Weathering the storm: restoring macroeconomics stability Pakistan Development Update Standard Disclaimer: The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Copyright Statement: The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development/The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of this work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, http:// www.copyright.com/. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail pubrights@worldbank.org. THE WORLD BANK GROUP JUNE 2019 2 PAKISTAN DEVELOPMENT UPDATE Weathering the storm: Restoring macroeconomic stability June 2019 Preface The objective of this bi-yearly report is to update the Government of Pakistan, think- tanks and researchers, the public and the World Bank’s senior management on the state of the Pakistan economy, its outlook, together with the structural reforms it requires and the development challenges it faces. The report begins with a chapter on economic developments, with sections on growth, fiscal policy, public debt, the external sector, monetary developments and inflation, and financial sector. The second chapter provides a medium-term macroeconomic outlook and describes risks faced and upcoming challenges, including structural reform needs. This is followed by special sections on the federal Finance Bill for FY20, state-owned enterprises, and the impact of child marriages and early childbearing in Pakistan. This report is based on data released up until 30th June 2019. Acknowledgements This update was prepared by the Macroeconomics, Trade and Investment Global Practice under the guidance of Patchamuthu Illangovan (Country Director, SACPK) and Manuela Francisco (Practice Manager, ESAMU). Muhammad Waheed (Senior Economic, ESAMU) authored the Executive Summary, and co-authored the ‘Fiscal Developments’ section. The ‘Real Sector’ chapter was authored by Zehra Aslam (Research Analyst, ESAMU), who also contributed to the ‘Debt and its Dynamics’ section and the ‘Outlook’ section. Adnan Ashraf Ghumman (Economist, ESAMU), authored the ‘Monetary Aggregates’ and ‘Inflation’ sections, and contributed to the “Balance of Payments” section, ‘Debt and its Dynamics’ section and the ‘Risks’ section. Nyda Mukhtar co-authored the “Fiscal Developments” section, contributed to the ‘Balance of Payments’ section, and authored the Special Section on ‘Finance Bill FY20’. Gonzalo J. Varela (Senior Economist, ESAMU) contributed to the “Finance bill FY20” and the “Next Steps on Structural Reforms” sections. Enrique Blanco Armas (Lead Economist, ESAMU) co-authored the ‘Risks’ section and the ‘Progress and Next Steps on Structural Reforms’ section. Marius Vismantas (Lead Financial Sector Specialist, GFCSN) and Rafay Khan (Economist, GFCSN) co-authored the ‘Financial Sector Developments’ section. The special section on ‘State Owned Enterprises’ was authored by Clelia Rontoyanni (Lead Public Sector Specialist, GGOAP) and the one on the “Impact of Child Marriages in Pakistan” was authored by Quentin Wodon (Lead Economist, GED07). Abid Hussain Chaudhry (Program Assistant, SACPK) provided helpful administrative support. The report benefitted from comments provided by Manuela Francisco and Muhammad Waheed. The overall effort was led by Adnan Ashraf Ghumman and Enrique Blanco Armas. Table of Contents Infographics����������������������������������������������������������������������������������������������������������������������������������������������������������������������������5 Executive Summary�������������������������������������������������������������������������������������������������������������������������������������������������������������11 A. Economic Update�����������������������������������������������������������������������������������������������������������������������������������������������������������14 1. Real Sector������������������������������������������������������������������������������������������������������������������������������������������������������������������������14 2. Monetary Aggregates������������������������������������������������������������������������������������������������������������������������������������������������������17 3. Inflation�����������������������������������������������������������������������������������������������������������������������������������������������������������������������������20 4. Financial Sector Developments�������������������������������������������������������������������������������������������������������������������������������������21 5. Balance of Payments�������������������������������������������������������������������������������������������������������������������������������������������������������24 6. Fiscal Account������������������������������������������������������������������������������������������������������������������������������������������������������������������28 7. Debt and Its Dynamics���������������������������������������������������������������������������������������������������������������������������������������������������33 B. Outlook and Upcoming Challenges�����������������������������������������������������������������������������������������������������������������������������35 1. Outlook�����������������������������������������������������������������������������������������������������������������������������������������������������������������������������35 2. Risks�����������������������������������������������������������������������������������������������������������������������������������������������������������������������������������38 3. Progress on Structural Reforms������������������������������������������������������������������������������������������������������������������������������������39 C. Special Sections���������������������������������������������������������������������������������������������������������������������������������������������������������������42 Special Section: Finance Bill FY20������������������������������������������������������������������������������������������������������������������������������������42 Special Section: State-Owned Enterprises ����������������������������������������������������������������������������������������������������������������������47 Special Section: Child Marriage, Early Childbearing, Low Educational Attainment for girls, and their Impacts in Pakistan�����������������������������������������������������������������������������������������������������������������������������������������������������������������������������52 Annex: Human Development Indicators�������������������������������������������������������������������������������������������������������������������������59 List of Tables, Figures & Boxes Table 1: Monetary Aggregates�������������������������������������������������������������������������������������������������������������������������������������������18 Table 2: Credit to Private Sector—Flow��������������������������������������������������������������������������������������������������������������������������19 Table 3: Selected Key Indicators of the Banking Sector�����������������������������������������������������������������������������������������������21 Table 4: Housing Finance Portfolio of Banks/DFIs - Outstanding Finance & No. of Borrowers���������������������� 24 Table 5: Balance of payments summary1y����������������������������������������������������������������������������������������������������������������������� 25 Table 6: Summary of Pakistan Fiscal Operations�����������������������������������������������������������������������������������������������������������30 Table 7: FBR Tax Collection����������������������������������������������������������������������������������������������������������������������������������������������31 Table 8: Analysis of consolidated spending���������������������������������������������������������������������������������������������������������������������32 Table 9: Gross disbursements – Public and Publicly Guaranteed External Debt (PPG) 1 G ��������������������������������� 34 Table 10: Key macroeconomic indicators������������������������������������������������������������������������������������������������������������������������37 Table 11: Key Indicators, Federal Budget FY19 and FY20 ������������������������������������������������������������������������������������������46 Table 12: Country examples of SOE Ownership and Oversight Models������������������������������������������������������������������48 Table 13: Completion Rates for Girls by Education Level and Prevalence of Child Marriage and Early Child- bearing by Age Group, Last Two DHS Surveys and Regional Averages (%)�������������������������������������������������������������54 Table 14: Relationships between Child Marriage, Early Childbearing, and Girls’ Educational Attainment���������� 55 Table 15: Impacts on Fertility and Population Growth�������������������������������������������������������������������������������������������������55 Table 16: Impacts on Health, Nutrition, and Violence��������������������������������������������������������������������������������������������������56 Table 17: Impacts on Work, Earnings, and Poverty�������������������������������������������������������������������������������������������������������56 Table 18: Impacts on Decision-making, Agency, and Other Areas�����������������������������������������������������������������������������57 Figure 1: Aggregate demand contribution to GDP growth �����������������������������������������������������������������������������������������15 Figure 2: Savings and investment��������������������������������������������������������������������������������������������������������������������������������������15 Figure 3: Sectoral contribution to GDP growth�������������������������������������������������������������������������������������������������������������17 Figure 5: Real policy and weighted average lending rates����������������������������������������������������������������������������������������������17 Figure 4: Large-scale manufacturing growth�������������������������������������������������������������������������������������������������������������������17 Figure 6: Headline Y-o-Y inflation������������������������������������������������������������������������������������������������������������������������������������20 Figure 7: Monthly moving average of core and headline inflation ����������������������������������������������������������������������������20 Figure 8: Credit to government sector������������������������������������������������������������������������������������������������������������������������������22 Figure 9: KSE 100 Index (Closing Value)������������������������������������������������������������������������������������������������������������������������23 Figure 10: Share in export growth (Y-o-Y)����������������������������������������������������������������������������������������������������������������������26 Figure 11: Major imports growth (Y-o-Y)������������������������������������������������������������������������������������������������������������������������27 Figure 12: Growth in sectoral sales of POL (Y-o-Y)�����������������������������������������������������������������������������������������������������27 Figure 13: Workers Remittances����������������������������������������������������������������������������������������������������������������������������������������28 Figure 14: Trends in public debt����������������������������������������������������������������������������������������������������������������������������������������33 Figure 15: Real GDP growth and twin deficits���������������������������������������������������������������������������������������������������������������37 Figure 16: Total federal revenue collection����������������������������������������������������������������������������������������������������������������������43 Figure 17: Impact of proposed custom duties����������������������������������������������������������������������������������������������������������������44 Figure 18: Change in tariffs on intermediates�����������������������������������������������������������������������������������������������������������������44 Figure 19: Federal expenditure�������������������������������������������������������������������������������������������������������������������������������������������45 Figure 20: Trends in SOEs’ revenues, profits/losses�����������������������������������������������������������������������������������������������������49 Figure 21: Profits/losses by sector������������������������������������������������������������������������������������������������������������������������������������49 Figure 22: Government financial support to federal SOEs������������������������������������������������������������������������������������������49 Box 1: Housing Finance in Pakistan���������������������������������������������������������������������������������������������������������������������������������23 Box 2: Sales Tax Coordination Challenge������������������������������������������������������������������������������������������������������������������������29 Box 3: Changes to Custom Duties – Finance Bill FY20�����������������������������������������������������������������������������������������������43 Box 4: Framework for the Analysis�����������������������������������������������������������������������������������������������������������������������������������52 Acronyms and Abbreviations CAD Current Account Deficit WBG World Bank Group CAR Capital Adequacy Ratio WHT Withholding Tax CPEC China-Pakistan Economic Corridor WTO World Trade Organization CRR Cash Reserve Requirement Y-o-Y Year on Year FATF Financial Action Task Force Ytd Year to date FBR Federal Board of Revenue FDI Foreign Direct Investment FED Federal Excise Duty Fiscal Responsibility and Debt FRDLA Limitation Act FY Fiscal Year GCC Gulf Cooperation Council GDP Gross Domestic Product KSE Karachi Stock Exchange LNG Liquefied Natural Gas LSM Large-Scale Manufacturing M2 Broad Money NDA Net Domestic Assets NFA Net foreign assets NFC National Finance Commission NFNE Non-Food Non-Energy NPL Non-performing loan Pakistan Demographic and Health PDHS Survey PDU Pakistan Development Update PKR Pakistani Rupee POL Petroleum, Oil and Lubricants PPG Public and Publicly Guaranteed PSDP Public Sector Development Program PSE Public Sector Enterprise RD Regulatory duties RM Reserve Money ROA Return on Assets ROE Return on Equity SBP State Bank of Pakistan SCRR Special Cash Reserve Requirement SME Small and Medium Enterprise SOE State-Owned Enterprise SRO Statutory Regulatory Order US$ United States Dollar Infographics 5 6 7 8 9 10 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Executive Summary Pakistan continues Pakistan’s economy is unable to sustain high growth rates for extended periods. Every to face significant few years, the economy faces a balance of payments crisis. The fundamental cause balance of payments for these short-lived growth cycles in Pakistan is that these are propelled by private pressures and government consumption, not by higher investment and exports. As a result, the country’s demand increases at a much higher pace than its supply of goods and services, prompting a need for higher imports which lead to large current account deficits. Successive governments have tried to notch up growth this way, often resulting in macro imbalances. Procyclical economic As highlighted in previous Pakistan Development Updates, the country’s macroeconomic policies to achieve indicators, which improved under the first three years of the previous administration, high growth without started to show signs of distress in FY17. The fiscal deficit widened due to weak revenue tackling structural growth and high expenditures on the eve of elections. Growth recovered briefly; challenges resulted primarily driven by high public and private consumption which increased reliance in record twin on imports. Investment continued to drag around 15 percent of GDP, reflecting the deficits longstanding structural challenges. Exports performance remained weak while imports started growing very rapidly. Foreign reserves declined rapidly from a high of 4 months of import coverage in mid-2016. The practice of sustaining the exchange rate at the expense of reserves contributed to external vulnerabilities. Delayed policy In the absence of an appropriate policy response by the authorities, these vulnerabilities response augmented were amplified, and twin deficits reached a record level by the end of FY18. Foreign the economic and exchange reserves declined to 1.5 months of imports. The new government, after financial cost to the assuming office, raised short-term financing from bilateral sources to shore up its economy reserves (details in the BOP section). It also took some measures to stabilize the economy, allowing the PKR to depreciate by almost 25.5 percent in FY19, imposing regulatory duties to curb imports and undertaking monetary tightening of 575 basis points till May 2019. The necessary Aggregate demand has started to moderate in response to these stabilization measures. stabilization Pakistan’s gross domestic product (GDP at factor cost) grew at 3.3 percent in FY19—a measures have 2.2 percentage point decline compared to the previous year. Industrial sector growth started impacting has slowed down and is estimated at 1.4 percent in FY19 compared to 4.9 percent in economic activities FY18. In FY18, the sector benefited from higher public-sector development spending (PSDP), an increase in CPEC related activities, private sector construction activities and consumer spending. However, in FY19, industrial sector slowed down as the impact of adjustment measures taken by the government began to take effect. Manufacturing, the largest component of the industry sector, contracted by 0.3 percent (5.4 percent growth in FY18), with large scale manufacturing (LSM) declining by 2.1 percent (5.1 percent growth in FY18). The services sector grew at 4.7 percent in FY19—1.5 percentage points slower than in FY18. Adverse weather conditions have dampened the agriculture sector growth to 0.8 percent in FY19, significantly lower than the targeted growth of 3.8 percent. JUNE 2019 THE WORLD BANK GROUP 11 Weathering the storm: restoring macroeconomics stability Pakistan Development Update However, recent Further adjustments will be necessary to achieve macroeconomic stability. The fiscal data releases deficit during Jul-Mar FY19 reached 5.0 percent of GDP as compared to 4.3 percent suggest that a more in the same period last year and is expected to reach 7.0 percent of GDP by end-June concerted effort will 2019. The government’s gross financing needs remain high and the public debt-to-GDP be required to regain ratio reached 75.5 percent at end-March 2019. The current account deficit improved macroeconomic during Jul-May FY19, but exports contracted by 1.8 percent over the same period. To stability restore macroeconomic stability, the government will have to undertake further reforms to reduce both fiscal and external imbalances. On 3rd July 2019, the IMF approved a 39-month Extended-Fund Facility (EFF) to support the country’s strategy for reducing domestic and external imbalances and tackling structural impediments to growth. Inflationary Consumer price index (CPI) inflation increased from 4.2 percent in May 2018 to pressures are 9.1 percent in May 2019 (Y-o-Y). Average inflation during FY19 is estimated at 7.2 visible and SBP percent, compared to 3.9 percent during the previous year. This increase is a result of is responding by persistent demand-driven pressures, exchange rate depreciation passthrough, a rebound increasing the policy in international oil prices, and an increase in prices of natural gas and LPG. Core rate inflation, reflecting underlying inflationary pressures, increased to 8.0 percent during Jul-May FY19 compared to 5.7 percent in July-May FY18. Given this momentum and inflationary outlook, State Bank of Pakistan (SBP) raised its policy rate by 575 basis points between July 2018 and May 2019. Current account Pakistan’s current account deficit