IMF review & state of economy

I expect an agreement on the review to come within this week, so, any day now. I can say that Pakistani authorities, the Minister of Finance, they deserve credit for in a very difficult time sticking to the programme they have. In Pakistan, the parental issue is tax collection. The country today collects a 12% tax-to-GDP.

We are saying it has to be at least 15% to have the revenues to sustain the functioning of your economy. So please people in Pakistan that can pay taxes collect it from them — IMF Chief, Kristalina Georgieva, in interview with Haslinda Amin of Bloomberg Television

The first review by the International Monetary Fund’s (IMF) team under the ongoing US$3 billion 9-month Stand-By Arrangement (SBA) was concluded on November 15, 2023. The sentiment throughout the talks remained optimistic, culminating in Pakistan’s success in completing the review, paving the way to receive the second tranche of SDR 528 million (US$ 700 million). The IMF in its Press release of November 15, 2023 confirmed the staff level agreement.

Reports from Pakistani media indicated that both Pakistan’s economic team and the IMF team were expected to collaborate on drafting the Memorandum of Economic and Financial Policies (MEFP). This development signaled a positive outlook for the economy. Pakistan agreed for implementation of a 40% windfall tax on banking sector profits expected to yield Rs 55 billion for the fiscal years 2021 and 2022.

Apart from the above development, it is a fact that our fiscal operations have consistently raised concerns for the global lender. In view of our turbulent history regarding adherence to agreed benchmarks, IMF authorities have been cautious about Pakistan’s performance.

Experts consider this caution as the primary reason behind the lender’s stringent conditions. Authorities have been actively working to adhere to the action points set by the IMF.

Avoiding any ‘economic misadventure’ would be a hard task due to the critical state of the economy. After the completion of the ongoing SBA, there is an urgent need to negotiate the next IMF extended fund facility programme with substantial financial allocations.

Pakistan’s revenue collection registered a robust growth, with a 25% year-on-year increase in tax revenue, reaching Rs 2.04 trillion, and an impressive 114.7% increase in non-tax revenue, touching Rs 453 billion for the July-September 2023 period.

These positive trends contributed to a primary surplus balance of Rs 417 billion. However, the country faces daunting challenges as unprecedented borrowing at historically high rates has led to a monstrous fiscal deficit of Rs 963 billion. The escalating debt cycle, where deficits are covered through increased borrowing, is raising concerns.

High debt-servicing costs are straining the validity of the ongoing budget, and if the borrowing pace and costs persist, the government may need to reconsider its deficit estimates, potentially leading to tax increases or reductions in developmental/operational expenditures and subsidies.

It is also reported that the government has agreed with IMF to take five major steps during the current fiscal year involving digitization of withholding taxes, digital invoicing of sales tax, broadening of tax base and introduction of simplified retailer scheme, anti-smuggling crackdown and digitization of under-invoicing.

While these measures are deemed essential, it seems that policymakers are inclined to continue with the withholding tax regime. However, a more effective approach would be to implement measures that guarantee a fair and efficient taxation system rather than promoting withholding taxation.

Additionally, the proposed broadening of tax measures includes imposing additional taxes and in the current review, the IMF and authorities have identified the imposition of tax on retailers, agricultural income, and real estate—a good step to include the real estate sector in the taxation network.

However, introducing preferential taxation for retailers appears to be unjustified and against IMF principles highlighted in the Tax Policy for developing countries, which states, “Good tax policy, therefore, ensures that the top marginal personal income tax rate does not differ materially from the corporate income tax rate”.

Our policymakers are neglecting crucial initiatives that could significantly contribute to achieving revenue targets, attract foreign investment, and shape a robust foreign policy that leverages our skilled human capital. This oversight extends to our foreign offices, which seem indifferent to the challenges faced by our expatriates.

Pakistan should proactively establish diplomatic channels with other nations to address concerns of our people living or planning to move abroad, to facilitate them in local corporate jurisdictions. The government, in return, should offer incentives to foreign corporate bodies for investments in our special zones, with the condition of hiring a specific number of our nationals. Implementing this strategy will not only increase foreign investment but also enhance remittances. Over time, these skilled professionals could play a pivotal role in shaping our foreign policy.

According to recent reports, the IMF has recommended additional taxes on retail, real estate, and agriculture in Pakistan. These sectors currently contribute limited direct taxes compared to their potential, creating imbalances in the tax system. Delayed reforms disproportionately affect salaried and corporate taxpayers already burdened by high tax rates.

Additionally, there are concerns about privacy laws as Pakistani authorities are reportedly agreeing to share data on tax evaders with IMF through institutions like FBR, banks, and NADRA. A more prudent approach would involve comprehensive tax system reforms, expanding the taxpayer base, ensuring fairness in taxation, and leveraging digitalization and technology to enhance efficiency, such as implementing systems like FBR’s Point of Sale (POS) and track-and-trace (T&T) to minimize problems like underreporting and parallel bookkeeping.

IMF’s demand for an additional power tariff hike raises significant concerns with media reports indicating that the average increase of Rs 5.75 per unit in July has been deemed insufficient. This inadequacy is particularly related to containing the circular debt at agreed levels, as Pakistan had committed to increasing prices by Rs 8 per unit.

Furthermore, disagreement persists with the lender regarding the revised ceiling of Rs 292 billion regarding the flow of circular debt. These developments highlight potential challenges in meeting IMF’s conditions and effectively addressing the circular debt issue.

The agreed ceiling in the Circular Debt Management Plan was Rs 155 billion, but the actual increase amounted to Rs 227 billion, pushing circular debt to Rs 2.537 trillion by the end of September 2023. Revising tariffs at this critical juncture poses a considerable challenge, given that businesses and the public at large are still grappling with the damage caused by high energy and power costs.

As reported in the media, Pakistan has informed the global lender of an increased debt servicing estimate, ranging from Rs 8.3 trillion to Rs 8.6 trillion for the current fiscal year. This exceeds the initial budgetary estimate of Rs 7.3 trillion, potentially reaching Rs 1,000 to Rs 1,300 billion.

Additionally, the global lender is urging the government to streamline expenditure on the Public Sector Development Program (PSDP) for the current fiscal year. With an initial development budget of Rs 950 billion, there is a likelihood of a reduction to Rs 800 billion or even less to align with the fiscal requirements of the current year.

The PSDP, which exceeded Rs 1000 billion in 2018, has consistently faced reductions, hampering vital development projects and impeding progress in infrastructure and socio-economic development resulting in unemployment and overall adverse economic growth.

Imposing more taxes, burdening existing taxpayers, or revoking subsidies could further negatively impact the economy.

It is a fact that small businesses are already on the verge of collapse in this bleak environment. The government must intensify and consolidate its recovery efforts to reduce circular debt accumulation, initiate privatization, and control the wastage of resources to realize Pakistan’s sustainable economic future.

(Huzaima Bukhari & Dr. Ikramul Haq, lawyers and partners of Huzaima, Ikram & Ijaz, are Adjunct Faculty at Lahore University of Management Sciences (LUMS), members Advisory Board and Visiting Senior Fellows of Pakistan Institute of Development Economics (PIDE) and Abdul Rauf Shakoori is a corporate lawyer based in the USA and an expert in ‘White Collar Crimes and Sanctions Compliance’)

Copyright Business Recorder, 2023