Coming out of fiscal mess

The only conclusion that one can draw after listening to the President’s speech in the joint session of Parliament on March 17, 2012—this was the first time in the history of the country that an elected President addressed the same parliament for the fifth time—is either he is totally aloof of the economic realities of Pakistan or hoodwinking the people is still his favourite pastime. During his 35 minutes speech, half of which was overshadowed by the opposition’s constant shouting, the President was mainly boastful of what the Pakistan People’s Party-led coalition government did in its four years and spoke little about its agenda for economic reforms and strategy to overcome the present fiscal chaos in the last year of its term that is expiring in March 2013.

The persistent failure of successive governments—military and civilian alike—to overcome budgetary deficit, remove fiscal imbalances and check ever-increasing wasteful expenditure has created a situation, where the very economic viability of the State is at stake. This year, the federal government is heading towards a massive shortfall in achieving its budgeted non-tax revenue target in addition to expected shortfall of Rs. 25-30 billion in tax revenues. But even if Federal Board of Revenue succeeds in collecting target of Rs. 1952 billion, the capping of fiscal deficit at 4.7% percent of the GDP is not possible at all.

In the first seven months of the current fiscal year (July 2011-June 2012), the government collected only Rs. 231 billion on account of non-tax revenues against revised target of Rs. 677 billion. The target of non-tax revenue was revised downwards from Rs. 780 billion to Rs. 677 billion. Against this revision on account of non tax revenues, the government had revised its budget deficit target upwards by 0.7 percent from 4 percent of GDP to 4.7 percent of GDP.

In the remaining period of the fiscal year, collection of Rs. 446 billion is a daunting task due to dependence on unpredictable inflows from the United States in the shape of coalition support fund (CSF) and doubtful and controversial auction of 3G licence. In the budget for 2011-12, the Ministry of Finance projected Rs. 119 billion ($1.34 billion) by calculating Rs. 84/85 against the US dollar on account of CSF in the current fiscal year, which was later on revised downwards to $ 800 million. Now the Ministry of Finance conceded that they expect only $ 400 million on account of CSF even after normalisation of relations with the USA and this money is likely to be received before end June 2012.

There is also shortfall in petroleum levy (PL) and snags in expected instalment of $ 800 million due from Escalate. All the indicators show that the existing worrisome situation on fiscal front is going to deteriorate further. It will force the government to borrow more from the banks. The International Monetary Funds (IMF) in its recent report has accused State Bank of Pakistan for directly and indirectly financing the government’s budget deficit. It termed the monetary policy “too accommodative”.

According to Press reports quoting official documents, “domestic debt ballooned to around Rs. 7 trillion by end-January, a net increase of Rs. 953 billion since July 2011. Of the total figure, the share of treasury bills stood at Rs. 2.4 trillion, a third of total debt. Similarly, the share of market treasury bills was slightly over a fifth, standing at Rs. 1.4 trillion. Investment bonds made up 12% of total debt as the government borrowed Rs. 882 billion through auctions. National savings schemes are the second biggest source of government borrowing. Their share was around Rs. 2 trillion, 29% of total domestic debt”.

In the first nine months of the current fiscal year, the gap between national income and expenditure widened to 5.5 percent of total national output or Rs. 1,153 billion, according to provisional estimates. Rates of return on treasury bills also rose in March 2012:  on three-month bills, the yield increased to 11.83%, up 23 basis points than the January 2012 rate and on six-month papers, the rate went up to 11.9%, 27 basis points higher than the previous auction.

Heavy and high government borrowing, especially from banks, is causing not only inflation but has destroyed the entire growth and expansion of the economy. Banks are not lending money to the private sector as they earn super and risk-free profits by lending to the government. According to news reports, four large private sector domestic banks “have tied up Rs. 1.478 trillion in government securities as on December 31, 2011 providing them comfort of secured loans at a reasonably high mark-up while crowding out credit for the private sector”.

