Economic policies: confusion prevails
Solution lies not in distorting market with protests, but in pro-market approach
By Bilal Zahid
Economic policies: confusion prevails
In the span of just a few days, two seemingly contradictory headlines graced the front pages of Pakistan’s newspapers, shedding light on the perplexing state of the country’s decision-making.
Unshackling Pakistan’s economy
Unshackling Pakistan’s economy
By Dr Khaqan Hassan Najeeb
Australia taught me a considerable amount of what I know about successful economic deregulation. Australia was a heavily regulated economy post-World War II. Protectionist measures like high tariffs and import controls were well in place. The financial sector was highly regulated. The government exercised price controls through agricultural boards.
This ambiance hindered competition, created inefficiencies, and restricted productivity potential. A similar story holds back the potential of Pakistan's economy to this very day.
Australia's exceptional journey towards economic deregulation began in the mid-1970s. Since then, it has been an impactful and transformative process – one that has been pursued quite well by successive Australian governments over the decades. Authorities have endogenously conceived and implemented a regulatory overhaul – insourcing economic thinking rather than relying on the outside. A path Pakistan consistently seems to miss.
Some key deregulation measures included floating the Australian dollar, deregulating financial markets, removing controls on foreign capital flows, decentralizing industrial relations, pushing a competition policy, broadening the tax base, and corporatizing state-owned enterprises. These reforms aimed to enhance economic freedom, reach new international markets, shape competitive behaviour, and better the economy's flexibility. The very story Pakistan needs to craft for itself.
Important areas of deregulation also included enhancing global trade by lowering trade barriers and tariffs and liberalizing sectors like telecommunication dominated by government entities, by removing prohibitions for new entrants. Government authorities engaged private-sector business development service providers for legal services and training for job seekers. Australia moved away from centralized wage fixing to enterprise bargaining. All worth learning lessons for Pakistan’s decision-makers.
Authorities responded to Australian-based Industry Commission reports on the payoffs and risks related to the corporatization and privatization of public utilities. The recommendations included administrative reform of public utilities and structural reform of a sector as a whole. The outcome included the introduction of competition into power generation and retail areas, and the privatization of publicly owned generation, transmission, and distribution assets. This is a valuable insight into Pakistan’s crumbling energy sector. The deregulation process gained steam in the energy sector in the early 1990s. Australia made a push to develop a National Electricity Market. The creation of an energy market has been pending in Pakistan for eons.
Australia's National Competition Policy (NCP) framework cut out regulatory barriers to competition, giving stronger incentives for suppliers to operate efficiently, be price competitive, and pursue innovation. A significant component of the NCP was the Legislation Review Program. This reform assessed whether regulatory restrictions on competition were in the public interest. It covered a large area of the economy including professional licensing, agricultural markets, insurance, and transport, among others.
A competition framework is a less understood area and a missing link in reforming the Pakistan economy. As a result, most businesses are uneasy operating outside the confines of our borders, protected by generous government concessions, exemptions and subsidies, and barriers to competition.
It is asserted that deregulation has been largely beneficial for the 26 million Australians. Competition has improved services, created long-term price stability and increased consumer choices. Labour has much higher wages, and citizens have experienced a surge in wealth and living standards. Importantly, the decades of economic growth are driven by private investments, not debt-funded fiscal largesse. Tragically, many of us are still unable to internalize this story for Pakistan. The thinking that foreign-funded projects, niche area investments, and an outsourced thought process can help us out of our morass is probably over-optimism. These actions are only likely to help at the periphery.
The present regulatory regime in Pakistan is a relic of a bygone era conceived to control and manage rather than facilitate and enable. We are still uncomfortable with market signals and rely on controls in many markets. It is time to recognize that undertaking economic reforms and liberalizing price controls and quotas creates a flexible and resilient economy. By prioritizing deregulatory policies, Pakistan can unlock productivity gains, and begin its journey to competitiveness in the global economy.
Australia carried out several studies to calculate the compliance costs of the prevalent regulations. These studies also considered the flow of regulation. They then set new guidelines to help reduce the flow. With little supporting evidence, most policymakers in Pakistan cannot relate to the heavy compliance costs that stifle entrepreneurship, create excessive paperwork, linger decisions, and lower the efficiency of the economy. The flow of new regulations and setting up of bodies has continued in Pakistan.
Australia’s success underscores the value for Pakistan in reducing unnecessary compliance costs, enhancing productivity, and driving economic growth. Deregulation is a potential driver of productivity growth. A step-up in Gross Domestic Product (GDP) growth is possible by freeing up the economy, reducing efficiency costs, and improving competition in several markets where it is currently constrained. The largest gains of a deregulatory effort would come from prioritizing a reduction in compliance costs relating to regulations that apply to large numbers of people and businesses, including an estimated 5.2 million small and medium businesses and their taxation regulation.
In 2016, I helped author a Doing Business Reform Strategy within the government. The reform agenda focused on smart regulations, simplified procedures, and competitive costs. This was to lay the foundation of a far wider effort to deregulate the economy. Short of a decade down the road, a few attempts have been made by the government through initiatives such as the Pakistan Regulatory Modernization Initiative, SMART, Digital Economy Enhancement Project, and Zero-time to start-up policy of the government of Punjab to signal regulatory reforms; albeit to our chagrin, we are a long way from home.
