Un-Economics of

Day-to-Day Life
From Myths to
Reality

“Modern tools with an old

mind never works rather it
devastates”
ABOUT THE
Author
Mr. Amir Zia is a qualified accountant from
Chartered Institute of Management Accountants
(CIMA-UK). He is Chief Financial Officer of Treet
Group of Companies. He has vast experience
and exposure in strategic planning, industry
analysis, financial/ economic analysis &
project evaluation, treasury management,
international trade and international trade
finance. His expertise also lies in financial and
non-financial reporting, tax management, stock/
fixed income securities analysis & trading,
financial restructuring (including debt/equity
restructuring/balance sheet repositioning &
capital restructuring); financial engineering and
corporate affairs.

1
Message from the
Author

We live in a wonderful country

with people from all backgrounds
having different experiences,
ideas, fictions, myths, and utopia.
These predispositions are [most
of the times] strengthening by
the ruling elites through media,
schooling systems and prevailing
environment.
This book is an attempt to unfold
some of the thinking patterns
prevailing amongst common man
of our Country.
Policies based on wrong
assumptions are liable to dismay
so it is important to have clear
understanding underlying factors
and an honest assessment of the
problems we are facing today.
This book is an attempt towards
this direction.

Amir Zia
Author

2
CONTENTS

Chapter 01 Chapter 02 Chapter 03

COMMON BELIEFS ECONOMIC ACTIVITY WE ARE LIVING
IN OUR SOCIETY IS RE-EXAMINED IN REALITY
06 09 15

Chapter 04 Chapter 05 Chapter 06

FINANCIAL TAXATION BLACK ECONOMY
MANAGEMENT SYSTEM & DEMONETIZATION
24 31 41

Chapter 07 Chapter 08 Chapter 09

PRO-POOR INDUSTRIALIZATION STORY
POLICY DILEMMA POLICY OF DEBT
44 47 53

Chapter 10 Chapter 11 Chapter 12

MY BELIEVES AND LAW INTERNAL BALANCE BEING PAKISTANI
OF THE COUNTRY VS. EXTERNAL BALANCE - WHAT I WANT?
59 63 67

3
Un-Economics of
Day-to-Day Life
From Myths to Reality

In this book we will try to buster common beliefs/ jargons prevailing in our society. We
will attempt to unveil the illogical reasoning behind those beliefs and will show how
[and why] these illogical sequences of our thoughts are mainly patronized and shaped
by the ruling elite. Most of the times we are quarreling with the symptoms and making
sacred those factors (causes) that are directly responsible for the symptoms.

4
We are building structure of this book on the following premises:

1. People are neither corrupt nor dishonest [and neither they are honest] but
they are rational and what they are doing/reacting is the best outcome of the
prevailing system.

2. Moral suasion will not affect the behavior but the change of system does.
Ethical education is effective only if it is tuned with the desired system [and
moral suasion should be logical and factual].

3. Economic growth in simple terms is triggered with Consumption Pattern

[demand creates its own supply] that nurtures within environment of trust [i.e.
business confidence] and continuity of policy.

4. We are not perfect. Any policy change will have beneficial impact on some
segment(s) of society and adverse effect on others. Then the only measurement
of the efficacy of particular policy is definite indices/indicators and if they are
moving in right direction then policy implementation is successful otherwise
failure. Adversaries can be compensated by the beneficiaries. Every decision
has to make trade-off.

5. Policy making and its execution are entirely two separate matters. Policy
cannot be effective [and efficient] unless we understand this difference.
False assumptions /predisposition amongst mandarins will result in wrong
assessment, analyses and hence poor policy and its execution.

6. Ultimate goal of a “Good” Society is to provide security, employment, ease of

mobility and freedom of speech with healthy mind to its people.

5
 Chapter 1

COMMON BELIEFS
IN OUR SOCIETY

“EVERY MYTH IS PSYCHOLOGICALLY SYMBOLIC. ITS NARRATIVES

AND IMAGES ARE TO BE READ, THEREFORE, NOT LITERALLY, BUT AS
METAPHORS.”

JOSEPH CAMBELL
6
 1. Simplicity is the best policy. Extravagant life and spending are largely
condemned. Day to day example we quote is to live in simple house, having few
clothes and avoid spending through borrowings and so on….

We will burst this myth in Chapter 2 – Economic Activity is Re-examined

2. Speculation and hoarding is taken as stigma in society. Most of the times

Government is vying with the hoarders and speculators. Are they really bad
then why they exist [from very beginning] in the first place and what role are
they playing?

3. Middleman role is also largely being scolded. It is common belief that he takes
the major chunk of the pie and producer is being exploited by him. Is it so? If
middleman role is so lucrative and he earns abnormal profits then Economic
Theory tells us that there should be more suppliers (middlemen) in the market
and competition fades away abnormal profits. Why is not so?

4. Most of the times people reprimands [and Government takes action against
them] people who provides low quality goods. What is the product quality? Can
it be defined in some meaningful way?

5. Profiteering is taken very negative in our society. What is excessive profits?

Does it really exist and being controlled by the profiteers?

6. Corruption remains a substantial obstacle for Pakistan where it is still

perceived to be widespread and systemic. Petty corruption in the form of bribery
is prevalent in law enforcement, procurement and the provision of public
services. We talk too much about corruption but can we define corruption in
some meaningful way? Corruption is cause of bad economy or is an outcome
(affect) of poor conceived policies.

We will burst these myths in Chapter 3 – We are living in Reality

7. Interest is widely condemned in the Society. But it exists in the Society [from
very beginning]. What is interest? What is trade? Can we eliminate interest?

We will explore Interest in Chapter 4 – Financial Management

8. We don’t pay taxes. We are non-filers. Less than 1% are only tax payers.
Increase the tax base if to increase the tax revenues and so on.

Is it true? Are we not really paying our taxes? How to increase the tax base? Why people
are generally shy of being filers? Are we really corrupt?

We will explore Taxation issues in Chapter 5 – Taxation System

9. Most of the times Media (Print & Electronic both) have discussion on size
of black economy. Black economy size in the Country is as much…….. it is

7
 increasing every year………….. and so on.

What is black economy? Can we control it? How it is linked with the Central Bank’s
Policy to increase the currency in circulation in the Country?

We will explore Black Economy issues in Chapter 6 – Black Economy & Demonetization

10. Education will trigger the economic growth. Investment in infrastructure

(road, industrial parks, power generation) has not primal importance. More
investment in education and hospitals.

Does pro-poor policies tackles the poverty issue or it accelerates the poverty? We will
try to answer this question in Chapter 7 – Pro-poor Policy Dilemma.

11. Import substitution is best policy we can save valuable foreign exchange. Does
it really work so? We will examine this factor in Chapter 8 – Industrialization
Policy.

12. We talk too much about Country’s loans. Our future generations are indebted
and they have to feel the burden. Loan is really bad? We are also future
generation of our past forefathers. Are we feeling this burden and in which
form? This will be illuminated in Chapter 9 – Story of Debt.

13. Law is supreme but what does it mean?

Being Pakistani which law do i need to follow? This dilemma is explored in Chapter 10
– My Believes and Law of the Country

14. Balance of Payment Deficit and resultant foreign currency loan. Can it be made
up through contractionary economic policy or expansionary economic policy
is better? Much confusion in public mind (e.g. dollar rate, dollar is sacred,
balance of payment deficit etc.) . This we will discuss in

Chapter 11 – Internal Balance vs External Balance – How to make trade-off?

15. And finally Chapter 12 - Being Pakistani – What I want?

We will highlight the structural issues we have in the Country and try to find out the
ways to tackle it.
In the end we will finalize our conclusion and will try to build a model in the light
of recent devaluation of Pak Rupee, Interest Rate hike and Taxation measures taken
(Finance Act, 2019) to improvise the Economic Activities and will try to suggest the
some policy measures to rejuvenate the economic activities.
We will use the concepts and tools developed in this book.

8
Chapter 2

ECONOMIC ACTIVITY
IS RE-EXAMINED

“HOW MANY MILLIONAIRES DO YOU KNOW WHO HAVE BECOME

WEALTHY BY INVESTING IN SAVING ACCOUNTS? I REST MY CASE.”

ROBERT G. ALLEN
9
Expense (i.e. consumption) of one person is income of another person. Thus, if to
increase the income of the whole society is to increase the consumption pattern.

Economic Activity is dependent on Consumption (speed of depletion of inventory and

frequency of repeat buying), technology (that determines productivity and innovation),
entrepreneurship (who takes risk and organize the factor of production), medium of
exchange (to facilitate the transaction process) and availability of credit to enable and
accelerate the consumption process)

Resources
being extracted Production is
or converted made available This consumption
Resources to the people for
with the help of (by One Group of
(either on earth or the Consumption
technology People) is Income
beneath it) through supply
(knowledge) and of another Group
capital by the chain
entrepreneur

Business activities are not carried out in vacuum but within policy framework (and
consistency in policies to give the business confidence), skilled workforce (to enable
technology transfers, innovation to boost the conversion process), infrastructure
(enabling environment) but above all consumption level that triggers this process.

The above diagram depicts seven important factors in improvising economic activities;

Known resources [existing and/

or are made available through If resources are not sufficient [and/
1. Resources R&D] and economically viable or not economically viable to ex-
(through price mechanism) to tract/deplete] can be imported.
deplete/ extract.
Know-how is very critical that
includes skilled work force,
technology transfer that ensures If know-how is not up to the mark
viability of an economic process in the Country can be imported.
amongst competitors. Skill labour force can be prepared
2. Knowledge and
Availability of finance [either with the development of vocational
Capital
through efficient Capital Market and technical institutes. Technol-
that acts as a catalyst to eco- ogy transfer can also be ensured
nomic growth and debt market] through bi-lateral arrangements.
ensures resources can be gath-
ered for an economic activity.

10
 That includes intermediaries
(e.g. dealers, distributors,
wholesalers, retailers, Supply chain signals to the
3. Supply Chain stockists, logistics etc). that producers about inventory levels
ensure availability of product for future production decisions;
throughout the Country within
short period of time.

Government can play very

Most of the times current behavior
important role in smoothening
or anomaly in the system is the
the economic activities
direct outcome of the existing
through legal frame work
policies, legal framework e.g. as
that determines roles, rights,
we will discuss in Chapter 8, Auto
4. Institutional responsibilities amongst
Policy is mainly responsible of
framework and participants, enabling taxation
the low density of cars per 1000
infrastructure measures, availability of
persons in the Country. There
required infrastructure,
are many other examples in this
elimination of red-tape etc.
book how this current behavior is
Consistencies of policies are
shaped up because of improper
very important in improvising
legal framework and policies.
business confidence.

Who will combine the resources, Less Government or More

gather the work force and Government?? Is the pivotal
take the risk of venturing an question that we need to ask.
economic activity? It is the Taxation is not c. We firmly believe
entrepreneur who does this that public sector is inefficient
5. Entrepreneur
because of the profit motive. and incompetent in its operation
He is ready to take more risk vis-à-vis private entrepreneurs and
and engage in more economic it is better to leave to the private
activity under conducive sectors to trigger the economic
business environment. process to the maximum extent.
Demand creates its own supply.
If inventory levels are depleted
Consumption includes private
because of consumption
consumption ( C ), investments (
it will be signaled through
I ) and Government spending ( G
supply chain to the producers/
) and imports ( M ). Producers will
6. Consumption manufacturers to produce more.
either produce for C + I + G or for
Likewise, if inventory levels are
Export ( E ). This E less M creates
piled up at supply chain because
external imbalance (as we will see
of less consumption, producer
in Chapter 11)
will likely to produce less in the
next production cycle.

11
 Enabling factors includes:

• Medium of Exchange –
currency in circulation, Efficient medium of exchange is
debit and other necessary to efficiently execute the
7. Enabling banking channels; transaction. Likewise availability
Factors • Credit cards, personal of credit is necessary to boost the
loans, mortgage consumption pattern.
finance, product
finance, installment
sales etc.

Entrepreneur will do production only if he is sure that his production is sold out.
Selling is only possible if it is being consumed. We take a simple example of shaving
disposable razors. If on average one disposable razor of particular brand is used
for 04 days and all of the consumer decides [having simplicity in mind and resultant
thrift drive] decides to use one shaving razors for 08 days. What will be the sales of
that Company it will be dropped to 50%, What this Company will do it will lay off its
employees or shut down the plant and end result will be contraction of activities and
layoffs. Paradox of thrift applies and will put the society into recession and poverty.
Now imagine if all consumers decide to use the shaving razors for 02 days only. Sales
of the Company will be doubled and it will hire more workers, invest in the technology
and research and development (innovation) and this ultimately leads into growth and
size of the economic pie will be increases.

Likewise, if everybody in the Society decides to have few clothes in their cupboard what
will happen to the textile industry?

What is total consumption or total sales? Consumption is product of two factors i.e.
individual consumption [in particular time frame]* x total no. of individuals (having
required purchasing power).

*Particular time frame is very important in determining repeat buying and its frequency
e.g. a society where a car is being replaced after every 10 year will have entire different
consumption pattern vis-à-vis a society where on average car is being replaced after
every 04th year.

If to increase the economic process we have to provide stimuli to both factors i.e. we
have to increase the individual consumption by providing him access to the credit (e.g.
credit card, personal loans etc.) and also to increase the no. of individuals having
required purchasing power but this is difficult task and will be done gradually (as
the size of pie increases, middle class of the society will be broaden) or have to work
out on the export markets. Simultaneously we have to work on social norms that are
detrimental to the consumption.

Simplicity or oppositely extravagance is very difficult to define. We take two simple

scenario.

12
Scenario 1: One person earns Rs. 30million per annum what is simplicity level for
him. Live simple life does not spend on goods and services rather store his wealth in
cash at home (leakage from the economic system that invoke the paradox of thrift)
or buy gold or purchase land (which are unproductive and are only transfer of wealth
from one person to another and hoarding in cash, dollar, gold are also having positive
correlation with the increasing the size of black economy as discussed in chapter 06)
and increases the value of unproductive resources. This person can be called miser
but definitely not contributing to the society rather detrimental to the Society. What
should he do either reduce his income levels and tuned up with his spending pattern
or increase his consumption according to his income level? In either case simplicity
argument bursts out.

