Lending from Privatized Banks: More for government, less for private sector

A new report released by PRIME finds that the commercial lending to the private sector has declined from 24.1 percent of GDP in 1995 to 17.9 percent in 2019 undermining private sector economic growth, while increasing bank’s profitability manifolds.
The report finds dramatic increase of share of government securities in banks’ investment portfolio from 10 percent in 2010 to 46.4 percent in 2020, which indicates that banks have turned to risk-free lending to the government rather than playing a role in allocation of capital to the private sector. On the other hand, the profitability of banking sector increased from Rs 7 billion in 2000 to Rs 244 billion in 2020. These are the main messages from a recently released report by PRIME, an independent think tank, authored by economist Beenish Javed.
The report finds that the private sector lending stands at 17.9 percent of GDP in Pakistan, while regional economies like Bangladesh stood at 45 percent and India at 50 percent.
The report mentions gradual extinction of Development Finance Institutions as a factor, which were used to complement the banking sector by bridging the gaps in the supply and demand of financial services.
The report notes that after privatization, the infection ratio that stood at 25 percent in December 2000 fell to 8 percent in 2017and then increased to 9.2 percent as of December 2020.
The report also finds that in Pakistan, the banks’ credit disbursements to private sector are heavily skewed towards large enterprises. The share of large sized borrowers in total loans of the banking sector stands at 87 percent in Pakistan, such borrowers account for only 1.6 percent of the total borrowers, in contrast to 72.5 percent in Bangladesh.
PRIME Executive Director Ali Salman, commenting on the report, said that “the government needs to minimize its reliance on commercial borrowing as it not only displaces the private sector firms but also reduces risk appetite in banks”. Ali also urged that the commercial banks should streamline their financial procedures to reach out traditionally unbankable but profitable enterprises thus helping the policy goal of financial inclusion.

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Policy Research Institute of Market Economy (PRIME) released a report titled ‘Debt without Growth’ that assesses government’s two-year performance in the domain of Public Debt.

As per the report, Pakistan’s foreign debt and liabilities increased by $17.6 bn or 18.5 percent between FY19 and FY20. This increase has been coupled with a deterioration in both the debt bearing and debt servicing capacity. During FY20 government borrowed an additional $3.7 bn worth of grants and loans to support country’s corona relief efforts thus adding to the debt burden. Like its predecessors, the government has not been able to fully capitalize on non-debt creating inflows like exports, remittances and foreign direct investment. Consequently, debt servicing remains the largest expense in the federal budget. The government has paid $11.9 bn in external debt servicing during FY20 which is 23 percent higher than the amount paid in FY19.

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Federal Government’s 2-Years Performance Report

Introduction

Upon completion of PTI’s two years in the federal government, PRIME is issuing a short report on its assessment of the government’s performance in the domains of Trade Performance, Tax Policy & Administration, and Business Regulations.

Trade

In its first two years in power at the federal level, PTI-led government has laid the ground for its tariff policy. The policy entails simplifying tariff slabs on the principle of cascading; reducing additional customs and regulatory duties; providing time bound protection to nascent industries; gradually reducing tariffs on raw materials, intermediate and capital goods; and eliminating difference in rates for commercial importers and industrial users to end misuse. The now finalized, National Tariff Policy is to be implemented over a five year period starting from Federal Budget 2020-21, so its performance remains yet to be seen.

To facilitate international trade, SBP maintained its Export Financing Scheme rate at 3%, and Long-Term Financing Facility at 6%. Phase-II of China-Pakistan Free Trade Agreement saw its implementation during the same period. On the legislative side, treasury bench tabled the Geographical Indicators (Registration and Protection) Bill, 2019, which has now been signed into an Act. Ministry of Commerce’ ‘Look Africa Policy’ has borne fruit in the form of a 10% increase in exports to Africa during Jul 2019 – Feb 2020. These exports now stand at $1.03 B. However, there is no visible change in the overall exports destination.

The most significant measure by the government which has impacted Pakistan’s international trade has been its policy of going for a market determined exchange rate. Over the two years, Pakistani Rupee has been let to devalue by around 34.5%. While it helped the government in reducing its import bill, it did not help in increasing exports.

Budget 2020-21 has been forthcoming in reducing the incidence of duties on imports to the extent that the customs duty proceeds for FY 2021 are forecasted to be 36% less than the previous fiscal year. However looking at the trade statistics for 2018-2020, goods imports have seen a large contraction from $55.6 B in FY 18 to $42.4 B in FY 20. Similarly, albeit to a lesser extent, goods exports dropped from $24.8 B in FY 18 to $22.5 B in FY 20. All things  considered,  during  PTI’s  two  years  in  government,  both  imports  and  exports  have  faced  a  substantial downward slide.

