Government trying to find balance in an election year
SHABBIR H. KAZMI
June 04 - 10, 2007
The ruling coalition is scheduled to announce Federal Budget for 2007-08 within the first fortnight of June 2007. Since the Budget is for the year in which general elections will be held, the focus is expected to be on attaining political mileage for winning majority seats throughout Pakistan, both in rural and urban areas. Therefore, greater allocations would be made for Public Sector Development Program (PSDP) and higher incentives would be offered to the agriculture sector.
To begin with there is a loud talk about allocation of about half a trillion rupees PSDP budget. Reportedly the plan is being prepared in the light of five principles 1) completion of ongoing projects, 2) initiation of important new approved projects, 3) initiation of unapproved but crucial projects, 4) implementation of public commitments made by the President and Prime Minister and, finally, 5) equitable distribution of funds among the provinces.
FERTILIZER & AGRICULTURE
To achieve a targeted higher GDP growth rate one area requiring immediate attention is accelerating agriculture growth rate by promoting balanced use of fertilizer. While bulk of urea demand is still being made from indigenous production, nearly 70% DAP demand is met through import. Analysts expect the government to further increase the subsidy from Rs 250/bag to Rs 400/bag on DAP to facilitate its use.
Though it is not part of budget, the government has to come up with an improved Fertilizer Policy. The policy announced has failed in attracting new investment in fertilizer manufacturing and import of fertilizer is creating two serious issues for the government 1) erosion of foreign exchange reserves and
2) payment of billions of rupees subsidy on imported fertilizer. It has been reiterated many times that fresh investment in fertilizer sector is dependent on a crucial factor guaranteeing price of feedstock.
One fails to understand rationale behind paying subsidy on imported fertilizer but refusal to supply inferior quality gas at discounted price. On top of this power plants are being supplied gas from Mari gas field, dedicated to fertilizer industry through Fertilizer Policy announced in 2001.
Size of forthcoming budget is expected to be Rs 1.5 trillion and CBR related revenue at one trillion rupees compared to Rs 835 billion for the current year. This does not seem ambitious because it would require just a half percent improvement in the tax-to-GDP ratio (assuming 7% GDP growth and 6.5% inflation). However, the only point of concern is that nearly one-third of expenditures would be financed through borrowed money which itself creates further issues in later years.
The target for fiscal deficit is expected to be 4% of GDP but analysts believe it may breach the target to reach 4.5% of GDP due to the election year considerations. Resultantly, the government would have to borrow from domestic as well as external resources in order to prevent the crowding out of private investment.
In addition, the privatization receipts would also be of key importance. Though, achieving any major break through seems difficult, handsome money could be raised through initial and secondary issues of state owned entities. It is suggested that government should re-launch 'Privatization for People' program. It has yielded good results in the past and also has the potential to mobilize more funds without transferring the management control of state owned entities.
HELPING BOOST EXPORTS
The government plans to fix an export target of US$ 20billion for the next year, which seems not only too ambitious but also too difficult to achieve. The current year has witnessed volatile economic performance, the worst being ballooning trade deficit due to dismal performance of the textile sector. While the government had fixed an export target of US$ 18.6 billion for the year, achieving it seems almost impossible. Total exports for July-April were close to US$ 14 billion. As oppose to this imports are expected to exceed US$ 28 billion target. Consequently, containing the current account deficit targeted at US$ 6.3 billion also seems impossible. The financial account has been more than efficient in filling the gap between the current inflows and outflows with the help of direct and portfolio investment.
It is need of the hour that the government should try to facilitate exporters by enhancing the competitiveness of the country's industrial base.
Although the country is expected to benefit from the recent appreciation of Asian currencies like Chinese Yuan and Indian rupee, the exporters expect more from the government. The government has already hinted towards ending the presumptive tax regime for exports and converting them into conventional income tax regime. Other benefits also sought include zero rating of packaging material being used for exportable goods.
Some of the quarters are suggesting depreciation of Pakistani rupee. However, there seems to be no reason because of the heavy depreciation that Pak rupee witnessed. On top of this there is no justification for any devaluation on the basis of REER. According to some analysts any such move could prove disastrous for the country already faced cost-pushed inflation.
