Revisiting fiscal federalism

Mushtaq Rajpar’s opinion piece on Fiscal Federalism (The News January 1, 2020) is a welcome addition to the debate on the subject. Admittedly, the matter relating to NFC has faced deadlocks for decades, with the last Award in 2010 after a gap of almost two decades. There is, thus a case for a more workable solution.

However, the writer’s proposal to create two separate strands of federal and provincial tax bases, with each retaining its collection, is a violation of the very spirit of a federation. Any union, be it a family or a state, consists of members that are strong and weak and resource-rich and resource-poor. And it is the spirit of the union that the weak and the resource-poor are not left to fend for themselves. The writer’s proposal would lead to just that.

Of the four provinces of the country, Balochistan is not resource-poor, yet the poorest. The irony exists on account the failure to develop the province’s social and economic infrastructure base over the last seven decades. The result is that, unlike Punjab and Sindh, Balochistan does not possess the tax base to generate sufficient revenues to finance its current and development expenditures. The Khyber-Pakhtunkhwa situation is similar, although not as dire.

A snapshot of Balochistan’s gross underdevelopment is provided by the state of its highways. Post-2000, the federal National Highway Authority allocated less that 10 percent of its budget to Balochistan, despite the province accounting for 44 percent of the country’s land mass. Pre-2000, Balochistan’s share in federal highway development budgets can safely assumed to be almost zero. The coastal highway to connect Gwadar to Karachi was built in 2004 – six decades after independence. Prior to its construction, the 500-kilometre journey from Gwadar to Karachi took 3-4 days, with passengers spending intervening nights in the open. Axle damage and tyre burst were common. To date, there is not a single dual carriageway in the 347,000 square kilometre province.

Efficient road networks are important for the economy and for individual businesses and households. Grape farmers in the northern mountain region of Chaman and fisherfolk in the southern Mekran coast complain of grapes and fish at the bottom half of trucks proceeding to the market on pot-holed roads being crushed on account of constant jerks and bumps – leaving them with half the expected income. This state of affairs is particularly painful, given that an amount of Rs. 7 trillion – in 2014 prices – has been transferred in the form of cheap gas from Balochistan to Punjab and Karachi over the period 1969-2014. In the event, for Balochistan to be told to raise and retain its own paltry revenues is adding salt to its wounds.

Most federations in the world – Canada, Germany, India – have resource distribution mechanisms, based primarily on the principle of fiscal equalization. The principle ensures resource transfers from economically strong federating units to economically weak ones. Germany, in particular, has poured millions of Euros generated from its wealthy western states into its underdeveloped eastern states.

That is the essence of a union and without this equity-based resource distribution, weaker units would be left with little incentive to remain in the union. Notably, the balkanization of a country would not stop here. Even if any one of the federating units were to secede, there would remain developed and underdeveloped regions within. And without an equitable resource distribution mechanism, the latter would also seek to secede.

The fact is that the failure for the NFC to perform its constitutional duty is not on account of the inability of the provinces to arrive at a consensus on the basis of give-and-take. The 7th NFC process proved that it is indeed possible. The responsibility for failure lies with Islamabad where the centrist, anti-federalist mindset rules the roost. It is these elements that have not reconciled to the political and fiscal autonomy achieved by the provinces by virtue of the 18th Amendment to the Constitution and the 7th NFC.

The historic 7th NFC Accord was signed in Gwadar in December 2009. Paragraph 12 of the Accord stated that General Sales Tax on Services was a provincial tax by virtue of the Constitution and would be collected by the provinces. However, the federal Finance Ministry Summary that was sent to the President for his signature was without paragraph 12!  Called to the Prime Minister’s office to explain the omission, an additional secretary of the federal Ministry of Finance said that they had omitted it as it was not feasible. Asked what authority they had to decide what was or was not feasible when a constitutional body had made a decision, the officer merely grinned and shrugged his shoulders. That was the audacity of the standard bearers of centralism dominating Islamabad. It goes to the credit of the then President that he exercised his authority to restore paragraph 12.

The writer was a member of the 7th National Finance Commission.

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Growing external dominance of Pakistan’s economy

Pakistan has faced recurrent balance of payments problems since the last three to four decades. Every round of crisis leads to knocking at the doors of so-called friendly states and the IMF and, in the latter case, submission to its conditionalities. The current round is the most serious, given the magnitude of the gap. Gravity of the present round can be gauged from the fact that, apart from the conditionalities, IMF has taken direct control of the Ministry of Finance and of the State Bank.

Clearly, Pakistan has forfeited its economic sovereignty. Incidentally, loss of economic sovereignty is almost always followed by erosion of political sovereignty. This is the situation Pakistan is beginning to face. The Kaula Lumpur summit fiasco has driven home the point that Pakistan is no longer free to choose who it does business with or what business it does. And this is the beginning; more serious capitulations are certain to follow.

