What does this budget say about the state of Pakistan’s economy?

By Hina Shaikh

The PTI government has presented its first federal budget of Rs 7.04 trillion in the absence of a full-time finance minister. The budget announcement also came amidst a flurry of political arrests and a recent staff-level agreement to a USD 6 billion IMF program. These developments were preceded by an overhaul of the government’s key economic decision-makers.

A day earlier, the latest Economic Survey released a bleak economic outlook for Pakistan. The country’s forecasted GDP growth at 3.3% – against a target of 6.2% – is set to hit a record 9-year low. Pakistan also faces the highest inflation in five years nearing double digits. Even the budget speech yesterday, was quick to acknowledge slow growth and static exports since the past five years.

gdp chart

Source: Dawn, June 11, 2019, Budget brief, 2009-2020

GDP growth rate for fiscal year 2018-2019 has been 3.3 percent, which is forecasted to further reduce to 2.4 percent in fiscal year 2019-2020.

 Facing a looming balance of payments crisis just two years after the completion of a USD 6.6 billion IMF program, and well into another one, the government was expected to take some tough economic decisions leading up to and included in the 2020 budget. In fact, the goals unveiled for FY20 underline the scale of the economic challenges the country faces.

 The budget for FY20 includes a strong commitment to narrow the primary deficit – the difference between current government spending and total current revenue (net of debt reservicing) – down to 0.6% of GDP from an anticipated 2.0% for this year.

 Much of the adjustment burden falls on revenues. Not surprisingly, therefore, the budget sets ambitious targets for revenue collection combined with aggressive expenditure control. The budget is loaded with new taxes and austerity measures/spending cuts.

 

Is PTI on its way to fixing what ails the economy? 

 Pakistan’s economy can only be fixed if we address its most fundamental structural flaws. This requires an understanding of what ails the economy –  a disparity between public sector spending and income, and an underdeveloped export base.

 Unless policymakers take concrete measures to address the underlying causes of macroeconomic crises, this fiscal situation will repeat itself every few years.

 What do we need to do to fix this?

 On the one end, we need sustainable and reliable flow of income – hence an increase in revenue generation. We need tax reforms to focus on progressive taxation and reduce reliance on indirect taxation and thus protect the interests of the low-income.

 On the other end, we need to rationalize expenditures, reduce losses of state-owned enterprises and streamline government machinery. At the end we need a strong export base and a strengthened business environment with a strong private sector engagement.

 Does the budget reflect this commitment and offer a stabilization of the macroeconomy and its fundamentals?

 The budget focuses on some aspects of the critical interventions needed to boost the economy, but there are glaring contradictions as well.

 Attending to IMF conditionality, a one-time sacrifice of defence budget’s increment, more income tax slabs and higher sales taxes are temporary measures to provide breathing space to help avert a current fiscal crisis. 

defence expenditure chart

Source: Dawn, June 11, 2019

Pakistan’s armed forces have voluntarily agreed to a reduction in their budget, mainly comprising salary cuts of officer corps. In a country that continues to remain embroiled in multiple external and internal conflicts, requiring military operations against terrorist groups,  this shows the resolve of military authorities to support the government. 

 The government is still committing to a high fiscal deficit at 7.1% compared to 7.2% of GDP in last year, owing primarily due to the large size of the debt repayments not leaving much for the private sector and businesses.

 In addition, the government has announced, in a low-growth period, highly challenging revenue targets relying mostly on taxes to be collected from the masses. A plethora of new taxes have been levied and income tax slabs revised. The burden has fallen onto the salaried classes – as is typical – and is bound to hit the consumption of middle-and-low income segments to further slow down economic activity and reduce aggregate demand.

 This is despite a recent World Bank report confirming that Pakistan is capturing only half of its revenue potential and needs to raise revenues by enhancing tax compliance not levying new taxes or increasing rates.

 A new structure of indirect taxes is bound to increase the prices of essential items such as electricity, gas, edible oil and sugar, and will impact the overall cost of doing business and cause further inflation.

 This is expected to worsen with a falling rupee which has already depreciated by more than 30% against the dollar since December 2017.