Research highlights that regulatory compliance costs across certain sectors can be as high as 40 per cent of GDP in Pakistan. An unnecessary and obsolete regulatory system burdens Pakistan’s investment climate. The economy is strangled at the federal, provincial, and municipal levels by a plethora of agencies. Regulatory overhang distorts markets and hinders economic activity while inflating costs and hurting the ease of doing business.
Regulatory Guillotine efforts, an approach towards determining the legality, necessity, business friendliness, and associated cost of regulation hangs in balance, as the Asaan Karobar Act, needs to move forward. The much-discussed single window for business and investment, Pakistan Business Portal is yet to be fully functional.
Brooding over the technically correct noises raised over the past decade regarding regulatory reforms and seeing limited impact on the ground, one feels that a serious action-oriented effort towards doing away with regulations that are no longer considered necessary; streamlining and harmonizing regulations across jurisdictions; and moving towards technology or digitization to ease frictions should be the hallmark of the economy for the next few years.
Sometimes life can be gratifying. The arduous hours of completing a doctorate, my engagement with a research think tank, and my industry work in Australia gave me invaluable insider perspectives into remodeling a well-regulated market economy. One could always feel the sense of this transformation in the air.
One understands Pakistan’s policymakers' mindset for focusing on visible outcomes. However, simplifying rules and regulations shows the state’s capability of deeper reforms. It is Pakistan's time to realize the depth and breadth of work required to make such a transformation – one sincerely hopes we can nudge the mindset of the nation for hard work to achieve a seriously deregulated competitive economy. God bless Pakistan.
The article was originally published in The News International on May 26 2024.
The writer is former adviser, Ministry of Finance. He tweets @KhaqanNajeeb and can be reached at: khaqanhnajeeb@gmail.com
Join ECONOMIC N-GEN Fellowship
ECONOMIC N-GEN Fellowships at PRIME
The Policy Research Institute of Market Economy is now accepting candidates for the Economic N-Gen Fellowship Program.
The Economic N-Gen Fellowship is exactly what it sounds like; it is a program designed to prep the next generation of Pakistanis to become the economic engine which drives Pakistan toward a future of economic openness, freedom, and prosperity.
Ideal candidates must be enrolled for a Master’s Degree in Economics at their University, and must demonstrate a will and enthusiasm for solving Pakistan’s economic problems through the improvement of public policy outcomes. Candidates will be selected based on their knowledge and understanding of competitive markets, private property, productive efficiency, and the fundamentals of capitalism.
Through the course of the 2-month Fellowship period, candidates will be familiarized with the work of think tanks and governments, be provided with educational lectures on contemporary economic policy issues, policy philosophy, and be required to write multiple short policy papers.
Candidates who will be able to successfully complete the program will have their work published by PRIME, and will be inducted into the Economic N-Gen Policy Fellows panel, after which they may be engaged for future assignments upon the completion of their Master’s degree.
The Economic N-Gen Fellowship is exactly what it sounds like; it is a program designed to prep the next generation of Pakistanis to become the economic engine which drives Pakistan toward a future of economic openness, freedom, and prosperity.
Ideal candidates must be enrolled for a Master’s Degree in Economics at their University, and must demonstrate a will and enthusiasm for solving Pakistan’s economic problems through the improvement of public policy outcomes. Candidates will be selected based on their knowledge and understanding of competitive markets, private property, productive efficiency, and the fundamentals of capitalism.
Through the course of the 2-month Fellowship period, candidates will be familiarized with the work of think tanks and governments, be provided with educational lectures on contemporary economic policy issues, policy philosophy, and be required to write multiple short policy papers.
Candidates who will be able to successfully complete the program will have their work published by PRIME, and will be inducted into the Economic N-Gen Policy Fellows panel, after which they may be engaged for future assignments upon the completion of their Master’s degree.
This is a hybrid opportunity with about 70 percent of remote work, and 30 percent on site at PRIME HQ, Blue Area, Islamabad.
Send your resume to saad@primeinstitute.org, along with a cover letter explaining how you may be a suitable fit for the Economic N-Gen Fellowship. Please use the subject line “N-Gen Application-<Your University Name>-<Your Full Name>"
Propelling the ICT sector via imports of IT products
Propelling the ICT sector via imports of IT products
As the second most prominent source of exports, easier access to IT products is critical
Author: Dr Aadil Nakhoda
The information, communication and technology (ICT) sector is often hailed as the engine of export growth amongst all the services sectors. The ICT sector generated $2 billion worth of exports in the first eight months of FY24, which is approximately 15% higher than the amount generated in the first eight months of the previous fiscal year. The exports from the ICT sector in FY23 and FY22 was reported at $2.6 billion. If the trend in the current fiscal year is to continue, the current exports can likely close in at $3 billion. This makes it the second most prominent source of exports, after the textile sector. However, as a technology intensive sector, it is likely that the IT firms are heavily dependent on the imports of IT goods. Hence, easier access to IT products becomes ever more critical.
A recent study by the Information Technology and Innovation Fund, titled “How Expanding the Information Technology Agreement to an ‘ITA-3’ Would Bolster Nations’ Economic Growth,” reported that several developing countries could benefit significantly by signing the ITA (Information Technology Agreement) and allowing duty-free imports of the proposed expanded list of ITA products. These countries could benefit by increasing the size of their GDP, increasing the size of the tax revenues and benefit from the improvement in the ICT-related infrastructure as well as from improved digitalisation.
