Fiscal Review 2012 by Business Recorder

Monday, September 24, 2012 | www.brecorder.com/fr2012

Country’s hope lies hidden in the next setup By Ali Khizar The cost is hyper-inf lation down the road -Dr. Hafiz A. Pasha Fiscal Devolution: Still an Unfinished Agenda By Rao Muhammad Asif Iqbal 7 NFC was no economic award Dr. Ashfaque Hasan Khan Not a drop to tax Syed Bakhtiyar Kazmi Government shying away from the bitter pill: Ibrahim Sidat Targeted subsidies needed to tackle persistent poverty By Zuhair Abbasi Blanket subsidies adding to inf lation Dr Mohammad Zubair Khan Inflation sitting on the pedestal of government borrowing By Sijal Fawad

BUDGET AT A GLANCE ECONOMY AT A GLANCE Corporate Tax Rate in Pakistan– Substantially high By M. Abdul Aleem

Contents

3G Spectrum Auction: Don’t delay- Do it now! By Parvez Iftikhar Auction for 3G licenses: Faulty reasoning, design By Hammad Haider Health of a polio-endemic country By Dr. Talib Lashari Challenges of a largely uneducated society By Heman D. Lohano Youth Unemployment: A Ticking Time Bomb By Sidra Farrukh Separation of commercial interestand regulatory role at KSE is our immediate priority Muhammad Ali Ghulam Muhammad, Chairman, SECP Media does not have any space for economic reforms Dr. Nadeem ul Haque Liberlized trade to expand markets, improve lives By Javeria Ansar Cyclical Bilateral Relations By Salman Zaidi FY13: Back to the Fund? By Mobin Nasir

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Don’t abandon hope From Editor’s Desk

In his highly-acclaimed Winesburg, Ohio, celebrated American novelist Sherwood Anderson wrote: “There is the truth of virginity and the truth of passion, the truth of wealth and of poverty, of thrift and profligacy, of carelessness and abandon.” In our context, however, a wave of gloom, uncertainty, pessimism, and despondency pervades across the country. People are moaning in despair and dismay. The reasons for this state of melancholy and depression are quite plausible. Two provinces are firmly in the grip of semi-insurgencies as these are in a condition of being in revolt or insurrection while the situation in other provinces is far from satisfactory; pathetically poor governance and massive corruption now represent themselves as more formidable challenges than ever; the economy is going south in the absence of a clear vision as growing macroeconomic imbalances continue to create profound complications, although inflation has softened up only recently while the country has been largely untouched by the financial meltdown that has been shaking up the economies of the US and the EU in particular—the two top trading partners of Pakistan -since 2008. As far as Pakistan’s foreign policy issues are concerned, the US continues to remain one of the most important countries for a variety of reasons. Unfortunately, however, there has been an unprecedented deterioration in Pakistan-US relations post-May 12 2011. Despite a semi-resolution of Nato supply route issue, there is a sudden surge in acts of terrorism amid reports that the government is contemplating moving into the hitherto no-go territory of North Waziristan to drive out terrorists from their safe havens. The production of a highly sacrilegious film in the US has only deepened anti-Americanism in the Islamic world, including Pakistan and Afghanistan. As far as Europe is concerned, it is still struggling to come out of recession after almost three years of the sovereign debt crisis. Victor Hugo’s European dream, it seems, is facing profoundly testing times in present-day Europe. In the region, there has been a welcome thaw in Pakistan-

India relations. The bilateral peace efforts have brightened the prospects of increased trade between the two countries in the short-and mid-term, which may ultimately lead to resolution of some core issues, including Kashmir. That the economy is not the successive governments’ top priority in Pakistan is a perception that hardly needs any elaboration or explaining. The incumbent government, it seems, has also failed to fully understand the message of its voters who catapulted it into power in February 2008. None of its leaders has ever said that they take it on the chin and they have got to learn from what people are saying. What people have been hankering after is government’s focus on issues that really matter such as law and order and economy; and they do not want to distract or burden their leaders with too many other issues, including education and healthcare, because they strongly appreciate the public sector’s lack of capacity to deliver in these areas. While the Benazir Income Support Program and Benazir Stock Option Scheme are its major success stories, the list of its failures in the realm of economy is very long. This newspaper seeks to underscore the need for competitive economy, which includes formulating and implementing such economic policies that provide an enabling framework so that private sector can operate with full efficiency; improve management of enterprises and gain cost effective access to highly specialized economic inputs. We are also a strong advocate for productive employment, which is at the core of market competitiveness. Policymakers must be able to identify the required technical and managerial skills to expand training programs that hone available technical, managerial and entrepreneurial skills. Dear readers, although this publication in your hands is no white-paper of the incumbent government’s performance in over four years and its arguably irrational and lopsided budgetary priorities in an election year, it seeks to look at

BR RESEARCH THE TEAM 1

the state of economy in accordance with the cardinal principle of journalism: objectivity. The issues thus covered range from the 7th NFC Award and provinces’ enhanced financial prowess post-18th Constitutional Amendment to the required tax reforms; from the curse of blind subsidies to a dangerously spiraling circular debt; from energy woes to water shortages; from analyses on federal and provincial budgets to challenges to macroeconomic stability; from glaring structural weaknesses in civil bureaucracy to lack of fiscal devolution; from challenges and handicaps bedeviling our exports on account of lack of competitiveness and costly imports because of a weakened PKR in the external sector; from abysmally low allocations for social sector to burgeoning population growth amid shrinking resources; and from recklessly wasteful and wildly extravagant government spending to alarmingly large fiscal and current account deficits. So on and so forth. We expect from all political stakeholders, particularly PPP, PML-N, PML-Q, PTI, MQM and ANP, the multilateral lending agencies such as the IMF, ADB and the World Bank, and key regulators such as State Bank of Pakistan and Competition Commission of Pakistan to respond to our effort, Fiscal Review 2012-13, which is clearly aimed at providing a firm basis for future planning efforts and creating bridges to emerging economic paradigms. Dear readers, there is something which tells us that the present difficult, unpleasant and painful situation will definitely end. Macroeconomic indicators paint a bleak picture but our abiding trust in the majesty of democracy and constitutionalism assures us there is light at the end of the tunnel.

CONTENT TEAM 1. 2. 3. 4. 5. 6. 7. 8.

DESIGN TEAM 9. Murtaza Khaliq | Creative Head 10. Abdul Musawer Gulzar | Illustrator

FISCAL REVIEW 2012 / September 24, 2012

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Country’s hope lies hidden in the next setup By Ali Khizar The democratically elected government presented the fifth budget of its tenure, marking national history in the process. But the Federal Budget 2012-13 is a denial of basic accounting standards. The numbers simply do not add up.

provinces for the past two years. But not only has this goal eluded them; the fiscal deficit has actually grown wider over this span of time. With the elections coming up, this tally is headed further south.

In fact the budget making exercise is expressive of the general apathy of the current political regime on the economic front. The budget was a non-event while the speech delivered by the Federal Finance Minister was unceremonious.

There is a dire need to smooth institutional functioning of Council of Common Interest with representation from the provinces and federal government and make it constitutional for the federating units to abide the decisions of the body.

The economic experts interviewed for this publication were more disappointed and disgruntled than ever encountered before. A general consensus has appeared that the government is too busy with daily firefighting and cash management issues, to focus on infrastructure development, job creation and debt management. Granted, this government inherited a shambling economy with structural imbalances exposed to global crises. Yet in the first year, it had fared relatively better. Shaukat Tarin captained the FinMin successfully into a stan-by arrangement with the IMF and the provinces reached consensus on the 7th NFC Award.

Persistently high fiscal deficits are eroding the purchasing power for consumers. In the last fiscal, the government borrowed over Rs1.2 trillion (almost doubled the amount last regime borrowed in its last year) from the banking system out of which more than half was high powered money creation and a quarter was liquidity injection through reverse open market operations. Nothing could be more inflationary in nature; according to some internal studies of State Bank, one quarter of inflation in the last year was attributable to this process of monetization. Had it been at zero, inflation would have been at 8-9 percent in FY12.

But there were few other blips on the fiscal radar. Debate over tax reform was sparked but extinguished before the time the fourth and the fifth budgets announcements were made.

Given the upcoming elections, the printing presses at SBP will likely be in over drive, so inflation shall persist despite falling international oil prices.

But the newfound fiscal space being enjoyed by the provinces appears only on paper. The transfer of power has been reluctant and selective. The friction in this process impeded service delivery, at least in the short run. The rift between the Federal Government and Government of Punjab is another irritant compounding the hurdles between public services and the public. Precedence to political expediency is leading to duplicity of resources, especially human resources.

Domestic debt which is much more expensive than external debt increased manifold in the past four years, as did debt servicing. Overall public debt increased from Rs4.8 trillion in 2007 to Rs12.5 trillion by June 2012. A weakening rupee has added another Rs1.5 trillion to public debt with Balance of Payments vulnerabilities looming the pie of foreign debt in rupee terms is going to increase further; every one rupee fall in dollar, public debt soars by Rs35 billion.

Nonetheless these transitions were long due and they may take their sweet time in acquiring new equilibrium. The next step of fiscal federalism which is not favored by mainstream political parties is the devolution of power to the third-tier of government.

The foreign exchange reserves at SBP are low and fragile. IMF payments are going to get heavy in the second half of this fiscal making the job harder at FinMin and SBP.

The Federal Government has been expecting budget surpluses from the

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The challenge is not attainability and question is not the legitimacy of what IMF is going to prescribe. The issue is to resolve the structural imbalances which are impeding the economic growth and hindering the macroeconomic stability. The foremost issue which is deeply felt by every Pakistani is power sector slippages. The core of the fiasco is the wrong choice of fuel – departure from indigenous gas to expensive imported furnace oil. FO is the most expensive fuel choice and its presence in fuel mixies of India, US and China is less than 5 percent; while here it’s at 35 percent. The resolution of the power crisis lies in short-term as well as medium-term responses. But the government response has come at snail’s pace. The new Power Policy 2012 is a good roadmap but no one has really hit the trail yet. Again all are waiting and hoping for new government to come and kick-start the much-needed power sector reforms.

and chart-out a plan on how to pull up the investment to GDP ratio from its lowest ebb in national history. The potential for domestic and foreign investment is enormous knowing the favourable demographics of the country and investors are hunting for good assets. Local groups, even in such a tough political and economic environment are grabbing good assets – whether its Tabba Group taking on ICI’s domestic operations, Dawood Group buying Hubco or Mansha bullying on AES Lalpir. Similarly foreign investors are eyeing telecom expansion, energy sector (both upstream and downstream) and other sectors. But the biggest deterrent for them is the inconsistent economic policies, poor law and order situation and bad governance. We need to provide policy security to reserve the trend of repatriation of profits and dividends which stand at an alarming level at present.

Then there are issues of tax to GDP ratio. Despite IMF pressure no new sector has come into the tax net. And more importantly nothing concrete is done on tax administration reforms. Broad based subsidies must go, power tariffs should be rationalized. Social support programmes such as the BISP are great steps but these are not enough. Poverty cannot be combated with hand-outs indefinitely.

There is a near consensus amongst the leading economists that going back to the IMF programme is inevitable. However, the On the macroeconomic stability; the need timing is critical. for all economic managers to sit down

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

FISCAL REVIEW 2012 / September 24, 2012

The cost is hyper-inf lation down the road -Dr. Hafiz A. Pasha Dr. Pasha is currently serving as the Chairman of the Advisory Panel of Economists to the Planning Commission and Convener of the Economic Advisory Council of the Prime Minister of Pakistan. He has formerly been Federal Minister for Commerce and Trade, Finance and Economic Affairs, Education and Deputy Chairman, Planning Commission in three different governments. From 2001 to 2007, Dr. Pasha was UN Assistant Secretary General and Director of the Regional Bureau for Asia and the Paciﬁc of UNDP. Dr. Pasha has an M.A. from Cambridge University, and a Ph.D. from Stanford University. He is currently the Dean of the School of Liberal Arts and Social Sciences at the Beaconhouse National University (BNU), Lahore, Pakistan. BR Research: What are your views about the fiscal outcome this year? Hafiz Pasha: It has busted all possible limits. You’ve crossed the peak level, which was last seen in 2007-08. The way the deficit is being financed is even more worrying. In FY12, borrowing from the banking system was over Rs1200 billion, while about Rs505 billion was from the central bank. Last year, government borrowing from SBP stood at Rs590 billion. So that’s the rate at which high powered money is being pumped into the economy. The only reason the money supply is not exploding is that the net foreign assets are contracting. Your reserves are cancelling out. The government has to borrow this kind of money from the central bank when they promised the net borrowing would be zero. Even more worrying is the fact that the federal government is now borrowing predominantly for consumption. So if you have an 8 percent deficit and your development program closes at slightly above 1-1.5 percent, it means that government borrowing stands around 6.5 percent of the GDP for consumption. BRR: What will be the economic impact of this? HP: The cost is hyperinflation down the road. This is a runaway fiscal deficit situation and even the International Monetary Fund must be having nightmares looking at these numbers. BRR: What about rupee depreciation? HP: We had managed to keep the debt-to-GDP ratio more or less constant

because, following the big devaluation in 2007-08 the currency had depreciated about Rs5 or so over a four year period. But this year, it depreciated by over Rs9, or about 10 percent. Now consider that every rupee of depreciation adds at least Rs60 billion to the country’s debt burden. I fear that we will soon also exceed the limit of 60 percent debt to GDP that was set in the Fiscal Responsibility and Debt Limitation Act. This year the government will likely be even less prudent given the fact that the elections are coming up. BRR: Will this have an impact on the upcoming general elections? HP: The issue is how long this government will carry on without holding elections. The timing issue is important, with regard to two aspects. Firstly, it will probably be cognizant of the frequency and seasonality of load shedding. Secondly, reserves are depleting faster than anticipated. We started the year at $14.8 billion. In May we lost $800 million because of IMF repayments. We came down to $10.1 billion – which is roughly 2-2.5 months of import cover before we got his breather of coalition support fund of $1.1 billion. You can easily go down to 1.5-2 months once you start making lumpy repayments to the IMF later this year. Financing the current account deficit is becoming a problem because the capital account has died. It was negative last month. Have you ever heard of a financial account being negative? There’s no FDI and no aid. So things could start looking very uncomfortable around September-October.

FISCAL REVIEW 2012 / September 24, 2012

If they are neck-deep in financial crises and load shedding, there is no way in the world they can win an election. The longer time stretches, the greater is the likelihood of a financial crisis. The rupee may fall another Rs20 by that time. There are risks of capital flight, of export proceeds being held back, speculative opening of LCs, which will precipitate the process. And the worst thing that could happen is the holding back of remittances. BRR: What about the rupee-dollar exchange rate? What does that show? HP: The worst indicator is the gap between the interbank rate and the open market rate which is unsustainable. It went up to around Rs1.50 a couple of months back; that’s a huge gap. Historically the gap has been at Rs0.5 at most. This may mean that informal remittances will increase because they get a better rate. BRR: What about the benefits of decreasing oil prices on the trade side?

by 17-18 percent, that’s a net benefit of 8 percent in rupee terms. But if the rupee continues to devalue, it cancels out. Besides, the injection of trillions of rupees of liquidity in the system will also have an effect on CPI, which has systematically gone up since December last year; core inflation is also on the rise. Reverse OMO operations are also creating artificial injection of liquidity in the system. The rollover rates of T Bills have also increased and that’s further pressure. BRR: What are your views on this year’s Federal Budget? HP: The budget shows an accounting error because development expenditure figures don’t add up. And the speech was very badly drafted. The full, published budget speech ignores underlying realities completely. The government has reduced tax rates for people earning Rs5 million a year. There is little justification for a tax break to individuals earning a million rupees or more each month. The lowering of presumptive tax rates will not only lower government revenues, it will also rekindle the evil of corruption in the tax administration.

HP: Whatever you gain on the imports front due to the decline in oil prices will be countered by a decline in exports, particularly to Europe which is the destination of about a fourth of the country’s total exports. The growth pattern BRR: What about provincial surpluses? of exports has been progressively in the negative over the past few months. HP: The provinces will not do anything as long as they have surpluses from the NFC, BRR: Won’t this mellow the effect on so they cannot be relied upon. Two are inflation? already in deficit; Punjab and Sindh. Only Balochistan and KP are in surpluses, but HP: No, because the rupee is being overall the four are facing budget deficits. devalued. If your rupee has devalued by 10 percent and oil prices have gone down This year with election spending coming in

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and bloated development programs, they are HP: It seems likely, but there will be several going to be under further pressure to borrow. conditions. In the controversial Article IV constitution of the IMF released in BRR: Will the development spending not have February this year, they have systematically stated many conditions. The first thing they beneficial spillover effects on the economy? have objected to is the currency being overvalued. So the first thing they’ll ask for HP: Development expenditure is pumping is a big devaluation. Then they’ll ask for the money. Look at the composition of the withdrawal of all exemptions and federal PSDP. At this time when power is reductions in tax rates given over the last your biggest constraint, its share in PSDP is two years ever since the Fund walked out. barely 20 percent. And the biggest hand goes to highways and roads, which have taken up about 25 percent more than power. The third condition from the IMF this time around will be the implementation of Reformed General Sales Tax (RGST). Then there is political programming with Fourthly the Fund will demand an special programs managed by the Prime enhancement in the sales tax rate to 20 Minister’s secretariat. There is no percent. Further conditions could be a precedent for the Prime Minister’s quantum jump in tariffs, privatization of Secretariat handling the brunt of some sectors like energy distribution, a development expenses which play to the compulsory budgetary surplus, zero limits tune of about Rs29 billion at present. on borrowing from the central bank, hike of Another anomaly is the Ministry of Finance 3-4 percentage points in the policy rate, etc. having been given 100 projects – related to water supply, by-passes, flyovers, urban BRR: But the conditions are hardly implemented by the government. development – under the President’s and PM’s directive which have not been HP: This time, you cannot get away with approved by the cabinet. FinMin is a mere lip service because the country has controlling ministry; it is not supposed to no credibility anymore. The reforms will be implement projects. There’s going to be front-loaded since not a single member of inefficient spending this year. You’ll see borrowings at astounding levels in the first the board will be on our side. But the question is which government will want to half of the year, particularly from SBP. take these measures in an election year? BRR: Will we have to go to the IMF again? So you are on the verge of a financial

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crisis, because we may need to go to the Fund within this fiscal year. BRR: What other signs and symptoms of a financial crisis do you see? HP: The real worry is high inflation, which is very destructive in terms of the effect it has on people. And that will happen if your currency is falling by a multiple, which happens in a crisis. Hyper inflation is defined as a period where the average price level doubles in three years. We are already flirting with that level. Collapse of saving schemes is also a worrying phenomenon. It has gone down by about 40 percent because of slow erosion of confidence in government papers, and people prefer to save in dollars instead of rupees. BRR: What is a feasible solution to these quagmires? HP: It is important to come up with a rational government which initiates serious reforms. Interestingly, if there is a soft bailout, you will never come to a point where some serious reforms will be taken. It seems that only a crisis will bring the tough decisions that have become so necessary for the sustained progress of Pakistan.

