Econ 101?

With the fifth and final year’s budget during the current tenure of the Sharif administration expected to be presented to parliament before the onset of Ramazan, ie, in the current week, there is a growing perception among independent economists that the Ishaq Dar-led Finance Ministry may benefit from some refresher Economics 101 tips – first year economics taught in the US universities.

Pakistan, as per several Pakistani retired International Monetary Fund (IMF) staff, is a perennial borrower and therefore has to agree to certain conditions that are in line with conventional economic theory. Ignored by successive finance ministers is the fact that these multilaterals operate within their own constraints which include: (i) conditions imposed by powerful members of their board of directors – including the US, European countries, Australia, Japan – who may support a loan not on economic grounds but on their geopolitical considerations; (ii) staff performance in these multilaterals is gauged by the number and amount of loans extended by the team leader, the bread and butter of these institutions, which may lead to a promotion, or, in other words, there is a bias in favour of loan completion that may account for waivers of time bound conditions; and (iii) standard normal conditions based on the premise that one size fits all – a policy that accounts for many a former multilateral employee criticising these very conditions. These three elements, local economists point out, account for the completed three-year Extended Fund Facility (EFF) by the IMF and the consequent poor sustained performance of key macroeconomic indicators requiring some blatant massaging that have by now reached critical levels.

Finance Minister Ishaq Dar is required to take note of six major flawed economic policies that he has endorsed since June 2013 and which require an emergent revisit if the next government, be it formed by PML-N or another party, is to be able to manage without going on yet another IMF programme.

First and foremost concern must focus on the rising trade imbalance reflecting a decline in exports and a rise in non-oil imports. An overvalued currency, and the rupee is estimated to be overvalued to the tune of around 20 to 25 percent by the IMF (an entity that Dar never tires of citing as one that is appreciative of his economic policies) will, as per basic economic theory disable our locally manufactured products from competing internationally and domestically (given rampant smuggling along our long porous borders with India and Afghanistan). And to compound the problem a more expensive rupee makes imports cheaper and therefore attractive. This explains why in spite of a massive decline in our oil and products import bill during the Sharif administration attributed to a decline in the international price of oil – to the tune of around 5.5 billion dollars – there was no commensurate decline in our import bill. Dar maintains that machinery imports increased which would fuel productivity however the rise under this head was only 2.2 billion dollars between 2013 and 2016 – or less than half.

It is therefore not only deeply disturbing but downright embarrassing that Finance Minister Dar boasts of a strong currency while representing Pakistan in international fora and, at the same time, indirectly acknowledges his failure to bring the large parallel illegal economy into the tax net by first levying a different tax for filers and non filers and thenceforth widening the differential in each subsequent budget. In addition, the tax on cash withdrawals above 50,000 rupees has led to a cash economy which may partly explain a rate of inflation higher (4.8 percent) than what was projected during the recently concluded Article IV consultations with the IMF (4.3 percent annual rate).

Secondly, what is disturbing is the fact that taxes on imported petroleum and products (an indirect tax with a heavier impact on the poor relative to the rich) account for around 42 percent of all tax collections – a reliance that makes a mockery of the government claims that it is engaged in reforming the tax structure with the objective of moving towards greater equity and fairness. The reliance on indirect taxes as a revenue source is a lot more than is evident in official documents as the Federal Board of Revenue (FBR) is mis-defining withholding taxes that are in the sales tax mode as direct taxes. Incidentally, withholding taxes now account for over 70 percent of all direct tax collections.

Dar has already launched two tax amnesty schemes which failed to meet the over-ambitious targets after much hype was created at their launch by the Prime Minister. Needless to add, both times the IMF cautioned the government but sadly did not insist that amnesty schemes be abandoned. According to well-informed sources, Dar is currently engaged in a third amnesty scheme that would allow those who have foreign accounts or assets to pay a small flat rate and no questions will be asked as to their source of income. While the general public believes that this amnesty scheme may be a way out for those with foreign accounts – offshore or otherwise – yet it is unlikely that those with offshore accounts that have not been hacked and released in the media are going to note them in their returns.

Thirdly, the government has focused on bringing the deficit down – an IMF programme condition. However, a lower deficit may not have accounted for a lower outlay on the federal Public Sector Development Programme (PSDP) but has certainly accounted for a lower provincial outlay on PSDP, which implies lower disbursements for the devolved social sectors like education, health and provision of clean drinking water. This is reflected by Dar’s decision in subsequent budgets to raise the provincial surplus in the federal budget (in his attempt to reduce the federal deficit). Informed sources revealed to Business Recorder that in the current fiscal year all provinces, including Punjab, have indicated that the target set of 339 billion rupees total provincial surplus is simply not attainable and, instead, provinces are expected to go into deficits.

Fourthly, by taking massive loans from the domestic sector the government has crowded out the private sector on the one hand and by not paying refunds on time the government has compelled the productive sector, including exporters, to borrow from the banking sector to meet their liquidity needs with the cost of borrowing money adding to input costs. Foreign loans have reached unprecedented levels and the government has begun taking very short-term loans at high rates of interest from the external commercial banking sector (it has borrowed up to 2 billion dollars already) and has begun borrowing from Chinese banks for balance of payment support. This puts further constraints on the budget with foreign debt repayments (interest and principal when due) accounting for 31 percent of total expenditure (understated because of the overvalued rupee).

Fifthly, the main difference in expenditure between the PPP-led coalition government and the incumbent government is in the outlay on subsidies which were as high as 512 billion rupees in 2011-12 the last full year of the PPP government and declined to 197 billion rupees last year – a reduction of over 61 percent. This reduction is almost solely attributable to the dramatic decline in the international price of oil. The finance minister Dar used these savings to lower the unsustainable deficit however an economist would have advised him to begin to use the fiscal space that was created through a dramatic fall in the international oil price by: (i) reducing the provincial surplus to enable the provinces to invest in their social sector development, and (ii) allowing the rupee to reach its market rate to ensure that exports do not suffer and imports are no longer attractive. Neither policy was followed.

And finally, there are disturbing reports that the next budget envisages massive releases to PML-N and coalition partner parliamentarians that may be termed pre-election rigging by the opposition – a contention strengthened by Nawaz Sharif’s impromptu announcements of unbudgeted releases estimated at 20 billion rupees since he began to hold jalsas in the aftermath of the Panama case hearings.

To conclude, between the flawed policies of the Dar-led Finance Ministry and the election campaign launched by the Prime Minister the next year’s budget may show some numbers whose relevance maybe limited to the budget speech and the emerging picture would simply worsen our economic woes compelling whichever party forms the next government to go back on an IMF programme.