37-                      JJ>  4 .:'
., CIRCUATING CoPy                          RESTRICTED
TO BE RETURNED TO REPORTS DESK    Report No. P1085
FtILE CcY
This report is for official use only by the Bank Group and specifically authorized organizations
or persons. It may not be published, quoted or cited without Bank Group authorization. The
Bank Group does not accept responsibility for the accuracy or completeness of the report.
INTERNATIONAL DEVELOPMENT ASSOCIATION
REPORT AND RECOMMENDATION
OF THE
PRESIDENT
TO THE
EXECUTIVE DIRECTORS
ON A
PROPOSED CREDIT
TO
THE ISLAMIC REPUBLIC OF PAKISTAN
FOR AN
INDUSTRIAL IMPORTS PROGRAM
May 31, 1972



Exchange Rate - Rps. 11.0 = US $1.00 *
Fiscal year ends June 30
* Country Data (Annex II)reflect, where applicable, pre-devaluation
rupees as noted.



REPORT AND RECOMEDATION OF THE PRESIDENT TO THE
EXECUTIVE DIRETORS ON A PROPOSED CREDIT TO THE
ISLAIC REPUBLIC OF PAKISTAN FOR AN IDUSTRIAL
IPORTS PROGRAM
1.        I submit the foUoving report and recommendation on a proposed
development credit to the Islamic Republic of Pakistan for the equivalent
of US $50 million on standard IDA terms, to help finance the foreign
exchange cost of industrial imports and fertilizer required during the
period July 1, 1972 to June 30, 1973.
PART I - THE ECOONMY
Introduction
2.        An economic report entitled "Economic Poaition and Prospects
of Pakistan" (R70-150, dated June 18, 1970) was distributed to the Executive
Directors on July 28, 1970. A,summary of the Country Basic Data is
attached as Annex II. An economic mission is scheduled to visit Pakistan
in September to review the economic situation and prospects of the country
and progress in redefining development priorities. A Bank staff meter
wif join an IMF review mission which wlll visit Pakistan in July 1972
to review progress in the implementation of the recently announced
program of economic and financial reforms and to set credit ceilings
for the standby arrangement after June 30, 1972. A mission is
currently in Pakistan to review the power sector.
3.        The application by the Goverrnment of Pakistan to the International
Development Association for an industrial inports credit of $50 million
eqaivalent has been made against the background of the very difficult
problems of economic adjustment which the country is facing at the present
tine. The case for such a credit should be considered in the context of
the Government's efforts to overcome these problems and to rebuild the
basis for development in Pakistan.
4.        To these ends, the Government has already taken action, and
intends to introduce further measures to improve substantially the
generation and efficient use of resources for development.   These
measures will, however, take time to make themselves felt.  In the
meantime, the Government 'a imediate concern is to prevent any farther
slow-down in economic activity which, with its attendant social and
political problems, would seriously hamper the process of adjustment. For
this reason the Government is seeking external assistance on a substantial
scale. This assistance, to be effective, has to be quick-diabursing in
support of current economic activity. Apart from its application to IDA,
the Govermnent has already obtained a standby of SDR 100 million from the



- 2 -
IMF and 1i endeavoring to restore ita aid arrangements with the members
of the Pakistan Consortium to a normal basis.
Recent Developments
5.         The severity of Pakistan'a current economic difficulties may be
illustrated by recent trends in a number of key indicators . GDP at
constant prices stagnated during the past two years, following a period
of sustained growth in the 1960'e at an annual rate exceeding 6 percent.
Thib deterioration reflects in part bad weather which particularly
affected the wheat crop. However, ite underlying cause has been the
protracted decline in the growth of large-scale manufacturing output,
from nearly 14 percent a year through 1967/68 to 2-3 percent in the past
two years.
6.        Public development expenditures had by 1968/69 recovered from
the effects of the 1965 war with India and two years of poor harvests
to a level roughly equivalent to 10 percent of GDP. Since then, they have
fallen to less than 6 percent of GDP, reflecting, mainly, the deterioration
in public savings, from nearly 3 percent of GDP to a current deficit of 1
percent of GDP, which were squeezed between stagnating revenues and fast
rising non-development outlays. At current prices, public development
expenditures declined from Rs. 3,200 million in 1968/69 to an estimated
level of RB. 2,400 million in the current fiscal year ending June 30,
1972, which is being financed by bank credit on.a scale which cannot be
sustained, and by external assistance. In real terms the decline has
been even greater. As outlays on Indus/Tarbela have absorbed about Rs. 800
million a year (excluding external grants), it has been very difficult to
provide adequate financing for other on-going development schemes, let
alone for new ones.
7.        Meaningful comparable data for private investment are not
available, but there iB ample evidence that, because of lack of confidence,
investment in the private sector has fallen considerably over the last
few years. Rougb estimates suggest that total gross investment in 1971/72
is down by about one fourth from the previous year and, at 12-13 percent
of GDP, substantially below the level of about 18 percent prevailing through
the late 1960's.
8.        The imediate economic problems confronting Pakistan are also
clearly shown in the balance of payuwnts. Late in 1969/70 and continuing
into 1970/71, in an attempt to revitalize industrial growth, which had for some
time suffered from inadequate supplies of imported materials, the authorities
eased restrictions on imports. Total imports in 1970/71 rose by about 10
percent and imports other than food and capital equipment by 7 percent. At
the same time, purchases of foreign exchange from East Pakistan fell sharply
because of political disturbancea. The adverse effects of these two factors
far exceeded the additions to receipts from exports and external assistance,
forcing Pakistan to draw on its reserves, including SDR's, at a monthly rate
of $16 million during the first nine months of the fiscal year. Since



reserves at the beginning of the year plus the 1971 allocation of SR?a
were only $317 million, they fast approached a dangerously low level. To
avert an acute payments crisis, the authorities tightened import restrictionB
frcm January 1971 onwards, and in June of that year substantially raised
the effective rupee cost of most imports through ad hoc adjustments in the
multiple rate system. They also imposed a moratorium on payment of a
large part of Pakistan's debt service obligations to bilateral creditors.
These measures, together with a further subatantial increase in exchange
earnings, succeeded recently in halting the steady decline in reserves.
Gross reserves have since fluctuated around  $200 million.



- 4 -
WEST PAKISTAN - FOREIGN EXCHANGE BUDGEr
(US $ Million)
1969/70         1970/71         1971/72
(Provisional)
Receipts                              828              932           1,053
Merchandis 1Exports2/                 338              420             570
Invisibles_                           175             141             168
Foreign Aid                           315              371             315
(Project)3/                        (180)           (255)           (210)
(Non-Project)4/                    (135)           (116)           (105)
Payments                            1,130           1,203            1,247
Public Sector Invisibles5/            158              155             202
Private Sector InvisiblesZ/            71               74              84
Debt Se <i.ce7/                       212              219             251
Imports_                              689              755             710
Overall Deficit                       302             271              194
Financed by:
Moratorium on Debt Service           -                28             118
Imputed Exchange Receipts from
Foreign Earnings of the
Eastern Province                  251              133               7
Use of Reserves°/                    51              110              69
Source:  Government of Pakistan, Finance Division, Economic Affairs Division,
Central Statistical Office and IBRD staff estimates.
1/ On shipment basis as recorded by CSO.
2/ For 69/70 and 70/71, estimated at eighty percent of corresponding figure
for the Western and Eastern Provinces taken together. The figure for
1971/72 includes an estimated $10 million for repatriation of foreign ex-
change under Martial Law Regulations 104 and 105 which required citizens
of Pakistan, with certain exceptions, to declare their assets held abroad
and to repatriate within a specific time their cash balances and proceeds
from the sale of movable property; special directives were given also
regarding immovable property. Funds surrendered under these Regulations
received bonus at the rate of 45 percent.
3/ Project aid disbursements as shown are reduced by 15 percent to allow for
the usually associated technical assistance component (the contra-entry
for which normally is not reflected in the foreign exchange budget).
4/ Including food aid.
Including payments for defense imports.
6  For 1969/70 and 70/71, estimated at sixty-six percent of corresponding
figure for the Western and Eastern Provinces taken together.
7/ Assuming full service on all debt outstanding as of December 1971.
9/ Including use of SDR's plus IMF credit facility, and residual balances.



9.        However, the stabilization was achieved at very considerable
cost to the economy because imports, other than food to meet shortages
of foodgrains, edible oils and sugar, had to be reduced significantly 1/
while the introduction of the moratorium further complicated Pakistan's
relations with the Consortium which has made no new commitments of aid
since early 1971. Thus, projections for 1972/73, prepared a few months
ago, suggested that Pakistan faced the prospect of having to cut total
imports by a further 30 percent and imports for current production even
more.
10.       The difficult economic situation that has been described
above can be traced principally to two causes: first, the failure of
previous Administrations in Pakistan over a period of several years to
take action appropriate to deal with a deteriorating economic situation;
secondly, the economic consequences for Pakistan of political events
since early 1971, culminating in the separation of the former Province
of East Pakistan, which declared its independence and became Bangladesh.
The situation has been aggravated further by rapidly rising debt service
obligations -- from $212 million in 1969/70 to $251 million in 1971/72
and $281 million in 1972/73 2/ __ and the decline in disbursements of
non-project assistance (excluding food aid) -- from $135 million in
1969/70 to $78 million in 1971/72, reflecting the absence of new commit-
ments since early 1971, other than for food. Non-project aid disburse-
ments (excluding food) from the existing pipeline in 1972/73 are
expected to be only $57 million.
11.       Among the inadequacies of past economic policies, those rela-
ting to the exchange and fiscal systems have had the most pervasive
adverse effects. Both systems as they had developed through numerous
ad hoc adjustments, had come to embody very severe distortions that
proved increasingly inimical to efficient use of resources for develop-
ment; and both systems were ill suited, in Pakistan's changing
economic circumstances, for the generation of resources for development
at a pace commensurate with the country's needs.
12.       The multiple exchange rate system was initially introduced as
a simple two rate regime intended to promote industrialization while
protecting the balance of payments, and to give special incentives to
exports of manufactures. In the course of the 1960's, the exchange rate
system underwent many ad hoc adaptations to changing circumstances --
partly, in response to a tightening exchange situation, to raise the
effective price of exchange with a view to atrengthening export incen-
tives and relieving pressures on the import control system; partly, in
1/   The figures shown in the foregoing table understate the extent of
the reduction because they do not take account of imports under inter-
wing trade which in 1969/70 amounted to about $l10 million at inter-
national prices and which have since ceased.
2/   Based on all external debt contracted by Pakistan up to December 1971.



-6-
response to the emergence of agriculture in the latter 1960's as a
potential growth sector, to extend to the development of that sector
(but with notable exceptions) the incentives previously given exclu-
-sively to industry.
13.       By the end of the l960's, these adaptations had produced a
range of effective prices of exchange so wide -- from Rs.3.10 to the
dollar to Rs.20, including duties, other taxes and subsidies -- that
the system could no longer function as a guide to the efficient alloca-
tion of resources. In particular:
(a) On the export side, it discriminated greatly against
primary products -- the rate being Rs.4.76 to the
dollar as against about Rs. 8.50 for manufactures --
at a time, when all indications were that strong
price incentives were necessary to promote increased
production of primary products for export.
(b)  On the import side, the effective cost of exchange.
for finished capital goods was about 60 percent less
than for industrial raw material imports, clearly
favoring the creation bf assets over their utiliza-
tion, discouraging the development of the domestic
capital goods producing industry, and distorting
factor relations in favor of capital as against
labor. These distortions were further reinforced
by the operation of the system of allocating import
licenses for industry, fiscal incentives for invest-
ment, and the credit system. Further adaptation of
the system in 1971 did not bring about essential
improvements, except in the case of primary exports,
the effective price of exchange for which.was raised
by Rs.0.90 per dollar, or nearly 20 percent.   This
largely accounted for the increase in the cotton crop
in 1971/72 by about one third.
14.       At the same time, the system required increasingly heavy
reliance on quantitative restrictions to maintain the equilibrium
between receipts and payments. The way in which these restrictions
were applied in controlling imports of industrial materials tended to
reinforce the bias in the price system in favor of further additions of
productive capacity, rather than increases in current production by
fuller utilization of the existing capacity.
15.       The fiscal system has suffered from the following weaknesses:
(a)  The tax system has been highly inelastic with respect to
income so that, at any given set of tax rates, the share
of tax revenue in GDP has tended to fall over time,
largely because income generated at the main sources of
growth -- manufacturing and, in the latter 1960's,
agriculture -- has either been excmpted altogether from



-7-
taxation or subjected to more or less fixed payments.
Furthermore, tax revenues have remained heavily
dependent on importa -- customs duties and related
levies account roughly for 40 percent of total tax
revenues -- while imports have tended to decline in
relation to GDP. As a result, substantial tax measures
which the Government has taken over the years merely
succeeded in maintaining the tax rate at about 10-12
percent of ODP. This is low by cotparison with other
developing countries, and certainly ±nadequate in
relation to Pakistan's needs. Present estimates
indicate that in the current fiscal year, tax revenues
declined by about 5 percent.
(b)  The revenue syatem has been inequitable between
income groups and between sectors, particularly
between agriculture and the rest of the economy.
As a remedy for the first inequity, the share of
direct taxation -- only about 17 percent of total
tax revenue and Just over 2 percent of GDP --
needs to be raised considerably. The latter
raises the whole question of agricultural taxation
(as well as subsidy and price policies) on which a
good deal of staff work was done in the Goverment
in 1969/70, only to be shelved beeause the Govern-
ment at the time was reluctant to move.
(c) Over time, a wide array of Interventions has been
built into the fiscal system, on both the revenue
and expenditure sides (exemptions or deductions in
taxes, subsidies) which, apart fram being in
certain instances mutually contradictory or in
conflict with incentives and disincentives built
into the exchange system, have on the whole proved
to be no longer useful or to have become positively
harmful.
16.       As regards the second principal cause of Pakistan's present
economic difficulties -- its truncation by the separation of its former
East wing -- it needs to be remembered that what used to be West and
East Pakistan never constituted a thoroughly integrated economic unit.
The high cost of transport between the two wings and the absence of
appropriate policies limited integration. Nevertheless, the independence
of Bangladesh has affected Pakistan in two vital areas, the balance of
payments and public financee, sggranating difficulties of economic adjust-
ment which Pakistan was already experiencing. Whether there was, in the
period immediately preceding separation, a net flow of resources to what
is now Pakistan or to Bangladesh is impossible to determine definitively,
in view of the lack of comprehensive data, the distortions introduced by



- 8 -
differential pricing, and the lack of a basis for judging what proportion
of the cost of Central Government services should have been borne by the
East and how much of the external assistance obtained should have accrued
to it.
17.       First, in respect of the balance of payments, Pakistan, separated
from Bangladesh, has lost access to substantial amounts of foreign exchange
which it used to purchase from the East tingg   These purchases reflected
the much greater degree of industrialization and the higher levels of
income and expenditures in the West wing, and the fact that Central
Government expenditures were largely made in the West wing. As shown in
the table in paragraph 8, and on the assumptions set out in the footnotes,
rough estimates place the amount of exchange so acquired by Pakistan at
about $250 million in 1969/70. At the same time, however, West Pakistan
had a sizeable surplus in inter-wing trade of Rs. 750 million, exports
being Rs. 1,665 million and imports Rs. 915 million. Because of wide dif-
ferences in domestic prices it is difficult to translate these rupee figures
into dollars at international prices. However, in rough orders of magnitude,
exports might be put at $200 mlllion equivalent, imports at $110 million,
and the trade surplus at $90 million.
18.       Thus, even if it were possible immediately to convert inter-wing
trade into international trade, Pakistan's exchange gap would be about $130
million larger than in 1969/70 (see table in paragraph 20). However, it
should be borne in mind that an important factor in this large increase in
the gap is the inclusion of the service of all the external debt contracted
by Pakistan up to December 1971.
19.       In fact, it would be unrealistic to expect that goods previously
exported under inter-wing trade can immediately be converted into exports
to international markets. For some goods, notably cotton and cotton manu-
factures, which have constituted about 30 percent of the total, diversion
should be fairly easy. For another 25 percent, comprising essentially rice
and tobacco, it may be very difficult to find alternative markets. The
remainder consists very largely of a wide range of manufactures, many of
which Pakistan did not in the past export in sizeable quantities. The need
to find new markets for them underscores the need noted above for adequate
incentives for exports; inevitably, however, diversion of exp6rts will take
time. In contrast to these problems of adjustment on the export side, there
should be no difficulty in switching to alternative sources of supply for
goods previously obtained under inter-wing trade. Moreover,, with the excep-
tion of tea (27 percent of the total) and small quantities of essential
consumer goods, these imports consisted of materials for production, and
therefore formed part of the supply of goods necessary to sustain production.
20.       The pressures on the balance of payments or the level of economic
activity, by these problems of trade and other adjustments associated with
the separation of Bangladesh, are illustrated in the table below.   It is
impossible to quantify all the balance of payments effects of separation
and the table must be regarded purely as illustrative of orders of magni-
tude. The figures for 1972/73 assume full diversion of inter-wing imports
at the 1969/70 level.



