Pakistans Economic Outlook June 2013 and beyond

Syed Shabbar Zaidi The Institute of Chartered Accountants of Pakistan Karachi, December 18, 2012

Chapters
International outlook-trends and effects on Pakistans economy General state of affairs Pakistans fiscal position-2012-2013 [June 30, 2013] Liquidity or going concern Issue Undocumented economy Nexus and Support Shrinking Government where required Receipt Side-Composition and Projections Expenditure Side - Choices and Options Expected horizon Beyond 2013 What should be done ?
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International Outlook-Trends and Effects on Pakistans Economy

US and West:
Fiscal Cliff will hit US economy. Tax increases and spending cuts. US $ 30 to 40 billion support for Pakistan is not monetarily important. however why, how, how long and for whom [IMF=US] will assist? Obama [till 2016] is a Democrat. Republicans and Pakistan had a different kind of partnership. Now, it is a different world with different people. Europe will remain in crises. Their position will not directly affect us. Exit from Afghanistan [by 2014] is relevant.

International Outlook-Trends and Effects on Pakistans Economy

China and India: Beyond 2013, China will be even a bigger economic player, however their international economic significance does not contribute anything for us. China-our competitor in low value exports and supplier of cheap imports has direct relation with our industrial productivity and growth. The boat for pro-growth economic relations with China has already been missed [Ordnance Factory versus Trans-shipment port or Mass Transit for Karachi]. China is not a lender of money. India: Notwithstanding our resistance, cannot be ignored. Trade will not open by choice in near future. Will do the same, via Dubai. Now, Pakistan is not as relevant, as we think, in Sino-Indian economic equation.
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International Outlook-Trends and Effects on Pakistans Economy

Conclusion: No major political and economic change in international outlook is expected [2013 to 2016]. International oil and commodity prices expected to remain stable [2013 to 2016]. International economic trends are predictable. They will not affect our economic outlook for 2013 and beyond.

General State of Affairs

Continued deterioration in law and order and security. Continued deterioration in quantity and quality of health, education, infrastructure, energy and expenditure for future generations for common man. Size of government in such sectors is shrinking. Dilution of Governments writ in collecting taxes, security and law and order. Continued demonstrations of luxurious lifestyle by people in power and persons not paying taxes. Widening gulf of income distribution between rich and poor. Comparative stability of prices and lesser inflation [12% to 9%] (2011-2012 and 2012-2013), not reaping any benefit for common man due to unemployment, underemployment and increasing burden of indirect taxes on lower income groups. Manufacturing sector continuously shrinking as a percentage of GDP.
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Pakistans Fiscal Position 2012-2013-Budget and Expected

What we budgeted:
Rupees in billion

Total Receipts (Tax and Non-Tax): Less: Transfer to provinces Net Available Expenditures: Total Deficit Expenditure on Debt servicing 1142 Defence 545 Subsidies 521 Federal Government exp. 404 Federal Government PSDP 350 Other 304

3422 1459 1963

3266 (1303)

Pakistans Fiscal Position 2012-2013-Budget and Expected

We projected Rs 1,303 billion deficit, we will end up as: Rs in billion
Revenue shortfall Increase in subsidies Decrease in PSDP Total increase in deficit 250 250 [50] 450

Total expected deficit will be around Rs 1,800 billion. Whole amount, except a nominal amount of Rs 350 billion, is being locally financed essentially from banks and increase in currency in circulation.

Pakistans Fiscal Position 2012-2013-Budget and Expected

Deficit is locally financed, so actually we are heading towards a public debt crises. Each year around Rs 1800 billion is adding in the outstanding liabilities [Rs 11,000 trillion]. Keeping in view the size of Pakistans economy and unexplored potential of tax collection this debt level is manageable. However the problem is precarious with present level of revenue collection. Over the last 30 years (1977 onwards), there is no effective improvement in quantity and quality of exports. Import bill is continuously increasing and its composition is deteriorating [spoiling]. Consumer and luxury items increasing in proportion to capital goods. US$ deficit on current account [around US $ 15 billion per annum] is a perpetual feature of Pakistans economy. Same will happen this year [20122013] and beyond. [Exports US$ 25 to 29 billion : Imports US$ 45 to 48 billion] There is an offset of around US $ 10 to 12 billion of labour remittances. So each year there is deficit of US $ 5 to 8 billion. Borrow or beg such US$ and after every five years have the same position as is today.
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Pakistans Fiscal Position 2012-2013-Budget and Expected

Effectively the problem is not new. This is a perpetual problem since inception. [total deficit since 1947 US$ 275 billion]. Temporary inflows in capital markets, investments in consumer oriented industry [telecoms etc] and investments in real estates bring temporary stability, however, these do not resolve the primary issues of the country. In fact, such inflows disguise the main and fundamental need of identifying and correcting perpetual and reemerging US $ shortfall [Current Account deficit]. An analysis of taxes collection and expenditure will reveal that essentially the problem is in Rupee account and composition and structure of economy of economy. The Going Concern issue is being handled as if it is a liquidity problem. Filling the temporary gap [by US or IMF] again will be an aspirin for a cancer patient.

