Sunday, 21 September 2014

Pakistan ties stand test of time

Copying the story from

By KRISHNA KUMAR VR in New Delhi / China Daily Asia Weekly
Postponement of Chinese president’s visit will not affect ever-deepening bilateral relations
Pakistan ties stand test of time
A project to connect Gwadar Port (above) in southern Pakistan to China’s Xinjiang Uygur autonomous region in the northwest will serve as a primary access for trade between China, the Middle East and Africa. (AFP)
“China and Pakistan are good friends, good partners, good neighbors and good brothers weathering all the storms together and sharing all the weal and woe. And China will continue, as always, to attach priority to Pakistan in its relations with the neighboring countries.”Though Islamabad is not on President Xi Jinping’s upcoming South Asia itinerary, the above statement voiced by Xi during his meeting with his Pakistani counterpart Mamnoon Hussain at the beginning of this year in Beijing tells the story of the two countries’ extraordinary bilateral relations.
Xi reiterated these thoughts when he met Prime Minister Nawaz Sharif in April on the sidelines of the Boao Forum for Asia (BFA) in South China’s Hainan province.
Since establishing diplomatic ties in 1951, China and Pakistan have enjoyed a close and mutually beneficial relationship, including numerous high-level visits.
Meanwhile, media reports suggest that despite the postponement of Xi’s visit to Pakistan next week due to anti-government protests in that country — which has delayed the signing ceremonies of several projects — both countries are exploring various options to keep the momentum of bilateral relations going.
“The Sino-Pakistan relationship is a time-tested bond,” Iftikhar Ali Malik, vice-president of the Chamber of Commerce and Industry at the South Asian Association for Regional Cooperation, tells China Daily Asia Weekly. “It is rock solid.”
Ali Malik, who has hosted several Chinese leadership and business delegations, is of the view that the postponement of one visit cannot jeopardize the billion-dollar Chinese investments in Pakistan. “Many high-level bilateral visits have happened in the past, and will continue to take place in the future,” he says.
Chinese Premier Li Keqiang, on his first official overseas tour, said in Islamabad that “the China-Pakistan friendship has stood the test of hardship and is more precious than gold”.
Following this, Sharif made Beijing his first overseas visit, shortly after taking the oath of office.
On his second visit, Sharif fully endorsed Xi’s proposal of reviving the ancient trade routes connecting China, Central Asia and Europe, as he said the revival of the Silk Road could help bring economic growth and prosperity to the region.
Pakistan’s geographic location supplements the potential of the Silk Road and enhances the scope of its revival.
“Pakistan has geographic advantages to promote economic development in the region,” says Li Qingyan, research fellow at the department for international strategic studies at the China Institute of International Studies in Beijing. “China’s new leadership attaches great importance to cooperation and integration with South Asia countries.”
Li says that when Xi visits Pakistan, the two countries will consolidate the foundation of building the economic corridor which is regarded as an important component of the Silk Road Economic Belt initiative.
The China-Pakistan Economic Corridor is an under-construction project to connect Gwadar Port in southern Pakistan with the Xinjiang Uygur autonomous region in Northwest China, via highways, railways and pipelines to transport oil and gas.
The billion-dollar corridor, once completed, will serve as a primary access for trade among China, the Middle East and Africa.
In particular, oil from the Middle East could be offloaded at Gwadar, which is located just outside the mouth of the Persian Gulf, and transported to China through Baluchistan province in Pakistan.
At present, more than 85 percent of China’s energy imports from the Middle East and mineral resources from Africa currently transit through the Indian Ocean.
“It is a win-win economic corridor,” says Hafeez Ur Rehman, chairman of the department of economics at Lahore-based University of the Punjab.
“Pakistan can reap the economic benefits of the corridor, especially for its underdeveloped region,” he says. “China’s western regions are also not so developed compared to the eastern coastal areas: By focusing on westward trade, it can bring economic benefits to the region.”
The economic corridor, first advocated by Chinese Premier Li, will play a crucial role in regional integration. It will connect China, Iran, Afghanistan, Central Asia and Myanmar.
The other projects proposed and finalized by the two sides include construction of the Karakoram Highway to Islamabad; a new airport at Gwadar, close to the border with Iran on the Arabian Sea; and the economic zones in the region.
To meet Pakistan’s energy needs, which in turn will boost the domestic economy, China has agreed to build 14 power plants in the country.
The power projects, with a total electricity generation capacity of 10,400 megawatts, are expected to be started immediately and put into operation by 2018. At present, the country faces an energy shortfall and the demand for electricity is rising by 8 percent every year.
“Once energy needs are taken care of, the economic development will happen on its own,” says Mustafa Hyder Sayed, executive director of the Pakistan-China Institute.
According to Pakistan official estimates, China is investing more than $35 billion in Pakistan’s energy and infrastructure. China has already committed $6.5 billion to build a new nuclear power plant in the southern city of Karachi.
Experts say that earlier China and Pakistan ties were defined in terms of strategic and military outcomes. However, the need to shift the discourse in terms of economic development is now being recognized.
“We also need to focus on technology transfer and the small scale sector,” adds Sayed.
The majority of Chinese companies in Pakistan are largely working in the oil and gas, IT, telecom, engineering, and mining sectors.
The two countries have also seen a significant expansion of trade in the last couple of years.
“Trade has seen considerable improvement after the FTA (free trade agreement) was implemented in 2007,” says Syed Mazhar Ali Nasir, vice-president of the Federation of Pakistan Chambers of Commerce and Industry.
“China has been contributing significantly to Pakistan’s imports even before the FTA was signed. Now Pakistan traders need more access to Chinese market,” he says.
The China-Pakistan Free Trade Agreement is the only such deal signed between China and a South Asian country. The free trade negotiations were concluded in 2006 and the agreement came into effect in 2007.
According to official data, bilateral trade between China and Pakistan touched the $13 billion mark in 2013, and is expected to reach $15 billion by 2015. In 2008, bilateral trade between the two countries was $7 billion.
“China enjoys very positive relations with Pakistan,” says Muhammad Ali Kemal, research economist at the Pakistan Institute of Development Economics in Islamabad. “There are signs of improving political stability in Pakistan as well, and if so, this will further boost Chinese investment and trade into the country.”

Thursday, 18 September 2014

BRICS by Brick: Will the BRICS Development Bank lead to the establishment of more such institutions like a SAARC bank to bolster regional economics?

The BRICS bloc, formerly known as BRIC before South Africa joined it in 2010, is a consortium of five newly industrialized advanced economies which include Brazil, Russia, India, China and South Africa. These five nations have 40 percent of the world’s population, account for 20 percent of the global economic output and hold among them $4 trillion as foreign exchange reserves. 

