Document ofThe World Bank Group

For Official Use Only

Report No. 35718-PAK

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

AND THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

AND THE

INTERNATIONAL FINANCE CORPORATION

COUNTRY ASSISTANCE STRATEGY

FOR

THE ISLAMIC REPUBLIC OF PAKISTAN

FOR THE PERIOD FYO6-09

April 4,2006

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not be otherwise disclosed without World Bank authorization.

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The last Country Assistance Strategy for Pakistan (Report No. 24114-PAK) was discussed on June 11, 2002 and a

Country Assistance Strategy Progress Report (Report No. 28262-PAK) was discussed on April 20, 2004

CURRENCY AND EQUIVALENTS

Currency Unit = Pakistan RupeeUS$1 = PKR 59.40

FISCAL YEAR

July 1 - June 30

ABBREVIATIONS AND ACRONYMS

AAA Analytical and Advisory Activities IDI Long Distance and InternationalADB Asian Development Bank LL LocalLoopADR Alternative Dispute Resolution MDG Millennium Development GoalsAIDS Acquired Immunodeficiency Syndrome MIGA Multilateral Investment Guarantee AgencyAJK Azad Jammu Kashmir MTBF Medium Term Budget FrameworkBMOs Business Membership Organizations MTDF Medium Term Development FrameworkCAE Country Assistance Evaluation NBP National Bank of PakistanCAS Country Assistance Strategy NEPRA The National Electric Power Regulatory AuthorityCAS-PR Country Assistance Strategy Progress Report NEAS National Education Assessment SystemCBR Central Board of Revenue NGOs Non-Governmental OrganizationsCFAA Country Financial Accountability Assessment NWFP North West Frontier ProvinceCGA Controller General of Accounts PDF Pakistan Development Forum

CWIQ Core Welfare Indicators Questionnaire PEP-MENA Private Enterprise Partnership for MiddleDCC Donor Coordination Cell East and North AfricaDFID Department for International Development (UK) PFM Initial Public OfferingDPL Development Policy Loan PIFRA Project to Improve Financial Reporting and

EAD Economic Affairs Division AuditingEBP Enterprise Benchmarking Program PIHS Pakistan Integrated Household SurveyERRA The Earthquake Reconstruction and PPAF Pakistan Poverty Alleviation Fund

Rehabilitation Authority PPPS Public-Private PartnershipsFSAP Financial Sector Assessment Program PRSC Poverty Reduction Support CreditGDP Gross Domestic Product PRSP Poverty Reduction Strategy PaperGEF Global Environment Facility PSCB Public Sector Capacity BuildingGoP Government of Pakistan PTCL Pakistan Telecommunications LimitedGTZ German Agency for Technical Cooperation PSLSM Pakistan Social and Living StandardsHIES Household Income and Expenditure Survey Measurement SurveyHIV Human Immunodeficiency Virus QAG Quality Assurance GroupIBRD International Bank for Reconstruction and SAC Structural Adjustment Credit

Development SME Small and Medium EnterpriseICR Implementation Completion Report TATF Technical Assistance and Trust FundsIDA International Development Association TMAs Tehsil Municipal AuthoritiesIEG Independent Evaluation Group USAID United States Agency for Int'l DevelopmentIFC International Finance Corporation WAPDA Water and Power Development AuthorityIMF International Monetary Fund WEF World Economic ForumIPO Initial Public Offering WHO World Health OrganizationIPP Independent Power Producer WTO World Trade OrganizationJBIC Japan bank for International Cooperation WSS Water Supply and Sanitation

The World BankVice President Praful Patel, SARVP

Country Director John W. Wall, SACPKTask Manager Torm Buckley, SACPK

The International Finance CorporationVice President Declan Du e CIOVP

Country Director Michael Essex, CMERCTask Manager Torek Farhadi, CMEHQ

TABLE OF CONTENTS

EXECUTIVE SUMMARY ...............

COUNTRY CONTEXT AND DEVELOPMENT CHALLENGES...............................................1

A. Political and Social Context............................... .................. 1

B. Social Progress and Poverty Profile................2........ ........... 2

C. Development Challenges ............................................. 2

D. Economic Developments and Outlook ........................ .......... 7

II. PAKISTAN'S POVERTY REDUCTION STRATEGY ............................................................ 10

A. The PRSP Strategy..................................... ........... 10

III. BANK GROUP ASSISTANCE STRATEGY ..................................................................... 12

A. Implementation of the Last CAS and Lessons Learned..........................12B. Context and Engagement Principles .......................... ......... 15

C. World Bank Group Program Priorities ................................. 17

IV. DELIVERING THE WORLD BANK GROUP PROGRAM.................................................33

A. The World Bank Program..........................................33B. The IFC Program................................................38C. MIGA Portfolio and Program.......................................40D. Partnerships and Harmonization.....................................40E. Communications and Outreach......................................41F. Monitoring and Evaluation......................................... 41

G. Managing Risks................................................ 42

TABLES

Table 1: Progress on Selected Social Indicators................................3Table 2: Competitiveness Rankings.........................................3Table 3: Medium Term Outlook - Key Indicators................................9Table 4: Pakistan's PRSP Targets and Alignment with Millennium Development Goals.........11Table 5: Bank Portfolio Indicators................................... ...... 13Table 6: Selected Health Indicators .................. 3......... ........... 29Table 7: Public Spending on Select Safety Net Programs .............................. 31

Table 8: Key Policy Performance Benchmarks for RD Lending ............ ....... 35

Table 9: Pakistan Credit Rating by Standard & Poor's ih.o..................... a......36Table 10: Maximum Projected IBRD Exposure ......................... ....... 37

Table 11: AAA - Indicative Key Outputs by CAS Theme ........................... 37

FIGURE

Figure 1: Recent Economic Performance ......................................... 8

Box

Box 1: Impact of the October 8 Earthquake ............. 6......... ............ 6

ANNEXES

Annex I: CAS Results FrameworkAnnex II: CAS Completion ReportAnnex III Private Sector StrategyAnnex IV: Country Financing ParametersAnnex V: Other Donor ActivitiesAnnex VI: CAS Consultation ProcessAnnex VII: Guidelines for EBRD LendingAnnex B 1: Country at a GlanceAnnex B2: Indicators of Bank Portfolio Performance and MgtAnnex B3: IBRD/IDA Program SummaryAnnex B3: IFC/MIGA Program SummaryAnnex B4: Summary of Non-lending ServicesAnnex B5: Poverty and Social Development IndicatorsAnnex B6: Key Economic IndicatorsAnnex B7: Key Exposure IndicatorsAnnex B8: Operations Portfolio (TBRD/IDA and Grants)Annex B8 (IFC) Statement of IFC Held and Disbursed Portfolio

EXECUTIVE SUMMARY

i. The FY06-09 Country Assistance Strategy (CAS) has been prepared at a time of great

opportunity for Pakistan. Since the beginning of the new millennium, Pakistan has managed a remarkableturnaround. During the 1990's Pakistan's progress in reducing poverty and improving the welfare of its

people was not very encouraging as economic growth slowed and progress in improving social indicators

stagnated. Beginning in 2000, the Government initiated a wide-ranging and ambitious reform programresulting in a dramatic turnaround. The FY03-05 CAS period witnessed the consolidation and

acceleration of this turnaround with sustained implementation of a program of 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 of the populationbelow the poverty line remains high. And despite recent indications of improvement, social and livingstandards remain well below countries with similar incomes and growth rates.

Development Challenges

ii. The key challenge for Pakistan is now to sustain its recent growth performance in order to

generate significant poverty reduction. Sustained growth will require continued sound macroeconomic

management along with further improvements in the investment climate. Pakistan's infrastructureplatform 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 Pakistan is making progress, analysis suggests that it will be challenging to achieve the MDGs forinfant mortality, child malnutrition, primary completion, and elimination of the gender gap in primary

enrolment. Looking beyond the MDG's, enhancing competitiveness in an increasingly globalized andtechnology driven world economy will require a growing pool of workers with leading edge skills

pointing to the need for increases in the level and quality of secondary, vocational and higher education.Thus, continued concerted efforts to address poor human development outcomes are important not only to

improve equity but also as an integral part of achieving Pakistan's growth objectives.

Pakistan's Poverty Reduction Strategy

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, andvulnerability and builds on the economic program first articulated in the fall of 1999 and furtherelaborated in the I-PRSP of 2001. The PRSP emphasizes policies to sustain rapid growth as the mainvehicle for poverty reduction and is 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 ofdelivering better development results and ensuring social and economic justice; (iii) investing in humancapital, with a renewed emphasis on effective delivery of basic social services; and (iv) targeting the poorand vulnerable to bring marginalized sections of the population and backward regions into the mainstreamof development, and to make marked progress in reducing existing inequalities. The PRSP's targets arefully aligned with the MDGs.

Bank Group Assistance Strategy

iv. In line with Pakistan's recent performance and the Government's request for increased BankGroup support, this CAS proposes a substantial increase in the volume of lending to Pakistan during thenext four years.' The immediate priority will be to assist in addressing the impact of the October 2005earthquake - up to US$1 billion in IBRD/IDA commitments will be used to support reconstruction andrecovery (US$840 million in new commitments have already been approved). In addition, based on the

1 In this report, the "Bank Group" refers to IBRD, IDA, IFC, and MIGA while the "Bank" refers to IBRD/IDA.

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Government's priorities for sustaining growth and accelerating poverty reduction, the CAS envisions anexpansion in lending in infrastructure (primarily energy, water, and transport) and humandevelopment. Bank Group program priorities will retain considerable continuity with the FYO3-05 CAS,focusing on the areas which are most critical for poverty reduction. The three inter-linked and mutuallyreinforcing pillars of the CAS correspond to the strategic priorities of the PRSP: (i) sustaining growth andimproving competitiveness; (ii) improving government effectiveness and service delivery; and (iii)improving lives and protecting the vulnerable.

Pillar I: Sustained Growth and Improved Competitiveness

v. The focus of this pillar of the CAS will be to support the investments and reforms needed sustainrapid, private sector-led growth. To help maintain the hard-won benefits of macroeconomic stability theBank will provide support to help the Government strengthen economic management through improvingthe composition and effectiveness of public expenditures and supporting tax reforms. In agriculture, thefocus of the Bank's work will initially be to support the preparation of a rural strategy, integrating issuesrelated to agriculture, natural resource management, the rural non-farm economy, infrastructure, ruralfinance and the need for targeted interventions. In irrigation the Bank will support a combination ofinstitutional reforms and investments throughout the system including major investments in rehabilitationof critical assets and reforms to improve the quality, efficiency, and accountability with which irrigationservices are delivered. Recognizing that sustaining the current high rates of economic growth requiresglobally competitive production in an increasingly demanding world market, the Bank Group will alsosupport reforms to improve the business environment.

vi. Infrastructure bottlenecks pose a significant threat to Pakistan's ability to sustain rapid growth. Inthe power sector the Bank Group will support further strengthening of sector governance to improveperformance and attract private investment while at the same time helping to address a significant backlogin investment, particularly to address technical losses. In telecommunications the Bank will supportadoption of measures to strengthen the policy and regulatory environment and possible investmentsupport for accelerating the provision of rural telecommunication infrastructure. In transport, the Bankand the government will adopt a strategic approach focusing first on the National Trade Corridor linkingPakistan's major ports in the south with its major cities and trade corridors to the North. The key outcomesought would be significant reductions in the time and cost of moving goods through the Indus corridor.Investment and policy-based lending for highways, trade facilitation, ports and railways will beconsidered, with an emphasis on increasing private sector participation in operation and management. Inthe financial sector, the Bank Group will support further financial sector reforms to increase access tofinance (especially for microcredit borrowers) and support further reforms with the aim of increasing theavailability of longer term savings instruments.

Pillar II: Strengthened Governance and Service Delivery

vii. Improving government effectiveness is a central theme of the PRSP. Priorities in this area will beto support further reforms and investment to increase efficiency, transparency and accountability in theuse of public resources. In public financial management, full implementation of the Project for ImprovedFinancial Reporting and Auditing (PIFRA) will be the focus along with analytical support to assist indefining the agenda for further reforms in financial management at the federal and provincial levels. TheBank will also support the achievement of transparent and efficient public procurement throughdevelopment policy lending, policy dialogue and capacity building. Working across sectors, the BankGroup will continue to support cross-cutting reforms to increase capacity and accountability of thoseresponsible for service delivery; empower communities and clients through enhanced access toinformation on finances and performance; and build the capacity of both communities and governments.Work will also include support to further civil service reform and devolution as well as a stepped-upengagement in the urban sector to improve municipal service delivery, especially in the larger cities.

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Pillar III: Improved Lives and Protection of the Vulnerable

viii. The PRSP recognizes that increased investment in human capital leading to significantimprovements in education and health will be necessary to build the skilled, healthy work force necessaryto sustain recent growth performance. The Bank strategy in education will continue to be focused on theprovinces, using development policy credits to support policy and systemic changes as well as the otherareas linked to education reform including decentralization and governance reforms. In health, at thenational level, the Bank will concentrate on encouraging the Government to focus on public healthfunctions (such as surveillance, quality control, monitoring and evaluation, and public information) whilesupporting the development and implementation of program and management reforms in the Lady HealthWorker program as a way of expanding access to primary health care and family planning. The BankGroup will also support the piloting and evaluation of new approaches for service delivery and demandside interventions. Recognizing that a major focus of efforts in health must be at the provincial and locallevel, we will support major system reforms through planned provincial Development Policy Credits,beginning in NWFP.

ix. The PRSP recognizes that protection for the poor and vulnerable is a cornerstone of any povertyreduction program. The Bank's assistance for social protection will include support for safety nets thathelp the chronic poor cope with and, where possible, escape poverty, and help families and individualscope with seasonal shocks and natural disasters. The Bank will also provide support for social security viaimproving formal sector pensions and consider innovative approaches to micro-insurance to address lifecycle risks. Pakistan's PRSP recognizes that while rapid growth will be the main driver of povertyreduction, targeted interventions and community-based approaches to rural development are also requiredto address the immediate needs of the poor and vulnerable, especially in drought prone and flood strickenareas, and help them share in economic growth. The Bank will continue to support implementation of theCommunity Investment Programs in NWFP and AJK and look for possible expansion and replicationopportunities. The Bank will also support the Government's newly announced program for rural povertyalleviation through social mobilization.

Delivering the World Bank Group Program

x. IBRD/IDA Lending. Pakistan's demand for World Bank financial support has grown to meet theneeds of its growth and poverty reduction strategy and to address the impact of the October earthquake.To meet this demand a flexible IBRD/IDA lending program of up to US$6.5 billion (approximatelyUS$3.1 billion IDA and US$3.4 billion IBRD) is proposed in order to support implementation of thePRSP. Pakistan's IDA allocation has been increased under IDA 14, with the three-year envelope set atSDR 1.5 billion (equivalent to about US$725 million per year). In addition Pakistan will have access toadditional IDA on hard terms estimated at SDR 130 million. The scale of IBRD financial support will bedetermined by the strength of the GoP's policy performance and macroeconomic management. The upperbound of the proposed IBRD lending range for FYO6-09 is $3.4 billion of which up to $1.3 billion couldtake the form of development policy loans. Annual lending could increase to as much as $1 billion peryear with up to $500 million in DPLs within this envelope.

xi. The IFC and MIGA Programs. In the upcoming CAS period, IFC will be increasing itsinvestment with the target range of US$500-600 million for the period. IFC will also exploreopportunities in pre-privatization investment. It furthermore plans to make more equity investment andintends to be a catalyst for and mobilize private equity in the country. IFC activity will focus on threemain sectors: financial, SME and infrastructure. With the recent creation of Private Enterprise Partnershipfor Middle East and North Africa region (PEP-MENA), IFC has initiated a substantial TA program inPakistan to build capacity and address constraints of the SME, infrastructure and financial sectors.MIGA's outstanding portfolio in Pakistan consists of 10 contracts of guarantee with a total gross exposureof US$136.8 million and a net exposure of US$106.8 million. An application seeking coverage for aUS$20.8 million equity investment in a hydropower project in Pakistan is currently pending.

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xii. Partnerships and Harmonization. The Bank Group's work in Pakistan is coordinated with andreinforced by the efforts of other donors in a wide variety of areas. The international response to theOctober earthquake has also served as an opportunity to substantially deepen donor harmonization andcoordination. The Government leads coordination of policy dialogue and donor support within theframework of the PRSP, using the Pakistan Development Forum (PDF), held annually in Islamabad, asthe principal forum for discussion with and among donors. A Donor Coordination Cell (DCC) has beencreated in the Economic Affairs Division (EAD). Formal donor group meetings are also held, at least twoto three times a year, to discuss implementation of the government's PRSP. Under the leadership of theGovernment of Pakistan, the Bank Group is increasing efforts to strengthen partnerships and improveharmonization of activities among donors in line with the Paris Declaration on Aid Effectiveness. Duringthe next four years we expect an increasing share of analytical activities to be carried out jointly withpartners.

Managing Risks

xiii. The proposed CAS program poses a number of risks, the greatest of which is that of possiblepolicy reversal due to shifting priorities or political changes. There are also implementation risksrelating to both the Bank and Pakistan. The Bank will seek to pro-actively manage these risks by activelyaddressing capacity constraints while seeking to build and sustain support for further reforms. We willcontinue to rely on the self-regulating nature of the programmatic approach wherein the volume and paceof lending will match the pace of 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 andachievement of MDGs?

b) Is the planned increase in the scale of World Bank Group support for Pakistan appropriate?

c) Is mix of instruments and activities consistent with the focus of the strategy?

I. COUNTRY CONTEXT AND DEVELOPMENT CHALLENGES

A. Political and Social Context

1. The FYO6-09 Country Assistance Strategy (CAS) has been prepared at a time of great

opportunity for Pakistan. Since the beginning of the new millennium, Pakistan has managed a remarkableturnaround. During the 1990's Pakistan's progress in reducing poverty and improving the welfare of its

people was not very encouraging. Economic growth slowed and progress in improving Pakistan's socialindicators stagnated. Successive governments initiated reforms, but with only modest results. Beginningin 2000, the Government initiated a more wide-ranging and ambitious reform program resulting in adramatic turnaround. The FYO3-05 CAS period witnessed the consolidation and acceleration of thisturnaround with sustained implementation of a program of stabilization and wide-ranging structuralreforms. Economic growth accelerated from the average of 3.3 per cent during 1997-2002 to 6.4 per centin 2003/04 and 8.4% in 2004/05. Public debt fell to 61% of GDP from almost 90% in 2000/01. Improvedfiscal performance and growing fiscal space resulting from savings on interest expenditures, generousexternal support and improved revenue administration have enabled the government to exceed targets foreducation spending. In short, Pakistan moved from crisis to growth, laying the groundwork for sustainedgrowth and significant poverty reduction.

2. Yet Pakistan's development challenges remain formidable. While provisional estimates for2004-05 suggest that poverty has declined compared with 2000-01, the proportion of the populationbelow the poverty line remains high. And despite recent indications of improvement, social and livingstandards remain well below countries with similar incomes and growth rates. For example Pakistan'sgross female primary enrolment rate is 33 percent below and its infant mortality rate is 27 per thousandabove that of countries with the same per capita income. Moreover, there remain substantial disparities inopportunity, particularly for the rural poor and women.

3. Politically, Pakistan is benefiting from a period of relative stability compared with the turmoil ofthe last decade. The past six years have been marked by consistent policies and sustained implementationof the government's reform program. Elections in 2002 restored the National and Provincial Assembliesand despite occasional slowdowns in implementation, the reform program has been carried forward underthe elected government. The prospects are good for continued stability and maintenance of thegovernment's pro-reform orientation. General elections are due to be held in 2007. The decentralizationinitiative has started the process of transferring responsibility and resources for public service delivery tolocal governments, laying the groundwork for more responsive and accountable government at the locallevel as well as improved services. Recent local government elections in 2005 were an importantmilestone in the institutionalization of the new local government system.

4. Internationally, relations with India have steadily improved over the past two years, although theconflict 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 2003and trade between the two countries is growing strongly, although from a low base. President Musharrafvisited India in late April 2005, and he and the Indian Prime Minister, Manmohan Singh, agreed toincrease transport links between the divided parts of Kashmir. The response to the October 8 earthquakehas served as an opportunity to expand peaceful interaction across the divided territory, demonstrating thepotential for cooperation and constructive engagement in the region. However, Pakistan's efforts to dealwith the spillover of post-9/11 conflict in Afghanistan and to cooperate in international efforts to combatterrorism continue to bring it into conflict with militant groups, particularly in remote border region.Clashes between law enforcement agencies and militants-many of them foreign-have resulted insignificant casualties.

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B. Social Progress and Poverty Profile

5. The most recent household survey from which poverty estimates can be derived is now 4 years

old, dating from 2000/01, when economic growth was depressed and much of the country's rural areaswere suffering severe drought conditions. A definitive evaluation of whether the economic turnaround of

the past few years has translated into lower poverty will have to await the release and analysis of theresults of the Household Income and Expenditure Survey which is expected in 2006; however,provisional estimates released by the Government indicate that the incidence of poverty which rose above30% in 1998/99, and rose further in 2000/01, fell to below 30% in 2004/05.2 The results of the 2000/01Pakistan Integrated Household Survey (PIHS) convey the characteristics of poverty in Pakistan and

highlight the challenge of attaining the Millennium Development Goal of halving the proportion of

population below the poverty line between 1990 and 2015.

6. Based on the PIHS, disaggregated poverty headcounts by province (using the official povertyline) show that NWFP and Balochistan are the poorest provinces and that poverty is far more widespreadin rural areas. Poverty is highest among unskilled labor in the informal sector and their condition becameworse between 1998-99 and 2001-02. Ownership of livestock and agricultural land are also closelyassociated with rural incomes. While the poorest quintile of the rural population accounted for only 10percent of the total estimated value of livestock in 2001-02, the top quintile accounted for 36 percent.Households with no land constituted 60 percent of the rural population in 2001-02, but accounted for 76percent of those in the bottom quintile; and poverty incidence among landless households actuallyincreased from 1998-99 to 2001-02. Vulnerability is a key feature of poverty; approximately 41 percent ofthe population is concentrated in a small range of 75 to 125 percent of the poverty line implying that, for avery large share of Pakistan's population, unanticipated shocks such as illness/disability, death, or naturaldisaster can result in poverty.

7. Poverty is also characterized by low level of human capability, manifested in poor outcomes ineducation, health and lack of connectivity to basic services and facilities. Here there is recent data tosuggest that Pakistan's reform program is beginning to pay off. Preliminary findings from the recentlycompleted Pakistan Social and Living Standards Measurement survey, measuring outcomes as well asaccess, satisfaction and usage of public services both at the household and facility level, are encouraging.The preliminary results show significant improvement in a range of indicators including primaryenrolment and immunization coverage (See Table 1). Nevertheless, across a range of indicators,Pakistan's social indicators continue to lag behind those of similar countries.

C. Development Challenges

8. The key challenge for Pakistan is now to sustain its recent growth performance in order togenerate significant poverty reduction. Pakistan's recent growth performance is encouraging, but itscontinuation is by no means assured. Sustained growth will require continued sound macroeconomicmanagement along with further improvements in the investment climate. Notwithstanding the economicrecovery, investment rates are insufficient to sustain high rates of growth needed to reduce poverty.Foreign direct investment, while recovering from the very low levels of the late 1990's remains lowcompared to more dynamic economies in Asia. Sluggish rates of investment reflect continued weaknessesin the investment climate; despite the recent successes in reducing state intervention in the economy andimproving the regulatory framework for private business, firms continue to face significant policy,regulatory, and infrastructure constraints. Security concerns and political uncertainty have also combinedto deter investors, both foreign and domestic. The impact of these constraints is reflected in the results of

2 The government has established a joint committee made up of donors, experts and officials to evaluate and analyzethe most recent data and carry out a detailed analysis of poverty incidence. The provisional estimates are subject tochange based on the results of this analysis.

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the World Economic Forum's (WEF) 2005-2006 Competitiveness Report which indicate that in 2005, ofthe 116 countries covered, Pakistan ranked 66th in 'business competitiveness' (see Table 2).

Table 1: Progress on Selected Social IndicatorsReported data

Indicator 1998-99 2001-02 2004-05

PovertyPoverty incidence (%) 30.6 32.1

DemographicsPopulation (millions) 135 141 151

EducationAdult literacy rate: 15+ years (%) 43 43 50

Female literacy rate as percent of male literacy (%) 48 51 57

Net enrollment rate (NER): grades 1-5 (%) 50 51 60

Female NER as a percent of male: grades 1-5 (%) 75 79 85

HealthLife 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) 116 114 na

Fully immunized children, age 12-23 months (%) 49 53 77

Percentage of pregnant women using pre-natal care 31 35 50Sources: PIHS 1998-99, 2001-02, Preliminary estimates from PSLM 2004-05.* Provisional estimate.

9. Pakistan's infrastructure Table 2: Competitiveness Rankingsplatform needs significant Business Competitiveness Indexinvestment in order to support Countries 2005 2004 2003investmnts inwh ad evc (116 countries) (103 countries) (102 countries)Pakistan's growth and servicedelivery goals. Infrastructure Singapore 5 10 8

services including electricity, paved India 3 3 37

roads, municipal services, and Thaia 37 37 31

telecommunications reach a Turkey 51 52 52relatively low proportion of the China 57 47 46

population. Moreover, inefficient Pakistan 66 73 75operations in key sectors, like Philippines 69 70 65power and transport, adversely SriLanka 72 68 57

affect competitiveness. The power Bangladesh 100 95 91

sector is characterized 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 2004captive generators. Much of theroad network is in poor condition and the railways are carrying only a small fraction of the nation'sfreight due to inefficiency. Delays at Pakistan's ports are also hurting cost competitiveness of Pakistan's

exports. Each day of delay in shipment is currently raising unit costs, on average, by over 0.5 percent off.o.b. prices of exports .4 At the same time, improvements in basic 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, GlobalCompetitiveness Report 2005-2006." The World Bank, Global Economic Prospects:- Trade, Regionalism, and Development- 2005, page 80.

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human development outcomes. Approximately 40 percent the population lacks access to power and about75% of 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 frompoor quality and limited availability.

10. The infrastructure challenge is particularly acute with respect to water as Pakistan relies on thelargest contiguous irrigation system in the world for 90% of food production and 25% of GDP.Agriculture is the single most important source of employment and irrigation represents more than 95%of the total consumptive use of water. However, this massive infrastructure is deteriorating and in need ofrehabilitation along with reforms to improve the allocation of water as well as the efficiency of its use.The capacity of existing reservoirs is diminishing as the result of siltation and no new reservoirs havebeen built since 1976. Moreover, competition for water is growing among the provinces and across thevaried needs for irrigation, industrial and domestic use, and the environment. Pakistan has already begunramping up its investments, beginning with the urgent rehabilitation of barrages. Yet there remains a needfor significant new investment, not only in irrigation but in other uses of water as well, including powergeneration and urban-industrial and domestic supplies (50% of the population is not served by a formalsupply system and sanitation and water treatment reaches less than 10% of the population). At the sametime there is uncontrolled pollution of surface and groundwater from agriculture, industry and rapidlygrowing cities.

11. For the poor to participate in and benefit from growth Pakistan needs to accelerate humandevelopment. International experience suggests that no country can hope to compete in the globaleconomy without an educated and healthy work force. Indeed, the lack of skilled manpower and lowerlabor productivity are often cited as constraints to raising productivity, strengthening competitiveness, andachieving sustained high economic growth by both business leaders and policymakers in Pakistan. WhilePakistan is making progress, analysis suggests that it will be difficult to achieve the MDGs for infantmortality, child malnutrition, primary completion, and elimination of the gender gap in primaryenrolment.5 Looking beyond the MDG's, enhancing competitiveness in an increasingly globalized andtechnology driven world economy will require a growing pool of workers with leading edge skillspointing to the need for increases in the level and quality of secondary, vocational and higher education.Thus, continued concerted efforts to address poor human development outcomes are important not only toimprove equity but also as an integral part of achieving Pakistan's growth objectives.

12. Pakistan's poor social indicators are not due solely to poverty or lower rates of economic growth;Pakistan significantly underperforms when compared to other countries at similar levels of per capitaincome, and when compared to countries at similar levels of development. For example, Pakistan has 36percent fewer births attended by trained personnel, an infant mortality rate that is 27 per thousand higher,and a gross primary enrollment rate that is 20 percent lower than countries with similar income levels.Similarly, growth in Pakistan appears to have less of an impact on social indicators than in othercountries-between 1960 and 1998, as per capita GDP more than doubled in Pakistan, infant mortalitydeclined by 43 percent, as compared to a decline of 73 percent in a group of low income countries that onaverage grew at the same rate.

13. Pakistan's relatively slow progress in improving human development reflects both low publicexpenditures on education, health, water and sanitation and other key sectoral expenditures as well asweaknesses in public service delivery which limit the effective use of scarce resources. As a result of thedebt burden, which reached a peak in the late 1990's, social sector spending was squeezed, with educationand health expenditures declining from 2.2 and 0.7 percentage of GDP in 1987/88 to 1.7 and 0.5percentage of GDP by 1999/00. Despite having risen since then, public expenditure on health andeducation remain low by international standards. Within sectors, resources have been poorly allocated

World Bank, Attaining the MDGs in Pakistan (Washington, DC, 2005).

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with emphasis on spending for new hiring and facilities at the expense of providing resources foroperations and maintenance. Weaknesses in management of public services also stem from capacityconstraints and in some cases lack of clarity about the roles and responsibilities of various levels ofgovernment. Moreover, social services are subject to, inter alia, high absenteeism rates of serviceprofessionals (25 percent for teachers), poor quality of inputs and materials, low community involvementand limited participation of the poor.

14. It is also important to note that a number of factors weaken the link between growth and povertyreduction in Pakistan. One such factor is the skewed structure of ownership and access to factors ofproduction (land, water and credit) in rural Pakistan, which limits the impact of agricultural growth on theincomes of the rural poor. Landless agricultural laborers and non-agricultural rural poor householdsaccount for 61 percent of the rural poor (and nearly 30 percent of the rural population). Another factor isthe ineffective targeting and delivery of government programs which reduces the benefits of increasedgovernment spending. Strong social and cultural norms restrict access to public services and reduce theeconomic opportunities of women and girls. Together these factors create obstacles for the poor andvulnerable to partake in the benefits of economic growth, highlighting the importance of interventionsthat 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 developmentoutcomes. Since the late 1990s, the Government of Pakistan has launched programs designed to increasegirls' school enrollments, enhance female access to health care, and facilitate women's participation in thepublic arena. Some progress has been made, but much more is needed. For example, legislationmandating reservation of seats for women in local governments, as well as in provincial and nationalassemblies, has substantially increased women's political representation. However, although more girlsare in school, a substantial gender gap in enrollment remains and worsens significantly as girls transitionfrom primary to middle school. Although gender differentials in child immunization have declined,considerable gender differentials persist in other aspects of health care. The use of reproductive healthservices is low, and maternal mortality ratios remain high. In the labor market, lower educationalattainment coupled with social norms that restrict mobility confine women to a limited range ofemployment opportunities and low wages. The achievement of Millennium Development Goals (MDGs)will require significant reductions in these gender gaps. Policy interventions directed specifically atgender inequality in these public domains are needed.

16. Pakistan's population is predominantly rural and dependent on agricultural lands, rangelands andforests. Natural resources and their sustainable management are therefore central to Pakistan's economicgrowth and to people's livelihoods. Salinization and waterlogging of land, increasingly pollutedagricultural drainage (partly due to excessive pesticide use), and loss of important ecosystem functionsfrom diversion of flows and from pollution are reflected in disappointing development outcomes andcompromised agricultural yields. Degradation of rangelands continues and the rate of deforestation isrelatively high (although the level of remaining forest cover is already low). The poorer rural dwellerssuffer most from these trends. Urbanization is increasing at a rapid rate and the provision of basicenvironmental services in these areas has not matched the pace of growth. In both rural and urban areasthere are problems of public health related to the lack of water, sanitation and other services and also tohigh levels of air pollution (in rural areas, this is related mainly to indoor air from use of poor qualityfuels). Addressing these problems is a necessary adjunct to a sustainable growth and poverty alleviationstrategy.

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Box 1: Impact of the October 8 Earthquake

The October 8, 2005 earthquake left widespread destruction in its wake, killing at least 73,000 people, severelyinjuring another 70,000, and leaving 2.8 million people without shelter. The affected areas suffered extensivedamage to economic assets and infrastructure, with social service delivery, commerce, and communications eitherseverely weakened or destroyed. Beyond the human toll, the overall costs associated with the earthquake aresignificant. A Joint Damage and Needs Assessment put the value of the direct damage sustained due to theearthquake at US$2.3 billion while resulting indirect losses are estimated at US$576 million. The estimated costsfor relief, livelihood support for victims, and reconstruction cost are estimated at approximately US$5.2 billion.

The earthquake is expected to have an adverse impact on the economy, most notably on the fiscal deficit. Theimpact on economic growth will be modest as the affected regions account for a very small part of the country'sGDP; growth at the national level is expected to decline by 0.4 percentage points in 2005/06. However, a largeshare of reconstruction costs, including restoration of social and physical infrastructure and governmentassistance to households to rebuild livelihoods and homes, will fall on the Government. Fiscal deficits duringFYO6-08 are expected to increase by 0.5 to 0.9 percent of GDP per year. While the impact on exports is projectedto be limited, relief and reconstruction needs have increased import demand due to higher demand for fuel andsteel.

These pressures could pose difficulties for Pakistan's macroeconomic balances and have the potential tocompromise the achievement of its long-term development goals. Whether and to what extent this occurs willdepend on the response of the Government and the international community. The Government intends to absorb apart of the budgetary impact of the earthquake by making cuts in low-priority expenditures and by raisingadditional domestic revenue while protecting priority expenditures needed to improve health, education, andpublic infrastructure. The decision to delay the purchase of new military aircraft indicates the Go%ernmenCsseriousness in this regard. Implementation of outstanding revenue and spending measures also need to beaccorded high priority. However, even with such measures (which are needed in any case), given the magnitudeof resources needed for rehabilitation of earthquake-affected areas, it is unlikely that the government will be ableto fully absorb the fiscal impact of the earthquake without significantly affecting public sector developmentactivities. Moreover, it is important that the poor in areas not affected by the disaster (the vast majority) not loseout due to increased allocation of public resources to the earthquake-affected areas at the expense of the rest ofthe country. Ensuring the dual objectives of rehabilitating and rebuilding earthquake affected communities andaccelerating Pakistan's development will require additional resource mobilization by Pakistan and theinternational community.

For the country assistance strategy, the main impact is on the lending program, particularly the use of IDAresources. While Pakistan's long-term development challenges and poverty reduction strategy have not beenfundamentally changed by the earthquake, its immediate financing needs have greatly increased. To help meetthese needs while protecting implementation of the PRSP reform program, the Bank has already made available$740 million in new IDA commitments and $100 million in IBRD lending. Overall earthquake-related financingmay reach $1 billion. This has significantly front-loaded the use of IDA 14 resources with expected FY06 IDAcommitments totaling over half of the three-year IDA allocation. In consultation with the Government, the CASlending program has been re-prioritized accordingly; some planned IDA operations have been reduced in size andadditional IBRD lending is planned, consistent with creditworthiness considerations. To the planned AAAprogram we have added dialogue and advisory activities to assist the Government in the development of acomprehensive hazard risk management strategy.

17. Addressing governance challenges and combating corruption are critical for improving theinvestment climate and strengthening the delivery ofpublic services. Public institutions delivering socialservices, law and justice and economic services suffer from inadequate capacity and ineffective internaland external accountability. Moreover, while reliable data is scarce, surveys cited in the Government's

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National Anti-Corruption Strategy indicate that corruption is a serious challenge. 6 The civil servicesuffers from weak capacity as a result of many years of rapid turnover, patronage-based employment atlower levels and inadequate compensation at senior levels. Accountability has been further weakened bylack of effective client voice, made worse by the over-centralization of power at higher levels ofgovernment. Together these weaknesses represent a major impediment to improving service delivery andthe investment climate.

18. Improving governance and combating corruption is one of the pillars of Pakistan's povertyreduction strategy. Key elements of the strategy include: (i) reducing opportunities for corruption byredefining and refocusing the role of the state through privatization and de-regulation; (ii) reforming thecivil service; (iii) establishing local government as an effective system of governance, participation andaccountability; (iv) supporting reforms in public financial management and procurement in order topromote prudent and accountable management of public resources while reducing opportunities forcorruption; and (v) strengthening enforcement mechanisms and the administration of justice.

19. Significant progress has been made in these areas. Local governments have been created toincrease responsiveness and accountability for provision of key public services. The tax administrationsystem has been redesigned to reduce interaction between taxpayers and tax officials. The Government'sprivatization program accelerated during the previous CAS period; over the last two years the governmentrealized US$4.35 billion in proceeds through 27 transactions compared with US$600 million during theprevious three years. Privatization of state-owned banks coupled with stronger regulation under arevitalized State Bank of Pakistan has reduced politically-motivated lending and non-performing loans.Progress has been made in improving public financial accountability through modernization of financialreporting systems and auditing, while the institutions of accountability like the Auditor General and theParliamentary Public Accounts Committees have been revitalized. The national power utility is beingunbundled to de-monopolize the industry, improve its transparency and efficiency and prepare forprivatization. The National Accountability Bureau was created, successfully prosecuting cases of high-level corruption. Nevertheless while this progress has been encouraging, most observers believe that agreat deal more needs to be done to address the deep governance challenges faced by Pakistan.

D. Economic Developments and Outlook

Recent Economic Developments and Prospects

20. Since the last CAS, Pakistan's economy has continued its strong recovery. Growth hasaccelerated from 3.1 percent in FY2001/02 to 8.4 percent in 2004/05. The recovery was driven by astrong rebound in exports of manufactures and, more recently, favorable weather conditions leading to astrong pick up in agricultural production. Large scale manufacturing grew by 18.2% in FY2003/04 and by15.4% in 2004/05. Fiscal performance has been sustained, despite limited progress in improving revenuecollections and reducing power sector losses. Due primarily to increases in non-tax revenues and savingson the interest bill, the overall fiscal deficit (excluding grants) declined from 6.6 percent of GDP in1999/2000 to about 3 percent of GDP in 2004/05. Moreover, despite this rapid fiscal adjustment, social-and poverty-related expenditures were raised by over 1 percentage point of GDP over the last three years,or by over 30 percent in real per capita terms, although they remain low in comparison with otherdeveloping countries.

21. The balance of payments turned around with strong export growth and sizable remittances, andinternational reserves were rebuilt to cover about five months of imports of goods and nonfactor servicesand over 250 percent of short term external liabilities (up from 11 percent in 1999/2000) at end 2004/05.

6 Government of Pakistan, National Anti-Corruption Strategy, Islamabad Pakistan, 2002(http://www.nab.gov.pk/Downloads/Doc/NACS.pdf).

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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 intodeficit in 2004/05. The trade deficit during FY05 rose sharply to US$ 4.3 billion and is projected toincrease further to over US$7 billion in FY06. This reflects the rapid increase in imports which rose bynearly 38% to US$18.8 billion due to strong import demand for a wide range of consumer and investmentgoods (including automobiles and machinery), agricultural and chemical goods (fertilizer), and to high oilprices. Exports increased by 13.8% to US$14.1 billion. Gross reserves fell by about US$800 million in2004/05 to US$9.8 billion at end-June 2005. The current account deficit is projected to reach 3.9% ofGDP in FY06.

Figure 1: Recent Economic Performance

% Economic Growth Balance of Payments and Reserves90- 50 - --------------- 1-8.0 -40Geoss int'l reserves in billions70 -60 Real GDP at factor cost5.0- 2 0804.0 10

-2 0 0605 0er capital GDP- --. 0 2 0

13.000 -10 4 0-- 0 20

-3 0 Current accoun t excluding official transfer (% of GDP)20-2.0-40 0 0

1995/96 1997/98 1999/00 2001/02 2003/04 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05

% Total and External Debt Fiscal Trends25.0 - ----------------

100..Expenditure90 Crosspablic debt (% of GP) 20. 0.80 15,07060 10.0 Revenue

50504 05..40

30 -0.0Total public & publicely guaranteed external debt

20 .50 .10 Budget balance (excl grats)0 -100

1999/00 2000/01 2001/02 2002/03 2003/04 2004/05 1999/00 2000/01 2001/02 2002/03 2003/04 2004/05

22. Pakistan's public debt burden has declined sharply in the past four years. Although the stock ofdebt remains high, it has declined faster than expected, and its net present value has been reduced. Thanksto 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. Totalexternal public and publicly guaranteed debt declined from 296 percent of exports of goods and servicesin FY2001/02 to 203 percent in FY2004/05 while debt service fell from 34 to 19 percent of exports ofgoods and services. Interest payments have fallen from 5.6% of GDP in 2001/02 to 3.2% in FY2004/05.

23. The response to the October earthquake-arguably the most debilitating natural disaster inPakistan's history-is expected to have an impact on fiscal outcomes during the current fiscal year andfor at least the next 3 years. The deficit, which had already been projected to grow as the result ofincreases in civil service salaries and a growing public investment program, is expected to rise further,reflecting the costs of rebuilding infrastructure and government services and of subsidies to restorelivelihoods and housing in the earthquake-affected areas. The FY06 fiscal deficit before grants isexpected to increase by around 0.6% of GDP, to 4.4% of GDP (see Table 3), which remains consistentwith 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 in the paceof debt reduction. The extent to which it does depends not only on the Government's efforts to reprioritize

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expenditures, but also the pace at which grants pledged at a November 2006 donors' conferencematerialize. The government has indicated that it is reprioritizing expenditures and strengthening revenueefforts so as to minimize the impact of the earthquake on fiscal balances. The latter is particularlyimportant since revenue performance suffered in FY05 due to a reduction in petroleum taxes (a movedesigned to cushion consumers from the impact of rising international oil prices), reductions in customsduties and special regimes for particular sectors. Some administrative reforms also may have contributedto a temporary dip in collections. However, collections during the current fiscal year are improvingmarkedly.

