Olive story – how to harness potential?

29/03/2022by PRIME Institute PRIME Institute No Comments

Olive story – how to harness potential?

Ali Salman

With 4m hectares identified for olive plantation, country can become major player in long run

TUNIS: Tunisian city famous for olives and olive oil where I was invited by one of the world’s largest producers of organic olive to visit their mill and processing facilities. In about 20 years since its formation, the company has achieved global leadership with annual production touching 50,000 tons of olive oil. There is a lot that Pakistan can learn as it has set its eyes to enter the competitive olive market.

The recent bilateral interest between Tunisia and Pakistan to enhance economic cooperation offers a fertile ground for both countries. For at least the last 15 years, the government in Pakistan has provided support to olive growers in the form of free plants, subsidised drip irrigation system and other facilities. It has even brought olives processing machines, which are available free of charge to the growers.

According to the government, 4 million hectares of land has been identified in Pakistan which is suitable for olive cultivation. Spain, the world’s largest olive oil exporter, which has almost 40% of global market share in exports, has around 2.5 million hectares of land for olive cultivation. Pakistan imported around 4,000 tonnes of olive oil in 2020, and locally produced 1,000 tonnes last year. Also, Pakistan is anticipated to import 3.7 million tons of edible oil in the current year.

These figures are clearly indicative of the huge gap that exists and suggest high level of potential demand for Pakistani olive oil – initially domestically, and then in the international market. Tax holidays on the import of machinery for olives, rupee depreciation and CPEC are all major factors that may contribute to increase in olive oil production by local companies.

In addition to the potential areas for greenfield projects, estimates have revealed that if 8 million wild olive trees in different provinces are grafted and converted into productive olive, there is a huge potential for earning export revenue. The government’s initiative in 2016 to launch an ‘Olive Valley’ programme in Potohar grew 1 million olive trees on 8,000 acres. Some 750 farmers worked on the programme to produce olive oil.

The government also plans to issue certifications for the marketing and branding of olive oil by the private sector. The project targets plantations over 50,000 acres in the country by 2022. There are many small-scale olive growers in Pakistan, and some of them have started branding and selling them locally. Local producers and sellers are now marketing Pakistani extra-virgin olive oil in the niche domestic markets.

Their pricing strategy largely follows the imported brands. With 12,000 hectares under plantation of olive plants already, and with 4 million hectares of land identified for olive plantation, Pakistan has the potential to become a major player in the long term. However, it needs patient investment, rigorous planning and vigilant execution over the next couple of decades. Thanks to a supportive government, the unmet demand and vast supply of land and olive plants, Pakistan may become the next olive story of the world. There are some major challenges.

First, it is the economies of scale without which it is not likely to reduce the current high level of cost – and hence high prices. This can only be done through land consolidation and corporate farming. Second, quality assurance and standardisation of labels is critical for winning customer trust. Third, investment in branding is an important precondition for getting market share. Fourth, investment in olive demands patient investment – it cannot yield even full-scale production in the first five years and earning of income only follows that.

Lastly, and most importantly, if we cannot sell olive oil at a price which is competitive in terms of substitutes, then this story will not go beyond hypes – of which we have seen a lot lately. The oft-repeated “Pakistan mein bara potential hai” (Pakistan has a lot of potential) is an over-rated statement of half-truth. One needs a realistic assessment and hard work before realising the potential. Pakistan’s emerging olive oil sector presents a similar potential but hopefully it will not face the same fate as others.

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

Published in The Express Tribune, February 28^th, 2022.

Cost of welfare policy

28/02/2022by PRIME Institute PRIME Institute No Comments

Cost of welfare policy

Ali Salman

Welfare is not free as someone always pays cost of this system

***Elderly women from Younisabad meet every two months since 2019 to discuss implementation of the Sindh Senior Citizens Welfare Act, 2014 that still remains pending. PHOTO: Sameer Mandhro***

ISLAMABAD: Welfare is an elusive term. Politicians talk about welfare all the time and seek votes on the basis of providing welfare to the masses.

There is a popular concept of a welfare state, which supposedly can take care of the masses, say through the provision of unemployment allowance or subsidies or food.

However, it is obvious that despite being packaged as free, or subsidised, welfare is not free. Someone always pays the cost of this welfare.

It’s a question of resource allocation and market structures who gets benefits and who pays costs. Academically speaking, welfare economics deals with this and considers policies which can maximise benefits for all or most members of a society.

