Liquidity Crunch Must End for Export Enhancement
Shahid Sattar & Madiha Nisar
Non-payment and delayed refunds accompanied with a complex filing process of refunds are some of challenges that exporters are struggling with. Blocking legitimate refunds by the Federal Board of Revenues (FBR) to show improved revenue collection has taken a heavy toll on exporters who were already reeling under the energy crisis and many other critical issues.
Delays in processing refunds under the outgoing government’s refunds schemes have blocked a substantial amount of 168.4 billion rupees of exporters. As per the estimates, refund over Rs. 15 billion are pending on account of income tax, Rs. 3 billion on account of Drawback of Local Taxes and Levies (DLTL) and a sum of more than Rs. 50 billion on duty drawbacks (DDY).
The current system of revenue targets for individual RTOS is net of any refunds hence In order to meet their net collection targets, regional tax offices (RTOs) adopt a go-slow policy and do not issue refund payment orders (RPOs) on time. They raise petty issues and delay the entry of the claims. The only way out of this dilemma is to assign the targets net of any refunds so that there is no inordinate delay in lodging of claims.
According to the law, refund claims must be cleared within 45 days but the authorities are flaunting the law with impurity. They continue to block payments for years which has damaged the export sector, especially the textile sector.
As a result of the hectic efforts by the industry to compel the government to pay blocked refunds, the former finance minister and advisor to FBR had made promises to pay Rs. 15 billion every month on account of refunds. Only the first installment of Rs. 15 billion was released and the hollow promises remained unfulfilled and hollow.
This illegitimate tactic of the finance ministry and FBR of the outgoing government has caused closure of many businesses while leaving others at the mercy of loan sharks which is slowly but surely killing the manufacturing sector.
According to an estimate, blocking of working capital of export sector has caused a huge loss of almost 500,000 jobs to the economy.
Consequently Pakistan is fast losing its share in the world export to Vietnam and Bangladesh. Pakistan is left with only 0.12 percent share in world total exports. The partial responsibility for this state of affairs is the lack of modernization and up-gradation due to the lack of liquidity/high cost of doing business.
Generally, tax authorities blame exporters for delay in refund for incorrectly filled columns in shipping bills or any mismatch in GST returns. This is because of faulty processes and procedure, with some mistakes committed by exporters. If the tax authorities at the field are ignorant, how can we expect a micro, small and medium enterprise exporter to be conversant with the tax laws, rules and procedures?
The situation can only be improved if the refund mechanism is fully automated. The government should fast-track the refunds process and should release at least 90% of the claimed amount immediately to help small and medium scale exporters tide over liquidity crisis arising out of delay in tax refunds and input tax credits.
It is proposed that each refund shall be lodged and paid within a maximum period of 60 days, failing which the claimant should be entitled to some significant penalty. For any claim that is partially disputed the undisputed amount shall be paid immediately and disputed amounts be settles within 6 months. Refusal to lodge sales tax refund claims should be made a cognizable offence.
To improve liquidity further Indirect exporters as long as they are zero rated should also be entitled to refunds as they supply their goods to exporters. Exempting them from refund claims serves no purpose except increase in cost of doing business. The facilities which are available to exporters, should also be made available to indirect exporters.
Moreover, zero rating is supportive to eliminate tax frauds once and for all as the system of collecting sales tax and then refunding is not only an exercise in futility but involves large number of sales tax personnel and precious time of FBR which can otherwise be utilized to bring more and more persons in the tax net to increase revenue for the FBR. This will serve the double purpose of expanding the tax net as well as exports.

Interest rate hike and devaluation are not the solutions!
Shahid Sattar & Madiha Nisar
The process through which changes in the monetary policy stance affect the aggregate demand and inflation is termed as the transmission mechanism of monetary policy. Interest rate channel is one of the five channels through which the monetary policy transmission works.
Claiming that inflationary pressures may be building, the State Bank of Pakistan has raised interest rate by a cumulative 4.25 percentage points in five rounds since January 2018 in an effort to rein in economic growth.
The state bank of Pakistan first hiked interest rates by 25 basis points in January this year, followed by 50 basis points in May, 100 basis points in July and 100 basis points in September.
Contrary to rational expectations of a moderate hike in policy rate, hawks of SBP came up with 150 bps increase on November 30th to take the policy rate at 10 percent while the core inflation is at 8.3 percent as of October 2018 and unemployment rate has reached a whopping 9 percent.
