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Headline: Up against the wall
Source: Euromoney
Date: June 2000
Author: Nick Kochan
Pakistan's new military-backed leaders are about to put the country through austerity none of its democratically elected governments have dared to impose. They are talking tough on default, fraud and the tax take and so far have won the confidence of domestic business. But the first task is to renegotiate with foreign creditors - at government, multilateral and private sector levels. Nick Kochan reports
Delpon de Vaux |
The message of the new men is not in doubt. "We need to get our control back from the multilaterals, we are desperate to be free of their grip," says Altaf Saleem, chairman of the Privatization Commission. "But it may take two or three governments to do so."
Quite how long the people will believe the technocrats and businessmen parachuted into power by the army, and how far this already poor country will go with the tough medicine, are the tests of this latest rescue bid.
For the moment, Pakistan is up against the wall and if it cannot agree a rescheduling of its $38 billion of outstanding debt before the end of this year it will be unable to meet its payments to the international agencies. By 2001, these will stand at $5.5 billion, and since Pakistan has only $1.5 billion in foreign reserves, that is a tall order indeed.
Persuading the IMF that it can trust the errant state with a $2.5 billion poverty reduction and growth facility is a top priority. Passing this IMF test would loosen up other multilateral lenders that will be asked for a three-year to five-year moratorium on interest payments on their outstanding foreign debt. A two-year moratorium on repayments of $3.6 billion in short-term debt to the Paris Club and on Pakistan's commercial debt is also required before the end of the year.
The pressure to do the deal with the multilaterals is now intense and when one banker enquired of the Paris Club where Pakistan could go without one, he was told there was no back-up. "All parties simply have to do a deal."
The shopping list of IMF demands is long and for the most part familiar. Key among them is Pakistan's need to resolve its outstanding dispute with the World Bank over the tariff the country agreed to pay international lenders to its power projects. Draining the poison from this vexatious issue is essential if the new men in Islamabad are to placate the IMF negotiators.
The country's case with the IMF has not been helped by an extraordinary admission from the new finance ministry that the regime of deposed prime minister Nawaz Sharif had fiddled its budget figures for three years to gain IMF favours. The budget deficit for 1997/98 has been revised upwards by 2% to 7.5% of GDP and the deficit for 1998-1999 by 1.4% to 5.9%. The government had to pay a $55 million fine in part restitution.
Reclaiming the parallel sector
Altaf Saleem |
For years the IMF has put pressure on the finance ministry to toughen up its tax collection system, and for years it has been sweet-talked. Now it looks as if the new men in Islamabad want to deliver, and they may have the means, if they can draw on the power of the army to make the difference. The introduction of a general sales tax in the retail trade and an agricultural tax will make many enemies and some of those will go onto the streets and even threaten disorder.
Says Altaf Saleem, chairman of the Privatization Commission: "Tax evasion was rewarded because tax evaders could collude with tax assessors and go scot-free. There were more people drifting outside the tax net." Already the government is facing strikes from shopkeepers protesting about the introduction of a general sales tax on the retail sector. The extent to which these tax evaders will face the army has yet to be seen.
They should ponder the fate of debt defaulters that have fallen foul of the government. Shortly after the new government seized power, it took steps to deal with the massive amount of non-performing debt that had built up in the banking system, and each publicly-controlled bank was required to submit a list of its write-offs, and explain their history. Large numbers of fraudsters, as well as simply incompetent banking officials, were exposed, giving cause for concern that the process might have gone too far, and be shaking business confidence.
According to Mohammah Aftab Mansoor, president and chief executive of Muslim Commercial Bank, the new government's drive to threaten with prison defaulters who are able to pay back their loans but deliberately evading the bank's demands has yielded results, and the bank has concluded some "very aggressive settlements". This has benefited investors, who are able to pick up defaulters' assets at bargain prices as banks sell them off, creating a glut. Prices of textile mills, for example, have dropped by as much as half over the past year, attracting back to the country investors who had formerly sourced material in the Gulf. Observers put the total paid back into the banking system at $250 million.
