By any measure of reckoning, the economy has performed well. Barring slow growth in agriculture sector and a low level of foreign direct investment, all other economic indicators point to an impressive and better than expected performance of the economy.
With the reduction of overall fiscal deficit to less than 3.5 per cent of the GDP in 2003-04, lessening of overall debt to 85 per cent from nearly 120 per cent of the GDP in late 90s.
After achieving surplus in the current account in the third consecutive year of $1.6 billion, the government's claim that Pakistan has achieved its coveted objective of macro-economic stability can hardly be disputed.
Concomitantly, the economic growth has accelerated to 6.4 per cent, the highest since 1995-96, while keeping the rate of inflation contained at 5 per cent. Also, the total investment has improved to 18 per cent of the GDP which is totally financed by domestic savings of 19.5 per cent of the GDP.
In contrast to the past trend of low domestic savings, since last three years the rate of domestic savings has been higher than that of total investment, which means that the country has been financing total investment with domestic savings and the surplus has been used to reduce public debt.
Thus, it is hardly surprising that the finance minister, who has steered a nearly insolvent economy of Pakistan over the past five years into a reasonably stable macro economic state is being promoted to the status of the first minister of the Islamic Republic.
The challenge for him now is whether he can build on the successes achieved in the past few years, largely owing to factors external to the economy after 9/11 and lead the country towards the goal of high growth rates of 7 to 8 per cent that is shared by vast majority of the country rather than making the rich richer and poor even more poor.
Key objectives of the budget: After achieving the macro-economic stability and revival of economic growth, the most important challenge for the economic managers while formulating the current budget was to further enhance this growth to around 7 to 8 per cent percent of the GDP and to sustain such high growth rate over the medium to long-term so as to enhance the income and living conditions of the largest number of people, especially the poor, and to reduce the menace of unemployment.
Also, such economic growth needs to be achieved while containing the inflation without creating artificially high asset price bubbles, as happened in early and mid nineties with share prices.
Another objective, which one would naturally expect from this government is the continuity of the reform to enhance the quality and effectiveness of governance, widen tax base and further increase the tax collections in order to preclude the risk of large fiscal imbalances experienced in the past.
How far has the budget addressed these critical issues and to what extent will the budgetary measures be able to generate employment and reduce poverty? In the following paragraphs I have discussed some of the key weaknesses and shortcomings of the policy framework underlying the budget from the perspective of these objectives.
There are several good steps in the budget aimed at promoting growth and investment and removing some of the anomalies which I have not discussed as these have already been highlighted by the government functionaries as well as others over the past few weeks.
Poverty and unemployment: Undoubtedly, the most critical issue confronting our economic managers today is the very large portion of population living below poverty line and related problem of widespread unemployment.
Poverty is a multi-dimensional concept and can not be measured simply by inadequacy of food intake. It is something that is hard to measure but easy to observe, that is, if we are willing to look and take notice of appalling conditions in which most people are spending their lives in abject misery.
Just visit a public hospital like the Karachi's Civil Hospital or a government school in the suburbs of Karachi, and the rural areas of Sindh or Balochistan and one would know what poverty means.
If we consider even the most basic prerequisites of life, such as person's ability to acquire basic health, primary education, electricity, clean drinking water and other social indicators, it will highlight that over 50 per cent of the people in Pakistan are extremely poor.
According to one study, despite remarkable GDP growth in the so-called golden era of 60s, the poverty (as per calorie-based approach) grew from 40 per cent in 63-64 to 49 per cent in 1969-70.
As compared to this, in 70s, when the economic growth had slowed down to 3 per cent, or half the growth rate in 60s, the poverty declined to 30 per cent in 1979-80 owing to pro-poor and distributional policies of the then government.
Therefore, the experience of Pakistan as well as many other countries clearly reflects that poverty would not necessarily reduce with the increase in economic growth, at least not in the short run.
An analysis of the factors that are contributing to growth such as steep rise in large scale manufacturing that has contributed to high output clearly indicates that such growth is not likely to result in creating significant employment or alleviate poverty.
For instance, major drivers of growth are the increase in the output of consumer goods such as automobiles, refrigerators and air conditioners mainly due to cheap financing available for such goods.
The consumer goods like automobiles and household consumer goods, to a large extent are imported or assembled in Pakistan. Similarly, in the case of textiles, much of the growth in output has been achieved through improved technology and the BMR by large textile mills rather than setting up of new factories that employ significant labour force.
On the contrary, improved technology is continuously reducing the manpower requirements of the manufacturing sector. Consequently, most of this increase in output has not created significant employment in the country.
Furthermore, the additional marginal employment that has been created in these sectors and some others like construction industry is not enough to absorb the additional job seekers being added every year.
While the government statistics reflect the number of unemployed people at around 3.6 million, the actual number could be four to five times of this. This is because the government statistics reflect that out of the total working age population of 102 million in the country, only 44.12 million is the workforce from which 40.47 million are employed and remaining 3.57 million (or 8.3 per cent) are unemployed.
