The ‘tough’ and ‘bold’ decisions that this government was being urged to take are finally here. In fact, ‘shock therapy’ would be the more appropriate term to describe the government’s recent policy decision on withdrawal of subsidies on cooking oil and fuel prices. And, by the looks of it, these will not be the only ‘bold’ decisions that will be taken in the weeks to come.
It is highly likely that the government will increase fuel prices again between now and when the National Assembly passes the budget. I am inclined to think that the announcement may come before the budget is presented in the assembly. Both petrol and diesel still carry a subsidy of around Rs9 and Rs23, respectively. This will have to go as well. Yet, the increase in fuel prices will not stop here. The government may succeed in delaying the announcement of further increases until the passage of the budget, depending on its agreement with the IMF.
The previous PTI government had promised the IMF a petroleum development levy (PDL) and a 17 per cent General Sales Tax (GST) on fuel. If these are announced in the current month, we can expect petrol and diesel prices to fall between Rs280 and Rs285 a liter. Of course, this assumes that international oil prices remain unchanged. If they register a spike in the coming weeks or months, that will have to be passed on as well.
Nepra has also revised the baseline electricity tariff by almost Rs8 per unit, more than a 45 per cent increase in the existing basic tariff. If the international oil prices increase, the tariff will go up again as it usually does under the fuel price adjustment mechanism. With the slide in Pakistan rupee, the inflationary impact of these changes will be felt through the coming months. None of this bodes well for the economy, particularly for the poor who will bear the brunt of these price changes the most.
There is no ambiguity in that this is being done on the IMF’s demand. Pakistan’s economy is in a tough spot, and the government’s standing vis-a-vis the IMF is particularly weak. The current account deficit is likely to reach $15 billion by the end of the current financial year on June 30. This has been the highest in our history and has happened largely due to a $45 billion trade deficit owing to high fuel prices and our continued reliance on importing essential food items and luxury consumer goods. Again, this is money that we do not have, and we have been borrowing through the financial year to pay for these imports. There is then the matter of external loans that needs to be serviced each year. We also do not have any money for that and resort to borrowing for that too.
All of this necessitated going back to the IMF without whose support we would find it extremely difficult, if not impossible, to raise debts internationally. Pakistan, in the past, has often been saved by four friendly countries — China, Saudi Arabia, UAE, and Qatar. Yet, as news reports have suggested, the message from them this time around was to first go to the IMF and only then would any support from them be available. All this points to the terrible shape the economy is in.
Going to the IMF will save us from a potential default but won’t bring any immediate relief. If the Article IV consultations done in February 2022 are anything to go by, the Fund is most likely pushing Pakistan to drastically control both fiscal and external account deficit. On the latter, some pressure will be relieved due to the temporary imports ban, and increases in prices through removal of subsidies, and a possible increase in duties on luxury items in the upcoming budget. The fiscal front will remain a key challenge for this government, especially because FY2022-23 will be election year.
Former finance minister Dr Hafeez Sheikh, speaking at a webinar organized by the Pakistan Institute of Development Economics in May 2022 claimed that Pakistan’s fiscal deficit for FY2022 at Rs5000 billion — or nine per cent of our GDP — will be the highest in our history. This despite the fact that we may end this financial year with the highest ever tax collection in our history. Controlling this high level of fiscal deficit would certainly push the government to apply severe expenditure cuts. A 40 per cent reduction in this would allow the fiscal deficit to settle between five and six per cent. In absolute terms, this would mean reducing government expenditures by a whopping Rs2000 billion.
In other words, the IMF’s prescriptions demand that the economy has to be squeezed drastically in order to reduce the inflationary pressures. There are indications that our now independent central bank agrees with this as well. In its last monetary policy statement, the State Bank of Pakistan stated that “with output gap now positive, the economy would benefit from some cooling.” In plain speak this means that the growth in the economy has taken it beyond the desired manageable level (the equilibrium point) and raising interest rates would be a good move.
It is important to see this in line with the shock therapy argument. A positive output gap represents movement beyond the equilibrium point and, theoretically speaking, the interest rates will have to be raised till the economy registers a negative output gap after which the rates can be lowered till the economy returns to equilibrium. I have no information for how long the SBP intends to keep raising the interest rate but, given the inflationary pressures due to the recent price hikes, one can expect the SBP to raise them further over the next two policy statements. Again, a lot will depend on what has been agreed with the IMF and how quickly it has been agreed to apply the adjustment. As said earlier, all this points to an increase in misery for the Pakistani people, especially the poor. So, what can be done to remedy the situation?
Two measures for the short run are important. First, ensuring food security of a country of 230 million through imports of essential food items is a recipe for disaster. This budget must ensure that we move away from this model and provide solid policy prescriptions for making us food secure in the coming few years. Second, reducing the fiscal deficit would not only demand a reduction in the federal government’s expenditure but also a further increase in taxes. This would be challenging given that an ‘overheated’ economy has to be ‘cooled’ down.
We must shift the burden of taxation on the rich. All cases studies done on Pakistan have found our tax system to be only mildly progressive at best. It is time this were changed and the rich and wealthy asked to pay their fair share.
This can be done by (re)introducing the wealth tax and revising the rates for capital gains and capital value taxes. The last tax, coupled with an upward revision and proper implementation of property taxes, may be necessary to move investments away from the unproductive real estate sector to more productive uses.
The next six months will be crucial to deal with the economic crisis, and giving a strong policy statement in the upcoming budget that this government does not mean business as usual will be important.Fahd Ali, "Petrol, people and policy," The News. 2022-06-04.
Keywords: Economics , Economic crisis , Economy-Pakistan , Economic returns , Imports , Taxes , Deficit , Dr Hafeez Sheikh , Pakistan , GDP , SBP , IMF