Moody’s Upgrades Pakistan's Economic Outlook. But Is That an Accurate Assessment?

This wouldn’t be the first time that the credit rating agency has published an assessment which has generated much debate amongst economists.

December began on an upbeat tone for Pakistan’s economy, as Moody’s Investors Service affirmed the government’s local and foreign currency long-term issuer and senior unsecured debt ratings at B3. The agency also changed the outlook to ‘stable’ from ‘negative’. 

Its explanation for upgrading Pakistan’s economic outlook is that that “the change in outlook… is driven by Moody’s expectation that the balance of payments dynamics will continue to improve, supported by policy adjustments and currency flexibility”.

This wouldn’t be the first time that the credit rating agency has published an assessment which has generated much debate amongst economists, especially with regard to the country’s rising external debt, highly depreciated rupee and subsequent repayments – none of which appear to be out of the red zone.

Following the global financial crisis of 2008, the Financial Crisis Inquiry Commission found that 73% of mortgage-backed securities rated by Moody’s were at AAA in 2006, and had to be downgraded to junk by 2010. 

The ability of Moody’s to be the primary and sole bellwether of a rosy future remains questionable. 

Consequently, Pakistan’s policy makers must remain alert to any slippages in milestones.

It is a fact that Islamabad cannot compete in regional markets, let alone global markets, simply because it continues to struggles with poor regulation, high labour costs, technology and processing.

While there was a minor increase in exports in terms of volume and income for the July-November period, it should be noted that Pakistan has the highest average tariff amongst 70 countries having more than $20 billion worth of annual exports and the levy of regulatory duties has pushed effective tariffs even higher. 

Since 2003, the global market share of Pakistan’s neighbouring countries China, India, Iran and Afghanistan (CIIA) has increased by 216%, that of the South Asian Association for Regional Cooperation (SAARC) region by 186% and Economic Cooperation Organisation (ECO) by 127%. In the same period, however, Pakistan’s share in the global market has decreased by 19%. Had Pakistan’s exports grown at the pace of CIIA’s, the country’s annual exports in FY’19 would have been $55 billion instead of $23 billion. The failure to keep pace with the regional export growth is primarily linked with the anti-export bias in Pakistan’s economic policy paradigm. Tariffs on imported inputs are one of the major drivers of anti-export bias.

In fact, Mian Zahid Hussain, president of Pakistan’s Businessmen and Intellectuals Forum (PBIF), recently expressed concern that the non-payment of refunds has pushed the export sector to its deathbed, while energy tariff has also become a matter of concern. Tariff liberalisation, which has been applied since 2000 in Pakistan, has been reversed by gradually increasing the applied tariff to 11.6%, which resulted in a decline in exports to $23 billion in FY’19. Owing to the inability of tax machinery to collect direct taxes, the reliance on taxes collected at the import stage had become alarming. The differentials in tariff rates for commercial importers and industrial users of raw material, intermediate and capital goods are severely misused, causing delays in the provision of essential material to small and medium enterprises (SMEs).

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Because tariffs have been applied so unreasonably, they have resulted in an erosion of competitiveness of the industry by increasing the cost of inputs, causing de-investment and closure of industries and making products more expensive. The outcome of this is imposing a burden of slipshod expensive products on the average Pakistani consumer.

Islamabad still has a long way to go to improve its image and market itself better at the global level. The moribund economy suffers from structural inefficiencies. If high real estate costs are the main drawback in one sector, the small pool of talented artisans and skilled labour is the key problem in another. On one hand, phytosanitary barriers to trade, lack of certifications/standards or high tariffs is the problem, on another, contract enforcement or IPR is the key obstacle. Pakistan struggles with informality or fragmentation concurrently with government price control which acts as the biggest barrier to sectoral growth in another. 

Textile and agriculture woes

A case in point is Pakistan’s textile industry. It is the country’s largest employer of labour in the manufacturing sector and accounts for nearly 60% of its exports. But as stated above, structural inconsistencies and infrastructural incompetency plague the economy. Endemic energy supply shortages, lack of investment in novel cutting-edge technology and failure of manufacturers to diversify their product range and move into the value-added apparel sector means that Pakistan’s share in the $820 billion international textile and clothing (T&C) export market has festered in spite of the country being one of the five largest cotton manufacturers in the world. 