decreased to US$12.7 billion (4.5 percent of GDP) deficit is declining in Jul-May FY19 compared to US$17.9 billion (5.7 percent of GDP) in Jul-May FY18. Exchange rate depreciation, tightening of policy rates and increases in regulatory duties to curtail some non-essential items have all had an impact on imports. Imports of goods declined by 5.9 percent Y-o-Y while import of services fell by 14.4 percent. Exports have not responded to the depreciation yet as regaining competitiveness after extended periods of an overvalued exchange rate will take some time, and exports, in fact, declined by 1.8 percent Y-o-Y. The financial account showed increasing inflows, driven by the significant increase in central bank deposits and bilateral flows due to liquidity injections from China, UAE and Saudi Arabia. However, these injections failed to stem the declining foreign reserves. These fell from US$9.8 billion at end-June 2018 to US$7.3 billion on 21st June 2019 (1.5 months of import coverage). With a stabilization Growth is projected to decelerate to 2.4 percent in FY20 as the government tightens fiscal program in place, and monetary policies to stabilize the economy. This adjustment entails a rebalancing growth is expected from domestic to external demand. While domestic demand will slow down quickly, to remain low in the net exports will only increase gradually. Growth is expected to only recover gradually near term to 3.0 percent in FY21 as external demand picks up, macroeconomic conditions improve, and structural reforms in fiscal management, improved governance of state owned enterprises and competitiveness are implemented. This recovery is conditional on effective implementation of the reform program, relatively stable international oil prices and reduced political and security risks. There are downside There are several risks to this outlook. Economic policies over the past few years have risks to the near- resulted in increased debt levels and a very low level of reserves. Pakistan has not built term economic the necessary buffers to be able to manage domestic or external shocks. Therefore, the outlook and Pakistan country needs to build and maintain buffers to withstand and manage economic risks needs to build fiscal in a context of high global economic and security uncertainty. Weak growth in several THE WORLD BANK GROUP JUNE 2019 12 Weathering the storm: restoring macroeconomics stability Pakistan Development Update and foreign reserves large developed and emerging economies and political tensions (such as a no-deal Brexit buffers to mitigate or further tensions in the Persian Gulf) could all affect investor sentiment and spark a risks and reduce flight for safe assets as seen in the past. This would reduce liquidity in financial markets macroeconomic and interest in riskier assets, at a time when Pakistan will need to return to financial vulnerabilities markets to meet its external financing needs. The main domestic Implementing the necessary structural reform agenda will entail political cost as this risk emerges from will impact the existing dominant elites and could have an overall negative short potential difficulties term impact on the general population. Domestic consensus building will be vital to in implementing implement some of these reforms. Simultaneously, the poor and vulnerable need to be the necessary sheltered, as much as possible, from the impact of the crisis and the adjustment process. adjustments and In the recent FY20 budget, the government has increased the allocation for safety net structural reforms programs to shelter the poor from the ongoing adjustment. In the medium Pakistan’s average economic growth rate has been declining over the past 30 to 40 term, Pakistan years, with periods of growth acceleration usually followed by a crisis. The recently must implement an approved IMF program is the 22nd in the country’s history. Often, stabilization is ambitious structural not followed by deep structural reforms. As argued in the World Bank publication reforms agenda to “Pakistan@100: Shaping the Future”, the origin of Pakistan’s frequent and recurring break the frequent macroeconomic crises is structural, not cyclical. It has a revenue system that is unable boom and bust to meet the government’s financing needs, a fiscal framework that does not bind cycle and become federating units to the broader national goals, a regulatory morass which discourages an upper middle- business and investments and Public Sector Enterprises (PSE) which continuously income country. post losses and constrain the private sector (see Special Section on SOEs). Pakistan’s human development indicators are poor and societal norms are not helping (see special section on child marriages). The available resources are unable to keep pace with the rapid population growth. Failure to address these structural challenges, in parallel to addressing the macroeconomic imbalances, just means that the next crisis is another 4 to 5 years away. JUNE 2019 THE WORLD BANK GROUP 13 Weathering the storm: restoring macroeconomics stability Pakistan Development Update A. Economic Update 1. Real Sector Global growth is Global growth is moderating as the upwards momentum in trade and manufacturing moderating is slowing down. Trade tensions between major economies have increased, global financing conditions have tightened and some large emerging markets and developing economies (EMDEs) have experienced substantial financial market stress. As a result, growth in EMDEs has lost momentum and downside risks have become more acute. These include a potential escalation in trade disputes and the possibility of disorderly financial market movements. Borrowing costs and debt vulnerabilities for EMDEs have increased. In this challenging environment, EMDEs need to rebuild appropriate macroeconomic policy buffers and tackle adverse debt dynamics1. South Asia remains South Asia remained the world’s fastest growing region in 2018 but growth declined the fastest growing from 7.2 percent in 2017 to 6.9 percent in 20182. Moreover, growth in the region region continued to be driven by domestic demand, resulting in double-digit volume growth of imports and limited exports. Despite the improved flow of remittances, current account deficits remained large in 2018.. Overall, fiscal pressures persist and government debt in some countries remains high and growing. Risks to future growth include faster- than-expected tightening of global financing conditions, rising commodity prices and heightened trade tensions3. Pakistan’s growth Pakistan’s gross domestic product (GDP at factor cost) grew at 3.3 percent in FY19—a slowed down in FY19 2.2 percentage point decline compared to the previous year. In FY18, the economy as the government had posted a growth of 5.5 percent, but the consumption driven growth resulted in undertook large twin deficits. The current government after assuming power in August 2018 took measures to correct steps to address these imbalances. The exchange rate was allowed to depreciate, with macroeconomic a cumulative depreciation of 25.5 percent in FY19, the development budget was cut, imbalances energy prices were increased, and the policy rate was raised by 575 bps (see next sections for details). To close the external financing gap, the government received financing4 from the Kingdom of Saudi Arabia (KSA), United Arab Emirates (UAE) and China. The government and IMF also agreed on a 39-month US$ 6 billion EFF, which was approved in early July 2019. On the demand side, Economic indicators suggest moderating aggregate demand, but further adjustments consumption growth will be necessary to achieve macroeconomic stability. Growth in private consumption slowed down in FY19 slowed down from 6.8 percent in FY18 to 4.1 percent in FY19 as the impact of government measures to curb demand sets in. Nevertheless, it comprised 81.8 percent of GDP in FY19 and contributed 3.6 percentage points to GDP growth (Figure 1). Remittances, an important source of income for consumption, increased by 10.4 percent during the first eleven months of FY19 as compared to 4.4 percent in the same period last year. Government consumption is the second largest component of GDP— at 12.2 percent of GDP in FY19—and contributed 1.2 percentage points to GDP 1 Global growth outlook is based on the Global Economic Prospects, June and January 2019, World Bank. 2 South Asia Economic Focus, Spring 2019, World Bank. 3 Ibid. 4 As of mid-June 2019, the Government of Pakistan has received US$3 billion from KSA and US$ 2 billion from UAE in central bank deposits and US$4.5 billion from China (US$2.5 billion in commercial borrowing and US$2 billion in bilateral flows). THE WORLD BANK GROUP JUNE 2019 14 Weathering the storm: restoring macroeconomics stability Pakistan Development Update growth. The contribution of export demand to growth was weak at 1.3 percent, while imports dragged GDP growth down by 1.2 percentage points. The fall in investment demand also slowed growth by 1.4 percentage points. Investment as a In FY19, Pakistan’s already low total investment-to-GDP ratio fell from 16.7 percent percentage of GDP in FY18 to 15.4 percent of GDP- a decrease of 1.3 percentage points. While private declined in FY19 investment fell from 10.3 percent of GDP in FY18 to 9.8 percent in FY19—the lowest it has been in the last five years, public investment also decreased from 4.8 percent of GDP in FY18 to 4.0 percent in FY19, in the same period. The fall in public investment is mainly due to a reduction in the Public Sector Development Program (PDSP) spending by the government. The decline in The low saving-investment equilibrium poses a key challenge to Pakistan’s long-term national savings economic growth. The significant decline in national savings over the past five years is continued into its concerning. In FY15, national savings stood at 14.7 percent of GDP, by FY19 they have fifth year declined to 10.7 percent of GDP (Figure 2). According to the report “Pakistan@100: Shaping the Future”, the low domestic savings are a binding constraint to increasing overall investment levels. In the past, inflows of foreign savings (in the form of grants, external loans and remittances) have helped fill this gap and led to brief periods of high growth but when these inflows dry up, insufficient domestic savings and investment are unable to maintain the growth momentum5. Figure 1: Aggregate demand contribution to Figure 2: Savings and investment GDP growth Percent Percent Source: Pakistan Bureau of Statistics Source: Pakistan Bureau of Statistics. Agriculture growth The agriculture sector grew by 0.8 percent in FY19, significantly lower than the targeted moderated in FY19 growth of 3.8 percent (Figure 3). After posting strong growth of 3.9 percent in FY18 and 2.2 percent in FY17, the sector’s performance was weak in FY19. While livestock (61 percent of agriculture sector) grew at 4.0 percent in FY19, the important crops subsector (22 percent of agriculture sector) contracted by 6.6 percent, slowing overall growth in the sector. Production of cotton, rice and sugarcane declined by 17.5, 3.3, and 19.4 percent, respectively in FY19. Wheat posted a marginal growth of 0.5 percent while maize production grew by 6.9 percent.6 Sector specific issues have impacted growth in 5 World Bank. 2019. Pakistan@100: Shaping the Future 6 Pakistan Economic Survey, 2018-19. JUNE 2019 THE WORLD BANK GROUP 15 Weathering the storm: restoring macroeconomics stability Pakistan Development Update agriculture. Firstly, scarcity of water is a key issue and contributed to a reduction in the area under cultivation of major crops. Secondly, higher prices of fertilizer and other inputs worsened the situation during Q2-FY197. On the other hand, livestock subsector benefitted from improved fodder production, good credit off-take and government initiatives aimed at improving animal health.8 Cotton ginning contracted by 12.7 percent (8.8 percent growth in FY18) due to a decrease in the cotton crop, fishing grew at 0.8 percent (1.6 percent in FY18), while the forestry subsector recorded a growth of 6.5 percent in FY19 (2.6 percent in FY18). Broad-based Industrial sector growth is estimated at 1.4 percent in FY19 compared to 4.9 percent in contraction in FY18. In FY18, the sector benefited from higher public-sector development spending, industrial sector an increase in CPEC related activities, private sector construction activities and compressed growth consumer spending.9 In FY19, industrial sector activities slowed down as the impact of to 1.4 percent in adjustment measures taken by the government began to take effect. Manufacturing, the FY19 largest component of the industry sector, contracted by 0.3 percent (5.4 growth percent in FY18), with large scale manufacturing (LSM) declining by 2.1 percent (5.1 percent growth last year) (Figure 4). This is the lowest growth in LSM since FY09. Depreciation of the PKR adversely affected import-reliant sectors, particularly automobiles whose prices witnessed several upward revisions in FY19. The increase in interest rates raised financial costs and moderated consumer spending.10 Mining and quarrying contracted by 2.0 percent in FY19 (7.7 growth in FY18),11 while construction growth fell from 8.2 percent in FY18 to -7.6 percent in FY19. The reduction in public sector development spending (PSDP)12 has negatively impacted construction-related activities. On the other hand, electricity and gas generation and distribution growth accelerated to 40.5 percent in FY19 from -9.1 percent in FY18 as generation capacity increased significantly due to investments in the previous 3-4 years. Services sector The services sector grew at 4.7 percent in FY19—1.5 percentage points slower than in growth continued FY18. The largest subsector within services, wholesale and retail trade, grew at 3.1 percent in FY19, although at in FY19 (6.6 percent in FY18). Value added in this subsector depends on output in a slower pace than agriculture and manufacturing sectors and volume of imports, hence in FY19, growth previous years in the sector can mainly be attributed to growth in livestock and the volume of imports.13 Growth in key backbone services such as transport, storage and communications (21 percent of the services sector), increased from 2.1 percent in FY18 to 3.3 percent in FY19. Growth in the finance and insurance subsector declined from 7.0 percent in FY18 to 5.1 percent in FY19. The subsector grew despite a decline in value added by the central bank due to positive growth in scheduled banks, non-scheduled banks and insurance subsectors14. General government services grew by 8.0 percent in FY19 (11.8 percent in FY18), driven mainly by the increase in salaries of federal, provincial and district governments. 7 The State of Pakistan’s Economy-Second Quarterly Report 2018-19. 8 Ibid. 9 Ibid. 10 Ibid. 11 The mining and quarrying sector growth declined due to negative growth in natural gas (-2.0 percent) and coal (-25.4 percent). 12 Public Sector Development Spending in Jul-Mar FY19 was PK578.5 billion as compared to 931.4 in Jul-Mar FY18, Ministry of Finance, Pakistan Fiscal Operations (multiple years). 13 Pakistan Economic Survey, 2018-19. 14 Ibid. THE WORLD BANK GROUP JUNE 2019 16 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Figure 3: Sectoral contribution to GDP growth Figure 4: Large-scale manufacturing growth Percent Percent Source: Pakistan Bureau of Statistics Source: Pakistan Bureau of Statistics. 2. Monetary Aggregates Macroeconomic Pressures emanating from the wide current account deficit, declining international imbalances, currency reserves, currency depreciation and accelerating inflation prompted SBP to increase depreciation, and policy rates by 575 bps between July 2018 and May 2019. Market is expecting further surging inflationary policy tightening, as evidenced in recent bid-pattern for government T-bills indicating expectations preference for three-month papers. The real interest rates increased marginally due to prompted monetary the recent hike in policy rates due to commensurate increase in inflation (Figure 5). policy tightening Figure 5: Real policy and weighted average lending rates Percent Source: State Bank of Pakistan. A sharp decline in Broad money (M2) grew by 4.9 percent during Jul–May FY19, compared to 6.7 percent NFA caused broad in the same period last year (Table 1). This marginal slowdown in M2 growth was money (M2) growth primarily due to a sharp decline in net foreign assets (NFA) in Jul-May FY19, especially JUNE 2019 THE WORLD BANK GROUP 17 Weathering the storm: restoring macroeconomics stability Pakistan Development Update to decelerate during of the SBP. NFA of the SBP recorded a decrease of PKR854.6 billion in Jul-May FY19 Jul–May FY19 compared to PKR711.3 billion decline during Jul-May FY18. The decline is triggered by continuous decline in SBP foreign exchange reserves. The net domestic assets (NDA) of the banking system, however, grew at 11.0 percent during Jul–May FY19, compared to 12.3 percent in the same period in FY18. Despite the large decline in the SBP’s NFA, reserve money grew by 10.5 percent in Jul-May FY19 compared to 11.3 percent in Jul- May FY18. The currency-deposits ratio has continued to increase since the imposition of financial transaction tax in FY16 and was 0.42 at end-May 2019, compared to 0.29 percent at the start of FY16. Growth in banking sector deposits also slowed down to 1.8 percent during Jul–May FY19, compared to 4.9 percent growth in the same period in FY18. Table 1: Monetary Aggregates PKR billion unless mentioned otherwise   Stock Flow (Jul-May)   30-Jun-17 30-Jun-18 FY18 FY19 Net Foreign Assets 602.0 -208.4 -748.2 -1002.7 of which: SBP 828.9 12.5 -711.3 -854.6 Net Domestic Assets 13978.8 16205.6 1725.4 1794.5 Government borrowing: 8955.6 10199.7 1166.4 1146.5 Budgetary borrowing 8282.1 9393.0 1047.4 1218.2 from SBP 2350.1 3613.4 2547.1 2454.1 from Scheduled banks 5932.0 5779.6 -1499.7 -1235.8 Commodity operations 686.5 819.7 114.8 -72.2 Non-govt. sector borrowing: 6011.3 7033.6 787.0 879.6 Private sector 5197.5 5973.0 571.8 558.5 Public Sector Enterprises 822.8 1068.2 214.2 319.4 Other Items -988.0 -1027.7 -227.9 -231.6 Broad Money (M2) 14580.9 15997.2 702.4 791.8 Reserve Money (RM) 4868.0 5484.6 548.0 576.4 Memorandum item         Currency in circulation 3911.3 4387.8 454.8 574.2 Total Deposits with Banks 10646.9 11582.4 518.2 210.5 CIC/Deposit ratio 0.4 0.4     Growth Y-o-Y, Since July 1     M2 13.7 9.7 6.7 4.9 RM 22.5 12.7 11.3 10.5 Currency in circulation 17.3 12.2 11.6 13.1 Total Deposits with Banks 12.4 8.8 4.9 1.8 Source: State Bank of Pakistan         NDA grew by 11.0 Significant borrowing by the government and private sectors contributed to healthy percent in Jul–May growth in NDA. Overall government borrowing grew by 11.2 percent during Jul–May FY19, compared to FY19, compared to 13.0 percent during the same period in FY18. Not only was overall 12.0 percent in Jul– borrowing (PKR1,218 billion) for budgetary purposes during Jul–May FY19 higher THE WORLD BANK GROUP JUNE 2019 18 Weathering the storm: restoring macroeconomics stability Pakistan Development Update May FY18 than in Jul–May FY18 (PKR1,047 billion), but its composition also tilted toward central bank borrowing. Table 1 shows that the government retired about PKR1,236 billion from commercial banks and borrowed PKR2,454 billion from the central bank. Private sector The private sector credit growth has remained robust in Jul-May FY19, despite the demand for credit monetary tightening in FY19. The private sector credit grew by 9.4 percent in Jul- was strong May FY19, albeit marginally lower than the 11.0 percent growth observed in Jul-May FY18. The disaggregated data shows that the textiles, food products & beverages, rice processing, refined petroleum, edible oil, fertilizer and motor vehicles manufacturers contributed to the PSC uptick.(Table 2). The credit intake of the food products, non- metallic mineral products, ship breaking, construction, and transport, storage and communication was significantly lower this year, pulling down overall credit growth. Table 2: Credit to Private Sector—Flow PKR billion unless mentioned otherwise   Stock Flow   end-June FY18 Jul-Apr FY18 Jul-Apr FY19 Total credit to Non-government sector (A+B+C) 6923.4 688.5 854.7 A. Investment in securities and shares 257.7 -3.8 -23.0 B. Loan to Private Sector (1+2+3) 5224.3 544.2 590.7 1. Personal: of which 606.2 82.7 58.6 Consumer financing 476.0 69.0 51.2 2. Trust Funds & NPOs and others 23.3 -1.5 -1.0 3. Loans to private sector businesses (a.