The State of Domestic Commerce in Pakistan Study 4 - Regulatory Issues in Domestic Commerce

8/10/2019 The State of Domestic Commerce in Pakistan Study 4 - Regulatory Issues in Domestic Commerce

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THE STATE OF DOMESTIC COMMERCE INPAKISTAN

S

TUDY

REGULATORY ISSUES IN DOMESTIC

COMMERCE

For

The Ministry of CommerceGovernment of Pakistan

November 2007

By

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


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Table of Contents

List of Abbreviations ............................................................................................................... iAcknowledgments ................................................................................................................ iv

Executive Summary ............................................................................................................ 3

Section 1: Regulatory Issues in Domestic Commerce ................................................ 91.1. Introduction ............................................................................................................... 9

Section 2: Retail and Wholesale ................................................................................. 102.1 Introduction ............................................................................................................. 102.2 Agricultural Marketing .............................................................................................. 102.3 Recommendations................................................................................................... 112.4 Main issues in Retail Markets .................................................................................. 112.5 Pakistan Shops and Establishment Ordinance 1969 ............................................... 12

2.5.1 Finance ........................................................................................................ 132.5.2 Recommendations ....................................................................................... 142.5.3 Taxation ....................................................................................................... 142.5.4 Recommendations ....................................................................................... 162.5.5 Infrastructure ................................................................................................ 162.5.6 Recommendations ....................................................................................... 172.5.7 Local Road and other Local Services ........................................................... 182.5.8 Recommendations ....................................................................................... 18

2.5.9 Contract Enforcement & Repudiation ........................................................... 182.5.10 Recommendations ....................................................................................... 202.5.11 Law and Order ............................................................................................. 20

Section 3: Transport Sector ........................................................................................ 223.1 Introduction ............................................................................................................. 223.2 Land Transport ........................................................................................................ 23

3.2.1 Railway ........................................................................................................ 233.2.2 Recommendations ....................................................................................... 243.3.3 Trucking ....................................................................................................... 243.3.4 Recommendations: ...................................................................................... 253.3.5 Inter and Intra City Passenger Traffic ........................................................... 25

3.3.6 Recommendations ....................................................................................... 263.3.7 Roads .......................................................................................................... 273.3.8 Recommendations ....................................................................................... 273.3.9 Ports ............................................................................................................ 273.3.10 Recommendations ....................................................................................... 28

3.3 Air Transport............................................................................................................ 28

Section 4: Warehousing and Storage ......................................................................... 294.1 Introduction ............................................................................................................. 294.2. Grain Storage .......................................................................................................... 29

4.2.1 Recommendations ....................................................................................... 304.3 Cold Chain .............................................................................................................. 30

4.3.1 Recommendations ....................................................................................... 314.4 Non-perishable Items .............................................................................................. 31


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Section 5: Real Estate and Construction ................................................................... 325.1 Introduction ............................................................................................................. 325.2 Cost of Doing Business ........................................................................................... 335.3 Main Regulatory Issues ........................................................................................... 33

5.3.1 Property Registration ................................................................................... 335.3.2 Taxation on Registration and Property ......................................................... 345.3.3 Commercialization and Other charges ......................................................... 345.3.4 Construction ................................................................................................. 345.3.5 Rental Property ............................................................................................ 34

5.4 Recommendations................................................................................................... 35

Appendix I ............................................................................................................... 36


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List of Tables

Table 1: IFC Cost of Doing Business Data for Pakistan ................................................. 33


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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 AssociationATT 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 IndexCPIA 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 TonnageGST 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 TechnologyITU International Telecommunications Union
http://en.wikipedia.org/wiki/Gross_Register_Tonnagehttp://en.wikipedia.org/wiki/Gross_Register_Tonnagehttp://en.wikipedia.org/wiki/Gross_Register_Tonnage


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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 ExchangeLCL 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 AuthorityNIE 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 TrustsRICS 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 InternationalTOR Terms of Reference


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Innovative Development Strategies (Pvt) 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 AmericaUSC 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


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Innovative Development Strategies (Pvt) iv

Acknowledgment

This work has benefited from a number of focus group discussions held all over the country

and feedback received at a series of seminars held at the Federal Ministry of Commerce

during early 2007. The results were also disseminated at a national seminar in April 2007 in

Islamabad. The study team is grateful to all the participants of these discussions as well as the2000 respondents who gave so freely of their time.

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

for their guidance, assistance and feedback during the course of this study. Our greatest

thanks go out to Syed Asif Ali Shah, Secretary, Ministry of Commerce for nurturing these

studies through all the stages.

Thanks are also due, in particular, to Mr. Naseem Qureshi and Mr. Ashraf Khan, Additional

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

Qaseem Subhani, Section Officer of the Federal Ministry of Commerce, for sparing their

precious time and efforts for the studies.

The support lent to this work by Mr. Saeed Ahmad Alvi, Secretary, Department of

Investment and Commerce, Government of Punjab is also gratefully acknowledged. Not only

did he make a great contribution to the conceptualization of the studies, but his office helped

to facilitate the workshops and field work in the Punjab for which we are eternally grateful.

The team feels a deep sense of gratitude for the Federal Minister for Commerce, Mr.

Humayun Akhtar Khan, who took out considerable time from his very busy schedule to guide

this work. It was his sincere and deep conviction in the value of quality research which

enabled us to conduct and compile this detailed and comprehensive study on Domestic

Commerce. Without his continued interest, guidance and oversight, this study would not have

been possible.

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


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v

19.Ministry of Petroleum, Government of Pakistan, Islamabad.20.Law, Justice and H.R. Division, Government of Pakistan, Islamabad.21.Agriculture Department, Government of Punjab, Lahore.22.Local Government and Rural Development Division, Government of Punjab, Lahore.23.Statistics Division, Government of Pakistan, Islamabad.


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1

REGULATORY ISSUES IN DOMESTICCOMMERCE

by

DR.FAISAL BARI


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Innovative Development Strategies (Pvt) 3

Execut ive Summary

1. Increasing globalization and the policies of liberalization, de-regulation, andprivatization that successive governments in Pakistan have been pursuing over the last decade

and a half have increased the need for domestic producers and service providers to be

competitive with the international counter parts. This is needed not only for exporting toother countries, developed or developing, but for competitive performance in the local

markets as well. With increasing globalization, this need to be competitive, both domestically

and internationally, will increase manifolds. If our economy is to maintain a high growth

trajectory, we need to be aware of all issues that might be creating hurdles in the way of

doing business, competitively, at the international level. If our local costs, direct or indirect,

are not in line with the costs in other countries, local producers will suffer, and so will the

local economy. This study reviews some of the regulatory issues facing various sectors in

domestic commerce and identifies the major regulatory hurdles related to each of them.

While recommendations are made on major issues much more detailed work needs to be done

on a host of others before an optimal course of action can be recommended. The main points

from each sector are summarized below.

