Pakistan in 2013 research paper 12/76 6 December 2012
Economic management – the Government’s record
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Economic management – the Government’s recordWith limited tax-raising capacity, significant military and debt-related spending commitments, generally weak fiscal management, and limited access to international capital markets, Pakistan has been almost continuously reliant on official external assistance since independence, both in the form of direct budget support and loans from the IMF, World Bank and Asian Development Bank, to avert fiscal crisis. At times, the PPP-led Government’s management of its international borrowing has been questionable: in a gesture towards self-reliance, it decided during the post 9/11 ‘boom’ to pay down concessional loans from the Asian Development Bank and IMF ahead of schedule, and at the same time issue euro-denominated debt (at much higher interest) to private creditors. With elections looming as part of the country’s transition in early 2008, the then Government of General Pervez Musharraf decided to protect domestic petroleum and food prices from sharp increases on international markets by increasing the public subsidy on these items. The result was a rapidly widening fiscal deficit, and with access to private capital drying-up in the wake of the global financial crisis, the new PPP-led Government was forced to enter into another $7.6bn IMF stand-by arrangement in late 2008, 180 augmented by a further $3.5bn in 2009.181 Unlike previous arrangements, there was little conditionality attached to the loans, except that Pakistan was expected to reduce food and petroleum subsidies, which it duly did, and implement long-delayed tax reforms, which it did not. The failure to make progress on tax policy and administration caused the programme to fall apart in early 2011, meaning the extra $3.5bn was left undisbursed. Pakistan’s tax-raising capacity has long been constrained by a weak and outdated tax administration; a fragmented legislative framework that hinders the co-ordination across regions of nationally-imposed taxes; and a reluctance on the part of governments to relinquish the power of statutory regulatory orders that allow it to selectively favour businesses and individuals by exempting them from tax without reference to parliament. Evasion is extremely widespread (there are fewer income tax payers than in Guatemala, with one twentieth of the population), fuelled by perceptions of corruption and inefficiency in the public sector, and enabled by a chronic lack of knowledge of individuals’ financial affairs by the tax authorities. 
As in other countries, Pakistan’s sales tax has been the cornerstone of recent reform efforts. Implementation of this type of tax can catalyse revenue raising in other areas, relying as it does on modern administrative practices such as self-assessment and auditing, and providing in its collection the information necessary to ‘smoke out’ income tax evaders. However, successive efforts to implement an effective sales tax and successive targets for revenue-raising have failed, and at 12.8%, Pakistan’s revenue-to-GDP ratio in 2011 was lower than at any point since at least 1990. The figure is well below the 18%-20% believed to be required to finance the infrastructure and generate the growth necessary to meet the Millennium Development Goals. The failure of tax reforms has occurred despite substantial outside assistance and pressure. The World Bank provided a $130m loan for Pakistan’s ‘tax transformation project’, but this quickly lost direction and was declared non-performing by the Bank in early 2008. Successive IMF programmes before the failed 2008 arrangement had set targets for increasing domestic revenues that were missed. 
The necessity for tax reform in Pakistan has to some extent been obviated by the substantial aid flows it has received, particularly during periods when donor sentiment has been favourable. For instance, Pakistan’s fiscal situation, and indeed the economy more generally, improved in the 1980s during the struggle against Soviet occupation of Afghanistan, and since the 9/11 terrorist attacks, when the co-operation between government and military have been of particular strategic importance. Conversely, following the end of the Soviet occupation of Afghanistan, and during periods of sanctions (notably following the military coup of General Zia ul-Haq in 1977 and after the testing of nuclear weapons in 1998), Pakistan’s dependence on external funds has been exposed, leading to economic difficulties. At such times, governments have been obliged to seek less concessional forms of assistance; when official assistance was cut off in the late 1990s, Pakistan’s reliance on short-term external borrowing, at very high interest rates, pushed net public debt to 88% of GDP in 2011. Since 9/11, Pakistan has also seen a significant amount of its debt, most of which is owed to governments and multilateral agencies, written-off or restructured, leading to a decline in the debt owed to foreigners from 54% of GDP in 2000 to 28% by 2006.182
According to the assessments of DFID and others, public financial management in Pakistan is weak, and is likely to become weaker still as a result of devolution. A lack of transparency in auditing and budgeting procedures, together with endemic corruption, is a major obstacle to effectively scaling-up aid to Pakistan. Transparency International places Pakistan 134th out of 182 in its corruption perceptions index, while an International Crisis Group report in 2010 described the country’s civil service as “incapable of providing effective governance and basic public services” and urged international donors to “condition aid on measures to institute greater accountability and transparency”. In a recent report, the Independent Commission for Aid Impact recommended that the planned scaling-up of UK aid to Pakistan should “be approached cautiously and with a very active risk management stance”.184 Economic prospects
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