The State of Domestic Commerce in Pakistan Study 3 - Subsidies and Incentive Regimes

THE STATE OF DOMESTIC COMMERCE IN PAKISTAN

STUDY 3

SUBSIDIES AND INCENTIVE REGIMES

For

The Ministry of Commerce Government of Pakistan

November 2007

By

Innovative Development Strategies (Pvt.) Ltd. House No. 2, Street 44, F-8/1, Islamabad

Table of Contents

List of Abbreviations ............................................................................................................... i Acknowledgments ................................................................................................................ iv Executive Summary ............................................................................................................ 3 Section 1: Introduction .................................................................................................. 6 1.1. Subsidies and Incentive Regimes .............................................................................. 6 1.2. Scoping the Study ..................................................................................................... 7 Section 2: Subsidies for Domestic Commerce ............................................................ 9 2.1 Cross Subsidization in the Energy Sector .................................................................. 9

2.1.1 Cross Subsidization in Electricity and Natural Gas Tariffs .............................. 9 2.1.2 Cross Subsidization in Fuel Pricing .............................................................. 13

2.2 Financial Incentives ................................................................................................. 14 2.3 Policy Package for Developing Storage Facilities .................................................... 15 2.4 Subsidy on Freight Transport .................................................................................. 15

2.4.1 The National Logistics Cell (NLC) ................................................................ 15 2.4.2 Pakistan National Shipping Corporation (PNSC) .......................................... 16

2.5 Incentives in Construction........................................................................................ 17 2.5.1 Khuda Ki Basti and the IHDS ....................................................................... 17 2.5.2 Defense Housing Authorities ........................................................................ 18

Section 3: Agricultural and Trade Subsidies ............................................................. 19 3.1 Agricultural Subsidies .............................................................................................. 19 3.2 Trade Subsidies and Incentives ............................................................................... 20

3.2.1 Export Finance Scheme ............................................................................... 20 3.2.2 Long Term Financing of Export Oriented Projects (LTF-EOP) ..................... 20 3.2.3 Scheme for Locally Manufactured Machinery ............................................... 20 3.2.4 Scheme for pre and post Shipment Under FE25 .......................................... 21 3.2.5 Freight Subsidy Scheme .............................................................................. 21 3.2.6 Skill Development and R&D Support for the Textile Sector .......................... 21 3.2.7 Quality Standards Certification ..................................................................... 21 3.2.8 Financial Incentives ..................................................................................... 22 3.2.9 Support for Participation in Trade Fairs ........................................................ 22 3.2.10 Support for Certification ............................................................................... 22 3.2.11 Support for Establishment of Retail Outlets Abroad ..................................... 22

3.3 Impact on Domestic Commerce............................................................................... 22 Section 4: Conclusions and Recommendations ....................................................... 24 4.1 Policy Recommendations ........................................................................................ 24

List of Tables Table 2.1: Schedule of Electricity Tariffs ....................................................................... 11 Table 2.2: Schedule of Natural Gas Prices ................................................................... 12 Table 2.3: Breakdown of Sale Prices of Petroleum Products ........................................ 13 Table 3.1: Green Box Subsidy Outlays (Million US $) ................................................... 19

Innovative Development Strategies (Pvt) i

List of Abbreviations

ABAD Association of Builders and Developers

ADB Asian Development Bank

ADBI Asian Development Bank Institute

APCA All Pakistan Contractors Association

ATT Afghan Trade Transit

BAF Bank AlFalah

BCI Business Competitiveness Index

BOR Board of Revenue

CAA Civil Aviation Authority

CBM Cubic meter

CBR Central Board of Revenue

CDA Capital Development Authority

CIB Credit information bureau

CMR Contract for the International Carriage of Goods by Road

CPI Corruption Perceptions Index

CPIA Country Policy and Institutional Assessment

DFID Department for International Development

DHA Defense Housing authority

EDF Export Development Fund

EIU Economist Intelligence Unit

EOS Executive Opinion Survey

EPB Export Promotion Bureau

ESCAP Economic and Social Development in Asia and the Pacific

FBS Federal Bureau of Statistics

FCL Full Container Load

FDI Foreign Direct Investment

FIAS Foreign Investment Advisory Service

Ft Foot

FY Fiscal Year

GCI Global Competitiveness Index

GCR Global Competitiveness Report

GD Goods Declaration

GDP Gross Domestic Product

GoP Government of Pakistan

GOR Government Officials Residences

GRT Gross Register Tonnage

GST General Sales Tax

HBFC Housing Building Finance Corporation

HBL Habib Bank Limited

HDR Human Development Report

HFIs Housing Finance Institutions

IFC International Finance Corporation

IFS International Financial Statistics

IMF International Monetary Fund

ISAL Informal Subdivision of Agricultural Land

ISO International Standards Organization

IT Information Technology

ITU International Telecommunications Union

http://en.wikipedia.org/wiki/Gross_Register_Tonnage

Survey Report on Domestic Commerce

Innovative Development Strategies (Pvt) ii

KBCA Karachi Building Control Authority

KDA Karachi Development Authority

KESC Karachi Electric Supply Corporation

KM(s) Kilometer(s)

KPT Karachi Port Trust

KSE Karachi Stock Exchange

LCL Less Than Container Load

LOA Length Overall

MCB Muslim Commercial Bank

MENA Middle East and North Africa

MOC Ministry of Commerce

MOD Ministry of Defense

MTDF Medium Term Development Framework

NBP National Bank of Pakistan

NCS National Conservation Strategy

NER Net Primary School Enrollment Rate

NHA National Highway Authority

NIE Newly industrialized economy

NIT National Institute of Transport

NLC National Logistics Cell

NTN National Tax Number

NTRC National Transportation Research Center

NTTFC National Trade and Transport Facilitation Committee

NWFP North West Frontier Province

PASSCO Pakistan Agricultural Storage and Services Corporation

PEC Pakistan Engineering Council

PHDEB Pakistan Horticulture Development and Export Board

PIAC Pakistan International Airlines Corporation

PIDE Pakistan Institute Of Development Economists

PIHS Pakistan Integrated Household Survey

PKR Pakistani Rupee

PQA Port Qasim Authority

PR Pakistan Railways

PREF Pakistan Real Estate Federation

PSDP Public Sector Development Program

R&D Research and Development

REER Real Effective Exchange Rate

REITs Real Estate Investment Trusts

RICS Royal Institute of Chartered Surveyors

SAI Social Accountability International

SBP State Bank of Pakistan

SKAA Sindh Katchi Abadis Authority

SME Small and Medium Enterprises

SPS Sanitary and Phytosanitary

SRO Statutory Regulation Order

Std Standard

TEP Total Factor Productivity

TEU Twenty-Foot Equivalent Units

TI Transparency International

TOR Terms of Reference


iii

TSDI Transport Sector Development Initiative

TTFP Trade and Transportation Facilitation Program

UK United Kingdom

UNDP United Nations Development Program

US United States

USA United States of America

USC Utility Stores Corporation

USD United States Dollars

WAPDA Water and Power Development Authority

WDI World Development Indicators

WEF World Economic Forum

WGI Worldwide Governance Indicators

WTO World Trade Organization

Innovative Development Strategies (Pvt) iv

Acknowledgment

The IDS team owes a debt of gratitude to the officers of the Ministry of Commerce for their

guidance, assistance and feedback during the course of this study. Our special thanks go out,

in particular, to Syed Asif Ali Shah, Secretary; Mr. Naseem Qureshi and Mr. Ashraf Khan,

Additional Secretaries; Mr. Abrar Hussian, Joint Secretary; Syed Irtiqa Zaidi, Consultant and

Mr. Qaseem Subhani, Section Officer, for sparing their precious time and efforts for the

study.

We feel a deep sense of gratitude for the Minister for Commerce. Mr. Humayun Akhtar

Khan, who took out considerable time from his busy schedule to guide us. It was his sincere

and deep conviction which enabled us to conduct and compile this detailed and

comprehensive study on Domestic Commerce of our country. His apt guidance and keen

analytical oversight were extremely helpful in finalizing the study and formulating the policy

recommendations.

This study has benefited from comments received from the following:

1. State Bank of Pakistan, Karachi.

2. Federal Board of Revenue, Government of Pakistan, Islamabad.

3. Planning and Development Division, Government of Pakistan, Islamabad.

4. Trade Development Authority, Government of Pakistan, Karachi.

5. (Management Consultants) Establishment Division, Government of Pakistan,

Islamabad.

