Aboard The Democracy Train

Value Chain Monthly Magazine recently talked to Majyd Aziz, Former President Karachi Chamber of Commerce and Industry, to solicit his views on the economy, especially the Federal Budget 2013-14. (The interview done on June 23, 2013 was published in the July 2013 issue

1. On the face of it, the recently announced federal budget has not imposed a new indirect tax except for a 1% increase in GST. Do you agree with this view that no new indirect taxes have been imposed?

Yes, GST has been raised from 16 percent to 17 percent and FBR expects to collect over Rs 63.5 billion while at the same time it estimates an additional Rs 18.5 billion to be realized through Federal Excise Duty.

2. What in your view are the venues for increasing direct taxes?

The prevailing culture of people to keep away from the tax net is one prime factor in government depending on indirect taxes to achieve the targets. However, the worst part is that it is through the complicity of corrupt elements in FBR that people are facilitated in evading their tax responsibilities. Moreover, FBR has seldom played the role of a facilitator and so there is a sense of averseness when it comes to entering the tax syndrome. It is therefore more convenient for FBR to reach towards the revenue target by relying more on indirect taxation.

The country has become a laughing stock in the comity of nations since her tax-to-GDP ratio is about 8.5% and continuing to decrease every year. The ideal way to collect direct taxes is to reduce the percentage of income tax and making it attractive for taxpayers to document their businesses or earnings. Although the Finance Minister did announce a reduction of 1% in corporate tax, i.e. from 35 to 34%, the bare fact is that it created ripples and not waves in corporate corridors.

It is incumbent upon FBR to identify tax evaders, to formulate a practical strategy to induce them to pay taxes, and to ensure that those who are identified are not allowed to escape the net. In well-established societies, people who pay taxes are aware that in return they would be able to get good schools, better health facilities, peaceful law and order environment, workable and sustainable physical infrastructure, accountability of errant bureaucrats and politicians, and a better and safe future for themselves, their families and businesses. When the state abdicates its responsibility, when the state wastes precious resources, and when the state treats citizens with scorn and disdain, then it loses the moral high ground to demand taxes and levies from those citizens who are obligated to pay their share in the country’s financial resources pool.

3. Will the 1% rise in GST have a significant impact on the cost of doing business and on inflation?

Government spin doctors regularly show their faces on various TV talk shows and vehemently and forcefully try to impress upon the viewers that the added 1% is not something to worry about and that there would be no negative impact on inflation or even on cost of doing business. The worrisome thought is that for the next five years, the country would be listening again to ill-informed political sycophants in the same manner and style witnessed in the last five years.

Why wouldn’t this increase in GST have an impact? There is a multiplier effect on everything that costs more or costs less. It is very simple to say that the end-user or end-consumer would not feel the added cost and would bear it in normal stride. On the contrary, whenever prices rise, for whatever reason, the impact is immediately felt and there is then the reaction to take this increase, add some more, and then pass it on. In cases where it is impractical to pass the added cost, then the producers absorb the increase and, in the process, either reduce their profit margin, either cut corners, or resort to non-documentation tactics. Another factor is that in many markets, the goods are often sold on credit and most of the time, the settlements are delayed or the credit period is longer. In that scenario, the working capital of the seller comes under pressure since the tax portion is also part of the credit given to the buyer.

4. People, business, and industry rightly expect the state to repair the infrastructure, especially the power sector, but this can’t be done without higher tax revenues. Then why is a rise in taxes resented by them?

There is generally a trust deficit between the business sector and the tax collectors. At times, there are many different tax collecting agencies, each with its own priorities and own dynamics. Trade and industry, as well as households, all expect the government to plan and provide the required and needed infrastructure so that the wheels of economy move smoothly and the citizens enjoy quality of life. Inspite of continuous lobbying and representations, Pakistan’s trade and industrial sectors are being denied their rightful share of sustainable infrastructure and the blame more often than not lies at the portals of the policymakers and the government of the day. The availability of resources is fundamental for development of any infrastructure and the low resource mobilization precludes any notion of initiating mega infrastructure projects.

