LAHORE: The Pakistani government is poised to implement a significant reduction in import taxes, totaling an estimated Rs120 billion in the upcoming fiscal year’s budget.
The move is part of a broader, five-year plan aimed at opening the economy to increased foreign competition. While proponents argue the measure will enhance productivity and encourage exports, concerns are mounting over the potential impact of a steep tariff reduction on the nation’s external financial stability.
Prime Minister Shehbaz Sharif has reportedly endorsed the comprehensive plan this week, overriding objections raised by the Ministry of Industries and the Ministry of Commerce.
These ministries voiced concerns regarding the potential negative effects of rapid tariff changes on the domestic manufacturing sector and the balance of payments.
Interestingly, the Ministry of Finance and the Federal Board of Revenue (FBR), which have historically favored higher tariffs for revenue generation, have reportedly supported the proposed reductions. The first phase of this five-year tariff rationalization plan is slated for implementation in the new budget.
Phased reduction in tariff slabs & rates
Under the approved plan, the number of customs duty slabs will be reduced from the current five to four over the next five years. The maximum tariff rate is targeted to decrease from the current 20% to 15% within this timeframe. This trajectory is considered by some to be even more ambitious than the tariff reduction plan agreed upon with the International Monetary Fund (IMF).
The total estimated revenue impact of the complete five-year plan is projected to be Rs512 billion, excluding adjustments to tariff rates for the oil and gas exploration and production sectors. The initial year’s implementation is expected to result in a revenue reduction of approximately Rs120 billion, with around Rs100 billion attributed directly to changes in slab rates.
Details of the new tariff structure
The upcoming budget is expected to provide legal backing for the new four-slab structure: 0%, 5%, 10%, and 20%. Currently, while some goods are imported at a 0% duty rate, they are still subject to additional customs duties and regulatory duties. The automobile sector’s import duties are not expected to be altered in this budget.
The existing 3% duty slab, which covers 972 items and includes additional customs and regulatory duties, is slated for abolition. These tariff lines will be shifted to either the 0% or 5% slabs, with a majority expected to move to the 5% category. This shift is anticipated to generate approximately Rs70 billion, helping to offset some of the revenue losses. The 11% slab will be lowered to 10%, while the 16% slab will be reduced to 15% in the upcoming budget. The current 20% slab is to be phased out gradually.
Concerns Over Balance of Payments and Manufacturing Sector
Despite the government’s push for liberalization, concerns persist that a sudden influx of imports due to lower tariffs could exacerbate the trade deficit and potentially trigger a balance of payments crisis. The finance ministry has estimated that a mere 1% reduction in duties could lead to a 1.7% increase in the trade deficit.
The commerce ministry had advocated for a six-slab structure with rates of 0%, 3%, 6%, 9%, 12%, and 20%, but this proposal was not accepted by the Prime Minister.
Abolition of Additional Duties and Schedules
The approved plan also includes the phased elimination of additional customs duties over four years, commencing with the new budget, and the removal of regulatory duties within five years. The Fifth Schedule of the Customs Act, which governs imports of capital goods and industrial raw material, is also set to be abolished over five years.
A senior tax official indicated that the revenue losses from reduced import taxes are expected to be compensated by increased tax collection from a stimulated domestic economy. In the first year, customs duty losses are estimated at Rs15 billion, additional customs duty losses at Rs50 billion, regulatory duty losses at Rs35 billion, and Fifth Schedule-related losses at around Rs20 billion.
Following these changes in the next fiscal year, the trade-weighted average tariff is projected to decrease from 10.62% to 9.57%, while the trade-weighted average customs duty will fall from 5.68% to 5.54%.
Rationale and Differing Perspectives
Sources suggest the Prime Minister’s office believes high tariffs have hindered productivity and discouraged local businesses from exporting. However, commerce ministry officials argue that the approved plan contradicts the principle of cascading tariffs, where raw materials have lower duties than finished goods.
They also expressed doubt that production costs would significantly decrease solely due to tariff reductions, citing high energy, labor, and productivity costs.
Approximately Rs300 billion of the total Rs512 billion in estimated revenue losses are expected to occur during the IMF’s current three-year program.
