Documentof The World BankGroup For Official Use Only ReportNo. 35718-PAK INTERNATIONAL BANK FOR RECONSTRUCTIONAND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE INTERNATIONAL FINANCE CORPORATION COUNTRY ASSISTANCE STRATEGY FOR THE ISLAMICREPUBLIC OF PAKISTAN FOR THE PERIOD FY06-09 April 4,2006 a restricteddistribution and may be usedby recipients only inthe performance of their official duties. Its contents maynot be otherwise disclosed without WorldBank authorization. The last Country Assistance Strategyfor Pakistan (Report No.24114-PAK) was discussed on June 11, 2002 and a Countly Assistance Strategy Progress Report (Report No. 28262-PAK) was discussed on April 20, 2004 CURRENCY AND EQUIVALENTS Currency Unit = Pakistan Rupee US$1 = PKR 59.40 FISCALYEAR July 1- June 30 ABBREVIATIONSAND ACRONYMS AAA Analytical and Advisory Activities ID1 Long Distanceand International ADB Asian DevelopmentBank LL Local Loop ADR Alternative DisputeResolution MDG MillenniumDevelopmentGoals AIDS Acquired ImmunodeficiencySyndrome MIGA MultilateralInvestment Guarantee Agency AJK Azad Jammu Kashmir MTBF MediumTermBudgetFramework BMOs BusinessMembership Organizations MTDF MediumTerm DevelopmentFramework CAE Country Assistance Evaluation NBP National Bank of Pakistan CAS Country Assistance Strategy NEPRA The National ElectricPower Regulatory Authority CAS-PR Country Assistance StrategyProgress Report SEAS National EducationAssessmentSystem CBR Central Board o f Revenue NGOs Non-GovernmentalOrganizations CFAA Country FinancialAccountability Assessment NWFP North West FrontierProvince CGA Controller Generalof Accounts PDF PakistanDevelopmentForum CWIQ Core Welfare IndicatorsQuestionnaire PEP-MENA Private EnterprisePartnershipfor Middle DCC Donor CoordinationCell East andNorth Africa DFID Department for InternationalDevelopment(UK) PFM Initial Public Offering DPL DevelopmentPolicy Loan PIFRA Project to Improve FinancialReportingand EAD EconomicAffairs Division Auditing EBP Enterprise Benchmarking Program PIHS PakistanIntegratedHouseholdSurvey ERRA The EarthquakeReconstructionand PPAF PakistanPovertyAlleviation Fund RehabilitationAuthority PPPS Public-PrivatePartnerships FSAP Financial Sector AssessmentProgram PRSC PovertyReduction Support Credit GDP Gross Domestic Product PRSP PovertyReduction StrategyPaper GEF Global EnvironmentFacility PSCB Public Sector CapacityBuilding GoP Government of Pakistan PTCL PakistanTelecommunicationsLimited GTZ GermanAgency for TechnicalCooperation PSLSM PakistanSocial and Living Standards HIES Household Income and ExpenditureSurvey Measurement Survey HIV HumanImmunodeficiencyVirus QAG Quality AssuranceGroup IBRD InternationalBank for Reconstructionand SAC Structural Adjustment Credit Development SME Small and MediumEnterprise ICR ImplementationCompletionReport TATF Technical Assistanceand Trust Funds IDA InternationalDevelopmentAssociation TMAs Tehsil MunicipalAuthorities IEG IndependentEvaluationGroup USAID United States Agency for Int'l Development IFC InternationalFinanceCorporation WAPDA Water and Power DevelopmentAuthority IMF InternationalMonetaryFund WEF World Economic Forum IPO Initial Public Offering WHO World HealthOrganization IPP IndependentPower Producer WTO World Trade Organization JBIC Japanbankfor InternationalCooperation wss Water Supply and Sanitation The World Bank Vice President : Praful Patel, SARVP Country Director : John W. Wall, SACPK Task Manager : Tom Buckley, SACPK TheInternational Finance Corporation Vice President : Declan Duff, CIOVP Country Director : Michael Essex, CMERC Task Manager : Torek Farhadi, CMEHQ TABLEOFCONTENTS EXECUTIVE SUMMARY .................................................................................................................... i I. COUNTRY CONTEXTAND DEVELOPMENT CHALLENGES ............................................... 1 A. Political and Social Context................................................................................................ 1 B. 2 Development Challenges .................................................................................................... Social Progress and Poverty Profile.................................................................................... C. 2 D. Economic Developments and Outlook ............................................................................... 7 I1. PAKISTAN'S POVERTYREDUCTION STRATEGY ............................................................ 10 A. The PRSP Strategy............................................................................................................ 10 I11 . BANKGROUP ASSISTANCESTRATEGY .......................................................................... 12 A. Implementation o f the Last CAS and Lessons Learned.................................................... 12 B. Context and Engagement Principles................................................................................. 15 C. World Bank Group ProgramPriorities ............................................................................. 17 IV. ..................................................... A. DELIVERINGTHE WORLDBANKGROUP PROGRAM 33 33 B. The World Bank Program................................................................................................. The IFC Program .............................................................................................................. 38 C. MIGA Portfolio and Program........................................................................................... 40 D. Partnerships and Harmonization....................................................................................... 40 E. Communications and Outreach., ...................................................................................... -41 F. Monitoringand Evaluation ............................................................................................... 41 G. Managing Risks................................................................................................................ 42 TABLES Table 1: Progress on Selected Social Indicators........................................................................... 3 Table 2: Competitiveness Rankings ............................................................................................ - 3 Table 3: Medium Term Outlook -K e y Indicators ....................................................................... 9 Table 4: Pakistan's PRSP Targets and Alignment with Millennium Development Goals .........11 Table 5: Bank Portfolio Indicators.............................................................................................. 13 Table 6: Selected Health Indicators............................................................................................ 29 Table 7: Public Spending on Select Safety Net Programs.......................................................... 31 Table 8: Key Policy Performance Benchmarks for IBRDLending ........................................... 35 Table 9: Pakistan Credit Rating by Standard & Poor's .............................................................. 36 Table 10: Maximum ProjectedIBRDExposure......................................................................... 37 Table 11: AAA - Indicative Key Outputs by CAS Theme ....................................................... -37 FIGURE Figure 1: Recent Economic Performance ........................................................................................ 8 Box Box 1: Impact ofthe October 8 Earthquake .................................................................................... 6 ANNEXES Annex I : CAS Results Framework Annex 11:CAS Completion Report Annex I11Private Sector Strategy Annex IV: Country FinancingParameters Annex V: Other Donor Activities Annex VI: CAS ConsultationProcess Annex VII: Guidelines for IBRDLending Annex B1: Country at a Glance Annex B2: Indicators o f Bank Portfolio Performance and Mgt Annex B3: IBRD/IDAProgram Summary Annex B3: IFC/MIGA Program Summary Annex B4: Summary o f Non-lending Services Annex B5: Poverty and Social Development Indicators Annex B6: Key Economic Indicators Annex B7: Key Exposure Indicators Annex B8: Operations Portfolio (IBRD/IDA and Grants) Annex B 8 (IFC) Statement o f IFC Held and DisbursedPortfolio EXECUTIVE SUMMARY 1. The FY06-09 Country Assistance Strategy (CAS) has been prepared at a time o f great opportunity for Pakistan. Since the beginning o f the new millennium, Pakistan has managed a remarkable turnaround. During the 1990's Pakistan's progress in reducing poverty and improving the welfare o f its people was not very encouraging as economic growth slowed and progress inimproving social indicators stagnated. Beginning in 2000, the Government initiated a wide-ranging and ambitious reform program resulting in a dramatic turnaround. The FY03-05 CAS period witnessed the consolidation and acceleration o f this turnaround with sustained implementation o f a program o f stabilization and wide- ranging structural reforms. Yet Pakistan's development challenges remain formidable. While provisional poverty estimates suggest that poverty declined between 2001 and 2005, the proportion o f the population below the poverty line remains high. And despite recent indications o f improvement, social and living standards remain well below countries with similar incomes and growth rates. DevelopmentChallenges ii. The key challenge for Pakistan is now to sustain its recent growthperformance inorder to generate significant poverty reduction. Sustained growth will require continued sound macroeconomic management along with further improvements in the investment climate. Pakistan's infrastructure platform needs significant investment in order to support Pakistan's growth and service delivery goals. For the poor to participate in and benefit from growth Pakistan needs to accelerate human development. While Pakistani s making progress, analysis suggests that it will be challenging to achieve the MDGs for infant mortality, child malnutrition, primary completion, and elimination o f the gender gap in primary enrolment. Looking beyond the MDG's, enhancing competitiveness in an increasingly globalized and technology driven world economy will require a growing pool o f workers with leading edge skills pointing to the need for increases in the level and quality o f secondary, vocational and higher education. Thus, continuedconcerted efforts to address poor human development outcomes are important not only to improve equity but also as an integral part o f achievingPakistan's growth objectives. Pakistan'sPovertyReductionStrategy iii. Pakistan's poverty reduction strategy paper (PRSP) sets forth a broad-based strategy for addressing poverty in its various dimensions including human development, governance, and vulnerability and builds on the economic program first articulated in the fall o f 1999 and further elaborated in the I-PRSP o f 2001. The PRSP emphasizes policies to sustain rapid growth as the main vehicle for poverty reduction and i s grounded on four pillars: (i) achieving and sustaining a high growth rate while maintaining macroeconomic stability, translating this higher growth into lower poverty, and bridging the social gap; (ii)improving governance and consolidating devolution, both as a means o f delivering better development results and ensuring social and economic justice; (iii) investing in human capital, with a renewed emphasis on effective delivery o f basic social services; and (iv) targeting the poor and vulnerable to bringmarginalized sections o f the population and backwardregions into the mainstream of development, and to make marked progress in reducing existing inequalities. The PRSP's targets are fully aligned with the MDGs. BankGroupAssistance Strategy iv. Inline with Palustan's recent performance and the Government's request for increased Bank Group support, this CAS proposes a substantial increase in the volume o f lending to Pakistan during the next four years.' The immediate priority will be to assist in addressing the impact o f the October 2005 earthquake - up to US$1 billion in IBRD/IDA commitments will be used to support reconstruction and recovery (US$840 million in new commitments have already been approved). Inaddition, based on the 'In this report, the "Bank Group" refers to IBRD,IDA, IFC, andMIGA while the "Bank" refers to IBRDLDA. Government's priorities for sustaining growth and accelerating poverty reduction, the CAS envisions an expansion in lending in infrastructure (primarily energy, water, and transport) and human development.Bank Group programpriorities will retain considerable continuity with the FY03-05CAS, focusing on the areas which are most critical for poverty reduction. The three inter-linked and mutually reinforcing pillars o f the CAS correspond to the strategic priorities o f the PRSP: (i)sustaining growth and improving competitiveness; (ii)improving government effectiveness and service delivery; and (iii) improving lives and protectingthe vulnerable. Pillar I:Sustained Growth and Improved Competitiveness v. The focus o f this pillar o f the CAS will be to support the investments and reforms needed sustain rapid, private sector-led growth. To help maintain the hard-won benefits o f macroeconomic stability the Bank will provide support to help the Government strengthen economic management through improving the composition and effectiveness o f public expenditures and supporting tax reforms. In agriculture, the focus o f the Bank's work will initially be to support the preparation o f a rural strategy, integrating issues related to agriculture, natural resource management, the rural non-farm economy, infrastructure, rural finance and the need for targeted interventions. In irrigation the Bank will support a combination o f institutional reforms and investments throughout the system including major investments inrehabilitation of critical assets and reforms to improve the quality, efficiency, and accountability with which irrigation services are delivered. Recognizing that sustaining the current high rates o f economic growth requires globally competitive production in an increasingly demanding world market, the Bank Group will also support reforms to improve the business environment. vi. Infrastructurebottlenecks pose a significant threat to Pakistan's ability to sustain rapid growth. In the power sector the Bank Group will support further strengthening o f sector governance to improve performance and attract private investment while at the same time helping to address a significant backlog in investment, particularly to address technical losses. In telecommunications the Bank will support adoption o f measures to strengthen the policy and regulatory environment and possible investment support for accelerating the provision o f rural telecommunication infrastructure. Intransport, the Bank and the government will adopt a strategic approach focusing first on the National Trade Corridor linking Pakistan's major ports inthe south with its major cities and trade corridors to the North. The key outcome sought would be significant reductions in the time and cost o f moving goods through the Indus corridor. Investment and policy-based lending for highways, trade facilitation, ports and railways will be considered, with an emphasis on increasing private sector participation in operation and management. In the financial sector, the Bank Group will support further financial sector reforms to increase access to finance (especially for microcredit borrowers) and support further reforms with the aim o f increasing the availability of longer term savings instruments. Pillar 11:Strengthened Governance and Service Delivery vii. Improving government effectiveness i s a central theme o f the PRSP. Priorities inthis area will be to support further reforms and investment to increase efficiency, transparency and accountability in the use o f public resources. Inpublic financial management, full implementation o f the Project for Improved Financial Reporting and Auditing (PIFRA) will be the focus along with analytical support to assist in defining the agenda for further reforms in financial management at the federal and provincial levels. The Bank will also support the achievement o f transparent and efficient public procurement through development policy lending, policy dialogue and capacity building. Worlung across sectors, the Bank Group will continue to support cross-cutting reforms to increase capacity and accountability o f those responsible for service delivery; empower communities and clients through enhanced access to information on finances and performance; and build the capacity o f both communities and governments. Work will also include support to further civil service reform and devolution as well as a stepped-up engagement inthe urban sector to improve municipal service delivery, especially inthe larger cities. Pillar 111:Improved Lives and Protection of the Vulnerable viii. The PRSP recognizes that increased investment in human capital leading to significant improvements ineducation and health will be necessary to buildthe skilled, healthy work force necessary to sustain recent growth performance. The Bank strategy in education will continue to be focused on the provinces, using development policy credits to support policy and systemic changes as well as the other areas linked to education reform including decentralization and governance reforms. In health, at the national level, the Bank will concentrate on encouraging the Government to focus on public health functions (such as surveillance, quality control, monitoring and evaluation, and public information) while supporting the development and implementation o f program and management reforms in the Lady Health Worker program as a way o f expanding access to primary health care and family planning. The Bank Group will also support the piloting and evaluation o f new approaches for service delivery and demand side interventions. Recognizing that a major focus o f efforts in health must be at the provincial and local level, we will support major system reforms through planned provincial Development Policy Credits, beginning inNWFP. ix. The PRSP recognizes that protection for the poor and vulnerable i s a cornerstone o f any poverty reduction program. The Bank`s assistance for social protection will include support for safety nets that help the chronic poor cope with and, where possible, escape poverty, and help families and individuals cope with seasonal shocks and natural disasters. The Bank will also provide support for social security via improving formal sector pensions and consider innovative approaches to micro-insurance to address life cycle risks. Pakistan's PRSP recognizes that while rapid growth will be the main driver o f poverty reduction, targeted interventions and community-based approaches to rural development are also required to address the immediate needs o f the poor and vulnerable, especially indrought prone and flood stricken areas, and help them share in economic growth. The Bank will continue to support implementation o f the Community Investment Programs in NWFP and AJK and look for possible expansion and replication opportunities. The Bank will also support the Government's newly announced program for rural poverty alleviation through social mobilization. Deliveringthe World BankGroup Program x. IBRD/IDA Lending. Pakistan's demand for World Bank financial support has grown to meet the needs o f its growth and poverty reduction strategy and to address the impact o f the October earthquake. To meet this demand a flexible IBRD/IDA lending program o f up to US$6.5 billion (approximately US$3.1 billion IDA and US$3.4 billion IBRD) i s proposed in order to support implementation o f the PRSP. Pakistan's IDA allocation has been increased under IDA 14, with the three-year envelope set at SDR 1.5 billion (equivalent to about US$725 million per year). In addition Pakistan will have access to additional IDA on hard terms estimated at SDR 130 million. The scale o f IBRD financial support will be determined by the strength o f the GoP's policy performance and macroeconomic management. The upper bound o f the proposed IBRD lending range for FY06-09 i s $3.4 billion o f which up to $1.3 billion could take the form o f development policy loans. Annual lending could increase to as much as $1 billion per year with up to $500 million inDPLs within this envelope. xi. The IFC and M I G A Programs. In the upcoming CAS period, IFC will be increasing its investment with the target range o f US$500-600 million for the period. IFC will also explore opportunities in pre-privatization investment. It furthermore plans to make more equity investment and intends to be a catalyst for and mobilize private equity in the country. IFC activity will focus on three main sectors: financial, SME and infrastructure. With the recent creation o f Private Enterprise Partnership for Middle East and North Africa region (PEP-MENA), IFC has initiated a substantial TA program in Pakistan to build capacity and address constraints o f the SME, infrastructure and financial sectors. MIGA's outstanding portfolio inPakistan consists o f 10contracts o f guarantee with a total gross exposure o f USS136.8 million and a net exposure o f US$106.8 million. An application seeking coverage for a US$20.8million equity investment ina hydropower project inPalustan i s currently pending, - iv - xii. Partnerships and Harmonization. The Bank Group's work in Pakistan is coordinated with and reinforced by the efforts o f other donors in a wide variety o f areas. The international response to the October earthquake has also served as an opportunity to substantially deepen donor harmonization and coordination. The Government leads coordination o f policy dialogue and donor support within the fi-amework o f the PRSP, using the Pakistan Development Forum (PDF), held annually in Islamabad, as the principal forum for discussion with and among donors. A Donor Coordination Cell (DCC) has been created inthe Economic Affairs Division (EAD).Formal donor group meetings are also held, at least two to three times a year, to discuss implementation o f the government's PRSP. Under the leadership o f the Government o f Pakistan, the Bank Group i s increasing efforts to strengthen partnerships and improve harmonization o f activities among donors in line with the Paris Declaration on Aid Effectiveness. During the next four years we expect an increasing share o f analytical activities to be carried out jointly with partners. Managing Risks xiii. The proposed CAS program poses a number o f risks, the greatest o f which i s that o f possible policy reversal due to shifting priorities or political changes. There are also implementation risks relating to both the Bank and Pakistan. The Bank will seek to pro-actively manage these risks by actively addressing capacity constraints while seeking to build and sustain support for further reforms. We will continue to rely on the self-regulating nature o f the programmatic approach wherein the volume and pace of lending will match the pace o f reforms. Issues for Board Discussion xiv. The following issues are suggested for Board discussion: a) Does the proposed program adequately support Pakistan's strategy for poverty reduction and achievement of MDGs? b) Is the plannedincrease inthe scale o fWorldBank Group support for Pakistanappropriate? c) I s mix o f instruments and activities consistent with the focus o f the strategy? I. COUNTRYCONTEXTANDDEVELOPMENT CHALLENGES A. Political and Social Context 1. The FY06-09 Country Assistance Strategy (CAS) has been prepared at a time of great opportunity for Pakistan. Since the beginning o f the new millennium, Palustan has managed a remarkable turnaround. During the 1990's Palustan's progress in reducing poverty and improving the welfare o f its people was not very encouraging. Economic growth slowed and progress in improving Pakistan's social indicators stagnated. Successive governments initiated reforms, but with only modest results. Beginning in 2000, the Government initiated a more wide-ranging and ambitious reform program resulting in a dramatic turnaround. The FY03-05 CAS period witnessed the consolidation and acceleration o f this turnaround with sustained implementation o f a program o f stabilization and wide-ranging structural reforms. Economic growth accelerated from the average o f 3.3 per cent during 1997-2002 to 6.4 per cent in2003/04 and 8.4% in2004/05. Public debt fell to 61% o fGDP from almost 90% in2000/01. Improved fiscal performance and growing fiscal space resulting from savings on interest expenditures, generous external support and improved revenue administrationhave enabled the government to exceed targets for education spending. Inshort, Pakistan moved from crisis to growth, laying the groundwork for sustained growth and significant poverty reduction. 2. Yet Pakistan's development challenges remain formidable. While provisional estimates for 2004-05 suggest that poverty has declined compared with 2000-01, the proportion o f the population below the poverty line remains high. And despite recent indications o f improvement, social and living standards remain well below countries with similar incomes and growth rates. For example Pakistan's gross female primary enrolment rate i s 33 percent below and its infant mortality rate i s 27 per thousand above that o f countries with the same per capita income. Moreover, there remain substantial disparities in opportunity, particularly for the rural poor and women. 3. Politically, Pakistan i s benefiting from a period o f relative stability compared with the turmoil o f the last decade. The past six years have been marked by consistent policies and sustained implementation of the government's reform program. Elections in 2002 restored the National and Provincial Assemblies and despite occasional slowdowns inimplementation, the reformprogram has been carried forward under the elected government. The prospects are good for continued stability and maintenance o f the government's pro-reform orientation. General elections are due to be held in 2007. The decentralization initiative has started the process o f transferring responsibility and resources for public service delivery to local governments, laying the groundwork for more responsive and accountable government at the local level as well as improved services. Recent local government elections in 2005 were an important milestone inthe institutionalizationo f the new local government system. 4. Internationally, relations with India have steadily improved over the past two years, although the conflict in Afghanistan and international terrorism continue to have serious repercussions for Pakistan. Relations with India have improved markedly under the comprehensive dialogue launched in early 2003 and trade between the two countries i s growing strongly, although from a low base. President Musharraf visited India in late April 2005, and he and the Indian Prime Minister, Manmohan Singh, agreed to increase transport links between the divided parts o f Kashmir. The response to the October 8 earthquake has served as an opportunity to expand peaceful interaction across the divided territory, demonstrating the potential for cooperation and constructive engagement in the region. However, Pakistan's efforts to deal with the spillover o f post-9/11 conflict inAfghanistan and to cooperate ininternational efforts to combat terrorism continue to bring it into conflict with militant groups, particularly in remote border region, Clashes between law enforcement agencies and militants-many o f them foreign-have resulted in significant casualties. - 2 - B. Social ProgressandPovertyProfile 5. The most recent household survey from which poverty estimates can be derived i s now 4 years old, dating from 2000/01, when economic growth was depressed and much o f the country's rural areas were suffering severe drought conditions. A definitive evaluation o f whether the economic turnaround o f the past few years has translated into lower poverty will have to await the release and analysis of the results o f the Household Income and Expenditure Survey which i s expected in 2006; however, provisional estimates releasedby the Government indicate that the incidence o f poverty which rose above 30% in 1998/99, and rose further in 2000/01, fell to below 30% in 2004/05.2 The results o f the 2000/01 Pakistan Integrated Household Survey (PIHS) convey the characteristics o f poverty in Pakistan and highlight the challenge of attaining the Millennium Development Goal o f halving the proportion of populationbelow the poverty line between 1990 and 2015. 6. Based on the PIHS, disaggregated poverty headcounts by province (using the official poverty line) show that NWFP and Balochistan are the poorest provinces and that poverty i s far more widespread inrural areas. Poverty is highest among unskilledlabor inthe informal sector andtheir condition became worse between 1998-99 and 2001-02. Ownership o f livestock and agricultural land are also closely associated with rural incomes. While the poorest quintile o f the rural population accounted for only 10 percent o f the total estimated value o f livestock in 2001-02, the top quintile accounted for 36 percent. Households with no land constituted 60 percent o f the rural population in 2001-02, but accounted for 76 percent o f those in the bottom quintile; and poverty incidence among landless households actually increased from 1998-99 to 2001-02. Vulnerability i s a key feature o f poverty; approximately 41 percent o f the populationi s concentrated ina small range o f 75 to 125 percent o f the poverty line implyingthat, for a very large share o f Pakistan's population, unanticipated shocks such as illness/disability, death, or natural disaster can result inpoverty. 7. Poverty i s also characterized by low level o f human capability, manifested in poor outcomes in education, health and lack o f connectivity to basic services and facilities. Here there i s recent data to suggest that Pakistan's reform program i s beginning to pay off. Preliminary findings from the recently completed Pakistan Social and Living Standards Measurement survey, measuring outcomes as well as access, satisfaction and usage o f public services both at the household and facility level, are encouraging. The preliminary results show significant improvement in a range o f indicators including primary enrolment and immunization coverage (See Table 1). Nevertheless, across a range o f indicators, Pakistan's social indicatorscontinue to lag behind those o f similar countries. C. DevelopmentChallenges 8. The key challenge for Pakistan is now to sustain its recent growth performance in order to generate signifcant poverty reduction. Pakistan's recent growth performance i s encouraging, but its continuation i s by no means assured. Sustained growth will require continued sound macroeconomic management along with further improvements in the investment climate. Notwithstanding the economic recovery, investment rates are insufficient to sustain high rates o f growth needed to reduce poverty. Foreign direct investment, while recovering from the very low levels o f the late 1990's remains low compared to more dynamic economies inAsia. Sluggishrates o f investmentreflect continuedweaknesses inthe investment climate; despite the recent successes inreducing state interventioninthe economy and improving the regulatory framework for private business, firms continue to face significant policy, regulatory, and infrastructure constraints. Security concerns and political uncertainty have also combined to deter investors, both foreign and domestic. The impact o f these constraints i s reflected in the results o f The government has established ajoint committee made up o f donors, experts and officials to evaluate and analyze the most recent data and carry out a detailed analysis o f poverty incidence. The provisional estimates are subject to change based on the results o f this analysis. - 3 - the World Economic Forum's (WEF) 2005-2006 Competitiveness Report which indicate that in2005, of the 116 countries covered, Pakistanranked 66th in `business competitiveness' (see Table 2).3 Table 1: Progress on Selected Social Indicators Reporteddata Indicator 1998-99 2001-02 2004-05 Poverty Poverty incidence (%) 30.6 32.1 Demographics Population (millions) 135 141 151 Education Adult literacy rate: 15+ years (%) 43 43 50 Female literacy rate as percent of male literacy(%) 48 51 5 1 Net enrollment rate (NER): grades 1-5 (%) 50 51 60 Female NER as apercent of male: grades 1-5 (%) 15 I 9 85 Health Life expectancy at birth(year) 64 65 Infant mortality rate 0-12 months (per 1000 live births) 90 82 na Under-five mortality rate (per 100,000 live births) 116 1I 4 na Fully immunized children, age 12-23 months (%) 49 53 71 Percentage of pregnantwomen usingpre-natal care 31 35 50 Sources: PIHS 1998-99,2001-02, Preliminary estimates from PSLM 2004-05. * Provisional estimate. 9. Pakistan's infrastructure Table 2: Competitiveness Rankings platform needs significant Business Competitiveness Index investment in order to support Countries 2005 2004 2003 Palustan's growth and service ~ delivery goals. Infrastructure Singapore 5 10 8 services including electricity, paved Malaysia India 23 23 26 31 30 37 roads, municipal services, and Thailand 37 37 31 telecommunications reach a Turkey 51 52 52 relatively low proportion of the China 57 47 46 population. Moreover, inefficient Pakistan 66 73 75 operations in key sectors, like Philippines 69 70 65 power and transport, adversely Sri Lanka 72 68 57 affect competitiveness. The power Bangladesh 100 95 91 sector ischaracterized by high Source: World Economic Forum, Global Competitiveness Report: 2005- losses and unreliable supply, forcing - 2006; World Economic Forum, Global Competitiveness Report: 2003- many large firms to invest in - 2004 captive generators. Much of the road network i s in poor condition and the railways are carrying only a small fraction o f the nation's freight due to inefficiency. Delays at Pakistan's ports are also hurtingcost competitiveness o f Pakistan's exports. Each day of delay in shipment i s currently raising unit costs, on average, by over 0.5 percent of f.0.b. prices o f export^.^ At the same time, improvements inbasic infrastructure are critical to improving WEF's `Business Competitiveness' index incorporates indicators of the `quality of the national business environment' and of the `company operations and strategy'. For details, see: World Economic Forum, Global Comvetitiveness Revort 2005-2006. The World Bank, GlobalEconomic Prospects: Trade.Regionalism, and Development- 2005, page 80. - 4 - human development outcomes. Approximately 40 percent the population lacks access to power and about 75% o f all rural health, education and market facilities are accessible only by earth tracks. Similarly, water and sanitation services which are critical to achieving human development outcomes suffer from poor quality and limited availability. 10. The infrastructure challenge i s particularly acute with respect to water as Pakistan relies on the largest contiguous irrigation system in the world for 90% o f food production and 25% of GDP. Agriculture i s the single most important source o f employment and irrigation represents more than 95% of the total consumptive use o f water. However, this massive infrastructure i s deteriorating and inneed o f rehabilitation along with reforms to improve the allocation o f water as well as the efficiency o f its use. The capacity o f existing reservoirs i s diminishingas the result o f siltation and no new reservoirs have been built since 1976. Moreover, competition for water i s growing among the provinces and across the varied needs for irrigation, industrial and domestic use, and the environment. Pakistan has already begun ramping up its investments, beginning with the urgent rehabilitation of barrages. Yet there remains a need for significant new investment, not only in irrigation but in other uses o f water as well, including power generation and urban-industrial and domestic supplies (50% o f the population i s not served by a formal supply system and sanitation and water treatment reaches less than 10% of the population). At the same time there i s uncontrolled pollution of surface and groundwater from agriculture, industry and rapidly growing cities. 11, For the poor to participate in and benefit from growth Pakistan needs to accelerate human development. International experience suggests that no country can hope to compete in the global economy without an educated and healthy work force. Indeed, the lack o f skilled manpower and lower labor productivity are often cited as constraints to raising productivity, strengthening competitiveness, and achieving sustained high economic growth by both business leaders and policymakers in Pakistan. While Pakistan i s making progress, analysis suggests that it will be difficult to achieve the MDGs for infant mortality, child malnutrition, primary completion, and elimination o f the gender gap in primary enr~lment.~Looking beyond the MDG's, enhancing competitiveness in an increasingly globalized and technology driven world economy will require a growing pool o f workers with leading edge skills pointing to the need for increases in the level and quality o f secondary, vocational and higher education. Thus, continuedconcerted efforts to address poor human development outcomes are important not only to improve equity but also as an integral part o f achievingPakistan's growth objectives. 12. Pakistan's poor social indicators are not due solely to poverty or lower rates o f economic growth; Pakistan significantly underperforms when compared to other countries at similar levels o f per capita income, and when compared to countries at similar levels o f development. For example, Pakistan has 36 percent fewer births attended by trained personnel, an infant mortality rate that i s 27 per thousand higher, and a gross primary enrollment rate that i s 20 percent lower than countries with similar income levels. Similarly, growth in Pakistan appears to have less o f an impact on social indicators than in other countries-between 1960 and 1998, as per capita GDP more than doubled in Pakistan, infant mortality declined by 43 percent, as compared to a decline o f 73 percent in a group o f low income countries that on average grew at the same rate. 13. Pakistan's relatively slow progress in improving human development reflects both l o w public expenditures on education, health, water and sanitation and other key sectoral expenditures as well as weaknesses inpublic service delivery which limit the effective use o f scarce resources. As a result o f the debt burden, which reached a peak inthe late 1990's, social sector spending was squeezed, with education and health expenditures declining from 2.2 and 0.7 percentage o f GDP in 1987/88 to 1.7 and 0.5 percentage o f GDP by 1999/00. Despite having risen since then, public expenditure on health and education remain low by international standards. Within sectors, resources have been poorly allocated World Bank,Attaining the MDGs in Pakistan (Washington, DC, 2005). - 5 - with emphasis on spending for new hiring and facilities at the expense o f providing resources for operations and maintenance. Weaknesses in management o f public services also stem from capacity constraints and in some cases lack o f clarity about the roles and responsibilities o f various levels o f government. Moreover, social services are subject to, inter alia, high absenteeism rates o f service professionals (25 percent for teachers), poor quality o f inputs and materials, low community involvement and limitedparticipation o f the poor. 14. It is also important to note that a number of factors weaken the link between growth andpoverty reduction in Pakistan. One such factor i s the skewed structure o f ownership and access to factors o f production (land, water and credit) inrural Pakistan, which limitsthe impact o f agricultural growth on the incomes o f the rural poor. Landless agricultural laborers and non-agricultural rural poor households account for 61 percent of the rural poor (and nearly 30 percent o f the rural population). Another factor i s the ineffective targeting and delivery o f government programs which reduces the benefits o f increased government spending. Strong social and cultural norms restrict access to public services and reduce the economic opportunities of women and girls. Together these factors create obstacles for the poor and vulnerable to partake in the benefits of economic growth, highlighting the importance o f interventions that address chronic poverty and vulnerability, and help the disadvantaged groups, including women, participate in economic growth. 15. Large gender inequalities represent a critical constraint to improvements in human development outcomes. Since the late 1990s, the Government o f Palastan has launched programs designed to increase girls' school enrollments, enhance female access to health care, and facilitate women's participation inthe public arena. Some progress has been made, but much more i s needed. For example, legislation mandating reservation o f seats for women in local governments, as well as in provincial and national assemblies, has substantially increased women's political representation. However, although more girls are in school, a substantial gender gap in enrollment remains and worsens significantly as girls transition from primary to middle school. Although gender differentials in child immunization have declined, considerable gender differentials persist in other aspects o f health care. The use o f reproductive health services i s low, and maternal mortality ratios remain high. In the labor market, lower educational attainment coupled with social norms that restrict mobility confine women to a limited range o f employment opportunities and low wages. The achievement o f Millennium Development Goals (MDGs) will require significant reductions in these gender gaps. Policy interventions directed specifically at gender inequality inthese public domains are needed. 16. Pakistan's population i s predominantly rural and dependent on agricultural lands, rangelands and forests. Natural resources and their sustainable management are therefore central to Pakistan's economic growth and to people's livelihoods. Salinization and waterlogging of land, increasingly polluted agricultural drainage (partly due to excessive pesticide use), and loss o f important ecosystem functions from diversion o f flows and from pollution are reflected in disappointing development outcomes and compromised agricultural yields. Degradation o f rangelands continues and the rate o f deforestation i s relatively high (although the level of remaining forest cover i s already low). The poorer rural dwellers suffer most from these trends. Urbanization is increasing at a rapid rate and the provision of basic environmental services in these areas has not matched the pace o f growth. In both rural and urban areas there are problems o f public health related to the lack o f water, sanitation and other services and also to high levels of air pollution (in rural areas, this is related mainly to indoor air from use of poor quality fuels). Addressing these problems i s a necessary adjunct to a sustainable growth and poverty alleviation strategy. - 6 - to have an advers will be modest as to rebuild livelih reconstruction nee 17. Addressing governance challenges and combating corruption are critical for improving the investment climate and strengthening the delivery of public services. Public institutions delivering social services, law and justice and economic services suffer from inadequate capacity and ineffective internal and external accountability. Moreover, while reliable data i s scarce, surveys cited in the Government's - I - National Anti-Corruption Strategy indicate that corruption i s a serious challenge. The civil service suffers from weak capacity as a result o f many years o f rapid turnover, patronage-based employment at lower levels and inadequate compensation at senior levels. Accountability has been further weakened by lack o f effective client voice, made worse by the over-centralization o f power at higher levels o f government. Together these weaknesses represent a major impediment to improving service delivery and the investment climate. 18. Improving governance and combating corruption i s one o f the pillars o f Pakistan's poverty reduction strategy. Key elements o f the strategy include: (i) reducing opportunities for corruption by redefining and refocusing the role o f the state through privatization and de-regulation; (ii) reforming the civil service; (iii) establishing local government as an effective system o f governance, participation and accountability; (iv) supporting reforms in public financial management and procurement in order to promote prudent and accountable management o f public resources while reducing opportunities for corruption; and (v) strengthening enforcement mechanisms and the administration o fjustice. 19. Significant progress has been made in these areas. Local governments have been created to increase responsiveness and accountability for provision o f key public services. The tax administration system has been redesigned to reduce interaction between taxpayers and tax officials. The Government's privatization program accelerated duringthe previous CAS period; over the last two years the government realized US$4.35 billion in proceeds through 27 transactions compared with US$600 million during the previous three years. Privatization of state-owned banks coupled with stronger regulation under a revitalized State Bank o f Pakistan has reduced politically-motivated lending and non-performing loans. Progress has been made in improving public financial accountability through modernization o f financial reporting systems and auditing, while the institutions o f accountability like the Auditor General and the Parliamentary Public Accounts Committees have been revitalized. The national power utility i s being unbundled to de-monopolize the industry, improve its transparency and efficiency and prepare for privatization. The National Accountability Bureau was created, successfully prosecuting cases o f high- level corruption. Nevertheless while this progress has been encouraging, most observers believe that a great deal more needs to be done to address the deep governance challenges faced by Pakistan. D. EconomicDevelopmentsand Outlook Recent Economic Developments and Prospects 20. Since the last CAS, Pakistan's economy has continued its strong recovery. Growth has accelerated from 3.1 percent in FY2001/02 to 8.4 percent in 2004105. The recovery was driven by a strong rebound in exports of manufactures and, more recently, favorable weather conditions leading to a strong pick up inagriculturalproduction. Large scale manufacturing grew by 18.2% inFY2003/04 and by 15.4% in 2004/05. Fiscal performance has been sustained, despite limited progress in improving revenue collections and reducing power sector losses. Due primarily to increases in non-tax revenues and savings on the interest bill, the overall fiscal deficit (excluding grants) declined from 6.6 percent o f GDP in 1999/2000 to about 3 percent of GDP in 2004/05. Moreover, despite this rapid fiscal adjustment, social- and poverty-related expenditures were raised by over 1percentage point o f GDP over the last three years, or by over 30 percent in real per capita terms, although they remain low in comparison with other developing countries. 