Economic reform agenda

[HASEEB ANSARI]

Economic reform agenda
By Dr Ashfaque H Khan

Part - I

If everything goes well, Pakistan should see a new post-election government taking charge of the state soon. The new government will inherit numerous economic and social problems – the redressal of which will certainly be challenging.

Five years of economic mismanagement and poor governance by the previous regime have not only damaged the economy but also severely weakened the key institutions of the country like the State Bank of Pakistan (SBP), the Ministry of Finance, the Planning Commission, etc. The new government will inherit an economy which has been growing at an average rate of 3.0 percent per annum over the last five years, failing to create enough jobs for new entrants each year and thereby increasing the size of the unemployed pool. Investment rate, at 12.5 percent of GDP, has been the lowest in the last fifty years and foreign investment has shrunk to one-tenth of what it used to be in 2007/2008.

Fiscal indiscipline was the norm rather than the exception during the last five years. Budget deficit averaged at 7.0 percent of GDP, reaching 8.5 percent of GDP last year and likely to surpass that figure this year. Persistence of large fiscal deficit along with sharp depreciation of the exchange rate caused public debt to rise at an unprecedented pace. Consequently, interest payment emerged as the single largest expenditure item of the budget, consuming over 50 percent of the tax revenue collected by the FBR, thus leaving very little money to be spent on people and infrastructure.

The energy crisis, as a result of the mismanagement of the power sector, has severely damaged Pakistan’s industries and commercial activities in addition to inflicting misery upon the people of Pakistan, particularly during the summer. As a result of the energy crisis, Pakistan is losing 2.5-3.0 percentage points in economic growth each year. Without addressing the energy issue, economic revival will be a distant dream for the new government.

Bleeding PSEs is another economic challenge that the new government will be inheriting. These PSEs are consuming over Rs300 billion per annum of taxpayers’ money. The previous regime has treated them as an employment bureau. Giving jobs to people is not the job of the government. Its job is to create conducive environment through policy initiatives where the private sector can come forward, expand its businesses and create jobs.

Most importantly, the new government will face the immediate challenge of insolvency. Pakistan’s foreign exchange reserves have depleted at a dangerous pace. The SBP has only $6.6 billion in its reserves, and if we exclude the forward buying of the SBP to prop up the rupee, the foreign exchange reserves, as of today, stands at around $4.3 billion. Over $800 million payment to the IMF alone is due by end-June 2013. Thus, the new government will inherit around $3.5 billion reserves – sufficient to finance less than three weeks of imports and more than enough to trigger a crisis of confidence and flight of capital.

In sum, the new government will have to revive the economy, restore investors’ confidence, reduce budget deficit by mobilising more resources and rationalising and prioritising expenditure, address the issue of bleeding PSEs and energy, and save the country from external default.

How can these challenges be addressed? Whether we like it or not, Pakistan has no option but to seek IMF assistance to prevent default. No friendly countries will come forward to bail Pakistan out. The size of the IMF programme, the pace of adjustment and the conditionalities will have to be negotiated by a competent team.

The conventional macroeconomic policies advocated by the IMF since the 1980s have always emphasised stabilisation in the narrow sense of reducing the budget deficit, controlling debt and keeping inflation low. Many countries including Pakistan succeeded in stabilising their economies at the expense of economic growth and social development by cutting expenditure on education, health and even infrastructures.

While keeping inflation low and budget deficit and debt under control are important objectives of macroeconomic policies, disregarding important development objectives could be highly detrimental for the economy’s long-term prospects. In this perspective, world leaders at the Rio+20 Summit in Brazil last June, as well as G-20 leaders during the spring meeting of the IMF-World Bank this month in Washington DC called for reframing the development agenda, including rethinking the macroeconomic policy paradigm that focuses on stabilisation alone.

They have recognised the importance of growth, job creation, equality, social development and environment for which they have advocated the adoption of forward-looking macroeconomic policies that promote sustainable development leading to inclusive and equitable economic growth on the one hand and stabilisation on the other. The forward-looking macroeconomic policies, as documented in the ESCAP Survey 2013, advocate striking a balance between stabilisation and developmental roles of macroeconomic policies.

The economic team of the new government must keep in mind that macroeconomic policies should not focus narrowly on reducing budget deficit, debt stabilisation and curbing inflation, but should be supportive of growth and employment creation as well. Such macro policies do not in any way advocate lax fiscal policy or encourage fiscal irresponsibility. Rather, they place greater emphasis on the quality and composition of public expenditure on the one hand and domestic resource mobilisation on the other. In other words, it is a matter of degree as well as pace of fiscal adjustment with a view to minimising the cost of adjustment.

What the economic reform agenda of the new government should be, as enshrined in the forward-looking macroeconomic policies, will be the subject matter of my article next week.

The writer is principal and dean of NUST Business School, Islamabad.

Email: ahkhan@nbs.edu.pk

[HASEEB ANSARI]

Economic reform agenda
By Dr Ashfaque H Khan

Part - II

In the first part of this article (April 30) I summarised the economic challenges that the new government will inherit, suggesting ways to address them particularly in the light of recent global developments on the macroeconomic policy paradigm. I also argued that whether we like it or not, Pakistan has no option but to seek IMF assistance in order to bail the country out. A broad framework to negotiate with the IMF was delineated as well.