- 9 -
Estimated Foreign Trade Adjustments
(US $ Million)
1969/70     1970/71    1971/72    1972/73
g&orts                          589           553       577        600
Normal_1/                      3d         =3          497       7500
Diversion                      -            34         73        100
Imputed Exchange Receipts
from Foreign Earnings of
the Eastern Province        251           133         7  .
Imports                         689          755       710         800
Normal                         W9          72E                   69 0
Diversion                      -            13        67         110
Balance                        -100          -202      -133       -200
1/ Shipment basis (excluding re-exports).
21.       Public finance is the second area in which the separation of
Bangladesh has created major problems. These derive essentially from the
fact that the great bulk of the Central Government establishment, both
civil and military, was located in the West Wlng. Thus the loss of central
revenues from the East Wing, which constituted roughly one fourth of the
total, was not associated with a corresponding reduction in non-development
outlays, particularly expenditures on defense services which, on the contrary,
increased by about 40 percent during the past two years. As a result, central
non-development expenditures (excluding debt service), which in 1969/70
absorbed about 60 percent of revenue, in 1971/72 are practically equal to
total revenue. This has been a major factor in turning a current surplus
of Pakistan's public sector of Rs. 1,000 million in 1969/70 into an estimated
current deficit of about Ra. 500 million in 1971/72 (at comparable pre-
devaluation prices).
A Program of Economic Reform
22.       The immediate economic difficulties as described above are in
sharp contrast to Pakistan's economic strength which justifies optimism
about longer-term prospects. Pakistan already possesses a well developed
irrigation system, the productivity of which will be strengthened greatly
when additional water becomes available from the Tarbela Dam in 1976.
This, together with achievement of self-sufficiency in foodgrains opens
up the prospect of substantial increases in agricultural production as land
use patterns change. Pakistan already has a strong and fairly diversified
industrial base which was described in the Bank report circulated in



- 10 -
19701{ Its entrepreneurs have proved themselves capable of rapidly expanding
production, not only for the damestic market but also for export, and the labor
force is easily trainable and hard working.
23.       Having, during its initial months in office, been preoccupied
with the political aspects of its task, President 3hutto's Administration
then turned its attention to the difficult economic problems facing Pakistan.
Recognizing that Pakistan can overcome its current difficulties and realize
its potential for development in the longer run only by thorough improvement
of the economi-c policy framework, it has embarked on a comprehensive economic
and financial program. Its purpose is to restore conditions conducive to
development by effecting substantial improvements in the mobilization of
resources, both foreign and domestic, and in the efficiency of their use.
24.       The crucial importance of a suitable exchange rate system to its
efforts of rebuilding a basis for development was recognized and on May 12,
1972 the Government announced a fundamental reform which raised the par
value of the Pakistani rupee from Rs. 4.76 to Rs. 11.00 to the US dollar,
abolished the previously existing system of multiple exchange rates, and
introduced measures designed to move towards a more liberal import policy.
The contents of the reform and an analysis of its effects are presented
in detail in the recent IMF documents in Annexes IV and V.
25.       For the reasons explained above, a thorough-going reform of the
exchange system has long been regarded as essential to the resumption
of adequate growth of exports and of production and investment.. The
Government, with the reforms recently announced, has acted effectively
to remedy a crucial weakness in Pakistan's economic policy framework, which
has had pervasive effect on the economy, both on the mobilization and on
the use of resources for development. In particular, the reform:
(a)  on the export side, raised the average rupee proceeds per
dollar by about 20 percent; and by 30 percent for primary
products, after allowing for export duties;
(b) on the payments side, increased the effective rate for
imports, on the average, by 40 percent and for invisible
payments, including debt service, by 117 percent, the average
for all payments being 66 percent;
1/ Industrialization of Pakistan, The Record, The Problems and The
Prospects (R70-53; April 2, 1970)..



(c)  through the new import policy provides for the elimination of all
quotas, categories and entitlements as existed under the old scheme.
Two basic "lists" replace the former regime of various categories
of imports: the free list and the tied list. The latter is confined
to some 25 items financed under aid and barter, while most imports
are on the free list comprising about 320 items. In addition, a
few specified commodities, such as coal, fertilizer, rail and
track material, electricity generating and transmission equipment,
etc., are reserved for public sector import only, and certain luxury
goods continue to be banned.
26.       As Pakistan's exchange system has for so long been marked by quanti-
tative restrictions and numerous complexities, it is difficult to quantify the
effects of the reform on the balance of payments. It is reasonable to expect
that exchange receipts will, over time, increase substantially; exports of
commodities have, in the past, proved highly elastic with respect to price.
Most of Pakistan's exports represent only a small fraction of world trade and the
price elasticity of demand for them is high, so that Pakistan should be able
to increase its export volume considerably without a significant effect on
prices; diversion to foreign markets of goods previously shipped under inter-
wing trade should be easier.
27.       The reforms will probably have only a very limited effect on the
level of payments as import liberalization is accompanied by a substantial
increase in effective rates for imports. However, the structure of imports
should be significantly affected because, by eliminating the artificially
low effective rate for imports of capital goods and the system of allocating
licenses to individual users in the manufacturing sector, the use of existing
capacity and development of the domestic capital goods producing industry
should be encouraged.
28.       While certain adjustments of the fiscal system have been made con-
currently with the introduction of the exchange reform and import liberalization,
the Government recognizes that the next steps must be directed towards a fun-
damental reform of the fiscal system and containment of non-development expen-
ditures. As the Government foresees a considerably enlarged role for the public
sector, the ultimate objective of such a reform must be to raise the shares
of public savings and public development expenditures above the levels of 3
and 10 percent of GDP, respectively, achieved in 1968/69. In view of the deter-
ioration that has since occurred and the low levels to which public savings and
development outlays have fallen, it will undoubtedly take time to achieve the
necessary improvements, in part because measures to raise public savings will
have to be designed so as to be compatible with other important objectives of
fiscal reform, in particular, achievement of greater equity and the elimination
of the distorting effects on resource allocation contained in the present
fiscal system.



- 12 -
290       The Government intends to introduce measures in the next budget,
due to be announced before the end of June, that will improve the working of
the fiscal system in the financial year beginning July 1, 1972. To help prepare
revenue measures, the Taxation Commission has been reconstituted and instructed
to make proposals for the 1972/73 budget. An important objective of that budget
will be-to raise significantly the contribution of donestically generated re-
sources to public development, while reducing reliance on bank credit, and
thereby to make possible a substantial increase in public development expenditures.
30.       Meanwhile, the Government has introduced measures to bring about reforms
in agriculture, industry, and financial institutions. A land reform program
was announced on March 1, and action is being taken to regulate relations between
landlords and tenants. With the objective of improving efficiency and combat-
ting tax evasion in the manufacturing sector, the Government replaced the managers
of all private companies in ten basic industries!/ by Government appointees
and the system of managing agencies was abolished. In the financial sphere,
the State Bank's control over private commercial banks and their credit policies
has been greatly expanded with the objective of ensuring a more effective and
equitable distribution of funds among the various sectors of the economy with
special regard also to smaller and less priviledged borrowers, particularly
in agriculture and industry; in this connection a National Credit Consultatite
Council wvith public and private representation is being formed. To deal with
pressing social problems, a public works program and new programs in education
and health were anhounced.
31.       For most of these policies, particularly those in the social field,
detailed and staged plans remain to be worked out. At the same time, the
Government is engaged in a, review of priorities for public development which
has become necessary because the Fourth Five-Year Plan, adopted in mid-1970, is no
longer relevant in the light of the change in circumstances resulting from the
separation of the East wing. The Government is also considering how best to:
reorganize public development planning to give effect to the increased respon-
sibility allocated to the Provincial Governments. Work on an interim develop-
ment program is planned to be completed and the results announced, in conjunction
with the budget for 1972/73.
Aid Requirements
32.       Comprehensive reforms along the lines described in the preceding section
should provide the basis for the restoration of an adequate rate of development.
However, the measures already taken, in particular the exchange reform and imp ort
liberalization, and those to be taken in connection with the budget for 1972/73,
will take time to make themselves felt. In the meantime, to facilitate adjustment
and to avoid a sharp decline in imports which would further complicate an already
difficult economic situation, Pakistan will require external assistance on
a scale substantially larger than it would normally need.
1/ Iron and steel; basic metals, heavy engineering, heavy electrical, motor
vehicle assembly and manufacture tractor assembly and manufacture, heavy
and basic chemicals, petrochemicals, cement and public utilities.



- U -
33.        Present projections  of the balance of payments for 1972/73, as
shown below, indicat that Pakistan will require a net transfer of resources
from abroad in the order of $285 million.
Balance of Payments
(US $ Million)
1969/70          1972/73
Receipts      Lco51t6j3
Merchandise Exports-                            3                  X
Invisibles                                      175              168
Payments                                          918             102
Merchandise Iiports                                9              80
Public Sector nvsibles                          158               168
Private Sector Invisibles                        71                84
Deficit on Goods and Services                     405               284
Imputed Exchange Receipts from
Foreign Eamings of the
Eastern Province                              251               ---
Net Foreign Transfers, inoluding
use of reserves                               154               264
I/ Shiipment basis
34.       As shown in the table, exchange earnings are projected to be about
75 percent higher in 1972/73 than they were three years ago. A relatively moderate
increase in foreign imports is expectedj assuming essentially a restoration of the
level in 1969/70 plus substitution of additional requirements of about $110 million
previously met fron interwing trade, bringing the total to about $800 million.
This projection, however, contains a considerable element of uncertainty as the
ultimate impact of the recent import liberalization measures in connection with
the exchange reform is, as yet, difficult to gauge. Moreover, while there were
very small imports of foodgrains in 1969/70, such imports are estimated to be
substantial (possibly as high as $50 million) in 1972/73 to overcome shortages
due to poor wheat crops in the past two years because of drought and to safeguard
against price pressures following devaluation. Thus, the above import projections
actually imply a considerable constraint on total non-food imports and, therefore,
are to be considered a minimum requirement to sustain economic activity at a level
compatible with the objective of rebuilding the base for development. In regard
to exports it must be observed that the very favorable performance in 1971/72,
reflecting largely a bumper cotton crop supported by high international prices,
cannot be expected to be repeated. The cotton crop may well remain below this
year's level and cotton prices already show a declining trend. Thus, export
projections too have to be viewed with ame caution.
35.       To determine gross aid requirements to make possible the net transfer
estimated above, Pakistan's debt service obligations have to be taken into
account. As shown in the table below, debt service obligations, estimated
on this basis,. amount to $281 million in 1972/73, as compared to $212 million
in 1969/70.



Total Deficit and Financing
(US $ Million)
1969/70    1972/73
Requirements
Deficit on Goods and Services                         437        284
Debt Service                                          212        281
Total                         649        565
Financing
Imputed Exchange Receipts from Foreign Earnings
of the Eastern Province                          251          -
External Financing (including use of reserves)        398         -
Total                         649
The 1972/73 requirement could be met as follows:
Existing credits for projects                               150
Existing credits for commodities and food                   118
Additional financing requirements                          297
Total                                    565
36.       The Government has approached the IMF, the members of the Pakistan
Consortium and IDA to help cover the residual deficit of about $300 million.
On May 17, 1972, the IMF Board approved Pakistan's request for a stand-by
credit of SDR  100 million, to provide net credit, after taking account of
repurchases due during the period, of SDR 74 million. Recourse to the
Fund is essential to cover the time until longer-term financing becomes
available and generally to supplement Pakistan's reserves in supporting
the exchange reform.
37.       The Government's immediate objective must be -- and is -- the
restoration of conditions conducive to adequate development and, in that
context, the maintenance of a reasonable level of economic activity to
facilitate the structural adjustments which are necessary. For external
assistance to be effective in supporting this objective it must be in a
form suitable for financing imports for productive use of existing capa-
city and be disbursed quickly.
38.       To meet part of the financing requirements on the basis of the
projected deficit, the bilateral members of the Consortium in a meeting
on May 26 agreed -- subject to concomitant bilateral arrangements
expected to be completed shortly -- to extend debt relief to Pakistan
equivalent to approximately US$234 million over the period from May 1,
1971 to June 30, 1973;  of this amount about US$90 million will provide



- 15 -
additional relief during fiscal year 1972/73. The Government of Pakistan
has also asked the Consortium (and non-Consortium) countries to make new
commitments of cammodity assistance. It is hoped that such commitments
will be made shortly and in an amount sufficient to provide disbursements
of up to $130 million in 1972/73.
39.       Commitments of such assistance to Pakistan, before the separa-
tion of Bangladesh, have not in recent years exceeded $150 million, so
that the amount requested from the Consortium is very large. Even if
it is fully met, the remaining gap would be much too large for Pakistan
to finance from its reserres and by drawings on the IMF. The proposed
program credit, by helping to bridge this gap, would be Important in
making more effective other external assistance, and in improving the
prospect that the far-reaching measures of exchange reform and import
liberalization recently introduced will be effective in restoring the
rate of economic and social development.
40.       Thus, the IDA credit would be part of a financing plan for
the projected deficit as follows:
(US$ million)
Projected Deficit                                      300
Financing:
Bilateral Assistance                              220
Disbursement from New Commitments
of Commodity Aid                             (130)
Debt Relief                                   (90)
IDA Imports Program Credit                         50
Sub-total                    270
Use of Reserves and/or INF Stand-by Credit         30
Total                        30Q0.
The above $30 million to be provided out of reserves and the IMF standby
credit would correspondingly increase if disbursements from new bilateral
commodity aid commitments fell short of the estimated $130 million.



- 16 -
PARr-Il - BANK GROUP OPERATIONS
41.       The Bank and IDA have made thirty-one loans and thirty-eight
development credits to Pakistan since 1952, in the following sectors:
agriculture, transport, power, education, water supply and sewerage,
communication and industry. The Bank Group has participated in the
joint financing of the projects financed through the Indus Basin and
Tarbela Development Funds and is the Administrator of these funds.
Bank/IDA comitments as at April 30, 1972 totalled $1,173W,3 million,
representing about 23 percent of Pakistan's total outstanding external debt.
Of this total, fourteen projects accounting for $383.1 million were in the
West wing, including five projects which were administered by agencies
operating in both wings, and twelve projects accounting 'for $137.6 million
were in the East Wing. Annex I contains a summary statement of Bank loans,
IDA credits and IFC investments as of April 30, 1972, and notes on progress
in the execution of projects.
42.       As the Executive Directors are aware, in December 1971 disburse-
ments on all outstanding loans and credits for beneficiaries in East
Pakistan were suspended. I expect to make-recommendations to the Execu-
tive Directors with regard to the undisbursed balances on these loans and
credits as soon as current discussions with the governments have been
completed. In the meantime, the Government of Pakistan, for the time
being, is continuing to carry the liability for servicing the debt with
respect to commitments attributable to projects In what was East Pakistan.
Action as reported in my memorandum to Executive Directors of April 4,
1972 (R72-74) is being taken, with the support of Sweden and in consulta-
tion with the Government of Bangladesh, with a view to resuming work on
these projects.
43.       IFC has made eleven investments in Pakistan totalling about
US $26 million, including one in Bangladesh, Karnaphuli Paper Mills Ltd.
(US $6.23 million), of which IFC currently holds US $15.4 million net of
cancellations, repayments and participations. IFS has some preliminary
applications under consideration for investments in Pakistan.
44.       This is the only lending operation in Pakistan which will be
presented for consideration this fiscal year.
45.       The Bank Group's strategy in the next few months will be to
assist, as Chairman of the Pakistan Consortium, the Government and the
Consortium countries in reaching agreement on longer term debt relief
proposals, and to prepare, towards the end of this calendar year, an
assessment of the economic situation and of the progress being made in
development planning in order to help establish the priorities for future
development assistance.



- 17 -
PART III - THE PROJECT
46.       In support of recent economic reforms, the Government has requested
assistance in the form of an imports program credit from the Association.
The proposed credit of US $50 million would complement the assistance by the
member countries of the Pakistan Consortium and the IMF referred to in
paragraph 36.
47.       A mission to formulate the credit proposal visited Pakistan in
March 1972. It had discussions with the Government and with industry
representatives and visited 24 large manufacturing enterprises, mainly in
the engineering sector, to assess the present situation and import needs
of industry. Negotiations were held in Washington on May 19 through 25,
1972. Pakistan was represented by a team headed by Mr. Zafar Iqbal,
Joint Secretary, Economic Affairs Division, Government of Pakistan.
48.       The Bank report "Industrialization of Pakistan"'/ dated March 10,
1970, describes in full the past record, the problems and prospects of
industry in Pakistan. The problems outlined in the report are low capacity
utilization, unsteady and insufficient supply of imported raw materials,
components and spare parts and widespread and increasing differences, at
the official exchange rate, between the domestic and foreign prices of
industrial goods. The recent internal disturbances and hostilities with
India have further aggravated these problems. Due to the lack of foreign
exchange, low public and private investment expenditure and to some extent
the loss of the market in East Pakistan, average"'oapacity utilization in
industry is lower than ever. For example, in the engineering industry,
which is heavily dependent on imported materials, it has fallen even lower
than the 40-50 percent of 1969 to 30-40 percent.
49.       The reforms now initiated by the Government offer the possibility
of overcoming these problems and of returning to reasonable levels of
capacity utilization. The change in the parity of the rupee brings the
domestic price level of industrial goods back on to a comparable basis
with international prices. Equally important, the Government has substantially
changed and simplified its import licensing system. As mentioned above,
Pakistan has operated a complicated system of multiple exchange rates,
import licenses and import entitlements, which has now been abolished.
50.       The basic strategy of the new import policy is to minimize the
administrative controls and complications. Import licenses remain, but
solely as a means of registering imports. Apart from a limited range of
commodities exclusively reserved for procurement against tied aid or barter,
1/ Industrialization of Pakistan, The Record, The Problems and The
Prospects (R70-53; April 2, 1970),



- 18 -
imports will be permitted from world-wide sources. Import of machinery
and equipment of up to Rs. 200,000 against cash and up to Rs. 500,000
against barter or credits, will be allowed freely. Imports of machinery
on a bigger scale will continue to be sanctioned subject to review by
the Ministry of Industries.
51.       As explained in Part I above, public development expenditures
have fallen drastically during the current fiscal year. Private invest-
ment, because of lack of confidence, has fallen considerably over a
longer period. With the Government's actions to improve mobilization
of resources and its plans to increase public development expenditures,
confidence appears to have returned and industrialists generally seem
optimistic about the prospects of industry. The loss of the market in
East Pakistan had comparatively little effect on industry as a whole.
The cotton industry which sold the highest share of its output to the
East Wing, is also the industry with the best prospects to shift to
other export markets. Other manufacturing industries (including the
engineering industry), sold on an average only 6 percent of output
to the East Wing, and the loss of that market had comparatively little
effect. Prospects for a return of industry to its pre-war level of
activity are good, provided sufficient imported materials can be made
available. Ample capacity to manufacture a wide variety of goods domes-
tically is available, and businesses are liquid. Industrial relations,
after considerable disruptions and upheavals, now appear to be improving.
52.      The proposed credit would be used to finance part of the imports
required in 1972/73 by a wide range of manufacturing industries, including
textiles, chemicals,paper making, leather goods, plastics and engineering.
In addition, for the purpose of securing sufficient compound and phosphatic
fertilizer for the crop to be planted in October, 1972, the credit would
also finance that part of the Government's program for the import of such
fertilizer which cannot be procured and financed from bilateral sources in
time. Not more than $3-5 million of the credit will be disbursed on these
fertilizer imports. Items which will not be financed from the Credit are
consumer goods, military equipment,iteme custemarily imported for the public
sector under project aid and items reserved for procurement from designated
countries. The list of'categories of goods to be financed out of the pro-
ceeds of the Credit is included in Annex III.
53.       In 1970/71 imports of the eligible goods, excluding fertilizer,
amounted to $237 million. It is expected that imports in 1972/73 may reach
the 1970/71 level so that the proposed credit would finance about 20-25
percent of industry's requirements of these goods. Some bilateral aid will
also be used to finance industrial and fertilizer imports. On the basis of
past usage, if bilateral commodity aid amounts to $130 million, approximately
$20 million will be used to import fertilizers and pesticides, $20 million will
be allocated for other public sector users, and about $90 million will be used
to finance private sector industrial imports. As the proposed credit and
bilateral aid taken together will probably be substantially lower than the
requirements of eligible goods, no difficulty is foreseen in disbursing the