For the former, a principal factor was Pakistan’s decision to approach the IMF. Initially, in order to get a better deal from the IMF, the then Finance team of the PM tried its best to increase its forex reserves by:

1.  Securing foreign currency deposits, loans, grants and deferred payment facilities from friendly countries such as Malaysia, Saudi Arabia, UAE, and China.
2.  By cutting down on its imports bill

Later on, once Pakistan entered into an IMF program under the Extended Fund Facility, it agreed to maintain a market based exchange rate and to improve its tax collection; factors which lead to further imports reduction. To meet its revenue targets, the government increased electricity tariffs, gas prices, and taxes on petroleum, which contributed to the slide in exports.

While the customs duties, regulatory duties, and import tariffs are being lowered in each successive fiscal year, there is no mentionable work on improving value-addition in exports, diversifying the exports basket or exploring new export destinations.

Tax Policy and Administration

Ever since assuming reigns of the federal government in August 2018, PTI has replaced four chairpersons of the FBR, in a period of two years. Each chairperson only got, on average, five and half months in office — a period too short to implement any meaningful reforms at FBR. Similarly, the top slot at Revenue Division has also changed hands thrice in two years.

To pursue its agenda of reforming tax policy, administration, and enforcement mechanism, PTI sold Shabbar Zaidi as the right man for the job. All the hope that there ever was about PTI being able to reform the tax system of the country, it relied upon Shabbar Zaidi to perform as an outsider to the bureaucracy, who wouldn’t face peer pressure in taking some much needed unpopular decisions that would face resistance from within the FBR. Nine months into the role, he took an indefinite leave from the job, citing health reasons, before he was officially replaced by a career civil servant again.

PTI’s boldest move in the domain of increasing the tax base was the move to bring the vast majority of non-tax paying retailers under the ambit of tax net. These retailers contribute around 18% to the national income but their tax contributions account for less than 1% of total FBR revenue.

The government imposed the condition of production of copy of CNIC for purchases over Rs. 50,000 and floated the idea of income tax calculated as a fixed percentage of annual turnover. Various trader unions organized shutter down strikes all across Pakistan and the pressure tactic seemed to have its desired effect as the government kept on extending the deadline for implementation of these measures so as to maintain status quo. While this resulted in resumption of market activity, it laid bare the weak writ of the state with respect to its ability to collect its dues.

At the same time number of tax filers has reached an all-time high of 2.7 million, credit for which goes to active enforcement measures by the FBR, and the amnesty scheme announced in May 2019. Overall, PTI government has announced two tax amnesty schemes in its tenure – one for the public in general, and one specifically for investments
in the construction industry. Bottom line – revised estimates for FBR taxes in 2017-18 stood at Rs. 3.94 billion; in 2019-20, the revised figure was recorded at Rs. 3.91 billion. Tax to GDP ratio is still in the single digit range, which has slipped to 9.5% from 9.9% last year.

Business Regulations

Pakistan’s Doing Business ranking has significantly improved from 136th to 108th in a year. This has been the result of successful implementation of a large number of initiatives across numerous departments, all of which cannot be mentioned here, for want of space. Few notable measures include elimination of requirement of physical inspection by FBR at the time of registration; time for obtaining building permit reduced from 30 days to 15 days; and number days required for obtaining electricity connection reduced from 73 days to 49 days in Lahore, and from 134 days to 73 days in Karachi. 

Government of Pakistan has established Pakistan Single Window (PSW), which will go live in 2022. The PSW is being developed at a cost of $67 million, borrowed from World Bank. The PSW programme includes phased establishment of an ICT-based platform involving simplification, harmonisation, and automation of regulatory process related to cross-border trade. It also includes implementation of a port community system to facilitate related logistics.

In the domain of promoting E-Commerce, in October 2019, Government of Pakistan introduced the country’s first ever E-Commerce policy. This is a step in the right direction however strong commitment by the government is required to make these reforms see the light of the day. Presently, Pakistan ranks 114th out of 152 countries on UNCTAD’s B2C E-Commerce Index. She lags her Asian competitors such as Malaysia, Thailand, India and Bangladesh that rank at 34th, 48th, 73rd and  103rd place, respectively. In 2020, SBP announced five-fold increase in the remittance limit for freelancers, from $5,000 to $25,000 per individual per month. Such meaningful measures for the industry can enable proliferation of E-Commerce transactions in Pakistan.

