Fire and Blood

• The IMF Executive Board completed the first review under the Extended Fund Facility (EFF) Arrangement, allowing the authorities to draw the equivalent of about $1 billion. The authorities have demonstrated strong program implementation, which has contributed to improving financing and external conditions, and a continuing economic recovery. • Moving forward, policy priorities will include advancing reforms to strengthen competition, raise productivity and competitiveness, reform SOEs, improve public service provision and energy sector viability, and build climate resilience. • The Executive Board also approved the authorities request for an arrangement under the Resilience and Sustainability Facility (RSF), which will support Pakistan’s efforts in building economic resilience to climate vulnerabilities and natural disasters, with access of around $1.4 billion. Washington, DC – May 9, 2025: Today, the Executive Board of the International Monetary Fund (IMF) completed the first review of Pakistan’s economic reform program supported by the EFF Arrangement. This decision allows for an immediate disbursement of around $1 billion (SDR 760 million), bringing total disbursements under the arrangement to about $2.1 billion (SDR 1.52 billion). In addition, the IMF Executive Board approved the authorities’ request for an arrangement under the Resilience and Sustainability Facility (RSF), with access of about US$1.4 billion (SDR 1 billion). Pakistan’s 37-month EFF was approved on September 25, 2024, and aims to build resilience and enable sustainable growth. Key priorities include (i) entrenching macroeconomic sustainability through consistent implementation of sound macro policies, including rebuilding international reserve buffers and broadening of the tax base; (ii) advancing reforms to strengthen competition and raise productivity and competitiveness; (iii) reforming SOEs and improving public service provision and energy sector viability; and (iv) building climate resilience. Pakistan’s policy efforts under the EFF have already delivered significant progress in stabilizing the economy and rebuilding confidence, amidst a challenging global environment. Fiscal performance has been strong, with a primary surplus of 2.0 percent of GDP achieved in the first half of FY25, keeping Pakistan on track to meet the end-FY25 target of 2.1 percent of GDP. Inflation fell to a historic low of 0.3 percent in April, and progress on disinflation and steadier domestic and external conditions, have allowed the State Bank of Pakistan to cut the policy rate by a total of 1100 bps since June 2025. Gross reserves stood at $10.3 billion at end-April, up from $9.4 billion in August 2024, and are projected to reach $13.9 billion by endJune 2025 and continue to be rebuilt over the medium term. 2 The RSF will support the authorities’ efforts to reduce vulnerabilities to natural disasters and to build economic and climate resilience. The authorities’ program: (i) prioritizes resilience to natural disasters and strengthen public investment processes at all levels of government; (ii) makes the use of scarce water resources more efficient, including through better pricing; (iii) strengthens coordination of natural disaster response and financing between federal and provincial governments; (iv) improves the information architecture, for and disclosure of, climate-related risks by banks and corporates; and (v) supports Pakistan’s efforts to meet its mitigation commitments and reduce related macro-critical risks. Following the Executive Board discussion, Nigel Clarke, Deputy Managing Director and Chair, made the following statement: “Pakistan has made important progress in restoring macroeconomic stability despite a challenging environment. Since the approval of the Extended Fund Facility, the economy continues to recover, with inflation sharply lower and external buffers notably stronger. Risks to the outlook remain elevated, however, particularly from global economic policy uncertainty, rising geopolitical tensions, and persistent domestic vulnerabilities. Against this backdrop, the authorities need to maintain sound macroeconomic policies and accelerate reforms to safeguard the macroeconomic gains and underpin stronger and sustainable, private sector-led medium-term growth. “The steadfast implementation of the FY2025 budget and the passage of key fiscal reforms, notably the Agricultural Income Tax, underpin the process of rebuilding policy making credibility. Continuing to mobilize greater revenue from undertaxed sectors and the noncompliant will make the tax system more equitable and efficient. This, combined with federal and provincial spending discipline, will strengthen sustainability, build resilience, and reduce the public sector’s crowding out of private credit. “Timely implementation of power tariff adjustments has helped reduce the stock and flow of circular debt. Meanwhile, cost-side reforms are showing early signs of success but need to be accelerated to safeguard the energy sector’s viability and improve Pakistan’s competitiveness. “The State Bank of Pakistan’s (SBP) tight monetary policy stance has been pivotal in reducing inflation to historic lows. Monetary policy should remain appropriately tight and datadependent to ensure inflation is anchored within the SBP’s target range. A more flexible exchange rate will facilitate the adjustment to external and domestic shocks, aiding the rebuilding of reserves. Prompt action to address undercapitalized financial institutions and vigilance over the financial sector are necessary for financial stability. Strengthening of AML/CFT frameworks is also needed. “Accelerating structural reforms will unlock Pakistan’s competitiveness, creating conditions to attract high-impact private investment. Reform priorities include reducing trade and investment barriers, advancing SOE reforms, and decisively strengthening governance and anticorruption institutions. “Reducing Pakistan’s vulnerability to extreme weather events will enhance macroeconomic stability and fiscal sustainability. The reforms under the Resilience and Sustainability Facility aim to build resilience to natural disasters by strengthening public investment processes, supporting efficient use of scarce water resources, strengthening coordination of natural disaster response and financing, improving the information on climate-related risks, and supporting Pakistan in meeting its international commitments.” 3

EXECUTIVE SUMMARY Recent Developments. The authorities’ policy efforts have continued to bear fruit. Financial and external conditions have continued to improve, with a current account surplus in the first eight months of FY25 and reserves exceeding program projections. Inflation has recently declined to historical lows, although core inflation remains elevated at around 9 percent. The economic recovery is continuing, although growth in FY25H1 was somewhat lower than anticipated. Program Performance. The 37-month Extended Arrangement under the Extended Fund Facility (EFF), approved on September 25, 2024, is on track. All seven QPCs and five of eight ITs were met at end-December. Most continuous and other SBs were met. Completion of the first EFF review would make available SDR 760 million (about US$1 billion) bringing total disbursements to SDR 1,520 million. EFF Policies. Continued strong and timely program implementation remains critical to safeguard recent hard-won economic stability and support sustainable growth. The FY25 primary surplus target is on track, but further fiscal reforms are necessary to strengthen revenue mobilization and reduce debt, while creating space for social and development spending. Monetary policy should remain tight and data dependent to ensure that inflation stays moderate, within the SBP’s target range. A more flexible exchange rate remains critical to absorb shocks and support the rebuilding of reserves. Efforts to ensure energy sector cost recovery via timely tariff adjustments remain necessary supported by broader reforms to restore viability and reduce the sector’s high costs. Structural reforms to improve governance and the trade and investment environment need to deepen, to support stronger sustainable and inclusive growth. RSF Request. The proposed arrangement under the Resilience and Sustainability Facility (RSF), with access set at 49.2 percent of quota (equivalent to SDR 1 billion), aims to reduce Pakistan’s balance of payments stability risks stemming from climate vulnerabilities. Reform Measures (RMs) aim to: (i) prioritize resilience to natural disasters April 25, 2025 PAKISTAN 2 INTERNATIONAL MONETARY FUND and strengthen public investment processes at all levels of government; (ii) make the use of scarce water resources more efficient, including through better pricing; (iii) strengthen coordination of natural disaster response and financing between federal and provincial governments; (iv) improve the information architecture, for and disclosure of, climate-related risks by banks and corporates; and (v) support Pakistan’s efforts to meet its mitigation commitments and reduce related macro-critical risks1. Financial and external conditions have continued to improve, but growth softened more than expected in FY25H1: • Economic activity and inflation. Following 2.5 percent GDP growth in FY24, growth slowed somewhat in H1, recording 1.3 percent and 1.7 percent (yoy) in FY25 Q1 and Q2, respectively, reflecting lower yields from the major Kharif crops and still-subdued industrial activity. Inflation fell to 0.7 percent (yoy) in March driven by tight macro policies and, principally, lower food and energy prices. However, core inflation is still elevated at around 9 percent