21. The balance of payments turned around with strong export growth and sizable remittances, and international reserves were rebuilt to cover about five months o f imports o f goods and nonfactor services and over 250 percent of short term external liabilities (up from 11percent in 1999/2000) at end 2004/05. 6 Government of Pakistan, National Anti-Corruption Strategy, Islamabad Pakistan, 2002 (http://www.nab.gov.pWDownloads/Doc/NACS.pdf). - 8 - However, the external situation has deteriorated somewhat over the past 18 months. Exports and workers' remittances have performed well, but with imports growing even faster, the current account moved into deficit in 2004/05. The trade deficit during FY05 rose sharply to US$4.3 billion and is projected to increase further to over US$7 billion in FY06. This reflects the rapid increase in imports which rose by nearly 38% to US$18.8 billion due to strong import demand for a wide range o f consumer and investment goods (including automobiles and machinery), agricultural and chemical goods (fertilizer), and to highoil prices. Exports increased by 13.8% to US$14.1 billion. Gross reserves fell by about US$SOO million in 2004/05 to US$9.8 billion at end-June 2005. The current account deficit i s projected to reach 3.9% o f GDP inFY06. Figure 1: Recent Economic Performance Y o Economic Growth Balanceof PaymenhandReserles 9 0 - Y oT 6 billions . ........ 8 0 - 5 0 12 0 1 4 0 Gross int'lreserves In billionsT RealGDP at factor cost 3 0 I O 0 5 0 - / 2 0 8 0 I O 0 0 6 0 -1.0 4 0 -2.0 -1 0 -, -3.0 2 0 -2 0 J -4 0 0 0 1995196 1997198 1999/00 2001102 2003104 1999100 2000/01 2001102 2002103 2003/04 2004105 I % Total andExternalDebt Fiscal Trends 100, ------_ Expendture 1 I1 10 0 Revenue Ii 5 0i I . _.._. ---..._ _._,C...---.-'-- I O Budget balance(excl grants) j 0 -10 0 . . . . . . . . . . . . . . . . . ,. 1999100 2000/01 2001/02 2002/03 2003104 2004/05 1999100 2000101 2001/02 2002103 2003104 2004/05 22. Pakistan's public debt burden has declined sharply in the past four years. Although the stock o f debt remains high, it has declined faster than expected, and its net present value has been reduced. Thanks to rapid growth, availability of grants and concessional finance, debt cancellation and fiscal consolidation, total government debt as a percent of GDP declined from 80% in 2001/02 to 61% in 2004/05. Total external public and publicly guaranteed debt declined from 296 percent o f exports o f goods and services in FY2001/02 to 203 percent in FY2004/05 while debt service fell from 34 to 19 percent of exports o f goods and services. Interest payments have fallen from 5.6% o f GDP in2001/02 to 3.2% in FY2004/05. 23. The response to the October earthquake-arguably the most debilitating natural disaster in Pakistan's history-is expected to have an impact on fiscal outcomes during the current fiscal year and for at least the next 3 years. The deficit, which had already been projected to grow as the result o f increases in civil service salaries and a growing public investment program, i s expected to rise further, reflecting the costs of rebuilding infrastructure and government services and o f subsidies to restore livelihoods and housing in the earthquake-affected areas. The FY06 fiscal deficit before grants is expected to increase by around 0.6% o f GDP, to 4.4% o f GDP (see Table 3), which remains consistent with a stable macroeconomic framework and the Fiscal Responsibility and Debt Limitation Law. However, the increase in public expenditures due to the earthquake may result in a slowdown inthe pace o f debt reduction. The extent to which it does depends not only on the Government's efforts to reprioritize - 9 - expenditures, but also the pace at which grants pledged at a November 2006 donors' conference materialize. The government has indicated that it i s reprioritizing expenditures and strengthening revenue efforts so as to minimize the impact o f the earthquake on fiscal balances. The latter i s particularly important since revenue performance suffered in FY05 due to a reduction in petroleum taxes (a move designed to cushion consumers from the impact o f rising international oil prices), reductions in customs duties and special regimes for particular sectors. Some administrative reforms also may have contributed to a temporary dip in collections. However, collections during the current fiscal year are improving markedly. Table 3: Medium Term Outlook - Key Indicators Projections 2002103 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 (in percentof GDP, unless indicatedotherwise) Output and Prices Real GDP at factor costs (percent change) 4.8 6.4 8.4 6.3 6.5 6.6 6.8 Consumerprices(period avg. percentchange) 3.1 4.6 9.3 8.2 6.5 5.5 5.0 ConsolidatedGovernment Budget Balance Excluding grants -3.8 -2.3 -3.3 -4.4 -4.4 -3.9 -3.6 Net ofEarthquake Impact -3.6 -3.5 -3.3 -3.1 PublicDebt Total governmentdebt 74 68 61 57 54 51 49 Domestic debt 39 36 33 32 28 25 23 Externaldebt 35 31 28 25 26 26 26 ExternalSector Current Account Balance 5.1 2.0 -1.3 -3.9 -4.3 -4.3 -4.1 Gross Reserves (US$ millions. IMFdefinition) 10,251 10,621 9,985 10,549 12,157 13,117 14,079 Reservecover to importsof GNFS (months) 6.9 5.0 3.7 3.4 3.4 3.2 3.0 Sources: 2002103 to 2004105- Government of Pakistan; 2005/06 to 2008/9 projections World Bank Staff estimates. - 24. The Government's fiscal policy aims to contain the deficit and continue to reduce the debt burden while increasing public investment and social spending. These commitments are embodied in the Fiscal Responsibility and Debt Limitation Bill approved by the National Assembly and subsequently passed into Law in 2005. The Law specifies that the revenue deficit be reduced to zero by June 30, 2008, and a surplus maintainedthereafter; that total public debt be reduced by 2.5% o f GDP per year; that PRSP expenditures be at least 4.5% o f GDP in any year; and that debt guarantees be limited to 2 percent o f GDP. An additional important clause introduced in the L a w by the Assembly i s the requirement that education and health expenditures, as a percentage of GDP, be doubled over the next ten years. Meeting these targets will depend in large part on the government's ability to improve revenue collection while continuing to reduce the losses o f state-owned enterprises, particularly in the power sector. The Government fiscal framework for 2006 through 2009 i s expected to remain consistent with the Fiscal Responsibility and Debt LimitationLaw. 25. Prospects for rapid growth to be sustained over the next 3 years are good, provided that political and macroeconomic stability are maintained, that the momentum o f structural reforms and investments to reduce the cost o f doing business i s sustained, and that domestic savings and public and private investment continue to increase The Government i s targeting a more ambitious growth path than the Medium Term Outlook table estimates, with growth projected to rise gradually to 7.8% of GDP by 2009. Emerging risks on the external sector can be mitigated by gradually reducing demand pressures. The Medium Term Outlook presented above assumes that the measures necessary to reduce inflationary pressures and the growing external and fiscal imbalances will be taken by the central bank and the Government o f Pakistan. Economic growth for FY06 i s projected to remain strong and broad-based. Led - 10- by strong domestic demand, industrial growth remains strong in the automobiles and consumer durables sub-sectors. The textile sector continues to perform well, in spite o f the end of the Multi-Fiber Agreement, and exports o f textile products have remained strong. Agricultural output in FY06 i s projected to be average, below last year's record-breaking levels, Foreign Direct Investment i s continuing to increase, as investor confidence i s strengthening. 11. PAKISTAN'SPOVERTYREDUCTION STRATEGY 26. The positive developments outlined above have set the stage for accelerating poverty reduction in Pakistan. Pakistan's poverty reduction strategy paper (PRSP), which was presented on December 31, 2003, sets forth the broad-based strategy for addressing poverty in its various dimensions including human development, governance, and vulnerability and builds on the economic program first articulated in the fall o f 1999 and further elaborated in the I-PRSP of 2001.' Since the PRSP was prepared, the Government has continued to develop and refine its program for implementing the PRSP agenda which i s embodied in the five-year Medium Term Development Framework 2005-20 10 (MTDF), adopted along with the FY2005/06 Budget. While the PRSP continues to serve as an overall framework for the poverty reduction strategy, the MTDF refines the strategy, taking into account recent developments, and updates the targets while providing further details on implementation strategies. The Government i s also in the process of preparing a new PRSP which i s expected to be finalized in2006. 27. Taken together, the PRSP and the MTDF constitute a comprehensive poverty reduction and growth strategy. The PRSP emphasizes policies to sustain rapid growth as the main vehicle for poverty reduction and i s grounded on four pillars: (i)achieving and sustaining a high growth rate while maintaining macroeconomic stability, translating this higher growth into lower poverty, and bridging the social gap; (ii) improving governance and consolidating devolution, both as a means o f delivering better development results and ensuring social and economic justice; (iii) investing in human capital, with a renewed emphasis on effective delivery o f basic social services; and (iv) targeting the poor and vulnerable to bring marginalized sections of the population and backward regions into the mainstream o f development, and to make marked progress inreducing existing inequalities. The PRSP's targets are fully aligned with the MDGs (see Table 4:). A. The PRSPStrategy 28, Pillar One: Accelerating economic growth while maintaining macroeconomic stability. The PRSP focuses on accelerating poverty reduction and improving social indicators through rapid, private- sector and export-led growth and more effective and equitable delivery o f health, water and sanitation, and education services. The PRSP also emphasizes enhancing competitiveness in the era o f globalization through higher investment and knowledge inputs. It recognizes that, while a great deal has been accomplished in terms o f restoring growth and addressing external vulnerabilities, considerable challenges remain to improve the efficiency o f resource use and raise factor productivity. The key source o f poverty reduction and employment i s expected to be rapid growth and job creation in the manufacturing and service sectors, which are already responding well to economic reforms. The PRSP projects a substantial increase in private sector investment and the continued expansion of private sector activity in order to sustain growth. To increase private investment, the PRSP outlines a set o f structural reforms to increase productivity and reduce the cost o f doing business in Pakistan. Overall, the strategy aims to expand the role o f the private sector inthe development process by the strengthening the enabling role o f the government through policy direction and creation o f a supportive regulatory environment. 'TheBank-Fund Joint Staff Assessment (JSA), discussed by the Board on March 11, 2004, endorsed the PRSP and indicated it provides a good policy framework for the implementation o f a strong reform program. Pakistan, Joint StaffAssessment of the Poverty Reduction Strategy Paper, Report 27625-PK, February 12, 2004. - 11- 29. Pillar Two: Improvinggovernance. The PRSP recognizes that continuing to improve governance in Pakistan matters critically for economic growth and the development o f human capital. The MTDF reinforces this emphasis. Key elements o f the Government's strategy include accelerating civil service reform, furthering devolution, improving access to justice, police reforms, accelerating improvements in public procurement and financial management, and additional measures to accelerate progress on fiscal and financial transparency and reduce opportunities for corruption. In addition to these areas, the MTDF also highlightsthe importance o f strengthening corporate governance, enhancing the quality and coverage of data and statistics, and making greater use o f participatory approaches inorder to improve program and project outcomes. Regarding civil service reform, the government's strategy highlights a flatter structure, merit-based recruitment and promotion criteria, performance based compensation, and incentives to innovation. There i s also a proposal to restructure the civil services in order to break free o f some o f the structural rigidities resulting from the current cadre system. The government also indicates its intention to implement further pay and pensionreforms. Table 4: Pakistan's PRSP Targets and Alignment with Millennium Development Goals Goals and Indicators 1990-91 2000-01 2o05-06 actual 2011 2015 1. EradicatePovertyand Hunger -- Povertypoverty level (% of population) Overall 26.1 32.1 28 22 16 gap ratio 4.53 6.84 2. Achieve UniversalPrimary Education -- Gross Enrollment* Literacyrate o f 15-24 years old (%) 49 58 59.5 78 86 73 87 104 104 100 3. PromoteGenderEquality and EmpowerWomen -- Proportiono Ratio o f literate females to males o f 15-24 years (%) 0.61 0.65 0.65 0.93 f Seats heldby women inthe Parliament: National Assembly (YO) 0.9 21 Senate (%) 1.o 17 Local Councils (%) 33 4. ReduceChild Mortality --- Proportion of rate Infantmortality 120 71 63 50 40 fully immunizedchildren 12-23 months 25% 53% 82% 90% >90% Under five mortality rate 140 105 80 65 52 5. ImproveMaternal Health --- Maternal mortality rate/100,000 550 450 350 180 140 Total fertility rate 5.4 4.1 4.0 2.5 2.1 LHW coverage oftarget population nla 45% 77% 90% 100% 6. Combat HIV/AIDS, Malaria and Other Diseases - Incidence of TB/I00,000 n/a 177 133 45 7. EnsureEnvironmentalSustainability -- Populationwith access to sanitation Sustainable access to safe water 82% 86% 90% 93% 28% 51% 55% I Source: Government of Pakistan, PovertyReduction Strategy Paper, 2003. *A sub-committee headedby Director, PIDE is engagedinreconciling PIHS and NEMIS data. 30. Pillar Three: Investing in human capital. In Pakistan, social development lagged even when growth was robust and the incidence o f income poverty declined. The Government's PRSP acknowledges that without a considerable improvement in social indicators, especially for women, Pakistan will be unable to sustain high rates o f economic growth. Education i s seen as the most important factor - 12- distinguishing the poor from the non-poor. The PRSP, therefore, includes increased allocations for education, health, water and sanitation, and rural infrastructure. The MTDF reflects a large increase in resources for educationwith the total public allocation for education expected to increase to 3.6 percent o f the GDP by 2010 with private sector expenditure adding another 1.5 percent. 31. Inhealth, the PRSPrecognizes the needto increase financing and enhance efficiency of spending through organizational and management reforms. Furthermore, the PRSP focuses on reorganization o f district health structures, strengtheningo f district and tehsil hospitals, improving hospital administration through greater autonomy, and regulation o f the private sector. On the programmatic front, the strategy i s to continue and strengthen the shift from curative services to preventive and primary health care. The strategy prioritizes control of communicable diseases, reproductive health, child health and nutrition. In health, the Federal Ministry would focus on development o f a public health surveillance system and on gradually devolving preventive care programs, which would increasingly be designed and not only implemented by provincial and local governments. The PRSP acknowledges that the achievement o f key PRSP goals in health depends also on policies and developments outside o f the health sector such as literacy, access to drinkingwater and adequate sanitation. 32. Pillar Four: Targeting the poor and the vulnerable. Targeting the poor and the vulnerable through social protection programs i s one o f the integral pillars o f the strategy. There are several social protection programs in Pakistan, which have as their objective improving the welfare o f the poor and vulnerable groups. The programs include cash transfers through the Zakat and Bait-ul-Maal programs, in-kindassistance through, for example, the school meals pilot program(Tawana Pakistan), andprograms to reduce the prevalence o f child labor (stipendschools for working children and their families), In addition to cash and in-kindtransfers, Khushali Bank and a number of NGOs provide microfinance to low-income households. There i s also a social security system for workers inthe formal sector. A modest number o f facilities provide institutionalizedcare or special education to specific vulnerable groups such as the disabled or child laborers. 111. BANKGROUPASSISTANCESTRATEGY A. Implementationof the Last CAS andLessonsLearned FY03-05 Actual lending,portfolio management, and IFCprogram 33. While new lending slowed during FY03 following the October 2002 elections, it picked up thereafter and overall CAS lending volume was close to that envisioned inthe high-case lending scenario of the FY03-05 CAS. New lending commitments during the CAS period totaled US$2.033 billion, including US$404 million o f IBRD, or 15% below the CAS highcase lending scenario o f US$2.4 billion including US$600 million inIBRDborrowing. The shortfall inIDA commitments was due inlarge part to delays in development policy lending for the provinces o f Sindh and NWFP as well as a shortfall in overall IDA 13 resources. Total IBRD commitments were one-third less than the high-case scenario total. A detailedcomparison o fplannedand actual lendingis included inthe CAS CompletionReport. Just over half o f IDA and IBRD commitments were fast disbursingdevelopment policy loans, compared with the 65% share projectedinthe CAS, again reflecting the delay inplanned development policy lending for the provinces. 34. With respect to the ongoing portfolio, performance throughout the CAS was generally good (see Table 5). Starting from a low point at the beginning of the CAS period, the portfolio has grown from 12 to 16 projects reflecting the increase in lending over the previous CAS. Despite the growing volume o f lending, the portfolio remains relatively small, a reflection o f the substantial proportion o f single tranche development policy credits in the program (about one-third o f the operations approved during the CAS period). Performance indicators showed sustained strong performance with 100 percent realism and - 1 3 - pro-activity and a disbursement ratio well above regional and Bank-wide averages. The percentage o f projects at risk remained low, although it rose somewhat in FY05. This increase i s being watched closely and managed intensively in consultation with the GoP (see para. 106). Table 5: Bank Portfolio Indicators 35. The CAS emphasis on Indicator FY02 FY03 FY04 FY05 knowledge transfer was reflected in NumberofProjects 12 15 18 16 the AAA program. Core diagnostic ProjectsRisk at 8.3 6.7 5.6 12.5 reports completed include a Public Commitments at Risk (%) 0.0 23.2 19.6 7.2 Expenditure Review (rated highly Realism (%) 100.0 100.0 100.0 100.0 satisfactory by QAG), a Poverty Proactivity (%) 100.0 100.0 100.0 100.0 Assessment, CFAA (complemented DisbursementRatio 37.0 28.0 24.7 40.7 by three provincial financial accountability assessments), an FSAP, and a Country Gender Assessment. Customized, high impact informal AAA such as the trade policy notes and power sector policy notes were used to support high level policy dialogue and catalyze implementation of reforms. A series of in-depth provincial economic reports was launched, beginning in FY04 with the Punjab Economic Report, followed by the NWFP Economic Report in FY05. By design, the AAA program has put less emphasis on delivery o f discrete outputs and teams have been encouraged to transfer knowledge through policy dialogue and non-lending TA. Major (or flagship) ESW Reports have been limited to no more than three a year to ensure quality and adequate managerial attention. 36. TheIFC Program over the previous CAS period included investments and significant increases in technical assistance and advisory service. Commitments during the three year period totaled US$187 million. Total exposure now stands at US$314 million in 32 companies including US$62 million in equity, down from U S 4 4 2 million in 48 companies at the time o f the CAS. Liquidity in the local financial markets led IFC to reassess its approach and provide more value-added instruments and put greater emphasis on TA. The focus during this period was on the financial sector, SMEs infrastructure, and targeted industrial interventions. IFC's investments supported expanded container capacity in Karachi's port, the first investment in information technology, Islamic financing in the leasing sector, and a linkage initiative in the textiles sector. TA included initiatives in all major pillars o f the Private Enterprise Partnership for the Middle East and North Africa (PEP-MENA) facility: financial sector, SMEs, business enabling environment, and privatization or public-private partnerships. IFC's TA program in Pakistan included a corporate governance program for banks, institution building in housing finance, and SME and microfinance, training in alternative dispute resolution, support for business membership organizations, and advice in the water sector. Moreover, during the last CAS period, IFC Technical Assistance and Trust Funds Program (TATF) completed a feasibility study in the health sector as well an analysis o f the competitive positions o f the country's leasing companies and investment banks, IFC's Environmental Opportunities Facility (EOF) completed a study to help optimize a wastewater treatment facility inthe textile manufacturing industry. Lessons learnedfrom IEG evaluations, client survey, and the CAS CompletionReport 37. The Country Assistance Strategy (CAS) for FY2006-09 builds on the lessons learned during implementation o f the FY03-05 CAS and the messages heard during consultations with stakeholders as well as the results o f a client survey. In addition, recent formal reviews o f the Bank's work in Pakistan include (i)the Independent Evaluation Group (IEG) Country Assistance Evaluation covering FY94-FY03; (ii) the FY03-05 CAS Completion Report; (iii) IEGProject Performance Assessment Recent Reports; (iv) ICRs o f projects closed duringthe CAS period; and (v) a QAGreview o f AAA work. - 14- 38. Results of the Client Survey. The survey o f 351 stakeholders drawn from government, national and provincial assemblies, the private sector, media and academia yielded a number o f insights on the Bank's contribution to Pakistan's development. Stakeholders reported that the greatest development challenges are poverty reduction, education and law/justice, with education emerging as a critical issue consistently throughout the survey-and an area where respondents believe the Bank can play a more profound role, Inaddition, stakeholders emphasized infrastructure as an area that i s critical for successful development-and an area where the Bank's work receives some o f the highest ratings from stakeholders. The Bank's role as a provider o f knowledge was also particularly valued. The Bank's greatest weaknesses were considered to be imposing technocratic solutions without regard to political realities and not exploring alternative policy options. A consistent and important message from both the survey and consultations i s that the Government o f Pakistan values its partnership with the World Bank. 39. Lessonsfrom the CAS Completion Report. The CAS Completion Report (Annex 2) reviews the Bank Group's effectiveness over the past three years and indicates that the Bank's strategy was appropriate and succeeded in making a significant contribution toward the achievement o f some o f the outcomes targeted in the FY03-05 CAS. Inparticular, targets for macroeconomic stabilization (including debt reduction) and increases in poverty-related expenditure were met and milestones in governance reforms in financial management and tax administration were achieved. While outcomes in several areas were not met, the Bank program helped in the development and implementation o f reform programs to which the government remains committed, even ifthe pace o f reform has not been as rapid as envisioned in the CAS. With respect to development outcomes, there is now preliminary data to suggest that the reforms o f the past three years are beginning to yield measurable improvement, although in some cases less than targeted inthe CAS. Taken together these reviews and feedback suggest that while the Bank has made a valuable contribution to Pakistan's development, there i s significant potential to increase our development impact. The chief lessons relevant to formulation o f the CAS are: e A programmatic approach provides theflexibility to support reforms while managing risk. The use of annual single tranche adjustment operations at boththe provincial and national level helped to support reforms while providing a mechanism to adjust the lending program to match the pace of reforms. This approach strengthened the link between borrower performance and the Bank lendingprogram. e Projects need to befocused and scaled tofit the capacity of the implementing agency, in terms of both project scope and the pace of implementation. While reinforcing the emphasis on the key role o f "client pull," the experience o f a number o fprojects that closed duringthe CAS, especially the multi-province umbrella projects, highlights the need for focused projects that are readily "implementable" with realistic schedules and clear ownership. Inparticular, governance reforms often took longer than planned. Realistic assessment o f technical and political implementation challenges need to be reflected in project designs which should exhibit a strong bias towards simplicity. e Greater attention to capacity building is needed. As indicated above, weak implementation capacity i s a widespread concern affecting project design and implementation. The Bank has begun to increase its capacity buildingprograms with the approval o f the Public Sector Capacity Building (PSCB) project in FY04 and the designation o f Pakistan as a focus country for WBI programs beginning in FY05. The Bank will also continue its support for civil service reforms through policy dialogue, the PSCB project and PRSCs. During the coming CAS, projects will have a greater emphasis on buildinginstitutional capacity. e Theprogram needs to continue to strengthen itsfocus on results. To address weak M&E systems and capacity within the GoP and implementing agencies, the Bank needs to support the strengthening o f statistical capacity and monitoring and evaluation as part o f institution strengthening. At the same time, the Bank needs to do a better job o f focusing on developing - 15- solid project-level results and indicators and incorporating the monitoring o f these results into the supervision process. The results-based CAS offers an opportunity to identify and focus on key strategic outcomes at the country level and provide a framework for joint monitoring and evaluation o f the overall country program with the Government. 40. The I E G Country Assistance Evaluation.IEG's Country Assistance Evaluation (CAE) rates the overall outcomes o f the Bank's assistance program as moderately unsatisfactory. During the period * covered by the IEG review (1994-2003), IEG found that the outcomes o f Bank support for macroeconomic management and growth achieved success, especially in the last few years. However, outcomes o f the Bank's assistance were found to be unsatisfactory inpoverty reduction and social sector development, governance, agriculture and natural resource management, fixed infrastructure, and revenue mobilization and expenditure management. Taken together, therefore, IEG rated the overall outcomes o f the Bank's assistance program as moderately unsatisfactory. Although the CAE primarily covers the decade prior to the beginningthe FY03-05 CAS, some o f its findings and recommendations are applicable to the new CAS and have been discussed by the Country Team and are reflected herein. The key recommendations o f the CAE are: (i) the Bank should continue its strong support o f analytical work while translating analysis into implementable actions taking into account political economy constraints; (ii) Bank interventions should have a greater focus on buildingsustainable institutional capacity; (iii) projects shouldbe more focused and scaled to fit the capacity o f implementing agencies; and (iv) the Bank should invest additional effort into improving donor relations. 41. A more recent IEG Project Performance Assessment9 drawing lessons from the provincial development policy loans for Sindh and NWFP has also informed the development of this CAS. In particular, the PPAR notes that sub-national development policy lending can make a significant contribution interms o f improving service delivery.Inthe context o f devolution, the PPAR also notes the importance o f clarifying the respective roles and financial relationships o f various levels of government. Finally like the CAE, the PPAR notes the importance o f takmg capacity constraints into account- especially at the local level-and recommends greater attention to capacity buildingin future operations. B. Context andEngagementPrinciples 42. While highlighting areas in need o f strengthening, the review o f our assistance and lessons learned outlined above also confirmthe value o f the Bank's strategic partnership with Pakistan. The Bank has come to be seen by the Government as a trusted development partner, valued not only as a major source o f development finance but also as a source o f global knowledge based on international experience. At the same time, the Bank has gained significant credibility as a catalyst for reform through its willingness to exercise selectivity, lending only in the presence o f strong ownership of, and commitment to, reform and where there i s clear evidence that the Bank adds significant value. The Bank i s therefore uniquely positioned to play a key role in helping Pakistan to sustain its recent strong performance and accelerate poverty reduction. Moreover, in light o f its recent successes, Pakistan i s well positioned to make real progress inpoverty reduction and has requested a significant increase inthe scale of Bank financial support. For the Bank, this represents an important opportunity to increase the impact of our work inPakistan by significantly scaling up our program over the FY06-09 period. 43. Inthis context, the Bank's work will continue to be guidedbythe following strategic engagement principles: ~ Pakistan - Country Assistance Evaluation (CODE2005-0058; il), June 29, 2005. The Pakistani authorities agree with the CAE's analysis in some areas, but note that the report did not emphasize adequately recent improvements and was too critical o f outcomes inagriculture and privatization. IEG,Project Performance Assessment Report. Report No. 33612, December 19,2005. - 16- 0 The Bank will commit resources only inthe presence o f strong "client pull"to ensure that scarce resources are applied only where there i s a highprobability o f success. Evidence o f client demand for Bank support will include the leadership o f committed reform champions who have demonstrated the willingness and ability to carry out needed reforms. At the project level, client demand will be reflected in the establishment o f adequate institutional arrangements and readiness for prompt implementation. 0 The Bank's program will reflect strategic selectivity, targeting Bank resources where they can be most effective. A principle consideration will be demonstration o f client pull as outlined above. In addition, while the program will span a wide range o f instruments and sectors, we will maximize impact by seeking replicate or scale-up approaches that have already been shown effective. We will continue to maintain a close dialogue with the Government and other partners to harmonize and reinforce our efforts and to target our activities in the areas where the Bank has the greatest comparative advantage. 0 This new CAS will have an even greater focus on outcomes. The Bank's program for Pakistan will be guided by the CAS results framework (Annex 1) which identifies: (i) long-term national development goals; (ii) associated CAS outcomes that the Bank can directly help to realize; and (iii) mixofBankGroupproductsandservicesthatbestcontributestotheseCASoutcomes. the An integral part o f the shift toward a results-based CAS will be the strengthening of the CAS M&E architecture. The CAS results framework also identifies indicators to monitor progress toward the achievement o f CAS outcomes as well as implementation o f World Bank Group CAS programs and will therefore serve as a mechanism for monitoring progress in CAS implementation. 0 Programmatic approaches will continue to form the core of the Bank program. The experience of the FY03-05 CAS supports the continued used o f a programmatic approach to provide sustained, flexible, and predictable support to medium-term reform programs. Experience has also shown that programmatic approaches are effective in strengthening ownership while accommodating the uncertainties inherent in medium-term reforms. Increasingly we will provide a range o f services-a combination o f dialogue, capacity building, expenditure review and technical assistance along with IDA resources-aimed at building effective service delivery systems at the local government level. Programs will seek to link inputs to outputs, be integrated into medium-term budget frameworks and include an effective monitoring system. 44. In line with Pakistan's recent performance and request for additional Bank support as well as application o f the strategic principles outlined above, the Bank will seek to deliver a substantial increase inits volume oflendingto Pakistan duringthe next four years. The immediatepriority willbe to assist in addressing the impact o f the October 2005 earthquake; up to US$1 billion in IBRD/IDA commitments will be used to support reconstruction and recovery (US$840 million in new commitments have already been approved). Inaddition, based on the Government's priorities for sustaining growth and accelerating poverty reduction, the expansion in lending will be primarily in infrastructure(primarily energy, water, and transport) and human development. Cross-cutting reforms, both at the national and provincial level will remain a key focus and a substantial share o f IDA lending will take the form o f PRSCs and provincial development policy credits to support, inter alia, fiscal/financial management improvement, transparent and efficient public procurement, power sector reforms, actions to improve the investment climate and cross-cutting initiatives to improve service delivery. Investment lending devoted to strengthening and reform o f the key governance institutions (e.g., tax administration, financial management, land records, and statistics) will also continue to make up a significant portion o f the lending program. - 11- 45. While the Government's request for additional financing for infrastructure will leadto an increase ininvestment lending, policy-based fast disbursinglendingwill continue to account for a significant share of total lending. Policy-based lending instruments are well-suitedto supportingthe Government's poverty reduction strategy which emphasizes second generation policy and institutional reforms. The experience of the FY03-05 CAS has demonstrated the effectiveness o f flexible, performance-based assistance in supporting policy reforms and crosscutting actions needed to improve service delivery. Annual PRSCs will form the core o f the Bank's support for implementation o f Pakistan's poverty reduction strategy at the national level. Province-level development policy operations will feature prominently where medium- term reform programs have advanced to the stage where Bank support can assist intheir implementation. As in the previous CAS province level development policy operations will couple fiscal and financial management reforms to improve financial sustainability with actions to improve the effectiveness o f service delivery. IBRD development policy lending will be considered to support reforms in urban management, irrigation, and transport, in conjunction with investment lending, policy dialogue and technical assistance. In each case, the choice o f development policy instruments will be driven by the strength o f medium-term reform programs and the capacity and track record o f counterparts. 46. The proposed assistance program will be aligned with the respective responsibilities o f national and provincial governments in Pakistan and tailored to meet the needs o f the individual provinces. Provinces and local governments bear most o f the responsibility for delivering public services including irrigation, education, health, and water supply and sanitation, but have very limited "fiscal space" to provide these services. Inthe FY03-05 CAS, the Bank's strategy was to focus on those provinces-Sindh and NWFP-that had embarked upon comprehensive reformprograms to support those programs through a series o f development policy credits. In addition the Bank provided programmatic support for education reforms in Punjab, beginning in FY04. Provincial reform programs in Punjab and Balochistan were supported through the Asian Development Bank's Resource Management Program loans. During the coming CAS period we will continue to support provincial reform programs in these provinces and maintain a dialogue with all provinces based on in-depthprovincial economic reports for each province. We will seek a balanced approach with lending and analytical services geared to the specific challenges and unique opportunities (e.g., the mineral sector inBalochistan) ineach province. 47. At the national level, policy-based and investment lending will focus on areas that are the mandate o f the federal government. The PRSC program will focus on the critical policy and institutional reforms to improve governance and the investment climate. Much o f the planned increase in investment lending will be for national-level programs, including national highways, ports, railways, power, and water. C. WorldBankGroup ProgramPriorities TheStrategic Framework 48. The Bank Group' program priorities will retain considerable continuity with the FY03-05 CAS. The World Bank program for FY06-09 will support the continuation and consolidation o f many o f the reforms initiated in previous years including cross-cutting governance reforms initiated in current and earlier CASs (financial management, procurement, tax administration, devolution and civil service reform). We will also assist in strengthening the institutions governing the market economy and continue to encourage reforms in the incentive and regulatory regimes for infrastructure, finance, trade and manufacturing to further improve the business climate. Working with the federal government and the provinces we will seek to improve the quality o f and expand access to basic services for the poor, including health, education and safety nets. 49. The Bank Group will focus its program on the areas which are most critical for poverty reduction. The three pillars o f the CAS correspond to the strategc priorities o f the PRSP: (i) sustaining growth and - 1 8 - improving competitiveness; (ii)improving government effectiveness and service delivery; and (iii) improving lives and protecting the vulnerable. The pillars o f the CAS are inter-linked and mutually reinforcing. Sustaining high and broad-based growth i s necessary to create employment and income- generating opportunities. Addressing poor human development outcomes i s a critical element o f the strategy to enable the poor to take part in and benefit fkom growth. Improving governance cuts across the entire strategy - it i s important both to improving the investment climate to support growth and to strengthening the delivery o f services to the poor. Within the three pillars o f the CAS, the Bank has identified a selected number o f outcomes that will be pursued during the CAS period. The rest o f this section explains the main issues and constraints in the areas o f the CAS pillars and how the proposed outcomes to be supported by the Bank Group program will assist Pakistan intackling these constraints. Pillar I : Sustained Growth and Improved Competitiveness 50. Strengthened macroeconomic management and allocation of resources. Maintaining the hard- won benefits o f macroeconomic stability will be critical to sustaining growth during the CAS period. While recent performance has been good, particularly with respect to growth, rising inflationary pressures and limited progress in improving revenue mobilization represent challenges. With the increased spending made necessary by the costs associated with earthquake recovery, there i s an even more acute need for fwther prioritization o f expenditures to maximize the benefit o f available fiscal space. Key priorities include reducing the drain on the budget caused by losses o f state-owned enterprises, improved management o f the public investment program, and strengthened debt management. 51. With the conclusion o f the IMF poverty reduction growth facility program, the Bank's macroeconomic monitoring and advice will occupy a more central role in our dialogue". In addition, the Bank will continue to provide support to help the Government strengthen macroeconomic management through (i) improving the level and composition o f expenditure; (ii)improving the effectiveness and impact o f public expenditures through the preparation o f a MediumTerm Budget Framework (MTBF) and the formulation o f sector strategies and sector investment programs; and (iii) continuing ongoing tax reforms aimed at improving tax payer services while increasing the tax-to-GDP ratio. PRSCs and province-level development policy lending will help to bolster these reforms while planned AAA will include reviews o f the Public Sector Development Program, a Public Expenditure Review, technical assistance inpension reform, and analytical support for tax policy reforms. 52. Improving Pakistan's low tax-to-GDP ratio will continue to be a major focus o f our work aimed at addressing weaknesses .inthe current system including: (i) inefficient tax administration; (ii)narrow a tax base - only 1.53 million taxpayers out o f 39.4 million employed; (iii) a complex and cumbersome tax system; and (iv) corruption and tax evasion. Recent reform initiatives have had a positive impact on tax management and in improving revenues - for the first time over the last two years, the Government was able to achieve its revenue targets, although this cannot be attributed to tax administration measures alone as strong growth has also contributed to rising revenue. Successful implementation o f the FY05 Tax Administration Reform project will be the centerpiece o f our efforts. The main challenges will include implementing organizational and management reforms, re-engineering o f operational processes that are likely to affect staffing levels and introducing automated risk-based systems that reduce contact between tax payer and tax officials to minimize corruption. In addition, with the end o f IMF program, ad-hoc and inconsistent tax policy changes have started to constrain expansion o f the tax base. Tax policy support, loA 3-year PRGF arrangement was approved in November 2001 and concluded in December 2004. All PRGF disbursements were made available upon completion o f program reviews although the GoP elected not to draw the final tranche in light o f its improved external position. Compliance with structural performance criteria and macroeconomic conditionality was better than average for Fund-supported programs. See, IMF, Pakistan 2005 Article I V Consultations and Ex Post Assessment of Longer-Term Program Engagement, November 2005. - 19- including a Tax Policy Study, i s planned and PRSC I11 will support tax policy measures to increase revenue mobilization. 53, Increased diversijication and exports in agriculture. The Government intends to accelerate agricultural growth by promoting the diversification o f agricultural production into high value products (including crops, livestock and fisheries) and ago-processing, improvement in factor productivity, and better integration o f supply chains. The Government has made good progress over the last couple o f years with respect to liberalization o f the domestic wheat trade (removing restrictions on transport), liberalizing wheat imports and maintaining a reasonable level o f strategic reserves. However, the Government remains involved in the procurement o f some 20% o f local production at a heavy cost. Long-term agricultural growth and poverty reduction are constrained by the structure and performance of key rural factor markets including land, water, and credit as well as a degrading resource base, inparticular soil and water. Given the constraints on land and productivity, the poor will benefit from agricultural growth only if the increase in productivity is translated into lower real prices of food and higher employment-to include the rural non farm poor, who together account for 61% o f the rural poor-and higher rural wages. 54. The focus o f the Bank's work in this area will initially be to support the preparation o f a rural strategy, integrating issues related to agriculture, natural resource management, the rural non-farm economy, infrastructure, rural finance and the need for targeted interventions. The strategy will also include analytical work on supply chains and World Trade Organization (WTO) issues, to understand the potential market access for agriculture through the opening up o f international markets and agribusiness networks. It will analyze and discuss the potential for increased public support through agricultural research, extension services, and technology transfers with an emphasis on adapting technology for rainfed areas and livestock. The Bank will also support policy and institutional reforms in land administration beginning with the Punjab Land Records Management Project. In addition we will seek to support reforms in the research and extension system to introduce more demand-driven participatory approaches based on public-private partnership. 55. Irrigation and drainage. Pakistan's extensive irrigation system i s under growing stress as the result o f growing demand, deteriorating infrastructure and poor governance. Building on the recently completed water strategy, the Bank will support a combination o f institutional reforms and investments including: (i) major investments in rehabilitation o f critical assets (including barrages), and will help put inplace Asset Management Plans which will set priorities for assetrehabilitation and maintenance, make explicit the requirements for public and user financing, and develop institutional arrangements for rehabilitating and maintaining this infrastructure; (ii)development o f capacity at the provincial and federal levels for improving water and associated natural resource management; (iii) efforts to improve the quality, efficiency, and accountability with which irrigation services are delivered; and (iv) investments in on-farm services (land leveling, watercourse lining, introduction o f new technologies) for increasing the productivity o f water use. Bank support will be provided through a range o f instruments including development policy lending in support o f key reforms as well as through investment lending to finance infrastructure and institutional development. Governance and communication improvements will be a central theme as poor governance and low trust are among the key underlying factors behind the poor performance o f the irrigation system and low productivity. Finally, given the major scientific, policy and implementation challenges ahead, the Bank, with support from the Government o f the Netherlands, will provide analytical and technical support to the federal and provincial governments. 