Huzaima Bukhari, Dr. Ikramul Haq & Abdul Rauf Shakoori
Pakistan at the moment is going through chronic political and economic turmoil. The most critical elements of the present crisis are polarisation of society and the effects of populist economic decisions of the recently ousted coalition government of Tehreek-e-Insaf (PTI) that are proving to be landmines for the newly formed coalition government, headed by the 23rd Prime Minister of Pakistan, Mian Shehbaz Sharif.
The earlier government, headed by Imran Khan, failed to meet major economic challenges and undertake structural reforms for sustainable inclusive growth. Resultantly, since 2018 the country is faced with many economic challenges like negative GDP, high inflation, increasing policy rate, fluctuating large-scale manufacturing index, and poor performance on the front of foreign direct investment. The PTI government, despite tall claims in its election manifesto, could not collect taxes of Rs. 10 trillion. The growth of around 30% in revenue collection for the nine months of the current fiscal year was either by imposing additional taxes or withdrawing exemptions or extracting the maximum from the existing taxpayers. Further, due to the failure in boosting growth in the country, the focus of PTI government remained on external borrowing to manage the balance of payment. The latest statistics show that our external debt has increased to US$ 130.6 billion. It is expected to go up further due to poor financial mismanagement leading to widening gap between imports and exports.
According to a recent report by the Pakistan Bureau of Statistics, imports rose to US$58.87 billion during July-March FY2022, compared to US$39.48 billion during last year’s corresponding period. Balance of trade is around negative US$35.52 billion that may deteriorate further by the end of the current fiscal year due to global increase in energy and commodity prices. Resultantly our foreign exchange reserves would be adversely affected. The PTI government left office with foreign exchange reserves, held by the State Bank of Pakistan (SBP), at US$ 10.849 while US$ 17.02 billion constituted total reserves. At the end of financial year 2017-18, total foreign reserves were US$ 16.383 billion which clearly means that instead of adding significantly, PTI government could only manage to add a mere US$ 700 million during its entire tenure.
A considerable portion of the reserves left by the PTI government include the deposit received from friendly countries under a support package. The entire tenure of the outgoing government shows inconsistency in their dealings ultimately leading the country into a huge financial crisis. Approaching the International Monetary Fund (IMF) was initially linked to committing suicide but later on, Imran Khan as premier personally traveled to the United Arab Emirates to meet the IMF’s Chief requesting an extended fund facility for Pakistan.
IMF accepted the request of Pakistan for an extended fund facility (EEF) and approved US$6 billion under commitment to implement the agreed reforms program. However, the PTI government did not fulfill its commitment and due to perpetual non-compliance, the IMF program was stalled on various occasions and most recently in March 2022. Disruption in the IMF’s EEF program badly affected our balance of payment needs, especially, when foreign reserves were declining sharply. Being the donor of last resort, in such a situation, IMF is/was the only lifeline available to avoid the possible risk of default.
Though the economy’s deteriorating condition needs structural reforms, yet without wasting any time and for firefighting, the new government on assuming power, approached the IMF for resumption and enhancement of EFF program. Finance Minister, Miftah Ismail with his team travelled to Washington for this purpose, a visit that has proved fruitful. IMF Mission Chief, Nathan Porter’s statement on our economic developments and policies under the EFF program, is a sign of relief. The new economic team has succeeded in increasing size of the loan from US$6 billion to US$8 billion with the EFF arrangement extended through June 2023. It is a signal of their “commitment to address existing challenges and achieve the program objectives” that they were previously criticizing ferociously.
IMF is expected to send its mission to Pakistan in May 2022 to resume dialogue for the 7th Review that had slowed down due to breach of commitments by PTI and consequent change of the regime. In these negotiations, the biggest challenge for Miftah Ismail will be the negotiation for implementing the reform agenda. He needs to be clear on terms agreed to by the previous government on fiscal policy reforms including revenue measures, spending efficiency, dealing with the projected deficit of the provinces and their contribution toward the fiscal strategy of the federal government, relying on the market source to finance the budget.