Distribution of welfare usually takes the form of allocation of resources towards a specific component of population.

Take one example – the subsidy or concession for housing loans. Ownership of houses has become difficult for the present generation, which increasingly comprises nuclear families.

In a recent PIDE publication, the popular notion of shortage of 10 million houses is contested, citing 70% home ownership at the national level as per PSLM 2019-20.

However, the government has announced a programme of constructing or facilitating the construction of five million houses. Following this target, the government announced various fiscal and monetary incentives in an effort to correct “market failures”.

It announced a major amnesty scheme to attract investment in real estate. It also set mandatory lending targets for commercial banks.

To date, with Rs38 billion disbursed, the Mera Pakistan Mera Ghar financing scheme has benefited not more than 10,000 households.

On the other hand, prices of land, which takes as much as 80% of the cost of a house in a city, have risen by 60% for everyone in cities like Lahore and Islamabad in just two years.

This has resulted from an unusual flow of capital in real estate – according to a recent news report, as much as $19 billion has been buried in empty urban plots in 2021 alone.

This is the direct consequence of a policy defined by tax exemptions and fiscal subsidies.

Lesson 1: The welfare policy in the name of poor people has benefited a few thousands while causing losses to millions of people.

A majority of households would have benefited in the absence of these incentives and especially through reforms in building regulations.

Another example of welfare policy is the universal health insurance – the Sehat Sahulat Card, which has provided Rs1 million medical insurance to all eligible citizens in Punjab and Khyber-Pakhtunkhwa.

This has been generally lauded by all. However, with a careful look – and as some time passes by – the problems in the universal medical insurance will become clear.

The government will find it impossible to fund the programme on its own very soon while the public health system will deteriorate.

A differently designed health protection programme would have led to the flow of greater investment in the public healthcare system.

A small admission fee is affordable by all and should be charged without exception. The government should have left insurance to be managed by the private sector.

This is how resource allocation and adjustment with market structures can work to maximise welfare for most of the population at the least cost.

Lesson 2: A universal and publicly funded health insurance is a bad idea and the government can achieve more by investing in the public healthcare system.

Another popular example of a welfare policy is price control. The prime minister and federal cabinet keep monitoring prices of fruits and vegetables – with noble intentions.

The government has established price control committees and hired more price inspectors than before.

Prices are only going up. If the government were to focus on a two-pillar strategy – invest in agricultural productivity and allow border trade, it would have provided both short-term and long-term solutions.

On the other hand, price controls have made sure no one invests in agriculture, thus undermining the major goal of keeping prices low.

Price controls provide clear signals to investors and traders – do not enter into the business.

Lesson 3: Price controls distort welfare.

Welfare policies must be put to a simple theoretical question of efficiency and incentives. To bring in welfare economics once again, one can look at the economic surplus – the sum of consumer surplus and producer surplus.

I will also add a fiscal equation here given our constraints and would caution against any policies becoming a fiscal burden.

As three examples above indicate, in each case, welfare policies have distorted incentives and have contributed to the reduction of welfare in fact. This is why, it is very difficult to design a welfare programme which can ensure increase in the overall welfare without greater loss.

A wiser option for a government may be actually do no welfare at all, especially if it poised to do more harm than good.

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

Published in The Express Tribune, February 28^th, 2022.

Should IMF define Pakistan’s economic policies?

14/02/2022by PRIME Institute PRIME Institute No Comments

Should IMF define Pakistan’s economic policies?

Ali Salman

Agreement with lender driving country’s economic direction, targeted reforms

The latest IMF Country Report on Pakistan is out, and $1 billion are in.

The report’s language is largely critical and cautionary. Whether one agrees with the IMF programme or not, one thing is clear – Pakistan’s economic direction, policy discussions and targeted reforms are all driven by the agreement with the IMF.

Anyone wishing to understand what our economic managers are deliberating or planning just needs to read the 34 pages of IMF report.

Everything, including taxation policies, housing finance policies, social protection programmes, and development spending has to follow the guidelines as defined in this document. Any policies or allocation not consistent with the IMF guidelines will be reversed.

Consider. There has been a heated media debate on the State Bank autonomy bill, which has already been passed by parliament. IMF’s prescription prevailed.

The government announced a major housing finance programme one year ago with unprecedented allocation of Rs30 billion as subsidy, which now risks reversal or reduction as the IMF staff disagrees with it.

