Pakistan’s fiscal policy at a crossroads

ISLAMABAD:

Fiscal policy in Pakistan is usually far from a fine balancing act and is more of a reckless feat. It has long been marked by a contentious debate between austerity and stimulus measures – with the government oscillating between these two approaches, often thoughtlessly.

Thanks to these policies, the past three years have been marked by high interest rates – a result of the State Bank of Pakistan (SBP)’s fight with inflation that has crushed the real estate market and raised unemployment numbers. But why Pakistan’s policy rate must be as high as 22% for so long remains a burning question. The root of this problem lies in the extravagant expenditures of the government’s machinery that includes salaries, pensions and other privileges coming in at around Rs5 trillion. These expenditures in the past and as of now have been funded by expensive debt and currently interest payments alone eat the bulk of the federal budget.

To discourage government borrowing and push it towards austerity, the SBP has been increasing interest rates post-Covid. The Covid-19 stimulus package for Pakistan was valued at Rs1.2 trillion, with an additional Rs100 billion supplementary grant for residual/emergency relief.

Since then, the SBP has been pushing forward its austerity agenda by setting a high policy rate to discourage further stimulus for the economy and encourage government to reduce its expenses.

Unfortunately, such signals appear to have fallen on deaf ears as far as the government is concerned and the feedback loop is apparently broken. Increasing payroll and pension expenses in the last budget by as high as 35% speaks for itself how serious the government is about taking austerity measures.

Moreover, the irony is that in this budget as well, there are proposals to inflate the payroll expense by another 12%. This staggering uptick in government expenses has not been funded by increased income taxes and revenues, leading to a permanent budget deficit which necessitates further borrowing through the issuance of more bonds at a higher rate to attract investors.

It has indeed become a vicious circle where government expenses are being met by expensive loans from commercial banks, causing persistent inflation and little access to capital for private players. At present, the only way forward for the federal government is to keep another circle of foreign debt and investment running – whether it is the IMF, CPEC, SIFC or CPEC 2.0. Only then our body politic can fulfill its obsession with GDP growth numbers and keep funding its political schemes and pet projects.

But amid all this pessimism, however, we can still opt for a two-tiered approach to fiscal policy that advocates austerity at the centre but stimulus at the periphery (provinces) – combining the best of both worlds.

Austerity at the centre

In this proposed model, the federal government can prioritise deficit reduction through spending cuts in the next budget and extensive tax reforms. Though a performance-based budgeting process is already in place, we also need to put a ban on supplementary budgets; and requests for ex post facto regularisations of such grants should be penalised.

Instead of seeking more funds, government departments should explore the monetisation of underutilised state assets through public-private partnerships (PPPs) or strategic divestments. This could generate revenue while maintaining essential services. One example could be allowing private companies to use underutilised conference/board rooms in ministries through an online reservation system for hourly payments.

Another approach to reduce fiscal burden at the centre could be devolving specific ministries to provinces as agreed under the 18th Constitutional Amendment but is still pending even after 14 years. Similarly, the regressive tax system should be replaced by a progressive one that places a higher burden on high-income earners and reduces the tax burden on low- and middle-income groups. This could involve wealth taxes, luxury goods taxes, or revising income tax brackets.

Fiscal stimulus for provinces

Thanks to the 18th Amendment and National Finance Commission (NFC) awards, provincial governments that enjoy greater spending flexibility can prioritise infrastructure development and social programmes. It should be provinces and not the P-block in Islamabad that should be planning and funding transportation networks, energy grids, water supply systems, and irrigation infrastructure.

They can partner with the private sector to finance, build, and operate profitable infrastructure projects. This reduces the upfront financial burden on the provincial government and leverages private sector expertise.

By identifying good projects, provincial infrastructure bonds can be issued to raise capital from domestic investors. However, this requires a strong credit rating and a clear plan for project returns.

Provinces can also give stimulus packages by implementing targeted social safety programmes to support vulnerable populations and stimulate domestic demand. This could include direct cash transfers, food assistance, and healthcare subsidies. The federal government should abstain from funding social safety net programmes such as Ehsaas or interest-free loans for marginalised populations.

However, any stimulus by provinces should not promote consumption and should focus on supporting local economies, creating jobs, promoting growth, and increasing revenue collection.

In a nutshell, Pakistan’s fiscal landscape necessitates a nuanced approach to reconcile its fiscal deficit and growth objectives.

A coordinated federal-provincial strategy, where the federal government implements austerity measures to address macroeconomic imbalances while provinces pursue the targeted fiscal stimulus to boost growth and job creation, can help strike an optimal balance between fiscal consolidation and economic expansion.

The writer is a Cambridge graduate and is working as a strategy consultant

Published in The Express Tribune, May 27^th, 2024.

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