Irrelevant budget? by Anjum Ibrahim

Anjum Ibrahim

A budget document is an economic treatise of a government in power and in a democratic setup parliament passes it after considerable debate from other political parties with different (alternate) economic priorities with different strategies. In this country, the budget was passed after a mere 8 days of debate. The question is why? Was the budget 2012-13 of such excellent quality that no possible suggestions for improvements could be made? Or was there another reason for its quick passage? 

There is little doubt in the minds of the general public as well as various political parties, within the coalition and in opposition as well as those outside parliament that the performance of the economy remains the Achilles' heel of the PPP government. The issues are so obvious that one really does not require the services of a competent economist to itemize them: they range from excessive loadshedding that has effectively downgraded the quality of life of Pakistani households, with the rich and the middle classes purchasing generators and UPSs at ever-rising rates, to the domestic and international erosion of the value of the rupee due to the government's massive increase in borrowing both domestically as well as from abroad (though the latter source is drying up due to failure to implement reforms), and a shrinking economy due to loadshedding and law and order problems leading to ever rising unemployment levels that cannot be documented accurately.

The budget itself, third year running, reflects a set of figures both in terms of expenditure allocations and revenue generation that are simply not credible - an opinion premised on the failure of the government to adhere to its budgeted current or development expenditure (with the former raised to provide untargeted subsidies particularly for inter-disco tariff differential and development expenditure mercilessly reduced to fund the former) or achieve its revenue generation targets (though the Federal Board of Revenue continues to be engaged in overstating revenue collection targets through a number of ways, some of which are under investigation by the Federal Tax Ombudsman). Can this year's overtly over-optimistic budgeted targets be any different? The answer has to unfortunately be in the negative given the fact that it is an election year and the government's coalition partners have demanded higher releases for parliamentarians, around 40 crore rupees per MNA given that the previous promise of 50 crore rupees per MNA did not materialise due to paucity of funds, a problem that remains and challenges the gullibility of the coalition partners in believing that the money would be released this time around. Those who maintain that this money, if released, would be targeted for development must keep two factors in mind. First the level of corruption in development projects, especially those on which third party audit is not undertaken, is in excess of 50 percent and second only those parliamentarians will be granted monies who support the government or in other words a form of pre-poll rigging will commence. Thus the budget was certainly not of good quality that it did not merit challenges. This probably explains why all coalition partners in the centre want to defer general election by as long as possible while the opposition parties are calling for immediate poll.

The fact that the PPP's coalition partners did not raise any objections to the budget is also inexplicable because MQM in its shadow budget supported tax proposals and expenditure measures that are not part of the 2012-13 budget including lower outlay on the military, more on power sector projects and taxing the rich and the influential. The ANP which has extended unswerving support to the PPP notwithstanding PPP's stance in Karachi lamented that the economic team did not take them into confidence or even bother to seek their views on the proposed budget. PML (Q) finally succeeding in installing Chaudhary Pervez Elahi as the Deputy Prime Minister supported the budget. Post budget passage the ANP, the MQM and indeed even the PML (Q) are saber rattling and insisting that the government release adequate funds to deal with the energy crisis, give development funds to their parliamentarians so that they can win seats in the forthcoming elections and of course resolve the Karachi law and order situation with MQM reemerging as a lead player in that city. Deals were struck before Raja Pervez Ashraf was elected and now one has to see if and to what extent they will be implemented.

The opposition PML (N) may well claim that it was busy protesting against a convicted Prime Minister Gilani and that engagement in the budget debate would have been tantamount to giving legitimacy to his cabinet. However, the party did not pass any cut motions and merely facilitated the passage of the budget, albeit indirectly. JUI (F) also claiming to be a party in opposition did present some cut motions but mysteriously withdrew them a day before the passage of the budget.

So who did benefit from the speedy passage of the budget? Hindsight is always twenty-twenty and those much enamoured of the President's political astuteness maintain that he cajoled his coalition partners to pass the budget speedily knowing full well that Gilani would soon be disqualified by the Supreme Court. This rationale does have merit if one looks at some critical dates: the budget speech was delivered on 1st June, the budget was passed on 14 June and Gilani was disqualified on 19 June. Perfect planning that can be credited to a wily President!

