BR Fiscal Review 2013 by Business Recorder

FISCAL

REVIEW 2013 FRIDAY, OCTOBER 25, 2013 | www.brecorder.com/fr2013

BR RESEARCH THE TEAM

Ali Khizar Aslam

Contents FISCAL REVIEW 2013 | October 25, 2013

Head of Research

FROM THE EDITOR’S DESK PAGE 3

Sohaib Jamali

CHALLENGES CAN BE EXTREMELY ARDUOUS Ali Khizar Aslam PAGE 4

Editor Research

Zuhair Abbasi Mobin Nasir

Senior Research Analyst Asst. Editor Research

Zuhair Abbasi Sijal Fawad

EX-DEBT MANAGER ASHFAQUE TERMS IMF PROGRAMME ‘RUTHLESS’ Interview with Dr. Ashfaque Hasan Khan PAGE 5

ISHRAT’S TAKE ON VERTICAL, HORIZONTAL RELATIONSHIPS Interview with Dr. Ishrat Husain PAGE 18 DEVOLUTION TO LOCAL LEVEL IS THE RIGHT ANSWER Dr Gulfaraz Ahmed PAGE 19 PLANNING COMMISSION UNDULY SIDELINED: KARDAR Interview with Shahid Hafeez Kardar PAGE 20

Research Analyst Senior Analyst

BUDGET AT A GLANCE PAGE 6

Hammad Haider

UNPLEASANT AND DEPRESSING: PASHA’S GRIM VIEWS Interview with Dr. Hafeez Pasha PAGE 8

Sidra Farrukh

ENERGY SELF-SUFFICIENCY: A PIPE DREAM Zuhair Abbasi PAGE 10

FUTURE OF GST SERVICES AS PROVINCIAL TAX UNCERTAIN Muhammad Sabir PAGE 26

INSIGHTS INTO PROVINCIAL INFRASTRUCTURE SPENDING Hammad Haider PAGE 11

AGRI INCOME TAX EVASION: A HUGE DISINCENTIVE FOR TAXPAYERS Nikhat Sattar and Muhammad Sabir PAGE 27

Research Analyst

Javeria Ansar Research Analyst

Sobia Muhammad Saleem Research Analyst

Adil Mansoor Research Analyst

Naseem Waheed Database Officer

Murtaza Khaliq Creative Head

INFRASTRUCTURE SECTOR REPRESENTS UNLIMITED POTENTIAL Interview with Mian Muhammad Mansha PAGE 13

STATISTICS ARE SACRED Dr. Vaqar Ahmed PAGE 21 BR RESEARCH ECONOMIC PERCEPTION SURVEY PAGE 22

FBR: THE STORY OF FAILED REFORMS Huzaima Bukhari & Dr. Ikramul Haq PAGE 28

SOCIAL SPENDING: PUNJAB SPENDS THE LEAST? Iffat Ara PAGE 14

FBR’S ACCESS TO BANK ACCOUNTS: THE COMPLEX DEBATE Sohaib Jamali PAGE 29

SHAH TERMS PSDP ‘CRONY SOCIALISM’ Interview with Dr. Salman Shah PAGE 16

TAX EVASION: NADRA PROVIDES NO MAGIC SOLUTION Syed Shabbar Zaidi PAGE 30

PROVINCES HAVE STRONG REVENUE POTENTIAL Muhammad Sabir PAGE 17

IMF EFF: THE INEVITABILITY OF VULNERABILITY Mobin Nasir PAGE 31

Editor’s note

Is there any strategy in W

idespread power shortages, worsening economic conditions and poor governance between 2008 and 2013 contributed to Pakistan People’s Party losing the elections and the electorate voted Pakistan Muslim League (Nawaz) into power. The nation favoured experience and change and not change alone. Against this backdrop PML-N within days of coming into power laid out their economic plank to address the macroeconomic imbalances and vulnerabilities built up over five years of mismanagement. PML-N budget departed sharply from the promises the party made in its election manifesto. It chose to reverse weak tax collections by raising taxes on those within the net instead of going after those who are outside the tax net. Energy sector subsidies were reduced by raising tariff instead of improving bill collection and reducing line losses. And, provincial governments continued to depend on Federal handouts instead of making a major effort to improve their own tax collections. Furthermore their modest tax effort is being undermined by the Federal Board of Revenue. Against this backdrop, PML-N rushed to conclude a 36-month arrangement with the International Monetary Fund as forex capital inflows were insufficient to finance even a modest current account deficit. The main reason for approaching IMF being Pakistan’s inability to pay back the loans obtained from multilateral institutions, including the Fund itself. PML-N government launched an ambitious economic programme with a view to stabilizing the economy to put the country back on a sustained growth path. It appears to have been adopted to satisfy the Fund rather than convince the people that structural problems particularly in the energy sector, security concerns and a

difficult investment climate have to be addressed. Technical and financial problems in the energy sector are leading to large-scale power outages depressing output and causing hardship to the public at large. Difficult business climate has contributed to shortfalls in private investment. Weak performance of large public enterprises in key industries constitutes a further drag on public finances and growth. Fiscal consolidation is needed to put debt on a declining path to foster sustainable growth. The PML-N government thus far has taken the same bureaucratic approach – raise taxes on the already taxed. And, impose additional levies on energy without taking into account the economic cost of these additional taxes. There appears to be no strategy to manage the debt or correct course to enhance the maturity profile of domestic debt that now consumes over 30 percent of the revenue despite an over 500 bps cut in SBP’s policy rate. Not enhancing the maturity profile in an interest rate lowering scenario shows mismanagement. And, the Ministry of Finance is yet to let go of debt management which needs to be at arm’s length from its budget management wing. Rs10.5 trillion stock of debt is on accrual basis while the budget is dependent on cash flow. Budget wing needs to provide the liquidity target and it should be left to debt management office to independently fix tenor and rate to provide the liquidity needed. Ministry of Finance’s inconsistency is harming fiscal consolidation and leading the country into a debt trap. Pakistan has committed to undertaking further revenue and expenditure measures to achieve a sustainable deficit of 3.5 percent of GDP beyond the current financial year. This includes elimination of concessionary rates of duties and taxes

availed by companies. This is a massive exercise and could involve unintended consequences; for example: what to do with SROs issued along with sovereign guarantees? Transferring this power from the executive branch of the state to the Parliament could affect the flow of Foreign Direct Investment (FDI), that is already diminishing due to security concerns and excessive judicial interference. Domestic investment could also suffer due to imposition of 0.5 percent income support levy on moveable assets. Similarly, failure of provincial governments to generate a revenue surplus after the last NFC Award that allocated 57.5 percent share of federal revenue to provinces has already created a severe imbalance between federal government expenditure and revenue. A new award due in 2014-15 cannot reduce the share of provinces, which is protected under the 18th Amendment. Unless the provinces are duty bound to generate a revenue surplus for the Federation, wherein fiscal decentralization is consistent with macroeconomic stability the chances of keeping the fiscal deficit within reasonable limit will be difficult. Last but not least, we, as a nation, are on the verge of moral, political and national ruin. Corruption dominates the ballot box and touched – until recently – even the ermine of the bench. People are demoralized. Nawaz Sharif, who is widely known as a firm believer in small government, low tariffs, transparency, accountability and rule of law is required to deliver without any further loss of time.

Fiscal Review | October 25, 2013 | 3

Challenges can be extremely arduous Ali Khizar

ven as economic woes piled on, the previous government took no significant steps to shield the country against growing crises; instead it opted to bide time and bequeath a multitude of problems for the new government. In the run up to the General Elections 2013, the federal and provincial governments spent hefty sums on development spending mainly on road infrastructure. All this while, the private sector remained ignored. Although the central bank opted for an easy monetary stance, exogenous factors such as energy crisis and dismal state of law and order kept business sentiment muted. By comparison, the PML-N government is perceived to be business-friendly and pro-investment. The heavy mandate it has received also gives it the muscle to implement necessary reforms. Its arrival at the helm of affairs has been interpreted positively by domestic investors; evident from the stock market rally immediately after the general elections. The Federal Budget 2013-14 was announced just a week after the Sharif government took office. The haste with which the exercise was completed was apparent in the speech of Finance Minister Ishaq Dar and in the budget documents. Some of the steps announced there have also been deemed counter-productive by industry stakeholders and economists alike. The levy on movable assets and access to bank accounts for the FBR are two such irritants. The usual misplaced optimism that is seen in budgets every year is also noticeable in the current fiscal plan. The target for revenues collected through the FBR appears lofty and low subsidies allocated to power sector and public sector entitieswill also appear headed for a cost overrun. So it is unsurprising that the proposed budget has already begun unravelling and keeping the budget deficit at 6.3 percent of GDP already seems unlikely. But economic management is a continuous job, and the so-called homegrown Extended Finance Facility obtained from the IMF has set the tone for structural reforms. The government is rightly focussing on energy reforms, and a few steps taken so far towards short-term management are spot on. The resolution of circular debt and enhanced supply of gas to the efficient thermal power plants are two important steps that are helping bridge the demand-

supply gap to some extent. Some rationalisation in power tariffs has also stymied the pace at which the inter-corporate debt burden piles on again. Likewise, the government’s idea to prioritise gas supply through price signals is also a good one. But these efforts are not enough to lead to a sustainable energy solution. There is an urgent need to substantially reduce transmission and production losses, and distribution (theft) losses. That can be done by corporatisation and privatisation of discos. But political compulsions have ensured that the government has no real strategy on this front, so far. While there is a need to change the energy mix towards indigenous resources; the process is long drawn and arduous. In the meanwhile it’s imperative to do away with the expensive furnace oil whose pie is expanding. It can be substituted by the relatively cheap imported fuel options. The choices at hand are limited to LNG or import of gas from Iran or Central Asia through pipelines, and coal. For now the government is betting on Gaddani Power Park and aims to commence production of 6600 MW of coal-fired energy within 18 months. But this expectation seems little more than a pipe dream considering that the infrastructure needed for the facility will have to be put up from scratch. The idea is all the more mind boggling considering that the requisite infrastructure is already available closer to Karachi at Port Qasim. Accessing financing for the project is also an uphill task at a time when no multilateral agency is keen to inject such levels of capital into coal-based projects due to environmental issues associated. While medium to long-term energy reforms are seemingly in jeopardy, the Sharif administration has bitten the bullet and implemented short-term fixes like rationalisation of power tariffs and interim resolution of circular debt. But the government’s team on power sector has so far outpaced its own economic managers. For one, Finance Minister Ishaq Dar can boast of no eminent economist in his team. The negotiations he led his team into with the IMF also came up short for the country while the Balance of Payment (BoP) crisis is still looming. The medium-term budgetary framework has been dubbed pro-business, but in the here and now, there is precious little to make investors smile. On the other hand, some of the steps introduced by the federal government

without consultation of federating units in the latest budget are a hindrance to savings and investment. The need for an institutional arrangement between the provinces and the centre cannot be over-emphasised. The role of Council of Common Interests (CCI) and National Economic Council (NEC) are of utmost importance in this regard. There are many other anomalies which require attention of such institutions. For instance, for the past many years, federation is showing surpluses on behalf of provinces but the latter are posting deficits. Not much has been done by provinces on imposition of GST on services even three years after the passage of the18th Constitutional Amendment and the 7thNFC award. The federating units are getting higher shares in revenues without adequately shouldering their responsibilities. To counter this, the FBR has attempted to encroach on provinces’ tax domain this year to meet its unrealistic targets. This will not only increase the cost of compliance for existing taxpayers but also limit the scope of additional resource mobilisation by the provinces. Since the federating units are not doing enough to raise revenues and not assuming their responsibilities as envisioned, the federal government must use the CCI to convince the provincial governments to own up to their share of the hard work. The upcoming NCF Award deliberations are also a viable platform for building coordination on this front. Sound fiscal management is simply not being exhibited. The macroeconomic fundamentals are jolting. There is no space for fiscal stimulus and nothing much is there to incentivise private investment to spur growth and generate employment. Then the lack of capacity at the FBR to collect direct taxes is burdening the existing lot of taxpayers by hiking rate on GST to fuel inflation. Measures could have been introduced to curb non-essential imports and quell the battering of the external account. There is a need for a heavy dose of regulatory duties on non-essentials, which is also a part of PML-N’s manifesto. Another innovative policy instrument is to play with the margin requirement on LCs opened for imports to effectively increase interest rates on imports. Such out of the box solutions are required for the revival of domestic industry. This can also help buildup country’s foreign exchange reserves which are abysmally low. Although the IMF has come

The writer works as Head of Research at Business Recorder. He can be reached at ali.khizar@br-mail.com

4 | Fiscal Review | October 25, 2013

to the rescue, the tranches it is providing are too meagre to really boost confidence among investors. The government’s strategy towards boosting its external accounts and foreign exchange reserves is primarily focused on loans from other multilateral agencies, Coalition Support Fund, euro bonds and privatisation proceeds. Targets for most of these heads were revised in consultation with the Fund. For instance, as committed to the IMF, the government is planning on restructuring and privatising 65 PSEs, yet there is no mention of these in the budget documents. On the front of restructuring and privatisation, the government seems to be taking the bull by the horns as it is gearing up to tackle PIA first. Its plan includes sell-off of 26 percent shares of the company along with management rights to the private sector. A successful deal here can boost confidence vis-à-vis government’s willingness to implement reforms and also bring in much needed foreign investments. At present, the current account is exhibiting a slight deficit while the BoP is deeper in the red. This vulnerable situation of the external accounts is the primary factor contributing to the local currency’s plunging trajectory in recent weeks. The local currency had already plopped by about 6.7 percent in the first quarter of this fiscal year. This trend will soon stoke inflation, in line with SBP’s own expectations of a year-end average of 11-12 percent. The subsequent monetary tightening is an imminent chokehold on the frail neck of economic revival. Jobs are already fleeting in the country and the IMF’s recent country report lamented that half of the population is suffering from multidimensional poverty while a fourth is living below $1 per day. Such high levels of unemployment and poverty spell food insecurity risks and the Benazir Income Support Program (BISP) alone will not be enough to feed all the hungry stomachs. All these problems require fiscal space and that space is just not visible in the current scheme of things. Nawaz Sharif has already accomplished what most would have considered impossible just a few years back: a third-term as Prime Minister. But from the look of things, this may just be the hardest of them all.

Ex-debt manager Ashfaque terms IMF programme ‘ruthless’ Dr. Ashfaque Hasan Khan Dr. Ashfaque Hasan Khan is the principal of NUST Business School in Islamabad. He has formerly served as Special Secretary/ Director General, Debt Office at the Ministry of Finance. He has a PhD in Economics from Johns Hopkins University.

akistan’s former debt manager appreciates the preliminary deal between the IMF and Pakistan’s government, for any delay would have been bad for the country’s economy, if not cataclysmic. “The implications of not going to the IMF Programme would have been severe. A default would mean foreign banks will no longer accept local letters of credit. That would affect imports, and hence raw materials, thereby impacting the economic activity. With very little fuel available, people would wait on the fuel stations, and productivity would suffer,” he told BR Research in an interview before the finalisation of IMF’s extended facility. Dr. Ashfaque noted that Pakistan is a user of the IMF loans since 1958. “Pakistan is among 9 countries (out of the 180-member club) that have borrowed heavily from the fund. About $18 billion were agreed to, in total, till the last programme, but only $10 billion were paid due to lack of commitment from many regimes,” he said. “Yet on the flip side, Pakistan was also the same country that successfully retired the IMF debt ahead of schedule in 2004, because economic growth was achieved and prudent debt management significantly reduced the country’s debt burden,” he noted. Ashfaque believes that the IMF has realised their mistake when they offered a front loaded programme. The government’s complacency which resulted in failure to achieve structural reforms forced the IMF to offer an equally-loaded programme this time around, according to Ashfaque. While he acknowledges that small tranches won’t solve the BoP problem, but the benefit that Pakistan can get out of IMF being at its back is huge, in terms of other inflows. Ashfaque does not seem too amused by the negotiations done by Pakistan with the IMF, which in his views, lacks the balance between stabilisation and growth. “This is not a comprehensive fiscal reform, because the programme has relied more on increasing tax rate rather than broadening the tax

base. Much more was needed on fiscal reforms, particularly in tax code and tax administration. I think cosmetic changes will be enough to at least keep the IMF happy”, he further added. He believes the current programme is a ruthless one and reminiscent of one from the 1980s. He laments the lack of human resource capacity in the Ministry of Finance to have agreed to this programme, which Ashfaque would never have agreed to. “I would have sought to strike a balance between stabilisation and growth. There is no talk of economic growth in this programme. Growth has been relegated as a by-product of stabilisation after five years,” he said. However, he stressed that “it is not the IMF money which is important. It is the IMF standing behind the country that matters; because it opens up the doors of other inflows to a country.” Commenting on IMF’s binding constraints to ensure provincial surpluses, for which provincial governments must be on board, Ashfaque said the reason why the provinces are running budget deficits has its roots in the manufacturing defects in the 7th NFC Award and the 18th constitutional amendment. According to him, the sequencing error – that is, the NFC Award significantly increased provincial allocations before new responsibilities were assigned to the provinces in the 18th amendment – is the core of the issue, which cannot be corrected now. Although the matter has be taken to the Council of Common Interests for an amicable resolution, Ashfaque had earlier suggested that since the federation is keeping only 30 percent of the revenue pool, whereas FY14 tax targets are unrealistic, and therefore provincial deficits will go even higher this year. He suggested that the finance minister needs to bring in a good team to implement the IMF agenda. “Though it is good that the process is now one-window due to Dar’s clout and hands-on approach, but he needs people who can deliver,” he said.

