Dr Shah was the Minister for Finance and Revenue in the caretaker government of 2007-08. He also served as an advisor to then Prime Minister on finance and revenue (2004-07). Previously, he served as Associate Dean at Lahore University of Management Sciences (1986-94). Dr Shah did his MBA and Ph.D. from the Kelley School of Business at Indiana University (1984). He is currently the CEO of Bridge Asia Financial Services.
"Certainly we need more revenues if we want a huge government but I think we have made a big mistake by creating so much noise over the taxation issue and making it into a single-point agenda for economic revival," " Salman Shah kicks-off the interview with these remarks on how to increase the tax-to-GDP ratio to resolve the fiscal deficit problem.
"Even Clinton regularly lectures us on how the Pakistanis don't pay taxes and expect the world to foot the bill.... look tax collection has increased 5 times in 1the last ten years. Tell me any other country where this has happened," he added.
Clearly, the former finance minister does not agree with some economists' fetish with tax-to-GDP as the miracle cure for the country's stagnating economy.
"Who cares about GDP based ratios; it is about how much money you have in your pockets. You spend according to what you have in cash...and so let's cool down a bit the rhetoric on the tax-to-GDP ratio and focus on the expenditure side" said Salman, while strongly advocating the need to approach the fiscal situation by looking at the resource envelope first and then fitting expenditures within it instead of doing it vice versa.
He's also skeptical about the emphasis on increasing direct taxes. "Our direct taxes are better than most countries at our level of development. I remember Turkey had 28 percent direct taxes and we are at 42 percent," he explained. "Certainly we need to bring more people into the tax net and get the tax dodgers but to do this we need to continue with an incentive compatible tax system rather than a coercive system that would be open to abuse and corruption," he added.
Shah's biggest concern on taxation is transparency (or lack thereof) in the workings of FBR. He suggests rigid adherence to self-assessment schemes and reinforcement of audit mechanisms based on international standards by developing in-house professional capability for desk audits and outsourcing the physical audit to professional audit firms.
"We should minimize the contact between the FBR and the taxpayer. And then be very ruthless with evaders if required," he says, adding that the FBR should incentivize people to pay more taxes such that whoever is a regular taxpayer and shows substantial increase in taxes paid every year should be given awards and freed from audits. Use the audit system to go after the people who are outside the net or who abuse the system.
But incentives like these take time to bear fruits; they won't help curtail the fiscal deficit in the short to medium term, BR Research inquires. Shah agrees, and says he sees FY12 budget as a "risky budget". "You will have to get everything right on the ambitious revenue targets as well as the expenditure side to make this budget work," he said, suggesting that the government is treading a tight rope with subsidies, which, he believes, are understated.
"If they would not be able to increase tariffs when oil prices shoot up then the subsidies in the election year will be much higher," he cautioned. Furthermore, state-owned enterprises are a big drain on the government exchequer and the burden can balloon without an effective privatisation program.
The former founding professor of the Lahore University of Management Sciences contends that the targeted budget deficit should be realistic for the sake of the IMF, saying that "if you tell them (IMF) the deficit is 8 percent, they will not be as angry as when you say it is 4 percent but it turns out to be 8 percent."
He deems the expenditure side, in particular debt financing, to be critical for the budget. "Debt servicing was Rs 375 billion in 2004. Today, it has reached Rs 825 billion!" he said. This is a result of high interest rate strategy of the state bank that has given us stagflation, crowding out of the private sector and squeezing the government fiscal space for the social sector.
The cuts in the higher education commission's budgets directly go to the banks for debt servicing. Cutting the interest rates to single digit could reduce debt servicing in the short term and free up some fiscal space for the government. He is also concerned that the inability to contain debt will worsen the situation.
"As per fiscal responsibility and debt limitation act, you have to bring debt to GDP ratio down by 2.5 percent every year, which automatically contains the debt. But, they are violating the law and eventually debt will pile up," he said. It is critical to live within our means and curb the fiscal deficit to agreed targets with the IMF.
