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Budgetary outcome in 2015-16

The information on fiscal operations by the federal and provincial governments in 2015-16 has been released recently by the Ministry of Finance (MoF). The budgetary outcome is mixed. On the positive side, FBR and provincial tax revenues have shown exceptional growth, the increase in current expenditure has been restrained and the Provinces combined have apparently generated a large cash surplus. On the negative side, non-tax revenues of the Federal government have plummeted, development spending has been severely cut back and overall fiscal deficit is significantly larger than the targeted.

They key findings on the fiscal front are described below.


— Overall growth in federal revenues is only 11%

Despite the high growth of 20% in FBR revenues, the overall growth in Federal revenues is only 11%. The primary reason for this is the big fall in non-tax revenues by over 17%. What explains the Rs 148 billion decline in non-tax revenues?

First, there has been a shortfall in receipts of Rs 50 billion from the Coalition Support Fund. Second, SBP profits have fallen by 43% in the absence of any privatization receipts from the banking sector like last year. Third, oil related income has declined. In fact, overall non-tax receipts are lower by 0.7% of the GDP. A new structural problem has emerged in the form of a constraint in non-tax revenues. This is tending to neutralise at least partially the gain in the tax-to-GDP ratio of 1.1 percentage points in 2015-16.

The growth in FBR revenues is due primarily to a ‘rate’ effect

Two taxes, namely, general sales tax and customs duties have demonstrated exceptional growth of 22% and 33% respectively, well above target. A large part of the rise in GST revenues is due to the jump in the effective rate on petroleum products from the statutory rate of 17% to the average of over 30%, in the presence of falling international prices. Similarly, the effective rate of customs duty on total imports has risen in one year from 6.5% to 8.6%, due to the levy of regulatory duties and an across-the-board minimum duty.

The performance of direct taxes is disappointing. Despite the vast expansion in the coverage and higher rates in the withholding tax regime it has yielded an extra 12% only in 2015-16. Also, there has been a big decline of 24% in collection on demand following audit. Consequently, there has been a shortfall of 10% in relation to the target.

Provincial tax revenues have shown phenomenal growth of 38%

The fiscal effort by the provincial governments, especially of Sindh and Punjab, needs to be recognised. For the first time, the provincial tax-to-GDP ratio has reached 1% of the GDP. The Sindh Revenue Board and Punjab Revenue Authority, in particular, have put in a stellar performance in broadening the base of the sales tax on services.


There is modest growth in current expenditure of only 6%

The restrained growth in current expenditure is visible primarily in the case of the Federal government, with an increase of only 4%. The corresponding figure in the case of the four Provincial Governments combined is significantly higher at 11%.

What explains the success of the federal government? First, the largest head of expenditure, debt servicing, has actually declined by 3% because of the sharp fall in mark-up rates. Second, defence services have shown a growth of below 9% only. Despite Zarb-e-Azb, the military is demonstrating greater cost effectiveness in its operations, resulting in saving of Rs 24 billion in relation to the budget estimate. Third, the tariff differential subsidy to the power sector has been reduced by Rs 50 billion, although this may have exacerbated the circular debt problem.

There has been a massive cutback in development spending of Rs 422 billion

This is due to slow growth in overall revenues and the need to restrict the deficit to the target agreed with the IMF. The cutback is equivalent to 24% of the budgeted level of development spending. It is 22% in the case of the federal government and 27% in the case of the four provincial governments combined.

The reduction in the PSDP related expenditures in 2015-16 is Rs 328 billion. This has not only reduced the short-run multiplier impact on the GDP but also slowed down the expansion in the productive capacity of the economy and retarded the process of revival of economic growth. Delayed releases and limits to implementation capacity have also contributed to the failure. In particular, the pace of execution of the China Pakistan Economic Corridor (CPEC) infrastructure projects has been adversely affected.

The process of fiscal decentralisation continues

A positive development, facilitated by the 18th Amendment and the 7th NFC Award, is the increase in the share of public expenditure by the Provincial Governments. The combined share was 30% on the eve of the NFC Award. It has now climbed to almost 36%.