56. While Pakistan recognizes the importance o f improving the efficiency o f water use, the Government's water strategy also assigns high priority to augmenting water storage capacity, both to offset the declining capacity o f existing reservoirs (due to siltation) and to meet growing demand. Indeed, compared with other countries Pakistan has relatively little water storage capacity and substantial untapped hydropower potential, indicating a potentially high payoff from new reservoirs. The GoP has recently announced a Presidential initiative under which it intends to build up to five new dams by 2016. - 20 - Given the importance o f such an investment for addressing long-term water issues, the Bank will consider providing technical assistance for this work. Looking further ahead, should the proposed project prove technically and economically sound, the Bank would be prepared to respond favorably to a government request to help finance construction, provided the project i s designed and implemented in conformance with internationalstandards for social andenvironment safeguards. 57. Improving the business environment for trade and investment Recognizing that sustaining the current high rates o f economic growth requires globally competitive production in an increasingly demanding world market, policy makers are focused on strengthening international competitiveness through rising productivity to support higher wages, a strengthened currency and increased returns to capital. Macroeconomic stability and the removal o f price distortions have eliminated impediments to productivity growth but will only translate into rising productivity if accompanied by a more conducive business environment. There i s consensus among policy makers, academics and the business community that improvement inPakistan's competitiveness derives inpart from success inthree "second generation" areas which impact firm-level productivity and thus have become important priorities for Pakistan. First, economic governance to instill market discipline and provide certainty in investment returns poses a particular challenge, encompassing such entrenched factors as efficiency and effectiveness o f government and autonomous institutions, quality o f regulation, policy uncertainty, and the rule o f law. Second, efficiency o f factor markets to foster flexibility and fluidity represents a major constraint to good resource allocation and ease o f entry, particularly in the case o f land and labor. Third, the degree to which entrepreneurs find it easy to do business has a major impact on international competitiveness. Many reforms were initiated inthese areas in recent years, and a number o f indicators o f `doing business' have improved as a result. 58. During the CAS period, the Bank Group will support the following: (i)strengthening the institutions and 1egaVregulatory frameworks in support o f a competitive market economy by updating corporate law and building the capacity o f courts and monopoly control authorities; (ii) lowering the burdenof government bureaucracy and regulation to ease entry and business operations, particularly for SMEs; (iii) improving labor market flexibility through legislative reform (employment and industrial legislation i s currently being revised); (iv) improving tax administration; and (v) further reduction o f trade protection. Inaddition, as provincial governments have a role inimproving their local investment climate, the Bank Group will work with provincial authorities to address areas within their domain such as improving management o f industrial estates and improving the functioning o f land markets. 59. Ongoing analytical work in this area includes studies on `Growth and Competitiveness', `Value Chain Analysis', and `The Labor Market.' This work will be followed by National and Sub-national Doing Business & Investment Climate Assessments and additional Provincial Economic Reports. The Public Sector Capacity Building Project (PSCBP) will be implemented along with an IDF grant for the Securities and Exchange Commission o f Pakistan. Capacity building for other institutions charged with government markets will also be deployed, such as efforts to strengthen the framework for fair and open competition. Annex 7 outlines in greater detail the World Bank Group Private Sector Strategy. 60. Improved infrastructure to Support Rapid Growth. Infrastructurebottlenecks pose a significant threat to Pakistan's ability to sustain rapid growth. During the next CAS period the Bank will focus on three areas: (i)supporting reform processes, including privatization and private sector participation in public utilities, technical assistance and capacity buildingto strengthen institutions in specific sectors; (ii) workmg closely with the IFC and MIGA to increase private investment in infrastructure; (iii) developing the legal and institutional framework to encourage private-public partnerships and (iv) undertakingIBRD investment operations where reforms have advanced sufficiently to make public investment effective. 61. At present, the power sector is not up to the challenge o f meeting growing electricity demand efficiently and reliably and extending service to underserved areas and poorer segments o f the population. - 2 1 - Challenges include high technical and commercial losses (over 20 percent in a number o f distribution companies and in some cases as high as 40 percent), bottlenecks in transmission and distribution, substandard quality o f supply, underinvestment, high costs, and inadequate tariffs. About 30 percent of population has no access to power. There are large cross-subsidies in the tariff structure, with industrial and commercial consumers subsidizing residential ones. Government subsidies to the sector total about US$1 billion annually. 62. Inrecent years the Government has made significant progress inimplementing its power sector program first initiated in the late 1990s. The reform program includes unbundling, corporatization, commercialization, and privatization o f the industry," establishment o f an independent regulatory agency; institutional strengthening in policy, governance, and corporate management; and mobilization o f resources from the private sector to meet the power sector's technical, financial and human resource needs. Although much remains to be done, progress has been made: a new legal framework for the sector was adopted, an independent regulatory agency (NEPRA) established, WAPDA was unbundled, privatization o f several companies in generation and distribution has been completed or i s underway, and a Policy and ImplementationCell inthe Ministryo f Water and Power established. 63. The Bank has been deeply engaged inthe power sector. Strategic and policy advice, supported by development policy lending including SAC I1and PRSC I,was instrumental in restructuring the sector. Although progress in improving financial performance has been disappointing, implementation o f the overall restructuring strategy for the sector has laid the groundwork for improved performance and opened the way for investment lending.Further strengthening o f sector governance i s required to improve performance and attract private investment. There i s a significant backlog o f investment, particularly in reducing the high technical and commercial losses in the distribution systems. In addition to continued support for policy, governance and regulatory reforms through the PRSC, planned investment lending includes support for distribution and transmission, investment in hydropower (including possible large- scale hydropower), and the expansion o f rural access. A programmatic approach i s planned, with a sequence o f investment loans and guarantees to address investment priorities as implementation o f the reform program proceeds. In the context o f expanding rural access, there i s good potential for the mobilization o f Global Environment Facility (GEF) and carbon finance to support "low-carbon'' growth inthe sector. Indeveloping options for affordable and sustainableprovisionofpower inrural areas-and in particular in NWFP and Balochistan where grid penetration is currently limited-the Bank will consider alternative investment and institutional approaches to rural electrification, including options for decentralized autonomous grids. 64. During the previous CAS period, the Bank supported Pakistan's telecommunication reforms through policy dialogue and lending, including PRSC Iand the Telecommunication Regulation and Privatization Support project. As a result o f the reforms, sector performance has begun to improve markedly as indicated by the increase in aggregate telecommunications density (fixed and mobiles) from 4.6 telephones lines per 100 inhabitants in June 2003 to about 17.8 by December 2005. Key reforms included (i)strengthened institutional and regulatory arrangements under the Ministry o f IT and Telecommunications and the Pakistan Telecommunications Authority; (ii) full liberalization o f the local loop (LL) and long distance and international (LDI) markets resulting in numerous new companies providing services at competitive rates; (iii) approval o f a new cellular mobile policy in January 2004 leading to licensing two new additional cellular mobile operators, rapid growth in penetration, and a dramatic reduction in prices; (iv) successful privatization o f Pakistan Telecommunications Limited (PTCL) generating U S 2 . 6 billion in proceeds and leaving the telecommunications sector fully managed ~ " The Water and Power Development Authority (WAPDA) has been responsible for electricity generation, transmission, and distribution in all areas o f Pakistan with the exception o f Karachi, where Karachi Electricity Supply Company (KESC) has played that role. The unbundling and restructuring elements o f the reform program applied to WAPDA only, as the dominant monopoly; the other elements o f the reform applied to the entire industry. - 22 - by the private sector. IFC made a very successful investment in TRG, (a call center company), with a strong demonstration effect. 65. Inspite ofthis success,telecommunications services fall well short oftheirpotentialcomparedto comparator countries. One important gap i s between rural and urban users; as o f March 2005 about 50% of Pakistan's 50,000 villages have no access to telecommunications services and very few villages have access to the Internet. The Bank will support over the CAS period (i) adoption o f additional measures to strengthen the policy and regulatory environment, including establishing pro-competitive licensing, interconnection and tariff regimes, addressing quality o f service and other consumer issues, and improving the management o f limited resources such as the radio spectrum and numbers; (ii) policy dialogue and advice; and (iii)investment support for accelerating the provision o f rural telecommunication infrastructure including e-services and broadband connectivity. Inaddition, IFC will support the expansion of services by the private sector. 66. Pakistan's transport sector i s inefficient, imposing additional costs on Pakistani business and threatens to become a serious obstacle to sustained growth, as well as an impediment to achievement o f the MDGs. It i s estimated that this inefficiency already costs 4-6% o f GDP per annum, constrains economic growth and diversification, reduces export competitiveness, and hinders social development. Key issues are: (i)poor rural mobility with 75% o f all rural health, education and market facilities accessible only by earth tracks; (ii)urban congestion and inadequate public transport which are raising the cost o f doing business, crowding out the urbanpoor, and increasing the health and safety hazards faced by passengers, pedestrians and residents; (iii)Pakistan Railways' financial and operating performance remains weak and as a result it carries barely 5% o f total cargo traffic, far less than its potential; (iv) costly port systems and inadequate trade facilitation are imposing highcosts and delays on shippers. 67. Reflecting the highpriority assigned to supporting growth and competitiveness, the Bank and the government are in the process o f developing a strategic approach to the transport sector focusing first on the National Trade Corridor linking Pakistan's major ports in the south with its major cities and trade corridors to the North. Together the ports, road and railways along this corridor handle 95 percent o f external trade and 65 percent o f total land freight serving the regions o f the country which contribute 8045% o f GDP. Corridor utilization i s more than 80% o f existing capacity and projected growth will double demand by 2015, and require much higher levels o f service. The objective i s to develop an integrated approach to planning, investing and managing the National Trade Corridor transport logistics system. The key outcome sought would be significant reductions in the time and cost o f moving goods through the Indus corridor. The GoP has already initiated reforms, reducing entry fees at Karachi port while seeking to reduce port dwell times. The Government i s also targeting improved trade and transport connectivity with China, Central Asia and Western Europe as a means o f promoting economic activity throughout the region and i s seeking World Bank support in this endeavor. The Bank has provided and will continue to provide analytical support to develop the frameworks to guide sub-sector policies (for highways, railways, ports and trade facilitation), including pricing, regulation and enforcement, medium term budgetary frameworks, restructuring and progressive commercialization o f public entities and strengthening o f institutions (NHA, PakistanRailways, etc.). An ongoing transport competitiveness study will help highlightpriorities for investmentlending and institutionalreforms. 68. Pakistan's investment needs in transport are enormous. There i s a significant maintenance backlog and current government investment in the sector i s as much as 5 times less (as percent o f GDP) than countries in East Asia. It i s estimated that modernization o f the Indus Trade Corridor alone will require investment o f about US$1 billion per year over the medium term. Inaddition, critical road links were destroyed or damaged in the October earthquake and their repair i s an urgent priority. The Bank i s currently supporting rehabilitation o f the national highway network through the Highways Rehabilitation Project (with additional financing to address the effects o f the earthquake) and assisting in modernizing trade and transport facilitation under the Trade & Transport Facilitation Project. There i s strong demand - 23 - from government for increased lending in the transport sector during the coming CAS period. Follow-on investment lending for highways and trade facilitation i s expected along the IndusTrade Corridor with an emphasis on increasing private sector participation in operation and management. In railways, a combination of development policy lending and investment projects may be considered should the government commit to a medium term reform program to revitalize Pakistan Railways by creating a separate, professionally managed, commercial freight business with its own rolling stock and staff. Inthe port sector the Bank will support a move towards port corporatization and professional management combined with a modern institutional and legal framework for port operations that would open the way for investment lending to upgrade port infrastructure. 69. While the emphasis i s on supporting growth, the Government also recognizes that transport, especially in rural areas i s important to improving development outcomes. Surveys have shown that healthcare for all, and above-primary educational opportunities for girls are particularly hard hit by mobility constraints. DuringFY03-05 the Bank prepared a Rural Access and Mobility Study focusing on options for the sustainable provision o f a core rural access network at the district level under the country's devolution framework. During the coming four years we will continue to explore options for providing assistance to this sub-sector including possible implementation o f pilot projects through the Pakistan Poverty Alleviation Fund. 70. Support for reform and development o f the oil and gas sector has been a strategic priority for the World Bank assistance program since 1999. Duringthe last CAS, the Bank continued to provide policy advice and technical assistance supported by development policy lending (SAC I1and PRSC I). Good progress has been made inthe deregulation o f the petroleum market, pricing and regulation o f natural gas, conversion o f power plants from fuel oil to natural gas, and acceleration o f exploration activities. However, gas tariffs continue to be distorted by cross subsidies among different classes o f consumer (particularly the very large and poorly targeted "lifeline" tariff slab and the low cost o f gas for the fertilizer sector) and implementation o f the gas price adjustment mechanismhas been erratic. Similarly, in 2004 the government elected only partially to adjust domestic petroleum product prices to reflect international oil prices, resulting in a fiscal cost o f Rs. 8 billion (US$130 million). 71. Looking ahead, a key priority i s to address looming gas shortages; while all gas i s currently domestically produced, given the combination o f rapid growth in demand and depleting reserves, gas imports will become necessary, possibly as soon as 2009. With this in mind, the Bank will continue to provide policy and technical advice and encourage further appropriate de-regulation and privatization in the industry while helping the government to build necessary capacity to engage in international gas import transactions. Possible investment lending or guarantees would support the expansion o f infrastructure for the importation, storage and distribution o f gas. Inaddition, IFC i s expected to support private participation inthe oil, gas and mining sectors. 72. Pakistan's infrastructure investment needs are as high as US$3.5 billion per year, far greater than can be financed by the public sector. The Government recognizes that public-private partnerships (PPPs) can play a key role in increasing resources and improving efficiencies by helping the country access not just finance, but also managerial expertise, new technology, better project design and implementation, and more efficient use o f resources. Past efforts to attract private investment, in particular inthe power sector, have shown both that these investments can be realized, but also that strong oversight i s neededto ensure that these are priority projects and that consumers and the government have the capacity to pay for them.12 Regardless o f sector or level o f government, PPPs should be pursued where they represent priority projects, are affordable to the government and consumers, and represent value-for-money, i.e. a better approach than would be delivered through public procurement. l2Fraser, Julia M.Lessonsfrom the Independent Private Power Experience in Pakistan. Energy and Mining Sector Board Discussion Paper No. 14. M a y 2005. - 24 - 73. The Bank Group will support the government's efforts to encourage PPPs through: (i) advisory support in developing the national PPP policy and, where needed, provincial policies and legal frameworks for PPPs; this would also cover strengthening oversight o f the fiscal costs o f PPPs; (ii) technical assistance for the development o f the institutional framework (including financial and subsidy support to PPPs) and to develop pilot PPPs ready for procurement and implementationwithinthe next 12- 18 months; and (iii) to support subsidies to address affordability issues for PPPs and for long- lending term finance for PPP service providers. 74. Improving access to market-based finance. Pakistan has undertaken major reforms in recent years inthe financial sector that have resulted ina sound and more efficient system. A major achievement has been the transformation o f a pre-dominantly state-owned and weak banking system into a healthier, market-based system, owned primarily by the private sector (nearly 80% percent o f sector assets are now under private ownership compared with 34 percent in 1999, and just 8% percent in 1990). This has been facilitated by the restructuring o f major banks, ongoing consolidation o f the sector, strengthening o f regulatory capacity, and improvements intransparency, corporate governance, and credit culture. This has helped improve access, and credit to the private sector has grown significantly over the past three years. These achievements have been endorsedby the findings o f ajoint Bank-IMF Financial Sector Assessment that was concluded in2004. 75. Despite these impressive accomplishments, important reforms remain to be done, and a large segment o f the economy continues to operate with little formal credit. A significant number o f financial institutions are still under government control including the National Bank o f Pakistan (NBP), State Life Insurance, the largest open end mutual fund, and a few large specialized banks. The legal framework needs to be strengthened to address banking laws, the Public Debt Act, the Insurance Ordinance, as well as laws pertaining to insider trading and take over o f companies, bankruptcyhnsolvency, payments systems, credit information and Anti-Money Laundering. Enforcement o f financial contracts remains weak pending clarification o f the Financial Recoveries Ordinance 2001. While there have been extensive reforms o f capital markets, under-development o f contractual savings has inhibited development; insurance penetration remains very low relative to other countries at Pakistan's income level, reflecting weak consumer protection and awareness. The pension system i s also weak - both civil service system and Employees Old Age Benefits Institution are fiscally unsustainable. Finally, the stock market has performed well but it remains shallow and narrow with inadequate investor protection systems. Leveraged financing o f share transactions coupled with weak supervision o f market intermediaries pose a threat to systemic stability. 76. Duringthe next CAS period the Bank Group will support further financial sector reforms in the following areas: increasing the number o f microcredit borrowers (especially in rural areas), restructuring and privatization o f the remaining state owned financial institutions, non-bank financial companies and other specialized institutions; continuing the revision o f the legislative framework to facilitate effective regulation and enforcement; aligning rates on National Savings Scheme (NSS) instruments more closely with market yields; strengthening and further deepening capital markets (including equities, bonds and swaps) with the aim o f increasing the availability o f longer term savings instruments, e.g. by establishing a comprehensive legal and regulatory framework for private pensions, reviewing the role and strategy for state owned insurance companies; and improving financial markets infrastructure and legal framework. New areas o f involvement will include expanding financial services-consumer financing, mortgage loans, SME financing, agriculture credit-through expansion o f banks' retail. Following on the recent Financial Sector Assessment and the approval o f the Banking Sector Development Policy Credit, future work will center on policy dialogue, and technical assistance, particularly to provinces as well as economic and sector work on access to finance. Lending operations to support technical assistance for the State Bank o f Pakistan and for capital market development will also be considered. The IFC will - 25 - selectively invest inthe financial sector to support the development o f housing finance, SME finance and microfinance, inaddition to providing TA through its PEP-MENA facility. Pillar 11:Strengthened Governance and ServiceDelivery 77. Improving government effectiveness remains a hallmark o f the Government o f Pakistan's reform program. As discussed earlier, inadequate and poorly targeted government spending on services and investment are only part of the problem; delivery o f government services i s hampered by the weak capacity and lack o f accountability o f service providers. Addressing these weaknesses i s critical for achieving most if not all o f the Government's poverty reduction goals. Far reaching reforms to improve the performance o f key government institutions including financial management, tax administration, and the civil service are underway inparallel with the government's decentralization initiative. Many o f these have been and will continue to be supported by the Bank Group. 78, Greater ef3ciency transparency and accountability in use of public resources. The government has been pursuingfar-reaching reforms in public financial management since 1996.The Bank has been deeply engaged inthis process and significant progress was made duringFY03-05 CAS period. Under the Bank-funded Project for Improved Financial Reporting and Auditing (PIFRA), a new computerized accounting system and a new chart o f accounts i s being implementednationwide. The new systems being introduced under PIFRA will eventually allow for the automated consolidation and reconciliation o f all the civil accounts o f the government, thereby greatly improving the timeliness, comprehensiveness, and accuracy o f financial data. Legislative oversight has improved with the re-establishment o f Public Accounts Committees at the federal level (a PRSC 1prior action), as well as inthe provinces. The federal Public Accounts Committee has made good progress in reviewing audit reports, and in traclung and monitoring cash recoveries from public officials in government departments and other public institutions. The Controller General o f Accounts (CGA) organization has been strengthened, and the timeliness o f reporting and reliability o f public accounts and audit reports has improved substantially. 79. Remaining challenges include full implementation o f the PIFRA system. Inaddition, the backlog in the review of audit reports and audited accounts remains substantial, due in large part to the poorer quality o f the older audit reports that resulted in a large number o f audit paragraphs beingplaced before the Committee. Inthe case o f accounting, the Government needs to clarify the roles, responsibilities and reporting relationships o f various players (e.g., Controller General (Accounts), Provincial Accountant Generals, District Accounts Officers and Treasury Officers) in the light o f devolution. Support for these reforms will continue to be a priority. The follow-on PIFRA-2 project, which was approved in September 2005, will extend the computerization to remaining sites across the country. An IDF Grant has recently been approved to strengthen the capacity o f the Public Accounts Committee at the federal level. The Bank will also work on supporting the improvement o f the accounting and auditing oversight arrangements following up on the Accounting and Auditing ROSC exercise, conforming corporate accounting and auditing practices to international standards. IFC's PEP-MENA facility will launch a comprehensive corporate governance project inPakistanto support private sector companies. 80. Building on the 2003 CFAA, the Bank will continue to provide analytical support to assist in defining the agenda for further reforms in financial management. The Bank will work with the Government and international partners (including DFID and ADB) to carry out public financial management and accountability assessments based on the PEFA P F M performance measurement framework approved in2005. A similar exercise, usingthe December 2004 PEFA Consultative Draft was conducted inFY 2005 for Punjab. The assessments will be carried out at the federal and provincial levels inorder to identifythe strengths and remaining weaknesses inthe accountability framework and provide the basis for drawing up comprehensive action plans that focus on areas most inneed o f action to mitigate shortcomings. The action plan will not only aim at further improving public financial management but will also support transparency, competition, value for money and controls inprocurement. - 26 - 81. Procurement irregularities have been a significant problem in Pakistan, in large part due to a weak regulatory framework that discouraged due diligence in contract awards and stifled open competition, Specific problems have included inadequate bidding documents, inadequate response time to bidders, prequalification as a means o f restricting competition, price negotiations, lack o f independent complaints handling process, and irregularities in inspections or measurements. During the CAS, the Bank will support the achievement o f transparent and efficient public procurement at federal and autonomous bodies levels. The Bank will support the Government in: (i)developing a implementing regulations for the recently notified public procurement rules; (ii)developing credible complaints handling process; (iii)developing rules for the selection o f consultants; (iv) introducing reporting requirements and a credible enforcement mechanism; and (v) capacity building for the Pakistan Public Procurement Regulatory Authority; and (vi) harmonizing audit and procurement procedures. Procurement will also be an integral part o f the PFMPerformance Measurement assessments planned during the CAS period. 82. Enhanced service delivery, The need to dramatically improve service delivery to Pakistan's citizens-with particular attention to programs in health, education, water and sanitation, and safety nets-is essential to the achievement o f Pakistan's poverty reduction goals. Working across sectors, the Bank Group will continue to support reforms to increase capacity and accountability o f those responsible for service delivery; empower communities and clients through enhanced access to information on finances and performance; and buildthe capacity o f both communities and governments. 83. Improving the quality o f public administration i s critical for making public expenditures more effective, and for improving service delivery. While the size o f the civil service in Pakistan i s not problematic, improving its performance i s recognized by the Government as a key challenge for improving service delivery. The key problems are: (i) systemic rigidities that make it difficult to recruit and move staff between departments as needed; (ii) compensation i s insufficient to attract skilled entrants at the higher levels but may be too generous at lower levels; (iii) inadequate training which has led to an erosion in the quality o f civil service and critical gaps in technical skills. Implementation o f a comprehensive civil service reform i s proceeding slowly, although there are very important pieces o f the reform going forward. The best progress has been made on merit recruitment, training, pay and pensions and capacity building o f selected government line and regulatory agencies. However, improvements in overall public service delivery require progress across a broader front inthe civil service program as well as inthe devolution agenda. Over the coming CAS period, the Bank will continue to support development and implementation o f a long-term strategy for public sector employment, which would include: further implementation o f merit-based recruitment and promotion; structural changes to support devolution; further pay and pension reforms; and continued capacity building through effective national and international training. 84. Pakistan's devolution initiative i s a cornerstone o f the government's strategy for improving service delivery by making the public sector more accountable to citizens and more efficient at delivering basic services. Creation o f the political structure for devolution began in 2001 with the creation o f a new local government structure consisting o f over 6,400 new elected local governments. New local governments were sworn in following local government elections in August 2005. However, while political devolution has moved rapidly, fiscal and administrative devolution have not advanced as well, creating obstacles for local governments and weakening incentives o f local government staff to improve service delivery. Local governments are also facing a number o f problems linked to capacity constraints, including lack o f strategic planning, poor financial management, lack o f skills and finance. Decentralization reforms need to be completed through a meaningful devolution o f administrative and fiscal powers and supported with capacity building assistance. This needs to include a greater share o f resources going to the provinces through National Finance Commission (NFC) awards-and to the districts-through the Provincial Finance Commissions and, to a lesser extent, conditional grants; - 27 - reassignment of tax bases from the center to local governments (e.g. agriculture income tax); and the transfer o f functions and administrative authority to local governments. Pakistan's PRSP also recognizes that devolution will not be complete until there i s some transfer o f responsibility from the federal to the provincial governments as well. The January 2006 Amendment to the NFC award was a positive step in this regard as it increased the provinces' share of revenues and should alleviate some of the fiscal pressures being faced by provincial and local governments. 85. The Bank has worked to support of devolution, both at the provincial and local levels, through analytical and capacity building support. A major study on progress in implementing devolution was undertaken jointly with the ADB and DfID. During the next four years, Bank support for devolution, much o f which will be provided inthe context o f ongoing operations, will feature: (i) analytical support to assist in the rationalization and clarification o f roles and responsibilities under the devolved framework; (ii)support for citizens participation through social mobilization, community driven approaches, and other mechanisms to strengthen the linkages between local governments and communities in order to increase their responsiveness and accountability; (iii)capacity building support for local governments. We will also ensure that the design o f lendingoperations reinforces the local government system. 86. With over a thirdof its populationlivinginurbanareas, Pakistan is currently the most urbanized country in South Asia and urbanization growth rates are twice the rate o f the overall population increase, But cities suffer from severe infrastructure bottlenecks, service deficiencies (roads, water, and waste removal), poor local governance, and distortions inland and housing markets. While the urban sector was an area o f limited engagement during the previous CAS, devolution has created opportunities for deeper engagement and the Government o f Pakistan has accorded greater priority to urban development with a particular focus on the "mega-cities" o f Karachi and Lahore. Devolution has transferred to municipalities (Tehsil Municipal Authorities - TMAs) the responsibility for services such as water supply, sewerage, sanitation, waste collection, urban transport and land management. 87. The Bank's strategy is to assist the Government's urban reform agenda by helping to address the weaknesses in policies and administrative structures that undermine service delivery in cities. Recent analytical work has highlighted the fragmentation of service provision, weak financing and management o f urban service delivery, especially water and sanitation, and dysfunctional land and housing policies. Two projects are currently being prepared. The Punjab Municipal Services Improvement Project (PMSIP) will build capacity and provide for grants for investments to improve service delivery in the smaller municipalities o f the Punjab Province. The Punjab Large Cities Development Policy Loan (DPL) will support implementation o f reforms to improve the functioning o f the Punjab's seven large cities. Reforms will focus on four broad areas: (i) governance and institutional reform; (ii) municipal finance and service delivery; (iii)urbanplanning and land management; and (iv) urban transport. The Bank i s also conducting economic and sector work to help shape our future involvement in the urban sector. With the support o f PPIAF/GPOBA financing, the Bank i s undertaking a detailed study o f eight major cities in Punjab to investigate options for improving the efficiency o f WSS service providers. A variety o f alternatives are being considered, including public-private contractual mechanisms (management contract, concession), financial incentives, and regulatory reform with possible downstream Bank and IFC project financing. A similar investigationo f solid waste management issues i s also underway. Finally, building on preliminary work carried out with the support o f the Italian Government through the Italian Trust Fund for Culture and Sustainable Development, the Bank will support development of Pakistan's cultural heritage and tourism. 88. Experience in Pakistan has shown that there i s considerable potential for improving access to and quality o f public services through the adoption o f alternative service arrangements and by empowering communities to monitor providers and influence resource allocation. In health, Pakistan has begun to experiment with contracting o f public services to private providers to circumvent weak administrative capacity o f the public sector and expand coverage. Initial results o f contracting out management of - 28 - primary health facilities in twelve districts o f Punjab to an NGO (the Punjab Rural Support Program) indicates significant improvement in utilization o f services. The Punjab education program has begun to expand public-private partnerships to tap into low cost private schools while strengthening School Councils to increase parental involvement and influence. InBalochistan, the planned Primary Education Project will focus on strengthening community-run schools. Duringthe CAS we will continue to pilot and scale up such initiatives. 89. Policy makers have also fostered private provision o f services in Pakistan in order to allow greater provider choice (and competition) to the population, and this has enabled the better off (but also the poor) to bypass the low quality public system. In education, the private sector has already demonstrated its potential with private schools accounting for a growing share o f total enrolments, in many cases with higher quality and lower costs than government schools. However, private sector providers need to be held accountable to particular standards (e.g., in education) and may need to be regulated(e.g., inthe case o f health). Pillar III:Improved Lives and Protection of the Vulnerable 90. During the next 5 to 10 years, in addition to the measures outlined below, improving social indicators i s likely to require strong economic growth, effective public sector management, a motivated and well managed civil service, increased pro-poor spending and more effective allocation o f resources. At the same time increased investment inhuman capital leading to significant improvements in education and health will be necessary to build the skilled, healthy work force necessary to sustain recent growth performance. Improved delivey of health and education services 91. The achievement o f universal primary education, with a particular emphasis on promoting girls' schooling, has been a government priority since the early 1990s.Resources for education have increased by over 60% over the past four years and a range o f programs to increase enrolments, especially for girls, have been put in place. These efforts appear to be starting to bear fruit; preliminary results o f a national household survey are encouraging and show an increase in the net primary enrolment rate from 42% in 2001/02 to 52% in 2004/05. Nevertheless, meeting Pakistan's goal o f increasing the net primary enrolment rate to 100% by 2015 remains a major challenge. The issues affecting the performance of the sector include inadequate resources, systemic weaknesses in public service delivery including over- centralization and weak public sector management, and poor performance o f the education system in terms o f access, governance and quality. 92. Reflecting the lessons o f the Social Action Program o f the 1990s and the requirements o f devolution, the Bank strategy has focused efforts at the provincial level using development policy credits to support policy and systemic changes as well as the other areas linked to education reform including decentralization and governance reforms. Under the Punjab Education program the Bank i s supporting free tuition and books, upgrading school facilities, stipends for girls inbackward areas and public funding o f the rapidly growing non-government-independent low-cost private-education sector. Results so far have been promising. The Bank will continue to support these refoms through education development policy credits in Punjab with annual tranches linked to outcomes; annual Development Policy Credits in other provinces, beginning in NWFP, with a special focus on education; and investment projects for regions where sector investment projects are a more viable option such as Balochistan. Gradually the focus o f reforms will shift from primary to higher levels o f education. 93. At the national level, policy dialogue on financing, governance, demand side interventions, improvements in quality of learning, inclusive education for the disabled, and service delivery issues, will be backed by analytical work, including an education sector review and evaluations o f the impact o f - 29 - different education' sector reforms and policies. Annual PRSCs will continue to support reform in education. The ongoing National Education Assessment System (NEAS) project will develop a baseline and monitoring system for measurement o f learning outcomes. We will also provide advice and technical support to the government's vocational/technical and higher education reforms which are needed to provide the skilled labor force neededto support sustained growth. 94. Given its far-reaching importance for reaching all o f the MDGs, gender equity in education will remain a highpriority. Buildingon the findings o f the recent Gender Assessment, the Bank will assist the government in developing strategies to address gender gaps in education. Recent analysis suggests that the practice o f restricted female mobility plays a large role in perpetuating gender gaps in school enrollments. As a result, school attendance for girls i s very sensitive to school proximity. Girls are much more likely to attend school if a school i s available within the settlement they reside in.This sensitivityto school proximity worsens as girls grow into adolescence. Qualitative studies suggest that concerns over safety and norms o f female seclusion are the primary factors behind the precipitous drop in enrollment beyond age 12. This concern i s also evident in the rising expenditure on transportation to school reported for older girls. A similar concern makes it difficult to attract female teachers to schools inremote areas. 95. While Pakistan has made Table 6: SelectedHealthIndicators some progress in improving health outcomes for the poor, the pace has Fertility Infant Child Maternal rate 2003 Mortality Mortality mortality been slow. Poor health outcomes and 2003 2003 2000 high fertility remain obstacles to Pakistan 4.1 77 103 500 economic growth and contribute Bangladesh 2.9 46 69 380 significantly to high levels o f poverty. India 2.9 63 87 540 In particular reducing fertility rates Sri Lanka 2.0 13 15 92 would contribute to: (i)improved Sources: World DevelopmentIndicators(2005), except MM:WHR 2005. women's health and reduced overall maternal mortality by reducing the number o f high order births; (ii) reduced infant mortality rates by increasing the time between births; (iii) helping empower women by providing them choices about when and how many children to have; and (iv) providing a necessary condition for sustained and rapid economic growth. Recent research has found quite a large impact on economic growth from lower dependency ratios brought about by lower adult mortality and fertility rates. There i s a continuing burden o f malnutrition and increasing burden o f hepatitis infections. Utilization o f essential maternal health services i s low, especially in rural areas. Pakistan also faces a real threat from AIDS; recent assessments found HIV epidemic among certainpopulations; for example, 27% o f injecting drug users and 7% of male sex workers in Karachi were found to be HIV-positive. The government is committed to increasing public health expenditure and has taken steps in that direction but the overall strategic allocation of public resources should be focused towards achievingbetter health for the poor and addressing the most urgent priorities, such as maternal and child health. In addition key constraints to effective utilization o f increased resources include: (i) limited management capacity; (ii)lack o f high quality data and program impact evaluation for decision making; (iii) o f a well-developed human lack resource development strategy; (iv) inadequate use of the private sector for national goals; (v) lack o f focus on quality o f care; and (vi) lack o f clarity on the roles and responsibilities o f the three levels of government. 96. During the past three years, IDA lending to the health sector consisted o f an HIV/AIDS Prevention Project and US$41 million to support polio eradication. Multi-sectoral policy-based loans (a PRSC and provincial structural adjustment credits) have supported HNP policy reforms as well. Recent analytical work has highlighted the potential for public-private partnerships (e.g. contracting with NGOs to deliver services) to improve basic health services. For example, one district in the Punjab (Rahim Yar Khan) contracted the management o f its 104 health units to an NGO and witnessed a doubling in the number o f outpatient visits and increased client satisfaction. Such successful efforts must be scaled up. -30- 97. Looking ahead, at the national level, the Bank will concentrate on: (i)encouraging the Government to focus on public health functions (such as surveillance, quality control, monitoring and evaluation, and public information), through analytical support and national level development policy lending; (ii) supporting the development and implementation o f program and management reforms inthe Lady Health Worker program as a way o f expanding access to primary health care and family planning; (iii)supporting increases inoverall health expenditures as envisioned inthe PRSP; and (iv) supporting the piloting and evaluation o f new approaches for service delivery and demand side interventions. Recognizing that a major focus o f efforts must be at the provincial and local level, we will support major system reforms through planned provincial Development Policy Credits, beginning in NWFP. Initially, the focus o f these credits will be on increasing access and coverage o f maternal health services, improving the functioning and utilization o f first level care facilities, and targeting underserved areas. Overall, Bank lending and analytical support in health will be guided by the following principles: (i) a focus on the poor and underserved areas; (ii) promoting testing and rigorous evaluation o f innovations by local governments; (iii) increased accountability, particularly at the district level; and (iv) increased integration o f services at the grassroots level. 