WASHINGTON, Nov 29: Deep seated structural problems and weak macroeconomic policies have continued to sap Pakistan’s economy of its vigour, says a report issued by the International Monetary Fund (IMF) on Thursday.

The report notes that Pakistan’s real GDP growth over the past four years has averaged only about 3 per cent annually, and is projected to be about 3¼ per cent in 2012-13. This is insufficient to achieve significant improvement in living standards and to absorb the rising labour force, the report warns.

The warning comes when a large Pakistani delegation headed by Finance Minister Abdul Hafeez Shaikh is visiting Washington for a meeting of the US-Pakistan working group on economy. The delegation is also meeting senior IMF and World Bank officials during its three-day stay here.

The IMF report notes that a key structural impediment to Pakistan’s economic growth is the problems in the energy sector, which have resulted in widespread and unpredictable power outages.

On Nov 21, the IMF Executive Board concluded the first post-programme monitoring discussions and the ex-post evaluation of exceptional access under the 2008 standby arrangement with Pakistan.

Highlighting key aspects of its evaluation, the IMF notes that headline inflation in Pakistan has decelerated recently, but is likely to return to low double digits by the end of 2012-13.

The external position has weakened substantially, as export growth turned negative in 2011-12 while imports grew. The financial account has also deteriorated, reflecting weak financial inflows and debt repayments. This has led to a decline in the State Bank of Pakistan’s foreign exchange reserves to under $10 billion in October 2012, below adequate levels.

The fiscal deficit (excluding grants) reached 8½ per cent of GDP in 2011-12, well above the original budget target of 4 per cent, reflecting both revenue and expenditure slippages, including higher subsidies mainly to clear arrears in the power sector.

The 2012-13 budget targets a deficit of 4.7 per cent of GDP, but on current policies the deficit would likely be closer to 6½ per cent, the IMF warns.

The report notes that Pakistan’s monetary policy has accommodated large fiscal deficits. The State Bank’s direct lending to the government and provision of liquidity to facilitate bank purchases of government securities have accommodated higher deficits at the cost of higher inflation and currency depreciation.

Citing declining inflation and weak investment, the State Bank has also lowered its policy rate by a cumulative 200 basis points since July 2012.

The IMF, however, acknowledged that financial sector appeared healthy based on standard indicators, but financial stability risks existed.

Banks’ nonperforming loans remain high at 15.9 per cent at end-June 2012, and capital and liquidity indicators are being boosted by large holdings of government securities.

At the same time, private sector credit growth remains subdued, with adverse consequences for growth. The government’s large financing needs, considerable commodity operations, together with risk aversion by banks, has contributed to a diversion of credit from the private sector.

IMF directors noted that while some progress had been made, Pakistan continued to face difficult macroeconomic challenges as growth remains insufficient, underlying inflation is high, and the external position is weakening.

The situation is compounded by an uncertain global environment and a difficult domestic situation, as well as adverse effects of natural disasters.

IMF directors emphasised that strong policy measures and deeper reforms are critical to addressing vulnerabilities, boosting sustainable growth, and reducing poverty.

The directors underscored that reducing the large fiscal deficit was essential for restoring macroeconomic and external stability. To achieve the government’s 2012-13 deficit target, they called for short-term revenue and expenditure efforts, including broadening key taxes and reducing subsidies, while protecting the most vulnerable.

To strengthen the fiscal position in the long run and create space for capital and poverty-related spending, the directors called for comprehensive revenue and expenditure reforms.

“Fiscal consolidation should focus on changes in tax policy and improvements in compliance,” the directors said.

Some directors urged reconsideration of the tax amnesty schedule currently being contemplated. Recognising the political difficulties in implementing a full VAT, they advised the authorities to consider credible alternative revenue measures including a modified GST and strengthening the income tax.

The IMF directors considered that Pakistan’s monetary and exchange rate policy needed to better contain inflation and external risks. They noted that the achievement of durably lower inflation would require more prudent monetary policy, accompanied by substantial fiscal adjustment to ease the government’s funding requirement, which has been driving inflation.

Greater central bank independence will be important in this regard. Directors recommended more exchange rate flexibility to facilitate external adjustment and safeguard foreign reserves.

The IMF directors noted that the banking system appeared healthy. However, they urged vigilance about risks arising from high NPLs and banks’ large and rising exposure to the sovereign.