• 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.

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 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.