Post the onset of Covid-19 in Pakistan, PM Imran Khan has brought forth the construction incentives package as his revival plan for the economy. The PM is chairing weekly meetings to review progress and resolve any issues faced by the industry. PM’s construction incentives package has offered builders and developers with a tax amnesty scheme; given the status of industry to construction sector; it has introduced a fixed tax regime for the industry; withholding Tax has been exempted on all construction-related goods andservices except steel and cement; only 10% of fixed tax to be payable for those constructing houses under Naya Pakistan Housing Program; and State Bank of Pakistan and all other banks directed to set aside 5 percent of their portfolios for house financing.

In the domain of tourism promotion, the PM appears keen to deliver. PTI has made several contributions to both the tangibles and the intangible affecting the industry. The government has set up several camping sites for tourists in Khyber Pakhtunkhwa. E-Visa facility has been introduced along with relaxation in NOC requirements for foreign visitors. The government has transferred ownership of government rest-houses to Tourism Corporation Khyber Pakhtunkhwa. These positive steps notwithstanding, existence of multiple and overlapping task forces
for coordination and promotion of tourism indicates lack of clear policy. This is further complicated by the fact that in June 2020, Pakistan Tourism Development Corporation shut down 30 of its managed tourist facilities and terminated 450 employees due to financial losses.

Conclusion 

In an effort to curtail the trade and current account deficits, the government has ended up reducing the total trade volume of the country in such a manner that total imports and total exports both have fallen down. As 18% of FBR revenue comes from customs duties, and 38% from Sales tax (of which approximately 55% is contributed by imports), naturally FBR revenues were bound to take a hit, which explains the lackluster revenue performance of the government. These issues notwithstanding, the government has achieved a noteworthy improvement of jumping up 28 spots in the World Bank Ease of Doing Business Index in a year – a feat which could not have been achieved without support from the provincial governments, most notably the Government of Sindh and the Government of Punjab. An increase in the tax registry to 2.7 million is a significant achievement however tax policy and administration still needs revamping. We once again call for considering a low-rate, flatter and broad-based income and sales tax regime with better enforcement which can encourage more people to file tax returns and can yield a predictable tax base.

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Federal Government’s 2-Years Performance Report

Federal Budget 2020-21

Federal budget speech 2020-21 notes that the expected recession due to Covid-19 calls for an expansionary fiscal policy. An expansionary fiscal policy aims for greater public spending, which drives up aggregate demand, generating employment opportunities and economic activity. Having mentioned the need for an expansionary fiscal policy without exposure to unsustainable deficit financing, the federal minister presenting the budget speech went on to present a budget with a stated total federal expenditure of Rs. 7,137 B1 as against the revised budget estimates of Rs. 8345.3 billion incurred in FY 2020. As for sustainable debt financing, this year’s budget entails further debt assumption, as the primary balance is still in the negative.

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PM Construction Package

With the increasing population of the country, the need for housing units has also been increasing. While the current capacity of developers in the country is to deliver only 150,000 housing units per year, the actual demand stands at 350,000 new housing units per year. This leaves a shortfall of 200,000 units each year. Given this demand and sectoral linkages of the construction sector, the Prime Minister Imran Khan announced a major package on the 10th July 2020, which has been warmly welcomed by all concerned stakeholders in the industry.

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Pakistan’s public debt has risen from Rs. 3 Trillion in 2000-01 to Rs. 15.41 Trillion in 2013-14. Pakistan’s debt servicing stood at 76 percent of Pakistan’s foreign exchange reserves, 28 percent of its export earnings and 46.6% of total revenue in 2013-14. This volume delineates critical issues related to public debt in Pakistan and identifies a possible road map. It contains both conference report and selected papers on public debt, thus making this as an important resource for discussions on national debt.

About 68 percent of public debt in Pakistan is expensive domestic debt, and 90 percent of debt servicing takes place to retire domestic debt. The reasons for this sharp increase in public debt, as explained by Sakib Sherani, are mainly rooted in the management of the economy including exchange rate correction, insufficient tax reforms, lack of power sector reforms, weak debt management, booking of past unpaid bills, and sharp fall in net external transfers. According to Dr. Kaiser Bengali, there has been a sharp increase in programme loans in Pakistan over a few decades which has only added to increasing liability, contrary to project loans which add up to the assets of the economy.