Agr icul ture Market ing

2. Pakistan clearly has a significant potential in export of fruits, vegetables, dairyproducts, meat and grains. These are important domestic sectors as well. But the potential has

so far not been fully exploited in any of the area mentioned above. In some of these sub-

sectors there are significant regulatory issues that could be crucially hampering further

developments.

3. Fruit and vegetable markets, regulated by the respective provincial agriculturaldepartments under the Market Committee Acts, pose significant hurdles to development of

such markets by the private sector. Despite recent amendments, private sector is still not keen

to enter this area and the small number of fruit and vegetable markets continue to impose

significant distortionary costs. The Market Acts give too much regulatory authority to the

government, allow it to interfere in the day to day functioning of these markets, and give it

powers to control governance structures, rentals and allocation of space in the market. Under

such restrictive conditions, it is not surprising that private sector has not entered the area in

any significant fashion. A thorough overhaul of the Market Act, with a view to facilitating

private sector entry is badly needed here.

Retai l and Wholesale Markets

4. Most of the retail and wholesale businesses in our sample are not registered asbusinesses either under the Companies Act or under the Shop Act. Though the latter is a

requirement for all shops, there is no real enforcement of the Act on small businesses. It is

not the level of fees related to registration of the shop that seems to be the major hurdle in

registration. It seems that a) shopkeepers either do not know of the requirement, or b) they

attempt it to avoid any implications that registration might have on the taxation side.

The main regulatory issues related to wholesale and retail businesses are summarized below 1:

1 A lot of these issues are common to all small and medium sized businesses, irrespective of sector or typeof business.


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5. Finance: Most small businesses do not have access to formal sector financialinstitutions. Since the bulk of Pakistani businesses fall in the category of SMEs or micro-

level businesses, this lack of access to finance poses a significant problem for firm growth as

well as overall growth. The main problems have to do with a) lack of reliable/contractible

information on individual small firms as well as the sectors they work in, b) lack of formal

registration of small businesses, c) lack of physical collateral, d) high cost, for formal sectorbanks, to deal with small loans, and e) high cost of collecting the required firm and sector

specific information.

6. The solutions to the problem are related to a) move to balance sheet lending instead ofasset based lending, b) training in balance sheet lending for bankers, c) creation of credit

bureaus that keep detailed information of small firms, d) generation of reliable sector specific

information, e) pooling of risk through creation of guarantee funds for initial lending.

7. Taxation: Income and sales tax levels are considered to be high. Time costs ofdealing with custom clearance, compliance costs to meet all the rules and requirements are all

considered to be high. There are distortionary threshold effects in our tax system and

relatively high levels of corruption (or a perception of it).

8. Documentation of supply chains, widening of tax net, rationalization of tax rates,move towards self-assessment with limited interaction with tax officials, moves against

corruption and lowering of compliance costs by streamlining the administrative systems

needs to continue. Detailed studies need to identify threshold effects in the tax system so that

they can be removed. Custom clearance processes need further improvement in terms of time

required for clearance as well as for reducing discretion in setting tariff rates.

9. Infrastructure: Very few businesses were happy with the infrastructure beingprovided.. The main complaints relate to electricity and gas provision, road quality, and

water/sewerage access and quality.

10. For electricity, the main issues are related to high tariff rates for commercial andindustrial activity, load-shedding, poor quality of service, delays in getting connections,

corruption, the arbitrary powers given to WAPDA, and the need to have back up (raising

costs) arrangements.

11. Better planning to get to an optimal mix of hydro/thermal generation is needed fortariff adjustment. Tariffs differentials, across activity, need rationalization. NEPRA needs to

be better resourced to be able to a) protect the consumers better, b) impose more discipline on

WAPDA, and c) ensure a level playing for all (private and public) players. Benchmark or real

competition needs to be introduced at the distribution level as well.

12. Local roads2 and infrastructure (water, solid waste management, sewerage, street-lighting, local chowkidari) are the responsibility of the local government. Better

accountability mechanisms need to be introduced at the local level. For industrial estates

there has been some experimentation, for infrastructure provision and management, throughprivate-public partnerships. This needs to be generalized across all industrial estates and the

same or a similar model needs to be considered for the retail and wholesale clusters and

warehousing areas.

13. Contract Enforcement:Contract enforcement and repudiation issues are distortingthe business environment in a variety of ways leading firms to depend on short term contracts

and spot deals, forcing them into backward or forward integration, forcing them to restrict

business to fewer buyers and/or suppliers, making them rely on family labour, and forcing

businesses to divide rather than grow. The total cost this might be imposing on Pakistani

business in terms of static costs as well as dynamic ones through distorted or restricted

2 Inter district roads and highways are treated separately under transport section.


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Regulatory Issues In Domestic Commerce


growth are difficult to estimate, but our data (interviews, focus group discussions, our survey

as well as previous surveys) does suggest that the costs are significant.

14. This area requires a lot more research but most solutions in the area will have toprovide a better functioning, more efficient and fairer judicial system. In addition,

experiments in Alternate Dispute Resolution (ADR) mechanisms and sector specific courts

might also be needed.15. Law and Order:The law and order situation in the country generally, and especiallyin some parts of the country (like Karachi) is quite poor and businesses complain that it

imposes a significant cost on them through a) hiring guards, b) direct losses through hold-ups

and so on, c) reduced business volumes due to reduced hours or reduced traffic. In some areas

there are payments made related to protection money as well. A poor law and order situation

can reduce future investments as well. Recommendations in this area are beyond the scope of

this paper on regulatory issues.

Transport Sector

16. Losses due to a) delays and slow movement of goods, b) accidents, and c) fatalities,are costing businesses and the people of Pakistan significantly.. Roads are the main carrier of

goods and passengers in Pakistan, and railways and airlines share a relatively minor part of

the total traffic. Port Qasim and Karachi are the main ports of entry for international trade.

17. Railway:Railway handles about 10 percent of intercity passenger traffic and less than5 percent of inland freight, even though given the long North-South route (Karachi to up

country) it should have had a cost advantage over road transport for freight. Pakistan railways

has always focused more on passenger traffic than freight. It is not run on a profit basis,

continues to service non-viable routes, and offers prices that are not worked out on a profit

basis. Higher management lacks performance related incentives, systems for accountability

and the discipline of hard budgets. The sector does not even have an independent regulator so

that Pakistan railways acts both as a monopoly in the sector and the regulator as well.

18. A sector specific regulator is needed in the area. Railways needs to be corporatized sothat it has a) specific and clear objectives, b) clear incentives for management, and c)

procedures for accountability. De-bundling of services and introduction of competition in the

sector, by allowing the private sector to enter the area, should also be considered.