NEW TAX ADMINISTRATION Ashfaque believes that the tax collection target of Rs2475 billion is difficult to achieve this fiscal year. “Even when one increases the last year’s target by a nominal growth of 13.5 percent and adds Rs100 billion taxes from additional measures, the tax collection will still fall short by around Rs160 billion in FY14. Last year, FBR collected Rs59 billion more from previous year. How can one expect it to raise Rs535 billion extra this year?” he inquired. The roots of a lot of taxation woes lie in current tax administration which Ashfaque thinks is now beyond revamping – he says that much of the taxation workforce does not even know the ABCD of taxation fundamentals. To turn this around, he suggests the government establishes a new organisation, which may go with the name like ‘Pakistan Revenue Authority’. “This new tax body should be mandated to collect just one type of tax in its beginning, keeping the rest with the FBR. If it performs well, the government should give them one more tax to collect the next year, and the process should continue so on and so forth. That is the only way Pakistan can ever, gradually, make its tax system efficient,” he said. Elaborating on his idea, Ashfaque opined that the new organisation should be manned by professionals who have done MBAs and MS in economics or finance or both. “Their training should be in tax administration. Their pays should be marked-based and achievement of their targets should be the merit. Only then can this organisation develop intolerance to corrupt practices that have taken roots in the FBR,” he asserted, adding that tax policy formulation should also be kept away from tax administrators so as to minimise the conflict of interest. BUDGET: SLIPPAGES APLENTY Dr. Ashfaque is convinced that there will be many budgetary slippages, this year, too, with non-tax revenues possibly taking the biggest hit.

The government’s complacency which resulted in failure to achieve structural reforms forced the IMF to offer an equally-loaded programme this time around

“Only about half of the money against the expectation of $1.1 billion in CSF inflows may be received. The 3G licenses have again been budgeted, at a higher sum of Rs120 billion this year. So is the case with Rs79 billion pending from Etisalat. Similarly, Rs110 billion from program loans are difficult to materialise. Eurobond sale worth Rs50 billion is also unrealistic because international yields on Pakistani bonds are still very high, and it’s not a good time for a bond sale,” he maintained. Then there are slippages on the expenditure side, too. “Government salaries were raised days after budget announcement, whose impact must be added to current expenditures. The budgeted FY14 average monthly subsidy on inter-disco tariff differential comes to about Rs30 billion – but a sum of only Rs150 billion has been kept in the budget for the entire year. Some Rs115 billion have been reserved for ‘New Development Initiative’ which is again a large sum with no specified projects,” he said. In this scenario, he deems it unlikely that the IMF demand to the government to limit budget deficit to 5.8 percent of GDP will be achieved.

Interview by Hammad Haider

Fiscal Review | October 25, 2013 | 5

Budget at a glance CORPORATE TAX RATE (%)

MAJOR SOURCES OF REVENUE RECEIPTS Rs (bn)

FY12-B

FY12-A

FY13-B

FY13-A

FY14-B

Direct tax Income tax

744 719

745 730

932 914

779 761

976 949

Indirect tax Customs Sales tax Federal Excise duty Petroleum levy

1,331 206 837 166 120

1,280 215 852 140 69

1,572 248 1,077 125 120

1,345 241 864 122 115

1,622 279 1,053 167 120

Non-tax revenue SBP profits Profits from PTA PTA (3 G Licenses) Dividends

658 200 75

512 200 0

733 200 0 79 65

712 200 5 0 64

821 200 14 120 68

FY12-B

FY12-A

FY13-B

FY13-A

FY14-B

Permanent Debt Pakistan Investment Bond Ijara Sukuk Bonds

129 50 80

175 50 126

144 54 90

105 15 90

165 75 90

Floating Debt Treasury Bills

119 82

209 160

156 110

0 -50

95 50

Public Account Saving Schemes

164 149

108 98

188 178

325 314

247 235

EXTERNAL RESOURCES FY12-B

FY12-A

FY13-B

FY13-A

FY14-B

A - Loans…of which Project loans Programme loans Euro Bonds Islamic Development Bank

287 68 118 44 44

181 166 5 0 6

275 140 41 47 47

215 183 7 0 25

467 159 110 50 198

B - Grants …of which Project grants Tokyo pledges Privatisation proceeds Kerry Lugar

127 9 4 70 34

46 19 1 0 20

109 25 1 74 8

29 21 1 0 7

109 28 1 79 1

414

226

384

243

576

SHARE OF PROVINCES IN FEDERAL REVENUE RECEIPTS Rs (bn)

FY12-B

FY12-A

FY13-B

FY13-A

FY14-B

Divisible Pool…including Income tax Sales tax * Customs (excluding EDS)

1043 408 437 112

1063 414 457 119

1303 518 584 146

1137 432 489 133

1379 538 597 154

Straight Transfers…including Royalty on crude oil Royalty on natural gas GDS

87 13 32 24

95 22 34 24

101 22 35 30

96 27 41 16

115 32 39 35

GST on Services

* Excluding GST on services

6 | Fiscal Review | October 25, 2013

14 Tax to GDP (%)

Sri Lanka Indonesia

12 11

China

India

United States

Bangladesh

9 8

Philippines

Pakistan 30

Corporate tax rate (%)

Source: KPMG, World Bank

FY14-B

FY13-A

FY12-A

Savings scheme T-Bills

PIB -20%

20%

40%

60%

EXTERNAL SOURCES

Rs (bn)

Total (A+B)

Malaysia

MAJOR CAPITAL FLOWS (as % of gross capital flows)

MAJOR SOURCES OF GROSS CAPITAL RECEIPTS Rs (bn)

South Korea

(as % of total budgetary sources) FY14-B

FY13-A

FY12-A

Total External sources Grants

Loans 0%

10%

15%

20%

25%

COMBINED PROVINCIAL FISCAL BALANCE Rs (bn)

167 120

125

80 23

FY11-B

FY11-A

FY12-B

FY12-A

FY13-B

FY13-A -62

FY14-B

FEDERAL TRANSFER TO PROVINCES Rs (bn)

FY10-A

FY11-A

FY12-A

FY13-A

FY14-B

Punjab Sindh Khyber Pakhtunkhwa Balochistan

332 199 89 36

464 278 157 99

586 313 198 112

578 326 204 113

709 400 252 142

Total

655

998

1,209

1,221

1,502

VARIANCE BETWEEN BUDGETED AND ACTUAL FEDERAL TRANSFER TO PROVINCES Rs(bn) 5

0.1 FY10

FY11 -36

EXTERNAL SOURCES

Rs (bn)

FY10-A

FY11-A

FY12-A

FY13-A

FY14-B

General Public Service, of which Servicing of foreign debt Foreign loan repayment Servicing of domestic debt

1,471 71 148 596

1,655 74 127 654

1,898 72 137 772

2,143 77 187 952

2,357 89 367 1,065

Defence Affairs and Services, of which 378 Defence Services 376 Defence Administration 1.2

445 443 1.3

510 508 1.9

570 568 1.7

627 625 1.8

Public Order and Safety, of which Police

37 34

58 55

61 56

72 66

78 72

Economic Affairs Education Affairs and Services Social Protection

80.6 32 4.3

80 40 2.9

72 45 30

50 52 1.5

52 59 1.8

TOTAL*

2,017

2,295

2,631

2,907

3,196

(as % of total budgetary sources) FY10-A

30%

FY14-B

33% 1.5%

0.3% 0.3% Servicing of domestic debt

Health Affairs

FY12-B

FY12-A

FY13-B

FY13-A

FY14-B

Wapda/Pepco Inter-Disco Tariff differential

123 50

419 412

135 120

265 250

165 150

45 45

50 50

84 84

55 55

Utility Stores Corp

Total Subsidies*

166

512

209

367

240

23%

14% 64% Wapda/Pepco

FEDERAL DEVELOPMENTAL SPENDING Rs (bn)

FY11-A

FY12-A

FY13-A

FY14-B

Federal PSDP Development Loans & Grants to Provinces Other Development Expenditure (Outside PSDP)

196 22 46

304 52 122

388 76 107

540 78 172

Total

263

478

571

789

(as % of total) 64% 11% 25%

MEDIUM TERM BUDGETARY STATEMENT FY14-B

FY15-F

FY16 F

4.4 8

5.5 8

7 8

14 11 10 20 15 5.1 -6.3 61

14 11 10 19 14 5.2 -5.0 59

14 12 11 18 13 5.3 -4.0 55

(as % of GDP)

68% 13% 19%

68% 10% 22%

KESC

69% Utility Stores

TCP

Others

MAJOR OUTLAYS IN 'OTHER DEVELOPMENT EXPENDITURE' (OUTSIDE PSDP) Rs (bn) FY12-A

FY13-A

45 74% 8% 17%

13%

* Includes other classification of subsidies not specified here

Federal PSDP Development Loans & Grants to Provinces Other Development Expenditure

Educations Affairs

FY14-B SUBSIDIES BREAK-UP 7%

Rs (bn)

Total Revenue Tax revenue FBR tax revenue Total Expenditure Current Development Fiscal balance Total Public Debt

Defence Services

FY10-A SUBSIDIES BREAK-UP

MAJOR SUBSIDIES

1.8%

19% 20%

* Includes other classification of expenses not specified here

25 KESC KESC on account of tariff differential 24

FY13

-238

CURRENT EXPENDITURE: MAJOR ITEMS

Real GDP Growth (%) Inflation (%)

FY12

FY14-B

10 Subsidy to TCP for Benazir Income Support Import of Urea Fertilizer Program (BISP)

14 15 8 Loans & grants to PPAF

Source: Annual Budget Statements & Economic Surveys years FY09 to FY14, and BR Research calculations thereupon. Other sources have been referenced seperately. FY refers to Fiscal Year. Pakistan's fiscal year runs from July 1st - June 30th. A: refers to actual data, provisional figures released by Ministry of Finance (MoF) B: refers to budgeted data for respective year F: refers to MoF forecast

Fiscal Review | October 25, 2013 | 7

Unpleasant and depressing: Pasha’s grim views During his long and distinguished career, Dr. Pasha has held a number of important public appointments including those of the Commerce Minister, Adviser to the PM for Finance and Economic affairs, Federal Minister of the Planning Commission and Education Minister during different governments. He is currently serving as the Dean of the School of Social Sciences at the Beaconhouse National University, Lahore.

The following is a brief transcript of the conversation, the gist of which in Pasha’s own words is that “we are perilously close to a financial crisis; yet we are living in a world of complacency”. BR Research: What are your views about the new government’s ‘ambitious’ budget? Hafiz Pasha: They’ve targeted a very substantial growth in revenues, a 50 percent jump in development expenditure, a reduction in deficit to the tune of 2.5 percent of the GDP, the resolution of circular debt and also assumed that the provinces will generate a surplus. So all in all, I would say it’s a very vivid and pleasant dream. The first big disappointment, which I’m sure the Ministry of Finance must have had, was the outcome of FBR revenues for FY13. Their budget was based on the revised estimates of Rs2,007 billion and the actual outcome turned out to the tune of Rs1,942 billion, so there was a shortfall of Rs65 billion, which is a significantly large number - especially when you consider the fact that this is in relation to a target revised at least three times. So last year’s growth in tax revenues was hardly 3 percent. And things appear even grimmer when you see that this growth rate of 3 percent is only after the FBR held back Rs50 billion of refunds; in effect, gross revenues have hardly witnessed any growth. Given this situation, the targets set out by current budget are so beyond ambitions that they are almost in the realm of impossibility. BRR: The budgetary outcome in FY13 indeed showed many negative developments. But would you say that the new government started off on a positive note? HP: The first month’s outcome was semi-positive, I would certainly agree with you on that. They collected Rs130 billion as opposed to a target of Rs140 billion, which was a fairly significant growth over last year’s numbers. However, a comparison with last year’s figures would be unfair since the Rs107 billion collected were part of an advanced tax fix. A better comparison would be with figures two years ago, which stood at around Rs112 billion. Year-on-year this represents a growth rate of about 16 percent, but even if they sustain this particular growth momentum they would be hard put to reach Rs2.3 trillion, let alone what their target is.

8 | Fiscal Review | October 25, 2013

The issue is that they are starting off with a handicap of a very large magnitude on the revenue side. That’s the first big piece of bad news for the Ministry of Finance. If they want to get Rs2,475 billion with the base of Rs1942 billion, they will have to show a growth rate of 27 or more percent, which happened only once in Pakistan’s history, way back in the early 90s. And even bigger challenges lie ahead. One particular cause of concern is US Secretary of State John Kerry’s visit, where there was no commitment whatsoever on reimbursement of any CSF money. Remember that the government has budgeted Rs112 billion under non-tax revenue inflow in lieu of Coalition Support Fund, which is a very substantial amount. In fact, last year the timely inflow of the CSF money was what helped contain the deficit, aiding both the country’s balance-of-payment and fiscal situation. There’s some unraveling on the non-tax side and overall the country might end up with a shortfall of Rs70-80 billion or more on the non-tax revenue side alone. BRR: Then there’s this whole business about the 3G license issue. What are your views on that? HP: That is another resource that remains untapped. The problem with the 3G license is that the government has - with all due respect - completely mismanaged the telecom sector. In the last few years, there has been a flight of capital from the sector with substantial taxation weighing on the players. With presumptive income tax at 15 percent and the provinces proceeding to collect the tax at 19 percent, the whole thing is basically an example of killing the goose that lays the golden eggs. It was a good source of revenue and we certainly could have managed it better. And this whole idea of a WHT at such a high rate is really absurd, since the funny part is that most of it hits the common man. I mean $300 million of money taken out from telecom sector in the last one year alone, it is preposterous! Who do you think will even be interested in your auction for 3G licenses at this point? BRR: What is your outlook on the balance of payment for FY14? HP: The BoP situation will remain extremely tricky. If you look at last year’s outcome, we had a current account deficit of about 1 percent of the GDP and we ended up with a deficit in the financial account perhaps for the first time in the history of this country.

More bad luck for the new government in this regard has been the situation in the Middle East. I would say that a 5 percent hike in oil prices would be a reasonable expectation. And the effects on the BoP situation will be a double whammy, because you see two things happening: The Pak currency is falling while international oil prices are soaring.

and federal development expenditure they will save around 1 percent; but they will still be sitting at 6.6 percent fiscal deficit. And since the prime mechanism of revival you were depending on was the big boost of 50 percent in the development expenditure which would have provided a big stimulus to the economy in the form of a fiscal multiplier, you can say that any plans of revival are now bust.

BRR: How is the government behaving thus far on the subsidies front? HP: The budget proposed a big reduction in subsidies – by Rs127 billion or 35 percent, especially to the power distribution companies. Part of this is supposed to have been achieved through an enhancement in power tariffs, which can be deemed a fiscally sound move, however ill-designed it may be. But the issue remains the ad hoc increments in subsidy spending. Every time the ECC meets they announce some new subsidy. First it was PIA, then the Pakistan Steel. So the year has started with an unplanned subsidy burden accumulated to the tune of an additional Rs18-19 billion, and God knows how much each subsequent ECC meeting is going to cost us. To add insult to injury, the government had not planned for the backlash from the public sector employees which prompted them to announce the pay raise. So we can assume that Rs30 billion is the net increase in liability of the federal government on account of these salary increases. Plus, provincial governments will also pay around Rs50-60 billion to their employees. The provinces having already budgeted for a combined deficit of Rs52 billion; adding another Rs60 billion will take their net to Rs112 billion. And this can’t happen because that exceeds their overdraft limit; so the only solution will be to massively chop the provincial development spending for the nth time in the last 5 years. BRR: The budget hinged massively on this developmental spending for growth. What will be implications of this cut? HP: Inevitably, the adjustment would have to be on the development side and I expect very little growth in development spending on a provincial level and a cutback of Rs115 billion on the federal side - in lieu of the “New Development Initiatives”. The end result will be an unraveling to the tune of Rs350 billion, which is about 1.3 percent of the GDP. So instead of 6.3, you are realistically sitting at a deficit of 7.6 percent. Through the saving on provincial

BRR: What are your views on country’s current account position?

Pakistan is a boiling pot right now. The security situation is progressively worsening, the government has raised industrial tariffs by 35 percent; the cost of doing business has gone through the roof. Who do you think is going to invest in this chaos?

HP: The current account position will remain precarious. If the government is at all serious about reducing the load-shedding, they’ll of course have to buy more furnace oil during the year- and my calculations say that we might have to import at least an additional billion dollars worth during FY14. Then fertiliser imports will grow and of all the things in the world, we might even have to import wheat this year. So basically the country’s import bill, which has been slated to grow at a leisurely pace of 7 percent, will easily go into double digit during the next twelve months. On the flipside, exports remain a cause for concern. Additionally our remittances are going down, having remained flat from March to June, with only a small seasonal jump during Ramadan. All in all, I see the current account deficit worsening to about $4 billion. BRR: Bringing in investment will remain a challenge, what do you think needs to be done? HP: Pakistan is a boiling pot right now. The security situation is progressively worsening, the government has raised industrial tariffs by 35 percent; the cost of doing business has gone through the roof. Who do you think is going to invest in this chaos? The best performing sectors during Shuakat Aziz’s golden age are now stumbling and bleeding. Banks have sold out; the telecom sector players want to be bailed out, so where will foreign investment come in a country where the locals are unwilling to invest? The only place where I see some money coming in is oil and gas exploration and very little elsewhere.

