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FBR reforms to create liquidity issues

The recently-released State Bank of Pakistan (SBP) annual report states that structural reforms introduced by the Federal Board of Revenue (FBR) for documenting business currently operating outside the income tax net (though they are paying across the boa

Updated 04 Nov 2019

The recently-released State Bank of Pakistan (SBP) annual report states that structural reforms introduced by the Federal Board of Revenue (FBR) for documenting business currently operating outside the income tax net (though they are paying across the board 17 percent sales tax) may create liquidity issues and thereby adversely affect overall economic activity in the short-term. The logic employed is fairly well-established in economic theory.
Enhancing documentation, a commendable objective that previous administrations abandoned after pressure from those operating outside the tax net, may lead to the undocumented sector to: (i) reduce its engagement in the economy which, in turn, would impact not only on output of medium- and small-scale industries (which began contracting subsequent to the rise in inflation this year due to a decline in demand) but also negatively impacted would be the downstream SMEs providing raw materials/semi-finished products to large-scale manufacturing (LSM) sector, for example, the automobile sector; and (ii) LSM has been contracting since last year and this trend is continuing as recent data suggests a further contraction of 7 percent in September. Lower Gross Domestic Product (GDP) growth than projected by the IMF of 2.4 percent, would have a multiplier effect on national output and as rightly suggested in the SBP annual report, lead to liquidity issues resulting in lower bank deposits, which have already declined considerably in recent months, and a further contraction of business activity that would lead to rising unemployment.
Two other factors are also impacting on liquidity namely the failure to clear sales tax refunds in spite of the commitment by Pakistan's economic team and the rupee erosion that is not only constraining imports (including raw material and semi-finished products required by LSM) but also incentivizing exporters to engage in under-invoicing.
This scenario should raise serious concerns within the political leadership of this country as it would further burden the people and may raise the ugly spectre of socio-economic discontent spilling out on our streets.
Business Recorder has been arguing since Pakistan's two economic team leaders (Advisor to the Prime Minister on Finance Dr Hafeez Sheikh appointed on 20 April 2019 and Dr Reza Baqir Governor SBP appointed 6 May 2019) signed the staff-level agreement with the International Monetary Fund on 12 May 2019 that the timelines agreed on implementation of the 'prior' conditions and structural reforms are extremely ambitious if not outright unrealistic.
The Fund's rationale for upfront adoption of key policy measures is based on its identification of numerous risks to the programme ranging from slippages in past programmes, to opposition by vested interest to governance and institutional building, to the provinces under-delivering on their commitment to the budget parameters, to the large amount of short-term debt which would require significant roll-over to absence of a majority in parliament that may hinder adoption of legislation. These are all valid risks; however, one would have hoped that the newly-appointed economic team leaders had engaged in a more realistic phasing of the programme for if the erosion of incomes continues at today's pace the likelihood of a political government actually completing the programme will diminish with time.

Copyright Business Recorder, 2019