 External conditions and the FX market. The current account recorded a surplus of US$0.7 billion in the first eight months of FY25, a significant improvement from the US$1.7 billion deficit in the same period of FY24. This reflects strong remittances and resilient exports, which offset higher imports. Gross international reserves exceeded program targets and stood at US$10.7 billion at end-March 2025, down from a peak of US$12 billion in November, reflecting ongoing government debt service. The SBP continued foreign exchange purchases, benefiting from the generally improved financial conditions, which were also reflected in a broadly stable exchange rate since program approval. Sovereign bond spreads declined sharply over the past year and stabilized at around 600 bps in March before rising by more than 300 bps following the April 2 tariff announcements. There has been no discernible parallel market pressure and interbank and open market rates remain aligned. Effective January 1, 2025, the SBP adopted a new regulatory framework for Exchange Companies (MEFP ¶15.e). • Monetary policy. Following the rapid disinflation on the back of tight monetary policy and easing of commodity prices, the Monetary Policy Committee (MPC) cut the policy rate by a cumulative 1,000 bps between June 2024 and January 2025, before holding it at 12 percent in -10 -5 0 5 10 15 FY 16/17 FY 18/19 FY20/21 FY22/23 FY24/25 Agriculture Industry Services GDP 0 5 10 15 20 25 30 35 40 Jul-2021 Jul-2022 Jul-2023 Jul-2024 Headline Inflation (yoy) Core Inflation (yoy) Policy rate PAKISTAN INTERNATIONAL MONETARY FUND 7 their March 10 meeting and leaving forward-looking real rates still considerably positive. Private sector credit growth has moderated, containing growth in monetary aggregates, and following a temporary spike during FY25Q2 (25 percent q-o-q), reflecting banks’ efforts to circumvent a tax on their income from government securities.

Fiscal developments. Fiscal performance in FY25H1 was strong, continuing the discipline observed in FY24. The general government recorded an underlying primary surplus of PRs 2,264 billion (2.0 percent of GDP). FBR revenue grew by 26 percent year-on-year but fell short of endSeptember and end-December targets due to lower-than-expected sales tax and import duties amid subdued imports and growth. Direct tax collection overperformed, partially offsetting the shortfall in indirect taxes, alongside stronger non-tax and provincial tax revenues. Provinces met their aggregate primary surplus commitments. BISP spending met its targets, while expenditures on subsidies, grants, health, education and federal PSDP were below budget projections due to administrative delays. • Energy sector. The flow of power sector circular debt (CD) strongly overperformed September and December, rising PRs 166 billion from end-June through February 2025 (well below the March IT of PRs 554 billion), with the stock standing at PRs 2,530 billion (2.2 percent of GDP) by end-February. This was driven by strong collection performance; lower interest charges on arrears amid falling interest rates; and timely and favorable intra-year tariff adjustments, which countered higher-than-expected losses and supported a reduction in electricity tariffs by roughly PRs 5/kWh between July 2024 and March 2025 (text chart, ¶X). In the gas sector, continued timely gas tariff adjustments also contained net CD flow to PRs 28 billion during July—December 2024, limiting the stock to PRs 2,842 billion (2.7 percent of GDP), a provisional estimate. 

PROGRAM PERFORMANCE 2. Performance against quantitative performance criteria (QPCs), Indicative Targets (ITs), and Structural Benchmarks (SBs) under the EFF has been strong (MEFP Tables 1–2): • Performance Criteria (PCs). The authorities met all seven quantitative PCs for end-December 2024: the floors on (i) net international reserves of the SBP; (ii) targeted cash transfer spending; and (iii) the number of new tax returns from new filers; and the ceilings on (iv) net domestic assets of the SBP; (v) the SBP’s FX swap/forward book; (vi) the general government primary budget deficit; and (vii) government guarantees. They also met both continuous PCs on (i) zero new flow of SBP credit to the government; and (ii) zero external public payment arrears. • Indicative targets (ITs). The majority of ITs were met at end-December, including the ceilings on: (i) the aggregate provincial primary budget deficit; (ii) net accumulation of tax refund arrears; and (iii) power sector payment arrears; and the floors on: (iv) revenues collected by provincial revenue authorities; and (v) the weighted average maturity of local currency debt securities. However, the ITs at end-December were missed for the floors on (i) government health and education spending; (ii) net tax revenues collected by the FBR; and (iii) net tax revenues collected from retailers under the Tajir Dost scheme. • Structural benchmarks (SBs). Nine SBs were met, including on approval of a National Fiscal Pact, improving safeguards for monetary policy operations and approval of amendments to bank resolution and deposit legislation. Three continuous SBs on not granting tax amnesties, seeking ex-ante parliamentary approval for any non-budgeted expenditures, and the maximum average premium between the interbank and open market rates were also met. The SB on provincial Agricultural Income Tax (AIT) legislation was not met at end-October, but this legislation was subsequently passed in February 2025, while another two SBs were missed due to delays in passing amendments to of the Civil Servants and Sovereign Wealth Fund (SWF) Acts, Pakistan: Circular Debt in the Power Sector, FY17– February 2025 (Billions of Pakistani rupees) Stock Position 1/ Flow Sources: Pakistani authorities; IMF staff calculations. 1/ Only the part held by the Power Holding Private Limited (PHPL) is publicly guaranteed (PRs 683 billion as of Feb 2025), not that of the Central Power Purchasing Agenda (CPPA). Changes in the stock reflect the CD flow and sustained gradual clearance of payment arrears. 2/ Includes, among others, change in input costs (fuel, exchange rate, and interest rates), generation mix, prior-year recoveries. 0 500 1,000 1,500 2,000 2,500 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 25-Feb CPPA payables PHPL payables -600 -400 -200 0 200 400 600 800 1,000 Other adjustments 2/ Non-payment by K-Electric Financial costs Unpaid subsidies Pending adjustments (ARs, QTAs and FPAs) DISCO inefficiencies and under-recoveries Total CD flow PAKISTAN INTERNATIONAL MONETARY FUND 9 respectively. Finally, two SBs relating to resolving undercapitalized banks and to captive power producers were missed, but subsequent policy actions are expected to accomplish the underlying objectives (see ¶¶ 12 and 14, respectively). OUTLOOK AND RISKS 3. The baseline macroeconomic projections reflect a moderately lower outlook for nearterm activity, including due to the impact of higher US tariffs on Pakistan (Box 1), while inflation and current account deficits are also revised down (Tables 1–7)

• GDP and Inflation. FY25 growth is revised down to 2.6 percent based on the weaker activity in H1 and broader global uncertainty, but the recent monetary easing is expected to support an acceleration in FY25H2 and beyond. FY25 inflation is also revised down, although it is projected to increase notably in the coming months due to adverse base effects, with a durable return to the target range (5–7 percent) expected during FY26 provided policy remains appropriately tight. • Balance of Payments. The current account deficit (CAD) for FY25 is now projected at about US$0.2 billion (0.1 percent of GDP), helped by resilient exports and a stronger remittance outlook, as improved macro and FX stability has supported a rebound in remittance inflows through formal channels. Over the medium term, the CAD is expected to widen modestly to around 1 percent of GDP as imports rebound. Gross international reserves are expected to continue to strengthen, supported by financing committed by multilateral and bilateral creditors, as well as prospective RSF disbursements (US$1.3 billion). Access to external commercial financing is expected to remain limited during the program, with a small “Panda” bond issuance anticipated in FY26, ahead of a gradual return to the Eurobond/Global Sukuk market assumed in FY27, reflecting a restoration of policy credibility. • Fiscal. The FY25 primary deficit target is within reach, although reflecting the anticipated lower nominal GDP in FY25, nominal tax revenues have been revised down, and efforts to accelerate 

revenue collection will continue in the coming months. Offsetting expenditure savings are expected to deliver the programmed FY25 nominal EFF primary balance. Ongoing revenue mobilization and spending rationalization efforts, including with considerable CD assistance, are expected to support the fiscal path for FY26 and beyond. • Public debt. Under the baseline, public debt remains sustainable over the medium-term (Annex I). Notwithstanding the continuation of fiscal consolidation and progress with lengthening maturities of domestic debt, near-term risks of sovereign stress remain high, reflecting Pakistan’s very large gross financing needs and past challenges in obtaining external financing. 4. Downside risks have declined somewhat but remain high. Uncertainties around the impact of recent tariff announcements on Pakistan’s economic and financial conditions are significant, with risks skewed to the downside. More broadly, geopolitically driven increases in commodity prices, tightening in global financial conditions, weakening of remittances, or higher trade barriers in other trading partners could adversely affect external stability. The other main immediate risk relates to policy slippages given pressures to ease policies and provide tax and other concessions and subsidies to connected interests. An intensification of political or social tensions could also weigh on policy and reform implementation. Finally, climate-related risks are substantial, driven by both Pakistan’s high exposure to natural disasters and large adaptation and mitigation needs.

