Pakistan's Finance Minister Resigns Post

Pakistan's finance minister Mr. Shaukat Tarin has resigned. Tarin is an accomplished banker and a protege of former Prime Minister Shaukat Aziz. He became Pakistan's finance minister in October 2008 when the nation's economy was on the brink of collapse. He led the negotiations with the International Monetary Fund for a 23-month, US $7.6 billion bailout package that boosted Pakistan's foreign-exchange reserves and helped avert a sovereign default.

There have been rumors that the ruling PPP politicians, particularly President Zardari and his inner circle, have ignored Tarin's key recommendations to address the acute power shortages in the country. Zardari's insistence on pushing rental power projects, rather than fix the huge circular debt problem in the energy sector first, specially frustrated the outgoing finance chief, when he reportedly threatened to quit last year.

In spite of the obstacles Tarin faced in his job, he has managed to stabilize the economy. International credit rating agencies Moody's and Standard and Poor both raised Pakistan's credit rating and outlook last year as reported by Bloomberg News.

S&P increased its rating on Pakistan’s long-term sovereign debt to B- from CCC+, six levels below investment grade and the same ranking as the Ukraine and Argentina. The outlook was maintained as stable.

“The upgrade reflects Pakistan’s improved external liquidity position, coupled with its successes in implementing corrective policy measures to rectify an unsustainable fiscal trajectory,” S&P said in a statement. “A narrowing current account deficit, helped by buoyant remittance inflows, and successive disbursals of the IMF and other multilateral loans have reduced the risk of near-term external payment difficulties for Pakistan,” S&P added in its statement last year.

Tarin recently said that Pakistan's economy may grow by at least 3.4%--faster than previously estimated--driven by a likely rebound in its manufacturing sector.

"The economy has started showing signs of recovery, but more work is needed on structural reforms," Tarin was reported as saying by the media.

The manufacturing sector, which makes up 25% of GDP, is now forecast to expand 5.5% this fiscal year ending in June, 2010, after having contracted by a similar margin last year, Tarin said. However, federal finances will be strained due to higher military expenditure and subsidies on electricity, he added.

As a result of investor confidence in Mr. Tarin's economic leadership, Pakistan's KSE-100 stock index surged 55% in 2009 in US dollar terms and 65% in rupee terms, in a year that also saw the South Asian nation wracked by increased violence and its state institutions described by various media talking heads as being on the verge of collapse.

Media reports have recently quoted Mr. Tarin as saying the government plans to meet investors in March to raise between $500 million and $1 billion in the last quarter of the current fiscal year, ending on June 30.

Here's the latest IMF assessment of Pakistan's economy on Tarin's watch, as reported by a private news channel Geo TV:

Pakistan’s economic growth has started recovering despite security and energy challenges and the country met almost all targets under the International Monetary Fund program, the global financial institution said Tuesday.

“Pakistan’s program is progressing well,” the Fund said in a statement following “constructive discussions” with Pakistani officials focusing on Pakistan’s recent economic performance, the outlook for the rest of the fiscal year.

Adnan Mazarei, who met with the Pakistani officials in Dubai over the past week to initiate discussions on the fourth review under Pakistan’s Stand-By Arrangement (SBA), noted that Islamabad observed all quantitative performance criteria for end-December 2009, except for the budget deficit target, which was exceeded by a small margin.

Listing positive trends Pakistan registered in recent months, the Fund said the exchange rate has remained stable at Rs. 84–85 per U.S. dollar and the international reserves position has strengthened (the banking system’s gross foreign exchange reserves, including the State Bank and commercial banks, reached US$14.3 billion in mid-February, of this total the State Bank held US$10.5 billion).

The early signs of recovery in some sectors and the improved external position are encouraging, although there are risks and challenges to Pakistan’s economic program.

“Economic growth in Pakistan is starting to recover; large-scale manufacturing output has started to increase, the improvement in the global economy has helped manufacturing exports, and private sector credit growth has picked up somewhat as businesses rebuild their working capital.”

The IMF’s package for Pakistan - approved in November 2008-has been extended to $11.3 billion.

Looking ahead, the IMF statement said, a resumption of higher growth is needed to raise living standards and will require improvements in the business climate to stimulate higher investment by local and foreign investors.

The financial institution also noted that the “resolve of the Pakistani authorities to implement their stabilization and reform program is a key factor in deepening macroeconomic stabilization, despite the risks associated with internal security and uncertainty as to the pace of global economic recovery.”

Emphasizing the need for stepped up donors support for the key anti-terror partner of the international community, the Fund said early disbursement of donor financing remains crucial to support Pakistan’s stabilization and reform efforts and laying the basis for a high and sustainable growth.

The IMF mission staff will prepare a report on the fourth review under Pakistan’s SBA that is scheduled for consideration by the IMF Executive Board in late March.

Pakistan should be able to attract financing from abroad "to the extent that they can demonstrate that there has been progress on these three fronts: growth; stand-alone external liquidity; and quality and size of budgetary revenues," Aninda Mitra, a vice president at Moody's, told the Wall Street Journal.

