table 6). narrowing due to a The trade deficit, which was lower by US$ 0.7 billion compared to same fall in imports, period of FY15, was the main contributor (see Table 6). Exports declined fast-growing by 11.1 percent during H1FY16, compared with a 9.1 percent drop in remittances and imports which was larger in absolute terms, thereby reducing the trade coalition support deficit. Worker remittances grew by 6.2 percent during the period and more fund inflows than compensated for the negative trade balance in absolute terms. These, together with about US$ 0.7 billion coalition support fund inflows, supported the improvement in overall CAD. Imports declined The significant contraction in the overall imports bill by 9.8 percent during due to cheaper H1FY16 was largely an impact of the decline in international commodity prices, international oil especially crude oil.20 The country was able to save around US$ 3.2 billion in the 20 Arabian light crude oil was around $90/barrel on average in H1FY15 and fell to $44/barrel in H1FY16 April 2016 THE WORLD BANK GROUP 11 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate prices, in spite of ‘crude oil and products’ category during H1FY16 compared to H1FY15. While Pakistan importing prices declined, Pakistan imported larger quantities of petroleum products and larger quantities of crude oil, which grew by 9 and 24 percent respectively (see Figure 5). petroleum and Nonetheless, the savings realized from imports of petroleum are neutralized by an crude oil increase in the import bill from the non-oil segment (see Figure 6). This category grew by 7.3 percent in H1FY16, though at a slower pace than H1FY15. This growth mainly came from a significant increase in imports of soybean oil by 82 percent and raw cotton by 197 percent21, followed by power and electricity generation machinery, fertilizer and insecticide. On the other hand, textile items, construction and office machinery, transport group, iron and steel scrap, jute, rubber and paper product witnessed a fall during the period under review. 22 Exports also The decline in exports is broad-based. Exports fell significantly by 11.1 percent declined, led by mainly due to weak performance of the textile sector and food 23 exports. The textile exports decline was also observed in exports of petroleum, carpets, leather manufactures, which suffered sports goods, chemical and pharmaceutical, engineering, furniture, and cement. from weak Textile exports—with around 60 percent share in total export in H1FY16 — fell economies in significantly by 4.5 percent, particularly in the high value-added segment. destination Despite duty-free access to the European markets under the GSP Plus scheme, markets and high value-added textile exports witnessed a fall of 0.3 percent against a healthy domestic growth of 9.5 percent in the comparable FY15 period. This decline reflected the bottlenecks weak economic situation in destination markets as well as persistent structural bottlenecks in the domestic economy. (See Section C1 for further discussion on export competitiveness.) Pakistan’s exports Pakistan’s exports are highly concentrated in terms of destination markets. And are highly although Pakistan’s export products are relatively diversified relative to peer concentrated in countries,24 roughly 60 percent of its export earnings are comprised of textiles and textiles and US that share has remained stagnant over many years. The other three major and European components are leather products, rice and chemical and pharmaceutical products, markets which together contribute about 17 percent of total exports. Pakistan has not made much progress in diversifying the number of products it exports (see Figure 7). In addition, its exports are highly concentrated to few destination markets. About 63 percent of Pakistan’s exports’ are destined to be sold to ten countries—US, China, UAE, Afghanistan, UK, Germany, France, Bangladesh, Italy and Spain—and over time, the share of exports to these countries has largely remained stagnant (see Figure 8). Among these countries, the highest export earnings come from USA (18 percent) and European countries (20 percent), which together comprise approximately one-third of the total. China, with a 9 percent share of total exports, has recently become an important trading partner (see Section C1). 21 There has been sharp increase in imports of raw cotton after slump in domestic production —especially in Punjab. Unfavorable weather and pest attack across the cotton growing areas caused this fall in production. Pakistan imported US$ 434 million worth of raw cotton during H1FY16 compared to US$ 146 million in H1FY15. 22 Specifically, a decline was observed in iron and steel scrap (-12 percent), jute (-14 percent), rubber crude (-8.2 percent), paper products (-4 percent) and construction machinery (-16.4 percent). 23 Rice export — constituting 50 percent of food group exports — declined by 13 percent due to cheaper supplies from India. Basmati rice export was particularly affected with a decline of 31 percent. 24 According to the Herfindahl Index. Source: Reis & Taglioni, 2013, Determinants of export growth at the extensive and intensive margins: evidence from product and firm-level data for Pakistan April 2016 THE WORLD BANK GROUP 12 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate Figure 5: Price & quantum effect on imports in Figure 6: Oil and non-oil contribution to import H1FY16 growth US $ million Measured in percent Quantum impact Price impact Oil Imports Non-oil Imports 1,000 Import Growth 500 10.0 0 -500 5.0 -1,000 -1,500 0.0 -2,000 H1FY13 H1FY14 H1FY15 H1FY16 -2,500 -5.0 Raw Cotto n Iron & Ste el S cra p Soyabe an Oil Syn Fib er and Silk Y arn Palm Oil Petrolu em Pro ducts Petrolu em Crude Fertilize r -10.0 -15.0 -20.0 Non-oi l Imports Petrolu em Source: State Bank of Pakistan Source: State Bank of Pakistan Figure 7: Export Shares by commodity Figure 8: Export Shares by Destination Measured in percent Measured in percent FY04 FY08 FY12 FY16 FY04 FY08 FY12 FY16 70% 35% 60% 30% 50% 40% 25% 30% 20% 20% 10% 15% 0% Mineral products Vegetable products Chemicals & 10% Prepared foodstuffs Textiles and articles Other Misc. manufactured Raw hide and Plastic and rubber products leather 5% 0% Gulf & China USA EU Others Saudi Arabia Source: State Bank of Pakistan Source: State Bank of Pakistan Pakistan’s highly The combination of a narrow product base and so few destination markets means concentrated that Pakistan exports are very vulnerable to exogenous shocks. During H1FY16, exports are Pakistan’s exports to most of its destination markets have shrunk—particularly particularly those to EU, UAE, and China. According to the World Economic Outlook vulnerable to the (WEO), the Chinese economy is projected to slow further to 6 percent in 2016 slow growth in key and 2017 from its current 6.8 percent growth. So Pakistan’s exports to China, markets and falling which have declined by about 10 percent during H1FY16 compared to the same April 2016 THE WORLD BANK GROUP 13 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate cotton and rice period of last year, are likely to decline further. Similarly, economic growth in the prices EU is not projected to accelerate from its current level of about 2 percent in medium-term, which will limit Pakistan’s potential for export growth. The share of exports to the UAE witnessed a decline in recent years from 8 percent in FY12 to 5 percent during the current fiscal year. Furthermore, global prices of cotton and rice —significant export products for Pakistan—are under pressure. Textile exports have also fallen in price and quantity, mostly due to weakening global demand and constrained domestic textile production. Pakistan’s Real Effective Exchange Rate (REER) is also appreciating compared to its comparators, which may be amplifying the effects of the global slowdown and domestic challenges. Remittances are a Current transfers (mainly remittances) continue to grow steadily. During H1FY16, substantial source current transfers increased to US$ 11.3 billion, mainly on the back of workers’ of foreign remittances, which posted a growth of 6.2 percent and reached US$ 9.7 billion, exchange inflows, compared ith US$ 9.2 billion during the same period in the preceding year. funding the trade Growth in remittances from all major countries, including Saudi Arabia, UAE, deficit and UK and other GCC countries (Bahrain, Qatar and Oman) increased —albeit at a comprising about slower pace than H1FY15. Workers’ remittances remained a source of comfort 7 percent of GDP for the overall external position as they financed almost 50 percent of the import in FY15 bill and more than compensated for the overall merchandise trade deficit. Remittances in Pakistan amounted to about 7 percent of GDP in FY15 and are one of the largest sources of non-debt creating foreign exchange inflows.25 If oil prices remain About two thirds of remittance inflows to Pakistan are from GCC countries, and low, it is likely that are currently facing downside risks. There is continuous emigration from Pakistan GCC countries will to these countries which, coupled with large public spending in GCC economies cut public due to high oil prices in the recent past, has supported rising remittance flows (see expenditure and Figure 9). However, many of these oil-dependent economies are now under fiscal drive down stress due to much lower international oil prices.26, 27 Given oil prices are expected remittance inflows to remain low for some time, the possibility of a further cut in public expenditure to Pakistan in GCCs is an important downside risk for Pakistan’s remittance flows. GCC countries were historically able to sustain their public spending in a temporary low oil price environment by drawing on reserves. However, a persistent low oil price may force some GCC countries to dramatically revise their public investments. This occurred between the late 1980’s and the early 2000’s, when oil prices remained very low and drove down remittances flows to Pakistan from Saudi Arabia and the UAE (see Figure 10). 25 Remittances in Pakistan not only support the overall current account but have also contributed significantly to supporting private consumption and poverty alleviation. Households that receive remittances tent to increase spending on health and education. 26 In 2016, Saudi Arabia is expected to post a fiscal deficit of 16.3 percent of GDP, with Qatar and Kuwait also likely to post deficits of 5.0 and 5.2 percent respectively. Source: 2016 Macroeconomic and Poverty Outlooks for relevant countries 27 Recent reports even suggest the Saudi Arabia Ministry of Labor has banned foreigners from working in mobile phone sales in an effort to create jobs for Saudis, and is considering similar bans in other industries. Source: http://www.reuters.com/article/saudi-labour-idUSL5N16G596 April 2016 THE WORLD BANK GROUP 14 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate Figure 9: Pakistani Migrants to Saudi Arabia and Figure: 10: Remittance outflow to Pakistan from the UAE Saudi Arabia and the UAE Number of people Remittance outflows (US$ million, LHS) and oil prices (US$/bbl, RHS) Migrants to Saudi Arabia Saudi Arabia (US$ million) Migrants to United Arab Emirates United Arab Emirates (US$ million) 600,000 Oil Price (US$/bbl, RHS) 500,000 6000 5000 400,000 4000 300,000 3000 200,000 2000 100,000 1000 - 0 1976 1991 2000 2006 2015 1970 1973 1979 1982 1985 1988 1994 1997 2003 2009 2012 Source: Bureau of Emigration and Overseas Employment Sources : Remittance data are from State Bank of Pakistan. Oil price is the average crude oil price from World Bank Commodity Price data The capital and The capital and financial account posted a surplus of US$ 4.2 billion in H1FY16, financial account higher than last year’s US$ 2.9 billion. This moderate improvement was driven by posted a surplus, issuance of US$ 0.5 billion worth of Euro bonds in international market28 and although foreign significant loans from IFIs (including US$ 756 million from WB). The country investment attracted FDI amounting to US$ 618 million compared to US$ 557 million in the remains subdued corresponding period of H1FY15, primarily on account of inflows from China under China-Pakistan Economic Corridor (CPEC) and concentrated in electricity generation and oil and gas exploration29. However, FDI from other countries has dried up, likely due to global economic uncertainty. In addition, the energy crisis and weak business environment have contributed towards investors’ dampening sentiments and slowdown in foreign investment. Overall, FDI continues to be a concern, remaining stagnant as a percentage of GDP. Increased reserves Official reserves reached US$ 15.9 billion by end-December 2015, an increase of have improved US$ 2.2 billion in first six months of FY16. The Rupee remained largely stable sentiment on the against the US dollar as a result of the foreign exchange market reacting positively foreign exchange to the build-up of reserves, with a small depreciation of 2.8 percent during market H1FY16. In addition, successful continuation of the IMF’s EFF program has also improved sentiment in the foreign exchange market. With a relatively stable nominal exchange rate against the US dollar and inflation that is stable in comparison to peer countries, Pakistan’s real effective exchange rate (REER) has appreciated in recent times and has perhaps contributed to declining competitiveness for exporters. 28 Pakistan was able to enter the international bond market and raised about US$ 500 million. 29 More FDI is expected from China under CPEC in coming years, and power and construction will likely be the main recipient. April 2016 THE WORLD BANK GROUP 15 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 4. Monetary, finance sector and inflation update The first half of While the government’s fiscal consolidation efforts are likely to increase pressur e FY16 saw largely on banks’ profitability, they are good news for the rest of the economy. Private positive sector credit has expanded significantly, with loans for both long-term investment developments in purposes and working capital more than doubling in the first half of FY16 the financial sector compared with H1FY15. Non-performing loans are also falling for both SMEs and consumers. Monetary easing has significantly reduced the average lending rate, although an uptick in inflation is likely to foreshadow a less accommodating monetary stance in the future. The financial sector is likely to grow more slowly going forward, reflecting the recovery in the real economy rather than a continuation of the historic boost from growth in government borrowing. Monetary easing Following a 350 basis points cut in FY15, continued improvement in has continued in macroeconomic fundamentals during the first six months of FY16 has led to a cut FY16 in the policy rate by 50 basis points30, resulting in a decade’s low policy rate of 6.0 percent31. However, headline inflation has started inching up since October 2015 (y-o-y) and has thus halted the declining trajectory of the policy rate. Monetary Monetary aggregates increased sharply in H1FY16. This was driven by unusually aggregates grew high seasonal demand for currency in Q1FY16 due to the two Eid festivals, 32 a substantially higher volume of cash transactions in anticipation of the government’s imposition of withholding tax on non-cash banking transactions33 and heavy injections in the interbank market (explained below). While reserve money accelerated to 25 percent in H1FY16, broad money supply grew by 13 percent during the same period compared with 10.9 percent in H1FY15. A visible improvement in the external account led to a sharp increase in the net foreign assets (NFA) of the banking system. The NFA of the central bank in H1FY16 expanded to almost three times that of the corresponding period of last financial year. This was primarily influenced by substantial official financial inflows34 during the period under review. On the other hand, the government’s retirement of funds to SBP for budgetary borrowing limited the growth in net domestic assets (NDA)35 and also resulted in meeting the net quarterly zero borrowing limit from the central bank under the SBP Act. This was more than substituted by sizeable borrowings from the scheduled banks, in continuation of last year’s trend, expanding the NDA of scheduled banks by 6.8 percent in December 2015 (y-o-y). Despite this, the overall amount of government borrowing from the banking system was down by Rs. 22 billion during H1FY16 compared to same period previous year, 30 The central bank decreased the policy rate from 6.5 percent to 6.0 percent in one of the three Monetary Policy Statements announced during H1FY16 (September 2015). 