| GEO Business|
| Govt urged to rid lavish expenditures|
| Updated at: 1320 PST, Tuesday, June 01, 2010|
NEW YORK: Merrill Lynch, the New York-based global investment bank said the government of Pakistan would have to take stock of its method relating payments of local and foreign loans to strike balance in its economy.
Also, the extravagant government expenses should be done away with to get rid of new borrowings, it was urged.
According to Merrill Lynch, of the Rs703 billion fiscal deficit, approximately Rs521 billion (74% of the total) is to be financed through domestic sources. This includes Rs155 billion through domestic banks. The remaining Rs366 billion is through non-banking sources, which Merrill Lynch sees as the problem.
Merrill Lynch expects the government to remove its exemptions from sales tax and the federal excise duty (FED) once it implements the Value Added Tax Ordinance, 2010. Analysts at JS Global Capital concur with that view.
Analysts at Merrill Lynch’s Pakistani affiliate, KASB Securities, say they also see the imposition of regular corporate income taxes on the export sector as a distinct possibility.
“[It is] a structural benchmark required by the IMF,” said Farah Marwat, analyst at KASB Securities. Ms Marwat, however, did note that a similar measure was withdrawn within one day of being proposed last year owing to stiff opposition from the exporters’ lobby.
The government has been pinning much of its hopes for increasing revenues on levying the value added tax (VAT). Government analysts expect the levy to raise as much as Rs70 billion in additional revenue. But most analysts seem to be skeptical of the achievability of that target.
Merrill Lynch identifies the sourcing of the government’s deficit financing, whether domestic or foreign, as a critical factor in determining the strength of the economic recovery.
“Government borrowing would contribute a major portion of potential monetary expansion of M3,” says Hamza Marath, analyst at KASB Securities, Merrill’s Pakistan affiliate.
M3, which is one of the broadest measures of money supply and is commonly used in Europe, is seen as a leading indicator of inflation. If the government borrows money from the State Bank – a euphemism for printing money – it will artificially increase the supply of money in the economy and increase inflation. Harmful even in the best of times, this would have a crippling effect on the nascent economic recovery.
It would also run counter to the central bank’s stated goal of seeking to reduce inflation.
Higher inflation leads to higher interest rates, which makes the cost of capital too high for many businesses to invest in growth. The central bank has acknowledged this as a problem but seems to lack the courage of its convictions to tell the government to stop monetizing the fiscal deficit.