A distant redemption By Sakib Sherani - Friday 25th March 2011

Source : http://www.dawn.com/2011/03/25/a-distant-redemption.html

ARE the recent fiscal consolidation measures announced by the government (its ‘Plan B’) going to be enough to forestall a slide into deeper macroeconomic instability? As has been noted widely, the answer is ‘probably not’ for at least three reasons.
First, the measures have come almost a year too late. Second, there appears to be some element of ambition in the projected outcome. Finally, for the most part, the measures are not structural in nature. The removal of zero-rating for domestic supplies of the export chain is a step in the right direction, however.
While the dominant part of the export sector has been vocal and effective in lobbying for its interests under various governments, it is a fact that the export sector has been receiving largesse at the expense of the domestic manufacturing sector. The regulatory and tax burden on the latter is very high, stunting the growth of the formal manufacturing sector in Pakistan. If all the benefits (privileges?) that accrue to the export sector are monetised, including an unjustified low tax regime and subsidised credit, there appears to be no anti-export bias in the exchange rate regime.
Even in regional terms, contrary to the propaganda put out, Pakistan’s export sector has been comfortably placed, till recently at least, in terms of the incidence of taxation or even utility costs. This was the clear conclusion of an international benchmarking study conducted in 2007 by an eminent global consultancy. Not surprisingly, the bureaucracy and the textile industry appear to have lost ‘institutional memory’ of this report.
While I had fully supported the provision of a large ‘lifeline’ to the export sector in the 2008-09 budget, the context of that decision was totally different. With a full-blown macroeconomic crisis under way and anti-state forces having rolled into Swat, and appearing uncomfortably close to the capital, it was clear that the last thing that Pakistan could afford was more unemployment. With the fiscal situation precluding the provision of a meaningful stimulus to the economy, the only choice before policymakers had to be to preserve jobs where possible.
The context has changed since those dark days. The ongoing global commodity price boom has provided large windfall
returns to two important sectors of the economy over the past two years: agriculture and exports.
This is as good a time as any to introduce a fairer tax regime in the economy, by reducing the incidence of taxation where it is too high, such as on domestic manufacturers (who account for approximately 63 per cent of total taxes paid), and increasing the incidence on agriculture (paying one per cent of total tax collected), and the export sector (which operates on a full and final tax regime of one per cent tax on sales). Hence, on export sales of around Rs1,600bn last year, the sector paid less than Rs15bn in direct tax.
Overall, of recent the economic team has made progress in difficult circumstances. Borrowing from the central bank has been reduced substantially, while the external account is operating in comfortable territory. However, both of these developments are on account of largely one-off favourable factors. A larger-than-budgeted transfer of SBP profits, combined with the release of Coalition Support Fund (CSF) monies, has boosted the non-tax revenue line. In the absence of a more robust tax revenue response, however, and in the absence of foreign inflows, the fiscal situation will continue to face strong headwinds.
The external account needs to be vigilantly monitored for at least two reasons. First, the focus on the overall current account balance is masking the underlying residual strength of aggregate demand in the economy. This is showing up in fairly healthy import demand for many commodities which is quantity-based and not just driven by higher import prices.
Second, the turmoil in the wider Middle East could have a negative fallout on worker remittances in the longer run, if the process of indigenisation of the labour force gains traction, as it is slowly doing in Saudi Arabia. This is likely to play out in the longer run, but is nonetheless a potentially worrying development. In addition, fairly lumpy repayments of external debt are due to start in a few years time, which need to be factored into the overall strategy.
In short, some measure of economic stability in the past two months should not distract from the wider job at hand of broadening and deepening the economic reforms process. In terms of overall economic governance, while the government’s policy response to critical issues over the past three years has either been weak or too late, or in some cases completely absent, the point about the comparison with the previous government being unfair is completely valid. While this government has had to respond to a near trebling of the international oil price, and did so with fairly robust increases in both domestic petroleum prices and electricity tariffs, the Musharraf-Shaukat Aziz dispensation kept electricity tariffs unchanged from 2003 to end-2007, and dithered on raising petroleum prices from 2006 onwards.
The previous, supposedly ‘technocratic’ government, preferred to play politics and kick the issue down the road for the next government to deal with. Unfortunately, the near-criminal inaction of the Musharraf government on a wide range of policy fronts has cost the economy — and future generations — heavily. Two examples of adopting a nonchalant attitude to critical issues confronting the economy at a time when there was unprecedented economic, political, social and geopolitic stability for Pakistan: the unwillingness or inability to raise the tax-to-GDP ratio, and the inability to restructure the public-sector enterprises, especially the power sector.
The failure to make a breakthrough on the tax front has contributed directly to Pakistan’s fiscal and public debt woes, and will be dealt with in a subsequent article.
The writer heads a firm providing economic research.

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