The tenth review of the 6.64 billion dollar Extended Fund Facility between the International Monetary Fund (IMF) team and the Pakistan authorities began in Dubai this week past. There is not much speculation as to the concerns of the Fund staff given the post-ninth review decisions taken by the government that may have prompted the Mission leader, Harald Finger, to take a conference call with Pakistan media on 12 January this year.
Tax amnesty scheme, referred to by Ishaq Dar and officials of his Ministry and entities under his administrative control including Federal Board of Revenue as Voluntary Tax Compliance Scheme (VTFS), is going to be debated during the negotiations. Technically this is the second tax amnesty scheme in two years – both announced by Prime Minister Nawaz Sharif, with few under any illusion that the Prime Minister had any input in the scheme or that the title is appropriate. While it is relatively easy to mislead the uninformed general public, yet it is unlikely that even a freshman student majoring in economics would be misled by the title, and accept the government’s claim that the scheme is not a tax amnesty scheme. The fact that the scheme allows those taking advantage of it amnesty from tax audit, however limited its scope (though it may be legally challenged because of its limited scope) qualifies as an amnesty scheme.
The Fund staff not only raised objections after the announcement of the first tax amnesty scheme (December 2013) but also recently after the second. The first scheme was criticized in the second mandatory staff review uploaded in March 2014 wherein it was stated that “The package seeks to improve the investment climate through reducing tax scrutiny. The package opens another loophole in the system in addition to the ones that already exist for remittances and equity stock investment, and raises potential money laundering risks. The immunity from routine audit hinders the self-assessment process, and the amnesty-entailed by waiving penalties and interests-is likely to be detrimental to improving compliance and collections as taxpayers will develop an expectation of future immunities. There are some factors that mitigate the negative impact of the package. The authorities consider this scheme as one-off, and will refrain from issuing another amnesty during the program period. The immunity from routine audit does not extend to cases where non-compliance is detected from other sources.”
Two years later and after the Dar-led Finance Ministry committed to the Fund in the December 2015 uploaded Letter of Intent that it would not issue any tax amnesty scheme it announced the VTCS less than three weeks later. It is no wonder that Harald Finger, the mission leader for the ongoing 6.64 billion dollar Extended Fund Facility in the conference call reiterated what was noted in the second staff review: “International experience, for example, indicates that tax amnesty schemes can undermine tax compliance and weaken revenue collection by penalising compliant taxpayers and potentially creating expectations also for further tax amnesties. And so we think it’s very important that the current agreement is implemented in a way that minimises these risks”. The scheme was approved by the national assembly on 21 January, though it was opposed by opposition parties, which may be taken as a shut-up call by the Fund though it certainly would merit extracting yet another commitment by the government not to announce a third amnesty scheme.
The second and related source of concern for the Fund is privatisation. Finger stated during the conference call that “privatising these public entities through strategic sales is a quite complicated process, a complex process, and so it also needs to be done right. Rushing it through in a way that would then endanger the success of it would not really help anybody. And so we will need to continue discussing these things… we will discuss with the authorities in our upcoming talks the ways forward with fixing the underlying problem of the loss-making public sector entities… In PIA, I think it’s important now that we come to some view on how to get consensus in the Parliamentary process now on next steps.” It is disturbing that the Fund staff known for imposing politically unsavoury conditions on debtor governments is advising our democratically elected government to be more inclusive and take parliament on board. And it is equally disturbing that PML-N’s Mushahid Ullah, a man not part of the economic team, held the press conference postponing the PIA sale by 6 months – an announcement that was followed by a statement that it was never meant to be a privatisation in any case as government shares would have been higher than those offloaded to a strategic investor. In addition, if the government does not change the top decision making team there will be little improvement in PIA finances in six months – the condition specified for abandoning the sale.
Thirdly, a source of concern to the opposition and the general public is the rise in borrowing to contain the budget deficit to agreed limits. Finger stated that “there is still an imbalance in the economy. There is a fiscal deficit that is still higher than it should be and that of course then requires a significant amount of borrowing. That borrowing needs to come from somewhere, and, on the domestic side, it largely comes from the banks that, for one reason or another, then don’t have the same incentive to lend to the private sector, which we think would be quite important to help kick-start that higher growth”. But while Finger acknowledged that government borrowing is compromising private sector growth he did not dwell on the reduction in public sector growth because of slashing of development expenditure (up to 40 percent by provinces) – a flawed condition set by the Fund.
Fourthly, failure to implement the anti-money laundering bill as agreed, with the bill defanged subsequent to Saleem Mandviwalla, the chair of the senate committee on finance, restricting it to sales tax though income tax is where money laundering is more applicable. State Bank autonomy is likely to be granted in letter though not in spirit.
Fifthly, over-valued exchange rate. Finger stated “we think that Pakistan’s nominal exchange rate should continue to be market-determined and any implied overvaluation of the real effective exchange rate can be corrected over the medium-term with continued structural reforms, gradual improvements of Pakistan’s competitiveness, and also with the help of supportive policies. And when I say policies I mean monetary and fiscal particularly and also financial sector policies”. However, the Fund noted in previous reviews that the authorities disagreed with respect to over valuation and given Finger’s admission that “the model estimates showed significant variation and thus they are only indicative” – a variation that previous reviews showed to be from 5 to 20 percent – it is almost a foregone conclusion that the authorities, if the Fund insists on a prior condition in this respect, would try to minimise the correction with obvious continued negative impact on exports.
So what has the programme achieved with around 8 months of the EFF remaining? Finger claimed that “At the beginning of the program, the macroeconomic stability was indeed in danger and the country stood close to a crisis. The fiscal deficit was in excess of eight percent of GDP. Foreign exchange reserves were down to a few weeks of imports. The country was on the brink. This government has been able to turn that around and put in place conditions that led to disappearance almost of any crisis risk and a large reduction of the underlying vulnerabilities that are there by bringing down the fiscal deficit quite considerably and to increase the foreign exchange reserves also to a large extent.”
So what about the trade-off between growth and deficit reduction? Finger in an interview with the Business Recorder last year stated that this linkage does not apply to Pakistan as there are too many imbalances. However, meeting the deficit reduction targets has been largely through a massive reduction in development expenditure that is compromising growth as well as the pace of implementation of the China Pakistan Economic Corridor. Finger claimed success in limiting government from borrowing from the SBP which he stated “is quite encouraging for the medium term” but this only led to the government borrowing from the commercial banking sector which is certainly not encouraging for private sector investment and growth.
And what about heavy reliance on external borrowing – a charge levelled at the Sharif administration by the opposition as well as economists. Finger in the conference call said it all: “a SBP report did mention that not since 9/11 has Pakistan seen inflows on this scale even though many of them are debt- creating.”