The conventional macroeconomic policies advocated by the IMF have always focused on stabilisation in the narrow sense of reducing budget deficit, bringing debt under control and keeping inflation low. The recent experiences of several European countries have forced global leaders to rethink sharp fiscal adjustment and the associated social costs and human sufferings arising out of austerity programmes. They argued for striking a balance between stabilisation and developmental roles of macroeconomic policies as enshrined in the forward-looking macroeconomic policies and well documented ESCAP Survey 2013.

Pakistan is currently facing the problems of deficit, debt, development and growth which are more or less similar to those faced by the European countries. Austerity programmes alone have not worked in Europe, therefore, a balance between stabilisation and development needs to be well articulated by the new government. Addressing long delayed structural issues and strengthening macroeconomic policies must form the key elements of a reform agenda to elicit support from international financial institutions and friendly countries.

A broad-based economic reform agenda must include: i) reforming the tax system and tax administration; ii) expenditure reform; iii) managing fiscal decentralisation; iv) restructuring and privatisation of public sector enterprises (PSEs); v) reforming the energy sector; vi) enacting reforms in the central bank; vii) improving the investment climate and viii) promoting inclusive and sustainable growth.

Tax system and tax administration reforms are vital for getting support from friendly countries. These countries have already made it clear to Pakistan that unless it taxes its rich and powerful, it should not expect any financial support from them. Broadening of the tax base will be the most critical reform under the tax system. Pakistan will have to bring all economic activities under the tax net, which have either remained untaxed or under-taxed. For example, income originating from agriculture has escaped direct taxation thus far. The new government must change that. There are many services that have also remained untaxed or under-taxed, for example, beauty parlours, inter-city bus services, doctors, lawyers, etc which need to be brought under direct tax net.

Improvement in withholding the tax regime will also be a major source of revenue. This is an issue of taxes being collected but not deposited in the government treasury. Bridging the gap between tax collected and tax deposited may generate Rs250-300 billion in three years. Political difficulties may hamper the implementation of full value added tax; therefore the new government may consider credible alternative revenue measures including a modified GST.

Removing ‘manufacturing defects’ of the new NFC Award will be an essential element of the tax system reform. In the presence of the existing NFC Award, no meaningful fiscal policy can be implemented. For three years in a row, the federal budget presented in parliament in June never saw the light of the new fiscal year in July. It has not worked and will never work unless we remove its defects. There are many ways to solve this problem. Pakistan’s tax authorities – the FBR and provincial tax departments – have been weakened to the core. No meaningful tax reforms can be implemented unless we strengthen tax administration through training and instituting the mechanism of reward and punishment. The new government will also have to improve the resource mobilisation efforts of the provincial governments.

On the expenditure side, there are many areas that need improvement. Untargeted subsidy is a bad economic policy. The new government will have to look at the subsidy programme carefully. The total amount of subsidies (power, food, PSEs etc) has crossed the country’s defence budget. The power sector subsidy must be faded out in a three to five years framework by improving governance as well as by raising tariff. The new government may consider privatising distribution companies (DISCOs), undertake the use of gas and coal to generate electricity, complete the ongoing construction of dams on priority basis and strengthen the finance department of Wapda.

The privatisation of bleeding PSEs will be a critical element of fiscal consolidation in Pakistan. Should we restructure first and then privatise or go for outright privatisation will be a decision that needs to be taken by the government. It should be absolutely clear that it is not the job of the government to be in the business of running steel mills, airlines, railways, grocery stores, etc. The sooner these rotten PSEs are offloaded from the government’s budget, the better it is for the institutions as well as for government finances. The government can save several hundred billion rupees which can be used to improve the country’s infrastructure, education and health.

In sum, the above listed reforms on the fiscal side do not advocate lax fiscal policy or encourage fiscal indiscipline. Rather, it gives greater emphasis to domestic resource mobilisation through tax systems and tax administration reforms on the one hand and gives greater emphasis to the quality and composition of expenditure by allocating more resources towards education, health, social protection, and infrastructure on the other. Fiscal reduction path must be a measured one spreading over three to five years. Sharp fiscal adjustment may bring pain and human sufferings, which will be counterproductive as well as difficult to implement.

Likewise, in the case of the monetary policy, there has to be more careful scrutiny of the direction or disbursement of credit rather than aggregate credit itself. Access to finance is among the top five business impediments for 93 percent of the countries in the Asia-Pacific region. Access to finance is critical for small and medium enterprises (SMEs) and agriculture as they depend solely on the banking sector for external financing. The central bank can play an important role in development by reducing entry barriers and promoting financial inclusion through changes to the regulatory framework to encouraging banks to extend financial services to the poor and marginalised. Financial inclusions can go a long way in reducing poverty and income inequality and increasing female employment. The new government must consider strengthening the board of directors of the SBP by inducting professionals and removing the finance secretary from the board.

Finally, improving the investment climate will be essential for promoting inclusive and sustainable growth for which more resources will need to be allocated towards strengthening the country’s infrastructure, education and health. Tax policy reforms will also help in improving the country’s investment climate and constant interaction between public and private sector will help restore investors’ confidence.

The suggested reforms are needed to rescue the country from the economic morass it currently occupies. Of course, the onus is upon the new government to ensure the success of these reforms by inducting a team par excellence of professional economists as well as the brightest civil servants. A combination of bureaucrats and technocrats will be required to implement and to monitor the reform agenda.

Concluded

The writer is principal and dean at NUST Business School (NBS) Islamabad.

Email: ahkhan@nbs.edu.pk