31 Before this, the lowest discount rate in Pakistan’s recent history was around 7.5 percent in November 2002. 32 Eid al-Fitr and Eid al-Adha are Muslim festivals, for which many Pakistanis travel to celebrate with their families. 33 In a bid to bring non-compliant taxpayers into the tax net, the government in the Federal Budget 2015/2016 imposed 0.6 percent withholding tax rate w.e.f. July 01, 2015 (from existing 0.3 percent) on such transactions. 34 These include, more notably, CSF inflows, US$ 500 million Eurobond, Second Power Sector Reform DPC, debt-creating inflows from China; and disbursements on commercial borrowing amounting to almost US$ 1 billion under Syndicated Finance Facilities by Credit Suisse and UBL, a Murabaha facility by Noor Bank, and oil import financing by Dubai Bank. 35 NDA of central bank amounted to Rs. 133.6 billion during H1FY16. April 2016 THE WORLD BANK GROUP 16 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate reflecting continued fiscal consolidation efforts. In a positive development, private sector credit also contributed to an increase in the NDA in H1FY16 36 (see Table 7). Market liquidity To ensure the overnight rates adjusted to the policy rate37 and neutralize the concerns were impact of high budgetary borrowing from the scheduled banks on interbank largely eased by liquidity, the central bank continued with open market operations (OMOs) during central bank FY16, averaging around Rs. 709 billion of injections38 (see Figure 11). This liquidity injections window also allowed the banking sector to extend credit to the government comfortably, given OMO cut-off rates stayed mostly above the policy rate and lower than Treasury bill yields. Weighted average yields (WAY) on T-bills have historically remained below the policy rate, however, after May 25, these have largely remained close to the interest rate corridor ceiling rate (see Figure 12). Moreover, the WAYs on 3-month and 6-month T-bills declined by 2.0 percentage points and 1.7 percentage points respectively39 in line with the decline in policy rate. Table 7: Monetary Aggregates (Flows during July - December) Rs. billion FY15 FY16 Net Foreign Assets 49 151 of w hich: SBP 67 180 Net Domestic Assets 394 329 Government borrowing: 191 152 Budgetary borrowing 216 194 from SBP -405 -436 from Scheduled banks 621 630 Commodity operations -26 -42 Non-govt. sector borrowing: 203 177 Private sector 222 353 Public Sector Enterprises 52 1 Other Items -71 -177 M2 443 480 Growth (YoY) 10.9 13.0 RM -80 334 Growth (YoY) 2.0 25.1 Currency in circulation 124 325 Demand and Time Deposits 343 270 Source: State Bank of Pakistan 36 Credit to private sector amounted to Rs. 353 billion during July-December 2015, thereby posting a hefty growth of 60 percent compared to same period previous year. More recently, it has grown by 9.85 percent (y-o-y) as of March 04, 2016 as compared to an almost 50 percent contraction witnessed as of March 06, 2015. 37 Under the newly-introduced SBP Target Rate (the policy rate) w.e.f. May 25, 2016 within the interest rate corridor (IRC). 38 During July 1, 2015-March 18, 2016 as opposed to an average of Rs. 226 billion during the same period last year. 39 As of March 16, 2016 (y-o-y). April 2016 THE WORLD BANK GROUP 17 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 11: Liquidity injections increased through Figure 12: T-bills WAYs remained above the policy OMOs rate Rates measured in percent (LHS), injections and mop-ups Measured in percent measured in Rs. billions (RHS) Mop-ups Injections 3‐ M 6‐ M W/A Overnight Rate Reverse Rep Rate 12‐ M SBP Target Rate Repo Rate SBP Target Rate Reverse Repo 12 1,600 10.5% 1,400 10.0% 10 1,200 9.5% 8 1,000 9.0% 800 8.5% 6 600 8.0% 400 7.5% 4 7.0% 200 6.5% 2 0 6.0% -200 5.5% 29‐ Apr ‐ 15 20‐ Aug‐ 14 04‐ Feb‐ 15 18‐ Mar ‐ 15 17‐ Feb‐ 16 14‐ Oct‐ 15 02‐ Oct‐ 14 24‐ Dec ‐ 14 25‐ Nov ‐ 15 12‐ Nov ‐ 14 02‐ Sep‐ 15 10‐ Jun‐ 15 06‐ Jan‐ 16 09‐ Jul‐ 14 22‐ Jul‐ 15 0 -400 May-15 Jan-16 Jan-15 Mar-15 Mar-16 Jul-14 Jul-15 Nov-15 Nov-14 Sep-15 Sep-14 Source: State Bank of Pakistan Source: State Bank of Pakistan The government’s Demand for government securities remained high and was matched by adequate budgetary supply. However, both the auction profile of T-bills and Pakistan Investment borrowing needs Bonds (PIBs) exhibited a shift of the market towards the shorter end of the were largely met sovereign yield curve in Q2FY16 due to the increase in inflation and an associated by medium-to- expectation of monetary tightening. The market offered the most for the 12- long term market month T-bill in Q1FY16 but offers declined in the second quarter,40 leaving the instruments government able to realize only around 75 percent of the target during that quarter (see Figure 13). Acceptance of T-bills during H1FY16 was just sufficient to roll-over due maturities. Thus, in order to meet financing needs, the government resorted to PIBs – where the market response was overwhelming – by accepting more than the initial targets in the second quarter while clinging to the pre-auction targets during Q1FY1641 at lower yields42. In this segment, a change in bid pattern was also witnessed. During both quarters, the market’s interest almost disappeared in 10-year paper and more than doubled in 5-year bonds43 (see Figure 14). 40 The bid pattern was somehow evenly distributed amongst the three tenors during Q1FY16 – mostly in the longest 12-month tenor (40 percent) followed by 36 percent offers in the 6-month paper – allowing the government to accept almost the same pattern and, in parallel, achieve a little above the targets announced for the quarter. In contrast, almost 45 percent of the bids were received in the shortest tenor of 3-months during Q2FY16 and, subsequently, the government mopped up the realized amounts in a way that reduced the acceptance-to-offer ratio by almost half compared to the previous quarter. 41 Against a target of Rs. 200 billion for Q1FY16, the market offered to the tune of almost 4 times and the government comfortably accepted the amounts in line with the targets. For Q2FY16, almost similar pattern was observed and the government, in a bid to compensate for the below -target realization under T-bills during the same quarter, accepted almost 116 percent of the pre-announced targets. 42 The WAYs on 3-, 5- and 10-year PIBs declined by 220, 210 and 150 basis points respectively as of February 25, 2016 (y-o-y). 43 The market offered almost 36 percent in the 5-year paper during H1FY16, in comparison to 18 percent during the same period last year. On the contrary, only 5 percent bids were received in the 10 -year PIB April 2016 THE WORLD BANK GROUP 18 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate Figure 13: T-bill auctions were held largely to Figure 14: PIBs were the preferred instrument for both cover maturities the market and the government Rs. billion Rs. billion 3-Y 5-Y 10-Y Target 3-M 6-M 12-M Target 1,400 400 350 1,200 300 1,000 250 800 200 600 150 400 100 200 50 - - Q1-FY15 Q2-FY15 Q1-FY16 Q2-FY16 Q1-FY15 Q2-FY15 Q1-FY16 Q2-FY16 Source: State Bank of Pakistan Source: State Bank of Pakistan Fiscal The interest environment has eased with the weighted average lending rate on consolidation incremental borrowing down tot 7.3 percent in December 2015 compared to 10.3 efforts and percent a year ago. In addition, the government’s incremental borrowing structural reforms requirements have reduced due to fiscal consolidation efforts, allowing more are yielding early liquidity to potentially be available for the private sector. There are early signs of results, with constraints easing from the government’s effort to address structural weaknesses private sector of the economy like power shortages, and law and order. As a result, private credit increasing sector credit has grown by 9.7 percent as of March 11, 2016 (y-o-y)44. Much of the almost 10 percent, increase among private sector businesses is stemming from the manufacturing year on year sector (particularly chemicals and textile) and construction. Another positive development is the increase in credit for long-term investment purposes, notably in transport45 and electricity sectors, by Rs. 91 billion in H1FY15 compared to Rs. 37 billion in the same period last year, followed by working capital loans that have doubled during this time (see Table 8). On the other hand, consumer financing, while recording a net contraction of 7 percent during H1FY16 as compared to the same period last year due to retiring personal loans46, has seen a revival in house building loans probably due to healthy construction activity and a rise in auto financing. The banking The key driver of robustness in the banking sector has been a shift in risk system remains behavior of banks from private sector loans to risk-free government securities. robust based on The banking sector has achieved sizable growth, driven primarily by increased standard solvency government borrowing. Commercial banks hold about Rs. 6.1 trillion of indicators, largely government domestic debt as of December 2015, which is about 43 percent of as opposed to 24 percent offers in H1FY15. The market interest for 3-year paper remained intact at almost 60 percent. 44 The private sector credit contracted by 48 percent same date last March (y-o-y). 45 Primarily due to land transport for construction and road network under China Pakistan Economic Corridor (CPEC). 46 Almost Rs. 6 billion were retired during H1FY16 as opposed to disbursements of almost Rs. 5 billion issued during H1FY15. April 2016 THE WORLD BANK GROUP 19 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate because of total assets (see Figure 15). Furthermore, investments in government securities government constitute approximately 90 percent of total banking system investments. As a borrowing result of zero risk-rating of government debt for capital adequacy purposes, this significantly reduces the risk-weighted assets of the banking system. For purposes of comparison, the capital to total assets ratio has declined from 10.0 percent to 8.4 percent during January-December 2015, while the capital adequacy ratio has increased from 17.1 percent to 17.3 percent during the same period. Table 8: Loans to Private Sector by Sector Flows during Jul-Dec, Rs. billion FY15 FY16 Loans to private sector businesses (a…+...h) 210 277 By sector: a. Agriculture 18 18 b. Manufacturing 119 158 Textile 60 75 Wearing apparel, readymade garments 4 2 Automobiles 2 2 Food products and beverages 15 5 Chemicals 4 41 Leather 3 (3) Others 30 34 c. Electricity, gas and w ater (4) 20 d. Ship breaking 7 (6) e. Construction 12 21 f. Commerce and trade 18 15 g. Transport, storage and communication 10 13 h. Others businesses 29 38 By type: Trade financing 86 55 Working capital 77 163 Fixed investment 37 91 Source: State Bank of Pakistan SME credit growth In another positive sign, there has been a moderate increase in credit to SMEs47 is recovering and since 2014, after a downward trend over the preceding five years. Non- non-performing performing loans (NPLs) have declined to 11.4 percent of the overall loan loans are falling in portfolio. Because of adequate provisioning, net NPLs also continued to decline, SME and reaching 1.9 percent in December 2015. Year on year, NPLs in small and medium consumer sectors enterprises (SMEs) decreased from 30.5 percent to 26.1 percent of all loans and NPLs in the consumer sector decreased from 11.6 percent to 8.7 percent during January-December 2015 (see Table 9). 