IMF says Pakistan economic outlook favourable, outlines risks

The Executive Board of the International Monetary Fund (IMF) concluded its Article IV consultation* with Pakistan on June 14, 2017.

Pakistan’s outlook for economic growth is favourable, the IMF said, with real GDP estimated at 5.3% in FY2016/17 and strengthening to 6% over the medium term on the back of stepped-up China Pakistan Economic Corridor (CPEC) investments, improved availability of energy, and growth-supporting structural reforms. Inflation has been gradually increasing but remains contained, the IMF team said, and the financial sector has remained sound.

However, macroeconomic stability gains made under the 2013-16 IMF Extended Fund Facility (EFF)-supported programme have begun to erode and could pose risks to the economic outlook, the IMF warned. Fiscal consolidation has slowed, with the 2016/17 budget deficit target of 4.2% of GDP (authorities’ latest projection) is likely to be exceeded, the IMF said.

The current account deficit has widened and is expected at 3% of GDP in 2016/17, driven by quickly rising imports of capital goods and energy. Foreign exchange reserves have declined in the context of a stable rupee/dollar exchange rate. On the structural front, while the successful implementation of business climate and financial inclusion reforms has continued, some renewed accumulation of arrears in the power sector has been observed, and financial losses of ailing public sector enterprises continue to weigh on scarce fiscal resources.

IMF Directors agreed** that the growth outlook remains favourable, but noted that policy implementation weakened recently and macroeconomic vulnerabilities are reemerging. They  emphasised that sustained fiscal consolidation over the medium term, in line with the Fiscal Responsibility and Debt Limitation (FRDL) Act, is critical to strengthen economic resilience, safeguard fiscal sustainability, and limit pressures on the current account and international reserves.

To this end, Directors recommended mobilising additional tax revenues by broadening the tax base and strengthening tax administration; and enhancing the composition of public spending by containing the wage bill’s growth, further reducing electricity subsidies, and increasing priority social spending. They suggested strengthening the national fiscal federalism framework and public debt management.

Directors stressed the importance of maintaining a prudent monetary policy stance to preserve low inflation, and of further advancing financial sector reforms to continue strengthening resilience and support financial deepening. They welcomed the progress in fostering financial inclusion and implementing the business climate reform strategy, and encouraged the authorities to press ahead with these efforts. Directors also recommended further strengthening social safety nets.

*Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

**At the conclusion of the discussion, the MD, as Chairman of the Board, summarises the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here.

IFSB PSIFIs project to be extended

The growth of Islamic finance has led to its emergence as a systemically important sector in an increasing number of economies in the Arab speaking countries, as well as in Asia, said Jaseem Ahmed, Secretary-General, Speech by the Secretary-General of the Islamic Financial Services Board (IFSB) at the AMF-IFSB-IMF Conference on Soundness Indicators for Conventional and Islamic Finance.

Jaseem noted that the International Monetary Fund (IMF) had recently approved the preparation of proposals for operationalising policy support to Islamic finance jurisdictions.
The Executive Board of the IMF held its first formal discussion on Islamic banking (IB) on February 3, and adopted a set of proposals on the role that the fund should play in this area. These proposals, and the case for adopting them, are contained in the staff paper Ensuring Financial Stability in Countries with Islamic Banking and the accompanying country case studies paper.

According to the IMF, IB is present in more than 60 countries and has become systemically important in 14 jurisdictions. "IB involves operations, balance sheet structures, and risks that differ from their conventional banking counterparts. Accordingly, there is a need for putting in place an environment that promotes IB financial stability and sound development, including legal, prudential, financial safety nets, anti-money laundering and countering the financing of terrorism (AML/CFT), and liquidity management frameworks," the IMF said in a statement.

As the number and complexity of IB-related issues arising during IMF country surveillance and the demand for policy advice and capacity development in this area have increased, the IMF's Directors have called for stronger efforts to establish a policy framework and environment that promote financial stability and sound development of Islamic banking, particularly for countries in which Islamic banking has become systemically important.

