IS IMF'S SBA IN JEOPARDY OVER VAT DEFERMENT?

SYED FAZL-E-HAIDER
(feedback@pgeconomist.com)

June 21 - 27, 2010

The Federal Minister for Finance Dr Hafeez Shaikh in the budget for next fiscal year 2010-11, starting from July 1, announced to introduce value-added tax (VAT) from October 1. Breach of commitment by Pakistan with International Monetary Fund (IMF) in regard to implementation of VAT from July 1 could cause a halt to IMF programme and postponement of fifth review and sixth installment of $1.2 billion under the Stand-by Arrangement (SBA) programme. VAT was to be imposed in the budget for 2010-11 presented this month but this could not be done due to differences between the federal and provincial governments and the government deferred the implementation of VAT for three months. Critics say that the government delayed implementation of VAT due to political exigency and faulty policy of convincing the ill-prepared nation for VAT regime that led to the situation where IMF program is in jeopardy.

Some private TV channels claimed that the IMF has stopped further disbursements to Pakistan, withholding about $1.15 billion, including budgetary support of $363.7 million. Under $11.3 billion bailout package of the IMF, the country is committed to impose the VAT from July 1, while the World Bank has also linked its $300 million assistance under the Poverty Reduction Support Credit (PRSC) with the imposition of the VAT from July 1.

The analysts are even skeptical about the deadline of October 1 as committed by the government for the implementation of VAT because the VAT rates have not yet been set and the local business community and opposition parties have serious reservations against VAT. Critics say that the government delayed implementation of VAT due to political exigency and faulty policy of convincing the ill-prepared nation for VAT regime that led to the situation where IMF program is in jeopardy.

Under the IMF demands, the country is not only required to implement VAT but also increase power tariff by six per cent under a 6-12-6 formula already accepted by Islamabad.

If VAT is not implemented by July 1, the IMF's next review is not expected to take place. IMF has reportedly warned the government that if power tariffs are not adjusted now, the delayed increase will have to be accommodated in the 2010-11 schedules, which may further enhance the adjustment rate.

The imposition of VAT is the part of the conditionalities of the IMF and the World Bank under the multi-billion dollar loan programmes. Islamabad will have to make hectic efforts to convince the IMF for avoiding delays into releasing the next tranche. Delay in introducing the VAT can delay disbursements under the IMF program.

Officials in Islamabad however dispel the impression that IMF has refused to hold further negotiations with Pakistan or there would be no more releases from the IMF under the Stand-By-Arrangement. IMF cannot deny holding negotiations with Pakistan after the new developments on VAT and it is expected that Pakistan would try to convince the IMF authorities on the VAT issue, and final decisions would be taken by the IMF Executive Board, according to the official sources.

In a post-budget press conference on June 6, Dr Hafeez Shaikh reportedly said that the government would inform the IMF about new dynamics which had led to a three-month delay in introducing the VAT. He said negotiations with the IMF would continue in the overall context of the economic reforms programme.

"We are a sovereign nation and take our decisions ourselves. However, we are confident of fulfilling our commitments with the IMF. Shaikh reportedly said. "I see no fundamental difficulty in our dialogue with the fund because Pakistan is successfully moving towards fiscal sustainability under the IMF programme."

The controversy over imposition of VAT between the Centre and Sindh province has not yet been resolved. Despite stern opposition from the Federal Board of Revenue (FBR), the Sindh government is still firm on its resolve to implement the VAT on services. Sindh contends that under the country's constitution the VAT on goods is the jurisdiction of federal government while imposition of VAT on services as well as its collection is the right of the provinces.

"We took taxation measures under Plan-B by taking various measures, including raising the GST (general sales tax) rate by one per cent after witnessing no consensus on the VAT," The News reported Chairman FBR Sohail Ahmed as saying. "After approving the VAT bills from parliament and four provincial assemblies, the tax will be imposed on goods and services and it will replace the existing GST from October 1, 2010 with the consent of the elected representatives."

Experts believe that the country lacks the required infrastructure for VAT and its implementation in a hurry would cause failure as witnessed in the case of the general sales tax. The establishment of an institutional framework with reference to multiple options for policy, enforcement, and relationship between various stakeholders is considered as the most serious challenge at the time of introducing VAT.

Some analysts believe that the implementation of VAT, which is basically intended to bring entire economy under documentation, will not yield desired results till the documentation of entire economy, and otherwise it would be a failure. They contend that the automation of the economy is also essential for success of the VAT system , as the manual system invites corrupt practices.

The critics say that VAT would have an inflationary impact and prices of consumer items would go up due to withdrawal of exemptions under the VAT regime. Imposition of VAT may increase prices of major categories of items, including food, by at least 15 per cent. About 22 categories in the food group and agriculture, currently exempted from general sales tax, would be brought under the tax net through 15 per cent VAT.

The government is reportedly examining the Chinese model of VAT for its policy framework and implementation mechanism. Some officials in Islamabad believe that implementing the Chinese VAT model would help achieve aims of the government and the donor agencies without creating any friction with taxpayers. China has a multiple tax rate structure, with 17 per cent basic tax rate, and lower slabs of 3, 6, and 13 per cent tax rates. While exports attract zero VAT in China, the agriculture, forestry, products of animal husbandry, aquatic products, edible vegetable and grain duplicates, tap water, heating and cooling equipments attract 13 per cent VAT.