Cover Story
| Loan Defaulters, Tax Evaders, IPPs and the Economy |
|
By Dr.
ANJUM SIDDIQUI,
Senior Advisor
Financial & Risk Management,
Dec 06 - 12, 1999
The Hub Power Company
An exclusive article for PAGE special by Dr. Anjum
Pakistan is facing its greatest challenge in its 52 year economic
history. Reviving a sick economy amidst poor investor confidence is an uphill task being
faced by the new administration. Mr. Shaukat Aziz has outlined a plan of action which
incorporates the recovery of loans, collection of taxes, privatization of state assets and
restoration of investor confidence to attract foreign investment.
Loan Defaulters & Tax Evaders
The GoP's drive to nab loan defaulters and tax evaders is a long
awaited attempt to reinforce the rule of law. The cleansing operation if successful could
have monumental effects in changing the tax and loan culture of this country. In terms of
dollars and cents, the revival of the economy has very little to do with the recovery of
loan defaults. However, it has everything to do with accountability. A number of loan
defaulters are also tax evaders as the complete breakdown of the rule of law encourages
theft on both playing fields. It is estimated that total loan defaults amount to Rs. 211
billion of which about 50% is the principal and the rest is accumulated interest. Although
there were threats of dire consequences and punishment, the Government has only managed to
collect loose change amounting to Rs. 8-10 billion which is only 4% of the outstanding bad
loans. This infinitesimal recovery is not inconsistent with our prior expectations. It is
not an open secret that lot of this money has been transferred overseas in financial and
real assets. Getting the money back would be a long and costly battle.
The smart way of going about it is to confiscate the defaulters' local
assets and auction them to the highest bidders. Instead of dragging the issue which is so
common in Pakistan, the retribution of justice should be swift. Delays in the judicial
order would only create opportunities for evasion of justice. The economic effects of loan
recoveries by banks are obvious. An improvement in the liquidity of banks would put
downward pressure on interest rates on business and consumer loans. But lower interest
rates are not the only determinant of business fixed investment, at least in a less
monetised economy such as Pakistan. Keynesian "animal spirits" or entrepreneurs'
expectations of return on investment are most important to spur investment activity. It is
here where the policy makers would face their greatest challenge.
Raising the entrepreneurs' confidence in the profitability of domestic
investment is not easy but it is doable. This confidence was eroded by successive shocks
to the economy. It may be recalled that at one time just before the ouster of the 2nd
Benazir government, the Karachi Stock Exchange Index had touched 2400 points. Soon after
it plummeted below 1000 points with successive policy faux pas. The decline started
with political instability surrounding Benazir's dismissal, followed by the IPP crisis
perpetrated by Nawaz Sharif, the freezing of the foreign currency accounts in the wake of
the unnecessary and ill timed nuclear testing, Nawaz Sharif's row with the judiciary and
the dismal failure of the Nawaz government to revive the economy. The end result was that
foreign exchange reserves sank to a couple of weeks of import financing and left with very
little options Pakistan opted for loan rescheduling or a quasi default with IMF and
multilateral agencies.
Once again Pakistan finds itself in a difficult position and is seeking
IMF assistance to finance its current account deficit. Foreign assistance is like a credit
card. It allows higher spending than income at the cost of accumulated and rising interest
payments. Living without credit (foreign assistance is possible) but naturally at the cost
of decreased consumption and investment until such time that enough national savings can
be generated to finance consumption and investment requirements.
Taxation Issues
Tax revenues of Rs. 307 billion, inclusive of direct and indirect
taxes, currently constitute 60% of the total Gross Federal Receipts of Rs. 501 billion. Of
this, direct taxes (income taxes) are only Rs. 112 billion which is only 22% of the
overall government receipts. The low direct tax base is the premier cause of all economic
problems of the country. For a healthy economy the ratio needs significant improvement. If
the government is able to enlarge the tax net by Rs. 50 billion, it would amount to a 16%
increase in tax revenues (inclusive of indirect taxes). Realistically speaking, one does
not expect any larger increase in the current fiscal year and even this increase would be
a trend setter and a mammoth achievement.
However, to reduce Pakistan's dependency on external resources and
inflationary indirect taxes, the direct taxes as a percentage of Gross Federal Receipts
should be around 50% plus. This would give the government further revenue of around Rs.
140 billion from enhanced direct tax collection alone. Can the nation withstand an income
tax collection of this proportion? The answer is an emphatic yes. It is common knowledge
that the size of the black economy is large and shopkeepers, retailers, traders and a
number of self employed people evade taxes. As if this was not enough, agriculturists are
exempted from paying taxes. It is interesting that agricultural income is not income in
the tax man's lexicon but making money through any other means is considered income.
The current tax collection of Rs. 307 billion is very small given the
potential for tax revenue. By even the most conservative estimates another Rs. 100 billion
plus can be easily collected, provided that the economy is documented and the exemption
for the fat agriculturists is removed. This is where the resolve of the current regime
would be severely tested. The worst method to enlarge the tax net would be to use the
corrupt CBR inspectors. The task of documentation is easy and should be given to the
private sector including the local government. The involvement of the various chambers of
commerce is a politically expedient idea.
IPP Crisis
An efficient power sector producing affordable power is the need of the
day and all Pakistanis are equally affected by the IPP crisis. It is most unfortunate that
the IPP issue has been politicized and mishandled. The endless stalemate of a purely
commercial issue continues to the detriment of the country's fragile and confidence torn
economy.
Innovative and indigenous solutions of the IPP issues are indeed
possible. However, a solution will only materialize once we do away with the rhetoric and
discuss a purely commercial issue in economic terms minus the politicization that it has
been subjected to over the last two years.
The Energy Policy needs to be reexamined bearing in mind Pakistan's
country risk, capital constraints, foreign exchange reserves and projected economic
growth. The restructuring of the energy sector requires the implementation of both demand
and supply side measures. All arguments that Pakistan has excess electricity capacity
would vanish with an increase in demand. Electricity consumption can be increased by four
policy initiatives which are: (i) reduction in power tariffs (ii) rationalization of
subsidies and power rates between domestic and industrial consumers (iii) supplying
electricity to the 50% population of Pakistan which is currently deprived of electricity,
and (iv) exporting electricity to India. These are demand side measures to enhance
electricity demand.
Supply side measures to increase the supply and to make it more
efficient are
(i) phasing out inefficient and old WAPDA & KESC plants and
increasing the utilization factor of efficient IPP plants (ii) privatization of WAPDA
expeditiously, so as to develop an efficient and cost effective transmission and
distribution network.
Indeed there is massive resistance from within WAPDA against any move
towards privatization. It is most amazing that infinite 'reasons' are being advanced
against privatization of the state utility and other public sector corporations. In fact,
the government's privatization plan has come to a virtual halt due to the lack of
political will and mayhem at the top.
The privatization of state corporations and specifically of WAPDA
should be a key policy initiative of the new administration. The health of the economy is
intimately interlinked with the IPP issues. Poor economic growth is the cause of low
electricity demand, which in turn reduces WAPDA's revenues and its ability to pay the
IPPs. Without an economic revival the fiscal health of the energy sector would continue to
be adversely affected.
In my opinion, it would not be possible to jump start the economy
without the following three key policy measures: (i) enhanced revenues through increase in
direct taxes (income tax) (ii) immediate privatization of banks, state corporations and
utilities such as Telecom and WAPDA, and (iii) restoration of investor confidence as an
immediate policy measure. Of these measures, higher revenue collection is of premier
importance and should be the principal focus of policy makers.