6. Finance Division, Government of Pakistan, Islamabad.

7. Pakistan Institute of Development Economics, Islamabad.

8. NTTFC, Karachi.

9. FPCCI, Karachi.

10. Planning and Development Board, Government of Punjab, Lahore.

11. Planning and Development Board, Government of NWFP, Peshawar.

12. Planning and Development Board, Government of Sindh, Karachi.

13. Planning and Development Board, Government of Balochistan, Quetta.

14. Investment and Commerce Department, Government of Punjab, Lahore.

15. Ministry of Communications, Government of Pakistan, Islamabad.

16. Housing and Works, Government of Pakistan, Islamabad.

17. Ministry of Food, Agriculture and Livestock, Government of Pakistan, Islamabad.

18. Ministry of Water and Power, Government of Pakistan, Islamabad.

19. Ministry of Petroleum, Government of Pakistan, Islamabad.

20. Statistics Division, Government of Pakistan, Islamabad.

21. Ministry of Commerce, Government of Pakistan, Islamabad.

22. Agriculture Department, Government of Punjab, Lahore.

23. Local Government and Rural Development Division, Government of Punjab, Lahore.

24. Statistics Division, Government of Pakistan, Islamabad.

1

SUBSIDIES AND INCENTIVE REGIMES*

by

SAFIYA AFTAB DR. GEORGE BATTESE DR. SOHAIL J. MALIK

* For a detailed analysis of the regulatory environment, please see the accompanying study

“Regulatory Issues in Domestic Commerce”.

Innovative Development Strategies (Pvt) 3

Executive Summary

1. The Agreement on Subsidies and Countervailing measures negotiated as part of the

Uruguay Round of the General Agreement on Tariffs and Trade (GATT) defines a subsidy as

‘a financial contribution by a government or any public body’. According to a study by Peters

and Fisher incentives are of two kinds: tax and non tax incentives1. Tax incentives include

measures such as property tax abatements, tax increment financing, sales tax exemptions and

credits, corporate income tax exemptions and credits for investment or jobs, while non-tax

incentives include business grants, loans, and loan guarantees.

2. The categories of subsidies and incentives analyzed in this report are cross

subsidization in energy pricing, financial incentives and incentives for development of

facilities (storage, warehousing etc.), subsidy on freight transport, incentives in the real estate

sector, agricultural and export subsidies. The objective of this report is to see how these

subsidies and incentive regimes affect domestic commerce and possible policy measures that

can be adopted to promote domestic commercial activity.

Subsidies for Domestic Commerce 3. There are two major forms of cross subsidization in the energy sector, which can

affect domestic commerce. The first is cross subsidization in electricity and natural gas

pricing, with commercial and industrial sectors subsidizing households. The purpose behind

cross subsidization is to make essential infrastructure and services available to all sections of

society. Subsidies in the energy sector can have distorting effects on consumption, leading to

wastages in sectors where costs are kept low, and a decrease of competitiveness in sectors

where energy is priced at higher rates. The second cross subsidization in the energy sector

relates to the cross subsidization in the pricing of fuels, with diesel being priced below

gasoline to facilitate freight transportation. The subsidy on diesel ensures that road freight

transport charges in Pakistan are amongst the lowest in the world. While retailers and

wholesalers on the whole benefit from this strategy (although experience low quality of

service), there are dual effects for the transport sector. On the one hand, possibilities for

expansion of the sector are considerable as the economy grows, but on the other hand, the

sector generates relatively low profits on a per unit basis. There are a number of quasi-

subsidies in the energy sector also, which can impact domestic commerce. These mainly take

the form of domestic crude transport to refineries at subsidized rates (using the National

Logistics Cell (NLC)), and a long term freight contract with the Pakistan National Shipping

Corporation (PNSC) for transportation of imported crude oil, again at subsidized rates – thus

a transport sector subsidy which allows two state owned enterprises to benefit.

4. With regard to financial incentives, Pakistan’s financial sector has witnessed

extensive liberalization since reforms began in 1991, and the system of provision of

subsidized credit for priority sectors has largely been done away with. However, the

commercial sector is at a disadvantage when it comes to formal sector financing options, as

banks have little experience of lending to commercial enterprises, and such enterprises often

cannot meet the collateral requirements of formal sector financial enterprises.

5. To develop storage facilities the government provides subsidized credit for the

establishment of cold storage facilities, and for the cost of obtaining international

certifications such as the ISO certifications. Although the terms of the package being offered

were broadly outlined in the trade policy, the storage owners contacted during the focus

group meetings were unaware of this facility, and the survey data, particularly data on

1 Peters, Alan and Peter Fisher. 2004. The Failures of Economic Development Incentives. Journal of the

American Planning Association, Vol. 70, No. 1., pp 27-37.



financing does not indicate any use of such a facility. Moreover the Ministry of Commerce

itself does not appear to have developed the scheme further or made any attempt to

operationalize it as yet.

6. The government has provided targeted subsidies to certain public sector freight

enterprises by disallowing the entry of private competitors in some fields, such as transport of

crude oil. This policy is meant to control prices of essential commodities, but has resulted in

the creation of near-monopolies in some forms of freight transport.

7. Construction is acknowledged to be a sector with strong backward and forward

linkages, and significant growth in this sector can have a remarkable impact on growth of

incomes. Given the buoyancy of the sector, and the unmet demand in the housing sector, the

government has been keen to introduce incentives in the housing and construction industries.

Since FY2002, the government has progressively introduced financial incentives in the

housing sector, allowing a proportion of the markup on housing loans to be tax deductible,

and introducing measures to encourage housing finance including increasing the maximum

lending limit and the loan period for loans given by the House Building Finance Corporation

(HBFC). Financial incentives, as announced by the government in successive budgets, cannot

have a major impact in a construction market where housing finance is practically unheard of.

However, the clear definition of property rights and transparency in procedures regarding the

sale and transfer of property, as well as the efficient supply of facilities and infrastructure to

housing estates would have a much greater impact in promoting the sector.

Agriculture and Trade Subsidies

8. Pakistan provides support to agriculture through subsidization of research, storage and

marketing, extension services, and infrastructure and flood protection services. Infrastructure

and flood protection services (which include primarily the construction and maintenance of

the irrigation infrastructure) account for the bulk of subsidy payments for the sector, with

only nominal expenditure on research and development, extension and storage and

marketing. Agricultural subsidies in general have little direct impact on these sectors beyond

the residual effects they may have based on their effects on production. The only area of

domestic commerce directly affected by agricultural subsidies is storage, given the federal

government’s support for the Pakistan Agricultural Storage and Services Corporation

(PASSCO), the prime public sector agency responsible for the storage of grains, particularly

wheat.

9. Pakistan cannot provide direct export subsidies as it used to prior to its inclusion in

the WTO regime, but can subsidize the cost of marketing and transportation of exports. The

government employs a range of incentive systems for exporters, mostly in the form of

financial incentives. Trade incentives offered by the SBP take a variety of forms including

concessionary credit for exporting industries and concessionary trade financing. With regard

to trade subsidies, the key impacts on domestic commerce come through the effects of

subsidies on production.

Conclusions and Recommendations

10. Utility and fuel pricing regimes need to be carefully reviewed as part of the ongoing

restructuring of the energy sector. There is a need for some degree of cross-subsidization

keeping in mind equity considerations and the need to supply basic services to low income

households. The commercial sector should not be expected to pay a price for the lack of

efficiency and mismanagement in utility providers.

Subsidies and Incentive Regimes


11. The subsidization of freight prices may benefit the commercial sector in terms of

ensuring cheap transport, but there are environmental costs involved and they hinder the

adoption of fuel efficient technology and better maintenance practices in road transport.

12. The performance of the NLC and the PNSC needs to be reviewed in addition to

PASSCO, to assess the feasibility of allowing the public sector to operate in areas where

private sector capability is increasingly available. While it is true that the role of the NLC

has been substantially reduced in recent years, the PNSC has not been subjected to similar

scrutiny.

13. In the real estate sector, an effort must be made to provide a level playing field to

developers with transparent systems for provision of infrastructure.