47 Advances to SMEs amounted to Rs. 22.6 billion during H1FY16 as compared to Rs. 18 .5 billion during the same period last year, exhibiting a y-o-y growth of 3.7 percent. April 2016 THE WORLD BANK GROUP 20 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate Figure 15: Commercial banks’ exposure to government Table 9: Selected Key Indicators of the Banking debt has increased Sector Stock of government debt measured in Rs trillion (LHS) while Measured in Rs. billion commercial bank’s exposure to government debt as a proportion of total assets is measured in percent (RHS) Dec-14 Dec -15 Stock of government debt % of total assets Profit Before Tax ytd 247 329 7 50% Credit to Private Sector 3,552 3,880 43% 41% 45% ROA Before Tax (%) 2.2 2.5 6 36% 35% 40% ROE Before Tax (%) 24.3 25.8 5 31% 35% 26% Advances to Deposits Ratio (%) 48.2 46.4 4 30% 25% Liquid Assets/Deposits (%) 64.5 73.3 3 20% Capital Adequacy Ratio (%) 17.1 17.3 2 15% Gross NPLs to Loans (%) 12.3 11.4 10% 1 Net NPLs to Loans (%) 2.7 1.9 5% 6 month KIBOR (%) 10.2 6.5 0 0% FY11 FY12 FY13 FY14 FY15 Dec 2015 Source: State Bank of Pakistan Source: State Bank of Pakistan The equity Pakistan’s equity market exhibited pronounced volatility during 2015 with the market’s volatility KSE-100 Index increasing only 1 percent during the year compared to 25 percent has overshadowed in 2014. The index fluctuated by 20 percent of its value between 28,927 and its past upward 36,228 points as a result of changing expectations on monetary policy and equity momentum market reforms. Market capitalization grew to Rs. 7.4 trillion, of which foreign investors represent 10 percent. The corporate The corporate bond market experienced an increase in new listing of debt to bond market is Rs. 25 million in CY2015 from Rs. 15 billion in CY2014, however the number of showing modest new listings remained lackluster with only two new issues. The Islamic bond recovery, with market has shown promising signs in the domestic corporate debt market. In promising signs in February 2015, the capital market regulator issued Sukuk Rules aligned with the the Sukuk market Accounting and Auditing Organization for Islamic Finance Institutions, aiming to improve governance standards and strengthen domestic bonds’ appeal to international investors. Following the issuance of the new rules, Karachi-based utility K-Electric sold US$ 216 million worth of seven-year Islamic bonds, the largest listed corporate Sukuk in the country. The outlook for The financial sector has benefited significantly from the government’s he avy financial sector borrowing requirement amidst high interest rates in recent years. Profitability performance is remained high without affecting capital adequacy. However, as the government’s cautious at best borrowing declines and the interest rate remains low, the sector is expected to witness less profit on investments and will need to resort to relatively riskier asset classes. Subsequent growth in the sector is unlikely to be driven by government securities, but will reflect the slow recovery in the real economy. The integration of the three stock exchanges of the country to a consolidated Pakistan Stock Exchange (PSX) is now complete, but there is still uncertainty related to divestment of 40 percent of the PSX to a strategic investor in line with Stock Exchanges (Corporatisation, Demutualisation and Integration) Regulations 2012. April 2016 THE WORLD BANK GROUP 21 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate The debt market may potentially see a higher number of issuances since interest rates are low and there have been successful debt raisings in the past year. Inflation remains Continuing soft international commodity prices supported by prudent monetary low, albeit with a management throughout FY15 have allowed inflation to remain subdued albeit slight up-tick in with a slight increase in recent months (see Figures 16 and 17). Average inflation recent months rose slightly throughout the first eight months of FY16, registering 1.7 percent48 for Q1 before rising to 2.5 percent in Q2 and 3.7 percent in Q3. This trend indicates a pick-up in aggregate demand and improved supply conditions. Nevertheless, these inflation measures are still far lower than those witnessed in the same period last year.49 Figure 16: Y-o-y inflation indicators seem to Figure 17: ...however, 12-month moving average have bottomed out indicators have slowed down Measured in percent Measured in percent Trimmed Core (NFNE) Headline Trimmed Core (NFNE) Headline 9.0 10.0 8.0 9.0 7.0 8.0 6.0 7.0 6.0 5.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 0.0 0.0 May-15 Jan-15 Jun-15 Jan-16 Mar-15 Feb-15 Feb-16 Oct-14 Apr-15 Oct-15 Jul-14 Jul-15 Aug-14 Sep-14 Aug-15 Sep-15 Nov-14 Dec-14 Nov-15 Dec-15 May-15 Jan-15 Jan-16 Jun-15 Feb-15 Feb-16 Mar-15 Oct-14 Apr-15 Oct-15 Jul-14 Jul-15 Aug-14 Sep-14 Sep-15 Aug-15 Dec-14 Nov-14 Nov-15 Dec-15 Source: Pakistan Bureau of Statistics Source: State Bank of Pakistan … largely driven Moderate food inflation has been offset by falling transport prices, which are by both direct and likely to continue to contain inflation in the near future. Representing the largest indirect impact of weight in the CPI basket (almost 35 percent), food and non-alcoholic beverages food factors saw their prices increase by 2.5 percent y-o-y in February 2016.50 As a result, average food inflation for Q3FY16 increased to 3.3 percent compared to 1.8 percent in Q2FY16. This was driven by an increase in international tea prices, damage to the gram crop and higher federal excise duty on cigarettes. On the other hand, the transport group actually experienced deflation of 8.6 percent in Q2FY16 continuing in Q3FY16 at negative 5.5 percent owing to the lagged impact of two downward adjustments in petroleum prices in Q1FY16 followed by an upward adjustment in November 2015. As international commodity prices 48 CPI inflation reached a 12-year low of 1.3 percent in September 2015. 49 Headline inflation in Q1FY15 was 7.5 percent falling to 4.7 percent in Q2FY15. 50 The food items which witnessed the largest y-o-y price increases in February 2016 included onions (76.9 percent), pulse mash (52.8 percent), pulse gram (49.7 percent), besan (44.7 percent), tea (30.1 percent), and cigarettes (26.8 percent) – Pakistan Bureau of Statistics April 2016 THE WORLD BANK GROUP 22 Fro m stab ility to p ro sp erity Pakistan Devel o p m en t Up d ate (especially crude oil)51 continue to fall, allowing the government to pass on lower oil prices to domestic consumers in February and March 2016, motor vehicle fuel has fallen by a significant 11 percent in Q3FY16. This, together with an abundant stock of major food items, is likely to result in minimal inflation growth during the remaining months of FY16. The subdued inflation outlook is also supported by the results of the January 2016 IBA-SBP consumer confidence survey which depicts a significant decline in inflation expectations. 51 The price of brent crude continued inching down from US$ 62.34/bbl at start FY16 to US$ 34.20 in February 2016 before increasing slightly to US$ 39.07/bbl in March 2016. WTI crude fell from US$ 59.8/bbl to US$ 37.77/bbl in the same period – Commodity Markets, Prospects Group April 2016 THE WORLD BANK GROUP 23 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate B. Outlook and upcoming challenges 1. Outlook Global growth is Global growth in 2015 fell short of expectations at 2.4 percent, held back by weak expected to capital flows to emerging and developing countries, weak trade and low recover only commodity prices. A modest increase in global growth to 2.9 percent is expected in modestly 2016, but this is predicated on an orderly rebalancing in China, continued gains in high-income countries, a gradual tightening of financing conditions, and a stabilization of commodity prices. These projections are subject to substantial downside risks, such as a disorderly slowdown in major emerging market economies, particularly China, rising U.S. interest rates, tightening financing conditions, and persistently weak commodity prices. Lower growth and sharply lower commodity prices have narrowed the space for policymakers to respond, especially in commodity-exporting countries, should risks materialize. Pakistan’s mild The outlook for Pakistan from FY16 to FY19 is for moderately higher economic recovery is growth. GDP growth is projected to accelerate from 4.2 percent in FY15 to 4.5 expected to percent in FY16 and 5.1 percent by FY18. Growth acceleration will be gradual, continue driven by strengthening investment flows and productivity gains in services, large- scale manufacturing and construction. These sectors should benefit from decreased power load-shedding and improvements in the business climate, with construction April 2016 THE WORLD BANK GROUP 24 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate also profiting from the infrastructure and energy projects associated with the CPEC. Fiscal Fiscal consolidation and a positive external balance should improve financing consolidation conditions for the private sector. Provided the upcoming election season does not agenda is expected stall the fiscal consolidation effort, continued fiscal improvement is expected to to continue reduce the government’s borrowing needs, reversing the crowding out of private sector credit witnessed over the past few years and creating fiscal space for public investment. Successful fiscal consolidation, gradual rebuilding of the external position and lowering of the country’s risk are expected to facilitate external financing and enable the business environment to stimulate private financial flows. Investment is Gross fixed investment is expected to increase from 13.4 percent in FY15 to 14.1 expected to percent of GDP by FY18. Any demand-driven economic expansion as a result of increase, largely CPEC’s implementation is expected to be limited in the short-run as increased driven by the investment will likely be offset by a significant increase in imports. However, CPEC supply-side effects facilitated by higher power generation capacity and better infrastructure will be beneficial for economy in the medium- to long-term. While the overall China’s investment in coal-based power projects under the CPEC has supported external balance FDI inflows52. However, slower growth in China and weak global demand, will likely remain particularly in the EU, has taken a toll on exports53 in FY16, revealing Pakistan’s positive, the vulnerability to a narrow base and high concentration in few products and current account destinations54. Imports also contracted in early FY16 but seem to be recovering deficit is expected since November 2015, particularly in food and machinery. Resultantly, a decline in to rise exports in FY16 (followed by weak export growth forecasts for the next two years) and an expected increase in imports will weaken the trade balance. The current account deficit is projected to increase slightly to 1.3 percent by FY18. The outlook assumes prolonged low oil prices, and subsequently constrained growth in remittances of around 5.5 percent55, chiefly due to tightening fiscal policies of the Gulf, as well as no large volatility in exchange rates over this period. Financial flows, including strengthening FDI, are expected to augment foreign exchange reserves. Inflation is Inflation continues in single-digits but expectations are shifting towards a gradual expected to rise increase. CPI inflation (y-o-y) has started to rise since October 2015, which has moderated the pace of monetary easing in FY16 relative to last year. Going forward, inflation is expected to steadily rise as the base effect diminishes, domestic energy prices increase, and aggregate demand grows. This may lead to a gradual monetary tightening. 52 Almost 58 percent of the net inflows during July-February FY16 are from China, more than doubling the share of Chinese investment in a years’ time. 53 Merchandise exports have contracted by almost 10 percent during July -February FY16, compared to a contraction of 4 percent during same period last year. 54 Only 10 percent of countries and 3 percent of items account for 75 percent of merchandise exports value. 55 Against the historical 5-year average of 16 percent . April 2016 THE WORLD BANK GROUP 25 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Table 10: Key macroeconomic indicators 2013-2019 Measured in percent unless otherwise indicated 2013 2014 2015 e 2016 f 2017 f Real GDP growth, at constant market prices 4.4 4.7 5.5 4.5 4.8 Private Consumption 2.1 5.4 3.6 3.8 4.5 Government Consumption 10.1 1.5 16.0 6.0 6.2 Gross Fixed Capital 2.6 4.2 8.3 6.0 6.9 Investment Exports, Goods and Services 13.6 -1.6 -2.6 -10.2 -0.5 Imports, Goods and 1.8 0.2 -1.1 -7.7 2.4 Services Real GDP growth, at constant factor prices 3.7 4.0 4.2 4.5 4.8 Agriculture 2.7 2.7 2.9 2.1 2.6 Industry 0.6 4.5 3.6 4.8 5.1 Services 5.1 4.4 5.0 5.2 5.4 Inflation (Consumer Price Index) 7.4 8.6 4.5 4.0 4.5 Current Account Balance (% of GDP) -1.1 -1.3 -1.0 -1.1 -1.1 Financial and Capital Account (% of GDP) 0.4 3.0 2.0 1.8 1.4 Net Foreign Direct Investment (% of GDP) 0.5 0.6 0.3 0.3 0.4 Fiscal Balance (% of GDP) -8.4 -4.9 -5.3 -4.7 -4.4 Debt (% of GDP) 64.7 64.7 64.4 63.9 63.1 Primary Balance (% of -3.9 -0.3 -0.5 0.0 0.3 GDP) Source: World Bank staff estimates Notes: e = estimate, f = forecast The government Poverty has continued to decline in recent years. In a positive step, the government has updated the has recently adopted a new, more inclusive poverty line that uses a new poverty line and methodology and identifies almost 60 million people as targets for pro-poor and adopted a cost-of- inclusive development policies. The new poverty line uses a cost-of-basic-needs basic-needs approach, which captures both food and non-food needs and is the methodology methodology, in most common use. It is based on a minimum caloric intake of 2,350 calories per which has adult equivalent per day and yields a poverty line of Rs. 3030 per month for each identified a adult. The back-casting of the new line illustrates that the declining poverty trend poverty rate of since 2001 is strictly preserved on both the old and the new threshold. On the old about 30 percent threshold poverty fell from 35 percent in 2001 to about 9 percent in 2014. On the in FY14 new poverty line, poverty fell from 64 percent to about 30 percent between 2001 and 2014. The declining trend in poverty is likely to continue at least in the short- run, driven by moderate growth in remittances, low commodity prices and relatively low inflation. April 2016 THE WORLD BANK GROUP 26 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 2. Next steps on structural reform The economic Over the past two and a half years, Pakistan has successfully implemented an reform program of economic reform agenda with a strong focus on achieving macroeconomic the Government of stability. The external balance has been positive over the past two and a half Pakistan continues years and international reserves have steadily increased to over four months of to support imports. Fiscal deficits have also declined and debt continues on a downward growth—although trajectory. Growth remains well below potential, projected at 4.5 percent in more can be done FY16, although addressing some of the key constraints seems to have given a boost to large manufacturing and private sector credit is also beginning to grow. To build resilience in an environment of global uncertainty, Pakistan should continue to focus on a reform agenda that lifts investment and accelerates growth. Energy sector An overloaded electricity netw ork remains one of Pakistan’s key economic reforms are paying constraints, particularly affecting the manufacturing sector. Energy subsidies off —reflected in and the accumulation of arrears in the energy sector also pose fiscal costs and reduced load- risks, which are likely to increase when oil prices recover. Government efforts shedding, losses to reform the energy sector were laid out in a policy approved in July 2013, and subsidies and and include higher electricity tariffs while reducing subsidies and reforms to increased improve the technical and commercial efficiency of the distribution investment—but companies. The government has also managed to attract significant significant investments into electricity generation, mostly private, which should be investment needs complemented by investments in transmission and distribution, altogether remain close to US$ 60 billion. Investments in transmission will mostly be public, while investments in distribution should be carried out by the private sector after the privatization of the distribution companies. As well as In addition to following through with the privatization of the distribution privatization, there companies, renewed efforts will be needed to eliminate subsidies through the is a need to implementation of the circular debt action plan, the establishment of a eliminate wholesale market for power that increases competition and a revised regulatory subsidies and regime for transmission that facilitates private investment. Together these strengthen efforts will contribute to improving availability of electricity for consumers competition while also putting the sector in a much stronger footing (see Section C2). Tax revenues have At 11 percent in the past fiscal year, Pakistan has one of the lowest tax to continued to GDP