Remember the lessons of the East India Company. They aren’t so ancient.

(This article was published in Pakistan Today on 03rd October 2013 titled: Remember the East India Company?

http://www.pakistantoday.com.pk/2013/10/02/comment/remember-the-east-india-company/ )

By: Omer Zaheer Meer

When Friedman and Savage (1948) put forth their behavioral theories, they discussed behaviors that contradict traditional finance assumptions of rational individuals always seeking to maximize the utility of their money and being risk-averse, they used examples of buying lottery tickets and insurance, in which expected utility is low but people participate in their purchases. One wonders of their joy only if they knew about the IMF sponsored economic plan of the current Pakistani Government.

Economic experts have been lambasting the outgoing PPP government’s economic policies as amongst the worst in the country. That was before the current Government unfolded its own, dictated by the IMF’s terms for a $ 6.7 billion loan package. The government pleaded its case for the borrowing citing it as absolutely “necessary” to pay back a previous IMF loan.

It also rightly stressed the importance to clear the circular debt of the energy companies to ensure “maximum” supply of electricity.  However, this was largely achieved by borrowing from the local market which to a large extent crowded out private sector businesses.  Finding it insufficient, the Government also printed currency worth PKR 804 billion in just 2.5 months (about the same amount for which the IMF program was accepted). This along with the SBP purchasing over $125 million in open market to “build” dollar reserves during the two months (July and August 2013) created immense pressure on PKR which for the first time in history has hit over PKR 108.7/$. As a result over PKR 330 billion has been added to the national debt just due to currency devaluation. This of course has increased the future debt servicing costs too.

While anti-public actions of the IMF program like increasing the power tariffs by gradually removing subsidies and devaluation of currency, causing high inflationary pressures, are being implemented in the name of economic reforms despite the dire situation of the industry, the much-needed structural reforms in the taxation system are being ignored. The rich and the powerful practically still enjoy a tax-free income stream while the poor and middle-class is being milked unjustly through indirect taxation.

Throughout the world the focus is on maximizing the direct taxation as indirect taxation always results in inflation and unjust taxation. To elaborate the point, rich person would be paying the same amount of indirect tax on fuel or groceries as a poor or a middle-class person resulting in high tax to income % for the less affluent.

With increased terrorism already paralyzing Pakistan’s economy, these are certainly not the best reforms one would expect from a properly prepared and prudent economic team. Consider the current economic situation of Pakistan:

The rupee is in a constant fall, already declining by 2.5% per month, inflation is rising at an increasing rate, power cuts have yet to be reduced significantly for industry (power supply for home consumers have improved at the cost of industry), industry is struggling against power crisis and increasing production costs, GDP growth is forecasted at about two and a half percent while fiscal deficit is expected to cross 9%.

Now examine the major effects of the “reforms” panned out by the government so far:

Constant devaluation of currency and increased interest rates resulting in even higher inflation, resulting reduced purchasing power leading to stagnant or reduced revenues for business and public exchequer, rounds of layoffs fuelling already serious crime rate and militancy, power crisis (not just electricity but also the gas load “management”) and inflation forcing more industries to shift abroad while further increasing unemployment and an even greater piece of national budget going to debt servicing.

What is actually needed is to extend the tax base by not only widening the numbers in existing tax classes but also bringing in the “forbidden” areas of agriculture especially big landlords in the tax net. It’s a pity that over two third of Pakistan’s population is associated with agriculture, yet there is no tax on it. Even where tax net exists, there are many famous cases where people were never taxed. There is a famous case of a “biryani wala” bought into tax net only after he bought property worth millions. An extensive focus in this direction with proper incentives, powers and training for implementation officers can actually yield much more effective results at much less economic costs and hardships than the current IMF program.

Another area to improve upon is inducing proper checks and balances and ensuring the system is followed in all financial dealings. The power companies’ circular debt payment is already viewed with suspicion due to the lack of the above.  A sum of over PKR 500 billion was paid to several power companies in haste without any audit and checks as to the accuracy of the bills. Furthermore, no material concession was successfully implemented even if negotiated at all. To give an idea of how material this was, it is about 75% of the total amount the IMF will be lending to Pakistan over the entire duration of its program.

Saving and restarting investment and economic activity requires political will to take tough decisions and introduce reforms that may not necessarily be anti-public. Unfortunately, Prime Minister Mian Muhammad Nawaz Sharif’s government has so far showed no signs of doing so. They better start doing so now as I still remember what an influential friend in London once told me, conquering the countries by wars is just too expensive but making them slaves economically is very effective and a proven way. Remember the lessons of the East India Company. They aren’t so ancient.

The writer is a leading Economist who is also a qualified Chartered Accountant, Financial Analyst and Anti-Money Laundering Expert. He can be reached on twitter @OmerZaheerMeer and www.myMFB.com ID: Omer Zaheer Meer