In the first part of this article (April 30) I summarised the economic challenges that the new government will inherit, suggesting ways to address them particularly in the light of recent global developments on the macroeconomic policy paradigm. I also argued that whether we like it or not, Pakistan has no option but to seek IMF assistance in order to bail the country out. A broad framework to negotiate with the IMF was delineated as well.
The conventional macroeconomic policies advocated by the IMF have always focused on stabilisation in the narrow sense of reducing budget deficit, bringing debt under control and keeping inflation low. The recent experiences of several European countries have forced global leaders to rethink sharp fiscal adjustment and the associated social costs and human sufferings arising out of austerity programmes. They argued for striking a balance between stabilisation and developmental roles of macroeconomic policies as enshrined in the forward-looking macroeconomic policies and well documented ESCAP Survey 2013.
Pakistan is currently facing the problems of deficit, debt, development and growth which are more or less similar to those faced by the European countries. Austerity programmes alone have not worked in Europe, therefore, a balance between stabilisation and development needs to be well articulated by the new government. Addressing long delayed structural issues and strengthening macroeconomic policies must form the key elements of a reform agenda to elicit support from international financial institutions and friendly countries.
A broad-based economic reform agenda must include: i) reforming the tax system and tax administration; ii) expenditure reform; iii) managing fiscal decentralisation; iv) restructuring and privatisation of public sector enterprises (PSEs); v) reforming the energy sector; vi) enacting reforms in the central bank; vii) improving the investment climate and viii) promoting inclusive and sustainable growth.
Tax system and tax administration reforms are vital for getting support from friendly countries. These countries have already made it clear to Pakistan that unless it taxes its rich and powerful, it should not expect any financial support from them. Broadening of the tax base will be the most critical reform under the tax system. Pakistan will have to bring all economic activities under the tax net, which have either remained untaxed or under-taxed. For example, income originating from agriculture has escaped direct taxation thus far. The new government must change that. There are many services that have also remained untaxed or under-taxed, for example, beauty parlours, inter-city bus services, doctors, lawyers, etc which need to be brought under direct tax net.
Improvement in withholding the tax regime will also be a major source of revenue. This is an issue of taxes being collected but not deposited in the government treasury. Bridging the gap between tax collected and tax deposited may generate Rs250-300 billion in three years. Political difficulties may hamper the implementation of full value added tax; therefore the new government may consider credible alternative revenue measures including a modified GST.
Removing ‘manufacturing defects’ of the new NFC Award will be an essential element of the tax system reform. In the presence of the existing NFC Award, no meaningful fiscal policy can be implemented. For three years in a row, the federal budget presented in parliament in June never saw the light of the new fiscal year in July. It has not worked and will never work unless we remove its defects. There are many ways to solve this problem. Pakistan’s tax authorities – the FBR and provincial tax departments – have been weakened to the core. No meaningful tax reforms can be implemented unless we strengthen tax administration through training and instituting the mechanism of reward and punishment. The new government will also have to improve the resource mobilisation efforts of the provincial governments.
On the expenditure side, there are many areas that need improvement. Untargeted subsidy is a bad economic policy. The new government will have to look at the subsidy programme carefully. The total amount of subsidies (power, food, PSEs etc) has crossed the country’s defence budget. The power sector subsidy must be faded out in a three to five years framework by improving governance as well as by raising tariff. The new government may consider privatising distribution companies (DISCOs), undertake the use of gas and coal to generate electricity, complete the ongoing construction of dams on priority basis and strengthen the finance department of Wapda.
The privatisation of bleeding PSEs will be a critical element of fiscal consolidation in Pakistan. Should we restructure first and then privatise or go for outright privatisation will be a decision that needs to be taken by the government. It should be absolutely clear that it is not the job of the government to be in the business of running steel mills, airlines, railways, grocery stores, etc. The sooner these rotten PSEs are offloaded from the government’s budget, the better it is for the institutions as well as for government finances. The government can save several hundred billion rupees which can be used to improve the country’s infrastructure, education and health.
In sum, the above listed reforms on the fiscal side do not advocate lax fiscal policy or encourage fiscal indiscipline. Rather, it gives greater emphasis to domestic resource mobilisation through tax systems and tax administration reforms on the one hand and gives greater emphasis to the quality and composition of expenditure by allocating more resources towards education, health, social protection, and infrastructure on the other. Fiscal reduction path must be a measured one spreading over three to five years. Sharp fiscal adjustment may bring pain and human sufferings, which will be counterproductive as well as difficult to implement.
Likewise, in the case of the monetary policy, there has to be more careful scrutiny of the direction or disbursement of credit rather than aggregate credit itself. Access to finance is among the top five business impediments for 93 percent of the countries in the Asia-Pacific region. Access to finance is critical for small and medium enterprises (SMEs) and agriculture as they depend solely on the banking sector for external financing. The central bank can play an important role in development by reducing entry barriers and promoting financial inclusion through changes to the regulatory framework to encouraging banks to extend financial services to the poor and marginalised. Financial inclusions can go a long way in reducing poverty and income inequality and increasing female employment. The new government must consider strengthening the board of directors of the SBP by inducting professionals and removing the finance secretary from the board.
Finally, improving the investment climate will be essential for promoting inclusive and sustainable growth for which more resources will need to be allocated towards strengthening the country’s infrastructure, education and health. Tax policy reforms will also help in improving the country’s investment climate and constant interaction between public and private sector will help restore investors’ confidence.
The suggested reforms are needed to rescue the country from the economic morass it currently occupies. Of course, the onus is upon the new government to ensure the success of these reforms by inducting a team par excellence of professional economists as well as the brightest civil servants. A combination of bureaucrats and technocrats will be required to implement and to monitor the reform agenda.