Spearhead Analysis – 14.03.2017
By Farrukh Karamat
Senior Research Coordinator, Spearhead Research
The Government continues with the policy of granting or gaining fiscal concessions to accommodate the apparently growing fiscal gaps. The latest concession includes the waiver of 15 per cent income tax on the profit that foreign commercial banks are earning on approximately US$2.5 Billion loans extended to Pakistan from 2013-2106 to bolster the foreign exchange reserves. These loans reflect the Government’s continued inability to gain traction in terms of increasing Exports, Remittances, or Foreign Direct Investment (FDI); while rising Imports and other outflows continue to worsen the balance of payments situation.
Since 2013, the government has borrowed around US$3 Billion from different foreign commercial banks, in addition to some US$4.5 Billion borrowed through issuance of dollar-denominated Euro and Sukuk Bonds, secured in some cases by national assets. The current account deficit has continued to worsen and has touched a level of US$4.7 Billion in the first seven months FY2016-17, with high levels of CPEC-related imports, persistently low exports, stagnant-to-declining remittances and no appreciable FDI. The trade deficit has now crossed the US$20 Billion mark during the current fiscal year.
With pressure from increasing outflows and no matching inflows, the once apparently robust foreign exchange reserves are starting to come under pressure and funds held by the State Bank of Pakistan and Commercial Banks have dipped below the US$22 Billion level, after having crossed US$24 Billion last year. It is expected that reserves would continue to remain under pressure with no appreciable increase in expected inflows over the coming months. The possibility of a ‘devaluation shock’ cannot be ruled out in the short-to-mid term. The government has been ‘managing’ the exchange rate, which did not allow the currency to trade at its normal levels, and as a result any potential one-off devaluation impact could be significant.
In the recent past while seeking approval for the Sukuk offering the Government, through the Ministry of Finance, accepted that the trade deficit was worsening and the balance of payments were under pressure. This was a classic example of continuing to place reliance on additional borrowing instead of instituting structural reforms to improve inflows into the country. This is something that has still not been done, apart from some cosmetic measures to boost exports in certain ‘favoured’ sectors through grant of relief packages.
The recent tax concession decision was basically taken last month by the Federal Cabinet, without consulting the National Assembly. The cabinet also provided ex-post facto approval of the debt that the Ministry of Finance had taken, which had raised transparency concerns recently. Transactional Transparency is an issue that continues to be voiced by different quarters, especially in the context of CPEC-related investments and loans.
After having recently changed the debt definition parameters and goal-posts for Debt-to-GDP ratio, the government has now waived the taxes on the profits for the commercial bank from these loans. The major beneficiaries of the 15 per cent tax concession include institutions such as Credit Suisse AG, United Bank Limited, Allied Bank Limited, Noor Bank of UAE, Standard Chartered, Dubai Islamic Bank and China Development Bank. It is unfortunate that the smaller customers depositing their savings are being subjected to Witholding taxes on all transactions over Rs.50,000 and being taxed on the profits that they receive on their deposits, yet the financial big boys are being exempted from paying taxes.
The loans from the commercial banks were obtained during the period 2013-2016 at interest rates linked to LIBOR and range between 3.5 per cent to 4.7 per cent in US Dollar terms. The Governments decision is deemed beneficial for these Banks at a time when the international borrowing cost remains at historically low levels. The Ministry of Finance has confirmed that “foreign commercial loans are offered with the condition that taxes applicable in Pakistan would not be borne by the lenders”.
During the past three years the government has been unable to bring about any meaningful improvement in inflows, which have actually worsened. At the same time reliance has continued to be on building reserves through borrowings. The fiscal gaps are also being plugged through additional borrowings. Hence the almost astronomical levels of debt, and the governments’ efforts to mask the burden through constantly moving the fiscal goal-posts and granting of concessions. There is a need to bring about structural changes to improve competitiveness of the Pakistani exports and jump-start the manufacturing sector. Infrastructure development is good, but development for enhanced revenue generation should be the priority. Only then would the government be able to move towards reduced reliance on borrowings and climb out of the debt trap.