To improve fiscal space, the country needed to surpass tax collection targets. A mini-budget was passed and the FBR is likely to exceed its collection target now.

By setting policy targets, the IMF has defined policy debate also – or at least the debate that the government will be keen to listen.

There are five dimensions. In IMF’s own words, these are (i) reinforcing fiscal discipline by mobilising revenues and controlling current spending (ii) ensuring disinflation through a tighter monetary policy stance; (iii) maintaining market-determined exchange rate and building external buffers; (iv) restoring financial viability of energy sector; and (v) advancing structural reforms, including by addressing deficiencies in AML/CFT regime, SOE governance, and business climate, as well as stepping up to the challenges posed by climate change.

Let me simplify. To remain in the IMF programme, the government must increase tax rates and cut state spending, increase interest rate further, keep exchange rate free floated, increase energy tariffs, and close down state-run companies.

All of these measures will result in fast deterioration of political capital and increase in public dissonance that the government is visibly experiencing.

Hypothetically speaking, one can get out of this “bondage”, by not agreeing to accept $6 billion in the first place, from which $3 billion is yet to be received.

With the remittance and export receipts expected to gross over $60 billion this year, and balance of payments cushion available through FDI, Roshan Digital Accounts and bilateral loans from countries like China and Saudi Arabia, Pakistan will not experience any major difficulty if it does not receive $1 billion of the IMF fund in one year.

The problem does not lie in finances. The problem lies in how to understand our economy and a missing credible resolve to put our house in order.

If we cannot understand, for example, what are our housing needs, we remain gullible to a political fiction – called construction of 5 million homes.

This target has no relationship with the demand from an increasingly mobile and dynamic population.

By allocating resources to concessionary financing for real estate, the government has done developers, especially the elite developers, a major favour. Real estate prices have skyrocketed and land has become unaffordable.

Fiscal and monetary measures were grossly misplaced. The IMF staff is right in asking to reduce and reverse this bonanza. It is, at the end of the day, a lender only and not an agency for housing policy.

Take another example. Pakistan needs more fiscal resources and also needs to stop leakage of hundreds of billions of rupees channelled through SOEs.

To close down inefficient state-owned enterprises is hard. To come up with an equitable tax mechanism is harder. The easier option to increase government resources is to increase the tax rates.

All that it takes is changing input figures in an excel sheet in a computer in the Q-block. This is the genesis of the mini-budget.

As a lender, the IMF does not, and should not, care about where the money comes from. It will care about performance criteria and structural benchmarks. Where the actual performance is missing, the commitment to future reforms is good enough reason to qualify for waivers.

Should we blame the IMF? Far from it. If I were Pakistan’s finance minister, I will actually follow the broad IMF guidelines – without asking for its funds and hence will define my own strategy, pace and priorities.

I will bring in a broad-based, low-rate regime instead of just hiking rates. I will figure out how to use the policy to unlock the dead land in cities. I will preserve the SBP policy autonomy and will reduce its operational autonomy.

These reforms need systematic thinking and research, otherwise they will be short-lived and will never get local ownership. While we continue to outsource policy and research to lenders, we will keep passing on the blame to them.

IMF is not right or wrong. It is the government approach to policy which can be right or wrong. It has the agency to design a reform programme which can work for Pakistan. It has stopped exercising this agency.

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

Published in The Express Tribune, February 14^th, 2022.

Economy – looking beyond numbers

17/01/2022by PRIME Institute PRIME Institute No Comments

Economy - looking beyond numbers

Ali Salman

PM and his team need to pay more attention to job creation, increase in real income

ISLAMABAD: In his speech to a gathering of more than 60 business leaders from all over Pakistan last week, Prime Minister Imran Khan gave an overall account of economic progress under the Pakistan Tehreek-e-Insaf (PTI) rule.

He mentioned various “historical records” – exports of $31 billion, remittance flows of $32 billion, tax collection exceeding targets, large-scale manufacturing growth of 15%, corporate profit of Rs930 billion, private sector credit of Rs1,138 billion, IT sector exports of $3.5 billion, and finally inflows of Rs1,100 billion into the rural economy.

At the outset, all of these numbers can be verified as correct. The devil, as they say, lies in detail. Let’s take exports. The sharp increase in the dollar value of exports has created an erroneous perception that the policies are finally delivering.