Factors such as the decrease in the monetary policy by the U.S. during the last recession followed by the reduction in the World Bank’s funding forced the BRICS countries to think of an alternative banking system which could finance their development projects. In March 2013, it was decided in the 5th summit of BRICS that the bloc would form a ‘BRICS Development Bank’. In July 2014, at their 6th summit at Fortaleza, Brazil, the five countries signed the agreement to establish the new bank. 

Initially, every member country will contribute $10 billion to raise $50 billion – the starting capital of the bank – and will gradually increase their share to $100 billion. The primary focus of the bank will be on providing funds for infrastructure projects, such as roads, energy, education, health, etc. Lending is expected to start from 2016. 

The New Development Bank (NDB) is seen as a competitor to the World Bank, the Asian Development Bank and the IMF because its main objective is to provide funds to developing countries. On an interesting note, the NDB will not decide on the projects that come up for lending. It will only choose from among the projects that ask for its lending support. Moreover, unlike the World Bank and the IMF, the NDB will not frame its own conditions for loans. This will help countries to follow their own policies. 

Apart from providing World Bank-type lending, the bank also has the provision of lending IMF-type loans. This type of lending is called Contingent Reserve Arrangement. It is a self-managed system to avoid short-term balance of payment problems. It will start with a capital of $100 billion; China has the largest share of $41 billion and South Africa the smallest with $5 billion, while the rest of the countries will contribute $18 billion each. 

Unlike the World Bank and the IMF, where the U.S. dominates the policies by virtue of having the power of veto, in the NDB every country has equal number of votes. Although China, being the largest country in the group, can exercise more control, it wants to stay away from any kind of dominance in the group, making way for the other four countries to work in a democratic way instead of getting bogged down in political intrigues. 

Although currently only the BRICS members have access to the funds available with the NDB, they can allow other countries to join the NDB with or without having voting rights. However, BRICS’ capital share cannot fall below 55 percent. This implies that if India can ask other countries to join and get their voting shares in the NDB then whosoever has more countries on its side can manipulate the decisions of giving loans by having more votes.

Considering the financial uncertainties in the global markets it is hoped that the NDB will stabilise financial flows to the developing economies which were volatile during the recession. Stability in financial flows will eventually stabilise the economy of BRICS countries. This will, in turn, put these countries on the path of sustainable growth in the long run. 
It is a fact that the dictatorial strings attached to World Bank and IMF loans are so harsh that they don’t allow the recipient countries to formulate their own policies. Both institutions put certain conditions to release each instalment of loans. With the emergence of the NDB, the dependence of the world community on the WB and the IMF will decrease over time. 

With a higher sustainable growth, India’s status in the region, especially among the SAARC countries, is likely to increase. While it will be in a position to provide funds on its own, other SAARC countries can also benefit from the NDB by joining it, especially to solve their short-term balance of payment problems.

It is still unclear what currency will be used for the bank’s reserves – U.S. dollar or Chinese yuan. Apparently, two major countries, China and India, have a good amount of foreign exchange reserves in U.S. dollar. Nevertheless, India’s balance of payment is consistently negative, while China has been enjoying a current account surplus for many years now. If Yuan is selected as the reserve currency then the countries can easily borrow from China irrespective of the U.S.’ influence to release Chinese foreign exchange reserves held at the U.S. treasury. Moreover, India can boost trade with China and finance its infrastructure projects using Chinese technologies. 

Even if the reserve currency is U.S. dollar, for not making China more powerful in the BRICS, the hypothesis of sustainable financial flows irrespective of global recession becomes even stronger given the argument that China holds a good amount of reserves and can ensure cash flows if any country is in dire need. China is also the maximum contributor in the CRA fund. 

India will get several benefits by obtaining loans for infrastructural development. It could be energy-related projects, roads or educational development. These projects will not only boost India’s GDP growth but will also attract people from all over the world as well as from SAARC countries to India – although Pakistan may be an exception. Moreover, it will also raise the standard of living of the ordinary Indian. 

Accordingly, India will be in a good position to set up a SAARC development bank which is also on the wish list of Indian Prime Minister Narendra Modi. The country can act as an experienced member and take the driver’s seat if such a bank is set up. 

It is clear that India’s status will considerably increase in the region, especially among the SAARC countries, due to the NDB. Thus India needs to be extra careful in formulating its foreign as well as domestic and economic policies as they can affect the smaller countries in the region. And if it wants to further bolster its status in South Asia, what other way to do it than forming a SAARC bank!

Article appeared in the South Asia Magazine in September 2014

Monetary Policy: Pragmatism or Obduracy

Economic growth should be the ultimate objective of policymakers along with redistribution of resources among the society to maintain the balance among the distribution of resources. Following such a policy may reduce the gap between rich and poor, hence lesser income inequality.
Nevertheless, talk of the town is not in general, growth but inflation, exchange rate depreciation or forced appreciation, on target and off target tax collections, piling or reducing public debt and these days the most important loss of economy due to dharna and floods. No doubt these are as important as some other indicators such as interest rate, private sector credit, debt servicing, allocation of budget etc. There is a possibility that everyone is thinking about “economic growth” but not explicitly. More importantly, most of us have failed to form a logical link between the above mentioned variables and economic growth.
I and some of my other colleagues and friends always follow theoretical foundations while presenting an argument. Although not everything can be explained by just theory, nonetheless, rigor always remains the core of the debate. In general, during the debate, just to win an argument, someone from the group would stand call other’s argument non-pragmatic. The above argument is important to mention here because when policymakers try to set different indicators in finding the pragmatic versions of debate/story they may divert from the actual target, which is growth. On the other hand while following “just growth” they may follow growth as well as welfare of the society. In my opinion following “just growth” is the pragmatic approach not the other way around.
Going back to traditional growth models investment is core of the economic growth. Investment can be done by utilizing saving or borrowing from the Banks. In Econ 101 we learn that investment is a function of interest rate. Although interest rate is insensitive to investment in the short run but it is not totally redundant. Studies suggest that interest rate investment nexus in the long run is significant therefore, we cannot ridicule it. Moreover, investors have been continuously asking to decrease interest rate since the new government took over the office last year.
Interest rate is the cost or price of borrowing. Nominal price is different than real price of borrowing. When we talk about nominal interest rate then it is nominal price of borrowing while real interest rate is the real price of borrowing. To contain the inflation the State Bank of Pakistan is not decreasing the interest rate. Although inflation is dropped to 7 percent nonetheless fear of higher inflation expectations is preventing the SBP from decreasing the discount rate.
It is evident from the picture that real interest rate is positive which implies real price of borrowing is quite high. Should it be closer to zero or negative?

