The Federal Budget 2012-2013 is growth-oriented with a striking new balance between measures for macroeconomic management and stability. No new taxes have been imposed, nor have any existing taxes been increased.
Better than expected cotton crop, improved large scale manufacturing output, as well as corporate profitability, rise in tax revenues and general resilience in agriculture and service sector tends to support higher growth prospects.
But all these prospects for economic advancement will come to naught unless major structural issues such as the energy crisis are addressed. Moreover, as long as the monetary policy remains stringent and government borrowing from the banking sector looms large, private enterprises will remain suffocated for want of affordable capital.
Consequently, future prospects for growth, as outlined in the growth strategy, are not bright. Add to this persistently high inflation and unemployment and a surefire recipe for abject poverty emerges. The remedy lies in fiscal measures. Tax breaks proposed in the Federal Budget may reduce the soaring costs of doing business in the country, but more is needed.
Surprisingly, the present economic document provides no clues about bridging the fiscal gap. There have been no significant attempts to broaden the tax net or tax sectors whose contribution to the revenues remains minimal despite thriving incomes.
Incomes from real estate businesses and agriculture remain outside the domain of effective taxation. Similarly, the power sector, which has been the largest drain on national resources of late, remains largely unaddressed. Therefore, the new incentives are not enough to boost investment and spur economic growth.
Financing the budget deficit, 4.7 percent of GDP, will also be difficult, more so given the dependence on provinces to generate budget surpluses. Pressure on the local currency will also continue to mount as debts mature and fresh foreign investments remain wanting.
Theory and empirics established the fact that trade is the engine of growth. Variability of macroeconomic indicators directly affects the variability of the external sector. Therefore, the impact of current fiscal measures can be judged through its impact on portfolio and industrial investment in the following ways. That is, if such measures profoundly change the prevailing investment environment of the country, variations will also emerge in the external sector of the economy.
1. Freezing of the Capital Gains Tax (CGT) rates for two years on holding securities for less than two years and zero tax rate of CGT where securities are being held for more than two years would lead to growth in portfolio investment.
2. Progressive tax rates on dividend income received by banks from money market and income funds may increase demand for alternative investments including the stock markets.
3. Enhanced concessions on tax credit for investment in shares and life insurance premium, and reduction in the respective lock-in period would encourage portfolio investment. Relatively higher availability of funds may stall rising costs of doing business.
4. Higher tax credit and largest period for absorption of tax credit on investment in machinery for the purpose of Balancing, Modernisation and Replacement (BMR) for those companies that were established prior to July 2011 may change the financial structure of these companies and reduce their cost of capital.
5. Reduction in the rate of turnover tax from 1 percent to 0.5 percent, along with the imposition of CGT on real estate would also raise opportunities for portfolio investment.
6. Standard rate of Sales Tax (ST) at 16 percent may reduce costs of production and lead to increase in industrial investment.
7. Abolishing the ST on imported soybean, rapeseed and sunflower seed would reduce the cost of solvent extraction industries and the resulting positive income effect may enhance opportunities of industrial investment.
8. Withdrawal of ST exemptions on imports for the manufacturing of goods to be supplied against internal tender may increase the costs of production and could reduce investment for exportable items.
9. Provision of zero rating of ST on cottonseed oil imports may preserve the competitive price structure of the respective sector and the resultant positive income effect could increase economic surplus. However, such incentives for increasing industrial investment could be mitigated due to higher expenses on cheaper imports.
10. Withdrawal of exemption from ST on imported industrial raw materials and other goods if imported directly by manufacturers will raise cost of production and may reduce the growth of industrial investment.
11. Reduction of Federal Excise Duty (FED) and Customs Duty (CD) on alternative sources of energy for cement industry will enhance the production capacity and consequently higher production will be available for exports from this sector at relatively low costs.
12. Reduction in CD on certain auto parts by 5 percent and concessionary rate of CD on import of raw material for 88 drugs would reduce the cost of production of these sectors. But higher demand for these imports may deteriorate the Pakistani Rupee against other currencies, nullifying the low price benefits.
However, the preceding analysis of the budgetary proposals on the expected growth of investment can only be realised if current energy shortages and soaring rate of public borrowings are restricted within affordable limits. Otherwise, the suggestive savings potential in the costs of capital/business will be eroded due to rising costs of capital/business.
Further, the growth of investments remains constrained due to the persistent decline in the value of the local currency and crowding-out effects of heavy public borrowings.
Therefore, the impact of proposed macroeconomic stability and growth potential may carefully be judged against these odds. If the requisite corrective measures are not adopted, the external sector will likely persist in the current doldrums, further aggravating the macroeconomic situation of the country.
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