With the glaring example of Sri Lanka defaulting on its debt, the risk of Pakistan facing a similar fate should be an impetus to spur ambitious reforms in almost every area of the economy. A default situation results in a damaged relationship with investors that will have far reaching consequences, so we must take a hard look at our policies, institutions and markets in order to identify roadblocks and inefficiencies. Only then can we enable economic stability and sustainable growth.
Pakistan needs to nurture an export culture, focus on investment, productivity, and exports, while removing bottlenecks such as sludge, financial, energy, and tariffs.
It is troubling to note the pace with which long-term growth is declining. This decline is taking place on multiple fronts. On the front of productivity and investment, there has been a negative trend implying a less efficient economy over time. Pakistan does not have an export culture, despite the fact that export-oriented units have a 30 percent higher productivity rate than companies serving domestic market. The export trend remains quite flat, and growth is volatile.
Furthermore, there is little room for markets. The overbearing government footprint currently stands at 67 percent of GDP. This makes progress extremely difficult, as the government is an active player in various sectors: Pakistan’s state-owned enterprises (SOEs) include energy, transportation, financial, trading, and manufacturing. Rather than allowing market forces to do their job, the government assumes the role of fixing prices: wheat, electricity, gas, medicines, milk, petrol.
‘Sludge’ is defined as the ‘excessive or unjustified frictions’ that make it harder for customers to achieve their goals, such as complicated forms and websites that are hard to navigate. This accurately describes most market activity in Pakistan, with the over-regulation characterizing 39 percent of GDP. Unnecessarily bureaucratic and time-consuming processes abound in seeking registration, licences, certificates, and other permissions.
Due to the ongoing IMF programme, there is no fiscal space available to the government, making it difficult to increase public investment. Taxes remain high, and the country finds itself in a long-term balance of payment (BoP) crisis. In short, the available policy choices are limited.
Historically, we focused on taxation, not on growth. We have to shift this focus to growth by prioritizing investment, productivity, and exports. In attempting to do so, we face a number of bottlenecks. The energy sector is in particular need of reform, as mismanagement and weak reform is rampant. One reform that should be seriously considered is limiting households to a single-point supply of energy, so that limited resources such as gas are prioritized for more productive uses.
The gas crisis is worsening as international exploration companies have left Pakistan and local companies are not performing, leading to lower domestic gas production. There are massive transmission and distribution losses to be addressed (Rs 473 billion during 2021 out of which Rs 402 was recovered through tariff and Rs 71 billion was added to circular debt). Meanwhile, LNG imports are hampered by Government Regulation/ PPRA.
In order to address the inefficiencies of gas companies, it is recommended to unbundle downstream monopolies between ‘pipeline’ and ‘retail’ business. The business model for gas companies should be based on profits from operational efficiency, by investing in the maintenance of the distribution network and banning domestic expansion projects. Furthermore, we must do away with politically-motivated gas allocation policy, and rethink the policy of importing LNG and injecting more gas into a leaking distribution system. In order to achieve gas market liberalization, there is a need for third-party access to regasification terminals, transmission, and distribution systems.
When it comes to the electricity sector, the economy would benefit from Discos being divided into smaller units (city-wise) for better administration and management. Listing of Discos on the Pakistan Stock Exchange should be mandated with a condition that a single party cannot hold a share of more than 5 percent. The billing system at the Disco level should be decentralized.
Given the current situation, we are not prepared to implement CTBCM. Independent evaluation of CTBCM is needed. It is best to facilitate ‘wheeling’ at the marginal cost to make it attractive for sellers (generation companies) and buyers (bulk power consumers). This will decrease the cost of energy for the industry
Moving on to financial issues, we see that Pakistan has the lowest ratio of credit to the private sector among the developing countries. Moreover, we have the highest currency in circulation (40 percent as compared to the maximum of 20 percent in other countries), which also impacts the banking multiplier by limiting liquidity available for the private sector.