He must be persuaded either to tune up his consumption pattern or put his savings in
banks, mutual funds etc. where it can be productively utilized by others.

Scenario 2: One person earns Rs. 200,000 per annum but his consumption level is Rs.
300,000 per annum what is simplicity level for him? Should he reduce his consumption
or try to increase his income levels? If he reduces his consumption and does not try
to increase his earnings, this feature maybe of laziness but not of simplicity. How
he is filling the deficit? With the availability of credit he can bridge the gap with the
understanding his future stream of income will be increased and this gap will be
bridged. His increased spending will trigger the economic process and there will be
more chance of increasing his income levels.

Giving over weight-age to thrift drive is working as vicious circle in our society. As a
nation we have hostile view on borrowings (credit cards, banking system, personal
loans etc.). This hostile behavior is stemmed from our surrounding environment (e.g.
strong proliferation of thoughts that banking system is not halal) and lack of interest by
ruling elite in developing habits [of common man] of using banking systems at School
and College levels and unnecessary glorification of simplicity in media, syllabus and
every sphere of life. Thus both factors of consumptions are subdued. Government has
to play the enabling role. Following factors are important in this regard:

1. Development of Financial System (that includes banks, mutual funds, national

saving schemes, capital market development etc. where saving can be
channelized and wealth can be stored in productive way);

2. Awareness of importance of Financial System [and Insurance and Assurance

System] at School and College level;

3. Stoppage of unnecessary hostile publicity towards financial system, insurance

mechanism in the Society in different forum and platforms;

4. Promoting consumption behavior in Society (and stoppage of unnecessary

glorification of simplicity in media, syllabus, and other forums);

5. Strengthening the Social Security System in the Society and promoting the

13
 culture of Insurance and Assurance;

6. Enabling taxation measures [this is discussed in Chapter 5 – Taxation System]

Most of the above measures are through policy making and rest will be done by the
private sector itself and Government does not need to spend.

Our Society is over risk overt due to many reasons that includes lack of [retirement
funds, social security benefits and meeting contingencies] and very unreceptive
behavior toward insurance system. People hoards money in their houses because they
have hostile behavior towards financial system and do not spend because of improper
social security system and don’t believe in insurance mechanism. But this is catch 22
issue. Providing social security needs taxation but taxation is dependent on economic
activities that in turn dependent on consumption pattern and consumption is subdued
because of lack of trust in financial system [and hoarding of money in their houses].
What is important is to build this trust in financial [and capital market] systems and
channelize the savings in the economic system and avoid leakages.

Moreover, Insurance [and Assurance] mechanism of modern society does not only
have positive impact on individual behavior but also reduces the craving for savings for
the contingencies. But unfortunately, insurance coverage ratio [both life and general
insurance] in our Country is minimal due to our skeptic views on insurance mechanism.

Important question we should ask whether our ruling elite does not know this issue.
Most probable answer is “Yes!” They know, but they don’t want to change the people’s
behavior [and their belief system] and want status quo [and want to have even more
fictional belief system] because of the political benefits and perhaps short term myopic
vision.

14
Chapter 3

WE ARE LIVING
IN REALITY

“HARDEST REALITY IS ACCEPTING THE REALITY.”

15
Role of Speculators

The word “speculation” carries a connotation of negativity. But first, what does
“speculation” really mean? As frequently as it’s used, the term is equally misunderstood.
We don’t really define it. Rather, it is one of those things that we know when we see. In
order to evaluate speculation, we must first understand what we mean by it.

Individuals who engage in speculation deliberately invest in risky assets, hoping to

obtain profit from the expected changes in the prices of these assets.

Speculators perform two vital economic functions:

• They sell protection from risk to other people, much as a fire insurance policy
sells protection from risk to a home owner.

A ticket broker attends a preview of a new comedy film and bets that it is likely to hit.
He decides to speculate by buying large block of tickets. In this way he takes over some
of the producer’s risk [that if his films flops and he gets cash in advance].

• Most importantly they help to smooth out price fluctuation by purchasing items
when they are relatively abundant (and cheap) and holding them (hoarding)
and reselling them when they are scarce. In this way they play a vital role in
helping to alleviate and even prevent shortage.

Speculators (or hoarders) accumulate and store goods in periods of abundance and
make goods available in periods of scarcity. For example if he suspects that next year’s
crop of wheat is affected with flood and rains and will not be available in abundance. He
will buy some now when it is cheap for resale when it becomes scarce and expensive.
In this way he will smooth out the swing in prices by adding his purchases to the total
market in the period of low prices (and which tends to bring the prices up) and bringing
his surplus during the high prices (which tends the prices down).

Far from aggravating instability and fluctuations, speculators work as hard as they can
to iron out fluctuations, for that is how they make their profits.

We take another [but very common] example of land speculators. It is commonly

alleged that;

1. Land prices are very high and out of reach of the common people because of
the land-speculators;

2. Money is tied up in unproductive resources (i.e. land) because of land-

speculators;

3. Prices of land will be declined to the level of common people if all speculators’
roles are eliminated;

Let’s examine the above statements and try to find out the truth with the help of

16
following diagram;

1. Land developer buys the marginal land from farmers at X amount of money and
intents to develop this land; there is no economic activity yet started and this
is only transfer of money from one owner to another owner i.e. only change of
hands. It can be either through cash and / through banking instrument. Farmer
can spend his money (X amount) at his will. No money is tied up anywhere.

2. Land developer give this news [of his intention to develop the marginal land]
to the market and issues files vis-à-vis his land. Speculators [any person
investors, buyers, myself, you and other common people) is ready to step
in and buys that file from Land Developer at X+Y amount. Still no economic
activities is yet started it is only change of hands. Buying and selling of files are
started. Buyers has transfer X + Y amount to the seller and seller can spend
this amount at his will. Again no money is tied up anywhere in this transaction.

3. Land developer with this success of secondary market [buying and selling of
files amongst speculators] started to develop the land (e.g. sewage, roads,
electrifications etc.). Now economic activities have been started and added to
the GDP.

Land (mainly
Speculators
agriculture land
(includes investors,
being held by
holders,
farmer, we call it
Land Developers buyers etc.)
marginal land
Land developer can
because of
also be amongst
pedagogical
them
reasons)

We can infer following conclusions from the above transaction trail;

1. Money is never tied up in the land transaction. It is only change of hands.

If it is through cash which is either not reported to the Government is part of black
economy or it is out of cash taken out from safe is part of economic leakage (as
discussed in Chapter 6) but it will not affect the scenario i.e. change of pocket;

2. Speculators in fact ensures the land developers that his land [when developed]
will be sold out. In this way it boosts the economic process otherwise marginal
land will not be developed. In this way speculators ensures to increase the
supply of developed land in the system;

3. Who are the speculators? Common man who participates in the process;

17
 4. Imagine if speculators do not exist and supply of marginal land is restricted
what would have been the prices of already developed land in absence of new
societies, new developed phases etc.? Exorbitantly high. Speculators ensure
to increase the developed land supply and give insurance to the land developer
to change marginal land to developed land and hence boosts the economic
process;

5. Developed land prices will generally minimally be increased at the rate of risk-
free interest rate otherwise nobody will like to hold the land.

Finally, speculators exist in the system means they have some natural role which they
are performing otherwise why market mechanism will pay them off? Another pivotal
question is can we eliminate their role? Probable answer is No! Speculation is not
result of market anomaly but is integral part of market mechanism and also the fact
that some of us are risk takers. Moreover, Government also performs the same role to
smooth out the price fluctuation between two periods. They store crops, give support
price to farmers (price flooring) and either they release it in the period of shortage or
just waste it in sea, as fodder etc. But they do this job with inefficiency as public sector
remains inefficient because of their own mechanism.

One way to control the wide price variation in the agricultural commodities during
two time periods (till the next crop come in the market) is through processing and
storage e.g. instead of using fresh tomatoes why not to use tomatoes’ paste [Tomatoes
Ketchup price remains same during the period]. Government has to promote the
habits amongst people to use processed food and to use taxation policy to promote the
Processing Industries (e.g. relaxation in import duties on processing machinery which
at the moment is surprisingly very high).

Role of middleman

It is common perception that middle man takes the major pie of profits [and exploits
the producers]. Is it so? Most probable answer is No! We take an example of agriculture
commodities and see the role of middleman and how the actual transaction of buying
(from producer) and selling (to the end use) executes.

An efficient marketing system means availability of inputs and outputs at desired place,
at right time and in the suitable form which is not possible without strong infrastructure
support, efficient transportation (especially for perishables), processing, grading and
storage facilities.

Middlemen are usually held responsible for farmer’s low share in the consumer rupee
and are blamed for exploiting the farmers. Government is usually urged to eliminate
or minimize the role of middlemen from the marketing chain for increasing welfare
of both the consumer and producer.

The role of middlemen acting as a link between producers and consumers is very
complex and needs an in depth analysis before concluding any results.

18
Middlemen provide many services but their role is considered as exploitative. It is
assumed that middlemen get very high margins but their share is generally justified by
considering provision of additional services and risks, which they usually undertake
at each stage.

We have to understand the two parts of the transaction. One is how price is determined
that he sells to the end users. Agriculture commodities have usually perfect
competition and he has no influence in determining the price in the market i.e. he is
price taker (which means he is assuming price risk of the transaction). Other part of
the transaction is risk factor i.e. he is also assuming other risks as well. These risks
are

• Delivery Risk – He has to make sure that (particularly in case of perishable

goods) his produce are make available (and clear) to the market in short time
or he has to arrange the appropriate storage which carries additional costs:

• Quality Risk – He bargains for the whole produce of the farmers meaning he is
assuming grading and sorting risks;

• Credit Risk – He pays in advance to the farmers but he gives credit to his
customers (dealers, distributors, stockiest etc.). In this way he is assuming
credit risk as well;
What is the rate of return of the whole transaction? Rate of return has two part one
is the risk free return and other part is risk premium. If farmer/producer is passing
risk to the counterpart then he should enjoy only risk free return which is lesser and
middleman should enjoy higher return since he is assuming additional risk(s). Most
of the times it is alleged that market is inefficient since it involves more than one
middleman so it adds up to costs to transaction. But this is not the case. Since we have
seen that he is price taker means price is determined by the market forces, it is only
types of the risks that are shared between different middleman and by doing so each
individual middleman reduces his share of pie.

Finally they exist in the system means they have some natural role which they are
performing otherwise why market mechanism will pay them off? Can we eliminate
their role? To some extent Yes! i.e. with the improved and availability of infrastructure,
symmetric information, transportation, sorting and grading services, producers’
bargaining position will be improved but the risk taking part & various roles in on
transaction continuum (as explained above) remains there. And his pay-off is dependent
on his own choice of the following:

1. Role he is ready to play;

2. Financial muscles he has; and
3. His risk appetite;

Finally, if middleman’s business is so lucrative, common sense says there should be

19
many suppliers (middlemen) in the market vying with each other and bring the prices
(their margins) down to the competitive levels. What we forget is the underlying risk
factors.

Quality is only relevant to Standards

Low quality or inferior quality is misnomer. Quality without reference to price tag is
meaningless. More relevant term is acceptable quality i.e. which conforms to the
followings:

• Minimum standards set by the Government below which is not permissible to

sell;

• Proper display of ingredient [and/or] quality information on the product[or its

packaging];

• Price tag (to ensure symmetric information across the consumers and no
exploitation);

From the above analysis we can infer that much of the hue and cry in the yeomanry is
without reference. Neither Government is working on these lines (as outlined above)
nor public wants to realize that they will get the quality according to its price.

Innovation & Economic Development are only because of Profit Motive

Profit is the surplus revenue after a firm has paid all its costs. Profit can be seen as
the monetary reward to owners of a business. In a capitalist economy, profit plays an
important role in creating incentives for business and entrepreneurs. For an incumbent
firm, the reward of higher profit will encourage them to try and cut costs and develop
new products. If an industry is profitable, it will encourage new firms to enter. If a firm
becomes unprofitable, it will either have to adapt and change or close down. This profit
motive can help increase efficiency, provide greater choice for consumers and allocate
resources according to consumer preferences.

Importance of Profit Motive in an Economy

Efficiency Profit encourages firm to cut costs and increase productivity.

Profit encourages entrepreneurs to create new products, develop

new markets. Higher profit enables a firm to spend more on
research and development. This can lead to better technology,
lower costs and dynamic efficiency. This profit is particularly
Innovation important for some industries such as oil exploration, drug
research and car manufacturing – which require significant risky
investment to develop. Without this profit and investment, the
economy will stagnate and lose international competitiveness,
leading to job losses in some sectors.

20
 High profit encourages resources to flow to profitable areas. e.g.
if the price of oil is high then it will become more profitable.
Investment These profits should encourage firms to develop new oil fields.
With mobile Apps becoming more profitable, it will encourage
more firms to enter.

Higher profit enables a rise in wages for workers (in the form of
Wages
incentives, bonuses, and pay raise)

Government collects more taxation revenues from profitable

Tax Revenues
ventures.

As discussed in Chapter 2, entrepreneur takes risk and organize the factor of production only
because of the profit motive. Higher profit acts as an incentive for entrepreneurs to set up
a business. Without the reward of profit, there would be less investment and fewer people
willing to take risks. In a command economy, there is no profit incentive but this can easily
lead to a lack of incentives.
Profit can be saved and provide insurance for an unexpected downturn, such as recession or
rapid appreciation in the exchange rate. This is important for volatile industries, like luxury
products. Luxury goods may be very profitable in boom years, but make a loss in recession.