This means that nearly 68 million souls are either not interested in employment because they may be students, housewives or are underemployed. The figure of what is generally termed as underemployed, i.e., people who were working for less than the "normal" duration (of 35 hours a week) on an involuntary basis and were seeking or were available for additional work has not been disclosed.
While the government is claiming (as per the Economic Survey) that the ratio of unemployment has remained unchanged compared to last year at 8.3 per cent, it is much higher than the unemployment rate in late 90s of less than 6 per cent.
The empirical evidence, based on the number of applications received by various government departments, indicates that the ratio of unemployment far greater than what is disclosed in the Economic Survey.
For example, in response to recent public advertisements by the Education Department of Government of Sindh for a few thousand vacancies of primary school teachers, it received a record number of over 400,000 applications and the government had to hire external agencies to arrange for written tests for such a large number of applicants.
I am told that the response to the vacancies for other non-teaching posts of lower grade has been even more overwhelming. Clearly, the ratio of applications to the number of vacancies has increased nearly three to four times compared to the position that existed five years ago, highlighting the rampant unemployment not adequately captured in the official statistics.
GOVERNANCE REFORMS: One of the major factors that can bring about a sea change in terms of economic prosperity and progress of the country is the quality of governance.
The major contribution of this government in improving the governance are the banking sector reforms, the introduction of the Code of Corporate Governance for listed companies by the Securities and Exchange Commission of Pakistan (SECP) and substantially improved and effective regulatory process by the State Bank of Pakistan (SBP) and SECP.
However, these improvements are the result of continuing reforms that were initiated by the earlier governments. For instance, key reforms such as autonomy of the SBP and establishment of the SECP in place of the old Corporate Law Authority was done by the earlier governments.
Nonetheless, due to the appointment of better quality of directors and chief executives in these regulatory agencies as well as a few other large institutions, the quality of governance, in terms of objectivity, leadership and transparency of these institutions has improved considerably.
Not with standing these improvements, most of the federal and provincial government departments and the government at large has remained aloof from such governance related reforms. Similarly, the local governments, which were invented by this government, and the related reforms process seems to have been abandoned or forgotten.
Tax Collections and Tax Base: Based on the progress of tax collections so far, the CBR is likely to meet its tax collection target of around Rs510 billion, up by Rs50 billion or 11 per cent more than the previous year's tax collections of Rs460 billion.
However, as our taxes are largely linked with the imports, which have grown in the first nine months of the year by nearly 18 per cent, the actual tax collections appear to be significantly lower than the potential.
While some of the reforms in the CBR, including setting up of Large Tax Payer Unit and the Universal Tax Assessment system are noteworthy improvements, some steps indicate reversal of the important reforms initiated in the past.
Such steps that can be categorized as anti-documentation steps include withdrawal of addition sales tax of 3 per cent on unregistered persons, enhancement of exemption limit for registration from Rs0.5 million to Rs5 million and introduction of presumptive income tax regime for retailers having turnover up to Rs5 million and introduction of presumptive regime for certain other sectors.
As a result of enhancing the limit for registration under sales tax law, it is estimated that over 40,000 registered persons or almost 30 per cent of the total registered persons will be deregistered.
Further, the withdrawal of additional 3 per cent tax on supplies made to unregistered persons has resulted in a big advantage for unregistered persons, who do not pay any tax compared to the registered persons.
Consequently, this may result in more and more people getting de-registered. These steps clearly negate the steps taken earlier by the government of carrying out a comprehensive tax survey to enhance the tax base.
It is due to such an approach of one step forward and two steps back that the total number of tax payers remain almost unchanged compared to the position in 1999 against the government's plan of increasing the number to nearly three times as a result of carrying out tax survey.
Low foreign direct investment: One critical area where the performance is far from satisfactory is the foreign direct investment, which is estimated at around $900 million in the last eleven months.
If we exclude the amounts received under privatization and mobile licenses sold recently, the figure will probably fall even below the previous year's level. Considering all-around improvements in the economy, including an impressive build-up of forex reserves and stable rupee, this level of foreign direct investment should be a cause for concern.
It should rather be embarrassing for our economic managers, especially in a period when the global growth gained momentum, and private capital flows to the developing countries increased to $200 billion in the year 2003 - their highest level in the last five years.
Flowing from this, the message from international investing community is both loud and clear, i.e., they do not consider Pakistan to be a favourable destination for investment. Why is this so and how can this impression be changed are the questions that need to be addressed on priority basis.
MISSED OPPORTUNITIES: As 2004-05 budget was prepared when government had much larger fiscal space owing to low interest rates, debt rescheduling etc., which has lowered the percentage of debt service cost from over 50 per cent to around 27 per cent, and at a time when Pakistan is coming out of the IMF programme, the government had a great opportunity to break from the past by following a combination of growth-oriented, pro-poor and distributional policies.