Positive real interest rate is certainly not good for the investors because no one wants to borrow and high real price. This is one of the reasons private sector credit creation is not picking up along with several constraints and hurdles faced by the investors, which shrinks the profitability of the ventures.  
Question is why are they not decreasing the discount rate? Is it only due to higher inflation expectations? These policies are similar to “sado monetarism”, a term coined by the Nobel laureate Paul Krugman. It is just spoiling the ultimate goal, i.e. growth.
According to the Asian Development Bank, IMF and World Bank Pakistan’s economy is recovering which implies that recessionary trends are going away. Inflation has come down. Exchange rate is at the unreasonable level after forced appreciation. Due to improvement in energy situation, though slightly, and better energy management investors want to invest. Therefore, there is no point in keeping the discount rate at higher level, which is also keeping the real rate higher.
Besides above, we are out of acute stagflation therefore, it is not good to follow conservative central banker’s policies. Since most of the SBP’s policies are governed or in-line with the Ministry of Finance therefore the SBP with the agreement of the MOF should decrease the interest rate so that real interest rate declines and come closer to zero if not negative. This would kick off the investment in various sectors including the services sector which is the most resilient sector, especially during the energy crisis since 2008.
Since rules of the game are not clearly spelled out thus it is also possible that the monetary policy does not follow pragmatic approach instead follows the instinct of the BOSS. If it is true then we should stay away from visceral type monetary policy and move towards objective oriented monetary policy.
Rules of the game are very important before managing any policy. If Central Bank’s task is to control inflation at the socially optimal or minimum possible level or growth enhancing level or monetary stability then it should be followed strictly. Nevertheless, the SBP needs complete operational independence to perform better. If they continue to listen to the Ministry of Finance then it is will be visceral Darnomics. No one knows what is it and what it will be. I hope they formulate the policies pragmatically instead of obduracy.

Sunday, 14 September 2014

The Failure of Inflation Targeting by Stiglitz
New York – The World’s central bankers are a close-knit club, given to fads and fashions. In the early 1980’s, they fell under the spell of monetarism, a simplistic economic theory promoted by Milton Friedman. After monetarism was discredited – at great cost to those countries that succumbed to it – the quest began for a new mantra.
CommentsThe answer came in the form of “inflation targeting,” which says that whenever price growth exceeds a target level, interest rates should be raised. This crude recipe is based on little economic theory or empirical evidence; there is no reason to expect thatregardless of the source of inflation , the best response is to increase interest rates. One hopes that most countries will have the good sense not to implement inflation targeting; my sympathies go to the unfortunate citizens of those that do.  (Among the list of those who have officially adopted inflation targeting in one form or another are: Israel, the Czech Republic, Poland, Brazil, Chile, Colombia, South Africa, Thailand, Korea, Mexico, Hungary, Peru, the Philippines, Slovakia, Indonesia, Romania, New Zealand, Canada, the United Kingdom, Sweden, Australia, Iceland, and Norway.)
CommentsToday, inflation targeting is being put to the test – and it will almost certainly fail. Developing countries currently face higher rates of inflation not because of poorer macro-management, but because oil and food prices are soaring, and these items represent a much larger share of the average household budget than in rich countries. In China, for example, inflation is approaching 8% or more. In Vietnam, it is even higher and is expected to approach 18.2% this year, and in India it is 5.8% By contrast, US inflation stands at 3%. Does that mean that these developing countries should raise their interest rates far more than the US?
CommentsInflation in these countries is, for the most part, imported . Raising interest rates won’t have much impact on the international price of grains or fuel. Indeed, given the size of the US economy, a slowdown there might conceivably have a far bigger effect on global prices than a slowdown in any developing country, which suggests that, from a global perspective, US interest rates, not those in developing countries, should be raised.
CommentsSo long as developing countries remain integrated into the global economy – and do not take measures to restrain the impact of international prices on domestic prices – domestic prices of rice and other grains are bound to rise markedly when international prices do. For many developing countries, high oil and food prices represent a triple threat: not only do importing countries have to pay more for grain, they have to pay more to bring it to their countries and still more to deliver it to consumers who may live a long distance from ports.
CommentsRaising interest rates can reduce aggregate demand, which can slow the economy and tame increases in prices of some goods and services, especially non-traded goods and services. But, unless taken to an intolerable level, these measures by themselves cannot bring inflation down to the targeted levels. For example, even if global energy and food prices increase at a more moderate rate than now – for example, 20% per year – and get reflected in domestic prices, bringing the overall inflation rate to, say, 3% would require markedly falling prices elsewhere.  That would almost surely entail a marked economic slowdown and high unemployment. The cure would be worse than the disease.
CommentsSo, what should be done? First, politicians, or central bankers, should not be blamed for imported inflation, just as we should not give them credit for low inflation when the global environment is benign. Former US Federal Reserve Chairman Alan Greenspan, it is now recognized, deserves much blame for America’s current economic mess. He is also sometimes given credit for America’s low inflation during his tenure. But the truth is that America in the Greenspan years benefited from a period of declining commodity prices, and from deflation in China, which helped keep prices of manufactured goods in check.
CommentsSecond, we must recognize that high prices can cause enormous stress, especially for lower-income individuals. Riots and protests in some developing countries are just the worst manifestation of this.

CommentsAdvocates of trade liberalization touted its advantages; but they were never fully honest about its risks, against which markets typically fail to provide adequate insurance. Over a quarter-century ago, I showed that, under plausible conditions, trade liberalization could make everyone worse off. I was not arguing for protectionism, but rather sounding a cautionary note that we must be aware of the downside risks and be prepared to deal with them. 
When it comes to agriculture, developed countries, such as the US and European Union members, insulate both consumers and farmers from these risks. But most developing countries do not have the institutional structures, or the resources, to do likewise. Many are imposing emergency measures like export taxes or bans, which help their own citizens, but at the expense of those elsewhere.  
CommentsIf we are to avoid an even stronger backlash against globalization, the West must respond quickly and strongly. Bio-fuel subsidies, which have encouraged the shift of land from producing food into energy, must be repealed. In addition, some of the billions spent to subsidize Western farmers should now be spent to help poorer developing countries meet their basic food and energy needs. 
CommentsMost importantly, both developing and developed countries need to abandon inflation targeting. The struggle to meet rising food and energy prices is hard enough. The weaker economy and higher unemployment that inflation targeting brings won’t have much impact on inflation; it will only make the task of surviving in these conditions more difficult. 

Tuesday, 9 September 2014

Losing the plot

Article was published in money matters on monday 8 sep 2014

Gross Domestic Product (GDP) is the measure of recording all the economic activities during a specific period of time. The time period varies from a month to quarter or annual. Although the Pakistan Bureau of Statistics tries its best to measure the GDP by including informal sectors but still large part of the economy is unrecorded.

Protests in the form of long marches, sit-in and strikes affect the economy in various ways. Strike in a city affects the economic activity based on the number of days it is called for. In general, a one day strike does not affect the economic activity of entire country unless other cities are dependent on it.

