PML-N Economic Agenda Tracking Report (January – March 2014)

31/08/2022by PRIME Institute PRIME Institute No Comments

PML-N Economic Agenda: Tracking Report reviews Pakistan’s economic performance by tracking the progress made on the implementation of economic manifesto announced by the party in power in Islamabad, Pakistan Muslim League-Nawaz (PML-N). The purpose is to initiate and inform policy dialogue and public debate on the progress made on the economic agenda of PML-N. This tracking directly serves the basic principle of a functioning democracy: accountability.

Structure
The report picks three distinct sections of the PML-N manifesto: Economic Revival, Energy Security and Social Protection, which it terms as “economic agenda”. These three “Areas” are then divided into “Components” and “Sub-components”. In most cases, these are based on a simple reproduction of text of the manifesto, and in some cases, some editing has been carried out for the purpose of clarification and structure, but without altering the meaning of the authors of the manifesto. Under the area of Economic Revival, 10 components and 55 sub-components have been identified. Under the area of Energy Security, 15 components and 21 sub-components have been identified whereas under the area of Social Protection,
three components have been identified.

To read the full report, click ahead: PML-N Economic Agenda Tracking Report (January – March 2014)

PML-N Economic Agenda Tracking Report (June-December 2013)

31/08/2022by PRIME Institute PRIME Institute No Comments

Introduction

This report reviews the first six months of the federal government’s economic performance spanning over June-December 2013 in the light of PML-N economic agenda, now the ruling party. Developed on the pattern of a scorecard, the report allocates scores on 26 goals identified by PML-N manifesto based on its performance in three areas: Economic Revival, Energy Security and Social Protection.

The score is assigned on an objective and quantifiable criteria and is not based on perceptions of any individuals. To ensure reliability, the score has been assigned on three distinct parameters: policy and legislative developments, institutional reforms, and implementation. The report and scorecard has been compiled by a team comprising political scientists and economists. It has been shared with a select audience from the business community, politicians and economists for the purpose of feedback and has undergone several revisions….

To access the full report, click ahead: PML-N Economic Agenda Tracking Report (June-December 2013)

Prime Note: Federal Budget 2022-23

14/06/2022by PRIME Institute PRIME Institute No Comments

Prime Note: Federal Budget 2022-23

By Tuaha Adil

Federal budget highlights the adoption of a contractionary fiscal policy for sustainable growth. The priority of the government is to stabilize the economy and control inflation as countries around the world are experiencing rising commodity and petroleum prices. The stabilization of the economy is imperative for sustainable growth because country experienced higher fiscal and current account deficits in the last fiscal year. The relief package announced in February deteriorated the sustainability of the economy; contributed to a significant burden on the national exchequer, a rise in fiscal deficit and current account deficits, and currency devaluation. The federal government expenditures for FY 2023 are kept at the level of FY 2022 i.e. Rs. 9,502 billion. However, the budgeted government expenditures for FY 2022 were Rs. 8,487 billion and actual spending increased by Rs. 1,015 billion to Rs. 9,502 billion. Therefore, the government needs to ensure it does not spend more than the budgeted amount.

The government believes that controlling public expenditures will help in reducing the aggregate demand and inflation. Inflation remains a challenge for the government, which requires a prudent mix of fiscal and monetary policies. In May 2022, the State bank of Pakistan increased the policy rate by 150 basis points to an ever high of 13.75 percent to discourage extravagance and reduce the mounting pressure on the domestic currency. However, raising the policy rate alone remained futile to control inflation and contributed to an increase in the domestic debt liabilities. The average inflation in FY 2022 remained at 11.2 percent and the government has set a target of 11.5 percent for FY 2023, which highlights the fact that the reversal of relief package and passing on the prices of electricity and petroleum products will result in a significant increase in inflation in the short term until the people alter their spending behaviors.

The budget maintains a significant allocation of funds for subsidies. In FY 2022, the government allocated Rs. 682 billion for subsidies but actual spending was 122 percent higher amounting to Rs. 1,514 billion. In FY 2023, the government has allocated Rs. 699 billion in terms of subsidies, which is higher than the budget for running a civil government. The power sector will receive a major proportion of subsidies amounting to Rs. 570 billion and allocation for the petroleum sector is Rs. 71 billion. The continuity of subsidies without any analysis of the outcome of subsidies poses a serious threat to the financial stability of the country.

