Further to my earlier article series: “Managing External Account – Monetary Policy” and “Managing External Account – Fiscal Policy”, this is third and final article, and perhaps the most important in terms of permanently addressing the chronic issues which results in external account problems to crop-up every now and then. As I have been saying in my earlier write-ups that all other tools to manage external account are operational and temporary in nature; long-term, sustainable solutions will come with the structural changes or reforms only. I must admit at the outset that these changes are hard to implement as they require phenomenal political-will and an extremely committed and competent executive team for execution and delivery. But unfortunately there’re no shortcuts to these structural reforms any more and as the time is passing-by the need for them is escalating given that other operational tools are almost exhausted as elaborated in my earlier articles.
The critical aspect is that to manage external account, the reforms must be board-based and cover all the main constituencies, including internal account and taxation. In fact, the circle expands to foreign policy and managing law and order situation in the country, as in this day and age, it’s impossible to divorce economy with politics. This will not be out of place to say that politics has most influence on economic factors. Globalization has also resulted in the lack of separation of local economy from international political and economic developments.
The recent economic environment in Pakistan is primarily a result of uncertainties prevailing on the political and the foreign policy fronts. The lack of boarder reforms in decades and fragile state of affairs of Public Sector Entities (“PSEs”) and Institutions, make the economy exposed to political and economic shocks. Whilst the economic growth has been on the up over the last four years; however, these strengths were not institutionalized, atleast not been embedded enough to sustain the moderate political vibration and; thus, inherent weaknesses started to surface, as we can be currently witnessed.
The single biggest vulnerability in the economy has presently been faced on the external account front – the growing current account deficit – which is a result of unprecedented increase in imports and almost stagnant exports. While there’re concerns on the fiscal deficit too; however, that’s something still manageable, albeit not through the best of tools available (in fact, a worst form in many ways) and only as a last resort – ie., printing of local currency; in other words, borrowing from State Bank of Pakistan. Nevertheless, there’s at least an option available on the local currency/ fiscal front to avert or defer the disastrous situation. In peaking order of risk exposure for Pakistan economy are: External Account, Taxation and Internal Account. Will discuss them all from least to worst risk in the ensuing paragraphs.
Internal Account: The local currency risk primarily emanates from funding losses of PSEs and Energy Sector. These risks shall only be addressed with an aggressive reform agenda across all PSEs and some, particularly energy sector, require fundamental structural adjustments – optimal generation mix and transmission upgradation/ enhancement. The decision-makers in the past merely focused on generation, where a very robust regulatory framework exists; transmission on the other hand was not given enough heed; resultantly, transmission became the dominant reason for load-shedding in the last 5/7 years. The policy-framework in transmission sector is still struggling and this area must be given attention on top most priority. Similar is the case in the Petroleum Sector, pipeline infrastructure is the primary reason for chocking. The point is that the logistics (all sorts, be it in energy sector, railways, air-cargo, storage, terminal, etc.) need policy direction and fixing. These’re all medium to long term issues and can’t be addressed in the short-run. A part of the solution in this respect is hidden in privatization of the state own entities but only when post restructuring and enforcement of strong legislative/ regulatory changes/ structures are in place and tested. However, in the interim, as an immediate measure, the restructuring of the regulators and the large PSE is inevitable. I have a “Top Five Theory” in this context, whereby if the “Five PSEs” and the “Five Regulators” are fixed – select the best professionals to run these entities, empower the professionals and their Boards to run these entities, without administrative interference from the relevant ministries, then the issue of fiscal deficit will be largely taken care of within the next 3/5 years. For the time being, this is the least of the risk areas in the order of attention priority, due to last resort option’s existence, as discussed above.