Box 1. Impact of Recent US Tariff Announcements On April 2, 2025, the US announced a large increase in country-specific tariffs, including a 29 percent tariff on Pakistan. While Pakistan’s export sector is relatively small (10 percent of GDP), the US is Pakistan’s largest trading partner, with the export of textiles and apparel the largest segment of that trade. Although some tariffs may be changed after negotiations, many of Pakistan’s competitors in these product segments also face large tariffs at this moment, including Bangladesh (37 percent), China (145 percent), India (26 percent) and Vietnam (46 percent). While there is considerable uncertainty about the final impact on the economy, the tariffs and subsequent financial market reaction are expected to weigh on Pakistan’s exports and GDP, with growth revised down marginally in FY25 (as less than a quarter is left in the year) and around 0.3ppts in FY26. In addition to the direct impact on Pakistan’s exports to the US, Pakistan is expected to face indirect effects including via the impact of the tariffs on the economies of Pakistan’s other trading partners, tighter global financial conditions, potentially lower remittances, and increased trade policy uncertainty. The net impact on the balance of payments is projected to be moderated by the recent commodity price declines and the downgrade in activity, which will reduce Pakistan’s import bill. Pakistan’s sovereign spreads have increased sharply since April 2, but market access to external financing in the near term is already limited vitiating any near-term impact. Nonetheless, if outflow pressures intensify it will be critical that the exchange rate is allowed to adjust. The net impact on inflation is also projected to be modest, with some downward pressure expected from lower commodity prices and weaker growth. PAKISTAN INTERNATIONAL MONETARY FUND 11 Pakistan: Goods and services exports by part

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EFF POLICY DISCUSSIONS A. Fiscal Policy 5. The authorities remain committed to achieving an underlying general government primary surplus of 1.0 percent of GDP in FY25. The nominal fiscal targets have been recalibrated to reflect the weaker outlook for nominal GDP, while preserving the original objectives in percentof-GDP terms. The fiscal position relies more on federal non-tax revenue, projected at 3.0 percent of GDP. Provincial tax authorities have also demonstrated robust performance supporting the overall fiscal effort. Achieving the FY25 primary balance target will require: • Strengthening tax revenue collection to ensure general government revenue reaches 12.3 percent of GDP in FY25, including FBR collections of 10.6 percent of GDP (PRs 12,332 billion). To support this effort, revenue administration measures to reduce the compliance gap will continue, focusing on compliance risk management (CRM), digital value chain monitoring, and detection of irregularities in sales tax returns, as well as closer monitoring of irregular import patterns (MEFP ¶5.d) and strengthened faceless customs assessments. The authorities are also actively pursuing the resolution of outstanding litigation cases (PRs 367 billion of a total of PRs 770 billion under dispute in these cases), including those before the Supreme Court (PRs 43 billion), High Courts in Islamabad, Sindh, and Lahore (PRs 217 billion), and the Appellate Tribunal Inland Revenue (PRs 104 billion). The Supreme Court has completed its initial hearing, with a final decision expected by mid-April. A favorable ruling could effectively resolve related cases worth an estimated PRs 120 billion (MEFP ¶5.a). Resolving these cases will help clarify the legal 

basis for federal taxation of the disputed claims, thereby supporting future revenue by reducing uncertainty and discouraging future litigation. • Containing primary expenditure to PRs 15,958 billion (13.8 percent of GDP), while preserving space for priority social spending (MEFP ¶5.b). Expected savings relative to the budget include PRs 54 billion from unnecessary energy subsidies reflecting overperformance (¶1), and PRs 188 billion from unused contingency allocations. An additional PRs 87 billion will be withheld from the Public Sector Development Programme (PSDP) allocation as a contingency to cover gaps that could emerge if litigation cases are not resolved favorably or on time, as the timing and outcome of these cases (currently expected in May and June) is uncertain. While fiscally prudent, this measure could slow the implementation of ongoing development projects. Proportional expenditure cuts will be applied in the event of a revenue shortfall (MEFP ¶5.a). 6. Important reforms to improve the fiscal framework and support the planned fiscal consolidation in the coming years are being implemented: • Provincial and Federal Tax reforms. In a significant achievement, provinces have amended their AIT regimes to align with federal income tax rules, with implementation starting January 2025 and collection in September 2025 (end-October 2024 SB). With support from both the World Bank and IMF, provinces are now preparing implementation plans to operationalize the new legislation, including compliance measures and communication/information campaigns (new end-June 2025 SB). Progress also continues on transitioning the goods and services tax (GST) on services to a negative list, effective FY26, and on moving to a capital-based property tax (MEFP ¶5.e). As a pilot initiative, all tax policy proposals for the FY26 budget will undergo cost-benefit analysis, with a full review of tax expenditures also being conducted so that costineffective measures to be phased out starting July 1, 2025 (MEFP ¶7.a). • Strengthening tax administration. Compliance risk management (CRM) systems are now operational in the Large Taxpayer Offices (LTOs) in Islamabad, Karachi, and Lahore (endDecember 2024 SB), and have also been extended to the Corporate Tax Units. The FBR has integrated internal data and will incorporate third-party information, with the final goal of developing an automated CRM system. While the Tajir Dost scheme (FBR initiative to bring traders and retailers into the tax net through simplified registration and fixed monthly tax liabilities) has underperformed, recent increases in withholding taxes on unregistered retailers have yielded positive results, including a 51 percent year-on-year increase in filers among retailers, wholesalers, and traders, and a 38 percent increase in filers with positive tax liabilities as of January 2025. A new indicative target (new IT) on income tax revenue from this group has been introduced to monitor progress on bringing retailers into the tax net. To further improve compliance, a bill has been submitted to Parliament proposing the elimination of the “non-filer” category, which if approved would restrict non-filers from engaging in key economic transactions such as vehicle and real estate purchases. In parallel, efforts to improve compliance 

