Looming Challenges!
When it comes to economic management, these first ten months of the Imran Khan-led government has been quite tumultuous. Heads have rolled (from the Finance Minister to the Finance Secretary), and a mockery has been made of tenure posts (governor central bank, chairmen board of investment and FBR, etc.).
In the meanwhile, the economy has plummeted: revenues are down; exports are down; expenses up; borrowings up; interest rates up; inflation up; growth down; unemployment and poverty levels up; stock market down and the Pakistani Rupee landing itself at historical lowest. In its defense, if one listens to the government’s rhetoric, one is told that how it has finally managed to insert the right men at important positions and things going forward will become much better.
These initial hiccups should be regarded as nothing but a ‘house cleaning’ exercise to set things in order, an exercise, which was not only inevitable but also necessary. However, to an average observer (or the common man) who stands as the main victim of such mayhem, the obvious questions that come to mind are that will things improve in the coming months and is there really a method to this madness? The answer, unfortunately: Apparently not, at least not in the short run!
The new FBR Chairman must be a very bright and pragmatic person, but the fact remains that 1.4 trillion rupees are being proposed in new taxes, and no matter the tall claims on finding new taxpayers or restraining the tax collection machinery from harassing the existing taxpayers.
Never mind the conspiracy theories on how the new imported (key) economic managers do not have any long-term interest in Pakistan, an element that is bound to reflect in their policies; or that they work on a specific agenda of being dealmakers with the international financial lending institutions.
That their presence basically serves as the surety these institutions need for implementation of their loan pre-conditions. Or, arguments that given their limited domestic experience they do not understand the real underlying nuances cum sensitivities of the Pakistani economy, and hence will not be able to deliver any visionary long-term sustainable solutions for Pakistan.
The real fear though is that 3 years after the incoming IMF program, we may yet find ourselves an economy, which has possibly paid its looming/urgent debt obligations, but has done so at the expense of fracturing its core underlying economic structure responsible for shouldering manufacturing competitiveness, investments, job-creation and for rendering growth with equitable distribution.
This will now be our 13th IMF program since 1988, and after going through the basic conditionalities of all these thirteen programs, one struggles to find any significant difference between any of them; the only exception being that this latest one faces the grimmest situation ever, by being front-loaded on conditions, as compared to the previous twelve.
Read more: More deeds less words needed on the economy
It raises two concerns, first, will this program even be successfully completed? The pain may prove too much for the common man to bear, for three long years, or for that matter the quarterly review may not be a tenable pre-condition given three months is too short a period for economic indicators to take shape. Second, what makes the PTI government so sure that this time, the outcome of a completed Fund program will be any different than before? Ironically, even a cursory look at IMF lending, over the last five decades, does not show a single Asian or South Asian example where a country emerged as an economic tiger post an IMF program.
All these points are now mostly moot, as the initial agreement with the Fund already stands signed, and only time will tell how things play out over the next three years. However, it will be fair to say that the real challenge to manage the economy will only manifest itself once the pain from the IMF program begins to take root.
Moreover, such a challenge relates to the very ability of the present managers to craft policies – amidst an on-going economic slowdown – that not only mitigate the fallout from the Fund’s policies (on high discount rates, devaluing currency, removal of across the board subsidies, raising tariffs, stoking inflation through the supply side and oft undertaking arbitrarily revenue drives), but also inspire confidence of the people to keep them calm by keeping their hope alive (an area where the government has miserably failed thus far).
Government Making Tall Claims on Tax
So, what exactly is required to be done? First and foremost, talk to the stakeholders to accommodate their genuine concerns and to remove the present uncertainty. It is adversely affecting the investors, businesses and industry, traders, and service providers, and with it the economic activity itself – markets are stagnating, which can never be good for business.
It is time for economic managers to move beyond the mere IMF agreement and look for real answers on why the economy is not responding and what exactly needs to be done.
The new FBR Chairman must be a very bright and pragmatic person, but the fact remains that 1.4 trillion rupees are being proposed in new taxes, and no matter the tall claims on finding new taxpayers or restraining the tax collection machinery from harassing the existing taxpayers, the reality is that this new burden of taxes will once again fall on the existing taxpayers and the average consumer through a spike in indirect taxation.
