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Author: PRIME Institute

State owned Electricity Distribution Companies: A Performance Review

by PRIME Institute PRIME Institute No Comments

State owned Electricity Distribution Companies: A Performance Review

Electricity Distribution Companies’ losses mounts to Rs.1355 billion

PRIME’s new report, “STATE OWNED ELECTRICITY DISTRIBUTION COMPANIES: A PERFORMANCE REVIEW” finds unsatisfactory performance of state-owned power sector distribution companies and recommended policy reforms. The distribution companies are continuously accumulating losses, which amounts to Rs.1355 billion in five years (2016-2020). The report highlights the underlying reason of inefficiencies such as delay in the structural reforms and continuous bailouts by government, which eliminates the need of improvement.

From 2016-2020, the report highlights that the distribution companies accumulated the loss of Rs. 452 billion in terms of inability to recover billed amount, while loss of Rs. 195 billion was accrued due to outdated transmission and distribution infrastructure.  The underlying reason for T&D losses remains lack of adequate investment on behalf of some distribution companies while some invested more than the allowed limit. The distribution companies were also found to be in breach of NEPRA targets, and for which small penalties were also imposed but there is still prevalence of defiance. Therefore, government has to bailout distribution companies every year to keep them afloat, which costed Rs. 708.4 billion in the stated period.

Despite the surplus generation capacity in the country, there is still prevalence of power outages and consumers faced average daily load-shedding of more than two hours in some regions. Consumers also faced disruption in services for which complaints were registered and some distribution companies received large complaints thus depicting low consumer satisfaction.

Public safety is an important component of the performance evaluation and incidence of 680 fatal accidents in five years display a grim picture and non-compliance of safety protocols. Furthermore, NEPRA also appears unable to ensure the implementation of safety protocols.

The report displays delays in the provision of new utility connections to the public depending upon the size of population. Total pending connections stood at 1.2 million in five years. These delays can be attributed to underutilization of surplus generation capacity.

The report recommends that government should undertake policy and technical reforms for higher efficiency of the sector. Therefore, a sustainable framework is needed for power sector reforms starting with complete or segment wise privatization of state owned entities, review of tariff regime to reflect costs and better implementation of policies through more empowered and resourceful NEPRA. Besides policy reforms, attention is also needed towards up-gradation of entire distribution infrastructure to curb losses.

Click Below to read full report:

STATE OWNED ELECTRICITY DISTRIBUTION COMPANIES: A PERFORMANCE REVIEW

For inquiries, please contact afzal@primeinstitute.org or call at 03330588885.

EAG concurs with interest rate hike, cautions on price control

by PRIME Institute PRIME Institute No Comments

EAG concurs with interest rate hike, cautions on price control

The independent Economic Advisory Group (EAG) convened a meeting to assess the latest economic developments and concurred with the government’s decision to raise the policy rate and allow markets to determine the exchange rate. However, it noted that a prudent mix of monetary and fiscal policies is needed to keep prices in check. Furthermore, distortionary regulatory policies should be avoided to enable market forces to operate in a sustainable manner.

The government has pursued an expansionary policy in the wake of the pandemic to keep businesses afloat, and to expedite the economic recovery by decreasing the policy rate, which has resulted in a fairly rapid recovery and surge in domestic demand. The rise in domestic demand and subsequent rapid increase in imports, as well as imported inflation, is indicative of an overheating economy.

Among other measures, the government has indicated that it plans to regulate prices through price controls. The EAG believes that there is ample empirical evidence that such administrative measures are rarely successful, and also lead to supply side distortions, such as hoarding and subsequent shortages, smuggling and price discrimination. The EAG also views the government’s decision to raise tariffs in order to reduce imports of what it considers as ‘luxury goods’ as counterproductive as it is difficult to define ‘luxury goods’.

The underlying cause of inflation is an output gap, which should be addressed by fiscal policies to dampen excessive aggregate demand, and long term growth should be catered for by augmenting supply instead of state intervention in the market price signalling mechanism. The market determined exchange rate policy and policy rate hike are sufficient to signal market players to adjust their business policies without the creation of any distortion. Furthermore, an indication has been given in the monetary policy statement that”the MPC expects monetary policy to remain accommodative in the near term, with possible further gradual tapering of stimulus to achieve mildly positive real interest rates over time.”

The monetary policy statement highlighted the disbursement of 44 percent of the total PSDP funds in just two and half months, which indicates that the fiscal stimulus is contributing to the surge in domestic inflation. The government spending pattern needs revision to keep fiscal deficit in check; otherwise, higher government spending will translate into higher government borrowing from the commercial banks, and lead to private sector crowding-out.

