The government must introduce economic reforms and focus on privatisation and exploration of new avenues for taxation
In 2019, the government led by Pakistan Tehreek-i-Insaf (PTI), reached the brink of a severe fiscal crisis through its indecisiveness and lack of control. Despite tall claims to the contrary, Prime Minister Imran Khan travelled to the United Arab Emirates to meet the International Monetary Fund’s chief and assured her of his government’s commitment to undertake structural and governance reforms.
Responding to the rescue call, the IMF approved a programme for Pakistan in July 2019, through which the crisis was averted and the government managed to partially stabilise the economy.
Accordingly, IMF’s Executive Board approved a $6 billion Extended Finance Facility (EFF) for Pakistan. Since then, the IMF-Pakistan relationship has moved through several phases. At times, the disbursement was delayed due to non-performance of commitments by Pakistan. These delays reflected badly on the national economy.
The conditions of the IMF’s programme and a letter of intent signed by Dr Abdul Hafeez Shaikh, the advisor to the prime minister of Pakistan, and Reza Baqir, the governor of the State Bank of Pakistan (SBP), required Pakistan to undertake numerous strategic, technical and transactional changes. However, on some review intervals, Pakistan failed to initiate the reforms as agreed.
The IMF has always emphasised maintaining a prudent monetary policy that should be reflective of real interest rates, rebuilding external buffers through natural means like bolstering exports and at the same time allowing exchange rate flexibility. This is because previously the exchange rate was allegedly managed through significant forex interventions, which contributed to imbalances on the external front.
In parallel, interest rates were kept low to support the local economy. However, this triggered consumption and import-driven growth, which added fuel to the fire of external imbalance and government’s reliance on local and international borrowing channels.
Currently, Pakistan is facing a challenge on account of debts. In the fiscal year (FY) 21, they rose to 100.3 percent of the gross domestic product (GDP). Pakistan’s gross external financing needs in FY 23 and FY 24 are estimated to be around $77 billion. Given the deteriorating current account balance, the situation is getting more complicated.
Pakistan therefore needs to work on increasing its exports, to explore new markets and must focus on technological advancements. Currently, the goods offered by Pakistan remain at the southern end of the global value chain.
Although Pakistan has signed free trade agreements (FTA) with China, Sri Lanka and Malaysia, and has preferential trade agreements with Iran, Indonesia, and Mauritius, except for China, not one of these countries falls in the category of main importers of Pakistan’s products.
According to the IMF report, in FY 2021 trade with the United States, United Kingdom, Afghanistan and Germany comprised about 37 percent of the exports. Exports to the three FTA markets were only around 10 percent. Entering FTAs with major export market destinations can boost Pakistan’s exports and reduce the external imbalance.
It is pertinent to mention here that, after a recent IMF staff review, the government has agreed to assess its export refinancing scheme by the end of this month. This might pose new challenges for export-oriented industries. The IMF has also raised concerns over refinancing schemes offered by the SBP to address long-standing large credit gaps and market failures and has warned that this expansion, if not temporary, would undermine its efforts to credibly implement monetary policy to achieve its primary objective and improve monetary policy transmission channels.
The conditions in the International Monetary Fund’s programme and a letter of intent signed by advisor to the prime minister of Pakistan and governor of the State Bank of Pakistan required that Pakistan undertake numerous strategic, technical and transactional changes.
To bring efficiency to its domestic financial operations, Pakistan needs to ensure that the energy sector is working in a financially viable way. Addressing the circular debt issue and strengthening the applicable regulatory framework is therefore of paramount importance. High transmission losses and low recoveries hamper payments to power companies. This is a major cause for accumulation of circular debt that is alarming not only for the power sector but also for the whole economy.
As of June 2021, the circular debt had reached a historic high level of Rs 2.3 trillion. The inefficiencies in power generation, transmission and distribution, and non-payment of subsidies in a timely manner are the main causes of increase in circular debt. In parallel, a new phenomenon of gas sector circular debt has emerged.
The IMF estimates provided in its Country Report No. 22/27 dated February 2022, warn that circular debt in the gas sector peaked at Rs 654 billion at the end of June 2021 (Rs 554 billion in system gas arrears and about Rs 100 billion in regassified liquefied natural gas arrears).
The constant bleeding of scarce resources in the hands of inefficient and loss-making state-owned enterprises (SOEs) is also a great concern. The SOEs have a significant market presence, particularly in key service sectors like power generation and distribution, energy, aviation and railways.
The recent State-Owned Enterprises Triage report provides a snapshot of the federal SOE landscape. It states that as of FY 2019, there are 213 SOEs, out of which only 85 have commercial operations (18 financial and 67 non-financial). The overall revenues of these SOEs in 2018-19 were recorded as Rs 4 trillion, that is roughly 10 percent of the nominal GDP. These SOEs employed more than 450,000 people which constitutes around 0.8 percent of the total workforce. The financial performance of several SOEs has remained worrisome, and in 2018-19, commercial SOEs collectively recorded net losses of Rs 143 billion.
The government must go for restructuring state-owned entities to reduce the state’s burden of funding these loss-making ventures. Their privatisation is the only viable option for modernising and revamping these institutions. This can generate employment and more tax revenues for the government. Otherwise, the state would be left at the mercy of global lenders who propose and impose policies with no consideration for challenges faced by the common man.
The recent resumption of the EFF indicates that the government has undertaken aggressive revenue measures by introducing amendments in indirect tax legislation by moving most goods from zero-rating (5th Schedule items) or reduced rates (8th Schedule items) to the standard sales tax rates by eliminating many exemptions listed under the Sixth Schedule to the Sales Tax Act, 1990.
The finance minister, Shaukat Tareen, has also expressed the government’s intention of increasing petroleum levy (PL) which is expected to help bridge the revenue deficit. According to the recently published IMF staff report, in early November, the authorities started gradually increasing the levy on gasoline and diesel oil by Rs 4 per litre, with a further Rs 4 per litre increase in December. The government will continue to increase the levy by Rs 4 per litre per month until it reaches Rs 30 per litre.
The global lender has also emphasised sales tax harmonisation. Currently, services are subject to provincial taxation and goods fall under the purview of federal sales tax. This dichotomy has created several compliance issues for taxpayers and administrative problems for taxation authorities. Further, in terms of direct taxation, the IMF staff reports indicate that Pakistani authorities are in the process of drafting Personal Income Tax legislation for next financial year, i.e., FY 22-23, which aims at reducing the number of rates, income tax brackets, tax credits and allowances.
After swallowing these bitter pills and consenting to “aggressive reform measures” Pakistan has now completed the sixth EFF review and the earlier withheld $1 billion tranche has been released. Pakistan has now obtained the $3 billion from the IMF under the current programme with $3 billion to be issued subject to successful completion of the remaining reviews.
These commitments are expected to attract a wave of taxes and duties, which can make the common man’s life more challenging. The government must achieve the equilibrium in a way that its revenue objectives are met without being regressive to the common man. This can be done by introducing economic reforms focusing on privatisation and exploration of new avenues for taxation.
Abdul Rauf Shakoori is a corporate lawyer based in the US and an expert in white collar crimes and sanctions compliance.
Huzaima Bukhari is an advocate of the High Court and adjunct faculty at Lahore University of Management Sciences (LUMS).