Pakistan is currently grappling with a severe economic crisis characterised by escalating electricity and fuel prices and a depreciating foreign exchange rate, resulting in widespread public discontent. The public and business communities are vociferously protesting against the surging electricity bills, which are anticipated to escalate further due to the persistent devaluation of the national currency and the elevated cost of imported fuel.
This dire economic scenario has been exacerbated by a protracted impending sovereign default situation, mainly stemming from the delay in the International Monetary Fund (IMF) review and the looming risk of non-completion of the IMF programme, a concern that has persisted for the past several months.
Despite the approval of a substantial stand-by arrangement (SBA) of US$ 3 billion in July 2023, the economic challenges afflicting the nation have not been alleviated. Because, the IMF assistance always comes with some conditionalities, performance indicators and targets. The conditions attached to the IMF assistance have, in many ways, exacerbated the situation, making it arduous for the current interim as well as the outgoing government to provide any form of financial relief or subsidies. This situation necessitates a comprehensive re-evaluation of the economic policies and strategies.
At the heart of Pakistan’s economic woes lie critical blunders in the energy sector. One pivotal fault was the Independent Power Producer (IPP) policy introduced in the 1990s and continued after that, particularly the practice of fixed capacity payments to IPPs. This approach has been detrimental, contributing to an unsustainable energy mix heavily reliant on imported fossil fuels, leading to exponential growth in the circular debt. Another vexing issue pertains to the rampant line losses, primarily due to electricity theft, and a non-transparent tariff structure characterised by an array of additional taxes, charges, and levies.
The underlying causes of these indirect taxes, both in electricity tariffs and fuel prices, can be attributed to Pakistan’s persistently low tax-to-GDP ratio and the failure of effective taxation reforms and implementation. Pakistan’s tax-to-GDP ratio, standing at approximately 9.3 percent, is starkly below the Asia and Pacific average of 19.8 percent and 17.7 percent for India. This glaring disparity highlights the need for substantial reforms in Pakistan’s taxation system to enhance revenue generation.
An intimately intertwined challenge is the progressively weakening local currency, the Pakistani Rupee (PKR), against the US$, primarily due to a widening trade deficit and current account deficit. A significant reason for this predicament is Pakistan’s lop-sided reliance on consumption-led growth, manifested in a staggering “final consumption expenditure” constituting 96.24 percent of the GDP, as per the World Bank’s Development Indicators (WDI). This is markedly different from the prudent consumption patterns observed in countries such as China, India, and Bangladesh, where these percentages stand at 54, 71, and 74 percent, respectively.
Similarly, the stark contrast in gross domestic savings rates further highlights the gravity of the situation. Pakistan’s gross domestic savings rate is a mere 3.76 percent of GDP, underscoring the lack of domestic resources available for investment in productive sectors. This is a stark contrast to countries like China, India, and Bangladesh, where the rates are 46 percent, 29 percent, and 26 percent, respectively. Consequently, Pakistan’s gross capital formation or investment as a percentage of GDP remains alarmingly low at around 15 percent. Unfortunately, only 3.76 percent of this is financed by domestic savings, necessitating substantial inflows of foreign capital, which in turn lead to escalating debt levels and currency depreciation.
In light of these pressing challenges, a profound economic transformation, i.e., a complete economic metamorphosis, is imperative to enhance both gross domestic savings and the tax-to-GDP ratio. This transformation entails a multifaceted approach that encompasses various measures, including tax reforms, strengthening of the energy sector, reduction of line losses, promotion of a diversified energy mix, and a strategic shift from consumption-led to investment-led growth.
To increase the tax-to-GDP ratio, governments can broaden the tax base by including more sources of income and wealth in the tax system. They can also increase tax rates but be careful not to do so too much as it can harm economic growth. Additionally, governments can improve tax administration by strengthening the tax collection agency, simplifying the tax code, and reducing corruption. Finally, they can reduce tax exemptions and deductions that allow some people and businesses to avoid paying taxes. Making it easier for businesses to pay taxes by providing electronic filing and payment options, and by simplifying the tax laws can also be helpful.
Likewise, to increase gross domestic savings and reduce reliance on a consumption-led economy, the government can promote financial literacy and a savings culture, increase access to credit, provide tax breaks for savings and investment, and create an enabling economic environment. In addition to the above measures, governments can also consider banning the use of big, oil-gulping vehicles, such as large SUVs and luxury mini trucks. These vehicles are typically less fuel-efficient than smaller cars and can contribute to air pollution. Banning these vehicles would help reduce fuel consumption and improve the balance of payment position.
Economic transformation is a massive task that requires reframing the economic foundation through long-term planning and political commitment. However, immediate actions such as energy sector reforms, broadening the tax base and tax-to-GDP ratios, and increasing the domestic resource base through increased domestic savings and conservation measures, can be the preliminary steps in the right direction.
