Interview: Ehsan Malik, CEO, Pakistan Business Council
Published in Jul-Aug 2021
AURORA: What is the PBC’s take on the new budget?
EHSAN MALIK: Taking a broader view and from a business and industry perspective, compared to how the economy stood four or five years ago, there have been a number of positive changes. One, we now have plenty of electricity available; it may not be at the right price, but the generation capacity is there. Affordability and reliability remain an issue. Here, I would add that we have over-invested in power generation and failed to invest in distribution. Two, the security situation has improved. Three, there is still, to some extent, optimism about the present government. Four, we have moved away from the unrealistic exchange rate we maintained which resulted in Pakistan’s exports losing their competitiveness and indirectly subsidising imports by making them cheaper. Imports were going up and exports down, creating an imbalance in the current account.
Now with what is called a ‘real effective exchange rate’ the current account deficit has gone down. In fact, until April, we had a current account surplus, but then imports went up due to supply issues on food items. Five, remittances have gone up significantly. Six, inflation has gone down and with it the cost of borrowing. From an economic management point of view, two major leakages in the economy have been plugged. The first was the result of the 2018 Amnesty (and the improving security situation); a lot of the money parked abroad was declared and some it has started coming back. The second is the fact that although Pakistan is still on the Financial Action Task Force (FATF) grey list, there is only one remaining condition left to comply with. Both measures have stemmed the outflow of money from Pakistan. Money is still flowing into real estate, but the government has changed the fiscal regime affecting real estate and this has reduced the outflow of money, although it has not stopped.
A: What part did the State Bank of Pakistan (SBP) play in stabilising the economy?
EM: The SBP has played an exceedingly positive role and there has been a sea change in the way it looks at economic management. The SBP introduced the Payroll Financing Scheme during the first lockdown. Originally, the Scheme targeted the SMEs only, but the PBC said this was not going to work because they do not have the bookkeeping transparency required to give the commercial banks the comfort level to lend to them, whereas the larger organisations do and besides which, they employ more people. The SBP modified the Scheme to include larger companies. The SBP also introduced the Temporary Economic Refinancing Facility (TERF). Originally, the Scheme was for new projects only, but again the PBC said no one is going to think about new projects in Covid times – they were unable to utilise their current capacity, let alone set up new projects – and we convinced them to allow the Scheme to be used for modernisation and replacement purposes. In our view, this was a golden opportunity to replace old equipment. Incidentally, there was an engagement between the PBC and the SBP about 18 months ago, when we pointed out that globally there are two types of inflation. One, when the economy heats up and people start buying goods on credit because the cost of borrowing is low (demand-pull) and this can be managed by increasing the cost of borrowing. The other is due to shortages in supply and prices go up. In this case, tweaking the cost of borrowing cannot solve the problem and other means have to be found to tackle the shortages – usually by importing or increasing the price, so that consumption goes down. Our view was that the SBP should be differentiating between these two types of inflation; this view was accepted and that is one factor that led to the reduction in the policy rate.
A: Fundamentally, why is Pakistan repeatedly driven to seek IMF assistance?
EM: The role of manufacturing in the economy has been either static or in decline. Ours is a consumption-led economy and if you are not manufacturing goods, you end up importing them, which eventually creates an imbalance in the external account and forces you to go to the IMF. Pakistan is very reliant on imports and there is a limited amount of import substitution we can do and so the only way to fix the trade balance is to get exports up. However, our exports are very narrow in terms of the basket of exports as well as in the countries we export to. We are very reliant on Europe, the UK and the US, which account for about 50% of our exports. If you compared Pakistan to Vietnam in 2001, both countries had the same levels of trade. Today, Vietnam’s exports have shot up; they are still importing but they have a positive trade balance of eight billion dollars. This comes off from $243 billion worth of exports and $237 billion worth of imports. They have become a conversion country; they convert their imports into finished goods which they re-export and in the process generate a lot of employment, which is what Pakistan needs.
Like Pakistan, Vietnam was also reliant on textiles, but today textiles represent less than 30% of their exports. They have diversified and are exporting domestic appliances, electronic goods and so on. If you look at Pakistan’s GDP, the 10-year average growth rate in the period from the 1960s to the 1970s (which you could call our golden period) was at 7.2 %. If you take the recent 10-year period, we are down to 3.6%. In these last 10 years, Bangladesh’s share of exports went up two-and-a-half folds and Vietnam over seven-folds. Vietnam has been wise in becoming a signatory of pivotal trade agreements which Pakistan is absent from. Vietnam is a member of ASEAN and they have free trade agreements with the US and the EU. Pakistan’s agreement with China was poorly negotiated and it was only because of lobbying by the PBC that it was renegotiated to Pakistan’s advantage about six months ago.
Even our integration in the global value chain is neither significant in terms of its total magnitude or in its make-up. There are two ways to become globally integrated. One, you become a supplier of raw material. You grow cotton and sell it to another country, which then does the value addition, brands and sells it at a significant mark-up. Pakistan’s total integration in the global value chain is only 33% (it is 57% in Vietnam and 42% in India) and the make-up is even more remarkable; 28% of this 33% comes from supplying raw materials and the value addition stands at five percent.
A: What role does the PBC play in advocating the interests of Pakistan’s business community?
EM: The overarching theme of the PBC is ‘Make in Pakistan’. It means generating jobs and getting into value added exports and sensible import substitution by manufacturing products we are good at making. However, for ‘Make in Pakistan’ to be successful, we need a high degree of documentation and a level playing field between the formal and the informal sectors.