Interview by Ali Khizar & Javeria Ansar

Fiscal Review | October 25, 2013 | 9

Energy self-sufficiency: a pipe dream Zuhair Abbasi

ever before in Pakistan’s short history were energy reforms the mainstay of political parties’ election manifesto and campaigns. But then, never before was the situation as adverse as it is today. For a struggling economy like Pakistan’s, to lose 2 percent of GDP growth annually just because of the energy crisis is a massive blow and unsustainable. The problems are well-documented, well-researched and widely known and so are the solutions. It is always the implementation end that has disappointed, largely due to a visible lack of political will. Whether the current government succeeds in reforming the energy sector is too early to call, but it can be safely said that is has at least shown the intent so badly lacking in the predecessors. The BR Research Economic Perception Survey (see page 22) highlights the severity of the issue, with energy tipped as the most pressing issue in the country affecting the businesses. Heartening to see there is still light at the end of the tunnel, as the business community has faith in the current government to resolve the energy crisis. POWER CRISIS The reform agenda is out and some steps have already been taken toward improving the overall picture especially in the power sector. Partial settlement of circular debt cost the government nearly a massive $5 billion, which invited criticism from many a corners. Surely this was not the smartest way to deal with circular debt, but Finance Minister Ishaq Dar felt that offering more liquidity space will help kick-start the reforms. Improving the power generation mix seems high on the reform priority list and rightly so. Thermal power generation constitutes two-third of the mix, which is the highest in the region. Coal and hydel-based generation are in the pipeline but have one obstacle too many to be considered even a medium-term solution. Pakistan will have to improve the mix within

the thermal generation by shifting more on gas and relying less on furnace oil. The improved liquidity of the energy chain has indeed resulted in reduced load shedding across the country, but it could all be an exercise in futility if it is not followed up with a concrete plan. Power

losses costing over Rs200 billion – it will remain a pipedream without streamlining the tariff regime and doing away with subsidy. KESC is a prime example, which is often at the receiving end of either interrupted fuel supply or non-payment on account of tariff subsidy form the govern-

Domestic sector currently sits at number one priority for gas allocation, which should never be the case as it also happens to be the most subsidised and most inefficient user category tariff rationalisation is a must to ensure the $5 billion spent on circular debt clearance don’t go down the drain. The government has been boasting of its tariff rationalisation initiative which has resulted in a much higher tariff for industrial and commercial consumers. Bear in mind though, the two segments constitute a little over one-third of the country’s electricity generation – therefore, the right word should be ‘select’ tariff rationalisation. The government does not want to irk the domestic and agriculture power consumers and appears to have taken the easy route of rationalising the industrial tariffs. Domestic sector constitutes half the country’s power consumption and receives subsidies in hundreds of billions of rupees every year. In fact, the revised definition of ‘lifeline consumers’ by raising the benchmark to 200 unit consumption –will wipe off all the good work done on account of industrial tariffs. The government has decided in principle to privatise power generation and distribution companies in a phased manner. This is no doubt a heartening decision, one that would yield fruits in the longer run. While privatisation will free the government of the high T&D and efficiency

ment. For privatisation to be successful – prioritising and implementing fuel supply to the power sector and end of the subsidy regime are must. GAS CRISIS While the power crisis attracts more criticism and attention, it is the natural gas crisis that costs the economy significantly more – in the tune of $7-10 billion every year, according to government’s own estimates. The efficiency problem mirrors that of the power distribution companies – with system losses over Rs200 billion every year. Privatisation, unlike the power sector, is not an option, so the government has a rather tough task to streamline the state-owned distribution companies. The current demand stands at 5.9 billion cubic feet per day (bcfd) - whereas supply hovers around 4 bcfd. Gas production has remained stagnant over the past five years due to a host of reasons, of which inadequate pricing is the key. The security situation is largely uncontrollable for which the authorities can be pardoned, but unattractive wellhead gas pricing remains the chief contributor towards a near halt in exploration and production activities.

The writer works as Senior Analyst at Business Recorder. He can be reached at m.zuhair.abbasi@gmail.com

10 | Fiscal Review | October 25, 2013

The gas reform plan mentions increasing the wellhead prices to desirable levels – something which should have been done long ago. That said, it’s never too late, but the government will have to simultaneously increase the retail prices for all categories. The highest pricing slab for natural gas is Rs636 per mmbtu in Pakistan, which pales in comparison to the average import price of Rs1500 per mmbtu. Pakistan has no option but to import gas in the near future, either in form of LNG or pipeline – for which we have to prepare beforehand by raising gas price gradually. Another area that needs a bit of oversight and strict reinforcement is gas allocation priority. Domestic sector currently sits at number one priority for gas allocation, which should never be the case as it also happens to be the most subsidised and most inefficient user category. Unfortunately, that is not going to change anytime soon as the current government plans to continue subsidising gas to domestic users with the top most priority. The BR Research Survey clearly shows the overwhelming majority of businesses in Pakistan want power sector to get the gas first, followed by industries and domestic, in strict order. The government though has other plans – and that is to continue with the current priority list which puts power sector second on the list. The goal can still be achieved if the CNG usage is discouraged through equating its price with that of petrol. This is a part of government’s gas reforms plan – but is less likely to be implemented, given the powerful lobby and possible judicial intervention. In such case, all efforts need to be made to expedite the gas imports, particularly LNG, before the crisis deepens and another $5 billion is doled out to clear the mess. Last but not least, the situation underscores the need for a single energy ministry in order to achieve canonised arrangements for better coordination and optimised synergies.

Hammad Haider The writer is a Research Analyst at Business Recorder. He can be reached at hammadshah24@gmail.com

he 18th Constitutional Amendment had devolved social sectors to provinces, while leaving federal government in charge of large infrastructure projects. However, a review of the provincial budgets for the fiscal year 2013-14 shows that the provinces still remain indulgent in infrastructure development, so much so that even in social sector the focus is primarily on brick and mortar than on improving the delivery mechanism and in lieu of it getting larger slice of development. Infrastructure matters! Economists maintain that Pakistan needs to undertake some mega projects to address its glaring infrastructure gaps. Economic Survey 2012-13 reported a decelerating growth of only 3.4 percent in the “transport and communications” industries in FY13, which make up about 25 percent of the services sector and roughly 14 percent of GDP. Although there is saturation in communication sector, there is much room in the transportation sector to grow. The effectiveness of federal PSDP portfolio – which has been eating up public and donor funds to build large public infrastructure – is in question. Hundreds of infrastructure projects, costing over two trillion rupees currently languish in limbo due to time and cost overruns mainly stemming from bureaucratic inefficiencies at various levels. No wonder then that the quality of Pakistan’s infrastructure fares poorly in comparison to other countries in South Asia and South-East Asia. The Global Competitiveness Report 2012-13 ranked Pakistan’s overall infrastructure at 105 among a total of 144 economies. Pakistan’s overall infrastructure is ranked only better than Bangladesh’s in the region (see illustration). Interestingly, its road infrastructure is ranked above what Russia, India, Bangladesh and Indonesia have. But its railroad, port and aviation infrastructures leave a lot to be desired. As the examples of Malaysia, Thailand and Sri Lanka show, Pakistan needs to improve upon its entire transport infrastructure to achieve a better overall competitiveness score in infrastructure. But provinces have other plans… Therein lies the rub. The federal government itself is resource-constrained to finance any major infrastructure projects in rail, port and aviation projects. The provinces won’t do it because it doesn’t fall in their domain, nor does it seem likely that they will pool resources for the federal government to do it. The need is to have some public private partnership to kick-start giant projects. Pakistan’s misfortune is that despite having a decent road density, its governments have been spending more and more on road infrastructure, ignoring other transport infrastructure. The federal government itself has been heavily funding the National Highway Authority for past many years, for building highways and

Insights into provincial infrastructure spending Quality of Infrastructure: Regional Ranking Country

Overall

Road

Rail

Port

Air

Malaysia

Thailand

Sri Lanka

China

Iran

132

India

Indonesia

104

Russia

101

136

104

Pakistan

105

Bangladesh

131

113

121

120

Source: Global Competitiveness Report (2012-13), World Economic Forum

motorways extensions, doing maintenance and patchworks. For provinces, it is about getting a bigger bang for the buck. Spending on ‘soft sectors’, such as healthcare and education, naturally takes many years before significant turnaround is achieved. Any improvement made is, at best, intangible; and it largely goes unreported and unnoticed. Even though provincial governments are now seen to be doubling down on social sector spending, they are sticking to their old ways of spending big on roads, flyovers/underpasses, bridges, and intersections: things which continue to dominate the development narrative in Pakistan. That is visible in provincial development budgets of this fiscal. Roadsters all the way… Provincial governments have allocated significant funds for non-transport infrastructure projects in FY14, but their fixation with roads and allied structures holds. Take the Punjab government for instance. It has allocated Rs90.7 billion, or 31.3 percent of its total development budget, for infrastructure development in FY14. About 32 percent of the province’s infrastructure development budget will be spent on roads. A mix of new and ongoing schemes, these road development schemes – worth Rs29 billion – start from the Murree hilltops, snake through the Pothohar, and travel down south all the way to Rahimyar Khan. A Rs4 billion block allocation has been set aside separately for ‘farm-to-market’ roads. Nearly half the infrastructure development schemes in Punjab’s FY14 Annual Development Plan are new, mostly in roads, energy and urban development. Foreign aid will finance only the irrigation and energy projects, not the road schemes. The blueprint of Punjab’s urban development schemes is concentrated around five large cities of Lahore, Faisalabad, Rawalpindi, Gujranwala, and Multan, where about Rs14 billion will be spent by using these cities’ respective development authorities. About Rs16 billion have been

earmarked for regional planning, with projects focusing mostly on the South Punjab and the Pothohar regions. If the incumbent Chief Minister Punjab’s modus operandi is any guide, one expects more funds to be allocated for new road schemes and flyovers/underpasses in these cities. Sindh’s development budget does not separately outline infrastructure development outlays. Various infrastructure

The KP government has allocated funds to build road networks for less developed areas. It will also construct 521 kilometers of blacktopped roads in major metropolis such as Peshawar, Abbottbad, Haripur and Nowshera. The government has allocated Rs5.2 billion for urban development schemes, in which the capital city of Peshawar will get a major chunk. Regional and urban development outlays are also expected to be channelled towards road building schemes. The FY14 development budget of Balochistan stands at Rs44 billion, of which infrastructure development will take up about 47 percent this fiscal, compared to 58.5 percent in FY13. To create fiscal space for greater social sector development, communication infrastructure development has been capped at 25 percent of development budget, down from 33.3 percent last fiscal. More infrastructure development will make it its way to other areas, including energy projects and urban development. It’s about political priorities There is no denying the socioeconomic benefits of building road infrastructure. But an overarching focus on paved roads is misplaced, which harms overall infrastructure development. Only the Balochistan

Infrastructure Development in Provinces Infrastructure development budget - Rs (bn) As % of total development budget

Balochistan

Punjab

Sindh

20.6

41.7

90.7

72.5

Provincial priorities for Infrastructure development Roads

Irrigation As % of respective provincial infrastructure Energy development budgets Urban/Reg./Rural Dpt. Public Buildings

Source: Provincial development budgets for FY14 (June 2013)

schemes are embedded in different categories. Their assortment yields that out of total provincial PSDP of Rs195 billion; over Rs72 billion (over 37 percent) has been set aside for infrastructure development in FY14. The Sindh government out-budgeted their Punjab counterparts by allocating 36 percent of their infrastructure development budget for building roads. Apart from all this, another Rs20 billion have been earmarked for a ‘district development programme’, which may include more infrastructure development schemes, especially roads. In the restive province of Khyber Pakhtunkhwa (KP), the provincial government budgeted about Rs42 billion for infrastructure development, which is about 35 percent of its Rs118 billion ADP. To address regional disparities within the provinces, 42 percent of this infrastructure development budget would be utilised on regional development and about 38 percent on building roads.

government seems to have fallen out of favour with building roads and bridges. For instance, out of the 89 new development schemes proposed in the budget by the new government, only three happen to be for building roads. On the other hand, out of every hundred rupees set aside in their respective development budgets, Sindh and KP will spend Rs13 each and Punjab Rs10 on building roads. It seems that these three provinces – where three different, major political parties are currently governing – will keep spending heavily on ‘visible’ transportation infrastructure. After all, earlier in May this year, majority of Pakistan’s electorate found concrete proof of governance in the concrete structures of sand, cement, and gravel.

Fiscal Review | October 25, 2013 | 11

Infrastructure sector represents unlimited potential As the Chairman of Nishat Group - the largest industrial and financial conglomerate of Pakistan- Mian Muhammad Mansha’s views about the economic climate in the country carry a weighty resonance within the business community. Talking to BR Research about the political change of gears and its impact on the sentiment within the business community, Mansha was characteristically optimistic, giving the newly formed government a resounding vote of confidence. The following is an excerpt from the conversation.

BR Research: Do you feel that the newly elected government has improved business sentiment in a very short time period? Mian Mansha: From an apolitical businessman’s point of view, I can say that the change in office has indeed improved sentiment within the business community. And this is mainly influenced by the perception of PML-N as a ‘business friendly’ political party which is expected to improve upon the current standard of governance and use its practical knowledge and understanding of business to manage the economy in a much more efficient way. And of course it doesn’t hurt that they have set precedent. When Shahbaz Sharif came into the office during his last term, he took some time to find his bearing and got involved in some well-intentioned but ill-thought out endeavors at first. However, during the last couple of years, some of the work done by his team has been exemplary and going forward we can expect that they will not make the same mistakes and maybe, will find their footing sooner. Overall, while no one expects changes to come into effect overnight, a very pronounced change of stance is visible within the business community. BRR: As a businessman with a vested interest in different sectors of the economy, what do you think will play out in the next few years? Where do you see the biggest push for growth? MM: We all know how the last five years have been. For the bigger players like us, things have not been as hard and in fact at MCB Bank we just had the best six months we have ever had. But it has only been these few prominent sectors – banking, textiles, cement- where our entire attention has been focused and I feel this is where this new government’s stance will shift. There are indications which tell me that things are finally beginning to look up for a lot of business sectors that had been relegated to the backburner by the last government. Looking ahead I think that as

the current government settles into office, some incentives for the construction and development sector will appear. And as that happens, some of the bigger names will immediately want to jump into housing, since that is another area where growth has really never kept pace with demand. Currently this sector represents unlimited potential for growth and if the government enters into some sort of partnership with private players, I see a lot of low-cost housing schemes cropping up in suburban areas of cities like Lahore. In fact, having foreseen this, we decided to jump into the urban development arena during the PPP-led regime when the outlook for the sector was still particularly grim. Currently, we are in the process of building a mega mall in the suburban fringes of Lahore and the project is expected to be on a scale which is unprecedented in the country. With the project are tied some very exciting foreign names and brands which we will be bringing to Pakistan for the first time. So without divulging too much I would say that exciting times are ahead. Then of course energy is going to be another sector where, hopefully, we will see a level-playing field being created as the government comes to the realisation that letting in the private investor is going to be the inevitable. We have already had meetings with the government regarding setting up of the Gadani Energy Park on the Balochistan coastline and we look forward to investing in the coal-fired power projects. BRR: What steps do you think the newly incumbent government can take to improve investor confidence going forward? MM: At this point, there’s still a long road to restoring the confidence of the international investor and the bigger challenge would be to compel the domestic investor to start putting up money first. Everyone knows how the energy crisis in this country has dented investments and I don’t need to repeat the story. Even within sectors that are performing well, the investment climate has been patchy at

best because who would want to set up an industrial unit and not be sure when they’ll get electricity to run their plant? I think in the short run domestic investor confidence hinges directly on how they manage the energy situation. Then of course a lot of hopes reside in the business acumen of the Sharif brothers. With the cost of doing business in Pakistan going up like it has, the business community expects the government to improve the investment climate on the basis of policy incentives that bring these costs down.

weak stance on their management have had an even bigger impact. Not only has this dragged on public finances and economic growth, it has also done some serious damage to our tenability as a viable investment destination. So this is one aspect that they will need to address in the medium term to counter the falling capital inflows. Another thing that they should concentrate on is ensuring stable policies and business processes. It has long been a norm in this country that every incoming political establishment throws out the outgoing establishment’s

I would suggest that they take the harder decisions during their first two years in the office as it will get progressively more difficult to make these decisions as time goes by In this regard I would suggest that they take the harder decisions during their first two years in the office as it will get progressively more difficult to make these decisions as time goes by. That this new found political stability will pave way for a more enabling business environment, I have no doubts about it. But how long it takes them to install the necessary regulatory head-works in place remains to be seen. BRR: You said that we still have a long way to go towards restoring the confidence of the international investor. But a persistent decline in FDI inflows is one very big issue staring the Sharif camp in the face. What strategic endeavours will they need to take up to improve the situation in the medium term? MM: I think that they would want to steer clear of pretty much everything that the last government did if they want to establish some credibility with foreign investors. While issues such as security concerns have loomed over us, I believe that the haemorrhaging PSEs and the government’s

MoUs and trade agreements etc. But this has got to stop. Until the investor can be sure that their business interests in the country are safeguarded by stable policies that transcend political regimes, you will not be able to attract the kind of new investment that contributes to the country’s long-term economic growth. Then of course there are the other confidence-building measures they will need to introduce as part of a comprehensive approach. A showcasing of good governance will go a long way and so will be reforms of the judiciary and civil services. Installing mechanisms that ensure transparency of processes, curbing the corruption of public funds and a viable long-term policy to combat terrorism are what I expect on the new government’s long-term roster. Going forward, security, stability and implementation of farsighted policies will be what leverages international investor confidence in Pakistan and I feel that there is enough political will to take on these challenges headfirst.