The expanded list of ITA products used in the aforementioned study includes semiconductors, smart appliances, robots, energy efficient storage systems and smart medical instruments. The GDP of Pakistan would increase 2% in the next 10 years if it provided duty-free access on the expanded list of products. ICT products are often labelled as ‘super capital’ as they are not only likely to add to the infrastructure but also help in improving the productivity levels in a country. Adoption of smart technologies can help boost productivity levels significantly as it improves the efficiency levels of several processes and procedures in manufacturing and service industries.
ITA was introduced in 1996 with a purpose to eliminate tariffs on the imports of IT products. Although, the signatories of ITA agreed to reduce their tariffs, several non-signatories also benefit from tariff reduction by the member countries due to the most-favoured nation principle of the World Trade Organisation, which requires members to give favourable treatment to all member countries. Currently, there are over 80 signatories of ITA, who contribute to more than 96% of global trade in ICT related products. Afghanistan, China, India and Vietnam have already signed the ITA, while Pakistan and Bangladesh are yet to do so. ITA-2 was introduced with an expanded list of products. The ITIF report discusses the benefits of ITA-3, which further expands the list of products provided in the ITA-2.
One of the largest exporters of IT products, as listed in the proposed ITA-3, is China. It exported more than $1.5 trillion worth of products on average between 2019 and 2022. Vietnam exported more than $165 billion. Both these countries exported more than they imported, running a trade surplus in this category of products. The South Asian countries reported a trade deficit in IT products, with India importing more than $100 billion and exporting $35 billion. Pakistan exported $1 billion, while it imported $7.2 billion. Bangladesh reported a similar pattern as Pakistan. The largest imports for Pakistan were mobile phones, photosensitive electrical equipment and other communication devices. All of these products are categorised as capital goods as they can be used to add further value in the economy. The main exports were refined copper, listed as an intermediate good, and medical and surgical devices listed as a capital good. The highest tariff rates on the imports of IT products are imposed by Pakistan and Bangladesh, which are significantly higher than those applied by the East Asia countries. The imports of consumer goods into Pakistan face an average tariff rate of more than 10%, while imports of similar goods into China face average tariff of less 5%. On the other hand, Pakistani and Bangladeshi exporters face lower tariff rates on their exports to their export destinations than their counterparts in China and India. Even with such preferences, the exports of IT-related products have not achieved the desired results in Pakistan. The total amount of trade creation, using a methodology based on tariff change and import elasticities, if tariffs are reduced to zero is approximately $2 billion.
Although, the tariff rates on IT products are relatively high, the non-tariff measures (NTMs) are relatively non-existent on the imports of IT products into Pakistan. The East Asian countries, such as China and Vietnam, impose several measures across the products, while they are significantly lower for the South Asian countries. Further, the Pakistan imposed different measures to curtail imports as a response to the rising trade deficit. These included import licensing requirements, internal taxation of imports, import tariffs and trade payment measures. The complex web of government interventions makes the import policies more intricate as businesses face several challenges that result in a less conducive business environment.
In essence, the share of the imports of the IT products in total imports tends to be higher in the richer countries than in the lower countries. IT products are not only likely to boost productive capabilities but can also aid the digitalisation of procedures and processes. For instance, digital products can help improve connectivity and take advantage of new innovations and facilitation tools. It is essential that the government rethinks its policies on the imports of IT products if it is to not only propel the exports of ICT services from Pakistan but also the country into the digital age.
Note: The content was also presented by the author at the 17th Annual Conference on Management of Pakistan Economy held at Lahore School of Economics in April 2024.
WRITER IS THE ASSISTANT PROFESSOR OF ECONOMICS AND RESEARCH FELLOW AT CBER, INSTITUTE OF BUSINESS ADMINISTRATION, KARACHI
THE ARTICLE WAS ORIGINALLY PUBLISHED IN THE EXPRESS TRIBUNE ON MAY 20TH, 2024.
A pro-growth flat tax policy
A pro-growth flat tax policy
Flat tax plan will dramatically change taxation structure by aligning incentives
Author: Rizwan Rawji
Pakistan can replace all taxes by introducing a flat-rate tax of 10% on personal income, 5% general sales tax (GST), 20% tax on corporate income, 5% customs duty and 3% excise duty.
Arguments for a flat tax are cast in a number of ways, with simplicity and efficiency being the two key selling points. These lead to two distinct and complementary paths for tax reform.
One focused on the broadest base and the lowest rate possible. The second focused on the concept of single taxation on the principle that income should be taxed only once (fairness and efficiency).
The broadening of tax base accomplishes, in part, the second objective. With the broader base, there is a less likelihood of double taxation.
To make the tax base as broad as possible and void of substitution effects, virtually all deductions and tax credits for individuals and businesses should be repealed.
Lowering the overall marginal tax rates acts as a ceiling for incentive-based activity. The higher the tax rate, the lower will be the incentive for highly productive individuals to step up their efforts.
With the lower marginal tax rates, economic activity will increase, with the added benefits of lower government entitlement spending and increased revenue generation.
