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SECOND AND FINAL REVIEW UNDER THE STAND-BY ARRANGEMENT—PRESS RELEASE; STAFF REPORT; AND STATEMENT BY THE EXECUTIVE DIRECTOR FOR PAKISTAN In the context of the Second Review Under the Stand-by Arrangement, the following documents have been released and are included in this package: • A Press Release including a statement by the Chair of the Executive Board. • The Staff Report prepared by a staff team of the IMF for the Executive Board’s consideration on April 29, 2024 following discussions that ended on March 19, 2024, with the officials of Pakistan on economic developments and policies underpinning the IMF arrangement under the Stand-By Arrangement. Based on information available at the time of these discussions, the staff report was completed on April 8, 2024. • A Statement by the Executive Director for Pakistan.

The IMF Executive Board completed the second review under the Stand-By Arrangement (SBA) for Pakistan, allowing for an immediate disbursement of SDR 828 million (around $1.1 billion), bringing total disbursements under the arrangement to SDR 2.250 billion (about $3 billion). The completion of the second and final review reflects the authorities’ stronger policy efforts under the SBA, which have supported the stabilization of the economy and the return of modest growth. • To move Pakistan from stabilization to a strong and sustainable recovery the authorities need to continue their policy and reform efforts, including strict adherence to fiscal targets while protecting the vulnerable; a market-determined exchange rate to absorb external shocks; and broadening of structural reforms to support stronger and more inclusive growth. Washington, DC – April 29, 2024: Today, the Executive Board of the International Monetary Fund (IMF) completed the second and final review of Pakistan’s economic reform program supported by the IMF’s Stand-By Arrangement (SBA). The Board’s decision allows for an immediate disbursement of SDR 828 million (around $1.1 billion), bringing total disbursements under the arrangement to SDR 2.250 billion (about $3 billion). Pakistan’s 9-month SBA, approved by the Executive Board on July 12, 2023, successfully provided a policy anchor to address domestic and external imbalances as well as a framework for financial support from multilateral and bilateral partners. The program focused on (i) necessary fiscal adjustment and maintenance of debt sustainability via FY24 budget implementation; (ii) protection of critical social spending; (iii) buffering external shocks and eliminating FX shortages by returning to proper FX market functioning; (iv) making progress on disinflation by maintaining a tight monetary policy; and (v) furthering progress on structural reforms, focused on energy sector viability, SOE governance, and climate resilience. Macroeconomic conditions have improved over the course of the program. Growth of 2 percent is expected in FY24 given continued recovery in the second half of the fiscal year. The fiscal position continues to strengthen with a primary surplus of 1.8 percent of GDP achieved in the first half of fiscal year 2024, well ahead of projections and putting Pakistan on track to achieve its endFY24 target primary surplus of 0.4 percent of GDP. Inflation, while still elevated, continues to decline, and, with appropriately tight, data-driven monetary policy maintained, is expected to reach around 20 percent by end-June. Assuming ongoing sound policies and reform efforts, inflation should return to the SBP’s target with growth continuing to strengthen over the medium term. Gross reserves have increased to around $8 billion, up from $4.5 billion at the start of the program, and are projected to continue being rebuilt over the medium term. Following the Executive Board discussion, Antoinette Sayeh, Deputy Managing Director and Chair, made the following statement:

“Pakistan’s determined policy efforts under the 2023 Stand-By Arrangement (SBA) have brought progress in restoring economic stability. Moderate growth has returned; external pressures have eased; and while still elevated, inflation has begun to decline. Given the significant challenges ahead, Pakistan should capitalize on this hard-won stability, persevering—beyond the current arrangement—with sound macroeconomic policies and structural reforms to create stronger, inclusive, and sustainable growth. Continued external support will also be critical. “The authorities’ revenue performance, as well as federal spending restraint, helped achieve a sizeable primary surplus in the first half of FY2024, in line with program targets. Continued revenue mobilization efforts and spending discipline at both federal and provincial levels remain critical to ensure that the primary surplus target is achieved. Beyond FY2024, continued fiscal sustainability and additional space for social and development spending depend on further mobilizing revenues, especially from non-filers and undertaxed sectors, and on improving public financial management. “The authorities have stabilized the energy sector’s circular debt over the course of the SBA through timely tariff adjustments and enhanced collection efforts. While these actions need to continue, it is also critical that the authorities undertake cost-side reforms to address the sector’s underlying issues and viability. “The State Bank of Pakistan’s tight monetary policy stance remains appropriate until inflation returns to more moderate levels. Further improvements in the functioning of the foreign exchange (FX) market, together with a market-determined exchange rate, will help buffer external shocks and attract financing, thereby supporting competitiveness and growth. The significant rebuilding of FX reserves under the SBA needs to continue. Moreover, stronger action to address undercapitalized financial institutions and, more broadly, vigilance over the financial sector are needed to ensure financial stability. “Achieving strong, long-term inclusive growth and creating jobs require accelerating structural reforms and continued protection of the most vulnerable through an adequately-financed Benazir Income Support Program. Priorities include advancing the reform of state-owned enterprises (SOEs), including to ensure that all SOEs fall under the new policy framework; strengthening governance and anti-corruption institutions; and continuing to build climate resilience.