Interview by Ali Khizar & Javeria Ansar

Fiscal Review | October 25, 2013 | 13

Social spending: Punjab spends the least? Iffat Ara With health and education becoming a strictly provincial subject in the post-18th Amendment scenario, it becomes imperative for the citizenry to understand how the four provinces are prioritising their spending on these two key social services. This article takes a look at provincial priorities set by the newly elected provincial governments, particularly the priorities given to the social services such as education and health in budget 2013-14. From the perspective of current expenditure – the budgetary head that comprises recurring operational costs involved in provision and maintenance of a range of government services – it appears that Punjab spends the least on health and education. Table 1 shows that budgeted current expenditure on health and education in FY14 is 12.5 percent and 7.3 percent respectively, whereas that by other provinces is fairly higher. However, before one starts rebuking the Punjab government, bear in mind that under the Local Government Ordinance 2001, education services were devolved to the district government. Since then, the provincial governments have been allocating funds under the head of ‘inter-government transfers’ to the district governments for delivering educational services particularly the primary education. A second look at Table 1 will show that except for Punjab, the governments in other three provinces either have no spending under inter-government transfers or have slashed it down in both current and development expenditures. This suggests that primary and secondary education is part of the local government in Punjab which is financed through inter-government transfers. Spending under this head constitute a share of 40 percent in current expenditures and 10.7 percent in development expenditures. Alternatively, the governments in other three provinces have kept the delivery of these largely to themselves. For example, the share of expenditures under intergovernmental transfers has declined massively in the budgeted figure of 2013-14 while the shares of expenditures under health and education affairs have increased in Khyber Pakhtunkhwa indicating reduction in the role of local governments. Therefore, in order to get a complete picture for comparison, the expenditures

14 | Fiscal Review | October 25, 2013

under education, health and inter-government transfers are clubbed together to serve as a proxy for allocation on social services. This proxy indicates that under current expenditure, Punjab’s allocation on social services was the highest -- 60 percent -- followed by 53 percent in Sindh, 50 percent in Khyber Pakhtunkhwa and the lowest share of 31 percent in Balochistan. Compared to the revised estimates of current expenditures in 2012-13, the combined share of social services has increased by 2.1 and 3.1 percentage points in Punjab and Sindh respectively indicating that the governments in these provinces have an emphasis on increasing consumption budget towards social sector in 2013-14. As against, the combined share

of social services has declined by 6 percentage points in Khyber Pakhtunkhwa, whereas in Balochistan, this share has almost remained unchanged. Development expenditure Developmental expenditures cover spending on new physical and social infrastructure, new facilities or even new administrative functions. This implies that while current expenditure can be termed consumption, the development expenditure can be described as an investment. A look at development spending in budget 2013-14 shows that except for Khyber Pakhtunkhwa, all other provinces have given their biggest priority to economic affairs. Over 53 percent of

development spending in Punjab is devoted to economic affairs, 35.4 percent in Sindh and 43.6 percent in Balochistan. In Khyber Pakhtunkhwa, however, the most prioritised allocation in development expenditures is education affairs that have a budgeted share of 29.2 percent. However, since expenditures under the head of inter-government transfers are largely for social services delivery, one has to take into account the allocation under this head. This means that for the purpose of analysis, we have to combine inter-government transfers with expenditures on education and heath to assess the share of overall spending allocated on social services in budget 2013-14. This combined share is the highest in Khyber Pakhtunkhwa with 37.8 percent,

Table 1: Provincial Priorities in Current and Development Expenditures Sindh

Punjab

Khyber PK

Balochistan

Head of Account

FY13 R

FY14 B

FY13 R

FY14 B

FY13 R

FY14 B

FY13 R

FY14 B

Current Expenditures Rs (bn) (% share) General Public Service Inter Government Transfers Public Order and Safety Affairs Economic Affairs Health Education Affairs and Services Others

549.8

607.6

342.1

356.0

195.0

211.0

104.8

117.3

7.5 40.4 16.6 15.3 10.6 6.8 2.7

6.7 40.2 16.6 15.4 12.5 7.3 1.3

16.9 11.4 15.4 12.6 10.0 30.8 2.8

17.8 11.2 15.3 9.7 10.2 33.8 1.9

17.9 46.6 15.3 6.4 3.9 5.7 4.1

21.7 6.6 14.3 8.3 9.1 34.5 5.6

23.0 0.0 14.5 24.9 9.3 21.9 6.2

20.6 0.0 13.8 29.1 9.5 21.1 5.9

Development Expenditures Rs (bn) (% share) General Public Service Inter Government Transfers Public Order and Safety Affairs Economic Affairs Health Education Affairs and Services Social Protection Others

166.9

290.0

110.9

185.0

88.1

118.0

34.8

43.9

1.5 15.0 0.5 34.7 10.1 4.3 0.9 33.0

3.3 10.7 0.5 52.3 7.9 11.1 1.0 13.3

2.9 0.0 0.0 38.2 13.1 5.5 35.5 4.8

7.3 0.0 0.0 37.2 9.2 7.4 35.4 3.5

11.1 1.9 0.4 35.4 7.7 22.0 1.1 20.4

15.8 1.4 0.8 28.6 7.2 29.2 3.8 13.2

13.2 0.0 0.4 62.5 2.6 4.8 2.6 13.8

11.5 0.0 1.3 43.6 9.2 24.0 0.2 10.2

Table 2: Composition of Expenditures on Education Punjab

Sindh

Khyber PK

Balochistan

FY13 R

FY14 B

FY13 R

FY14 B

FY13 R

FY14 B

FY13 R

FY14 B

41.2

40.6

105.4

120.5

11.2

72.7

23.0

24.7

2.4

44.6

42.7

1.7

38.0

28.8

25.7

Secondary Education

44.2

35.8

25.1

26.1

1.1

40.7

41.5

36.9

Tertiary Education

43.5

51.7

15.3

14.9

82.7

15.4

17.6

17.2

9.9

10.1

15.0

16.3

14.6

5.9

12.1

20.2

7.1

32.1

6.1

13.7

19.4

34.4

1.7

10.5

Pre-Primary and Primary

0.9

5.0

0.0

18.5

58.3

29.8

13.8

Secondary Education

22.6

80.9

19.7

35.0

35.3

11.6

21.9

53.5

Tertiary Education

76.5

13.4

57.4

37.2

45.5

29.3

19.8

27.1

Other Education

0.0

0.7

23.0

27.7

0.7

28.5

5.6

Current Rs (bn) (% share) Pre-Primary and Primary

Other Education Current Rs (bn) (% share)

followed by 33.2 percent in Balochistan, 29.7 percent in Punjab and 16.6 percent in Sindh. Compared to revised estimates of FY13, the share of budgeted development spending share in FY14 is almost the same in Punjab, while it is 2 percentage points lower in Sindh. On the other hand, it is 6.2 percentage points higher in Khyber Pakhtunkhwa and 25.2 percentage points higher in Balochistan. Shifting priorities? With the budgetary allocation for education affairs and services, there has been an interesting shift in priorities for spending on primary, secondary and tertiary education by the provinces. In terms of magnitude under current expenditures, the government of Sindh has allocated Rs 120.5 billion to education affairs allocated in budget 2013-14, which the highest amount compared to other provinces. Compared to the revised estimates of 2012-13, a significant increase in current expenditures on education is seen in Khyber Pakhtunkhwa which increased from Rs11.2 billion to Rs72.7 billion. In terms of priority, all provinces, except for Punjab, have emphasised on primary and secondary education as evident from the

share of these expenditures. In contrast, Punjab has allocated the highest proportion to tertiary education followed by secondary education. A shift in priority is observed only in Khyber Pakhtunkhwa where almost the entire emphasis was on spending on tertiary education in 2012-13 whereas in 2013-14 the emphasis has shifted to primary and secondary education (See Table 2). In budgeted development expenditures on education for FY14, secondary education is the top priority by the government of Punjab (81 percent). In Sindh and Balochistan, the priorities are tertiary and secondary education whereas in Khyber Pakhtunkhwa, secondary and tertiary education. The composition of expenditures on health in Table 3 shows that in both current and development, spending on hospital services is the top priority of every province. Hospital services include medical products, appliances and equipments, drug control and outpatient services. Provinces have slashed their priorities of spending on public health services that include anti-malaria, chemical examiner and laboratories, EPI (Extended Programme of Immunization) and other health facilities/preventive measures. The category of research and development is visible only in Sindh budget in which the

allocation in the development budget has increased from 3.2 percent to 10.6 percent. Conclusion The analysis shows that a positive attitude is seen towards prioritising investment in social sector by the governments of Khyber Pakhtunkhwa and Balochistan as shown by the comparison of budget estimates of FY14 and revised estimates of FY13. In Punjab, the investment in social services, particularly education, was not the biggest priority in FY13, nor was it the case in FY14. In Sindh, investment on social services has in fact declined. This happened due to vast destruction because of floods and the government expects the same this year too. It is also noticed that the current budget does not have any link with development budget particularly in Sindh. While, the revised estimates of 2012-13 and budget estimates of 2013-14 indicate a focus on primary education, development budget does not show any allocation for the same. It is learnt that expenditure on some development work is now placed under Sindh Education Reform Program, which is the part of current budget and not the development budget.

Except for Punjab, the governments in other three provinces either have no spending under inter-government transfers or have slashed it down in both current and development expenditures

The author is principal economist at the Social Policy and Development Centre (SPDC), Karachi

Fiscal Review | October 25, 2013 | 15

Shah terms PSDP ‘crony socialism’ Dr. Salman Shah Dr. Salman Shah is a Lahore-based economist, who has served as the Minister for Finance and Revenue in the caretaker government of 2007-08. Between 2004-2007 he had served as an advisor to the then Prime Minister on finance and revenue. Shah holds a PhD in Finance and Economics from Indiana University, Bloomington's Kelley School of Business. He also has 16 years of teaching experience at institutions such as University of Michigan, Indiana University, University of Toronto, and Lahore University of Management Sciences. The following is an excerpt from a conversation that he recently had with BR Research at his residence in Lahore.

“E

very economist you talk to will tell you that what we need the most in this country is an economic system that has the clout to become an engine of growth,” starts Shah alluding to the system “which gives birth to millions of creative entrepreneurs and rewards business innovation and market suavity”. “But sadly enough, our’s is a system based entirely on government monopolies, patronage and private cartelisation, and the newly appointed government has shown a very lightweight stance on the subject of reforms that address these deep-rooted maladies,” he laments. Amongst the issues that need immediate attention of the new government, Shah believes the issue of de-regulation stands out by a mile. “The state needs to stop running business enterprises; it should carry out market reforms to lay the foundations of a competitive private sector-led market economy – an economy that roots out the prevalent culture of rent seeking and SROs,” he says. But unfortunately, the road toward these ideals is littered with many a dead body, he continues, saying that the previous government’s stance on privatisation, energy and tax reforms has actually led to reverse the liberalisation headworks installed during the Musharraf era. “Those at the helm now need to move past the lip service and realise that it is only through the implementation of these direly needed free market reforms that we will ever see our economy reap the true benefits of choice and opportunity,” he stresses. FIRST STEP: DEPOLITICIZE THE ENERGY SECTOR Continuing the discussion about what he says the centre’s involvement in every aspect of the economy, Shah believes that Interview by Ali Khizar & Javeria Ansar

16 | Fiscal Review | October 25, 2013

the first steps towards liberalisation reforms should come in the form of a deregulated energy sector. “The government has the opportunity to create an extremely competitive power market (akin to the much touted telecom market), and for that, the centre will have to relinquish its control over sales, production, pricing and investment in the sector,” he said. “Considering our plight rationally, we can see that the extensive regulations in the sector have made the sector’s supply curve into one of the most expensive in the world. So the question is how do we now shift it downwards and make it more competitive? And again, the solution is minimising long run costs by allowing private sector investment into the sector to bridge the energy gap,” he says.

him,” he continues, saying that this is the way you can introduce competition in a market which is starving for competitive, de-regulated, market-led pricing. “At this point in time, you don’t need to be a visionary to see that these are the only solutions that can get the sector on its feet once again. And if there is even a single good reformist with his head on the right way in the Nawaz camp, this should be the direction they will take going forward,” he predicts. CRONY SOCIALISM Another area that needs a release from government monopoly is the PSDP sector, says Shah who believes that the public sector development projects are a festering example of ‘crony socialism’.

The state needs to stop running business enterprises; it should carry out market reforms to lay the foundations of a competitive private sector-led market economy – an economy that roots out the prevalent culture of rent seeking and SROs Shah also believes that discos - where possible - should be privatised, whereas the management of the rest should be outsourced to curb the inefficiencies that stem from structural weaknesses within these organisations. “Once you allow the private sector to come in, the entire distribution and transmission system should be open to any producer who wishes to supply to any consumer who wants to purchase from

“The complete government control over these spending allows the rulers opportunities to reward their cronies with appointments, numerous lucrative and shady contracts,” he says, which in addition to misplaced and unsustainable project commissioning is inflicting a huge wound in the system. “If you look at the figures allocated for your PSDP spending, you see that they come close to your fiscal deficit,” he

continues, saying that it is about time that the government laid out a framework which allowed development funding to be sourced through public-private partnerships. The planning divisions should be allowed to devise their own funding mechanisms, something that will not only allow for implementation of commercially viable development programs, but also allow much-needed investment into the system – investment that has truly been stifled at the hand of governmental regulations. IN A NUTSHELL Going forward, the newly instated government would “also need to take steps to deregulate all sectors of the economy from agriculture to urban development if they do not want to go the way of the previous establishment,” says Shah. Shah believes that no amount of short-cuts and quick-fixes will do the trick until political powers make these hard decisions once and for all. “And transformation that comes as a result will also deprive the populist government officials of opportunities for patronage, and corruption,” he adds. “We need a system where the government’s role is curtailed and well-defined in the sense that it moves out of the way of the private investment, because that is the only way we can chart the road to a place where our economy is growing at the rate of 8-10 percent per annum and we are competitive at least in a regional context,” he concludes.

Provinces have strong revenue potential Muhammad Sabir When different political parties took lead in different provinces, it was generally hoped that different political leadership in each provincial government will lead to healthy competition in resource mobilisation and setting expenditure priorities as per the capacity and needs of their provinces. To what extent these hopes have been materialised - or dashed for that matter â&#x20AC;&#x201C; one will need to dissect through the intricate set of budget documents, before any conclusion could be reached. Broadly speaking, the provincial governments have three sources of revenues i.e. (1) own tax revenues, (2) non-tax revenues, and (3) federal transfers constituted through NFC awards. So far, the largest source of revenues is federal transfers, which include both divisible pool transfers as well as straight transfers and grants. It is argued that since the buoyant taxes like income tax, sales tax on goods, customs and excise duties are in federal domain, there is less scope for provincial resource mobilisation. Consequently, the provincial governments rely heavily on federal transfers to finance their expenditures. However, post devolution, it is said that provincial governments now have agriculture income tax, sales tax on services, motor vehicle tax, urban immovable property tax and land revenues. While, these taxes may be difficult to collect, there are no doubts that they are also buoyant source of revenues. A look at provincial taxation list indicates that provincial governments have five direct taxes namely tax on agriculture income, property tax, land revenue, tax on profession, trades and callings, and capital value tax on immoveable property. In addition, several indirect taxes are also under provincial domain including sales tax on services, provincial excise, stamps duty, motor vehicles , sale of opium, and others (like, entertainment tax , tax on hotels, electricity, cotton fees, and others). However, despite the long list of taxes, the share of provincial tax collection has not yet reached 10 percent of the total tax revenues of the country. In order to analyse the resource mobilisation strategy of provincial governments, tax revenues are divided into two categories: (1) provincial tax revenues excluding sales tax on services, and (2) sales tax on services. While, the sales tax on services is a provincial tax, it is collected by the Federal Board of Revenue (FBR) on behalf of provinces in Khyber Pakhtunkhwa and Balochistan. The Government of the Punjab and Government of Sindh collect this tax through recently established separate entities namely Punjab Revenue Authority (PRA) and Sindh Revenue Board (SRB). The rest of the provincial taxes are collected through traditional tax machinery.

The Punjab government pitched a relatively high target of tax collection amounting to more than Rs64 billion for 2013-14, which is 20 percent higher than the revised estimates for 2012-13. In absolute terms, it has targeted to fetch around an additional revenues of Rs11 billion. The decomposition of growth in tax revenues indicates that the additional amount is budgeted to be collected from urban immovable property tax (Rs3 billion), followed by stamp duties (Rs2.2 billion), land revenue (Rs3 billion) and agriculture income tax (Rs1.2 billion). Motor vehicle tax and capital gains on urban immovable property are other two sources of additional revenues. For 2013-14, Punjab set a very high target of more than Rs62 billion for sales tax on services, which is 68 percent higher compared to the revised estimates for 2012-13. In 2012-13, the GotP developed the Punjab Revenue Authority (PRA) to collect sales tax on services. This high tax target would be a litmus test for PRA regarding fully capitalising the provincial tax base of services. The government of Sindh has also set a high target for provincial tax amounting to more than Rs49 billion for 2013-14, which is 20 percent more than the revised estimates of

2012-13. In absolute terms, Sindh is targeting an additional revenue of around Rs8 billion. An analysis of growth in tax revenues revealed that the Sindh Development Maintenance of Infra-Structure (SDMIS) and Electricity Cess are likely to be the largest contributors to additional resources. It has planned to get an additional amount of Rs3 billion from SDMIS and more than Rs2 billion from electricity. Urban immovable property tax (Rs0.8 billion), stamp duties and capital value tax on immoveable property (Rs0.5 billion each), and motor vehicle tax (Rs1.2 billion) are other major sources of additional revenues. In Sindh, sales tax on services shows a growth of almost 20 percent in 2013-14 compared to the revised estimates of 2012-13. Sindh announced a few measures that include bringing tax exempted services like beauty parlours, marriage halls and other services into the tax net. It seems that the tax mobilisation strategy heavily focuses on urban areas of the province. Khyber Pakhtunkhwa and Balochistan have relatively low tax collection. Their tax collection contributed hardly 5 percent of their total resources. Khyber Pakhtunkhwa set a tax target of more than Rs10 billion for tax collection

based on the assumption that the FBR will collect Rs6 billion through GST services on behalf of the province. Compared to Punjab and Sindh, there is not much dynamism in their own tax revenues. In contrast, the Government of Balochistan showed a growth of more than 27 percent in their tax collection target for 2013-14 compared to 2012-13. However, this growth is eroded by the expectation of lower collection in sales tax on services. Consequently, Balochistanâ&#x20AC;&#x2122;s own revenues show a decline of Rs0.2 billion in 2013-14 compared to 2012-13. In a nutshell, it can be concluded that provincial resource mobilisation strategy is largely based on sales tax on services. Based on the momentum in sales tax collection, it would not be surprising if the collection of SRB and PRA surpasses the collection from remaining provincial taxes in Sindh and Punjab respectively within two years. Given the successes of SRB and PRA, it can be inferred that other provincial taxes also have revenue potential, which can be capitalised through taxation reforms and modernising tax collection in line with that seen in Sindh and Punjab.

