Debt: passing the buck to provinces

Economic coverage on TV talk shows is limited and in the case of a few exceptions, opinions without analysis are not uncommon. Recently, the tendency was observed in an otherwise respectable show on one of the main channels. The issue under discussion was the rising burden of debt-servicing and possible ways of reducing it. The anchor came out with a bizarre proposal that the provinces should be made to shoulder the burden through changes in the National Finance Commission (NFC) Award. The seemingly professional guests said aye.

Soon after the operationalisation of the 7^th NFC Award, the centrist forces had begun to blame all our macroeconomic troubles on it. No evidence is presented in support. It is true that in a number of federations, the debt of the subnational governments was an important factor in creating fiscal crisis. In Pakistan, however, there are restrictions on provincial borrowing. Although the 18^th amendment allows provinces to borrow abroad and locally, they are required to follow the guidelines provided by the National Economic Council. At the end of February 2022, government domestic debt and liabilities stood at Rs28.3 trillion, with nil provincial contribution. In January 2022, the provinces held only 13% of the total external public debt of $86.4 billion. Economic Affairs Division enforces a relending policy. According to its latest version issued in 2020, foreign loans are relent to the provinces on the same terms and conditions as those agreed by the federal government. In FY21, the provinces repaid Rs110.3 billion as principal and interest. So the provinces take loans and repay. They are not into the risky bond financing. Moreover, the provinces are regularly forced to support federal deficit by showing provincial revenue surpluses. In FY22 thus far, these amount Rs600 billion. In a word, the provinces are already bearing more than their proportional share of fiscal adjustment.

The beam is in the federal eye. According to the clause 9(2) of the 7^th NFC Award 2010, the federal and provincial governments were expected to take the tax to GDP ratio to 15% by 2015. From 9.9% in FY10, the ratio has inched up to 11.1%. Out of this, 1.1 percentage points is the contribution of provinces, which is twice their share in 2010. The provinces would have done better, had they followed the NFC recommendation to bring agricultural incomes and real estate in the tax net. But the federal government has failed miserably in broadening the tax base. It prefers to borrow and subsidise. Tax expenditures are a no-go territory and failing public enterprises are provided crutches. Poor tax performance does not contain the ambition to spend. It continues in areas devolved to the provinces under the 18^th amendment. The so-called development packages to gain political mileage in areas best left to municipalities, dig another hole. Little wonder, debt-servicing is the largest claimant of federal resources. Again, the second largest claimant has its tail longer than required for sharper teeth. Who will wag the tail?

In our situation, reducing federal transfers to provinces is unlikely to have the so-called ‘flypaper effect’ — the provinces’ tendency to spend more out of federal transfers than own resources leading to net fiscal improvement. The federal tendency to spend follows the ‘please effect’: an increase in revenue only increases spending. Instead of disturbing hard won consensuses — the 7^th NFC Award and the 18^th Amendment, the federal government must put its own fiscal house in order. If it can’t raise taxes, it must reduce spending in the spirit of the 18^th Amendment.

Published in The Express Tribune, May 13^th, 2022.

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