SECOND AND FINAL REVIEW UNDER THE STAND-BY ARRANGEMENT EXECUTIVE SUMMARY Recent developments. The signs of economic stabilization are strengthening, with gradual disinflation underway and external pressures easing further since the first review on the back of improved fiscal balances. However, the outlook remains challenging, with downside risks remaining exceptionally high. Program performance. The 9-month Stand-by Arrangement (SBA), approved on July 12, 2023, is on track with key program objectives largely achieved (see Annex I). All seven QPCs and all four ITs for end-December were met. All structural benchmarks since the completion of the first review were also met. Support from multilateral and bilateral creditors remains strong and the program is financed. Policies. The new coalition government that took office on March 11 expressed its commitment to continue to implement policies in line with the SBA to address Pakistan’s structural weaknesses and cement the stability established over the past 9 months. In this regard, strict adherence to the FY24 fiscal target and further adjustment beyond FY24, while protecting development needs and the social safety net, are essential to alleviate external and domestic pressures and ensure fiscal sustainability. A flexible exchange rate is necessary to buffer shocks and rebuild reserves, and monetary policy should remain tight to bring inflation to more moderate levels and agile to respond proactively if signs of inflation reemerge. Continued regular energy tariff adjustments, keeping pace with costs, are necessary to end the creation of CD, but broader reforms are needed to fundamentally restore energy sector viability. Further progress is also needed on the state-owned enterprise and broader governance reform agendas, which are critical to spur private sector investment, activity, and jobs. SBA review. Staff supports completion of the review, which would make available SDR 828 million, bringing total access to SDR 2,250 million, and help anchor essential financing from official partners.

RECENT DEVELOPMENTS 1. Following the February 8 elections, a new cabinet was sworn in on March 11. The two leading parties of the previous government (April 2022-August 2023), the PML-N and PPP, together with some small parties formed a new coalition, and Shehbaz Sharif (PML-N) was elected as prime minister. Independents associated with former prime minister Imran Khan’s PTI party won more votes than any other group and have formed a sizable opposition in the National Assembly. 2. Macroeconomic conditions continue to improve: • Economic activity. The gradual economic recovery has continued over recent months. Real GDP grew by 1.0 percent yoy in Q2, with agricultural output continuing to rebound strongly (+5.1 percent), offsetting weaker industrial (-0.8 percent) and services (0.0 percent) activity. Q1 GDP growth has also been revised up, to +2.5 percent yoy. The large-scale manufacturing index grew by 1.8 percent yoy in January 2024, and preliminary yield estimates for the Rabi crop suggest a further strengthening of the agricultural recovery. Survey measures of business and consumer confidence have rebounded from September’s lows, and the stock market rallied from OctoberDecember, and again following the election, attracting foreign portfolio inflows (Figure 2). • Inflation and monetary policy. Although still high, headline inflation fell to 20.7 percent yoy in March, helped by favorable base effects, lower food inflation (16.8 percent), and gradually easing core inflation (15.4 percent). Noting the still high level of inflation, and considerable risks to its outlook, including from elevated inflation expectations, the Monetary Policy Committee (MPC) kept the policy rate unchanged at 22 percent at its meeting on March 18. 

Foreign exchange market. The SBP has completed the transition of the interbank spot market to electronic trading, with a new centralized trading system (featuring anonymized bids) coexisting alongside the pre-existing bilateral trading venue. The FX market has been functioning more normally following SBP efforts to improve pricing transparency in the open market and strengthen the governance requirements for exchange companies. In particular, the premium between interbank and open market rates has remained negligible, and there is no evidence of pressures in the parallel market. 1 The authorities have eliminated, effective January 31, the remaining multiple currency practice (MCP) related to exchange rates applied to transactions between the SBP and the government, 2 and effective January 30, the remaining exchange restriction resulting from the limitation on advance payments for imports.

• External conditions. The current account deficit narrowed to around US$1 billion over JulyFebruary FY24 (against US$3.8 billion over the same period in FY23), driven by higher exports and lower imports and some recovery in remittances. The authorities implemented a first National Tariff Policy (2019-24) which has reduced the complexity of the tariff schedule and introduced duty-free access for imported inputs. Gross reserves remain around US$8 billion, as the SBP’s FX purchases helped offset ongoing debt service payments and the decline in the SBP’s swap/forward book. Market sentiment has improved further, with EMBIG spreads currently around 750 bps, down from 1,400 bps in early January. The external sector assessment finds that Pakistan’s FY23 external position was broadly in line with the level implied by medium-term fundamentals and desirable policies (Annex II). However, as the inflation differential between Pakistan and its peers is still high and the exchange rate has remained broadly stable at around 

PRs 280 per US$ in recent months, the real effective exchange rate has appreciated somewhat since the beginning of the year. • Banking sector. Banks’ sovereign exposure has continued to increase from 48 percent of assets at end-FY21 to 57.4 percent at end-January 2024, crowding out credit to the private sector. As of end-December 2023, banks’ capital adequacy ratio (CAR), at 19.7 percent, remains well above the regulatory minimum of 11.5 percent (including the capital conservation buffer). NPLs remained at 7.6 percent, with provisioning at 92.7 percent. Out of 32 banks, three small banks (two private and one public, holding less than 1.5 percent of total banking sector assets) continue to report CAR below the regulatory minimum while the microfinance bank sector faces persistent vulnerabilities. • Fiscal developments. Fiscal balances improved on the back of strong budget execution and revenue performance. The general government achieved a primary surplus of 1.8 percent of GDP in FY24H1, exceeding projections by 0.4 percent of GDP, driven by strong PDL, excise, and direct tax revenues, which offset lower-than-expected import-related revenues and SBP profits. Federal current spending matched program forecasts, but federal PSDP was significantly underexecuted. Provincial overspending was only PRs 136 billion in FY24H1, as Punjab's total expenditures in FY24Q2 were curtailed to partially offset an earlier overrun. 4 Other provinces’ PSDP is anticipated to remain close to SBA projections given the government’s constraints and the time required for the new government to develop new schemes. 

