THE federal government has presented its budget for the next fiscal year under challenging conditions.
While the economic situation is dire, the political context is no less difficult and trying. The incumbent government leads an eight-party “rainbow” coalition engaged in tough negotiations with the IMF, with seven members of the political alliance least interested or invested in austerity budgeting.
In addition, the government has little more than a year before it heads into elections, and is already having to face a public backlash over its measures as well as a tough opposition breathing fire.
While the government is caught between a rock and a hard place politically, its situation is even more difficult economically. The macroeconomic context, to which the budget must respond, is the most challenging Pakistan has faced in decades.
Large fiscal slippages have accelerated public debt accumulation over the past few years. Interest payments now consume 40 per cent of gross federal revenue — and a whopping 71pc of net federal revenue (ie after transfers to provinces).
The effects of overly accommodative policy settings have been amplified by the global super cycle in commodities since the start of 2021, to produce an unsustainable external current account deficit. Sharply higher external debt repayments, and lower financing, have meant that the overall financing gap on the external account has been met by drawing down foreign exchange reserves held by the central bank. The sharp decline in the country’s international liquidity has led to uncertainty in markets and an evaporation of confidence in the rupee — triggering a vicious inflationary spiral.
Estimation errors and weak prioritisation will make the budget a non-starter for the IMF.
Given the polarised political environment, current commentary on the macroeconomic situation facing the country is sharply divided and very rarely balanced. Hence, it is important to place the economic and fiscal situation in proper context.
A large part of the fiscal and monetary accommodation since 2020 was in response to a once-in-a-lifetime pandemic. The previous government opened the spigots to protect jobs, incomes and businesses from the effects of the Covid-19 pandemic, in line with measures taken by governments around the world.
Spending on social safety nets via the Ehsaas programme and other initiatives was ramped up. The central bank introduced a host of low-cost loan and financing schemes while easing monetary policy. In total, the government spent around 3pc to 4pc of GDP under its efforts to combat the effects of Covid, with the result that the economic contraction Pakistan experienced during 2020 was amongst the lowest in the world, with a sharp bounce back in growth in 2021.
The problem occurred not with the fiscal and monetary measures per se, but with their persistence.
In a similar vein, the previous government’s subsidy on petrol and electricity effective March 1 has been made the villain of the piece by the current government and many commentators. While the untargeted nature of the subsidy and uncertain financing were problematic, the subsidy lasted less than one and a half months with total budgetary spending amounting to an estimated 0.06pc of GDP. On its own, it can hardly explain the mayhem in the economy unleashed since April.
A far more potent factor has been the sharp, sustained spike in global commodity prices — and the sluggish and confused policy response.
Nonetheless, given the macroeconomic context, the budget priorities were clear: achieving significant fiscal consolidation, while finding ways to expand social safety nets and continue to provide relief to not just the poor but the lower middle class segment as well. More specifically, the fiscal adjustment should be achieved through a combination of revenue mobilisation and expenditure rationalisation.
Under these circumstances, a key objective before policymakers is to ensure that the ‘burden of adjustment’ falls on the affluent to the largest extent possible, and is commensurate with ability-to-pay. Given these priorities, how did the announced federal budget perform?
On a positive note, it showed intent in a key area — clawing back via taxes on windfall profits some of the overly generous incentives and subsidies given to various sectors over the past two years, that had outlived their utility. On the negative side, a fundamental issue relates to the pork-barrelling nature of spending at a time when the entire burden of global commodity prices is being passed on to consumers. Special perks for the military, the bureaucracy and the judiciary, large allocations for coalition partners, and ‘special’ unexplained allocations for segments like film and drama reflect policy capture, weak prioritisation and a lack of empathy.
If the government is claiming credit for taking ‘difficult decisions’, surely cuts to allocations for special interests, and enforcing austerity on coalition partners, should be less difficult than burdening the average Pakistani with a whirlwind of inflation?
An important parameter in the current context against which the budget needs to be evaluated is the extent of fiscal consolidation — and its composition. The government aims to reduce the overall budget deficit by an overly ambitious 3.7pc of GDP. While this target is dictated by the revised parameters agreed with the Fund in March, the targeted reduction is based on both revenue overestimation as well as expenditure underestimation.
The revenue overestimation is based not on the unrealistic growth rate assumed, which will be compensated by inflation being much higher than targeted, but on the underlying tax elasticity estimate. Under conditions of high inflation and severe demand management economy-wide, FBR is unlikely to extract an increase in tax revenue commensurate with the increase in nominal GDP.
More significantly, the underestimation in interest payments on account of the grossly unrealistic assumption regarding inflation makes the fiscal deficit target look unachievable. Any hope of coming close has been wrecked by the evaporation of the assumed provincial surplus of Rs800 billion. In sum, the overall fiscal deficit is likely to be around 2pc of GDP over the budget target in the best of circumstances.
This likely out-turn, in addition to reversals in agreed areas of reform such as personal income tax, will make navigating the budget past the IMF difficult in its current form.