In this context, enhancement of public sector development programme to over 200 billion and incentives to the SMEs and agriculture sectors are steps in the right direction.
However, many steps that should have been taken to make Pakistan more competitive in a highly competitive world to attract foreign as well as local investment have not been taken. Such critical steps include:
* Lowering of the Corporate and individual tax rate from 35 per cent to 25 per cent. The current tax rate of 35 per cent, similar to the rate prevailing in the developed economies including the US, is considered too high, especially for manufacturing entities which are also required to pay workers participation fund discussed below.
At this level, Pakistan is unlikely to attract any significant foreign direct investment. The question is why should one invest in Pakistan, which is not an ideal country from the perspective of availability of infrastructure and law and order, when there are several jurisdictions offering lower tax rates (like Malaysia with 28 per cent, Indonesia 30 per cent, Thailand 30 per cent, Singapore 20 per cent just to name the few) besides, better living conditions and without such a serious law and order problem?
Therefore, in order to attract foreign direct investment and even to induce local investment, the government should seriously consider to reduce the tax rate, both for corporate as well as individuals.
* The rates of allocation to the workers' profit participation fund and workers welfare fund should be significantly reduced from current 7 per cent (5 per cent for the WPPF and 2 per cent for WWF) to a maximum of 2 per cent. At present, the effective corporate tax rate, after including the WPPF and the WWF comes to 42 per cent.
These allocations, because of the very low ceilings for allocation to workers up to Rs5000, are largely transferred to the government treasury without any significant benefit to workers. Therefore, it is essential for enhancing the investment activity to restrict such charges to a maximum of 2 per cent.
* Tax on dividend should be eliminated, considering that this is a double taxation on the share holders. From the shareholders/investor's perspective, the actual tax rate goes upto over 52 per cent (Corp tax 35 per cent+WPPF and WWF 7 per cent+Dividend 10 per cent).
Instead of tax on dividend, it may be more appropriate to tax capital gains as is the case in India where tax on dividend is exempt but the capital gains are taxed. This would be a much better tax regime to generate long-term and sustainable investment through stock exchanges rather than short term speculative gains that create asset price bubbles.
* In the last few years, government has been following the policy of gradual reduction in the tax rates of banking and private companies to bring them at par with the listed companies.
While the tax rates of these entities were unusually large and required to be reduced, the policy of equal treatment of listed and non-listed companies is seriously flawed. In order to encourage investment in listed entities, their tax rates must be significantly lower than the other entities.
* While the additional sales tax on unregistered persons of 3 per cent has been abolished, the overall sales tax rate of 15 per cent is considered exorbitant, much higher compared with even some developed countries. As this is a tax on consumer, it is a tax on the poor and by its nature is inflationary. Besides, it is an additional cost of doing business in Pakistan.
The above tax rate is considered very high, even when compared to some of the developed countries like the US, where sales tax is a state tax, it varies between 5 to 8 per cent. The sale tax rates in several other emerging markets such as India, Indonesia, Malaysia, Thailand etc., ranges between 7 per cent to 10 per cent.
FLAWED PRIORITIES: Instead of capitalizing on the large fiscal space that had become available to reduce tax rates as pointed out above to make Pakistan more competitive in a globalized world, we continue to waste resources on non-development expenditure.
Last year, the government had announced that the defence expenditure will be frozen at the level of Rs160 billion but instead, the spending increased to Rs181 billion in the revised estimates.
Now, the defence expenditure in the budget 2004-05 is pitched at Rs194 billion, or nearly Rs34 billion more than the budget estimates of the outgoing year. With the improved relations with India, the appropriate course would have been to freeze the defence expenditure at last year's level and use this saving to meet the shortfall for reducing the corporate, individual and the sales tax rates as explained in the preceding paragraphs.
The proposed public sector development programme of Rs202 billion, although looks impressive in terms of absolute figure, it is only 3.3 per cent as a percentage of the expected GDP of nearly Rs6000 billion in 2004-05.
Further, it reflects excessive focus on bricks and mortars rather than investing on human resource development. Nearly 25 per cent of this amount is proposed to be spent by an organization like Wapda, which has poor governance structures and pathetic track record in terms of implementing projects.
Compared to such spending, investment in basic education, health, population welfare, sanitation, rural village electrification etc., is meager. To conclude, Pakistan's recent transformation and progress are no doubt remarkable, but the true benefits of such transformation can only be achieved if the accelerated economic growth coupled with low inflation can be sustained over a long-term period and the benefits of such growth are well dispersed to wider and poorer sections of our population.
Further, Pakistan also needs to become far more competitive to capture the benefits of globalization by reducing the tax rates, lowering the cost of doing business, improving work ethics and environment and further improving its governance structures and processes, including rule of law and justice dispensation system.
The most important thing to remember is that it all depends on the quality of the people at the helm because people are more important than the systems and processes. If you have good people, they will make the bad systems work. If you have bad people, even the best of the systems will fail.