The government has set an ambitious target of collecting Rs. 7,004 billion as FBR revenues on the back of adjustment in the rates of taxes. The share of direct taxes is 37 percent while the share of indirect taxes is 63 percent, whose incidence is more among people in lower-income groups. Income tax constitutes a major proportion of the direct tax and its share in total FBR revenue is 39 percent. The government envisages an18 percent increase in income tax revenues compared to the last fiscal year. Sales tax constitutes a major proportion of indirect taxes and total tax revenues with a share of 44 percent. The government estimates indicate an increase of 23 percent in sales tax compared to the previous fiscal year. With an expected rise in inflation, there is a possibility of a slowdown in aggregate demand and a subsequent fall in expected sales tax revenues. The tax to GDP ratio proposed in FY 2023 is 9.2 percent, which is a manifestation of a dismal performance of our tax administration. The government should strive for bringing more people into the tax net and restrict tax evasion through an overhaul of the country’s taxation system.

The government has introduced changes in the taxation system to protect lower-income groups and put the burden on higher-income groups. The threshold income exempted from income tax for salaried individuals has been increased from Rs. 0.6 million to Rs. 1.2 million. Furthermore, the threshold income exempted from tax for business individuals and AOPs has been increased from Rs. 0.4 million to Rs. 0.6 million. The government has proposed a fixed tax regime for small retailers where Rs. 3,000 to Rs. 10,000 will be collected along with electricity bills. The government has proposed a capital gain tax of 15 percent on the transaction of immovable property in the first year, the advance tax rate on the purchase and sale of property for filers is proposed to be enhanced to 2 percent from the 1 percent and for non-filers, increased from 2 percent to 5 percent.

Government’s reliance on customs duties for revenue collection continues to distort trade and manufacturing. The use of tariffs for revenue purposes affects the performance of local industries. For FY 2023, the government has anticipated a 17 percent growth in revenue collection from tariffs compared to an actual collection in the previous year. The government has rationalized 400 tariff lines related to the manufacturing sector, and extended exemptions on agricultural inputs and machinery. Although tariff rationalization is a good initiative, the country’s tariff structure is still complex. Moreover, the government continues to protect domestic industries from international competition thereby eliminating incentives for them to improve, restricting the transfer of knowledge and technology, and enforcing consumers to buy low-quality domestic products at higher prices.

Privatization of loss making state-owned enterprises is included in the budget with expected revenue of Rs. 96 billion. Every year government includes the privatization of loss making enterprises but remains unable to carry them out. Resultantly, the government had to provide funds to bleeding enterprises to keep them afloat. The total loss of SOEs in 2019 was Rs. 143 billion. It is imperative to cut loose loss making enterprises to ease the burden on the government and put public resources to efficient use.

External financing head in the budget brief does not indicate any inflow from IMF and China’s safe deposits. Pakistan has been struggling to fulfill the requirements to resume the IMF program for which subsidy on petroleum products and electricity was removed and prices were raised. This contradicts the previous efforts of the government to convince China to lend money to Pakistan as safe deposits and also negates the struggle to resume the IMF program. However, the government is going to borrow money from both sources. This is an effort by the government to hide external borrowing and deflate the overall debt and liabilities of the government. Therefore, the ability of the government to accurately assess the debt liabilities will be affected, which will lead to mismanagement in the debt servicing.

Collection of Rs. 750 billion as petroleum development levy (PDL) seems difficult in the current environment of high petroleum prices. The government intended to collect Rs. 610 billion PDL in the FY 2022 but was able to collect Rs. 135 billion. Currently, a significant jump in global demand for petroleum products from ease in pandemic enforced restrictions and the start of the Russia-Ukraine War have resulted in a tremendous increase in the petroleum prices thereby making it impossible to collect intended revenues. For FY 2023, the government intends to collect a PDL of Rs. 750 billion from oil and PDL of Rs. 8 billion from gas, which will be impossible as it will contribute significantly to already unfettered inflation. The government will not be able to levy PDL as it will deteriorate the political capital of the coalition government and result in a higher than anticipated fiscal deficit.