Energy sector. The circular debt (CD) stock stabilized in late 2023 and early 2024, secured by continued efforts to bring energy tariffs in line with costs and, in the power sector, continued anti-theft measures. Power CD, at PRs 2.6 trillion (2.5 percent of GDP), has remained broadly flat since October 2023 after some slippage earlier in the fiscal year (due largely to lower-thanexpected recoveries following the large annual tariff rebasing in July 2023). In the gas sector, the authorities implemented another significant (24 percent on average) gas tariff increase on February 15. The change maintained a progressive rate structure to protect vulnerable residential consumers; significantly increased and equalized prices for fertilizer companies in the system; and modestly increased prices for captive power and some industrial users.

PROGRAM PERFORMANCE 3. Overall performance against end-December quantitative performance criteria (QPCs), Indicative Targets (ITs), and Structural Benchmarks (SBs) under the SBA was satisfactory (LOI Tables 1–2, Annex I). • Performance Criteria (PCs). The authorities met all seven quantitative PCs for end-December 2023: the floors on (i) net international reserves of the SBP; and (ii) targeted cash transfer spending; and the ceilings on (iii) net domestic assets of the SBP; (iv) the SBP’s FX swap/forward book; (v) net government budgetary borrowing from the SBP; (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 authorities also met all four ITs for end-December 2023: the floors on (i) budgetary health and education spending; and (ii) FBR net tax revenues; and the ceilings on (iii) net accumulation of tax refund arrears; and (iv) power sector payment arrears.

Structural benchmarks (SBs). The SBs on (i) the BISP inflation adjustment; (ii) notification of the semiannual gas tariff adjustment determination; and (iii) development of a plan to strengthen the SBP’s internal control systems in lending operations were met. The continuous SBs on (i) not granting further tax amnesties; (ii) avoiding new preferential tax treatments or exemptions; and (iii) maintaining an average premium of no more than 1.25 percent between the interbank and open market rate were also met. Work toward amending four dedicated SOE laws (missed SB, end-November 2023) remains in progress to align legislation with requirements; the timing of its passage is contingent on the recently-seated National Assembly

OUTLOOK AND RISKS 4. The baseline macroeconomic outlook is broadly in line with the first review’s projections, (Tables 1–7):

Inflation developments have generally been close to the first review’s expectations, but food inflation has slowed somewhat more gradually than anticipated. As a result, year-end inflation in FY24 and FY25 has been revised up modestly. • Balance of Payments. For FY24, the current account deficit (CAD) is projected at US$3.0 billion (0.8 percent of GDP), somewhat lower than projected at the first review. A more muted import rebound is now expected, reflecting favorable commodity price changes and a larger than anticipated drop in food and cotton imports given the domestic agricultural recovery, while exports are slightly higher. Staff expects the CAD to remain around 1½ percent of GDP over the medium term, reflective of a flexible exchange rate consistent with efforts to rebuild reserves. • Public debt. The end-FY24 debt-to-GDP ratio is projected to decrease markedly, driven by fiscal consolidation and ex-post negative real interest rates. That said, risks to debt sustainability remain acute given very large gross financing needs and the persistent challenges in obtaining external financing, and that real interest rates are projected to become an adverse driver of debt dynamics in the coming years. Provided that program policies are sustained over the medium term and assuming adequate multilateral and bilateral financial support, public debt would remain sustainable and on a downward path. 

Downside risks remain exceptionally high. While the new government has indicated its intention to continue the SBA’s policies, political uncertainty remains significant. A resurgence in social tensions (reflecting the complex political scene and high cost of living) could weigh on policy and reform implementation. Policy slippages, together with lower external financing, could undermine the narrow path to debt sustainability and place pressure on the exchange rate. Delays in post-program external financing disbursements would also place further pressure on banks to finance the government (further exacerbating crowding out of the private sector). Geopoliticallydriven higher commodity prices and disruptions to shipping, or tighter global financial conditions, would also adversely affect external stability.

The authorities remain committed to achieving a FY24 general government primary surplus of at least PRs 401 billion (0.4 percent of GDP), which will require steadfast effort. While the FY24H1 fiscal targets were met, rapid provincial spending, small additional federal current expenditure, and a shortfall in anticipated SBP profits (0.1 percent of GDP) require: • Strengthening revenue collection to ensure alignment with the FY24 budget. The annual FBR revenue targets remain unchanged but there are risks of shortfalls in April and May 2024 due to holidays that will see port closures and weigh on revenue collection. Agreed contingency measures will be adopted should collections fall short. Additional efforts are also needed to meet the SBA’s revenue administration goals. Efforts to collect additional revenue from retailers have been delayed (¶8), and challenges continue in the tobacco sector where, despite the mandatory implementation of track-and-trace systems, smuggling and clandestine production continue despite efforts to curtail informal production and imports. The FBR is expanding its track-and-trace system to additional commodities such as sugar, fertilizer, and cement to tighten control over informal markets in these sectors. The FBR has, however, successfully registered 1.1 million new filers, from which 170,999 new returns have been obtained through enforcement measures, with the remainder coming voluntarily. • Containing primary expenditure to PRs 12,912 billion (12.1 percent of GDP) while preserving space for priority social spending. As foreshadowed in the first review, federal PSDP was reduced by PRs 61 billion to offset the SBP profit shortfall and further projected savings (PRs 40 billion) are expected from rationalization of unnecessary subsidies. Conversely, additional expenditures of PRs 49 billion are expected, mainly due to unanticipated increases in the military wage and pension bills. The authorities reaffirmed their commitment to stay within the overall primary expenditure envelope, avoid any supplementary grants, and use the PRs 250 billion budgeted emergency fund to absorb budget deviations. • Continued fiscal coordination with provincial governments. The provinces have reiterated their commitment to achieving their FY24 budget surplus targets as specified in their December 2023 MoUs with the federal government. Punjab, in particular, has pledged to further contain current and development expenditures for the remainder of FY24. Sindh will continue settlement

