In the long run: Strategy needs to shift from borrowing to taxing

Govt’s reliance on banks should decrease, private sector must be developed

LAHORE: Provisional figures of budget deficit for the first three months of FY16 have shown that it stands at 1.1% of GDP, according to the website of the Finance Ministry.

Historically, the successive governments have shown budgetary deficit from 1.1 to 1.3% of GDP in the first quarter since they start every year with zeal to curtail expenditure, which usually remains lower in the first two quarters due to the allocation mechanism.

In addition, higher level of targeted GDP, which is around $287 billion for FY16, also helps reducing the budget deficit for the time being, though the actual GDP at the end would remain lower than the targeted one.

The lower actual GDP would increase budget deficit when the final figures conclude.

In the current expenditure, the mark-up payments are hovering around 1.4% of GDP in the first quarter. These mark-up payments constitute domestic and foreign debt servicing, which is consuming Rs416 billion, leaving little fiscal space for the government for development expenditure.

The mark up payment to GDP ratio has stagnated over the years. In the current low interest rate environment, higher mark-up payments reflect that borrowing spree of the government is going on from the banking system.

The banking system is composed of commercial banks and the State Bank of Pakistan (SBP). The budget constraint of the government is usually ‘soft’, meaning that government can relax this constraint when needed by borrowing from SBP.

However, currently, the government is facing a ‘hard’ budget constraint under the Extended Fund Facility (EFF) of the International Monetary Fund (IMF). It is bound to borrow from commercial banks, while borrowing from the SBP is supposed to be zero.

Normally, the IMF imposes this penalty so that the government improves its performance either by raising tax revenue or curtailing its expenditure.

Successive regimes have been unsuccessful in raising tax revenue. Similarly, it is rather difficult for them to either curtail or control the total expenditure since there is an element of inertia and successive regimes are tied up with political aspirations.

The government’s borrowing from commercial banks acts as a double edge sword. On one hand, it pays higher interest rate to commercial banks as compared to SBP since the government borrows at market interest rate just like a normal borrower. On the other hand, borrowing from commercial banks, paves way for ‘lazy banking’.

By investing in government securities, banks become free from default and liquidity risks and put aside their core function of lending to business firms and consumers. This “lazy banking” is inimical to the growth of industrial capitalism and is one of the significant factors for low borrowing by private businesses in the economy.

Options left

The best option is to strive for increasing the tax base. The increase in tax base takes considerable time since it is not a short term strategy.

Another option is to keep rolling over the current commitments to the next government which has already been happening. As a result of roll over, debt servicing cost is currently stagnating due to lower interest rate and would increase when interest rates go up.

As another option, governments are trying to book higher non-tax revenue to scale down their budget deficit. For instance, the government has already booked a higher profit of Rs67 billion from SBP for the first three months of FY16 against the full year target of Rs320 billion. On this pace, it would book more than the targeted profit from SBP.

Similarly, higher revenue is generated from Gas Infrastructure Development Cess (GIDC) which would put cost pressure on the limping industrial sector.

Interestingly, dividend payments of the government have stagnated over the years since the government has sold its stakes in corporations and commercial banks.

Since the development of productive capacity is significant from a medium to long term economic perspective, this goal is being brushed aside in the current practice.

The role of the government is to complement the private sector in the development of productive capacity. The government should focus on grave problems of tax policy and governance to increase the tax base and facilitate healthy banking system in the medium to long term.

The writer is an Assistant Professor of Economics at Lums

Published in The Express Tribune, November 23^rd,  2015.

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