and expand the tax base will be monitored under a modified QPC on the number of new taxpayers with a positive tax liability. 1 • Federal-provincial fiscal relations. On September 30, 2024, the federal government and all provincial governments signed the National Fiscal Pact (end-September 2024 SB). The pact is an ambitious effort to rebalance spending responsibilities and better align provincial and federal taxation policies. Provinces agreed to the devolution of specific expenditures from the federal to provincial governments in line with the 18th Constitutional Amendment. Provinces have also committed to enhancing tax collection, and implementation efforts are underway. Starting in FY26, all new PSDP projects impacting just one province are expected to be financed directly from provincial budgets (MEFP ¶7.d). The federal right-sizing exercise is progressing, with Phase IV currently underway and implementation of Phase I recommendations nearly complete (September 2024 SB). The right-sizing committee is expected to finalize recommendations for all ministries by end-June 2025. Ambitions over the extent of federal streamlining under the federal government’s right-sizing efforts, however, may need to increase so that they (as outlined in the National Fiscal Pact) correspond to the extent of the reallocation of expenditure mandates under the 18th constitutional amendment. Staff also recommended the authorities develop a framework to guide provincial investment of their accumulated cash surpluses in government securities through non-competitive bidding (MEFP ¶7.e). • Public financial management (PFM). The FY26 budget process was advanced by one month, with the budget circular issued in January, allowing the Ministry of Finance adequate time to engage with ministries and review allocations. To strengthen fiscal monitoring and analysis, monthly and mid-year budget execution reports will be enhanced with more detailed information on execution and the drivers of deviations (MEFP ¶7.g.i). Implementation of PIMA and C-PIMA recommendations remains ongoing, including the introduction of a scorecard to evaluate new development projects and the application of a 10 percent cap on the inclusion of new projects in the PSDP pipeline (end-January 2025 SB) (MEFP ¶7.g.ii). The pipeline has been streamlined, with low-priority projects identified for capping (and removal from the pipeline in FY26) and priority projects expedited for completion in FY25. Cash management is improving, with sweeping arrangements expected to be expanded to cover all current accounts, followed by the inclusion of savings accounts (MEFP ¶7.g.iii). • Spending Transparency. Continued roll-out at the federal and provincial levels of the electronic procurement system (developed with WB support) will improve spending transparency and accountability, especially through public disclosure of beneficial ownership. Access by the National Accountability Bureau and Competition Commission to information in the system and the planned external audit by the Auditor General are also positive developments (MEFP ¶7.h). • Institutionalizing Tax Policy improvements. The Tax Policy Office (TPO) was established within the Ministry of Finance last September as part of efforts to strengthen institutional 1 Previously the QPC monitored all new filers, but many of these returns claim no tax obligation

capacity for tax policy design and analysis. The authorities have requested IMF technical assistance to support the development of short- and medium-term work plans for the TPO (MEFP ¶7.c). While the office is in the early stages of operationalization, the World Bank is providing interim analytical support for budget preparation, including cost-benefit analyses of tax proposals and tax expenditures to be published alongside the budget. • Debt Management. Effective debt management is essential for addressing debt vulnerabilities. Thanks to a favorable market environment, the authorities successfully extended the maturities of domestic debt issuance towards the end of 2024, thereby achieving the end-December 2024 IT. However, approximately 80 percent of domestic debt consists of either short-term or floating-rate instruments, making it highly exposed to interest rate risk. The authorities should revise their medium-term debt management strategy to reflect the current financial and fiscal outlook, aiming to strike a balance between costs and risks. Ideally, the revised strategy should be published before the start of FY26 to inform the annual borrowing plan. Broadening the investor base is key to mitigating debt vulnerabilities given the significant dependence on banks for borrowing. To facilitate this, the authorities should conduct a thorough assessment of the local currency bond market to identify obstacles and opportunities for further market development. Issuance of government guarantees (QPC), including those related to SOEs’ commodity operations, should continue to be contained to limit fiscal risks. B. Poverty Reduction and Social Protection 7. The year’s BISP budget, which is on pace to be fully executed, includes a significant increase in unconditional cash transfer (UCT), an effort which should continue. The larger envelope—a 27 percent nominal increase over FY24—allowed for the January 2025 implementation (structural benchmark) of an increase in the quarterly UCT Kafaalat program benefit from PRs 10,500 to PRs 13,500. This benefit increase included an inflation adjustment, a one-time additional adjustment to increase the stipend’s generosity level (from 9.6 percent of the bottom income quintile’s consumption basket to 12.4 percent), with the absorption of an additional 700,000 families into the program, bringing total enrollment to 10 million this fiscal year. Going forward, it is critical that Kafaalat benefits maintain their purchasing power—another inflation adjustment that would increase the quarterly benefit from PRs 13,500 to PRs 14,500 is planned 

(end-January 2026 new SB) —and that, upon the availability of a new household survey (HIES), the generosity level, which is low by international standards, is again increased gradually towards 15 percent of the bottom income quintile’s consumption basket (MEFP ¶8). Recent improvements in the BISP electronic payment model—in which more banks participate, and users move from limited mandate to full mandate accounts—will provide greater choice and access to beneficiaries (MEFP ¶9). 8. The authorities are also on track to execute the planned conditional cash transfer (CCT) budgets. CCT expansion this year has included an increase in education program enrollment by 1.1 million, to 10.8 million, and an anticipated 500,000 increase in nutrition program enrollment, to 2.5 million. Federal and provincial authorities are coordinating their efforts on BISP and provincial CCT programs, a process which should continue such that (i) CCT programs remain complementary and do not overlap; (ii) there is a common base of users, based on the National Socio-Economic Registry; and (iii) eligibility standards are common across the federal and provincial levels. 9. Efforts need to be strengthened to improve provincial health and education spending capacity. Health and education spending, the large majority of which outside of social support programs is provincial, has declined since 2018. The FY25 budget targeted a modest increase in general government health and education spending to 2.4 percent of GDP. However, execution has fallen short this year, particularly in Sindh and Khyber-Pakhtunkhwa, due to issues related to absorption. Improved health and education outcomes are critical to boosting long-term growth; as such, provinces should improve efforts to execute spending in these areas, for which a similar amount should be allocated for FY26 (MEFP ¶10). C. Monetary, Exchange Rate, and Financial Sector Policies 10. Monetary policy has successfully lowered inflation and needs to remain sufficiently tight to anchor inflation durably inside the SBP’s target range. The MPC’s decision to hold the policy rate in their March 10 meeting was appropriate, allowing time for past rate cuts to feed through to the economy, ward against growing external uncertainty, and minimize the risk of costly policy reversals, especially considering still-elevated core inflation. Changes to central bank communication, particularly greater clarity on the MPC’s assessment of the current and desired policy stance, have been welcome and should continue to help the public better understand the MPC’s reaction function to incoming data, and guide expectations between meetings. The revised regulations concerning SBP’s collateral framework and counterparty eligibility policy, in line with the recommendations of the 2023 Safeguards Assessment, to become effective in July 2025, will help mitigate financial and reputational risks arising from monetary policy operations (MEFP ¶14) . 11. Reserve rebuilding through FX purchases should continue while the interbank FX market should be deepened. The reserve buildup during FY25H1 is welcome and should continue as buffers still remain low for Pakistan’s conditions. Notwithstanding this improvement, underlying structural vulnerabilities persist in Pakistan’s economy, and the authorities should monitor the recent REER appreciation to avoid eroding competitiveness. Exchange rate flexibility remains necessary to support external rebalancing and resilience to shocks. In addition, efforts should continue to deepen 

the FX market. Banks continue to satisfy their FX inflows and outflows mostly in house, minimizing reliance on the interbank market, resulting in low turnover volumes. Banks, both those on the longand short-side of the market, should more actively see the interbank FX market as the most effective way to manage their positions, regardless of the extent of market liquidity, and this will lead to a deeper interbank FX market. Staff continue to recommend unwinding the January 2022 shortening of the period of repatriation of export proceeds (which is assessed as an outflow CFM according to the IMF Institutional View on the Liberalization and Management of Capital Flows) once macroeconomic and BOP stability is being restored. 2 12. Progress has been made in addressing undercapitalized financial institutions, which will further bolster financial stability. Significant strides have been made toward the recapitalization of two undercapitalized private banks (MEFP ¶16.b): One of these banks has completed a merger with a larger bank, and the consolidated entity is compliant with capital requirements. The shareholders of the second bank are executing their multi-step recapitalization plan. Since the plan of the second bank was not in place by end-October 2024 and lacked legally binding status, the end-November 2024 SB was missed. However, the shareholders of the second bank have given their regulator, the SBP, an unconditional commitment to fully align this bank’s capital with the minimum requirement by end-April 2025. If the bank fails to meet the prescribed capitalization requirements by end-April, the SBP is ready to exercise its powers to put the bank under resolution. Beyond these two private banks, an undercapitalized public bank was put into liquidation and its license was revoked in December 2024. In the microfinance banking sector, the SBP should continue to engage with owners and potential investors to address capital shortfalls, with five of twelve microfinance banks remaining undercapitalized. Following the approval of the amendments to bank resolution and deposit insurance legislation in October 2024 (end-October 2024 SB), the SBP should now develop the necessary operational toolkit to implement the new framework through the recently established “Financial Institutions Resolution Unit” (MEFP ¶16.a). 13. Clarity on the structure and ground rules of the financial system post-2027 will allow market participants to prepare and to ensure financial stability during the transition. The authorities’ financial sector strategy should clearly identify and prepare for the implications of the mandated removal of ‘riba’ (interest) from the economy by January 2028, following the 26th constitutional amendment in October 2024, which would have significant implications for the structure of the financial sector, financial stability, banking supervision and monetary policy implementation (MEFP ¶16.d). Publication of this plan and all necessary guidance will help align the expectations of market participants, investors, and regulators, allow them time to prepare, and mitigate concerns about any possible cliff effect (proposed new SB, end-June 2026). More broadly, the authorities should develop a strategic action plan to support further capital market development to address the sovereign-bank nexus and improve access to private sector financing. Finally, AML/CFT effectiveness should be enhanced with respect to risk-based supervision, beneficial ownership transparency, and risk mitigation of trade-based money laundering (MEFP ¶16.e). 