The downside is that this is the consequence of a big increase in the share of revenue transfers to the Provincial Governments out of the total Federal revenues. This share was 32% in 2009-10, which has risen to almost 46% by 2015-16. The Federal Government has, of course, developed sources outside the divisible pool, like the petroleum levy and the Gas Infrastructure Development Cess (GIDC). However, the sharp decline in Federal non-tax revenues indicates that there may not be much ‘fiscal space’ for an increase in the vertical share of the Provinces in the 9th NFC Award.

Budget deficit

The overall budget deficit is significantly understated

The ‘above line’ (expenditure minus revenues) deficit is estimated at Rs 1561 billion while the ‘below line’ (total financing) deficit is reported at Rs 1349 billion. The latter is taken as the official estimate of the consolidated fiscal deficit. It is equivalent to 4.6% of the GDP, somewhat above the target of 4.3% of the GDP.

The difference between the two estimates of the deficit has been resolved by assuming a large ‘statistical discrepancy’ of Rs 212 billion. Over the last three years, the cumulative discrepancy reported is a colossal Rs 605 billion. This has never happened before and reflects a virtual breakdown in the budgetary process. The naiveand under par IMF staff mission has preferred to ignore this failure.

However, there are reasons to believe that the two estimates are closer to each other and the ‘statistical discrepancy’ is much smaller. It appears that financing of the budget through external borrowing has been greatly understated. As per the fiscal operations, this was Rs 342 billion in 2015-16. According to the earlier revised estimates it was expected to reach Rs 502 billion. Also, according to the public external debt figures of the SBP, the federal government borrowed Rs 504 billion in 2015-16 from external sources. As such, external borrowing has been understated by almost Rs 162 billion.

A more realistic estimate of the budget deficit is Rs 1511 billion, equivalent to 5.1% of the GDP. This indicates that the process of fiscal stabilisation has been slow during the tenure of the IMF programme. The deficit has declined by only 0.4% of the GDP in three years, as compared to the original expectation that the deficit would be brought down to 3.5% of the GDP by 2015-16. Instead, it has remained higher by almost 1.6% of the GDP.

Public debt

Public debt has risen to almost 68% of the GDP

The public debt has increased by Rs 2,676 billion in 2015-16 and reached Rs 20,051 billion, according to the SBP. Cumulatively, over the three years of the PML (N) government the rise in public debt is Rs 5,476 billion. Consequently, the public debt-to-GDP ratio has risen from less that 65% in 2012-13 to almost 68% in 2015-16.

Today the level of public debt is significantly higher than the ceiling imposed by the Fiscal Responsibility and Debt Limitation Act of 60% of the GDP. Further, a matter of concern is the rise in share of external debt and liabilities to 32%, even in the presence of a substantially overvalued rupee.

Budgetary prospects for 2016-17

Major risks to budgetary operations

The target deficit for 2016-17 is 3.8% of the GDP. The major risks in attainment of the target are as follows:

(i) No provisioning in the Budget for announcements made in the Budget Speech for the agriculture package and salary increases.

(ii) There is a serious problem with the high growth rate of 38% anticipated in federal non-tax revenues in 2016-17. In particular, lack of CSF inflows could mean lower receipts of as much as Rs 170 billion assumed in the budget estimates for 2016-17.

(iii) There will be some difficulty in achieving target growth of FBR revenues of 16%. There is no margin for further tax rate increases. As such, the likely growth rate is close to projected nominal GDP growth rate of 11%. In addition, provision has to be made for payment of refunds to exporters.

(iv) 2016-17 is the last full year before elections. There is pressure on both federal and provincial governments to spend more. Therefore, big cutbacks are unlikely in the respective PSDPs. At the federal level, there is already a spate of new projects being announced.

(v) Provincial cash surpluses are unlikely to reach a combined Rs 337 billion as these governments are likely to aim at coming close to budgeted estimates of expenditure, with somewhat lower revenue transfers than anticipated.

Overall, it will not be surprising if the overall budget deficit once again reaches 5% of the GDP in 2016-17. This is a somewhat sad story of the about to conclude IMF Program of Pakistan failing to help in achieving control over the size of the budget deficit and in the stock of public debt, while sacrificing growth in the process by heavy additional taxation and cuts in development spending.

Hafiz A. Pasha, "Budgetary outcome in 2015-16," Business Recorder. 2016-09-19.
Keywords: Economics , Fiscal policy , Private companies , Program budgeting , Economic development , Tax revenue estimating , Pakistan , CPEC , FBR , GST , PSDP , GIDC