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Contingency planning

The Government claims that the new IMF program of $6.7 billion under the Extended Fund Facility is based on implementation of ‘home grown’ reforms. If this is the case then Pakistan has voluntarily opted for a set of reforms which will effectively put the economy into a ‘straight jacket’. The growth rate is projected to fall to only 2.5% while the economy will go back to double-digit inflation. This is in contrast to the budgetary framework of the Ministry of Finance which targets for a growth rate of almost 4.5% in 2013-14 and single-digit inflation.

The first year of the Program is critical. During 2013-14, repayments to the IMF reach their peak of $3.2 billion. Subject to successful completion of quarterly reviews, Pakistan will receive $2.2 billion from the Fund during the year. This implies that there will still be a net outflow of funds to the IMF even in the presence of the program.

Despite this, foreign exchange reserves are expected to rise to $9.6 billion by the end of 2013-14, representing over two months of import cover. This will reduce the vulnerability of the economy to a foreign exchange crises and presumably the economy can get back on the path of revival from 2014-15 onwards. But attaining this target of reserves is fraught with many risks. First, some of the inflows are quite uncertain. These include the $1200 million from the Coalition Support Fund, $1200 million from the 3-G auction and $800m from privatisation proceeds. Second, exports are expected to show exceptional dynamism in a slow-growing global economy and rise by 11%. Third, foreign direct and portfolio investment (excluding privatisation proceeds) is also projected to rise by more than 50% in 2013-14.

But if one or more of these projections do not materialise then the foreign exchange reserves position will remain vulnerable. The Fund may insist on even faster depreciation of currency, especially through larger purchases from the spot market. This increases the danger of even more inflation, putting thereby a larger burden of the adjustment process on people.

How can this situation be avoided? The time has come to contemplate some genuine ‘home grown’ reforms especially as part of contingency planning. In the event, the strategy of short – term expansion of exports of goods and services fails then the alternative may have to be a policy of import compression.

Already, exports in the first two months of 2013-14 have grown by only 3%, while imports have shown a faster growth of 6%. Reserves are likely to fall to $5 billion or even less by the end of September, $1 billion less than at the start of the year, despite release of $544 million by the IMF.

How can import compression be achieved without affecting significantly the rate of inflation? The answer lies in protecting essential imports while achieving a significant cutback in non-essential imports. The former include items like wheat, edible oil, pulses, machinery, fertiliser, medicines and petroleum products. These items accounted for 52% of imports in 2012-13.

Excluding essential imports, regulatory duties may be introduced at rates of up to 10%. This will impact on 48% of the import bill. In addition, while a comprehensive review of SROs is under way, an interim measure should be adopted. In the case of items outside the list of essential imports, if the import is allowed under an SRO at a concessional duty rate more than 5 percentage points less than the statutory rate, then the difference should be restricted to 5 percentage points. On top of this, the import margin requirements on non-essential imports may be raised from 35% currently to 60%.

This battery of measures has the potential of reducing the non-essential import bill by almost $2.5 billion. The result will not only be an improvement in the balance of trade but also in larger foreign exchange reserves. Simultaneously, with lower depreciation of the rupee, prices of essential items will rise less and insulate better the bulk of the population from the adverse consequences of the adjustment process. The IMF generally does not like higher import tariffs and has, in fact, asked for trade liberalisation later in the program by reduction in the maximum import tariff rate to 25%. However, regulatory duties are recognised by WTO as a legitimate measure in the event of balance of payments difficulties. These duties can be scaled down once foreign exchange reserves rise to safe levels.

The advantage of this ‘home grown’ measure is that it not only leads to an improvement in the balance of payments but also contributes to higher revenues. The suggested move, as a contingency option, could yield almost Rs 100 billion of additional customs duty revenues. On top of this the consequential effects on sales tax and presumptive income tax will yield another Rs 20 billion. Therefore, this measure could help substantially in achieving an ambitious FBR revenue target.

It is surprising that the Government did not adopt this measure in its first Budget, instead of raising the GST rate from 16% to 17%. The PML (N) manifesto explicitly proposes the imposition of regulatory duty on non-essential imports. Are there any other measures which need to be adopted as part of contingency plan in the event of continued vulnerability of the economy? These will include measures on the expenditure front. First, despite the transfer of many functions to the Provincial Governments after the 18th Amendment, the Federal Government remains bloated in size. A number of new Ministries/Divisions were created by the previous Government with little justification. The new Government may consider setting up a Rightsizing Commission to undertake zero-base budgeting not only of the new Ministries but also of the almost one hundred semi-autonomous bodies and attached departments at the Federal level.

Second, in order to expand the number of taxpayers meaningfully certain types of persons may be asked to compulsorily file returns, including those who own a property (above 10 marlas) in urban areas, a motor vehicle, have a credit card, have electricity bills above Rs 5000 per month, etc.

In conclusion, the IMF Program has not contributed yet to bolstering confidence and in recent days the rupee has begun to depreciate rapidly. Achievement of the performance criteria in the Program in the first quarter remains fraught with risks, especially those relating to the floor on net international reserves, ceiling on net domestic assets and on net borrowing from SBP. Pakistan has to safeguard its position and remain ready to implement ‘home grown’ measures of the type mentioned above if the situation arises when the targets are not achieved and more action is needed.

(The writer is a former Finance Minister of Pakistan)

 

Dr Hafiz Ahmed Pasha, "Contingency planning," Business recorder. 2013-09-25.
Keywords: Economics , Economic system , Economic policy , Economy-Pakistan , Economic issues , Economic crisis , Economic growth , Economic activities , Economic planning , Nuclear programme , AIDS , Pakistan , IMF