Pakistan has enjoyed some economic growth, largely on the back of the China-Pakistan Economic Corridor, while security has improved and more reliable power supply should aid investment. But the deep-seated problems of tax avoidance and corruption persist. Edward Russell-Walling reports.

Pakistan economy

Pakistan’s economy is somewhat irrational. Though much of it is ‘informal’, to use the local euphemism, underlying activity and growth are positively robust. Yet its public finances are once again in poor shape.

Politicians, now preparing for a July 25 general election, seem to know what is needed to put things right. But few believe that the centre-right Pakistan Muslim League – Nawaz (PML-N), or the leftist Pakistan People’s Party (PPP), which have dominated civil government until now, will risk the attendant unpopularity.

Meanwhile, economic growth continues. ‘Formal’ gross domestic product (GDP) growth in the financial year to June 2017 was a creditable 5.4%. The outgoing government projected 5.8% growth in financial year 2018, based on nine-month data. The State Bank of Pakistan (SBP) and independent economists are slightly less sanguine, but even the International Monetary Fund (IMF) is expecting 5.6%.

Manufacturing uptick

At the halfway mark of 2018, large-scale manufacturing in Pakistan was expanding faster than the year before, thanks to healthy consumer demand and buoyant construction activity (all black money, according to one investment banker). These stimuli are likely to support the industrial sector through to the end of 2018. Pakistan’s rapidly growing car market has now attracted Nissan, which will start producing its Datsun brand in the country in 2019. 

Growth in agriculture is looking more muted, partly because water shortages have restricted the area under wheat cultivation. Water scarcity is a serious long-term threat to the economy, with some observers warning that Pakistan will run dry as early as 2025.

A weaker rupee and improved demand in Western markets helped official exports to grow by 11% in the first half of financial year 2018, compared with a 4% fall in the same period of financial year 2017. Growth in imports almost doubled from 9.8% to 18.1%, partly reflecting an increase in energy prices. The growing trade gap and resulting drain on foreign reserves will probably oblige any new government to call in the IMF.

The China-Pakistan Economic Corridor (CPEC) has been boosting imports over a more sustained period. Promising $62bn of investment, this collection of infrastructure projects is a keystone of China’s Belt and Road Initiative. It turns Pakistan into a transport corridor for Chinese imports and exports, running from their shared border in the north down to the Arabian Sea port of Gwadar.

So far, CPEC has consisted mainly of power-related projects funded by Chinese banks. But the hope is that once improved road and rail infrastructure is in place, Chinese companies can be lured to Pakistan to manufacture value-added exports or import substitutes. CPEC will eventually increase Pakistan’s GDP by 2% to 3%, according to the Ministry of Planning.

“The danger of CPEC is that Pakistan gets overwhelmed,” says one senior Pakistani banker. “The Chinese are much more organised, and there’s a question over Pakistan’s capacity to absorb it all.”

One-way street?

Some commentators see CPEC as a one-way street in which China gets most of the benefits and Pakistan spends the next 40 years picking up the tab. Many working within local industries want Pakistan’s 'poorly negotiated' free-trade agreement with China renegotiated, to stop Chinese imports killing off domestic manufacturing in sectors such as clothing and glassware. 

Others think China’s motives are as much geopolitical as economic, and that it has a vested interest in the stability and prosperity of its southern neighbour. “What makes us special [to China] is India,” says Dr Mushtaq Khan, a former SBP economist now running his own consultancy, Doctored Papers. “We keep India at bay. And China doesn’t want a 200 million-strong nuclear-armed neighbour being unstable, especially with what’s happening in the Middle East.”

Some notorious obstacles to investment in Pakistan have been coming down. Until recently, industry was hobbled by load-shedding that regularly disrupted power supply. Energy investment has now largely solved this issue, at least for big industrial customers, though tariffs have shot up and the underlying problem of circular debt in the energy sector lingers.