Table 3: Medium Term Outlook - Key Indicators

Projections2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09

(in percent of GDP, unless indicated otherwise)Output and PricesReal GDP at factor costs (percent change) 4.8 6.4 8.4 6.3 6.5 6.6 6.8Consumer prices (period avg. percent change) 3.1 4.6 9.3 8.2 6.5 5.5 5.0

Consolidated Government Budget BalanceExcluding 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

Public DebtTotal government debt 74 68 61 57 54 51 49

Domestic debt 39 36 33 32 28 25 23External debt 35 31 28 25 26 26 26

External SectorCurrent Account Balance 5.1 2.0 -1.3 -3.9 -4.3 -4.3 -4.1Gross Reserves (US$ millions. IMF definition) 10,251 10,621 9,985 10,549 12,157 13,117 14,079Reserve cover to imports of GNFS (months) 6.9 5.0 3.7 3.4 3.4 3.2 3.0

Sources: 2002/03 to 2004/05 - 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 debtburden while increasing public investment and social spending. These commitments are embodied inthe Fiscal Responsibility and Debt Limitation Bill approved by the National Assembly and subsequentlypassed into Law in 2005. The Law specifies that the revenue deficit be reduced to zero by June 30, 2008,and a surplus maintained thereafter; that total public debt be reduced by 2.5% of GDP per year; that PRSPexpenditures be at least 4.5% of GDP in any year; and that debt guarantees be limited to 2 percent ofGDP. An additional important clause introduced in the Law by the Assembly is the requirement thateducation and health expenditures, as a percentage of GDP, be doubled over the next ten years. Meetingthese targets will depend in large part on the government's ability to improve revenue collection whilecontinuing to reduce the losses of state-owned enterprises, particularly in the power sector. TheGovernment fiscal framework for 2006 through 2009 is expected to remain consistent with the FiscalResponsibility and Debt Limitation Law.

25. Prospects for rapid growth to be sustained over the next 3 years are good, provided that politicaland macroeconomic stability are maintained, that the momentum of structural reforms and investments toreduce the cost of doing business is sustained, and that domestic savings and public and privateinvestment continue to increase The Government is targeting a more ambitious growth path than theMedium 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. TheMedium Term Outlook presented above assumes that the measures necessary to reduce inflationarypressures and the growing external and fiscal imbalances will be taken by the central bank and theGovernment of Pakistan. Economic growth for FY06 is projected to remain strong and broad-based. Led

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by strong domestic demand, industrial growth remains strong in the automobiles and consumer durablessub-sectors. The textile sector continues to perform well, in spite of the end of the Multi-FiberAgreement, and exports of textile products have remained strong. Agricultural output in FY06 isprojected to be average, below last year's record-breaking levels. Foreign Direct Investment is continuingto increase, as investor confidence is strengthening.

II. PAKISTAN'S POVERTY REDUCTION STRATEGY

26. The positive developments outlined above have set the stage for accelerating poverty reduction inPakistan. 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 includinghuman development, governance, and vulnerability and builds on the economic program first articulatedin the fall of 1999 and further elaborated in the I-PRSP of 2001.' Since the PRSP was prepared, theGovernment has continued to develop and refine its program for implementing the PRSP agenda which isembodied in the five-year Medium Term Development Framework 2005-2010 (MTDF), adopted alongwith the FY2005/06 Budget. While the PRSP continues to serve as an overall framework for the povertyreduction strategy, the MTDF refines the strategy, taking into account recent developments, and updatesthe targets while providing further details on implementation strategies. The Government is also in theprocess of preparing a new PRSP which is expected to be finalized in 2006.

27. Taken together, the PRSP and the MTDF constitute a comprehensive poverty reduction andgrowth strategy. The PRSP emphasizes policies to sustain rapid growth as the main vehicle for povertyreduction and is grounded on four pillars: (i) achieving and sustaining a high growth rate whilemaintaining macroeconomic stability, translating this higher growth into lower poverty, and bridging thesocial gap; (ii) improving governance and consolidating devolution, both as a means of delivering betterdevelopment results and ensuring social and economic justice; (iii) investing in human capital, with arenewed emphasis on effective delivery of basic social services; and (iv) targeting the poor and vulnerableto bring marginalized sections of the population and backward regions into the mainstream ofdevelopment, and to make marked progress in reducing existing inequalities. The PRSP's targets are fullyaligned with the MDGs (see Table 4:).

A. The PRSP Strategy

28. Pillar One: Accelerating economic growth while maintaining macroeconomic stability. ThePRSP focuses on accelerating poverty reduction and improving social indicators through rapid, private-sector and export-led growth and more effective and equitable delivery of health, water and sanitation,and education services. The PRSP also emphasizes enhancing competitiveness in the era of globalizationthrough higher investment and knowledge inputs. It recognizes that, while a great deal has beenaccomplished in terms of restoring growth and addressing external vulnerabilities, considerablechallenges remain to improve the efficiency of resource use and raise factor productivity. The key sourceof poverty reduction and employment is expected to be rapid growth and job creation in themanufacturing and service sectors, which are already responding well to economic reforms. The PRSPprojects a substantial increase in private sector investment and the continued expansion of private sectoractivity in order to sustain growth. To increase private investment, the PRSP outlines a set of structuralreforms to increase productivity and reduce the cost of doing business in Pakistan. Overall, the strategyaims to expand the role of the private sector in the development process by the strengthening the enablingrole of the government through policy direction and creation of a supportive regulatory environment.

7 The Bank-Fund Joint Staff Assessment (JSA), discussed by the Board on March 11, 2004, endorsed the PRSP andindicated it provides a good policy framework for the implementation of a strong reform program. Pakistan, JointStaffAssessment of the Poverty Reduction Strategy Paper, Report 27625-PK, February 12, 2004.

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29. Pillar Two: Improving governance. The PRSP recognizes that continuing to improve governancein Pakistan matters critically for economic growth and the development of human capital. The MTDFreinforces this emphasis. Key elements of the Government's strategy include accelerating civil servicereform, furthering devolution, improving access to justice, police reforms, accelerating improvements in

public procurement and financial management, and additional measures to accelerate progress on fiscaland financial transparency and reduce opportunities for corruption. In addition to these areas, the MTDFalso highlights the importance of strengthening corporate governance, enhancing the quality and coverageof data and statistics, and making greater use of participatory approaches in order to improve program andproject outcomes. Regarding civil service reform, the government's strategy highlights a flatter structure,merit-based recruitment and promotion criteria, performance based compensation, and incentives toinnovation. There is also a proposal to restructure the civil services in order to break free of some of thestructural rigidities resulting from the current cadre system. The government also indicates its intention toimplement further pay and pension reforms.

Table 4: Pakistan's PRSP Targets and Alignment with Millennium Development Goals

Goals and Indicators 1990-91 2000-01 2005-06 2011 2015actual

1. Eradicate Poverty and Hunger- Overall poverty level (% of population) 26.1 32.1 28 22 16- Poverty gap ratio 4.53 6.84

2. Achieve Universal Primary Education- Literacy rate of 15-24 years old (%) 49 58 59.5 78 86- Gross Enrollment* 73 87 104 104 100

3. Promote Gender Equality and Empower Women- Ratio of literate females to males of 15-24 years (%) 0.61 0.65 0.65 0.93- Proportion of Seats held by women in the Parliament:

National Assembly (%) 0.9 21Senate (%) 1.0 17Local Councils (%) 33

4. Reduce Child Mortality- Infant mortality rate 120 77 63 50 40- Proportion of fully immunized children 12-23 months 25% 53% 82% 90% >90%- Under five mortality rate 140 105 80 65 52

5. Improve Maternal 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 of target population n/a 45% 77% 90% 100%

6. Combat HIV/AIDS, Malaria and Other Diseases- Incidence of TB/100,000 n/a 177 133 45

7. Ensure Environmental Sustainability- Sustainable access to safe water 82% 86% 90% 93%- Population with access to sanitation 28% 51% 55%

Source: Government of Pakistan, Poverty Reduction Strategy Paper, 2003.*A sub-committee headed by Director, PIDE is engaged in reconciling PIHS and NEMIS data.

30. Pillar Three: Investing in human capital. In Pakistan, social development lagged even whengrowth was robust and the incidence of income poverty declined. The Government's PRSP acknowledgesthat without a considerable improvement in social indicators, especially for women, Pakistan will beunable to sustain high rates of economic growth. Education is seen as the most important factor

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distinguishing the poor from the non-poor. The PRSP, therefore, includes increased allocations foreducation, health, water and sanitation, and rural infrastructure. The MTDF reflects a large increase inresources for education with the total public allocation for education expected to increase to 3.6 percent ofthe GDP by 2010 with private sector expenditure adding another 1.5 percent.

31. In health, the PRSP recognizes the need to increase financing and enhance efficiency of spendingthrough organizational and management reforms. Furthermore, the PRSP focuses on reorganization ofdistrict health structures, strengthening of district and tehsil hospitals, improving hospital administrationthrough greater autonomy, and regulation of the private sector. On the programmatic front, the strategy isto continue and strengthen the shift from curative services to preventive and primary health care. Thestrategy prioritizes control of communicable diseases, reproductive health, child health and nutrition. Inhealth, the Federal Ministry would focus on development of a public health surveillance system and ongradually devolving preventive care programs, which would increasingly be designed and not onlyimplemented by provincial and local governments. The PRSP acknowledges that the achievement of keyPRSP goals in health depends also on policies and developments outside of the health sector such asliteracy, access to drinking water and adequate sanitation.

32. Pillar Four: Targeting the poor and the vulnerable. Targeting the poor and the vulnerablethrough social protection programs is one of the integral pillars of the strategy. There are several socialprotection programs in Pakistan, which have as their objective improving the welfare of the poor andvulnerable groups. The programs include cash transfers through the Zakat and Bait-ul-Maal programs,in-kind assistance through, for example, the school meals pilot program (Tawana Pakistan), and programsto reduce the prevalence of child labor (stipend/schools for working children and their families). Inaddition to cash and in-kind transfers, Khushali Bank and a number of NGOs provide microfinance tolow-income households. There is also a social security system for workers in the formal sector. A modestnumber of facilities provide institutionalized care or special education to specific vulnerable groups suchas the disabled or child laborers.

III. BANK GROUP ASSISTANCE STRATEGY

A. Implementation of the Last CAS and Lessons Learned

FYO3-05 Actual lending, portfolio management, and IFC program

33. While new lending slowed during FY03 following the October 2002 elections, it picked upthereafter and overall CAS lending volume was close to that envisioned in the high-case lending scenarioof the FYO3-05 CAS. New lending commitments during the CAS period totaled US$2.033 billion,including US$404 million of IBRD, or 15% below the CAS high case lending scenario of US$2.4 billionincluding US$600 million in IBRD borrowing. The shortfall in IDA commitments was due in large part todelays in development policy lending for the provinces of Sindh and NWFP as well as a shortfall inoverall IDA 13 resources. Total EBRD commitments were one-third less than the high-case scenario total.A detailed comparison of planned and actual lending is included in the CAS Completion Report. Just overhalf of IDA and IBRD commitments were fast disbursing development policy loans, compared with the65% share projected in the CAS, again reflecting the delay in planned development policy lending for theprovinces.

34. With respect to the ongoing portfolio, performance throughout the CAS was generally good (seeTable 5). Starting from a low point at the beginning of the CAS period, the portfolio has grown from 12to 16 projects reflecting the increase in lending over the previous CAS. Despite the growing volume oflending, the portfolio remains relatively small, a reflection of the substantial proportion of single tranchedevelopment policy credits in the program (about one-third of the operations approved during the CASperiod). Performance indicators showed sustained strong performance with 100 percent realism and

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pro-activity and a disbursement ratio well above regional and Bank-wide averages. The percentage ofprojects at risk remained low, although it rose somewhat in FY05. This increase is being watched closelyand managed intensively inconsultation with the GoP (seepara. 106). Table 5: Bank Portfolio Indicators

. Indicator FY02 FY03 FY04 FY0535. The CAS emphasis onknowledge transfer was reflected in Number of Projects 12 15 18 16the AAA program. Core diagnostic Projects at Risk (%) 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 (%) 100.0 100.0 100.0 100.0satisfactory by QAG), a Poverty Proactivity (%) 100.0 100.0 100.0 100.0Assessment, CFAA (complemented Disbursement Ratio 37.0 28.0 24.7 40.7by three provincial financialaccountability assessments), an FSAP, and a Country Gender Assessment. Customized, high impactinformal AAA such as the trade policy notes and power sector policy notes were used to support highlevel policy dialogue and catalyze implementation of reforms. A series of in-depth provincial economicreports was launched, beginning in FY04 with the Punjab Economic Report, followed by the NWFPEconomic Report in FY05. By design, the AAA program has put less emphasis on delivery of discreteoutputs and teams have been encouraged to transfer knowledge through policy dialogue and non-lendingTA. Major (or flagship) ESW Reports have been limited to no more than three a year to ensure qualityand adequate managerial attention.

36. The IFC Program over the previous CAS period included investments and significant increases intechnical assistance and advisory service. Commitments during the three year period totaled US$187million. Total exposure now stands at US$314 million in 32 companies including US$62 million inequity, down from US$442 million in 48 companies at the time of the CAS. Liquidity in the localfinancial markets led IFC to reassess its approach and provide more value-added instruments and putgreater 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 inKarachi's port, the first investment in information technology, Islamic financing in the leasing sector, anda linkage initiative in the textiles sector. TA included initiatives in all major pillars of the PrivateEnterprise 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 TAprogram in Pakistan included a corporate governance program for banks, institution building in housingfinance, and SME and microfinance, training in alternative dispute resolution, support for businessmembership organizations, and advice in the water sector. Moreover, during the last CAS period, IFCTechnical Assistance and Trust Funds Program (TATF) completed a feasibility study in the health sectoras well an analysis of the competitive positions of the country's leasing companies and investment banks.IFC's Environmental Opportunities Facility (EOF) completed a study to help optimize a wastewatertreatment facility in the textile manufacturing industry.

Lessons learned from IEG evaluations, client survey, and the CAS Completion Report

37. The Country Assistance Strategy (CAS) for FY2006-09 builds on the lessons learned duringimplementation of the FYO3-05 CAS and the messages heard during consultations with stakeholders aswell as the results of a client survey. In addition, recent formal reviews of the Bank's work in Pakistaninclude (i) the Independent Evaluation Group (IEG) Country Assistance Evaluation coveringFY94-FYO3; (ii) the FYO3-05 CAS Completion Report; (iii) Recent IEG Project Performance AssessmentReports; (iv) ICRs of projects closed during the CAS period; and (v) a QAG review of AAA work.

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38. Results of the Client Survey. The survey of 351 stakeholders drawn from government, nationaland provincial assemblies, the private sector, media and academia yielded a number of insights on theBank's contribution to Pakistan's development. Stakeholders reported that the greatest developmentchallenges are poverty reduction, education and law/justice, with education emerging as a critical issueconsistently throughout the survey-and an area where respondents believe the Bank can play a moreprofound role. In addition, stakeholders emphasized infrastructure as an area that is critical for successfuldevelopment-and an area where the Bank's work receives some of the highest ratings from stakeholders.The Bank's role as a provider of knowledge was also particularly valued. The Bank's greatest weaknesseswere considered to be imposing technocratic solutions without regard to political realities and notexploring alternative policy options. A consistent and important message from both the survey andconsultations is that the Government of Pakistan values its partnership with the World Bank.

39. Lessons from the CAS Completion Report. The CAS Completion Report (Annex 2) reviews theBank Group's effectiveness over the past three years and indicates that the Bank's strategy wasappropriate and succeeded in making a significant contribution toward the achievement of some of theoutcomes targeted in the FY03-05 CAS. In particular, targets for macroeconomic stabilization (includingdebt reduction) and increases in poverty-related expenditure were met and milestones in governancereforms in financial management and tax administration were achieved. While outcomes in several areaswere not met, the Bank program helped in the development and implementation of reform programs towhich the government remains committed, even if the pace of reform has not been as rapid as envisionedin the CAS. With respect to development outcomes, there is now preliminary data to suggest that thereforms of the past three years are beginning to yield measurable improvement, although in some casesless than targeted in the CAS. Taken together these reviews and feedback suggest that while the Bank hasmade a valuable contribution to Pakistan's development, there is significant potential to increase ourdevelopment impact. The chief lessons relevant to formulation of the CAS are:

* A programmatic approach provides the flexibility to support reforms while managing risk. Theuse of annual single tranche adjustment operations at both the provincial and national level helpedto support reforms while providing a mechanism to adjust the lending program to match the paceof reforms. This approach strengthened the link between borrower performance and the Banklending program.

* Projects need to be focused and scaled to fit the capacity of the implementing agency, in terms ofboth project scope and the pace of implementation. While reinforcing the emphasis on the keyrole of "client pull," the experience of a number of projects that closed during the CAS, especiallythe multi-province umbrella projects, highlights the need for focused projects that are readily"implementable" with realistic schedules and clear ownership. In particular, governance reformsoften took longer than planned. Realistic assessment of technical and political implementationchallenges need to be reflected in project designs which should exhibit a strong bias towardssimplicity.

* Greater attention to capacity building is needed. As indicated above, weak implementationcapacity is a widespread concern affecting project design and implementation. The Bank hasbegun to increase its capacity building programs with the approval of the Public Sector CapacityBuilding (PSCB) project in FY04 and the designation of Pakistan as a focus country for WBIprograms beginning in FY05. The Bank will also continue its support for civil service reformsthrough policy dialogue, the PSCB project and PRSCs. During the coming CAS, projects willhave a greater emphasis on building institutional capacity.

* The program needs to continue to strengthen its focus on results. To address weak M&E systemsand capacity within the GoP and implementing agencies, the Bank needs to support thestrengthening of statistical capacity and monitoring and evaluation as part of institutionstrengthening. At the same time, the Bank needs to do a better job of focusing on developing

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solid project-level results and indicators and incorporating the monitoring of these results into thesupervision process. The results-based CAS offers an opportunity to identify and focus on keystrategic outcomes at the country level and provide a framework for joint monitoring andevaluation of the overall country program with the Government.

40. The IEG Country Assistance Evaluation. IEG's Country Assistance Evaluation (CAE) rates theoverall outcomes of the Bank's assistance program as moderately unsatisfactory.8 During the periodcovered by the IEG review (1994-2003), IEG found that the outcomes of Bank support formacroeconomic management and growth achieved success, especially in the last few years. However,outcomes of the Bank's assistance were found to be unsatisfactory in poverty reduction and social sectordevelopment, governance, agriculture and natural resource management, fixed infrastructure, and revenuemobilization and expenditure management. Taken together, therefore, IEG rated the overall outcomes ofthe Bank's assistance program as moderately unsatisfactory. Although the CAE primarily covers thedecade prior to the beginning the FYO3-05 CAS, some of its findings and recommendations are applicableto the new CAS and have been discussed by the Country Team and are reflected herein. The keyrecommendations of the CAE are: (i) the Bank should continue its strong support of analytical work whiletranslating analysis into implementable actions taking into account political economy constraints; (ii)Bank interventions should have a greater focus on building sustainable institutional capacity; (iii) projectsshould be more focused and scaled to fit the capacity of implementing agencies; and (iv) the Bank shouldinvest additional effort into improving donor relations.

41. A more recent IEG Project Performance Assessment 9 drawing lessons from the provincialdevelopment policy loans for Sindh and NWFP has also informed the development of this CAS. Inparticular, the PPAR notes that sub-national development policy lending can make a significantcontribution in terms of improving service delivery. In the context of devolution, the PPAR also notes theimportance of clarifying the respective roles and financial relationships of various levels of government.Finally like the CAE, the PPAR notes the importance of taking capacity constraints into account-especially at the local level-and recommends greater attention to capacity building in future operations.

B. Context and Engagement Principles

42. While highlighting areas in need of strengthening, the review of our assistance and lessonslearned outlined above also confirm the value of the Bank's strategic partnership with Pakistan. The Bankhas come to be seen by the Government as a trusted development partner, valued not only as a majorsource of development finance but also as a source of global knowledge based on internationalexperience. At the same time, the Bank has gained significant credibility as a catalyst for reform throughits willingness to exercise selectivity, lending only in the presence of strong ownership of, andcommitment to, reform and where there is clear evidence that the Bank adds significant value. The Bankis therefore uniquely positioned to play a key role in helping Pakistan to sustain its recent strongperformance and accelerate poverty reduction. Moreover, in light of its recent successes, Pakistan is wellpositioned to make real progress in poverty reduction and has requested a significant increase in the scaleof Bank financial support. For the Bank, this represents an important opportunity to increase the impact ofour work in Pakistan by significantly scaling up our program over the FY06-09 period.

43. In this context, the Bank's work will continue to be guided by the following strategic engagementprinciples:

Pakistan - Country Assistance Evaluation (CODE2005-0058; /1), June 29, 2005. The Pakistani authorities agreewith the CAE's analysis in some areas, but note that the report did not emphasize adequately recent improvementsand was too critical of outcomes in agriculture and privatization.9 IEG, Project Performance Assessment Report. Report No. 33612, December 19, 2005.

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* The Bank will commit resources only in the presence of strong "client pull" to ensure that scarce

resources are applied only where there is a high probability of success. Evidence of client demandfor Bank support will include the leadership of committed reform champions who have

demonstrated the willingness and ability to carry out needed reforms. At the project level, clientdemand will be reflected in the establishment of adequate institutional arrangements andreadiness for prompt implementation.

* The Bank's program will reflect strategic selectivity, targeting Bank resources where they can bemost effective. A principle consideration will be demonstration of client pull as outlined above. Inaddition, while the program will span a wide range of instruments and sectors, we will maximize

impact by seeking replicate or scale-up approaches that have already been shown effective. Wewill continue to maintain a close dialogue with the Government and other partners to harmonizeand reinforce our efforts and to target our activities in the areas where the Bank has the greatestcomparative advantage.

* This new CAS will have an even greater focus on outcomes. The Bank's program for Pakistanwill be guided by the CAS results framework (Annex 1) which identifies: (i) long-term nationaldevelopment goals; (ii) associated CAS outcomes that the Bank can directly help to realize; and(iii) the mix of Bank Group products and services that best contributes to these CAS outcomes.An integral part of the shift toward a results-based CAS will be the strengthening of the CASM&E architecture. The CAS results framework also identifies indicators to monitor progresstoward the achievement of CAS outcomes as well as implementation of World Bank Group CASprograms and will therefore serve as a mechanism for monitoring progress in CASimplementation.

* Programmatic approaches will continue to form the core of the Bank program. The experienceof the FYO3-05 CAS supports the continued used of a programmatic approach to providesustained, flexible, and predictable support to medium-term reform programs. Experience hasalso shown that programmatic approaches are effective in strengthening ownership whileaccommodating the uncertainties inherent in medium-term reforms. Increasingly we will providea range of services-a combination of dialogue, capacity building, expenditure review andtechnical assistance along with IDA resources-aimed at building effective service deliverysystems at the local government level. Programs will seek to link inputs to outputs, be integratedinto 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 asapplication of the strategic principles outlined above, the Bank will seek to deliver a substantial increasein its volume of lending to Pakistan during the next four years. The immediate priority will be to assist inaddressing the impact of the October 2005 earthquake; up to US$1 billion in IBRD/IDA commitmentswill be used to support reconstruction and recovery (US$840 million in new commitments have alreadybeen approved). In addition, based on the Government's priorities for sustaining growth and acceleratingpoverty 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 levelwill remain a key focus and a substantial share of IDA lending will take the form of PRSCs andprovincial development policy credits to support, inter alia, fiscal/financial management improvement,transparent and efficient public procurement, power sector reforms, actions to improve the investmentclimate and cross-cutting initiatives to improve service delivery. Investment lending devoted tostrengthening and reform of the key governance institutions (e.g., tax administration, financialmanagement, land records, and statistics) will also continue to make up a significant portion of thelending program.

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45. While the Government's request for additional financing for infrastructure will lead to an increasein investment lending, policy-based fast disbursing lending will continue to account for a significant share

of total lending. Policy-based lending instruments are well-suited to supporting the Government's povertyreduction strategy which emphasizes second generation policy and institutional reforms. The experienceof the FYO3-05 CAS has demonstrated the effectiveness of flexible, performance-based assistance insupporting policy reforms and crosscutting actions needed to improve service delivery. Annual PRSCswill form the core of the Bank's support for implementation of Pakistan's poverty reduction strategy atthe 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 in their implementation.As in the previous CAS province level development policy operations will couple fiscal and financialmanagement reforms to improve financial sustainability with actions to improve the effectiveness ofservice delivery. IBRD development policy lending will be considered to support reforms in urbanmanagement, irrigation, and transport, in conjunction with investment lending, policy dialogue andtechnical assistance. In each case, the choice of development policy instruments will be driven by thestrength of medium-term reform programs and the capacity and track record of counterparts.

46. The proposed assistance program will be aligned with the respective responsibilities of nationaland provincial governments in Pakistan and tailored to meet the needs of the individual provinces.Provinces and local governments bear most of the responsibility for delivering public services includingirrigation, education, health, and water supply and sanitation, but have very limited "fiscal space" toprovide these services. In the FYO3-05 CAS, the Bank's strategy was to focus on those provinces-Sindhand NWFP-that had embarked upon comprehensive reform programs to support those programs througha series of development policy credits. In addition the Bank provided programmatic support for educationreforms in Punjab, beginning in FY04. Provincial reform programs in Punjab and Balochistan weresupported through the Asian Development Bank's Resource Management Program loans. During thecoming CAS period we will continue to support provincial reform programs in these provinces andmaintain a dialogue with all provinces based on in-depth provincial economic reports for each province.We will seek a balanced approach with lending and analytical services geared to the specific challengesand unique opportunities (e.g., the mineral sector in Balochistan) in each province.

47. At the national level, policy-based and investment lending will focus on areas that are themandate of the federal government. The PRSC program will focus on the critical policy and institutionalreforms to improve governance and the investment climate. Much of the planned increase in investmentlending will be for national-level programs, including national highways, ports, railways, power, andwater.

C. World Bank Group Program Priorities

The Strategic Framework

48. The Bank Group' program priorities will retain considerable continuity with the FYO3-05 CAS.The World Bank program for FYO6-09 will support the continuation and consolidation of many of thereforms initiated in previous years including cross-cutting governance reforms initiated in current andearlier CASs (financial management, procurement, tax administration, devolution and civil servicereform). We will also assist in strengthening the institutions governing the market economy and continueto encourage reforms in the incentive and regulatory regimes for infrastructure, finance, trade andmanufacturing to further improve the business climate. Working with the federal government and theprovinces we will seek to improve the quality of 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 of the CAS correspond to the strategic priorities of the PRSP: (i) sustaining growth and

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improving competitiveness; (ii) improving government effectiveness and service delivery; and (iii)improving lives and protecting the vulnerable. The pillars of the CAS are inter-linked and mutuallyreinforcing. Sustaining high and broad-based growth is necessary to create employment and income-generating opportunities. Addressing poor human development outcomes is a critical element of thestrategy to enable the poor to take part in and benefit from growth. Improving governance cuts across theentire strategy - it is important both to improving the investment climate to support growth and tostrengthening the delivery of services to the poor. Within the three pillars of the CAS, the Bank hasidentified a selected number of outcomes that will be pursued during the CAS period. The rest of thissection explains the main issues and constraints in the areas of the CAS pillars and how the proposedoutcomes to be supported by the Bank Group program will assist Pakistan in tackling these constraints.

Pillar I: Sustained Growth and Improved Competitiveness

50. Strengthened macroeconomic management and allocation of resources. Maintaining the hard-won benefits of 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 pressuresand limited progress in improving revenue mobilization represent challenges. With the increasedspending made necessary by the costs associated with earthquake recovery, there is an even more acuteneed for further prioritization of expenditures to maximize the benefit of available fiscal space. Keypriorities include reducing the drain on the budget caused by losses of state-owned enterprises, improvedmanagement of the public investment program, and strengthened debt management.

51. With the conclusion of the IMF poverty reduction growth facility program, the Bank'smacroeconomic monitoring and advice will occupy a more central role in our dialogue 0 In addition, theBank will continue to provide support to help the Government strengthen macroeconomic managementthrough (i) improving the level and composition of expenditure; (ii) improving the effectiveness andimpact of public expenditures through the preparation of a Medium Term Budget Framework (MTBF)and the formulation of sector strategies and sector investment programs; and (iii) continuing ongoing taxreforms aimed at improving tax payer services while increasing the tax-to-GDP ratio. PRSCs andprovince-level development policy lending will help to bolster these reforms while planned AAA willinclude reviews of the Public Sector Development Program, a Public Expenditure Review, technicalassistance in pension reform, and analytical support for tax policy reforms.

52. Improving Pakistan's low tax-to-GDP ratio will continue to be a major focus of our work aimedat addressing weaknesses in the current system including: (i) inefficient tax administration; (ii) a narrowtax base - only 1.53 million taxpayers out of 39.4 million employed; (iii) a complex and cumbersome taxsystem; and (iv) corruption and tax evasion. Recent reform initiatives have had a positive impact on taxmanagement and in improving revenues - for the first time over the last two years, the Government wasable to achieve its revenue targets, although this cannot be attributed to tax administration measures aloneas strong growth has also contributed to rising revenue. Successful implementation of the FY05 TaxAdministration Reform project will be the centerpiece of our efforts. The main challenges will includeimplementing organizational and management reforms, re-engineering of operational processes that arelikely to affect staffing levels and introducing automated risk-based systems that reduce contact betweentax payer and tax officials to minimize corruption. In addition, with the end of IMF program, ad-hoc andinconsistent tax policy changes have started to constrain expansion of the tax base. Tax policy support,

10 A 3-year PRGF arrangement was approved in November 2001 and concluded in December 2004. All PRGFdisbursements were made available upon completion of program reviews although the GoP elected not to draw thefinal tranche in light of its improved external position. Compliance with structural performance criteria andmacroeconomic conditionality was better than average for Fund-supported programs. See, IMF, Pakistan 2005Article IV Consultations and Ex Post Assessment of Longer-Term Program Engagement, November 2005.

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including a Tax Policy Study, is planned and PRSC III will support tax policy measures to increaserevenue mobilization.

53. Increased diversification and exports in agriculture. The Government intends to accelerateagricultural growth by promoting the diversification of agricultural production into high value products(including crops, livestock and fisheries) and agro-processing, improvement in factor productivity, andbetter integration of supply chains. The Government has made good progress over the last couple of yearswith respect to liberalization of the domestic wheat trade (removing restrictions on transport), liberalizingwheat imports and maintaining a reasonable level of strategic reserves. However, the Governmentremains involved in the procurement of some 20% of local production at a heavy cost. Long-termagricultural growth and poverty reduction are constrained by the structure and performance of key ruralfactor markets including land, water, and credit as well as a degrading resource base, in particular soil andwater. Given the constraints on land and productivity, the poor will benefit from agricultural growth onlyif the increase in productivity is translated into lower real prices of food and higher employment-toinclude the rural non farm poor, who together account for 61% of the rural poor-and higher rural wages.

54. The focus of the Bank's work in this area will initially be to support the preparation of a ruralstrategy, integrating issues related to agriculture, natural resource management, the rural non-farmeconomy, infrastructure, rural finance and the need for targeted interventions. The strategy will alsoinclude analytical work on supply chains and World Trade Organization (WTO) issues, to understand thepotential market access for agriculture through the opening up of international markets and agribusinessnetworks. It will analyze and discuss the potential for increased public support through agriculturalresearch, extension services, and technology transfers with an emphasis on adapting technology forrainfed areas and livestock. The Bank will also support policy and institutional reforms in landadministration beginning with the Punjab Land Records Management Project. In addition we will seek tosupport reforms in the research and extension system to introduce more demand-driven participatoryapproaches based on public-private partnership.

55. Irrigation and drainage. Pakistan's extensive irrigation system is under growing stress as theresult of growing demand, deteriorating infrastructure and poor governance. Building on the recentlycompleted water strategy, the Bank will support a combination of institutional reforms and investmentsincluding: (i) major investments in rehabilitation of critical assets (including barrages), and will help putin place Asset Management Plans which will set priorities for asset rehabilitation and maintenance, makeexplicit the requirements for public and user financing, and develop institutional arrangements forrehabilitating and maintaining this infrastructure; (ii) development of capacity at the provincial andfederal levels for improving water and associated natural resource management; (iii) efforts to improvethe quality, efficiency, and accountability with which irrigation services are delivered; and (iv)investments in on-farm services (land leveling, watercourse lining, introduction of new technologies) forincreasing the productivity of water use. Bank support will be provided through a range of instrumentsincluding development policy lending in support of key reforms as well as through investment lending tofinance infrastructure and institutional development. Governance and communication improvements willbe a central theme as poor governance and low trust are among the key underlying factors behind the poorperformance of the irrigation system and low productivity. Finally, given the major scientific, policy andimplementation challenges ahead, the Bank, with support from the Government of the Netherlands, willprovide analytical and technical support to the federal and provincial governments.

56. While Pakistan recognizes the importance of improving the efficiency of water use, theGovernment's water strategy also assigns high priority to augmenting water storage capacity, both tooffset the declining capacity of existing reservoirs (due to siltation) and to meet growing demand. Indeed,compared with other countries Pakistan has relatively little water storage capacity and substantialuntapped hydropower potential, indicating a potentially high payoff from new reservoirs. The GoP hasrecently announced a Presidential initiative under which it intends to build up to five new dams by 2016.

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Given the importance of such an investment for addressing long-term water issues, the Bank will considerproviding technical assistance for this work. Looking further ahead, should the proposed project provetechnically and economically sound, the Bank would be prepared to respond favorably to a governmentrequest to help finance construction, provided the project is designed and implemented in conformancewith international standards for social and environment safeguards.

57. Improving the business environment for trade and investment Recognizing that sustaining thecurrent high rates of economic growth requires globally competitive production in an increasinglydemanding world market, policy makers are focused on strengthening international competitivenessthrough rising productivity to support higher wages, a strengthened currency and increased returns tocapital. Macroeconomic stability and the removal of price distortions have eliminated impediments toproductivity growth but will only translate into rising productivity if accompanied by a more conducivebusiness environment. There is consensus among policy makers, academics and the business communitythat improvement in Pakistan's competitiveness derives in part from success in three "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 aparticular challenge, encompassing such entrenched factors as efficiency and effectiveness of governmentand autonomous institutions, quality of regulation, policy uncertainty, and the rule of law. Second,efficiency of factor markets to foster flexibility and fluidity represents a major constraint to good resourceallocation and ease of entry, particularly in the case of land and labor. Third, the degree to whichentrepreneurs find it easy to do business has a major impact on international competitiveness. Manyreforms were initiated in these areas in recent years, and a number of indicators of 'doing business' haveimproved as a result.

58. During the CAS period, the Bank Group will support the following: (i) strengthening theinstitutions and legal/regulatory frameworks in support of a competitive market economy by updatingcorporate law and building the capacity of courts and monopoly control authorities; (ii) lowering theburden of government bureaucracy and regulation to ease entry and business operations, particularly forSMEs; (iii) improving labor market flexibility through legislative reform (employment and industriallegislation is currently being revised); (iv) improving tax administration; and (v) further reduction of tradeprotection. In addition, as provincial governments have a role in improving their local investment climate,the Bank Group will work with provincial authorities to address areas within their domain such asimproving management of industrial estates and improving the functioning of land markets.

59. Ongoing analytical work in this area includes studies on 'Growth and Competitiveness', 'ValueChain Analysis', and 'The Labor Market.' This work will be followed by National and Sub-nationalDoing Business & Investment Climate Assessments and additional Provincial Economic Reports. ThePublic Sector Capacity Building Project (PSCBP) will be implemented along with an IDF grant for theSecurities and Exchange Commission of Pakistan. Capacity building for other institutions charged withgovernment markets will also be deployed, such as efforts to strengthen the framework for fair and opencompetition. Annex 7 outlines in greater detail the World Bank Group Private Sector Strategy.

60. Improved infrastructure to Support Rapid Growth. Infrastructure bottlenecks pose a significantthreat to Pakistan's ability to sustain rapid growth. During the next CAS period the Bank will focus onthree areas: (i) supporting reform processes, including privatization and private sector participation inpublic utilities, technical assistance and capacity building to strengthen institutions in specific sectors; (ii)working closely with the IFC and MIGA to increase private investment in infrastructure; (iii) developingthe legal and institutional framework to encourage private-public partnerships and (iv) undertaking IBRDinvestment operations where reforms have advanced sufficiently to make public investment effective.

61. At present, the power sector is not up to the challenge of meeting growing electricity demandefficiently and reliably and extending service to underserved areas and poorer segments of the population.

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Challenges include high technical and commercial losses (over 20 percent in a number of distributioncompanies and in some cases as high as 40 percent), bottlenecks in transmission and distribution,substandard quality of supply, underinvestment, high costs, and inadequate tariffs. About 30 percent ofpopulation has no access to power. There are large cross-subsidies in the tariff structure, with industrialand commercial consumers subsidizing residential ones. Government subsidies to the sector total aboutUS$1 billion annually.

62. In recent years the Government has made significant progress in implementing its power sectorprogram first initiated in the late 1990s. The reform program includes unbundling, corporatization,commercialization, and privatization of the industry," establishment of an independent regulatory agency;institutional strengthening in policy, governance, and corporate management; and mobilization ofresources from the private sector to meet the power sector's technical, financial and human resourceneeds. Although much remains to be done, progress has been made: a new legal framework for the sectorwas adopted, an independent regulatory agency (NEPRA) established, WAPDA was unbundled,privatization of several companies in generation and distribution has been completed or is underway, anda Policy and Implementation Cell in the Ministry of Water and Power established.

63. The Bank has been deeply engaged in the power sector. Strategic and policy advice, supported bydevelopment policy lending including SAC II and PRSC I, was instrumental in restructuring the sector.Although progress in improving financial performance has been disappointing, implementation of theoverall restructuring strategy for the sector has laid the groundwork for improved performance andopened the way for investment lending. Further strengthening of sector governance is required to improveperformance and attract private investment. There is a significant backlog of investment, particularly inreducing the high technical and commercial losses in the distribution systems. In addition to continuedsupport for policy, governance and regulatory reforms through the PRSC, planned investment lendingincludes support for distribution and transmission, investment in hydropower (including possible large-scale hydropower), and the expansion of rural access. A programmatic approach is planned, with asequence of investment loans and guarantees to address investment priorities as implementation of thereform program proceeds. In the context of expanding rural access, there is good potential for themobilization of Global Environment Facility (GEF) and carbon finance to support "low-carbon" growthin the sector. In developing options for affordable and sustainable provision of power in rural areas-andin particular in NWFP and Balochistan where grid penetration is currently limited-the Bank willconsider alternative investment and institutional approaches to rural electrification, including options fordecentralized autonomous grids.

64. During the previous CAS period, the Bank supported Pakistan's telecommunication reformsthrough policy dialogue and lending, including PRSC I and the Telecommunication Regulation andPrivatization Support project. As a result of the reforms, sector performance has begun to improvemarkedly as indicated by the increase in aggregate telecommunications density (fixed and mobiles) from4.6 telephones lines per 100 inhabitants in June 2003 to about 17.8 by December 2005. Key reformsincluded (i) strengthened institutional and regulatory arrangements under the Ministry of IT andTelecommunications and the Pakistan Telecommunications Authority; (ii) full liberalization of the localloop (LL) and long distance and international (LDI) markets resulting in numerous new companiesproviding services at competitive rates; (iii) approval of a new cellular mobile policy in January 2004leading to licensing two new additional cellular mobile operators, rapid growth in penetration, and adramatic reduction in prices; (iv) successful privatization of Pakistan Telecommunications Limited(PTCL) generating US$2.6 billion in proceeds and leaving the telecommunications sector fully managed

1 The Water and Power Development Authority (WAPDA) has been responsible for electricity generation,transmission, and distribution in all areas of Pakistan with the exception of Karachi, where Karachi ElectricitySupply Company (KESC) has played that role. The unbundling and restructuring elements of the reform programapplied to WAPDA only, as the dominant monopoly; the other elements of the reform applied to the entire industry.

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by the private sector. IFC made a very successful investment in TRG, (a call center company), with astrong demonstration effect.

65. In spite of this success, telecommunications services fall well short of their potential compared tocomparator countries. One important gap is between rural and urban users; as of March 2005 about 50%of Pakistan's 50,000 villages have no access to telecommunications services and very few villages haveaccess to the Internet. The Bank will support over the CAS period (i) adoption of additional measures tostrengthen the policy and regulatory environment, including establishing pro-competitive licensing,interconnection and tariff regimes, addressing quality of service and other consumer issues, andimproving the management of limited resources such as the radio spectrum and numbers; (ii) policydialogue and advice; and (iii) investment support for accelerating the provision of ruraltelecommunication infrastructure including e-services and broadband connectivity. In addition, IFC willsupport the expansion of services by the private sector.

66. Pakistan's transport sector is inefficient, imposing additional costs on Pakistani business andthreatens to become a serious obstacle to sustained growth, as well as an impediment to achievement ofthe MDGs. It is estimated that this inefficiency already costs 4-6% of GDP per annum, constrainseconomic growth and diversification, reduces export competitiveness, and hinders social development.Key issues are: (i) poor rural mobility with 75% of all rural health, education and market facilitiesaccessible only by earth tracks; (ii) urban congestion and inadequate public transport which are raising thecost of doing business, crowding out the urban poor, and increasing the health and safety hazards faced bypassengers, pedestrians and residents; (iii) Pakistan Railways' financial and operating performanceremains weak and as a result it carries barely 5% of total cargo traffic, far less than its potential; (iv)costly port systems and inadequate trade facilitation are imposing high costs and delays on shippers.