Energy Sector Policy 14. Timely tariff adjustments have improved the power sector but need to be supplemented by structural reforms to restore the sector’s viability. • The end-June 2025 CD flow IT has been tightened, from PRs 417 billion to PRs 337 billion, given strong overperformance in FY25H1, over FY24 (PRs 457 billion, 0.4 percent of GDP).3 This overperformance reflects lower than anticipated interest rates and, importantly, the early initial impact of reforms to strengthen tariff payment/collection. Achieving the revised target will require timely notification of remaining quarterly tariff adjustments and monthly fuel cost adjustments; continued effort on collection; improved performance on loss prevention; and the disbursement of remaining budgeted subsidies of PRs 353 billion. Recent reform actions aimed at reducing costs in the sector in the near term—including the application of the Captive Power Transition Levy (CPL, ¶15) and the renegotiation of some independent power producer (IPP) contracts—as well as a temporary and limited subsidy (ending June 2026) across all non-lifeline consumer categories (MEFP¶20.c) to bring forward some reform benefits already evident, should also help reduce pressure on tariffs and thus both the non-payment of bills and CD pressures. Going forward, timely notification of the annual rebasing for FY26, set at cost recovery and incorporating cautious assumptions that take account of the sensitivity of costs to internal and external factors (July 1, 2025, new SB), is critical. • The authorities are also implementing a plan to convert most (up to 80 percent) of the existing CD stock (effectively CPPA payment arrears) to CPPA debt through a new sukuk which, given low interest rates, would reduce the financial burden on the power sector (MEFP¶20.b). The operation will significantly reduce interest charges on arrears, which in recent years have comprised nearly half of CD flow. CD targets have consequently been set lower for FY26H1—it is anticipated that, with this operation and other reforms cited below, CD flow should continue to decline through the end of the operation (repayment of the sukuk) in FY31, and with it the need for budgeted power subsidy (a third of which is currently dedicated to CD stock clearance). It is imperative, given limited fiscal space, that payments for the operation are entirely financed out of the existing debt service surcharge (DSS). While DSS flows are expected to fully cover payments, the authorities must remove the existing DSS cap (end-June 2025 new SB) to ensure that the DSS can be adjusted if needed to cover payments should there be any shortfall. • These efforts should be supported by fundamental structural reforms to restore the power sector to viability. Key measures include continued progress on DISCO privatization and/or moves toward private concessions to improve DISCO performance and services; sustained efforts to shift captive power to the electricity grid (¶15); complete the restructuring of the National Transmission Dispatch Company to improve efficiencies; privatizing inefficient public generation companies; and making further gradual progress toward a competitive electricity market (MEFP ¶20.d). The authorities have committed to ensure that implementation these reforms will bring the flow of any new CD to zero by FY31 (when the above stock operation ends) at the latest (MEFP ¶20.b). 

15. Gas tariffs should continue to be adjusted on time in line with revenue requirements while further progress is made on CD monitoring and shifting CPPs to the electricity grid. • The large gas CD stock warrants vigilance with regard to on-time tariff adjustments in line with sectoral revenue requirements, while maintaining a progressive tariff structure, including ahead of the next adjustment in mid-2025 (July 1, 2025, and February 15, 2026 new SBs). The authorities should maintain momentum on the significant progress over the past year in developing a well-defined data set of CD statistics for monitoring purposes. The next step would be the start of regular quarterly CD reporting, creating the basis for a gas sector CD Management Plan (CDMP). These tools would allow the authorities to pinpoint the sources of CD flow and further guard against fiscal and financial risks in the sector. • The shifting of CPPs to the electricity grid—to boost grid demand while preserving scarce gas resources to more efficient gas-based power generators— remains a reform priority for the sector. The cutoff of CPPs from gas supplies did not happen at end-January 2025 as planned, partly because approximately a quarter of CPPs were not operationally ready to move to the grid. As an alternative, the authorities decided to use the price mechanism to incentivize the shift to the grid. Specifically, a CPL was introduced on February 1, 2025, which set the price of all gas for CPPs equivalent to the industrial grid plus a 5 percent levy; the levy will increase by an additional 5 percent every six months until it reaches 20 percent in August 2026. Levy proceeds—the difference between the actual price (levy included) and the OGRA-determined CPP gas price—will be transferred to the electricity grid to reduce the average effective grid tariff (evenly across the existing tariff structure). In support this effort, the authorities have made Pakistan: Power Sector Total Fiscal Cost, FYs19– 25 (Billions of Pakistani rupees) Power Prices, June 2020–March 2025 (Notified weighted-average, post-subsidies, pre-tax price in PRs per kWh) Sources: Pakistani authorities; IMF staff calculations. 1/ Inter-DISCO tariff differential subsidy and special subsidy packages. 2/ Repayment of CPPA arrears to IPPs and GPPs and amortization of PHPL debt. 0 750 1,500 2,250 0 250 500 750 1,000 1,250 FY19 FY20 FY21 FY22 FY23 FY24 FY25p TDS and other 1/ CD stock operations 2/ CD stock change CD stock (RHS) Budget subsidy CD flow -5 0 5 10 15 20 25 30 35 40 45 Jun-20 Aug-20 Oct-20 Dec-20 Feb-21 Apr-21 Jun-21 Aug-21 Oct-21 Dec-21 Feb-22 Apr-22 Jun-22 Aug-22 Oct-22 Dec-22 Feb-23 Apr-23 Jun-23 Aug-23 Oct-23 Dec-23 Feb-24 Apr-24 Jun-24 Aug-24 Oct-24 Dec-24 Surcharge Base tariff QTAs Monthly FCAs PAKISTAN INTERNATIONAL MONETARY FUND 19 progress in facilitating service-level agreements between DISCOs and CPPs, and this should continue as quickly as possible so that CPPs can reliably use the grid. The CPL was introduced as an ordinance, but to ensure the CPL becomes permanent, the authorities must pass CPL legislation through parliament (end-May 2025 new SB).