In conclusion, the EAG agreed with the adoption of a market determined exchange rate, and the gradual move towards positive real interest rate to keep the growth momentum sustainable. But it expressed serious reservations on the distortionary price control mechanism adopted by the government, and expressed concern that it will prove to be futile like in the past.

The Economic Advisory Group is an independent group of individuals from economics, policy and the private sector that deliberates regularly on economic developments and shares its views with the government and the public. It is supported by PRIME, an independent think tank.

For media inquiries, please contact Afzal Khan at afzal@primeinstitute.org or 0333-0588885.

Pakistan Prosperity Index – September 2021

by PRIME Institute PRIME Institute No Comments

Pakistan Prosperity Index – September 2021

Economic Slowdown: Pakistan Prosperity Index decreases by 5%

As per PRIME’s latest report, Pakistan Prosperity Index (PPI) has declined by 5.2%, an indication of slowdown in the economy. PPI is an agglomeration of trade volume, lending to private sector, purchasing power and manufacturing output indices. The trade volume witnessed an increase of Rs.298 billion Y-o-Y and a decrease of Rs.182 billion M-o-M on account of depreciation of local currency and rise in international prices.

Purchasing power declined as the Y-o-Y Inflation was reported at 8.4%, while the M-o-M inflation clocked at 1.3%, an illustration of fall in purchasing power. The prevalent high levels of inflation are at the back of hike in food and energy prices and currency devaluation.

Large Scale Manufacturing (LSM) declined by 4.91% M-o-M. This decrease can be attributed to the intermittent disruptions caused by pandemic and continuous surge in prices. Out of 15 large scale industries, 10 showed growth less than 1%, auto industry showed growth greater than 2%, while 4 industries posted negative growth. 

The private sector borrowing from banks showed a continuous surge with Rs.177 billion Y-o-Y and Rs.17.8 billion M-o-M increase. This increasing trend can be credited to lower cost of borrowing and a reduction in the budget deficit, which has reduced the government’s borrowing needs from the commercial banks thus reducing the crowding out effect.

The economic performance is not encouraging and highlights several underlying issues. Depreciation of rupee is making necessary imports expensive, which translates into higher cost of businesses and subsequently, lower manufacturing output. There is dire need to curb the inflationary pressure by augmenting productivity and output, as this will not only improve the purchasing power/real incomes but also reduce the input cost of LSM. Instead of distorting markets through price controls, addressing the supply side shocks of basic food items is imperative to lower food inflation, which is the main cause of rising overall inflation in the economy.  

The overall economic outlook, as measured by PPI, shows declining trend and in contrast to government’s growth agenda. The supply side shocks call for more liberal trade measures and elimination of state intervention in the market. Moreover, prudent economic planning is needed to ensure uninterrupted provision of LNG to the manufacturing sector for higher yield.

Click down to read the full Report & Methodology:

Pakistan Prosperity Index September 2021

PPI Methodology Sep'21

PRIME Institute publishes monthly PPI report with a lag of two months based on the availability of required data, the current report comprise data from August 2020 to July 2021.

For inquiries, please contact afzal@primeinstitute.org or call at 03330588885.

PTI’s three-year performance: economy on the mend

by PRIME Institute PRIME Institute No Comments

PTI’s three-year performance: economy on the mend

Ali Salman

Rising inflation, unemployment threaten future sustainable growth

prime minister imran khan s party emerged as the single largest party after clinching 26 direct seats in july 25 elections photo twitter pti
Prime Minister Imran Khan’s party emerged as the single-largest party after clinching 26 direct seats in July 25 elections. PHOTO: TWITTER/PTI

ISLAMABAD: The Pakistan Tehreek-e-Insaf (PTI) government has completed its three years. The discussion on its economic performance is largely coloured by partisan lines or by a selective use of indicators. If you ask someone how inflation has fared, the answer will be it has been on the rise. If you ask how the government has managed its current account, the answer is it has managed quite well. In this article, I will attempt a holistic review of the economic performance.

Considering economic system as a whole, let’s consider three sub-systems, which are distinct yet overlap: the government, the firm and the household. In an ideal economic system, these sub-systems should interact and sync. For example, a reduction in the tax rates by the government should imply low tax burden on the private firms and more disposable income for the households. However, in practice, this may not happen. A reduction in the tax rate in an economy where millions of firms are out of tax net, may not translate into wider benefits.

Let’s consider government’s economics. First of all, after inheriting a large current account deficit of around $20 billion, the government graduated into a current account surplus. Though we are again in a deficit, this is not necessarily a bad situation for a country like us. Keeping a market-based exchange rate is more important. The government has also performed reasonably well in lowering and maintaining fiscal deficit from 9% in 2019 to 7% in 2021.

