The revised Federal Budget for 2018-19 has raised a number of concerns ranging from the failure of the Government to use this occasion to share its vision for the economy, to the process followed and to the budgetary estimates for revenues and expenditures. These aspects are discussed in detail below.
Missing vision for economy
The government missed this opportunity to inform markets by setting out explicitly and comprehensively its intentions on the structural reforms that it plans to initiate and to this end the policy direction and actions it expects to take to remodel the economic landscape to steer the economy onto a higher sustainable growth path. To illustrate, it has not spelt out the tools it hopes to employ to significantly improve financial discipline and economic management. It has not proposed any serious measure to broaden the tax base and has relied essentially on a cumbersome and predatory tax system, employing inadequately effective existing instruments to mobilize resources.
More importantly, it has not shared its strategy, the blueprint of an action plan and the associated instruments to address the short-term challenges facing the urgent and most vulnerable element of the economy-the massive balance of payments deficit whose gross financing requirement could touch US$30 billion this year – in case of a business as usual scenario.
The continued silence and vagueness on whether it will be negotiating a program with the IMF is not helping mitigate the prevailing uncertainty. How it proposes to attend to these matters has largely been left to our imagination and speculation.
The PSDP at the Federal level has been slashed by over 28%, from Rs 800 billion to Rs 575 billion. The Constitution required that the revised PSDP for 2018-19 be presented to the National Economic Council, chaired by the Prime Minister, with representation of the Provincial Governments.
The presentation of a Budget also includes the simultaneous dissemination of a standard set of budget documents. These range from Budget Details on Grants and Appropriations, printed copy of the Budget Speech, Budget in Brief and so on. Instead, there is a one page unverified Budget at a Glance. Apparently, even this was also not circulated widely.
Given the cut in the PSDP, the revised document, Public Sector Development Program, 2018-19, should also have been made available.
For ensuring transparency and accountability presentation of the complete set of standard documents is necessary. To fulfill this objective all taxation related proposals should have been included in the Finance Supplementary (Amendment) Bill. This has not been done. The FBR has indicated that two SROs which are to supersede earlier SROs were to be issued on the day the revised Budget was to be presented. This has not happened yet. These SROs relate to levies of additional duty and regulatory duties. The use of SROs instead of covering taxation measures in the Finance Bill runs contrary to the spirit of transparency and repeatedly castigated practice of bypassing the legislature where empowerment vests on such matters.
The preamble to the Budget generally sets out the macroeconomic targets which Government policies, including the fiscal policy, will aim to achieve in the financial year. The budget strategy has to be consistent with the achievement of these targets. The original Budget presented by the PML (N) Government for 2018-19 had set the following targets: 6.2% for GDP growth, 6% for rate of inflation, 13.8% for the tax-to-GDP ratio, 4.9% of the GDP for the budget deficit, 63.2% of the GDP for the net Public Debt and foreign exchange reserves at $15 billion.
The present government has already revised one target relating to the budget deficit from 4.9% to 5.1% of the GDP. No statement has been made by the Finance Minister about the other Key macroeconomic targets for 2018-19. Does this mean that the other original targets remain unchanged?
These targets provide become the basis for assessment of the Government’s performance in managing the economy. So, a clear statement is needed on macroeconomic targets for 2018-19.
The FBR revenue target for 2018-19 has been set at Rs 4398 billion. It is lower than the original target by Rs 37 billion, despite taxation proposals in the Revised Budget which are expected to yield Rs 183 billion over the year. Now even after inclusion of revenues from taxation proposals of Rs 183 billion the FBR tax-to-GDP ratio is expected to rise by only 0.2% of the GDP.
The normal practice is for the FBR to prepare a statement of the revenues expected or foregone from each taxation proposal or relief, in comparison to the tax structure in 2017-18. This should be done for major proposals like the big reduction of income tax rates on annual incomes above Rs 0.4 million, rise of the excise duty on cigarettes and large cars and enhancement of the advance tax on banking transactions.