Few regret the attention paid by the newly enhanced National Accountability Bureau (NAB) to local businessmen like Asif Saigol, the head of the huge Saigol textile empire, who is said to owe the banks Rs3 billion ($57.8 million). He was put in jail, and his uncle, Nasim Saigol, had to sell the family bank, Union Bank, to retain his liberty. The $150 million he received from a group of Saudi investors helped him pay off his creditors. Other businessmen facing the purge are two of the Lakhani brothers, Sultan and Amin, whose companies own Pakistan's McDonald's and Colgate Palmolive franchises, as well as a tobacco company and a newspaper. They were picked up by the NAB in secret raids and clapped in jail.
There have also been raids on Pakistan's smugglers, although the government has given these operators some leeway to pay fines for their misdemeanours, seen by some as evidence of weakness. But a wholesale crackdown on these companies would not merely be divisive but logistically impracticable as Pakistan's borders with Afghanistan, where most operate, are extremely porous. Observers see the government approach as "well thought-out". One described it as "taking the smuggling approach off the main streets and onto the back streets, where the volume is less". Delpon de Vaux, chairman of Lever Brothers Pakistan, says that the new government is the first to bite the bullet. "It's going to require courage and determination as the smugglers have powerful friends. The positive side is that the people chosen to implement the crackdown don't have an obvious self-interest."
Abdul Razak Dawood |
Although the purge should encourage greater respect for the law, and proper practice by the financial community, it is essential that it is performed by competent people who work within sensible limits. "Purges have their value and the black sheep need to be expelled," says one banker, "but life has to go on, and confidence needs to be brought back into the banking system." There is some evidence, however, that the austere forces driving the crusade against illegitimate practice have stepped over the mark and become an economic thought police. Observers put the departure of Shaukat Tarin, the chairman of the publicly owned Habib Bank, and a former Citibank country head, down to the attentions of over-assiduous officials who were irritated by Tarin's ill-advised disclosures about his salary. "He received hassle from people looking for a scapegoat," says one banker. "He didn't have the support of the government," says another. "They wanted their own team in place." It is widely agreed that Tarin was a competent manager of Habib who was driving the bank towards a speedy privatization before his departure. This sale how now been postponed, while Zakir Mahmood, a competent manager from Crédit Agricole, replacing Tarin, gets his feet under the table.
Aberrations of this kind should not be allowed to colour a generally improving relationship between government and the banking system, says Amar Khan, the president of state-owned United Bank. He says that the new team are avoiding repeating the mistakes of predecessors and pressuring the banks to extend loans to politicians' pet schemes that are uneconomic. In the new spirit of proper practice and fear of abuse, bankers are investigating much more carefully requests for finance from individuals who cannot explain the sources of their funds.
Although the immediate purges will inculcate fear, the new administration will have to prove that this is not merely a short-term effect before the country goes back to its old ways, and here business will take some persuading. Says Delpon de Vaux, "Levying a sales tax is one thing, getting it in the pocket is quite another." Restoring a culture of tax-paying and civic responsibility, and dispelling the widespread cynical belief that taxes go straight into bureaucrats' or politicians' pockets presents a particular challenge. "There has to be a change of mind-set."
That is the primary task of the new finance minister. Shaukat Aziz is a former senior Citibank manager who has not merely won the respect of the IMF - indeed some say the whole programme hangs on the relationship - but who has also become an inspiration to the local financial community. One banker says Aziz is "a smooth talker, he has fantastic presentation, although some people say he doesn't push the regime on things that need doing. I am sure he has his strategy". His former Citibank colleague, Zubyr Soomro, described Aziz as "very dynamic, with a lot of energy and a good communicator. He recognizes the problems and understands what needs to be done."
Aziz is inculcating his message through a team of 25 officials, appointed shortly after the new government took power, whose boast is that they are economically competent and politically uncommitted. Aziz did a sweep of private business and the multilateral agencies to find his key colleagues. These now head up the Ministry of Commerce, Privatization Commission, Securities & Exchange Commission and the State Bank of Pakistan among other institutions. De Vaux is impressed: "They are a team of competent and experienced people." But the finance minister is already discovering that taking people out of their private business and bringing them into public service has a cost. Saleem at the privatization commission has said his business can't afford his absence, and he wants to return to private life when his initial 15-month term has expired. "He's not going anywhere," insists Aziz, but dismisses any damage to confidence his departure might wreak.