Given the existing draconian tax laws and the arbitrary powers that remain vested in the tax collector, undertaking such ambitious revenue drives, without first bringing the long-awaited reforms in the current tax collection mechanism, will not only be foolhardy but also counterproductive, since it would further erode the trust of the taxpayer in the government, as new stories of harassment, extortion and corruption unfold.
The greater public fear though is not just limited to this imminent intrusion but goes far beyond to all sorts of other additional proposals that seem to be doing the rounds on the government’s behest. Like, for example, abolishing the present zero-rating facility on the five principal export sectors of the country; subjecting the ‘expenses’ entries to scrutiny – currently exempt under section 115(4) and allows the exporters a full and final settlement of their tax liabilities by deduction at source.
Talk is that the government plans to impose 17% GST on the exports’ sectors. Needless to say that these concerns should be quickly and adequately addressed, because such levies will not achieve much for the national exchequer, but result in tying up scarce liquidity of the exporters and increase their costs, making our exports uncompetitive. For example, 70-75% of the textiles production is meant for export, and only around 25% gets consumed locally. The trouble is that for anyone who has little or no practical understanding or the sensitivities of the Pakistani economy, it is difficult to understand that it has a peculiar way of working.
Read more: Growing Disappointment!
Over the last 40 or 50 odd years, in many ways the informal and formal sectors have become intertwined where they complement each other by cutting corners cum costs at different stages of the manufacturing chain and today a large portion of our export competitiveness is driven by the low-cost structures of the undocumented sector – For example, the ready-made garments sector, which by the government’s own admission is our fastest growing (by nearly 29%) export sector, would suffer immensely if suddenly its entire supply chain was to put under a sales tax regime.
Documentation of the economy should happen, but key supply chain structures cannot and should not be changed overnight. Any brash cum knee–jerk actions like suddenly abolishing the zero-rating of the five main exporting sectors of the economy or burdening the home manufacturing disproportionate to regional realities, runs the risk of dismantling the entire economic system of the country, and with it whatever little manufacturing-based exports that we have at the moment.
Any change to bring the informal sector into the documented domain needs to be gradual and through incentives and not coercion. In recent history, Bangladesh, Vietnam and now Myanmar have shown how targeted facilitation in sync with the broader vision (in their case promotion of exports) can work miracles!
The trouble is that the new economic managers do not have a domestic track record that businesses can relate to, and hence, there is an unsaid trust deficit between them and stakeholders. Despite the recent claims by the government that they now have the situation under control, regrettably, there seems to be little light at the end of the tunnel.
The main problem one feels is in the approach or the warped mindset that everyone is a thief, flawed thinking that naturally manifests itself in policymaking via an operational plan based on negative energies of witch-hunting and coercion, giving an impression that this government is after everything that one has earned or possesses. This is in itself very dangerous, because it gives a message that instead of expanding businesses would be better off contracting their activities.
One only has to look as far as Bangladesh to realize how they have cleverly encouraged smaller FDI inflows and have allowed only those investments that bear synergies with its larger vision of making Bangladesh a supply-chain powerhouse of the world.
What is needed today is for the government to restrain itself from sucking liquidity out of markets and instead focus on seeking revenues through growth and by bringing comprehensive reforms that incentivize a tax culture based on reciprocity. It is time for economic managers to move beyond the mere IMF agreement and look for real answers on why the economy is not responding and what exactly needs to be done. ‘Change’ Management requires a clear vision, strategy, and practical implementation.
Instead, what we see is confused signaling where the actions invariably tend to differ from the rhetoric. Obvious follies of the past, against which this party struggled for 22 years, are creeping back in: poor human resource choices; untamed bureaucracy; naked corruption, and in taking the easy way out by burdening the consumer instead of improving operational efficiencies; all elements that are adding to the uncertainty and stifling hope. The brewing situation takes us to the second part: to quickly re-think the policy choices taken thus far in the ten months.
Investment
A significant failure of the previous government was its over-reliance on state-to-state investments and in the process failing to spur investment from the private sector (domestic and foreign) that invariably is based on sustainability rather than any other considerations.
While state-to-state investment may occasionally have a strong rationale based on the project’s sheer magnitude or in targeting the promotion of a specific sector that the government prioritizes but is unable to penetrate on its own or to serve as a confidence booster or catalyst in kick-starting the investment climate, however, by and large such investments tend to be counterproductive as the majority tend to be based on factors other than pure market principles. Naturally, the state’s patronage and the extraordinary concessions that accompany such projects result in promoting rent-seeking in an economy, thereby not only distorting the market itself but also resulting in accumulation of large unserviceable debt.