 Moreover, how are exports expected to grow with a withdrawal of zero-rating facility accorded to the five leading export sectors namely: textile, carpets, leather, surgical and sports goods? Almost 65% of the exporting sector will now be liable to pay 17% duties.

 In the short run, these budget commitments may become unsustainable, necessitating interim finance bills to provide quick fixes.

 The PTI government has already passed two mini-budgets in the past fiscal year. Another one will only confirm the fears of the government’s worse critics.

 

How different is this budget from the previous ones?

 Unlike the previous budgets this budget comes at the backdrop of an imminent sign off to a three-year extended fund facility with the IMF. What this means is that this budget is front loaded with prior actions to meet the IMF conditionality grounded in market-led reforms.

 Imran Khan came to power promising to create 10 million jobs and build 5 million low-cost housing units over a five-year period, as part of his vision for an ‘Islamic welfare state’.

 In the backdrop of a stabilization package, constraints of the IMF conditionality are expected to cut across Imran Khan’s attempts to establish a welfare state. And the new budget is underpinned by this underlying economic reality.

 The total budget outlay is 30% higher than previous year. However, the focus is on two critical two critical aspects – raising revenue and cutting down expenditures. Both actions are geared towards reducing the primary deficit in the immediate future.

 What stands out in this budget is the excessive focus on revenue generation, setting seemingly unrealistic, through probable, targets and austerity measures across all sectors. Tax collection targets of Federal Board of Revenue (FBR) alone are estimated at Rs 5.555 trillion to bring tax-to-GDP ratio to 12.6%. Overall federal revenues are estimated at Rs6.717 trillion – 19% higher than the previous year’s revenue.

 What remains unchanged, despite the high revenue targets, is that the salaried class as always bears the brunt of the tax reforms. At the same time a rise in indirect taxes will make everyday use commodities more expensive.

 However, some of the suggested tax measures are seen as positive steps towards documenting the economy. These include the condition that property cannot be registered in the name of non-filers and much higher tax rates for unregistered companies.

 This budget is also focused on austerity measures and spending cuts.

 The army has also decided in an unprecedented move to voluntarily skip this year’s increment. The budget outlay for defence remains unchanged at Rs 1.1 trillion. This reveals clearly government’s keenness to ensure IMF has everything it needs for a sign off.

 Government’s running expenses have also been slashed down. Cabinet members will take a 10% cut in their salaries while grade 20 and 21 officers will also forgo any increment in their salaries.

 The government has however taken some measures to safeguard the unprotected and low-income strata.

 Some projections suggest that, over a three-year adjustment period, almost 1 million jobs could be lost and some 1 million people could fall below the poverty line. Mindful of this, the IMF insisted the new budget maintains social spending at the level of previous year.

 The government has formed a new ministry to eliminate poverty to launch programs for social safety and become the umbrella organization to manage the Ehsaas program.

 At the same time, stipend through BISP scheme has increased from Rs5,000 to Rs5,500, with a 10% rise for pensioners while a ration card scheme is being introduced where 80,000 people will benefit via interest-free loans.

 This year’s budget also sees an increase in the minimum wage from Rs 15,000 in the last two budgets to Rs 17,500.

 

Where can we expect the economy to be at the time of the next budget?

 Any successful IMF program requires government’s commitment to policies (some painful) that are outlined in the program. Associated with a new loan will be extensive pressure to reduce aggregate demand of which the largest burden will be on the fiscal side. A limited fiscal space can hamper Khan’s efforts to substantially enhance public spending and also hit economic growth.

 The last time Pakistan entered the IMF program, growth rate stood at under four percent. Projections already reveal that growth rate will fall further to 2.4% while inflation will enter double digit figures at 13%.

 This poses a challenge to the new government, voted in with high expectations to set up an Islamic welfare state. Its electorate will expect initiatives for social uplift and job creation and at the same time, high growth.

 What we can expect before the next budget, in the face of an economic slow-down, is higher inflation and a tighter job market as economic activity takes a hit.

