Fiscal adjustment, social safety must go hand in hand

NORTHAMPTON: “Pakistan is currently facing significant macroeconomic challenges on the back of large fiscal and financial needs and weak and unbalanced growth.” This was said by International Monetary Fund (IMF) First Deputy Managing Director and Acting Chair David Lipton following the IMF executive board discussions.

This has pushed the country to seek IMF support to reduce economic vulnerabilities and generate sustained and balanced growth. A key ingredient in achieving sustainable growth is decisive fiscal consolidation to reduce public debt and build resilience while expanding social spending.

Why is fiscal consolidation important and what are some of the measures that can be adopted to achieve it?

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Fiscal consolidation

Fiscal consolidation is defined as periods of fiscal adjustment during which spending cuts are made or non-commodity revenue is mobilised to improve fiscal position. This is necessary to reduce economic vulnerabilities leading to disproportionate shocks to the system.

It is important that fiscal consolidation goes hand in hand with spending on critical infrastructure as well as social spending to protect low-income households. This is essential to prevent strains on economic growth, resulting from consolidation efforts.

A key recommendation given in this regard by the IMF programme is to broaden the tax base and raise tax revenue in an equitable manner. This requires coordinated efforts at the provincial level as well to improve the quality and efficiency of public spending.

Pakistan’s fiscal position remains weak. Years of misaligned economic policies have resulted in large fiscal deficits and the deficit is expected to widen to almost 7% of gross domestic product (GDP) in FY19 against the budget target of 5.1% of GDP.

This deterioration is largely driven by a significant revenue shortfall. Pakistan’s tax-to-GDP ratio is 13% of GDP, which is the lowest in the region. In addition to this, the fiscal deficit has also widened due to increase in expenditure stemming from higher interest payments, subsidies and defence spending. The financing of this expenditure has largely been through borrowing from the central bank.

Quasi-fiscal losses have also contributed to the weak fiscal position. This is contributed by a significant circular debt in the power sector and loss-making public-sector organisations such as Pakistan International Airlines, Pakistan Steel Mills and Pakistan Railways. Combined losses of these organisations have accumulated to over 2% of GDP.

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Recommendations

Fiscal vulnerabilities can only be reduced through a coordinated consolidation programme, which reduces fiscal and quasi-fiscal losses. Given Pakistan’s low tax-to-GDP ratio and insufficient resource allocation to priority areas, there should be sincere efforts to widen the tax base to increase the tax-to-GDP ratio by 4-5 percentage points.

Revenue mobilisation efforts should be directed towards spending on investment, human capital development and social protection. These efforts, if made, can reduce general government debt from 80.5% of GDP in FY20 to 67% of GDP in FY24.

Public financial management reforms must be undertaken to instil budgetary discipline and improve transparency and confidence in the spending of budgetary resources.

Several reforms have been initiated and recommended under the IMF programme. External-sector vulnerabilities and budgetary problems have resulted in the country entering the IMF programme in the past as well.

Partial implementation of such reforms has also been conducted in the past. Consistent adherence by governments beyond their elected term is the only way to correct years of wrong policies.

The writer is a doctoral candidate at The Bartlett, UCL

Published in The Express Tribune, July 22nd, 2019.

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