We keep India at bay. And China doesn’t want a 200 million-strong nuclear-armed neighbour being unstable, especially with what’s happening in the Middle East

Mushtaq Khan

Law and order and security have improved significantly. The army has effectively won the war against the Pakistani Taliban. Paramilitary crackdowns have greatly reduced political and criminal violence in cities such as Karachi. Expensive cars now cruise city streets where, before, they would have invited robbery, hijack or worse. Asked what better law and order meant to him, one Karachi banker said that he could now take his wife for a walk in the park in the evening.

Taxing problem

Pakistan’s most endemic economic problem is harder to crack – the failure of almost everyone, including a majority of parliamentarians, to pay taxes. Feeble tax revenues are at the root of most of the country’s other problems, not least a rising budget deficit. Successive governments have been well aware of this, but have lacked the backbone – or, having begun to act, the stamina – to fix it. 

Doctored Papers’ Mr Khan believes the civil service, once able to defy political pressures, has become part of the twin deficit problem. He points the finger at the central bank, the tax authorities and the Ministry of Finance itself, among others. “Shallow economic reforms and short-term policy measures have characterised the operations of each of these institutions for a while,” he writes in a recent paper, Reality Bites. 

Some tax avoidance is inexplicably legal. In one of the most glaring anomalies, agricultural income is exempt from federal tax. But most is simple evasion; undervaluation of real estate for tax purposes is legion, for example, and only 1.2 million of the 207 million population bother to file a tax return. Big manufacturers are burdened unduly, accounting for 13.5% of GDP but paying 58% of all direct taxes, the Pakistan Business Council complains.

The outgoing PML-N government announced major tax reforms shortly before making way on June 1 for a non-political caretaker government, as is constitutionally required before polling day. The reforms seemed more like an election manifesto than a reform package, and included cutting the maximum tax rate from 30% to 15%, ostensibly as an incentive for non-filers to file. There was an amnesty for undeclared assets both inside and outside Pakistan, with penalties ranging from 2% to 5%. Repatriation, which would boost foreign reserves, was not mandatory.

Another proposal, a watered down version of an Indian tactic, gave the government compulsory purchase rights over any real estate at twice its declared value. In India, the premium is only 25%. Moreover, non-filers could only buy one car, and then only up to a certain value.

Political issues

Will whoever forms the new government at the end of July have any real appetite for tax reform? The frontrunners are PML-N, PPP and Pakistan Tehreek-e-Insaf (‘movement for justice’ – PTI), founded by former international cricketer Imran Khan.

The Supreme Court has permanently barred PML-N’s former prime minister, Nawaz Sharif, from politics, after an investigation into family assets. His former finance minister fled to London accused of corruption. Voters increasingly see leadership of the two main parties, past or present, as tainted, and PTI has been gathering support in consequence. 

“Imran has no depth, he’s unpredictable and he shoots from the hip,” says one local banker. “But no one can accuse him of corruption.” Mr Khan’s party already governs Khyber Pakhtunkhwa province, where it has effected much-admired police, health and education reforms.

The PML-N retains widespread support in Punjab, the most populous province. But in Pakistani politics, the army is never far away. It is said that the ‘establishment’ – for which read the army and the judiciary – has set its face against the PML-N and the Sharif clan.

This has prompted some parliamentary defections to PTI, which is now expected to do well in the election, though perhaps not well enough to form a government. Many predict a hung parliament, possibly producing a PTI-led coalition with the PPP. 

Dealing with deficits

The new government will inherit threatening trade and fiscal deficits, allowed to worsen since the last IMF programme ended. It faces worsening relations with Donald Trump’s US administration, which has frozen military aid while moving closer to rival India. Nonetheless, Pakistan can still count on China as its 'all-weather' friend.

If GDP growth was indeed 5.8% in financial year 2018, that would be the economy’s best performance in 13 years. It may also represent a peak. Since China is not planning to be its new lender of last resort, the incoming government will surely call in the IMF.

A new IMF programme would probably insist on further devaluation of the rupee, together with tighter monetary and fiscal policies, causing a slowdown in growth. Based on that scenario, Standard Chartered senior economist Bilal Khan is forecasting growth of only 4.8% in financial year 2019.


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