 Some of this inflation could be offset if income taxes were lowered, but that is not the case as Pakistan targets to grow tax revenues at the fastest pace in recent years. With less than 1% of the 208 million people filing their returns, it may be difficult to meet the ambitious revenue targets.

 While a slow-down in the demand for imports will help to prevent the dollar drain and reduce the trade gap and higher taxes along with spending cuts can help reduce budget deficit, the government may save enough to spend on development projects.

But this process will take time.

It may take two years may before economic growth can bounce back and government is able to fix the larger macroeconomic problem. If not, then we could be looking at another bailout.

A shorter version of this article was first published in Dawn. It appeared in Prism: https://www.dawn.com/news/1487766/is-the-pti-budget-sustainable-for-an-economy-like-pakistans

Hina Shaikh is the Country Economist at the International Growth Centre (IGC)

One comment

  1. Solution to Pakistan Imports/Trade deficit

    The burgeoning Pakistani import kills the PKR (due to deficit and FX timing of flows in the spot cash and IBR market) and is a drain of FX earnings

    But the solution is simple – just 5 steps.dindooohindoo

    Step 1 – Ban all luxury imports

    Ban all luxury imports,like the destruction of wine and alcohol cedars by Babar,in his conquest of Hindoosthan – as a moral proxy for the jehad in Kashmir,and the character required,to support the Kashmiri freedom struggle against Hindoo oppression.Within that,Liquor,Tobacco,Intoxicants and Cosmetics are easy for a Muslim and would appeal to the common Pakistani (as a sacrifice made by the Rich Pakistanis – in terms of abstinence)

    Next are pristine luxuries – watches, cell phones,jewellery,cars and expensive bikes etc – which are really not required at this juncture.,Imports of Liquor etc can be allowed only for Diplomats and Foreign tourists in quotas renewed each year – and imported by CANALISED IMPORTS by Pakistan PSU only.(Embassies,in any case,can import free of restrictions under UN conventions)

    Lastly, are autos.There is no need for people for import cars/bikes,if they already have 2 vehicles. So A TBT can be imposed that a certificate is sought on number of vehicles by actual user – at the time of remittance.Some people will use drivers names to import autos – so better to ban them outright.

    At a later stage, sole manufacturing and assembly rights can be given to a few licensees to make these items in Pakistan so that the cost of power,labour and some materials are in PKR and the profits are retained for some time,so that some FX is saved,and the rest is postponed.

    Most Asian nations are sitting on unused capacities and so low capital goods imports is not an issue,in any case

    Step 2 – Restructure Imports paid by Inter bank route

    For all imports paid by “inter bank route on CAD or DA” – shift it to LC mode on usance mode (from the Pakistani importer bank).The problem is that some importers may be making small imports and so the cut off limit by value, of imports by amount,can be set.The objective is to roll over the LC payments,as far as possible – so that the date of USD outflow is deferred,for the Pakistan banking system.

    If cost of LC usance (on life cycle mode) is high – the importers can use SB LCs to secure the suppliers (who will discount the drafts on Day 1) and the rollover financiers.

    As a result,the Pakistani importer will have surplus cash in that period and some importers will divert it – so that cash has to be blocked/liened by the bank on the date of the 1st date of rollover.During the tenor of the LC rollover,the FX position has to be hedged as a mandatory rule and the cash invested in safe T- Bills or Short dated GSecs,to finance the cost of the FX covers.

    The importer wil earn a treasury profit,and will have time to fine tune the date of crystallisation of the FX rates on the date of remittances – vs using the IBR TTSR,as of today.In the alternate – Blue chip entities (in terms of ethics) can use the cash surplus of the LC,to discount supplier bills (whose deemed cost of capital is 25-30% per annum) with significant margin improvements for the importer and the suppliers

    There is no dearth of banks who will roll over Pakistani LCs of 1st class banks (In Dubai/London/EU/New York. .For Non 1st class banks – some Pakistani Top rated bank or Foreign bank in Pakistan can add confirmation of the LC.LCs can by creative tools be rolled over – forever – till Jesus returns to earth.Some Hedge Funds also might also do it,as it is safe bet with a yield ,way over the USPR.