ratios in the world. Significant efforts by the government have increased increase and are the tax to GDP ratio by 1.5 percentage points in only three years. Tax on track to reach administration reforms and the elimination of tax exemptions have 12 percent of GDP contributed most to this increase in tax revenues. Going forward, it will be by the end of the important to broaden the tax net. A very small number of Pakistani businesses fiscal year—but and people pay taxes. A recent scheme by the government to attract traders challenges remain into the tax net was met by limited take-up. Efforts may need to focus on in broadening the strengthening the authorities’ capacity to monitor and enforce compliance tax net through market analysis, access to data and information as well as increased recourse to tax compliance audits. This should be coupled with renewed efforts to improve governance and reduce corruption in tax administration, since many businesses argue that a corrupt tax administration is the main reason for not joining the tax net. April 2016 THE WORLD BANK GROUP 27 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Improving the Private investment remains relatively low, although the most recent FDI and business private sector credit numbers suggest a timid recovery. While there may be a environment will number of constraints to increase private sector investment, businesses often be key to complain about Pakistan’s investment climate. A number of indicators (e.g. the increasing private World Bank’s Doing Business Indicators) suggest that these complaints by the sector investment private sector reflect a weak, and over the past decade worsening, investment climate. Pakistan is currently ranked 138 out of 189 economies on the overall ease of doing business rankings in 2016, having fallen 62 ranks since 2008 and slipped across all Doing Business indicators. To reverse this trend, the Government of Pakistan, together with the provincial governments (since addressing many of the constraints that affect businesses are actually the responsibility of provincial governments), have jointly developed a time-bound action plan to improve the investment climate. This will come on top of recent efforts to address constraints for private sector investment, such as a heavy legislative agenda in the financial sector (Credit Bureau Act, amendments to the SECP Act, the Secured Transactions Bill as well as the Financial Institutions Amendment Bill) to improve access to finance as well as efforts by the FBR to simplify processes to pay taxes. April 2016 THE WORLD BANK GROUP 28 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 3. Risks and challenges Further slowdown Of all the countries in South Asia, Pakistan is most exposed to China. Almost 10 in China would be percent of Pakistan’s exports go to China, primarily raw materials like cotton yarn, a particular chromium ores, raw hides, marble and articles of copper. The slowdown in China concern is already impacting exports which shrank by 12.5 percent in the first eight months of FY16. Further slowdown in China could lead to a further decline. Pakistan expects to receive significant FDI from China under CPEC at a time when the Chinese economy is slowing down. The CPEC, if completed, could be a game changer for Pakistan, but is currently facing high political risks. Reliance on Pakistan remains one of the largest remittances destinations in the world, and remittances from remittances are the principal source of financing the trade deficit. More than 60 GCC is risky percent of Pakistan’s remittances originate from GCC countries, and this is a source of concern given oil price projections. Remittances from GCC countries have continued to grow in FY16 but at a much slower pace than before 56. Some of this deceleration is explained by the fact that remittances for Eid in 2014 and 2015 were both captured in FY15 statistics. But persistently low oil prices may eventually affect public investment in GCC countries, and therefore construction where many Pakistani migrants are employed. It will be important to monitor some of the drivers of remittances, such as government budgets in GCC countries and the resulting restrictions on foreign employment. In a sign of growing fiscal pressure, Bahrain, Oman, Saudi Arabia, UAE and Qatar are all expected to post fiscal deficits in 2016, likely reaching 16.3 percent of GDP for Saudi Arabia 57. Pakistan should also closely monitor oil price projections; expectations have lately been revised down to US$ 37 for 2016 from the earlier projected US$ 51 due to both supply (Iran, US) and demand factors (weak emerging markets growth). Elections in 2018 As the election year approaches in 2018, the government may find it difficult to pose a risk to fiscal implement difficult decisions, particularly on taxation and energy. This, combined reform with pre-election spending pressures, poses a risk to prudent fiscal policy. Job creation Pakistan’s success in poverty reduction is likely to falter if it is driven by should be the remittances or windfalls generated by low commodity prices. Sustainable poverty focus for poverty reduction, including the government’s focus on inclusion, requires investment and reduction job creation within the economy combined with efforts to substantially raise agricultural productivity. The high-growth The recent pickup in growth is encouraging, but at 4.2 percent it remains modest - potential can be not sufficient to create jobs for the large number of youth joining the work force unlocked every year, and significantly below the accelerated growth path that some countries have taken to become strong and confident middle income countries. GDP per capita in Pakistan only increased by about 50 percent over the past 25 years, which is far lower than most of its peers. GDP growth rates closer to those of China would quadruple Pakistan’s GDP per capita within a generation. Given the strong relationship between growth and poverty in Pakistan, strong growth would also allow Pakistan to eliminate extreme poverty within a generation. 56 Total remittances during the first eight months of FY16 grew by 6 percent as opposed to 17 percent growth witnessed same period last year. Remittances received from GCC countries grew by 8.7 percent compared to 21.8 percent expansion respectively. 57 World Bank, 2016, Macroeconomic and Poverty Outlook, Saudi Arabia April 2016 THE WORLD BANK GROUP 29 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate For this to occur, Pakistan will need to invest more to accelerate growth. Pakistan is investing only 15 investment is the percent of GDP, one of the lowest investment rates in the world, and about one key half the South Asia average. Current government efforts are geared towards addressing some of the constraints to increase investment, such as limited fiscal space for public investment, a weakening investment climate, significant electricity shortages and limited access to finance in order to create more and better jobs for the growing population of Pakistan. April 2016 THE WORLD BANK GROUP 30 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate C. Special sections 1. How can Pakistan improve its export competitiveness? Falling commodity prices and slowing global demand are creating strong headwinds for Pakistan’s export performance. The steady decline of Pakistan’s share of world trade (see Figure 20) suggests, however, that its poor export performance is primarily due to a deterioration of its export competitiveness. Diminished export competitiveness is an outcome of poor trade facilitation, logistics and infrastructure, a protectionist trade policy, and worsening investment climate.58 Export Export performance has been subpar when compared regionally and internationally, performance has both as a percentage of GDP and in absolute terms. In 2000, Pakistan’s trade-to- lagged behind GDP ratio was close to China’s. Over the past decade, China’s trade -to-GDP ratio others in the has doubled, while Pakistan’s ratio has increased by only 2.6 percentage points. region Pakistan also ‘under-trades’ relative to countries at comparable GDP per capita. Pakistan’s exports of goods and services rose from US$ 8.6 billion to US$ 19.9 billion (a mere 2.3 times) in 23 years from 1991 to 2014 while those of Bangladesh rose 22 times from just US$ 1.1 billion to US$ 24.3 billion. Over the same period, 58 This note was prepared by Rafay Khan (Research Analyst, T&C) and Connor Spreng (Senior Economist, T&C) April 2016 THE WORLD BANK GROUP 31 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Vietnam’s exports grew 33 fold, India’s grew 14.5 times and China’s by more than 25 times (see Figures 18 and 19). Figure 18: The gap between exports and imports has Figure 19: Pakistan has been overshadowed by been broadly growing59 competitors’ export performance (2004-2014) Rs. trillions Rs. trillions 55 Vietnam India Exports Imports Pakistan Thailand 50 350 45 300 40 250 35 200 30 150 25 20 100 15 50 10 0 Source: World Trade Organisation Source: World Trade Organisation Dismal export Lagging export performance is only partly explained by external factors (a fall in performance is global commodity prices and slowing global demand) and is more directly causing Pakistan attributable to Pakistan’s declining export competitiveness. Pakistan’s market share to lose market in world trade has been declining over the years, while that of Malaysia, Mexico, share in world and Thailand has doubled, and China’s tripled. Pakistan has lost 1.45 percent trade annually in export market share over the past decade. In an increasingly globalized world where 80 percent of global trade is carried out through global value chains, developing countries are increasingly focusing on trade competitiveness to exploit opportunities for growth and poverty reduction. Pakistan’s exports Diminished export competitiveness is also indicated through increased export are highly concentration and an export bundle comprised predominantly of labor-intensive concentrated and low-tech manufacturing. Pakistan’s export bundle is relatively diversified in geographically and terms of products60, but is concentrated at the market level leaving the country labor-intensive exposed to partner-specific shocks. Geographically, the European Union (EU) and United States (US) represent the most important destinations of Pakistan’s ex ports, with the US absorbing 18 percent and the EU absorbing 20 percent of all Pakistani exports. The technological content of Pakistani export is very low; high tech exports constituted less 2 percent of all exports in 2008. This share, for the most part, has remained unchanged over the past 25 years. Larger export firms (the top 1 percent of exporters account for approximately 45 percent of total export value) 59 Note that the trade deficit fell slightly in H1FY16, although much of this is attributable to a fall in the value of imports rather than export growth. See S ection A3 for further discussion of current external sector developments. 60 Source: Reis & Taglioni, 2013, Determinants of export growth at the extensive and intensive margins: evidence from product and firm-level data for Pakistan April 2016 THE WORLD BANK GROUP 32 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate are less likely to switch export strategies and primarily rely on intensive margins61 for growth, indicating a lack of dynamism. Figure 20: The Share of Pakistan Exports in World Trade has Declined (2004-2014) Measured in percent Pakistan Linear (Pakistan ) 15.5% 15.0% 14.5% 14.0% 13.5% 13.0% 12.5% 12.0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: World Trade Oraganization Declining trade The declining trend in Pakistan’s relative trade performance and export performance is competitiveness has structural underpinnings anchored in three areas: 1) trade explained by three facilitation, logistics and infrastructure; 2) trade policy; and 3) investment climate. structural factors The following paragraphs offer a brief discussion of each of the three areas. Slow processing Poor trade facilitation, logistics and infrastructure have inhibited export times and high competitiveness and trade growth. Presently, Pakistan’s logistics a re worse than costs translate to India’s and the South Asian and global averages. South Asia itself lags behind all uncompetitive regions except Sub-Saharan Africa. Given that more than 90 percent of Pakistan’s trade facilitation, international trade is transported by sea and 80 percent of land transport is over logistics and roads, there is a critical need to improve customs and border management for infrastructure lowering logistical costs, particularly port operations and customs procedures. A journey in Pakistan takes three times longer than the same length journey in Europe. The typical container dwell time at ports in Karachi (95 percent of Pakistan international trade currently goes through one of the two ports in Karachi) is 7 days, three times that of developed countries and East Asia. The vessel call charge in Karachi Port is nearly US$ 27,000, compared to US$ 2,975 in Singapore and US$ 2,890 in Dubai. Inefficient trade facilitation and logistics are leaving Pakistan at steep competitive disadvantage to regional competitors. As of 2015, border and documentary compliance to export from Karachi takes 141 hours, in contrast to 20 hours in OECD countries. Similarly, border and documentary compliance to import takes 294 hours, in contrast with 13 hours for OECD countries. Pakistan is Reducing trade costs, upgrading service quality, and improving connectivity seeking to improve between domestic and foreign markets can play a decisive role in attaining export trade facilitation competitiveness. Pakistan has initiated a series of reforms in recent years to but these efforts upgrade its trade facilitation and logistical infrastructure. However, these reforms 61 Level, growth and market share of existing exports April 2016 THE WORLD BANK GROUP 33 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate need to be will need to be sustained and synchronized with other efficiency enhancing efforts sustained to bear meaningful results. Protectionist trade Pakistan’s trade policy has reverted to protectionism over the past decade. The policy has limited country embarked on a major trade liberalization program in the mid-1990s which opportunities for resulted in reduced trade tariffs, simplification of the overall tariff structure, and participation in abolition of most quantitative restrictions. However, gains made in the 90s and global supply early 2000s have been gradually losing ground to import substitution policies that chains have discouraged exports. Pakistan is currently the world ’s seventh most protected economy as measured by the Overall Trade Restrictiveness Index (OTRI)62. Pakistan’s tariffs are almost twice as high as the world average and three times more than those in South East Asia. Given that 30 percent of international trade is now comprised of re-exports of intermediate goods, import duties on intermediate inputs used by exporters raise production costs and erode processing margins. Trade policy is Pakistan’s trade policy has grown increasingly co mplex and discretionary