+.h) 4594.7 463.1 533.2 By sectors:       a. Agriculture 305.5 6.8 -13.4 b. Manufacturing 2707.6 294.1 423.5 Textile 807.0 117.9 177.3 Wearing apparel, readymade garments 87.8 10.5 5.3 Food products and beverages 755.5 90.7 78.0 Chemicals 292.8 -48.6 20.8 Non-metallic mineral products 147.5 44.3 32.9 Leather 25.9 5.1 7.3 Others 591.1 74.2 101.9 c. Electricity, gas and water 399.5 59.5 70.2 d. Ship Breaking 52.7 -1.4 -29.8 e. Construction 164.4 14.9 -11.2 f. Commerce and trade 377.0 42.7 52.0 g. Transport, storage and communication 234.2 22.0 -1.2 h. Real estate 167.8 28.6 23.4 i. Other businesses 186.0 -4.1 19.7 C. Others 1 1441.4 148.1 287.0 of which NBFCW 136.1 -9.4 28.9 1 This also includes credit to Public Sector Enterprises and others.       Source: State Bank of Pakistan JUNE 2019 THE WORLD BANK GROUP 19 Weathering the storm: restoring macroeconomics stability Pakistan Development Update The SBP actively As discussed above, a sharp decline in NFA resulted in decelerated M2 growth. However, used open market overall market liquidity conditions remained volatile during FY19 primarily due to i) operations to increase in policy rates, and ii) retirement of government borrowing from commercial manage liquidity banks. Given expectations of policy rate increases due to ongoing macroeconomic pressures, commercial banks were not inclined to invest in short-term government treasury bonds. This resulted in government borrowing aggressively from the central bank during H2-FY19, leading to easy liquidity conditions in the interbank market. To manage excess liquidity, SBP continued using open market operations. 3. Inflation Inflation has Consumer price index (CPI) inflation increased from 4.2 percent in May 2018 to doubled in the past 9.1 percent in May 2019 (Y-o-Y). Average inflation during the ongoing fiscal year is year projected at 7.2 percent, compared to 3.9 percent during the previous year. Persistent demand-driven pressures, exchange rate passthrough, a rebound in international oil prices and increase in natural gas prices along with CNG and LPG have contributed to this surge in prices. The largest impact on non-food inflation came from revision in natural gas prices and increase in petroleum product prices. That led to an increase in non-food inflation from 5.3 percent in Jul-May FY18 to 9.2 percent in Jul-May FY19 (average). In effect, the rising headline inflation was checked by moderate levels of food inflation (Figure 6). Food inflation picked Food inflation remained moderate during Jul-May FY19 at 4.2 percent compared to up in H2FY19, but 1.7 percent in Jul-May FY18. This is attributable partly to abundant stocks of staple remained moderate commodities15 and a decrease in prices of perishables including fresh vegetables. From in Jul-May FY19 July 2018 onwards, food inflation decreased steadily owing to easy supply conditions— by end-December, it had touched 0.9 percent (Y-o-Y). This trend was reversed from January onwards and food inflation had increased to 8.7 percent by May 2019 (Y-o-Y). Core inflation is on Core—non-food non-energy (NFNE)—inflation increased considerably to 8.0 percent the rise during Jul-May FY19 compared to 5.7 percent in July-May FY18. Core inflation saw an upward trend since the start of the FY, which suggests that rising oil prices, increases in natural gas prices as well as rupee depreciation all had second-round effects on the underlying inflation dynamics (Figure 7). Figure 6: Headline Y-o-Y inflation Figure 7: Monthly moving average of core Percent and headline inflation Percent Source: Pakistan Bureau of Statistics Source: Pakistan Bureau of Statistics. 15 These include wheat, sugar, and pulses. THE WORLD BANK GROUP JUNE 2019 20 Weathering the storm: restoring macroeconomics stability Pakistan Development Update 4. Financial Sector Developments The banking system Deposits held with the banking system of Pakistan have continued increasing, in line continues to remain with trends witnessed in recent years, and reached an all-time high of PKR 14.2 billion robust based on in December 2018, from PKR 13 billion in December 2017. The rising policy rates of standard indicators SBP and, correspondingly, the rising rates offered by banks were among the key drivers of the deposit growth, in addition to measures taken by the government to enhance financial inclusion in the country. Overall, soundness of the banking sector remains strong as indicated by a healthy capital adequacy ratio of 16.2 percent, improved asset quality as indicated by declining NPLs and ample liquidity Table 3: Selected Key Indicators of the Banking Sector PKR billion unless mentioned otherwise         Dec-2017 Dec-2018 Profit before tax YTD 267 243 ROA before tax 1.6% 1.3% ROE before tax 19.5% 17.4% Advances to deposits ratio 50.1% 55.8% Liquid assets/deposits 76.1% 67.2% Capital adequacy ratio 15.8% 16.2% Gross NPLs to loans 8.4% 8.0% Source: State Bank of Pakistan     But the financial and Moody’s has changed the outlook for Pakistan’s banking sector to negative from stable business outlook owing to its over-exposure towards government lending amid a higher fiscal deficit. remains muted Banks’ large holdings of government bonds link their credit profiles to the low-rated government while slower economic growth will contain business opportunities for banks and may stall improving trend in problem loans. Depreciation of the rupee, and growing interest rates and inflation are all factors which affect business and consumer confidence and the private sector’s debt repayment capacities. Credit to the Credit to the private sector increased by 18.7 percent over the period Feb 2018 – Feb private sector has 2019, reaching an all-time high of PKR 6.1 trillion in Feb. 2019, in comparison to continued to grow PKR 5.1 trillion in Feb. 2018. Most of the increase in credit to the private sector was in recent months absorbed by the manufacturing sector, which saw its credit portfolio increase by 25.5 in the backdrop of percent i.e. from PKR 2.4 trillion to PKR 3.1 trillion. Growth witnessed in private sector increased liquidity credit in recent months has been primarily driven by favorable liquidity conditions due to retirement of government borrowing from commercial banks. In a major shift in policy, the government, faced with worsening bank lending terms, has increased its net borrowing from SBP to PKR 6.8 trillion as of Feb. 2019, a massive 87.9 percent increase from June 2018 when total borrowing from the SBP stood at PKR 3.6 trillion. Most of the incremental borrowing from the SBP has been used to retire debt owed to commercial banks. This change left the banks with substantial liquidity and pressure to deploy the funds to increase earnings. JUNE 2019 THE WORLD BANK GROUP 21 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Figure 8: Credit to government sector PKR billion Source: State Bank of Pakistan. SME financing has SME financing accounts for 8.5 percent of the total private sector financing portfolio grown in sync with of banks and DFIs in Pakistan, a far cry from the mid-2000s when SME financing broader growth in accounted for a notable 17 percent of the total. While the current levels of financing credit to the private pale in comparison to the mid-2000s, SME financing is witnessing a turnaround, sector having registered double digit growth (16 percent) over the period of December 2017-December 2018. As of December 2018, the total SME financing portfolio of relevant institutions amounted to PKR 513.6 billion. Loans are currently extended to 180,704 SMEs, signifying a 10.3 percent increase over the reporting period, in various sectors of the economy. The trend witnessed in recent months is aided by the abovementioned liquidity, falling NPLs, which have declined from 17.1 to 14.7 percent over the reporting period, and a proactive policy stance taken by the SBP. The SBP launched a dedicated policy in December 2017 to encourage financing for SMEs in Pakistan. The policy seeks to enhance the sector’s share in private-sector credit from 8.7 to 17 percent and increase the number of borrowers from less than 164,500 to half a million by 2020, given the importance of SMEs for the economy. The SBP estimates that SMEs contribute 30 percent to the GDP of Pakistan and 25 percent to total export earnings, in addition to constituting 90 percent of all business enterprises in Pakistan; yet their financing by the formal financial system has been inadequate. Compliance Pakistan was placed on the FATF’s grey list in June 2018. An action plan was developed with FATF is an and put into active implementation by the authorities. The performance and progress immediate concern under the plan were reviewed in early 2019. A FATF plenary meeting in February 2019 noted some progress, yet also emphasized inadequate efforts, particularly on the counter-terrorism financing front. A set of short-term priorities was suggested, and Pakistan was encouraged to achieve more substantial progress in implementing the action plan by May 2019 in order to pave the way for its delisting from the grey list. Equity market The country’s equity market has displayed high volatility over the last few months with performance, as gains made in the first half of the calendar year 2018 (the index closed at 40,711 points gauged from the on Jan 1, 2018) being wiped out by losses in FY19 (the index closed at 35,505 points on KSE100 index has June 3, 2019). Volatility displayed by the market in recent months has been exacerbated been on a downward by lackluster volumes which have shown a marked decline since early 2018. Poor trajectory since April performance, especially in recent months, was the outcome of an uncertain geopolitical 2018. and macroeconomic environment leading to subdued interest and investments by both local and foreign investors. THE WORLD BANK GROUP JUNE 2019 22 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Figure 9: KSE 100 Index (Closing Value) Index Source: Pakistan Stock Exchange (PSX). Box 1: Housing Finance in Pakistan With outstanding mortgages of around US$ 660 million, or 0.2 percent of GDP, housing finance remains very low in Pakistan. Mortgages grew around 12 percent during 2018 (Table 4), albeit from a low base. One of the notable trends was a substantial decrease of non-performing mort- gages, the bulk of which is concentrated in the DFIs (particularly in the Housing Finance Building Company), driven by reduction of the DFI exposures and new lending by Islamic and conven- tional banks. Another trend was a concentration in mortgage lending, highlighted by a substantial decrease in the number of borrowers, especially in the Islamic banks, yet a significant increase in larger (>PKR 5 million) mortgage loans. The average loan for the latter category increased from PKR 7.3 million to PKR 9.7 million during 2018. The Pakistan Mortgage Refinancing Company (PMRC) started its operations in 2018. It is supported by a project with the WB under which US$ 58 million, or around 9 percent of the total outstanding mortgage volume, has been disbursed for refinancing bank-issued mortgages. In March 2019, the Prime Minister and the SBP have reaffirmed the Naya Pakistan Housing Pro- gram under which 5 million units are to be constructed in the next 5 years. While the program will require very large volumes of new housing finance which are currently beyond the means of the financial system, the SBP has put forward an incentive package to kick start the mortgage lending program to low-income population segments. Under the package, the SBP will be refinancing bank lending for units below PKR 3 million (around US$ 21,500), with loan-to-value ratio of up to 90 percent, for up to 12.5 years at 5 percent interest rate. A corresponding Mudarabah-based facility is also availed for Islamic banks and DFIs. This lending will carry a 25 percent risk weight for capital adequacy purposes (as opposed to the standard 35 percent). Furthermore, borrowing by the mort- gage lenders from the PMRC has been excluded from the mandatory cash reserve and statutory liquidity requirements. Finally, micro-finance banks had their maximum housing loan limit doubled to PKR 1 million and had a requirement to maintain at last 60 percent of their housing loan port- folios with small loans up to PKR 250,000 dropped. All in all, the package is expected to boost availability of mortgage finance, especially at the lower-cost end of the spectrum. JUNE 2019 THE WORLD BANK GROUP 23 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Table 4: Housing Finance Portfolio of Banks/DFIs - Outstanding Finance & No. of Borrowers PKR billion unless mentioned otherwise         Dec-18 Dec-17 Outstanding Housing Finance (by loan size) 92.39 82.59 Up to PKR1 Million 7.27 7.95 Above PKR1 Million to PKR5 Million 20.65 19.51 Above PKR5 Million 64.46 55.13       Outstanding Housing Finance (by bank category) 92.39 82.59 Islamic Banks 40.78 36.09 Conventional Banks 37.27 31.97 DFIs 14.34 14.54       NPL Ratio (Banks & DFIs, %) 11.26 15.51 NPL Ratio (Banks, %) 7.64 9.59         Dec-18 Dec-17 No. of Housing Finance Borrowers (by loan size) 62,432 68,515 Up to PKR1 Million 44,311 47,837 Above PKR1 Million to PKR5 Million 11,470 13,138 Above PKR5 Million 6,651 7,540       No. of Housing Finance Borrowers (by bank category) 62,432 68,515 Islamic Banks 5,891 9,237 Conventional Banks 10,298 10,472 DFIs 46,243 48,806 Source: State Bank of Pakistan     5. Balance of Payments The Balance of Pakistan’s current account deficit decreased to US$12.7 billion (4.5 percent of GDP) Payment (BOP) in Jul-May FY19 compared to US$17.9 billion (5.7 percent of GDP) in Jul-May FY18. continues to be The trade deficit in Jul-May FY19 was 9.3 percent of GDP as compared to 9.1 percent under pressure in Jul-May FY18. External pressures and high inflation led to policy rate increases, as a given the limited measure to stem consumer demand, contain financial outflows, and reduce the pressure improvement in the on the exchange rate. Goods imports declined by 5.9 percent Y-o-Y while services trade account imports fell by 14.4 percent, primarily due to the rupee depreciation and regulatory measures by the government to curtail non-essential imports. The supply response THE WORLD BANK GROUP JUNE 2019 24 Weathering the storm: restoring macroeconomics stability Pakistan Development Update from exports to the depreciation has been slow and exports, in fact, declined by 1.8 percent Y-o-Y. The deficit on primary income worsened slightly (4.3 percent in Y-o-Y comparison) while the secondary income balance improved by 6.2 percent in the same period, driven by 10.4 percent Y-o-Y growth in remittances –the main factor behind the improvement in the current account balance. The financial account showed increasing inflows, driven by the significant increase in central bank deposits from China, UAE and Saudi Arabia and reliance on commercial borrowing. However, these inflows failed to stop the decline in foreign exchange reserves, which fell from US$9.8 billion (1.7 months of import coverage) at end-June 2018 to US$7.3 billion on 21st June 2019 (1.5 months of import coverage). Table 5: Balance of payments summary1y US$ billion unless mentioned otherwise       Jul-May FY18 Jul-May FY19 i. Current account (A+B+C+D) -17,926 -12,678 A. Trade balance -28,713 -26,110 Exports 22,754 22,340 Imports 51,467 48,450 B. Services net -5,496 -3,946 C. Balance on primary income2 -5,017 -5,233 D. Balance on secondary income2 21,300 22,611 of which, remittances 18,286 20,191 ii. Capital account 329 181 1. Balance from current and capital accounts (i+ii)3 -17,597 -12,497 2. Financial accounts4 -11,826 -11,938 of which:     Direct investment -3,152 -1,599 Portfolio investment -2,311 1,246 Net acquisition of financial assets 106 137 Net incurrence of financial liabilities 6,469 11,722 3. Errors and omissions -718 -614 Overall balance (-1+2-3) 6,489 1,173 SBP reserves (excl. CRR, SCRR) 9,509 7,863 Memorandum items     Current account (percent of GDP) -5.7 -4.5 Trade account (percent of GDP) -9.1 -9.3 Export growth (percent) 13.1 -1.8 Import growth (percent) 18.1 -5.9 Remittance growth (percent) 4.4 10.4 Financial account (percent of GDP) -3.8 -4.2 Notes: 1: As per Balance of Payments Manual 6 (BPM6). 2: In BPM6, the income account has been renamed ‘primary income’ and current transfers, ‘secondary income’. 3: A negative balance shows that the economy is a net borrower from the rest of the world. 4: A negative balance highlights a net increase in the incurrence of foreign liabilities. Source: State Bank of Pakistan. JUNE 2019 THE WORLD BANK GROUP 25 Weathering the storm: restoring macroeconomics stability Pakistan Development Update The slowdown in The decline in exports when comparing Jul-May FY19 and Jul-May FY18 is evident in exports was most the food group and most of the manufactured goods including textile which rely on prominent in food machinery imports and intermediate goods imports. The food group, which recorded group, textiles growth rate of 33.5 percent in Jul-May FY18 (mainly due to boom in rice exports), and chemicals & contracted by 5.2 percent. This contraction in food group was trigged by a significant pharmaceutical decline in fish, wheat, and sugar exports and slower growth in Basmati rice exports. products Textile exports slowed down, as exports of cotton cloth, ready-made garments, bed wear, and towels, which account for 32.2 percent of total exports, grew by only 1.0 percent compared to 7.7 percent during the same period in the previous year. Chemical and pharmaceutical products that account for 5.0 percent of total exports, declined by 14.0 percent during Jul-May FY19, compared to growth of 36.0 percent in the same period of last fiscal year. Surgical goods remained stagnant compared with a growth rate of 13.0 percent last fiscal year. Figure 10: Share in export growth (Y-o-Y) Percent Source: State Bank of Pakistan. The import bill Imports contracted by 5.9 percent in Jul-May FY19 as compared to the growth of 18.1 decreased in tandem percent in the same period last fiscal year, as the effects of the rupee depreciation, the with the depreciation higher policy rates, and regulatory restrictions on non-essential imports materialized. of the PKR The import bill fell to US$ 48.5 billion in Jul-May FY19 as compared to US$ 51.5 billion in Jul-May FY18. The largest decline in imports was in the category of transport and machinery group, which declined by 23.4 percent and 23.0 percent Y-o-Y respectively. Food group and metal imports also saw declining imports of 12.2 percent and 15.6 percent respectively in Jul-May FY19 as compared to the same period in the previous fiscal year. Petroleum related imports continued to grow (5.0 percent), although at a lower rate than in the same period last fiscal year (28.9 percent). Agriculture imports also grew by 2.8 percent Y-o-Y in Jul-May FY19, compared to a growth rate of 17.2 percent in Jul-May FY18. Petroleum group Petroleum group16 imports continues to be the largest contributor to imports, comprising imports remain 26.5 percent of total imports17. Within the petroleum group, the composition of strong, driven by imports is changing. Petroleum products as a percentage of total petroleum group imports has fallen to 43.4 percent in Jul-May FY19 as compared to 52.2 percent in the 16 Petroleum group is comprised of the following categories: petroleum products, crude petroleum, natural gas (liquefied), petroleum gas (liquefied) and others. 