    This will avoid squeeze of USD in the IB markets – data about which is known to bankers,and so is also known to speculators and then the grey market.It affords flexibility in pushing out USD payments at various points of time – and can be restricted at any time by the SBOP.The Uncertainty in the SBOP policy on rollovers will ensure that the market is unaware of the CRYSTALLISED FX Liability on ANY DATE for the banking system (as there will never be a CERTAIN CRYSTALLISED DATE)

    So no punter will be able to speculate in the FX market,as the SBOP can change the crystallised liability on any date (unless the SBOP leaks the data) and the date of CRYSTALLISATION CAN BE CHOSEN IN SOME CASES, WHEN THE PKR HAS APPRECIATED

    For large importers in Pakistan importing on 90 – 120 days clean credit for many years on a regular basis – factoring and forfaiting limits can be set up in Dubai/London etc., to make the suppliers draw bills of exchange (drafts) for the rollover period of say 180 days or 270 days,which are accepted by the Pakistani importers.The drafts can be factored or forfaited by overseas financiers,with recourse to the importers (at say LIBOR + X points) and with recourse to suppliers (at a lower rate). The Risk is that the Pakistani importer signs the draft and disappears with the money (for the companies with doubtful ethics).In such cases,the importers bank can co-accept the drafts (and block or lien the importer funds)

    In the alternate,if the supplier cost of capital is lower, the supplier can “extend longer credit based on SB LC” issued by Pakistani importer (banker) and then “keep rolling it over” – based on “effective rates and arbitrage”

    Step 3 – Grey Market Imports

    This is the market where “no import duty is paid” and the USD is bought in cash “in advance” in Karachi or HK or Guangzhou. None of the imported items are necessities – denial of which will lead to death of the user.Some portion of the imports are made by baggage imports by air – which is an evil,which can be overlooked.

    Speculators take advantage of the squeeze in the interbank and the DEMAND of these grey market imports,to play havoc in the spot market – which hits the headline on the newswire.

    The solution is to identify say “500 high value imports by Tariff codes” and BAN Them – and direct only imports vide canalised imports from Pakistan PSUs (called,say SOPSU) with liaison offices in Dubai,HK/Singapore/Guangzhou/Shanghai.The Pakistani importers can identify their supplier and cargo – the chinese supplier will raise the bill on the SOPSU,who will stamp it as accepted – after the Pakistani importer has accepted it – on a back to back basis.The SOPSU will accept it after the Pakistani importer has deposited the PKR in Pakistan,with the SOPSU.

    The Chinese importer will take the SOPSU accepted bill to any Chinese bank and get the money. Of course, now the money is “on recprd and liable to Chinese Tax”.However,in Foshan,Chengdu,Dalian,Shanghai,GZOU there are many Chinese financiers,who can discount a draft endorsed by a chinese and PAY IN CASH (with no questions) so long as the drawer has no restriction/objections.

    Surely,some Chinese and Pakistanis will start “printing SOPSU acceptances” – SO THE SOLUTION IS TO DIGITISE ALL LIVE ACCEPTANCES and UPLOAD THE SAME,for all discounters to be aware of it (and this is to be printed on the acceptance)

    The SOPSU will pay the Chinese banks on deferred payments (after 6/12/18 months) at the pegged rate,on date of acceptance plus interest.

    This will take out all the Spot cash USD-PKR demand,in Karachi/HK/Dubai.

    Next,it is the Pakistani importers turn to take delivery from the Chinese after receipt from the Chinese banker – and clear it from Pakistani customs
    the way he wants (as he is doing today).It is easy to know that the chinese exports recorded from chinese ports do not reach (on paper) the stated ports of import in Africa,West Asia,East Asia and South Asia – so the Pakistani trader can operate the way he wants.

    The other way is that the SOPSU can canalise all the logistics in BULK by booking containers with Shipping lines and get much lower freight rates.Some Chinese and other flag carriers with Old Ships and Containers can be used to cut down the freight – where the containers are on the last voyage to the Karachi scrapyard etc. In such cases,the imports will be on record – so the importer will pay only the DEEMED DUTY (bribes) which he is paying currently + freight saved.Since the State has wiped out the hawala and FX punters and launderers, the duty can be lowered to the level of the DEEMED DUTY + freight saved ,as the corruption in Customs is wiped out,FX is controlled and all FX racketeering is wiped out.