over growing in recent years. Both the overall level of tariffs as well as the range of different tariffs complexity… across sectors and products have increased over time. Services and basic raw materials are mostly free of import restrictions, and products at an intermediate stage of production have moderate tariff levels. By contrast, industries that are competing against imports, especially of finished products, are protected by very high tariff levels. Complexity in the tariff structure is primarily dr iven by Pakistan’s Indigenization Program, which seeks to control and limit the competition and new entrants in specific industries, including through limiting imports. These negative trends have seen some reversal over the past two years. The highest tariff rate has been brought down to 20 percent from 30 percent, and the government is also working on curtailing the use of tariff exemptions and targeted protective tariffs. …and institutional Institutional fragmentation within the government has been a challenge in fragmentation has streamlining the trade policy. Key policy level decisions linked to trade in Pakistan hindered any are in the domain of multiple government agencies, including the Ministry of moves to remove Commerce, Federal Board of Revenue and Ministry of Finance. Policy decisions the complexity in regarding, for example, exchange rate, taxes and refunds are presently driven by trade policy fiscal considerations. This partially explains the government’s insistence on maintaining tariffs at a high level given that import duties contribute close to 30 percent of Pakistan tax revenues, compared to 2.5 percent in Vietnam and an average of less than 5 percent for comparator countries. Conflict in implementing a coherent public policy is also evident in the delays in GST and duty drawback refunds. Pending sales tax refunds stood at Rs. 97 billion (US$ 970 million) in March 2015, creating a liquidity constraint for exporters. Pakistan’s poor Investment climate constraints (see Figure 21) continue to impede private sector investment climate growth, economic development and competitiveness in Pakistan. Pakistan ranks also affects its 138 out of 189 economies in the Doing Business Report 2016, having fallen 62 competitiveness ranks since 2008. Similarly, Pakistan also ranks 126 out of 148 economies in the World Economic Forum’s Global Competitiveness Index 2015 -16, a major fall from being 91 out of the 134 economies covered in 2006. The Doing An increasing cost of doing business in Pakistan, as measured across the three core Business dimensions of doing business (cost, time and steps), highlights the competitive 62 T he OTRI quantifies the uninform tariff that if imposed on home imports instead of the existing heterogeneous structure of protection would leave aggregate imports at their current level. April 2016 THE WORLD BANK GROUP 34 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate indicators reflect disadvantage of Pakistani businesses. It takes 19 days to start a business in the disadvantage Pakistan, in comparison to the South Asian average of 15.7 days and OECD faced by Pakistani average of 8.3. Over the last decade, frequency of tax payments for limited liability businesses companies in Pakistan has remained at 47, significantly higher than the South Asian average of 31 and the OECD average of 11 payments per year. The cost of getting an electricity connection for business establishments is approximately twenty times higher in Pakistan than in the OECD high-income countries. This cost has reduced from 1435 percent o f Pakistan’s income per capita in 2010 to 1225.5 percent in 2016, which is lower than the South Asian average of 1386 percent, but it still remains high for micro, small and medium sized enterprises. Figure 21: The time involved in doing business in Pakistan is much higher than elsewhere Measured in hours Source: Ease of Doing Business, World Bank The poor Pakistan’s worsening performance on indices measuring the overall investment investment climate climate in the country is reflective of the significant costs and perceived risks to is reflected in low investing and operating in Pakistan. This is evident in the declining investment in and declining Pakistan. Total investment as a percentage of gross domestic product (GDP) in investment Pakistan has declined from approximately 19 percent in 2006-07 to around 15 percent in 2014-15; the annual average for South Asia as a region is almost 33 percent. Private sector investment to GDP has almost halved over the last decade; from a high of approximately 16 percent in 2006 to less than 10 percent in 2015. In recognition of the importance for competitiveness of a conducive investment climate, the government is in the process of initiating a package of reforms at the national and sub-national levels to correct regulatory and institutional level bottlenecks. Pakistan can Pakistan needs to revitalize and enhance its export competitiveness in order for improve its volume exports to become a driver of economic growth. Increased export competitiveness and breadth of will not only allow Pakistan to strengthen its existing range of exports, but also to exports by expand its export basket and improve market diversification. There is a need to strengthening its institute an enabling environment to increase Pakistan’s export competitiveness. competitiveness This enabling environment, as a starting point, can be improved through the provision of adequate and efficient trade facilitation and logistical infrastructure, streamlining trade policy, and improving the investment climate. April 2016 THE WORLD BANK GROUP 35 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 2. Pakistan’s electricity sector reform—addressing the funding gap The Pakistan government plans to increase generation capacity by 33,000 MW to eliminate electricity shortages by 2025. The government has made substantial progress in securing the additional US$ 41 billion required for generation investment. But complementary investments of US$ 11 billion in transmission and US$ 6 billion in distribution are also needed (see Figure 25). Private funding will be imperative to closing this gap. To mobilize private investment, further reforms are vital to address the circular debt, create greater competition through the development of a wholesale market, privatize distribution and encourage private participation in transmission.63 The government is Electricity shortages have long been identified as a major constraint to economic pursuing a growth in Pakistan, and the current government has taken significant steps to dramatic increase improve supply. It has raised tariffs and reduced subsidies, while also making efforts in electricity to improve the technical and commercial efficiency of the electricity distribution generation companies (Discos). The government has announced that it is pursuing the development of several thousand megawatts (MW) of new generation capacity. This special section looks at the size and composition of the generation investment and the need for complementary investment in transmission and distribution, and finally highlights four key reforms needed to attract the necessary private capital. Electricity demand Peak demand for electricity rose from nearly 14,300 MW in 2005 to 20,300 MW in is projected to 2010 and nearly 28,000 MW in 2015. The system fell short of peak demand by 5,500 increase MW in the summer months of 2015. Demand is projected to continue to grow significantly between 2016 and 2025. Preliminary findings of a generation and transmission system expansion plan64 forecast peak demand to increase to over 37,000 MW in 2020 and 48,400 MW by 2025 (JICA 2015). Pakistan’s p rogram to increase electricity generation capacity to address its power shortage forecasts a net addition of addition of over 32,800 MW by 2025, sufficient to meet peak demand in that year (see Figure 22). Increased To deliver this program of increased generation capacity, some US$ 41 billion of generation is investment is needed between 2016 and 2020 (JICA 2015) and this fleet of new contingent on plants will depend upon: financing and fuel supplies  significantly increased natural gas supplies to come mainly through LNG imports (6,600 MW);  initial development of Thar coal fields (3,100 MW) as well as imported coal (4,600 MW);  additions from hydropower projects under construction (5,700 MW); and  additions to Pakistan’s nuclear power generation fleet (700 MW) as well as new solar (1,050 MW) and wind (1,825 MW) installations. 63 Thisnote was prepared by Richard Spencer (Lead Energy Specialist, Energy & Extractives) with inputs from Mohammed Saqib (Senior Energy Specialist, Energy & Extractives), Kazim Saeed, Umul Awan, Beatriz Arizu and Roberto D’Addario (Consulta nts, Energy & Extractives) 64 Prepared by the National Transmission and Despatch Company (NTDC) with support from the Japan International Cooperation Agency (JICA) April 2016 THE WORLD BANK GROUP 36 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 22: A mix of energy sources are planned to lift capacity to meet peak demand Energy sources’ additional generation capacity measured in MW (LHS) while capacity and peak demand a re measured in MW (RHS) Biogas/Biomass Hydro Nuclear Wind Furnace Oil Gas (Domestic) Gas (LNG) Solar Coal Available capacity Existing Capacity Peak Demand 10,000 60,000 8,000 50,000 40,000 6,000 30,000 4,000 20,000 2,000 10,000 0 0 2005 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: Japan International Cooperation Agency, 2015 Most of the For the 2016-2020 period, funding commitments of about US$ 36 billion have funding has been already been secured. Of this total, over two-thirds or nearly US$ 25 billion is secured for expected to come from the private sector (mostly from IPPs and some from K- expanding Electric). Most of the rest (nearly US$ 10 billion) is expected to be financed by the generation from federal government, donors and International Financial Institutions (IFIs). A similar 2016 to 2020 mix of investment sources is expected for the 2021-2025 period. But the electricity In recent years, the capacity constraints of Pakistan’s power transmission and transmission and distribution networks have become more visible. Figure 23 shows the number of distribution overloaded 11 kV feeders (which mainly serve neighborhoods) has increased by 57 networks are also percent between FY10 – FY14. During the same period, planned and forced overloaded outages of inter-city 220 kV and 500 kV transmission lines have increased by 49 percent (see Figure 24). A complementary An expansion of Pakistan’s generation capacity will require commensurate investment in upgrades to transmission and distribution networks. JICA estimates Pakistan must transmission is invest US$ 11.3 billion in transmission between 2016 and 2020. Against this need, required – but only only US$ 3.1 billion of funding is available: US$ 2.6 billion is committed from the a fraction of public sector and US$ 268 million from donors for the NTDC network. K-Electric necessary funding plans a little over US$ 400 million for its own transmission lines. There is, is available therefore, a substantial funding gap of US$ 8.2 billion for 2016-2020. Comparable NTDC expenditures on system expansion between 2010 and 2015 were around US$ 1 billion. Hence even if there is a substantial overestimate of the financing need for transmission expansion, it seems almost inevitable that there will be a significant shortfall. There is also a The investment needs in the distribution sub-system are smaller than those of sizeable funding generation, but the funding gap is a much larger proportion of the required funds gap facing the (see Figure 25). Figure 26 shows the actual investment by DISCOs in FY10- distribution sub- FY15 compared with the petitioned (and NEPRA-approved) investment level for system each year. It also shows the total investment requirement associated with the coming rise in generation capacity. In the 2016-2020 period, the JICA-projected investment requirement for distribution is US$ 5.6 billion. Against this April 2016 THE WORLD BANK GROUP 37 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate requirement, the estimated funding gap is about US$ 3.3 billion given a funding estimate of US$ 2.3 billion including consumer contributions. By comparison, the 2010-2015 period saw an investment of US$ 2.6 billion by the DISCOs compared to their own estimate of an investment need of US$ 3.9 billion. Figure 23: The number of overloaded feeders in Figure 24: …as has tripping in transmission lines transmission networks has increased… Measured in number of lines Measured in number of feeders PESCO IESCO GEPCO LESCO FESCO Planned Outages Forced Outages MEPCO HESCO SEPCO QESCO 700 600 500 326 355 400 381 314 300 304 200 1,025 1,009 611 673 675 100 0 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014 Source: National Electric Power Regulatory Authority State of Industry Report 2014 Private funding The large investment in generation is chiefly expected through private will be necessary participation. Investment in transmission is largely expected to come from public to close the sector financing but on present plans the amount available is likely to be funding gaps considerably less than that required. Whether there is adequate investment in facing the distribution hinges on the likelihood and timing of privatization, because the new transimission and owners of Discos will be required to implement investment programs as part of distribution sub- the conditions of purchase. It follows that if privatization is delayed, there will be systems continued dependence on public sector funding, which on present plans will be less than the amounts foreseen in the Discos’ five-year investment plans. Underinvestment will lead to a continuing shortage of transmission and distribution capacity. Not only will this result in poor reliability and quality of service, but it also implies that scarce resources will have been misallocated with too much allocated to generation assets and too few to transmission and distribution. If the investment in generation that is already committed is not to be under- utilized, there must be commensurate investment in transmission and distribution. Public sector funding is limited, and so there has to be a change in the way they are financed, which implies significant reform is required. Four reforms stand out as important and which require bold and timely actions. Reducing circular 1. Reducing circular debt: debt and The government has made serious efforts in the last year to reduce the eliminating accumulation of overdue payables – the circular debt – in the sector. By December subsidies will 2015, the stock of debt amounted to Rs. 326 billion and the flows had been make the sector reduced to zero. Nevertheless, there remain upward pressures on circular debt and April 2016 THE WORLD BANK GROUP 38 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate more attractive to as long as it remains or there is a risk of its re-emergence, the private sector will private investment hesitate to invest or seek guarantees from government. Hence continuing to implement the circular debt action