We have identified several building blocks to achieve this. The first is a competitive exchange rate, which we now have; a fairer trade agreement with China and we have that too. A cascading tariff; until recently the same duties were applied to a finished product as well as to the different components required to manufacture that same product. Why would anyone bother to import the constituent parts? We asked for the introduction of a cascading tariff system and the government listened and today duties have been reduced on 4,000 raw and intermediate items. Historically, 40% of Pakistan’s total tax revenue has come from import duties, but if you want to promote manufacturing, particularly of items that rely on imported raw materials, you cannot follow that process. Because of our advocacy, there is an understanding that we need to incentivise the import of raw materials and to do that we need sensible duties. The move from using tariffs as a revenue raising tool to an industry supporting one is both a revolutionary as well as a sensible step to take. Another major ask is for equitable and consistent taxation. Unfortunately, partly to please the IMF, the government did a major sweep of all the exemptions that still had two to three years’ life left. Imagine having invested on the basis of a five-year tax relief and suddenly a year later, this is withdrawn; this doesn’t inspire confidence and next time, given the choice, you may decide not to invest in Pakistan.
The PBC also brought together the Overseas Investors Chamber of Commerce and Industry and the American Business Council for a joint presentation to the government. Several points were discussed, including the fact that Pakistan is already subjected to 40% higher rate in energy costs compared to the rest of the region and if another 28% were added to the tariffs (as requested by the IMF), manufacturing, which is not growing, will die – and fortunately, no move to jack up the utility rates was made in the budget. The other major ask was not to impose a further 23% to 24% additional taxes, given that the government is already generating approximately 14% to 15% from existing taxpayers – and the fact that no further taxes were imposed is another positive outcome of the budget. To bridge the gap, we recommended that more people be brought into the tax space. If you examine the composition of the GDP, 19% of the total comes from industry, about 19% from agriculture and about 29% from wholesale and retail and the rest from services. The government is now taking measures to bring wholesale and retail into the net by encouraging the use of POS terminals to help document the economy and introducing a track and trace system for items that tend to lose themselves in the undocumented economy. Another positive in this budget is the fact that there are two levels of taxation for the SMEs depending on their size – the idea being to gradually induct them into the tax net.
A: What has been the impact of TERF?
EM: TERF led to Rs 425 billion worth of investment in plant and machinery and looked at holistically, the quantum of investment generated is almost one trillion rupees; perhaps the highest investment Pakistan has ever achieved in a relatively short period of time. So promoting investment has worked and when these industries become productive, they will generate higher tax revenues. Unfortunately, the SMEs were unable to take advantage of this opportunity as much as they could have, because they are largely undocumented. However, the Finance Minister in his budget speech said there was a plan to come up with a government guaranteed TERF like facility for SMEs and the government would provide banks with the required guarantees, up to a certain amount. Such schemes are necessary for a poorly documented country like Pakistan.
A: Overall would you call this budget a business friendly one?
EM: I have seen at least five budgets since I joined the PBC and this is the most ‘Make in Pakistan’ friendly one so far. The important thing is that it has been accepted that the only sustainable way to increase exports and manage the current account is to promote manufacturing in every area where Pakistan has the capability.
A: What needs to happen next, from the business as well as the government side, to make this achievable?
EM: First of all, the people who are already paying taxes need to continue doing what they are doing but more diligently and by putting all their efforts into maximising exports or creating import substitution. The SMEs will need to go through an evolutionary process and come into the formal sector, based on assurances that they will be able to access concessional financing and lower taxation rates. As we move closer to the elections, there will be a greater need to put money into public sector development programmes.
However, if the economy does not grow and the IMF funding does not come through, the government will have to ask businesses to pay more taxes, which is why it is incumbent on businesses to grow as much and as quickly as they can. As they grow, so will their profits and they will pay more taxes – and businesses don’t mind paying more taxes as long as it comes from a larger profit. The government, for its part, has to create the right environment for growth. The greater hope lies with the SMEs. The government and all the stakeholders need to ensure they enter the formal sector and take advantage of the funding that is coming their way, because they are the backbone of the economy. The budget is a move in the right direction, but we need to recognise that a single year’s budget cannot cure the ills accumulated over the past. At least it has started moving the wheel on key things.
A: Moving forward, what are the critical steps required to achieve sustainable economic growth?
EM: Pakistan is at the bottom of the pyramid in terms of per capita income in South Asia. If you want to improve the lives of the people, on the economic front at least, all governments, irrespective of their political affiliation, must buy into a consensus to deliver at least 80% of the things that are important to the economy. The PBC has developed a ‘Charter of the Economy’ that puts the emphasis on reform and growth in a number of crucial areas. Our cities are not configured properly. Health and education is lacking and skill development is not taking place, which means the industry cannot evolve in terms of value-addition because it doesn’t have the skills.
The economy has to be formalised; if 35% is left undocumented it will not have a multiplier effect – the informal sector cannot export anything because they will not find customers abroad. Fiscal reforms are imperative; bringing the tax rates down is only one part, you also need the power to collect and this has to be done intelligently and not through harassment. Our agricultural productivity is suboptimal across all our five major crops in terms of yield per acre, and the growth is not keeping pace with the population. In real terms, the amount of food availability in Pakistan is going down per capita and we need to double the output, improve the quality and manage it properly. We need to resolve the circular debt issue and this means tackling the distribution losses and the distribution companies themselves. They have not been devolved to the provinces and therefore the provinces have no incentive to collect unpaid dues.
Ehsan Malik was in conversation with Mariam Ali Baig. For feedback: firstname.lastname@example.org
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