March 18, 2001

Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street NW
Washington, D.C. 20431
U.S.A.

Dear Mr. Köhler:

The Pakistan authorities held discussions with Fund staff for the first review under the Stand-By Arrangement approved by the Fund's Executive Board on November 29, 2000. Based on these discussions, the attached Memorandum on Economic and Financial Policies (MEFP), which supplements that dated November 4, 2000, updates the macroeconomic framework, reviews economic developments and policy implementation during the first half of 2000/01, and discusses the stabilization policies and structural reform program which have been specified in the context of the present review. Moreover, for reasons detailed in the MEFP, we request a waiver of the quantitative performance criterion on revenue of the Central Board of Revenue (CBR) at end-December 2000, a waiver of the structural performance criterion related to petroleum price adjustment on December 15, 2000, and modifications of the performance criteria on the CBR revenue and the net domestic assets (NDA) of the State Bank of Pakistan (SBP) for end-March 2001. On the basis of the performance up to end-December 2000 and policies set out in the attached memorandum, the government requests that the completion of the first review be considered by the Executive Board of the Fund.

The Government of Pakistan will provide the International Monetary Fund with such information as the International Monetary Fund may request in connection with Pakistan's progress in implementing the economic and financing policies and achieving the objectives of the program. The government believes that the policies set out in the attached Memorandum are adequate to achieve the objectives of the program. However, it stands ready to take any additional measures appropriate for this purpose, and will consult with the Fund in accordance with the policies of the Fund on such consultations.

Attachments:
Memorandum of Economic and Financial Policies
Technical Memorandum of Understanding

PAKISTAN

Memorandum of Economic and Financial Policies

1. This Memorandum of Economic and Financial Policies (MEFP) reviews economic developments and policy implementation in the first half of fiscal year 2000/01 (July-December 2000), updates the macroeconomic framework, and discusses the stabilization policies and structural reform program for the remainder of the fiscal year. It updates and supplements the MEFP dated November 4, 2000.

I. Developments During July 2000-January 2001

2. The macroeconomic performance in the first half of 2000/01 was adversely affected by exogenous factors. Lower-than-expected rainfalls have led to a small contraction in the production of cotton following the bumper crop of 1999/2000, and have weakened prospects for the forthcoming spring wheat crop. At the same time, available data appear to confirm the expected recovery in the industrial sector. In the circumstances, we now expect real GDP growth at 3.8 percent for the year, compared to an original target of 4.5 percent. Inflation as measured by the average CPI during July 2000-January 2001 picked up to only 4.9 percent instead of the projected 5.4 percent. The less-than-anticipated increase reflected primarily lower food prices, although delays in the adjustment of administered petroleum prices, and a lesser-than-expected pass through of the recent exchange rate depreciation also played a role.

3. During the first half of 2000/01, the underlying external current account position was broadly in line with program projections, with shortfalls in exports and larger profit transfers compensated by lower imports and higher worker remittances. Taking into account State Bank of Pakistan (SBP) purchases in the kerb market, the current account registered a significantly lower deficit than programmed. The export shortfalls were due to lower unit values; volumes increased as programmed with strong growth in non-traditional exports, such as, pharmaceuticals, chemicals, and leather goods. Despite lower-than-projected foreign direct investment inflows and shortfalls in Asian Development Bank (AsDB) and IDB disbursements, gross official reserves (excluding FE25 foreign currency deposits and short-term swaps and forwards) at end-December 2000 amounted to US$735 million, somewhat higher than the program target. Taking into account the program adjusters, including for external-financing shortfalls, the performance criterion on net foreign assets of the SBP was met (Table 1). Reflecting largely debt service and oil import payments, gross reserves declined to US$566 million at end-February 2001. The interbank market exchange rate, which had depreciated by 12 percent during July-November 2000, depreciated further by 2 percent during December 2000-February 2001, despite a sizable dollar-liquidity injection by the SBP to finance lumpy oil payments and avoid upsetting a thin market. During this period, the premium on the kerb market remained in the daily range of 4-5 percent.

4. The consolidated government deficit (including grants) for the first half of 2000/01 amounted to 2.2 percent of programmed annual GDP, 0.7 percentage points lower-than-programmed, with shortfalls in tax revenues more than compensated by higher-than-projected federal nontax revenue and stronger-than-envisaged expenditure restraint. On the revenue side, shortfalls in tax revenues, in the order of 0.4 percent of annual GDP, were the result of shortfalls in Central Board Revenue (CBR) revenues (mainly in sales and income tax collections) and, to a lesser extent, in receipts from energy surcharges. Nonetheless, CBR revenue recorded an increase of 14 percent during July 2000-January 2001 over the corresponding period last year. Total expenditure and net lending was nearly 1 percent of GDP lower than programmed. The underspending mostly reflected lower current and capital spending at the provincial levels, owing to deliberate expenditure restraint and better enforcement of accountability and governance standards. The latter also partly explains why, despite full release of budgeted appropriations at the beginning of the year, social and poverty-related expenditures fell short of program objectives by PRs 13.6 billion (as per provisional accounts); weak financial management and delivery systems at district levels were also factors. Federal current spending was higher than anticipated due to higher subsidies on account of larger-than-programmed payments to Water and Power Development Authority (WAPDA) and wage spending (including military), reflecting mostly the advance payment of January 2001 wages in December 2000 because of the Eid holidays. In the circumstances, the performance criteria on the fiscal deficit and net bank borrowing were met with large margins while that on the CBR revenue was breached.

5. The higher-than-expected demand for cash and the rebound in private credit complicated the conduct of monetary policy. With a continued increase in the cash-to-deposit ratio (see below), the targeted growth in reserve money in the program proved excessively tight. Furthermore, while discount and treasury bill rates were raised in the fall of 2000 by about 360 basis points, banks generally did not raise deposit rates and with booming credit demand, were faced with a liquidity crunch at year-end. To ease the crunch while observing the performance criteria on central bank net domestic assets (NDA) at year-end, the SBP took several steps in December 2000. It gave banks the option to convert into T-bills part of the reserves freed up with the reversal in early December 2000 of the weekly cash reserve requirements (CRR) from 7 percent to 5 percent; allowed banks to convert temporarily the rupee counterpart of the foreign currency deposits of nonresident institutional investors held with the SBP into T-bills; reduced the daily CRR from 4 percent to 3 percent and waived it on December 31, 2000; and closed the discount window on December 30, 2000. While the NDA target was thereby met with a comfortable margin, we recognize that the underlying monetary stance was more expansionary than indicated by the artificially depressed reserve money stock at end-year, and that correcting for the above-described operations at end-year would indicate a reserve money expansion in the order of 15 percent for the year, primarily driven by increased demand for cash.

6. Broad money expanded to 12.1 percent in the year through December 2000, above the programmed level of 8.7 percent. On the liability side, the expansion was largely driven by the unexpected growth in currency holdings (a 20 percent increase year-on-year compared to a reduction of 1.8 percent envisaged under the program). The currency-to-deposit ratio rose to 38.5 percent, compared to a decline to 30.5 percent projected under the program. While difficult to quantify, we believe that the continued strong preference for cash reflects, inter alia, the lingering effects of the bumper crops on incomes in the rural sector with limited access to financial intermediation services; the ongoing tax survey/documentation drive; increased transaction demand for the rupee in Afghanistan as confidence in the Afghani declined further with a severe drought and the tightening of UN sanctions; and exceptional factors relating to the coincidence of year-end and the end of Ramadan. On the asset side, monetary expansion reflected: (a) a stronger-than-envisaged growth in private sector credit owing to higher cotton prices and the related rising working capital needs of the textile industry; (b) a lower credit expansion last year during the same period, which resulted in lower retirement in current year and; (c) a large increase in other items net, owing mainly to a sharp temporary increase in suspense accounts during the long holidays at end-December 2000. Both claims on government and net foreign assets of the banking system contracted by more than programmed. Preliminary figures for January 2001 indicate that some of the exceptional factors explaining the surge in demand for cash may be unwinding as reflected in some decline in currency and broad money growth.