BRR: In your opinion, should the power sector be deregulated like the telecommunications sector? HP: The remarkable leap in technology was a major factor in deregulating the telecommunication sector. We don’t have that dramatic increase in technology as far as the energy sector is concerned. The telecom revolution was lead by MNCs; not Pakistani companies. Today, sovereign guarantees are not being honored. So the prospect of big money coming into this sector from MNCs or from local private companies is gone because you have destroyed the sector so much. Rental power didn’t help either. There are many short-term issues that need to be focused on. There must be no tolerance for electricity theft or non-payment of utility bills; gas supply must be prioritized for power production, industries and fertilizer sectors. Unfortunately, the current regime has shown little willingness to even increase CNG rates, let alone sweeping reforms across the power sector.

BRR Interview by Ali Khizar

FISCAL REVIEW 2012 / September 24, 2012

Fiscal Devolution: Still an UnďŹ nished Agenda By Rao Muhammad Asif Iqbal In the context of federalism, Pakistan has witnessed two major developments in the last two years or so. The first of these developments was the 7th National Finance Commission (NFC) Award, which came into effect in July 2010 and resulted in significant changes in revenue sharing arrangements between the federal and provincial governments. The other major development is the 18th Amendment to the Constitution. It contains far reaching stipulations for empowering Pakistanâ&#x20AC;&#x2122;s four federating units, giving them unprecedented autonomy. The amendment makes very clear demarcation of legislative authority between federal and provincial governments. With this amendment the Concurrent List of legislation in the Constitution stands abolished, devolving the functions contained in this list to the provincial governments. This significantly enhances the range of legislative and functional responsibilities of provincial governments. Some changes have also been made in the Federal Legislative List (FLL). Only a provincial assembly will have power to make legislation with respect to any matter not spelled out in the FLL. The only exception is that legislation with respect to criminal law, criminal procedure and evidence can be made both by Parliament and Provincial Assembly. The erstwhile Concurrent List contained 47 subjects, which now have been transferred to the provinces. However, some subjects such as electricity, legal, medical and other professions and standards in higher education have been added to FLL Part I. The role of provinces is also enhanced by transferring few subjects from FLL Part I to FLL Part II since the latter comes under the Council of Common Interests (CCI), which is well represented by the provinces. These subjects include major ports, census, national coordination and planning, and inter-provincial jurisdiction of police force. Moreover, all regulatory authorities established under federal law and management of public debt have also been given under the control of CCI. Moreover, some subjects have been omitted from FLL Part I, implying that legislative authority for these subjects will

now be prerogative of provincial government. These include state lotteries, duties in respect of succession to property, sales tax on services and taxes on capital value of immovable property. On the other hand, international treaties, conventions and agreements and international arbitration have been added to FLL. More autonomy to the federating units also calls for greater coordination between the provincial and federal governments. In this regard, an important and welcome step is revitalisation of the Council of Common Interests (CCI). In the past, the CCI has occasionally played a very important role in reaching agreements on disputed issues. For example, the 1991 Water Accord was agreed upon during a CCI meeting. Under the 18th Amendment, composition of the CCI has been changed. Although the total number of members remains unchanged (four from provinces and four representing federal government), the Prime Minister has been made a permanent member as well as the Chair of the Council. The council has the power to formulate and regulate policies in relation to matters enumerated in Part II of the Federal Legislative List as well as to exercise supervision and control over related institutions. In order to make the CCI an effective body, the Constitution has provided that CCI would have a permanent secretariat and meet at least once in three months.

Transfer of Functions to the Provinces The 18th Amendment resulted in redistribution of functional responsibilities of federal and provincial governments. The federal government dissolved its 18 ministries, which are mostly related to social sectors. On the contrary, eight new ministries have been formed by the federal government though one would have expected much smaller size of federal cabinet after devolution.

Dissolved Ministries Culture Education Food and Agriculture Health Labour and manpower Livestock and dairy Development Local Government and Rural Development Population welfare

Newly formed Ministries Human Resource Development Professional and Technical Training Food Security and Research National Regulation and Services emerge regarding retention of various institutions/departments by the federal government and their placement within federal divisions. Foremost, the legal grounds for retaining these institutions are at best, murky.

More autonomy to the federating units also calls for greater coordination between the provincial and federal governments. Several institutions involved in service delivery have been retained by the federal government; the most controversial being Employeesâ&#x20AC;&#x2122; Old-Age Benefits Institution (EOBI) and Workers Welfare Fund (WWF) which have been transferred to newly formed Ministry of Human Resource Development. Punjab and Sindh have already voiced concerns over this decision.

There appears to be a dichotomy in the policy of federal government where it has A number of departments and institutions transferred some institutions requiring a national approach, such as health and related to dissolved ministries were education services to the provinces, transferred to the provinces while many while retaining others that are strong of them were retained by the federal contenders for devolution. government. Some issues, however,

FISCAL REVIEW 2012 / September 24, 2012

Social Welfare and Special Education Special Initiatives Sports Tourism Woman Development Youth Affairs Zakat and Ushr

National Heritage and Integration National Harmony Climate Change Capital Administration and Development For example, two federally run hospitals namely Jinnah Post Graduate Medical Centre Karachi and Sheikh Khalifa Bin Zaid Hospital Quetta were transferred to government of Sindh and Balochistan, respectively. On the other hand, Zayed Post-Graduate Medical Institute Lahore and Shaikha Fatima Institute of Nursing and Health Sciences Lahore have not been transferred to the government of Punjab. Similarly, federal government has retained Tuberculosis Centre and Women and Chest Diseases Hospital (both based Rawalpindi), which should have been handed over to the province. In the same manner, National Colleges of Arts (Lahore and Rawalpindi) and Marine Biological Research Laboratory Karachi have been retained. In summary, while the 18th Amendment has provided greater autonomy to the provinces, in order to reap the full benefits of this paradigm shift, transfer of functions and responsibilities will have to be made in line with the spirit of the Constitution.

The author is Principal Economist at the Social Policy Development Centre. His areas of concentration include Governance, Civil Society and Public Finance.

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NFC was no economic award Dr. Ashfaque Hasan Khan

Dr. Ashfaque Hasan Khan is currently the Dean and Professor, NUST Business School, National University of Sciences & Technology (NUST), Islamabad. He has been the Special Secretary Finance/Director General, Debt Ofﬁce of the Ministry of Finance, Islamabad. He is also the Director and Vice Chairman of Saudi Pak Industrial and Agricultural Investment Company Ltd. BR Research: Do you agree with the current government’s claim that they inherited the power sector crisis from previous regime?

supply-demand breakeven, therefore, reached in 2005 instead of 2007. It is fair to ask what power projects the previous government undertook.

Dr. Ashfaq Hassan Khan: There are many misconceptions about Pakistan’s economy – created either deliberately or are based on ignorance. A little background and history of the power crisis is in order here. Pakistan was facing power shortages prior to the Power Policy of 1994. The Power Policy attracted massive investment from the IPPs, and by 2001, we had surplus of 3,000 megawatts. The government had to pay for electricity produced, not consumed, so there were financial implications of this surplus at that time. The tensions with India following the December 2001 attack on Indian parliament broke down negotiations for the export of electricity.

Fifty new power projects – totaling 12,141 MW – were launched between February 2004 and June 2007 due to early warning signs. These projects were to become operational between October 2008 and December 2015. These dates have now been removed from the website of the PPIB due to political pressure. The incumbents focused on rental power plants and did not work as much on the already planned projects. The new captive power generation capacity added to the grid is due to the projects commissioned in previous regime. The credit needs to be given where it’s due.

In 2003, Pakistan was still carrying a surplus of 2,000 megawatts. Several exercises were conducted by the government to determine if the supply would match the demand in coming years. Power demand had been rising at an average rate of three percent per annum prior to 2003, which meant that at that rate the break even would reach in 2010. Assuming a 6 percent GDP growth in the coming years (double the 2003 rate); the breakeven was to be reached in 2007. Hence, it did not make any economic sense to commission new power plants in 2003, since Pakistan was carrying a large power surplus at that time.

In the presence of existing NFC Award, there can never be any meaningful fiscal policy in the country.

BRR: Coming to the budget affairs, why is Pakistan’s tax-to-GDP ratio going down?

Between 2003 and 2007, Pakistan’s economic growth rate averaged 7.3 percent, something beyond the expectations of the government. During the period, power demand grew by 9 percent, against 6 percent we had projected earlier in 2003, due to increased economic growth, commercial activities, infrastructure development, rise in the middle class, etc. The power

AHK: Firstly, we need to understand the tax-t-GDP ratio in the right perspective. Pakistan did a GDP rebasing in 2000, in which the GDP deflator had increased by 20 percent. That is why the then 12-13 percent tax-to-GDP ratio fell down to 9 percent soon after. Now, coming back to your question, there are many reasons for gradual decline in the ratio.

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One, the agricultural lobby is very strong – that is why the agriculture sector contributes around one percent to the tax base. I feel that a more precise measure would be tax-to-(Non-Agriculture) GDP ratio, because the 22 percent of GDP (that is, agriculture) is not being taxed. The services sector is 52 percent of the GDP, but it contributes just 26 percent to the tax pool, and the tax proceeds are mainly coming from the telecom and banking sectors. There are many services sectors that are not in the tax-net, like. retail, transportation, professional service (e.g. doctors, lawyers, technicians, etc.) So, the GDP is rising, but the contributors to GDP growth are not contributing in enlarging the tax pool. As you can see, the services sector is growing, but its tax contributions are not. As long as the current political structure and system are intact, the agricultural incomes may not be taxed. Some portions of manufacturing income will also be reported under agriculture income and hence not taxed. Whichever political party comes to govern, this problem will remain. The structure of parliament is such that the issue will remain. In addition, the capacity of FBR has eroded over the years. The quality of taxmen has eroded in the last 15-20 years. There is a lot of politicization. Every government paid attention towards reforming tax system, but nobody focused on tax administration reforms. The two must go hand in hand, but tax administration remained neglected. BRR: What are your thoughts on the existing fiscal policy framework? AHK: In the presence of existing NFC Award, there can never be any meaningful fiscal policy in the country.

FISCAL REVIEW 2012 / September 24, 2012

Remittances growth is a mystery, as Pakistan’s growth rate defies the regional and global trends in remittance inflows. This is creating a Dutch Disease, as financing current account deficit with remittance inflows is not sustainable.

Publicly, the government claims credit for the passage of this Award, but privately, they realize that they have made a mistake. It was a political award, not an economic one. The fiscal discipline shifted from federal government to provincial governments, since 60 percent of the resource is going to the latter.

Hence, almost 90 percent of interest payments are on account of domestic debt, the rest is external debt servicing.

This is happening at a time when federal government itself is starving for resources. The government team did not think about future power sector subsidies, or calculate the hundreds of billions doled out to the PSEs.

Till 2007, Pakistan’s total public debt was Rs4.8 trillion. The figure reached Rs12.5 trillion in June 2012. It has actually more than doubled. The higher debt accumulation during last five year is due to a variety of reasons. Upto Rs1500 billion of the increase is due to exchange rate depreciation. For every dollar in external borrowing, public debt has increased by Rs35.

The IMF has also acknowledged this in their latest Article IV review. The government made a mistake, so they must correct it and move on. But they probably won’t as they want to take credit for it, not the blame. Resources were transferred to the provinces very quickly – without regard to capacity building and fiscal discipline. Hence, the provinces are running budget deficits. The provincial development expenditures have risen by 90 percent since, and this has bred corruption. If the 18th Amendment had preceded the NFC Award, things would have been different. The federal government was profoundly naïve to think that since the resources had been increased through the 7th NFC Award, the provinces would take up additional responsibilities after the 18th Amendment. On the contrary, provinces demanded more resources for additional assignments. On another note, the size of the federal government did not shrink, as one would have expected – it actually enlarged after devolution. There is a need to address these issues in the NFC Award, to bring binding constraints. The budget making exercise is made redundant in this scenario. It has become just a piece of paper. Just look at the unrealistic allocations for power sector subsidies. People have lost their interest in the budget. BRR: Public debt has almost doubled since 2007, with major increase in domestic debt. How alarming is that? AHK: There was a purpose behind the Fiscal Responsibility and Debt Limitation Act [2005], which was to establish fiscal discipline in the government. The decade of the 1990s taught us this lesson that government borrowings slow down investment and growth, and fuel inflation. The intention was to allow for a prudent fiscal path to be trodden, with a constant check on the government’s fiscal practices. We have been off-track since 2008; hence debt has grown manifold, growing faster than GDP growth rate. The domestic and external debt components are almost equal. The difference is that external debt is cheap, but domestic debt is very expensive. On an average, the servicing of external debt is 3-3.5 percent, whereas domestic debt’s servicing is at a rate of 13-14 percent.

FISCAL REVIEW 2012 / September 24, 2012

BRR: What is your outlook on the exchange rate? AHK: There is a lot of focus on the current account deficit and its implications on the macro economy. But I think that it is the capital account which is going to create difficulties or be a source of improvement in the balance of payments position. The foreign inflows matter – both debt-creating and non-debt-creating. A current account deficit of $4 billion shouldn’t worry an economy as large a size as Pakistan’s. But due to problems in the capital account, financing even this small current account deficit becomes an issue.

exchange rate in next two years, with all its adverse consequences for the economy. BRR: What is your view on the inflation trend? AHK: The official figure of 9.5 percent is just because the finance minister wanted a single digit number. There is no way this target can be achieved this fiscal year. I think inflation will remain in the vicinity of 12 to 12.5 percent. Pakistan has been a low-inflation country, with occasional double-digit spikes. This is the only regime during which inflation never slipped back in single digits. There is a lot of unrest among people due to high inflation in recent years, because they are not used to this. BRR: The investment- and savings-to-GDP ratios are at all time low. How can we turn these around?

AHK: Gross domestic saving rate is 5.8 percent, lower than it was in 1947. The root cause is the budget deficit, simple. The government is borrowing from the commercial banks, with the latter earning risk-free returns. The bankers are doing business, not banking, and they are not to blame. The private sector is suffering due to low credit availability. Hence, the investment level is falling down, and I think that the investment-to-GDP ratio has actually fallen The forex reserve position will deteriorate, as the usable below 10 percent. Majority of what businesses have reserves with the SBP will be under pressure. The gap in borrowed from the banks is running finance, for working trade and services account balances is also widening. Remittances growth is a mystery, as Pakistan’s growth rate capital needs, and very less is for fixed capital investment. defies the regional and global trends in remittance inflows. Curtailing the fiscal deficit would free up space for the private sector to take traction. This will help SBP to reduce This is creating a Dutch Disease, as financing current interest rates. If the private sector cannot come in, the account deficit with remittance inflows is not sustainable. We have become so much addicted to this that any drop in government should establish industries based on the PIDC model. This will bring in investment, create jobs, and remittances could spell trouble. I hope these remittance enable private sector to take control later. flows are legitimate, but my thinking suggests that there is something wrong with this. Non-debt-creating inflows are a big question mark, as the traditional sending countries in the North America and Europe are befuddled with their own economic woes. The surplus has shifted to Asia, where unlike the West, there is no tradition to give aid.

The problems will start in this fiscal year, due to external sector. Pakistan has to pay back to the IMF, it has to finance its trade and services account deficits, and it has to pay off its amortized external debt. This will create difficulties in terms of ability to pay back. We will be depending on the US clout, which is, again, a question mark. Foreign aid is not forthcoming. I see pressure on

BRR Interview by Ali Khizar

Page 09

Not a drop to tax By Syed Bakhtiyar Kazmi

A problem which has no solution is an undeniable fact ignored only by the vain or the insane.

are referred to the history of aristocratic misrule and landlordism prevalent in global governance.

Pursuant to expectations, this journey continues with the remaining few curious and adventurous readers.

The chronic antagonists quick to disagree with any other viewpoint are admonished to go no further. The receptive and open minded intelligentsia, in agreement with the above, is invited to deliberate upon the following observation:

Irrespective of the means by which power is acquired democracy or dictatorship - the meek have yet to inherit the earth.

Responding to the question postulated in the hypothesis above, it would be a gargantuan task, even for the agencies, to keep an outbreak of mass insanity within the political elite under wraps. So, by default, is vanity the culprit? On the other hand, this conclusion is even more illogical since the powerful driven by their vanity would have taxed agriculture ages ago; mere lip service is therefore confusing.

Since the past few decades, successive governments have dodged legislating agriculture tax in spite of apparent and persuasive exigencies, which should be sufficient evidence to conclude that eternal status quo is a fact. The question then is, why does not the motif die its natural death? Is it because of the conspiratorial mischief of the vain or the insane? The proponents of a change culminating through awareness and public or moral pressure created by a vibrant media, who by now should also have joined the ranks of the dissenters to the aforestated hypothesis,

Page 10

The unconventional approach adopted herein, most likely, is already discernible to the readers; nevertheless a further clarification is warranted. Deference to economic or other statistics in this article is kept at the minimal as they are but a distraction only. Imaginative people have a proven capacity to eventually pull out some boring statistic for justifying any cause or covering up any debacle. Unsurprisingly, statistics are a dime a dozen. And for those having a penchant for details, there are sufficient other sources to whet the appetite. â&#x20AC;&#x153;Money in the bankâ&#x20AC;? needs no statistical alibi.