On the public debt, we can see a rise from 77% in 2019 to 84% of GDP in 2021, though a significant part of this rise is attributed to the long overdue exchange rate correction. The Federal Board of Revenue (FBR) has also shown improvement in its performance by increasing the revenue, however, it has not been successful in diversifying and broadening tax revenue base.

The government has also brought down interest rate from 12% to 7% in two years, though now pressure is rightly building up to increase again – to come back to positive real interest rate. On the whole, the government has managed its finances reasonably well. I will give it a B+ grade.

Let’s now look at the firm’s economics – how the private sector has done. If we look at two broad parameters; the large scale manufacturing index and commercial lending to the private sector, we can notice significant improvements.

The country’s textile sector is working at full capacity and has increased investments in the last one year translating into higher exports. Similarly, the auto sector, after a stagnant year, is posting significant growth. The IT sector is fast emerging into a reliable export engine. These sectors provide jobs to millions of people especially in the cities, hence, their performance matters quite a lot for political stability.

However, it is also clear that no major change in the productive structure is on the horizon, thus limiting the prospects of sustainable growth in the future. I will give B grade on this account.

The biggest challenge, as everyone now recognises, that the government is facing is rising inflation, and particularly food inflation. This has to be carefully examined. Rising food inflation on account of rising food imports (such as palm oil, which is main ingredient for ghee) and pulses is a result of rising commodity prices worldwide. Rising prices of wheat should be seen not just from an urban consumer angle, but also rural producer angle.

Pakistan’s agriculture producing population has benefited from rising prices, which itself is a result of both a surge in the international prices and domestic demand. The sudden spike in the price of the poultry was a result of a disease, which is now fully recovered.

Similarly, rising prices of vegetables like onion and tomato was a result of import restrictions with India and destruction of crops last year due to floods. Thus, it is true that food inflation is on a rise, but it should not lead to wrong policy reactions like price controls, which are certainly doing more harm than good. If implemented, these price controls will force the producers to substitute activities or products, thus undoing the whole objective.

Another key factor in the household economics is of jobs. Have we reduced unemployment? As per ILO, the unemployment has increased – from 4.08% in 2018 to 4.65% in 2020. A rise in the unemployment number given addition of two million young people in the job market every year is not surprising in the post Covid situation.

Perhaps the private sector is maintaining current level of employment but not adding new jobs. Also, there are no longer large infrastructure projects after completion of the China-Pakistan Economic Corridor (CPEC). One must, however, acknowledge the government and the private sector for not allowing any vast job retrenchment during the crisis. I will give the government a B minus grade in the household economics.

Unlike what most commentators, politicians and media would like us to believe, the economic situation in Pakistan under PTI has improved, laying foundations of a sustainable growth in the future. However, the biggest threat to this future is not from outside, it is from within the government.

The writer is Founder and Executive Director of PRIME, an independent think tank based in Islamabad

Published in The Express Tribune, September 13th, 2021.

Liberalize and Integrate: EAG outlines its vision of a new auto policy

by PRIME Institute PRIME Institute No Comments

Liberalize and integrate:
EAG outlines its vision of a new auto policy

Transformation of the Auto Industry needed from protection and indigenization to liberalization and integration

The independent Economic Advisory Group (EAG) convened detailed deliberations to assay the outcome of contemporary automotive development policy, and the initiatives proposed in the Finance Bill 2021-22. It observed that prevalent policies do not present a path for transformation for the sector to either meet the needs of the domestic consumer or become globally competitive. Specifically, these fall short at both providing a mechanism to bring down prices on sustainable basis and ensuring development of Pakistan’s industrial capabilities necessary for competing in international markets.

EAG observes that the incentive structure in place is not designed to leverage the country’s latent comparative advantage. This is precisely the reason why, despite decades of protection, the industry has failed to become competitive internationally. Instead, a more efficacious policy would focus on exploiting Pakistan’s inherent latent comparative advantage, which would incentivise greater concentration of resources in segments of auto-industry supply chain where Pakistan has necessary capabilities to compete globally. For example, although by no means guaranteed, an auto-policy which moves away from specializing in the end-product (e.g. assembly) and, instead, focuses on subsectors where comparative advantage is more probable is better suited for achieving policymakers’ objectives – consumer welfare and increase in industrial capabilities.

The auto industry has received protection from government for more than three decades without robust analysis of requisite pre-conditions, which has been standard practice in most trading blocs (e.g. EU) for several decades. For instance, researchers use empirical efficiency tests like the Mill test and Bastable test, and analyse of the welfare implications of the incentive structure to objectively measure the impact of protectionist measures in place. On both these measures, the auto industry and, implicitly, auto-policies fail. This relaxed approach to providing incentives at the expense of consumer explains why the industry continues to struggle at achieving the economies of scale necessary for competing globally.

