Oct 25 - 31, 2010

Donor countries declared this month at the meeting of Friends of Democratic Pakistan (FoDP) in Brussels that there would be no blank cheque for Pakistan, as post-flood aid to the country was the part of a two-way deal on economic reform. The meeting of the FoDP came as the World Bank and Asian Development Bank estimated damages for Pakistan's devastating floods since July at $9.7 billion - almost twice the amount of its 2005 earthquake.

The donors pressed Islamabad for stronger economic reform, including measures to widen the tax base to generate more funds for post-floods reconstruction.

FoDP forum, which includes the US, UK, Japan and Saudi Arabia, was formed in 2008 to provide help to the country that is in the forefront of the fight against terrorism.

This month, the third ministerial meeting of the FoDP in Brussels discussed the country's needs after the floods, which began in July, left more than 10 million people homeless and devastated the country's economy, already fragile before the disaster. World powers considered tax reforms vital for financing relief efforts after devastating floods in the country with a tax-to-GDP ratio, one of the lowest in the world.

United States believes that the country's economic reforms, linked to the release of the next tranche of an $11 billion International Monetary Fund (IMF) bailout programme, are not moving fast enough. The IMF's mission chief for Pakistan Adnan Mazarei, recently said that the country's taxation system was very unfair and inequitable because the rich often avoid paying taxes.

US Secretary of State Hillary Clinton said it was absolutely unacceptable that Pakistan's wealthy were not paying more for flood relief and urged Islamabad to include tax improvements in democratic and economic reforms.

"It is absolutely unacceptable for those with means in Pakistan not to be doing their fair share to help their own people while the taxpayers in Europe, the United States and other contributing countries are all chipping in to do our part," US Secretary of State Hillary Clinton reportedly told reporters in Brussels.

The United States has also voiced concern that Pakistan's fight against militants inside its borders, which Washington sees as essential in the wider US-led war against the Taliban in neighboring Afghanistan, may suffer as resources and official attention are diverted by the flood disaster.

"Pakistan is under extraordinary pressures, internal and external," Reuters reported Richard Holbrooke, the US envoy to Afghanistan and Pakistan as saying while talking to reporters in Brussels last week. "The US government is under tremendous pressure, the EU is under budget pressure, we have our own infrastructure problems ... We will help Pakistan but we cannot do everything in the reconstruction phase."

The country's external debt amounts to $55 billion and the government has estimated the cost of recovery and reconstruction at $45 billion, which may substantially alter the fiscal outlook for the current financial year 2010-11 and beyond. Debt-servicing is depleting the country's budget from funds that could be channelled towards reconstruction. In 2010-11 budget, the cost of servicing foreign debt accounts for nine per cent of total government expenditure or $17 per capita.

International aid agency Oxfam appealed the rich countries to write off Pakistan's debt, according to a press statement of Oxfam. The debt must be written off in view of the level of destruction caused by recent unprecedented flooding and massive cost of immediate relief and longer-term reconstruction. Between July 2009 and March 2010, Pakistan spent $4.3 billion servicing external debt. Of the total amount paid by the country in servicing external debts in this period, $335m was paid to the FoDP - more than a third of the amount received from FoDP in post-floods humanitarian assistance.

Critics say that the government's decision to further delay the introduction of value added tax (VAT) or reformed general sales tax (RGST) has sent a negative signal to bilateral donors who have indicated that their taxpayers are no more able to take the burden of Pakistan's taxpayers who are continuously avoiding tax payments leaving their government to depend on aid and grants from donor countries. IMF wants the country to use the VAT to raise its tax-to- GDP ratio by 3 to 4 per cent.

Implementation of VAT or RGST is expected to increase the country's tax-to- gross domestic product (GDP) ratio to around 11 per cent by fiscal year 2013, which presently hovers around nine per cent, one of the lowest in the world.

Islamabad again delayed imposition of VAT or RGST for a month, from October 1 to November 1, because of differences between the provinces and the centre over input adjustment and time required for preparation of the new draft of RGST bill. The tax was a precondition of the IMF for possible release of $1.7 billion tranche, which is facing a delay, under Stand-By-Arrangement (SBA). IMF had already warned Islamabad that further talks with the country on macroeconomic review could be held only after the government introduced VAT or RGST from October 1.

The VAT has also been one of the key conditions of the World Bank for possible lending in future, as almost all the bilateral and multilateral donors and lenders are pressing the country to increase its domestic resources.

Experts argue that the country direly needs additional international aid flows, increased revenue targets and more drastic cuts on development and current expenditures, as the country's financial requirements have gone up tremendously in the aftermath of devastating floods.

The IMF mission is scheduled to visit by the end of this month to hold preparatory level talks on implementation of the performance benchmarks agreed under the SBA. The government may find it difficult to convince the IMF mission to further delay the introduction of RGST from October 1 to November 1. The authorities at the Ministry of Finance strongly feel that again the delay of one-month in the introduction of RGST from October 1, to November 1, would give a wrong signal to the country's major lenders like IMF, World Bank and Asian Development Bank as well as bilateral donors like United States and other developed countries.

IMF's executive board had delayed the completion of the fifth review under the SBA during September due to the non-observance of some of the key performance benchmarks by the country including non-introduction of RGST from July 1.

The country's revenue collection stood at around Rs1,340 billion in the last fiscal year, while the country has set an ambitious target of Rs1,667 billion for the current fiscal 2010-11. Critics say that that the Tax Administration Reform Program (TARP) could not yield results as the country failed to tap the real potential of revenue collection.

"The increase in tax revenue is necessary to allow total expenditures, as a share of GDP, to be maintained at the current level, says a document on TARP recently released by World Bank. It will provide sufficient resources for planned investments in social and physical infrastructure. The World Bank's report stresses that FBR should enhance project performance by improving integrated management system to monitor taxpayer compliance and electronic filing of returns. It also emphasises the need of extensive cross-checking of information, which would provide a strong justification for the proposed restructuring.