On an annualized basis the expected additional revenue from FBR is Rs 244 billion, with half from unspecified improvements in tax administration. There is the substantial risk that this target will not be achieved especially due the loss of revenues of over Rs 80 billion in personal income tax from the level in 2017-18, reduction of import duty on intermediate inputs for exports, reduction in sales tax from 17% to 12% on LNG imported by the gas companies and exemption of a number of medical items from sales tax.
The hope that administrative efforts and processes using technology and triangulation techniques will help increase tax revenues by roughly Rs 90 billion is misplaced since it runs contrary to experience. Revenues from administrative improvements have always remained elusive. The weakness in this expectation is manifest in the growing reliance on revenues from ‘non-filers’ (a legal category which in other jurisdictions would be ‘classified’ as tax evaders). It is also intriguing that the FBR does not vigorously go after the non-filers although the tax deducted and deposited by the withholding agents enables identification and possible location.
It appears that the government was pressured by motor vehicle assemblers and real estate agents and developers to undo the decision of the previous government to prevent non-taxpayers from acquiring motor cars and property worth more Rs 5 million. Even if we were to accept the argument that the earlier proposal was not in line with Article 23 of the Constitution, it could have got around this apparent breach and contravention by substantially raising the rate for non-filers, in keeping with the over-riding objective of documentation of the economy.
Overall, there was need for more progressive and innovative taxation proposals, especially to broaden the tax base. The budget is effectively a ‘tax free budget’ as the net revenue from taxation proposals is near zero after allowance is made for revenue foregone due to the tax concessions. It is indeed unfortunate that at a time when there is need to contain the fiscal deficit a budget with weak revenue generating proposals has been presented. It appears unlikely that even the modest FBR revenue target will be met given the concessions.
Federal non-tax revenues plummeted by 30% in 2017-18. The original Budget anticipated an increase in these revenues of Rs 141 billion in 2018-19, equivalent to a growth rate of 22.3%. Now the Revised Budget proposes to increase this even further by another Rs 121 billion, implying a growth rate of as high as 41.5%. Where will this phenomenal growth in non-tax revenues come from?
There are now dim, if any, prospects of defence receipts from the Coalition Support Fund. The budget proposes limits on borrowings from the SBP. Hence, SBP profits are unlikely to show much growth in 2018-19. Also, Public Sector Enterprises (PSEs) are having problems in meeting their mark-up payment obligations on loans from the federal government. We are left with only one possibility, that is, of large receipts from privatization and sale of Government assets. If this is indeed the case the proposed privatization programme may, therefore, be placed before the Parliament. Otherwise, it is unlikely that non-tax revenues will show a growth of 41.5% in 2018-19.
The budget statement does not propose enhancing the Petroleum Levy. This is the right policy in the face of high international oil prices. Nevertheless, other taxes, besides the Petroleum Levy, are still expected to show an increase of Rs 98 billion. These other taxes include the Gas Infrastructure Development Cess (GIDC), Natural Gas Development Surcharge and other taxes (ICT). The nature of the latter taxes is not clear.
Both the GIDC and other taxes (ICT) were expected to yield large additional revenues of Rs 85 billion and Rs 33 billion respectively, compared to the original Budget for 201819. Already with a big increase in gas price, it is perhaps not politically and economically feasible to raise substantially more revenue with enhanced enforcement of GIDC. Overall, the additional revenues, of Rs 98 billion may not be entirely forthcoming in 2018-19.
There is an expectation that net Revenue Receipts of the Federal Government, after mandatory transfers to Provincial Governments, will increase by as much as Rs 565 billion, almost 23%, in 2018-19. Lest we forget they actually fell even in absolute terms in 2017-18.The high growth will hinge not only on FBR’s performance but also on growth in non-tax revenues. Given the uncertainty about the 41.5% growth in non-tax revenues in 2018-19 the projected growth of 23% in net Revenue Receipts looks very ambitious.
The reduction in the budget deficit requires action both in terms of higher resource mobilization and an aggressive containment of expenditures. We have already demonstrated above that on the revenue side the revised Budget estimate is significantly overstated.
Therefore, the onus for deficit reduction is squarely on the expenditure side. What should be the strategy for achieving cuts in expenditure? Ideally, the reduction ought to be focused on containment of current expenditure. However, there are limited degrees of freedom in cutting such expenditure because a large part is salaries, allowances and pensions and debt servicing obligations.