The efficacy of any policy is contingent upon prudent allocation of resources. EAG argues that the prevailing policies have allocated country’s resources in production activities where Pakistan has an inherent disadvantage. The 1.8 million people currently employed throughout the supply chain could be reemployed across activities where Pakistan enjoys a latent comparative advantage. The misuse of resources remains the least appreciated point and EAG wishes to bring it to policymakers’ attention.

The evolution of trade has prompted countries to realize comparative advantage, cars made in Germany compete with cars made in Japan, and specialize in the stages of supply chain, it is impossible to say where a car is manufactured. Data shows we are likely to have a comparative advantage in auto-parts and two/three wheel automobiles, and for which, there are significant primary/secondary markets in Africa and Asia.

The EAG proposes that the upcoming auto policy should promote integration of domestic parts manufacturers with global value chains through two actions. First, liberalization of trade regime to give market access to international automobile manufacturers in exchange for integrating domestic parts manufacturers in their value chains. Second, identify and engage with key auto markets across the world with the aim to reduce frictions to cross border trade and provide certainty to international auto players vis-a-vis operating their supply chains from Pakistan.

Policy should focus on securing access to African and Asian markets to expand exports to primary/secondary markets, which can be accomplished through actively seeking FTAs with African Union, RCEP, and Central Asian countries.

Investment in the enhancement of domestic capabilities for the expansion of potential areas of comparative advantage should be the central stage of transformation. First, businesses need to be incentivized to invest in research and development and produce new products. Second, coordination between relevant business associations, domestic manufacturers, and global players is needed for the standardization of both products and production processes.

Furthermore, it is imperative to identify emerging skills’ requirements and liaise with engineering universities and NAVTTC to ensure appropriate intervention at the earlier stage.

EAG has also made available a presentation on auto-sector reforms on PRIME’s website with the aim to present an alternate set of policies than what is being currently proposed.

The Economic Advisory Group is an independent group of individuals from economics, policy and the private sector that deliberates regularly on economic developments and shares its views with the government and the public. It is supported by PRIME, an independent think tank.

Click below to read the complete presentation:

Auto-Industry-Presentation.pdf

For media inquiries, please contact Afzal Khan at afzal@primeinstitute.org or 0333-0588885.

Economic Freedom Promotes Upward Income Mobility

by PRIME Institute PRIME Institute No Comments

Economic Freedom Promotes Upward Income Mobility

New study shows increased economic freedom leads to greater income mobility for workers and entrepreneurs

Islamabad, Pakistan—Economic freedom enhances income mobility while the poor in unfree nations have fewer opportunities to escape poverty and build prosperity, finds a new study released today by Policy Research Institute of Market Economy (PRIME) in conjunction with Canada’s Fraser Institute, an independent, non-partisan public policy think-tank.

“The main purpose of economic development should be to provide opportunities for upward social mobility of a vast majority of citizens. This can be achieved through inclusive economic policies and re-allocation of resources from rent seeking to efficiency seeking activities” said Ali Salman, Executive Director PRIME.

Many factors contribute to economic freedom but the most important for income mobility are rule of law and restrictive regulations. In uneconomically free nations, domineering government and crony elites use the rule of law, not to protect the freedom of all but entrench the privilege of their cliques while undermining the rights of everyone else.

Similarly, regulations are too often used to exclude people from work and opportunity, even in nations with a relatively robust rule of law. Government regulation may require workers to purchase occupational licenses or train to acquire credentials before they can work.

Pakistan ranked 139 in rule of law, ranked 140 in economic freedom and 123 in regulations; the country stood at 137 in terms of labor market regulations and 109 in business regulations.

“Government regulations impede the ability of workers to make themselves better off by slowing the upward mobility of workers,” said Vincent Geloso, an assistant professor of economics at George Mason University, senior fellow at the Fraser Institute and co-author of Economic Freedom Promotes Upward Income Mobility

The study shows that labor regulations across industries slow wage growth for low-income workers. And, particularly, inappropriate minimum wages and occupational licencing tends to hurt income growth among the poor more than among higher-income workers.

The same effect is also observed for would-be entrepreneurs who face barriers to entering certain industries because of regulatory costs and fees.

“If governments are genuine in their desire to help low-income workers climb the income ladder during the COVID recovery and beyond, they should take a second look at regulations and look for ways to increase economic freedom in their respective jurisdictions,” Geloso said.

The Fraser Institute produces the annual Economic Freedom of the World report in cooperation with the Economic Freedom Network, a group of independent research and educational institutes in nearly 100 countries and territories, including PRIME Institute in Pakistan. It’s the world’s premier measurement of economic freedom.

