Impact of Covid-19 on Pakistan’s economy and fiscal relief measures – An overview

Pakistan’s government was already struggling with the economic crisis even before covid-19, mainly due to substantial fiscal and current account deficits, overburdening foreign and local debt, and the local currency’s devaluation against the US dollar. The government took certain difficult and unpopular decisions, including reducing public spending, withdrawal of tax exemptions, speeding up the tax broadening measures, and linking the exchange rate with market forces, et centra. These tightening measures adversely impacted unemployment and inflation and reduced the overall economic activity. However, the country’s export sector and overseas Pakistanis felt some support due to local currency devaluation. 

Covid-19 made things more complicated, particularly during the fourth quarter of the last fiscal year ended in June 2020. It, however, started recovering from July 2020 onwards, owing to the government’s stimulus packages and supplementary grants, substantial lowering of base interest rate from 13% (pre-covid-19 level) to 7% currently, cash assistance to support daily wagers and lower-class spending, fiscal relief package for the construction industry, duty drawbacks and refunds to export-oriented sectors, phenomenal increase in inward foreign exchange remittances from overseas Pakistanis, low import bill, the decline in oil prices, etc. Resultantly, the current account deficit, which was persistently whopping before Covid-19, has now converted into surplus for the last five consecutive months. 

The government also successfully managed to control covid-19 cases. The new cases per day declined from 4,000 to 5,000 in April & May to 400 to 600 in August 2020. The decline in covid-19 cases enabled the government to ease lockdown and other restrictions, thereby re-opening an industry that attracted global buyers of textile products. Pakistani exporters started getting an increased number of export orders from the international market. The textile industry’s recovery, coupled with increased construction activity due to the government’s relief package, triggered a recovery in other businesses like the automobile, banking, and agricultural sectors. The large-scale manufacturing accordingly registered growth during the first quarter of this fiscal year (2020-21) 

The State Bank of Pakistan also introduced enhanced credit facilities to support the private sector’s working capital, especially for the payment of salaries and wages to their employees. The State Bank also lowered the base interest rate that supported the businesses and capital market. Owing to lower interest rates and recovery in the manufacturing sector, the KSE 100 index registered an increase of approximately 40%, comparing the levels of September 2020 with the lowest level on the emergence of Covid-19 in March 2020.

Achieving tax collection targets has been an uphill task for the Federal Government, especially for the last two years. As per the Finance Ministry of the Federal Government of Pakistan, the fiscal deficit increased to around 8% of GDP in 2019-20 from about 7% in 2018-19. The government missed the tax collection target by a vast amount that has directly impacted public sector development expenditure and allocation of funds to provincial governments. In the backdrop, it was not easy for the government to offer substantial fiscal relief to the taxpayers in the pandemic. The most it could do is not to impose new taxes. Despite this, the government came up with fiscal relief measures, including a major one for the construction sector to fuel the economy by promoting construction & allied industries. Some significant tax relief measures include:

  1. Relief package for the construction industry:
    • Individuals and single-purpose companies & partnerships were allowed to avail of relief by getting themselves registered from April 17, 2020, to December 31, 2020. The relief was made available for existing and new projects to be completed by September 30, 2022. 
    • These projects were made taxable at reduced fixed rates per covered area of construction or development, to be computed annually over the estimated project life. 
    • Low-cost projects were incentivized by offering a further reduction of tax liability by 90%.
    • Registered builders and developers were declared exempt from making withholding tax from the payment of supplies and services other than payment for steel and cement and payments for services to companies.
    • Shareholders of registered companies eligible for relied upon under this package were declared exempt from tax (15%) on dividend, and the companies were allowed to pay a dividend without withholding tax @ 15%.
    • Eligible builders and developers were allowed to incorporate income as declared income in their books to the extent of 10 times of tax paid under the scheme. In case of actual income is more than ten times of tax payment, the builder has to pay tax at normal rates to include such excess income as declared income in its books.
    • Immunity was granted from the question about the source of income in respect of funds invested in construction or development projects, amount invested in shares of companies or partnerships formed for such projects, the first purchase of newly constructed building of the eligible project, or for purchase of plot for construction of building thereon, etc.
    • Construction of buildings, roads, structures, etc., was given the status of “industrial undertaking” for certain relief, including relief from withholding taxes on import of plant & machinery for this business.
  2. Federal and provincial governments reduced sales tax to zero percent for construction services, services of property dealers and realtors, etc., subject to certain conditions and option to follow normal regime;
  3. Federal and provincial governments reduced sales tax to zero percent on other service sectors affected by Covid-19 ranging from the business of personal care, hotels, healthcare, recreation, HR and personal development services, travel agents and tour operators, car and automobile dealers, services through digital platforms including IT-enabled and IT-based industry, software development businesses, etc.
  4. Covid-19 related medical equipment and medical devices were declared exempt from sales tax and withholding tax at the import stage;
  5. Donations to Prime Minister’s “Covid-19 Pandemic Relief Fund” was declared as eligible for straight deduction against taxable income;
  6. The provincial governments exempted imports from payment of Infrastructure Development Cess from April to June 2020.

The future outlook seems quite challenging. The second wave of the pandemic is yet to show its effects. The recovery and positive trends seen in the previous quarter are largely attributed to some blessings in disguise that the pandemic brought for Pakistan. These effects may, however, be short-lived. The government seems to be working on the policy framework and institutional reforms that have long been overdue. The government’s institutions and departments, including the Federal Board of Revenue, the tax collection department, are being planned to be reformed and reconfigured with technology’s help. Other challenges for the government include revamping of loss-making state-owned entities, rusted energy sector infrastructure, and managing huge debt financing that has consumed much of the already scarce government’s resources, leaving less for public spending. A coherent effort by the public and private sector has never been more important to formulate innovative solutions to drive the economy to the path of sustainable prosperity.

Islamabad Business Specialist
Shehzad Zuberi

If you have any queries in relation to doing business in Pakistan then feel free to contact our Islamabad Business Specialist Shehzad Zuberi at islamabad@d-b-in.com

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