Support Rationale for Pakistan Business Council’s 8-Point Agenda on the Economy

AGENDA POINT ONE

Immediate moratorium on new trade agreements, including ones with Turkey and Thailand; renegotiate existing to Pakistan’s advantage. Besides net positive trade flow, FTAs must deliver three key objectives:

• More local employment;
• System-wide increase in tax revenues;
• Increase in non-commodity exports.

• None of the FTAs to date have had a significant impact on reducing Pakistan’s trade deficit.
• The most important FTA signed is with China. Pakistan’s trade deficit grew from $2.4 Bn when signed in 2006 to $9 Bn by 2015. The same per the Chinese statistics grew from $3.2 Bn in 2006 to $14 Bn in 2015. The disparity is ostensibly due to under-invoicing in Pakistan.
• Whilst exports to China did grow over this period, imports outgrew significantly
• Largest increase in exports was of commodities and low value-added items, generating very few jobs in Pakistan. Imports were however of value-added items, undermining local industry, jobs and tax revenue.
• Negotiators failed to secure access for several items of export potential from Pakistan
• Subsequent to the FTA with Pakistan, China granted more favorable terms to ASEAN, Australia and New Zealand. There was no clause in the agreement to require China to offer similar terms to Pakistan.
• Pakistan could avail of just 5% of the concessional lines available to it under the FTA. Many of these Pakistan had no capability of availing; others it couldn’t due to energy shortage and energy cost. China on the other hand availed of 57% of the concessional lines.
• There is significant mismatch between Pakistan’s export capability and those of Turkey and Thailand. For every additional $ increase in Pakistan’s exports to Turkey, Turkish imports to Pakistan would increase by roughly $3. Similarly, for every potential $ increase in Pakistan’s exports to Thailand, imports from Thailand would increase by $4.
• Pakistan already enjoys relatively low tariff access to both countries in the items it can export
• Both Thailand and Turkey aspire to get access to Pakistan’s automobile, auto-parts, chemicals, plastics and rubber markets which if granted would undermine existing industry
• Turkey is one of the highest users of trade defences, even against its FTA partners. Presently it has anti-dumping, countervailing and safeguard levies on Pakistan’s cotton yarn, made-ups, PET.
• Both Turkey and Thailand would seek best of China and Sri Lanka FTA terms, which if granted would impact the remaining local industry.

AGENDA POINT TWO

A comprehensive 3-year rolling trade strategy with full support from all line ministries; PM to oversee its implementation. Aim is to position Pakistan on par with Vietnam, etc. Should address all impediments to value addition, incl. import integration and the revival of units closed due to energy shortage and influx of cheap imports under FTAs and PTAs.

