ECONOMIC CRISIS IN PAKISTAN

How to resolve the issues

Ahmad Shakeel Babar

Pakistan is the 5^th most populous country in the world, having an economy of over $245 billion. Being the only nuclear power from the Muslim world, its importance increases manifolds. However, it is, yet again, undergoing stagnant economic growth and hyper-inflation. Its GDP grew by only 3.8 percent – one of the lowest in the region – in 2018-19 whereas the inflation remained as high as 13 percent – one of the highest in the region. This macroeconomic crisis is mainly caused by inefficient domestic resource mobilization, current account deficit and loss of market confidence.

Revenue inadequacy is one of the main reasons for this economic meltdown. Tax-to-GDP ratio is hovering around 11.6 percent whereas only 1 percent of the population files annual income tax returns.  Insufficient revenue collection forces the government to obtain loans and seek bailouts, which further pushes the country into debt trap. Horizontal inequality of taxes amongst various sectors of the economy, narrow tax base, presence of huge informal economy – over 35 percent of the GDP – and capacity constraints of the tax administration are few of the reasons hampering sufficient revenue generation. Similarly, at times, spending side is also considered opaque and politically motivated giving reasons to the public to avoid taxes.

Second factor contributing to this stagnation emanates from current account deficit. Pakistan had kept its currency over-valued for years and it created huge demand for imported goods. This not only destroyed the local industry but also resulted in draining of hard-earned foreign exchange. Very limited export portfolio and severe energy crisis coupled with over-valued local currency further eroded whatever competitive edge the Pakistani products had in the international market. This trade imbalance rose to over $18 billion – 5.7 percent of the GDP – for financial year 2017-18, triggering balance of payment crisis for Pakistan.

Furthermore, some of the government policies also resulted into erosion of market confidence resulting in reduction of economic activity in the country. One such example is imposition of higher taxes on purchase of cars which reduced the demand. Consequently, the auto sector is forced to shut down plants for several days and lay-off its employees in order to cut its business costs. The move also affected the related vending and ancillary industry which not only hampered economic activity in the country but also reduced the very revenue for which the tax was imposed. Similarly, the PTI came to power with the slogan of ‘Corruption-free Pakistan’ and across-the-board accountability. However, the accountability process is largely seen as unbridled, politically motivated and ruthless which deteriorated the overall confidence of the business community. Such moves not only deter the new investors but also subdue the entrepreneurship.

Now, the remedial measures.

Despite being embroiled into one of the severe macroeconomic crises of its history, all is not over yet for Pakistan. The government should concentrate on expansion of tax net through digitization, data integration and country-wide surveys. It should also invest in the tax administration through provision of adequate resources to implement tax policies and development of the human resource in the tax administration. Secondly, export portfolio needs to be diversified so as to capture new international markets and gain competitive edge. Currency manipulation creates distortions which should be avoided. Moreover, tax policy needs to be aligned with the macroeconomic policy of the country. Tax is a by-product of economic growth therefore it should be economic policy driven, not the vice-versa. Tax policies should be devised in a way that they promote ease of doing business and entrepreneurship in the country.

In a nutshell, dual deficit, extremely narrow tax base and inappropriate policies triggered this economic crisis. However, with better governance and some policy interventions, the crisis can be averted. The silver lining is already there in the form of gradual improvement in the macroeconomic indicators coupled with government’s unshaken resolve for wide-ranging structural reforms.

The writer is a scholar of Public Policy at KDI School of Public Policy & Management, South Korea.