67. Reflecting the high priority assigned to supporting growth and competitiveness, the Bank and thegovernment are in the process of developing a strategic approach to the transport sector focusing first onthe National Trade Corridor linking Pakistan's major ports in the south with its major cities and tradecorridors to the North. Together the ports, road and railways along this corridor handle 95 percent ofexternal trade and 65 percent of total land freight serving the regions of the country which contribute80-85% of GDP. Corridor utilization is more than 80% of existing capacity and projected growth willdouble demand by 2015, and require much higher levels of service. The objective is to develop anintegrated approach to planning, investing and managing the National Trade Corridor transport logisticssystem. The key outcome sought would be significant reductions in the time and cost of moving goodsthrough the Indus corridor. The GoP has already initiated reforms, reducing entry fees at Karachi portwhile seeking to reduce port dwell times. The Government is also targeting improved trade and transportconnectivity with China, Central Asia and Western Europe as a means of promoting economic activitythroughout the region and is seeking World Bank support in this endeavor. The Bank has provided andwill continue to provide analytical support to develop the frameworks to guide sub-sector policies (forhighways, railways, ports and trade facilitation), including pricing, regulation and enforcement, mediumterm budgetary frameworks, restructuring and progressive commercialization of public entities andstrengthening of institutions (NHA, Pakistan Railways, etc.). An ongoing transport competitiveness studywill help highlight priorities for investment lending and institutional reforms.

68. Pakistan's investment needs in transport are enormous. There is a significant maintenancebacklog and current government investment in the sector is as much as 5 times less (as percent of GDP)than countries in East Asia. It is estimated that modernization of the Indus Trade Corridor alone willrequire investment of about US$1 billion per year over the medium term. In addition, critical road linkswere destroyed or damaged in the October earthquake and their repair is an urgent priority. The Bank iscurrently supporting rehabilitation of the national highway network through the Highways RehabilitationProject (with additional financing to address the effects of the earthquake) and assisting in modernizingtrade and transport facilitation under the Trade & Transport Facilitation Project. There is strong demand

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from government for increased lending in the transport sector during the coming CAS period. Follow-oninvestment lending for highways and trade facilitation is expected along the Indus Trade Corridor with an

emphasis on increasing private sector participation in operation and management. In railways, acombination 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 aseparate, professionally managed, commercial freight business with its own rolling stock and staff. In the

port sector the Bank will support a move towards port corporatization and professional management

combined with a modem institutional and legal framework for port operations that would open the wayfor investment lending to upgrade port infrastructure.

69. While the emphasis is on supporting growth, the Government also recognizes that transport,especially in rural areas is important to improving development outcomes. Surveys have shown thathealthcare for all, and above-primary educational opportunities for girls are particularly hard hit bymobility constraints. During FY03-05 the Bank prepared a Rural Access and Mobility Study focusing on

options for the sustainable provision of a core rural access network at the district level under the country'sdevolution framework. During the coming four years we will continue to explore options for providingassistance to this sub-sector including possible implementation of pilot projects through the PakistanPoverty Alleviation Fund.

70. Support for reform and development of the oil and gas sector has been a strategic priority for theWorld Bank assistance program since 1999. During the last CAS, the Bank continued to provide policy

advice and technical assistance supported by development policy lending (SAC II and PRSC I). Goodprogress has been made in the deregulation of the petroleum market, pricing and regulation of natural gas,conversion of power plants from fuel oil to natural gas, and acceleration of exploration activities.However, gas tariffs continue to be distorted by cross subsidies among different classes of consumer(particularly the very large and poorly targeted "lifeline" tariff slab and the low cost of gas for thefertilizer sector) and implementation of the gas price adjustment mechanism has been erratic. Similarly, in2004 the government elected only partially to adjust domestic petroleum product prices to reflectinternational oil prices, resulting in a fiscal cost of Rs. 8 billion (US$130 million).

71. Looking ahead, a key priority is to address looming gas shortages; while all gas is currentlydomestically produced, given the combination of rapid growth in demand and depleting reserves, gasimports will become necessary, possibly as soon as 2009. With this in mind, the Bank will continue toprovide 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 gasimport transactions. Possible investment lending or guarantees would support the expansion ofinfrastructure for the importation, storage and distribution of gas. In addition, IFC is expected to supportprivate participation in the oil, gas and mining sectors.

72. Pakistan's infrastructure investment needs are as high as US$3.5 billion per year, far greater thancan 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 countryaccess not just finance, but also managerial expertise, new technology, better project design andimplementation, and more efficient use of resources. Past efforts to attract private investment, in

particular in the power sector, have shown both that these investments can be realized, but also that strongoversight is needed to ensure that these are priority projects and that consumers and the government havethe capacity to pay for them. 12 Regardless of sector or level of government, PPPs should be pursuedwhere they represent priority projects, are affordable to the government and consumers, and representvalue-for-money, i.e. a better approach than would be delivered through public procurement.

12 Fraser, Julia M. Lessons from the Independent Private Power Experience in Pakistan. Energy and Mining SectorBoard Discussion Paper No. 14. May 2005.

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73. The Bank Group will support the government's efforts to encourage PPPs through: (i) advisorysupport in developing the national PPP policy and, where needed, provincial policies and legalframeworks for PPPs; this would also cover strengthening oversight of the fiscal costs of PPPs; (ii)technical assistance for the development of the institutional framework (including financial and subsidysupport to PPPs) and to develop pilot PPPs ready for procurement and implementation within the next 12-18 months; and (iii) lending to support subsidies to address affordability issues for PPPs and for long-term finance for PPP service providers.

74. Improving access to market-based finance. Pakistan has undertaken major reforms in recentyears in the financial sector that have resulted in a sound and more efficient system. A major achievementhas been the transformation of a pre-dominantly state-owned and weak banking system into a healthier,market-based system, owned primarily by the private sector (nearly 80% percent of sector assets are nowunder private ownership compared with 34 percent in 1999, and just 8% percent in 1990). This has beenfacilitated by the restructuring of major banks, ongoing consolidation of the sector, strengthening ofregulatory capacity, and improvements in transparency, corporate governance, and credit culture. This hashelped improve access, and credit to the private sector has grown significantly over the past three years.These achievements have been endorsed by the findings of a joint Bank-IMF Financial Sector Assessmentthat was concluded in 2004.

75. Despite these impressive accomplishments, important reforms remain to be done, and a largesegment of the economy continues to operate with little formal credit. A significant number of financialinstitutions are still under government control including the National Bank of Pakistan (NBP), State LifeInsurance, the largest open end mutual fund, and a few large specialized banks. The legal frameworkneeds to be strengthened to address banking laws, the Public Debt Act, the Insurance Ordinance, as wellas laws pertaining to insider trading and take over of companies, bankruptcy/insolvency, paymentssystems, credit information and Anti-Money Laundering. Enforcement of financial contracts remainsweak pending clarification of the Financial Recoveries Ordinance 2001. While there have been extensivereforms of capital markets, under-development of contractual savings has inhibited development;insurance penetration remains very low relative to other countries at Pakistan's income level, reflectingweak consumer protection and awareness. The pension system is also weak - both civil service systemand Employees Old Age Benefits Institution are fiscally unsustainable. Finally, the stock market hasperformed well but it remains shallow and narrow with inadequate investor protection systems. Leveragedfinancing of share transactions coupled with weak supervision of market intermediaries pose a threat tosystemic stability.

76. During the next CAS period the Bank Group will support further financial sector reforms in thefollowing areas: increasing the number of microcredit borrowers (especially in rural areas), restructuringand privatization of the remaining state owned financial institutions, non-bank financial companies andother specialized institutions; continuing the revision of the legislative framework to facilitate effectiveregulation and enforcement; aligning rates on National Savings Scheme (NSS) instruments more closelywith market yields; strengthening and further deepening capital markets (including equities, bonds andswaps) with the aim of increasing the availability of longer term savings instruments, e.g. by establishinga comprehensive legal and regulatory framework for private pensions, reviewing the role and strategy forstate owned insurance companies; and improving financial markets infrastructure and legal framework.New areas of involvement will include expanding financial services-consumer financing, mortgageloans, SME financing, agriculture credit-through expansion of banks' retail. Following on the recentFinancial Sector Assessment and the approval of the Banking Sector Development Policy Credit, futurework will center on policy dialogue, and technical assistance, particularly to provinces as well aseconomic and sector work on access to finance. Lending operations to support technical assistance for theState Bank of Pakistan and for capital market development will also be considered. The IFC will

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selectively invest in the financial sector to support the development of housing finance, SME finance andmicrofinance, in addition to providing TA through its PEP-MENA facility.

Pillar II: Strengthened Governance and Service Delivery

77. Improving government effectiveness remains a hallmark of the Government of Pakistan's reformprogram. As discussed earlier, inadequate and poorly targeted government spending on services andinvestment are only part of the problem; delivery of government services is hampered by the weakcapacity and lack of accountability of service providers. Addressing these weaknesses is critical forachieving most if not all of the Government's poverty reduction goals. Far reaching reforms to improvethe performance of key government institutions including financial management, tax administration, andthe civil service are underway in parallel with the government's decentralization initiative. Many of thesehave been and will continue to be supported by the Bank Group.

78. Greater efficiency transparency and accountability in use of public resources. The governmenthas been pursuing far-reaching reforms in public financial management since 1996. The Bank has beendeeply engaged in this process and significant progress was made during FY03-05 CAS period. Under theBank-funded Project for Improved Financial Reporting and Auditing (PIFRA), a new computerizedaccounting system and a new chart of accounts is being implemented nationwide. The new systems beingintroduced under PIFRA will eventually allow for the automated consolidation and reconciliation of allthe civil accounts of the government, thereby greatly improving the timeliness, comprehensiveness, andaccuracy of financial data. Legislative oversight has improved with the re-establishment of PublicAccounts Committees at the federal level (a PRSC 1 prior action), as well as in the provinces. The federalPublic Accounts Committee has made good progress in reviewing audit reports, and in tracking andmonitoring cash recoveries from public officials in government departments and other public institutions.The Controller General of Accounts (CGA) organization has been strengthened, and the timeliness ofreporting and reliability of public accounts and audit reports has improved substantially.

79. Remaining challenges include full implementation of the PIFRA system. In addition, the backlogin the review of audit reports and audited accounts remains substantial, due in large part to the poorerquality of the older audit reports that resulted in a large number of audit paragraphs being placed beforethe Committee. In the case of accounting, the Government needs to clarify the roles, responsibilities andreporting relationships of various players (e.g., Controller General (Accounts), Provincial AccountantGenerals, District Accounts Officers and Treasury Officers) in the light of devolution. Support for thesereforms will continue to be a priority. The follow-on PIFRA-2 project, which was approved in September2005, will extend the computerization to remaining sites across the country. An IDF Grant has recentlybeen approved to strengthen the capacity of the Public Accounts Committee at the federal level. The Bankwill also work on supporting the improvement of the accounting and auditing oversight arrangementsfollowing up on the Accounting and Auditing ROSC exercise, conforming corporate accounting andauditing practices to international standards. IFC's PEP-MENA facility will launch a comprehensivecorporate governance project in Pakistan to support private sector companies.

80. Building on the 2003 CFAA, the Bank will continue to provide analytical support to assist indefining the agenda for further reforms in financial management. The Bank will work with theGovernment and international partners (including DFID and ADB) to carry out public financialmanagement and accountability assessments based on the PEFA PFM performance measurementframework approved in 2005. A similar exercise, using the December 2004 PEFA Consultative Draft wasconducted in FY 2005 for Punjab. The assessments will be carried out at the federal and provincial levelsin order to identify the strengths and remaining weaknesses in the accountability framework and providethe basis for drawing up comprehensive action plans that focus on areas most in need of action to mitigateshortcomings. The action plan will not only aim at further improving public financial management butwill also support transparency, competition, value for money and controls in procurement.

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81. Procurement irregularities have been a significant problem in Pakistan, in large part due to aweak regulatory framework that discouraged due diligence in contract awards and stifled opencompetition. Specific problems have included inadequate bidding documents, inadequate response timeto bidders, prequalification as a means of restricting competition, price negotiations, lack of independentcomplaints handling process, and irregularities in inspections or measurements. During the CAS, theBank will support the achievement of transparent and efficient public procurement at federal andautonomous bodies levels. The Bank will support the Government in: (i) developing a implementingregulations for the recently notified public procurement rules; (ii) developing credible complaintshandling process; (iii) developing rules for the selection of consultants; (iv) introducing reportingrequirements and a credible enforcement mechanism; and (v) capacity building for the Pakistan PublicProcurement Regulatory Authority; and (vi) harmonizing audit and procurement procedures. Procurementwill also be an integral part of the PFM Performance Measurement assessments planned during the CASperiod.

82. Enhanced service delivery. The need to dramatically improve service delivery to Pakistan'scitizens-with particular attention to programs in health, education, water and sanitation, and safetynets-is essential to the achievement of Pakistan's poverty reduction goals. Working across sectors, theBank Group will continue to support reforms to increase capacity and accountability of those responsiblefor service delivery; empower communities and clients through enhanced access to information onfinances and performance; and build the capacity of both communities and governments.

83. Improving the quality of public administration is critical for making public expenditures moreeffective, and for improving service delivery. While the size of the civil service in Pakistan is notproblematic, improving its performance is recognized by the Government as a key challenge forimproving service delivery. The key problems are: (i) systemic rigidities that make it difficult to recruitand move staff between departments as needed; (ii) compensation is insufficient to attract skilled entrantsat the higher levels but may be too generous at lower levels; (iii) inadequate training which has led to anerosion in the quality of civil service and critical gaps in technical skills. Implementation of acomprehensive civil service reform is proceeding slowly, although there are very important pieces of thereform going forward. The best progress has been made on merit recruitment, training, pay and pensionsand capacity building of selected government line and regulatory agencies. However, improvements inoverall public service delivery require progress across a broader front in the civil service program as wellas in the devolution agenda. Over the coming CAS period, the Bank will continue to support developmentand implementation of a long-term strategy for public sector employment, which would include: furtherimplementation of merit-based recruitment and promotion; structural changes to support devolution;further pay and pension reforms; and continued capacity building through effective national andinternational training.

84. Pakistan's devolution initiative is a cornerstone of the government's strategy for improvingservice delivery by making the public sector more accountable to citizens and more efficient at deliveringbasic services. Creation of the political structure for devolution began in 2001 with the creation of a newlocal government structure consisting of over 6,400 new elected local governments. New localgovernments were sworn in following local government elections in August 2005. However, whilepolitical devolution has moved rapidly, fiscal and administrative devolution have not advanced as well,creating obstacles for local governments and weakening incentives of local government staff to improveservice delivery. Local governments are also facing a number of problems linked to capacity constraints,including lack of strategic planning, poor financial management, lack of skills and finance.Decentralization reforms need to be completed through a meaningful devolution of administrative andfiscal powers and supported with capacity building assistance. This needs to include a greater share ofresources going to the provinces through National Finance Commission (NFC) awards-and to thedistricts-through the Provincial Finance Commissions and, to a lesser extent, conditional grants;

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reassignment of tax bases from the center to local governments (e.g. agriculture income tax); and thetransfer of functions and administrative authority to local governments. Pakistan's PRSP also recognizesthat devolution will not be complete until there is some transfer of responsibility from the federal to theprovincial governments as well. The January 2006 Amendment to the NFC award was a positive step inthis regard as it increased the provinces' share of revenues and should alleviate some of the fiscalpressures being faced by provincial and local governments.

85. The Bank has worked to support of devolution, both at the provincial and local levels, throughanalytical and capacity building support. A major study on progress in implementing devolution wasundertaken jointly with the ADB and DfID. During the next four years, Bank support for devolution,much of which will be provided in the context of ongoing operations, will feature: (i) analytical support toassist in the rationalization and clarification of roles and responsibilities under the devolved framework;(ii) support for citizens participation through social mobilization, community driven approaches, andother mechanisms to strengthen the linkages between local governments and communities in order toincrease their responsiveness and accountability; (iii) capacity building support for local governments.We will also ensure that the design of lending operations reinforces the local government system.

86. With over a third of its population living in urban areas, Pakistan is currently the most urbanizedcountry in South Asia and urbanization growth rates are twice the rate of the overall population increase.But cities suffer from severe infrastructure bottlenecks, service deficiencies (roads, water, and wasteremoval), poor local governance, and distortions in land and housing markets. While the urban sector wasan area of limited engagement during the previous CAS, devolution has created opportunities for deeperengagement and the Government of Pakistan has accorded greater priority to urban development with aparticular focus on the "mega-cities" of 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 theweaknesses in policies and administrative structures that undermine service delivery in cities. Recentanalytical work has highlighted the fragmentation of service provision, weak financing and managementof 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 smallermunicipalities of the Punjab Province. The Punjab Large Cities Development Policy Loan (DPL) willsupport implementation of reforms to improve the functioning of the Punjab's seven large cities. Reformswill focus on four broad areas: (i) governance and institutional reform; (ii) municipal finance and servicedelivery; (iii) urban planning and land management; and (iv) urban transport. The Bank is also conductingeconomic and sector work to help shape our future involvement in the urban sector. With the support ofPPIAF/GPOBA financing, the Bank is undertaking a detailed study of eight major cities in Punjab toinvestigate options for improving the efficiency of WSS service providers. A variety of alternatives arebeing considered, including public-private contractual mechanisms (management contract, concession),financial incentives, and regulatory reform with possible downstream Bank and IFC project financing. Asimilar investigation of solid waste management issues is also underway. Finally, building on preliminarywork carried out with the support of the Italian Government through the Italian Trust Fund for Cultureand Sustainable Development, the Bank will support development of Pakistan's cultural heritage andtourism.

88. Experience in Pakistan has shown that there is considerable potential for improving access to andquality of public services through the adoption of alternative service arrangements and by empoweringcommunities to monitor providers and influence resource allocation. In health, Pakistan has begun toexperiment with contracting of public services to private providers to circumvent weak administrativecapacity of the public sector and expand coverage. Initial results of contracting out management of

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primary health facilities in twelve districts of Punjab to an NGO (the Punjab Rural Support Program)indicates significant improvement in utilization of services. The Punjab education program has begun toexpand public-private partnerships to tap into low cost private schools while strengthening SchoolCouncils to increase parental involvement and influence. In Balochistan, the planned Primary EducationProject will focus on strengthening community-run schools. During the CAS we will continue to pilot andscale up such initiatives.

89. Policy makers have also fostered private provision of services in Pakistan in order to allowgreater provider choice (and competition) to the population, and this has enabled the better off (but alsothe poor) to bypass the low quality public system. In education, the private sector has alreadydemonstrated its potential with private schools accounting for a growing share of total enrolments, inmany cases with higher quality and lower costs than government schools. However, private sectorproviders need to be held accountable to particular standards (e.g., in education) and may need to beregulated (e.g., in the case of 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 socialindicators is likely to require strong economic growth, effective public sector management, a motivatedand well managed civil service, increased pro-poor spending and more effective allocation of resources.At the same time increased investment in human capital leading to significant improvements in educationand health will be necessary to build the skilled, healthy work force necessary to sustain recent growthperformance.

Improved delivery of health and education services

91. The achievement of universal primary education, with a particular emphasis on promoting girls'schooling, has been a government priority since the early 1990s. Resources for education have increasedby over 60% over the past four years and a range of programs to increase enrolments, especially for girls,have been put in place. These efforts appear to be starting to bear fruit; preliminary results of a nationalhousehold survey are encouraging and show an increase in the net primary enrolment rate from 42% in2001/02 to 52% in 2004/05. Nevertheless, meeting Pakistan's goal of increasing the net primaryenrolment rate to 100% by 2015 remains a major challenge. The issues affecting the performance of thesector include inadequate resources, systemic weaknesses in public service delivery including over-centralization and weak public sector management, and poor performance of the education system interms of access, governance and quality.

92. Reflecting the lessons of the Social Action Program of the 1990s and the requirements ofdevolution, the Bank strategy has focused efforts at the provincial level using development policy creditsto support policy and systemic changes as well as the other areas linked to education reform includingdecentralization and governance reforms. Under the Punjab Education program the Bank is supportingfree tuition and books, upgrading school facilities, stipends for girls in backward areas and public fundingof the rapidly growing non-government-independent low-cost private-education sector. Results so farhave been promising. The Bank will continue to support these reforms through education developmentpolicy credits in Punjab with annual tranches linked to outcomes; annual Development Policy Credits inother provinces, beginning in NWFP, with a special focus on education; and investment projects forregions where sector investment projects are a more viable option such as Balochistan. Gradually thefocus of reforms will shift from primary to higher levels of 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, willbe backed by analytical work, including an education sector review and evaluations of the impact of

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different education sector reforms and policies. Annual PRSCs will continue to support reform ineducation. The ongoing National Education Assessment System (NEAS) project will develop a baselineand monitoring system for measurement of learning outcomes. We will also provide advice and technicalsupport to the government's vocational/technical and higher education reforms which are needed toprovide the skilled labor force needed to support sustained growth.

94. Given its far-reaching importance for reaching all of the MDGs, gender equity in education willremain a high priority. Building on the findings of the recent Gender Assessment, the Bank will assist thegovernment in developing strategies to address gender gaps in education. Recent analysis suggests thatthe practice of restricted female mobility plays a large role in perpetuating gender gaps in schoolenrollments. As a result, school attendance for girls is very sensitive to school proximity. Girls are muchmore likely to attend school if a school is available within the settlement they reside in. This sensitivity toschool proximity worsens as girls grow into adolescence. Qualitative studies suggest that concerns oversafety and norms of female seclusion are the primary factors behind the precipitous drop in enrollmentbeyond age 12. This concern is also evident in the rising expenditure on transportation to school reportedfor older girls. A similar concern makes it difficult to attract female teachers to schools in remote areas.

95. While Pakistan has made Table 6: Selected Health Indicatorssome progress in improving health Fertility Infant Child Maternaloutcomes for the poor, the pace has rate 2003 Mortality Mortality mortalitybeen slow. Poor health outcomes and 2003 2003 2000high fertility remain obstacles to Pakistan 4.1 77 103 500economic growth and contribute Bangladesh 2.9 46 69 380significantly to high levels of poverty. India 2.9 63 87 540In particular reducing fertility rates SriLanka 2.0 13 15 92would contribute to: (i) improved Sources: World Development Indicators (2005), except MM: WHR 2005.

women's health and reduced overall maternal mortality by reducing the number of high order births; (ii)reduced infant mortality rates by increasing the time between births; (iii) helping empower women byproviding them choices about when and how many children to have; and (iv) providing a necessarycondition for sustained and rapid economic growth. Recent research has found quite a large impact oneconomic growth from lower dependency ratios brought about by lower adult mortality and fertility rates.There is a continuing burden of malnutrition and increasing burden of hepatitis infections. Utilization ofessential maternal health services is low, especially in rural areas. Pakistan also faces a real threat fromAIDS; recent assessments found HIV epidemic among certain populations; for example, 27% of injectingdrug users and 7% of male sex workers in Karachi were found to be HIV-positive. The government iscommitted to increasing public health expenditure and has taken steps in that direction but the overallstrategic allocation of public resources should be focused towards achieving better health for the poor andaddressing the most urgent priorities, such as maternal and child health. In addition key constraints toeffective utilization of increased resources include: (i) limited management capacity; (ii) lack of highquality data and program impact evaluation for decision making; (iii) lack of a well-developed humanresource development strategy; (iv) inadequate use of the private sector for national goals; (v) lack offocus on quality of care; and (vi) lack of clarity on the roles and responsibilities of the three levels ofgovernment.

96. During the past three years, IDA lending to the health sector consisted of an H /AIDSPrevention Project and US$41 million to support polio eradication. Multi-sectoral policy-based loans (aPRSC and provincial structural adjustment credits) have supported HNP policy reforms as well. Recentanalytical work has highlighted the potential for public-private partnerships (e.g. contracting with NGOsto deliver services) to improve basic health services. For example, one district in the Punjab (Rahim YarKhan) contracted the management of its 104 health units to an NGO and witnessed a doubling in thenumber of outpatient visits and increased client satisfaction. Such successful efforts must be scaled up.

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97. Looking ahead, at the national level, the Bank will concentrate on: (i) encouraging theGovernment to focus on public health functions (such as surveillance, quality control, monitoring andevaluation, and public information), through analytical support and national level development policylending; (ii) supporting the development and implementation of program and management reforms in theLady Health Worker program as a way of expanding access to primary health care and family planning;(iii) supporting increases in overall health expenditures as envisioned in the PRSP; and (iv) supporting thepiloting and evaluation of new approaches for service delivery and demand side interventions.Recognizing that a major focus of efforts must be at the provincial and local level, we will support majorsystem reforms through planned provincial Development Policy Credits, beginning in NWFP. Initially,the focus of these credits will be on increasing access and coverage of maternal health services,improving the functioning and utilization of first level care facilities, and targeting underserved areas.Overall, Bank lending and analytical support in health will be guided by the following principles: (i) afocus on the poor and underserved areas; (ii) promoting testing and rigorous evaluation of innovations bylocal governments; (iii) increased accountability, particularly at the district level; and (iv) increasedintegration of services at the grassroots level.

98. Improving the health outcomes of the poor will also depend on complementary interventionsoutside of the health sector. Recent research has highlighted the strong effects on infant and childmortality from improved maternal education and basic infrastructure services, such as access tosanitation, piped water, clean cooking fuels and electricity. The Government has recently announced amajor initiative to expand access to clean water by building water treatment facilities at the local level. Inlight of this, water supply and sanitation will continue to feature in the Bank's lending and analyticalwork, in both the urban sector and through support for community infrastructure, especially in rural areas.

99. Current analytical work on the health and economic costs associated with air and water pollutionhas confirmed the high impacts, with losses estimated to be more than 2% of GDP. The Bank isdeepening 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 supportingthe Government at federal and provincial levels in the identification and preparation of priorityinterventions. Key areas for action in relation to health issues will be urban air quality in the major cities,protection of water supplies and management of increasing amounts of industrial and hazardous waste.

Reducing vulnerability and poverty through effective safety nets and targeted programs to reach thepoor

100. The PRSP recognizes that protection for the poor and vulnerable is a cornerstone of any povertyreduction program and Pakistan has a range of programs which aim to improve the welfare of the poorand vulnerable including microfinance, old age security, public works, cash and in-kind transfers, andprograms for child laborers, the disabled, and other highly vulnerable groups. However, these programsare severely under-funded, covering only a very small fraction of the poor and vulnerable (see Table 7 fordetails). Total spending is equivalent to 0.5% of GDP, substantially lower than the levels found in otherdeveloping countries. Moreover, there are severe shortcomings in the existing safety net programs: (i)there is 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 in the formal sector; (iii)existing programs do too little to protect the human capital of the vulnerable--efforts to use safety netmeasures to support health, nutrition, and education of the poor are in their infancy; and (iv) the size ofbenefits is often negligible. Other issues include the weak administration, targeting, and deliverymechanisms, lack of coordination between agencies, and poor monitoring and evaluation.

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101. The Bank's Table 7: Public Spending on Select Safety Net Programsassistance for socialassitane fo soialBudget / spending Number ofprotection will include (in Rs. Billion) Beneficiariessupport for safety nets Wheat subsidy 8.00 (untargeted)that (i) help the chronic Bait-ul-Mal (Food Support and other) 4.50 1,250,000poor (e.g. widows, Tawana (mid-day meals for girl students) 0.70 530,000disabled, and the elderly Zakat (cash transfers and other) 5.86 1,733,000with no means of Employees Old Age Benefits (EOBI) 1.74 850,000livelihood) cope with Total 20.80 4,363,000

poverty, and, where possible, (ii) help the poor escape poverty, e.g., via conditional cash transfers andother demand side interventions, (e.g., inclusive education) aimed at increasing access to basic socialservices for the poor and marginalized; and (iii) help families and individuals cope with seasonal shocksand natural disasters (e.g., via workfare). We will also provide support for social security which helpsmitigate risks, via improving formal sector pensions, and consider innovative approaches to micro-insurance to address life cycle risks. Building on ongoing analytical work and policy dialogue, the Bankis helping the government develop a comprehensive social protection strategy to guide policy reform inthis area over the medium and long term. Reforms will be supported through the PRSCs, a stand aloneSocial Protection operation, support for persons with disabilities in the earthquake affected areas as wellas social protection components in provincial DPCs and emergency operations. Technical assistance willinclude support for strategy development, design of new social protection interventions (workfare,demand-side incentives for health and education, etc), program implementation, e.g. improved targetingmethods, 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 thatseeks to mainstream disability in the education sector.

102. Pakistan's PRSP recognizes that while rapid growth will be the main driver of poverty reduction,targeted interventions and community-based approaches to rural development are also required to addressthe immediate needs of the poor and vulnerable, especially in drought prone and flood stricken areas andhelp them share in economic growth. The Bank is supporting the Government through a series ofanalytical and advisory services in the definition of a rural development strategy that would look in anintegrated way at farm and non-farm opportunities as well as policy and institutional issues. TheGovernment has announced a major increase in its pro-poor public works program and has asked forBank's support for the continuation of a drought/flood assistance program (DERA). The Bank willcontinue to support implementation of the Community Investment Program in NWFP and AK and lookfor possible expansion and replication opportunities. A major focus of these efforts will be to strengthenthe partnership between communities and local governments by supporting citizen participation inidentifying priorities for public investment and by building the capacity of local governments. At thesame time, the Bank would support the Government's newly announced program for rural povertyalleviation through social mobilization. Such program would be critical in fostering organizations of thepoor and their access to income generating activities as well as in enhancing accountability mechanismsand the effectiveness of Government programs. These investments yield not only better project outcomebut also help in the longer term to build communities that are better organized and in control of their owndevelopment. The Bank will seek to build on the successful experience of the Pakistan PovertyAlleviation Fund (PPAF) which has already reached 6,500 communities through micro-credit andcommunity driven physical infrastructure projects. The experience of the PPAF has also shown that theimpact of targeted interventions is enhanced through up-front investments in social capital formation thatbuild ownership and increase sustainability.

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Reducing Pakistan's Vulnerability to Natural Disasters

103. The Government, with support from the international community has responded capably to theOctober earthquake and its aftermath. The Army, with support from UN agencies and bilateral donors, leda massive and largely successful relief campaign to provide shelter and food for the displaced. Despite theextremely difficult conditions with many affectees in inaccessible regions subject to severe winter afeared "second disaster" of mass freezing and starvation did not materialize. By mid-February thegovernment had managed to provide immediate cash relief to some 543,000 households (over 90 percentof those declared eligible), with payments made through individual bank accounts to reduce potential forleakage. Arrangements for assisting households with housing reconstruction are progressing withgovernment partnering with local NGOs to mobilize assistance and inspection teams to administer reliefand provide technical support. Reconstruction of major highways commenced in mid-March with theonset of favorable weather. Donors pledged a total of US$6.5 billion at the November 19th donor'sconference. Of this total, US$3.1 billion has been committed and US$1 billion disbursed as of mid-February. A key challenge now is to complete institutional arrangements linking The EarthquakeReconstruction and Rehabilitation Authority (ERRA) with local and provincial governments and tocomplete detailed reconstruction strategies in some sectors, particularly for education, health and publicadministration.

104. The October earthquake highlighted the vulnerability of the poor to natural disasters and theimportance of hazard risk management. This is an issue of continuing concern since in addition to beingin an earthquake prone area, Pakistan frequently experiences weather-related hazards, resulting insignificant economic losses from localized and seasonal floods, landslides and droughts. Pakistan hasbeen identified as being among the more vulnerable countries in the world on the basis of mortality andeconomic risks induced by such hazards. " Lack of enforcement of building codes, unsafe land usepatterns, and poor construction practices contribute to high economic and human losses. To address suchissues, hazard prevention and mitigation strategies are relevant and integral to Pakistan's nationaldevelopment framework.

105. Effective hazard risk management should be mainstreamed as part of Pakistan's povertyreduction strategy with the purpose of reducing future losses of lives and livelihoods, protectinginfrastructure and investments and promoting a stable foundation for private sector investment. Atpresent, Pakistan has an ad hoc approach to hazard risk management. Interventions are primarily focusedon relief and response with insufficient ex ante mitigation measures. Given its social and economicvulnerability to natural disasters, it is essential that Pakistan improve its approach to hazard riskmanagement. Following the relief period, Pakistan needs to develop a strategic approach to hazard riskmanagement based on five key pillars: risk identification, risk reduction, capacity building, emergencypreparedness, and risk transfer mechanisms, to achieve a sustainable recovery program and buildin-country capacity for hazard risk management. Beginning with the ongoing Emergency Recovery Creditthe Bank will assist in the process of developing Pakistan's hazard risk management strategy. The Bankplans to continue to work with government and other partners to develop the capacity to carry out thisstrategy and to integrate risk management into development programs.

13 Dilley, Maxx and others. 2005 Natural Disaster Hotspots: A Global Risk Analysis. Washington, D.C: The WorldBank.

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IV. DELIVERING THE WORLD BANK GROUP PROGRAM

A. The World Bank Program

Portfolio management strategy

106. The key to maintaining strong portfolio performance will be continued attention to good qualityat entry and timely attention to implementation issues through joint portfolio monitoring. The plannedincrease in investment lending, especially in large-scale infrastructure projects, will pose a challenge insustaining current good portfolio performance. To meet this challenge we will continue to closelyscrutinize new lending and apply "readiness filters," screening new projects for ownership, adequacy ofinstitutional and policy frameworks, and implementation capacity. This is being reinforced by Regionalmanagement by requiring a formal "decision meeting" prior to project appraisal in order to institutionalizea formal review of project readiness. For projects that have already been approved, we will jointlyestablish with the GOP key portfolio indicators for each year (e.g., portfolio riskiness; disbursement etc.)which will be jointly monitored on a regular basis. Quarterly joint portfolio review meetings will continueto 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 of progress in achieving CAS outcomes andadjust the lending and AAA programs accordingly.

107. Portfolio Fiduciary Risk Management. Taking into account the result of reforms implementedover the past five years, including recommendations from the CFAA and provincial financialaccountability reviews and implementation of PIFRA, overall Bank portfolio fiduciary risk has fallenfrom an average rating of 'substantial to high' during the 2002-05 CAS to an average of 'moderate tosubstantial'. The strategy for managing this risk will emphasize project design and capacity building.Projects will be designed with increased participation of beneficiaries in projects (e.g., CDD projects andenhancing the role of school management committees in education projects) and generation and publicdissemination of project performance information including information generated through third partyvalidation exercises. Project readiness filters will include assessment of the adequacy of fiduciaryarrangements. A risk-based approach to financial management and procurement will guide the Bank'sfiduciary team, both in project design and supervision. Intensive supervision and enhanced procurementarrangements will be put in place in selected projects where fiduciary risks are deemed to be highest.

108. Continued strengthening of government financial management and audit capabilities will be a keyelement of the strategy. The Bank recognizes the Supreme Audit Institution (Office of the AuditorGeneral of Pakistan) as the independent auditor for Bank-financed operations implemented by mostgovernment entities. 14 Bank financing is fully integrated into federal and provincial budgets anddisbursements for Bank-financed operations flow through the State Bank of Pakistan to the nominatedaccount of the projects and programs to ensure that Bank funds are accounted as part of the overall fundsflow of the Government. Successful roll-out of PIFRA to the provinces will enable the timely preparationof reliable and comprehensive financial reports as well as timely, high quality audits, not just for Bankprojects but also for the entire government. We will also continue to work with government to strengthenprocurement practices at the federal and provincial level (see paras. 78-81). Supporting the improvementof country systems and the overall control environment will support planned development policy lendingand enable mainstreaming of investment lending operations using government PFM systems. While over90% of project financial statements are received on time, due to uneven quality of presentation andcontent of the statements, about 25% of the statements are unacceptable at first submission. Capacity

14 Bank-financed projects that are implemented by corporatized entities are audited by independent firms ofChartered Accountants whose acceptability will continue to be assessed by the Bank on a case-by-case basis.

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building of project financial management teams in financial reporting will therefore also be an importantarea of Bank intervention during the CAS.

FY05-09 lending scenarios and triggers

109. IBRD/IDA Lending. As indicated above, Pakistan's demand for World Bank financial supporthas grown to meet the needs of its growth and poverty reduction strategy and to address the impact of theOctober earthquake. To meet this demand a flexible IBRD/IDA lending program of up to US$6.5 billion(approximately US$3.1 billion IDA and US$3.4 billion IBRD) is proposed in order to supportimplementation of the PRSP."s In light of the extraordinary demands posed by the earthquake and theneed to protect implementation of the PRSP program, the Government of Pakistan is seeking additionalconcessional financing from the donor community. The proposed program is consistent with Pakistan'sfinancing requirements, IDA allocation, debt management strategy, and the Bank's exposure guidelines.

110. IDA will account for about half of Bank Group support to Pakistan. Pakistan's IDA allocation hasbeen increased under IDA 14, with the three-year envelope set at SDR 1.5 billion (equivalent to aboutUS$725 million per year). In addition Pakistan will have access to additional IDA on hard termsestimated at SDR 130 million. 6 Annual IDA availability is therefore expected to be in the range of anaverage of $785 million per year. It is expected that the full IDA allocation would be utilized providedPakistan continues to maintain a policy environment conducive to growth and PRSP implementationwhile making further progress in implementing reforms. A dramatic deterioration in performanceincluding, for example, failure to maintain a sound macroeconomic framework, reversal of governancereforms in public financial management and procurement, and inappropriate reductions in poverty-relatedexpenditure would warrant a review of the overall strategy and could preclude full utilization of theIDA 14 allocation. In assessing performance, the Bank will focus on progress in achieving key outcomestied to PRSP reforms and CAS program priorities.

111. Priorities for IDA resources include support for second generation structural reforms to facilitateprivate sector growth, improve governance and continue to expand PRSP-related expenditures. Inaddition, the demands placed on IDA have risen dramatically as a result of the October 8 earthquake withincremental IDA commitments of $740 million already approved. As a result, utilization of IDA will befront loaded; over half of the three year IDA allocation will be committed by end-FYO6 and the full IDAallocation could be exhausted by end FY-07. Other priorities for IDA support include support for policyreforms and institution building to help reach MDG targets as well as financing for pro-poor targetedprograms such as micro-credit, social protection and community-driven infrastructure. Annual PovertyReduction Support Credits will serve as the foundation of our support for PRSP implementation at thenational level. These will be complemented by development policy lending for the provinces to supportservice delivery and improve human development outcomes. IDA will also continue to be used to financegovernance-related institution building (tax administration, financial management, land administration).

112. The scale of IBRD financial support will be determined by the strength of the GoP's policyperformance and macroeconomic management. Continued good policy performance and soundmacroeconomic management leading to continued improvements in IBRD creditworthiness would formthe basis for IBRD lending of up to $400 million per year, of which no more than $200 million would bein the form of development policy loans. The upper bound of the proposed IBRD lending range forFYO6-09 is $3.4 billion of which up to $1.3 billion of IBRD lending could take the form of developmentpolicy loans. Annual lending could increase to as much as $1 billion per year with up to $500 million in

1 Four-year IDA access is estimated on the basis of IDA 14 allocation.16 IDA hard-term lending allocations are additional to regular allocations under IDA14. The hard-term IDAallocation for Pakistan in FY06 is SDR 62 million. The allocation for FYO7/08 is indicative and subject to changebased on implementation of the IDA 14 grant component.

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DPLs within this envelope. Reaching this upper bound would take place only in the context of strongperformance as demonstrated by reaching the key benchmarks set forth in Table 8. In the event of policyreversals resulting in the macroeconomic framework going off-track, the Bank would seek to limit itsexposure 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 deficitreflect increased pressure and the need for continued vigilance.

Table 8: Key Policy Performance Benchmarks for IBRD Lending

Lending IBRD lending up to $1.6 billion Total IBRD lending up to $3.4 billion($400 million per year) (up to $1 billion per year)

* Maintenance of a soundmacroeconomic framework and no e Continued improvement in fiscalsubstantial decline in fiscal discipline. performance and debt management as

Macroeconomic [as demonstrated by public debt to demonstrated by achieving in eachManagement and GDP ratio at or below FY05 level and year all targets for the revenue deficitDebt Reduction foreign exchange reserves equivalent and debt reduction in the Fiscal

to at least 3 months offollowing fiscal Responsibility and Debt Limitationyear's projected imports of Goods and Act of 2005.Non actor Services]

* No substantial deterioration in the Continued improvement in the

Promoting business environment, business environment t ahrough[as evidenced by no substantial movesby enn

privatehsectorb toward protectionist or interventionist a t b governmin ofeFslRpolicies or reversal offinancial sector legstions and e mpoimtiont

reforms] ervices]* Implementation of modernized

" Continued conmmitment to financial accounting and auditing systemsPromotcapturing 65% of the federation's

aeene expenditure budget by June 2007 and

Governance 80% by June 2009

t Notification of regulations to support * Satisfactory implementation ofimplementation of the national national procurement rules to reduceprocurement rules. procurement irregularities.

113. The level of IBRD lending will also reflect the extent to which sectoral policies and governancearrangements are conducive to effective Bank engagement. The Government of Pakistan's priorities for

IBRcD financing are in infrastructure, primarily water, power, transport and urban development. In each of

these areas the viability of investment lending will depend on the establishment of a policy environmentconducive to project implementation and to the achievement of targeted outcomes. In some cases, the

conditions necessary for increased lending have already been met while in others key policy actions arerequired before expanded investment lending can take place. Reaching the upper end of 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 of GAS outcomes. Annex 7

summarizes key sector reforms that would serve as indicators to guide IBRD lending.

114. Actual lending amounts will also depend on the ability to prepare high quality operations as well

as continued satisfactory portfolio performance. As indicated in the GAS Progress Report, work has

already begun to meet the demand for stepped-up IBRD support and the pipeline of IBRD projects is

growing. Nevertheless, given the fact that this new lending is in sectors where Bank has lending has beenlimited in the recent past, the scale-up will take some time. At present, with concerted effort on the part ofboth the Bank and GoP counterparts, we expect IBRD lending to reach US$850 million in FY07.