Aziz will need to promise a vision and defuse excessive expectations for the new regime, says Citibank's Soomro. "The range and depth of the problems are enormous, the issue is not just making progress, but tackling expectations. Most of the policies are well-meaning, but the benefits will take a long time to come through. All previous governments have done short-term fixes, this government is looking at the longer term, but the people are impatient."
The point is confirmed by ABN Amro's Muhammad Aurangzeb, who says: "This government has refrained from stating over-optimistic goals. Although the thrust of the revival package is conservative, the structural reforms are ambitious." The exception to the new government's realistic approach may in fact be in its claims to be able to increase tax revenues. Some bankers argue that targets look unrealistically high, and the government will have to reduce them when the subject is negotiated with the IMF.
The massive amount of outstanding debt built up over the years by profligate politicians is a painful legacy for the new reformers. The debt-to-GDP ratio currently stands at some 70%, and the government is under pressure from the IMF to hack it down. The multilaterals want a ceiling on borrowing from the banking system as well as the deficit made a binding condition on future IMF lending.
An assault on debt servicing costs is now under way. This includes cuts in treasury bill rates paid to borrowers. These now stand at around 10%, down from 16% three years ago. Interest rates on debt raised from non-banks and individuals have also fallen from 16% to 14% for short-term paper. Finally, interest rates paid to investors in the country's massive National Saving Scheme (NSS) - which account for almost half of the total Rs1.5 trillion of domestic debt - have been cut. So far 3% has been lopped off the rates, with more set to come. ABN Amro argues that this remains insufficient. "The government and the IMF must together devise a system to equalize the cost of all domestic borrowing." NSS rates should be linked to a relevant benchmark, says the bank. The overall policy has met with some success and the rate of growth of the cost of debt servicing has fallen, from 23% in 1996 to a forecast 6.3% in 2000.
The balance-of-payments deficit is another economic indicator triggering alarm bells at the IMF. Previous governments had fed the public desire for imported consumer goods to retain popularity, long after the country could afford such luxuries. They funded this expensive habit with aid money in the 1980s and overseas workers' remittances in the 1990s. But when foreign currency deposits were frozen in May 1998 - a defensive measure to prevent capital flight after the nuclear bomb tests - the balance of payments took the hit.
Remittances into the country were put out of the government's reach through unofficial channels, called the Hundi system, though recently the central bank has sought to regain some of the lost ground by announcing it was buying currency on the "kerb" or unofficial market to sweep up some of the loose foreign exchange.
The new regime wants to solve the foreign currency problem by self-sufficiency through a boosted export sector. "We won't get out of our balance of payments difficulties unless we get our exports up," says Abdul Razak Dawood, the new commerce minister. The government is targeting to lift exports from the $8 billion level of each of the past five years to $9.2 billion in 2000. The omens of the first half-year are promising, with exports of $4.1 billion some 7% higher than for the previous period last year. The challenge to the export push will be the exchange rate, which some argue is too strong. A reduction in the rupee's foreign exchange value would satisfy a demand of the IMF, but it would also increase the fiscal deficit, by raising the cost of servicing the foreign debt.
The long-term success of Pakistan's exports depends heavily on the performance of its textiles sector, says Dawood, and he has developed a long-term strategy called Textiles Vision 2005. This embodies a strategy to implement change and new market-driven efficiencies in the run-up to the end of the Multi-fibre Agreement in five years' time. Demands for government support have been a long-term bane of the sector, but Dawood says he is applying a new regime of self-sufficiency so when companies come to him for government backing, he refuses it. "When they got into trouble, they used to run to the government for help. I said no. Then they put appeals in the newspapers for help, the industry will collapse, I said no. Now they know we won't interfere."
Dawood says local industry is presented with many "tough choices" as it is forced to accept the new government's market-driven policy. For example, he says he had to warn a section of the chemical industry that its production was going to decline. "I told them, 'shape up or get out, you have no other choice'. People are going to get mad with the new government, but there is no alternative. You will survive if you are efficient."
Exporters' terms of trade have not been helped by the way rates for the confirmation of letters of credit rocketed from 2% a year to 2% a quarter after the May 1998 shock, when Pakistan conducted a nuclear test in the face of adverse world opinion. Rates have since moved back to 2.5% to 3% a year, but bankers fear that some of that advantage may be lost if there is a poor IMF response to the present government's rescue measures.