• Strategic Trade Policy Framework not a strategy: The Ministry of Commerce’s ambition to enhance exports, as embodied in the Strategic Trade Policy Framework (STPF) 2015¬-2018 is a single stakeholder’s ambition which cannot be termed a strategy! A pragmatic and achievable strategy requires buy-in from all stakeholders. The Ministry of Commerce is to be lauded for leading the thought process. However, in Pakistan’s context, it is not the sole stakeholder in trade (especially exports) nor adequately resourced or empowered to deliver the ambition.
• Stakeholder Buy-In: The Missing Link. The PBC advocates a long-term national trade strategy to be developed jointly by all relevant ministries i.e. commerce, industry, textiles, agriculture, planning, labour, finance, etc. Secondly, that all provinces buy into it; and last but not the least, that implementation of the strategy is overseen by a high level body accountable to the Prime Minster. Only then will trade (including exports) receive the priority and focus that countries like Vietnam and Bangladesh have successfully achieved and sustained in the recent past.
• Import Policies Need To Dove-Tail Into Export Strategies. In Bangladesh’s case, burgeoning garment exports feed off a well-aligned strategy, covering the import of cotton that it doesn’t grow. 40% of Malaysia, Vietnam and Thailand’s exports are based on imported inputs. In Pakistan, import content is less than 10%. Without a sound strategy covering the entire value chain, a clear allocation of responsibilities and a robust accountability process, the ambition to boost exports will remain only an ambition.
• Strengthening Competiveness Of Domestic Manufacturing Largely Ignored. A proper exercise to develop a long term trade strategy would perforce address the competiveness of domestic industries. In a country with a population of 200 million people, industries should enjoy an inherent advantage of size and scale that could be deployed to limit imports and boost exports. However, poorly negotiated Free Trade Agreements have resulted in cheap imports which (through a combination of the misuse of Afghanistan transit treaty, smuggling, under-invoicing, defective import valuations, counterfeiting and wide¬spread tax evasion) have so severely undermined local industries’ capacities and capabilities that survival in the domestic market is a challenge and global competitiveness is a far stretch. Indeed, these negative factors have encouraged businesses to trade rather than manufacture, a trend that needs to be urgently arrested and reversed if we are to create employment opportunities for our growing young population. The STPF fails to address the competiveness of domestic industry or import reliance in a holistic manner.
• FTAs And PTAs Are Not A Panacea For Export Growth. The PBC has consistently cautioned against hastily entering into FTAs which fail to protect local industry, undermine tax revenues, and often also fail to secure terms for Pakistan exports that are (and will remain) competitive against alternative sources into evolving destination markets. The FTA with China is a case in point. Whilst cheap imports from China have undermined local industries, China now offers more concessional access to ASEAN countries than it does to Pakistan, thus impacting exports. The Ministry of Commerce’s limited resources would be better deployed in renegotiating existing FTAs. The PBC has also advocated transit arrangements for Afghanistan that secure domestic industries from misuse. Large markets in most cities brazenly deal in smuggled and counterfeited items. Controlling smuggling, etc., are outside the purview of the Ministry of Commerce, and so only an inter-ministerial approach can address the fundamentals of competiveness. Whilst laudable that the Ministry of Commerce has taken the lead in trying to shape a trade policy, other ministries must join in pulling in the same direction.
• Strategy For Promoting New Markets & New Products – Vague. An export strategy must focus on the diversification of products and destinations, and include the export of services. Textiles, the main-stay of Pakistan’s exports, represent just 6% of world trade. The incentives included in STPF 2015-18 to encourage diversification are so few that they do not warrant discussion. Unless Pakistan can proactively and continuously address export competiveness in the dynamic and competitive global markets, it will constantly play a catch-up game with countries, who have a more focused export vision.
• Nothing Concrete For Defending Existing Export Levels. The STPF draws attention to the need to promptly refund taxes and there can be no disagreement with that. However, it fails to address the necessity to simplify duty drawback and export rebates. Pakistan’s energy and labour costs (50% to 100% higher than eye-ball competitors) impact exports, especially as a large percentage is still in the low value-added, mass oriented, low-margin segment. A graduated incentive system linked to the degree of value addition and incorporation of local inputs would help reposition exports to less cost-sensitive segments. The STPF touches on the need to build brands to sustain exports. Whilst true, there is no concrete proposal, for example to allow exporters to retain a meaningful percentage of export earnings for investment in brand building.
• No Value Addition Strategy For Our Textiles. Pakistan should discourage export of raw cotton, yarn and fabric, as opportunities to convert to higher value exist or should be created as energy becomes available at competitive cost. By exporting commodities and semi-finished items, we nurture competition from countries such as Bangladesh that have no domestic supplies. They then hurt our value-added exports.

AGENDA POINT THREE

Integral part of CPEC should be attracting jobs displaced in China, esp. in textiles, due to rising labour cost. Concessions in SEZ’s be conditional on jobs and exports incremental to, and not at the cost of, existing industry

CPEC will no doubt be a game changer for Pakistan and there is hardly a facet of the economy that will not be touched by it. However, there needs to be greater transparency on how CPEC will impact the competiveness of existing domestic industries and the safeguards that will be deployed to prevent it becoming a channel for cheap imports. This is a concern as reportedly industries established in Special Economic Zones under CPEC will enjoy extensive concessions. It is important to ensure that such ventures add incrementally to jobs and exports and don’t displace existing sources in the country. Pakistan should leverage CPEC to attract a meaningful percentage of the millions of jobs that are likely to move out of China given the rising labor and conversion cost there. Indeed that should be an integral part of CPEC. Pakistan will have to service the CPEC debt and equity. It is estimated that it would amount to between $3 Bn to $5 Bn pa starting in a few years. Only if Pakistan is able to generate export earnings would that become possible. So far there is a general reluctance to look the CPEC gift horse in the mouth; the domestic industries’ fear is that it could turn out to be a Trojan horse! This needs to be allayed.

