Redefining Pakistan’s economy

This article is an effort on not only understanding the fundamental economic issues but also some tough but realistic reforms that can provide immediate corrections and some medium to long-term solutions that can actually redefine and fix the economy.

Since 1947, Pakistan’s economy has been controlled by well-organized interest groups and the actual problem remains the political power structure resulting in an almost socio-economic collapse.

Rent-seeking is so deeply embedded that the state’s ability to carry out critical functions such as ensuring effective regulation to prevent market failures and efficient delivery of goods and services has been considerably diminished.

While we all know that following are the main problems, it’s important to understand the underlying reasons and what can be done to address them through reforms. The major problem areas include:

• Revenues less than expenditures

• Foreign and domestic debt including circular debt

• Current account and trade deficits along with imports overshadowing exports

• One of the lowest Gross National Saving Rates (GNSR) and a super consumption pattern

• Undocumented economy and financial inclusion

• Loss-making State Owned Enterprises (SOE’s)

• Structural and capacity issues in agriculture, industrial and services sectors

• Foreign Direct Investment (FDI) and Investor confidence

• Energy infrastructure

• Climate change

• Youth bulge

• No regional economic integration and no resources for education, health and general welfare

However, looking at the country with such problems we can add the following positives to the list, like, most of the world is aging and our population is getting younger, a buoyant market of goods and services with 220 million people, foreign remittances of non-residents, a vital source of foreign exchange that continue to rise.

This can further be elaborated by looking at the key macroeconomic realities: Tax to GDP is still less than 10%, according to the World Bank, tax revenues above 15% of a country’s GDP are a key ingredient for economic growth and poverty reduction. For Pakistan, revenues to surpass expenses we require 18% tax to GDP, in comparison India is at 13%, Turkey 24%, China 18% and Egypt is at 15%. By addressing this, the government’s reliance on domestic and foreign debt shall fall substantially, however, this is not easy and requires an iron will to implement and change mindsets across society. In order to achieve this, all incomes must pay taxes.

Pakistan needs an equitable broad-based efficient tax regime with a “No Sacred Cows” stance. While this may be a time-consuming process, it needs to remain a high priority.

Currently, the composition of direct and indirect taxes is 35% and 65%, respectively, which shows that chargeability of the taxes on income is very low. Income Tax is being collected from 25 lac persons only. Some of the areas that need to be brought into tax net include real estate, retail, agriculture and financial markets.

We are one of the highest consumption-based economies with a GNSR at 8%, compared to Bangladesh 25%, India 28%, Iran 38%, China 44%, Korea 35%. This can be addressed through Islamization of economy that shall be discussed later in the article.

As a result of this, low levels of domestic investment cannot achieve a high single digit GDP growth necessary for sustainable development, the per capita income growth rate of Pakistan since 2007 is also the lowest at 17%, compared to Bangladesh at 73% and India 60%.

Our domestic and international debt, the rates along with maturity tenors have become a major problem. Today we cannot even sustain unless there is a fresh debt to pay the interest payment of existing portfolios with a yearly requirement of USD 25 billion. This is a result of criminal negligence of our successive economic regimes.

Immediate concern of the country is foreign currency cash flow management, as perception of Pakistan going into default is growing every day.

Export and import imbalance is evident from the fact that since 2014 exports increased from USD 24 billion to USD 28 billion, while imports grew from USD 41 billion to USD 72 billion resulting in increasing the trade deficit from USD 17 billion to nearly USD 43 billion. Our exports while being low, are not competitive and have no value addition with even traditional exports like textile that is heavily subsidized and contributes nearly 50%.

Our exports remain around USD 30 billion, compared to Bangladesh at USD 48 billion and India at USD 670 billion. SOEs specifically the chronic loss-making ones give a drag of 8% of GDP, with a yearly loss of approximately PKR 600 billion including losses from PIA, Railway, Steel Mill, DISCOs and GENCOs. Even in the case of profit making SOEs such as the oil and gas sectors, they have poor operational efficiencies and profits compared to peer group in the private sector.

Other main areas of imbalance are the wealth and income distribution: top 10% Pakistanis control 60% of wealth and 43% of income, middle 40% control 35% wealth and 40% income, and the bottom 50% of the population has mere 5% of wealth and 17% of income (World Inequality Database). Similarly, if we look at the land distribution, in reality 5% of the people hold 64% of farm land and more than 50% of the population does not own a single foot of land (Land Portal).

Our financial inclusion and documentation of economy remains one of the lowest in the developing world. Currency in circulation still remains less than 35%, depicting a larger undocumented economy out of any tax or regulatory regime. Banking sector still remains unrepresentative as 88% of deposits come from Karachi, Islamabad and sixteen other major cities of Punjab. Rest of Pakistan contributes only 12%, depicting a very little belief in banking, this could be because of interest-based banking or tax evasion.

The way forward

There are certain short-term and immediate solutions that can be achieved through rectifying the anomalies in our system. We have to rework the 18th amendment in specific NFC (National Finance Commission). Firstly, the criteria of resource allocation must be changed and rationalized with much lesser weightage to population and more on developmental parameters.

Provinces must complete PFCs (Provincial Finance Commissions) and devolution process through local government elections and legislation within six months with focus on increasing the pie of local taxes, sales tax, agriculture tax etc. If the provinces do not abide, the federal government should reduce proportionally the share by adjusting debt repayments and defence from the provincial share.