plan65 remains of vital importance. Further efforts to eliminate subsidies will also be needed. A financially sustainable sector will provide significant comfort to all investors. Figure 25: The funding gap is a much greater proportion of the transmission and distribution investments $US billions Public funding (including donors) Private funding Funding gap 45 40 6 35 30 25 20 15 10 8 5 3.3 0 Generation Transmission Distribution Source: JICA Figure 26: A large funding gaps remains in distribution investment US$ millions Actual Investment by DISCOs Planned funding (PSDP, donors, KE) NEPRA Approved Investment Investment Required Amount Petitioned by DISCOs 1600 1400 1200 1000 800 600 400 200 0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 Source: NEPRA determinations, World Bank estimates and JICA Introducing 2. Creation of CPPA-G and establishment of a wholesale market for power: competition in Historically, NEPRA has regulated generation prices but the structures are now in generation would place that would allow a move towards regulation by competition. Competition improve service will improve service delivery and reduce costs. Initially this could be through a delivery and direct contract between a generator and a Disco. In addition, the Central Power reduce costs Purchasing Agency Guarantee Limited (CPPA-G) could act as an agent of one or 65 ‘Managing Circular Debt ’ – Ministry of Water and Power, Pakistan, September 2015 April 2016 THE WORLD BANK GROUP 39 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate more DISCOs. In the longer term, a wholesale market is envisaged. Wholesale competition gives greater freedom to investors while also reducing the demand for government guarantees. Essential next steps include further development of the commercial code to allow bulk power consumers to purchase power directly from generators, due consultation with all market participants, standardization of power purchase agreements that reflect the new arrangements, and transparency in the wholesale market cashflow management and in CPPA-G operation and reporting. Privatizing 3. Privatization of distribution: distribution Privatization of the Discos is expected to attract investment leading to sustainable companies would network improvement and expansion that will result in lower distribution losses, lead to network improved service quality for customers and greater commercial discipline in the improvements and sector. The privatization experience of K-Electric saw a reduction in transmission expansion and distribution losses of about 12 percent from FY09 to FY15, and there was a 60 percent reduction in transformer tripping from FY09 to FY15. Crucially, distribution network improvements will result in greater amounts of generated power reaching end consumers rather than being lost through inefficient equipment or being stolen. The government 4. Private sector participation in transmission: has started The government is now turning its thinking to how to bring private investment seeking private into transmission. In 2015 it introduced a transmission policy framework, which sector sets out a number of legal and regulatory requirements, and in August 2015, participation in NEPRA granted the first transmission license to a private company for a short transmission 132kV transmission line. It is now considering a tariff petition for a 600kV high voltage direct current transmission line. Further reforms To take full advantage of the potential for private investment in the transmission are necessary to segment, further refinements to the regulatory regime and the introduction of a maximise private more streamlined and predictable path to investment will be needed. These investment in include: a clear transmission investment plan to be developed based on an transmission optimized generation and transmission expansion plan; more transparent decisions on which new transmission investments (lines and/or substations) are to be solicited from the private sector; the private sector must be required to compete to build and operate the lines; and a regulatory approach must be adopted including establishing the tariffs, quality standards, and third party access to which the new operator will be subject. April 2016 THE WORLD BANK GROUP 40 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 3. The opportunities and challenges of Pakistan’s urbanization 250 million more people are expected to live in cities in South Asia over the next 15 years. Urbanization provides South Asian countries, including Pakistan, with the potential to transform their economies to join the ranks of richer nations in both prosperity and livability. A new World Bank report finds the region, while making strides, has struggled to make the most of the opportunity. Official statistics show that urbanization is occurring relatively slowly in the region, and particularly in Pakistan, suggesting that cities are struggling to overcome congestion forces. As a result, urbanization has been messy and hidden – manifesting in slums and urban sprawl, and growing most quickly outside metropolitan limits. To address these problems, Pakistan and the rest of South Asia should ensure that infrastructure, basic services and land and housing markets stay abreast of growing urban populations. This will require Pakistan to equip local governments with the discretion, resources and accountability to address local congestion challenges. It won’t be easy but such actions are essential in making cities prosperous and livable.66 Urbanization Urbanization provides South Asian countries with the potential to transform their presents an economies to join the ranks of richer nations in both prosperity and livability, but a opportunity for new World Bank report, Leveraging Urbanization in South Asia: Managing Spatial South Asia, Transformation for Prosperity and Livability, finds the region, while making strides, has including Pakistan struggled to make the most of the opportunity. With recent elections throughout Pakistan and a new mayor to be named in Karachi, the ability to concentrate on urban reforms with renewed energy is an opportunity that should not be squandered.67 The urbanization Pakistan has been presented with an enormous opportunity to boost its of vast numbers of development trajectory as its population urbanizes in vast numbers. Urbanization people can drive can foster productivity through the agglomeration of both people and enterprises in dramatic towns and cities. This can produce ‘agglomeration economies’, which include the productivity benefits arising from, for example, the spillover of ideas and knowledge between growth through firms and workers, the better matching of firms and workers, and the existence of the agglomeration dense networks of local suppliers of intermediate inputs. South Asia’s urban of people and population is poised to grow by almost 250 million people by 2030. This could enterprises propel the region toward greater economic growth and prosperity. But to realize these benefits, policymakers must effectively manage the congestion forces that can stifle the productivity benefits of urbanization and diminish liveability in cities and towns. Productivity gains Agglomeration economies do not accrue indefinitely. As settlements grow and rely on effective become more dense, pressures grow on infrastructure, basic services, land, housing management of and the environment. These congestion pressures undermine the exploitation of congestion forces agglomeration economies and the ability to compete in international export markets. An economy’s ability to access the potential gains from urbanization will depe nd on its management of these forces. The benefits of According to official figures, urbanization is occurring relatively slowly in Pakistan, urbanization are suggesting the potential economic benefits of the trend are not being fully realized. not being fully The share of the population living in officially classified urban settlements has been realized growing at only 0.80 percent a year from 2000 to 2010. Throughout South Asia the 66 This note was prepared by Jessica Schmidt (Urban Specialist, South Asia Urban Unit) with inputs from Peter Ellis (Lead Urban Economist) and Mark Roberts (Senior Urban Economist). 67 To learn more about Pakistan and the larger region’s urbanization past and future, please visit www.worldbank.org/southasiacities to read the full report. April 2016 THE WORLD BANK GROUP 41 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate share of the population in official settlements has grown by 1.1 percent a year. By contrast, when it was at a similar urbanization level, China’s urban share of population grew 3.1 percent a year, moving from 26.4 percent in 1990 to 35.9 percent in 2000. High urban The persistently high poverty rates in Figure 27: Urban Poverty Comparison for poverty rates South Asian cities are one indication Most Populous South Asian Countries suggest South that the economic benefits of Asia’s cities are agglomeration are eluding many not providing residents. Although progress since opportunities for 2000 has been impressive, South all Asian cities remain characterized by high levels of poverty, bad housing conditions, and generally poor livability for many of their inhabitants (see Figure 27). Around half of Pakistan’s urban population lives in slums. For the very poorest in Pakistan, under-five mortality is higher in urban than in rural settings. These vulnerable urban dwellers often live in informal settlements characterized by poor construction, insecure tenure, and underserviced housing plots. The lack of decent, affordable housing not only impairs their welfare, it potentially affects their health, and reduces female labor force participation. Pakistan’s cities Pakistan’s cities are also producing high levels of pollution, increasing the likelihood are also producing of residents suffering from stroke and heart and lung diseases. Analysis of World unhealthy levels of Health Organization outdoor air pollution in cities data reveals that Karachi has an pollution annual mean of 117 g/m3, twice the recorded annual mean concentration for Beijing, China.68 On an The struggles of the urban Table 11: EIU Livability Index (2015), Data reused international scale population are also apparent with permission of the Economist Intelligence Unit of liveability, in poor performance in Pakistan’s cities international rankings of rank poorly cities. One of the most respected measures is the livability index published by the Economist Intelligence Unit (EIU), which assesses cities across five dimensions of a “livable city.” The 2015 68 T his designation is according to data on annual mean concentrations of particulate matter with a diameter of less than 2.5 microns (that is, PM2.5) from the World Health Organization’s “Ambient (outdoor) air pollution in cities database 2014” (http:// www.who.int/phe/health_topics/outdoorair / databases/cities/en/). April 2016 THE WORLD BANK GROUP 42 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate livability index of the EIU ranked Karachi 135 th out of 140 cities in the world (see Table 11).69 Many of these There are two dominant features of South Asia’s urbanization that may illustrate challenges are why the region is not yet fully enjoying the livability and prosperity that can driven by the accompany growing cities. The process of urbanization in South Asia—and in messy and hidden Pakistan specifically – has been both messy and hidden. Messy urbanization refers nature of South to the proliferation of urban sprawl and slums while hidden urbanization, a related Asia’s concept, refers to urbanization that is not captured in official statistics, often on the urbanization peripheries of major cities. The following paragraphs discuss these phenomena in greater detail. A failure to Following a process of messy urbanization, a sizable proportion of South Asia’s manage land and urban population lives in slums. Cities have grown outward, spilling over their housing markets administrative boundaries, rather than upward through the construction of taller has led to messy buildings. Messy urbanization is reflected in faster population growth on the urbanization, peripheries of major cities in areas beyond municipal boundaries – this is occurring where cities are in Pakistan as it is in much of South Asia. The spillover of cities across their growing most boundaries creates challenges for metropolitan coordination in the delivery of basic quickly on their services and the provision of infrastructure. Estimates suggest that at least 130 peripheries million of South Asia’s urban residents live in slums and are disproportionately deprived of basic infrastructure and access to basic services. The prevalence of urban slums in South Asian cities reflects a failure to adequately manage land and housing markets. And with growth occurring beyond city limits, much urbanization has been hidden — a growing number of people in the region live in places that possess strong urban characteristics but that are not officially recognized as urban. Around 20 percent Hidden urbanization stems from official national statistics that understate the share of all Pakistanis of Pakistan’s population living in areas with urban characteristics. An alternative live in urban areas measure of urbanization, the Agglomeration Index — which, unlike official outside measures, is comparable across countries and regions — shows that official statistics administrative may substantially understate the number of people living in areas that look and feel boundaries, and urban, even if they are not counted as such in national population and housing are ‘hidden’ from censuses. According to the index, the share of Pakistan’s population living in areas official figures with urban characteristics in 2010 was 55.8 percent. This compares to an official estimate of just less than 36 percent, suggesting the existence of considerable hidden urbanization. This is leading to The combination of messy and hidden urbanization has led to a phenomenon multicity known as multicity agglomerations, defined as a continuously lit belt of urbanization agglomerations, containing two or more cities70 . As these cities sprawl and grow, they eventually which present meet, forming a long corridor or mass of development. Pakistan saw a net decline governance in multicity agglomerations from 12 to 10 during the period 1999-2010 as the challenges but formation of new agglomerations was outpaced by the merging of existing have the potential agglomerations. The Lahore agglomeration expanded to absorb those of Chiniot, to yield enormous Gujranwala, Gujrat, Lalamusa, and Sialkot. This explains the increase in the average economic benefits number of cities per agglomeration in Pakistan from four in 1999 to 6.5 in 2010, making Pakistani agglomerations the largest in the region. The fusing of existing agglomerations points to an increasingly connected network of cities across South 69 Data reused by permission of The Economist Intelligence Unit. Further permission required for reuse. 