The defence expenditures, says Shah, are also linked directly with economic growth. "If the economy suffers, there cannot be an affordable defence budget or modernisation, of the armed forces," he says, adding that "currently, Pakistan's defence budget is around $5 billion and India's is $30 billion. This is roughly 3 percent of GDP for us and 2 percent for them. But India is growing at 8 percent and we are growing at 2 percent. So, high economic growth in Pakistan is critical for the security of the country."
MANAGING DEVELOPMENT
Asserting that the IMF and the government must think of ways to increase investment, Salman decries that "investment has fallen from 24 percent in FY 2007 to 13 percent of GDP in FY11, which translates into an annual drop of $20 billion."
Twenty billion dollars is indeed a lot of money! 'And if that has been kept out of the economy, there is going to be a very negative impact on growth", he said adding that the major driver of investment by Pakistani entrepreneurs is access to credit and the cost of credit.
Shah, who is very critical of high interest rates, argues that inflation in Pakistan is not demand related, and is rather driven by energy and commodity prices. "It is an oil-related phenomena and not demand-related at the moment when the monetary policy is very tight. People have even dropped their food consumption what to talk of excess demand. Shah forecasts inflation to be in single digits "at the minimum" - nearing 3-4 percent - in 2012 now that the boom in commodity prices is dying and oil prices have been stable, suggesting the discount rate be lowered to 9 percent in the next six months. .
"It is foolish what we are doing right now! If you compare our inflation with that of India, there is no difference; yet, our interest rates are 13.5 percent and theirs are only 7 percent," he said adding that at this time the central bank's main aim should be to make the economy grow.
For increasing investment in the public infrastructure, Shah proposes to invite the private sector. "If you notice, the fiscal deficit is more or less equal to the Public sector development program (PSDP)," and therefore he believes it can be excluded from the budget. Instead, he says, it should be financed through public-private partnerships, a phenomenon observed all over the world.
"The government doesn't need to do all these development works. If there is a need to make a hospital building, the government can ask private builders to build it and then lease it to the government, that can be funded by user fee," he explains, adding that most major roads, highways, ports etc, in Korea are made under public private partnerships. "But for this, you need a government that is honest, transparent, and competent," he aptly quipped.
CONSUMERISM VS SAVINGS
Sticking to his long held beliefs, Shah says that domestic savings are important but can be substituted by foreign investment.
"In this day and age of globalisation, it is the global savings that really matter. And we want competitiveness in attracting those savings. The Pakistan Brand we had developed in the capital markets of the world has been shattered. Irresponsible financial management by the financial managers of the new government ignited capital flight and a balance of payment crisis. The biggest damage done by the new government was promoting the fallacious idea that in Pakistan consumerism was mother of all evils, thereby negating the advantage of our domestic markets. Every economy in the world has been driven by consumerism; India is all consumerism," he said.
He highlights how consumer finance, at its peak in Pakistan, was no more than 6 percent of GDP, while it is 80 percent of GDP in Malaysia. "Why should banks cater to the big 'seths' only? Why not individuals?, Why not SMEs? You need to make sure that every segment of the economy that needs finance should be able to get finance!" Shah exclaims.
Shah is also critical of the fact that "97 percent of local businesses are SMEs and that we do nothing for them".
"I recently did a study where I compared the SME support agencies of different countries and I ranked them on the per capita expenditures made on these entities. In Japan and Malaysia, they spend around $70 per person on what would be our equivalent of SMEDA. In Brazil, they spend $7 per person and in Pakistan we spend only 1 cent per person!" he said if we want to embark on a major industrialisation then we have to hold the hand of the SMEs and help them to expand and create the jobs our country needs.
We are a young country with over 100 million people under the age of 25. If we can grow the economy at around 8 percent a year we will create the employment opportunities needed, he says. In turn the employed people, as they save and consume, will create enormous opportunities for investment in virtually every sector of the economy. "As the wealth effect takes hold, the savings rate will go up and your dependence on foreign savings will decline," he asserts.
THE LONG VIEW
Shah urges Pakistanis to "look at the bigger picture; this region has the biggest resource of gas, oil and energy in the world right now; the Middle East; Iran and Central Asia are full of energy".