For example, a strike in Karachi also affects other cities as well as the stock market because it is the commercial capital of the country. Interestingly, one day strikes call are, in general for half a day and in the second half of that day, economic activity may mitigate the effect of loss from the first half of the day.

Nevertheless, transport business as well as banking and financial market and manufacturing sector may not mitigate the effect of half day strike, thus contributing to loss.

Long marches, on the other hand, do not decrease the economic activity, in-fact it may increase the economic activity because the participants get breakfast, lunch, and dinner. Moreover, it also uses banners, flags, music system and placards.

Sit-in is a special kind of protest in which economy may not suffer at all. Nonetheless, if it happens in every city or major area of the city then it may affect the overall economic activity.

Government has significant role in mitigating and/or aggravating the economic loss during protests. Economics loss varies accordingly if the government provides safe passage to the protestors or government create hurdle for the protestors.

Although there are other types of protests as well but objective of today’s piece is to discuss the economic loss due to current protest by PTI and PAT and role of government in it.

Different articles in various newspapers discussed the extent of loss that the economy has faced. Among them the most discussed and most significant was loss in the market capitalization due to crash in the stock market because market situation was very vulnerable. Nonetheless, if stock market bounces back to the same level in few days then loss due to market capitalization will be lessened. However, at micro level people who lost everything during the three weeks may not come to same welfare level which they were enjoying before the protest started. Similarly, people who invest/divest to earn for their living daily meal be harmed during the crisis.

Another important loss mentioned was increase in external debt in rupees due to depreciation in exchange rate. The onus is not only the protest but since it is the significant event affecting both exports as well as imports, therefore, the onus of the depreciation is associated to the protest.

Although the above two mentioned issues are big in monetary terms but they are not affecting too many people. There are several other sectors which are directly or indirectly affected by the protest. At first, the protest has started from Lahore and the Government put containers everywhere to block their marches and restrict people to join them. The containers were taken by force to block roads and protect important national and international buildings/offices. Each container costs Rs.20, 000 to 1.5 lakhs per day depending on the size of the container and overhead cost including security and insurance paid on it.

Moreover, the crane, which is used to place the containers at certain places cost Rs.10, 000 per container but it may vary if used it in bulk. We can assume that since government has its own machinery therefore, it may have not cost them a penny but when government will return the containers to their owners, the owner will incur the cost.

It is worth mentioning here that the price of each container is in millions. It varies from Rs.1 million to Rs.5 million. If some containers are damaged or lost then there is a good amount price owners need to pay.

We have already seen “bhangras” after throwing/removing the container, which definitely ruin the containers from inside as well as outside.

It is wrong to assume that containers were empty. Some containers were filled with luggage which was paid by the traders. In the end, trader bears the cost of the material in it, unless they find it safe inside the container if they get it.

Contractual workers in construction sector and workers used for loading and unloading are the most affected people because if there is no business they will not be hired for work. However, it is also believed that the contractual workers are then going to these protests to feed themselves. Therefore we cannot say unambiguously that welfare level of contractual workers will be reduces but it is clear that economic activity of that sector in which they work is reduced.

Services sectors especially situated in the vicinity of protest are the most critical to address. While the sit-in was at the Aabpara market, sale of perishable items such as bread, eggs, halwa, puri, milk, tea, cold drinks have increased, while sale of clothing and other household non-food items has decreased.

When sit-in moved into the red-zone area, social welfare organizations are bringing in food items for protestors and some protestors are going out to eat as well. This implies that sale of tea stalls may have gone down but sale of clothing and other non-food items may have gone up. Nevertheless, due to insecurity customers are not visiting markets very often thus the sales of Aabpara market is definitely low. Similar to Aabpara market, businesses at other markets has also reduced.

Although the main sit-in or protest is taking place in Islamabad but few days ago it has started in other cities as well. Since supply chain of all the retail market is wholesale market, therefore, I asked a wholesaler in Lahore about his business during August. He told me exaggerating figure, i.e., sale of his products gone down to less than 10 percent of total sales compared to normal days. To lessen the extent of exaggeration if we say 20 percent, even then it implies that during the protest the sales have reduced to one-fifth of total sales, which is a big loss to the entire business community. This kind of loss cannot be covered afterwards.

Restaurants are also not getting enough customers. Since offices, schools and shops are closed transport sector is also bearing loss. Similarly, drivers and ticket checkers who are on daily wage are severely affected. Business persons, who have offices in blue area and other markets, by the end of the month, need to pay rent of office and salaries to their permanent employees irrespective of whether they get business in the last month or not.

Government offices are closed. Projects, which have already started by the government, will be delayed if they do not get proper funding at proper time which will increase the cost of each project.

From the above discussion we may conclude that traders are bearing huge amount of money due to forced hoarding of their containers. Moreover, since people are not spending therefore, their savings may have increased. Similarly, government offices are closed, which implies lesser expenses in terms of electricity etc. But overall we cannot say that it is benefitting the economy. The loss of economic activity per day is large but cannot be in billions. It would be interesting to see that if the process of calculating GDP ignores these losses, if they do, the sit-ins, may not impact the overall recorded GDP at all.
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Tuesday, 26 August 2014