7. Structural reforms gained momentum in a number of areas and structural performance benchmarks and criteria were met, except that related to the adjustment in petroleum prices (Table 2). Domestic petroleum prices were adjusted on December 31, 2000 instead of December 15, 2000 to avoid socio-political stress during the Ramadan period. The price increases in the range of 7 percent to 23 percent exceeded the requirements implied by the agreed formula, except for kerosene for which the price was increased less than implied by the formula to protect poor households (which consume the bulk of this product). In view of the short delay in adjusting petroleum prices, the government would request a waiver for nonobservance of the structural performance criterion related to the petroleum price adjustment in December 2000.

8. The 3½-year long tariff dispute between Hub Power Corporation (HUBCO) and Water and Power Development Authority (WAPDA) was settled. The settlement resulted in overall savings to WAPDA of US$63 million per annum and US$3 billion over the life of the contract. Following the interim tariff increases (of 4 percent in September 2000) granted to WAPDA and Karachi Electricity Supply Corporation (KESC), WAPDA was granted another 0.9 percent increase in December 2000. The agreement between WAPDA and the government on the settlement of past arrears was implemented as planned, resulting in a decline in the stock of arrears of the government vis-à-vis WAPDA. At the same time, WAPDA made debt service payments to the budget as programmed. The special audit of the Central Directorate of National Savings (CDNS) was completed in late 2000; follow-up actions on unresolved issues and accounting problems as well as the audit of the 1999/2000 accounts have been initiated. A new market-based medium- and long-term instrument, the Pakistan Investment Bonds (PIBs), was launched in December 2000 and interest rates on new Defense Savings Certificates were formally linked to PIB yields. Restructuring of the nationalized commercial banks continued with the closure of large numbers of unprofitable branches. In the trade area, the anti-dumping law was enacted in December 2000 thereby paving the way to abolish regulatory duties discriminating against imports. On civil service reform, the autonomy of the Federal Public Services Commission (FPSC) has been strengthened through the enactment of a new law, and greater autonomy has been given to agencies and ministries for appointments and promotions.

9. In the fiscal area, the Accountant General Pakistan Revenue verified the fiscal accounts for the first quarter of the fiscal year, and more generally the drive to improve accounting, reconciliation, and reporting of public finances continued. The fiscal reform unit has been established, and the Ministry of Finance (MOF) has made progress in public expenditure analysis, fiscal projections in the context of a medium-term budget framework, compilation of data on contingent liabilities, and strengthening of external debt statistics. Also, the Committee on Income Tax Reform undertook a tax expenditure analysis. The technical preparations for a new income tax law that will streamline withholding taxes, rationalize corporate rates, and reduce exemptions have advanced; the income tax committee submitted its preliminary recommendations to the MOF at end-December 2000 as envisaged. The tax survey/documentation drive was pursued despite strong resistance from many of the undocumented and unregistered taxpayers, bringing some 25,000 new taxpayers into the sales tax net and over 100,000 direct taxpayers. In parallel, new national tax numbers (NTN) were issued to 90 percent of taxpayers, although the target of issuing NTN to all taxpayers by year-end was not achieved. The preparation of the report of the Task Force on Tax Administration was delayed primarily due to technical reasons. The tax survey is expected to have a favorable impact on revenue collection over the medium term, but has distracted considerable CBR resources from traditional tax administration tasks, as reflected in a deterioration of compliance indicators (e.g., number of audits, outstanding tax arrears, number of non-filers). This partly explains the shortfalls in CBR revenue from program targets.

II. Macroeconomic Objectives and Policies for the Remainder of Fiscal year 2000/01

10. The government's medium-term macroeconomic objectives of achieving high levels of growth with low inflation and building up of official foreign exchange reserves remain broadly in line with those under the original program. However, in light of the outcome in the first half of 2000/01, we have somewhat revised the macroeconomic targets for the year. Expected real GDP growth has been revised downward to 3.8 percent, and the target for the annual average inflation rate to 5 percent. The external current account deficit target remains unchanged at 1.6 percent of GDP. However, we now aim at a somewhat less ambitious build-up of reserves to about US$1.6 billion (equivalent to 6.6 weeks of imports) by end-June 2001, mainly because of expected shortfalls in external financing. The macroeconomic policy mix remains broadly unchanged. Fiscal policy will aim to reduce the budget deficit to 5.3 percent of GDP, reflecting a somewhat lower nominal GDP than envisaged. The SBP will continue to move towards a market-based exchange rate system, and monetary policy will remain appropriately tight to ensure that inflation and reserves targets are met.

11. The overall fiscal deficit target for 2000/01 remains at PRs 186 billion as originally programmed. However, reflecting developments so far, revisions have been made to revenue and expenditure levels and composition. In light of the shortfalls in most tax revenue categories in the first half, the whole-year target for tax revenue has been reduced by PRs 16 billion, most of it in CBR revenues. Nevertheless, the revised target remains ambitious and implies an improvement in tax revenue by 16 percent over the last year. The government will forcefully implement a short-term action plan for improving tax administration prepared with FAD technical assistance (attached). The plan includes detailed timetables and specific monitoring indicators and focuses on strengthening the CBR resources devoted to the audit and arrears collection process, along with a tighter penalty regime for nonfilers and late payments which went into effect in March 2001. The 14.4 percent average increase in gas prices, which became effective mid-March 2001, will also help revenue mobilization; the PRs 1.5 billion estimated revenue impact of this measure has not been reflected in the revised fiscal projections and would provide a small cushion for possible shortfalls in other areas. In view of the remedial measures that have been put in place to prevent further slippages in CBR revenue performance and the other measures that are being implemented to ensure the achievement of the overall budget target under the original program, the government requests a waiver of the end-December 2000 performance criterion and the modification of the end-March 2001 performance criterion on CBR revenue.

12. The target for total expenditures has been revised downward by PRs 15 billion, mostly on account of lower development spending through cuts in low priority projects in the PSDP, net lending due to the higher-than-expected repayments of government loans by the Oil and Gas Development Corporation (OGDC), and the impact of improved financial control. Cuts in the public sector development program (PSDP) will reduce investment expenditures by the National Highway Authority, Pakistan Railways, and WAPDA. The containment of expenditures will also be facilitated by the package of measures to strengthen WAPDA's finances (discussed below). The objective to increase social/poverty-related spending by at least 0.4 percent of GDP remains unchanged. Expenditure authorizations for social sectors and poverty alleviations have been fully released and the provincial government has been encouraged to achieve targeted levels in this area. It is however conceivable that some savings could be realized also in this category because of efficiency gains induced by better accountability, without affecting the delivery of social services. The financial performance of the seven large public enterprises remains broadly on target, although it will be affected by higher payments to independent power producers (IPPs) following the settlements with HUBCO and Kot Addu Power Corporation (KAPCO).

13. To ensure achievement of the fiscal deficit target in case of further revenue shortfalls or other unexpected factors, the MOF will continue to monitor expenditure closely. For the three-quarters ending in March 2001, the MOF has released 60 percent of annual appropriations for spending other than for social sectors or poverty alleviation. The remaining budgetary provisions will be released keeping in view the fiscal deficit target and overall revised revenue projections.