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However, reaching this level would require a considerably strengthened pace of project preparation andstrong implementation capacity.

115. The level of policy based lending will depend on several factors. Continued soundmacroeconomic management will continue to be a pre-condition for development policy lending as willsatisfactory implementation of PRSP reforms. Similarly, development policy operations at the provincelevel will take place in the context of fiscal and financial management reforms aimed at increasing fiscalspace and ensuring sustainability of reform programs. Within the context of a sound macroeconomicenvironment, the use of DPOs will be driven primarily by the appropriateness of the DPO instrument vis-A-vis alternatives (see para. 45). In addition, the share of IDA-funded development policy lending in theoverall IDA lending program will be managed in the context of commitments on the Bank-wide share ofpolicy-based lending under the IDA 14 agreement.

116. Due to its rapid economic turnaround, Pakistan is far more creditworthy than at the time of thelast CAS. Total government debt outstanding is 61 percent of GDP in 2004/05 (compared with 74 percentin 2002/03) and is projected to decrease to 47 percent by 2008/09. Debt service has fallen from 26 percentof exports of goods and services in 2002/03 to 15 percent in 2004/05. Recent debt sustainability analysissuggests that public and external debt are projected to continue to decline over the medium term andsensitivity analysis indicates that this downward trend is not likely to deteriorate significantly under avariety of shocks to the baseline scenario. Pakistan's improved creditworthiness is also reflected inimproved ratings on its sovereign bonds (Table 9), although the country's rating remains several gradesbelow minimum investment grade.The Government of Pakistan's first Table 9: Pakistan Credit Rating by Standard & Poor's

international Islamic 'Sukuk' bond Local Currency Foreign Currencyoffering (this is the GoP's second Date Sovereign Credit Sovereign Creditbond offering, following last year's Rating RatingEurobond US$500 million issue) JulY 9, 1999 B/Stable/B SDNM/SDattracted subscriptions worth US$1.2 Dec.21,1999 B+/Stable/B B-/Stable/Bbillion for a bond issue of US$600 Dec.12,2002 BB-/Stable/B B/Stable/Bmillion on January 18, 2005. TheBB-/Positive/B B/Positive/B

authorities have also indicated that Sou. Sa r & PorS.they intend to initiate further bondofferings on an annual basis.

117. IBRD lending of up to the maximum of US$3.4 billion over the FY06-09 GAS period wouldincrease total 11BRD exposure to Pakistan from the current US$2.5 billion, or 2.3% of the portfolio toUS$3.3 billion in FY10, about 3% of the IBRD portfolio. Bank Group exposure guidelines limit the ratioof IBRD debt service to public debt service to no more than 20%, and the ratio of IBRD debt service toexports of goods and services to no more than 4%. Even if total IBRD lending reaches US$3.4 billionover the CAS period-the upper end of the proposed range-neither of these limits would be breached.Pakistan does have a high share of external debt owed to preferred creditors and the preferred credit ratio(debt service to preferred creditors as a percent of total public debt service) is above the 35%recommended by IBRD exposure guidelines. But this risk is mitigated by bilateral debt rescheduling andPakistan's debt reduction strategy which has emphasized the retirement of expensive short term debt andincreased reliance on multilateral concessional debt, including IDA. In combination these factors haveserved to reduce both the stock of external public debt and the associated debt service.

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Table 10: Maximum Projected IBRD ExposureProjected

FY05 FY06 FY07 FY08 FY09 FY10*

IBRD Debt Disbursed and Outstanding 2,464 2,149 2,192 2,571 2,835 3,293Preferred creditor ratio 61.3 60.4 57.1 52.7 42.8 45.6

Share of Total IBRD Portfolio (%) 2.3 2.1 2.2 2.5 2.7 3.0

IBRD Debt Service as % of Total Debt Service 17.7 19.9 16.5 15.1 11.6 10.8IBRD Debt Service as % of Exports of GNFS 1.8 1.6 1.3 1.2 1.0 0.8* FY10 Exposure projected on the basis of continued lending at the upper end of the FYO6-09 CAS lending range.

Knowledge Services: AAA and Building Capacity

118. AAA and capacity building will be integral to the Bank Group program. Consistent with ourfocus on outcomes, ESW and TA will be programmed on the basis of their contribution to achieving CASoutcomes, recognizing that knowledge transfer, often without financing, can be instrumental in achievingresults. The AAA program will also provide the analytical underpinning of the lending program. Based onthe FY04 QAG review of the Pakistan AAA program, we will invest more in dissemination and outreach.

Table 11: AAA - Indicative Key Outputs by CAS Theme

FY06 FY07 FY08 FY09

Sustained Growth * Sindh Economic * Balochistan Economic * Banking Sector a Access to Financeand Improved Report Report NLTA * SkillCompetitiveness * 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

CompetitivenessStrengthened * Provincial * Monitoring and * Land Market * StatisticalGovernance and Procurement Evaluation NLTA Administration Strengthening TAService Delivery Assessment NLTA

* Urban NLTA * Devolution TA* Civil Service

Pension ReportImproved Lives * Safety Net Report * Public-Private * Education Sector * Education TAand Protection of Partnerships in Reviewthe Vulnerable Education * Pension Reform

* Health Sector Review NLTA

Crosscutting/Core * Strategic Country * Integrated Public * PovertyDiagnostic Environment Financial Assessment

Assessment Management andAccountabilityAssessments(CFAA/CPAR/PER)

119. Based on the lessons learned in implementing the last CAS as well as the recommendations of theCAE, the FYO6-09 CAS has been designed with greater emphasis on capacity building and ensuring thatcapacity constraints are adequately addressed in project design. The Public Sector Capacity Building

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project, approved in May 2004, is revitalizing civil service training and building the capacity of keyministries and regulatory agencies that are in the forefront of design, implementation and monitoring ofreforms. With the designation of Pakistan as a focus country, the World Bank Institute will also play a

greater role in building capacity in support of operations. For example WBI has provided training inmunicipal management feeding directly into the capacity building component of the Punjab MunicipalServices project. The partnership between WBI and country operations has been strengthened with the

appointment of regional coordinator located in Dehli. WBI activities are expected to focus primarily on

governance, including decentralization, urban management and parliamentary oversight of spending.

120. At the project level, projects will have a stronger emphasis on building institutional capacity.

Projects will be designed with capacity issues in mind and capacity considerations will play a greater role

in appraisal of projects' readiness with an explicit requirement that projects not proceed to negotiationunless institutional issues are resolved and project management capacity is in place. The proposed

guidelines for IBRD lending address capacity constraints as well as policy reforms and therefore will helpserve as a "capacity filter" for judging project readiness. Capacity building will also increasingly beincorporated in project design with provision for associated technical assistance included in projects.

Country Financing Parameters

121. The country financing parameters pursuant to the Bank's policy OP-BP 6.00, Bank Financingwere established in November 2004, and reviewed during the preparation of this CAS (see Annex IV).This framework allows the Bank to finance expenditures needed to meet the development objectives ofthe operations it supports within a framework that addresses country risks related to fiscal sustainabilityand appropriate use of Bank resources. The policy has added flexibility in the use of Bank financing for anumber of expenditures. To implement this policy, the Bank and Government have agreed upon countryfinancing parameters for Pakistan. Under these financing policy parameters, the Government of Pakistanwill have flexibility in allocation and management of resources in the following areas: overall costsharing; local cost financing; recurrent expenditures; and financing of taxes and duties. Application of thepolicy is not expected to have an adverse impact on fiscal sustainability. The above policy is based theGovernment's five-year track record of stable and prudent fiscal management and debt reduction coupledwith a sound medium term fiscal framework, approval of a Fiscal Responsibility and Debt Limitation

Bill, and commitment to implement its development program with all donor assistance fully integratedinto the budget.

122. The financing parameters for cost sharing, local and recurrent costs, and taxes and duties will beapplied on a project-by-project basis, depending upon the type of operation, to ensure efficientimplementation and sustainability after project closure. This will not impact the overall cost sharing of theBank, and the magnitude of financing in any individual project would be limited by the total availableIDA and IBRD resource envelope; the flexible financing arrangements in some projects will be offset byother projects, depending upon the nature, type and sectoral intervention. Periodically, the financingparameters and cost sharing for individual projects, will be reviewed with the Government and the Bankto ensure that overall Bank financing remains within the total IDA/IBRD envelope and funding isconsistent with the Government's PRSP and availability of local resources. Details can be found inAnnex IV.

B. The IFC Program

123. Over the last CAS period, IFC helped existing clients to restructure and strengthen their financialposition and provided financing for new projects in infrastructure, manufacturing, and the financial sectorto support small and medium enterprises (SMEs). IFC committed a total of US$187 million in 16 projectsin Pakistan from FY03 to FY05. IFC's committed portfolio in the country as of July 31, 2005 wasUS$314 million in 32 companies, including US$62 million in equity. The largest exposure is in the power

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sector, representing 37% of the portfolio in five independent power producer (IPP) projects, with theremaining portfolio spread across the financial and industrial sectors.

124. During the previous CAS period, local banks became active providers of longer term financing atcompetitive rates, driven by strong liquidity inflows and the increased efficiency of the recently privatizedcommercial banks. The business environment in the country also benefited from recent governmentprivate sector policies (visible in the improvements in the Doing Business indicators), which have spurredinvestment activity. Therefore, IFC was selective in its investments during this period and did notcompete 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 in pre-privatization investment. Itfurthermore plans to make more equity investment and intends to be a catalyst for and mobilize private

equity in the country. In addition EFC will increase technical assistance (TA) activity in Pakistan. IFCactivity will focus on three main sectors; financial, SME and infrastructure. With the recent creation ofPrivate Enterprise Partnership for Middle East and North Africa region (PEP-MENA), EFC has initiated asubstantial TA program in Pakistan to build capacity and address constraints of the SME, infrastructureand financial sectors.

126. In the financial sector, opportunities include: microfinance; SME lending; support for recentlyprivatized banks and those expected to consolidate; and long term lending and securitization for housingfinance. IFC will also continue to support the expansion of trade finance for SMEs, and expansion of theasset management sector where it has played a pioneering role in the country. TA will complement theinvestment program. PEP-MENA will focus on strengthening financial markets and on expanding accessto finance for micro, small and medium-sized enterprises, improving corporate governance practices, andexpanding access to affordable housing for low and middle-income citizens. PEP-MENA will launch atraining and advisory project for the housing sector and will work with individual banks to improveinternal 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 tohelp meet the funding needs of SMEs, specifically in health and education. To help enhance the country'sbusiness enabling environment, PEP-MENA is supporting commercial dispute settlement through itsalternative dispute resolution (ADR)/mediation pilot project in Karachi. The project will establish a pilotmediation center for SMEs to provide training on mediation for judges, lawyers and the private sector. Itis expected that the pilot will result in a decline in court litigation, which is particularly burdensome forSMEs, and could eventually be replicated in other provinces. PEP-MENA is also providing support tobusiness membership organizations (BMOs) to improve services and support to their SME members.PEP-MENA will also launch its business management training tool, Business Edge, in Pakistan to supportbusiness development service providers through train-the-trainer workshops. This management trainingtool is to provide SMEs greater access to business development, management training and advice.

128. IFC intends to increase its investments in infrastructure and housing finance activities in order toaddress financing gaps in these sectors. In the infrastructure sector, the country is addressing constraintsin power generation and distribution. IFC is developing a number of investment proposals to address

these challenges. IFC is 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 areexpected to support the expansion of the private telecom industry, which is growing strongly after the

privatization of Pakistan Telecommunications Limited (PTCL) and after the rapid expansion in mobiletelephony and value added telecommunication services.

129. As to the development of housing finance sector, a key driver for stimulating the growth in themortgage market would be for originators to have access to long term local currency financing. This

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would be led by the development of the local capital market, via securitizations and other capital marketinstruments, which mobilize domestic capital to support funding for mortgage finance. Some legal andregulatory framework needs to be changed to ensure that the environment for securitization is enhanced.PEP-MENA is exploring ways to support the GoP to enhance the legal regulatory framework. IFC willexplore ways to support pilot securitization efforts with some local financial entities that could bedeveloped in tandem with some of the changes in the legal and regulatory infrastructure.

130. In privatization and public-private partnership (PPP) development, PEP-MENA will support theGoP's regulatory bodies and its infrastructure privatization efforts. IFC currently has two advisorymandates in Pakistan: (i) structuring a PPP for Lahore Water and Sewerage Agency; and (ii) privatizationof Faisalabad Electric Supply Company. IFC is working with Global Partnership on Output Based Aid(GPOBA) and Infrastructure Department of the Bank on other PPP-related transactions and on theinstitutional framework in support of PPPs.

C. MIGA Portfolio and Program

131. MIGA's outstanding portfolio in Pakistan consists of 10 contracts of guarantee-four in thefinancial sector, five in the infrastructure sector and one in the services sector-with a total grossexposure of US$136.8 million and a net exposure of US$106.8 million. An application seeking coveragefor a US$20.8 million equity investment in a hydropower project (Laraib Energy Ltd.) in Pakistan iscurrently pending. In FY07 MIGA intends to implement an Enterprise Benchmarking Program (EBP)Survey in South Asia, and Pakistan is expected to be one of six or seven countries that will participate.The EBP will provide detailed investor-focused information to assist Pakistan's investment promotionefforts.

D. Partnerships and Harmonization

132. The Bank Group's work in Pakistan is coordinated with and reinforced by the efforts of otherdonors in a wide variety of areas. The Government leads coordination of policy dialogue and donorsupport within the framework of the PRSP, using the Pakistan Development Forum (PDF), held annuallyin Islamabad, as the principal forum for discussion with and among donors. The PDF has allowed theGovernment (federal and provincial) to actively participate and present their policy reforms to the donorcommunity. This has enabled the development partners to learn first hand from key policy makers andimplementers, about the country's economic reforms and to experience the ownership of the program atall levels of the government. To follow-up on the PDF in a systematic manner, a Donor Coordination Cell(DCC) has been created in the Economic Affairs Division (EAD). Formal donor group meetings are alsoheld, at least two to three times a year, to discuss implementation of the government's PRSP. Provincialgovernments have also continued to engage development partners in the implementation of theirprovincial reform programs. Building on the positive experience of the provincial development forummeetings in Sindh and NWFP, a Punjab development Forum was held in 2005, and another NWFPDevelopment Forum is planned in 2006.

133. Under the leadership of the Government of Pakistan, the Bank Group is increasing efforts tostrengthen partnerships and improve harmonization of activities among donors in line with the ParisDeclaration on Aid Effectiveness. Analytical activities are increasingly being prepared jointly; during thelast CAS five ESW reports were prepared as joint products with the support and participation of the Bank,IMF, ADB, the EC and the UK Department for International Development. During the next four years weexpect an increasing share of analytical activities to be carried out jointly. A comparison between theWorld Bank's and ADB procurement rules was undertaken in 2004 as part of the harmonization exerciseand as a result, harmonized procurement documents are available for use. A similar exercise is underwayin the area of financial management where DFID and ADB will be working jointly together on theplanned PFM Performance Measurement assessments for the federal government, Punjab and NWFP. A

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similar PFM assessment for Punjab was carried out jointly by the World Bank, DFID, and the EC in2005. Discussions are underway with a number of donors including the US, UK and EC to harmonizeprogram support and we will continue to seek opportunities for harmonization of budget support, both atthe national and provincial level, under common policy frameworks. Details of partner activities can befound in Annex V.

134. The international response to the October earthquake has served as an opportunity to substantiallydeepen donor harmonization and coordination. The Preliminary Damage and Needs Assessment was theproduct of a multi-agency mission led by the Asian Development Bank (ADB) and the World Bankincluding experts from the government as well as international organizations, including the EuropeanUnion, the United Kingdom's Department for International Development (DFID), the German Agency forTechnical Cooperation (GTZ), the German KfW, the Japan Bank for International Cooperation (JBIC),the Japan International Cooperation Agency (JICA), the United States Agency for InternationalDevelopment (USAID), the World Health Organization (WHO), and UN Agencies." A core group ofseven donors including the ADB, DFID, the European Union, Japan, UN, USAID, and the World Bankhas continued to meet on a near-weekly basis to coordinate activities by designating lead agencies anddevelop common approaches, including assisting in development of sector reconstruction strategies toguide government and donor efforts over the coming months. During the CAS we will seek to build onthis mechanism to institutionalize and deepen donor coordination.

E. Communications and Outreach

135. An important complement to partnership and coordination efforts is the Bank Group's overalloutreach. Accordingly, the Bank has increased its interactions with the different levels of government, themedia, civil society, and business community to establish partnerships based on a shared vision forPakistan's development. The Bank Group has intensified efforts to build the local media's capacity, andwill continue to conduct training programs for business and economic journalists in collaboration withlocal universities and WBI. In keeping with the Bank's goal of sharing knowledge, increasingtransparency, and enhancing accountability, the Bank Group's web site not only provides informationabout Bank operations in Pakistan but also provides real time access to stakeholders allover the world onannual events like the Pakistan Development Forum. The web site and other web-based communicationschannels like virtual meeting rooms and discussion space have played a great role in donor coordinationduring the recent earthquake in Pakistan. Additional efforts will be made to extend the Bank Group'soutreach through more periodic dialogue with stakeholders. This will be done through widerdissemination of the Bank Group's reports and disclosure of project documents (especially in locallanguages), greater engagement with civil society organizations and opinion makers. The Bank willcontinue also its highly effective consultative process in the preparation of specific projects.

F. Monitoring and Evaluation

136. Successful implementation of the results-based CAS will require further improvements inmonitoring and evaluation. At the level of the country program, the CAS results framework establishesthe specific results which the Bank Group aims to assist the Government to achieve (Annex 1). Progresstoward 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 anddisseminate data. To supplement the data available from household surveys, beginning in 2005, theFederal Bureau of Statistics (FBS) has begun conducting a Pakistan Social and Living StandardsMeasurement Survey (PSLM). This survey consists of a Core Welfare Indicators Questionnaire (CWIQ),which for the first time is gathering data at the district level, and a Household Income and Expenditure

1 Pakistan: 2005 Earthquake Preliminary Damage and Needs Assessment. SecM2005-0585/IDA/SecM2005-0588,November 18, 2005.

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Survey (HIES), which is provincially representative. Together with household surveys, the CWIQ and theHIES 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 of governmentprograms which can be used to assess effectiveness and make needed adjustments. The Bank will alsosupport the strengthening of administrative reporting systems with independent cross-checks provided bythird party validation surveys, an approach that is already being implemented in the Punjab Educationprogram.

137. Like several other South Asian countries, Pakistan boasts a strong statistical system with a longtime-series of household surveys with extensive data on economic, demographic, and social trends.Already a participant of the General Data Dissemination System, the GoP has announced its intention toadopt the Special Data Dissemination Standard. Further, as the country moves forward in implementingits poverty reduction strategy, increasing information demands are being placed on its statistical system.Recognizing the importance of timely and reliable statistics for policy analysis and public debate, the GoPhas embarked on an ambitious plan to restructure existing statistical agencies and develop a long-termplan to strengthen its system of official statistics to meet these challenges. The World Bank is providingtechnical assistance to the GoP to help prepare a strategic plan for the merger of the various statisticalagencies into one organization, to help draft a new statistical law specifying the respective roles andresponsibilities of various actors in the revamped statistical system, as well as to develop animplementation plan to strengthen the overall system, including training and motivation of staff and thestrengthening of the statistical infrastructure. In addition, the Bank has also helped the Federal Bureau ofStatistics carry-out the CWIQ survey in 2004/05.

138. Improvements in monitoring and evaluation will also be a focus of efforts at the project andportfolio level. Based on the results of a recent portfolio monitoring and evaluation review, there is scopefor improving the M&E focus of projects by enhancing projects-level results frameworks, strengtheningthe selection of measurable outcome indicators, and strengthening M&E information channels at theproject level. We will continue to build the capacity of the Planning Commission for evaluation andmonitoring of development projects. Further support, including lending and technical assistance forimplementation of the statistical restructuring plan, will also be considered during the CAS period.

G. Managing Risks

139. The greatest risk faced in the new CAS is the risk of policy reversal due to shifting priorities orpolitical changes. While the government has shown itself able to sustain its reform program over anextended period, the period leading up to elections in 2007 could bring greater uncertainty. In thiscontext, a slowdown in decision making is possible as are shifts in government policies and priorities.While the Bank's ability to mitigate this risk is limited, we will seek to build and sustain support forfurther reforms, using our AAA work as appropriate to help make the case for reform in public and tostrengthen the hand of reformers in policy debates. The government is also sensitive to this risk and haslaunched a variety of initiatives which aim to spread the benefits of growth and reform as widely aspossible, particularly among the poorer regions in the country. In this way, the government seeks to buildpopular support for continued reform. We will support these efforts. Finally, we will continue to rely onthe self-regulating nature of the programmatic approach: the volume and pace of lending will match thepace of reforms.

140. Recent macroeconomic developments including rising inflation and a growing current accountdeficit suggest an increase in the risk of macroeconomic slippage. On the fiscal front, expenditurepressures are evident due in part to the October 2005 earthquake and associated claims on the federalgovernment's finances. Disbursement of grant donor funding pledged at the November 19, 2005Conference in Islamabad has been slower than planned. There is also a risk of increased externalvulnerability as shown by the rapid increase in the current account deficit during FY05 and the first half

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of FY06. These risks are offset to some extent by the Government's track record over the past five yearsin managing the economy coupled with its strong commitment to sound macroeconomic management asembodied in the Fiscal Responsibility Law. The Bank will seek to further mitigate this risk through itsengagement in macroeconomic policy dialogue and in the context of the PRSCs and other developmentpolicy operations, as well as technical assistance and capacity building.

141. Despite some favorable trends over the past several years, Pakistan will remain vulnerable tosecurity risks which may affect implementation of the strategy. While the peace process with Indiaremains on track, the threat of violent conflict persists. Some episodes of violence in Balochistan and inthe border regions near Afghanistan over the past year have caused disruption in project or programimplementation. Moreover, it is likely that security concerns have acted as a constraint on theeffectiveness of Pakistan's reform program by dampening somewhat the private sector's response to therapidly improving investment climate. While the Bank cannot address security issues directly, itsengagement can have a demonstration effect and help to "crowd in" private investment. We will mitigatethe security risk to Bank operations by continuing to closely monitor developments and by respondingquickly to safeguard staff while maintaining our engagement.

142. The October earthquake has highlighted Pakistan's vulnerability to exogenous shocks, includingnatural disasters. Pakistan is subject to earthquakes as well as weather-related hazards including floods,landslides and droughts, all of which were experienced during the last CAS period. The response to theearthquake has also demonstrated Pakistan's capacity to weather such shocks, as well as the need toimprove hazard risk management practices in Pakistan. This risk will be mitigated by ensuring the Bank'sreadiness to provide necessary support-resources, AAA and leadership-to assist in responding toemergencies. In addition we will work with the Government to strengthen hazard risk managementstrategies and capacity.

143. The IBRD exposure risk is deemed to be acceptable based on Pakistan's improving debtsustainability indicators and growing access to international financial markets. Nevertheless, IBRDlending at the upper end of the proposed range will take place only in the context of further improvementsin creditworthiness. In consultation with the IMF, the macroeconomic situation will be monitored closelyand I3RD lending adjusted accordingly. Moreover, application of the guidelines for IBRD lending willserve to modulate the lending program based on policy performance at the sector level.

144. There are implementation risks relating to both the Bank and Pakistan. As outlined earliertechnical and institutional capacity constraints, particularly at the local level, could delay implementationof reforms or slow the preparation of new projects. On the Bank side, the planned increase ininfrastructure lending poses risks related to the timeliness and effectiveness of Bank support as were-engage in sectors where there has been little or no lending during the previous CAS. Portfolio riskswill also be more prominent as we scale up infrastructure lending. As outlined above, we will aim toincrease our support for capacity building, both through stand-alone operations and as an integral part ofnew activities. We will also apply a "capacity filter" to new operations to ensure that projects proceedonly with adequate capacity in place or with a clear strategy for building it. To address the environmentaland social risks associated with scaling-up and programmatic support, particularly in the infrastructureand water/irrigation sectors, the Bank will increase efforts, working with our clients, to identify at anearly stage the critical issues affecting the potential sustainability of the programs and to put in placeappropriate mechanisms to address them. To mitigate the implementation risks on the Bank side willrequire a concerted effort to streamline project preparation and ensure timely attention to implementationissues on the part of both the Bank Group and GoP.

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ANNEX I: PAKISTAN FYO6-09 CAS

RESULTS FRAMEWORK

Pakistan's Development Agenda World Bank CAS

Pillar 1: Sustaining High and Broad-based Growth and Improving Competitiveness

1. Strengthened Macroeconomic Management and Utilization of Resources

* Poverty incidence reduced Macroeconomic * Fiscal deficit (before grants) at or a Satisfactory implementation of the Fiscal Lending:

from 32% in 2001 to 28% vulnerabilities: (i) low below 4.5%; Tax-to-GDP ratio Responsibility and Debt Limitation Bill * PRSCs

in 2005-06 and 22% in revenue mobilization, (ii) increased to at least 11.5% by e Progress in restructuring CBR and 9 Provincial DPCs

2011 high costs of power sector, 2008-09 implementing improvements in

* Average real GDP growth (iii) pension liabilities * Improved organizational management, HR and revenue operations

rate of 6.5% from 2006- e Public Sector Capacity

2009. I nefficient tax efficiency and effectiveness of 9 The share of pro-poor expenditures rises Bidn rjc

* Macroeconomic stability administration, narrow tax the Central Board of Revenue from 4.8% in 2004/05 to 6.8% in 2008 with

maintained base, skewed tax structure, * Strengthened capacity for monitoring and evaluation mechanisms to AAA

* Stock of public debt and evasion macroeconomic, poverty and track progress * Tax Policy Study

reduced to 50% of GDP * High debt and low social monitoring * Adoption of a strategic plan for * TA for pensions reform

by 2008-09 creditworthiness reorganization of statistics function under a * Growth and Competitiveness

eLow savings, and public new statistical law. report

and private investmentinsufficient to support

sustained high growth e Poverty Assessmnt

b Statistical strengthning TA

* Monitoring and evaluation

(TA)

2. Increased Diversification and Exports in Agricultural

" Increase in agriculture 9 Distortions due to 9 increased productivity and Preparation of an action plan for the LENDING

productivity/competitiven subsidies on inputs and diversification at the farm level revamping of the Ag. R&D system OFWMP in NWFP and

ess (including livestock) some commodity prices o Better functioning of land 9 Automated land records management Sindh

" Improved functioning of * Stagnant yields and limited markets system implemented in Punjab province. Punjab Land Records Mgt

rural factor markets: access of small farmers to e Increased horticulture production (07)

Water, Land, Credit improved technology 9 nrae xoto o-AAA

*increased exot leas no1.%nb

* Shallow land, credit and traditional crops. * Rural DPR (06)

water markets hindermaccess by the poor restructuringiCBR

m High transaction costsrevenueoperati

Page 2 of8

Pakistan's Development Agenda World Bank CAS

Isue an Costait Ban Gru Iitnc,.'

facing small scale farmers * Livestock review (07)

and inefficiencies in the TA

marketing chains * Workshops/TA on landmarkets administration

3. Efficient and Sustainable Irrigation and Drainage Infrastructure and Service Delivery

* Efficient, transparent and e Inefficient water use and o Improved management of * Asset Management Plans prepared with * Punjab Barrage

accountable water and water shortages irrigation and drainage increased funding provided for maintenance Rehabilitation and

irrigation sector e Supply-driven system non infrastructure and rehabilitation Modernization (07)

supporting increased responsive to farmers' 9 Improved irrigation service e Number of FOs created and at least 40% of * Sindh Water sector

agricultural production needs delivery through increased abiana collection is transferred to them in improvement (07)

infrastructure degradation cost recovery in irrigation and modernized and an action plan for (07)

* Lack of transparency and * Transparent and more equitable water infrastructure development is * Punjab Irrigation DPL

equity in the water water allocation and distribution prepared (annual beginning FY06)

allocation and monitoring of water * Drainage master plan and drainage accord 9 Workshops/TA on irrigation

system concluded among provinces sector institutional reforms

w Inter-provincial water allocation agreement (05)

and related monitoring system in place

* Reduced water losses in irrigation system in

OFWM canal commands

4. Improving the Business Environmentfor Trade and Investment

Strengthened * Labor market rigidities 9 Enhanced labor market flexibility Existing labor laws amended * PRSC

competitiveness , hinder enterprise * Strengthened legal framework for - Increases in DB index of hiring and firing * Labor Market Study

increased productivity and adjustment and factor competition flexibility Competition Policy TA

improved investment mobility the water

climate * Inadequate legal and nCompetition Li annoued

*CompetitionmLawgamproved

institutional arrangementsto promote competition.M

* Government regulationspose barriers to entry andbusiness operations

Modernized Legal and e Underdeveloped Established and operational New laws, regulations, and procedures Policy dialogue; Capacity

Regulatory Framework framework for private Mineral Rights Cadastre introduced building reform using PHRD

investment in exploration Ia

Page 3 of 8

Pakistan's Development Agenda World Bank CAS

Long Term GOP-MDG . Outcomes the Bank expects to Intermediate milestones/indicators to track I

Goals issues and Constramts influence during the CAS period implementation towards CAS outcomes

for the mineral sector and development of * Functional Cadastre with trained staff Grant, PSRCs

minerals * Basic geo-information used to promote * Mineral Sector TA Loan (FY

exploration and develop investment

5. Improved Delivery and Efficiency of Infrastructure Services

A financially self- * Poor technical and * Power sector corporatized into * Notification of tariffs for individual * Transmission and

sustaining power sector commercial efficiency, independent generation, corporate entities; transfer of assets, Distribution Improvement

capable of supporting service quality, and transmission and distribution liabilities and staff; adoption of trading Loan (FY07)

economic growth and reliability entities by region rules and mechanisms for independent * PSCB

providing reliable services * Inadequate tariffs with * Improved performance of the financial flows

to existing and new substantial cross subsidies regulatory framework * Investment in transmission and distribution

consumers* Under-investment and lack * Reduced fiscal costs of the sector. * Reduced technical and commercial losses

of maintenance

* Expanded use of * Poor sector performance as * Increased fixed, mobile, and rural * Develop and implement the Universal * Support to

telecommunications evidenced by: (i) limited teledensity Service Strategy by using private operators Telecommunications

services access especially in rural * Strengthened legal and policy to deliver services Regulator (PTA) through the

areas, where teledensity is framework and improved * MOITT policy-making capacity and PTA's PSCB Project

less than 1%; (ii) long performance of the regulatory regulatory regime strengthened * Rural Telecom project

waiting time for telephone regime (FY08)

connection and (ii) poorperformance of PTCL and * Increase in delivery of e-services * IFC/MIGA support to private

the cellular operators for citizens..... ... .... ........ ...... .......-.......... -- .......... ......-..... ...... .......... ..... ..... ... ...............

* A more efficient, safe and 9 Long travel times and Improved Traffic Flow on * Rehabilitation of highways under the e National Trade Corridor

reliable transport system congestion National Trade Corridor as National Highway Improvement Program Project

moving people and goods e Limited access and poor measured by operating costs and e Road Maintenance Account operational and * Transport Competitiveness

more effectively and condition of netork travel times financing Annual Maintenance Program Study

safely Prvtsetrpriiainn* Inadequate investment in P Satisfactory progress in implementing

system maintenance. road transport increased agreed NHA institutional reform program

* Lack of private sector 9 Reduction in communities lacking basic

participation in road access to transport services: 10%

transport sector

A competitive Oil and * Government intervention Percentage of households using * implementation of pricing regimes for oil * Policy dialogue

Gas sector, providing and price controls gas as cooking fuel increases and gas * Analytical work on open

quality products in an e Mis-targeted and non- from 30% to 40% * P0 and NRL privatized by FY07 access, strategic storage,

efficient and costs

Page 4 of 8

Pakistan's Development Agenda World Bank CAS

uneconomic allocation of through imports FY o7 * Advice on gas importsscarce resources

* IFC support to private miningand gas field dev. operators

6. Improving Access to Market-Based Finance

oA strong and diversiiedatcot of financial in ing aents syste, DIt * PRC Nce o vafinancial sector withand aMd improved capit Market Trequitable access operatingin the give * t r or eve d eled * B ai sect or A

*ifraewnt numer ofPadNBF HuigFnneTfmiinstitutiondlglsk

under sound regulation controlGoeraneen Srve DeNvedy* Under-development of * Strengthened public e n to cerdasctr l pial

contractual savings has oouanaemntereitofetansato covered u ne a PIF . TAinhibited capital markets I e i cdernizedinan reotng adudit o IF foruFede P adevelopmentity of financial

inomaindusotimelins governmentn fiania AM Provinedcial FaAtisrmn

* Gaps in the legislative Ti ine a de lo aniframework pose (B n IA)eHuigFnneT

*ddtoofaa Repoiing astasured banks reoni * PRSC nWP DPc

instii f gtoenmiden audisSe c e b a m c m *re* NtinaSvigsSchmeretrctr ofrdt subivtzed wihnoeya MFaamety andot o

D f* Strengthened legalfavew for f* Public Debt Act,cInsurance O i n law * Cpita lty TAs

fe i overign htn public expenditure p eran n to over f co s and

*ccountable Isefpbli goerntm e c* Role of trainct,dp nt Offies ndi *IFAC ae1fm ia amtitutise Weakened l v Trery fic clarii

* Tracklog pogras u evelo pt edra udelite *

r s ( eli mi and a y e n FYo in7ia n A

instituta andsegal riskspotn smesrdb rcniitinP Sweakesss inimpovedquaity nd imelnes benhmaks (00%by 209)* IFCegtchn bic asitanca

reconcilPillar 2: Strngteneadit Goenne nd% Servi Delie ihnoeyar Mngmnn

7. GraerEfcinylTasanys inanAcouabilityeintteed ePublie esourcescoutbiiysssmet

*eCredible,otransparent andcepniue oe fDsrctAcutOfcsan CA/PRPR* Weaked capailt v nauyOfce lrfe

overnmet accounting-eie edpstfeealaui

reconciliationby nd Y0

Page 5 of 8

Pakistan's Development Agenda World Bank CAS

Long Term GOP-MDG Outcomes the Bank expects to Intermediate milestones/indicators to track

Goals influence during the CAS period implementation towards CAS outcomes

* Efficient and transparent * Non- transparent 9 Improved transpareney and a 100% of federal procurement eondueted * Provincial Procurement

public procurement procedures at Federal, efficiency in public procurement under modernized regulation by FY 2007. AssessmentsProvincial, Municipal and at Federal, Provincial, Municipal . Establishment of appeals procedure * PSCB capacity building

Autonomous bodies level and Autonomous bodies level

* Lack of implementing e Improved credibility of bidding e Procurement Regulations for implementing * Punjab Education SAC

Regulations and clear Procurement rules notified. Procurement e PRSC 11, 111 (FYs 06,07)

intttoa ragmns process Law enacted 9 NWFP SAC Ill (FY06)institutional arrangementsfor public procurement 9 Alignment between PPRA and o Monitoring and reporting mechanism * Sindh SAC 11 and Ill (FY06,

" akofefrcmn,Auditor Generals Of Pakistan established to provide statistics on public 07* Lack of enforcement,

monitoring and appeals procurement

handling process o Engagement of Auditor Generals Office in

* Weak capacity of the development and implementation of

procurement officials Procurement Rules, Regulations andProcedures; conduct of annual audit

8. Enhanced Capacity for Service Delivery and Public Sector Management

e Efficient, accountable * Low levels of competence Professional qualifications of * FPSC capacity strengthened and PRSC

civil service staffed by in policy and operational civil servants increased responsibility for recruitment process Devolution TA/Policy Notes

highly qualified management * Civil service compensation reaffirmed PSCB project

individuals * Weak accountability reformed to reflect market e National Executive Service created

realities District and Local Government Services

* Civil service restructured to createdfurther devolution i Pay compression ratio reduced from 1:10

e Civil service pensions reformed * Increased proportion of senior civil servants

with internationally recognized training

* HRMIS system made operational

*Accountable and efficient *Incomplete fiscal and *Increased transfer of national *Districts given full APT authority over all e TA

local governments, administrative devolution fiscal space to provincial and staff at grades 19 and below CIP Projects

SLack of clarity about roles local governments *Share of overall government resources Capacity building for lucal

and responsibilities of e Administrative and Fiscal provided to provinces/districts government through the

various tiers of devolution completed * Greater Federal/Provincial and Devolution Trust

government * Strengthened links between local Provincial/District tax reassignments.

" Fiscal imbalances among governments and community e Increased utilization of local development

tiers organizations (COs) resources

" Limited capacity of local * Increased capacity of COs to P Number of Community OrganizationsP

Page 6 of 8

Pakistan's Development Agenda World Bank CAS

Long Term GOP-MDG Issues and Constraints Outcomes the Bank expects to Intermediate milestones/indicators to track ,Goals sseanCosrms influence during the CAS period implementation towards CAS outcomes

governments participate in development created

* Weak links between planning

communities and localgovernments

9. Improved Municipal Service Delivery

* Improved quality of life in * Rapid urban transition Improved quality, efficiency and 9 improved urban land management system e Urban Non-lending TA

the urban areas and e Weak urban service access to urban services in implemented in 6 TMAs * Punjab Municipal Servicesincreased contribution of delivery as a result of selected municipalities e Adoption of clearly articulated vision and Improvement Projecturban areas to growth and fragmented improved urban planning and policy framework for urban development (PMSIP)

poverty reduction responsibilities, weak management frameworks by provincial governments e Punjab Large Citiescapacity and limited implemented in selected * Implementation of capacity building Development Policy Loanaccountability of public municipalities activities and development grants through (DPL)sector institutions *Increased access to water, the Punjab Municipal Development Fund a IFC support for municipal

* Uneconomic pricing and sanitation, transport and other Company water and sewer operators

inefficient public service urban services in selecteddelivery mechanisms. municipalities

* Poorly performing land *Improved quality and condition

markets of intra-city roads and

o Inadequate regulation and transportationenforcement

Pillar 3: Improving Lives and Protecting the Vulnerable

10. Improved Delivery ofHealth and Education Services

Education *Limited client voice in *Gross primary enrolment e National Learning Assessments conducted LENDING

" Increased leaning improving the quantity and increases from 72 to 104 percent. twice during the CAS period Provincial DPCs

achievement of primary quality of service delivery * Gross enrollment rate for middle Improved teacher attendance a Punjab PEDPC

school students *Weak management, school increases from 41 percent 9 Results of annual survey based assessments * Balochistan Ed. Loan (06)

" Gender gap in literacy including lack of focus on: in 2001-02 to 52 Percent in 2009 of providers show marked increase in e IFC support for privatereduced: ratio of literate (i) information-outcome e Increase in gross enrollment of quality of service provision educationfemale/males increases based policy making, (ii) girls in primary school from 61 in - Increased non-salary recurrent expenditures e Higher Education Reforrmfrom 65 percent in 2005 standard setting regulation; 2001-02 percent to 85 percent in in education

to 93 percent by 2015 (iii) monitoring and 2009

* itray ae f 5-4 evaluation * Successful implementation of education a Education Sector Reportea o rasie icenti o * Increase gross enrollment of girls stipend program for girls in selected Private Sector Participation

eiin middle school from 35 in districts58% in 2001 to 78% in providers that link 2001-02 percent to 45 percent in in Punjab

2011 autonomy with 2009 Higher Education Policy

--~~~~~~~~~~ ~ ~ ~ ~ Imp ove quaity effiienc and... ..._-....... ..... . ..... ..

