. .
A



FEDERAL BUDGET 2002-2003

Managing the available resources in the interest of the economy

By AMANULLAH BASHAR
June 24 - 30, 2002

The Federal Budget for the financial year 2002-03, is the third annual exercise of the present government to get the optimum benefits of the available resources in the best interest of the people and the economy of Pakistan.

Although, majority of the budgetary proposals presented by the Finance Minister Shaukat Aziz were identical to the usual budget making exercise, yet some of the aspects were really appreciable and are likely to set new trends in our economy, if the soul of the purpose was not injured by the powerful lobby of the vested interests.

The most outstanding and significant aspect of the budget is the introduction of the new Income Tax Ordinance with effect from July 01, 2002 while the second one is the effective control over the backbreaking impact of the debt-servicing on our economy.

According to a financial expert, the best characterized as tinkering round the edges of a fiscal system whose structural features are increasingly being shaped by IMF and World Bank conditionalities. However, the budget contains one major departure from its predecessors: the formal introduction of the Income Tax Ordinance 2001 from the start of the next fiscal year July 01, 2002.

The Ordinance is as the Finance Minister described it a philosophical departure from the previous ITO 1979, in that it transfers the responsibility of determining taxable income and computing income tax, from the income tax officer to the taxpayer. Provided the letter and spirit of the new tax law is given full play and does not fall prey to fiscal expediency, or opposition by vested interest. The new law aims to shift the course of the country's tax culture. It will help shaping the income tax regime along with sales tax as one of the twin pillars of the future fiscal revenue edifice of the country.

The Debt-Servicing and the Defence Expenditures are the two major factors, which generally consume the major chunk of the available resources. Expenditures under these two heads have been curtailed in the federal budget, which certainly is an outcome of the successful rescheduling of the external debt of the country.

A cut of 12 per cent especially in the debt servicing side reflects the skill of the economic managers in their budgeting exercise for the country.

It is however difficult to put an exact suffices to the federal budget. People have to think twice before making a judgement whether it should be called as the investment friendly, peoples friendly or the government friendly budget. The housewives however feel unhappy over what they generally remark the taxing of the vegetable oil and increase in electricity charges which they say adversely affect the kitchen of every house whether rich or poor.

Against the total outlay of Rs742 billion, the gross revenue receipts for the next year have been estimated at Rs674.9 billion. The revised receipts of Rs632.8 billion and the overall budgetary deficit has been fixed at 4 per cent of the GDP against 5.7 per cent recorded in the current year.

Despite formidable situation due to mounting border tension between India and Pakistan, the allocation for defence in the next year's budget has been lowered to Rs146 billion against Rs151.7 billion estimated in the revised budget for the current year. This also shows the command and confidence of the government over the situation.

The Federal Budget is a continuation of the long-term strategy of the government and hence is a logical progression from the financial year 2002 budget and the changes in the economic policy over the last year.

The key theme of the government's economic strategy, which include enhancing tax revenues through increasing the tax base, improving tax collection, curtailing unproductive expenditure and reducing the role of the government in the economy, are all prevalent in the budget. The budget, while neutral for the economy, is rather expansionary relative to the financial year 2002 budget. This is because of the extra fiscal space created by positive developments in the external account over the past eight months, with forex reserves now standing at a record high of $6 billion. This outstanding reserve position achieved by the present team of economic managers is not due to September 11 or as a result of Pakistan joining the coalition against terrorism. It is the culmination of the policies as the government achieved $4 billion foreign exchange reserves before September 11, 2001, as observed by the finance minister in his budget speech. The process of de-dollarization is another indication of government's economic policies and also the stable exchange rate, the minister said.

IMPACT OF THE BUDGET ON THE SOCIAL AND ECONOMIC SECTORS OF THE COUNTRY.

EDUCATION

An amount of Rs2.6 billion has been earmarked for the education sector in the budget 2002-03 against Rs2.5 billion allocated in the current fiscal year.

The government's strategy would focus on primary and secondary education, universal education, technical education, higher education and reforms in traditional Islamic institutions of learning. The Cost of Education Sector Reforms (ESR) to be implemented by the provincial and the local government is estimated Rs55 billion for a period of three years.

This large sum and from our own resources, it is not possible to fund the entire cost of this programme. A number of donor agencies, impressed by the quality of the programme, had shown keen interest to provide necessary financing and the government hoped to provide increasing allocations to the ESR in the years ahead. In order to improve girl's participation in education, the Ministry of women development has also introduced a new programme named "Tawana Pakistan".