Section 1

Introduction

1. Most of the available literature on subsidies in Pakistan deals with export subsidies

and agricultural subsidies, with the more recent studies focusing on the impacts of the gradual

phase-out of subsidies in the last decade. The TORs are not specific about the proposed

scope of the study, and refer in very general terms to a need to make an inventory of all

prevailing subsidies. This is, however, not a useful exercise unless we are clear about the

policy arena that we are operating in. Our first task therefore, is to specify how we define

subsidies and incentives, and than to scope out the proposed study.

1.1. Subsidies and Incentive Regimes

2. A commonly accepted legal definition of a subsidy is that given in the Agreement on

Subsidies and Countervailing Measures negotiated as part of the Uruguay Round of the

General Agreement on Tariffs and Trade (GATT).2 The Agreement (commonly known as

the Subsidies Agreement) defines a subsidy as “a financial contribution by a government or

any public body.” Financial contributions are defined as direct transfers or potential direct

transfers of funds (grants, equity infusions, or government guarantees), non-collection of

government revenue that is otherwise due (for example, tax credits), government provision of

goods and services (other than infrastructure), and government purchases of goods for

provision at below market rates.

3. Incentives are more difficult to define, but a recent paper by Peters and Fisher gives a

workable classification.3 The paper divides incentives into two kinds: tax and non tax

incentives. Tax incentives include measures such as property tax abatements, tax increment

financing, sales tax exemptions and credits, corporate income tax exemptions and credits for

investment or jobs, while non-tax incentives include business grants, loans, and loan

guarantees.

4. The general argument for subsidies and incentives needs careful consideration, and

the case for/against each subsidy or incentive also needs to be very carefully delineated. The

political economy of subsidies/incentives suggests that these are relatively easy to institute

and extend, especially where potential beneficiaries are concentrated and those who are to

bear the cost are larger in number and more scattered. Take the hypothetical case where

government wants to impose a levy of Rs. 1 per person per month on the larger population

and pass this on as a subsidy to X industry of the country, constituting 50 manufacturers of

that good. The additional cost to a family of 8, per month, is only Rs. 8. But the benefit to the

50 manufacturers would be Rs. 150 million (assuming that to be the population) per month,

2 See http://www.wto.org/english/docs_e/legal_e/ursum_e.htm#kAgreement 3 Peters, Alan and Peter Fisher. 2004. The Failures of Economic Development Incentives. Journal of the

American Planning Association, Vol. 70, No. 1., pp 27-37.



or Rs. 3 million per manufacturer per month and Rs. 36 million over a year. The additional

cost to each family or individual is so low that it would be hard for the larger population to

mount a campaign against such a levy4. But for each manufacturer it would make sense to

lobby for a subsidy of this kind. In fact, they would be, individually and collectively, willing

to spend a substantial amount, as side payment, bribes and gifts, to lobby for such a subsidy.

And if such a subsidy is once given, in the limit, the manufacturers should be willing to spend

up to the extent of the subsidy to ensure that the subsidy continues. So once granted, the

subsidy would be hard to remove. Furthermore, the manufacturers can come up with other

explanations, about employment, industrial development, export potential and so on, to

‘justify’ the subsidy as well. One would require rigorous analysis and research to a) thwart

attempts to lobby for such subsidies, and b) decide whether any subsidy should continue or

not. Thus, in general, the political economy of subsidies/incentives would suggest that the

government and people need to be very wary of arguments for subsidies and need to set strict

standards for giving any subsidies, and the onus for making the case should be on the group

lobbying for it. Subsidies and incentive schemes can be an important and sometimes

necessary way of correcting market failures, defraying first mover disadvantages, subsidizing

fixed and sunk costs, and for ensuring certain types of redistributions. But they are market

distorting and they are costly. So, we need to have solid, well researched and well established

reasons for extending any subsidies. Furthermore, there should be time table for phasing out

of the subsidy accompanied with the arguments for extending the subsidy, and the time table

should be strictly adhered to, unless there are good reasons not to. Finally, there should be,

for all subsidies/incentive schemes, frequent and in-depth studies to figure out a) if the

subsidy is indeed serving the purpose for which it was offered, and b) if it is time to phase it

out.

1.2. Scoping the Study

5. Subsidies and incentive regimes take a variety of forms in Pakistan. Given that our

focus in this set of reports is on domestic commerce, the limits of this study have to be

delineated very carefully, to maintain the required focus. A review of available literature on

subsidies as well as on key sectors of domestic commerce suggests that we scope out the

study, so as to relate it to domestic commerce, to include the following categories of

subsidies and incentives:

Cross subsidization in energy pricing

Financial incentives and incentives for development of facilities (storage,

warehousing etc.)

Subsidy on freight transport

Incentives in the real estate sector

6. Each of the above sectors has a strong link with other sectors of domestic commerce

we will be analyzing as part of our compendium of studies. Our objective in this exercise

will be to see how these subsidies and incentive regimes affect domestic commerce, and what

are the policy measures that can be adopted, in terms of possible changes to these subsidies

and incentives, to promote domestic commercial activity.

4 See Mancur Olson’s ‘The Logic of Collective Action’ for detailed arguments regarding why larger more

dispersed groups are at a disadvantage, usually, against smaller, better identified and better knitted groups when it comes to organizing collective action. The main points have to do with a) lower costs of organization in smaller groups, b) higher possibility of avoiding ‘shirking’ and being able to impose punishment on defectors, and c) the higher benefits, of any successful action, per capita, that members of a smaller group are likely to accrue.



7. In addition to the subsidies listed above that have a direct bearing on domestic

commerce, we will also be looking at agricultural and export subsidies to the extent that these

can generate production in key sectors, which will in turn have a bearing on domestic

commerce. The report is structured as follows. Section 2 describes the nature of subsidies

directly affecting domestic commercial activity. Section 3 analyzes agricultural and trade

subsidies and discusses how these affect domestic commerce. Section 4 is the concluding

section which also includes recommendations for the subsidies and incentives regime.


Section 2

Subsidies for Domestic Commerce 2.1 Cross Subsidization in the Energy Sector

8. There are two major forms of cross subsidization in the energy sector, which can

affect domestic commerce. The first is cross subsidization in electricity and natural gas

pricing, with commercial and industrial sectors subsidizing households; the second relates to

the cross subsidization in the pricing of fuels, with diesel being priced below gasoline to

facilitate freight transportation. In addition, there are a number of quasi-subsidies in the

energy sector also, which can impact domestic commerce. These mainly take the form of

domestic crude transport to refineries at subsidized rates (using the National Logistics Cell

(NLC)), and a long term freight contract with the Pakistan National Shipping Corporation

(PNSC) for transportation of imported crude oil, again at subsidized rates – thus a transport

sector subsidy which allows two state owned enterprises to benefit. These different forms of

subsidy are discussed in more detail below.

2.1.1 Cross Subsidization in Electricity and Natural Gas Tariffs

9. Energy pricing policies all over the world seek to achieve a balance between

considerations of financial viability, and the need to extend service, and make basic

infrastructure services available to all sections of the population. In Pakistan, equity

considerations have given rise to a pricing policy wherein energy prices are skewed in favor

of households (and agricultural users), at the expense of industrial and commercial

consumers.

10. Power tariff determination was the sole preserve of the public sector utilities, the

Water and Power Development Authority (WAPDA) and the Karachi Electric Supply

Corporation (KESC) until the late 1990s. The tariff structure was complex, with a relatively

low base tariff, and a number of surcharges.5 There was little or no determination of actual

costs of supply, but tariffs for low voltage consumers (households and agricultural tubewell

users) were estimated to be below cost. After the negative experiences with Independent

Power Producers (IPPs) in the mid 1990s, the government decided to establish a regulatory

authority to oversee the planned unbundling of WAPDA, and to create a level playing field

for private companies envisaged to enter the power generation and distribution sectors. The

National Electric Power Regulatory Authority (NEPRA) was established through an Act in

1997, with the mandate to determine tariffs for the generation, transmission and distribution

of electric power, in addition to powers of licensing etc. Although the structure of the power

tariff has been simplified over the past six years, with higher base rates, and a reduction in the

5 See Haider, Syed Waqar. 2004. Energy Pricing Policy in Pakistan: Existing Prices and a Proposed

Framework. LEAD Pakistan Occasional Paper No. 17.



number of surcharges, the differentiation in tariff rates by consumer category remains.