AGENDA POINT FOUR

Provide Industry access to energy, water and labor at regionally comparable costs, failing which, implement the export package to prevent further loss of market share. Use the exchange rate tool wisely.

Provision of electricity and gas at a competitive cost is an issue broader than just to sustain exports. Supply of energy to domestic industry at globally competitive rate helps in withstanding the onslaught of imports. Pakistan’s value-added export sector is encumbered by energy costs that are 60% to 100% higher and an exchange rate that has been adjusted the least vs. most competitors:

Factor	Pakistan	China	India	Bangladesh	Vietnam
Energy (c/KWH)	14.25	8.5	9	113	7
Min. Wage $/M	133	150-320*	115-135*	68	107-156*
Cur. +/- vs US$ since Jul’15	-2.93%	-11.35%	-6.19%	-1.06%	-4.19%
Cur. +/- vs Euro since Jul’15	+0.89%	-7.21%	-2.25%	+3.05%	-0.66%

The cost disparity between Pakistan and Bangladesh is between 1.3 to 2.7 times:

	Pakistan	Bangladesh	Pak/BD Mult.
Energy -Electricity US$/KWH -Gas US$/KWH -Steam US$/Hour	0.145 0.27 16.27	0.11 0.12 6.75	1.34 2.7 2.47
Labour US$/M -Min Wage -Total incl overtime and social security	133 223	68 97	1.98 2.29

The government’s package to support value-added exports should be implemented as soon as possible to stem loss of market share. In the broader context, the narrative on energy must now shift from generation and supply to cost.

AGENDA POINT FIVE

Urgently address FBR’s talent and technology gaps; curb Its discretionary powers, promote an environment which encourages expansion of the tax base. Its KPI must be weighted to taxes collected from new taxpayers. Stop mistrusting the formal sector; reward it for acting as a collection agent. Taxation needs to be equitable and competitive and promote capital accumulation/consolidation to build scale and competiveness.

Government’s own deficit target and the target it sets the FBR for tax collection do not differentiate between taxes raised from existing and new tax payers. This drives the FBR to extract more from the already taxed, sometimes through actions bordering on harassment and others that risk long term health of business. Indeed harassment is the biggest turn-off for those not already in the tax base. FBR is not currently structured with talent and capacity to deploy technology to broaden the tax base. Here are some facts:

• Total taxes grew by 60% in the last 3 years but most of this came from existing tax payers
• Total number of filers of tax returns was only 1.1 million in 2015 and while the FBR has estimated 1.8 million returns will be filed by December 15, 2016, it looks like even the 2015 figure will be difficult to achieve.
• Less than 60 top private sector tax payers account for every fifth Rupee of tax revenue Withholding taxes accounted for 70% of total tax revenue. These were collected by the formal sector as unpaid tax collectors.

	Corporate Tax %	VAT%	Pak/BD Mult.
Pakistan	32*	17
Singapore	17		7
Sri Lanka		15	12
Bangladesh	25		15
Vietnam		22	10

The tax regime also does not encourage capital formation and consolidation. Undistributed reserves are taxed at 10%, bonus shares at 5% super tax is levied at 3% for corporates & 4% for banking companies, and inter-corporate dividends taxed at 12.5% A Pakistan Business Council inspired government task force recommendation was enacted in 2007 to promote holding companies. Regretfully for a mere Rs. 2 Bn of tax revenue, this was repealed in a retrogressive manner, rendering pure holding companies pointless.