of its accumulated commodity debt over coming years with a total of PRs 63 billion allocated for principal payments in FY24 (PRs 40 billion scheduled for FY24H2). The federal government will maintain an ongoing dialogue with each province to ensure their plans remain consistent with the general government fiscal goal. 7. The authorities are moving forward with plans to privatize Pakistan International Airlines (PIA) and other assets and have advanced their broader privatization agenda. The authorities aim to complete, by June 2024, the bidding for PIA’s core business, of which the government would likely seek to sell a (controlling) 51 percent stake. To limit state balance sheet implications, the use of divestment proceeds would prioritize the settling of governmentguaranteed debt—to be transferred from PIA’s balance sheet to a holding company—held by commercial banks (PRs 242 billion, of a total of PRs 629 billion in liabilities to be transferred). Several smaller SOEs are also currently on an active privatization list. 8. Fiscal structural reforms remain essential to longer-term fiscal sustainability:  Strengthening revenue mobilization through tax policy reforms and enhanced revenue administration. Implementation of some reforms started by the caretaker government have been delayed, and renewed efforts are needed to expedite their execution. The anticipated launch of a scheme to register retailers and enforce filing and collection of their tax obligations, initially scheduled for January 1, 2024, has been postponed. The authorities published the Statutory Regulatory Order (SRO), which creates the legal framework for the scheme, on March 30, 2024. The first phase, involving registration, has started, and tax collection will begin by July 1, 2024. Plans to transform the FBR into a semi-autonomous Revenue Authority have been delayed so that an international consulting firm can be engaged for final reforms. Despite these setbacks, there has been progress in other areas, such as the passage of the documentation law mandating data sharing with the FBR and collaboration with NADRA to ensure secure data transmission. The Compliance Risk Management team, which focuses on the identification and audit of high-risk cases, has identified 39 cases, with 31 audited, with projected additional revenues of at least PRs 40 billion. Plans are in place to extend risk management training to local offices across provincial capitals and Islamabad. The framework for the digital invoicing system is established, though implementation challenges led to a second licensing round, expected to conclude by June 30, 2024.  Enhancing Public Financial Management (PFM). The authorities agreed to prepare quarterly reports comparing budget projections with actual execution and undertake corrective measures in response to any significant deviations. The authorities have committed not to issue any supplementary grants, and instead seek ex-ante approval from the National Assembly for any non-budgeted expenditures exceeding the parliamentary-approved FY24 budget appropriation. To enhance federal-fiscal reporting and coordination with the provinces over budget execution, standardized monthly

Increasing spending transparency. Federal ministries and provincial agencies continue to increase utilization of the electronic procurement system (e-PADS), with PRs 1,587 billion of 

planned procurement entered into the system. Continued public access to suppliers’ beneficial ownership information and a future audit by the Auditor General of Pakistan will further promote spending transparency and prevent corruption and misappropriation. • Improving debt management. The initial primary issuances of Shariah-compliant instruments via the Pakistan Stock Exchange in December 2023, with the goal of deepening financial markets and widening the investor base for domestic securities, received ample interest from investors. However, since the initial auction, interest savings for the government have been limited as rates across government securities markets converged. Staff and the authorities agreed that a ceiling on government guarantees remains a key tool for limiting debt risks outside of the general government perimeter, and the authorities have advanced work to include SOE debts related to commodity operations in the guarantee perimeter. B. Poverty Reduction and Social Protection 9. The authorities are on pace to execute the FY24 BISP envelope of PRs 472 billion (0.4 percent of GDP), a significant increase over FY23 BISP spending. The larger envelope allowed the program to absorb another 300,000 families into the Kafaalat UCT program this fiscal year, bringing total enrollment to 9.3 million. The benefit adjustment carried out in January (end-January 2024 SB) protected the scheme’s generosity level, which remains low by international standards. Such adjustments should be institutionalized to at least maintain generosity levels in real terms. 10. Improving health and education outcomes means accelerating enrollment into, and improving the quality of, the BISP conditional cash transfer (CCT) programs. In FY24 0.9 million families and 1.9 million children, respectively, have been enrolled into these health and education CCT programs. Health and education spending outside of BISP, for which the end-December 2023 target was met, should be protected and fully executed as budgeted for the rest of FY24. Pakistan’s progressive energy tariff structure continues to protect the most vulnerable, but in the long term this should be replaced by BISP cash transfers. 11. The authorities continue to improve BISP's administrative apparatus. The authorities aim to have 20 million households in the fully operational dynamic registry by September 2024, at which point the next recertification cycle will proceed. BISP has updated its contracts with banks to expand coverage across the country, enhance payment efficiency, and reduce administrative costs. 

