The Pakistani government continues to pursue a pro-investment agenda in the second federal budget of its term announced last Tuesday by Finance Minister Ishaq Dar. The business-friendly budget for the 2015 fiscal year starting on July 13 comprises an array of proposals including fiscal incentives for new businesses and export-oriented sectors and a cut in corporate tax rates.
As well, deliberate steps are being taken to encourage filing returns by imposing high tax rates within various sectors for non-filers. The aim is to improve the country’s abysmally low tax collection ratio of 9% of GDP.
Dar, a chartered accountant by profession and a close confidante of Prime Minister Nawaz Sharif, expressed enthusiasm about the economic recovery and “sound policies” of the government. Thanks to changing business cycle globally and marginally improved energy supply at home, the economy is estimated to have grown by 4.1% in fiscal 2014 that ends on June 14 – the highest growth since 2008. The industrial sector expanded by an impressive 5.8% against 1.37% in 2013. However, performance in the agriculture and services sectors was subdued.
The finance minister aims to lift GDP growth to 7.1% in three years from now. Although the target is a little too optimistic, the budget contains a number of measures to entice both domestic and foreign investment.
For instance, the tax rate for an industrial venture set up between July 1 this year and June 30, 2017 is proposed to be reduced to 20% if at least half the cost of the project including working capital is financed through owners’ equity or foreign direct investment.
Pakistan’s corporate taxes are among the highest in the region, and that is one of the reasons fresh investment is low. Apart from promoting equity investment both by domestic and foreign investors, tax rates of existing non-financial businesses are to be reduced in a phased manner to 30% from 35% by the time the Pakistan Muslim League-Nawaz (PML-N) government completes its five-year term.
The reduction in the corporate tax rate by one percentage point each year might not be incentive enough to entice new ventures and expansion of existing businesses. The rate now stands at 33%; a better policy would have been to cut it to 30% in one go.
Investment mobilisation remains an issue. Current policies have not been effective, as evident in the reduction in the investment-to-GDP ratio of 0.6 points 14% in fiscal 2014. A similar pattern is observed in gross capital formation. That is not the desired outcome as clearly growth is tilted toward consumption, while net exports have declined. Hence, the pro-investment and pro-business policies haven’t started paying dividends yet.
Textiles are country’s chief exports, accounting for 60% of country’s $25 billion in overseas shipments of goods. The sector had a tough last year as higher raw material prices along with a substantial increase in power tariffs eroded competitiveness, as did the sharp appreciation of the rupee in February and March this year. Dar is aware of this fact and has announced some incentives for the industry.
Following the Chinese model, the government is setting up the Export-Import Bank of Pakistan to enhance export credits. Then to reduce borrowing costs, the export refinancing rate has been reduced to 7.5% from 9.4%, and long-term financing rates to 9% from 11.4%. Another important incentive will be tax rebates to textile exporters that achieve at least 10% growth in export values. As well, Pakistan has obtained GSP+ status from the EU, which may give its exporters an edge over competitors.
Energy bottlenecks also figured in the budgetary measures. One of the prime reasons for sluggish economic growth in recent years is the yawning gap between energy supply and demand. Pakistan’s peak constrained demand is at 17 Gigawatts while supply usually hovers around 10GW.
The government plans to add 10 to 15GW to the national grid in the next five to seven years by establishing coal-fired power plants. Apart from that, a few hydroelectric and nuclear plants are in the pipeline. Many of the projects will involve public- and private-sector partnerships with entities from China.
However, such expansion has to be properly utilised when the additional power comes online. Households currently consume 60% of the country’s electricity, leaving only 40% for industries. This suggests that imports would benefit more from enhanced production than exports as the former’s coefficient to production is 0.34 while the latter’s is 0.24. This means increased economic activities may worsen the trade deficit, so the government sees the effectiveness of fiscal incentives to exporters as paramount.
The government is also largely relying on infrastructure development to spur growth and generate employment. It has allocated $1.1 billion for infrastructure development. Again, in partnership with China, there are plans are to invest $12 billion over five to seven years on megaprojects such as the Pak-China Economic Corridor and major segments of a new 950-kilometre motorway between Lahore and Karachi. Then, there are plans to revamp Pakistan Railways, which will receive $770 million for development and employee remuneration.
In the information and communication technology sector, Pakistan has finally entered the era of high-speed mobile broadband, issuing four 3G licence and one 4G licence to existing players two months ago.
Following up on telecom sector deregulation in 2003-04, which revolutionised the mobile business, mobile broadband and other value-added services are now expected to create a more pronounced impact on the sector and the overall economy, fuelling data services uptake by businesses, government and users in the rural hinterlands.