Tax rates have two effects on tax revenues. First, “the arithmetic effect” which shows that when tax rates change, tax revenues per dollar of the tax base also change in the same percentage.
Second, “the economic effect” which shows that when tax rates change, the tax base also changes, but in the opposite direction. The economic effect, thus, always works in the opposite direction from the arithmetic effect. This is the logic behind the Laffer Curve.
Economics is all about incentives and taxes have consequences. Pakistan needs a pro-growth flat-rate broad-based tax system. A flat tax system is inherently equal, as everyone pays the same proportion of their income and treated the same.
Fairness in taxation creates incentive for better compliance, accelerates economic growth and generates more government tax revenues. A paradigm shift is required to restructure the entire tax system to induce more work, savings and investments.
High tax rates, complex tax codes with exceedingly technical and abstruse wording and procedures, weak enforcement, inefficiencies riddled with SROs, exemptions, concessions, amnesties, etc have kept Pakistan struggling with a low tax-to-GDP ratio, high fiscal deficit and sluggish growth.
Pakistan can learn and adopt a pro-growth flat tax experience from a number of flat tax countries in Central and Eastern Europe that were part of the Communist bloc just three decades ago.
The flat tax revolution of the 1990s had put pressure on politicians to lower tax rates and reform their tax systems to attract jobs and capital from the uncompetitive high tax nations. Globalisation had a positive impact on tax policy because governments had to compete and “converge” with wealthier nations.
Leading the flat tax trend were the Baltic states (Estonia, Latvia and Lithuania), then soon followed by the Balkan nations (Macedonia, Montenegro and Albania), Romania, Bulgaria, Georgia and Russia.
Critics such as the International Monetary Fund (IMF) then said that flat tax was unrealistic and that it only works in small jurisdictions and cannot work in large economies.
But when Russia and other large Eastern European countries got on the flat tax bandwagon, opponents began to concede that flat tax regimes were feasible, but reasoned that tax reform worked only in transition economies.
The IMF, in its study in 2006, labelled it as a fad and boldly stated; “looking forward, it is not so much whether more countries will adopt a flat tax as whether those that have will move away from it”.
None of the flat tax nations returned to a discriminatory rate structure and the flat tax seems securely enshrined. The international bureaucracy’s powers of prediction certainly leave much to be desired, because the study was wrong about countries moving in the other direction.
Bulgaria, now a European Union and NATO member, adopted a flat tax regime (10% flat tax on income and corporates and 20% flat tax on value addition) two decades ago and has kept it intact till today. Ironically, Bulgaria also happens to be the country of birth for the current IMF Managing Director Kristalina Georgieva.
However, the flat tax is not a cure-all for every economic ill. To maximise the economic benefits of tax reform, a nation should have the rule of law, property rights, sound money, limited government and low levels of regulations. In such an environment, the flat tax ensures the tax code will not be an obstacle to growth.
A flat tax reform plan would dramatically change the structure of taxation in Pakistan by correctly aligning incentives to promote economic growth, voluntary tax compliance and increase in government revenues.
It will launch Pakistan onto a new trajectory of economic growth and prosperity for all of its citizens.
The writer is a philanthropist and an economist based in Belgium
The article was originally published in The Express Tribune on May 20th, 2024.
Illegal trade: short-term gains, long-term economic decline
Illegal trade: short-term gains, long-term economic decline
Instead of asking IMF for $6b, govt must aim to plug tax loss hole of Rs1.5-2tr
Author: Dr Ali Salman
When Pakistan’s government imposed restrictions on imports to reduce the country’s trade deficit in 2022, it did not deter the inflow of goods – it encouraged substitutes and possibly smuggling, which is growing at 18% annually.
In particular, the large-scale manufacturing firms and multinational companies were negatively impacted, whereas small-scale firms and commercial importers managed to find alternative routes, often without the knowledge of the government, and at times in connivance with some elements within the state.
Taking account of the impact, Prime Minister Shehbaz Sharif had to recently declare that “illegal trade and smuggling have caused huge losses to the country”.
I present an informed guess to quantify this loss here. First, I qualify that for this article, illicit trade comprises legitimate goods, being produced, sold, and consumed through illegal means including non-documentation and tax evasion.
The illicit trade can be classified into: counterfeit, tax evasion, smuggling, and under-invoicing/misdeclaration.
According to some sources, smuggling through the Afghan Transit Trade (ATT) alone may be responsible for causing at least Rs1,000 billion loss to the national exchequer in terms of foregone import-related tax revenue.
Looking at another dimension of the illegal trade, the government is losing approximately Rs300 billion every year in tobacco taxes, which is rising. If we add another Rs270 billion estimated to be lost due to Iranian oil smuggling into Pakistan, the overall loss is at least Rs1.5 trillion.
These are only estimated numbers and as the nature of illegal trade would dictate, it is impossible to find a reliable number.
Using another source, the Pakistan Business Council estimates the size of grey and shadow economy to the tune of $68 billion. If the tax is assumed to be 10%, this would translate into tax losses of almost Rs1.9 trillion.
Therefore, it is safe to assume that the overall loss to the national exchequer caused by illegal trade, smuggling and tax evasion can be between Rs1.5 trillion and Rs2 trillion, which would be 21% of the current tax target.
