It is not an easy task to discern the nature of fiscal adjustment inherent in the just announced budget unless we examine it within the context of debt dynamics that the country is facing and how they are addressed in the budget.
Let us explain it. The fiscal deficit is estimated at Rs 3137 billion or 7.1% of GDP, and that too based on a hefty surplus of Rs 423 billion or nearly 1% of GDP. Ordinarily, it is unthinkable that an IMF program would allow such a large deficit to be incurred. The program has changed the target of deficit away from overall deficit to primary deficit. The latter is worked out after subtracting from it the interest payments. The debt dynamics teach us that if the primary deficit is positive then notionally it is possible to not just cover interest payments but partially retire a portion of the principal amount of debt. Thus it is a situation where the borrower is not pushed to borrow even to cover interest payments. If there is a primary deficit, some interest payments are also paid through borrowing. Under this condition, the debt accumulation path is explosive.
During the last three years, primary deficit has risen sharply. It was 0.3% of GDP in 2015-16, then rose to 1.6% in 2016-17, 2.2% in 2017-18 and 2.0% in 2018-19 (which is the revised estimate and is likely to go up). The fiscal deficit during these periods were recorded at 4.6%, 5.8%, 6.6% and 7.2%, respectively. If we subtract the primary deficit from these fiscal deficit numbers we get 4.3%, 4.2%, 4.4% and 5.2%, respectively, which is the burden of interest payments during these years. The challenge on the fiscal side, therefore, was to arrest this rising trend in the primary deficit and turn it into a primary surplus. This year it has been targeted to come down from 2% (revised estimate), or Rs 880 billion, to 0.6%, or Rs 264 billion, which gives an adjustment of 1.4% or by Rs 616 billion.
In the following years, there would be a primary surplus, which would begin to lower the interest payments. But more significant reductions in debt servicing burden would come only after interest rates startcoming down. This would happen when inflationary pressures abate. In the short-run, immediately after budget, there would be further pressure on prices because of new taxation measures adopted in the budget. But mercifully, the international oil prices, the main driver of inflation, are coming down and hence we may expect the inflation to come down much earlier than expected. Surely, the base effect of higher inflation during this year would also kick-in.
The biggest reduction in primary deficit is coming from taxation, which is billed at Rs 5550 compared to the revised estimate of Rs 4150 billion (which is an over-estimate since only Rs 3300 billion have been collected in eleven months and hence final collection of Rs 3900 billion would be a major achievement). The proposed increase is about 32% (which would be 42% if the base is Rs 3900). This is a phenomenal increase but considering the fact that the loss of Rs 500 billion during the year was primarily a result of poor policy actions or court intervention, it is not an unachievable target. This lost tax revenue is in the system but was either given in exemptions or stopped by a court order. Since these distortions have been removed, this lost amount should be taken in the base. Adding the autonomous growth during the year leaves only a manageable tax effort of Rs 500 billion, which is what is budgeted for the next year. What is laudable is that new tax measures are not dependent on increase in the tax rate of existing taxes, particularly such as the increase in GST rate or maximum rate of income tax, which many had apprehended. A number of measures are base-enhancing though in many cases rate of taxes have been increased where room existed, most notably through additional duties chapters that carry finished products. This was also balanced by giving significant concessions in duties on raw materials for industries. Furthermore, removal of exemptions has been a significant focus of the tax measures. The most commendable reform is the fundamental restructuring of the distinction of filer and non-filer. While doing away with the distinction, the law allows a non-filer to buy immovable property or vehicles subject to becoming a filer within 45 days. This is a reform that would contribute to broadening the base.
The expenditure side has limited flexibility in the short-run to help reduce the deficit. Yet, some decent moves have been made in this regard also. The most significant is the freezing of defense budget at the last year’s level, which has easily saved at least Rs 110 billion (0.25% of GDP). The reduction of Rs 30 billion by the civil government is also a right step. Unlike these savings, the budget has made handsome increases in such important areas like development expenditure and social spending. The development expenditure is pitched at Rs 700 billion compared to the revised estimate of Rs 500 billion for the current year. Despite being a hefty increase, this is still below the spending level that the country had seen few years ago. However, given the massive cut applied during the year, it is a good beginning and more needs to be done in the next few years as the fiscal space becomes available. Sizable allocations have been made for the social protection, including BISP and other Ehsas programs, which would be helpful in partially mitigating the burden of adjustment on the poorest segments of the population.The government has also announced that it would stop additions in circular debt within two years
The most significant development is the financing of deficit of Rs 3137 billion. More than half the financing would come from external sources budgeted at Rs 1829 billion. This increased access to foreign resources would be made possible by continued adherence to Fund program. From domestic sources, the major financing would come from non-bank sources budgeted at Rs 983 billion (of which Rs 883 billion from national savings schemes and Rs 150 billion from privatization proceeds). From the banking sources only Rs 339 billion have been budgeted, all of which would come from the commercial banks and none from the central bank. This is a major reform effort, as in the last three years, the government had accessed SBP financing without any restrained leading to a huge build of SBP borrowings of Rs 8.6 trillion until mid-May 2019 from Rs 1400 billion on 30-6-2016.
Before closing, let us underline the fact that this is a budget that is based on the understanding that the government has reached with the IMF. Several of its measures are the prior actions for program approval by the Board. It seems the budget has faithfully implemented the program conditionality. In our view, this is the easier part of the program because at this stage political leadership is fully alive to ground realities and has the necessary resolve to move ahead. But this is just the first step of the proverbial ‘journey of thousands miles’. A great deal of energy and discipline is needed to implement the program over a three-year period with twelve quarterly reviews. For most of the programs, economic managers and political leaders alike have failed to muster such resolve. The budget is imminently deliverable, and so are the other program targets so far known. It could fail only on account of our perennial inability to carry reforms to the finish line. Let’s hope this team and leadership would prove that they are imaginative and resolute to complete the program with distinction.
(The writer is former finance secretary)email@example.com
(This news/article originally appeared in Business Recorder on June 14th, 2019)