Sunday July 03, 2022

Agenda for a charter of economy

October 25, 2021

The writer is a former civil servant.

Our economy faces structural issues of twin deficits, circular debt, loss-making public-sector enterprises, low productivity, low end exports and is therefore trapped in a boom-and-bust cycle.

The growth spurts are invariably arrested by what economists call ‘over heating’ of the economy, forcing us to resort to fiscal stabilisation measures to slow down the growth momentum mainly because the underlying structural issues crippling the economy remain unaddressed owing to political economy constraints. The boom-and-bust cycle over the last seventy years of our economic history tells us that there is no shortcut to sustainable growth until and unless we tackle these structural issues head on.

The periodic high growth has been prodded through episodic public sector spending and investments, sometimes in the form of CPEC or sometimes through foreign aid inflows. It is, therefore, high time we developed a bare minimum political consensus on addressing the structural issues of our economy in the medium- to long-term period as any further delay would exacerbate our economic woes posing serious challenges to the stability of our polity.

These are the key areas where the political parties must reach an agreement to bring the country out of low road of development – a road characterised by low productivity, low value-added exports and low growth:

First, reducing the fiscal deficit by increasing the revenues and curtailing or freezing of expenditures: The political parties should agree to increase the tax-to-GDP ratio up to 20 percent from the current 10 percent over a period of, say, the next ten years. There should be a broad consensus on broadening the tax base, rationalising the tax rates, eliminating exemptions, plugging leakages, updating and integrating the database of different economic transactions, strengthening enforcement, reducing the imbalance between the direct and indirect taxes and restructuring and revamping the tax machinery/administration.

Simultaneously, we need to control and freeze our current expenditures by rationalising the number of employees in the government with a clear understanding that the government can no longer be the employer of the last resort and by making pensions ‘off budgetary’ item through creation of a pension fund and changing the pension design from the existing defined benefit pension system to a defined pension contribution scheme for the new employees.

Second, addressing the current account deficit through promoting higher productivity and high-end exports rather than relying on borrowings and remittances. The gap between exports and imports has always put brakes on our path to economic recovery and growth on a sustained basis as rising imports vis-a-vis stagnant and low value-added exports worsen the trade deficit, weaken the currency resulting in devaluation and inflationary pressures further requiring adjustments to stabilise the economy rather than to continue on the path of economic growth over a longer period of time to graduate from low-income countries to middle/high income countries.

Economic history tells us that the way to achieve sustained growth is by converting your comparative advantage into competitive advantage by shifting from low-end exports to high-end exports through technological up-gradation and higher productivity. South Korea is a case in point. On the one hand, this calls for investment in your human capital. On the other hand, we need to devise a strategy for increasing exports which should cover both goods and services, explore and develop hitherto unexplored sectors and find new markets to earn much needed foreign exchange. We need to focus on the IT sector, mines and minerals, automobiles (a sector which has extensive backward and forward linkages with the other sectors of the economy), pharmaceuticals, etc to increase the exports from current level of average of $ 24-25 billion to $ 40 billion over a period of next five years.

We need to prepare a very comprehensive incentive package for the new and high-tech sectors, along with export targets (as was done by South Korea), to become competitive at the global level and then to sustain this package without any disruptions irrespective of any changes in the political government. We must also resort to e-commerce, upgrade our infrastructure, and bring about efficiency in ports and shipping services to reduce the cost of doing business and enhance our competitiveness.

The third area where we need to have a political agreement is that of privatisation. The political forces of this country must agree that the government will not venture into an area where goods and services can be provided by the private sector in the first place (with some exceptions for strategic reasons like national security). The economic rationale to continue supporting organisations like PIA and Pakistan Railways, to name a few, at the cost of budgetary deficit is no longer tenable given our precarious fiscal position. There is no justification to run corporations and businesses.

Having a consensus on privatisation is going to achieve the three-fold objective of bringing efficiency in the economy, expanding the private sector and also reducing the fiscal deficit as a huge amount is being provided through annual budgets to the loss-making public-sector enterprises in the form of financial support.

Fourth, subsidies to public-sector enterprises and on food and energy items also contribute to the fiscal deficit. It should be agreed that the government will not try to control or subsidise the market prices of food and energy items. All commodities should be traded in the market at the prevailing market prices. The government will only provide direct cash transfers to the poorest of the poor. The cash transfers should be linked with food and energy prices. In times of high commodity prices, the amount of cash transfers should be increased and vice versa. We have come a long way in institutionalising a robust system to manage and run a direct cash transfer programme in the form of Ehsaas/BISP and we now only need to eliminate a parallel system of providing across the board subsidies to the rich and poor alike.

Fifth, resolution of structural issues will remain an elusive dream without holistically reforming our energy sector and having a consensus in this sector is imperative, given that the successive political governments have shied away from directly remedying the fundamental issues in energy sector due to immense political costs that a political regime might have to bear as a result of reform measures. There is a need to reduce the currently predominant reliance on imported fuels for generation of power by shifting to renewable sources of power like solar, wind and hydel under a well-defined plan to be implemented over a period of time. Furthermore, we need to replace cross-subsidies with direct subsidies using the Ehsaas database to identify the deserving users.

The government needs to deregulate and privatise electricity and gas distribution and allow the private sector to compete and provide these services, as has been successfully done in other countries. Even if the Nepra determined tariff is fully implemented, the circular debt flow will not stop due to billing under-collection and excessive transmission and distribution losses thus necessitating reform and ultimately privatisation of DISCOs which has been delayed time and again by successive governments due to political pressures. We therefore need an across-the-board political agreement to take ownership of this reform. DISCOs privatisation should be backed by a strong and effective regulatory regime with well-defined incentives and penalty structures.

Sixth, the 7th National Finance Commission Award has resulted in skewed distribution of resources between the federal government and the provinces, leaving the federal government at a fiscally disadvantageous position as the latter continues to retire debt, provide a budget for subsidies (meant for population residing in the provinces), fund BISP/social protection expenditure (which should ideally be borne by the provinces) and incur expenditure on the civil armed forces which essentially perform law and order duties mainly in the provincial jurisdictions.

Consequently, the provinces have little incentives to increase their own revenues – notwithstanding the fact that they were required to contribute to increasing the tax-to-GDP ratio by taxing the agriculture and real-estate sectors under the 7th NFC arrangement. It is, therefore, the need of the hour to review the NFC arrangement by either altering the revenue sharing arrangements to make them more balanced and equitable or by provinces partaking some of the expenditure liabilities that essentially belong to them in the first place as per assignment of functions laid down under the constitution.

Seventh, Pakistan’s debt indicators continue to worsen due to persistent primary deficits, relatively high exposure to the external debt (which leads to abrupt increases in the debt burden because of currency devaluation) and high cost of domestic debt (owing to higher inflation and above market cost of saving schemes). External debt constitutes 35 percent of the total public debt. We need to run primary surpluses for the next ten years – meaning thereby that we do not have to obtain additional debt to meet our non-interest expenditures. Secondly, we need to reduce the proportion of external debt from 35 percent to 25 percent or less over a period of next five years. Thirdly, the political parties should solemnly commit to strictly adhering to the debt-to-GDP ceilings as prescribed under the Fiscal Responsibility and Debt Limitation Act. Fourthly, lower inflation combined with lower borrowing needs would result in lower borrowing costs, making more resources available for private and public sector investments stimulating economic growth. Lastly, we need to increase the proportion of longer-term debt in our overall debt portfolio.

The process to build consensus on the above issues should be led by the government involving consultations with all the main political actors and other stakeholders and any changes after finalisation of the charter of economy should also be made only with the agreement of all concerned.