- 19 -
credit as well as bilateral aid.  Furthermore, as much of the bilateral aid
may become available somewhat later than the proposed credit, disbursements
are likely to be rapid.
54.       Most of the imports to be financed by the credit would be direct
imports by the private firms through normal commercial channels. The
Trading Corporation of Pakistan (TGP), a state corporation, is the designated
importer of a limited number of items where economies can be secured by
importing in bulk. Of these items, pig iron, steel strip, non-ferrous
metals, newsprint, pharmaceutical raw materials, wood pulp and manmade
fibers may be financed by the IDA credit. Total annual requirements of
these items amount to about $25 million. Part of the imports of these
items may be financed by bilateral aid and it is, therefore, impossible
to make an estimate as to what share of the IDA credit would be used for
imports through TCP. The Ministry of Agriculture is the designated govern-
ment agency for the procurement of fertilizer. The Government has agreed
that goods and services to be procured through TCP or the Ministry of
Agriculture and to be financed out of the credit will be procured on the
basis of international competition. In passing on imports to industrial
users, TOP charges its actual cost plus a service fee ranging from 2-4
percent, depending of the scale of the purchases.
55.       For the time being, Pakistan is continuing to allow Commonwealth
preferences on a limited number of items. However, in the case of purchases
by TCP and the Ministry of Agriculture, tenders will be evaluated on the
basis of c.i.f. prices, so that tariff preferences will not be taken into
account.
56.       All disbursements, covering the c.i.f. cost of qualifying imports,
would be on a reimbursement basis.  For administrative convenience,
qualifying imports costing less than $5,000 would be ineligible for reimburse-
ment. Wh-le no retrospective financing would be allowed, it is intended
to permit disbursement in respect of goods imported under licenses issued
before the date of the credit and paid for after June 30, 1972. The State
Bank of Pakistan will be responsible for collecting, through nominated
banks, invoices, evidence of shipment and evidence that the supplier had
received payment. Such evidence will be forwarded to the Bank in support
of withdrawal applications. The State Bank will also provide a certifica-
tion in each case that the goods have been supplied from member countries
of the Bank or Switzerland and that they had not been financed already by
any bilateral source or by another international development finance insti-
tution. The credit should be disbursed over a period of nine to twelve
months.



- 20 -
PART IV - LEGAL INSTRUMENTS
AND AUTHORITY
57.       The draft Credit Agreement between the Association and the Islamic
Republic of Pakistan and the Recommendation of the Committee provided for
in Article V, Section l(d) of the Articles of Agreement, are being distri-
buted to the Executive Directors separately.
58.       Under Section 7.02 of the draft Development Credit Agreement, the
Association would be entitled to suspend further disbursement if, after
reviewing with the Government the progress made in implementing the various
economic and financial measures taken, it determines that the purpose of
the Credit, i.e., the support of the successful implementation of the Govern-
ment's economic and financial program, is not likely to be achieved.
59.       I am satisfied that the proposed development credit w'ould comply
with the Articles-of Agreement of the Association.
PART V - RECOMMENDATION
60.       I recommend that the Executive Directors approve the proposed credit.
Attachments                                            Robert S. McNamara
President
May 31, 1972



ANNEX I
Page 1 of 5
THE STATUS OF BANK GROUP OPERATIONS IN PAKISTAN
STATEMENT OF BANK LOANS AND IDA CREDITS
(as at April 30, 1972)
Amount (US $ Million)
Loan or                                                                 Less Cancellations
Credit                                                                               Undis-
Number   Year   Borrower              Purpose                         Bank    IDA    bursed
Loans and credits fully disbursed                           352.8   222.9
Loans and credits being disbursed
266     1960   Pakistan           Indus (multipurpose)                90.0    -       18.5
50     196)4  Pakistan           Education                             -     8.5      3.3
376     196)4  Karachi Port       Port Development                    17.0    -        4.3
54     1964   Pakistan           Highways                              -    17.0      1.4
106     1967   Pakistan           Lahore Water Supply                   -     1.8      0.01
548     1968   Pakistan           Tarbela (multipurpose)              25.0    -       25.0
549     1968   Dawood Hercules    Fertilizer                          32.0    -        0.002
578     1968   Pakistan           W.P. Highways II                     1.1    -        0.1
145     1969   Pakistan           Telecommunications                    -    16.0      6.8
590     1969   PICIC              Industrial Development              40.0    -        3.8
597     1969   SNGPL              Sui Northern Gas II                  8.0    -        0.2
621     1969   Pakistan           Western Railway                     14.5    -        9.7
157     1969   Pakistan           Agricultural Bank III                 -    30.0     13.3
177     1970   Pakistan           Ind. Development (IDBP)               -    20.0     11.6
696     1970   SNGPL              Sui Northern Gas III                19.2    -        6.7
S-9     1970   Pakistan           Port Engineering                      -     1.0      0.6
186     1970   Pakistan           Telecommunications II                 -    15.0     15.0
206     1970   Pakistan           Engineering Education                 -     4.0      4.0
213     1970   Pakistan           W.P. Power Distribution               -    23.0     23.0
Sub-Total                    2                 7.31
Credits on which disbursements are suspended
41     1963   Pakistan           Dacca Water Supply                    -    13.2      7.2
42     1963   Pakistan           Chittagong Water Supply               -     7.0      3.7
49     1964   Pakistan           Education                                   4.5      0.8
53     1964   Pakistan           Highways                                   22.5     18.9
83     1966   Pakistan           Foodgrain Storage                     -    19.2      0.8
87     1966   Pakistan           Education II                          -    13.0      9.0
S-8     1969   Pakistan           Dacca SW Irrigation (Eng.)            -     0.8      0.06
S-10    1970   Pakistan           Irrigation Engineering                -     2.4      1.1
184     1970   Pakistan           Chandpur II Irrigation                -    13.0     12.4
192     1970   Palcistan          Small Industries                      -     3.0      2.8
208     1970   Pakistan           Tubewells                             -    14.0     13.9
228     1971   Pakistan           Reconstruction                        -    25.0     25.0
Sub-Total                       -             93 95. 6
Total                                           599.6  496.8
Of W[hich Has Been Repaid                       171.1     0.45
Total Now Outstanding                            2      79-6
Amount Sold                22.3
O" Which Has Been Repaid  20.8                   1.5
Total Now Held by Bank & IDA                    427.0   496.35
Total Undisbursed                                68.3    174.67  242.97



ANNEX I
Page 2 of 5
STATEMENT OF IFC INVESTMENTS
(as at April 30, 1972)
Amount in US$ Million
Year         Investment               Type of Business         Loan  Equity   Total
1958     Steel Corp. of Pakistan     Rolled Steel Products     0.63    -      o.63
Ltd.
1959     Adanjee Industries Ltd.     Textiles                  0.75    -      0.75
1962-    Ismail Cement Industries    Cement                    5.25   0.42    5.67
1965     Ltd.
1963-    PICIC                       Development Financing      -     o.49    0.49
1969
1965     Crescent Jute Products      Textiles                  1.95     -      1.95
Ltd.
1965     Packages Ltd.               Paper Products            2.31    o.84   3.15
1967     Pakistan Paper Corp. Ltd.   Paper                     3.20    2.02   5.22
1969     Dawood Hercules Chemicals   Fertilizers               1.00    2.92    3.92
Ltd.
1969     Karnaphuli Paper Mills      Pulp and Paper            5.60    0.63   6.23
Ltd.
Total Gross Commitments                                  20.69    7.32   28.01
Less Cancellations, Terminations,
Repaymients and Sales                                  11.74    0.91   12.65
Total Cmnmitments Now Held by IFC                         8.95    6.41   15.36
Total Undisbursed                                         1.00     -      1.00



ANNEX I
Page 3 of 5
C. PROJECTS IN EXECUTION
US$90.0 million (Indus Basin) loan of September 19, 1960 (Ln. 266)
All major project items (except Tarbela Dam) completed. Settlement
of a number of claims and some remedial works outstanding. No fur-
ther disbursement of Bank Loan is expected during remainder of this
calendar year.
US$17.0 million (Karachi Port) loan of May 14, 1964 (Ln. 376)
Postponement of the Closing Date will be necessary. A supervision
mission is scheduled for June. The present Closing Date is June 30, 1972.
US$25.0 million (Tarbela Dam) loan of July 10, 1968 (Ln. 548)
Loan was limited to residual financing, therefore no disbursements
are expected until FY 1976. Good progress is being maintained on the
works.
US$32.0 million (Fertilizer) loan of July 10, 1968 (Ln. 549)
Construction work was completed in July 1971 and commercial production
was started in February 1972. Only $1,900 is undisbursed.
US$1.1 million (Highways) loan of December 20, 1968 (Ln. 578)
A mission is tentatively scheduled for June to discuss the
recommendations of the consultants' transportation study with the
Government.
US$40.0 million (Development Finance Company) loan of March 21, 1969
(Ln. 590)
Disbursement in full is expected by the Closing Date. A supervision
mission is tentatively scheduled for September 1972.
US$8.0 million (Gas Transmission) loan of May 13, 1969 (Ln. 597)
Project is virtually completed. A supervision mission visited the
project in early May.
US$19.2 million (Gas Transmission) loan of June 29, 1970 (Ln. 696)
The recent hostilities have delayed execution of this project and also
caused cost increases. The nature and amount of these are being
ascertained by the supervision mission which visited the project in
early May.



ANNEX I
Page 4 of 5
US$14.5 million (Railways) loan of June 26, 1969 (Ln. 621)
No problems expected. Most recently, the Association has approved
the Borrower's request to extend MIS Sofrerail's contract to include
implementation of their recommendations and a study of some aspects
of the management of Pakistan Western Railways.
US$8.5 million (Education) credit of March 25., 1964 (Cr. 50)
Procurement for polytechnics in Sind and Punjab can,be completed
before the Closing Date.  At Agricultural University Lyallpur', con-
struction cannot be completed by the Closing Date, but teaching
buildings should be substantially completed and equipped.  The Govern-
ment of Pakistan has requested postponement of the Closing Date
for an unspecified period, reallocation of the proceeds of the Credit
to purchase additional instructional equipment for the Agricultural
University amounting to $250,000, and increase in the reimbursement
percentage for local expenditures on construction to 25% (from 10%).
This request is under consideration.
US$17.0 million (Highways) 'credit of June 11, 1964 (Cr. 54)
Construction is completed.  The Association has approved a third
postponement of the Closing Date (to December 31, 1972) to permit
the settlement of contractors' outstanding claims.
US$1.75 million (Lahore-Water Supply, Sewerage and Drainage) credit of
May 12, 1967 (Cr.,106)
SIDA participation is $1.75 million equivalent. The project is vir-
tually completed. Lahore Improvement Trust (LIT) requested a change
in withdrawal ratio between IDA and SIDA credits. The'Association
has agreed to LIT's request in order to allow full utilization of both
credits.
US$16.0 million (Telecommunications) credit of March 6, 1969 (Cr. 145)
Procurement problems are now largely resolved. A supervision mission
which visited Pakistan in May discussed a revision of the
project in light of the suspension of those parts of it which are
in East Pakistan. Postponement of the-Closing Date by about one year
is expected. The present Closing'Date is December 31, 1972.
US$15.0 million (Telecommunications) credit of May 22, 1970 (Cr. 186)
See Credit 145-PAK.
US$30.0 million. (Agricultural Development Bank) credit of June 26, 1969
(Cr. 157)
Disbursements continue to be far behind schedule. Tractor supplies
have been disrupted because the Government has not issued licenses
since September 1971. Lending for tubewells is continuing slowly as
a result of difficulties in WAPDA providing electrical connections,
due to power shortages. Postponement of the Closing Date by twelve
to eighteen months is likely.  The present Closing Date is June 30, 1972.



ANNEX I
Page 5 of 5
US$20.0 million (Development Finance Company) credit of February 11,
1970 (Cr. 177)
IDBP'a immediate future has been uncertain for some time as a result
of thela*c of a clear.industriaal policy and a change in Managing
Director. A supervision mission is tentatively scheduled for late
June.
US$4.0 million (Engineering Education) credit of June 29, 1970 (Cr. 206)
Construction scheduled to start in January 1973. Procurement is
not yet started. No major disbursements are expected during the
calendar year except for payments to consultants.
US$23.0 million (Electric Power Transmission and Distribution) credit
of August 14, 1970 (Cr. 213)
After initial delays, the project has started to make some progress.
Contracts have been awarded for power transformers ($4.7 million
equivalent), and for the Dharki-Rohri 132 KV transmission line ($h22,000
equivalent). Bids for substations phase I (estimated foreign exchange
cost $5.6 million) and power transformers phase II (estimated foreign
exchange cost $2.4 million) have been opened but evaluation reports
are not yet received. Bids for 11 KV switch gear (estimated foreign
exchange cost $1.6 million) and substations phase II (estimated foreign
exchange cost $2.8 million) should have been opened but no information
has been received about them. WAPDA has requested financing from
the Credit for additional special transmission work in Lahore (total
cost about $1.0 million equivalent, of which $0.6 million equivalent
is in foreign exchange), which will need a revision of the project
description in the Credit Agreement. This request is under.consider-
ation.
US$1.0 million (Port Ehgineering) credit of June 10, 1970 (Cr. S-9)
Final report of engineering feasibility study was completed in mid-
May. A preappraisal mission is scheduled for early June.



