Category Archives: Pak Economy

NGOs and development in Pakistan

An interesting article on Pakistan has been posted at Global Dashboard (a knowledge hub for issues in international affairs and foreign policy) by Seth Kaplan “Why do some countries have so few NGOs?“, a policy consultant on state instability, governance and development based in New York. The thesis of it is as follows:

Nongovernmental organizations (NGOs) are significant for service delivery to the poor, they hold governments accountable and are a positive impact on development. However, in Pakistan there is a very small number of NGOs, and as thus development Pakistan has suffered. Additionally respectable think tanks, and independent monitoring organizations (IMOs) are also few and far between.

Kaplan goes on to say that this lack of independent organizations extend to politics with political parties structures on kinship ties. However philanthropic contributions are huge (1% of GDP) but “a relatively small share of this money is going to build institutions that contribute to state building and social development. The poor may be gaining adequate relief from destitution—the streets of Pakistan have far fewer beggars than India—in ways that did little to change the situations.”

Firstly, the blame according to Kaplan falls on the Pakistani society dominated by kinship relationship that distrusts externally developed institutions. Secondly, institutions are not run by consensus but by cults of personality.

The arguments are not without merits but Kaplan forgets some of the subtleties of the cases of India and Bangladesh that have a proliferation of NGOs. Most NGOs start off providing a specific serves in a specific policy areas and this hold true for India and Bangladesh as well. In India much of the drive behind NGOs and independent service delivery is entrepreneurship and a good business environment. In Pakistan the economic environment is too complex to such NGO growth. It is not kinship and ethnic ties that doesn’t let NGOs proliferate, its taxation, security, terrorism, inflation, transportation costs, road infrastructures etc., that make wide scale operations too risky or too costly. With many NGOs in Pakistan trying to works as self sustaining non-profit organizations, much of the activity is constrained because of economic reasons rather than the frailty of trust networks.

Kaplans second point on institutions being hijacked by the people who are running them is also flawed because assuming NGOs to be independent ventures, initially NGOs are the effort of a few people but there is no evidence to suggest that these people are corrupt or grossly inefficient. Personal power in government institutions is a different matter and it is too much of a generalization to bunch NGOs with all other institutions and say that these are run on personal agendas.

Kaplan’s broad-brushed analysis then jumps to the weakness of civil society being weak and only advocating specific issues. But is that not how civil society and lobbying groups work?

Accepting that Pakistan has fewer NGOs, can we even say that NGO’s cause development? NGOs are small scale service provides where the state cannot reach, they fill in the gaps in development and give signals to the state and civil society highlighting vulnerabilities. Development has always been the job of the state. The weakness of civil society advocacy and participation is key to this. NGOs do have a role in this, however the case of Pakistan is different from that of Bangladesh and India. We have vast networks of charity based on societal trust (that Kaplan says is weak in Pakistan). Even NGOs like SOS Children’s Villages and CARE in Pakistan operate on these donations. Just because Pakistan does not have an NGO titan like Grameen, does not mean that philanthropy and non-state service delivery are not present. Additionally there is a large growing criticism of microfinance and its actual impact on development due to high interest rates and defaults with loans. The problem with too many NGOs is that the governments starts relying on these NGOs for development, and this is not a sustainable solution for long term economic and social development and it de-links civils society from the state.

Rather than just looking at the number of NGOs in Pakistan as a problem, a better question would be to see how significant NGOs actually are for development in Pakistn and what are the conditions that are inhibiting development as compared to India and Bangladesh? NGOs is probably not the answer.

Pakistan Policy Group 2012. 

Flashback to the NFC Award debates: What about the budget deficits?

The NFC award after its approval in 2009 has become an issue of last year, so I wrote this to try to understand what it means for the current economic scenario. 

In December last year, the Annual Conference of the Pakistan Society of Development Economists, our national experts came to the conclusion that the 7th NFC Award approved in 2009 was a political and not an economic Award.

Pakistan’s macroeconomic management has remained centralized until 2009-10. However,the 7th NFC Award and 18th Amendment contributed heavily to the decentralization of the macroeconomic management. We are all aware of the problems plaguing the economy, a narrow tax base (A World Bank report from 2004 states that out of the 39.1 million employed only a paltry 2.14 million, or 5.59 percent, paid taxes), double-digit inflation, rising debt servicing and a large budget deficit. In such time, is such decentralization logical?