Supplementary grants were passed without demur which increased allocation for grants and appropriations from what was budgeted by 660 billion rupees thereby adding significantly to the budget deficit. Water and Power Division accounted for only 188 million supplementary grant with 17.5 million rupees for employees related expenses and 167.4 million rupees for operating expenses. Privatisation Division received a supplementary grant of 47 million rupees, inexplicable given that its output in terms of generating revenue from privatization remained zero. This money was spent on a propaganda campaign in favour of the Benazir employees' stock scheme which benefited only a little over 300,000 people. Defence Ministry under community development, for improvement of park opposite Cantonment board office Attock, received 10 million rupees. Development expenditure of professional and technical training division was 1.2 billion rupees and development expenditure outside Public Sector Development Programme (PSDP) was 47.5 billion rupees though the government noted development expenditure outside PSDP allocation increase of only 24.6 billion rupees in other budget documents reflecting the shoddy nature of the documents. No opposition to any of these grants was a disservice to the people of this country who elected the parliamentarians.

The Senate came up with 145 recommendations for the budget and the Finance Minister sanctimoniously stated that God willing he would incorporate most of them. However, in the final Finance Bill 2012 only 5 of the recommendations were incorporated and included (i) advance tax on sale of immovable property shall be adjustable and not collected in the case of federal, provincial or local government, and (ii) turnover tax reduced from 1 to 0.5 percent. The other recommendations were non-specific and in some cases the Senate simply was not aware that the recommendation has been a part of previous budgets as well as the 2012-13 budget. An example being suggestion 97: "The senate recommends that attractive support package maybe announced for investment in Balochistan". Recommendation 22 fails to recognize that it is in place and one of the reasons for the continued hemorrhaging of the economy, "the Senate recommends to the National Assembly that Food and Energy subsidy may be provided."

Ishaq Dar's recommendations, the PML (N) response to Dr Hafeez Sheikh were vague, non-specific and rather disappointing - none of which were adopted in the budget. These include "the government recommends to the national assembly that the federal government may stop forthwith loadshedding of gas and electricity for industrial units." He proposed enhancing subsidy on fertilizers from 26 to 50 billion rupees though this would almost certainly be in conflict with the recommendation to end loadshedding.

To conclude, the budget 2012-13 was unrealistic and some analysts maintain that it became irrelevant a day after it was passed and those responsible for its passage are the parliamentarians, including the PPP and its coalition partners, and those sitting on the opposition benches.

Look out for the neighbourhood changes By Shahid Javed Burki

NOW that Pakistan has a new economic team in place – a new finance minister and a new deputy chairman of the Planning Commission – this may be a good time to rethink the way the country should be planning for its future. In doing so it should look at the changing world outside its borders, in particular at the opportunities that are being created in the country’s immediate neighbourhood.

For decades, economic policymaking was focused on domestic issues. The world outside was never factored in to the strategy for development. This has to change in light of the significant developments that are taking place in the structures of the global production and trading systems. There are also important changes in the world of finance.

For a country that remains dependent on external flows in order not only to pay for investment but also to help it meet its external obligations, the restructuring of global finance must be fully understood. In the article in this space last week, I took a look at the emergence of sovereign funds as an important source of finance for the capital-short countries of the world, both developed and developing. The subject today is the development in Pakistan’s immediate neighbourhood. All the countries that share borders with Pakistan are experiencing enormous changes that could have a bearing on the future of its economy. These should be noted by our policymakers, in particular those who now have responsibility for finance and planning. Afghanistan, Iran, India and China are all going though changes, some positive and some negative. All of them matter for Pakistan.

Given its high rate of economic growth and industrial expansion, China’s appetite for natural resources – particularly energy and material – is practically insatiable. It is making massive investments in places such as Afghanistan and the Middle East to import the materials it needs. Some of this could be transported through trade corridors that connect China through Pakistan with these sources of supply

India also has natural resources and consumer goods to export to Pakistan, Afghanistan and points beyond. Those destined for Afghanistan and Central Asia could be transported through Pakistan. Gas from Iran and the Middle East is needed by both China and India, two giant economies that are short of energy. This could flow through Pakistan from the several points of origin to several points of consumption. Pakistan, in other words, could become a major artery of commerce for the fast developing and rapidly changing areas around its many borders.