ANNEX 1I
Forma No. 81.02                                                                WRDBN         RU
(5-72)                                                                      WRDBN          RU
COUNTRY DATA
COUJNTRY: Pakistan (West)
~~~ 794,613 ~~~~~~~~~~~~~~~~~~POPULATION: 60.07                      mlllian 1970/71                                     DENSITY:        76     per ko
Nate of Growt 2.7   8   (fram 1969/70 to 1970/71)                        Thu=           316    Per km   of to) tivatod l1nd
POP0trATCON  CRARACTERISRTICU:                                                                         HEALTH,:
CUde. mrtA Rate (per, 1,021)    0      1968                                                           -Paoplstloa per physician       1970   4,361.
Crdteth Nate (Per 1,000)1 2C         1968Polt.np                                                                    hsialbd        17     196
Infant Mortality (per 1,000 lve births)        (year.oaalmprheptlhl                                                                   170,9
jN,COMr DISTRI.BUTION:                                                        DIS~~~~~~~~~~~~~R1TRIBUTION OP LAND OWNERNSHIP
hjgheeotqaltina ) Nat available                                                 . of I-od oc-d by tap 107. o-are
q   ~~~~~~~~~~~                                      %~~~~7 of load owood by ..melest 10% macar)  Rat availble
ACCrftI '10 P0TAB11 W4hrER (7 of pop.lotio-)                                                           ACCESSO'I0 ELECTRICITY'  (7. of popalarlo-l
Rorol )Not -milahle                                                                                     nro)Rt av,abla     .
0fTiOtN:        GoOP.,ect.             yar                   PERCAPITA:    814.6  1970/71                     EDUCATICON:
Caori    clkNIA frrorvet                  yer                 At au~et factar                                           _Tiktersay rate           11%   1961
Per capita Protein Rotate Cgraoone)      (yswr) )c/A          ost and at offiolal                                  Primay schoil anrolmert (8)    4.6%  1970
parity rate of Ro.
11R0S0 00G10T1C PROD100T (1970/71  (siae)4.76 per UI 8)                                               AMML (COMP¶OUND) DATE, Opl Gop GROWTH (%, oonstanxt factor o..st)
GKP -t ... k.t prices  9,181  lui-.O                                                    ~~~~~~~~~~~~~1960 161-1964/6t  1965/66-1969/70  1970/71
Gro.. lI-.tstOat                     1,575            17.0
Grosa Cutlooci Soviage               i,195            13.0                                            Agiouitur               3.7               5.6              -2.2
Corroat A-mocot Balanme                380             4.2                                            Induotry 2/            13.1               7.5               2.9
Osporta of Goode, ((PU                8480             9.2                                            lervicee                6.8               .u42.8
Teporte of Cod.NES                   1,228            13.4.                                             COPto                                                      _
OUTPUT. 0B0R PUORCE AllD
PRODU0C'T0ITY IN -1970/71: (GDP estimates at ourret fc,otor coot)
faita Oddod         .r,r r                                        ~~~~~~~~~~~~~Voice idleS Par dorker
Agriculture                      3.262           37.5                       02        88                       11.9                            43
Tud.aotry                        2.123           24.3                       .         2l8g12
Totl/Roerogo               NM              100.0                        25.     109                         9      -.                    100
PUBLIC PINA) CIT INl 1970/71
Co....lidated Csatr.1 and Pravimakl Govr,amea domamtst,                             e F l Ca. rmeI
dRAouont                                  %of Orp              (R.. Milli..)        0---    of7 GDP-aoara.
Current R-1p-                            m~~~(s.  illion)   % of COP           last tao years 5/1        drvot      % of GOP      last tam years 5/
Correot Rrorlpcs                         r~~~~      ~       ~~~~~,182  16.4.        16.5                 5,551       12.7             10.7
Ro:1-D-veopoe..t Empemdittree (tool. tranafers)       6,768               15.4.                  14.8                 6,158        14.1            13.8
Correot Scro1os/Defi.tot                                411.                0.9                   1.6                 - 607       - 1.1.            1.2
D-ovoim..eot.lopeeditare                              2,810                6.4.                   6.8                 2,629         6.0             6.7
bt-isrol   . ioltar~.c (gross)                        1,249                2.8                    2.8                 2,249        2.8              2.8
PRICES 01I0 CREITO?
amd of year:                                       (R,oleoalo Prima Iodeo                     2m-b Crotll to Pobio leotor                   Both Cre1It to lrlvcto Ivotor
~~ 1P68/69                        108am~~~~~~Id.  1959/60.100  % Chuwg           (oct)               % mh-mCe                  (-.n'ct)              achaogo
PY 1969/70                                    132                     15
PG 197.1/71                                   137                   + 3.8                                     (Na separt'e figure for West Paknistano)
Pebroamy 1970                                       138 
Pab O.. ' 1971                                      148                   +7.2
R3ALANCE Op PAYMENTS1 fIn last tom years)                        US                              OERCRANDIIE EXPORTS (Aveare af the last three X.ear)1968/69.1970/71 2/
R ...__                                                                                         Hoo Rw Cotton                                                     50           16
RMeoteh  d.     .P,t.                            3 30               205                        Cotton Mooc"tantr                                               113            30
T-ivlibles 3/                                   175               1LI                         Rime                                                             30             6
Leather and Leather looads                                       30             8
Pezoonte       Irot                                                                             Flak                                                             14.            4
Imisiblo.                                   oi ~~~~~~~~~~~~~~~~Ohes12713
bnvialilas                         ~~~~~~~229         229
Publio ISotor                                (58                (155)                       Total                                                            372          100
Private  Smctor                              (71)              (74)
bit lervAcs                        ~~~~~~212          219
Pntrestp.                                               .      83N                        EXTERNAL. DEW ON JUnE 30. 1970
____________  __                                                                                                       ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~($Inv.)
Overall flefimit                -617              ~~~~           ~           ~~~~~~~~-612  Melian and Long-tern Credits, Poblim                 2928
Edocomed by                                                           Roo~~~~~~~~~~~~~~N.-Gouraoteed Priv.at M0.T
Foreign Aid 9                                 315               371
Moratoriumo or. Debt Osroime                                      28                       Total Outstanding and Diebuorsad
Purhase of Foreign Excanege from
the Eastern Provinos21                                         3
Use 0, Offi..1 Re.---   5151                         110                     DENT 0 ER0ICERNATIO 197o/n7                      1.0% 
XRO/TIh L0911N1. APRIL 30. 1972 9/(8 mL.)
IBRD              lIDA
Outstanding and Disbursed                           406                32-
Uadiiabrsed                                          68                 79
Outatanding incl. Undlebursed                       4.74               10'
Nate of EunhanIge,,     RS $1.01    R A. 1.76                     Dots: lMaY 31, 1972
Rupee  1.00     US0 8_0.21
Dooartmnet: South Asia
.1 M-aotuaturing, miniog, qoar.rying, monstruction, electricity, gas, eater mad aOootaryeroa.
2/ E.mluding re-poorts.
Incloluding Workers' remittances.
WProeiot aid disbu,rsaents 00ncoluded are reduced by 15 Perceot to adjust for tamally ontainmd serio.s
ooonal.v oot remarrdoas a0 moatr-entry in the forsige esohange budget.
51 lomludlng 'toe of SD"0s PIus DI credit, and residual balances.
AlTotal debt burds (iooloeive of East Pakcistan,) related to West Pakistan,'sa foreign soohooge earnings only.
13 Eamiuding inter-wing emports.
JThose loans and credits &lolh wer intended for disbursemnt in both wings are treated as for West Pakistan osly.
2/1969/70 mad 1970/71 aoveas..



ANNEX III
Page 1 of 2
PAKISTAN - INDUSTRIAL IMPORTS PROJECT
CREDIT AND PROJECT SUMMARY
Borrower:                          Islamic Republic of Pakistan
Amount:                            Equivalent in various currencies of US $50
million.
Terms:                             Standard
Project Description:               Provision of foreign exchange to pay for
imports of industrial raw and semi-finished
materials, components, spare parts and
miscellaneous items of manufacturing equip-
ment and fertilizers to oupport Pakistan's
program of economic development.
Procurement Arrangements:          Mainly by private importers through commercial
channels. Some items to be bulked for import
by Trading Corporation of Pakistan after
international competition. Compound and
phosphate fertilizer, up to $5 million
after international competition to be
procured by the Ministry of Agriculture.
The categories of goods eligible for
disbursement are the following:
Raw vegetable materials
Tanning and dyeing extracts
Vegetable oils
Salt sulphur chemicals and compounds
Phosphatic fertilizer
Plastic materials
Rubber
Raw hides and skins
Industrial wood
Paper and paper board
Silk and textile materials
Fire brick and graphite
Industrial glass
Iron and steel
Non-ferrous metals
Manufactures of metal
Boilers
Electrical machinery and equipment
Mechanical machinery and equipment
Commercial and industrial vechiles, parts
thereof other than passenger cars



ANNEX III
Page 2 of 2
Estinaated Disbursements:           September 72 Quarter           $ 5 million
December 72 Quarter            $10 million
March 73 Quarter               $20 million
June 73 Quarter                $J5 million



ANNEX IV
CONFIDEATIAL
INTERNATIONAL MONETARY FUND
Pakistan: Change of Par Value and Wider Margins
Prepared by the Middle Eastern Department and
the Exchange and Trade Relations Department
(In consultation with the Legal and Treasurer's Departments)
Approved by Ernest Sture and John W. Gunter
May 8, 1972
I. Introduction
In a letter dated May 4, 1972 (Appendix III) Pakistan has proposed
a change in the par value of the Pakistan rupee from 0.186621 gram of fine
gold to 0.0744103 gram of fine gold per Pakistan rupee in accordance wit}
Article IV, Section 5, that is to correct a fundamental disequilibrium. 1
It is proposed that the change would be effective on May 11, 1972 at 10 p.m.
Washington time. The Government of Pakistan has also stated that it avails
itself of the wider margins under Executive Board Decision No. 3463-(71/126),
adopted December 18, 1971, and that it will use the United States-dollar as
its intervention currency.
The new par value now proposed represents a decrease in the gold value
of the Pakistan rupee of 60.13 per cent and corresponds to 11.9428 Pakistan
rupees per special drawing right or, 0.0837321 special drawing right per
Pakistan rupee. At the new par values, the United States dollar is equal
to 11 Pakistan rupees per U.S. dollar.
The proposed change is to be supported by a financial program submitted
to the Fund in2/onnection with a stand-by arrangement which is the subject
of EBS/72/150.-   Details of recent economic developments are described in
that paper.
II. Background to the Proposed Change
For many years Pakistan has operated a complex exchange and trade system
involving multiple e change rates and substantial reliance on exchange and
trade restrictions.3" The system utilized an Zxport Bonus Scheme introduced
in 1959 as a stimulus to exporters. Exporters of specified commodities were
issued "bonus vouchers" up to specified percentages of their export proceeds.
1/ The initial par value of the Pakistan rupee agreed with the Fund on
March 19, 1951, was 0.268601 gram of fine gold per rupee. This was changed
to the present par value on July 30, 1955.
2/ A Fund mission consisting of M4essrs. John W. Gunter, A. S. Gerakis,
J. Rose, S. Cnossen and H. Baas discussed the exchange reform and financial
program with the Pakistan authorities in Islamabad, February 17-24, 1972.
3/ The system is described in detail in SM/70/198 and SM/70/210. Changes
in the system since January 1, 1971 are set out in Appendix II.



- 2 -
These vouchers could be sold to importers as a form of entitlement to the
import of a range of specified goods or could be used. by the exporters
themselves for imports additional to licensed entitlements. While all
purchase and sale transactions of exchange itself were based on the exist-
ing par value rate (PRs 4.7619 per US$1), effective exchange rates wrere
determined by: whether or not transactions were subject to the receipt
or surrender of bonus vouchers: the percentage of the value of an export
transaction for which vouchers were given or of an import transaction for
which they were required; and the current market rate for vouchers. Over
time the scheme was subject to continual modifications reflecting the
state of the balance of payments and the use of multiple currency practices
in an effort to promote various economic and social objectives. Such
modifications were achieved by: changes in the lists of export and import
items and, later, invisible payments and receipts covered by the scheme;
in the rates of bonus epplied to transactions covered by the scheme; and
in the period of validity of bonus vouchers and the timing of their
surrender.
While the scheme doubtless contributed to the good experience Pakistan
enjoyed for some years in the expansion of manufactured exports, it failed
to produce an exchange rate system serving an appropriate pricing function.
Despite the fact that the par value became increasingly unrealistic over
time, a large volume of transactions, including public sector payments
and receipts and imports under aid and bilateral trade, continued to be
effected at that rate (although some such imports were subject to "equali-
zation" taxes). On the other hand, the other rates for transactions covered
by the scheme were progressively depreciated so that the spread between
effective rates widened. Demand for imports remained excessive and the
control systemi was under continuous pressure in trying to rationalize the
distribution of available exchange resources for imports; in addition, there
was a stringent control over invisible payments. Complemented by the effects
of other policies, exchange policy resulted in serious distortions in
resource allocation.
The existing exchange rate structure is set out in Table 1. The
structure of the import licensing system is given in Appendix I and detailed
changes in the exchange and trade system since January 1971 in Appendix II.



- 3 -
Table 1.  Exchange Rate Structure-/
(Pakistan rupees per U.S. dollar)
Buying                                Selling
Official   4.76  Public sector        Official   4.78 Public sector pay-
invisibles and                        ments, imports under
private sector                        aid/barter and
invisibles not                        invisibles not
receiving bonus                       subject to bonus
10% bonus  5.66  Primary goods; some
private sector
invisibles
35% bonus  7.92  Jute and cotton
manufactures
45% bonus  8.83 All other manu-       45% bonus  8.86  Certain invisibles
factures and trans-
actions              50% bonus  9.32 More essential non-
aid imports and
certain invisibles
(so-called 'cash-
cum bonus" rate)
100% bonus 13.86 INonessential imports,
all imports in excess
of licensed allocation
and all other permitted
transactions
1/ Calculated on basis of market rate for bonus vouchers of PRs 190 per
PRs 100 vouchers; actual market rates have been close to this rate in recent
weeks.
During 1971, external policies reflected an extreme tightness in the
foreign exchange position. Foreign exchange reserves fell from $343 million
in March 1970 to $174 million in iarch 1971 (equivalent to about five weeks9
payments on current and capital account).   In April 1971, the Government
unilaterally declared a moratorium on a large part of its debt service
obligations. Moreover, the half-yearly import program (January.-June), which
itself had been more restrictive in terms of new import prohibitions, under-
went a severely restrictive revision at that time.   More items were prohibited



- 4 -
and imports were made more costly by movements of items to import lists
subject to more depreciated exchange rates. The import program for July-
December 1971 remained essentially unchanged, but as nonproject aid
availabilities dwindled because the aid pipeline was not being replenished,
many raw materials which had been available to industry from aid at the
official rate (PRs 4.78 per US$1) could only be procured with free exchange
at the most depreciated selling rate (PRs 13.86 per US$1). Announcement
of the import program for January-June 1972 was delayed until mid-February
and while structurally it remained virtually unchanged as compared to the
previous program, there was a continuing severe constraint on exchange
resources for its financing.
During 1971, exports from (West) Pakistan showed a strong growth,
manufactured exports being assured of necessary imported inputs on a
privileged basis. There was also a continuing extension of the most
depreciated buying rate (45 per cent bonus) to a widening range of invisible
receipts. Exchange reserves, which, after the belt-tightening of April
1971 as well as the impact of some temporary factors, had risen from $174
million at end-March to $221 million at end°August and were at $217 million
at end-November, came under heavy pressure thereafter and fell to $190
million at end-January 1972, despite the allocation of SDR 25 million in
that month.
In September 1971 the exchange rate for the Palcistan rupee, previously
pegged to sterling, was pegged to the U.S. dollar. In late December 1971,
in response to the Managing Director's enquiry, the State Bank of Pakistan
informed the Fund that Pakistan would maintain unchanged its official rate
for rupees in terms of dollars.
III.  The Proposed Exchange Reform
As a key element in a reformulation of economic policy, the Pakistan
authorities have decided to unify the exchange rate system at a fixed rate
of US$1 = PRs 11. They believe that it is essential to adopt a fixed rather
than transitionally floating rate in order to ensure public confidence in
the change. They feel confident that the proposed new par value is realistic
and will support their intention to eliminate progressively nontariff trade
restrictions and payments restrictions. The reform and the supporting
stabilization program should, in their view, enable Pakistan to eliminate
any further decline in net external reserves by not later than June 1974
(see letter of intent for reouested stand-by arrangement).
As regards the import regime, it is proposed to establish a single
licensable list including a large number of commodities for which all
existing restrictions will be eliminated and licenses issued freely.
This list will conk-ain the bulk of raw materials, spare parts
and componenits needed for industry. All imports not on the list will be
prohibited. Given the balance of payments situation, the liberalization
policy cannot be pressed further immediately, but extensions in its coverage
will be feasible in due course, when foreign exchange receipts respond to



- 5 -
the devaluation. Mloreover, the existing structure of industry has developed
behind highly protective barriers and a rapid move to comprehensive liberali-
zation might be quite disruptive. Therefore, the policy will be to reduce
progressively nontariff restrictions on imports as the pattern of domestic
industry is rationalized and its competitive ability is improved. Further-
more, the authorities are undertaking a comprehensive review of the tariff
schedule. While a primary objective of this review will be to raise
revenues,I' it is also intended to increase the use of the tariff as an
instrument of protection.
Some exceptions to the complete freedom of imports of items on the
licensable list will be made due to difficulties in the absorption of tied
aid and bilateral payments balances. Hitherto, this has been ensured
through the exchange system by giving tied aid and bilateral imports the
preferential official (par value) rate. To replace this loss of incentive
for the use of nonconvertible exchange resources by importers, it may be
necessary to use fiscal measures and/or quantitative restrictions. It is
expected, however, that such measures will be applied on a limited scale;
imports affected will probably be considerably less than one fifth of total
imports. Concurrent with import liberalization, there is to be a movement
toward liberalization of payments for current invisible transactions.
On the side of receipts, the Government will apply the following
duties on exports as temporary measures designed to siphon away windfall
profits which would otherwise accrue to exporters, and to raise revenue
for the budget:
Approximate export duty-/
Commodities                      (In Pakistan rupees per US$1)
1. Raw cotton, cotton waste, hides
and skins                                          4.50
2. Wool                                                  3.50
3.  Quality (Basmati) rice                               3.00
4. Cotton yarn, tanned and semi-
tanned leather                                     2.00
5. Fish, other primary commodities,
grey cloth                                         1.50
As indicated below, despite these duties, incentives for export production
will be improved significantly during the initial period after the devalu-
ation, and it is intended to encourage exports further with a gradual
reduction of taxation.
1/ Tariff rates will be reduced on average less than in proportion to
the devaluation, so that the landed cost of imports will rise somewhat more
than the increase in effective exchange rates.
2/ Some of the duties will be specific so that the indicated effective
taxes are approximate.



- 6 -
IV. Balance of Payments and Related Effects of the Reform
In appraising the extent of the devaluation proposed by the Pakistan
authorities, the exchange rate to be established by the reform (after
allowing for export duties) should be measured against the rates in effect
before the reform. There are a number of conceptual problems in making
such comparisons and, moreover, not all of the data needed in order to