The situation becomes more depressing when the government has to resort to external financing and agreeing to stringent conditionalities set by the international development financing institutions. These measures further alienate the people from the government and at times become the catalyst that sparks discontent and restlessness in the country. However, the scenario becomes deplorable when the government squanders away the resources on frivolous adventures and non-developmental expenses. That is why any increase in duties and taxes also results in agitation by trade and industry.

5. The Federal PSDP has been allocated Rs 540 billion out of which Rs 222 billion will be spent on repairing the power sector. Do you think this investment will improve electricity production and cut losses?

Public Sector Development Projects are meant to being about the positive change in the country and through which various facilities and improvements are conceived, planned and approved. Usually, due to myriad reasons, PSDP funds are under-utilized and the blame eventually is placed on non-implementation of the projects. Furthermore, whenever FBR is unable to reach revenue targets and the non-developmental expenses become a budgetary headache, or at times when natural calamities inflict monumental losses of lives and assets, the government diverts allocated PSDP funds to tackle these issues. Therefore, while PSDP funds are supposedly the outcome of a planned vision, the performance at the end of the year tells a different story.

The allocation of a formidable amount of nearly 50% of the Federal PSDP (including Federal financing of Rs107 billion while another Rs118 billion to be arranged by the Water and Power Development Authority (WAPDA) from its own kitty) towards the power sector manifests the government’s desire to address its election campaign promise to resolve the menace of loadshedding and power outages. Among the various measures in the energy strategy, such as resolution of the circular debt, prompt availability of fuel, fast track conversion of generation to coal, immediate introduction of renewable energy, etc, a very crucial step is to rehabilitate and upgrade the existing power network. Years of neglect, corruption, sabotage, use of shoddy material and other factors have affected the network in many areas. Even USAID has undertaken to provide funds and expertise to improve the power network in selected areas. The proper and judicious utilization of the funds would go a long way in bettering efficiency, reducing transmission and distribution losses, providing proper voltage to end-consumer, and maybe, just maybe, reduce costs for the power producing units. Hence, this step of the government needs to be conditionally lauded provided it achieves the purpose and objective.

6. The budget assumes that in 2013-14 exports will touch $26 billion. Will that be possible?

The government is to be complimented for focusing on a doable target rather than setting unconsidered export targets. There are many factors that debilitate a high enhancement in export figures. The horrible infrastructure scenario is a significant cause for snags in improving the country’s production of goods and services. These shortages also result in high production costs due to non attainability of economies of scale. The country’s agriculture output is also pathetically low with an annual growth not exceeding 3 to 3.5%. The agriculture sector still relies on out-dated farming equipment and methods and there is low awareness of seed technology and productivity enhancement tools. Inheritance plays a major role in division of agriculture lands and this cultural custom always impacts the cost of production and reliance of modern farming equipment. Thus Pakistan is not able to produce substantial cash crops at cheaper prices.

Pakistan has not been able to channelize software exports through a transparent and friendly official process and thus most of the software exports are out of the legal domain. Information technology software development is a 30% annual worldwide growth opportunity that this country should not miss. Mineral exports have picked up substantially in the last few years. However, the major impediment has been the mindset of the miners and the middlemen who do not subscribe to global market dynamics. They take the prevailing price as the benchmark figure and are averse to reducing it when world demand slows down. This creates frustration among exporters and the hard-earned space in global minerals market is lost to other countries whose miners are tuned in to the world market trends.

