Deaf & Blind

By Amir Zia
Newsline
February 2011

As the economy crumbles and business moves elsewhere, Pakistan's rulers refuse to listen to advice from its own financial experts to enact tough economic reforms

For Pakistan’s financial managers, it is a race against time. With the budget deficit for the current fiscal year – July 2010 to June 2011 – likely to shoot to a staggering 8% against the targeted 4.7%, and inflation, according to the State Bank of Pakistan’s estimates, to hit 15-16% against budget estimates of 11.5%, keeping the country’s economy afloat is indeed a daunting task.

With most of the key economic indicators painting a gloomy picture, the financial team led by Finance Minister Abdul Hafeez Sheikh appears to be struggling to convince Pakistan Peoples’ Party (PPP) bosses, allies and the opposition about the gravity of the situation and the necessity of pushing the tough reform agenda on a fast-track basis. So far, the efforts of this team have proved futile.

The government’s bid to generate revenues through the imposition of the reformed general sales tax (RGST) this financial year hit a dead end in the wake of stiff opposition, and not just from the main opposition parties, but even allies. Now the implementation of the RGST has been put on hold at least for the current fiscal year. In another major reversal, the government had to backtrack a decision to raise fuel prices by 9% in early January, because of the political backlash, costing the national exchequer around 4 – 4.5 billion rupees a month. No wonder the revenue target of 1.667 trillion rupees for the year will be missed. Top government officials now confess behind closed doors that if government revenues get anywhere close to the Rs 1.6 trillion mark, it would be an achievement.

The government has been sending negative signals to foreign and local investors through its inconsistent policies, poor governance and tendency to yield to the pressure of interest groups, and this includes such disastrous steps as forcing privately run Karachi Electric Supply Company (KESC) to reinstate sacked employees (see “Digging a Deeper Hole”).

The non-implementation of the reform agenda, which also includes reforms in the energy sector, has a far-reaching adverse impact on the country’s economy. The International Monetary Fund (IMF) held back the disbursement of the last two tranches of an $11.3-billion loan to Pakistan under a standby arrangement, which was supposed to end last year, forcing Islamabad to seek a nine-month extension in the programme. The disbursement of loans from other lending agencies also remains on hold.

Pakistan’s western allies including the United States, which are supporting Pakistan’s wobbly economy, have been urging Islamabad to tax its rich and expand the revenue base. With the country’s tax-to-GDP ratio hovering at less than 9% against the world average of 16-18%, the demand to tax wealthy Pakistanis remains justified if the country wants to continue getting relief of the backs of western taxpayers.

The government’s credibility remains so low that most donors want to spend money in Pakistan through non-government organisations, rather than giving it to the authorities because of the fear of corruption and embezzlement.

Pakistan’s privatisation programme remains stalled since 2008 when this government took power. Furthermore, foreign investment plunged to a mere $2.08 billion at the end of fiscal 2009-10 from the highs of $8.42 billion in fiscal 2006-07. The chances of a turnaround in fortunes appear bleak given the government’s poor record and lack of commitment to reforms. The grave law-and-order situation and rampant crime only add to the many economic factors that are keeping foreign investors and business people away from the land of the pure.

On the domestic front, sentiment remains equally weak in industrial and corporate spheres regarding the government’s economic policies. Most local investors have put their investment and business plans on hold because of the country’s political instability, poor governance, acute energy shortages, inconsistent economic policies and terrorism and crime. According to industry sources, many are moving capital and expanding businesses in safe havens like Malaysia, Dubai, South Africa and even Bangladesh.

Foreign clients of some of Pakistan’s leading textile manufacturers are not only afraid to come to Pakistan because of the security risk, but also doubt their Pakistani suppliers’ abilities to continue production here in the medium and long-run. They have asked their Pakistani partners to find facilities elsewhere in the world if they want to do business with them.

In the wake of the enormous and pressing challenges faced by the economy, the government’s response has been weak and inadequate. It appears to lack both the will and the capacity to take the bull by its horns and go for tough decisions on the two most important (and most basic) fronts – revenue generation and expense management.

Government officials say that they started the current fiscal year on an optimistic note: they kept reasonable targets that included a 4% GDP growth rate. This, however, has now been slashed to 2.5%. Last year’s devastating floods and a steep rise in oil prices jolted the economy, they said. “Floods damages alone were more than 10 billion dollars,” the finance minister told a group of journalists during a recent visit to Karachi. “The lack of consensus among major parliamentary parties about the tax reforms has hurt efforts to meet the revenue target,” he said.

Although government sources say that efforts to build consensus with the major political parties, including the Pakistan Muslim League-N, have made advances, other insiders say that there has not been any meaningful development on key issues, such as the imposition of RGST and the withdrawal of subsidies.

The PML-N 10-point agenda far from offers any recipe to soothe the country’s present crisis. The very first demand of the withdrawal of the petroleum price hike remains lethal for the economy at a time when world oil prices are close to $100 a barrel. The government had to reduce its levy on petroleum products to accept the demand from its allies and political parties and this created a further dent in its revenues. Selling fuel at the current rates will not be feasible for the country, admits a senior finance ministry official. “The subsidies should be targeted at the poor rather than given to all.”

Out of the remaining nine points from the PML-N agenda, none address efforts to boost revenues. The focus is on political issues, which clearly sell among a particular section of the public and the media. After the first couple of rounds of talks, PPP and PML-N leaders had little to offer to the nation but their intentions of goodwill. Analysts say that the PML-N and the government diluted the economic agenda in the 10-point plan by including political issues such as the restructuring of the Election Commission and the implementation of all decisions of the judiciary, including the decisions on the National Reconciliation Order. There should have been only one point on the agenda of the talks between the government and the opposition: the economy. The delay in tackling the economic crisis with serious, workable decisions is strengthening the pull of the financial quicksand.

An official of an international lending agency, who spoke requesting anonymity, said that the government seems to lack direction when it comes to the economy. “There appears to be a paralysis, and nothing is being done to ward-off the crisis,” he said. “The reforms are crucial, but they are being sacrificed on the altar of the politics of expediency. There appears a complete disconnect between the financial team and the PPP bosses.”

The finance minister, however, says that the situation remains difficult, but manageable. “Tough decisions are required to cut expenditure and mobilise resources,” he said. “And for this, we need a political consensus.”

The government is already considering slashing the annual development budget by 100 billion rupees to bring it down to around 180 billion rupees. It is also urging provinces, which under the new National Finance Commission (NFC) have received 10% more resources from the federal government, to show greater financial discipline. Sadly, in the short term, things look bleak. The finance minister’s pleas to his party and the opposition to bite the bullet and accept the RGST and other reforms have so far been in vain. Moreover, Sheikh’s prescription – backed by the IMF – hardly appears to have any takers in the ruling party itself. Making matters worse is the state of the PPP government and its weak coalition: the PPP is not just tainted with corruption allegations, but remains locked in a struggle for survival on a day-to-day basis, further eroding its capacity act.