PROSPECTS & CHALLENGES
SALMAN AHMED SHAIKH,
May 30 - June 5, 2011
Pakistan saw decline in poverty in later part of 90s and until at least by 2005 when the economy experienced a boom after 9/11. But, in the aftermath of the economic meltdown, poverty has started to increase again as poor people have lost jobs and those who have retained their jobs have not been getting increase in their real wages, especially the workers in private sector. Increase in wages is not proportionately equal to the increase in inflation.
In Pakistan, at least 33 per cent of the people live below the line of poverty. Hence, one third of the population is not even able to get subsistence standard of living. Poverty is not just a standalone problem; it is a mother of many problems.
Poor people are deprived of clean drinking water, adequate sanitation, and affordable medical facilities and therefore, they have malnourished children, high infant mortality, and plethora of other diseases to bear with.
Poor people are also not able to get adequate education. Even if free education is provided to them, their opportunity cost of not sending their children to work is usually greater than the cash subsidy provided to them (if any) for education and leaving work. Therefore, the children of poor families remain uneducated and then it becomes extremely difficult for them to get out of the poverty trap.
In Pakistan, there is a significant income inequality and it results in social stratification. This stratification affects social relations like marriages and economic relations in the form of nepotism. National cohesion and collective work towards national goals is overlooked. Classes exist to consolidate their own existence and vested interests. Only short-term policies are pursued and that too on the direction of international agencies like IMF and the World Bank. Policies even though proven effective in one system need modification sometimes to be effective in another system with a different set of characteristics.
Short-term orientation leads to economic growth in patches but without any long-term orientation towards capacity building and infrastructural development, the growth is unsustainable. Therefore, poverty and inequality persist in the society.
Poverty and inequality lead to illiteracy, inadequate health conditions, and poor standards of living in general. Education, health, sanitation and adequate standards of living can all be provided if the country has enough income and if that income is distributed fairly equally. Conversely, if there is low per capita income and if it is distributed unequally, the basic amenities of life cannot be provided to the masses.
The fundamental problems of world can generally be categorized under 'poverty' and 'inequality' in the 21st century. However, it is overshadowed by its consequences in the form of terrorism, poor health and sanitation facilities and illiteracy.
The dearth of documentation and security/collateral deprives poor people of official and formal sources of financing. Hence, poor people use informal sources of financing paying higher interest rates and if they default, they often become subjects to their lenders and sometimes have to submit themselves and their children after them to bonded labor. It makes it very difficult for them to get out of the debt trap.
With the passage of time, access to quality education also becomes a function of one's level of income. Therefore, income inequality also results in unequal access to quality education. In most developing countries, development expenditure is usually contingent on the loans and grants obtained. Therefore, state patronage of developing SME financing and micro financing remains an issue given low priority.
Unemployment is also another big problem which Pakistan is facing in recent years. Even if unemployment has decreased a bit in last 5 years, it has created many other problems. Employment generation has taken place mostly for educated people. Employment generation for poor and uneducated has increased mostly in urban areas. It has resulted in huge migration from rural to urban areas. This massive migration in last 10 years from rural areas to urban areas hasn't been complemented by the same increase and development in infrastructure. Therefore, it has resulted in increase in cost of real estate in urban areas, power shortage, pollution and even crimes.
Furthermore, after WTO implementation, textile and other sectors of Pakistan have been exposed to the global competition and domestic producers are finding it very difficult to be competitive as government is also short of funds and cannot provide incessant subsidies to the ailing industries. Therefore, this has and unfortunately may further result in more layoffs and unemployment in the times to come.
KEY ECONOMIC HIGHLIGHTS
ECONOMIC VARIABLE 10MFY11 Revenues Rs1156 billion GDP 2.5 per cent Current Account Surplus $748 million Remittances $9.05 billion Exports $17.23 billion Forex Reserves $17.18 billion Foreign Investment $1.232 billion
KEY HIGHLIGHTS OF BUDGET STRATEGY PAPER 2011-14
KEY ECONOMIC WORRIES
ECONOMIC VARIABLES FY11 Total debt Rs11.2 trillion Debt-to GDP Ratio 61.3pc Inflation 14.5pc Tax-to-GDP ratio 9.1pc Fiscal Deficit 6.2pc (Projected) for FY11 Current Account Surplus $748 million Remittances $9.05 billion Losses of Key SOEs Rs245 billion Taxpayers-to-Population Ratio 1.6pc Key Policy Rate 14pc (Highest globally) Corporate Tax Rate 3rd Highest globally
HIGHLIGHTS OF THE BUDGET STRATEGY PAPER
ECONOMIC VARIABLE TARGET FOR FY12 Revenues Rs1,952 billion GDP 4.2pc in FY12; 4.7pc in FY13 Inflation 12pc Tax-to-GDP ratio 10.3pc over 2011-14 Fiscal Deficit 4.5pc; to be reduced by 0.5pc annually Defense Expenditure Rs442 billion
KEY DEVELOPMENT WORRIES
ECONOMIC VARIABLES VALUE Human Development Index Ranked 125th HDI Value 0.490 Poverty rate In excess of 33pc Population below $2 a day 60.3pc Unemployment Rate 15pc for 2010 Malnourished Population In excess of 33pc Malnourishment in Children Approximately 38pc Births handled by skilled personnel Approximately 39pc Schools damaged by floods More than 8,000 Children not attending school More than 42 million Illiteracy rate Approximately 50pc Roads damaged by floods 24,000 km Affected people from floods 20 million Population with food insecurity Approximately 50pc Inequality (as per Gini Coefficient) 0.336
Higher debt to GDP ratio exceeding the 60 per cent limit set by the Fiscal Responsibility & Debt Limitation Act 2005 is a big concern.