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Liquidity or going concern Issue

Pakistans economy in accounting terms, in Rupee Account [and resultantly in US$] is a Non-Going Concern as per past records (1947-2012). The past and the expected future reveal that it is not possible to keep the economy afloat unless there is an injection of capital after almost every decade [PK 480, Afghan War, War on Terror, Stability Programme in 2008, etc.]. Nevertheless, all economic policies at least in the last 30 years (post 1977) have been undertaken as if it is a liquidity issue. The problems are structural.

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Undocumented Economy Nexus and Support

All estimates, projections and forecasts about Pakistan economy lose their significance on account of scale, nature, penetration and effects of undocumented economy. There are guesses for the scale of such sectors, however, empirical evidences reveal that such transactions now exceed around 40 percent of all commercial transactions undertaken. Number of bank accounts in the country, their transactions, travels and personal expenses, properties of Pakistanis in and outside Pakistan etc. are all empirical evidences of that part of economy. There is a theory that such undocumented economy is actually a support to our economy. That theory may have merits, however, there is a limit for the same. If this is supplemented by official perpetual whitening then there will be complete erosion of tax system. This has happened in Pakistan. No government can balance its books unless level of undocumented sector is reduced to below 5 percent. Present level is not sustainable.
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Shrinking Government where required

The foremost point that is missed, in all equations, is Governments role and the responsibility in education, health, infrastructure and security for common man. In this society over 80 percent of the population is Disfranchised. In such societies Trickle Down Theory in any form, without incremental stress on governmental efficiency, is catesthropic. All our efforts are there to support private sector [This is a necessity]. However, in this country the problem lies with government which is still the biggest player and will remain so for a long time. This is what Manmohan Singh is saying by using the term Inclusive Growth inspite of achieving / attaining over 8 percent growth in the last 15 years.

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Receipt Side-Composition and Projections

By June 30, 2013, budgeted collection of revenue from taxes is around Rs 2351 billion. Expected collection is Rs 2100 billion. Shortfall of around Rs 200 to Rs 250 billion is expected. By December 1, 2012 collection was around Rs 1,000 billion [tax and non-tax revenue]. Estimate was around 1,100 billion. There is no reason to believe that this shortfall amount will be reasonably collected. Extraordinary measures, like whitening scheme will also not bear fruits in rupee terms. This is not unusual for what was expected. In the present inelastic tax system the revenue can not surpass Rs 2250 billion. Sliding US $ is also a blessing in disguise for Pakistan tax collection. Value for imports in Rupee term increases the tax collection as a substantial portion of tax collection is import value based in Rupee. In fact, around 25 to 30 percent of taxes have been collected on account of Rupee Depreciation.
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Receipt Side-Composition and Projections

Out of the total collection of Rs 2,250 billion, around Rs 1,300 billion are indirect taxes. Out of total Rs 950 billion of direct taxes around Rs 350 billion are effectively disguised indirect taxes having no relation to income of the tax payers. Out of balance Rs 600 billion around Rs 450 billion is paid by less than 200 companies. In short, there is effectively no direct tax collection from all other people / businesses / activities in Pakistan. A Pakistani common man bears the tax burden equally with a rich man on oil, electricity, mobile phones, phone, gas etc. Disparities in tax collection has some startling dimensions: Out of the total resources available say consumption of industrial and commercial energy in various geographical areas of Pakistan say Karachi, Central Punjab, KPK etc. then it transpires that tax collection per unit of energy consumption in Karachi is effectively 4 times higher than other areas. KPK is even half of Central Punjab. There is no correlation of tax collection and industrial and commercial use of electricity [In other words, use of 16000 mgwtt produced, used and the places from where tax is collected].
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Receipt Side-Composition and Projections

Large scale manufacturing sector contributes 85 percent whereas (1) Wholesale and Retail trade, (2) Agriculture and (3) Services each contributing around 25 percent of GDP i.e. contribute in aggregate less than 15 percent of total taxes. Sindh, Punjab, KPK and Baluchistan contribute totally in different proportion in relation to their GDP contribution. In our system, all major sectors of economy pay direct taxes on Presumptive Basis [Not on net income basis] such as exports, imports, retail trade, house property, interest and dividend. Effectively there is no system of taxing income. Resultantly there is no asset record. In short, the problem is fundamental and badly spoilt having political dimensions. Repeated policy errors have ended up in a paralysed administration.
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Receipt Side-Composition and Projections

Beyond 2013: There will be pressure to improve tax collection in theory. Nevertheless, there is no implementable plan with any major political party, establishment and lenders. All the three parties are not concerned with the present un-equitable system. Only loser is the common man of Pakistan. Fundamental correction is not expected in immediate future even after June 30, 2013 [New Government].