14. Monetary policy is geared towards achievement of the reserve targets and prevention of any resurgence in inflation. Taking into account the slower-than-expected unwinding of increases in cash demand above trend for the reasons explained above, we have revised our reserve money target. For the year through June 2001, we will aim to reduce reserve money growth to 5.5 percent. The resulting stance of monetary policy recognizes, on the one hand, that the above-trend demand for rupee cash appears to be of a more permanent nature and that the original targets for March 2001 would therefore be excessively tight. On the other hand, it also recognizes that the underlying monetary stance through end-December 2000 was insufficiently tight (veiled by an artificially depressed reserve money stock at end-year), as indicated by the difficulties in achieving reserve targets and the rapid loss of reserves in January 2001. Accordingly, the NDA target was also eased somewhat and the government would request a modification of the performance criterion on the NDA of the SBP. Given the uncertainty surrounding the evolution of the cash-to-deposit ratio, the SBP will exercise vigilance to ensure that monetary policy is tightened through indirect instruments, as needed, to achieve the reserves target and to keep inflation under control in case the demand for cash declines faster than assumed. In particular, despite the decline in interest rates abroad, nominal interest rates on rupee assets will be maintained or even raised if needed. Indeed, the three-month treasury bill rate was increased by 50 basis points on February 21, 2001. Broad money growth for the year through end-June 2001 is projected at 10.3 percent, broadly in line with expected nominal GDP growth. Given the envisaged buildup of net foreign assets and repayment of government credit, this would allow for a 12.2 percent growth in private sector credit.

15. The government remains committed to move towards a market-based exchange rate system to achieve the external sector objectives. To this end, the SBP will stop providing foreign exchange to the interbank market to finance petroleum imports, limit its interventions to smoothing out the temporary effects of bulky transactions in the thin interbank market, and for the year as a whole, the SBP will not be a net provider of foreign exchange to the interbank market after taking into account government debt service payments effected through commercial banks. A market-based exchange rate system will also require the deepening of the interbank foreign exchange market and cessation of SBP purchases in the kerb market; however, given the low level of reserves, these measures would need to be implemented gradually and cautiously. As an initial step, the SBP's practice of dealing for same day value in foreign exchange has been changed to two-day value for spot dealing, in line with best international practice. Nostro limits on banks' balances held abroad on account of trading activities will be relaxed around mid-2001. The government reiterates its firm commitment to not hinder the flow of funds for current account transactions. Combined with the gradual withdrawal of the SBP from the kerb market, this policy should help prevent the emergence of any multiple currency practice and ensure compliance with Pakistan's obligations under Article VIII of the Fund's Articles of Agreement.

III. Structural Reforms

16. The government remains committed to implementing the structural reform agenda laid out in the original MEFP of November 4, 2000, which is a crucial part of its strategy to revive the economy and to address the many distortions and governance problems that have impeded higher sustainable growth and contributed to a trend of growing poverty.

A. Tax and Trade Reforms

17. The tax registration drive has been successful in terms of bringing additional taxpayers into the GST/income tax net. However, so far the payoff in terms of revenue has fallen short of expectations. In the circumstances, the government has adopted the aforementioned short-term action plan to improve tax administration. To address lingering uncertainties among taxpayers, the government has confirmed in several public pronouncements that no further tax amnesties will be granted. Beyond these short-term actions, the task force on tax administration will submit its report to the government in early-March 2001, and on this basis, the government will derive a strategy for fundamental reform of the CBR to be launched with the next budget.

18. The planned reforms of the GST and the income tax are on track. The GST will be extended to pesticides and urea fertilizers on March 31, 2001 and to all remaining agricultural inputs by September 1, 2001. The government has reconfirmed in various public pronouncements its intention to extend GST to the retail level (for turnovers exceeding PRs 5 million) as planned on July 1, 2001; a vigorous campaign to prepare retailers for the associated filing and documentation requirements is underway. Agricultural income is for the first time being taxed in 2000/01. Relevant provincial legislation is in place and implementing regulations will be issued shortly to allow filing to commence in the coming weeks, although expected revenue gains for the current fiscal year will be limited. Preparations for the overhaul of the income tax are underway. The report of the relevant committee and a draft law will be submitted to the cabinet by end-March 2001, to be promulgated with the next budget.

19. The government is firmly committed to trade liberalization envisaged in the program. By July 1, 2001, the maximum tariff will be reduced to 30 percent; the number of tariff slabs will be reduced to four; the differential excises on imported and domestically produced goods will be eliminated; and all remaining regulatory duties will be allowed to lapse. The government will phase out quantitative import restrictions maintained for balance of payments reasons by end-June 2002 according to a schedule agreed with the World Trade Organization Committee on Balance of Payments Restrictions in November 2000.

B. Public Enterprise Reform and Privatization

20. The government remains committed to an ambitious program to streamline, restructure, corporatize, and in some cases privatize public enterprises. For the coming year, the focus will be on steps towards improving the financial situation of major enterprises through further moves towards market-based pricing policies, greater efficiency through labor shedding and reduction in subsidization and cross-subsidization, and settlement of arrears. For the major nationalized commercial banks, a large number of unprofitable branches will be closed in the first half of 2001. For a few selected enterprises (nationalized commercial banks, telecommunications, OGDC, and Pakistan Petroleum Limited (PPL)), preparatory work towards privatization will continue, although we now expect delays in the privatization of the Pakistan Telecommunications Company Ltd. (PTCL) due to the financial difficulties of the major international players. By contrast, the scheduled steps towards market-based pricing in the gas sector should pave the way for successful privatization of the PPL. More generally, the process of deregulation of the energy sector continues. To this end, the government has decided to deregulate the import of High Speed Diesel from April 2001, dismantle the residual freight pool for petroleum products (a mechanism is being worked out) and make biannual adjustments in consumer gas prices in order to maintain parity with oil prices. The first adjustment (of 14.4 percent) has been announced for mid-March 2001.

21. The government recognizes the particular urgency to address the financial difficulties of WAPDA and KESC. Agreement has now been reached between WAPDA and the Sindh Province on the settlement of PRs 6.7 billion of overdue receivables. Sindh has already paid PRs 1.7 billion during July 2000-January 2001 and will pay an agreed amount monthly to settle remaining arrears. The federal government will continue to ensure that federal agencies and provinces remain current on their electricity bills, including if needed through deduction at source from the provincial share in tax revenues. In addition, the independent national power regulatory authority (NEPRA) is expected to authorize WAPDA to increase its tariffs by at least an additional 4.5 percent in March 2001, in conjunction with a rationalization of its tariff structure in consultation with the World Bank, and to grant WAPDA's request for an automatic fuel price adjustment clause. Together with a streamlining of its expenditure and a deferment of scheduled debt service payments to the government of PRs 2 billion in FY 2001, this should allow WAPDA to remain current in its debt service payments and obligations towards the IPPs and other suppliers. However, the government will keep WAPDA's situation under close review, as its financial position will remain fragile. It remains particularly vulnerable to furnace fuel price increases on international markets and shortfalls in rain that would force WAPDA to increase relatively expensive thermal power production to substitute for hydro-power. The financial situation of KESC remains of even greater concern. A financial and technical restructuring operation supported by the AsDB aims to turn around KESC's financial position and prepare it for privatization by end-2002. As an important step, KESC will implement an increase in the average tariff of 9.5 percent in March 2001. Although KESC will need exceptional financing for its projected cash shortfalls, borrowing from the banking system for FY 2001 will be limited to PRs 7.5 billion.