Relevant question is whether entrepreneur are earning excessive profits? We have

to analyze the following:

1. Required rate of return from any business venture is dependent on risk free
return (e.g. from Government Bonds) plus risk premium. Risk premium in
general term is determined by the following factors:

a. Market risk i.e. risk pertaining to overall economic, political

environment in which business is taking place;

b. Specific risk of that particular business e.g. oil exploration is relatively

more risky as compared to corrugation business;

2. Nature of the industry in which that particular business is taking place e.g.
perfect competition, monopoly, oligopoly etc. Can a business charge any price
for a given output? Answer is No! Usually either he is price taker or faces
downward sloping demand curve for his products.

3. When we talk about excessive profits we usually talk about successful

businesses we see. But we don’t know [or don’t want to talk] about numerous
business which are failed. e.g. retail business is a risky business. Many shops
that opened are bound to fail within a year. What about shops which operates
successfully? Should they earn normal profits? Answer is No! e.g. if 05 shops
are opened and 04 are closed due to business failure. The remaining successful
shop should more than earn 05 times normal profits because it is taking that
risk and does not know at outset who will be bound to fail.

21
 4. Rent seekers should be separated from the entrepreneurship. Rent seekers
gain because of asymmetric information they have because of their political
position or windfall gain.

Though profit plays an important role in an economy, it is worth bearing in mind.

1. Pursuit of profit may damage the environment. But this can be prevented
through regulatory framework and taxation policy;

2. Higher profit may lead to greater inequality in society. It depends whether firms
have monopoly/monopsony power. Government can play role by providing
free arena / infrastructure/ legal frame work and equal opportunities to all
participants;

3. The pursuit of short-term profit can encourage risk-taking and reckless

behavior. For example, commercial banks took more risks in the 1990s and
early 2000s; this contributed to the credit crunch. But again this can be
controlled through better regulatory framework;

Corruption - Concepts and definitions

The concept of corruption is considered as complex, complicated and difficult to grasp.

The reason is there are different ideas of what constitute corruption. However without
deeper understanding of the phenomena it is difficult for the policy makers to have
concrete measures for its control. We categorize corruption in three main categories;

Category - 1 Category - 2 Category - 3

Society makes law in favor of

Society makes laws and particular person or group of
Society makes laws and
regulations but executors persons and/ or that person
execution but one has to go
creates hurdles (through or group of persons having
against them
red-tape) in its execution asymmetric information due to
his/their power nexus

Examples:- Lobbies, possessing

Examples:- Smuggling, asymmetric information due to
Examples:- bribes,
drug trafficking, underworld position and power, preferential
commissions, nepotism
activities treatments, allocation of quotas,
permits, plots etc.

22
 In media and in common
man language this is the This type of corruption
corruption that exists (which in fact is never being
in the Society. Since it considered as corruption) is
This type of corruption exists
affects common man everywhere in the world and prevalent everywhere in the
directly (e.g. he is exposed perhaps in much larger scale Society and all over the world.
to police, law and order, in the developed countries asGovernment possesses power
patwari culture etc.). But well. But since few segments and information and they can
in term of magnitude, (whether patronized or not use this power and information
this category false much by throne) are involved and to the benefit of particular
behind the other two are under shadow. This type segment of Society.
categories which are never of corruption is not under This is legalized corruption
discussed in the Society. limelight. and much larger in magnitude
Developed Countries are as compared to other two
able to control this type of categories
corruption.

Understanding of Corruption [as described above] is necessary while making any policy
to combat it. But this understanding is altogether is missing in the Society as a whole
and amongst the policy makers as well.

“Corruption is an outcome — a reflection of a country’s legal, economic, cultural, and

political institutions. Corruption can be a response to either beneficial or harmful
rules.”

Corruption is not hindrance to economic growth but rather an outcome of poor and
misaligned policies and craving (on part of ruling elites and mandarins) to have “more
Government” i.e. large public sector.

How do economists perceive corruption? Economists generally focus on corruption

in either of the two ways: (1) identifying structures of incentives that make corruption
more likely or (2) assessing the impact of corruption on efficient economic outcomes.
And with regard to the impact of corruption on efficient outcomes or development,
especially in the less developed countries, economists are as divided as on other issues.
Greasing the wheel or sanding the wheel arguments can be given on both side. But we
favour “Less Government” and having less bureaucratic structure in place since public
sector is generally be considered as inefficient and corrupt and increase the likelihood
of asymmetric information which is main source of legalized corruption.

23
 Chapter 4

FINANCIAL
MANAGEMENT

“THE RATE OF INTEREST ACTS A LINK BETWEEN INCOME-VALUE

AND CAPITAL-VALUE”

IRVING FISHER

24
In the financial management terms interest is time value of money i.e. money or asset
available at the present time is worth more than the identical sum in the future due to
its potential earning capacity.

In simple term it is related to time period e.g. motor cycle that have a cash price of Rs.
40,000/- is available on installment for three years at Rs. 80,000/- the difference of Rs.
40,000/ - is the interest that seller is charging [at the rate of 4.36% per month (if 36
equal installments).

In the religious contest definition of interest is form over form irrespective of time
period involved and anything excess in form irrespective of quality received in return
is considered as interest [and there is no distinction over high or lower interest rate].
If form is changed in exchange then it is considered as trade [and excess value is
considered as profit not as an interest rate]. In the above quoted example of motor
cycle, it is trade not interest embedded transaction.

In the modern world the nominal interest rate is the rate of interest before adjusting
for inflation. This is how money supply and money demand come together to determine
nominal interest rates in an economy.

Interest rate varies according to [apart from its determinant like interaction of money
supply and demand, inflation rate, State Bank’s discount rate policy etc.] following two
factors:

1. The interest rate risk structure for interest rates is called the Risk Premium or
Risk Spread. It is the extra interest that a risky asset must pay relative to a risk-
less asset since investors demand compensation for taking on higher risk e.g.
interest rate on Pakistan Income Bond (PIB) of 05 Years will be lower than the
interest rate charged on TFC (Term Finance Certificate) of a reasonable Company
because of the risk factor (former is considered as less risky);

2. The term structure of interest rates is the relationship between interest rates or
bond yields and different terms or maturities. When graphed, the term structure
of interest rates is known as a yield curve, and it plays a central role in an economy
e.g. interest rate on 10 years PIB is usually higher as compared to interest rate
yield on 05 years PIB due to longer duration.

The other extreme is moving away from interest rate and having profit & loss sharing
mechanism in the business transaction (e.g. partnership, investment in Company’s
shares etc.). So we have following Risk & Reward Continuum:

25
PROFIT & LOSS SHARING MECHANISM
Partnerships, Investment in listed/unlisted
Companies. But rate of return that is Interest Rate Based Securities
required is dependat on risk free interest TFC and other Fixed or KIBOR
Risk free Return
rates plus risk premium required based Securities of Companies but
T-Bill, PIB etc. depending on
[dependeant on market risk and specific depending on individual appetite
Indivisual's appitite for particular
risk of that business and industries]. for particular risk i.e. movement
duration i.e. movement along Term
along risk structure of interest
Structure of Interest Rate
rate.

01 02 03

REQUIRED RATE OF
RETURN WILL BE INCREASED
AS THE RISK OF
INVESTMENT INCREASES

In the hybrid structure we can have multiple choices which borrower and lender can
exercise.

Individuals, depending upon his risk appetite, financial muscles and duration required
[or secondary market exists where he can take exit], have wide variations of choices
available in the market and in the listed securities scenario his return has two part i.e.
dividend [or interest] + capital gain / (loss) during the period. But why interest is being
scolded [but surprisingly not in the case if` embedded in the product as mentioned in
motor cycle case stated above]. It has historical reasons:

26
History

The creation of individual title to land (or any other property) made possible (since
it becomes negotiable instrument) to rise other dubious agent in socio-economic
structure, the exploitative moneylenders. Because of their monopoly position (in
the village or region), they were able to lend money on exorbitant terms. e.g. In the
subsistence rural economy, his (money lender) activities had been restricted to
supplying the peasant with money to tide him over crop failure or to cover extraordinary
ceremonial expenditures such as family wedding or funerals etc. These loans were paid
in kind at very high interest rate. By charging exorbitant rates or inducing peasants to
secure large credits than they could manage, moneylenders were often able to drive
the peasants off their land.

This exploitation is an example of Monopoly (or influent) position. But why to condemn
monopoly in money market only? Monopoly, whether it is in product market or in
bargaining contracts etc., is exploitative in nature (unless there is “natural monopoly”
supervised (not controlled) by government) and is equally condemnable.

Interest is Unrelated to Business Outcome

Often interest is condemned because it puts us in fixed commitment i.e. borrower

has to pay interest (as well as principal amount) irrespective of borrower’s financial
position and interest is not related to business outcome. But Interest is not only one
of fixed commitment nature, rent, wages (under service contracts) and other inputs
(like electricity, gas, and other services once incurred) are also fixed commitments.
Principal payment (excluding interest) is also fixed commitment and has same impact.
But Society never condemns these. Finally, in most of the countries interest rate is very
nominal i.e. 3% or even less [and even negative]. Still it is condemned but trader who is
charging exorbitant rate on his installment sale is justifiable in the Society.

We take another example, “A” wants premises (for shelter or business) and comes to
“B” who has required “premises” (worth of Rs100,000/-) and he lets his premises to
“A” on rent of Rs10,000/- for a year and after one year “A’ has to pay Rs.10,000/- and to
vacate his premises. This transaction is same as if we slightly change our assumption.
“A” goes to “B” and ask for premises but “B” says I don’t have a required premises but
instead have Rs. 100,000/- in cash and he lends that money to “A” and ask him to buy
required premises from “C” and “A” stipulates to return his money (Rs100,000/-) after
one year by selling the premises (ignoring inflation or deflation) coupled with interest
of Rs10,000/-. The substance of transaction is identical in nature but will be labeled
Interest based transaction.

Most of the times we accuse/scold wrong factors that are not real and actual factors
escape from the scene.

• We have abundant labor force (who are unemployed and situation is worsened if
we include women in labor force). Poor conceived government policies are biased
towards capital-intensive technology (soft credits, depreciation allowances etc.),

27
 and detrimental to labor-intensive technology (minimum labor laws, lack of
required R&D in this area (since it is not required by developed countries since, it is
not their problem), etc.). And these policies are not only widening gap between rich
and poor, but also deteriorating employment problem and worsening job market
in the Country (particularly in rural areas). Since technology/ machines can raise
productivity per worker but also “save” labor who are already abundant in supply).

• Historically entrepreneur is shy from using Capital Market as a mode of financing

and prefer bank borrowings which are relatively easily available. Reasons for not
using capital market as a financing tools are:

1. Corporate taxation [Tax on Company plus tax on dividend] is quite higher as

compared to individuals and partnerships;

2. Tax System favors interest-based securities for financing since it is tax

deductible whereas dividend is not;

3. Listing process is time consuming and expensive;

4. Fear of unknown exists in the mind of businessman e.g. outside directors will
interfere with the affairs of the business;

5. Businessman is businessman; he is not trained in finance and he has to be

dependent on his finance team who has neither incentive to go beyond normal
working nor have enough corporate expertise;

6. Capital gain taxation on listed securities is also acting as hindrance;

7. Corporate formalities are quite cumbersome for listed companies without

compensating incentives;

These above factors create two types of leverage i.e.

1. Operating Leverage: - When investment is made in “Capital-Intensive Technology”

it indulges the investor in fixed commitment (i.e. by making fixed expenditures
today in plant/machines etc. ). Contribution Margin of capital-intensive technology
is high (increase in fixed expenditure is counter-balanced by reduction in variable
cost mainly labor*). Operating leverage is not related to mode of financing.

*Labor contracts may be of fixed duration, but hiring and firing of labor is much easier
than acquisition or disposal of plant, particularly plant is being disposed of when
market conditions for a firm are bleak.

2. Financial Leverage:- When “Capital Intensive Project” is financed through

interest-based securities, a fixed commitment is made to make periodic payments
(amortization and interest) when fall due irrespective of business conditions.

28
Characteristic of leverage is:

When Market conditions are good, it is very good but when market conditions are
gloomy, it is worst

Thus when there are buoyant sales, excessive surplus (i.e. high contribution margin
less interest payments) goes to owners (and they never “complain” about this) , but
when market conditions started to deteriorate (e.g. factors that are not foreseen or
investor was optimistic in his project feasibility or having bad intention to embezzle
funds** etc.), Business is not able to cover its fixed commitments. Corollary of leverage
is it reduces the entity’s adjust-ability and flexibility, on the other hand, labor can be
hired and fired with much flexibility & ease and cost reduction is much easier.

So investor scolds/accuses banks for their rigid behavior, if he cannot honor its
periodic commitments to the bank. Although, his problem is not created by bank but he
plummets in financial crunch due to government policies (as described above). Result
would be unaffected even if funds are raised through bonds* (interest based securities)
made at large to the public (i.e. raised in capital market, not provided by the bank).

But since interest creates financial leverage, must it be condemned? As discussed

above any sort of fixed commitment will indulge investor in leverage position.

Secondly, through “limited” companies liability vehicle, borrower (when he borrows)

in fact purchases “put option” and if present value of company’s stream of income is
below the worth of loan outstanding. He (borrower) can exercise his put option and
discharge his liability (i.e. loss to lender as well and that loss is same as capital loss if
funds are raised through Capital market).

Thirdly, to investors, equity shares are risky as compare to debt shares and they
(investors) demand higher rate of return on equity shares. Borrowers, on the other
hand, if indulging into fixed commitment, are also enjoying low cost of financing.

Business practices are not evolved in a day. They are evolved as better and better after
learning from past mistakes.

To conclude, we can recapitulate our discussion in following points;

1. Exploitation (and harshness) stems from anomalies of market perfection.

Competition at both sides (supply and demand) ensures efficiency and nobody in
position to dictate the market.

2. When we talk about money lending transactions, we usually take it for granted
that lenders are big sharks and borrowers are paupers and depressed groups.
But modern economy has turned the situation in reverse, now there are numerous
small savers who pool up their savings (through banks or NBFIs) and borrowers
are usually big industrialists or landlords or influential groups (major value share
of total loans goes to them).

29
3. How to finance government expenditures on public goods/ activities? Since these
are not done on profit/loss basis. If to finance these activities entirely through
taxation, this would seriously deepen the recession if occurred (or severe the
inflation if boom is the case).