98. Improving the health outcomes o f the poor will also depend on complementary interventions outside o f the health sector. Recent research has highlighted the strong effects on infant and child mortality from improved maternal education and basic infrastructure services, such as access to sanitation, piped water, clean cooking fuels and electricity. The Government has recently announced a major initiative to expand access to clean water by buildingwater treatment facilities at the local level. In light o f this, water supply and sanitation will continue to feature in the Bank's lending and analytical work, inboth the urban sector and through support for community infrastructure, especially inrural areas. 99. Current analytical work on the health and economic costs associated with air and water pollution has confirmed the high impacts, with losses estimated to be more than 2% o f GDP. The Bank i s deepening its engagement with the Government on environmental management to address these issues. The recently approved National Environment Policy provides the framework and the Bank is supporting the Government at federal and provincial levels in the identification and preparation o f priority interventions. Key areas for action inrelation to health issues will be urban air quality in the major cities, protection o f water supplies and management o f increasing amounts o f industrialand hazardous waste. Reducing vulnerability and poverty through effective safety nets and targetedprograms to reach the poor 100. The PRSP recognizes that protection for the poor and vulnerable i s a cornerstone o f any poverty reduction program and Pakistan has a range o f programs which aim to improve the welfare o f the poor and vulnerable including microfinance, old age security, public works, cash and in-kindtransfers, and programs for child laborers, the disabled, and other highly vulnerable groups. However, these programs are severely under-funded, covering only a very small fraction o f the poor and vulnerable (see Table 7 for details), Total spending i s equivalent to 0.5% o f GDP, substantially lower than the levels found in other developing countries. Moreover, there are severe shortcomings in the existing safety net programs: (i) there i s no program (such as workfare) to help the rural poor cope with chronic or seasonal under- employment; (ii) formal social security covers only the small minority employed inthe formal sector; (iii) existing programs do too little to protect the human capital o f the vulnerable--efforts to use safety net measures to support health, nutrition, and education o f the poor are in their infancy; and (iv) the size o f benefits i s often negligible. Other issues include the weak administration, targeting, and delivery mechanisms, lack o f coordination between agencies, and poor monitoring and evaluation. - 3 1 - 101. The Bank`s Table 7: Public Spendingon Select Safety Net Programs assistance for social Budget/ spending Number of protection will include (inRs.Billion) Beneficiaries support for safety nets Wheat subsidy 8.00 (untargeted) that (1) help the chronic Bait-ul-Mal(FoodSupport andother) 4.50 1,250,000 poor (e.g. widows, Tawana(mid-daymeals for girl students) 0.70 530,000 disabled, and the elderly Zakat (cash transfers andother) 5.86 1,733,000 with no means of EmployeesOldAge Benefits(EOBI) 1.74 850,000 livelihood) cope with Total 20.80 4,363,000 poverty, and, where possible, (ii) the poor escape poverty, e.g., via conditional cash transfers and help other demand side interventions, (e.g., inclusive education) aimed at increasing access to basic social services for the poor and marginalized; and (iii) help families and individuals cope with seasonal shocks and natural disasters (e.g., via workfare). We will also provide support for social security which helps mitigate risks, via improving formal sector pensions, and consider innovative approaches to micro- insurance to address life cycle risks. Buildingon ongoing analytical work and policy dialogue, the Bank i s helping the government develop a comprehensive social protection strategy to guide policy reform in this area over the medium and long term. Reforms will be supported through the PRSCs, a stand alone Social Protection operation, support for persons with disabilities in the earthquake affected areas as well as social protection components in provincial DPCs and emergency operations. Technical assistance will include support for strategy development, design o f new social protection interventions (workfare, demand-side incentives for health and education, etc), program implementation, e.g. improved targeting methods, administration, and evaluation. The Bank will also broaden its work on pensions to cover old- age security mechanisms in their entirety, and continue and deepen its work on inclusive education that seeks to mainstreamdisability inthe education sector. 102. Pakistan's PRSP recognizes that while rapid growth will be the main driver o f poverty reduction, targeted interventions and community-based approaches to rural development are also required to address the immediate needs o f the poor and vulnerable, especially in drought prone and flood stricken areas, and help them share in economic growth. The Bank i s supporting the Government through a series o f analytical and advisory services in the definition o f a rural development strategy that would look in an integrated way at farm and non-farm opportunities as well as policy and institutional issues. The Government has announced a major increase in its pro-poor public works program and has asked for Bank's support for the continuation o f a drought/flood assistance program (DERA). The Bank will continue to support implementation o f the Community Investment Program in NWFP and AJK and look for possible expansion and replication opportunities. A major focus o f these efforts will be to strengthen the partnership between communities and local governments by supporting citizen participation in identifying priorities for public investment and by building the capacity o f local governments. At the same time, the Bank would support the Government's newly announced program for rural poverty alleviation through social mobilization. Such program would be critical in fostering organizations o f the poor and their access to income generating activities as well as in enhancing accountability mechanisms and the effectiveness o f Government programs. These investments yield not only better project outcome but also help inthe longer term to buildcommunitiesthat are better organized and incontrol o ftheir own development. The Bank will seek to build on the successful experience o f the Pakistan Poverty Alleviation Fund (PPAF) which has already reached 6,500 communities through micro-credit and community driven physical infrastructure projects. The experience o f the PPAF has also shown that the impact o f targeted interventions i s enhanced through up-front investments in social capital formation that build ownership and increase sustainability. - 32 - Reducing Pakistan's Vulnerability to Natural Disasters 103. The Government, with support from the international community has responded capably to the October earthquake and its aftermath. The Army, with support from UNagencies and bilateral donors, led a massive and largely successful relief campaign to provide shelter and food for the displaced. Despite the extremely difficult conditions with many affectees in inaccessible regions subject to severe winter a feared "second disaster" o f mass freezing and starvation did not materialize. By mid-February the government had managed to provide immediate cash relief to some 543,000 households (over 90 percent of those declared eligible), with payments made through individual bank accounts to reduce potential for leakage. Arrangements for assisting households with housing reconstruction are progressing with government partnering with local NGOs to mobilize assistance and inspection teams to administer relief and provide technical support. Reconstruction o f major highways commenced in mid-March with the onset o f favorable weather. Donors pledged a total o f US$6.5 billion at the November 19th donor's conference. Of this total, US$3.1 billion has been committed and US$1 billion disbursed as of mid- February. A key challenge now i s to complete institutional arrangements linlung The Earthquake Reconstruction and Rehabilitation Authority (ERRA) with local and provincial governments and to complete detailed reconstruction strateges in some sectors, particularly for education, health and public administration. 104. The October earthquake highlighted the vulnerability o f the poor to natural disasters and the importance o f hazard risk management. This i s an issue o f continuing concern since in addition to being in an earthquake prone area, Pakistan frequently experiences weather-related hazards, resulting in significant economic losses from localized and seasonal floods, landslides and droughts. Pakistan has been identified as being among the more vulnerable countries in the world on the basis o f mortality and economic risks induced by such hazards.13 Lack of enforcement of building codes, unsafe land use patterns, and poor construction practices contribute to high economic and human losses. To address such issues, hazard prevention and mitigation strategies are relevant and integral to Pakistan's national development framework. 105. Effective hazard risk management should be mainstreamed as part o f Pakistan's poverty reduction strategy with the purpose o f reducing future losses o f lives and livelihoods, protecting infrastructure and investments and promoting a stable foundation for private sector investment. At present, Pakistan has an ad hoc approach to hazard risk management. Interventions are primarily focused on relief and response with insufficient ex ante mitigation measures. Given its social and economic vulnerability to natural disasters, it i s essential that Pakistan improve its approach to hazard risk management. Following the relief period, Pakistan needs to develop a strategic approach to hazard risk management based on five key pillars: risk identification, risk reduction, capacity building, emergency preparedness, and risk transfer mechanisms, to achieve a sustainable recovery program and build in-country capacity for hazard riskmanagement. Beginning with the ongoing Emergency Recovery Credit the Bank will assist in the process o f developing Pakistan's hazard risk management strategy. The Bank plans to continue to work with government and other partners to develop the capacity to carry out this strategy and to integrate riskmanagement into development programs. l3Dilley, Maxx and others. 2005 Natural Disaster Hotspots: A Global Risk Analysis. Washington, D.C: The World Bank. Iv. DELIVERING WORLD BANKGROUPPROGRAM THE A. The World BankProgram Portfolio management strategy 106. The key to maintaining strong portfolio performance will be continued attention to good quality at entry and timely attention to implementation issues through joint portfolio monitoring. The planned increase in investment lending, especially in large-scale infrastructure projects, will pose a challenge in sustaining current good portfolio performance. To meet this challenge we will continue to closely scrutinize new lending and apply "readiness filters," screening new projects for ownership, adequacy o f institutional and policy frameworks, and implementation capacity. This i s being reinforced by Regional management by requiring a formal "decision meeting" prior to project appraisal inorder to institutionalize a formal review o f project readiness. For projects that have already been approved, we will jointly establish with the GOP key portfolio indicators for each year (e.g., portfolio riskiness; disbursement etc.) which will bejointly monitored on a regular basis. Quarterly joint portfolio review meetings will continue to serve as a forum for discussing portfolio performance and for elevating and resolving project issues. The CAS results framework will also serve as the foundation for monitoring the portfolio for outcomes. Starting in FY07, we will undertake a yearly joint review o f progress in achieving CAS outcomes and adjust the lending and AAA programs accordingly. 107. Portfolio Fiduciary Risk Management. Taking into account the result o f reforms implemented over the past five years, including recommendations from the CFAA and provincial financial accountability reviews and implementation o f PIFRA, overall Bank portfolio fiduciary risk has fallen from an average rating o f `substantial to high' during the 2002-05 CAS to an average o f `moderate to substantial'. The strategy for managing this risk will emphasize project design and capacity building. Projects will be designed with increased participation o f beneficiaries inprojects (e.g., CDD projects and enhancing the role o f school management committees in education projects) and generation and public dissemination o f project performance information including information generated through third party validation exercises. Project readiness filters will include assessment o f the adequacy o f fiduciary arrangements. A risk-based approach to financial management and procurement will guide the Bank's fiduciary team, both in project design and supervision. Intensive supervision and enhanced procurement arrangements will be put inplace in selectedprojects where fiduciary risks are deemed to be highest, 108. Continued strengthening o f government financial management and audit capabilities will be a key element o f the strategy. The Bank recognizes the Supreme Audit Institution (Office o f the Auditor General o f Pakistan) as the independent auditor for Bank-financed operations implemented by most government entities. l4Bank financing i s fully integrated into federal and provincial budgets and disbursements for Bank-financed operations flow through the State Bank o f Pakistan to the nominated account o f the projects and programs to ensure that Bank funds are accounted as part o f the overall funds flow o f the Government. Successful roll-out o fPIFRA to the provinces will enable the timely preparation o f reliable and comprehensive financial reports as well as timely, high quality audits, not just for Bank projects but also for the entire government. We will also continue to work with government to strengthen procurement practices at the federal and provincial level (see paras. 78-81). Supporting the improvement o f country systems and the overall control environment will support planned development policy lending and enable mainstreaming o f investment lending operations usinggovernment PFM systems. While over 90% o f project financial statements are received on time, due to uneven quality o f presentation and content o f the statements, about 25% o f the statements are unacceptable at first submission. Capacity l4Bank-financed projects that are implemented by corporatized entities are audited by independent firms o f Chartered Accountants whose acceptability will continue to be assessedby the Bank on a case-by-case basis. - 34 - building o f project financial management teams infinancial reporting will therefore also be an important area of Bank intervention duringthe CAS. FY0.5-09 lending scenarios and triggers 109. IBRDDDA Lending. As indicated above, Pakistan's demand for World Bank financial support has grown to meet the needs o f its growth and poverty reduction strategy and to address the impact o f the October earthquake. To meet this demand a flexible IBRD/IDAlending program o f up to US$6.5 billion (approximately US$3.1 billion IDA and US$3.4 billion IBRD) i s proposed in order to support implementation o f the PRSP." In light o f the extraordinary demands posed by the earthquake and the need to protect implementation o f the PRSP program, the Government o f Pakistan i s seeking additional concessional financing from the donor community. The proposed program i s consistent with Palustan's financing requirements, IDA allocation, debt management strategy, and the Bank's exposure guidelines. 110. IDA will account for about halfo fBank Group support to Pakistan. Pakistan's IDA allocationhas been increased under IDA 14, with the three-year envelope set at SDR 1.5 billion (equivalent to about US$725 million per year). In addition Pakistan will have access to additional IDA on hard terms estimated at SDR 130 million.16 Annual IDA availability i s therefore expected to be in the range o f an average o f $785 million per year. It i s expected that the full IDA allocation would be utilized provided Pakistan continues to maintain a policy environment conducive to growth and PRSP implementation while making further progress in implementing reforms. A dramatic deterioration in performance including, for example, failure to maintain a sound macroeconomic framework, reversal o f governance reforms inpublic financial management and procurement, and inappropriate reductions inpoverty-related expenditure would warrant a review o f the overall strategy and could preclude full utilization o f the IDA 14 allocation. Inassessing performance, the Bank will focus onprogress inachievingkey outcomes tied to PRSP reforms and CAS programpriorities. 111, Priorities for IDA resources include support for second generation structural reforms to facilitate private sector growth, improve governance and continue to expand PRSP-related expenditures. In addition, the demands placed on IDA have risen dramatically as a result o f the October 8 earthquake with incremental IDA commitments o f $740 million already approved. As a result, utilization o f IDA will be front loaded; over half o f the three year IDA allocation will be committed by end-FY06 and the full IDA allocation could be exhausted by end FY-07. Other priorities for IDA support include support for policy reforms and institution building to help reach MDG targets as well as financing for pro-poor targeted programs such as micro-credit, social protection and community-driven infrastructure. Annual Poverty Reduction Support Credits will serve as the foundation o f our support for PRSP implementation at the national level. These will be complemented by development policy lending for the provinces to support service delivery and improve human development outcomes. IDA will also continue to be used to finance governance-related institution building(tax administration, financial management, land administration). 112. The scale o f IBRD financial support will be determined by the strength o f the GoP's policy performance and macroeconomic management. Continued good policy performance and sound macroeconomic management leading to continued improvements in IBRD creditworthiness would form the basis for IBRD lending o f up to $400 million per year, o f which no more than $200 million would be in the form o f development policy loans. The upper bound of the proposed IBRD lending range for FY06-09is $3.4 billion o f which up to $1.3 billion o f IBRD lending could take the form o f development policy loans. Annual lending could increase to as much as $1 billion per year with up to $500 million in Four-year IDA access i s estimated on the basis o f IDA 14 allocation. l6 IDA hard-term lending allocations are additional to regular allocations under IDA14. The hard-term IDA allocation for Pakistan in FY06 i s SDR 62 million. The allocation for FY07108 i s indicative and subject to change based on implementation o f the IDA 14 grant component. - 35 - DPLs within this envelope. Reaching this upper bound would take place only in the context o f strong performance as demonstrated by reaching the key benchmarks set forth in Table 8. Inthe event o f policy reversals resulting in the macroeconomic framework going off-track, the Bank would seek to limit its exposure by suspending IBRD lending. Although recent macroeconomic performance has been good, rising inflation, earthquake-related increases in the fiscal deficit, and a growing current account deficit reflect increased pressure and the need for continuedvigilance. Table 8: Key PolicyPerformanceBenchmarksfor IBRD Lending Lending IBRD lendingup to $1.6 billion TotalIBRD lendingup to $3.4 billion ($400 millionper year) (up to $1billionper year) Maintenance o f a sound macroeconomic framework and no 0Continued improvement infiscal substantial decline infiscal discipline. performance and debt management as Macroeconomic [as demonstrated by public debt to demonstrated by achieving ineach Management and GDP ratio at or below FYOS level and year all targets for the revenue deficit Debt Reduction foreign exchange reserves equivalent and debt reductioninthe Fiscal to at least 3 months of followingjscal Responsibility and Debt Limitation year'sprojected imports of Goods and Act o f 2005. Nonfactor Services] 0 No substantialdeterioration inthe Continued improvement inthe Promoting business environment. business environment through privatesector-led [as evidenced by no substantial moves approval by Government o f growth toward protectionist or interventionist policies or reversal ofjnancial sector legislation governing employment reforms] conditions and a competition law. Implementationo f modernized accounting and auditing systems 0 Continued commitment to financial management reforms. capturing 65% o f the federation's expenditure budget by June 2007 and Governance 80% by June 2009 Notification o f regulations to support Satisfactory implementationo f implementation o f the national national procurement rules to reduce procurement rules. procurement irregularities. 113. The level of IBRD lending will also reflect the extent to which sectoral policies and governance arrangements are conducive to effective Bank engagement. The Government o f Pakistan's priorities for IBRDfinancing are ininfrastructure, primarilywater, power, transport andurbandevelopment. Ineach o f these areas the viability o f investment lending will depend on the establishment o f a policy environment conducive to project implementation and to the achievement o f targeted outcomes. In some cases, the conditions necessary for increased lending have already been met while in others key policy actions are required before expanded investment lending can take place. Reaching the upper end o f the proposed lending range would require strong progress across the board in implementing the sector reforms necessary to ensure that IBRD investments lead to the achievement o f CAS outcomes. Annex 7 summarizes key sector reforms that would serve as indicators to guide IBRDlending. 114. Actual lending amounts will also depend on the ability to prepare highquality operations as well as continued satisfactory portfolio performance. As indicated in the CAS Progress Report, work has already begun to meet the demand for stepped-up IBRD support and the pipeline o f IBRD projects i s growing. Nevertheless, given the fact that this new lending i s in sectors where Bank has lending has been limited inthe recent past, the scale-up will take some time. At present, with concerted effort on the part o f both the Bank and GoP counterparts, we expect IBRD lending to reach USS850 million in FY07. - 36 - However, reaching this level would require a considerably strengthened pace of project preparation and strong implementation capacity. 115. The level o f policy based lending will depend on several factors. Continued sound macroeconomic management will continue to be a pre-condition for development policy lending as will satisfactory implementation o f PRSP reforms. Similarly, development policy operations at the province level will take place in the context o f fiscal and financial management reforms aimed at increasing fiscal space and ensuring sustainability o f reform programs. Within the context o f a sound macroeconomic environment, the use o f DPOs will be driven primarily by the appropriateness o f the DPO instrument vis- a-vis alternatives (see para. 45). Inaddition, the share o f IDA-funded development policy lending in the overall IDA lending program will be managed in the context o f commitments on the Bank-wide share o f policy-based lending under the IDA 14 agreement. 116. Due to its rapid economic turnaround, Pakistan i s far more creditworthy than at the time o f the last CAS, Total government debt outstanding i s 61 percent o f GDP in 2004/05 (compared with 74 percent in2002/03) andis projectedto decrease to 47 percent by2008109. Debt service has fallen from 26 percent o f exports o f goods and services in 2002/03 to 15 percent in 2004/05. Recent debt sustainability analysis suggests that public and external debt are projected to continue to decline over the medium term and sensitivity analysis indicates that this downward trend i s not likely to deteriorate significantly under a variety o f shocks to the baseline scenario. Pakistan's improved creditworthiness i s also reflected in improved ratings on its sovereign bonds (Table 9), although the country's rating remains several grades below minimum investment grade. The Government o f Pakistan's first Table 9: Pakistan Credit Rating by Standard & Poor's international Islamic `Sukuk' bond Local Currency Foreign Currency offering (this i s the GoP's second Date Sovereign Credit Sovereign Credit bond offering, following last year's Rating Rating Eurobond US$500 million issue) July9, 1999 BiStableiB SD/NM/SD attracted subscriptions worth US$1.2 Dee* 2 1 71999 B+/Stable/B B-/Stable43 billion for a bond issue o f US$600 Dec. 12,2002 BB-/Stable/B BiStableiB million on January 18, 2005. The Dee, 2,2003 BB-/Positive43 BiPositiveiB authorities have also indicated that Nov. 22, 2o04 Source: Standard Poor,s. BBIStableiB B+iStable/B they intend to initiate further bond offerings on an annual basis. 117. IBRD lending o f up to the maximum o f US$3.4 billion over the FY06-09 CAS period would increase total IBRD exposure to Pakistan from the current US$2.5 billion, or 2.3% o f the portfolio to US$3.3 billion in FY10, about 3% o f the IBRDportfolio. Bank Group exposure guidelines limit the ratio o f IBRD debt service to public debt service to no more than 20%, and the ratio o f IBRD debt service to exports o f goods and services to no more than 4%. Even if total IBRD lending reaches US$3.4 billion over the CAS period-the upper end o f the proposed range-neither o f these limits would be breached. Pakistan does have a high share o f external debt owed to preferred creditors and the preferred credit ratio (debt service to preferred creditors as a percent o f total public debt service) i s above the 35% recommended by IBRD exposure guidelines. But this risk i s mitigated by bilateral debt rescheduling and Pakistan's debt reduction strategy which has emphasized the retirement o f expensive short term debt and increased reliance on multilateral concessional debt, including IDA. In combination these factors have served to reduce boththe stock o f external public debt and the associated debt service. - 37 - Table 10: MaximumProjected IBRD Exposure Projected FY05 FY06 FY07 FYOS FY09 FY10" IBRDDebt Disbursed and Outstanding 2,464 2,149 2,192 2,571 2,835 3,293 Preferred creditor ratio 61.3 60.4 57.1 52.7 42.8 45.6 Share o f Total IBRD Portfolio (%) 2.3 2.1 2.2 2.5 2.7 3.0 IBRDDebt Service as % o fTotal Debt Service 17.7 19.9 16.5 15.1 11.6 10.8 IBRDDebt Service as % o fExports of GNFS 1.8 1.6 1.3 1.2 1.o 0.8 * FY10 Exposure projected on the basis of continued lendingat the upper end ofthe FY06-09CAS lendingrange. Knowledge Services:AAA and Building Capacity 118. AAA and capacity building will be integral to the Bank Group program. Consistent with OUT focus on outcomes, ESW and TA will be programmedon the basis o f their contribution to achieving CAS outcomes, recognizing that knowledge transfer, often without financing, can be instrumental in achieving results. The AAA program will also provide the analytical underpinning o f the lendingprogram. Based on the FY04 QAGreview o f the Palustan AAA program, we will invest more in dissemination and outreach. Table 11: AAA -IndicativeKey Outputs by CAS Theme FY06 FY07 FY08 FY09 Sustained Growth 0 Sindh Economic Balochistan Economic Banking Sector Access to Finance and Improved Report Report NLTA Skill Competitiveness Growth and Export Investment Climate Development Development & Competitiveness Assessment Policy Review Labor Market TA Rural Development Poverty Update PPP for Agric. Report Tax Policy Study Technology and Transport Services Competitiveness Strengthened Provincial Monitoring and LandMarket Statistical Governance and Procurement EvaluationNLTA Administration Strengthening TA Service Delivery Assessment NLTA UrbanNLTA Devolution TA Civil Service Pension Report Improved Lives Safety Net Report Public-Private Education Sector EducationTA and Protection of Partnerships in Review the Vulnerable Education Pension Reform Health Sector Review NLTA Crosscutting/Core Strategic Country IntegratedPublic Poverty Diagnostic Environment Financial Assessment Assessment Management and Accountability Assessments (CFAAICPARR ER) 119. Based on the lessons learned inimplementing the last CAS as well as the recommendations o f the CAE, the FY06-09 CAS has been designed with greater emphasis on capacity building and ensuring that capacity constraints are adequately addressed in project design. The Public Sector Capacity Building - 38 - project, approved in May 2004, i s revitalizing civil service training and building the capacity o f key ministries and regulatory agencies that are in the forefront o f design, implementation and monitoring o f reforms. With the designation o f Pakistan as a focus country, the World Bank Institute will also play a greater role in building capacity in support o f operations. For example WBI has provided training in municipal management feeding directly into the capacity building component o f the Punjab Municipal Services project. The partnership between WBI and country operations has been strengthened with the appointment o f regional coordinator located in Dehli. WBI activities are expected to focus primarily on governance, including decentralization, urban management and parliamentary oversight o f spending. 120. At the project level, projects will have a stronger emphasis on building institutional capacity. Projects will be designed with capacity issues inmindand capacity considerations will play a greater role in appraisal of projects' readiness with an explicit requirement that projects not proceed to negotiation unless institutional issues are resolved and project management capacity i s in place. The proposed guidelines for IBRDlending address capacity constraints as well as policy reforms and therefore will help serve as a "capacity filter" for judging project readiness. Capacity building will also increasingly be incorporatedinproject design with provision for associated technical assistance included inprojects. Country Financing Parameters 121. The country financing parameters pursuant to the Bank's policy OP-BP 6.00, Bank Financing were established in November 2004, and reviewed during the preparation o f this CAS (see Annex IV). This framework allows the Bank to finance expenditures needed to meet the development objectives of the operations it supports within a framework that addresses country risks related to fiscal sustainability and appropriate use o f Bank resources. The policy has added flexibility inthe use o f Bank financing for a number o f expenditures. To implement this policy, the Bank and Government have agreed upon country financing parameters for Pakistan. Under these financing policy parameters, the Government o f Pakistan will have flexibility in allocation and management o f resources in the following areas: overall cost sharing; local cost financing; recurrent expenditures; and financing o f taxes and duties. Application o f the policy i s not expected to have an adverse impact on fiscal sustainability. The above policy i s based the Government's five-year track record o f stable and prudent fiscal management and debt reduction coupled with a sound medium term fiscal framework, approval o f a Fiscal Responsibility and Debt Limitation Bill, and commitment to implement its development program with all donor assistance fully integrated into the budget. 122. The financing parameters for cost sharing, local and recurrent costs, and taxes and duties will be applied on a project-by-project basis, depending upon the type o f operation, to ensure efficient implementation and sustainability after project closure. This will not impact the overall cost sharing o f the Bank, and the magnitude o f financing in any individual project would be limited by the total available IDA and IBRDresource envelope; the flexible financing arrangements insome projects will be offset by other projects, depending upon the nature, type and sectoral intervention. Periodically, the financing parameters and cost sharing for individual projects, will be reviewed with the Government and the Bank to ensure that overall Bank financing remains within the total IDNIBRD envelope and funding i s consistent with the Government's PRSP and availability o f local resources. Details can be found in Annex IV. B. The IFC Program 123. Over the last CAS period, IFC helped existing clients to restructure and strengthen their financial position and provided financing for new projects in infrastructure, manufacturing, and the financial sector to support small and medium enterprises (SMEs). IFC committed a total o f US$187 million in 16projects in Palustan from FY03 to FY05. IFC's committed portfolio in the country as of July 31, 2005 was US$314million in 32 companies, includingU S 6 2 million inequity. The largest exposure i s inthe power - 39 - sector, representing 37% o f the portfolio in five independent power producer (IPP) projects, with the remainingportfolio spread across the financial and industrial sectors. 124. Duringthe previous CAS period, localbanks became active providers of longer term financing at competitive rates, driven by strong liquidity inflows and the increased efficiency o f the recentlyprivatized commercial banks. The business environment in the country also benefited from recent government private sector policies (visible in the improvements inthe Doing Business indicators), which have spurred investment activity. Therefore, IFC was selective in its investments during this period and did not compete with local banks. 125. In the upcoming CAS period, IFC will be increasing its investment with the target range of US$500-600 million for the period. IFC will also explore opportunities inpre-privatizationinvestment. It furthermore plans to make more equity investment and intends to be a catalyst for and mobilize private equity in the country. In addition IFC will increase technical assistance (TA) activity in Pakistan. IFC activity will focus on three main sectors; financial, SME and infi-astructure. With the recent creation o f Private Enterprise Partnership for Middle East and North Africa region (PEP-MENA), IFC has initiated a substantial TA program in Pakistan to build capacity and address constraints o f the SME, infrastructure and financial sectors. 126. In the financial sector, opportunities include: microfinance; SME lending; support for recently privatized banks and those expected to consolidate; and long term lending and securitization for housing finance. IFC will also continue to support the expansion o f trade finance for SMEs, and expansion o f the asset management sector where it has played a pioneering role in the country. TA will complement the investment program. PEP-MENAwill focus on strengthening financial markets and on expanding access to finance for micro, small and medium-sized enterprises, improving corporate governance practices, and expanding access to affordable housing for low and middle-income citizens. PEP-MENA will launch a training and advisory project for the housing sector and will work with individual banks to improve internal credit and risk systems, policies and procedures to promote affordable housing finance. 127. IFC expects to support innovative financing to promote funding to SMEs from local banks and to help meet the fundingneeds o f SMEs, specifically inhealth and education. To help enhance the country's business enabling environment, PEP-MENA i s supporting commercial dispute settlement through its alternative dispute resolution (ADR)/mediation pilot project in Karachi. The project will establish a pilot mediation center for SMEs to provide training on mediation for judges, lawyers and the private sector. It i s expected that the pilot will result in a decline in court litigation, which i s particularly burdensome for SMEs, and could eventually be replicated in other provinces. PEP-MENA i s also providing support to business membership organizations (BMOs) to improve services and support to their SME members. PEP-MENA will also launch its business management training tool, Business Edge, inPakistan to support business development service providers through train-the-trainer workshops. This management training tool i s to provide SMEs greater access to business development, management training and advice. 128. IFC intends to increase its investments ininfrastructure and housing finance activities inorder to address financing gaps in these sectors. In the infrastructure sector, the country i s addressing constraints in power generation and distribution. IFC is developing a number of investment proposals to address these challenges. IFC i s pursuing opportunities to further develop the country's natural gas resources, where clients value IFC's political risk mitigation. In addition, IFC lending and advisory services are expected to support the expansion o f the private telecom industry, which i s growing strongly after the privatization o f Pakistan Telecommunications Limited (PTCL) and after the rapid expansion in mobile telephony and value added telecommunication services. 129. As to the development o f housing finance sector, a key driver for stimulating the growth in the mortgage market would be for originators to have access to long term local currency financing. This - 40 - would be led by the development o f the local capital market, via securitizations and other capital market instruments, which mobilize domestic capital to support funding for mortgage finance. Some legal and regulatory framework needs to be changed to ensure that the environment for securitization i s enhanced. PEP-MENA is exploring ways to support the GoP to enhance the legal regulatory framework. IFC will explore ways to support pilot securitization efforts with some local financial entities that could be developed intandem with some o f the changes inthe legal and regulatory infrastructure. 130. Inprivatization and public-private partnership (PPP) development, PEP-MENA will support the GoP's regulatory bodies and its infrastructure privatization efforts. IFC currently has two advisory mandates in Palustan: (i) structuring a PPP for Lahore Water and Sewerage Agency; and (ii) privatization o f Faisalabad Electric Supply Company. IFC i s working with Global Partnership on Output Based Aid (GPOBA) and Infrastructure Department o f the Bank on other PPP-related transactions and on the institutional framework insupport o fPPPs. C. MIGA Portfolio andProgram 131. MIGA's outstanding portfolio in Pakistan consists o f 10 contracts of guarantee-four in the financial sector, five in the infrastructure sector and one in the services sector-with a total gross exposure o f US$136.8 million and a net exposure o f US$106.8 million. An application seeking coverage for a US$20.8 million equity investment in a hydropower project (Laraib Energy Ltd.) in Pakistan i s currently pending. In FY07 MIGA intends to implement an Enterprise Benchmarking Program (EBP) Survey in South Asia, and Pakistan i s expected to be one o f six or seven countries that will participate. The EBP will provide detailed investor-focused information to assist Pakistan's investment promotion efforts. D. Partnerships and Harmonization 132. The Bank Group's work in Pakistan i s coordinated with and reinforced by the efforts o f other donors in a wide variety o f areas. The Government leads coordination o f policy dialogue and donor support within the framework o f the PRSP, usingthe Pakistan Development Forum (PDF), held annually in Islamabad, as the principal forum for discussion with and among donors. The PDF has allowed the Government (federal and provincial) to actively participate and present their policy reforms to the donor community. This has enabled the development partners to learn first hand from key policy makers and implementers, about the country's economic reforms and to experience the ownership o f the program at all levels o f the government. To follow-up on the PDF ina systematic manner, a Donor CoordinationCell (DCC) has been created in the Economic Affairs Division (EAD). Formal donor group meetings are also held, at least two to three times a year, to discuss implementation o f the government's PRSP. Provincial governments have also continued to engage development partners in the implementation o f their provincial reform programs. Building on the positive experience o f the provincial development forum meetings in Sindh and NWFP, a Punjab development Forum was held in 2005, and another NWFP Development Forumi s planned in2006. 133. Under the leadership of the Government of Palustan, the Bank Group i s increasing efforts to strengthen partnerships and improve harmonization o f activities among donors in line with the Paris Declaration on Aid Effectiveness. Analytical activities are increasingly being preparedjointly; duringthe last CAS five ESW reports were prepared asjoint products with the support and participation o f the Bank, MF, ADB, the EC and the UKDepartmentfor InternationalDevelopment.Duringthe next four years we expect an increasing share of analytical activities to be carried out jointly. A comparison between the World Bank's and ADB procurement rules was undertaken in 2004 as part o f the harmonization exercise and as a result, harmonizedprocurement documents are available for use. A similar exercise i s underway in the area of financial management where DFID and ADB will be working jointly together on the planned PFM Performance Measurement assessments for the federal government, Punjab and NWFP. A - 4 1 - similar PFM assessment for Punjab was carried out jointly by the World Bank, DFID, and the EC in 2005. Discussions are underway with a number o f donors including the US, UK and EC to harmonize program support and we will continue to seek opportunities for harmonization o f budget support, both at the national and provincial level, under common policy frameworks. Details o f partner activities can be found inAnnex V. 134. The international response to the October earthquake has served as an opportunity to substantially deepen donor harmonization and coordination. The Preliminary Damage and Needs Assessment was the product o f a multi-agency mission led by the Asian Development Bank (ADB) and the World Bank including experts from the government as well as international organizations, including the European Union, the United Kingdom's Department for International Development (DFID),the German Agency for Technical Cooperation (GTZ), the German KfW, the Japan Bank for International Cooperation (JBIC), the Japan International Cooperation Agency (JICA), the United States Agency for International Development (USAID), the World Health Organization (WHO), and UN Agencies." A core group o f seven donors including the ADB, DFID, the European Union, Japan, UN, USAID, and the World Bank has continued to meet on a near-weekly basis to coordinate activities by designating lead agencies and develop common approaches, including assisting in development o f sector reconstruction strategies to guide government and donor efforts over the coming months. Duringthe CAS we will seek to build on this mechanism to institutionalizeand deepen donor coordination. E. Communicationsand Outreach 135. An important complement to partnership and coordination efforts is the Bank Group's overall outreach. Accordingly, the Bank has increased its interactions with the different levels o f government, the media, civil society, and business community to establish partnerships based on a shared vision for Pakistan's development. The Bank Group has intensified efforts to build the local media's capacity, and will continue to conduct training programs for business and economic journalists in collaboration with local universities and WBI. In keeping with the Bank's goal o f sharing knowledge, increasing transparency, and enhancing accountability, the Bank Group's web site not only provides information about Bank operations in Pakistan but also provides real time access to stakeholders allover the world on annual events like the Pakistan Development Forum. The web site and other web-based communications channels like virtual meeting rooms and discussion space have played a great role in donor coordination during the recent earthquake in Pakistan. Additional efforts will be made to extend the Bank Group's outreach through more periodic dialogue with stakeholders. This will be done through wider dissemination o f the Bank Group's reports and disclosure o f project documents (especially in local languages), greater engagement with civil society organizations and opinion makers. The Bank will continue also its highly effective consultative process inthe preparation o f specific projects. F. MonitoringandEvaluation 136. Successful implementation o f the results-based CAS will require further improvements in monitoring and evaluation. At the level o f the country program, the CAS results framework establishes the specific results which the Bank Group aims to assist the Government to achieve (Annex 1). Progress toward the achievement of these objectives will be monitored and jointly reviewed on an annual basis. This process will be supported by activities to improve government systems to collect, analyze and disseminate data. To supplement the data available from household surveys, beginning in 2005, the Federal Bureau o f Statistics (FBS) has begun conducting a Pakistan Social and Living Standards Measurement Survey (PSLM). This survey consists of a Core Welfare Indicators Questionnaire (CWIQ), which for the first time i s gathering data at the district level, and a Household Income and Expenditure "Pakistan:2005EarthquakePreliminay DamageandNeedsAssessment.SecM2005-0585lIDAISecM2005-0588, November 18,2005. - 42 - Survey (HIES), which i s provincially representative. Together with household surveys, the CWIQ and the HIES provide information on intermediate and final development outcomes as well as on satisfaction with government services and provide decision makers with annual feedback on the results o f government programs which can be used to assess effectiveness and make needed adjustments. The Bank will also support the strengthening o f administrative reporting systems with independent cross-checks provided by third party validation surveys, an approach that is already being implemented in the Punjab Education program. 