C. Financial Sector Reforms

22. The government remains committed to establishing a market-based financial system. To this end, the planned overhaul of the National Saving Scheme (NSS) is under way. Following the recent linking of the interest rate for new issues of Defense Savings Certificates (DSCs) to PIB yields, beginning January 1, 2001 interest on all other NSS instruments will also become market-based beginning July 1, 2001, when their returns will be linked to benchmark bonds or treasury bills of similar maturities. Concomitantly, the tax- exempt status for new NSS instruments will be removed and income from NSS instruments would be taxed in the same manner as other financial instruments. In a similar vein, all subsidies under the existing export finance scheme (EFS) will be eliminated by mid-2001, while a new fully market based export finance window is being developed with support from the AsDB to enhance export credit access for small- and medium-sized enterprises. Consistent with this strategy, the SBP has raised the interest rate for the EFS by 1 percentage point to 9 percent in January 2001. The remaining interest subsidy will be phased out in two steps to be taken by end-March 2001 and end-June 2001. Subsequently, the EFS interest rate would fully cover the cost of funds (based on the 6-month treasury bill rate) and cost of intermediation. The government is also reviewing various options of moving to an Islamic financial system and will prepare a roadmap for the transition that will not endanger financial stability and efficiency.

23. The government is accelerating its drive to strengthen the financial soundness of the banking system, and especially the major nationalized banks. Ongoing operations include the closure of nonprofitable branches in the rural sector and strong efforts to recover nonperforming loans. In addition, the government is discussing World Bank support for additional action involving major labor shedding of the nationalized commercial banks and liquidation or merger of a number of development financial institutions. More generally, the government has strengthened enforcement of prudential regulations and have requested an early FSAP mission to assist in assessing the weaknesses in the banking sector and in formulating a comprehensive strategy to develop a financial sector that is viable and contributes to higher investment and growth.

24. The restriction on commercial banks' placement abroad of the funds associated with the mobilization of new foreign currency deposits (FE25s) will be withdrawn effective April 1 2001, and prudential norms will be put in place to ensure their safety. Accordingly, the banks should be required to maintain CRR in U.S. dollars for all foreign currency deposits under FE25s. We, therefore, intend that 25 percent of foreign currency deposits under FE25s will be placed as CRR with the SBP, of which at least 20 percent will be remunerated at market-related rates.

D. Transparency, Governance, and Public Sector Financial Management and Accountability

25. The government remains committed to the original agenda of a wide range of reforms aimed at enhancing governance, and in particular, measures to curb rent seeking and improve the efficiency of public expenditure and delivery of social services to the intended beneficiaries. To allow greater and better informed public debate and public participation in formulating economic policies, the government would continue its drive towards greater transparency with respect to economic and financial developments and policy intentions. In this context, the government intends to publish in a few weeks a report on its debt strategy and will prepare the next budget in the context of medium-term budgetary framework. The government is preparing with broad participation of civil society, a poverty reduction strategy with a first blueprint to be discussed with donors, NGOs, and others in March 2001.

26. Specific steps to improve public sector financial accountability over the coming months will include the promulgation before end-June 2001 of legislation separating the government audit and accounting functions into two separate departments, with effective application starting with the next budget. Both the accounting and the audit functions will be strengthened under a World Bank project (PIFRA), including through computerization and better human resource management. A new accounting model (NAM) broadly consistent with the revised GFS methodology was recently promulgated and will be gradually implemented over the next two years, in the context of a major computerization drive and with technical and financial assistance from the World Bank. To increase transparency and accountability, the government will provide public access to the deliberations of the ad-hoc Federal Public Accounts Committee and release outstanding audit reports for FY 1997/98 through FY 1998/99 before end-June 2001. Also, the government would release before end-March 2001 the second quarterly report prepared by the fiscal monitoring committee covering the second quarter of FY 2000/01 after reconciliation of federal expenditure. Reconciled provincial data for the first three-quarters of fiscal year 2000/01 would be available to the Ministry of Finance for the preparation of consolidated budget data by end-May 2001.

27. The government is preparing additional steps to improve fiscal reporting and transparency, notably the publication of public contingent liabilities, greater disclosure of quasi-fiscal activities, and publication of the schedule of tax expenditure. To drive this work forward, the government set up a fiscal reform unit in February 2001. The government will also speed up the process of reconciliation of provincial fiscal data, especially against the background of the forthcoming devolution of many fiscal tasks to the newly created district administrations. At the provincial level, at least quarterly detailed expenditure accounts (e.g., economic classification of current spending, social and poverty-reducing spending) will be prepared with a lag of at most two months.

28. Progress is also made with the devolution of the delivery of relevant government services to local government. These will be operational by August 2001, but to ensure fiscal control and accountability, the fiscal transfer systems and financial accountability mechanisms will be devolved gradually over 2001-03. Particular emphasis will be given to ensuring that transfers for health and education reflect needs at the district levels, are well coordinated with donor programs, and that strong incentives for good performance on agreed outcome indicators are in place from July 1, 2001. Responsibility for accounting and auditing will remain for the time being with the established structures reporting to provincial/federal rather than local government. With regard to civil service reform, the review of civil service pay and benefits will be completed over the next few months, and its results will be reflected in the 2001/02 budget. We will complete the action plan for the restructuring of the Ministry of Finance and Planning and implement it by June 2001, and remain committed to restructure the other federal ministries by July 2002.

29. The government broadly endorses the recommendations arising out of the Fund's recent assessment of the SBP's financial safeguards and has incorporated a specific implementation plan into their reform program. The SBP adopted resolutions in the areas of accounting and audit to require compliance with internationally recognized standards; and prior to Board presentation of the forthcoming review, will establish a formal process for reconciling data reported to the IMF, as well as guidelines to prohibit operations that pledge or encumber reserves, or place restrictions on or otherwise impair the availability of foreign exchange reserves outside an authorized framework. By mid-2001 the SBP will prepare an IAS-compliant reporting format and comparable IAS financial statements for the previous years ended June 30, 2000, and will also commission and complete an independent review of SBP's internal audit function. By mid-September 2001, the SBP will publish audited IAS financial statements for the year ended June 30, 2001 and commission external auditors to prepare a separate report on net foreign assets as reported to the IMF as part of the annual audit. To strengthen the safeguarding of reserves, the SBP will reduce its deposits with Pakistani banks abroad to a maximum of US$200 million by end-June 2001 and formulate a plan to further reduce placements with Pakistani banks abroad. Finally, the government will prepare draft revisions to the SBP Act and issue resolutions to the Monetary and Fiscal Policy Coordination Board to: (a) ensure that the Governor and other SBP board members can only be removed by legal cause; and (b) guarantee autonomy of the SBP in respect of reserves management.

IV. External Financing Issues

30. Following the approval of the Stand-By Arrangement, the Paris Club creditors agreed on January 23, 2001 to reschedule Pakistan's public sector medium- and long-term debt covering arrears and current maturities through September 2001 on loans contracted before end-September 1997. The debt relief provided by the Paris Club is broadly in line with that assumed under the program. The government will proceed expeditiously with bilateral negotiations with all Paris Club and other bilateral creditors. The AsDB approved the disbursement of US$50 million under the micro-credit program in February 2001. The government will implement in March 2001 all the agreed measures required for disbursements by the AsDB under Trade Export Promotion and Industry Loan (TEPIL) and Small- and Medium- Enterprises Trade Enhancement Facility and will implement expeditiously all the measures required for the envisaged disbursements from the World Bank (Structural Adjustment Credit) and the AsDB (Energy Sector Loan and an additional Tranche of TEPIL) in the fourth quarter of 2000/01. However, disbursements from the AsDB will be less than envisaged in the original program by US$125 million mainly due to delays in the processing of the Agricultural Program Loan, which is expected to be disbursed in the first half of 2001/02. Representatives of institutional foreign currency deposit holders agreed to rollover 75 percent of their deposits until end 2001/02. Deposits of foreign financial institutions with the SBP or the National Bank of Pakistan have also been rolled over on existing terms and conditions.