It is important to trace the route that has brought us to this point. The first stone was cast in 1993, with the imposition of imported caretaker Prime Minister and Governor of the State Bank. The more organized process of control was set in place over 2000-2007. Tax and trade policies were tweaked to create an import-dependent economy. Imports began to be liberalized with a vengeance, with the result is that imports have replaced many locally manufactured goods. Many industries have shut down, causing job losses; these jobs have been created in other countries from where imports originate! Industrial slowdown has also meant loss of capacity to export. After all, we can only sell if we produce.

Import growth was also facilitated by keeping interest rates low and opening a window of consumer banking. Demand for automobiles and electronic goods shot up – most of which was imported or assembled with imported components. Rising imports and stagnant exports meant that net dollar outflow increased and the trade deficit ballooned. Over the period 2000-2007, imports grew by 177% and exports grew by 109%. In 2000, we imported US$ 117 worth of goods against US$ 100 worth of exports; the deficit was 17%; in 2007, we imported US$ 155 worth of goods against US$ 100 worth of exports; the deficit was 55%. The gaping trade deficit is the main reason for the balance of payments hole the country has fallen into.

Monetary policy created mechanisms to enable banks – privatized to foreign interests – to make enormous profits. One of these mechanism was to allow large ‘spread’, meaning the difference between the interest rate paid by banks to depositors and the interest rate charged on loans to borrowers. Resultantly, value addition in the finance sector in two years, 2004-05 and 2005-06 averaged 40% – 4 to 5 times the normal! Profits were repatriated to host countries, causing large outflows of foreign exchange.

Foreign exchange outflows were also facilitated by FDI policy. FDI in China was in manufacturing for export. Thus, assume for example that a foreign producer in China exported 100 dollars worth of goods and remitted to their home country 99 dollars as profits; China also benefited to the extent of one dollar. In Pakistan, almost all the FDI has been in service and consumer goods sectors: telecommunications, clothing, restaurants, chocolate and ice-cream parlors, etc. Foreign companies operating in Pakistan earn their revenues in rupees and remit their profits in dollars; there is little by way of export/dollar income for Pakistan. The cumulative effect of all of the above is a large and growing Balance of Payments deficit. The hemorrhage of foreign exchange continues. Foreign interests continue to rake in profits. Pakistan’s dependence on foreign loans keeps growing.

The recent rise in interest rates to a high of 13.25% was unjustified on economic grounds. It has resulted in raising the cost of doing business; many businesses have curtailed their production or shut down altogether – causing job losses. However, high interest rates have attracted the attention of international money traders who have brought in over one billion dollars as investment in government securities; most of it of short term (less than one year) duration. They will earn large profits and repatriate them in dollars; however, when interest rates will be brought down (and they will be), these money traders will take their money to other more profitable havens by just a click of the mouse! Foreign money traders are benefiting at cost to Pakistani businesses and the economy will be left reeling from the resulting volatility.

And now to the subject of current account surplus. A surplus is beneficial to the economy if it is generated by export growth, which boosts incomes and employment. A surplus can also be beneficial if it is achieved by reducing consumer imports – advantaging domestic industry and employment. However, a surplus can also be achieved by curtailing industrial machinery and raw material imports; which will cause industries to cut back production and employment. The latter is how Pakistan has achieved the current account surplus!

Further, a current account deficit causes foreign private capital to flow in – import of capital a la FDI or even short term speculative investment, as in the current case of Pakistan. Conversely, a current account surplus causes local private capital to flow out – export of capital a la Pakistani investment in other countries. The irony here is that private capital will be investing Pakistani capital abroad – money that the Government has borrowed from abroad! Private money traders will profit, with Government repaying loans by taxing businesses and the poor within the country.

The resultant rising foreign debt on account of the above developments has created a situation where Pakistan is hostage to international creditor organizations and to individual creditor countries as well. It is, however, time to reclaim our economic sovereignty. The economy of Pakistan must be managed for the benefit of the people of Pakistan.

 

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Is Pakistan’s economy collapsing

The economic crisis that Pakistan faces today is not the first; however, it is the most serious, given the magnitude of the foreign exchange gap that the country is facing. The term ‘default’ has been heard before during earlier similar crises; this time the threat is real. Technically, Pakistan is already in default; given that there emerges a net negative balance, if the foreign loans that Pakistan owes to foreign interests are deducted from the foreign exchange reserves. This time, default can be avoided only by compromising some of our political sovereignty.

This crisis has not arisen as a ‘short-term cash flow problem’ phenomenon. It is rooted in long-term decay of the productive sectors of the economy. The analysis of the last quarter century performance of the economy shows that 25-year average growth rates of key crops and manufacturing sectors have ranged from negative to as low as one percent and has been consistently unstable.

Agriculture and manufacturing are the commodity producing base of the economy and has deteriorated to levels where output, exports, revenues and employment opportunities are effectively declining. GDP growth reported year to year is artificial, as wealth is being created largely through speculation in the stock market, the property market and the commodity market. Pakistan has become a casino economy and development projects are identified, not in the public interest, but by contractor (thekedar) interests. The management of the economy, particularly post-2000, has rendered the economy hostage to foreign interests.