4. As discussed in Chapter 3, if consumption is to stimulate as an economic driver,

then credit cards, personal loans, mortgage finance to be made available and these
loans are interest based. So Society’s norms have to be changed.

5. Business practices are constantly changing with the passage of time according to
new innovation and ideas. We should not assume it (or its pace) constant. We can
learn from good ideas of any one. Japan’s economic success lies under their superb
ability to assimilate modern western technology and ideas. Our rigid behavior and
primitive culture are detrimental to our progress, but we have a desire to build
“utopia” without understanding of underlying factors that would harness us on
development path.

30
Chapter 5

TAXATION
SYSTEM

“THE HARDEST THING TO UNDERSTAND IN THE WORLD IS THE

INCOME TAX”

ALBERT EINSTEIN

31
We start our analysis with two generalized statement often we read/listen in media,
forums etc.

• The country has been struggling to broaden the tax base with what the FBR
chairman said only one percent of the people carrying the burden of the entire
state. Despite all efforts and punitive taxation, less than two million people –
out of 220 million population – have so far been encouraged to file returns.

• Pak tax-to-GDP ratio shamefully low: Minister - The Nation

We will analyze both these statements and answer the question whether Pakistanis
are tax evaders and do not want to pay taxes.

Some Definitions:

Direct Taxes, as the name suggests, are taxes that are directly paid to the government
by the taxpayer. It is a tax applied on individuals and organizations directly by the
government e.g. income tax, corporation tax, wealth tax etc.

Indirect Taxes are applied on the manufacture or sale of goods and services. These
are initially paid to the government by an intermediary, who then adds the amount of
the tax paid to the value of the goods / services and passes on the total amount to the
end user.

Examples of these are sales tax, service tax, excise duty etc.

Following is the summary of tax collection by FBR for 2017-2018. 60% of the collections
come from indirect taxes.

Rs. In billion 2017-2018

Provisional Collection
Direct Taxes 1,536.60 40%
Sales Tax 1,491.30 39%
Federal Excise 205.90 5%
Cusom Duty 608.30 16%
3,842.10

But how direct taxes are collected. Mainly, it is collected either on withholding mode (as
some percentage criteria on payment by one party (withholding agent) to another party
or on collecting mode i.e. as some percentage on invoice by one party (who collects like
sales tax) to another party. Following is an analysis of direct taxes:

32
 Analysis of Direct Taxes
Rs. In billion
Indirect Collection on Demand 104.13 6.78%
Direct With Returns 41.64 2.71%
Direct Advance Tax - Section 147 335.79 21.85%
Withholding / Collecting Taxes
Indirect Contracts / Supplies / Services 283.16 18.43%
Indirect Imports 218.76 14.24%
Direct Salary 133.36 8.68%
Direct Dividends 57.85 3.76%
Indirect Telephone 47.38 3.08%
Direct Bank Interest 45.65 2.97%
Indirect Cash Withdrawals 34.00 2.21%
Indirect Electricity 33.83 2.20%
Direct Export 28.28 1.84%
Direct Technical Fee 26.01 1.69%
Indirect Others 146.76 9.55%

Direct 668.57 44%

Indirect 868.03 56%
Thus Adjusted Direct Taxes 17.40%
We slightly change the definition and treat tax which is either linked to payment (of
goods and services) or linked with invoice as indirect taxes [since taxpayer has to pay
this tax irrespective of his income either it is treated as final discharge or gone into
refund from FBR which itself is gigantic task. Then direct tax collection is just 17.40%
not 40%.

First of all we analyze Direct Taxation and then other taxes and try to answer the
question we posed in the start of the Chapter.

Direct taxation:

There are numerous withholding / collecting taxes whereas major chunk comes from
mainly 10 main heads shown above or as an advance tax under Section 147 (coupled
with tax on return or on demand). Then why we have so many other head counts where
no significant tax collection is being made. Just to create complexity and indulging
corruption in the taxation system. Complexity in the system is being used as harassment
tool. This is one of the reason people do not want to come under tax net.

Tax with return is significantly low (just 2.71% of total direct taxes) but takes too much
discussion in media and various forums. Withholding / collecting tax rates are designed

33
without understanding of underlying supply chain and business process.

From the below table it is evident that taxation rates for non-filers are significantly
higher. But it shows two factors:

1. Most of the taxes are already being collected or withheld on transaction

stage and this includes non-filers too so actual persons paying taxes (direct
according to FBR definition) is significantly higher as compared to 1% figure
claimed by FBR (described in outset of the Chapter);

2. Quoting 220million population is misnomer. Most of the population is either

underage or females who do not actively participate in labor force (including
aged population). Moreover, our workforce ratio is just 31.70%. Our low per
capita income (Rs.150,000 (appx) indicates that majority of the people are
amongst lower and middle class who are nevertheless not under tax brackets
and they are not filing the tax returns thus non-filers. But bringing them
into the tax net will not increase the tax revenues [but increase the level of
harassment that being filer one has to faces from the Tax Authorities].

3. Worrisome thing is that people are still not filing tax returns despite significantly
higher tax on non-filers, This is because of basic lack of understanding of
business process/supply chain by policy makers;

Income Tax AOP AOP PUB PUB

Ordinance, 2001 IND IND PVT PVT
2018-2019 Filer Non-Filer Filer Non-Filer
Goods Section 153(1)(a) 4.50% 9.00% 4.00% 8.00%
Contract Section 153(1)(c) 7.50% 15.00% 7.00% 14.00%
Freight Section 153(1)(b) 2.00% 2.00% 2.00% 2.00%
Electronic & Print Media Section 153(1)(b) 1.50% 15.00% 1.50% 12.00%
Export Commission Section 154(2) 5.00% 5.00% 5.00% 5.00%
Petroleum Section 156A 12.00% 17.50% 12.00% 17.50%
Advertising Agents Section 233 10.00% 15.00% 10.00% 15.00%
Dividend Section 150 15.00% 20.00% 15.00% 20.00%
Capital Gain - Listed Securities Section 37A 15.00% 20.00% 15.00% 20.00%
Profit on Debt Section 151 10.00% 17.50% 10.00% 17.50%
Cash Withdrawals Section 231A 0.30% 0.60% 0.30% 0.60%
Tax on AOP Division 1 of Part 1 o First Schedule 0%~30%
Tax on On Individuals Division 1 of Part 1 o First Schedule 0%~29%
Tax on Companies Division 2 of Part 1 o First Schedule 29.00%

AOP = Association of Persons IND = Individuals PUB = Public Companies PVT = Private
Companies

(Taxation reference is taken from Income Tax Ordinance, 2001 updated till March 11,
2019)

34
Taxation Anomalies: Following are few example just to show the problems in basic
structure and is another reason people do not want to come under tax net.

1. Corporate culture is very limited in the Country. Major reason is tax structure.
We can see from the above table taxation on AOP / IND 0%~30% (depending
on the profit level) but it is straight 29% (for Companies) plus up to 20% on
dividend meaning effective rate is 43.20% [1-(1-0.29)*0.8] that is significantly
higher. Why would an entrepreneur want to do business with Company (where
regulatory requirements are also very high particularly if it is listed company).

2. Capital gains on listed securities (up to 20%)are also higher as compared

to unlisted companies shares (where proceeds is reduced to 75% if holding
period is more than one year and resultant capital gain tax is taxed normally
0~30% for AOP /IND).

3. If every business becomes tax compliant and file due sales and profitability
figures then in the supply chain every recipient of goods/ service has to
withhold taxes according to above table. Intermediaries do not earn that
much margins (and they come under final tax regime) particularly FMCG (Fast
Moving Consumer Goods) dealers, distributors work only 3%~4% margins.
Even in other cases margin figures are not that high. We have to rationalize
the withholding tax regime with the understanding of supply chain process.

4. Taxation on cash withdrawals that were introduce to curb cash transaction has
in fact work against banking regime. People have bypassed banking channels
and introduced parallel receipt system. This will be discuss in detail in Chapter
6 – Black Economy & Demonetization.

Indirect taxation:

Indirect taxes include sales tax, import duties, FED etc.

Analysis of Sales Tax Sales Tax - Sales Tax Custom Federal Total
Domestic (Import) Duty Excise
Rs. In billion
POL Products 283.03 264.21 70.65 617.89 26.80%
Electricity 45.28 45.28 1.96%
Withholding Agents 26.01 26.01 1.13%
Cement 24.10 53.96 78.06 3.39%
Cigerrates 20.53 67.14 87.67 3.80%
Natural Gas 20.32 10.69 31.00 1.34%
Sugar 19.87 19.87 0.86%
Aerated Water / Beverages 17.65 22.35 40.00 1.74%
Food Products 15.19 15.19 0.66%
Iron & Steel Products 14.94 68.31 53.27 136.51 5.92%

35
 Machinery & mechanical Ap-
pliances 120.37 69.92 190.28 8.25%
Vehicles 66.75 97.09 163.85 7.11%
Plastic, resins etc. 45.15 12.19 57.34 2.49%
Edible Oils 40.98 28.21 3.81 72.99 3.17%
Organic Chemicals 17.55 17.55 0.76%
Services 44.86 44.86 1.95%
Tea & Coffee 13.29 13.29 0.58%
Others 189.69 178.09 276.98 3.10 647.86 28.10%
676.60 814.70 608.30 205.90 2,305.50

Few facts from the above figures are eminent. They are:

1. Major share in the indirect taxation is from POL products, Cigerrates, Natural
Gas, Vehicles, and Machinery etc.
Rs. In billion
Tax on Imports 1,641.76 43%
Other Direct 1,317.84 34%
Other Indirect 882.50 23%
3,842.10

2. Major share in total taxation (Federal) is coming from port taxes (import) that
accounts for 43%. Whereas, other share is either on withholding pattern or collecting
pattern where persons are collecting/withholding taxes and depositing requisite tax.
FBR is directly responsible for 12.53% of total collection. Is it justifiable of having such
a large department with heavy administrative burden?
3. The above figures do not include provincial autonomy to levy sales tax on
services (particularly construction); this has added another problem for
taxpayers having multiple tax authorities; particularly taxation on construction
activities is detrimental to the business where related sales tax is not allowed
as an input. What is rationale of this [particularly if VAT mode system is to be
placed] is still a big question mark.
4. Sales tax on intermediaries is a futile effort as indicated in above table. Goods
either imported or being manufactured in the Country. Government has better
controls on port and relatively better control on manufacturers than better to
collect sales tax from them either third schedules goods basis (i.e. sales tax
on retail price is to be paid by manufacturer) or additional 1% sales tax to be
added to cover the supply chain.
5. Documentation of economy can be done in other way as fully discussed in
Chapter 6.
6. Indirect taxation is also taxation meaning individual Pakistanis are paying this

36
 tax. Thus, persons paying taxes in the Country is much higher than 1%. Second
misconception in the Society is poor is paying more taxes than rich persons.
This is not true. If we analyses direct taxation slab, it starts from Rs.1,200,000
and if we come to indirect taxation, we have shown most of the taxation is on
import stage and poor usually don’t use imported items (except POL products
but this % spending on POL out of total income is not substantial) and most
of the products they use is sales tax exempt e.g. agri-products. Whereas,
luxurious items have very high rate of duties.

Now we analyze the second statement that our tax to GDP ratio is very lower;
1. Taxation includes following: Rs. In billion Federal Provincial
a. Federal Tax Revenues
b. Provincial Tax Revenues Tax Revenue 3,647,476 321,772
c. Federal Non-Tax Revenues
d. Provincial Non-Tax Revenues Non-Tax Revenue 887,976 79,499
Amount of Non-Tax Revenue is quite hefty.
Problem here is when we refer to the figures
we only talk about Federal Tax Revenues and
ignore other levies. But being Pakistanis, we
are paying these tax/levies.

1. Tax to GDP has two factors one is Tax (numerator) but other is GDP (denominator).
It is not apple to apple comparison we include those sectors in GDP who are tax
exempt (agricultural sector for example). Thus correct indicator is to exclude
those sectors which are tax exempted. We have recalculated tax to GDP ratio
for 2017-2018:
Rs. in Million 2017-18
Agriculture 2,964,029 Exempt 9.15%
Live Stock 4,615,565 Exempt 14.25%
Forestry 183,196 Exempt 0.57%
Fishing 148,132 Exempt 0.46%

Agriculture 7,910,922 24.43%

Manufacturing - Large Scale 3,331,363 Taxable 10.29%

Small Scale 506,842 Taxable 1.57%
Slaughtering 379,545 Taxable 1.17%
Mining & Quarrying 755,223 Taxable 2.33%
Electricity Generation 480,960 Taxable 1.49%
Construction 772,755 Taxable 2.39%

Industrial Sector 6,226,688 19.23%

Wholesales & Trade 6,232,724 Taxable 19.25%

37
 Transport, Storage & Communication 3,522,417 Taxable 10.88%
Finance & Insurance 680,741 Taxable 2.10%
Housing Services 1,848,600 Taxable 5.71%
General Government Services 2,629,924 Taxable 8.12%
Others 3,333,280 Taxable 10.29%

Service Sector 18,247,686 56.35%

32,385,296
This figure
Tax to GDP ratio (only Federal Tax Reve-
12.55% is usually
nues)
quoted
Tax to GDP ratio (all Sources) 16.14%

Taxable GDP 24,474,374

Tax to GDP ratio (all Sources) 21.36%

From this table we can see that for the Federal Tax Revenues, Tax to GDP ratio is
12.55% otherwise it is 16.14%. And if we exclude the exempt sectors tax to GDP ratio
is 21.36%. Which is not low (relative to the income levels of the masses). In our view
we are over-taxing the taxable sectors.
What is ultimate goal of Taxation policy? An effective and efficient tax policy should
adhere to the following principles;

1. Policy making should be separated from its execution. Executives will make
things more complex for their own benefits. It is clear conflict of interest;
2. Taxation itself is not sacred per se but part of Fiscal policy that has wider goal
of nurturing business confidence, jobs creations, infrastructure development
etc. We favor Less Government doctrine and more role to private sectors;

More Government Less Government

Recession Economic Recession Economic Boom
Boom
Government More Less Spending
Spending Spending
Taxation High Taxation Less
Taxation

Moreover, one of the primary objective of fiscal policy is job creation and improvisation
of economic activities but taxation is not sacred. Government’s major role is providing
legal and institutional frame work, law and order and infrastructure rest of the job can
be done effectively through private sector.