Click below to read full report:

Economic-Freedom-Promotes-Upward-Income-Mobility.pdf

MEDIA CONTACT:
Afzal Khan: afzal@primeinstitute.org or call at 03330588885

CCP ruling on sugar industry: the second opinion

by PRIME Institute PRIME Institute No Comments

CCP ruling on sugar industry: the second opinion

Ali Salman

ECC’s role in granting permissions for import, export of sugar should be discontinued

  • The ECC allowed K-P government to borrow Rs43 billion after the province busted its budget limit. PHOTO: PID

ISLAMABAD: Adam Smith noted centuries ago, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

He was probably right here and may have rightly predicted the tendency of business associations towards collusive practices.

This is the main message of the ruling of the Competition Commission of Pakistan (CCP) in the case of Pakistan Sugar Mills Association (PSMA) and its members, finding them guilty of collusive practices and imposing the biggest-ever fine of Rs44 billion.

The CCP has found that the PSMA has deliberately facilitated the formation of a cartel on behalf of its members, which has resulted in welfare loss.

The CCP has also found that real-time stock tallying by the firms was carried out to manipulate the availability of sugar in the market, influence export decision and thus influence pricing.

The CCP has classified the stock sharing as “commercially sensitive information” and has almost entirely relied on this assertion for reaching the conclusion.

A rare event in this case is that the commission, comprising four members, was split into half and the chairperson cast her second vote to endorse the decision. While this legal point will be challenged, we need to understand the economics of it.

The authors of the “second opinion” have differed with the judgement on Issue I (sharing of sensitive commercial stock information), Issue II (collective decision to export), Issue III (effect of collective decision of export on price), Issue IV (zonal divisions in Punjab to coordinate sales) and Issue V (collective bargaining practice in USC tenders).

It will be instructive to read the “second opinion” – as published on pages 135-173 of the 186-page decision that the CCP has issued. These pages contain a deep analysis of the sugar market dynamics in Pakistan as well as some legal arguments leading to dissent.

The dissenting members of the commission found that the allegation of market manipulation against PSMA needed further analysis.

Concurring with this, the sugar industry being a heavily regulated sector is a peculiar case where rent-seeking on the one hand by the firms and excessive intervention by the government on the other hand have resulted in the “worst of both worlds”.

Consumers get expensive sugar whereas farmers and industrial units remain inefficient. The net winner may be the government which reaps more revenue in the form of taxes than the profit earned by the firms.

Here is my theory. The CCP is unanimous that no single firm is in a dominant position to influence the market, however, collectively they do.

What is the one factor which brings these competing firms to become one voice? It is the collective formed by the Sugar Advisory Board, cane commissioners and the Economic Coordination Committee (ECC).

By actively deciding the input price, time of harvest, time of crushing and controlling import and export, these collectivist institutions create a uniform condition for market players, kill competition and encourage them to form a cartel.

In the instant case, by constantly asking the PSMA and sugar mills to provide their stock data, the government has effectively made price levels insensitive to the stock position. As noted in the second opinion, the supply and demand forces are no more at work.

Which laws can be used to indict the government for encouraging the collusive behaviour?

Unfortunately, the Competition Act 2010 bars the CCP from indicting the government itself if it is found guilty. That is why we see that the CCP seems to be overly concerned with price control, which is not its mandate.

It has recommended the government to make efforts to collect information about stocks independently. Instead, it should have recommended the government to exit this sector.

The moment the government exits, the sugar firms will lose the platform where they can directly negotiate commercial decisions with the government. They will continue, perhaps, their own “merriment and diversion”. Let them be.

The government should allow free market forces to play their role. If domestic players collectively decide to raise the price, a competitive trader, while pursuing self-interest, will import sugar, thus keeping prices in check.

If prices go up in the international market, local producers will be free to sell in the external market. The increased price of sugar will finally dictate the consumer behaviour. But we have killed this cycle of free competition in the name of welfare.

This goes beyond the CCP but the role of ECC in granting permissions for import or export of sugar should be discontinued.

All archaic laws (the Sugarcane Act 1934, Sugar Product Control Order 1948, Sugar Factories Control Act 1950 and Control on Industries Establishment & Enlargement Ordinance 1963) along with concomitant institutions need to be phased out and abolished.

The CCP decision may be received positively by the public and the government, as it confirms the “mafia” image of sugar industry.

But it falls short of understanding a centrally controlled market, where supply and demand are irrelevant. Without understanding the market, the law itself cannot prevail.

The writer is the founder and executive director of PRIME, an independent think tank based in Islamabad

Published in The Express Tribune, August 30th, 2021.

Moving to new industrial policy

by PRIME Institute PRIME Institute No Comments

Moving to new industrial policy

Ali Salman

Policy should be based on open trade, export orientation, value addition and innovation

ISLAMABAD: The debate on premature de-industrialisation in developing economies hinges on the premise that open trade, elimination of protective tariffs and withdrawal of subsidies are harmful for local industries.

