Budget 2012: IMF agrees to drop RGST demand

Budget deficit target set at 4 per cent, tight fiscal space unlikely to leave room for subsidies.


Shahbaz Rana May 18, 2011

ISLAMABAD:


Pakistan has managed to convince the International Monetary Fund (IMF) to drop its demand for Islamabad to levy the value added tax – also referred to as the reformed general sales tax (RGST) – during the upcoming fiscal year, effectively burying the politically unpopular measure.


Finance ministry officials, in Dubai for talks with the IMF, confirmed that the RGST would not be levied during the fiscal year ending June 30, 2012. As a substitute, the government would continue to withdraw general sales tax (GST) exemptions, a process that began in March this year.

The government expects to raise at least Rs90 billion through the removal of exemptions from sales tax on domestic oil sales, poultry and cattle feed, according to officials at the Federal Board of Revenue (FBR), in addition to retaining the withdrawals of exemptions initiated in March.

Officials familiar with the negotiation said that both sides agreed to a budget deficit of Rs802 billion, or 4% of the total size of the economy. The government has set a tax revenue target of Rs1,952 billion for the upcoming fiscal year.

Pakistan had asked for permission to run deficits between 4.5% and 5% of gross domestic product. The narrower deficit target means that the government is likely to withdraw or reduce several subsidies and not introduce any new ones.

As a result of the agreement between Pakistan and the IMF, the Washington-based lender is expected to disburse $1.7 billion to Islamabad by September in what is expected to be the final tranche of the current IMF bailout programme, which ends later that month. The next meeting between finance ministry and IMF officials will take place in July, after the federal budget has passed Parliament, to review progress made on the promises made this week.

At the height of the global financial crisis in late 2008, Pakistan had asked for a bailout from the IMF, which agreed to an $11.3 billion only after attaching several conditions, including levying the value added tax (as the RGST is internationally known).

The RGST was meant to increase the tax-to-GDP ratio in Pakistan from the current, abysmal 9.1% of GDP to 14% of GDP within five years of levying the tax. Doing so would have reduced the budget deficit by more than four-fifths of its current level.

However, the plan faced stiff resistance from within  Parliament, dominated by agricultural and business interests, as well as within the FBR. Sources familiar with the negotiations say the reason the tax was so bitterly opposed is that it would allow the government to better document the economy, forcing many of the wealthiest citizens in the country to finally begin paying taxes on hitherto hidden income.

The value added tax levies a tax across the entire value chain, as opposed to just at the end user stage, thus making it an inherently fairer tax. And it requires a greater degree of documentation of business revenues and expenses, since VAT is levied on the full revenues of a company, which must then apply for a refund for the taxes it paid on expenses. This higher level of documentation makes tax evasion more difficult.

The IMF, in its press release, also warned Islamabad to end its “quasi-fiscal operations”, a reference to the government’s commodity procurement programme, which often results in significant outstanding liabilities on the government’s ledger. The agricultural lobby, however, has beaten back any efforts to end the programme.

The international lender also asked the government to continue to broaden its tax base by going after tax evaders and continue to remove exemptions from the sales tax regime. The government has agreed to audit tax withholding agents, an estimated 53% of whom do not file their taxes.

The IMF also continued to insist that the government phase out subsidies in the energy sector and focus fiscal resources instead on improving the quality of the country’s infrastructure, including health, education and transportation.

The IMF also raised concerns over Pakistan’s debt management. It said “government debt has increased and debt management needs to be improved”. This puts a big question mark on the efficiency of Directorate of Debt Management, currently being run by a private sector professional. The IMF has also asked Pakistan to carefully monitor the financial sector to assure continuing financial stability.

Published in The Express Tribune, May 18th, 2011.

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COMMENTS (15)

meekal ahmed | 10 years ago | Reply Dr Ehtisham, even if your are my first-cousin, thank you for this cogent and bold clarification. Even without it, I had my msigivings about the author's report. As I have said many times before, the IMF has consistently let us off-the-hook. They have been too easy and too generous with Pakistan and too liberal with re-setting our commitments to a later date. Pakistan is famous in the IMF Board for seeking waivers for things we should have done but did not do. This, as I have also said before, vitiates any positive impact reforms may have.
Dr. Ehtisham Ahmad | 10 years ago | Reply I would strongly urge people to read the
 actual communique that is on the IMF website.
 There is no mention of the dropping of the RGST "demand" (it was not a
 demand in the first place--it was an integral part of the strategy put to
 the IMF). In fact, the statement encourages the government to continue with
 the reforms of the GST.
 With the modest tinkering around of exemptions proposed (plan B, as
 some journalists have called it), there is no hope of getting the
 additional tax revenues of around three to four percentage points of GDP in
 the near future and in time to facilitate the repayments to the IMF that come due starting next year. And as the communique correctly points out, we have an
 incipient debt sustainability problem. This makes it difficult to repay the IMF starting
 next year, even with slashing military spending--remember we live in a
 dangerous neighborhood, and we should not cut off our nose to spite our face. The unpalatable conclusion is that it is probably already too late for the tax reforms as far as the repayments to the IMF are concerned. There is no mention of the next tranche of the $1.7 billion in the communique. But why would we want to draw on more IMF funds? To stick in reserves? Remember that these cannot be used for budget purposes, are expensive, can't be repaid, and there doesn't seem to be a pressing balance of payments need!! It would thus be madness for us to draw on the augmented outstanding part of the current IMF program. Besides, the IMF staff and Board are not
 going to throw good money after bad, especially when they are saying
 publicly (read between the lines) that we will have trouble repaying what we
 have borrowed already. So tough debt restructuring is on the cards in short order--but only if the facts are faced squarely and we do not keep trying to kid ourselves. The IMF is not a development agency or charitable institution and they have to safeguard the funds that belong to the Central Bank of member countries. And if we insist on the letter of comfort with this
 scenario in mind, we might not like the letter that they will write. Dr. Ehtisham Ahmad University of Bonn and London School of Economics
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