70 The definition also requires each city to have a population of at least 100,000 living within its administrative boundaries in 2010. April 2016 THE WORLD BANK GROUP 43 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Asia. If the challenges that they present for urban governance can be overcome, these agglomerations carry great potential for the exploitation of agglomeration economies and the building of economic prosperity. It is apparent that The challenges outlined above suggest that Pakistan’s towns and cities have been Pakistan’s cities struggling to deal with the pressures of population on their infrastructure, basic and towns have services, land, housing and environment. The forces that generate agglomeration been struggling to economies—for example, spillovers between firms and workers—are largely outside deal with of the control of policymakers. The forces of congestion, by contrast, are directly congestion forces influenced by policy decisions regarding the supply of infrastructure and basic services and the way in which cities are planned. The high congestion costs experienced in Pakistan’s cities have constrained both urban growth and agglomeration benefits by making cities less attractive places to migrate to and by encouraging cities to grow outward rather than upward. Figure 28: Mercer Quality of Life Survey Ranking, 2012 Source: Ranking surveys by Mercer (2012); population density data derived from United Nations Statistics Division (UNSD) (2014) and Demographia (2014). To manage The strength of congestion forces can be largely mitigated if investments in congestion forces, infrastructure and basic services keep pace with demand as more people and firms governments must congregate in urban areas. Without sufficient investment, urban infrastructure and ensure services become stretched, reducing quality and access. Similarly, the effects of infrastructure, congestion forces depend on the ability of land and housing markets to respond to basic services, and rising demand for urban residential, industrial, and commercial property. This housing markets increased demand results in higher density, which, if improperly planned, can lead to keep pace with a lower quality of life. In Figure 28, both Karachi and Lahore have over 10 million demand people living in their urban agglomerations, and yet tend to rate on the lower end of quality of life surveys. This is partly due to a failure of agglomeration economics to overcome congestion pressures as well as a failure of policy. Effective urban To address key congestion constraints, policymakers need to equip urban local local governments governments with the tools to manage local congestion pressures as they arise. This will be crucial means addressing three fundamental urban governance deficits—empowerment, resource and accountability. Addressing these deficits will require empowering urban local governments, identifying practical ways to increase the resources April 2016 THE WORLD BANK GROUP 44 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate available to them to perform their mandated functions and strengthening the mechanisms that hold local governments accountable for their actions. Recent reforms are The recent local elections in Pakistan are an important step toward reducing these moving in the three deficits. The new local government laws, which were enacted in most right direction provinces in 2013, have started to re-empower local governments after the expiration of the 2001 Local Government Act.71 However, urban Most urban local governments in South Asia suffer from unclear institutional roles local governments and limited functional and revenue assignments. That leaves local governments with are still uncertain authority and limited power to make decisions for most service delivery disempowered obligations. They depend greatly on transfers from upper tiers of government, and the reporting requirements for budget approvals are heavy. Functions and resources assigned to Pakistan local bodies are very limited. Only about 5% of Pakistan’s public spending is undertaken at the local level. Institutional roles Empowering urban local governments will require a dedicated commitment to for each level of clarifying intergovernmental fiscal legal frameworks by amending existing laws, government enforcing them, and in some cases, establishing new and simpler laws. In Pakistan’s should be clarified case, it may be necessary to rethink the role of local government to empower them as the primary agent for service delivery, local economic development and economic and social outcomes, which may ultimately require legislative change. Fiscal transfers to Local government revenue mobilization is constrained by established fees and tax local governments rates, as well as by narrow tax bases. In Pakistan, local governments have some are significant but formal discretion over setting local tax rates but are generally subject to strong state constrained and provincial revenue regulations and oversight. In addition, most South Asian countries have some type of formula-allocated transfers from central to urban local governments, with relatively large allocations in Pakistan. However, although the transfers are officially unconditional, they often come with higher-level rules and “guidance” on use, limiting the discretion of local governments to determine priorities. Across the region, the key challenge is to design and implement more effective intergovernmental fiscal transfers. Local government Formal administrative accountability systems generally exist in the region, but many accountability are fairly weak or little used. The main causes for their infrequent implementation should be are the fragmentation and lack of clarity in institutional roles and the lack of inter- strengthened jurisdictional cooperation. Bridging the accountability deficit will require the development of better systems and practices and building the capacity of both government (at all levels) and citizens. In addition, local elections need to be transparent and sufficiently competitive to give voters meaningful choices. Non- electoral mechanisms—input-oriented processes and feedback mechanisms—can be highly productive if well-designed and appropriately implemented. Key reform ideas For Pakistani cities to realize their potential and transform themselves into include prosperous and livable centers, they must not only manage the frequently rapid strenghtening expansion on their peripheries; they must also address existing and future challenges transport links, at their cores. See Figure 29 for an example of the development that occurs when adopting granular the center of cities are congested. Urban upgrading and infrastructure work can add spatial planning, qualitative value at street level and revitalize areas and neighborhoods. At the 71 For more information, please see Ming Zhang’s blog “Local elections in Pakistan: A chanc e to improve public services”: https://blogs.worldbank.org/endpovertyinsouthasia/local-elections-pakistan- chance-improve-public-services April 2016 THE WORLD BANK GROUP 45 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate and rejuvenating national level, how cities are connected as a system through flows of goods, labor, city cores and ideas is important. To bolster opportunities for prosperous and livable cities, planners and government decision makers can focus on four strategies:  The first is to invest in strengthening transport links that improve connectivity between urban areas—between large and secondary cities, and secondary cities and towns. Better transport links will lead to the development of more efficient systems of cities.  The second strategy is to adopt forward-looking planning approaches to guide expansion where it is most rapid —on city peripheries.  As a complement, the third strategy is to unlock the potential of city cores, rejuvenating those in decline. The Government of Sindh has started work on a Karachi Transformation Strategy that will ensure a good understanding of the city’s structural challenges, investment needs and priorities, as well as focus on the livability and quality of life of its citizens. For example, a pedestrianized street in front of the Custom House opened in December 2015.  Fourth, to facilitate the formation of more vibrant neighborhoods, granular spatial planning approaches can permit greater variation in land uses and development. Such planning should be flexible, allowing land uses to adapt within a framework that takes a long-term view of a city’s development. Congestion also Highly congested land and housing markets are exacerbating an affordable housing requires innovative crisis and undermining cities’ livability. It is not just the poor, but also many housing finance middle-income households, that lack access to affordable housing. To turn back the and a greater tide of proliferating slums, Pakistani cities must embark on land and housing supply of reforms and foster innovative housing finance. The extent of construction—both affordable housing formal and informal—on the edge of Karachi is remarkable, creating longer commutes and the need for increased infrastructure. City and suburban governments need to go beyond slum upgrading and embrace measures to stimulate the supply of affordable housing. Also needed are infrastructure to open up land for residential development, easy-to-use land titling and registration systems, and greater access to construction and mortgage finance. Resilience to By concentrating people and property in disaster risk-prone areas, such as deltas, disasters and the floodplains, coasts, and the Himalayan belt, Pakistan’s cities have increased the effects of climate exposure of people and property to natural hazards. Cities in Pakistan that lie along change the Himalayan range are at risk of earthquakes and many are also at risk of heavy inland flooding. The first step in developing a resilience strategy is to accurately identify and quantify the national, subnational, and city risks. Governments at all levels should conduct risk assessments to identify the vulnerabilities of communities and the potential exposures to given hazards. April 2016 THE WORLD BANK GROUP 46 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 29: Economic activity has followed highway investment rather than traditional urban patterns Pakistan has so far Pakistan and the rest of South Asia have so far struggled to make the most of its struggled to deal urbanization. Difficulties in dealing with the congestion forces brought about by the with congestion pressure of population on land, housing, infrastructure, basic services, and the forces environment lie at the heart of the relative lack of its cities’ livability. By fostering messy and hidden urbanization, those forces are also constraining the potential of powerful agglomeration economies to bring about faster improvements in prosperity. With policy Looking ahead, policy makers face a choice between two paths. The first is to reform, Pakistan continue with the same policies that have allowed congestion pressures in urban can realize the areas to mount, thus undermining the exploitation of agglomeration economies. potential of its This path would leave Pakistan on its current trajectory of underleveraged cities urbanization, structural change, and development. The second path is to undertake difficult and appropriate policy reforms to alleviate both current and future congestion pressures and to facilitate the exploitation of agglomeration economies, thereby enabling the tremendous untapped potential of its cities to be realized. It will not be easy. But it is essential to making the region’s cities prosperous and livable. April 2016 THE WORLD BANK GROUP 47 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate 4. Provincial development spending in Pakistan – the case of Punjab Provinces have enjoyed a large expansion in fiscal space since the 2010 7th NFC Award. As a result, Punjab — with a population of over 100 million people—now accounts for almost a third of total Pakistan development spending. Punjab’s development expenditure has more than doubled since FY11. While such a rapid increase presents enormous opportunities to strengthen infrastructure and services in the province, it also puts considerable pressures on the bureaucratic systems managing the development budget. This section aims to give particular attention to the structural issues impeding the effectiveness of development expenditure in Pakistan’s provinces by examining Punjab’s Annual Development Plan (APD) as a case study. 72 Punjab accounts One fourth of total consolidated government PSDP-related development spending for a large share takes place in Punjab. Over the last four years, average consolidated government of Pakistan’s budgeted development spending stood at Rs. 919 billion, of which 31 percent was overall spent in Punjab. This is not surprising given Punjab is the largest province in development Pakistan accounting for roughly three-fifths of the country’s population and income; spending and its economy therefore has a major influence on national economic and social indicators. Development Punjab development expenditure for FY16 is budgeted at Rs. 400 billion or 38 expenditure in percent higher than FY15 revised estimates. This allocation includes Rs. 67 billion for Punjab is almost other development initiatives. The Annual Development Plan (ADP) for FY16 40 percent higher attempts to emphasize projects that are aligned with Punjab Growth Strategy 2018. in FY16 The thrust of the ADP is towards improvement of infrastructure and investment in the energy sector with extra weight assigned to resources for Southern Punjab. Punjab has Punjab development expenditure has increased significantly during the period of 7 th directed its large NFC Award. During FY06-FY10, provincial development expenditure grew by 90 fiscal increases percent, and this growth accelerated to 207 percent during the period of 7 th NFC towards Award (FY11-FY16). In comparison, the growth of recurrent expenditures of the development province averaged around 76 percent during the period under the 7th NFC Award expenditure compared to 100 percent growth during FY06-FY10. This suggests that the increased fiscal space which became available to the province during the 7th NFC award has been directed towards fulfilling development needs. The ADP budget The fragmentation of the ADP into too many projects is a legacy issue, which has is becoming more further deteriorated in the past three fiscal years. Between FY11 and FY14, the ADP fragmented, showed a positive trend toward consolidation: the number of projects in the ADP reversing the decreased by 49 percent; the average project size increased by 126 percent; the postive trend average allocation per project increased by 157 percent; and the average annual towards financing ratio per project increased from 29 percent to 32 percent. By contrast, consolidation between FY14 and FY16, these trends were reversed: the number of projects during FY11 to increased by 152 percent; the average project size decreased by 34 percent; the FY14 average allocation per project decreased by 45 percent; and the average annual financing ratio per project decreased from 34 percent to 27 percent (see Figures 30 and 31). 