19. Trucking:There seems to be a low level self-reinforcing equilibrium in the truckingindustry that needs to be broken up. High levels of competition in the sector, due to low entry

barriers, are forcing freight rates to be low. But this forces competitors to cut corners on

quality, leading them to a) overload, b) drive for longer hours or more recklessly, c) not buy

insurance, and d) compromise on driver quality. Since competition is on prices and there donot seem to be any economies of scale, escape from this low level equilibrium seems hard.

NLC, the army backed company, is different, but it is only one company and since it has the

backing of the army, it actually distorts the sector even more.

20. The sector needs regulation that would break the low level equilibrium describedabove and force trucking companies to raise standards. This will a) erect some entry barriers,

and b) raise the cost of transport, but that might be the only way of reducing costs (in terms of

time delays, damages and accidents) in the long run and of developing a trucking industry in

the country.

21. Passenger Traffic:Rules for inter and intra-city passenger traffic need to be workedout. Currently the sector has too many provider specific exceptions, especially in the intra-

city route allocation and enforcement. There is also a need to recognize that entry has to berestricted on specific routes to ensure adequate returns for players: the transport market


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cannot be perfectly competitive as the marginal cost of provision is likely to lie below the

average cost of provision.

22. Some of the same issues arise in the taxi markets in cities as well. Regulationsregarding entry as well as fares are needed to ensure a) a minimum quality package and b)

adequate returns for providers.

23. Roads: Responsibility for highway planning, construction and maintenance lies iswith the National Motorway and Highway Authority. The way the authority is set up it has

little incentive to a) construct roads of high quality, and b) maintain roads optimally. There

needs to be a separation between the construction/maintenance and regulatory roles and there

also need to be changes in the incentive structures of the Authority to ensure a) management

has incentives that are aligned with the objectives of the authority and b) optimal incentives

are offered for planning for the future needs, managing construction quality and optimal

maintenance.

24. Ports: Dwell time and docking costs at Pakistani ports continue to be high, ascompared to other ports in the region. Longer custom clearing times, lack of processing

facilities outside the docks, and lack of adequate inland transport network contribute to the

longer dwell times. Rationalization of port charges should also be a high priority item on theagenda for reform.

Warehous ing and Storage

25. Storage and warehousing is a very important link in supply chain management inmodern economies. It is particularly important for the Pakistani economy as a) significant

issues in transport and logistics imply a higher need for managing inventories, b) being an

agricultural economy, the need for storing perishable items is significant. Storage of

agricultural items is important for exports of course, but it is important for managing

domestic prices as well. Cold-chains for non grain perishable items are generally missing

from the Pakistani markets so far. Without cold chains it is impossible to export meat, dairy

products and fruits and vegetables or to efficiently meet local needs.

26. Grain storage: The Government is still the major player in the procurement andstorage of major food grains despite the fact that it has over the over the last decade or so,

allowed the private sector to enter grain trade, export/import and storage as well. But the

rules of the game are not made absolutely transparent and there have been many unexpected

turnarounds that have severely affected the development of the private sector in this sector. It

is difficult, under these circumstances, for the private sector to decide whether to invest in

storage facilities or not and whether to enter grain trade or not. The government needs to

clearly state its procurement, storage, marketing and pricing policies and think adhere to

them. Without these, it is hard to see private sector role increasing in the sector.27. Cold Chain: The creation of a cold chain involves a significant fixed and sunkinvestment in infrastructure related to a) buildings near hubs of output as well as near airports

and ports, b) refrigeration facilities and electricity generation back-up systems and c)

refrigerated trucks. If the demand for the cold chain is not well articulated, concentrated and

guaranteed, it might not be feasible for a private sector entrepreneur to enter the area on

his/her own and without support from the government. A government subsidy or guarantee to

all the links in the cold chain might be needed to break the ice and tide the investor over the

initial period.

28. Non-Perishable Items: Storage facilities for non-perishable items for retail,wholesale as well as for industry, do not seem to have any major regulatory issues, other than

ones that are related to all businesses (discussed under retail and wholesale section). Mostretailers do their own storage in or near their shops. The same is true of most wholesalers. If


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more space is needed, businesses develop storage near their place of business, on empty lots

or rented or owned property.

Real Estate and Con struct io n

29. Construction is not only a significant contributor to the GDP, its indirect contributionto year to year growth is also significant. In addition, its current and potential contribution to

employment is also large given its potentially large backward and forward linkages..

30. Real estate and construction sector have been repeatedly identified in our surveys andfocus group discussions as sectors that have significant regulatory issues that need resolution.

Cost of urban land, difficulty in identifying clear titles and ownership, time and cost of doing

so, cost of transfer and registration, and other taxes and costs have been identified as some of

the problems in the real estate area (since property regulation are a provincial subject, we use

Punjab as an example of the kind of issues that are present in this market).

31. Property Registration:Pakistan does not have an efficient and transparent cadastralsystem for property registration. What is registered is transfer of property, and not title and so

records only shows transfers. Therefore, establishing ownership is a matter of following thetransfer trail, spending time and money on it, and living with a certain uncertainty regarding

titles. The costs, in terms of time and lawyer fees and so on, can be substantial. Unclear

records also lead to excessive and sometimes even frivolous litigation. These also limit the

value of real estate as collateral.

32. Taxation on Registration and Property: One percent registration and 5 percentstamp duty on property transfer registration (on value of property) is high. Added to these are

court fees, brokerage fees, search costs and so on. This encourages informal non-registered

transfers and under reporting and make the property market even more opaque.

33. Commercialization and Other Charges: Commercialization fee (residential tocommercial) is 20 percent of value of plot, and there are high development charges for

provision of water, sewerage and road facilities.

34. Construction:Building and zoning codes vary from city to city and have a plethoraof unclear and vague regulations. Some of the smaller cities do not even have codes. Some

codes are out dated, for example, restriction on height of buildings. There is a great need to

introduce modern building codes..

35. Rental Property:Rent restriction ordinance distorts the market for rental property.Limits on rents, excessive tenant rights and differential taxes on rental property (compared to

owned property) limit development of property for rental purposes and reduces incentives for

optimal maintenance. This puts upward pressure on rents on existing property. Rental

property is taxed at a much higher rate than owned property setting disincentives for

disclosure despite any sound economic reasoning for the differential in taxes.36. Establishment of a transparent and efficient cadastral system for property titleregistration should be a high priority). Stamp duties on property related transactions and

registration fees need to be rationalized. Non-registered transactions have to be banned. Most

of the regulatory issues connected with the real estate sector are in the purview of the

provincial and local Governments. Change of use charges and Development charges by

water/sanitation authorities need to be rationalized on the basis of costs. Building and zoning

codes need to be modernized and harmonized across the province. Possible environmental

impacts of expansion of urban and industrial areas need greater recognition. Rental property

laws need to be revised. Market distorting effects of rent control, excessive tenant rights and

differential taxation (registration, stamp duty and property tax) all need to be rationalized to

ensure efficiency and growth in this sector..


