The Economic Wizard

As Pakistan faces a difficult economic future, Finance Minister Muhammad Aurangzeb’s leadership will be a crucial factor in determining whether the country can emerge from this crisis stronger or more vulnerable.

Interview: Sohail Chaudhry
Mr. Muhammad Aurangzeb, Pakistan’s Finance Minister, is a figure whose role has become increasingly pivotal as the country navigates the turbulent waters of economic crisis and geopolitical complexity. His ascent to one of the most challenging portfolios in the Pakistani cabinet is a testament to both his expertise and the immense challenges facing the nation’s economy. With a background steeped in finance and banking, Aurangzeb is seen by many as a technocrat capable of implementing the tough reforms needed to stabilize Pakistan’s economy.

However, his tenure is not without significant challenges. Pakistan’s economy is beset by a myriad of issues: soaring inflation, a looming balance of payments crisis, and a heavy debt burden. Aurangzeb has inherited an economy that has been struggling to stay afloat amidst these difficulties, compounded by the effects of global economic slowdown and domestic political instability.

Aurangzeb’s approach to economic management has been pragmatic, focusing on securing vital external support from institutions like the International Monetary Fund (IMF) while simultaneously attempting to shore up domestic revenue. His strategy has been to implement difficult but necessary austerity measures to meet the conditions of international lenders, even as these measures have sparked widespread public discontent.

His balancing act between ensuring economic stability and managing the political fallout from unpopular reforms is a delicate one, and it is a challenge that will likely define his legacy.

Critics argue that Aurangzeb’s policies may be exacerbating economic inequality, with the brunt of austerity being borne by the lower and middle classes. Nonetheless, his supporters contend that these measures are the bitter medicine needed to steer the country away from economic disaster. As Pakistan faces an uncertain economic future,

Mr. Aurangzeb’s leadership will be a crucial factor in determining whether the country can emerge from this crisis stronger or more vulnerable.

The Economic Affairs had the privilege to sit with the worthy Federal Finance Minister who touched every aspect of the economy during conversation. Here are the excerpts of the interview:

Sir, can you please provide an overview of the key economic achievements under your tenure as Finance Minister?

During the last five months, we adopted an optimal combination of policy, structural, and administrative measures, due to which the fiscal year 2024 concluded with several achievements, the most significant being the stabilization of the economy.

The government has completed the SBA program with all targets met. IMF acknowledged that Pakistan’s economic and financial position has improved on the back of prudent policy management. This is evidenced by the moderate recovery in economic activities that resulted in the GDP growth of 2.4% mainly driven by 6.2% growth in the agriculture sector – the highest in the last 19 years. Inflation is on a downward trajectory from 28.3% in July 2023 to 11.1% in July 2024 – due to exchange rate stability, monetary tightening, fiscal consolidation, smooth food supply, and favourable global commodity prices.

The current account recorded the 13-year lowest deficit of $0.7 bn supported by healthy growth in exports and home remittances. Forex reserves have strengthened, increasing by $4.8 billion to reach $14 billion (SBP: $9.4 billion, commercial banks: $4.6 billion) in FY2024, compared to $9.2 billion the previous year. This improvement in reserves has alleviated pressure on the exchange rate, which appreciated by 2.8% in FY2024 (from Rs 286.1/$ in FY2023 to Rs 278.3/$ in FY2024).

Tax revenue collection grew by 30% to Rs.9311, surpassing the assigned target of Rs.9252 bn. The fiscal deficit reduced to 6.8% of GDP and the primary balance turned into a surplus of 0.9% of GDP owing to effective resource mobilization and prudent expenditure management strategy. 

These achievements reflect the government’s commitment to lay a strong foundation for future development and prosperity in Pakistan.

Mr. Finance Minister, what measures have you implemented to stabilize the economy and promote sustainable growth?

