June 23, 2003	Monday	Rabi-us-Sani 22,1424

Remember Domingo Cavallo? He was Argentina’s finance minister during most of the l990s. He crafted that country’s fiscal strategy in the wake of the IMF’s restructuring of Argentinean debt in 1992. Shaukat Aziz’s 2003-2004 budget seems to be a carbon copy of many of the budgets introduced by Cavallo during 1992-1997.

Cavallo came to the Argentinean finance ministry straight from the IMF. His budgets emphasized (a) a reduction in the public expenditure-to-GDP ratio; (b) a falling budget deficit; (c) an increased reliance on indirect taxes(specially the general sales tax); (d) accelerated privatization;(e) reduction of corporate taxation (specially on financial institutions); (f) lowering of import taxes and (g) a one-third reduction in the defence budget over a two-year period. Does this not mirror the fiscal strategy of Shaukat Aziz?

Cavallo and Shaukat Aziz are strong believers in fiscal conservatism. The central doctrine to which they subscribe is that cutting back the size of the state “crowds in” (opens space for) the private sector. Both Cavallo and Aziz are therefore committed to drastic reduction of the public expenditure-to-GDP ratio. Commitment to this ideology makes it impossible for Shaukat Aziz to devise a growth oriented budget.

Shaukat Aziz sought to cut the size of the budget by about 4 percent in 2002-2003. He failed to do so. He now seeks zero growth in public expenditure during 2003-04. Expenditure in the 2003-2004 budget is stagnant at the revised 2002-03 budget level i.e. Rs805 billion. If the economy grows by 4 per cent next year and prices rise by 3 per cent the public expenditure-to-GDP ratio will fall significantly. Can this be a growth oriented budget?

The government is pursuing a conservative fiscal strategy. Tax revenue is expected to rise by about 11 per cent in 2003-04 as compared to the revised estimates of the budget for 2002-03. Indirect taxes are expected to contribute 68.4 per cent of the total tax revenue in the 2003-04 budget as in the revised estimates of the budget for 2002-03.

Surcharges will account for about 11 percent of total tax and non-tax revenue in the budget for 2003-04. Direct taxes will account for less than 30 per cent as they did in the revised estimates for the previous budget. The overall regressivity of the tax structure will thus not be reduced in 2003-04 for it is the poor who bear the burden of indirect taxes and surcharges. Non-tax revenue is expected to decline from Rs175.8 billion in the revised 2002-03 estimates to Rs157.2 billion mainly on account of an almost 50 per cent fall in receipts from civil administration.

Gross revenue receipts are expected to rise by a modest 3.8 percent over revised estimates for 2002-03. The provincial share will rise by 11.4 per cent. Therefore net revenue receipts will remain stagnant. Net capital receipts will decline significantly from Rs104.9 billion in 2002-03 (revised estimate) to just Rs36.7 billion in 2003-04. External receipts are also expected to Continued from PI

decline from Rs169 billion in the revised estimates for 2002-03 to Rs159.1 billion. The original budget estimates for 2002-03 had expected external resources of Rs198 billion. There was thus a 15 per cent shortfall between actual external inflows and expectations.

No rescheduling of debt is expected in 2003-04 and project aid will decline from Rs45 billion to Rs43.9 billion. External resources will thus finance 19.75 per cent of total revenue receipts in FY 04. In the revised estimates of FY 03 the share of external resources in total receipts was 21 per cent. In the original budget estimates for FY 03 external resources share of total revenue was expected to be as high as 26.7 per cent. We have already now scaled down our expectation of foreign support and the fiscal space created by the aftermath of the September 11 counterattack on America has largely been exhausted. This has forced the government to abandon its strategy of retiring domestic debt. The government will borrow Rs28 billion from the banking system in FY 04. It returned Rs33 billion to the banks in FY 03.

The contractionary nature of Mr. Aziz’s fiscal stance’ is further demonstrated by the structure of expenditure. Current expenditure will fall from Rs673.3 billion in F 03 (revised estimate) to Rs645.2 billion in FY 04. Debt servicing will remain stagnant at about Rs257 billion in FY 04 accounting for 39.6 per cent of current expenditure. This is higher than debt services share in the current expenditure for FY 03 (38.2 per cent, revised estimate). The share of external debt servicing in total debt servicing will rise form 33.1 per cent in FY )3 to 33.4 per cent in FY 04.

Defence expenditure will be stagnant at Rs160 billion. This represents a decline in real terms and is alarming given the serious security threat and the expanded military expenditure by India. Rs57.8 billion in the revised estimate for FY 03 are assigned as ‘unallocable’. They account for almost 95 per cent of the excess of actual (revised) expenditure over planned (original) estimates in fiscal 03. In FY 04 the unallocable category has been allocated only Rs1.9 billion.