compute averages for broad categories of transactions are available.
Therefore, the figures given in Table 2 should be treated with some caution
and regarded as indicating orders of magnitude, rather than precise measure-
ments. This table shows that the average rate for exports, due allowance
being made for the export duties, will rise by about 20 per cent; the rates
for individual export commodities will be between 15 per cent and 25 per
cent higher in rupee terms than those presently in force. For invisible
receipts, including emigrant remittances, the average rate will go up by
about 55 per cent and for total receipts (exports, invisibles and foreign
aid) by almost 45 per cent. On the side of imports, the new par value will
be somewhat lower than the bonus rate currently applicable to about one fifth
of total import payments; on the other hand, it will be considerably above
the cash-cum-bonus rate and almost two and one-half times asl,high as the
official rate, which now applies to 55 per cent of imports.-    On the
average, the effective rate for imports will increase by about 40 per cent.
The average rates for invisible payments, including debt service, and for
total payments, will rise by 117 per cent and 66 per cent, respectively.
Thus, it is apparent that the exchange reform would involve a major
depreciation of effective exchange rates. It should be noted that the
depreciation of the rate structure shown in Table 2 would be additional
to the devaluation which has been achieved since August 1971 vis-a-vis
Pakistan's trading partners as a group by pegging the Pakistan rupee to
the U.S. dollar.
Owing to Pakistan's prolonged reliance on restrictions and other com-
plexities, it is difficult to predict the balance of payments effects of
the reform. However, it is reasonable to expect that there will be a
substantial increase in exchange receipts. Production of many export goods
should prove sensitive to price incentives (for example, the record cotton
crop in 1971 is attributed, at least in part, to bonus on exports announced
in July 1970). 'The price elasticity of demand for the exports of Pakistan
is high; since these exports represent small fractions of the respective
world totals, they can be increased significantly with little or no decline
in their international prices. Moreover, the devaluation should facilitate
efforts to export to foreign countries commodities previously sold in the
sheltered market of the Eastern Province. With regard to invisible receipts,
a staff study suggests that the largest, most immediate impact on exchange
income would be in this category, particularly emigrant and other remittances;
to some extent this would reflect. a reversal of capital outflows caused by
expectations of a devaluation.
1/  No allowance has been made for 1;equalization" taxes imposed on some
aiT&-financed imports at the official rate to adjust their landed costs more
nearly to similar imports financed at the cash-cum-bonus rate. the overall
picture presented in Table 2 is only marginally affected by this omission.



Table 2. Effective Costs of Foreign Exchange (Adjusted for Export Duties) Before and After Reform
(Amounts in millions of U.S. dollars; rates in Pakistan rnpees ner U.S. dollar)
Effective Return                                                      Effective Rates
After     Before                                                      After      Before
Receipts                                Amount    Reform    Reform       Payments                             Amount     Reform    Reform
Exports                                  536       9.30      T.7T-       Imports                               T04      11.00       7.834/!
Raw cotton; cotton waste; h_des                                          At officiel r.ate before reform      384      11.00      4.78
and skins                            101       6.50      5.66          At cash-oun-bonus rate before         -
Wool                                      i      7.50      5.66            reform                             166      11.00      9.32
Quality rice (Basmati)                  38,      8.00-     5.66          At bonus rate before reform          153      11.00     13.86
Cotton yarn: semitsnned, tanned
leather                              101       9.00      7.92        Invisibles and debt service
Fish; other primary exports;                                              (interest and princi9al)            52       11'.O
grey cloth                            86       9.50      5.66;         Public sector., including defense
7.92 
Other manufactured extorts             206      11.00      T.92;           i93ports                           332      11.00      4.78;
o.83 -        Private sector                       193      11.00      4.78;
Invisibles2/                             347      11.00      L.9>/                                                                  9.32
Bublic sector 236.                              11.00       4.76            Grand total                     1.2        11.00      6.64
2/
Private sector-                        111'     11.00      4.76;
5.66;
7.92
Capital (aid) receipts                   221      11.00      T4.76
Grand total                         903      10.00      6.90
Sources: State Bank of Pakistan, Ministry of Commerce and Central Statistical Office.
1M  Calculated from data provided by the State Bank of Pakistan shoving export receipts end volume of bonus vouchers issued to exporters
in July-December 1971. The data are totals for the Western and the Eastern provinces taken together.    The average rate for Paki,stan
separately has been computed after deducting from the respiective totals receints and vouchers issued for exports of raw jute and jute
manufactures (almost all of which relate to exports from the Eastern province).
/ Including private transfer receipts.
3/ Based on State Bank totals for both provinces taKen together for July-Iecember 1971; it was assumed tnat private sector invisible
receipts at the official rate were negligible.
4/ Computed from data of the Central Statistical Office shoving total imports on the basis of customs returns for July-December 1971 and
from data of the Ministry of Commerce (see Appendix I) showing private sector imoorts licensed by the Chief Comptroller of Imports and Exports.
It has been assumed that public sector cash-cum-bonus imnorts in these six months snmoi,jted to PRs 50 million.
Notes: The anounts of receipts and payments shown in this table are based on the foreign exchange budget for 1971/72. In computing
average effective rates for the pre-reform system the price of the bonus voucher vas taken as equal to 190 per cent of its face value. -Due
to rounding, components may not add uD to the respective totals exactly in the table.



- 8 -
The effects on payments are somewhat more uncertain. The liberalization
measures accompanying the reform will have an expansionary influence, while
the substantial increase in the effective rates for im.ports and other pay-
ments and the contemplated adjustments in tariffs will curtail effective
demand for foreign exchange. Many imported items may be expected to rise
in price domestically, and it seems unlikely that foreign exchange expendi-
tures will change greatly from the pre-reform level.
Pakistan is in the process of working out with its creditors revised
arrangements on external debt involving relief for a substantial part
of its debt service obligations falling due in the 26 months ending
in June 19T3; it is expected that there will also be discussions with
the IBRD and members of the Pakistan Consortium regarding the pledging of
new aid for the development program.
The impact of the reform on exchange receipts and import demand coupled
with what appear to be reasonable expectations of the results of these
negotiations with the Consortium (and non-Consortium members), suggest that
the payments deficit would be considerably reduced in 1972/73 and that the
target of eliminating the further deterioration of the reserve position by
June 1974 is realistic. It must be borne in mind that the scope of banned
imports is to be initially substantial. A broadening of the coverage of
the liberalization to include additional commodities would no doubt lead
to an increase in the size of the import bill; thus such broadening is to
be approached gradually as the balance of payments position improves.
Another important effect of the reform would be to help improve the
allocation of resources. One of the principal benefits will result from
the elimination of the artificially low effective rate for capital goods
imports. This rate had provided an incentive for excessive expansion of
industrial capacity in some areas. It had also been a factor inhibiting
the growth of the domestic capital goods industry and in particulr the
engineering industry; as emphasized in a study by the IBRD staffl' these
industries were caught in a cost-price squeeze, since they were forced to
compete with imports at the official rate while having to use raw materials
and spare parts imported mainly at the more depreciated cash-cum-bonus rate.
With the adoption of more realistic rates for exports, investment in export
industries will be stimulated. Lastly the liberalization policy will make
possible a more rational distribution of imports among users.
1/ International Bank for Reconstruction and Development, Industrialization
of Pakistan: The Record, the Problers and the Prospects, March 10, 1970,
Volume 1, page 23.



- 9 -
V. Staff Appraisal
Pakistan has been experiencing severe balance of payments problems
for a number of years. Domestic financial and economic policies have
contributed heavily to this, but a more direct cause has been the inadequate
exchange rate system. Past efforts to revise and simplify the system have
proved ineffective, although they did lead to some degree of depreciation.
While the system made possible a marked increase in industrial exports, it
also encouraged the growth of demand for imports. This demand could not be
met by the rising volume of export receipts and the sizable inflow of capital
and, as a result, the authorities were obliged to rely heavily on quanti-
tative restrictions with distorting effects on production and investment.
The reform now proposed involves a steep devaluation and unification
of the exchange system and some liberalization of imports. It may be
expected to strengthen Pakistan's competitive position, lead to a consider-
able increase in exchange receipts and slow down the growth in the demand
for imports. Therefore, coupled with the arrangements for rescheduling
part of the country's debt service obligations and for a resueption
of foreign commodity aid, the reform should make possible within a reasonable
period of time the elimination of the existing deficit in the external
sector; moreover, it should contribute to a-more rational use of the
country's scarce resources. With the improvement of the balance of payments,
the authorities will be able to extend the scope of import liberalization
and this will have further beneficial effects on the competitive ability
of the economy and on resource allocation.
The conclusion of the staff is that the proposed par value appears to
be realistic, falling within the range appropriate for the correction of
the fundamental disequilibrium in Pakistan's balance of payments. It should
be emphasized, however, that it will be essential for the reform to be
supported by a resolute implementation of domestic financial policies
designed to prevent the emergence of inflationary pressures. Such policies
are outlined in the letter of intent requesting a stand-by arrangement
with the Fund.



- 10 -
VI. Recommended Decisions
The following decisions are accordingly recommended for the consideration
of the Executive Directors:
I.   1.  The Government of Pakistan has proposed a change in the
par value of the Pakistan rupee to become eff'ective
May 11, 1972. .The proposed par value is:
0.0744103 gram of fine gold per Pakistan rupee
418.000 Pakistan rupees per troy ounce of fine gold.
2. The Fund concurs in this proposal.
3. This par value corresponds to PRs 11.9428 per one special
drawing right.
II. The Fund notes that Pakistan is availing itself of wider
margins under paragraph 1 of Executive Board Decision No.
3463-(71/126), adopted December 18, 1971.



- 11 -                      APPENDIX I
Pakistan: Structure of the Imnort Licensing System
There are four types of import licensing for the private sector
with items listed on (a) a Free List, (b) a Licensable List, (c) a Cash-
cum-bonus List, and (d) a Bonus List. The following is only a broad
summary of the "List" system, there being a myriad of subsidiary con-
ditions, qualifications and exceptions.
(a) Free List imports are financed from aid and bilateral balances and
are restricted to "entitlement" holders on a first come first served
basis with payment at the official rate (PRs 4.78 per US$1). Regional
and subregional allocations are made to ensure that different parts of
the country get an equitable share of these imports. Items on the list
are those negotiated with aid donors and bilateral partners and, while
the number of items is limited, the list includes important categories
of goods such as specified iron and steel items, chemicals and tools
and workshop equipment.
(b) Licensable List imports are also now financed only from aid and
bilateral balances and are specifically licensed to authorized
industrialists and commercial importers with payment at the official
rate (PRs 4.78 per US$1). The Chief Controller of Imports and Exports
draws up a detailed budget fixing ceilings for each item. Items on
the list are those consumer goods and raw materials which are con-
sidered essential and prices of which are to be kept low, including
medicines, books and specified agricultural equipment.
(c) Cash-cum-bonus List imports are financed from Pakistan's own
foreign exchange resources subject to surrender of bonus vouchers
equivalent to 50 per cent of the exchange cost of the import, resulting
currently in an effective rate of about PRs 9.32 per US$1. The basis
of licensing is determined by the Chief Controller.   Items on the list
are a mixture of raw materials and more essential consumer goods.
Additionally, there is a Raw Material Replenishment Scheme whereby all
exporters--industry and trade--extorting certain goods may obtain
licences for the import of specific items required for the production
of the respective exports, payments for such items being on a cash-cum-
bonus basis.
(d) Bonus List imports are financed from Pakistan's own foreign
exchange resources subject to surrender of bonus vouchers equivalent to
100 per cent of the exchange cost of the import, resulting currently in
an effective rate of about PRs 13.86 per USl1.   There are no quantita-
tive restrictions on bonus imports. Items on the list are mostly less
essential consumer goods with some raw material and machinery items,
but items on any of the other lists may be imported on bonus terms.



- 12 -
Details of licensing of private sector imports by category of
licensing 1968/69 through to the first half of 1971/72 are given in
Appendix Table 1. The Table chiefly illustrates the sharp decline in
the rupee value of licensed imports in 1971, particularly in the second
half, attributable to the termination of Licensable List imports from
Pakistan's own resources in April 1971 (such imports having henceforth
to be financed on a cash-cum-bonus basis) and the decline in aid availa-
bility in the second half of the year. Chiefly as a result of these
factors and the movement of cash-cum-bonus list items to the basis of
bonus financing also in April 1971, there was a substantial rise in
bonus list imports. Effectively, both the volume of imports declined
sharply and their average cost in rupee terms was increased sharply.



Table 1. Pakistan:   Private Sectot Imports by Category of Licensing-/
(In millions of rupees)
-        Per             Per             Per             Per              Per             Per            Per
Cent            Cent            Cent             Cent            Cent            Cent           Cent
July-   Share   Jan.-   Share    July-   Share   Jan.-   Share   July-   Share   Jan.-- Share    July-   Share
Dec.     in     June     in     Dec.      in     Jure     in     Dec.     in     June     in     Dec      in
1968    Total   1969    Total    1969    Total   1970    Total   1970    Total   1971    Total   1971- Total
I. Pakistan's own resources
1. Free List (Barter)      91.1      8.9    57.2     5.8    83.4     6.9    42.5     3.9    88.9     ,6.9    86.3     8.7    77.9   .9.8
2. Licensable List        223.5    21.8    25T.5    26.2   304.2    25.4   259.5    23.8   217.9     16.9    98.4     9*§      -
3. Cash-cum-bonus List    135.6    13.2    242.4    214.7  300.6    25.1   385.0    35.3   324.2     25.1   182.9    18.4   285.2   35.8
4. Edibie oils under
P.L. 480 on cash-
cum-bonus ters                  - /                                                     36.9     2.9    38.1     3.8    17.8   .2.2
5. Bonus List             285.7    27.9    235.8    24.0   251.0    20.9   269.3    24.7    259.8    20.2   358.8    36.2   325.8   )o.8
Total                735.9      18    792.9    80.7   939.2       3   956.3     87.7   927.7    72.0   764.5  7        706     88.6
II. Aid
Free and L#icensable Lists
(and edible oils on
cash-cum-bopus)3/       288.9     28.2   189.0    19.3   260.1    21.7   134.4     12.3   359.7    28.0   228.8    9   0      .7  11.4
Grand total        1024.8981.9                      1,199.3         1,090.7          1,287.4           993.3           797.14
Source:  Chief Comptroller of Imports and Exports, Government of Pakistan.
1/ In addition to imports covered by the licensing system, the private sector also receives imports through the operations of financial
agencies such as the Pakistan Industrial Credit and Investment Corporation and the Industrial Development Bank of Pakistan. In 1969/70
total imports of PRs 5,100 million were made up of Dublic sector imoorts of PRs a8O million (17 per-cent) and private sector imports of
PRs 4,210 million of which PRs 2,290 million (45 per cent of total imports) was under licensing and PRs 1,920 million (38 per cent of total
imports) was through the agencies outside the licensing system.
2/ Provisional accounting which somewhat understates actual imports.
3/ In the first half year of 1970/71 import of edible oils under P.L. 480 was made subject to surrender of 50 per cent bonus vouchers.
In this table therefore the bonus element is costed in Section I and the cash element in Section II (Aid).



- 14 -                      APPPWDIX II
Pakistan:  Changes in Exchange and Trade System since January     1971
1971
March 5. The facility for writers and journalists to use foreign
exchange earnings for the import of articles for their personal use was
withdrawn but the 45 per cent bonus given to such earnings repatriated
to Pakistan was extended to artists' earnings.
March 11. Special exchange facilities were extended to pilgrims to
Iran and Iraq for Ziarat.
April 15. Delegated authorities to authorized dealers covering
remittances for specified subscriptions, membership fees, purchases of
academic and technical literature, and reimbursement of specified charges
overseas on export cargoes were withdrawn.
April 24. The import program for the half-year was revised: 46 items
on the bonus import list were prohibited and 28 items on the licensable
list financed from Pakistan's own exchange resources (including gasoline
and petroleum products) were moved to the cash-cum-bonus list. While
import duties were reduced or abolished for some affected items, a regulatory
import duty of 25 per cent was applied with specified exceptions to imports
on the free and licensable lists financed from aid and under bilateral
arrangements. With the exception of edible oils, licensing for exports
under the Raw Material Replenishment Scheme and of 36 items retained for
East Pakistan only, the existing cash-cum-bonus import list was suspended,
items on the list having henceforth to be financed at the full bonus rate.
Restrictions on inter-wing trade and regulations permitting the surrender
of bonus vouchers at the time of receipt of shipping documents rather than
at the time of application for import licenses were liberalized.
April 24. The rate of bonus on exports of jute woolpacks was raised
from 35 per cent to 45 per cent.
April 28. Forty five per cent bonus was extended to receipts by
Pakistani architects and consultants for services provided abroad.
May 6. Forty five per cent bonus was extended to foreign exchange
earnings of Pakistani shipping companies from conference pools.
June 3. The rate of bonus on exports of flourspar/flourite was
raised from 35 per cent to 45 per cent.
June 27. The import program, announced for the second half-year,
involved only minor changes..
July 10. The bonus on raw jute exports was raised from 10 per cent
to 15 per cent.



- 15 -
July 19. Remittances-by foreign-owned enterprises for Head Office
expenses abroad, previously effected at the official rate, were to be
effected at the cash-cum-bonus rate.
July 22. Forty five per cent bonus was extended to foreign exchange
commissions on imports earned after July 8 by registered indenting agents.
July 30.   The amount of Pakistan currency notes which persons other
than those travelling on category "A" visas could take into Pakistan was
reduced from PRs 80 to PRs 20.
September 17. The Pakistan rupee, previously pegged to sterling,
was pegged to the U.S. dollar with the State Bank selling spot U.S.
dollars at PRs 4.7775 per U.S. dollar and buying spot dollars at
PRs 4.7619: the Bank, however, would continue to deal in sterling with
authorized dealers at rates based on New York quotations.
October 18. Forty five per cent bonus was extended to certain cash
donations received in foreign exchange for relief and rehabilitation in
East Pakistan.
October 18. The annual exchange allocations for Haj travel were
announced. For travel by air and first class by sea, bonus vouchers had
to be surrendered. For second class travel by sea, exchange could be
obtained at the cash-cum-bonus rate, while for third class travel by sea,
exchange could be purchased at the official rate.
November 24. Prohibitions were introduced on the export of specified
metal manufactures and animal and food products other than to Afghanistan.
November 24. The period of validity of bonus vouchers was extended
from 21 days to 42 days.
November 27. Forty five per cent bonus was extended to inward
remittances of foreign exchange for services provided abroad by Pakistani
engineers and consultants.
November 30. Payment of foreign port charges and specified freight
charges were made subject to surrender of bonus vouchers equivalent to
50 per cent of the remittance.
December 5. The period of validity of bonus vouchers was extended
from 42 days to 90 days.
December 6. The Central Government undertook to buy during the
succeeding two months export bonus vouchers for spot delivery at a
premium of 175 per cent.
December 6. Existing regulations blocking the accounts of Indian
nationals were extended to the accounts of the Indian High Commission.



- 16 -