Mitra said if Pakistan's economic growth could return to a range of around 4%-5% "sooner than later without generating macroeconomic imbalances or inflationary pressure, that will be a pretty notable outcome."

It is also important for Pakistan to be able to enjoy sufficient external liquidity without depending on further contingent support from external official sources and for it to manage long-term budgetary pressures, he said.

Financial markets appeared to take news of Mr. Tarin's departure in stride.

Pakistan's dollar-denominated bonds and the costs of insuring against a default or restructuring of its debt were steady Wednesday. Its five-year credit default swap was last quoted at 1,112 basis points, or hundredths of a percentage point, on the bid side while its bonds were hardly traded. With holders of Pakistan's bonds mostly buy-and-hold investors, and given the small size of outstanding issues, trading volume tends to be relatively low.

Wall Street Journal says Pakistan's fiscal improvement has stalled recently mainly due to unforeseen factors such as the delays in the receipt of pledged aid from friendly countries as well as the conflict in the northwestern part of the country and resulting delay in military reimbursement from the U.S.

"The government has had to issue debt to finance such shortfalls," Mr. Mitra said. "We don't think that these are permanent or deep setbacks for the fiscal situation regardless of the transition" of leadership at the finance ministry, he added.

Media reports indicate front-runners to succeed Tarin include Nasim Beg, CEO of Arif Habib Investments Ltd.; Planning Minister Makhdoom Shahab-ud-Din; and Junior Minister for Economic Affairs Hina Rabbani Khar, who presented the 2009-10 budget in parliament last year.

Although IMF is closely watching Pakistan's economic management for now, I believe it is still very important for the next finance minister to be persuasive, and display sufficient independence from the political leadership in managing the nation's economy as a professional.

Related Links:

US Fears Aid Will Feed Graft in Pakistan

Pakistan Swallows IMF's Bitter Medicine

Shaukat Aziz's Economic Legacy

Pakistan's Energy Crisis

Karachi Tops Mumbai in Stock Performance


Riaz Haq said…
Here is an Op Ed by Shaukat Tarin, Pakistan's fomer finance minister published in Daily Times:

Pakistan’s perennial structural weakness has been its abysmally low – and declining – tax collection. Even Pakistan’s most powerful government of recent times, that of Pervez Musharraf, left in its wake a tax-to-GDP ratio of less than 10 percent after over eight years in unbridled power. This is amongst the lowest tax collection ratios in the world.

Leaving total collection aside, the composition of tax receipts in Pakistan depicts huge inequity. Direct tax collection constitutes less than 3.5 percent of GDP, with wide ranging exemptions to powerful segments of society coupled with governance issues at FBR. The bulk of the tax receipts are collected in the form of sales tax. Far from being progressive, the taxation regime is highly regressive, meaning that the poor and less affluent are taxed more heavily as a proportion of their income than the rich.

The other weak (rather, missing) link in public finances is the lack of fiscal effort by the provinces. With some of the largest segments of economic activity such as agriculture, real estate, and services in the provincial domain with regards to taxation, it is baffling that provincial tax receipts total an abysmal 0.7 percent of GDP.

At the heart of it, these issues are related to governance. This state of affairs is a manifestation of a broader challenge that Pakistan has grappled with virtually since independence – the shifting of the burden of responsibility by a small, self-serving and venal elite to the rest of the population.

The flip side of not collecting taxes, and not being able to manage expenditures, is debt. This was never more evident than in early 2008 when a new government took office after elections. It inherited a tax-to-GDP ratio of less than 10 percent, a fiscal deficit of nearly 8 percent of GDP, and a current account deficit of over $14 billion (a record 8.5 percent of GDP). Despite receiving generous assistance from the international community year after year, as reflected in the country’s total external debt rising from $35 billion to $46 billion between 2005 and 2008 (over and above budgetary grants), the previous administration mind-bogglingly resorted to printing currency to the tune of over Rs 700 billion in two years. This factor was a major contributor to the spiral of inflation that was set in motion from 2007 onwards.

The nexus between not collecting taxes and having to borrow cannot be over-emphasised. To place this in context, consider the following: if Pakistan’s tax to GDP ratio had been increased to a modest 13 percent in 2005 when the global as well as domestic economic conditions were most favourable, and kept stable since, Pakistan’s public debt would have been almost 15 percent of GDP lower (at around 44 percent of GDP, instead of close to 60 percent currently). Put differently, since 2005, the government has cumulatively borrowed over Rs 1,600 billion largely on account of not being able or willing to collect taxes.

The net effect of this state of affairs was high inflation, pressure on FX reserves, a decline in the value of the rupee, and an erosion of market and investor confidence. This was a perfect recipe for tipping the country into a full-blown macroeconomic crisis, which came with full force in 2008. To stabilise the country’s fast depleting reserves, it is not surprising that the government had to resort to borrowing from the IMF in November 2008.

Hence, the primary factors behind the increase in public debt over the past three years include recourse to the IMF, a large adjustment in the value of the rupee after several years of the currency being kept artificially stable, and a large decline in grants and other non-debt creating inflows such as FDI after 2007.

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