Monday, March 13, 2023

PAKISTAN
The cost of the shadow economy

Dr Abdul Wahid
Published March 13, 2023 


The informal sector’s contribution to Pakistan’s economy is remarkable as it adds a handsome volume of approximately $661 billion, tantamount to 35.6 per cent of GDP. According to the International Labour Organisation, it constitutes 75pc and 68pc of jobs in rural and urban areas; however, it is pregnant with issues like child and bonded labour, gender-based discrimination, and insecurities in the workplace.

Moreover, it embodies small and medium enterprises (SMEs) that are populated by self-employed entrepreneurs, small businesses, informal associations, and street vendors in agriculture and micro-enterprise setups, and thus, they tend to be more resilient to economic downturns. Despite its volume and contribution to the economy, the informal sector creates financial vulnerabilities for formal setups.

Let’s consider the formal market. The Growth Enterprise Market (GEM) board of the Pakistan Stock Exchange (PSX) is a sub-market for SMEs and high-growth companies looking to go public. The GEM board was established following Alternative Investment Market in London, which itself was established in 1995 by the London Stock Exchange as a sub-market to provide a market for SMEs, business startups, and incubates to raise capital and provide a platform for investors to access returns from small businesses.

It has become one of the world’s leading growth markets in the UK for smaller companies, with over 3,000 listed companies from over 70 countries. Though companies listed on the GEM board in Pakistan are subject to less stringent listing criteria and regulations as compared to the ones listed on the main board of the PSX, to the present date, only three SMEs made it to the GEM board, i.e. Pak Agro Packaging Ltd, Supernet Ltd and Universal Network Systems.

Informal setups are backed by special interest groups through a complex mix of tax laws and regulatory compliances for the formal sector

This anomaly has a handful of reasons, like investor participation seems minuscule as only 0.3 million accounts are registered with the National Clearing Company of Pakistan Limited out of around 57.5m bank accounts. This indicates less than 0.5pc of investor participation at the PSX forum.

Investor participation, driven by incentivisation and a less stringent regulatory burden to the informal sector, is visible in real estate property pricing bubbles, higher forex trading returns, and inflationary pressure. These avenues produce ample easy money with the least risk and low regularity compliances under state patronage.

The Imran Khan-led government launched a construction amnesty scheme to promote housing to generate jobs and fill the gap of millions of housing unit shortages. According to Zameen.com, since 2018, the average per square feet price has increased from Rs3,300 to 7,000, which is 26pc returns per annum in open plots investment in Islamabad.

It not only doubled the real estate prices in other cities such as Karachi, Lahore, Peshawar and Faisalabad but also shifted the investment chunk toward the real estate sector. Many industrialists shifted their attention to the real estate sector.

Similarly, the gold price in December 2017 was Rs56,200 per tola, but now it is Rs201,000 per tola, which is more than 50pc return per annum in gold investment. Likewise, on 14 Jan 2018, the exchange rate of rupees to the dollar was Rs110 to a dollar, and now it is Rs278 — an average of 30-35pc returns per annum.

On the flip side, KSE-100 Index provided compounded annual returns of 14.55pc, and industrial profit was recorded at less than 15pc per annum. The inflation rate in 2018 was 5.08pc, and now it is above 30pc. If the inflation-adjusted returns per annum are calculated, it can be said that the real return an investor receives in the formal market and industrial setup is negative.

Pakistan already has one of the highest income tax rates in the world as far as corporations are concerned, which further depicts a decrease in the wealth of formal sector investors. Consequently, since 2013, more than 200 companies have been delisted from PSX. Only 526 companies are listed on the main board, and just three SMEs are listed on the GEM board; however, the total number of registered companies with the Securities and Exchange Commission of Pakistan now stands at 176,000.

The prominent explanation for delisting is a cost-benefit trade-off. If a listed firm’s marginal benefit/cost ratio is less than shedding avoidable costs, this may lead to de-capitalisation.

Nevertheless, investor participation is more in informal sectors in which most of the businesses are unregistered. The Asian Development Bank (ADB) confirms that more than 90pc of the SMEs that operate in the informal sector are set up with the help of family members and friends.

These businesses generally operate in agri-business, food chain, agri-machinery, and textile sectors. Some of these raise money for seasonal products and services and wind up their business when the season ends. These setups are more visible during harvest in rural areas and in food chain industries in urban areas. They earn money by stocking up on necessities like sugar, flour, wheat, grains, oils etc.

They employ the staff on a seasonal or contractual basis and then lay them off. Furthermore, fewer salaries are paid to them compared to minimum wages in cash form without any social security i.e. health insurance and accommodation. Consequently, social and financial vulnerabilities for unemployed youth are increasing drastically, resulting in modern slavery.

Informalisation is proliferated to avoid income tax, intense documentation and regulation, which further fuels decapitalisation and insecurities in the labour market. These informal setups are backed by special interest groups of local politicians, families of bureaucrats, and land elites through a complex mix of tax laws and regulatory compliances for the formal sector.

The writer is an Assistant Professor (PhD Financial Economics) at the National University of Modern Languages, Islamabad. He can be reached at (abwahid.fms@gmail.com)

Published in Dawn, The Business and Finance Weekly, March 13th, 2023

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