ARTICLE (June 15 2009): FY09, termed as a year of consolidation by Advisor to Prime Minister, is the worst economic year of the decade, as real economic growth is estimated to dip at 2.0 percent (lowest in eight years) against the average of 6.3 percent in last six years, amid global recession graduating to depression and militant insurgencies compelled war in northern area.
The government has already spent $35 billion to counter extremism in Pakistan in last few years. FY10 Budget, in our view, is a status quo budget. However, it has given direction towards industrial revival and poverty reduction. Medium-term focus in coming three years is to strike a balance to curtail deficits by revenue enhancement and import curbing measures while applying adequate resources to address poverty and boost growth.
Pakistan's economy under IMF program has shifted its policy mix to tightening fiscal and easing monetary policy--against the initial stipulated conditions of IMF--from a reverse stance witrillionessed in FY02-07 period. A total federal Budget outlay of Rs 2.48 trillion has been announced for FY10 with a deficit of Rs 722.5 billion (4.9 percent of GDP).
This deficit is targeted to be financed by external and internal sources of Rs 265 billion and Rs 458 billion, respectively. An optimistic tax revenue target of Rs 1.51 trillion (28.2 percent higher than revised FY09 target) is set. Current expenditure is envisaged to decline in phased manner by reducing it to 15.3 percent and 14.7 percent of GDP in FY10 and FY11, respectively. This is to be achieved by abolishing non-productive subsidies.
In the midst of arguably worst ever global crisis, with world economies dwindling by 1.3 percent, real GDP of Pakistan is estimated to grow by a meagre 2 percent, with commodity producing sector, including agriculture and manufacturing sector, depicting a growth of 0.2 percent--lowest in last 15 years. The agriculture sector has shown some resilience by 4.7 percent growth, beating the target of 3.5 percent.
The bumper crops of wheat and rice, along with high support prices and better water availability, paved the way for agriculture sector high growth. However, this is offset by dismal performance of manufacturing sector--declined by 3.3 percent. Large scale manufacturing subsector has got the major brunt of slowdown in exports, acute power shortage, tight monetary policy and war on terror by massive contraction of 7.7 percent in July-March period.
Services sector, nucleus of growth momentum in last six years, also felt the heat, showing a growth of 3.6 percent (last five years average was 6.9 percent). Finance and Insurance sector amid global deleveraging was the worst performing services subsector--declined by 1.2 percent against a growth of 12.9 percent of last year.
In March 09 LSM observed a decline of 20 percent YoY, if this trend would continue for last quarter of outgoing fiscal year, the real GDP growth estimate of 2 percent is in jeopardy. GDP is targeted to grow at 3.3 percent in FY10, whereas growth for FY11 and F12 is envisaged at 4.0 percent and 4.5 percent, respectively.
Agriculture is expected to grow at 3.8 percent in FY10. On the other hand, industrial and services sectors growth is forecasted at 1.8 percent and 3.9 percent, respectively. In order to help the ailing manufacturing sector, federal excise duty (FED) on CKD has declined by 5 percent to support automotive manufacturers and vendor industry. Moreover, FED on cement is reduced by Rs 200 per ton to promote construction activity in country.
Withholding tax on imported goods is increased by 2 percent to 4 percent to arrest the balance of payments crisis by curbing import demand. Customs duty on CBU motorcycle has been slashed by 5 percent to 65 percent, and import duty on four-stroke rickshaws is reduced by 12.5 percent to 20 percent to help lower middle class. Concessions have been given to Pharmaceutical raw materials, life saving drugs and cancer diagnostics in upcoming financial year.
Reliefs available to agriculture sector in the form of duty exemption on tractors, gas subsidy on fertiliser, subsidy on running tube-wells and wheat support prices are continued. On capital markets, especially stock market, a status quo is maintained with no new levy or no incentive announced amid worst ever stock market crash last year.
However, commodity-based sectors listed at stock exchanges have some positive relief measures in offering. Cement, automotive and pharmaceuticals sectors profitability and revenues would likely enhance by tax incentives mentioned above, whereas banking and oil sector would not have any significant direct impact from any taxation measure. Per capita income in dollar terms has shown a meagre growth of 0.3 percent to $1,046.
Real private consumption has attained a growth of 5.3 percent. However, medium to long term growth indicator, gross fixed capital formation has depicted a decline of 6.9 percent. This anomaly is synonymous to denial stage of a broken relationship. Consumers generally take some time to adjust consumption pattern owing to change in macro economic factors that phenomenon is termed as overhang period.
Hence, in the absence of policy reforms to induce investment-friendly environment, the medium term growth stabilisation program is in jeopardy. The poor performance of LSM and decline in total investment (from 22.5 percent of GDP in FY07 to 19.7 percent of GDP in FY09) is partially explained by liquidity crunch--credit to private sector was just Rs 14.0 billion in July-May 09 as compared to Rs 383.6 billion in similar period of last year.