137. Like several other South Asian countries, Pakistan boasts a strong statistical system with a long time-series o f household surveys with extensive data on economic, demographic, and social trends. Already a participant o f the General Data Dissemination System, the GoP has announced its intention to adopt the Special Data Dissemination Standard. Further, as the country moves forward in implementing its poverty reduction strategy, increasing information demands are being placed on its statistical system. Recognizing the importance o f timely and reliable statistics for policy analysis and public debate, the GoP has embarked on an ambitious plan to restructure existing statistical agencies and develop a long-term plan to strengthen its system o f official statistics to meet these challenges. The World Bank i s providing technical assistance to the GoP to help prepare a strategic plan for the merger o f the various statistical agencies into one organization, to help draft a new statistical law specifying the respective roles and responsibilities o f various actors in the revamped statistical system, as well as to develop an implementation plan to strengthen the overall system, including training and motivation o f staff and the strengthening o f the statistical infkastructure. Inaddition, the Bank has also helped the Federal Bureau o f Statistics cany-out the CWIQ survey in2004/05. 138. Improvements in monitoring and evaluation will also be a focus o f efforts at the project and portfolio level. Based on the results o f a recent portfolio monitoring and evaluation review, there i s scope for improving the M&E focus o f projects by enhancing projects-level results frameworks, strengthening the selection o f measurable outcome indicators, and strengthening M&E information channels at the project level. W e will continue to build the capacity o f the Planning Commission for evaluation and monitoring o f development projects. Further support, including lending and technical assistance for implementation o f the statistical restructuringplan, will also be considered duringthe CAS period. G. Managing Risks 139. The greatest risk faced in the new CAS i s the risk o f policy reversal due to shifting priorities or political changes. While the government has shown itself able to sustain its reform program over an extended period, the period leading up to elections in 2007 could bring greater uncertainty. In this context, a slowdown in decision malung i s possible as are shifts in government policies and priorities. While the Bank's ability to mitigate this risk i s limited, we will seek to build and sustain support for further reforms, using our AAA work as appropriate to help make the case for reform in public and to strengthen the hand o f reformers inpolicy debates. The government i s also sensitive to this risk and has launched a variety o f initiatives which aim to spread the benefits o f growth and reform as widely as possible, particularly among the poorer regions inthe country. Inthis way, the government seeks to build popular support for continued reform. We will support these efforts. Finally, we will continue to rely on the self-regulating nature o f the programmatic approach: the volume and pace o f lending will match the pace o f reforms. 140. Recent macroeconomic developments including rising inflation and a growing current account deficit suggest an increase in the risk o f macroeconomic slippage. On the fiscal front, expenditure pressures are evident due in part to the October 2005 earthquake and associated claims on the federal government's finances. Disbursement o f grant donor funding pledged at the November 19, 2005 Conference in Islamabad has been slower than planned. There i s also a risk o f increased external vulnerability as shown by the rapid increase in the current account deficit during FY05 and the first half - 43 - of FY06. These risks are offset to some extent by the Government's track record over the past five years inmanagingthe economy coupledwith its strong commitment to sound macroeconomic management as embodied in the Fiscal Responsibility Law. The Bank will seek to further mitigate this risk through its engagement in macroeconomic policy dialogue and in the context o f the PRSCs and other development policy operations, as well as technical assistance and capacity building. 141. Despite some favorable trends over the past several years, Pakistan will remain vulnerable to security risks which may affect implementation of the strategy. While the peace process with India remains on track, the threat of violent conflict persists. Some episodes o f violence in Balochistan and in the border regions near Afghanistan over the past year have caused disruption in project or program implementation. Moreover, it i s likely that security concerns have acted as a constraint on the effectiveness o f Pakistan's reform program by dampening somewhat the private sector's response to the rapidly improving investment climate. While the Bank cannot address security issues directly, its engagement can have a demonstration effect and help to "crowd in" private investment. We will mitigate the security risk to Bank operations by continuing to closely monitor developments and by responding quickly to safeguard staff while maintaining our engagement. 142. The October earthquake has highlighted Pakistan's vulnerability to exogenous shocks, including natural disasters. Pakistan i s subject to earthquakes as well as weather-related hazards including floods, landslides and droughts, all o f which were experienced during the last CAS period. The response to the earthquake has also demonstrated Pakistan's capacity to weather such shocks, as well as the need to improve hazard riskmanagement practices inPakistan. This risk will be mitigatedby ensuring the Bank's readiness to provide necessary support-resources, AAA and leadership-to assist in responding to emergencies. In addition we will work with the Government to strengthen hazard risk management strategies and capacity. 143. The IBRD exposure risk i s deemed to be acceptable based on Pakistan's improving debt sustainability indicators and growing access to international financial markets. Nevertheless, IBRD lending at the upper end o f the proposed range will take place only inthe context o f further improvements increditworthiness. Inconsultation with the IMF,the macroeconomic situation will be monitored closely and IBRD lending adjusted accordingly. Moreover, application o f the guidelines for IBRD lending will serve to modulate the lendingprogram based on policy performance at the sector level. 144. There are implementation risks relating to both the Bank and Pakistan. As outlined earlier technical and institutional capacity constraints, particularly at the local level, could delay implementation of reforms or slow the preparation o f new projects. On the Bank side, the planned increase in infrastructure lending poses risks related to the timeliness and effectiveness o f Bank support as we re-engage in sectors where there has been little or no lending during the previous CAS. Portfolio risks will also be more prominent as we scale up infrastructure lending. As outlined above, we will aim to increase our support for capacity building, both through stand-alone operations and as an integral part of new activities. We will also apply a "capacity filter" to new operations to ensure that projects proceed only with adequate capacity inplace or with a clear strategy for buildingit. To address the environmental and social risks associated with scaling-up and programmatic support, particularly in the infrastructure and waterhigation sectors, the Bank will increase efforts, working with our clients, to identify at an early stage the critical issues affecting the potential sustainability o f the programs and to put in place appropriate mechanisms to address them. To mitigate the implementation risks on the Bank side will require a concerted effort to streamline project preparation and ensure timely attention to implementation issues on the part o fboth the Bank Group and GoP. >. . 35 . . 4 . . c rd . . 0 . . . . . . 0 . . . . . . . . . . . I * e e * e e e e e e e e U 5 e, 0 d 5 > a a a a . a a . a a a . a a . a a a a a . a . a * * a . 25 I z M 2 mB e r n e e e e e e e e e e e e e e . e e . e B P 5 E e . . . e . e . e e e e e e . e ... c6 & 1 I z 0 .-0 e, 5 I -0 .e + -rc m 0 0 .e I .- Fo gE I .-.-N e I UW8W b . m , 3 e L P E ? z 5 E a 0 . 0 . . . . . . . . . . . . 0 . i o . 4 . . . . . . . . . . . . . . . . . . . . . . 0 . . . . . . . . . . . . . . . Pakistan: CAS Completion Report Page I of30 ANNEX11: CASCOMPLETIONREPORT Country: Pakistan Date o f CAS: June 24,2002 Date o f CAS Progress Report: April 28,2004 Period covered by the CAS Completion Report: July 2002 -June 2005 CAS Completion Report completed by: Thomas Buckley, Senior Country Officer Date: M a y 27,2005 1. This CAS Completion Report evaluates the effectiveness o f the World Bank's Country Assistance Strategy for Pakistan (FY2003-2005). It i s a self-evaluation by the country team o f the extent to which expected CAS outcomes were achieved and the extent to which Bank performance was satisfactory in helping to design and implement the CAS toward outcomes, with a view toward longer term strategic goals. The purpose o f the report i s to identify the lessons relevant to the design and implementation o f the new results-based CAS. Completion o f this report coincides with the completion by the Independent Evaluation Group (IEG) of a Country Assistance Evaluation covering FY1994-2003 which, although it covers a different period, offers additional lessons relevant to the new CAS. 2. This report evaluates the CAS against the outcomes established inthe FY2003 CAS. The report assesses: (i)the alignment o f the CAS with Palustan's goals and expected development results; (ii) the degree to which CAS outcomes were achieved during the CAS period; and (iii) the Bank's performance during this period. Since the CAS was presented to the Board in June o f 2002, a CAS Progress Report was discussed in April 2004. Progress in achieving CAS outcomes i s summarized in Annex-1 while annexes B and C compare plannedand actual deliveries o f lending and non-lending support over the CAS period. Overview 3. From independence through the 1980s, Palustan's economy grew at a respectable rate - always over 5 percent after the 1950s and in the 1980s over 6 percent per year. Inthe 1990s, however, growth slowed while public debt accumulated rapidly and poverty increased. The imposition o f sanctions following the 1998 nuclear tests exposed the vulnerability o f the economy, leading to severe balance o f payments difficulties, spending cuts, import restrictions, tax increases and external debt service arrears. 4. The government which assumed power in 1999 succeeded in turning this situation around; Palustan's macroeconomic performance has improved significantly and more rapidly than expected. Sustained implementation of the Government's stabilization and economic reform program, along with the generous support ffom the World Bank and other donors, has resultedinmacroeconomic stability and accelerating growth, laying the foundations for poverty reduction. Economic growth has increased from the average o f 3.3 per cent during 1997-2002to the average o f nearly 6 per cent during 2002-04. Against the target o f 5.3% for FY04, GDP growth was recorded at 6.4%, the highest rate in 8 years. For FY05, despite the impact o frising oil prices, growth reached 8.4%. 5. There has been significant progress in implementing a wide ranging program o f structural reforms with deep World Bank engagement. The banking sector has been strengthened through Pakistan: CAS Completion Report Page 2 of 30 privatization, a strengthened legal and regulatory environment, and significant improvements in transparency, corporate governance, and credit culture. There has also been progress in de-regulating the economy so as to reduce the cost o f doing business inPakistan. The regulatory and policy framework for the telecommunications sector has been improved to establish a competitive telecommunications market. There has been progress in implementation o f the oil and gas reform agenda, in particular in the petroleum downstream sector. Governance reforms have continued to advance including: (i) reforms in public financial management and public procurement to increase fiscal transparency, accountability, and value for money; (ii) restructuring o f the Central Board o f Revenue to strengthen tax administration; (iii) a devolution initiative aimed at improving the delivery of public services by creating more accountable local governments; and (iv) reform o f the civil service to improve incentives and accountability. A. Longer T e r m Strategic Goals 6. The 2002 CAS and June 2001 CAS Progress Report reflected and supported the program which the government had formulated starting in 1999. Soon after the military coup, the new government issued a seven-point agenda to revive the economy, address endemic corruption, depoliticize state institutions, devolve power to the grass-root level, and improve checks and balances and democratic processes in society. InDecember 1999, following national consultations, the government announced its development strategy which focused on: (i) strengthening governance and the integrity o f the civil service; (ii) creating opportunities through accelerating growth o f agnculture, small and medium scale industries, information technology, and oil and gas sectors; and (iii) reducing poverty through revival o f growth and re-orienting public expenditure towards human development and poverty reduction. 7. Later, these goals became the basis o f the government's Interim Poverty Reduction Strategy Paper which was completed inNovember of 2001. The CAS outlined a Bank program in support o f the I-PRSP.' The I-PRSP specified five main goals: engendering growth, reforming governance, creating income generating opportunities (specifically for the poor), improving human development, and reducing vulnerability to shocks (at the microeconomic level). While not explicitly linked to the MDGs, the I-PRSP was closely aligned to them. The full PRSP (discussed in greater detail below), which was completed in December 2003, went on to make the link between the MDGs and Pakistan's poverty strategy explicit, setting targets for poverty reduction, education, health, and gender equality that are fully aligned with the MDGs. In addition, both the I-PRSP and the PRSP included M&E frameworks to track progress toward the MDGs as well as intermediate indicators to guide policymakers and program managers. 8. During the CAS period, the government's longer term objectives underwent a process of refinement and elaboration, butremained fundamentally unchanged. Parliamentary elections were heldin October 2002 leadingto the formation o f a government under the leadership o f an elected Parliament and Prime Minister. The civilian government has largely adhered to the policy priorities o f the military government. Many key ministers have remained in place and President Musharraf has continued to exercise considerable influence on policy matters. Mr. Shaukat Aziz has remained Finance Minister throughout the CAS period while also beingelevated to Prime Ministerin2004. 9. The PRSP prepared in December 2003 outlined a policy which continued and built upon the I-PRSP. Pakistan's PRSP i s grounded on four pillars: (i) achieving sustained high and broad-based economic growth, focusing particularly on the rural economy, while maintaining macroeconomic stability (ii)improving governance and consolidating devolution; (iii)investing inhuman capital; and (iv) targeting the poor and vulnerable. ' The I-PRSP and Joint Staff Assessment were discussed by the Board on December 4, 2001. Pakistan: Interim Poverty Reduction Strategy Paper and Joint IDA-IMF StaffAssessment, Report23189-PAK,November 15,2001. Pakistan: CAS Completion Report Page 3 of 30 10. Overall, Pakistan has made substantial progress towards the longer term goals set in the I-PRSP. As outlined above, growth has resumed, macroeconomic stability has beenrestored, and fiscal adjustment has been successful, creating fiscal space for increased spending on poverty-related programs. Governance reforms were launched including the devolution initiative, financial management improvements and tax administration reforms. Some progress has been made in each o f these areas and there are early indications o f success as shown by increasing timeliness and accuracy of government financial reporting, and improved customer satisfaction by the Central Board o f Revenue. With respect to devolution, the new devolved political structure i s fully inplace, but the fiscal and administrative aspects of devolution have yet to be fully implemented creating obstacles for local governments seeking to improve delivery o f public services. There has been less progress in civil service reform. Nevertheless, given the long term nature o f governance reforms this i s a respectable track record, even though in some respects it falls short o f the goals set inthe CAS. 11. Public expenditure has been reoriented toward human development, a shift made possible by a dramatic reduction in interest expenditures brought about by successful implementation o f a debt reduction strategy. Poverty related expenditures have increased substantially, exceeding in some cases the targets set in the I-PRSP. However, public spending on health and education remains l o w by international standards and it i s too early for a full assessment o f whether additional expenditures have led to significant increases in the quality and availability of services, let alone outcomes. Nevertheless, there are examples o f increased access inseveral areas. Improvements inthe effectiveness, as well as the level, of social spending will be necessary to reach the MDGs. Consequently, the government's governance reform agenda i s a key ingredient o f a strategy for improving human development outcomes. Additional resources have been targeted toward social safety nets, but here too the government recognizes the need to improve the targeting and efficiency o f these programs and has launched efforts, supported by the World Bank, to do SO. B. CAS Outcomes 12. The CAS was designed to support Palustan's pursuit its I-PRSP goals through a Bank program organized around three pillars corresponding to major areas o f the government's reform program: (i) strengthening macroeconomic stability and government effectiveness; (ii)improving the business environment for growth; and (iii) improving equity through support for pro-poor and pro-gender equity policies. For each o f these pillars, a set o f country outcomes and associated indicators or milestones were identifiedinthe CAS program matrix. The CAS triggers also included specific performance criteria for assessing progress inthe main areas o f the CAS. 13. The results framework established inthe 2003 CAS program matrix has some weaknesses when compared to the approach now developed for use in a results based CAS. Some objectives, such as improved performance o f CBR lack specificity, although milestones in the CBR reform program are reflected in the CAS and these are expected to lead to improved performance. Other objectives, such as higher private investment represent longer term country goals and don't have a clear link to the CAS program, representing instead a medium-term outcome expected to come about as the result o fthe overall government reform program to strengthen the environment for private sector investment. In some cases, performance indicators were identified without baselines or targets. Nevertheless, despite these limitations, the CAS and its program matrix together present an adequate monitoring and evaluation framework for assessing progress toward CAS outcomes. The CAS Progress Report updatedthe program matrix and assessed progress against the objectives in the program matrix as well as the CAS triggers. Progress inachieving CAS objectives i s discussed inthe following sections. Pakistan: CAS Completion Report Page 4 of 30 MACROECONOMIC STABILITY AND GOVERNMENTEFFECTIVENESS 14. This pillar o f the CAS embodied two key elements o f the I-PRSP: consolidating recovery from the macroeconomic crisis o f the late 1990's while reversing the long term deterioration in governance. The I-PRSP and CAS were based on two premises: first, the economic growth essential for poverty reduction required in the first instance correction of macroeconomic imbalances and maintenance o f a sound macroeconomic framework. Second, that low growth and rising poverty were in part a reflection of poor governance requiring concerted efforts to improve government performance and restore confidence instate institutions. Macroeconomic Stability 15. Upon coming to power in 1999, the Musharraf government moved quickly to stabilize the economy and restore confidence. By the time o f the 2002 CAS, considerable progress has been made and for the first time in its history Palustan had successfully concluded an IMF Stand-by arrangement. Nevertheless, the macroeconomic situation remained perilous and the outlook was made more uncertain by the impact o f 9/11. The I-PRSP set targets for further fiscal consolidation, accelerating growth, and management o f debt. The CAS incorporated these targets as well as the targets inthe PRGF arrangement with the IMF. Overall, progress has been impressive, particularly with respect to restoration o f growth (see table 1). With respect to the PRGF program, targets were mostly met or exceeded and structural reforms measures were largely followed through, though in some cases with delays.2 All PRGF disbursements were made available upon completion o f program reviews although the authorities elected not to draw the final tranche inlight o f the improved external position. ~ Table 1: Key Indicators: I-PRSP vs. Actual' 2000-01 2001-02 2002-03 2003-04 2004-05 RealGDP Growth I-PRSPTarget 2.7 3.7 5.0 5.3 5.8 Actualiproj. 2.2 3.4 5.1 6.4 8.4 Inflation I-PRSPTarget 4.4 5.0 5.O 4.0 4.0 Actualiproj. 4.4 2.5 3.1 4.6 9.3 BudgetBalance(excl.grants) I-PRSPTarget -5.2 -5.3 -4.1 -3.2 -3.9 Actualiproj. -5.2 -6.7 -4.6 -2.9 -4.1 DevelopmentExpenditure I-PRSPTarget 2.7 3.4 3.6 3.9 4.1 Actualiproj. 2.6 3.5 3.2 3.6 4.3 PRSP Expenditure I-PRSPTarget 3.4 3.6 3.8 4.0 4.2 Actualiproj. 3.6 3.7 4.2 4.7 4.7 16. The instruments employed to support Palustan's stabilization program consisted o f a series o f one-tranche development policy credits to the federal and provincial governments. These supported policy reforms while assisting inthe restoration o f financial equilibrium. This strategy was carried out in partnership with the IMF which took the lead in assisting in the adoption o f supportive monetary and exchange rate policies. A 3-year PRGF arrangement was approved inNovember 2001 and concluded in December 2004. Other donors also provided significant budget support. The Bank development policy lending program constituted a multi-year commitment o f budget support tied to fiscal and governance reforms keyed to the pillars o f the I-PRSP. The first o f these, SAC I,was approved in 2001 while the IMF, StaffReport for the 2004 Article I V Consultations, Ninth Review Under the Poverty Reduction and Growth Facility, and Requestfor Waiver of Performance Criteria, November 16,2004 Pakistan: CAS Completion Report Page 5 of 30 second, SAC I1was approved along with the CAS in June o f 2002. SAC 111, which was expected to be approved inFY03, was delayed as a result o f a slowdown the reform program following the elections and political transition inlate 2002. Reform accelerated in 2003 and 2004 opening the way for resumption o f development policy lending which came in the form o f a Poverty Reduction Support Credit (PRSC I) which was approved in September 2004. 17. The CAS recognized that there were acute fiscal imbalances at the provincial as well as the national level. The provinces and local governments in Pakistan bear most o f the responsibility for delivering public services including education and health, but have very limited fiscal space to provide these services. Therefore, the CAS initiated a program o f single tranche development policy credits to provide performance-based budget support to enable the provinces restore financial equilibrium while undertakmg reforms. The resources provided an immediate means to address the imbalance between the provinces' responsibilities and their fiscal capacity while the fiscal management reforms supported under these credits were designed to improve fiscal sustainability through increasedrevenue mobilization at the provincial level. The provincial credits also supported governance reforms and service delivery improvements to address the governance problems that historically limited the effectiveness o f spending increases. 18. A first round o f provincial development policy credits-for Sindh and NWFP-was approved in FY03. As in the case o f the federal government, the elections in 2002 and resulting political transitions slowed implementation o f the provinces' reform programs. As a result, planned follow-on credits were delayed. Inthe case o f NWFP, a second NWFP credit was approved in June 2004. A principal objective inthe CAS for provincial development policy lendingwas to restore the provinces fiscal space and allow them to increase spending on social services by undertakmg reforms. Inthis respect, the provincial SACS were effective, allowing the provinces to re-profile their debt and reduce interest costs while re-orienting expenditures, including very large increases in development spending on education and health. As a result the government o f NWFP has been able to increase the share o f PRSP spending from 29% to 38%. Provincial tax revenue has grown by 14%. In Sindh, the SAC-supported provincial reform program resulted in substantial increases inprovincial revenues and development spending as well as an increased share in the budget for health and education. However, given the provinces' overwhelming reliance on fiscal transfers from the federation, sustainability o f these fiscal reforms and maintenance o f adequate fiscal space at the provincial level depends in large part on the (still pending) outcome o f the National Finance Commission which will establish the formula for allocating federal revenues among the provinces and federal government. 19. The development policy lendingprogram was complemented by policy dialogue and economic and sector work. The CAS was based on a Development Policy Review, a Poverty Assessment, and a Country Procurement Assessment. During the CAS period the Bank completed work on a Public Expenditure Review, Country Financial Accountability Assessment and an FSAP and the Bank annually conducted reviews o f the Government's Public Sector investment program. A series o f trade policy notes was prepared duringFY04. The Bank also worked closely with the Fund, providing advice and technical support inthe implementationo f the I-PRSPPRSP program. Governance Reforms 20. The Bank's support for improving the effectiveness and accountability o f state institutions focused on the following areas: (1) reforms in public financial management and procurement to increase fiscal transparency and accountability; (ii)restructuring o f the Central Board o f Revenue to strengthen tax administration; (iii)a devolution initiative aimed at improving the delivery o f public services by creating more accountable local governments; and (iv) civil service reforms. The specific CAS outcomes Pakistan: CAS Completion Report Page 6 of 30 supported by the Bank took the form o f milestones in the institutional reform processes as well as, in some cases, indicators o f improvedperformance. 21. Inpublicfinancial managementandprocurement, the focus ofthe CAS was on improvements ingovernment accounting, auditing, and legislative oversight alongwiththe adoptionand implementation o f modem public procurement laws and regulations. The strategy was to assist in modernization and computerization o f the government accounting system coupled with strengthening o f the audit function and revitalization o f the external oversight process. The centerpiece o f the Bank's support was the Project to Improve Financial Reporting and Auditing (PIFRA) which was approved inFY97 and closed in FY05. SAC I1 and PRSC Ialso supported these reforms with prior actions related to expenditure reconciliation targets and establishment o f the Federal Public Accounts Committees as well as the notification o f new Public Procurement Rules. Non-lending assistance took the form o fpolicy dialogue, a Country Financial Accountability Assessment, and provincial financial accountability assessments for the Sindh, NWFP and Punjab provinces. 22. Overall, there was steady advance in the government's financial management reform program. The CAS Progress Report described substantial progress as demonstrated by improvements intimeliness and reliability o f financial statements as well as progress in launching o f computerized accounting sites under PIFRA. The CAS Progress Report also described improvements in the timeliness o f audits, the launch o f an Annual Audit Program, and recruitment of qualified auditors to develop district level auditing capacity. Nevertheless, in several areas progress fell short o f the benchmarks set in the CAS. The CAS targeted extension of PIFRA reforms to the district level which ultimately was delayed as overall PIFRA implementation proved slower than anticipated, with PIFRA reforms extended to 30 o f a planned 56 districts. Full Roll-out o f PIFRA systems to the district level will be completed in the next generation PIFRA I1project which will be approved in FY06. The CAS also set an ambitious target for the public accounts committees to eliminate the backlog o f unreviewed audit reports and remain current in the review of audits under the new government. This could not be achieved as a result of delays in reconstituting the PACs following the October 2002 elections. In procurement, adoption o f new procurement rules did not take place untilJuly 2004 and implementation remains a concern. 23. The CAS identified improvements in tux administration as critical for improving the business climate and enhancing revenue mobilization. The government's two-pronged strategy-approved in November 2002--called for changes in tax policy coupled with tax administrationreform to improve the efficiency o f tax collection. Both the Bank and the Fundprovided advice on tax policy reforms supported through policy lendingand PRGF performance benchmarks. The CAS also targeted Bank support toward the restructuringo f the Central Board o f Revenue over a three-year period. CAS outcomes were keyed to achievement o f key milestones in this process, including organizational changes, adoption o f revised HR policies, and measures to increase transparency. The Bank supported the CBR reform process through both development policy and investment lending. Approval of the reform program was a prior action under SAC I1and the Bank financed preparation o f the detailed reform program, leading to approval o f the Tax Administration Reform project inDecember 2004. Additional support to CBR was also provided under the Public Sector Capacity BuildingTA project. 24. The restructuring program for the Central Board o f Revenue (CBR) progressed well during the CAS, althoughmore slowly than anticipated. A new recruitment policy has been put inplace for key staff inorder to attract specific slulls while incentiveand meritbasedremunerationandpromotionmechanisms have been adopted on a pilot basis. The improved organization structure for tax collection has been piloted in the form of a Large Taxpayers Unit and a Medium Taxpayer Unit and similar pilots are underway in the area o f customs administration and sales tax. Performance indicators including revenue targets and changes in policies are published on a quarterly basis and are also available on the CBR website. While some measures to broaden the tax base were implemented, including the withdrawal of Pakistan: CAS Completion Report Page 7 of 30 tax exemptions and extension o f sales tax to additional categories, a significant widening o f the tax base has yet to be accomplished and the revenue-to-GDP ratio remains low by international standards. 25. Pakistan's devolution initiative i s an integral part o f the GOP's strategy for improving service delivery by making the public sector more accountable to citizens and more efficient at delivering basic services. The Bank supported devolution by providing analytical support focused on areas where the Bank had a comparative advantage; a number o f Pakistan's development partners were also supporting the devolution program. The targeted outcomes related to devolution represented key milestones in implementing the initiative, especially those that affected the ability o f the districts to deliver public services. These included promulgation o f Provincial Finance Commission awards transferring resources to districts, and implementation o f capacity building programs at the district level. Provincial DPLs targeted fiscal reforms designedto increase resources for basic service delivery. 26. A major ESW report on devolution was completed in FY04 which outlined the progress and remaining challenges facing Palustan in implementing its devolution strategy. The provincial development policy credits for NWFP and Sindh (3 o f the planned 6 operations were approved) included prior actions related to enhanced transfers o f resources and responsibilities to district governments through formula-based provincial finance commission awards. Assistance in financial management improvements through P E R 4 and development policy lending also aimed at strengthening local government capacity. By providing performance-based conditional grants to district governments willing to commit to reforms in education, the Punjab Education Sector Adjustment Credits (approved in FY04 and FY05) also served as a means of helping to increase financing for local government delivery o f education. 27. The CAS Progress Report reported that Palustan's progress in implementing devolution was substantial with respect to putting in place the new local government political structure. However local government autonomy, both financial and managerial remains limited. District governments face significant obstacles caused by incomplete administrative and fiscal devolution as well as severe capacity constraints. Insome cases these constraints are exacerbated by political rivalries. 28. Civil Service Reform. The I-PRSP recognized the importance o f improving the quality of the civil service in order to increase the effectiveness o f its poverty reduction programs and set out an agenda of restructuring, recruitment reform, enhanced training, and pay and pensionreform. The CAS outcomes for civil service reform were to (i)strengthen merit recruitment and promotion; (ii) launch pay and pension reforms; (iii) implement a civil service training plan; and (iv) improve the composition o f the workforce which i s highly skewed toward lower grades. The instruments to support civil service reform were the federal and provincial development policy operations which supported recruitment and pay and pension reforms. In addition, the Public Sector Capacity Building (PSCB) TA project i s financing civil service professional development and capacity buildinginkey agencies, ministries, and regulatory bodies. 29. The government has made some progress in implementing these reforms. The Federal and provincial public service commissions (responsible for civil service recruitment) have been strengthened and changes inthe promotion system have been introduced to make evaluations more objective, increase transparency inpromotion, and to linkpromotion to higher grades to required training. Pay reforms were instituted in January 2002 which restored about 75 percent o f the lost purchasing power o f wages (which had not been increased since 1994) and introducedimportant structural reforms inpension and pay scales. Further pay increases were implemented in July 2003 and July 2004 in the form o f interim across-the- board salary increases. This has improved compensation somewhat but the wage structure remains severely compressed. The compression ratio (of top to bottom salaries) i s 1:lO. It was 1:46 inthe 1960's. As a result, the higher echelons o f public servants have significantly lower compensation than comparators, making it difficult to recruit high-caliber staff. Options for further pay reforms designed to Pakistan: CAS Completion Report Page 8 of 30 tighten the link between compensation and responsibility are under discussion as are proposals for structural changes in the civil service. Civil service training i s beingrevamped under the PSCB project, but this process i s still at an early stage. There has been a modest improvement in the ratio of professional to support staff. Taken together, these reforms represent a promising start, but are only the beginningo f the more far reaching reforms needed to address the challenge o f developing a strong civil service inPakistan. Assessrnenfiessons Learned 30. Inretrospect, the mix ofinstruments inthe CAS was appropriate to supportthe reformprogram in this pillar of the CAS. The use o f development policy operation supported both macroeconomic stabilization and a broad array o f structural reforms targeting the key weaknesses in government effectiveness. The government's macro strategy called for rapid fiscal adjustment; sizable external financing on concessional terms was a key ingredient in its debt reduction strategy, allowing it to re- profile high interest debt. Given the severity o f the debt problem, this emphasis was appropriate. Complementary investment lending was used when government reforms had progressed sufficiently and where targeted assistance was needed to reinforce reforms. Investment lending advanced institutional modernization and capacity strengthening, as in the case o f public financial management, (PIFRA) tax administration reform (Tax Administration Reform Project) and government capacity building (Public Sector Capacity Building TA). The use o f a series o f single tranche operations was appropriate to take into account Pakistan's uneven track record and the uncertain political and security environment, enabling the Bank to match its support to the pace o f the reform program - when the pace o f reforms slowed, so didBank financial support. 31. With respect to macroeconomic stabilization, the government reform program, supported by the Bank, the IMF and other donors effectively supported the government reform program and made significant progress with respect to engendering growth. Improvementsunder SAC I1and PRSC Iinclude a continued acceleration in growth, from 3.1% in FYO1/02 to over 8% in FY04/05, and major improvements in the fiscal and current accounts. Fiscal outcomes improved significantly in FY03 and FY04. The fiscal deficit fell from 6.7% o f GDP inFY02 to 4.6% o f GDP inFY03, falling below 5% for the first time in more than 25 years. It fell further to less than 3% o f GDP inFY04 despite continued low levels of revenue mobilization and highlosses by public sector enterprises beforerising to 4.1% inFY05. Palustan's debt service burden has fallen significantly from 34% o f export earnings in 2001/2002 to 25% in 2004/05. With respect to governance, results have been more modest; the government has launched ambitious reforms in tax administration and devolution, but implementation has been slower than expected and the expected results are not likely to be seen until the next CAS. Implementation o f ongoing financial managementreforms was also delayed. 32. Exogenous factors had significant impacts, both positive and negative, on the achievement o f CAS objectives under this pillar. Throughout the CAS period, security concerns were prominent as a result o f events both inside and outside o f Pahstan including the war in Afghanistan and its effects, the war in Iraq, and the confrontation with India in 2002. On the negative side, risk perceptions and increased defense expenditures were a negative factor for the investment climate and fiscal balance, while rising oil prices put significant pressure on the budget and balance o f payments. On the positive side, Pahstan's geopolitical role led to increased grant aid, debt restructuring on highly concessional terms, and expanded textile quotas. The post-9/11 tightening o f money-laundering regulations resulted inlarge- scale repatriation o f holdings abroad and growing remittances, accelerating the accumulation o f reserves. The growing rapprochement with India, beginning in 2003, has greatly reduced tensions and over the longer term holds the prospect for increasedtrade and economic integration. Pakistan: CAS Completion Report Page 9 of 30 33. Pakistan's performance contributed significantly to meeting CAS objectives. As reported in the CAS Progress Report, Palustan's performance in implementingreforms put it in the high case and the macroeconomic turnaround was dramatic. On governance reforms, there were areas where the pace was slow such as in financial management, procurement and civil service reform. In some cases this reflected challenges in implementing a complex modernization and reform program while in others, proposed reforms faced formidable institutional and political obstacles, making the pace o f change foreseen in the CAS too optimistic. STRENGTHENINGTHE ENABLINGINVESTMENTCLIMATE 34. This pillar o fthe CAS was aligned with the I-PRSP which emphasizedthe importance of creating a favorable environment for trade and investment. The PRSP continued this emphasis, outlining measures to deregulate and open additional sectors to private sector activity and competition while increasing public sector investment, for example to address infrastructure bottlenecks. The CAS was designed to support the achievement o f the following objectives: (i)improving the incentive and regulatory regime, (ii) privatization, (iii) financial sector reform, and (iv) accelerating rural growth. CAS performance benchmarks related to adoption o f measures to modernize trade and industrial regulations and enforcement practices; complete selected privatization transactions; undertake reforms inpower, oil, gas and transport; and implement reforms in water management and irrigation. The CAS also targeted improvements in related indicators such as growth in FDI, trade, and private investment, although baselines and specific levels were not targeted. 35. These outcomes were supported through development policy lending at both national and provincial levels as well as investment lending and AAA. SAC I1 and PRSC Isupported actions in privatization, adoption o f trade and regulatory reforms, and reforms inpower, oil and gas. The provincial adjustment credits also set targets for the adoption o f regulatory and other reforms designed to improve the business climate for growth in Sindh and NWFP. Banlung Sector reforms were financed with development policy lending and investment lending including the Banking Sector Restructuring and Privatization project, the Technical Assistance to the Banlung Sector project and the Banlung Sector Development Policy Credit. In infrastructure, the Ghazi Barotha Hydropower project and the Telecommunications Regulation and Privatization Support Project were completed and closed duringthe CAS period while the National Highways Rehabilitation project was approved in FY04. AAA support included an Investment Climate Assessment and the Doing Business surveys, as well as policy dialogue and IDF support to the Committee on Reforms in RegulatoryLegal and Policy Environment. A Financial Sector Assessment Program (FSAP) report was prepared in FY04. In trade, the Trade and Transport FacilitationProject (FYO1) was completed while trade policy notes were prepared inFY04 and FY05. 36. With respect to rural growth, the CAS strategy was to target next generation reforms to address the unequal opportunity and capacity to access assets and markets - land, water, credit, technology and output markets. The instruments to support these reforms included both lending and AAA. Lending in water and irrigation consisted o f the National Drainage Program project (FY98-05) and On Farm Water Management projects inNWFP (FYO1) and Sindh (FY04). PRSC Ialso supported agriculture and water sector reforms including further liberalization o f wheat and sugar markets and further development of national water and drainage policies. Ongoing policy dialogue was supplemented by ESW reports on Rural Factor Markets and a Water CAS. The Public Expenditure Review also dealt extensively with irrigation and water issues. A planned Rural Development Policy Review originally planned for FY03 i s now plannedinFY06. Pakistan: CAS Completion Report Page I O of 30 Incentive and Regulatory Environment 37. The Government implemented a range o f measures to improve the incentive and regulatory environment. A number o f laws and regulations governing industrial relations were consolidated and promulgated in the Industrial Relation Ordinance 2002. In addition, the h g Act 1976, long considered to be a deterrent to the healthy development o f a pharmaceutical industry, was revised with input from stakeholders and promulgated as the Drugs Ordinance 2002. Additional reform o f laws concerning industrial relations and labor protection i s also proceeding and revised legislation i s expected to be presented in 2006 including: (i) Amendment to Industrial Relations Ordinance 2002; (ii) Conditions of Employment Act; (iii)Wages Act; (iv) Occupational Safety and Health Act; (v) Human Resource Development & Control of Employment Act; and (vi) Labor Welfare and Social Security Act. Reforms to business registration procedures were undertaken in 2002 cutting the time for business start-up by more than half, from 53 to 22 days while provincial authorities in Sindh and NWFP reformed factory and business inspections to reduce harassment. 38. In trade, the CAS targeted increased exports, lower levels o f effective protection and improved trade facilitation. Pakistan i s one o f the more open countries in South Asia. The maximum tariff rate i s 25% and the number o f tariff bands i s four. The Government has eliminated quantitative restrictions, regulatory duties, para-tariffs, and several other measures that restricted trade in the past (with the exception o f trade with India). Duringthe CAS period, the government sustained the momentum o f tariff reductions and weighted average tariffs continued to decrease from 14.2% to 13.4%. Agriculture has the lowest tariff rates inthe region (13.1 %, down from 13.9% last year). Inthe FY05 budget, duties on cars were reduced from the range o f 75%-150% to 50%-100%. The Trade and Transport Facilitation Project was completed satisfactorily in 2005, having contributed toward bringing Palustan's traditional trade and transport practices inline with international best practices. 39. Financial Sector Reforms. The FSAP conducted in FY04 concluded that banlung sector reforms have been effectively implemented and have significantly improved the soundness and efficiency o f the financial systemby reducing state interventionand improving the environment for banking. Privatization of large state-owned banks during the CAS period (Habib Bank and United Bank Limited) substantially changed the structure o f the banhng sector and nearly 80 percent o f sector assets are now controlled by private banks as compared with 34 percent in 1999, and just 8 percent in 1990. As a result access to finance has improved and credit to the private sector has witnessed significant growth during the past three years. Last year alone private sector credit showed an increase o f over 30 percent. A large part o f the success o f the reforms stems from the improved legal and regulatory framework and enhanced corporate governance as a result o fthe reducedrole o f the government and the enhancedrole and capacity of the regulators, especially the State Bank o f Pakistan which i s being supported through the Banlung Sector TA loan (FY03). Profitability and liquidity indicators for the commercial banks have shown a marked improvement. The banking sector has also become considerably more competitive and responsive. Efforts by the SBP are also underway to further strengthen the payment system to enhance its transparency and efficiency. 