The latest increase of 150 bps in the interest rate is aimed at containing inflation, while the previous hike of 275bps was targeted at taming the unsustainable current account deficit, which ate up the country’s dollar reserves and posed import payment and debt repayment challenges.
But history shows that previous 275 bps hike in interest rate from May to October 2018 had no impact on inflation as it continued to inflate. Moreover, data of previous ten years shows that every policy rate hike in past years was accompanied with a more or less equal hike in inflation rate. The highest inflation rate of 17.19 percent was experienced in 2009 when interest rate was 14 percent, highest in last ten years. Previous data proves that inflation and interest rates have a side by side relationship, any increase in any of one will also cause an increase in other.
The target policy rate affects all other interest rates in the economy, eventually making it more expensive to borrow, and serving as a brake on the pace of economic activity. Typically, higher borrowing costs slow the economy by forcing consumers and businesses to cut back on spending and investment. But the impacts of rising interest rates affect different groups in different ways.
The growth momentum has already slowed down, which is visible from GDP growth forecast for fiscal year as it is downgraded to 5pc. In the last monetary policy statement released in July, the SBP had forecast GDP growth at 5.5pc while Asian Development Bank has anticipated it to be 4.8 pc for FY19. The continuous downgrades in the growth forecast suggests a sharply decelerating economy. The interest rate hike has added 0.75% of gross domestic product (GDP) to the budget deficit.
The other shock to growth is possibly coming from less than targeted cotton production, which would not only hurt agriculture growth but also have its toll on services growth.
The rate hike will most adversely impact the federal government by increasing its debt servicing cost. Increase in policy rate hike plus continuously depreciating currency will make it difficult for the government to curtail the fiscal deficit.
According to experts, a 1% increase in interest rate increases the cost of debt servicing by roughly Rs180 billion. The claim is proved by the history as after 250 bps increase in interest rate from May to September, Pakistan’s debt and liabilities surged to 30.87 trillion with an addition of 0.98 trillion within three months only (July-September). Gross public debt which is sole responsibility of government has also surged by 0.83 trillion within three months. The adverse impact of the latest policy rate hike on government’s debt servicing will be visible in upcoming data release of SBP.
Owing to higher interest rates and currency depreciation, Pakistan’s debt as well as debt servicing cost will further go up in the current fiscal year even if no fresh loan is taken.
Furthermore, in alliance with universally declining trend, and in response to increased policy rate by an aggressive 150 bps, the stock market in Pakistan remained volatile the past week, as the benchmark KSE 100 index made a net loss of over 1,800 points, slipping below the two touchstones of 40,000 points and 39,000 points.
It is said that there is a direct relationship between interest rates and the value of domestic currency. All else being equal, hike in interest rates leads to currency appreciation as investors see higher returns on their investments. But this assertion is not true for the economy of Pakistan as previous contractionary measures always resulted in more inflation and currency depreciation in Pakistan. Following the previous interest rate hikes the rupee has depreciated by almost 26 percent since January 2018.
In addition to nominal exchange rate, official data released by State Bank of Pakistan (SBP) revealed that Pak Rupee’s Real Effective Exchange Rate index (REER) has also decreased by 2.68 per cent in October, falling to a value of 108.1450 from 111.1276 in September.
Thus government’s claim that interest rate hike is to contain inflation and currency depreciation is not tenable. Take the example of the textile sector which has traditionally contributed more than 60 percent of the exports of Pakistan. The devaluing impact on the industry contrary to conventional wisdom is marginal if not already negative. This is because 80 percent of the input cost, cotton, energy, MMF, machinery and spare parts are all imported and dollar dominated.
The only rationale for the devaluation appears to be import curtailment. But even the imposition of RDs and currency depreciation failed to achieve this target in past. Despite high regulatory duties and currency devaluation, imports have increased by almost 13pc in fiscal year 2017-18 while exports improved by only 8pc. Considering inelastic nature of imports depreciation of currency will only contribute to increase in imports bills and will also violate the world trade organization’s treaties.
Increasing exports through devaluation is highly contentious. The ground realities suggest that long-term policy of maintaining the cost of doing business competitive to other countries, provide access to capital tax expansion and new industry and have a progressive outlook through innovation and new methods.

