imf intend letter

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International Monetary FundPakistan and the IMFPress Release:IMF Executive BoardApproves US$451Million Disbursement

in Emergency NaturalDisaster Assistancefor PakistanSeptember 15, 2010Countrys PolicyIntentions DocumentsE-Mail NotificationSubscribe or Modifyyour subscription

Pakistan: Letter of IntentSeptember 10, 2010

The following item is a Letter of Intent of the government of Pakistan, whichdescribes the policies that Pakistan intends to implement in the context of its

request for financial support from the IMF. The document, which is the propertyof Pakistan, is being made available on the IMF website by agreement with themember as a service to users of the IMF website.

LETTER OF INTENTIslamabad, PakistanSeptember 10, 2010Mr. Dominique Strauss-KahnManaging DirectorInternational Monetary FundWashington, DC 20431

Dear Mr. Strauss-Kahn:The floods that hit Pakistan in late July and August are a naturaldisaster of massiveproportions. Some 1,540 people have died, a further 2,320 have beeninjured, and more than2 million families have been displaced. Over 15 million people (almost10 percent of thepopulation) have been affected and large parts of the country, fromthe Chinese border to themouth of the Indus River, have been flooded. Although fewer casualtieshave been sustained

than after the 2005 earthquake, the damage to economicinfrastructure and private property ismuch more severe.It is too soon for a precise estimate of the economic fallout andreconstruction cost, butundoubtedly we will need substantial support. The World Bank and theAsian Development


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Bank (ADB) will provide a Damages and Needs Assessment by mid-October. But, it isalready clear that our needs will far exceed our means.We are, therefore, seeking rapid assistance from the IMF to help uscope with the immediate

economic impact of this disaster, and request a purchase under thepolicy on EmergencyAssistance for Natural Disasters (ENDA) in the amount of SDR296.98201 million(28.73 percent of quota). The assistance will be used to meet theimmediate financing needsof the government for providing urgent food, shelter, and healthservices without overburdeningdomestic financial markets or depleting foreign exchange reserves.Financialassistance from the IMF will also help sustain confidence in our

external position duringthese difficult times, and encourage financing from other sources. Weremain very muchcommitted to the reforms we are undertaking under the Stand-ByArrangement (SBA), asdiscussed in our letter of May 3, 2010 to the Fund, and hope to be ableto complete the fifthreview under the program in the coming months.Economic and Budgetary Developments before the FloodsEven before the floods, our economic circumstances were far fromeasy, but we were making

progress with our stabilization and reform program. Manufacturingactivity had rebounded inrecent months and real GDP growth in 2009/10 reached 4.1 percentaccording to provisionalestimates. We had been on track to reach at least 4 percent GDPgrowth this year. Inflation2had come down from 25 percent in October 2008 to 1213 percent inrecent months. Tocontain inflation, in July the State Bank increased its policy interestrate by 50 basis points

to 13 percent. Gross reserves reached US$13 billion in June 2010, andthe exchange rate hasbeen stable around 8586 rupees per dollar. The pickup in reservesresulted from a steadynarrowing of the current account deficit, to US$3.5 billion (2 percent ofGDP) in 2009/10.Fiscal policy faced a number of challenges in 2009/10. Thereorganization of the tax


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administration had a temporary adverse impact on tax collection and,despite our efforts, taxcollection fell short of target. At the same time, there were overruns insecurity spending dueto the difficult security situation, and provincial spending was higher

than expected.Consequently, the 2009/10 fiscal deficit reached 6.3 percent of GDP,compared with anunadjusted program target of 5.1 percent and an adjusted target of 4.6percent of GDP.Although we were able to draw on domestic bank and non-bankfinancing, we also had torely on central bank financing, which exceeded the target by Rs. 42billion. We have met allother end-June performance criteria under the Fund-supportedprogram.

Our budget for fiscal year 2010/11, set before the floods, targets adeficit of 4 percent ofGDPa federal fiscal deficit of 5 percent of GDP combined with aprovincial surplus of1 percent of GDP. To achieve this target, we have raised the generalsales tax (GST) rate by1 percent and increased some excise and direct taxes. We have alsoresumed tax audits, usingrisk-based selection criteria to increase their efficacy.We have also worked closely with the provinces to ensure they run thedesired surpluses.