Government allocates Rs. 360 billion for the protection of unprivileged people under the Benazir Income Support Program. The government has increased the allocation for social protection by Rs. 114 billion to Rs. 360 billion for FY2023. This is a good initiative on behalf of the government to help the deprived segments of society who are struggling to survive when inflation remains unabated. In May 2022, food inflation cloaked at 15.5 percent in urban areas and 19 percent in rural areas. Therefore targeted support for the needy people is appreciable.

PRIME finds the proposed budget to be lacking insight and unrealistic to achieve the sustainable growth. PRIME proposes the adoption of broad-based flat tax rates to promote compliance and voluntary registration as higher tax rates, which the current budget proposed, only contribute to higher tax evasion and avoidance. The tariff and non-tariff barriers create anti- export bias, disincentivize the industry to ameliorate, narrow their focus to domestic demand, prevent the industry to become a part of global value chains and compel citizens to pay a higher price for substandard goods. Therefore, rationalization of the entire tariff structure is inevitable for the sustainable growth of the country. The government remains incapable to cut losses by privatizing bleeding SOEs just for political aspirations but business as usual is not possible now; therefore, the government needs to set aside political motivations and ease the unnecessary financial burden. The exclusion of credit inflow from China and IMF makes the efficacy of the entire budget questionable. The dependence on higher petroleum revenues at the time of rising global prices and soaring inflation at home is also not a wise strategy for fiscal sustainability.

Download the full PDF of the budget note here: Prime Note Federal Budget 2022-23

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.

Roadmap for Economic Transformation launched

11/12/2021by PRIME Institute PRIME Institute No Comments

Roadmap for Economic Transformation launched

December 10^th, 2021

The Economic Advisory Group (EAG) has launched a document “New Vision for Economic Transformation”, which analyses the factors hindering the efficient allocation of resources hence contributing to the economic slowdown, and presents practical suggestions. The document was presented by Mr. Javed Hassan, Chairman EAG, and Mr. Ali Salman, Executive Director PRIME.

Mr. Asad Umar, Federal Minister for Planning, Development, Reforms, and Special Initiatives expressed his views at the launch as,

In Pakistan, we lack discourse on economic transformation among the intelligentsia. EAG is a good initiative and you are making a really good and tangible contribution by putting specific ideas on the table for discussion. This vision document is a good start to translate that from global learnings to what has happened in Pakistan. The more competitive landscape we create, the more chances there are for transformation.

He cited an example of transformation in the telecommunication sector where investment has contributed to a local assembly of mobile phones in the country.

Ms. Shandana Gulzar, Member National Assembly, commented during the panel discussion that

The markets and firms in Pakistan are not adhering to the international standards, which has resulted in a decline in exports. The sugar industry is highly protected in the distribution and production phases, through tools such as special regulatory duty and minimum support price, but the benefits have never reached farmers. We have selected winners and losers. The federal subsidy is directed more to the industrial sector and less to the agriculture sector despite having a lesser contribution to the GDP. This illustrates distortions from the misallocation of resources. We not only have to ensure efficient allocation of resources and better implementation but also build an expeditious judicial system.

Dr. Muhammad Ahmed Zubair, Chief Economist Planning Commission, stated that this vision document presents suggestions that can become the basis of further research to support the transformation agenda and contribute to policymaking.

Dr. Ali Hasanain, Head of Economics Department LUMS, congratulated EAG for putting ideas of transformation in one document at the launch. According to him, the core strength of this document is that it articulated economy is not about production but productivity and how contestable markets are. The contestability comes from creating a level playing field, which has not happened in Pakistan. Therefore, we have to provide a level playing field for which institutions are important with the core responsibility of security of life, property rights, and contract enforcement.

The suggestions put forth in the document are organized under four themes: revisiting pricing regimes that currently govern agriculture and commodities sectors; revamping of 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 regional trade blocs; and, finally, rethinking 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.

EAG Vision for Economic Transformation launched

EAG's New Vision for Economic Transformation

The Economic Advisory Group is an independent platform of individuals drawn from economics, policy, and the private sector, formed in January 2021, under the auspices of PRIME Institute, an independent think tank, which serves as its secretariat.

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

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.

EAG concurs with interest rate hike, cautions on price control

27/09/2021by PRIME Institute PRIME Institute No Comments

EAG concurs with interest rate hike, cautions on price control

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

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

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

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

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

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

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

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

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.