To explore the improbable, the intent behind the controversial inclusion of the provision to exempt agriculture in the Constitution needs exposition. Without beating around the bush, letâ&#x20AC;&#x2122;s just go with the assumption that feudalism, from an undisputed position of strength, was able to negotiate a better deal when the legislation was being enacted. But herein lies the paradox: while the British landlords, the famous Corn Law saga,

FISCAL REVIEW 2012 / September 24, 2012

The rich are only willing to pay for their luxuries, so the only solution is to tax them where it hurts!

struggled to keep corn prices high, Pakistani landlords are struggling to keep them low! The fallacy that direct taxation on agriculturists will in isolation only impact their income needs to be absolutely destroyed. That nobody in the world wants to pay tax willingly is an ugly truth. Hence when forced, coerced and cornered into paying tax, any rational person will make all attempts to pass the burden on. Admittedly, compared with immediate passing on of indirect taxes, the time lag will be longer. Nonetheless, the inherent favorable space between domestic and international prices of produce, will supplement the landed aristocracy’s endeavors to swiftly avoid taxes and make the poor pay. Another tax on the poor! When will the rich pay? The rich are only willing to pay for their luxuries, so the only solution is to tax them where it hurts! But if the verdict is to be infallible and defendable, we must not jump to conclusions.

The singular possible conclusion at this stage can only be that either the problem is phrased incorrectly, or a solution exists. “When you have eliminated the impossible, whatever remains, however improbable, must be the truth,” Sherlock Holmes, a personal favorite, quoted in Star Trek by Mr. Spock.

Page 11

Revisiting history, the British industrialist was ferociously against the Corn Laws not because of their love for the poor, but because a higher cost of sustenance meant higher minimum wage and lower profits for the rich. Correspondingly, any agriculture tax will logically increase the cost of business reducing their profits thereby negating any net gain to tax collection. Since higher cost of produce impacts the entire populace, an adverse impact can also not be ignored. Self sustainability of food at minimum cost is a primary directive of every nation. No wonder even the West ferociously protects its agriculture sector. The sensitivities of landlords are such a credible threat that tampering with individual produce is considered risky, lest the landlords shift to some other produce contrary to national interest. Having a support price for wheat and taxing farmers is synonymous with transferring money from one pocket to the other. Realistically, so is subsidizing power and enhancing indirect taxation across the populace. That the meek will forever subsidize the mighty is an unavoidable absolute truth.

around agricultural tax. A sector-wise reconciliation between GDP and tax collected can perhaps affirm this conjecture beyond doubt. The plight of existing taxpayers at the hands of desperate tax collectors is definitely credible circumstantial evidence pointing in this very direction. Trying to squeeze water from a rock is contrary to universal laws. Already taxpayers popularly refer to income tax by a synonym worse than draconian, which for reasons of optics cannot be quoted here. Take another example. The undocumented economy, which time and again has proved to be the white knight for Pakistan’s economy, is generally invested in the real estate. Fiddling with this sector without taking cognizance of the related overall impact on the economy is a fatal strategy. Attempts to proactively regulate property ownership can have an adverse affect on foreign currency flows. By now the truth behind the title “Not a drop to tax” should be clearer. The point is that taxation is not the only option in the equation. Governments have generally chosen the much simpler option of printing money to fill coffers. While the gurus have postulated extensive theories for the optimum quantity of money, troubled nations have always chosen to simply relate quantity with the cost of paper and ink. Unfortunately, however, this strategy leaves the populace worse off. Inflation is a hidden tax which has the dual effect of reducing purchasing power and eliminating wealth. Conceivably, economic growth is the only incontrovertible mechanism to enhance the absolute amount of tax collected, assuming a constant percentage to GDP can be maintained. A small digression, comparing the tax collected to GDP ratios between countries is an exercise in futility since all other factors are not constant between such samples. Growth, however, requires investment which again is only possible through surplus resources.

Summarizing the conclusions thus far, if the inhabitants of the corridors of power ever wanted agriculture to be taxed, bread would be dearer today. If the “will to do” is conspicuous by its absence and the presence of any benefit at best is unproven, why so much noise?

But all is not lost. Revenue is one side of the picture only; austerity is the other more righteous path. Consider, if workers remittance from fellow Pakistanis have gone up from $5.4 billion to $12 billion in the past five years, why is the country still struggling with its balance of payments? For abundant clarification, note that the increase in inward remittance is a “windfall” outside the control of any government. What if this windfall had not materialized?

Serendipitously, noise is a tool for distracting limelight from fundamental issues. The inability to effectively implement existing tax legislation can be a probable cause for the pandemonium

The answer to the second question is most likely bankruptcy leading to abject slavery. The answer to the first question is worse; Pakistanis continued to live beyond their means resulting in

uncontrolled imports. Befuddled by economic theories postulating consumer supremacy, the nation lost sight of reality. Recall grandmother’s famous dictum, “Hamesha chadar daikh ker pair phelana” (live within your means).. So what is the nation importing worth $35 billion other than debt and devaluation? Venturing a guess, a geek’s analysis will identify significant imported wants that can and should be curtailed, which dovetails into our earlier conclusion. Those who desire luxuries should pay a premium. What are luxuries and how are they to be taxed will require “out of the box” brainstorming, which is hardly possible in the current, already abused limited space. Nonetheless, while the path maybe difficult, the objective is achievable. There are nations with a proven track record around import substitution and enhanced export philosophy; Germany, Japan and China, to highlight a few. The objective behind pinpointing imported uncontrolled wants was simply to highlight the existence of variable problems and solutions for conquering “Everest”. Domestic wants are another dimension that can also be explored. The key limitation to trailblazing a different path is misguided effort. If policymakers continue to believe their own excuses, a solution to Pakistan’s economic squeeze will remain a fantasy. Struggling with not a drop to tax and at the same time desperate for growth, finance managers will need to rewrite economic theory or perhaps go back to the basics. Scanning international news interestingly reveals that today the very proponents of free markets are concerned about externalities. Tariffs, currency regulation and protectionism are once again around the corner? Every problem has a solution; all that is needed is honest hard work!

The author is a chartered accountant based in Islamabad. He can be reached at: syed.bakhtiyarkazmi@gmail.com

FISCAL REVIEW 2012 / September 24, 2012

Government shying away from the bitter pill: Ebrahim Sidat “While Quaid-e-Azam Muhammad Ali Jinnah was on his death bed, those around him were quite concerned for his health and that his appetite had all but faded. So some well wishers decided to call in a good chef who cooked for the Quaid. After eating, Jinnah inquired as to why the food was more palatable. He was told of the newly-arrived chef. The Father of the Nation immediately wrote out a cheque from his personal account to cover the travel expenses of the cook and gave strict instructions that none of his incidentals should be paid for from the government coffers”.

“The state is passing on the role of tax collection to a host of withholding agents. While the businesses are being burdened with the task of collecting taxes on behalf of the state, entire legions of taxmen are shirking their responsibilities,” said renowned tax expert Ebrahim Sidat in an interview with BR Research. “At every level, the government appears to be shying away from the bitter pill, necessary to cure the ill of low tax collection and lack of tax culture in the country. Successive governments have opted for the easier, softer options instead of concrete measures that could yield sustainable, equitable taxation,” he said. Drawing attention to the dismal state of utilities and basic infrastructure which the government is supposed to provide, Ebrahim Sidat explained how many prospective tax payers are suspicious towards government’s ability to equitably collect taxes and disburse the proceeds. “Water shortages are frequent, even in the posh neighbourhoods, property rights are not ensured while law and order is in a dismal state,” said Sidat, explaining that the lack of proper governance is also a sign of the weakening social contract between the government and the governed.

Page 12

Recalling the plethora of exemptions that have been granted against various taxes and duties, he commended FBR for its recent efforts to “hack down the list of exemptions”. He said that soon after Independence, the government had introduced a surcharge for the resettlement of refugees, after which followed a surcharge to deal with the devastation of cyclones in the then-East Pakistan and many other similar taxes. “All these surcharges had one thing in common” he said, explaining that “they were all stop gap measures for shoring up government revenues”. “I have no sympathy for tax dodgers”, he iterated, adding that, “but the realities of our environment must be given due consideration in the debate over tax collection. It is true that tax evasion is rampant and that even among those who do pay, many are understating their incomes to minimize their contributions to the government’s kitty.”

EQUITABLE TAXATION “Although we are considered an agrarian economy, all the government gets from the agriculture sector is peanuts,” said Sidat. He was drawing attention to the fact that agricultural income remains largely outside the purview of income tax. “Unfortunately, most legislators in the National, Provincial assemblies and the Senate are bent upon perpetuating this status quo because they are among the biggest beneficiaries of the agri sector,” he highlighted.

“But it is also a fact that those who pay are often harassed by tax authorities. And then at the end of the fiscal when the government misses its revenue generation targets, there are instances of taxmen calling on big businesses to deposit advance taxes or other refundable amounts,” explained the expert.

FISCAL REVIEW 2012 / September 24, 2012

DOCUMENTATION Nadra has brought about a huge change in terms of providing the government with a comprehensive database on citizens. Sidat suggested that a similar database of business entities is direly needed. “Experience has taught us that the tax authorities are feared and loathed among business community, so sending them out for gathering data on business activities yields little cooperation from business owners,” according to him. Instead, Sidat proposed that the help of university students, particularly business management students should be taken as they would receive more open responses from business owners. He highlighted the fact that the real efficacy of withholding taxes is for purposes of documentation of various sectors and registration of businesses. But he added that for this purpose to be achieved, the tax rate should be nominally low while stress must be on reporting requirements.

PRESUMPTIVE TAX REGIME Ebrahim Sidat headed the Direct Tax Committee of the Tax Reform Commission in the early 1990s. In this capacity, he acquired intimate knowledge of the tax reforms introduced in the country at that time. He explained that the complaint from business owners that their refunds were often withheld unreasonably and that tax authorities needlessly bothered them laid the foundations of the Presumptive Tax Regime. He had expressed reservations to the PTR as he considered it “a negation of income tax” as the tax was not cognizant of the amount of income generated by each business. Over time the ambit of presumptive tax widened as it presented an easier way of collecting revenues for tax authorities and on the other hand allowed businesses to steer clear of sleuthing taxmen. “Unfortunately, the tax administration viewed withholding tax as an opportunity to evade their responsibilities of thoroughly assessing incomes and reviewing taxes filed by businesses. As a result, a time came when as much as three-fourths of total taxes were being collected through withholding agents, while the rest came from advance taxes,” he stated.

INCENTIVES FOR INVESTMENT “You may consider the security situation or the political uncertainty but they all culminate as the lack of stability. Risk is a given in every economy, not just in Pakistan and that is especially true in contemporary times with the economies of the world being strained. But investors and multinational corporations looking to set up business in any country, always crave stability,” summed up the expert. He recalled that under the previous regime, steps were taken to bolster fiscal stability in the country by limiting the government’s ability to take on debt. There were other moves to ensure regulations that businesses are subjected to would remain relatively stable. “As a result of this, we were receiving many more queries from investors than we are receiving at present”, he said.

CORPORATE TAX RATE “Many of the companies listed at the stock exchanges have gone public only because they were forced to do so by law,” contended Sidat. He explained that under the older Monopoly Control Restriction Ordinance, all companies whose balance sheet exceeded a certain sum had to be publicly listed. He added that due to such controls, companies went public but since they were not quite interested in raising capital from the public, their management structures and processes did not evolve accordingly. “Tax rates should be lower for listed companies. Firms must be given ample incentives to list on the exchanges. That is the way to bolster a culture of disclosure and transparency among local businesses.”

Sidat, who has ample experience of advising governments and companies alike on taxation issues, ceded that PTR has helped shore up tax collection. “But it is the easy way out. If taxes were being collected based on the actual incomes, they would be yielding much higher collection tallies,” he asserted.

The author is Country Managing Partner, Ernst & Young Ford Rhodes Sidat Hyder. He can be reached at: ebrahim.sidat@pk.ey.com

FISCAL REVIEW 2012 / September 24, 2012

Page 13

Targeted subsidies needed to tackle persistent poverty By Zuhair Abbasi One-third of Pakistan’s population, according to the World Bank, continues to live in poverty, which corresponds to nearly 60 million people. Social protection is widely used as a tool to combat poverty in the major part of the world and the United Nations defines it as ‘preventing, managing and overcoming situations that adversely affect people’s well-being’. Social assistance in Pakistan has traditionally revolved around Workers’ Welfare Fund and pension funds, which broadly cover the social insurance. The impact of these two programmes is minimal considering that they are directed towards formal public sector employees that form less than 10 percent of the labour force. Moreover, the contribution is insignificant in monetary terms, as these two instruments resulted in a combined outlay of only Rs13 billion in FY12. Furthermore, the nature of social insurance is contributory without state support; therefore social assistance becomes more meaningful in gauging the state’s effort in elevating living standards. On the social assistance front, Pakistan has moved on steadily after the commencement of Benazir Income Support Programme (BISP) in 2009. The Zakat and Baitul Mal system has long

been in place but it has oft been criticised for its limited reach and minimal outcome as a total of only Rs4 billion went to the poor’s pocket in FY12. A World Bank review showed that the traditional safety programmes in Pakistan are fragmented and often duplicative; having low coverage of around 2-3 percent of population, well below the requirement. The WB also termed the capacity of the institutions as insufficient and inefficient. The poorly targeted nature of these programmes was also a concern, which led to the introduction of BISP. The BISP has a more direct approach and has the potential of immense coverage, for which capacity building is required. The government of Pakistan doled out Rs50 billion for BISP in FY12 through its three components namely, Waseela-e-Haq, Waseela-e-Taleem, Waseela-e-Sehat and Waseela-e-Rozgar. Waseela-e-Haq focuses on interest free microfinance loans, but the progress so far has been slow as the outreach has been restricted to a little over 6,000 people. Waseela-e-Rozgar is a training based assistance that aims to provide basic vocational skills to the underprivileged to be able to earn their

THE RISE IN SUBSIDY Total subsidy

Power subsidy

(Rs mn) 600,000

400,000 300,000 200,000 100,000

Page 14

It is heartening to see the Government working seriously on data collection, an oft-neglected area in policy implementation in Pakistan. A Nationwide Poverty Scorecard Targeting Survey was launched a couple of years back, based on international best practices minimising the exclusion probabilities. The data entry has thus far resulted in identification of over 6 million beneficiaries and the number is expected to go up to 27 million households. Assuming that the data gathering and entry process goes as planned, it will have the bases covered to specifically target the needy. The government is also working on building capacity to successfully implement the programme and WB and the ADB are constantly working to ensure smooth transition. However capacity constraints may render the exercise futile if the relevant institutions cannot reach all households identified.

THE UNTARGETTED SUBSIDY The government spent a whopping ten times over and above the BISP disbursement on total subsidies in FY12, the bulk of which was untargeted. Nearly half the country’s fiscal deficit is owed to massive overrun in the allocate amount on subsidies. The subsidy of Rs513 billion in FY12 alone accounted for 2.6 percent of the GDP, resulting in missing the fiscal deficit target by a long shot.

GDP. It is heartening that the government has moved away from subsidising petroleum products but the way it has dealt with the power sector is inexcusable as four years is enough time to at least show signs of addressing issues. The worst part is that the power sector subsidy is largely blanket subsidies and the huge sum of money that goes down the drain ever year, does nothing to resurrect it. Since, over 90 percent of power sector subsidy is on account of inter-disco tariff differential, it puts the ball in the government’s court. It is the government’s inability to take the politically unpopular but economically rational decision of passing the entire power generation cost to the users. Besides the energy sector’s troubles cause huge losses in industrial and commercial production, exports, employment and fuel further inflation. The policy of allowing for the use of natural gas in vehicles is a classic case of a poorly placed subsidy. This results in high power tariffs as a result of imported furnace oil based generation, high cost of exportable items because of higher fuel prices, higher import bill on account of fertiliser and oil imports and more subsidy on imported fertilisers. Pakistan will continue to lag behind other developing nations in terms of social safety nets if the existing practise of doling out blanket subsidies prevails.

The major culprit is the ailing power sector, which has constituted a staggering 85 percent of the total subsidies in the previous three fiscal years. Power sector subsidies are single-handily responsible for the massive overrun in allocated amount and were 2.4 percent of the GDP in the outgoing fiscal year.

500,000

livelihoods. The outreach so far, though has been restricted to only 20,000 people.

