ISLAMABAD/KARACHI, Dec 8: The International Monetary Fund has expressed concern over Pakistan’s large current account deficit, warning that further widening could compromise external debt sustainability.

During consultations with officials of the finance division in Islamabad, the IMF proposed a raft of measures to arrest the deficit. The measures include the raising of electricity charges, devaluing the rupee by 10 per cent and the floatation of investment bonds.

In a recent staff report for the year 2006, put on its website on Thursday, the IMF considers sustainable an annual external account deficit of five to six billion dollars provided the ratio of external current account deficit to GDP declines.

The IMF’s board of directors ‘noted the risks to the (economic) outlook, including the continued strength of domestic demand, and its adverse effects on trade and current account deficits as well as on the pace of disinflation during 2005-06’, a statement said.

Differences appeared to have emerged between Islamabad and the IMF on the rupee’s real exchange value during extensive consultations in August. The IMF mission met the prime minister, his adviser on finance and State Bank governor.

The IMF has suggested a 10 per cent devaluation of the rupee to narrow down the current account deficit to a level that stabilises the net foreign assets to GDP ratio at the level of 2004.

But the government sees the current real exchange rate as appropriate, contending that its devaluation in the nineties was unreasonable and that the exports have not been affected by the recent real appreciation. The IMF however noted that while domestic pressures, rather than losses in external competitiveness, had been a major factor behind the increase in the trade and current account deficits since 2003-04, it proposed that Pakistan should see to it that the real exchange rate does not rise over the medium term.

The IMF had a word of praise for the economy nevertheless. “Pakistan’s economy has withstood well the impact of large negative shocks, including the earthquake, a sharp increase in international oil prices and unfavourable weather conditions.”

The board advised Islamabad to strengthen the balance of payments to reduce external vulnerabilities by containing the external current account deficit. It also urged the government to obtain foreign financing in keeping with external debt sustainability.

Most of the directors felt that macroeconomic policies during the current fiscal year should aim at reducing domestic demand and strengthening the balance of payments. They cautioned the government against deferring measures to tighten monetary policy, calling for increasing cut-off rates at treasury bill auctions to keep the inflation target in sight.

The IMF called upon the government to make the exchange rate flexible and to adopt measures to keep this year’s budget deficit, excluding grants and earthquake-related expenditures, at the level of the last financial year. The directors stressed that beyond 2006-07, Pakistan’s macroeconomic policies should ensure that the external current account deficit-to-GDP ratio remains on a declining path, with a steady build-up of reserves. In this regard, they encouraged the authorities to adopt a policy stance that maintains real interest rates at `positive levels’, accompanied by a close monitoring of credit growth and a fiscal consolidation programme that lowers the overall deficit to a sustainable level over the medium term.

The IMF noted that progress on structural reforms was mixed and criticised the government for not going ahead with reforms in the power sector. “Reform of the power sector has stalled and the schedule of higher regional electricity tariffs has not yet been implemented. Progress on trade liberalisation has slowed.”

The IMF viewed the favourable prospects for sizable FDI inflows as important for future gains in productivity and investment. But at the same time, it warned, `challenges lie ahead’ for macroeconomic policy. They observed that continued reliance on FDI inflows of an uncertain size and timing would require a large degree of flexibility.

The Fund cautioned that the option of resorting to use of international reserves to cover shortfalls in external financing, especially those stemming from delays in FDI-related flows, ought to be used sparingly. They viewed structural reforms as conducive to higher saving and investment, an improved business climate, and poverty-related spending as critical to sustaining growth and reducing poverty.

The IMF asked the government to quickly complete the reform of the regulatory and tariff framework for the power sector, and step up efforts to broaden the tax base and further curtail tax exemptions. Islamabad was also advised to improve its debt management strategy by increasing the issuance of long-term marketable securities and by reducing reliance on treasury bills and the National Savings Schemes (NSS) to finance fiscal deficit.

It also urged the authorities to expedite the process of subscribing to the Special Data Dissemination Standard.

The fund noted that the fiscal deficit exceeded the original budget target for 2005-06 owing to the earthquake-related spending. Excluding the latter, the increase in revenues and expenditures was roughly the same as in the previous fiscal year.