IMF Directors expressed support for staff's proposed approaches to developing and providing policy advice on Islamic banking-related issues in the context of Fund surveillance, programme design, and capacity development activities. They also called for staff's continued support to the work of the relevant international standard setters and other international bodies to help address current gaps in the international regulatory framework for Islamic banking. 

Directors saw merit in considering a proposal to formally recognise the Core Principles for Islamic Finance Regulation for Banking, prepared by the IFSB as a standard under the Fund/Bank Standards and Codes Initiative. Directors also called for full implementation and consistent application of the standards, and for strengthening supervisory capacity with respect to Islamic banking.

Directors emphasised the importance of having in place robust Islamic banking-specific resolution regimes and other financial safety nets for countries in which Islamic banking operates. Noting the slow progress achieved in these areas, they underscored the importance of additional work in collaboration with relevant international bodies on the design of legal regimes and institutional arrangements for effective Islamic banking resolution, deposit insurance schemes and AML/CFT, as well as adapting the conventional lender-of-last-resort framework to cover Islamic banking.

Directors agreed that the availability of high-quality liquid assets for Islamic banking is important for effective liquidity management and financial stability, and for the sustainable development of the Islamic banking industry. In this context, they called for increased efforts to deepen the government sukuk markets. Directors also noted the importance of having in place relevant central banking liquidity facilities and instruments.

Directors agreed that the emergence in recent years of hybrid financial products in Islamic banking, which replicate the relevant aspects of conventional finance, may have brought some benefits, but also raise financial stability concerns. Such concerns include the emergence of new complex risks, the applicability of existing prudential regimes, governance and consumer protection concerns, and reputational risk. Directors encouraged additional work, by staff and other relevant international bodies and standard setters, to better understand the nature of these activities and how they can be effectively regulated.

"A key aspect of the proposals is that they will recommend the recognition of the IFSB’s Core Principles for Islamic Finance Regulation of the Banking Sector (IFSB-17), under the IMF/WB Standards and Codes Review, Jaseem said. "The IFSB welcomes these developments, which point towards an international recognition of Islamic finance that is commensurate with its importance and significance to large communities of human beings in the world today, and to financial and economic stability internationally."

Islamic finance has a system of ethics, is grounded on the real economy and on risk sharing, and avoids harmful activities, Jaseem noted, but also has risks such as those resulting from uneven development of Islamic financial markets and financial instruments.

"The external vulnerability is faced by us all: namely, that the performance of the Islamic financial system cannot be isolated from developments in conventional finance and in the global economy. We are vulnerable to external economic, financial and monetary shocks and these seem to be bigger or more volatile than ever. These vulnerabilities remain with us, they are real and they bring large risks with them which must be identified, made transparent, and managed at both the micro and macro levels," he said.

To determine if the industry can withstand turbulence arising from both internal and external sources of risk, a well-developed global database with reliable time series data is required for macroprudential oversight. The Financial Soundness Indicators (FSIs) from the IMF and adapted by the IFSB are just such a tool. FSIs are macroprudential indicators of the condition of the entire system that supplement the traditional microprudential measures used by bank supervisors. In 2004, the IFSB launched a global database of Prudential and Structural Islamic Financial Indicators (PSIFIs), which are the measures of the aggregate strength or vulnerabilities of the Islamic financial system.

The PSIFIs consist of 19 core and eight additional core indicators, compared to the IMF’s FSIs 12 core and eight additional core indicators. PSIFIs data are similar to the FSIs, aggregated banking sector data of an individual country. As almost all of the core indicators on asset quality, earnings, leverage, liquidity and sensitivity to market risks are similar to FSIs, the indicators permit a comparison with the IMF’s FSIs for a country’s entire financial system.

These PSIFIs would also facilitate comparisons between conventional banks and institutions offering Islamic financial services as part of a peer group exercise on the effectiveness of the application of the IFSB capital adequacy formula.