    Most importantly, since the Pakistani importer has paid the import amount in PKR to the SOPSU on Day 1, the SOPSU will earn interest in PKR,for say 36 months at 20% per annum – which is 30%,and might close out the import financing on a date,wherein the PKR has appreciated (w.r.t the date on Day 1 – as the SOPSU would know the intervention plans of SBOP).For exporter nations,where there is no currency peg w.r.t the USD, the SOPSU will need to hedge the exposures (but the cost will be far below the Treasury gains)

    Step 4 – Making Exporters pay for Pakistan Import Duties and FX mismatch (defacto basis)

    W.r.t the “indusrial raw materials” legally imported by entities in Pakistan – the imports are “scattered and in small lots” based on “JIT concepts” – and the suppliers are loading “country,price (exchange traded) and credit risk” in the price

    These imports should be canalised by a SOPSU whose sovereign status will ensure that there is no country and credit risk in the price.In addition ,since purchases can be be aggregated on a BULK shipment,and ALSO for a LONG TENOR, THE BENEFITS OF STRATEGIC SOURCING WILL ACCRUE. For LME/CBOT/NYMEX/DALIAN/SME products,price formulas and hedges will TAKE OUT THE price risk BUILT INTO THE PRICE – and could reduce the price sharply, in some cases.

    If required,the SOPSU can issue a SB LC or a comfort letter,for purchases for 12 months and identify bankers in London,who will provide pre-shipment credit to the exporter of the industrial material (w/o recourse to the SOPSU)

    Long term contracts will reduce costs of affreightment.

    Then the SOPSU can find bankers to roll over the financing of the purchases,for 12-18 months,with the supplier getting payment on BL SOB.

    This will save 15- 25 % in purchase costs and the SOPSU would have deferred the FX outflow with treasury gains,and the BL can be endorsed
    to the pakistani user on High seas,or the SOPSU can clear the cargo and sell it to the user

    In essence,the cost of the supply chain to Pakistan,is lowered by 20%,and the FX out flow is pushed out by 18 months,and there are treasury gains.The Pakistani user can pay the SOPSU, the way he is paying in the existing mode.

    W.r.t the industrial raw materials illegally imported (w/o duty or misdeclaration) by entities in Pakistan – the imports are scattered and in small lots
    based on JIT concepts – and the suppliers are loading country and credit risk in the price and THE PAKISTANI IMPORTER IS PAYING ON CASH DOWN MODE (in USD) AS THESE CARGOS ARE MISDECLARED – AND SO,THE CARGO IS INSURED AS X WHEN IT IS Y,AND WITH A VALUE OF A WHEN THE VALUE IS C .

    These imports should be canalised by a SOPSU,AS ABOVE, AND THE SAVINGS CAN BE OFFERED TO THE IMPORTER AND HE CAN ASKED TO PAY THE SAME AS IMPORT DUTY.THIS WIPES OUT CUSTOMS CORRUPTION AND ALL HAWALA IN THIS TRADE and ACCRUES REVENUE TO THE STATE. THE IMPORTER WILL PAY THE ENTIRE AMOUNT ON DAY 1 (AS HE IS PAYING TODAY) AND THE SOPSU HAS A ROLL OVER PERIOD OF 18 months,with huge treasury gains and possibility of closing out the trade at an appreciated PKR

    Step 5 – Crypto

    Pakistani IT experts can tie up with some Chinese engineers to “start a Crypto” for Arabs,Bangladeshis,Lankans and Pakistanis working overseas for their remittances and student fees.This Crypto can be used by DIE HARD PAKISTAN smugglers for payments to suppliers – so that the PKR:USD is not pressured AT ALL FOR GREY MARKET IMPORTS.

    The Crypto Algo can be altered,to delete forensic trail,after a certain layer.

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s