Economic challenges: response not befitting enough

The Economic Survey for 2010-11 reflects two divergently opposite trends with respect to the performance of economy. On one side of the spectrum is the poor performance of our major macroeconomic indicators that include Gross Domestic Product growth and its key components, fiscal balance, investment and savings, inflation and employment.
However, external sector of the economy improved remarkably due to a surge in exports and home remittances while GDP growth was restricted to only 2.4 percent as against the target of 4.5 percent due mainly to devastating floods and an ongoing energy crisis. Agriculture sector was projected to grow by 1.2 percent against the target of 3.8 percent while manufacturing growth was negligible -1.7 percent due to severe power and gas shortages.
Floods were not the only factor that impacted negatively on farm output. Diversion of gas to electricity generating plants in an effort to meet the continuing power shortages significantly resulted in curtailment of gas to fertiliser manufacturing, causing a rise in the price of urea. Due to significant reduction in fertiliser off-take (an 11.3 percent decline) urea prices soared by 25.8 percent and DAP became expensive by 46.5 percent in the current financial year.
Industrial sector's performance was poor due mainly to (i) energy shortages, a major input for most industrial output, (ii) crowding out of private sector credit as government in its struggle to control the rising budget deficit resorted to heavy borrowing from the banking sector, (iii) government slashed its development budget by over 90 billion rupees that had negative consequences for the industrial sector as a whole as well as on overall investment that declined by 4.5 percent - from 17.9 percent last year to 13.4 percent in 2010-11, (iv) high cost of borrowing as the State Bank of Pakistan maintained a high rate of interest in an effort to control inflation. Domestic savings declined by 1.6 percent - from 14.5 percent last year to 9.5 percent this year.
The private sector was unable to save due to rising prices and shrinking incomes and the government was unable to save due to a burgeoning budget deficit - from the target of 4 percent of GDP to 5.1 percent. According to the finance minister, the fiscal deficit could jump up to 5.7 percent if it included Rs 120 billion in circular debt - a spiral that began in country's oil and gas sector in mid-2008.
The services sector rose by 4.1 percent, with wholesale and retail trade activities clearly the leaders. Those operating in this sector but reliant on farm and industrial output for example transport, storage and communications sub-sectors, understandably registered a small growth of 1.3 percent. Given the performance of these three major contributors to the country's GDP two elements need to be noted. First and foremost, there is an urgent need for FY12 budget to contain critical policy measures that would increase the output in the farm as well as industrial sector - measures that must include a serious effort on the part of the government to propel its own investment for the development of the infrastructure sector (physical and social) as well as desist from deficit financing (borrowing form the banking sector to ensure that the private sector has a fighting chance to become the engine of growth).
And second and equally importantly while it is increasingly evident that the government does need more revenue to reduce its reliance on bank borrowing or on external resources that seem to be declining over the past few years yet care must be taken that the new or enhanced taxes that are envisaged do not compromise the growth rate. Ideally, the government should focus on tax reforms with the objective of rendering the system equitable and less anomalous as well as creation of a data bank, capacity enhancement for data mining and strict audit within the Federal Board of Revenue. The legal system allowing FBR to track transactions has to be in place for the revenue hounds to make meaningful progress in improving tax to GDP ratio of the country.
Given this set of data the question as to why exports performed so well as did remittance inflows begs an explanation. Part of the reason for the rise in exports is attributable to the higher per unit price of our major exports for the year and as commodity prices are subject to wide fluctuations from year to year, depending on world output, therefore a rise in exports may have little to do with government policy. Pakistan's textiles exports rose by 32 percent this year, which can be attributed to the phenomenal rise in cotton prices in the international market.
Sports goods exports posted a nearly 8 percent increase. Remittances have also soared by 1.5 billion dollars - from 8.0 billion dollars last year to over 11 billion dollars this year - which may be attributed to almost negligible interest rates in the West as well as the initiatives in this regard taken by the State Bank of Pakistan. In this context it is relevant to note that it is the rise in exports and remittance income that allowed the country to post a current account surplus.
It needs to be recognised that unprecedented damage wrought by floods (estimated at $10 billion); on-going deterioration in the security situation; and sustained rise in international oil prices were some of the factors that manifested themselves in falling revenues and rising expenditure making the fiscal deficit soar to 5.7 percent against a 4.0 percent target. We beg to differ with the survey's assessment that "despite many challenges, the overall performance of the economy has been moderately satisfactory". The government was, however, seen to be painfully slow in articulating its response to the challenges enumerated by the survey. Floods hit the country in July 2010. But the government waited until end-March to announce flood surcharge and add it to Income Tax. Similarly, it had become increasingly clear by the first quarter of FY11 that the proposal for imposition of RGST in the VAT mode from 1st October 2010 would not materialise. The economic managers should have shifted gears and adopted a fallback strategy through withdrawal of exemptions on tractors, fertilisers and pesticides. A fixed tax on five major export sectors should have been imposed on October 1st 2010 or earlier. An amount of Rs 53 billion estimated to be collected from the three measures taken in the last quarter would have actually fetched over Rs 150 billion if the government had not shown any laxity in this respect. The most important power a government enjoys is its authority to lay and collect taxes as the lack of a power to tax renders a government ineffectual.
The government should have resigned or called for early elections if it had failed to muster the required number of votes in the parliament to do so. The economic managers need not take the blame for the slow response. It is the collective failure of political leadership at the helm ie Zardari/Gilani who could not obtain a consensus both within the coalition and across the aisle. As a result, we were forced to seek extension in IMF's programme till September 2011. However, the slow implementation of fiscal reforms has led the Fund to block disbursement of remaining two tranches since August 2010.
What is the way forward? The government must focus on increasing productivity by allowing the private sector to be the engine of growth and at the same time focus on a budget that compels all sectors, even the sacred cows, to make a sacrifice in terms of expenditure that must be diverted to development of the critically lacking infrastructure. Broadening of the tax base and enhancing investment to create more employment opportunities must be the main objective of the Finance Bill 2011-12. Prioritising availability of energy first to the export sector followed by power generation and other industrial units without disruption. And, initiating a flurry of exploration and production (E&P) activities and curtailing energy wastage. We also hope Finance Minister Dr Abdul Hafeez Sheikh would unveil in his budget speech the plan to privatise/restructure state-owned enterprises (SOEs). It should include (with firm timelines) list of companies that will be: (a) listed on stock exchanges through public offering; (b) additional disinvestment of shares of existing listed companies; (c) strategic sale of shares with management control of SOEs; and (d) offering management contract to the private sector without sale of equity in government managed entities. One hopes the budget FY12 fearlessly and proactively unravels myriad economic problems facing the country today and offers their solutions aimed at stabilisation, stimulus, recovery and growth.