RGST failure may result in record budget deficit

Dependence on domestic market for financing will fuel inflation, increase interest rate.

ISLAMABAD: Failure to implement the reformed general sales tax (RGST) is likely to result in a record Rs1.2 trillion budget deficit, which may compel the government to borrow over Rs1 trillion from the domestic market for financing.

This might prompt the central bank to further increase the interest rate by up to 2 per cent to offset the inflationary impact.

Sources from the ministry of finance said that in case the government remains unable to get the general sales tax bill passed by parliament, it will immediately result in the blockage of foreign assistance including the disbursements from the Coalition Support Fund by the United States.

Conservative assessments show that the budget deficit will shoot above seven per cent of gross domestic product against a target of 4.7 per cent, they added. With a 4.7 per cent budget deficit the government will borrow over Rs500 billion from the domestic market. It has already obtained Rs200 billion from the central bank for budget financing. Meanwhile, revenue collection is already behind target by Rs76 billion in the first five months of the current fiscal year.

“The increasing gap between income and spending will shift almost the entire burden of financing on domestic sources,” said a source. The State Bank of Pakistan has already said that government borrowing for budget financing was fuelling inflation, forcing an increase in interest rates.

The International Monetary Fund’s (IMF) suspended bailout programme for the country still has two tranches worth $3.4 billion left. The US has already indicated that it will stop funding if Pakistan does not implement the RGST. The government intends to increase the tax-to-GDP ratio from 9 to 13 per cent in the medium term through the RGST.

Pakistan and the IMF had agreed to keep the budget deficit to 4.7 per cent of the economy. Sources said that even this number is unrealistic as the government is still considering arranging Rs60 billion by selling 3G licences to telecommunication companies.

The Pakistan Telecom Authority has informed the government that this deal may not be sealed during this fiscal year which translates to 0.4 per cent increase in deficit.

The government has also estimated that it will receive $1.4 billion (Rs120 billion) from the Coalition Support Fund. Sources said that the US could try to block this money to put pressure on the country to implement tax reform. The final disbursement may remain around $600 million (Rs51.6 billion).

The shortfall may further swell the deficit by another 0.4 per cent. The government is also planning to realise another Rs30 billion through flood surcharge and by doubling special excise duty rate.

The government has budgeted inflows of $1.3 billion (Rs111 billion) from foreign sources for budget financing. Some of the money has already been received and RGST failure is likely to block the remaining financing.

Shifting the burden on to domestic sources will not only dry out the private sector credit but also increase the cost of government borrowing. Domestic debt has soared to Rs4.9 trillion and a one per cent increase in interest rate increases the cost of debt servicing by Rs49 billion.

“It’s a doomsday scenario that can be avoided through the approval of the RGST,” said one of the most senior officials of the ministry of finance. The bill is being currently debated in the National Assembly’s standing committee on finance.

The government is also contemplating asking the IMF for a three-month extension in the bailout programme that is due to finish on December 31. “Pakistan will submit an extension request of three months to draw the last two tranches worth $3.4 billion from the International Monetary Fund at an appropriate time,” said Secretary for Finance Salman Siddique.

“An extension of three months can be sought from the IMF and will require approval from the executive board,” said Siddique. The IMF, in a statement on Friday, said that Pakistan has so far not formally requested for an extension.

Siddique said that Pakistan would have to make the request one week prior to the envisaged date which means that Islamabad will have to submit its formal request around December 23. However, this was dependent upon the GST approval, he added.

Published in The Express Tribune, December 4^th, 2010.