40. Power Sector Reforms. The CAS made improvement in the Performance o f the state-owned power sector a major focus. In part this reflected recognition that Palustan needed expanded, more reliable supplies o f power at reasonable costs to support its growth objectives. At the same the sector's considerable drain on the budget was seen as a threat to successful fiscal adjustment. Incoordinationwith the FundPRGF program, SAC I1supported sector reforms and set targets under a financial improvement plan. However, progress in impro&g the financial performance o f the main power utilities, WAPDA and KESC, fell short o f expectations. The financial improvement plan agreed under SAC I1was not fully implemented as the tariff increase approved was smaller than forecast and electricity rates were subsequently reduced despite continued high losses. Moreover, little progress was made in reducing Pakistan: CAS Completion Report Page 11 of 30 public sector arrears and technical losses. Nevertheless, the program achieved a number o f positive steps, particularly in laying the groundwork for the corporatization and eventual privatization o f the sector. In addition, a top priority-the privatization o f KESC-has moved ahead with successful biddingin January o f 2005. 41. Reforms in infrastructure. The I-PRSP and PRSP identified telecommunications reform as a key element o f the reform program because o f its linkages to other sectors. Progress in reforms has been strong, emphasizing enhanced competition within a supportive regulatory framework. InJanuary o f 2004, Pakistan de-regulated the sector, allowing free entry o f new fixed-line private operators to compete with the state-owned Pakistan Telecommunications Company Limited (PTCL). PTCL was privatized in 2005. A new mobile telephone policy was also been approved to introduce further competition and additional cell phone licenses have been issued under a competitive biddingprocess. 42. Progress in implementation of the reform agenda in oil and gas was mixed as the Government's success in privatizing state-owned assets, increasing supplies, and improving regulation was offset by inability to adjust consumer prices as foreseen in the CAS. InFY05 the Government temporarily suspended its policy o f automatic fortnightly petroleum price adjustments based on global oil prices, a setback which had a significant cost to the budget. Even though overall gas tariff collections met policy goals, implementation o f the six-monthly gas price adjustment mechanism was also inconsistent and the government did not make progress in rationalizing the abnormally low gas tariffs maintained for the fertilizer industry. Accelerating Rural Growth 43. There was only incremental progress in achievingthe CAS outcomes targeted inthis area, namely improved land and water markets and improved efficiency o f institutions in irrigation and drainage. Moreover, agncultural growth has been disappointing, averaging 1.7 percent per annum during the last seven years, though this i s in large part attributable to drought; with favorable weather conditions, FY05 agrlcultural growth rebounded strongly, reaching 7.5%. The National Drainage Program (NDP) was the centerpiece o f Bank projects to support implementation o f institutional reforms in water, including decentralization and management transfer of irrigation and drainage systems inthe Provinces. The NWPF On-Farm Water Management project (approved in FYO1) and the Sindh On-Farm Water Management project (approved in FY04) also targeted enhanced water management and agricultural productivity through improved governance and investment in secondary and tertiary irrigation infrastructure. Implementation o f the Sindh On-Farm Water Management project i s in its earliest stages, progress in implementation o f the NWFP On-Farm Water Management project has been slow. 44. Relative to its stated objectives and program targets the achievements o f NDP were disappointing and its overall performance unsatisfactory, although there i s now much greater ownership for its reform objectives. Notwithstanding its overall unsatisfactory rating, the project yielded several positive outcomes. Firstit helpedclear the backlog o f deferred maintenance o f the existingirrigation and drainage system. Second although the institutional reform component has had mixed performance, the need, strategy, and decision to carry out the reforms have been endorsed at the highest levels o f the GOP and Provinces. Third it was instrumental in the completion o f key policy and sector studies that have paved the way for introduction o f a National Water Policy and a drainage sector strategy for the country. Fourth the project improved the knowledge base by financing research, learning and international advice. Fifth, the project organized 223 farmer organizations covering an area o f approximately 2 million hectares in which farmers are now responsible for the operation and maintenance o f the irrigation system. Finally the project provided the studies, technical discussions, and the general forum for the discussion o f long-term options for the sustainable development of the Indus river basin and as a consequence has raised awareness o f the importance o f sound environmentalplanning and management. Pakistan: CAS Completion Report Page 12 of 30 AssessmenULessonsLearned 45. The mix o f lending and non-lending activities for this pillar o f the CAS was satisfactory and contributed to the achievement o f some o f the outcomes sought. Policy dialogue and AAA were successful in helping the government to refine and articulate its reform vision and contributed to the adoption o f a variety o f measures. Inparticular, the use o f development policy lending was well suited to supporting the very wide range o f reforms that the Government o f Pakistan was trying to implement. Developmentpolicy lending also provided financial incentives to undertake reforms and helpedreformers advance their agenda within Palustan. In areas where results fell short o f expectations as in the power sector and in irrigation, the reforms sought were perhaps overly ambitious and resistance to adopting them was underestimated. An additional challenge, relevant to the water sector, was the difficulty in implementing a national level program in an area o f provincial responsibility and where the provinces have adopted alternative approaches. 46. However, as noted by IEG with respect to the FY94-03 period, the range o f activities in the rural sector could have been broader. The Bank's agenda for rural growth was limited mainly to policy dialogue on removing distortions in pricing trade and taxes (most o f which had been removed by 2002) and work on reforming the irrigation system. Consequently there was a lack o f strategic focus on agriculture and therefore key constraints to agricultural growth were not addressed. 47. Exogenous factors played an important role in determining CAS outcomes. Drought conditions which prevailed during 2000-2002 reduced agncultural output while significantly worsening the financial situation o f the power sector due to the need to import oil to make up for diminished hydropower availability. The rapid run-up in oil prices in 2004 clearly made it difficult for the government to continue to implement the oil pricing policy as originally envisioned. 48. Borrower performance in the Investment Climate pillar was generally satisfactory with a few exceptions. The Government's reform program was highquality and had the attention and support o f the President, Prime Minister (once in place) and Finance Minister. Significant achievements were made in implementing reforms-particularly in the financial sector-and their impact in terms o f increased exports and investment i s now apparent. However, it i s likely that these early results are in large part the result o f the macroeconomic turnaround rather structural reforms. Further, second generation reforms, will beneeded to maintainhigher rates o f growth and investment. 49. Insome areas the pace ofreform didnot matchthe timelines envisioned inthe CAS. This was principally due to an overall slowdown following the elections o f 2002 and the lengthy transition thereafter. There were also delays inimplementinginvestment projects, for example NDP. Insome areas, particularly energy pricing, the Government found itself unable to carry out pricing measures that turned out to be more politically difficult than anticipated. In addition, some of the assumptions behind the government's reformprogram (for example with respect to reducing technical losses in the power sector) proved unrealistic. Nevertheless, in view o f the accomplishments, the summary judgment i s that borrower performance was satisfactory. SUPPORTINGPRO-POORAND PRO-GENDEREQUITY POLICIES 50. This pillar o f the CAS reflected two elements o f the I-PRSP and later the PRSP: (i) investingin human capital, and (ii) targeting the poor and the vulnerable. Recognizing the urgency o f addressing the challenge posed by Palstan's lagging social indicators, the I-PRSP outlined a strategy for improving delivery o f health and education services through a combination o f additional expenditure and improved governance to increase the effectiveness o f social sector spending. The PRSP maintained this emphasis, Pakistan: CAS Completion Report Page 13 of 30 noting that without considerable improvement in social indicators, including for women, Pakistan will be unable to sustain growth and poverty reduction. Since health and education are primarily sub-national concerns, with the bulk o f expenditure taking place at lower levels o f government, the GoP's devolution strategy represented the core policy action to address weaknesses in governance and improve the effectiveness o f spending. At the same time, the provincial governments implemented other measures to strengthen management while scaling up promising approaches inhealth and education. 51. The Bank's strategy inEducation was to support implementationofthe Government's Education Sector Reform (ESR) program which was designed to improve access to and quality o f education through investments in: (i) infrastructure; (ii)curriculum and textbook revision; (iii)teacher training; and (iv) establishment o f a national education assessment system. The CAS aimed at a few intermediate outcomes including meeting the I-PRSP targets for increased expenditure on education, successful transition to distnct based delivery o f education, and launching o f the National Education Assessment System (NEAS), a sample-based national assessment o f student learning, with standardized tests conducted at grades 4 and 8. The CAS indicated that these intermediate outcomes were intended to move Pakistan toward the MDG goal o f universal primary education by 2015 with a goal o f reducing the gender gaps in primary and secondary education by 2005. The latter goal was not met and no intermediate target was set for primary education outcomes. 52. The Bank program targeted both the federal and provincial governments recognizing their respective roles and responsibilities. At the federal level, engagement focused on supporting increased education expenditure in line with the I-PRSP and launching o f the NEAS. Initially, the broad-based provincial DPLs in NWFP and Sindh were key instruments to support the provinces' education reform programs by opening up fiscal space at the provincial level to increase financing while supporting the implementation o f reforms. However, the CAS also envisioned a more targeted instrument in the form o f sector adjustment lending. This took the form o f the Punjab Education Reform DPC, the first in a series o f one-tranche education DPCs which was delivered in FY04 and which also supported devolution by strengthening incentives for improved service delivery at the local government level. A second credit was approved in FY05. The Northern Education project (approved in FY98) closed in FY04. The AAA program in support o f education included a study o f public and private partnerships in education and an MDGassessment, outlining the critical constraints and strategies for achievingthe MDGsinPalustan. 53. The CAS outcomes targeted for education were partly achieved. Financing for education has increased in line with I-PRSP targets with consolidated federal and provincial education spending rising from 1.5 percent o f GDP inFY2001/02 to 1.8 percent of GDP inFY2003/04. The FY05 education sector allocations in the budget are consistent with the PRSP targets at 2.1% o f GDP. The NEAS initiative was launched with Bank support in the form of a TA loan approved in FY03 and pilot testing o f Grade 4 students in Language and Mathematics was conducted throughout the country in April 2004, although overall the NEAS project i s behindschedule. 54. At the provincial level, reforms have moved forward at different speeds inthe various provinces. In Sindh and NWFP a variety of education initiatives were supported through the provincial DPCs. Despite delays in follow-on rounds o f these loans, budget allocations for education have been increased, additional teachers recruited, facilities rationalized and enrolments have increased. InPunjab, most targets under the education reformprogramhave been exceeded. Education spending inFY04 was inline with program targets and the FY05 budget projects a further 15% increase. Free textbooks were distributed on time to 90% o f primary school students and approximately 175,000 girls have received regular installment o f monthly stipends to encourage retention and to increase enrolments in elementary grades. Preliminary school census data suggests significant increases in enrollments during the first year o f the program. Pakistan: CAS Completion Report Page 14 of 30 55. Pakistan continues to make progress in improving key health andpopulation outcomes, but the pace o f progress has been slow. The health status o f Pakistan's population remains well below countries inthe region with similar or lower levels ofincome. The fertility rate remains much higher than its South Asian neighbors and a serious impediment to sustained economic growth. The PRSP recognizes the need to further increase financing and enhance the efficiency o f spending and calls for the doubling o f resources for the health sector over the next three years. The Government's priorities in health are to strengthen public health programs-immunization, communicable diseases, maternal and child health and family planning-while improving the quality o f care at district and sub-district hospitals. 56. The CAS outcomes related to health included strengthening o f key public health programs including Lady Health Workers, tuberculosis control, the Expanded Program o f Immunization, polio eradication, malaria control, HIVIAIDS, and family planning and reproductive health. Inline with the I-PRSP, increased expenditure on health was targeted along with an increased share o f non-salary expenditures. Indicators to measure improved service delivery included increases in the percent o f births attended by trained providers, access to Lady Health Workers, coverage o f pre-natal care, contraceptive prevalence, and immunization coverage. Country outcome indicators for reductions in infant and child mortality and total fertility were drawn from the I-PRSP. 57. The Bank's strategy in health was to support reforms in health through a combination o f development policy and investment lending as well as AAA. Both SAC I1and PRSC Iincluded actions related to increasing expenditure on health while implementing reforms to increase the effectiveness o f spending, including expanding service delivery through NGOs and developing demand side interventions, Similarly, the provincial DPLs in Sindh and NWFP targeted increased health spending and improved management o f health care facilities. An HIV/AIDS project was approved in FY03. Under an innovative partnership with the Gates Foundation, an IDA credit o f $20 million was approved in FY03 to finance polio vaccine procurement for use in subsequent rounds o f vaccination aimed at eradicating polio in Pakrstan by 2005. Supplemental funding o f $21 million was approved in FY05. AAA instruments included the MDG Assessment and a report on the public health surveillance system to assist in the development and implementation o f a Public Health Surveillance and Response System. 58. The CAS outcomes targeted in the area o f health were only partly achieved. Public health expenditures have increased, but not as rapidly as foreseen in the PRSP. Consolidated health expenditures have increased by 18% from Rs 22.4 billion inFY03 to 26.6 billion in FY04.However, as a percentage o f GDP expenditures (using old GDP numbers) are estimated to have increased from 0.56% in FY03 to 0.59% in FY04, well short o f the target o f at least 0.7% o f the GDP set in the PRSP. Strengthening o f the immunization program for children has been launched and immunization coverage for children has increased from 49 percent in (1998/99) to 77 percent in (2004/05). Good progress was made towards polio eradication through supplemental immunization campaigns with the number o f polio cases decreasing from 119 in 2001 to 53 in 2004. In 2005, only nineteen cases were reported through September. Pakistan has made significant progress in expanding TB DOTS program to 93% o f the population with treatment success rate o f 78%. However, the TB case detection rate i s only 43%, indicating the need for enhancing demand for services. The Lady Health Workers (LHW) Program has been expanded to 92,000 LHWs, covering 56% o f the population against a target o f 70% mainly in rural areas. It i s apparent that the program i s having an effect on some important indicators but there i s still significant room for improvement in many important areas, such as immunization and family planning. The national HIViAIDS control program was launched in 2004. The Government has started to contract NGO to provide services to vulnerable populations; however the processhas experienced delay. 59. Pro-Poor TargetedPrograms. Targeting the poor and the vulnerable was an integral pillar o f the I-PRSP and remains so inthe full PRSP. The government's strategy was based primarily on expansion o f safety net programs such as microfinance, public works programs, and transfer programs like Zakat and Pakistan: CAS Completion Report Page 15 of 30 food support. The PRSP recognized the need to improve the targeting and delivery o f these cash and in-kmdbenefit and other poverty alleviation programs in order to increase their coverage and reduce the leakage o f benefits. The CAS also aimed to bring about strengthened governance and improved delivery of basic infrastructure services at the local level along with a deepening o f the rural asset base. N o specific indicators were identified for assessingprogress inachieving these outcomes. 60. The CAS focused the Bank's role in this area toward a strategy o f directly targeting rural poverty through rural community-based infrastructure projects and micro-credit, building on approaches which had been introduced in the previous CAS. At the same time, SAC I1and PRSC Isupported measures to scale up and strengthen existing safety net programs. The NWFP Community InfrastructureProject was underway at the time the CAS was prepared and a follow-on project was approved in FY04. The AJK Community Infrastructure Project (CIP) was approved in early FY03. Similarly, the Palustan Poverty Alleviation Fund project was underway and a $238 million credit was approved in FY04 to extend additional support to this highly successful project which supports NGO-implemented infrastructure and micro-credit schemes. To help the government develop a strategy for strengthening safety net programs, the Bank prepared a detailed study o f existing programs proposing reforms to improve their effectiveness and targeting, as well as enhancing the monitoring and evaluation o fprograms. 61. The outcomes inthis area o fthe CAS are being achieved, though in some cases more slowly than anticipated. To date, the PPAF has surpassed most project targets and its poverty reduction programs have helped more than 2 million poor in all four provinces, extending loans to 122 thousand clients with an estimated average recovery rate o f around 95 percent. Implementation o f CIP projects has progressed somewhat more slowly than planned. The government has formed a Social Protection Worlung Group to discuss the progress o f the work on social safety net reform inPalustan. 62. The Bank assistance program inthis pillar o fthe CAS reflected the trade-offs inherent intrying to improve delivery o f social services in Palustan in the context o f devolution. The use o f development policy lending was appropriate as a means to support the needed fiscal, policy and systemic changes. However responsibility for implementation rested with local governments having limited capacity and thus broad based federal and provincial development policy lending was less effective in supporting sector reforms. The more focused approach o f using a sector DPC as in Punjab seems to have been more effective than the broader approach taken with the Sindh and NWFP SACs, although other factors, including an extraordinary degree o f high-level commitment and ownership were also at work. In retrospect, greater use o f TA to complement development policy lending might have been useful to help the authorities, especially at the provincial and local level to implement and monitor reforms adopted under the SACs. More in-depth analytical work at the provincial level might also have been helpful to strengthen the provincial reform programs. With completion o f the Punjab Economic Report in FY04, and initiation o f Economic Reports for Sindh and NWFP inFY05, this need i s now being addressed. 63. Borrower performance under this pillar o f the CAS was hampered by shiftingresponsibilities and capacity constraints. Specifically, provincial governments need to strengthen their policy formulation capabilities to ensure that well crafted departmental policy proposals, together with their financial implications are submitted for cabinet review and discussion during budget formulation. Similarly, the ongoing transition to district based service delivery has been accompanied by some hiccups such as delayed release o f funds to districts. Some investment projects including HIV/AIDS, NEAS, and community infrastructure projects have experienced slow or delayed implementation. SUMMARY ASSESSMENT OF CASPERFORMANCE 64. During the FY03-05 period, the Bank program in Pakistan was for the most part successful in either achieving or making substantial progress toward the achievement o f the outcomes set in the CAS. Pakistan: CAS Completion Report Page 16 of 30 As described above and in summary table in Annex 1, many of the intermediate outcomes representing milestones in implementation of the reform program were met. While a number o f outcomes were not met, the underlying reform programs are inplace and government commitment appears strong, even ifthe pace o f reform has not been as rapid as envisioned inthe CAS. To the extent that data i s available, final outcome indicators show some promising trends toward improvement. 65. Sustainability. The sustainability o f the CAS outcomes i s likely, although Palstan's longer-term track record as an intermittent reformer suggests that this cannot be taken for granted. The CAS i s well aligned with Palustan's own reform agenda and continued commitment to the reform program appears likely. President's Musharraf s tenure in office will continue until at least 2007. The Prime Minister, Mr. Aziz, i s a strong reformer. There is a high level o f support from the international community. Despite occasional slowdowns, the government has shown the ability to sustain reforms in the face o f significant challenges and political pressures. 66. Institutional impact. Bank assistance under the 2002 CAS has contributed to institutional development but this i s an area where additional attention i s needed. Key government institutions were targeted for modernization including the Central Board o f Revenue, State Bank o f Pakistan, Controller General, Auditor General, regulatory bodies, and key economic ministries. Capacity building assistance has been provided through investment lending and most have demonstrated improved performance. However, as observed in the CAE, institutional capacity i s a widespread concern. Recognizing that institutional development and capacity buildingrepresent a cross-cutting challenge for Pakistan, a Public Sector Capacity Building Project was developed and approved in FY04 to support institutional development and capacity buildinginkey ministries and regulatorybodies. C. MeasuringBankPerformance Quality of Products and Services 67. IEG's FY03-05 performance ratings for Pakistan show that o f the eleven projects that exited during the CAS period which were reviewed by IEG, one had a highly satisfactory outcome, four had satisfactory outcomes, three had moderately satisfactory outcomes, two had moderately unsatisfactory outcomes and one was rated unsatisfactory (see Table 3, page 20). The latter project, the highly ambitious Social Action Program project, approved in FY1998, was the subject o f an intensive learning Implementation Completion Report (ICR) which identified key lessons which are being used to guide the formulation o f future Bank interventions in the social sector^.^ A QAG panel carried out a Quality at Entry Assessment for the FY03 Sindh Structural Adjustment Credit. The panel rated the operation satisfactory overall, citing specific aspects as highly satisfactory including implementation arrangements, the degree o f borrower ownership during preparation, and the quality o f the Task Team. The panel also gave a rating o f Satisfactory for Bank inputs and processes 68. Inearly FY04, the Quality Assurance Group (QAG)carried out a Country AAA Assessment for Pakistan. The report assessed the quality o f a sample o f AAA products from FYO1-03 as well as the overall AAA program within the context o f the strategic framework. While part o f the sample related to work undertaken prior to the FY03-05 CAS, several FY03 tasks were evaluated and the overall conclusions are applicable to this completion report. Overall, QAG found the Palustan AAA program to be satisfactory. O f the sample reviewed, four tasks were completed duringthe CAS period and o f these two were rated highly satisfactory and two were rated satisfactory. However, QAG also noted the strong emphasis o f the program on macroeconomic management and recommended further work on other, growth-related, sectors including rural development, trade, and infrastructure as well as more attention to Implementation Completion Report, Second Social Action Program Project, ReportNo: 26216, June 25,2003. Pakistan: CAS Completion Report Page 17 of 30 the sub-national level. QAG also found that greater attention is needed in the areas of dialogue and dissemination inorder to increase the impact o fthe AAA program. 69. Portfolio Performance. The World Bank's active portfolio in Pakistan, on June 30, 2005, comprised 16 projects with loansicredits amounting to $990 million (net o f cancellation). Also included in the portfolio are two Grant projects-GEF- Protected Areas Management ($10 million); and the Montreal Protocol Phase-Out o f Ozone Depleting Substances ($13 million). About $561 million remained undisbursed. The disbursement ratio remained well above the target o f 18 percent throughout the CAS period (see Table 2).4 Actual Performance Indicator FY02 FY03 FY04 FY05 Number o f Projects 12 15 18 16 Projects at Risk (%) 8.3 6.7 5.6 11.8 Commitmentsat Risk (%) 0.0 23.2 19.6 6.5 Realism(%) 100.0 100.0 100.0 100.0 Proactivity (%) 100.0 100.0 100.0 100.0 DisbursementRatio 67.1 28.0 24.7 40.6 70. Portfolio Management. The portfolio has grown somewhat over the CAS period after reaching a low at the end o f FY 02 (the beginning o f the CAS). The earlier reduction reflected the results o f an aggressive portfolio improvement program under which 32 projects were closed. This trend has since been reversed as lending has picked up although the substantial proportion o f single tranche development policy credits in the program (about one-third o f the operations approved during the CAS period) has meant that the size o f the portfolio has grown only modestly. Portfolio management has continued to emphasize good "quality at entry" and close collaboration with the Government o f Pakistan to ensure project readiness and adequate management attention to emerging issues. To avoid delays inproject start- up, newprojects havebeen subjectedto close scrutiny to ensure that they exhibit strong client ownership and are ready for implementation prior to approval. Over the past three years, 100 percent pro-activity has been maintained. This process has been facilitated by country office leadership o f project teams (50 percent o f projects inthe active portfolio are managed inthe country office) and decentralization o f many o f the regional core services functions to Pakistan and regional hubs inthe South Asia region. 71. Despite these efforts, a number o f portfolio issues have begun to reemerge. Several projects in the current portfolio are slow moving and facing implementation issues; most o f these relate to: (a) delayed project start-up, which has often led to slower progress subsequently during implementation; and (b) weak capacity to effectively implement projects according to agreed plans. Besides project specific implementation issues, key generic factors contributing to slow implementation include lack o f adequate staff and funds for start-up activities, delays in obtaining routine clearances for loan negotiatiodsigning as well as opening o f accounts, and delays ininitiating the procurement process. These issues are being addressed intensively with the GoP in order to prevent a deterioration in portfolio performance. As it relates to Bank performance, these findings indicate that there i s room for improvement on the part o f Bank teams in developing simpler, more readily "implementable" projects with realistic timetables that reflect the time consuming nature o f institutional reforms and decentralized approaches. Disbursementratio represents disbursementsas apercentageofundisbursedbalances at the beginning of the fiscal year, for investment lending only. Pakistan: CAS Completion Report Page 18 of 30 72. There i s also a need to improve the results focus o fthe portfolio. The Bank recently undertookan Monitoring and Evaluation (M&E) Review o f (i) its on-going portfolio; and (ii)Government systems for project M&E. The report found that due to weak M&E systems and inadequate capacity within GoP and implementing agencies, there i s limited focus on monitoring o f outcomes and results inmany projects. At the same time, Bank teams need to do a better job of focusing on developing project-level results and indicators and incorporating the monitoring o f these results into the supervision process. Country Dialogue and Aid Coordination 73. The Government has taken the lead in donor coordination under the leadership o f the Economic Affairs Division (EAD), under the Ministry o f Finance, which i s responsible for development assistance coordination. Donor meetings resumed in 2001 and the Palustan Development Forum (PDF) has been held on an annual basis since then, with all but one meetingtalung place inIslamabad. Civil society and private sector representatives have participated in the PDF. The Bank's strategy has been to play a facilitating role in the government-led coordination process by supporting the PDF and actively sharing information and facilitating partnerships among donors and the GoP. 74. These efforts have been paying off as external partners have been increasingly aligning their strategies to the PRSP and making greater use o f cooperative approaches in their assistance programs. For example, the UK and the U S have begun to align their budget support with the Bank's PRSCs. In addition, the Bank has undertaken more joint analytical work in partnership with the Government and other donors. In 2003 the World Bank, DFID, and ADB completed jointly a CFAA. Two economic reports-- the Devolution in Pakistan (District Assessment) Report and the Punjab Economic Report-- were prepared as joint products o f the World Bank, ADB, and DFID. The upcoming NWFP Economic Report i s being prepared in collaboration with DFID and the Sindh Economic Report i s being prepared in collaboration with the ADB. Nevertheless, IEG found that a number o f donors expressed dissatisfaction with their interactions with the Bank. Among issues raised were inadequate consultation; lack o f continuity o f Bank staff interacting with donors; intermittent participation o f senior staff at donor meetings; and poor information flow to donors andNGOs. 75. There are now strong efforts to harmonize with country systems, with a large percentage o f development assistance disbursed as budget support once a year following the approval o f the national budget. There have been efforts to improve the procurement and financial management systems o f some line ministries and at the provincial level. A comparison between the World Bank`s and ADB procurement rules was undertaken in 2004 as part o f the harmonization exercise and as a result, harmonized procurement documents are available for use. A similar exercise i s underway in the area o f financial management. Inaddition, external partners have agreed to put together a joint "Portfolio Issues Paper" focused on key generic portfolio management issues faced by externally financed projects, for discussion with the Government. D. Key Lessons for the Next CAS 76. Based on the preceding analysis and the 1994-2003 CAE, the following are the key lessons learned and recommendations for the next CAS. Projects should be as simple and realistic as possible. The experience o f a number o f projects that closed during the CAS, especially the multi-province umbrella projects, highlights the need for focused projects that are readily "implement-able" with realistic schedules and clear ownership. Inparticular, governance reforms often took longer than planned. Inthe context o f development policy lending, there i s a need to guard against over-optimism as the difficulty o f Pakistan: CAS Completion Report Page 19 of 30 implementing reforms, especially those with wide impact and high visibility was at times underestimated. The CASprogram should give greater emphasis to capacity building. The CAE and a number o f ICRs completed during the CAS identify weak implementation capacity as a critical constraint, especially at the local government level. This will require more TA in the program and in projects, buildingon the Public Sector Capacity BuildingProject approved inFY04.Civil service reform and institution building should continue to receive attention. Projects will also have to be designed to take capacity constraints into account, being realistic about both the scope and pace of implementation giventhose constraints. A programmatic approach provides theflexibility to support reforms while managing risk. The use of annual single tranche adjustment operations at boththe provincial and national level helped to support reforms while providing a mechanism to adjust the lending program to match the pace of reforms. This approach strengthened the link between borrower performance and the Bank lending program. Theprogram needs to continue to strengthen itsfocus on results. To address weak M&E systems and capacity within GoP and implementing agencies, the Bank needs to support the strengthening of statistical capacity and monitoring and evaluation as part o f institution strengthening. At the same time, the Bank needs to do a better job o f focusing on developing solid project-level results and indicators and incorporatingthe monitoring o f these results into the supervision process. The results-based CAS offers an opportunity to identify and focus on key strategic outcomes at the country level and provide a framework for joint monitoring and evaluation o f the overall country program with the Government. * -0 u 4 -1 4 2Y Y 3 d I A A A A A A E c 2 ,n e 0 e e e e e /E U c m - - A A a a a A e e e e 0 c 0 c 0 A A I . .-* { V B . .-A a, m UJ A A A A A A A -E d aw c z L a c 5 v, ._ c 0 .-c F - c m ca, 3 > m D .- h g! ._ 9 cG c 0 YD E a a a a a a a a m U a, 3 r Q 3 .-m -sc n a, c a, G9 m c E Y ._u, L E m rN m U9 - A a a a a a a a a a 58 d m L 0 m a e M YU d 0 + L + cd * m a r% a I A A A A A A I 0 s 0 In I 0 73 m 8 ._ S LI In m W Is) E 9 8 m 0 0 N e! ._ S z Q - m --% 0 p c m s 2 m m N m F .. c a, ae! .-m E d 1 9 3 c 0 .-W c E c a, In 8 c 8 J m A x0 z 2 Q p 4 p B - m 1 % --% Bm 0 E 0E s 8 8 E A A A A A A A A A A A A a a a a Pakistan: CAS Completion Report Page 29 of 30 Annex B:Pakistan-PlannedLendingProgramand Actual Deliveries CAS PIans (May 15,2002) ProgressReport (March 26,2004) Status $(M) -FY Project 1 IBRD IDA 2002 Drought EmergencyRecoverye 130.0 Actual I] 130.0 Banking Sector RestructuringiPrivatization 300.0 Actual 300.0 AJK Community Infrastructure Forwardedto 2003 Banking Sector TA Forwardedto 2003 Structural Adjustment Credit I1 500.0 Actual 500.0 Sindh Structural Adjustment Credit (SAC) 100.0 Forwardedto 2003 - Total 947.0 Total 800.0 2003 AJK Community Infrastructure Banking Sector TA 26.5 Sindh SAC 100.0 NWFP Provincial Adjustment Credit 90 Actual 90.0 Highways Rehabilitation 100 Forwardedto 2004 (now actual) HIViAIDS Prevention 20 Actual 37.1 National Education Assessment System 5 Actual 3.6 Education Reform SAC 150 Forwarded to 2004f Tax Administration Reform 100 Forwarded to 2005 Provincial Adjustment Credits (Sindh, 110 NWFP forwarded to 2004 (now actual); NWFP) & Sindh dropped Economic ReformTA 25 Additional Actual Proiects: I I Partnershipfor Polio Eradication 20.0 - Total 600.0 Total 11297.2 Progress Report (March 26,20 I) Completion Report %(L $ 1 L -FY Project IBRD I D A Status IBRD I D A 2004 Poverty Alleviation FundI1 238.0 Actual 238.0 Highways Rehabilitation 50.0 150.0 Actual 50.0 150.0 Punjab Education Sector Reforms 100.0 Actual 100.0 Public Sector CapacityBuilding TA 52.0 Actual 55.0 SindhOnFarmWater Management 61.0 Actual 61.1 NWFP Community Basic Infrastructure 37.0 Actual 37.1 Poverty ReductionSupport Credit 350.0 Forwarded to 2005 Additional Actual Projects NWFP SAC I1 90.0 - Total 50.0 988.0 Total 50.0 731.2 I 2005 PRSC I 300.0 Improving FinancialReportingand 80.0 Forwarded to 2006 Auditing Tax Administration Reform 100.0 Actual 24.4 78.5 Balochistan Irrigation 25.0 Forwarded to 2006 Infrastructure Development 100.0 Actual (Changed to Taunsa Barrage 130.0 Rehabilitation) Banking Sector Adjustment Credit 175.0 Actual 200.0 100.0 Poverty Reduction Support Credit 175.0 Forwarded to 2006 NWFP SAC I1 90.0 Approved in2004 Additional Actual Projects Partnershipfor Polio EradicationI1 21.5 Punjab Education Development I1 100.0 I Total 100.0 645.0 Total I 354.4 600.0 eReallocation from already committed IDA resources- not counted as new commitments, Project changedto Punjab Education SAC Pakistan: CAS Completion Report Page 30 of 30 Annex C:Pakistan -Non-Lending Services: Planned and Actual Deliveries (FY03-05) F03-05 CAS Plans Status: CAS Progress Report ?Y Product Status '003 [nvestment Climate Zompleted ProvincialEconomic Reform ;orwarded to FY04-06 Policy Note to New Government Zompleted JSA - PRSP Zompleted =FAA I1 Zompleted ZPAR I1 3ropped Dil & Gas Sector Review Zompleted Financial Sector Assessment ?orwardedto FY04 CAS Progress Report Forwarded to FY04 Public Expenditure Review Zompleted Rural DevelopmentPolicy Review Forwarded to FY06 Power Sector Review Forwarded to FY05 SindhRuralDevelopment Policy Review Dropped Social RiskAssessment Dropped ddditional Actual ProL,..cts: FY04-05 CASProgress Report ~ ZOO4 District AssessmentDevolution Completed Punjab Economic Report Completed Poverty Update Completed Trade Policy Notes Completed Rural Factor Markets Completed Power Policy Notes Completed Textile & Clothing Policy Note Completed Financial Sector Assessment Completed Urban Development Non-Lending TA Forwardedto FY06 Mineral Sector Development Ongoing 2005 Water Sector Strategy Completed NWFP Economic Report Completed Country Gender Assessment Completed Public-Private Partnership inEducation Forwarded to FY07 PakistanMDGAssessment Ongoing JSA - PRSP Progress Report Completed Labor Market Policy Note Forwarded to FY06 Social Protection NLTA Changed to Repoflorwardedto FY06 Pakistan-India Trade Study Dropped Sindh Economic Report Forwarded to FY06 Agriculture OutDut Market Dropped Page f of16 ANNEX111: PAKISTANPRIVATE SECTOR STRATEGY 1. This note describes progress in implementation o f the World Bank Group's (WBG) Private Sector Strategy for FY03-05, reviews the current challenges and outlines a Bank Group Private Sector Strategy for FY06-09 talung into account changing market conditions and the evolving agenda emanating from the continuous process o f multi-level economic reform. Economic Context 2. Following some of the lowest growth, highest debt and fastest growing poverty in South Asia duringthe 1990s, the early part of the new millennium represented a key period o f transition inPakistan's recent economic history. At the beginning o f the decade, policy makers fundamentally adjusted the development policy toward unleashing the power o f the private sector. Reforms which addressed macroeconomic imbalances, opened the economy to trade, reduced regulation and began transforming the role o f the state as an owner/operator were complemented by a buoyant world economy, significant capital and remittance inflow and improved market access. Macroeconomic stability was achieved, debt dynamics reversed and policy credibility was re-established leading to a positive economic response of higher output, more predictable market signals and a growing confidence within the business community. Economic growth returned to over 6 percent 2003-04 and, helped by a strong agricultural season accelerated to over 8 percent in2004-5. 3. Despite this early success investor response has so far been muted as investment's share in GDP has fallen from 16 to 13 percent over the last few years. Rapidly increasing competition in global markets for Palustan's traditional exports has added uncertainty to long term growth prospects and sustained the economy's dependence on lower value added activities. There i s growing awareness among stakeholders o f the need for entrepreneurial dynamism, technology adoption and a business-friendly policy environment to raise productivity growth and improve international competitiveness. The challenge i s enormous, given Palustan's historical legacy o f stagnant world market shares concentrated in low value added products (Box 1). The World Economic Forum's competitiveness benchmarks capture the myriad influences on national productivity and show Pakistan's relatively low, but increasing position in global and regionalranlungs.' Progress Since the Last CAS 4. The Government's interim Poverty Reduction Strategy Program, was operationalized in the FY2002-2005 Country Assistance Strategy. For private sector development, the CAS emphasized Government undertaking near term actions to foster a more favorable business environment while embarlung on the long, difficult process o f converting the State's role as owner operator to business facilitator and regulator. This conversion required stable policies, improved infrastructure, modernization of business regulations, improved tax administration, trade liberalization, privatization o f public sector enterprises, reduced barriers to entry by new and smaller entrepreneurs, deepened financial sector reform, and expanded access to finance for new and under-served sectors. Specifically, the private sector strategy envisioned (i) buildingthe knowledgebase inPSD; (ii) strengthening Pakistan's investment climate, (iii) conversion o f the role of government; and, (iv) adequate provision o f infrastructure services. Good progress was achieved inmany o f the strategic areas as described below. ~ Pakistan's 2004 rankings inthe Growth Competitiveness, and Business Competitiveness indicators were 91 and 75 respectively out o f 104 countries while the Heritage Economic FreedomIndex placedPakistan at 153 out of 176. In 2005, these ranking rose significantly, with the Growth and Business Competitiveness indicators at 83 and 66, respectively and the Herigage Economic FreedomIndex improving to 110 out o f 153. Page 2 of I 6 Box 1: Pakistan's Starting Point: The Challenge of Growth in a Global Economy (GOP, Towards a Prosperous Pakistan. A Strategyfor Rapid Industrial Growth, March 2005) Industrialization and export orientation outcomes over recent years reveal the challenge Pakistan faces in moving to a more globally competitive and dynamic set of economic activities. K e y facts cited below underscore the challenges inherent inPakistan's starting point. Lagging industrialization. Over the past three decades, the share o f manufacturing value added inGDP increased ii-om 14 percent inthe 1970s to around 18.4 percent today while the share o f exports to GNP increased from 8 to 17 percent over the same period (with 3 percentage points added in the past three years) - a muchlower supply response to globalization than that witnessed inEast Asia. Stagnant global market share. Pakistan's share o f world exports has been stagnant over the past 25 years while the share of manufacturing exports from Malaysia, Mexico and Thailand have doubled and the share from China has tripled. High concentration of low value added production. Two thirds o f manufacturing value added i s accounted for by textiles, leather, sugar, food, beverages and tobacco, pharmaceuticals, industrial chemicals, minerals, and basic metals while three quarters o f exports derive from 5?? product groups: cotton based yam, textiles and garments, rice, leather and leather products and sports goods. Within cotton based textiles, fabrics, knitwear, bedwear and cotton yam account for half. Low share of dynamic exports. In 2002, 31 percent o f exports were considered "dynamic" where Pakistan achieved an increasing market share o f a growing world market. In 40 percent of products, Pakistan i s losing market share. Technological sophistication is low. With much lower resource based exports over the past two decades, the share of low technology products increased from 54 to 76 percent o f total exports while medium technology products increased from 7.8 to 8.4 percent. Hightech products remained negligible at 0.6 percent o f total exports in2002. Note: Low tech products have stable, well diffused technologies, and include textiles, garments, footwear, other leather, simple metal and plastic, furniture andfootwear. Barriers to entry are low and competition is based on price. Medium tech products are heavy products like autos, industrial chemicals, machinery and standard electrical goods. These products require complex, stable technologies with moderate R&D but advanced engineering and design skills, and large scale production. Barriers to entry tend to be high due to capital requirements and strong learning effects in operation and design. High tech products are complex electrical, pharmaceuticals, aerospace, precision instruments, and fine chemicals. These products have fast-changing technologies and complex skill needs and therefore have the highest barriers to entry. 