NEPRA has issued tariff determinations for all the eight distribution companies (DISCOs)

servicing Pakistan, and for KESC. Although there are minor variations across the DISCOs,

the range of rate differentials is fairly narrow, and an examination of average tariffs serves

our purpose.

11. As can be seen from Table 2.1, for residential consumers (or the General Supply

Tariff A-1 category), tariffs are determined at Rs. 2.41 per Kwh for the first 100 units of

consumption. Commercial tariffs, on the other hand, are determined at Rs. 6.80 per Kwh (see

the General Supply Tariff A-2 category). The maximum tariff for residential users is Rs. 6.74

per Kwh which becomes applicable for users who use more than 1000 units of electricity.

Similarly, fixed minimum monthly charges are determined at Rs. 45 per month (for single

phase connections) and Rs. 100 per month (for three phase connections) for households,

whereas the comparable charges for commercial users are Rs. 150 and Rs. 300 respectively –

a three fold increase. Industrial tariffs, though not comparable in the exact sense as the scale

determination is different, nevertheless work out to be higher than residential, but lower than

commercial tariffs.

12. The same structure of cross subsidization is apparent in natural gas pricing also (see

Table 2.2), where rates for domestic consumers start at Rs. 80.98 per million cubic feet

(mmcft), rising to a maximum of Rs. 306.79 per mmcft, while rates for commercial use

average Rs. 271.07 per mmcft. Natural gas prices were historically fixed at rates lower than

fuel oil, particularly for domestic consumers and fertilizer producers, a policy that caused

inter-fuel substitution and increased the use of gas as a fuel both in the domestic and

industrial sectors. However, as concerns about the depletion of domestic gas supplies has

increased, and industrial consumers have had to face shortages and load-shedding in winter

months as supplies are re-directed to domestic use, gas prices have been on the rise,

increasing by almost 66 percent between 2002 and 2006.

13. The argument behind cross subsidization is rooted in the need to make essential

infrastructure and services available to all sections of society, and to set tariffs in accordance

with estimates of “ability of pay” for different income groups. Nevertheless, subsidies can

have distorting effects on consumption, leading to wastages in sectors where costs are kept

low, and a decrease of competitiveness in sectors where energy is priced at higher rates.

While there has been a significant outlay of research on household and industrial energy

demand and its relation with prices, there is no parallel research for the commercial sector, and

little information on how electricity pricing in particular affects wholesale and retail trade, as

well as storage (particularly cold storage).

14. Information from the domestic commerce survey indicates that the mean monthly

expenditure on electricity on retail establishments is Rs. 3662, while the median expenditure is

Rs. 1200. In contrast, the Household Income and Expenditure Survey (HIES) for 2001-02

reports average household expenditure on fuel and lighting as Rs. 529 per month, of which 46

percent is spent on electricity. Even the highest income quintile in the HIES survey,

expenditure on fuel and lighting is just Rs. 730, with 56 percent of this, or Rs. 408 spent on

electricity. For urban areas, average monthly expenditure on fuel and lighting for the highest

income quintile was Rs. 844, and average monthly expenditure on electricity was Rs. 472.

While the HIES is a nationwide survey, and even the highest quintile in the survey may not

represent the middle class urban consumers, there is little doubt that average monthly

expenditure on energy is likely to be significantly higher for commercial enterprises than for

households, for a given level of energy consumption.

15. There are too many questions that need to be answered in this area before we can come

to a more informed decision on whether the current tariff structures and cross subsidization

levels make economic sense or not. It is not clear, so far, if the tariff rates being imposed on any



of the customer categories are optimal or if they are a result of many years of cost plus

thinking. If the latter is the case, NEPRA needs to have an exercise to determine optimal tariffs

and then decide whether WAPDA/KESC should deviate from these tariffs or not. Charging

higher rates to industry and commercial activity, on the margin, does raise their cost of

business. In fact most surveys, including ours, has pointed out that the cost of electricity is one

of the major concerns for people in both manufacturing as well as trade. It constitutes one of the

major input costs for most manufacturing processes. At the same time we know it is cheaper to

supply electricity to larger clients (industry) than physically dispersed domestic users, and it is

easier to collect bills from commercial/industrial clients as well. More importantly, the

government needs to decide if the higher charge to industry and trade is raising their costs to

the extent that it is having a significant distortionary effect on their current business, growth

prospects and future investment plans6. If there is a significant effect of these, the government

needs to decide whether the cross subsidization should continue as it is, or it would be better to

fund WAPDA and KESC losses from domestic consumers through another source. The current

tariff structure might also be diluting WAPDA/KESC incentives for achieving higher levels of

efficiency and delivery of better quality service (both issues have been flagged in our survey),

the subsidy needs to be restructured to ensure such dilution does not occur. Most of the

responsibility for undertaking the research and analysis mentioned above lies with NEPRA.

Currently, NEPRA does not have the experience and expertise needed for such analyses and

significant investments need to be made in human and technical resources at NEPRA before

they will be able to carry out the required work.

Table 2.1: Schedule of Electricity Tariffs

Effective 1-07-2005

Tariff Category/ Fixed/Min Energy F.A.S. Additional Surcharges Total

Particulars Charges Charges Subsidized Surcharge @ 10.4% Avg-Rate

(Rs/KwM) (Rs/Kwh) (Rs/Kwh) (Rs/Kwh) (Rs/Kwh) (Rs/Kwh)

GENERAL SUPPLY TARIFF A-1( including FATA)

Upto 50 Units - 0.61 0.73 0.06 1.40 For Consumption > 50 units upto 1000 units 0.00 0.00 0.00

For First 100 units - 0.41 0.43 1.48 0.09 2.41 For next 200 units - 0.58 0.43 2.19 0.11 2.31

(101-300)

For next 700 units - 1.51 0.43 3.45 0.20 5.59 (301-1000)

Above 1000 units - 1.88 0.31 4.32 0.23 6.74 Minimum Monthly

Charges: a) Single Phase Connections Rs 45/-

b) Three Phase Connection: Rs 100/-

GENERAL SUPPLY TARRIF A-2( including FATA)

For first 100 units - 2.70 0.00 3.82 0.28 6.80 Above 100 Units - 2.94 0.00 3.67 0.31 6.92

For peak load requirement above 20kv

220 1.09 0.12 2.83 0.23 5.27

Minimum Monthly Charges:

a) Single Phase Connections Rs 150/-

b) Three Phase Connection: Rs 300/-

Continued…

6 Many other countries have their tariffs structured the other way. Industry pays lower rates. The argument for

such tariffs is that lower rates for industry encourage competitiveness, industrial activity, expansion and investment. The benefits accruing from such an expansion, in terms of more jobs and national income, would in the long run not only allow people to have higher incomes, they would make further growth possible as well. For achieving the positive outcome, if current domestic consumers have to sacrifice a little, in terms of paying a little more, it would make sense to do that at a national level and even at individual level customers might eventually be better off, due to higher incomes, than if they were currently subsidized at the cost of future industrial growth.



Effective 1-07-2005

Tariff Category/ Fixed/Min Energy F.A.S. Additional Surcharges Total

Particulars Charges Charges Subsidized Surcharge @ 10.4% Avg-Rate

(Rs/KwM) (Rs/Kwh) (Rs/Kwh) (Rs/Kwh) (Rs/Kwh) (Rs/Kwh)

INDUSTRIAL SUPPLY

B-1 upto 40 kw - 1.81 0.13 2.97 0.20 5.11

There shall be minimum monthly charges of Rs 70/Kw for first 20 Kilowatts of load and Rs 90/Kw for rest load between 21 - 40 kw B-2 (>41-500 kw) 300 1.30 0.13 1.99 0.26 4.76

B-2 TOD ( Peak) 300 1.98 0.13 2.22 0.36 6.01 B-2 TOD (Off Peak) 300 1.20 0.13 2.07 0.24 4.57

B-3 (Normal) 11&33 kv not exceeding 5000 kw

290 1.29 0.13 2.01 0.22 4.38

B-3 TOD (Peak) 290 1.97 0.13 2.68 0.28 4.61

B-3 TOD (off Peak) 290 1.15 0.13 1.60 0.19 3.62 B-4 Normal 66/132/220 kv - All

loads 280 1.24 0.13 1.86 0.23 4.29

B-4 TOD (Peak) 280 1.87 0.13 1.69 0.27 4.57

B-4 TOD (off Peak)

280

1.11

0.13

1.49 0.19

3.50

Source: Government of Pakistan. 2006. Economic Survey, 2005-06. Economic Advisors Wing. Finance Division.