For that to happen, a major change will be required in Pakistan’s position with respect to the use of its territory for the purpose of transit. Whenever I have discussed this possibility with the senior leaders of Pakistan, I have been told that security and geo-political considerations exclude the possibility of giving transit rights to India for trade with the countries it cannot reach via land.

That is a mistake for several reasons. The first is simply a cost-benefit issue. Before taking such a firm position, Pakistan should carefully study the benefits that would accrue to the economy if India was allowed to use the country’s territory for trade. Once an estimate is available – say the benefit to the Pakistani economy is equivalent to one per cent of the country’s gross domestic product every year – then Islamabad would know what it is sacrificing in terms of potential growth by not granting transit rights to India through its territory.

What kind of benefits Pakistan could expect from the use by India of its territory for international commerce? To begin with it will increase the use of the motorway system that Pakistan has constructed at a great cost to the economy. The system is underused. By charging Indian trucks and buses significant transit fees, the country would not only recoup some of the investments it has made. It will also be able to generate the revenues for expanding the system.

The current system links Lahore with Peshawar with a world-class motorway. This could be extended east to the border with China, northwest to the border with Iran and west to Karachi and Gwadar to provide Afghanistan, China and India access to the resources of the Middle East and the region’s rapidly developing markets.

Pakistan also needs to rethink its international trade strategy. The focus has always been on market access to the world’s developed countries – the United States and the European Union. And when Islamabad talks about market access the reference is to the export of textiles. Both elements of this trade strategy are misplaced. Even though textiles are the largest component of Pakistan’s industrial sector and provide employment to a significant proportion of the workforce engaged in manufacturing, this is not where the future is if the country wishes to build a strong and dynamic economy.

The country has to focus on the development of industries that have a rapidly increasing demand in the global market place, where a large number of new workers can find employment, where Pakistan can accommodate its youth in well paying jobs, and where there are important forward and backward linkages. These objectives won’t be easily realised in the sector of textiles.

Our planners have to concentrate their attention on the development of modern services – the IT and communication sector, the sectors of health and education, the activities related to sports and culture – which could provide employment for millions of skilled and well trained workers. A simple calculation tells us that employing an additional one million people in the IT sector alone can provide additional exports worth $20 billion a year.

The other important adjustment that needs to be made is to find markets closer at home than search for them in the places that are very distant from Pakistan. The gravity model of trade tells us that destinations of exports should be largely the countries in the neighbourhood. Pakistan is uniquely placed in this respect. It has as its immediate neighbours two countries that are the world’s most rapidly growing economies and have rapidly expanding markets. Both China and India should be the preferred destinations of the export industry in Pakistan rather than the United States and the European Union.

This brings me back to the need for aggressively developing trade and economic relations with India. I am aware of the fact that there are important constituencies in India that are against developing close relations with Pakistan. The same is true for Pakistan. Serving these two groups is not in the larger interest of both India and Pakistan.

At the “Aman ki Asha” conference held in New Delhi in May this year at which I was one of the keynote speakers, I was asked why Pakistan had not granted the “most favoured nation” status to India which it is required to do under the WTO. My answer was simple and honest. I said that the reason why that had not happened was once given to me by former President Pervez Musharraf. When I pressed him on that issue by saying that it was in Pakistan’s own interest to extend the MFN status to India, he said that the problem was that the term “most favoured nation” did not translate well in Urdu.

The conservative Urdu press would play up the issue that Pakistan had declared India to be the “nahaet pasandeeda mulk.” That would be hard for his government. The United States was once faced with the same quandary with respect to its trade relations with China. It dropped the term MFN in favour of trade promotion activity. Pakistan could do something similar.

The main conclusion that we should draw from this analysis is that a serious reconsideration of our economic strategy is required to factor in the opportunities available in the country’s immediate neighbourhood.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/look-out-for-the-neighbourhood-changes-160

Sharing national wealth By Afshan Subohi

THOUGH the budget proposals 2010-2011 have made the distribution of public resources comparatively fairer, these have failed to provide the much-needed impetus for augmenting national wealth. The people would be unable to realise their dream of a better life over the year ahead.

The share of provinces in the federal resource pool has been enhanced as envisaged in the Seventh National Finance Award, rising to 57.7 from 46 per cent earlier. This would translate into a steep 139 per cent increase in the share of Balochistan, 88 per cent for Khyber Pakhtunkhwa, 47 per cent for Punjab and 44 per cent for Sindh as compared to the outgoing fiscal year.