31. On the basis of the revised current account projections and taking into account the above-described financing elements, the targeted level of reserves at end-June 2001 would fall slightly short of the program objective, as noted above.

V. Program Monitoring

32. The government is aware that purchases under the Stand-By Arrangement remain contingent on the observance of quantitative and structural performance criteria and the completion of reviews. The monitoring of the program by the Fund staff will also take into account indicative targets and structural benchmarks.

33. For purposes of monitoring the remainder of the program for 2000/01, quantitative performance criteria and quantitative indicative targets have been agreed for end-June 2001 as presented in Table 1, and structural performance criteria and benchmarks were set as detailed in Table 2. The government has implemented or will implement a number of measures as prior actions for the Board completion of the first review under the arrangement; these are listed in Table 3. Remaining purchases under the Stand-By Arrangement shall be subject to reviews to be completed in June 2001 and September 2001. Definitions of each of the monitoring variables and, where necessary, of the structural performance criteria and benchmarks, together with reporting requirements and monitoring mechanisms are detailed in the attached revised and updated Technical Memorandum of Understanding.

PAKISTAN

Technical Memorandum of Understanding on the Program Supported by
Stand-By Arrangement

(March 2001)

1. This memorandum sets out the understandings between the Pakistan authorities and the Fund staff relating to the monitoring of the program for 2000/01 supported by the Stand-By Arrangement. Section I specifies the quantitative performance criteria; Section II specifies the indicative targets; Section III specifies structural performance criteria; Section IV specifies structural benchmarks; Section V specifies the content and frequency of the data to be provided for monitoring the financial program; and Section VI describes the mechanism for monitoring of the petroleum price adjustments and national accounts project. Definitions of the relevant financial variables are provided in the Annex.

I. Quantitative Performance Criteria

2. The quarterly performance criteria will consist of ceilings or floors on the following variables:

• Cumulative change from July 1, 2000 in the net foreign assets of the SBP;

• Cumulative change from July 1, 2000 in the net domestic assets of the SBP;

• Cumulative overall budget deficit from July 1, 2000;

• Net borrowing from the banking system by the government from July 1, 2000;

• Cumulative CBR revenue from July 1, 2000;

• Banking system credit from July 1, 2000, to the seven major public enterprises listed in Table 1 of the Memorandum on Economic and Financial Policies (MEFP);

• Accumulation of budgetary arrears to the Water and Power Development Authority (WAPDA) from July 1, 2000;

• Contraction of short-term public and publicly guaranteed external debt;

• Contraction of new nonconcessional medium- and long-term public and publicly guaranteed external debt from July 1, 2000, with a subceiling on debt with an initial maturity of over one year and up to and including five years; and

• Non accumulation of external payments arrears.

3. The floors and the ceilings applicable to the preceding variables will be monitored on the basis of the magnitudes specified in Table 1 of the MEFP.

A. Adjustments to the Net Foreign Assets of the SBP

4. The floors on the net foreign assets of the SBP will be adjusted:

• Upward by the rupee equivalent of the excess in program financing;

• Downward by the rupee equivalent of the shortfall in program financing provided that the SBP net foreign assets remain above PRs -78.0 billion at end-December 2000, above PRs -61.3 at end-March 2001, and above PRs -20 billion at end-June 2001. These amounts will be calculated at program exchange rates.

• Upward by the rupee equivalent of the full amount of any privatization proceeds from abroad; and

• Upward by the rupee equivalent of the excess in nonresident institutional foreign currency deposits with SBP forward cover above the end-August 2000 level (US$1,068 million), in foreign currency exchange swaps of the SBP above the end-August 2000 level (US$717 million), in outright forward sales of foreign exchange by the SBP above the end-August 2000 level (US$23 million), and in SBP foreign exchange reserves held with foreign branches of domestic banks above the end-June 2000 level (US$545million).

• The floor for end-June 2001 will also be adjusted upward/downward for the excess/shortfall in FE25s held with the SBP above their projected end-June 2001 level of US$530 million (PRs 31.62 billion).

B. Adjustments to the Net Domestic Assets of the SBP

5. The ceilings on the net domestic assets of the SBP will be adjusted:

• Downward by the rupee equivalent of the excess in program financing;

• Downward by the rupee equivalent of the full amount of any privatization proceeds from abroad used by the budget;

• Upward by the rupee equivalent of the shortfall in program financing provided that the net domestic assets of the SBP remain below PRs 541.3 billion at end-December 2000, below PRs 563.1 billion at end-March 2001, and below PRs 545 billion at end-June 2001; and

• Downward by the rupee equivalent of the excess in foreign-currency deposits with SBP forward exchange cover above the end-August 2000 level, in foreign exchange swaps of the SBP above the end-August 2000 level, in outright forward sales of foreign exchange by the SBP above the end-August 2000 level, and in SBP foreign exchange reserves held with foreign branches of domestic banks above the end-June 2000 level.

• Downward/upward by the amount of banks' reserves freed/seized by any reduction/increase of daily CRR of 4 percent and by the amount of any reduction/increase in the deposit base with respect to the programmed level of PRs 1,084 billion at end-March 2001 and PRs 1,143 billion at end-June 2001 that is related to changes in deposits subject to CRR. Changes in required reserve regulations will modify the NDA ceiling of the SBP according to the formula: ∆NDA = ∆rB₀ + r₀∆B + ∆r∆B, where r₀ denotes the daily reserve requirement ratio prior to any change; B₀ denotes the programmed level of the reservable money supply in the period prior to any change; ∆r is the change in the reserve requirement ratio; and ∆B denotes the change in the reservable deposits with respect to the programmed level as a result of changes in definition of reservable money supply (deposits).

• The ceiling for end-June 2001 will be adjusted downward/upward for the excess/ shortfall in FE25s held with the SBP above their projected end-June 2001 level of US$530 million (PRs 31.62 billion).

C. Adjustments to Net Banking Borrowing

6. The ceiling on net bank borrowing by the government will be adjusted:

• Downward by the rupee equivalent of the excess in net external budget financing (defined below);

• Upward by the rupee equivalent of the shortfall in net external budget financing provided that net bank borrowing by the government remains below PRs 21.1 billion at end-December 2000, below PRs 34.8 billion at end-March 2001, and below PRs -8 billion at end-June 2001; and

• Downward by the rupee equivalent of the amount of any privatization proceeds used by the budget.

D. Adjustments to Credit to the Seven Major Public Enterprises

7. The ceilings for end-December 2000, end-March 2001, and end-June 2001 will be adjusted downward by the difference between program and actual amounts of restructuring credits to KESC related to the financing of its cash shortfall agreed with AsDB is positive; the program amount is PRs 7.5 billion.

II. Indicative Targets

8. The following variables constitute quarterly indicative targets: (a) cumulative change from July 1, 2000, in the net domestic assets of the banking system; and (b) federal tax revenue in 2000/01 (comprising taxes collected by the Central Board of Revenue, gas and petroleum surcharges, and the foreign travel tax); and (c) social and poverty-related spending in 2000/01. Social and poverty-related budgetary expenditures are defined as central and provincial government spending under the Public Sector Development Program (PSDP) and the Social Action Program (SAP), including outlays on agricultural income generating programs, education and training, health and nutrition, rural development (farm to market roads), manpower and employment, women and development, population and welfare, social welfare, environment, integrated rural and urban development, and the special areas social action program. SAP spending also includes basic education and health sector current outlays. Expenditures under the Zakat program outside the budget are excluded. Observance of these quarterly indicative targets will be monitored on the basis of the magnitudes specified in Table 1 of the MEFP.