Efforts to formalize the real estate sector and to bring those not filing tax returns into the tax base are to be applauded. However, serial amnesties and reliance on withholding taxes are not long term solutions. The Rs. 21 Bn collected last year by way of withholding tax at 0.4% on banking transactions of non-filers palls against the Rs. 5 Trillion of transactions that it was derived from. Unless FBR is able to locate potential tax payers and enforce the writ of law, there will be no significant expansion of the tax base.

It is recognized that without sufficiently strong political will, none of the reforms suggested would work.

AGENDA POINT SIX

Misuse of Afghan Transit Trade and smuggling from Iran need to be curbed. Duty on transit goods should be charged at point of entry for refund on exit. Specific duty structure (by unit/ weight/ pieces/size) will reduce under-invoicing. Importers be made to file tax returns, to prevent abuse of the “full and final” tax regime.

• The combination of import duties, GST and income tax provide a good incentive to misuse the Afghan transit arrangements.
• In many cases the quantities of goods “transiting” Pakistan are not commensurate with the size of Afghanistan’s population; the types are not in line with its tastes/preferences; and it does not have the industrial capability or capacity to convert some of the raw materials “imported” into finished products. These are either smuggled back to or never leave Pakistan, severely impacting industry and tax revenue.
• Porous borders facilitate movement from both Afghanistan and Iran into Pakistan. Unless physical controls are tightened, goods imported via Chabahar and Bandar Abbas in Iran for Afghanistan will continue to find their way into Pakistan
• Many markets in Pakistan brazenly deal in smuggled goods
• Imports are under-invoiced, quantity imported is under-reported, goods are mis-described and under-valued, all to avoid paying full import duty
• The “full and final” tax regime allows those who under-invoice to avoid fiing tax returns

AGENDA POINT SEVEN

Simplify laws and address silo management of ministries, federation & provinces to ease/reduce cost of doing business. Multiple taxes/agencies be replaced with a unitary collection system. Remove powers in the Companies Ordinance 2016 which overlap with/are in the domain of other authorities and will needlessly encumber corporates, the pillar of the formal sector.

There is growing fragmentation of authority between federal ministries which are increasingly operating in silos. Trade is a case in point:

• FBR is driven by the immediate need of tax revenue to meet deficit targets rather than longer term impact on the economy or business. In the context of trade, many imported inputs for potentially value-added exports are taxed at high duty rates. Duty draw back scheme is difficult for medium sized businesses to avail. As a result, import incorporation into exports in the case of Pakistan is less than 10% vs. 40% in Vietnam and Thailand and over 60% in Bangladesh which produces no cotton, yet leads Pakistan 2:1 in textile exports by deploying its labour to convert cloth to apparel.
• Ministry of Commerce is motivated by export considerations which it feels Free Trade Agreements can secure. It operates oblivious of the impact on imports, trade deficit, local industry, jobs or tax revenue.
• Ministry of Finance in juggling the fiscal deficit delays tax refunds, impacting exporters’ ability to fund business
• The provinces which, post devolution, are responsible for agriculture do not spend enough time energy or money on research with the result for example that cotton seed in Pakistan is outdated and the country is facing shortage of the raw material that feeds Textiles, it main export. Exports is not seen as a KPI of provincial governments

Pakistan ranks poorly in virtually every global ranking, in many cases well below its immediate neighbors, who also don’t fare well:

 

Fragmentation of authority creates complexity for business. A simpler, technology-driven, one-window operation would considerably ease doing business and bring down the cost. A unified taxation return and collection system would save time, effort and money. Multiple agencies and authorities of the federal and provincial governments are responsible for tax collection in Pakistan. In the city of Karachi a medium sized enterprises needs to pay 47 different federal, provincial and local taxes (vs. 25 in India and 5 in Singapore). Due to complexity and multiple taxes and agencies, Pakistan stands at 155 of 190 countries in the World Bank/PwC Paying Taxes Ranking.