Monetary, Exchange Rate, and Financial Sector Policies 12. Continuing a tight monetary stance is critical to durably entrench disinflation and demonstrate that the monetary policy framework is fit for purpose. Considering the risks to inflation and the criticality of re-anchoring expectations to the SBP’s medium-term inflation objective, staff welcomed the MPC’s decision to keep policy rates on hold. The authorities agreed that any loosening of the policy stance should be supported by further evidence that inflation remains on a declining trend, pass-through remains contained, and possible exchange rate pressures from FX market normalization are limited. Guiding inflation down successfully is critical to reinvigorating public confidence in a consistent and effective monetary policy framework, with (i) the primacy of the medium-term inflation objective; (ii) the interest rate as the main policy tool (rather than the exchange rate as an intermediate tool); and (iii) monetary transmission operating, albeit slowly, through the standard channels. 13. The authorities are committed to a flexible exchange rate and a transparent interbank FX market, which are needed to support external sector rebalancing and the rebuilding of reserves. Staff welcomed the elimination of the remaining MCP and the exchange restriction, and steps to modernize the FX market environment (¶2).5 Staff recommended continuing to proactively build reserves via interbank purchases, and positively noted that the reduction of the SBP’s swap/forward position aided the decompression of forward premia. However, the recent stability of the rupee should not lead to renewed expectations that this will persist in the future. In this regard, banks should be free to transact in the interbank FX market without any constraints, which together with the SBP’s efforts to improve its functioning, would help build a deeper FX market that can serve as a buffer for shocks. 14. Close monitoring of the banking sector and addressing undercapitalized institutions remains essential. Amendments to the bank resolution and deposit insurance legislation will further strengthen Pakistan's crisis management and bank resolution framework. With the National Assembly elected, the reform package, in line with Fund TA, should be swiftly adopted and operationalized by the SBP, for which the first steps have already been taken. The authorities again reported mixed progress on the three undercapitalized banks. More progress was made in winding down an undercapitalized public bank, with almost all deposits repaid and branches closed, although the commencement of liquidation procedures faced some delay. Two private banks remain undercapitalized, despite some initial progress in partially recapitalizing one bank, with the authorities continuing to pursue options with the shareholders. Regarding vulnerabilities in the microfinance sector, the authorities have asked owners to provide time-bound recapitalization plans where necessary. This approach has been successful in returning two institutions to regulatory minimum standards. Staff welcomed work on a plan to strengthen internal control systems in the SBP’s lending operations but urged that the counterparty eligibility policy include a requirement that counterparties are financially sound.

Energy Sector Policy 15. Timely implementation of scheduled tariff adjustments, full disbursement of budgeted FY24 power subsidies, and broader reform efforts are critical to restoring energy sector viability. • Power sector o With the April 1, 2024 notification of the delayed Q2 FY24 quarterly tariff adjustment, the continuation of anti-theft efforts, and the release of budgeted subsidies, the authorities should be able to meet their FY24 CDMP target of PRs 2.3 trillion (net zero stock accumulation). 6 Timely notification of the FY25 annual rebasing will be critical to the continued prevention of further CD flow, as will further collections efforts, including steps to enhance and institutionalize digital monitoring. In parallel, the authorities should press ahead with agricultural tube well subsidy reform, for which a finalized plan is targeted by end-FY24. o However, restoring energy sector viability requires strong cost-side reforms. This includes (i) continuing efforts underway to improve transmission infrastructure, including for better integration and expansion of renewable energy capacity; (ii) improving DISCO performance via either privatization or long-term management concessions; (iii) moving captive power demand to the grid; (iv) revisiting, where feasible, the terms of power purchase agreements; and (v) continuing to convert publicly-guaranteed PHPL debt into cheaper public debt.

Gas sector: After some delays, the resumption of gas tariff adjustments in line with cost recovery has contributed to a modest decline in natural gas CD, to PRs 2,083 billion (2.0 percent of GDP) as of January 2024. 7 Continued timely gas tariff determinations and notifications within the required 40-day window, while protecting vulnerable households, starting with the June 2024 semiannual adjustment, are critical to preventing further CD flow. Price adjustments should continue to move toward the full phasing out of captive power usage this year, with cheaper natural gas prioritized for the most efficient power plants. They should also include efforts to fully equalize gas prices for all fertilizer companies. The authorities signaled an intention to move toward fully implementing a weighted average cost of gas (WACOG) across Pakistan, which would introduce a uniform gas price while helping to ensure cost recovery. E. Structural Policies 16. Further progress on the structural agenda is needed to achieve long-term sustainability and inclusive growth. Key aspects of the agenda include: • Enhancing SOE effectiveness. The authorities are implementing the SOE Act and SOE policy framework, including (i) an effective updating of the March 2021 SOE Triage Plan to propose which SOEs are to be retained, privatized, and/or restructured; (ii) a review of any required governance restructuring to align with the new provisions; (iii) furthering amendments for four statutory SOEs to be brought into line with the SOE Act (a missed SB for end-November 2023). The authorities anticipate then moving on to the remaining 16 statutory SOEs; (iv) the issuance of legal guidelines and training for SOEs on the application of the new framework; and (v) the further operationalization of the Central Monitoring Unit (CMU), which published its first SOE Report in December 2023. The CMU’s next report in June 2024 should make further progress toward reporting elements required by the SOE Act; progress against performance benchmarks is expected in later reports in FY25. • Further clarifying the classification and governance arrangements for the seven SOEs under the Sovereign Wealth Fund established in August 2023, which is not yet operational but which exempts these SOEs from the SOE Act. Governance safeguards for these SOEs should be brought on par with the SOE Act and its framework. • Building a level investment- and job-friendly business environment. The Special Investment Facilitation Council (SIFC) created in August 2023, aimed at attracting and facilitating investment in Pakistan, requires safeguards to bring projects identified through the SIFC under Pakistan’s existing PIMA framework to ensure accountability and transparency. This is particularly important given the SIFC’s power to offer regulatory relief and other immunities and the centrality of a level playing field for all investors. • Strengthening anti-corruption institutions. Safeguarding the independence of anti-corruption institutions and enhancing their effectiveness in combating corruption will help protect public 