38
 Employment % GDP %
Agriculture 38.50% 24.43%
Mining & Manufacturing 16.28% 16.84%
Services 37.61% 50.64%
Construction 7.61% 8.09%

Major job creation is being done either through Agriculture or Service Sector
(excluding housing). Most of the Government’s efforts are to promote manufacturing
which either do not have size-able impact on GDP or on employment. Our major
taxation comes from LSM (Manufacturing), Financial and Insurance Services
(Service), Housing, Communication (Service) and imports. But overwhelming
importance is being given to manufacturing alone.

The above table indicates the basic mis-tuning of linkages between Contributions to
GDP ----------- Contribution to Employment ----------- Contribution to Tax Revenues
[and Government’s approach towards Fiscal Policy (i.e. More or Less Government as
indicated above)]. As discussed in Chapter 8, we do not have competitive advantage in
manufacturing due to lack of economies of scale and required skill sets but in assembly
(CKD units), processing industries, services and trade. Energizing economic activities
with the right selection of targeted industries through consumption pattern and
conducive environment (through institutional and legal frame work and infrastructure)
should be the ultimate Government’s role. But this needs paradigm shift amongst
ruling elite where import substitution strategy takes overwhelming weightage.
3. Sales tax / FED etc. should be levied on products after studying respective
elasticity of demand; Less tax will be collected if higher rate is applied to
elastic products;
4. Taxation on discretionary items should be avoided (e.g. tax on bonus shares)
but designed in such a way that relaxation in one area is compensated in
others areas e.g. lowering tax rates on listed companies will increase the no.
of companies to go for listing thus will increase capital value tax and capital
gain tax on listed shares transactions;
5. Law and policy making should be combined at Federal level and its execution
can be devolved to provincial levels;
6. Policy makers have to understand the business process and respective
supply chain before levying taxation. Taxation has to be made simple. Taxation
that hampers transaction should be avoided e.g. excessive taxation on land
transaction. REITs and Societies which are organized sectors should have
lower transaction rate for sale and purchase of real estate;
7. Taxation that triggers parallel system (e.g. tax on cash withdrawals) should be
avoided;

39
40
Chapter 6

BLACK ECONOMY
& DEMONETIZATION

“DEMONETIZATION WOULD BRING OUT THE BLACK MONEY”

41
Black Economy is the part of a country’s economic activity which is unrecorded and
untaxed by its government; these activities can be legal or illegal depending on whether
goods or services that involved are within legal ambit (law of the Country) or outside
that ambit.

Legal Activities but not Reported to Tax Illegal Activities but not Reported to Tax
Authorities Authorities
Any goods or services (Doctor’s fee, lawyer’s Smuggling, ransom, underworld activities
fee, goods manufactured) whereupon either etc.
tax is not paid or tax paid as a non-filer but
not reported to the relevant authorities.

We will concentrate our discussion on black economy of legal activities that are not
reported to the tax authorities;

However, media and forum usually make no distinction while referring to black or
shadow economy;

The second confusion is about size of black economy and what is grossly misunderstood
that annual accretion (i.e. size of black economy as a % of annual GDP that is generated
each year) and level of wealth as on particular time that is resultant of annual accretion.
Annual accretion figures are not that humongous (quite to the contrary common
belief) as discussed in Chapter 9 but wealth position which is result of past cumulative
earnings is substantial.

One of the reason for shadow economy (as discussed in Chapter 5) is complex taxation
system prevailing in the country but the other reason is most of the routine transaction
in Pakistan is conducted through cash. We may ask a pivotal question whether increase
in currency in circulation increases the size of black economy? Probable answer is Yes!
After all Government cannot trace the cash transactions If to curtail the size of black
economy we have to curtail the size of currency in circulation i.e. we have to shift to
debit/credit cards, banking transactions. But how?

Demonetization can have desired effect as follows;

1. Cancellation of existing currency note during particular time frame;

2. Rs. 150,000/- can be exchanged with new currency notes;
3. More than Rs. 150,000/- only 25% of the amount will be exchanged with
new currency notes and rest of the amount will be credited to individual’s
bank account;
4. Control from State Bank of Pakistan on printing of new currency notes;
5. Improvement of online and phone banking across the Country including
availability of credit/debit card machines at grass root levels;
6. This exercise will be done under amnesty scheme and tax structure will
be revamped (as discussed in chapter 5) beforehand to give comfort level

42
 to the people;
7. Only certain percentage of bank deposits (say 10%~15%) to be allowed as
cash withdrawals during the year.

The above demonetization will automatically restrict the large cash transactions.
Moreover, importance of banking (and online banking, debit/credit cards) should be
taught from School and College level education.

As far as illegal activities are concerned they will be done in dollars or gold and unlikely
to be curbed with demonetization but legal activities part will be controlled this way.
One immediate reaction of the people will be to convert their money into prize bonds
(bearer), dollars or gold. To control this effects following measures have to be taken:

1. Bearer bonds to be abolished and it is under Government’s control;

2. Conversion into gold, let it be. Gold can be store of value but not good as a
medium of exchange and it will gradually come into organized channel since
cash transactions will be restricted due to unavailability of cash. Moreover,
hoarders of Gold will not be able to take advantage of tax amnesty scheme
and has to pay higher tax with penalties. Thus conversion into gold will not be
exercised generally;
3. Conversion into dollar will be done through money exchangers. Money
exchanger has to exchange that money into dollar but ultimately they have to
deposit that money into banking system within stipulated dates for conversion.
Here, we can have check in place. Ceiling will be placed on money exchangers
that is maximum amount that money exchanger can exchange per passport
(not CNIC).This data needs to be reported. If money exchangers exceeds that
amount (i.e. his surrendered currency is more than the reported exchange
currency) he has to pay certain tax say 40% of the exchanged value;
4. All this demonetization exercise will be done through computerized system in
order to exercise control and ensure efficacy e.g. till Rs. 150,000/- threshold
no CNIC is required but above this figure CNIC is required and inbuilt checks
for money exchangers as well.

To justify a withdrawal of paper money, we may argue that a fully digitalized system
would eradicate tax evasion, leakages from the systems, and money laundering, reduce
transaction costs and enable financial authorities to stimulate economic growth. A
cashless system would enable governments to track and record every transaction,
leaving no loopholes for fraudsters to exploit. Moreover, central banks would be able to
impose any desired monetary policy – including negative rates – as consumers would
have no way to retrieve their cash from the banking system.

43
Chapter 7

PRO-POOR
POLICY DILEMMA

“GOVERNMENT IS NOT THE SOLUTION TO OUR PROBLEM.

GOVERNMENT IS THE PROBLEM”

RONALD REAGAN

44
‘Pro-poor’ is a term that has become widely used in the development literature. The
general understanding that can be drawn from this literature is that pro-poor policies
are those that directly target poor people, or that are more generally aimed at reducing
poverty.

There is a trade-off between equality and efficiency and the total amount of income
in Society is not independent of how we try to distribute it. Policies that redistribute
income reduces the rewards for high-income earners while raising the rewards of low-
income earners. Hence they reduce the incentive to earn high income. Measures taken
to increase the amount of economic equality will reduce economic efficiency. In trying
to divide the pie more equally, we may inadvertently reduce its size. This is the dilemma
of pro-poor policies.

One common argument is to spend more on health and education and less on roads,
industrial estate developments. Educated and skill people will harness the growth
path; But this argument has following flaws:

1. If size of the economy is not expanding, and so does the tax revenues of the
government, how will the government be able to spare more money for social
services;
2. In the growth economy, people will have jobs and wages will be higher thus,
they will learn skills and be able to spend more on health care and education;
Moreover, private sector in the enabling environment will make them learn
new techniques and hence their productivity;
3. Education does not give entrepreneurship; economic development is only
possible in enabling environment, continuity of policies where entrepreneurship
is groomed;
4. People having unearned money in the form of donation, charity etc. makes
them more lazy and less incentive to the work;
5. Government has limitation to provide health services and education but private
sector does not have that limitation; We can see the conditions of government
hospitals and educational institutes only because of lack of motivation,
overpopulated and inflows from that segment of society as well who can
relatively afford better services in private sector;

Pro-poor policies/activities such as price ceiling for consumers, price flooring

for producers, discretionary donations, ration cards, utilities stores etc. trigger
inefficiencies in the market in terms of black marketing, parallel market, wastage,
shortage and lack of incentive to work etc.

Moreover, argument for more pro-poor policies gives the justification for More-
Government i.e. size of the government will be increased;

What should be done? In our opinion growth policies (that increases the size of economic
pie) are the best way to combat poverty. Instead of feeding them fish, teaching fishing is

45
better policy; These enabling policies are;

 Addressing economic poverty: facilitating access to affordable credit (micro-

credit, group banking, etc.);
 Building human capacities: encouraging vocational skills training, and a wide
variety of other long or short term training schemes. Particularly in villages,
imparting agricultural related education instead of conventional education;

 Addressing political aspects of poverty: informing disadvantaged people of

their rights and providing access to legal support; facilitating collective action; and
building public speaking and negotiation capacities.

 Addressing socio-cultural aspects of poverty (this can require particularly

carefully tailored interventions): facilitating the full and equal representation
of different groups of people in community decision-making processes; working
with both men and women to combat gender-based violence and mutilation; and
supporting discriminated groups and individuals to claim their human rights.

 Building protective capacities: these Social Security measures concern the

ability of people to withstand domestic and external shocks such as a severe illness
or accident of a family member, or the loss of possessions following a flood or war.
Insecurity and vulnerability are crucial aspects of poverty and may be particularly
relevant in humanitarian crises in which identifying the most vulnerable can be a
matter of life or death.

 Income Support Card: Instead of having price ceiling in place (e.g. bus fare) or
donation, charity etc. that are undirected and unscrupulous should be channelized
to Government Fund where it can support the system of Income Support Card that
should further be improved;

46
Chapter 8

INDUSTRIALIZATION
POLICY

“YOUR COMPETITIVE ADVANTAGE MUST BE PERCEIVABLE,

PROMOTABLE, AND SOMETHING THE MARKET WILL PAY FOR”

BRIAN TRACY
47
First of all we develop a case in point then try to answer the question in the light of our
industrialization policy.

“Number of road motor vehicles per 1,000 inhabitants is just 17 which is very low even
if we compare it with Sri Lanka (70), Egypt (62)”

Why this number is so low; we are poor country but poverty is not the reason our auto-
policy is major culprit for this low number.

Most of the arguments can be given in favor of import substitution policy such as saving
valuable foreign exchange, employment generation, skill development and so on.

Industrial policy does not work in vacuum but within coherent conducive environment
that requires systematic efforts to make following policies [and its execution] in tandem;

Investment Industrial Agricultural

Trade Policy Service Policy
Policy Policy Policy
This coves This covers This covers This covers This covers
finance side selected the asset side the asset side the asset side
of the balance efforts to of the balance of the balance of the balance
sheet. Invest- develop and sheet. sheet. sheet.
ment policy grow selected
ensures con- manufactur- Trade poli- Agricultural ‘Tertiary sec-
tinuous funding ing sectors of cy refers to the policy de- tor of industry’
requirements to economy regulations and scribes a set by econo-
finance growth agreements of procedures mists) in-
/ infrastructure This covers that control and laws volve the
projects the asset side imports and ex- relating to provision
of the bal- ports to foreign domestic ag- of services to
It includes: ance sheet. It countries. riculture and businesses as
includes: imports of well as final
It includes: foreign agri- consumers.
cultural prod-
ucts.
Interest rate, Import Foreign ex- Availability of Trade and
availability of substitution change de- inputs (seed, distribution
credit, SME fi- strategies, termination fertilizers, including logis-
nance and other export led and balance agricultural tics, shipping
growth of payment on equipment,
Monetary Policy policies, current account water etc.)
determinants back-ward of the Country
and forward
linkages.

48
Capital market Other factors Bi-lateral trade Harvesting Services like
development: that are part agreements, techniques, tradesman
Capital mar- of this policy compliance to research and ship health
ket is catalyst is job cre- international development, care, banking,
to economic ation, value standards etc. storage facil- insurance/
growth. It is addition ities (includ- assurance,
amongst two ing cleaning brokerage,
factors that has and grading advisory, legal
accelerated system). and profes-
world’s growth Availability of sional services,
one is special- processing media etc.
ization (through industries for
division of value addition
labor) and other and smooth-
is invent of capi- ing price
tal market fluctuations
Foreign direct Availability of Fisheries
investments Symmetric tourism, hotel
(FDI), foreign information, management,
investment in access to housing, edu-
capital markets roads and cation and so
(hot money), markets etc. on.
foreign grant
and supplier
credits etc.

The above policies are not executed in vacuum but needs coherent support policies to
create conducive business environment;

Infrastructure Micro Economic Policies Institutional Framework

Development Policies Policies
This includes road and This includes paradigm This includes legal structure
railway network, dams, shifts (change in adverse defining rights and obligation.
canals, vocational insti- thinking, believes Moreover, defining opera-
tutes, utilities etc. system), increase in tional mechanism to follow,
consumption pattern, pollution control, pricing
using banking channel mechanism, title to land,
and to avoid leakages arbitration etc.
etc. More discussion on
this topic is in Chapter
10 – My Believes and
Law of the Country

49
 The Private sector plays a major role in developing a nation’s wealth. The govern-
ment and companies’ policies should be compatible. An above all, these activities
are conducted in secured environment i.e. law and order situation of the Country
and under political process that ensures continuity of policies, eliminates threat to
nationalization of industries and controls on repatriation etc. that undermines the
business confidence;

Thus government has substantial effect on every day and personal choices through
such measures as provision of physical and social infrastructure, fiscal and monetary
policies, investment policy, industry policy, trade policy and so forth. Government
policies encourage or discourage growth and employment prospects through effects
such policies have on people’s choices to save, invest, work and use their leisure etc.

