ISLAMABAD-PRIME, an independent economic think tank, has noted that out of control spending and excessive government footprint have put public sector on the brink of collapse.
PRIME has published a quarterly report, Prime Plus, on Pakistan’s economy comprising an analysis of the progress and developments on the pillars of economic prosperity in CY 2022. The report also contains an analysis of the trends in macroeconomic indicators in the second quarter of FY 2023. The report highlights that Pakistan is facing challenges on the domestic and external fronts, and absence of reforms to address the structural issues has weakened the prospects of economic recovery.
Economic prosperity is contingent upon identifying and resolving problems prevalent in the economy, which otherwise hinder economic activity and efficiency. Dr. Arthur B. Laffer, while analyzing the underlying reasons for recurring crises in Pakistan, highlighted six pillars of economic prosperity. The pillars are deregulate the economy, cut spending, rationalize taxes, reduce trade barriers, establish sound money and privatize loss-making state-owned enterprises. The report highlights that the footprint of the government in the economy is increasing as shown by a continuous increase in the annual recurring expenditures. The current expenditures increased by 15 percent from Rs. 7.5 trillion in FY 2022 to Rs. 8.6 trillion in FY 2023. The grants and transfers increased from Rs. 1 trillion in FY 2022 to Rs. 1.2 trillion in FY 2023. The unfunded subsidies like the provision of cheap electricity to the export sector and agriculture package contribute to fiscal imbalances and deficits.
The taxation system in Pakistan is complex and remains incapable of completely financing public expenditures. The revenue generation has remained skewed towards indirect taxes with a 63 percent share while direct taxes contribute only 37 percent. One of the reasons behind lagging performance is the prevalence of exemptions. In FY 2022, the tax expenditure was Rs. 1.4 trillion or 2.6 percent of GDP. Moreover, large number of taxes and high rates have reduced the compliance of people due to which the government has to extend deadline for filing returns several times every year.
The report indicates that CY 2022 was a spectacle of trade suppression. The government restricted the imports through a complete ban on imports of some goods, requirement of a 100 percent cash margin, blocking of LCs and reducing the limit of international transactions. Moreover, the SBP also jacked up the rates of export financing scheme and long-term financing facility to slowdown industrial activity and imports.
The currency market remained highly volatile in CY 2022 where the rupee lost its value by 28 percent from Rs. 177 in January to Rs. 227 in December. However, it is widely believed that exchange rate was being managed by the government. This management contributed to emergence of three exchange rates in the country; interbank rate, open market rate at which dollar is not available and black market rate at which dollar is being traded.
The governments have been lagging in cutting losses through privatization of loss-making SOEs. The total losses of SOEs in 2019 were Rs. 143 billion and accumulation of debt till May 2022 was Rs. 1.74 trillion. Every year government includes revenues from privatization in budget but did not proceed due to political considerations. The unsatisfactory performance of the government in all the themes has contributed to exacerbation of the crisis. Moreover, the delay in the completion of 9th review of the IMF program can also be attributed to these factors.
The report highlights that political instability in the country has contributed to the deterioration in business conducive environment. The delay in the resumption of the IMF program, trade restrictions, depletion of foreign exchange reserves and currency devaluation are responsible for slowdown in economic activity. The trade restrictions and exchange rate management has not only reduced the current account deficit but led to a fall in exports, remittances and reemergence of informal banking channel for international transactions.
The government is struggling to control inflation and people continue to face a rise in prices and a fall in purchasing powers. The underlying reasons for inflation are not only an increase in international petroleum and food prices but also an increase in money supply at home and a delayed response of the SBP to raise policy rate. Moreover, the restriction on imports also contributed to disruption in the supply of goods and subsequently, the increase in prices due to shortages. There are following steps that the government needs to take to mitigate the crisis. The government needs to reduce its footprint in the economy to create space for the private sector to become an engine of growth.
The government needs to cut its expenditures to improve fiscal management and move away from domestic borrowing to ensure availability of capital for the private sector. Taxation system in the country needs to be overhauled by reducing the number and rates of taxes to broaden the tax base and promote compliance. Import substitution policy has failed to reap desired objectives. The government needs to open trade by reducing tariff and nontariff barriers to allow transfer of knowledge and technology and incentivize innovation for the domestic industry through exposure to international competition. The government needs to control the monetary expansion by reducing borrowing for public expenditures to control inflation. Market determined exchange rate is the key to stability in the currency market and stopping depletion of foreign exchange reserves. Loss-making SOEs need to be privatized on a priority basis to reduce the burden on the government and pace of debt accumulation.