BRICS Contingent Reserve Arrangement: Treaty for the Establishment

Melbourne, June 21, 2014
This BRICS Contingent Reserve Arrangement ("CRA") is between the Federative Republic of Brazil (“Brazil”), the Russian Federation (“Russia”), the Republic of India (“India”), the People’s Republic of China (“China”) and the Republic of South Africa (“South Africa”) (henceforth referred to, individually, as “Party”, and collectively, as the "Parties").
WHEREAS, the Parties agree to establish a self-managed contingent reserve arrangement to forestall short-term balance of payments pressures, provide mutual support and further strengthen financial stability.
WHEREAS, the Parties agree that this contingent reserve arrangement shall contribute to strengthening the global financial safety net and complement existing international monetary and financial arrangements.
THEREFORE, this Treaty sets out the terms and conditions of such contingent reserve arrangement, as follows:
Article 1 - Objective
The CRA is a framework for the provision of support through liquidity and precautionary instruments in response to actual or potential short-term balance of payments pressures.
Article 2 - Size and Individual Commitments
a. The initial total committed resources of the CRA shall be one hundred billion dollars of the United States of America (USD 100 billion), with individual commitments as follows:
i. China – USD 41 billion
ii. Brazil – USD 18 billion
iii. Russia – USD 18 billion
iv. India – USD 18 billion
v. South Africa – USD 5 billion
b. The Parties shall be entitled to make a request to access committed resources at any time. Until such time as one of the Parties (the “Requesting Party”) makes such a request and that request is acceded to by the other Parties (the “Providing Parties”) and effected through a currency swap, each Party shall retain full ownership rights in and possession of the resources that it commits to the CRA. While commitments shall not involve outright transfers of funds, committed resources shall be made available for any eligible request.
Article 3 - Governance and Decision-Making
a. Governance of the CRA shall be constituted by a Council of CRA Governors (the “Governing Council”) and a Standing Committee.
b. The Governing Council shall comprise one Governor and one Alternate Governor appointed by each Party. Governors must be a Finance Minister, Central Bank Governor, or hold an equivalent post. The Governing Council shall take decisions by consensus and shall be responsible for high level and strategic decisions of the CRA. It is hereby authorized to:
i. Review and modify the size of the committed resources of the CRA as well as approve changes in the size of individual commitments;
ii. Approve the entry of new countries as Parties to the CRA;
iii. Review and modify the CRA’s instruments;
iv. Review and modify the framework for maturities, number of renewals, interest rates, spreads, and fees;
v. Review and modify the preconditions for drawings and renewals;
vi. Review and modify the provisions concerning default and sanctions;
vii. Review and modify the provisions concerning access limits and multipliers;
viii. Review and modify the percentage of access de-linked from IMF arrangements;
ix. Decide upon the creation of a permanent secretariat or the establishment of a dedicated surveillance unit;
x. Approve its own procedural rules;
xi. Review and modify the rules pertaining to the appointment and functions of the coordinator for the Governing Council and the Standing Committee;
xii. Review and modify voting power and decision rules of the Standing Committee;
xiii. Review and modify the authority and functions of the Standing Committee;
xiv. Approve the procedural rules concerning the functioning of the Standing Committee;
xv. Decide upon any other issues not specifically attributed to the Standing Committee.
c. The Standing Committee shall be responsible for the executive level and operational decisions of the CRA and shall comprise one Director and one Alternate Director appointed by each Party; these shall be appointed from central bank officials unless decided otherwise by the respective Party. It is hereby authorized to:
i. Prepare and submit to the Governing Council its own procedural rules;
ii. Approve requests for support through the liquidity or precautionary instruments;
iii. Approve requests for renewals of support through the liquidity or precautionary instruments;
iv. Approve operational procedures for the liquidity and precautionary instruments;
v. In exceptional circumstances, determine the waiver of conditions of approval, safeguards and required documents under this Treaty;
vi. Approve a Party’s encashment request;
vii. Decide whether to impose sanctions in case of a breach of this Treaty;
viii. Carry out other functions attributed to it by the Governing Council.
d. As a matter of principle, the Standing Committee shall strive for consensus on all matters. The decisions of the Standing Committee pertaining to items C.ii and C.iii shall be taken by simple majority of weighted voting of Providing Parties. The decisions pertaining to items C.v, and C.vii shall be taken by consensus of the Providing Parties. All other decisions of the Standing Committee shall be taken by consensus.
e. Whenever a decision is taken by weighted voting, the weight attributed to each Party’s vote shall be determined as follows: (i) 5 percent of total voting power shall be equally distributed among the Parties; and (ii) the remainder shall be distributed among the Parties according to the relative size of individual commitments.
Article 4 - Instruments
The CRA shall include the following instruments:
i. A liquidity instrument to provide support in response to short-term balance of payments pressures.
ii. A precautionary instrument committing to provide support in light of potential short-term balance of payments pressures.
Article 5 - Access Limits and Multipliers
a. The Parties shall be able to access resources subject to maximum access limits equal to a multiple of each Party’s individual commitment set forth as follows:
i. China shall have a multiplier of 0.5
ii. Brazil shall have a multiplier of 1
iii. Russia shall have a multiplier of 1
iv. India shall have a multiplier of 1
v. South Africa shall have a multiplier of 2
b. The total amount available under both the precautionary and the liquidity instruments shall not exceed the maximum access for each Party.
c. A portion (the “De-linked portion”), equal to 30 percent of the maximum access for each Party, shall be available subject only to the agreement of the Providing Parties, which shall be granted whenever the Requesting Party meets the conditions stipulated in Article 14 of this Treaty.
d. A portion (the “IMF-linked portion”), consisting of the remaining 70 percent of the maximum access, shall be available to the Requesting Party, subject to both:
i. The agreement of the Providing Parties, which shall be granted whenever the Requesting Party meets the conditions stipulated in Article 14, and;
ii. Evidence of the existence of an on-track arrangement between the IMF and the Requesting Party that involves a commitment of the IMF to provide financing to the Requesting Party based on conditionality, and the compliance of the Requesting Party with the terms and conditions of the arrangement.
e. Both instruments defined in Article 4 shall have IMF-linked and De-linked portions.
f. If a Requesting Party has an on-track arrangement with the IMF, it shall be able to access up to 100 percent of its maximum access limit, subject to the provisions under paragraph (d) above.
Article 6 - Inter-central Bank Agreement
In order to carry out the transactions under the liquidity and precautionary instruments mentioned in Article 1, the Central Bank of Brazil, the Central Bank of the Russian Federation, the Reserve Bank of India, the People’s Bank of China and the South African Reserve Bank shall enter into an inter-central bank agreement setting out the required operational procedures and guidelines.
Article 7 - Currency Swaps
A Party may request support through one of the instruments specified in Article 4 according to the procedures established by the Standing Committee in accordance with Article 13 of this Treaty. Provision of USD to the Requesting Party shall be effected through currency swaps carried out between the Parties’ central banks on the basis of common operational procedures to be defined by the Standing Committee in accordance with Article 3.C.iv and the inter-central bank agreement, entered into pursuant to Article 6.
Article 8 - Definitions
The following terms shall have the respective meanings specified in this Article:
“Requesting Party Currency” shall mean the currency of the Party that requests to draw funds through a currency swap;
“Swap Transaction” shall mean a transaction between the Requesting Party’s central bank and a Providing Party’s central bank by which the Requesting Party’s central bank purchases US dollars (USD) from the Providing Party’s central bank in exchange for the Requesting Party Currency, and repurchases on a later date the Requesting Party Currency in exchange for USD;
“Drawing” shall mean the purchase, at the Value Date (defined below), of USD by the Requesting Party’s central bank;
“De-linked Drawing” shall mean a Drawing by the central bank of a Party that is not engaged in an IMF arrangement;
“IMF-linked Drawing” shall mean a Drawing by the central bank of a Party that is engaged in an IMF arrangement;
“Business Day” shall mean any day on which markets are open for business in all financial centers needed for the swap transactions to take place;