Adjustments to the net domestic assets of the banking system

9. The ceilings on the net domestic assets of the banking system will be adjusted:

• Downward by the rupee equivalent of the excess in program financing;

• Upward by the rupee equivalent of the shortfall in program financing provided that the net domestic assets of the banking system remain below PRs 1,495.5 billion at end-December 2000, below PRs 1,515.7 billion at end-March 2001, and below PRs 1,545.8 billion at end-June 2001;

• Downward by the rupee equivalent of the full amount of any privatization proceeds from abroad; and

• Downward by the rupee equivalent of the excess in foreign currency deposits with SBP with forward exchange cover above the end-August 2000 level.

III. Structural Performance Criteria

10. The following measures constitute structural performance criteria:

• Implementation of the quarterly petroleum price adjustment (program period) for all major petroleum products as described in Section VI below;

• Ban on introduction of new GST exemptions and fixed-tax schemes under the GST (continuous during the program period);

• Publication of quarterly fiscal reports that have been verified by the Accountant General Pakistan Revenue (program period, starting with the first quarter of 2000/01; reports are to be published no later than two months after the end of the quarter);

• GST extension to urea fertilizer and pesticides by end-March 2001 and to all other agricultural inputs by September 1, 2001;

• The promulgation of a new income tax law with the passage of the 2001/02 budget that puts into place a global income tax with: (a) a simpler rate structure for individuals; (b) uniform tax of all companies; (c) less emphasis on withholding and presumptive taxes; (d) fewer exemptions; and (e) replacement of investment incentives by a simple system of accelerated depreciation;

• The extension of income tax to all new issuance of NSS instruments on the same basis as the income tax currently applies to other financial instruments with the passage of the 2001/02 budget;

• The extension of the GST to all retailers/traders above the PRs 5 million threshold with the passage of the 2001/02 budget;

• The reduction of the maximum custom tariff to 30 percent and the number of tariff slabs to 4 on July 1, 2001; and

• The elimination of the interest rate subsidy in the export finance scheme on July 1, 2001. The subsidy will be measured as the difference between the export finance scheme interest rate less 1.5 percentage points and the average 6-month Treasury bill yield prevailing in auctions during the previous quarter.

• Preparations of an IAS-compliant reporting format and comparable IAS financial statements for the SBP for the previous year ended June 30, 2000 by end-June 2001.

• Reduction of SBP deposits with Pakistani banks abroad to a maximum of US$200 million and formulation of a plan to further reduce placements with Pakistani banks abroad by end-June 2001.

IV. Structural Benchmarks

11. The following measures constitute structural benchmarks:

• Completion and publication of a special audit in line with international standards of the CDNS (end-October 2000);

• Establishment and implementation of a formula linking interest rates on new Defense Savings Certificates (DSCs) to the market-determined yield of the new government bond (January 1, 2001);

• Enactment of the anti-dumping law (end-December 2000); that would lead to the withdrawal of the differential excises applied to domestically-produced and imported goods as an anti-dumping measure.

• Preparatory steps relating to the promulgation of a new income tax law with the 2001/02 budget: (i) the income tax committee will submit its preliminary recommendations to the Ministry of Finance by end-2000; and (ii) the final report, with a draft law, will be submitted to the cabinet by end-March 2001; and

• Measures to improve national accounts statistics, as detailed in Section VI.

• Commissioning and completion of an independent review of SBP's internal audit function by end-June 2001.

• Preparations of draft revisions to the SBP Act and issuance of resolutions by the MFP Coordination Board: (i) to ensure that the Governor and other Central Board members can only be removed by legal cause; and (ii) to guarantee autonomy of the SBP in respect of the management of reserves.

12. In addition, the following measures constitute structural benchmarks related to improving fiscal transparency:

• Establish basic reconciliation processes in all provinces. All provinces will produce quarterly reports for internal use and reporting to the Ministry of Finance that are fully reconciled in terms of between Accountant General and departmental accounts, clearance of suspense accounts, SBP and scheduled bank accounts, and provincial/federal records of intergovernmental flows, starting end-March 2001 (covering data through December 2000).

• A statement of contingent liabilities should be published as an annex to the Economic Survey presented prior to the 2001/02 budget.

• A schedule of tax expenditures should be published as an annex to the Economic Survey presented prior to the 2001/02 budget.

• Initiate a review of Part A (covering cost of government services such as wages and salaries) of the budget by end-December 2000.

• Establish a fiscal reform unit in the Ministry of Finance by January 2001 to build up technical capacity and more effective ownership of fiscal reform programs, which would cover tax reform as well as public expenditure management reform.

V. Financial Program Reporting Requirements

13. The following information, including any revisions to historical data, will be provided to the Middle Eastern Department of the Fund through the office of the Senior Resident Representative of the IMF in Pakistan:

• Monthly statements on federal tax revenue.

• Deposits into and withdrawals from the privatization accounts for each quarter of 2000/01. Withdrawals are to be reported with the following breakdown: (i) those which constitute budgetary use of privatization proceeds; (ii) those which constitute costs of privatization; and (iii) other (please explain the purpose of other withdrawals).

• Quarterly statements on nontax revenue.

• Quarterly statements on capital receipts and disbursements, including repayments of bonds, recovery of loans from provinces and "others".

• Quarterly statement on consolidated budgetary expenditure.

• Quarterly data on social sector and poverty-related budgetary expenditures.

• Quarterly data on the stock of domestic government debt, broken down by instrument.

• Quarterly data on budgetary arrears to and from WAPDA.

• Quarterly data on external financing (as defined in paragraph 9 of the Annex), including project aid, commodity aid, food aid, and other nonproject financing (including suppliers' credit used by NHA).

• Quarterly data on the revenues and expenditures of the seven public enterprises as per the formats adopted in Tables 28 through 34 of the Recent Economic Developments paper (SM/97/253).

• The following monthly monetary data on a last-Saturday basis, both at current and program exchange rates:

  (a) monetary survey;
  (b) accounts of the State Bank of Pakistan (SBP);
  (c) consolidated accounts of the scheduled banks;
  (d) lending to the government; and
  (e) deposits of the government and of public sector enterprises on account of external debt service payments subject to rescheduling (in arrears).

• The same tables as in the preceding item, but on an end-quarter basis, both at current and program exchange rates.

• Weekly data on SBP's sales and purchases in the kerb and interbank foreign exchange markets, swaps and forward outright sales.

• Monthly data on the outstanding stock of the SBP's forward foreign currency operations, including swaps and outright forward sales and purchases. The terms of any new transactions will also be provided.

• Monthly data on the SBP's foreign exchange reserves, with details on the currencies, instruments, and institutions in which the reserves are held.

• Quarterly data on bank credit to the seven major public enterprises listed in Table 1 of the MEFP.

• The following quarterly data on external debt:

  (a) Stock of public and publicly guaranteed external debt (including deferred payments arrangements), with initial maturities of up to and including one year;

  (b) Loan-by-loan detail of the contracted new medium and long-term non-concessional public and publicly-guaranteed external debt with separate identification of the contraction of debt with an initial maturity of over one year and up to and including five years; grace periods and scheduled repayments; currency denominations; and interest rates;

  (c) Monthly data on external payments arrears on public and publicly guaranteed debt;

  (d) Monthly statements on rescheduling agreements on public and publicly guaranteed debt reached with creditors; and

  (e) Monthly data on deposits in special accounts by public sector enterprises on account of rescheduled (or in arrears) publicly guaranteed debt service payments.

• Copies of new ordinances regarding changes in tax policy and administration no later than 3 days after official issuance, or notification that ordinances have been posted on the CBR website.