17 Using Jul-Jun FY18 figures. THE WORLD BANK GROUP JUNE 2019 26 Weathering the storm: restoring macroeconomics stability Pakistan Development Update increased import of same period last year. Liquified Natural Gas saw an increase of 46.6 percent in Jul-May LNG FY19 as compared to the same period last fiscal year, and comprised 21.2 percent of total petroleum imports, up from 15.2 percent in the same period last fiscal year. While the import of petroleum products declined by 12.8 percent, crude petroleum saw an increase in imports by 15.6 percent, considerably lower than the growth rate in Jul-May FY18 of 53.3 percent. Figure 11: Major imports growth (Y-o-Y) Figure 12: Growth in sectoral sales of POL (Y-o-Y) Percent Percent Source: State Bank of Pakistan. Source: State Bank of Pakistan. Remittance growth The balance of secondary income grew by 4.2 percent when comparing Jul-May FY19 mitigated some with Jul-May FY18. Remittances grew by 10.4 percent during Jul-May FY19 as compared of the impact of to the previous fiscal year, primarily due to higher flows from the US – an increase of the negative trade 21.6 percent between Jul-May FY19 and Jul-May FY18 - increasing the share of US balance on the remittances to 15.5 percent of total remittances. Remittances from Malaysia increased current account by 37.3 percent as compared to 7.5 percent in the previous fiscal year. Remittances from the Gulf Cooperation Council (GCC) countries saw a modest increase of 3.4 percent in Jul-May FY19, with remittances from Saudi Arabia growing by 3.3 percent while remittances from other GCC countries, primarily Bahrain and Kuwait saw a decline of 5.5percent and 5.7 percent respectively. JUNE 2019 THE WORLD BANK GROUP 27 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Figure 13: Workers Remittances Index Source: State Bank of Pakistan. Financing flows The financial account in Jul-May FY19, at US$11.9 billion, remained very similar to in FY19 remained Jul-May FY18 (US$11.8 billion). But financing sources underwent significant changes. similar than in Foreign direct investment fell from US$3.1 billion in Jul-May FY18 to US$1.6 billion FY18, although in the same period this year, due to the decline in Chinese FDI by 72.6 percent Y-o-Y. its composition There was a net outflow of US$1.2 in portfolio investment in Jul-May FY19, compared changed to inflows of US$2.3 billion in the same period in FY18. Financing was primarily supported by large borrowings from and liquidity injections by China, Saudi Arabic and UAE to build up the foreign reserves of the country. Structural changes Pakistan needs to sustainably improve external balances, primarily through improvement are required to boost in exports. Pakistan will be exposed as long as it relies on remittances or liquidity injections export performance from other countries to balance its external accounts. The response of exports to the depreciation will happen with a lag, as price changes lead to changes in production and consumption patterns. Policy reforms to reduce current anti-export bias in tariff structure, maintain a market driven exchange rate regime, and improvement in trade facilitation are required to enhance export performance. 6. Fiscal Account The fiscal deficit Despite the two amendments to the Finance Bill by the incoming government, aimed at widened due to correcting fiscal imbalances, Pakistan registered a consolidated18 fiscal deficit (excluding underperforming grants) of 5.0 percent of GDP19 for Jul-Mar FY19 (Table 6), 0.7 percentage points revenues and higher than the same period last fiscal year. During the first amendment to the Finance rigid recurrent Bill in September 2018, the government revised the fiscal deficit target upwards to expenditures 6.6 percent of GDP from 4.9 percent envisaged in the original budget. A slowdown in revenue growth and rigidity in recurrent expenditures contributed to this outcome. While tax revenues increased marginally by 2.8 percent in Jul-Mar FY19 over the same period in FY18, non-tax revenue declined by almost 17 percent during the period, resulting in no growth in overall revenues. Indirect tax revenues The FBR tax collection grew by 2.9 percent in Jul-Mar FY19 as compared to the first three quarters of FY18 (Table 7). Collection from direct taxes has declined slightly (by 18 This analysis refers to the consolidated fiscal accounts of federal and provincial governments. 19 Based on the GDP target for FY 2018/19. THE WORLD BANK GROUP JUNE 2019 28 Weathering the storm: restoring macroeconomics stability Pakistan Development Update are performing 1.2 percent) in a Y-o-Y comparison. The reduction in income tax slabs and reduced rates better than direct in the original FY19 approved budget resulted in a significant erosion of the income taxes tax base. This was only partially overturned as part of the first amendment to the Finance Bill by the new government in September 2018. The exemptions at the lower end of the income slab were maintained.20 The impact on direct revenue collection is still expected to be significant for the full year as evident in reduced collections for the first three quarters. On the other hand, indirect tax collections by FBR have increased by 5.5 percent compared to the first three quarters of FY18, primarily due to almost 18 percent increase in custom duties collection—an effect of the increase in the rupee value of imports because of depreciation.21 Sales tax on goods, which contributes to over 60 percent of the total indirect tax collection, has increased negligibly by 0.1 percent (Y-o-Y) compared to Jul-Mar FY18. Provincial tax All provinces collectively contributed about 9 percent of the overall tax collection collection remains during the first three quarters of FY19 (Table 6). Given that the bulk of the provincial relatively low revenues comprises of federal transfers, the provinces have little incentive to improve their tax collection.22 Overall provincial tax collection rose by 3 percent from Jul-Mar FY18, with only Sindh and Khyber Pakhtunkhwa registering a growth of 6 and 3 percent respectively, while Punjab failed to register any growth. Balochistan has seen a decline of 1 percent during the same period in tax collections. Sales tax on services that comprises the largest proportion of provincial taxation saw a decline of 5 percent in the Y-o-Y comparison, driven by poor performance in Punjab, Khyber Pakhtunkhwa, and Balochistan, which saw a decline in collection of sale tax on services of 12 percent, 8 percent, and 7 percent respectively. Sindh was the only province that registered a minor increase (4 percent) in its collection of sale tax on services. See below the box on sales tax coordination challenges. Box 2: Sales Tax Coordination Challenge Sales tax policy and administration in Pakistan is fragmented with federal government responsible for sales tax on goods while sales tax on services is constitutionally a provincial tax. This has led to three major issues emerging: (i) high administrative costs, with businesses operating nationally having to file approximately 60 returns for sales tax that increases cost of doing business as well as promotes a culture of informality and evasion; (ii) fragmented bases, as definitions between goods and services unclear legally, and complaints are raised by both Federal and provincial governments on the other having impinged on their tax base; and (iii) different in taxation principles, as some provinces apply the destination principle whereas others use the origin principle to determine tax liability, leading to a cascading of sales tax burden when goods are traded across provinces. Over- coming this constraint requires a tax reform that establishes a harmonized sales tax system across Pakistan with a uniform definition of tax bases harmonized collection through a single system, and an updated revenue sharing measure. 20 For the FY19 budget, the minimum threshold for income tax was raised from PKR0.4 million per annum to PKR1.2 million per annum. The subsequent amendment to the Finance Bill attempted to reverse this, but only introduced a token tax for those between the PKR0.4 million and PKR1.2 million income brackets. 21 In FY19, the PKR has depreciated by 25.5 percent against the US dollar in the interbank market. 22 The largest tax bases for the provinces are sales tax on services, agriculture income tax and urban immovable property taxes. JUNE 2019 THE WORLD BANK GROUP 29 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Table 6: Summary of Pakistan Fiscal Operations PKR billion (unless mentioned otherwise)            Percent growth Jul-Mar Jul-Mar   FY17 FY18 Jul-Mar FY18 Jul-Mar FY19 FY18 FY19 Total Revenue 4,937 5,228 3,582 3,584 13.9% 0.0% Tax Revenue 3,969 4,467 3,076 3,162 14.2% 2.8% Federal 3,647 4,066 2,796 2,874 13.5% 2.8% Provincial 322 401 280 288 21.4% 2.8% Non-Tax 967 761 506 422 -33.5% -16.7% Federal 888 614 380 356 -3.2% -6.1% Provincial 79 147 127 65 113.6% -48.4% Expenditures 6,801 7,488 5,063 5,506 15.5% 8.7% Current of which: 5,198 5,854 4,075 4,798 13.0% 17.7% Interest 1,348 1,500 1,173 1,459 7.2% 24.4% Defence 888 1,030 624 775 16.5% 24.2% Development 1,693 1,584 993 656 23.6% -34.0% Expenditure Net lending (13) 38 9 28     Statistical Discrepancy (78) 12 (15) 24     Fiscal Balance (1,864) (2,260) (1,481) (1,922)     % of GDP (5.8) (6.6) (4.3) (5.0)     Memorandum             items: GDP (nominal) 31,862 34,396 34,396 38,388     Source: Ministry of Finance (MoF) Non-tax revenues Non-tax revenues which peaked in FY17 have continued to decline. In Jul-Mar FY19, declined sharply non-tax revenues declined by almost 17 percent as compared to FY18. This is primarily due to a decline in central bank profits (by 3 percent as compared to Jul-Mar FY18) and a 50 percent decline in the “Others” category, which together comprised 59 percent of the total non-tax revenue collected in FY1923. Provincial non-tax revenue declined more sharply in a Y-o-Y comparison as compared to the Federal Government, led by the decline in net hydel profits receipts. 23 These two categories comprised 73 percent of total non-tax collection in Jul-Mar FY18 and 65 percent of non-tax collection for the complete FY18. THE WORLD BANK GROUP JUNE 2019 30 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Table 7: FBR Tax Collection PKR billion unless mentioned otherwise           Percent growth   FY17 FY18 Jul-Mar FY18 Jul-Mar FY19 Jul-Mar FY18 Jul-Mar FY19 Direct 1,343 1,537 1,009 997 13.1 (1.2) Indirect 2,018 2,306 1,619 1,707 18.3 5.5 Customs 496 608 430 507 25.2 18.0 Sales Tax 1,323 1,491 1,050 1,048 16.9 (0.1) Federal Excises 199 206 139 151 9.4 8.8 Total Taxes 3,361 3,842 2,628 2,705 16.2 2.9 Source: Ministry of Finance         Development The Government announced an austerity drive to curtail overall expenditures and expenditure was reduced development spending by 34 percent as compared to Jul-Mar FY1824, while slashed to reduce protecting strategic projects such as the China Pakistan Economic Corridor. While overall expenditures expenditure on the federal Public Sector Development Program (PSDP) declined by 14 percent in the first nine months of FY19 as compared to the same period in FY18, provincial development expenditure declined by almost 52 percent during the same period. However, increase Despite the effort to reduce total spending, recurrent spending is non-discretionary and in recurrent increased by 18 percent in Jul-Mar FY19 when compared to the same period last year (a expenditures 20 percent increase for the federal government and 14 percent increase for provincial resulted in an overall governments). As a result, total expenditures grew by 8.7 percent during Jul-Mar-FY19 increase in fiscal compared to the same period in FY18. At the federal level, interest payments, which deficit are the largest budgetary item, increased by 24 percent, primarily due to the increase in interest payments on external debt (increased 80 percent Y-o-Y) and to a lesser extent on domestic debt (increased 19 percent Y-o-Y). Defense spending has also seen a spike as compared to the first three quarters of the last fiscal year, registering a 24 percent increase. Provinces provided In aggregate terms, all provincial development expenditures have declined on Y-o-Y some fiscal comparison, with the two larger provinces (Punjab and Sindh) having registered declines consolidation in development expenditures of 67 percent and 31 percent respectively, while Khyber Pakhtunkhwa reduced its expenditure by 23 percent and Balochistan by 34 percent. Recurrent expenditures of all provinces have increased due to high salary and pension bills. However, all provinces have posted positive fiscal balances at the end of March 2019. Punjab posted a surplus of PKR 157.3 billion (0.4 percent of GDP) at end-March 2019, compared to a negligible surplus of PKR 7.0 billion at end March 2018. On the other hand, Sindh and Khyber Pakhtunkhwa’s fiscal balance, albeit positive, is 6 percent and 3 percent lower respectively than their Jul-Mar FY18 balances. Balochistan’s fiscal balance is 3 percent higher in a Y-o-Y comparison with Jul-Mar FY18. Overall, the provinces have provided a fiscal surplus of PKR292 billion, an increase of 88 percent when compared with the first three quarters of last fiscal year. Positive fiscal balances 24 The decline is also due to the start of a new government, that is determining its priorities, and the end of the election year that saw an acceleration in development spending. JUNE 2019 THE WORLD BANK GROUP 31 Weathering the storm: restoring macroeconomics stability Pakistan Development Update for the first three quarters are common for the provinces; however, almost all the provinces posted a negative fiscal balance at the end of FY18 (apart from Balochistan). While the federal government may be requiring provinces to contribute to lowering the consolidated fiscal deficit, the last quarter’s spending by provincial governments can be high and unpredictable. Table 8: Analysis of consolidated spending         PKR billion unless mentioned otherwise           Percent growth Jul-Mar Jul-Mar   FY17 FY18 Jul-Mar FY18 Jul-Mar FY19 FY18 FY19 Total expenditures 6,801 7,488 5,063 5,506 15.5% 8.7% Current 5,198 5,854 4,07 4,798 13.0% 17.7% Federal 3,472 3,790 2,653 3,181 8.8% 19.9% Interest payments 1,348 1,500 1,173 1,459 7.2% 24.4% Domestic 1,220 1,323 1,071 1,277 6.1% 19.2% External 128 177 101 182 19.9% 79.8% Pensions 304 334 245 293 17.3% 19.7% Grants 352 384 234 227 8.7% -2.8% Defense 888 1,030 624 775 16.5% 24.2% Public Order and 128 125 94 106 14.8% 12.9% Safety Health & Education 106 115 75 80 9.0% 6.4% Others 346 303 209 241 -86.8% 15.2% Provincial 1,726 2,065 1,422 1,617 22.0% 13.7% Development 1,693 1,584 993 656 23.6% -34.0% PSDP 1,578 1,456 931 578 24.7% -37.9% Federal 726 576 354 302 9.1% -14.5% Provincial 852 880 578 276 36.7% -52.2% Other Dev. Expenditures 116 128 62 77 8.3% 25.0% Net Lending (13) 38 9 28 Statistical Discrepancy (78) 12 (15) 24 Source: Ministry of Finance           Structural fiscal With the provinces posting surpluses, the federal government’s large deficit is imbalances are constraining the fiscal consolidation efforts. Until expenditure is managed in a contributing to poor consolidated effective manner, and revenue collection is increased, it will be very fiscal outcomes difficult to maintain a balanced fiscal stance in a sustainable manner. A misalignment of institutional responsibilities between provinces and the center has contributed to Pakistan’s poor fiscal outcomes. This is because the mandate to drive fiscal consolidation rests with the federal government, while the fiscal space and flexibility in spending rests with the provinces. In this situation, consolidated fiscal targets requires a consistent coordination between all federating units. The current fiscal architecture thus lacks the necessary institutions and a regulatory framework for coordinating and implementing a credible and effective fiscal policy nation-wide. The government has established a Fiscal THE WORLD BANK GROUP JUNE 2019 32 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Coordination Council (FCC) to tackle these issues but it lacks the necessary institutional set up and support within the Ministry of Finance to be able to drive this agenda. 7. Debt and Its Dynamics Public debt Pakistan’s public debt25 stood at 75.5 percent of GDP at end-March 2019—5.0 increased during Jul- percentage points higher than the end-March 2018 stock (Figure 14). This debt level is Mar FY19 in breach of the Fiscal Responsibility and Debt Limitation Act FRDLA 2005 (amended in 2017) which stipulates a reduction of total public debt to 60 percent of GDP by FY19. Both external and domestic public debt increased during FY19 . However, of the total increase in external debt, almost 75 percent came from the depreciation of the Pakistani rupee against the US dollar between March 2018 and March 2019. Figure 14: Trends in public debt External and domestic debt measured in PKR trillion (LHS), public debt-to-GDP measured in percent (RHS) Source: State Bank of Pakistan and WBG staff calculations External financing Pakistan received gross disbursements worth US$13.4 billion in Jul-Mar FY19 compared flows increased in to US$8.0 billion in Jul-Mar FY18 under public and publicly guaranteed (PPG)26 external Jul-Mar FY19 debt (Table 9). To meet external financing needs, the government received loans of US$3.0 billion from KSA and US$2.0 billion from UAE. During Jul-Mar FY19, almost 47 percent of these debt inflows came from China and included US$2.0 billion bilateral flows for balance of payments support. Aggregate flows from China (both bilateral disbursements and commercial loans) surpassed inflows from multilaterals. 25 The public debt-to-GDP ratio is estimated by the World Bank as per the Government Financial Statistics Manual 2014 and is the definition used in this report. This entails including the external debt of public enterprises not included in the debt stock as defined by the Government of Pakistan. 26 Official statistics do not include central bank deposits as part of public debt. However, this section considers these deposits as part of Public and Publicly Guaranteed external debt. JUNE 2019 THE WORLD BANK GROUP 33 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Table 9: Gross disbursements – Public and Publicly Guaranteed External Debt (PPG) 1 G  US$ million unless mentioned otherwise                   FY14 FY15 FY16 FY17 FY18 FY18 (Jul-Mar) FY19 (Jul-Mar)2 Multilateral 3,099 2,774 3,784 2,963 2,894 2,084 1,193 Bilateral 927 1,359 1,247 1,793 2,377 1,685 9,170 Of which: China 594 1,161 1,042 1,583 1,811 1,275 3,885 Commercial 323 150 1,381 4,368 3,716 1,722 3,108 Of which: China - - - 2,300 2,200 1,000 2,534 Eurobonds/ 2,000 1,000 500 1,000 2,500 2,500 - Sukuks Total 6,349 5,283 6,913 10,124 11,487 7,991 13,471 disbursements Memo: China 594 1,161 1,042 3,883 4,011 2,275 6,419 1: GoPak received US$3.0 billion from the KSA and US$2.0 billion from UAE which are included in this table as part of bilateral flows. The authorities do not consider central bank deposits as part of public debt, but in this table, we included them as part of PPG external debt. 2: This includes SAFE deposit of US$2 billion from China. Source: Economic Affairs Division, Ministry of Finance, Government of Pakistan     The domestic debt Since FY17, the government has increasingly relied on short-term domestic financing. profile tilted further Contrary to strategic guidelines set in the Pakistan’s medium-term debt management towards the short- strategy27 and despite substantial external inflows from multilateral, bilateral and term thus amplifying commercial funding sources, rising fiscal deficits have forced the authorities to increase the roll-over risk borrowing in the domestic market. Domestic debt increased by PKR1,754 billion in Jul-Mar FY19 compared to PKR1,225 billion in Jul-Mar FY18. Borrowing from State Bank of Pakistan (SBP) increased sharply during Jul-Mar FY19, increasing inflationary pressures in the economy. The deterioration of the macro fundamentals and market expectations of further interest rate hikes have reduced the appetite for medium to long-term securities, leading to an increase in financing through shorter tenor Treasury Bills. This has elevated refinancing and repricing risks28. 27 Covering the period FY17-FY19. 