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Calculated Risks and the Available Options
By: Dr. Abid Qaiyum Suleri
The discussion on economy of Pakistan revolves around tackling menace of two deficits, i.e., rupee deficit and dollar deficit. The former gets manifested as fiscal deficit, whereas the latter gets reflected as (im)balance of payment or current account deficit. These deficits have built up due to certain chronic structural issues faced by Pakistan’s economy. Energy circular debt, loss-making public sector enterprises, expanding tax net, overvalued rupee, and trade (im)balance are some of those structural issues.
Before assessing the performance of current government on economic front, it is important to understand the structural issues affecting our economy for the last few decades. 
Energy Circular Debt 
It started piling up as the cost of electricity generation was higher than the cost of electricity supply, not only because of expensive fuel, but also because of transmission (technical) and distribution (pilferage, non-recovery of bills) losses. The situation aggravated during 2011 to 2014 when global price of Brent crude oil almost tripled and ranged between USD 90-120 per barrel. This substantial increase in crude prices turned electricity generation in Pakistan quite expensive. The thermal power generation plants were unable to recover their cost of generation from distribution companies and thus were not able to pay Pakistan State Oil for the fuel, which in turn was not able to pay oil refineries. The oil refineries were not able to pay petroleum levy and FED to the government, and the vicious cycle led to a cumulation of circular debt across energy sector. The result was prolonged hours of power outage and accumulation of energy circular debts. In 2013 the government cleared some of the circular debt but new debt kept accumulating for the next one year (2014) until Brent crude prices started declining in 2014 and reached below USD 30 per barrel in 2016. However, the prices started increasing again and currently they hover around USD 60 per barrel. The fluctuation of oil prices in global market resulted in fluctuation of electricity generation cost in Pakistan – which could not be passed on to consumers due to various reasons and coupled with transmission and distribution losses – leading to further accumulation of energy circular debt. More recently, supply of gas to different sectors below the cost of import of LNG, and capacity charges that government is bound to pay to power producers (irrespective of the fact whether it buys any electricity from them) are also adding up to energy circular debt. It is pertinent to mention here that due to various considerations, successive governments could not implement (or fully implement) Oil and Gas Regulatory Authority (OGRA)’s recommendations to increase the prices of petroleum products.  All of this has led to a situation where cumulative energy circular debt has surpassed the total defence budget for the year 2018-2019.
Loss-making Public Sector Enterprises (LPSEs) 
This is another sore point for Pakistan’s economy. Successive governments treated recruitment, posting and promotions in public sector enterprises as an easy way to provide jobs and to accommodate those who had some political influence. This practice negatively affected the productivity and efficiency of organizations such as Pakistan Steel Mills (PSM), Pakistan Railways, and PIA etc., which in turn led to a situation where the per annum losses due to these organizations have touched a whopping figure of Rs. 500 billion per year. Handling LPSEs have become extremely tricky. Both the previous governments have failed to privatize or revive these LPSEs due to political opposition. It is expected that present government would also face the opposition, this time from previously ruling parties if it tried to privatize these units. 
Expanding tax base, bringing the taxable non-taxpayers in the tax net, and relying on direct taxation instead of indirect taxes (which hurts the poor and non-taxable section of society the most) remained a major challenge for every government in Pakistan and the current government is not an exception. 
The fact that in the run up to general elections 2018, the political transition year, Pakistan’s economy became victim to larger political economy considerations, further aggravating the problems for current government on revenue collection front. The previous government in its sixth budget (May 2018) announced very generous reduction in tax rate on salaries and increased the taxable income threshold from 0.4 million rupees per annum to 1.2 rupees million per annum. This was an uncalled for move and would result in a revenue loss to the tune of Rs. 70 billion in this fiscal year. Supreme Court’s verdict against withholding tax imposed on telecommunication subscribers would add another 55 billion rupees revenue loss in the current financial year. It is expected that Federal Board of Revenue (FBR) would face a shortfall of Rs. 495.9 billion in revenue collection during current fiscal year. Apart from the two reasons mentioned above, this shortfall would be a result of the following policy measures: 
•  Rs. 80 billion shortfall from revenue collection (under section 153 of Income Tax Ordinance 2001) from contractors, suppliers, and service providers due to reduced government spending as a result of slashed Public Sector Development Programme (PSDP was slashed to contain fiscal deficit and under austerity measures). 
•   Rs. 16 billion loss of tax deduction from imports (under section 148 of ITO 2001) due to import compression. 
•    Reduced banking profit would result in reduced tax on dividend income and lead to a revenue shortfall of Rs. 25 billion.