Soon after assuming the charge, the government implemented a series of tough policy, structural, and administrative measures aimed at stabilizing the economy and putting it on the path to recovery. In addition to the home-grown revival plan, the government successfully implemented IMF’s SBA program with a focus on fiscal consolidation, gradual withdrawal of import restrictions, market-determined exchange rates, energy, SOEs, and governance reforms. These efforts, characterized by prudent policy management, significantly improved Pakistan’s economic and financial position.

The government’s determined policy efforts have brought progress in restoring economic stability as evidenced by a moderate recovery in GDP growth, a decline in twin deficits, decelerating inflationary pressures, stability in the exchange rate, and improvement in forex reserves. To further strengthen macroeconomic stability and create conditions for stronger, more inclusive, and resilient growth, Pakistan and IMF staff have reached a staff-level agreement on a 37-month Extended Fund Facility Arrangement (EFF) of about US$7 billion. The focus is on strengthening the fiscal and monetary policy and reforms to broaden the tax base, improve SOE’s management, strengthen competitiveness, secure a level playing field for investment, enhance human capital formation, and scale up social protection through increased coverage in the BISP Program.

Similarly, to encourage investment in the country, one major initiative is the establishment of the SIFC. It has been established to enhance Pakistan’s business environment by adopting a cooperative approach, attracting domestic and foreign investments across crucial sectors like Defence, Agriculture, Minerals, IT & Telecom, and Energy. SIFC is improving Pakistan’s business environment by adopting a cooperative approach, attracting investments across crucial sectors.

The government’s determined and prudent policy management has placed Pakistan on a path of sustained economic recovery and financial stability, laying a robust foundation for future growth.

Sir, how have you addressed the issue of inflation, and what results have you seen so far?

The government efforts are being fruitful to bring down inflation in the country. It has come down, from 38% in May 2023 to 11.1% in July 2024, the lowest sinceOctober 2021. This achievement is due to our efforts in fiscal consolidation, prudent monetary policy, stable exchange rates, falling global prices, better domestic production, and administrative measures of the provincial governments.

We’re committed to taking strong action against illegal foreign exchange companies, smuggling, and hoarding in the commodity market. These steps are crucial for keeping our exchange rate stable, maintaining market confidence, and ensuring that commodities are readily available.

To help the poor segment of society, we’ve allocated Rs. 65 billion to the Utility Stores Corporation for FY2025. Additionally, we’re continuing our fiscal consolidation efforts to bring the fiscal deficit down to 5.9% of GDP in FY2025, from 6.8% in FY2024. This will reduce our need for borrowing and help to keep inflation in check by avoiding monetary expansion.

Sir, Can you elaborate on the positive macroeconomic indicators observed during your term and their significance?

Our timely and effective measures to implement tough economic decisions paid off in terms of improved macroeconomic indicators.

The recently concluded fiscal year 2024 witnessed theeconomic growth of 2.4% on the back of 6.2% in agriculture and 1.2% both in industrial and service sectors. The growth in the agriculture sector is the highest since FY2005. It has not only ensured food security but also brought down food and overall inflation. The inflation which increased to 38% in May 2023 has nose-dived to 11.1% in July 2024. Similarly, food inflation decreased to 3.4% in July 2024 from the peak of 48.1% in May 2023.

On the external front, the current account deficitnarrowed down by 79.2% to $0.7 billion compared to $3.3 billion in FY2023 due to improvement in exports and workers’ remittances. It has eased out the external sector pressure, stabilized the foreign exchange reserves and exchange rate. Resultantly, investors’ confidence has improved.

During FY2024, the primary balance posted a surplus of Rs 953 billion (0.9% of GDP)-after a gap of 20 years. Similarly, the fiscal deficit declined to 6.8% of GDP compared to 7.8% of GDP in FY2023. It has ensured the fiscal sector’s sustainability and stability. Additionally, the public debt to GDP ratio also came down significantly to 67.2 in FY2024 from 74.8% in Fy2023.

Sir, what are your priorities and plans to ensure sustainable economic growth and stability?