In the case of auto policy, the proponents of this debate devised import substitution policies, which led to the deletion programme. Thus, while it helped local auto parts industry to develop, it gave rise to a protected auto industry, which has continued to flourish on the back of tariffs and other incentives. The government and automobile industries are the main beneficiaries as this has led to a stable flow of income for both at the cost of consumers, who have been forced to pay more for less.

Furthermore, the rising demand for cars on the back of income and improved infrastructure has created opportunities for the market to arbitrage the lag in production, resulting in the unique phenomenon of “on money”. This policy has not only caused harm to the consumers, but it has also proven to be a bad industrial policy. Pakistan has not been able to produce a single car which is competitive regionally or internationally.

As Pakistan has not achieved economies of scale, there is hardly any incentive in innovation and product development. The benchmark of economies of scale for the auto sector is 500,000 units (cars, vans and jeeps) in a year, whereas the government target was to achieve production of 350,000 units. The country’s production has barely crossed 100,000 units. Thus, the high tariffs have led to expensive assembled vehicles, suppressing demand and hence production.

This has resulted in an oligopolistic structure where some players have benefitted hand in hand with the government, which has benefitted from the high level of excise duties, which in turn has made cars more expensive. This is the double jeopardy that the country’s old industrial policy has visited upon us. As the government is revisiting the industrial policy, and in particular the automobile policy, there is an opportunity to evolve a new industrial policy.

“The past and contemporary policies have been focused on merely establishing assembly units, instead of developing manufacturing capacity, which is the real driver of growth in an economy; consequently, the inflow of FDI has been limited compared to profits earned and repatriated out of the country,” observed recently the independent Economic Advisory Group.

The timing is critical. Pakistan is stuck at a low level of exports and there is no way to jump on this ladder while relying on the existing product mix, which has been maintained for the last 20 odd years. Pakistan’s commodity basket including textile, rice, leather, etc is highly unlikely to help achieve the ambitious export targets. While the country may see a gradual rise in total exports, thanks to IT services, the manufactured exports will not be contributing to this rise. Thus, we may be seeing de-industrialisation even more rapidly.

Government measures are only contributing to the de-industrialisation. In the context of the upcoming auto policy, the decrease in tariffs on completely knocked down (CKD) kits, as envisaged in the Finance Bill 2021, which will be imported into the country and then assembled, in reality, discourages the domestic auto parts makers because imported items are being subsidised against domestic production. This implies that relative profits will be higher in the assembly business as compared to the auto parts manufacturing business, which will gradually reduce the linkage between the auto assemblers and the domestic auto parts makers.

In the context of expected foreign direct investment (FDI) in the telecom sector, if mobile phones are assembled without value addition arising from some intrinsic latent advantage but only as a result of some fiscal incentive, then the industry will remain dependent on protection from the government and manufacturing will not become a profitable avenue for companies. Such investment will be market-seeking instead of efficiency-seeking.

The new mobile phone manufacturing policy is also regressive as tariffs are more than 70% on lower-end mobiles and hover around 40% on higher-end phones. The policy also fails to incentivise the inflow of new technology and latest devices to the country as consumers will be paying higher prices for old-generation phones just to enable companies to set up assembly units in the country.

What needs to be done?

As envisioned in the Vision for Economic Transformation, Pakistan needs to alter the existing incentive structure dramatically.

As a corollary, we propose a new industrial policy. The main parameters of the new industrial policy should be open trade, universal reduction of tariffs instead of selective reduction, integration with the global value chains, export orientation, value addition, product development and innovation. The government should play an active role through the new industrial policy.

It should use its democratic power to counter the influence of powerful lobbies and ill-informed bureaucrats. An incremental approach will not work and will only provide more time for protective lobbies as well as arbitragedriven investors to maximise profits at the cost of the country’s manufacturing capability and consumer choice, which is the ultimate arbiter of market.

THE WRITER IS THE FOUNDER AND EXECUTIVE DIRECTOR OF PRIME, AN INDEPENDENT ECONOMIC POLICY THINK TANK IN ISLAMABAD

Published in The Express Tribune, August 09th, 2021.

Financing private sector growth

by PRIME Institute PRIME Institute No Comments

Financing private sector growth

Ali Salman / Beenish Javed

Increasing private sector credit is imperative to improve business confidence

ISLAMABAD: Over the last two decades, Pakistani banks have experienced structural reforms and a phenomenal growth.

Their profitability has multiplied several times and they have played an important role in job creation as well. But it remains debatable whether the privatisation of banks has contributed meaningfully to financing the private-sector growth.

