Pakistan Seeks $4 Billion IMF ‘Insurance’ to Cover Budget Gap

Pakistan has asked the International Monetary Fund for a $4 billion stand-by loan to be used if foreign donors fail to deliver aid needed to fund a widening budget deficit.

The IMF facility is “insurance” if pledged assistance is delayed or does not arrive, Shaukat Tarin, finance adviser to the prime minister, told reporters in Islamabad today. The budget gap for the year starting July 1 is estimated at 4.9 percent of gross domestic product, higher than the 4.6 percent goal set by the Washington-based lender as part of its $7.6 billion bailout of South Asia’s second-biggest economy.

International donors meeting in Tokyo in April pledged to provide Pakistan with $5 billion to shore up the country’s ailing finances and fight terrorism. The government’s seven-week campaign against Taliban insurgents in the northwest Swat Valley has had an “extremely high cost” on the economy, Tarin said.

President Asif Ali Zardari moved troops into the North West Frontier Province in late April, aiming to purge the region of Islamic militants threatening the nation’s political stability. The offensive has created more than 2 million war refugees and has had what Standard Chartered described as a “devastating impact” on the resource-rich region.

“Terrorist attacks have undermined Pakistan’s macroeconomic stability and dampened growth prospects,” Junior Economics Minister Hina Rabbani Khar told parliament in Islamabad yesterday. “The global financial crisis seeped into the economy causing substantial decline in exports and a visible decline in foreign direct investment.”

War Refugees

The government plans to double relief spending for people displaced by the recent military operations and to rebuild damaged roads, buildings and bridges, Khar said as she unveiled the government’s 2009-2010 budget. Defense spending was higher than budgeted this fiscal year, Tarin said today.

The nation’s defense forces will be allocated 343 billion rupees ($4.2 billion) next year, a 16 percent increase on the estimated 296 billion rupees provided in the previous 12 months, according to budget documents. Military personnel will also receive a pay bonus.

“Defense and debt servicing costs may exceed estimates, resulting in a cut in development spending,” said Asif Qureshi, head of research at Invisor Securities in Karachi. “A lot of this budget will depend on external assistance being received in time because there are no real measures which will increase the tax base.”

Suicide Bombings

Pakistan’s economy has deteriorated over recent years as terrorist attacks in the major cities of Karachi, Lahore and Islamabad deter foreign investors and erode business confidence. Overseas direct investment plunged 14 percent in the 10 months ended April 30, to $3.2 billion.

Anti-Taliban cleric Sarfaraz Naeemi, along with six other people, was killed in a suicide bombing at a mosque and religious school in Lahore on June 12. That came three days after an attack on the five-star Pearl Continental hotel in Peshawar left 16 dead, including two United Nations officials.

The government hopes its latest offensive in the Swat Valley will help to restore stability in the North West Frontier Province, which accounts for about 10 percent of national GDP and 21 percent of Pakistan’s mining output.

Pakistan’s GDP growth slumped to 2 percent this year, down from an average annual 6.8 percent over the past five years.

Economic growth is estimated to accelerate to 3.3 percent in the year starting July 1, Khar said yesterday. The pace of expansion is forecast to quicken to 4 percent and 4.5 percent in the subsequent two years, she added.

‘Foremost Challenge’

“Our first and foremost challenge is to maintain macroeconomic stability,” said the junior minister, who was presenting the budget on behalf of Finance Adviser Tarin. Pakistan needs to “arrest as best we can the economic crisis and terrorism that threatens the very fabric of our economy, polity and society,” she said.

Pakistan was forced to turn to the IMF for a rescue package in November 2008 to help prop up its crumbling economy, after the nation’s foreign reserves plunged 75 percent in a year and the current-account deficit widened to a record.

Initial conditions for the IMF loan included a commitment by Pakistan to reduce its budget deficit to 3.4 percent of GDP next year, though the Washington-based lender last month agreed to relax that target to 4.6 percent to help “boost growth.”

Pakistan’s central bank also agreed to raise borrowing costs in order to secure the IMF bailout, increasing its benchmark rate by the most in a decade to 15 percent.

IMF Conditions

The measures adopted to get the IMF loan “underestimated” the impact of higher borrowing costs on the banking system and resulted in a “sharper-than-anticipated” slowdown in growth, according to Sayem Ali, an economist at Standard Chartered Plc in Karachi.

Government workers and retirees will receive a 15 percent pay rise amid higher living costs. Inflation peaked at a 30-year high of 25.3 percent in August 2008 and the government is targeting consumer price gains of 9.5 percent next year.

Weaker economic growth has prompted the government to look for new areas of revenue to prevent a fiscal blowout. Tax will be imposed on services and real estate next year and a 30 percent levy will be applied to corporate bonuses above 1 million rupees, Khar said in yesterday’s budget speech.

The government aims to collect a record 1.5 trillion rupees in taxes this year. Last year’s tax revenue is estimated at 1.18 trillion rupees, less than a targeted 1.25 trillion rupees.

Cement makers like Lucky Cement. Ltd., the nation’s biggest, and D.G. Khan Cement Co., the second-largest, will benefit from a reduction in duty and because of higher infrastructure spending, according to Imran Khan, research head at First Capital Equities in Karachi.

Car makers like Pak Suzuki Co., the biggest, and Indus Motor Co., which makes Toyota Motor Corp. cars, will also benefit due to a 5 percent reduction of import duties on assembly kits, Khan said.