Rogue deficit

The yawning budget deficit is now adrift like a ship, whose captain and crew are either too busy bailing it out or have no clue how to helm it out of storm, thus leaving it at the mercy of fate, especially in the wake of increasing tax revenue shortfall amid expenditures that went out of control during the fiscal.

After coming into power, Pakistan Tehreek-e-Insaf- (PTI) led government first hiked the budget deficit target from 4.2 percent to 5.1 percent in September 2018. They did it by rightly arguing the outgoing Pakistan Muslim League-Nawaz- (PML-N) led regime had prepared the budget on wrong assumptions where revenues were overestimated and expenditures were underestimated.

Again the budget deficit target was silently hiked to 5.6 percent of GDP around December 2018. On the eve of maiden National Finance Commission (NFC) meeting, the provinces were told the budget deficit might cross 6.1 percent of GDP for the current fiscal year.

But independent economists like Dr Hafiz A Pasha are projecting the budget deficit touching 7 percent of GDP in the ongoing financial year keeping in view a massive shortfall in tax and non-tax revenues.

The budget deficit in first half of the current fiscal year ballooned to Rs1,030 billion or 2.7 percent of GDP. The budget deficit could be divided into 40:60 ratios in first and second half of financial year keeping the record of last two decades in view. With this empirical evidence in mind it can easily be projected the budget deficit might hover around 7 percent of GDP.

The Ministry of Finance is claiming the budget deficit would be curtailed less than the last year’s 6.6 percent of GDP, asserting they have prepared a strategy to achieve the desired target. The government is mainly relying upon renewal of licenses of three mobile operators, sell-out of two regasified natural gas (RLNG) plants and another major transaction in order to bridge the yawning deficit.

On other hand, the Federal Board of Revenue’s (FBR) shortfall that has been increasing with every passing day is projected to reach Rs350 billion given the status-quo approach. However, with revenue mobilisation efforts this shortfall could be reduced depending on the performance of the taxmen in terms of achieving success on realising revenue efforts.

So far the FBR faced a shortfall of Rs237 billion in first eight months (July-Feb) period of the current fiscal year as the collection stands at Rs2,328 billion against an assigned target of Rs2,565 billion.

In February 2019, the collection fetched Rs268 billion against the fixed target of Rs314.070 billion for the month. The board’s high-ups argued the ongoing tension with India resulted into a drop in collection in the last three days of February 2019 because even Goods Declarations (GDs) were not filed by the importers by end of the ongoing month.

The collection stood at Rs2,060 billion in first seven months and after adding Rs268 billion, the overall collection went up to Rs2,328 billion in the first eight months (July-Feb) period of the current fiscal year. The collection in the same period of the last fiscal stood at Rs2,259 billion. It indicates that the FBR collection increased only Rs69 billion so far in the current fiscal year.

Collection fell short of target because of incentives -by the last regime- for salaried class, massive reduction in utilisation of Public Sector Development Program (PSDP), suspension of withholding tax on mobile phone usage, and lower sales tax on petroleum products. The sales tax on petroleum products was brought at a standard rate of 17 percent. The sales tax collection on POL products at import stage decreased by Rs43 billion so far.

Ministry of Finance in its draft medium term strategy envisages the fiscal deficit, which under the International Monetary Fund (IMF) program was brought down to 4.6 percent of GDP in 2015-16, has shot-up to 6.6 percent in two years in 2017-18. It was mainly due to lack of effective coordination between the federal and provincial governments.

In addition, financial losses of state-owned enterprises (SOEs) were at a record high level of 1.4 percent of GDP. The energy sector’s circular debt crossed Rs1.2 trillion-mark.

Overall, expenditures of the two tiers of the government increased Rs1.7 trillion (i.e. by 30 percent) over these two years with recurrent expenditure increasing Rs1.34 trillion and development expenditure by Rs351 billion. In addition, the losses of SOEs, especially those in energy sector, increased the quasi fiscal deficit to 1.2 percent of GDP.

High fiscal deficits adversely impacted economy through multiple influences: First, both a cause and an effect of high fiscal deficits is the substantial increase in public debt – both foreign and domestic. The former, that was at $70 billion in 2017-18, has increased by $20 billion (38 percent) over the last three years, i.e. since the close of IMF program. During the same period, domestic debt increased Rs4.2 trillion (by 3.7 percent of GDP). The overall public debt at the end of 2017-18 stood at 76.1 percent of GDP, far in excess of the limit of 60 percent of GDP imposed by Fiscal Responsibility and Debt Limitation Act (FRDLA).

Despite the artificial stability in interest and exchange rates, interest payments on domestic and foreign debt increased 5 percent and 26 percent, respectively, adding to the fiscal deficit. In addition, repayment of foreign debt led to an outflow of $5 billion/annum.

Second, high fiscal deficits were financed by large-scale borrowing from the banking system. Bank borrowing by the government increased rapidly in the last two years –from Rs787 billion in 2015-16 to Rs1,120 billion in 2017-18. This implies that almost one-and-a-quarter of a trillion of banking system credit is siphoned by the government every year. In addition, financing is also required to meet the financial losses of public sector enterprises and the market operations (largely for wheat procurement) of the federal and provincial governments. The share of government in the banking system (i.e. SBP and commercial banks) credit increased from 35 percent in 2005-06 to 74 percent in 2017-18. This leaves only 26 percent of bank credit for the private sector, thereby adversely affecting private investment.

Large borrowing from the banking system crowds out capital market development and creates a number of distortions in the capital market.

First, by guarantying at least a minimum income through its large risk free lending to the government, banks have no incentive to be more competitive or innovative in terms of introducing new products in the market for depositors or lenders.

The short-term nature of government borrowing from the banking system prohibits establishment of long-term yield curve, which in turn impedes development of capital market in the country.

Islamic banking, which has a considerable potential in Pakistan, suffers as they cannot lend to the government.

The government’s insatiable demand for financing has now spread beyond the commercial banks and many institutional investors are also lending mostly to government e.g. insurance firms, mutual funds, pension funds etc, further compromising the development of capital markets.

Third, large fiscal deficits are symptomatic of persistently negative government savings leading to low overall savings and consequently low investment. Public dissaving over the last 5 years averaged 1.5 percent of GDP. In 2017-18, private sector savings amounted to about 12.2 percent of GDP, of which 1.4 percent was preempted by the government to finance its consumption. A significant part of appropriation of private savings for government consumption takes place through the National Savings Schemes (NSS), these schemes use long-term retails savings to finance short-term government expenditures rather than long-term investment in the country. Hence, savings in Pakistan is extremely low at 10.8 percent of GDP, which is limiting investment and increasing reliance on foreign savings.

The NSS savings represent a key risk as long-term retails savings are being used to finance short-term government expenditures. It is important to focus on measures that would promote long term savings to be utilised for long term investments.

Finally, and critically, higher fiscal deficits also contributed to higher current account deficits, adding to the external vulnerabilities.

The higher fiscal deficit is mother of all economic ills and the government will have to devise strategy to curtail it with or without IMF program, otherwise the debt burden will mount more than exponentially in next five years.

The writer is a staff member