May 192008

By Yousuf Nazar

It seems the two largest parties were not ready to assume power and face an unusually tough economic situation. There are no signs that the government has a comprehensive strategy and it took about 45 days to come up with just some administrative measures for energy conservation.

Finance Minister Ishaq Dar has departed from the scene after spending much time blaming the previous government and doing little to come up with solutions. In the meantime, the rupee value has dropped by over seven per cent, inflation has jumped to 17 from 14 per cent and the foreign exchange reserves have fallen by more than a billion dollars while the oil price has spiked by 19 per cent setting new records. Last Thursday, the Standard and Poor’s cut Pakistan’s credit rating by one notch to B with a negative outlook.

The top leadership is out of the parliament and has devoted most of its time to the judges’ issue inside and outside the country. The jury is out whether Mr Asif Zardari will prove to be a “Sonia Gandhi” but we certainly do not appear to have a Manmohan Singh or Chidambaram -the two finance wizards- credited with India’s economic success. Where are we headed? If we are moving towards an ‘economic meltdown’ as Mr Zardari put it, how ready we are or more pointedly, are we capable enough to face and manage a period of severe economic distress?

In normal circumstances, economic policy matters can be left to a team of economic experts but even they are in short supply though a lot of bankers and failed bureaucrats abound. Pakistan is currently passing through a critical phase of political transition where the old order is very much in place and the new leadership is cautiously navigating the troubled waters while trying to save a fragile coalition and manage internal and external powers that matter.

A practical implication of our vulnerabilities, a consequence of failed polices and incompetence, is that our economic, political, defence and foreign policy issues have become extremely entangled and complex. A strategy that treats the inflation or foreign investment as a ‘finance ministry issue’ is doomed to fail because of the multitude and inter-relatedness of the issues involved and the capacity required to deal with them.

One of the country’s most pressing needs is the financing of external deficit otherwise rupee will inevitably fall further, not withstanding the central bank’s interventions, and add to the inflationary pressures. External financing needs a multi-pronged approach involving foreign governments, multilaterals, and private investors. The government claims it would be able to raise around $3.5 billion in the next few months but this won’t be enough. It must also take measures to build the confidence of foreign investors and lenders that the government is fully alive to the gravity of the situation and has a plan to deal with it beyond passing on higher energy costs. Free markets cannot be controlled by governments. They need to be persuaded that the overall policies are on a sound footing and the government has the will and capacity to implement them.

While we have been the partners of the United States and the UK in the War on Terror, their capacity to help us financially is rather limited given their own constraints. US administration’s fiscal year 2009 “base” budget request for South Asian states — Afghanistan, Pakistan, Bangladesh, India, Nepal, Sri Lanka, and Maldives — was about than two billion dollars. Gary Ackerman, the head of the US House of Representatives panel on issues relating to South Asia said recently, “The United States is one of the largest donors in South Asia, if not the largest. But, we can’t do it all”.

The largest pools of money are in the Middle East, China and other Asian countries. Our foreign policy must recognise the changing world economic power balance, rethink its strategies, and redirect its efforts accordingly. Although some people may think it is a long term issue, it is not. We have failed to leverage our long standing ties with countries like China and Saudi Arabia. Consider this. We raised a little over $6 billion in privatisation deals during 2000-2007. Compare this with Congo – a small and poor country with exports of only $2.6 billion. Last September Chinese Export-Import Bank, through which the Chinese government disburses its foreign aid, signed an agreement with Congo to finance $6.5 billion-worth of improvements to the country’s infrastructure and $2 billion-worth of construction and refurbishment of mines, using mineral reserves as collateral.

We must start top level strategic dialogue with the oil-rich Arab countries, China, Russia, Singapore, and Taiwan to attract large scale investments as well as short-term financial assistance on commercial terms because it takes time for such efforts to yield results.

Another pressing issue is the level of government’s highly inflationary domestic short-term bank borrowings that have increased by over $7.5 billion during the current fiscal year. They must be replaced, to the extent possible, with longer term local and foreign market instruments such as local medium term bonds and foreign currency syndicated loans. Equally important is addressing the issue of subsidies that have contributed to the ballooning debt.