Taxation reforms are also greatly needed. A lower uniform rate for GST will foster compliance and lower the incentive to cheat. The distinction between filers and non-filers should be abolished as it just creates a nuisance and does not contribute to improving the tax net.
In Pakistan, a fundamental structural issue is insufficient forex earnings to sustain the economy. To this effect, the country has huge export potential that is not being adequately leveraged. To tap this potential, policy must be formulated to:
• Simplify Taxation Regime (online portal or one window operation)
• Allow currency to depreciate
• Provide credit on simple terms (minimal documentation) linked to export receipts
• Sunset clauses for protection given to industries
• Any tax levied must be on net profits, not revenue/no turnover taxes.
The ideal way forward is through developing an export culture wherein all investments and operations are focused to maximize exports. To this end, the textile sector is the key player since it contributes 62 percent of all exports.
The sector has performed exceptionally well in the last 2 years, with textile exports increasing by 43 percent in FY22 as compared to FY18. The industry has invested a sum of $5 billion over the past few years in new plant & machinery and upgradation.
Further expansion and increase in exports is limited by the sustained availability of energy both gas and electricity at Regionally Competitive Energy Tariffs (RCET).
This export spur has occurred due to the focus of the government to provide regionally competitive terms for the sector to remain competitive.
However, to maintain this momentum and to increase exports exponentially what is required is:
• Implementation of Textile Policy (2020-25)
• Assurance of uninterrupted energy at regionally competitive energy tariffs for a sustained period.
• Removal of all hindrances for setting up of new factories & upgradation.
• In line with stated government policy of no duties on raw material, duty on PSF to be abolished to enable Pakistani export products to compete internationally.
• Availability of long-term financing as well as working capital at competitive rates.
• Rationalization of GST applicability through a lower rate. According to a very recent IMF report, the cascading impact of GST has harmed Pakistani exporters’ competitiveness.
• Improving standard duty drawback schemes
• The government to simplify regulation related to exports; cumbersome bureaucratic procedures negatively affect new exporters.
• Export subsidies such as DLTL, where given, must be linked to the performance of the recipient firms and be automatically withdrawn when thresholds are crossed.
Pakistan’s domestic cotton production has declined over the last decade, dropping to 7.42 million bales in 2021-22, which is about half than the textile sector requirements. The sector has therefore had to resort to importing cotton from a number of countries in order to compete in the textile export industry; in the past two years, this bill has reached $3 billion.
Cotton, once Pakistan’s favorite cash crop, had its area under cultivation decline by over 1 million acres over the course of ten years. Decline in cotton crop caused by a number of variables involved. To offset this decline and reduce the crop to its former glory, we must encourage the textile industry to grow its own cotton, reform variety approval system to speed up the process as well as to support private sector R&D organizations. Identification and development of new areas for cotton can also provide great returns.
As we are targeting holistic reform, we must also emphasize the role of the real estate market, which has huge potential to bring growth once it is effectively deregulated. We must also prioritize improvements in public life, by rethinking cities to better serve as engines of growth, removing car use subsidy to reduce the burden on city development, and enabling alternative in-city mobility policies from public transport to walking. Making the internet widely and cheaply accessible, possibly by fully funding access in 2023-24, will maximize job opportunities.
There remains a need to tackle economic distortions and to formulate effective policies for economic sustainability. This requires a specific focus on supplementing the export sector’s role in steering growth, along with greater efforts to empower, educate and harness the potential of our youth, to encourage investment in human capital and to develop a system whereby external shocks and political instability do not hamper economic progress.
A strong export base serves as the baseline to strengthen the economy without reliance on any external force such as foreign aid. In Pakistan’s context, the textile sector provides a reliable pathway to counter the debt that has accumulated from back-to-back loans and relief packages. Earnings through enhanced exports can strengthen the economy significantly, bringing Pakistan out of its current account deficit and economic stagnation.
Copyright Business Recorder, 2022