For example, the policymakers have interpreted the year-on-year increase of 28% in the dollar value of textile exports during the first five months of fiscal year 2021-22 as evidence that existing subsidies such as the preferential energy tariff have been successful in meeting their intended objective.

On a careful look, and contrary to the perception of policymakers, the independent Economic Advisory Group (EAG) finds that the increase in dollar value of exports has little to do with these policies.

One of the EAG members, Ahmed Pirzada, has used the publicly available data on textile exports to decompose the increase in dollar value of textile exports into price and quantity effects. The analysis shows that out of the $1.7 billion increase in textile exports during Jul-Nov 2021, more than two-thirds is simply due to an increase in international prices. In other words, had international prices remained the same as in the previous year, the dollar value of textile exports would have increased by only 7.8%. Changes in world economic conditions have also played an important role in driving the quantum of exports.

For example, the drop in world economic activity during Covid led to a 25% drop in exports relative to the trend. However, the sharp recovery in world economic activity since then has had a positive effect on Pakistan’s export performance during most of fiscal year 2020-21. Let’s take up remittances. It needs to be acknowledged that increasing the flow of remittances has been very helpful for Pakistan to manage its current account deficit.

On the other hand, it is well argued that it acts as the Dutch Disease, whereby windfall revenue gains can erode or reduce a country’s competitiveness.

The overflow of remittances can lead to an increase in the Real Effective Exchange Rate, reducing trade competitiveness. It also reduces the pressure for reforms, especially in the area of taxation and tariffs. This point needs careful empirical examination.

Now take taxes. It is true that the Federal Board of Revenue (FBR) has exceeded the tax collection target by Rs282 billion. However, the contribution of income tax to this increase is only Rs5 billion and the balance mainly comes from sales tax at the import stage and customs duty.

In terms of revenue collected at the import stage, and its share in the total tax revenue, Pakistan is probably on top of the world. It is not only regressive but also creates cash flow problem for the industry.

There is no doubt that large-scale manufacturing activity has picked significant pace, and that is something we need to appreciate. The private sector credit offtake is also showing progress. Similarly, IT sector is performing well, which is contributing to growth and job creation. Also, the growth in the agriculture sector has increased rural income considerably, though its distributional effects need to be examined.

Where the prime minister and his team need to pay more attention is job creation and increase in real income, which comes on the back of productivity. While listening to the PM’s speech, I realised that while the government spends considerable time explaining how Ehsaas – the social protection programme with a budget of Rs260 billion – is helping the low-income class, it glosses over big-ticket items. Pakistan needs to create far more jobs, and more well-paying jobs than it is doing now. Opportunities can be created by aligning incentives with efficiency and productivity. We should not be content with just an increase in the level of production – whether in the number of cars or quantity of crops. While these increases are helpful, the real income will rise by transforming our way of doing government – and business, and by increasing productivity.

It is not about leaving agriculture and jumping to the IT bandwagon. It is doing better in whatever we produce – and to begin with – from agriculture and agro-based products. That is the play of both the government and the private sector.

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

Published in The Express Tribune, January 17, 2022.

From economic growth to transformation

20/12/2021by PRIME Institute PRIME Institute No Comments

From economic growth to transformation

Ali Salman

It calls for grand re-look at allocation of resources including public spending, taxes and tariffs

ISLAMABAD: Economists in Pakistan generally agree that the country has followed a boom-bust cycle of economic growth throughout its history.

While the long-term average growth rate is a respectable 5%, the cyclic nature of this growth, largely propelled by external finances, has always led to macro imbalances. That, in turn, has forced successive governments to seek bailout from the IMF that has always started from stabilisation.

We have run this model for 22 times. If the current trends continue, we will do it again.There is something deeply wrong in our growth model, or indeed in how we understand growth. The underlying driver of growth has never been productivity, which is why it is always short-lived and uneven.

Moreover, its distributional impact on both businesses and poverty remains questionable.

Our productive structure remains ossified, exhibited in a very narrow export basket. Our average income has not increased much and in recent years, we have begun to fall behind regional peers. Lastly, the public finances have remained in shambles, with the increasing portion of tax revenue being allocated to service our debt.

Dr Hafiz Pasha has already predicted that soon 100% of tax revenue may have to be allocated to debt servicing. We both pray it proves to be wrong.

There is no short-term respite from this crisis. In the medium to long term, we must transform our economic model. For that to happen, we need to change our narrative from growth to transformation.

