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18 - 24 Aug, 2012
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ECONOMIC REVIEW
Reduction in Discount Rate
It is a good omen but bringing down interest rate alone can't usher fresh investment
by SHABBIR H. KAZMI

Reduction in Discount Rate
The State Bank of Pakistan (SBP) has curtailed policy rate by 150bps to 10.5% from 12% in an attempt to lure new investment. The overall perception is that this reduction may help in curtailing debt servicing of the government but attaining any substantial increase in investment may remain an unfulfilled dream. The immediate response of experts is, as long as capacity utilization of existing facilities remains low, expecting any fresh investment can be termed 'hoping against the hopes'. Unless the sole reason of poor capacity utilization – load shedding of electricity and gas – is removed, neither the local manufacturers can become competitive in the global markets nor the country can produce exportable surplus.
Experts have the consensus that cost of doing business has remained high in Pakistan because of high interest rate and double digit inflation in the country. However, the recent extensive load shedding of electricity and gas has virtually crippled economy of the country. This is right but the most encouraging point is the robustness of Pakistan's economy, achieving 2.5% GDP growth rate and exports of nearly US$24 billion.
The situation would have been entirely different had there been uninterrupted supply of energy products at affordable cost. Pakistan is also facing billions of dollars losses because of being 'frontline partner' in war on terror. Withholding of payments due from Coalition support Fund (CSF) has increased government borrowing from the domestic sources. There is growing pressure on the government to pull Pakistan out of 'proxy US war' in Afghanistan.
In the past the SBP had opted for keeping interest rate high in a bid to contain inflation in the country. While the policy didn't help in achieving the target, the fallout has been massive reduction in investment. Since local investors are shy, foreign investors also prefer not to increase their exposure in Pakistan. Not only foreign direct investment touched historic low, inflow of portfolio investment also remained dismal, partly because of depreciating rupee but more importantly the government following of absurd policies.
Despite fully cognizant of huge investment potential in oil and gas exploration and power sectors, investors have remained least interested in making fresh investment. Experts say unless the issue of circular debt isresolved on permanent basis, no investment can be expected in these two strategically important sectors. If IPPs are suffering due to prevailing circular debt issue, fertilizer industry is also facing poor capacity utilization because of government following a bad policy, curtailing gas supply of Reduction in Discount Ratefertilizer plants and diverting it to power plants. While there has been no ease in load shedding, the country has been forced to import nearly 1.2 million tons urea. Let it be remembered that the country has attained the capacity to produce 1.2 million tons exportable surplus.
Historically, nearly two dozen listed companies have remained focus of foreign portfolio managers. These companies belong to fertilizer manufacturing, commercial banking, insurance, exploration and production and oil and gas marketing sectors. Circular debt has not only plagued the entire energy sector but also affected banking and insurance companies, banks are suffering due to rising delinquencies and insurance companies due to poor income from their investment. Cement manufacturers have managed to post profit because of rising exports but higher energy cost is also shrinking their gross margins. The added problem is that since most of the cement companies are highly 'leveraged' bulk of the gross profit is eaten up by out of proportion financial cost.
Share of textiles and clothing in Pakistan's total exports remained high for FY12; despite the initial concern the segment may witness a decline of up to US$4 billion. This shows that there are units which have managed to overcome electricity and gas load shedding, mainly by establishing captive power plants. These units have also achieved higher value addition through backward and forward integration. While the performance of standalone spinning, weaving and processing units remained dismal, composite units also having made-up manufacturing facilities performed well. Sponsors of these units have stopped talking about outages and started focusing on in-house power generation, even by using diesel. They have learnt the difficult lesson that running the units on slightly expensive in-house generation is far better than facing interruption in production.
Experts have the consensus that following the policy of mobilizing more revenue from the existing tax players is proving counterproductive. On one hand the policy is encouraging tax evasion and on the other hand size of undocumented economy is growing, therefore, overall GDP size is understated. Bringing tax rate down and facilitating documentation can boost up not only size of the GDP but overall tax collection. The rule of thumb is, higher the tax rate, higher is the evasion. In many countries the governments have successfully increased revenue collection by reducing applicable tax rates.
Along with this a policy decision has to be taken that all sorts of income, irrespective of the source should be declared taxable. This has specific reference to taxing income from agriculture. It is on record that people have started clubbing all sorts of income under 'income from agriculture' to claim exemption. However, the rate should be low and without any cascading, at present as the income grows the tax rate also become higher.
Pakistan is a victim of cost pushed inflation, therefore the strategy has to be evolved for: 1) achieve food security, 2) changing energy mix to bring down the cost of energy products, 3) curtailing dependence on fossil oil and 4) removing the irritants. Let everyone keep this in mind that Pakistan has survived without soliciting any standby facility with the International Monetary Fund (IMF).
It is necessary to reiterate that Pakistan's energy crisis can be overcome by following good governance. Despite having above 24,000MW electricity generation capacity average output has been hovering around 12,000MW due to inability of the generation companies to buy fuel. Cash flow of distribution companies can be improved by containing electricity pilferage and enhancing recovery of overdue amounts. Gas shortage can also be overcome by containing theft and leakages and resolving litigation pertaining to some mega gas fields.

 
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