Pakistan’s economy is projected to grow at 3.6%, and average inflation to decline further to 12% in FY2025. To achieve these targets along with strengthening the hard-earned gains in FY2024, the government is making concerted efforts. Recently, IMF and Pakistan have reached a staff-level agreement on a 37-month Extended Fund Facility (EFF) program of about US$7 billion.

The government is committed to making this the last program of the country. Budget 2024-25 lays the foundation for a home-grown reform plan to put the economy on a higher, inclusive and sustained growth trajectory ultimately achieving self-reliance. Key reformsinclude a broad-based fair taxation system, privatization, SOEs & energy sector reforms, private sector development, moving from government-led to a market economy, and a targeted social protection system.

The government is enacting necessary structural reforms to bridge the fundamental revenue-expenditure gap. Weprioritize effective domestic resource mobilization through extensive tax measures and administrative improvements as a central component of its economic agenda. On the expenditure side, the government is adhering to prudent consolidation practices such as right-sizing of the government, pension reforms, devolved subjects to be funded by the provinces, etc. We are fully committed to promoting free market principles, demonstrated by the phased approach to privatizing SOEs.

Undoubtedly, Pakistan is contending with myriad of challenges on both external and internal fronts. The government acknowledges these obstacles and understands the necessity of pursuing a trajectory of higher, inclusive, and sustainable growth to fortify the nation against any external or internal shocks.

What specific reforms have been introduced in the Federal Board of Revenue (FBR) to improve efficiency, broadening of tax base and enhancing revenue collection? What challenges have you faced in implementing these economic reforms, and how have you overcome them?

The Federal Board of Revenue (FBR) is Pakistan’s key revenue collection agency, responsible for tax administration and policy implementation. As the country’s economic landscape evolves, FBR is actively reforming its systems to align with global technological advancements and enhance its efficiency.

Key Initiatives and Reforms: FBR has introduced several measures to broaden the tax base and increase revenue. These include imposing additional income slabs and super tax rates, collecting a 0.6% advance adjustable tax on cash withdrawals exceeding Rs. 50,000 from non-active taxpayer list (ATL) persons, and increasing withholding tax rates on certain transactions. FBR has also imposed a tax on the issuance of bonus shares and raised withholding tax rates on payments made through debit/credit cards to non-residents.

The agency is targeting affluent individuals employing foreign domestic workers, with a Rs. 200,000 advance tax on employers or sponsors of such workers. FBR has also introduced a windfall profit tax on exceptional profits, following international practices, with rates of up to 50%.

In the Information Technology (IT) and IT-enabled Services (ITeS) sector, FBR has implemented several amendments to simplify and enhance business operations. These include automating the issuance of tax exemption certificates, continuing a concessionary fixed tax rate of 0.25% for exporters of IT & ITeS, and proposing to relax the sales tax return filing requirement for these exporters.

Regional Exemptions and Foreign Investment: Following the 25th Amendment to the Constitution, FBR has extended tax exemptions for residents of former Federally Administered Tribal Areas (FATA) and Provincially Administered Tribal Areas (PATA) until June 2024. To attract foreign investment, the Foreign Investment (Promotions and Protection) Act, 2022, offers exemptions and concessions across various tax regimes.

Customs Reforms: FBR has reorganized the Directorate General of Reforms and Automation-Customs and the Directorate-General of Customs Risk Management (DGCRM) to improve trade functions and service delivery. New dry ports and customs stations have been notified to address congestion and reduce clearance times. To mitigate the shortage of petroleum products, a scheme for the import, domestic sale, and re-export of petroleum products has been introduced under customs bonded facilities.

The Export Facilitation Scheme (EFS) has also been expanded, with over 1,500 exporters currently benefiting from it. FBR has broadened the definition of Permanent Establishment (PE) in Pakistan to align with global best practices, ensuring broader tax compliance for non-resident entities operating in the country.

