Miftah Ismail, the finance minister during the tail end of the PML-N tenure under the prime ministership of Shahid Khaqan Abbasi, referred to the 28 February relief package announced by Prime Minister Imran Khan (envisaging a ten rupee per litre reduction from the fortnight before and 5 rupee per litre reduction in electricity tariffs and pledging these rates will remain applicable till 30 June 2022) and the industrial package on 1 March (with the third amnesty scheme in three and a half years) as a “bomb” to sabotage the country’s economy for the next administration.
Few economists would disagree with Ismail in spite of the Prime Minister’s claim that the relief package was possible due to improved tax collections for two reasons: (i) 3.799 trillion rupee tax collections (July-February 2021-22) are at par with the budgeted target of 5.8 trillion rupees however for the remaining four months of the current fiscal year there is likely to be a shortfall as the State Bank of Pakistan (SBP) allows the rupee to continue to depreciate with the objective of curtailing imports (to arrest the trade deficit fast approaching a historical high) — imports that contributed 52.2 percent of total tax collections for the first eight months of this year; and (ii) there has been a significant reduction in collections under non-tax revenue specifically in collections under petroleum levy budgeted at 610 billion rupees while actual collections are expected to be less than half due to the relief package.
Thus the relief package envisages a rise in expenditure (subsidies) without a rise in revenue, generating a consensus amongst economists that never have political as opposed to economic considerations been so paramount. In the past even during an impending election the focus was on containment of existing rates as opposed to a significant reduction.
The 1 March industrial package can also not be supported for two reasons. First, the amnesty scheme, the third during the Khan administration, is likely to raise serious concerns in the Financial Action Task Force (FATF) that may account for Pakistan, at best, being retained on the grey list while ongoing talks on the seventh review with the International Monetary Fund (IMF) will remain stalled as the Fund, and all other international donor agencies, have pledged to work with the FATF. In addition, donor agencies oppose amnesty schemes as being a disincentive for the honest taxpayers – a view that was ironically held by Prime Minister Khan before taking oath in 2018.
And second the package envisages granting fiscal and monetary benefits to the rich and influential at the cost of the general public. The conflict between the Prime Minister’s claim that “mafias” are operating in all major sectors raking in windfall profits and his industrial package that would benefit mainly these mafias - those operating in the legal and illegal domain — is sadly becoming more stark with the passage of time.
The Prime Minister maintains that wealth creation is critical for development and exports is the way forward. He would in all probability not be pleased to learn that this was precisely the mind-set of his nemesis Nawaz Sharif, though his modus operandi was different in some respects, mainly attributed to his Finance Minister Ishaq Dar’s overarching objective to present a more favourable picture of the achievements of the Ministry of Finance than was in fact the case – an objective that led to his browbeating the SBP as well as commercial banks to take inappropriate measures that included: (i) artificially keeping the rupee value high, a major flawed policy, to understate the external debt servicing costs which played havoc with the country’s exports just to show a lower budget deficit; he compounded this economic folly by (ii) borrowing externally instead of domestically by arguing that the interest rate was a lot lower abroad – Dar added around 30 billion dollars to foreign debt in five years and domestic debt rose from 9.5 trillion rupees to 16.4 trillion rupees; (iii) extending interest free loans under the Prime Minister’s Youth Programme, to poor farmers (including Benazir Income Support Programme beneficiaries), 100 billion rupees interest free loans for small and medium enterprises while Shehbaz Sharif, the then Chief Minister Punjab announced a 100 billion rupee loan scheme for poor farmers – schemes that have been revitalized by the Khan administration under a different name; and (iv) keeping the discount rate low, leading to negative real interest rates, to lower capital (input) costs for the large scale manufacturing (LSM) sector which was and remains the largest borrower from the commercial banking sector.
The Khan’s economic team has been changed three times with three different heads of the Finance Ministry, however the major ‘influencer’ remains Dr Hafeez Sheikh as he together with Governor SBP agreed to a set of extremely harsh upfront conditions (in one case untenable) with the International Monetary Fund (IMF) in May 2019 and signed off on the first five reviews with the IMF — agreements that the Fund is unwilling to renegotiate or phase out. The one untenable condition was to link the discount rate to headline inflation instead of core inflation (non-food and non-energy items that are not susceptible to discount rate adjustments in Pakistan) considered inappropriate by all previous generations of SBP officials and governors. The result: throttling of the LSM sector as discount rate (input cost) was too high. And to add insult to injury the then existing short-term debt was converted into long-term debt when the discount rate was 13.25 percent, thereby raising debt servicing costs (part of the budgeted current expenditure) astronomically.
Today the discount rate is 9.75 percent, higher than the regional average, left unchanged as per the 8 March 2022 Monetary Policy Statement however the SBP, as mentioned above, is using the exchange rate as the shock absorber to contain the trade deficit and consequently the current account deficit, that, if the trend continues, is projected to be higher than what the Khan administration inherited in 2018. Manipulating the exchange rate instead of the discount rate hits the common man much more than the elite as it raises costs of all imported items particularly transport cost which then impacts on price of all commodities.
There has been a massive rise in reliance on borrowing (with the highest ever growth in borrowing during the past three and a half years, including the Dar years): domestic debt rose from 16.5 trillion rupees in 2018 to over 27 trillion rupees today and external borrowing rose from 95 billion dollars to over 130 billion dollars (with 10 billion dollars used to support current expenditure while 50 percent of our foreign exchange reserves are borrowed).
The foregoing shows that the Sharif and Khan economic teams went to extremes in using the policy tools available and one would urge for a middle ground and: (i) use the exchange rate as a shock absorber sparingly because it is impacting on the poor more than the rich; (ii) borrowing can and should be curtailed - domestic and foreign - by slashing current expenditure that has risen from 4.3 trillion rupees in 2017-18 to over 7.5 trillion rupees; disturbingly the focus of the IMF programme on primary deficit (minus debt servicing costs) has merely increased reliance on borrowing; and (iii) during the Sharif era, interest-free loans to the poor and to small and medium enterprises were either hijacked by the rich operating in the sector or the rate of non-performing loans rose to alarming levels. Higher output and employment as the primary objective of these loans was rarely observed though part of the rise may have been in the illegal parallel economy. It is time to streamline interest loan policy based on empirical evidence.
To conclude, the economy is in a tailspin and remedial measures are urgently required though the mood of the Prime Minister with the looming threat of a vote of no-confidence is on extending relief (subsides) to the general public that the economy can ill afford — measures that are fueling the budget deficit, a highly inflationary policy, and making the announced relief measures inadequate soon after they are announced.
Copyright Business Recorder, 2022
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