The primary concern is today very much with the largest current account deficit ever of $ 18 billion. There is not yet much appreciation of the fact that the year, 2017-18, has also seen the largest fiscal deficit in the history of Pakistan of Rs 2260 billion. Therefore, we have today a very acute state of destabilization of the national economy and an incipient financial crisis.
There is need to appreciate that the ‘twin’ deficits are linked to each other. A large fiscal deficit raises aggregate demand in the economy and fuels the demand for larger imports. This aggravates the size of the current account deficit.
Similarly, a large current account deficit increases the external financing requirements. The government is compelled to meet this requirement by resort, increasingly, to high cost borrowing through flotation of bonds in the international capital market and short-to-medium-term commercial borrowing. This adds to the cost of debt servicing in the Federal Budget and increases the fiscal deficit.
What is the state of public finances of Pakistan? The year, 2017-18, has closed with a deficit equivalent to 6.6% of the GDP, the highest in the last five years. The true deficit is actually larger if a downward adjustment is made to revenues for the once-and-for-all tax revenues from the amnesty scheme. Also the Ministry of Finance (MoF) has reported the receipt of grants and sale of Government assets as non-tax revenues when these flows are actually in the category of financing of the deficit.
Further, there is borrowing by PSEs with guarantees provided by the government. The servicing of this debt is done largely through the budget. Therefore, such borrowing should be added to the deficit. Overall, the ‘true’ fiscal deficit has approached 7.5% of the GDP in 2017-18.
The question is whether the rise in the fiscal deficit in 2017-18 can be attributed to the fact that it was the ‘pre-election’ year. There is indeed a pattern here. The last year, 2007-08, of the Musharraf government saw a very big fiscal deficit of 7.4% of the GDP. This was a very large jump from the deficit in the previous year, 2006-07, of only 4.3% of the GDP. Similarly, the last year, 2012-13, of the PPP government witnessed a deficit of 6.4% of the GDP even after retirement of circular debt that year is excluded.
There is, however, a difference in the nature of the budgetary outcome among the three ‘pre-election’ years. The years, 2007-08 and 2012-13, witnessed a phenomenal jump in the total expenditure combined of the federal and provincial governments of 36% and 25%, respectively. This was the consequence of different forms of pork barreling including creation of more jobs, larger grants, hefty salary increases, bigger subsidies and more development funds to elected representatives.
The behaviour of the PML (N) government appears to have been different. Federal spending went up by only 8% in 2017-18 and the level of development expenditure actually showed no increase. The provincial governments demonstrated somewhat more profligacy with a growth in expenditure of 15%. By and large, there was more restraint in expenditure shown in the pre-election year of 2017-18 as compared to the previous two occasions.
However, the PML (N) government found a new way of garnering votes. Contrary to the past practice and conventions it chose to present a sixth budget for 2018-19 on the eve of its departure. This was a budget characterized by various tax concessions, including the extraordinary income tax break to individual taxpayers. Therefore, in this case, the pre-election fiscal behaviour will impact on the budgetary outcome in the year after the elections, that is, 2018-19.
What then are the factors contributing to the large fiscal deficit in 2017-18? The answer is to be found primarily on the revenue side. Believe it or not, this is the first time in living memory that federal net revenue receipts have actually fallen in absolute terms.
They showed an annual growth rate of 13% in the first four years of the PML (N) government. Suddenly, in 2017-18 they have fallen by 4%, from Rs 2583 billion in 2016-17 to Rs 2478 billion in 2017-18. In effect, they have plummeted from a peak of 8.1% of the GDP to 7.2% of the GDP in one year. This is slightly larger than the increase in the fiscal deficit from 5.8% of the GDP in 2016-17 to the reported 6.6% of the GDP in 2017-18.
The fall in federal net revenue receipts is attributable to the precipitous decline in federal non-tax revenues. They declined in one year in 2017-18 by as much as Rs 272 billion. This highlights a new structural problem that has emerged in the public finances of the country.
Hitherto, the focus has been on the relatively low tax-to-GDP ratio of Pakistan. There is need to recognize that during the tenure of the PML (N) government this ratio has shown a marked increase from 9.8% of the GDP in 2012-13 to 13% of the GDP in 2017-18.
Despite all the negative perceptions, FBR has done a commendable job in raising its tax collections from 8.6%of the GDP in 2012-13 to 11.1% of the GDP by 2017-18. Also, for the first time, the provincial governments have made a significant contribution by raising their tax revenues by 0.5% of the GDP, largely on the back of a buoyant sales tax on services.
What explains the debacle in non-tax revenues? First, there is the virtual end to defense receipts in 2017-18. These were mostly in the form of reimbursements by the USA from the Coalition Support Fund (CSF). They were budgeted at Rs 142 billion in 2017-18, but the actual receipts were less than Rs 13 billion, implying a fall of over Rs 129 billion.
The other major shortfall is in other non-tax revenues. These were relatively high in 2016-17 at Rs 306 billion, but collapsed to Rs 118 billion in 2017-18. These revenues consist mostly of the receipts from UN peacekeeping operations by the Pakistani Armed Forces and the money realized from the sale of government assets. Clearly, there is need for more transparency as much of the decline is in the proceeds from sale of government assets. It is not even clear as to what are these assets?
The bottom line is that there will be greater pressure this year and incoming years for federal tax revenues to show even faster growth to compensate for the low level of non-tax revenues and their tendency to continue falling. However, the MoF has projected optimistically that they will rise to Rs 772 billion in 2018-19, thereby demonstrating a high growth rate of 23%.
The two main sources of increased revenue anticipated are SBP profits and mark-up payments by PSEs. Rising interest rates could facilitate the flow of higher profits from the central bank. As opposed to this, there is likely to be a big shortfall in the other major source. Given the poor financial state of the PSEs, it is unlikely that they will be able to honour fully their mark-up payment obligations as has happened already in 2017-18.
The second and new element of risk in the budgeting for federal revenues is the big increase anticipated in non-FBR taxes. These stood at Rs 223 billion in 2017-18 and again, believe it or not, MoF expects them to more than double in one year to Rs 453 billion in 2017-18.
There is the overall conclusion that a new Achilles heel has emerged in federal finances. These are revenues from non-tax and non-FBR tax sources. Potential shortfalls in relation to budgeted revenues may add almost 1% of the GDP to the fiscal deficit in 2018-19.
The new government will have to focus on achieving the target of revenues, such that the fiscal deficit is close to 5% of the GDP. Otherwise, the higher level of aggregate demand due to a larger budget deficit will continue to put pressure on the size of the current account deficit.
(The writer is Professor Emeritus at BNU and former Federal Minister)
(This news/article originally appeared in Business Recorder on September 4th, 2018)