Download Monetary Policy

Lecture 32
Monetary and Fiscal Policy
Instructor: Prof.Dr.Qaisar Abbas
Course code: ECO 400
Lecture Outline
A. Monetary Policy
B. Fiscal Policy
Monetary Policy
Monetary Policy
•
Monetary policy is concerned with regulation of quantity, cost and allocation
of money and credit in the economy. It is a mechanism, which has serious
implication for economic development .It helps individuals decide the
amount and place of investment, rate of savings and spending.
Definition of Monetary Policy
•
The actions of a central bank, currency board or other regulatory committee
that determine the size and rate of growth of the money supply, which in
turn affects interest rates. Monetary policy is maintained through actions
such as increasing the interest rate, or changing the amount of money
banks need to keep in the vault
•
http://www.investopedia.com
Monetary Policy
•
Money policy in many countries has been kept away from direct arena of
government. The government only establishes basic rules and eventual
targets. However, in Pakistan many policy has been a much more
government controlled and influenced tool.
Monetary Policy
– Interest rates have been pre-determined
– Sector credit targets are defined
– Market has not played an influential role
The monetary management may be divided into two periods
• pre-1991 period
• Post-1991 period
Pre- 1991 Period
•
Pre-1991 period
– Before the 1991 financial sector reforms, the government’s management program was
considered to be a loosely managed, highly unorganized system. In 1972, when the
banking reforms were taken, a National Credit Consultative Council (NCCC) was
established to determine the distribution of credit in the economy.
– An annual credit was and still is devised each year to determine the extent of
monetary expansion for the year. The government administered all rates of return and
the whole economy had to accept them. It is far to say that Money Policy prior to
1991 worked fairly well and government had pursued an economic growth
strategy :
•
By controlling interest rates
•
Directing credit to priority sectors
•
Obtaining cheap credit from banking sector
Post-1991
•
Post-1991
– From 1991 till today the financial sector has been in the throes of
major transformation. The impetus to these drastic reforms is the World
bank and International Monetary Fund.
Recent Monetary Policy Framework in Pakistan
•
Objective(s) of SBP’s monetary policy is to strike a delicate balance on inflation
containment and maintaining/supporting economic growth.
•
Change in the monetary policy stance is communicated through adjustment in
the policy rate – the overnight rate at which SBP provides collateralized cash to
bank(s). If required, changes in the Cash Reserve Requirement (CRR) and
Statutory Liquid Reserve requirement (SLR) are also made.
10
Inherited Macroeconomics Imbalances
•
Government inherited large macroeconomic imbalances
owing to expansionary monetary and fiscal policies, with
them having spillover effects on the current account but
without adjustment of the exchange rate because of large
capital inflows.
FY
05
FY
06
FY
07
FY
08
FY
09
FY
10
Inflation %
9.0
8.0
8.0
12
21
12
Overall Fiscal Deficit %
age of GDP
3.3
4.3
4.4
7.6
5.3
6.3
Current Account Deficit
% of GDP
1.5
4.4
5.1
8.5
5.7
1.7
19.1
15.1
19.3
15.3
*
9.6 *
12.5
2.0
4.5
8.4
5.4
2.6
2.1
Money Supply (%)
*-
Pvt./FDI/Portfolio (US $
billion)
Low money growth in FY08 and FY09 was due to depletion of reserves.
11
Recent experiences with monetary management:
Inflation
•
After a sustained reduction, from 20.8 percent in FY09 to 11.7 percent in FY10,
inflation has started to increase again in FY11, September & October in excess
of 15.4% YoY
•
Most of this inflation is being contributed by food, fuel and transportation
groups after floods.
•
The resurgence in inflation is attributable to a number of factors.
•
Reform measures (to dismantle past distortion/suppression of energy and oil
prices) whose impact is being felt in the short-term.

Reduction in energy related subsidies.