The share of tax revenues distributed to them increased significantlyunder the 7th NationalFinance Commission award. As spending responsibilities have not yetbeen transferred to theprovinces as envisaged following the 18th constitutional amendment,the provinces wereexpected to save the additional funds and run surpluses. They haveagreed to revise initialbudgets and scale back spending plans.Economic and Budgetary Impact of the FloodsThe floods have destroyed infrastructure and seriously undermined the

economic outlook.Agriculture, which accounts for 21 percent of GDP and 45 percent ofemployment, has beenhit particularly hard. There is significant damage to cotton, rice, andsugarcane crops as wellas livestock. This will hurt our export performance, especially in thetextile sector, and will


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lower domestic demand in other sectors. We expect GDP growth to be23 percent thisyear, about 1 percentage points lower than would have beenpossible without the floods.Furthermore, the damage to crops and the disruption of supply chains

in rural areas willinevitably lead to higher inflation for food and other items. Additionaldemand for buildingmaterial, medicine, and social services will also contribute to pricepressures. We expect theaverage annual inflation rate to increase from 11.7 percent to 13percent this year. Thefinancial sector is also suffering, with dozens of bank branches closedin flood-hit areas.While it is presently difficult to estimate with any accuracy, the floodswill have considerable

budgetary impact. The rescue and relief operations and the costs ofrepairing and rebuilding3public infrastructure will place a heavy burden on public finances atboth the provincial andthe federal level. At the same time, tax revenues are likely to fall aseconomic activityweakens. The floods will likely hurt the balance of payments. Importswill rise in the shortrun as food and other basic goods will need to be sourced from abroad,while capital

equipment imports will increase when reconstruction begins.Our Response to the FloodsThe Government of Pakistan has moved swiftly to provide relief andmobilize resources. TheNational Disaster Management Authority, its provincial counterparts,and other agencieshave made great efforts to provide rescue and relief operations in theareas affected by thefloods. Thousands of people have been evacuated, food and medicinehave been distributedto displaced persons, and some emergency repairs have been made to

roads and otherinfrastructure.Donors have responded with emergency assistance, aid pledges, andreallocation ofresources. The United Nations has led the effort for early recovery andassistance operationsfor which it needs US$460 million, of which so far it has securedUS$275 million from


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public and private international donors. Also, the World Bank and theADB have committedto reallocate US$1 and US$2 billion, respectively, to help us financereconstruction.The cost of emergency operations and the reconstruction that lies

ahead will compel us toadapt our fiscal framework to boost budgetary resources and enablethe government toaddress the emergency, improve service delivery to the population,and increase publicinvestment to raise growth. We will, therefore, shift resources fromnon-priority current anddevelopment spending to relief and reconstruction spending. We willalso introduce atemporary 10 percent income tax surcharge. Despite these efforts,there is no doubt that the

massive spending needs and the revenue shortfall that are beingcaused by the floods willpush the deficit above 4 percent of GDP. Given the limitations ondomestic resources,additional external financing is urgently needed, preferably in the formof budgetary grants.The SBP is taking steps to limit the damage to the economy and thefinancial sector. It isworking closely with banks to facilitate the flow of credit and also withinternationaldevelopment agencies to expand and redirect the existing financing

facilities to small andmedium-size enterprises and microfinance projects in the areas hit bythe floods. And, tomake sure Pakistans international trade and financial relationscontinue to functionnormally, we will not impose any restrictions on the making ofpayments and transfers forcurrent international transactions nor introduce any trade restrictionsor enter into anybilateral payment agreements that are inconsistent with Article VIII ofthe Funds Articles

of Agreement.We will continue to co-operate closely with the Fund in the context ofour SBA, both toprovide support for our reform efforts and help provide a consistenteconomic and financialframework in the challenging period ahead. Specifically, the existingGST will be


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transformed through the introduction of a reformed GST capturing thefeatures of a VAT,enabling us to start raising the tax revenues required for sustainablegrowth. We also remaincommitted to reform the electricity sector in order to eliminate tariff

differential subsidies4and resolve circular debt, and to address the quasi-fiscal implicationsof commodity credit.We will adopt measures to cap the fiscal deficit at 4 percent of GDPbefore the impact of theflood. The macroeconomic framework will be re-evaluated once thedamage needsassessment has been completed, and a revised budget will besubmitted for approval to thecabinet and presented to the standing committees on finance and

revenue of the NationalAssembly and the Senate of Pakistan. We are working actively todeliver these reforms andthus remain confident that the fifth review under the SBA can becompleted later this year.Sincerely,/s/ /s/Abdul Hafeez Shaikh Shahid H. KardarMinister of Finance Governor of the State Bank of Pakistan

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