In this backdrop and in light of a new study by PRIME, this article assesses the trend of banking credit for the government and private sector in the post-reform period.

In the 1990s, banking reforms were introduced to reduce government’s footprint in the industry, increase private sector credit, minimise the ratio of non-performing loans, and improve banks’ efficiency and profitability.

Despite improvements in technical efficiency and profitability, the banking sector post-privatisation has not delivered necessary dividends for the private sector, as also noted by former chief economist Pervez Tahir.

It has been inefficient in performing its core function of channeling depositors’ savings into loans for private businesses. Instead, these funds are being increasingly geared towards government debt instruments to earn easy and secure profits.

Consequently, a large proportion of private businesses, particularly the small and medium enterprises (SMEs), remains financially excluded and faces difficulty in accessing finance.

Pakistan continues to lag behind regional economies with respect to penetration of bank credit and private investment.

According to the study, the ratio of private sector credit-to-gross domestic product (GDP) declined from 27.7% in 1985 to 18% in 2019, indicating a low bank credit penetration into the economy post-reform. This ratio remains significantly higher in Bangladesh (45%) and India (50%).

Furthermore, private sector’s participation in fixed investment remains lacklustre at 11% while the same stands at 23% in Bangladesh and 21% in India.

Several demand- and supply-side factors have contributed to the post-reform decline in private sector credit.

Starting with the supply-side factors, the first and foremost has been the rising government footprint in credit market in the form of increased borrowing from commercial banks, supported by the rise in interest rates.

In 2011, the suspension of Standby Agreement with the International Monetary Fund (IMF) forced the government to increasingly rely on local banks to meet its budgetary requirements, resulting in crowding out of the private sector.

Between 2015 and 2018, the focus of government borrowing shifted from scheduled banks to the State Bank of Pakistan (SBP), resulting in a decelerated pace of scheduled banks’ investment in government securities.

Over the last two years, banks’ investment in government securities has surged again on account of IMF condition restricting government borrowing from the SBP.

The large federal footprint in the credit market has thus suppressed private credit offtake by reducing the funds available for private credit. Moreover, the lucrative mark-up on government securities has provided an impetus to the banks to increasingly invest in them.

As of December 2020, credit to the government stood at Rs15.2 trillion as against private sector credit of Rs6.5 trillion.

Second, the decline in private sector credit can partially be attributed to the shrinking footprint of development finance institutions (DFIs).

Post-reform, these institutions gradually faded due to the broad restructuring of the financial sector, leaving a void in terms of institutions that could provide long-term financing for the development of key industries.

Third, loans and advances given to the private sector generally entail the risk of default. This risk, however, is more pronounced in case of Pakistan due to non-existence of bankruptcy laws and imperfect information.

Given that there is an alternative of risk-free investment available and credit demand from the government continues to increase on the back of rising budgetary requirements, the post-reform banking sector has little incentive to extend credit to the risky private sector, especially the SMEs that are often subject to credit rationing.

Fourth, the red tape or cumbersome procedures to access finance through formal channels have repercussions for the private sector credit.

Post-reform banks have devised procedures and systems keeping in mind the blue-chip corporations. The higher collateral requirements and legal costs in case of default increase the compliance cost and put SMEs at a significant disadvantage.

Fifth, the restructuring of financial sector has been detrimental from the inclusion standpoint as banks’ disbursements are heavily skewed towards blue-chip corporations, while SMEs remain financially deprived.

The share of large-sized borrowers in total loans of the banking sector stands at 87% in Pakistan relative to 72.5% in Bangladesh while such borrowers account for only 1.6% of the total borrowers in Pakistan.

There are demand-side constraints to private sector credit as well including poor financial awareness and attitude towards formal finance as well as sluggish demand for long-term investment.

Moreover, the high mark-up on long-term loans has undermined the financial incentives and failed to stimulate demand for long-term investment. Therefore, most borrowing by the private sector centres around working capital, which is cheaper to avail.

During these unprecedented times, increasing private sector credit and ensuring financial inclusion is imperative to improve the business confidence and propel private sector activity.

This needs all parties – banks, private sector and the government – to alter their course and take a different direction. The government must roll back and the banks must make an advance.

The writers are affiliated with the PRIME Institute, an independent economic policy think tank based in Islamabad

Published in The Express Tribune, July 19th, 2021.

A Case Study of Auto Industry in Pakistan (Draft Note for Discussion)

by PRIME Institute PRIME Institute No Comments

A Case Study of Auto Industry in Pakistan (Draft Note for Discussion)

Vision for Economic Transformation

This is a Draft Note for Discussion authored by PRIME’s Research Economist Mr. Tuaha Adil. The policy note comprises valuable inputs from the members of the Economic Advisory Group.

