The road to a sustainable economic recovery
It may become imperative for the government to seek yet another package
from the IMF for consolidating macroeconomic gains. The new agenda should
be to take measures for macroeconomic consolidation to ensure that the
economic conditions does not force Pakistan to fall back on IMF

By M. Sharif

The incoming federal finance minister has an advantage of taking over the economy that is not in too bad a condition as was being experienced a year ago.

However, there still prevails a strong perception among stakeholders, common people and donors that a lot remains to be done to further improve the economy. It will be challenging for the new incumbent to improve the business environment and fiscal imbalances, boost investors’ confidence and make life easier for the common man. But fight against terrorists in the northern regions, the US-Pakistan agenda, has a long way to go before signs of peace may emerge.

Sustainable economic recovery cannot be achieved without chalking out a roadmap for the next three years by taking important stakeholders and political forces on board. Achieving these objectives makes the task of the federal finance minister more challenging than it looks.

Removing of fiscal imbalances is one of the most crucial agendas for sustainable economic recovery, an area that presumably got neglected during past two years in a bid to retrieve the economy from near collapse. Understandably, that phase is over, and now is the time to reflect back and implement fiscal, monetary and administrative measures that have to be result oriented. It is understood that the federal finance minister despite holding the most important government position, can hardly have the leverage of making all the decisions related to the economy independently, even if they were to impact the common people positively. The finance minister is required to take decisions under extreme pressure in the midst of conflicting interests and demands from various stakeholders and power brokers, and is also to take care of the common people and economy. Unless the finance minister stays on course, the possibility of achieving objectives of the roadmap might remain as far fetched as they have remained so far.

Currently the economy’s management is tied up with the Stand-By Arrangement (SBA) of the International Monetary Fund (IMF). There is a serious constriction of inflows from the US and friends of Pakistan (FoP) to the tune of more than $2.5 billion for bridging the fiscal gap during current fiscal year, double digit inflation and a high discount rate persists apart from a host of other issues of less importance, but significant enough not to be shied away. The federal finance minister is to make an agenda within the framework of existing ground economic realities and set up goals that he intends achieving during his tenure. He is also to convince the federal cabinet and donors about the economic priorities and measures that he intends taking to achieve those goals. The first item on his agenda should be winning the confidence of domestic and foreign investors for one simple reason that the economy needs huge investments to boost growth, which is essential for improving fiscal, monetary, social and human indicators. According to experts, the Incremental Capital Output Ratio (ICOR) that determines the efficiency of an economy is between five and six for the national economy meaning thereby, “the country has to invest five to six per cent of GDP to produce one per cent increase in GDP growth”. Pakistan needs to lift economic growth by no less than 3.0 to 4.0 per cent.

SBA will finish by the end of current year. It is doubtful if the objectives achieved through its implementation by then would have built sufficient capacity for economic growth, and other macroeconomic indicators to plug holes in the grey areas during next few years to make the economy self-sustaining. Economic growth is likely to remain modest, around 3.0 per cent during current fiscal year compared to 2.0 per cent of last fiscal year. IMF has predicted a growth of 4.0 per cent for next financial year subject to commodity and oil prices remaining moderate in international market. Such a growth is hardly sufficient to work as a catalyst to give impetus to growth. Even an average growth of 5.0 per cent being envisaged by the Planning Commission for the 10th five year plan for the period 2010-15, might not do the trick to address the various socio-economic problems faced by the people. With the conclusion of SBA, foreign inflows that average $6.5 billion a year will cease. One year after, payment of $11.3 billion received from the IMF under SBA will commence. It would not be without kick starting new problems.

Certain analysts are raising the question that it might become imperative for the government to seek yet another package from the IMF for consolidating macroeconomic gains. In the backdrop of such concerns, the second issue on the new incumbent’s agenda should be to take measures for macroeconomic consolidation to ensure that Pakistan does not fall back on IMF because the conditionalities would put too many restrictions on the government, and ultimately common citizens would be the worst hit. The outgoing finance minister had vowed to end dependence on the IMF but due to conflicts of interest the end result was obvious. The new finance minister with his team will have to do a lot of brainstorming to come up with viable solutions to give a boost to economic growth, increase tax revenue collection and make an all round development.

It is essential that henceforth the focus of the government should shift towards improving tax revenue collection, targeted at Rs1,380 billion for current fiscal year. It is likely to fall short despite claims by the Federal Board of Revenue (FBR) to the contrary. It is understood that tax evasion, estimated to be around Rs500 billion a year is a serious issue. It is serious to the extent that US Secretary of State had to testify about it before the Senate Foreign Relations Committee. She is reported to have said, “The very well-off in Pakistan do not pay their fair share for the services that are needed for health and education primarily. The US along with the IMF and World Bank (WB), was looking for ways to pressure the governments that received loans and grants to broaden tax base.” The government during past two years and previous governments also have persistently maintained that they were to increase tax base and tax-to-GDP ratio, but they hardly took concrete measures to make their rhetoric result oriented. In fact, during past few years tax-to-GDP has decreased from 12.0 per cent of GDP to 9.3 per cent.

Under IMF pressure the government has agreed to replace general sales tax (GST) by value added tax (VAT) from next financial year. A bill to this effect has been placed before the parliament for approval. According to estimates of FBR’s officials, “the current gap between financial resources and public expenditure of almost Rs400 billion to Rs500 billion could be easily filled once the VAT mode is implemented in letter and spirit.” It will increase tax-to-GDP ratio by 2.4 per cent. The other avenues of enhancing tax revenue include reviving capital gains tax (CGT) on stocks that according to an estimate has the potential to yield Rs25 billion and taxing real estate business where trillions of rupees are stuck up. Agriculture income needs to be taxed also. Increase in tax revenue will reduce dependence on foreign financial resources that have practically dried up presently, as has been made obvious from a cold response by the FoP.

The current strategy of indiscrete borrowings from abroad and the domestic market has proved counter-productive because of accumulation of a huge public debt of $55.0 billion, foreign and domestic debts exceeding Rs4.0 trillion with a heavy debt servicing liability that is more than the combined defense and current expenditures. It is likely to increase in case the present tend persisted. It is therefore pertinent to emphasise that the third item of the finance minister’s agenda should be to reduce dependence on public debt to bridge the fiscal gap. According to the latest figures released by the

State Bank of Pakistan (SBP), the government borrowed Rs257 billion from the banking system for budgetary support during current fiscal year due to rising expenditures and a shortfall in revenue.

A roadmap for sustainable economic recovery based on three essentials of winning investors’ confidence for making higher investments to boost growth, increasing tax revenue collection, doing away with dependence on the IMF and reducing dependence on public debt, sounds like a far fetched dream keeping in view the government’s performance during past two years. It reflects the government’s mindset of preferring to live beyond its financial means and maintaining the status quo of not taking radical decisions to improve the economy through home grown, tough solutions. Can the status quo of collecting revenue through indirect taxation, accumulating more public debt, and continuing corruption in tax regime be changed? It certainly cannot be changed. The focus of the government should be on managing the economy based on fiscal and monetary discipline with a vision to make it a strong and competitive regional economy, for which it has the potential. However, the government is bent on managing the economy by depending on external resources for reasons that can be avoided comfortably.