Note: 1) The above figures cover some portion of the tariffs schedule. For full details, WAPDA may be consulted.

2) The above tariffs are inlusive of GOP subsidy in FAS and discount in addl. Surcharges

Table 2.2: Schedule of Natural Gas Prices

(Rs/mcft)

Date / Category

20-8-2002

25-10-2002

21-3-2002

20-8-2002

1-7-2003

1-7-2004

2-2-2005

1-7-2005

1-1-2006

DOMESTIC (Slab)

I Upto 3.55 66.86 67.95 67.95 67.95 69.31 73.95 73.95 73.95 80.98

II 3.55 to 7.1 100.73 102.37 102.37 102.37 104.42 111.42 111.42 127.92 147.41

III 7.1 to 10.64 161.16 163.78 163.78 163.78 167.06 178.25 192.96 204.17 235.84

IV 10.64 to 14.20 (MCFT/M) 201.45 213.06 213.06 213.06 217.32 231.88 251.01 265.59 306.79

V All over 14.20 217.85

COMMERCIAL 186.98 190.02 190.02 190.02 193.82 204.88 221.78 234.67 271.07

General 166.18 168.88 168.88 168.88 172.26 182.09 197.11 208.56 240.91

Cement 222.32 222.32 222.32 222.32 209.78 209.78 227.09 240.28 277.55

CNG Station 166.18 168.88 168.88 168.88 172.26 182.09 197.11 208.56 240.91

Pakistan Steel 208.56

Captive Power 208.56 240.91

FERTILIZER

SNGPL'S SYSTEM

(i)For Feed Stock

Pak.Americal Fertilizer Ltd.PAFL 36.77 36.77 36.77 36.77 36.77 36.77 36.77 36.77 36.77

F.F.C Jorden 36.77 36.77 36.77 36.77 36.77 36.77 36.77 36.77 36.77

Dadoud/ Pak Arab 62.57 62.57 62.57 62.57 67.26 73.99 73.99 83.24 83.24

Pak china/ Hazara 66.40 66.40 66.40 66.40 71.38 78.52 78.52 88.34 88.34

(ii)For Fuel Generation 166.18 168.88 168.88 166.88 172.26 182.09 197.11 208.56 240.91

Daood and Pak Arab 168.88 168.88 168.88

FOR MARI GAS CO. SYSTEM

(i)For Feed Stock

FFC Engro Chemical(New) 13.09 13.09 61.68 61.68 66.31 72.94 72.94 82.06 82.06

Continued…



(Rs/mcft)

Date / Category

20-8-2002

25-10-2002

21-3-2002

20-8-2002

1-7-2003

1-7-2004

2-2-2005

1-7-2005

1-1-2006

FFC Engro Chemical(Old) 61.68 61.68 61.68 61.68 66.31 72.94 72.94 82.06 82.06

Pak Saudi 61.68 61.68 61.68 61.68 66.31 72.94 72.94 82.06

(ii)For Fuel Generation(Power) 166.18 166.88 168.88 168.88 172.26 182.09 182.09 208.56

SNGPL & SSGCL'S SYSTEM 166.18 168.88 168.88 168.88 172.26 182.09 197.11 208.56

Liberty Power Ltd. 190.80 190.80 190.80 222.89 235.77 234.33 262.03 303.25 303.25

GAS DIRECTLY SOLD TO

WAPDA'S GUDDU POWER STATION

SUI FIELD (917 BTU) 145.51

KANDHKOT FIELD (866 BTU) 160.54 163.15 163.15 163.15 166.41 175.90 190.41 201.47 232.72

MARI FIELD (754 BTU) 156.14 158.86 158.68 158.68 161.85 171.08 185.19 195.95 226.34

SARA/SURI FIELD 156.14 158.68 158.68 158.68 161.85 171.08 185.19 195.95

Source: Government of Pakistan. 2006. Economic Survey, 2005-06. Economic Advisors Wing. Finance Division.

2.1.2 Cross Subsidization in Fuel Pricing

16. The transportation of finished petroleum products from the refineries to supply

stations all over the country is regulated under the Equalized Prices and Freight Pool system.

As the name suggests, the system ensures that product prices are the same throughout the

country, and prices are determined on a cost plus formula, wherein average freight cost,

government levies, distributor and dealer margins (at 3.5 percent and 4 percent respectively)

and sales tax (at 15 percent) is added to the ex-refinery price to determine the end-product

price. In July 2001, government gave the responsibility for consumer price determination of

petroleum products to the Oil Prices Advisory Committee (OCAC) which revised product

prices fortnightly in accordance with international prices of crude oil, and which determines

the ex-refinery price on the basis of “import parity,” or the landed price of crude oil.7 Since

May 2006, this task has been carried out by the Oil and Gas Regulatory Authority (OGRA).

17. While deregulation has thus taken place to some extent (as import price follows the

trends in the international market), the surcharges and levies on petroleum products give the

government the opportunity to maneuver within the price mechanism and maintain

differential pricing. The government has consistently followed a policy of keeping the prices

of diesel below the prices of different forms of gasoline (as shown in Table 2.3 below). As

the table illustrates, diesel is exempted from export duty, petroleum levy and dealer margins,

and charged significantly less for inland freight and OMC margin, resulting in a sale price

that is almost 50 percent less than the price of motor spirit.

Table 2.3: Breakdown of Sale Prices of Petroleum Products

Price Breakdown as of 1 December 2006

Ex-refinery / IPD

Excise Duty

Petroleum Levy

Inland Freight

OMC Margin

Dealer Margin

Sales Tax

Sale Price

Motor spirit 26.87 0.88 17.79 1.13 1.63 1.87 7.53 57.70

HOBC 27.60 0.88 22.43 1.57 1.84 2.10 8.46 64.88

High Speed Diesel 25.51 0 0 1.85 0.96 0 4.25 32.57

Source: OGRA website

7 See www.ocac.org.pk/ex_refinery5.asp for the detailed pricing formula.

http://www.ocac.org.pk/ex_refinery5.asp



18. The subsidy on diesel is estimated at about Rs. 5 per liter. Given that about 8 million

tonnes of diesel are consumed annually in Pakistan in the road transport sector, the subsidy

on diesel is estimated to cost the government about Rs. 60 billion.8 Fuel costs are estimated

to constitute about 65 percent of freight costs on any given route.9 The substantial subsidy on

diesel thus ensures that road freight transport charges in Pakistan are amongst the lowest in

the world.10

While retailers and wholesalers on the whole benefit from this strategy

(although experience low quality of service), the transport sector itself sees it as a double-

edged sword. On the one hand, possibilities for expansion of the sector are considerable as

the economy grows, but on the other hand, the sector generates relatively low profits on a per

unit basis. The environmental costs, in terms of pollution, are also higher for diesel than

petrol or CNG. But this cost has not been estimated and added to the overall cost of the

subsidization policy. In fact, there seems to be a clash of subsidies here as well. The

government has announced, a number of times, that they would like public transport,

especially intra-city passenger transport, to shift to CNG instead of diesel due to the high

pollution costs, and has even announced some incentives for helping with the conversion. But

if diesel prices are also subsidized, the subsidy on CNG would have to be higher to make the

conversion possible. The diesel subsidy thus needs to be revisited in light of the estimates of

the pollution costs.

2.2 Financial Incentives

19. Pakistan’s financial sector has witnessed extensive liberalization since reforms began

in 1991, and the system of provision of subsidized credit for priority sectors has largely been

done away with. However, the commercial sector is at a disadvantage when it comes to

formal sector financing options, as banks have little experience of lending to commercial

enterprises, and such enterprises often cannot meet the collateral requirements of formal

sector financial enterprises. There is little published data on the banking sector’s lending to

commercial enterprises - the State Bank’s Annual Report gives data for growth in private

sector credit by type of business, and reports a growth of 43.5 percent in credit to Commerce

and Trade in FY200611

, but this is surmised to be primarily growth in trade financing.12

However, there are some tax incentives offered to the commercial sector which are listed as

follows.

20. Withdrawal of Excise Duty on Travel by Train: Excise duty on train travel (on

second and third class coaches) has been withdrawn with effect from June 2006, a measure

which was anticipated to ease the load on road transport13

and provide some benefit to the

lower income commuters and travellers.