In phase I, the IFSB Secretariat established a Task Force for the project and undertook the preparation of a Compilation Guide which was adopted by the IFSB Council in March 2007. The IMF, Asian Development Bank (ADB) and the Islamic Development Bank (IDB) supported the PSIFIs from the beginning, and are important members of this and subsequent Task Forces.

This was followed in Phase II by a pilot study of the compilation of data through which the IFSB developed a standardised reporting template in which four member countries – namely Indonesia, Malaysia, Pakistan and Sudan – participated.

In 2014, the IFSB launched the third phase of the PSIFIs project with the aim of achieving, by 2016, the first dissemination of data, as well as a further revision of the Compilation Guide, particularly to align it with the developments of Basel III. After the successful launch of PSIFIs data on 27 April 2015, the IFSB has been regularly disseminating macro-level data collected from 17 IFSB member countries. The database is accessible to the public.

"Overall, the PSIFIs member countries collectively hold more than 85% of global Islamic banking assets. Amongst these countries are eight economies which are also members of the Arab Monetary Fund (AMF), and in which the Islamic finance sector is of systemic importance – in that it accounts for more than 15% of total banking sector assets," said Jaseem.

He also disclosed that a fourth phase of the PSIFIs project, to further extend the coverage of the database to additional countries that have a stake in the Islamic banking sector, has been approved.
Jaseem added that the Bank of England has recently confirmed that it will join the PSIFIs project.

"Today, the PSIFIs database comprise a set of well-developed and tested Islamic finance statistics reflecting sharī`ah-compliant accounting practices and regulatory standards that serve the purpose of better oversight by regulatory and supervisory authorities and the global surveillance community, as well as the analytical needs of the IFSB which are shared with our international stakeholders through the IFSB’s Annual Islamic Financial Services Industry Financial Stability Report," he said.

"The national and international members of the IFSB PSIFIs Task Forces have contributed enormously to the development and the streamlining of the reporting formats, and to the coming on line of this project. It will be important to continue this collaboration, and to develop both formal and informal networks of experts and knowledge centres, as we jointly attempt to better understand and control both domestic and cross-border sources of risks emanating from interconnected financial and economic systems," Jaseem said.

"Our goal should be further collaboration among international and national organisations so as to better measure these interconnected elements which can support better contingency planning and timely policy response by the authorities."

IMF forecasts challenging year for Palestine

• Strong revenue mobilisation efforts contributed to a marked reduction in the 2016 fiscal deficit
• 2017 is likely to be a very challenging year for the Palestinian economy
• Budget pressures require continued strong domestic policies, more donor support, and more predictable revenue transfers from Israel.

An International Monetary Fund (IMF) mission led by Karen Ongley visited East Jerusalem and Ramallah from January 31 to February 9, 2017 to assess recent economic developments in the West Bank and Gaza and the financial situation of the Palestinian Authority (PA).

The mission met with Prime Minister Rami Hamdallah, Finance Minister Shukry Bishara, Governor Azzam Shawwa, and other Palestinian officials. At the end of the mission, Ongley issued the following statement that outlined "increasingly difficult conditions" for the Palestinian economy.

“While we estimate that GDP growth increased from 3.5% in 2015 to 4% in 2016, this was not sufficient to generate new jobs and unemployment rose to more than 28% in September. Consumption is still the primary driver of growth, as political uncertainties and access restrictions continue to inhibit private sector investment across the West Bank. While donor-funded reconstruction in Gaza continued, aid disbursements were delayed and humanitarian conditions remain dire, particularly as the provision of public services worsens," Ongley noted in the statement.

“The Ministry of Finance and Planning managed these testing circumstances skillfully. Strong revenue mobilisation efforts contributed to a marked reduction in the 2016 fiscal deficit. In particular, discussions between the PA and government of Israel contributed to the payment of past obligations to the PA and these one-off factors helped to increase tax and non-tax receipts by about two percentage points of GDP. The sharp increase in total revenue saw the recurrent deficit decline to 5.6% of GDP in 2016 from 9.6% of GDP in 2015. However, a further decline in donor budget support contributed to a financing shortfall and the accumulation of arrears.