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Section 1Regulatory Issues inDomestic

Commerce

1.1. Introduct ion

1. Domestic commerce can form the back bone for industrial activity in the country, and canprovide the platform for our export efforts. If Pakistani businesses cannot conduct their trade and

manufacturing, within the borders of the country, in an efficient and unhampered manner, it is not

likely that we will be able to compete effectively in a global environment as well. In fact,

smoothly functioning domestic markets and vibrant domestic commerce might be a pre-condition

for good performance beyond our borders, and it might be a pre-condition for attracting high and

sustained levels of investment as well.

2. Domestic commerce crucially depends on retail and wholesale, warehousing and storage,transport, and real estate markets. These have been studied in detail in the following sections that

are dedicated to each of these markets. But each area offers some regulatory issues that need to be

looked at as well. This section focuses on these issues exclusively and in some detail. We takeeach sector in turn and point out the main regulatory issues that have been identified in the area,

in previous literature as well as through our data collection, and then discuss the issues in some

detail to suggest some recommendations for almost all of the areas concerned. This is by no

means an exhaustive list of all regulatory issues. But it does make an effort to point out all of the

major issues, and it does make an effort to contextualize each issue sufficiently to motivate the

recommendations made. It goes without saying that some of the issues require further study

before we can get to the bottom of the issues mentioned. This is particularly true of issues

surrounding the area of contract enforcement and repudiation. We hope this section will go some

way in starting a debate in the area.

3. Regulation needs to be seen as an enabler and facilitator. Regulation helps thegovernment and the society to facilitate business operations and to provide a level playing field

for all. It should not be seen as a way of controlling activity or creating hurdles in the way of

businesses. As such, the issue is not of over or under regulation, but of effective regulation. In

some cases Pakistan has good regulatory laws and systems, but their implementation is weak. In

other areas there are not enough regulations and in some there are too many. What is needed,

from the government side, is a) an attempt to think of regulation as an enabler, b) to create a

continuous dialogue with the business community that will allow fine tuning of regulations, and

c) a constant effort to ensure effective implementation. The government has to get out of the habit

of making rules for some and it has to get out of the habit of making exception as well. Markets

cannot function well without optimal regulation, but regulation that is optimal and effective. This

is the direction we have to move in to ensure better functioning domestic markets in all areas.


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Section 2Retail and Wholesale

2.1 Introduct ion

4. The importance of retail and wholesale sector in direct contribution to the GDP, the

growth of GDP, and to employment in the country is already well established through themacro data available with us3. Retail alone contributes some 18 percent to the GDP and some

12-15 percent to employment. The sector has been growing at a healthy rate but is still

lagging behind, in size and development, to retail and wholesale sectors in other comparator

countries, so significant potential still remains in the sector. Why does the country have no

large scale retail chains? Why does it have retail clusters (Azam Cloth market, Hall Road

electronics market, etc.) with thousands of shops selling similar products rather than a smaller

number of larger shops? Why has growth been in number of small shops rather than in size of

shops or multiple shops under single ownership structures? Some of the factors have to do

with regulatory issues related to the retail sector. Property rights regime in the country,

contract enforcement issues, cost of introducing technology that increases the span of control

of unified management structure across multiple locations, among others, are some of theissues that need to be understood from a regulatory perspective.

5. Regulatory issues related to retail and wholesale markets can be split into two areas:a) agricultural produce wholesale markets and b) other retail and wholesale markets. The fruit

and vegetable wholesale markets are managed under a separate law and this needs separate

consideration. For other products the distinction between wholesale and retail markets is not

that clear or even important from a regulatory perspective, and their issues are similar as well

they are thus treated together.

2.2 Agric ul tura l Market ing

6. Grain, fruit and vegetable and livestock wholesale markets are quite heavily regulatedin the country across the four provinces, except if the market is in a small town. For the

Punjab, grain markets are regulated by provincial food department, the fruit and vegetable

wholesale markets by the provincial agricultural department, and the livestock markets by the

livestock department. We have discussed grain markets in the section on storage and

warehousing so we will focus on problems of fruit and vegetable wholesale markets here.

7. Fruit and vegetable wholesale market regulation comes under the agriculturedepartment (and now the new agriculture marketing department of the province). The market

regulation is enacted through the Market Committees under the Market Committee Acts. The

way these Acts have been set up, no wholesale fruit and vegetable market can be set up

without prior permission from the government; a market committee enjoys monopoly power

3 Details are given in the sections on retail and wholesale sectors.


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in its domain and no wholesale trading can take place outside of the areas that the committee

designates4, and then the Act also gives almost dominant power to the government even at the

operational level.

8. The government controls the set up of the Market Committee, it controls who getsnominated to the Market Committee, it controls a major share of the revenue from markets,

controls rents and other charges that can be collected, controls allocation of shops and shopspace, controls expansion and other major decisions as well. Under the circumstances, it was

not surprising that private sector did not participate in setting-up of fruit and vegetable

wholesale markets. Government-provided facilities were inadequate, did not give enough

returns to players to provide high quality infrastructure in the markets that existed - roads,

storage and other facilities, cleanliness, and so on - or to plan for optimal expansion. A city as

big as Lahore has only four markets for more than 7-8 million people!

9. The government of the Punjab did acknowledge the problem and set up a separatedepartment, Agricultural Marketing department, with the explicit task of modifying laws and

institutions so that private sector involvement in setting up and running wholesale markets,

on a commercial and for-profit basis, could be increased. But they asked the bureaucracy toamend laws to limit the power of the bureaucracy. The result was that despite amendments,

no private sector party became interested in entering the sector over the next couple of years.

The amended laws still retain most of the power of the government in nominating the

committee, setting rentals and most of the allocations, and micro-managing the operations

and day-to-day activities of the markets. It is not a surprise that the private sector has not

come into the sector despite the large potential for profits. The Market Committee Act needs

a more thorough revision to reduce the role of government to just ensuring smooth

functioning, protection of consumer and seller rights, and ensuring due diligence on

environmental concerns.

2.3 Recommendat ions

A thorough overhaul of the Market Committee Act to reduce the role of governmentto that of a true regulator and facilitator of commercial activity. This will mean

reducing its role in determining market committee members, nominating members,

determining rents and allocations, determining levies, and micro managing the day-to-

day operations of markets.

2.4 Main iss ues in Retail Markets

10. Our sample shows that most of the retail shops are not registered and many of themdo not even feel they have to register, though some felt that the cost of registering was toohighpointing to an interesting situation. By law, of course, all shops have to register under

the Shop Act. But the charge for that is nominal and there is no major hassle involved in this

process. There can be an issue of visits from officials and the issue of side payments

(corruption), but this is usually related to the labor department and is not linked to registration

under the Shop Act. Even in this case, this is not a major issue in terms of the total cost - in

time and money. But this is not the same as the registration of a business as a company, etc.

