To attribute the state of the economy entirely to the current political uncertainty is not correct. The fact is that it was in a fragile state, no matter what gloss one tried to put on it.
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CURRENT ACCOUNT DEFICIT UP
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(US$ Bn) FY 2017 FY 2016
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Exports 20.4 20.8
Imports 53 44.6
Trade Bal -32.6 -23.8
Remittances 19.3 19.9
Cur A/C Bal -13.3 -3.9
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Exports have been declining for some time. The FY 17 closed with the lowest exports in six years. The export package was too little, too late and in any case has not been fully implemented to have a meaningful impact as yet. Imports have risen as the oil price relief subsided and also due to CPEC- related investment. There are fundamental issues with Pakistan''s trade competiveness discussed below. Remittances are down due to contraction of Gulf economies, and are now well below 50% import cover they previously provided. The current account deficit as a result is at a record $13 Bn. Multilateral and bilateral funding and external borrowing will be required to close the gap. The Pakistan Rupee per the IMF is currently over-valued by 20%.
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FISCAL DEFICIT AND DEBT MOUNTING
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Tax collections Short of target
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Government revenue 15.5% of GDP lower than most peers
Fiscal deficit 4.7% likely for FY 17 vs 3.8%
target AND 4.1% for FY 16
Government debt 75.4% of GDP vs 52.8% median
for B rated countries
Debt profile Short term 32%
Foreign 31% of GDP
Debt service cost Eats 25% of export earnings. Debt
cost as % of revenue at 28% is 3x
median for B rated sovereigns
Import cover 3.5 months
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With tax collections short of target and a tax base that remains narrow, fiscal deficit is likely to exceed the target. Pakistan''s total debt is well above the median for B rated countries. The high reliance on short term debt makes it vulnerable to rate hikes. Equally, exchange rate change would impact the high foreign component of debt. As it is, more than a quarter of export earnings are used to service debt and the cost as% of revenue is three times that of B rated sovereigns. Import cover is precarious at 3.5 months.
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PAKISTAN AT BOTTOM OF SA CREDIT RATING
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Business Recorder Moody''s
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India BBB- India Baa3
Bangladesh BB- Bangladesh Ba3
Sri Lanka B+ Sri Lanka B1-
Pakistan B Pakistan B3
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Whilst Sri Lanka is on a negative watch-out by both S&P and Moody''s, Pakistan ranks lowest on the two agencies credit rating.
FUNDAMENTAL FLAWS EXIST IN THE ECONOMY
Without addressing some fundamental flaws in the policy framework, Pakistan will continue to confront economic challenges.
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1. Pakistan s economy is consumption driven
with poor investment and savings levels
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% of GDP Pakistan Sri Lanka Indonesia
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Private 80% 69.4% 36.1%
Consumption
Government 11.8% 8.7% 9.5%
Consumption
Investment 15.2% 29.5% 33.8%
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With both private and government consumption levels well above peers, the re is little room left for investment. Pakistan also has amongst the lowest savings rates. Private sector credit as % of GDP has halved from 29% in 2004 to 14% currently. The government is crowding out the private sector from bank lending as it tries to fund its deficit. The large informal sector is also unable to provide adequate collateral for loans.
2. The country is deindustrializing prematurely
(Manufacturing as % of GDP down 500 bps)
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3. The Exchange rate tool has not been
fully deployed to create competitiveness
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Exchange Rate vs US$ over last 5 years
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Destination markets Sourcing Competitors
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PKR -13.5% PKR -13.5%
Euro -18.9% India -20.2%
GBP -21.1% Turkey -51.7%
Jap Yen -25.8% Sri Lanka -14.4%
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4. Significant input cost disparity exists
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Gas cost Labour cost
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Bangladesh 1.9 x 2 x
India 1.8 x 2.3 x
Sri Lanka 2.6 x 1.9 x
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5. Pakistan s tax rates are higher than peers
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Corp Tax % VAT/GST%
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Pakistan 38%* 17%
Singapore 17% 7%
Sri Lanka 15% 12%
Bangladesh 25% 15%
Vietnam 22% 10%
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-- Incl WWF/WPPF/Super Tax
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6. The Tax base is narrow
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% of GDP % Tax Rev
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Agriculture 19.5% <1%
Manufacturing 13.5% 58%
Retail/Whole. 18.5% 1%
Services Total 59.6% 37%
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7. Agriculture is a larger part of the
economy but productivity is low
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% GDP Pakistan India Indonesia
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Agriculture 19.5% 16.5% 13.7%
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Pakistan Output % World Best
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Wheat 36%
Cotton 52%
Sugar Cane 51%
Maize 41%
Rice 29%
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8. Industry is a smaller component of
Pakistan s economy than of peers
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% GDP Pakistan India Indonesia
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Industry 20.9% 29.8% 40.3%
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The country is deindustrializing prematurely with the role of manufacturing declining. We are outsourcing jobs to China and elsewhere as a result of flawed Free Trade Agreements. The one with China has seen our trade deficit grow from $3.2 Bn when signed in 2006 to over $14 Bn now. Yet we pursue fresh agreements with counties like Thailand and Turkey, which have more to gain than us. The latter also placed import protection measures against our exports.