• Monthly data on the import parity prices of the seven major oil products listed in Table 1.

VI. Monitoring Mechanisms

A. Monitoring of Petroleum Products Price Adjustments

14. The quarterly adjustment of prices for petroleum products will be undertaken using an automatic formula based on absolute prices that would determine pump prices as the sum of average import parity prices (IPP) during the preceding three months plus applicable margins and taxes as specified in Table 1. Prices of the following products will be adjusted automatically on the basis of this formula each quarter during the program period (on September 15, 2000; December 15, 2000; March 15, 2001; and June 15; 2001): Motor Spirit (MS), High-Octane Blend Component (HOBC), Methyl Tertiary Butyl Ether (MTBE), Kerosene (SKO), High-Speed Diesel (HSD), Light-Diesel Oil (LDO), and Jet Fuel (JP-4). The automatic price adjustment for each product will be corrected to the extent necessary to eliminate negative surcharges, and with constant or higher total surcharges for each product over the program period as shown in Table 1 for September 2000.

B. Monitoring of National Accounts Project

15. Detailed planning of the full improvement of the National Accounts Project including a draft allocation of the available budget will be completed before October 15, 2000. A report outlining the plan will be provided to the Statistics Department of the Fund by end-October 2000.

16. Reports on research studies, including tabulation of statistical results and a description of the methodology followed, in the framework of this project will be sent to the Fund's Statistics Department according to the following schedule:

Date	Economic Activity	Main Issues for Improvement
March 31, 2001	Fishing	Coverage Increased specification types of fish Capital formation
March 31, 2001	Shipping	Coverage, forward/clearing agents
March 31, 2001	Services	Estimates for newly emerged   Business and personal services
June 30, 2001	Livestock	Yields of milk. Meat, by-products,   Inputs structure
June 30, 2001	Mining & Quarrying	Coverage surface mining Services of mining Input structure; transport incidental    to oil and gas
June 30, 2001	Public Admin. & Defense	Budget classification Capital formation Deflation methodology

ANNEX

Definitions of the Monitoring Variables

Reserve money

1. Reserve money (RM) is defined as the sum of currency outside scheduled banks, scheduled banks' domestic cash in vaults, scheduled banks' (deposit money banks) required and excess deposits with the State Bank of Pakistan (SBP), and deposits of the rest of the economy with the SBP excluding those held by the federal government, the provincial governments, CEC, RECP, and counterpart funds. For end-June 2001, reserve money will be defined as above minus the change in the reserve money due to changes in the cash reserve requirements (CRR) on FE25s according to the following formula: RM-(CRRFE25s-0.05)*FE25s.

Net foreign assets of the SBP

2. The net foreign assets of the SBP are defined as the difference between its foreign assets and foreign liabilities. Foreign assets of the SBP consist of gold, foreign exchange, balances held outside Pakistan, foreign securities, foreign bills purchased and discounted, net IMF position and SDR holdings. The definition of foreign assets of the SBP will need to be fully consistent with the Data Template on International Reserves and Foreign Currency Liquidity. Gold will be valued at SDR 35 per fine troy ounce. Foreign liabilities of the SBP include deposits with the SBP of foreign governments, foreign central banks, foreign deposit money banks, and international organizations. For monitoring purposes, assets and liabilities denominated in SDRs, including the SDR value of the gold holdings and assets and liabilities resulting from transactions with the Fund (purchases, disbursements, repurchases, and repayments) will be converted into U.S. dollars at the rate of US$1.3648 per SDR.¹ Those denominated in currencies other than the U.S. dollar will be converted into U.S. dollars at the market rates of the respective currencies prevailing on June 30, 2000, as published in the IFS. The U.S. dollar value of foreign assets and liabilities will be converted into Pakistan rupees at end-September 2000, at the rate of PRs 54.60 per U.S. dollar, at end-December 2000 at PRs 58.66 per U.S. dollar, at end-March 2001 at PRs 59.52 per U.S. dollar, and end-June 2001 at PRs 59.66 per U.S. dollar.

Net domestic assets of the SBP

3. The net domestic assets of the SBP are defined as the difference between reserve money and the net foreign assets of the SBP.

Domestic liquidity

4. Domestic liquidity is defined as currency outside scheduled banks plus demand, time, and savings deposits of private residents held with the banking system in both domestic currency and foreign currency. Foreign currency deposits denominated in currencies other than the U.S. dollar will be converted into U.S. dollars at the market rates of the respective currencies prevailing on June 30, 2000 as published in IFS. The U.S. dollar value of foreign currency deposits will be converted into Pakistan rupees at end-September 2000 at the rate of PRs 54.60 per U.S. dollar, at end-December 2000 at PRs 58.66 per U.S. dollar, at end-March 2001 at PRs 59.52 per U.S. dollar, and at end-June 2001 at PRs 59.66 per U.S. dollar.

Net foreign assets of the banking system

5. The net foreign assets of the banking system are defined as the difference between foreign assets and foreign liabilities of the banking system. Foreign assets of the banking system are defined as the sum of the foreign assets of the SBP (as defined above), balances held abroad by the scheduled banks, and foreign bills purchased and discounted by the scheduled banks. Foreign liabilities of the banking system are defined as the sum of the foreign liabilities of the SBP (as defined above), deposits of nonresidents held with the scheduled banks and borrowing from banks abroad by the scheduled banks. For monitoring purposes, the assets and liabilities denominated in currencies other than the U.S. dollar will be converted into U.S. dollars at the market rates of the respective currencies prevailing on June 30, 2000 as published in IFS. The U.S. dollar value of foreign assets and liabilities will be converted into Pakistan rupees at end-September 2000, at the rate of PRs 54.60 per U.S. dollar, at end-December 2000 at PRs 58.66 per U.S. dollar, at end-March 2001 at PRs 59.52 per U.S. dollar, and at end-June 2001 at PRs 59.66 per U.S. dollar.

Net domestic assets of the banking system

6. The net domestic assets of the banking system are defined as the difference between domestic liquidity and net foreign assets of the banking system.

Net borrowing from the banking system by the government

7. Net borrowing from the banking system by the government is defined as the difference between the banking systems claims on the central and provincial governments and the deposits of the central and provincial governments with the banking system (including domestic currency counterpart deposits for relief from debt rescheduling on government and military debt). For purposes of this memorandum, claims on Government exclude: (i) revaluation of securities in the IMF accounts; and (ii) credit for commodity operations. In turn, government deposits exclude: (i) Zakat deposits; and (ii) balances in the privatization fund.²

Overall budget deficit

8. The consolidated overall budget deficit—the excess of total budgetary expenditure over total budgetary revenue of the consolidated fund of the federal government and provincial governments—will be measured by the sum of: (a) budgetary use of privatization proceeds; and (b) total net financing to the federal and provincial governments. The latter is defined as the sum of net external financing (defined below), net borrowing from the banking system (as defined above), and net domestic nonbank financing (defined below).

Net external financing of the budget

9. Net external financing is defined as follows:

• All plan resources (grants and loans) enumerated in the 2000/01 Budget document "Estimates of Foreign Assistance", including Project Aid; Non-Food Commodity Aid; Food Aid; and Other Aid (Short-term Borrowings), including financing from the Islamic Development Bank.

• Net receipts from the issuance of foreign currency denominated debt including FEBC, DBC, and FCBC and special government dollar bonds. Net receipts from these bonds will be adjusted downward (upward) by the increase (decrease) in the stock of those bonds held by the banking system.

• The accumulation of arrears on public foreign currency debt (including military debt), since July 1, 2000.