The NFC award has corrected a major fiscal anomaly in the quasi-federal system that was a persistent source of political tension. The devolution of financial power, it is believed, would lead to a more efficient and effective utilisation of funds as it does away with much of the Islamabad’s remote control mode. There would be automatic federal financial releases and without any hassle.

Besides, the government has pushed up the exemption limit of taxable income to Rs300,000 a year. The measure would provide some relief to the low rung of the salaried class.

To serve the dual purpose of increasing revenue generation and discouraging speculation in the capital market, capital gains tax has been introduced for trading on shares held for less than a year on a progressive rate. The government has increased the rate of sales tax by one per cent from 16 to 17 but exempted food, health and education from its ambit. It has slashed some subsidies on energy and food but their overall impact would only become clear over next few days and weeks.

Minister for Finance and Revenue Dr Hafeez Sheikh in his post-budget statement described tax measures as fair, just and equitable.

The minister, however, did not enlighten the nation on how the government intends to deal with the challenge of low propensity to invest in the real sectors of the economy. Despite a vast resource base, the country has one of the lowest rates of capital formation in the region. This threatens the very sustainability of even the current level of economic development as number of job aspirants keep swelling while the capacity to employ them stagnates.

The private sector is frustrated for being ignored. “It is the first budget that is devoid of any incentive to encourage investment or exports”, a businessman said while responding to a query through email.

“No matter how good a formula of redistribution, it cannot go far if there are no resources to distribute”, an analyst disappointed with the continued neglect of issues of growth and development under an elected government told Dawn.

“The outside help is not dependable. The government knows it better that the foreign funds are not easy to secure and often conditional. The local resources will have to be generated for sustainable development. However, more taxes in absence of expansion in the real economy would scare the financially resourceful class. It would ultimately lead to the outflow of capital in search of more secured investment options overseas,” argues an investment analyst.

Similarly, doleouts are symbolic gestures and not a solution to growing unemployment and poverty. The distribution of petty cash to a limited number of poor cannot create any significant dent in poverty when almost one-third of 170 million people subsist below the poverty line.

The move to absorb additional labour and unemployed youth without economic expansion would actually depress the already low labour productivity levels. It could even make an enterprise where manpower is adjusted, sick by increasing the wage bill without adding value. It is not a viable or a sustainable solution.

The country desperately needs new investment in agriculture, industry and trade to increase job opportunities.

As the government does not have the capacity and the resources to make major investment, it needs to prop up private sector to do the job. The budget proposals 2010-11 have failed to address this basic issue.

“Yes, there are problems but the country needs investment. The corporate sector has earnings and savings that can be invested. It is their national duty to plough back these resources in the economy by expanding their operations. But because of the privileges they enjoyed under military dictatorships they have become addicted to risk-free investments. Yes, the current government cannot afford and does not want to promote rent seeking”, said a leader of Pakistan Peoples Party defending the budget.

“They (private sector) just do not like the democratic government. The government went out of the way and accommodated their demand of deferring the introduction of value added tax despite the immense pressure from the donors. They are still complaining. I do not think it is possible to satisfy their greed and condone their irresponsible social behaviour”, said a seasoned bureaucrat who participated in the budget-making exercise responding to the criticism of the budget by the trade representatives.

“The Budget 2010-11 offers no policy package to encourage investment in the real sector that could boost the rate of capital formation. I see no future of even social sector initiatives such as Waseela-i-Sehat, Youth Internship Programme, etc. as the flow of resources is not guaranteed”, an analyst commented when reached in Islamabad.

The 10 per cent tax credit for balancing, modernisation and replacement and five per cent tax credit to a company for listing in a tax year is not seen enough of a stimulus for boosting investment.

“The government is trying to swim with both hands tied at its back. It would be naïve to expect robust performance under the difficult circumstances”, said another well-placed government sympathiser.

“I do not agree with the approach. The country needs fresh investment and the government should make it happen. Yes, it needs innovative initiatives. It needs confident economic leadership. Instead of taking the bull by the horn, the new budget shows that government is just trying to appease everyone. It is not laying the foundation for sustainable development”, an economist summed up on the condition of anonymity.