Over the last five years the Pakistan Rupee has appreciated vs the Euro, the British Pound and the Japanese Yen. The EU represents 33% of Pakistan''s exports.Thus in these destination markets its exports have become less competitive. Also against India, Turkey and Sri Lanka, three important sourcing competitors, the Rupee has devalued at a lower rate.
Pakistan suffers a significant input cost disparity relative to Bangladesh, India and Sri Lanka. Pakistan''s gas and labour costs are between 1.9 to 2.6 times the level prevailing in these competitor sourcing countries. Despite claims of additional power generation, it is not clear when energy costs will become competitive.
Pakistan''s rate is higher than global average. For shareholders of companies it is effectively 47%. 70% of the country''s tax revenue is derived from indirect taxes, also at a higher rate. Group loss relief has been cut and cascading taxes levied on inter-corporate dividends. Super tax and tax on retained reserves discourage capital formation and scale thwarting competiveness.
Pakistan''s tax base is narrow with manufacturing carrying a disproportionate burden. Also, the formal sector faces an uneven playing field vs. smugglers, counterfeiters, under-invoice rs and those who misuse the Afghan transit treaty. The tax system is complex with 47 types of levies. Withholding tax on non-filers has become a revenue raising tool rather one that incentivizes more to join the tax base.
Despite agriculture being a more prominent part of Pakistan''s economy relative to others, as a result of poor seed and water management, our output lags the world''s best by a considerable margin. India''s cotton output, thanks to GMO seeds and higher acreage is now three times that of Pakistan. Cotton availability limits Pakistan''s textiles (65% of the country''s exports) from growing. Despite duty free access to the EU, Pakistan commands very low share, partly due to this reason.
Due to premature deindustrialization resulting from poorly negotiated free trade agreements, unfair competition from the informal sector, heavy taxation, shortage of cotton and other agricultural convertibles, energy shortfall, higher input costs than competing sourcing countries, Pakistan''s industry has not grown to become a more prominent part of the economy. As a result fewer jobs have been created, critical mass that would lead to greater competiveness has not been allowed to develop, exports have suffered and we are rapidly becoming a nation of traders, content on consuming imported items.
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POLICY REFORMS THAT WOULD IMPROVE THE ECONOMY
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Current Framework Reforms required
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- Policies framed by those who have poor - Promote capital formation and
understanding of business, pay little or consolidation to drive investment and to
no tax themselves and in general mistrust improve competiveness. Withdraw Super
business people Tax, restore group relief, remove
- High degree of fragmentation, silo cascading tax on inter-corporate
management, conflict between policies dividends and on retention of reserves
of ministries and between the federation - Tax actual profit, not a percentage of
and provinces. Result is complexity. Turnover
- A tax regime that discourages risk taking, - Separate tax policy formulation from tax
capital accumulation and consolidation collection to prevent knee-jerk revenue
- Fiscal measures are knee-jerk and measures
targeted to meet revenue shortfalls - Withdraw Full and Final tax regime for
- In general, an environment of commercial importers. This presently
harassment of the corporate tax payers promotes under-invoicing
- Government lacks the political will and - Renegotiate FTA with China and factor
FBR the talent and technology to employment and tax revenues in future
broaden the tax base agreements
- Poorly negotiated free trade agreements - Create jobs via value-added exports; stop
- A presumptive tax regime that allows export of commodities; support import
under-invoicing to thrive substitution
- Review tariffs to ensure RM and
intermediates are taxed at lower than
finished goods
- Use the exchange rate tool to create
competitiveness
- Provide energy at competitive cost
- Promote savings and investment (local
and FDI).
- Create long term debt market to fund
mortgages, commercial credit,
infrastructure
- Allow businesses to deploy WWF & WPPF
to improve lives and upgrade skills
- Make doing business easier through
simplification and digitization
- Restore and enhance incentive to deal
with the formal sector
- Address capacity and technology needs
of FBR to harvest data on non-filers
- Make WHTs on non-filers a real penalty
rather than a revenue raising measure
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