E. Other Structural Policies 16. Continued efforts to strengthen governance, SOE management, and private sector development are necessary for generating sustainable growth, improving living standards and social outcomes: • Governance Diagnostic Assessment (GDA) (MEFP ¶25.a). The target date of the publication of the GDA report (supported through IMF TA) faced operational delays related to the identification of a focal point (proposed resetting of end-July 2025 SB to end-August 2025). In addition to publication of the GDA, the authorities are also committed to publish their action plan to implement the GDA’s recommendations (proposed new SB, end-October 2025). • Strengthening the effectiveness of anti-corruption institutions (MEFP ¶25.b-e). The authorities are working to enact legislation to publish asset declarations of high-level public officials, but additional time is needed owing to delays in the legislative process (proposed resetting of end-February 2025 SB to end-June 2025). Cabinet agreement to publish the full UNCAC Review Report is expected after an assessment of the relevant cabinet committee led by the Law Ministry. Banks’ access to asset declarations for AML/CFT purposes has been enhanced with FBR’s launch of new digital portal, and future access will also include high-level provincial public officials. Provincial anti-corruption establishments will be authorized to receive and request financial intelligence from the Financial Monitoring Unit in relation to corruption-related investigations. • Ensuring that all SOEs are subject to the SOE Act and SOE Policy. This includes amending the laws of nine remaining statutory SOEs to bring them into line with the SOE Act (end-June 2025 SB). 4 Operationalization of the SWF should occur only after governance safeguards for the SWF and SOEs transferred to it are brought on par with the new SOE governance framework and international standards and best practices on SOE holding companies and public asset management. Needed amendments to the SWF Act should include (i) clarifying the SWF’s mandate and strengthening its governance arrangements; (ii) requiring transparent and competitive procedures for divestment and procurement; (iii) ensuring that appropriate fiscal safeguards are in place, and (iv) subjecting SWF-SOEs to the SOE Act (MEFP ¶23.b; end-March 2026 proposed reset SB).

• SOE transparency and governance It is critical that the new SOE Act and Policy are fully implemented to limit losses, improve public services, protect public assets, reduce the state’s role and enhance accountability. Some progress has been made, with development partner support, establishing business plans, statements of corporate intent, and published and audited financial statements and annual reports for all SOEs, as well as on the identification and contracting of public service obligations with the government. These efforts should be accelerated, including via the revision of manuals and issuance of supplementary guidance notes, in line with development partner recommendations. Greater progress is also needed in establishing majority-independent boards; this is currently the case for only about half of commercial SOEs. Finally, the Central Monitoring Unit (CMU) should continue to refine its electronic database to meet all reporting requirements under the SOE Act and ensuring that its reporting is in line with OECD best practice. • Interventions in commodity markets (MEFP ¶24). The authorities refrained from wheat procurement operations during the past year and in absence of government-imposed support prices, consumers have seen large benefits as reflected in subdued food inflation. Meanwhile, provinces have paid off most of the legacy debt related to commodity operations, and the authorities are working towards a new food security framework for wheat that will neither create distortions in the market nor jeopardize fiscal sustainability. While these steps are welcome, the authorities should broaden their efforts to other commodities, including by reviewing the relevant legislation and empowering competition authorities, to enable an agile and competitive agricultural sector that also serves the needs of consumers. • Trade and Industrial Policy. Addressing the anti-export bias resulting from restrictive trade policies and an ineffective tariff structure is central to unlocking Pakistan’s competitiveness and attracting private investment (MEFP ¶¶26–28). The new National Tariff Policy (FY25–30) should substantially streamline and reduce tariffs (customs and regulatory duties) and reduce nontariff barriers and move away from the regime of special duties applied to imports for particular industries. Trade barriers are particularly extensive in the automotive sector, and the next iteration of the automobile policy (covering FY26–31), on which consultations are still ongoing, should reduce tariffs and preferential support for local production. Ahead of this, the authorities will remove the existing ban on commercial imports of used vehicles (new end-July 2025 SB for submission of legislation). Where contractual provisions allow, ineffective incentives for Special Economic Zones (SEZs), Export Processing Zones (EPZs), Special Technology Zones (STZs) and any other industrial zone or park should be phased out (end-June 2025 SB and new endDecember 2025 SB for comprehensive implementation plans for SEZ/EPZ and STZ/other zones, respectively) and no new special zones should be created. • Strengthening the macroeconomic statistics. Efforts to enhance the national accounts continue, with the PBS publishing quarterly estimates of the expenditure side for the first time in December. Field work for three major surveys (Agricultural Census, Labor Force Survey, and Household Integrated Economic Survey) is at an advanced stage, and results will be published by end-December (MEFP ¶29), which will help address important gaps in the economic statistics

and be an important input for the upcoming GDP rebasing. More broadly, preparations are underway for three other major surveys (the Family Budget Survey, and surveys of both large and small-scale manufacturing) in FY26, and to commence monthly data collection from July 2025 for a new producer price index. RSF ARRANGEMENT: BOOSTING CLIMATE RESILIENCE 17. Pakistan is highly exposed to extreme weather events, creating significant macroeconomic, fiscal, and development risks (Figure 4, Annex II.A). Analysis suggests that steps to build resilience would buffer Pakistan from climate-related growth and balance of payments shocks: for instance, an additional 1 percent of GDP in investment in climate adaptation and resilient infrastructure per year for five years would reduce the negative impact of a natural disaster shocks on growth by about half, five years after the shock and would allow a much quicker return of the economy to the previous GDP level (Annex III). Importantly, it will reduce the humanitarian impact (loss of lives, and displacement of people) such shocks have, most recently evidenced by the catastrophic 2022 floods. In addition, Pakistan's large greenhouse gas emissions, driven by the agriculture and energy sectors, have nearly doubled in 30 years, placing Pakistan among the world's top emitters. Pakistan’s main source of energy consumption is fossil fuels, with weak energy policies (including, until recently, underpricing, as well as large subsidies) exacerbating inefficient energy use. (Figure 4, Annex II.B). 18. The authorities have ambitious international climate commitments and national adaptation plans. The 2023 National Adaptation Plan sets Pakistan's sectoral adaptation agenda across sectors (Annex II.D) and the authorities are working with development partners on its implementation, as well as on strengthening policy gaps in areas identified by diagnostics (including the IMF’s 2023 C-PIMA, the World Bank’s 2022 Country Climate Development Report, and the Asian Development Bank’s 2024 Climate and Disaster Resilience Enhancement Program) such as disaster risk management, public financial management, and climate finance (Annex II.D, H). Mitigation policies follow Pakistan's 2021 Nationally Determined Contribution (NDC), which sets a 15-50 percent reduction target (below business-as-usual emission levels) and ambitious transportation transition for Pakistan by 2030 (Annex II.E). 19. The authorities' RSF request aims to support their efforts to address key gaps in adaptation and mitigation policies, while focusing on macro-critical and/or transformative reform measures. The RSF will help the authorities address long-standing vulnerabilities to climate shocks; build economic resilience and prospective balance of payments stability by complementing ongoing policy efforts; and catalyze support from other multilateral and regional partners and private sector investment by strengthening Pakistan’s green investment enabling environment. In particular, the RSF package will reduce balance of payments stability risks stemming from its climate vulnerabilities by (i) strengthening public investment and budget planning processes at all levels of government to assess and prioritize projects that build resilience to natural resources (RMs 1, 2, and 3); (ii) advancing the more efficient use of scarce water resources, including through improving water pricing practices (RMs 4 and 5); (iii) strengthening federal-provincial coordination of naturaldisaster risk financing (RM 6); (iv) improving Pakistan’s climate information architecture and disclosure of climate-related risks by banks and corporates to improve the enabling environment for climate finance (RMs 7 and 8); and (v) shifting away from imported fuels/petroleum products via decarbonization (RMs 9, 10, and 11). Other reform measures (RMs12 and 13) will support Pakistan’s efforts, as a major emitter, to meet its mitigation commitments and reduce related macro-critical risks. Reform Area 1: Mainstreaming Climate Issues in Budget and Investment Planning 20. The RSF will support the authorities’ efforts to boost climate’s prominence in Pakistan’s PIM and budget processes. Doing so will help Pakistan better identify and target projects facilitating the adaptation investment required to boost resilience to climate shocks (¶19, Annex III), as well as those to support Pakistan meet its NDC commitments. This will include increasing the weight of climate elements in PSDP selection for infrastructure projects (RM1, MEFP ¶32); revising public investment management (PIM) policies such that, for potential projects costing PRs 7.5 billion or more, only those that have gone through climate assessments will be included in the PSDP (RM2, MEFP ¶32); and, building on initiatives already undertaken at the federal level to introduce and expand green budgeting, take measures to enhance federal green budgeting transparency and expand green budgeting practices to provincial governments (RM3, MEFP ¶33). These RMs fills gaps in the authorities’ C-PIMA Action Plan adopted in December 2023 (a completed SB under the 2023-24 Stand-By Arrangement), on which much progress has already been made. Reform Area 2: Improving Water System Resilience and Disaster Response Financing 21. Measures to improve irrigation water pricing and revenue collection will bolster water management and infrastructure. Pakistan’s irrigation system suffers from weak revenues and irregular tariff adjustments, which hinders cost recovery and limits provinces’ ability to cover operational and maintenance expenditures. This, in turn, drives low service standards, poor reliability and supply adequacy; problems related to waterlogging, soil salinization, groundwater depletion; and, ultimately, water insecurity and low irrigation productivity, leaving Pakistan more exposed to climate shocks (Annex II ¶4, Annex II. Figure 7). In addition, artificially low irrigation water tariffs discourage efficient water use. To this end, the RSF will support the digitization of revenue collection processes for irrigation authorities in three provinces, following the successful recent example of Punjab (RM4, MEFP ¶34); and the introduction of an irrigation water tariff adjustment mechanism in Punjab and Sindh (RM5, MEFP ¶34), which represent the large majority of Pakistan’s agricultural production. Such reforms would be expected to allow for improved water distribution efficiency, and thus an improved delivery system. 22. Improving coordination capacity on disaster risk financing (DRF) will fill a gap in Pakistan’s disaster risk management (DRM) framework. DRM practices between the federal and provincial governments are inconsistent, and federal-provincial DRM and DRF coordination remains a key challenge that is not currently covered by development partners’ engagement on the issue (Annex II. ¶21). RM6 (MEFP ¶35) will support the adoption of an implementation framework for the authorities’ National Disaster Risk Financing Strategy (NDRFS). It will establish a coordination