So the two registrations are different. It is the latter, registration of a business, that is more

4 An exception is going to be made for large scale grocery stores that are going to be coming to Pakistan

soon and starting operations here. But it seems this is going to be an exception only, without a change inthe larger law: an indication of how uneven the playing field can be for domestic and foreign or largeplayers.


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lending to occur. Of course it might be preferred by banks that its clients be formal sector

players, but this does not give sufficient and needed information to the bank.

20. It is of course in the interest of the banks as well as the potential borrowers to havesuch institutions, but there is a cost to setting up institutions. It might well be that where both

sides might see the value of such institutions, it might not be in the interest of any one party

to foot the bill for setting up such institutions. And if joint solutions from the side of clientsor from the side of banks are also not easy to achieve, it might have to be the government

who initially has to foot the bill, till the institution shows the value of its services and can

start charging for it. It makes sense for the government to foot the bill for such institutions as

it can break the low level equilibrium and create value for the entire economy. The exact

form of institutions can vary, but rating agencies, agencies for creating sector specific

knowledge, and credit bureaus are all needed to address the asymmetry. In addition, these

institutions will need to be connected to each other too to provide a more complete

information set.

21. There do not seem to be any major obstacles to the creation of such bodies. The StateBank of Pakistan has already made provisions for income based lending:, it has also extended

the remit of its credit bureau to include information on borrowers of all loan size. But wehave not yet seen the rise of credit bureaus with more complete information and rating

agencies focusing on some sectors or on smaller firms. This might need some further

encouragement from the government.

2.5.2 Recommendations

Creation of credit bureaus that not only have information on those who have alreadyacquired loans, but also on prospective and potential clients. SBP has a bureau that

has information on existing borrowers, we need to create bureaus that have

information on potential clients as well, and the field of information will need to be

more than just information on loans. It will have to have information on any

outstanding legal disputes, relationships with buyers and suppliers of the business,

information on history of relationship with the utility providers and any other

information that might be pertinent in establishing the credit worthiness of the

business.

Creation of sector specific information providers. SMEDA could play a significantrole here, but the federal government needs to redefine SMEDAs role to take on this

effort in a much more concentrated manner.

2.5.3 Taxation

22. Most retailers7have a problem with the level of income and sales tax in Pakistan. Inaddition, taxation structures impose significant compliance costs on businesses, and the

compliance costs are higher for small and medium sized businesses, as a percentage of their

sales or turnover, as compared to the larger businesses, and there are significant threshold

effects as well that the current tax structure creates. These threshold effects distort incentives

for registration as well as growth of enterprises, and thus create significant distortions overall

as well. We will deal with these issues in turn.

23. Most retailers (and other small business owners) do not want to register their business(as a company) or do not want to get caught in the formal net as they feel that they then

7 Most manufacturers as well as service providers have similar issues with the tax authorities. We arefocusing on retailers here, but the arguments made should be considered to be more general.


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become a target for the tax authorities. This issue of being a target has a number of facets. A

lot of retailers feel that the rate of income tax (corporate as well as personal) is too high. If

they are in the net, they feel they will be under more scrutiny and will have to pay the

requisite tax rate. Secondly, almost all of them feel that 15 percent sales tax is too high and is

a burden on them as well as the consumers and creates hurdles in their business and its

growth. Retailers also feel that since the sales tax chain is not fully documented, some ofthem have to bear a higher burden of taxation, for being in the formal sector, than others. This

is truer of manufacturing industry than retailing, but is a general complaint. Thirdly, a

number of importing retailers and wholesalers complain that the import duty and clearance

process is still a major hurdle for them. The issues with Customs clearance have to do with a)

the time it takes to get goods cleared, and b) the duty imposed on imports. There is still a lot

of discretion, with the Customs officials, as to what duty rate to charge for a particular brand

and good and this creates uncertainty for importers and it opens up the doors for corruption as

well.

24. The issue of compliance cost is raised by many people, and in different ways. OneFaisalabad textile manufacturer and exporter mentioned that he had absolutely no problems

with the sales tax regime of the country and he thought everything was fine with him. Thiswas unusual as almost every other person in our sample complained of tax issues. When

asked how many people he had in his accounts office to deal with compliance issues related

to taxation, the manufacturer said he had six people dealing with sales tax issues, another 4

dealing with customs and another 3-4 people dealing with income tax issues. This was

independent of any accountants and lawyers that they hired at the time of yearly filing or in

case there was a litigation to deal with. The cost of these 13-14 people, in terms of salaries

and other support material was not being figured in as a cost of compliance by this

manufacturer. But clearly the cost is substantial. Sales tax and income tax regimes require

significant level of paperwork and interaction with the requisite departmental authorities and

customs clearance is still seen as a major hurdle by exporters. The contact with authorities

and the paperwork requirement also create openings for corruption and side payments as

well. A number of less educated retailers and wholesalers mentioned that it was either the

CBR officials or the lawyers who these retailers had hired to represent them who were

making money. Since they could not understand the intricacies of the procedure they could

not offer any effective checks on what the lawyers and the officials decided. The cost of

compliance will be higher for smaller firms compared to larger ones, as a percentage of the

sales. Even side-payments have a certain threshold size and they are not monotonic with size

so that smaller firms will be paying more, again as a percentage of their turnover. It is not

surprising that, given the above, most firms like to stay below radar level of the CBR and

would prefer to avoid registration if they can.

25. Taxation structure still has threshold effects that discourage growth and distortbusiness activities. Retailers are required to pay a 3 percent turnover tax if they haveturnovers below a certain limit and pay 15 percent sales tax if they move beyond the point.

This sets incentives for businesses to report below threshold level turnover, and in case they

do go over, it creates incentives for businesses to subdivide, at least on paper, rather than

cross the threshold. For example, where one of the larger confectionary makers of the

country, with many shops across Pakistan, is registered as one business and pays 15 percent

sales tax, his main competitors have every shop registered as a separate business and pay only

3 percent turnover tax. In effect the threshold effect is not only encouraging distorted growth,

it is penalizing the person who wants to grow in a legally sound manner.

26. The issues related to local taxes have been addressed to a certain extent over the last

decade. Most provinces have reduced/consolidated the number of taxes they levy and thoughsome work still needs to be done in the area, regarding labour levies, local taxes are not a


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major cause of regulatory problems for businesses now. The procedures might still be a bit

time consuming, and there are still some problems of corruption in this area, but these are not

a major regulatory concern any more.


Continued focus on rationalizing the income tax structure. The introduction of self-assessment scheme has helped in lowering compliance costs and corruption costs, the

process needs to continue. In addition, as the tax net broadens, the government needs

to think about lowering tax rates. This will lower incentives for corruption as well as

increase incentives for joining the formal sector.