Money Supply (M2) expanded by a mere 6.5 percent versus last year's expansion of 15.4 percent. Government borrowing for budgetary support increased by Rs 321 billion as compared to Rs 364 billion in corresponding period of last year. SBP financing, inflationary in nature, soared by Rs 159 billion (similar periods last year: Rs 563 billion) - in line with IMF conditionality.
However, borrowing from scheduled banks increased by Rs 162 billion (decline of Rs 198 billion in similar period of last year), crowded out private investment visible from dismal commodity sector performance. In order to support the industrial sector, zero rated tax regimes for export-oriented sectors have been maintained.
Moreover, Rs 40 billion (Rs 20 billion each from development fund and commercial banks) are allocated for export-related sectors. This is in addition to relief measures mentioned above on cement, SMEs and pharmaceutical sectors. There is dearth of investment in health, education, modern agriculture (corporate farming) and industrial sectors in Pakistan.
With favourable demographics of Pakistan amid worsening security situation requires a pull strategy to attract foreign long-term investment in the above-mentioned area. It is imperative to formulate a pull strategy to attract the much-needed foreign investment in power generation plants and transport infrastructure.
There is abundance of untapped coal reserves all of which requires right technological investment to reduce its sulphur content and burn it to produce power. The policy makers remained silent on this issue for yet another year. A new levy, carbon surcharge, on petroleum products has been imposed.
However, in essence, it already existed in non-tax revenues under the head of petroleum development levy (PDL). Hence, 40 percent of increment in tax revenues (Rs 134 billion) is attributed to change in accounting treatment on petroleum levy. There was a tremendous pressure on the government to remove PDL amid high inflation and falling oil prices.
Hence, the government in line with developed countries' practice has imposed a carbon surcharge to protect environment and clear pricing mechanism. The question arises here that to protect environment what alternative incentives are in offering to reduce the consumption of high carbon content products like allocation of resources for better public transport or incentives for investment in low carbon content energy production technology.
None is mentioned in this regard. In an effort to expand tax base, capital value tax on immovable properties has been increased from 2 percent to 4 percent. Rs 132 billion (0.9 percent of GDP) are allocated to subsidies in FY10 Budget which is 48 percent lower than revised estimates of Rs 252 billion (1.9 percent of GDP) in outgoing fiscal year. The major reduction is witnessed on fuel and electricity subsidies.
Subsidies for power sector are slashed by 40 percent. Amid falling commodity prices, nothing is allocated for DAP fertiliser subsidy against revised estimate of Rs 21 billion in FY09. However, gas cross subsidy is decided to eliminate in phase manner to support industrial sector. Agriculture sector with 44.7 percent of labour force employment and 21.8 percent of GDP contribution is to continue to subsidise and remained out of tax net.
An optimistic tax revenue target of Rs 1.51 trillion (28.2 percent higher than revised FY09 target) is envisaged. Pakistan's tax-to-GDP ratio--one of the lowest in the region - is a prime issue of running high fiscal deficits. Although FBR tax collection was increased at an average of 16 percent per annum during FY00-09 as compared to 12 percent in the decade of 1990s, the tax-to-GDP ratio has declined from 11.0 percent in FY91 to 9.0 percent in FY09 (lowest in last two decades) against the ambitious target of 10 percent.
This necessitates serious reforms, both at institutional level to improve tax collection and policy level to broaden the tax net. The share of direct tax, however, increased from 18 percent in early 1990s to 39.6 percent in FY09, accounts for only 4 percent of GDP relative to 7 percent for other developing countries. Direct tax is more equitable and non-inflationary in nature but require efficient tax enforcing and collection institution.
Hence, reliance on indirect taxes (less equitable and inflationary in nature) exacerbates poverty issue. Within the ambit of indirect taxes, GST (over 60 percent of indirect taxes) increased by 17.5 percent in FY09 notwithstanding nominal GDP growth of around 42 percent. This also undermines the tax growth.
On the expenditure front, not much in policy makers' control to curtail current expenditure owing to domestic security situation. War on terror coupled with global financial turmoil hindered the privatisation process and narrowed the conduit of other forms of foreign investment. Only channel available is aid by bilateral and multilateral agencies to support resistance against militants and help IDPs.
In the outgoing year, fiscal deficit target of 4.3 percent is going to be met at the cost of development expenditure--fall to 1 percent of GDP in first half of FY09, lowest in five years. This is not desirable for medium term growth sustainability and poverty reduction. Fiscal deficit for FY10 is budgeted at 4.9 percent with PSDP allocation Rs 626 billion, current expenditure is budgeted at Rs 1,699 billion.
In order to address poverty, the Government has allocated Rs 70 billion for BISP in upcoming fiscal year to enhance its reach to 5 million poor families, whereas Rs 50 billion has been allocated for relocation of 2.5 million internally displaced people (IDPs) affected from Swat operation against militants.
How would government react if the pledged amount of around Rs 1.7 billion (Rs 1.2 billion from Friends of Pakistan and Rs 500 million form World Bank) by different donors does not materialise? The only rescue path to curtail deficit would again be development expenditure. Hence, to be self-reliant, structural reforms are imperative. Symbolically, higher government officials should reduce their perks and curtail the ever-increasing number of ministries.
