Compliance or Bust

Spearhead Analysis – 15.11.2018

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

It is estimated that Pakistan’s GDP is much larger than the official fi­gure of around US$300 Billion. This is because the offi­cial data does not capture the contribution of the informal or undocumented economy, which as per some estimates varies between 30 per cent and 90 per cent of the offi­cial GDP. Within this range of the contribution coming from informal economy, the actual GDP of Pakistan economy can safely be estimated at around US$450 – 500 Billion. Given the size and scale of the informal economy, which is large and significant, there is a clear potential of market distortions, poor governance and disproportionate administrative regulations. It is this lack of accounting and transparency that is leading towards greater economic problems as a cash-starved government with rampant corruption, struggles to meet the rising deficits. The low levels of compliance and evidence of money-laundering on a massive scale has further complicated the situation as Pakistan struggles to be complaint with the Financial Action Task Force (FATF) regulations.

Recently, there has been news of the fake bank accounts and the billions being transferred through these accounts. To date no progress appears to have been made in this regard to nab the real culprits behind these scams through proper forensic audits and investigations. This was followed by up news of Banks being hacked and again millions being siphoned out of consumer accounts. This is symptomatic of a wider malaise inflicting the economy – lack of compliance or the understanding that one can get away with murder given the archaic and weak systems within these organisations and the regulatory bodies. Rampant tax evasion is being tolerated and minimal efforts are being made to expand the tax base and make collection easier. These are issues that are costing the country dearly, draining the much-required funding from within the system due to inherent inefficiencies that are being deliberately tolerated. Compliance needs to be strengthened across the economic and financial eco-system to conserve resources and enhance efficiency in their use. It is very easy to impose regulatory duties – the need is for enhancing real revenue from the money available within the undocumented economy.

It is a noble thought to have a vision of an Islamic Welfare State and Social sector programmes of low-cost housing and healthcare, but for that the government needs real money to fund the projects. At the moment the financial managers are scrambling for loans from different sources to plug the huge deficits. Unless the government can carry out the required institutional reforms to boost tax collection through an expanded tax base and document the economy, Pakistan would continue to face major economic issues. For that the undocumented sector has to be phased in to the documented sector to improve financial compliance. At the same time there is a dire need to increase the industrial base to enhance exports, reduce reliance on imports and provide meaningful employment to the huge and growing population youth bulge.   

In an effort to rein in the rising imports the government has followed a dual strategy of raising regulatory duties and devaluing the Rupee. In line with this the government imposed regulatory duty on import of 36 new products and raised its rates on the existing 240 items in October 2018 to try and curtail the rising trade deficit. The Federal Board of Revenue (FBR) recently issued a notification for the regulatory duties on 731 tariff lines, increasing the regulatory duty by 5 to 10 per cent on the import of 570 ‘luxury’ items with an aim to curtail imports and strengthen the local industry. These regulated items include daily use consumer items, which would contribute towards fueling further inflation; with question marks over the production and availability of lower cost locally produced alternatives. According to the FBR, the purpose of imposing the regulatory duties was to curtail imports and in the process add Rs.8 Billion in revenue through the levy of regulatory duties.

Adding to the woes of the consumers is the falling value of the Rupee, which has shed almost 27 per cent in value against the US Dollar since December 2017. The government has also increased the prices of gas, electricity and petroleum products, with further hikes expected in the wake of the IMF bail-out package. The immediate impact is a rise in the cost of living for the people as these price hikes translate into immediate price increases for consumer products. With a large number of consumer products imported into Pakistan including items of daily use, this would translate into higher costs and lower disposable income for the people. The automobile companies have been the leaders in terms of price hikes and have raised their prices repeatedly since December 2017, while providing low specification and low quality standards.

It is all very well to raise the prices on imported goods, but the emphasis then has to be on providing comparable lower cost products within the country through import substitution. Taking the example of automobiles, the consumers are being burdened with sub-standard products and low service levels at high prices. These products are not as per global manufacturing standards and one fails to understand how can companies such as Toyota, Honda and Suzuki allow product degradation in the case of Pakistan, at such high prices and low quality, safety and comfort features. Again an issue of our weak compliance structures, which allow these manufacturers to get away with such practices at the cost of the consumer, while adding Billions in profits to their bottom-lines.

It is the same story across the other product lines as sub-standard goods are being produced locally in basic categories, including food. There needs to be an emphasis on raising manufacturing standards to bring them in compliance with international requirements. It is all very well to raise prices and shift the burden on the consumers, while filling the coffers of the state with regulatory duties on quality products, but there has to be concern for what the consumers are being dished out and their safety and health should not be put on the line at any cost.

A recent case is that of bottled water, where the bottlers were paying a minimal charge for extraction of ground water but were charging exorbitant rates for apparently sub-standard water (as per recent media news). The Chief Justice of Pakistan has once again come to the rescue and has asked the bottlers to pay Rs.1 per liter of water to the government in the form of a levy or duty. The bottlers will of course transfer this amount to the price of their product and the consumer will be burdened with an additional cost. In the process the already low levels of ground water would continue to be further depleted as Pakistan marches towards the ranks of a water-stressed country. The need is for a multi-pronged strategy where the State needs to ensure that useable water is available in the country negating the use of bottled water. If at all the bottled water is required, then perhaps we should not be depleting our meager water resources but rather importing the water and imposing a duty for its consumption in the country. Those who can, will buy it, the state will collect duties, while our resources would be conserved. At the same time the State could ensure the quality of the local water while the imported water would be up to higher standards, reducing the ill-health effects for the users.

With rising input costs on raw materials, utilities and manpower; low competency levels and technology and a lack of investable funds and incessant governmental intervention it is difficult to determine who would invest in Pakistan to set up import substitution industries. There has to be a clear-cut strategy for attracting investment in the country on a long-term basis with adequate legal and constitutional coverage. In the absence of that we would continue to flounder and sink.  As of now the confidence levels in the PTI led government appear to be declining as the government has not exhibited the required professionalism, planning or pragmatic strategy that was the need of the hour. An ominous lack of direction and communication is inflicting immense damage by fueling uncertainty and speculation. For an economy that has for years survived on an undocumented parallel system it is important to phase in a robust economic plan to gradually bring in the undocumented sector into the mainstream documented realm. A harsh, extractive, and accusative overnight stance will do more harm than good as the money would flow out of the country rather than into productive uses within it. Prudence and a conciliatory approach alongside simplification of documentation and reporting requirements is the need of the hour; alongside transparency and objective accountability to infuse confidence in the system, reduce corruption levels and ensure compliance with the required international standards.