•  Abolition of tax on cash withdrawal from filers (under section 231-A of ITO 2001) would result in Rs. 5 billion shortfall.
The revenue collection would also get a hit of Rs. 40 billion due to reduced sales tax and federal excise duty on petroleum products, fertilizers, and car booking for non-filers. Likewise, reduced general sales tax on import of LNG, and sales tax exemption of LNG supply of natural gas to fertilizer plants would also affect FBR revenue collection. Finally, compressed imports have considerably reduced the custom duty collection by FBR. It is estimated that there would be a shortfall of Rs. 50 billion in custom duty collection due to compressed imports.  
Although the government is trying to bring the non-taxpaying taxable to the tax net, there is still no move (by provincial governments as it is a provincial subject) on taxing agricultural income above a certain threshold. Reduced revenue collection would have a direct bearing on fiscal deficit. 
Trade (Im)balance 
This is another chronic issue facing Pakistan’s economy. The PPP government could only take Pakistan’s exports from USD 20.2 billion in 2008 to USD 24.8 billion in 2013. Although USD 25 billion was a modest figure, however, it remained a mission impossible for the previous government to cross 2013’s export figure. In fact, export declined during the last five years from USD 24.8 billion (10.7 percent of GDP) in FY13 to USD 23.2 billion (7.3 percent of GDP) in FY18; and the current government though able to marginally improve trade imbalance (mainly by curtailing imports through regulatory duties and rupee deprication) is struggling with increasing the exports.
Till January 2018, exporters of Pakistan were complaining of overvalued rupee against major currencies of the world. They held high energy tariffs responsible for high cost of doing business in Pakistan. They also complained of lack of liquidity due to their rebates and refunds which were stuck with FBR. They complained about the skewed tariffs (import duties and levies) that discourage export competitiveness. They blamed law and order, the security situation, difficulties in getting contractual obligations implemented, weak protection of copyrights, and political uncertainty for making it difficult to do business – the list went on. Without absolving Ministry of Commerce from its responsibilities, one could say that our exports were not picking up, partly because of export-unfriendly economic policies.
The current government is trying to take export friendly measures. State Bank of Pakistan (SBP) let the overvalued rupee to depreciate to reflect its real effective exchange rate. The stuck-up refunds and rebates of exporters are being adjusted against “promissory notes”. Asad Umar’s second mini budget (economic reform package) contained many policy decisions (effective from July 1, 2019) such as reduction in import duty on raw material to reduce the cost of doing business, which would in turn boost exports in the medium to long-term. This is because it would take some time before the economy may recover from anti-export economic policies of the last decade. 
Overvalued Rupee 
Overvaluation is yet another important structural problem for Pakistan’s economy. A strong rupee against dollar is certainly important, especially when it comes to paying our import bill. However, a weak rupee does not by default, reflect a weak economy. In economic terms, Pakistan follows a “dirty managed” exchange rate regime. It means the SBP tries to manage the value of rupee against dollar within a certain range. SBP can stabilize the value of rupee against dollar through supporting the demand of dollars in foreign currency markets. Instead of stabilizing the value of rupee, during the first four years of the previous government, SBP kept the rupee overvalued. 
An overvalued rupee, in fact subsidizes imports as it reduces the prices of imported items. This, in turn, negatively affects local industry (and livelihoods) as people prefer “affordable” imported items over locally produced alternatives. An overvalued rupee also increases the prices of exports, thus adversely affecting the balance of payment. However, the worst impact of overvalued rupee in our case was on foreign currency reserves. SBP sold USD 22 billion in the open market to keep the value of rupee below Rs. 105 per dollar. The move could have been justified if the SBP’s dollar reserves were built through exports, foreign direct investment, or remittances. However, those were the borrowed dollars and resultantly increased government’s non-productive debt. 
Why Debts?
Crippled by the chronic structural issues affecting Pakistan’s economy, successive government must borrow to meet their fiscal and current account deficits. 
After paying the provincial share of revenue from the federal divisible pool, the federal government is left with barely enough to meet two non-discretionary expenditures: debt retirement including mark-up payment, and the defence budget. In order to run day-to-day governance (salaries and pensions of the civil services) and to fund the developmental budget of the PSDP (the only discretionary expenditure), it relies on loans or external assistance. New loans are taken to pay off old ones and the cycle goes on. It is in this context that the current government had to borrow too. It is pertinent to mention here that with the depreciation of value of rupee against dollar, the size of Pakistan’s external debt increases proportionally. Likewise, the increase in SBP policy rate (mark-up) increases Pakistan domestic debt servicing. On top of securing new loans to return the old one, the current government had to use both the policy measures depreciating the overvalued rupee, increasing the policy rate for improving macroeconomic stability. Hence there are reports of record debt hike in first eight months of the government. 