FY08

FY09

FY10

FY11

FY12

The government can be excused for its first budget of FY08 as the Musharraf regime close to the elections chose to hold petrol prices for consumers, resulting in subsidies of nearly 4 percent of the

The writer works as Research Analyst at BR Research. He can be reached at m.zuhair.abbasi@gmail.com

FISCAL REVIEW 2012 / September 24, 2012

Blanket subsidies adding to inf lation Dr Mohammad Zubair Khan

Dr Khan is a former Federal Commerce Minister. Apart from a brief stint at the World Bank, Dr Zubair has been associated with the IMF from 1981 to 1992. Since returning to Pakistan, he has been consulting for the World Bank, ADB, UNDP, JBIC and other international organizations on a range of issues, including macroeconomic stabilisation policies, monetary policy, trade and exchange rate issues, ﬁscal federalism, tax administration, and poverty related issues. He has served as Member National Finance Commission, Member Advisory Board Securities and Exchange Commission, Pakistan, Member Provincial Finance Commission NWFP, Member Board of Directors Bank of Khyber for many years. He has a doctorate from Johns Hopkins University in Political Economy. BR Research: What are you views on the budget 2012-13? Some circles say that the figures don’t add up. What are your views on that? Dr. Zubair: The budget was terrible. If you put the figures on a spreadsheet, you will find a lot of numbers that do not add up.The budget deficit is way over what the finance minister informed us in his budget speech – it is close to 8 percent according to my working.This is a very odd period in time when we evaluate the past and the future, based on nine months of actual data. Therefore you can claim that the year gone by was superb based on assumptions – which are why they claim success.Just because no one in the parliament has the time or skill to analyze the numbers, no one knows that the numbers are just not adding up. It is a very disappointing and irrational presentationof the national accounts. It is notonly unprofessional, it is also criminal. The best way to check the actual deficit is through the monetary accounts. The deficit has to be viewed from the financing side as you have to finance the deficit eventually. Even the fudged numbers do not add up. BRR: How do you see theinflation evolving and how are subsidies affecting it? DZ: Every single rupee that the government is spending on blanket subsidies is adding to inflation. BISP is not

the solution. Similarly, the induction of employees in public sector entities continues to be on the basis of political affiliations and they are getting undue salary raises.They are trying to hide inflation, SBP has withered discussing inflation. Their claim that inflation is on a downward trend is baseless. All the monetary figures suggest that inflation will again be on the rise. Commercial banks’ exposure to the treasury has increased significantly and which is why there is reluctance to lend to the private sector.Now they are injecting liquidity into the system through Open Market Operations bythe SBP.And the worrying thing is that core inflation is picking up. And very strangely, food inflation is also picking up, which is not according to its seasonal behaviour. It’s the central bank’s job tocontrol monetary aggregates. On one hand, they are continuously funding the government and on the other, they are criticising the government.They just get away by saying that since the banks face liquidity shortage, we are injecting liquidity in the system. We are now injecting more reserve money into the system, which is far more inflationary. BRR: Do the reserves face a huge downward pressure in the near term? DZ: I think this year, we will see a further decline in both reserve and exchange rate, assuming the current government setup continues.If Musharraf’s government could

FISCAL REVIEW 2012 / September 24, 2012

do what they did in an election year, then just imagine the ruckus this government can cause.I fear the election campaign will not be fought, it will be bought, and it will have a telling impact on the fiscal deficit. This budget will probably become a victim of election and if it goes that way, it will cause more troubles to the economy. The government firmly believes that they will buy the elections. But the voter can also surprise by actually coming out to vote. In Pakistan, almost all major political parties are in power, one way or the other.It is very difficult to predict the mood of the common man. I predict that the outcome will unfortunately be pretty similar in the next general elections. BRR: So if you don’t see things changingon the political front, how do you see the economic situation evolving? DZ: Your energy sector is crippling, inflation is high and there is no credit available for the private sector. There is hardly anything left for the industries as the government continues to borrow heavily. The banking system also has to share the blame, as they have now forgotten their role of intermediation. No business can thrive and survive in such dire circumstances.The economy is being killed from within – it is a collapse of the domestic economy which we are witnessing. Just look at the investment to GDP ratio which was around 22 percent five years

back, it is now in single digits.The bulge of the population growth has already reached the employment age, and there are hardly any opportunities for the taking. These are seriously grave issues at hand. We are fortunate that the oil prices may remain mellow, but our exports are not increasing either.The cotton price outlook is very negative; the prices are expected to remain on the lower side for another year on account of slowdown in demand of China. So the current account deficit is here to stay as there is nothing expected on the FDI front, therefore, a decline in reserves is inevitable. It is the remittances that have saved the current account from falling further, and that’s beyond anybody’s policy control. The downside risk on the current account is very high, as remittances can be vulnerable. BRR: How can the situation be tackled? Is going to the IMF the only option? DZ: Yes for sure, they will have to go to the IMF. The current economic team is a bunch of clueless and incompetent people. They will have to change the policies to comply with the IMF conditions; otherwise they will not entertain us.

Interview by Ali Khizar

BRR & Hammad Haider

Page 15

Inflation sitting on the pedestal of government borrowing By Sijal Fawad To say that monetary policy alone can influence inflation would be quite a misstatement for Pakistan. If you’ve taken a look at the State Bank’s monetary policy statement issued in June 2012, you’d know what this means. “Inflation expectations cannot be effectively anchored around single digit targets without limiting fiscal borrowings from the banking system, particularly the SBP,” said the MPS under discussion. So to place the entire onus of containing inflationary pressures on the monetary side alone is a tad unfair. But why isn’t there any scaling back on fiscal borrowings from the banking system? Obviously, a fiscally-strained nation doesn’t have much choice. Pakistan has been lagging behind in terms of fiscal management for quite some time, with the government’s revenues always falling short of its expenditures. Faced with the dilemma of financing the fiscal deficit, any government has three options to finance it: through note-printing, borrowing from domestic sources, and borrowing from external sources. All three sources are inflationary, with money printing being the most directly inflationary. Check out the given graph showing how Pakistan’s fiscal deficit and inflation have moved in tandem for the past more than 20 years. In simple words, when the government spends more than what it earns in revenues, excess demand is created in the economy which is inflationary. How printing money contributes to this is quite obvious: excess money creation leads to greater demand in the economy, which is not backed by adequate supply. As for domestic borrowing, a 2009 paper by Ayesha Serfraz and Mumtaz Anwar of the University of the Punjab says, “Governments, for financing deficit, may choose to spend more than their current income by borrowing; but domestic borrowing causes interest rates to rise, which contributes to inflation by crowding out private investment and a reduction in aggregate supply.”

Page 16

At the same time, foreign borrowing also plays its part in stoking inflation, with Serfraz and Mumtaz’s paper citing Pasha and Ghaus (2009): “Financing fiscal deficit through external borrowings leads to an increase in non-interest current account deficits and capital losses on external debt due to real exchange rate depreciation which leads to inflation.” Needless to say, the problem of hefty government borrowing in the fact of the chronic fiscal deficit problems has plagued Pakistan for quite a while. The problem has become particularly acute in the past 3-4 years, with inflation having moved in double-digits, while the fiscal deficit also soared. Budgetary deficits are also to be blamed for influencing inflationary expectations of people, as increased public spending raises anticipations about rising price levels in the economy. Besides, high inflation levels due to government borrowing also lead to a vicious cycle whereby people expect hefty inflation levels to continue, fueling inflation even more. The consequent impact on growth adds to the concerns that abound from this phenomenon. Ironically, while growth remains stunted in the economy, inflation continues to increase, thanks to government borrowing for financing the fiscal deficit. Chronic fiscal deficits mean lesser fiscal space for investments in the economy, meaning a consequent stunting of growth. As for inflation, though some inflation is actually beneficial when it comes to economic growth, very high inflation levels start affecting output growth negatively. In a 2006 paper published in the SBP Research Bulletin, Asif Idrees Agha and Muhammad Saleem Khan cited another research: “Economic growth is affected only when the economy’s inflation rate is above (a) threshold. That threshold level of inflation calculated for Pakistan was around 9 to 11 percent.” With current inflation levels already in double digits, and even the targeted inflation level of 9.5 percent for FY13 – which is believed to be a little idealistic

anyway – being above the 9 percent mark, not much can be hoped about real growth being kicked off in the economy. Considering the central bank may have to resort to raising interest rates to arrest inflationary pressures, one can see how inflation affects growth. But while government borrowing may appear to be a problem, it is actually a symptom of the even greater problem – budget deficits. In order to avoid the need for borrowing in the first place, the government ought to first, to put it quite crudely, live within its means. This means some serious fiscal reforms are required, both in terms of enhancing revenues and curbing expenditures. Revenue enhancement would need reforms in the likes of expanding the tax base and brining more people in the tax net, many of whom are not even registered tax payers. As for containing expenditures, energy sector reforms as well as rectification of loss-making SOEs need to be implemented.

n o i t a Infl

At the same time, policymakers need to pay attention to real GDP growth as well, as at the end of the day, that is the real growth driver and employment generator for the economy. With improved real growth, the supply side stimulus for the additional demand in the economy will be created, helping restore some economic balance. It’s obvious how the various aspects of the economy are interlinked, with fiscal woes leading to inflationary pressures which toughen policy choices for the monetary side. The government ought to pay heed to this predicament and work towards containing budgetary deficits in the first place and government borrowing in the second. The writer is Research Analyst at BR Research. She can be reached at sijal.fawad@br-mail.com

FISCAL REVIEW 2012 / September 24, 2012

BUDGET AT A GLANCE STRUCTURE OF REVENUES (Rs in billion) FY 12-P

SOURCES OF REVENUES RS(bn)

FY-13

FY08-R FY09-R FY10-R FY11-R FY12-B FY12-P FY13

Direct tax

388

461

1,483

627

744

745

1800

Income tax

367

443

520

603

719

730

914

1600

Indirect Tax

617

719

943

1,052

1,331

1,280

1,572

1400

Customs

148

145

165

173

206

215

248

1200

Sale tax

375

457

540

655

837

852

1,077

1000

Federal Excise Duty

116

134

133

166

140

125

120

Petroleum levy

800 600 400 200 0

Direct taxes

Indirect taxes

Non tax revenue

Sales tax

Non-tax revenue

393

1,784

2,052

2,236

658

512

730

SBP profit

150

213

185

200

Profit from PTA

Dividends

1,224

1,397

1,238

1,529

1,328

1,775

Total Federal Revenue Net 942

MAJOR CAPITAL INFLOWS

CAPITAL RECEIPTS

(as a % of total capital receipts) FY 12-P

FY-13 FY12-B

FY12-P

FY13

Permanent Debt Pakistan Investment Bond Ijara Sukuk Bonds

129.26 50 80

175.381 50 125.546

143.81 54 90

Floating Debt Treasury Bills

119.1 82.1

209.218 160

155.627 110

Public Account Saving Schemes

164.2 149.2

108.03 97.608

187.592 178.171

Total

395.65

525.496

477.779

Rs (bn) Saving Schemes

Floating Debt

Permanent Debt 0%

10%

15%

20%

25%

30%

35%

40%

45%

EXTERNAL SOURCES

EXTERNAL RESOURCES

(as a % of total budgetary sources)

FY12-B

FY12-P

FY13

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

287.2 67.5 117.6 44.0 13.9 44.0 0.0

180.5 165.7 4.6 0.0 4.0 6.2 0.0

274.9 140.4 41.5 46.5 0.0 46.5 0.0

B - Grants … of which

126.7

45.6

112.0

Project grants Tokyo pledges Privatisation proceeds Kerry Lugar

9.3 3.7 70.4 34.2

18.7 1.0 0.0 20.4

25.5 1.0 74.4 8.2

Total (A+B)

413.9

226.2

386.9

Rs (bn) FY 12-P

FY-13

Total

Grants

Loans 0%

932

10%

12%

14%

FISCAL REVIEW 2012 / September 24, 2012

16%

Page 17

PROVINCE-WISE SHARE IN DIVISIBLE POOL (FY12)

KPK

16%

Punjab Sindh Khyber Pakhtunkhwa Balochistan

PUNJAB

48%

BALOCHISTAN

SHARE OF PROVINCES IN FEDERAL REVENUE RECEIPTS

SINDH

27%

Rs (bn) Income Tax Sales Tax * Federal Excise (net of gas) Customs Duties (excluding EDS) GST on Services Royalty on crude oil Royalty on gas Gas Dev. Surcharge

FY12-P 414.40 457.42 71.96 119.28 40.54 22.32 34.49 23.52

FY13 518.85 584.00 63.39 136.77 44.60 21.59 35.44 30.27

Total

1,208.62

1,458.92

* Excluding GST on services

CURRENT EXPENDITURE Rs bn

FY08-R FY09-R FY10-R FY11-R FY12-B FY12-P FY13

General Public Services

882

1,133

1,472

1,656

1,660

1,898

1,877

Defence Affairs & Services

277

311

378

445

495

510

545

Public Order and Safety Affairs

Economic Affairs

293

137

Education Affairs and Services

Environment Protection

Housing and Community Amenities 1

Health Affairs & Services

Recreational, Culture and Religion

Social Protection

1,516

1,649

2,017

2,296

2,315

2,632

2,612

GENERAL PUBLIC SERVICES EXPENSES (Rs bn) (major components) FY 12-B

FY 12-P

Servicing of Foreign Debt

846

FY-13

243 76

715

772

137

216

Foreign Loan Repayment

Servicing of Domestic Debt

Source: "Budget In Brief " Ministry of Finance

Page 18

FISCAL REVIEW 2012 / September 24, 2012

MAJOR SUBSIDIES SUBSIDIES & GRANTS (as a % of total expenditure)

FY12-B

FY12-P

FY13

Wapda/Pepco Inter-Disco Tariff differential Interest on TFCs

123 50 56

419 412 -

135 120 -

KESC KESC on account of tariff differential

25 24

45 45

50 50

TCP on sugar operations on wheat imports/exports

4 4 -

18 17 0

0 --

Utility Stores Corp Others

2 13

2 28

6 17

Total Subsidies

166

512

209

Rs (bn)

10 5 0

FY02

FY04

FY06

FY08

FY10

FY12

DEVELOPMENT SPENDING (Rs in billion) Federal PSDP

Provincial PSDP

Total

AVENUES OF FEDERAL DEVELOPMENT SPENDING * 873

730

734

430

300

304

360

FY12-B

FY12-P

FY13

Cabinet division Defence division Higher Education Commission Finance Division Planning & Development Railways Pakistan Atomic Energy Commission Water & Power

516

Current Expenditure

Development Expenditure

C.E (as a % of GDP)

D.E (as a % of GDP) 20 15

2000 1500

1000

500 FY05

FY06

FY07

FY08

FY13

0.9% 1.3% 4.7% 3.5% 10.7% 5.0% 7.3% 12.0%

0.6% 2.1% 3.2% 3.3% 7.4% 3.3% 9.1% 11.1%

0.6% 0.9% 4.4% 3.8% 10.5% 6.4% 10.9% 13.1%

STRUCTURE OF EXPENDITURE*

2500

FY12-P

* As a % of total Federal PSDP

WHERE WE SPEND Rs (bn) 3000

FY12-B

FY09

FY10

FISCAL REVIEW 2012 / September 24, 2012

FY11

FY12

FY13

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13

Current operations

Development

Defence

Debt servicing

73.8 76.4 81.4 80.4 78 90 83 82

26 24.1 19.9 19 20 10 16 18

17.2 13.9 12.2 20.5 15 17 18 17

24.4 25.4 25.4 34.8 26 28 28 26

*as a percent of total expenditure

Page 19

ECONOMY AT A GLANCE

GROWTH OF VALUE ADDITION IN PAKISTAN Agriculture

Industry

Services

GROWTH IN REMITTANCES: PAKISTAN VS BANGLADESH & INDIA

TOTAL HEALTH EXPENDITURE TO GDP

GDP

CY00 %

% 0

Pakistan

CY09 1

CY 00

30%

CY 09

20%

CY 00

10%

1 -1

CY07

CY08

CY09

CY10

CY11

CY 09

Bangladesh

India

0% -10%

CY 00

DEBT SERVICING RATIO Pakistan

CY 00

CY 09

Bangladesh

CY 09

10 5

CY 00 CY09

CY 05

CY 06

CY 07

CY 08

CY 09

CY CY 10 11e

CY10

Pakistan

Sri Lanka

CY07 CY08 CY09 CY10 CY11 CY12* CY13*

-4

CY 09

CY11

India

% 4

CY 00

CY08

CY 04

CURRENT ACCOUNT BALANCE (% OF GDP)

CY07

CY 03

CY 09

Sri Lanka

India

40%

7 3

Bangladesh

-8 -12

ELECTRICITY ACCESS IN SOUTH ASIA

FISCAL BALANCES OF CENTRAL GOVERNMENT (% OF GDP) 63.40%

75%

76.60%

Bangladesh % 0

62%

CY07

India

Pakistan

CY08

CY09

Sri Lanka CY10

CY11

-2 -4

16%

10%

-6 -8 -10

Bangladesh

Page 20

Pakistan

India

Sri Lanka

Afghanistan

Nepal

-12

FISCAL REVIEW 2012 / September 24, 2012

HEALTH & EDUCATION COMPARISON

12% FDI INFLOWS SOUTH ASIA REGION CY10

Score (1-7)

BANGLADESH Health and primary education

Higher education and training

PAKISTAN Health and primary education Higher education and training

INDIA Health and primary education

India Pakistan Bangladesh Sri Lanka Others

Higher education and training

CHINA Health and primary education Higher education and training

SRI LANKA Health and primary education Higher education and training

78%

IRAN Health and primary education Higher education and training

TOP PROBLEMATIC FACTORS OF DOING BUSINESS IN PAKISTAN

2012 DOING BUSINESS RANKING FOR SOUTH ASIA REGION 89 105 132

Government Corruiption Policy Inedequate Govt. Access to inability/coups instability infrastructure Bureaucracy finance

122

154

INFLATION IN SOUTH ASIA Bangladesh

India

Pakistan

South Asia

% 20 15 10 5 0

FISCAL REVIEW 2012 / September 24, 2012

CY07

CY08

CY09

CY10

CY11

Page 21

Corporate Tax Rate in Pakistan– Substantially high By M. Abdul Aleem FBR has recently announced that it collected over Rs1905 billion in revenues in FY12, showing an increase of over 24 percent over FY11. This is an admirable achievement; 14 percent real increase after taking into account 12 percent inflation, considering that there were no new taxes levied during the period. This healthy growth in tax collection is evenly reflected in both direct (which constitutes 38 percent of the total revenues) and indirect taxes (62 percent). It is all the more significant for an economy showing modest GDP growth of only 3.7 percent during the period. Besides organic growth in certain specific sectors of the economy like consumer products, fertilizers and banking contributing to higher revenue collection; it appears that FBR has also achieved some success in its continuing efforts to reach out to those evading or under paying government dues in the

past. Despite the healthy growth, there is a common consensus that there is still considerable potential to significantly increase tax collection, mainly income tax, provided massive tax evasion is plugged and generous but unjustified, exemptions to some highly revenue rich, but protected, segments of the society are withdrawn by leading them to pay their due share and be part of the tax net of the country. Following the above brief overview of tax collection, let us focus on a global overview of Corporate Tax rates in Pakistan and their relevance in attracting investment to the country. In the absence of official and more precise details of the overall contribution of the corporate sector in the form of direct taxes, we have to rely on the figures made available from certain surveys conducted recently by Overseas Investors Chamber of Commerce and Industry (OICCI).