Digitalization and Automation: FBR has made significant strides in digital transformation under the Improved Resource Mobilization and Utilization Reform Program (DRM) funded by the Asian Development Bank (ADB). Key achievements include conducting an independent third-party survey to monitor taxpayer perceptions, implementing a Synchronized Withholding Administration and Payment System (SWAPS), and rolling out IRIS 2.0 for improved cybersecurity.

The agency has also introduced a model tax treaty policy framework and a manual for exchange of information on request (EOIR) to enhance international tax transparency. Under the Pakistan Raises Revenue Project (PRRP) funded by the World Bank, FBR has piloted a Single Portal and Single Sales Tax Return with Provincial Revenue Administrations for the Telecom Sector.

Challenges and Areas for Improvement: Despite these efforts, Pakistan’s tax-to-GDP ratio has remained stagnant around 10% over the past 25 years, with taxes primarily collected at the federal level and a heavy reliance on indirect taxes. Key challenges include a significant undocumented economy, split taxing rights between federal and provincial governments, and frequent ad-hoc policy changes that disrupt stability and predictability in the tax system.

FBR also faces issues with automation, particularly in terms of user-friendliness, system integration, and data analytics. The agency relies heavily on other government agencies that operate manually or with substandard digital data, hindering effective data sharing and integration.

The shortage of skilled human resources is another major challenge, with FBR struggling to manage new systems and processes. Despite having a dedicated IT company (PRAL), the agency lacks sufficient trained personnel, preventing it from fully realizing its potential.

Resistance from taxpayers, limited IT infrastructure, challenges in data analysis, and public skepticism further complicate FBR’s efforts to implement reforms. To address these issues, FBR is focusing on digitalizing all business processes, separating tax policy and administration functions, and deploying an integrated Machine Learning-based Compliance Risk Management System.

Future Objectives: FBR aims to fully digitalize its processes in line with international best practices and document the entire supply chain through digital tools. The agency plans to separate tax policy and administration functions, making policy formulation independent of revenue targets and considering its long-term economic impacts.

The implementation of a Compliance Risk Management (CRM) system will help prevent under-reporting, misreporting, and non-reporting by analyzing data and identifying patterns of non-compliance. FBR also plans to improve user experience and simplify taxpayer-facing services to encourage voluntary compliance.

FBR will continue to reengineer its business processes to adapt to changing economic conditions and technological advancements. The agency will enhance the skill set of its foreign-qualified officers and revamp its communication and branding strategy to better inform and educate taxpayers.

While FBR has made significant progress in modernizing its systems and processes, several challenges remain. Addressing these challenges will require a continued focus on digitalization, human resource development, and stakeholder engagement to ensure sustainable revenue growth and effective tax administration in Pakistan.

Mr. Finance Minister, what is the progress of digitalization of FBR and its impact on the efforts to broaden the tax net and documentation of the economy?

At present, FBR’s Digital Initiatives Wing is working on for main digital initiatives:

FBR Point of Sale, Track and Trace System, SWAPS (Synchronized Withholding Administration and Payment System), and FBR Digital Invoicing. All of these initiatives aim for end-to-end supply chain integration from the manufacturer to the retailer. Currently, more than 10,000 Tier-1 retailers have been integrated with FBR’s Point of Sale System, enabling FBR to capture 600 million Business to Consumer invoices.

Consumer participation has also enabled FBR to identify new taxpayers liable to be integrated with FBR Point of Sale System. Moreover, from 1st of July 2024, FBR has expanded the implementation of FBR POS to 14 sectors which include Restaurants, Hotels, Inter-city travel by road, courier services, all medical service providers, pathological laboratories, private schools and hospitals and others.

FBR has also implemented the Track and Trace System in the tobacco, sugar, fertilizer, and cement industries, allowing FBR to capture production data in real-time and control tax evasion and illicit trade, especially in the tobacco sector. Day to day operational issues that come up are being resolved on priority.

FBR is also working on real-time payments of withholding taxes through a system called SWAPS, which is currently under development. The pilot phase will be conducted with three commercial banks. SWAPS aims to ensure simultaneous tax payments to FBR and vendors, real-time withholding rate updates, reduced withholding audits, and auto-population of Income Tax Returns of the withholdee.

