Extended Fund facility review: IMF demands raise in Income tax, sales tax, RD

ISLAMABAD: The International Monetary Fund (IMF) has asked Pakistan to take additional taxation measures in the shape of Income Tax, Sales Tax, and Regulatory Duty (RD) for jacking up the annual tax collection target from Rs5.8 trillion to Rs 6.3 trillion.

At the same time, the World Bank (WB) has lowered Pakistan’s GDP growth prospects to 3.4 percent for the current fiscal year as the government refocuses on mitigating external pressures and managing long-standing fiscal challenges in its South Asia Economic Focus titled “Shifting Gears: Digitization and Services-Led Development,” projecting the region to grow by 7.1 percent in 2021 and 2022.

The IMF’s fresh demand has surfaced during the ongoing virtual talks in the context of losses incurring on account of non-collection of petroleum levy of over Rs600 billion during the current fiscal year. The government will have to take additional revenue measures on the FBR front to bridge the gap that surfaced on account of non-collection of petroleum levy, said the official.

The IMF also recommended further jack up in the base price of electricity tariff to the tune of Rs1.40 per unit to curtail the surge in circular debt. Although, the Pak authorities have done quarterly adjustments in the power tariff but if the base price is not increased, then it is feared that the pace of accumulation envisaged under the Circular Debt Management Plan (CDMP) could not be materialized.

“Talks are underway and both sides may evolve a consensus on staff-level agreement whereby the FBR’s target may be jacked up from Rs5.8 trillion to Rs6-6.1 trillion for the current fiscal year in the wake of FBR’s increased collection at import stage,” top official sources confirmed while talking to The News here on Thursday.

The official sources said that the IMF also suggested increasing the rate of personal income tax by adjusting the higher income bracket earning Rs75 million on annual basis. There are different proposals under consideration to adjust the rate of personal income tax to fetch an additional Rs100 billion to Rs150 billion. There is another proposal to withdraw more GST exemptions within the current fiscal year. The FBR has also prepared a list of a few dozen items where the RD will be jacked up for getting additional revenues. The withdrawal of Additional Customs Duty recommended by the National Tariff Commission might be delayed but the final decision was expected on the eve of the upcoming budget.

The IMF wants to amend the Nepra law where the automatic adjustments both downward or upward adjustments on a quarterly basis should be done without the intervention of the government. The IMF considers the existing pace of FBR’s revenue collection as unsustainable, so additional revenue measures are imperative for achieving fiscal sustainability. There are two major outstanding issues including fiscal sustainability and fixing the cash bleeding energy sector.

“We are hopeful that the staff-level agreement will be achieved till October 15, 2021, as Minister for Finance Shaukat Tarin will be visiting Washington D.C from coming Tuesday for finalising review talks for clubbing both sixth and seventh reviews under the $6 billion Extended Fund Facility (EFF)” said the official sources. If everything goes well then, the IMF’s Executive Board will grant approval of $1 billion by end of November 2021, the official added.

Talking to journalists after attending the Senate Standing Committee on Finance here at the Parliament House, the Chairman FBR, Dr. Mohammad Ashfaque, said the ongoing talks with the IMF did not conclude so far but the Fund staff was satisfied with the collection of the board. He said that the FBR exceeded its target by Rs186 billion in the first quarter as the revenue collection stood at Rs1,395 billion in the first three months of the current fiscal year. The FBR’s annual tax target, he said, would be achieved. The FBR high-ups briefed the IMF on direct and indirect taxes.

Meanwhile, the World Bank (WB) has lowered Pakistan’s GDP growth prospects to 3.4 percent for the current fiscal year as the government refocuses on mitigating external pressures and managing long-standing fiscal challenges. The WB has projected that the country’s debt would peak to 90.6 percent of GDP by end of the current fiscal year. However, it would slightly decline to 89.3 percent of GDP in the next fiscal year 2022-23. Inflation would be hovering around 9 percent in the current fiscal year while it might recede to 7.5 percent in the next fiscal year 2022-23.

The government had sought the real GDP growth target of 4.8 percent for the current fiscal year 2021-22 against a provisional growth estimate of 3.94 percent for the last fiscal year 2020-21. The latest South Asia Economic Focus titled “Shifting Gears: Digitization and Services-Led Development” projects the region to grow by 7.1 percent in 2021 and 2022.

While the year-on-year growth remains strong in the region, albeit from a very low base in 2020, the recovery has been uneven across countries and sectors. South Asia’s average annual growth is forecast to be 3.4 percent over 2020-23, which is 3 percentage points less than it was in the four years preceding the pandemic.