We have seen far too many episodes of borrowed growth, whether it is funded by consumption, investment or debt. Each time, we have successfully managed the cash flow crisis to live to another day. Transformation was never our need. I believe we have reached the brink now.

The recently launched document, “New Vision for Economic Transformation: Rethinking Resource Allocation and Productive Structures” by the Economic Advisory Group, offers a solution. It analyses the factors hindering the efficient allocation of resources, hence contributing to economic slowdown, and presents practical suggestions.

It builds on a number of good studies, which have been done in recent years, and presents a coherent framework for policy debate. The suggestions put forth in the document are organised under four themes: revisiting the pricing regimes that currently govern agriculture and commodities’ sectors; revamping the education system with the aim to introduce and mainstream pathways for vocational training at the level of higher and post-secondary education; reduction in tariff and non-tariff trade restrictions and greater integration with the regional trade blocs; and, finally, rethinking the industrial policy with special emphasis on moving away from picking winners to rewarding innovators, improving land use within cities, and simplification of the tax code.

Examples of success

To naysayers, let me offer two good examples. The liberalisation of our motorbike industry 20 years ago opened up the sector for new investors and manufacturers.

Our annual production went up manifold from around 50,000 in 2000 to above 600,000 in 2008 and crossed 1.3 million in 2020. This phenomenal increase was accompanied by a downward pressure on prices. The motorbike assembled in Pakistan with the leading brand name was sold for Rs70,000 in 1999, which I remember paying as I bought my own two-wheeler after graduation.

The amazing fact is that it was still available at the same price in 2018. In fact, now Pakistani consumers can afford to buy a motorbike at almost half the price of the leading brand.

Another example. In the last three years, Pakistani footwear sector has registered a stunning growth and may reach $1 billion in exports by 2027. One major policy change that enabled this growth was slashing down import duties on industrial raw material in 2018-19. Once the government was convinced of giving up a portion of its customs revenue, it enabled the private sector to grab the opportunity. It already had the necessary manpower and skillset.

In just three years, the production has registered a 50% growth. This can be done in all other sectors.

In both examples, what we witnessed was not just growth but also sectoral and structural transformation. Growth eventually followed, but it is a sustainable growth. Transformation bears fruit for businesses as it helps create opportunities. It leads to more job creation, which helps in social harmony. It facilitates the government in changing its revenue basis – from dependence on indirect taxes to shift to direct taxes, which is more equitable.

While these are great examples of success, our large-scale sectors, particularly in agriculture and industry, have remained in protected walls.

Without altering the productive structure of our economy, and without letting some of them to fail, we cannot hope to improve the livelihood of our masses. The best welfare regime is the creation of productive and well-paying jobs. To change the productive structure, we need to change how we distribute incentives. When we withdrew incentives available to one or two motorbike assemblers, through protected tariffs, we experienced transformation and growth.

When we altered our import substitution to export-led model in the footwear sector, we again saw transformation and growth. Transformation is not just about liberalisation, which is a necessary but insufficient condition. It is about a grand re-look at how we allocate and re-allocate our resources including public spending, taxes, tariffs and regulations. It is not a pipedream. We have already begun doing it.

The writer is the founder of PRIME Institute and a member of the independent Economic Advisory Group

Published in The Express Tribune, December 20^th, 2021.

Laffer postulates: a way out of economic conundrum

22/11/2021by PRIME Institute PRIME Institute No Comments

Laffer postulates: a way out of economic conundrum

Ali Salman

Economist suggests low tax rates, spending curbs, free trade, selling bleeding SOEs

to meet another imf condition the federal cabinet approved state owned enterprises soe bill to revamp the existing management structures of these enterprises photo file — ***To meet another IMF condition, the federal cabinet approved State-Owned Enterprises (SOE) Bill to revamp the existing management structures of these enterprises. PHOTO: FILE***

ISLAMABAD: Arthur Laffer’s name is no stranger to economics. Known as creator of the “Laffer Curve” and the “Father of Supply-Side Economics”, the maestro was in Islamabad recently.

During his keynote address at the Pakistan Prosperity Forum, Laffer outlined six pillars of prosperity: low rate and broad-based flat taxes, spending restraints, sound money, reduce excessive regulations, promote free trade, and privatise the bleeding state-owned enterprises (SOEs).

An additional postulate in this presentation was redefining building codes, which impede economic activities in urban centres. In this article, we present his main postulates and briefly relate them with Pakistan’s situation.

