Mini-budget lacks solutions for fiscal constraints: Moody’s

KARACHI: Pakistan’s recently announced mini budget lacks new solutions to address its fiscal constraints and debt sustainability will largely remain at risk, ratings agency Moody’s Investors Service said on Thursday.

“In absence of new spending cuts or revenue-raising measures, however, these (budgetary) measures will keep Pakistan’s budget deficits wider for longer, potentially eroding the credibility of government efforts to achieve fiscal consolidation,” US credit rating agency said in a report.

“There is a greater risk of fiscal slippage and slower fiscal consolidation in the absence of further revenue-raising measures.”

The Pakistan Tehrik-e-Insaf government on January 23 announced its second mini-budget largely focused on revenue-based measures to improve supply-side conditions for businesses and incentivise domestic reinvestment.

Moody’s said the government remains committed to fiscal consolidation, however “a wider for longer deficit could raise questions over the credibility of the government’s fiscal policy”.

Moody’s said the budget outlined limited revenue-raising measures, primarily taxes on large vehicles and high-end mobile phones.

The mini-budget places greater weight on improvements in tax administration and spending restraint for the government to meet its deficit target of 5.1 percent of GDP.

“We expect the deficit to widen to 6 percent of GDP in fiscal 2019 because revenue growth is likely to be below government projections, given slower economic growth and the new revenue-based incentives, before gradually narrowing to 5 percent of GDP by fiscal 2021 as the economy picks up,” it added.

Pakistan’s revenue base was a narrow 15.4 percent of GDP in fiscal 2018.

Compared with the government’s first mini-budget in September 2018, which emphasised spending cuts, the second mini-budget aims to improve business conditions, including for manufacturers and exporters, by removing or reducing existing taxes that erode profit margins or dis-incentivise reinvestment.

Moody’s said the measures, if effective, would support Pakistan’s manufacturing

sector, fostering exports and import substitution, and help narrow the current-account deficit.

Specific measures include reductions in import custom duties on essential raw materials and machinery, the abolition of tax on retained earnings, and incentives for the agriculture sector, which accounts for around 20 percent of the country's exports.

The mini-budget came against a backdrop of low export growth in the first six months of fiscal 2019, despite the rupee’s 25 percent decline against the US dollar since December 2017.

The government is seeking to narrow the current-account deficit by reducing some of the tax distortions exporters’ face.

Weak exports aside, Pakistan's current-account dynamics have been largely positive in recent months.

Remittances rose by 10 percent year on year in dollar terms in the first half of fiscal 2019, while goods imports slowed sharply to around three percent year on year as non-fuel goods imports contracted.

“However, although we expect the current-account deficit to narrow to 4.7 percent of GDP in fiscal 2019 and to 4.2 percent in fiscal 2020 from 6.1 percent in fiscal 2018, it will remain sizable and wider than in 2013-16, driving Pakistan’s external financing needs,” it added.

The government has secured $12 billion in financing from Saudi Arabia and the United Arab Emirates – in each case amounting to $6 billion and divided equally between deposits and deferred oil payments – which is likely to largely cover the country’s net financing needs for fiscal 2019.

However, a net financing gap beyond fiscal 2019 remains because of the still sizable current-account deficit.

Pakistan remains in negotiations with the International Monetary Fund over a new programme that would provide a stable additional source of external financing, as well as technical support and assistance on macroeconomic rebalancing and structural reform policies.

The country is also in discussions with other countries and multilateral lenders such as China, Qatar, the Asian Development Bank, the IBRD and the Islamic Development Bank over external funding support to shore up its external position, Moody’s said.