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ISLAMABAD: Pakistan’s GDP growth rate is projected to slow to four percent in fiscal year 2022 from 5.6 percent in fiscal year 2021 and inflation is expected to pick up, averaging 11 percent in fiscal year 2022, says the Asian Development Bank (ADB).

The bank in its latest report, Asian Development Outlook (ADO) 2022 stated that the slower growth in the current fiscal year reflects the government reactivating its stabilization programme under the International Monetary Fund (IMF) Extended Fund Facility (EFF) to narrow the current account deficit, raise international reserves, and cut inflation. Pakistan’s GDP growth is projected to slow as the government applies measures to reduce the current account deficit, raise international reserves, and cut inflation. Growth is expected to accelerate to 4.5 percent in fiscal year 2023 due to stronger private consumption and investment.

Inflation will rise in the current fiscal year, driven by higher fuel prices, before receding in fiscal 2023, with the current account deficit widening in fiscal 2022 and narrowing in fiscal 2023.

Pakistan has a low tax-to-GDP ratio compared to other emerging economies, averaging only 11 percent from fiscal year 2010 to fiscal year 2021, the report noted.

February: Pakistan's inflation reading drops marginally to 12.2%

Domestic demand is expected to slow from monetary tightening, restrictions on automobile financing, and additional fiscal consolidation measures enacted in January 2022. The forecast for accelerated growth in fiscal year 2023 reflects stronger private consumption and investment, as key structural reforms and greater macroeconomic stability boost household and business confidence.

The government’s package of subsidized inputs and increased support prices of wheat and sugarcane will continue to benefit agriculture in the current fiscal year. But industry growth will decelerate, reflecting fiscal and monetary tightening, a significant depreciation of the local currency resulting in costlier imports of raw materials and capital goods, and upward adjustments to domestic oil and electricity prices. Large manufacturing, which accounts for over half of industry, has weakened since September 2021, with growth slowing to 3.5 percent in the first 5 months of fiscal year 2022 from 6.9 percent in the same period of fiscal year 2021. Construction, however, is expected to support industry, helped by robust public investment spending and fiscal incentives, and subsidized credit under the government’s Naya Pakistan Housing Programme.

Growth in services is expected to be trimmed by a slowdown in manufacturing and the implementation of the government’s stabilization programme, weakening this sector’s contribution to growth in fiscal year 2022.

Inflation is expected to pick up in fiscal year 2022, averaging 11 percent. Headline inflation accelerated to 10.5 percent in the first 8 months, reflecting higher international energy prices, significant currency depreciation, and elevated global food prices from supply disruptions. Core inflation in rural areas rose to 9.4 percent and 7.8 percent in urban areas in February 2022, levels that reflect the ongoing economic recovery. Because Pakistan is a net importer of oil and natural gas, with both comprising almost 20 percent of total imports, the country will continue experiencing strong inflationary pressure for the rest of the current fiscal year from the jump in global fuel prices related to the Russian invasion of Ukraine. A prolonged conflict could raise wheat prices and stoke higher food inflation since Ukraine is an important source of Pakistan’s wheat imports.

Additional tax measures in January 2022 will cause a one-time rise in prices. Inflationary pressures are likely to be less pronounced in fiscal year 2023 as fiscal consolidation progresses and oil and commodity prices stabilize, allowing inflation to moderate to a forecast 8.5 percent. The central bank tightened monetary policy in response to rising inflation and fast-growing external imbalances, especially during the second quarter of fiscal year 2022, raising the policy interest rate by a cumulative 275 basis points.

Rising energy prices will also add to strains on public finance, notably where fuel is subsidized—such as in Pakistan, where spreads for 10-year sovereign bonds widened by 57 basis points from 16 February to 25 March.

The State Bank of Pakistan Act was amended in January 2022 to strengthen the central bank’s autonomy; the act mandates price stability as the monetary authority’s primary objective. The act prohibits the government from borrowing directly from the central bank, which should help anchor lower inflation expectations in fiscal year 2023.

The government plans to continue its medium-term fiscal consolidation, rationalizing less essential current spending and expanding tax and nontax revenue. These reforms are projected to trim the fiscal deficit to 5.7 percent of GDP in fiscal year 2022 and 5.5 percent in fiscal year 2023, return the public debt to more sustainable levels, and reduce the crowding out of private sector borrowing. Sustained recovery boosted Federal Board of Revenue (FBR) tax collection by 30.4 percent in the first 7 months of fiscal year 2022, equal to 6.2 percent of GDP, surpassing the 5.7 percent target for the period. For the first half of fiscal year 2022, total fiscal revenue rose from 6 percent to 6.2 percent of GDP, reflecting a higher contribution from sales and income tax that offset a shortfall in the petroleum levy.

The renewed buoyancy of fiscal revenue is expected to strengthen further on the tax measures enacted in January 2022, planned further increases in petroleum levy rates, and additional policy and administrative measures to broaden the tax base. These measures include launching a track-and-trace system, the continued rollout of the point-of-sale system in the retail sector and its integration with the FBR, introducing a single sales tax portal for the FBR and provincial revenue authorities, and reviewing property valuations to bring them closer to market rates. Total government expenditure rose to 8.3 percent of GDP in the first half of fiscal year 2022, due to higher subsidies, from 8.1 percent in the same period of fiscal year 2021, bringing the first half fiscal deficit to 2.1 percent of GDP.