Higher debt to revenue ratio confirms that going forward this rising trend in debt is not sustainable.
Higher debt service to revenue ratio confirms that debt servicing takes up approximately half of the revenue and leaves very little for development spending.
Excessive debt has resulted in rising fiscal deficit and increasingly diminished development spending as a percentage of GDP.
MISCELLANEOUS SHORT TO MEDIUM TERM RECOMMENDATIONS
* The prices of some food items are fixed in the budget and the implementation does not follow on ground subsequently. Policies need to be pursued with sincerity and commitment.
* There should be ban on export of all necessary food items i.e. wheat, sugar, rice etc. until the domestic food requirements are met. Smuggling shall be strictly controlled through exemplary punishment.
PROMOTING & PRIORITIZING EDUCATION AT GRASS ROOTS LEVEL
* Access to education must not become a function of one's wealth and income. Subsidized quality education needs to be provided to the masses for which the allocation for education alone needs to be increased to five per cent of GDP.
* Social sector development is of pivotal importance at least to the 90 per cent population of Pakistan. Education especially technical, vocational and skills oriented needs to be encouraged. Primary and secondary education shall be given more share in the education budget. A postgraduate is in a better position to attain scholarships worldwide, but the rural primary and secondary education can only be funded by the state.
* It shall be made compulsory for all government employees to send their children in government schools. It can be made a part of the degree requirement that every graduate has to teach at a government school for a period of six months to obtain degree and employment. It will create public awareness, novel ideas, strong communal bond, and an affinity in the young professional aspirants with their community members.
CHECKING CONSPICUOUS CONSUMPTION & TRADE DEFICIT
* Import of consumer goods especially the comforts and luxury items should be discouraged through heavy import duties.
* Government must levy high import duty on consumer products which are non-productive and contribute very little to the economy. Foreign cars on the roads do not indicate development.
BROAD BASED TAX REFORMS
* Charging a high petroleum development levy and suggested similar levy on gas is unacceptable while there has not been witnessed any degree of self-sufficiency attained in energy sector.
* Capital gains tax shall be levied on all investments. It will curb speculation and day trading. Since it is an income tax paid out of the capital gain received on investment, it will not hurt investors. A highly speculative market needs rationality through tax imposition.
* A reduced uniform tax rate along with uncomplicated tax procedures and ease in interest rates is needed to boost production.
* Tax base needs to be expanded through documentation. Tax disclosure shall be made necessary in most material transactions. A strong and vibrant information network is necessary encompassing major financial, legal, accounting, auditing and tax institutions for timely disclosure of malpractices and tax evasion.
* Income tax should be levied on agricultural income, stock trade, and real estate investment. Services especially the hotels/restaurants, franchises etc. must be brought in tax net rather than looking to burden the already registered taxpayers.
* Amnesty scheme shall be introduced for people to whiten their money. Rather than using the stick approach, the carrot approach could be used this time and people be given a one-time chance to whiten their money in an attractive scheme.
FINANCIAL SECTOR REFORMS
* Banking spreads are at an all time high. No further incentives shall be provided to the banks, as the current situation will urge them to lend to the private sector and industries. But, for that, government needs to reduce domestic borrowing. If banking spreads remain high, the central bank could increase the tax rate on banking companies rather than taxing the small savers (already very little in number amid high inflation) with capital gains tax and withholding tax.
* Banks should be compelled to open branches in rural areas. This will provide formal sources of finance to the rural poor and it will enable them to get out of usurious loans they have to take from landlords and in case of non-payment, have to surrender themselves and their children to bonded labor. This proposed policy will deepen the democratic culture in Pakistan in the long term and will improve the civil rights of the poor masses.
PROVISION OF ADEQUATE HEALTH SERVICES
* Health budget shall be increased to four per cent of GDP. It shall be made compulsory for all medical science graduates to work for six months in a public hospital to obtain degree and license to practice.