Read more: Why is the Economy not responding?
We have witnessed this in recent years from CPEC related projects and similarly the refinery proposal now coming in from Saudi Arabia may not be too different! Ironically in our case, these state-to-state investments have even failed in their complementing purpose of catalyzing investment. Foreign Direct Investment in April ’19 clocked in at a paltry $132 million – lowest in recent memory – and LSM on latest figures shrunk by more than 10%.
Also, it is debatable that with weak investors’ confidence and a general slowdown in the economy, whether it is even the right time for significant state-to-state investments to take place, since our economy at present may lack the capacity and depth to absorb such large capital inflows. The government will instead be better off facilitating the domestic investor in a way that locks directly into industrialization, which in turn can go on to boost our exports and generate employment.
One only has to look as far as Bangladesh to realize how they have cleverly encouraged smaller FDI inflows and have allowed only those investments that bear synergies with its larger vision of making Bangladesh a supply-chain powerhouse of the world. In contrast, Bangladesh’s FDI from $700 million in 2009, has merely gone up to $2.58 billion in 2018, and almost all of it has gone into manufacturing that helps Bangladesh bolster its ever-rising exports – the rule of thumb being that every $1 investment is allowed only if it results in a minimum increase of $3 in annual exports.
The Footprint of Government
This stems from an inherent mindset of distrust of the private sector, displayed by successive Pakistani governments that keep on pushing capital into the public sector domain. No marks for guessing that the public sector essentially is a less efficient user of capital than the private sector. Meaning, the more one expands the public sector at the expense of the private sector, the more one loses. While, the ‘Change’ agenda proposed by the PTI led government should have reduced the governmental footprint in the economy, ironically, the contrary seems to be the case.
The thing is that when we closely study the global export miracles over the last five decades, we learn that a sustainable increase in exports primarily comes through a stable currency and not the other way around.
Announcements such as 5 million houses at a cost of Rs1.50 million each; continued borrowings to fund inefficient state-owned operations (2.24 trillion rupees merely in its first 5 months); increasing the size of the government instead of reducing it, etc., all point to business as usual for the state sector.
Ten months in government and so far, there is no real plan to fix the loss-making SOEs (State Owned Enterprises), where losses today by some estimates are touching near rupees 1.6 trillion annually. Moreover, over these last 10 months, it seems that new champions-of-losers have emerged in the shape of Discos (almost 1.1 trillion per annum with the circular debt in itself touching the 1.2 trillion mark) that now lead the pack (eclipsing past villains, such as PSL & PIA).
Missing are not only the much-touted urgent measures to weed out operational cum management inefficiencies and corruption from the loss-making giant WAPDA but also there are no signs of any long-term reforms plan whereby to open up the power sector. Simply transferring the burden to the consumers is the easy way out and does not solve anything.
To move towards market principles and transparency a host of legislative changes will need to be adopted, starting with some initial steps like doing away with the unnecessary legal protection extended to WAPDA’s functionaries; immediately allowing direct-distribution to the private sector producers by giving them access to distribution networks against a paid-sharing formula; revisiting all IPP agreements; allowing the provinces a direct stake via tariffs (as in India) to help control line losses and theft; and by simply taking over some of the heavy loss-making operations and putting them instead under private-public management controls.
Read more: IMF & Policy Options
Again, going by Bangladesh’s example, it only subsidizes power to its exporting industries and that too partially. If some part of exports needs additional support, then it is compensated through other ways like outright export-subsidies ranging from 5-20%, depending upon the specific product category. The idea is to not allow losses to pile up in their power companies even if it means increasing the general tariff in accordance with market realities. Power rates in Bangladesh have risen by as much as nearly 50% over the last three years, i.e. from $0.06 cents in 2015 to $0.09 cents/kWh as of today.
Exports
There is no argument that focusing on increasing exports is the right thing to do, but the trouble is that in today’s competitive world, increasing exports is a science and from what one has seen so far policymakers appear clueless. The concerned either don’t have the necessary experience in the field or don’t understand the nuances of the modern-day export industry. A simplistic route by way of devaluing the currency will not do, and this is becoming quite obvious by now. Post-devaluation, country’s exports have posted a mere 1.64% increase over the nine months from July ’18 to March ’19; in fact, exports decreased 1.78% in January ’19 over December ’18 and April ’19 over March ’19.