funds, improve the business climate, and boost public and donor confidence. The authorities are committed to publishing, as soon as they are finalized, the anti-corruption framework review by the Ministry of Justice and Law task force, with participation of independent experts, and the full UNCAC review report after its finalization. Further training and engagement with banks to leverage their access to the FBR’s database of asset declarations of high-level public officials for AML/CFT purposes can prevent, detect, and deter laundering of proceeds of corruption, tax evasion, and smuggling through the financial sector. A digital portal will help efficiently facilitate access requests by banks and the FBR’s responses, which are still low relative to the risks. Public access to asset declarations of elected and unelected Federal Cabinet members is also expected to be institutionalized. Undertaking a comprehensive governance diagnostic assessment in the future will help the authorities identify severe governance vulnerabilities and prioritize key anticorruption structural reforms. • Continued progress on building climate resilience. Following the cabinet’s adoption of the CPIMA action plan (SB end-December 2023), the authorities are moving forward on near-term agenda items that target climate-related investment and urban planning, project selection, fiscal risk analysis, and capacity building. Beyond the C-PIMA, the authorities have drafted and plan to submit to parliament carbon market policy guidelines and aim to have developed a climate scoring methodology for National Adaptation Plan-aligned projects in the PSDP portfolio by September 2024. PROGRAM MODALITIES AND CAPACITY TO REPAY 17. Financing. The program is fully financed and the reserve position at end-FY24 is consistent with program objectives (Table 3a). While total delivery of the SBA financing commitments in FY24 is expected to fall somewhat short of projections in the SBA request (US$4.0 billion out of the US$4.6 billion have been disbursed), with some disbursements spilling into FY25, this has been compensated by a tighter current account and savings from a debt rearrangement with a major bilateral creditor prior to the first review. Nonetheless, given Pakistan’s external sector vulnerabilities, it is important that the remaining commitments are delivered in a timely way. Over the medium-term, risks arise from large public sector external rollover needs, a persistent current account deficit, a difficult external environment for Eurobond and Sukuk issuance, and limited reserve buffers. 18. Capacity to repay. Pakistan’s capacity to repay the Fund is subject to significant risks and remains critically dependent on policy implementation and timely external financing. The Fund’s exposure reaches SDR 6,546 million (322 percent of quota, approximately 102 percent of projected gross reserves at end-April 2024) with completion of all purchases under the SBA (Table 8). Exceptionally high risks—notably from delayed adoption of reforms, high public debt and gross financing needs, low gross reserves and the SBP’s net FX derivative position, a decline in inflows, and sociopolitical factors—could jeopardize policy implementation and erode repayment capacity and debt sustainability. Restoring external viability is critical to ensure Pakistan’s capacity to repay the Fund, and hinges on strong policy implementation, including, but not limited to, external asset accumulation and exchange rate flexibility. Geopolitical instability is an additional source of risk, 

even as uncertainty surrounding global financial conditions has declined somewhat since the last review. 19. Enterprise risk. The SBA poses significant enterprise risks which are largely unchanged from the time of the first review. These include risks related to credit concentration, capacity to repay, reputation and engagement, sociopolitical tensions, and the security situation. In addition to the factors discussed in the first review, there is further mitigation from the newly formed government’s intention to continue the policy adjustment after the SBA, and interest in a successor arrangement from the Fund, although political uncertainty remains significant. STAFF APPRAISAL 20. Consistent implementation of stronger policies over the past nine months has brought the economy back from the brink and onto a path of stability. A gradual economic recovery has increasingly taken hold and inflation has declined substantially in recent months, though remaining well above target. The SBP has taken advantage of increased inflows, easing external pressures, and the moderation of the current account deficit to begin rebuilding FX reserves. Fiscal performance has also improved, with the government posting a large primary surplus in H1. This overall satisfactory performance suggests that unwavering and consistent policy implementation can bring positive results, rebuild confidence, and support economic recovery. 21. Although this SBA broadly achieved its narrow objectives, the challenges ahead remain uncomfortably high and will require sustained efforts to effectively address them. Pakistan’s fiscal and external vulnerabilities remain very high, including debt sustainability and refinancing risks as well as crowding out of the private sector, and structural weaknesses constrain productivity, investments, and growth. The SBA recognized that resolving Pakistan’s structural challenges will require continued adjustment and creditor support beyond the program period. It is now critically important that the effort that started under this SBA continues. In this regard, the authorities’ interest in a successor arrangement is welcomed to anchor the policy adjustment in the coming years, restore Pakistan’s medium-term sustainability, and pave the way for strong and inclusive growth. 22. The caretaker government should be commended for its decisive efforts to meet the FY24 primary surplus target, overcoming political cost considerations, and these efforts should continue to put debt on a firm downward trajectory. Ensuring strict budget compliance and fostering close coordination with the provinces is critical to mitigate significant risks to macroeconomic stability and fiscal sustainability. There is an urgent need to accelerate the adoption and implementation of structural reforms aimed at enhancing revenue mobilization and spending efficiency. Securing ex-ante approval from the National Assembly for any budget deviation will bolster the authorities’ credibility and budget transparency. 23. Notable progress made on strengthening social spending and institutions to alleviate poverty and effectively protect the most vulnerable is welcome and must continue beyond 