28 The latest public debt risk report points towards deterioration in key indicators. For instance, domestic debt re-fixing in 1 year has increased from 52.8 percent of total domestic debt as of end-June 2016 to 60.1 percent as of end-December 2017 (Source: Public Debt Management Risk Report (various issues), Debt Policy Coordination Office, Ministry of Finance). These levels for FY18 are coinciding with the magnitude witnessed in FY13, implying an erosion of gains achieved during the early years of the Pakistan’s first debt management strategy FY14-FY18. THE WORLD BANK GROUP JUNE 2019 34 Weathering the storm: restoring macroeconomics stability Pakistan Development Update B. Outlook and Upcoming Challenges 1. Outlook GDP growth Growth is projected to decelerate to 2.4 percent in FY20 as the government tightens is projected to fiscal and monetary policies to stabilize the economy. Pakistan’s adjustment entails decelerate in FY20 a rebalancing from domestic to external demand. While domestic demand will slow followed by a down quickly, net exports will only increase gradually. Growth is expected to only recovery in FY21 recover gradually to 3.0 percent in FY21 as external demand picks up, macroeconomic conditions improve, and a package of structural reforms in fiscal management and competitiveness is implemented. This recovery is conditional on relatively stable international oil prices and reduced political and security risks. Slower growth in In FY19, agriculture growth moderated due to lower output in important crops (rice, services and industry cotton and sugarcane) due to adverse weather conditions but the sector is expected to is expected to slow recover in FY20 as crop production improves. The industry and services sectors are overall growth in projected to post growth rates of 1.2 percent and 3.1 percent respectively in FY20 as FY20 contraction in domestic demand affects growth in these sectors. In FY21, growth in the industry and services sectors is expected to recover to 2.1 percent and 3.7 percent respectively as economic conditions improve. On the demand side, Private consumption growth is expected to compress to 1.7 percent in FY20 from 4.1 consumption and percent in FY19 and an average of 7.7 percent between FY16-18. Similarly, government investment growth consumption is projected to contract by 3.6 percent in FY20 as the government will decline in the undertakes fiscal consolidation measures before recovering to 1.1 percent in FY21. near term Contraction in Gross Fixed Capital Formation (8.9 percent in FY19) is expected to continue in FY20 (0.4 percent) as the impact of stabilization measures to moderate aggregate demand continue. These trends are in line with the decline in domestic demand that was observed in previous adjustment periods, particularly in FY09-10. Imports are projected to contract in FY20 (1.3 percent) whereas exports are projected to grow by 12.3 percent as exports start to respond to the lower exchange rate. Inflation is expected Inflation is expected to rise in FY20 to 13.0 percent, the highest since FY11 and remain to peak in FY20 and elevated in FY21. The increase in prices will be driven by exchange-rate pass-through to remain elevated in domestic prices and a moderate increase in international oil prices29. Domestic energy FY21 prices (gas, electricity and fuel) were increased in FY19 and this trend is likely to continue in FY20 as the gap between generation costs and prices is further reduced. This will add to inflationary pressures directly and through second-round effects. In view of the rising inflation, the government has already adjusted the policy rate substantially in FY19. The inflation outlook suggests that further policy rate adjustments are likely in FY20. Energy price increases will affect consumption, which will require government support (e.g. in the form of additional cash transfers) to mitigate the impact on the poor and vulnerable. Rising demand of Pakistan’s commercial banks remain well capitalized. However, the rising demand of public sector credit public sector credit (mainly central government borrowing) and rising interest rates 29 The empirical evidence suggests that a nominal depreciation has moderate effect on domestic prices in Pakistan. The pass- through is primarily concentrated in commodities including fuel, wheat, cotton, and sugarcane. JUNE 2019 THE WORLD BANK GROUP 35 Weathering the storm: restoring macroeconomics stability Pakistan Development Update will keep commercial are expected to crowd out private credit in the near-term. The increased government banks well insulated borrowing from commercial banks will facilitate that commercial banks grow their from macroeconomic sovereign exposures, requiring little effort in terms of risk underwriting compared slowdown to private sector lending (due to zero risk weights of sovereign exposures) and offer attractive yields leading to stable profitability of banks. The current account The current account deficit is expected to decline to 2.6 percent of GDP in FY20 and deficit is expected further to 2.1 percent of GDP in FY21 as increased exchange-rate flexibility, together to decline in FY20, with domestic demand compression and other regulatory measures, support an increase but external gross in exports amid a deceleration in imports. The exchange rate has depreciated by 25.5 financing needs will percent in FY19. The authorities have committed to a market-based exchange rate remain high going forward, which will ensure that the exchange rate moves in line with economic fundamentals to reduce external imbalances. Remittances are projected to finance over 90 percent of the trade deficit in FY20. However, external gross financing needs will remain upwards of US$25 billion30 in the near to medium term due to large amortization payments. FDI, multilateral, bilateral, private debt-creating flows as well as financing from international markets are expected to be the main financing sources. The fiscal deficit is The consolidated fiscal deficit is projected to reach 7.0 percent of GDP in FY19 and expected to remain remain elevated at 6.9 percent of GDP in FY20. In the recently proposed federal high in FY20 before budget for FY20, the government has set a high revenue target with additional revenue improving in FY21. collection of PKR1.7 trillion when compared to the FY19 revised revenue target. The increase in revenues will be achieved through several measures, including the removal of tax exemptions (particularly SRO 1125(I)/2011 regime which relates to the zero- rating of five export-oriented industries), an increase in taxation on sugar, carbonated drinks and cigarettes, updating of property valuation tables to almost 85 percent of the market value, lowering of personal income tax thresholds from PKR 1.2 million to PKR 0.6 million for salaried individuals and PKR 0.4 million for non-salaried individuals and making non-filing of taxes a prosecutable offense. Moreover, as part of fiscal consolidation measures, provinces are expected to post a collective surplus of PKR 423 billion or 1 percent of GDP. However, large increases in interest payments in FY20 will raise current expenditures and result in a high fiscal deficit. In FY21, the fiscal deficit is projected to decline to 4.8 percent of GDP as the government takes further fiscal consolidation measures. Public debt will The public debt-to-GDP ratio is expected to remain elevated in FY20, reaching 79.5 remain elevated in percent of GDP and increasing Pakistan’s exposure to debt-related shocks. Fiscal the medium-term consolidation will be needed for the public debt to decline over the medium term, but the debt-to GDP ratio is not expected to fall below 70 - the debt burden benchmark for high risk Emerging Markets - before FY23. Pakistan’s debt dynamics will remain challenging mainly due to large foreign currency debt amortization31 coupled with sizeable refinancing of short-term domestic debt. 30 This assumes, as per recent discussions in the media, that non-traditional bilateral financing partners will maintain exposure to Pakistan by rolling over a large share of the debt contracted over the past few years. 31 This is primarily due to (i) Eurobond/Sukuk bullet repayments; (ii) bullet maturities of Chinese commercial lending; (iii) repayments on the rescheduled Paris Club debt under Official Development Assistance (ODA) that started since FY17; and (iv) those of the IMF-EFF. THE WORLD BANK GROUP JUNE 2019 36 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Figure 15: Real GDP growth and twin deficits Percent Source: Data from Pakistan Econonic Survey, State Bank of Pakistan, Ministry of Finance and World Bank staff estimates Table 10: Key macroeconomic indicators                             FY16 FY17 FY18 FY19 (e) FY20 (f) FY21 (f) Real GDP growth, at constant factor prices (%) 4.6 5.2 5.5 3.3 2.4 3.0 Agriculture 0.2 2.2 3.9 0.8 1.8 2.0 Industry 5.7 4.6 4.9 1.4 1.2 2.1 Services 5.7 6.5 6.2 4.7 3.1 3.7 Real GDP growth, at constant market prices (%) 5.5 5.6 5.8 3.3 2.4 3.0 Private Consumption 7.6 8.5 6.8 4.1 1.7 2.0 Government Consumption 8.2 5.3 8.6 10.0 -3.6 1.1 Gross Fixed Capital Formation 7.5 10.3 7.1 -8.9 -0.4 4.0 Exports, Goods and Services -1.6 -0.6 10.4 13.2 12.3 8.7 Imports, Goods and Services 16.0 21.2 15.8 5.8 -1.3 1.5 Inflation (Consumer Price Index) 2.9 4.2 3.9 7.2 13.0 11.0 Current Account Balance (% of GDP) -1.7 -4.1 -6.3 -4.7 -2.6 -2.1 Exports of Goods (% growth) -8.8 0.1 12.6 0.8 7.0 9.0 Imports of Goods (% growth) -0.2 18.0 16.2 -3.7 -5.9 3.8 Remittances (% growth) 6.4 -2.8 2.9 9.7 4.2 4.6 Financial and Capital Account (% of GDP) 2.5 3.5 4.7 4.4 3.3 4.1 Net Foreign Direct Investment (% of GDP) 0.8 0.9 1.1 0.6 0.7 0.9 Fiscal Balance Excluding Grants (% of GDP) -4.6 -5.8 -6.5 -7.0 -6.9 -4.8 Primary Balance Excluding Grants (% of GDP) -0.3 -1.6 -2.2 -1.8 -0.6 0.8 Debt (% of GDP) 68.7 68.0 73.0 79.4 79.5 76.3 Sources: World Bank, Macroeconomics, Trade and Investment Global Practice     Notes: e = estimate, f = forecast.             JUNE 2019 THE WORLD BANK GROUP 37 Weathering the storm: restoring macroeconomics stability Pakistan Development Update 2. Risks Economic policies Prudent macroeconomic policies build buffers so that countries can use those buffers over the past few in the case of a large shock – whether domestic or external. But Pakistan’s policies years have resulted over the past few years, using limited international reserves to maintain an overvalued in increased debt exchange rate and with widening fiscal deficits means that it has not built such buffers. levels and a low level International reserves have declined from 4 months of imports in mid-2016 to around of reserves, limiting 1.5 months of imports on 21st June 2019. Public debt levels have increased from below the economy’s ability 60 percent in 2009 to almost 80 percent today. Part of the strategy to withstand and to absorb shocks manage economic risks in a context of high global uncertainty is to build buffers and maintain them. Turbulences in Weak growth in the US and the Euro zone means that interest rate increases by the US financial markets Federal Reserve or the European Central Bank are unlikely to materialize in the near- could affect term. But weak growth in these countries, together with weak growth in several large Pakistan’s access to emerging economies and political tensions that may spill over into the economy (such external financing as a no-deal Brexit or further tensions in the Persian Gulf) could all affect investor sentiment and spark a flight for safe assets as seen in the past. This would reduce liquidity in financial markets and interest in riskier assets, at a time when Pakistan will need to return to financial markets to meet its external financing needs. Weak demand in Pakistan’s adjustment requires a rebound of exports to contribute to a more sustainable global markets and external balance. But global demand is weakening and so is growth in some of Pakistan’s trade tensions could main trade partners, including China. Lower growth in China could have implications dampen external for global and regional trade. A significant slowdown in China could affect commodity demand prices, as has been seen in the past. Slower growth may also limit investment abroad and Pakistan has been one of the main beneficiaries of China’s investments abroad. Ongoing trade tensions could affect growth but given Pakistan’s limited integration in regional value chains it is unlikely to have a significant effect on trade flows. The main domestic Pakistan needs to adjust its policies to restore and maintain macroeconomic stability. risk emerges from Reducing fiscal deficits and fiscal risks emanating from SOEs, in particular in the potential difficulties energy sector, as well as exchange rate flexibility to restore the competitiveness of in implementing Pakistan’s exports are all necessary reforms. But as with any reform process, there the necessary will be costs, particularly in the short term. These reforms can be politically costly, if adjustments and not well implemented. Interventions can help to mitigate the impact of the reforms structural reforms on the most vulnerable. A failed adjustment process would pose a significant risk for Pakistan’s medium- and long-term growth prospects, by not addressing the existing macroeconomic imbalances and not addressing the structural challenges that prevent higher and sustainable growth (see next section on structural reforms). The mix of lower growth, high inflation and attempts to widen the tax net will test the government’s resolve and its ability to see through a difficult but necessary adjustment period. THE WORLD BANK GROUP JUNE 2019 38 Weathering the storm: restoring macroeconomics stability Pakistan Development Update 3. Progress on Structural Reforms A combination Pakistan will need a combination of short-term adjustment measures to address of short-term macroeconomic imbalances and medium-term structural reforms to accelerate and adjustment measures sustain growth. Pakistan is frequently affected by bouts of macroeconomic instability. and medium- The origin of these frequent imbalances is structural, not just the result of poor term structural macroeconomic policy choices. Very low revenue levels combined with relatively reforms will be rigid expenditure assignments at the federal level result in large fiscal deficits. Poor needed to restore competitiveness limits the country’s exports and ability to finance its imports, resulting macroeconomic in large external imbalances. Measures to address macroeconomic imbalances in the stability and short term are urgently needed to restore macroeconomic stability. But unless the accelerate and structural imbalances affecting the economy are also addressed, the next macroeconomic sustain growth crisis is only a few years away. Implementation of adjustment measures to restore macroeconomic stability needs to be done in tandem with a structural reforms agenda that addresses constraints to higher and sustained growth. This should include efforts to broaden the tax net, improve fiscal management for fiscal sustainability as well as a competitiveness agenda. Domestic Revenue Pakistan has substantial potential to increase tax receipts without imposing new taxes Mobilization or raising tax rates, using a broad-based low-rate approach. A tax gap analysis recently completed by the World Bank indicates that Pakistan is collecting much less than its potential. The tax gap is larger in the services sector than in manufacturing and it is larger for the General Sales Tax (GST) on goods and services than for income tax. Broadening the tax base will involve scaling back the extensive tax expenditures, estimated at 2 percent of GDP in FY18. These exemptions distort competition and economic actors’ incentives. A broader tax base also requires expanding the tax net, by lowering the thresholds for becoming taxpayers and addressing widespread tax evasion, enabled by weaknesses in compliance control. The number of tax filers remains very small at 1.5 million, and only 1.1 million filers declared taxable incomes/sales in FY18. Legal loopholes in “Benami” accounts, bearer prize bonds, foreign remittances and low taxation in certain sectors (agriculture, real estate) also facilitate tax evasion and money laundering. The tax system is complex because of overlapping jurisdictions (federal government and four provinces) with different laws, exemptions, and frequent policy changes. This often results in double taxation and a high compliance burden. The high reliance on indirect taxes and withholding agents results in a regressive tax system, with taxes withheld in practice becoming a transaction tax, which applies equally to everybody irrespective of income level. Withholding taxes places a significant administrative burden on businesses and distorts economic actor’s incentives, e.g. the withholding tax on financial transactions reduces people’s willingness to use banks for financial transactions. To guide efforts for domestic revenue mobilization, the Federal Board of Revenue has developed a Transformation Roadmap. This will guide reform efforts in the medium term, and it envisages the transformation of FBR into a world-class, technology-driven, and taxpayer-centric revenue authority. This roadmap includes (i) a review of tax laws and regulations to simplify and make them more accessible to taxpayers and enable improvements in tax administration, (ii) the implementation of a set of compliance JUNE 2019 THE WORLD BANK GROUP 39 Weathering the storm: restoring macroeconomics stability Pakistan Development Update enforcement measures, including a new Tax Audit Policy based on risk management, a Specialized Tax Unit to analyze data received from foreign jurisdiction on assets held by Pakistani residents and exchange of taxpayer information with NADRA and provincial tax authorities, and (iii) initiatives to strengthen the performance of FBR as an organization (ICT systems, human resources). Fiscal Management The misalignment of institutional responsibilities between provinces and the center has Reforms contributed to fiscal instability and frequent boom-bust cycles in Pakistan. Implementing a credible fiscal policy across the country is challenging as the mandate to drive fiscal consolidation rests with the federal government, while provinces have no constitutional responsibility to contribute to these national goals. The 7th NFC award, implemented in FY10, reduced the federal government’s share in the divisible pool of revenue by about 14 percent without any significant reduction in its expenditure mandates, resulting in a structural deficit for the federal government. In addition, the 18th constitutional amendment enhanced the fiscal autonomy of provinces without establishing any mechanism to implement consolidated fiscal targets for the general government. A centralized fiscal policy function at the Ministry of Finance, currently lacking, should develop a medium-term fiscal framework considering the intergovernmental fiscal architecture of the country. The absence of institutional and regulatory anchors for coordinating and implementing a credible and effective fiscal policy across the general government contributes to the country’s frequent boom-bust cycles. Addressing the “responsibility misalignment” between center and provinces requires the establishment of an institutional framework that coordinates macro-fiscal policymaking. Pakistan has taken steps in this direction by establishing the Fiscal Coordination Committee (FCC), which met for the first time in October 2018. The FCC is formed of federal and provincial finance ministers and is tasked with reviewing and monitoring federal and provincial fiscal policy, including expenditures, revenues, debt and cash management. However, FCC lacks the necessary institutional set up and support within the Ministry of Finance to be able to drive this agenda. Therefore, it will be important to build a credible centralized macro-fiscal function in the Ministry of Finance, to conduct macroeconomic and fiscal analysis or forecasting, preparing a medium term macroeconomic and fiscal strategy, to ensure that budgets are well- informed and fiscal risks are managed adequately. Improving fiscal management will also require the establishment of a centralized Debt Management Office. Debt management in Pakistan is fragmented, with limited coordination to implement a coherent debt management strategy. There are several debt managers in separate units in the Ministry of Finance as well as outside the Ministry of Finance. All these units operated independently with no single entity empowered to or tasked with achieving debt management objectives. The fragmentation in the debt management function has resulted in a high reliance on short-term debt to finance fiscal deficits, with limited development of the domestic debt market and increased exposure to roll-over and re-financing risks. Competitiveness Re Pakistan has been losing export