It is common economic knowledge that a good government is that which can maintain fiscal discipline by keeping the budget deficit low. But in developing countries, especially Pakistan, governments love to spend but hate to collect taxes. So does the NFC Award that hands over 56 percent of tax resources to the provinces help maintain fiscal discipline? For some like Ashfaque H. Khan, Dean of NUST Business School in Islamabad and Sohail Zafar, Dean of the Lahore School of Economics Business School, the answer is a big ‘no’. Governments federal and provincial are never going to spend this among prudently.

Why so? Well the timing is such that the federal government’s expenditure is growing rapidly (more than doubling of interest payments in three years from Rs.365 billion to over Rs.800 billion this year, high defence spending, power sector subsidies of over Rs.175 billion, and crumbling public sector enterprises eating resources). There are hardly enough resources for the federal government to meet it’s own set expenditures, how does it expect to cater for provinces? The provinces themselves only generate 0.5% of total tax revenues; and the NFC Award further dampens the incentives to step up tax collection.

A historical overview of the NFC Awards shows that even with the amounts promised aren’t transferred. Well simply because they don’t exist. The data below illustrates his fact (there isn’t data available on the latest NFC Award).

Only around 75% of expected funds are typically forthcoming. NWFP is the worst, receiving limited funds of around 50–60%. Baluchistan is the only province receiving more than what it had expected. This discrepancy has resulted in a considerable shortfall of funds to most provinces, forcing them to borrow to meet their expenditure needs. It has also made planning at the provincial level more difficult.

Pakistan can only come out of the present economic crisis if it maintains fiscal discipline keeping its budget deficit low. But economists feel this may not be possible with the 7th NFC Award unless the provinces themselves can deliver surpluses to meet the federal deficits.

‘Change comes from policy, not budgetary handouts’- Nadeem Ul Haq, Planning Commission Chief

Saadia Gardezi talks to Dr Nadeemul Haque, deputy chief of Pakistan Planning Commission and chancellor of Pakistan Institute of Development Economics, about the new budget and the new growth strategy- The Friday Times, 11th June, 2011

TFT: To what extent do you think the Ministry of Finance has been successful in making a budget that can draw Pakistan out of its current downslide? Economists like Shahid Javed Burki have said it is a disappointing budget. Are these concerns well founded?

Dr Nadeemul Haque: I think the ministry did as well as they could with the situation they have. We tend to think that the budget solves all problems of the economy. It cannot and it does not. That’s what the finance minister also said: the budget is just one part of government policy. The budget is just there to clarify expenditures and revenues. In Pakistan, we expect too much of the budget and seldom focus on the policy.

TFT: Do you think the current budget removes barriers to private investment mobilisation?
NH: I don’t know if it is the responsibility of the budget to do this. The budget is about what is and what is expected to come. For the impediments in the private sector you need a good growth strategy. And nobody reads the growth strategy.

TFT: One proposal of the budget is slashing subsidies, including those to the power sector, from Rs395 billion in 2010-11 to Rs166 billion. In the current fiscal, power sector subsidies alone remain more than Rs200 billion. What problems do you foresee with regards to cutting subsides?
NH: If the cutting of the subsidies means creating efficiency, it’s not going to cause problems. With subsidies to the power sector there’s a lot of wastage and theft. Line losses have to be decreased. On the other hand, subsides to the agriculture sector have not been touched.
The creation of efficiency and the movement away from protecting and subsidising is an important part of a reform we are trying to push for. Yes there will be opposition and some short term problems with cutting useless expenditures but hopefully we will grow.

TFT: The budget speech also promises to reduce inflation by half, to 9% in 2011-12. Do you think this is possible or is the government being too optimistic?
NH: Yes it can, I don’t think there is anything to stop us from moving in the right direction. If we control money supply, stop printing more money and keep the deficit small, inflation can come down. This requires strict fiscal discipline, but why not? Just because you get into trouble doesn’t mean you can’t grow up.

