Navigating the gathering economic storm

When the French critic and novelist Jean-Baptiste Karr penned his famous epigram “the more things change, the more they remain the same” over a century and a half ago, he could not have imagined how aptly it would describe the economic history of Pakistan. Each time national income growth begins to surpass per capita levels, countervailing pressures emanating from the balance-of-payments side lead to ‘macroeconomic stabilisation’ measures, invariably under the disciplinary auspices of an IMF programme. The standard prescriptions: depreciation of the rupee, imposition of new regressive and arbitrary taxes, interest rate hikes and borrowing to shore up forex reserves end up scuttling growth while structural imbalances and constraints to economic performance remain unaddressed. And then the cycle repeats itself.

Pakistan is on the cusp of another down-cycle as pickup in growth (5.3% last year) is threatened by record high trade ($32 billion) and current account deficits ($12 billion). As the hackneyed calls for depreciation grow and speculation mounts about when Pakistan will solicit a new fund programme, what short-term practical policy measures can Pakistan undertake to stabilise the external account while limiting the fallout on inflation and growth?

The first order of business should be to reduce the current account deficit to a manageable 1-1.5% of GDP in the next nine months. Effectively, this means culling the deficit by at least $10 billion. Exports are mired in problems of competiveness and adverse global terms of trade. These include a product mix skewed towards the low added value of textiles; relatively high cost of inputs (utilities, wages); restricted liquidity (stuck up tax refunds); and a loss of market share in key markets. Rather than looking to untangle the Gordian knot of inter-provincial utility pricing and taxation in the short term, an effective measure to boost exports would be for the government to offer a direct 8-12% rebate in rupee terms for every dollar of exports. The amount of rebate can be linked to value addition to incentivise movement up the value chain and deliver greater dollar bang for every government rupee of rebate. However, to make the measure meaningful it should be for all exports (not just five sectors); be unburdened by conditionalities (like a 10% YoY growth requirement); and most importantly, rebates must be released immediately upon receipt of export remittance. The government must also clear at least 50% of tax refund claims — approximate Rs.75 billion, which will reduce costs and boost liquidity.

With these two measures and in this time frame we can expect exports to ramp up by between $3 billion and 3.5 billion. This will add around Rs100 billion to public expenditure (0.3% of GDP), which can be adjusted against the PSDP, through cost savings in current expenditure, and offsetting taxation. Contrast this relatively small cost with the addition of almost Rs400 billion in public debt that an alternative policy of 5% depreciation will create.

The government needs to aggressively cut the import bill by at least 10% ($5 billion) while protecting inputs of growth like machinery and raw materials. This can be managed through raising the price of petroleum products (excluding HSD and kerosene). Approximately 20 million Pakistani motorists (cars & bikes) pay one of the lowest prices for petrol in the region. A 10-15% increase in price through additional taxes will reduce record-breaking demand and offset some of the additional pressure created on public finances by the measures for exports. Furthermore, regulatory duty and additional cash-margin requirements must be imposed for non-essential imports. To illustrate the room for cuts consider that last year Pakistan imported almost $700 million of mobile phones, $5 billion of non-essential foodstuffs, and $1 billion of vehicular CKD/SKD kits. These measures must be accompanied by an appropriate realignment of incentives for the private sector to import-substitute these items over the medium term. After all ‘made in’ is in vogue the world over, why can’t we have more ‘Made in Pakistan’?

Foreign remittances need to increase by $3-3.5 billion. Incentivising remittance through formal channels using schemes such as lucky draws; 1 per cent bonus in rupee terms for remittances of less than $1,000 per beneficiary; and an appropriately-designed tax amnesty scheme can achieve this. A flat 10-15% tax on declarations within a tight timeline, followed by rigorous enforcement of the law using the recently-signed OECD convention on cross-border tax evasion can be the salient features of such a scheme. This will boost remittances and net tax revenue of around Rs25-30 billion. Past amnesty schemes have failed because of low deterrence stemming from weak enforcement of the rule of law. With political resolve and access to OECD asset databases, the stick of enforcement can now effectively follow the carrot of amnesty. Successful examples from the region include India, which implemented a fairly successful scheme last year and netted $10 billion in new asset declarations.

These are short-term measures for navigating an emerging crisis without resorting to blunt, untargeted instruments such as depreciation (remember 65% of the inputs to GDP are imported and 35% of public debt is in dollar terms) and another unimaginative fund programme. However, the medium-term challenges of addressing the structural constraints to economic performance — including an overhaul of taxation design and enforcement, import substitution, raising productivity and building competitive, high value-added export clusters — remain important avenues of policy endeavour. After all, as Iqbal writes, “the only thing that is constant is change”.

Published in The Express Tribune, September 28^th, 2017.

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