Foreign exchange reserves may come down, equivalent to only two months of imports, by the end of year 2012-13, and there could be a serious financial crisis in the country by the second half of 2012-13 on the eve of next general elections. This would happen because of haemorrhaging of foreign exchange reserves due to the sharp increase in the current account deficit.
This was claimed in the 'Fourth Annual Report 2011, The State of the Economy Devolution in Pakistan', prepared by the Institute of Public Policy, Beacon House National University. The main thesis of this year's annual report is ensuring good governance. For progress to be made in this critical area, action is required on a number of fronts, which include ensuring responsibility, deliverability and accountability on the part of the public sector.
According to the executive summary of the report, the rate of GDP increase is only 2.0 percent in 2011-12; increasing to 3.3 percent the following year; only to drop to 2.8 percent in 2014-15. The rate of investment would decline from 11.5 percent to 8.5 percent; the rate of inflation to increase from 14.5 percent to 20.1 percent, and fiscal deficit to grow from 7.0 to 7.6 percent. Real exchange rate would drop from Rs 92 to the US dollar to Rs 133.
The report suggests that Islamabad should undertake major tax reforms, starting with the budget of 2011-12, which should include introduction of the comprehensive reformed general sales tax, the reformed general sales tax (RGST). This would withdraw all the remaining exemptions on goods and eliminate all distortions that have crept into the current system. Provincial sales tax on services will also be broadened. Wealth tax will be reintroduced, and a strong effort will be made to curb tax evasion.
These measures will be seen as making the system more equitable and should improve compliance. In addition, the provinces will develop their tax systems to generate more resources from within their economies, taking advantage of some of the provisions in 7th NFC of 2009.
On the expenditure side, the best case scenario focuses on improving the working of large loss making enterprises on eliminating the problems of 'circular debt' that is constraining the supply of electric power from existing capacity, and careful review of the public sector development programme by placing emphasis on the completion of high priority projects.
These measures will bring significant improvement in the governments' financial situation. Within the context of monetary policy , the best case scenario assumes that State Bank of Pakistan will have the autonomy to order its policies with the objective of containing inflation and not meeting the fiscal deficits of the federal government. The central bank will also let the market determine the exchange rate.
About the financial implication of devolution plan on the provinces after 18th amendment, the report said that according to the Planning Commission the cost of devolved development liabilities is of the order of Rs 202.3 billion, which would increase to Rs 317 billion if the expenditure on Higher Education Commission (HEC) and some other special initiatives is included.
According to the report, the revenue gain for the provinces was budgeted at Rs 222 billion for 2010-2011. This would erode to Rs 42 billion because of the shortfall in revenue collection and the increase in salaries of all government employees by 50 percent. This implies that additional revenue transfers due to the 7th NFC Award will not finance the additional liability from the transfer of functions under the 18th amendment. This would pose a challenge for the provinces which they should deal with by increasing their own resources rather than looking for more support from the financially stressed federal government.
To overcome this situation, provincial tax mobilisation can help to manage and finance the functions being devolved. The report presents a resource mobilisation strategy for provinces to substantially augment their revenues through, in particular, urban immovable property tax (UIPT) and agriculture income tax.