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Assignment 4 Solution
MGT 111
What are risks and challenges the BUDGET 2006 -07 is facing .Write
your own views in point form please.
Risks and challenges: Despite the superb economic performance of the economy,
there are serious impediments and risks to growth momentum in future years. Many
analysts assert that there has been overheating of the economy that has resulted in higher
rate of inflation, asset price bubble and excessive consumerism. Some of these risks are
summarized below:
Rising inflation: A major adverse indicator that has somewhat marred last two years’
performance is the steep rise in the inflation. While the growth may have brought riches
to the few, the overwhelmingly large number of people living below the poverty line and
lower middle income people have been rendered poorer owing to growing inflation that,
even as per the government’s own admission, is estimated to be eight per cent. This rate,
when seen in the perspective of previous year’s inflation rate 9.3 per cent, clearly reflects
continuing escalation in cost of living compared to most other emerging markets.
More specifically, steep rise in sugar, cement, petroleum and house rents have made it
extremely difficult for the common man to make his both ends meet.
Sustainability of agricultural growth: Despite some changes in the contribution profile
of various sectors to GDP in the recent years, the agricultural sector continues to lead the
way by contributing nearly twenty-two percent of total output (GDP). It also contributes
substantially to exports.
Unfortunately, there has not been adequate investment to generate productivity gains
from use of technology and modern agricultural practices and our yield remains low and
dependent mostly on favorable weather. In the absence of major focus and large
investment required, the growth of this sector is likely to remain cyclical.
Foreign direct investment: Although FDI during the year is expected to exceed $3
billion, bulk of it has been generated from sale of large public sector enterprises like
PTCL, KESC and Pakistan Steel.
If we exclude privatization proceeds, the FDI would be reduced to around $1 billion,
which is one of the lowest when compared to over $400 billion foreign direct investment
that has gone to the emerging markets this year. This shows that Pakistan is still to appear
on the radar screen of foreign investors.
A major reason for low FDI despite good economic performance remains the image of
Pakistan abroad, law and order situation and continuing unrest in Balochistan and NWFP.
Unsustainable trade deficit: Unlike most other emerging markets, Pakistan’s growth is
largely generated by increase in consumption that has accelerated its imports to $28
billion in 2005-06, and the increase in exports estimated at $17 billion, which is far too
low when compared to imports. The resulting trade deficit of $11 billion and the
consequential current account deficit of over $5 billion, which have been met partly
through FDI, privatization of major public sector entities and remittances, may not be
sustainable in the foreseeable future.
Also, as the privatization of major public sector entities nears exhaustion in about a
year’s time, not only this source of additional funding will dry-up, there is apparently no
alternative major source of foreign currency inflows to meet the potential increase in
outflows in the form of dividends / returns to the foreign investors from such entities.
Infrastructure and savings rate: Although there has been a major effort to increase the
Public Sector Development Programme to build the infrastructure that is essential to
sustain economic growth on a sustained basis, the actual utilization of the planned
programmes invariably remains low. There is serious shortfall of energy, as is evident
from escalating load shedding, and the investment and time required to add additional
energy may be a major impediment to growth over the next few years.
Also, the rate of savings remains low when compared to the required investment. These
factors pose significant risks and are likely to significantly hinder sustaining economic
growth of around seven per cent over the next 3-4 years.
IT software outsourcing: Compared to the tremendous opportunity in this area, and
unlike our neighboring country India, unfortunately Pakistan has not been able to achieve
even a small share of this global market. Last year, India’s software and services exports
amounted to massive $46 billion for the fiscal year to March 31, 2005, up by 71 per cent
from previous year and it is expected to cross $60 billion in current year.
The expected growth of Indian export of services over the next few years is likely remain
above 30 per cent. As against this, Pakistan’s export of software and other services is so
small that it is not even disclosed separately in the exports.
The lopsidedness of the fiscal policies is also evident from the fact that the export of
goods is virtually exempt from income tax but no such exemption exists for services,
other than some IT enabled services. This is the key area that needs greatest attention of
the government for sustaining future economic growth and balancing our trade and
current accounts.