Having reached the conclusion that textiles and clothing sector cannot help in meeting the export target, the next potential sector is Cement sector. It is also expected to be a key beneficiary in more than one ways. With greater allocation for infrastructure development projects, particularly dams, roads and bridges, cement off take is expected to remain robust and facilitate improvement in capacity utilization.
The government is fully cognizant of emerging oversupply of cement and may offer further incentives to facilitate higher export of cement. The government is expected to decrease duties and taxes on the industry but will have to contain any reduction in revenue collection from the industry by creating additional demand for cement. Pakistani cement is already starting to be introduced in new markets such as South Africa as well as gaining market share in Iraq.
Textile sector has been demanding numerous incentives ranging from soft-term loans to withdrawal of duty on synthetic yarn and zero rated duties on machinery and inputs. However, it is on record that only big players benefit from such incentives and units making real value addition continue to borrow from informal sources. The debt swap, if approved, would also benefit those units having enjoyed debt to the maximum limit because swap is aimed at facilitating further borrowing.
AUTOS AND OIL
Within large scale manufacturing sector, analysts are talking most about the auto assemblers rather than the vendor units. The proposed tariff based measures are also tilted towards the OEM rather than the vendors.
It may be encouraging to note that government aims at rationalizing import of secondhand cars to facilitate the assemblers but any dent to vendor industry could be more fatal because it employs about half a million people and most of the units fall under the category of small, medium and micro enterprises.
One of the reasons for widening trade deficit is higher international prices of crude oil. In order to curb POL import there has been a gradual switchover to gas, both in power generation and transportation (private cars). While one may give many reasons for higher POL prices in the domestic market, the two real contributors are 1) negligible indigenous production of crude oil and 2) refineries operating on decades' old technology. On top of this government also considers petroleum developments surcharge a tax and it is not willing to bring its rate down.
POWER CUTS & KESC
At present the country faces worst electricity crisis being the result of delayed decision making at the highest ministerial levels. All the concerned know the demand and supply gap and the rate at which it is widening. With the passage of time the gap is getting wider and WAPDA and KESC have no option but to opt for extensive load shedding.
While the government aims at accelerating GDP growth rate, ongoing load shedding emerges to be the biggest hurdle threat because 1) the spells of load shedding are exceeding announced duration and 2) the fears that load shedding may continue beyond 2015. Though, the government said that electricity shortfall was 1,500MW at the maximum, the intensity of load shedding tells a different story in Karachi.
On top of this the recent hike in electricity tariff by the KSEC causes more frustration among the consumers. Trade and industry has been critical of the electricity tariff and term it much higher as compared to the tariff being charged in other regional countries. It is necessary to point out that KESC and WAPDA would continue to ask raise in tariff because of out of proportion transmission and distribution losses. The exorbitant losses could be due to highly depleted T&D network but theft remains the key reason. It has been often said that consumers in Karachi are willing to pay higher tariff provided uninterrupted and surge free is supplied.
Though, investment in power generation and distribution sector is governed by Power Policy, the government will have to announce incentives to attract fresh investment by the private sector and ensure completion of these projects on war footings. The worst fallout of electricity shortage is deceleration in economic activities, which no government could afford to let the success story turn a big failure.
The robust equities market has helped the government in luring investment as well as projecting Pakistan as preferred investment destination. There have been many achievements starting from successful launch of GDRs by OGDC and MCB Bank and the latest been seven times over subscription of Eurobond.
This budget is expected to provide some strong incentives to the equities markets. Most of the incentives would be targeted at listing of new companies at the local stock exchanges. Some of the expected measures are:
1) offering incentives for new listings are being proposed in the form of favorable tax structure that includes reduction in corporate tax rate for the listed entities can be lowered as compared to the unlisted ones (as used to be the case before 2002) in order to make the listing option more attractive. The budget is also expected to offer incentives for IPOs, depreciation allowance and tax credits for raising capital from markets.
2) Special measures are also expected from the budget that includes establishment of holding companies.
3) While there are proposals to reduce the GST (currently at 15%) and inter-corporate dividend tax (currently at 5%), we don't think that the government would be taking any step towards addressing such proposals.
4) The government is expected to make some important changes in the tax structure for the shares trading.
Currently, the CVT is at 0.02% while the withholding tax (charged to the seller) is at 0.01%. Both the taxes were doubled in the last budget. In the upcoming budget, there are expectations that the structure would be simplified while maintaining the quantum of total levies.