December 9. The State Bank, while honoring outstanding forward
sterling contracts, otherwise restricted its exchange dealings to
U.S. dollars.
December 11. Forty five per cent bonus was extended to inward
remittances for the National Defence Fund.
December 18. All permits and approvals for remittances issued by
the Offices of the State Bank in East Pakistan were declared invalid.
December 20. The official exchange rates for buying and selling
U.S. dollars were maintained and there were no changes in exchange
regulations and practices.
December 29. Forty five per cent bonus was extended to foreign
exchange received as management fees for services rendered abroad by
Pakistanis.
December 30. Bonus vouchers issued in East Pakistan without
authentication by a State Bank office in West Pakistan were deemed
invalid.
1972
January 3. All citizens of Pakistan except students and workers
abroad were required to declare and surrender all assets held abroad
unless they were held with the permission of the State Bank.
January 13. Repatriation of foreign exchange and the proceeds of
movable properties in accordance with the requirements of January 3 was
to be effected by January 25 and February 15, respectively. Forty five
per cent bonus was extended to repatriated foreign exchange and the rupee
proceeds were exempted from all taxes.
January 18. Restrictions on the bank accounts of the Indian High
Commission and their personnel were lifted.
February 8. The terminal dates for the declaration of foreign assets,
repatriation of foreign exchange and proceeds of movable properties were
amended to February 15, February 29 and March 15, respectively.
February 12. The import policy of July-December 1971 was to be
continued largely unchanged for January-June 1972. An amount of PRs 20
million was to be made available on a cash-cum-bonus basis for investment
in export industries and access to balancing, modernization and replacement
machinery for export industries under the Raw Material Replenishment Scheme
was liberalized.



- 17 -                      APPENDIX III
Minister for Finance
Economic Affairs & Development
Government of Pakistan
Islamabad, the _Iay      1972.
Dear Mr. Schweitzer,
While Pakistan has for many years maintained multiple currency
practices, you are aware that we have had an objective of unification
of the exchange rate system at a realistic level. The Government has
now undertaken a review of the existing system and its implications for
the new economic programmes it is intended to formulate and implement.
This review indicates that the time is now propitious for the move to a
unitary exchange rate and a concurrent movement toward liberalization of
import trade restrictions.
The Government therefore now proposes to establish with the concur-
rence of the IMF a par value of 0.0744103 gram of fine gold per Pakistan
rupee. The Government intends to avail itself of wider margins on the
basis of this rate, in accordance with Executive Board Decision No. 3463,
December 18, 1971, with the U.S. dollar as the intervention currency.
The proposed change in par value is necessary to correct a fundamental
disequilibrium in the balance of payments of Pakistan.
As regards import liberalization, it will not be possible for this
to be comprehensive at the initial stage but it is intended to undertake
a full review of the effects of existing tariff and non-tariff restrictions
with, inter alia, an objective of progressively reducing reliance on the
latter over time. On the export side, the exchange rate change would
require imposition of some export duties in order to avoid excessive bene-
fits to certain exporters. We have had the opportunity to inform the Fund
staff of our intentions in these respects and of the financial programme
to be undertaken in support of this reform.
It is proposed to bring the new par value into effect at 8.00 A.M.
local time May.12, 1972.
Yours sincerely,
/s/
(Dr. Mubashir Hasan)
Mr. Pierre-Paul Schweitzer,
Managing Director,
International Monetary Fund,
WASHINGTON D.C.



ANNE V
CONFIDENTIAL
INTERNATIONAL MONETARY FUND
Pakistan - Request for a Stand-By Arrangement
Prepared by the Middle Eastern Department and
the Exchange and Trade Relations Department&/
(In consultation with the Fiscal Affairs, Legal
and Treasurer's Departments)
Approved by John W. Gunter and Donald K. Palmer
May 9, 1972
I. Introduction
In a letter dated May 4,  1972, the Minister of Finance has requested
on behalf of the Government of Pakistan a stand-by arrangement for one year
in an amount equivalent to SDR 100 million. Since this amount exceeds 25
per cent of Pakistan's quota, a waiver is required under Article V, Section
4 of the Fund Agreement. Copies of the letter and the proposed stand-by
arrangement are annexed. This stand-by arrangement would support an exchange
reform, which is the subject of EBS/72/149, and the domestic financial
policies described below. Purchases under the requested stand-by arrangement
would not, without the consent of the Fund, exceed the equivalent of: SDR 50
million prior to August 1, 1972; SDR 67 million prior to November 1, 1972;
and SDR 84 million prior to February 1, 1973.
Pakistan's present quota is equal to SDR 235 million.   As of the end of
March 1972, Pakistan had purchased from the Fund a gross amount equivalent
to SDR 150.5 million, and repurchased the equivalent of SDR 76.4 million; as
a result of these and certain other transactions,a/ the Fund's holdings of
Pakistan rupees were equal to 118 per cent of quota. Pakistan is obligated
to make repurchases totaling the equivalent of SDR 78.5 million, mainly under
a schedule agreed by the Executive Directors (Decision No. 3453-(71/118),
adopted November 22, 1971) in reltion to a stand-by arrangement of SDR 75
million approved in October 1968.-   Assuming that these repurchases are
1/ A staff team consisting of Messrs. John W. Gunter, A. S. Gerakis,
J. Rose, S. Cnossen and H. Baas visited Islamabad during February 17-24
and discussed with the Pakistan authorities the exchange reform described
in EBS/72/149 and the financial program explained in the present paper.
2/ Pakistan's currency subscription on its initial quota was equal to 96.5
per cent of quota. The gold subscription in connection with its quota increase
in November 1970 was reduced by SDR 4.4 million in accordance with paragraph
5 of Resolution No. 25-3 of the Board of Governors. Moreover, Pakistan has
paid in Pakistan rupees some charges on balances in excess of quota.
3/ Specifically, Pakistan is to make four repurchases each equivalent to
approximately SDR 0.9 million in November 1972, 1973, 1974 and 1975: these
repurchases are related to the mitigation of the gold subscription on the
quota increase in 1970. Of the eight repurchases relating to the stand-by
arrangement of 1968, the first equivalent to SDR 5 million is to be made in
September 1972; the remaining seven, each equivalent to SDR 10 million, are
to be effected in: December 1972; March, June, September and December 1973;
and March and July 1974.



carried out as scheduled and that the proposed stand-by arrangement equivalent
to SDR 100 million is utilized fully, Fund holdings of Pakistan rupees will
amount to 139 per cent of quota on June 30, 1972 (see Table 1) and to slightly
under 150 per cent of quota when the stand-by arrangement expires.
Table 1. Changes in Fund Holdings of Pakistan Rupees During
the Life of the Proposed Stand-By Arrangement
(In millions of special drawlng rights)
Fund's Holdings
Per cent
Purchases     Repurchases     Amount      of Quota
1972
March 31                                                  277.6      118.1
May,                        50.0                          327.6      139.4
August 1                    17.0                          344.6      146.6
September 22                                5.0           339.6      144.5
November 1                  17.0                          356.6      151.7
November 27                                 0.9           355 7      151.4
December 22                                1.0          345.7       147.1
1973
February 1                  16.0                          361.7      153.9
March 22                                   10.0           351.7      149.7
Pakistan is a participant in the Special Drawing Account and has been
allocated a total of SDR 81.6 million. Of this amount, Pakistan has used
SDR 43.9 million, of which SDR 25.9 million for repurchases and in payment
of charges with the General Account and SDR 18.0 million to obtain currency
from other participants designated by the Fund. As of the end of March 1972,
Pakistan's holdings of special drawing rights amounted to SDR 37.7 million
representing 46.2 per cent of its net cumulative allocation.



II. Recent Economic Developments and Policies
Over the long run, Pakistan-/ has achieved substantial economic progress
featured by high rates of growth of G0IP and exports.  In thle last two years,
however, political developments and other factors have combined to interrupt
this favorable situation. Economic activity has slowed down. The budget has
incurred sizable deficits and credit expansion has exceeded appropriate
limits. Considerable increases in prices and a rise in the unemployment
rate have led to extensive labor unrest. Moreover, the external position
has been under severe pressure and reserves have declined appreciably, despite
the moratorium declared by Pakistan on part of its debt service obligations.
1.   ?ational income and production
During the decade of the 1960s Pakistan's rate of growth in real terms
was about 6.3 per cent per annum, or approximately 3.6 per cent on a per
capita basis (Table 2). Political developments in 1970/71, together with
unfavorable weather conditions for agriculture led to a small decline in
GDP; the slowdown in economic activity w7as particularly pronounced in the
last four months of the year. According to present forecasts, GDP will
increase by somewhat less than 3 per cent in the current financial year
1971/72; it is expected that the value of agricultural production in constant
prices will rise by 4-5 per cent, that industrial product on will increase
3-4 per cent and that services will decrease mar4nally.
1/ Unless otherwise stated, all the data in this paper for Pakistan
relate to the western territories. For purposes of clarification, it has
sometimes been necessary to refer to Patistan as the Western Province and
distinguish it from the territory hereinEfter referred to as the Eastern
Province.
2/ The percentage increases in GDP in the decade ended in 1969/70 and in
the year 1970/71 have been calculated on the basis of the data in Table 2.
These data do not allocate between the Western and Eastern Provinces
the totals for three economic sectors (see footnotes to this table). An
appropriate allowance for such an allocation might lead to the conclusion
that GDP increased slightly in 1970/71. These three items were allocated
in the above-mentioned forecast for 1971/72.



Table 2. Gross Domestic Product at Factor Cost
(In millions of Pakisten rupees at
constant 1959-60 prices)
1959/60  1967/68  1968/69  1969/70 1970/71
Agriculture                      7,711    10,982   11,478   12,215   11,770
Major crops                    3,882    6,078     6,408    7,038    6,522
Minor crops                      893    1,406     1,516    1,536    1,517
Livestock                      2,837    3,307     3,373    3,440    3,508
Fishing and forestry              99      191       181      201      223
Mining and quarrying                70       137      141      144      147
Manufacturing                    2,018    4,267     4,634    5,156    5,300
Large-scale                    1,159    3,209     3,548    4,042    4,156
Small-scale                      859    1,058    1,086     1,114    1,144
Construction                       427    1,037     1,317    1,357    1,390
Electricity, gas, etc.              87       224      251      276      300
Transportation, storage and
communications                   921    1,729    1,823     1,875    1,918
Wholesale and retail trade       2,105    3,754     4,020    4,365    4,275
Banking and insurance 
Ownership of' dwellings            837    1,067     1,099    1,127    1,156
Public administration and
defense                          397      760       782      853      994
Services                         1,411    1,954     2,031    2,106    2,191
Total gross domestic
product                  15,984    25,911   27,576   29,474   29,441
Source: Central Statistical Office.
Note: Above estimates do not include the data for the three items not
allocated between provinces in the past, i.e'., Pakistan International Airlines,
part of central public administration and defense, and banking and insurance.
The unallocated amounts are (in millions of Pakistan runees):
1959-60               999
i967-68             2,060
1968-69             2,220
1969-70             2,424
1970-71             2,746



The overall projection for agricultural production in 1971/72 is based
on an estimate that the wheat crop (to be harvested in April-June) will
amount to about 6.8 million tons, higher than in 1970/71, but considerably
short of the record crop of 7.2 million tons in 1969/70 (Table 3); in the
last two years wheat has been adversely affected by a continuing drough,t
which appears to have come to an end recently. Of the other major crops
sugarcane is expected to be down for the second consecutive year. Rice
production is projected at a record level of about 2.4 million tons. The
estimate of the cotton crop harvested in September-October 1971 places
that crop at almost 3.8 million bales, 26 per cent above the previous peak
level; this most encouraging performance was due to a number of factors,
including the additional inceZyive given to the cotton grower through the
exchange system in July 1970.-
Table 3. Selected Agricultural Statistics
Estimates-
1959/G0 1968/69   1969/70  1970/71  1971/72
Wheat
Area (thousand acres)          12,055   15,221   15,393   14,972
Production (thousand tons)      3,847    6,513    7,179    6,401     6,8o0
Yield (maunds per acre)           8.7     11.6     12.7     11.6
Rice
Area (thousand acres)           2,974    3,842    3,877    3,651
Production (thousand tons)        979    2,000    2,346    2,077     2,400
Yield (maunds per acre)          10.7     14.2     16.5     15.5
Sugarcane
Area (thousand acres)             9e0    1,336    1,532    1,420     1,350
Production (thousand tons)     10,494   21,624   25,952    20,874  i,400
Yield (maunds per acre)         291.5    440.7    461.1    400.2
Cotton
Area (thousand acres)           3,313    4,308    4,338    4,285
Production (thousand bales)     1,639    2,961     3,015    2,957    3,800
Yield (maunds per acre)           2.3      3.3      3.3      3.3
Sources: Central Statistical Office and Ministry of Finance.
1/ Estimates prepared by Ministry, of Finance. The cotton and sugar crops
and part of the rice crop have been harvested already. The wheat crop will
be harvested in the period April-June.
1/  When bonus at the rate of 10 per cent was granted to cotton and other
primary commodities.



-6-
The continuing slowdown in industrial production is attributable to
three principal reasons. (1) So far, it has not proved possible to divert
to foreign countries more than a relatively small fraction of the exports
previously shipped to the Eastern Province. (2) There has been a fall in
investment activity reflecting a cttback in the development program as well
as fears that a substantial segment of industry would be nationalized.
(3) The persistent shortages of imported inputs which have plagued domestic
and import substituting (but not export) industries have increased recently
due to the restrictive measures taken in order to cope with the intensified
pressures on the external sector.  The effect of these factors is illustrated
respectively by the current low production levels in the cigarette, cement
and tire industries. Ho%rever, a number of the country's major industries,
including cotton yarn and textiles, vegetable products, sugar and fertilizer
have not been affected; during the first half of 1971/72, output in these
industries was higher than in the comparable period of the previous fiscal
year, in some instances considerably so.L/
The Government which assumed power on December 20, 1971 has undertaken
major reforms affecting the agricultural and industrial sectors. On March 1
President Bhutto announced a far-reaching land reform. The existing ceilings
on individual ownership of 1,000 nonirrigated and 500 irrigated acres are to
be reduced, respectively, t9,300 and 150 acres, or to an area equivalent to
15,000 produce index units,- whichever is greater; an additional area
equivalent to 3,000 produce index units is to be allowed to owners who have
made specified investments on their land, such as installing a tubewell. No
ceiling is to be placed on family owniership and educational institutions are
exempted from the reform. On the other hand, civil servants, excluding
those in the armed forces, will not be permitted to retain an area in excess
of 100 acres acquired by them during their tenure in office or after retire-
ment. All land taken over by the Government will be distributed to farmers
free of charge. No compensation is to be paid to the former landlords, but
every effort will be made to facilitate consolidation of their remaining
holdings. The timetable for the reform is as follows: (1) Declarations
of holdings are to be submitted by April 30. (2) Decisions regarding con-
fiscation of land will be made by June 15. (3) These decisions will be
implemented by July 1.
1/ Thus, output of fertilizer almost doubled owing to the completion of
new plants. Output of sugar was 19 per cent higher, but this increase was
in a sense more apparent than real, since it reflected the earlier harvest
of the sugarcane crop. Despite the loss of the market in the Eastern
Province, production of cotton yarn and textiles was up 13 per cent and 6
per cent, respectively.
2/ The produce index takes into account: (a) the average acreage of each
crop on each class of land; (b) the average yield per acre; and (c) the
average price obtainable. This index has been devised in an attempt to
assure that land left to individual owners following a land reform is of an
approximately equal value.



- 7 -
The President also announced measures to regulate landlord/tenant
relations. These are aimed at: protecting the tenant against arbitrary
eviction; assuring that the water rate, agricultural taxes and the cost of
seed will be borne by the landlord, and that the cost of remaining inputs
is shared equally between the landowner and his tenant; and giving the
tenant the right of pre.-emption in the event of sale of the land he tills.
The new Government has also implemented significant changes in industrial
policy.  In ten "basic industries"1! the managers of all companies were re*-
placed by gcv-;nment appointees. The stated objectives of this measure are
to improve eff-iciency and combat tax evasion. No nationalization or confis-
cation of pro-perty is involved and, therefore, indemnification of shareholders
will not be r-oluired. It appears that this measure is to be applied to a
relatively small part of the industrial sector; some of the major industries,
including textiles, have been specifically exempted. Secondly, the existing
system of "managing agencies" (under which one was permitted to organize a
company, raise most of the capital by selling stock to the public, but retain
for oneself the right to appoint the manager) was eliminated. It has been
emphasized that these two measures do not affect the rights of foreign
investors.
2.   Government finance
Table 4 shows the available budgetary statistics consolidating the
data for revenues and disbursements of the Central Government with those of
the four provinces of Pakistan!2/ for the current fiscal year and, in order
to provide some degree of comparison, for the previous two fiscal years.
On the basis of these data it can be computed that current revenues amount
to between 15 per cent and 17 per cent of gross domestic product.3/   Non-
development (i.e., current) expenditure is usually of a somewhat smaller
order of magnitude, but it has been rising rapidly on account of larger
outlays for defense which are now equal to more than half of all current
expenditure and approximately 9 per cent of gross domestic product. Normally
the Government realizes a surplus on its current operations. The size of
the development program has been decreasing in recent years, not only in
relation to GDP but also in absolute terms (i.e., by almost PRs 700 million
or 23 per cent between 1969/70 and 1971/72).   There is a large 'overall
deficit" (i.e., investment expenditure minus or plus the surplus or deficit
in the current budget) financed by: foreign loans and grants; "net capital
receipts," which include such items as nonbank borrowing and sales of capital
assets by the public sector; and substantial borrowing from the banking
system. In forecasting Treasury reliance on bank financing, particularly
over periods shorter than one fiscal year, it is useful to distinguish between
the deficit of the budget proper and borrowing for the Government's commodity
operations (i.e., operations to support prices of major agricultural crops
and to stockpile agricultural inputs) which have a strong seasonal element;
unfortunately, this breakdown is available for the current fiscal year only.4
1/  i.e., iron and steel, basic metals, heavy engineering, heavy electri-
cal, motor vehicle assembly and manufacture, tractor assembly and manufacture,
heavy and basic chemicals, petrochemnicals, cement and public utilities.
2/  i.e., the Punjab, Sind, the Northwestern Frontier Province and
Baluchistan.
3/ In current prices.
El More specifically, the available data comprise actuals for the first
half and projections for the second half of 1971/72.



- 8 
Table 4.  Summary of Government Budgets-1/
(In millions of Pakistan rapees)
1970/71        1971/72
1969/70     Provisional     Revised
Actuals       Actuals      Estimates
1.  Revenues                             6 892        7,182          6,849
a.  Tax revenue                     552604                       5,333
b.  Nontax revenue                  1,543         1,578          1,516
2. Nondevelopment (i.e., current)
expenditure                       5,900         6,725          7,274
a.  Defense                         2,662         3,200          3,8702,
b.  Interest payments                  991        1,18o            931-
c. Civil administration and
other expenditures            2,248         2,345         2,473
3. Revenue (i.e., current) surplus!
deficit (-) (3=1-2)                 992           457           -426
4.  Development expenditure              2,990        2,810          2,320
5.  Overall deficit (5=4-2) financed
by:                                1,998        2,353          2,746
a.  External aid                    1,129         1,249            863
Project aid                     (355)        (431)          (205)
Indus Basin loans               (233)        (271)          (235)
Commodity aid                  (543)         (5b6)          (423)
b.  Net capital receipts                70          188            797