competitiveness in world markets for more than forms a decade. The export bundle lacks sophistication, e.g. the textiles sector is primarily cotton based, despite the global shift toward the more sophisticated apparel made of synthetic fibers. Exporters in Pakistan struggle to sustain export flows and to grow THE WORLD BANK GROUP JUNE 2019 40 Weathering the storm: restoring macroeconomics stability Pakistan Development Update (when compared to the experience of other countries), which suggests that the export business is a lot riskier in Pakistan. Exporters in Pakistan also remain relatively small when compared to exporters in other countries. Pakistan’s ability to attract FDI into its export sector has been very limited, preventing Pakistan’s integration into global value chains. Competitiveness is affected by several issues. An overvalued exchange rate depressed export competitiveness over the last years, while a weak investment climate increases the costs of doing business for domestic and export-oriented firms alike. There are three particular drivers of lagging competitiveness more closely related to an economy’s ability to export and attract FDI. First, a weak institutional set up to drive the trade and investment agenda, reflected in high fragmentation and limited coordination in reform initiatives. Second, the current regulatory environment discourages internationalization and integration into global value chains. Trade tariffs are high (e.g. average tariffs on intermediate goods are four times those in East Asia) and there is significant tariff escalation, that introduce an anti-export bias: firms prefer to sell domestically because they are shielded behind high tariff barriers, rather than venturing in highly competitive export markets. FDI attraction efforts are hampered by inconsistencies in the legal framework for foreign investment that add to the high risks of doing business in Pakistan already perceived by foreign investors. Third, the public support system to boost firms’ productivity and innovation is ineffective, with focus on protecting incumbent firms rather than innovation and ‘creative destruction’, and without sunset clauses for support systems. Competitiveness reforms should rest on three pillars to address these issues. First, there is a need to strengthen institutions for trade and investment, including the establishment of a consolidated institutional and organizational framework to enhance the competitiveness of Pakistan’s export-oriented firms at a global level. This revised framework should improve coordination, between government levels and relevant agencies as well as with the private sector. Second, the regulatory environment needs to change to make integration profitable for firms, by focusing on reducing the anti- export bias of trade policy through a thorough rationalization of tariffs and para- tariffs, and on harmonizing the investment policy framework to reduce risks. The third pillar of reforms needs to focus on supporting firms’ capabilities (particularly SMEs and new firms), to ensure that firms are equipped with the skills and information required to become more competitive and export. This would include support to adopt internationally recognized managerial practices and to become accredited suppliers and the provision of export intelligence services. JUNE 2019 THE WORLD BANK GROUP 41 Weathering the storm: restoring macroeconomics stability Pakistan Development Update C. Special Sections Special Section: Finance Bill FY20 The FY20 budget is The proposed FY20 budget is a response to immediate stabilization needs. As the country an integral part of continues the adjustment to address macroeconomic imbalances, with a particular focus the government’s on revenue generating measures, real GDP growth is expected to decline. The proposed efforts to restore FY20 budget targets a fiscal deficit of 7.2 percent of GDP (at par with the revised fiscal macroeconomic deficit target of FY19) and a primary deficit of 0.6 percent of GDP. stability The focus of the Total revenues are budgeted to grow by 33 percent over FY19 revised estimates. adjustment program Revenues are projected at PKR 5.0 trillion in FY19, a shortfall of PKR 629 billion (PKR is in raising more 500 billion in tax revenues) against targeted revenues. Revenues are projected at PKR revenues 6.7 trillion in FY20, an additional PKR1.7 trillion in revenue, of which PKR 1.4 trillion is expected in additional tax revenue. Expenditures are Expenditure growth in FY20 is expected to remain strong, driven by interest payments. budgeted to grow Total federal expenditures are expected to grow by 32 percent in FY20 when compared as debt servicing to FY19, from 13.8 percent of GDP in FY19 to 16 percent of GDP in FY20. Current continues to be high expenditures are expected to grow by 33 percent (from 12.1 percent of GDP in FY19 to 14.1 percent in FY20) and development expenditure (excluding social protection/ BISP) by 55 percent (from 1.7 percent of GPD in FY19 to 1.9 percent of GDP in FY20). Provinces are To maintain the national fiscal deficit at FY19 levels, the federal government is relying expected to provide on provinces to post large fiscal surpluses in FY20 – collectively around 1 percent of much-needed GDP. surpluses for fiscal consolidation THE WORLD BANK GROUP JUNE 2019 42 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Revenues The FY 20 budget Tax revenues are projected to grow from 11.4 percent of GDP in FY19 to 13.2 percent aims to remove tax of GDP in FY20. The largest increases are expected in sales tax on goods collection concessions to raise (41 percent), followed by 37 percent gain in Federal Excise Duties (FED). Pakistan’s more revenues tax code has many special exemptions and distortions with significant fiscal costs. The proposed budget eliminates many of these concessions. Specifically, in sales tax, the removal of SRO 1125 which eliminates zero-rating for five export-oriented sectors will generate significant revenues. The government The government has proposed to levy additional taxation on sugar, soft-drinks, and has also announced cigarettes (FED). The budget also proposes to bring valuation tables for immovable additional tax properties in line with market values. The undervaluation of real estate provides an measures on income incentive to invest in this sector, which has resulted in large flows of funds to the real taxes and trade estate sector at the expense of other sectors of the economy. Another proposal is related taxes to, for the first time, make non-filing of tax return a prosecutable offense. Direct tax collection is budgeted to increase by 25 percent over the revised FY19 estimates. This will be driven by a lowering of minimum thresholds for personal income tax from PKR 1.2 million to PKR 600,000 for salaried individuals and PKR 400,000 for non- salaried individuals. Government reliance on trade taxes continues as custom duties are expected to increase by 36 percent. It has also been proposed to restrict the powers of the Federal Government and FBR to grant zero-rating. Figure 16: Total federal revenue collection PKR billion Source: Budget in Brief FY20, Ministry of Finance Box 3: Changes to Custom Duties – Finance Bill FY20 The recent Budget approved introduces changes in duties on imports, mainly through increases in Additional Customs Duties, increasing protection by roughly 1 percentage point. This policy decision aims at increasing customs revenues, with an estimated yearly impact of 383 million JUNE 2019 THE WORLD BANK GROUP 43 Weathering the storm: restoring macroeconomics stability Pakistan Development Update USD. It is also expected to reduce imports by 188 million USD (0.4 percent). More importantly, this policy decision is expected to have detrimental effects on export competitiveness through two channels. First, increases in import duties increase the anti-export bias of Pakistan’s trade policy framework. While tariffs, regulatory duties and additional customs duties are devised as taxes on imports, they act as implicit taxes on exports. When import tariffs increase, Pakistani firms face increased incentives to sell in the internal market rather than exporting, since the price of imported varieties rises, thus also raising profit margins of domestically oriented firms. This is particularly the case when import duties on final goods increase by more than import duties on raw materials and intermediate products – that is, when effective protection increases - as it is the case in this Budget (Figure 17). An increased anti-export bias of trade policy puts a toll on long-term growth, because it reduces the scope for increases in efficiency that is brought about by exposure to export markets, and because it prevents the allocation of resources into their most efficient uses. Second, increases in import duties increase production costs for Pakistani firms that rely on imported intermediates. Firms willing to remain competitive source their intermediate inputs from wherever they are produced at lowest cost, or with the required quality standards. For exporters, for example, it is estimated that about 20 percent of inputs into exportable products is imported. Thus, increases in import duties increase production costs of Pakistani firms. While this budget focuses on import duty increases on final goods, there are some non-negligible increases in intermediate input tariffs faced by firms. For example, for wearing apparel, increases in intermediate input tariffs are estimated at 20 percent, while for vegetable oils and fats, it is estimated at 17 percent (Figure 18). It is crucial that these increases in import duties aiming at reducing the fiscal vulnerability of the economy are temporary measures so that they do not compromise long-run growth. In the short term, exporters need to access efficient duty suspension schemes so that they can still compete globally. In the medium to long term, it is crucial that Pakistan moves away from imports as a source of tax revenue, as countries typically do as they move up the development ladder. Figure 17: Impact of proposed custom duties Figure 18: Change in tariffs on intermediates Source: WBG Staff calculations Source: WBG Staff calculations based on World Bank Upstream Tariff Simulator. THE WORLD BANK GROUP JUNE 2019 44 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Expenditures Recurrent Interest payments are budgeted to increase from PKR1,987 billion (5.2 percent of expenditure is GDP) in FY19 to PKR 2,891 billion (6.2 percent of GDP) in FY20. Around 88 percent budgeted to increase of the interest payments are expected to be domestic interest payments. Since FY15, the significantly due to share of external debt in total debt stock is increasing but domestic debt still dominates interest payments the portfolio and accounted for 64 percent in FY18. Salary expenditure is also expected and salaries, while to increase considerably (32 percent in FY20 – maintaining its share of 4.6 percent of defense expenditure the total federal expenditure). This is primarily due to the ad hoc relief allowance of is expected to PKR 79 billion announced in the Federal budget. Under this measure, a 10 percent remain at the same increase was announced for grades 0 to 16 (non-officers) of the Federal Government; level as this year a 5 percent increase for grades 17 to 20; and no increase for grades 21 and 22. The measure also includes a 10 percent across the board increase for all military personnel. Pensions are budgeted at PKR 421 billion—an increase of 23 percent over revised estimates of FY19. Defense expenditure is budgeted to increase by 1.3 percent, and its share in total expenditure will decline to 16.4 percent in FY20 from 21.4 percent in FY19. Subsidies, especially In nominal terms, subsidies are projected to increase by 6 percent (although they are for the energy sector, declining as a share of GDP from 0.7 percent in FY19 to 0.6 percent in FY20). Around are budgeted to 92 percent (PKR 250.5 billion) of the total federal subsidies are in the energy sector, of increase in FY20 which PKR 198.5 billion are tariff differential subsidy of some form. The remaining 8 percent of the subsidies are for food, mostly for wheat commodity operations. The government For the first time, Ehsaas/BISP has not been budgeted under development expenditure has budgeted a and has been shifted to current expenditures with an allocation of PKR188 billion significant increase (0.4 percent of GDP). This is 2.7 percent of the total federal expenditure in FY20, an for social safety net increase from the 2.2 percent of the total federal expenditure in FY19. The shift to the programs to counter recurrent budget will allow social protection to be more firmly embedded as one of the the effects of the government’s key service delivery operations. adjustment on the most vulnerable Figure 19: Federal expenditure Source: Budget in Brief FY20, Ministry of Finance. JUNE 2019 THE WORLD BANK GROUP 45 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Development Despite the pressure to reduce public spending, the government has been able to carve spending is out fiscal space for public investment in a bid to improve the medium-term growth budgeted to increase outlook. Development expenditure has been budgeted at PKR 843 billion (1.9 percent of GDP) in FY20 and includes provisions for the merged districts of FATA (PKR 48 billion), various initiatives to promote trade and a low-cost housing scheme. However, among non-PSDP expenditure, the largest budgeted outlay is for “Duty Drawback of Taxes Order FY2016/17” of PKR 35 billion as the Government plans to clear its dues under this head. The total PSDP has an allocation of PKR 701 billion in FY20, up from PKR 500 billion in FY19 – an increase of 0.3 percent of GDP (from 1.3 percent in FY19 to 1.6 percent in FY20). Ambitious tax Over the past few years Pakistan has struggled to meet its fiscal targets, with aggregate revenue targets and expenditure outturn exceeding the budget by 130 percent in FY17 and 126 percent the realization of in FY18. Fiscal risks remain high and impact budget credibility. One of the key fiscal contingent liabilities risks the government will face is the underperformance of the tax system, particularly could affect fiscal given how ambitious the revenue targets are. In most fiscal year revenue collection consolidation efforts falls short of the target. The growing pension and wage bill further constraining fiscal space. Guarantees issued to State-Owned Enterprises (SOEs) also pose fiscal risks. The arrears in the energy sector (the Circular Debt) have grown to an estimated PKR1.6 trillion for the electricity sector and PKR150 billion for the gas sector. Table 11: Key Indicators, Federal Budget FY19 and FY20           FY19 FY20 Key Indicators Budget Revised Budget as % of GDP       FBR collection 11.6 10.8 12.6 Non-tax revenue 2 1.7 2 Grants 0.1 0.1 0.1 Federal Transfers to provinces 6.2 6.4 7.4         Federal Expenditure 13.7 13.8 16 Current Expenditure 11.4 12.1 14.1 Development Expenditure 2.3 1.3 1.6         Provincial surplus 0.7   1         Budget Balance excl grants -4.9 -7.2 -7.2 Budget Balance incl grants -4.8 -7.1 -7.1 Primary Balance excl grants -0.7 -2 -0.6 Primary Balance incl grants -0.6 -1.9 -0.5 Source: Annual Budget Statement, Ministry of Finance THE WORLD BANK GROUP JUNE 2019 46 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Special Section: State-Owned Enterprises The federal As of June 2017, the federal government owned 204 State-Owned Enterprises (SOEs)32 government of supervised by 17 ministries and three other government departments. The SOEs are Pakistan owns a active in a wide range of sectors and vary in size from large companies to entities that diverse set of State- would barely meet the government’s definition of Small and Medium-sized Enterprises Owned Enterprises (SMEs). This diversity and decentralized arrangement for the oversight of SOEs makes under the purview of it difficult for the government to have a consolidated view of the SOE universe or different ministries develop a coherent policy on SOEs. The decentralized In many cases oversight of an SOE by a sectoral ministry gives rise to actual and/ oversight of or perceived conflicts of interest, whereby the ministry plays several roles – as the SOEs by various owner of the SOE (on behalf of the Government of Pakistan); as the sector regulator; ministries has and/or as the primary client or financing source for the SOE. Such examples include several drawbacks oversight of the National Highway Authority by the Ministry of Communication, that work against Pakistan International Airlines by the Aviation Division, and Pakistan Railways by the efforts to improve Ministry of Railways. The risks associated with this type of oversight arrangement are the corporate particularly high in sectors without an independent regulator and exacerbated in cases governance and where the SOEs have a dominant market share, such as the insurance sector in Pakistan. performance of There is also a risk of line ministries lobbying the government for financial support SOEs for SOEs in their sector, thereby disincentivizing these SOEs from improving their financial performance. Of course, such issues and risks are by no means unique to Pakistan. In many countries, however, they have prompted governments to abandon the decentralized model of SOE ownership and oversight. The government has The establishment of a holding company, Sarmaya-e-Pakistan Limited (SPL), with the recently taken a step mandate to manage its stakes in SOEs, is one such step to centralize the SOE oversight towards centralizing function. In this regard, Pakistan is following the example of many countries that have the SOE oversight moved away from decentralized oversight of SOEs, whereby SOEs are supervised function by line ministries, towards more centralized arrangements (Table 12). The main alternatives to the decentralized model are known as the dual and centralized models. Under the dual model, line ministries maintain oversight over operational aspects of SOEs’ performance in their respective sectors, while oversight of SOEs’ financial performance is the responsibility of a central body, usually the Ministry of Finance. Under the centralized model, a central entity is responsible for the management of the SOE portfolio. This role may be performed by a central ministry (e.g. Ministry of Finance or Industry, or dedicated Ministry for SOEs), a government agency or a holding company set up for this purpose. Centralized Many countries have initiated the transition to the dual or centralized model when they management of found themselves in a difficult fiscal situation, when reducing the financial drain of loss- government holdings making SOEs on the budget became imperative. In such circumstances, governments in SOEs offers can benefit from taking a whole-of-portfolio approach to their SOE holdings. A several advantages portfolio approach facilitates the formulation of an evidence-based policy on SOEs. and tends to be Such a policy would articulate a coherent set of objectives and principles such as particularly useful in national security, economical provision of public goods and services in areas of market 32 This report refers to the SOEs per the definition of the federal Ministry of Finance in its annual reports on SOEs’ financial performance. JUNE 2019 THE WORLD BANK GROUP 47 Weathering the storm: restoring macroeconomics stability Pakistan Development Update situations of fiscal failure, generation of non-tax revenues, and competition in domestic markets. These pressure objectives and principles could provide clear criteria to guide high-level decisions on the SOE portfolio. Such decisions could include whether to maintain or divest government states in SOEs; revising the legal status or mandates of SOEs; and defining conditions for financial support to SOEs. Table 12: Country examples of SOE Ownership and Oversight Models     Model Countries Decentralized model: Technical and financial -    Pakistan oversight of SOEs by sector ministries with no umbrella -   Cambodia ownership and oversight arrangement. -    Lao PDR -    Myanmar Centralized model: Single entity (holding company, -          China ministry of government agency) manages the SOE -          France portfolio, including oversight