21. Zero Rating of Sales Tax on Import and Supply of Trucks and Dumpers: In

another measure announced in June 2006, sales tax on import of heavy vehicles (5 tonnes and

above) and on the inputs used in manufacture of such vehicles was withdrawn to facilitate use

of such equipment, mainly in construction and allied industries.

8 Using a measure of 1.42 kg to a liter. 9 See report on Transport, which is part of the compendium of reports on domestic commerce. 10 See chapter on Transport in the Interim Progress Report for a discussion on this. 11 For a more detailed discussion of the regulatory issues involved in this area, see the chapter on regulatory

issues in domestic commerce. 12 See State Bank of Pakistan. 2006. Annual Report. Table 5.5, pp 99. 13 Though this is not likely to result in a major shift. Railway carries only about 10 percent of the overall inter-

city passenger traffic, and the popular routes are usually over crowded. So even with the incentive, the passenger shift that can be expected can only be small.



22. Sales Tax Exemption on Aircrafts of All Kinds: Such exemptions were earlier in

place for heavy aircraft only, but since June 2006, have been extended to all aircraft to

promote the growth of small cargo carriers14

.

23. Input Tax Adjustment for Wholesalers/Retailers: Wholesalers and retailers

importing in bulk have, since July 2006, been allowed to adjust input taxes against sales tax

under the regular VAT regime. The measure is designed to encourage traders to pay sales tax

at the standard rates.

2.3 Policy Package for Developing Storage Facilities

24. The trade policy for 2006-07 mentions the provision of subsidized credit for the

establishment of cold storage facilities, and for the cost of obtaining international

certifications such as the ISO certifications. In addition, the policy announced that any

company setting up cold storage facilities would be eligible to use the Export Development

Fund (EDF) to meet the first 6 percent of the mark-up of any credit obtained for the purpose.

The key development here was that the facility was extended to all private sector

entrepreneurs opening up cold storage facilities, and not just to those whose goods were

explicitly marked for export. A recent report indicates that the capital expense of setting up a

cold storage is Rs. 16.2 million, and the project would have an estimated financial internal

rate of return (FIRR) of 16.8 percent.15

25. Although the terms of the package were broadly outlined in the trade policy,

implementation has not begun in earnest. The storage owners contacted during the focus

group meetings were unaware of this facility, and the survey data, particularly data on

financing does not indicate any use of such a facility. Moreover the Ministry of Commerce

itself does not appear to have developed the scheme further or made any attempt to

operationalize it as yet16

.

2.4 Subsidy on Freight Transport

26. In addition to the subsidization of freight transport through differential fuel pricing as

mentioned in Section 2.1.2, the government also provides targeted subsidies to certain public

sector freight enterprises by disallowing the entry of private competitors in some fields, such

as transport of crude oil. This policy is meant to control prices of essential commodities, but

has resulted in the creation of near-monopolies in some forms of freight transport as

explained below.

2.4.1 The National Logistics Cell (NLC)

27. The NLC was formed in 1978 as a means of transporting essential commodities

across the country, in an attempt to forestall hoarding. NLC assumed prominence particularly

14 This looks like a classic case of an incentive being given without any real justification for it. Domestic air

transport of cargo is a negligible part of the overall market, and cost structures are such that it is likely to remain so in the future too. Air travel is a very small part of the total inter-city domestic travel as well. But the incentive has still been extended. It seems that this measure was more to facilitate import of smaller planes that some of the richer people in Pakistan had started to buy. But in that case the incentive was not needed. A rich person thinking of importing a plane is unlikely to be affected by sales tax if he/she is deciding whether to buy a plane or not.

15 See Asian Development Bank. 2005. Report and Recommendations of the President to the Board of Directors on a Proposed Loan to the Islamic Republic of Pakistan for the Agribusiness Development Project. Table A.12.1, pg 63.

16 For regulatory issues related to storage, and a justification of such a subsidy, see the chapter on regulatory issues.



after 1979, when it became the primary agency in charge of logistics for relief goods for the

Afghan refugees. The company currently has a fleet of 1700 heavy duty trucks,17

500 units

of earth moving equipment, as well as bowsers for transportation of liquids (mainly crude

oil), and is now involved in construction (and has expanded its services to Afghanistan and

Qatar), toll collection on specified routes, machinery renting, and even cultivation of

mushrooms!18

The company is also expanding into development of port facilities, including

installation of equipment for detection of trade in contraband; and in its last annual report,

mentions moving into real estate development and private equity investment. Of its total

revenue in FY2004, only 43 percent came from transport, while 39 percent was from

construction, 12 percent from its dry ports facilities and the remaining from tolling and other

enterprises.

28. In 2006, the NLC signed MOUs with the Government of Punjab for upgradation of

buildings and other civil works in public sector schools, rural health centers and hospitals and

police posts. The Corporation was given this responsibility because of allegations of rampant

corruption in the award of contracts on the part of district level Departments of Civil Works.

Although it will use the same method of awarding contracts and will probably use the

services of the same contractors used by the district governments, NLC’s superior

management practices are supposed to curb corruption. It is still too early to comment on the

effects of this policy.

29. Although NLC manages less than 5 percent of the freight transport in the country, it

has exclusive rights for road transportation in some areas. It is the only agency allowed to

transport goods by road for Afghan Transit Trade (ATT), as it was the first company in

Pakistan with bonded container facilities. Since 1994, private operators have entered the

field, but the transport of commodities for the ATT remains an NLC preserve. Until the mid

1990s, the company was the sole transporter of domestic crude oil from the field to the

refinery, but crude transport has since been opened up to private operators.19

2.4.2 Pakistan National Shipping Corporation (PNSC)

30. After nationalization of the shipping industry in 1971, the PNSC became the sole

shipping company in Pakistan. Since the early 1990s, there have been attempts to encourage

private sector shipping operations, but these have proved largely unsuccessful. PNSC has a

fleet of 15 vessels (including 4 tankers), and in 2001 was awarded a ten year contract to carry

all crude oil imports into Pakistan. In the same year (2001), the government again made an

attempt to promote private shipping by offering a range of financial incentives for private

shipping, but given PNSC’s monopoly in the transportation of crude oil, and the fact that

private shipping companies had to obtain a “no-objection certificate” from PNSC if applying

to transport government cargo, there was little chance of private operators entering the

shipping business.

17 Recent newspaper reports indicate that the NLC may be allowed to import 300 used trucks duty free. The

government has maintained a tariff on import of used trucks to protect domestic manufacturers, and has not waived this restriction in the face of repeated demands from private transporters.

18 See National Logistics Cell. Annual Report, 2005. 19 The World Bank’s Oil and Gas Sector Review, 2003, contends that NLC is the sole transporter of

indigenous crude oil in Pakistan. The NLC counter claims that it transports on an average, only 40 percent of crude oil transport to Pakistan’s refineries (see letter to the editor in the News International, January 19, 2006).



2.5 Incentives in Construction 31. According to the National Housing Policy of 2001, there was a backlog of 4 million

housing units in the country in that year, with the backlog growing at the rate of 300,000

units each year. Construction is acknowledged to be a sector with strong backward and

forward linkages, and significant growth in this sector can have a remarkable impact on

growth of incomes. Given the buoyancy of the sector, and the unmet demand in the housing

sector, the government has been keen to introduce incentives in the housing and construction

industries. Since FY2002, the government has progressively introduced financial incentives

in the housing sector, allowing a proportion of the markup on housing loans to be tax

deductible, and introducing measures to encourage housing finance including increasing the

maximum lending limit and the loan period for loans given by the House Building Finance

Corporation (HBFC). Nevertheless, the growth of housing has been hampered by

uncertainties and the prevalence of fraudulent practices in the land titling and registration

processes, and by delays in the development of basic infrastructure (mainly roads), obtaining

utility connections20

.

32. Financial incentives, as announced by the government in successive budgets, cannot

have a major impact in a construction market where housing finance is practically unheard of.

However, the clear definition of property rights and transparency in procedures regarding the

sale and transfer of property, as well as the efficient supply of facilities and infrastructure to

housing estates would have a much greater impact in promoting the sector. For low and

medium cost housing, such incentives have been provided on a very limited scale, with NGO

involvement in schemes such as the Khuda ki Basti and the Incremental Housing

Development Schemes (IHDS) in Karachi and Hyderabad respectively. In high cost housing,

schemes developed by the Defense Housing Authorities are the prime examples of such

developments where the true incentives to construction come from clear legal processes for

land ownership, and the provision of quality infrastructure. These schemes are discussed as

follows.