PROVINCIAL RESOURCE MOBILIZATION 2012-13

Rs (bn) Provincial Own Revenues: Punjab Tax Receipts (excluding GST Services) GST on Services Non-Tax Receipts Total Provincial Own Revenues Share in General Revenue Receipts Provincial Own Revenues: Sindh Tax Receipts (excluding GST Services) GST on Services Non-Tax Receipts Total Provincial Own Revenues Share in General Revenue Receipts Provincial Own Revenues: KPK Tax Receipts (excluding GST Services) GST on Services Non-Tax Receipts Total Provincial Own Revenues Share in General Revenue Receipts Provincial Own Revenues: Balochistan Tax Receipts (excluding GST Services) GST on Services Non-Tax Receipts Total Provincial Own Revenues Share in General Revenue Receipts

Growth

2013-14

RE-BE

BE-RE

54.5 40.5 21.1

53.5 37 28.5

64.4 62.4 23.6

-1.90% -8.60% 35.30%

20.30% 68.50% -17.30%

150.3

2.50%

26.30%

14.90%

116.1

16.50%

17.20%

11.20%

4.30%

41.2 32 23.4

41.3 32 27.4

49.4 42 28.8

0.30% 0.00% 16.90%

19.60% 31.30% 5.10%

96.6

100.7

120.2

4.20%

19.30%

20.20%

23.00%

22.70%

13.70%

-1.00%

4.3 6 6.6

-2.50% -56.60% -0.10%

10.60% 39.90% 6.40%

4 9.9 6.2

119

3.9 4.3 6.2

20.1

14.4

16.9

-28.40%

17.50%

7.20%

5.30%

5.20%

-26.10%

-1.40%

1.4 4.1 2.1

1.2 5.5 1.6

1.6 4.5 2.1

-12.10% 34.90% -24.90%

27.40% -18.00% 29.80%

7.6

8.3

5.10%

5.60%

8.1 5.00%

9.50%

-2.10%

9.60%

-9.70%

The author is principal economist at the Social Policy and Development Centre (SPDC), Karachi

Fiscal Review | October 25, 2013 | 17

Ishrat’s take on vertical, horizontal relationships Dr. Ishrat Husain Dr Hussain served as governor of the State Bank of Pakistan for two terms (1999 to 2005). In May 2006, he was appointed Chairman of the ‘National Commission for Government Reforms’, where he undertook an exhaustive two-year review of civil services and oversaw production of a two-volume report on governance reforms. In March 2008, Dr. Hussain was appointed the Dean and Director of IBA, Karachi. He is currently a member of Middle East Advisory Group of the IMF and the Regional Advisory Group of the UNDP. Dr. Husain joined the Civil Service of Pakistan in 1964, held mid-level policy making positions in the Finance, Planning and Development departments, and moved to Washington in 1979 to join the World Bank. He was conferred the prestigious award of “Hilal-e-Imtiaz” in 2003.

The previous government did well to start on the path of devolution and empowering the provinces through the passage of the 18th Constitutional Amendment and the successful agreement of the federation and provinces on the 7th National Finance Commission Award. But, according to the former State Bank Governor, Dr. Ishrat Husain, a lot more must be done before the process of devolution can reach its logical conclusion. In a recent interview with BR Research, he laid out a step-by-step programme for ensuring that the benefits of devolution reach the entire population of the country. Foremost, he advocates the establishment of an integrated budgetary framework, whereby the federal and provincial governments would coordinate their revenue generation and respective expenditures. Starting off with integrated budgetary framework, Husain pointed out that two constitutional forums exist for this purpose; the Council Common Interests (CCI) and the National Economic Council (NEC). Elaborating on the model he said, “In these forums the provinces and federation are both represented so we may develop an integrated budgetary framework for the whole year and decide what fiscal deficit is going to be in a consolidated form.” He added that the federal government is carrying only 40 percent of the divisible tax pool and its expenditure mostly comprises of inflexible heads like debt repayment, development and defence. So, for the sake of argument, let us assume it is allowed to run a fiscal deficit of 7.5 percent of the GDP. Using illustrative numbers, he goes on to explain that the provinces can be given mandates through these forums. For instance, if Khyber Pakhtunkhwa and Balochistan are allowed to run deficits of 0.5 percent each while Sindh and Punjab produce a combined fiscal surplus of 1.5 percent, the cumulative fiscal deficit can be kept at 6.5 percent. Interview by Mobin Nasir

18 | Fiscal Review | October 25, 2013

“Such a framework would ensure consistency between federal and provincial budgets and also empower the provinces to raise their own revenues if they wish to spend more on development or other sectors,” he explained. The raison d’être for this and other arrangements explained subsequently is that “the inter-provincial and federationprovincial relationships have to be institutionalised; they cannot just be left stranded.” INTER-PROVINCIAL COORDINATION The process of coordination must not be limited to budget formulation and broad contours of fiscal management. Drawing on his experiences in the civil service and international developmental organisations, Husain elucidates that despite devolution of ministries such as health, education, environment and agriculture, “there remains a dire need for greater harmonisation among the provinces at the policy level.” But he stresses that achieving this goal does not require large ministries at the federal level. “Instead he proposes skeletal staff for each of these sectors within the federal inter-provincial affairs ministry. Husain contends that this staff can liaise with the relevant provincial secretaries to ensure harmonised policies. Such a setup would also provide representatives from the country at international platforms such as WHO, UNESCO, UNICEF and ILO. LOCAL GOVERNMENTS AND DISTRICT CIVIL SERVICE “For the fruits of devolution to reach the common man, empowered and fully functional local governments must be established in the country,” stated Dr. Husain, in no ambiguous terms. Elaborating on the assertion, he highlighted that the common man’s interaction with the

government occurs “when he needs a school so his kids can get educated, healthcare for his family and law enforcers to protect his life and livelihood.” Besides empowered local governments, he also advocates a restructuring of civil services infrastructure. He pointed out that 85 percent of all civil service employees are in grade 16 or lower. “We propose districtlevel reporting for these civil servants so that they remain in their native areas and present at their posts, instead of chasing after MPAs and MNAs in their respective provincial capitals for favourable postings.” Not only would this ensure better accountability at district level, it would also ensure that people with stakes in those areas will be performing the various functions of public education, healthcare, etc; so their motivation to perform could be enhanced. TAXATION: BEYOND BALANCING THE BOOKS “A lot has been written about the fact that there is a substantial potential taxable income that is not being tapped,” said Husain, as he lamented over the dismal tax-to-GDP ratio of the country. In his view, the foremost task for revenue department must be to get all existing NTN holders to start filing their returns, accurately and comprehensively. When asked what would change the general apathetic attitude towards paying taxes and filing returns, he is quick to retort with a one-liner response: “fear of audit”. He elaborated that the FBR can easily link up with Nadra to find out people’s residence status, travel itineraries and other major expenses they incur. The discrepancies between their reported income and expenses can be used by tax sleuths to confront tax dodgers and evaders. He pointed out that out of 3 million NTN

holders, only 1.1 million regularly file returns and added that “even if you bring another million of these individuals and companies into the fold, the tax-to-GDP ratio can be improved by up to two percent.” Other measures for raising tax revenues have been discussed in a recent interview with Business Recorder. But in the former SBP Governor’s view, provinces have an eminent role to play in this process, asserting that “in the case of real estate taxes, there is a strong case for collecting dues on a district level.” He pointed out that empirical evidence from all over the world shows people are more willing to pay taxes when they see visible results in their immediate environment. “When real estate taxes are collected at district level, the money will also be spent in those areas to improve their roads and public infrastructure, schools, hospitals, etc. The people will get back in the form of services, what they pay in taxes.” “Tuition centres, doctors, lawyers, architecture and engineering consultants, hair salons and wedding halls are all minting money in Karachi and other major cities, yet their contribution in direct taxes is negligible. It is up to the provincial governments to rein in the services sector and that’s where tax revenues can and should grow”. Husain lauded the federal government for mandating proof of payment of agriculture tax for those claiming income from agriculture to avoid income tax dues to FBR. “The focus of taxation must not be limited to balancing books. It has to be a form of reducing social inequality and for that to happen government must rely on collecting direct taxes from the haves instead of notching up indirect taxes like sales tax which have a greater adverse impact on those who can least afford it.”

Devolution to local level is the right answer Dr Gulfaraz Ahmed

ocal governments are an important tier of governance; they are close to the grassroots and are commonly employed in all forms of governments whether democratic or otherwise. The local governance usually provides municipal services to the local populace who elects the office bearers and holds them locally accountable. The design and scope of local governments vary widely from an amalgam of village councils and municipalities on one end to fully devolved county government on the other. In democratic states, local government system provides a grass roots nursery for representation at sub-national and national levels and is essential for maturing and strengthening the democratic process. Every district may have a unique economic potential in climate, flora, fauna, natural and mineral resources and only a system of effective local governments can exploit the unique economic potential to usher in grassroots prosperity. Pakistan inherited a weak local government system of village ‘panchaits’ and municipalities under a strong district bureaucracy. Further development of the system is essentially a legacy of military rulers. The LG system introduced in 1979 was a carefully crafted system of local councils operating under the control of district bureaucracy and entrusted with municipal functions. This was changed radically on August 14, 2001 when an empowered system through devolution of functions from the provincial powers was introduced. General Musharraf had designs for a long reign of power and he aimed at a system of service delivery at the grassroots through a devolved LG system. Another target of the devolved LG system was a powerful district bureaucracy; a local administrative service at the district level was instituted and the offices of the District Magistrate/ Deputy Commissioner/ Commissioner which had long served as the fulcrums of the district administration, were dismantled. The bureaucracy in the sub-continent had been designed for the specific purpose of protection of colonial rule. Control rather than development was the central theme of the administration. Mulling on the subject, Alexis Mamaux and Aidan Williams established in a book (20th Century World History) that the British administration in

India was required to keep a tight control of the people with least expenditure on development to save maximum funds for the imperial war effort. The foundation of control rather than development-centered bureaucracy was inherited by the fledgling country after its independence in 1947. There was no well-orchestrated national programme of re-orientation and re-objectivisation of the public service towards nation building. The thrust of the bureaucracy, especially at the district level, remained on control and the deputy commissioner emerged as the local power house often misused by military/political governments as an instrument of coercion. As a result, the 2001 LG System based on devolution of powers to district level was eagerly looked up to by the masses but internally resisted by the bureaucracy who stood dismantled by the same system. It was, therefore, crucial that new system were launched after thorough preparation and with adequate transition. All the provinces were opposed to the system as they were not taken onboard and had serious reservations. Provincial governors and chief secretaries had raised serious objections to the proposed system during the final meeting chaired by General Musharraf. Despite this, the system was still approved and enforced overnight on the eve of August 14/15, 2001. The age-old system was upstaged and a newly devolved but highly complicated system was enforced without any transition. The seeds of failure were sowed more by callous implementation. The intended purpose and goals could not be achieved and it soon stood discredited. Administrator or ‘nazim’ as it was called at the district level had to replace the hitherto DC/DM setup. He was supposed to be a hands-on administrator to manage the devolved functions and newly instituted district administration service. He was supposed to run the district administration more effectively and meet the aspirations of the people. The merit and competence of district nazims were key requirements of the success of the system. It was initially decided that district nazims would be elected thorough direct elections and be made accountable to scrutiny by district as well tehsil councils. Both these features to cultivate the district

nazims were later compromised to support the hitherto secret plan for the highly non-transparent referendum for the office of the President that was soon to follow. Once elected, it was important that district administrators/nazims take oath of offices in their districts close to the people they were to serve. Instead, they were flown at public expense to Islamabad and administered oath collectively by the President. After federal hobnobbing in the capital, the district nazims changed their orientation from local to federal links at the expense of their primary roles. It was commonly believed that they were needed more for federal objectives than local deliverance. Their lack of administrative experience/training, shifting of focus from local responsibility to federal politics, and conflict of interest in evenhanded treatment of local population led to non-deliverance of the romanticised system of devolution. The system was new and complicated and could not develop roots without a well planned and facilitated transition – something which South Africa had followed late last century. South Africa had introduced a less ambitious three-tier local government system limited only to the municipalities without replacing district administration by the end of the Apartheid regime. They provided five years transition from 1995 to 2000 by keeping the elected mayors an understudy of professionals recruited on competitive packages through international advertisements. At the end of the transition, the understudy mayors took control and the well-rooted system is performing to the designed goals and objectives. The devolution to local level is the need of time and it was right to pursue it intelligently but it got disenfranchised for the wrong reasons. The law and order system that had grown and matured over decades through a coordination cum control nexus between district magistrate/deputy magistrate/ commissioner and the superintendent of police/ divisional inspector general was effectively serving the purpose. Under this system, law and order situation resulting from public unrest or natural disasters in any district was collectively controlled by a structured cadre of four experienced, resourceful and powerful public officers of Commissioner,

DC, SP and DIG who together were backed by a combined field experience of over fifty years. Together, they could shift and apply divisional resources in any district in line with specific situation. The 2001 LG system did away with this age old system of law and order but provided nothing to fill the vacuum and law and order took a nose dive thereafter. The pressure groups, religious extremists and sponsored terrorists took advantage of this erosion of public authority leading to the precarious state of public peace and order affecting people's fundamental right to security of life, property and respect. It is unfortunate that the provincial governments that were to be the architects/custodians of the LG system were opposed to it. To ensure the success of LG system, ownership of the provincial governments was not only essential but crucial. Once the devolved system stands discredited for no fault of the concept, it may take years before it makes a comeback setting the reform clock behind. The political governments have long followed a practice of giving local development funds to political representatives of national and provincial assemblies. This practice deprives the provincial as well LG authorities of the funds for local development and in addition leads to political patronage or victimisation as the case might be. This may be another reason that democratic governments in Pakistan appear hesitant in introducing an empowered LG system through devolution of powers to the district level. A clever mix of the long tried system of law and order, devolution in selected areas especially health and education, empowerment of women and disadvantaged section of grassroots society and provision of local revenue sources for municipal functions will be a great improvement over the 1979 system and would be more implementable than the complex 2001 system. POSTSCRIPT: This article was drafted before the provinces approved their local government (LG) models. But models of all 4 provinces are quite in line with the conclusions of this article, and are a practical version between the 1979 LG system and the 2011 LG system.