Automatic pass through of increase in international prices of oil in electricity
tariffs.
12
Recent experiences with monetary management:
Inflation
Average Consumer Price Inflation
Oct-10
Overall
Food, Beverages and Tobacco
Apparel Textile & Footwear
House Rent
Fuel and Lighting
Household Furniture and Equipment
Transport & Communication
Recreation and Entertainment
Education
Cleaning, Lauundry & Personal
Appearance
Medicare
Core inflation
Non-Food Non-energy
Trimmed Mean
Source: Federal Bureau of Statistics
Jun-09
Jun-10
12-month
average
YoY
20.8
23.7
14.2
17.1
25.5
11.7
12.5
6.3
13.8
14.1
13.1
15.1
7.8
10.8
16.7
15.3
20.1
10.8
7.1
21.1
13.1
6.4
6.8
9.4
23.8
11.3
17.3
6.0
5.9
12.4
13.8
9.8
9.9
18.5
14.5
6.3
18.0
10.6
10.2
10.5
11.4
6.6
8.5
10.5
17.6
19.2
11.0
11.6
10.1
11.9
9.3
12.8
13
Recent experiences with monetary management: Inflation
Multiple Shocks/Factors
•
•
External-Increase in international commodity prices such as those of
edible oil, wheat, rice, corn, etc.
•
Domestic
•
Food inflation (Prices of perishables increased by 48 percent during
Aug-Sep,10 and have declined by only 6.7 percentage points in
October) after floods (supply chain issues)
•
Crop Losses
•
Damage to communication infrastructure
•
Increase in transportation costs.
•
Hoarding and cartelization
•
Impact of expansionary fiscal operations to finance relief expenditures.
•
Government borrowings from SBP (Rs 184 billion since 1st July) owing
to security & flood related expenditures and delayed receipt of external
assistance and re-imbursements.
To contain inflationary pressures SBP has raised the policy rate twice
since the beginning of FY11 (in July and September 2010), by 50 bps14
each.
Recent Policy and Administrative Monetary Policy
•
Establishment of a Monetary Policy Committee (MPC).
- A 9 member MPC chaired by Governor SBP with two external academic experts.
-
Minutes of MPC meetings along with votes of members (without names) on
monetary policy decisions posted on SBP’s website, increasing transparency of
monetary policy formulation process and SBP’s credibility.
•
Frequency of Monetary Policy reviews and decisions has been increased.
- Instead of twice a year SBP now announces its monetary policy decisions six
times a year.
- This has reduced uncertainty and increased SBP’s ability to influence market
expectations and respond to changing economic conditions in a timely manner.
15
30.0
25.0
Jul-91
May-92
Mar-93
Jan-94
Nov-94
Sep-95
Jul-96
May-97
Mar-98
Jan-99
Nov-99
Sep-00
Jul-01
May-02
Mar-03
Jan-04
Nov-04
Sep-05
Jul-06
May-07
Mar-08
Jan-09
Nov-09
Sep-10
Policy Rate vs. Inflation in Pakistan
Inflation (YoY)
Discount rate
20.0
15.0
10.0
5.0
0.0
16
B. Fiscal Policy
Fiscal Policy
•
Definition
• Fiscal policy is considered as a tool to control and adjust the
human behavior which can be affected by incentives and
disincentives provided by changes in government revenues and
expenditure.
Objectives of Fiscal Policy
•
Achievement of Full Employment
•
Economic stability
•
Resource Allocation
•
Mobilization of Resources
•
Equitable Distribution of Income
Other Objectives
•
To increase exports and control unnecessary imports
•
To minimize dependence on foreign aid and achieve self-sufficiency
•
To provide inducement for saving and channel those savings into
investment
•
To increase per capita investment
Tools of Fiscal Policy
Total of fiscal policy
Government Taxes
Tax Revenue
Government Expenditure
Non-Tax Revenue
Direct Taxes
Income and corporate
taxes
Wealth tax, property tax
Indirect Taxes
Excise Duty, sales Tax,
Taxes on
international trade
,Surcharges
Interest and dividends
trading profits.
come from prost offices,
receipts
from civil admin others
Current Expenditure
Defense ,debt servicing,
Govt subsidies ,
general admin, economic
and
community services
Development (or Capital)
Expenditure
Irrigation ,transport
Communication,
Industrial and agricultural
development,
railways, social welfare
Fiscal Policy in Pakistan
•
Fiscal policy relates to the government’s resource mobilization, collection
and expenditure. The government requires funds to finance public
investment and social development schemes and day to day running of the
government machinery.
•
Taxes are levied on incomes, profits, goods and services, which enable the
government to carry out their services. Fiscal policy also provides
stabilization mechanism, which may be used to control and direct key
economic variables such as inflation and unemployment.
Taxation system
•
