Assessing the budget for 2010-11

The new finance minister was eloquent in his budget speech and it was a pleasure to hear an economist talk about economics. Pakistan has achieved a measure of economic stability following the balance of payments crisis of 2008. Macroeconomic adjustment has taken root, inflation has been brought down and the economy’s twin deficits are better contained. The new budget aims to build on these accomplishments with the hope that economic growth can add jobs and cut poverty.

Fiscal policy as embodied in the budget is appropriately tight. At four per cent of GDP, the fiscal deficit target for 2010-11 would appear to be consistent with the need to take macroeconomic stabilisation forward, reduce inflation further and ensure that the external current account deficit and debt are kept in check. However, rather than looking at the absolute numbers it is instructive to look at it as a percentage of projected GDP; and that comes to a modest 9.8 per cent. Prominent among the tax measures is the proposal to increase the GST by one per cent. Raising tax rates in Pakistan begins to yield diminishing returns but this can be seen as an interim measure until the VAT is phased in at a single, lower rate. The long-awaited tax on the stock market is a welcome, base-broadening measure as are cuts in import duties on a range of commodities.

The failure to implement the VAT by July 1 means that Pakistan will breach a “performance criteria” under the IMF’s Standby Arrangements and will need a waiver of non-compliance from the Fund’s executive board. In the absence of support from all the provinces and the lingering impression that the VAT regime has not been explained to the public fully, the deferment is probably wise. The spending side of the budget, however, disappoints. Experience elsewhere shows that fiscal consolidation efforts that are spearheaded by restraints on spending and lasting spending cuts are more likely to be successful. There is a hint that non-interest, non-defence, non-salary current spending is to be held constant in nominal terms which will imply a fall as a per cent of GDP. Assessing the merits of the significant rise in pay for government servants to compensate for past inflation is always difficult. It seems prima facie to be the right and fair thing to do. But playing “wage catch-up” not only validates past inflation, it also risks stalling the all-important aim of bringing inflation down to the mid-single-digit level. In any event, the target inflation for 2010-11 of 9.5 per cent is disappointingly unambitious even allowing for the cost-push effects of the increase in wages and the removal of ill-targeted subsidies in the budget. Inflation needs to be brought down quickly and this would be the best pro-poor measure that the government could bequeath to the people.

The parlous state of the public enterprises and the quasi-fiscal deficits they create is deeply worrying. The government needs to come up with a programme of restructuring and improving efficiency even if this means large job losses in the case of public-sector companies which are a deadweight burden on the economy. Restructuring, and in some cases, privatisation, will need to be accompanied by fair and equitable severance packages.

Shifting much of the development expenditure responsibilities to the provinces is an important step towards financial devolution. One is concerned however whether the provinces have the requisite technical and administrative absorptive capacity to spend wisely and well.  In short, this is a good budget. We now need to move to the more difficult task of implementing it.

Published in the Express Tribune, 8^th, 2010.