The current economic crisis had begun well before the ongoing global economic meltdown. Over the past eight years, official policies had essentially focused on the services sector at the cost of agriculture and manufacturing sectors. The economy faced many challenges with worsening fundamentals, resulting in depletion of the foreign reserves and depreciation of the rupee.

The biggest problem is that government expenditures exceed earnings, which, can be managed only by austerity and cut in non-development expenditures. This is indicated by the federal budget 2008-09.

Domestic debt: The total domestic debt – permanent, floating and unfunded – swelled to Rs3,465.8 billion by September 2008, up from Rs2,700 billion in the same month last year. The increase in domestic debt mainly emanates from floating debt while the other two components, unfunded and permanent, witnessed a modest growth.

External debt: The external debt and liabilities went up to $40.2 billion in 2006-07 from $36.5 billion in 2001-02. With falling foreign exchange reserves, a debt default appeared round the corner. The IMF approved a $7.6 billion loan, of which $3.1 billion were disbursed to bolster foreign exchange reserves. The Fund’s programme is expected to stabilise the economy.

In the last decade, the economy did witness a major transformation. The GDP increased from $60 billion in 2000-01 to $170 billion (on the existing exchange rate) in 2007-08 with per capita income rising from under $500 to over $1,000. Simultaneously, the volume of foreign trade increased from about $20 billion to nearly $60 billion, two-thirds of which was imports. For most of this period, the real GDP grew at more than seven per cent a year with relative price stability.

The improved macroeconomic performance enabled Pakistan to re-enter the international capital markets in the mid-2000s. Large capital inflows financed the current account deficit and contributed to an increase in gross official foreign exchange reserves at $14.3 billion (3.8 months of imports) at end-June 2007. This strong macroeconomic performance resulted from a series of important structural reforms.

The macroeconomic situation, however, deteriorated significantly in 2007-08 and the first four months of 2008-09 owing to adverse security developments, large exogenous price shocks and global financial turmoil. Consumer Price Index (CPI) 12-month inflation rose to 25 per cent in October 2008 with core inflation increasing to 18 per cent.

The external current account deficit widened to about $14 billion. The surplus in the financial account of the balance of payments declined to $7.7 billion from $10.1 billion in 2006-07. Reserves dwindled to $3.4 billion (less than one month of imports) as of end-October 2008.

The fiscal deficit has risen to 7.4 per cent of GDP in 2007-08, from 4.3 per cent in 2006-07. The deficit was largely covered through SBP financing.

To contain inflationary pressures, between July 2007 and July 2008 the SBP increased its discount rate by 350 basis points, to 13 per cent. On November 13, the discount rate was raised from 13 per cent to 15 per cent to curb still surging inflationary pressures.

The banking system was well-capitalised and liquid as of end-June 2008. But liquidity problems emerged recently. Domestic pressures and the global financial crisis led to rising dollarisation and an outflow of deposits from the banking system during July-October 2008, which contributed to liquidity crunch.

In response to liquidity pressures in October, the SBP reduced the reserve requirement by four percentage points and eased liquidity requirements. In addition, the SBP has encouraged merger of four small banks. These measures seem to have stabilised liquidity conditions in recent weeks.

Macroeconomic outlook: The government’s financial policies for the remainder of 2008-09 and for 2009-10 are aimed at macroeconomic stability and restoring investor confidence. The government’s programme envisages a significant fiscal consolidation, and the SBP will tighten monetary policy, if need be, to lower inflation and improve foreign exchange reserves.

The tighter financial policies, higher disbursements from IFIs, lower commodity prices and restored business confidence are expected to contribute to a significant strengthening of the external position in 2008-09.The external current account deficit is projected to narrow to $10.6 billion.

The surplus in the financial account would decline to $6.2 billion, as an increase in disbursements from IFIs (to about $4 billion) would be more than offset by weaker FDI and portfolio flows relative to 2007-08, reflecting in part the impact of the global financial turmoil.

Given the target to increase gross official reserves to $8.6 billion by end-June 2009, the residual financing gap of $4.7 billion will be covered by drawing on IMF resources. To further bolster confidence, the government is seeking additional financial support from donors.

The external financing gap for 2009-10, which is projected at $3.6 billion, are to be covered by disbursements from the IMF and Global Depository Receipts (GDRs) proceeds. External financing gaps are planned to be fully eliminated by the end of the Standby Arrangement (SBA).

Fiscal policy: The fiscal deficit is targeted to decline to 4.2 per cent of GDP in 2008-09. This fiscal effort is necessary to help reduce the

external current account deficit, move toward a sustainable fiscal position and eliminate SBP financing of the government.

The IMF standby facility will help in building confidence in the economy. The country required a quick injection of funds to meet the extreme challenges it faced, given its balance of payment position, the eroding rupee, and the depleting foreign exchange reserves.

The IMF package seeks to bring accountability and to target the fiscal and monetary policy reforms. The macroeconomic fundamentals that are the focus of the IMF are the budget deficit, circular debt, a tighter monetary policy and a rupee value determined by the raised discount rate from 13 per cent to 15 per cent. Exchange rate volatility will be reduced by flexible rate policy. However, inflationary pressure should be controlled in larger interest of macro economy.