The writer is currently attending a conference on Innovation Journalism at Stanford University.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/sharing-national-wealth-460

Margin financing rules and investor risk By Khaleeq Kiani

THE draft Margin Financing Rules placed on the website of the Securities and Exchange Commission of Pakistan for public comments seem to be inconsistent with the investors’ constitutionally guaranteed right of equality before the law.

The draft rules are also in conflict with statutes under which these purport to have been made and the regulatory body itself has been created.

The draft rules will give the stock brokers an opportunity to make money in two ways: First, they will be able to lend money to their clients at exorbitant interest rates as they did in the past. Second, the leverage so introduced in the market will generate trading volumes and multiply brokers’ brokerage commissions.

On the other hand, draft rules will breed false hopes of gains among investors funded by the borrowed money. As the empirical evidence demonstrates, nobody has ever been able to do it at least in the long run. These rules under section 16 of SE Ordinance protect brokers’ interests.

Investors’ protection lies in the effective enforcement of Sec 22 and 24 of SE Ordinance and Sec 28 of CDC Act which provide heavy penalties and imprisonment for those who misuse the leverage facility provided under the draft rules.

The SECP has consistently protected brokers’ interests through diverse and sometimes very risky leverage facilities. When it came to protecting investors, the SECP established the offence under section 22 of the Ordinance against 56 KSE brokers in April 2007 but exonerated them all on irrelevant grounds.

When five brokers made confessions before the SECP of their offence under Sec 28 of CDC Act in June, 2009, it did not prosecute the offenders. This discriminatory application of capital market law to protect brokers’ interests and deny the investors legally mandated protection was inconsistent with the constitutional provisions.

An Act of Parliament (or Ordinance) can only empower a regulator to register the regulated entities and issue directives to regulate their working. Sec 5 and 5A of SE Ordinance empower the SECP to register stock exchanges and brokers. Sec 40B of the SECP Act and Sec 20 of the SE Ordinance empower SECP to issue directives to regulate their working. The SECP intends to implement the proposed margin financing facility through directives of the sorts which no statute empowers it to issue.

The SECP has resolved the problem by conferring this power on itself through rules 13, 19 and 22 of the draft rules. Moreover, SECP wants stock exchanges and brokers to duplicate registrations for margin financing which no law empowers it to do. It has again resolved its problem by conferring this power on itself through rule 3(4) and on the stock exchanges through rule 8 of the draft rules. Taking a clue from the past, the SECP seems to have made an assessment that the brokers’ abuse of leverage facility is bound to recur.

The SECP has devised a mechanism in draft rules, shedding its responsibility to check brokers’ malpractices. Rule 8 requires a stock exchange to register the broker for margin financing and rule 9 requires to regulate his activities. Its attempt to marginalise its responsibility this way is in conflict with Sec 5A of SE Ordinance and Sec 20(4)(d) of the SECP Act which requires it to register the brokers and regulate their working.

Even otherwise draft rules are a strange mix of irrelevant, ambiguous and non- transparent provisions. The core matters of a margin financing regime like initial margins, maintenance margins and margin calls are missing from draft Rules. Rule 13 couches these concepts in ambiguous terms and leaves their specifications to future directives which no law empowers the SECP to issue.

The earlier Margin Trading Rules, 2004 which the draft rules purport to replace at least made a mention of initial margins and maintenance margins although their numerical specifications were likewise withheld from the rules and kept under the SECP’s discretion.

In Rules 11 and 13 of its earlier rules of 2004, SECP had prescribed a plethora of credit risk assessment, reporting, monitoring and disciplining requirements. However, nothing worked and the massive abuse of margin financing facility by brokers contributed heavily to the market crashes of 2005 and 2008. In contravention of the earlier rules, brokers used clients’ funds for margin financing.

In violation of Rule 4(1)(a) of 2004, brokers pledged en block their clients’ shares without clients’ authorisations, for their personal gains. All the checks against abuse provided in earlier rules failed because the SECP wilfully avoided to specify the percentage wise initial margins and maintenance margins in striking contrast with the international best practices where initial margin is normally fixed at 50 and the maintenance margin at 25 per cent.

Specification and diligent enforcement of these margins could prevent the misuse of margin financing facility better than the plethora of requirements prescribed by the SECP in its earlier rules.