The Companies Ordinance 2016 (now rejected) duplicated power and authority of other bodies, placing further burden on the corporate, tax-compliant sector instead of making it easier to do business. For example, Section 452 requiring disclosure of foreign shareholdings overlaped with powers of the State Bank of Pakistan and the Federal Board of Revenue. Section 456 (2) (a) required real estate developers to seek SECP’s permission prior to announcement of projects, in addition to obtaining requisite sanctions, NOCs, etc., from authorities that regulate the real estate sector. These were non-value-adding duplications.

AGENDA POINT EIGHT

Transform the framework to promote the Information, Communications and Technology sectors to reposition Pakistan in the digital economy

For the longest time, Pakistan’s fiscal and other incentives for business have been focused on the manufacturing sector. If Pakistan is to position itself as a meaningful player in the growing digital economy, it needs to significantly improve the policy framework to encourage the ICT sector.

Broadband penetration in Pakistan is low. 1% through fixed lines and 16% via wireless compare poorly with OECD averages of 27% and 78% respectively. Whilst 3G/4G have contributed to raising wireless penetration, a key impediment is affordability. 83% of Pakistanis can’t afford broadband. Broadband cost is impacted by high taxes on equipment as well as mobile connectivity. It is burdened with taxes as high as 33%. In United States which has amongst the highest broadband penetrations in the world, the US House of Representatives in June 2015 passed the Permanent Internet Tax Freedom Act (PITFA). This law bars federal, state and local governments from taxing household Internet subscriptions and from imposing discriminatory Internet-only taxes. The table below shows a direct relationship between tax rates and wireless penetration across multiple geographies:

	Tax Rate	3G Penetration
Pakistan	33%	16%*
India	12%	82%
Sri Lanka	28%	80%
Philippines	12%	140%

Reduction in tax rates in other countries has proven to lead to more use, greater productivity and efficiency, higher GDP growth and improvement in social welfare. The net result over time is higher tax revenue. The UN’s International Telecommunications Union estimates that a 10% increase in broadband penetration leads to increase of 1.4% in GDP growth and the GSM Association feels that every 1000 new broadband subscribers leads to 33 direct and indirect jobs.

Affordable and reliable fixed line and wireless access to internet is fundamental to people’s empowerment and a key enabler of ICT. More inclusive and democratized web access will boost education, agriculture, health, mobile payments and e-commerce. Besides, it will boost employment, particularly of women, disseminate knowledge across a very wide spectrum of socially and economically relevant areas. There is an also acute need for government to deploy IT to simplify and make doing business easy. This is an opportunity for local software houses to develop or to partner global companies to digitize the government.

Fiscal investment incentives tailored for fixed asset intensive manufacturing sector are ineffective for intellectually-driven, asset lean ICT sector. Export earnings of the ICT sector, post the Finance Act 2016 attract tax at 3 to 4 times the rate applicable to export of goods. Aside from LUMS, UET and GIKI there are no quality training institutes. Software industry is unable to borrow to fund working capital needs because banks are reluctant to collateralize work-in-progress. In Philippines, the BPO industry employs a million people and generates $25 Bn of exports – larger than entire exports of goods and services from Pakistan! There are niche but significant opportunities to attract BPO to Pakistan. As India and China, the traditional centres of BPO have yet to implement the IFRS accounting standard which Pakistan has, there is a window of opportunity for outsourced accounting services. There is therefore considerable potential to generate jobs, exports and taxes from the ICT sector.

ABOUT PAKISTAN BUSINESS COUNCIL (PBC)

PBC is a business policy advocacy platform, established in 2005 by Pakistan’s leading private-sector businesses, including multinationals. Its objectives are to provide for the formation and exchange of views on the conduct of business in and from Pakistan, to promote and facilitate the integration of businesses in Pakistan into the world economy, to interact with governments in the economic development of Pakistan and to facilitate, foster and further the economic, social and human resource development of Pakistan. Its members, all from the private sector, are engaged in thirteen important sectors of manufacturing and services. They include 22 MNCs from 12 countries. Together, PBC members account of 10% of Pakistan’s GDP and nearly every fifth Rupee of annual tax and export revenues. Collectively, they directly employ 315,000 people, with millions more in the extended value chain. More information is available on www.pbc.org.pk.