The transformation of an economy is contingent upon the utilization of resources in the most productive manner. Sectors of the economy will operate at maximum potential when business conducive ambiance is created through favorable and ease promoting government policies. The economic transformation policy based on the identification and resolution of contemporary structural and sectoral inefficiencies and futile economic policies is inevitable for the prosperity of the country. The performance of the auto sector is analyzed as a case study to evaluate the efficiency of government industrial policies. The government’s policies and initiatives to expand the auto industry are based on the assumption of latent comparative advantage. Therefore, domestic auto companies are protected from international competition through tariffs and tax cuts. However, the outcome of policies and performance of the sector have been unsatisfactory due to confinement to assembly of vehicles and nonexistent localization of products. The policies adopted by countries having developed automobile industries have also been discussed to evaluate shortcomings of the policies adopted in Pakistan.

Click below to read the full report;

Auto-Policy-Note-10.8.21.pdf

PRIME Institute hosts an event on the report “State Owned Electricity Distribution Companies: A performance Review”

by PRIME Institute PRIME Institute No Comments

PRIME Institute hosts an event on the report
“State Owned Electricity Distribution Companies: A performance Review”

PRIME Institute has arranged an event in Islamabad Hotel on the release of its report ‘State Owned Electricity Distribution Companies: A performance Review’ which was lead by its Executive Director, Ali Salman and the research team: Tuaha Adil and Sarah Javaid

The incompetency of state owned electricity DISCOs have accumulated to a whacking loss of Rs 1.35 trillion further contributing to circular debt over 5 years. (2016-2020)
Research Economist Tuaha Adil, at PRIME; Policy Research Institute at Market Economy, finds out how the incompetence of state driven distribution companies have lead to 680 fatalities in DISCOs territory over 5 years, under-utilization of generation capacity following power outages, growing trade deficits, 1.2 million pending connection applications due to inefficient regulation by NEPRA, Rs 195 billion of accrued losses bred by poor T&D performance, and continuous Government’s bail outs.

Click below to Read Full report:

STATE OWNED ELECTRICITY DISTRIBUTION COMPANIES: A PERFORMANCE REVIEW

PRIME Budget Review FY 2022

by PRIME Institute PRIME Institute No Comments

PRIME Institute, Islamabad based independent think tank has released its commentary on the federal budget 2021-22. According to the report authored by PRIME research economist Beenish Javed, the budget is both pro-growth and inflation prone. The key messages of the report are:

• The federal budget strategy for FY22 is pro-growth and spending-led.

• Customs and Federal Excise Duties have been reduced to facilitate the industry and
exports.

• The new budget entails reduction in existing indirect taxes with no new direct tax on salaried class and businesses.

• Gains from higher growth rate can be wasted in the case of increased food inflation.

• If international oil price does not come down, a possible hike in petroleum levy is likely to result in cost-push domestic inflation.

• The budget FY22 entails increase in power subsidies but not food subsidies.

• Fiscal prudence in the case of Public Sector Enterprises (PSEs) and commitment to privatization is appreciable.

PRIME since 2013, has been advocating for reduction of tax rate, lowering import tariffs and reducing wasteful expenditures. The lowering of customs duties and tariffs on a wide range of raw material imports as well as announcing of zero duty regime on IT products is certainly a great news.

Commenting on the budget, PRIME Executive Director Ali Salman said that “the government has presented a pro-growth budget by tax cuts and demonstrating fiscal prudence, though some of the additional indirect taxes on key commodities will backfire.” He also said that the budget sanctity has to be ensured and hoped that no mini-budgets are introduced in the next fiscal year. Ali said that on the whole this budget will be appreciated in the board rooms but may not be welcomed in the kitchens.

PRIME report mentions that Federal government’s commitment to improved recoveries from state-owned enterprises as well as higher targets from privatization proceeds is appreciable. This is high time that the government delivers on its promises of turning around loss-making public sector enterprises.

The report says that contrary to the claims of being a pro-poor budget, ambiguity remains as to how this budget will reduce food inflation in the upcoming fiscal year. Under the federal budget FY22, government has proposed to increase the turnover tax on wheat from 0.25 percent to 1.25 percent, while the sales tax on flour bran is set to enhance from 7 percent to 17 percent. Moreover, Rs. 7 billion would also be collected from sales tax on sugar. Since both are essential commodities, increase in their prices is likely to worsen food inflation. Direct and indirect cash transfers to low-income group is a short-term solution for mitigating the effects of food inflation and other socio-economic issues, which this budget entails. However, a long-term and a more sustainable approach calls for increasing real incomes, employment opportunities, human capital development and sustaining economic growth in order to achieve a definite improvement in socio-economic indicators.

Please click on the pdf below to read the full report.

PRIME-Budget-Review-FY-2022Download