Page 7 of 8

Pakistan's Development Agenda World Bank CAS

Long Term GOP-MDG Issues and Constraints Outcomes the Bank expects to Intermediate milestones/indicators to track

Goals influence during the CAS period implementation towards CAS outcomes

Improve post-primary accountability * Increase enrollments in Higher Note

access and quality * Limited opportunities for Education (particularly for TA

public-private partnership bottom 20 percent of the * Skill development/Laborpopulation) market TA

* HD Monitoring andEvaluation TA

Improved Health Weak management: Contraceptive prevalence rate e Increase in LHW (and skilled birth 9 Partnership for Polio

Outcomes compounded by (i) poor increased from 28% to 34% by attendants) from 84,000 to 110,000 by Eradication (FY06)

* Under 5 mortality rate accountability of service FY09 FY09 e Lady Health Workers (FY07)

reduced from 103 to 60 providers and managers, *Proportion of births attended by * Timely availability of polio vaccines and e National HIV/AIDS Control(per 1,000 live births) (ii) limited autonomy, and skilled health personnel rises increased SIA coverage of targeted children project (FY03)

* Maternal mortality rate (iii) lack of performance- from 31% to 38% to at least 80% in polio endemic provinces

reduced from 450 to 250 based incentives * National Public Health

(per Lack of focus on Pn/ Surveillance and Monitoring(pe 10,00liv brts)months) fully immunized contracted to deliver services to high-risk System (08)

* Polio eradicated information-outcome increased from 77% to 85% groups rises from 7 to at least 26based policy making, (ii) e Health sector review

* Spread of HIV infection monitoring and evaluation 9 HIV prevalence remains below including assessment of the

reduced 5% of female sex workers andc aiitstabilizes among male sex

and responsibilities for workers, truckers, jail inmates * IFC support for private

different levels of and IDUs providers

government

11. Reduced vulnerability and Improved livelihoods of poor communities through effective safety nets, targeted interventions; and hazard risk management

Vulnerability reduced * Lack of national strategy Increased school attendance e SP strategy and approved by Government Lending

through implementation for social protection among poor children (bottom 2 e Pilots for safety net reforms (CCTs) * Social Protection (FY08)

of well targeted, e Limited, ad hoc, and quintiles) and among disabled implemented and scaled up e PRSCs, Provincial DPCs,financially viable, and unevaluated use of safety children Safety net targeting mechanism developed Emergency Recovery

adminiteredsocia Uncleerar offiaftyinetsfncroles

well nets and social security and administrative capacity to deliver and Operations (06-09)

securiaeptiy ppvalnceratassistance and social instrumeninrease fo 2% o 34%r (byto oio rgasipoeA

seuiyporm Existing safety net 2 quintiles) e Civil service pension reforms enacted; * Safety net Report (FY06)programs not designed to * Reduction in fiscal liabilities of reforms of other formal/informal pensions

help poor cope with the civil service pensions design ed/agreed, and reforms initiated (FY06)rvc Pnio epr

shocks/natural disasters p rise

or build human capital safetinesinpndgonovrytgeted * Pension Report/ TA (FY07-

f Social Protection programs 308)

are under-funded and have e Micro-insurance Report

low/poor coverage (FY08)

* Weak implementation *HIVpreval

Page 8 of 8

Pakistan's Development Agenda World Bank CAS

capacity leading toinefficient administration

*Improved livelihoods and LiieacestbaiInraecomnt InraereitainoComntBsd *PAF adIIservices for poor services and infrastructure participation in the decision Organizations (CBOs) (from 120 in June * Kushall Pakistan/Socialcommunities and drought hinder opportunities for making process and partnership 2004) Mobilizationprone areas economic activities and between municipalities and * Number of community infrastructure 9 NWFP CIP 1

income generation for the CBOs on service delivery projects launched and number of ruralrural poor Improved delivery of services, communities reached. * AJK CIP

* Weak community based and productive and social * Number of active microcredit borrowers.organizations and rural infrastructureinstitutions Increased access to credit,

* The poor (esp. in rural including microcreditareas) lack access to credit

*Areas affected by October e High risk of natural *Vulnerable populations provided e Number of houses restored/rebuilt to * Earthquake Emergency2005 earthquake disaster including livelihood support during post- earthquake resistant standards. Recovery Credit

rehabilitated earthquake, floods and earthquake period Number of communities/households Earthquake Emergency

CVulnerability to hazards drought * Basic services and public benefiting from livelihood support Response package

reduced through increased e Ad hoc approach to infrastructure restored in paymentspreparedness dealing with Hazard Risk earthquake affected area Development of National Emergency

Management (HRM) Owner driven housing Management Plan

i Undeveloped institutional reconstruction complete inframework and limited selected areascapacity for disaster * Strengthened GoP capacity toresponse and rRM limited manage and minimize the impact

of future disasters

Pakistan: CAS Completion ReportPage 1 of 30

ANNEX II: CAS COMPLETION REPORT

Country: Pakistan

Date of CAS: June 24, 2002 Date of 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: May 27, 2005

1. This CAS Completion Report evaluates the effectiveness of the World Bank's CountryAssistance Strategy for Pakistan (FY2003-2005). It is a self-evaluation by the country team of the extentto which expected CAS outcomes were achieved and the extent to which Bank performance wassatisfactory in helping to design and implement the CAS toward outcomes, with a view toward longerterm strategic goals. The purpose of the report is to identify the lessons relevant to the design andimplementation of the new results-based CAS. Completion of this report coincides with the completionby the Independent Evaluation Group (IEG) of a Country Assistance Evaluation covering FY1994-2003which, although it covers a different period, offers additional lessons relevant to the new CAS.

2. This report evaluates the CAS against the outcomes established in the FY2003 CAS. The reportassesses: (i) the alignment of the CAS with Pakistan's goals and expected development results; (ii) thedegree to which CAS outcomes were achieved during the CAS period; and (iii) the Bank's performanceduring this period. Since the CAS was presented to the Board in June of 2002, a CAS Progress Reportwas discussed in April 2004. Progress in achieving CAS outcomes is summarized in Annex-1 whileannexes B and C compare planned and actual deliveries of lending and non-lending support over the CASperiod.

Overview

3. From independence through the 1980s, Pakistan's economy grew at a respectable rate - alwaysover 5 percent after the 1950s and in the 1980s over 6 percent per year. In the 1990s, however, growthslowed while public debt accumulated rapidly and poverty increased. The imposition of sanctionsfollowing the 1998 nuclear tests exposed the vulnerability of the economy, leading to severe balance ofpayments 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;Pakistan's macroeconomic performance has improved significantly and more rapidly than expected.Sustained implementation of the Government's stabilization and economic reform program, along withthe generous support from the World Bank and other donors, has resulted in macroeconomic stability andaccelerating growth, laying the foundations for poverty reduction. Economic growth has increased fromthe average of 3.3 per cent during 1997-2002 to the average of nearly 6 per cent during 2002-04. Againstthe target of 5.3% for FY04, GDP growth was recorded at 6.4%, the highest rate in 8 years. For FY05,despite the impact of rising oil prices, growth reached 8.4%.

5. There has been significant progress in implementing a wide ranging program of structuralreforms with deep World Bank engagement. The banking sector has been strengthened through

Pakistan: CAS Completion ReportPage 2 of 30

privatization, a strengthened legal and regulatory environment, and significant improvements intransparency, corporate governance, and credit culture. There has also been progress in de-regulating theeconomy so as to reduce the cost of doing business in Pakistan. The regulatory and policy framework forthe telecommunications sector has been improved to establish a competitive telecommunications market.

There has been progress in implementation of 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, andvalue for money; (ii) restructuring of the Central Board of 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 of the civil service to improve incentives and accountability.

A. Longer Term Strategic Goals

6. The 2002 CAS and June 2001 CAS Progress Report reflected and supported the program whichthe government had formulated starting in 1999. Soon after the military coup, the new government issueda 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 insociety. In December 1999, following national consultations, the government announced its developmentstrategy which focused on: (i) strengthening governance and the integrity of the civil service; (ii) creatingopportunities through accelerating growth of agriculture, small and medium scale industries, informationtechnology, and oil and gas sectors; and (iii) reducing poverty through revival of growth and re-orientingpublic expenditure towards human development and poverty reduction.

7. Later, these goals became the basis of the government's Interim Poverty Reduction StrategyPaper which was completed in November of 2001. The CAS outlined a Bank program in support of theI-PRSP.I The I-PRSP specified five main goals: engendering growth, reforming governance, creatingincome generating opportunities (specifically for the poor), improving human development, and reducingvulnerability to shocks (at the microeconomic level). While not explicitly linked to the MDGs, theI-PRSP was closely aligned to them. The full PRSP (discussed in greater detail below), which wascompleted in December 2003, went on to make the link between the MDGs and Pakistan's povertystrategy explicit, setting targets for poverty reduction, education, health, and gender equality that are fullyaligned with the MDGs. In addition, both the I-PRSP and the PRSP included M&E frameworks to trackprogress toward the MDGs as well as intermediate indicators to guide policymakers and programmanagers.

8. During the CAS period, the government's longer term objectives underwent a process ofrefinement and elaboration, but remained fundamentally unchanged. Parliamentary elections were held in

October 2002 leading to the formation of a government under the leadership of an elected Parliament andPrime Minister. The civilian government has largely adhered to the policy priorities of the militarygovernment. Many key ministers have remained in place and President Musharraf has continued toexercise considerable influence on policy matters. Mr. Shaukat Aziz has remained Finance Ministerthroughout the CAS period while also being elevated to Prime Minister in 2004.

9. The PRSP prepared in December 2003 outlined a policy which continued and built upon theI-PRSP. Pakistan's PRSP is grounded on four pillars: (i) achieving sustained high and broad-basedeconomic growth, focusing particularly on the rural economy, while maintaining macroeconomic stability(ii) improving governance and consolidating devolution; (iii) investing in human 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 PovertyReduction Strategy Paper and Joint IDA-IMF StaffAssessment, Report 23189-PAK, November 15, 2001.

Pakistan: CAS Completion ReportPage 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 been restored, 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 of these areas andthere are early indications of success as shown by increasing timeliness and accuracy of governmentfinancial reporting, and improved customer satisfaction by the Central Board of Revenue. With respect to

devolution, the new devolved political structure is fully in place, but the fiscal and administrative aspects

of devolution have yet to be fully implemented creating obstacles for local governments seeking to

improve delivery of public services. There has been less progress in civil service reform. Nevertheless,given the long term nature of governance reforms this is a respectable track record, even though in some

respects it falls short of the goals set in the CAS.

11. Public expenditure has been reoriented toward human development, a shift made possible by adramatic reduction in interest expenditures brought about by successful implementation of a debt

reduction strategy. Poverty related expenditures have increased substantially, exceeding in some casesthe targets set in the I-PRSP. However, public spending on health and education remains low byinternational standards and it is too early for a full assessment of whether additional expenditures have led

to significant increases in the quality and availability of services, let alone outcomes. Nevertheless, thereare examples of increased access in several areas. Improvements in the effectiveness, as well as the level,of social spending will be necessary to reach the MDGs. Consequently, the government's governancereform agenda is a key ingredient of a strategy for improving human development outcomes. Additionalresources have been targeted toward social safety nets, but here too the government recognizes the need

to improve the targeting and efficiency of these programs and has launched efforts, supported by theWorld Bank, to do so.

B. CAS Outcomes

12. The CAS was designed to support Pakistan's pursuit its I-PRSP goals through a Bank program

organized around three pillars corresponding to major areas of the government's reform program: (i)

strengthening macroeconomic stability and government effectiveness; (ii) improving the businessenvironment for growth; and (iii) improving equity through support for pro-poor and pro-gender equitypolicies. For each of these pillars, a set of country outcomes and associated indicators or milestones were

identified in the CAS program matrix. The CAS triggers also included specific performance criteria forassessing progress in the main areas of the CAS.

13. The results framework established in the 2003 CAS program matrix has some weaknesses when

compared to the approach now developed for use in a results based CAS. Some objectives, such asimproved performance of CBR lack specificity, although milestones in the CBR reform program arereflected 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 of the 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 theselimitations, the CAS and its program matrix together present an adequate monitoring and evaluationframework for assessing progress toward CAS outcomes. The CAS Progress Report updated the programmatrix and assessed progress against the objectives in the program matrix as well as the CAS triggers.Progress in achieving CAS objectives is discussed in the following sections.

Pakistan: CAS Completion ReportPage 4 of 30

MACROECONOMIC STABILITY AND GOVERNMENT EFFECTIVENESS

14. This pillar of the CAS embodied two key elements of the I-PRSP: consolidating recovery fromthe macroeconomic crisis of 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 povertyreduction required in the first instance correction of macroeconomic imbalances and maintenance of 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 restoreconfidence in state institutions.

Macroeconomic Stability

15. Upon coming to power in 1999, the Musharraf government moved quickly to stabilize theeconomy and restore confidence. By the time of the 2002 CAS, considerable progress has been made andfor the first time in its history Pakistan had successfully concluded an IMF Stand-by arrangement.Nevertheless, the macroeconomic situation remained perilous and the outlook was made more uncertain

by the impact of 9/11. The I-PRSP set targets for further fiscal consolidation, accelerating growth, andmanagement of debt. The CAS incorporated these targets as well as the targets in the PRGF arrangementwith the IMF. Overall, progress has been impressive, particularly with respect to restoration of growth(see table 1). With respect to the PRGF program, targets were mostly met or exceeded and structuralreforms measures were largely followed through, though in some cases with delays. 2 All PRGFdisbursements were made available upon completion of program reviews although the authorities electednot to draw the final tranche in light of the improved external position.

Table 1: Key Indicators: I-PRSP vs. Actual

2000-01 2001-02 2002-03 2003-04 2004-05

Real GDP Growth I-PRSP Target 2.7 3.7 5.0 5.3 5.8Actual/proj. 2.2 3.4 5.1 6.4 8.4

Inflation I-PRSP Target 4.4 5.0 5.0 4.0 4.0

Actual/proj. 4.4 2.5 3.1 4.6 9.3

Budget Balance (excl. grants) I-PRSP Target -5.2 -5.3 -4.1 -3.2 -3.9Actual/proj. -5.2 -6.7 -4.6 -2.9 -4.1

Development Expenditure I-PRSP Target 2.7 3.4 3.6 3.9 4.1

Actual/proj. 2.6 3.5 3.2 3.6 4.3

PRSP Expenditure I-PRSP Target 3.4 3.6 3.8 4.0 4.2

Actual/proj. 3.6 3.7 4.2 4.7 4.7* For comparability with I-PRSP targets, figures above do not reflect 2005 GDP re-basing.

16. The instruments employed to support Pakistan's stabilization program consisted of a series ofone-tranche development policy credits to the federal and provincial governments. These supportedpolicy reforms while assisting in the restoration of financial equilibrium. This strategy was carried out inpartnership with the IMF which took the lead in assisting in the adoption of supportive monetary andexchange rate policies. A 3-year PRGF arrangement was approved in November 2001 and concluded inDecember 2004. Other donors also provided significant budget support. The Bank development policylending program constituted a multi-year commitment of budget support tied to fiscal and governancereforms keyed to the pillars of the I-PRSP. The first of these, SAC I, was approved in 2001 while the

2 IMF, Staff Report for the 2004 Article IV Consultations, Ninth Review Under the Poverty Reduction and GrowthFacility, and Request for Waiver of Performance Criteria, November 16, 2004

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second, SAC II was approved along with the CAS in June of 2002. SAC III, which was expected to beapproved in FY03, was delayed as a result of a slowdown the reform program following the elections andpolitical transition in late 2002. Reform accelerated in 2003 and 2004 opening the way for resumption ofdevelopment policy lending which came in the form of 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 thenational level. The provinces and local governments in Pakistan bear most of the responsibility fordelivering public services including education and health, but have very limited fiscal space to providethese services. Therefore, the CAS initiated a program of single tranche development policy credits toprovide performance-based budget support to enable the provinces restore financial equilibrium whileundertaking reforms. The resources provided an immediate means to address the imbalance between theprovinces' responsibilities and their fiscal capacity while the fiscal management reforms supported underthese credits were designed to improve fiscal sustainability through increased revenue mobilization at theprovincial level. The provincial credits also supported governance reforms and service deliveryimprovements to address the governance problems that historically limited the effectiveness of spendingincreases.

18. A first round of provincial development policy credits-for Sindh and NWFP-was approved inFY03. As in the case of the federal government, the elections in 2002 and resulting political transitionsslowed implementation of the provinces' reform programs. As a result, planned follow-on credits weredelayed. In the case of NWFP, a second NWFP credit was approved in June 2004. A principal objectivein the CAS for provincial development policy lending was to restore the provinces fiscal space and allowthem to increase spending on social services by undertaking reforms. In this respect, the provincial SACswere effective, allowing the provinces to re-profile their debt and reduce interest costs while re-orientingexpenditures, including very large increases in development spending on education and health. As aresult the government of NWFP has been able to increase the share of PRSP spending from 29% to 38%.Provincial tax revenue has grown by 14%. In Sindh, the SAC-supported provincial reform programresulted in substantial increases in provincial revenues and development spending as well as an increasedshare in the budget for health and education. However, given the provinces' overwhelming reliance onfiscal transfers from the federation, sustainability of these fiscal reforms and maintenance of adequatefiscal space at the provincial level depends in large part on the (still pending) outcome of the NationalFinance Commission which will establish the formula for allocating federal revenues among theprovinces and federal government.

19. The development policy lending program was complemented by policy dialogue and economicand sector work. The CAS was based on a Development Policy Review, a Poverty Assessment, and aCountry Procurement Assessment. During the CAS period the Bank completed work on a PublicExpenditure Review, Country Financial Accountability Assessment and an FSAP and the Bank annuallyconducted reviews of the Government's Public Sector investment program. A series of trade policy noteswas prepared during FY04. The Bank also worked closely with the Fund, providing advice and technicalsupport in the implementation of the I-PRSP/PRSP program.

Governance Reforms

20. The Bank's support for improving the effectiveness and accountability of state institutionsfocused on the following areas: (i) reforms in public financial management and procurement to increasefiscal transparency and accountability; (ii) restructuring of the Central Board of Revenue to strengthen taxadministration; (iii) a devolution initiative aimed at improving the delivery of public services by creatingmore accountable local governments; and (iv) civil service reforms. The specific CAS outcomes

Pakistan: CAS Completion ReportPage 6 of30

supported by the Bank took the form of milestones in the institutional reform processes as well as, insome cases, indicators of improved performance.

21. In public financial management and procurement, the focus of the CAS was on improvementsin government accounting, auditing, and legislative oversight along with the adoption and implementationof modern public procurement laws and regulations. The strategy was to assist in modernization andcomputerization of the government accounting system coupled with strengthening of the audit functionand revitalization of the external oversight process. The centerpiece of the Bank's support was theProject to Improve Financial Reporting and Auditing (PIFRA) which was approved in FY97 and closed inFY05. SAC II and PRSC I also supported these reforms with prior actions related to expenditurereconciliation targets and establishment of the Federal Public Accounts Committees as well as thenotification of new Public Procurement Rules. Non-lending assistance took the form of policy dialogue, aCountry Financial Accountability Assessment, and provincial financial accountability assessments for theSindh, 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 in timelinessand reliability of financial statements as well as progress in launching of computerized accounting sitesunder PIFRA. The CAS Progress Report also described improvements in the timeliness of audits, thelaunch of an Annual Audit Program, and recruitment of qualified auditors to develop district levelauditing capacity. Nevertheless, in several areas progress fell short of the benchmarks set in the CAS.The CAS targeted extension of PIFRA reforms to the district level which ultimately was delayed asoverall PIFRA implementation proved slower than anticipated, with PIFRA reforms extended to 30 of aplanned 56 districts. Full Roll-out of PIFRA systems to the district level will be completed in the nextgeneration PIFRA II project which will be approved in FY06. The CAS also set an ambitious target forthe public accounts committees to eliminate the backlog of unreviewed audit reports and remain currentin the review of audits under the new government. This could not be achieved as a result of delays inreconstituting the PACs following the October 2002 elections. In procurement, adoption of newprocurement rules did not take place until July 2004 and implementation remains a concern.

23. The CAS identified improvements in tax administration as critical for improving the businessclimate and enhancing revenue mobilization. The government's two-pronged strategy-approved inNovember 2002--called for changes in tax policy coupled with tax administration reform to improve theefficiency of tax collection. Both the Bank and the Fund provided advice on tax policy reforms supportedthrough policy lending and PRGF performance benchmarks. The CAS also targeted Bank support towardthe restructuring of the Central Board of Revenue over a three-year period. CAS outcomes were keyed toachievement of key milestones in this process, including organizational changes, adoption of revised HRpolicies, and measures to increase transparency. The Bank supported the CBR reform process throughboth development policy and investment lending. Approval of the reform program was a prior actionunder SAC II and the Bank financed preparation of the detailed reform program, leading to approval ofthe Tax Administration Reform project in December 2004. Additional support to CBR was also providedunder the Public Sector Capacity Building TA project.

24. The restructuring program for the Central Board of Revenue (CBR) progressed well during theCAS, although more slowly than anticipated. A new recruitment policy has been put in place for key staffin order to attract specific skills while incentive and merit based remuneration and promotion mechanismshave been adopted on a pilot basis. The improved organization structure for tax collection has beenpiloted in the form of a Large Taxpayers Unit and a Medium Taxpayer Unit and similar pilots areunderway in the area of customs administration and sales tax. Performance indicators including revenuetargets and changes in policies are published on a quarterly basis and are also available on the CBRwebsite. While some measures to broaden the tax base were implemented, including the withdrawal of

Pakistan: CAS Completion ReportPage 7 of 30

tax exemptions and extension of sales tax to additional categories, a significant widening of the tax basehas yet to be accomplished and the revenue-to-GDP ratio remains low by international standards.

25. Pakistan's devolution initiative is an integral part of the GOP's strategy for improving servicedelivery by making the public sector more accountable to citizens and more efficient at delivering basicservices. The Bank supported devolution by providing analytical support focused on areas where theBank had a comparative advantage; a number of Pakistan's development partners were also supportingthe devolution program. The targeted outcomes related to devolution represented key milestones inimplementing the initiative, especially those that affected the ability of the districts to deliver publicservices. These included promulgation of Provincial Finance Commission awards transferring resourcesto districts, and implementation of capacity building programs at the district level. Provincial DPLstargeted fiscal reforms designed to increase resources for basic service delivery.

26. A major ESW report on devolution was completed in FY04 which outlined the progress andremaining challenges facing Pakistan in implementing its devolution strategy. The provincialdevelopment policy credits for NWFP and Sindh (3 of the planned 6 operations were approved) includedprior actions related to enhanced transfers of resources and responsibilities to district governmentsthrough formula-based provincial finance commission awards. Assistance in financial managementimprovements through PIFRA and development policy lending also aimed at strengthening localgovernment capacity. By providing performance-based conditional grants to district governments willingto commit to reforms in education, the Punjab Education Sector Adjustment Credits (approved in FY04and FY05) also served as a means of helping to increase financing for local government delivery ofeducation.

27. The CAS Progress Report reported that Pakistan's progress in implementing devolution wassubstantial with respect to putting in place the new local government political structure. However localgovernment autonomy, both financial and managerial remains limited. District governments facesignificant obstacles caused by incomplete administrative and fiscal devolution as well as severe capacityconstraints. In some cases these constraints are exacerbated by political rivalries.

28. Civil Service Reform. The I-PRSP recognized the importance of improving the quality of thecivil service in order to increase the effectiveness of its poverty reduction programs and set out an agendaof restructuring, recruitment reform, enhanced training, and pay and pension reform. The CAS outcomesfor civil service reform were to (i) strengthen merit recruitment and promotion; (ii) launch pay andpension reforms; (iii) implement a civil service training plan; and (iv) improve the composition of theworkforce which is highly skewed toward lower grades. The instruments to support civil service reformwere the federal and provincial development policy operations which supported recruitment and pay andpension reforms. In addition, the Public Sector Capacity Building (PSCB) TA project is financing civilservice professional development and capacity building in key agencies, ministries, and regulatory bodies.

29. The government has made some progress in implementing these reforms. The Federal andprovincial public service commissions (responsible for civil service recruitment) have been strengthenedand changes in the promotion system have been introduced to make evaluations more objective, increasetransparency in promotion, and to link promotion to higher grades to required training. Pay reforms wereinstituted in January 2002 which restored about 75 percent of the lost purchasing power of wages (whichhad not been increased since 1994) and introduced important structural reforms in pension and pay scales.Further pay increases were implemented in July 2003 and July 2004 in the form of interim across-the-board salary increases. This has improved compensation somewhat but the wage structure remainsseverely compressed. The compression ratio (of top to bottom salaries) is 1:10. It was 1:46 in the 1960's.As a result, the higher echelons of public servants have significantly lower compensation thancomparators, making it difficult to recruit high-caliber staff. Options for further pay reforms designed to

Pakistan: CAS Completion ReportPage 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 is being revamped under the PSCB project,but this process is 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

beginning of the more far reaching reforms needed to address the challenge of developing a strong civilservice in Pakistan.

Assessment/Lessons Learned

30. In retrospect, the mix of instruments in the CAS was appropriate to support the reform program in

this pillar of the CAS. The use of development policy operation supported both macroeconomicstabilization and a broad array of structural reforms targeting the key weaknesses in government

effectiveness. The government's macro strategy called for rapid fiscal adjustment; sizable externalfinancing on concessional terms was a key ingredient in its debt reduction strategy, allowing it to re-

profile high interest debt. Given the severity of 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 of public financial management, (PIFRA) tax

administration reform (Tax Administration Reform Project) and government capacity building (Public

Sector Capacity Building TA). The use of a series of single tranche operations was appropriate to takeinto account Pakistan's uneven track record and the uncertain political and security environment, enabling

the Bank to match its support to the pace of the reform program - when the pace of reforms slowed, sodid Bank 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 madesignificant progress with respect to engendering growth. Improvements under SAC II and PRSC I includea continued acceleration in growth, from 3.1% in FY01/02 to over 8% in FYO4/05, and majorimprovements in the fiscal and current accounts. Fiscal outcomes improved significantly in FY03 andFY04. The fiscal deficit fell from 6.7% of GDP in FY02 to 4.6% of GDP in FY03, falling below 5% forthe first time in more than 25 years. It fell further to less than 3% of GDP in FY04 despite continued lowlevels of revenue mobilization and high losses by public sector enterprises before rising to 4.1% in FY05.Pakistan's debt service burden has fallen significantly from 34% of 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 of

ongoing financial management reforms was also delayed.

32. Exogenous factors had significant impacts, both positive and negative, on the achievement of

CAS objectives under this pillar. Throughout the CAS period, security concerns were prominent as aresult of events both inside and outside of Pakistan including the war in Afghanistan and its effects, thewar in Iraq, and the confrontation with India in 2002. On the negative side, risk perceptions andincreased defense expenditures were a negative factor for the investment climate and fiscal balance, whilerising oil prices put significant pressure on the budget and balance of payments. On the positive side,Pakistan's geopolitical role led to increased grant aid, debt restructuring on highly concessional terms,and expanded textile quotas. The post-9/1 1 tightening of money-laundering regulations resulted in large-scale repatriation of holdings abroad and growing remittances, accelerating the accumulation of reserves.The growing rapprochement with India, beginning in 2003, has greatly reduced tensions and over thelonger term holds the prospect for increased trade and economic integration.

Pakistan: CAS Completion ReportPage 9 of 30

33. Pakistan's performance contributed significantly to meeting CAS objectives. As reported in the

CAS Progress Report, Pakistan's performance in implementing reforms 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 of change foreseen in theCAS too optimistic.

STRENGTHENING THE ENABLING INVESTMENT CLIMATE

34. This pillar of the CAS was aligned with the I-PRSP which emphasized the importance of creatinga 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 of the following objectives: (i) improving the incentive andregulatory regime, (ii) privatization, (iii) financial sector reform, and (iv) accelerating rural growth. CASperformance benchmarks related to adoption of measures to modernize trade and industrial regulations

and enforcement practices; complete selected privatization transactions; undertake reforms in power, 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, althoughbaselines 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 II and PRSC I supported actions inprivatization, adoption of trade and regulatory reforms, and reforms in power, oil and gas. The provincialadjustment credits also set targets for the adoption of regulatory and other reforms designed to improvethe business climate for growth in Sindh and NWFP. Banking Sector reforms were financed withdevelopment policy lending and investment lending including the Banking Sector Restructuring andPrivatization project, the Technical Assistance to the Banking Sector project and the Banking SectorDevelopment Policy Credit. In infrastructure, the Ghazi Barotha Hydropower project and theTelecommunications Regulation and Privatization Support Project were completed and closed during theCAS period while the National Highways Rehabilitation project was approved in FY04. AAA supportincluded an Investment Climate Assessment and the Doing Business surveys, as well as policy dialogueand IDF support to the Committee on Reforms in Regulatory Legal and Policy Environment. A FinancialSector Assessment Program (FSAP) report was prepared in FY04. In trade, the Trade and TransportFacilitation Project (FY01) was completed while trade policy notes were prepared in FY04 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 andoutput markets. The instruments to support these reforms included both lending and AAA. Lending in

water and irrigation consisted of the National Drainage Program project (FY98-05) and On Farm Water

Management projects in NWFP (FY01) and Sindh (FY04). PRSC I also supported agriculture and watersector reforms including further liberalization of wheat and sugar markets and further development ofnational water and drainage policies. Ongoing policy dialogue was supplemented by ESW reports onRural Factor Markets and a Water CAS. The Public Expenditure Review also dealt extensively withirrigation and water issues. A planned Rural Development Policy Review originally planned for FY03 isnow planned in FY06.

Pakistan: CAS Completion ReportPage 10 of 30

Incentive and Regulatory Environment

37. The Government implemented a range of measures to improve the incentive and regulatoryenvironment. A number of laws and regulations governing industrial relations were consolidated andpromulgated in the Industrial Relation Ordinance 2002. In addition, the Drug Act 1976, long consideredto be a deterrent to the healthy development of a pharmaceutical industry, was revised with input fromstakeholders and promulgated as the Drugs Ordinance 2002. Additional reform of laws concerningindustrial relations and labor protection is also proceeding and revised legislation is expected to bepresented in 2006 including: (i) Amendment to Industrial Relations Ordinance 2002; (ii) Conditions ofEmployment 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 tobusiness registration procedures were undertaken in 2002 cutting the time for business start-up by morethan half, from 53 to 22 days while provincial authorities in Sindh and NWFP reformed factory andbusiness inspections to reduce harassment.

38. In trade, the CAS targeted increased exports, lower levels of effective protection and improvedtrade facilitation. Pakistan is one of the more open countries in South Asia. The maximum tariff rate is25% and the number of tariff bands is four. The Government has eliminated quantitative restrictions,regulatory duties, para-tariffs, and several other measures that restricted trade in the past (with theexception of trade with India). During the CAS period, the government sustained the momentum of tariffreductions and weighted average tariffs continued to decrease from 14.2% to 13.4%. Agriculture has thelowest tariff rates in the region (13.1 %, down from 13.9% last year). In the FY05 budget, duties on carswere reduced from the range of 75%-150% to 50%-100%. The Trade and Transport Facilitation Projectwas completed satisfactorily in 2005, having contributed toward bringing Pakistan's traditional trade andtransport practices in line with international best practices.

39. Financial Sector Reforms. The FSAP conducted in FY04 concluded that banking sector reformshave been effectively implemented and have significantly improved the soundness and efficiency of thefinancial system by reducing state intervention and improving the environment for banking. Privatizationof large state-owned banks during the CAS period (Habib Bank and United Bank Limited) substantiallychanged the structure of the banking sector and nearly 80 percent of sector assets are now controlled byprivate banks as compared with 34 percent in 1999, and just 8 percent in 1990. As a result access tofinance has improved and credit to the private sector has witnessed significant growth during the pastthree years. Last year alone private sector credit showed an increase of over 30 percent. A large part ofthe success of the reforms stems from the improved legal and regulatory framework and enhancedcorporate governance as a result of the reduced role of the government and the enhanced role and capacityof the regulators, especially the State Bank of Pakistan which is being supported through the BankingSector TA loan (FY03). Profitability and liquidity indicators for the commercial banks have shown amarked improvement. The banking sector has also become considerably more competitive andresponsive. Efforts by the SBP are also underway to further strengthen the payment system to enhance itstransparency and efficiency.

40. Power Sector Reforms. The CAS made improvement in the performance of the state-ownedpower sector a major focus. In part this reflected recognition that Pakistan needed expanded, morereliable supplies of power at reasonable costs to support its growth objectives. At the same the sector'sconsiderable drain on the budget was seen as a threat to successful fiscal adjustment. In coordination withthe Fund PRGF program, SAC II supported sector reforms and set targets under a financial improvementplan. However, progress in improving the financial performance of the main power utilities, WAPDAand KESC, fell short of expectations. The financial improvement plan agreed under SAC II was not fullyimplemented as the tariff increase approved was smaller than forecast and electricity rates weresubsequently reduced despite continued high losses. Moreover, little progress was made in reducing

Pakistan: CAS Completion ReportPage 11 of 30

public sector arrears and technical losses. Nevertheless, the program achieved a number of positive steps,particularly in laying the groundwork for the corporatization and eventual privatization of the sector. Inaddition, a top priority-the privatization of KESC-has moved ahead with successful bidding in Januaryof 2005.

41. Reforms in infrastructure. The I-PRSP and PRSP identified telecommunications reform as a keyelement of the reform program because of its linkages to other sectors. Progress in reforms has beenstrong, emphasizing enhanced competition within a supportive regulatory framework. In January of 2004,Pakistan de-regulated the sector, allowing free entry of 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 additionalcell phone licenses have been issued under a competitive bidding process.

42. Progress in implementation of the reform agenda in oil and gas was mixed as the Government'ssuccess in privatizing state-owned assets, increasing supplies, and improving regulation was offset byinability to adjust consumer prices as foreseen in the CAS. In FY05 the Government temporarilysuspended its policy of automatic fortnightly petroleum price adjustments based on global oil prices, asetback which had a significant cost to the budget. Even though overall gas tariff collections met policygoals, implementation of the six-monthly gas price adjustment mechanism was also inconsistent and thegovernment did not make progress in rationalizing the abnormally low gas tariffs maintained for thefertilizer industry.

Accelerating Rural Growth

43. There was only incremental progress in achieving the CAS outcomes targeted in this area, namelyimproved land and water markets and improved efficiency of institutions in irrigation and drainage.Moreover, agricultural growth has been disappointing, averaging 1.7 percent per annum during the lastseven years, though this is in large part attributable to drought; with favorable weather conditions, FY05agricultural growth rebounded strongly, reaching 7.5%. The National Drainage Program (NDP) was thecenterpiece of Bank projects to support implementation of institutional reforms in water, includingdecentralization and management transfer of irrigation and drainage systems in the Provinces. The NWPFOn-Farm Water Management project (approved in FY01) and the Sindh On-Farm Water Managementproject (approved in FY04) also targeted enhanced water management and agricultural productivitythrough improved governance and investment in secondary and tertiary irrigation infrastructure.

Implementation of the Sindh On-Farm Water Management project is in its earliest stages, progress inimplementation of the NWFP On-Farm Water Management project has been slow.

44. Relative to its stated objectives and program targets the achievements of NDP were disappointingand its overall performance unsatisfactory, although there is now much greater ownership for its reformobjectives. Notwithstanding its overall unsatisfactory rating, the project yielded several positiveoutcomes. First it helped clear the backlog of deferred maintenance of the existing irrigation and drainagesystem. 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 of the GOP andProvinces. Third it was instrumental in the completion of key policy and sector studies that have pavedthe way for introduction of a National Water Policy and a drainage sector strategy for the country. Fourththe project improved the knowledge base by financing research, learning and international advice. Fifth,the project organized 223 farmer organizations covering an area of approximately 2 million hectares inwhich farmers are now responsible for the operation and maintenance of the irrigation system. Finally theproject provided the studies, technical discussions, and the general forum for the discussion of long-termoptions for the sustainable development of the Indus river basin and as a consequence has raisedawareness of the importance of sound environmental planning and management.

Pakistan: CAS Completion ReportPage 12 of30

Assessment/Lessons Learned

45. The mix of lending and non-lending activities for this pillar of the CAS was satisfactory andcontributed to the achievement of some of the outcomes sought. Policy dialogue and AAA weresuccessful in helping the government to refine and articulate its reform vision and contributed to the

adoption of a variety of measures. In particular, the use of development policy lending was well suited to

supporting the very wide range of reforms that the Government of Pakistan was trying to implement.

Development policy lending also provided financial incentives to undertake reforms and helped reformersadvance their agenda within Pakistan. In areas where results fell short of 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 of provincial responsibility and where the provinceshave adopted alternative approaches.

46. However, as noted by IEG with respect to the FY94-03 period, the range of activities in the ruralsector could have been broader. The Bank's agenda for rural growth was limited mainly to policydialogue on removing distortions in pricing trade and taxes (most of which had been removed by 2002)

and work on reforming the irrigation system. Consequently there was a lack of strategic focus onagriculture and therefore key constraints to agricultural growth were not addressed.

47. Exogenous factors played an important role in determining CAS outcomes. Drought conditionswhich prevailed during 2000-2002 reduced agricultural output while significantly worsening the financialsituation of 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 tocontinue to implement the oil pricing policy as originally envisioned.

48. Borrower performance in the Investment Climate pillar was generally satisfactory with a fewexceptions. The Government's reform program was high quality and had the attention and support of thePresident, Prime Minister (once in place) and Finance Minister. Significant achievements were made inimplementing reforms-particularly in the financial sector-and their impact in terms of increasedexports and investment is now apparent. However, it is likely that these early results are in large part theresult of the macroeconomic turnaround rather structural reforms. Further, second generation reforms,will be needed to maintain higher rates of growth and investment.

49. In some areas the pace of reform did not match the timelines envisioned in the CAS. This wasprincipally due to an overall slowdown following the elections of 2002 and the lengthy transitionthereafter. There were also delays in implementing investment projects, for example NDP. In some areas,particularly energy pricing, the Government found itself unable to carry out pricing measures that turnedout to be more politically difficult than anticipated. In addition, some of the assumptions behind thegovernment's reform program (for example with respect to reducing technical losses in the power sector)proved unrealistic. Nevertheless, in view of the accomplishments, the summary judgment is thatborrower performance was satisfactory.

SUPPORTING PRO-POOR AND PRO-GENDER EQUITY POLICIES

50. This pillar of the CAS reflected two elements of the I-PRSP and later the PRSP: (i) investing inhuman capital, and (ii) targeting the poor and the vulnerable. Recognizing the urgency of addressing thechallenge posed by Pakistan's lagging social indicators, the I-PRSP outlined a strategy for improvingdelivery of health and education services through a combination of additional expenditure and improvedgovernance to increase the effectiveness of social sector spending. The PRSP maintained this emphasis,

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noting that without considerable improvement in social indicators, including for women, Pakistan will beunable to sustain growth and poverty reduction. Since health and education are primarily sub-nationalconcerns, with the bulk of expenditure taking place at lower levels of government, the GoP's devolutionstrategy represented the core policy action to address weaknesses in governance and improve theeffectiveness of spending. At the same time, the provincial governments implemented other measures tostrengthen management while scaling up promising approaches in health and education.

51. The Bank's strategy in Education was to support implementation of the Government's EducationSector Reform (ESR) program which was designed to improve access to and quality of education throughinvestments in: (i) infrastructure; (ii) curriculum and textbook revision; (iii) teacher training; and (iv)establishment of a national education assessment system. The CAS aimed at a few intermediate outcomesincluding meeting the I-PRSP targets for increased expenditure on education, successful transition todistrict based delivery of education, and launching of the National Education Assessment System(NEAS), a sample-based national assessment of student learning, with standardized tests conducted at

grades 4 and 8. The CAS indicated that these intermediate outcomes were intended to move Pakistantoward the MDG goal of universal primary education by 2015 with a goal of reducing the gender gaps inprimary and secondary education by 2005. The latter goal was not met and no intermediate target was setfor primary education outcomes.

52. The Bank program targeted both the federal and provincial governments recognizing theirrespective roles and responsibilities. At the federal level, engagement focused on supporting increasededucation expenditure in line with the I-PRSP and launching of the NEAS. Initially, the broad-basedprovincial DPLs in NWFP and Sindh were key instruments to support the provinces' education reformprograms by opening up fiscal space at the provincial level to increase financing while supporting theimplementation of reforms. However, the CAS also envisioned a more targeted instrument in the form ofsector adjustment lending. This took the form of the Punjab Education Reform DPC, the first in a seriesof one-tranche education DPCs which was delivered in FY04 and which also supported devolution bystrengthening incentives for improved service delivery at the local government level. A second credit wasapproved in FY05. The Northern Education project (approved in FY98) closed in FY04. The AAAprogram in support of education included a study of public and private partnerships in education and anMDG assessment, outlining the critical constraints and strategies for achieving the MDGs in Pakistan.

53. The CAS outcomes targeted for education were partly achieved. Financing for education hasincreased in line with I-PRSP targets with consolidated federal and provincial education spending risingfrom 1.5 percent of GDP in FY2001/02 to 1.8 percent of GDP in FY2003/04. The FY05 education sectorallocations in the budget are consistent with the PRSP targets at 2.1% of GDP. The NEAS initiative waslaunched with Bank support in the form of a TA loan approved in FY03 and pilot testing of Grade 4students in Language and Mathematics was conducted throughout the country in April 2004, althoughoverall the NEAS project is behind schedule.

54. At the provincial level, reforms have moved forward at different speeds in the various provinces.In Sindh and NWFP a variety of education initiatives were supported through the provincial DPCs.Despite delays in follow-on rounds of these loans, budget allocations for education have been increased,additional teachers recruited, facilities rationalized and enrolments have increased. In Punjab, mosttargets under the education reform program have been exceeded. Education spending in FY04 was in linewith program targets and the FY05 budget projects a further 15% increase. Free textbooks weredistributed on time to 90% of primary school students and approximately 175,000 girls have receivedregular installment of monthly stipends to encourage retention and to increase enrolments in elementarygrades. Preliminary school census data suggests significant increases in enrollments during the first yearof the program.

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55. Pakistan continues to make progress in improving key health and population outcomes, but thepace of progress has been slow. The health status of Pakistan's population remains well below countriesin the region with similar or lower levels of income. The fertility rate remains much higher than its SouthAsian neighbors and a serious impediment to sustained economic growth. The PRSP recognizes the needto further increase financing and enhance the efficiency of spending and calls for the doubling ofresources for the health sector over the next three years. The Government's priorities in health are tostrengthen public health programs-immunization, communicable diseases, maternal and child health and

family planning-while improving the quality of care at district and sub-district hospitals.

56. The CAS outcomes related to health included strengthening of key public health programsincluding Lady Health Workers, tuberculosis control, the Expanded Program of Immunization, polioeradication, malaria control, HIV/AIDS, and family planning and reproductive health. In line with theI-PRSP, increased expenditure on health was targeted along with an increased share of non-salaryexpenditures. Indicators to measure improved service delivery included increases in the percent of birthsattended by trained providers, access to Lady Health Workers, coverage of pre-natal care, contraceptiveprevalence, and immunization coverage. Country outcome indicators for reductions in infant and childmortality 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 ofdevelopment policy and investment lending as well as AAA. Both SAC II and PRSC I included actionsrelated to increasing expenditure on health while implementing reforms to increase the effectiveness ofspending, including expanding service delivery through NGOs and developing demand side interventions.Similarly, the provincial DPLs in Sindh and NWFP targeted increased health spending and improvedmanagement of health care facilities. An HIV/AIDS project was approved in FY03. Under an innovativepartnership with the Gates Foundation, an IDA credit of $20 million was approved in FY03 to financepolio vaccine procurement for use in subsequent rounds of vaccination aimed at eradicating polio inPakistan by 2005. Supplemental funding of $21 million was approved in FY05. AAA instrumentsincluded the MDG Assessment and a report on the public health surveillance system to assist in thedevelopment and implementation of a Public Health Surveillance and Response System.