Interestingly, draft rules repeat some of the same provisions which have already been abused by brokers and nobody has been punished. For instance, Rule 12(1)(b) and 21(c) prohibit brokers to use clients funds for margin financing and to pledge clients’ shares without their authorisations. Like the earlier Margin Trading Rules, draft rules avoid specification of margins.

A new provision of shares lending and borrowing in draft rules makes the investors even more vulnerable. Now anyone having no shares will be able to borrow and short sell the same in the hope that market will decline and he will be able to purchase and return to lender the same shares at lower prices.

What if borrowers’ bet fails, market rises and the borrower is trapped in the middle? Who will be responsible to return lenders’ shares if the borrower defaults? Again provisions governing such sensitive matters have not been made part of the draft rules. Rule 19 leaves such matters to the SECP to specify in its directives which again no law gives it the authority to issue.

The Rule 4(1)(b) provides for suspension of registration of the stock exchanges for margin financing for failing to comply with provisions of SE Ordinance. What about the eligibility of a stock exchange to get registered for margin financing if it faces serious allegations of breach of the Ordinance and the SECP has avoided to investigate the matter? What about the eligibility of 56 brokers in terms of rule 7(e) to get registered for margin financing against whom the SECP established the breach of Ordinance in 2007 but exonerated them from punishment?

Whether the arbitrary draft rules will stand the test of judicial scrutiny is not yet clear.

What is clear is that the SECP seems ready to take the first step towards another stock market debacle.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/margin-financing-rules-and-investor-risk-460

The IMF option By Nasir Jamal

THE calls for an early exit from the International Monetary Fund’s stand-by arrangement (SBA) have intensified in the recent weeks as public investments shrink, energy subsidies go and unemployment and poverty rise.

But can Pakistan afford to quit the fund at a time when inflation is resurging, external assistance and foreign investment dwindling, gap between public spending and income widening, public debt mounting and growth decelerating?

On top of that, the government’s tax revenues are stagnating, and its effort to mobilise more domestic resources and restructure tax regime by replacing the existing, distorted general sales tax (GST) with the future-looking value added tax (VAT) is being opposed both inside and outside of the parliament.

Such is the intensity of opposition to VAT that finance minister Hafeez Shaikh named it as “reformed GST” in his budget speech for the next fiscal year and delayed its enforcement till October 1 to gain time for building a bipartisan political consensus and take provinces on board on it.

Many analysts believe that it would be difficult, if not impossible, for the government to obtain a wider political support for VAT and develop a bipartisan agreement on the issue. Even those who want Islamabad to exit from the IMF programme are not prepared to support government on tax resource mobilisation to reduce reliance on external bilateral and multilateral financing. But political rhetoric apart, none of the economic experts or politicians has come forward with an alternative strategy in case the fund programme is terminated prematurely and VAT abandoned.

“What other options are you left with but to go to the IMF for money when you are not ready to enforce financial discipline and mobilise your domestic resources (to meet your needs)?,” wonders eminent economic expert Shahid Kardar.

“If we exit from the fund’s programme it’ll become difficult for other bilateral and multilateral lenders donors to support us financially,” he argues. At the same time, he says, “we will not learn to enforce strict financial discipline on ourselves unless the world abandons us, completely.”

Ali Cheema, another leading economist, cannot agree more with him. “When expenditure is rising and revenues falling, what alternative do you have?,” he asks.

But, he says, politicians could get out of the IMF programme if they decide to make hard choices – imposition of strict financial discipline through cuts in public spending and reorganisation and restructuring of taxes to increase domestic revenues.

Nonetheless, the government cannot make this trade-off on its own. Others will also have to support it. Yet the chances of politicians making this trade-off remain slim. “Even tax reforms are being carried out not because we want to do it but because the fund is pushing us for this,” laments Cheema, who is dismayed by politicisation of the debate on VAT for the benefit of the rich who do not want to pay taxes.

“Imposition of VAT has to be a political decision. But it should not be used for doing adversarial politics,” he contends.

He dismisses fears of hyper inflation as a result of imposition of VAT. “Consumers are paying value added tax for last 20 years in the form of GST. It is only that it is now being levied at the retail stage and is being freed from all distortions and exemptions to the rich.” He feels that VAT is being opposed because it would document the economy and reveal actual income of many who are not paying taxes commensurate to their financial position.