COMPARISON OF REGIONAL CORPORATE TAX RATES (%) Pakistan

Singapore

Indonesia

India

Bangladesh

Malaysia

The tax rate instead of being used to incentivize businesses towards corporatization and listing at stock exchanges, was reversed incentivized in June 2012 in favor of Association of Persons (AOP) segment by bringing down their tax rates to the one which is applicable to non-salaried individual’s i.e. ,well below the corporate tax rate.

As compared to global tax rates, Pakistan has substantially higher and varied tax rates for various enterprises that lead to an inherent disadvantage to the country for foreign investment.

25 20 15 10 5

Page 22

Besides the worldwide financial meltdown of 2008, businesses in Pakistan had to encounter downturn due to concerns on law and order, energy shortage, deterioration in the currency and rapid increase in the cost of doing business. In such an environment the corporate sector deserved a more forward looking approach on not only taxation, but also in terms of facilitation at all levels in the value chain.

Comparative analysis of Corporate Tax rates

The amount of corporate tax collections in Pakistan has shown a steady growth, especially among OICCI members. The Government has maintained the corporate tax rate at 35 percent since 2007 despite regular recommendation by various chambers, well respected analysts and economists to reduce it in line with the regional trend and provide relief to the business sector.

2007

2008

2009

2010

2011

2012

Direct tax rates among Asian countries have remained at an average of 27 percent in 2011, while income tax rate in Pakistan, is 35 percent for companies but much less for AOP and small companies. In addition to direct taxes, companies in Pakistan also pay other levies like the Workers Profits

Participation Fund (WPPF) at the rate of 5 percent of the accounting profit and Workers Welfare Fund at the rate of 2 percent of the taxable income, besides some provincial taxes, like Sindh Government’s levy of Sindh Development and Maintenance of Infrastructure (SDMI) cess of 0.5 percent (and stamp duty on purchase orders that leads to additional tax burdens and increase in cost of doing business. These are in addition to indirect taxes such as sales tax, federal excise duty and customs duty. The above is a snap shot of tax rates. However, if we see the trend of corporate income tax over the past five years in these countries, we will notice that most of the comparable countries had reduced the same during 2010-2011; some like Sri Lanka, Singapore and Malaysia did so even earlier, to align tax rates to the relatively difficult economic environment. In the background of reducing corporate tax rates in seven countries of the region, Pakistan’s unchanged corporate income tax rate of 35 percent (highest in the region) does not help in either attracting Foreign Direct Investment (FDI) or domestic investment, nor does it encourage corporatization efforts of the Government. It will be relevant to mention that the corporate sector in Pakistan had been pleading for many years that the rationale for reducing the corporate tax rates is in line with the trend in the region and that FBR also had shown indication to gradually reduce it but this promised and well justified reduction in corporate tax rates has not yet materialized. It was also proposed by various industrial and professional forums that dividend payouts by a listed company should also be made a criterion for reducing the basic tax rate. It may be worthwhile to note that besides higher tax rates, the corporate sector has to face considerable

FISCAL REVIEW 2012 / September 24, 2012

A comparative analysis of current direct taxes rates charged in Pakistan with seven other regional countries is given below: Head of Income

Pakistan

India

Malaysia

Indonesia Singapore

Company Income Tax Capital Gain Branch Tax Withholding Tax Dividends Interest Domestic Company Royalty Fee for Technical Services Branch Remittance Tax

35 35

20 40

7.5/10 10

0 10

0 15

15/30 6/15

10 10

hardships in terms of ever- increasing requirements to document withholding tax. The receipt of long pending tax refunds and the rising frequency of litigation due to last minute pressures exerted by tax authorities to meet Government revenue targets, also present mounting challenges for the corporate sector in Pakistan.

17 0 17

15/20 15/20

0 15 10

2 20

positive on the potential of the country for improvemrnt and had plans to invest sizeable investments in the country over the next 2-5 years (OICCIâ&#x20AC;&#x2122;s 2011 Perception and Investment Survey).

To conclude, it is necessary to appreciate that one of the most important considerations for any business is the countryâ&#x20AC;&#x2122;s legal Devolution of various subjects to the taxation infrastructure which should, inter alia, provinces under the 18th Amendment to the ensure that it is fair, transparent and Constitution is expected to be an experience proportionately taxes all income irrespective in itself with some impact on corporate of its source and that those responsible for performance until the matter is fully administrating the tax infrastructure should understood and resolved by all implement them in a transparent manner. stakeholders. A case in point is the Sind Therefore, it will only be fair if FBR and Sales Tax Act on Services 2011 which has provincial tax authorities review their

70% respondents showed dissatisfaction with the fairness and clarity of law, had difficulty in getting tax refunds and found that policy implementation or ease of doing business in Pakistan is an area of concern been enacted whilst the corresponding FBR provisions are , by and large, still intact and can be used negatively against the taxpayer. Furthermore the Sindh Infrastructure Cess (SDMI) and stamp duty on purchase orders remain contentious for businesses based in Sindh as it is a contributor to the increased cost of doing business in that province. It may be noted that a similar tax does not exist in other provinces and that most of the registered corporate entities are based in Sindh. The purpose of bringing this subject here is to highlight to all those who have a stake in making businesses prosper, creating jobs and generating taxes, the importance of facilitating the growth of businesses instead of merely committing resources to resolving tax disputes. In a recently conducted survey done among the foreign corporate investors, members of OICCI, approximately 70% respondents showed dissatisfaction with the fairness and clarity of law, had difficulty in getting tax refunds and found that policy implementation or ease of doing business in Pakistan is an area of concern. Yet more than 60 percent of the respondents were

processes and procedures and consider putting in place a system to regularly review and align corporate tax rate and other levies to remain regionally competitive for investment, with tangible incentive for attracting businesses to get corporatized. At the same time, it is incumbent upon all businesses, including the corporate sector, to assist the authorities like FBR in their efforts to document the economy, broaden the tax base and amicably resolve disputes in a timely manner. Paying taxes is an obligation of all citizens and the expectation from authorities is to make it a pleasant experience. NB: The above is the personal view of the author and do not reflect the view of the organization referred above.

The author is Secretary General at the Overseas Investors Chamber of Commerce and Industry. He can be reached at: mabdul.aleem@oicci.org

FISCAL REVIEW 2012 / September 24, 2012

3G Spectrum Auction: Don’t delay- Do it now! By Parvez Iftikhar

Parvez Iftikhar was the founding CEO of Pakistan’s “Universal Service Fund”, where he served till December 2011. His advice on Universal Service for ICT is sought in various countries by global institutions like ITU, USAID/GBI and the World Bank. Prior to USF, Parvez was country-head of Siemens Telecom in Pakistan. He has been on sabbaticals to Carnegie Melon University, USA and Oxford University, UK. Recently, he started independent consultancy services (mainly on USF) abroad.

KEY BENEFITS OF MOBILE BROADBAND • It has a positive contribution to GDP, which is magnified as penetration increases • It delivers basic services like health, education, governance and commerce to millions of citizens in all areas • It accelerates the achievement of development targets • It can counter the trend of massive urbanization by facilitating people in their indigenous locales • Its promulgation contributes to job creation • It facilitates productivity gains • It creates new opportunities for the country’s IT industry • It facilitates women, who can now also work from home instead of leaving the workforce • It reduces the needs for physical travel by connecting people and businesses virtually.

Broadband internet has changed the way people communicate, access information, share experiences and knowledge, and engage in business transactions. Broadband is revolutionizing our social, political, and commercial interactions. According to a market research firm, ‘Infonetics’, the number of global mobile broadband subscribers reached 846 million in 2011, exhibiting an almost 50 percent increase over the previous year. By 2016, this figure is expected to reach a whopping 2.6 billion, with Asia accounting for more than half of these subscriptions. While people in developed countries usually use mobile-broadband in addition to fixed broadband, the former is often the only access method available in developing countries. Mobile broadband penetration in developing countries reached an estimated 8.5 percent by the end of CY11. But broadband penetration in Pakistan is abysmal, as the availability is limited to less than 300 towns and cities. Total broadband subscriptions of two million connections – evenly split between fixed broadband (e.g. DSL) and wireless broadband (e.g. WiMAX) – are serving an urban population of less than 60 million, leaving out the rural population completely. However, thanks to the ubiquitous 2G cellular networks across the country, 3G can take mobile broadband to every nook and corner of the country, making it accessible to more than 90 percent of the population. Thats why mobile broadband (or 3G/4G) is important for us. With the world already headed in that direction, Pakistan needs to urgently do something to stay abreast.

3G auction: The fiscal side Spectrum auctions and license fees can yield substantial amounts to balance budgets, but the experiences with 3G license fees earned towards the early days of 3G in the West suggest that competitive mechanisms must be used with caution. The high bids for spectrum bands can impose a massive cost burden on the telecom industry, which ultimately has to be carried by consumers. Despite the European experience of the initial highly detrimental market effect of overpayment for licences (an effect that cascaded throughout the global telecommunications industry), many in the governments still have the view that awarding 3G licences should result in high licence fees. ICT is a unique sector where the government normally doesn’t need to bother about as far as development budget allocations are concerned. On the contrary, it brings Foreign Direct Investment (FDI) in the country. There are challenges in trying to balance the view that the award of a 3G licence is an opportunity to generate cash for government treasuries versus the realities of the cost of network rollout and service deployment, versus the near and medium term potential for 3G services. Thus, the manner in which 3G licenses are awarded needs to be evaluated with care. For a country like ours, it is more important to impose challenging and aggressive coverage obligations/targets than to expect more up-front cash. It must be understood that there is a trade-off between licence fees and other obligations.

Page 24

PAKISTAN'S FISCAL DEFICIT AND INFLATION OVER THE YEARS Fiscal deﬁcit (% of GDP)

Inﬂation (%)

20 15 10 5 0

FY91

FY94

FY97

FY00

FY03

FY06

FY09

FY12

Source: FinMin, PBS

FISCAL REVIEW 2012 / September 24, 2012

The revenues of all operators are capped by demand factors in the countries in which they operate. If a government decides that social and economic objectives – such as lower consumer prices, rural coverage and technological innovation – are key objectives, then it is fair to expect that the imposition of obligations to achieve these objectives will result in lower licence fees.

allocated for the existing 2G networks. This essentially translate into about twice the number of base stations to provide the same coverage as a 2G system in the 1800 MHz band. Thus, roughly twice as much investment in base station equipment is required for a 3G system compared to an equivalent 2G system. This higher cost of a 3G network is for both capital and operational expenses.

In any case, mobile network operators will need large investments for the rollout of the 3G-enabled data services. This is because, as shown in the illustration below, the 3G spectrum of 2.1 GHz provides about half the coverage of the 1800 MHz spectrum

The main benefit of mobile broadband comes after its deployment. Just like 2G was an effective engine of growth for the economy for over a decade, 3G’s contribution could be massive too. Pakistan’s telecom industry contributed

RISING GOVERNMENT BORROWING OVER THE YEARS SBP Credit to Government Sector (Net) Scheduled Banks Credit to Government Sector (Net) Rs in tr

3 2 1 0

Jun 06

Jun 07

Jun 08

Jun 09

Jun 10

Source: SBP

FISCAL REVIEW 2012 / September 24, 2012

Jun 11

June 12

Rs117 billion to the exchequer in FY11 alone, according to FBR and PTA. This does not include the direct and indirect contributions of various private telecom entities. It also does not include the jobs created and intangible benefits of “connectivity” brought about. But as can be seen in the illustration below, the taxation contribution has been more or less static over the last few years. This, in itself, is a sign that if the government wants more sustainable and continuous flows of cash, it needs to break new grounds, like 3G.

motorway of today, the more negative would be the impact. Another significant loss caused by the delay is the widening technology gap between other countries and Pakistan. Considering the fact that around 50 percent of our population is below 25 years of age – normally considered early adopters of modern technology – the amount of productivity losses that are taking place is enormous.

Expediting the delayed Impact of delay on Social and Economic Development process of 3G in Pakistan of Pakistan There is no need of re-inventing the wheel. Over eighty percent of countries worldwide had launched 3G networks by June 2012. The delay, so far, has made Pakistan lose huge opportunities (as mentioned above) relating to job creation, international trade, economic growth and FDI. The policy and regulatory measures governing broadband also have implications for other sectors of the economy, as well as society as a whole, given broadband’s role as critical information infrastructure underpinning other key sectors (like: power networks, transport, health and financial services). Broadband has to be regarded as part of a country’s critical infrastructure as important as roads, airports and electricity. The more we delay in laying this information

We have the experience of a successful 2G auction behind us and we can build on it. The main thing that we need to re-do is the Information Memorandum (IM) – especially the part that deals with obligations of the license winners (like aggressive rollout obligations, tower sharing, etc). To take care of the transparency issue, an international consultant of repute should be appointed through a process that is also transparent, who should (a) review and advise regarding changes in the IM, and (b) advice and oversee the whole auction process. Such an auction for 3G spectrum has been done so many times in the world now that if there is no outside interference, it can easily be over before the year 2012 is out.

Page 25

Auction for 3G licenses: Faulty reasoning, design By Hammad Haider It appears that the federal government budgets for the 3G license auction proceeds just for kicks every year. It budgeted Rs75 billion in FY12, and Rs79 billion this fiscal year. If the Telecom Policy of 2004 is to be followed, the authorities are already four years late into introducing the 3G technology in Pakistan. One wonders if the said auction would actually take place in FY13, as the odds are visibly stacked against it. It cannot be stressed enough that how important the introduction of 3G network technology is for Pakistan. In 3G services, the ailing and wailing mobile network operators (MNOs) will find a substantial and lucrative revenue stream; customers would get to experience high speed mobile broadband; and the government will raise sizable revenues. The rollout of 3G services is expected to lead to greater socioeconomic uplift. Recently, some official activity has been reported vis-à-vis auction for 3G licenses. The cabinet seems interested this time; the finance minister looks keen again; while the parliamentary committees on IT remain ever-inquisitive. On top of that, there are fresh faces seen heading the Ministry of IT and the Pakistan Telecommunications Authority. Hiring of a consultant is reportedly in the works who will work out the modalities of the auction.

market, which can seriously hurt the customers in terms of service quality, pricing and availability. The remaining 2G operators might be sublet some of the spectrum, but that will come at a high cost, hence the premium data prices may remain high for longer than usual. There is an agreement amongst telecom experts that the participation of a foreign operator can fuel the auction frenzy, yet the current IM itself preempts that. How? It is going to be a tremendous disincentive to have the sole international competitor (the winner of Instaphone license) to bid alongside local, established operators for 3G license. The foreign operators’ value proposition is going to be markedly different than the locally grounded operators, and they will actually lose out even before the auction starts. Hence, the lukewarm response from foreign operators is not surprising, even though PTA had conducted quite a few road shows abroad earlier this year.

Right after the IM’s release, many objections were raised in different quarters, including the base price, technology-neutrality and license payment mechanism post-auction. These issues are secondary, because base price is only a starting point of the auction. The auction could be limited to The Fiscal Opportunity just the 3G technology and there can be more strict The fiscal side of the much-awaited 3G license auction cannot be ignored. payment provisions. The emphasis has to be on value maximization for the stakeholders, including government. There is a certain amount of spectrum (around Auction Design 30MHz) available to be assigned for 3G services. The spectrum should be allocated efficiently and assigned competitively, to those operators who The core of the whole problem lays in a attach a higher value proposition to it than the others. faulty auction design. The auction design should be such that chances of It is understood that the auction modalities are supposed to be revised foreign participation increase and local by the awaited consultant. The original modalities for the 3G auction, MNOs are nudged out of laxity – all which the PTA released in January this year in an Information through a fair and competitive process. Memorandum, make one wonder if it was some kind of balancing act, an attempt to shield the local, established operators from fair bidding Whatever amount of license fees are competition for 3G licenses. The regulator is supposed to look out for all raised in the process would be the stakeholders: industry, customers and the government. Yet the reflective of competitive forces and existing auction modalities seem not only anti-competitive, but also demand factors. It shouldn’t matter if hostile to future 3G customers. Intriguingly, the owner of the spectrum, the treasury is delighted or the government, could be at a serious disadvantage here. disappointed afterwards.

Issues in the existing Auction Modalities According to the IM, government will offer three blocks of 10MHz each in the 1900/ 2100MHz frequency bands. Leased for a period of 15 years, the base price was set at $210 million for each block. The open outcry, multiple-round bidding process would continue until bids cease to be raised. As for the potential foreign operator or new entrant, it would participate alongside existing operators after successfully bidding for the defunct Instaphone license (8MHz for 8 years, at a base price of $155 million).