This is more than 100% of the total targeted collection of federal excise duty and customs duty, as announced in the budget for 2023-24. This is coincidentally almost equal to the new loan being negotiated with the IMF.
These estimates do not include under-invoicing or misdeclaration as well as losses due to counterfeit products. These also do not include implications for business environment, and in particular, incentives for international investors, who look for a level playing field when it comes to tax policy and its practice.
Clearly, in a country where the government is seemingly focused on extracting taxes only from large-scale and corporate businesses, it provides wrong signals to existing investors, who essentially sends similar messages to future investors.
One should not be surprised that foreign direct investment (FDI) rates in Pakistan have remained abysmally low over the last few years.
According to the Transnational Alliance on Combating Illicit Trade (TRACIT), Pakistan is ranked 72nd out of 84 countries on the “Global Illicit Trade Environment Index”, which is published by the Economist Intelligence Unit. Its parameters are government policy, supply and demand, transparency and trade, and customs environment.
Illegal trade may provide short-term benefits to the economy in terms of cheaper alternatives, but in the long run, it deprives the country of productive investment, innovation, and competitiveness. In some cases, such as spurious medicines or pesticides, this also implies direct threats to public health.
Prime Minister Shehbaz Sharif’s government is rightly concerned about damages being caused by illegal trade activities and tax evasion. The strategy is multi-dimensional: tax compliance, improving enforcement, evaluation of track and trace mechanism and digitalisation of FBR.
It is not the first time that the government has launched such drives. A tax compliance initiative, known as “Tajir Dost Scheme” launched without due homework, is already failing.
It was able to bring only around 200 enterprises on the tax register, out of, well over, three million enterprises. The prime minister has already expressed his dismay over the track and trace system, which was implemented in four sectors in 2020.
Industry sources claim that counterfeit stamps are being produced in tobacco and sugar sectors. This system has met with similar failures in many other countries.
We have borrowed hundreds of millions of dollars for digitalisation of FBR in the last few years, and have found, to the national embarrassment, that FBR was using fake software!
While I hope that recent measures will bear fruit, one should remain wary of over-reliance on technology where policy design is faulty.
As Pakistan remains one of the most protected economies of the world, unless we minimise barriers (as demonstrated in taxes, tariffs, and regulations) to legal trade, the government has no chance of generating enough growth to raise required tax revenues and is set on a clear path towards bankruptcy.
The prime minister has a stark choice: instead of asking the IMF to provide another $6 billion (or Rs1,674 billion) to be disbursed over three years, he can take a different route and aim to plug the hole of tax losses estimated at Rs1.5-2 trillion over the same time period.
The writer is founder and executive director of the Policy Research Institute of Market Economy (PRIME), an independent economic policy think tank based in Islamabad
The article was originally published in The Express Tribune on May 13th, 2024.
Illicit Trade in Pakistan: The Twin Task of Combating Illicit Trade and Boosting Economic Growth
Illicit Trade in Pakistan: The Twin Task of Combating Illicit Trade and Boosting Economic Growth
The report investigates the situation of illicit trade across sectors in Pakistan. The convergence of various structural weaknesses in Pakistan’s economy challenges its ability to sustain recent gains in poverty reduction and undermines objectives for long-term growth in GDP. Since these factors also create fertile ground for illicit markets to strengthen, this report investigates the associated impacts and suggests remedies for consideration by Pakistan’s policy leaders. The report highlights that high levels of inflation and tax evasion compound the problems, and urgently calls for a comprehensive and coordinated approach to address them. The report contends that effectively tackling illicit trade will be a crucial ingredient in achieving Pakistan's economic prospect
The report has been published by TRACIT. To access the report, kindly click on the link provided below.
TRACIT warns Pakistan that counterfeiting and illicit trade stifle growth, economic development
TRACIT warns Pakistan that counterfeiting and illicit trade stifle growth, economic development
- 6 May 2024, Islamabad – Today, the Transnational Alliance to Combat Illicit Trade (TRACIT) presented policy recommendations to government officials and industry stakeholders participating in a forum hosted by Pakistani think tank, the Policy Research Institute of Market Economy (PRIME). The report highlights the impact of Pakistan’s ongoing economic problems with a staggering 25 percent inflation rate. High levels of inflation have had a disastrous impact on consumer purchasing power and product affordability, which is widely regarded as the primary driver for illicit trade.
“Record high inflation is perhaps the most pressing problem,” said TRACIT Director-General Jeff Hardy. “When prices rise faster than incomes, illicit and black-market products become more tempting to consumers desperately cheaper alternatives.”
Speaking on this occasion, Executive Director of PRIME, Dr Ali Salman explained that “the 68 Billion Dollar black and gray markets are fueled by high taxes, tariffs and duties, because in these times of crippling inflation, citizens have nowhere else to go”.
According to Dr Salman, “Unless we minimize barriers to legal trade, the government of Pakistan has no chance of generating enough growth to raise required tax revenues and is set on a clear path towards bankruptcy”.
In Pakistan, the shadow economy is already equal to about 40 percent of GDP and significant levels of illicit trade can be found in many key economic sectors, including food fraud, illicit petroleum pesticides, counterfeiting, and trade in falsified and substandard pharmaceuticals. Discussants at the forum delineated the challenges faced in tackling illicit trade across sectors.