The opponents of the IMF programme, including former finance minister Salman Shah, criticise what they dub as harsh macroeconomic stabilisation conditions attached to it and hold them responsible for the slower growth, job losses, inflationary pressures, high domestic energy prices etc.

Others argue that the economic slide could have been steeper and uncontrollable if the fund had not stepped forward to help Islamabad in November 2008 in the absence of sufficient bilateral assistance specially when the war against militancy is claiming a huge portion of its limited fiscal resources.

The Institute of Public Policy’s annual report on the state of the economy during 2009/10 underlines that the return of “considerable” macroeconomic stability and reduction in financial imbalances are largely due to the financial assistance provided by the fund. Yet, at the same time, it concedes that the policies of fiscal tightening being pushed by the fund for macroeconomic stabilisation are responsible, albeit partially, for causing hardships to people and pushing poverty.

Whether one likes it or not, many believe that Islamabad may have to join yet another IMF programme once the ongoing facility expires in December to protect the “fragile economic recovery” and pay back the loan to the fund unless we get our economic and financial priorities and policies right. The government has to return $11 billion to the fund in three years to June 2015, according to the IPP report.

No matter what position one takes on the country’s relationship with the IMF, one thing is clear: we just don’t have alternative to the fund’s financial assistance for the moment. Not unless we decide to live within our means and pay taxes, honestly.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/the-imf-option-460

Why value added tax? By Waqar Wadho

SINCE its inception in 1954 in France and wherever it has been initiated, VAT has been debated more extensively than any other tax mode. But for more than 100 countries, VAT is the mainstay of their tax systems because it is said that it raises more revenues with lower costs than any other broad-based consumption tax.

What makes it more fascinating than GST or other sales taxes is that VAT generates higher revenues in a neutral fashion. A comprehensive VAT does not cause individuals or firms to budge their choices, such as goods or locations etc. It does not discriminate capital or the labour intensive firms, specialised or the integrated firms, or corporate or the non-corporate firms.

The present sales tax system in Pakistan can be claimed a VAT with coverage up to manufacturing stage. Another salient facet of the VAT is that it’s the first consumption tax to integrate the taxation of services with the taxation of goods. Today, most of the countries have been taxing services comprehensively along with the goods.

In a country like Pakistan, where services account more than 54 per cent of the GDP, taxing services comprehensively would fetch much more revenues required to bridge the growing budget deficits.

VAT is also called the money-machine due to its revenue generation capacity. In OECD countries, it raises revenues up to five to eight per cent of the GDP, while its share is between 15 to 20 per cent of the total tax receipts. In Pakistan where sales tax accounts for more than 60 per cent of the tax receipts, an introduction of VAT will certainly bring a much-needed boost in the tax revenues.

The underlying reasons why Pakistan should adopt it are associated with very basic features of the VAT. 1) Tax coverage: manufacturers, wholesalers and retailers, all would be registered. The extension through the retail stage would not only make this sector documented. In contrast to the general perception, the VAT contains the regressive effects of the conventional sales tax system. Even a quasi- progressiveness can be achieved by levying two to three different tax rates. For example, in France the normal VAT rate is 19.6 per cent, but for tourisms, cultural services, transport, restaurants and water etc. , the rate is reduced to 5.5 which is further reduced to 2.1 per cent for the medicine, press etc.

2) Tax base: VAT taxes the broadest possible range of the goods and services. It ensures the comprehensive taxing of the services that brings in efficiency as compared to the conventional sales tax system.

First, by not taxing services comprehensively, the tax rate for goods will be higher, which would enlarge the excessive burden of the tax.

Second, since Pakistan is developing economy and in its process of the development, the productivity gains of the industrial sector are likely to be larger and taxing only goods would be equal to taxing these gains in the industrial sector that would further erode the development process.

Furthermore, the income elasticity of demand for most services exceeds unity and thus taxing services will have an overall progressive impact. The efficiency argument of comprehensively taxing services does not rule out the role of exemption on the social grounds. Thus, education, health, social and public services can be exempted. Even, it would be better to introduce zero rates for these services as they could claim reimbursements of the inputs they used.