“Trade Date” of a Drawing or renewal of Drawing shall mean the date in which the spot market exchange rate for the Drawing or renewal of Drawing is established;
“Value Date” of a Drawing or renewal of Drawing shall mean the date the Requesting and Providing Parties’ central banks credit each other’s accounts. The Value Date shall be the second Business Day after the Trade Date;
“Maturity Date” of a Drawing or renewal of Drawing shall mean the date on which the Requesting Party’s central bank shall repurchase the Requesting Party Currency in exchange for USD. If any such Maturity Date should fall on a day which is not a Business Day, the Maturity Date shall be the next Business Day.
Article 9 - Coordination
a. The Party that chairs the BRICS shall act as coordinator for the Governing Council and for the Standing Committee.
b. The coordinator shall: (i) convene and chair meetings of the Governing Council and the Standing Committee; (ii) coordinate voting as needed; (iii) provide secretariat services during its term; and (iv) inform the Parties of the activation or renewal of liquidity or precautionary instruments.
c. Any Party requesting or receiving support through a liquidity or precautionary instrument – Article 4 – or opting out from participating as a Providing Party or asking for encashment of outstanding claims – Article 15(e) – shall not serve as coordinator. In this case, the next chair of the BRICS shall assume the role of coordinator.
Article 10 - Purchase and Repurchase under a Swap Transaction
a. The exchange rate that shall apply to each purchase and repurchase under a Swap Transaction shall be based on the prevailing exchange rate (hereinafter referred to as “the Swap Exchange Rate”) between the Requesting Party Currency and the USD in the Requesting Party’s spot market on the Trade Date.
b. The Requesting Party’s central bank shall sell the Requesting Party Currency to the Providing Parties’ central banks and purchase USD from them by means of a spot transaction, with a simultaneous agreement by the Requesting Party’s central bank to sell USD and to repurchase the Requesting Party Currency from the Providing Parties’ central banks on the maturity date. The same exchange rate (i.e., the rate of the spot leg) shall be applied to both the spot and the forward legs of the Swap Transaction.
c. On the Maturity Date, the Requesting Party’s central bank shall transfer the USD plus interest back to the Providing Parties’ central banks in exchange for the Requesting Party Currency. No interest shall be accrued on the Requesting Party Currency.
Article 11 - Interest Rate Determination
a. The interest rate to be paid by the Requesting Party on the USD purchased from the Providing Parties shall be an internationally accepted benchmark interest rate for the corresponding maturity of the swap transaction plus a spread. The spread shall increase periodically by a certain margin, up to a predetermined limit.
b. In the case of the precautionary instrument, the amount committed but not drawn shall be subject to a commitment fee, to be specified in the inter-central bank agreement.
Article 12 - Maturities
a. A De-linked Drawing under the liquidity instrument shall have a Maturity Date six months after the Value Date and may be renewed, in whole or in part, three times at most.
b. An IMF-linked Drawing under the liquidity instrument shall have a Maturity Date one year after the Value Date and may be renewed, in whole or in part, two times at most.
c. If the Requesting Party is not engaged in an IMF arrangement, access to the precautionary instrument shall have a tenure of six months and may be renewed, in whole or in part, three times at most.
d. If the Requesting Party is engaged in an IMF arrangement, access to the precautionary instrument shall have a tenure of one year and may be renewed, in whole or in part, two times at most.
e. The maturity of a De-linked Drawing under the precautionary instrument shall be of six months and that of an IMF-linked Drawing shall be of one year. The precautionary instrument, once drawn upon, shall not be renewed.
f. The Requesting Party may repurchase the Requesting Party Currency in exchange for USD at the Swap Exchange Rate before the Maturity Date. In this case, the accrued interest rate shall be calculated on the basis of the actual number of days elapsed from (and including) the Value Date to (but not including) the early repurchase date.
Article 13 - Procedures for Requesting or Renewing Support through the Liquidity or Precautionary Instruments
a. A Party that wishes to request support through the liquidity or precautionary instruments, or renewal of such support, shall notify the members of the Standing Committee of the type of instrument, the amount requested, and the envisaged starting date.
b. The Requesting Party shall provide evidence that it complies with the safeguards specified in Article 14 below.
c. Upon receiving the notification, the CRA coordinator shall convene a Standing Committee meeting to discuss and vote the Requesting Party’s request. The Standing Committee shall decide upon the request up to seven days after its submission.
d. Once a request for support through the liquidity instrument is approved, the Requesting Party’s central bank and the Providing Parties’ central banks shall activate Swap Transactions promptly, in a timeframe to be specified in the inter-central bank agreement.
e. Once a request for a Drawing under an approved precautionary instrument is made, the Requesting Party’s central bank and the Providing Parties’ central banks shall activate Swap Transactions promptly, in a timeframe to be specified in the inter-central bank agreement.
f. If the Requesting Party wishes to renew support through the liquidity instrument, it shall notify the members of the Standing Committee at least fourteen days before the Maturity Date.
g. If the Requesting Party wishes to renew support through the precautionary instrument, it shall notify the members of the Standing Committee at least seven days before the expiration of access under such instrument.
Article 14 - Conditions of Approval, Safeguards and Required Documents
a. When submitting a request for support through the liquidity or precautionary instrument, or renewal of such support, the Requesting Party shall sign and deliver a letter of acknowledgement committing to comply with all obligations and safeguards under this Treaty.
b. The Requesting Party shall also comply with the following conditions and safeguards:
(i) Submit all required documents and economic and financial data, as specified by the Standing Committee, and provide clarification to comments;
(ii) Ensure that its obligations under this Treaty at all times constitute direct, unsubordinated and unsecured obligations ranking at least pari passu in right of payment with all other present or future direct, unsubordinated and unsecured foreign currency-denominated external indebtedness of the Requesting Party;
(iii) Have no arrears with the other Parties or their public financial institutions;
(iv) Have no arrears with multilateral and regional financial institutions, including the New Development Bank (NDB);
(v) Be in compliance with surveillance and provision of information obligations to the IMF as defined, respectively, in Articles IV, Sections 1 and 3, and VIII, Section 5, of the Articles of Agreement of said institution.
Article 15 - Burden Sharing, Opt-out and Encashment Provisions
a. Providing Parties shall share the disbursement of drawings in proportion to their respective commitments to the CRA, subject to paragraphs (b) and (c) of this Article. In no event shall any Party be required to provide more resources than the amount that it has committed to provide in Article 2(a).
b. The approval of a request for support through the liquidity or precautionary instruments under this Treaty suspends, for as long as such support is in place, the Requesting Party’s commitment to participate as a Providing Party in any subsequent request for support through the liquidity or precautionary instruments.
c. When a request for support through the liquidity or precautionary instruments, or for renewal of such support is presented, a Party may opt-out from participating as a Providing Party, provided this is justified by its balance of payments and reserve position or by an event of force majeure, such as a war or natural disaster. The Party opting-out shall provide the necessary information to justify its decision. In this case, the other Providing Parties shall provide resources to allow opt-out in proportion to their commitments to the CRA, subject to paragraph (a) of this Article.
d. A Providing Party may request encashment of outstanding claims provided this is justified by its balance of payments and reserve position or by an event of force majeure, such as a war or natural disaster. The Providing Party applying for encashment shall provide the necessary information to justify its request. If the request is approved, the other Providing Parties shall provide resources to allow encashment in proportion to their commitments to the CRA, subject to paragraph (a) of this Article.
e. A Party that has opted-out or encashed from an outstanding currency swap or has opted out from an outstanding precautionary instrument shall not serve as a coordinator, as defined in Article 9, for the length of the transaction from which the party has opted-out or encashed.
Article 16 - Breaches of Obligations and Sanctions