The advance-to-deposit ratio of the four banks, namely Habib Bank Limited, United Bank Limited, MCB Bank Limited and Allied Bank Limited according to their annual reports for the year 2011 was 52.55 percent, 59.76 percent, 50.52 percent and 65.61 percent, respectively. The total amount tied up in government securities as on December 2011 was 47.06 percent of the total assets of HBL, 44.99 percent of the total assets of UBL, 60.68 percent of the total assets of MCB Bank, and 44.82 percent of the total assets of ABL.

Analysis of amounts tied up in the government securities like treasury bills and Pakistan Investment Bonds as on December 31, 2011  reveals that Habib Bank Limited has an exposure of Rs. 500.64 billion of which Rs. 46.047 billion were with State Bank of Pakistan, Rs. 14.675 with National Bank of Pakistan, Rs. 268.80 billion in treasury bills, Rs. 70.81 billion in Pakistan Investment Bonds (PIB), Rs. 16.07 billion in Ijara Sukuk Bonds (ISB), Rs. 425 million in WAPDA Sukuk and others, Rs. 73.37 billion as advances to the government and Rs. 10.418 billion as advance tax.

MCB Bank with Rs. 390.35 billion has the next largest exposure with the government of Pakistan. Out of this, Rs. 2.713 were bank’s balances with the State Bank of Pakistan, Rs. 15.23 with NBP, Rs. 256.59 in treasury bills, Rs. 1.54 in euro bonds, Rs. 4.10 in ISB, Rs. 800 million in WAPDA Sukuk, Rs. 49.08 as advances to the government and Rs. 5.99 billion as advance tax.

Exposure of the UBL is to the tune of Rs. 350.05 billion out of which balance with SPB amounts to Rs. 26.966 billion, balance with NBP Rs. 22.251 billion, treasury bills Rs. 167.43 billion, PIB Rs. 52.21 billion; euro bonds Rs. 7.37 billion, ISB Rs. 7.96 billion, WAPDA Sukuk Rs. 51 million, advances to government Rs. 63.71 billion, advance tax Rs. 3.09 billion. The lowest exposure of Rs. 231.59 billion was that of ABL having balance of Rs. 22.15 with SBP, Rs. 7.13 with NBP, treasury bills worth Rs. 122.01, WAPDA Sukuk valued Rs. 1.59 billion, advances to the GOP Rs. 48.95 billion and advance tax Rs 1.59 billion.

Since the government’s appetite for borrowing is increasing every day, the commercial banks are least pushed to market their credit products to the private sector as they consider government borrowing risk-free. It is disastrous for national economy. A near-bankrupt government wrought with corruption and devoid of governance is playing havoc with people’s money lying in banks. The four leading commercial banks now owned by seths (vernacular term for crafty business tycoons) are earning billions but not passing on due benefits to the account holders in violation of the existing profit and loss sharing scheme (sic) between the banks and depositors/investors or even as much as helping the private sector in opening new vistas of job opportunity for the unemployed.

The larger banks are strengthening their current accounts and saving accounts (CASA) portfolio to earn more even if they lend to the government sector where they do not usually get premium over the policy rate of the central bank. The data of the four banks reveal that MCB Bank with CASA of 80.9 percent is the leader in this regard meaning that only 19.1 percent of its 491.189 billion deposit base consists of high mark-up term deposits. The CASA of ABL was 72.45 percent with a deposit base of Rs. 399.56 billion. The CASA of HBL was 71.90 in deposit base of Rs. 875.30 billion while UBL’s CASA deposits were 71.86 percent in total deposits of Rs. 612.98 billion. HBL in 2011 earned after tax profit of Rs. 20.74 billion, MCB Bank earned Rs. 19.42 billion, UBL Rs. 15.5 billion, and ABL earned Rs. 10.14 billion. Cost of deposit ratio of 4.17 percent was lowest in the UBL, followed by the MCB Bank at 4.25 percent, HBL at 4.77 percent and ABL at 5.21 percent. MCB had the highest capital adequacy ratio of 21.79 percent, followed by HBL 15.15 percent, UBL 14.28 percent and ABL 12.80 percent.

