Farewell to a year of economic vows

This year, the government must act fast to establish macroeconomic stability and improve regulatory frameworks and business environment

Farewell to a year of economic vows

The second half of the last year started on a positive note of a full-fledged vaccination campaign. There was optimism that economic distress resulting from Covid-19 would fade out. However, for Pakistan, 2021 will go down as another year of financial challenges, worsening social indicators, high inflation, failed commitments, and administrative failures. Now with the emergence of the Omicron variant, hopes of an early economic recovery are again clouded by uncertainty.

The hike in commodity prices is unbearable for the general public. The most recent data compiled by the Pakistan Bureau of Statistics (PBS) confirms the continuing rise. Inflation was largely under control in 2013-2018. It has been rampant since then and every subsequent year has been more turbulent than the outgoing.

The State Bank of Pakistan’s Annual Report on the economy for FY 2021 highlighted that in Financial Year 2017 and Financial Year 2018 the inflation rate in Pakistan was 4.81 percent and 4.69 percent, respectively. During Financial Year 2021, it was around 9 percent, more than double the global average of 4.3 percent.

The poor decision to free-float the rupee caused massive depreciation of the currency. Next, the failed administration jacked up prices. This led to high inflation. The Consumer Price Index (CPI) for November 2021 was recorded at an alarming level of 11.5 percent on a year on year basis as compared to 8.3 percent during the same period last year.

Frequent changes were made in our policy rates with the sole purpose of controlling the inflation rate. In the recent past, Monetary Policy Committee of the SBP increased the policy rate by 25-basis points in September 2021. This was followed by another 150 basis points hike in November. The committee further increased it by 100 bps on December 14. The rate currently stands at 9.75 percent. In just three months, our policy rate changed thrice to deny the economy the consistency required to boost commercial activities in the country.

Moreover, according to recent official publications, the current account deficit has increased sharply this year due to a rise in imports. According to PBS data, imports rose to $32.9 billion during July-November from $19.5 billion during the same period last year. The current account posted a deficit of $7.1 billion for July-November as against a surplus of $1.9 billion during the same period last year. The main contributor to the current account deficit was the import of fuel. However, no efforts were made to explore alternative sources of energy.

The previous government took a landmark initiative in setting up the first LNG terminal and regasification plants in Pakistan. This helped reduce the economy’s reliance on expensive crude oil. However, due to mismanagement the current government failed to fully benefit from it.

Higher import prices have contributed to the deteriorating balance of payments. The current account deficit over the recent months has increased substantially beyond the forecast. Moreover, the burden of these external pressures has fallen on the rupee which has lost more than 40 percent of its worth in the last three years.

The rupee has been depreciating continuously and setting new records. If the exchange rate is stable the local market can absorb the impact of higher prices of imported inputs. This helps increase output without raising the cost too much and ultimately protects the general public from high inflation. The government has instead found an easy solution, borrowing from the international market, so that at the end of the first quarter for FY 22, i.e., September 2021, Pakistan‘s external debt and liabilities have ballooned to $127 billion.

This represents a massive increase, about 33 percent or $31.78 billion, since the incumbent government took power. Chronic issues like growing fiscal and current account deficits; rising inflation; growth deterioration; and depleting foreign exchange reserves have worsened at an alarming pace.

According to the monthly Economic Update and Outlook for December 2021, the FBR was able to significantly increase its collection by 36.8 percent to Rs 2,319 billion during July-November FY-2022, compared to PKR 1,695 billion in the corresponding period last year. The collection is 15 percent above the target set for July-November. According to the same publication, among domestic taxes, the collection under direct tax grew by 31 percent, sales tax by 40.7 percent, and FED by 16.7 percent.

The collection under customs duty increased by 46.5 percent during July-November. The evidence-based estimation by the FBR states that the overall FBR taxes are progressing (with 1.04 overall buoyancy) and are expected to improve subject to the attainment of positive macroeconomic indicators. The estimation states that during the last 20 years, the FBR revenues have grown at an average of 14 percent. Further break-up reveals that the direct taxes are most buoyant with a 1.13 buoyancy value, followed by sales tax (domestic) with a 1.11 buoyancy estimate.

On the other hand, sales tax (imports), customs and federal excise duty have relatively lesser buoyancies. Worryingly, these claims of success are not enough for the government to manage its expenditure and increase revenue collection at a pace corresponding to its needs. Consequently, the government’s reliance on the banking system for budgetary support continues to increase compared to June 2018 levels. The total domestic debt, as of October 21 has increased by more than Rs 10 trillion or 60 percent, reaching approximately Rs 27,140 billion. With the accumulation of large stocks of debt, the government financing needs have made the economic situation more vulnerable.

The tax system has failed to generate sufficient resources for the state to perform its key functions. The quantum of revenue being generated is sourced from a limited pool of people who are burdened with various types of regressive taxation.

The taxation authorities were supposed to address critical issues, such as a narrow tax base, unnecessary disparity, exemptions, problems of undervaluation and misreporting at the import stage, so that leaks can be plugged. Moreover, there are many avenues that can generate substantial revenues for the country but are either unregulated or taxation authorities have failed to devise an adequate mechanism to tax their revenue. These include agriculture and virtual assets.

The previous government’s strategy of creating a distinction between tax filers and non-filers and charging the latter higher rates has managed to generate more revenue and forced more people to file their returns, thus expanding the documented economy. However, there is still a perception among many non-filers that if they file tax returns, they shall be exposing themselves to tax audits and recovery proceedings.

The regulatory and operational framework must be designed in a way that generates more revenue and provides facilitation to the taxpayers. Historic perspectives provide evidence that Pakistan has slowly and gradually evolved into a state that collects less, spends more, and borrows enormously. This results in large deficits.

The incumbent government has been in office for more than three years. When they assumed charge they promised reforms and improved governance. However, they are still lagging behind in this regard. The IMF programmes are taking a lead in dictating economic policies for Pakistan. They have already handed over a long list of “deliverables” like removing subsidies, eliminating tax exemptions and privatisation of state-owned businesses.

The government must act fast to improve resource allocation, establish macroeconomic stability, improve regulatory frameworks and business environment and curtail corruption. Otherwise, the goals of self-sustainability, development, and better quality of life for the common man will not be achieved.

Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in white collar crime and sanctions compliance. Huzaima Bukhari is an advocate of High Court and adjunct faculty at the Lahore University of Management Sciences (LUMS) 

Farewell to a year of economic vows