mechanism that consolidates federal and provincial DRF needs and facilitates smooth national disbursement of disaster financing and access to appropriate financing instruments in the event of a relevant shock, plugging a gap in Pakistan’s existing DRM framework. Reform Area 3: Strengthening the Climate Information Architecture and Management of Climate-related Financial Risk 23. The RSF will support Pakistan’s green finance agenda by strengthening the enabling environment for green investment. Reforms under the RSF will include (i) improving climate-related financial risk management and supervision; and (ii) adopting and implementing Pakistan’s green taxonomy, which is currently in development with the World Bank and is anticipated to be completed by end-June 2025. Specifically, the SBP will issue guidelines for the implementation of climate-related financial risk management and supervision, in line with 2022 BCBS principles and applicable to supervised commercial banks (RM7, MEFP ¶36); and the SECP will develop guidelines based on a phased approach to enable listed companies to disclose climaterelated risks and opportunities information, including taxonomy-aligned data (RM8, MEFP ¶37). This should support adaptation by allowing banks and private firms to incorporate climate-related risk considerations into their risk management and investment activities. Reform Area 4: Promoting Green Mobility and Transport Decarbonization 24. Reforms will shift Pakistan further support decarbonization and support its transition to greener and less polluting transportation in the process delivering significant CO2 emissions reductions. The authorities will do this by adopting a carbon levy via the FY26 Finance Act (RM9, MEFP ¶38), to be phased in over two years for gasoline and diesel products, and to be applied to fuel oil as well, disincentivizing fossil fuel use (especially the use of ICE vehicles and heavy-polluting fuel oil in electricity generation). Possible distributional impacts of this levy would be counterbalanced by annual BISP UCT benefit inflation adjustments for inflation ¶7). The RSF will also help to implement the authorities' new 2025-30 New Energy Vehicle (NEV) Policy which seeks to, in line with NDCs, ensure 30 percent of new vehicles are EVs by 2030. This will include a subsidy scheme for EVs combined with a supplementary sales tax on ICE vehicles (RM10, MEFP ¶38), calibrated in a revenue-neutral fashion and in line with Pakistan's NDC targets for new EV uptake; and a viability gap funding framework to promote the private sector development of the necessary charging station infrastructure in Pakistan via one-off subsidies (RM11, MEFP ¶38), with modalities to be determined in line with FAD recommendations. The Fund’s Climate Policy Assessment Tool (CPAT) and associated transport module suggest that, taken together, by 2030 these policies would reduce emissions by 9.6 MtCO2e per year relative to the current policy scenario and support Pakistan meeting its NDC commitments (Annex II. ¶14, Figure 15). 5 The emission reduction is equivalent to a 4 percent reduction from the baseline CO2 emission in 2030. Beyond the climate

impact, these reforms should significantly reduce the heavy health impact from the high level of pollution in a number of Pakistani cities. Reform Area 5: Aligning Energy Sector Reforms with National Climate Mitigation Commitments 25. Reforms to power subsidies and improvements in energy efficiency will reduce regressive overconsumption, losses, and wastage. Pakistan's energy subsidies are poorly targeted, resulting in overconsumption among upper income quintiles. The RSF will support transferring power (RM12, MEFP ¶39) subsidies from the budget and tariff structure to budgetfinanced, targeted subsidies delivered through BISP. This will support the poorest forty percent of energy consumers while wealthier consumers will face higher tariffs, providing an incentive to conserve energy. The RSF will also support (RM13, MEFP ¶40) the implementation of recently adopted requirements that new electric appliances entering the market (specifically fans, LEDs, refrigerators, air conditioners, and motors) meet minimum energy performance standards (MEPS) by setting targets for each by the end of the RSF; and by ensuring that MEPS for these five appliances are applicable in all public procurement. This is expected to deliver large energy savings and spur efforts for similar efficiency adoption in the private sector, thereby complementing the energy pricing efforts in RMs 9 and 12. PROGRAM MODALITIES 26. Updates to EFF-related conditionality are proposed to guide program implementation in the coming year (MEFP Tables 1-2): • Modifications to end-June targets. The PCs on the floor on the SBP’s net international reserves and the ceiling on net domestic assets of the SBP are proposed to be tightened, to lock in progress in rebuilding reserves and containing monetary aggregates. The end-June PC on the floor on the number of tax returns is proposed to be raised given the sharp increase already achieved by January, and the definition of new tax returns has been narrowed. Similarly, the IT on power sector payment arrears is proposed to be tightened to lock in progress in containing arrears through February. Conversely, the PC on the general government primary deficit and the IT on net tax revenues collected by the FBR are proposed to be reduced in line with the revised outlook for nominal GDP growth. Finally, the IT on net tax revenues from the Tajir Dost is proposed to be replaced by a new IT on income tax revenues collected by the FBR from retailers. • New quantitative targets. New PCs and ITs are proposed for end-September 2025 and endDecember 2025 consistent with the EFF objectives, including supporting revenue mobilization and fiscal adjustment, containing inflationary pressures and bolstering FX reserves. • Structural Benchmarks. Test dates for four SBs (including two of the missed SBs) whose implementation has been delayed are proposed to be reset. New SBs are proposed covering critical areas of the authorities’ agenda for the next year, including fiscal structural reforms, governance, the energy sector, and trade liberalization.

27. RSF Access, Phasing and Modalities. Pakistan is eligible for RSF financing (Group C). Access is proposed at 49.2 percent of quota (SDR 1,000 million), in line with the overall strength and quality of the reform package and Pakistan’s sustainable debt and capacity to repay. Access would begin in parallel with the second review of the EFF and continue over the remaining reviews of the EFF. Reform implementation will be monitored through semiannual reviews concurrent with EFF reviews. The proposed RSF will be used as budget support, creating fiscal space to address Pakistan’s climate vulnerabilities and substituting for more expensive domestic commercial financing. Disbursements will increase reserves and thus improve the balance of payments. 28. Financing. The program is fully financed, with firm commitments for the next 12 months and good prospects for the remainder of the Fund-supported program (Text Table). Substantial progress has been made in realizing financing committed ahead of the EFF request, with US$2.6 billion already disbursed or expected to disburse in the coming months, including from Saudi Arabia, the Islamic Development Bank, and a commercial loan backed by an ADB-partial guarantee. Firm commitments are also in place for an additional US$1 billion of financing in the next 12 months. Key bilateral partners remain committed to rolling over existing short-term liabilities in the remaining program period.

