Pakistan has informed the International Monetary Fund (IMF) that it would require external financing on an emergency basis preferably in the form of budgetary support as domestic efforts, inclusive of introduction of a 10 percent temporary income tax surcharge and shifting non-priority current and development resources to meet rehabilitation and reconstruction would not be sufficient.
According to the Letter of Intent (LoI) submitted to the IMF, Pakistan stated that the cost of emergency operations and the reconstruction that lies ahead would compel the government to adapt fiscal framework to boost budgetary resources and enable the government to address the emergency, improve service delivery to the population, and increase public investment to raise growth.
"We will shift resources from non-priority current and development spending and introduce a temporary 10 percent income tax surcharge for relief and reconstruction spending. Despite these efforts, there is no doubt that the massive spending needs and the revenue shortfall that are being caused by floods would push the deficit above 4 percent of GDP," the government said, adding that given the limitations on domestic resources, additional external financing is urgently needed, preferably in the form of budgetary grants.
The government said it was committed to reform the electricity sector in order to eliminate tariff differential subsidies and resolve circular debt and to address quasi-fiscal implication of commodity credit. The existing GST will be transformed through the introduction of a reformed GST that would enable the government to start raising the tax revenue required for sustainable growth.
Pakistan has assured the IMF that it would continue to cooperate closely with the fund in the context of Stand-By-Arrangement (SBA), both to provide support for reform efforts and to help provide a consistent economic and financial framework in the challenging period ahead. Pakistan said it would adopt measures to cap the fiscal deficit at 4 percent of GDP before the impact of floods was assessed and re-evaluate macroeconomic framework once the damage needs assessment is completed. The revised budget would be submitted for approval to the Cabinet and presented to the Standing Committees on Finance and Revenue of the National Assembly and Senate.
The SBP is taking steps to limit the damage to the economy and the financial sector. It is working closely with banks to facilitate the flow of credit and also with international development agencies to expand and redirect the existing financing facilities to small and medium-size enterprises and microfinance projects in the areas hit by floods.
And, to make sure Pakistan''s international trade and financial relations continue to function normally, the LoI pledges that the government "will not impose any restrictions on the making of payments and transfers for current international transactions nor introduce any trade restrictions or enter into any bilateral payment agreements that are inconsistent with Article VIII of the Fund''s articles of Agreement."
Pakistan also informed the IMF that the country''s GDP growth is expected to be 2.5 to 3 percent for the current fiscal year against 4.5 percent estimated in the budget due to devastation. Floods have destroyed infrastructure and seriously undermined the economic outlook. Agriculture, which accounts for 21 percent of GDP and 45 percent of employment, has been hit particularly hard. There is significant damage to cotton, rice, and sugarcane crops as well as livestock, which would hurt export performance, especially in the textile sector and would lower domestic demand in other sectors. The damage to crops and the disruption of supply chains in rural areas will inevitably lead to higher inflation for food and other items.
Additional demand for building material, medicine and social services will also contribute to price pressures. The average annual inflation rate is expected to increase from 11.7 percent to 13.5 percent this year. The financial sector is also suffering, with dozens of bank branches closed in flood-hit areas. While it is presently difficult to estimate with any accuracy, the floods will have considerable budgetary impact.
The rescue and relief operations and the costs of repairing and rebuilding public infrastructure will place a heavy burden on public finances at both the provincial and the federal level. At the same time, tax revenues are likely to fall as economic activity weakens. Floods will likely to hurt balance of payments. Imports will rise in the short run as food and other basic goods will need to be sourced from abroad, while capital equipment imports will increase when reconstruction begins.
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