- It is estimated that 40 percent of the medicines sold in the country are counterfeit or substandard. Illicit trade in pharmaceuticals will need to be addressed from different angles, including amending the existing regulatory framework and undertaking aggressive law enforcement measures.
- Manufacturers of illicit pesticides have recently been the target of government investigations, with recent seizures of large quantities of illicit pesticides and fertilizers worth millions of rupees. Efforts by the Department of Plant Protection (DPP) to establish a special anti-pesticide adulteration campaign can usefully shut down the production and distribution of illicit pesticides and can also improve agricultural production and economic development.
- More than half of the cigarettes consumed in Pakistan are sold without the payment of taxes, leading to annual losses of tax revenues of around USD 860 million. Since the recent imposition of federal excise taxes, the share of illicit cigarettes has jumped to about 67 percent of the market. Government efforts to implement track and trace systems have been somewhat effective but have only captured a fraction of the tobacco market. Greater enforcement of the track and trace system can help ensure that tax revenues due to the government will be collected.
- While historically most of the fast-moving consumer goods purchased in Pakistan were imported from China, there has been a noticeable increase in local manufacturing of counterfeits in Pakistan. This makes counterfeiting far easier and has increased the magnitude of counterfeit products in the market. Pakistan needs to look at counterfeiting and illicit trade as a serious criminal issue. And, unless the circumstances are dealt with, counterfeiting and illicit trade will continue to be the biggest hurdle in the revival of the Pakistan economy.
“These illicit markets have plagued the country for years – perpetuating a vicious circle of associated money laundering, organized crime, corruption, and tax evasion,” said Mr. Hardy. “We are pleased that the government is stepping up law enforcement against smuggling, money laundering and black marketers.”
Tax evasion is also a major problem in Pakistan, undermining its capacity for fiscal resource mobilization, especially when it amounts to as much as 6 percent of GDP. Tax evasion related to illicit trade in tea, tires and auto lubricants, and pharmaceuticals has grown to about PKR160 billion per year. The unregulated, untaxed illicit trade in cigarettes, which had increased about 10 percent over the last few years, now drains PKR 240 billion from fiscal revenue collections.
“Improving enforcement and tax collections can help mobilize domestic revenues without the need to raise taxes, which could stifle growth and the fragile economic recovery,” said Mr. Hardy. “Additional revenues resulting from tighter compliance with existing taxes and track and trace systems can help preserve economic stability and enhance debt sustainability.”
TRACIT and the Prime Institute also signed a Memorandum of Understanding establishing a framework for cooperation to mitigate illicit trade in Pakistan. Among the agreed areas for collaboration will be the development of a new, in-depth investigation of the size, scope and associated negative impacts of illicit trade on the Pakistan economy.
“One of the main takeaways from today’s meeting is the urgent need for more information and a better understanding of the drivers of illicit trade in Pakistan,” said Dr Ali Salman, Executive Director of the Prime Institute.
“We look forward to working with the Pakistan government and will leverage on the international expertise of TRACIT to start a research and advocacy agenda to implement comprehensive policies that consider the potential impact on all sectors of the economy and work to reduce the incentives for criminals to engage in illegal activities.”
Dr Ali Salman highlighted that “Smuggling is growing faster than legal trade and presently stands at 20% of GDP, indicating that formal markets are unable to meet the increasing demand of the Pakistani middle class. who are willing to take high risks to avoid the excessive cost of taxes and tariffs.
About TRACIT: The Transnational Alliance to Combat Illicit Trade (TRACIT) is an independent, private sector initiative to mitigate the economic and social damages of illicit trade by strengthening government enforcement mechanisms and mobilizing businesses across industry sectors most impacted by illicit trade.
About PRIME: The Policy Research Institute of Market Economy (PRIME) is an independent economic policy think tank based in Islamabad.
Contact: Cindy Braddon, Head of Communications and Public Policy, TRACIT, Tel: +1 571-365-6885 / cindy.braddon@TRACIT.org / X: @TRACIT_org. The full report and associated content are available at www.TRACIT.org.
SOEs continue to strain public finance; privatization is inevitable
SOEs continue to strain public finance; privatization is inevitable
The government provided financial support of Rs. 1.93 trillion to SOEs during FY 2019-22 to keep them operational. The power sector posted a loss of Rs. 321 billion, while the infrastructure, transport, and communication sector posted a loss of Rs. 295 billion.
PRIME has published its quarterly assessment report, Prime Plus April 2024, which analyzes the financial performance of State-Owned Enterprises (SOEs) in Pakistan. The report evaluated the financial performance of SOEs and the private firms operating in the oil and gas marketing sector, banking sector, steel sector, and power generation sector.
The Power Sector and Infrastructure, Transport and Communication (ITC) Sector were the major contributors to the overall loss, incurring losses of Rs. 321 billion and Rs. 295 billion, respectively, during the fiscal year 2022. On the loss-making side, seven out of the ten largest loss-making SOEs are DISCOs, while the remaining three entities belong to the ITC sector. The combined losses of DISCOs amounted to Rs. 375.81 billion in FY 2022 alone. Pakistan Steel Mills incurred a loss of Rs. 206 billion from 2019 to 2022. In contrast, the Oil and Gas sector, a highly regulated sector, stands out as the most profitable segment within the SOE portfolio.
