Debt, taxes and inflation: Highlights from the last 10 years of Pakistan's economy

No matter who's in charge, some characteristics of the Pakistani economy remain constant.
Published April 26, 2018

Since the restoration of democracy in 2008, Pakistan has witnessed extensive constitutional and economic reforms, the main ones being the 18th Amendment, National Financial Commission (NFC) 2010, Benazir Income Support Program (BISP), Kisaan Package and of course the China Pakistan Economic Corridor (CPEC).

While the 18th Amendment and the BISP were feathers in the Pakistan People’s Party’s cap despite their turbulent five years in government from 2008-13, the Pakistan Muslim League-Nawaz has never shied from brandishing their credentials when it comes to megaprojects.

As the outgoing government presents its budget on April 27, 2018, it’s pertinent to survey Pakistan’s economic performance in the last 10 years and see some of the most persistent trends in the country’s economy, no matter the party in charge.

This is part 1 of a two-part series looking back at the last 10 years of Pakistan's economic performance. Read part 2 here.

Rising debt

Domestic debt increased by five times and external debt by 1.4 times in between 2009 and 2018

Servicing of debt is an overarching theme of the Pakistani economy. Despite the government’s self-congratulatory claims, the fact remains that the entire paradigm of economic development continues to be underpinned by debts and subsidies.

CPEC is very much going to perpetuate the paradigm, as well as the defence budget, which weighs heavily as ever on the public exchequer.

Rigid tax structure

Pakistan’s taxation system continues to be rigid and reliant on indirect taxes. The ratio of direct versus indirect taxes remained around 38:62 in last 10 years.

Of those direct taxes, more than 60 percent are collected as withholding taxes, which are easy to collect and monitor and therefore betray government inaction when it comes to diversifying the tax net.

Finance Minister Ishaq Dar has been generous in relaxing the tax rate for direct taxation. While corporate tax rates and salaried tax rate were reduced, and exemption limits were raised at the same time, indirect taxes were increased. Most indirect taxes were added to the goods and services with inelastic demands such as electricity and gas.

The main issue with indirect taxes is that they lead to higher inflation as they are added to the cost of a product.

One of Dar's most contentious decisions was the imposition of withholding tax on withdrawal of cash from bank accounts. It led to a crisis of deposits and the percentage of total deposits declined from 27.6 to 25 percent right after it was introduced.

As for the provinces, the service sector makes up around 55 percent of the economy. With the General Sales Tax (GST) devolved to the provinces after the 18th Amendment, taxation on services had increased scope. Unsurprisingly, GST on services constitutes major chunk of provincial revenue.

But with majority of tax revenue dependent on a single source, the provinces are not making significant effort to reform and expand the tax net.

The tax mix of the provinces shows an overriding reliance on indirect taxes, which leads to inflation, and the same is likely to continue in future.

Agriculture tax can be one of the most significant sources of tax revenue for the provinces, but remains untapped — as it has been since the Government of India Act of both 1919 and 1935.

In fact, the agriculture sector is heavily subsidised and more so when the PPP comes to power, which helps the landed elite. The subsidies are 20-25 times higher than the income tax collected from this sector.

Trade and deficit

Pakistan’s exports are constrained by product and market non-diversification. 60-70 percent of the country's exports come from a handful of products. With the passage of time, Pakistani products have also lost their competitiveness.

Pakistan was in a serious balance of payments crisis in 2009 when the current account deficit was as high as 5.5 percent of GDP.

But the PML-N was fortunate to get Generalised Scheme of Preferences Plus status in 2013 and managed to bring down the trade and current account deficits.

Agriculture sector and policies

During the PPP government, the price of wheat doubled due to its insistence on increasing the support price for wheat. This resulted in overall food inflation and increased hardship for the poorer segments of the society.

Support price is an incentive given to producers or growers that the government guarantees to purchase their output at a price set by the state.

The PML-N, on the other hand, did not allow the level of support price to fluctuate. It also directed the subsidies to tubewells, electricity, fertilisers, seeds, etc.

In September 2015, the prime minister announced the Kisaan Package worth Rs341 billion, which included benefits in terms of tax reduction on agriculture machinery from 45 percent to nine percent, reduction in sales tax from 17 percent to seven percent on cold chain machinery, tax holidays and mark up-free loans for farmers with less than 12.5 acres of land holding.

Due to input subsidies instead of support price subsidies, the PML-N managed to control food price inflation. Nonetheless, the overall structure of agriculture subsidies in Pakistan is inefficient and does not work to reduce inequality and support poor farmers.

Subsidies are based on number of units consumed, which implies marginal piece of the pie for small farmers, as their consumption of electricity, fertilisers and seeds is very little.

Large farmers, on the other hand, use more fertilisers, tubewells, electricity and machinery imports and therefore enjoy larger subsidies.