We can see from the above table that Industrial Policy is just one part of the coherent
system thus if other policies are nonexistent or do not in tune with each other it is
bound to fail. Thus careful analysis is not required within particular policy itself but
also its relevance to [and from] other policies as well.

Case in Point: Capital market was not conducive during 2018-19 no public IPO was in
place. Interest rates were doubled within very short term period. Development budget
was curtailed. What these actions had effect on cement [as well as steel] industry?
Those companies are already highly leveraged [because of the reasons outlined in
Chapter 4- Financial Management].

As far as Industrial Policy is concerned we have to understand the following factors;

1. Economies of Scale through large volume – if an industry is build up under

protection (e.g. high level of import and regulatory duties on import of items
competing with that industry), it will neither cope with rapid technological
changes taking place outside world nor products will available to Society
at equivalent international prices thus exploitation of Society will be done
if economies of scale is not examined. Our Auto Policy is the best example
fits under this issue [we will shortly discuss it in detail]. It is not viable to
protect those industries which required large volumes to be economical (i.e.
economies of scale) or requires rapid innovation and change.
2. Power Intensity i.e. Utility to Sales Ratio - Fuel is scarce in the Country. Electricity
is in shortage, gas reservoirs are not enough. Formulating Industrial Policy to
encourage the power intensive industries (e.g. fertilizers, paper & board etc.).
Although some goods that are highly fuel intensive are not tradable (import/
export) because of high weight/volumes and relatively less value and incur
high transportation and inventory costs will be produced within a Country even
without any protection. But otherwise we don’t have competitive advantage in
having industries with high power intensity.
3. Impact on Employment i.e. job creation – Manufacturing through backward
and forward linkages creates employment. But fully automatic plants have

50
 very minimal impact on employment plus these require import of expensive
technical expertise. Job creation impact should carefully be examined and
industries like processing needs to be encouraged. Otherwise, alternatively,
coherent policies needs to be developed for job creation in service and
agricultural sectors;
4. Technology transfer – as explained above, if high tech industries are planted
then import of technical expertise is inevitable. Swift transfer of technology
requires standard vocational institutes that provide the required skills. Private
sector is spending time and money in developing required skills and very less
facilitation from the Government side.

Case in point – Auto Sector

Auto-policy [2016-2021] places high regulatory duties on import of vehicle [CKD or

CBU form]. It places requirement for deletion program to develop certain parts locally
and rest of parts at high import duties. But this policy has following inherent flaws:

Car sales (icluding LCVs and jeeps) Vehicles per 1000 people
23
22
239,724 235,491 21
224,244 20

203,537 208,677 19
per 1,000 people

18
17
16
15
14
13
12
11
ega d’Ivoire PDR bia bod
ia ista
n
eroo
n India ique ietman Mali
Sen Lao Zam Cam Pak Cam amb V
Cote Moz

2014 2015 2016 2017 2017 2018

(Jan to Nov) (Jan to Nov)

• Car Assembly is very capital intensive and requires not only investment in plant
but also heavy investments in backward linkages (auto parts development) as
well as forward linkages (3-S service i.e. availability of spare parts, service
dealers and sales centers) and this investment in backward and forward
linkages are more than investment in plant itself; Who is going to invest in
these linkages?

Backward Linkage:

a. If Part manufacturers, they will require surety of certain minimum orders for
particular model for certain point of time to ensure that payback period;
b. If Auto Assembler to invest in back ward linkages (e.g. in moulds dyes, jig

51
 machines etc.) his investments in the project will be very high and he himself
has to ensure certain numbers of vehicles (of particular model) to be sold
during his payback period;
c. Both of the above factors increases the payback period of the investment and
restricts his ability either to offer multiple models or change the model within
short time;

Forward Linkage:

d. Auto Assembler has to ensure availability of spare parts for certain period
of time even after discontinuation of particular model; it means auto part
manufacturers to provide parts of various models at a time. This increases his
investments, labor and time (thus increases the cost).
• The overall impact of above points is availability of relatively low quality
vehicles at high prices and for longer period of time (particular model).
It is argued that this backward integration (forward integration is same if
we follow alternate policy as discussed below) creates jobs and economic
activities but in our analysis it hampers the economic activities and hence
job creations;

Alternate Policy : Encouragement of Assembly plants and permissibility of CKD kits

that can be assembled at relatively low duties [currently custom duties go up to 150%
plus sales tax, advance tax etc.] not more than 50%; this will increase the tax revenues
of the government through more volumes [as we have seen in Chapter 05];

• Jobs will be created through more assembly plants and wider 3-S network
[since volumes will be increased];
• Parts will be imported at relatively higher duties. This will induce local
auto parts industry to flourish not on the basis of OEM sales but secondary
market sales;

Negative impact on foreign exchange (because of increase in import of vehicles) will be

tackled through Foreign Exchange Policy and this is discussed in Chapter 11 – Internal
Balance vs External Balance – How to make trade-off?

Advantage of this policy will increase the welfare of the consumers i.e. availability of
good quality vehicles at reasonable prices with the latest technology and also help to
increase the consumption pattern;

52
Chapter 9

STORY
OF DEBT

“PROMISES MAKE DEBT, AND DEBT MAKES PROMISES”

53
National Debt is the hottest topic of media and literature. There are two types of
national debt;

Debts in Local Currency (Local Debt in Foreign Currency (Foreign Debt)

Debt)
This debt is accumulated mainly This debt is accumulated mainly because
because of budget deficits. of current account deficit. Moreover, budget
deficit and current account deficit has
positive correlation.

First of all we will see the local debt and then . We need to explore the issue and will
show that most of the arguments given advanced by those who claim that having debt
burden we are placing intolerable burden on future generation.

Argument 1:- Our children and grandchildren will be burdened by heavy interest
payments and to meet these payments there have to be higher taxes;

1. Higher payment in terms of interest if meet by higher taxation is having only

reshuffling impact in a society i.e. higher taxes being paid by our children
and grandchildren will be received by our children and grandchildren
in the form of interest payments; These transfers may or may not be
desirable but they are hardly burden to the nation as a whole;
2. Secondly, we are also future generations of our predecessors. Are we
feeling this burden in the form of inflation rates, high interest rates and
taxation? Interest rates till December 2017 were very stable so does the
inflation figures. What is eminent is that they are more responsive to
particular monetary policy rather than debt levels alone;
3. Debt or taxation which is better choice in financing government’s
expenditures. This will be discussed shortly;

Argument 2:- It will ruin the nation when we repay the enormous debt and it will
bankrupt the nation;

1. Unlike a private sector, the nation need never payoff its debt. Instead it can
rollover by floating more debt;
2. No nation need ever fear defaulting on debts that calls for repayment in its
own currency and it can monetize it debt through Central Bank;

Debt is a burden only in case of crowding out effect i.e. when government budget
deficit takes place in high employment economy, the crowding out effect will probably
dominates, so the deficit will exert a burden by leaving a smaller capital stock to future
generations. However, deficit in a slack economy may well lead to more investments.
In this case the debt is a blessing rather than a burden.

54
Statistical Data

Domestic Foreign Total Nominal Debt to % Change in

Debts Debt Debt GDP GDP Ratio Local Debt

2009-10 4,654 4,352 9,006 14,867 60.58%

2010-11 6,017 4,750 10,767 18,276 58.91% 29%
2011-12 7,638 5,057 12,695 20,047 63.33% 27%
2012-13 9,522 4,797 14,319 22,386 63.97% 25%
2013-14 10,920 5,071 15,991 25,169 63.53% 15%
2014-15 12,199 5,182 17,381 27,443 63.33% 12%
2015-16 13,627 6,051 19,678 29,076 67.68% 12%
2016-17 14,855 6,552 21,407 31,963 66.98% 9%

Foreign currency loan should be reported in foreign currency, giving rupee value is
misnomer due to exchange rate fluctuations and foreign currency loan taken in foreign
currency has to be payed back in foreign currency. Foreign debt in US$ was almost
constant (till 2015) despite of increase in economic activities.
Rs. In million Tax Collections % Increase
2010-11 2,252,855
2011-12 2,566,514 14%
2012-13 2,982,436 16%
2013-14 3,637,297 22%
2014-15 3,931,042 8%
2015-16 4,446,979 13%
2016-17 4,936,723 11%
2017-18 5,228,014 6%
*Extrapolated for full year
Moreover, %increase in domestic debt is also calm down gradually showing
corresponding improvement in tax collection. This is quite contrary to the common
belief that tax collections are not being increased and Government is depending on
debt to finance its deficit.

Deficit Financing

Income velocity of money of the Country is very low (2.30~2.40) that depicts the size of
black economy in the Country i.e. transactions are taking place but not being reported.
Organized sector is being over-taxed as we have seen in the Chapter 5. One way to tax
unorganized sector (black economy) is through deficit financing. This works as follows:

55
For an individual disposable income is relevant which he can spend after payment
of taxes. Disposal income is reduced if taxes are increased. Another way to reduce
disposable income is through inflation i.e. government should finance its expenditures
through borrowings [including monetizing of part of its debt] this will induce inflation in
the system and it will effect both [filer and non-filer not paying tax] equally and reduces
the disposable income to the desired level. Higher the size of black economy, inflation
rate will be the lesser.
Estimated
% Increase % Increase
Rs. In million M2 Inflation (CPI) Real GDP Increase in
M2 Real GDP
Nominal GNP
2011-12 7,641,795 14.1% 11.00% 9,733,907 2.54% 13.82%
2012-13 8,856,364 15.9% 7.40% 10,161,854 4.40% 12.12%
2013-14 9,966,583 12.5% 8.60% 10,636,891 4.67% 13.68%
2014-15 11,282,144 13.2% 4.50% 11,140,138 4.73% 9.44%
2015-16 12,824,853 13.7% 2.90% 11,755,824 5.53% 8.59%
2016-17 14,580,882 13.7% 4.20% 12,408,775 5.55% 9.99%

According to Quantitative theory of Money MV = PQ meaning increase in money supply

(e.g. 13.70% in 2016-2017) if multiplied with velocity (whose change is taken as fixed
in the short run) will give equivalent rise in price levels multiplied by real increase in
output which in our case is 9.43%. Since inflation effects both reported and unreported
sectors, thus rest of the effect is absorbed in black economy i.e. V part and Q part of the
equation which is 3%~4% constantly in our economy that depicts black economy size of
29%~35% of the reported nominal GNP.

Foreign Debt
As outlined above, needs to be reported in foreign needs to be reported in foreign
currency only. Translating that figure in local currency is misnomer. Moreover, rapid
increase in is happened in last 02~03 years otherwise it remained constant in past
years.

110k

100k

90k

80k

70k

60k
2011 2012 2013 2014 2015 2016 2017 2018 2019
External Debt: Total

56
The country witnessed a significant increase in its overall debt in the past three years.
There is nothing wrong with debt in itself. Private businesses borrow happily, as long as
the rate of return on the debt-financed investment is higher than the cost of borrowing.
The surging debt is a burden for Pakistan because its Gross Domestic Product (GDP)
growth is not faster than the rate at which debt is serviced. The cost of external debt
is incurred in foreign currency, hence a surge in the debt burden depletes foreign
reserves, triggers devaluation and increases the cost of debt. The central bank’s forex
reserves have started depleting due to a sudden spike in imports of heavy machinery
under the China-Pakistan Economic Corridor (CPEC) and growing obligations of debt
servicing.
What we are experiencing today on vogue of balance of payment arena should not be
taken as surprise? This is to happen ultimately……………………………
A simple mathematical equation can explain why this was inevitable?
If we assume that Pakistan is experiencing “d” percentage rate of increase of that
total debt “D” and has to pay “r” interest rate ( or r*D = interest payment) on that total
debt “D”, then basic transfer (i.e. net foreign exchange inflow or outflow) related to
international borrowing) can be expressed as;
BT = dD-rD = (d-r)D
The above simple equation can tell us the whole story. How? Let’s see!
In the period of debt accumulation (particularly from 2015 and onwards), when we
have relative small total debt (D) e.g. 2013-14 levels , rate of increase (d) was high
and making interest payment (r) was not an issue since d>r. This is one of the reason
exchange rate was stable during 2013-2018 till November 2017).
A serious problem arises, however, when:
1. The accumulated debt becomes very large [particularly after CPEC project in
last three years] so that its rate of increase “d”, naturally begins to decline as
amortization rises relative to new gross inflows, And this process of decline
in “d” was accelerated when political shift was made from China to America;
2. The sources of foreign capital is mainly floating rate and LIBOR rate is
increasing trend since last 04 years (that cause “r” to rise) . Moreover, previous
deferrals are begun to crystallize;

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

Jul 2015 Jul 2016 Jul 2017 Jul 2018 Jul 2019

1M LIBOR 3M LIBOR 6M LIBOR 12M LIBOR

57
 3. A global recession or some other shocks, such as jump in oil prices, or a steep
rise in US interest rates on which floating rate loans are based or sudden
change in value of dollar in which such debts are denominated worsened the
position so far;

All the above factors contributed to lower “d” and raise “r” in basic transfer equation.
The government is in a spot of bother as the country’s debt servicing linked needs are
projected at $9.3 billion during the ongoing FY19. As per projections of the International
Monetary Fund, the country’s external debt servicing needs were determined at over
$19 billion by 2023. This is one of the reason of recent accelerated depreciation of
Pak Rupee. CPEC project that has accelerated the internal growth and positive impact
on employment and GDP but internal balance was achieved on the cost of external
imbalance;

The problem we have is our imports and exports are usually of inelastic goods e.g. our
main import bill is on POL products, vehicles, plant and machinery etc. Our exports
mainly of textile, carpets, surgical goods etc. having inelastic demand, Devaluation
of Rupee will not improve our current account balance. We need paradigm shift to
improve our balance of payment crises. Trading of goods through rupee devaluation is
not working. Constant increase in “d” is neither possible and nor desirable. In these
circumstances, we need to work on service sectors and have to change the mindset of
our Society. We have good potential of developing following sectors and earn foreign
exchange;

1. Development of tourism but it needs quite drastic changes in societal norms

as discussed in Chapter 10;
2. Medical tourism;
3. Financial service sector again it needs drastic changes in societal norms;
4. We can provide good passage to central Asian countries and china [which
is ultimate plan of CPEC) and earn good foreign exchange on these logistic
services but it needs to implement the CPEC projects as well as peace in the
region [Pakistan and Afghanistan];
5. Image building of Pakistan through embassies and marketing which indeed is
very poor.