“Notwithstanding recent progress on the budget, 2017 is likely to be a very challenging year. We therefore welcome the prudent approach in the 2017 budget of assuming lower donor support and no additional one-off transfers from Israel. Despite efforts to bolster domestic receipts, the assumed decline in clearance revenue and other payments from Israel points to a reduction in overall revenues, while spending pressures remain. The recurrent deficit is projected to widen by about 2% of GDP and, with another 15% decline in donor budget support, this would result in a financing gap of almost 6% of GDP."

The IMG encourages the authorities "to build on recent efforts and explore mitigating options. In the near term, this could include considering contingency measures such as limiting the increase in the wage bill to inflation, as this is the largest expenditure item."

Ongley's mission statement also noted that the upcoming Public Financial Management (PFM) strategy could help to enhance the efficiency of spending and promote lasting fiscal improvements. "An action plan of well-prioritised PFM measures could also provide a strong basis for increased donor engagement and support for the government’s priorities in the context of the 2017-2022 National Policy Agenda. Other priority areas include civil service and pension reform, as adopting a strategic approach to the wage bill would free up resources for priority public investments," she stated, identifying the reversal of the decline in donor support and continued discussions with the Israel government on enhancing and improving the predictability of revenue transfers as key success factors.

Ongley disclosed that the Palestine Monetary Authority (PMA) remains committed to strengthening the anti-money laundering and combating the financing of terrorism (AML/CFT) framework, in line with international standards. "In this context, we welcome the constructive working relationship between the Palestine Monetary Authority (PMA) and Bank of Israel. Another important step is the PMA’s recently accepted request for a comprehensive AML/CFT evaluation by Middle East & North Africa Task Force (MENAFATF)*, along with plans to continue with AML/CFT-related reforms, with technical support from the IMF and other development partners," she stated in her mission report.

*MENAFATF combats laundering and terrorist financing.

Go for ijarah sukuk and have respected shari'ah scholars certify them: IMF working paper

The type of sukuk and the choice of shari'ah scholar could affect interest in a sukuk issue.

In Do the Type of Sukuk and Choice of Shari'a Scholar Matter?, a working paper* from the International Monetary Fund (IMF) released in August 2014, authors Christophe Godlewski, Rima Turk, and Laurent Weill study a sample of 131 sukuk from eight countries from 2006 to 2013 and find both criteria do indeed matter.

Some observations from the analysis include: 

• The average coupon is above 4%, maturity is 8 years, and the average amount issued is US$1,270 million with a large standard deviation. 
• An average of three scholars certify an issuer’s sukuk. 
• On average, half of the team of scholars is from the same country as the issuer. 
• A typical scholar certifies on average 24 sukuk per year, or almost 75 issues over three years. 
• Issuing firms have issued on average more than 11 bond issues.

According to the working paper, ijarah (اجارۃ) sukuk "exert a positive influence on the stock price of the issuing firm". The authors suggest that ijarah structures may benefit the most from the expansion of sukuk markets because of the better investor reaction to them compared to other structures. 

The authors observe that sukuk in the musharakah and mudarabah formats, which are partnership contracts in which the financier and entrepreneur share profits based on pre-agreed ratios but also the losses that are proportional to their contributions (financial or physical) to the partnership, are not as popular. "Ijarah is a debt-based instrument that is not based on profit and loss sharing principles; hence, it does not suffer from the possibility of attracting borrowers of poor financial condition as would a musharakah instrument," the authors suggested.

A similar positive impact was observed with sukuk that had been certified by prominent shari’ah scholars from the same country as the sukuk issuer. In more than half of the sample, at least one scholar is from the same country as the issuer, the authors observed. 

"Our finding provides some evidence that high compensation for reputable shari’ah scholars certifying sukuk may be justified on the grounds of better valuation of issuing firms," the authors said.

*Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. The views do not necessarily represent the views of the IMF or IMF policies.