A privatization programme is at the hub of the new government's agenda as is a specific privatization law to avoid the endless litigation that has bugged previous government deals.
In addition to reforming the law, the government also wants to use privatization to reform the state businesses, through a managerial approach. This matters more than the opportunity the programme provides to retire state debt, insists Saleem. "We want to privatize to reform, we do not think the business of government is business."
The government plans to launch small stakes in key state companies on the local stock exchange before seeking "strategic investors" for the controlling stake and management. Saleem believes that investors will receive a good deal. "We are not going for optimal pricing, instead there will be a sweetener for the investors." The aim is to inject accountability. Selling small stakes will also give the government a chance to find an appropriate strategic investor. Saleem is concerned the government will not be forced to take the first-comer with immediate funds. Instead he is looking for buyers that also bring management "additionality" to the state company.
State sales scheduled
A three-stage timetable has been introduced for state sales. Businesses thought to be efficient will be sold immediately. Intermediate businesses that would benefit from private-sector efficiency will be sold in the next 20 months. The most inefficient state concerns will have to wait longer for market discipline.
Specific immediate privatization plans include the sale of stakes of around 7% in Habib Bank. The government is seeking advisers for this sale, as the contract awarded formerly to Citibank has expired. A successful launch would be followed by further such sales. At the same time, the government is looking for a strategic buyer for United Bank, a search being undertaken by ANZ Securities, which Saleem says is doing "soft marketing" in the Gulf. It is also seeking a buyer for 49% of the National Bank of Pakistan.
Other companies in the early tranche of privatization include Pakistan State Oil, which Saleem says is an efficient business, and Pakistan Telecom. PakTel chairman Naseem Mirza says the company is one of the more financially aggressive of the privatization candidates. Already companies from Singapore, Malaysia and Egypt are sniffing around it. Although a date has not yet been announced for the privatization, a key marker is 2002, when PakTel's monopoly in the Pakistan market expires.
Businesses destined for the third stage include Pakistan's steel industry, its railway company, and its airline, Pakistan International Airlines.
Investor confidence bears the scars of the past two years of political opprobrium abroad and economic insecurity at home. Government has shown goodwill by removing controls on repatriation of profits, but it has a major sales job persuading the global markets that the country offers long-term stability.
When the military-backed government leaves the stage at the end of its allotted three-year term, it says it would like to have started a process of change that subsequent "political" administrations could not stop, even if they wanted to. "Change is a long process," says Saleem, "it takes five years to change a company, how long will it take to change a country?" *
Shaukat Aziz, finance minister on a mission
Shaukat Aziz |
What is your mission at the finance ministry?
The administration is here because the system that we had previously did not work, and so things deteriorated. Whether it was the system, or whether it was the fault of individuals is debatable. It may have been a combination of both.
The government is staffed by professionals. We have brought in 25 new people from the public and private sectors, the World Bank, the IMF and ADB to look at where we are, and where we're going, in a more professional and businesslike way.
People in the government don't have a political agenda, they want to do the right thing. Once they do what they have to do, then eventually the government will go back to being an elected government. The supreme court has set out a framework for a government in transition. Three years is a good time to get some reforms under way and put some runs on the board. When the next government comes in, some of the basic issues will have been addressed and resolved.
What has the government achieved so far?
The government stabilized the situation concerning cashflows, and made sure that all payments were kept current. In addition we have liberalized the foreign-exchange regime to provide a vote of confidence. We have taken a lot of administrative decisions such as freeing up the remittance of dividends and royalties.
Then we set out to create a road map for the economy. The chief executive specified economic renewal as one of the key factors. Four objectives were established for the economy. They are: self reliance, poverty reduction, building investor confidence, and good governance.
To these ends, we brought together 200 stakeholders from different parts of the economy, from the public and private sectors, from the press and other areas, and we created an economic advisory board as a permanent body. This resulted in the establishment of a structural reform agenda, whose topics comprise: fiscal reform, financial sector reform, privatization, poverty reform, agricultural reform, oil and gas sectoral reform, and institutional reform.
Could you outline your plans for dealing with Pakistan's low tax take?
