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Provincial finances and spending

The role and importance of provincial governments has been enhanced by a larger vertical transfer of revenues from the federal government under the 7th NFC Award and by allocation of more functions with the abolition of the Concurrent List in the 18th Amendment to the Constitution. Now these governments have a share in total public expenditure of almost 38 percent. In the last year prior to the NFC Award, 2009-10, it was 29 percent. Excluding interest payment on public debt, the share of provinces in service-related expenditure has approached 46 percent.

A number of questions arise with regard to provincial finances and spending. Has the larger transfer, of almost 1.5 percent of the GDP, following the 7th NFC Award from the federal government led to a slackening of fiscal effort by provincial governments? What are the expenditure outlays, priorities and the resulting impact on development? What contribution is being made to the consolidated fiscal deficit?

Answers to these questions are derived from the information which has become available on fiscal operations of both the federal and provincial governments for 2016-17. In addition, data has been obtained from other sources like the PBS and the World Bank.

Regarding the level of fiscal effort, it may come perhaps as a surprise that the share of provincial governments in national revenues, has actually increased after the 7th NFC Award from 5 percent to 8 percent in 2016-17. The primary reason for this is that the sales tax on services was transferred to these governments in the NFC Award.

This opportunity has been exploited well by the provincial governments, especially of Sindh and Punjab. In 2016-17, the total collection from this tax is Rs 171 billion, equivalent to 53 percent of total provincial tax revenues. The overall provincial tax-to-GDP ratio has gone up from 0.4 percent in 2009-10 to 1 percent of the GDP in 2016-17. Of course, more could have been achieved. In particular, direct taxes like the agricultural income tax and the urban immoveable property tax remain very underdeveloped.

The extent of self-financing of provincial expenditure, current plus development, stands at 16 percent in 2016-17, as compared to 13 percent in 2009-10. In comparison with federal revenue growth of 12 percent annually over the last six years, provincial revenues have shown faster rate of increase of 17 percent.

Turning to the distribution of expenditure between the two levels of government, the shares have also altered significantly since the commencement of the 7th NFC Award. In the current expenditure, the share of the four provincial governments combined has gone up from 25 percent in 2009-10 to 33 percent in 2016-17. Similarly, the share in PSDP/ADP-related development expenditure is up from 49 percent to 54 percent in 2016-17. It is important to note that more development activity is undertaken now by the provincial governments than the federal government.

The mix of provincial expenditure has also tilted recently towards development spending. This is a major step in the right direction. The share of PSDP expenditure in the budgets of these governments was 29 percent in 2009-10. This has increased to 33 percent in 2016-17, due to growth of 44 percent in development spending. The provincial budgets for 2017-18 collectively target a growth rate in the size of the PSDP/ADPs of 29 percent.

A key issue is the share of expenditure which the provincial governments are allocating to the social sectors – education, health, water supply and sanitation. The latest year for which full information is available on the pattern of actual provincial expenditure is 2015-16. During this year, the four provincial governments combined together devoted Rs 839 billion on the social sectors, representing a share of 39 percent of their budgets. This level of spending is equivalent to 2.9 percent of the GDP. It was significantly less prior to the NFC Award at 2.3 percent of the GDP.

Given the higher level of social sector spending, what has been the impact on the level of human development in the country? The major contribution to human development is by provincial governments with a share in social sector expenditure of 84 percent, with the remainder by the federal government.

According to the UNDP Human Development Index, Pakistan was ranked at 147th out of 188 countries in 2015 and categorized as a country with medium level of human development. Unfortunately, the index has moved up very slowly for Pakistan since 2010, despite the higher volume of social sector spending. The HDI was 0.525 in 2010 and 0.550 in 2015, showing an annual rate of increase of only 0.9 percent. The annual growth rate of the index was significantly higher at 1.5 percent during the period, 2000 to 2010.

This raises the fundamental issue of lower efficiency of expenditure on social sectors by the provincial governments, after the 7th NFC Award that transferred substantially more resources to them. The outcomes in terms of the key social indicators confirm this finding.

According to the World Bank, the adult (aged 15 years and above) literacy rate was 43 percent in 1998 which rose by 12 percentage points by 2009 to 55 percent, representing an annual rate of increase of over one percentage point. In 2015, it stood at 56 percent, implying that the increase annually from 2009 to 2015 was less than even 0.2 percentage points. Similarly, the primary enrolment and infant mortality rates have shown much smaller changes since 2009.

There is a dire need to investigate the reasons for the substantially lower impact of larger social sector expenditures on the key indicators. A number of explanations can be offered ranging from wrong expenditure priorities within each social sector, termination of effective district local governments with wide-ranging functions, rising poverty leading to less enrolment, larger dropout of children from the school system and to more under-nutrition. Ultimately, the answer has to be found in a poorer quality of governance by provincial governments. This has probably led to more corruption and wastage in the line departments responsible for delivery of services.

The final question on provincial finances relates to their contribution to the consolidated fiscal deficit. This is also important because sub-national governments in other federations like India and Brazil have been responsible for a larger share of the deficit due to profligate spending and borrowing. For example, in India, the share of state governments in public expenditure is 55 percent and more than half the national fiscal deficit is incurred by them.

The situation is fundamentally different in Pakistan. Historically, the provincial governments have faced a hard budget constraint, with very little resort to borrowing. In fact, during the tenure of the IMF programme, from 2013-14 to 2015-16, they were forced to generate larger cash surpluses by slashing the size of their development programmes to help in achieving the target agreed with the IMF on the size of the consolidated fiscal deficit. Cumulatively, during these three years, the four provinces combined produced a cash surplus of Rs 492 billion.

The Federal Ministry of Finance and some writers have tried to create the perception that a large part of the increase in the fiscal deficit in 2016-17 to 5.8 percent of the GDP versus the target of 3.8 percent of the GDP is due to the cash deficit of Rs 163 billion shown by the provincial governments.

First, this is the wrong figure. Inclusive of the public account of the provincial governments, the overall deficit of these governments is Rs 16 billion in 2016-17. Second, it has not been possible to generate a big surplus due to a big shortfall in federal transfers of Rs 170 billion. Third, the provinces are under no obligation, as per the NFC Award, to generate large cash surpluses. As such, they have opted to increase their development spending substantially in 2016-17.

Overall, an assessment of provincial finances and spending during the tenure of the 7th NFC Award leads to mixed conclusions. The provinces have mobilized more resources, raised the component of self-financing of their expenditure, devoted larger share of their budgets to development spending and significantly raised the level of expenditure on the social sectors. The big disappointment is that there has been very little corresponding improvement in social indicators despite the larger spending. Reasons for this big failure need to be investigated.

Dr Hafiz Pasha, "Provincial finances and spending," Business Recorder. 2017-09-19.
Keywords: Economics , Fiscal deficit , Human development , Tax , Budgets , Education , Pakistan , GDP

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