Sales tax regime requires significant work: a) the tax rate needs rationalization, b)sales tax chain needs full documentation, c) compliance procedures need to be

streamlined. The zero rating of textile to get rid of a major portion of the refund game

was a big positive step.

Customs clearance process has been improved a lot over the last few years. But weneed further improvements to ensure a) speedier clearance and b) less discretion for

setting tariff rates, to minimize chances of corruption and time delays.

More detailed studies of the taxation system are needed to pinpoint all thresholdproblems that distort incentives and could be affecting the growth of enterprises as

well as entire sectors. This requires micro-studies of tax systems across sectors, but is

something that the CBR can accomplish on its own. Removing these distortions need

not have any tax revenue implications and so should be win-win for both businesses

as well as the government.

2.5.5 Infrastructure

27. Almost all retailers have talked about the poor quality of infrastructure servicesoffered by the state. This is again a problem that is common with all other types of businesses

as well. The problems with telecommunication facilities have come down significantly in the

last few years. The main problems that exist now are with a) WAPDA, b) local and national

road providers, c) water, sewerage and solid waste management providers.

28. Electricity: Most businesses point out that electricity rates for commercial andindustrial activity are very high, the quality of supply and other services related to electricity

provision are poor, and there are high levels of corruption that they have to face in getting

connections as well as in dealing with getting and paying bills.

29. Tariff rates for commercial usage of electricity are the most expensive in the country,

and then come industrial rates. Domestic usage and tubewell usage rates are the lowest. Butthis tariff structure defies economic and developmental logic. Industrial and commercial

electricity is cheaper to supply, cheaper to meter and receive money from, and contributes the

most to the growth and development of the country. Keeping it more expensive raises the cost

of production of firms in Pakistan, compared to other countries, and can make our industry

less competitive in these times of global competition. Still the tariff structure favors domestic

users. In addition, it is not even clear what the link between cost of production and provision

is to the tariff rates charged to each of the groups mentioned above. WAPDA and NEPRA do

not seem to have conducted any optimal tariff analyses in this regard and tariff rates seem to

be based more on historical and political reasons than on any economic reasoning.

30. The quality of service of WAPDA comes under criticism as well. Electricity supplies

are disrupted often, load-shedding can be frequent, unpredictable and unannounced, andrepair services are patchy. This forces most manufacturers as well as wholesalers/retailers to


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invest in back-up generators and sometimes even alternative systems for having full time

supply. But captive power, though efficient when WAPDA is not doing its job, is nonetheless

a costly and inefficient by-pass to the potential service that a national grid could provide. The

cost, in terms of inefficiency, and non-productive expenditure, is borne by the society. There

is a further distortion related to size here too. For the larger manufacturer or

retailer/wholesaler, it is still possible to invest in a generator or back up system. The cost is asmall proportion of their turnover or can be raised through bank financing. But for the smaller

producer or retailer, investing in back up power can be a significant fixed and sunk cost, and

could be a significant portion of its savings or working capital. But if they do not or cannot

invest in back up power, they have to live with frequent disruptions to their business activity.

Both options will be costly for them.

31. The arbitrary powers that have been accorded to WAPDA are costly formanufacturers and can create significant uncertainty for them. The legality of detection bills

is quite dicey. If WAPDA does send someone a detection bill, even if it is completely

unwarranted, the concerned enterprise has to deposit the said amount with WAPDA before

they can even start contesting the issue. The contestation can take up to months and even if

the enterprise gets relief from WAPDA, the excess amount deposited is likely to be adjustedagainst future bills rather than being refunded. The entire process can be, again for the

smaller producer, quite disruptive and costly. In one instance one of the manufacturers

interviewed8 mentioned that he bought a gas turbine unit to provide him with alternative

power as he was tired of the problems with WAPDA, but when he applied to WAPDA to

have his industrial connection dismantled, WAPDA told him that he would have to continue

to use it (and pay for it) for three years before they would let him shift to his gas based unit.

This was very costly for him as he had to now sit on his unit (and the investment he had made

in it) for three years before he could benefit from it.

32. The issue of arbitrary power, though not as common, is also true for other utilityproviders as well. The natural gas provider in Lahore requires manufacturers to pay 3 months

expected bill in advance to the utility company. But there is no recourse, for a quick and fair

hearing, against such steps.


There is a need for better planning regarding our future needs for electricity. This istied to a) setting up new hydroelectricity projects, b) getting access to more natural

gas, c) having a better thermal, nuclear and hydroelectricity mix. The government has

a number of initiatives in this regard, and these need to be initiated and completed on

a priority basis.

WAPDA has to be forced to rationalize its tariff structure to reflect more clearlyarticulated economic objectives. Commercial and industrial activity is subsidizingdomestic usage and this is driving the cost of business much higher than is acceptable.

National Electric Power Regulatory Authority (NEPRA) has to be built up technicallyso that it has the power as well as ability to a) provide effective checks against abuse

of power by WAPDA, b) carry out analyses, regarding costs and tariffs, that can

provide alternative inputs into policymaking for the government, c) offer help to

WAPDA to work out better tariff structures, d) provide a more effective control for

services offered by WAPDA.

Benchmark or real competition has to be introduced between and within DISCOs, thelocal distribution companies, to improve the quality of services offered by them. The

8 A Faisalabad based textile manufacturer.


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incentives systems of employees within DISCOs have to be aligned to ensure delivery

of better services.

NEPRA and the judicial system have to provide speedier and fairer recourse toprovide relief in cases where WAPDA or DISCOs have oversteped their bounds.

2.5.7 Local Road and other Local Services

33. The state of the local roads that are off the national arteries is generally very poor. Inmany cases the dilapidated condition or even non-availability of farm to market roads adds

significantly to the costboth in terms of money and timeof business. It also contributes to

wastage of produce. Poor road conditions in and around markets increases delivery times,

causes damage to goods and to vehicles, and is a cause of accidents as well. Poor roads in and

around industrial estates have been a major gripe of industrialists for a long time.

34. Local roads and other local services like provision of water, street lighting, localchowkidari, solid waste management, and sewerage systems are the responsibility of the city

local government. Local governments receive a percentage of the motor vehicle registration

and token fees for the purpose. But the key issue here is of incentive systems. Localgovernments may focus attention on better provision in areas and to constituencies from

where they can get more electoral support. Industrial and commercial clients might not be

high on their agenda. Local activism might be the only solution to the problem. The issue of

provision in and around an industrial estate can be separated out from this. Management of

local services for industrial estates can be handed over to management committees from

within the industrial estate as well. There have been some interesting experiments, in this

regard, under PIEDMC in the Punjab where management of Multan industrial estate, Kot

Lakh Pat industrial estate in Lahore and some others have been handed over to local

committees and in some cases the provision of services has improved significantly since then.

This model might be worth exploring for other industrial estates as well, it might be possible

to adapt it for vegetable/fruit markets as well as other wholesale and retail clusters.


