Duty Enhancement – Another Knee-jerk Reaction?

Spearhead Analysis – 19.10.2017

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

The debt burden or deficit levels by themselves are not a particularly worrisome factor. Countries such as the USA are operating with far higher levels of debt and deficits than Pakistan. The danger is the relative inability of a government to govern and institute appropriate policies to improve the mechanism for enhancing the inflows. Having been embroiled in one self-created controversy after another, the focus of the Pakistan Government has remained on conflict and self-preservation at the cost of the country. Ill-guided expensive projects took precedence over ground realities and a will to bring genuine improvement through capacity building and revenue enhancement. This has delayed much needed reforms as the government continues to rely on a patch-work of policies in the different economic spheres, which come across more as knee-jerk reactions, rather than well-thought out policies and plans.

In FY2016-17 Pakistan’s foreign debt servicing amounted to US$8.16 Billion, up 53 per cent over FY2015-16. Of this amount US$6.54 Billion was in principal repayment, while US$1.62 Billion was the interest component. It is expected that there would be a rise in the debt servicing cost in FY2017-18 as the government continues to increase its borrowing to bolster reserves, given the precedent of having borrowed US$4.4 Billion at commercial rates in in FY2016-17 for this purpose.

Despite measures to shore up reserves through commercial borrowing, the government has been unable to arrest the decline. As of October 6, 2017, the reserves stood at US$19.67 Billion with SBP reserves of US$13.78 Billion and commercial bank reserves of US$5.88 Billion. This is in sharp contrast to the peak in October 2016, when the reserves stood at US$24.02 Billion, with SBP reserves of US$18.92 Billion and commercial bank reserves of US$5.10 Billion. On an overall basis the reserves have declined by 18 per cent during the past one year, with SBP reserves down by 27 per cent during this period.  The decline in reserves is indicative of a developing situation, where the economy is coming under increasing strain as the outflows continue to outpace the inflows. While the government continued to borrow with relative impunity over the past four years to manage the fiscal and trade deficits, this cannot continue indefinitely.

The trade deficit has continued to balloon, and is being bridged largely through the meagre inflows. Pakistan’s trade deficit touched an all-time high of US$32.85 Billion during FY2016-17, recording an annual growth of 37 per cent. In the first quarter of FY2017-18 Pakistan’s trade deficit widened by 29.75 per cent to US$9.08 Billion as per Pakistan Bureau of Statistics (PBS).

During this period imports registered an increase of 22.19 per cent to US$14.26 Billion as compared to US$11.67 Billion in the corresponding quarter of the last fiscal year. The increase in imports has been attributed to the rise in import of petroleum goods, food products and capital goods. The exports exhibited growth of 10.84 per cent to US$5.17 Billion in the quarter as compared with US$4.66 Billion in the same period of the last year. Exports have continued on an upward trajectory from March 2017, after the announcement of the Rs.180 Billion relief package by the government of Pakistan in January 2017.

As per data from SBP, the current account deficit touched a record high of US$12.1 Billion (4 per cent of GDP) in FY2016-17. In the first two months of FY2017-18 the current account deficit has widened by 102 per cent and stands at US$2.6 Billion compared to US$1.29 Billion in the same period of the previous fiscal year.

After the January 2017 policy of enhancing the cash margin requirements for imports failed to achieve the desired results, the government in a bid to control the rapidly rising imports and deficits has made a policy change after the first quarter of the current fiscal year. It is an attempt to control the rising import bill through enhancing the regulatory duties by up to 350 per cent on 356 essential and luxury items. This includes a rise in regulatory duties on all types of imported cars, including hybrid vehicles. The decision to enhance regulatory duties on cars may be in violation of the automobile policy, approved earlier by the federal cabinet, and could affect investments in the sector.

With imports of around US$53 Billion it remains to be seen how serious the government is in maintaining the regulatory duties and whether it will be forced to back-track on its recently announced policy. It is estimated that the government will be able to generate around Rs.40 Billion in additional revenues through these regulatory changes. It is also expected that the additional duties may help contain the import bill during the current fiscal year. These regulatory duties are in addition to up to 20 per cent custom duties rates that the federal government charges on the imports.

The category-wise regulatory duties for some of the major items are detailed below:

  • Items such as baby wipes have 30 per cent;
  • Firearms 20 per cent, while fruits and juices 50 per cent;
  • Non-alcoholic beer 20 per cent, while aerated water has 40 per cent;
  • Regulatory duties on dairy products up by 166 per cent on products such as yogurt, butter, cheese, curd and honey;
  • 203 vegetables and fruits have been targeted with up to 350 per cent increase in their existing duty rates. The regulatory duty on potatoes has increased from 15 per cent to 50 per cent and on frozen fruit and juices to 50 per cent;
  • Shelled items 45 per cent;
  • Duties on all types of cosmetics have gone up by 233 per cent to 50 per cent;
  • Duty on marble has been increased 125 per cent to 45 per cent of the value;
  • The regulatory duty on imported furniture has been doubled to 40 per cent;
  • All sports goods have been slapped with 30 per cent to 50 percent regulatory duty; 
  • There is a 15 per cent regulatory duty on new cars up to 1800cc, including hybrid vehicles;
  • The new mini vans and buses have been targeted with 15 per cent regulatory duty;
  • Duty rates on new sports cars have been increased by 60 per cent to 80 per cent of the import value;
  • The old and used car duty rates have been increased from 50 per cent to 60 per cent;
  • The duty rates on all-terrain vehicles have been increased from 50 per cent to 80.

The imposition and enhancement in the regulatory duties will have an inflationary impact on the economy, and the IMF has expressed the view that such administrative measures would not yield the desired results and the government may have to review the import policies.

Some positive developments have taken place in recent months. Remittances, increased by one per cent in July-September 2017 to US$4.79 Billion, but remittances in September 2017 were down 33.8 per cent over August 2017. This could indicate that the increase in the first two months of the current fiscal year was due to Eid and is not a sustainable increase. In such an eventuality there would be further pressure on the economy, with rising outflows.

As per SBP there was a 56 per cent increase in the foreign direct investment (FDI) during the first quarter of FY2017-18 on YoY basis. With an increase of US$238.5 Million, the inflows surged to US$662 Million from US$423 Million of the last year first quarter.

The government continues to face problems due to the widening current account and trade deficits. The foreign exchange reserves continue to be under pressure though with a rise in foreign remittances, FDI, and exports it appears to be a better start for the current fiscal year. The exchange rate has been controlled, but there is a potential as well as pressure for devaluation. The government is said to be planning to borrow from the international market through Islamic bonds in the range of US$500 Million to US$1 Billion, and the cost of such borrowing would be a crucial factor for future repayments. Given that the country is mired in a political tussle, with the sitting Finance Minister on the verge of being indicted by the courts, it is indeed a difficult time, for it is now that economy needs the maximum impetus.