this program. Efforts to maintain, if not increase, generosity levels in real terms via annual inflation indexation going forward and to expand CCT programs where possible are welcome, as are continued improvements in BISP’s administrative capacity. 24. With inflation still well above target, monetary policy should remain appropriately tight and vigilant against emerging pressures. The recent deceleration of inflation is welcome and will reduce the high burden on Pakistani society, and particularly the most vulnerable. Monetary policy should remain data-driven and attentive of stickiness in core inflation, as well as resolutely address any emerging risk. Guiding inflation back to target is imperative not only to buttress a sustainable recovery but also to build central bank credibility. 25. A flexible exchange rate resulting from a deep and well-functioning FX market is critical to buffer external shocks and allow the rebuilding of FX reserves. The authorities’ resolve in eliminating the remaining MCP and the exchange restriction and efforts to improve the functioning of the FX market are welcome. Efforts should continue to achieve greater FX market depth, while proactively rebuilding reserves via interbank purchases as conditions permit. The external position of Pakistan in FY23 was broadly in line with the level implied by medium-term fundamentals and desirable policies. 26. Maintaining financial sector stability requires continued vigilance, and actions to address undercapitalized institutions are long overdue. This includes ensuring all banks and microfinance banks are compliant with the minimum capital requirements or otherwise exit the market in an orderly fashion. The long noncompliance of banks with those requirements risks undermining the credibility of banking supervision and prudential standards. Passing the legal reform of the crisis management framework remains crucial to ensure the authorities have the appropriate powers and toolkit to deal with weak institutions. 27. Recent energy tariff increases represent major steps to prevent further CD arrears, but broader cost-side reforms are critical for sectoral viability. The regularization of energy tariff increases, in line with costs and legal requirements, represents a major step for the authorities in addressing Pakistan’s energy crisis. However, the only sustainable solution for the sector is decisive action to address cost-side and infrastructure issues. 28. Structural reforms must progress to create a basis for sustainable and inclusive growth. The progress made on the SOE reform agenda is an important step toward reducing the footprint of the state and spurring private sector growth. Momentum in this area must be continued and further steps need to be taken to ensure a level playing field with regard to the investment environment. Effective and independent anti-corruption institutions and tools (e.g, asset declarations) and AML/CFT measures, which could be further supported by a future governance diagnostic assessment, are critical to safeguarding public funds, inclusive growth, and political stability. Sustainable growth also requires building up climate resilience. 29. Downside risks remain exceptionally high. The external environment remains challenging, with still tight global financial conditions, volatile commodity prices, and elevated geopolitical 

tensions. External and domestic financing needs in coming years are very large, and policy adjustment will need to be sustained in the post-SBA period to materialize this financing and prevent a re-intensification of fiscal and balance of payments pressures. 30. On the basis of the authorities’ program implementation and policy commitments, staff supports the authorities' request for completion of the second review under the SBA

Annex I. Progress Under the SBA and Challenges Ahead 1. The objectives of Pakistan’s 2023-24 Stand-By Arrangement (SBA) were largely achieved. The SBA began at a difficult juncture: Pakistan was recovering from devastating floods; faced acute external financing pressures; and was adversely affected by misaligned domestic policies. Reflecting significant policy effort by the authorities, the SBA succeeded in stabilizing the economy, rebuilding buffers, and making some progress on the structural reform agenda. 2. Projected outcomes are broadly in line with initial program projections. Projected FY24 growth was revised down from 2.5 to 2.0 percent at the time of the first review, reflecting weakerthan-expected domestic demand. The FY24 current account is now expected to be stronger, reflecting outturns over the course of FY24, though this was offset by lower than anticipated financing inflows. Market sentiment has improved significantly since the start of the program, with EMBIG spreads down over 1,300 bps, although risks to debt sustainability remain large. The medium term growth outlook is broadly the same, although external balances are expected to be stronger than at the time of the SBA request. Reserve buildup is also expected to be larger. 

Macroeconomic resilience has improved as short-term vulnerabilities eased. The authorities are on track to fully implement the FY24 budget, representing a strong primary balance improvement during the program, including strong revenue performance. They also maintained an appropriately tight monetary policy that saw the start of disinflation (despite the implementation of necessary energy tariff increases to avoid CD accumulation); and amid easing external pressures FX market functioning has improved. 4. Good progress was made on the structural reform agenda. Benchmarks related to sound budget practices; social spending; the FX market; energy sector stability; SOE governance reform (work toward the missed end-November 2023 SB on amending four dedicated SOE laws remains in progress); climate resilience; and macroeconomic statistics were all achieved. 5. Significant challenges remain beyond the life of this program. Debt sustainability remains a large risk. Continued revenue-driven fiscal consolidation is critical. Inflation remains high 

despite the disinflation trajectory and the SBP must remain vigilant, ready to take prompt actions if needed. Likewise, a flexible exchange rate is key to moderating balance of payments pressures and rebuilding international reserves. Significant progress was made over a short period on the structural reform agenda (though the creation of the SWF and SIFC in August 2023 pose risks to the SOE reform and business environment agendas). However, much more is required in the areas noted above to achieve medium-term viability and address Pakistan’s broader structural challenges, including its narrow export base, low private investment and FDI, weak revenue base relative to public investment needs, low health and education spending levels in the context of major human capital development needs, elevated poverty levels, and income and gender inequality. 

