History behind the economic problems faced by Pakistan (3)

The second option of approaching the IMF has been severely criticised.

Many learned commentators have questioned why the economic team had to yield

to all the conditionalities imposed by the IMF. Why did not the country negotiate

softer conditions? As I mentioned our only motivation for entering into an

agreement with the IMF was to secure rescheduling of Pakistan’s external debt.

To retain its reputation as a vigilant watch dog, the IMF insisted, before

reaching an agreement, on tougher measures and upfront actions from the

government as we had displayed a poor track record in the past. Their management

was of the view that Pakistan had very low credibility as successive governments

had agreed on a number of conditions but these were either not fulfilled or partially

fulfilled. They wanted the present government to implement all those conditions as

prior actions before they could take the loan proposal to their Board. These prior

actions consisted of the free float of rupee, (without intervention by the State Bank

of Pakistan), agriculture income tax, GST on retail trade, GST on services,

deregulation of petroleum imports, linking domestic POL prices to international prices, increase in consumer prices of gas, adjustment in electricity prices, widening

of the tax base, removal of the subsidies. Naturally the Government had little

choice – if it did not take these actions an agreement with the IMF could not be

reached and thus rescheduling would not have been possible. In other words, we

had to make up for our past lapses – all in one go. There are many on-going time

bound conditions that have to be met during the next 9 months, which are structural

in nature such as privatisation, restructuring of public corporations, financial

sector reforms and civil service reforms. While the fulfilment of these prior

conditions and conclusion of agreement with the IMF has restored the credibility of

Pakistan vis-a-vis International Financial Institutions, Paris Club and G-7

Governments and improved the market sentiment among credit rating agencies and

fund managers abroad, I must confess that it has not been widely welcomed

domestically.

The reasons for this domestic reaction are understandable. There has been

very little investment in the country for the past several years with the result that

unemployment has been rising. Fixed income groups – salaried class, pensioners

etc., have not been granted any relief in the form of salary adjustments.

Depreciation of the Rupee in the last several years has made imported goods and

inputs quite expensive. Public sector investment has declined from 6% of GDP to

3% and lack of adequate tax revenues made it impossible to increase public

spending and offset the slack created by low private investment. Government’s

highly desirable tax survey and documentation would widen the tax base and bring in additional revenues but not immediately as it will take some time to complete the

process and show results. The first year was devoted to get this survey accepted and

put in place. In the meanwhile, those who were profiting from the untaxed black

economy are running scared of documentation, finding ways to dodge the survey

and withdrawing from economic activity. Thus trade, services, real estate,

construction and transportation which were the main beneficiaries of untaxed

income, are under severe strain. The businessmen who were habitual defaulters of

bank loans are being asked to pay back. Tax payers who were registered but were

evading taxes, are also finding it hard to find secure avenues for concealing their

incomes and have thus slowed down their business activities. Utility companies have

embarked on a vigorous campaign to detect theft of electricity and gas and recover

dues from users. These structural changes during a short period of 12-14 months

have altered the basic calculus of profitability and the sharing of costs and benefits

between private businesses and the public exchequer. In the past, a large part of

private investment including the equity of sponsors and profits were generated by

obtaining loans from nationalised commercial banks and DFIs, which were seldom

repaid in full, by evading taxes, concealing income and by underpayment to utility

companies. Under these arrangements, the costs were borne by the public exchequer

and the benefits accrued to those private businesses that indulged in these practices.