a. Failure by a Requesting Party to fulfill payment obligations on the Maturity Date of a Drawing or a renewal of Drawing, unless corrected within 7 days, shall result in the following:
(i) all outstanding obligations of the Requesting Party to repay the Providing Parties under this Treaty shall be immediately due and payable;
(ii) the Requesting Party’s eligibility to further Drawings or renewals of Drawings under this Treaty shall be suspended;
(iii) any undrawn portion of a precautionary instrument of the Requesting Party shall be cancelled; and
(iv) any payments by the Requesting Party of its overdue obligations to the Providing Parties must be made on the same date and in proportion to the amounts due to each Party.
b. In case of an event of force majeure, the application of the measures above may be suspended.
c. In case of a persistent and/or unjustified delay in settling overdue payment obligations, a Requesting Party’s right to participate in any decisions under this Treaty may be suspended. After 30 days of unfulfilled payment obligations, the Providing Parties should consider whether this action is appropriate.
d. If, after the expiration of a reasonable period following the decision under paragraph (c), the Requesting Party persists in its failure to settle overdue payment obligations, the Governing Council may require the Requesting Party to withdraw from this Treaty.
e. The Requesting Party in breach of a payment obligation should agree to take measures that preserve the net present value of its obligations if the Providing Parties collectively decide to exercise this option.
f. In case the Providing Parties decide by consensus at the Governing Council level, the Requesting Party in breach of a payment obligation should agree to a novation of its obligations under this Treaty, including by issuing marketable debt securities that would not be subject to the Requesting Party’s jurisdiction. The Requesting Party should not unreasonably withhold consent to terms and conditions of such debt securities as shall be required by the Providing Parties.
g. The Requesting Party would be liable to a late fee in addition to the interest rate applied to the swap transaction to which payment is overdue. This late fee should increase periodically by a certain margin, up to a predetermined limit.
h. In case of a breach of any obligation under this Treaty, other than failure by a Requesting Party to fulfill payment obligations, the following sanctions may apply:
(i) all outstanding payment obligations under this Treaty shall be immediately due and payable;
(ii) eligibility to further Drawings or renewals of Drawings under this Treaty shall be suspended;
(iii) any undrawn portion of a precautionary instrument shall be cancelled;
(iv) the right to participate in any decisions under this Treaty may be suspended;
(v) after the expiration of a reasonable period following the decision under item (iv), the Governing Council may require the Party to withdraw from this Treaty.
i. The sanctions applied should be commensurate with the severity of the breach.
Article 17 - Language and Communications
a. The official language of the CRA shall be English. The English language versions of this Treaty and of any documentation under it shall be the official versions. All written and oral communication between the Parties shall be in English, unless the Parties otherwise agree in writing.
b. Any notice, request, document or other communication submitted under this Treaty shall be in writing, shall refer to this Treaty, and shall be deemed fully given or sent when delivered in accordance with the contact details that shall be provided separately by each Party.
Article 18 - Representation and Warranties
Each of the Parties hereby warrants and represents that:
a. It has the full power and authority to enter into and perform its obligations under this Treaty and shall provide evidence of such authority if requested by any other Party;
b. This Treaty and the performance by it of its obligations under this Treaty do not contravene any law or other restriction binding upon it or any of its property, and there is no legal or regulatory hindrance which could affect the legality, validity or enforceability of this Treaty or of obligations hereunder or have a material adverse effect upon its ability to perform such obligations;
c. All transactions under this Treaty shall be exempt from any administrative or legal obstacles to their completion;
d. All payments by it under this Treaty shall be made without withholding or deduction for, or on account of, any present or future taxes, duties, assessments or governmental charges of whatever nature imposed or levied by or on behalf of its country or any authority therein or thereof having power to tax. In the event that the withholding or deduction of such taxes, duties, assessments or governmental charges is required by law, it shall pay such additional amounts as may be necessary in order that the net amounts received by the other Parties after such withholding or deduction shall equal the amounts which would have been received under this Treaty in the absence of such withholding or deduction; and
e. It shall not assign, transfer, delegate, charge or otherwise deal in its obligations under this Treaty without prior written consent of the other Parties.
Article 19 - Legal Status of the CRA
The CRA does not possess independent international legal personality and cannot enter into agreements, sue or be sued.
Article 20 - Dispute Settlement
a. Any disputes relating to the interpretation of this Treaty shall be solved by consultations in the Governing Council.
b. If any dispute, controversy or claim relating to the performance, interpretation, construction, breach, termination or invalidity of any provision in this Treaty shall arise and not be resolved amicably by the Governing Council within a reasonable period, it shall be settled by arbitration in accordance with the Arbitration Rules of the United Nations Commission on International Trade Law (excluding Article 26 thereof) in effect on the date of this Treaty (the “UNCITRAL Arbitration Rules”). In case of resorting to arbitration, the language to be used in the proceedings shall be English and the number of arbitrators shall be three.
c. The Parties agree that in any such arbitration and in any legal proceedings for the recognition of an award rendered in an arbitration conducted pursuant to this Article, including any proceeding required for the purposes of converting an arbitral award into a judgment, they shall not raise any defense which they could not raise but for the fact that they are sovereign state entities.
Article 21 - Withdrawal from and Termination of the Treaty
a. A Party may withdraw from this Treaty by giving notice of such intention to the other Parties six months prior to the date of the envisaged withdrawal. However, withdrawal from the Treaty by any Party is not allowed for a period of five years from its entry into force.
b. During this six-month period, the Party that has given notice of such intention shall provide the other Parties with an opportunity to express views on its intention but does not have the right to request or the obligation to provide resources.
c. In the event that any obligation under this Treaty, including any obligation for the payment of money, remains outstanding at the time of termination of or withdrawal from this Treaty, all the terms and conditions of this Treaty (except for those entitling the Parties to any Drawing or renewal of a Drawing) shall continue to apply until such obligation has been fulfilled.
Article 22 - Acceptance, Depositary and Amendments
a. This Treaty shall be subject to acceptance, ratification or approval, according to the respective domestic procedures of the Parties.
b. The instruments of acceptance, ratification or approval shall be deposited with the Federative Republic of Brazil, which shall be the depositary of this Treaty.
c. The depositary shall promptly inform all Parties of: (i) the date of deposit of each instrument of acceptance, ratification or approval (ii) the date of the entry into force of this Treaty and of any amendments and changes thereto, and (iii) the date of receipt of a withdrawal notice.
d. If the Party that acts as depositary decides to withdraw from this Treaty, all the terms and conditions of Article 21 shall apply, with the exception that: (i) the depositary shall give notice of its intention to the other Parties; and (ii) as of the date of receipt of the depositary’s withdrawal notice, the role of depositary shall be assumed by one of the other Parties, as agreed upon by them.
e. This Treaty shall not be subject to unilateral reservations.
f. Any proposal to amend this Treaty shall be communicated to the Party that acts as coordinator for the Governing Council, which shall then bring the proposal before the Governing Council. If the proposed amendment is approved, the coordinator shall ask all Parties whether they accept the proposed amendment. If a Party, according to its domestic procedures, accepts the proposed amendment, it shall notify the depositary accordingly. The amendment shall become effective on the date of receipt of the last notification. Any decision of the Governing Council related to modifying Article 2 shall be considered an amendment.
Article 23 - Entry into Force
This Treaty shall enter into force 30 (thirty) days after the deposit of the fifth instrument of acceptance, according to each Party’s legal requirements.
Done in Fortaleza on the 15th of July of 2014, in five originals in English, one for each Party.