Therefore, cuts in development expenditure may also become essential. This could be achieved by largely dropping or deferring implementation of new projects, approved or not approved, unless a particular new project is in a high priority sector or program like CPEC, water resource or power distribution.
At this stage, it is essential to determine from the object classification of expenditure where the scope for economy exists. The Budget publication, Demands for Grants and Appropriations, contains this information. Current expenditure at the Federal level in 2018-19 includes operating expenses of Rs 392 billion, acquisition of physical assets of Rs 287 billion, civil works of Rs 142 billion and repairs and maintenance of Rs 14 billion. These are expenditures where there is maximum scope for economy. The total adds up to Rs 835 billion. It is possible that with 10% economy a saving of Rs 83.5 billion could be achieved. Given the announced emphasis by the Tehreek-e-Insaf’s government on economy in expenditure, there is the need to see if the Revised Budget focuses on this area.
Contrary perhaps to expectations, the Revised Budget estimates of total current expenditure at Rs 4413 billion for 2018-19 are actually almost 6% higher than the original estimate. There is no evidence apparently of some austerity on expenditure.
For example, there is no saving in the running of Civil Government. It is expected to rise by over 14% over the level in 2017-18. The non-salary and allowance part of operating costs is projected to increase by as much as 18% and reach Rs 218 billion by the end of 2018-19. Clearly, this is an area where effective monitoring systems against leakages could lead to savings of roughly Rs 20 billion.
Defense expenditure has been projected at Rs 1100 billion, a modest increase of 7% over 2017/18. But then last year the actual expenditure exceeded the budgeted amount by as much as Rs 110 billion.
The big expenditure item in grants is provision for meeting contingent liabilities of Rs 210 billion. This is the cover that has to be provided against debt guaranteed by the Federal Government of PSEs. The fear is that given the growing financial stresses of these enterprises the outlay will be eventually higher than budgeted in 2018-19.
It is not clear how the Rs 44 billion subsidy to the textile sector, of not passing on the bulk of the revision in gas tariffs, is being paid for. Is it being cross-subsidized by other consumer categories? If not, then the budget estimate for subsidies is understated by this amount and also by the subsidies on imported fertilizer and consumption of LNG in the production of fertilizer.
Hence, the claim that the budget deficit is being adjusted by almost 2.1% of GDP is grossly overstated-the pronounced rupee estimate of this reduction is well below the estimate of Rs 840 odd billion for a correction of this magnitude. Therefore, to summarize, the targets for the recurrent side of the budget are not likely to be realized, resulting in a larger budget deficit.
Development expenditure at the federal level has three components – the PSDP, lending operations and other development expenditure. The last component is primarily the expenditure on social protection, including the BISP.
Given the low level of fiscal effort and the lack of a serious attempt to contain current expenditure the bulk of the adjustment to bring down the fiscal deficit has fallen on a big cut back in the Federal PSDP, considering that in the previous year a cut back of 34% had already taken place. Against the budgeted PSDP of Rs 1001 billion in 2017-18, the actual expenditure was restricted to Rs 661 billion.
The original Budget envisaged a PSDP financed from budgetary resources of Rs 800 billion, which has now been reduced to Rs 575 billion, translating into a cut of over 28% and only 1.5% of the projected GDP compared with a ratio of roughly 2.1% of GDP in the original Budget thereby enabling a reduction of 0.6% of the GDP in the deficit.
There are some major implications of the big cut back in the PSDP. Inclusive of the ‘multiplier’ effect this could reduce the GDP growth rate in 2018-19 by over 1.2 percentage points. This will lead to less creation of 300,000 jobs. The government’s target of creating 2 million jobs annually is likely to be missed in 2018-19 by a wide margin.
There was a need for explicitly identifying the criteria being used for rationalizing the PSDP. The revised PSDP consisting of the portfolio of projects being executed in 2018-19 and their respective allocations should be shared with Parliament.
