HIGH COST OF DOING BUSINESS
S.KAMAL HAYDER KAZMI,
Research Analyst, PAGE
Feb 14 - 20, 2011
The investment scenario has drastically changed with Pakistan losing its attraction to foreign, as well as domestic investors, due to the rising costs of doing business for the last three years.
There are number of reasons due to which investors hesitate to invest in Pakistan, global recession being one of them. The other main reasons include political instability, deteriorating law and order situation, high interest rates, and frequent power and gas outages.
The increase in power and gas tariffs is likely to put an additional burden on the country's industrial sector and squeeze the gross margins of industries. The local manufacturers forecast more job losses in future.
In Pakistan, many foreign firms appoint local agents to provide market intelligence and to facilitate distribution. These agents typically work on a fixed commission, which can range from two to 10 per cent for plant and equipment purchases and from 15 to 20 per cent for spare parts. Some agents prefer to make suppliers quote net prices to them and they, in turn, add the commission to arrive at their selling price. Other agents operate as consultants on a retainer-ship basis, receiving their fee regardless of the volume of total sales.
Probably, the most common arrangement is the exclusive agency agreement, under which the supplier agrees to neither appoint another dealer/distributor, nor to negotiate sales through any other party. In return, the agent is barred from handling similar items produced by other companies. Under this arrangement, the agent receives commissions on all sales of the product regardless of the channels through which the order is placed.
The agent often imports and stocks the spares most frequently required by the end-users. Overseas suppliers may look after the interests of their local agents in various ways. For product pricing, foreign companies represented by a local agent, distributor, licensee, or other intermediary generally work closely with their local affiliates in determining prices.
As an illustration of the scale and complexity of various taxes and duties imposed on imported consumer items, marketers of products build into their final sales price the following factors: landing charges, customs duty, sales tax, bank charges, insurance premiums, and GST.
In other cases, local agent/distributors may add up to 30 per cent to the list price as their commission, depending on the nature of the product. For duty and tariff purposes, they quote the principal's list prices only. On average, retailers mark up imported machinery and equipment by 10 to 15 per cent and imported general merchandise 20 to 30 per cent.
However, capital-constraint is a major obstacle in the way of establishment of heavy industries.
Pakistan's society is mostly consumer oriented so the savings rate is very low. On the other hand, banks follow stern conditions and tiresome procedures while advancing loans to consumers. Mostly bank loans are granted to affluent persons while the smaller businesspersons are discouraged in a number of ways, for example, by charging higher interest rates.
Pakistan is perhaps one of the few countries in the Asian region where the interest rates (14 per cent) are very high. The country lags behind its neighbors in economic development and exports due to high interest rates and energy crisis.
SBP's high policy rate has not only added to the rising business costs, but has also enlarged the size of non- performing loans. The effect of the high interest rates resulted in losses for a number of industrial units.
Terrorism is yet another reason causing huge losses to the industrialized and trading sectors. The rising political instability exerts a negative impact on the economy and stock markets.
Cost of doing business in Pakistan also escalates because of poor infrastructure. Transport depends on CNG and oil; prices of both have recently risen to a higher level. Pakistan is producing about 20 per cent of its oil requirement. But, due to failing efforts to find new reserves and its lavish consumption, this percentage seems to fall in the coming years.
The trivial viewpoint that a higher tax rate will generate more tax revenue holds not much logic in the age of diversified business environment. Prevailing business tax rate of 35 per cent is excessively high. A high tax rate essentially gives a way to tax evasion and contracts business activities in the country.
Practices such as red-tapism and the long awaited departmental procedures are big barriers in doing business. Licenses, NICs, gas, electricity, and water connections etc. cannot be obtained easily. The investors have to face the insulting behavior of the bureaucrats. Corruption and malpractices are successful in preventing easy entry of foreign investors, and those succeeding, their effective participation in economic activities. In fact, retaining investors has never been observed as an area deserving attention of the concerned departments' officials.
Many hurdles have been linked with five broad groups ranging from purchasing of land and site development to financial and executive regulations, along with taxation related matters. Investors, who are able to start up their businesses in less than eighteen months time period are considered lucky and termed as enterprising or having the right connections. But, in any case they also have to live up with administrative procedures taking up about fifteen per cent of their revenues.
The cost of doing business in Pakistan is alarmingly increasing. It is impossible for Pakistani investors to pay 21 to 22 per cent bank interest.
Bankers with supreme authority govern the country for the last 10 years and they take measures, which are only beneficial to the banking industry. The banking spread (highest in the world) is 7.8 per cent and needs to be cut down by two per cent at least. This will save us from the clutches of financial institutions like the IMF, the World Bank, and the ADB.
Interest rate should be brought down to a single digit. If the interest regime prevails, the unemployment will increase to an alarming stage.
Cutting interest rates to a single digit can produce multiple benefits for the economy, as it will lower the cost of doing business, give a strong boost to business and industrial activities, provide easy credit and loaning facilities to trade and industry, promote better investment and exports, and generate more tax revenue for the government. The GDP growth has declined due to an economic slowdown following the tight monetary policy. The high interest rates are the main reason behind the fall in the country's industrial output and exporters are facing multiple difficulties due to high cost of production.