Dr. Gulfaraz has served as member of the National Reconstruction Bureau NRB (2001-02). He was a member of the sixth and seventh National Finance Commissions (NFC), representing the province of Baluchistan, in 2003 and 2010, respectively. He played an active role in the finalisation of the watershed 7th NFC Award, which transferred 57.5 percent of the divisible pool to the provinces. He can be reached at gulfarazahmed@gmail.com

Fiscal Review | October 25, 2013 | 19

Planning Commission unduly sidelined: Kardar Shahid Hafeez Kardar One of the most eminent economists of Pakistan, Shahid Kardar recently sat down with BR Research to talk about the pressing issue of inter-provincial fiscal harmony and the road that is needed to be paved for its institutionalisation. Having previously served as the governor of State Bank of Pakistan (SBP), Punjab finance minister, member of the National Commission for Government Reform and the Banking Laws Review Commission, and chairman of the Punjab Education Foundation, Kardar has now set camp on the city campus of BNU where he works as its Vice Chancellor. Following is a brief excerpt from the conversation.

n a bid to achieve overambitious revenue targets, Kardar says the FBR will once again be guilty of encroachment on provincial tax spaces; he believes that as a consequence of double taxation, the scope for additional resource mobilisation by provincial governments will be severely constrained once again. “This has become an old fable now, and as pointed out by many others; both the timing of and the structural inefficiencies within the NFC award and the 18th Amendment are to be blamed for this.” “Experts have passionately argued that since the provincial resources have been increased through the NFC award; the provinces should automatically be expected to take on the additional responsibilities. But there is a mismatch between these responsibilities assigned to them and the financial wherewithal available to them to fulfill these obligations,” says Kardar. “We all agree that for fiscal federalism to work, a democratic NFC award is necessary. But how can we expect a judicial resource distribution when there is such a clear chasm between the centre and federating units?” he asks. “Greater autonomy granted to the federating units also came with a greater need to ensure coordination between federal and provincial governments,” he says. But sadly, that has not been the case at all. “This is now becoming an issue of us versus them, and the centre and the provinces need to sit down and talk these matters through if we want any future NFC awards to work,” Kardar adds. He explains that the objective should be to bring all provinces at par in growth and development. Ownership of natural resources, fiscal autonomy, and revenue collection should be further negotiated and Interview by Ali Khizar & Javeria Ansar

20 | Fiscal Review | October 25, 2013

consensus must be achieved if we expect things to move forward. FISCAL DEVOLUTION TO LOCAL GOVERNMENT Kardar underscores the need for extending fiscal devolution from provincial level to local level, especially in case of a province such as Punjab, where judicial division of resources is creating problems. “How can you expect to set up huge development infrastructure in urban cities and expect the poor from rural areas to finance your projects?. Do you really think that a farmer from Pakpattan is benefitting from expressways in Multan? And if he isn’t then why should he be paying for it?” he asks.

pal self-governance and that is where these funds should be tapped from.” But sadly enough, no one has yet taken up this cause,” Kardar continues. “I was expecting the political parties to wake up by now and take up this matter but in a country where the initiation of a judicial and effective Provincial Finance Commission is still an unrealised dream, I do not know how long it will take us before we make this leap of faith,” he remarks. CCI AND INTER-PROVINCIAL FISCAL HARMONY “As we go forward, there are heightened expectations from the Council of Common Interests (CCI), and we are waiting to see if it

We need a system where the government’s role is curtailed and well-defined in the sense that it moves out of the way of the private investment “In my opinion, if the people of Lahore feel so inclined to set up a metro bus service, then frankly, they should pay for it themselves instead of burdening the rest of the province with their debt servicing liabilities,” says Kardar, stressing that his argument for fiscal devolution to the local level rests on the simple premise that local developmental expenses of any area (whether a district or a sprawling urban centre) should be paid for by the taxes collected within that locality. “That is the whole concept of municipal governments. The power to levy and collect taxes is one of the cornerstones of munici-

can help create the space for provincial governments to participate in the formulation of policy on a list of matters that fall under the jurisdiction of the federal government but which inevitably concern provinces,” he says. However, one gripe that Kardar has with the CCI would be that the autonomous body simply has too much on its plate at any given time to give some matter the kind of lengthy consideration they might need. “If you expect the CCI to work to maintain the federal spirit and act as an effective platform for conflict resolution

amongst the provinces, then first and foremost you need to refine their agenda,” he suggests. Kardar also believes that as an institution, the CCI currently needs more vision and that it should be strengthened, and its meetings regularised. EXPECTATIONS FROM THE IMF Kardar believes that the IMF - despite all claims and supposed good intentions - does not really understand structural reforms. “This is mainly because of its mandate and the fact that they have short-term lending engagements, which means that the typical time period of an IMF programme is inadequate for carrying out any sort of lasting structural and institutional reforms,” he argues. In other words, IMF is only interested in attaining macro-economic stabilisation whose focus is limited to budget deficits and issues such as interest and exchange rates, says Kardar, and therefore the main push for this stabilisation needs to come from within. “On a tangent, I would also like to add that since the Ministry of Finance is IMF’s institutional counterpart; the new government has sadly allowed them to hijack the entire reform agenda and the Planning Commission has been unduly sidelined as a result of this”. “The government should reconsider the role of the Planning Commission and in this regard I would suggest that the PC be re-housed under the umbrella of a Ministry of Economic Reforms that can take up the agenda of structuring a long-term economic road-map for the country to follow,” he says.

Statistics are sacred Dr. Vaqar Ahmed

et me begin by inviting you to Google Pakistan’s federal and provincial statistics departments’ websites. You will note that federal and Punjab government’s websites will appear prominently, but that of Sindh and Baluchistan bureau do not appear at all. The website of Khyber Paktunkhwa’s bureau of statistics still reads ‘NWFP Bureau’ in the search engine, though it provides major development indicators from the year 2009. Such is the priority attached to compiling and disseminating statistics in Pakistan in an age when statistics play an instrumental role in strategic planning, research and evaluation in any country. But who cares about statistics? When we talk to officials in these departments, we are told that it is difficult to reform because there is little demand for data. There is some truth in it. After all we have not raised our voices enough for updating the 15-year-old population census data. The previous government refused to release any information regarding the poverty profile in Pakistan. The inter-industry flows usually provided by supply-use tables was last published in 1991. The provincial gross domestic product (GDP) is rarely updated. We don’t see quarterly national income accounts – so much needed by the private sector for business planning. There are also no inter-regional trade matrices for Pakistan.....and the list for such information gaps can go a mile long. I am forced to compare ourselves with the neighbours and if we only consider population census as a case in point, then India had a census released in 2013 (current year), Bangladesh had the same for 2011, Sri Lanka for 2012 and Nepal for 2011. What is keeping us so behind in producing something that is intuitively important for planning and development in Pakistan? We start by analysing three hypotheses. First, is it the lack of resources that prevents collection of statistics in Pakistan? Second, it may be the institutional governance of our statistical institutions that is preventing them to move proactively. Third, perhaps the lack of capacity in the permanent staff housed at these federal and provincial offices is not allowing proliferation of statistics. Having a background with the Planning Commission, I fairly remember that the

project proposal (PC-I) for updating supply-use tables was twice tabled in CDWP meetings since 2002. The first time the request came for updating until 1999-2000. A similar request came later for updating those tables until 2005-06. Both these requests were entertained with development budget fully provided for. However, both projects remain incomplete to-date. So we may conclude that access to financial resources is not a large part of the problem. What about institutional governance? For a very long time the Federal Bureau of Statistics remained an attached department of the Ministry of Finance and Economic Affairs Division. In fact the officials at the Finance Division were occasionally accused of manipulating data. Later, it was reorganised and called Pakistan Bureau of Statistics. But it still remained an attached department of the same ministry for administrative and related purposes.

Going forward, there is a need for serious introspection with regards to gaps in institutional governance and capacity. The easiest way towards correction will be to benchmark processes with high performance statistics departments More recently the Federal Bureau of Statistics was merged with the Population Census Organization and Agriculture Census Organization. The new entity Pakistan Bureau of Statistics claims that it has wider autonomy now over its operations. This federal entity has had access to various foreign expertise through technical assistance arrangements. Since

2005 GTZ – a German entity has in fact been sitting inside the offices of Pakistan Bureau of Statistics with an aim to build capacity of Pakistani statisticians. At the federal level, most provincial bureaus of statistics are under the Department of Planning and Development. They house vast teams with an assistant director level position responsible for reporting at district levels. There are also field offices in most districts. One struggles to find studies that have evaluated the capacity gaps of the provincial bureaus. One of the key weaknesses of the provincial bureaus in the past has been the weak dissemination of their efforts. Still we see at least two bureau offices not maintaining/updating their websites regularly. I often ask a simple question to the assistant directors responsible for their district. What is this district’s GDP? The answer has not come yet. Taking a look at press clippings, one feels that there have been times when the autonomy of statistics authorities in Pakistan was breached. Not allowing them to independently conduct operations of National Accounts Committee, population census and poverty estimation are a few examples among many. Most of the officials who have headed the statistics department have later complained about the lack of empowerment required to disseminate data in a transparent manner. Finally we turn to the capacity issue. There are three key constraints here. First, the statisticians graduating from Pakistani universities lack applied experience. Second, the on-job training provided to the statisticians is usually obsolete (e.g. Pakistan until today has not been able to completely implement UN System of National Accounts 1993). Third, the foreign trainings provided to several statisticians pay little dividend as upon their return these officials either do not serve in same positions for long or leave the department on account of a poor career structure. There are examples where statisticians recruited by the Federal Bureau of Statistics are now serving under Section10 or on contract basis in other ministries or attached departments of the government. One should not blame them entirely as their counterparts in attached depart-

ments have a remuneration package which is three times than what they get in their parent department. Due to these constraints, the federal statistics department has been renewing the contracts of the foreign-funded project being managed by GTZ for in-house capacity building. This is not sustainable unless the officials being trained have certainty of tenure in current positions and are empowered to carry out changes in methodology, compilation and dissemination of data. At the same time, they should be allowed a respectable career path where their promotions on satisfactory performance should be ensured besides allowing a market based salary. Lastly, the timely and accurate provision of statistics is vital for the post-18th Amendment policy planning and implementation. Our statistical authorities need to respond to the changing administrative roles of various government tiers. One example is not having updated the sampling methodology for conducting micro level surveys across Pakistan. We have a household-level Pakistan Social and Living Standards Measurement Survey – of which the sampling methodology has rarely changed. One struggles to find any representative data in this survey on for example FATA or Azad Jammu and Kashmir. Such regions could have become part of our dataset had we adopted revolving samples across various years. The question of how representative is the survey exercise also applies to labour force survey of Pakistan as well as several more frequent exercises such as surveys related to prices and production. Going forward, there is a need for serious introspection with regards to gaps in institutional governance and capacity. The easiest way towards correction will be to benchmark processes with high performance statistics departments – many of which are open to public through their training or symposiums. I cannot end without recognising the utter lack of motivation in the official staff working in our statistical departments. This must be addressed not just through financial but also non-financial means such as recognition of services, provision of foreign trainings on merit basis, certainty of tenure, and timely promotion.

The author is Deputy Executive Director at Sustainable Development Policy Institute. He can be reached at vaqar@sdpi.org

Fiscal Review | October 25, 2013 | 21

BR Research

ECONOMIC PERCEPTION SURVEY T

his year Business Recorder Research brings you the first of its kind ‘Economic Perception Survey’ by any mainstream media publication in the country. Being a business elite survey, the survey questions were designed to gather the opinions of top corporate bosses on major economic problems, institutional performance, prioritisation of reforms, taxation issues and their outlook on key macroeconomic indicators. The rationale behind conducting a business elite survey is the notion that the experience and observations of Pakistan’s business community form a crucial input for driving policy reform and inclusive economic growth in the country. The questionnaire was

such as sugar, dairy, textile, and fertiliser to FMCGs, and from chemicals and cement to pharmaceutical and automobiles. A little more than half the respondents (27 to be exact) belonged to listed companies that had a combined market capitalisation of Rs1492 billion, representing 27 percent of all-share market capitalisation of the Karachi Stock Exchange (as of September 15). The survey was conducted between August 1 and September 15. It is hoped that policymakers would keep the findings of this survey in their mind in order to shape a better future for Pakistan.

developed in consultation with industry leaders, where the evaluation criteria for taxation and related affairs was devised in consultation with the country’s leading tax experts. A total number of 50 respondents were selected; of which 23 belonged to the manufacturing sector and the rest were from the services sector. In the services sector, 18 respondents were from financial services including banks, insurance, securities brokerage and mutual funds. The rest of them were from telecom, IT, trade and advisory services. In the manufacturing sector, the respondents were selected from a wide array: from agri-related industries

WHICH ISSUE AFFECTS YOUR BUSINESS THE MOST? BASED ON TOTAL NUMBER OF RESPONSES

BASED ON RESPONSES FROM SERVICE SECTOR HIGHEST POSSIBLE SCORE: 162 | LOWEST POSSIBLE SCORE: 27

HIGHEST POSSIBLE SCORE: 300 LOWEST POSSIBLE SCORE: 50

CORRUPT/INEFFICIENT BUREAUCRACY

177 INCONSISTENT ECONOMIC POLICIES

162 27

FISCAL WEAKNESS

118 89

WAR ON TERROR

227

133

FISCAL WEAKNESS

LAW & ORDER IN MAJOR CITIES

ENERGY

LAW & ORDER IN MAJOR CITIES

229

INCONSISTENT ECONOMIC POLICIES

ENERGY

CORRUPT/INEFFICIENT BUREAUCRACY

162

162 WAR ON TERROR

145

BASED ON RESPONSES FROM MANUFACTURING SECTOR HIGHEST POSSIBLE SCORE: 138 | LOWEST POSSIBLE SCORE: 23

300

Question: Respondents were asked to rank the issues

LAW & ORDER IN MAJOR CITIES CORRUPT/INEFFICIENT BUREAUCRACY

Findings: Energy sector has been ranked as the biggest

22 | Fiscal Review | October 25, 2013

100

INCONSISTENT ECONOMIC POLICIES

in the order they thought were the most troublesome. To arrive at rating points for each issue, the responses were assigned different weights in proportion to the ranks that ranged from 1 to 6.

problem followed by law & order issues in major cities and inconsistency of economic policies. To much surprise, however, war on terror has been ranked as the least problematic issue of all. When the responses were segregated by industry type, it appeared that law & order issues and war on terror were rated relatively higher by the services sector. It is interesting to see that inconsistent economic policies are rated the least problematic by the services sector, but are rated the second biggest issue after energy by the manufacturing sector.

111

ENERGY

FISCAL WEAKNESS WAR ON TERROR

60 138

LIKELIHOOD OF THE ISSUE BEING RESOLVED IN NEXT FIVE YEARS Question: This question inquired about the perceived likelihood of each issue being resolved by the current government. Respondents were asked to select the likelihood of resolution on a grid of ‘unlikely’, ‘less likely’, ‘likely’ and ‘most likely’. Rating points were arrived at by assigning different weights to the responses. Finding: It appears that the only issue the business community

thinks that the current government can resolve is the energy crisis. All other issues are either perceived to be ‘less likely’ or ‘unlikely’ to be resolved as is evident from the downward skewed responses.

REGULATORS’ COMPETENCE AND INDEPENDENCE Question: A set of paired questions was asked to rate the competence and independence of the governing bodies, where independence was taken to be independence from the influence of the private sector, of the government and/or of any political party. Rating points were arrived at by assigning different weights to the responses obtained on a 5-point scale. Finding: The State Bank of Pakistan enjoys the confidence of businesses as the most competent and most independent regulator. Unsurprisingly, no respondent believes that Ogra fits in the ‘most competent’ or ‘most independent’ category.

200

Independence

128

CCP NTC - 25

-50

PTA

Nepra - 25

Ogra

SBP

SECP

81 71

-50 Competence

50 HIGHEST POSSIBLE SCORE: 200 FOR MOST LIKELY

HIGHEST POSSIBLE SCORE: 50

LOWEST POSSIBLE SCORE: 50 FOR UNLIKELY

LOWEST POSSIBLE SCORE: MINUS 50

WHICH GOVERNANCE REFORM IS MOST IMPORTANT?

SHOULD POWER DISTRIBUTION COMPANIES BE PRIVATISED?

Question: Respondents were asked to rate the importance of each reforms for their business sector. Rating points were arrived at by assigning different weights in accordance with the responses. Finding: While judicial reforms are most sought after in aggregate terms, it is the PSE reforms that are deemed the ‘most important’ by most respondents on a 4 point scale. 138

JUDICIARY

124

PSE POLICE CIVIL SERVICE

50 HIGHEST POSSIBLE SCORE: 200 LOWEST POSSIBLE SCORE: 50

200

94%

INDUSTRIES *

164 157

DOMESTIC

Finding: Gas allocation to power sector

FERTILISER

emerges as the top priority in what seems to be an overwhelming response. The domestic sector, which is the government’s existing top priority, gets the third spot.

* MAINLY TEXTILES

200

POWER

rank the sectors in the priority they thought was most important. Rating points were arrived at by assigning different weights in proportion to the ranks that ranged from 1 to 5.

116

WHICH SECTOR SHOULD HAVE HIGHEST POSSIBLE SCORE: 250 PRIORITY FOR GAS ALLOCATION? LOWEST POSSIBLE SCORE: 50 Question: Respondents were asked to

122

YES

TRANSPORT

123 66 250

Fiscal Review | October 25, 2013 | 23

OUTLOOK FOR YEAR-END INFLATION AND INTEREST RATE YEAR-END INFLATION OUTLOOK

YEAR-END INFLATION OUTLOOK (SECTOR-WISE) No. of respondents: Financial: 18 | Manufacturing: 23

35%

Financial sector

Manufacturing 39% 35%

24% 28%

16% 12%

26%

12% 17% 13%

13%

11% 9%

Less than 7%

7-8%

8-9%

9-10%

10-12%

More than 12%

Less than 7%

7-8%

8-9%

9-10%

10-12%

More than 12%

YEAR-END INTEREST RATE OUTLOOK (SECTOR-WISE)

YEAR-END INTEREST RATE OUTLOOK

No. of respondents: Financial: 18 | Manufacturing: 23 Financial sector

29%

Manufacturing 39%

27%

33%

22%

28%

18%

22%

17%

17% 13%

4% 0% Reduce

No change

9.5-10

10-10.5

10.5-11.5%

More than 11.5%

OUTLOOK FOR YEAR-END EXCHANGE RATE (PKR/USD) YEAR-END EXCHANGE RATE OUTLOOK

Reduce

No change

9.5-10

10-10.5

No. of respondents: Financial: 18 | Manufacturing: 23 Financial sector

Manufacturing

44% 39% 24%

28%

18%

22%

10%

13% 6%

4% Upto 105.7

Upto 108

24 | Fiscal Review | October 25, 2013

More than 11.5%

YEAR-END EXCHANGE RATE OUTLOOK (SECTOR-WISE)

34%

No change

10.5-11.5%

Upto 110.5

Upto 113

More than 113

No change

13%

11%

6% Upto 105.7

6% Upto 108

Upto 110.5

Upto 113

More than 113

WHICH TAXATION ISSUE IS MOST DETRIMENTAL TO ECONOMIC STABILITY?

229

NARROW TAX BASE

152

EXCESSIVE RELIANCE ON INDIRECT TAXATION

Question:

Respondents were asked to rank the taxation issues. To arrive at rating points for each issue, the responses were assigned different weights in proportion to the ranks that ranged from 1 to 5.

