BR Research Newsletter

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BR RESEARCH
BR Research is the research wing of Pakistans premier financial newspaper, the daily Business Recorder.

FBRs opiate: revenue without documentation A message for SBP - bring back the minutes Slight gains in Jul-Aug trade Car sales: the shrinking economy segment

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Wednesday, September 25, 2013| BR Research Newsletter |

BR Research Newsletter

FBRs opiate: revenue without documentation

From international lenders and multilateral agencies to domestic economists and think tanks; all agree that Pakistans abysmal tax-to-GDP ratio has kept a chokehold on the governments ability to discharge its duties. Each year, the countrys tax sleuths make last ditch efforts to meet revenue targets as the fiscal year draws to a close. But their focus has never been on documenting the economy and promoting an equitable taxation system, despite the alarm bells sounded by all and sundry. Even after pledging economic reforms to the public and to the IMF in return of a bailout, status quo persists at FBR and the Ministry of Finance. Whatever little was announced to rein in tax dodgers in the federal budget, has been taken back piece-meal in subsequent weeks. Now the FBR seems to be formulating yet another change in the rules of the game, aimed at boosting revenue collection without breaking a sweat. Heres how: When the Third Schedule was added to the Sales Tax Act of 1990, its purpose was to highlight a list of consumer goods whose producers would print retail prices to be charged to consumers and would submit the total GST as calculated on this price to FBR. While the introduction of this schedule helped boost tax collection, the move was only an easy way, a kind of a short cut around the problem. The FBR was criticised by experts and industry alike as it allowed the unregistered distributors, wholesalers and retailers to stay out of the tax net, given that their would-be contributions in GST were paid by the manufacturers.

Now the FBR has moved to remove many items, including household electronics (air conditioners, refrigerators, deep freezers, televisions, etc), foam or spring mattresses, auto parts and accessories, biscuits and confectionary, among them, from this list. But dont be fooled into assuming that the removal of these items from the Third Schedule will lead to documentation of the erstwhile tax dodging distribution channel players. That possibility has been wiped out by the decision that the responsibility of GST collection will continue to lie with the manufacturers of these products. What purpose then is served by the removal of a host of items from this list? The rate of tax applicable on these items has been raised by two percent points, on top of the one percentage point hike in GST already announced in Finance Bill 2013. Also, now that these items are not featured in the Third Schedule, manufacturers are not mandated to print their respective retail prices. So far no SRO has been issued to inform the public of this change, which was decided upon in a meeting chaired by Finance Minister Ishaq Dar on Saturday. Speculating on the changes in the tax collection, renowned tax expert Adnan Mufti stated that it is possible that the enhanced rate will be applied to the trade price instead of the retail price. Mufti, who also serves as an advisor on GST to the Karachi Chamber of Commerce and Industry, opined that the move represents another step in governments focus on revenue generation instead of documentation. In a recent interview with BR Research, former SBP governor Dr. Ishrat Husain stressed that reliance on indirect taxation breeds inequitable distribution of wealth in society. Adnan Mufti goes further, terming the enhanced GST on packaged items as unjust and discriminatory. Incidentally, the decision to reduce the withholding sales tax rate on purchases from 17 percent to one percent was also taken at the same meeting. Registered businesses had been delivered a shocker earlier when

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BR Research Newsletter
they were mandated to pay 17 percent sales tax on behalf of their unregistered suppliers. The din raised by the affected businesses convinced the FBR and Ministry of Finance to cut that rate down to one percent. That leaves one wondering whether milking consumers through an enhanced rate of 19 percent GST on packaged consumer products will be pulled back too, if only average consumers can also form a powerful lobby with access to the corridors frequented by the babus.

3 | BR Research Newsletter | Wednesday, September 25, 2013

BR Research Newsletter

A message for SBP - bring back the minutes

The Fed had earlier said that QE would be tapered off by the end of this year; a time period which the market read as September, since October may have been politically difficult due to the search for Ben Bernankes successor. In both cases the markets can be blamed for over reading the cues. Market men are quite famous for overreacting and following the herd. But both cases also raise fingers at the respective central banks, for their failure to effectively communicate with the market to provide clarity (See BR Research story Accommodative or not? published on Sep 16, 2013). After the US Fed embarrassed global market pundits by not cutting back the QE, global financial media has brought some interesting critics forward. Why bother with transparency when you can and do change your mind, one fund manager was quoted by the Financial Times. Another Goldman Sachs divisional head was reported to have said that Feds surprise raises the question of whether markets will believe the Fed in the future as much as they have in the past. This comes in the backdrop of scholarly evidence which suggests that clear and effective communication can be an important and powerful part of the central bank. Gone should be days of esoteric communication. A 2008 working paper published by US-based National Bureau of Economic Research (NBER) noted that central banks communication has the ability to move financial markets, to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks' macroeconomic objectives.

Last week the US Federal Reserve pulled an SBP on global markets. Just as the SBP surprised the markets with a rate hike after co-signing a LoI that had suggested an accommodative monetary stance; the US Fed surprised the markets by deciding not to taper off the QE in September.

Recognizing the impact of communication on market stability and volatility, the US Fed initiated the practice of released minutes of decision meetings a habit that the State Bank of Pakistan picked up in 2009 but gave away in 2011.