Power sector
Shahid Sattar and Asad Abbas
“”
November 20, 2019
Power shortages and high power tariffs in Pakistan have been at the root of many problems faced by the Pakistan economy; substantial reduction in the rate of GDP growth, economic stagnation, slow job creation, increasing unemployment, serious adverse impact on the federal budget, and extreme household consumer distress. As a result of the erratic and unreliable grid supply, industrial consumers have been forced to install relatively inefficient but reliable in-house capacity which by any standards is uneconomic.
Without sufficient and continuous power supply, it is impossible to achieve sustainable long term growth rates. A study by Pasha et al. (2013) on the impact of power shortages on economic activity estimated power outage costs at 7 percent of GDP and found that electricity shortages have reduced the country’s economic growth by about 2 percent per annum. This is primarily due to insufficient investment (especially during 1995-2015) to improve electricity generation capacity; the shortfall in electricity supply was as much as 32 percent of total demand. Together with poor governance and sector management, these problems led to higher losses in transmission & distribution and increased financial instability. Insufficient investment in the energy sector has also led to overloaded, antiquated and inefficient transmission and distribution systems. As a result, the gap between demand and supply widened, leading to prolonged power outages experienced by all consumers, where rural areas had more frequent breakdowns than urban areas as a matter of injudicious government policy.
Industry-specific price rates had reached levels that were significantly higher than in neighbouring countries and had contributed portentously rendering exports of Pakistan uncompetitive on world markets.
The current government recognized the severity of the highly uncompetitive industrial tariffs and announced regionally competitive tariff of 7.5 cents for export-oriented sectors. This regionally competitive (albeit implementation is currently patchy) tariff rates to have any real long term impact, would have to continue for at least 05 years so that the industry can grow and invest in expansion and rehabilitation to increase the exports.
Investment in power generation since 2014 has covered the demand-supply gap more than adequately but suffers from a fatal aw; unaffordable and uneconomic tariff rates. These tariffs have rendered the entire supply of energy a luxury item for the people and made our exports uncompetitive in the world market. Some examples of high-generation tariffs are as follows: 1320MW coal power plants that obtain USc 8.3601 & USc 9.16 tariffs per Kwh, while international tariffs are around 6 cents per Kwh. Solar power plants are operating at 18 to 19 cents/kWh tariff rates, whereas solar tariff in India our direct competitors are 7-8 cents/KWH whereas the current solar tariffs are below Rs 5/KWH or 3 cents/KWH.
Over the past eight years, frequent power breakdowns in Pakistan have instigated issues of law and order. However, an improvement in the supply situation over the last few years has reduced the frequency of protests against load shedding but resentment has shifted towards higher tariffs. The resolution of the power crisis is therefore crucial not only for the economy of Pakistan, but also for political stability.
Household consumption of electricity has increased since the last 42 years at an average annual rate of 10 percent per year. The government also actively pursued a rapid electrification policy for rural areas during this period. Resultantly, households’ share of total electricity consumption increased from
12 percent in 1971-72 to 47 percent in 2000-2001. This primarily was at the expense of industry, whose share in the same era fell from 54 percent to 30 percent.
Lifeline tariff for 50 units of consumption of the Rs 2/KWH is neither economic nor conducive to efficiency and requires the government to dish out massive annual subsidies. Alternative to the life line tariff is a direct subsidy to the poor consumers through existing channels such as BISP. This would inculcate a sense of efficiency and reduce wastage of electricity so that it can be used for productive purposes.
The shift in demand pattern has also resulted in industrial tariffs for certain categories and slabs becoming unsustainable, particularly in a regime where budget subsidies are require accordance with IMF conditionalities.
The period (2000-2007) witnessed a credit-driven consumption boom, increasing the use of electrical appliances across Pakistan. The Asian Development Bank’s (2008) report states that the prevalence of inefficient electrical appliances means that more than one quarter of the electricity used by households is wasted.
Energy intensity of Pakistani industries is among the highest in the world and stands for enormous energy consumption with an annual increase of 5 percent to 6 percent of electricity demand. In 1980, Pakistan had the same level of energy intensity as India; nonetheless, improvement in energy-use efficiency in India (at 1.9 percent per annum) and Sri Lanka (at 1.5 percent per annum) was somewhat faster than in Pakistan (at 1.3 percent per annum). Now Pakistan is 15 percent more energy-intensive than India.
