Sherani is a former Principal Economic Advisor to the Ministry of Finance, Government of Pakistan (September 2009 to December 2010). Sherani, who also served as member of the Prime Minister's Economic Advisory Council, had headed the Economics Unit of ABN Amro Bank Pakistan Ltd/Royal Bank of Scotland before he ventured into public career. Sherani has worked closely with government on macroeconomic issues over the past many years.
He was the member of Task Force on Economic Policy (TEP) (November 2004 to October 2007). He also served as a member of the working group on preparation of the Macroeconomic Framework 2005-2010 for the Planning Commission (August-October 2004). Currently, he heads his own economic consultancy, Macroeconomic Insights (Pvt) Ltd, in Islamabad.
Soon after the budget BR Research sat down with Sakib Sherani to take his views on the macro economic affairs of the country. In this interview Sherani talks of government's ballooning budgetary borrowing, FBR's collection targets, and shortfalls in the Planning Commission's new growth strategy. Below are edited transcripts.
BR Research: Some circles believe that the interest rates should be cut to spur demand. What is your view?
Sakib Sherani: Interest rates cannot be lowered in the presence of such a large, persistent borrower. Even if the SBP brings the policy rate down to 5 percent, there will be a total disconnect as market interest rates will not follow the discount rate. Auctions determine borrowing rates and not administrative rates. You have to stop the government from voracious budgetary borrowing if you wish to live in a low interest rate environment.
BRR: Do think the budgetary borrowing will ease this fiscal year?
SS: The budget presented is not credible. There is an overestimation of revenues and an under-estimation of expenditures. Revenues will be around Rs 200 billion less than what have been projected, with shortfalls in FBR collection, 3G licence proceeds, and FBR's proposed "administrative improvements". Expenditures might overrun by Rs 150 billion or so.
BRR: What do you make of the provincial budgets? They were supposed to show surplus but they ended up in deficit. SS: I think there are architectural issues that need to be resolved. The idea that in the post-18th amendment era the government should go to the CCI before preparing the overall fiscal targets is the right one. This has been propounded by people like Dr Ishrat Hussain (former SBP Governor).
Once the CCI had endorsed the provincial surplus targets, the framework would have become binding on provinces. Then you can expect the provincial budgets to be made in the overall framework of the country. But this was not done, despite the fact that it is extremely important after the 18th Amendment.
Moreover, we need additional work on the overall fiscal framework; we need to rein-in borrowing by the provinces. For this, it will be important to pass provincial fiscal responsibility laws. Without that, there remains a lacuna as the provinces may act in ways that undermine overall fiscal stability. The anomaly where you have an overall fiscal responsibility act, but provinces are not bound by it, has to be removed.
BRR: How fruitful has NFC been and how do you see the devolution process unfolding?
SS: Because there was a political imperative to do the NFC, it was pushed through in a rush; many things were not taken to a logical conclusion. For example, we did not build sufficient safeguard measures with regards to provincial fiscal effort.
We could have had the NFC transfers kick-in only if the provinces had met certain criteria. At such a dismal tax-GDP ratio of 8.9 percent you cannot service the NFC transfers. All the major tax avenues are with the provinces, The NFC transfers should only take place when provincial tax collection increases to at least 1 percent of GDP instead of the current 0.5 percent.
Moreover, if the overall tax-to-GDP ratio is over 9.5 percent, then only can the NFC award kick-in, otherwise it should remain in abeyance. Your ability to generate revenues is contingent on provinces signing on two things: one is the integrated VAT, on which they have backed off.
Secondly, the provinces also need to sign up on implementing the agriculture income tax collections. So, if the tax-to-GDP ratio remains below 9.5 percent, servicing NFC transfers won't be easy and there will be ad hoc arrangements in place.
We need to incentivise the provinces to get their act together, which they have not done yet. The centre should not tolerate the irresponsible behaviour of the provinces.
However, the bureaucracy also played the villain's role in creating a trust deficit; otherwise all the parties had signed and agreed on an integrated VAT.
Overall, there should have been at least one year of preparatory work prior to the NFC discussions.
Another problem in the NFC is that the federal finance minister does not represent the federation; he acts as an impartial "referee". I feel you do not have sufficient high powered representation for the federation.