Taxes used as a tool for expanding government services create hurdles in the way of businesses and put extra burden on the people. The purpv ose of tax is to discourage bad behaviour like curbing smoking by imposing taxes.

He said, “When we tax income, then earning more becomes less attractive, and economic activity declines.”

Higher number and rates of taxes have contributed to lower compliance and surging evasion in the country. Currently, 7.1 million people are registered with the Federal Board of Revenue (FBR) and only 3.1 million are filing annual tax returns while 4 million are evading taxes and the FBR is lacking capacity to bring those to the tax net. This manifests flaws in our contemporary taxation system.

Although there has been some improvement in tax collection, yet it has not contributed to significant changes in the underlying tax structure.

Laffer believes “the size of governments is increasing in the world and taxes are imposed to finance those expenses. Pakistan with low per capita income should not be spending more as government expenditures by generating revenues through taxes”.

The sugar industry of the country manifests inefficiencies emanating from excessive state regulations. From the crop sowing area to wholesale and retail prices, everything is determined by the government through administrative bodies at federal and provincial levels.

Yet, the price of the commodity increased sharply by 127% in the last three years from Rs55 per kg in December 2018 to Rs125 per kg in October 2021. This calls for the reduction in regulations and moving towards free market.

The total debt accumulated by SOEs amounts to Rs1.97 trillion. When annual losses of SOEs and tax exemptions are included, we will see a significant amount.

In addition, despite the closure of Pakistan Steel Mills in 2015, Pakistani taxpayers spent Rs55 billion over the last five and a half years on salaries of 9,350 workers, many of whom reportedly secured other employment during the period.

The government needs to move away from businesses and proceed with privatisation to make resources available for development. Private sector is better equipped to bring necessary capital to make these enterprises operational and promote their efficiency.

The domestic currency has seen significant devaluation in recent years on the back of unsatisfactory economic performance. Pakistan has not sound money, which creates uncertainty in the business environment.

Laffer said, “There is nothing that can bring your economy to its knees quicker than unsound paper money.”

It is pertinent for growth and prosperity to have a stable currency, which will only happen when businesses prosper and economy activity reaches its potential.

The country is suffering from low productivity and lack of innovation as a result of high trade barriers.

Laffer said, “There are some things we make better than foreigners and there are some things foreigners make better than we do. We and they would be foolish if we don’t sell them those products we make more efficiently than they do and they sell us those products they make more efficiently than we do. It’s a win win. Trade is critical not only to the economy but to prosperity, and it’s also critical to peace on earth.”

It is imperative to review our policies for the promotion of trade, which will only happen when we reduce tariffs and minimise regulatory barriers.

The economic policies of Pakistan should focus on promotion of these pillars to reach our potential. While many economists are saying these Lafferian ideas do not apply anymore, we see their understanding is needed more given where Pakistan’s economy is.

There is no harm in paying heed to one of the most influential economists of the 20th century for a country where economists are mostly busy telling a 19th century state tools for revenue extraction. Let markets work and let fountain heads of prosperity explode. Finally, while people may support free markets in general, when it comes to implementation, they usually try to procrastinate. In Laffer’s view, “Free markets are most needed when you’re in trouble because they are the way out of trouble.”

The writers are affiliated with PRIME, an independent think tank based in Islamabad

Published in The Express Tribune, November 22^nd, 2021.

Tariffs reforms: one step forward, two steps back?

25/10/2021by PRIME Institute PRIME Institute No Comments

Tariffs reforms: one step forward, two steps back?

Ali Salman | Tuaha Adil

Country has failed to diversify its produce as tariff structure restricts innovation, efficiency

the think tank noted that the pti government has laid the ground for tariff policy but trade figures are not showing promising results photo file — ***The think tank noted that the PTI government has laid the ground for tariff policy. But trade figures are not showing promising results. PHOTO: FILE***

ISLAMABAD:

Three years have passed since the Pakistan Tehreek-e-Insaf (PTI) government came to power with the agenda of reforms to remove structural inefficiencies in the economy and put the country on a growth trajectory.

Strengthening trade, revitalising industries and boosting exports are part of PTI manifesto.

Customs tariffs, if effectively employed (or perhaps not used at all), can help in import of innovation, leading to economic growth, whereas their regressive use could erode competitiveness, cause de-industrialisation and push down exports. Clearly, Pakistan’s is a case of latter.