c. Eorrowing from baniking system
of wrhich:                      799           916         1,086
Budget proper                 (n.a.)        (n.a.)        (1,180)
Commodity operations           (n.a.)       (n.a.)          (-90)
Source: Ministry of Finance.
1/ Consolidated f'gures for the operations of Central and Provincial
Governments in Pakistan.
2/ Excluding PBs 445 million on account of the debt moratorium.



As compared to the provisional actuals for the previous year, the revised
estimates for 1971/72 project a decline in revenues and a sharp increase in
nondevelopment expenditure, mainly due to aeTense outlays; a5 a result there
will be a sizable deficit in the current budget. Despite a steep cutback
in the development progrem and the moratorium on debt service obligations,
the overall deficit is expected to increase considerably. The authorities
anticipate that both foreign aid and net capital receipts will be large,
but that the former will be distinctly lower and the latter appreciably
higher than in the preceding year. Borrowing from the banking system will
be very heavy, estimated at PRs 1,086 million; this figure takes into account
the projection that the Government's commodity operations will have a con-_
tractionary impact of PRs 94 million. These revised estimates may not prove
entirely accurate. In particular, they seem to reflect an overstatement of
provincial revenues and net capital receipts; in addition, it is unlikely
that the full amount of foreign aid assumed will be in fact received. Ifow-
ever, these shortfalls on the revenue side will be probably offset by a
decreape in investment expenditure below the anticipated level.   It would
seem, thXerefore, that the estimate of borrowing from the banding system is
realistic.
In July-December 1971, reflecting heavy expenditures in the Eastern
Province, Treasujry reliance on the banking system for both provinces amounte4
to PRs },800 million, more than in any other comparable period in the past.1
However, according to the authorities, in Pakistan itself the budget proper
recorded a deficit of only PBs 280 million, while commodity operations were
contractionary to the extent of PRs 334 million.  In view of these results
for the first six months and the ebove-mentioned forecasts for fiscal 1971/72
as a whole, the Pakistan authorities expect that in the second half of the
year, there will be a budget deficit of PRs 900 million and that commodity
operations will be expansionary in line wTith seasonal patterns by PRs 240
million.2/ hence, total Treasury borrowing from thie banking system in this
period is estimated at PRs 1,140 million.
Tne Government has devoted considerable attention to strengthening the
country's tax system. In October 1970 it appointed a Taxation Commission
which submitted an interim report in June 1971. This report dealt mainly
with direct taxes, i.e., the income and corporation tax, and taxes on
capital, in particular, the net wealth, estate and gift tax; recommendations
were also made with regard to excise duties and provincial and local taxes.
Many of the Commission's mroposals regarding direct taxes have been imple-
mentea. In respect of the income tax, the personal, investment and conveyance
allowances have been reduced and provisions on perquisites and capital gains
tightened; the tax holiday provision has been suspended for one year and
undistributed profits of companies are nowr subject to a higher rate of tax.
The excise duty on tobacco has also been increased and a duty imposed on
bank checks. The Commission is now engaged in a study of taxation of agri-
cultural income and other possible revenue measares.
1/  This figure is based on the monetary statist ics which until December
1971 were available only for both provinces together and not separately for
each province.
2/ Largely on account of government purchases from the wheat crop which
will be harvested in April-June 1972.



- 10 -
3.   Money, credit, prices and wages
The official monetary statistics, Mhich are compiled by th.e Sotate Bank
of Pakistan, are available only as totals for the Western and Eastern
Provinces taken together; no data have been compiled for Pakistan (i.e., the
Western Province) separately. Unofficial estimates made by the Research
P'partment of the State Bank indicate tentatively that domestic liquidity
and private sector credit in Pakistan accounted for about 75 per cent and
70 per cent of the respective totals for both provinces. So far, however,
it has not been pcssible to break down convincingly the other principal
headings of the monetary accounts.
Nevertheless, on the basis of all the available information, it is
clear that in both 1970/Ti and the first half of 1971/72 the increase in
net domestic credit was excessive.  The main expansionary factor was the
budget deficit. Bank financing of the private sector rose significantly
in 1970/71, but it was distinctly sluggish in July*-December 1971 reflecting
the slowdown in economic activity.  Despite the sharp decline in net foreign
assets in both these periods, monetary expansion was sharply out of line
with the growth requirements of the economy.
There appear to have been considerable increases in prices in the last
18 months or so. The indices shown in Table 5 indicate that wholesale
prices rose by about 11 per cent and the cost of living (for clerical)
wage eari2'3rs) in Karachi by 12 per cent.  It should be noted, however, that
due to various deficiencies in their coverage and weighting system, these
indices are believed to lunderstate actual price movements.
Table 5. Price Indices
Consumer Prices for Clerical
Wholesa'le Prices      Wage Earners in Karachi
-               959/60 = 100 )            (1961 = iso)
1966/67                       124                        123
1967/68                       126                       1.28
1968/69                       130                       131
1969/70                       132                        136
1970/71                       137                      1ih
1971 January                  138                        144
February                 138                       144
March                    138                       144
April                    133                        145
May                      138                        145
June                     13° 148
July                     141                       150
August                   143                        150
September                143                       150
October                  144                       152
November                 145                        151
December                 146                        153
Source:  Central Statistical Office.



- 12. -
The recent inflationary trend together with the rising level of
unemployment have led to considerable labor unrest featured by extensive
strikes and ;'gheraos` (i.e., demonstrating workers lock management in the
premises of an industrial and other plant and do not allow it to leave
until it accedes to their demands); there have also been instances of more
violent protest. Against this background of developments, the President
has announced a new Labor Policy which provides inter alia that: (1) the
share of wages in annual profits will be raised from 2 per cent to 4 per
cear.; (2) workers will receive 10 per cent cf additionel profits zesulting
from increesed troductivity; and (3) tne 2 per cent levy on wages for the
existing heal th insurance plan will be &colished and the contribution of
emv.oyers raised frcm 4 per cent to 6 per cent. Other measures in the new
Policy aim at strengthening labor unions, redressing individual grievances
equitably, laying down improved procedures for the settlement of collective
disputes, preventing arbitrary dismissals of employees, improving fringe
benefits and so forth. On the cther hand, the President stated that the
Government does not intend to raise minimum wages at the present time, since
such a move would tend to intensify inflationary presslres. Mfiore recently,
the Government decreed salary increases of between 10 per cent and 40 per
cent for the "nongazetted" (i .e. , lower level ) ti-vil service employeesl.
4.   Balance of payments
In recent years Pakistan ':ias had a substantial balance of payments
deficit with foreign countries, On the other hand, it realized a surplus
vis-a-vis the Eastern Province with which, in effect, it purchased foreign
exchange from that Prcvince to finance para,of its international deficit.
Table 6 gives foreign exchange budget data- for Pakistan, actuals for
19610/70 and 1970/71 and proiections for the second half of 1971/72 and for
1972173; it should be noted that these projections do not allow for the
effects of the exchange reform. In preparing this table, the authorities
have attempted to divide foreign aid between the Eastern Province and the
Western Province, but they have allocated to Pakistan all foreign exchange
expenditures of the two Provinces combined for debt service and defense
imports. While this method tends to overstate materially Pakistan's inter-
national deficit in the past, it serves to present a realistic picture of
the situation at the present time. As regards transactions with the Eastern
Province only trade statistics are available; they show that Pakistan's trade
surplus amounted to $157 million (at the official rate) in 1969/70 and to
$121 million in 1970/71. It is also believed that Pakistan had a substantial
surplus on services reflecting receipts under the headings of transportation,
blanking and insurance, profits and dividends.
1/ It is estimated that this increase will add to the budget a burden of
PBs 68 million annually. However, this additional expenditure will be partly
or wholly offset by another recent government decision to pension off before
the mandatory age of retirement 1,300 civil servants whose conduct in office
has been judged reprehensible by committees appointed for that purpose.
2/ The foreign exchange budget differs in some respects from the usual
balance of payments presentation.



12 -
Table 6. Foreign Exchange Budget
(In millions of U.S. dollars)
1971/72
July- Jan.-
1969/70  1970/71  Dec.    June   Total  1972/73
Receipts                         860    1'000    429    515     944     903
Merchandise exports              336      443    227    267     494      535
Invisiblesl/                     175      141     68     88     156     147
Foreign aid2_/                   347      416    134    160     294      221
(Project)                     (212)    (300)  (107)  (103)   (209)   (175)
(Nonproject)                  (135)    (116)   (27)   (57)    (84)    (46)
Payments                       1,130    ',2o4    552    615   1,167    1,229
Public sector invisibles3/       158      155     86     73     159      168
Private sector invisibles4/       71       74     36     36      72       84
Debt service5/                   212      219    111    139     250      273
Imports                          689      756    319    367     686     704
Overall deficit, financed by:6/ 270       204    123    100     223      326
Decline in official reserves      16       77     39
Moratorium on debt service        --       28     67
Purchases of exchange from
the Eastern Province           254       99      7
Source: Ministry of Finance.
1/ Eighty per cent of corresponding figure for the Western and Eastern
Provinces taken together. The figure for the second half of 1971/72 includes
an estimate of $8-11 million for repatriation of foreign exchange under
Martial Law Regulations 104 and 105. These Regulations instructed citizens
of Pakistan, with certain exceptions, to declare assets held abroad by
February 15, 1972 and to repatriate by February 29, 1972 and March 15, 1972,
respectively, their cash balances and proceeds from the sale of movable
property; additional directives were to have been issued regarding immovable
property. Funds surrendered under these Regulations receive bonus at the
rate of 45 per cent.
2/ Figures for project aid disbursements have been reduced by 15 per cent
to allow for the technical assistance component (the contra-entry for which
has been omitted from the estimates).
3/ Including payments for defense imports and debt service.
1/ Sixty-six per cent of corresponding figure for the Western and Eastern
Provinces taken together.
5/ Assuming full payment for both the W4estern and Eastern Provinces.
6/ It is expected that in the second half of 1971/72 and in 1972/73 this
deficit will be financed also by arrangements with creditors to reschedule
part of Pakistan's debt service obligations and by new commitments of
commodity aid from IDA, the members of the Consortium and other countries.



- 13 -
As indicated in the table, in 1969/70 Pakistan's international deficit
(i.e., the "overall deficit," using the terminology of the Pakistan
authorities), was equal to .$270 millions this deficit was financed to the
extent of $254 million by purchases of foreign exchange from the Eastern
Province and to the extent of $16 million by a drawdown of reserves. In
1970/71 Pakistan's exports increased substantially, thus resuming the upward
trend which had been interrupted in the two preceding years; the gains in
export receipts were mainly due to higher international prices for cotton,
the continued growth of certain nontraditional exports and some diversion
to foreign countries of some exports previously shipped to the Eastern
Province. There was also a considerable increase in foreign aid. At the
same time, import payments increased and invisible receipts declined due in
part to speculation inspired by rumors of devaluation. Pakistan's "overall
balance of payments deficit"i (as defined in the table) declined noticeably.
However, the political difficulties in the latter half of 1970/71 led to a
considerable decrease in the receipts of the Eastern Province from the rest
of the world and, therefore, in the volume of foreign exchange which Pakistan
could purchase from that region. As a result, Pakistan's external position
came under severe pressure; reserves were drawn down by $77 million and the
authorities imposed a moratorium on part of their debt service obligations.
In light of the available actuals for the first half of the year, the
authorities project that in 1971/72 exports will again rise considerably.A/
There may be a small increase in invisible receipts, reflecting m7inly some
repatriation of funds under rviartial Law Regulations 104 and 105.2? Moreover,
imports will decline appreciably. On the other hand it is known that foreign
aid will be substantially below the level of the previous year and debt
service considerably larger; indeed, if all debt obligations were discharged,
the net inflow of resources from abroad would be only $44 million as compared
with $135 million and $197 million in the two preceding years. The expected
overall deficit of $223 million is somewhat larger ihan in 1970/71. This
deficit will be covered in part by using reserves.31 For the remaining part,
it is hoped that additional financing will be obtained througb arrangements
with Consortium and non-Consortium coantries.
For 1972/73 the projections of the authorities place the deficit in
the external sector at $326 million. However, negotiations among Consortium
countries, as well as negotiations between Pakistan and the non-Consortium
countries, for a total amount of debt relief of $100.million have now
reached an advanced stage. Furthermore, there will probably be some new
nonproject assistance from the members of the Consortium and mainland China
and a sizable industrial imports credit (commodity aid) from IDA. As a
consequence of the devaluation, export and other receipts should increase
and Fund assistance should bridge most of the remaining gap, but there may
also be some decline in reserves. It is expected that reserve losses will
come to an end by the end of 1973/74.
1/ Despite the interruption in December and their normal seasonal pattern,
exports in July-December 1971 amounted to more than half of the total for
1970/71.
2/  See footnote 1 on page 12.
3/ There was a reserve loss amounting to $39 million in July-December 1971
followed by a gain of $9 million in January 1972 (including the allocation
of SDR 25 million).



- 14 -
III. Analysis of the Reform
The program described in the attached letter of intent contains two
basic elements: an exchange reform which has been analyzed in detail in
EBS/72/149 and financial policies designed to eliminate excessive expansion
of bank credit and permit an acceleration of the development effort. It
is recognized that the financial aspect of the program is essential to the
realization of the benefits expected from the exchange reform.
Fiscal policy
During the second half of the current fiscal year ending June 30, 1972
Treasury reliance on the banking system will amount to PRs 1,140 million,
of wbich PRs 240 million will be needed to finance the seasonal requirements
of the Government's commodity operations. This deficit is higher than would
have been desirable in different circumstancest' and the authorities recognize
that it should be curtailed in the next fiscal year 1972/73. At the same
time, however, it will be necessary to increase investment expenditure in
order to step up the country's lagging development effort. A major effort
will be required, therefore, both to curtail current expenditures and to
increase revenue. The details of the budget are to be worked out prior to
June 30, 1972 and will be discussed with a staff mission to visit Pakistan
in July (see below).
As indicated earlier in this report, the Taxation Commission has been
instructed to study and propose new revenue measures for the 1972/73 budget;
inter alia the Commission will explore ways to increase agricultural taxation,
which is regarded as unduly low under existing arrangements. In the near
future, the Government intends to review and raise public utility rates, for
electricity and water in particular; subsidies are to be scrutinized also, with
a view to reducing them progressively over time. The authorities are aware
that effective tax administration can be an important factor in increasing
revenue and they hope to enact for this purpose a new income tax law, which
has been drafted with Fund technical assistance.
The net budgetary impact of the exchange reform and associated measures
is. expected to be approximately neutral. The rupee cost of the Government's
expenditure abroad, mainly on imports of defense equipment and debt service,
will rise following the devaluation, though the burden of this additional
expenditure on the budget will be eased considerably by the expected agree-
ments with creditor countries regarding a rescheduling of Pakistan's external
debt. In view of the fact that the reform will tend to raise costs and prices,
the authorities have decided to increase subsidies on certain important
agricultural inputs, in particular fertilizer and pesticides; furthermore,
they may alleviate to a limited extent through subsidies or adjustments in
tariffs the price effects on items weighted heavily in the cost of living of
the lower income groups. Some additional expenditure may also be incurred
due to higher prices of goods procured locally by the Government. Hlowever,
these increases in budgetary costs are to be offset by increases in receipts
1/ See discussion on credit ceilings on page 15.



- 15 -
from three principal sources. In the first place, substantial revenue will
accrue from the export duties described in EBS/72/i49. Secondly, counterpart
funds froia foreign commodity assistance aiid from the expected "program loan"
from IDA will rise considerably. Thirdly, receipts from import duties will
increase since the intention of the Government is to reduce tariff rates on
the average less than in proportion to the devaluation.
Credit Dolicy
The financial program of the Pakistan authorities is designed to limit
the bal ce of payments deficit to the afore-mentioned projection of PRs 490
million- in the January-June period; in view of the real factors inherent
in the present situation, an attempt to curtail the deficit below that level
would have serious adverse effects on the economy. A second objective of the
program is to contain the increase in prices to that which is in fact unavoid-
able as a consequence of the exchange reform. To assist in achieving these
objectives, a ceiling is established on the banking system's net claims on
government plus its gross claims on the private sector. In the six months
ending in June 1972, total credit under these headings will not be allowed
to increase by more than PRs 1,540 million; given the assumed deficit in the
external sector and given the expected contraction of PRs 100-150 million in
'Bother items"' in the monetary accounts, a volume of bank financing equal to
the maximum permissible under the ceiling woul5/leed to an expansion in
domestic liquidity of the order of 5 per cent.-   Seen against the background
of the slowdown in the economy, such an increase may appear to be unduly
large. However, owing to the price effects of the devaluation, nominal
incomes are likely to rise more than 5 per cent in the period discussed.
Therefore, the anticipated expansion in domestic liquidity will tend to have
the desired restrictive impact on the balance of payments and to prevent
price increases from causes other than the devaluation. The overall ceiling
of PRs 1,540 million assumes, as noted earlier, a budget deficit of PRs 1,140
million leaving an amount of PRs 400 million for financing of the private
sector. Such an allocation of credit between the public and private sectors
may be justified in part, in light of the current slowdown in the economy.
However, with the expected pickup in economic activity, the budget deficit
will need to be reduced considerably in the next fiscal year and the shares
of the two sectors in total bank credit changed appreciably. It was not
considered feasible to formulate credit ceilings for 1972/73 in view of
present uncertainties and the fact that budget plans for that year have not
yet been wrorked out. Such ceilings wi].l be discussed at the time of the
review in July. It is recognized that they should provide for a slower rate
of monetary expansion in line with the real growth in the monetized sector
of the economy.
1/ As shown in Table 6 the authorities project an overall deficit of $100
million in January-June 1972, of which they hope to cover .39 million with a
debt moratorium to be arranged with creditor countries. The remaining
effective deficit of $61 million, part of which will have been incurred before
the devaluation, has been converted above at an average rate of US$1 = PRs 8.
2/ This calculation assumes that domestic liquidity (on December 31, 1971)
amounted to about PRs 18 billion, in line with the estimates of the Research
Department of the State Bank of Pakistan referred to on page 10 above.



- 16 -
It would have been preferable to establish the credit ceiling on net
domestic assets, including "other items," rather than on net claims on
government plus gross claims on the private sector.  iiowever, in the coming
months the sorting out of the monetary accounts as a consequence of the
separation of the Eastern Province is likely to lead to erratic movements
