July Issue 2013

The first budget of the Pakistan Muslim League-Nawaz (PML-N) proved an ordinary one for extraordinary and difficult times. Most independent and not-so-independent economic experts rebuffed the efforts of Finance Minister Ishaq Dar and his team on grounds that the new government avoided difficult and bold decisions and attempted to keep the country’s battered economy afloat by working in the existing template in the new financial year 2013-14 (July-June).

However, there have been voices of support for the budget coming mainly from business people and industrialists, who declared it pro-growth and investment friendly. They argue that despite many shortcomings, it remains the best budget under the existing circumstances where the government was short of options and fiscal space. They also add that Dar and his team barely got a week to incorporate PML-N’s vision in the budget and that the document was prepared mainly by the caretakers.

The government, nonetheless, has accepted a challenging assignment. On the one hand, it wants to achieve economic stabilisation, trigger growth by greater resource mobilisation and increase development spending in the current fiscal year. On the other hand, it wants to qualify for another loan from the International Monetary Fund (IMF) to ensure that Islamabad does not fail on its foreign debt repayments and maintains the foreign exchange reserves figure to a minimum of at least three months of the country’s import bill. This is also vital to stabilise the rupee, which has remained under pressure since the country’s historic return to democracy in February 2008.

While the new budget aims to do all this through a series of steps that have won support from some and opposition from others, the chronic structural flaws of the economy, by and large, remained unaddressed.

To begin with, rather than expanding the tax-base for the much-needed resource mobilisation, the government banked on the existing pool of tax-payers. It further squeezed the salaried class, which has to pay slightly higher taxes compared to the last fiscal year because of the alterations in the income tax slabs. The oppressive indirect taxation, which hurts the middle and lower classes, has again won favour instead of direct taxation; the unpopular increase in the General Sales Tax (GST) by 1% — from 16% to 17% — underlines this fact. The impact of this decision remains inflationary and hits the common man the hardest.

An increase in the withholding tax on cash withdrawals from banks and slapping of the same on a section of the service industry, including wedding halls and hotels, are among the key measures for resource mobilisation along with increased taxes on a number of items.

But the government has made no attempt to bring more direct tax-payers into the net. The retailers, middlemen and wholesalers — the main support base of the PML-N — continue to remain out of the ambit of direct taxes. So are many other lucrative professions and key sections of the service sector. The agricultural income, barring Punjab, remains untaxed as its imposition falls under the provincial governments.

In Sindh, the tax exemption on the agriculture sector income is further polarising its politics as the provincial government targeted the urban centres to increase revenues by jacking up taxes on property and various services. The Sindh Assembly, dominated by feudal lords and landowners belonging to the PPP, is in no mood to hurt the interests of the ruling class, especially in the rural areas.
Many analysts believe that without bringing two-thirds of the recorded GDP into the tax fold, which comes from the agriculture and service sectors, the government would not be able to improve its tax-to-GDP ratio, which remains stuck at around 9%. To ensure the tax-to-GDP ratio of 15% by the financial year 2015-16, as envisioned by the PML-N’s budget, it is necessary to bring the vast unregulated sector of the economy in the direct tax net as well.

Rather than expanding the tax-base for the much-needed resource mobilisation, the government banked on the existing pool of tax-payers. The oppressive indirect taxation, which hurts the middle and lower classes, has again won favour instead of direct taxation; the unpopular increase in the General Sales Tax (GST) by 1% — from 16% to 17% — underlines this fact. The impact of this decision remains inflationary and hits the common man the hardest.

While bold steps on the tax front remain missing in the budget, the government has set itself an ambitious revenue collection target of Rs 3,420 billion, which is more than 20% higher than the revised figures of Rs 2,837 billion in the current financial year. This raises questions whether the government will be able to achieve the fiscal deficit target of 6.3% in the current financial year, given its plans to boost growth by spend Rs 712 billion under the Public Sector Development Programme and ‘other development expenditure.’

Going by the performance record of the Federal Board of Revenue (FBR), which missed its revenue collection target by a wide margin of more than Rs 400 billion in the fiscal year 2012-13, skeptics seem justified in raising eyebrows about FBR’s ability to achieve this fiscal year’s targeted amount of Rs 2,475 billion.

As far as the non-revenue generating resources are concerned, the optimistic PML-N government hopes to recover Rs 79 billion from Etisalat, which remain unpaid because of the unresolved dispute over the ownership of various properties of the Pakistan Telecom Co. Ltd after its privatisation. “This payment has been part of the financing items for the last five budgets, but has yet to be realised,” says Dr Ashfaque Hasan Khan, a former finance ministry adviser and the dean of the Business School of NUST.

The planned risk of increasing development expenditures, which is unlikely to be welcomed by the IMF and other bilateral donors, is seen as a step in the right direction to pull the country out of the cycle of low growth. Pakistan recorded an annual growth of less than 3% during the previous PPP rule.

Similarly, the availability of the coalition support fund from the US, amounting to Rs 112 billion, also remains doubtful. From the US point of view, it owes nothing to Islamabad now, said Dr Khan underlining the risk attached to the factoring in of this inflow.

The government is counting on Rs 120 billion from the sale of the 3G cellular services as another source of its non-tax revenues. According to Dr Khan, the sale of 3G licenses also remains doubtful.

On the expenditure side, the government has rightly opted for austerity, but these measures are more of a symbolic nature. The planned 30% reduction in the public sector’s running expenses is unlikely to have a significant impact on the overall government expenditures once we factor in debt servicing, defence and public sector salary expenses.

The availability of funds for the Rs 712 billion development budget, which includes big infrastructure projects, would be doubtful if there are slippages in revenue collection or non-revenue financing.

But the planned risk of increasing development expenditures, which is unlikely to be welcomed by the IMF and other bilateral donors, is seen as a step in the right direction to pull the country out of the cycle of low growth. Pakistan recorded an annual growth of less than 3% during the previous PPP rule.

Many economists also believe that it remains vital for the country to end its current state of stagflation i.e. the cycle of low economic growth and high inflation.

However, the task is easier said than done, as removing the macroeconomic imbalances remains impossible without taking unpopular and painful decisions.

Achieving this goal becomes even more difficult in an atmosphere where foreign as well as domestic investors remain wary because of the rampant lawlessness, the challenge of terrorism and the soaring crime rate in the country.

The government would have to perform a high-wire act to ensure consistent and long-term policies, beating extremist forces and establishing the rule of law which has eroded not just in the mountainous regions of Pakistan, but also in major cities like Karachi. Without increased investment, the target of putting the country on the path of economic growth would remain a pipe dream.

The government’s capacity to fix the ailing public sector enterprises, which have been draining billions of rupees every month, would also be put to the test as it would require many unpopular steps.
Reforms in the power sector, for which increasing the electricity price is necessary, would also require courage and resolve. The government’s current plan to wipe out the circular debt of energy companies is not enough to fix the power sector woes. Preventing electricity theft is also important, for which the government will have to substantially increase tariffs coupled with cracking down on vested interests

However, the big plus point for the PML-N, as compared to the PPP, remains that it is considered business-friendly and expected to handle the economy in a more efficient manner. But in order to transform this positive sentiment into something concrete, the PML-N has to travel a long and rocky road. It would also need skill, vision, courage and commitment to resolve the multiple, intertwined economic, political and security challenges facing the country, especially since the public’s patience is running out
and many state institutions stand paralysed.