A very important factor that can enhance the export base is the attitude of the government and the official policy makers in export promotion. The present scenario is that there is a Trade Development Authority of Pakistan that is more or less concerned with improving the trade base and facilitating exporters. However, the desired advancement and effectiveness of this vital organ is nothing to write home about. Furthermore, the steps taken by the government in areas such as increase of sales tax, the withdrawal of subsidies, the late payment of duty drawback and rebate cheques, the display of cronyism and favoritism, and the proverbial red-tape and bureaucratic indolence, have all contributed towards the stagnation of exports. The stranglehold of big time exporters and godfathers, especially in the affairs of export based trade associations and chambers, have demoralized small and medium exporters who suffer from a perpetual lack of a level playing field.

There is this hope that Pakistan would be able to obtain GSP Plus status from the EU on January 01, 2014. This would surely enable the exporters, especially textiles-based, to increase exports to EU countries. At the same time, there is a need to introduce Track II diplomacy by the business community by lobbying vigorously in Washington with Congress, with labor federations, with government officials, and with business counterparts so that Pakistani products also get a wider window for entry into the United States at competitive rates vis-à-vis regional competitors. Moreover, efforts should be made to enhance exports to Afghanistan, China and India. This strategy would pave the way for boosting the export figures otherwise the stagnation in exports would in a couple of years would prove to be an unmitigated disaster.

7. To reduce the cost of doing business and contain inflation, the exchange rate of the Rupee must be stabilized, in fact improved by at least 5% but for that we need higher exchange reserves. Besides borrowing from the IMF, what other options Pakistan has and how useful they could be?

There is scant possibility of reduction in cost of doing business while the hope is that inflation would be contained in single digit figures. It should be noted that external circumstances impact upon the domestic cost of production, such as global oil rates, strong foreign currencies, and changing goalposts through various policies (introduction of Non-Tariff Barriers, denial of preferential trade facilities, regional economic blocs, etc). The incidence of imported input in textile exports is over 30% and therefore this also affects the cost of production. The continued deterioration of the Rupee in the last five years from Rs 60 to nearly Rs 100 has had a wrecking-ball impact on the various inputs.

Normally, a depreciating currency does help a country in marketing products at a favorable rate in the global marketplace. This induces buyers to source their requirements from a country that has a low currency rate, skilled manpower, and capacity to produce. Notwithstanding these advantages, Pakistan has not been able to cash in these advantages, albeit in whatever status these are. Therefore, improvement in the value of the Rupee would not bring about any marked improvement in the cost of production.

The country’s Foreign Exchange Reserves continue to dwindle down inspite of pronouncements from the State Bank of Pakistan. The situation is precarious, to say the least, and these are less than two months of imports bill. The inclusion of reserves held by banks and private citizens as if these are Treasury’s reserves is another way of hoodwinking the world. Recently, the IMF team was here and probably not satisfied with the presentations given by the Pakistani economic managers. A loan of $5 billion is being sought. What this new loan would do is to rollover the outstanding loan already due to IMF. The proverbial begging bowl has been polished once again.

Pakistan’s finance managers are banking on a steep increase in foreign remittances from expatriates and expect this amount to cross $15 billion. They are hoping that the Pakistani Diaspora would use official channels to remit the money. The government is also contemplating new incentives to boost up foreign remittances. The financial managers are advised to study the Indian, Sri Lankan and Philippine models as these are success stories. The distressing news that Saudi Arabia would deport over 50,000 Pakistani workers should be viewed with serious consternation. This would negatively impact on the inflow of remittances.

Pakistan can be the recipient of foreign exchange through export proceeds, remittances, foreign investment –portfolio and capital, grants, and foreign loans. It is advisable and important that the government concentrates more on generating revenue from domestic resources and the ideal way is to broaden the tax base, remove untargeted subsidies, facilitate capital investment, reduce the GST rate so that more units are brought into the net as it would increase revenue and not decrease as is publicized, and more importantly drastically reduce non-developmental expenses, especially colonial-era ostentation, casual foreign visits, all kinds of wastage, unbridled corruption, and excessive unannounced holidays. Prosperity comes through a full force activity of the economy. As US Congressman and Vice Presidential candidate Paul Ryan stated: “Borrowing and spending is not the way to prosperity.”