in "other items" of the banking system.  Thle feasibility of including 'other
items" in the ceilings for 1972/73 will be considered during the July review.
In order to strengthen control over credit and as a step toward pushing
the interest rate structure up to a realistic level, the discount rate will
be raised from 5 per cent to 6 per cent before June 30, 1972 and appropriate
adjustments made in lending and deposit rates of the commercial banks as well
as in rates paid on new issues of government securities. The need for a
larger adjustment in interest rates in due course is recognized, and this
limited first step reflects concern with present depressed conditions in
the private sector. Should the demand for credit prove much stronger than
is currently anticipated, further upward adjustments in interest rates will
be considered.
Other provisions
Other provisions of the program relate to liberalization of trade and
payments, bilateral payments agreemenits and foreign debt.  The policy with
regard to liberalization and measures to assure the utilization of tied aid
are discussed in EBS/72/149 relating to the exchange reform. The program
includes an undertaking by the authorities not to conclude additional
bilateral agreements with Fund member countries and to take steps for the
purpose of terminating the three existing agreements with members of the
Fund, i.e., with Ceylon, Nepal and Yugoslavia. As regards foreign debt,
the Government intends to continue stringent controls on external borrow-
ing by the private sector and to permit the public sector to contract
short-term supplier credit only in exceptional circumstances.
Review
The program described above is to be reviewed with the Fund staff early
in the fiscal year 1972/73, probably in July. The review will focus on the
functioning of the new exchange system, progress toward liberalization of
imports, export taxation, the budget plans for 1972/73 and the credit ceil-
ings for that year. The use of Fund resources after June 30, 1972, is
subject to the establishment of appropriate credit ceilings for the remainder
of the period of the stand-by arrangement and the observance of these
ceilings.



- 17 -
IV. Staff Appraisal
In the staff appraisal to EBS/72/140 dealing with the exchange reform,
it is noted that Pakistants external payments problems for a number of years
have been due to both domestic financial policies and an inadequate exchange
rate system. The authorities have stated their determination to embark on
a comprehensive financial program, containing appropriate external and
domestic policies to rectify the balance of payments problem within a
reasonable period. With regard to exchange policy, it is concluded in
EBS/72/149 that the "proposed new par value appears to be realistic, falling
within the acceptable range appropriate for the correction of the fundamental
disequilibrium in Pakistan's balance of payments."
The domestic financial policies described in the letter of intent are
designed to prevent the emergence of inflationary pressures which would
erode the benefits of the exchange reform. The details of domestic financial
policies have in many respects yet to be worked out. As the authorities
recognize, much will depend on the quality of the measures to be applied,
including the 1972/73 budget and the credit ceilings for that year. It
should be recognized also that the implementation of an effective stabili-
zation policy in existing circumstances will be a difficult task and will
require determination on the part of the Pakistan authorities. A staff
mission is to visit Pakistan in July to review the plans for 1972173 and
to reach understandings on the credit ceilings to be established for the
period after June 30, 1972.
The authorities intend to implement the program in such a manner that
it will make an important contribution to the restoration of a satisfactory
growth rate in both the short and longer run. Thus, the exchange reform
will stimulate export production and assist the economy to recover from the
present slowdown. Furthermore, an important objective of fiscal policy is
not only to hold total Treasury reliance on the banking system within
appropriate limits, but also to increase investment expenditure by the
public sector. The improved allocation of resources, which is expected as
a consequence of the devaluation and import liberalization, should also tend
to increase the rate of growth over the longer run.



- 18 -
V. Proposed Decision
The following draft decision is submitted for the consideration of
the Executive Board:
The Government of Pakistan has requested a stand-by
arrangement for a period of one year and for the equivalent
of SDR 100 million. The Fund approves the stand-by arrange-
ment attached to EBS/72/150 and grants any necessary waiver
of the conditions of Article V, Section 3 (a)(iii), of the
Articles of Agreement.



Stand-By Arrangement
1.  Annexed hereto is a letter dated May 4,   1972 from the .'rrister
of Finance setting forth the objectives and policies which the authorities
of Pakistan will pursue.
2. The International Monetary Fund grants this stand-by arrangement
to support these objectives and policies.
3. Pakistan will remain in close consultation with the Fund during
the period of the stand-by arrangement and, in particular, will consult
with the Fund in accordance with paragraph 16 of the annexed letter. These
consultations may include correspondence and visits of the officials of the
Fund to Pakistan or of representatives of Pakistan to Washington, D.C. For
the purpose of these consultations, Pakistan will keep the Fund informed of
developments in the exchange, trade, credit and fiscal situation through
reports at intervals or dates requested by the Fund during the period the
stand-by arrangement is in effect.
4. For a period of one year from May 18, 1972, Pakistan will have
the right, after making full use of any gold tranche that it may have, to
make purchases from the Fund in the currencies of other members in exchange
for its currency in an amount equivalent to SDR 100 million provided that:
(i)   purchases under the stand-.by arrangement shall not,
without the consent of the Fund, exceed the equivalent
of SDR 50 million until August 1, 1972, SDR 67 million
until November 1, 1972 and SDR 84 million until
February 1, 1973; and
(ii) the right of Pakistan to make purchases under the
stand-by arrangement shall be subject to paragraph 15
of the annexed letter to the extent that such purchases
would increase the Fund's holdings of the Pakistan
rupee beyond the first credit tranche. If at any time
the limit in (i) above would prevent a purchase under
the stand-by arrangement that would not increase the
Fund's holdings of the Pakistan rupee beyond the first
credit tranche, the limit will not apply to that
purchase.
The amounts available in accordance with this paragraph 4 shall be augmented
by amounts equivalent to repurchases in respect to purchases under the
stand-by arrangement, unless when any such repurchase is made, Pakistan
informs the Fund that it does not wish the stand-by arrangement to be
augmented by the amount of that repurchase.
5. Pakistan will pay charges for this stand-by arrangement in accord-
ance with Executive Board Decisions Kos. 270-(53/95), adopted December 23,
1953; 876-(59/15), adopted April 27, 1959; and 1345-(62/23), adopted May 23,
1962.



- 2 -
6. Subject to paragraph 4 above, Pakistan will have the right to
engage in transactions covered by this stand-by arrangement without
further review by the Fund. This right can *be suspended only with respect
to requests received by the Fund after (a) a formal ineligibility, or (b)
a decision of the Executive Board to suspend transactions, either generally
(under Article XVI, Section 1 (a)(ii)) or in order to consider a proposal,
made by an Executive Director or the Managing Director, formally to suppress
or to limit the eligibility of Pakistan. When notice of a decision of
formal ineligibility or of a decision to consider a proposal is given
pursuant to this paragraph 6, purchases under the stand-by arrangement
will be resumed only after consultation has taken place between the Fund
and Pakistan and understandings have been reached regarding the circum-
stances in which such purchases can be resumed.
7. Not later than three years after each purchase of exchange by
Pakistan under this stand-by arrangement, Pakistan will repurchase an
equivalent amount of Pakistan rupees from the Fund; provided that, if
the Pakistan rupees held by the Fund as a result of transactions under
this stand-by arrangement are reduced by repurchases under Article V,
Section 7, or otherwise, such reductions shall be credited against the
earliest amounts that become payable under this paragraph 7. Repurchases
shall be made in gold, or in convertible currencies acceptable to the
Fund, or in special drawing rights, in accordance with the Fund's policies
and practices at the time of repurchase.



Minister for Finance
Economic Affairs & Development
Government of Pakistan
Islamabad, the    Miay 4,   1972.
D.O.No.2054/FS/S/72.
Dear Mr. Schweitzer,
In my letter of iMay 4, 1972, I communicated to you the Government of
Pakistan's decision to establish a new par value with the concurrence of
the Fund, effective May 12, 1972. The previously existing exchange rate
system will be abolished and in its place a single rate structure based on
a new par value of 0.0744103 gram of fine gold per Pakistan rupee will be
adopted. The Government considers this fundamental reform essential to
eliminating the existing disequilibrium in Pakistan's external payments
and restoring conditions for a resumption of an adequate growth in pro-
duction, exports and investment.
2.   However, the Government realizes that in order to attain these objectives,
the exchange reform will have to be accompanied by appropriate financial
measures and is accordingly embarking on a comprehensive financial programme.
The principal measures which have been or will be adopted and the policies
which we will pursue within the 'territory administered by the Government of
Pakistan axe set out below. These measures, which will have to be pursued
over several years, together with the exchange reform should enable Pakistan
to reduce its balance of payments deficit which may be expected to continue
through the fiscal year 1972-73 and to eliminate anby further decline in net
external reserves by the end of the following year.
3.   In view of the low level of our foreign exchange reserves and the time
it will take for the remedial measures to take effect, financial assistance
from the International Monetary Fund is needed. Therefore, the Government of
Pakistan requests a one-year stand-by arrangement in the amount of SDR 100
million.
4.   The programme to deal with the balance of payments problem described
in this letter is based on the premise of a continuation of financial a
assistance from the consortium of countries which have been providing such
assistance in support of the development programme for a number of years.
Discussions are under way within the Consortium, and it is expected that
Pakistan will receive substantial additional assistance which will include
debt relief on an agreed basis and additional pledges of non-project
commodity aid. The latter, it is hoped, will permit a buildup of the
pipeline of commodity aid which is now at a rather low level. The principal
reasons for requesting Fund assistance are to provide financing during the
period of time needed to reconstitute this pipeline and to meet any unfore-
seen pressures arising from the exchange reform. Although there continues
to be a sizable pipeline of project financing, new pledges will also be



- 4 -
needed soon to provide a basis for accelerating the development effort.
Pakistan is also seeking to import some wheat under U.S. P.L. 483 arrange-
ments, made necessary by the short crop in 1971, and. alditioaal finarcial
assistance from non-consortium sources for the development programme.
5.   The Government is faced with a difficult financial problem growing
out of recent developments, which have made necessary a sharp cutback in
development expenditures and heavy reliance on domestic bank financing of
the public sector deficit. Thus, it is imperative not only to increase
the domestic funds available for developmenit in order to make effective use
of the expected increase in external assistance and to restore the growth
of the econoy at a reasonable rate, but also to assure that the bank-
financed deficit will not threaten.a renewal of inflation which would
undermine the new exchange rate and again give rise to distortions in the
economy.
6.   The adjustments being made in the fiscal system concurrently with the
introduetion of the new exchange rate are described below:
(a) A number of commodities will be subject to export duties (see
Attachment 1) including raw cotton, rice, cotton yarn, wool and hides and
skins. In the absence of such duties the application of the new rate to
these commodities would result in substantial windfall profits with serious
inflationary consequences. In all cases, however, a substantial increase
in export incentive is being provided, and it is expected that these duties
will be gradually reduced with a view to providing ample incentive for
continued expansion of production and export of these items.
(b) In adJusting customs duties on imports some changes will be made
to correct existing anomalies, which in some cases will involve revenue
losses, but overall the policy will be to assure that there is a net increase
of revenue from this source.
(c) As a result of the exchange reform, there will be substantial
increases in some domestic costs and prices. It will be necessary to
alleviate this burden in relation to some of the items entering into the
cost of living of the lower-income groups and the prices of certain imported
inputs of strategic economic importance. However, many of these items have
been or will be adjusted upward in price to some extent and the deficit from
these measures will be offset fully by other adjustments.
(d) A particular problem which may arise from the exchange reform is
the utilisation of tied aid and bilateral balances. Hitherto this has been
ensured through the exchange system by application of the preferential
official rate to import procurements uith these resources.   With the loss
of this exchange rate expedient, some fiscal incentive may have to be given
for aid and barter imports wherever necessary to compensate for the loss of
the exchange rate incentive. To the extent that donors untie aid and our
exports can gain unrestricted access to non-bilateral markets, this difficulty
will be eased.



-5_
7.   In the existing circumstances it is inevitable that the budget deficit
will be for several months larger than desirable, perhaps involving net bank
financing of the Central and Provincial Governments of about PRs 900 million
from December 31, 1971 to June 30, 1972. There will also be a need for
seasonal financing of commodity operations rising by about PRs 240 million
during this period to a peak in June. The performance could turn out to be
better than this, but the numerous uncertainties make it impossible to count
on it.
8.   For the next fiscal year beginning July 1, 1972 a major improvement in
the budget will be made. Stringent controls vill be imposed on nondevelop-
ment expenditures, and a tight rein will also be imposed on subsidies. A
review of rates charged by public utilities is expected to improve the
revenue situation as is the intensified effort in the field of tax admini-
stration. The 1972-73 budget will include new revenue measures. Particular
attention will be given to the income tax as its effective implementation
will meet the Government's objective of achieving greater equity. To this
end the Government aims for a speedy adoption of a new income tax law as
the basis for a better administration of this tax. The Taxation Commission
has also been reconstituted and instructed to make proposals for next year's
budget. In the longer run the Government intends to remodel the fiscal
system in order to attain a better balance in the pattern of taxation
between the agricultural and the non-agricultural sectors of the economy.
It is not feasible at this time to establish a firm limit on the budget
deficit, but it will be greatly reduced compared to that expected in 1971-72
and will be consistent with the overall credit limitation considered
appropriate for the economy as a whole.
9.   As indicated above, the public sector may require net bank credit of
as much as PRs 1,140 million, partly for seasonal requirements, between
end December 1971 and June 30, 1972.  Private sector credit requirements
from the banking system, taking into account some expected recovery in
activity and the impact of the exchange reform on costs and prices, are
estimated at about PBs 400 million for the same period.  At no time during
the period up to and including June 30, 1972 will the total of these two
elements exceed the level of PBs 25,243 million outstanding on December 31,
1971, by more than PRs 1,540 million subject to adjustment for changes in
government moratorium deposits. It is recognized that this rate of credit
expansion is high in relation to the growth of the economiy and quarterly
ceilings on the net domestic assets of the banking system will be established
for 1972-73 on a much lower relative rate of expansion. These ceilings will
take into account seasonal factors and will be closely related to the
estimated growth of the economy in real terms with due allowance for the
expanding money-using sector of the economy. With regard to the credit
ceilings to apply in l972--73, understandings will be reached with the Fund
when adequate information is found to be available to make satisfactory
Judgments.



- 6 -
10. It is felt that an upward adjustment in the interest rate structure
is needed, particularly as economic recovery gains momentum, although there
is some question whether this action should be taken immediately. However,
the discount rate of the State Bank of Pakistan will be increased from 5 per
cent to at least 6 per cent by June 30, 1972 and other appropriate adjust-
ments made simultaneously in lending and deposit rates of the commercial
banks. A similar adjustment will be made for new issues of government
obligations. If the demand for credit by the private sector is much stronger
than has been projected in paragraph 9, further upward adjustments in interest
rates may be made as a measure of restraint and in order that an appropriate
level of rates for the pricing of capital may be attained.
11. With the introduction of the new exchange system and the adjustments in
customs duties, it will be possible to make a move toward a more liberal
import policy. While this pol-cy will have to be approached with some
caution in the early stages of this programme, liberalisation will be pressed
as rapidly as circumstances permit. Reference has, however, already been
made in paragraph 6 (d) to the problem of ensuring the utilization of tied
aid and bilateral balances. In this respect, as a possible supplementary or
alternative means to some fiscal incentives, it may be necessary to impose
restrictions on the import of a limited number of items with freely con-
vertible exchange so that demand for those items is met with available
nonconvertible exchange resources. Concurrent with import liberalisation,
the intention is to move toward liberalisation of current invisible payments.
12. Pakistan maintains bilateral payments agreements with Nepal, Ceylon
and Yugoslavia, and payments arrangements also exist under the Regional
Cooperation Agreement with Iran and Turkey. In addition, bilateral pay-
ments agreements are in effect with a number of countries not members of
the Fund. It is the Government's policy not to conclude additional bilateral
payments agreements with members of the Fund and it will take steps with a
view to terminating the three existing agreements with Fund members during
the period of the stand-by arrangement.
13. As regards external borrowing, intergovernmental loans are under
discussion with the Consortium. All foreign borrowing by the private sector
is controlled. Such borrowing by the banking system is negligible and
access to foreign supplier credits is limited to export industries under
specified conditions. It is the intention that these controls should be
continued and that the public sector should contract short-term supplier
credit only in exceptional circumstances.
14. Early in fiscal year 1972-73 the programme described in this letter
will be reviewed with the Fund. Particular attention will be paid to the
functioning of the new exchange system and the progress toward import
liberalisation and to the 1972-73 budget and the credit ceilings to be
established for that fiscal year.



15. During any period of the stand-by arrangement in which (1) multiple
currency practices, restrictions on the making of payments and transfers
current international transactions or bilateral payments arrangements with
Fund members have been introduced or intensified; or (2) the limit on bank
credit set forth in third sentence of 9th paragraph is not observed; or
(3) any restrictions on imports have been introduced or intensified other
than in accordance with paragraph 11; or (4) in the period following June 30,
1972 understandings about limits on credit have not been reached or are not
observed, Pakistan will not request any purchase under stand-by arrangement
which would raise Fund's holdings of its currency beyond first credit tranche,
except after reaching understanding with Fund regarding circumstances in
which such purchases may be made.
16. The Government believes that the policies set forth in this letter
are adequate to achieve the objectives of the programme but will take any
further measures that may become appropriate for this purpose. During
the period of the stand-by arrangement, Palkistan will consult the Fund on
the adoption of any measures that may be appropriate at the initiative of
Pakistan or whenever the Managing Director requests consultation because
any of the criteria in paragraph 15 above have not been observed or because
he considers that consultation on the programme is desirable. In addition,
after the period of the stand-by arrangement and while any Fund holdings of
Pakistan's currency above the first credit tranche include currency result-
ing from purchases under the stand-by arrangement, Pakistan will consult
the Fund from time to time, at the initiative of Pakistan or at the request
of the Managing Director, concerning Pakistan's balance of payments policies.
17. Before requesting any purchase under the proposed stand-by arrangement,
the Government of Pakistan will consult with the Managing Director on the
particular currencies to be purchased from the Fund.
Sincerely yours,
/s/
(Dr. Mubashir Hasan)
Mr. Pierre-Paul Schweitzer,
Managing Director,
International Monetary Fund,
WASHINGTON, D.C.



- 8 -
Attachment 1
List of cowmodities which will be subject to export duities.
1. Raw cotton
2. Cotton waste
3. Cotton yarn
4. Grey cloth
5. Rice (Basmeti)
6. Rice (coarse)
7. Raw wool
8. Raw hides and skins
9. Semitanned and tanned skins
10. Oil cake