The thing is that when we closely study the global export miracles over the last five decades, we learn that a sustainable increase in exports primarily comes through a stable currency and not the other way around. Without going into the details of its reasoning, for now, it was always writing on the wall that we too will get no real or meaningful increase in our exports by devaluing the Pak Rupee. With no real accumulated export surplus in hand and an industry eroded by the damaging policies of Mr. Dar, at best the need was for a devaluation of no more than 10%, but certainly not 32% – this too to absorb the inflation of the Dar period and with it to just arrest the on-going decline in exports at the time.
To create a business-friendly environment, calm and confidence will need to be restored, and the constant outbursts on accountability and clampdowns will have to come to an end.
However, to seek a substantial export growth a more precise strategy is needed that not only explicitly identifies the growth areas, but then backs it up with direct support for capacity building and shoring up competitiveness to beat the competition. For example, despite the 32% devaluation, whereas, we saw quite several categories lose volumes the Ready-Made Garments category posted a robust gain of nearly 29%, clearly identifying where Pakistani exports carry a future potential.
Similarly, in today’s data rich world via IT, we can quickly determine which categories to support, where to focus on skill development, how and where to tweak existing FTAs, precisely which new products to launch, what specific subsidies to provide and to whom, what global price points to adopt for our products, and which markets to target. Ironically, an export specialist seems to be missing both in the TDAP and the Commerce Ministry.
Ease of Doing Business
For a meaningful investment to happen and for businesses to flourish and benefit economy, ease of doing business is an index, which nearly all-aspiring countries take very seriously these days. Despite, election time rhetoric, unfortunately, the PTI’s government in its short tenure thus far has not inspired any confidence in this sphere. The interest rate has climbed, now into double digits at 10.25%, meaning the effective borrowing rate for the SMEs being close to 17%. No matter what the government says, a simplistic link of such high-interest rates to inflation does not make too much sense in the case of Pakistan.
Read more: Why Pakistan’s exports are not growing?
The key elements in our CPI Basket that measures inflation hardly have any correlation to the central bank’s discount rate (34% Food Items, 24% House Rent & 15% Fuel & Transport).
Further, to ease operations, we still have no announcements on the one-window compliance facility, implying businesses still have to grapple with multiple governmental agencies, which some count at being in excess of 50 (including federal, provincial and municipal) and for that matter none either on any operational reforms aimed at a) distancing the taxpayer from the tax collector; b) reducing excessive and often counter-productive governmental oversight on businesses; c) tangibly reducing bureaucratic red tape in routine operational requirements, and d) rebalancing the skewed business laws that give unnecessarily extensive powers to the regulator – in short, all talk and no real action so far to help ease doing business in Pakistan.
On the contrary, doing business in Pakistan has become more difficult over the last ten months, a notion perhaps further confirmed by the untimely resignation of the Chairman, Board of Investment. Also, a massively devalued Rupee affecting economy has compromised on the connectivity of the Pakistanis per se, with the outside world – a natural side effect of any devaluation drive – with added capital pressures on any new plant investments for capacity addition, up–gradation for value addition or for balancing and modernization. Any further devaluation will isolate Pakistan further.
On the contrary, in Pakistan, these subsidized import oriented industries not only add to a huge import bill but also stoke many other issues such as negatively affecting the delicate trade-off between public and private transport preferences.
If the government is still serious about arresting the present economy decline, it needs to defend its currency and not allow the Rupee to sink further, because regardless of all the jargon about market forces-supply & demand, the reality is that in non-tradable currencies, such as the PKR, respective governments have a distinct role to play in determining their global parity.
To create a business-friendly environment, calm and confidence will need to be restored, and the constant outbursts on accountability and clampdowns will have to come to an end. While Indians take pride in their corporations successfully putting India’s footprint on the corporate map of the world, Pakistani businessmen are being hounded for making any such efforts!
Losing out on Winners in the Economy
From what one understands, and what was recently also explained by a provincial minister, that the government is looking to shift investment away from the real estate sector in order to stop avenues for parking un-taxed money, so that this money gets diverted to more productive sectors, because in his opinion the real estate in Pakistan has become too expensive.
