In 2019, the Pakistani-led Tehreek-i-Insaf (PTI) government came to the brink of a severe fiscal crisis due to its indecisiveness and lack of control. Despite loud claims to the contrary, Prime Minister Imran Khan traveled to the United Arab Emirates to meet the head of the International Monetary Fund and assured her of his government’s commitment to undertake structural and governance reforms.
Responding to the bailout call, the IMF approved a program for Pakistan in July 2019, thanks to which the crisis was averted and the government managed to partially stabilize the economy.
As a result, the IMF Executive Board approved a $6 billion Extended Financing Facility (EFF) for Pakistan. Since then, relations between the IMF and Pakistan have gone through several phases. At times, disbursement has been delayed due to Pakistan’s non-fulfilment of commitments. These delays have had a negative impact on the national economy.
The conditions of the IMF program and a letter of intent signed by Dr. Abdul Hafeez Shaikh, the adviser to the Prime Minister of Pakistan, and Reza Baqir, the Governor of the State Bank of Pakistan (SBP), compelled Pakistan to undertake many strategic projects, technical and transactional developments. However, at certain review intervals, Pakistan has not embarked on the agreed reforms.
The IMF has always placed emphasis on maintaining a prudent monetary policy which should reflect real interest rates, rebuilding external reserves through natural means such as supporting exports and at the same time allowing flexibility in the change rate. Indeed, previously, the exchange rate was allegedly managed through large interventions in the foreign exchange market, which contributed to imbalances on the external front.
At the same time, interest rates have been kept low to support the local economy. However, this triggered consumption and import-led growth, which fueled the fire of external imbalance and the government’s reliance on local and international borrowing channels.
Currently, Pakistan is facing a challenge because of debts. In FY21, they reached 100.3% of Gross Domestic Product (GDP). Pakistan’s gross external financing needs for FY23 and FY24 are estimated at around $77 billion. Given the deterioration of the current account balance, the situation is complicated.
Pakistan must therefore work to increase its exports, explore new markets and focus on technological advances. Currently, goods offered by Pakistan remain at the southern end of the global value chain.
Although Pakistan has signed Free Trade Agreements (FTAs) with China, Sri Lanka and Malaysia, and has concluded preferential trade agreements with Iran, Indonesia and Mauritius, with the exception of China, none of these countries fall into the category of major importers of Pakistani products. .
According to the IMF report, in fiscal year 2021, trade with the United States, United Kingdom, Afghanistan, and Germany accounted for about 37% of exports. Exports to the three FTA markets were only around 10%. Concluding free trade agreements with major export market destinations can boost Pakistan’s exports and reduce the external imbalance.
It is relevant to mention here that after a recent IMF staff review, the government has agreed to assess its export refinancing program by the end of this month. This could pose new challenges for export-oriented industries. The IMF also raised concerns about the refinancing programs offered by the SBP to fill large credit gaps and long-standing market failures and warned that this expansion, if not temporary, would undermine its efforts to credibly implement monetary policy in order to achieve its main objective and improve the transmission channels of monetary policy.
The conditions of the International Monetary Fund program and a Letter of Intent signed by the Advisor to the Prime Minister of Pakistan and the Governor of the State Bank of Pakistan required Pakistan to undertake numerous strategic, technical and transactional changes.
To bring efficiency to its domestic financial operations, Pakistan needs to ensure that the energy sector operates in a financially sustainable manner. Addressing the issue of circular debt and strengthening the applicable regulatory framework is therefore of paramount importance. High transmission losses and low recoveries hamper payments to power companies. This is a major cause of circular debt accumulation which is alarming not only for the electricity sector but also for the whole economy.
By June 2021, circular debt had reached a historically high level of Rs 2.3 trillion. Inefficiencies in electricity generation, transmission and distribution and failure to pay subsidies in a timely manner are the main causes of the increase in circular debt. At the same time, a new phenomenon of circular indebtedness in the gas sector has appeared.
IMF estimates provided in its Country Report No. 22/27 dated February 2022, warns that circular debt in the gas sector peaked at Rs 654 billion at the end of June 2021 (Rs 554 billion gas arrears from system and about Rs 100 billion in arrears of regasified liquefied natural gas).
The constant bleeding of scarce resources into the hands of inefficient and loss-making public enterprises is also a big concern. SOEs have a significant presence in the market, particularly in key service sectors such as power generation and distribution, energy, aviation and railways.
The recent State-Owned Enterprises Triage report provides an overview of the federal state-owned enterprise landscape. It says that as of FY 2019, there were 213 state-owned companies, of which only 85 have commercial operations (18 financial and 67 non-financial). The aggregate revenue of these SOEs in 2018-2019 was recorded at 4 trillion rupees, or around 10% of nominal GDP. These state-owned enterprises employed more than 450,000 people, representing approximately 0.8% of the total workforce. The financial performance of several state-owned enterprises remained of concern, and in 2018-2019 commercial state-owned enterprises collectively recorded net losses of Rs 143 billion.
The government should opt for the restructuring of public entities in order to reduce the burden on the state to finance these loss-making enterprises. Their privatization is the only viable option to modernize and reorganize these institutions. This can generate jobs and more tax revenue for the government. Otherwise, the state would be left at the mercy of global lenders who propose and impose policies without regard to the challenges faced by the common man.
The recent EFF resume indicates that the government has taken aggressive revenue action by introducing changes to the indirect tax laws moving most goods from zero rate (items in the 5th schedule) or reduced (8th Schedule items) to standard sales tax rates by eliminating many of the exemptions listed in the Sixth Schedule of the Sales Tax Act of 1990.
Finance Minister Shaukat Tareen also expressed the government’s intention to increase the Petroleum Tax (PL) which is expected to help bridge the revenue gap. According to the recently released IMF staff report, in early November the authorities began to gradually increase the tax on petrol and diesel by Rs 4 per litre, with a further increase of Rs 4 per liter in December. The government will continue to increase the levy by Rs 4 per liter per month until it reaches Rs 30 per litre.
The global lender has also focused on harmonizing sales tax. Currently, services are subject to provincial taxation and goods are subject to federal sales tax. This dichotomy has created several compliance issues for taxpayers and administrative issues for tax authorities. Also, in terms of direct taxation, IMF staff reports indicate that the Pakistani authorities are in the process of drafting personal income tax legislation for the next fiscal year, that is to sayFY 22-23, which aims to reduce the number of income tax rates, brackets, tax credits and allowances.
After swallowing those bitter pills and agreeing to “aggressive reform measures”, Pakistan has now completed the sixth EFF review and the previously withheld $1 billion tranche has been released. Pakistan has now secured the $3 billion from the IMF under the current program, including $3 billion to be issued subject to passing the remaining reviews.
These commitments are expected to attract a wave of taxes and duties, which can make life more difficult for the common man. The government must strike a balance in such a way that its revenue targets are met without being regressive for the common man. This can be done by introducing economic reforms focused on privatization and exploring new avenues of taxation.
Abdul Rauf Shakoori is a US-based corporate lawyer and expert in collar crimes and compliance with sanctions.
Huzaima Bukhari is a High Court Barrister and Adjunct Professor in Lahore University of Management Sciences (LUMS).