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BR Research Newsletter
Despite doing away with that practice, the perception of SBPs communication with the market to provide some sort of forward guidance has become better over time. A BR Research poll of treasury bosses at banks and brokerage houses shows that the SBPs communication is currently ranked at an average of 6 on a scale of 1-10, showing an improvement over their perception in 2007. The improvement is largely attributed to detailed monetary policy statements, data compendiums, and higher frequency of policy decisions. By comparison, the communication skills of other central banks, polled by Barclays, have deteriorated. The two polls are not exactly commensurable due to differences in poll size BR Research poll is of fifteen leading players whereas Barclays poll is of 844 players worldwide. But at least one message is very clear from the market: bring back the monetary policy minutes. As for ensuring effective central bank communication, opinions at home and abroad converge on more transparency and forward looking guidance than less; and one reason for this view is that economic uncertainties of today are far greater than five or ten years ago. The only problem is that the variation in communication strategies among central banks across the world implies that a consensus is yet to emerge on what really constitutes an effective and transparent communication strategy. Until then, the central bankers who are not sold on the idea of providing clarity will continue to have a field day of playing with the markets.

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BR Research Newsletter

Slight gains in Jul-Aug trade

Exports of naphtha (hydrocarbon mixtures used mainly as solvents) seem to be rebounding this year, with nearly 200,000 metric tons of the product exported for $167.7 million in Jul-Aug period. In addition, cement, tanned leather, leather garments & footwear, surgical & medical instruments, pharma products, and other chemical products fetched greater export dollars during the period. The countrys imports have increased by just 0.54 percent year-on-year. Except for the machinery and metal groups, fewer dollars were spent on nearly all major importing groups, compared to last year. Major dollar decline was seen in imports of items like iron and steel, power generating machinery, telecom apparatus, motor vehicles, raw cotton, fertilizer, palm oil, and pulses. The August ban on gold imports also kept gold imports muted.

Pakistans foreign trade statistics this fiscal seem to be on the same path as the previous year. According to data released recently by the Pakistan Bureau of Statistics, the countrys trade deficit for the Jul-Aug period had declined by three percent year-on-year. The pattern of small reductions in the trade deficit, on the back of low growth in exports and very marginal rise in imports, is holding out. Still, the shortfall of exports over imports was nearly $3.3 billion in these two months. Export growth remained sluggish, increasing by 3.66 percent to reach $4.09 billion. Encouragingly, nearly all export groups showed growth. The food group exports grew 10.17 percent to reach $682.7 million thanks to both volumetric and dollar value gains in items like non-basmati rice, vegetables, fish, and meat products. The textile group churned up $2.3 billion worth of exports in the Jul-Aug period, which is 7.24 percent more than last year. Quite expectedly, cotton yarn and cotton cloth were the main drivers, though demand for cotton cloth has declined from Chinese buyers. Meanwhile, readymade garments and bed wear segments fetched more dollars in the value-added category, while volumetric growth slumped.
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Petroleum import bill stood at $2.63 billion in the Jul-Aug period. But that is nearly six percent less than the corresponding period last year due to a considerable, 15 percent decline in dollar imports of petroleum products (petrol, oil and lubricants). Meanwhile, crude oil shipments have shown significant increase in both volume and value, thanks to increased domestic refining activity. Going forward, will the trade deficit continue its pattern of small contractions? The answer to that depends on international prices of crude oil and industrial activity within the country. Crude oil prices have lately gone down, thanks to a lull in the Syrian standoff, improving US-Iran relations, and reportedly higher crude output from Libya and Iraq. But recent news reports of governments sweeping winter season gas curtailment/shutdown plan for industrial units, fertiliser manufacturers, captive power producers and transport sector, mean that the trade deficit will likly worsen. Limited or no gas supply will not only hurt export volumes of industries like textiles, but also increase Pakistans reliance on imports of furnace oil for power production and petrol for transportation.

BR Research Newsletter

Car sales: the shrinking economy segment

The chairman of All Pakistan Motor Dealers Association H.M. Shahzad lays blame with local assemblers, stating that the discontinuation of models, lack of innovation and regular hikes in prices of smaller cars despite Yen depreciation reflects their disinterest in the lower-end of the market. Bank financing and leasing options were also major drivers of demand in yesteryears. The lack of these options has dented demand for new cars even for the bottom-of-the-pyramid Suzuki Mehran. The suspension of Suzuki Alto due to a ban on import of engines from India is another reason why the market share of 1000cc cars has sliced to less than half. But profit margins of all three major domestic assemblers have jetted in the past five years, despite lower sales of small cars. According to industry analysts, higher margins on upscale car segments has fattened the bottom line even for Pak Suzuki, which in the past used to derive demand mostly from the lower segment. Over the last five years, higher fuel prices, inflationary pressures, ban on factory-fitted CNG kits, weak economy and poor law and order; have all contributed to the decline in demand for new cars by the middle income segment. But the disparity in demand of cars may just be symptomatic of broader socio-economic realities. Who knows perhaps vehicle ownership is another manifestation of income disparity in this land of irony.

There was a time, not so long ago, when local car assemblers were selling as many as 180,000 cars in a year (FY07). Then when the economy went south in FY08, car sales went with it and their tally has never even come close to those levels since. But while it is true that overall volumes have declined, thats not the whole story. The share of the 1300cc and above segment in total car sales has leapt from 30 to 50 percent, recording 3.4 percent annual growth (on average) in the past five years. On the other hand, the 1000cc economy segment has been the worst performer during this period. Based on these numbers, one may be tempted to assume that the import of used cars has dealt a fatal blow to this segment.
7 | BR Research Newsletter | Wednesday, September 25, 2013