Tuesday, 8 July 2014

Monetising perks

Monetising perks     
Most of the time consumers give taxes, but this money is not forwarded to the government - 

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The article was published in "Money Matters" on Monday 7 July 2014

Budget 2014-15 (July-June) again reminds us that revenues and expenditures by the government are critical in Pakistan. We talk so much on these issues that we ignore the real problem, i.e., growth. Although Prime Minister Nawaz Sharif has a wish to increase the share of education expenditure by 4.0 percent but financing it would be a bigger problem than we think. Deficit financing of 1.8 percent is one way to increase spending on education but if other expenditures remain the same, it will increase our debt, hence debt servicing and repayments.

I resist myself to say anything in favor of imposing any new tax because it will eventually be paid by the bourgeois class in the form of taxation or increase in prices (inflation tax). More importantly, we need to stop certain expenditures such as untargeted subsidies, #PerksPlotsProtocols and other bigger leakages in the economy.

Dr Nadeem-ul-Haque has been saying on different forums that we are not taxing #PerksPlotsProtocols. If we monetize them they will come under the tax net, unless government declares it no-taxed income. Neglected document of the Planning Commission “Framework for Economic Growth”, which was written in the presence of Dr Haque as deputy chairman says “all of the perks in Malaysia are monetized.” Everything is quantified in incentives which have been in practice for more than 10 years. Therefore, following the model of Malaysia by monetizing all the perks, we can increase the revenue collections.

In general it is believed that the Framework for Economic Growth (FEG) is difficult to implement. Some fears that it will take 30-40 years to implement these policies. With due respect, No. It’s a misconception. The FEG talks about different reforms which may take one minute to sign and few months of implementation effectively. Above all the government does not need huge budget (in billions) to implement these reforms.

Guestimates of spending on #PerksPlotsProtocol range between Rs.250-500 billion, which if monetized will generate sufficient revenues because it will become part of the civil servants’ income. Question is who will do it? Bureaucracy?

Another wicked policy is granting SROs which are popular among the business communities. SROs consume billions of rupees every year, which significantly affect our budget deficit. According to some estimates, last year we lost around Rs.500 billion due to several SROs issued by the government. Finance Minister Ishaq Dar appears keen to abolish several SROs which caused Rs.300 billion loss last year. Nevertheless, whether abolishing that SRO will contribute Rs. 300 Billion is a separate question.

One of the other issues which I have observed lately is the problem of collection or in other words problem of enforcement. Most of the times we as consumers give taxes, but this money is not forwarded to the government. The FBR does not have proper mechanism to track these transactions and collect the total amount of taxes which consumers pay by consuming various goods and services. I’ll try to clarify problem of collection by giving few examples.

One may disagree with my calculation based on the assumptions I have taken. Nevertheless this is a good area which needs to be explored intensively. While standing at a local and relatively smaller restaurant I asked about the daily sales of his best selling product. I multiply total sales with 17 percent sales tax which the restaurant is taking from the customers but it is not accounted anywhere because all the transactions are based on cash. Then I multiply it with 5 assuming that on average sale of four other products matches with the sale of the best selling product. Furthermore, I assume 2500 restaurants all over Pakistan which are similar to this restaurant. My calculation shows that GST which can be collected from these restaurants is Rs.110 Billion in six months. I still believe that it is an understated figure.

Let’s look at another example. Every city has bakeries. Some ask for sales tax while others don’t. Nevertheless, I went to a good bakery and asked the total daily sale of best selling item. Following the same procedure my calculations show that across Pakistan if we take 1500 similar bakeries, we are losing Rs.68 billion due to inefficiency and lack of proper infrastructure of revenue collection.

While looking at the above figures, I firmly believe that we do not need more taxes. We are already heavily burdened by taxes.  These were just examples of such non-collections. Bottom line is that collection should be made better instead of imposing new oppressive taxes.

Another interesting tax which was levied in the last few years is tax on cell phones usage. We pay sales tax, withholding tax when we load the prepaid card. Other than that we pay tax on each call, each package (such as friends and family numbers, 1000 SMS in a week for just Rs. 10 etc), special SMS and sharing balance with someone. While calculating the effective rate I was shocked to see that we pay almost half in taxes, implies that on Rs. 100 card we consume 50 and we pay 50 in taxes.

Another important issue is introduction of VAT, which is welfare enhancing. What is VAT? It is a tax on value-added of any product at each stage of production. In simpler words, if a product is sold at Rs.100 and it is further improved by processing it further then the VAT will be applied on the difference between the new price and old price (Rs.100). In this way the end customer need not to pay tax on the total amount but on the value addition. Consider the example of a restaurant which was discussed above. If price of certain product doubles after value addition then customer pays only half of the amount on taxes which he/she is paying currently. Thus VAT is welfare enhancing.

VAT has been discussed for the last two decades but it was never implemented due to lack of documentation and according to some lack of political will. Huzaima Bukhair and Ikram ul Haq wrote in one of their writings that VAT is not considerable to businessmen because of unscrupulous traders, dishonest tax advisers and corrupt tax officials. Therefore, we need to reform our tax administration.

In the end, I’ll copy the statement from the FEG that in Malaysia the whole cabinet and Prime Minister were pro reforms.  Thus, political will with the support of cabinet is the key to support reform initiatives.
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