But I do not agree with the critics when they say that the sequencing is flawed ie that the NFC award should have followed after the 18th amendment. You have to keep in mind that these are political economy decisions.
BRR: The essence of devolution ought to be decentralisation but it seems to be the exact reverse. What are your views on that?
SS: I don't think the Rabbani Commission has really thought through the situation. For example, let's say you devolve these 18 ministries.The provinces do not have the capacity. It should have been a long thought out process; it was done in a hurry. If they are not able to even house the ministries physically, then service delivery is going to collapse, beyond doubt. It should have been done in a planned and orderly fashion.
BRR: What should be the role of the Planning Commission?
SS: The job should be to get all the provinces on board. You need to expand the PC membership to formally include members from each province. And there should be some co-ordination between the PC and the planning departments in the concerned provinces. The PC in India gives a broad plan and programme, and the states carry out the national plans accordingly in parallel to their own devised programs.
But once again, I do not see the capacity on the provincial planning side either.
BRR: What's your view on the New Growth Strategy?
SS: Despite being involved in it, I think that we have put the cart before the horse in many areas. Most of us were on the same page, but the Deputy Chairman has a different set of ideas with regard to export promotion or the agriculture sector, for example. I think the document lacks a clear vision. It also lacks an implementation mechanism, which I believe is being worked on. I think it is too idealistic, to be honest.
The Planning Commission should also be telling the government how to navigate the next two to three years. Just telling about the next ten to twelve years leaves a yawning gap and isn't just good enough. They have not applied themselves sufficiently to current challenges and issues.
BRR: What should be the framework that gets the provinces and centre on the same page?
SS: The CCI and the NEC have to play a much bigger role and they should be meeting much more frequently than they currently do. Another element missing is the Prime Minister; we need a much stronger PM. He has not discussed the economy properly in three years. The PM, the CMs, the PC and the provincial planning bodies should be working in co-ordination, which should help a lot.
There should be a review meeting every month with the Finance Minister, the provincial finance people and the secretaries should all meet and discuss the situation.
BRR: How should the PSDP backlog be treated?
SS: We need to go slightly beyond the current strategy of the completion stage and judge projects on priority basis. We have to see the developmental objectives and alignment with the national strategic goals. I am not sure if the PC has worked on that or not.
BRR: Do you see the power sector subsides phasing out anytime soon?
SS: You need to fix the governance side of things in the sector. Tariff increases won't do the trick, and we have been trying to tell this to the government and the IMF. They have to replace the boards with honest and competent people. This has not been done.
We are in an election year, so reforms might not move swiftly. We could end up about with a deficit of 6.5 percent of GDP in FY12, and could be even higher. The government may disregard fiscal consolidation. The main damage could happen in this fiscal year.
BRR: How will the FBR achieve Rs 1952 billion target of tax collection?
SS: It doesn't make sense. This year, if you take inflation at the GDP deflator rate, the nominal growth is about 23 percent. They will end up the fiscal year at about 14 percent growth in revenues which is 68 percent of the nominal growth that they have been able to capture. Next year, they are targeting 140 percent of the nominal growth, which is not achievable.
BRR: Where do you see inflation in the near future?
SS: Inflation is not likely to be below 14 percent. The government is likely to continue borrowing. They might get a breather on the BoP side if the EU pressures persist and oil prices cool down.
The link between consumption and credit has broken to some extent. Aggregate demand has been underestimated; however, it may begin to fall a bit now as the government does not have the ability to run commodity operations as much as it did during the last three years.
BRR: Some circles suggest that currency should be devalued by 10-15 percent to boost the exports. What do you think?
SS: Our exports only constitute 10-12 percent of GDP; it is not a very large export sector. The argument of stimulus does not hold true. The argument is in fact of a more basic nature, that you have a real effective exchange rate indicating that the currency is overvalued.
BRR: Remittances have shown tremendous growth of late - is it sustainable and what could have caused such growth?
SS: We have no idea about the remittance sources. A few people say that it is black money which is being whitened. I think the interest rate arbitrage is big but risky. The more likely scenario is that it is whitening of money, including some impact of policy measures taken under the Pakistan Remittance Initiative.
An interview with SAKIB SHERANI
Interview by Ali Khizar
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