Despite the presence of a variety of natural resources, Pakistan had been facing a signi cant constraint in the power generation. The level of investment in the sector decreased sharply particularly during the period 1995-2015, leading to a slower expansion of installed capacity than required as well as depriving the sector of key investments to improve efficiency.
Pakistan’s total installed power generation capacity has now surpassed peak demand. Power sector nancial problems stem primarily from poor governance and ineffective government policies that fail to change the prices charged to customers, despite signi cant cost increases.
More and more consumers are now opting to go out of the system because of the lower cost of self-generation since installed capacity is more than required (a classic capacity trap), the cost of idle capacity is borne by the consumers on the grid. With decrease in dependence of the consumers on electricity supplied by the grid, the grid will eventually become totally unaffordable as more and more consumers opt for self-generation.
Management-related issues include low levels of human resource capacity, corruption, rent-seeking and poor regulatory capacity. Although electricity transmission and distribution losses have decreased marginally in Pakistan (from-25-28% of total electricity generation in 1995 to 20% by 2017), the rate and degree of change is lower than many developing countries, including some utilities in South Asia. Continued high rates of losses have high nancial implications for both utilities and the government. Although the government has tried to introduce performance plans to track progress and ensure improvements over time, there is no documented evidence of effective enforcement
To defer the issue of payment to IPPs to reduce the circular debt, the government has planned to issue bonds to IPPs. These bonds will legitimate the billing and dues created by the IPPs through billing at rates which have generated them rate of return of over 60 percent in dollar terms. The matter is under investigation of NAB and such schemes should not be considered till such time as the NAB inquiry is under way. To avoid repetition of this disastrous situation, Nepra should conduct periodical
audits so that the generation tariffs do not generate returns over and above the policy committed 15 to 16 percent.
Dealing with the crisis in the power sector needs a multifaceted response. Some of the changes needed to tackle the issue include:
 Increasing efficiency in the sector by pushing generation and new investment by a conducive market based approach.
 Investors should start adopting market based approaches (e.g. bidding on the price of power they produce, develop their own customer base) and not rely on government guarantees, e.g., market-based power sector.
 Freely allowing Housing societies to generate distribute and sell power as Captive power units without requiring and licensing or tariff setting by Nepra.
 Finally, all Discos must be run by the boards in accordance with corporate principles.
Furthermore, the following changes in the administrative and legal system toward power consumption in addition to a shift of consumer attitudes need a radical change, some of these are:
a) New investments must be based on competitive bidding and a power market be operated to allow free sale and purchase of electricity generated.
b) The function of NEPRA needs rede nition towards a market based system.
c) Strengthening NEPRA’s nancially and provide an oversight to avoid costly mistakes of unjustifiable high priced generation tariffs being awarded.
d) Consumers need to accept that electricity is not a free commodity so they must pay for the power they consume; the police and judicial system must promptly investigate and prosecute all complaints about electricity theft.
e) Regular and ongoing investment to upgrade and maintain networks, and adopt state of the art management systems for better surveillance of distribution to companies.
f) Investment not only for maintenance of existing equipment, but also for acquiring modern technology and systems.
g) Strengthening the legal framework for investigating, prosecuting and penalizing theft and corruption.
h) Use Renewable Energy (RE) to lower costs through judicious injection of RE where the total cost of RE is less than the fuel component of the installed capacity.
i) Give high importance to initiatives such as energy conservation and adoption of more efficient energy usage practices are viable, desirable and sustainable.

Dismal saving and investment rates
Shahid Sattar and Asad Abbas
“”
November 07, 2019
Much of Pakistan’s current economic crisis revolves around the low savings and investment rates. This is the primary reason why Pakistan has been unable to compete with rest of the dynamic Asian region which has recorded phenomenal economic progress in the last three decades. Low savings rates have resulted in lower volumes of investible funds, whereas, low investment rate have stymied any growth potential. The intermittent phases of relatively high growth have been only due to the “seasonal” heavy inow of external grants, loans and remittances. This begs the question, how can Pakistan raise the savings rate and productivity on a sustainable basis so that it can achieve a higher output to generate exportable surpluses.
