The burgeoning fiscal deficit

The ministry of finance has recently released figures relating to the outcome of fiscal operations in 2009-10. The fiscal deficit stands at Rs929 billion, equivalent to 6.3 per cent of the GDP. In 2008-09 the deficit was Rs680 billion or 5.3 per cent of the GDP. The agreement with the IMF as part of the on-going program was that the fiscal deficit would be contained at Rs762 billion or 5.1 per cent of the GDP in 2009-10. Therefore, there has been substantial ‘overshooting’ of the target. No doubt, a performance waiver will eventually be sought, but it is clear two years down the road that the Fund program has been unsuccessful in achieving a degree of fiscal adjustment in Pakistan’s economy.

What explains the higher fiscal deficit of Rs167 billion in relation to the target? On the revenue side there is a shortfall of Rs95 billion. FBR missed its revenue target by Rs53 billion, despite probably holding back more refunds and collecting more advance taxes. In addition, the surcharges on petroleum and gas yielded Rs18 billion less than expected and other revenue fell short by Rs24 billion.

The tax-to-GDP ratio of Pakistan continues to decline. It has fallen from 10.4 per cent of the GDP in 2008-09 to 10.2 per cent in 2009-10. This demonstrates the difficulty in achieving fast revenue growth in a slow growing economy. The lesson here is not to target for too ambitious a rise in tax revenues till such time as the economy returns to a relatively high growth path. This is particularly relevant for the current year. Post-floods the economy is likely to show little growth.

Turning to expenditure, there was overspending of Rs72 billion in relation to the budget agreed with the Fund. Much of the spill-over is in development expenditure of Rs52 billion. While the federal government remained within the limits imposed, the four provincial governments combined expanded their PSDPs by an extra Rs58 billion, probably as they geared up to increase their capacity to absorb the larger transfers from 2010-11 onwards following the Seventh NFC Award.

How was the larger fiscal deficit financed? Not only were the financing needs larger last year but there was a massive shortfall of Rs161 billion in external resources. Clearly, the federal government substantially over-pitched its expectations of foreign aid, especially from the so-called Friends of Democratic Pakistan. The consequence was the resort to substantial bank borrowing, Rs133 billion in excess of the target. But what ‘bailed out’ the Government in 2009-10 was the extraordinary inflow in non-bank borrowing, above target by almost Rs200 billion. This demonstrates the lack of savings outlets today, especially for households, due to stagnant stock and property markets and low rates of return offered by banks to depositors. However, given the growing perception of financial difficulties at the federal level, people may be less willing now to invest in these schemes at existing rates of return.

Based on the outcome of 2009-10, the original deficit target of 4 per cent of the GDP in 2010-11 looks virtually unattainable. It involves, for example, a growth in FBR revenues of almost 26 percent, from Rs1,327 billion to Rs1,667 billion. On top of this, the impact of the floods in terms of higher outlays initially for relief and rehabilitation and subsequently for reconstruction of damaged infrastructure has to be factored in. It is clear now that Pakistan will remain in a fiscal quagmire for some years to come.

Published in The Express Tribune, September 19^th, 2010.