The report highlights vulnerability to external shocks emanating from wars. The continuity of the Russia-Ukraine war and unbated Gaza genocide may promote uncertainty throughout the world. These wars have affected trade in the Mediterranean Sea, which could result in disrupting the supply chain. Externally, the financial obligations due to debt and imports will keep the exchange rate under stress as the foreign exchange reserves are merely sufficient for two months’ imports. It is pertinent to highlight that a market-based exchange rate is the only way to promote economic sustainability.
Domestically, public finance is under pressure due to higher expenditures and lower revenue collection. FBR collected Rs. 2,241 billion in the third quarter of FY 2024. During the first nine months of FY 2024 (July-March), FBR collected Rs. 6.710 trillion, beating the Rs. 6.707 trillion target by Rs. 3 billion. Compared to revenues, the total government expenditure increased by 49 percent to Rs. 7,532 billion against Rs. 5,058 billion in the first seven months of FY 2023.
In the third quarter of FY 2024, total government borrowing increased by Rs. 2,490 billion compared to an increase of Rs. 1,959 billion last year. At the end of the third quarter of FY 2024, total government borrowing was cloaked at Rs. 28.2 trillion. The government borrowing from the scheduled banks increased by Rs. 1,405 billion in the third quarter of FY 2024. The central government’s total debt stood at Rs. 64.8 trillion, out of which domestic debt is Rs. 42.7 trillion and external debt is Rs. 22.1 trillion.
Inflation remains a challenge for the government. People face continuous declines in their purchasing power. In the third quarter of FY 2024, the average CPI inflation stood at 24 percent compared to 31.5 percent in FY 2023. The inflation in the first nine months of FY 2024 stood at 27.06 percent. The underlying cause of inflation is the higher growth in the money supply compared to the growth in the supply of goods.
The government needs to ensure efficient allocation of resources and reevaluate its spending patterns. The government cannot continue to support loss-making SOEs and should prioritize the privatization of the highest loss-making enterprises. An increase in revenue generation has been observed, but the government should refrain from increasing tax rates and focus on broadening the tax base. This could be accomplished through a flat, low-rate, and broad-based taxation system.
The report is available on PRIME’s website and can be accessed by clicking here
For further information, contact our communications officer Mr. Farhan Zahid at farhan@primeinstitute.org or call +92 331 522 6825.
Sound money needed for stability
Sound money needed for stability
Economy is struggling with low growth as it lacks prerequisites for prosperity
Author: Dr Ali Salman & Dr Wasim Shahid
In his 2011 article, Dr Muhammad Yaqub, the former governor of the State Bank of Pakistan (SBP), emphasised the need for controlling money supply to maintain its soundness.
PRIME’s report on Sound Money, which evaluates Pakistan’s monetary stability and analyses macroeconomic policies that have shaped its current state, echoes the same.
Pakistan’s economy is struggling with low growth due to a lack of necessary prerequisites for economic prosperity. The path towards prosperity is determined by the functioning of markets, which requires economic freedom for its agents.
Economic freedom is defined as the degree to which individuals’ property rights are respected in society. Money is a property held by almost all individuals, as market transactions now take place in exchange for money.
To ensure property rights over money, macroeconomic policies must maintain its soundness. In the modern world, a country’s money is sound if its value remains stable against domestic and foreign goods, services, real and other financial assets.
The Fraser Institute of Canada uses the Economic Freedom Index to evaluate and rank countries based on their economic freedom. The index consists of five categories, including sound money.
According to the latest annual report, Pakistan ranks 123rd out of 165 countries with a score of 5.98/10. Unfortunately, Pakistan’s rank for sound money is even worse, standing at 150th out of 165 countries with a score of 6.37/10.
Pakistan has maintained an average score of 6.22 for sound money from 2001 to 2023, with the highest score of 6.83 observed in 2002 and the lowest score of 4.60 in 2023.
From 1974 to 2023, the purchasing power of money for the goods and services included in the Consumer Price Index (CPI) basket decreased by a factor of 68. Similarly, the value of one US dollar went up from less than Rs10 in 1974 to Rs248 in 2023, leading to a 25-fold loss in the rupee value.
This monetary fragility can be attributed to excessive monetary growth, where broad money (M2) has grown significantly faster than the real and nominal gross domestic product (GDP).
Over the past 50 years, the real GDP increased by 10 times and the nominal GDP increased by 644 times, while money supply expanded by over 1,000 times.
The report reveals that the government is mainly responsible for the unsoundness of money due to the inefficient mix of monetary, fiscal, and exchange rate policies. Specifically, the rate of monetary expansion has been out of sync with economic fundamentals.
Pakistani government has historically relied heavily on borrowing from the SBP to finance its budget, leading to an unsustainable monetary expansion. Although the amended SBP Act has limited the government’s ability to issue debt to the central bank, monetary expansion has continued.
The SBP has attempted to control inflation and currency depreciation through a reactionary approach, using interest rate as its policy instrument. However, this approach has been unsuccessful, as keeping market interest rates close to the SBP policy rate makes it difficult to control money supply.
If the government, the lead borrower in the market, does not reduce its demand for funds in response to interest rate hikes, achieving the interest rate target becomes challenging. The SBP has to provide necessary liquidity to the market to achieve short-term interest rate targets, making it impossible to control monetary expansion.