Oil subsidies must be eliminated quickly along with those given to the refiners but sales tax must be cut to five per cent (from 15) on diesel. In the absence of any fiscal space, the subsidies cannot be sustained.

However, the question of food subsidies is more complicated. It is fashionable to talk about targeted subsidies but in a country where 74 per cent of the population lives on $2-a-day or less and more people are likely to be pushed below the poverty line, targeted food subsidies are an oxymoron, impractical, and do not represent the ground realities.

In an Asian Development Bank study released on May 14, Pakistan was ranked at the bottom, that is, 31st out of 32 countries on the Social Protection Index. The index provides a combined measurement tool of the extent to which Asian and Pacific countries provide welfare, labour market, social security, health insurance, micro credit, child protection, targeted education, and health support programmes to their citizens, especially those living below the poverty line. Given the abysmal state of social protection and poverty levels, the government should at least provide wheat subsidy by cutting other current expenditures and raising revenues.

Moving on to the overall situation beyond the immediate funding needs, the government must take some bold and tough steps to reform the tax system. It may no longer have any option but to take the risk of a radical restructuring of the tax regime to stimulate economic growth and boost revenues.

The basic premises behind these suggestions is that elimination of special treatments, reduction in the number of taxes and rates of taxes, and simplification in collection procedures have universally proven to be a successful combination needed to expand the tax base and increase revenues. We should stop trying to reinvent the wheel and consider the following:

• Cut the maximum income tax rate to 15 per cent for publicly listed companies (except banks) and to 20 per cent for all other companies and businesses.

• Green field projects should have a five-year tax holiday after they become profitable and provided they are publicly listed within three years of incorporation.

• The government should apply a withholding tax of 15 per cent on purchases of all crops. It should aim to maintain the prices of grains at a level similar to India’s to prevent smuggling.

• Reduce the general tax rate (GST) to 10 per cent to provide some respite from inflation to the people.

• Abolish excise duty, rebates, and special treatments and loop holes like R&D allowance to the textile industry.

• Impose capital gains tax at the rate of 20 per cent on stock transactions where the holding period is less than one year. For holding period of more than one year, the tax should be 10 per cent. Turnover taxes e.g. CVT should be abolished.

• Abolish Employees Old Age Benefits and Workers Welfare Fund. They essentially represent payroll taxes and do not contribute to workers’ welfare. Eliminating them could actually help the employers to pay more cash compensation to the staff.

• The rate of withholding tax on interest income should be increased to 15 per cent where the gross interest income is more Rs50,000 per annum and to 20 per cent where it is more than Rs150,000 per annum.

• Import duties on all industrial equipment and machinery should be abolished.

• Import tariffs on electricity generators, cars, mobile phones, processed foods, and other such items used by higher income groups should be revised upwards.

•Capital value tax on property transactions should be raised to 15 per cent.

• Declare agriculture as an industry for lending purposes provided the borrowing farm is organised as a limited company. Finally, a word about monetary policy. The government must resist the temptation to use interest rate hikes as a tool of controlling inflation. Given that the GDP growth may slow down sharply in the next 12-24 months, there is actually a case of easing monetary policy a bit to provide some relief to the industry without the use of special subsidies.

It would be prudent to put restrictions on the lending for consumer durables that have contributed to the rising imports. A judicious mix of monetary measures involving interest rate cuts, elimination of subsidised lending, restrictions on imprudent consumer lending, and increase in cash reserve requirement should be considered to lower the cost of public and private debt and control of money supply to non-productive channels.

But all of the above would require political will and leadership at the highest levels of government and the political parties. Managing serious economic crises requires focus and leadership at the highest level as many leaders including Z.A. Bhutto, Margaret Thatcher and Bill Clinton demonstrated in the recent history. The task should not be and cannot be delegated to just some ‘experts’ and bureaucrats

Source: Daily Times, 19/5/2008

 Posted by at 11:36 pm

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