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November 22, 2011

How to revive the economy


November 22, 2011

A long and harsh winter has gripped Pakistan’s economic landscape over the last four years. Neglect or mismanagement of the economy, along with a weak, frivolous and disjointed economic team, can be held responsible for the destruction of Pakistan’s economy. A national consultation on how to revive Pakistan’s economy was held by the government recently. In fact the consultation was not focused on economic revival but rather on the prevention of economic collapse.
Pakistan is currently facing near and long-term economic challenges that have caused a long and harsh winter to bring about a stagnating economy and forestall economic growth and prosperity. The short-term economic challenges pivot upon restoring fiscal discipline, maintaining price stability and promoting economic growth. Addressing the fiscal policy challenge that has emerged after the New NFC Award has been identified as another near term economic challenge.
How to remove constraints to economic growth is the single most significant medium-to-long-term economic challenge facing the country. Ways to overcome constraints to economic growth include addressing energy bottlenecks (gas and electricity), making it easy for private businesses to grow, improving human capital, strengthening the country’s physical infrastructure, reforming the tax system and tax administration, and building a robust financial system. Misgovernance, corruption and opaque economic policy-making are yet other constraints to economic growth that will have to be addressed in the medium-to-long-term period.
Reviving the economy will require addressing both near and medium-to-long term economic challenges. The solution to these challenges boils down to restoring macroeconomic stability on the one hand and promoting economic growth through growth critical reforms on the other.
Let me share my thoughts on these economic challenges. For addressing near term economic challenges, the commitment to fiscal discipline

is a pre-requisite. A sound fiscal position is essential to achieving macroeconomic stability, which is increasingly recognised as a critical ingredient for promoting strong and sustained economic growth and lasting poverty reduction. An adequate level of revenue generation is sine qua non for the public policy to fulfil growing expenditure requirements.
The thrust of revenue mobilisation must include reducing tax rates, broadening the tax base, shifting the incidence of taxes from imports and investments to consumption and incomes, and providing a congenial environment to increase tax compliance. Every sector of the economy must be brought under the tax net. An equitable taxation system demands that income originating from any sector, if it crosses the threshold level, must be taxed.
Potential areas which can be brought under the direct tax net include agricultural income, incomes of doctors, lawyers, beauty parlours, chartered accountants, wholesalers and retailers and transporters to name a few. Improving withholding tax regime would increase the government’s tax revenue immensely. Taxes are being collected by withholding tax agents but are not being deposited in the government’s treasury. I am glad that the FBR has taken note of this and is making efforts to address this issue.
On the expenditure side, the government will have to take a bold decision as to the future of the rotten PSEs. In particular, how long can the government bail out these bleeding institutions from taxpayer money? The time has come to offload some of them even at a rupee each and appoint the best team available to manage the others. The government can save at least over Rs300 billion which can be spent on millions of defenceless poor and improving the country’s physical and human infrastructure.
Inept handling of the power sector has resulted in the accumulation of unsustainable circular debt. By raising the power tariff alone, the government has caused circular debt to balloon. Raising the power tariff is tantamount to raising tax rates. It is common knowledge that if we keep on increasing tax rates people will avoid paying taxes. Similarly if we keep on raising power tariffs it will encourage people to use unfair means to avoid paying electricity bills. As long as there are line losses and power theft, the issue of circular debt will always be there.
The government will have to reduce fiscal deficit from 6.5 percent of GDP last year (2010-11) to three percent by 2013-14. This can be achieved, provided there is commitment to fiscal discipline. Reduction in fiscal deficit will reduce the government’s borrowing requirements which in turn will help the SBP to reduce interest rate thereby freeing more credit for the private sector. This would also help the government to lessen its borrowing from the SBP and to moderate inflation.
Restoring fiscal discipline would help maintain price stability provided the government maintains moderation in enhancing government administered prices such as support price of wheat, and power and gas tariffs. Mobilising more resources through taxation on POL products would not help in reducing inflation. Thus, reducing budget deficit, moderation in government administered prices and maintaining exchange rate stability would be critical to bringing inflation down to a single-digit.
The new NFC Award has created structural issues for Pakistan’s fiscal policy. The acknowledgement of this debacle would be the first step in finding solutions. How to save this NFC Award and hence restore fiscal discipline is an important near term issue. One way to address this problem is to put some binding constraints on the provincial governments over the generation of a targeted surplus in their budgets. Let this be a time bound solution, perhaps for the next three to five years, and in the meantime let the provincial governments improve their own taxation and build capacity to spend money prudently.
Whether a weak government can undertake the above-mentioned policies to address near term economic challenges is a difficult question to answer but it can surely make a start by addressing the most pressing challenges. How to address the medium-to-long term economic challenges will be discussed in my next article.

The writer is principal and dean of NUST
Business School, Islamabad. Email: [email protected]

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