Development expenditure is expected to go up from Rs131 billion in FY 03 to Rs160 billion in FY 04. Federal development expenditure will rise by 25 per cent but provincial development expenditure will rise by 12.7 per cent only. Development expenditure in Balochistan is expected to decline from Rs4.2 billion in FY 03 to Rs4.1 billion in FY 04. Expenditure in NWFP will be stagnant at around Rs10 billion in both FY 03 and FY 04. The development expenditure-to-GDP ratio will remain stagnant at about 4 per cent in 2003-04.

The fiscal strategy of the government is in accordance with the commitments made to the IMF under PGRF. The emphasis is on reducing the fiscal deficit excerpt when the IMF sanctions an increase as it did in FY 03. The government is providing incentives for the expansion of investment in some sectors but it does not see its role as initiating a big push or directly financing major projects. That is why public investment has now fallen to less than 4.5 per cent of GDP and the size of the budget will remain stagnant at the level of the previous year.

What will be the overall impact? Once again it is useful to look at Cavallo’s Argentina. After two years of ‘stabilization’ the economy ‘returned to the take-off stage’ (Cavallo’s words - Shaukat Aziz speaks Cavallo’s language) in 1991. During 1991-94 GDP grew at an annual average rate of over 6 per cent in Argentina. Real wages stopped falling. Employment rose in most sectors and the threat of bankruptcy was averted for many firms. Foreign capital rushed in. Prices remained stable and the IMF and the World Bank were ecstatic in their praise of the new miracle economy created by Cavallo.

As Joseph Stegltiz shows the miracle disappeared by 1996. Argentina since 1999 has been experiencing one of Latin America’s most severe crisis. The IMF and America have chosen to look the other way for most of the period. Cavallo, they say, is back in Chicago.

Shaukat Aziz is Argentinizing Pakistan. We are experiencing immiserising growth. As figures in the latest Economic Survey show unemployment (specially disguised unemployment) levels are rising. The macro-economic strategy has an anti-poor bats and there is systemic discrimination against the small sector - thus loans from SME bank carry an interest rate of 14 percent, more than double the average interest rate charged by the NCBs. Both Balochistan and the NWFP share of the 2003-2004 PSDP has been reduced.

Most ominously the present acceleration of growth has taken place without an acceleration of investment. Fixed investment as a ratio of GDP actually declined to 13.1 percent in 2002-2003 from an average 13.4 per cent in 2000-03. Domestic saving also declined from an average of 15.7 per cent during 2000-03 to 14.7 per cent. Public investment has fallen and private investment is stagnant. The modest increase in total investment is entirely due to change in stocks. The significant increase in national savings is attributable entirely to the growth of foreign resources (especially remittances).

National savings exceed total investment and domestic savings exceed fixed investment by a substantial margin and this has been the case throughout 2000-03. Savings are being exported especially in the form of foreign exchange reserves. Foreign reserves now exceed fixed investment by a substantial margin.

Moreover the major reason for the acceleration in growth has been a substantial improvement in the balance of payment position of the country. The trade deficit during the first nine months of 2002-03 has increased due to a much faster growth of imports than of exports. Private transfers rose by over a billion dollars and home remittances more than doubled. They are expected to exceed $4 billion by end of 2002-03. Net official transfers also exceed $1.8 billion and the current account balance (including official transfers) exceeds $4 billion.

The reprofiling of debt in 2002 has led to a reduction in the debt servicing burden. Total outstanding debt has however not declined significantly. Public debt increased by about 0.5 per cent at end March 2003 in comparison to end June 2002. the Paris Club debt rose by over 3 per cent during this period. Total long and medium term debt rose by 0.3 per cent. Foreign exchange liabilities have been reduced by about $1 billion during the period and the fall in total debt and liabilities is insignificant (about 2 per cent).

There are indications that the major benefit of the rescheduling may have been exhausted as debt servicing increased from $1.2 billion in FY 02 to $1.42 billion in FY 03.

Growth is unsustainable for two reasons. First it is largely foreign funded excluding official transfers the current account balance for 2003-04 falls to $2.56 billion. Were remittances to fall to the level of a “normal” year— i.e. about $1 billion- - the current account surplus would vanish. The world economy is teetering on the verge of a depression. Reliance on foreign resources in such circumstances is necessarily dangerous.

Moreover foreign resource inflows are not contributing to the growth of fixed investment. Indeed they are raising investment costs - specially the cost of land - and fuelling a consumer boom. That is why productive capacity is not expanding and no change is taking place in the structure of manufacturing production and manufacturing capital formation. Instead Pakistan is exporting capital, specially in the form of foreign exchange reserves to America. And as the dollar depreciates we loose more and more by building up dollar reserves. We lost 12 per cent on this account in 2002-03.

Growth is unsustainable because the economy is de-technologizing. Old and obsolete machinery is not being replaced. The capital goods industries are stagnating. The stock market is booming - but there are no new issues.

Musharraf and Aziz are calling for more foreign aid. As in Argentina so in Pakistan sustaining this immiserising growth strategy depends on access to foreign capital. This strategy collapsed in Argentina - it may also collapse in Pakistan, perhaps more disastrously.