The whole notion strikes as being very odd, because not only several other sectors stand aligned with real estate development, but also one fails to understand that how unwanted capital in one industry can become kosher or productive in another? And then, who ascertains the right price points of real estate or any product for the matter: market forces or the government? The trouble is that given a recessionary trend both at home and in the international markets, this is not a time to experiment.
Read more: The cost of economic dependency
Just retain your winners whether they are in the shape of real estate or the stock exchange or beauty parlors or food retail outlets – the mantra, for now, should be to keep the economy ticking. The revenue collection, for the time being, can mostly come through indirect measures, at least till the markets improve: Meaning, by taxing consumption (especially high end) through a fixed mechanism (like a pre-determined turnover tax regardless of profitability) rather than monitoring daily sales, and additionally by continuing to milk the petroleum sales – Petrol prices in Pakistan are still the cheapest in South Asia.
The key to economic management is not only a holistic approach but also to ensure that policies from all ministries work in tandem, to deliver the desired outcome. For a meaningful investment to happen and for businesses to flourish, ease of doing business is an index, which nearly all-aspiring countries take very seriously these days.
When one analyses things closely, one finds out that over the last 15 years the Pakistani economy has either de-industrialized, in the process losing some of its traditionally strong sectors of production in the SME (small and medium-sized enterprises) domain OR it has simply shifted to industries that either encourage import-based consumption through policy breaks (a legacy of Shaukat Aziz with examples being those of the automobile industry, motorcycles assembly, home appliance assembly, etc.) or due to corruption and weakening of oversight institutions (CCP, SECP, EDB, etc.).
Our industries today have been reduced (from being icons once) to primarily thriving on rent-seeking (IPPs, Fertilizer, Sugar, Banking, etc.), thereby negating the very advantage Pakistan once enjoyed in these sectors. Automobile or motorcycle assembly, for example, has been a futile and costly exercise, as it mainly operates on long-standing subsidies allowed through import duty breaks. Sadly, in all these years, they have done scant little in achieving the desired deletion targets.
Needless to say for us to embark on this clichéd new beginning, the journey will be slow, tedious, and a delicately timed process that entails due transition to a new vision. Also, it will take some doing!
In contrast, all over the world, such assembly plants are installed with permissions based on strict targets on exports and on achieving almost full indigenous manufacturing in the stipulated period. As an example, the Czech Republic produces as many as 1.50 million cars per annum and its next-door neighbor, Slovakia, produces another 1.3 million cars per year, but more than 90% of these cars in both cases are meant for exports.
In addition, between 80-90% deletion has already been achieved for foreign vehicles such as Volkswagen, Audi, Hyundai, BMW, Land Rover, and others. On the contrary, in Pakistan, these subsidized import oriented industries not only add to a huge import bill but also stoke many other issues such as negatively affecting the delicate trade-off between public and private transport preferences; environment and pollution; safety; distorted urbanization; and last but not least, enhanced household petrol consumption that otherwise could have been avoided – oil imports as we know constitute the most substantial chunk of our imports.
So the challenge is not just to re-start the process of industrialization in the country, but (through visionary policymaking) to redraw the future industrial map in a way that a) places reliance on homegrown industrial solutions in a competitive manner; b) encourages exports and replaces imports; and c) promotes the SME sector – the engine of growth and employment generation in any economy.
Read more: Economic Gurus: November 2018
Back in the 90s working with Dr. Bentzien of Belika, I was intrigued to find that how successive German governments consciously channel its funding to ensure a minimum level (as high as) of 10% for start-ups every year and to retain an industrial share of around 30% for the Mittelstadt in its manufacturing – Mittelstadt’s, as we know is primarily the family-owned SME sector of Germany and its real engine of growth, employment generation and exports since the 1950s – No wonder they succeed since the planning is so clear and precise. Needless to say for us to embark on this clichéd new beginning, the journey will be slow, tedious, and a delicately timed process that entails due transition to a new vision. Also, it will take some doing!
Dr Kamal Monnoo is a political analyst. He is honorary consul general of the Czech Republic in Punjab, Pakistan, and a member Board of Governors of Islamabad Policy Research Institute. He is the author of two books ‘A Study of WTO’, and ‘Economic Management in Pakistan.’ He can be reached at: kamal.monnoo@gmail.com. The views expressed in this article are the author’s own and do not necessarily reflect the editorial policy of Global Village Space.