Recipe for disaster

INSIGHT

The expansionary fiscal policies unveiled by the outgoing Pakistan Muslim League-Nawaz (PML-N) in budget 2018/19 might be beneficial for luring voters to win the next general elections, but it could be a recipe for disaster, bringing macroeconomic instability in its wake.

The doling out of incentives has outpaced the taxation measures. The bureaucrats responsible for preparing the budget proposals have tactfully inserted certain proposals, which if approved by the Parliament could provide space for ensuring mobilisation of non-tax revenues that would not become part of the Federal Divisible Pool (FDP) for distributing among the provinces under the National Finance Commission (NFC) Award. One such proposal is the additional petroleum development levy which has been jacked up from Rs10 per litre to Rs30 per litre.

The government has understated the revenue impact steps they have undertaken in this budget and overstated relief in a bid to win the support of voters. It is evident that this budget does not tackle the challenges rising on the fiscal front due to the twin deficit, including the budget deficit and the current account deficit.

Despite applying such tactics through Finance Bill 2018, it would be a miracle for the outgoing regime to restrict the budget deficit below six percent of the gross domestic product (GDP) in the outgoing fiscal year of 2017/18. For the incoming government too, it would be difficult to keep it below five percent of GDP with the existing taxation and non-taxation measures.

Unsustainable federal budgets have remained a constant in Pakistan over the years.

An unsustainable budget is one when the government spends most of the earnings on its legal commitments, especially due to its mandatory programmes leaving no room in the budget to spend on other programmes, which might not be mandatory, but are still very important to provide public services and public investment. Such spending comes under the head of “discretionary expenditures”.

Although, there should be no distinction between the “discretionary” and “non-discretionary” expenditures in a budget, limited resources force a government to spend on legally binding commitments. In Pakistan, non-discretionary spending in public finance includes the legally “charged” expenditures necessary to finance constitutionally established bodies, debt servicing on domestic and external fronts, distribution of revenues under the NFC Awards, spending on security forces, and disbursement of salaries to the public sector employees.

The federal government’s fiscal sustainability has been declining persistently due to several factors, including tax to GDP ratio, steady increase in debt servicing obligations, and over-hiring in the federally-owned enterprises, despite the provisions in the 18th Amendment, which transferred many of the service delivery responsibilities to the provinces.

One of the major casualties due to the erosion of discretionary space in the federal budget has been the PSDP, the size of which is reduced each time the government needs to cut down its expenditures. The ratio of PSDP has decreased to three percent of GDP in the outgoing financial year 2017/18 compared to 4.7 percent in 2006/07. This has also impacted service delivery and service quality in the non-salary component of the public sector.

Sadly, if the current trend of slashing the PSDP continues over the years, there will be a time when there is no space in the budget to accommodate development programmes. This would also impact Pakistan’s overall national development and the human development index, which is already doing poorly.

Experts are already of the opinion that it is difficult to reverse the existing trends with shrunken fiscal space due to rising demand for debt servicing and defence.

To rid Pakistan of debt and to reduce the fiscal difficulties, a strict political resolve is must, which includes taking tough decisions such as “right-sizing” in the federal public sector, taxing the untaxed to increase the tax-to-GDP ratio, and documenting the economy to generate more revenues.

Without fiscal sustainability, the budget deficit would be bound to increase thus pushing up demand for imports. Although the government had slapped regulatory duty and imposed non-tariff barriers that had helped slow down imports a little, the government was unable to manage financing of rising current account deficit, which is why the foreign currency reserves kept depleting at a rapid pace. The foreign currency reserves had already fallen below $11 billion held by the State Bank of Pakistan (SBP). Further depletion of reserves in the next few months would force Islamabad to knock at the door of the International Monetary Fund (IMF).

With this announcement of budget 2018/19 by the newly promoted Minister for Finance Miftah Ismail, the PML-N would have to strive hard to get this budget approved from the Parliament. The PML-N would have to keep the required number of parliamentarians within the fold of the party and ensure their presence at the crucial occasion of getting the approval of the National Assembly. In case none of that happens, it would be difficult for the government to get the Finance Bill and other budgetary measures approved.

Several macroeconomic indicators could be changed by the incoming government on the basis of this argument that the PML-N led regime had forced the economic ministries to prepare the budget on half cooked figures. It is worth noting that the budget proposals have been made on the basis of data collected between six to eight months, which means that the reality of figures would be completely changed by the time the new government takes charge.

This would be a unique year for Pakistan on the fiscal side. It is possible that the country would witness the presentation or preparation of three budgets for 2018/19. One has been presented by Finance Minister Miftah Ismail last week. Another could be an adjusted bill made by the caretaker setup, and the third could be an amended one by the new government, that will take up governance after the general elections this year.

The proposed budget, instead of focusing on luring voters should have paid attention to the fiscal situation. The current document does not show prudent planning, however the sloganeering about “stable economy” has continued, which will culminate in macroeconomic instability confronting Pakistan over the next few months.

The PSDP would be altered in a big way, where many ongoing schemes would be shelved and major adjustments would be made. Some taxation measures would be reversed by the coming government in a bid to keep budget deficit within the desired limits.

The IMF prescription will be crystal clear, cut down expenditures and mobilise revenues to keep the budget deficit around four percent of the GDP so growth will be the ultimate victim. The IMF is known for “one size fits all” policy so nothing will change this time again.

As a matter of caution for policy makers, it will be a nightmare for them to convince the IMF to provide increased resources for meeting the requirement.

The writer is a staff member