This understanding is critical, as 56% of federal resources – on average PKR 4 trillion, that is almost equal to fiscal deficit goes to provinces, with inefficient federal and provincial governments coupled with corruption has actually become a curse.

Similarly, reduce the size of federal/provincial governments and empower local governments, reduce the federal/provincial ministries to no more than fifteen that could include: Cabinet, Finance and EAD, Foreign Affairs, Revenue & FBR, Climate Change (along with NDMA), Science & Technology, Maritime, Health & Education & FS Policy, Energy (Power & Petroleum), Interior, SAFRON, and Industrial Development & EPZs.

In the same way 30% to 40% of federal/provincial departments to be closed within six months as most of them are useless. These two measures can bring down the cost of running the government by almost a half.

Aggressively renegotiate at least 30% of our foreign bilateral and multilateral debt by three to five years with the firm commitments to demonstrate reforms. This could ease-up repayments and release pressure of foreign currency cash repayments by approximately USD 16 billion.

The loss-making SOEs are prime real estate assets worth trillions of rupees but non-productive. These should be immediately sold through transparent sale proceeds, their defaults should be adjusted along with management changes whereby market-based talent should replace the existing incompetent senior management and boards. If not, then immediate privatization should be initiated.

Immediate reopening of regional trade markets, refocus on SAARC, India, Afghanistan, Iran and CIS states. This should include preferable trade agreements and not to compete products in international markets.

Increase industrial and commercial share in the power/energy sector. It is 65:35 (domestic:commercial) in Pakistan compared to international average of 35:65. Similarly, develop a regulated energy model on pattern of emerging markets.

Islamization of economy is also a viable alternate and can go a long way in fixing fundamental problems. It can actually help in increasing the revenue (tax to GDP ratio), documentation of economy and financial inclusion, including GNSR thereby capacity building for domestic investments and also attracting FDI. Introduction of a hybrid official “Zakat” structure for joining the income tax regime.

In Pakistan around seventy-five million individuals pay Zakat but none of it hits the exchequer account. We should create a separate entity, independent of FBR (Federal Board of Revenue) to collect and consume Zakat in a transparent mechanism. All those participating shall be given three to five years of tax exemption. A rough estimate based on the per capita income and income distribution pattern of Pakistan where top 10% Pakistanis control 43%, the revenue collection could easily be between PKR 1 – 1.5 trillion.

Similarly, introduction of “Ushr” on agriculture produce on the valuation date could also add another PKR 2 trillion revenue to the national kitty. As discussed earlier, 5% large land holders hold 64% of farm land; these are the ones who control the middlemen, have flour, rice, sugar and textile mills but either avoid or don’t pay tax at all. With Pakistan being the seventh largest producer of agriculture of around USD 65 billion, Ushr can actually help in materializing this untaxed sector.

Islamic banking’s share is mere 19% in the industry in a country of 97% Muslim population. A strategic refocus can help the economy multifold on documentation, financial inclusion, replacing straight debt instruments through new Sukuks, increasing GNSR, increasing the existing banking footprint manifolds. Most of the country does not bank as many people consider even keeping a current account in a bank as usury, other reason could be tax evasion.

There should be a strict 18-month window (in line with Federal Shariah Court decision) for all banks to convert at least 50% of their branches to Islamic. This would enable the industry to create new Sukuk avenues rather than just pledging existing GoP assets. Sukuks, as evident from GCC (Gulf Cooperation Council) market, can be issued to create and finance new assets and projects.

This could include education, health care facilities, highways, railways, ports and shipping, climate change infrastructure, etc. A major portion of PSDP (Public Sector Development Programme) could also be structured through Islamic bonds, enabling the economy to generate cash flows without borrowing funds at higher rates from domestic and foreign lending institutions and will encourage investment locally and bring FDI into the country. This will also substantially increase the GNSR.

Agriculture sector reforms that include revamping farm to market inefficiencies and anomalies including water management, PCR Abiyana, seed, fertilizer, middleman replacements, storage/silos facilities, easy access to bank loans and integration/connectivity with neighborly and regional markets. Focus should be on establishing agro-based export and value-added industry for all major crops, dairy, fruits and livestock. While being the seventh largest agro producer, our yields are one of the lowest; we need to make our agricultural research institutions more effective and agriculture departments need total revamping, or privatize them.

Industrial sector’s capacity and performance are far below the economic requirement of the country. We need to reshape this sector again on the lines of export orientation and value addition. The main sectors to focus are information technology, mining, defence exports, fishery, solar and semi-conductor/chip industries.

There is a dire need to develop a regulated energy model on the pattern of emerging markets. Focus on alternate energy resources like run-of-the-river hydropower, solar and nuclear for reducing reliance on thermal. This could be done while strengthening the transmission lines to reduce line losses and to control over theft. Our transmission and distribution losses on average are 21% compared to global average of 7%, similarly revenue losses are 10% compared to 1% globally.

Regulatory capacity needs improvement, domestic use of gas has to be capped and moved to industry and privatisation of Discos and Gencos is inevitable. There is a need to revamp FBR, Planning Commission, BoI (Board of Investment), etc., to focus on ease of doing business. We must initiate a 10-year plan for industrialisation, tourism industry, FDI initiatives and for social protection, education and health sectors.

Last but not the least, devolution in actual spirit by making local governments more effective, and federal and provincial governments’ role to be curtailed to bare minimum. A suggestion could also be to replace the current political system by proportional representation to get rid of the ‘political electable mafias’.

Copyright Business Recorder, 2023