Heavy revenue, thin reform

July 15, 2019

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Topped with heavy revenues all along five years, the recently concluded $6 billion IMF programme is front-loaded with steep fiscal adjustments. The long outstanding structural reforms to address deep rooted economic haemorrhages remain on the back burner once again.

Put together, the Federal Board of Revenue’s (FBR) taxes are estimated under the programme to increase from Rs3.84 trillion for the fiscal year ending June 30, 2019 to Rs10.5tr by 2023-24, an increase of 174pc or Rs6.66tr in five years. Wish this comes true because then the International Monetary Fund (IMF) expects the tax-to-GDP ratio to improve from 10.4 per cent now to 14.3pc by 2023-24.

That means the government will have to collect Rs1.66tr of additional revenue (a mammoth 43pc jump) during the current year to reach Rs5.5tr target committed to the IMF. This has to be followed by Rs1.5tr of additional tax recovery (27pc) in FY2020-21 and Rs1.3tr (19pc) in FY2021-22. Beyond that, the additional taxes would amount to Rs1.175tr (14pc increase) in 2022-23 and then Rs1.02tr (11pc) in 2023-24.

Apart from that, the focus of the programme is the increase in electricity and gas rates already delivered and then to be followed by biannual and quarterly adjustments to ensure complete cost recoveries. Even the changes to energy sector regulatory laws envisage automatic pass through of full costs to consumers without delays, forgetting the principles of prudent cost recoveries from consumers.

Real reforms that may benefit the taxpayers in the long run have no set targets or performance benchmarks

This is despite the fact that both the IMF and the PTI government agreed at the outset that the lacklustre progress in structural reforms were the key bottleneck of investment as inefficient state owned entities went on without correction.

Even the thrust of revenue increase is more on withdrawal of tax exemptions and increase in rates to deliver the revenue collection targets under various structural benchmarks. However, real reforms that may benefit the taxpayers in the long run, like the transformation of General Sales Tax into a broad-based value-added tax, have no set targets or performance benchmarks.

In the words of the IMF, quasi-fiscal losses increased further and represent a significant risk. “Following several years of steady decline in the flow of circular debt in the power sector, new arrears were accumulated over 2018 and 2019, reaching close to Rs800bn (around 2pc of GDP)”.

Delays in adjusting tariffs, reversal of policies — such as revenue-based load shedding — and the non-payment of implicit subsidies by the government have been the main contributors to the increase in arrears. As a result, the stock of circular debt stood at over 4pc of GDP as of March 2019.

Also, arrears in the gas sector have now emerged, with the stock totalling over half percent of GDP, coming mostly from delays in tariff notifications and increasing technical losses. Beyond the energy sector, losses in the three largest state-owned enterprises (SOE) — Pakistan International Airlines, Pakistan Steel Mills and Pakistan Railways — have continued to accumulate, now totalling over 2pc of GDP, according to the IMF.

Yet, the programme focuses initially only on cost recoveries and postpones the structural improvements to a later stage. This is in line with its previous programmes when privatisation and private-sector participation in loss-making entities was delayed again and again and then never materialised.

Under the last IMF programme signed in 2013, there were also structural benchmarks for public listing, strategic divestment and outright sale of more than 30 entities but could not be materialised as these were not front loaded.

This time again, the focus of the programme is more on increasing revenue than strategic decision making in the SOEs. For example, the government has to notify the electricity tariff schedule for 2019-20 as determined by the regulator before end of September this year.

Likewise, it has to prepare a comprehensive circular debt reduction plan in collaboration with international partners by end of September 2019. This was also done under the previous programme and even implemented but could not be sustained because the focus remained on recoveries.

By the end of this year, the government has to submit to the parliament amendments to the National Electric Power Regulatory Authority (Nepra) Act to ensure full automaticity of the quarterly tariff adjustments and eliminate the gap between the regular annual tariff determination and notification by the government. The passage of the amendments would remain a challenge in the difficult political environment.

The government is also required to conduct and publish new audits by reputable international auditors of PIA and PSM by the end of December this year. After a long gap, by the end of September 2020, the government is bound to conduct a triage of all SOEs, to conclude whether to divide them into companies to maintain under state management, privatise them or liquidate.

Similarly, the government also has to submit to parliament a new law to improve governance and transparency, in line with IMF recommendations, to modernise and clearly define the role of the state as owner, regulator, and shareholder of SOEs, by September 2020.

In this context, the recently established holding company — Sarmaya Pakistan — to manage SOEs will follow the required governance and transparency principles in line with international best practices. “The IMF will provide technical assistance to support the development of this law and to review ownership arrangements with a view to designing an effective ownership model”.

By that time, the IMF programme will be almost half-way through and there is no guarantee the politico-economic conditions remain conducive as the previous government had to give up privatisation or restructuring of SOEs.

The government has nevertheless given commitment to the IMF to revive upfront the privatisation programme with fewer entities having minimal operational, financial and human resource issues. The list includes two newly commissioned RLNG power plants, two specialised banks (SME Bank and First Women Bank) and two real estate assets namely Jinnah Convention Centre-Islamabad and Services Hotel-Lahore. In addition, the programme will offer the government 19.39pc residual equity in Mari Petroleum.

Published in Dawn, The Business and Finance Weekly, July 15th, 2019