58. The CAS outcomes targeted in the area of health were only partly achieved. Public healthexpenditures have increased, but not as rapidly as foreseen in the PRSP. Consolidated healthexpenditures have increased by 18% from Rs 22.4 billion in FY03 to 26.6 billion in FY04. However, as apercentage of GDP expenditures (using old GDP numbers) are estimated to have increased from 0.56% inFY03 to 0.59% in FY04, well short of the target of at least 0.7% of the GDP set in the PRSP.Strengthening of the immunization program for children has been launched and immunization coveragefor children has increased from 49 percent in (1998/99) to 77 percent in (2004/05). Good progress wasmade towards polio eradication through supplemental immunization campaigns with the number of poliocases decreasing from 119 in 2001 to 53 in 2004. In 2005, only nineteen cases were reported throughSeptember. Pakistan has made significant progress in expanding TB DOTS program to 93% of thepopulation with treatment success rate of 78%. However, the TB case detection rate is only 43%,indicating the need for enhancing demand for services. The Lady Health Workers (LHW) Program hasbeen expanded to 92,000 LHWs, covering 56% of the population against a target of 70% mainly in ruralareas. It is apparent that the program is having an effect on some important indicators but there is stillsignificant room for improvement in many important areas, such as immunization and family planning.The national HIV/AIDS control program was launched in 2004. The Government has started to contractNGO to provide services to vulnerable populations; however the process has experienced delay.

59. Pro-Poor Targeted Programs. Targeting the poor and the vulnerable was an integral pillar of theI-PRSP and remains so in the full PRSP. The government's strategy was based primarily on expansion ofsafety net programs such as microfinance, public works programs, and transfer programs like Zakat and

Pakistan: CAS Completion ReportPage 15 of 30

food support. The PRSP recognized the need to improve the targeting and delivery of these cash and

in-kind benefit and other poverty alleviation programs in order to increase their coverage and reduce the

leakage of 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 of the rural asset base. No

specific indicators were identified for assessing progress in achieving these outcomes.

60. The CAS focused the Bank's role in this area toward a strategy of directly targeting rural povertythrough rural community-based infrastructure projects and micro-credit, building on approaches which

had been introduced in the previous CAS. At the same time, SAC II and PRSC I supported measures to

scale up and strengthen existing safety net programs. The NWFP Community Infrastructure Project was

underway at the time the CAS was prepared and a follow-on project was approved in FY04. The AJKCommunity Infrastructure Project (CIP) was approved in early FY03. Similarly, the Pakistan PovertyAlleviation Fund project was underway and a $238 million credit was approved in FY04 to extendadditional support to this highly successful project which supports NGO-implemented infrastructure andmicro-credit schemes. To help the government develop a strategy for strengthening safety net programs,the Bank prepared a detailed study of existing programs proposing reforms to improve their effectivenessand targeting, as well as enhancing the monitoring and evaluation of programs.

61. The outcomes in this area of the CAS are being achieved, though in some cases more slowly thananticipated. To date, the PPAF has surpassed most project targets and its poverty reduction programshave helped more than 2 million poor in all four provinces, extending loans to 122 thousand clients withan estimated average recovery rate of around 95 percent. Implementation of CIP projects has progressed

somewhat more slowly than planned. The government has formed a Social Protection Working Group todiscuss the progress of the work on social safety net reform in Pakistan.

62. The Bank assistance program in this pillar of the CAS reflected the trade-offs inherent in trying to

improve delivery of social services in Pakistan in the context of devolution. The use of developmentpolicy 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 supportingsector reforms. The more focused approach of 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 of high-level commitment and ownership were also at work. Inretrospect, greater use of TA to complement development policy lending might have been useful to helpthe authorities, especially at the provincial and local level to implement and monitor reforms adoptedunder the SACs. More in-depth analytical work at the provincial level might also have been helpful tostrengthen the provincial reform programs. With completion of the Punjab Economic Report in FY04,and initiation of Economic Reports for Sindh and NWFP in FY05, this need is now being addressed.

63. Borrower performance under this pillar of the CAS was hampered by shifting responsibilities andcapacity constraints. Specifically, provincial governments need to strengthen their policy formulationcapabilities to ensure that well crafted departmental policy proposals, together with their financialimplications are submitted for cabinet review and discussion during budget formulation. Similarly, theongoing transition to district based service delivery has been accompanied by some hiccups such asdelayed release of funds to districts. Some investment projects including HIV/AIDS, NEAS, andcommunity infrastructure projects have experienced slow or delayed implementation.

SUMMARY ASSESSMENT OF CAS PERFORMANCE

64. During the FYO3-05 period, the Bank program in Pakistan was for the most part successful in

either achieving or making substantial progress toward the achievement of the outcomes set in the CAS.

Pakistan: CAS Completion ReportPage 16 of 30

As described above and in summary table in Annex 1, many of the intermediate outcomes representingmilestones in implementation of the reform program were met. While a number of outcomes were notmet, the underlying reform programs are in place and government commitment appears strong, even if the

pace of reform has not been as rapid as envisioned in the CAS. To the extent that data is available, finaloutcome indicators show some promising trends toward improvement.

65. Sustainability. The sustainability of the CAS outcomes is likely, although Pakistan's longer-termtrack record as an intermittent reformer suggests that this cannot be taken for granted. The CAS is well

aligned with Pakistan's own reform agenda and continued commitment to the reform program appearslikely. President's Musharraf's tenure in office will continue until at least 2007. The Prime Minister, Mr.Aziz, is a strong reformer. There is a high level of support from the international community. Despiteoccasional slowdowns, the government has shown the ability to sustain reforms in the face of significantchallenges and political pressures.

66. Institutional impact. Bank assistance under the 2002 CAS has contributed to institutionaldevelopment but this is an area where additional attention is needed. Key government institutions weretargeted for modernization including the Central Board of Revenue, State Bank of Pakistan, ControllerGeneral, Auditor General, regulatory bodies, and key economic ministries. Capacity building assistancehas been provided through investment lending and most have demonstrated improved performance.However, as observed in the CAE, institutional capacity is a widespread concern. Recognizing thatinstitutional development and capacity building represent a cross-cutting challenge for Pakistan, a PublicSector Capacity Building Project was developed and approved in FY04 to support institutionaldevelopment and capacity building in key ministries and regulatory bodies.

C. Measuring Bank Performance

Quality of Products and Services

67. IEG's FYO3-05 performance ratings for Pakistan show that of the eleven projects that exitedduring the CAS period which were reviewed by IEG, one had a highly satisfactory outcome, four hadsatisfactory outcomes, three had moderately satisfactory outcomes, two had moderately unsatisfactoryoutcomes and one was rated unsatisfactory (see Table 3, page 20). The latter project, the highlyambitious Social Action Program project, approved in FY1998, was the subject of an intensive learningImplementation Completion Report (ICR) which identified key lessons which are being used to guide theformulation of future Bank interventions in the social sectors.3 A QAG panel carried out a Quality atEntry Assessment for the FY03 Sindh Structural Adjustment Credit. The panel rated the operationsatisfactory overall, citing specific aspects as highly satisfactory including implementation arrangements,the degree of borrower ownership during preparation, and the quality of the Task Team. The panel alsogave a rating of Satisfactory for Bank inputs and processes

68. In early FY04, the Quality Assurance Group (QAG) carried out a Country AAA Assessment forPakistan. The report assessed the quality of a sample of AAA products from FY01-03 as well as theoverall AAA program within the context of the strategic framework. While part of the sample related towork undertaken prior to the FYO3-05 CAS, several FY03 tasks were evaluated and the overallconclusions are applicable to this completion report. Overall, QAG found the Pakistan AAA program tobe satisfactory. Of the sample reviewed, four tasks were completed during the CAS period and of thesetwo were rated highly satisfactory and two were rated satisfactory. However, QAG also noted the strongemphasis of 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, Report No: 26216, June 25, 2003.

Pakistan: CAS Completion ReportPage 17 of 30

the sub-national level. QAG also found that greater attention is needed in the areas of dialogue and

dissemination in order to increase the impact of the AAA program.

69. Portfolio Performance. The World Bank's active portfolio in Pakistan, on June 30, 2005,comprised 16 projects with loans/credits amounting to $990 million (net of cancellation). Also included

in the portfolio are two Grant projects-GEF- Protected Areas Management ($10 million); and the

Montreal Protocol Phase-Out of Ozone Depleting Substances ($13 million). About $561 million remained

undisbursed. The disbursement ratio remained well above the target of 18 percent throughout the CASperiod (see Table 2).4

Table 2: Portfolio IndicatorsActual Performance

Indicator FY02 FY03 FY04 FY05

Number of Projects 12 15 18 16

Projects at Risk (%) 8.3 6.7 5.6 11.8

Commitments at 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

Disbursement Ratio 67.1 28.0 24.7 40.6

70. Portfolio Management. The portfolio has grown somewhat over the CAS period after reaching alow at the end of FY 02 (the beginning of the CAS). The earlier reduction reflected the results of an

aggressive portfolio improvement program under which 32 projects were closed. This trend has sincebeen reversed as lending has picked up although the substantial proportion of single tranche developmentpolicy credits in the program (about one-third of the operations approved during the CAS period) hasmeant that the size of the portfolio has grown only modestly. Portfolio management has continued to

emphasize good "quality at entry" and close collaboration with the Government of Pakistan to ensure

project readiness and adequate management attention to emerging issues. To avoid delays in project start-

up, new projects have been subjected to 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 of project teams (50percent of projects in the active portfolio are managed in the country office) and decentralization of many

of the regional core services functions to Pakistan and regional hubs in the South Asia region.

71. Despite these efforts, a number of portfolio issues have begun to reemerge. Several projects inthe current portfolio are slow moving and facing implementation issues; most of 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 specificimplementation issues, key generic factors contributing to slow implementation include lack of adequatestaff and funds for start-up activities, delays in obtaining routine clearances for loan negotiation/signingas well as opening of accounts, and delays in initiating the procurement process. These issues are beingaddressed intensively with the GoP in order to prevent a deterioration in portfolio performance. As itrelates to Bank performance, these findings indicate that there is room for improvement on the part ofBank teams in developing simpler, more readily "implementable" projects with realistic timetables thatreflect the time consuming nature of institutional reforms and decentralized approaches.

4 Disbursement ratio represents disbursements as a percentage of undisbursed balances at the beginning of the fiscal

year, for investment lending only.

Pakistan: CAS Completion ReportPage 18 of 30

72. There is also a need to improve the results focus of the portfolio. The Bank recently undertook anMonitoring and Evaluation (M&E) Review of (i) its on-going portfolio; and (ii) Government systems forproject M&E. The report found that due to weak M&E systems and inadequate capacity within GoP and

implementing agencies, there is limited focus on monitoring of outcomes and results in many projects. Atthe same time, Bank teams need to do a better job of focusing on developing project-level results andindicators and incorporating the monitoring of these results into the supervision process.

Country Dialogue and Aid Coordination

73. The Government has taken the lead in donor coordination under the leadership of the EconomicAffairs Division (EAD), under the Ministry of Finance, which is responsible for development assistancecoordination. Donor meetings resumed in 2001 and the Pakistan Development Forum (PDF) has beenheld on an annual basis since then, with all but one meeting taking place in Islamabad. Civil society andprivate 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 sharinginformation and facilitating partnerships among donors and the GoP.

74. These efforts have been paying off as external partners have been increasingly aligning theirstrategies to the PRSP and making greater use of cooperative approaches in their assistance programs.For example, the UK and the US have begun to align their budget support with the Bank's PRSCs. Inaddition, the Bank has undertaken more joint analytical work in partnership with the Government andother donors. In 2003 the World Bank, DFID, and ADB completed jointly a CFAA. Two economicreports-- the Devolution in Pakistan (District Assessment) Report and the Punjab Economic Report-- wereprepared as joint products of the World Bank, ADB, and DFID. The upcoming NWFP Economic Reportis being prepared in collaboration with DFID and the Sindh Economic Report is being prepared incollaboration with the ADB. Nevertheless, IEG found that a number of donors expressed dissatisfactionwith their interactions with the Bank. Among issues raised were inadequate consultation; lack ofcontinuity of Bank staff interacting with donors; intermittent participation of senior staff at donormeetings; and poor information flow to donors and NGOs.

75. There are now strong efforts to harmonize with country systems, with a large percentage ofdevelopment assistance disbursed as budget support once a year following the approval of the nationalbudget. There have been efforts to improve the procurement and financial management systems of someline ministries and at the provincial level. A comparison between the World Bank's and ADBprocurement rules was undertaken in 2004 as part of the harmonization exercise and as a result,harmonized procurement documents are available for use. A similar exercise is underway in the area offinancial management. In addition, external partners have agreed to put together a joint "Portfolio IssuesPaper" focused on key generic portfolio management issues faced by externally financed projects, fordiscussion 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 lessonslearned and recommendations for the next CAS.

* Projects should be as simple and realistic as possible. The experience of a number of projectsthat closed during the CAS, especially the multi-province umbrella projects, highlights the needfor focused projects that are readily "implement-able" with realistic schedules and clearownership. In particular, governance reforms often took longer than planned. In the context ofdevelopment policy lending, there is a need to guard against over-optimism as the difficulty of

Pakistan: CAS Completion ReportPage 19 of 30

implementing reforms, especially those with wide impact and high visibility was at timesunderestimated.

* The CAS program should give greater emphasis to capacity building. The CAE and a number of

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, building on the Public Sector Capacity Building Project approved in FY04. Civil servicereform 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 given those constraints.

* A programmatic approach provides the flexibility to support reforms while managing risk. The

use of annual single tranche adjustment operations at both the provincial and national level helpedto 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 Banklending program.

* The program needs to continue to strengthen its focus on results. To address weak M&E systems

and capacity within GoP and implementing agencies, the Bank needs to support the strengtheningof statistical capacity and monitoring and evaluation as part of institution strengthening. At thesame time, the Bank needs to do a better job of focusing on developing solid project-level resultsand indicators and incorporating the monitoring of these results into the supervision process. Theresults-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 of the overall country

program with the Government.

Pakistan: CAS Completion ReportPage 20 of 30

Table 3: Projects Closed During the CAS Period

ICR Rating for: IEG Rating for:

Closing Approval Institutional Institutional

Date FY Outcome Dev Sustainability Outcome Dev Sustainabili

Social Action Program 11 Jun-02 1998 U M L Unsatisfactory Modest Non-Evaluable

Moderately

Structural Adjustment Credit II Dec-02 2002 S M L Satisfactory Modest Likely

Moderately

Sindh Structural Adjustment Credit Dec-02 2003 S M L Unsatisfactory Modest Unlikely

Moderately

NWFP Structural Adjustment Credit Dec-02 2003 S M L Satisfactory Modest Likely

Telecom Regulation & Privatization Jun-03 1996 S M L Satisfactory Modest Likely

Moderately

NWFP Community Infrastructure June-03 1996 S SU L Unsatisfactory Modest Unlikely

Northern Education Sep-03 1998 S SU L Satisfactory Substantial Likely

Moderately

Ghazi Barotha Hydropower Project Oct-03 1996 S M L Satisfactory Modest Likely

Punjab Education Sector Adjustment Credit Sep-04 2004 S SU L Satisfactory Substantial Likely

National Drainage Program Dec-04 1998 ## -- -- --

Highly

Poverty Alleviation Fund Dec-04 1999 S SU L Satisfactory Substantial Likely

Banking Sector Restructuring and Privatization Dec-04 2002 HS # HL Satisfactory Substantial Likely

Pakistan PRSC I Dec-04 2005 S L M -- -- --

NWFP SAC II Dec-04 2004 S M L -- -- --

Improving Financial Reporting and Auditing May-05 1997 S SU L

HS=Highly Satisfactory, MS=Moderately Satisfactory, S=Satisfactory, MAS=Marginally Satisfactory, MS=Marginally Unsatisfactory, MU=Moderately Unsatisfactory,

U=Unsatisfactory; HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High; SU=Substantial, P=Partial, N=Negligible,

NRT=Not Rated, UNC=Uncertain

Pakistan: CAS Completion ReportPage 21 of30

ANNEX A: PAKISTAN COUNTRY PROGRAM RESULTS MATRIX (FYO3-05)

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicators

Macroeconomic Stability

Despite good macroeconomic Macroeconomic Stability as Achieved; external balances have met or exceeded PRF PRGF successfully concluded with quantitative targets met

management, the external and demonstrated by achieving targets trom targets, inflation remains subdued and foreign exchange Economic growth has continued to accelerate and external

domestic public debt are both I-PRSP for fiscal consolidation, reserves have risen to a comfortable level and domestic imbalances have been brought to sustainable

quite large and hence there are domestic savings, debt levels. However inflationary pressures have grown

still concerns over the fragility ofthe external position and future Tax1GDP ratio has risen from 12.9% in FY01 to 13.6% in Limited progress overall. FY03104 Tax1GDP ratio was 13.6%,

growth prospects. The o Higher Tax/GDP ratio FY03. FY04105 programmed at 13.8% ("old" GDP).

September 11 shock has alsoincreased the risks to thebalance of payment position by e Reduced Fiscal DeficitYGDP Fiscal deficit (excluding grants) declined from 6.7% to 4.5% FY03104 fiscal deficit 4. 0% of GDP,- FY04105 fiscal deficit was

making more uncertain an early of GDP. 4.1% of GOP which is broadly consistent with the PRSP fiscal

resumption of long-term private framework.

capital inflows as well asincreased access to * Sustainable current account deficits > Achieved; FY03 current account surplus of 4,4% of GDP. Achieved. FY03u04 current account balance was 1.4 percent

international capital markets of GDP surplus; FY0405 balance was -1.e6%

* Provinces fiscal space restored Provinces have expanded own revenue collection while Provinces, particularly NWFP and Punjab have substantially

using donor resources to re-profile debt and reduce interest increased fiscal space through debt management andcosts. The upcoming National Finance Commission Award increased revenue collection. However inability to reach

is expected to include a substantial increase in the agreement on NFC award leaves provinces' share of

provinces' share in overall revenue, resources unresolved and makes sustainability uncertain.

SContinued tight management of )o> Evident in primary surplus and progress in debt reduction. External government debt has fallen from 35% of GOP in

external borrowing Pre-payment of high cost debt and increased reliance on 2002/003 to 28.2%% in 20042005. New external borrowing

concessional financing have reduced interest expenses has been weighted toward official sources on soft terms.

from 37% to 31% of government expenditure. A4DebtPolicy Coordination Office has been established to sustainimplementation of strict controls.

c Sound financial position of WACDA While there has been some progress in sector restructuringthis has yet to result in a significant improvement in WAP Afinances

Pakistan: CAS Completion ReportPage 22 of 30

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicators

Restoring the Integrity andAccountability of StateInstitution

*At the core af the poor *Improvement in government >Difficult to assess comprehensively, but promising steps in Reforms ate still being developed. Further rest ructutingan

governance problem in effectiveness at federal, provincial, and civil service reform and in key reforming agencies apparent. pay/pension reforms are being developed to improve

Pakistan is the leadership's district levels efficiency and support devolution

abuse of state institutions,widespread corruption, and Transparent budgetary processes and MTBF is still in a pilot phase with expansion to cover the entire

disregard for the separation improvement in overall quality of federal budget not expected until 2010/2011

of powers and respect for the financial management thru the MTBF

rule of law"Improved public sector, accounting, Substantial progress. Expenditure reconciliation increased Though less than planned, there was substantial progress in

auditing, and reporting capacity, to 99% in FY03 Modernized chart of accounts and introducing modernized systems under PIFRA I (closed in

automated accounting system being introduced, though at FY05), laying the groundwork for further improvement under

a slower pace than envisioned. Timeliness and quality of PIFRA (FY06). About 40 percent of financial and fiscal

audits improving. transactions of government expenditures are covered byPIFRA-modernized systems.

* Promulgation of a ProcurementOrdinance National Procurement Progress has been slow. GoP has created a procurement Government notified new procurement rules conforming to

Authority established regulatory authority (the PPRA), but is still in the process of international best practice in 2004. However, implementingpreparing revised guidelines. The NWFP government has regulations, monitoring systems and enforcement

approved a modern procurement ordinance and is in the mechanisms remain to be established

process of issuing regulations to implement it,

* Improved CBR performance Functional reorganization of CBR underway. Pilot Large Progress continues to be satisfactory. Additional Large and

and Medium Taxpayer units functioning with improved Medium Taxpayer units have been established. Tax

customer satisfaction ratings. Administration Reform Project approved in FY05

* Ad-hoc Public Accounts Committees(PACs) have cadt botte o Limited progress. Ad-hoc PACs reduced, but did not The Federal PAC has now been established along with theFedAs hand Pcal levelsh the eliminate the backlog. These have now been disbanded to Provincial PACs. It has made good progress in reviewing auditFederal ofit Repors tye be replaced by regular PACs under the auspices of elected reports and tracking and monitoring cash recoveries from

reviewed ofAndi taeaport follow- national and provincial assemblies. However, while the public officials. It is still devising a strategy for addressing theacion provincial governments have reconstituted PACs, the backlog of audit reports with capacity building assistance

up ifederal govement has yet to constitute its PAC. The new under an F grant and with WI support. The backlog is due

PACs will need time to address the remaining backlog of in part to the poor quality of the audit reports resulting in a

reports. very heavy volume of audit findings

accutabrilit tro Freel se Proceedings of the ad-hoc federal and provincial PACs See above on functioning of PACs. Federal PAC proceedings

Iccunformaiit, etih futo of te were open to the public. Phase 1M CFAA was published in are open to the public and a Freedom of InformationPublrmtic n, Ac ctve omm ies, ofthe December 2003; implementation plan is being developed. Ordinance was enacted in October 2002 and implementingPubic Agreement s the NAB organization and legal basis are under review rules were passed in June 2004. The Ordinance provides a

automated acontn syste beingn inroucd thugea

Pakistan: CAS Completion ReportPage 23 of'30

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicatorsoutcomes of the second phase of the legal right to access public records. NAB organization and

CFAA, and the establishment of a legal basis are still under review.

lasting institutional basis for theNational Accountability Bureau.

* Better performance evaluation, merit-based promotions, and training > Reforms in the promotion system have been introduced to Government has appointed a Pay and Pensions Committee to

programs, as well as the make evaluations more objective, increase transparency in develop recommendations to reform civil service

implementation of the reforms of the promotion, and to link promotion to higher grades to compensation. Its recommendations were issued in 2005.

pay and pension systems required training. Two rounds of pay increase have been Civil service training is being revamped under the Public

implemented but pay scales remain highly compressed. Sector Capacity Building Project.

Strengthening the EnablingInvestment Climatea Heavy burden of tax *Low tax and regulation compliance >Investment Climate Survey carried out and results According to the 2005 Doing Business indicators, the cost to

administration and regulation, costs Lower compliance costs reported disseminated through workshops. Business registration start a business fell from 70 percent of gross per capita

and related corruption in business environment surveys, procedures reformed, cutting the time for business start-up income in 2002 to 47 percent in 2003 and further to 36 percentin half, from 53 to 24 days. The GoSindh has streamlined in 2004. Government is in the process of revising labor

* Unstable, distorted industrial business inspections from 23 to 7, with all to be done on legislation to improve labor market flexibility and reduce

policies one day. discretion of government inspectors. Administrative Barriers to

* Anti-export policy bias investment study has been completed, identifying turther

* limited availability of financing actions.

from weak financial sector tothe particular disadvantage of * Increased availability of domestic Credit to private sector increased from 107 Rs.B (July02-

the SME sector financing for private investment Mar03) to 362 Rs B (JulyO43-AprO5)

a High regulatory and policyrisks for private investment in 9 Greater private provision of ptne n orderlto

extractive industries and infrastructure regulatory framework for public-private

infrastructure encourage greater private provision of infrastructure. These

* Development of extractive industries efforts are starting.

* Lower levels of effective protection Good progress in streamlining tariff schedule and reducing Pakistan continues to liberalize the trade regime. Thebarriers to trade. The simple average tariff rate declined 2004/05 budget reduced tariffs on capital goods and loweredfrom 51 percent in 1995 to 17 percent in 2004. Numerous the average customs duty to 14.9%.quantitative restrictions, regulatory duties and other para-tariffs eliminated. Statutory regulatory orders and relatedexemptions also reduced.

* Higher FDl > FD remains low, but is increasing, rising to $800 million in FD grew by 60% in FY05 to reach $1.5 billion

FY03, vs. $485 million in FY02.

Pakistan: CAS Completion ReportPage 24 of 30

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicators* Higher exports : Exports grew 19 percent in 2003. Continued strong growth; Pakistan's exports reached $ 14.4

billion in FY05, growing by 15.9 percent over the FY04.

* Higher private investment > Private investment has started to increase, but remains low Investment has risen, but further improvements in

by historical standards. microeconomic fundamentals are needed to encourageadditional increases in investment.

* Increase in output and employment in > Data not yet available. SME sector contributed 30% to GDP and generated 25% of

SMEs manufacturing sector export earnings.

* WAPDA corporatization completed > Corporatization complete "on paper" by end December Further progress achieved. NEPRA has issued cost reflective

2003, but this has not yet resulted in managerial and tariff determinations, however notification is still pending and

financial independence needed to give the newly formed the newly independent entities have not yet been made

entities the incentives to improve service financially autonomous.

* Effective regulation thru NEPRA > Performance of NEPRA (the power regulator) continues to Difficulties in completing the tariff determination process

improve as reflected in the timeliness and quality of tariff indicate that NEPRA needs further strengthening to fully

determinations and support to the corporatization and assume its role.privatization processes through the timely issuance ofoperating licenses.

* KESC Privatized > Not done. Brought to point of sale but limited investor Met. Kanooz Al-Watan of Saudi Arabia/ Siemens consortium

interest prevented sale. successfully bid to acquire 73% of shares in early 2005

e Rehabilitated highways, improved NHA > Bank supported Highways Rehabilitation Project underway. Highways Rehab project is progressing satisfactorily. Trade

financial management, and improved Improvements in NHA financial management include facilitation reform has not yet streamlined the systems; it still

trade facilitatnion. adoption of Medium-Term Budgetary Framework and takes an average of 17 days to clear an import container

operation of a Road Maintenance Fund to help ensure through customs.sustainable delivery of a productive and efficient nationalhighway network. IDA supported Trade and TransportFacilitation program under implementation.

Accelerate Rural Growth Acceerat Rual Gowt e HgherRurl GrwthRural growth increased from -0.1 % in FY01 to 4.2%. Average* Skewed land distribution and * Higher Rural Growth" Skwedlanddisribuionandfor GAS period is projected to be 4.3% vs. -0/9% for previous

low agricultural productivity GAS period, due mainly to drought

* Weak link between ruralgrowth and reduction of rural * Improved efficiency of institutions in Irrigation and drainage infrastructure remains underdeveloped

poverty irrigation and drainagerelative to Pakistan's needs and water markets are

Smrv dainxagdedirgtoan undeveloped. Additional water storage capacity is also* Improved and expanded irrigation and__________________Irrigationan drainage infrastructure neemainsficincyderdevelopedslow

Pakistan: CAS Completion ReportPage 25 of 30

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicators

* Strengthened community/farmer Community/farmer organizations have been strengthened in

organizations some areas. Overall institutional reforms are still in earlystages, and advancing in select areas.

* Full implementation of institutional and > Irrigation reforms in the Nara Canal are well advanced. Institutional reforms have been fully put in place and physical

physical rehabilitation reform in 1 major rehabilitation begun. These efforts will be deepened and

canal command (Nara Canal). expanded in the follow-on Sindh Water Sector ImprovementProject

* Improved land and water markets > Reforms in water markets are advancing in a limited area Institutional reforms in water management are being extendedand will need to be implemented more broadly to increase and deepened in Sindh while similar reforms have begun inefficiency of water use. Land markets reforms in initial Punjab. The Bank is supporting improvements in land

stages registration systems to improve land market functioning.

* Reduced vulnerability to drought. > Some progress through DERA project implementation Improved hazard risk management being pursued

* Update knowledge on rural > Rural Factor Markets Study underway Rural Factor Markets Study completed. Rural DPR underway

development

* Devolution and Delivery of Rural > Too early for comprehensive assessment Rural services The legal framework and administrative structures for

Services devolved, but transitional issues are affecting delivery. devolved delivery of rural services are in place but funding andNWFP CIP/l project will support rural service delivery while administrative capacity are lacking at the local governmentaddressing local government capacity. level and links between local governments and communities

need to be strengthened.

Education

* Education service delivery mproved access to, quality of, and Primary net enrolment reported to have reached 60 percent in

system in crisis equity in primary education, moving 2004 vs. 43% in 2001/02. Nevertheless, it appears unlikelytowards the MDG goal of universal that the country will achieve the MDG of full primary

* Low enrollment, poor primary enrollment by 2015 completion by 2015.achievements, poor quality ofeducation Closing of the gender gap in primary Female enrolment as a percent of male enrolment rose from

* Very poor governance and secondary education by 2005 79% to 85% from 2001/02 to 2004. With sustained efforts it ispossible to eliminate gender disparities in primary enrolmentsby 2007

* Implementation of Education Reform The federal ESR program is under imp/ementation and itsStrategy elements are reflected in the full PRSP and in the federal

Pakistan: CAS Completion Report

Page 26 of 30

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicatorsbudget. A remaining challenge is to ensure that ESRpriorities are fully reflected in provincial and local educationprograms.

* Development of a reliable monitoring > Largely achieved with poverty outcomes monitored through The first results from the CWIQ Survey were released in

system for HD outcomes. strengthened Pakistan Integrated Household Survey. December 2005 and the results of a full household survey areIntermediate outcomes are monitored through a CWIQ expected in 2006survey. Full PRSP outlines comprehensive monitoringsystem under Federal PRSP Secretariat.

* Successful implementation of district > Under devolution districts have assumed responsibility for National and provincial governments' sector reforms are

based delivery of education services delivery of education but more work is needed to increasingly aligned to the devolved delivery system.strengthen their capacity and ensure their fiscal andadministrative autonomy in order to fulfill their role.

* Improved governance in social service Too early to tell. Some promising early signs of improveddelivery governance resulting from provincial education reforms

under devolution, but comprehensive assessment is not yetpossible.

Health, Nutrition andPopulation

* Low public spending and poor * Country Outcomes in the IPRSP, tobe MR has decreased from 83 per 1000 live births to 76 per

value for money because of achieved by 2003-04 include: to reduce 1000 live births in 2003 (Pakistan Demographic Survey) TFR

governance and management the MR to 65/1000, to reduce child of 4.1 meets I-PRSP target; MR target likely not metweaknesses mortality to 17/1000, to reduce the TFR

to 4.1 children per woman, The I-PRSP* Weak capacity in the public also sets targets in terms of improved

sector for policy formulation, coverage of water and sanitation,programming,implementation, and M&E

" Poor quality of private health 0 Strengthened and expanded key public Increased resources have been provided for each of these The programs have been strengthened and expanded

care services and consumer health programs, including Lady Health programs. Progress mixed with LHW, Polio and TB Dots although overall spending has increased by less than planned.

abuse Workers, TB-Dots, EPI, polio making significant progress and immunization program

eradication, malaria, HIcVAIDS, and showing modestly positive results, although significant* Important factors outside the family planning/reproductive health. challenges remain.

health sector include poverty,lack of education especially of - Increase in the % of births attended by >Likely to be achieved, FY01102 actual was 24% increasing Achieved. Skilled birth attendance has increased to 31 %, upwomen, environmental trained providers to 25% by 2003-04 from baseline of 19% from 23% in 2001 and 18% in 1998factors, and manyhouseholds lacking access to * Increase in the % of fully immunized Modest progress; FY01102 coverage was 53%, rising from Immunization coverage reached 77% in 2004/05

safe water and sanitation children to 85% by 2003-04

Pakistan: CAS Completion ReportPage 27 of 30

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicators

* Increase in the coverage of prenatal > Modest progress; FYO1/02 coverage increased from 31% to Achieved. Pre-natal care coverage has increased to 50%care to 50% by 2003-04 35%.

* Increase in the % of population with > 56% of population has access to LHWs, increasing from Not met: 65% coverage achieved in FY003/04. The LHW

access to Lady Health Workers (LHWs) baseline of 40%. - target revised to 70% of population program continues to expand and improving access to PHCto 90% by 2003-04. targeting mainly rural population. Revised target likely to be and FP services as envisaged in the PRSP. The program has

achieved by end FY05. expanded to 92,000.

* Increase in the CPR to 39% by 2003- > Updated data since last CAS not yet available. (Projected Latest estimate: 32% in 2003

04 CPR estimated at 32%)

* Increase in public expenditure on > Increases achieved inline with 1-PRSP targets from 0.5% of Public health expenditures have increased, but not as rapidlyhealth and nutrition as a percentage of GDP to 0.6% of GDP. Further increases programmed as foreseen in the PRSP. Budget allocations have beenGDP. under full PRSP. increased, but utilization has lagged. While health

expenditures increased in nominal terms by on average 18%annually, as a percentage of GDP they grew only marginallyfrom 0.44% in FY02 to 0.48% in FY05.

* Increase in the share of non-salary > Data not yet available Data not yet available

expenditures in total government healthexpenditure

* Increase in the share of government > Data not yet available. Data not yet available

subsidy in health services accruing tothe poor

Pro-Poor Rural Infrastructureand Services and SocialProtection

* Very poor rural infrastructure * Community driven development of local Implementation of PPAF and Community Infrastructure

and social service delivery service provision Projects has resulted in improvements in project areas, but

systems there is a need to scale-up these efforts through enhanced

* High vulnerability of rural poorto idiosyncratic shocks

* Strengthened governance and > Comprehensive assessment not yet possible. Progress varies across provinces and sectors, but overall

improved delivery of basic Improvements in governance and service delivery at the there are signs of improvement.

infrastructure services at the local level, local government level are beginning to show, but further

Pakistan: CAS Completion ReportPage 28 of 30

CAS Strategic Objectives & Status at FY04 CAS Progress Report Update at end-CAS

Key issues/ Diagnostic Outcome Indicatorsprogress in adapting to the devolved local governmentframework is needed for widespread improvement.

* Rural asset base deepened through > Bank supported community infrastructure project (CIP)rural community-based infrastructure underway in AJK. Recently completed CIP in NWFPprojects and spread of micro-credit. delivered community infrastructure projects in 90

communities. PPAF project supported over 3,000 small-scale infrastructure projects in 2000+ villages.

Pro-Poor and Pro-Gender-Equity Policies

* Significant gender gaps in * National Resettlement Plan Policy > A Resettlement Ordinance has been prepared, but awaits No further progressboth literacy and health status action.

* Institutional and attitudinal * Resolution of outstanding Resettlement Satisfactory progress in addressing outstanding cases. Resettlement cases associated with Bank projects resolved

discrimination against women cases

* National Gender Policy > Government issued a National Policy for the Developmentand Empowerment of Women in 2002.

SChanges in Laws to promote gender > Electoral reservation system has been instituted, Changes in laws to promote gender equity have beenein dramatically expanding women's political participation. Little proposed, but not acted upon by Parliament

equity progress in amending discriminatory statutes.

Pakistan: CAS Completion ReportPage 29 of 30

Annex B: Pakistan - Planned Lending Program and Actual Deliveries

CAS Plans (May 15, 2002) Progress Report (March 26, 2004)S(M) Status $(

FY Project IBRD IDA IBRD IDA2002 Drought Emergency Recoverye 130.0 Actual 130.0

Banking Sector Restructuring/Privatization 300.0 Actual 300.0AJK Community Infrastructure 20.0 Forwarded to 2003Banking Sector TA 26.5 Forwarded to 2003Structural Adjustment Credit II 500.0 Actual 500.0Sindh Structural Adjustment Credit (SAC) 100.0 Forwarded to 2003

Total 947.0 Total 800.02003 AJK Community Infrastructure 20.0

Banking Sector TA 26.5Sindh SAC 100.0

NWFP Provincial Adjustment Credit 90 Actual 90.0Highways Rehabilitation 100 Forwarded to 2004 (now actual)HIV/AIDS Prevention 20 Actual 37.1National Education Assessment System 5 Actual 3.6Education Reform SAC 150 Forwarded to 2004fTax Administration Reform 100 Forwarded to 2005Provincial Adjustment Credits (Sindh, 110 NWFP forwarded to 2004 (now actual);NWFP) Sindh droppedEconomic Reform TA 25

Additional Actual Projects:Partnership for Polio Eradication 20.0

Total 600.0 Total 297.2

Progress Report (March 26, 2004) Completion Report$(MS M)

FY Project IBRD IDA Status IBRD IDA2004 Poverty Alleviation Fund II 238.0 Actual 238.0

Highways Rehabilitation 50.0 150.0 Actual 50.0 150.0Punjab Education Sector Reforms 100.0 Actual 100.0Public Sector Capacity Building TA 52.0 Actual 55.0Sindh On Farm Water Management 61.0 Actual 61.1NWFP Community Basic Infrastructure 37.0 Actual 37.1Poverty Reduction Support Credit 350.0 Forwarded to 2005

Additional Actual ProjectsNWFP SAC II 90.0

Total 50.0 988.0 Total 50.0 731.22005 PRSC I 300.0

Improving Financial Reporting and 80.0 Forwarded to 2006AuditingTax Administration Reform 100.0 Actual 24.4 78.5Balochistan Irrigation 25.0 Forwarded to 2006Infrastructure Development 100.0 Actual (Changed to Taunsa Barrage 130.0

Rehabilitation)Banking Sector Adjustment Credit 175.0 Actual 200.0 100.0Poverty Reduction Support Credit 175.0 Forwarded to 2006NWFP SAC II 90.0 Approved in 2004

Additional Actual ProjectsPartnership for Polio Eradication II 21.5Punjab Education Development II 100.0

Total 100.0 645.0 Total 354.4 600.0

Reallocation from already committed IDA resources - not counted as new commitments.Project changed to Punjab Education SAC

Pakistan: CAS Completion ReportPage 30 of 30

Annex C: Pakistan - Non-Lending Services: Planned and Actual Deliveries(FYO3-05)

FYO3-05 CAS Plans Status: CAS Progress ReportFY Product Type Status2003 Investment Climate Rpt Completed

Provincial Economic Reform Rpt Forwarded to FYO4-06Policy Note to New Government Pol CompletedJSA - PRSP Rpt CompletedCFAA II Rpt CompletedCPAR II Rpt DroppedOil & Gas Sector Review Rpt CompletedFinancial Sector Assessment Rpt Forwarded to FY04CAS Progress Report CAS Forwarded to FY04Public Expenditure Review Rpt CompletedRural Development Policy Review Rpt Forwarded to FY06Power Sector Review Rpt Forwarded to FY05Sindh Rural Development Policy Review Rpt DroppedSocial Risk Assessment Rpt Dropped

Additional Actual Products:

FYO4-05 CAS Progress Report2004 District Assessment/Devolution Rpt Completed

Punjab Economic Report Rpt CompletedPoverty Update Rpt CompletedTrade Policy Notes Pol CompletedRural Factor Markets Rpt CompletedPower Policy Notes Pol CompletedTextile & Clothing Policy Note Pol CompletedFinancial Sector Assessment Rpt CompletedUrban Development Non-Lending TA TA Forwarded to FY06Mineral Sector Development Pol Ongoing

2005 Water Sector Strategy Rpt CompletedNWFP Economic Report Rpt CompletedCountry Gender Assessment Rpt CompletedPublic-Private Partnership in Education Rpt Forwarded to FY07Pakistan MDG Assessment Rpt OngoingJSA - PRSP Progress Report Rpt CompletedLabor Market Policy Note Pol Forwarded to FY06Social Protection NLTA Rpt Changed to Report/Forwarded to FY06Pakistan-India Trade Study Pol DroppedSindh Economic Report Rpt Forwarded to FY06Agriculture Output Market Rpt Dropped

Page I of 16

ANNEX III: PAKISTAN PRIVATE SECTOR STRATEGY

1. This note describes progress in implementation of the World Bank Group's (WBG) Private

Sector Strategy for FYO3-05, reviews the current challenges and outlines a Bank Group Private SectorStrategy for FYO6-09 taking into account changing market conditions and the evolving agenda emanatingfrom the continuous process of multi-level economic reform.

Economic Context

2. Following some of the lowest growth, highest debt and fastest growing poverty in South Asiaduring the 1990s, the early part of the new millennium represented a key period of transition in Pakistan'srecent economic history. At the beginning of the decade, policy makers fundamentally adjusted thedevelopment policy toward unleashing the power of the private sector. Reforms which addressedmacroeconomic imbalances, opened the economy to trade, reduced regulation and began transforming therole of the state as an owner/operator were complemented by a buoyant world economy, significantcapital 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 ofhigher 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 seasonaccelerated to over 8 percent in 2004-5.

3. Despite this early success investor response has so far been muted as investment's share in GDPhas fallen from 16 to 13 percent over the last few years. Rapidly increasing competition in global marketsfor Pakistan's traditional exports has added uncertainty to long term growth prospects and sustained theeconomy's dependence on lower value added activities. There is growing awareness among stakeholdersof the need for entrepreneurial dynamism, technology adoption and a business-friendly policyenvironment to raise productivity growth and improve international competitiveness. The challenge isenormous, given Pakistan's historical legacy of stagnant world market shares concentrated in low valueadded products (Box 1). The World Economic Forum's competitiveness benchmarks capture the myriadinfluences on national productivity and show Pakistan's relatively low, but increasing position in globaland regional rankings.'

Progress Since the Last CAS

4. The Government's interim Poverty Reduction Strategy Program, was operationalized in theFY2002-2005 Country Assistance Strategy. For private sector development, the CAS emphasizedGovernment undertaking near term actions to foster a more favorable business environment whileembarking on the long, difficult process of converting the State's role as owner operator to businessfacilitator and regulator. This conversion required stable policies, improved infrastructure, modernizationof business regulations, improved tax administration, trade liberalization, privatization of public sectorenterprises, 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 strategyenvisioned (i) building the knowledge base in PSD; (ii) strengthening Pakistan's investment climate, (iii)conversion of the role of government; and, (iv) adequate provision of infrastructure services. Goodprogress was achieved in many of the strategic areas as described below.