PSPD

An amount of Rs134 billion has been allocated for the Public Sector Development Program 2002-2003 against budget estimates of Rs130 billion of the current year, showing a three per cent increase as compared to last year. Actually, the PSPD allocations are 7.5 per cent higher than the current year's final revised estimated of Rs124.7 billion.

Of the total allocation of Rs134 billion for the next year, Rs90 billion would be spent on federal projects against Rs100 billion during the current year, down by 10 per cent, including Rs46.7 billion for federal ministries and divisions, Rs26 billion for state-owned corporations, Rs9.4 billion for special programmes, Rs7.7 billion for special areas like Azad Kashmir, Northern Areas, FATA and Rs44 billion for provinces.

The provincial programmes for 2002-2003 have been kept at Rs44 billion, which is higher, by 46.7 per cent when compared with the budget estimates of 2001-02. The provincial PSPD has been formulated keeping in view the additional resources being transferred to the provinces under 2.5 per cent GST transfers.

OIL REFINING

At present the older refineries operating in Pakistan NRL ARL and PRL operate within a regulated rate of return band, consisting of a ceiling net return on paid-up capital of 40 per cent and a floor of 10 per cent. Earnings above the ceiling are paid to the government of Pakistan by way of a surcharge, while a shortfall below 10 per cent is received from the government as a subsidy. This system does not apply to the PARCO refinery, which was set up under the 1994 Petroleum Policy and is guaranteed a minimum 25 per cent return on capital or the recently floated Bosicor refinery which is being set up under the 1997 policy that removed return guarantees. Last year the government paid the refineries Rs13.5 billion in arrears for subsidies due to them, as international-refining margins dropped.

The budget proposes to remove the floor return and let the old refineries compete in the market without intervention. Instead the refineries will be given tariff protection: 10 per cent ad valorem on import of HSD, 5 per cent ad valorem plus 1 per cent surcharge on import of kerosene, LDO and JP-4. Excise duty on oil products is being abolished and the per unit petroleum levy reduced to limit the impact on consumer prices. Despite the duty protection, this move will expose the refineries (except PARCO which will continue to receive the guaranteed return) to the volatility of global oil refining margins, including the possibility of operating losses when margins dip below a certain level.

AUTOMOBILE

The reduction in custom duties on imported cars is negative news for the domestic automobile and motor cycle sector, In itself, the proposed cut in duty will not impact vehicle prices and hence the assemblers' revenues and profits. However, while the duties are still very high after the cuts, providing domestic assemblers with sufficient protection against imports, the reduction signals the initial response from the government to the continuous collusion between domestic manufacturers to reduce supply in order to artificially raise prices and boost their profitability at the customers' expense. Domestic assemblers are being told to behave, or else face steeper cuts next time that would impact prices and earnings. The cuts in duty also mean that assemblers will need to accelerate indigenization levels to hedge against the threat of possible future cuts in duty. Investors would now also need to focus on the aspect of assemblers' performance in making stock investment choices.

The increase in the motor vehicle depreciation-ceiling amount from Rs0.75 million to Rs1 million may have a positive impact on the demand for the 1300cc/1600cc/2000c models produced by Indus Motors (Toyota) and Honda Atlas. However the negative impact of the above mentioned duty cut is a more significant factor for the auto sector in Pakistan.

BANKS

The reduction in the corporate tax rate for banks by 3 per cent from the next fiscal year for five years (to achieve parity with the standard corporate rate of 35 per cent) is clearly a positive development for banks' post-tax earnings. Although, the reduction in banks' tax rate was widely expected, the announcement of a timetable removes uncertainty and hence is a positive development.

TEXTILES

The protection afforded to the sector in the form of duty drawbacks is being gradually phased out and the revisions, which were delayed, will now be effective from July 1, 2002. The trade policy will disclose the extent of the revision. However a decrease in the duty drawback may have an adverse impact on textile exporters whose earnings have already been impacted by the country's tenuous political and economic situation.

The withholding tax of 10 per cent on the import of filament yarn has been removed in the Federal Budget to enhance the usage of polyester stable fiber (PSF). The purchasers of local PSF will be able to import the same under the DTRE rules or claim duty drawback on deemed import basis. These measures are primarily designed to encourage the use of PSF in the textile sector and to provide some relief to companies producing blended yarn and fabric.