of financial and -          Indonesia operational performance and corporate governance. -          Kazakhstan -          Malaysia -          The Netherlands -          Peru -          Poland -          Singapore -          South Africa -          Spain -          Vietnam Dual model: Sectoral departments maintain direct -          Bangladesh oversight of SOEs’ operations, while the Ministry of -          Brazil Finance or other dedicated government entity exercises -          India financial oversight and overall SOE policy. -          Japan -          Mexico -          Morocco -          New Zealand -          Sri Lanka -          Thailand -          Turkey Source: World Bank Group Staff In Pakistan, too, Full or partial privatization of government stakes in SOEs has been the most frequently governments have pursued approach to reducing the fiscal risks arising from SOEs. This approach has paid close attention been successful to some extent, especially when the government divested its majority to SOEs in times of positions in large enterprises operating in sectors with competitive markets. This has fiscal difficulty been notably the case of the banking and telecommunications sectors, where gradual divestments of government stakes generated budget revenues, boosted competition in these sectors, and relieved the government of fiscal risks related to state-owned banks. Privatization efforts however have been less successful in other sectors, especially when it comes to loss-making enterprises that are less attractive to prospective investors. SOEs in the oil and gas sector have been the most profitable, and financial sector SOEs THE WORLD BANK GROUP JUNE 2019 48 Weathering the storm: restoring macroeconomics stability Pakistan Development Update In recent years have also been consistently profitable. On the other hand, the transport and industrial the profitability sectors have been loss-making, with some of the largest loss-making SOEs such as of federal SOEs the NHA, PIA, Pakistan Railways, and PSM. Power distribution companies (DISCOs) has declined, include both profitable and loss-making enterprises. Financial results in energy sector though financial SOEs are to a large extent driven by trends in oil and gas prices. Higher prices bolster performance varies the profits of SOEs in the oil and gas sector, while negatively affecting power-sector across sectors SOEs, thereby exacerbating cost-recovery challenges due to controlled tariffs, non- payment, electricity theft, and technical losses. Figure 20: Trends in SOEs’ revenues, Figure 21: Profits/losses by sector profits/losses PKR billion PKR billion Source: Ministry of Finance. Source: Ministry of Finance. The present fiscal At the portfolio level, SOEs present a net cost to the federal exchequer. Several large situation makes SOEs depend on financial support from the government in various forms including the current scale subsidies, loans, debt guarantees, and equity injections. In recent years the federal of government government has reduced subsidies and grants to SOEs, providing financial support financial support to increasingly through loans and guarantees for SOEs’ borrowing from commercial SOEs increasingly banks (Figures 18, 19). In principle, this approach makes the SOEs somewhat more untenable accountable for meeting their financial liabilities, but also generates contingent liabilities for the government. At the same time, the government’s annual budget financing to SOEs (loans, grants, and subsidies) has risen overall, as the profitability of SOEs has declined since FY2014/15. Budget financing of SOEs amounted to 1.8 percent of GDP and 13.2 percent of total public expenditure in 2016/17. This financing becomes increasingly costly as the government’s borrowing costs rise in line with domestic interest rates. Figure 22: Government financial support to federal SOEs Figure 22: Government financial support to PKR billion federal SOEs Source: Ministry of Finance. JUNE 2019 THE WORLD BANK GROUP 49 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Reducing SOEs’ At present, SOEs lack strong incentives to improve their financial performance. dependence Government financial support should be conditional on results agreements, whereby on government SOEs commit to improving financial performance with specific milestones and financing and targets. Failure to meet targets should carry sanctions including dismissal of an making them SOE’s management and Board. Likewise, the government needs to enforce financial financially transparency requirements, notably publication of annual financial statements and sustainable will external audit reports. SOEs that do not meet these requirements should be disqualified take decisive and from financial support. Loss-making SOEs with substantial assets (e.g. National consistent action Highway Authority, Pakistan Railways) need to come under intense scrutiny over their under-utilization of these assets for revenue generation. The government Goods and services may be subsidized according to unit costs (e.g. average cost of also needs objective delivering mail in rural areas) and volume of outputs. For most goods and services criteria for however (e.g. fuel, power distribution, public transport) a preferable approach is to subsidizing public channel subsidies directly to consumers and allow the enterprises to charge adequate services and/or rates for cost recovery. This approach is more efficient, as it allows the government to goods provided by target subsidies to consumers according to need and reduces the risk of enterprises SOEs inflating operational costs. In addition, passing the subsidy on to the consumer (e.g. through discount cards) would not distort competition in sectors where SOEs compete with private enterprises (e.g. fuel distribution). In addition to This would involve minimizing the preferential treatment of SOEs compared to reducing the fiscal private firms to ensure a level playing field in domestic markets. For example, sovereign burden of SOEs, guarantees of SOEs’ borrowing from commercial banks distort the banking sector’s a new government incentives in favor of issuing credit to SOEs, thereby crowding out credit for the private policy on SOEs sector. Preferential treatment of SOEs in terms of regulatory oversight, taxation, access can contribute to government property, and government financial support reduces private investors’ to improving the incentives to enter sectors where SOEs have a large presence. Such sectors include competitiveness of insurance, aviation, and power distribution. In turn, preferential treatment reduces the economy SOEs’ incentives to improve their products and services, invest in new technologies, and provide better value-for-money for customers. A centralized The federal Ministry of Finance would be able to design and implement the institutional conditionality for financial support to SOEs, but it would require a dedicated unit or arrangement for wing to prepare and monitor results agreements on actions and targets to improve the government’s financial performance and recommend budget measures accordingly. Without a ownership and central ownership entity however, the government might have difficulty holding SOEs oversight function accountable. For example, the authority to appoint and dismiss board members would would be optimal need to be transferred from line ministries, which as discussed often have conflicts of for implementing interests among the multiple roles of line ministries as de facto owners, regulators, and/ policies to improve or customers of SOEs, which result in various forms of preferential treatment and SOE performance anti-competitive practices. Finally, SOEs’ A new policy on SOEs would disqualify incumbent and retired government officials performance from management positions in SOEs and strictly limit their presence on SOE Boards to is unlikely to no more than a third of Board members. The composition of SPL’s recently appointed improve unless Board of Directors, with eight out of eleven directors drawn from the private sector, they are managed sets a good precedent to be applied across SOEs. Enforcing this practice has two THE WORLD BANK GROUP JUNE 2019 50 Weathering the storm: restoring macroeconomics stability Pakistan Development Update by business important advantages. First, an arm’s length relationship between government and professionals SOEs would also enable public officials to perform their fiduciary duties without the constant apprehension of being caught up in a judicial investigation over alleged mismanagement of SOE resources. Second, it would help ensure that SOEs have managers and directors with knowledge and experience of developing assets, increasing the value of a company’s balance sheet, and generating financial returns. Divestments of minority stakes to strategic investors can also help bring experienced business persons to SOE Boards who can hold managers accountable. International experience amply demonstrates that is unrealistic to expect public officials to acquire this knowledge by taking a training course for directors. JUNE 2019 THE WORLD BANK GROUP 51 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Special Section: Child Marriage, Early Childbearing, Low Educational Attainment for girls, and their Impacts in Pakistan Trends in child marriage, early childbearing, and educational attainment for girls This chapter When girls marry or have children before they are physically and emotionally ready to explores the impacts do so, the negative impacts on them and their children can be dramatic. The economic and costs of child and social costs of child marriage, early childbearing, and low educational attainment for marriage, early girls are large. Providing better opportunities for girls is essential for Pakistan to reach childbearing and its development potential. To catalyze investments towards improving girls’ education, low educational ending child marriage, and preventing early childbearing, and based on a framework attainment for girls outlined in Box 3, this chapter documents trends over time in these issues and their in Pakistan. impacts on development outcomes. Box 4: Framework for the Analysis A simple framework guides the analysis. As shown in Figure 21, we recognize first that girls’ education and child marriage as well as early childbearing are closely linked. The literature and estimates from this series suggest that keeping girls in school is one of the best ways to delay marriage and childbearing. In contrast, marrying early or becoming pregnant leads girls to drop out of school. Furthermore, child marriage is one of the main drivers of early childbearing. These relationships are acknowledged in the top part of Figure 1. In turn, both girls’ educational attainment and child marriage/early childbearing matter for other development outcomes. Four main outcomes are considered: fertility, health (including nutrition and the risk of exposure to intimate partner violence), work (including labor force participation and earnings), and agency (including decision-making and other impacts). While some of these impacts are estimated for girls marrying or dropping out of school early, others are estimated for their children. Selected economic costs or benefits associated with the impacts of girls’ education and child marriage or early childbearing are estimated next. Examples of benefits from educating girls, ending child marriage, and preventing early childbearing include (1) higher GDP per capita growth thanks to lower population growth, (2) higher labor earnings for women in adulthood, (3) higher labor earnings for children in adulthood thanks to less stunting, (4) valuation of the benefits associated with children’s lives saved, and (5) reduced budget needs thanks to lower population growth. This list of benefits is by no means exhaustive, but it includes some of the largest economic benefits that can be expected. Finally, we note that the benefits from educating girls and ending child marriage at the level of individuals and households have broader implications at the national and even global level. By raising standards of living (through higher GDP per capita with lower population growth and higher earnings for women), educating girls and ending child marriage will reduce poverty as well as inequality. THE WORLD BANK GROUP JUNE 2019 52 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Pakistan does Table 13 provides estimates of child marriage (a formal or informal union before better than most the age of 18) and early childbearing (having a first child before the age of 18) for other South Asian women of various ages. Among girls aged 18 to 22, the prevalence of child marriage countries on child decreased from 18.7 percent in 2012-13 to 17.4 percent in 2017-18. The prevalence marriage and early of early childbearing remained stable between the two years, with a drop of only 0.2 childbearing, but percentage point albeit from a smaller base. These trends are encouraging, and the it lags behind the prevalence of both child marriage and early childbearing used to be higher in the regional average past. Yet the recent pace of progress is not sufficient to end child marriage by 2030. for educational In addition, while Pakistan has lower rates of child marriage and early childbearing attainment for girls. than the South Asian average, it lags behind the regional average for girls’ educational attainment as observed through the proportions of girls of various ages who complete their primary, lower secondary, and upper secondary education. Age groups to estimate these measures are defined to allow girls a few more years beyond the normal age to complete a level (to account for the possibility of late entry and/or repetition). Significant progress has been made at the primary level over the last three decades. Yet progress between the last two surveys for 2012-13 and 2017-18 is limited, with a gain in completion rates for girls aged 15-18 at the primary level of only 2.8 percentage JUNE 2019 THE WORLD BANK GROUP 53 Weathering the storm: restoring macroeconomics stability Pakistan Development Update points. Between 2012-13 and 2017-18, larger gains were observed for lower and upper secondary completion, but the gains are again too small to achieve the SDGs by 2030. Furthermore, at the secondary level, girls still lag behind boys in terms of completion rates, and educational attainment for girls is behind the South Asia average. Table 13: Completion Rates for Girls by Education Level and Prevalence of Child Marriage and Early Childbearing by Age Group, Last Two DHS Surveys and Regional Averages (%) Primary Completed 15-18 19-22 23-30 31-40 41-49 South Asia 76.08 70.99 57.32 37.88 22.70 Pakistan 2012-13 62.01 57.48 50.74 36.51 25.75 Pakistan 2017-18 64.78 66.70 58.41 48.57 32.59 Lower Secondary Completed Upper Secondary Completed (standardized at primary + 3 years) (standardized at primary + 6 years) 18-20 21-24 25-30 31-40 41-49 21-24 25-30 31-40 41-49 South Asia 56.15 51.61 38.72 22.49 13.15 29.66 21.88 12.45 7.06 Pakistan 2012-13 41.45 44.76 34.43 24.12 16.29 34.85 27.13 19.26 12.9 Pakistan 2017-18 51.45 52.52 44.23 34.59 20.97 41.55 35.09 25.83 15.19 Child Marriage Early Childbearing 18-22 23-30 31-40 41-49 18-22 23-30 31-40 41-49 South Asia 26.91 36.23 46.57 49.17 13.00 19.56 25.83 24.65 Pakistan 2012-13 18.73 27.04 36.83 43.15 6.81 11.70 15.50 18.62 Pakistan 2017-18 17.43 21.90 30.14 37.45 6.61 9.57 13.89 14.53 Source: Authors. Notes: The regional average is based on the latest available DHS surveys for Afghanistan, Bangladesh, Bhutan, India, the Maldives, Nepal, and Pakistan. The average is not weighted by country populations to better compare rates between countries. The fact that in some cases educational attainment estimates for the second age group are higher than for the first reflects delays in entering primary school as well as high repetition rates when in school. Child marriage, Analysis of the timing of marriage and births suggests that child marriage is likely early childbearing, the cause of three fourths of all instances of early childbearing. In some cases, early and low educational childbearing may lead to child marriage, but the reverse is more often the case. In attainment for girls addition, the causality between child marriage and early childbearing on the one hand, are related. and girls’ educational attainment on the other hand, goes both ways. Child marriage and early childbearing have a negative effect on educational attainment, although other factors also play a role for girls dropping out, including a lack of secondary (high) school supply and failures at board exams that are needed to pursue one’s education. Conversely, keeping girls in schools reduces the risks of child marriage and early childbearing. These relationships are summarized in Table 14, suggesting that incentives for girls to remain in school or go back to school if they dropped out are among the most effective ways to delay marriage and childbearing. Achieving universal secondary completion for girls could dramatically reduce child marriage and early childbearing, but while ending child marriage and early childbearing would help improve girls’ educational attainment, this would not be sufficient to ensure universal secondary completion. THE WORLD BANK GROUP JUNE 2019 54 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Table 14: Relationships between Child Marriage, Early Childbearing, and Girls’ Educational Attainment Relationship between child marriage and early childbearing Child marriage is likely the cause of three fourths of instances of girls having children before the age of 18 and four in five births of children from mothers younger than 18. As a result, ending child marriage could reduce the risk of early childbearing for girls and the risk of an early childbirth for children by about three fourths. Impacts of child marriage and early childbearing on girls’ educational attainment Child marriages and pregnancies are major reasons declared by parents as to why their daughters drop out of school. Once a girl is married, it is difficult for her to remain in school. Estimations suggest that child marriage reduces the likelihood of completing secondary school by 3 to 22 percentage points depending on the age at marriage. Child marriage is also likely to affect the education of the children of girls marrying early, at least indirectly. Impacts of girls’ educational attainment on child marriage and early childbearing Each year of secondary education leads to reductions in the risk marrying and having children early of 3 percentage points. Note: Most estimates are based on the 2017-18 DHS, but some are based on the 2012-13 DHS. Impacts on other development outcomes Child marriage, Women who marry earlier are likely to begin childbearing earlier and have more children early childbearing, over their lifetime. Depending on the age at marriage, child marriage increases the and girls’ education number of children women have over their lifetime (total fertility) by 18 percent to effect how many 43 percent. Ending child marriage could reduce total fertility by almost 10 percent children women have nationally. Higher educational attainment also leads to large reductions in total fertility. in their lifetime and For example, achieving universal secondary education could reduce fertility rates by 11 population growth percent. While ending child marriage would not affect the use of modern contraceptives in a substantial way, improving educational attainment for girls could. Simulations using demographic projection models suggest that ending child marriage and early childbearing could reduce annual rates of population growth by 0.04 percentage point. This estimate is smaller than in many other countries with substantial shares of girls marrying before the age of 18, and it may be on the low side. Nevertheless, this would have beneficial effects for standards of living. Larger reductions would come from better educational attainment for girls, although these are not computed here. Table 15 summarizes the findings. Table 15: Impacts on Fertility and Population Growth Depending on the age at marriage, child marriage increases total fertility by 18% to 43%, with secondary education (partial or completed) reducing total fertility by 13% to 22%. As