144

DISCRETIONARY POLICIES (SRO CULTURE)

142

PRESUMTIVE TAX REGIME

Finding: Narrow tax base is considered the most

detrimental taxation issue by an overwhelming majority of 42 respondents.

INADEQUACY OF TAX RATE/ LACK OF HARMONY IN TAX RATES

119

HIGHEST POSSIBLE SCORE: 250 LOWEST POSSIBLE SCORE: 50

250

AREA/ISSUE-WISE SATISFACTION WITH FBR HIGHEST POSSIBLE SCORE: 50 FOR HIGHEST LEVEL OF SATISFACTION LOWEST POSSIBLE SCORE: MINUS 50 FOR HIGHEST LEVEL OF UNSATISFACTION

Question: Respondents were asked to rate the Federal Board of

Revenue on six different evaluation criteria. Rating points were arrived at by assigning different weights to the responses that were obtained on a 5-point scale.

Finding: FBR is rated very low by almost all businesses as evident by negative satisfaction scores in all categories, with ethics of tax officials emerging as single biggest issue in the revenue collection authority.

2% 12%

-28

REFUND SYSTEM AUDIT SYSTEM

-17

Most Satisfied

23%

ETHICS OF TAX OFFICIALS

-19

HOW SATISFIED ARE YOU WITH THE FBR? Most Unsatisfied |

-28.5

OPERATIONS/ADMINISTRATION COMPETENCE/CAPABILITY OF TAX COLLECTOR

-16

31%

32%

-6.5

-50

AUTOMATION

EVALUATION OF TAXATION PRINCIPLES

Question: Respondents were asked to give their opinions about Pakistani taxation system vis-à-vis the principles of taxation. Rating points were arrived at by assigning different weights to the responses that were obtained on a 5-point scale.

41% 19%

Finding: There is an overall dissatisfaction with the system, where lack of equity appears to be the most problematic area. This corresponds with the findings above, where narrow tax base and indirect taxation are rated as top two problematic areas.

SATISFACTION LEVEL WITH REFERENCE TO THE PRINCIPLES OF TAXATION

HOW SATISFACTORY DO YOU THINK PAKISTANI TAX SYSTEM IS WITH REFERENCE TO THE PRINCPLES OF TAXATION?

HIGHEST POSSIBLE SCORE: 50 FOR HIGHEST LEVEL OF SATISFACTION LOWEST POSSIBLE SCORE: MINUS 50 FOR HIGHEST LEVEL OF UNSATISFACTION

-31.5

EQUITY

-26.5

EFFICIENCY

-24.5

EASE OF COMPLIANCE

-22

FACILITATION

-20.5 -50

ADEQUACY 0

30%

Fiscal Review | October 25, 2013 | 25

Future of GST services as provincial tax uncertain Muhammad Sabir

The 7th National Finance Commission (NFC) Award and 18th constitutional amendment have brought the much needed steps toward fiscal decentralisation. While these two delegate more fiscal autonomy to the provinces by accepting their right on collection of GST services, there are mixed opinions about the implications of this tax on overall tax collections. According to constitution, the federal government is empowered under 4th schedule (Federal Legislative List Article 70(4) of the constitution entry 49) to levy sales tax on the sales and purchase of goods; and since GST on services is not part of the Federal Legislative List, it exclusively falls under the domain of provincial governments. Moreover, the 18th Amendment added an explanatory statement “except sales tax on services” in the same entry which explicitly accepts provincial right on collection of GST services.

federal tax similar to GST goods. This arrangement affected the provincial revenues negatively. During the deliberation for 7th NFC Award, Sindh fought the case for devolution of GST services on constitutional ground and successfully convinced the National Finance Commission that GST services in any mode is a provincial tax. Consequently as reported in the 7th NFC Award, “NFC recognizes that sales tax on services is a provincial subject under the Constitution of the Islamic Republic of Pakistan, and may be collected by respective provinces, if they so desire.” Despite that constitutional status, federal government was reluctant to delegate the collection powers to provinces. One of the reasons behind its unwillingness was its commitment to the IMF to collect GST on goods and services in a VAT mode and decentralisation of GST services turned out to be the biggest hurdle in its way.

Table 1: GST on services (as % of province's own taxes) 2012-13

2013-14

Budget

Revised

Budget

Punjab

42.60%

40.90%

49.20%

Sindh

43.70%

46.00%

Khyber Pakhtunkhwa

71.30%

52.50%

58.30%

Balochistan

74.60%

81.90%

74.40%

Provinces combined

46.10%

44.10%

49.00%

Before the 18th amendment, and in accordance with the 1973 constitution, the provinces had already started levying sales tax on services on 15th July 2000 simultaneously. They designated its collection to federal government through an ordinance on the directives of federal government. As a result, GST on services, although being a provincial tax, has been collected by the federal government and treated as straight transfers in the federal documents. However, its distribution among provinces had been carried out on the basis of population rather than collection. Moreover, federal government levied and collected GST on services especially on telecommunication under the name GST on services (CE Mode) and treated it as a

But even then, Sindh government established a separate modernised unit namely Sindh Revenue Board (SRB) to collect GST services. Based on the early successes of SRB, Punjab government also established Punjab Revenue Authority (PRA) similar to SRB. The budget 2013-14 is the third consecutive year in which SRB is independently collecting GST services, while it is the second year for PRA. However, Khyber Pakhtunkhwa and Balochistan have not yet established any unit to collect GST services by themselves and are relying on FBR for their collection. A look at Table 1 indicates that more than 40 percent of provincial tax revenue is collected from GST services and its share is growing. If this trend continues, it

is likely that within a couple of years more than half the provincial tax revenues would be collected from GST services. In other words, collection from GST services alone would exceed the collection from the aggregate of rest of the provincial

percent compared to the revised estimates of 2012-13. For the same period, FBR set a relatively moderate target of Rs10.5 billion, which shows a growth of 7.4 percent compared to the revised estimates of 2012-13.

Table 2: GST on services

FBR and Provincial Collection Targets 2012-13 Revised Budget FBR Collection Khyber Pakhtunkhwa Balochistan Total FBR Collection Growth Provincial Collection SRB Collection PRA Collection Total Provincial Collection Growth

taxes, including agriculture income tax, capital gain tax, stamp duties, motor vehicle tax and the likes. At this point a comparison of collection made by the FBR versus the provinces own collection is warranted. Table 2 presents the estimates of GST services collection for 2012-13 and 2013-14 by FBR on behalf of Khyber Pakhtunkhwa and Balochistan, and PRA for Punjab and SRB for Sindh. FBR had set a target of almost Rs14 billion for FY13. However, revised estimates show a decline of 30 percent. For the same year SRB set a target of Rs32 billion and PRA Rs40.5 billion. Revised estimates for FY13 show that while PRA missed its target by 9 percent in the first year of its inception, SRB successfully achieved its target. These successes not only yield more revenues to Sindh and Punjab but also minimise dependence on federal government to finance their expenditures. Based on this, both PRA and SRB set a relatively high target of GST services amounting to Rs62.3 billion and Rs42 billion for FY14, which shows a combined growth of 51

9,886 4,075 13,961

4,290 5,496 9,785 -29.90%

6,000 4,505 10,505 7.40%

32,000 40,496 72,496

32,000 37,000 69,000 -4.80%

42,000 62,350 104,350 51.20%

Despite, the initial successes of SRB and PRA, the future of GST services as a provincial tax is uncertain. One of the concerns is the recent Extended Fund Facility by the IMF, which is aimed to finance current account deficit that Pakistan is currently facing. The value-added tax is one of the favourite prescriptions of the IMF for Pakistan to raise tax-to-GDP ratio, which require clubbing of both GST on goods and GST on services. The history of GST reforms tells us that FBR has tried to implement VAT in Pakistan since 1990s with considerable technical assistance from IMF technical teams. However, the efforts to convert GST into VAT and increase tax-to-GDP ratio have never been successful. If the IMF insists on VAT this time again and the government of Pakistan accepts it then the process of decentralisation would likely to be derailed. This time it will not only affect the much-needed tax decentralisation but also the country will lose sizeable revenues without reaping the fruits of VAT.

The author is principal economist at the Social Policy and Development Centre (SPDC), Karachi. He can be reached at muhammadsabir@spdc.org.pk

26 | Fiscal Review | October 25, 2013

2013-14 Budget

Agri income tax evasion: a huge disincentive for taxpayers Nikhat Sattar and Muhammad Sabir

he Carnegie Endowment for International Peace reports that “fewer than three million of Pakistan’s 175 million citizens pay any income taxes, and the country’s tax-to-GDP ratio is only 9 percent.” This is one of the lowest tax-toGDP ratios in the world. The country is rich, with its elite owning billions in assets both within and outside the country, yet they evade paying taxes. It was perhaps in recognition of this problem that the new government made several changes in the income tax ordinance through the Finance Bill 2013 to increase revenue through taxation. But the burden fell on the salaried and middle class. The feudal landlords remain exempt from paying their share, although many sit in national and provincial assemblies and enjoy perks at the cost of the public. One of the possible explanations of this situation is exclusion of agricultural income from the tax domain. Agricultural income tax was a provincial tax and remains so after the 18th Amendment. It is generally argued that it is a difficult tax to collect. The highlighted complexities in collection include uncertainty in the income due to vagaries of weather. But the main reason appears to be the presence of large landholders in provincial and federal assemblies who are involved in making and amending laws. The vested interests of these individuals and agricultural forums advance various arguments to resist the necessary reforms needed to collect

agricultural income tax. One of their arguments is that agriculture is already overtaxed indirectly in the form of cane and cotton cess, sales tax on inputs, abyana and malya road taxes. In reality, however, every sector in the economy pays both direct and indirect taxes. In fact, as per estimates by Federal Board of Revenues (FBR), Pakistan’s agricultural sector paid lowest share of the tax in relation to its contribution to GDP (See graph). Tax collection from agricultural sector including both direct and indirect taxes is hardly 0.5 percent of the sectoral contribution of agriculture sector in the GDP. In contrast, the ratio for manufacturing and services sectors stood at 28.6 percent and 5.7 percent respectively. PROVINCIAL BUDGETS FY14 A look on the provincial budget documents indicates variations in agricultural income tax targets for budget 2013-14. For instance, Punjab government has set a target of more than Rs2 billion from agricultural income tax this year compared to Rs863 million in 2012-13. While, this is more than a 100 per cent increase in tax revenue and therefore commendable, the tax potential is much higher than the target given the large agriculture base of the province. In contrast to Punjab, the government of Sindh has set a tax target of Rs550 million for 2013-14, which is only 10 per cent higher than the last year’s collection. Khyber

Province-wise Agriculture Income Tax Rs (mn) 2012-13 Punjab Sindh KPK Balochistan Four Province Combined

2013-14

Budget

Revised

Budget

721 500 22 0 1,243

864 500 22 0 1,386

2,019 550 22 2 2,593

Source: Province-wise Annual Budget Statement 2013-14,

Sector-wise taxes (as % of sectoral GDP) Agriculture

Mining & Quarrying

Manufacturing

Services

Source: CBR Quarterly Review Vol. 6, No. 2, 2006-07 28.6 24.8

25.5 22.7

5.9 0.0

0.7

5.7 3.0

2.7

0.4

Direct tax

Indirect tax

Pakhtunkhwa’s agricultural income tax target shows literally no growth for 2013-14 over its collection in 2012-13. This shows either a lack of capacity or willingness to improve the system and the machinery to increase revenue through agricultural income tax collection in both provinces. The government of Balochistan has set a target of Rs2 million for 2013-14 compared to no collection in 2012-13. Although the magnitude of tax is very low, this is a positive step. In a country where agricultural sector contributes a substantive part (more than 20 percent) to national economy, the agricultural income tax targets for 2013-14 are insignificant, and essentially mean that the sector is grossly under taxed. Higher collection from agricultural income tax is also important for horizontal equity and economic efficiency points of view. If any sector in the economy is excluded from income tax, it creates an incentive for people to evade taxes by fabricating their books such that income other sectors is shown to be as income from agriculture sector. It also creates a disincentive for taxpayers when they see such a large sector (and a rich group) not paying their due share of taxes. The agricultural income tax is justified on the principle that the government infrastructure provides benefits to the agricultural sector. The latter also benefits from low interest loans and public expenditures on research and development.

0.5

Total taxes

Furthermore, it continues to receive various subsidies and tax concessions. Based on these arguments, serious tax reforms are needed to tap agricultural income. It is important to note that these reforms should aim to collect taxes from landlords who have more than 12 acre of lands. One of the reasons for low collection is the uniformity of tax rate, which is the same for land sizes of more than 25 acres for all crops. A progressive taxation structure needs to be introduced in the agricultural income tax system, based on either income from agriculture or linked to the size of land holdings. In this regard, the taxation structure of Indian states such as Kerala may be studied. In Kerala, agricultural income taxation is progressive i.e. tax rate increases with the land size and the tax rate is higher for more profitable crops. In addition to revision in tax rate, the taxation machinery needs to be revamped and modernised in line with the Sindh Revenue Board and the Punjab Revenue Authority. In order to cross verify income from agricultural income, both the FBR and provincial tax authorities should share their income tax data which each other. Above all, the rich landlords should be brought n the tax net and strict implementation should be ensured without consideration of political affiliation or clout.

The authors are technical advisor and principal economist respectively, at the Social Policy and Development Centre (SPDC), Karachi.

Fiscal Review | October 25, 2013 | 27

Huzaima Bukhari & Dr. Ikramul Haq

he Federal Board of Revenue (FBR) has earned notoriety in all areas: from failure of reforms to mega scandals, from lack of will in taxing the elected members to bungling of funds, from corruption to highhandedness and inefficiency. It is thus not surprising that the FBR is dubbed as a highly inefficient, corrupt and incompetent organisation full of yes-sir men ready to obey any commands of the political masters. It is also a matter of record that the FBR wasted millions of borrowed dollars given by the World Bank and other donors for implementation of a comprehensive Tax Administration Reform Project (TARP). Since the inception of TARP, the apex revenue collection body failed on all fronts; be it meeting revenue targets, broadening of tax base, implementing sales tax, increasing share of direct taxes or improving tax-to-GDP ratio. At the end of TARP, Pakistan’s tax-to-GDP ratio nosedived to 8.8 percent from 9.4 percent in the year when the programme started. Despite having both money and expertise, the FBR could not introduce an effective automated tax intelligence system to bridge the huge tax gap of over 200 percent. The World Bank in its study, titled ‘Implementation, Completion and Result Report’ issued on the completion of TARP observed that “the current narrowbase of general sales tax (GST) in Pakistan remained almost entirely unchanged throughout 2005-2012, despite efforts to overhaul the indirect taxation structure by introducing a reformed GST featuring few exemptions and wide coverage of goods and services.”

Total number of returns/ statements received in 2011 Nature Business returns Salary returns Employees’ statements Total

Number 513,044 160,903 769,467 1,443,414

Source: Data compiled by PRAL

FBR performance FY07-FY12 Growth in Collection (%) (LHS) Tax to GDP ratio (%) (LHS) Percentage of target achieved (%) (RHS) 25

120

110 100

5 0

70 FY97 FY99 FY01 FY03 FY05 FY07 FY09 FY11

Source: Economic Annual Surveys & FBR Year Books

FBR: The story of failed reforms Pakistan’s biggest litigant The state of tax administration can be measured from the fact that every year over 35,000 writ petitions/appeals are filed in Pakistan where most of the appeals are by the FBR which files them after losing cases at various forums. Due to litigation imposed by the FBR, taxpayers have to wait for years to obtain orders. On the contrary, in developed countries, only a few cases go for litigation to higher courts. A case in point is the United Kingdom where the number of income tax payers alone is 30 million but appeals reaching the Lord Chancellor during a year number only around 25-30. This confirms the tremendous public satisfaction with the system and good governance by the tax administration. In Pakistan, we have less than 1.5 million income tax return filers and around 35,000 active sale tax registered persons, but the number of appeals filed annually is in thousands! This speaks volumes of the putrid tax system.

Perils of SRO culture The notion that the FBR has been a tool in the hands of businessmen-turned-politicians in getting enormous tax benefits through the infamous Statutory Regulatory Orders (SRO) system is something known for long. As it turns out, the SROs also benefit the bureaucracy itself. One such example is the SRO 569(I)/2012 passed on 26 May 2012. The said SRO reduced the tax rate on monetised transport allowance, given to Grade 20-22 government officers, to just 5 percent. This benefit for bureaucracy, including FBR officials, was secured by blatantly bypassing the parliament. Obviously, Auditor General of Pakistan never raised an objection, himself being a beneficiary! This proves how bureaucrats hoodwink the nation. Private sector employees for the same allowance are taxed at normal, rather exorbitant rates!

The review of GST is important because unlike other sources of tax revenue in Pakistan, the administration of GST entails a full-fledged operation of major FBR functionalities, including: registration, monthly tax return processing, collection, refunds, audit and enforcement. GST operation also integrates joint effort from both internal revenue administration and customs since GST import tax is collected at the borders and zero-rating is targeted for export operations, besides other activities. It is the very reason why the World Bank used GST administration as an indicator for evaluating FBR’s overall performance during the TARP. The results compiled by the bank were highly disappointing - GST productivity turned out to be only 23 percent, compared to an average ratio of 34 percent worldwide. According to the World Bank, “the estimation covering the project life reflected an overall decreasing trend between FY06 and FY11 suggesting feeble tax administration efforts throughout the reform period.” Shockingly, throughout the reform implementation period, there was “a declining performance in both tax policy and administration.” Even during the economic boom (2005-08), GST productivity index “showed a rather declining trend despite modest buoyancy gains in FBR revenue collection, signaling relatively poor tax administration performance amidst relatively favorable overall economic conditions”, says World Bank.