TFT: There has been a lot of discussion in the media that this is not a pro-poor budget. What is a pro-poor budget and is this budget pro-poor?
NH: I don’t think the budget allocations can be thought in terms of being less or more pro-poor. There a set amount that has to be given out. Now there is a huge allocation made for the Federal Public Sector Development Programme (PSDP), and I suppose you could call that pro-poor. The budget makes allocations for these sorts of development expenditures. It doesn’t make policies to tackle poverty, unemployment or underdevelopment.
For policy you have something like the growth strategy. A policy strategy that can guide the government towards better growth and expansion. With growth, employment will be created so that people can benefit. Making a concerted effort to reform the economy to encourage investment, entrepreneurship and growth to create new jobs is what is pro-poor. Handouts given in the budget are not pro-poor, creation of new jobs is. It doesn’t make sense to rely on budgetary handouts for poverty alleviation.

TFT: In the Planning Commission’s new growth strategy, the private sector is the growth-driver in an open market environment. Do you think the budget is structured according to this growth strategy?

NH: Yes it is. The budget simplifies the tax structure and the tariff structure and so encourages the private sector. This fits very well with the strategy to build an open economy. We have an economy that is often closed down for the sake of a few and we protect sections without viable economic reasons to do so. If we can stop doing that, stop regulating the economy for the sake of a few people, then we can create more space and create competitive markets. The budget is complementary to the growth strategy.

TFT: Are the provinces on board with the growth strategy?
NH: The growth strategy does not operate in a command economy, where we tell people what to do. It is a vision and a way forward. It talks of creating space for knowledge, for entrepreneurship, technology and capital formation. With the strategy we talked to the government and various ministries and everyone seem to largely support it and appreciate it.

TFT: Previous governments have also focused on growth led by the private sector. What is different about this growth strategy?
NH: Simply advocating private sector growth does not mean much. We have been talking about private sector-led growth for a long time. We are talking about entrepreneurship in this report. Encouraging entrepreneurship is going to create much more innovative competition.

TFT: How long are the reforms outlined in the growth strategy going to take? 
NH: A time frame has not been specified in the strategy. Reforms will take a long time, and at the end of the growth strategy we have defined the process. The government will need to stop competing with the private sector and provide public goods that have a higher social rate of return than the private rate of return, as well as transparent rules.
If the leadership takes an interest, then reforms can be implemented successfully. We have to create an open economy and society. The old 3-year and 5-year plans don’t work. They only worked in the Soviet Union. We are talking of gradual reform.

TFT: Can these reforms happen in the current political scenario? Will there be political opposition?
NH: Political opinion does not exist in isolation from public opinion. If the society wants change, then it cannot be stopped. I am looking towards ownership of these ideas in the society. If you accept these ideas, if universities buy into this type of a strategy, if people are wiling to talk about reform, then the political leadership will as well.

Pakistans Growth strategy can be downloaded as a pdf here

 

‘Not a panacea’- Inflation, private investment and growth in the new Budget 2011-12

Published in the Friday Times, June 10, 2011 in their issue on the budget. 

Current GDP growth estimates for Pakistan are at 2.4%. A figure insufficient to create jobs for the 2 million strong that join the labour force every year. According to IMF estimates an annual growth figure of 8% is needed to absorb the labour force while our target is 4.2%. Inflation, the evil twin of growth, is likely to increase with soaring oil and food prices threatening the current account into deficit. And then with the sad state of our finances, what of foreign donor confidence and private investment?

The budget has come under heat from major economists. Syed Akbar Zaidi for one said that “the finance minister’s speech yesterday was empty and disappointing. It was devoid of merit and failed to identify or address any of Pakistan’s numerous problems.” He went on to say that the budget panders to politicians due to its proximity to the election. Former Finance Minister Shahid Javed Burki was of the view that Hafeez Shaikh’s team consisted of brilliant minds, yet didn’t do much with the budget. Burki is of the opinion Hafeez Shaikh did well with the privatisation portfolio under Pervez Musharraf’s government and should have used his experience to hand over some of the poor performing public sector corporations. “Where will this budget take the economy over the next financial year? Not very far. It will not revive economic growth, not reduce the dependence on foreign flows, not reduce the incidence of poverty, nor integrate the economy with rest of the world.” But as Finance Minister Hafeez Shaikh says, it’s a budget not a panacea.

