Since time immemorial, Pakistan’s macroeconomic cycle has been nothing but a series of booms and busts. The current government came on the promise of breaking this wheel and fixing the structural issues once and for all.
Thus began the stabilisation path which saw serious belt-tightening for an average citizen. But along the way, the administration has mastered the art of giving mixed signals, thanks to the frequent changes in the finance ministry.
Yet there was a general narrative of austerity for the most part. That is until Shaukat Tarin was brought in, who had been a vocal critic of these policies and is now increasingly signaling towards growth. Obviously, one can debate the sustainability and election politics of it which is mainly what they want but nonetheless, this move has given a ray of hope to the business community, particularly those in the pro-cyclical sectors who saw a couple of rocky years in the wake of slowdown.
To get a sense of how the industry is viewing this newfound economic direction, Mettis Global interviewed Ehsan Malik, the chief executive officer of Pakistan Business Council, a policy advocacy group comprising some of the most notable corporate names in the country. He has previously worked for Unilever and served as its CEO.
The excerpts below have been edited for clarity.
What do you make of the signals coming out of the finance ministry?
EM: It has been a key change that has brought in a lot more clarity about the country’s economic direction. Mr Tarin brings his own style, which is of a very go-getter nature and shows the right amount of impatience. This is in contrast to the previous finance minister who was a very capable person and did a lot to stabilise the economy but his hands were tied with first the International Monetary Fund Programme and then the Covid-19. We have to take cognizance of the critical cycle that the country is in, with just over two years left for the government. There can be two approaches now, one is the stabilisation that Hafeez Shaikh led and is also the stance of the IMF. The other, that the new finance minister has come with, is basically to fire the engine of growth.
Obviously, there are going to be some challenges. The big danger now is that are we going to service this demand from domestic manufacturing or will we be back to square one with import-driven growth and running large external imbalances? It’s one of the dark clouds overhanging the economic thinking and I am sure Mr Tarin is acutely aware of it. There’s already a talk that some of the sectors are being fuelled by Shaukat Aziz-style of steps, such as housing finance or auto finance.
Three other storm clouds that are hanging all effectively lead to higher inflation and thus potentially an elevated borrowing cost, leading to a curtailment of demand. First is the talk of raising energy rates, which if happens, will be passed on through higher prices by the industry as it’s already uncompetitive, spare the five export-oriented sectors. Second is the unrealistic tax targets agreed with the International Monetary Fund so far. The third major challenge is within the ambit of the mismanagement of the food supply chain, manifested by poor cotton and wheat output, which again raises the likelihood of inflation. These are the things that Shaukat Tarin has talked about (and against) too.
With inflation once again entering double digits, do you believe there is a possibility of returning to the high-interest rate environment like olden times?
EM: When the policy rate was at 13.25%, the State Bank was taking a blinkered view and there were motives behind that, one of which is to create a buffer for forex reserves and making it attractive for foreign investors to park money in rupee bonds. Pakistan Business Council and a few other groups drew their attention to how this wasn’t a wise choice. Then Covid-19 came which triggered a flight of capital that also came around Governor Reza Baqir’s public statement that they will be differentiating between the headline and core inflation.
One thing that’d lead to higher inflation and ultimately creep into the core inflation is the utilities. If I make shoes and my energy costs rise by 30% and let’s assume that it occupies 20% share in the total cost then obviously my products will become more expensive and the end consumer will have to pay more. Now the good realisation is that to the maximum degree possible, there is going to be the differentiation between the types of inflation while determining the policy rate. What’s also very helpful is the forward guidance that the State Bank has given, basically saying that if things remain more or less where they are and if inflation is mostly led by the cost-push side then we’re unlikely to make changes in the policy rate. That’s giving very solid confidence to the industry and I don’t see any near-term increase in that.
How do you assess the effectiveness of the recent real estate amnesty in fuelling economic activity?
EM: The way I look at it is that if you want to kickstart the economy, this is a good way as it will trigger activity for sectors like steel and cement. However, it’s not very sustainable for the simple reason that the asset being invested in is not commercial and won’t create productivity. A house is a very desirable social goal but it’s not really going to add value in the long term. Obviously, its timing in the backdrop of Covid-19 was important and attempted to minimise that harm. To make it (relatively) sustainable, you will have to fix the foreclosure laws so that no negative effect is felt on the banking sector, once the government’s guarantee runs out.
To unlock this sector, the government didn’t really have a huge amount of choice in bringing it to the formal net by opening this window but obviously if there are no determined efforts to broaden the tax base, you have to undertake a series of frequent amnesties. That has been happening over the past few years.
What are some of the gaps in our (foreign) investment landscape? From a local perspective, how much value can the TERF add?
EM: When we talk of foreign investment flowing into Pakistan or growing by this or that much, we have to also look at where it has been coming. The first area where the funds have been poured into is the power projects. Why? They get a guaranteed return, so it doesn’t involve high risk. The second is the telecom sector. Lastly, where quite a large investment has been made is the products, which contains very high as well as quick payback. Why are consumer products companies coming into Pakistan? They are enamored by the fact that we have a very young population, rapid urbanization and growing urban middle class so it’s easier to change habits and switch people to branded products. We always talk about inward investment, not the repatriation though, there have been phenomenal returns.
But now what we need is a differentiated FDI policy and should be encouraging and incentivising agriculture which is the backbone of our economy. We have only two international dairy players, not a single one in the meat that I know of, anyone in horticulture? You should be facilitating investments by making land available, which is one of the most scarce commodities now. The special economic zones must be expedited in this regard, with serious thought put into their locations as well. For example, Dhabeji is ideal thanks to its proximity with a city like Karachi and a seaport. But if you are going to make it in a remote area that lacks any infrastructure or roads, then it’s not particularly useful. Lastly, you have to build them in clusters so there is an opportunity for sharing knowledge and expertise. There is a need to promote corporatization which is not helped by, say, double taxation on dividends first at the holding company level and then to the shareholder. No uniform standardisation across the country and dealing with different regulatory bodies in every province is another example that will actively raise the cost of production for a business.
Coming to TERF, in my opinion, it is probably the single most successful tool in the last 30-40 years to trigger investment. Initially, it was meant for the only greenfield but the Pakistan Business Council lobbied for it to include companies that want to expand or modernise their current operations. Rs434 billion has been given to the State Bank for planting machinery and as per our estimates, another Rs300bn worth of investment into land and buildings has also taken place. If you take the turnover to asset cover ratio, which ranges from 5-10x depending on the industry. Assuming the asset base is Rs350bn and leads to revenues of Rs3.5tr, even considering the current minimum tax rate at 1.5%, that will be far in excess of the interest rate subsidy. I believe there is rationale to continue with this scheme but this time make it more targeted, say for only entities up to a certain size or of a particular size. The State Bank should consider it, but obviously that depends on the IMF too.
What should be the key priority areas for the upcoming budget?
EM: I think we have to be realistic, so expecting any relief in terms of rates is probably not the wisest. As far as our recommendations are concerned, the focus should be on directional matters than line items. For example, there should be two different targets, one for existing, that should be in line with the expected nominal growth of the economy, and the other for new taxpayers. We can’t really hope for a high increase from the latter since the Federal Board of Revenue still hasn’t been restructured and that should be a priority area. Obviously, it won’t happen in a single budget but we’d like to see some signal. Taxpayers submit millions of records with the authorities and there is a need to mine that data to identify evaders and for that, improving its technology infrastructure is important.