The ashraafia have enough financial cushion to bear the brunt of the emerging crisis. In any case, all they will have to worry about is how to reach the airport to fly out to the safety of their stashed-away investments abroad. The awaam, the bulk of the population, will be left facing mass unemployment and inflation – and poverty and hunger.

The economic decline also poses serious threats to the security of the country. Pakistan’s armed forces personal are second to none in courage and bravery and have not been shy of making sacrifices in times of war on our borders and within. However, soldiers, sailors and airmen cannot fight with their muscles alone. They need armored cars and tanks and fighter planes and warships to carry the fight to the enemy. All of these need gasoline; gasoline costs dollars; dollars are earned through exports; and exports are generated by a vibrant manufacturing sector. Wars cannot be fought on the back of a collapsing economy.

The attached tables and graphs show the magnitude of the problem. Urgent and radical measures are called for to arrest further decline. There are two gaps: the dollar gap (current account deficit) and the rupee gap (budget deficit). The dollar gap can be addressed by reducing imports and by raising exports. The rupee gap can be addressed by reducing non-development expenditure.

12-point Economic Revitalization Programme

  1. Ban all non-essential consumer imports

2. Shift the basis of electricity generation from imported fuels to:

  • Hydel
  • Domestic coal
  • Off-grid solar

3. Rehabilitate Railways and shift bulk of inter-city goods transportation from road to rail transport [Rail consumes one-third less fuel per tonne/kilometer than road transport].

Set up a Holding Company to own Pakistan Railways and NLC and create an integrated goods transportation network: long distance by container trains and onward by container trucks.

4. Amend FDI policy to encourage investment that earn export value greater than profit remittance.

5. Reduce GST (Goods) rate to 5%; single stage (no adjustments, no refunds) to promote manufacturing.

6. Strengthen capital gains tax measures in capital markets to discourage short-term speculative trading.

7. Introduce principle of ‘Right of First Purchase’ in land/property transactions.

[Every proposed transaction, with details of size, structure and price, be placed on a designated website for, say, 20 working days and any third party to have first right to purchase the land/property at, say, 20% above the specified value. This measure will curb speculative trading in the land/property market.]

8. Introduce principle of ‘Right of First Purchase’ in imports.

[Every proposed transaction (Letter of Credit), with details of product and price, be placed on a designated website for, say, 20 working days and any third party to have first right to purchase the product at, say, 20% above the specified CIF value. This measure will curb under-invoicing and protect local industry.]

9. Revive PIDC’s role in setting up industries in PPP mode. Industries be set up by PIDC, with majority public funds and private management and sold to the private partner after achieving commercial production.

10. Fix retail gasoline price at $ 150 equivalent to conserve consumption and imports and to compensate for (short-term) revenue loss on account of reduction of GST (Goods) rate.

11. Reduce current expenditure, including non-combat defence expenditure by at least 20 percent.

The following spurious Ministries and Divisions be abolished:

  • Education and Training
  • Housing and Works
  • Human Resources and Training
  • Industries and Production
  • National Food Security and Research
  • Climate Change
  • National Harmony
  • National Heritage and Integration
  • National Regulation and Services

The following Divisions be merged with their original Divisions

  • Defense Production – Defense
  • Information Technology and Telecommunications – Communications
  • Postal Services – Communications
  • Revenue – Finance
  • Statistics – Finance
  • States and Frontier Regions – Kashmir and Gilgit-Baltistan Affairs
  1. Implement a 10-year federally funded scheme to develop one million small/medium sized urban residential serviced plots annually across the country.

The multiplier impact of the scheme will produce two impacts:

  • One, it will boost employment in a variety of sectors across the country.
  • Two, the increased household income will expand consumer demand and revitalize domestic industry.

 

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Enter the Liquidators!

Pakistan is now a target of the ‘predatory global capital’. This global capital has for years seen the Pakistan economy as increasingly dependent on foreign largesse and the State as weak and tottering, run by a self-serving civilian and military elite. In corporate terminology, it is considered a soft target for a hostile takeover, with little possibility of resistance and willing acquiescence from elements within the State apparatus. Collaboration in this regard has been forthcoming for over two decades from a stream of foreign and locally based Pakistani technocrats in the employ of global capital and willing and unwitting Establishment big-wigs and darbari economists and professionals – turncoats a la Mir Jaffars who have no qualms about selling a piece of their country. Continue reading

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Bane of Slave Mentality

The signing of a defence treaty between the United States and India in mid-2016 and growing defence ties between Pakistan and China amounts to history repeating itself –with different combination of players. In the 1950s, India allied itself with the erstwhile USSR, while Pakistan aligned itself with the US. Qualitatively, India’s relationship with the USSR and now with the US was and is different from Pakistan’s relationship with the US and now with China. India was and is not seeking Big Power protection against any enemy. Pakistan did and does. Continue reading

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