# Annex 1: Application of the Residual Expenditure Method in Urban Pakistan

This annex provides a detailed explanation of how the Residual Expenditure Methodology (REM) was adapted from the Residual Income Methodology (RIM) for application in Pakistan. It presents the key assumptions used in the analysis, and one way in which the REM methodology can be applied to lowincome countries where reliable income data is often not available, but expenditure data is.

Pakistan’s housing shortage is currently estimated at approximately 10 million units and growing. About half of this shortage occurs in urban areas, where 47 percent of households live in over-crowded housing units in informal settlements ( _katchi abadis_ ) with inadequate infrastructure and services.<sup>18</sup> In response to the growing housing shortage, the Government of Pakistan launched the ambitious Naya Pakistan Housing Program (NPHP) in April 2019 with the objective of providing 5 million housing units across the country over five years. In the context of the NPHP and the World Bank’s housing sector engagement in Pakistan,<sup>19</sup> housing affordability analyses were conducted to inform policy dialogue and project design that would support the better targeting of housing subsidies to those in lower-income brackets for whom affordable housing is out of reach.

Using data from the Pakistan Household Integrated Economic Survey (HIES) 2018/19, the REM was used to estimate housing unaffordability for households in urban parts of the country. The findings suggest that approximately 25 percent of households are unable to cover their basic food and non-food, nonhousing expenses after accounting for housing costs, with the poorest segment facing the highest affordability challenge (94 percent). In contrast, the EIR approach suggests that housing is unaffordable for only 44 percent of households, and that housing is least affordable for the highest quintile, with close to 60 percent of households spending more than 30 percent of their household income on housing. The REM approach highlights the need for a much more accurate methodology to facilitate nuanced understanding of affordability in the housing sector in Pakistan.

The RIM measures housing affordability by accounting for a household’s ability to meet its non-housing basic needs after paying for housing. By establishing a minimum threshold of non-housing expenditure, the RIM method classifies households as facing unaffordable housing conditions if they do not have enough resources to meet these residual basic needs. However, the RIM approach is often limited in its ability to measure housing affordability in low income and developing country contexts due to the lack of income data as well as limited information on the most appropriate budget standards (i.e., the minimum food and non-food expenditure that is necessary to maintain an adequate standard of living). In most developing countries, including Pakistan, consumption expenditure is used as a proxy for household welfare. This is because income is difficult to measure and may not be an informative indicator of welfare. The large size of the informal economy and the high prevalence of smallholder agricultural production makes it difficult to capture income levels.

> 18 Urban Unit. “Punjab Spatial Strategy 2047 Technical Paper – Housing”.

> 19 This engagement includes Additional Financing to the Pakistan Housing Finance Project (P172581) which will support the scaleup of the credit Risk Sharing Facility that was developed in 2018 under the parent project to promote access to mortgage loans for low- and informal-income households; and the Punjab Affordable Housing Program (P173663) which will help strengthen housing institutions and systems and enhance housing supply, including affordable housing for lower-income households in Punjab.

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