a result, ending child marriage could reduce national fertility rates by 10%, with an additional reduction of 11% from universal secondary education. Marrying as a child does not have a substantial marginal impact on modern contraceptive use, therefore ending child marriage would not affect national use of modern contraceptives substantially. By contrast, ccompletion of upper secondary education is associated with an increase in contraceptive use by 7 points. As a result, universal secondary education could increase contraceptive use by 20% from the base value nationally. Ending child marriage and early childbearing could reduce population growth by 0.04 percentage point. Achieving universal secondary education would likely lead to an even larger reduction in population growth. Note: Estimates based on the 2017-18 DHS except the impact on population growth based on simulation tools. Early childbearing For girls, physical immaturity may increase risks of complications during pregnancy and JUNE 2019 THE WORLD BANK GROUP 55 Weathering the storm: restoring macroeconomics stability Pakistan Development Update can impact the childbirth, resulting in higher maternal mortality and morbidity. Early childbearing as health of both girls well as a lack of educational attainment for young mothers may also affect the health and their children of young children. Contrary to what has been observed in many other countries, in Pakistan children born of mothers younger than 18 do not have higher risks of dying by age five or being stunted than other children after controlling for other factors affecting those risks. However, mother’s educational attainment affects under-five mortality, so that universal secondary education could reduce those risks substantially. Finally, child marriage also increases the risk of intimate partner violence (IPV). Table 16 summarizes the main findings. Table 16: Impacts on Health, Nutrition, and Violence Being born of a mother younger than 18 does not increase the risk of under-five mortality, but completion of secondary education by the mother reduces this risk by 4 points, so that universal secondary education could cut under- five mortality by almost half. Neither being born of a mother younger than 18, nor secondary education for the mother affect the risk of under-five stunting. Child marriage increases the risk of intimate partner violence for women, but higher educational attainment for women does not appear to reduce those risks. Note: Estimates based on the 2017-18 DHS. The impact of child Estimates suggest that women who married early could have benefited from an increase marriage on labor in earnings of 13 percent if they had married later. Nationally, this could lead to an force participation increase in the population’s overall earnings of almost one percent. Through their impact tends to be small, on both total fertility and educational attainment for girls, ending child marriage and but through early childbearing would also have positive effects on welfare and poverty. Finally, the lower educational impacts of universal primary or secondary education on earnings and thereby poverty attainment, child could be even larger. For example, primary education is associated with a marginal gain marriage reduces in earnings of one fourth versus no education, and the gain is at more than 80 percent women’s expected with secondary education. Table 17 summarizes the estimated impacts. earnings in adulthood Table 17: Impacts on Work, Earnings, and Poverty Ending child marriage could lead to a small increase in labor force participation (LFP) indirectly, while primary and secondary education are not associated with large gains in LFP but tertiary education is. Ending child marriage could increase earnings in adulthood for women marrying early by 13%, and overall earnings for the labor force nationally by 0.9%. Given the earnings gains associated with educational attainment, uuniversal secondary education would have a much large positive effect on national earnings. Ending child marriage and achieving universal secondary education for girls could have large positive effects on household welfare and could lead to large reductions in poverty. Note: Estimates based on the 2012-13 DHS and other survey data for earnings. Child marriage, Agency is complex, and only a few partial indicators are considered. The focus is early childbearing, on women’s decision-making ability within the household, including their ability to and low educational seek care, and other aspects such as the likelihood of land ownership, knowledge of THE WORLD BANK GROUP JUNE 2019 56 Weathering the storm: restoring macroeconomics stability Pakistan Development Update attainment may HIV/AIDS, and birth registration for young children. The direct impacts of child also affect women’s marriage or early childbearing (depending on the indicator) on these indicators are agency in the not always statistically significant or tend to be limited. However, child marriage and household. early childbearing reduce educational attainment for girls, which often leads to negative impacts on agency through education. Indeed, for most indicators, the impact of girls’ secondary educational attainment is statistically significant and sometimes large. Table 18 summarizes the estimated impacts. Table 18: Impacts on Decision-making, Agency, and Other Areas The impact of child marriage on decision-making ability tends to be small. By contrast, universal secondary education could increase women’s decision-making ability by 11 percent. Child marriage and educational attainment are associated with a higher likelihood of land ownership for women (the mechanisms for the association in the case of child marriage is not clear and that effect is small). Higher educational attainment is associated for women with more decision-making ability to seek healthcare and a higher knowledge of HIV/AIDS (effects are also observed in the same direction for child marriage). Early childbearing is not associated with a reduction in the likelihood of birth registration for young children, and similarly, educational attainment for mothers is mostly not associated with higher birth registration rates. Note: All estimates based on the 2017-18 DHS except for land ownership based on the 2012-13 DHS Economic costs: the case of child marriage The economic costs While providing a monetary valuation of all the costs associated with child marriage is of child marriage are not feasible, costs for some impacts are estimated. The focus is on benefits from ending likely to be large. child marriage related to (1) a reduction in the rate of population growth and (2) gains in expected earnings in adulthood through higher educational attainment. Lower population If child marriage and early childbearing had ended in 2015 (base year for simulations), growth. the immediate annual benefit could have been equivalent to US$ 306 million in purchasing power parity (PPP). These benefits increase to US$ 5.5 billion by 2030. The welfare benefits for Pakistan from the lower population growth that would result from ending child marriage and early childbearing are smaller than for other countries, but still significant. In addition, there could be over time budget savings thanks to a reduced demand for public services due to lower population growth, although those savings would not be large given the limited impact of child marriage on population growth. As to the benefits from the reduction in under-five mortality and stunting, they are not valued because the impacts of early childbearing on those two outcomes are not statistically significant in the regression analysis based on data from the latest DHS survey. Higher earnings. Child marriage’s impact on educational attainment has implications for the earning potential of child brides in adulthood. This is reflected in gains in earnings that would have been observed today if the women who married as children had been able to marry later. In Pakistan, the value of the additional earnings that women would have been able to earn in 2015 if they had not married early is estimated at $ 6.3 billion in purchasing power parity, which is large. JUNE 2019 THE WORLD BANK GROUP 57 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Potential options for policies and programs To end child Laws should not permit marriage before the age of 18. For educational attainment at marriage and early the secondary level and in remote areas, there may be a need to build schools closer to childbearing, and where children (boys and girls) live. As an alternative, adequate modes of transportation improve educational to schools could be provided, or if going to school is not safe, communities could attainment for girls, implement initiatives to accompany girls on their way to school and back. Schools basic conditions must be affordable, and girls need to be able to learn in school for families to find it should be met. valuable to make the sacrifices needed for them to remain in school. Providing separate hygiene facilities for girls is also important, as is the need to reduce the risk of violence and sexual harassment in school. Finally, for other challenges such as intimate partner violence and gender-based violence more generally, community-based interventions with men, women, leaders and service providers can help, with successful pilots existing in Pakistan. In addition, the Programs to provide life skills and reproductive health knowledge: These interventions often literature suggests rely on safe space programs empowering girls through life skills training, better that a three-pronged knowledge of sexual and reproductive health, and other skills. These programs can approach can help generate benefits for girls, not only in terms of knowledge acquired, but also through improve young gains in self-esteem and confidence, among others. Yet, without additional livelihood women’s sexual and opportunities or incentives for schooling, it is not clear that safe spaces by themselves reproductive health, are sufficient to delay marriage and childbearing. delay marriage and childbearing, and Programs to expand economic opportunities: Interventions that combine an emphasis on raise educational empowering girls, often again through safe spaces, but with an additional focus on attainment. providing livelihood opportunities have demonstrated some success in increasing earnings for participants, as well as employment and savings. In some cases, they may also improve reproductive health outcomes and delay marriage or childbearing, but not systematically so. Programs to keep girls in school or delay marriage: Interventions to promote education, especially by reducing the opportunity and out-of-pocket cost of schooling, are among the most likely to help delay the age at marriage and childbearing, especially if accompanied by safe spaces. Some of these programs also enable girls who dropped out to return to school. Programs providing financial incentives to girls or families directly to delay marriage may also work. For example, conditional cash transfers have been successfully implemented in Pakistan. Programs providing information to parents about school attendance may also be effective to prevent drop-outs. Implications for policy: While some of the programs work better than others to delay marriage and childbearing and to improve educational attainment for girls, all three categories of programs have benefits. By targeting different groups of girls, for example those in school or those who dropped out but have the potential to return to school, as well as those who dropped out and may not be able to return to school, all three categories of programs should be considered when implementing a strategy aiming to improve opportunities for adolescent girls THE WORLD BANK GROUP JUNE 2019 58 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Annex: Human Development Indicators No. Indicator     HIES 2015 - with sampling weights:   EDUCATION AND SKILLS+ PSLM 2010 analytical weights (aw) 1 Overall pre-primary participation rate ages 4-5 (%) 36.5 43.4 Male 38.4 45.4 Female 34.5 41.3 Balochistan 21.7 18.0 Khyber Pakhtunkhwa 27 29.3 Punjab 45.2 54.3 Sindh 27 34.5 2 School Participation Rate Ages 6-10 (%) 74.3 74.6 Male 79.5 79.6 Female 68.6 69.2 Q 1 (poorest) 47.9 61.1 Q 5 (richest) 94.6 90.5 Balochistan 57.6 49.9 Khyber Pakhtunkhwa 74.1 75.9 Punjab 80.2 82.1 Sindh 66.1 63.0 3 School Participation Rate Ages 11-15 (%) 66.5 65.6 Male 73.3 73.3 Female 58.6 57.3 Q 1 (poorest) 34.7 46.1 Q 5 (richest) 90.4 87.9 Balochistan 49.7 45.5 Khyber Pakhtunkhwa 68.2 70.7 Punjab 69.6 70.6 Sindh 61.2 55.3 Percentage of 18-24 year olds enrolled in higher education or 4 8.1 13.7 skills training (%) Male 9.4 15.8 Female 6.9 11.8 Q 1 (poorest) 0.7 2.8 Q 5 (richest) 19.9 32.3 Balochistan 5.3 8.1 Khyber Pakhtunkhwa 7.7 14.6 Punjab 8.0 14.2 Sindh 8.7 13.3 5 Expenditure on education (% of GDP) 1.7 2.2(2017) JUNE 2019 THE WORLD BANK GROUP 59 Weathering the storm: restoring macroeconomics stability Pakistan Development Update   HEALTH AND NUTRITION DHS2006/7 DHS2017/18 6 Percentage of births attended by a skilled health personnel 38.8 69.3 National - urban 60.1 83.8 National - rural 29.8 62.6 Balochistan 23.0 38.2 Khyber Pakhtunkhwa 37.9 67.4 Punjab including Islamabad (ICT) 37.7 Punjab excluding Islamabad (ICT) 71.3 ICT 86.6 Sindh 44.4 74.8 Q 1 (poorest) 16.1 46.0 Q 5 (richest) 77.3 93.2 Child immunization rate (full immunization based on recall 7 47.3 65.6 and records) for children ages 12-23 months Male 49.8 68.0 Female 44.3 63.1 Q 1 (poorest) 25.9 38.2 Q 5 (richest) 63.7 80.0 National - urban 54.2 70.8 National - rural 44.0 63.0 Balochistan 35.2 28.8 Khyber Pakhtunkhwa 46.9 54.7 Punjab including Islamabad (ICT) 52.6 Punjab excluding Islamabad (ICT) 79.9 ICT 67.8 Sindh 37.0 48.8 Percentage of population (ages <5) that is moderately or 8 44.8 37.6 severely stunted* Male 47.9 38.2 Female 41.7 37.1 National - urban 37.1 30.7 National - rural 48.2 40.9 Q 1 (poorest) 61.6 56.5 Q 5 (richest) 23.0 22.0 Balochistan 81.9 47.4 Khyber Pakhtunkhwa 41.9 40.4 Punjab including Islamabad (ICT) Punjab excluding Islamabad (ICT) 39.8 29.8 ICT 22.2 24.4 Sindh -- 9 Expenditure on health (% of GDP) 0.6(2008) 0.9 (2017) THE WORLD BANK GROUP JUNE 2019 60 Weathering the storm: restoring macroeconomics stability Pakistan Development Update   POVERTY 2010 2013 Poverty headcount based on FY14 poverty 10 36.8 29.5 line (%) (poverty, earlier years back casted) Balochistan 48.9 56.8 Khyber Pakhtunkhwa 42.3 27.6 Punjab 34 25.3 Sindh 37.7 34.2 Shared Prosperity Premium (difference between the 11 percentage growth real consumption of the bottom 40 percent 2.90% -2.6% and the growth in real consumption of the mean)(%)** Balochistan -4.60% 1.3% Khyber Pakhtunkhwa 3.00% -4.6% Punjab 2.70% -5.4% Sindh 1.30% 5.2%   WATER AND SANITATION 2010 2015 Percentage of households whose main source of drinking 12 87.7 89.5 water is improved water (%) National - urban 93.2 92 National - rural 84.8 88 Balochistan 49.5 62.2 Khyber Pakhtunkhwa 72.3 75 Punjab 93.6 95.5 Sindh 89.4 87.2 13 Percentage of households with piped water supply (%) 31.8 26.7 National - urban 57.7 50.1 National - rural 18.5 12.7 Balochistan 35.4 33.4 Khyber Pakhtunkhwa 45.1 34.6 Punjab 24.1 17.8 Sindh 43.3 41.1 14 Percentage of households with toilet facility at home (%) 81.7 86.7 National - urban 98.3 99.2 National - rural 73.2 79.4 Balochistan 86.9 86.7 Khyber Pakhtunkhwa 82.1 88.3 Punjab 76.9 83.7 Sindh 92.4 92.5 Percentage of households where toilets are connected to any 15 66.5 (2011) 67.2 (2016) drainage system (%) National - urban 96.5 (2011) 95.3 (2016) National - rural 50.7 (2011) 51 (2016) Balochistan 31 (2011) 47.8 (2016) Khyber Pakhtunkhwa 62.5 (2011) 53.8 (2016) JUNE 2019 THE WORLD BANK GROUP 61 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Punjab 72.5 (2011) 73.2 (2016) Sindh 57.8 (2011) 62.7 (2016)   GENDER 2010 2016 16 Adolescent birth rate (births per 1000 women aged 15-19) 41 37.7 (2016) 17 Labor Force Participation Rate (Ages 15-64) 51.9 53.3 (2018) Male 81 81.46 (2018) Female 22.9 26.3 (2018) 18 Share of seats in Parliament held by women (%) 22.2 20.6 (2018) Maternal Mortality Ratio (per 100,000 live births calculated 19 211 178 (2015) for women between 15-49 years Access to finance (percentage of female population ages 15 20 and above, using banking and other formal financial services 4 (2008) 11 (2015) (%) Notes: * Data is compared for DHS2012/13 and DHS2017/18 ** Consumption growth is being measured over the period FY08-FY11 for the year 2010, and over the period FY11-FY14 for the year 2013. Sources: PSLM (various years), PRSP progress reports, National Nutrition Survey 2011, HIES (various years), LFS, World Bank gender data portal, Pakistan Demographic Health Survey (various years), Pakistan Economic Survey (various years), Access to Finance Surveys (various years), World Population Prospects (United Nations Population Division). THE WORLD BANK GROUP JUNE 2019 62 Weathering the storm: restoring macroeconomics stability Pakistan Development Update Rationale for the Choice of Indicators Indicator Definition Rationale School Participation Rate SPR is defined as the share of children SPR allows greater flexibility for (SPR) (pre-primary, ages in each age cohort enrolled in school late entrants into the school system. 6-10 and ages 11-15) (regardless of grade level) Although the official primary school entrance age is 5, late entry into the schooling system is common in Pakistan as approximately one fourth of all children begin schooling at the age of 6 and older Percentage of government This is calculated as the number of Given the lack of provincially comparable school teachers with a government school teachers with a measures of teacher quality, and the fact Masters qualification or masters qualification or higher divided that teachers are the main input in the higher by the total number of teachers education system, this indicator serves as a proxy for the academic qualifications of teachers. Percentage of youth This is calculated as the number of This indicator is aligned with the SDG 4 enrolled in higher individuals between the ages of 18-24 indicator relating to youth participation in education or skills enrolled in either higher education or higher education and skills training training skills training courses Labor force participation This is calculated as the total labor This is a widely reported indicator rate (youth, by gender and force divided by the total working age internationally and allows for inter- overall) population (ages 15-64) country comparisons. Percentage of births This is calculated as the percentage This indicator is aligned with SDG3, in attended by a skilled of births attended by any one of the particular with target 3.1 By 2030, reduce health personnel following: doctor, nurse, midwife or the global maternal mortality ratio to less than LHV 70 per 100,000 live births Child immunization rate This is calculated as the percentage This indicator is aligned with SDG 3 and (full immunization based of children between the ages of 12- it serves as a proxy for universal coverage. on recall and records) 23 months that have received the for children ages 12-23 following immunizations (based on months record or recall): Percentage of population This is defined as the proportion of This indicator is widely reported that is moderately or the population less than 5 years of internationally, and it is essential for the severely stunted age that is below minus two standard case of Pakistan where stunting rates deviations from median height for age have been stagnant for the past 40 years. of reference population Public expenditure on This includes all public expenditure on This is a widely reported indicator education as a percentage education at various levels of education internationally and allows for inter- of GDP expressed as a percentage of GDP country comparisons. Public expenditure on This includes all public expenditure on This is a widely reported indicator health as a percentage of health expressed as a percentage of internationally and allows for inter- GDP GDP country comparisons. JUNE 2019 THE WORLD BANK GROUP 63 20-A Shahrah-e-Jamhuriat, G-5/1, Islamabad 44000, Pakistan. Ph: +92 51 9090000, Fax: +92 51 2827040 www.worldbank.org/pk www.facebook.com/worldbankpakistan