This piece now turns towards one of the various ways in which the said 3G

The IM states that the highest bidder can choose to take two out of three spectrum blocks, 20MHz in total, which renders the whole process anti-competitive. Suppose, if an MNO takes two blocks, there will be only two 3G operators in the

Page 26

FISCAL REVIEW 2012 / September 24, 2012

Spectrum Auction Highlights Frequency band No. of licenses Frequency size Base Price Duration of License Bid earnest money Original auction date

2G (Instaphone)

1900/2100 MHz Three 9.8 MHz $210 mn 15 years $31.5 mn 29-Mar-12

800 MHz One 7.38 MHz $155 mn 8 years $23.25 mn 28-Mar-12

Source: PTA (Information Memoranda, Mobile Cellular License / Spectrum (3G /4G/ LTE) Auctions, Jan. 2012)

auction can be designed competitively in the Pakistani context. But first, there are certain things that need to be kept in perspective:

- Radio spectrum is a scarce national resource. It is the government’s property, and it’s her prerogative to design the spectrum auction, whichever way she wants. The private sector is only the user of the spectrum, not the owner. - No matter how much the operators end up paying for spectrum, the price curve for 3G services will slant downwards if the available spectrum is assigned competitively to various operators. - Pakistan’s experience with 2G cellular subscriptions, heavy sms trend and mobile internet usage data renders this notion fallacious that 3G or mobile broadband won’t have significant customer uptake. - Existing MNOs are going to bid aggressively to protect their post-paid and high-end prepaid customers who offer a large chunk of their revenues. MNOs need to protect these segments and grow at the same time following the 3G auction. - A solid business case will figure majorly in potential foreign operator’s decision to enter Pakistan than the security perception. After all, ICT industry is still standing on a sound footing in Pakistan following all these turbulent years. The local telecom market looks attractive, with mobile subscriptions over 120 million, and a tech savvy, data hungry, young population.

and B will have a bandwidth of 10MHz each, and licenses C and D 5MHz each. Bidding should be through an open, having multiple rounds. License A should be set aside for a new entrant, meaning that only foreign operators and / or new local players can bid for this license. The existing MNOs should not be allowed to bid for this license so as not to put the foreign bidders at a significant disadvantage. Foreign operators will have dual incentives: they will be fighting it out on equal ground and stand a good chance to be assigned a fair amount of spectrum. One may wonder, what about the Instaphone license that was supposed to be auctioned to a foreign operator! Well, the winner of License A could be awarded Instaphone license based on the ‘price per MHz per year’ it paid for the 3G license it just won. The way existing auction is designed, it is feared that Instaphone would have no foreign operator bidding on it. License B should be bid only amongst the existing five MNOs. The competition for this license will be huge; as the bigger MNOs will be scrambling to take this larger block of 10MHz. Losing here would relegate them to bid

would come down in due course as customer adoption of mobile broadband and usage increase. Such an auction design is certainly going to interest reputable, foreign 3G operators, whose entry into the Pakistani market is bound to push the local frontiers of data-enabled services, value addition, mobile application development and branding. There will still be two unsuccessful 2G operators left, who will have their options open. It is the competition that will drive the market post-auction, provided the 3G rollout obligations are followed through. It merits mentioning here that the joint ownership structure of Mobilink and Telenor Pakistan – wherein the Telenor Group holds majority shares in VimpelCom that manages Mobilink – may introduce the element of collusion among the two companies in this auction. This issue can be countered to some extent through silent bidding, but that is not advisable. Foreign operators have known to be averse to silent bidding out of fear of overpaying, which in Pakistan’s context has happened before to Etisalat whose bid for PTCL’s 26 percent stake in 2006 was a whopping $1.3 billion more than the second highest bidder.

The owner of the spectrum, the government, could be at a serious disadvantage for two smaller licenses of 5MHz each which the smaller operators would be more interested in buying given their small subscription base. License B will eventually fetch the highest price. For License C, the remaining existing MNOs will bid for spectrum that is half the size of earlier auctions and whose base price is also half. Here, it will become a battle for survival among operators, so expect the competition to go into overdrive. The License D could either be offered to any one of the remaining three operators who matches the License C’s peak price or further bid upon if there is more than one contender willing to do that.

Conclusion Rather than getting lost into unnecessary details, it is the auction design which the yet-to-be-hired consultant should be focusing on, keeping international experience in mind. By no way is it suggested here that the lemon be squeezed dry. However, it won’t do anyone any good if only the operators’ interests are kept ahead of other stakeholders’. Designing this auction competitively is the only way to arrive at a price point where the interests of all the stakeholders can converge.

Auction Design: A scenario Bandwidth License A

10MHz

License B

10MHz

License C

5MHz

License D

5MHz

Eligibility Base Price New Entrant / Foreign P* Operators Existing P MNOs Remaining Existing P/2 MNOs Remaining Existing P/2 MNOs

The writer works as Research Analyst at BR Research. He can be reached at hammadshah24@gmail.com

* Revised Base Pricee

How to go about this? In light of global experience, a 3G auction has to meet the objectives of precise monetization of the economic value of spectrum on sale, efficient allocation and utilization of spectrum, and hence competitive provision of the 3G services to the customers. Here is a hypothetical auction design for Pakistan, the likes of which have been successfully implemented in the United Kingdom, Singapore, Switzerland and Belgium. The 30MHz of available spectrum should be divided into four license blocks: Licenses A, B, C and D. Licenses A

FISCAL REVIEW 2012 / September 24, 2012

Interesting Possibilities The outcomes of the auction could be varied, in terms of the peak price for various licenses and the winning operators. Expect some surprises and upsets. Importantly, such an auction design can ensure a post-auction competitive scenario, wherein consumers will have a choice amongst a number of 3G operators. With no single operator holding a large chunk of spectrum (which would potentially be the case if PTA’s current auction design is followed), the data price curve

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Health of a polio-endemic country

ari By Dr. Talib Lash

Introduction Events since 2005 earthquake, floods of 2010-11; Dengue fever outbreak; deaths due to spurious cardiac drugs; demands of health workers for better job conditions led to bring health on the agenda of broader political spectrum. Thus, health has become one of the most discussed subjects. Recently, Pakistan also became the focus of the world’s attention for being one of the last three remaining polio endemic countries. Difficulty in tackling polio indicates some of the reasons other than core health sector issues such as security situation, lack of infrastructure to maintain cold chain and difficult terrain to reach to targeted children. This clearly shows how the healthcare has transformed merely from a dogmatic approach of ‘drugs, doctors, and hospitals’ to a broader socio-political, economic and a societal behavioral paradigm of human life. It’s evident that health sector interventions have implications for economies. Bill Gates one of the biggest donors in polio eradication told amid debate in US that polio eradication if successful can save US $ 50 billion in 2035. In the backdrop of the realm of socio-economic aspects of health there has been discourse in Pakistan for the last two years at the Planning Commission on economic impact that access to quality healthcare brings for a given society. This led to incorporating health into Pakistan’s newly approved economic policy the ‘Framework on Economic Growth’. The Framework suggests health sector reforms under three broader themes i.e. access to and availability of health services; equity and fair financing; and governance and accountability. Its roughly estimated that several billions of US$ can be generated by 2015 into Pakistan’s economy if premature deaths due to preventable and treatable diseases are averted during working age by saving Disability Adjusted Life Years (DALYS) – a measure of overall disease burden, expressed as number of years lost due to morbidity or mortality. Thus, health has emerged as part of socio-political and economic agenda in contemporary Pakistan.

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Health has been the focus of discussion also due to the 18th Constitutional Amendment that abolished the Concurrent List; amended Federal Legislative List and placed health at the disposal of provinces. This has further brought into the limelight, the issue of roles and responsibilities of federal and provincial tiers. The 18th Amendment coupled with the 7th NFC Award has drawn attention of policy makers and decision makers towards much needed discourse on financing mechanisms in health sector. In this context, this article examines the healthcare aspect from financing perspective in Pakistan and then will revert to the fundamental policy issue of looking at health as broader social asset in a society. Finally the article suggests policy options to address health issues from that perspective.

A cursory look at federal and provincial governments’ expenditures on health suggests that Pakistan spends less than one percent of its GDP on health (Fig 2). Though there has been incremental increase in health budget on yearly basis, a decline was noticed in years 2005-06 and 2010-11 which was mainly attributed to devastating earthquake and rain floods respectively.

FIGURE 1: TOTAL HEALTH EXPENDITURE BY FINANCING AGENT 2005-06 (%) OOP.H. Exp.

Provincial/Fed.Govt.

Social Security

Military

Private Insurance

Donors

Zakat

Cantonment Board

4.03

20.46

Healthcare Financing

1.93

180 million population of Pakistan depends upon a mix of healthcare systems (Fig 1). According to National Health Accounts (2005-06) there is 77.25 percent utilization of healthcare in private sector which is slightly more in urban areas (79.02%); there is 22.58 percent utilization of public sector facilities which is slightly more in rural areas (24.18%). A further elaboration of public and private sectors’ expenditures on health provides a complex picture.

1.11

More than 64.27 percent expenses for health come from out-of-pocket; federal and provincial governments spend more than 20 percent; international development partners (donors) provide 2 percent of the total financing; military and cantonment boards’ health expenditure is 4.12 percent; private insurance makes up 0.23 percent; zakat 0.28 percent and 1.11 percent are spent through social security schemes. There are three basic issues in utilization of services and expenditures in health sector. First, a huge amount of expenditure in health comes through household expenditures (out-of-pocket) which comprise more than 90 percent of the private sector share in utilization of healthcare. Second, there are negligible mechanisms of risk pooling. Third, public sector facilities are less utilized.

0.28

64.27

0.23 0.09

Source: National Health Accounts 2005-06, GoP Despite economic difficulties, there has been increase in health investments in Pakistan marked with a six times-increase in development budget as indicated by a recent WHO study. This enhancement is an attempt to achieve targets related to poverty reduction and Millennium Development Goals (MDGs).

18th Amendment, devolution and financing of healthcare Health sector is in transition in the wake of recently introduced devolution. Two years back, the Constitution (18th Amendment) Act 2010 was passed in the

FISCAL REVIEW 2012 / September 24, 2012

parliament that abolished the Concurrent List of the Constitution. Thus the subject of health was placed under the control of provinces except for few functions remaining on the Federal Legislative List. Apart from other functions the nine vertical/preventive health programs have been devolved to provinces. These programs include population welfare; maternal neonatal & child health; Family Planning & Primary Healthcare (LHWs); Expanded Program on Immunization; Hepatitis; Blindness; HIV & AIDS; Tuberculosis; Malaria; and Avian Influenza. The Council of Common Interest (CCI) has decided to continue funding these provincial programs at the level of 2010-11 budgeted level through federal Public Sector Development Program (PSDP) during the currency of NFC Award till 2014-15. In this regard, the federal government has allocated more than Rs21 billion to fund the above mentioned programs during FY13. The provinces and donor funding shall chip in so as to narrow down the financing gap.

areas but, a comparison against Millennium Development Goals, the country is still lagging behind by a long way. In the backdrop of broader socio-economic context; health expenditures by public and

HEALTH EXPENDITURE AS A % OF GDP

sedentary life style, lack of physical activity, and the lack of proper housing. These social determinants need to be addressed.

(%) 0.8 0.7

Second, the data mentioned in this article illustrates that the health sector lacks risk pooling mechanisms. Consequently one of

0.72 0.59

0.6

0.58

0.57

0.5

0.51

0.57

0.56

0.54

TABLE 1: SELECTED HEALTH & POPULATION INDICATORS – TRENDS

0.4 0.3

0.23

0.2

0.27

0.1 0

FY01

FY02

FY03

FY04 FY05

FY06

FY07

FY08 FY09 FY10

FY11

FY12

Source: Economic Survey 2011-12

In this regard, data pertaining to health related Annual Development Plans (ADPs) of provinces for the last three years under pre and post devolution scenario reveal that there is increase in funding during current fiscal year as compared to pre-devolution year; FY11 – though in most of the provinces the raise is incremental.

decisions, which are sensitive to broader health inequities. A healthcare financing strategy may be devised so that risk pooling mechanisms redirect out-of-pocket expenditures which will have poverty reduction effect. Governance and accountability measures may be

private sector and corresponding health status of the population indicate the need to identify and address fundamental policy issues in the health sector.

Policy Reforms

World Health Organization had recommended that developing countries The province of Punjab has allocated should spend 2 percent of GDP on health Rs16.5 billion during FY12 compared to by 2007. Pakistan needs to work on Rs14.5 billion in FY11. Khyber Pakhtunkhwa alternative resource mobilization so as to has allocated Rs7.5 billion during the enhance spending on health. In addition, it current fiscal year as compared to Rs6.5 is imperative to spend scarce resources billion in the previous fiscal. Similarly, Sindh more efficiently and effectively by has increased its allocation from Rs3.7 streamlining disbursements, effective billion to Rs11 billion, over the same period utilization, transparency and accountability while Balochistan rose from Rs0.83 billion for results. to Rs1.1 billion. Keeping in view the limited funding in the Collectively, federal and provincial health sector, the impact of other social governments have allocated Rs57.3 billion sectors on health cannot be in health sector during the outgoing fiscal. underestimated. For instance, much of the health issues lie outside health sector i.e. Though, implications of devolution are yet poverty, illiteracy, environmental pollution, to be assessed, Pakistan’s selected health lack of safe drinking water and sanitation, indicators show improvement in some road traffic injuries, food preferences,

FISCAL REVIEW 2012 / September 24, 2012

Indicators

1990

2000

Current

MDGs ( 2015)

Human Development Index (HDI)

145

Infant Mortality Rate

102

63.26

Maternal Mortality Ratio

533

350

276

140

Contraceptive Prevalence

11.8

Skilled Birth Attendants coverage (%)

18.8

>90

Immunization (%)

51*

>90

Source: PDHS 2007; Pakistan’s Economic Survey; MDGs Report 2010; PSLM 2004-05; *PDHS 1990-91: 35.1%

the contributing factors of poverty is catastrophic illnesses forcing people to sell their assets and spend out of savings thus, pushing them into poverty. Thirdly, 18th amendment has introduced a policy shift in the health sector. The Ministry of Health was abolished and health programs transferred to provinces. The residual health functions at federal level are spread into seven federal ministries. There is a need for a ‘coordinated mechanism’ between those divisions so that functions at Federal Legislative List are adequately addressed and streamlined. In conclusion, health sector reforms are the need of the hour in terms of social policy

strengthened mainly coordinating functions at the federal level pertaining to the Federal Legislative List.

The author is Advisor on Health to the Planning Commission. He has contributed to health reforms in various capacities in the public and private sectors. He can be reached at: taliblashari@gmail.com

Page 29

Challenges of a largely uneducated society By Heman D. Lohano Education sector plays a vital role in the development of any economy. Improving the education sector not only increases the efficiency in producing goods and services, but also solves the problem of poverty in the country. A market benefit of education is a higher income level due to increased labor productivity. Studies on the earnings of education have shown that income increases by 2.7 percent with every additional year of primary school education and by 4 percent with every additional year of secondary school education in Pakistan. Non-market benefits include better personal health, expanded capacity to enjoy leisure, increased efficiency in job search and other personal choices. There are also social benefits of education due to spillover effects. These include enhanced productivity of co-workers, awareness of adopting slower population growth, alleviation of environmental stress, crime reduction and so forth.

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Low literacy rate and low school enrollment rate have always remained an issue of concern in Pakistan. According to Pakistan Social and Living Standards Measurement Survey (PSLM) 2010-11, the literacy rate of population aged 10 years and above is 58 percent, net enrollment rate at the primary level (age 5-9) is 57 percent, and net enrollment rate at the primary level (age 6-10) is 66 percent. Government has been taking several initiatives and efforts to achieve higher levels of enrollment in primary schools; however the required levels and targets are yet to be achieved. Government power and administration has been devolved under the Local Government Ordinance 2001.

TABLE 1: EDUCATION STATUS IN 2010-11 Urban male Literacy rate 81 Net enrollment rate (5-9 years) 67 Net enrollment rate (6-10 years) 78 Highest rank district: Chakwal (Net enrollment rate 6-10 years) 91 Lowest rank district (Net enrollment rate 6-10 years) 71

Urban female 67 65 75

Rural male 63 57 68

Rural female 35 48 56

Overall 58 56 66

Source: PSLM 2010-11

FISCAL REVIEW 2012 / September 24, 2012

The objective of devolution is to improve the performance of education sector and other social services delivery through participatory approach of planning, executing and monitoring. Recently, the government has formulated National Education Policy 2009 to uplift the education sector in Pakistan. Government of Pakistan is signatory to the Dakar Framework for Action for moving the ‘Education for All’ agenda. One of the objectives of this framework is to achieve Universal Primary Education (UPE) by the year 2015, which is also established in the Millennium Development Goals of the United Nations. Following the federal government policy, the provincial governments and other administrative units have also launched a program of ‘Education for All’ for achieving the goal of universal and free primary education by 2015. Universal primary education has also been underscored in Pakistan’s Vision 2030 document (2007) with targets of achieving 100 percent net enrollment rate at the primary level by 2015, along with 100 percent net enrollment rate at the secondary level by 2030.

The major challenge in achieving universal education is the disparity in the education status between urban and rural, male and female, across provinces, and even across districts. As mentioned above, the overall literacy rate in Pakistan is 58 percent. However, the literacy rate is only 35 percent in rural females and 81 percent in urban males (Table 1). Similarly, there is disparity in the enrollment rate. Much more serious challenge is the disparity in the enrollment rates across districts of Pakistan. In 2010-11, the enrollment rate at the primary level (6-10) was only 14 percent in Dera Bugti district in Balochistan, and 90 percent in Chakwal district in Punjab. The enrollment rate in rural female was only 2 percent in Dera Bugti (Table 1). There are many other rural districts with less than 10 percent enrollment rates among females, which are Laralai, Musa Khel and Barkhan. The target of 100 percent net enrollment rate at primary levels means that it is 100 percent everywhere including urban and rural areas, male and female, in all districts including Dera Bugti. In addition to the issues of low enrollment rates and high disparity, the other issues are high drop-out rates, low quality of

FISCAL REVIEW 2012 / September 24, 2012

education, absence of teachers employed in the government schools, and many others. Now the questions are: Can we achieve the target of 100 percent net enrollment rate at primary level everywhere in Pakistan by 2015 or even 2030, which has been envisioned for 100 percent net enrollment rate not only at primary level but also at secondary school level in the Vision 2030 document? What strategies are required to achieve this target as soon as possible? Given the current status, it is impossible to achieve this target by 2015. In view of the disparity of education status highlighted above, it is very difficult to achieve this target of 100 percent net enrollment rate at primary level by 2030. The PSLM surveys indicate that the overall net enrollment rate at primary level (6-10) increased from 60 percent in 2004-05 to 66 percent in 2010-11. This indicates that the average enrollment rate has increased annually by only 1 percentage point during this period. If we continue to make the progress at the same pace, the target of 100 percent enrollment at primary level would be much farther. To meet the targets of education status, the Vision 2030 document planned to increase public expenditure on education and skills from 2.7 percent of GDP in 2007 to 5

percent in 2010 and at least 7 percent by 2015. The records show that the current year budget allocated to education misses this benchmark. So, the first strategy will be to increase the share of education in the budget to support more school enrollment. Secondly, the government should aim to reduce the disparity by focusing on the areas with relatively low enrollment. The government should allocate more resources for the areas with low enrollment rates. Achieving the Universal Primary Education requires a lot of efforts not only from federal, provincial and local governments but also from local people, civil society, NGOs, and media.

