ISLAMABAD - The International Monetary Fund (IMF) has noted that macroeconomic risks for Pakistan have begun to re-emerge since the end of the IMF’s programme last year.

“The pace of fiscal consolidation has slowed, public debt remains high, and mobilisation of tax revenue needs to be further strengthened. External vulnerabilities have increased with a widening current account deficit and rising medium-term external repayment obligations linked to the China Pakistan Economic Corridor (CPEC) and other large investment projects. Foreign exchange reserves have declined since the end of the EFF-supported programme and remain below comfortable levels,” the IMF stated in its recent report on Pakistan.

On the structural front, the Fund has observed that progress in electricity sector reforms has been mixed, with a renewed build-up in circular debt; and financial losses of ailing public sector enterprises (PSEs) have continued. Private investment and exports remain low to support higher private-sector led growth and catalyse needed job creation. Unemployment is at 5.9 percent (10½ percent among youth and 9½ percent among women) and the informal economy is large. Despite significant progress over the past two decades, poverty remains high at about 30 percent in 2013 (9 percent based on the 2001 poverty line), inequality slightly declined but remains sizable, and priority social spending, although having increased significantly, needs to be further enhanced.

According to the IMF, the economic recovery is expected to continue and to strengthen over the medium term. Buoyant activity in construction and services along with recovering agriculture are driving real GDP growth, which is estimated at 5.3 percent in FY2016-17. Strong machinery imports and fast growing iron and steel and auto sectors point to strengthening domestic demand. Growth is benefitting from rising investment related to CPEC, strengthening private sector credit growth, and reduced fiscal drag, and there are increasing signs of a recovery in exports. However, moderating (though still strong) growth in domestic cement despatches and sluggish remittances are signs of caution. Headline inflation will likely be contained at 4.3 percent on average in FY2016-17.

Over the medium term, growth is expected to increase to about 6 percent on the back of CPEC and other energy sector investments, and helped by growth supporting structural reforms. Domestic risks could arise from political polarisation in the pre-election period and security issues. “In staff’s view, fiscal pressures could rise during the period leading up to the mid-2018 general elections, and growth-supporting reforms could slow,” the Fund noted.

The Fund expected growth to accelerate to 7pc in the medium term supported by strong CPEC related investments, favourable second-round effects from better infrastructure and energy availability, and an improved security environment. They expected a moderately smaller medium term current account deficit, assuming a more pronounced slowdown in import growth and a stronger recovery in exports and remittances. The authorities also underscored that security conditions have significantly improved, with limited downside risks to the outlook.

The IMF stressed that reversing the recent decline in reserves and allowing for greater exchange rate flexibility are needed to rebuild external buffers, which are below adequate levels, and strengthen Pakistan's competitiveness, which has been affected by real effective exchange appreciation. Based on standard models of real effective exchange rate valuation, which are subject to significant uncertainty, the Fund estimated that Pakistan's external position is moderately weaker than suggested by fundamentals and desirable policies and that the real exchange rate is moderately overvalued between 10 and 20 percent.

The IMF has also stressed that gradually reducing the stock of government borrowing from the SBP would be important to support the independence and credibility of monetary policy. The authorities indicated their commitment to reduce the stock and underscored that the surge in government financing earlier in the year was due to a one-off operation.

Accumulation of power sector arrears resumed in the first half of FY2016-17 (Rs53 billion), with the stock increasing to Rs374 billion (about 1.2 percent of GDP). This reflected a widening of the system’s operational deficit due to delays in passing through to end-consumers higher generation tariffs and weaker bill collection by distribution companies (DISCOs), only in part compensated by the positive impact of a reduction in DISCOS’ distribution losses and still low oil prices.

The IMF stressed the need to strengthen Discos’ performance and adjust end-consumer tariffs to reflect higher input costs, also in view of upcoming increases in generation capacity. In this regard, staff welcomed the introduction of a daily monitoring system for Discos which will contribute to closely follow their operations. While most Discos met their end-December 2016 targets in terms of collection, about half met their targets in terms of distribution losses. Furthermore, moving ahead with the planned IPOs of Discos is key to strengthen corporate governance and mobilise proceeds to start reducing the stock of outstanding arrears.