58
Chapter 10

MY BELIEVES AND LAW

OF THE COUNTRY

“WHEN THE STATE IS THE MOST CORRUPT THEN LAWS ARE

MOST MULTIPLIED”

TACITUS

59
We are living in a strange environment where mythology driven concepts take
overwhelming weightage as compared to logical sequences. In a modern society
knowledge management starts with hypotheses and data collection then we analyze
the data and apply some statistical tool to infer results and on the basis of those results
either we accept or reject our hypothesis then we recognize pattern out of data and
formulate some theory and rules on the basis of “other things being equal” then we
try to formulate our policies on the basis of those inferred rules and theories, How
our process of knowledge management begins it starts with conclusion based on our
mythological belief system and we quote reference of our preference with no data
collection [data analysis and inference is too remote] and on the references we draw
our conclusion that in reinforces our preconceived conclusion we have already made.

We, as a society, have grown increasingly intolerant of religious differences and

theological biases. And as a result, a fraction among us (albeit on the fringes of the
spectrum of beliefs) has resorted to violence against anyone who disagrees with their
particular brand of religious interpretation. And here we are not talking about one
religion against another (like the Crusades), but rather an intra-religious Crusade,
where within the same religion, one school of thought is killing the other.

What is source of this mind distortion? Our school curriculum, media, religious places
and all these activities are patronized by the State. We are emotional and accustomed
to oppose and are supposed to fight with everything that is initially introduced to us
without going into depth of underlying thing.

It is not understandable why we are trying to re-invent the wheel every time. Business
practices are not evolved in a day. They are evolved as better and better after learning
from past mistakes. Business practices are constantly changing with the passage of
time according to new innovation and ideas. We should not assume it (or its pace)
constant. We can learn from good ideas of any one. And ideas/practices should not be
labeled as “Arabs” or “Non-Arabs” or “Muslims” or “Non Muslim” ( i.e. it should be
evaluated from its own merit(s) not to be biased to origin ).

Here are some common believes in Pakistani society that shows logical pattern of
thinking is altogether missing even at the policy making level;

1. Attributing failures to fate, foreign hands or conspiracy – Every country in the

world is busy in conspiracy against Pakistan. We are the only country in the
world who cannot travel without visa to neighboring countries.

2. Let’s ask the religious scholar instead - Different matters related to the
broad spectrum of human life, economics, sciences and other knowledge-
based fields are taken to mullahs or clerics, as if they have all the knowledge
in the world and are the most potent problem solvers. They are human too;
stop putting them on a pedestal.

3. Civilians are less patriotic – and all politicians are corrupt. Current political
system is non-sharia based and bound to be changed.

60
4. Secularism means Godlessness - This common notion in our society
highlights that secularism means Godlessness. Those propagating these
beliefs, for obvious political reasons, need rigorous lessons in political
science.

Secularism means the right to be free from religious rulings of the state
and the right to freedom from the government’s imposition of religion upon
people within a country that is neutral on matters of belief. It essentially
means a religiously neutral country, not Godlessness.

5. No power on earth can undo Pakistan – Very strange belief and this narrative
should have drowned in the Bay of Bengal in 1971 but it still manages to
stir hyper (blind) nationalists to the core. The Two Nation’s Theory (which
was a political agreement, not a divine revelation) has also been challenged
by scholars but certain circles label these intellectuals to be traitors, just
because people are blinded by a false sense of nationalism.
6. Modernism is taking off ones clothes - In the same way, being ‘modern’ is
also gauged on an illogical scale.

7. Arts? A futile pursuit - Artists are change-makers in any society; they evoke
new ideas through different art-forms and enable a society’s progress. The
downfall of art as a whole in Pakistan has a lot to do with this norm, injected
into individuals by the society from a very early age.

8. Foreigners are strange creature – We stare at foreigners particularly lady

like strange creature. We still don’t know how to behave them and shy of
talking to them.

9. Distorted History - Other area where minds are polluted is our history. It is not
possible to have hero from our own forefathers rather all our amongst Arabs
or invaders. We don’t teach history of Gandhara, Mohanjudhoro, Bhambur
or Harappa to our children but history of Mughals, Muhammad bin Qasim.
Our children don’t know about Ashoka, the Mauria and Gupta Empires etc.
due to religious biasedness. This has created identity crisis. Sometimes
we stand with Arabs sometimes with Persians and Mughals. Every Muslim
triumph of any era, sect or region is ours and we attach ourselves with them.

10. The most distortion of mind is done against supremacy of law. What are the
common believes of common people for laws and institutional system? Here
are few examples;

61
 a. Out taxation system is non-Islamic thus to follow the taxation laws
and pay due taxes are not considered necessary [but rather non-
compliance is better justifiable]; though taxation system has flaws
but this pattern of thinking is exacerbating the issue;
b. Smuggling is trade since custom duties are not Sharia-compliant;
c. Banking System is based on interest is non-Islamic but paying
exorbitant interest rates on installment sale is Sharia compliant;
d. Our monetary system, financial system and even political system are
non-Islamic;
e. Insurance, assurance are unnecessary and reliance to be made to the
God and hence non-Islamic;
f. Secondary capital market is highly speculative and is not permissible;
g. Our statutes are not Sharia compliant;
h. Leader has to be pious and noble no need to have technical expertise,
experience and exposure and if he is true Muslim he would have
magic wand to correct and fix everything.

Things are not stopped here and some strongly advocate to have jihad against
State to implement the Sharia. Different sects have no harmony amongst
themselves and have their own agenda and propositions. With this state of
mind how should we expect that policy making and its execution [and follow-
ship] will be made in the right direction after careful analysis of the problem
and inferences will be made on sound logical basis. What we are harvesting
is what we have sown.

If we want to harness the development path serious efforts have to be made

to change the thinking pattern of the nation. State has enough power to
change the minds e.g. basant was once celebrated as festival but when State
decides to stop this event it has totally changed the mindsets of the people.

62
Chapter 11
INTERNAL BALANCE
VS. EXTERNAL BALANCE
- HOW TO MAKE
TRADE-OFF?

“THE PURSUIT OF BALANCE CAN CREATE IMBALANCE BECAUSE

SOMETIMES SOMETHING IS TRUE.”

DANIEL OKRENT

63
Recent (during 2018-19) upsurge in interest rates, plunge of Pak Rupee vis-à-vis dollar
within a very short period draws special attraction. Balance of payment deficit and
resultant foreign currency loan (as discussed in Chapter 9). Can it be made up through
contractionary economic policy or expansionary economic policy is better? We will try
to answer these question with the help of SWAN model as depicted below;
Real Exchange Rate i.e. E x Cost Ratio of International Prices

Zone 1: Overemployment and XX

Curve
Current Account Surplus
Appreciation of PKRs. --------- Depreciation of PKRs.

D
(P*) Domestic Prices (P) i.e. EP*/P

Zone 4: Zone 2:
Underemployment Overemployment and
and Current Account C B Current Account
Surplus Deficit

Zone 3: Underemployment
and Current Account Deficit

II
Curve

Fiscal Tightening (G ↓ or T ↑) ----------------------Fiscal Ease (G ↑or T ↓)

Real Domes�c Expenditure

Internal Balance (II Curve) :- Internal balance requires full employment level i.e.
aggregate demand equal the full employment level of output (Yf ) i.e.
Yf = C (Yf - T) + I +G + CA(EP*/P, Yf - T) where C is consumption depending on disposal
income (Yf - T), I is investment, G is Government Expenditures and CA is Current Account
balance which is dependent on exchange rate, cost ratio and disposable income.
Thus Current Account Surplus is decreasing function of disposable income and
increasing function of real exchange rate i.e. fiscal ease (G ↑or T ↓) will increase
the output level beyond full employment level thus corresponding appreciation of
rupee will worsen the current account balance and hence restore the full employment
level output. In nutshell, for given full employment level of output, there are various
combination of exchange rates and domestic expenditure and internal balance curve
(II) is downward sloping and thus below this curve is unemployment and above this
curve is over employment. We have both tools (exchange rate and level of fiscal ease)
to correct the internal imbalances.

64
External Balance (XX Curve) :- External balance requires achieving targeted (X) current
account balance through managing fiscal policy and exchange rate mechanism i.e.
CA(EP*/P, Y - T) = X
Where CA is current account balance E is the exchange rate, P*/P is the cost ratio
between two countries and Y-T is disposable income at any output level and X is the
desired level of current account balance. Given cost ratio, depreciation of currency
makes domestic goods cheaper and hence improve current account balance. Moreover,
fiscal ease worsen the current account balance thus if fiscal ease is the Government’s
policy corresponding depreciation has to be made to restore full employment level.
Thus XX curve is upward sloping and area above XX curve depicts Current account
surplus and area below this curve depicts current account deficit.
Now we have four zones if an economy is not balance they are :

Internal Balance
External Balance Under employment Over employment
Current Account Deficit Zone - 3 Zone – 2
Current Account Surplus Zone - 4 Zone - 1
We have enough tools to analyze Pakistan internal/external balance position. In 2013
were in Zone 3 i.e. point A, expansionary policies (mainly due to CPEC projects) during
2013-2018 moved us to Zone 2 i.e. point B i.e. even wider current account deficit.
Current account deficit were financed with capital inflows [“d” was higher than “r” as
explained in Chapter 9] and is one of the reason dollar remained stable during that
period till November 2017. Expansionary policies also put inflation under control due
to higher growth levels in GDP, black economy and sterilization policies of Central
Bank. But when “d” started to decline with corresponding increase in “r” , balance of
payment crisis was eminent that put Government to take following steps:
1. Extensive depreciation of local currency;
2. Contractionary Fiscal Policy i.e. Fiscal Tightening (G ↓ or T ↑)
With the hope that this will move us to Zone 4 first (i.e. point C) with some unemployment
and when current account problem is solved then we can move to Zone 1 (point D). How
this approach is realistic? Since creating unemployment in the Country is socially and
politically undesirable and our import and exports both are inelastic (as we have seen
in Chapter 9) and expecting hot money to flow in the Country because of high interest
rates but with unstable political and shattered business confidence environment is very
unlikely and there is no assurance to achieve Zone 4 target. Another pivotal question
that we need to as any other way to move from Zone 2 (point B) to Zone 1 (point D)?
As we have seen in Chapter 9, achievement of this objective requires out of box thinking
and policies and change of societal norms (as mentioned in Chapter 10) where we can
nurture tourism, health care and other service sectors (particularly logistic services
with multilateral linkages) without compromising employment goals. All the policies
(as mentioned in Chapter 8) need to be coherent and in logical sequence.

65
Exchange Rate Policy

What should be the exchange rate policy if external balance to achieve and to move on
to Zone 1 (Point D)? Following factors to keep in mind:

1. Change of pace of “d” factor as discussed in Chapter 9;

2. “r” factor and its trend as discussed in Chapter 9;
3. Levels of import and export and their elasticity;
4. Interest rate differential between two countries;
5. Global business environment;
6. Level of Internal Balance;
7. Short run and long run impact to understand and inflation level.

We are not considering Import Substitution Policy as a policy tool if not based on
economies of scale [and continuous innovation and development] will be exploitative.
It may have short-run positive impact on balance of payment but in term very high cost
[due to inefficiencies and obsolete technology].

Fixed exchange rate or floating exchange rate mechanism? All have its pros and cons
what is important is the combination and in tandem policies all around e.g. fiscal policy
to ensure employment and infrastructural development, monetary policy to ensure
interest rates not to detrimental for investment, coordinated policies (as outlined in
Chapter 8) and exploration of new areas (tourism, service sectors etc.) to boost foreign
exchange earnings, change of society’s norms, country’s image building, bilateral trade
particularly with neighboring countries, CPEC project to increase logistic earnings,
conducive business environment (through consistencies of policies, infrastructural
development and legal framework to smooth competition with definite rights and
obligations, enabling tax policies, encouragement to consumption pattern and better
law and order situation) to improve FDIs (till the times Current Account position is
restored we have to keep “d”> “R” through accumulation of debt and preferably more
FDIs), developing required skills through vocational training and we have to come out
of our traditional mind-sets that so far is the failure.

66
Chapter 12

BEING PAKISTANI
- WHAT I WANT?

“YOU ARE NOT REQUIRED TO SET YOURSELF ON FIRE TO KEEP

OTHER PEOPLE WARM”

67
No nation today is free from problems, even though nature, depth, and range of issues
vary widely. In face of formidable problems facing nations, and the complex underlying
forces, nations have to clarify what they can realistically hope to accomplish. A nation’s
wealth creation, to a great extent, should be both physical realities and state of mind in
which society the drives and means to pursue a better life have.

What I want is to have:

• A Good Economy that ensures employment opportunities, social security,

health care, education and respect of work;
• A Good Society that ensures freedom of speech, ease of mobility within and
outside Country, logical pattern of thinking with no biasness (and no prejudice),
no gender discrimination, religious or otherwise and tolerance;
• A Good Political Process that ensures continuity of policy, build business
confidence, secured law and order position, transparent judicial process,
clarity and simplicity in statutes and good relationship with other countries
(particularly with other neighboring countries);

If we gauge ourselves with the above wish list we stand nowhere. Our issues, day to
day discussions and arguments are superficial, mythical and purposely perpetuated by
interested groups and lobbies. Our Children have no idea of thinking to have breakfast
in Amritsar – just few kilometers away (neighboring country) which is normal way of
life in rest of world. As a nation we neither used to travel (except religious tourism)
nor having experience (and don’t want to experience) of foreign tourists in the Country.
Every institution in the Country is working out of its domain and having own building
block totally in mistuned with others.