Key problems identified in the current Economic Survey released by the State Bank are persistent and high inflation, low growth, low revenue collection leading to a high fiscal deficit that continues to add to the overall debt, and a dramatic fall in the investment rate. As Dr Sohail Zafar, Dean of the Business School at the Lahore School of Economics put it, “It’s a gloom and doom scenario, and all attempts to be consciously optimistic are not supported by sane logic and data.”

Of deficits, inflation and other sins: Consider the 4.2% growth target for instance, not impossible to achieve, not enough for our needs and yet a bit ambitious considering last year’s performance. Other targets like decreasing inflation to 9% seem too optimistic. The idea here is that the smaller deficit target will reduce the printing of money and reduce inflation. All this requires strict fiscal discipline, and actually meeting the 4% fiscal deficit target which we bounded over last year.

The central bank has the same view, that the government tightening its belt will decrease inflation, reduce borrowing costs and encourage consumer demand. However, government borrowings have increased 55% since the end of the last fiscal year. In an interview with Bloomberg (June 4), director of the monetary policy department, Hamza Ali Malik said that further tightening would be difficult, “Low growth, high inflation, rising debt. It’s a nightmare for any economy.” Furthermore, Dr Sohail Zafar says that expectations about foreign resources to meet the deficit seem are not likely to be realized.

The core problem facing Pakistan that affects the situation of government expenditures is of taxation and revenues. The tax policy has been somewhat contradictory. On the one hand the finance minister said that only 1.5 million people have filed their tax returns this year, only half of those who are registered and over 70,000 have been given notices. On the other hand the budget raises the taxable income level by Rs 50,000 to give relief. Then there’s a 15% pay increase for government employees, above the 50% increase given last year. How’s that for fiscal discipline?

The one percent decrease in the GST rate, from 17% to 16% will hardy impact inflation. As Irfan Hussain writes in Dawn (7 June), “If international prices of sugar are rising in Chicago, not even a Supreme Court suo motu notice will keep them down in retail outlets across Pakistan. Artificially low prices enforced by the state will only succeed in driving stocks underground, and encourage the creation of a black market.” Which brings us to the issue of subsidies and price control.

Does subsidy removal cause inflation? The decrease in GST is to offset the effect of the withdrawal of exemptions in fertilisers, pesticides, tractors, leather, surgical items, sports goods, carpets and some other sectors. There has been much hue and cry over this cut that this would cause inflation. Speaking at a post-budget press conference on 4th June, Dr Hafeez Shaikh said this would not happen because the subsidies would be made more targeted so they were not misused by wealthy people.

Subsidy removal, without spending the associated savings, may increase poverty due to the rise in input costs relative to the selling prices of products sold by most firms and farms. But the government’s fiscal policy will ultimately determine the effects. Inflation resulting from subsidy removal can be reduced with a conservative fiscal policy. Inflation comes from two sources: the initial increase in general prices due to the higher cost of inputs and more spending by the government as funds are freed up. Therefore, if their goal is to reduce the inflationary effect, the government has to keep spending to a minimum, focusing only on areas that can increase the country’s productive capacity. Our focus is defence (Rs 495 billion) and interest payments (Rs791 billion).

Even with an expansionary policy, to keep inflation low, government spending of associated savings needs to increase purchasing power and raise production. Wasteful public projects which do not add much to the country’s productive capacity should be avoided and private production encouraged. The new growth strategy by the Planning Commission of Pakistan focuses solely on the private sector as an engine of growth.

Pakistan and the private sector: Private investment in Pakistan has been shrinking for some time. Investment in the large-scale manufacturing has declined by 32% (compared to 17% last year). The investment-to-GDP ratio dropped to below 17% last year because of decreasing private investment. The manufacturing sector has been hit the hardest.

An improvement in electricity generation will also have a large impact on production levels and costs in the country. It should kept in mind, however, that such investments may take years to materialise.