During the last seven-ten years, the external debt in Pakistan has escalated to $ 66.5 billion from $40.5 billion. All efforts of the current government have been to generate foreign exchange which is adding to external debt stock. IMF has loaned out an amount of $ 6.6 billion during the last three years, for BOP support, however it is uncertain that how this debt will help us in improving productivity. In 2012, government accounted for 90 percent of all incremental borrowing. Since then it has reduced, and government is taking 70% of commercial banks credit which still narrows down the room for private borrowers. As per Juvaria Jafri, increased public debt must be regarded as a hindrance to economic freedom, which is a mean to macroeconomic growth and stability.

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This report is a product of the PRIME Institute’s National Debt Conference held in Islamabad on October 26th, 2017. Supported by Friedrich Naumann Foundation for Freedom and the National Endowment for Democracy, the objective behind the conference was to initiate an open and informed dialogue on the status of public debt in Pakistan and its consequences for the country’s future.

The conference provided an excellent opportunity for all stakeholders to share their thoughts on the subject. Though public debt is essentially a political economic issue, the dialogue in that conference took place in a non-partisan environment. It is the government which is ultimately responsible for decisions on debt. However, instead of making the forum as an accountability instrument or a charge sheet against any government, participants presented a cogent analysis, and precise policy recommendations and alternatives.

This report, therefore, serves as a resource paper on the subject of public debt. None of the contents of this report are owned by the author and is reproduced work based on the presentations and the speeches delivered at the conference, this note is to duly acknowledge all the speakers for their content reproduced in this report.

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It is a long held economic belief that higher level of public debt breeds risk for a country’s economic and political freedom. Political freedom is compromised when the government borrows money from various International Financial Institutions (IFIs) and donor countries, while the economic freedom is jeopardized when the debt is serviced through printing of money, heavy taxation or further debts.

Pakistan’s public debt plight is becoming increasingly unsustainable. In actuality, the public debt to GDP ratio stands at 66.3 percent as of 2018, with the stock of total public debt rising by Rs. 1.4 trillion during the first half of the current fiscal year.  Presently, the debt servicing to revenue stands at 41 percent – exceeding the government established sustainability criterion of 30 percent.

Although debt can be conducive to growth and development, it can be detrimental if not put to optimal use – as has been the case in Pakistan. For most part, twin deficits have been responsible for the mounting debt burden. In particular, the burgeoning budget deficit has been the underlying factor in excessive government borrowings. The budget deficit and consequently the public debt has been increasing owing to plethora of factors such as inefficiencies of State-owned Enterprises, excessive administrative costs (current expenditures), poorly targeted infrastructure and welfare spending etc.

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During the last decade, Pakistan’s economy tackled several challenges: the energy crisis, terrorism and political instability. These stifled the country’s capacity to focus on macroeconomic stability resulting in current account and external account imbalances. The newly elected government of Pakistan took office in August 2018 and elected Imran Khan, chairman of the winning political party, as the 22^nd prime minister of Pakistan. Having severely criticized the economic reforms agenda of governments over the last 22 years, this new government promised the public to come up with a strong mandate for economic reforms. These reforms vowed to not only focus on economic growth and development but also to improve the living standards of the poor. The Pakistan Tehreek-e-Insaaf (PTI) government guaranteed to increase the tax base, reform the Federal Bureau of Statistics, generate private sector activity, establish a 5 million unit housing project and improve foreign direct investment and remittances.

However, ever since the PTI government took office, like their predecessors they have claimed that Pakistan’s treasury is in fact empty. They expressed worry over the country being in need of at least 18 billion dollars. This would then enable the government to finance a severe short fall in foreign exchange arising from mounting import bills and debt financing, triggered by a sharp fall in exchange rate in term of dollars.

Pakistan landed into a macroeconomic crisis as early as March 2018 when the overall public debt burden reached Rs 28,297 billion on March 31, 2018. Amounting to every citizen being indebted with Rs1,36,700 on average. While there has been a continuous rise in import bills, the export to GDP ratio has declined from 11.2% in 2007 to 7.2% in 2017. To pacify the yawning gap between exports and imports the PTI government has charted down a strategy. One instance is of the government trying to assist exporters by discovering new markets overseas and working to improve the ease of doing business rankings. Furthermore, Pakistanis employed overseas have been requested to send their money back to Pakistan through formal banking channels so that country’s FOREX can be increased. However, with Pakistan’s low credit rating, the government knows it is difficult to raise any amount above two to three billion dollars from international markets. Another external factor which seem to have aggravated the financial crisis within the country is the rapid rise in oil prices in international markets.

