Thursday, 20 June 2013

BUDGET: Scrambling for Revenues

The Article was published in the Money Matters on June 17, 2013 
 Scrambling for revenues 
 By M Ali Kemal 
The budget is an important event. Based on the budget presented, each year investors take decisions regarding investment and divestment, entrepreneurs take decisions for changes in wages and in the prices of their products, and households make their decisions for consumption and savings. In this way the total economy works in an efficient way.

People always have high expectations from the budget every year. However, irrespective of whether it is an investor, the head of a household or an entrepreneur, everyone wants a favourable budget. Here comes the importance of manifestos and ideology of the political parties, which people forget when voting for the candidates belonging to different parties. The PML-N discussed a pro-economic revival increase, tax revenues and mitigation of the energy shortage in its manifesto.

The presence and increasing importance of social media makes it easy to get frequent responses on the things happening around us. The expectations of people on the social media were evident on both Facebook and Twitter. Fortunately or unfortunately, the PML-N has either fan following or people are against them as far as the current situation is concerned. It is just because they are in power.

Pro-PML-N people were really expecting a better budget but they were continually saying that since it is a very difficult time for the country, it is not easy for the party to make a budget in favour of everyone. Thus, their arguments are justifications for the PML-N budget is not in accordance with everyone’s expectations. On the other hand, anti-PML-N people were cautiously stating their positions and tweeting proposals on what should be done in the budget. Nevertheless, they have already loaded their guns and ready to open fire as soon as the budget is presented.

Considering the history of the PML-N government, people were not expecting a pro-poor budget. Nor were they were expecting an increase in salaries since they always called for austerity measures. It was expected to be pro-economic revival and mitigate the energy shortage. Additionally, many were bullish regarding the tax measures the government would take. Whereas no significant policy has been announced to cope with the energy crisis, apart from allocating an insufficient amount for circular debt, hopefully, the government has a concrete policy up its sleeve.

Given that there are various expenditures which cannot be avoided, such as interest payments on the piling public debt which has one-third share in the total expenditures, the huge fiscal deficit is inviting a big problem of continuous piling up of the public debt. Thus, increases in tax revenues are mandatory for the government. There are several ways of increasing tax revenues. Since we have a very narrow base for all the taxes, just an increase in the base would result in more revenues.

This budget is a budget of economic revival and revenue collection. It is definitely not a pro-poor budget. Different taxes have been introduced, such as a tax on wedding halls, an increase in the sales tax to 17 percent, and more commodities are brought in under the sales tax. Bukhari and Haq pointed out in their article published in The News that if we tax everyone, the real revenue potential of the country is not less than Rs8,000 billion, while our expenditures are Rs3,190 billion. Thus, the government does not need higher taxes if they are able to get Rs8 trillion in tax revenues and certainly they will have more fiscal space to play with. 

Increase in revenues needs certain reforms such as exemptions should be withdrawn. Income tax should be applied on all the income, irrespective of its source. SROs should be abolished, reliance of too much centralisation should be avoided, an e-governance system should replace the old system, a punishment and fines system can be introduced for those who do not pay taxes, educate FBR people who collect and audit tax returns, monetise of employees’ perks. Most of the things are said by Shahid Kardar in his several articles on tax reforms. The PML-N government is expected to implement all the reforms he has suggested because all his suggestions are for revenue enhancement. However, exemptions given on sales tax to Khyber Pakhtunkhwa are withdrawn but agriculture income is still not taxed, and we can just hope that after local bodies elections provincial governments were asked to collect certain taxes, so that we move away from centralised tax system.