29. Enterprise risks are broadly unchanged from the time of approval of the EFF request. Program performance to-date, complemented by ongoing reforms and new commitments for this review, demonstrates the authorities’ strong ownership and keeps business risks in check, though residual risks to program performance persist (¶4). While the new RSF will increase the Fund’s financial exposure, it would help mitigate financial risks by supporting improved resilience to withstand the impact of climate change, and also reduce business risks by addressing critical challenges of a member country. 30. Capacity to repay. Pakistan's capacity to repay the Fund has improved somewhat but remains subject to significant downside risks and critically dependent on policy implementation and timely external financing. The Fund’s exposure would peak at SDR 9,466 million in September 2027 (466 percent of quota and about 51 percent of projected gross reserves in 2027). Pakistan’s outstanding debt to the Fund as a percent of gross international reserves is above the 75 percentile of comparator countries. The three flow indicators (i.e., debt-service to the fund as a percent of government revenues, exports, and gross international reserves) are all above the 75 percentiles of the comparator group, indicating significant risks (Figure 5). Risks to consistent policy implementation include resistance to adoption of reforms, underperformance of tax revenue, high gross financing needs, low gross reserves, and sizeable net FX derivative position of the SBP, coupled with sociopolitical tensions, which could erode repayment capacity and debt sustainability. Uncertainty about global geoeconomic and financial conditions in major trading partners adds to these risks. Adequate and timely execution of the firm and credible financing assurances from official creditors remains essential to mitigate these risks. STAFF APPRAISAL 31. Commendable program implementation has restored economic stability and is laying the foundations for sustainable economic growth. The economic turnaround since the approval of the 2023 SBA has been impressive, and the ongoing EFF-supported program is helping the authorities address deep seated structural challenges and navigate a difficult external environment. However, the gains are still fragile, and policy and reform efforts need to be sustained to strengthen public finances, rebuild external buffers, improve the provision of critical public services, and create a favorable environment for private sector led growth. 32. The authorities' frontloaded revenue mobilization effort under the EFF and commitment to meet the FY25 primary surplus target demonstrate the government’s commitment to tackling key economic vulnerabilities. The full implementation of ongoing fiscal reforms are the only way to bolster fiscal sustainability. Strict adherence to the FY25 budget will help reduce risks to macroeconomic stability and fiscal sustainability. Efforts should also continue to improve revenue administration, including by ensuring effective implementation of tax policy, and to broaden the tax base by addressing under-taxed sectors and reducing compliance gaps. In this regard, the legislative approval of AIT by provinces and the new National Fiscal Pact are major achievements, which along with continued reforms in areas such as property taxation and the rationalization of tax expenditures, will support a more equitable and efficient tax system. In parallel,

preserving social assistance while curtailing non-priority spending, right sizing the federal government, prioritizing productive public investment, and enhancing public financial management will be important to optimize the use of scarce public resources. Diversification of the investor base for government securities is also important to help unwind the sovereign-bank nexus and reduce the crowding-out of private sector financing. Steadfast implementation of these efforts will lay the basis for meeting the fiscal objectives for the coming years, strengthening public finances, and bolstering debt sustainability. 33. The SBP has skillfully managed to lower inflation, and monetary policy should remain appropriately tight and data-dependent to ensure that inflation is anchored within the SBP’s target range. While the reduction in headline inflation has been impressive, core inflation remains elevated and the SBP should continue to calibrate monetary policy carefully, removing monetary restraint gradually and contingent on clear evidence that inflation is firmly anchored within the SBP’s target range. Effective communication will help the public better understand the MPC’s reaction function and build support for its policy decisions. 34. A more flexible exchange rate should be an integral part of Pakistan’s policy framework, facilitating a smooth adjustment of the economy in the face of external and domestic shocks. The SBP needs to continue efforts to deepen the interbank FX market, which will facilitate international transactions and trade, while also enabling effective price discovery. Thanks to SBP’s sustained efforts gross international reserves have increased significantly since mid-2023, and they should continue to build reserve buffers to more comfortable levels, helping bolster confidence and increasing Pakistan’s resilience to external shocks. 35. The authorities need to remain proactive on their financial sector agenda. Completing the process of addressing undercapitalized financial institutions is essential, with the SBP exercising its powers as needed under the upgraded resolution framework. The remaining Safeguards Assessment recommendations—clarifying the prohibition on quasi-fiscal activities in legislation and filling SBP senior management positions—should also be implemented quickly, while clarity around anticipated changes in the post-2027 regulatory and institutional framework would help ensure a smooth transition. 36. Protecting the most vulnerable and building human capital is vital to long term and inclusive growth. The authorities’ commitment to maintaining UCT benefits in real terms and gradually increasing its generosity and coverage is welcome and should continue. Efforts are needed to ensure complementarity between BISP and provincial CCT programs, with consistent eligibility and generosity. Efforts to absorb greater provincial health and education spending need to improve. 37. Timely energy tariff adjustments have supported a marked improvement in the energy sector finances and must be complemented by broader reforms to restore energy sector viability and competitiveness. Continued power and gas tariff adjustments in line with cost recovery should be combined with medium- and long-term reforms to improve distribution governance and management, transmission, and generation operations; coordination between DISCOs and CPPs to ensure the latter move to the electricity grid; and follow-through on gas CD

monitoring developments to boost planning capacity. Full implementation of the new CPL is a key part of this process. 38. Advancing structural reforms is critical to generate sustainable and inclusive growth. Full implementation of the SOE governance framework, and the inclusion of all SOEs within that framework, is crucial to improving their performance and reducing fiscal risks. Governance frameworks should continue to be strengthened to enhance transparency and accountability and mitigate risks of undue influence and corruption in policy making and implementation. The new national tariff and auto sector policies should set an ambitious course for reducing protection from external competition, which combined with ending subsidies, concessions, and preferences are critical to the unlocking of Pakistan’s competitiveness and attracting new higher-productivity private investment. Ongoing efforts to improve the macroeconomic statistics will support more informed policymaking, including by providing a better basis for assessing the adequacy of social support. 39. Pakistan’s high vulnerability to climate-related shocks and status as a large emitter pose significant macroeconomic risks and challenges, which the proposed RSF-supported program aims to address. The authorities have made strong progress in addressing many of these challenges in recent years but large gaps, and thus vulnerabilities remain. The RSF is designed to help Pakistan bolster its macroeconomic resilience via better incorporation of climate considerations into PIM and budgeting processes at the federal and provincial levels; strengthening water management and infrastructure; improving federal-provincial DRF coordination; and enhancing the climate finance enabling environment by improving the information architecture; while at the same time addressing mitigation commitments and related macroeconomic risks through climate-relevant energy sector reforms and efforts to decarbonize the transport sector. 40. Risks remain elevated amidst rising global uncertainty. External risks are increasing, notably from the economic and financial impact of the April 2 US tariff announcements and subsequent market reaction, broader geopolitical tensions and elevated global economic policy uncertainty, with potential spillovers to (already tight) global financial conditions and commodity prices. Domestic political economy pressures to unwind and delay reforms remain present and may intensify, which would quickly eviscerate Pakistan’s hard-won economic stability. 41. On the basis of the authorities’ program implementation and policy commitments, staff supports their request for completion of the first review under the EFF and for an RSF arrangement. Staff also supports the authorities’ request for modification of performance criteria under the EFF.