It seems that some efforts have been made in this budget to aid private sector growth by reducing some taxes and duties, but they may be too lean. All special excise duties have been abolished. Regulatory duty on 392 items have been abolished. It is now limited to luxury vehicles, cigarettes, arms and ammunition, betel nuts and sanitary ware. Federal excise duty on cement will be phased out in three years. The federal excise on beverages has also been reduced from 12% to 6%. The tax rate on interest income from government securities will be 10% with no tax return requirement. The finance minister also announced on June 4 a five-year tax holiday on loan-free equity investments.

It is unclear whether this budget will do well for industry. Dr Zafar is of the view that there is a disconnect between monetary policy and the fiscal policy embodied in the budget. “Interest rates may be low theoretically, but are too high practically to push the private sector. New investments in the industry are not likely to show improvement during the next year.” But at least no new taxes were imposed to hurt investment.

Saadia Gardezi is a political economist

Pakistan Budget 2011-12: Expenditures

Basically the total Rs 2.767 trillion is going to be spent as:

Expenditures Rs in Billion
Interest Payments 791
Defence affairs and services 495
Federal PDSP 300
Grants and transfers 295
Repayment of foreign loans 243
Running of civil governmnet 203
Subsidies 166
Other development expenditures 97
Pension 96
Development Loans and grants to provinces 55
Provision for pay and pension 25

Thats means 39% or so of the expenditure is debt servicing.

More on this later. Just wanted to post the colorful pie made for The Friday Times.

(Please credit if you copy-paste)

Pakistan’s economic underbelly

I was recently researching the extent and measurement of the informal economy in Pakistan for a colleague and the econometric methods used to estimate the shadow economy are pretty interesting and intuitive. For every Rs 100 in taxes, the government receives only Rs 38 and the rest is eaten up by the tax payer, the collector and tax practitioner.

The official description of the shadow economy is ‘unmeasured and untaxed economic activity’ taking place in a country. And this is obviously poorly reflected in official measures of national income and output. Pakistan can very easily fall into the description of the ‘shadow state’ where decisions and actions are taken by an individual ruler and do not conform to a set of written laws and procedures, although these might be present. A history of our politics and the way constitutions and have been torn ad taped together with new paragraphs added here and there is a testament to this fact. In a shadow state rulers ‘manipulate external actors’ access to both formal and clandestine markets, by relying on the global recognition of sovereignty, and are thereby able to undermine formal government institutions’. This weakens bureaucratic structures and manipulates markets. These “informal commercially orientated networks” are created that operate alongside government bureaucracies (The Shadow State in Africa: A Discussion,  Nikki Funke and Hussein Solomon, 2002).

A State Bank of Pakistan study last year (Arby, Malik and Hanif, 2010) makes use three different methodologies to measure the informal economy of Pakistan. The first is the monetary approach based on the idea that higher tax rates induce people to use currency for transactions to avoid tax reporting (known as the ARDL model). The assumptions of this approach are that informal economic activities are the direct consequence of high taxes. Since such transactions are mainly carried out by currency, the overall currency in circulation in the economy has two components: currency used for informal economic transactions and formal transactions. Thus the transaction velocity of money in both the informal and formal economies is the same.

The second method, the electricity consumption method is even more novel. Electric-power consumption is regarded as the single best physical indicator of economic activities in a country. Overall economic activity and electricity consumption can be observed and move together with GDP. By exploiting this relationship, one can have a proxy measurement for the overall economy and estimates of the hidden economy can be found by subtracting official GDP from the estimated overall GDP.

The last method they use is an economic model (MIMIC model) that whereby the informal economy is taken as a latent variable which on the one hand caused by a set of variables and affects other variables on the other. The model they select consists of three causes of the informal economy including tax/GDP ratio, M2/GDP and the regime durability as well as two indicators including currency in circulation (as ratio to M2) and growth in electricity consumption.

The ARDL results show that the informal economy has increased its share in the Pakistan’s economy until end of 1990s and has a declining trend since then. In the 1960s and 1970s it was below 30 percent and increased to 33 percent in the 1990s, and declined to 23 percent in current decade of 2000s. Results of MIMIC model show that the informal economy has been around 30% of the total economy in Pakistan. The growth path remains steady irrespective of the initial values. It is evident that ratio of informal economy to the recorded economy has been fairly stable in Pakistan. Thus we can conclude that the informal economy has grown with almost the same rate as the recorded economy. The electricity approach, on the other hand, shows that the extent of the unmeasured economy was less 5 percent during 1970s which then increased sharply until 1990s and then remained stagnant. However, this approach may not reflect the actual performance of the economy as official numbers of electricity consumption do not incorporate self- generation of electricity by economic agents in the mid 1990s onward due to crisis in official sector of power generation and distribution in Pakistan.