Both production and export of cotton cloth and made ups increased during the outgoing financial year, indicating that the local textile sector is realizing value addition is the only way the industry will be able to compete after opening up the market to world trade in the financial year 2004.

TELECOMMUNICATIONS

The privatization of PTCL and other public sector entities that are at an advanced stage of privatization should be completed at the latest by December. Though the deadline for privatization has not been stated explicitly, the Privatization Commission has been talking about September as the specific deadline for the complete of PTCL's privatization process.

The cellular service providers have been optimistic that the current budget would bring a reduction in activation charges to Rs1500 from the current Rs2000. However this has not materialized. Instead, withholding tax on telephones, mobile phones and prepaid cards for fixed/mobile phones are being rationalized downwards.

The current budget abolishes the central excise duty on optical fibers. This should give incentive to private sector corporations in the telecommunication as well as the IT sectors.

POWER

This budget is also emphasized a shift in focus away from thermal power generation and towards hydel electricity. The reason is the high cost of imported furnace oil and its negative impact on input cost and the country's foreign exchange reserves.

The total installed capacity of electricity generation in Pakistan has increased by 76,045 GWh since 1991 to 152,923 GWh as at June 30, 2001. This was driven by the 48,907 GWh capacity additions of new IPPs since 1997. Hydro electricity accounted for 28 per cent and thermal generation (gas and furnace oil) and other (nuclear/coal) equaled 72 per cent of total generation in 2001. The installed capacity of hyderal electricity generation has remained static since 1995 at 42,276 GWh.

The government owned national utility WAPDA remained the leading electricity generating company in 2001 with a share of 50 per cent in total electricity generation of 68,117 GWh. KESC, HUBCO and KAPCO (International Power of UK) produced 11.7 per cent, 10.5 per cent and 9 per cent of total generation respectively, whereas the share of other IPPs remained close to 16 per cent in 2001. There are 13 listed IPPs on the Karachi Stock Exchange of which Hubco commands almost 85 per cent share in the power sector's market capitalization. The decision of the government to privatize KESC by December 2002 and two Jamshoro Power Co Ltd thermal power generating units has assured the positive restructure of the power sector in Pakistan. The power sector reform process is likely to continue as International Financial Institutions have linked future funding with these power sector reforms and the government would be inclined to service its tariff agreements with various IPPs. The government is also planning to announce a new power policy focused on Hydel generation to attract long term investment into the second and has already earmarked Rs29 billion for Ghazi Brotha hydropower project in the budget for 2003.

GAS

The government has recently decided to remove more than Rs5 billion out of a total of Rs6 billion of subsidies granted to domestic consumers who use up more than 18 per cent of the total natural gas produced in Pakistan. The use of natural gas by cement plants has also been on the decline drop of 18.5 per cent over 2000 as the government has increased natural gas prices by over 4.5 per cent during December 2001 with a planned price increase of 10 per cent in July 2002.

The existing transmission and distribution network is insufficient to accommodate the recent gas discoveries.

According to industry sources, oil and gas exploration companies are reluctant to increase the pace of their exploration activities not only because of the low returns, but also because the current transmission and distribution infrastructure's inability to absorb new gas supplies. According to industry sources, the government of Pakistan requires around $600-700 million foreign investment to overhaul and expand its existing transmission and distribution network. Foreign investment in the oil and gas sector, which has shown signs of an increase over the last two years, is bound to pick up once the government deregulates the gas sector going forward. The change in the return formula is the key if the government is seriously interested in attracting foreign investment to the gas sector. However, protection of the interest of the consumers is also of vital importance for overall economic growth of the country. Hence the government will have to maintain a balance between the interest of the investors as well as the consumers in the larger interest of the economy.

PROSPECTS

Patriotic Pakistanis are happy over the good results shown by the economy. Unprecedented balance of payment position and over $6 billion reserves all give a sense of achievement to the people. But how long this patriotism will last if the benefits of these achievements are not passed on to the common man. Their major concern is to be able to live within the available means. However, the rising inflation continues to deprive of their purchasing power. People in general are least bothered if the prices of automobiles have been reduced in the budget. In fact they are more concerned of increasing prices of daily living such as vegetable oil, utility bills and transportation charges. They need a budget, which can at least make life easy for them