Present Government’s Economic Strategy
Contrary to the common perception, the current government does have a strategy to overhaul Pakistan’s economy. Its short-term objective was to manage balance of payment for the current fiscal year without going to the IMF. Thanks to the support of friendly countries, that objective was achieved. Its medium-term objective is to address the structural issues haunting Pakistan’s economy. And the long-term objective is to put Pakistan’s economy on a growth trajectory through revival of industry and attracting foreign direct investment (FDI). 
To address the structural issues, the government is not shying away from taking tough decisions.  Someone had to take these decisions, even at the cost of one’s political capital. The apparently unpopular measures will help the economy in the medium-to-long run (the medium-term objective of the government). The energy circular debt is being managed through passing on the real cost of generation to the consumers (lifeline consumers are still being subsidised). Imports are being discouraged through regulatory duties on non-essential items and through depreciation of the overvalued rupee against the dollar, whereas the tax net is being broadened through tightening the noose against ‘taxable’ non-taxpayers.
Government’s economic diplomacy to attract investment from friendly countries in sectors that can create jobs, revive local industries and improve balance of trade, seems to be working. In the long run, this investment will put Pakistan on a growth trajectory. The Saudis are quite serious about the refinery and petrochemical complex in Gwadar and are willing to invest around USD 10 billion. China has agreed on technology transfer, industrial cooperation, and investment in labour-intensive sectors such as agriculture. Additionally, Malaysia is keen to invest in halal meat, telecom sector, and assembling its signature vehicle Proton in Pakistan. 
Why Going to the IMF is Important?
I believe Pakistan has no other option but to go to the IMF one more time. It would help to address the structural issues of Pakistan’s economy. Furthermore, through this engagement we would be able to secure a “letter of comfort” (LoC) from IMF. This endorsement is a prerequisite for our engagement with the World Bank, Asian Development Bank, and other lenders. It would also help in improving our credit rating and enable us to float sukook and overseas bonds. 
IMF loan conditions would not be much different than the reforms that the PTI government wants to introduce in FBR, the energy sector, loss-making public sector enterprises, governance, and in the cost/ease of doing business etc. In fact, the current government has the chance to deliver where previous governments failed in the last 21 IMF engagements – i.e., bringing about reforms.
Why IMF is Tough on Pakistan?
Pakistan, like the other 188 members of IMF, can resort to it to secure fiscal stability. The borrowing country presents a home-grown solution (certain loan conditionalities, outlining how government would remain within its means, i.e., no further deficits). Immature termination of a programme implies that the borrowing country could not implement the loan’s conditions. For such countries, the IMF imposes even tougher conditions for future engagements. Pakistan became an IMF member in 1950; since 1958, it has made 21 arrangements with the Fund. However, only one programme (the last programme during 2013-2016) could be successfully completed, that too with 16 waivers. The rest of the 20 programmes remained incomplete and had to be abolished. That’s why IMF is asking for front loading (or prior actions) before agreeing to release of the loan. 
Current State of Negotiations with the IMF
The negotiations with the IMF mission are progressing well. Initially the IMF was insisting on a free-floating exchange rate (i.e., market determined exchange rate without any intervention of SBP), tightened monetary policy, and increase in energy tariffs to reduce energy circular debt as a part of loan conditionalities. However, now that Pakistani negotiators argued well and the IMF is flexible, SBP can mark some funds that it may use on monthly basis to do some interventions in foreign exchange market if required. Pakistan may start its IMF program from the next financial year.
How to Provide Relief to Masses?
The process of bringing reforms (through or without an IMF programme) may hit certain segments of the society. That is where the newly announced ministry of social protection and poverty reduction would play its role. The relief for people of Pakistan could come from provincial governments, who are mandated to deliver on social sector development. That is where PM Khan would have to ensure that the provincial governments of the three provinces where PTI is in power complete their homework and start delivering to their people. 
The good news is that if the government wholeheartedly implements the apparently unpopular but extremely crucial economic reform agenda, it will be in a position to heal the chronic wound hurting Pakistan’s economy. Imagine a Pakistan with no circular debt liabilities and no loss-making public sector enterprises. Imagine a Pakistan where the tax-to-GDP ratio exceeds 20 percent, and where doing business is much easier and a lot cheaper than regional competitors. Only by doing that can Pakistan’s social sector expenditures be non-discretionary and debt retirement a discretionary expense. 
We may not see such a Pakistan in 2019, but the present government should certainly aim for such a ‘Naya Pakistan’ within its remaining tenure. This would ensure that current IMF program is the last program for many years to come.

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The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.