Budget 2025: beyond accounting

Fiscal policy is a key arm of macroeconomic policy, one under the direct control of the government of Pakistan. Fiscal policy works through changes in the amount and structure of government spending, the amount and kind of taxes and levies imposed, and the amount and form of government borrowing.

The government can directly influence economic activity through current and capital expenditure. The indirect influence comes through the impact of the framework of subsidies, transfers to the private sector and investments.

We have learned the damaging effects of fiscal account deficits (government expenditures exceeding revenues) through various empirical works. Fiscal account deficits (FAD) lead to macroeconomic volatility, crowd out private investment, and impede economic growth.

Fiscal Year (FY)24 is the third year running with Pakistan’s economy estimated to clock a FAD nearing a whopping 8.0 per cent of GDP – the largest on record. In nominal terms, it translates to an FAD of over Rs8,300 billion or $30 billion, the highest number in the country’s history. FAD bloated to 7.9 per cent of GDP in FY22 similar to FY19, sadly the highest in over two decades. FY23 is no different with FAD at 7.8 percent of GDP. Surely, the authorities must be concerned.

Elevated FAD has left Pakistan struggling with slugflation, dwindling private and public investment levels, and rising debts. Debt distress has worsened with a painful weakening in the key sustainability indicators. Debt to revenue, interest to revenue, and especially the ratio of debt servicing to exports show issues of sustainability and liquidity being much more severe in FY24 compared to the past.

However uncomfortable the numbers, we cannot give up hope that somehow Budget 2025 will be more than an accounting exercise, and will recognize the gravity of economic vulnerabilities. It will be a response to the crisis. It will not burden the average Joe but rather address inflationary pressures by undertaking a fiscal correction.

Inevitably, the budgetary discussion in Pakistan hovers around the dismal federal tax-to-GDP ratio, huge tax gaps, and differential treatment of the same levels of income from different sources. The more informed folks highlight the tax structure as being distortionary and unfair. There is a discussion of its inability to provide sufficient resources to pay for critical government services, while pushing the misallocation of resources within the economy by incentivizing unproductive sectors where hundreds of billions of illicit wealth is stashed. These are hard facts. One fully endorses the need to reform all these areas.

Intellectually, the discussion on the revenue side needs to be broadened to include provincial budgets. Provincial revenues remain uncomfortably low at less than one percent of GDP. Urban property tax, General Sales Tax on services, motor vehicle tax, and agriculture income tax are all in the provincial domain. Certainly, they have high potential which is hardly being tapped.

Truth be told, the ideas debate for Budget 2025 has to focus equally on the issues in the expenditure side of the fiscal equation - in terms of quality and quantity. The expenditure side is a less well-understood and researched area. Since the 7th NFC Award in 2010, especially with ballooning fiscal deficits, the authorities should have undertaken a worthwhile in-house review of the budgetary expenditure. Handling the growth in Pakistan’s federal spending is critical to ensuring fiscal and debt sustainability and improving the social contract between the state and its citizens.

Issues that must be addressed in Budget 2025 include settling the fiscal devolution of subjects on the current and development sides and a framework for sharing subsidies with provinces. For eons, we have talked about targeting the subsidies in power, gas, and agriculture, but failed in our execution. Hopefully, there will be the realization to put our money where our mouth is and divert the resources that can benefit the poor.

Bold reforms can include a move to a contributory pension scheme for new entrants, a ban on new recruitment for a couple of years, and abolition of all vacant positions. Further, monetization of the perks and privileges of the civil and military bureaucracy can help reduce pilferages. This work has to be formalized by a team of actuaries. Several committees over a decade have been a wasteful exercise – we still have not begun to scratch the surface in this regard. Not being serious has been a recipe for disaster.

Similarly, a ban is required on forming new divisions and districts for a few years. A meaningful restraint on travel with a shift to video connectivity may not save billions but is good for optics. The size and structure of development spending needs to be reconsidered. The authorities should show restraint with additional projects till the backlog of ongoing projects is substantively reduced. Project design for the future should be based on a bang-for-the-buck analysis and emphasis on the economic value proposition. The quality of development expenditures needs revision with the objective of improving human development indices.

Pakistan’s debt, both external and domestic, is only sustainable with adjustments. The projections of the International Monetary Fund on Pakistan’s debt profile are looking quite uncomfortable. The central government debt from Rs68,342 billion at the end of FY23 is estimated to rise to Rs119,918 billion in FY28 (a 75 per cent rise). Pakistan’s external and domestic debt review with the view of debt reprofiling, recycling, debt for development, and environmental swaps are doable options.

The country’s budget FY23 (the latest available) entails tax exemptions and concessions for income tax, sales tax, and customs duty of about 2.7 per cent of GDP or Rs2,200 billion. It is imperative to wean off the undeserving from this state largesse. Strengthening the budgeting process including fully operationalizing the Treasury Single Account can help reduce public borrowing needs.

Rationalizing provincial expenditure is also essential. Provinces need to review commodity operations and the subsidies dolled out on them. Provincial state-owned enterprises (SOEs) are an unreviewed area. Reforms of the provincial salary bill should strengthen the link between pay and productivity, and eventually raise efficiency in the provision of public services. This work requires a serious research effort.

Budget 2025 cannot and should not be another weak document. Pakistan needs a well-thought-out and discussed piece of paper laying the foundation of future fiscal sustainability. One realizes that both the NFC Award and bleeding SOEs cast a heavy burden on federal resources. They need to be addressed. However, the idea is to be less overwhelmed and resolve at least those issues that can be handled in Budget 2025 - if the government chooses to do so.

A sluggish pace of fiscal consolidation, when fiscal instability is the dominant variable holding the whole economy hostage, is unacceptable. I have deliberately framed my argument of deficit reduction policies leaning more on careful prioritization of spending. This is well supported by research.

A 2018 paper (Alesina, Alberto, and Silvia Ardagna. 2018. ‘Climbing out of Debt’, in Finance and development) confirms that expenditure-based plans are generally less harmful to growth than tax-based plans and are a sure bet for a reduction in debt to GDP. The above ideas are a doable agenda of reforms for Budget 2025. Time is of the essence. Budget 2025 will be presented in June 2024 – as always, we keep our fingers crossed.

Twitter/X: @KhaqanNajeeb

Email: khaqanhnajeeb@gmail.com

The writer is an economist and public-sector specialist, and has served as an adviser to the Ministry of Finance.