Financial discipline and the IMF | Political economics


he annual budget is an important document by which the government indicates the financial direction of the country in terms of generating the revenues necessary for the functioning of the State. The current coalition government presented its first budget on June 10, at a time when the country faces huge twin deficits and desperately waits for foreign financial assistance with low expectations for relief.

The most immediate task is to secure a financial lifeline from the International Monetary Fund (IMF) to avoid the risk of default. However, it appears that Prime Minister Shahbaz Sharif’s economic team ignored IMF guidance and Pakistan’s commitments to the IMF under the Extended Financing Facility (EFF). This deviation endangered the fate of the EFF.

In its staff-level report published in February 2022, the IMF highlighted the consequences of the delay in the reform process. He said he would increase government debt and gross financing needs and reduce foreign exchange reserves. The report also says this would undermine program objectives and erode repayment capacity and debt sustainability.

The government has failed to implement clear reform guidelines and mandates from the global lender. On the contrary, he denied these conditions, thus creating obstacles to the satisfaction of our financial needs. Pakistan had agreed to embark on a process of reforming personal income tax and harmonizing general sales taxes. It had also agreed to broader reforms in tax administration and public finance and debt management. Instead, the government did something else, offering personal income tax relief to people in multiple income brackets. The government has also sought to relieve stock market players at a cost of around Rs 8 billion.

As a measure of income, the government introduced a capital value tax (CVT). Motor vehicles valued at more than Rs 5 million will attract CVT at 2% and movable or immovable assets exceeding Rs 100 million held outside Pakistan by a resident will be subject to 1% CVT. Pakistan is considered a tax haven for the rich. In the past, several amnesty programs were introduced to facilitate the privileged classes by allowing them to legalize their wealth.

The financial mismanagement of the previous government had an impact on the country’s overall growth. At the time of signing the IMF staff-level agreement on economic development and policies under the EFF for the release of SDR 750 million (about US$1 billion), GDP growth for the current year was projected at 4%.

Based on the final results released by the National Accounts Committee, recorded GDP growth was 5.97%. Strong GDP growth is known to lead to a current account deficit. Governments are then forced to take corrective measures to avoid a financial crisis. The result is a general slowdown in the economy.

As a result, the growth target for next year is 5% even as commodity prices rise globally. The government may not achieve the target set by the Minister of Finance in his speech.

The Minister of Finance has predicted that the inflation rate for the 2022-23 financial year will be 11.5%. However, rising commodity prices due to Covid-19 and now the Russian-Ukrainian war are likely to drive up inflation. While he forecast lower inflation compared to the previous year, the Minister of Finance did not share his tax reform plan to control fiscal imbalances.

In its service-level report published in February 2022, the International Monetary Fund highlighted the consequences of the delay in the reform process. He said it would increase government debt and gross financing needs and reduce foreign exchange reserves. The report also states that this would undermine the objectives of the program.

The public, which was already struggling to make ends meet, is now witnessing a new tsunami of inflation. In a very short time, the prices of petroleum products have increased by almost 40%. Electricity tariffs were also significantly increased and the CPI reached a new high of 13.8%. It seems that the Minister of Finance is more inclined to raise fuel and electricity prices than to implement the IMF’s policy reform program.

The minister projected the current account deficit for the next financial year at 2.2% without providing a clear roadmap to achieve this ambitious target. If a ban is imposed on imports, it will impact growth and lead to increased unemployment. In addition, the government plans to spend around Rs 800 billion during the year on development projects. Given all these factors, keeping the current account deficit at 2.2% will be quite a challenge.

The projected budget deficit for the coming year is around 4.9%. The government expects a collection of Rs 7 trillion in revenue through the Federal Board of Revenue (FBR). While not an unreasonably high target, the current policy rate and rising utility prices are expected to impact the profitability of small and medium-sized enterprises (SMEs) as well as the common man. and hamper tax collection.

The finance minister appears to have overlooked the effect of nearly 1.4 trillion rupees ($7 billion) owed to China and the global lender. The government expects to collect an amount of Rs 750 billion through the Petroleum Development Tax (PDL) in the coming fiscal year. It seems overkill. The highest amount ever recovered in the PDL was 425 billion rupees (in 2021) when crude oil prices were below $60 per barrel. Now that oil prices are already high, a PDL collection of Rs 750 billion can only add to the misery of the common man. Estimates of a provincial surplus of Rs 800 billion also seem unrealistic. The gap, most likely, will be filled by raising funds from lenders.

With the current levels of budget and current account deficits, we cannot continue ad hoc borrowing approach to fill gaps. Debts are growing day by day and currently 41% of budgeted expenditure is allocated to interest payments. Rather than taking concrete steps to formalize the economy, the government has driven a new chasm between the corporate and non-corporate/informal business sectors.

The current budget proposes simplified, nominal taxes for retailers through electricity bills compared to a 29% tax on profits for retailers. Extending a fixed tax regime rather than profit-based taxation may favor informal sectors and cash transactions, which will impede documentation of the economy. The resulting increase in domestic and external debt will have an additional impact on government estimates. Fiscal debt could therefore exceed 6% of GDP.

The coalition government inherited many of these problems and cannot be blamed for the current situation. They are aware that the country is in an IMF program and that the previous government violated the terms of the agreement signed with it. They are also aware that there is a long list of outstanding fiscal reforms that require a strict fiscal adjustment policy, the adoption of strong fiscal measures, including the implementation of corporate income tax reforms personal and general sales tax, improving expenditure efficiency, improving public finance management through the introduction of new coordination mechanisms, public debt management and privatization.

Reforms also require poverty reduction and social protection measures to achieve sustainable development to reduce our dependence on global lenders. Mere criticism of the previous government for signing an agreement to raise fuel and electricity prices will not help in the long run. Our sovereignty will remain compromised until the tax reforms are implemented.

Abdul Rauf Shakoori is a US-based corporate lawyer

Huzaima Bukhari, lawyer, is Adjunct Professor at Lahore University of Management Sciences (LUMS)

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