While the current value of world textiles and apparel exports totalled $315 billion and $505 billion respectively in 2018, up by 6.4% and 11.1% from a year earlier. With exports of around eight billion dollars, Pakistan occupies the ninth position among the 10 largest exporters of non-apparel textiles with China, the EU and India taking the top three places. In apparel exports from South Asia Bangladesh enjoys market share of $32.5 billion and Vietnam a share of $31.5 billion. Compare this with Pakistan’s apparel exports of $5.5 billion.

Recently, the Imran Khan government decided to withdraw sales tax exemptions enjoyed by the exporting companies on the purchase of their inputs under the zero-rated regime. The government has promised exporters it will refund the sales tax three days after they file their monthly sales tax returns along with the goods declaration forms. Yarn manufacturers have lamented that they are unable to pay wages to employees as they are facing an acute liquidity shortage partly due to the massive delay in release of tax refunds by the government.

Additionally, the sales tax refund filing procedure has been made so complex that it is impossible for most of the exporters to file the claim in such a way that it fulfils all the requirements prescribed by the Federal Board of Revenue (FBR), which makes the refunds possible. Even cotton production in Pakistan has witnessed a free fall, led by a secular decline in acreage over the past decade. 

Pakistan’s agriculture sector has systemically taken short-term decisions to cater to the urban elite, often ignoring hydrological conditions of the specific areas. Like, for example, Pakistan is one of the few countries in the world which is growing rice (paddy) in desert conditions. More recently, water-intensive crops have been introduced to out-of-basin regions. For instance, farmlands in Punjab have been converted to cotton growing areas which were not fit for the purpose due to arid conditions.

This doesn’t even begin to account for the un-regularised urbanisation in Pakistan, leading to unaccounted abstraction of ground water. Most sugar mills in the country are owned by the first-tier leadership of Pakistan’s major political parties, leading to phenomenal increase of area under cultivation of sugarcane even though Pakistan’s sugar output has remained export-uncompetitive for decades. Despite the substantive agricultural output, Pakistan is facing one of the biggest crises of malnutrition and stunting in the world. 

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The federal government’s non-tax revenue has declined sharply, by 44% during FY19, mainly due to a steep decline in the State Bank of Pakistan’s profit. According to the SBP, the federal government’s non-tax revenue stood at Rs 427.3 billion in the last fiscal year (FY19) compared to Rs 761 billion in FY18, depicting a sharp decline of Rs 333.7 billion. Most of the decline was visible in collections from National Highway Authority, Wapda, Discos and Chashma Nuclear Power Plant.

Sales tax refund claims have touched about Rs 350 billion. The government of Pakistan continuously claims to have expedited the payment of refund claims, every time giving a new date, but the reality is far cry, causing a severe liquidity crunch for exporters. 

Announcing the Expeditious Refund System (ERS) for automated payment on generated RPOs, the government had withdrawn zero-rated facility for five export-oriented industrial sectors in the budget 2019-20, but this has not been implemented so far. Record inflation has hit the purchasing power of the common person, due to which business activities have reduced drastically.

A difficult tax system and a trust deficit have stunted efforts to promote small and medium enterprises (SMEs). A large portion of this sector remained undocumented and reluctant to come under the taxation system. There are 3.1 million industrial and commercial consumers in Pakistan who should have been in the tax net, but only 43,000 consumers are registered in the sales tax. Although the present Pakistani government has been stressing the need to reform this sector and generate employment, the reality is that SMEs have to face the reluctance of commercial banks to provide more loans, creating a catch-22 situation. 

While the Pakistani government has been very exuberant about the improvement in the balance of payments position of the country, it is less forthcoming about the lack of pick-up in FDI in its equity markets. 

Added to all this are the recent changes in the fiscal and monetary policies, which have significantly spiked the overall cost of doing business by increasing the working capital requirements of manufacturers and blocking fresh investments in capacity expansion and technology replacements. 

By what measure has Moody’s upgraded the outlook for the economy? One can only guess, but hopes shouldn’t stem from the IMF’s recent loan, which almost certainly will send the country into an external debt trap.  

Vaishali Basu has worked as a consultant with the National Security Council Secretariat (NSCS) for several years. She is presently associated with the think tank Policy Perspectives Foundation.