We want to broaden the tax net, reduce the number of taxes and get every segment of the population to pay their fair share. A large part of the economy is in the parallel sector, and we want to bring them into the net. The general sales tax has been in force in the country for five years and it is now our single largest tax. But we plan to introduce a comprehensive tax survey that will embrace every single shop and every single house in 13 cities. This will be a mammoth undertaking, and we have recruited several thousand people, but the goal is to ensure that people contribute their due share to the national exchequer.
What plans do you have in store for the financial sector?
We are putting professionals into the banks, and we are creating an RTC to take sick assets out of the banking system, in preparation for privatization of the state banks. We are also creating a micro-economic bank to handle our poverty reduction programme, and bring credit to sectors where it is not currently available. As far as regulation goes, our plan is to strengthen the banking supervisory powers of the State Bank to provide an overarching umbrella. We have freed interest rates, and these have already come down by 2%, and they may do so again, but these are market-driven, and not administered rates.
Is privatization a priority of the new government?
We are introducing a privatization law, and the privatization programme will resume shortly with some small sales. We look forward to privatizating some larger units, and subjecting them to the discipline of the Securities & Exchange Commission and the Stock Exchange. Then they will be required to declare financial results and hold board meetings. We are eager that the public should be able to participate in the assets of the country. We are also proscribing that 90% of the proceeds of privatization should go towards debt reduction, while 10% goes towards poverty reduction programmes.
Poverty is a major problem. How you plan to alleviate it?
We believe that through the conduct of sensible economic policies, we will encourage economic growth and that the fruits of this will trickle down to the poorer segments of society so that their lot improves. We will target intervention against poverty through a food support programme, through micro-credit, and through a rural and urban poverty development programme. These will be aimed at creating new jobs at the lowest level and in due course raise living standards. Micro-credit is particularly important because there are many people who do not want the dole, but they want the ability to work and earn an honest wage.
What are the key indicators, and problems?
Debt servicing costs are high - they are over 50% of the budget - and they are an issue. The biggest element in the figure is domestic debt, not foreign debt, as many commentators incorrectly believe.This year, we expect GDP growth to be 4.5%, up from 3.2% last year. This in part reflects the strength of the agricultural crop and the buoyancy of the textile sector. An indication of the strength of the textile sector is the fact that a record $400 million of machinery has been ordered.
Because of a tight monetary policy, we have kept inflation at 4%. This year we expect exports to be 11% higher than last year. Tax collection has also been strong, and is now showing an 18% year-on-year increase.
Could you outline the situation with the IMF?
There is no dispute, we just want to have a programme. The government has been working with the Fund for a long time. We have had discussions in Washington and we presented to the IMF our home-grown package and their reaction was good.The IMF programme is important because once in place it will ensure greater confidence in our economic programme. We also hope to get some money from them, and then we will get other creditors feeling better. We know that the Paris Club, the ADB, the World Bank - all are watching for the start of the IMF programme. It is our hope that IMF money will start flowing in July. We have managed our foreign exchange reasonably well and are current on our payments.
Have you progressed in negotiations over the IPP tariffs?
Of all the highly disputed price tariffs for the independent power projects (IPP), all but two have been negotiated. Hubco is the only remaining issue, but now that we have a tariff benchmark, that too should be resolved. We want to negotiate a commercial deal with National Power and its partners. But whatever we do will have to be in the national interest. The World Bank will be involved because they are guarantors to the project and I think it is recognized by everybody that everybody will have to take a bit of a haircut. The tariff structure is quite rich and we will have to renegotiate it. The government and Hubco want an amicable commercial solution.
Ishrat Husain, State Bank of Pakistan
Ishrat Husain
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What are the biggest challenges to Pakistan's economic managers?
There are three major imbalances in the economy. First, there is the existence of crony capitalism. For a long time a small group of businessmen, landlords, industrialists and civil servants have hijacked the benefits of economic activity and growth. Tax breaks or customs rebates or unpaid loans were provided to these businessmen, creating distortions in resource allocation. This in turn has suppressed economic growth, so the amount of investment that could have given us 6% growth in GDP was giving us only 4%.
Two, the public sector has been living beyond its means. The quarterly fiscal deficit of the public sector has been unsustainably high at 8% to 10% of GDP. This was financed by domestic debt and external borrowing but such fiscal imbalances have produced a very high debt stock, equivalent in scale to our entire GDP. That is one of our heaviest burdens.
Third, foreign exchange earnings have lagged foreign exchange consumption. We continued to import goods freely while our exports were never adequate to finance the imports. This forced us to go to external borrowing.