Overall Assessment: The external position of Pakistan in FY23 was broadly in line with the level implied by medium-term fundamentals and desirable policies. The current account (CA) deficit narrowed to 0.7 percent of GDP, compared to 4.7 percent in FY22. Nevertheless, without import payment restrictions, the CA deficit in FY23 would have been larger, requiring additional real exchange rate depreciation in order to bring the CA back to equilibrium. Potential Policy Responses: The authorities should allow the exchange rate to act as a buffer for shocks and refrain from any restrictions on import payments, which could artificially compress the CA. There is also a need for fiscal tightening to alleviate real exchange rate appreciation pressures, as well as structural reforms to boost productivity and competitiveness. 

Background. Pakistan’s Net International Investment Position (NIIP) reached US$-131 billion in 2023, a similar level to 2022 but markedly lower than FY2019-2022, when NIIP averaged US$-116 billion. Net direct investment stood at US$-28.8 billion, whereas net portfolio investment reached US$-9.3 billion. Pakistan’s IIP does not feature substantial positions in financial derivatives. Assessment. Gross debt-service obligations remain substantial, and current account imbalances stemming from insufficient exchange rate flexibility and import restrictions may require additional policy adjustment to reach external equilibrium. 

Background. The CA posted a small surplus in FY24Q2 of about US$200 million, driven by an increase in exports. Staff projects imports to increase over the remaining two quarters, with the CA balance for FY24 reaching approximately -0.8 percent of GDP, compared to -0.7 in FY23, -4.7 in FY22, and -0.8 in FY21. Assessment. The cyclically adjusted CA in FY23 is estimated to have been -0.6 percent of GDP. While the EBA CA norm is estimated at -0.7 percent of GDP, staff judges the norm to be closer to -0.5 percent of GDP, consistent with the need to strengthen NIIP through building external assets and reducing external liabilities. As a result, staff judges the CA gap to be -0.1 (compared to 0.1 in the CA model). The impact of import payment restrictions on the CA in FY23 is not captured by the EBA model; these distortions, when unwound, tend to move the CA gap towards a weaker external position and the REER gap towards further overvaluation.

Real Exchange Rate Background. Pakistan’s REER has depreciated over the past two years (5.8 percent in FY23 and 1.2 in FY22). In contrast, the REER appreciated 2 percent in FY21. The change in the 2023 REER reflects a trade-weighted nominal depreciation of about 26.5 percent, as well as foreign inflation of around 7.5 percent among Pakistan’s trading partners, and domestic inflation of 29 percent. This trend has reversed during the current fiscal year, however: by end-FY24Q2 the REER had appreciated about 10 percent compared to FY23 Q1, with the nominal exchange rate remaining broadly stable at around PRs 280 per US$ since July 2023. Assessment. Staff’s assessment places the FY23 REER gap at 0.7 percent using the EBA CA model. Results do not take into account the influence of import payment restrictions, which, when removed, would likely require additional real depreciation. In light of these considerations, staff continues to see a need for greater exchange rate flexibility. Capital and Financial Accounts: Flows and Policy Measures Background. The financial account posted a deficit of US$2.5 billion in FY23, driven primarily by government debt repayments: general government amortizations exceeded disbursements by US$2.9 billion. These flows were partially offset by US$900 million in “Other investment assets” of the general government. Net portfolio investment totaled just over US$-1 billion, whereas net FDI reached US$600 million. In previous years, however, the financial account remained in positive territory, averaging US$9.1 billion over FY19-22, and driven primarily by disbursements to the general government (and to monetary authorities in the specific case of FY19). Pakistan’s international financial integration continues to be limited, with a normalized Chinn-Ito Index of 0.16 placing the country at the 25th percentile of the world sample in terms of capital mobility, a score that has remained unchanged over the past five years.

Assessment. Authorities have been proactive in their intent to phase out distortive measures, but there is still space for additional reforms. FX Intervention and Reserves Level Background. Gross reserves decreased sharply during FY23, totaling US$4.5 billion (about 1.3 percent of GDP, or 0.8 months of imports) in contrast to US$9.8 billion in FY22 and US$17.2 billion in FY21. More recently, reserves have gradually recovered, reaching US$8.2 billion in December 2023. In addition to spot FX interventions to accumulate reserves, the SBP has also gradually reduced its negative net forward position, from US$-4.5 billion in July 2023 to US$-3.4 billion by end-December 2023. During 2024, SBP’s forward position has remained broadly unchanged. Assessment. Pakistan’s gross reserves in 2023 reached 18.2 percent of the IMF’s (capital controls-adjusted) ARA metric, well below the normative adequacy range of 100-150 percent of the ARA metric. In order for SBP’s ongoing reserve accumulation efforts to continue (gross reserves are projected to reach US$22 billion by end-FY29), it is imperative to avoid any actions to manage the current account, which could lead to excessive real appreciation.