2.5.1 Khuda Ki Basti and the IHDS 33. The IHDS (which was later replicated under the name Khuda ki Basti in eight areas in

Karachi and Hyderabad) was the brainchild of the then head of the Hyderabad Development

Authority (HDA), Tasneem Siddiqi. The first scheme was started on government land in

1986, and was developed using an “incremental” approach in that plots were allotted at

affordable prices, and facilities were then developed incrementally as payments were made.

Thus the scheme started out with just a communal water supply scheme, and public transport

links to the city center, but as allottees continued to pay their monthly installments for

ownership of the land, facilities were added till the full range of basic facilities, i.e. house to

house water connections, electricity, roads etc were made available.

34. The scheme differs from other developments in low cost areas, because ownership

rights were accorded to the allottees after payment of the initial amount, and facilities were

added on after ownership had been established. This was in reverse to the practice usually

followed in slum areas where basic facilities are provided at expensive rates, but land

ownership is never established. The HAD devised a number of steps to discourage

speculation in the scheme, including demarcating a large number of small plots, issuing

ownership papers once allottees had started building shelters, and ensuring that families are

being accommodated in the housing being built.

20 See chapter on regulatory issues as well.



35. The IHDS is an example of a government agency taking the lead to provide incentives

to rightful owners to develop housing for their own use, rather than encourage speculation.

However, the development of the scheme had more to do with the efforts of an individual,

with a strong development ethos, rather than an entrenched process. The success of the

schemes is expected to have results though, with the government considering the possibility

of replicating the Karachi schemes in the form of “sasti bastis” all over the country. Sasti

bastis are now functional in five districts in Sindh under the auspices of the Sindh Katchi

Abadies Authority (SKAA). Similar proposals are under consideration in Punjab, possibly to

be carried out by the proposed Punjab Urban Commission.

2.5.2 Defense Housing Authorities

36. For high income consumers, government incentives for housing and construction take

the form of management of housing schemes in all major cities by the Defense Housing

Authorities (DHAs) owned by the military, who acquire land, or develop housing estates on

land owned by the military. The DHAs in Karachi and Lahore were originally formed as

Cooperative Housing Societies (the Karachi society was formed as far back as 1953), but

were later converted through Presidential Orders or Ordinances into Housing Authorities.

Other DHAs, most recently in Islamabad/Rawalpindi have also been constituted under

Ordinances. The practice of the military acquiring land to parcel out as part of a package of

benefits to its personnel originated in British India, and was conceived as a way for the

Crown to retain the loyalties of the armed forces in colonized lands. The practice has

continued post partition, but has assumed complexity as development of real estate on

military lands, or on state lands acquired by the military, and real estate transactions by

military owned agencies have significantly increased in value.

37. DHAs have an upper hand in the housing market because of the security of land title

once the scheme is announced, the relative ease of infrastructure provision, and good

maintenance of infrastructure in the housing estates. However management and allotment

systems in these schemes are typically opaque, and land acquisition for such schemes has

invariably been at below market rates.21

The DHAs are essentially a distortion in the real

estate market and represent a significant subsidy to military personnel who come to acquire

the land as part of their package of benefits, and to real estate developers associated with the

military who are provided opportunities to develop the land on favorable terms. While it is

difficult to quantify the extent of the subsidy to DHA, it is likely to be exceptional –

according to one estimate, 3375 acres of land were acquired for the Rawalpindi DHA at a

cost of Rs. 11 billion, and the land was later sold for Rs. 135 billion.22

21 Land acquisition in the recently developed Lahore DHA and the Rawalpindi DHA is a case in point. In both

cases, there are reports of original owners not being compensated adequately, or being pressurized to give up land.

22 See Agha, Ayesha Siddiqa. 2006. The New Land Barons? Article in Newsline, July.


Section 3

Agricultural and Trade Subsidies 3.1 Agricultural Subsidies

38. Pakistan’s accession to the WTO requires it to furnish the WTO Secretariat with

details of subsidies given in agriculture. According to Annex 2 of the Agriculture Agreement

under the WTO, permissible subsidies in the agriculture sector, also called “Green Box”

subsidies, cannot distort trade and must cause minimal domestic distortion. In addition, price

support of any kind is not permissible, and subsidies have to be funded out of government

budgets and clearly identified in budgets as such, rather than be funded by passing on the

burden of subsidization to the consumer. Pakistan provides support to agriculture through

subsidization of research, storage and marketing, extension services, and infrastructure and

flood protection services. The table below gives Pakistan’s outlays under the green box.

Table 3.1: Green Box Subsidy Outlays (Million US $)

Type of Measure

1986-88

1995-96

1996-97

1997-98

1998-99

1999-00

2000-01

2001-02

Total

General services on research

14.5 12.8 7.7 7.6 2.44 3.18 1.67 2.14 52.03

Storage facilities

4.8 0.8 0.3 0.2 0.00 0.08 0.19 0.04 6.41

Marketing services

0.1 0.1 0.1 0.0 0.11 0.00 0.02 2.32 2.75

Extension services

22.1 2.4 2.2 1.6 2.44 1.86 4.58 8.87 46.05

General services

0.3 0.5 0.0 0.0 0.70 0.01 0.06 0.30 1.87

Infrastructural services

147.5 335.0 312.6 266.1 235.76 213.07 203.59 140.94 1854.56

Flood protection services

7.9 34.6 15.9 22.8 7.94 7.18 7.38 1.17 104.87

Water supply services

31.3 53.7 53.9 14.1 14.43 13.04 7.71 0.82 189

Total 228.5 439.9 392.44 312.45 263.82 238.42 225.2 156.6 2257.54

Source: WTO Notifications

39. As the data shows, infrastructure and flood protection services (which include

primarily the construction and maintenance of the irrigation infrastructure) account for the

bulk of subsidy payments for the sector, with only nominal expenditure on research and

development, extension and storage and marketing



3.2 Trade Subsidies and Incentives

40. Pakistan cannot provide direct export subsidies as it used to prior to its inclusion in

the WTO regime, but can subsidize the cost of marketing and transportation of exports. The

government employs a range of incentive systems for exporters, mostly in the form of

financial incentives. Some of the key incentives in this regard are as follows.

41. Trade incentives offered by the SBP take a variety of forms including concessionary

credit for exporting industries and concessionary trade financing. The four main schemes of

the SBP are discussed below.

3.2.1 Export Finance Scheme

42. The Export Finance Scheme (EFS) was first sponsored by the SBP in 1973 to

facilitate the provision of bank credit to exporters, and has undergone many transformations

over the years as the government has faced pressure from international agencies on the

provision of subsidized credit. Exporters are eligible (upon satisfaction of certain conditions)

under the scheme to obtain export finance (post pre and post shipment) from commercial

banks at a markup rate which is linked to the weighted average yields of T-bills and Pakistan

Investment Bonds (PIBs).

43. Other related incentives include the establishment of the Pakistan Export Finance

Guarantee Agency (PEFGA), which provides insurance against risk for exporters and thus

covers the collateral requirements of banks. The PEFGA credit thus enables exporters to

hedge against the financing risks of commercial banks.

3.2.2 Long Term Financing of Export Oriented Projects (LTF-EOP)

44. The second major scheme sponsored by the SBP, and initiated in 2004, enables

financial institutions to provide credit at attractive terms to export oriented firms who require

financing for imports of raw materials, machinery, plant and equipment not manufactured

locally. The scheme was announced as a follow up to incentives for exporters announced in

the Trade Policy for 2003-04. Under the scheme, the SBP provides refinance facilities for

banks lending to manufacturers who export at least 50 percent of their output. Rates of

refinancing are determined on the basis of the weighted average yields on 12 month T-bills

and 3 to 5 years Pakistan Investment Bonds (PIBs). Banks are permitted to earn a maximum

spread of 2 percent under the scheme.23

45. While banks make decisions on who to lend to, they are constrained to make choices

from amongst clients who fulfill certain criteria, and who make specific requests for

machinery import. The scheme is also supposed to encourage SME participation – initially

50 percent of funds allocated by the SBP to specific banks for refinancing purposes were

supposed to be used for refinancing of loans given to SMEs. This condition has now been

done away with, but banks are encouraged to prioritize the needs the SMEs. Funds loaned

under the scheme can also be utilized to import equipment necessary to acquire a brand name

or franchise.