How can these imbalances be reversed?
Our strategy involves deep-rooted structural changes and institutional reforms. The starting point for an implementation strategy is the reform of our tax structure, which will happen in three ways:
First, we need to expand our tax base, which is very narrow. A broader tax net will bring in professionals, traders and agriculturalists. We also want to reduce the tax rate so people are not penalized for working hard.
Second, we have excessive numbers of taxes, and we want to streamline the system to three taxes at the federal level, three at the provincial level, and three at the local level.
Three, the extensive discretion available to tax collectors has opened up opportunities for malpractice and the government now plans to introduce a system of self-assessment.
Only a random 5% to 10% of cases will be audited, as opposed to the present system where every taxpayer is required to explain his position.If this system succeeds, and the tax-take is increased, the benefits will flow through to our fiscal deficit, reducing our need to borrow.
How will you deal with opposition to the policy?
Economic reforms inevitably result in losers and winners. The losers from our tax policies are people who have never paid any taxes for the past 50 years. They will lose some privileges and income, and they are bound to resist. The government is well aware of their concerns, we are talking to the traders about them, and will incorporate some of them into the reforms. But the bottom line is that this government is not here to win votes but to revamp the economy, and that it will do.
Could you describe your approach to negotiations with the IMF?
We are adopting a different style to our predecessors in respect of our dealings with the multilateral agencies. In the past, the IMF asked us to do a bunch of things and we signed on the dotted line. Then after the first tranche was paid over, we were unable to deliver on our policies, and there was disappointment all round.
The new government has developed its own programme for consideration by the IMF. That will go to the IMF and if it feels that the programme is worthy of its support, then it should come forward. We are quite prepared to discuss performance criteria relating to the size of the fiscal deficit or the money expansion, but at least we will have established the framework for discussion. This process will result in an agreed outcome as to how the economy will evolve over the next three years, and ultimately lay out a benchmark for IMF tranche releases.
That said, there are outstanding conditions that we have to meet in any IMF negotiations. These include the promise to introduce a general sales tax on trade, an agricultural income tax, and a means to resolve the dispute with Hubco. There will have to be some amicable resolution on these issues before the IMF goes to its board to approve a programme [which could start in July].
What incentives can you offer foreign investors?
We have removed all restrictions on remittances of foreign exchange by private foreign investors in the three areas of loans, direct investment or portfolio investment in the stock exchange. In doing this, we are reversing the law passed after the May 1998 nuclear test, which prohibited the removal of money from the country without central bank approval. This move is designed to attract foreign investors, and it has been well received. We are already seeing the return of institutional investors who left the country.
What are your borrowing and funding plans?
For the past year, we have not borrowed. In fact we have we have been a net capital exporter to the World Bank, the IMF and the ADB. We paid them $500 million more than the amount we received, but as no new loans were sanctioned over the year following the May 1998 nuclear test, inflows were close to zero. We paid from our own reserves.
In normal years, we would receive $1 billion of new inflows, and outflows would amount to $500 million, the cost of debt servicing. But even though there were no inflows, we have been able to maintain stable foreign exchange reserves without borrowing. We have paid everyone on time, all our contractual obligations have been met, our imports have been taken care of, the exchange rate has remained within a narrow range, and the differential between the market rate and the inter-bank rate is stable. Without borrowing we have done reasonably well.
But over a longer period, we need to re-establish relationships with the international financial institutions, and that is why we are talking to the IMF. If we can have a programme with the IMF, doors to the World Bank and Asian Development Bank will open.
We don't have many bilateral donors except for Japan, which used to provide $500 million a year. But they are still very keen for Pakistan to sign the Comprehensive Treaty for the Ban of Nuclear Testing and their official loans stopped after May 1998.
If negotiations with the multilaterals stall, how will you manage?
Managing for another year would be quite difficult. Restoring normal relationships with the multilaterals is very important to us. If we implement our economic programme as outlined, in a disciplined and rigorous manner, that will help establish our credibility.
Do you expect the IMF to take a tough line?
I don't think there is any question of them squeezing us. If we are set unrealistic targets that we cannot accomplish, it will look bad for them and bad for us. So we hope we will come together with some realistic, achievable targets for the fiscal deficit.
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