1 Pakistan's 2004 rankings in the Growth Competitiveness, and Business Competitiveness indicators were 91 and 75respectively out of 104 countries while the Heritage Economic Freedom Index placed Pakistan at 153 out of 176. In2005, these ranking rose significantly, with the Growth and Business Competitiveness indicators at 83 and 66,respectively and the Herigage Economic Freedom Index improving to 110 out of 153.

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Box 1: Pakistan's Starting Point: The Challenge of Growth in a Global Economy

(GOP, Towards a Prosperous Pakistan. A Strategy for Rapid Industrial Growth, March 2005)

Industrialization and export orientation outcomes over recent years reveal the challenge Pakistan facesin moving to a more globally competitive and dynamic set of economic activities. Key facts cited belowunderscore the challenges inherent in Pakistan's starting point.

* Lagging industrialization. Over the past three decades, the share of manufacturing value added in GDPincreased from 14 percent in the 1970s to around 18.4 percent today while the share of exports to GNPincreased from 8 to 17 percent over the same period (with 3 percentage points added in the past threeyears) - a much lower supply response to globalization than that witnessed in East Asia.

* Stagnant global market share. Pakistan's share of world exports has been stagnant over the past 25years while the share of manufacturing exports from Malaysia, Mexico and Thailand have doubled andthe share from China has tripled.

* High concentration of low value added production. Two thirds of manufacturing value added isaccounted for by textiles, leather, sugar, food, beverages and tobacco, pharmaceuticals, industrialchemicals, minerals, and basic metals while three quarters of exports derive from 5?? product groups:cotton based yam, textiles and garments, rice, leather and leather products and sports goods. Withincotton based textiles, fabrics, knitwear, bed wear and cotton yam account for half.

* Low share of dynamic exports. In 2002, 31 percent of exports were considered "dynamic" wherePakistan achieved an increasing market share of a growing world market. In 40 percent of products,Pakistan is losing market share.

* Technological sophistication is low. With much lower resource based exports over the past twodecades, the share of low technology products increased from 54 to 76 percent of total exports whilemedium technology products increased from 7.8 to 8.4 percent. High tech products remained negligibleat 0.6 percent of total exports in 2002.

Note: Low tech products have stable, well diffused technologies, and include textiles, garments, footwear, otherleather, simple metal and plastic, furniture and footwear. Barriers to entry are low and competition is based on

price. Medium tech products are heavy products like autos, industrial chemicals, machinery and standardelectrical goods. These products require complex, stable technologies with moderate R&D but advancedengineering and design skills, and large scale production. Barriers to entry tend to be high due to capitalrequirements 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-changingtechnologies and complex skill needs and therefore have the highest barriers to entry.

* Building the knowledge base in PSD. Two important firm level surveys took place during theperiod which underscored the 'micro-level' impediments that have constrained Pakistan fromfully enjoying the benefits of global integration.2 A number of policy notes assessed theeffectiveness of trade reforms and encouraged stronger export-oriented growth. Finally, an IDFgrant implemented by the Ministry of Industry and Special Initiatives (MOI&SI) examined arange of areas in support of economy wide regulation and strategy formulation.4

2 The Investment Climate Assessment (PK-ICA, 2003) demonstrated that productivity can be enhanced byimproving key elements of the country's investment climate. The Administrative and Regulatory Cost Survey Study(ARCS, 2004) examined the official and unofficial costs associated with administrative barriers.3 These include a TariffRationalization Study and Implications ofAbolition of the Textile and Clothing Quotas.' The areas studies included, labor legislation, the Drug Act, regulation at the level of SMEs, anti-competitivebehavior and company registration studies in support of an industrial strategy.

Page 3 of 16

* Strengthening the enabling Investment Climate. Based on the initial analytical work, the key

areas of reform initially address focused on the business-Government interface in the areas of

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 aswell as the PRSC. Implementation support in the areas of tax and customs was supported by

capacity building for the Central Board of Revenue while the revision of the labor code was

initiated with the deregulation grant.

* Conversion of state's role from owner/operator. The enormous challenge of fundamentally

transforming the state's role from owner-operator to facilitator-regulator across many key

economic activities was accelerated. Privatization of finance, utilities, and industrial enterprises

made great progress, the opening of 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 performancetriggers were supported under SAC II and PRSC I while directed support has been provided togovernment and independent agencies carrying out new roles.'

* Infrastructure. In addition to ownership, regulatory and governance improvements attention to

other challenging areas of infrastructure in power, telecom, and gas and transport, including tariff

policies in power and gas, the financial viability of key public sector entities like WAPDA andthe elimination of losses throughout the power system. Transport issues include poor rural

mobility, urban congestion, inadequate financial and operational performance of Pakistanrailways 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 supportedby development policy lending through SAC II and PRSC I and in telecommunications,complemented by the Telecommunications Regulation and Privatization project. In addition to astrong program of analytical work, the Bank is supporting rehabilitation of the highway network

(through the Highways Rehabilitation Project) and assisting in modernizing trade and transportfacilitation under the Trade and Transport Facilitation Project.

* Access to finance. Similarly, ownership, soundness and regulatory strengthening in the financialsector will go far to expand access to finance for formalized commercial activities. A BankingSector Adjustment Credit approved in 2005 is supporting sustained soundness of the newlyprivatized banking sector while the Banking Sector TA in providing continued support for

operational strengthening of the State Bank of Pakistan. In addition, along with commercialbanking reforms, efforts to widen access were supported by the Bank under PPAF and otherbanking operations, including expanding micro-finance to the bankable poor, widening prudential

regulations to cover SME, consumer, and micro-finance lending and establishing private creditinformation services

* IFC's program during the last CAS period. Over the past three years, IFC introduced newfinancial 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 technicalassistance and advisory services in addition to traditional investment operations.

o Investment operations. During the period, US$187 million in sixteen new investments werecommitted in infrastructure, information technology, the financial sector, textiles, and pulpand paper. Particular examples of groundbreaking investments include:

Including through the Telecom Regulation and Privatization project, the Banking Sector Adjustment and TechnicalAssistance Loans and the Public Sector Capacity Building Project.

Page 4 of 16

* Pakistan International Container Terminal to upgrade the port of Karachi, including civilworks, container handling equipment and expansion of capacity in the-container yard.

* TRG, which demonstrated the viability of Pakistan as a location for call centers. Thecompany became the largest of its type in the country and is expanding operationsthroughout the region.

* First UDL Modaraba where an Islamic financing product was used in the leasing sector.

* Dewan Salman Fibre Limited where the introduction of preference shares, the provisionof a local currency product and a linkage program with its small suppliers complementedan investment to expand its production capacity and restructure its balance sheet.

o Technical Assistance Trust Funds (TA TF) During the period, two studies were completed: (i)a feasibility study on the country's private health care industry, including an assessment ofthe market for general and specialized services; and (ii) an analysis of the competitivepositions of the country's leasing companies and investment banks. Foreign Investment

Advisory Service (FIAS) completed a private sector development strategy for the NorthwestFrontier province.

o PEP - MENA. An extensive technical assistance and ramped up advisory program focusedon supporting (i) improvements in the business enabling environment (BEE), (ii) financialsector, (iii) SMEs and (iv) challenging advisory assignments addressing privatization issuesand public-private partnerships. Particular examples include:

* Financial markets support covering a range of activities, such as corporate governance,institution-building in housing finance, women's banking, and micro and SME finance.

* Business enabling environment including (i) assistance to the Pakistani Securities andExchange Commission in efforts to de-mutualize the countries three stock exchanges, (ii)the introduction of alternative dispute resolution to promote mediation for SMEs.

* General support to SMEs in the form of work with business membership organizations toassist them in supporting SMEs in their industries including work focused on theautomotive supplier sector and the introduction of its "Business Edge" program, whichprovides a platform for Training of Trainers for SMEs.

* Advisory and Public-private Partnerships including the initiation of a program to(i) advise on the privatization of the Faisalabad Electric Supply Company, and (ii) bringprivate sector operators into the water sector through work on the Lahore Water public-private partnership.

Strategic Objectives

5. The Government's objectives for private sector development are based not only replacing thestate in commercial activities, but on becoming globally competitive through cost minimization andinnovation. As Pakistan moves from a focus on macroeconomic stability and restoring growth to one ofproductivity growth and sustained private investment, innovation through FDI and technologydevelopment will be needed to enable further gains and economic diversification. To accomplish this, theeconomy will require lowering the cost of doing business, stronger domestic competition with easier entryand exit, better infrastructure and wider access to finance, including equity, fixed income and projectbased. Therefore, PSD objectives seek:

* An environment which fosters a dynamic manufacturing sector and entrepreneurial activitywithin an export-oriented policy framework based on improved competition in product and factor

Page 5 of 16

markets, innovation and skills upgrading, greater diversification and participation in globalsupply chains;

* An investment-friendly policy stance for all enterprises, large and small, through continuedreorientation of the state's role, strengthened economic governance, improved infrastructure andbetter law and order;

* Improving the financial sector environment for intermediation, the legal framework and judicial

process for enforcing financial contract, the depth of capital markets, the quality of financialinfrastructure and access to financial services,- and

* Development of rural areas where most of the poor live based on productivity gains in agriculture

and non-farm activities from improvements in policies and rural infrastructure.

Current Policy Challenges

6. Policy makers increasingly recognize that sustaining the current high rates of economic growthrequires globally competitive production in an increasingly demanding world market. Therefore, basedon considerable progress in stabilizing and reorienting the economy, policy makers are focused onstrengthening international competitiveness through rising productivity in order to support higher wages,a strengthened currency and increased returns to capital. Macroeconomic stability and the removal ofprice distortions have eliminated impediments to productivity growth but will only translate into risingproductivity if accompanied by a conducive business environment.

7. Notwithstanding Pakistan's notable policy achievements and company level strengths, there is aconsensus among policy markers, academics and the business community that improvement in Pakistan'scompetitiveness derive from success in three "second generation" areas which impact firm levelproductivity. First, economic governance to instill market discipline and provide certainty in investmentreturns poses a particular challenge, encompassing such entrenched factors as efficiency and effectivenessof government and autonomous institutions, quality of regulation, political uncertainty, corruption and therule of law. Second, efficiency of factor markets to foster flexibility and fluidity represents a majorconstraint to good resource allocation and ease of entry, particularly in the case of land and labor. Third,physical infrastructure and transport logistics have a major impact on international competitiveness andhave become important priorities for Pakistan.

8. In addition to these, two specific areas are of interest to Pakistan's policy makers, concerned withensuring that growth is sustainable and broad based. First, issues reflecting technology adaptationrepresents the new frontier for Pakistan business in an increasingly globalized market. Second,sub-national differences are particularly poignant in Pakistan as a federation of four vastly differentprovinces with growing urban - rural divide.

9. Economic Governance. A driving force behind firm-level productivity is an environment ofopen and fair competition which encourages low costs, high efficiency and innovation to survive.Minimized cost of regulatory compliance, ease of entry, expedient exit and institutional protection ofproperty rights and fair competition are key components of a supportive policy regime. Not surprisingly,institution building is a long, difficult process for the executive, judiciary and independent regulators. Asa result, the consistency, certainty, and predictability of the economic governance framework - includingthe laws and regulations, the adjudication mechanisms and their enforcement agencies - still fall short ofminimal standards as reflected in a recent deterioration in governance indicators.6

6 In 2004, Pakistan ranked in the bottom 20 percent in four of six indicators with the other two in the bottom thirdDuring the 2000 - 2004, the ratings fell for three of the six indicators and did not change for two others (Kaufmann,Kraay Mastruzzi, Governance Matters IV. Governance Indicators for 1996 - 2004, The World Bank, May 2005.

Page 6 of 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 of regulatory processes, but key challenges

remain in terms of land acquisition, site development, construction licensing, and utility hook up, all of

which carry a high degree of 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 of these areas, the Government is undertaking comprehensive

programs with the explicit objectives of lowering the compliance burden while improving theeffectiveness of government oversight. Legislated efforts are being driven at the federal level and a rangeof 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 protection.9

11. Court Efficiency. Without the credible threat of an efficient and effective insolvency,adjudication and dispute resolution mechanism, risk taking by businesses is suppressed and innovationforgone. Court processes, judicial capacity and supporting institutions (advocates, registries, accountancyand related professions) have been notoriously ineffective in enforcing contracts and protecting property

rights in Pakistan. Just over a third of businesses surveyed in 2002 expressed confidence in the judiciaryas commercial parties increasingly use the courts to delay and or stop transactions through stays and

continuances. Case backlog-around half of which concern cases of commercial nature-in the High

Courts of Sindh and the Punjab number over a hundred thousand, and for the lower courts, in the millions.When cases do go forward, it takes, on average, 46 steps, more than a year and almost a third of thecontract value to enforce a contract.10 Standardized indicators comparing the average time (2.8 years) and

cost (4 percent of 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 andinadequate. Adjudication of commercial cases, already a lower priority in the courts, will become evenmore inadequate as new legal frameworks are introduced for foreign investment, insolvency, monopolyregulation, anti-money laundering, insider trading and corporate governance.

12. Competition Policy. Pakistan lacks effective legal framework to govern fair competition and anassociated 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 of domestic competition, industrial concentration and barriers to entry in theeconomy is not well understood in Pakistan.. However, with the opening of previously uncontestablemarkets, large scale privatization and anecdotal evidence citing concentration in primary sectors such as

cement and fertilizer, Pakistan has recorded low rankings for local competition." At the same time,sectors such as power, oil and gas, telecommunications and electronic media are opening to private sectorcompetition and are experiencing some of the natural challenges associated with rapidly transformingregulatory landscape in technically difficult areas.

Cite Pakistan's 2006 DB Rankings. Recent surveys detail the process of business start-up, demonstrating that theprocess to initiating business operations can take more than a year. Accordingly, the World Economic Forum's

indicator, "Administrative Burden for Startup," fell from 7 2nd in the world in 2003 to 9 2nd in 2004.An indication of the regulatory impact on formal firms' cost of doing business is that Pakistani managers, on

average, spend 10 percent of their time dealing with Government regulation; higher than other comparator countriesapart from China and India, (The World Bank, Investment Climate Database).9 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 combiningvisits and pre-announcing (Sindh), self-regulation (Punjab) and exemptions for low risk firms (NWFP).10 The high number of steps to enforce a contract may be a contributor to the perception that the judiciary is one ofthe most corrupt institutions in the country." For example by The World Economic Forum, Global Competitiveness Report.

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13. Factor Market Conditions. Well functioning markets for land, labor and capital enable optimalresource allocation and maximum factor productivity growth. Pakistani authorities have taken bold stepsto improve the banking sector, but deficient labor and land markets continue to be viewed as majorconstraints in Pakistan's investment climate.

14. Labor Market and Skills. Pakistan's labor market efficiency ranks low by international standardsdue, in part, to antiquated and restrictive regulations governing maximum hours, overtime conditions,length of temporary contracts, remuneration rates, welfare contributions and retrenchment procedureswhich impact bilateral market relationships and cause real wages to diverge from productivity levels,preventing efficient resource allocation and harming competitiveness. The discretionary approach ofprovincial inspectors, labor tribunals and wage authorities in enforcing requirements and adjudicatingdisputes adds considerable uncertainty to labor market outcomes. The result is that many, if not most,firms circumvent labor laws to some degree, most often by using contracted or piece rate labor on a veryshort term basis and often hired through intermediaries, suppressing investment in labor skills1 2 andsustaining concentration on low value added activities.

15. Land Market and Industrial Estates. Access to land markets and the use of land as loan collateralis fraught with difficulties, involving a multitude of public agencies at the federal, provincial and statelevel which own, manage, tax and regulate commercial land. For transactions which do occur in theprivate sector, the inherent weaknesses of the system of registering prevent certainty of property rights.These include the multiple agencies involved in land registration, complex and opaque records keepingand sale transactions taking place without valid conveyance documents. These legal inadequacies andprocedural deficiencies prevent indisputable land title and is one of the primary causes of the case backlogin the courts. Moreover, without clear property rights, lenders will not consider collateral as loan securitywithout an original sale deed in the bank's possession. The resulting "dead capital" and lack of siteaccess, hinders leveraged investment, firm level entry and efficient resource allocation. The rapid rise inland prices throughout Pakistan has made the situation even more constrained as hoarding is encouraged,underreporting for tax purposes is rising, and a new cadre of speculative players has entered the market.

16. Federal and provincial governments have countered problems with land access and sitedevelopment by making available plots on government owned land in industrial estates with mixedsuccess.13 Reason include (i) inappropriate selection of location; (ii) poor quality of infrastructure andsupport services; (iii) insufficient land in prime business locations; (iv) rigid government rules regardingeligibility of investment; and (v) inadequate stakeholder participation in estate management. The FederalGovernment is piloting new models of public-private partnerships to locate, develop and manage newindustrial estates, drawing on the Sundar experience in Punjab.

17. Financial Markets. The past five years witnessed considerable deregulation, liberalization andprivatization in the financial sector. Starting from three quarters of banking assets controlled by thepublic sector in the late 1990s, almost 80 percent of assets are now under private control. Reforms wereinitiated to strengthen the regulations and the regulator, reform the National Savings Scheme (NSS) torationalize interest rates, strengthen enforcement of financial contract; rationalize the tax structure andfoster greater disclosure and transparency. Still, the supply of longer term finance and capital marketdevelopment remains limited. Among other implications, this constrains the development of nascentfinancial markets such as housing and leasing which depend on the availability of long term funding inthe banking sector. The insurance and pension system is small, dominated by public institutions, invests

12 Pakistan's basic education and skills indicators are at the lower end of global rankings and have been falling.A survey of the 35 principal industrial estates across the country reveals a stock of more than 17,000 plots, two

thirds of which have been allotted. The survey also reveals the low occupancy rate for most estates apart from 100percent occupancy in SITE in Sindh, and Raiwind and Kot Lakhpat in Punjab Ministry of Industry, Production andSpecial Initiatives, A Prosperous Pakistan, 2005.

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in government assets, and is highly taxed. The 700 companies listed on the Karachi stock exchange4 are

capitalized at around 24 percent of 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 isfaced with problems at the execution level,1 5 and credit bureaus are at an early stage of development. Thelack of a tested secured transaction regime as well as the nascent private credit information system limitsaccess.

18. Infrastructure Development. In addition to low penetration density and coverage ratios, theperformance.of infrastructure services has been relatively poor, particularly in the area of power. At thesame time, the conditions of the roads, railways and ports hinder Pakistan'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, is access to reliable power both at the business start-up phase, in terms of obtaining

electricity connections, and during business operations, in terms of having reliable supply. In addition,the sector's pricing structure involves cross-subsidization with the burden falling particularly hard onindustry, adversely impacting investment decisions and competitiveness enhancement. Currentchallenges include (i) the high technical and commercial losses in the system, increasing from 23 to 27percent of total output between 1995 and 200216 and in some cases reaching as 40 percent; and (ii) the

extension of services to underserved areas as estimates indicate that almost of third of the population hasno access to power.

20. Telecommunications. In the global market with growing connectivity requirements,telecommunications represents a key determinant of the country's investment climate. Pakistan has taken

significant steps to (i) end the state monopoly for fixed lines resulting in numerous companies providingservices at competitive rates; (ii) privatize the public telephone company leaving the sector fully managedby the private sector; and (iii) approve a cellular mobile policy in January 2004 leading to two additionalcellular mobile operators being licensed. These initiatives have led to a complete liberalization of thesector and significant foreign investments. Low penetration rates are increasing rapidly, as telecomsdensity has increased from 4.6 to 9.8 lines per 100 inhabitants between 2003 and 2005 and the sector as

seen a dramatic reduction in prices. Connection time is improving and the sector now has the potential to

be a strength in Pakistan's investment climate. However, there is a significant lag in ruraltelecommunications access, as the positive developments and impact in the sector are mostlyconfined to the urban and semi-urban areas. The difference in penetration between rural and urbanusers is quite high , as half of Pakistan's 50,000 villages have no access telephones or the internet. This isprimarily due to its lack of commercial viability and penetration is at a meager 1 percent. Facilitatingrural telecommunications access will enable e-government and e-services to be delivered to rural areasand assist in overall economic development of the country.

21. Oil and Gas. Representing 41 and 36 percent, respectively of the total commercial energyconsumption, the Government's long-term goal for Oil and Gas is to institute a largely privatized sector.Beginning with a fundamental policy shift in 2000, the Government began to focus more on policy issues,state enterprises were slated for privatization and natural monopolies were entrusted to an autonomousregulatory body. Progress in the reform agenda has been mixed. The movement toward Governmentdivestment and improved regulation has proceeded relatively well. On the demand side, the domesticprice mechanisms continue to be distorted by cross subsidies among different classes of consumers andthe mechanism for adjusting gas price has been erratic. In 2004, petroleum prices were prevented from

14 KSE lists all companies on the Lahore and Islamabad stock exchanges apart from five companies listed inLahore.15 The Financial Recoveries Ordinance 2001, has been effective for several years but has been used sparingly due torecent judicial challenges. It will only become fully effective once it is upheld by the supreme court of the country.16 The World Bank, World Development Indicators, 2005.

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adjustmenting to reflect world market conditions, creating pressure on private suppliers and distortions in

consumption and investment patterns.

22. Transport: Roads, Railways, Ports. Pakistan's potential competitive position is highly dependent

on the quality and cost of its internal and external transport systems. However, the sector is inefficient

and so far has been unable to overcome the competitiveness disadvantages of both long sea and land

transport links. Major markets are located at considerable distances from Pakistan and the location of its

main production center is over 1,000km from the sea. The sector faces further cost disadvantaged in

terms of scale, since total import/export flows are relatively small. Key sector issues are: (i) poor ruralmobility;" (ii) urban congestion;" (iii) ineffective state railways monopoly carrying 3 percent of the totalcargo traffic; and (iv) costly port systems and inadequate trade facilitation.

23. Innovation, Globalization and FDI. Policy makers and the business community recognize thatimproved processes and increased efficiency at the firm level will require appropriate technologyadoption and a drive 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 bysophisticated 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 of knowledge transfer which comes from participation in theglobal economy, through integration with inward FDI and participation in global supply chains requiring

producing to world standards of price, quality and delivery time.

24. Though a rapidly developing ICT infrastructure, is undoubtedly having a positive impact ontelecommunications and innovation, the challenge for Pakistan to develop into a more knowledge basedeconomy are morebasic, given the education and labor skill outcomes described above. In addition

inadequate technical expertise to support innovation,19 a limited amount of risk capital along with a lowdegree of globalization 20 and low levels of inward FDI, despite one of the more liberal regimes in theworld21 is limiting Pakistan'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, significantdifferences 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 of vertical

integration and inter-firm linkages in the global marketplace, such regional differences become an issueof national competitiveness. While inter-provincial competition can be healthy for reform, the creation of

policy induced location advantages and differences in perceptions of security, crime and political stabilitycan adversely affect efficient resource allocation. Moreover, as provincial governments and increasingly

local authorities are responsible for much of the business interface with regard to labor and other type of

business inspections, tax administration, license approval, land and site development issues and judicialenforcement, the nature of a firm's investment climate depends on good implementation and coordination

with Federal policies.

17 Particularly as 45 percent of unpaved roads are mostly in rural areas.1 Particularly in Karachi and Lahore, which support close to a third of Pakistan's GDP.19 Science and technology indicators as well as higher education outcomes have fallen over the past decade andcurrently lag most other comparator countries (The World Bank, Knowledge Assessment Database, 2005).20 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 of 163countries in FDI as a share of 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 foreignownership, reducing required approvals, expanding profit repatriation and providing national treatment and legalprotection. Seedy dispute resolution and a further opening of the service sector was legislated in 2005.22 Pakistan ranks 81s in the world according to the WEF indictor "Regional Disparities in the BusinessEnvironment".

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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

is 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 publicservices through more sophisticated public-private partnerships in municipal services particularly water

and sewage, road building, information technology and knowledge development.

27. Entry and Post-Entry 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. In addition, there are other pre- and post entry regulations

solely within the purview of provincial governments that need to be reviewed to ensure that barriers to

entry are minimized and the cost of doing business is comparable with other countries. Implementationshould be at a harmonious pace across Pakistan to avoid perceptions of permanent policy induced locationadvantages.23

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 of land marketswhich in turn will support improved access to finance. In the interim, improved management of industrial

estates can provide increased access to publicly held land and utilities In addition, as they are responsiblefor enforcement of labor legislation, provincial governments have a key role in breaking long standingmarket rigidities. As Federal legislation is being reformed, provincial governments will need to re-tooltheir implementation mechanism to enable real wages to better reflect productivity, supportingcompetitiveness and improving resource allocation.

29. Judicial Efficiency. Property rights are weak in Pakistan generally, with contract enforcementand land disputes based more on negotiated settlements than rule of law and judicial enforcement.Provincial governments can directly contribute to improvements in judicial processes in three ways. First,improved governance and better performance of government officials in implementing regulations would

lessen the crowding out of purely commercial disputes. Second, efforts to improve the functioning ofland and labor markets would remove a second source of taxation on court time. Finally, ensuringadequate capacity and a rational structure at lower court levels while simultaneously working toward

filling vacancies and improving procedures for commercial cases at the High Court, would significantlycontribute to the certainty and predictability of property rights.

30. Security and Crime. Issues outside the normal parameters of economic management have been

shown to significantly affect investment climates around the world,24 but are perhaps more important for

Pakistan than for other economies. Perceptions of security risks as well as local crime, though hard toquantify, have clearly had an adverse impact on investment and growth. Perception of political instabilityat the regional political arena, even if constrained to the local region, has been a clear deterrent toinvestment throughout Pakistan, as well. Together local issues of crime and political stability, can infectthe entire country and contribute to a short term corporate view and suppresses investment by the businesscommunity.

23 Doing Business Pakistan, 2004 shows significant regional differences in the legislated cost and time associatedwith a number of business procedures, including opening a business, contract enforcement, and property andcollateral registration.24 For example, Ayyagari, Demirgtig-Kunt and Maksimovic, How Important Are Financing Constraints? The Roleof Finance in the Business Environment, (Forthcoming) shows that "maintaining political stability, keeping crimeunder control, and undertaking financial sector reforms are likely to be the most effective routes to firm growth."

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The Way Forward

31. Economic Governance. As the economy increasingly opens up to international trade andinvestment, attention has turned to regulatory and institutional reform to create a more certain andpredictable environment for commercial transactions. Good progress is being made in tax, customs,financial, labor and utility regulation as the first areas to be tackled with the next round focused on:

* Risk based approaches emphasizing self-assessment will be deepened through tax and customsadministration reform and will be expanded to labor inspections under the planned new laborcode and prudential regulation of the financial sector under Basel II.

* Business laws will have their own program of modernization, particularly in areas coveringinsolvency, corporate governance, and competition law. In addition the Securities and ExchangeCommission of Pakistan (SECP) will be strengthened and complemented by an activation of acredible competition authority.

* Expeditious adjudication of commercial cases is being actively pursued. Implementation of thepending legal reform bill will limit procedural delays (stays, continuances, etc.) and introduceformalized alternative dispute resolution. More fundamental reform is under considerationincluding a commercial court, commercial benches, streamlined and summary procedures, andsystems of registries, accountancy, and enforcement.

* In all areas the principal of strengthening enforcement agencies to implement strengthened legalframeworks, along with a credible system of operational rules, procedures and monitoringsystems will be pursued.

* Process reengineering would be a central part of capacity building efforts with an expansion ofexisting pilot e-government initiatives to improve the business-government interface.

32. Efficient Factor Markets. Efforts to improve the functioning of factor markets are a centralpillar of Pakistan's drive for economic restructuring. Deepening financial sector reforms, expandingefforts to improve labor markets and initiating a more rational approach to land markets will involve:

* Codifying, rationalizing and liberalizing antiquated legislation governing labor compensation,industrial relations, working conditions, health and safety requirements and human resourcedevelopment.2 5

* Initiating a two tracks system to develop land markets: (i) develop a new, clean system of landtitling for new transactions to ensure sovereign backing, easy transferability, and rationaltaxation; and (ii) begin carrying out the complex and delicate parallel activity to establishproperty rights in the face of ownership disputes. In the interim, in order to feed and providecredibility to the new land titling system, federal and provincial authorities would inventoryunderutilized land to be auctioned and transferred according to the newly introduced system.

* In the interim, provincial governments will observe implementation of the various models ofpublic-private partnership in industrial estate development and management such as SITE, Ltd inSindh and Sundar in Punjab to formulate "best practice" guidelines for estate management.

25 Laws are being redrafted to replace 30 - 40 federal and provincial laws and regulations covering employmentconditions, labor welfare, health and safety and human resource development. The first act, Services andEmployment, recognizes piece-rate contract workers in the legislation, expands the weekly hours and overtimehours, particularly for women and reduces the compliance cost on business.

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* To deepen financial sector reforms and improve term transformation, the remaining large publicsector commercial bank, specialized financial institutions and insurance companies will beprivatized, regulatory constraints on investments by insurance and pension/ provident funds will

be rationalized and corporate governance will be strengthened. Further deepening of 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 positivespillover effects on the rest of the economy by spurring household and entrepreneurial savingsand investment spending.

* Access to credit will increase with improvements in the legal framework and judicial processesfor enforcement of financial contracts (such as a modem secured transactions regime for movablecollateral) and an expansion of private credit registry coverage.

33. Infrastructure. Government efforts to provide better infrastructure have been intensive in recent

years and characterized by successes in telecommunication and oil/gas and slow progress in power sector

reform. Therefore, the near term agenda in infrastructure includes:

* In power, strengthen implementation of the Government's Sector Recovery Plan, which aims at(i) completing the unbundling of Water and Power Development Authority (WAPDA) intoseparate transmission and distribution companies; (ii) accelerated privatization in generation anddistribution; (iii) aggressive cost and loss reducing measures throughout the system; and (iv)improved tariffs and subsidies, for distribution companies to enable better targeting of subsidesand enhance operational and financial performance. Implementation delays are causing morelosses in the system, further complicating the challenge. Based on the investment backlog in thesector, investment lending would support distribution and transmission, hydropower and ruralaccess.

* In telecommunications, continue to implement the 2003 deregulation policy and 2004 mobilecellular policy by (i) strengthening the policy and regulatory environment for licensing,interconnection and tariff regimes; (ii) completing the privatization of the state-owned monopolyas an integrated company; (iii) continue opening the cellular market to further competition byselling additional licenses; and (iv) accelerating rural telecommunication and broadbandconnectivity. Under this new competitive, open regime, capacity enhancement is needed both forthe Ministry as a policy making body as well as the regulator.

* In oil and gas, domestic prices should reflect fully world market conditions. Gas tariffs, arepriced close to long run costs on average but are still below opportunity costs for households andfor 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 willbegin in the coming y ears. On the oil side, efforts to unbundle and privatize the large enterprise(Pakistan State Oil, Oil and Gas Development Company and Pakistan Petroleum Limited) will bestrengthened as world petroleum prices are increasingly passed through to the consumers.

* In transport and trade logistics, develop a strategic approach to the sector focusing first on theIndus trade corridor linking the major ports with the major city and corridors in the North with anobjective of developing an integrated approach to planning, investment and managing the Indus

transport logistics system. There is a significant maintenance backlog in the sector requiringmaintenance of $1 billion per year. Continued high-level commitment and support will helpaccelerate reform initiatives in the Pakistan Railways. Capacity constraints at the NationalHighway Authority of Pakistan will be addressed to avoid delays in new highway construction.Finally, delays in finalization and adoption of laws, rules, and procedures that were developed

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under the trade and transport facilitation program will be eliminated. As a particular emphasis,transport in rural areas will be pursued under the country's devolution framework.

* The institutional framework for Private Public Partnerships (PPP) in infrastructure needsimmediate attention to attract private financing to transport, urban services, energy and otherinfrastructure areas. The immediate steps will be to prepare and issue a PPP policy to identifysectors, the institutional framework (PPP unit) and funding mechanism while in tandem pilotprojects are pursued to demonstrate the viability of the PPP framework, for example withhighways or municipal services.

34. Innovation, Technology Improvement and FDI. To help capture productivity gains fromadvances in business processes, improved techniques and increased technology content of production,public and private initiatives will aggressively seek competitive markets at home, participation in theglobal economy and development of the human and financial resources required for innovation,including:

* A globalization driven, outward-orientation is needed in firm level business strategy to benefitfrom a broader set of markets, resources and technologies. However, to participate, domesticfirms require a competitive operating environment at home which rewards firm-level innovation,investment in skills, improved industrial organization and risk taking.

* Pakistan needs to offset perceived risks of foreign direct investors stemming from perceptionsregarding security, stability, and corruption with an aggressive program to attract foreigninvestors. Recognizing the lingering reputation risk from high profile disputes with privatecompanies, passing legislation to recognize international arbitration would be a strong and apositive signal to foreign investors concerned with unpredictable contract enforcement.

* Government's role in knowledge development is to focus on the basics, including (i) improvededucation outcomes and coverage, (ii) better telecommunications infrastructure; (iii) programs tosubsidize connectivity for disadvantaged sectors of society; and (iv) improving science andtechnology at home through support for basic R&D; and (v) leveraging the Pakistan Diaspora tofoster linkages between business, research institutions and academia.

35. Provincial Role in Determining the Investment Climate. As the Federal government deepensits reform agenda into institution building, regulatory reform and legal modernization, and as devolutionrestructures economic relationships, provincial governments will play an increasingly active role in anumber of key areas, including,

* Establish public-private policy and reform-related dialogues - create institutions to encouragedialogue, e.g. investor council, consultative mechanisms, etc. Contributing to greater public-private activity, but also helping to raise the level of awareness and understanding of the privatesector amongst ministries and staff. and ultimately will develop a PPP Framework

* The new coordinating body in the Federal Government will encourage provincial governments toimplement reforms through active consultation, monitoring and domestic benchmarking, toencourage a unified and competitive approach to implementation of provincial regulations.

* The high level of business sophistication and large numbers of specialized business associationsand chambers around the country can be leveraged through public-private partnerships tostrengthen inter-firm supply chains.

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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. Analytical Work. As policy makers develop comprehensive plans for the next round of strategic

policy decisions, contemporaneous, rigorous and informed analysis will assist in directing efforts towardthe binding constraints to improved microeconomic efficiency. The previous CAS sought the building ofa strong analytical basis to advise the Government on various dimensions of private sector development.Since then a number of studies were launched. The Growth and Competitiveness flagship report sets theintegrates microeconomic factors into growth modeling in order to provide an in depth analyses ofconstraints to sustained rapid economic growth. The yearly benchmarking of Pakistan 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 competitiveness will examine specific dimensions of 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 valuechain study of 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 ofwork and complement it with international benchmarking and productivity analysis.

38. Lending Support for Policy Reform. Supporting one of the pillars of the PRSP, key elementsof the Government program of private sector led growth have been supported by policy lending at thefederal and provincial levels during the previous CAS and will continue for the coming CAS period. Atthe Federal Level, the PRSC dialogue has supported reforms in infrastructure, particularly power, a newlabor 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 of institutions for a market economy. The Development Policy Credit for NWFP issupporting an emerging private sector orientation by the provincial government.

39. Non-Lending Technical Assistance. Small scale capacity building support to regulatoryagencies will assist in strengthening regulatory and oversight agencies. A World Bank IDF grant wasapproved to support the Securities and Exchange Commission. In cooperation with DFID the Bank is

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, toprovide practical capacity building support for the Board of Investment and is seeking to build the SouthAsia Enterprise Benchmarking Program, an example of an operational diagnostic study with key outputs

being marketing profiles, outreach and promotion activities and product development to assist each

participating country to promote itself more effectively for foreign investment.

40. Public Investment Lending. Lending in areas which support private sector development hasgenerally taken the form of 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 of the Public Sector Capacity Building program are aimed at strengthening utility regulatorsand will help with infrastructure services. A series of projects aimed at infrastructure development,particularly the power sector are being developed. In the future, projects will be pursued which focus oninstitutions for a market economy and combine public investment with technical assistance to enhance

international competitiveness and develop capital markets. In the financial sector, future lending by the

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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 FYO6-FYO9. In the coming CAS period, IFC will build upon the efforts tosupport strategic sectors, particularly the financial sector, SMEs and infrastructure. IFC will also look for

opportunities to provide value-added to industrial clients. IFC will broaden the scope of technicalassistance and advisory work, both linked to investment and on a stand-alone basis. The focus of IFC

efforts will be to provide a package of services and financing aimed at addressing the specific needs ofour clients.

42. During the upcoming CAS period, IFC expects to increase its investment with the target range ofUS$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 between theprograms. For example, in the financial sector, IFC can provide TA to develop microfinance institutions,while at the same time providing investment for nascent institutions, which in turn provides such funds to

entrepreneurs. Work to support the microfinance sector is seen as a particularly effective way to spreadthe benefits of development to a broader segment of society. Microfinance institutions are set up outside

the reach of traditional financial institutions and therefore can support entrepreneurs in more remoteareas. Also in the financial sector, PEP-MENA TA to banks will be aimed at the next size of enterprises- efforts to help banks develop their ability to assess risks of SMEs can be accompanied by credit lines.Other priority areas in the financial sector include housing finance, leasing, and trade finance. Housingfinance efforts can help increase the availability of affordable housing, and improve the opportunity forpeople of middle income and even lower income to buy their own homes. IFC's efforts in this sector caninclude institution building TA and investment to provide long-term lending and securitization forhousing finance. Work with banks and other institutions will include TA to improve internal credit risksystems, policies and procedures, and upgrade training of staff. IFC through PEP-MENA will work withbanks to develop Corporate Governance practices.

43. In the SME sector, beyond the financial component, IFC will continue to provide TA supportthrough "Business Edge" and work with business membership organizations to improve services for thesupport of their SME members. IFC believes that there are opportunities to support SMEs in strategicsectors such as health and education, both with TA and investment.

44. In infrastructure, IFC will focus on the energy sector, including power, gas and utilities, andtelecommunications through investment operations supporting the Government's strategy. There is aparticular need to improve the physical infrastructure in the country to allow for the efficient flow ofgoods, people and energy. Without improvements in this vital area, the long-term benefits of Pakistan'sliberalization will be stifled. IFC expects to have an investment program in infrastructure where it is opento the private sector. IFC will also put emphasis on advisory work for privatization and will supportpublic-private partnerships to improve the management of these facilities. IFC's recent efforts in the

water and sanitation sector will continue in the upcoming CAS period. IFC could consider newinvestments in power, building upon its extensive experience in the sector. Advisory mandates will alsobe pursued, particularly those which address constraint in power generation and distribution. IFC canassess opportunities to invest in the development of the country's natural gas resources, where clientslook for political risk mitigation. In the telecommunications sector, IFC could consider opportunitiesfollowing privatization in the sector and the expansion of mobile networks as well as value-addedservices. IFC will focus on efforts to improve the business enabling environment to ease constraints andaddress needs of the private sector. This will include work to improve the legal and regulatoryenvironment.

Page 16 of 16

45. On the industrial side, IFC will look for niche opportunities, including supporting Pakistanicorporations as they embark on south-to-south expansions. IFC will also look for ways to support thedevelopment of linkage programs to involve local SME suppliers to larger companies. IFC's ability toprovide innovative financing tailored to the needs of clients will be pursued selectively where there isclear value-added.

46. Political Risk Insurance. MIGA will advance its marketing and promoting for foreigninvestment in key sectors, working with key public agencies and private sector bodies (Chambers, etc.) toidentify opportunities for using political risk insurance to support FDI into Pakistan. In addition,subnational risk mitigation has become an important aspect of the MIGA political risk insurance productand it is considered important in the breach of contract coverage. MIGA's new Small Investors' Program(SIP) offers a streamlined, simplified and more cost effective political risk insurance program to supportforeign investment into SMEs.

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ANNEX IV: PAKISTAN - COUNTRY FINANCING PARAMETERS

Item Parameter Explanation/Remarks

Cost Sharing: Limit on the proportion of Up to 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. In many projects, the practice of requiringgovernment counterpart funding would continue. Ingeneral, low to moderate contribution by Government(federal/provincial), beneficiaries and others are expectedin CDD-type projects and water sector projects. Moderate

contribution by Government (federal/provincial) is

expected in infrastructure projects. 100% Bank financingcould occur in pro-poor projects, such as social sectorprojects and projects in poor and remote areas. 100% Bankfinancing may also occur in capacity building projects withmoderate 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 of recurrent costs in

that would apply to the overall amount of 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 of recurrent costs will be carefully assessed,particularly financing of Government staff salaries, whichthe Bank will only finance for specific purposes. Forexample, where our support is primarily programmatic(such as in the education sector), there may be need tofinance recurrent costs and for a longer duration (as long asprogram continues) to support achievedent of programobjectives. Recurrent cost financing may also be allowed tosupport cost of managing project implementation and toensure sustainability of project activities.

Local Cost Finance: Are the requirements Yes The two criteria are met. Therefore the Bank may finance

for Bank financing of local expenditures local costs in any proportion needed in individual projects.

met, namely that: (i) financing

requirements for the country's

development program would exceed thepublic sector's own resources (e.g., fromtaxation and other revenues) and expected

domestic borrowing; and (ii) the financingof foreign expenditures alone would not

enable the bank to assist in the financing of

individual projects

Taxes and Duties: Are there any taxes and No Taxes and duties in Pakistan are generally reasonable. Also

duties that the Bank would not finance? taxes and duties are not discriminatory against Bank-financed projects. At the project-level, the Bank would

consider whether taxes and duties constitute an excessivel

high share of project cost.

z 7l

Partnerrr- fF5

Growth and Investment

Financial Sector

Energy

Transport

-Agriculture & Rural Dev.

XHealth, Nutrition

Education

Environment

Water & Sanitation

Social Protection

Public Sector Management

Judicial & Legal Reform

Devolution

Page ] of 3

ANNEX VI: CAS CONSULTATION PROCESS

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 of 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 feedbackgiven during the consultation process are summarized below.