The voice against the VAT is build around an illusion that it would feed a spiral of tax, prices and wages that would lead to inflationary impacts on the economy, and it will adversely impinge on the poor. For its adverse effects on the poor, since it stretches up to the retailers and comprehensively taxes the services; the VAT is less distortive than the existing general sales tax.

Regarding inflation, VAT by itself, can never lead to a sustained increase in the rate of change of prices (it may change the level of price). Second, there is no evidence from the previous studies that VAT has actually caused any inflation. Third, when we talk about the price hike due to VAT, one need to take into account the existing tax that it will replace.

The prevailing general sales tax can be cascading i.e. the tax is imposed on every stage of supply chain without deduction of the tax paid in early stages. On the other hand, the comprehensive VAT avoids the GST cascading. Fourth, VAT enforces tax neutrality, there would be no changes in the aggregate demand and thus would not have any impact on the aggregate price level.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/why-value-added-tax-460

Fiscal stimulus for investment By M. Iqbal Patel

THE federal budget 2010-11 has failed to address serious problems such as issues in industrialisation, rising unemployment and rampant corruption. It appears to be a routine exercise with the hands of the policymakers tied behind their backs under the Stand-by Agreement (SBA) with the IMF.

The VAT has been deferred till October 1. The GST will continue for the interim period July-September with increased rate of 17 per cent, from 16 per cent. The burden of additional taxes will fall on the impoverished masses.

In addition to one per cent increase in the GST rate across the board, the government has also raised excise duty by 100 per cent to Rs10 per mmbtu of natural gas, from Rs5.

Both of these measures would have multiple adverse effects on ordinary citizens. But the matter does not end here and the Nepra has approved an increase in KESC tariff from 0.6 paisa to Rs1.70 with retrospective effect from July 2009 to March 2010 which will make the life of the consumers miserable.

The budget proposals will have negative effect on the socio-economic conditions. The development budget for education and Higher Education Commission (HEC) has been reduced from Rs21.3 billion to Rs20.8 billion. The Economic Survey 2010 has recognised that public expenditure on education as percentage to GDP is the lowest compared to other countries of South Asia. The current budget has cut Rs7 billion from allocation for the Higher Education Commission which is bound to devastate the infrastructural and academic development of the public sector universities across the country.

Similarly the allocation for health has been slashed by 27 per cent to Rs16.94bn from Rs23.15 billion in 2009-10 The finance minister has defended the low allocation for education and health by saying “these are provincial subjects”.

Besides the above, the budget has not mentioned of steps to be taken to eliminate circular debt which is affecting the performance of energy sector and is the main reason behind the power crisis, resulting in industrial slowdown and high unemployment rate.

One may safely conclude that the budget has failed to fix the right direction for revival of the economy, alleviation of poverty, creating job opportunities, elimination of corruption, financial indiscipline in the state-run units and resolving energy crisis.

However, the budget has some appreciable features as it provides tax incentives on foreign and domestic investment. Foreign lenders would enjoy tax-free repatriation of profits earned on foreign industrial loans. The rate of withholding tax has been reduced from 30 to 20 per cent on non-specified payments to non-residents.

Besides, tax-free payment to non-residents on profit on debt will be allowed 10 per cent tax credit for BMR, five per cent tax credit to a company in the tax year of its enlistment. It has enhanced the ceiling of the income tax exemptions for the salaried and non-salaried class to Rs300,000.

After a long period of 36 years since 1974, the capital gains on sale of securities have been brought into tax net which is a welcome step on the part of policymakers as well as the stock exchanges.

Withholding tax at the rate of 0.3 per cent is applied on cash withdrawal from a bank exceeding Rs25,000 in a day is now extended to all banking transactions. This measure is not necessary as the withholding tax was initially imposed to curb cash transactions to encourage documentation but taxing the payment made through any mode such as Pay Order etc., would result in change of banking culture and will promote parallel economy.

It is not clear whether the tax will be imposed on payment through crossed cheque though FBR Member has stated in the press statement that it wouldn’t apply to crossed cheques transactions but this should be required to be notified by the FBR to avoid the confusion.

In any case, this step would have adverse effect on the banking culture and needs review.

The taxation measures include harsh penalties for the taxpayers who failed to comply with the provisions of the tax statute which requires reconsideration to create taxpayers-tax collectors friendly environment.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/fiscal-stimulus-for-investment-460