Who will rectify the situation [rather that how to rectify] is the big question mark.
Neither our ruling elite is understanding [because of their short term myopia and in-
capabilities] nor our society as a whole want to leave/distract from their superficial
thinking process [which in fact is being reinforced by the ruling elite].

To summarize the current state of affairs in the Country we are presenting following
model:

Harnessing a Growth Path through Multi Directional Approach

Harnessing development path is neither single step task nor working on only one
end. It requires candid efforts on all directions. As outlined above our, socio, political,
economic factors are misaligned and acting as an irritant to development path. We have
to come out of our traditional thinking and attitude if to correct the things otherwise any
policy designed in isolation will be bound to failure. Moreover, any policy and attitude
change will create some beneficiaries and some will be adversely effected so what
is required is to draw realistic performance indicators and if they are moving in right
direction then policy implementation is successful otherwise failure. Adversaries can
be compensated by the beneficiaries. Every decision has to make trade-off.

Moreover, policy making should be detached with the execution otherwise self-interest

68
mechanism will flawed policy making process.
Monetray and
Fiscal Policies

In-tandem Fiscal
policy that ensures
"less" Government,
Attitude towards work, enabling tax policies,
Change of mind-set skills, education, training, Infra-structure
(changing societal no gender discremination, devlopment, deficit
freedom of speech and not Capital market
norms), consumption financing, Social Security
living in and aspiring past development banking
pattern, mobility, measures, Job creation and non-banking
mixing with other measures institutes development,
societies, toterance
coorporate culture

Social
Factors
Policies making that
needs to be in tandem
and consistant, Political stability, law In-tandem Monetary
Institutional framework and order position, Policy exchange rate,
that includes relatioship with other interest rate, controlling Foreign Direct Investment
simplification of law, Countries black economy, (FDIs), incremental change
enuring competition, moderate (demand in foreign curreny debts
judicial process driven) inflation, credit (i.e. "d" > "r") till the
availability (particularly current account comes in
to SMEs), monetization Green, hot money
of debt
Political
Factors

Some Suggestions in the light of recent Pak Rupee Devaluation, Interest Rate hike
and Budget 2019-2020 to improvise the Economic Activities

Following is the Revenue and Expenditure Summary that we will analyze in the following
scenario:
1. Dollar is appreciated by 35.28% in one year RS.
and if we assume target rate of dollar is Dollar as on 30/06/2018 121.60
Rs. Rs. 170.00 then % increase of dollar is
around 40% since July 2018. Dollar as on 30/06/2019 164.50
2. Interest rates are climbed to 13.63% from % Increase 35.28%
7.53% in one year time and likely to increase Target Rate (Mid Value) 170.00
further due to more ensuing inflation. Tar-
get rate of inflation is 13% and expected in- %Increase (Target) 39.80%
terest rate will hover around 15%. Target Inflation 13.00%
3. Imports and exports are more or less in- One Year KIBOR as on
elastic as we have seen in Chapter 9. 30/06/2018 7.53%
4. Most of the tax collections comes from im-
port taxes (43%). One Year KIBOR as on
5. Demonization is better tool to document the 30/06/2019 13.63%
economy as explained in Chapter 6 rather % Increase 81.01%
than through tax collection measures which Target Rate (Mid Value) 15.00%
are detrimental to conducive business envi-
ronment and harassment to tax payers. %Increase (Target) 99.20%
6. Payment of interest rates on domestic debt
is re-shuffling of income from one group to
another group in the Society i.e. taxation
taken from one group and paid and interest
income to another group.

69
The following summary clearly explain the choices available to the policy makers in the
light of above factors (exchange rate, inflation and interest rates).
Revised Budgeted
Rs. in million % Increase
2018-2019 2019-2020
Direct Taxes 1,659,000 2,081,945 25%
Indirect Taxes 2,491,000 3,473,055 39%
Other Tax Receipts 243,876 267,160 10%
Non-Tax Receipts 637,751 894,464 40%
Capital Receipts 953,501 766,198 -20%
External Receipts 1,403,156 3,032,325 116%
Public Account Receipt 282,652 250,754 -11%
Privatization Proceeds & Others 1,415,302 911,991 -36%
Less : Provincial Share (2,462,651) (3,254,526) 32%
6,623,587 8,423,366
Revised Budgeted
% Increase
2018-2019 2019-2020
Direct Taxes 1,659,000 2,081,945 25%
Custom Duties 735,000 1,000,500 36%
Sales Tax 1,490,000 2,107,738 41%
Federal Excise 266,000 364,817 37%
Others 243,876 267,160 10%
4,393,876 5,822,160 33%
- -
Excluding Others 4,150,000 5,555,000 34%
Expenditures
Debt Servicing 4,048,341 5,607,042 39%
Defense 1,137,710 1,152,535 1%
Other Expenses - Revenue Account 403,380 528,602 31%
Other Expenses - Capital Account 204,479 185,291 -9%
Development Expenditures 829,679 949,896 14%
6,623,589 8,423,366
1. Interest rate hike creates two problems for the economic activities which
needs to be addressed through compensating measures;
a. Value of business attributable to owners (e.g. shareholders) is future

70
 cash flow (after deducting taxation and debt servicing) discounted with
the required rate of return.
b. Interest rate have negative correlation to equity i.e. increase in interest
rates increase the required returns on equity and hence depress the
equity prices.
c. Leveraged companies’ future cash flows are depressed due to higher
interest payments and hence equity prices are further depressed due
to impaired cash flows.
2. Exchange rate on the vogue of inelasticity’s of export and import renders it
relatively ineffective tool to correct balance of payment crisis unless and until
following measures are taken;
a. Attraction of hot money as explained in Chapter 11 in debt and
equitable securities through corresponding corrective measures and
conducive business environment (that are missing for the time being).
b. As explained in Chapter 9 more avenue for export potentials through
CPEC projects, bilateral arrangements (for FDIs), tourism etc. We
need Export Oriented policies rather that Import Substitution policies.
c. Rupee devaluation must have positive impact on workers’ remittances.
This area need further incentives and attentions.
3. Exchange rate hike triggers inflation within domestic economy since imported
goods are becoming expensive and hence competing domestic goods will be
able to increase their price. Inflation has redistribution of income effect.
4. Higher inflation, interest rates and high import values will generally increase
Government’s revenues.

5. What is important is to rejuvenate the economic activities through taxation

measures and coherent policies and legal framework as described in this
Chapter8.

6. Most of the chunk of revenue Debt Servicing

is going in debt servicing and Foreign Debt 1,234,574 1,455,018
defense. Although local debts Local Debt 1,681,564 2,531,685
(and others) is redistribution of
income amongst Society and Others 1,132,203 1,620,339
(interest plus amortization) As we have seen above, despite all hue
creates balance of payment and cry, reliance is still made on external
problem but also has increase borrowings.
of money supply impact in
domestic economy that has
inflationary impact. Increase
in interest rates increases the
debt burden of Government.

71
 7. Sizeable chunk to debt servicing and defense depicts inflexibility of Fiscal
Policy on part of policy makers. These are fixed commitments and has to be
made and contemporary monetary policy increases the burden of interest
rates payment burden.
8. Interest rates and Pak Rupee devaluation eroded business confidence and this
needs to be restored through counter measures as explained above.
9. Budgetary targets are likely to be achieved due to tax on imports, relatively
higher tax on interest payments and generally increased price levels. What
is more important is to rejuvenate economic activities through private sector
and infrastructure development and channelizing interest payments (from
Governments to Society) to more productive ways.
Extrapolation based
2019-2020
on 2018-2019
Custom Duties + Sales Tax on Import +
Tax on Imports 43% 2,479,158
Advance Tax on Import
All Taxes excluding Domestic Sales Tax,
Other Direct 34% 1,998,701
Federal Excise and Tax on Imports
Other Indirect 23% 1,077,141 Domestic Sales Tax + Federal Excise Duty
5,555,000

10. Following is the some suggested taxation measures to rejuvenate economic

activities and restore business confidence.
a. Corporate culture to be promoted and taxation on dividend and
corporate tax to be reduced.
b. Likewise CVT, taxation on capital gains on listed securities to be
substantially reduced.
c. Most of the tax revenues come from ten heads and very less tax
revenues is collected in other majority heads and needs to be either
abolished or to be reduced. This will boost the taxpayers’ confidence
and reduces the harassment from tax authorities.
d. Taxes on supply chain need to be revamped after full understanding of
the underlying margins of supply chain participants. More rationalized
system will increase the tax base.

11. Economic activities to be triggered through boosting consumption pattern

through:

72
 Suggested
Ratios** Extrapolated Adjusted Impact on Economic
+ Adjusted Remarks
2017-18 2019-2020 2019-2020 Activities
%*
Reduction in Withholding Taxes
Advance Tax -
25.48% 509,277 28.00% 559,636 will increase the collection Positive Impact
Section 147
under this head
With Returns Reduction in Withholding Taxes
& Collection 11.06% 221,091 13.50% 269,825 will increase the collection Positive Impact
on Demand under this head
Contracts / Tax Rates to be reduced to
Supplies / 21.49% 429,448 14.72% 294,117 make it compatible with Supply Positive Impact
Services Chain Margins
Provided overall
Salary 10.12% 202,263 11.44% 228,557 Increase of Tax Rates Economic Activities
to be maintained
To be reduced to encourage
Dividends 4.39% 87,734 1.00% 19,987 Capital Markets and providing Positive Impact
alternate finance
Provided overall
Telephone 3.60% 71,862 3.60% 71,862 Status Quo Economic Activities
to be maintained
Increase in interest rates and
Bank Interest 3.46% 69,229 10.35% 206,859 Negative Impact
increase of tax rates
To be controlled
Cash through
2.58% 51,566 2.58% 51,566 Status Quo
Withdrawals Demonetization
Policy

Electricity 2.57% 51,311 3.85% 76,967 Increase of Electricity Rates Negative Impact

Export 2.15% 42,889 3.00% 59,960 Pak Rupee Devaluation Positive Impact

Provided overall
Technical Fee 1.97% 39,442 1.97% 39,442 Status Quo Economic Activities
to be maintained
Unnecessary taxation in Positive Impact if
Others 11.14% 222,589 6.00% 119,922 numerous heads causing taxes are reduced or
harassment to the tax payers eliminated
*Impact of activity level, Exchange Rate (Rupee Devaluation) and tax rate (as per Budget 2019-
2020)
** Ratios for 2018-2019 are not yet available i.e. FBR Revenue Division Yearbook 2018-19 is not
yet available.

a. Development expenditures particularly at provincial levels;

b. Channelizing interest payments into more productive manner through
banking channel. This is important area and discussed in detail;
c. Boosting capital market [and providing alternate financing options to
the business] through taxation measures;
d. Attracting FDIs’ through bilateral agreements and incremental debts
in foreign currency;
e. Coherent institutional and legal frame work coupled with policies
based on competitive advantage;
f. Paradigm shift in Society’s pattern of thinking as outlined in this book;
g. Encouraging supply chain participants through reliefs (quite to the

73
 contrary existing harsh measures against them);
12. Provincial taxation and revenues (since major pie is going to them) is to be
monitored and guided on the same lines as mentioned here for Federal
Taxation.
13. Heaving taxation on transaction (e.g. taxation/ levies on sale/purchase of land)
that debarred them should be reduced e.g. relaxation of levies in case of sales/
purchase of land transaction through registered societies, REIT etc.
14. Encouragement of corporate farming, processing industries, assemblies
through taxation policies and industrialization policies.

Channelizing interest payments into more productive manner through banking channel

Revenue side of the budget is heavily dependent on External Receipts (less external
payments (interest plus principal payment of ) shown in expenditure side) which if
materialized would have monetary supply (M2) expansion effect that will drag interest
rates down but if not channelized to energize economic activities (Real GDP growth)
will be inflationary in the economy. Moreover, domestic interest payments (plus net
domestic borrowings) will have reshuffling impact within economy i.e. transfer of
money from one segment of Society (in the form of taxation) to other segment of
Society (in the form of interest + principal payments. What is more important is to
boost economic activities.

MONETARY POLICY FISCAL POLICY ECONOMIC ACTIVITIES

INTEREST RATE, C + I + G + X-M (EXTRACTION,
EXCHANGE RATE, CONVERSION AND
MONEY SUPPLY TRADE (AND SERVICES)

C = Private Consumption , I = Investment,

G = Government Expenditures, X-M = Export less Import

1. Monetary policy has used its tools and increase the interest rates, exchange
rate and money supply.

2. As we have seen more of the expenditures by the Government is on debt

servicing and defense and very less room for development and non-
development expenditures. This renders Fiscal Policy (G) relatively ineffective
as a policy option. More reliance to be paid to legal and policy framework [and
Social factors] to boost consumption ( C ) and Investments ( I ) and Import/
Exports (X-M).
3. Investment ( I ) is determinant of interest rate and business confidence. Interest
rate is already increased. Business confidence needs to be restored through
infrastructure projects and coherent policies based on competitive advantage.
Capital market to be developed as a catalyst to economic growth. External

74
 funding if crystallizes will stabilize the dollar and interest rates will come
down (short run impact) which has to be augmented with real GDP growth in
service, trade, agricultures, assembly and construction activities (as outlined
in this book) otherwise monetary policy would have inflationary impact and will
increase the interest rates further up (long term impact).

4. Consumption pattern to be boosted through change in thinking pattern of

society (gradual impact), job creation (particularly in service and agriculture
sectors including processing industries), availability of credit (personal credits,
credit cards etc.).

75
 Dedicated to:
My parents
Ali and Rania, who have taught me
the joys of being father.
My friend, Wasif Rasheed who
encouraged me to write this book.
“I do not believe in taking the right decision, I take a decision and
make it right.”
“Think a hundred times before you take a decision, but once that
decision is taken, stand by it as one man.”

Quaid-e-Azam