The government’s fiscal branch is often held responsible for monetary expansion, resulting from increased spending without the matching revenue. While this argument holds, the federal government is currently caught in a cycle of debt accumulation.
The seventh NFC Award increased the share of provinces compared to the federation, which may be desirable but has made the federal government vulnerable to shocks. The delay in implementing reforms to reduce the size of the federal government in accordance with the 18th Constitutional Amendment exacerbated the problem.
After paying the provinces their due share, the federal government is left with limited resources that are hardly sufficient to service its debt. Debt servicing being charged expenditure is paid first, leaving the government with no room to provide public goods.
Moreover, the government has to borrow more to service its debt when the SBP raises interest rates to control inflation. This borrowing strains the market for loanable funds, prompting the SBP to inject liquidity. Hence, the money supply expands despite the government being barred from directly borrowing from the SBP.
A comprehensive reform agenda is required to improve Pakistan’s money stability. This includes reducing the size of the government, coordinating fiscal and monetary policies more effectively, managing debt efficiently, and creating an environment that promotes sustained and inclusive economic growth.
Reviewing the current monetary-fiscal policy mix and determining an appropriate operating instrument for the State Bank to limit monetary expansion and maintain its autonomy is crucial.
The practice of expanding money supply in response to government borrowing from scheduled banks while setting the policy rate to contain inflation is not productive.
The government has to comply with the Fiscal Responsibility and Debt Limitation Act, and an accountability mechanism should be in place for non-compliance..Dr Ali Salman is the Executive Director of PRIME and Dr Wasim Shahid Malik is a PRIME fellow. He is the author of the report “Pakistan Economic Freedom Audit: Sound Money as a Case Study”
The article was originally published in "The Express Tribune" on April 15, 2024.
Pakistan Economic Freedom Audit – Report Launch
Pakistan Economic Freedom Audit -Report Launch
The Policy Research Institute of Market Economy (PRIME), in collaboration with the Atlas Network, hosted a report launch event for the ‘Pakistan Economic Freedom Audit: Sound Money as a Case Study.‘ on 29th, March 2024.
The event featured speakers including Dr. Ali Salman, Executive Director of PRIME, Dr. Wasim Shahid, the report author, and Dr. Nadia Tahir, Economist. The audience included a diverse group of professionals from academia, government, media, and field experts.
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PRIME Report: Assessing Pakistan’s Economic Freedom with a Focus on Sound Money
Report: Assessing Pakistan's Economic Freedom with a Focus on Sound Money
The Policy Research Institute of Market Economy (PRIME), in collaboration with the Atlas Network, has published a report titled “Pakistan Economic Freedom Audit: Sound Money as a Case Study,” delving into Pakistan’s economic freedom with a focus on monetary stability.
Authored by economist Dr Wasim Shahid Malik, a fellow at PRIME, this study thoroughly explores Pakistan’s financial system, emphasizing the stability of its money. It also evaluates the effectiveness of the Sound Money sub-index in measuring economic freedom, using the Fraser Institute’s Economic Freedom Index. The report finds that Pakistan’s sound money rating has consistently been low and has further decreased due to high inflation in 2023, resulting in its lowest rating to date. Over the past 50 years, the Pakistani currency has lost 68 times its value against a typical consumer’s basket and has depreciated 25 times its value against the US dollar.
“Recent assessments reveal that Pakistan’s sound money rating for 2023 is 4.60, which is the lowest in Pakistan’s history, primarily due to exceptionally high inflation during the year,” says the report.
According to the report, monetary fragility is primarily caused by excessive monetary growth that exceeds GDP growth. This growth in the money supply is due to a lack of fiscal discipline, as the government has been borrowing heavily from the State Bank of Pakistan. Despite the amendment to the SBP Act, the government continues to borrow heavily from commercial banks due to a high fiscal deficit and higher interest rates. This, in turn, crowds out the private sector, limits economic activity and lowers the value of money. Maintaining the money market interest rate close to the SBP policy rate, while the government continues to borrow and spend, SBP provides liquidity to commercial banks who lend it to the government. Additionally, the report identifies exchange rate overvaluation as another contributing factor to monetary fragility. Historically, the exchange rate has been kept overvalued, leading to unsustainable trade deficits and continuous reliance on external borrowing. This has resulted in recent exchange rate depreciation, which has made the country’s currency value unstable against foreign currencies.
The report recommends improvements in the methodology used to measure the Sound Money Sub-index of the Economic Freedom Index. It also proposes a comprehensive reform plan to maintain the stability of the country’s money value. The report suggests a number of measures, including rationalizing the size of the government, implementing an efficient and fair revenue mobilization system, adopting an effective monetary policy to control inflation, ensuring effective coordination between monetary and fiscal policy, demonstrating a strong commitment to the Fiscal Responsibility and Debt Limitation Act, setting up an accountability mechanism for fiscal authorities not adhering to the FRDL Act and for monetary authorities not controlling inflation, and limiting the government’s intention to keep the exchange rate overvalued.
The report is available on PRIME’s website and can be accessed by clicking here
For further information, contact our communications officer Mr. Farhan Zahid at farhan@primeinstitute.org or call +92 331 522 6825.
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