Involvement of committees of local retailers, wholesalers and industrialists, from thelocal cluster, might be one way of ensuring delivery of better quality local services.

2.5.9 Contract Enforcement & Repudiation

35. Issues related to contract enforcement and repudiation affect businesses in a whole

variety of ways that distort current business activity as well as growth trajectories and futurescenarios. In fact, the area is so important, from a regulatory point of view, that it might be

important to conduct a separate study on this issue eventually. Our focus groups, interviews

and data point out to a number of concerns related to the area.

36. Most retailers/wholesalers pointed out that they were competing in sectors wherecompetitive pressures were high and there were many competitors even in vicinities where

they were working. Yet, all of them also pointed out that they tended to work with a limited

number of buyers and sellers, upstream and downstream, on a regular basis. The relationships

they had tended to be based on repeat interactions, additions to the set happened on the basis

of referral and there was hardly any place where this was based on formal contracting and

document signing. Most people even pointed out that in cases of disputes, they had their own

mechanisms for dispute resolution and few went to the formal sector judicial system forredress. The repeated game and reciprocal arrangement might be effective and low cost


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arrangement but it can surely only be the second best as it restricts growth of these

organizations, imposes significant costs of selection and development of reputations and

reciprocity arrangements, and even investments in multilateral institutions of redress.

37. A large scale retailer and manufacturer of confectionery9mentioned that he had had tointegrate backwards into production of ghee because he could not find a reliable ghee

manufacturer in the country who could provide him with the quality of ghee he wanted andprovide requisite quality assurances too. Since his reputation crucially depends on the quality

of his ingredients, he could not take a chance on quality variance in ghee. So he had to

integrate backwards into ghee manufacture, even though a) his comparative advantage is in

retailing and confectionery manufacturing, and b) his growth targets are related to taking his

brand name, as a retailer and manufacturer of confectionery, to many countries around the

world. Lack of reliable partners and possibilities of long term contracting are forcing this

manufacturer to choose a growth path that is distorting his growth and advantage and slowing

down his growth in the direction he wants to move in.

38. A chain-departmental store owner10mentioned that they also had a tailoring unit thatproduced mens shalwar kameez suiting under their own brand name. This was an attempt to

leverage their brand name as a quality retailer into a new area that of mens clothing. Butwhat was surprising was that they had set up their own tailoring shop as well and were

managing it themselves. Again their comparative advantage lay in managing retail and not in

managing manufacturing. But the answer was the same: they could not find reliable tailoring

outfits in the city of Lahore. Hence they were also forced to integrate backwards. This is even

more curious than the previous example. Where ghee was a crucial ingredient for the

confectionery manufacturer, mens shalwar kameez does not require the same sort of quality

assurance, and was definitely not crucial to the retail operation of this organization. But the

result was the same: they had to integrate backward where their advantage and organizational

goal lay in the direction of developing the retail chain more.

39. The same story was repeated by a manufacturer of spare parts for automobiles as well.He said that if he decided to make any new part, he had to set up the entire process for

himself and could not get any sub-parts, even screws and nuts, made from outside. This not

only raised the setup time for any new parts for him, it also increased his R&D as well as

overall cost of manufacturing as well as he had to invest into all of the relevant machinery for

sub parts as well. And the reason for the same again: could not find reliable partners.

40. In all of the cases mentioned, lack of possibilities for long term sophisticatedcontracting, ensuring quality and delivery times, is forcing firms to integrate backwards, limit

their expansion in areas where their core competence lies and restricting as well as distorting

their growth.

41. On the retail and wholesale side as well, lack of possibilities of long term

sophisticated contracting is leading to very limiting outcomes. There are some 15,000wholesale and retail cloth shops in the Azam Cloth market area in Lahore. All of these shops

are relatively small, all of them sell similar types of products, and all of them source their

products from similar places. So their cost structures, businesses and contacts are similar as

well. The question to ask is: why are there 15,000 shops and not say 500 larger ones? Why is

it that every time a generation grows up, all of the brothers try to set up separate shops and do

not join the father, formally, in expanding the same shop to a bigger size, under some suitable

partnership or formal company arrangement. Similarly, a number of even larger retailers

pointed out that the number of branches they had were restricted to the number of brothers

they had: they thought they could not go into long term contracting with professional

managers to create a larger chain.

9 Interview with the Chief Executive.10 Interview with the key manager and one of the directors.


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42. An importer and wholesaler11of automobile parts pointed out that they had only 14odd dealers in the country. These dealers were given goods on credit, had been developed

over a 20 year period through a process of weeding out and now they did not add any new

dealers to the lot. He said adding new dealers was too costly as one had to go through a long

process of screening (inquiring about reputations from the market, finding people who could

put pressure on the person if need be) and slowly building trust (starting with smalleradvances and then building up from there). In the 20 year history they had faced delays and

problems with payments a number of times, but had never gone to courts with that. Instead

they had invested in creating informal councils of elders in all markets and it was these

councils who mediated their disagreements. Even in a case where one dealer went bankrupt,

it was this informal council that managed the selling of the bankrupt persons shop and then

payments to all the creditors, in proportion with loan size. Though the system worked, the

owner was very aware that this was not optimal as it was holding their growth back.

43. The issues mentioned above all point to a significant cost that businesses in Pakistanare paying for not having an efficient and effective contract enforcement environment. The

court system in Pakistan takes a long time to adjudicate disputes, and many people mentioned

that they did not even have confidence in the court decisions anyway. So, the time and moneycosts of getting contract enforcement through courts are very high. As a result businesses

have either developed alternatives that can deliver second best outcomes (depending on

alternate dispute resolution mechanisms, mechanisms based on reciprocity or repeated

interactions), or they have avoided taking on the area (subdividing businesses instead of

forming partnerships) or have been forced to take on the issue themselves (backward

integration or integration of activities that might not be their core activities). In each of the

case mentioned, the option chosen might be the best available, but it does distort the optimal

functioning of businesses, and it impacts the longer term growth prospects of the firms as

well.


It is hard to suggest recommendations for this area as it still needs further and morein-depth study. So one recommendation would be exactly that: the area of contract

enforcement, as a part of the need for second generation reforms, should be accorded

high priority and should be studied in a lot more detail as it seems to be imposing a

significant cost on businesses in terms of carrying out day to day activities as well as

planning optimally for the future.

Many countries have started experimenting with lower cost Alternate DisputeResolution Mechanisms, but formal sector ones. This should be looked into for

commercial disputes at least. Some countries have also experimented with setting up specialized courts. We have

done that for the area of banking. Maybe it could be tried for commercial areas as

well.

2.5.11 Law and Order

44. Retailers, wholesalers, manufacturers, transporters, in fact businesses from all sectors,pointed out that the poor and deteriorating law and order situation imposed significant costs

of their business operations. But the problems pointed out were different for different areas.

