Pain is coming

Pakistan’s most important decision-makers are now facing a dire and extreme choice. They can either choose to inflict some long overdue pain on elite rent seekers, or they can choose to inflict even more pain on the already long suffering middle class and the poor.

That is the clear economic choice that now confronts Pakistani decision-makers. Continue the existing elite consensus of high subsidy-low tax for the rich, and runaway inflation, dysfunctional public services and misery for the poor. Or stop the bleeding by ending the subsidies raj, ending amnesties, ending low or no tax wealth and asset accumulation. Pain (or rather, more pain) is coming. Pakistan’s decision-makers just have to choose who will feel it. The rich? Or the poor?

Last fiscal year, government expenditure was Rs16.1 trillion, whilst government revenue was Rs9.6 trillion. Some people say that this is an indicator that Pakistan spends too much money. It isn’t. It is an indicator that Pakistan does not collect enough money or revenue. It does not have enough revenue because Pakistan is a high subsidy and low tax zone for the rich and super rich. When the most capable in a society refuse to pay into the system, the system gets stretched.

Last year, this stretch was a mean one. Pakistan had to find Rs6.5 trillion from somewhere. It found it through borrowing money – mostly from Pakistani banks. Where do the banks get that money? They get it from the State Bank of Pakistan. Where does the State Bank get this money? It just prints it. Khurram Husain estimates that in the past three months alone, somewhere to the tune of Rs10 trillion in new rupees have been added to our economy. Mostly so that Pakistani elites can continue living in the magical world of high subsidies (for the elite) and low taxes (for the elite).

What happens when a country keeps borrowing money without collecting some of that money in the form of taxes? Well, the future of that country becomes more and more bleak with each additional rupee borrowed, especially in a world of high interest rates or markups. More urgently, all this borrowing is taking place not from within a given stock of money, but from a constantly and rapidly expanding stock of money. The printing of money is dangerous. To understand how dangerous this is, we must simplify a little. Imagine it is the beginning of time, and there is only one hundred dollars out there in the universe, and only one hundred rupees. Then, all other things equal, the rupee to dollar exchange rate in this imaginary world would be Re1 to $1.

Now imagine that someone goes out and decides to start printing rupees. They go and print an extra hundred rupees. The rupee to dollar rate would then just straight up double to Rs2 to $1. You print another hundred and the rupee to dollar rate would rise to Rs3 to $1. Last month, the rupee to dollar rate crossed the Rs300 to $1 barrier – so you can imagine just how many rupees have been printed.

Of course, in this scenario, we have been a bit unfair. All other things are not equal. The dollar is the most powerful fiat currency on the planet. The Pakistani rupee has had to carry the burdens of wars, poverty, post-colonial baggage, a partition in 1971, constant geopolitical gamesmanship, terrorism and an unrelenting existential adversary. So if you were a Pakistani decision-maker – in charge of directing or governing the economy – the question would be simple. Knowing that all other things are not equal, would you be more careful (red pill) about how many rupees you print and how rapidly you cheapen your currency, or would you be less careful (blue pill) and continue undermining your currency?

The Pakistani decision-maker has, so far, kept on choosing the blue pill. This is how, broadly, we went from one dollar costing Rs100, then Rs200, and then Rs300. Then, last month, a bunch of phone calls were made, people were threatened, and the fear of the Lord Almighty was restored among ‘rogue’ speculators and ‘illegal’ hoarding outfits. And ‘abracadabra’: like magic, our poor old rupee started to stand up to the great US dollar.

In a short period of time, the rupee has gained 6.0 per cent against the dollar. And just like that, the sense of panic and urgency for meaningful and serious changes to how the economy is governed has been replaced by a familiar smugness in Islamabad and Rawalpindi: “experts and naysayers are always too pessimistic, but look, Pakistan is back, baby!” Decision-makers are awash in the afterglow of a successful effort to reign in the rate of the rupee to the US dollar. The sycophants and charlatans that whisper economic alchemy waswasa into the ears of decision-makers are buzzing with excitement.

Do the remarkable gains of the rupee against the dollar merit mockery? Absolutely not. But they should not be celebrated either. Any gains in the value of the rupee – whilst the country’s poorest and most vulnerable buckle under inflationary pressures – are welcome. But we should ask ourselves more about these gains. How were such gains achieved so swiftly?

If all it takes to wipe out twenty rupees per dollar is a crackdown on hoarding and smuggling, curious minds and sharp intellects should be less focused on buying mithai, and more focused on asking why such a crackdown requires the leadership of the military to intervene. In what kind of a country is it the job of a military (in the midst of a new war on terror) to have to force speculators and hoarders to take a break from their loot and plunder? And does anyone seriously believe that this loot and plunder won’t be renewed as soon as Pakistani decision-makers are distracted by the next major crisis?

All countries borrow money to supplement their tax collection. Pakistan taxes the poor and the working class to supplement its borrowing. Both the overarching economic crisis in Pakistan and the metastasizing problem of a cheapening rupee are anchored in the absence of a reasonable fiscal equation in the country.

In European Union countries, almost all of whom carry a much larger stock of both domestic and external debt than Pakistan, the fiscal deficit is on average about 3.0 per cent of GDP. Traditionally, international financial institutions expect countries like Pakistan to run fiscal deficits of roughly 4.0 per cent. Last year, Pakistan’s fiscal deficit was 7.7 per cent. That 3.7 per cent difference isn’t small. It comes to around Rs3.4 trillion. If Pakistan was generating an extra Rs3.4 trillion in taxes, it would neither need to print so many rupees and watch the rupee fall against the dollar, nor need to borrow so much money at historically high interest rates that its debt servicing bills keep ballooning. Where can Pakistan find Rs3.4 trillion in taxes?

There are 37.5 million households in Pakistan. The only segment of the population that should be the focus of taxation is the highest income bracket. So let’s focus only on the top 10 per cent, or about 3.75 million households. If we were to split the burden of Rs3.4 trillion upon these top 10 per cent of households, we would need each household to pay roughly Rs76,000 each month (around $250), or a total of around Rs907,000 per annum.

When this data is presented to decision-makers, the super-rich will scream bloody murder. In part they will be equipped with data about average income levels of the highest income quintile. But this should only serve to whet the appetite of decision-makers to ensure equity and fairness in taxation – and to engineer a nuanced, focused and targeted tax collection exercise in which the richest and most able carry the largest share of this Rs3.4 trillion tax vacuum.

Ultimately Pakistani decision-makers must realize that the countries they constantly seek bailouts from, like the Kingdom of Saudi Arabia and the People’s Republic of China, have all already gone through this exercise of learning how to collect revenue from their rich and super rich.

Saudi Arabia is an economic juggernaut today in part because it has learnt to have ambitions that are far grander than its oil wealth. Non-oil revenue in Saudi Arabia in the second quarter of 2023 surged to 43 per cent of total revenue. Of this non-oil revenue, the vast majority came from taxes on income, profit, capital gains, goods and services. In short, Saudi Arabia has chosen to be a country where the most able carry the biggest burden.

The world awaits Pakistan to make a similar choice. The signals from Pakistani decision-makers so far are not encouraging. A rising rupee can delay the dawn of reality for a short while, but it cannot evade the inevitable. Pain is coming.

The writer is an analyst and commentator.