3.2.3 Scheme for Locally Manufactured Machinery

46. The scheme was initiated in 1987 and provides concessionary finance for export of

locally manufactured machinery. The scheme is applicable to “the manufacture of plant,

23 This was previously 3 percent, but was reduced by a percentage point in FY2007.



equipment, transport equipment, cargo vessels, ships, fixtures, fittings, accessories and

consumer durables which are to be used for industrial applications and which undergo

processing in Pakistan for value addition.”24

The scheme does not cover machinery and

equipment that uses more than 80 percent imported components, and it provides for both pre

and post shipment finance.

3.2.4 Scheme for pre and post Shipment Under FE25

47. Foreign exchange deposits were made available for trade financing under the FE-25

scheme after the 1998 freezing of foreign currency accounts. The scheme started operating in

August 2002, and works on a self-liquidating basis. Authorized foreign exchange dealers

extend pre-shipment finance to exporters, and are then allowed to adjust the loan against the

proceeds of the post-shipment facility, like discounting of foreign bills in foreign currency.

The scheme was considered feasible in that it enabled banks to earn higher returns than they

were earning by placing the funds in foreign countries at rates of barely 2 percent. It also

facilitated exporters who could obtain finance at 4 percent interest rather than the 8 percent

they were charged on local currency loans under even concessionary finance schemes. There

was no currency risk involved as export proceeds were being used to pay off the loans.

48. The Ministry of Commerce offers a range of incentives to exporters including freight

subsidy, support for marketing and research and development (R&D), as well as a range of

fiscal incentives. These are discussed as follows.

3.2.5 Freight Subsidy Scheme

49. The scheme was announced in the trade policy for FY2003, and consisted of a 25

percent freight subsidy on export of new goods, and goods going to new markets. The

scheme has since undergone some modifications, and is currently tenable for exports to

Africa, Eastern Europe (non EU countries), Central Asia and the Pacific Islands. In addition,

the subsidy is available to exports which fall in the “developmental” category, even if they

are going to established export markets. The export of leather goods is also eligible for a 25

percent freight subsidy.

3.2.6 Skill Development and R&D Support for the Textile Sector

50. The Ministry of Commerce sponsored the establishment of the Textile Skill

Development Board to facilitate training for workers in the textile industry. In 2005, the

Government extended the facility of a 6 percent compensatory rebate to the garment and

knitwear industry. The scheme has been extended to June 2008 at a lower rate of rebate.

3.2.7 Quality Standards Certification

51. The Ministry covers 50 percent of the costs of acquisition of certain quality standards

by exporting firms. In addition to the ISO certifications, this scheme now covers eco labeling

and certification of organic foods.

24 See the website of the Export Promotion Bureau, www.epb.gov.pk.



3.2.8 Financial Incentives

52. There are a number of financial incentives for exporters including taxing export proceeds

at concessional rates of withholding tax; concessional corporate tax rates for SMEs; sales tax

exemptions on gas and electricity for five export industries, as well as exemptions on imports of

certain items of machinery and some kinds of plants; and sales tax exemption on purchase of raw

materials for certain industries among other things.

53. The TDAP is the new face of the Export Promotion Bureau (EPB) – the Authority came

into being as a result of a Presidential order issued in November 2006. As was the case with the

EPB, the TDAP is mainly concerned with export marketing and facilitation. Some of the key

incentives offered by the TDAP are as follows.

3.2.9 Support for Participation in Trade Fairs

54. The TDAP provides full funding for participation of women entrepreneurs in trade fairs

abroad. This is in addition to the 50 percent subsidy on airfare and per diem given to business

delegations.

3.2.10 Support for Certification

55. TDAP provides an interest subsidy on loans acquired for the establishment of certification

and accreditation facilities, and also supports the full cost of consultancy services for the

establishment of such facilities. It also bears 75 percent of the cost of product listing in a lab

specified by a foreign importer, under a plan to provide financial support for mandatory

certifications.

3.2.11 Support for Establishment of Retail Outlets Abroad

56. The TDAP provides financial support to meet rental costs of retail outlets established in

other countries for a period of three years. For the first year, the TDAP meets 50 percent of rental

cost, while in the second and third years 25 percent and 10 percent of rental costs are covered by

TDAP.

3.3 Impact on Domestic Commerce

57. The purpose of the above listing is to assess the possible impacts of agricultural and trade

subsidies on domestic commerce, particularly on retail and wholesale trade, transport, storage and

real estate. Agricultural subsidies in general have little direct impact on these sectors beyond the

residual effects they may have based on their effects on production. The only area of domestic

commerce directly affected by agricultural subsidies is storage, given the federal government’s

support for the Pakistan Agricultural Storage and Services Corporation (PASSCO), the prime

public sector agency responsible for the storage of grains, particularly wheat. In addition to

PASSCO, provincial Food Departments also manage public sector grain storage facilities. Until

some years ago, grain storage was exclusively the preserve of the public sector, but in 2001, with

the government increasingly under pressure from international agencies to deregulate the wheat

market, the private sector was allowed to participate in the procurement and storage of wheat.

However, in spite of the federal government agreeing to conditionalities of at least one

multilateral donor, the Asian Development Bank (ADB), to phase out provincial food

departments and restructure PASSCO and restrict its role, little progress has been made on either

of these initiatives.



58. With regard to trade subsidies, the key impacts on domestic commerce come through the

effects of subsidies on production. An analysis of whether trade subsidies do indeed boost local

production and export is beyond the scope of this study. However, our hypothesis would be that

if these effects are indeed observed, trade subsidies would indirectly boost the domestic

commerce sector, particularly wholesale trade, storage and transport. Data limitations, however,

do not permit us to quantify these effects.


Section 4

Conclusions and Recommendations

59. Compiling an exhaustive list of subsidies and incentives to domestic commerce is an

arduous task given that there are few subsidies explicitly directed towards these sectors. The

bulk of our study has concentrated on analyzing the effects of “hidden subsidies” given to

certain institutions or sectors, many of which actually function as taxes on the domestic

commerce sector. Thus, differential utility rates act as taxes on domestic commerce, as does

preferential treatment given to certain public sector corporations. There is little by way of

direct subsidization of commerce beyond the few financial incentives we have listed here.

This is perhaps appropriate in a policy environment that is increasingly moving away from

subsidization. However, in the same spirit, it is advisable to review policies which

discriminate against the private sector in domestic commerce. Our recommendations are

summarized as follows.

4.1 Policy Recommendations

60. Medium Term: In the medium term, there is a need to resolve issues of negative

taxation in the commercial sector, in addition to a need to make subsidies explicit in budget

documents.

Utility and fuel pricing regimes need to be carefully reviewed as part of the ongoing

restructuring of the energy sector. While the need for some degree of cross-subsidization

may be necessary given equity considerations and the need to supply basic services to low

income households, the commercial sector cannot pay a price for the lack of efficiency

and mismanagement in utility providers.

The subsidization of freight prices may benefit the commercial sector in terms of ensuring

cheap transport, but entails environmental costs and hinders the adoption of fuel efficient

technology and better maintenance practices in road transport. Given the recent meteoric

increases in oil prices, it is not advisable to urge a rationalization of diesel prices at this

stage, but the cost of the diesel subsidy should be clearly identified in budget documents

to give the government a clear idea of its expenses in this regard, and to facilitate a

possible review of the policy at a later stage, perhaps when more fuel efficient

technologies gain prominence.

61. Long Term: In the long term, there is a need to ensure a level playing field for all

stakeholders in the trade and commerce sector. The performance of the NLC and the PNSC

needs to be reviewed in addition to PASSCO, to assess the feasibility of allowing the public

sector to operate in areas where private sector capability is increasingly available. While it is

true that the role of the NLC has been substantially reduced in recent years, the PNSC has not

been subjected to similar scrutiny. In the real estate sector, an effort must be made to provide



a level playing field to developers with transparent systems for provision of infrastructure.

There is also a need to develop an integrated model on the effects of trade subsidies on the

domestic economy.

The State of Domestic Commerce in Pakistan Study 3 - Subsidies and Incentive Regimes

Economy & Finance

Transcript of The State of Domestic Commerce in Pakistan Study 3 - Subsidies and Incentive Regimes