Budget: growth-debt trade-off

The annual budget is a reflection of the government’s priorities.

Alternatively, it is an opportunity to materialise economic recovery, growth, and inclusivity through fiscal management. On June 11, the current government announced its fourth budget with a total outlay of Rs8.487 trillion and gross revenue receipts (tax and non-tax) of Rs7.909 trillion.

The budget is presumed to be growth-oriented, as the focus has been shifted from stabilisation to a growth-centric phase where some incentives have been offered to various sectors. Among these, support to industrialists, exporters, stocks traders, and construction and services sectors through reduction or exemption in duties or taxes are the obvious ones.

Likewise, social protection to marginalised groups, loan facilities to low-income households, fiscal stimulus through 61% increase in the Public Sector Development Programme (PSDP) have all been setting the stage for continuity in growth.

These incentives notwithstanding, the budget entail a deficit of Rs3.99 trillion which may further aggravate Pakistan’s debt situation. In other words, we have to understand the dynamics of the growth-debt trade-off in order to ensure sustainability in growth without adding further to the country’s debt-burden.

In 2020-21, amid the Covid-19 pandemic and the consequent global slowdown, Pakistan surpassed growth projections, with GDP growth of 3.96% against a target of 2.1%.

The GDP growth is based on 2.77, 3.57 and 4.43% growth in agriculture, industrial and services sectors, respectively. Thanks to the growth in large-scale manufacturing, and wholesale and retail trade combined with a surge in remittances which made this progress possible.

Growth with stabilisation in terms of improved fiscal deficit and current account is encouraging but needs sustainability. In other words, economic growth must spur investment as periods of higher economic growth in Pakistan have usually been associated with higher final consumption, especially household consumption, leaving little space for capital accumulation.

To ensure continuity, the government set a growth target at 4.8% for 2021-22, with a claim to put the economy on path of a growth rate of 6-7% in the next two to three years. In order to make it possible, the government has approved around Rs2.135 trillion developmental budgets, including Rs900 billion federal PSDP while Rs1.235 trillion for provincial PSDP, which is around 61% higher than that of previous year.

The priorities in this regard are water and food security, CPEC-related projects, climate change, social sector, projects under public-private partnership (PPP), allocations for marginalised areas, etc.

In addition to increase in PSDP, the budget offers a variety of incentives to the private sector. To support industrial sector, the government aims to give away Rs119 billion to industries and individuals. These include Rs42 billion relief in customs duty (CD), Rs19 billion in sales tax (ST) and federal excise duty (FED), and Rs58 billion in income tax (IT).

For instance, withdrawing FED on industrial units in the erstwhile Fata/Pata, reduction in FED from 17% to 16% on telecommunication, withdrawal of FED and value-added tax (VAT) and reduction in ST on small cars are some of the relief measures. Likewise, reduction in CD and additional customs duty (ACD) on 328 tariff lines related to raw materials, chemicals and intermediate goods for the chemical, engineering and leather industry would boost exports in these sectors by lowering the cost of raw materials. Similar would be the effect of reduction or exemption in CD, ACD and RD on imports of 584 tariff lines including fabric in the value chain of the textile sector. With respect to trading, the reduction in capital gains tax on stocks from 15% to 12.5%, removal of withholding taxes on banking transactions, stock exchange transactions, margin financing, air travel services, debit and credit card-based international transactions, and mineral explorations would encourage economic activities in the country. Further, support to SMEs through the allocation of Rs12 billion, and focus on low-income households through Rs500,000 interest-free business loans, Rs200,000 interest-free loans for tractors and machinery, and Rs2 million worth of low-interest loan for house building would have beneficial effects on the country’s economic growth.

As far as the cost side of this fiscal stimulus is concerned; the budget entails a gross deficit of Rs3.99 trillion. Of the gross revenues of Rs7.909 trillion, the center will have a net amount of Rs4.497 trillion after transferring Rs3.142 trillion to provinces under National Finance Commission (NFC). As is proposed in the budget, the deficit will be plugged by Rs1.2 trillion in external financing and Rs2.4 trillion in domestic financing, with the remainder from privatisation proceeds.

A combined allocation of Rs4.43 trillion for defense and debt-servicing implies that the entire PSDP and around 41% of the current expenditure will be financed through borrowings. Given proceeds from privatisation of around Rs252 billion and a forecast surplus of Rs570 billion from the provinces, a gross of Rs3.168 trillion will be added to total debt of the country which constitute roughly 6% of GDP. At present, the debt-to-GDP ratio is approximated to be around 87% in June 2021 while the limit fixed in Fiscal Responsibility and Debt Limitation Act of 2005 is 60% of GDP.

These statistics suggest that we have already crossed the optimal limit of debt to GDP ratio. In other words, we are pursuing expansionary fiscal policy amid a huge burden of debt, including both the domestic and external components of debt.

What needs to be done amid this growth-debt trade-off? I would like to posit that a two-pronged strategy should be pursued. First, economic growth must be pursued as growth is essential for sustainability of debt.

A simple arithmetic shows that if our economy grew by 7% for 15 years, our prospective GDP would be around $700 billion at current exchange rate in 2035. This translates into an increase in revenues of around $100 billion if we impose a simple flat tax rate of 20% on the growth component of GDP. However, this increment in revenues can only be capitalised on if we contain fiscal deficit during the same period. In fact, deficit financing is a short-run phenomenon which is worth if it generates economic growth and if it does not, then it is a debt-increasing instrument.

Thus, as a second strategy, we have to keep fiscal deficit in a manageable limit, which can be assessed by comparing economic growth with the cost of borrowing. It is shown in a recent knowledge brief of Pakistan Institute of Development Economics (PIDE) that as long as the cost of borrowing is less than economic growth, the debt-burden will not rise. Thus, we can ensure the sustainability of the current debt by higher economic growth and reduction in reliance on future borrowing.

Published in The Express Tribune, June 22^nd, 2021.

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