“Make in Pakistan” has been used as a slogan both by businesses and government agencies to gain support and promulgate policies, but the country has failed to diversify its produce because the contemporary tariff structure restricts innovation and efficiency. There is correlation between imports and exports, as the former comprises necessary inputs that will be morphed into value-added commodities for domestic and foreign consumption. But the country is following an import substitution policy, which restricts productive activities, hinders adoption of modern technology, limits competitiveness of domestic industries and creates anti-export bias.

Import substitution is an idea from the 1960s playbook, which has long been shelved, especially in Asian economies, which were later called Asian tigers.

The heart of import substitution-based industrialisation lies in levying protectionist duties and other associated tariff and non-tariff measures. They exponentially increase the value of imports, translate into higher cost of production and deprive manufacturers of necessary capital.

They also diminish the competitiveness of commodities internationally and cause inflation domestically. As a result, Pakistan is in the list of countries having high tariff and non-tariff barriers to trade and its weighted average tariff stood at 12.1%. In contrast, the weighted average tariff of China, Indonesia, Malaysia and even Sri Lanka is 7.5%, 8.1%, 5.7% and 9.3% respectively. Imposition of additional customs duties and regulatory duties makes the gap even wider. In November 2019, a major policy change took place in the form of entrusting the Ministry of Commerce, instead of the Federal Board of Revenue (FBR), the task to determine tariffs. Therefore, a tariff policy board was constituted and the Tariff Policy Centre was established in the National Tariff Commission (NTC) for assistance.

Although NTC was assigned the task to carry out research and formulate proposals in consultation with stakeholders, the Ministry of Finance still played a leading role in the determination of regulatory and other duties imposed during the year.

The PTI government can be credited with the formulation of country’s first National Tariff Policy (NTP), yet implementation of the policy remains to be seen in true sense.

Customs duty on raw material was slashed but on intermediate and final goods it remained unchanged while additional customs duty and regulatory duties were increased, thus making the overall impact insignificant.

The reason behind the myriad duties is the protection of domestic industries from international competition and revenue generation to manage budgetary requirements.

In the framing of country’s trade policy, revenue generation has taken precedence over long-term sustainability and industrial competitiveness, which can be illustrated by the fact that revenue collection at the import stage has stood above 40% of the total FBR collection, ie Rs2,129 billion was collected at the import stage out of total FBR’s collection of Rs4,732 billion in FY21.

On the other hand, continuous provision of protection to industries without realisation of their potential to become internationally competitive has eliminated the incentive to innovate, thereby making them crippled and in need of government support. Subsequently, the transfer of knowledge and technology associated with trade did not happen in the case of Pakistan. NTP envisages reducing complexity in the entire tariff system, but items are frequently moved from one schedule to another through which application of duties remains consistent along with time to time promulgation of SROs, which negates the purpose of creating different tariff slabs, and the implementation has become more intricate.

Moreover, the government has promulgated 43 SROs in the last three years while the PML-N government had promulgated 53 SROs in five years, which created uncertainty and difficulty in the implementation of tariff policy along with making the system more complex.

The application of multiple duties and complexity of the system makes the implementation of policies difficult and leads to the emergence of distortions. It has been globally acknowledged that higher the number and amount of taxes, higher will be the tax avoidance. Similarly, high tariffs have contributed to under-invoicing, mis-declaration of quality and quantity of goods and more importantly smuggling, which is a signal that tariffs are priced too high for customers.

Pakistan’s complex and progressive tariff policy contributes to stagnant exports and requires revision. There are several recommendations:

First, the tariff structure needs simplification through reduction in the number and rates of tariffs. Second, the country needs a comprehensive long-term trade policy to create certainty and provide a road map to businesses, and move away from distortion-creating SROs.

Third, imports translate into exports, therefore, import substitution policy should be rescinded.

Four, tariffs should not be used as a revenue generation tool. Lastly, the protection provided to inefficient industries should be ended to incentivise innovation and adoption of modern technology for higher production and exports.

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

Published in The Express Tribune, October 25^th, 2021.

Free electricity distribution by state

04/10/2021by PRIME Institute PRIME Institute No Comments

Free electricity distribution by state

Ali Salman | Tuaha Adil

Subsidy policy revision, technological solutions can address inefficiencies in power sector

ISLAMABAD: According to a recent report released by PRIME, state-owned electricity distribution companies (DISCOs) have caused a cumulative loss of Rs1,355 billion over the last five years.