0 Building the knowledge base in PSD. Two important firm level surveys took place during the period which underscored the `micro-level' impediments that have constrained Pakistan fiom fully enjoying the benefits o f global integration.' A number o f policy notes assessed the effectiveness o f trade reforms and encouraged stronger export-oriented Finally, an IDF grant implemented by the Ministry o f Industry and Special Initiatives (MOI&SI) examined a range o f areas in support o f economy wide regulation and strategy form~lation.~ The Investment Climate Assessment (PK-ICA, 2003) demonstrated that productivity can be enhanced by improving key elements of the country's investment climate. The Administrative and Regulatory Cost Survey Study (ARCS, 2004) examinedthe official and unofficial costs associated with administrative barriers. These include a TariffRationalization Study and Implications of Abolition of the Textile and Clothing Quotas. The areas studies included, labor legislation, the Drug Act, regulation at the level of SMEs, anti-competitive behavior and company registration studies insupport of an industrial strategy. Page 3 of I6 Strengthening the enabling Investment Climate. Based on the initial analytical work, the key areas o f reform initially address focused on the business-Government interface in the areas o f labor, tax, customs and business entry. The investment climate agenda was mainstreamed into federal and provincial level policy based operations, including the NWFP and Sindh SACS as well as the PRSC. Implementation support in the areas o f tax and customs was supported by capacity building for the Central Board o f Revenue while the revision o f the labor code was initiated with the deregulation grant. Conversion of state's role from owner/operator. The enormous challenge o f fundamentally transforming the state's role from owner-operator to facilitator-regulator across many key economic activities was accelerated. Privatization o f finance, utilities, and industrial enterprises made great progress, the opening o f controlled markets in telecommunications, media and ICT was initiated and has been accelerating, and legal and regulatory frameworks along with independent regulatory oversight have been strengthened. Policy reforms and performance triggers were supported under SAC I1and PRSC Iwhile directed support has been provided to government and independent agencies carrying out new roles.' Infrastructure. Inaddition to ownership, regulatory and governance improvements attention to other challenging areas o f infrastructure inpower, telecom, and gas and transport, including tariff policies in power and gas, the financial viability o f key public sector entities like WAPDA and the elimination o f losses throughout the power system. Transport issues include poor rural mobility, urban congestion, inadequate financial and operational performance o f Pakistan railways and costly port systems and inadequate trade facilitation. Bank operations in power, telecommunications and oil and gas have been focused on strategic and policy advice supported by development policy lending through SAC I1 and PRSC Iand in telecommunications, complemented by the Telecommunications Regulation and Privatization project. Inaddition to a strong program o f analytical work, the Bank i s supporting rehabilitation o f the highway network (through the Highways Rehabilitation Project) and assisting in modernizing trade and transport facilitation under the Trade and Transport Facilitation Project. 0 Access tofinance. Similarly, ownership, soundness and regulatory strengthening inthe financial sector will go far to expand access to finance for formalized commercial activities. A Banking Sector Adjustment Credit approved in 2005 i s supporting sustained soundness o f the newly privatized banking sector while the Banking Sector TA in providing continued support for operational strengthening o f the State Bank o f Pakistan. In addition, along with commercial banlung reforms, efforts to widen access were supported by the Bank under PPAF and other banking operations, including expanding micro-finance to the bankable poor, widening prudential regulations to cover SME, consumer, and micro-finance lending and establishing private credit information services 0 I F C s program during the last CAS period. Over the past three years, IFC introduced new financial products and a greater focus on key strategic sectors, including financial markets, small and medium-sized enterprises and infrastructure. IFC has also put greater emphasis on technical assistance and advisory services inadditionto traditional investment operations. o Investment operations. Duringthe period, US$187 million in sixteen new investments were committed in infrastructure, information technology, the financial sector, textiles, and pulp and paper. Particular examples o f groundbrealung investments include: ~ Including through the Telecom Regulation and Privatizationproject, the Banking Sector Adjustment and Technical Assistance Loans andthe Public Sector Capacity Building Project. Page 4 of 16 .. Pakistan International Container Terminal to upgrade the port o f Karachi, including civil works, container handling equipment and expansion of capacity inthecontainer yard. TRG, which demonstrated the viability of Pakistan as a location for call centers. The .. company became the largest o f its type in the country and is expanding operations throughout the region. First UDLModaraba where an Islamic financing product was usedinthe leasing sector. Dewan Salman Fibre Limited where the introduction o f preference shares, the provision of a local currency product and a linkage program with its small suppliers complemented an investment to expand its production capacity and restructure its balance sheet. o TechnicalAssistance Trust Funds (TATF) Duringthe period, two studies were completed: (i) a feasibility study on the country's private health care industry, including an assessment o f the market for general and specialized services; and (ii) an analysis o f the competitive positions o f the country's leasing companies and investment banks. Foreign Investment Advisory Service (FIAS) completed a private sector development strategy for the Northwest Frontier province. o PEP - MENA. An extensive technical assistance and ramped up advisory program focused on supporting (i) improvements in the business enabling environment (BEE), (ii)financial sector, (iii) SMEs and (iv) challenging advisory assignments addressing privatization issues .. and public-private partnerships. Particular examples include: Financial markets support covering a range o f activities, such as corporate governance, institution-building inhousing finance, women's banlung, and micro and SME finance. Business enabling environment including (i) assistance to the Palustani Securities and . Exchange Commission in efforts to de-mutualize the countries three stock exchanges, (ii) the introduction of alternative dispute resolutionto promote mediation for SMEs. General support to SMEs in the form of work with business membership organizations to assist them in supporting SMEs in their industries including work focused on the . automotive supplier sector and the introduction o f its "Business Edge" program, which provides a platform for Training o fTrainers for SMEs. Advisory and Public-private Partnerships including the initiation o f a program to (i) ontheprivatizationoftheFaisalabadElectricSupplyCompany,and(ii) advise bring private sector operators into the water sector through work on the Lahore Water public- private partnership. StrategicObjectives 5. The Government's objectives for private sector development are based not only replacing the state in commercial activities, but on becoming globally competitive through cost minimization and innovation. As Palustan moves from a focus on macroeconomic stability and restoring growth to one o f productivity growth and sustained private investment, innovation through FDI and technology development will be needed to enable further gains and economic diversification. To accomplish this, the economy will require lowering the cost o f doing business, stronger domestic competition with easier entry and exit, better infrastructure and wider access to finance, including equity, fixed income and project based. Therefore, PSD objectives seek: 0 An environment which fosters a dynamic manufacturing sector and entrepreneurial activity within an export-oriented policy framework basedon improved competition inproduct and factor Page 5 of I 6 markets, innovation and skills upgrading, greater diversification and participation in global supply chains; An investment-friendly policy stance for all enterprises, large and small, through continued reorientation o f the state's role, strengthened economic governance, improved infrastructure and better law and order; 0 Improving thefinancial sector environment for intermediation, the legalframework andjudicial process for enforcing financial contract, the depth of capital markets, the quality of financial infrastructure and access tofinancial services; and Development of rural areas where most of thepoor live based on productivity gains inagriculture and non-farm activities from improvements inpolicies and rural infrastructure. Current Policy Challenges 6. Policy makers increasingly recognize that sustaining the current high rates o f economic growth requires globally competitive production in an increasingly demanding world market. Therefore, based on considerable progress in stabilizing and reorienting the economy, policy makers are focused on strengthening international competitiveness through rising productivity in order to support higher wages, a strengthened currency and increased returns to capital. Macroeconomic stability and the removal o f price distortions have eliminated impediments to productivity growth but will only translate into rising productivity ifaccompanied by a conducive business environment. 7. Notwithstanding Pahstan's notable policy achievements and company level strengths, there i s a consensus among policy markers, academics and the business community that improvement in Pakistan's competitiveness derive from success in three "second generation" areas which impact firm level productivity. First, economic governance to instill market discipline and provide certainty in investment returns poses a particular challenge, encompassing such entrenched factors as efficiency and effectiveness of government and autonomous institutions, quality o f regulation, political uncertainty, corruption and the rule of law. Second, eflciency of factor markets to foster flexibility and fluidity represents a major constraint to good resource allocation and ease o f entry, particularly in the case of land and labor. Third, physical infrastructure and transport logistics have a major impact on international competitiveness and have become important priorities for Palustan. 8. Inadditionto these, two specific areas are ofinterest to Pakistan's policy makers, concerned with ensuring that growth i s sustainable and broad based. First, issues reflecting technology adaptation represents the new frontier for Palustan business in an increasingly globalized market. Second, sub-national differences are particularly poignant in Palustan as a federation o f four vastly different provinces with growing urban-rural divide. 9. Economic Governance. A driving force behind firm-level productivity i s an environment o f open and fair competition which encourages low costs, high efficiency and innovation to survive. Minimized cost o f regulatory compliance, ease o f entry, expedient exit and institutional protection o f property rights and fair competition are key components o f a supportive policy regime. N o t surprisingly, institution buildingis a long, difficult process for the executive, judiciary and independent regulators. As a result, the consistency, certainty, and predictability o f the economic governance framework - including the laws and regulations, the adjudication mechanisms and their enforcement agencies - still fall short o f minimal standards as reflectedina recent deterioration ingovernance indicators.6 In2004, Pakistan ranked inthe bottom 20 percent infour of six indicators with the other two inthe bottom third During the 2000 - 2004, the ratings fell for three o f the six indicators and didnot change for two others (Kaufmann, Kraay Mastruzzi, Governance Matters IV. Governance Indicators for 1996- 2004, The World Bank, May 2005. Page 6of 16 10. Entry and Post - Entry Regulation. Starting and running a business in Pakistan has become easier in recent years due to concerted effort across a range o f regulatory processes, but key challenges remain in terms o f land acquisition, site development, construction licensing, and utility hook up, all o f which carry a high degree o f administrative burden and are governed by provincial and local authorities.' A significant source of government-business interface stems from compliance processes involved with tax, customs and labor regulation.* In all o f these areas, the Government i s undertaking comprehensive programs with the explicit objectives o f lowering the compliance burden while improving the effectiveness o f government oversight. Legislated efforts are being driven at the federal level and a range o f implementing agencies are undergoing capacity building and process re-engineering to ensure better government - business interface, focusing initially on federal tax administration, customs facilitation and labor prote~tion.~ 11. Court Efficiency. Without the credible threat o f an efficient and effective insolvency, adjudication and dispute resolution mechanism, risk talung by businesses i s suppressed and innovation forgone. Court processes, judicial capacity and supporting institutions (advocates, registries, accountancy and related professions) have been notoriously ineffective in enforcing contracts and protecting property rights in Pakistan. Just over a third o f businesses surveyed in 2002 expressed confidence in the judiciary as commercial parties increasingly use the courts to delay and or stop transactions through stays and continuances. Case backlog-around half o f which concern cases o f commercial nature-in the High Courts o f Sindh and the Punjab number over a hundredthousand, and for the lower courts, inthe millions. When cases do go forward, it takes, on average, 46 steps, more than a year and almost a third o f the contract value to enforce a contract." Standardized indicators comparing the average time (2.8 years) and cost (4 percent o f the estate), to close a firm are not excessive by international standards, but legislated restrictions in labor law, the company law and its associated insolvency procedures are cumbersome and inadequate. Adjudication o f commercial cases, already a lower priority in the courts, will become even more inadequate as new legal frameworks are introduced for foreign investment, insolvency, monopoly regulation, anti-money laundering, insider trading and corporate governance. 12. Competition Policy. Palustan lacks effective legal framework to govern fair competition and an associated institutional framework to promote competition within the domestic market. At a time when privatization, utility deregulation and economic restructuring are radically changing the competitive landscape, the extent o f domestic competition, industrial concentration and barriers to entry in the economy i s not well understood in Palustan.. However, with the opening o f previously uncontestable markets, large scale privatization and anecdotal evidence citing concentration in primary sectors such as cement and fertilizer, Palustan has recorded low ranlungs for local competition.'' At the same time, sectors such as power, oil and gas, telecommunications and electronic media are opening to private sector competition and are experiencing some o f the natural challenges associated with rapidly transforming regulatory landscape intechnically difficult areas. ' Cite Pakistan's 2006 DB Rankings. Recent surveys detail the process o f business start-up, demonstrating that the process to initiating business operations can take more than a year. Accordingly, the World Economic Forum's indicator, "Administrative Burden for Startup," fell from 72"dinthe world in2003 to 92"din2004. An indication o f the regulatory impact on formal firms' cost o f doing business is that Pakistani managers, on average, spend 10percent of their time dealing with Government regulation; higher than other comparator countries apart from China and India, (The World Bank, Investment Climate Database). For example, federal tax and customs authorities are undergoing institutional restructuring and process reform. For labor inspections, provincial governments are experimenting with different approaches, including combining visits and pre-announcing (Sindh), self-regulation (Punjab) and exemptions for l o w risk firms (NWFP). lo The highnumber of steps to enforce a contract may be a contributor to the perception that the judiciary i s one o f the most corrupt institutions inthe country. 11 For example by The World Economic Forum, Global Competitiveness Report. Page 7 of 16 13. Factor Market Conditions. Well functioning markets for land, labor and capital enable optimal resource allocation and maximum factor productivity growth. Pakistani authorities have taken bold steps to improve the banking sector, but deficient labor and land markets continue to be viewed as major constraints inPakistan's investment climate. 14. Labor Market and Skills. Pakistan's labor market efficiency ranks low by international standards due, in part, to antiquated and restrictive regulations governing maximum hours, overtime conditions, length of temporary contracts, remuneration rates, welfare contributions and retrenchment procedures which impact bilateral market relationships and cause real wages to diverge from productivity levels, preventing efficient resource allocation and harming competitiveness. The discretionary approach o f provincial inspectors, labor tribunals and wage authorities in enforcing requirements and adjudicating disputes adds considerable uncertainty to labor market outcomes. The result i s that many, if not most, firms circumvent labor laws to some degree, most often by using contracted or piece rate labor on a very short term basis and often hired through intermediaries, suppressing investment in labor skills'* and sustaining concentration on low value added activities. 15. Land Market and Industrial Estates. Access to land markets and the use o f land as loan collateral i s fraught with difficulties, involving a multitude o f public agencies at the federal, provincial and state level which own, manage, tax and regulate commercial land. For transactions which do occur in the private sector, the inherent wealmesses o f the system o f registering prevent certainty o f property rights. These include the multiple agencies involved in land registration, complex and opaque records keeping and sale transactions tahng place without valid conveyance documents. These legal inadequacies and procedural deficiencies prevent indisputable land title and i s one o f the primary causes o f the case backlog inthe courts. Moreover, without clear propertyrights,lenders will not consider collateral as loan security without an original sale deed in the bank's possession. The resulting "dead capital" and lack o f site access, hinders leveraged investment, firm level entry and efficient resource allocation. The rapid rise in land prices throughout Palustan has made the situation even more constrained as hoarding i s encouraged, underreporting for tax purposes i s rising, and a new cadre o f speculative players has entered the market. 16. Federal and provincial governments have countered problems with land access and site development by mahng available plots on government owned land in industrial estates with mixed S U C C ~ S S . ' ~Reason include (1)inappropriate selection o f location; (ii) quality o f infrastructure and poor support services; (iii) insufficient land inprime business locations; (iv) rigid government rules regarding eligibility o f investment; and (v) inadequate stakeholder participation inestate management. The Federal Government i s piloting new models o f public-private partnerships to locate, develop and manage new industrial estates, drawing on the Sundar experience inPunjab. 17. Financial Markets. The past five years witnessed considerable deregulation, liberalization and privatization in the financial sector. Starting from three quarters o f banking assets controlled by the public sector inthe late 1990s, almost 80 percent o f assets are now under private control. Reforms were initiated to strengthen the regulations and the regulator, reform the National Savings Scheme (NSS) to rationalize interest rates, strengthen enforcement o f financial contract; rationalize the tax structure and foster greater disclosure and transparency. Still, the supply o f longer term finance and capital market development remains limited. Among other implications, this constrains the development o f nascent financial markets such as housing and leasing which depend on the availability o f long term funding in the banking sector. The insurance and pension system i s small, dominated by public institutions, invests Pakistan's basic educationand skills indicators are at the lower end of global rankings andhave beenfalling. l3 A survey of the 35 principal industrial estates across the country reveals a stock of more than 17,000 plots, two thirds of whichhave beenallotted. The survey also reveals the low occupancy rate for most estates apart from 100 percent occupancy in SITE in Sindh, and Raiwind and Kot Lakhpat in Punjab Ministry o f Industry, Production and Special Initiatives, A Prosperous Pakistan,2005. Page 8 of I 6 in government assets, and is highly taxed. The 700 companies listed on the Karachi stock e~change'~are capitalized at around 24 percent o f GDP as compared with 50 and 130 percent in Mumbai and Kuala Lumpur, respectively. The legal system for enforcement of financial contracts is partly untested and is faced with problems at the execution leve1,'j and credit bureaus are at an early stage of development. The lack of a tested secured transaction regime as well as the nascent private credit information system limits access. 18. Infrastructure Development. In addition to low penetration density and coverage ratios, the performance-of infrastructure services has been relatively poor, particularly inthe area o f power. At the same time, the conditions o f the roads, railways and ports hinder Palustan's competitiveness by preventing adequate logistical linkages among firms and with their customers 19. Power. The principal infrastructure issue facing the business community, particularly larger established firms, i s access to reliable power both at the business start-up phase, in terms o f obtaining electricity connections, and during business operations, in terms o f having reliable supply. In addition, the sector's pricing structure involves cross-subsidization with the burden falling particularly hard on industry, adversely impacting investment decisions and competitiveness enhancement. Current challenges include (1) the high technical and commercial losses in the system, increasing from 23 to 27 percent o f total output between 1995 and 200216and in some cases reaching as 40 percent; and (ii) the extension o f services to underserved areas as estimates indicate that almost o f third o f the population has no access to power. 20. Telecommunications. In the global market with growing connectivity requirements, telecommunications represents a key determinant of the country's investment climate. Pakistanhas taken significant steps to (i) end the state monopoly for fixed lines resulting innumerous companies providing services at competitive rates; (ii) privatize the public telephone company leaving the sector fully managed by the private sector; and (iii) approve a cellular mobile policy in January 2004 leading to two additional cellular mobile operators being licensed. These initiatives have led to a complete liberalization o f the sector and significant foreign investments. L o w penetration rates are increasing rapidly, as telecoms density has increased from 4.6 to 9.8 lines per 100 inhabitants between 2003 and 2005 and the sector as seen a dramatic reduction inprices. Connection time i s improving and the sector now has the potential to be a strength in Palustan's investment climate. However, there i s a significant lag in rural telecommunications access, as the positive developments and impact in the sector are mostly confined to the urban and semi-urban areas. The difference in penetration between rural and urban users i s quite high ,as halfo f Palustan's 50,000 villages have no access telephones or the internet. This i s primarily due to its lack o f commercial viability and penetration i s at a meager 1 percent. Facilitating rural telecommunications access will enable e-government and e-services to be delivered to rural areas and assist inoverall economic development o f the country. 21. Oil and Gas. Representing 41 and 36 percent, respectively o f the total commercial energy consumption, the Government's long-term goal for Oil and Gas i s to institute a largely privatized sector. Beginning with a fundamental policy shift in2000, the Government began to focus more on policy issues, state enterprises were slated for privatization and natural monopolies were entrusted to an autonomous regulatory body. Progress in the reform agenda has been mixed. The movement toward Government divestment and improved regulation has proceeded relatively well. On the demand side, the domestic price mechanisms continue to be distorted by cross subsidies among different classes o f consumers and the mechanism for adjusting gas price has been erratic. In 2004, petroleum prices were prevented from l4 KSE lists all companies on the Lahore and Islamabad stock exchanges apart from five companies listed in Lahore. l5 The Financial RecoveriesOrdinance2001, has been effective for several years but has beenused sparingly due to recent judicial challenges. It will only become fully effective once it i s upheldby the supreme court of the country. l6 The World Bank, WorldDevelopmentIndicators,2005. Page9of16 adjustmenting to reflect world market conditions, creating pressure on private suppliers and distortions in consumption and investmentpatterns. 22. Transport: Roads, Railways, Ports. Palustan's potential competitive position i s highly dependent on the quality and cost o f its internal and external transport systems. However, the sector i s inefficient and so far has been unable to overcome the competitiveness disadvantages o f both long sea and land transport links. Major markets are located at considerable distances from Pakistan and the location o f its main production center i s over 1,OOOlun from the sea. The sector faces further cost disadvantaged in terms o f scale, since total impodexport flows are relatively small. Key sector issues are: (i) ruralpoor mobility;" (ii) urban congestion;'8 (iii) ineffective state railways monopoly carrying 3 percent o f the total cargo traffic; and (iv) costly port systems and inadequate trade facilitation. 23. Innovation, Globalization and FDI. Policy makers and the business community recognize that improved processes and increased efficiency at the firm level will require appropriate technology adoption and a dnve for innovation. Effective demand for new technology by commercial enterprises will rise as they participate in vibrant competitive markets exposed to global prices and driven by sophisticated consumer demand. The adaptation process also requires (i)an educated workforce; (ii) positive incentives for risk-taking; (iii) integration between academic/government sponsored research and business applications; and (iv) a spillover o f knowledge transfer which comes from participation in the global economy, through integration with inward FDI and participation in global supply chains requiring producing to world standards o f price, quality and delivery time. 24. Though a rapidly developing ICT infrastructure, i s undoubtedly having a positive impact on telecommunications and innovation, the challenge for Paktstan to develop into a more knowledge based economy are morebasic, given the education and labor skill outcomes described above. In addition inadequate technical expertise to support inno~ation,'~a limited amount o f risk capital along with a low degree of globalization'' and low levels o f inward FDI, despite one o f the more liberal regimes in the world21i s limitingPalustan's ability to capture productivity gains emanating from innovative ways to do business. 25. Provincial Role in the Investment Climate. As a highly diverse federation, significant differences in the investment climate are seen across provinces, attributable in part, to variances in political, security, and economic management issues.22 Due to the increasing importance o f vertical integration and inter-firm linkages in the global marketplace, such regional differences become an issue of national competitiveness. While inter-provincial competition can be healthy for reform, the creation o f policy inducedlocation advantages and differences inperceptions o f security, crime and political stability can adversely affect efficient resource allocation. Moreover, as provincial governments and increasingly local authorities are responsible for much o f the business interface with regard to labor and other type o f business inspections, tax administration, license approval, land and site development issues and judicial enforcement, the nature o f a firm's investment climate depends on good implementation and coordination with Federal policies. l7 Particularly as 45 percent o f unpavedroads are mostly inrural areas. l8 Particularly inKarachi and Lahore, which support close to a third o f Pakistan's GDP. l9 Science and technology indicators as well as higher education outcomes have fallen over the past decade and currently lag most other comparator countries (The World Bank, Knowledge Assessment Database, 2005). 2o Pakistan's ranks in the bottom ten out of 62 countries for four globalization dimensions economic, personal, technological and political (AT Kearney / Foreign Policy Globalization Index, 2004),and ranks 144 out o f 163 countries inFDIas a share o f GDP for the period 1998-2003 (World Bank, World Development Indicators, 2005). 21 The government liberalized the foreign investment regime in the 1990s by opening strategic sectors to foreign ownership, reducing required approvals, expanding profit repatriation and providing national treatment and legal protection. Seedy disputeresolution and a Wher opening o f the service sector was legislated in2005. *' Pakistan ranks 81" in the world according to the WEF indictor "Regional Disparities in the Business Environment". Page I O of I6 26. Public-Private Dialogue. By establishing close connections to the local business community, provincial governments have mobilized private sector initiative to play an important role in activities traditionally considered exclusively as within the public sector's domain. Areas where the private sector i s increasing getting involved include strategy formulation and policy advice (Sindh, NWFP), industrial estate management (Punjab, Sindh, NWFP), vocational training (NWFP), and privatization transactions (Sindh). Increasingly, the private sector will be able to play more substantive roles in providing public services through more sophisticated public-private partnerships in municipal services particularly water and sewage, road building, information technology and knowledge development. 27. Entry and Post-Ently Regulation. To achieve a favorable impact from reforms addressing business start-up, labor regulation, and tax administration, federal reforms require complementary implementation efforts at the provincial level. Inaddition, there are other pre- and post entry regulations solely within the purview o f provincial governments that need to be reviewed to ensure that barriers to entry are minimized and the cost o f doing business i s comparable with other countries. Implementation should be at a harmonious pace across Pakistan to avoid perceptions o f permanent policy induced location advantage^.^^ 28. Factor Markets. As market mechanisms for land, labor and capital, are only starting to be addressed, provincial governments have an important responsibility in the development o f land markets which inturn will support improved access to finance. Inthe interim, improved management of industrial estates can provide increased access to publicly heldland and utilities Inaddition, as they are responsible for enforcement of labor legislation, provincial governments have a key role in brealung long standing market rigidities. As Federal legislation i s beingreformed, provincial governments will need to re-tool their implementation mechanism to enable real wages to better reflect productivity, supporting competitiveness and improvingresource allocation. 29. Judicial Efficiency. Property rights are weak in Palustan generally, with contract enforcement and land disputes based more on negotiated settlements than rule o f law and judicial enforcement. Provincial governments can directly contribute to improvements injudicial processes inthree ways. First, improved governance and better performance o f government officials in implementing regulations would lessen the crowding out o f purely commercial disputes. Second, efforts to improve the functioning o f land and labor markets would remove a second source o f taxation on court time. Finally, ensuring adequate capacity and a rational structure at lower court levels while simultaneously worlung toward filling vacancies and improving procedures for commercial cases at the HighCourt, would significantly contribute to the certainty and predictability o f property rights. 30. Security and Crime. Issues outside the normal parameters o f economic management have been shown to significantly affect investment climates around the but are perhaps more important for Palustan than for other economies. Perceptions o f security risks as well as local crime, though hard to quantify, have clearly had an adverse impact on investment and growth. Perception o f political instability at the regional political arena, even if constrained to the local region, has been a clear deterrent to investment throughout Palustan, as well. Together local issues o f crime and political stability, can infect the entire country and contribute to a short term corporate view and suppresses investmentby the business community. 23 Doing Business Pakistan, 2004 shows significant regional differences in the legislated cost and time associated with a number o f business procedures, including opening a business, contract enforcement, and property and collateral registration. 24 For example, Ayyagari, Demirgiiq-Kunt and Maksimovic, How Important Are Financing Constraints? The Role of Finance in the Business Environment, (Forthcoming) shows that "maintaining political stability, keeping crime under control, andundertaking financial sector reforms are likely to be the most effective routes to fmgrowth." Page II of 16 The Way Forward 31. Economic Governance. As the economy increasingly opens up to international trade and investment, attention has turned to regulatory and institutional reform to create a more certain and predictable environment for commercial transactions. Good progress i s being made in tax, customs, financial, labor and utility regulation as the first areas to be tackled with the next round focused on: 0 Risk based approaches emphasizing self-assessment will be deepened through tax and customs administration reform and will be expanded to labor inspections under the planned new labor code and prudential regulation o f the financial sector under Base111. 0 Business laws will have their own program o f modernization, particularly in areas covering insolvency, corporate governance, and competition law. Inaddition the Securities and Exchange Commission o f Palustan (SECP) will be strengthened and complemented by an activation o f a credible competition authority. 0 Expeditious adjudication of commercial cases i s being actively pursued. Implementation o f the pending legal reform bill will limit procedural delays (stays, continuances, etc.) and introduce formalized alternative dispute resolution. More fundamental reform i s under consideration including a commercial court, commercial benches, streamlined and summary procedures, and systems o f registries, accountancy, and enforcement. 0 In all areas the principal of strengthening enforcement agencies to implement strengthened legal frameworks, along with a credible system o f operational rules, procedures and monitoring systems will be pursued. 0 Process reengineering would be a central part o f capacity building efforts with an expansion o f existingpilot e-government initiatives to improve the business-government interface. 32. Efficient Factor Markets. Efforts to improve the functioning o f factor markets are a central pillar o f Pakistan's drive for economic restructuring. Deepening financial sector reforms, expanding efforts to improve labor markets and initiating a more rational approach to land markets will involve: 0 Codifying, rationalizing and liberalizing antiquated legislation governing labor compensation, industrial relations, worlung conditions, health and safety requirements and human resource de~elopment.'~ 0 Initiating a two tracks system to develop land markets: (i)develop a new, clean system o f land titling for new transactions to ensure sovereign backing, easy transferability, and rational taxation; and (ii)begin carrying out the complex and delicate parallel activity to establish property rights in the face o f ownership disputes. In the interim, in order to feed and provide credibility to the new land titling system, federal and provincial authorities would inventory underutilizedland to be auctioned and transferred according to the newly introduced system. 0 In the interim, provincial governments will observe implementation o f the various models of public-private partnership in industrial estate development and management such as SITE, Ltdin Sindh and Sundar inPunjab to formulate "best practice" guidelines for estate management. 25 Laws are being redrafted to replace 30 - 40 federal and provincial laws and regulations covering employment conditions, labor welfare, health and safety and human resource development. The first act, Services and Employment, recognizes piece-rate contract workers in the legislation, expands the weekly hours and overtime hours, particularly for women and reduces the compliance cost o n business. Page 12 of 16 0 To deepenfinancial sector reforms and improve term transformation, the remaining large public sector commercial bank, specialized financial institutions and insurance companies will be privatized, regulatory constraints on investments by insurance and pension/ provident funds will be rationalized and corporate governance will be strengthened. Further deepening o f the financial sector through analytical and advisory assistance and operational investment in key finance sectors such as housing finance, leasing, SME finance and microfinance will have positive spillover effects on the rest o f the economy by spurring household and entrepreneurial savings and investment spending. 0 Access to credit will increase with improvements in the legal framework and judicial processes for enforcement o f financial contracts (such as a modem secured transactions regime for movable collateral) and an expansion o f private credit registry coverage. 33. Infrastructure. Government efforts to provide better infrastructure have been intensive inrecent years and characterized by successes in telecommunication and oiligas and slow progress inpower sector reform. Therefore, the near term agenda ininfrastructure includes: 0 Inpower, strengthen implementationof the Government's Sector Recovery Plan, which aims at (i)completing the unbundling of Water and Power Development Authority (WAPDA) into separate transmission and distribution companies; (ii) accelerated privatization in generation and distribution; (iii)aggressive cost and loss reducing measures throughout the system; and (iv) improved tariffs and subsidies, for distribution companies to enable better targeting o f subsides and enhance operational and financial performance. Implementation delays are causing more losses in the system, further complicating the challenge. Based on the investment backlog in the sector, investment lending would support distribution and transmission, hydropower and rural access. 0 In telecommunications, continue to implement the 2003 deregulation policy and 2004 mobile cellular policy by (i)strengthening the policy and regulatory environment for licensing, interconnection and tariff regimes; (ii)completing the privatization o f the state-owned monopoly as an integrated company; (iii) continue opening the cellular market to further competition by selling additional licenses; and (iv) accelerating rural telecommunication and broadband connectivity. Under this new competitive, open regime, capacity enhancement i s needed both for the Ministryas a policy malung body as well as the regulator. 0 In oil and gas, domestic prices should reflect hlly world market conditions. Gas tariffs, are priced close to long run costs on average but are still below opportunity costs for households and for the fertilizer industry. Over time, pricing decisions will be made by the Gas Regulator (ORGRA) rather than the Cabinet, but with rising demand and depleting reserves, imports will begin in the coming y ears. On the oil side, efforts to unbundle and privatize the large enterprise (Palustan State Oil, Oil and Gas Development Company and Palustan Petroleum Limited) will be strengthened as world petroleumprices are increasinglypassed through to the consumers. 0 Intransport and trade logistics, develop a strategic approach to the sector focusing first on the Indus trade corridor linkingthe major ports with the major city and comdors inthe Northwith an objective o f developing an integrated approach to planning, investment and managing the Indus transport logistics system. There i s a significant maintenance backlog in the sector requiring maintenance o f $1 billion per year. Continued high-level commitment and support will help accelerate reform initiatives in the Pakistan Railways. Capacity constraints at the National Highway Authority o f Palustan will be addressed to avoid delays in new highway construction. Finally, delays in finalization and adoption o f laws, rules, and procedures that were developed Page 13 of I 6 under the trade and transport facilitation program will be eliminated. As a particular emphasis, transport inrural areas will be pursuedunder the country's devolution framework. 0 The institutional framework for Private Public Partnerships (PPP) in infrastructure needs immediate attention to attract private financing to transport, urban services, energy and other infrastructure areas. The immediate steps will be to prepare and issue a PPP policy to identify sectors, the institutional framework (PPP unit) and funding mechanism while in tandem pilot projects are pursued to demonstrate the viability o f the PPP framework, for example with highways or municipal services. 34. Innovation, Technology Improvement and FDI. To help capture productivity gains from advances in business processes, improved techniques and increased technology content o f production, public and private initiatives will aggressively seek competitive markets at home, participation in the global economy and development o f the human and financial resources required for innovation, including: 0 A globalization driven, outward-orientation i s needed in firm level business strategy to benefit from a broader set o f markets, resources and technologies. However, to participate, domestic firms require a competitive operating environment at home which rewards firm-level innovation, investment inskills, improved industrial organization and risktaking. 0 Pakistan needs to offset perceived risks of foreign direct investors stemming from perceptions regarding security, stability, and corruption with an aggressive program to attract foreign investors. Recognizing the lingering reputation risk from high profile disputes with private companies, passing legislation to recognize international arbitration would be a strong and a positive signal to foreign investors concerned with unpredictable contract enforcement. 0 Government's role in knowledge development i s to focus on the basics, including (i)improved education outcomes and coverage, (ii) better telecommunications infrastructure; (iii) programs to subsidize connectivity for disadvantaged sectors o f society; and (iv) improving science and technology at home through support for basic R&D; and (v) leveraging the Palustan Diaspora to foster linkages between business, researchinstitutions and academia. 35. ProvincialRole in Determiningthe Investment Climate. As the Federal government deepens its reform agenda into institution building, regulatory reform and legal modernization, and as devolution restructures economic relationships, provincial governments will play an increasingly active role in a number o fkey areas, including, 0 Establish public-private policy and reform-related dialogues - create institutions to encourage dialogue, e.g. investor council, consultative mechanisms, etc. Contributing to greater public- private activity, but also helping to raise the level o f awareness and understanding o f the private sector amongst ministries and staff. and ultimately will develop a PPPFramework 0 The new coordinating body in the Federal Government will encourage provincial governments to implement reforms through active consultation, monitoring and domestic benchmarking, to encourage a unified and competitive approach to implementation o f provincial regulations. 0 The high level o f business sophistication and large numbers o f specialized business associations and chambers around the country can be leveraged through public-private partnerships to strengthen inter-firm supply chains. Page I 4 of I 6 Role of the Bank Group 36. The World Bank Group has provided support to the Government's objectives through a number of avenues, grouped into analytical work, non-lending technical assistance, policy support and investment operations. 