• Debt relief associated with rescheduling of public debt (including military debt) owed to bilateral and commercial creditors.

• Receipts from the contracting other foreign currency government debt, not specified above.

Less:

• The repayment due of foreign loans enumerated in schedule II of the 2000/01 Budget document "Demands for Grants and Appropriations" (medium- and long-term debt); and

• The repayment due of short-term foreign credits enumerated in section II (Capital Receipts) of the 2000/01 Budget document "Explanatory Memorandum on Federal Receipts."

Amounts assumed in the program for components of net external financing of the budget are provided in the table below:

Pakistan: Net External Financing of the Budget Deficit from July 1, 2000 1 (In billions of Pakistani rupees)
	2000/01
			Projection Cum. From July 1, 2000
	Q1	Q2	Q3	Q4
External Financing (net)	22.3	71.5	87.0	122.0
External receipts	44.2	115.6	154.4	211.0
Project aid 2	9.3	19.9	32.5	51.4
Commodity aid (non-food)3	0.0	22.2	23.6	43.5
Food aid	0.0	0.0	0.0	0.0
Other	19.1	42.5	65.6	84.4
Islamic Development Bank (loans)	8.0	18.5	26.2	32.0
Gulf countries (grant) 4	11.0	23.7	36.6	44.7
F16	0.0	0.0	2.4	4.8
FCD conversion bonds	0.1	0.3	0.4	2.9
FEBCs/DBCs/FCBCs (net)	-0.7	-1.4	-2.1	-1.0
Amortization (due)	21.9	44.1	67.4	89.0
Arrears	-20.5	-20.5	-20.5	-29.0
Debt rescheduling	36.9	53.0	55.2	61.7
Memorandum items:   Exchange rate (PRs/US$, quarterly average)	53.8	58.3	59.4	59.6
Sources: Ministry of Finance; and Fund staff projections. 1 External financing data in Pakistani rupees is derived from quarterly data in U.S. dollars using quarterly average exchange rates, except in the cases of external financing related to issuance of foreign currency denominated debt and the Saudi oil facility. In those cases, financing is derived from the change in the rupee-denominated debt stock as reported by the SPB (which converts the debt stock into rupees at the exchange rate prevailing at issuance) and rupee deposits of refineries in the dedicated SBP account, respectively. 2 Includes grants. 3 Includes all AsDB and World Bank lending; assumes SAL disbursements in 2000/01 Q4. 4 Assumes 80,000 barrels a day and US$29.5 per barrel.

Net domestic nonbank financing of the budget

10. Net domestic nonbank financing is defined as the change, during each fiscal year, in the stock of: (a) permanent debt, which consists of non-bank holdings of prize bonds, SLIC bonds, BNFBs, FIBs, the new long-term bond and other receipts; plus (b) floating debt held by nonbanks; plus (c) public account (or unfunded debt), which consists of NSS debt, Postal Life Insurance, and the Provident Fund; plus (d) stock of deposits and reserves received by the Government; plus (e) suspense account; plus (f) any other government borrowing from domestic sources net of repayments; minus (g) government deposits with NBFIs.

11. Nonbank holdings of permanent and floating debt is defined as total debt outstanding, as reported by the SBP, minus holdings of banks as per the monetary survey. Total treasury bill debt is valued at discount value.

Public and publicly guaranteed external debt

12. The performance criteria on contracting of noncessional medium- and long-term public and publicly guaranteed external debt and on contracting of short-term public and publicly-guaranteed external debt apply not only to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (adopted on August 24, 2000), but also to commitments contracted or guaranteed for which value has not been received. Public and publicly-guaranteed external debt includes the following (a) guarantees provided by the SBP; (b) partial credit guarantees from external creditors, if covered by a Government counter guarantee; and (c) external debt contracted by state-owned enterprises or banks when they are clearly only motivated by balance of payments considerations. It excludes: (a) the foreign currency deposit liabilities of the banking system; and (b) the outstanding stocks of FEBCs, DBCs, and FCBCs. Short-term external debt is defined as loans with original maturity of up to and including one year. Medium- and long-term external debt consists of debt with initial maturity of over one year. The external debt will be expressed in U.S. dollar terms, with debts in currencies other than the U.S. dollar converted into U.S. dollars at the market rates of the respective currencies prevailing on June 30, 2000 as published in IFS.

Nonconcessional borrowing

13. Nonconcessional borrowing is defined following the methodology set out in the staff report SM/96/86 and approved by the IMF Executive Board on April 5, 1996. The discounting rate will be the average Commercial Interest Reference Rates (CIRRs) prevailing during the previous six-month period (February 15 to August 14 or August 15 to February 14) for maturities of less than 15 years; and the average CIRRs for the period 1986-95 for maturities of at least 15 years, as prepared by the Policy Development and Review Department of the Fund.

Program financings

14. Program financing is defined to include balance of payments support loans, including adjustment loans from multilateral creditors other than the Fund, balance of payments support from bilateral creditors, and rescheduling and arrears on medium- and long-term public and publicly guaranteed debt. Specifically, balance of payments support loans are defined to include:

• adjustment loans from the World Bank and the Asian Development Bank

• bilateral grants and loans for balance of payments support

• loans from commercial banks (net)

• rollover of FE-45 deposits (net)

• Saudi oil facility

• less principal payments due to the World Bank, AsDB, IDB, and IFAD.

 

Pakistan: Balance of Payments Support Loans (Cumulative from July 1, 2000) (In millions of U.S. dollars)
	Sept. 2000	Dec. 2000	Mar. 2001	Jun. 2001
Program financing	86	570	567	918
World Bank loans	0	0	0	350
AsDB loans	0	380	405	403
Bilateral grants and loans     Saudi oil facility     Project grants	220 205  15	452 422  30	689 640  49	858 773  85
Additional commercial bank borrowing	0	45	95	195
Debt relief from commercial bank	0	0	-207	-298
Amortization to multilateral    Creditors, excluding the IMF	-140	-320	-434	-590

15. Rescheduling and arrears on medium- and long-term public and publicly guaranteed debt is defined as the difference between the debt service due on the debt to bilateral, supplier, and commercial creditors, and payments made on this debt (see paragraph 14). External financing counted as reserve liability of the SBP is defined to include all net deposits of foreign banks and agencies with the SBP, and net purchases and disbursements from the IMF, as well as bridge financing.

Pakistan: External Financing Counted as Reserve Liabilities of SBP (Cumulative from July 1, 2000) (In millions of U.S. dollars)
	Sept. 2000	Dec. 2000	Mar. 2001	Jun. 2001
Total	-12.1	117.7	205.8	218.2
Deposit of NBP	66.0	66.0	66.0	-22.0
Fund disbursements	0.0	204.7	348.0	491.3
Repayments to the Fund	-78.1	-153.0	-208.2	-251.1

Budgetary arrears to WAPDA

16. Payments of electricity bills of federal and provincial governments overdue by more than 30 days, as reported by WAPDA in the following format:

Position Of Billing/Receivables And Reconciliation In Respect Of Federal And Provincial Government Departments Vis-A-Vis Wapda For The Quarter Of ____ To ___
SR. NO.	Category	Receivables At The Quarter End Of Previous	Amount Withdrawn Against Previous Quarter	Billing During Quarter	Amount Reconciled Against Column 5	Total	Payment During Quater	Receivables At The End of The Quarter
1	2	3	4	5	6	7=3-4+5	8	9=7-8
A I. II.	Federal Govt. Federal Govt. Agencies AJK
	Subtotal
B I. II. III. IV.	Provincial Govt. Depts Punjab NWFP Sindh Baluchistan
	Subtotal
C	Total Govt (A+B)
WAPDA Debt Service Liability to government
Net position