Dr. Heman D. Lohano is Associate Professor of Economics at the Institute of Business Administration, Karachi. He has Ph.D. from the Department of Applied Economics, University of Minnesota, Twin Cities, USA. He can be reached at: hlohano@iba.edu.pk

Page 31

Youth Unemployment: A Ticking Time Bomb By Sidra Farrukh

A crisis around the Globe A well paying job or a lucrative business and a secured future seem a distant dream for many as the world is at the brink of tipping into another trough. Youth unemployment, usually higher than the adult unemployment and defined for the age bracket 15-24 by ILO, has reached a staggering height all around the world. Globally, the unemployment rate amongst the youth has remained high at 12.6 percent in CY11 as per ILO data, steeply rising after the economic crisis of 2008. Fiscal retrenchment in the Euro zone and slowing global economy are adding to the headwinds. Developed countries and especially the European Union have witnessed the bluntest rise in youth unemployment rates since the global financial crisis 2008. Though regional differences linger, the entire world, including the emerging economies, is facing the challenge of youth employment. With the bursting population and increasing poverty incidence in the country, Pakistanâ&#x20AC;&#x2122;s biggest asset, youth, has become a stark reality not only because of the global recessionary pressures but also its endogenous factors.

Ailing Education System and Labor Market No prizes for guessing that the ailing educational system is a core reason for the smothering employment status, be it youth or adult population. In the light of what is

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happening around the emerging world, the younger population in Pakistan is not only the victim of structural unemployment but has also surrendered to underemployment. The lack of educational facilities especially in the rural areas has been a lingering problem for decades along with minimal access to quality primary and higher education. Skill development has been insufficient, and it does not go without saying that the 15-24 aged youth population is gradually losing direction. An important youth specific challenge is the jittery transition from education to work. This delay in switching from school to labor market has left many young people looking for temporary and part-time contractual employment in the informal sector. Though these jobs do provide them some financial support, many of these jobs are usually underpaid with no job security. The most striking issue within the realm of youth employment especially in the urban centres emerging from the jagged transition, is the incidence of higher unemployment for youth with decent education versus those with little or no schooling at all. Career opportunities in the formal sector are up the creek as the domestic job market is scarred deeply by the fiscal woes of in the country. With around 60 percent of youth population in the rural areas, the severity of the issue is different there. People living in poverty struck areas, like those of Balochistan and interior Sindh, have been working in miserable conditions

as they are left with no choice. Furthermore, the work ethic is informal, agricultural, family owned and rigid which allows no room for development. Injurious to its core, the lack of social protection beleaguers the future of this susceptible generation. With majority of the employed youth in the informal sector, the current state of employment refuses to provide entitlements such as social security, pensions, health insurance, provident funds and other social protection measures.

Divergent Youth Participation An issue that has attracted international attention is the wide schism between the participation rates of young males and females. Although the participation of the youth in the labor market has improved and is higher than the adult population, gender disparity is a red herring. On the other hand, male participation is quite higher than female participation in the labour market, when compared to the world and the region. Disbanding the literacy rates gender-wise, it is not astounding that the women in Pakistan are the victim of cultural blockade. Furthermore, pervasive poverty is a consequence of low labor participation rates by women to some extent, as majority of the working women are generally in the informal markets, earning very little to break the vicious cycle of poverty.

FISCAL REVIEW 2012 / September 24, 2012

PROVINCE WISE YOUTH EMPLOYMENT TO POPULATION RATIO Punjab

Sindh

KPK

Balochistan

45% 40% 35%

Career opportunities are up the creek as the domestic job market is scarred deeply by the fiscal woes of in the country. Labor market and educational reforms are definitely the most essential ways of defusing the demographic time bomb.

30% 25% FY06

FY07

FY08

FY09

FY10

FY11

Source: PBS

Female

In the medium to long term, the melancholic situation weighs heavy on the mental health and future of this rightly called ‘lost generation’. With bleak prospects for future employability and wages, many educated and affluent leave the country in search of better jobs.

% 100

A turnaround much needed Youth employment challenges might look manageable on the onset, but long periods of unstable employment and unemployment have serious consequences on the social stability in the long term.

Sri Lanka

Pakistan

Bangladesh

India

Iran

Source: EFA Global Monitoring Report 2011, UNESCO

YOUTH EMPLOYMENT AND VULNERABILITY Employment to Population

Vulnerable Employment (RHS)

43%

62%

42%

61%

41%

60%

40%

59%

39%

58%

38%

Like many of the developing countries in South Asia, the youth in Pakistan has been inflicted with poverty, hunger, illiteracy and unemployment. These distraught conditions lead them into negative activities, wearing down the society. In the short term, the widespread youth unemployment as well as underemployment do not only increase social evils like drug addiction, crime rates and youth felony but also pressurize government budget.

PAKISTAN'S GENDER DISPARITY IN YOUTH LITERACY LARGEST IN THE REGION Male

The Social and Economic Cost

FY06

FY07

FY08

FY09

FY10

Source: PBS

FISCAL REVIEW 2012 / September 24, 2012

FY11

57%

The macro level threat of youth unemployment in shape of social disintegration calls for policies targeted at 15-24 aged young generation. On the whole, the idea should not be restricted to encouraging new avenues for employability; improving the existing structure to wipe out unemployment amongst the blossoming younger generation and assuaging the vulnerable employment should be on the cards too. However, a privation of institutional framework is one stumbling block. Though the issue is a top priority on the country’s UN Millennium Development Goals, the efforts seem to lag behind. In its endeavour to address the barriers to job growth, the government has commenced Benazir Bhutto Youth Development Program, monthly stipend with training and credit young people and entrepreneurs respectively.

Other organizations have also extended efforts in promoting skill development, but what remains completely unattended is the For a country like Pakistan, labor market and educational reforms are definitely the most essential unavailability of social protection, job-skill departure and policy initiative. ways of defusing the demographic time bomb. Side by side, stirring up the private sector and Finally, the resolution of the ongoing energy government support are also of core importance. crisis, which has emerged as a massive threat to the labor market in recent times, and has already For an overhaul from the grass root level, the brought the economic activity to a halt, should be issue needs to be attended at a macro level by on the priority list. With a government spending addressing the educational system in the of only 2-3 percent of GNP on education, sadly country. Investment in human capital through the youth employment is high and dry! formal and informal education and smoothing out the education to labor market transition can go long way. At micro level, mandatory career counseling and mentoring at the universities, and targeted vocational and skill development could jump start the stalled youth activity. Nevertheless, job creation needs to be broad-based and investment should encourage new and better job creation. The opportunities should purge any gender, location, religious or social divide. Especially, the government needs to prop up women education, job and entrepreneurship prospects as gender disparity in youth literacy and labor participation in Pakistan exceeds that of other countries in the South Asia region.

The writer is Research Analyst at BR Research. She can be reached at sidra03@gmail.com

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Separation of commercial interest and regulatory role at KSE is our immediate priority Muhammad Ali Ghulam Muhammad, Chairman, SECP Muhammad, appointed Chairman of the SECP in December 2010, has an extensive and diversified corporate and financial markets experience spread over 20 years. An MBA from the Institute of Business Administration (IBA), Ali started his career with Citibank and moved on to Smith New Court Securities in London. In 1994, Ali finalised a joint venture with Indosuez W.I. Carr Securities (Asian brokerage arm of Credit Agricole Indosuez) and led Indosuez W. I. Carr Securities, Pakistan for six years. He also served as Country Manager for Elixir Securities Pakistan (Pvt.) Ltd for over two years. Mr. Ali has served as a Director on the Boards of reputable companies like Engro Corporation Limited, Karachi Stock Exchange (Guarantee) Limited, Dawood Bank limited amongst others. BR Research: What have been the main priorities of the Security and Exchange Commission of Pakistan, over the past one year? Mohammad Ali: There have been many internal and external challenges and opportunities that have been in our cross hair over this time. Chief among these are stock market reforms, including Capital Gains Tax (CGT) and demutualization; debt market and efforts to stir capital formation.

reasons. Firstly, there are already other alternatives where black money can be whitened, against the payment of one or two percent. Secondly, eluding CGT requires an investor to hold their portfolio for at least four months. Volumes have still not reached satisfactory levels, however we are on course to achieve demutualization, this year. The Demutualization Bill will completely change the way our capital markets function as brokers and members will cease to have control over the stock exchanges. The biggest challenge shall be finding the right investor for the exchange.

of the exchange to a strategic investor is concerned, we shall execute that when the right opportunity presents itself to all stakeholders.

The Demutualization Bill will completely change the way our capital markets function as brokers and members will cease to have control over the stock exchanges.

The separation of ownership and management, and separation of commercial interest and regulatory role are more immediate targets for us. The Ideally we should get an international stock emergence of independent management, which has already commenced, shall exchange of good repute, significant size differentiate the commercial interests of the and adequate expertise to invest in Pakistan. Such an entity would also be able exchange and its responsibilities as the front line regulator. to perform the role of an effective front line regulator, something that has been missing Developing the debt market requires in the existing model. Now that these reforms have been collaboration with the State Bank of promulgated, we expect the government to Pakistan and the Ministry of Finance. We Demutualization of the stock exchanges receive a higher tally from this avenue as have laid some ground work, including the will firstly, bring in a strategic investor and compared to last year. Some critics have preparation of a regulatory framework and secondly, change the structure of the dubbed these reforms as a ‘whitening setting up a bond pricing agency. Right bourses. Among these, as far as the sale scheme’, but that is inaccurate for two Activity at the stock exchanges had plunged previously and contentions over Capital Gains Tax (CGT) had swelled to the level of a crisis. So in the past 18 months or so, we held regular deliberations with all key stakeholders to implement CGT in a form that would bring substantial contributions to the government without stifling volumes at the capital market.

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now MUFAP is performing this role, but we believe that an independent body will bring more credibility to this market. We also need many more derivatives products and

leverage tools. We are also working on introducing online trading across the market, and link it to mobile telephony. The possibility of integrating the three stock exchanges also warrants attention. BRR: Despite negative real returns on deposits, majority of the people continue to prefer banks over asset management companies. What are the factors behind this, and what role is SECP playing in generating vibrancy among the NBFIs? MA: If an individual is offered a rate of six percent for depositing money in a bank, and a rate of 11 percent for depositing money in

FISCAL REVIEW 2012 / September 24, 2012

Sooner or later we will have to rationalize tax rates for the corporate sector in line with the levels charged on other forms of businesses.

a mutual fund, a rational investor would be expected to choose the latter. Also consider the fact that most banks are currently parking their funds in treasury bills, just like the Asset Management Companies (AMCs), so the risk profile is also similar between the two options available to individual savers. The real difference is in the perceptions towards banks and AMCs because the former are perceived to be less risky. AMCs have to build their brands so that confidence among the people improves. Secondly, AMCs do not have the distribution network, so we are working on ways to incentivize these firms to expand their branch presence. This sector will not be able to take off unless they expand the number of branches significantly. In a number of other countries, commercial banks are not allowed to indulge in investment banking activities so that there are more players in the market. In Pakistan, we face the same choice. If we continue with the status quo, 20 years down the line there will only be banks dominating all segments of financial markets. On the other hand, we can go into a regime that encourages non-banking companies to enter the market. In my opinion, we have to take the second route so that the systemic risk can be spread out and competition enhanced for the betterment of consumers. Coordination between regulators is necessary for such reforms. Right now we have a bilateral coordination committee each, with the central bank and FBR. We need a multilateral platform where all financial and corporate regulators as well as the Ministry of Finance can together look at the bigger picture. SECP, SBP, FBR and MoF can together address existing and emerging challenges much more effectively, if such a forum exists. BRR: Private sector borrowing is at dismal levels, new businesses are not emerging at a mentionable rate and hardly any new corporate entities are being registered. What is SECP doing to alleviate these problems? MA: Encouraging capital formation is contingent on the overall financial landscape of the country. The reality is that people are only keeping money in banks despite earning negative returns. And the banks are largely satisfied with parking these proceeds in Treasury bills instead of lending to the private sector for growth and expansion of businesses. That is in itself discouraging fresh investments.

A lot of creativity and entrepreneurship is being killed because the Small and Medium Enterprises (SMEs) are not able to access financing from the banks or the capital markets. If we wish to achieve sustainable economic growth, we must develop and bolster the environment for entrepreneurs to be able to make money. With this realization, we have commenced work on a Small and Medium Enterprise Exchange that would allow startups and other companies of relatively smaller size to reach out directly to potential investors and get the funding necessary to take their businesses to the next level. However, encouraging capital formation and economic growth requires a holistic approach from economic managers. Another key area is documentation of the economy. For the past five decades, we have been attempting to do this through taxation. Clearly, that has failed. The first step would be to document all businesses; right now only 60,000 companies out of about 3 million businesses are registered. If we continue with higher tax rates for corporate, entities along with audit requirements, corporate governance requirements, etc there will be no incentive for businesses to corporatize. Sooner or later we will have to rationalize tax rates for the corporate sector in line with the levels charged on other forms of businesses. The SECP has already forwarded recommendations to this end to the FBR and, it is a possibility that cannot be avoided, ad infinitum. Real Estate Investment Trusts Another major change that you will see in the next 12 months shall come in the regime for Real Estate Investment Trusts (REITs). The current regime is restrictive: the minimum fund size requirement is Rs2 billion, and one has to have a property in advance to be able to establish a REIT. These clauses defeat the entire purpose of setting up such trusts.

FISCAL REVIEW 2012 / September 24, 2012

The purpose behind introducing REITs was so that capital could flow towards real estate development in the economy. The Trust should facilitate buyers to buy into a fund, which is professionally managed and geared towards quality real estate development. We intend to lower the fund size requirement soon and the reforms will hopefully, spur the blossoming of these ventures. The quality of housing and of real estate development will improve dramatically as a consequence. Best professionals will be better paired with the enabling capital. SECP is working with multilateral agencies to develop micro insurance which will provide the supporting infrastructure for robust relationship between new home buyers and REITs.

Tax reform The implementation of Capital Gains Tax did not address the stated focus of expanding the tax net. It was simply an attempt to boost government revenues; which was not very effective. If one part of the financial sector is taxed and the others are not; money will simply flow out of that sector and into other markets. Thatâ&#x20AC;&#x2122;s exactly what happened at the stock exchanges in the aftermath of CGT. The local stock market had at one point in time become the most liquid market in Asia. But in three years, it dropped to the bottom of the list. On the other hand, over the next two years, no investor will be able to avoid CGT and every transaction will be documented. In this time, one major section of the economy will be fully documented. We need to think of similar measures in other sectors. The prevalent presumptive tax regime presents a reality where a vast majority of businesses are not paying taxes based on their earnings, but rather on certain minimum benchmarks or on turnover. The blind eye turned to documentation over decades must change; but an overnight shift will be painful

for the capital markets and for any other sector where these principles have never been established. The change required now is fundamental to the core of the way businesses work in Pakistan.

SME Exchange We need a market place where anyone with a viable business proposition can go and generate the necessary capital for that business. At the same time, we need to protect the public at large, the investors. We are lacking a market place which enables entrepreneurial spirit; that is the void an exchange for SMEs will fill. The stock exchanges have an important role to play here, in terms of marketing and investor education. The SECP has to get together all the stakeholders including the stock exchanges, policymakers, investors and SMEs; that is what we are working towards. Such an exchange must also be able to cater customized solutions for specific sectors or types of ventures. Consider the example of the IT sector; the West took decades to develop private equity funds and markets that could support entrepreneurial ventures in this sector. We donâ&#x20AC;&#x2122;t have the luxury of waiting that long. Businesses with higher risk levels require the participation of sophisticated investors. We are looking at profiling businesses based on type and risk. For example an IT startup may be relatively high risk. Based on these criteria, the regulator defines which types of investors can invest in the business. This will ensure that ordinary investors are not placing bets on risky propositions; rather specialized and professional institutions are assessing investment based on expertise.

BRR Interview by Ali Khizar

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circumstances? We are not culturally linking up with the rest of the world.

Media does not have any space for economic reforms Dr. Nadeem ul Haque Dr. Nadeem ul Haque, Deputy Chairman, Planning Commission, is a well-known Pakistani economist with extensive experience in the international policy and research environment. In a 27-year career at the IMF, he served as Advisor in the Research Department and the IMF Institute and also as IMF Resident Representative in Sri Lanka and Egypt. He has also worked at the World Bank and International Food Policy Research Institute (IFPRI). Dr. Haque has also contributed signiﬁcantly to economic policymaking and research in Pakistan, including in his roles as Trade Policy Advisor to Federal Minister of Commerce and as Vice Chancellor of Pakistan Institute of Development Economics.

BR Research: It has been over a year since the New Growth Strategy was approved by the NEC, yet there has been no action on its policy recommendations. Why is that so? Dr. Nadeem Ul Haque: There are some issues at work here. The country as a whole has no stomach for reforms. The preoccupation with politics and international relations has barely left any appetite for economic reforms. Remember, the political system always follows the civil society, but the Pakistani civil society is not prepared to discuss and campaign for economic reforms. Media – which ought to have space for intellectual discourse – also does not have any space for economic reforms. So the country as a whole is not ready. The political system is often blamed for inaction, but the political system is a mere reflection of the civil society.

