Budget 2023-24: an astonishing read

Pakistan is currently facing the most challenging conditions in history, with a severe economic crisis compounded by political uncertainty. The economy is facing stagflation as it is expected to shrink – accompanied with skyrocketing inflation of over 30 per cent.

The rupee has devalued by 40 per cent in the past year, foreign currency reserves plunged to a month’s imports and fiscal and current account deficits have persisted for decades. The country encountered the most devastating floods last year that affected over one-third of the population, and has been impacted by the consequences of the Russia-Ukraine war.

Adding to the difficulties is the inability to revive the IMF programme, which is essential for receiving loans from international financial institutions and maintaining some confidence of investors and lenders about its progress towards stabilization of balance of payments. As a consequence, three major credit rating agencies have downgraded Pakistan’s rating to near-default status.

In this context, it is astonishing that the finance minister has presented a hugely expansionary budget for FY24, with total federal government expenditure of Rs14.4 trillion, 50 per cent more than the original budget of the current year. Current expenditure is budgeted at Rs13.3 trillion, up 52 per cent compared to the original budget and 27 per cent compared to the revised estimates for the current year.

The biggest item in the budget is obviously interest on debt of Rs7.3 trillion, 85 per cent higher than the original budget for the current year, but likely to increase significantly for the reasons discussed in this article. There will be a steep increase in the establishment expenditure due to a hefty increase in salaries (30-35 per cent) and pensions (17.5 per cent) of current and past government employees. Subsidies will cost Rs1 trillion, and the development programme has been raised by 100 per cent to Rs1.14 trillion compared to the revised estimate of Rs0.562 trillion in the current year.

A review of the budget will leave the reader dumbfounded, as it does not give any impression that the country is in distress and unable to pay its debts. In such a situation, any country would naturally focus on drastic actions to cut unproductive expenditure and invest in sectors that provide maximum economic benefits and cash flows. Given the critical need for a major IMF programme in the coming months, it was essential to target a fiscal deficit of below 4.0 per cent and primary surplus of at least 0.5 per cent to meet the Fund’s expectations. Contrarily, the budget targets a fiscal deficit of 6.5 per cent and primary surplus of 0.4 per cent, based on highly optimistic revenue targets that will be difficult to justify.

The finance minister also announced in the post-budget press conference that the next government (which means the new elected government after the elections, the timing of which remains uncertain) will manage the future IMF programme, which further escalates uncertainty. It also indicates virtually no inflow of foreign currency loans, thus more stringent restrictions to curtain imports in coming months will continue creating more distortions in trade and supply chain.

Let me highlight my concern regarding misreporting of the most critical indicator in the budget – the fiscal deficit. The revised estimate of fiscal deficit for the current year is reported as Rs5.94 trillion. In a country that is entirely dependent on financing its deficits through public debt, the amount of fiscal deficit should be equal to the increase in public debt. However, the increase in public debt in the nine-month period up to March 31, reported in the Economic Survey, was Rs10 trillion. Since public debt is likely to increase further by at least Rs2.5 trillion in the last quarter by June 30, the overall fiscal deficit for this year (the total increase in public debt) is likely to be Rs12.5 trillion – which amounts to 14.4 per cent of GDP, rather than reported figure of 7.0 per cent of GDP.

It appears that the government is not taking into account the exchange loss due to translation of foreign currency loans in computing the fiscal deficit, resulting in its understatement, which is clearly incorrect. This practice seems to have been followed in the past and continues in the FY24 budget. It is due to this that actual increase in public debt has been much higher than reported fiscal deficits over the years.

The ceaseless expansion of the government through borrowing, recurring large and under reported fiscal deficits have devastated the economy. In FY23, the federal government deficit was projected at Rs4.5 trillion, with planned bank borrowing of Rs3 trillion. However, the revised deficit increased to Rs6.4 trillion, due to which government borrowing from banks will be significantly higher. Per SBP figures, the total investments of the banking sector on March 31 (comprising over 95 per cent government securities), amounted to Rs19.77 trillion compared to the corresponding figure of Rs15.37 trillion in March 2022.

This means that the banking sector provided approximately Rs4.4 trillion to the government during the last one year. Compared to this, the total increase in all bank deposits and advances was Rs3.5 trillion and Rs1.4 trillion, showing that banks provided more funds to the government than net increase in their deposits. Since they also provided advances to the private sector, the difference amount was borrowed by banks from the SBP through its open market operations (OMOs). It is also noteworthy that since December 22, the situation has further deteriorated, as banks’ total advances declined by Rs79 billion, which indicates that the private sector is reducing their borrowing owing to very high interest rates.

Moreover, since deposits are insufficient to meet the government’s borrowing appetite, the difference is being provided in the form of short-term paper sourced from the State Bank’s OMOs, which has increased from less than Rs2 trillion in June 2021 to Rs7.3 trillion on June 9, 2023. All of this reflects a huge risk to the banking system, which seems to be working substantially to finance the public sector’s expansion rather than productive activities of the economy.

Given these conditions, in FY24, the federal fiscal deficit is pitched at Rs7.57 trillion, out of which estimated local borrowing – largely from the banking system – is planned at Rs5 trillion. In view of highly optimistic revenue targets and extreme difficulties in raising more foreign currency debt in the absence of the IMF during the first half, it is natural that the federal deficit and need for local bank borrowing will increase steeply. Even if it turns out to be Rs5 trillion, this will be a monumental amount – much higher than the increase in total deposits of the banking system.

Additional borrowing of trillions will be needed to repay the short-term banking debt that will mature in the coming months. Already, there is nervousness in the banking circles regarding further lending to the government, and it may become extremely challenging to raise even local debt of such large amounts. In any case, the banks are likely to significantly increase interest rates, further burdening the government and leading to much higher interest cost than what has been budgeted.

The above budget strategy effectively means that virtually all of the domestic savings will be used to finance the government’s unproductive expenditure, while the private sector – which is reluctant to borrow at interest rates of over 22 per cent – is likely to reduce borrowing, leading to further contraction in the economy.

An expansionary budget in these most difficult times, which will unleash much higher inflation than what has been projected, reflects a fundamental problem embedded in the mindset of the political class. There is continuous expansion of the state, based on the assumption that it has unlimited resources and that distribution of largesse can continue endlessly.

To meet the massive expenditure requirements, highly ambitious targets of tax and non-tax revenue have been set. While high revenue targets may align with the IMF requirements, the steep increase in expenditure is clearly aimed at the upcoming elections. Thus, the government has tried to please three stakeholders: the IMF, their potential election candidates, and the public. However, it is unlikely that these numbers will satisfy the IMF. As to the people, an overwhelmingly large population will suffer from unprecedented inflation.

Clearly, Pakistan needs to finalize the new IMF programme together with restructuring and re-profiling its external debt as early as possible to eradicate the risk of sovereign default and create an environment of trust in its economy. For any such programme, the IMF and other lenders will require major structural reforms, including measures to reduce unproductive expenditure and curb unsustainable recurring fiscal deficits.

Therefore, in my humble view, the FY24 budget is unsustainable, and likely to undergo significant adjustments in the coming months to make it acceptable to the IMF and other lenders. The year ahead appears far more difficult than what has been portrayed, and the attempt at creating a popular budget at this time is simply unworkable.

The writer is a former managing

partner of a leading professional services firm and has done extensive work on governance in the public and private sectors. He tweets @Asad_Ashah