With regard to Pakistan, the WB states that in line with the 25-basis point policy rate hike in September 2021, fiscal and monetary tightening are expected to resume in FY22, as the government refocuses on mitigating emerging external pressures and managing long-standing fiscal challenges. Output growth is therefore projected to ease to 3.4 percent in FY22, but strengthen in the South Asian country thereafter to 4.0 percent in FY23 with the implementation of key structural reforms, particularly those aimed at sustaining macroeconomic stability, increasing competitiveness and improving financial viability of the energy sector.

Inflation is projected to edge up in FY22 with expected domestic energy tariff hikes and higher oil and commodity prices before moderating in FY23. Poverty in accordance with international standard ($1.9 on PPP) is expected to continue declining, reaching 4.0 percent by FY23. The low middle income poverty rate ($3.2 in 2011 PPP) stands at 35.7 percent population. The upper middle income poverty rate ($5.5 in 2011 PPP) stands at 76.2 percent population.

The current account deficit is projected to widen to 2.5 percent of GDP in FY23 as imports expand with higher economic growth and oil prices. Exports are also expected to grow strongly after initially tapering in FY22, as tariff reform measures gain traction supporting export competitiveness. In addition, the growth of official remittance inflows is expected to moderate after benefiting from a COVID-19 induced transition to formal channels in FY21.

Despite fiscal consolidation efforts, the deficit is projected to remain high at 7.0 percent of GDP in FY22 and widen to 7.1 percent in FY23 due to pre-election spending. Implementation of critical revenue-enhancing reforms, particularly the General Sales Tax harmonization, will support a narrowing of the fiscal deficit over time. “Public debt will remain elevated in the medium-term, as will Pakistan’s exposure to debt-related shocks,” it maintained. This outlook assumes that the IMF-EFF program will remain on-track, the WB assessed.

Due to low-base effects and recovering domestic demand, the real GDP growth (at factor cost) is estimated to have rebounded to 3.5 percent in FY21 from a contraction of 0.5 percent in FY20.

Buttressed with record-high official remittance inflows, received through formal banking channels, and an accommodative monetary policy, private consumption and investment are both estimated to have strengthened during the FY. Government consumption is also estimated to have risen, but at a slower pace than in FY20 when the COVID-19 fiscal stimulus package was rolled out. In contrast, net exports are estimated to have contracted in FY21, as imports growth almost doubled that of exports due to strong domestic demand.

On the production side, supported by strong large-scale manufacturing, industrial activity is projected to have rebounded after contracting for two consecutive years. Similarly, the services sector that accounts for 60 percent of GDP, is estimated to have expanded, as generalized lockdown measures were increasingly lifted. In contrast, agriculture sector growth is expected to have slowed, partly due to a near 30 percent decline in cotton production on adverse weather conditions. Despite slowing to 8.9 percent in FY21 from 10.7 percent in FY20, headline consumer price inflation remained elevated – mostly because of high food inflation, which is likely to disproportionately impact poorer households that spend a larger share of their income on food items compared to non-food items.

With the policy rate being held at 7.0 percent throughout FY21, real interest rates were negative, supporting the recovery. The current account deficit narrowed from 1.7 percent of GDP in FY20 to 0.6 percent in FY21 as robust remittance inflows offset a wider trade deficit.

Foreign direct investment decreased, while portfolio inflows increased with the issuance of US$2.5 billion Eurobonds. Overall, the balance of payments surplus was 1.9 percent of GDP in FY21, and the official foreign exchange reserves rose to US$18.7 billion at end-FY21, the highest since January 2017 and equivalent to 3.4 months of total imports. Accordingly, the Rupee appreciated by 5.8 percent against the US dollar over the FY, while the real effective exchange rate rose by 10.4 percent. In FY21, the fiscal deficit narrowed to 7.2 percent of GDP from 8.0 percent in FY20, as revenue growth, underpinned by stronger domestic activity, outpaced higher expenditures.

Public debt, including guaranteed debt, tickled down to 90.7 percent of GDP at end-June FY21 from 92.7 percent of GDP at end-June FY20. Bolstered by the recovery in the industry and services sectors and resultant off-farm employment opportunities, poverty incidence, measured at the international poverty line of US$1.90 PPP 2011 per day, is expected to have declined to 4.8 percent in FY21 from 5.3 percent in FY20.

However, this change is not statistically significant, and downside risks arising from lockdown-induced disruptions to employment and high food inflation remain.

In Pakistan, GDP is estimated to have grown by 3.5 percent in FY20/21, an upward revision of 2.2 percentage points compared to the last forecast. Strengthening private consumption and investment are projected to have driven the overall recovery, while net exports are estimated to have contracted due to strong domestic demand driving import growth. GDP growth is expected to ease to 3.4 percent in the current fiscal year, as both expansionary fiscal and monetary measures are expected to unwind. For FY22/23, growth will pick up again to reach 4 percent as major structural reforms are implemented that are expected to strengthen the economy’s overall competitiveness, it concluded.