The results are generally close to those obtained by other studies on Pakistan but their remain some concerns as other studies show a rising trend up to the end of 1990s while some show a declining trend. M. Ali Kemal (Pakistan Institute of Development Economics, 2007), writes that if there was no tax evasion, budgets balance might have been zero and positive for some years and we would not have needed to borrow as much as we have.

The impact of the underground economy is significant to the movements of the formal economy, but the impact of formal economy is insignificant in explaining the movements in the underground economy. In the long run, underground economy and official economy are positively associated. Kemal (2007) estimates that the black economy ranged between Rs 2.91 trillion and Rs 3.34 trillion (54.6 percent of GDP to 62.8 percent of GDP respectively) in 2005 and tax evasion ranged between Rs 302 billion and Rs 347 billion (5.7 percent of GDP to 6.5 percent of GDP respectively) in 2005. Underground economy and tax evasion were increasing very rapidly in the early 1980s but the rate of increase accelerated in the 1990s. It declined in 1999, but reverted to an increasing trend until 2003. It declined again in 2004 and 2005. This supports Arby, Malik and Hanif’s ADRL model.

A study conducted by The Lahore University of Management Sciences in 2003 showed that the Rs 720 billion collected in tax in 2005-06 was only the 38 percent of the Rs 2 trillion that could have been collected. Two-thirds of the income earned in the shadow economy is estimated to flow into the official economy. The growth of the informal economy affects everyone.

The State Bank of Pakistan study can be found here.

State of the economy- Towards recovery?

The state of the economy is shaky but not unsalvageable according to State Bank reports. Below is a summary of the recent issues and policies under the State Bank

The Friday Times, November 19-25, 2010

Macroeconomic indicators: According to State Bank (SB) reports, the economy showed an improvement in macroeconomic indicators during the 2009-10 fiscal year. The economy grew at a rate of 4.1 percent, compared to 1.2 % in 2009. Other signs for improvement seem to be a decline in annual inflation and current account deficit.
The decline in the current account overshadowed worsening of the financial account and thus allowed the external account balance to record a surplus in FY10 (after a gap of two years). Foreign exchange reserves rose to $16.9 billion by end-June 2010. The combination of declining imports and higher reserves meant that the import coverage improved.

Yet the 4.8 percent depreciation of the rupee during FY10 is a puzzle. According to the Business Recorder (Oct 26) the explanation lies in the fact that the larger part of the financing for the current account deficit was in the form of loans from multilateral agencies (predominantly the IMF), which do not enter the interbank market. Moreover, the SB had also stopped the provision of liquidity for oil purchases, with the interbank market shouldering this additional demand as well.

Economic Indicators (2009-2010)

Indicators 2006-07 2007-08 2008-09 2009-10 (Jul-Sep)
2010-11
Exports
(Billion $)
17.01 19.22 17.79 19.63 5.24
Imports
(Billion $)
30.54 39.96 34.82 31.05 8.21
Trade Balance
(Billion $)
-13.53 -20.74 -17.03 -11.42 -2.97
FDI
(Billion $)
5.13 5.15 3.72 2.21 0.39
Foreign Investment
(Billion $)
8.42 5.19 2.67 2.14 0.46
Worker Remittances
(Billion $)
5.49 6.5 7.81 8.91 2.65
Forex Reserves
(Billion $)
15.18 10.83 12.23 16.07 17.10
Exchange Rate
(Rs. / US$)
60.50 71.0 88.90 86.21 85.94
GDP Growth 7.00% 5.80% 2.10% 4.10% 4.10%
Inflation 7.90% 10.30% 13.10% 11.17%

Source: State Bank of Pakistan (SBP), Federal Bureau of Statistics (FBS) Continue reading State of the economy- Towards recovery?