Even by the standards of the Asian tigers, Pakistan’s economic growth has looked impressive in the last three decades. The country’s GDP has risen, on average, by nearly 6 per cent a year while inflation has consistently remained well below 8 per cent. If these economic gains hadn’t been eroded by a population growth rate of over 3 per cent every year — a peak by any yardstick — the record would have been enviable.
In the last two years, however, the economy seems to have hit a bad patch. Economic growth was 2.3 per cent in 1992-3 and 3.9 per cent in 1993-94. Inflation has crept up to 13 per cent (much higher according to unofficial estimates) and is rising steadily. Has the country been inflicted, as many businessmen believe, with a bout of stagflation, a disease common enough in the rest of the world?
The government of prime minister Benazir Bhutto clearly doesn’t think so. Nor does the International Monetary Fund (IMF), which helped set the guidelines for Pakistan’s 1994- 95 budget announced on June 9th. The new budgetary measures are aimed at widening the income tax net, raising the rate and incidence of indirect taxes and increasing development expenditures. Ms Bhutto hopes to reduce the fiscal deficit from 6 per cent this year to 4 per cent in 1995. Since some of these these recipes are traditionally reserved for an overheated economy, how on earth does the government expect to pull the economy out of the recession? For an answer, we should look at the structure of the Pakistani economy.
Agriculture still accounts for a large chunk of GDP (38.9 per cent in 1991-92), yet agricultural incomes and wealth have never been taxed because national parliaments are dominated by big landlords. The service sector, which includes transport, storage, communication, wholesale and retail trade, contributed 49 per cent to GDP in 1993-94. But it has consistently refused to keep accounts and remains largely out of the tax net. Electricity and gas distribution accounted for 3.7 per of GDP in 1993-94. But bad management and corruption in public sector companies which distribute these services has meant that only 80 per cent of all revenues due are actually collected. Even in the manufacturing sector, which contributed 18.6 per cent of GDP in 1993-94, small scale industry (5.6 per cent of GDP) has generally escaped the tax net.
Since only 1 in every 1000 Pakistanis actually pays any income tax at all, successive governments have concentrated on raising revenues through indirect means — import duties and excise taxes make up nearly 80 per cent of all government revenues. Consequently, governments have been obliged to finance development and balance their budgets by borrowing increasingly huge sums of money from domestic and foreign lenders. Pakistan’s disbursed foreign debt has risen from US$ 145 million in 1959-60 to US$ 20.3 billion in 1993-4 (about 41 per cent of GDP). Its domestic debt has shot up from Rs 58 billion in 1980-81 to Rs 688 billion in 1993-94 (about 43.5 per cent of GDP). Such colossal indebtedness in turn exacts a heavy toll on the annual budget — nearly 40 per cent of it goes into debt-servicing.
But if the government is in debt, so too are thousands of Pakistani businessmen. It is estimated that Pakistani banks carry a liability of about Rs 60 billion in bad debts. Most of this money is owed to state-owned financial institutions.
As if this isn’t a terrible burden on the exchequer, governments also have to pump huge sums into defence in order to keep the cold war with India alive. Military expenditures account for nearly 5.6 per cent of GDP and 35 per cent of annual budgetary expenses.
In consequence, the fiscal deficit has hovered around 7 per cent throughout the last three decades. And government outlays for population planning, education and health have been abysmally low. The government’s Social Action Programmes have never exceeded 3 per cent of the budget.
For years, sensible people have warned that Pakistan is living on borrowed time and money. The IMF, in particular, has continued to stress the need for structural reforms in the economy — reduction in defence expenditures, reliance on direct rather than indirect taxation, lowering tariff barriers to make domestic industry more competitive, increased spending on the social sector and better financial management to keep the deficit down. But for short-term political reasons, every government has tended to postpone the day of reckoning.
Despite such prodding, this state of affairs might well have continued a bit longer if it hadn’t been for the arrival of a new government in 1990 headed by Mr Nawaz Sharif. Mr Sharif did some things that needed to be done. For instance, he deregulated the economy and launched a dynamic privatisation programme to rid the government of its lumbering state sector. But he was careless in managing his finances. Instead of putting the proceeds from privatisation into a debt-retirement fund, he went on a reckless spending spree. Among other things, his passion for a US$ 1 billion, 370 km motorway from Lahore to Islamabad was probably misplaced. Also, in a bid for popularity, he spent nearly US$ 1 billion in scarce foreign exchange handing out interest-free loans to people for the purchase of tens of thousands of duty-free ‘yellow taxis’.
