Outlook for public finances

The Federal Budget for 2017-18 apparently has all the right ingredients. Resource mobilization, especially through FBR taxes, is to be raised substantially. Growth in current expenditure will be severely restricted and development expenditure pushed up at a rate not achieved in the last five years.

However, the fundamental question is whether the targets set in the Federal budget can be achieved or not? The bottom line is that the fiscal deficit of the Federal and Provincial Governments combined in 2017-18 is to be reduced to 4.1 percent of the GDP from 5.8 percent of the GDP in 2016-17. The latter year, in fact, saw a breakdown in the process of fiscal stabilization with a large increase in the deficit by as much as 2 percent of the GDP in relation to the target of 3.8 percent of the GDP.

The Federal Ministry of Finance (MoF) must accept the responsibility for having grossly understated the size of the fiscal deficit in the revised estimates presented to the National Assembly in late May 2017 along with the budget for 2017-18. The Budget Speech indicated that the deficit will be 4.2 percent of the GDP whereas it turned out to be 5.8 percent of the GDP.

How could the deficit increase by Rs 509 billion over the projected level in a period of only five weeks? This can be construed as an attempt to deceive the Parliament.

This divergence has been largely attributed by the MoF to the failure of the provincial governments to generate a combined cash surplus of Rs 339 billion, over 1 percent of the GDP. Instead, there was a cash deficit of Rs 16 billion. The MoF does not, of course, highlight that federal transfers to the Provinces fell short by as much as Rs 244 billion. This was due partly to the shortfall in attainment of the revenue targets for divisible pool taxes and partly because of holding back of due transfers in the last quarter of 2016-17.

The provincial governments had been compelled to generate a cumulative cash surplus from 2013-14 to 2015-16 of Rs 492 billion to support the attainment of the fiscal deficit target set each year during the tenure of the IMF Program. However, as per the 7th NFC Award and earlier awards, the Provincial Governments have the necessary autonomy to fully use the resources transferred under the mandatory revenue-sharing formula. As such, there is no formal requirement to generate cash surpluses. In fact, as per the Constitution, the Provinces can incur some deficit and engage in limited borrowing up to the limit imposed by the National Economic Council.

Therefore, the setting of a cash surplus to be generated by the provincial governments of Rs 347 billion in 2017-18 is extremely unlikely to be realized. The on-going year is the election year and each Government will be under pressure to raise development and other spending to the extent possible. The combined PSDP of the Provinces has been set at Rs 1100 billion. This represents a high rate of growth of 29 percent over the level achieved last year. As such, the first contributing factor to a higher deficit in 2017-18 is the likely absence of Provincial cash surpluses of almost 1 percent of the GDP.

Turning to federal revenues, the targeted growth rate is over 13 percent, with 19 percent growth in tax revenues and 9 percent in non-tax revenues. The former target is ambitious, especially since last year the growth rate in FBR revenues was down to 8 percent only. The performance will depend, of course, upon how the economy performs. Taxes linked to imports are likely to show high growth given the jump in imports. One target in particular looks infeasible. The Gas Infrastructure Development Cess is expected to yield Rs 110 billion. This is 161 percent above last year’s level. Overall, achievement of a growth of 15 percent or so in Federal tax revenues in 2017-18 will be considered a relatively good performance. However, this will imply a shortfall of almost Rs 150 billion.

There is even greater uncertainty about the achievement of the target of Federal non-tax revenues. First, the Federal Budget envisages a receipt of almost Rs 140 billion from the Coalition Support Fund in 2017-18. This will not happen given the strained relationship with the USA. Second, other non-tax revenues are expected to yield Rs 180 billion from unknown sources. The shortfall in Federal non-tax revenues is expected to exceed Rs 200 billion. The overall shortfall in Federal revenues could reach Rs 350 billion in 2017-18, equivalent to 1 percent of the projected GDP.

The truly remarkable feature of the 2017-18 Federal Budget is that current expenditure will be held, more or less, constant at last year’s level. Debt servicing growth will be limited to only 1 percent, despite the fact that public debt increased by 10 percent last year and there is little scope for further reduction in interest rates. Therefore, debt servicing could be higher by almost Rs 120 billion.

The real surprise is the less than 5 percent increase in the defence budget. This is at a time when Raddul Fasaad operation is in full swing. Last year the growth in defence spending was relatively high at 17 percent. This big decline in the growth rate is a clear indication of the emergence of a financial constraint on security spending. Additional resources of Rs 100 billion or so will have to be allocated somehow for defence. Overall, current expenditure at the Federal level is likely to be higher by Rs 220 billion over the budgeted level. This will represent a slippage of 0.6 percent of the GDP.

Federal development expenditure and net lending are expected to show unprecedented growth of 47 percent in 2017-18, with the size of PSDP increased by 36 percent to Rs 1001 billion. Here again, there will be pressure with impending elections to allocate adequate funds, especially for special programs of a political nature.

Overall, the deficit can be higher than the projected level in 2017-18 of Rs 1480 billion by as much as Rs 917 billion. The rise is likely to be Rs 347 billion due to lack of generation of cash surplus by the Provincial Governments; Rs 150 billion because of a likely shortfall in tax revenues and Rs 200 billion in non-tax revenues. In addition, current expenditure at the Federal level could be higher by Rs 220 billion due to higher outlays for debt servicing and defence.

The realistic projection of the consolidated fiscal deficit is close to Rs 2400 billion in 2017-18, equivalent to 6.6 percent of the GDP. This indicates that the deficit could be higher by 2.5 percent of the GDP over the projected level of 4.1 percent of the GDP by the MOF. This is an even larger slippage potentially than the 2 percent of the GDP last year. Clearly, the stabilization in public finances apparently achieved during the tenure of the IMF Program was very temporary in character.

The likely slippage is already demonstrated by the outcome in the first quarter of 2017-18. Bank borrowing exceeded Rs 420 billion by end-September, despite the growth in FBR revenues of 20 percent. Inclusive of other sources of borrowing the fiscal deficit has exceeded Rs 540 billion or 1.5 percent of the likely GDP. Last year the consolidated deficit was 1.3 percent of the GDP and in 2015-16, 1.1 percent of the GDP in the first quarter.

The State Bank of Pakistan has indicated in its recently released Annual Report for 2016-17 that the fiscal deficit will be in the range of 5 to 6 percent of the GDP. As such, SBP also expects a large slippage in the attainment of the deficit target of 4.1 percent of the GDP in 2017-18.

The implication is that the Central Bank will have no other option but to go in for printing of a large quantum of money to finance the very large fiscal deficit. Last year it was Rs 887 billion. This year it could approach Rs 1200 billion. With two years of printing of money by over Rs 2 trillion along with significant depreciation of the exchange rate we may have to brace ourselves for a return to double digit inflation in 2018-19, post the forthcoming elections. The sad conclusion is that the twin deficits have reached unsustainable levels during the tenure of the present government.

(The writer is Professor Emeritus and former Federal Minister)