Turning to lending operations, the Revised Budget has brought this down from Rs 101 billion to Rs 87 billion. The big concern here is that the accumulation of circular debt in the power sector has reached a critical sate. It now stands at Rs 1.2 trillion and the liquidity constraints along the value chain have become very severe. The Government has apparently taken the decision already to inject Rs 50 billion in the sector. This pressure will continue in the absence a full upward adjustment in power tariffs and there is no further increase in the quantum of circular debt.
The Government is faced with a huge quandary. If the full increase in power tariff is passed on then this will fundamentally impair export competitiveness and lead to a big jump in the price level. At this point, an intermediate solution will most probably be found. There will be a partial increase in the tariff and more funds will be diverted from the Budget to the sector through enlarged operations of lending. As such, the outlay on lending could rise substantially above the currently proposed level of Rs 87 billion.
Other development expenditure primarily includes the allocation for the BISP, with a share of almost 70%. It is surprising that amount proposed in the original Budget of Rs 180 billion has been raised significantly to Rs 234 billion. This may include an allocation for the new Health Insurance Scheme being launched by the Government. Also, there is likely to be more expenditure to cover the payment of duty drawbacks to exporters.
A summary assessment of the likely budget deficit in 2018-19 has to be based on the disappointment with the low level of fiscal effort in the Revised Budget, whereby the revenue foregone due to tax breaks is almost as large as the revenue generated from taxation proposals. On top of this, there will be pressure for higher allocations to different heads of development and recurring expenditure. Thus the only tangible attempt to reduce the budget deficit is the cutback of Rs 225 billion in the budgetary PSDP. As such, the federal deficit is likely to remain close to 6.5% of the GDP in 2018-19. The stated objective of lowering the federal deficit by over 2% of the GDP is not consistent with the change and intensity of actions proposed in the Revised Budget.
We finally take up the issues emanating from the strategy proposed for financing the deficit.
Financing the deficit
The Revised Budget has estimated the federal fiscal deficit at Rs 2265 billion. This is expected to be reduced by Rs 286 billion cash surplus generated by provincial governments. As such, the consolidated deficit is projected at Rs 1979 billion, equivalent to 5.1% of the GDP. The provincial governments have not generated a significant surplus in the last two years. This pattern is likely to continue this year because of lower transfers than originally anticipated and the big salary hike.
Contribution of domestic non-bank, bank and net external borrowing is expected to be 27%, 54% and 19% respectively of the total financing. The first issue relates to the expected level of net external borrowing at $3 billion as compared to $7 billion in 2017-18. Why is there such a big drop?
The implication is that the external financing of the current account deficit in the balance of payments will become more difficult with the rising price of oil and potential shocks in the global environment-the trade wars and the resulting pressures on currencies, the Iran sanctions and further increases in US interest rates. With net Government external borrowings of $3 billion, FDI of $3 billion and other sources contributing another $3 billion (although both expectations look somewhat ambitious), the total financing likely to be available will be $9 billion. The financing gap will then range from $9 to $ 11 billion. This will put enormous pressure on the foreign exchange reserves unless other sources of financing can be found at a time of growing global unpredictability.
In contrast, the level of non-bank borrowing has perhaps been pitched too high at Rs 533 billion. This represents a jump of 51% over last year’s level. Last year there was actually a fall in the inflow into National Savings Schemes of 3%. Attainment of the ambitious target in 2018-19 will require a quantum jump in interest rates on these schemes.
The residual source of financing is bank borrowing. It is targeted at Rs 1072 billion and could rise substantially if the deficit rises. SBP may be called on to be the principal source of bank borrowing, exacerbating inflationary pressures in the economy.
In conclusion, there is need to recognize that the ruling party has come into power amidst an incipient financial crisis. No doubt, there will be more ‘learning by doing’. The prospect is that there may be more ‘mini budgets’ in an increasingly uncertain environment, especially if the Government goes to the IMF for balance of payments support. We hope that the Government can successfully manage a very difficult situation.Dr Hafiz A Pasha and Shahid Kardar, "Federal Budget 2018-19 (Revised): An appraisal," Business Recorder. 2018-10-02.
Keywords: Economics , Revised Budget estimates , Federal budget , Budget speech , Substantial risk , Development Surcharge , Circular debt , PSDP , GDP , LNG , GIDC , BISP