"Omanis are building a port in Salalah and they are going to connect it with the oil wells on the Arabian side; we have made Gwadar to connect to Central Asian and Iranian oil and gas, and huge markets in western China; India is making a port in Gujarat, and they are also looking to make it a transshipment point for oil, gas refinery operations, etc. Similarly, Sri Lanka has made a port with help of China, which is going to be the biggest port for LNG and oil shipments. China is making a huge port in Burma that will connect the two," said Shah while arguing that there is a global scramble for oil and gas supplies particularly in the Indian Ocean and Pakistan has to play a leading role in this.
"The project in India, Gujarat, doesn't have supply, it only has demand, so they are looking at the Indian market, plus ship it where ever they can; but Gwadar has the advantage of connecting supply and demand from all these countries and you can transship it also," he added. Our future depends on exploiting the geographical and demographic advantage of Pakistan and every citizen of Pakistan from Balochistan to Gilgit will benefit. We can wipe out poverty in our lifetime.
Shah thinks urbanisation in Pakistan is being ignored. "We will soon have 50 percent of the people living in urban areas," he says, adding that the development of mega urban infrastructure projects for investment and growth is very important.
He highlights that rural areas and the agriculture sector give 20 percent of the output employing 70 percent of the people, which is unsustainable. "To produce 20 percent of the output, you only need maybe 30 percent of the people. Ultimately, the 70 percent have to move to the cities." That means massive growth in manufacturing and services.
Shah brings to light the importance of connecting cities by highlighting the National Trade corridor project started by the last government that essentially connects the whole country by building a motorway from Karachi port to Khunjerab Pass (at Pak-China border). The project that has been in the doldrums needs to be expedited and implemented so that each region will connect and feed its products and services to the great Pakistan Common Market for growth and prosperity.
"When this motorway will be built, there should be a major city after every 100 miles, which would then act as an engine of growth for the entire surrounding area," said Shah, adding that the domestic common market would act as a great unifier of the country.
Then again, all this would be formidable task without affordable energy supply. "It is a life-and-death issue for us, we cannot afford a very high price of oil," Shah emphasises, adding growing demand are not likely to suppress oil prices. As long as oil prices are above 100 dollars a barrel our economy cannot be stabilised we need to immediately start work on energy independence by building our hydel capacity without further politics or delay.
This places the onus on dams, the financing of which is critical, and therefore requires ingenious thinking. When financing was refused for 'Neelam-Jhelum' by the international financial institutions on grounds of it being a disputed territory, Shah came up with the idea of charging a surcharge of 10 paisa per unit to the consumer bills under the head "NJS". This generates $100 million every year which for the "Neelam-Jhelum" hydro power company. This amount is sufficient along with suppliers credit to build the project.
Shah's fearful that if Pakistan doesn't take the initiative on dams due to political deadlock, India would eventually build dams on our rivers and we'll lose our rights because of not utilising the water. "It must be realised that India is making hundreds of projects on our rivers".
Backing dams further, he explained, "'Neelam-Jhelum' is technically a very complicated project involving huge tunnels and power from it will cost Rs 1.75 per unit, while Kalabagh a much simpler project will generate 3600 mw of power at less than Rs 1.50 per unit. Rental power, in contrast, is costing us Rs 18 per unit. There is no comparison!"
He says he is surprised to see that even though Sindh will be the biggest beneficiary of Kalabagh Dam, they are the ones opposing it the most. "All provinces will benefit, but for Sindh it will provide predictable water to areas which are currently not getting any water at all."
"Kalabagh Dam will cost $8 billion but for 30 years Pakistan will get $8 billion benefits every year and I am not counting the multiplier effect yet," said Shah enumerating the benefits of the dam. We are a big country with a population that can really benefit from globalisation as we have been exposed to western legal and commercial systems for more than 150 years.
"From Sir Syed Ahmed Khan to Mohammed Ali Jinnah our leaders have promoted the quest for global outlook in our thinking. Some of our universities are celebrating their centennials, our accountants, doctors, engineers, lawyers are in great demand world-wide. If we exploit our competitive advantages we can certainly win the both the war on terror and the battle of Globalisation and usher in an era of sustained economic growth and prosperity in our country," says an optimistic Shah.
Interview by Ali Khizar & Ayesha Aftab
An interview with
DR. SALMAN SHAH