The World Bank concluded that during the economic crisis period and subsequent years (2008-11), GST productivity index declined at a higher rate compared to FBR-tax-to-GDP ratio. This was despite a swift turnaround in project implementation and concomitant positive trends in some outputs by the last two years of project life. The report while pinpointing out weak compliance levels, lacklustre results in reform implementation, especially those related to short term actions aimed at curbing evasion through more effective enforcement actions by the final year of project implementation, noted that performance from 2008 onwards, was far from the project’s objectives envisioned at the outset. At the end of TARP like sales tax, income tax indicators were extremely poor. The table here shows that out of total population of 180 million, less than 1.45 million filed returns in 2011, where the share of business returns was only 35.5 percent. This is the sordid story of tax reforms in Pakistan even when enormous funds—over US$100 million—and best professional advice was available. As confirmed by the report of World Bank, FBR not only lost its credibility and usefulness as an organisation, but proved to be counterproductive for the very purpose for which it was established.

The writers, tax lawyers and partners in HUZAIMA & IKRAM (Taxand Pakistan), are Adjunct Professors at Lahore University of Management Sciences (LUMS). They can be reached at ikram@huzaimaikram.com

28 | Fiscal Review | October 25, 2013

FBR’s access to bank accounts: the complex debate Sohaib Jamali

or an issue involving something as complicated as bank secrecy, the nationwide debate around FBR’s access to bank accounts has been oversimplified by many. The picture is far more nuanced and therefore demands a little clear-headed deliberation. Let’s take this from the top. Effective taxation, management of public finance, removing socio-economic inequities, and maintaining rule of law are some of the many functions that the state has the monopoly on. It is what makes a state, a state. Ergo, catching tax evaders, a euphemism for tax thieves, becomes an important responsibility of the state, for they steal what rightfully belongs to the public. This means the state has the moral right to obtain any information relevant for the purpose of catching the perpetrators. The kind of taxation emergency Pakistan currently faces, whereby millions are involved in tax evasion – in cahoots with tax officials or without questionable collaboration – demands a full-fledged multi-year and multi-layered tax investigation. At this point, realists would throw in a plethora of arguments. The first of these would revolve around the notion that banking is all about trust and confidentiality and that giving FBR the access to bank accounts is against the law since banking secrecy is protected under Banking Ordinance 1962 and Protection of Economic Reforms Act 1992. Be that as it may, the fact of the matter is that laws can be changed, for laws are made to facilitate justice under a given set of morals or social realities. If the realities dictate that bank information ought to be shared with government authorities to catch tax evaders, then the argument that FBR’s access to bank accounts is against secrecy laws is weak. It’s a defence that will only last until such time; somebody has the guts to amend those secrecy laws. Bear in mind that going after tax thieves is not just a local need; it’s a global trend. A 2006 OECD survey titled ‘Tax Cooperation Towards a Level Playing Field’, reported that most of the 82 countries it reviewed have some access to bank information for tax

purposes and “50 countries give their authorities access to bank information for all tax purposes”, i.e. for the consumption of local authorities as well as for exchanging information under bilateral tax treaties. This is despite the fact that in all of these countries surveyed by the OECD, banks were obligated by law to treat customers’ affairs as confidential. Yet, in a majority of these countries, revenue authorities had access to information from banks and other financial institutions (FIs). The gale of globalisation, technology and obscure financial innovations of today’s century demand that tax departments or other relevant state apparatus is given

The main question is should Pakistani economy, the state and its people be hostage to tax evaders, for fear that if we touch them, their reaction would damage the economy. Should the state even negotiate with tax evaders, who are draining the very blood from the economy’s veins? Well, given the realities, when the Taliban can be negotiated with, surely the government can negotiate with tax evaders. It is beyond the scope of this article to spell out the exact details of possible options to put on the negotiation table. But in principle, the authorities can consider giving an escape route from one end while throwing in the net from the other.

And this is exactly where the third realist argument sets in. The critics argue that giving FBR the access to bank accounts may lead to harassment by tax officers and what not. The FBR can try to dispel those fears as much as it want, by arguing that only senior tax officials will have access to it and that those misusing the access will be punished. But the reality speaks otherwise. The revenue department has been consistently ranked in the top ten corrupt government departments by Transparency International Pakistan. The Economic Perception Survey of leading corporate bosses conducted by this newspaper (See page 22) also shows that ethics of tax

As a starting point what really needs to be done is to fix the revenue department itself. The onus of fixing it lies with the government; only then the government can hope to gain a buy-in of the stakeholders to give FBR the access to banking and financial information access to banking and financial information in order to conduct their forensic investigation and bring the tax thieves to justice. This is the meta-reality we are living in – so much so that even the Swiss banks -- the epitome of bank secrecy -- are not as clandestine as they were before. The second argument the realists would throw is that giving FBR the access to bank accounts would lead to real estate bubble, flight of capital and dollarisation of economy. The central bank also expressed its fears in its latest monetary policy statement saying that “giving authority to the FBR to access bank account information of individuals might deter savers to hold deposits with the banks. This, in turn, could adversely affect the currency to deposit ratio, which does not bode well for financial intermediation.” The counter argument is that some of these feared consequences can be checked or mitigated by better governance and administrative measures. For instance, real estate bubbles can be checked if the recording of real estate transactions are better governed and thereafter better taxed. But that’s another matter.

For instance, laws can be passed compelling banks/FIs to ask all their depositors/clients to submit their National Tax Numbers (NTNs), sans legitimate exceptions. Failing to do so, the banking/financial relationship would either be frozen after a certain pre-notified period, or complete bank details will be shared with the tax department. And while they do this, an escape route can be provided in some kind of an ‘efficiently governed’ amnesty scheme where tax evaders can wipe their slate clean at little or no costs. Here a representation problem might arise, for there is no All Pakistan Association of Tax Evaders as such. But let’s face it, the tax evaders are around us, in our families and friends, those who own or work in factories and those have their shops, saloons, coaching centres etc. In other words the authorities need to bring relevant business associations to the table and negotiate a way out of this tax conundrum. Once bank depositors and clients of other financial institutions are forced to submit their NTNs to their respective banks/FIs, then it will be up to the FBR to prove their competence, which frankly is so far found wanting.

officials is the most questionable and problematic area within the FBR. This of course adds to the question as to whether the FBR will be able to make efficient use of additional NTNs, when they cannot even properly tap the existing ones. Yet, regardless of FBR’s perceived corruption issues, efforts should be made to make this policy work and not shun it. In principle, information pertaining to banks and FIs ought to be shared with the revenue department; the realities unique to Pakistan as well as global economic realities at large dictate it. Banking secrecy laws can be amended, the dollarisation and other risks to economy can be mitigated by means of negotiation and providing a soft exit to tax evaders. But as a starting point what really needs to be done is to fix the revenue department itself. The onus of fixing it lies with the government; only then the government can hope to gain a buy-in of the stakeholders to give FBR the access to banking and financial information.

The writer works as Research Editor at Business Recorder. He can be reached at srjamali@gmail.com

Fiscal Review | October 25, 2013 | 29

Tax evasion: Nadra provides no magic solution Syed Shabbar Zaidi

t’s been nearly three years since Pakistanis and international lending agencies, including the International Monetary Fund (IMF), have been waiting for the ‘miraculous results’ of the revelation through which a large number of tax evaders have been identified on the basis of the information about their spending habits. This revelation and the action to be undertaken against these tax delinquents are seen as a panacea of sorts for the ailment of lower and non-declaration of direct taxes. Realistically, however, there is a wide gap between the cup and the lip. There are many procedural, legal, technical and practical un-bridgeable gaps between what has been hoped for and the actual realisation of due tax from these tax evaders. The gaps have

ment between sums spent on consumption and return for direct taxable income of that person. However, in Pakistan for some major sources of income, direct tax system has essentially been an ‘uncivilised’ disguised form of ‘recovery’ of revenues, a phenomenon which ignores primary tax principles. There is a tacit acknowledgement and understanding that ‘net income’ and tax thereon is not to be collected. In summary, the relationship between ‘expenditure’, as identified from Nadra’s information cannot be traced back leading to the recovery of due taxes for following three primary reasons: Firstly, tax for some major sources of income such as exports, commercial import, supplies (other than manufacturers), interest on bank deposits, is

certain amnesty in available for certain receipts. This includes funds sent from abroad. Amnesty, for such receipt, is not the primary hurdle in the process of identifying delinquent taxpayers; it is the other side of the picture, which is the possibility that funds are sent outside Pakistan only to be routed back to the country as remittances which can then be claimed under ‘Amnesty’. All this is the result of a paralysed exchange control system which is abused for tax purposes. A nexus has evolved leading to perpetual immunity from direct taxation. This brief description is not enough to appreciate comprehensively the reasons why such a glaring demonstration of ‘expense’ remains divorced from the direct tax system.

Those who have serious concerns about Pakistan’s tax system should devote attention to the grass root issues. The ultimate solution is direct taxation, with a reasonable rate on net income basis without apparent or disguised amnesties mostly been turned into chasms by way of policy over the due course of country’s taxation history. Let us begin with Nadra, the national identity card agency. Information gathered by Nadra is the product of process identifying certain information about CNIC holders. In those cases, where there is a mandatory requirement of using CNIC, whilst incurring expenditure, for example, international travel, the information can be retrieved by Nadra. Same is the case with club subscription, etc. The ‘only’ information that can be gathered from this methodology is that XYZ persons, having certain CNICs, have travelled or spent their money on certain purposes. There is nothing more to it. Now, in an ideal situation, in a ‘civilised’ tax environment, there has to be a relationship and reporting require-

determined on bases that are not capable to identify expenditure with the declared income. This relationship becomes more complicated if the person spending the money is the owner / shareholder of the entity earning income rather than being directly involved with it. This represents uncivilised presumptive manner of taxation; Secondly, some major sources of income, such as gain or sale of immovable properties, agricultural income, agricultural products trading, remain un-taxable under the federal tax system. These sectors and similar others contribute to over 60 percent of the GDP. Thus any chance, rationale and manner of reaching any conclusion from certain ‘expenditure’ is not more than a tantalising media coverage; and Lastly, Pakistan’s direct tax code, contains various provisions, whereby

A person unfamiliar with the intricacies of Pakistan’s tax code and practices will pin his hopes to the idea that information from Nadra and other such sources can be relevant and revealing. However, given the weaknesses in the policy and code at present, this kind of information is only an exciting bit of ‘news’, and not really a practical way forward to catch delinquent taxpayers. Those who have serious concerns about Pakistan’s tax system should devote attention to the grass root issues. The ultimate solution is direct taxation, with a reasonable rate on net income basis without apparent or disguised amnesties. The so-called revelations under the present system are not more than sensations which will lead to nowhere, unless changes are not made at the grass root level.

The writer is a Partner at A F Ferguson & Co and Member Revenue Advisory Council, Government of Pakistan. He can be reached at s.m.shabbar.zaidi@pk.pwc.com

30 | Fiscal Review | October 25, 2013

IMF EFF: the inevitability of vulnerability Mobin Nasir

iscal Review 2012 ended with a warning that a return to the lender of last resort is inevitable and that the shortest possible explanation for this inevitability is: inaction. Raising the all-important question, how did we get here, the last article of that review had opined, “we got here by doing nothing that we had intended to accomplish when the country’s economic managers joined heads with IMF officials” back in November 2008. Now as you peruse Fiscal Review 2013, that inevitability has turned to reality. The IMF has agreed to provide about $6.6 billion under an Extended Fund Facility (EFF). In return, the government has pledged a host of reforms that will test its abilities both in terms of economic ingenuity and political jostling. Much has been said about the economic reforms needed in preceding articles and interviews in this publication. To conclude, we shall present an overview of the political challenges that these efforts may entail. But before lodging into a diatribe over these, it is imperative to point out some of the differences that are already evident between what the Ministry of Finance has agreed over with the IMF and what it had presented in the Federal Budget FY13-14. HE SAID, SHE SAID Don’t be fooled by the fact that the divergence between the numbers quoted by the Ministry of Finance and the IMF is only a few percentage points each (see table). To put things into perspective, consider that the difference in the GDP projection for FY16 is nearly Rs3 trillion. That’s enough money to pay off the entire circular debt accumulated in past five years, six times over. The growth rate forecast by the ministry for that fiscal is nearly double the estimate provided by the Fund. On the other hand, the IMF expects consistently lower inflation tallies; which appears to be a hint that the monetary stance must remain significantly tight in coming years. The divergence between estimates for development spending also warrants attention because as these expenditures contract, the chances of a broad based economic revival also shrink.

Besides the divergence in the projections for various economic variables, there are also some gaps between the government’s stance as exhibited in the Letter of Intent (LoI) to the IMF, and the federal budget which was announced just a few weeks prior to this agreement. The opening of the LoI exudes confidence on the part of the government proclaiming that it “has a majority in parliament and a strong mandate to implement ambitious economic reforms to stabilize the economy and put our country on the path to growth and prosperity.” On the surface, there is nothing wrong with this assertion. After all, the PML-N government has emerged victorious with a heavy mandate and unlike its predecessors, it doesn’t need to constantly coax and coerce other parliamentary parties to form coalitions or muster enough support to pass legislation. But the post 18th Constitutional Amendment reality is that any and all significant fiscal reform is only possible with the nod of the provincial governments. PROVINCES REIGN SUPREME Of course, the government is cognizant of that fact, so the communiqué that forms the first part of the LoI concludes with the assurance that the IMF Programme has the firm support of “provincial government leaders as indicated by the recent decision to this effect by the Council of Common Interests.”

Likewise, it has also contended that since the provinces now receive the bulk of government revenues; they will also play a leading role in ensuring provincial surpluses and help cut down the fiscal deficit. It has promised that when negotiations over the new NFC award commence later this year, the terms of fiscal decentralisation will be consistent with “the imperatives of macroeconomic stability.” Leading economic experts like Dr. Ishrat Husain have also suggested a similar route for ensuring buy-in from the provinces. But the debacle here is that the provinces are not obligated to agree to any such performance criteria upon which their share from the divisible tax pool may be hinged in the future. If the provincial governments find any of the government’s recommendations unpalatable, they can simply walk away from the negotiations and the formula of the previous NFC Award will have to be maintained. Besides, the provinces have already been reporting budgetary deficits for each of the past three years while the federal government had envisioned surpluses on this account at the beginning of each of those periods. Likewise, expanding the tax pool and boosting revenues in this lieu is also heavily dependent on the provinces. In the case of tax on real estate and also direct taxes on those operating in retail, wholesale and services sectors, the buy-in of Sindh government is indispensable.

WITH AND WITHOUT YOU Real GDP growth (%) Inflation (%)

MoF: Medium Term Estimates

IMF: Programme estimates

FY14-B 4.4 8

FY16-F 7 8

FY14 2.5 7.9

FY15 3.5 9

FY16 3.7 7

FY15-F 5.5 8 as % of GDP

Total Revenue Tax Revenue

14 11

14 12

14 11

15 12

Total Expenditure Current Development

20 15 5.1

19 14 5.2

18 13 5.3

20 17 3.3

19 16 3.1

19 16 3.2

Fiscal Balance Total public debt GDP at market prices (Rs bn)

-6.3 61 26,001

-5.0 59 29,749

-4.0 55 34,622

-5.5 67 25,351

-4.4 64 28,600

-3.6 61 31,738

FAMILY JEWELS AND FAMILY FUEDS Another important facet of the promised reforms is the restructuring and intended privatisation of public sector entities. The LoI has highlighted that “We are working on a time-bound strategy for 65 PSEs approved for privatisation by the Council of Common Interests (CCI) to facilitate decisions to either privatise firms, restructure those with prospects of profitability but which the government wishes to retain in the public sector, or close nonviable firms.” The plan entails announcing the restructuring/sell-off strategies for all 65 firms before the end of December. But the Federal Medium Term Budget Estimates for Service Delivery which were revealed along with the budget mention only three PSEs to be privatised in the ongoing fiscal while the tallies for the next two periods are reported at five in each year. In other words, if the government hopes to move beyond mapping a strategy and get to actually restructuring or selling-off some of these companies; it certainly skipped the mention in its medium-term plans. Selling the family jewels is bound to ignite some family feuds too. Chief Minister Sindh Qaim Ali Shah, who is also a senior leader of the PPP, has already warned that any attempt to privatise PIA will be blocked in the CCI. Other parliamentarians have oft repeated criticism of the privatisation of KESC; attempts by the Shaukat Aziz government to privatize Pakistan Steel Mills earned the ire of the courts and the complete handover of assets to PTCL’s buyer Etisalat in return for an outstanding amount of $800 million are all thorny reminders that the privatisation path is fraught with challenges. The previous government spent most of its tenure in ensuring enough support to keep it planted on the treasury benches. As it turned out, politics of reconciliation translates into dormancy of economic reforms. The Sharif administration is seemingly in a much more secure position at the centre. But if the ambitious reform agenda is to be implemented successfully, it will only be possible with the support of its arch political rivals.

Source: Budget documents, Ministry of Finance & IMF Country Report No. 13/287

The writer works as Asst Editor-BR Research. He can be reached at mmobinn@gmail.com Fiscal Review | October 25, 2013 | 31

We are not here for facebook likes...

BRResearch http://www.brecorder.com/br_research.html | research@br-mail.com |

Intelligence you can bank on BRResearch |

@BRResearch09