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Receipt Side-Composition and Projections

Beyond 2013: There can be cosmetic improvements and change of faces however there is no sign of any substantial change or way towards change. The biggest error will be to obtain another recipe from IMF that may be theoretically correct but practically and politically unimplementable. This would gain be a liquidity solving recipe. There will further erosion of writ of government in collecting taxes.

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Expenditure Side-Choices and Options

The expense side is almost frigid. Interest Payments and defense are almost fixed. Nothing much can be done in the short run. Default is not an option. Pakistani banks are paying taxes on effectively unrealized interest income on government borrowings of account of repeated rollovers. It is the result not the problem itself or the cause of the problem. [These fixed expenditure eats up around Rs 1600 billion]. The other big line item is Provincial Governments share. [Another Rs 1500 billion] Allocation to provinces has increased after NFC award. Provinces are responsible for education, health, infrastructure, law and order, and security. These are effectively the only relevant concern for a common man.

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Expenditure Side-Choices and Options

Now that there is effectively no financial constraint for the provinces, however, provincial governments are not ready to devolve and deliver. Governments are not serious on subjects like education, health, infrastructure, district judiciary and law and order as people in power are not affected by deterioration. There is no effective pressure on governments to improve. After these two major heads, we start our books with a substantial negative.

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Expenditure Side-Choices and Options

The next item is Subsidies and Grants which has been budgeted at around Rs 500 billion however in actual terms expenses would be around Rs 800 billion. Bulk is subsidy for electricity for WAPDA / KESC. This is the biggest unknown and unsettled issue that will haunt Pakistan for days to come. At the moment, government is spending around Rs 40 to 50 million for each megawatt produced [Rs 800 billion 16000 megawatt]. With the production of around 60 percent of the capacity we have to spend around Rs 800. Actual expenditure will be around Rs 1000 billion if full capacity is produced. Depreciating rupee increases the cost as almost all inputs are imported. This will be the biggest problem for economy in post 2013. No government will be able to resist the pressure of electricity shortage however that shortage is effectively the shortage of funds to produce electricity.

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Expenditure Side-Choices and Options

The other three real solutions being (1) reduction in line losses, (2) increase in prices and (3) correcting input for electricity production cannot be done in near future [2013-2017]. This issue is being politicized rather than being handled in its total perspective. The next item of around Rs 700 to 800 billion is Federal Government expenses. There is no reason for the size of government of that level after the 18th amendment. Out of this around 350 billion represent losses of PSE. It is almost impossible to reduce the size of government at Islamabad. This is not expected to be done beyond 2013. Thus, there will be consistent duplication [triplication] of governments without any delivery. This issue is not on agenda for any government or any political party in power or the ones looking for their role in future. We are actually preparing for more centralization.

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The Expected Horizon Post June 2013

A new arrangement with [IMF = US] for dealing with US$ shortfall [Inflow of around US$ 10 billion]. No concrete measure for resolving Rupee Shortfall or Fiscal Deficit. Rhetoric and politicized debate on Energy subsidy, Temporary inflows in US$ to balance the US$ books and exchange parity [2013-2015] to demonstrate that the new government is better than the past; US$ 5 to 10 billion is enough to create that sentiment. Budget collection for 2013-2014 in real terms to be Rs 2700 billion with a nominal increase of around 10 percent in Rupee terms. In this horizon, life for common man will further deteriorate that could result in bigger tragedy after the temporary (good) phase that will be over by [2013-2015].

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What should be done ?

Additional contribution of around Rs 800 billion(with 10% increase every following year) from taxes from untaxed sectors. Out of box Solutions Revamping of Indirect / Direct Tax Structure Devolution Documentation Asset Records Automation No Disguised Whitening. Devolution of administration of health, education and infrastructure and law and order to local bodies. Decentralization Localization and Automation. [e.g. total cost of complete automation [cameras and control rooms with rapid squads] of only Karachi and Lahore is around Rs 50 billion (one time); Benefits atleast 200 billion plus 95% security]. Open Book Study for Energy subsidy and effective Decentralization of WAPDA [Separation of Generation / Distribution / Transmission]. PSDP to be devolved out of Islamabad.

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What should be done ?

Land records, income from land and land transfers to be automated on emergency basis.

Let us hope that things happen in this manner. However, there is no apparent sign that What should be done will happen. Ultimate result of a prolonged non-going concern is not good for any operation. Nevertheless states do not operate like businesses. In this case the consequences are more tragic and painful. Better sense will prevail if there is correct and complete dissemination of information with an independent [non-politicized] analysis. Let us do something for the better future of our generations.

Thank you
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