The economy of Pakistan has been trapped in a boom-bust cycle for the last two decades, wherein the duration between boom and bust is falling as structural reforms continue to be shelved, and an incessant obsession with consumption-oriented growth through borrowed capital squeezes the country’s fiscal position.
On a structural level, Pakistan’s industries are largely inward-looking, and exports have largely remained flat over the last decade. The country’s share of global exports continues to decline, as the focus of successive governments has never been the development of a competitive export-oriented industry. Pakistan doesn’t have thriving export-oriented industries, and what there is, is highly subsidised. From pulses to edible oil, and even basic machinery, what’s used and consumed is largely imported.
The country moved from export- to import-dependent in the last 15 years as it increasingly started relying on borrowed dollars to fund its growth through consumption. As the world moved away from a zero interest rate regime, and borrowed dollars started getting expensive, the country found itself in a liquidity crisis. To pay dollars, it needed more dollars, and those were not available. For Pakistan, the overall quantum of debt is not as big an issue as liquidity is.
It is rationing imports, and restricting it to essential items, such as energy, food and medicines. As the rationing continues, there will be destruction of industrial capacity, with industrial units starting to decay. For Pakistan, land and labour are effectively its core competitive strengths, but a competitive economy that leverages its strengths was never developed. It didn’t use land to increase the agricultural output through investment in yield, and thus maintains one of the lowest agricultural yields among its peers. Even after a disastrous few years, Pakistan will be importing another three million tons of wheat over the next 12 months, further fueling inflation, while also having in place a support price.
A complete failure to revitalise agriculture and enhance yields can be linked to overall sluggish economic performance. On the human capital front, we continue to underinvest in education and up-skilling of population. More than a quarter of the population of children under five are stunted, and almost 40% are malnourished – which does not bode well for a potential demographic dividend, which may turn into a demographic liability.
When various multilateral institutions and bilaterals gave loans to improve educational outcomes of children, or other interventions to improve social outcomes, the funds were largely used to finance imports for the elite, such as luxury cars, or to finance consumption. Resources were reallocated for consumption, and not investments.
About 85% of taxes are indirect. There needs to be an increase in direct taxes, and a broadening of the tax base. The taxes need to be increased for real estate, wholesale and retail segments, while an ever-increasing informal economy needs to be brought into the tax net. Real estate can’t be taxed because certain vested groups with considerable influence hold a significant chunk of it. If revenues are not increased, the fiscal deficit is only going to get wider, and it may not be possible to bridge the gap with more debt – as any more debt will result in potential hyperinflation. We have reached an edge, and pushing our luck more may have disastrous consequences.
Pakistan needs to start taxing the informal segment, and make formal business easier to do, and bring more sectors into the tax net. Like India, Pakistan needs demonetisation so that there’s money in the formal financial segment. Currency in circulation as a percentage of GDP is close to 20%, which is at its highest-ever level. The social cost of not demonetising and letting an untaxed informal economy thrive is much higher than the social cost of demonetisation.
In Pakistan, the informal economy is big, and it readjusts itself and cash keeps flowing. This parallel economy is not taxed. So the domestic economy keeps chugging along, thereby driving demand for imports in the formal economy. There’s no political will to fix the situation because many parliamentarians simply do not pay taxes themselves, and therefore, incentives are misaligned.
The country is endowed with significant physical, mineral, and human capital resources. There is a dire need to restructure and retool the economy to move away from consumption-driven growth, to investment-oriented growth. It is entirely possible to reduce the size of the informal economy and bring it within the ambit of the tax net – this will provide the necessary stimulus to the economy. There exists a dire need to formalise capital, and reorient that capital towards export-oriented industries. The demographic and economic dividend that can be unlocked through tactical interventions can enhance economic value generation across the region, and beyond. The problems can be fixed, but the will to fix them is non-existent.
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