Taxes have a far-reaching effect on the economy. They influence savings
and investment decisions in both private and public sectors. There are three
major groups of taxes responsible for much of the revenue collected in
Pakistan:
– Income tax
– Sales and excise tax
– Taxes on foreign trade
SOME SALIENT FEATURES OF PAKISTAN’S RECENT
TAX SYSTEM
A.
FEDERAL
Income Tax
• Heavy Reliance (53%) on Withholding/Presumptive Taxes
• Progressive Personal Income Tax (max rate: 20-25%)
• Corporate Income Tax (35% rate)
• Universal Self-Assessment Scheme
• Advance Tax Regime
General Sales Tax
• On Goods only
• VAT features
• Zero Rating, also of domestic sales of exporters
• Standard Rate of 17%
• Exemptions to basic food items, agricultural inputs, medicines,
newsprint.
SOME SALIENT FEATURES OF PAKISTAN’S TAX
SYSTEM
Custom Duty
• Cascaded Tariff Structure (max rate: 25%; six slabs)
• Tariff Peaks in Automobiles and other luxury goods
• Share of Dutiable Imports (51%)
Excise Duties
• on few industries like cigarettes, beverages and cement
• on Services in VAT mode
• 1% Excise Duty across-the-board on manufacturing and imports
B. PROVINCIAL
Taxes
• AIT, Land Revenue, Stamp Duty, Motor Vehicle Tax, Property Tax, Excises
• Sales Tax on Services
TAX-TO-GDP RATIO OF PAKISTAN
2000-01 To 2009-10
(% of GDP)
Direct
Taxes
Indirect
Taxes
Surcharge
/Levy*
Total
Taxes
FBR
Revenue
Share of
Direct Taxes
2000-01
2.99
6.89
0.73
10.61
9.42
28.18
2001-02
3.20
6.41
1.23
10.83
9.11
29.54
2002-03
3.17
6.94
1.41
11.53
9.57
27.49
2003-04
2.92
6.84
1.09
10.84
9.25
26.94
2004-05
2.72
7.01
0.41
10.14
9.05
26.82
2005-06
2.82
7.06
0.67
10.54
9.36
26.75
2006-07
3.85
6.41
0.74
11.00
9.76
35.00
2007-08
3.79
6.47
0.34
10.60
9.83
35.75
2008-09
3.46
6.00
0.99
10.44
9.08
33.14
2009-10
3.66
5.83
0.90
10.39
9.05
35.23
Year
* On petroleum products and natural gas
Source: Ministry of Finance, Government of Pakistan.
THE IMBALANCED SECTORAL DISTRIBUTION
OF THE TAX BURDEN
2004-05
(%)
Share in
GDP
Share in Tax
Revenue
Ratio
Agriculture
22.5
1.2
0.053
Industry
23.5
70.4
2.995
Services
54.0
28.4
0.526
Total
100.0
100.0
1.000
Source: Ministry of Finance, Fiscal Policy Statement.
Taxation system of Pakistan
•
Till date the taxation system of Pakistan is criticized on the following
grounds.
– There is wide spread tax evasion
– The proportion of indirect taxes in the total tax revenue is very high.
– The tax system is not elastic i.e. government revenues do not rise
proportionally with rise in incomes.
Taxation system of Pakistan
•
The need for reform in the tax system has been passing in recent years at
government expenditures have increased and budget deficit is rising.
•
Fiscal deficit
• The roots of fiscal deficit date back to the 1970’s.it originated to the
eternally financed development spending in the form of investment
by public enterprises.
RECENT REFORMS (2008-09 ONWARDS)
Carbon Tax
• Introduction of Fixed Levy on Petroleum Products as ‘Carbon Tax’ with large
revenue yield of over Rs 110 billion ($1.3 billion)
Direct Taxes
• Taxation of (Short Term) Capital Gains on Shares
• Extension of the Withholding Tax Net (Bank Cash Withdrawals, Air Travel)
• Introduction of Minimum Tax on Turnover (of 1%)
• Random Ballot for Audit with Outsourcing to private Accounting Firms
• Detection of New Tax Payers through Collateral Evidence
Sales Tax
• Enhancement in Rate from 15% to 17%
Excise Duty
• Introduction of Across-the-Board Special Excise Duty at 1%
PROPOSED REFORMS
Introduction of Comprehensive VAT (or reformed GST)
•
Objective is to broaden tax base and reduce tax rate (17% 15%)
•
Elimination of exemptions on goods, except basic foodstuffs and life-saving
drugs, could generate ¼% of GDP
•
Enhanced coverage of services (excluding education and health) could
increase tax revenues in the medium term by 1½ % of GDP
•
Reduction in tax burden on industry
• Introduction delayed till 1st October 2010 due to

~ issue of collection by provinces of the sales tax on services

~ lobbies (especially the trading community)
PROPOSED REFORMS
Provincial Taxes
Areas of focus:
• Capital Gains Tax on Property
• Urban Immovable Property Tax
• Agricultural Income Tax
•
The target in the on-going IMF Program is to raise the tax-to-GDP ratio by
3½ percentage points by 2012-13.
References
•
Economics Survey of Pakistan (Latest Issues), Economic Advisor’s Wing,
Ministry of Finance, Government of Pakistan
•
www.investopedia.com
•
Zaidi, S. Akbar,(1999),“Issues in Pakistan Economy”, Oxford University
Press.