Contrary to what Shahid Kardar suggested, the reforms are not done in a clean way. The budget is prepared after every sector was taken into consideration. It is more likely that it is done by taking lobbyists (financers) into consideration since they are going to invest in the country. Some measures which are taken by the government, such as an increase in the tax base by asking industrial and commercial units to have NTN number otherwise they will be charged 5 percent more electricity bill may not have a significant result. Instead, it will create problems for smaller industrial and commercial units. But if the administration and governance structure will improve, then we may see an improvement in the tax base as well as collection. The FBR, having access to all the bank accounts, would be a good strategy if it is used in a proper way otherwise misused of the policy may worsen the law order situation for common person since we do not have a good governance structure in police. Moreover, the increase in sales tax was necessary according to Dr Waqar Masood since the government had a shortfall of revenues by Rs300 to Rs400 billion. The strategy is not convincing, although the government must have calculated the numbers, but this type of taxes raises the inflation rate. Since the government is not providing relief to a common person apart from the BISP Rs75 billion and increase in pension rates by ten percent, the misery of a common person is going to increase.

Items proposed in the budget can be revised before the final approval. An item-wise debate is necessary in the coming days so that a revised and better version of the budget is approved for the prosperous of the country. Moreover, certain allocations, such as Rs3 billion for the distributing laptops, should be stopped since these policies do not contribute much to society.

The budget should be more focused since we do not have much fiscal space to spend on everything. This year, if the major focus is revenue-generation, all reforms are taken which helps in increasing revenues. Itís about time to change our mindset from taking populist measures to doing something to deal with the real problems people are facing.

The writer is a research economist at PIDE. Twitter @malikemal

Friday, 7 June 2013

Escaping a crisis

The article came in money matter on 27 May 2013

Terrorism, energy shortage and economic revival are the three top tasks for the new government of PML-N. The PML-N’s manifesto has laid special emphasis on these issues, particularly the energy crisis: PML-N leaders have already announced that a solution to the energy problem will be their top priority.

Electricity is directly linked to economic growth. Rehana Siddiqui’s research at the Pakistan Institute of Development Economics (PIDE) shows that a five percent growth rate in GDP requires 4.75 percent growth in electricity supply. According to a recent USAID-Planning Commission report, Pakistan’s GDP growth rate in the last five years slowed down by two percent per year due to the shortage of energy. This implies that we have lost at least 10 percent growth in the last five years.

Energy shortage, especially in the production and supply of electricity, is due to the problem of circular debt, and if we deal with circular debt we can overcome the entire problem. Pakistan’s circular debt, which was Rs84 billion in 2006, has ballooned to over Rs800 billion. In an article, Sartaj Aziz has blamed the policy of inviting IPPs in 1994 for production of electricity. He said that the ratio of hydel to thermal was 60 to 40 in 1994 and price of crude oil was $10-15 a barrel. Now the ratio of hydel to thermal is 20 to 80 and the price of oil is more than $100 per barrel since 2008. He further said that the cost of generating one unit at an IPP thermal plant is Rs18 per KWh when produced with furnace oil and Rs24 per unit when produced through diesel. The government needs to give a subsidy of Rs9 (if furnace oil is used) to Rs15 per KWh (if diesel is used) if the average price of electricity is to be Rs9 per unit. He described this as the root cause of the growing problem of circular debt. Thus, we need to stay away from thermal energy due to its higher cost and explore other methods for production of energy at a lower cost.

In her comprehensive report on the energy situation, Afia Malik of the PIDE pointed out several institutional shortcomings. For example, DISCOs are highly inefficient. Nepra has a weak administrative structure. Because lack of autonomy and expertise it has been unable to carry out its function effectively, such as issuing licences. Moreover, unnecessary delays in the decision-making process due to lingering bureaucratic and administrative procedures discourage the private investor, which is a major sign of institutional weaknesses. One of the major reasons of the delays is getting multiple agencies involved in the decisions-making process. She further said that delays in subsidies payment by the government and non-payments to GENCOs raised the problem of circular debt.

In a report in 2007 USAID reported availability of energy falling behind demand, especially in the peak hours, and emphasise the need for provision of more energy supplies through expansion and conservation and increasing access to modern energy services to regions and population groups which lack them. The government has failed to increase energy supply either through expansion or the use of rental power plants.