The current account deficit is projected to widen to 3.5 percent of GDP in the current fiscal year as strengthening domestic demand and rising international energy and commodity prices propel import costs, outpacing export growth. The 55.1 percent surge in merchandise imports in the first 7 months of fiscal year 2022, which exceeded export growth of 27.4 percent, reflects rising global commodity (especially energy) prices, COVID-19 vaccine procurement, and greater demand for intermediate goods due to the domestic economic recovery. Services imports rebounded by almost 40 percent reversing a 24 percent contraction in the first 7 months of fiscal year 2021.

Services imports were underpinned by easing global travel restrictions and higher payments for transport and financial services linked to the surge in merchandise imports. Consequently, the deficit in goods and services widened from 4 percent of GDP in the first 7 months of fiscal year 2021 to 6.7 percent in the same period in fiscal year 2022, turning a current account surplus equivalent to 0.3 percent of GDP in the first seven months of fiscal year 2021 to a deficit of 3.1 percent of GDP a year later.

Remittances are projected to remain buoyant, supported by the Roshan Digital Account initiative and the recovery in the global economy, providing a major source of foreign currency inflows ($15.8 billion in the first 6 months of fiscal year 2022). The current account deficit is projected to narrow to 3 percent of GDP in fiscal year 2023 as stabilizing commodity prices and continued fiscal consolidation slow import growth.

The major risks to the economic outlook emerge from higher-than-expected inflation due to a prolonged conflict following the Russian invasion of Ukraine.

If global food and energy prices remain elevated longer than anticipated due to supply disruptions, heightened inflationary pressures could undermine growth prospects in the current and next fiscal year.

High prices of imported food and energy products will widen the trade deficit, worsening external imbalances and exerting pressure on the local currency. A larger than projected current account deficit and a weaker Pakistan rupee will undermine fiscal consolidation. The International Monetary Fund Extended Fund Facility is scheduled for conclusion in September 2022; the possible end to reform efforts may affect the fiscal and debt outlook in the medium term.

The report further stated that Pakistan has a low tax-to-GDP ratio compared to other emerging economies, averaging only 11 percent from fiscal year 2010 to fiscal year 2021. Low tax revenue contributes to high fiscal deficits and constrains fiscal space for infrastructure and social spending. The continued structural weaknesses of the tax system are reflected in a narrow tax base and poor taxpayer compliance due to the large informal economy, tax avoidance in the formal sector, and under-taxation in certain sectors.

Pakistan’s tax regime is complex and unpredictable, marred by excessive exemptions and preferential treatment, multiple rate structures, frequent ad hoc changes in tax policy, and fragmented tax administration. Revenue from direct taxation is low compared with indirect taxes and remains concentrated among salaried workers and large industries. Indirect taxes comprised two-thirds of the total tax revenue in fiscal year 2021. The extensive use of withholding and sales taxes collected by third-party agents has become a preferred mode of revenue collection. Provincial tax collection, compared to the share of federal tax revenue, remains miniscule, averaging 8.9 percent of total tax revenue over the last 5 years. Recent studies by the International Monetary Fund and the World Bank on Pakistan’s tax gap estimate that tax revenue could potentially reach 22.3 percent to 26 percent of GDP.

The challenge is to tap this potential through well-defined and comprehensive reforms in tax policy and administration. A simplified and easy to understand tax system that makes it easy to file tax returns would encourage voluntary compliance and reduce tax evasion. The effective enforcement of tax laws can be achieved by improving governance, continued investment in information technology infrastructure, and more and better-trained staff. Modernizing tax administration by integrating internal database and information systems, and improved training in data management, can enhance efficiency, improve compliance risk management and audit capability, and reduce the cost of paying taxes. Gains from recent administrative and technological improvements facilitating smoother digital filing can be increased by improving taxpayer education and facilitation services. Developing and strengthening technical capacity in data analysis can facilitate evidence-based policy making and support better compliance by identifying tax gaps and facilitating systematic monitoring and evaluation. These measures, complemented with broader efforts to improve the business climate and measures to address the trust deficit in the delivery of public services, can encourage informal businesses to enter the formal sector.

Improving the ability of provincial governments to raise revenue is critical for the success of tax reforms. Expanding the provincial tax net, particularly in services like retail trade; boosting the capacity of provincial tax collection; improving the efficiency of collecting vehicle tax; and optimizing the urban property tax would substantially increase the generation of provincial revenue. Stronger institutional arrangements are needed to improve the coordination of tax policies and administrative laws among the federal and provincial governments.

Pakistan’s Medium Term Budget Strategy fiscal year 2021–fiscal year2024 outlines directions for tax reforms, focusing on broadening the tax base and widening the tax net, removing exemptions, simplifying procedures, and digitalizing tax administration.

The FBR is preparing a strategic reform plan that delineates similar reform interventions with specific and measurable outcomes over the next 5 years. If implemented in a sustained manner, tax reforms can pave the way for realizing Pakistan’s tax potential, providing greater fiscal space to fund critical public services.

Copyright Business Recorder, 2022

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