Then, in late 1991, disaster struck. Unprecedented floods in Punjab, the most prosperous province, wiped out nearly 25 per cent of the country’s cotton crop which accounts for 55 per cent of Pakistan’s exports. For the first time in history, agricultural output actually declined by 5.3 per cent in 1992-93. 1993 was another bad year for cotton when a virus attack reduced the crop considerably.
Political instability in the last two years has also hurt the economy. When an interim government took over in 1993, Pakistan’s foreign exchange reserves were equivalent to only three weeks import bill and the country was on the verge of defaulting on its debt payments.
During Mr Sharif’s tenure, GDP rose by 7.7 per cent in 1991-92 and the fiscal deficit stood at 7.5 per cent. However, in 1992-93 GDP rose by only 2.3 per cent while the fiscal deficit went up to 8 per cent. In fiscal 1993-94, Ms Bhutto’s government has upped GDP by 3.9 per cent and brought the deficit down to 6 per cent. Next year, she promises, the deficit will be down to 4 per cent while the economy will grow by 6.9 per cent. How does she expect to bring about this small miracle?
Ms Bhutto’s budget envisages an outlay of Rs 385 billion, up from Rs 332.52 billion last year. Tax revenues are expected to be Rs 237.6 billion (up by 22 per cent), domestic bank borrowings will be Rs 15 billion (down by 25 per cent) and external loans will amount to Rs 82.4 billion (up by 35 per cent). Other sources of revenues like proceeds from privatisation etc will cover the rest of the deficit. On the other side, expenditures on debt servicing will amount to Rs 135.9 billion (up by 8 per cent) and defence will consume Rs 101.9 billion (up by 11 per cent). The Annual Development Plan is Rs 90 billion (up by 21 per cent). The rest of the money will be spent on other non- development activities, including the upkeep of the state’s civilian institutions.
The budget rests on the central plank of additional taxes worth Rs 45.5 billion compared to last year. These are to be collected largely through indirect means — Rs 20 billion from a new sales tax of about 15 per cent on an additional 108 imported items and 169 domestic goods (total items under sales tax are 763), Rs 13 billion from additional customs revenues, Rs 7.5 from extra excise duties and an additional Rs 4.3 billion from income and wealth taxes (including, finally, a small wealth tax on agricultural farms which will yield Rs 100 million).
There is a reduction in import tariffs from a maximum of 92 per cent to 70 per cent. The idea is to force domestic industry to become more competitive and check smuggling (estimated at Rs 50 billion annually). The government is also hoping that price-elastic imports will help increase its total customs revenues after a fall in the rate of import duties.
Ms Bhutto has made the Pakistani Rupee fully convertible in order to encourage foreign investment. She is going to spend Rs 1.2 billion more on the Social Action Programme which is directed at improving facilities for education, health, population planning etc. She has increased the salaries of civil servants and military personnel — long overdue — by 35 per cent. And she has been careful not to increase the rate of tax on sensitive items like sugar, petroleum and electricity. All these measures have evoked a positive response from society.
But businessmen are not pleased by the higher tax burden imposed on them. The Karachi Stock Exchange Share Price Index fell by 11.85 points the day after the budget. Mr Hafiz Pasha, a former commerce minister in the Moeen Qureshi regime, claims that higher taxes will lead to inflation and cut demand. Mr Sartaj Aziz, the former finance minister in the Nawaz Sharif regime, says that “the government should have kept the deficit at 5 per cent and not increased the tax burden so substantially”.
Equally realistic objections are raised by independent economists who worry about how the government will meet its revenue objectives. In the 1993-94 budget, the Central Board of Revenue failed to meet its targets and there was a shortfall of Rs 17.5 billion. Serious doubts are being expressed about the ability or will of the government to reduce corruption in the tax department or rein in smuggling.
All said and done, though, the last word on the budget, belongs to Mr Nisar Memon, head of IBM Pakistan and president of the Overseas Investors Chamber of Commerce and Industry. “This is a revenue-oriented, optimistic and challenging budget”, admits Mr Memon, “it will need determination and political will to implement it”.
Truer words haven’t been spoken. But Ms Bhutto will probably need more than ‘will’ and ‘ability’ to scrape through. If the cotton virus rears its head again this year, or if the monsoon doesn’t behave itself (drought so far but floods can’t be ruled out), she will be in deep trouble with stagflation. Opposition leader Nawaz Sharif is waiting for precisely such a situation to develop before he pounces on her. If Ms Bhutto is able to deliver the goods, well and good. If she can’t, we will all be in a lot of trouble.