72T his note was prepared by Saadia Refaqat (Senior Economist, MFM) with inputs from Syedah Mohsina Atiq (Consultant, MFM) April 2016 THE WORLD BANK GROUP 48 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 30: Average estimated cost and average ADP Figure 31: Trends in ADP composition in the periods allocations per project FY11-14, FY14-16 Rs. millions Measured in percent change in # of projects Total cost FY allocation change in average project total cost 500 change in average project allocation 450 change in annual financing ratio 400 200% 350 150% 300 250 100% 200 50% 150 100 0% 50 -50% 0 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 -100% FY11-14 FY14-16 2010/11-2013/14 2013/14-2015/26 zSource: FABS, World Bank staff calculations Source: FABS, World Bank staff calculations There are a large At the same time, the share of new projects in the ADP has increased. With an number of new increasing portion of the development program consisting of new projects, the projects in the portfolio is getting younger every year. Between FY13 and FY16, the share of new ADP and projects in the ADP jumped from 22 percent 48 percent. On the other hand, in the allocation to them past two years allocations to ongoing projects have exceeded allocations to new remains too high projects (see Figures 32 and 33). In FY16, allocations to ongoing projects stood at 53 percent of the total – significantly higher than 38 percent in FY12. This is a positive trend, as it improves the prospects of ongoing projects being completed within schedule. Figure 32: ADP composition: ongoing vs. new Figure 33: Allocations to ongoing and new projects projects Measured in percent of total Measured in number of projects Ongoing New 66% 62% 57% 53% 54% 47% 46% 43% 38% 34% FY12 FY13 FY14 FY15 FY16 Source: Annual Development Plan, Punjab, various years April 2016 THE WORLD BANK GROUP 49 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate An increasing In the past couple of years, the share of small projects in the ADP has also proportion of increased. Almost half of the projects in the FY16 ADP have a total estimated cost ADP projects are of less than Rs. 50 million, and micro-projects below Rs. 10 million account for 42 small—under Rs. percent of the total, compared to 36 percent and 35 percent respectively in FY14 50 million (see Figures 34 and 35). Only 16 percent of all projects in the FY16 ADP had a cost over Rs. 50 million. Most of the micro-projects involve small-scale civil works at separate project sites (e.g., boundary walls, tube wells, drainage works, rural roads). As the decentralization of functions and financing to local government units (LGUs) advances, small projects in areas of LGU competence (school education, primary and secondary health, water supply and sanitation, local roads) will need to be selected and implemented by the LGUs—ideally in consultation with the relevant line departments. Figure 34: Distribution of allocations within ADP Figure 35: Distribution of project sizes within ADP Measured in percent of projects Measured in percent of projects 77% of projects 2013/14 2013/14 90 36% of 16% of 35% projects projects 75 24% 60 17% 45 8% 11% 30 1% 2% 1% 15 ≤ Rs . 10mll i on i Rs . 10- 2 0m io il n Rs . 20- 5 0m io il n Rs . 50- 1 00mi llon i . 10 Rs 0- 500mli i on . 50 Rs 0m 0- 100 il ion . 1- 5bi Rs loin >Rs . 5bi llon i 0 m 5- 1 0- 5 0m 10- 15m15- 20m20- 25m 30m 25- 35m 30- 40m 35- 40- 45m 50m 45- 50- 55m 60m 55- 65m 60- 70m 65- 75m 70- 80m 75- 80- 85- 85m 90m 95m 95- 10 90- 10 0- 12 0- 11 0m 11 0- 13 0m 13 0m 12 0m 14 0- 14 0- 15 0m 16 0m 15 0- 16 0- 17 0m 17 0- 19 0- 18 0m 18 0- 20 0m 19 0- 25 0m 20 0- 30 0m 25 0- 35 0m 35 0m 30 0m 40 0- 45 0- 40 0m 45 0- 50 0m 60 0m 50 0- 80 0- 70 0- 60 0m 80 0m 70 0- 90 0m 0m 90 .5 0- 1b1- 1 5- 2 b 1. b 3- 4 b 2- 3 b 7- 9 b 5- 7 b 4- 5 13b13- b 9- 1b 11- 20b20- 15b15- 30b30- 25b25- 35b 42% 82% of projects 2015/16 49% of 2015/16 350 projects 10% of 19% 21% 280 projects 9% 210 7% 140 1% 1% 0% 70 0 100 - 110m 200 - 250m 300 - 350m 120 - 130m 140 - 150m 160 - 170m 180 - 190m 400 - 450m 500 - 600m 700 - 800m 1.5 - 2b ≤ Rs. 10 Rs. 10 - Rs. 20 - Rs. 50 -Rs. 100 -Rs. 500 - Rs. 1 - 5 > Rs. 5 40 - 45m 10 - 15m 20 - 25m 30 - 35m 50 - 55m 60 - 65m 70 - 75m 80 - 85m 13 - 15b 20 - 25b 900 - 1b 9 - 11b 0 - 5m 3 - 4b 5 - 7b 90 - 95m million 20 50 100 500 100 0 billio n billio n million million million million million Source: Annual Development Plan, Government of Punjab Fragmentation in Lower allocations to a larger number of projects are bound to result in longer the ADP budget timeframes for project completion. Despite the inclusion of 1,923 new projects, the is a serious ADP assumes that 59 percent or 2,325 projects will be completed within a year. concern, leading Another 1,148 projects in the development portfolio will take 1-5 years to complete, to a lower rate of provided the present level of allocation is maintained. This means almost 87 percent implementation of the ADP portfolio is assumed to be completed within 5 years. On the other hand, allocations for some of the projects are clearly insufficient to ensure timely completion. For instance, there are 104 projects (24 percent of them ongoing) in the FY16 ADP portfolio, which at current levels of allocations would take 10-20 years to complete (see Figure 36). 40 percent of The ADP also contains a significant number of unapproved projects (approval will projects included be sought during the FY), whose share in the ADP has grown in the past couple of in the ADP are years. Unapproved projects accounted for 41 percent of all projects in the ADP for unapproved, FY16. This reflects a negative trend since FY2013/14 when only 21 percent of all suggesting low projects were unapproved. The large number of unapproved projects indicates low implementation implementation readiness, which is likely to result in delays and budget under- readiness execution. For example, in FY16 almost 46 percent of projects were unapproved at the time of presentation of the budget (see Table 12). April 2016 THE WORLD BANK GROUP 50 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 36: Projected completion time for projects in Figure 37: Allocations in block grants, FY16 the ADP FY16 Measured in Rs. billions Measured in number of projects and grouped according to years 16 15 2500 New Ongoing 14 12 12 12 2000 10 9 9 8 1394 1500 6 4 1000 2 0.5 0.02 503 0 500 931 110 645 13 25 3 2 200 79 40 0 17 11 Upto 1 1 - 5 5 - 10 10 - 20 20 - 50 50 - Over 100 100 Source: Annual Development Plan, Govrnment of Punjab Source: World Bank estimates Table 12: Approved and unapproved projects in the ADP FY14 FY15 FY16 No. Allocation No. Allocation No. Allocation Ratio of approved to total 79% 47% 62% 62% 54% 59% Ratio of unapproved to total 21% 53% 38% 38% 46% 41% Source: Annual Development Plan, Punjab Block allocations On the other hand, block allocations have declined in recent years. This is a positive have reduced trend insofar as it indicates that the planning and preparation of high-profile projects may have improved, and are now reviewed and financed under the regular ADP rather than from block allocations (see Figure 37). Per-capita ADP Per-capita ADP allocations vary significantly across districts. Analysis based on per allocations vary capita average allocation over the past three years shows Mianwali district as the top significantly recipient with Rs. 3,606 per capita allocation, followed by Multan (Rs. 3,331), across districts— Lahore (Rs. 3,097), Bahawalpur (Rs. 2,644), and Gujranwala (Rs. 2,569). The requiring further districts receiving the lowest per capita allocation include Gujrat (Rs. 691), Sargodha policy action (Rs. 725), Jhang (Rs. 729) and Lodhran (Rs. 829). Moreover, a review of the past three years’ average per capita allocations shows that the top ten districts, which account for an estimated 35 percent of the provincial population, receive one third of ADP allocation (see Figure 38). By contrast, the bottom ten districts, which account for about 26 percent of the population, received only 8 percent of ADP funds. To address the infrastructure gaps and lagging economic and human development indicators across districts in Punjab, the Government would need to rebalance ADP allocations even further. April 2016 THE WORLD BANK GROUP 51 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 38: Three-year average per-capita allocations across districts Measured in Rupees T op ten districts: on average, 35% population receives 1/3 of ADP allocation 4,000 Bottom ten districts: on average, 26% 3,500 population receives 8% of allocation 3,000 2,500 2,000 1,500 1,000 500 0 Source: Annual Development Plan, Government of Punjab; Punjab Development Statistics 2014 and World Bank staff calculations Note (i): Analysis excludes ‘Punjab-based projects’ (cluster) for which Rs. 137 bn, Rs. 101 bn & Rs. 127 bn have been respectively allocated in FY14, FY15 & FY16. Several steps can This analysis suggests a number of recommendations: be taken in the short- and  There is a need to review alignment of the ADP in line with the province’s medium-term to medium-term development strategy such as the Growth Strategy. improve the  Setting a threshold for the size of projects submitted for inclusion in the effectiveness of ADP may improve portfolio consolidation. ADP spending  A close scrutiny of non-performing projects is required, particularly those that have not met disbursement and physical milestones for two fiscal years.  It is essential to minimize or altogether eliminate unapproved projects from the ADP.  Start preparation for an automated ADP monitoring system. Required functionalities would include: (i) link with FABS for obtaining real-time data on commitments and disbursements; (ii) capacity to include project GIS data and data on physical progress; (iii) coverage of the whole project cycle; and (iv) data aggregation and analysis capabilities, ideally through user dashboards.  Start preparation of a unified assets register. Ensure that all line departments and LGUs record all new assets, and start tracking movable assets through property numbers (ideally in the form of barcodes) and expand geo-tagging of immovable assets. The Government may also start conducting valuations of newly completed assets and record them in the assets register. April 2016 THE WORLD BANK GROUP 52 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate D. Appendix: Pakistan’s economy in pictures Figure 1: GDP growth is steadily increasing and is Figure 2: The services sector is the main supply-side expected to maintain its modest momentum... contributor to GDP growth Real GDP growth (percent - at constant factor Percentage point contribution to GDP growth prices) Agriculture Industry 6.0 4.8 5.1 8.0 Services GDP Growth 4.0 4.2 4.5 5.0 3.6 3.8 3.7 5.0 4.0 2.6 3.8 3.7 4.0 4.2 3.6 3.0 2.6 2.0 1.0 0.5 0.0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Actual Proj. -2.0 Figure 3: On the demand side, consumption is Figure 4 ....with private consumption the main driving growth.... contributor Percentage point contribution to GDP growth Composition of consumption's contribution to GDP Total Consumption Total Investment growth (percentage points) Net Exports GDP Growth (MP) Private Consumption Public Consumption 8.0 5.5 8.0 Total Consumption 4.4 4.7 4.7 4.3 4.5 3.5 3.5 2.8 2.8 2.7 2.7 1.6 3.0 1.7 1.6 0.8 -2.0 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 -2.0 Figure 5: Investment and savings have historically Figure 6: Falling inflation has created space for been low, although investment is forecast to grow policy rate cuts Percent of GDP Percent of GDP Total Investment Gross Fixed Investment Total Investment Gross Fixed Investment National Savings National Savings 20.0 20.0 15.0 10.0 10.0 5.0 0.0 0.0 FY08 FY10 FY13 FY16 FY09 FY11 FY12 FY14 FY15 FY17 FY18 FY08 FY11 FY14 FY17 FY09 FY10 FY12 FY13 FY15 FY16 FY18 Actual Proj. Actual Proj. April 2016 THE WORLD BANK GROUP 53 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 7: The overall external balance remains Figure 8: ...while the trade balance has been positive persistently negative Current Account (USD Billions) Balance of Payments (US$ billion) Current Transfers (Net) Errors and Omissions 20.0 Income (Net) 5.0 Capital and Financial Account Services (Net) Current Account Trade (Net) Overall Balance 0.0 0.0 -5.0 -20.0 Figure 9: Textiles form the main export… Figure 10: …while imports are broad-based but Exports by Commodity (US$ Billions) concentrated in petroleum Food Textiles Imports by Commodity (US$ Billions) 15.0 12.5 Metal Agri. & Chemicals 12.1 12.2 12.2 11.1 10.8 Petroleum Machinery 9.3 Food Total Imports 10.0 40.0 20.0 20.1 21.1 22.1 20.1 15.1 16.8 5.0 20.0 0.0 0.0 H1FY10 H1FY12 H1FY14 H1FY11 H1FY13 H1FY15 H1FY16 H1FY1 H1FY1 H1FY1 H1FY1 H1FY1 H1FY1 H1FY1 0 2 4 6 1 3 5 Figure 11: Reserves and remittances remain strong Figure 12: While private deposits are falling, private while the exchange rate is stable credit is growing steadily Reserves, remittances (US$ Billion) & exchange rate Outstanding credit to private sector and private trends (Rs./US$) deposits (y-o-y percent growth) Reserves (LHS) Remittances (LHS) Private Deposits Credit to Private Sector NEER (RHS) REER (RHS) 25.0 140 21.1 15 17.9 120 20.0 12 100 15.0 11.5 9 80 10.2 9.3 8.6 60 10.0 6 5.7 40 5.0 4.8 4.4 3 5.0 7.4 3.7 20 0 0 - Feb-15 Feb-16 Jul-14 Sep-14 Jul-15 Sep-15 Jun-15 Dec-14 Dec-15 Aug-14 Nov-14 Aug-15 Nov-15 May-15 Oct- 14 Jan- 15 Oct- 15 Jan- 16 Mar -15 Apr -15 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 April 2016 THE WORLD BANK GROUP 54 Fro m stab ility to p ro sp erity Pakistan Develo p m en t Up d ate Figure 13: The banking sector appears to be healthy Figure 14: The fiscal deficit is driven by low tax revenues and high recurrent expenditure Banking Sector Indicators (Percent) Net NPLs/Loans (LHS) Fiscal Operations (Rs. billions) Return On Assets (LHS) Total Revenue Advances/Deposit (RHS) Tax Revenue Total Expenditures 10.0 Capital Adequacy Ratio (RHS) 100.0 Current Expenditures 3,000 Development Expenditures 0 2,500 Fiscal Balance (% of GDP) (RHS) -0.5 5.0 50.0 2,000 -1 1,500 -1.5 1,000 -2 0.0 0.0 500 -2.5 0 -3 H1FY12 H1FY13 H1FY14 H1FY15 H1FY16 Figure 15: Interest payments have partially driven Figure 16: Public debt remains high but has stopped recent increases in recurrent expenditure growing Rs. billion Trends in Public Debt (Rs. billion) Interest Payments Current Expenditures External Domestic Public Debt to GDP (RHS) 20,000 70.0 2,500 18,000 FRDLA 16,000 65.0 2,000 14,000 12,000 60.0 1,500 10,000 8,000 55.0 1,000 598 632 6,000 553 573 4,000 50.0 397 500 2,000 0 45.0 FY13 FY14 FY15 FY11 FY12 FY15 FY16 0 H1- H1- H1FY12 H1FY13 H1FY14 H1FY15 H1FY16 Figure 17: T-bill auctions are covering maturities Figure 18: The market’s preference for short term debt strengthened significantly in the second half of FY15 Rs. billion Rs. billion 3-M 6-M 12-M Target 3-Y 5-Y 10-Y Target 1,500 1,245 1,200 1,225 400 1,000 300 700 200 500 100 - - Q1FY15 Q2FY15 Q1FY16 Q2FY16 Q1FY15 Q2FY15 Q1FY16 Q2FY16 urces: State Bank of Pakistan, Ministry of Finance, Pakistan Bureau of Statistics and World Bank staff estimates April 2016 THE WORLD BANK GROUP 55 20-A Sharah-e-Jamhuriat, G-5/1, Islamabad 44000, Pakistan. 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