Last but not least, FBR through S.R.O 28 of Sales Tax, has recently made it mandatory for buyers and sellers in the FMCG sector to issue digital invoices through FBR Digital Invoicing System. This will enable FBR to achieve end-to-end supply chain integration in the FMCG sector and identify new taxpayers who previously remained anonymous in the supply chain.

Sir, You have promised to make this the country’s last IMF Programme. Please tell us the concrete steps your government has taken to make that a reality?

Pakistan successfully completed the Stand By Arrangement (SBA) with disbursement of about USD 3 billion in FY 2023-24, which resulted in stabilization of our economy as indicated by the improvement in the macroeconomic indicators. IMF has itself projected Pakistan’s GDP to grow at 2% in FY 2024-25 and 3.5% in FY 25-26.

In order to capitalize on the gains of the reform agenda initiated under the SBA and to put the economy on a path of sustainable growth, the Government of Pakistan expressed its intention to the IMF for a home grown, medium term Fund supported program  The IMF mission visited Pakistan in mid-May to discuss Pakistan’s plans for a home-grown economic program that can be supported under the IMF’s Extended Fund Facility (EFF).

Building on the economic stabilization achieved through the successful completion of the 2023 Stand-by Arrangement, the IMF and the Pakistani authorities held comprehensive virtual discussions on the reform agenda for the new program which culminated in reaching Staff Level Agreement on the 12th of July 2024 for a 37 month long, 7 billion dollar programme. The agreement is subject to approval by IMF Executive Board.

This is a home-growth IMF programme therefore the Government is fully committed to completing the reforms even thought it would entail tough decisions.

The Government intends to address its Achilles heel of low tax collection by holistically expanding tax base, removing exemptions and digitizing operations in order to increase its fiscal space for development and social spending. For FY 2024-25, the Government has set a target of increasing its revenues by 1.5% of GDP and by 3% till FY 2026-27.  A primary surplus of 1% of GDP will also be achieved for FY 2024-25. The Government is also taking concrete steps to improve the management and operations of State-Owned Enterprises (SOE), and synergizing the privatization process.

The Federal Government will work in close coordination with the Provinces to rebalance the federal and provincial spending in line with 18th Amendment in sectors such as higher education, health, social protection, and public infrastructure. Provinces have also committed to increase their tax revenues. To this end, the Provinces will institute the necessary legislative measures to align their Agricultural Income Tax regimes with that of the Federal Personal and Corporate Income Tax.

At the Federal level the Government has notified a committee to “right size” the Federal Government, which is manifestation of the Government’s keenness to reduce its own expenditure.

The Government is also committed to restoring energy sector’s viability and minimizing fiscal risks through the timely adjustment of energy tariffs, decisive cost-reducing reforms, and refraining from further unnecessary expansion of generation capacity.

The State Bank of Pakistan (SBP) will continue to maintain a flexible exchange rate and continue improving the functioning of exchange market and the transparency of FX operations.

Pakistan has already completed the prior actions for the proposed programme. Furthermore, Pakistan has also demonstrated its commitment to undertake reform measures through the successful completion of the SBA. Since this programme is a continuation of the SBA, therefore there will be no difficulty in implementing the proposed reforms. The Government is committed to achieving economic stability and translating it into sustainable growth as Pakistan’s economic and financial future is contingent on these reforms.

Can you discuss the process and success of rolling over Chinese Debt and its impact on the country’s financial stability?

China State Administration of Foreign Exchange (SAFE) has deposited USD 4.0 billion with the State Bank of Pakistan (SBP) at an interest rate of 6 month Term SOFR + 1.71513%. The deposit was given in 4 tranches with a tenor of 1 year each. On maturity of each tranche, China SAFE extends the maturity of the deposit by another one year on the request of Government of Pakistan. These deposits help ease pressure on the external account of the country.