Rationality - the missing link

The pressure created by the rising tide of terrorism and targeted killings, disclosures before the Judicial Commission investigating the allegations of organised rigging of the 2013 elections, and routinely exposed frauds and maladministration in state offices (the shocking sign thereof being the sacking of the Auditor General) are a bad setting for drafting the Federal Budget 2015-16. These pressures are forcing the government to portray a more-than-attractive profile of the economy because a justification must be concocted to validate, at least on paper, the government's plans to increase indirect taxes to plug the rising fiscal deficit. How desperate is the FBR in this context was exposed by its proposal (luckily, rebuffed) to tax inward foreign remittances.
The fact that the FBR hasn't done enough to expand (and prepare via focused training) its field formations to expand the tax net, foretells a rise in the number and rates of indirect taxes. Apparently, none in the FBR read the recently released Organisation for Economic Co-operation and Development (OECD) report, which highlights the negatives of imposing indirect taxes.
In the OECD too, over-reliance on indirect taxes expanded the income gap to its highest level in three decades, with the richest 10 percent of the population earning 9.6 times the income of the poorest 10 percent. By end-2015, this gap touched it peak; the top 1 percent owned 18 percent of the household wealth, and the poorest 40 percent owned just 3 percent of it.
According to OECD Secretary-General, "We have reached a tipping point. Inequality in OECD countries is at its highest since records began," and went on to add that "By not addressing inequality, governments are cutting into the social fabric of their countries and hurting their long-term economic growth." He had the courage (which we don't) to admit failures.
These inequalities are Pakistan's reality too, where petty and mega crimes, extortion, and targeted killings became a 'profession' for thousands of its illiterate, unskilled youth. Reason: over-reliance on indirect taxes instead of redistributive taxes to raise the resources for arrangements to contain the decline in educational attainment and skills among families in lower income groups.
Even if its convenience-driven taxation strategy must rely on indirect taxes, has the FBR developed the capacity in its field formations to effectively check and verify that these taxes collected by business and industry, are surrendered fully to the FBR without a significant delay because otherwise these taxes help enrich businesses and increase economic inequalities?
The tragedy shared by imposers of indirect taxes and beneficiaries of tax theft is the wasted economic potential portrayed by a burgeoning frustrated youth population, and lower social mobility, and its damaging outcomes are the rise of poverty - its indicator being the rise in the number of those falling below the poverty line, and the falling savings-to-GDP ratio.
While the government keeps failing in its obligations, the SBP too ignores these escalating threats. In its latest Monetary Policy announcement it has cut its discount rate by 100 basis points (against expectations of a 50 basis point cut) although, according to its policy statement, on year-on-year basis, in April 2015, non-food non-energy inflation dipped from 5.9 to 5.4 percent.
Globally, non-food non-energy inflation index is the yardstick used by central banks to set their discount rates; as per SBP's policy announcement, while this yardstick rate came down only by 50 basis points, SBP's discount rate was cut by 100 basis points. Your guess is as good as mine about whether SBP visualized the impact this cut will have on the incentive for saving.
This issue becomes more controversial because, while non-food non-energy inflation index (a much-criticised yardstick because it excludes the costs with maximum impact on the vast poor majority) is 5.4 percent, the SBP has promised that the minimum profit rate on saving accounts will be 4.5 percent (though it will give the savers a negative return of 0.9 percent per annum).
The majority of Pakistan's businesses are over-leveraged. Thus, their borrowing cost forms a large portion of the total costs. Given Pakistan's negatives, while lower MUP rate can justifiably be cited as an incentive for encouraging investment, do we also have the administrative capacity to monitor and ensure that businesses share with their customers the benefits of lower financing cost?
According to the SBP, fiscal deficit continues to be financed from domestic borrowing. During July-March FY15, the stock of total debt and liabilities soared by Rs 954 billion. Also, that scheduled banks have been funding almost the entire government borrowing needs. In such a vulnerable scenario, should saving be discouraged by offering real negative returns?
The latest disincentive for saving comes in the backdrop of (SBP-admitted) expanding savings-investment gap. But while the poor are left with little to save, instead of being invested in Pakistan, savings of the rich are flying out. In the first quarter of 2015, Pakistanis invested $379 million in real properties in Dubai - the third biggest chunk of foreign investment in Dubai's real estate sector.
This trend has gone on since 2013; during 2013-14, Pakistanis invested nearly $4.4 billion in Dubai's real estate sector. However, the government seems content with the fact that foreign remittances and a drop in oil prices are plugging the balance of trade, while both neither exports and foreign direct investment are sliding rapidly. What does this foretell about the future?
It isn't difficult to visualize; slide in credit to private sector (to Rs 202 billion in FY15 vs. Rs 335 billion in the corresponding period last year) foretells an economic slowdown and social unrest. Yet, the Secretary Finance told National Assembly's Standing Committee on Finance that GDP growth target for FY16 has been set at 5.5 percent (vs. 4.2 percent actual in FY15), and Rs 580 billion will be allocated for PSDP. He admitted that (in violation of the Fiscal Responsibility & Debt Limitation Act), in FY15, the debt-to-GDP ratio would remain 63 percent of the GDP, but promised to reduce to 61.5 percent in FY16, and to 55 percent in FY18. Also, that forex reserves would rise to $19 billion by end-June 2015 and to $25 billion in 2017-18. Every Pakistani wants the future he predicts. But for that rationality must prevail in government circles.
This implies stopping the waste of resources on motorways and highways, and their diversion to the power sector to cut load-shedding, and stabilize oil and energy prices to permit dependable planning by businesses. Alongside, the police must be de-politicized to ensure that it focuses on restoring investor confidence. Above all, FBR must double its capacity to impose and collect direct taxes to meet its Rs 3.1 trillion revenue target.