* Most of the chronic diseases can be avoided if clean drinking water and adequate sanitation facilities are provided to the poor regions. This must be prioritized and state should play a leading role in solving this problem.
STRENGTHENING SOCIAL SAFETY NETS
* A guaranteed income of Rs10,000 can be provided to the households with no earning member in the family. It can be provided for a period of three years to enable them to survive and obtain finance from VC funds as in the proposed model.
* Since the government has scarce resources right now, any subsidy given shall be a targeted and not be transferable and 'blanket' so that it only benefits the desired industry, project or social class.
* The problem is not with public sector enterprises. The problem is with poor performance management and governance framework. East Asian countries have successfully developed their industrial base with state playing an active role in the overall process. State patronage until 1988 in Pakistan also brought much better results than afterwards when the country decided to surrender itself to the World Bank and IMF.
FACILITATING & INCENTIVIZING VALUE ADDITION
* Value addition is the key for growth in exports. A targeted subsidy in the form of tax holidays and R&D support should be provided to induce value addition.
* Services industry like IT outsourcing, gemstones polishing, healthcare, tourism etc shall be given priority as they require less infrastructure and are labor intensive. Since they can be started even on the most barren lands with no diminishing marginal returns, they are ideally suited for Pakistan.
* Value addition requires venturing into production/manufacturing. It requires a clear incentive in manufacturing over trading. In the absence of incentive in production/manufacturing, 'rent seeking' behavior sets in and more producers opt for trading. This extends the supply chain with excess intermediaries, which also result in increase in prices. A distinct monetary incentive (i.e. cheap financing) and/or fiscal incentive (i.e. tax concession) to production is necessary to deal with rent seeking behavior.
DEALING WITH ENERGY CRISIS
* Energy is the main asset for any country from now onwards. More energy resources will reduce the cost of production leading to decrease in prices and cost of a healthy standard of living. It will induce production, exports and attract foreign investment while reducing unemployment and increasing purchasing power. Investment in energy sector shall be encouraged and prioritized.
* Crosschecking and random checking on rotational basis be made compulsory in utility companies to identify line losses in particular regions. The connivance of officials with people who are not paying utility charges can be broken this way. In an independent crosscheck, if line losses exceed a threshold limit, the person responsible for that region shall be expelled. Rather than paying penalty (which are not rational, outdated and extremely low for many crimes) and which encourage continuing theft operations as before, the door of corruption must be seized for the corrupt. This is going to be much more effective than running expensive TV ad campaigns.
* Alternate sources of energy must be explored especially solar and wind energy. Price hike must take into account that high-end consumers be burdened with price hike more than the low-end consumers. But, it must be noted that too high a price could once again increase line losses.
PROMOTING SME EXPORTS
* Commodity exports need to be repackaged and presented as branded.
* In TDAP exhibitions, the fees should be made affordable for the small exporters. Minimum flat fee with proportional increase based on number of orders received in exhibitions can be charged to encourage small exporters.
ENHANCING CAPITAL FORMATION AND INVESTMENT
* Overseas Pakistanis shall be encouraged to invest in industry rather than in stock market and real estate.
* In developed economies, there is less check on investment coming in and strict check on investment going out of the country. It is the opposite in Pakistan. It is vital to facilitate investors especially overseas Pakistanis which can come even if they are provided with very few incentives. Investment facilitation from scratch to the complete set up of industry can also be provided on a fee basis. Most foreign investors will opt for investment facilitation and it will increase not only the pace with which an investment project will be completed but also open a new window of revenue generation for the government.
* Foreign investment in Pakistan has come into sectors like real estate and stock market which does not create real increase in output and does not provide employment to the masses. Government schemes should promote investment in local industries, local plants and equipment and manufacturing within Pakistan so that employment generation can take place inside Pakistan.
* Law and order situation in Pakistan has been very poor especially in a large metropolitan and hub of trading city like Karachi. Law and order is essential for the foreign direct investment. Deteriorated law and order situation not only affects trading and business activities, but also creates a lot of fear and disappointment on the part of investors and entrepreneurs.
REVITALIZING ZAKAT SYSTEM
* The institution of Zakat needs remodeling and reinterpretation. The concept of 'wealth' if made broadened to include all the assets one has and the concept of 'Ushr' if broadened to include all forms of production including the production of industries and services, the tax base will expand manifold. Since it is a religious obligation, it is expected that it will result in less tax evasion.
REDUCING CURRENT EXPENDITURE
Government also has to reduce expenditure on running government machinery. Each minister has all the facilities available for a lavish lifestyle. For a poor country like Pakistan, this is absolutely detrimental. Government has to reduce expenditure on government officials and their unnecessary perks.
The writer is the Head Islamic Financial Advisory, BMC Pakistan.