5) NSS announcement is not a part of the budget (NSS rates are usually revised on a half yearly basis and are thus expected to be announced in early July).
However, we expect no change in NSS rates in the upcoming revision owing to the fall in PIB yields in the recent auction and the not-so-significant upward move in yields in the secondary market either.
Any incentive announced in the budget to favor the listed sector would obviously be positive for the market. The incentive may come in the form of a lower tax rate. A negative surprise, in the form of an increase in CVT is not expected.
Providing incentives for the establishment of holding companies would certainly bode well for the various group companies listed on the exchange. We are already witnessing abnormal price movement in the scripts of some important group companies.
Raising revenue has haunted all the government in Pakistan. Experts say that one of the reasons for a low tax to GDP ratio is a mismatch between the contribution of various sectors of the economy towards GDP and their respective tax contribution. For example, lately agricultural tax revenue totaled Rs 874 million or 2.4% of the provincial taxes, whereas the share of agriculture in GDP was 21.6%. The CBR attributes agricultural tax evasion to the fact that it is out of the purview of the federal taxes.
It has also been points out that tax contribution of textile sector is far less than desired. During 2004-05 the industry paid Rs 13.8 billion as indirect taxes whereas CBR paid back Rs 40.7 billion as refund and rebate. Thus, net tax contribution of the industry was minus Rs 26.9 billion.
This situation is said to be partly due to zero-rating of exports for sales tax and partly to the wide-ranging tax exemptions and concessions granted by the government due to pressure of the strong textile lobby. In case of income tax, the industry only pays withholding tax 0.75-1.5 per cent at the export stage.
TOTAL TAX COLLECTION THROUGH THIS MODE IS ALSO UNIMPRESSIVE.
Levy of 3% sales tax on domestic sales of textiles fetched an insignificant amount of Rs 4.4 million only against the potential of Rs 1.9 billion. At this stage it is pertinent to determine whether the textile sector is paying any amount under sales tax or income tax on its domestic supplies that are not zero-rated,' the report suggests. CBR estimates that 80% of textile produce is exported and 20% sold in the local market.
USING FOREIGN REMITTANCES
In one of his articles veteran journalist Sultan Ahmad has raised a pertinent question — the squandering of the increasing home remittances of overseas Pakistanis which will exceed US$ 5 billion for the current financial year. He has raised this question based on utilization of the proceeds of the first 10 months amounting to US$ 4.450 billion. This issue has also become pertinent after the decision to raise foreign exchange reserve of the country to US$ 15 billion.
Achieving such a target would be easy at the current level is nearly US$13.8 billion. In fact this target could have been achieved last June when the reserve stood at US$14.59 billion, but it declined due rising trade and current deficits.
Building larger reserve by converting the rupee reserves of the government is rather easy. In fact the Pakistan has done this in the past. The current reserves include billions of dollars bought by the State Bank of Pakistan from open market and partially through inter-bank deals. Now it has been decided to raise additional reserve only through inter-bank deals. The real solution to the problem is to bridge the trade deficit by increasing exports and containing imports. The quantum of plant and machinery is on the decline but import bill of consumer goods and some luxury items is on the rise.
Foreign direct investment has also shown an impressive growth this year, contributing substantially to the balance of payments despite a huge current account deficit. However, in the next year it might not show an impressive growth due to a high-base effect and also because of the growing political uncertainty ahead of elections. The same holds true for foreign portfolio investment.
Many people talk more about the numbers and percentages expressed in the federal budget. However, it should be considered a policy statement expressed in numbers for better comprehension. Therefore, top priorities should be 1) PSDP aiming at providing better infrastructure 2) tax target aiming at expanding the tax net rather than putting additional burden on existing tax payers, 3) announcing sector specific policies to facilitate investment and improve competitiveness, 4) making specific amendments in Power Policy, Petroleum Policy and Fertilizer Policy 5) discouraging import of unnecessary goods.
The prevailing electricity cannot be overcome through load shedding. WAPDA and KESC seem helpless because the government has put the cart before the horse. The KESC should be facilitated in establishing its own power generation facilities and generation, transmission and distribution companies (corporatize entities of WAPDA power wing) should be privatized immediately.