11 Interview with one of the owners.


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45. A number of manufacturers and retailers12from Karachi pointed out that a) they hadto hire more guards for the protection of their homes as well as businesses, b) they had to

have guards for their accountants who carried cash to and from banks, c) they even had to pay

protection money to groups to ensure the safety of their businesses. Despite the above, there

was a significant proportion of businessmen who mentioned that their places of work or home

had been robbed over the last few years, a number had had family members abducted forransom. A number of businessmen mentioned that they had acquired immigration to Canada

and some had even sent their families abroad, and some mentioned that they would not be

expanding their business in Pakistan and would leave if they could sell their businesses are

reasonable prices.

46. Law and order issues were not as acute in other parts of the country, but a high levelof dissatisfaction did exist with the overall law and order situation. A car rental company

owner mentioned that almost all of his drivers had been robbed, at least once, in various parts

of the Punjab, while on duty. The incidence of mobile phone snatching has been talked about

enough in the newspapers already.

47. Perceptions of law and order affect investment and growth decisions of businesses. If

domestic commerce is to take off, law order situation, across the country, will have toimprove substantially.

12 Based on interviews.


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Section 3Transport Sector

3.1 Introduct ion

48. Transport sector is a significant contributor to the GDP - 11 percent of GDP - and

employment level - 6 percent - in the country.13

But the contribution of the sector could bemuch larger if we had a more efficient transport sector that could focus on delivering a higher

quality of service. Though the estimates of inefficiency vary, even the smallest of these

estimates is in a few percent of the yearly GDP of the country.14 More significantly, the

indirect contributions of an efficient and high quality transport sector, in terms of lowering

the costs of doing business in Pakistan, delivering goods and services on a strict time frame,

ensuring on-time deliveries, especially for the export markets, could be quite significant as

well. As trade barriers come down and Pakistani firms have to compete for export shares and

even compete in local markets, any disadvantage that might be there, due to higher

transportation costs or higher delivery times, is going to be quite costly for the country as a

whole.

49. One manufacturer of engineering goods mentioned that he lost orders for exportingparts to Japan because he could not guarantee time bound deliveries. The Japanese firm

wanted a strict timetable for deliveries that this Pakistani manufacturer could not live up to.

He said: I could promise when I would deliver my consignments to the port in Karachi, but I

could not guarantee when they would reach Japan as I had no control over the clearance

process in Karachi and every time the time it takes for clearance is different. This was not

good enough for the Japanese company so they cancelled the order and instead sourced their

material from a South East Asian country.

50. An inefficient and low quality transport sector is costly in another way as well.Pakistan has one of the highest fatality rates, per head, due to accidents, in the world. The

loss, to the country, in terms of lost wages, lost capital and lost future earnings, is quite

significant. And this is taking the loss of life in pure economic terms only. The loss, in humanterms, is of course much more and possibly immeasurable.

51. Transport sector includes air, sea and land transport, for both passengers as well asfreight. Land transport includes both road as well as railway, and the inland transport market

is also segmented between inter and intra city segments. Each of the above mentioned

categories has its own set of regulatory issues. We will look at these separately.

13 See section on transport in this study. The figures are quoted in various World Bank and ADB studies aswell.

14 These estimates are given in the section on transport issues.


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3.2 Land Transpor t

52. For both freight and passenger traffic railway and predominantly private sector (busand trucks) compete in the intercity market. Railways is a government owned and run

monopoly, while on the road transport side, apart from NLC, a army owned entity, most of

the trucking as well as bus industry is in the private sector.

3.2.1 Railway

53. Pakistan railways handles about 10 percent of inter city passenger traffic and onlyabout 5 percent of the inland freight market. Pakistan Railways focuses primarily on

passenger traffic even though there is a larger potential for profits on the freight side. But

Railways is still not run on profit basis. It continues to have run routes that are financially not

viable, spend resources on maintaining these, and offer prices that are not worked out on the

basis of costs. In return Pakistan Railways receives subsidies from the state and also runs

significant losses. But this is not the only result of the lack of focus and clarity of purpose.

Due to the above objectives (or lack thereof) the incentives for Pakistan railway, to provideefficient and high quality service to passengers as well, are severely diluted. Furthermore,

lack of focus on the freight business has also meant that Pakistan railway is not making

profits from the area that it could have used to cross subsidize its passenger service. But this

is a result of overall lack of incentivization in the entire organization.15

54. On the freight side, the share of Pakistan railways is very small. On cost estimatebasis railway should have a substantial advantage over road transport for long haulage and

given the North-South route in Pakistan, railways should be the optimal choice for freight

transfer. But it is not. The main reason seems to be the inefficiencies in the railways system.

On average it takes 8-10 days for railways to transport goods from Karachi to Peshawar,

while trucks cover the same route in three days.16Our focus group participants pointed out

that nepotism and corruption in the railways meant that people with money or connections

could get early deliveries but others had to wait longer and also could not predict when the

goods would be delivered. They also pointed out that incidents of pilferage were also more

common on Pakistan railways. For both of the above reasons some people pointed out that

they preferred to use trucks for delivery of loose or smaller items and use railways for only

the larger items and full container hauls.

55. The main issues with the railway system and organization have to do with a) lack ofclear objectives for the organization, b) lack of high powered incentives, for the executives,

to achieve clearly stated objective, and c) lack of hard budgets and efficiency bench marks

for the organization and people. But these issues are within the railway system. Some of the

main problems emanate from outside. Railways is a government monopoly with almost nocompetition or private sector involvement. In addition, there is not even an independent

sector specific regulatory authority that can impose any effective checks on the organization.

So it suffers from the classic problems of non-regulated government monopolies. But the

inefficiencies of Pakistan railway are affecting more than railways themselves. They are

raising freight costs from what they could be and they might also be forcing excessive

development and usage of trucking industry due to the distortions created by them.

15 See section on transport.16 Interviews as well as views of focus group participants.


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Since the sector is never going to be perfectly competitive, due to large fixed costs oftrack, there is a need to establish an independent and empowered regulator that can

enforce some quality and efficiency standards on Pakistan Railways.

Railways needs to be corporatized so that we can a) state the specific objectives it issupposed to achieve, b) have incentive alignment for its management, and c) create

reward/punishment systems for all levels, in line with objectives.

Not all portions of the railway are necessarily a natural monopoly. For example, thetrack is a natural monopoly, but how many players run their trains on these tracks or

how many players run their carriages on these tracks are not pre-determined.

Railways, once it is corporatized, needs to introduce competition in areas that are not

a monopoly.

Debundling of services (such as in electricity now where production and distributioncan be quite competitive while the national grid remains a monopoly) might be

another option that railways can contemplate.

56. None of these options will work if the government does not allow the creation of anindependent regulator and does not treat railways as a corporation and does not create some

distance between itself and

The State of Domestic Commerce in Pakistan Study 4 - Regulatory Issues in Domestic Commerce

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