Rejoinder to MoF

Business Recorder published on Tuesday, 19th of July, 2016, the response of the Ministry of Finance, Government of Pakistan to my article on the `IMF Eleventh Review`. It is indeed surprising that the response has come from the MoF, when the article is a comment on the eleventh review IMF staff mission report. The IMF does have a relationship with civil society in borrower countries. The Regional Director of the Fund makes it a point whenever he visits Pakistan to get a feedback from independent experts on progress achieved and problems, if any, with the on-going IMF program. As such, the response should have come either from Washington or from the IMF Resident Representative Office in Islamabad.

I appreciate the valiant efforts of the Economic Advisor to the MoF in preparing the response. However, he is probably not a part of the Government team which has discussions with the IMF at the time of each Review. Therefore, it is not clear how much knowledge he has directly on the views of the IMF.

Regarding the upward revision by the IMF of the GDP growth rate from 4.5 per cent to 4.7 per cent in 2015-16, the Economic Advisor ignores the basic point that this has been done despite the inability of the economy to meet two major macroeconomic demand targets related to total investment and exports respectively. The IMF has failed to quantitatively indicate other factors which have may have compensated for the lack of realisation of the two key targets and thereby led to a higher growth rate.

It may be noted that, according to the PBS, the large-scale manufacturing sector has shown negative growth rate on a year-to-year basis in the months of April and May 2016. This sector is beginning to lose whatever little buoyancy it had. The eleven month growth rate for the sector is down to 3.4 per cent from the nine month growth rate of 4.6 per cent in 2015-16. The latter higher growth rate has been used for estimating the GDP growth rate in 2015-16.

Independent economists do not estimate the GDP, as pointed out. However, on the basis of various indicators, they can indicate if the GDP growth rate appears to be biased or not. A similar controversy has raged in India where the high growth rate claimed of GDP of 7.6 per cent in 2015-16 has been generally challenged.

The biggest objection relates to the difference in figures reported to the Parliament at the time of the presentation of the Budget and to the IMF respectively. This difference is most vividly observed in the case of PSDP spending. For 2015-16 the revised estimate mentioned in the Budget documents released on the 3rd of June was Rs 1394 billion. Earlier, on the 11th of May 2016, the IMF staff mission had already been informed during the eleventh review that the total PSDP expenditure in 2015-16 will be 1040 billion. Why was a figure higher by Rs 354 billion reported subsequently to the Parliament?

There is an even bigger problem for 2016-17. The five budgets presented by the Federal and the four Provincial Governments indicate a proposed combined PSDP expenditure approaching Rs 1840 billion. However, the IMF report projects this at Rs 1236 billion, a difference of over Rs 600 billion. Is this an insidious attempt by the IMF, under pressure from its major shareholders, to force reduction in allocations, especially to key CPEC infrastructure projects and thereby delay implementation?

The Economic Advisor makes the point that the last minute cutback in the Federal PSDP spending of almost 25 per cent is due to limits to implementation capacity of executing agencies. Actually, the problems lie in the delay in releases by the MoF and in implementation constraints. According to information provided in the website of the Planning Commission, the total releases as of the 15th of May 2016 were Rs 474 billion, equivalent to 68 per cent of the budgeted size of the Federal PSDP of 2015-16. This implies that as much as 32 per cent of the releases were deferred to the last six weeks of the fiscal year. This establishes the pattern of a big delay generally in releases.

The MoF, however, highlights the constraint in implementation capacity as a very serious issue. This is especially relevant in the context of CPEC. It is therefore, not surprising that the Chinese have apparently asked for greater involvement of the military in the execution of CPEC projects and/or for the establishment of a separate Development Authority. It may also be noted that only 47 per cent of the annual allocation for CPEC highway projects had been released up to the 15th of May, 2016.

Recent developments in the US Congress have further increased the uncertainty about the inflows from the Coalition Support Fund (CSF). There is already a significant shortfall in 2015-16. If the projected amount in the Budget for 2016-17 of almost Rs 170 billion does not materialise then this will not only lead to a larger fiscal deficit but also worsen significantly the balance of payments position. Hopefully, the Foreign Office will be successful in ensuring the full CSF inflows in future.

Regarding the agriculture relief package, the Budget speech of 2016-17 indicates the total cost to the Federal Government of Rs 50 billion. This includes 50 per cent of the fertiliser subsidy amounting to Rs 23 billion and of Rs 27 billion on subsidy in the form of lower tariff on tube wells. However, there appears to be no provision in the budget of 2016-17 for the latter. The budget estimate of the overall power tariff differential subsidy in 2016-17 actually implies a big reduction of Rs 53 billion. Further, the amount allocated in the Federal budget is only Rs 7 billion for the fertiliser subsidy in 2016-17. This represents under provisioning of Rs 20 billion.

The ability of the Line Ministries to absorb the cost of the pay and pension increases announced in the budget is very limited in 2016-17. No provision has been made for the cost of salary increases and the salary bill has been kept unchanged for next year. The projected increase in the pensions is only Rs 9 billion. The Finance Minister had indicated that the cost of the pay and pension package is Rs 57 billion in 2016-17. Clearly, extra budgetary provisions will have to be made.

The external vulnerability of the country depends on the magnitude of amortisation and interest payments on external debt, both public and private. In the Eleventh Review report, IMF has projected (in Table 10) that the total external debt of Pakistan will rise sharply from 193 per cent of exports of goods and non-factor services in 2012-13 to 270 per cent by 2018-19. This will include about 14 per cent of domestic private sector debt. Given the projection of exports by IMF, this implies that the total external debt will rise to $88 billion by 2018-19. If CPEC related borrowings are larger it could even exceed $93 billion. .

More importantly, the response by the MoF fails to recognize that the external financing needs will more than double in the next three years from $7.2 billion to $15.1 billion. Therefore, there is the likelihood of a big erosion of foreign exchange reserves unless the current account deficit is reduced substantially by rapid growth especially in exports and non-debt creating FDI. The apparent complacency of the MoF about the ability to meet the external financing needs is worrying: The Debt Office should prepare an updated yearly projection from 2016-17 to 2019-20 under different scenarios of how the growing external debt obligations will be managed. This should be placed before the Parliament.

Another major inconsistency that has become visible recently is in the magnitude of bank borrowing for budgetary support in 2015-16. As of June 24, 2016, this is reported by the SBP at Rs 971 billion. However, the IMF Eleventh Review report estimates total bank borrowing at Rs 511 billion for 2015-16, lower by Rs 460 billion. Does this mean either that the Government has brought down bank borrowing by this large magnitude in the last week of the financial year or that the fiscal deficit will be significantly higher than the targeted level of 4.3 per cent of the GDP in 2015-16?

Turning to the FBR revenue projections for 2016-17, the MoF again appears to be confident that the target will be met, based on the exceptional performance in 2015-16. It needs to be reiterated that this achievement was facilitated by a number of factors. First, the low oil prices generated windfall revenue gains through big enhancement in sales tax rates on petroleum products, especially on High Speed Diesel (HSD) oil. However, oil prices have gone up recently. Since May 2016, the sales tax per liter of HSD has fallen by almost Rs 7. Second, direct tax revenues have shown high growth due to expansion in the withholding tax regime and enhancement in rates of advance taxation. It is interesting to note that the growth rate in the income tax was only 13 per cent in the first nine months of 2015-16. This rose sharply to 29 per cent in the fourth quarter, thereby creating the suspicion that taxes have been collected in advance from some entities.

Third, customs duty, an otherwise declining source of revenue, has shown remarkable buoyancy with the highest growth rate among taxes of over 30 per cent in 2015-16, at a time when imports have declined by 2 per cent. The imposition of a minimum import duty and its enhancement to 3 per cent has yielded significant revenues. But this has involved taxation of essential goods like vegetables, pulses, fertiliser, pesticides, books, petroleum products, etc. Even the Holy Quran (HS 4901.9910) was not exempted. Further, regulatory duties were imposed on a wide range of goods, including wheat and sugar, in the presence of low import prices. Overall, the tax system has become more regressive in 2015-16.

IMF has highlighted that tax expenditures in direct taxes were only 0.2 per cent of the GDP in 2015-16, based on information contained in the Pakistan Economic Survey. The exclusion of the cost of other major exemptions and concessions is justified apparently on the grounds that they are the same as international best practices. I urge the Economic Advisor to look at the Statement of Revenues Foregone due to tax expenditures in India. This statement lists as many as 33 types of tax expenditure in direct taxes. In fact, this statement is one of the documents circulated at the time of the presentation of the Budget to the Parliament. This practice ought to be also adopted in Pakistan to ensure greater transparency.

The exceptional treatment enjoyed by the rich in Pakistan is demonstrated in a recent UNESCAP report. The highest marginal personal income tax rate is attained in Pakistan at an income level which is fifty times the per capita income of the country. In Turkey it is reached at only four times the per capita income; in India at ten times the per capita income and in Bangladesh at eighteen times the per capita income. Also, according to UNESCAP, Pakistan has experienced the least inclusive growth among sixteen Asian countries.

The Economic Advisor states that barring some input tax adjustments will not affect the value added tax feature of the GST. This is used as a justification for the withdrawal by FBR of provincial sales tax on services input tax invoicing in the Federal GST on goods. But this leads to `cascading`, that is, a `tax on tax`. Effectively, this has meant an increase of almost two percentage points on average in the Federal GST rate from 17 per cent to 19 per cent.

The unusual methodology adopted for zero rating of the sales tax in the five export oriented sectors by removing GST on inputs is subject to leakages. This facility is available only to registered manufacturers in the five sectors. If an input can be used in other than the five sectors, there will be an incentive for the registered manufacturers in the export sectors to import inputs more that their requirements and sell the rest at the tax paid value to manufacturers in other sectors. Preventing this malpractice will require much greater vigilance at the individual unit level by the IRS.

Focusing on the power sector, the State of Industry report by Nepra for 2014-15 was visibly delayed possibly because it may have been subject to whetting by the Ministry of Water and Power. This report does make some positive statements about developments in the power sector as highlighted by the MoF. But it also includes some notes of caution. It states that `sustained efforts are, however, required at all levels so that smooth and transparent implementation of projects is achieved within the target dates'. The report also points out that the transmission system constraint could hinder the utilisation of the new capacity created. For 2014-15, it also highlights that `the DISCOs did not show any noticeable improvement in their performance`. The recent large number of protests in many cities testifies to the fact that the power load shedding problem is far from being resolved. Also, if as reported by the Economic Advisor, performance of the power sector has visibly improved in 2015-16, then why did the tariff differential subsidy to the sector increase by 31 per cent? It should have fallen.

The Tenth Review by the IMF has already stated (in page 67) that the stock of payment arrears in the power sector included respectively the payables of Rs 326 billion and the stock of PHCL of Rs 335 billion as of end December 2015. Clearly, the stock of circular debt is now well in excess of Rs 650 billion. Overall, while the IMF has apparently been benign and sympathetic in its approach to the quarterly reviews under the EFF, it has skilfully stopped some critical measures by the Government of Pakistan. The well-designed and comprehensive agricultural relief package announced by the Prime Minister of Rs 341 billion in September 2015 was severely restricted to less than Rs 30 billion. This has probably led to a big increase in rural poverty in 2015-16. Now, the Fund may be attempting to delay the implementation of CPEC by imposing severe cuts on development spending. The IMF program, however, comes to an end in September 2016. It is hoped that the Government will then be able to address the critical national development priorities in a more effective manner.

(The writer is Professor Emeritus and a former Federal Minister)