The most lamentable aspect of the existing scenario is apathy of banks towards account holders and people in need of money either for starting their business or expanding the existing ones. They are concentrating on low cost accounts and earring enormously from the government that shows no sense of responsibility towards masses or economy. The government is engaged in endless borrowing and then ruthlessly wasting the funds rather than employing them on productive projects. What makes the situation more tragic is cutting of development spending under the Public Sector Development Programme against budgetary allocation.

It is a pity that total gap between current expenditure and tax collection is over Rs. 600 billion. We cannot overcome our budgetary gap unless rulers drastically cut non-developmental wasteful expenditure and increase tax collection. They will have to show political will in collecting taxes wherever due by abandoning the policy of appeasement towards the rich and mighty. An unshakable determination with consistency is required to curb the 64-year-old habit of defying tax laws along with complete purge in tax machinery. Do fiscal managers really know why our total revenues have fallen from 18% of the GDP to 10% of the GDP during the last twenty years? The answer is NO.

Presently, the collection of taxes by FBR is mainly based on imports and exports as well as extraordinary profits by banks (who claim they have profit sharing accounts yet deny due share to deposit-holders!). Importers, contractors, retailers and even service providers are, in fact, passing on their tax burden to consumers and clients, courtesy presumptive tax regime introduced in income tax in 1991-92 and widened manifold since then. This erratic taxation is at the expense of equity and poor people are the real victims of this fiscal highhandedness.

It is an established fact that despite resorting to all kinds of highhandedness, illogical policies and unjust withholding taxes, FBR has failed to improve the tax-GDP ratio, which is below 10% for the last many years. The burden of a number of presumptive taxes levied under the income tax law (which are nothing but crude forms of indirect taxes) has been shifted from income earners to consumers and clients. These presumptive taxes have not only distorted the whole tax system, destroyed economic growth and made the consumer/client the ultimate sufferers but these despotic, short-term, myopic and figure-oriented measures have even failed to bridge the fiscal deficit, which is estimated to soar to Rs. 1800 billion this year.

The men in power say that 64 years of problems cannot be resolved in a few months or even during the 5 years’ term for which they have been elected. Their main problem is how to deal with powerful tax machinery, which is inefficient and corrupt. On the recommendation of tax bureaucracy, successive governments have been announcing unprecedented concessions for the corrupt in the form of tax amnesty and money-whitening schemes and latest one is for investors (sic) in stock markets which is the worst of all. The rulers admit massive tax evasion through these schemes and no further proof is required of the criminal culpability of tax officials in the entire episode. It is an unholy alliance between corrupt politicians and tax bureaucrats. Through these schemes, tax bureaucrats please their masters, who are the plunderers of national wealth.  If elected representatives are sincere in mending the situation, they should pass asset-seizure legislation and confiscate all ill-gotten and untaxed assets for the benefit of have-nots.

In the wake of such a bold step, resource mobilisation will not be a problem any more.  Once political elite starts paying tax and control wasteful expenditure on personal perquisites, the rest of the nation will follow their footsteps. The rich and mighty, which do not pay taxes, should be taken to task. If the present government brings big absentee feudal landlords into the tax net, manages to get taxes from the influential ones and succeeds in imposing sales tax across the board (preferably with a low rate of 5% at one single point), there would be no budget deficit. This goal can only be achieved if the government simultaneously tackles issues related to tax evasion and rampant corruption in the tax machinery (by not just throwing them out of jobs but rather, making the system workable and just). Pakistan is quite capable of substantially reducing or even eliminating its fiscal deficit within few years provided that a comprehensive programme, well designed work plan, scientific approach and multi-dimensional strategy is adopted for rapid economic growth, tax reforms and resource mobilisation.

The writers, tax lawyers and partners in Huzaima Bukhari & Dr. Ikramul Haq (Taxand Pakistan), are Adjunct Professors at Lahore University of Management Sciences (LUMS).