Client Survey

2. The Client Survey was carried out in October 2004 through February 2005. About 800stakeholders of the World Bank in Pakistan were asked to fill out a mail-in survey. Respondents wereasked to indicate: (i) their overall attitudes toward the Bank; (ii) which of the broad areas of the WorldBank's economic and social development activities bring the greatest value to the country; (iii) the

importance of specific areas of the Bank's work and the Bank's effectiveness in those areas; and (iv) theirlevel of agreement with a series of statements about the way the World Bank does business. Respondentswere also asked to indicate which of a list of general development issues facing Pakistan was of highestpriority and the level of impact a variety of challenges have on development. In addition, respondents

were asked about the Bank's communication and outreach efforts in Pakistan.

3. Survey participants were drawn from the federal government, members of Parliament, provincialgovernment officials, members of provincial assemblies, district/Tehsil Municipal Administration (TMA)government offices or staff, union councilors, bilateral and multilateral agency staff, private sectorbusinesses or organizations, civil society organizations, the media, and members of academia. Themajority of respondents were federal government officials, indicating that the results of the survey reflectprimarily the views of the Bank's government counterparts.

4. In sum, the Client Survey results show that the World Bank's work is appreciated on a number of

levels, as are certain aspects of the Bank's relationships with clients and stakeholders in Pakistan.However, there are certain areas of the Bank's efforts that may require additional focus and attention.

5. Respondents overwhelmingly (80 percent) indicated that they felt that Pakistan was headed in theright direction. Poverty reduction emerged as the top development priority with over half of 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 of the law

and justice system as priorities for Pakistan.

6. Respondents were also asked to assess the impact of various development challenges. Inadequateaccess to quality education and inadequate infrastructure development were considered to have the mostsignificant impact on development in Pakistan. Health issues were considered to have the least impact ondevelopment.

7. Across all respondents, the Bank's overall effectiveness in Pakistan received a 5.6 rating on a 10-point scale, with 1 being very unfavorable and 10 being very favorable. Respondents from localgovernment, federal government officials, and provincial government officials gave the highestfavorability ratings of the Bank. In contrast, respondents from academia, other organizations, and themedia gave significantly lower favorability ratings. Respondents saw the Bank as most effective inhelping to develop physical infrastructure, helping to develop water resources, and helping to improve theperformance of the energy sector, all receiving mean ratings of 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 of development projects was

seen as most important. Respondents felt that the Bank's greatest weakness was imposing technocraticsolutions without regard to political realities. Stakeholders' views of the Bank's effectiveness in some

Page 2 of 3

areas considered top priorities by stakeholders were not terribly positive: poverty, governmenteffectiveness and growth.

8. Across all respondents, there was a solid level of agreement that the Bank is a good source ofknowledge; the Bank's effectiveness in producing knowledge (studies, analyses) that is useful andtechnically sound both received the ratings of 3.9 on a 5-point scale with 1 being not at all effective and 5being very effective. There was less agreement, however, that the Bank was able to adapt its knowledgeto Pakistan's needs, receiving a mean rating of 3.2.

9. Overall relationships are somewhat strong; stakeholders perceive the Bank as relativelyaccessible, straightforward, and responsive. However the survey revealed that usage of the Bank'swebsite is lower in Pakistan than in other SAR countries surveyed last year. This finding is beingexamined with a view to developing strategies to increase usage. Usage of the Public Information Centersis also low in Pakistan, due in large part to security requirements limiting access to the Bank office inIslamabad. As PICs and websites are important tools for engagement with broader audiences-including"tomorrow's leaders" (e.g., students)-following up on these finding will be a priority. As a first step, fullpublic access to the PIC in Islamabad was restored in March 2006.

10. The initial quantitative survey was followed by a qualitative survey using more focused, in-depthinterviews with a subset of respondents in order to probe survey responses and get a better sense of theviews and opinions behind the results of the quantitative survey. These follow-up interviews were carriedout by an independent opinion research firm to provide assurances of anonymity.

11. Results of the qualitative follow-up reinforced the relevance of the Bank's poverty reductionmission while highlighting the importance of demonstrating results. Respondents unanimously rankedpoverty as the greatest challenge facing Pakistan. At the same time some, particularly in the media,expressed skepticism about the benefits of the recent economic turnaround which they believed wasbenefiting only a narrow segment of society. A clear message was that economic growth is not by itselfan adequate measure of success and respondents want to see clear indications of concrete improvement inthe lives of the poor. These findings highlight the importance of targeted interventions that reach the pooras well as the continuing need to strengthen capacity to generate reliable, timely data on developmentoutcomes both to guide policymakers and to help build support for poverty reduction programs.

12. On the role of the Bank, the in-depth survey showed that a majority held a positive view of theBank's effectiveness. However there was a range of views about the areas where the Bank is mosteffective. There was a strong consensus that the Bank should play a supporting role, allowing theGovernment to set the agenda and providing support as requested. A majority felt that such a supportingrole is especially important in the areas of governance and corruption where the government must be inthe lead. A critical role of the Bank in this regard is to monitor the use of resources. A majority ofrespondents appreciated the role of the Bank in generating and disseminating knowledge, but they urgedgreater attention to dissemination. A number of respondents highlighted the need for the Bank to simplifyits procedures and reduce the administrative burden of Bank lending.

Stakeholder Workshops

13. A series of consultation meetings were held in Islamabad and the four provincial capitals duringJanuary 2006. Meetings were held with provincial governments, the private sector, Parliamentariansdonors and civil society groups. On the whole, there was endorsement of the general thrust of the CAS,especially of its strategic principles and program priorities. In particular, there was strong support for therenewed emphasis on infrastructure lending. The CAS was also endorsed by provincial governmentswhich endorsed the overall thrust of the CAS and welcomed the proposed World Bank engagement at theprovincial level. Each of the provinces urged the Bank to take into account their respective uniquechallenges and accomplishments and to tailor the Bank program accordingly. There was specific

Page 3 of 3

endorsement of the move away from umbrella multi-province projects in favor of provincial lending. Acommon theme among the provinces was the need to be mindful of capacity constraints at the localgovernment level.

14. Consultations with representatives from the private sector were held in Lahore and Karachi. Theprivate 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 difficultyof finding literate workers for manufacturing work. They voiced strong support for targeted povertyprograms and governance, citing problems related to land titling and litigation and the need for strongerregulatory agencies. Financial sector development also emerged as a priority with representativesconcerned about access and interest rate fluctuations. There was strong support for an enhanced role forIFC.

15. A civil society stakeholder consultation workshop was held in Islamabad and attended byrepresentatives of various organizations from throughout Pakistan. While participants agreed with thethrust of the CAS, they expressed concern that the benefits of growth are not yet reaching the poor andthat the Bank should emphasize activities directly targeting the poor. They urged the Bank to use itsinfluence to help ensure that the needs of the poor are reflected in Government priorities. They alsostressed the importance of timely accurate demographic and social data and urged the Bank to givepriority to ensuring that accurate data is publicly available. Finally, several representatives mentioned theimportance of addressing gender issues.

Page ] of 2

ANNEX VII: GUIDELINES FOR IBRD LENDING

The following guidelines for IBRD lending in various sectors set out key sector-specific reforms

that would be needed to establish conditions necessary for successful scaling-up of Bank lending.

Sector Guidelines for New Lending

In addition to support for power sector reforms in PRSCs, investment lending in thePower power sector will be accompanied by the following key reforms:

* Satisfactory progress on corporatization of the Water and Power DevelopmentAuthority with establishment of legally and financially independent distributioncompanies operating under competent and stable management

* Establishment of a fully functional and institutionally properly placed CentralPower Purchase Agency (CPPA), operating under transparent and efficient rulesfor power trading and financial settlement;

* Well defined and sustainable government subsidy policy* Well performing regulatory framework, with independent regulator (NEPRA) and

separation of the regulatory, policy, and ownership functions.At the provincial level, investment and development policy lending in the water and

Water/irrigation irrigation would require commitment to and in some cases up-front actions to:* Increase transparency of water allocations and entitlements;* improve the quality of irrigation service delivery though greater user participation,

and formal contractual arrangements between bulk water providers and users; and* enhance on-farm productivity and water use efficiency.

At the national level, investment lending for major new Indus Basin storageinfrastructure would require:* Consensus among the provinces* an explicit, transparent agreement for implementing the 1991 Water Accord and

sharing the benefits equitably* an agreed Environmental Flow allocation to the Indus Delta* Commitment to institutional reforms and investments at the provincial, canal

command and farms levels to ensure more equitable, efficient use of waterScaled-up investment lending in the highways will require commitment to increase

Highways private sector orientation and enhance management and implementation capacity in theNational Highways Authority (NHA) as demonstrated by:* Increased private sector membership on NHA Executive Board;* induction of adequate professional staff in the Planning, Design and Procurement

sections;* introduction of project management consultants under Project Directors

In addition, satisfactory progress in the implementation of existing projects includingthe Highway Rehabilitation Project, including progress in fulfilling financial covenantswould also be necessary.Lending in the railways sector would require government commitment to a medium

Railways term reform program to revitalize Pakistan Railways (PR) as demonstrated by:* Appointment of a professional, private sector CEO to head PR reform, with

support of a dedicated reform team in PR;* GOP endorsement of a medium term reform program which would, inter alia,

create a professionally managed, commercial freight business with its own rollingstock and staff and transfer non core activities and businesses to a separatelymanaged holding company outside PR;

* Restructuring the governance of PR (possibly as a state corporation) under anautonomous and restructured Board;

* Separation of policy function (to be carried out by the Ministry of Railways) andoperational 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 movePorts towards port corporatization and professional management combined with a modem

institutional and legal framework for port operations as demonstrated by:* Induction of port management specialists;* Commitment to abolish the Karachi Dock Labour Board and right-size port labor

levels;* Updating of the National Ports Master Plan;* Progress in port corporatization;* A reduction in port tariffs of at least 15%.

Lending in the Urban sector will take place in the context of provincial and localUrban government commitment to develop and implement action plans in the following areas

of urban local government management:* policy, institutional and regulatory reforms necessary to improving service

provision, and notably water service provision in urban centers, in terms ofaffordability, reliability, and sustainability (environmental and financial);

* enhancing the municipal revenue bases through, for example, improving propertytax collection; applying formula-based transfers in a timely, predictable manner;and aligning local government revenues with service delivery responsibilities

* improving local planning capacity, including preparation of multi-year capitalinvestment programs by local governments and establishment of mechanisms toensure consistency between land-use planning and development regulations.

Annex B]Page 1 of 2

Pakistan at a glance 4/4/06

POVERTY and SOCIAL South inC Development diamond*Pakistan Asia income Delpmndion2005Population, mid-year (millions) 155.8 1,447 2,343GNI per capita (Atlas method, US$) 690 590 510 Life expectancyGNI (Atlas method, US$ billions) 107.3 859 1,188

Average annual growth, 1999-05

Population (%) 2.4 1.7 1.9Labor force (%) 3.0 2.1 2.2 ros

per primaryMost recent estimate (latest year available, 1999-05) capita enrollment

Poverty (% of population below national poverty line) 33Urban population (% of total population) 34 29 31Life expectancy at birth (years) 64 63 58Infant mortality (per 1,000/ive births) 74 66 79Child malnutrition (% of children under 5) 35 49 43 Access to improved water sourceAccess to an improved water source (% of population) 90 84 75Literacy (% of population age 15+) 47 61 61Gross primary enrollment (% of school-age population) 68 103 100 - Pakistan

Male 80 108 105 Low-income groupFemale 57 97 94

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1985 1995 2004 2005Economic ratios*

GDP (US$ billions) 31.1 60.6 96.1 110.7Gross capital formation/GDP 18.3 18.5 17.3 16.8Exports of goods and services/GDP 10.4 16.7 16.0 15.3 TradeGross domestic savings/GDP 5.9 15.8 18.4 12.2Gross national savings/GDP 22.7 21.0 23.0 18.0

Current account balance/GDP -4.1 -4.0 2.0 -1,3 Domestic CapitalInterest payments/GDP 1.7 2.0 0.8 0.7 savings formationTotal debt/GDP 43.2 49.9 37.1 31.8Total debt service/exports 24.5 27.6 22.3 12.3Present value of debt/GDP .. ,. 29.8Present value of debt/exports . 149.3

Indebtedness1985-95 1995-05 2004 2005 2005-09

(average annual growth)GDP 5.2 3.7 6.4 7.8 6.5 - PakistanGDP per capita 2.6 1.2 3.9 5.2 4.6 Low-income groupExports of goods and services 9.8 6.5 -1.5 7.6 15.5

STRUCTURE of the ECONOMY

(% of GDP) 1985 1995 2004 2005 Growth of capital and GDP (%)

Agriculture 28.5 26.1 22.3 21.6Industry 22.5 23.8 24,9 25.1 5

Manufacturing 15.9 16.3 17.6 18.2 -Services 49.0 50.1 52.7 53.3 -. 00 01 03

Household final consumption expenditure 82.0 72.4 73.3 80.0 -isGeneral gov't final consumption expenditure 12.1 11.7 8.4 7.8 GCF --- GOPImports of goods and services 22.8 19.4 14.9 19.9

(average annual growth) 1985-95 1995-05 2004 2005 eGroth of xports and imports (%)

Agriculture 4.1 2.7 2.2 7.5 oTIndustry 6.3 4.4 12.0 10.2 4o

Manufacturing 5.7 5.9 14.1 12.5Services 5.2 4.3 6.0 7.9 20 -

Household final consumption expenditure 4.3 3.5 8.2 16.8 o x 01 t2 03 osGeneral gov't final consumption expenditure 3.9 2.4 2.1 2.3 -20-

Gross capital formation 4.3 0.8 -3.2 1.7 - Exports -0-ImportsImports 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 willbe incomplete.

Annex B1Page 2 of 2

Pakistan

PRICES and GOVERNMENT FINANCE

Domesticlprices 1985 1995 2004 2005 Inflation (%)

(% change)Consumer pnces .. 13.0 46 9.3 201Impiicit GDP deflator 4.5 13.9 78 9.8

Government finance(% of GDP, includes current grants) oCurrent revenue 16.4 17 1 151 14.3 00 01 02 03 04 05

Current budget balance -1.3 -2.5 1.1 -0.1 - GDP deflator -*--CPIOverall surplus/deficit -7.8 -6.7 -1.8 -3.0

TRADE

(US$ millions) 1985 1995 2004 2005 Export and import levels (US$ mill.)

Total exports (fob) 2,460 7,759 12,395 14,371 20,000Cotton 279 62 48 111Rice 222 454 634 933 0Manufactures 1,922 4,627 7,568 8,268

Total imports (cif) 6,009 10,296 13,607 18,724 0

Food .. 1,627 659 706 5,000Fuel and energy 1,398 1,722 3,066 4,534Capital goods ..

99 00 01 02 03 04 05Export pnce index (2000=100) .. 117 115 124

Import pnce index (2000=100) .. 107 118 131 OExports COImports

Terms of trade (2000=100) . 110 98 94

BALANCE of PAYMENTS

(U$mlin)1985 1995 2004 2005 FCurrent account balance to GDP (%)(US$ millions)Exports of goods and services 3,247 9,628 15,123 17,725 TImports of goods and services 7,106 13,023 17,714 25,557Resource balance -3,859 -3,396 -2,591 -7,832

Net income -506 -1,729 -2,207 -2394 2

Net current transfers 3,090 2,709 6,684 8,819

Current account balance -1,275 -2,416 1,886 -1,407 12 03 04 05_2

Financing items (net) 227 2,647 -809 2,019Changes in net reserves 1,048 -231 -1,077 -612 .4

Memo:Reserves including gold (US$ millions) 1,190 3,534 11,395 10,722Conversion rate (DC, locallUS$) 15.2 30.8 57.6 59.1

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) 1985 1995 2004 2005 Composition of 2005 debt (USS mill.)

Total debt outstanding and disbursed 13,467 30,229 35,687 35,208ID 352 3,581 2,601 2,464 1,245 A: 2464

IDA 1,312 3,340 6,020 6,61 F: 2,054

Total debt service 1,435 3,216 4,285 ,1R2 58 413 386 2,407 e: 04

IDA 19 56 141 161

Composition of net resource flowsOfficial grants 257 312 574 379 5, 12,505 0 1,521

Official creditors 443 932 -685 905Pnvate creditors -169 318 152 -389Foreign direct investment (net inflows) 131 442 752 1,162Portfolio equity (net inflows) 0 1,280 156 465 D 7,367

World Bank programCommitments 678 706 781 847 A - IBRD E - BilateralDisbursements 152 691 304 984 B - IDA D - Other multilateral F - Private

Prncipal repayments 37 235 385 431 C - IMF G - Short-term

Net flows 115 456 -81 554Interest payments 40 233 143 130Net transfers 75 222 -224 424

Development Economics 4/4/06

Annex B2

Page 1 of I

PakistanSelected Indicators* of Bank Portfolio Performance and Management

As of March 21, 2006

Indicator 2003 2004 2005 2006

Portfolio AssessmentNumber of Projects Under Implementation a 15 18 16 18

Average Implementation Period (years) b 3.1 2.7 2.5 2.8

Percent of Problem Projects by Number a, c 6.7 5.6 12.5 16.7Percent of Problem Projects by Amount a, c 23.2 19.6 7.2 6.3

Percent of Projects at Risk by Number a, d 6.7 5.6 12.5 16.7Percent of Projects at Risk by Amount a, d 23.2 19.6 7.2 6.3Disbursement Ratio (%) e 28.0 24.7 40.7 33.2

Portfolio Management

CPPR during the year (yes/no)

Supervision Resources (total US$)

Average Supervision (US$/project)

Memorandum Item Since FY 80 Last Five FYsProj Eval by OED by Number 141 18

Proj Eval by OED by Amt (US$ millions) 11,030.4 3,237.6

% of OED Projects Rated U or HU by Number 22.0 16.7

% of OED Projects Rated U or HU by Amt 25.2 11.2

a. As shown in the Annual Report on Portfolio Performance (except for current FY).

b. Average age of projects in the Bank's country portfolio.

c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP).

d. As defined under the Portfolio Improvement Program.

e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the

beginning of the year: Investment projects only.

* All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio,which includes all active projects as well as projects which exited during the fiscal year.

Annex B3Page 1 of 3

Pakistan - FYO6-09 Lending Program Projects Under Consideration(as of April 2006)

Fiscal b Strategic ImplementationYear Project Name US$(M) Rewards d Risks

IDA IBRD Total

FY06Punjab Education DPC II 100 100 M HPIFRA II 84 84 M MEarthquake Response - Additional Financing e/ 340 100 440 H HEarthquake Emergency Recovery Credit 400 400 M HPolio Eradication II 47 47 M MNational Highways Rehab - Additional Financing 65 65 M LNWFP DPC I 90 90 H HBalochistan Primary Education 20 20 M HPunjab Irrigation DPL I 100 100 H HPunjab Municipal Services Improvement 50 50 M HPRSC II 300 300 H HPunjab Land Records Management 35 35 H H

Result 1,416 315 1,731

FY07PRSC III 300 300 H HPunjab Education DPC III 100 100 M HNWFP DPC II 130 130 H HSindh Education DPC I 50 50 H HPunjab Irrigation DPL II 100 100 H LSindh Water Sector Improvement 140 140 H HBalochistan Small Scale Irrigation 25 25 M HElectricity Transmission and Distribution 200 200 H HDERA II/Kushaal Pakistan 200 200 M MNational Trade Corridor I 300 300 H HWater Investment TA 50 50 H MLady Health Workers 200 200 M M

Result 945 850 1,795

FY08PRSC IV 100 200 300 H HPunjab Education DPC IV 100 100 M HNWFP DPC III 130 130 H HSindh Education DPC II 50 50 H HPunjab Irrigation DPL III 100 100 H HEarthquake Recovery Credit II 125 125 M HHigher Education 100 100 M HPunjab Barrage Rehabilitation 200 200 L MBalochistan Mineral Sector Development 25 25 50 M MPunjab Large Cities Improvement DPL I 100 100 H MSocial Protection 50 50 M HKushaal Pakistan/social mobilization 150 150 H MHealth Surveillance System Improvement 50 50 M MNational Trade Corridor II 300 300 H HSindh Fiscal DPC 100 100 H H

Result 605 1,300 1,905

FYO6-08 Expected Total Commitments 2,365 2,465 4,830

Annex B3Page 2 of 3

Pakistan - FYO6-09 Lending Program Projects Under Considerationl(as of April 2006)

Fiscal b/ c/ Strategic ImplementationYear Project Name US$(M) Rewards Risks

IDA IBRD TotalFY09

PRSC V 350 350 H HPunjab Education DPC V 100 100 H HNWFP DPC IV 130 130 H HPakistan Poverty Alleviation Fund III 200 200 M MSindh DPC 150 150 H HPunjab Large Cities Improvement DPL II 100 100 H HElectricity Transmission and Distribution II 200 200 H HRural Telecom 30 30 M MCapacity Building II 100 100 M MNational Trade Corridor III 300 300 H HProvincial Irrigation Infrastructure 100 100 M MFederal Water Infrastructure 300 300 H H

Result 1,030 1,030 2,060

FYO6-09 Expected Total Commitments 3,090 3,400 6,490

a/ This table presents possible projects under consideration for the four-year CAS period. Depending upon evolvingcountry needs and priorities, additional projects may be added and others may be dropped. Type of financing (IBRD, IDA or blend)may also be adjusted. Overall lending will remain within limits set by IDA availability (estimated at S3.1 billion) and IBRDlending envelope (up to S3.4 billion).b/ Project titles are subject to modification as project details are further refined.c/ All amounts are indicatived/ Indicates whether Strategic Rewards and Implementation Risks are expected to be High (H), Moderate (M), or Low (L).e/ Includes additional IDA financing under PRSC I ($150 million), NWFP SAC II ($50 million), PPAF II (S 100 million),AJK Community Infrastructure and Services Project ($30 million) and NWFP On-Farm Water Management ($10 million),and IBRD lending ($100 million) under National Highways Rehabilitation project.f/ Reflects expected total commitments based on IDA 14 availability and IBRD lending at the upper end of the proposed range

Annex B3

Page 3 of 3

Pakistan - IFC and MIGA Program, FY 2003-2006

2003 2004 2005 2006

IFC approvals (US$m) 84.3 80.7 41.4 150.0

Sector (%)

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

Investment instrument(%)

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 B4Page ] of 2

Pakistan - Summary of Nonlending ServicesAs of April 2006

Product Completion FY Cost (US$000) Audience a Objective b

Recent completionsWater Sector Strategy 2005 210 B, D, P PD, PSNWFP Economic Report 2005 355 G, D, B, P PSCountry Gender Assessment 2005 490 G, D, B, P KG, PD, PSDisease Surveillance Policy Note 2005 65 G, D, B, P KG, PD, PSPakistan Trade Policy Notes 1 2005 70 G, D, B, P KG, PD, PSEarthquake Preliminary Damage and Needs Assessment 2006 150 G, D, B, P KG, PD, PSGrowth and Export Competitiveness 2006 300 G, D, B, P KG, PD, PSSindh Economic Report 2006 390 G, D, B, P KG, PD, PS

Underwav/PlannedDisability TA/Action Plan 2006 G, D, P KG, PSPension Reform Strategy 2006 G, P KG, PSProvincial Procurement Assessment 2006 G, D, P, B KG, PSRural Growth and Poverty Reduction 2006 G, D, P, B KG, PD, PSSafety Net Report 2006 G, D, P, B KG, PD, PSHigher Education Policy Note 2006 G, D, P, B KG, PD, PSSocial Protection TA 2006 G, D, P PSLabor Market Study 2006 G, D, P, B KG, PD, PSStrategic Country Environment Assessment 2006 G, D, P, B KG, PD, PSTrade Policy Notes 2006 G, D, P, B KG, PD, PSGap Analysis of Public Accounting and Auditing 2006 G, D, B KG, PSUrban non-Lending TA 2006 G, D, P, B KG, PD, PSTransport Competitiveness 2006 G, D, P, B KG, PD, PS

Balochistan Economic Report 2007 G, D, P, B KG, PD, PSPublic Sector/Judicial Study 2007 G, D, P, B KG, PD, PSPoverty Update 2007 G, D, P, B KG, PD, PSPrivate Sector Education in Punjab 2007 G, D, P, B KG, PD, PSTax Policy Study 2007 G, D, P, B KG, PD, PSEducation Sector Report 2007 G, D, P, B KG, PD, PSCompetition Policy TA 2007 G, D, B PSInvestment Climate Assessment 2007 G, D, P, B KG, PD, PSHealth Sector Review 2007 G, D, P, B KG, PD, PSLivestock Policy Note 2007 G, D, P, B KG, PD, PSLocal Government Civil Service Reform TA 2007 G, D, B PSOil & Gas Non-Lending TA 2007 G, D, B PSPublic Financial Mgt/Accountability Assessments 2007 G, D, P, B KG, PD, PSMonitoring and Evaluation TA 2007 G, B PSPension Reform TA 2007 G, B PSDevelopment Policy Review 2007 G, D, P, B KG, PD, PSProvincial Public Financial Accountability Assessment 2007 G, D, P, B KG, PD, PSPublic-Private Partnership in Education 2007 G, D, P, B KG, PD, PSWheat Policies and Food Security 2007 G, D, P, B KG, PD, PS

Access to Finance 2008 G, D, P, B KG, PSCapital Mkt. TA 2008 G, D, B KG, PSDevolution TA/Policy Note 2008 G, D, P, B KG, PD, PSHD Monitoring and Evaluation TA 2008 G, D, P, B KG, PD, PSSindh Education 2008 G, D, P, B KG, PD, PSStatistical Strengthening TA 2008 G, D, B PSFisheries Policy Note 2008 G, D, P, B KG, PD, PS

Annex B4Page 2 of 2

Pakistan - Summary of Nonlending ServicesAs of April 2006

Product Completion FY Cost (US$000) Audience a Objective bLand Markets Administration TA 2008 G, D, P, B KG, PD, PSPolicy Notes for New Government 2008 G, D, P, B KG, PD, PSMicro-insurance Report 2008 G, D, P, B KG, PD, PSPPP for Agriculture Technology and Services 2008 G, D, P, B KG, PD, PSSkill Development/Labor Market TA 2008 G, D, B KG, PD

Statistic Strengthening TA 2009 G, D, B KG, PDHousing Finance 2009 G, D, P, B KG, PD, PSDebt Market Development 2009 G, D, P, B KG, PD, PSAccess to Finance 2009 G, D, P, B KG, PD, PSBanking Sector TA 2009 G, D, P, B KG, PD, PSEducation TA 2009 G, D, P, B KG, PD, PS

a. Government (G), Donor (D), Bank (B), Public Dissemination (P)b. Knowledge Generation, (KG), Public Debate (PD), Problem-Solving (PS)

Annex B5Page 1 of ]

Pakistan Social IndicatorsLatest single year Same region/income group

South Low-1975-80 1985-90 1999-05 Asia income

POPULATIONTotal 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 1.8Urban population (% of population) 28.1 30.6 34.5 28.3 30.7Total 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 24.2Rural headcount index .. .. 35.9

INCOMEGNI per capita (US$) 330 420 670 590 510Consumer price index (1995=100) .. 185Food price index (1995=100) .. ..

INCOME/CONSUMPTION DISTRIBUTIONGini index .. .. 33.0Lowest quintile (% of income or consumption) .. .. 8.8Highest quintile (% of income or consumption) .. .. 42.3

SOCIAL INDICATORSPublic expenditure

Health (% of GDP) .. .. 1.1 1.3 1.5Education (% of GNI) 2.0 2.7 .. 3.1 3.2Social security and welfare (% of GDP) 0.2 .. 0.2

Net primary school enrollment rate(% of age group)

Total .. .. 59 87 78Male .. .. 68 89 82Female .. .. 50 85 76

Access to an improved water source(% of population)

Total .. 83 90 84 75Urban .. 95 95 93 89Rural .. 78 87 80 69

Immunization rate(% of children ages 12-23 months)

Measles 1 50 61 67 66DPT 2 54 67 71 67

Child malnutrition (% under 5 years) 53 49 35 48 44

Life expectancy at birth(years)

Total 53 59 64 63 58Male 53 58 63 62 57Female 54 60 65 64 59

MortalityInfant (per 1,000 live births) 105 96 74 66 79Under 5 (per 1,000) 156 138 98 92 122Adult (15-59)

Male (per 1,000 population) 283 232 221 249 317Female (per 1,000 population) 291 230 198 199 266

Maternal (per 100,000 live births) .. .. 500 534 538Births attended by skilled health staff (%) .. .. 23 36 38

CAS Annex B5. This table was produced from the CMU LDB system. 04/06/06Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due tochange from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before oneyear of age.

Annex B6Page 1 of 2

Pakistan - Key Economic Indicators

Actual Estimate Projected

Indicator 2001 2002 2003 2004 2005 2006 2007 2008 2009

National accounts (as % of GDP)

Gross domestic producta 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 88.7Gross 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 3.8Private investment 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 21.7Imports (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 savingsc 17.7 19.7 23.1 23.0 18.0 14.1 15.0 16.1 16.8

Memorandum itemsGross domestic product 71496 71485 82350 96115 110732 125514 134880 145209 156626(US$ million at current prices)GNI per capita (USS, Atlas method) 480 490 520 600 670 730 810 870 920

Real annual growth rates (%, calculated from 2000 prices)Gross domestic product at market prices 1.9 3.2 5.0 6.4 7.8 6.3 6.5 6.6 6.8Gross 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 4.8Total consumption -2.8 0.4 -1.2 4.9 12.5 5.2 3.9 3.5 4.1Private consumption -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 33935Merchandise FOB 8934 9140 10889 12395 14371 16764 19846 23857 29116

Imports (GNFS)b 12535 11646 14047 17714 25557 32713 37570 42768 49054Merchandise FOB 10202 9432 11333 13607 18724 23967 28255 32735 38223

Resource balance -2251 -590 -361 -2591 -7832 -11958 -13475 -14386 -15119Net current transfers 3299 4500 6775 6684 8819 9623 10182 10508 10904Current account balance -1112 1591 4204 1886 -1407 -4918 -5800 -6237 -6396

Net private foreign direct investment 322 368 612 752 1162 3080 5019 4081 4780Long-term loans (net) -489 -1490 -868 -1531 -1885 1983 1788 2504 2013Official 747 781 -147 -685 905 1185 1235 1458 1620Private -1236 -2271 -721 -846 -2790 798 553 1046 393

Other capital (net, inc. errors & ommissions) 2560 2807 1731 -30 2742 619 670 770 770

Change in reservesd -1282 -3276 -5679 -1077 -612 -764 -1677 -1118 -1167

Memorandum itemsResource balance (% of GDP) -3.1 -0.8 -0.4 -2.7 -7.1 -9.5 -10.0 -9.9 -9.7Real annual growth rates ( YROO prices)

Merchandise exports (FOB) 11.9 5.6 8.1 2.7 7.9 13.2 16.1 19.0 21.1Merchandise imports (CIF) 7.3 -5.1 8.0 9.3 23.6 18.6 17.3 16.1 16.6

(Continued)

Annex B6Page 2 of 2

Pakistan - Key Economic Indicators(Continued)

Actual Estimate Projected

Indicator 2001 2002 2003 2004 2005 2006 2007 2008 2009

Public finance (as % of GDP at market prices)eCurrent revenues 14.3 16.3 17.5 15.1 14.3 14.0 14.7 14.8 15.1Current expenditures 15.5 15.9 16.6 14.0 14.4 14.1 14.0 13.6 13.5Current account surplus (+) or deficit (-) -1.3 0.3 0.8 1.1 -0.1 -0.1 0.6 1.2 1.6Capital expenditure 1.7 2.9 1.8 3.3 3.9 3.8 4.5 4.7 4.9Foreign financing 1.9 1.2 -0.5 -0.7 1.7 1.8 1.5 1.9 1.4

Monetary indicatorsM2/GDP 36.7 40.0 43.1 44.9 45.3 46.1 46.8 48.0 49.3Growth ofM2 (%) 9.0 15.4 18.0 19.6 19.3 17.0 15.1 15.3 15.2Private sector credit growth! 1318.9 125.8 1852.9 81.8 101.1 60.6 81.8 86.1 87.5total credit growth (%)

Price indices( YROO =100)Merchandise export price index 91.9 89.0 98.1 108.8 116.8 120.4 122.7 124.0 125.0Merchandise import price index 96.4 93.9 104.4 114.7 127.8 137.9 138.6 138.3 138.5Merchandise terms of trade index 95.3 94.8 93.9 94.8 91.4 87.3 88.5 89.6 90.2Consumer price index (% change) 4.4 2.7 3.1 4.6 9.3 8.9 6.2 5.2 4.8GDP deflator (% change) 7.7 2.4 4.4 7.8 9.8 8.2 6.5 5.5 5.0

a. GDP at factor costb. "GNFS" denotes "goods and nonfactor services."c. Includes net unrequited transfers excluding official capital grants.d. Includes use of IMF resources.e. Consolidated central government.f. "LCU" denotes "local currency units." An increase in US$/LCU denotes appreciation.

Annex B7Page ] of ]

Pakistan - Key Exposure Indicators

Actual Estimate ProjectedIndicator 2001 2002 2003 2004 2005 2006 2007 2008 2009

Total debt outstanding and 31706 33675 35885 35687 35208 37032 38668 40991 42777

disbursed (TDO) (USSm)a

Net disbursements (USSm)a 554 341 43 230 261 1871 1636 2324 1786

Total debt service (TDS) (US$m)a 2996 2850 2936 2907 2780 2438 2703 2900 3651

Debt and debt service indicators (%)

TDO/XGSb 276.1 248.4 198.3 186.1 158.4 144.5 132.3 121.3 107.9

TDO/GDP 44.3 47.1 43.6 37.1 31.8 29.5 28.7 28.2 27.3

TDS/XGS 26.1 21.0 16.2 15.2 12.5 9.5 9.2 8.6 9.2

Concessional/TDO 61.9 64.5 67.2 .. ., ..

IBRD exposure indicators (%)

IBRD DS/public DS 17.6 15.8 14.5 10.4 17.7 19.9 16.5 15.1 11.6

Preferred creditor DS/public DS (%)c 61.9 61.9 69.2 70.7 61.3 60.4 57.1 52.7 42.8

IBRD DS/XGS 3.5 2.8 2.0 2.0 1.8 1.6 1.3 1.2 1.0

IBRD TDO (US$m)d 3043 2943 2813 2601 2464 2149 2192 2571 2835

Share of IBRD portfolio (%) 2.5 2.4 2.4 2.4 2.3 2.1 2.2 2.5 2.7

IDA TDO (USSm)d 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 (US$m) 97.0 154.0 128.0 142.0 129.6 129.6 ..

a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-

term capital.

b. "XGS" denotes exports of goods and services, including workers' remittances.

c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the

Bank for International Settlements.

d. Includes present value of guarantees.

e. Includes equity and quasi-equity types of both loan and equity instruments.

f. Represents maximum IBRD exposure based on lending at the upper end of the proposed CAS lending range.

Annex B8

Page 1 of 2

Pakistan - Status of Bank Group Operations21-Mar-06

IBRD/IDATotal Disbursed (Active) 375.44

of which has been repaid 0.00Total Disbursed (Closed) 13,214.58

of which has been repaid 5,201.13Total Disbursed (Active + Closed) 13,590.02

of which has been repaid 5,201.13Total Undisbursed (Active) 1,279.71Total Undisbursed (Closed) 0.00Total Undisbursed (Active + Closed) 1,279.71

Difference Between

Active Projects Last ISR Expected and Actual

Supervision Rating Original Amount in US$ M Disbursements al

Development Implementation Fiscal

Project ID Project Name Objectives Progress Year IBRD IDA GRANT Cancel. Undisb. Orig. Frm Rev'd

P071454 AJK Community Infrastructure & Services S S 2003 50.0 42.1 9.2

P074797 Banking Sector Technical Assistance S S 2003 26.5 13.1 7.9

P035823 GEF-Protected Arcas Management Project U MS 2001 10.1 7.9 2.4

P010556 Highways Rehab S S 2004 150.0 150.0 236.3 20.4

P074856 HIV/AIDS Prevention Project MS MS 2003 37.1 27.9 9.9 7.2

P082621 NWFP Community Infrastructure U U 2004 37.1 33.8 2.4

P071092 NWFPOn-FarmWaterManagementProject S S 2001 31.4 3.4 22.7 11.3 5.6

P077288 National Education Assessment System S S 2003 3.6 3.1 1.5

P034301 Phase Out of ODS Pre S S 1997 13.0 5.1 0.5 0.6

P076872 PIFRA 11 S S 2006 84.0 71.1 -10.0

P083370 Public Sector Capacity Building S S 2004 55.0 38.3 4.7

P099110 Pakistan Earthquake ERC # # 2006 400.0 313.4

P097402 Second Partnership for Polio Eradication # # 2006 46.7 47.2

P082977 Second Poverty Alleviation Fund Project S S 2004 338.0 191.5 -5.1

P056213 Sindh On-Farm Water Management MS U 2004 61.1 49.6 20.6

P056213 Trade & Transport S S 2001 3.0 0.1 0.1

P088994 Taunsa Barrage Emergency S MS 2005 123.0 92.8 23.2

P077306 Tax Administration Reform S S 2005 24.4 78.5 96.8 26.4

Overall Result 297.4 1,402.0 23.1 3.4 1,292.5 125.2 13.4

Annex B8Page 2 of 2

International Finance CorporationStatement of IFC's Held and Disbursed Portfolio

Amounts in US Dollar MillionsAs of: 02/28/2006

Country: PakistanInstitution LN ET QL+QE GT RM All LN ET QL+QE GT RM All

Approval Fiscal Short Cmtd-IFC CmId-IFC Cmtd-IFC Cmtd-IFC Cmtd-IFC Cmtd-Part Out Bal- Out-FC Out-IFC Out-IFC Out-IFC Out-PartYear Name IFC

2001 ABN AMRO PAK 0.00 000 0.00 6.00 000 000 000 0.00 0.00 600 0.00 0.00

1995 AES Lal Pi, 14.94 950 000 0.00 0+00 0.00 14.94 9.50 0.00 0.00 0.00 000

1996 AES Pak Gen 920 950 000 0.00 000 537 920 950 0.00 0.00 000 5.37

1995 Abamco Mgmt 0.00 0.20 00 0000 0000 0000 00 029 0.00 000 000 000

2001 Askarn Bank 0.00 000 000 4.00 0.00 000 0.00 0.00 000 4.00 0.00 000

19911199411995 BRRIM 0.00 0.27 0.00 0.00 0.00 0 000 027 000 0.00 000 000

19931 1997/2001 Crescent Bahuman 0.00 301 0.00 314 0 00 4.40 0.00 291 0.00 3.14 000 250

2004 Dewan SME 0.00 0.99 000 000 000 000 0. 00 0.00 000 0.00 0.00

200312004 Dewan Salman 27.50 0.00 5.00 0 0.00 0.00 27.50 000 400 0.00 0.00 000

19911199511997 Engro Chemical 0.00 1.95 0 00 000 000 000 000 1 95 0.00 000 0.00 000

2001 Eni Pakistan 15.00 0 00 0.00 000 000 0.00 15.00 0.00 0.00 0.00 0.00 0.00

1990/1992/1996 FIlB 000 0.07 0.00 0.00 0.00 000 0.00 067 0.00 000 0.00 0.00

19931199412002 Fauji Cement 000 0 0.00 000 0.00 36.07 000 000 0 0.00 0.00 0.00

1995/2004 First UDL 0.00 0.00 000 7.00 000 0.00 0.00 0 00 0 00 0.00 0.00 0.00

2006 GTFP Metmpolita 0.00 0.00 000 1 38 0.00 000 0 0 00 000 0.92 0 00 000

1996 Gul Ahmed 8.10 410 0.00 000 000 522 8.10 4.10 0 00 0.00 0.00 S.22

2003 KCT 6.89 0.00 1 50 0.00 0.00 000 6.89 0.00 1 50 0.00 0.00 000

1995 Kohinoor 625 6.30 0.00 0.00 0.00 2.03 6.25 630 0.00 0.00 0.00 2.03

2003 Metropolitan Bnk 0.00 000 000 3.00 0.00 0.00 0.00 0.00 0.00 3.00 000 0.00

2002 Micro Bank 0.00 2.43 000 0.00 0.00 0.00 0.00 243 0.00 0.00 000 000

2004 NBFI Ciedd 6.50 0.00 0.00 0.00 0.00 0.00 6.50 000 0.00 000 Dn 00o0

2002 Network Leasing .00 0.00 0 00 1.95 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

199412006 Orix Leasing 17.00 0.00 000 0.00 000 000 0 000 0 0 00 0.00 000

2000/2006 P/CT 14.00 0.00 0.00 0.030 0.00 0.00 0.00 000 0.0 0.00 0.00 0.00

1983/198411094/119952002 PP. 000 &6.0 0.030 0.00 0.0 0.0 0.0 6.04 0.00 0.00 000 000

1965/ 1980/ 1982/ 1987119911 Packages 0.00 5.78 0.00 25.00 0.00 000 0 00 1 83 0.00 000 0.00 0001994/1995/20051993/11996/2001 Sarah Test/les 1.12 0.00 0.00 0.48 0.00 0.00 1.12 0.00 0.00 0.48 0.00 0.00

2001 Soneri Bank 0 00 000 30 000 0.00 0.00 0000 0 00 3.00 0.00 000

200T T Pak/stan 0.00 420 0.0 000 000 000 aOo 420 0.00 00 0.00 00

2006 TameerSBank 0.00 1.St 0.00 0.00 0.00 000 amD i.oi 000 000 0.0 0.00

1004 UhO Pnw-r 1360 0.00 0.0 0 16.00 0.00 1360 0.00 0.00 0.00 6.00i 0.0

2003 UnionnBank -PAK 000 0.00 000) 200 0.00 0.00 000 0.00 000 2.00 0 00 000

-TOtW Portforw 140-10 00.42 0.00 08.94 1053~f.09 109.10 5.37 0.00 22.53 6"0 15.12: