The battle for Pakistan...

Pakistan is waging war on more than one front. While success in its ongoing struggle against extremism is critical to Pakistan's well-being, the other war which it should be fighting, but is not, is essential for its survival. That war is against vested interest which prevents taxation of the elite and derails the best laid-out plans for improving the efficiency of government as well as of the public sector. Unless Pakistan succeeds in the latter (broad-based, equitable taxation), it will continue to meet only partial success in the fight against militancy.
Introduction: Pakistan's perennial structural weakness has been its abysmally low - and declining - tax collection. Even Pakistan's most powerful government of recent times, that of General Musharraf (Retd), left in its wake a tax-to-GDP ratio of less than 10% after over 8 years in unbridled power. This is amongst the lowest tax collection ratios in the world.
Leaving total collection aside, the composition of tax receipts in Pakistan depicts huge inequity. Direct tax collection constitutes less than 3.5% of GDP, with wide ranging exemptions to powerful segments of society coupled with governance issues at FBR. The bulk of the tax receipts are collected in the form of sales tax. Far from being progressive, the taxation regime is highly regressive, meaning that the poor and less affluent are taxed more heavily as a proportion of their income than the rich.
The other weak (rather, missing) link in public finances is the lack of fiscal effort by the provinces. With some of the largest segments of economic activity such as agriculture, real estate, and services in the provincial domain with regards to taxation, it is baffling that provincial tax receipts total an abysmal 0.7% of GDP.
At the heart of it, these issues are related to governance. This state of affairs is a manifestation of a broader challenge that Pakistan has grappled with virtually since independence - the shifting of the burden of responsibility by a small, self-serving and venal elite to the rest of the population.
The flip side of not collecting taxes, and not being able to manage expenditures, is debt. This was never more evident than in early 2008 when a new government took office after elections. It inherited a tax-to-GDP ratio of less than 10%, a fiscal deficit of nearly 8% of GDP, and a current account deficit of over US $14 billion (a record 8.5% of GDP). Despite receiving generous assistance from the international community year after year, as reflected in the country's total external debt rising from US $35 billion to US $46 billion between 2005 and 2008 (over and above budgetary grants), the previous administration mind-bogglingly resorted to printing currency to the tune of over Rs 700 billion in two years. This factor was a major contributor to the spiral of inflation that was set in motion from 2007 onwards.
The nexus between not collecting taxes and having to borrow cannot be over-emphasised. To place this in context, consider the following: if Pakistan's tax to GDP ratio had been increased to a modest 13% in 2005 when the global as well as domestic economic conditions were most favourable, and kept stable since, Pakistan's public debt would have been almost 15% of GDP lower (at around 44% of GDP, instead of close to 60% currently). Put differently, since 2005, the government has cumulatively borrowed over Rs 1,600 billion largely on account of not being able or willing to collect taxes.
The net effect of this state of affairs was high inflation, pressure on FX reserves, a decline in the value of the rupee, and an erosion of market and investor confidence. This was a perfect recipe for tipping the country into a full blown macroeconomic crisis, which came with full force in 2008. To stabilise the country's fast depleting reserves, it is not surprising that the government had to resort to borrowing from the IMF in November 2008.
Hence, the primary factors behind the increase in public debt over the past three years include recourse to the IMF, a large adjustment in the value of the rupee after several years of the currency being kept artificially stable, and a large decline in grants and other non-debt creating inflows such as FDI after 2007.
To stabilise the macroeconomic situation, the economic team took strong corrective action in late 2008 with full support of Parliament and restored a visible measure of macroeconomic stability while providing a framework for structural reform. As a result, the following was achieved:
1) A reduction of the fiscal deficit to 5.2% of GDP in 2008-09, a fiscal adjustment of over 2.4% of GDP in less than a year and 3.8% of GDP in the first nine months of FY 2009/10
2) A containment of the external current account deficit to 5.3 % of GDP in 2008-09 and 2.5% in 2009-10 from 8.5%
3) A build-up of foreign exchange reserves to over US $16 billion from their low of under US $6 billion in October 2008
4) One critical element of the improvement in the FX reserves position was a sharp rise in worker remittances into Pakistan. Since the launch in May 2009 of a special initiative called the Pakistan Remittance Initiative (PRI), remittances have increased from US $700 million to US $900 million a month
5) Inflation was brought down from 25% in October 2008 to a low of 8.5% as of October 2009 before it began rising again
6) Based on the economic team's reform plans and successful implementation of the stabilisation program agreed with the IMF, the international credit rating agencies upgraded Pakistan by one notch in August 2009
7) The prices of Pakistan's outstanding Eurobonds surged in the second half of 2009 making them amongst the strongest performers in emerging markets
8) Foreign portfolio investment in the Karachi Stock Exchange (KSE) also began to pick up very sharply, with the KSE-100 index recording a strong gain
These were early successes. We recognised we had a long way to go. To consolidate these initial gains, the Prime Minister's Economic Advisory Council (EAC), under my Chairmanship, crafted a wide ranging structural reform programme, which was dubbed the "Nine-Point Plan". The nine areas that were identified for serious and sustained policy intervention included:
1) Macroeconomic Stabilisation with tax reform as the lynchpin
2) A well-crafted, targeted Social Protection plan (the largest in Pakistan's history) with appropriate exit mechanisms
3) Unlocking productivity gains in Agriculture
4) Energy sector reform (culminating in drafting the first Integrated energy plan)
5) Improving Industrial Competitiveness
6) Infrastructure development through innovative use of public-private Partnership (PPP) models
7) Increasing the depth of capital markets
8) Human capital development
9) Administrative and governance reform
By the time of my departure earlier this year, the status of some of the most critical reforms was as under:
-- In order to raise the Tax-to-GDP ratio, a key pillar of the government's economic strategy, a draft law to implement a broad-based Value Added Tax (VAT) with minimal exemptions from July 1, 2010 was presented to Parliament.
-- In addition, other measures such as improving tax administration and reinstating tax audits were taken. It was estimated that the cumulative effect of these policy measures was an expected increase in Pakistan's tax-to-GDP ratio to 13% by 2013 (from under 10 % in 2008/09).
-- Concurrently, an austerity plan was prepared and approved by the cabinet in December 2009 to cut back on the non-development expenditures for the Federal and provincial governments. It was all encompassing and was unanimously approved by the Federal Cabinet in the presence of all the chief ministers.
-- On the social protection side, the present government launched the Benazir Income Support Programme (BISP). An allocation of Rs 70 billion was made in the Federal Budget 2009-10 with the aim of targeting 5.5 million poor and vulnerable households in Pakistan with a cash transfer of Rs 1,000 per month to each. The size of BISP makes it the largest social protection scheme in the country's history.
-- A Cabinet Committee on Restructuring (CCoR) was formed in December 2009 to restructure key public sector enterprises (PIA, PEPCO, Railways, TCP, USC, Pakistan Steel Mills, NHA) with a view to stopping leakages caused by losses, amounting to approximately Rs 300 billion a year. The eventual aim was to turnaround these PSEs into profitable, self-sustaining ventures under public-private partnership mode. The plan was approved by the Cabinet in March 2010 for implementation.
-- Under reform of the power sector, electricity tariffs were raised over 40 % in less than two years in an effort to reduce the level of subsidies absorbed in the budget, while simultaneously moving to a full cost-recovery tariff for the power utilities. Under a new act of parliament, adjustment in tariff for changes in fuel prices for power generation was made automatic. In addition, an integrated energy plan was drafted by the Economic Advisory Council to provide a roadmap for energy security for the next 25 years.
At the same time, at least 4 power projects based on Thar coal were provided impetus.
-- The government successfully concluded the Seventh National Finance Commission (NFC) award - only the fourth in Pakistan's entire history and the first for the last 19 years.
This award greatly augments the quantum of resource transfer from the Centre to the provinces.
In conjunction with the higher resource transfer to the provinces, the Centre will also devolve some major functions/expenditure heads to the sub-national governments in line with the provisions of the 1973 Constitution.
-- In order to introduce administrative reforms in the public sector, a National Governance Plan (NGP) was prepared and approved by the Primer Minister. This took forward the work of the Dr Ishrat Hussain Committee. The scope of the NGP includes (1) human capital management (with the aim of making government/the public sector the "employer of choice"); (2) process re-engineering; (3) restructuring of public sector enterprises (PSEs); and (4) improved economic governance.
Success in implementing the Nine-Point Plan would have moved Pakistan's growth rate to a higher - and more sustainable - trajectory. In addition, the growth would be qualitatively different as it would be more equitable and will achieve greater - and more longer-lasting - poverty reduction. Given the mounting challenges, the economy is facing and the erosion of the macroeconomic stability that was painstakingly achieved in 2009, it is time to return to the basics of the Nine-Point Plan. This is a well-thought-out and visionary plan to turnaround the economy. I believe the time for talking is over and now let's WALK THE TALK.