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Factors impacting on FY22 budgets

There is a need to identify some of the factors which are likely to impact on the key budgetary magnitudes of the Federal and Provincial Budgets for 2021-22. These factors are either positive or negative.

The positive factors are identified first. The major impetus that will be provided to FBR revenues is the prospect of faster growth in 2020-21 in industrial production due to the low ‘base effect’, especially after the Covid-19 attack. Some key industries which contribute to sales tax and excise duty revenues are showing exceptional dynamism. These include industries such as sugar, POL products, cement, cigarettes, and automobiles. A 1 percent faster growth in industrial production contributes an additional Rs 33 billion to FBR revenues.

While higher oil prices can be considered as leading to more inflation, they unambiguously contribute to higher import duty and sales tax revenues. The price of oil in the global market has gone up from $35 per barrel in June 20 to over $67 per barrel currently. The average price in 2020-21 is likely to be close to $57 per barrel. If the price stays at $67 per barrel in 2021-22 then the additional tax revenues could be as much as Rs 100 billion.

Overall, if the economy grows faster by 1 percentage point in 2021-22, then given the high elasticity of import demand, the overall quantity level of imports could rise faster by 1.3 percent. This will contribute additional revenues of over Rs 30 billion.

The largest source of withholding income tax revenue is from contracts. Currently, construction activity is booming in the country due to the incentives provided to real estate development and more concessional credit for low-cost housing. A 1 percent faster growth in construction activity, both directly and indirectly, can yield higher tax revenues of Rs 15 billion.

Turning to the negative factors, first, there is the drastic reduction in the rates of petroleum levy in the last few months to neutralize the impact of higher international prices of petroleum products. This has large implications on the level of revenues. Annual revenues of up to Rs 500 billion from the levy were feasible when the rate was Rs 30 per liter both on HSD oil and Motor Spirit. Now the rates are Rs 12 and 10 per liter, respectively. If they remain unchanged in 2021-22, then this could imply a large revenue loss of almost Rs 315 billion.

The positive impact of a stronger rupee is sizeable, especially downstream on the rate of inflation. Nevertheless, by reducing the rupee value of imports, it implies a lower tax base for import-related taxes. The likely average value of the rupee is likely to be close to Rs 161 per dollar for the year 2020-21. It is currently operating at under Rs 155 per dollar. If this exchange rate remains unchanged in 2021-22 or the rupee appreciates somewhat more the revenue loss could be of Rs 70 billion.

There are factors operating also on the expenditure side. Since 2018-19, the Military establishment has focused on economizing on defence spending to facilitate management of public finances by the civil government. Currently, the expenditure on defence services is expected to come down from 2.7 percent of the GDP in 2020-21 to 2.5 percent of the GDP in 2021-22. This implies a saving in expenditure of over Rs 105 billion.

The big decline in the SBP policy rate after the first Covid-19 attack from 13.25 percent to 7 percent is now beginning to yield results in terms of lower growth in costs of servicing domestic debt. This is projected to fall from 6.1 percent of the GDP in 2020-21 to 5.9 percent of the GDP in 2021-22, again leading to a saving of Rs 105 billion.

The major factor that will contribute to higher current expenditure is the impending rise in salary and pensions to be announced by the Federal Government in the Budget. Similarly, the two Governments of Punjab and Khyber-Pakhtunkhwa have also announced similar awards. The Federal Government has made a provision for this purpose in the Medium-Term Budget Strategy (MTBS) paper of Rs 260 billion for this additional expenditure. If the four Provincial Governments announce increases in pensions and salaries of a similar magnitude, then the combined cost to these Governments will approach Rs 300 billion.

A new factor is the need to make a provision for larger subsidy to the power sector to also finance the payment of arrears to the IPPs. There is no explicit provision for this is the MTBS. However, the forthcoming Federal Budget may include up to Rs 200 billion for this purpose.

Overall, it is likely that the budgetary implications of negative factors both on the revenue and expenditure side will substantially exceed the impact of the positive factors by almost Rs 700 billion, equivalent to 1.3 percent of the GDP in 2021-22. This will imply that the budget deficit in 2021-22 will persist in the range of 7 to 7.5 percent of the GDP.

The agreement with the IMF originally was to bring down the budget deficit from 7 percent of the GDP in 2020-21 to 5.5 percent of the GDP in 2021-22. The MTBS has proposed a higher target of 6.0 percent of the GDP for next year. Apparently, now the target is 6.3 percent of the GDP as per the presentation made recently to the Finance Committee of the National Assembly by the Ministry of Finance.

The higher projected deficit of 6.3 percent of GDP is still understated given the net impact of negative factors highlighted above. Inevitably, the consequence will be a cutback in development spending, which was expected to play a key role next year in stimulating the economy. The proposed size of the Federal PSDP for 2021-22 is Rs 900 billion. This may have to be cut down by over 20 percent and still imply a larger deficit than the targeted level.

The year, 2021-22, promises to be a difficult year given the impact of large negative factors like the reduction in revenues from the petroleum levy, a big salary and pension award and the need to make provisions for bringing down the circular debt of the power sector. This will dominate over the contribution of positive factors.

Hopefully, the IMF will continue to show an understanding for the difficult situation the country faces in the aftermath of successive attacks of COVID-19. There may be need for performance waivers in the sixth and subsequent reviews. The IMF needs to be reminded that as many as twelve waivers were given during the tenure of the last IMF programme from 2013 to 2016.

Dr Hafiz A Pasha, "Factors impacting on FY22 budgets," Business Recorder. 2021-06-01.
Keywords: Economics , Provincial Budgets , Federal government , National Assembly , Pakistan , GDP , MTBS , IPPs. SBP

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