Taxation: The recent initiatives by the current Government are in the right direction. The fundamental reason for taxation issues emanate from the fact that the whole taxation regime has become too complicated and there’s an element of increased intimidation by the taxmen for the genuine tax payers. Harassment is the single biggest hurdle that keep people from paying taxes. The other factor being the lack of trust on the Government to judiciously use the tax collected from masses; in other words, the element of corruption and leakage in the system. This is, therefore, imperative that the interaction between the taxmen and the taxpayer is reduced to the minimal. This is possible through: i) use of technology; ii) flat tax regime, particularly in customs; and iii) substantial reduction in direct taxes. The total net contribution of direct taxes in the revenue collection of FBR is merely 12% whilst on the other hand the direct taxes require heavy paraphernalia and resources. The truth is that we, as a nation, for right reasons or wrong, do not pay taxes voluntarily; therefore, it makes sense to collect the taxes through indirect sources which are not only cost efficient but also effective in terms of collections. There’s an argument which is raised by the tax-experts that indirect taxes, in the strictest sense of the word, are discriminatory in nature and direct income taxes, on the other hand, are more just. This argument has its own merits; however, this also has the element of vested interest plus with slight tweaking of the indirect tax proposition/ structure (making it ad valorem), the opposition to this point of view could be totally killed. With the above measures, not only the number of tax payers will enhance, but the amount collected will also be boosted. The flat tax regime too has it’s own merits and it’s been argued vehemently by International financial experts and think tanks. The flat tax in our case is critical to check the discretionary powers of the taxation machinery; thus, mitigating corruption and harassment. As mentioned above, making the taxation system simpler and eliminating the interaction with the taxman alone will help in enhancing the taxation collection. This objective could be achieved through some policy changes discussed above and with the use of technology. Whilst FBR has come a long way on the technology front; however, this area still require reforms and professionals engagement. There will be a considerable resistance to this change, for obvious reasons; therefore, strong political and institutional will and commitment is a prerequisite as the reforms are absolutely inevitable in FBR.
Now the real elephant in room and the main topic of our debate: the External Account. This area must be looked into short and long term measures. There’re very limited options available in the short run other than borrowing (be it swap funds, term deposits, loans or otherwise) from the various available sources and perhaps getting free access for our exports to the markets like China, EU, etc., where our competitor countries like Bangladesh, India, Vietnam, have very clear edge over us. The only other promising opportunity on the external account in the immediate future are the “enhancement in Worker Remittances”. There’s still a very large chunk of remittance out there (US $15/20Mn) to be attracted through the banking channels which currently either comes from non-banking/ unofficial channels or don’t come at all and get invested in various saving instruments in the overseas Pakistanis’ resident countries. To attract these remittances, we need saving instruments (for example, Overseas Pakistanis Saving Certificates, etc.); and perhaps offering a preferential exchange rates as special incentive to the overseas Pakistanis for routing remittances from the banking channel. Currently, the banks, through which the remittance comes into the Country, are paid subsidy; instead the benefit of this subsidy maybe paid directly and passed on to the ultimate remitter or eventually to the beneficiary. This way, we maybe able to discourage people from going through the unofficial channels and encourage more remittances via banking channel in the short run. While another short term measure – another Amnesty Scheme – is perhaps a good move but it’s a one-off measure (not a recurring benefit) and it must have unwavering buy-in from all the pillars of the State; otherwise, this measure will not bear fruit. Furthermore, for immediate future, IMF is virtually inevitable. Not because of money but because of our international positioning to meet our FX funding needs on a sustainable basis, and more so, for implementing the much-needed, broad-based, structural reforms. However, we need to take the discussion forward with IMF with care, which the present Government seem to be doing. We should talk to IMF with the position of strength and that strength we can be drawn from the visible investment support from China and KSA. KSA recent support has proved to be a “man-o-salwa” (food from heaven). The integrated petrochemical complex (US $10bn ish) is a long term play and happens to be falling in the defined CPEC territory. Given the strategic nature of the project, this is in the best interest of all 3 stakeholders – Pakistan, KSA & China – that this project goes through. Like any commercial project, this project will also have it’s debt and equity components. We need to appreciate that all these projects are set-up on commercial lines and in line with the established financing principles. Since equity is always more expensive than debt; therefore, there will always be a predominant debt portion in all the commercial projects (maximum to the extent possible), irrespective of where they’re located – within CPEC or outside, simply because it improve returns for the investors. If this principle is settled with us then our apprehensions about the CPEC projects will subside to a very large extent. In medium to long run; however, import substitution (something always resisted and opposed by the Template Institutions – ie., IMF, World Bank, etc.), particularly in the area of energy security (E&P, Refinery, etc.), and structural changes in exports to promote value-added textile products and encourage non-conventional products and services particularly in agriculture, technology, etc., through policy intervention, are the only solution to fix this on-going issue of current account deficit. The whole trade-policy, budgeting exercise, energy-policy, and other policy decisions, consistently over a 5/7 years, must be in-sync and shall revolve around predominantly one objective – self sufficiency in the area of external account – and then only we will be able to address the issue of external account deficit once and for all and get rid of the Template Institutions to ensure long term sustainability of the economy and our self-pride and sovereignty.