Recent USAID-Planning Commission report on circular debt has pointed out several shortcomings within the system which are causing problem of circular debt. Poor governance is among the major concerns of this report. Among other problems delays in the tariff differential subsidy payment by the ministry of finance takes the top spot followed by non collections from private consumers and government, delays in tariff determination and further delays in notification by the government, poor revenue collections by the DISCOs, transmission and distribution losses and theft, and prolonged delays in fuel price adjustment are the major problems contributing to the accumulation of circular debt. They suggested two major tasks for the government to eliminate the circular debt: “(1) Move the circular debt amount to the government’s debt, reallocate in consumers tariff or place a tax on the consumer to recovery over time; (2) Undertake specific policies and programmes to improve the governance and performance of energy-sector entities to decrease costs, increase cash flow, and ensure operational/financial integrity of the sector.” It also emphasises the need for increase in hydroelectric power, renewable energy and less dependence on thermal energy. Other policies recommended by the report are quite similar to what Afia Malik has proposed in her report.

The PML-N aims to merge the ministries of water and power and petroleum and natural resources in order to avoid the policy disconnect among different policies related to energy. Moreover, certain reforms were mentioned to improve the performance of DISCOs and GENCOS, including the corporatisation and privatisation of both, ending cross subsidies of DISCOs, decrease in the transmission and distribution losses to fewer than ten percent, eradicating problem of non-payments through prepaid billing systems, and replacement of furnace boilers by coal boilers in all GENCOs. The circular debt issue is also handled by giving subsidies to only lifeline users who consumes up to 100 units of electricity.

The Planning Commission has projected a deficit in supply of electricity for the next seven years based on generation capability and change in demand. Projections show that electricity shortfalls will increase to 5,570 megawatts by 2015-16 and then start declining. This implies that power outages will continue in the next three years, and may even increase. In 2016-07 the shortage will be reduced if effective steps are taken. The shortfall will likely be eliminated in 2019. This picture was presented by Shahid Sattar, Member (Energy) at the Planning and Development Division. The PML-N government has a major task on its hands. Most of the initial reforms have already been announced by the PML-N leadership, including merger of all industries which are related to energy so that policy disconnects are mitigated to enable better policy formulation. Shahid Sattar says there is a need for building of dams, but since the sites of Neelum-Jhelum and Basha are located at disputed territories no one is willing to finance them. Generation of energy through coal is also feasible but for that Pakistan needs bigger investment. However, international agencies do not provide funds due to the pollution the use of coal will produce. According to him, wind energy has a narrow scope and solar energy has a high cost. He is in favour of civil-nuclear energy. According to him, it is the cheapest form of energy available in Pakistan. He says if we do not adopt civil-nuclear energy we will suffer in the long run, as we did by inviting IPPs to produce electricity because we did not foresee the present high prices of oil.  

It is clear that the problem of energy shortage is not just the problem of circular debt. Reforms are needed at various stages, such as giving autonomy to the Nepra and make it a better regulatory body. One of the major tasks of Nepra is to bring investment, which it has failed to do for many years. Reforms at DISCOs and GENCOs are necessary to achieve the required results. Prepaid meters are a good option for mitigation of the amount of theft. However, a comprehensive plan is needed for reduction of line losses. Better management through provision of electricity to DSICOs in accordance with their needs and provision of gas and coal instead of furnace oil will reduce the cost of electricity production and thus reduce the overall circular debt.

Do we need to stick to one kind of energy generation or produce mixed forms of energy? This is one of the major tasks for the government. If the decision taken is based only on cost of generation then we may have severe power outages for some more years.

Talking to some industrialists, I observed that they are comfortable to get electricity at Rs18 per unit if the supply is continuous. This shows that even if we are producing at higher cost—such as wind energy or solar energy—and it is distribute to the industries at matching cost they have no problems in paying for it.  The PML-N government should try to solve the problem of outages in the first two years of its tenure to escape a political crisis.