ISLAMABAD: The World Bank has projected a primary balance for Pakistan at negative 0.4 percent (-0.4) for the current fiscal year 2023-24, as opposed to a 0.4 percent surplus (0.4) by the International Monetary Fund (IMF), while claiming that its data is updated relative to the Fund.
This was stated by Adnan Ashraf Ghumman, economist at the World Bank during a media briefing here on Tuesday at the launching ceremony of the report, “Pakistan Development Update”.
Pakistan’s large and persistent fiscal deficits threaten sustainability, stability, and economic growth, while weaknesses in revenue and expenditure policies have contributed to economic imbalances, distorted resource allocation, and constrained productivity growth, says the World Bank.
The bank stated that the public debt stock, including guaranteed debt, reached 82.3 percent of GDP at end fiscal year 2023, increasing from 58.4 percent of GDP at end-fiscal year 2012, breaching the thresholds defined in the Fiscal Responsibility and Debt Limitation (FRDL) Act, 2022, which requires public debt to be at most 60 percent of GDP by end of fiscal year 2023, says the World Bank. The growing debt stock imposes high fiscal costs and exposes the country to debt vulnerabilities.
Pakistan’s large and persistent fiscal deficits have led to public debt accumulation, crowding out private sector borrowing and posing macroeconomic risks.
The tax structure is distortionary and inequitable, providing insufficient resources to pay for critical government services, while contributing to the misallocation of resources within the economy.
Because public expenditures are rigid and focused on consumption rather than investment, government spending drives inflation and imports, rather than expanding the productive base of the economy.
Periods of high spending therefore necessitate subsequent remedial cooling policy measures to resolve the resulting fiscal and external imbalances, creating recurrent boom–bust cycles that deter investment and slow economic growth.
Pakistan’s existing fiscal institutions and intergovernmental coordination arrangements are constraining effective management of the government’s finances and contributing to the fiscal sustainability challenge. Fiscal policymaking is fragmented across numerous bodies, resulting in institutional gaps that contribute to the lack of focus on achieving sustainable fiscal outcomes at the national level.
In parallel, current approaches to debt management, partly arising from the weaknesses of debt management institutions, have led to higher debt risks and costs. Pakistan’s general government debt has grown sharply compared to economic peers, including Indonesia, South Africa, Thailand, and Türkiye.
The growing debt stock imposes high fiscal costs and exposes the country to debt vulnerabilities. The persistent fiscal deficits and debt repayments have maintained high annual gross financing needs, averaging 27 percent of GDP over the last decade—significantly higher than the emerging market threshold of 15 percent.
The bank noted that Pakistan’s reliance on floating rate domestic debt instruments and a comparatively high share of external borrowing exposes the country to macroeconomic risks.
Between 2013 and 2023, exchange rate depreciation contributed a cumulative 28.9 percentage points of GDP to the public and publicly guaranteed debt, of which 24.3 percentage points occurred over four years in FY19–23.
Although the contribution from interest rate changes was negative over the same period—contributing to a reduction of the debt stock—this was more than offset by the revaluation losses due to exchange rate depreciations. The lack of an integrated debt management function undermines sound debt management and leads to suboptimal borrowing choices.
Federal tax collection relies primarily on indirect and withholding taxes, while provincial tax collection remains critically low.
Pakistan’s tax system is complex, has a narrow tax base, and high tax rates. The tax system has numerous special provisions, concessional rates, exemptions, and, to some extent, unorthodox approaches to tax policy.
Many of these policy choices were implemented to balance the provision of fiscal support to certain groups or industries with the need to maintain a minimum level of revenue collection. This has resulted in a complex system with many vested interests and has come at the cost of losing economic efficiency and revenue.
Tax-free allowances, tax brackets, and tax rates differ significantly between salaried individuals and other taxpayers, which risks generating economic distortions and creating opportunities for tax avoidance through income shifting.
In addition, a significant tax base comprising of unsalaried individuals and sole proprietors including retailers are out of the income tax net. Within salaried individuals, the income tax exemption threshold is set sub-optimally high, leaving formally employed salaried individuals outside of the tax net.
At the same time, the threshold for the top income tax bracket for salaried individuals is also very high and is likely to only capture a very limited number of taxpayers.
Pakistan relies heavily on liability-financed expenditure to meet recurrent spending obligations and to achieve short-run policy objectives. Rigidities in government expenditures constrain efforts to reprioritize public spending towards development targets. The share of recurrent expenditure in total general government expenditure has increased from 79.5 percent of total consolidated expenditure in FY15 to 88.2 percent in FY23.
Meanwhile, the share of development expenditure has significantly dropped from 20.5 percent of total outlays to 11.8 percent over this period. Consisting mostly of rigid expenditures such as debt servicing, pensions, and wages, recurrent expenditure has increased at both the federal and provincial level as a share of total outlays. As a result, spending does not lead to a significant growth dividend and instead risks perpetuating a cycle of increasing debt and debt service expenditure.
Interest payments to service the country’s public debt are the primary driver of the government’s current spending. Over the last 10 years, interest spending averaged 4.7 per cent of GDP per year and jumped to 7.0 percent of GDP in FY23 from 4.8 percent in FY22. The share of interest payments in total current spending reached 40 percent in FY23—the highest in the last 10 years.
Fiscal costs for Pakistan’s civil servants’ pension schemes have dramatically grown over the past several years and risk further increase over the coming years driven by ad hoc indexation that is much higher than inflation, historical growth in civil service headcount, and liberalization of the eligibility requirements for benefits such as the survivorship benefits.
The bank has recommended reducing sales tax exemptions and strengthening administration through (a). Remove concessional rates on sales tax on goods through the elimination of the 8th schedule of the Sales Tax Act and apply the standard rate on all goods subject to reduced rates. (b). Limit the list of goods subject to zero-rating exclusively to exports only.
All domestically sold goods mentioned in the 5th schedule of the Sales Tax Act could initially be moved to the exempt list under the 6th schedule before exemptions are also rationalized. (c). Reduce items included in the 6th schedule of the Sales Tax Act, limiting exemptions only to those considered as basic food, basic public health services, and selected financial transactions. (d). Strengthening tax administration to bring retailers with an annual turnover above the legally defined threshold under the Sales Tax Act into the tax system.
The bank also recommended increasing cigarette excise duty. (a). Collapse the two tiers structure into a single rate and levy the premium excise tax rate, applied on an ad-valorem basis to allow automatic indexation to inflation.
Further increase, improve, or implement new taxes on property and agriculture. (a). Reform agriculture tax: (i). Reduce or refine the current 12 ½ acre tax exemption threshold to bring more agricultural land into the tax net. (ii). Ensure appropriate categorization of land for tax rates, taking into account size, location, and irrigation status (simulations of an acreage-based tax indicated a potential to generate additional provincial revenues of around one percent of GDP).
This also extends to agricultural land being used for non-agriculture purposes but continues to be taxed under agriculture income tax scheme, leaving opportunities for tax arbitrage. (b). Strengthen property tax collection: (i). Increase property tax rates to match those applied in peer economies (in Punjab, for example, the UIPT rate is currently set at 5 percent of the annual rental value, which translates into a capital value-based tax rate of 0.07 percent, compared to 0.5 percent in many low-income countries). (ii). Harmonize the three valuation systems being used for different land-related taxes, with tax rates based on capital values that are reflective of market prices, (iii). Continue or complete the establishment of reliable records of land ownership linked to computerized national identity cards (CNICs) and national tax number.
Copyright Business Recorder, 2023