Economy: 2015 to be fraught with new challenges

Calendar year 2014 was marked by the PML-N government claiming that it embarked on a politically challenging economic reform agenda with some positive outcomes. The extent of the ailing economy, government supporters further pointed out, remained impediments to the speedy recovery of appallingly poor macroeconomic indicators that the incumbent government inherited; however, there was sufficient good news for the International Monetary Fund’s (IMF) fourth tranche release that faced a review hiccup, before being jointly released with the fifth tranche by this month.

Key macroeconomic indicators that improved during the year were a decline in the budget deficit from 7.4 percent realised in 2011-12, (the budgeted deficit for the year was an unrealistic 4 percent); the budgeted deficit for 2012-14 was 4.7 percent with the realised figure almost double at 8.8 percent (with PML-N government held responsible for enhancing the deficit by around 1.5 percent due to retirement of the circular energy debt on 30 June 2013). The budgeted deficit for 2013-14 was 6.3 percent that was subsequently revised to 5.8 percent. For the ongoing fiscal year the deficit target is set to decline to 4.9 percent. Thus the focus of the Dar- led Finance Ministry has been on deficit reduction which has left it open to criticism by economists who maintain that this focus compromised the potential for growth.

Lower deficit did enable the government to reduce inflation – from 11.5 percent in the revised estimated of 2011-12 to 8.5 percent in 2013-14 which is expected to decline further to 8 percent in fiscal year 2015. However, public sector continued to provide fodder to inflation through a steady rise in utility rates with the government, like its predecessor, relying on raising utility prices to cut subsidies as opposed to improving performance through raising receivables and reducing the heavy transmission and distribution losses, with no discernible improvement in the provision of electricity or gas.

Dar continues to be accused by his critics of committing non-innovative and innovative data manipulation. Non-innovative is defined as understating the 2011-12 growth to 3.8 percent, instead of a 4.4 percent rate noted in official documents at the time, to enable him to make the inane claim that during his first year as the Finance Minister growth crossed the 4 percent mark the first time after 6 years. In addition, by claiming that growth rose by 4.4 percent in 2013-14, discrepancies emerged in the official data of growth components. This included overstating the growth of large scale manufacturing, the not credible construction growth of 11.3 percent and the claim that banks, major components of banking and insurance sector, whose profitability declined by 15 percent registered a 5.2 percent growth rate. The innovative data manipulation came with respect to using foreign exchange reserves held by the private sector as part of the country’s foreign exchange reserves as well as using the profit of the State Bank as part of government reserves. Foreign debt increased from 47.3 billion dollars in 2012-13 to 65.6 billion dollars as of today.

The government focused on foreign borrowing as a policy decision and explained this focus by correctly maintaining that (i) borrowing from abroad at low rates of return of around 5 percent and retiring domestic debt incurred at around 12 percent was good policy; and (ii) entry into the capital market after a gap of six years, inclusive of issuance of one billion dollar each of Eurobonds and Sukuk, was a reflection of a favourable perception of foreign investors about the domestic economic reform agenda. However, economists advise the present government to take account of the exchange rate risk, with even highly conservative estimates of rupee depreciation of 5 percent per annum making the rate of return of 7.5 and 8.5 percent for half a million dollars worth of Eurobonds of 5 and 10-year tenors as well as a fairly imprudent sukuk flotation. According to the data on State Bank of Pakistan’s website, the increase in foreign investment is attributable almost entirely to portfolio investment – a type of investment that can leave the country overnight as countries afflicted during the Asian financial crisis learnt to their cost. Foreign Direct Investment inflows increased from 849.1 million dollars in 2014 to 1371.2 million dollars in 2015 – the rise made up by outflows which rose from 494 million dollars to 984.4 million dollars.

Tax reforms were largely cosmetic with the onus of generating revenue continuing to be borne by existing payers including the salaried as well as through raising and/or widening the sales tax net whose incidence on the poor is greater than on the rich. The rise in tax to GDP ratio, the objective of successive governments including the incumbent, appeared to be met through redefining tax collections by the Federal Board of Revenue (FBR) by heavier than ever reliance on withholding taxes which do not underscore the need for greater documentation and are not collected by the FBR but by their agents. For example, unlike in the budgets presented by the PPP-led coalition government, Ishaq Dar placed both the Gas Development Surcharge and Gas Infrastructure Development Cess under other taxes rather than under non-tax revenue, enabling him to present a higher tax to GDP ratio. The government’s commitment to the nation that it would initiate the process of taxing those with interest income on large deposits held in banks abroad did not materialise. The government’s decision to defer the implementation of the challenging tax deal struck between previous government and the stock market players is seen by many as ensuring that it can rely on the stock market to show a favourable performance as and when criticism against its policies mount.

Be that as it may, the decision of the IMF to release the fourth and fifth tranches is being positively viewed by independent economists. The Fund has projected a 16 percent investment growth, no doubt mainly attributable to the inflow of the 34 billion dollar expected Chinese investment and, given the anticipated public private partnership envisaged in Chinese funded projects; private sector investment growth is projected at 21 percent. One would hope that these projects materialise as soon as possible; however, the mechanism for Chinese investment has not yet been made public and neither have the terms and conditions for Pakistani private sector participation agreed between the Chinese and the Pakistani governments. The other component is the rise in portfolio investment by 1.2 billion dollars excluding the Sukuk issue may be missed.

Pakistan is at present ready to launch a massive crackdown against the terrorists and the estimated cost of implementation of the National Internal Security Plan is estimated at 32 billion rupees with around 93 million rupees only having been budgeted for the current year. In other words, budgeted expenditure would rise significantly and with the budgeted over ambitious revenue targets unlikely to be met, yet another year would see the deficit would rise leading to a cut in development outlay. In the event that the government can effectively tackle terrorism it is hoped that a major impediment to foreign and domestic investment would be removed which would provide the necessary fuel to the economy to emerge from the impasse it has faced for several years, although the question in relation to the need for new job opportunities will continue to constitute a formidable challenge to the present government mainly on account of reduced development spending. No doubt, the year 2015 will be fraught with new challenges.