This includes the loss due to failure in bill recoveries (Rs495 billion), financial loss due to transmission and distribution loss (Rs195 billion), and tariff differential subsidy (Rs708 billion) over 2016-2020.

This should not be surprising given the inefficiencies with which the distribution component of the power sector is marred with.

It has a direct bearing on under-utilisation of the electricity surplus capacity, which in turn has led to the ever-increasing circular debt and rising electricity tariffs.

Failure on the part of successive governments to take tough decisions has landed the country into this quagmire.

As the report shows, the performance of state-owned DISCOs remains unsatisfactory as they have not met National Electric Power Regulatory Authority’s (Nepra) targets for transmission and distribution (T&D) losses, bill recovery, investment and public safety.

The ultimate burden of the inefficiencies is put on the consumers. The higher cost of electricity and power outages has disrupted economic activities in the country, increased the operational cost of businesses, contributed to sluggish growth in gross domestic product (GDP), and led to a decline in the competitiveness of local industries.

In terms of T&D performance, DISCOs are found to be slightly in breach of Nepra targets, therefore, their five-year accumulated losses reached Rs195 billion.

To keep DISCOs operational, governments are forced to regularly pour in money to bail out the defaulting distribution firms in the form of tariff differential subsidy.

Public safety is a cardinal component of power sector efficiency, but DISCOs’ performance is lacking with total fatal accidents mounting to 680 in five years.

FY21 saw an increase in cases of electrocutions where 185 people lost their lives. The incidence of fatal accidents is contingent upon a number of factors such as the condition of infrastructure, population density, encroachments and planning of cities.

Although there is surplus generation capacity in the country, there is still prevalence of power outages, which manifests inefficiency. DISCOs have shown improvement in curtailing T&D losses while the performance of some companies has deteriorated as per latest Nepra report released a few days ago.

Consumers face average daily load-shedding of more than two hours in jurisdictions of various DISCOs. The indiscriminate power outages in loss-making regions are compelling the compliant citizens to look for alternative sources of uninterruptable electricity, therefore, DISCOs are drawing less power from the allocated quota.

This is further exacerbating the problem of surplus generation capacity and subsequently, the burden will fall on the narrow consumer base in the “take or pay” regime.

There are over 1.2 million pending electricity connections, which suggests a significant level of unmet demand. Delays in the provision of electricity connection put the burden of capacity payments on the narrow consumer base and prompt the government to raise tariffs.

As K-Electric example suggests, once incentives are realigned, it can be hoped that the private sector will start investing in the T&D sector.

Total investment made by K-Electric after privatisation has been $3 billion, including Rs68 billion between 2016 and 2020. It has also received a subsidy of Rs143 billion in five years.

Its financial loss from unrecovered bills and T&D losses is calculated at Rs134 billion in five years.

To promote consumer compliance in the lower-tier income groups, the company started a programme in which people could pay bills in installments.

It removed 200,000 Kundas (illegal electricity connections) in 2020 alone to curb power theft. It indicates that despite all shortcomings, K-Electric privatisation has been an overall success story.

Reforms

The government needs to move away from the business-as-usual strategy and temporary fixes, as they threaten the sustainability of power sector. Therefore, a sustainable framework is needed for power sector reforms starting with restructuring and privatisation, either partial or segment-wise, and adoption of competitive tariffs.

The policy of subsidy allocation needs a revision to create incentives for DISCOs to innovate and improve. Besides the policy, technological solutions are also needed like GIS mapping, automated meter reading (AMR), energy audit and accounting, and prepaid metering system, which are the technical solutions to the power sector issues.

As recent news suggests, the distribution firms have admitted sending inflated bills to consumers. A private sector entity free from political power but under a watchful regulator cannot do it.

It is high time that T&D segments are freed from state clutches after strengthening energy regulators at all levels. An efficient and transparent market of electricity generation and distribution is what customers need.

This will also help the government to directly support lifeline consumers instead of distributing the cost of inefficiency across the board.

The writers are affiliated with PRIME, an independent think tank based in Islamabad

Published in The Express Tribune, October 4^th, 2021.

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

13/09/2021by 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 13^th, 2021.

CCP ruling on sugar industry: the second opinion

30/08/2021by 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 30^th, 2021.

Moving to new industrial policy

30/08/2021by 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 09^th, 2021.

Financing private sector growth

30/08/2021by 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 19^th, 2021.