ISLAMABAD - The International Monetary Fund (IMF) on Friday noted that significant terrorist activities as well as sectarian violence and urban criminal activity could depress investment and economic growth of Pakistan, which might reach 3.1 percent by the end of the current fiscal year.

“Security conditions in Pakistan remain difficult, with significant terrorist activity as well as sectarian violence and urban criminal activity which could depress investment and growth,” said the report titled “Second review under the extended arrangement and request for waivers of nonobservance of performance criteria.” Pakistan continues to face important security and political challenges. Taliban-related violence has picked up in the recent weeks in different parts of the country, complicating public administration in some areas, the report added.

Expressing concerns over the prime minister’s investment incentive package, the IMF report noted, “The package opens another loophole in the system in addition to the ones that already exist for remittances and equity stock investment, and raises potential money laundering risks. The immunity from routine audit hinders the self-assessment process and the amnesty entailed by waiving penalties and interests, is likely to be detrimental to improving compliance and collections as taxpayers will develop an expectation of future immunities.”

The Fund, however, changed its earlier viewpoint regarding Pakistan’s economic growth of 2.8 percent for it projected GDP growth at 3.1 percent as manufacturing sector would perform well due to partial easing of electricity shortages, while agriculture sector growth is weaker. Over the next fiscal year 2014-2015, the growth is expected to reach about 3.7 percent and rise further in the medium term as fiscal adjustment eases and structural reforms alleviate constraints in the energy sector, boost the efficiency of public enterprises and improve the investment climate, the report maintained.

Similarly, the inflation rate is projected to be around 10 percent in the remainder of this fiscal year before easing to around 5-7 percent in future years. Meanwhile, the current account deficit is expected to be about one percent of GDP.

The IMF notes pressures are mounting on the government to weaken key aspects of its resolve to broaden the tax net and greater exchange rate flexibility. The report says the State Bank is building its reserves through global markets’ borrowing and decisive actions on privatisation as well as accelerating disbursement of existing official loans and grants. However, even with the full implementation of these measures, the reserves situation will remain very tight over the next two quarters.

The IMF acknowledged that Pakistan had controlled the budget deficit mainly due to tight control over expenditures. Revenues are broadly in line with expectations despite lower-than-envisaged outturn in certain categories (petroleum and gas levies, and disbursements from the Coalition Support Fund). Spending on subsidies and grants also remained subdued, including those for targeted cash transfers, where the indicative target was again missed.

The Fund has underlined the need to eliminate tax exemptions at least 0.5-0.75 percent of the GDP (Rs 130 to 200 billion) per year over the next two years in order to achieve the fiscal consolidation targets without increasing tax rates. Pakistan has estimated to withdraw tax exemptions worth 0.35 percent of the GDP.

Economic development has been slightly better than expected. The preliminary data for the first quarter (July-Sept) of fiscal year 2013-14 recorded 5 percent growth, mainly driven by services and manufacturing.  This growth is stronger than the 2.9 percent posted during the same period last year.

The indicative target on social transfer payments was also missed for a second time due to further administrative difficulties which have since been addressed.

According to the report, with smaller than programmed deficit for the first half of the fiscal year 2012-13, the government is on track to meet the fiscal year 2013-14 deficit target of 51/2 percent of GDP. The revenue side is broadly in line with expectations and revenue growth will pick up in the second half of the year with the Gas Infrastructure Development Cess now entering the government coffers. On the expenditure side, the programmed reduction in electricity subsidies and tight spending should create room for a pick-up in capital spending in the second half of the fiscal year.