Let me hasten to add that it is far from my intention to suggest that all businessmen

were guilty of this malfeasance. Far from it, the majority of the businessmen want

to work honestly. Neither do I wish to ignore the fact that this state of affairs wasin additional revenues but not immediately as it will take some time to complete the

process and show results. The first year was devoted to get this survey accepted and

put in place. In the meanwhile, those who were profiting from the untaxed black

economy are running scared of documentation, finding ways to dodge the survey

and withdrawing from economic activity. Thus trade, services, real estate,

construction and transportation which were the main beneficiaries of untaxed

income, are under severe strain. The businessmen who were habitual defaulters of

bank loans are being asked to pay back. Tax payers who were registered but were

evading taxes, are also finding it hard to find secure avenues for concealing their

incomes and have thus slowed down their business activities. Utility companies have

embarked on a vigorous campaign to detect theft of electricity and gas and recover

dues from users. These structural changes during a short period of 12-14 months

have altered the basic calculus of profitability and the sharing of costs and benefits

between private businesses and the public exchequer. In the past, a large part of

private investment including the equity of sponsors and profits were generated by

obtaining loans from nationalised commercial banks and DFIs, which were seldom

repaid in full, by evading taxes, concealing income and by underpayment to utility

companies. Under these arrangements, the costs were borne by the public exchequer

and the benefits accrued to those private businesses that indulged in these practices.

Let me hasten to add that it is far from my intention to suggest that all businessmen

were guilty of this malfeasance. Far from it, the majority of the businessmen want

to work honestly. Neither do I wish to ignore the fact that this state of affairs wasin additional revenues but not immediately as it will take some time to complete the

process and show results. The first year was devoted to get this survey accepted and

put in place. In the meanwhile, those who were profiting from the untaxed black

economy are running scared of documentation, finding ways to dodge the survey

and withdrawing from economic activity. Thus trade, services, real estate,

construction and transportation which were the main beneficiaries of untaxed

income, are under severe strain. The businessmen who were habitual defaulters of

bank loans are being asked to pay back. Tax payers who were registered but were

evading taxes, are also finding it hard to find secure avenues for concealing their

incomes and have thus slowed down their business activities. Utility companies have

embarked on a vigorous campaign to detect theft of electricity and gas and recover

dues from users. These structural changes during a short period of 12-14 months

have altered the basic calculus of profitability and the sharing of costs and benefits

between private businesses and the public exchequer. In the past, a large part of

private investment including the equity of sponsors and profits were generated by

obtaining loans from nationalised commercial banks and DFIs, which were seldom

repaid in full, by evading taxes, concealing income and by underpayment to utility

companies. Under these arrangements, the costs were borne by the public exchequer

and the benefits accrued to those private businesses that indulged in these practices.

Let me hasten to add that it is far from my intention to suggest that all businessmen

were guilty of this malfeasance. Far from it, the majority of the businessmen want

to work honestly. Neither do I wish to ignore the fact that this state of affairs was taking place without the active connivance of public servants, tax officials, utility

company employees and the staff of banks and DFIs. The point which I wish to

make is that the post October 1999 period has witnessed, to some extent, a reversal

of this past trend, however, this has been accompanied by a slow down in the

desired pace of economic activity in the untaxed and informal sectors of the

economy. This does not mean that there has been no movement on the investment

front. The three areas where investment activities are most brisk are Oil and Gas,

I.T. and Textiles. Oil and Gas is highly capital intensive and thus the spill over

effects to the rest of the economy will remain limited until such time that gas

replaces fuel oil in power generation, cement and other industries. I. T. is highly

skill intensive and is still in its infancy. It will create some employment opportunities

for skilled and educated manpower both within the country and outside, but the

overall impact on employment will again not be not very significant. Software

exports are starting from such a low base that even 100% growth is unlikely to

make much of a difference initially. The majority of young men and women in this

country have obtained their higher degrees in Liberal Arts and Humanities with

very few marketable skills – naturally they are not going to benefit. Textile industry

is undergoing balancing, modernisation and replacement with the revival of a few

sick and closed units. This industry will no doubt record productivity improvement

as a result of this investment but will use the existing labour force without any

demand for new labour. It is thus obvious that while investment is taking place in some areas, its impact on overall employment, exports or import substitution in the

short-term is likely to be limited. Although this will lay the foundation for a

diversified economy in the future, but in the short run, the urban areas where most

of the vocal elements reside, will not notice any perceptible improvement in their lot

immediately.