Despite PTI’s initial reluctance to approach international agencies for short term economic bailout plans, the Finance Minister has entered negotiations with IMF, requesting for another bailout program. More than 35 percent of Pakistan’s public debt is external, and most of this debt is taken from multilateral lending institutions like IDP, ADB, IMF and World Bank etc.  This policy brief critically analyses Pakistan’s approach to an IMF bailout program. It further sheds light on the historic context to provide a rationale, if any, in benefiting to stabilizing Pakistan’s macro economy through availability of short term lending support by IMF in coming months.

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This report provides an analysis and evaluation of Benazir Income Support Programme (BISP), a major social safety net programme initiated in 2008 in Pakistan. The worldwide public opinion has assumed that such programmes are successful at reducing inequality and poverty.

However, the effects of social safety nets tend to differ across country to country and region to region therefore a detailed study is in order to discern the success of the programme.

Safety net interventions in Pakistan have suffered from a conspicuous lack of evidence based policy making. Numerous evaluations of the targeting process of programmes have identified design and implementation weaknesses. According to World Development Indicators (WDI) 2013, 60 per cent of the population in Pakistan lives below poverty line corresponding to $2 or Rs. 210/-1 per day so social protection as an area of government intervention has achieved enhanced budgetary priority in Pakistan recently with the advent of programme like BISP.

The aim of this report was to review the design of BISP, its effect on the private charity, attitudes of programme beneficiaries, focusing on collecting information regarding disbursements, procedural problems, and needs fulfillment and it examined the impact on the household standard of living. A survey was conducted among 1,000 beneficiaries of BISP from Malakand and Azad Jammu & Kashmir.

The results indicate that there are inefficiencies and irregularities in disbursement procedures. The amount of cash grant is in-sufficient to fulfill expenditure needs of the beneficiary families at large and has no impact on their living standards rather it has created a very high dependency of the beneficiary families on the cash grants. People do not conceive cash grants as their right instead they regard it as a help from government. Even if they consider it as a help it is a discouraging fact that the cash grant are unable to motivate people for work. While private charity continued to prevail along with BISP cash grants.

It is recommended that to achieve poverty alleviation, the programme requires restructuring towards long-term and permanent solutions such as replacing cash grants with programmes through which human capital is enhanced like vocational training and educational programmes.

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Is foreign aid effective?. This question becomes all the more important if viewed against the backdrop of calls for doubling foreign aid to developing countries. The answer to this enquiry, however, has spawned a debate among mainstream academia with each side postulating viable arguments in their defense. In case of developing countries, the for-aid camp points toward the foreign-exchange bottleneck as well as insufficient savings as the rationale for foreign aid which makes up for such deficiencies. The theoretical foundations for this argument can be traced to the famous Harrod-Domar model which implicates that low saving rate dents the growth process (Harrod, 1939 and Domar, 1946). As of late the case for foreign aid has assumed a humane face by appealing to the stalled social sectors of developing countries.

This role of foreign aid was duly formalized by the integration of Official Development Assistance in now defunct Millennium Development Goals (MDGs) and the recently promulgated Sustainable Development Goals (SDGs). Contrarily, not-for-aid camp directs their criticism on foreign aid based on the fact that it rather than helping the poor countries, subverts the growth process by distorting market incentives and highly politicizes the development endeavor beyond bounds. Criticism of foreign aid is also leveled from the political spectrum both from “the Left” and “the Right” with the latter hinting the potential pauperism that it can ensue while the former points its neo-imperialist connotations. The empirical evidence also paints a contradictory picture of aid effectiveness. There is wide literature which suggests that “by and large” aid has been effectiveness contending that income per capita would have been lower in the recipient countries had there been no aid (McGillivray, 2004 and Sasaki, 2006). One strand of literature asserts that aid affective is contingent on the domestic policies of the recipient countries like Burnside and Dollar; 1997, 2000, 2004; Collier and Dollar, 2001, 2002; Collier and Hoeffler, 2002.

This paper attempts to add to this debate on aid effectiveness by evaluating it in the light of arguments for and against foreign aid from the perspective of Pakistan with especial focus on its political economy. It must be noted here that this research is limited only to aid flows by bilateral and multilateral sources to Pakistan instead of private flows of funds. Furthermore, to the best of our knowledge the paper also assesses arguably for the first time in Pakistan whether foreign aid has become a resource case. Section 1.2 delineates the major concepts of aid economics; section 1.3 takes stock of Pakistan’s incessant relationship with foreign aid and section 1.4 gives a bird’s eye view of the structure of foreign aid in Pakistan. Furthermore, section 2 and section 3 evaluates the arguments for and against aid respectively in terms of Pakistan while the final section concludes.