Source: World Bank Uncertain policies, poor governance, security threats, energy shortfalls, and an overall lack of investment from public sector (not that the public sector really made any difference) are the causes of the bleak investment levels in Pakistan. Besides this, in terms of “Business regulations”, Pakistan has plummeted from a ranking of 83 in 2011 to 136 (out of 175) in 2019. Unfavorable, rigorous and inconsistent business conditions in Pakistan have not only discouraged the foreign investors from investing but have also deterred local businesses from expanding.
The investment rate has also been a prisoner of the cyclic changes of political regimes, changing economic policies and the resultant volatility in the balance of payments.
The investment rate in Pakistan has decreased by 15 percent over the last ten years which indicates the decrease in non-financial investment by rms (as a percentage of GDP). A high investment to GDP ratio is a sign of long-term sustainable economic growth as investment yields modernization which in return increases the output. For a sustainable level of growth, domestic savings are vital as foreign inflows are subject to change in the exchange rates, external shocks and changing world economies.
According to World Bank’s Report (2019), Pakistan’s economy could reach $2 trillion by 2047 with the implementation of appropriate and innovative economic policies. The enormous gaps between investment and savings have contributed to the low growth potential of the economy over the last ten years. The saving rate of Pakistan has distressed the scale and current account balances resulting in a low investment in human and physical capital. The current account deficit, investment and saving gap are the result of the weak policy formulation of governments. The gap between domestic savings and investments implies that one-third of the country’s investment was financed by foreign resources. The improper funnelling of resources into uneconomic investments has also negatively impacted GDP growth. In developing countries, FDI is used as a proxy to ll the gap in financing investment when the domestic resources are insufficient.
Source: World Bank The fiscal deficit is an indication of consistent negative savings which leads to overall low savings and investment. In previous year savings in Pakistan were approximately 11 percent of the GDP, being extremely low and therefore limiting investment. This is less than half of the saving rate of Bangladesh, one-third of India’s and approximately 1/5th of China. High rate of population growth, weak tax incentives to save, deposit rates and real interest rates are the main factors that determine the levels of saving. The channelization of saving through the financial sector for efficient allocation of investment is important. A study reveals that less than 50 percent of the national savings and their way into the financial sector whereas the rest is used in other sectors by informal channels. This is problem for Pakistan given the new anti-money laundering and FATF regulations.
Investment remains constricted due to unfavourable investment and business climates coupled with rigorous regulations and taxation. The access to Finance is not only constrained by high-interest rates but also by the weak financial system, high processing costs, high collateral terms and conditions and illogical regulation. This vast gap between lending and deposit rates is a clear indicator of rivalry between commercial banks to attract additional depositors/borrowers. To protect the lenders and borrowers, the implementation of a bankruptcy law is fundamental. There should be a bankruptcy law put into practice which promotes protection to the lenders as well as the borrowers.
To increase saving and investment levels; the vide a favourable business environment which is only possible by providing consistent policies, smooth and competitive energy availability with better governance.
The role of the tor is crucial in domestic resource mobilization. Commercial banks must focus on extracting stagnant household savings and channelizing them into productive investment. The dependence of the government over commercial banks for exhaust the ability of commercial banks rendering them incapable of offering saving schemes to the public.
Due to weak investment levels, our exports lack modernization of technology resulting in lower quality and resultant decline of export to GDP ratio. The severity of this decline in export to GDP ratio can be derived from the fact that Pakistan’s ratio is 8.2 percent while our regional competitors India and Bangladesh stand at 19 and 15 percent, respectively.
Long-term investment is vital for the export-oriented sector to enhance productivity through latest technology. Apart from increasing investment for capacity building and technology, there is need to improve the local design capacity by developing new clusters for training, design, testing and adaption of modernizing technology in the textile sector of Pakistan.
Only a comprehensive and long term industrial policy coupled with a marked increase in savings rates can improve the investment climate, reduce the cost of doing business, increasing proy of the industry and encourage the expansion of business. The Industrial policy must focus on the improvement of productivity by increasing competitiveness in the market and resolving the obstructions faced by the business community. In short, the policy should be aimed to increase investment while making it more productive and proocus on the population, especially on youth who are suffering from mass unemployment. Over the formulation of consistent industrial policy, the government should provide incentives to encourage the manufacturers towards high value-added products as well as attracting investment in technology which would allow a shift from low value-added products to high value-added products. In the same way, the focus on expanding technical and vocational education institutions and establishing industry-academia linkages can yield fruitful and much needed positive economic results.