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More alarmingly, for the past number of decades, rather than move towards globalization, we are moving away from globalization. The economic factors want us to go global, but the civil society wants to take us away from globalization. I am talking not just about the fundamentalists – even otherwise, all of us want us to have this ethos of being separate, of being distinct and unique; of being outside the global economy. BRR: What other things are holding us back from integrating with the global economy? NH: Our infrastructure is also anti-globalization. International airlines coming to Pakistan are few and far between. Very few foreign tourists visit Pakistan now. Foreign investment has fallen so low. How can outside cultures arrive here and mix with the local culture in such

We need to understand that globalization is about cities – not about rural areas. It is as much about software as hardware. Bangladesh and Sri Lanka have recognized that they are small countries with no strategic influences. And that is why they have realised that they must go ahead and seek economic development. Sri Lanka had a civil war – it took a tough decision and somehow managed it – but they have made their minds on economic development. They are yet to get their politics and civil society right – just like Pakistan – but they are a little bit better than us in terms of economic reforms agenda. That’s because these countries, including India, have a global mindset. BRR: What kind of a policy framework can pull the country out of this so-called anti-global mindset? NH: That is essentially what we have highlighted in the New Growth Strategy. We have got to change our mindset on different things. Firstly, the role of cities needs to be understood. We do not have the ‘real’ cities in our country, and we need to accept that. The characteristics of a city are different – what we have here is mere large agglomeration of people. Density in the city center, clear definition of a dense downtown, high rise, mixed use, walkability, rise of the creative class: these features define modern cities. If we allow these conditions to be created, we will be able to develop a global creative class. Ultimately, globalization is all about linking up of the creative global class – and this happens in dense, walkable, high rise cities. And yet we are still busy building flyovers, but uninterested in building cities. Besides, the state is the occupant on major chunks of lands in urban areas, which does not allow the middle class to develop. There are not many public places where one can interact in a creative way, not many areas where one can house a business in. Secondly, the markets need to be made vibrant and competitive. The industrial sectors are virtually living on SROs and concessions, and the protection culture is very much prevalent. These industries must become competitive, but rent-seeking does not let that happen. Our industries are still in their infancy after six decades, due to protection. How can there be globalization when these industries don’t want competition, when there are many SROs for so many sectors. Virtually every industry is protected, and there is negligible concern for consumer – the ultimate stakeholder. Lobbies are very

powerful, and governments are not independent of them – not in Washington and not in Islamabad. BRR: So, will it remain business as usual? NH: There is a tendency in every system to co-opt. There are moments of change, events that lead to it, but change cannot happen as an isolated incident. Change cannot be decreed; even Kings in the past have failed. I have no alarming predictions of change – it will be more of the same. Societies don’t flip on a dime – they keep doing something until they reach a tipping point. But our tipping point is not in sight yet, so I think we’ll continue to muddle along. Societies have not always lived with a strong sense of and reliance on states, as it was only in the 20th century that the concept of state first emerged. So, people do not care about a failed or failing state, they survive somehow. It is time that we ask ourselves some tough questions, too, as the state is not responsible for all that’s wrong. There is a large segment of society that does not want to change. For instance, we cannot grow unless we allow women to work. BRR: Pakistan’s economy has been in the low-growth, high-inflation phase for the past four years. But some areas are picking up, due to the phenomenon of consumer-based growth. What sort of growth profile do you see in the coming years? NH: There is nothing wrong with consumer-based economic growth. Yet the growth is constrained, below the natural growth rate of five percent, due to over-regulated economy and large, protected industrial sectors. There is not enough market competition going on and barriers to entry abound. We need to deregulate the economy strongly and stop protecting the incumbents. Business is as much about birth as death, just like life, so the business sectors should be allowed to develop on their own. The role of cities is again important here. Proper building and zoning regulations can allow for construction industry to jump start other allied industries. We need to clear our market space, and focus on productivity as well. The macroeconomic indicators are fine. Barring large external shocks, we are going to be alright. We may not be way out of the woods, but we are not in a lot of trouble either. We are in the middle. We could do a lot better, but we do not have the ability to do it yet.

Interview by Ali Khizar

BRR & Hammad Haider

FISCAL REVIEW 2012 / September 24, 2012

Liberlized trade to expand markets, improve lives

Indi

deization l Tra era Lib

By Javeria Ansar Pak-India Trade: Suiting Up to Get Rained On?

demonstrated how a trade barrier relaxation could benefit both countries by the way of lowering transport and communication costs.

For a nation like Pakistan, which faces immense economic challenges in the form of back breaking energy crises, political infirmity and a rising populace of youth going the way of unemployment, regional trade represents a cornucopia of rich possibilities.

A study by the State Bank of Pakistan similarly noted that the accordance of the MFN status to India could mean a five-fold increase in bilateral trade and would allow for transfer of technology, lowering domestic prices and providing manufacturers with economies of scales as the “effective market size expands”.

But despite the fact that both economic theory and empirical evidence have marked a clear link between regional trade and its ability to foster economic growth within regional partners, Pakistan and India have long remained at odds with each other, unable-or rather uninterested in enjoying the proverbial low-hanging fruits of economic cooperation. A report prepared by the World Economic Forum indicates that the South Asia still remains one of the “least integrated” regions in the world- both from a political and economic perspective- which means that businesses within this region do not have access to economic opportunities that the more integrated parts of the world have. And in spite of the existence of legal framework for trade in place through the South Asian Association for Regional Cooperation (SAARC) and the South Asian Free Trade Agreement (SAFTA), trade barriers between the two neighboring giants continue to hover like a cloud of bad omen over the prospects of economic cooperation within the region.

India: The Bane of our existence?

And it is not just the industry that is likely to benefit from an improved trade relation with India. Research indicates that trade lead growth is beneficial for a wide sector of a country’s economic stakeholders; effecting both the large players and the bottom feeders. Implications of improved regional cooperation Multiple researches studying the impact of regional trade between India and Pakistan calculate that the granting of the MFN status to India and the dismantling of the tariff and non-tariff barriers could mean that the bilateral trade between the two neighbors- which is estimated to be around the $2 billion mark as of 2011could easily jump to $8 to $10 billion annually. Trade harmonization within the region would open the gates for joint ventures within a number of industries including pharmaceutical, Information technology, automotives and petro-chemicals, facilitating technology transfer within the businesses. Moreover there is a great potential within Pakistan to export its specialized products across the border, gaining a very large market.

Not only that, bilateral trade liberalization spells big bucks for the well-settled Pakistani manufacturers who will have access to the Indian middle class which comprises of roughly 300 million people having purchasing power which rivals that of the middle income group belonging to countries from southeastern Europe. Former Governor State Bank, Dr Ishrat Husain, on the Public discourse on the Pakistan- India trade is laced prospects and challenges for the Pak-India trade notes with myths and misconceptions, with a majority of that even a 10 percent penetration into the Indian middle people questioning whether this expansion will be actually conducive to any growth this side of the border class market would easily double the market size for or whether it would simply allow India to smother what is Pakistani firms. left of our industry. However, credible research on the The break through therefore, that came with Pakistan’s subject has earmarked an implicit impact of trade accordance of the MFN status to India is likely to do improvement with India on Pakistan’s economy. more good than bad in the long run and is, according to the general consensus among economic experts, likely A study carried out by the Indian Council for Research to be a win-win situation. on International Economic Relations (ICRIER) has A relatively straight forward concept, the “Illusion of Truth Effect” states that a person is more likely to believe in a familiar statement than an unfamiliar one. And we in Pakistan like to stick to our beliefs, no matter how outmoded or contrary to empirical evidence they might be.

FISCAL REVIEW 2012 / September 24, 2012

Liberalization and Industry concerns Understandably enough, some factions within our Industry which have long been allowed to prosper under protectionist regimes have a certain level of trepidation where trade with our next-door neighbors is concerned. A paper presented by Dr. Ishrat Husain at the Woodrow Wilson Centre Conference on Pakistan-India Trade at Washington, D.C. in April 2012, makes note of some of the concerns that majority of Pakistani business men had when asked about the Pak India trade. It highlights multiple issues including excessively stringent licensing requirements from the Bureau of Indian Standards, restrictive visa requirements, lengthy certification procedures and transit restrictions that are likely to hamper flow of produce from Pakistan. Moreover, a number of sectors including the pharmaceutical manufacturers have trepidations related to the competition their relatively pricier products are going to have against those that come from across the border. Backed by economies of scale and lower costs of productions due to easier access to raw material, a number of industrial concerns believe that Indian products are much likely to have an unfair advantage from the onset. It would also be in India’s long term interest to invest in establishing healthier relationships with Pakistan. Similarly, it is essential for Pakistani producers to realize that in the short-term there are going to be some losers and some winners as a result of the trade augmentation within the region, but the medium and long term benefits of trade liberalization in the region will be undeniably bountiful.

The writer is Research Analyst at BR Research. She can be reached at javeriaansar08@gmail.com

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Cyclical Bilateral Relations By Salman Zaidi The official dialogue between India and Pakistan has stacked up an impressive list of achievements ever since talks resumed back in February 2011. There have been major breakthroughs in trade and commerce, a new bilateral visa regime ready for implementing, very frequent secretary-level talks that have addressed strategic issues, in addition to progress on other fronts. No doubt there has been a subtle shift in the bilateral conversation towards cooperation, more likely to endure than become hostage to another 26/11 like terrorist attack that derails the present momentum. But while it is important to recognize how the Indo-Pak dynamic is changing, it may be wise not to pin too many hopes on bilateral policy change in the near future. We may just be approaching the end of a lucky cycle in Indo-Pak relations.

Cautious Optimism In the two years that followed the terrorist bombings of 26/11 in Mumbai; India and Pakistan had minimal official contact. The Composite Dialogue had been shelved and bilateral distrust was at an all time high. It took painstaking Track 2 efforts during this time to keep channels of dialogue open between India and Pakistan and to address the concerns emanating from both countries. Track 2 not only kept the Composite Dialogue alive, it shored up political will on both sides to restore the official track and created a wealth of policy options for resolving outstanding issues. Many of the positive developments witnessed since February 2011 are the result of Track 2 initiatives undertaken in India, Pakistan or ‘neutral locations’ elsewhere. Some of these initiatives have deliberately been low key, aiming to bring together interlocutors from political, military and diplomatic backgrounds to discuss strategic security issues. Other initiatives have taken a more public approach by engaging the media and other diverse actors who can come to bear on policymaking. Both approaches have worked well and created a growing cohort of peace-builders, as well as interest in policy change. In recent months Track 2 has been able to diversify the set menu of bilateral issues, owing to progress in the official dialogue, by including new subjects like public healthcare and higher education as areas of potential cooperation.

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On the security front, the future of Afghanistan has sparked intense debate and is the most contentious subject in these dialogues, followed by the question of water sharing between India and Pakistan. Siachen has new relevance due to the tragic incident in Giyari earlier this year and the internal dynamics of Kashmir determine the current debate on that subject. With regard to trade and commerce, there are now attempts to identify industrial sectors that can integrate, where and how. Pakistan’s decision to grant the MFN to India and the liberalized visa regime go hand in hand. Trade will certainly contribute towards normalizing ties and hopefully create a sequence for resolution of other issues; however, one reason for cooperation on trade is that it has never been a contentious bilateral issue. While there may be some ideological resistance in Pakistan to trade with India and vice versa, the overwhelming majority view is in favor of Indo-Pak trade. There is also a much larger constituency of stakeholders that stands to benefit directly from enhanced trade and which played a pivotal role in changing trade related policies. Unlike trade, other issues like Kashmir or the Samjhauta Express investigations are highly politicized, if not outright contentious at the moment. It will take much longer for them to be resolved and for similar policy changes to occur. Track 2 can only proceed with cautious optimism.

traded and mainstream many other products traded illegally or via third countries. Some analysts consider the imposition of the negative list as counter-productive to trade liberalization and the major obstacle in realizing the $10 billion-benchmark over coming months. Meanwhile, stakeholders in Indo-Pak trade have pointed out several other areas of concern at the Track 2 level. For example, the Reserve Bank of India’s blacklisting of Pakistani companies prevents FDI (including portfolio investment) from coming into the country or the lack of common banking facilities; the long standing cellular connectivity problem that hampers communication; PIA being the sole airline flying infrequently between India and Pakistan.

Track 2 engagements have produced a wealth of workable recommendations over the last two years in this regard, including the opening up of all 12 border entry points The Case for for trade as well as the resumption of the Karachi-Mumbai shipping route; consulates Economic Integration reopened where they had been shut down In FY11, Pakistani exports to India were and new ones established in cities that worth $264 million and imports worth have heavy tourism or business related $1743 million; an overall trade relationship traffic; modernizing commercial and of $2 billion according to official statistics. arbitration laws that can facilitate movement Trade through third countries and illegal of skilled labour and goods; strengthening trade combined are worth $5-10 billion, institutional capacity and common bureau as estimated by various studies standards to cater for economic integration; conducted over the last decade. complementarities in the pharmaceutical, telecomm and automobile industries to be The composition of goods traded will also made use of; and joint ventures in change with lower non-tariff barriers, renewable green energy resources, water brought about by the newly signed security and agriculture. Redressal of Trade Grievances Agreement, Mutual Recognition Agreement and Future Expectations Customs Cooperation Agreement. In What will the next six months bring for addition, establishing the integrated check post at Wagha-Attari border has created a Indo-Pak relations? Perhaps some headway on the Mumbai trials, but not greater degree of confidence among much else. One major reason is investors and traders. The adoption of the Pakistan’s internal political transition, negative list regime in March by Pakistan which in the lead up to the election, is will incrementally allow more goods to be

likely to be focused on domestic issues rather than foreign policy on India. This is not to suggest that India does not factor in Pakistan’s internal debates; indeed one must recall the time not too long ago when the rallying cry of Kashmir could sway votes in favor of a political party. Perhaps this is still the case in parts of Pakistan, but common wisdom now demands that good relations with India are necessary. Another reason for slow progress is the bureaucratic delay on both sides. It has been reported that MFN related paperwork will not be complete till late in 2012. Some of this has to do with segments of Pakistan’s business community complaining of short and medium term losses created by the MFN and other issues that merit consideration. However, bureaucratic delay also denotes that progress on common banking or opening up more trade routes, for example will take an indefinite amount of time. Perhaps the one sector likely to open up before others and facilitate trade over the foreseeable future is the telecom industry. How long it will take for trade to pick up pace and what effect it will have on the overall dynamic of Indo-Pak relations is an open question for now. With the official dialogue mired in Mumbai attack investigations, it may very well be that we have approached the end of a very productive cycle. Whatever it will be, the next change in bilateral policy is perhaps a long way off.

The writer works as the Deputy Director of Jinnah Institute. The views expressed in this article are his own. He can be reached at salmanzaidi22@gmail.com

FISCAL REVIEW 2012 / September 24, 2012

FY13: Back to the Fund? By Mobin Nasir The writing is on the wall: Pakistan’s economy is teetering on the edge of a fiscal cliff. Prominent economists, former finance ministers and just about all who keep tabs on the fiscal affairs of the government concur that the GoP shall be knocking on the IMF’s window for support soon. The only debate on the matter concerns the timing of the country’s return to a standby arrangement with the multilateral organization. But Pakistan had entered an arrangement with the Fund as recently as November 2008 and repayments for the same have only just gathered pace. In fact, the GoP has so far made payments worth about $1.3 billion, while the remainder of about $8 billion is to be paid in coming months. While the total repayment schedule stretches to the end of FY15, the installments will peak at about $3.38 billion in FY13. The official foreign exchange reserves held by the State Bank of Pakistan stood at $10.23 billion as of August 24, 2012; having dropped by $2.55 billion since January 01, 2012. With limited prospects of major inflows in the form of aid, investments or payments

But a fresh deal with the IMF cannot be taken for granted. For starters, the current government will not, in all likelihood, want to enter into an arrangement with the Fund for the second time in its tenure for fear of the So, how did we get here? In a word, it was public backlash just before the general elections which are expected around March inaction. That’s right; we got here by doing nothing that we had intended to accomplish 2013. when the country’s economic managers joined heads with IMF officials in a series of The Fund would be unwilling to negotiate meetings that culminated in the form of the with the caretaker government, given the historical precedent set by previous previous standby arrangement. Pakistani governments of ignoring the commitments made by those who came The implementation of Reformed General before them. Sales Tax was aborted in the face of street agitation by traders. Neither any significant So the next government to take office, tax reforms were enacted in the tenure of whenever that may be, will probably have to the outgoing government. Back in March take up the unenviable position of entering 2011, Finance Minister Hafeez Sheikh assured this scribe that RGST and other tax into a fresh deal with the international lender of last resort, soon after taking office. But by reform discussed with the IMF would be that time the government kitty that is already implemented, saying that “the government stretched thin, may be left with a very weak cannot spend a lifetime on developing hand going into these deliberations. consensus for tax reforms”. against expenses incurred in the war against terrorism, the country’s foreign exchange reserves are likely to witness the precipitous decline already seen in recent months.

Yet the entire tenure of the democratically elected government ended without any mentionable increment to the tax base. Tax revenues as a percentage of GDP stood at 9.9 percent, at the end of FY12; barely budging from the 9.4 percent in FY11. Effectively the government failed to broaden the tax base or to narrow the tax gap (difference between what is owed and what is paid by tax payers). But unhindered by the modesty of the resources available to it, the government continued to spend in ‘Mughal-style’, amassing a fiscal deficit which according to the official tally stands at 6.6 percent of GDP. This does not include the Rs391 billion spent on debt consolidation, termed a “one-off” payment by Ministry of Finance, despite the fact that such payments have been made in each of the five fiscal cycles overseen by this government. Five finance ministers, three deputy chairmen of the Planning Commission, four SBP governors, three FBR chairmen; all came and went but the GoP remained on the collision course of looming default. Perhaps the former finance minister Salman Shah said it best when he contended that “a return to the IMF is inevitable, while its timing may be affected by the movement of international oil prices”.

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FISCAL REVIEW 2012 / September 24, 2012

The Fund, which has already been dismayed by the lack of government initiative to bring about much-needed structural changes, is expected to put forth very stringent pre-conditions. If the terms being offered to ailing European economies such as Greece and Spain are any measure of the IMF’s bargaining stand, the incoming government better include a thick-skinned Finance Minister and a team of economic gurus that can deliver where their predecessors have failed. Whenever the inevitability may be realized; one thing is clear. The incoming government will once again inherit a burden of debt and a looming Balance of Payments crisis, just as the outgoing government inherited from the Musharraf regime.

The writer works as Asst Editor-BR Research. He can be reached at mmobinn@gmail.com

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