Budget features and impact: The budget 2006-07 clearly appears to be an election
process with an unusually large public sector development programme of Rs415 billion,
and consequently, includes a higher fiscal deficit target of Rs373 billion or 4.5 per cent of
GDP compared to 4.2 per cent of GDP in the revised estimates for current year.
This is in contrast to the policy of fiscal discipline of the previous years. The proposed
bank financing to meet this deficit is pitched at Rs140 billion.
In contrast to the past, this budget has proposed a number of incentives for weaker
sections of the society that are likely to help in alleviation of poverty, albeit many of
them may turn out to be intentions that are hard to implement. These include: * A number
of incentives to agriculture sector, including exemption on duty on tractors and special
incentives for livestock and dairy industry. * Rozgar (employment) programme that is
planned to be subsidized by the federal government. * Relief to government employees
through dearness allowance of 15 per cent, * Minimum wages increased to Rs4000 *
Reduction in tax rates for salaried employees and individual tax payers, including
increase in basic exemption, applicable on gross salary. * Subsidies to reduce sugar price
and expansion in the number of Utility Stores.
An important feature of this year’s budget and economic survey announcements is,
almost unbelievable results of Pakistan Integrated Household Survey (PIHS), as per
which, it is claimed that the population living below poverty line has declined from 34
per cent in 2001 to around 24 per cent in 2005. Looking at ground realities, the results of
this survey need further corroboration.
Sustaining growth: Several incentives and policies announced in the budget appear to be
pro-poor but may not be adequate. Also, like in the past, implementation of policy
announcements has been far from satisfactory, and there is no reason to expect a major
change, given the same quality and level of administrative machinery.
Furthermore, there seems to be no serious effort for enhancing the competitiveness of the
economy that is critical for sustaining the progress made in recent years mainly owing to
changed external environment. The tax burden is extremely high and substantial relief
required to reduce the cost of doing business has not been given.
The effective income tax rate which approaches 48 per cent (35 per cent income taxes+7
per cent WPPF and WWF+ 5.8 per cent income tax on dividends {(100-35-7)*10 per
cent} acts as a strong disincentive to investment in the formal sector.
With the improvement of revenues, it was expected that over all corporate tax rate would
be lowered by at least five per cent. Further, the rate of indirect tax in the form of sales
tax at 15 per cent, which is a tax on poor and creates inflation, remains very high. It
should be reduced to a maximum of 10 per cent.
Currently, the biggest challenge is whether the textiles will be able to compete in an era
of quota free regime after the expiry of Multi Fiber Agreement last year. The initial
period indicates falling prices as the competition for the textile markets begins to
intensify.
While the exports have shown a growing trend mainly through larger volumes, the
growth of imports has been much bigger. Unfortunately, Pakistan has not made
substantial efforts that were required to enhance its competitiveness in the value- added
products, by lowering the cost of production.
Most of the irritants such as high cost inputs like electricity, business disruptions, and law
and order remain unresolved. While the government policies, including improvement in
governance and policies aimed at achieving macro-economic stability have provided
dividends, much more needs to be done to ensure sustainability of economic growth,
which should be export-led and not import-based.
Nearly 60 per cent of our exports are cotton based and around 75 per cent are based on
five products cotton, leather, rice, synthetic textiles and sports goods. In geographical
terms, our exports are concentrated in few markets including USA, Germany, UK,
U.A.E, Japan, Hong Kong and Saudi Arabia. Only USA takes around 24 per cent of our
exports. Such a situation shows a serious vulnerability of our economy to a catastrophic
event such as cotton crop failure.
The diversification of exports thus should be the primary objective of the government and
the most viable sectors in which we could compete are the export of services such as IT
software and other back office services, business process outsourcing and off shoring.
Why can’t Pakistan emulate India? Without such diversification, and specially focused
strategy on export of services etc. through enhancing the number of qualified and skilled
people in these sectors, it will be extremely difficult, in the long run, to sustain the
successes achieved in recent years.
For this purpose, the primary investment in future will need to be in our human
resources-on education (including higher education), skill development and health.
Looking at the budget and the medium-term macro-economic framework, both the
investment as well as focus on human development is significantly less than what is
essential to achieve and sustain the targeted growth.