It may be remembered that PTI government agreed with IMF to remove various exemptions in the upcoming budget of 2023 including sales tax waiver on the import of fertilizers and tractors. It constitutes 23% of current general sales tax expenditure. This step would negatively affect our agricultural sector. Additional terms were implementation of personal income tax by July 1, 2022, simplification of the tax system, reduction of rates and brackets, reduction in tax credits, the introduction of special tax procedure for small taxpayers and broadening of tax base by bringing new taxpayers in the tax net. Deadline to implement the new personal income tax is approaching but the relevant draft supposed to be finalized for debate by end of February 2022, is yet not available. We have been writing consistently in these columns that Pakistan has the potential to collect Rs. 12 trillion as tax revenues but no one has bothered to implement suggestions contained in Towards Flat, Low-rate, Broad and Predictable Taxes (PRIME Institute, 2016 and 2020).
It is a fact that Pakistan is facing an historic current account deficit and circular debt and now we have accumulated a monstrous gas circular debt as well. Our contingent liabilities towards loss-making enterprises have surpassed Rs. 450 billion equal to one percent of GDP. We have already violated the Fiscal Responsibility and Debt Limitation Act, 2005—it requires curtailing debt to GDP ratio up to 60%. Even after revising the GDP base by PTI government, our current debt to GDP ratio is around 86%.
The silver lining is clarity of thought and direction by the new government. Economic decision-making requires bold and practical steps rather than playing for the gallery. Our current financial situation does not allow unrealistic subsidies when the basic revenue generation infrastructure is not performing to fulfill the country’s financial requirements. In its previous tenure—from 2013-to 2018—Pakistan Muslim League (Nawaz) introduced the landmark China Pakistan Economic Corridor (CPEC) initiative with an investment of around US$ 60 billion. The dividends of this initiative included resolution of the chronic energy crisis, development of infrastructure across Pakistan, establishment of economic zones, generation of employment, and contribution to decade-high GDP growth rates. At the time of its launch and execution, the PTI was its biggest critic, so after coming into power it slowed down the pace of its execution eventually, putting it on the back burner.
As per the plan, nine Economic zones were to be completed under CPEC, namely, Rashakai Special Economic Zone, Dhabeji Special Economic Zone, Allama Iqbal Industrial City, Bostan Special Economic Zone, ICT Model Industrial Zone, Industrial Park on Pakistan Steel Mills Land, Mirpur Industrial Zone, Mohmand Marble City, and Special Economic Zones. However, none of them have been completed to date. This halt disrupted the overall flow of foreign direct investment in Pakistan. The newly formed coalition government should prioritise its efforts in attracting more foreign direct investment. Increased flow of foreign exchange will help in offsetting the pressure of foreign reserves and will also enhance economic activity at the local level which will translate into higher economic growth and creation of employment opportunities.
Due to recent inflationary and external imbalance pressures, the Monetary Policy Committee (MPC) of SBP raised the policy rate by 250 basis points to 12.25%. The MPC has noted that SBP is in the process of taking further actions to reduce pressure on inflation and current account, namely, an increase in the interest rate on export refinance scheme (EFS) and widening the set of import items subject to cash margin requirements. These items are mostly finished goods including luxury items but exclude raw materials. The announcement of these measures is expected soon and will complement the action taken by MPC by way of an increase in interest rates. The local industry is already combatting higher costs of input and doing business. Though this rate hike is made as an anti-inflationary measure, it will adversely impact businesses as their access to affordable and cheap funding will be constrained, which can ultimately affect their sustainability and growth plans.
In view of the above, the new government needs to devise a long-term strategy in a way that does not erode the purchasing power of the common citizen who is already finding it hard to make both ends meet.
Huzaima Bukhari & Dr. Ikramul Haq, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE). Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’. They have recently coauthored a book, Pakistan Tackling FATF: Challenges and Solutions