37. AnalyticalWork. As policy makers develop comprehensive plans for the next round o f strategic policy decisions, contemporaneous, rigorous and informed analysis will assist in directing efforts toward the bindingconstraints to improved microeconomic efficiency. The previous CAS sought the buildingo f a strong analytical basis to advise the Government on various dimensions o f private sector development. Since then a number o f studies were launched. The Growth and Competitiveness flagship report sets the integrates microeconomic factors into growth modeling in order to provide an in depth analyses o f constraints to sustained rapid economic growth. The yearly benchmarlung o f Palustan at the global, regional and sub-national levels using the Doing Business methodology provides insight and monitoring for economic governance issues. Studies covering administrative barriers, labor markets, access to finance, and transport competitivenesswill examine specific dimensions o f the investment climate. Sector studies on retail, construction and tourism will look at sector specific issues. Four provincial economic reports and the rural growth strategy will shed analytical light on sub-national dimensions and a value chain study o f particular products will provide specific case studies to illustrate competitiveness issues. Finally, investment climate assessments at the federal and provincial level will synthesize this body o f work and complement it with international benchmarlung and productivity analysis. 38. Lending Support for Policy Reform. Supporting one o f the pillars of the PRSP, key elements of the Government program o f private sector led growth have been supported by policy lending at the federal and provincial levels during the previous CAS and will continue for the coming CAS period. At the Federal Level, the PRSC dialogue has supported reforms in infrastructure, particularly power, a new labor code, privatization transactions and financial sector reform. Future policy lending in the private sector will continue to focus on regulatory reform, infrastructure and privatization and will expand to further development o f institutions for a market economy. The Development Policy Creditfor NWFP i s supporting an emerging private sector orientation by the provincial government. 39. Non-Lending Technical Assistance. Small scale capacity building support to regulatory agencies will assist in strengthening regulatory and oversight agencies. A World Bank IDF grant was approved to support the Securities and Exchange Commission. Incooperation with DFID the Bank i s also providing technical assistance to help government design a new competition policy, law and agency. In terms of promoting new foreign investment, MIGA is willing, if requested by the government, to provide practical capacity building support for the Board o f Investment and i s seelung to build the South Asia Enterprise BenchmarlungProgram, an example o f an operational diagnostic study with key outputs being marketing profiles, outreach and promotion activities and product development to assist each participating country to promote itselfmore effectively for foreign investment. 40. Public Investment Lending. Lending in areas which support private sector development has generally taken the form o f technical assistance and capacity building,or large infrastructure investments. The Tax Administration Reform Project, a major program aimed at improving federal tax and customs administration will be implemented during the CAS period and may require a repeater activity. Components o f the Public Sector Capacity Buildingprogram are aimed at strengthening utilityregulators and will help with infrastructure services. A series o f projects aimed at infrastructure development, particularly the power sector are being developed. Inthe future, projects will be pursued which focus on institutions for a market economy and combine public investment with technical assistance to enhance international competitiveness and develop capital markets. Inthe financial sector, future lending by the Page I 5 of I 6 Bank will build on first generation reforms and focus on term transformation investments that increase access to long term funds for household and entrepreneurial activities such as housing, leasing and domestic capital investments. 41. IFC Priorities for FY06-FY09. In the coming CAS period, IFC will build upon the efforts to support strategic sectors, particularly the financial sector, SMEs and infrastructure. IFC will also look for opportunities to provide value-added to industnal clients. IFC will broaden the scope o f technical assistance and advisory work, both linked to investment and on a stand-alone basis. The focus o f IFC efforts will be to provide a package o f services and financing aimed at addressing the specific needs o f our clients. 42. Duringthe upcomingCAS period, IFC expects to increase its investment with the target range o f US$500-600 million for the period. IFC will also explore opportunities in pre-privatization investment. It furthermore plans to make more equity investment and intends to be a catalyst for and mobilize private equity in the country. In addition IFC will increase technical assistance (TA) activities through the PEP- MENA program. The two pronged approach of investment and TA will allow for synergies betweenthe programs. For example, inthe financial sector, IFC can provide TA to develop microfinance institutions, while at the same time providing investment for nascent institutions, which inturn provides such funds to entrepreneurs. Work to support the microfinance sector i s seen as a particularly effective way to spread the benefits o f development to a broader segment o f society. Microfinance institutions are set up outside the reach o f traditional financial institutions and therefore can support entrepreneurs in more remote areas. Also inthe financial sector, PEP-MENATA to banks will be aimed at the next size o f enterprises -effortstohelpbanksdeveloptheir abilityto assessrisksofSMEscanbeaccompaniedbycreditlines. Other priority areas in the financial sector include housing finance, leasing, and trade finance. Housing finance efforts can help increase the availability o f affordable housing, and improve the opportunity for people o f middle income and even lower income to buy their own homes. IFC's efforts inthis sector can include institution building TA and investment to provide long-term lending and securitization for housing finance. Work with banks and other institutions will include TA to improve internal credit risk systems, policies and procedures, and upgrade training o f staff. IFC through PEP-MENAwill work with banks to develop Corporate Governance practices. 43. Inthe SME sector, beyond the financial component, IFC will continue to provide TA support through "Business Edge" and work with business membership organizations to improve services for the support o f their SME members. IFC believes that there are opportunities to support SMEs in strategic sectors such as health and education, both with TA and investment. 44. Ininfrastructure, IFC will focus on the energy sector, including power, gas and utilities, and telecommunications through investment operations supporting the Government's strategy. There i s a particular need to improve the physical infrastructure in the country to allow for the efficient flow o f goods, people and energy. Without improvements in this vital area, the long-term benefits o f Palustan's liberalization will be stifled. IFC expects to have an investment program ininfrastructure where it i s open to the private sector. IFC will also put emphasis on advisory work for privatization and will support public-private partnerships to improve the management o f these facilities. IFC's recent efforts in the water and sanitation sector will continue in the upcoming CAS period. IFC could consider new investments in power, buildingupon its extensive experience in the sector. Advisory mandates will also be pursued, particularly those which address constraint in power generation and distribution. IFC can assess opportunities to invest in the development o f the country's natural gas resources, where clients look for political risk mitigation. In the telecommunications sector, IFC could consider opportunities following privatization in the sector and the expansion o f mobile networks as well as value-added services. IFC will focus on efforts to improve the business enabling environment to ease constraints and address needs o f the private sector. This will include work to improve the legal and regulatory environment. Page 16of 16 45. On the industnal side, IFC will look for niche opportunities, including supporting Pakistani corporations as they embark on south-to-south expansions. IFC will also look for ways to support the development o f linkage programs to involve local SME suppliers to larger companies. IFC's ability to provide innovative financing tailored to the needs o f clients will be pursued selectively where there i s clear value-added. 46. Political Risk Insurance. MIGA will advance its marketing and promoting for foreign investment in key sectors, working with key public agencies and private sector bodies (Chambers, etc.) to identify opportunities for using political risk insurance to support FDI into Pakistan. In addition, subnational risk mitigation has become an important aspect o f the MIGA political risk insurance product and it i s considered important in the breach o f contract coverage. MIGA's new Small Investors' Program (SIP) offers a streamlined, simplified and more cost effective political risk insurance program to support foreign investment into SMEs. ANNEXIV: PAKISTAN COUNTRYFINANCING - PARAMETERS Item ExplanatiodFtemarks Cost Sharing: Limit on the proportion o f upto 100% The Bank's financing percentage in each project would be individual project costs that the Bank may determined on a case-by-case basis, depending upon project finance type, sector, etc. Inmany projects, the practice o f requiring government counterpart funding would continue. In general, low to moderate contribution by Government (federaVprovincial), beneficiaries and others are expected in CDD-typeprojects and water sector projects. Moderate contribution by Government (federaVprovincia1) i s expected in infrastructure projects. 100% Bank financing could occur in pro-poor projects, such as social sector projects and projects inpoor and remote areas. 100%Bank financing may also occur in capacity building projects with moderate to high in-kind contribution by the Government (such as staff time, office space and equipment). Recurrent Cost Financing: Any limits No country- In determining Bank financing o f recurrent costs in that would apply to the overall amount o f level limit individual projects, the Bank will take into account recurrent expenditures that the Bank may sustainability issues at the sector and project levels. finance Financing o f recurrent costs will be carefully assessed, particularly financing o f Government staff salaries, which the Bank will only finance for specific purposes. For example, where our support is primarily programmatic (such as in the education sector), there may be need to finance recurrent costs and for a longer duration (as long as program continues) to support achievement o f program objectives. Recurrent cost financing may also be allowed to support cost o f managing project implementation and to ensure sustainability o fproject activities. Local Cost Finance: Are the requirements Yes The two criteria are met. Therefore the Bank may finance for Bank financing o f local expenditures local costs inany proportion needed inindividual projects. met, namely that: (i) financing requirements for the country's development program would exceed the public sector's own resources (e.g., from taxation and other revenues) and expected domestic borrowing; and (ii) the financing of foreign expenditures alone would not enable the bank to assist inthe financing of individual projects Taxes and Duties: Are there any taxes and No Taxes and duties inPakistan are generally reasonable. Also, dutiesthat the Bank would not finance? taxes and duties are not discriminatory against Bank. financed projects. At the project-level, the Bank woulc consider whether taxes and duties constitute an excessive11 highshare o fproject cost. ANNEXVI: CAS CONSULTATIONPROCESS 1. Preparation of the CAS benefited from consultations with Federal and Provincial governments, the private sector, donors and civil society. Consultations were carried out using a two stage process consisting of: (i)a two-part client survey to solicit input on Pakistan's development challenges and the role o f the World Bank in Pakistan, and, (ii) stakeholder consultations with provincial governments, the private sector, and civil society to obtain feedback on the proposed strategy. Highlights of the feedback given duringthe consultation process are summarized below. Client Survey 2. The Client Survey was carried out in October 2004 through February 2005. About 800 stakeholders o f the World Bank in Pakistan were asked to fill out a mail-in survey. Respondents were asked to indicate: (i) their overall attitudes toward the Bank; (ii) o f the broad areas o f the World which Bank's economic and social development activities bring the greatest value to the country; (iii) the importance of specific areas o f the Bank's work and the Bank's effectiveness inthose areas; and (iv) their level o f agreement with a series o f statements about the way the World Bank does business. Respondents were also asked to indicate which o f a list o f general development issues facing Pakistan was o f highest priority and the level of impact a variety o f challenges have on development. In addition, respondents were asked about the Bank's communication and outreach efforts inPakistan. 3. Survey participants were drawn from the federal government, members o f Parliament, provincial government officials, members o f provincial assemblies, district/Tehsil Municipal Administration (TMA) government offices or staff, union councilors, bilateral and multilateral agency staff, private sector businesses or organizations, civil society organizations, the media, and members o f academia. The majority of respondents were federal government officials, indicating that the results o f the survey reflect primarily the views o f the Bank's government counterparts. 4. Insum,theClient Surveyresults showthattheWorldBank's work isappreciatedonanumberof levels, as are certain aspects o f the Bank's relationships with clients and stakeholders in Pakistan. However, there are certain areas o f the Bank's efforts that may require additional focus and attention. 5. Respondents overwhelmingly (80 percent) indicatedthat they felt that Palustan was headed inthe right direction. Poverty reduction emerged as the top development priority with over half o f all respondents identifying it as either the most important or second most important development priority. Respondents also cited education, government effectiveness, and improving the effectiveness o f the law andjustice system as priorities for Palustan. 6. Respondents were also asked to assess the impact o f various development challenges. Inadequate access to quality education and inadequate infrastructure development were considered to have the most significant impact on development inPalustan. Health issues were considered to have the least impact on development. 7. Across all respondents, the Bank's overall effectiveness inPakistan received a 5.6 rating on a 10- point scale, with 1 being very unfavorable and 10 being very favorable. Respondents from local government, federal government officials, and provincial government officials gave the highest favorability ratings o f the Bank. In contrast, respondents from academia, other organizations, and the media gave significantly lower favorability ratings. Respondents saw the Bank as most effective in helping to develop physical infrastructure, helping to develop water resources, and helping to improve the performance o f the energy sector, all receiving mean ratings o f 3.3 on a 5-point scale with 1 being not effective at all and 5 being very effective. The Bank's role as a financier o f development projects was seen as most important. Respondents felt that the Bank's greatest weakness was imposing technocratic solutions without regard to political realities. Stakeholders' views o f the Bank's effectiveness in some Page 2 of3 areas considered top priorities by stakeholders were not terribly positive: poverty, government effectiveness and growth. 8. Across all respondents, there was a solid level o f agreement that the Bank i s a good source o f knowledge; the Bank's effectiveness in producing knowledge (studies, analyses) that i s useful and technically sound bothreceived the ratings o f 3.9 on a 5-point scale with 1being not at all effective and 5 being very effective. There was less agreement, however, that the Bank was abIe to adapt its knowledge to Palustan's needs, receiving a meanrating o f 3.2. 9. Overall relationships are somewhat strong; stakeholders perceive the Bank as relatively accessible, straightforward, and responsive. However the survey revealed that usage o f the Bank's website i s lower in Pakistan than in other S A R countries surveyed last year. This finding i s being examined with a view to developing strategies to increase usage. Usage o f the Public Information Centers i s also low in Pakistan, due in large part to security requirements limiting access to the Bank office in Islamabad. As PICs and websites are important tools for engagement with broader audiences-including "tomon-ow's leaders" (e.g., students)-following up onthese findingwill be apriority. As a first step, full public access to the PIC inIslamabadwas restored inMarch 2006. 10. The initial quantitative survey was followed by a qualitative survey usingmore focused, in-depth interviews with a subset of respondents in order to probe survey responses and get a better sense o f the views and opinions behindthe results o f the quantitative survey. These follow-up interviews were carried out by an independent opinion research firmto provide assurances o f anonymity. 11. Results o f the qualitative follow-up reinforced the relevance o f the Bank's poverty reduction mission while highlighting the importance o f demonstrating results. Respondents unanimously ranked poverty as the greatest challenge facing Pakistan. At the same time some, particularly in the media, expressed skepticism about the benefits o f the recent economic turnaround which they believed was benefiting only a narrow segment o f society. A clear message was that economic growth i s not by itself an adequate measure o f success and respondents want to see clear indications o f concrete improvement in the lives o f the poor. These findings highlightthe importance o f targeted interventions that reach the poor as well as the continuing need to strengthen capacity to generate reliable, timely data on development outcomes both to guide policymakers and to help build support for poverty reduction programs. 12. On the role o f the Bank, the in-depth survey showed that a majority held a positive view o f the Bank's effectiveness. However there was a range o f views about the areas where the Bank i s most effective. There was a strong consensus that the Bank should play a supporting role, allowing the Government to set the agenda and providing support as requested. A majority felt that such a supporting role i s especially important in the areas of governance and corruption where the government must be in the lead. A critical role o f the Bank in this regard i s to monitor the use o f resources. A majority o f respondents appreciated the role o f the Bank in generating and disseminating knowledge, but they urged greater attention to dissemination. A number o f respondents highlighted the need for the Bank to simplify its procedures and reduce the administrative burden o f Bank lending. Stakeholder Workshops 13. A series o f consultation meetings were held in Islamabad and the four provincial capitals during January 2006. Meetings were held with provincial governments, the private sector, Parliamentarians donors and civil society groups. On the whole, there was endorsement o f the general thrust o f the CAS, especially o f its strategic principles and program priorities. Inparticular, there was strong support for the renewed emphasis on infrastructure lending. The CAS was also endorsed by provincial governments which endorsed the overall thrust of the CAS and welcomed the proposedWorld Bank engagement at the provincial level. Each of the provinces urged the Bank to take into account their respective unique challenges and accomplishments and to tailor the Bank program accordingly. There was specific Page 3 of 3 endorsement o f the move away from umbrella multi-province projects in favor of provincial lending. A common theme among the provinces was the need to be mindful o f capacity constraints at the local government level. 14. Consultations with representatives from the private sector were held in Lahore and Karachi. The private sector representatives welcomed the emphasis on infrastructure, especially transport and power. Education was also mentioned as a priority by the private sector with representatives citing the difficulty of finding literate workers for manufacturing work. They voiced strong support for targeted poverty programs and governance, citing problems related to land titling and litigation and the need for stronger regulatory agencies. Financial sector development also emerged as a priority with representatives concerned about access and interest rate fluctuations. There was strong support for an enhanced role for IFC. 15. A civil society stakeholder consultation workshop was held in Islamabad and attended by representatives o f various organizations from throughout Palustan. While participants agreed with the thrust o f the CAS, they expressed concern that the benefits o f growth are not yet reaching the poor and that the Bank should emphasize activities directly targeting the poor. They urged the Bank to use its influence to help ensure that the needs o f the poor are reflected in Government priorities. They also stressed the importance o f timely accurate demographic and social data and urged the Bank to give priority to ensuring that accurate data i s publicly available. Finally, several representatives mentioned the importance o f addressing gender issues. Page 1 of 2 ANNEX WI: GUIDELINESFORIBRD LENDING T h e following guidelines for IBRDlending in various sectors set out k e y sector-specific reforms that would b e needed to establish conditions necessary for successful scaling-up of Bank lending. F Sector Guidelinesfor New Lending [naddition to support for power sector reforms inPRSCs, investment lendinginthe Power power sector will be accompanied by the following key reforms: Satisfactoryprogress on corporatization o f the Water and Power Development Authority with establishment o f legally and financially independent distribution companies operating under competent and stable management Establishment o f a fully functional and institutionally properly placed Central Power Purchase Agency (CPPA), operating under transparent and efficient rules for power trading and financial settlement; Well defmed and sustainable government subsidy policy Well performing regulatory framework, with independent regulator (NEPRA) and separation o f the regulatory, policy, and ownership functions. At the provincial level, investment and development policy lendinginthe water and irrigation would require commitment to and insome cases up-front actions to: Increase transparency o f water allocations and entitlements; improve the quality o f irrigation service delivery though greater user participation, and formal contractual arrangements between bulk water providers and users; and k enhance on-farmproductivity and water use efficiency. At the national level, investment lending for major new IndusBasin storage infrastructure would require: Consensus among the provinces an explicit, transparent agreement for implementing the 1991Water Accord and sharing the benefits equitably an agreed Environmental Flow allocation to the IndusDelta Commitment to institutional reforms and investments at the provincial, canal command and farms levels to ensure more equitable, efficient use o f water Scaled-up investment lending inthe highways will require commitment to increase Highways private sector orientation and enhance management and implementationcapacity inthe National Highways Authority (NHA) as demonstratedby: Increasedprivate sector membership on NHA Executive Board; induction o f adequate professional staff inthe Planning, Design and Procurement sections; introductiono f project management consultants under Project Directors Inaddition, satisfactoryprogress inthe implementationo fexistingprojects including the Highway Rehabilitation Project, including progress infulfilling financial covenants would also be necessary. Lending inthe railways sector would require government commitment to a medium Railways term reformprogramto revitalize Pakistan Railways (PR) as demonstrated by: Appointment o f a professional, private sector CEO to head PRreform, with support o f a dedicatedreformteam inPR; GOP endorsement o f a medium term reformprogram which would, infer d i u , create a professionally managed, commercial freight business with its own rolling stock and staff and transfer non core activities and businesses to a separately managed holding company outside PR; Restructuring the governance o f P R (possibly as a state corporation) under an autonomous and restructured Board; Separation o fpolicy function (to be carried out by the Ministry o f Railways) and operational functions (to be carried out by the restructured PR). Page 2 of 2 Sector Guidelines for New Lending Enhanced investment lending would support a government commitment to move Ports towards port corporatization and professional management combined with a modem institutional and legal framework for port operations as demonstrated by: Induction o f port management specialists; Commitment to abolish the Karachi Dock Labour Board and right-size port labor levels; Updating o f the National Ports Master Plan; Progress inport corporatization; A reduction inport tariffs o f at least 15%. Lendinginthe Urbansector will take place inthe context o fprovincial and local Urban government commitment to develop and implement action plans in the following areas o f urban local government management: policy, institutional andregulatory reforms necessary to improving service provision, and notably water service provision inurban centers, interms o f affordability, reliability, and sustainability (environmental and financial); enhancing the municipal revenue bases through, for example, improving property tax collection; applying formula-based transfers ina timely, predictable manner; and aligning local government revenues with service delivery responsibilities improving local planning capacity, including preparation o f multi-year capital investment programs by local governments and establishment o f mechanisms to ensure consistency between land-use planning and development regulations. Annex B1 Page I of 2 Pakistanat a dance 4/4/06 POVERTY and SOCIAL South Low- Pakistan Asia income I Developmentdiamond' 2005 Population, mid-year (millions) I 155.8 1,447 2,343 GNI per capita (Atlas method, US$) 690 590 510 Life expectancy GNI (Atlas method, US$ billions) 107.3 859 1,188 T Average annual growth, 1999-05 Population (%) 2.4 1.7 1.9 Labor force (%) 3.0 2.1 2.2 Gross primary Most recent estimate (latest year available, 1999-05) capita enrollment Poverty (% of population below nationalpoverty line) 33 Urban population (% of totalpopulation) 34 29 31 Life expectancy at birth (years) 64 63 58 - Infant mortality (per 7,000live births) 74 66 79 Child malnutrition (% of children under 5) 35 49 43 Access to improved water source Access to an improved water source (% of population) 90 84 75 Literacy (% ofpopulation age 15+j 47 61 61 - Gross primary enrollment (% of school-age population) 68 103 100 I Pakistan Male 80 108 105 __ Low-incomegroup Female 57 97 94 I KEY ECONOMIC RATIOS and LONG-TERMTRENDS 1985 1995 2004 2005 I Economicratios' GDP (US$ billions) 31.1 60.6 96.1 110.7 Gross capital formationiGDP 18.3 18.5 17.3 16.8 Exports of goods and servicesiGDP 10.4 16.7 16.0 15.3 Trade Gross domestic savingsiGDP 5.9 15.8 18.4 12.2 - Gross national savings/GDP 22.7 21.0 23.0 18.0 Current account balanceiGDP -4.1 -4.0 2.0 -1.3 1 Interest paymentsiGDP 1.7 2.0 0.8 0.7 Domestic Total debffGDP 43.2 49.9 37.1 31.8 savings Total debt sewiceiexports 24.5 27.6 22.3 12.3 Present value of debffGDP 29.8 I 1 Present value of debffexpods 149.3 Indebtedness 1985-95 1995-05 2004 2005 2005-09 (average annual growth) GDP 5.2 3.7 6.4 7.8 6.5 I - Pakistan GDP per capita 2.6 I.2 3.9 5.2 4.6 __ Low-incomegroup Exports of goods and sewices 9.8 6.5 -1.5 7.6 15.5 STRUCTURE of the ECONOMY 1985 1995 2004 2005 (% of GDP) Growth of capital and GDP (Oh) I Agriculture 28.5 26.1 22.3 21.6 Industry 22.5 23.8 24.9 25.1 Manufacturing 15.9 16.3 17.6 18.2 Services 49.0 50.1 52.7 53.3 Household final consumption expenditure 82.0 72.4 73.3 80.0 General gov't final consumption expenditure 12.1 11.7 0.4 7.0 Imports of goods and services 22.8 19.4 14.9 19.9 -GCF +GDP I 1985-95 1995-05 2004 2005 1 (average annual growfh) Growth of exports and imports (X) Agriculture 4.1 2.7 2.2 7.5 ' T Industry 6.3 4.4 12.0 10.2 40 6 0 1 Manufacturing 5.7 5.9 14.1 12.5 Services 5.2 4.3 6.0 7.9 20 - Household final consumption expenditure 4.3 3.5 8.2 16.8 General gov't final consumption expenditure 3.9 2.4 2.1 2.3 Gross capital formation 4.3 0.8 -3.2 1.7 Imports of goods and services 3.4 1.4 -8.6 44.1 Note: 2005 data are preliminary estimates. Group data are to 2004. * The diamonds show four key indicators In the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete. Annex Bl Page 2 of 2 Pakistan PRICES and GOVERNMENT FINANCE 1985 1995 2004 2005 Inflation (Oh) Domestic prices (% change) ' O T Consumer pnces 13 0 4 6 9 3 Implicit GDP deflator 4 5 13 9 7 8 9 8 Government finance (% of GDP, inciudes current gfank) Current revenue 164 17 1 15 1 14 3 Current budget balance -1 3 -2 5 1 1 -0 1 -GDP deflator +CPI Overall surDlus/deficit -7 8 -6 7 -1 8 -3 0 I TRADE 1985 1995 2004 2005 Export and import levels (US$ mill.) (US$ miiiions) ~ I Total exports (fob) 2,460 7,759 12,395 14,371 20,000 Cotton 279 62 48 111 Rice 222 454 634 533 15.000 Manufactures 1,922 4,627 7,568 8,268 Total imports (cif) 6,009 10,296 13,607 18,724 10,000 Food 1,627 659 706 5.000 Fuel and energy 1,398 1,722 3,066 4,534 I Capital goods 0 99 00 01 02 03 04 05 Export pnce index (2000=100) 117 115 124 Import pnce index (2000=100) 107 118 131 0 Exports mlmports Terms of trade (2000=100) 110 98 94 BALANCE of PAYMENTS 1985 1995 2004 2005 i Current account balanceto GDP (Oh) (US$ miiiions) n Exports of goods and services 3,247 9,628 15,123 17,725 ' T Imports of goods and services 7,106 13,023 17,714 25,557 Resource balance -3,859 -3,396 -2,591 -7,832 4 1 2 1I Net income -506 -1,725 -2,207 -2,394 Net current transfers 3,090 2,709 6,684 8,819 nl in Current account balance -1,275 -2,416 1,886 -1,407 g9 00 3 02 03 04 05 Financing items (net) 227 2,647 -809 2,019 2 Changes in net resewes 1,048 -231 -1,077 -612 -4 1- Memo: Reserves including gold (US$miiiions) 1,190 3,534 11,395 10,722 Conversion rate (DEC, /oca//US$) 152 30 8 57 6 59 1 EXTERNAL DEBT and RESOURCE FLOWS 1985 1995 2004 2005 [ (US$ miiiions) Composition of 2005 debt (US$ mill.) Total debt outstanding and disbursed 13,465 30,229 35,687 35,208 IBRD 352 3,581 2,601 2,464 G' 1.245 A: 2,464 IDA 1,312 3,340 6,020 6,651 F.2,054 Total debt service 1,435 3,216 4,285 2,736 IBRD 58 413 386 400 IDA 19 55 141 161 composition of net resource flows Official grants 257 312 574 379 Official creditors 443 932 -685 905 Pnvate creditors -169 318 152 -389 Foreign direct investment (net inflows) 131 442 752 1,162 / Portfolio equity (net inflows) 0 1,280 156 465 D 7,367 World Bank program Commitments 678 706 781 847 A IBRD - E -Bilateral Disbursements 152 691 304 984 B IDA . D. Other multilateral F Private Pnncipal repayments 37 235 385 431 G Short-ten -- Net flows 115 456 -81 554 Interest payments 40 233 143 130 Net transfers 75 222 -224 424 Development Economics 4/4/06 Annex B2 Page I of I Pakistan Selected Indicators* of Bank Portfolio Performance and Management As of March 21,2006 Indicator 2004 2005 2006 Portfolio Assessment NumberofProjects UnderImplementation a 15 18 16 18 Average Implementation Period (years) b 3.1 2.7 2.5 2.8 Percent o f Problem Projects by Number a, c 6.7 5.6 12.5 16.7 Percent o f Problem Projects by Amount a, c 23.2 19.6 7.2 6.3 Percent o f Projects at Risk by Number a, d 6.7 5.6 12.5 16.7 Percent o f Projects at Risk by Amount a, d 23.2 19.6 7.2 6.3 Disbursement Ratio (%) e 28.0 24.7 40.7 33.2 Portfolio Management CPPR duringthe year (yesfno) Supervision Resources (total US$) Average Supervision (US$/project) Memorandum I t e m Since FY 80 Last Five FYs Proj Eval by OEDby Number 141 18 Proj Eval by OED by Amt (US$ millions) 11,030.4 3,237.6 % o f OED Projects Rated Uor HUby Number 22.0 16.7 % o f OED Projects Rated Uor HUby Amt 25.2 11.2 a. As shown inthe Annual Report on Portfolio Performance (except for current FY). b. Average age o fprojects in the Bank's country portfolio. c. Percent o fprojects rated Uor HUon development objectives (DO) and/or implementation progress (IP). d. As definedunder the Portfolio Improvement Program. e. Ratio o f disbursements during the year to the undisbursed balance o f the Bank's portfolio at the * beginning o f the year: Investment projects only. All indicators are for projects active inthe Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year. Annex B3 Page I of 3 Pakistan FY06-09 Lending Program Projects U n d e r Consideration"' - (as of April 2006) FY06 Punjab EducationDPC I1 100 100 M H PIFRA I1 84 84 M M EarthquakeResponse Additional Financinge/ - 340 100 440 H H EarthquakeEmergencyRecovery Credit 400 400 M H Polio EradicationI1 47 47 M M National Highways Rehab Additional Financing - 65 65 M L NWFP DPC I 90 90 H H BalochistanPrimary Education 20 20 M H Punjab IrrigationDPL I 100 100 H H Punjab Municipal ServicesImprovement 50 50 M H PRSC I1 300 300 H H Punjab LandRecordsManagement 35 35 H H Result 1,416 315 1,731 FY07 PRSC I11 300 300 H H Punjab EducationDPC I11 100 100 M H NWFP DPC I1 130 130 H H Sindh EducationDPC I 50 50 H H Punjab IrrigationDPL I1 100 100 H L SindhWater Sector Improvement 140 140 H H BalochistanSmall Scale Irrigation 25 25 M H Electricity Transmissionand Distribution 200 200 H H DERA IIiKushaal Pakistan 200 200 M M National Trade Corridor I 300 300 H H Water Investment TA 50 50 H M Lady HealthWorkers 200 200 M M Result 945 850 1,795 FY08 PRSC IV 100 200 300 H H PunjabEducationDPC IV 100 100 M H NWFP DPC 111 130 130 H H Sindh EducationDPC I1 50 50 H H Punjab IrrigationDPL 111 100 100 H H EarthquakeRecoveryCredit I1 125 125 M H Higher Education 100 100 M H Punjab BarrageRehabilitation 200 200 L M BalochistanMineralSector Development 25 25 50 M M PunjabLarge Cities Improvement DPL I 100 100 H M Social Protection 50 50 M H Kushaal Pakistadsocialmobilization 150 150 H M Health Surveillance System Improvement 50 50 M M National Trade Corridor I1 300 300 H H Sindh FiscalDPC 100 100 H H Result 605 1,300 1,905 FY06-08 Expected Total CommitmentsE/ 2,365 2,465 4,830 Annex B3 Page 2 of 3 Pakistan FY06-09 LendingProgramProjectsUnder Considerationa' - (as o f April 2006) Fiscal Strategic Implementation Year Project Name b/ W$(M) Rewards d/ Risks IDA IBRD Total FY09 PRSCV 350 350 H H PunjabEducationDPC V 100 100 H H NWFP DPC IV 130 130 H H PakistanPovertyAlleviation Fund I11 200 200 M M Sindh DPC 150 150 H H Punjab Large Cities ImprovementDPL I1 100 100 H H Electricity Transmission and DistributionI1 200 200 H H Rural Telecom 30 30 M M Capacity Building I1 100 100 M M National Trade Corridor 111 300 300 H H Provincial Irrigation Infrastructure 100 100 M M FederalWater Infrastructure 300 300 H H Result 1,030 1,030 2,060 FY06-09 ExpectedTotal Commitments fl 3,090 3,400 6,490 a/ This table presents possible projectsunder consideration for the four-year CAS period.Dependingupon evolving countryneeds and priorities, additionalprojects may be added andothers may be dropped. Type of financing (IBRD, IDA or blend) may also be adjusted. Overall lending will remainwithin limits set by IDA availability (estimatedat S3.1 billion) and IBRD lending envelope (up to 53.4 billion). b/ Project titles are subject to modificationas project details are further refined. c/ All amounts are indicative d/ Indicateswhether Strategic Rewards and ImplementationRisks are expectedto be High(H),Moderate (M),or Low (L). e/ Includesadditional IDA financing under PRSC I($150 million), NWFP SAC I1($50 million), PPAF I1($100 million), AJK Community Infrastructureand ServicesProject(530 million) and NWFP On-FarmWater Management ($10 million), and IBRDlending ($100 million) under National Highways Rehabilitationproject. f/ Reflects expectedtotal commitments based on IDA 14 availability and IBRD lending at the upper endof the proposedrange Annex B3 Page 3 of 3 Pakistan IFC andMIGA Program,FY 2003-2006 - 2003 2004 2005 2006 IFC approvals (US$m) 84.3 80.7 41.4 150.0 Sector (YO) Collective Investment 1 12 Finance & Insurance 47 56 38 Information 6 Pulp & Paper 73 Textiles, Apparel & 42 37 Transportation and 11 14 62 Total 100 100 99 100 Investmentinstrument(%) Loans 45 14 90 Equity 1 8 25 10 Quasi-Equity 7 Other 47 92 60 Total 100 100 99 100 MIGA guarantees (US$m) 141.0 138.5 0.0 0.0 Annex 84 Page 1 of2 Pakistan Summary of Nonlending Services - As o f April 2006 Product Completion FY Cost (US$OOO) Audience a Objective Recent completions Water Sector Strategy 2005 210 PD, PS NWFP Economic Report 2005 355 PS Country Gender Assessment 2005 490 KG, PD, PS Disease SurveillancePolicy Note 2005 65 KG, PD, PS Pakistan Trade Policy Notes I 2005 70 KG, PD, PS Earthquake PreliminaryDamageand NeedsAssessment 2006 150 KG, PD, PS Growth and Export Competitiveness 2006 300 KG, PD, PS SindhEconomic Report 2006 390 KG, PD, PS Underwav/Planned Disability TAiAction Plan 2006 KG, PS PensionReform Strategy 2006 KG, PS Provincial ProcurementAssessment 2006 KG, PS Rural Growth and PovertyReduction 2006 KG, PD, PS Safety Net Report 2006 KG, PD, PS Higher EducationPolicy Note 2006 KG, PD, PS Social ProtectionTA 2006 PS Labor Market Study 2006 KG, PD, PS Strategic Country EnvironmentAssessment 2006 KG, PD, PS Trade Policy Notes 2006 KG, PD, PS Gap Analysis of Public AccountingandAuditing 2006 KG, PS Urbannon-LendingTA 2006 KG, PD, PS TransportCompetitiveness 2006 KG, PD, PS BalochistanEconomicReport 2007 KG, PD, PS Public SectoriJudicialStudy 2007 KG, PD, PS PovertyUpdate 2007 KG, PD, PS PrivateSector Educationin Punjab 2007 KG, PD, PS Tax Policy Study 2007 KG, PD, PS EducationSectorReport 2007 KG, PD, PS CompetitionPolicy TA 2007 PS InvestmentClimate Assessment 2007 KG, PD, PS Health Sector Review 2007 KG, PD, PS Livestock Policy Note 2007 KG, PD, PS Local Government Civil ServiceReformTA 2007 PS Oil & Gas Non-LendingTA 2007 PS Public FinancialMgtiAccountability Assessments 2007 KG, PD, PS Monitoring and EvaluationTA 2007 PS PensionReformTA 2007 PS DevelopmentPolicy Review 2007 KG, PD, PS Provincial Public FinancialAccountability Assessment 2007 KG, PD, PS Public-PrivatePartnershipinEducation 2007 KG, PD, PS Wheat Policiesand FoodSecurity 2007 KG, PD, PS Access to Finance 2008 G, D, p, B KG, PS CapitalMkt.TA 2008 G, D, B KG, PS Devolution TAiPolicy Note 2008 G, D, p, B KG, PD, PS HDMonitoring and EvaluationTA 2008 G, D, p, B KG, PD, PS SindhEducation 2008 G, D,P, B KG, PD, PS Statistical StrengtheningTA 2008 G, D, B PS FisheriesPolicy Note 2008 G, D,P, B KG, PD, PS Annex B4 Page 2 of2 Pakistan Summary of Nonlending Services - As of April 2006 Product Completion FY Cost (US$OOO) Audience a Objective LandMarketsAdministration TA 2008 G, D, P, B KG, PD, PS Policy Notes for New Government 2008 G, D, P, B KG, PD, PS Micro-insuranceReport 2008 G, D, P, B KG, PD, PS PPP for Agriculture Technologyand Services 2008 G, D, P, B KG, PD, PS SkillDeveloprnent/LaborMarket TA 2008 G, D, B KG, PD StatisticStrengtheningTA 2009 G, D, B KG, PD HousingFinance 2009 G, D, P, B KG, PD, PS DebtMarketDevelopment 2009 G, D, p, B KG, PD, PS Access to Finance 2009 G, D, P, B KG, PD, PS Banking SectorTA 2009 G, D, p, B KG, PD, PS EducationTA 2009 G, D, P, B KG, PD, PS a. Government (G), Donor (D), Bank (B), Public Dissemination(P) b. KnowledgeGeneration, (KG), Public Debate(PD), Problem-Solving(PS) Annex B5 Page I of I Pakistan Social Indicators Latest single year Same regionlincome group South Low- 1975-80 1985-90 1999-05 Asia income POPULATION Total population, mid-year (millions) 82.7 108.0 155.8 1,447.7 2.338.1 Growth rate (% annual average for period) 3.0 2.6 2.4 1.7 1.8 Urban population (% ofpopulation) 28.1 30.6 34.5 28.3 30.7 Total fertility rate (births per woman) 7.0 5.8 4.5 3.0 3.6 POVERTY (% of population) National headcount index 32.6 Urban headcount index 24.2 Rural headcount index 35.9 INCOME GNI per capita (US$) 330 420 670 590 510 Consumer price index (1995=100) 185 Food price index (1995=100) INCOMElCONSUMPTlON DISTRIBUTION Gini index 33.0 Lowest quintile (% of income or consumption) 8.8 Highest quintile (% of income or consumption) 42.3 SOCIAL INDICATORS Public expenditure Health (% of GDP) 1.1 1.3 1.5 Education (% of GNl) 2.0 2.7 3.1 3.2 Social security and welfare (% of GDP) 0.2 0.2 Net primary school enrollment rate (% of age group) Total 59 87 78 Male 68 89 82 Female 50 85 76 Access to an improved water source (% of population) Total 83 90 84 75 Urban 95 95 93 89 Rural 78 87 80 69 Immunization rate (% of children ages 12-23 months) MeasIes 1 50 61 67 66 DPT 2 54 67 71 67 Child malnutrition (% under 5years) 53 49 35 48 44 Life expectancy at birth (years) Total 53 59 64 63 58 Male 53 58 63 62 57 Female 54 60 65 64 59 Mortality Infant (per 1,000 live births) 105 96 74 66 79 Under 5 (per 1,000) 156 138 98 92 122 Adult (15-59) Male (per 1,000population) 283 232 221 249 317 Female (per 1,000 population) 291 230 198 199 266 Maternal (per 100,000 live births) 500 534 538 Births attended by skilled health staff (%) 23 36 38 CAS Annex 85. This table was producedfrom the CMU LDB system. 04/06/06 Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due to change from ISCED76to ISCED97. Immunization:refers to children ages 12-23 months who receivedvaccinations before one year of age. Annex B6 Page 1 of 2 Pakistan- Key EconomicIndicators Gross domestic productd 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture 24.4 23.6 23.6 22.3 21.6 21.0 20.5 20.0 19.4 Industry 23.1 22.9 23.0 24.9 25.1 25.8 26.8 27.7 28.3 Services 52.5 53.4 53.4 52.7 53.3 53.2 52.8 52.3 52.3 Total Consumption 83.9 83.3 82.5 81.6 87.8 91.5 90.7 89.5 88.7 Gross domestic fixed investment 15.8 15.5 15.3 15.6 15.3 16.5 17.8 18.9 19.4 Government investment 5.7 4.2 4.0 4.8 4.4 2.7 3.4 3.6 3.8 Privateinvestment 10.2 11.3 11.3 10.8 10.9 13.8 14.4 15.3 15.6 Exports(GNFS)b 14.8 15.4 16.9 16.0 15.3 16.5 17.9 19.5 21.7 Imports (GNFS) 15.9 15.5 16.3 14.9 19.9 26.1 27.9 29.5 31.3 Gross domestic savings 16.1 16.7 17.5 18.4 12.2 8.5 9.3 10.5 11.3 Gross national savings` 17.7 19.7 23.1 23.0 18.0 14.1 15.0 16.1 16.8 Memorandum items Gross domestic product 71496 71485 82350 96115 110732 125514 134880 145209 156626 (US$ million at current prices) GNIper capita (US, Atlas method) 480 490 520 600 670 730 810 870 920 Realannual growth rates ("h,calculated from 2000 prices) Gross domestic productat market prices 1.9 3.2 5.0 6.4 7.8 6.3 6.5 6.6 6.8 Gross Domestic Income 0.8 3.1 2.8 6.0 7.2 4.0 6.3 6.1 6.0 Real annual per capita growth rates (%, calculated from 2000 prices) Gross domestic product at market prices -0.6 0.8 2.5 3.9 5.2 4.3 4.5 4.6 4.8 Total consumption -2.8 0.4 -1.2 4.9 12.5 5.2 3.9 3.5 4.1 Privateconsumption -2.2 -0.9 -1.9 5.6 14.0 5.0 3.8 3.4 3.7 Balance of Payments(US$millions) Exports(GNFS)b 10284 11056 13686 15123 17725 20755 24094 28381 33935 Merchandise FOB 8934 9140 10889 12395 14371 16764 19846 23857 29116 Imports (GNFS)~ 12535 11646 14047 17714 25557 32713 37570 42768 49054 Merchandise FOB 10202 9432 11333 13607 18724 23967 28255 32735 38223 Resourcebalance -2251 -590 -361 -2591 -7832 -11958 -13475 -14386 -15119 Net current transfers 3299 4500 6775 6684 8819 9623 10182 10508 10904 Current accountbalance -1112 1591 4204 1886 -1407 -4918 -5800 -6237 -6396 Net private foreign direct investment 322 368 612 752 1162 3080 5019 4081 4780 Long-term loans (net) -489 -1490 -868 -1531 -1885 1983 1788 2504 2013 Official 747 781 -147 -685 905 1185 1235 1458 1620 Private -1236 -2271 -721 -846 -2790 798 553 1046 393 Other capital(net,incl.errors & ommissions) 2560 2807 1731 -30 2742 619 670 770 770 Change inreservesd -1282 -3276 -5679 -1077 -612 -764 -1677 -1118 -1167 Memorandum items Resourcebalance("A of GDP) -3.1 -0.8 -0.4 -2.7 -7.1 -9.5 -10.0 -9.9 -9.7 Realannual growth rates ( YROO prices) Merchandise exports (FOB) 11.9 5.6 8.1 2.7 7.9 13.2 16.1 19.0 21.1 Merchandise imports(CIF) 7.3 -5.1 8.0 9.3 23.6 18.6 17.3 16.1 16.6 Annex 86 Page 2 of 2 Pakistan Key Economic Indicators - (Continued) Actual Estimate Projected Indicator 2001 2002 2003 2004 2005 2006 2007 2008 2009 Publicfinance (as % of GDP at marketprices)e Current revenues 14.3 16.3 17.5 15.1 14.3 14.0 14.7 14.8 15.1 Current expenditures 15.5 15.9 16.6 14.0 14.4 14.1 14.0 13.6 13.5 Current account surplus (+) or deficit (-) -1.3 0.3 0.8 1.1 -0.1 -0.1 0.6 1.2 1.6 Capitalexpenditure 1.7 2.9 1.8 3.3 3.9 3.8 4.5 4.7 4.9 Foreignfinancing 1.9 1.2 -0.5 -0.7 1.7 1.8 1.5 1.9 1.4 Monetaryindicators M2iGDP 36.7 40.0 43.1 44.9 45.3 46.1 46.8 48.0 49.3 Growth of M 2 (%) 9.0 15.4 18.0 19.6 19.3 17.0 15.1 15.3 15.2 Private sector credit growth 1 1318.9 125.8 1852.9 81.8 101.1 60.6 81.8 86.1 87.5 total credit growth ("h) Price indices( YROO =loo) Merchandiseexport price index 91.9 89.0 98.1 108.8 116.8 120.4 122.7 124.0 125.0 Merchandiseimportprice index 96.4 93.9 104.4 114.7 127.8 137.9 138.6 138.3 138.5 Merchandiseterms o f trade index 95.3 94.8 93.9 94.8 91.4 87.3 88.5 89.6 90.2 Consumer price index (% change) 4.4 2.7 3.1 4.6 9.3 8.9 6.2 5.2 4.8 GDP deflator ("hchange) 7.7 2.4 4.4 7.8 9.8 8.2 6.5 5.5 5.0 a. GDP at factor cost b. "GNFS" denotes "goods andnonfactorservices." c. Includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Consolidatedcentral government. f. "LCU" denotes "local currency units."An increase inUS$/LCUdenotes appreciation. Annex B7 Page 1 of1 Pakistan Key Exposure Indicators - Actual Estimate Projected Indicator 2001 2002 2003 2004 2005 2006 2007 2008 2009 Total debt outstandingand 31706 33675 35885 35687 35208 37032 38668 40991 42777 disbursed (TDO) (USSm)a Net disbursements (US$m)a 554 341 43 230 261 1871 1636 2324 1786 Totaldebt service (TDS) (US$m)a 2996 2850 2936 2907 2780 2438 2703 2900 3651 Debt anddebt service indicators (?h) TDO~XGS~ 276.1 248.4 198.3 186.1 158.4 144.5 132.3 121.3 107.9 TDOiGDP 44.3 47.1 43.6 37.1 31.8 29.5 28.7 28.2 27.3 TDSiXGS 26.1 21.0 16.2 15.2 12.5 9.5 9.2 8.6 9.2 ConcessionaliTDO 61.9 64.5 67.2 IBRD exposureindicators (%) IBRD DSipublicDS 17.6 15.8 14.5 10.4 17.7 19.9 16.5 15.1 11.6 PreferredcreditorDSipublic DS (%)c 61.9 61.9 69.2 70.7 61.3 60.4 57.1 52.7 42.8 IBRD DSiXGS 3.5 2.8 2.0 2.0 1.8 1.6 1.3 1.2 1.o IBRD TDO (US$mld 3043 2943 2813 2601 2464 2149 2192 2571 2835 Shareof IBRD portfolio (%) 2.5 2.4 2.4 2.4 2.3 2.1 2.2 2.5 2.7 IDA TDO (USSmld 4123 5097 5604 6020 6651 7309 8013 8674 9583 IFC (US$m) Loans 332.2 305.4 252.9 193.0 168.0 136.0 100.0 100.0 150.0 Equity and quasi-equity /e 76.2 84.5 71.8 62.0 57.0 46.0 50.0 50.0 80.0 Guarantees 64.5 88.4 75.9 116.0 105.0 135.0 MIGA MIGA guarantees(USSm) 97.0 154.0 128.0 142.0 129.6 129.6 a. Includespublic andpublicly guaranteeddebt, privatenonguaranteed,use o f IMF credits and net short- term capital. b. "XGS" denotesexports of goods and services, includingworkers' remittances. c. Preferredcreditors are defined as IBRD,IDA, the regionalmultilateraldevelopmentbanks, the IMF, and the Bank for InternationalSettlements. d. Includespresentvalue of guarantees. e. Includesequity and quasi-equitytypes of bothloan and equity instruments. f. RepresentsmaximumIBRDexposurebasedon lendingat the upperendoftheproposedCAS lendingrange. :: 9 s 42